Aug 182016
 

Early Retirement 

For professional skiers the best time to retire is when they start to go downhill. But what about the rest of us? Well for most people the question isn’t at what age we should retire, it’s at what income. ūüėČ People who want to retire early¬†seem to¬†have a clear and consistent focus to grow¬†their wealth so that it can provide them with enough passive income to sustain their lifestyles forever. This¬†can be¬†done through a number of ways such as reducing living expenses, increasing income, and making high investment returns. ūüôā

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I recently read a CNBC article that featured a couple, Carl and Mindy, who retired in their early 40s with a million dollars. And they did it pretty much the same way as most other early retirees.

In 2012 the husband-wife duo with 2¬†kids already had $570,000 saved up. But they were inspired to retire early so they set a clear goal to build a portfolio of $1 million and no debt. And earlier this year in 2016, they have accomplished their dream. ūüôā

The CNBC article suggests that “anyone can do the same ‚ÄĒ and you don’t have to be an investment banker raking in millions. All it takes is smart decisions along with intelligent saving and investing.

Here are some steps the couple took to reach their financial goals.

  • Track spending –¬†“My wife and I wrote all of our expenses in a book,” says the husband.
  • Live in an affordable location –¬†¬†The couple resides¬†in a low-cost area in Colorado, and lives on $2,000 a month for the whole family.¬†They mention this would not be possible in San Francisco or Manhattan.
  • Cut bills –¬†“I learned that you don’t need a lot of money,” said the wife. “My quality of life has not changed since we became laser-focused on cutting out our expenses. I don’t need the cable TV. I don’t need a super-expensive phone plan.¬†I don’t miss all this stuff because it didn’t really add to my life,” she said.
  • Invest in appreciating assets – The couple bought a¬†$176,000 fixer upper home that they estimate is now worth over $400,000. They also¬†I bought 2,000 shares at Facebook at $30 a share which is now worth around¬†$120 a share!
  • Consistent savings – They’ve continuously put away $2,000 per month into their investment portfolio.

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Sep 152015
 

Where to put your extra savings

Let’s say you earn $3,000 a month and spend $2,500. Great! You are living within your means. But saving is only half the battle. Now you must decide how to allocate¬†your extra $500. Should you pay down your debt or invest and watch¬†your money grow? Should you max out your Tax Free Savings Account or contribute to your RRSP? Knowing the proper way to allocate your money can prevent a lot of costly mistakes.

Back when I was saving up for a¬†car I guess you could¬†say I had a lot of driving ambition. But sometimes there are more immediate and pressing concerns to address¬†before spending money on wants and non-essentials.¬†Below is¬†a chart that shows where to put your savings in descending order starting from most important priority. It’s not perfect but¬†it’s a relevant starting point for most people. ūüôā

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Aug 052015
 

The Easiest way to Plan for Retirement

Some people say the money is no better when we retire, but the hours are! But how much money is enough to retire on? Retirement planning can sometimes be difficult if we don’t know where to start, or how much to save.

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So today I’d like to simplify the process and break it down¬†into two commonly asked questions. Answering both these questions will determine if you are either on the right track to retirement or falling behind. You can use the handy retirement calculator further down the post to find out. Let’s¬†start with the first question.

How Much Money Do I Need To Retire?

Assuming you’ll retire at age 65, here is the formula to figure out how much money you will roughly need to have saved up by the start of your retirement. By “money,” I mean investable¬†assets which include your¬†retirement accounts, investment properties, stock portfolio, annuities, etc.

 [1.019 ^ Number of years left until retirement] x [25 x (Current Annual Expenses Р$14,000)] = Total Savings Needed to Retire

So for example, imaginary Laura is 40 years old and spends $30,000 a year. She wants to find out how big her investment portfolio will need to be when she eventually stops working 25 years from now.

[ 1.019 25 ] x [25 x ($30,000 – $14,000)] = $640,345

Using the formula Laura would need to have $640,346 saved up by 65 years old to retire. For couples and families, simply use the total annual household expense and replace the $14,000 figure with $25,000 instead.

This brings us to the second common question everyone wants to know:

How Much Money Should I Be Saving Each Year?

Laura has amassed an investment portfolio worth $100,000 so far. She currently saves $5,000 a year by making automatic contributions to her retirement account, but is it enough? She knows from the first formula that she needs $640,346 to retire by 65. She can use the following formula to calculate how much she needs to actually save per year.

0.05 x (Total Savings Needed to Retire РCurrent Savings Amount x 1.05 ^ Number of years left until retirement) / ( 1.05 ^ Number of years left until retirement Р1 ) = Suggested Annual Savings Rate 

Alas, it appears saving $5,000 per year¬†is not enough for her since she’ll need to save at least $6,322.

[0.05 x (640,345 Р100,000 x 1.0525 ] / [1.0525-1] = $6,322

Use the following spreadsheet to experiment with your own retirement numbers. 

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Download Freedom 35 Blog’s¬†Simple Retirement Income Calculator Excel File. It has both formulas in it. ūüėČ (Alterative¬†.ods version.)

Laura decides to increase her¬†retirement contributions by $150 every month, bumping her total annual savings to $6,800. It’s important to make these changes early because increased savings will translate directly into decreased spending. If she can live on less money now then she will also require less savings to retire on in the future. Well done, Laura! ūüėÄ

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Jul 072015
 

Determining which accounts (Tax Free, Retirement, or Taxable) to hold different investment types in

Should you put stocks in your RRSP or TFSA? What about fixed income like bonds? This post will answer these types of questions. It’s assumed the reader is already familiar with the¬†TFSA, RRSP, and regular taxable accounts.

There are two parts to every investment decision we make; the investment itself, and the type of account to hold that investment in.

Asset allocation helps to spread out our risk so we don’t put all our eggs in one basket. But asset location is also important¬†because different types of investment incomes¬†are taxed at different rates. We can hold our investments in special tax advantaged accounts to shelter our profits so we don’t pay more tax than we have to. ūüėČ

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In an ideal world all of our investments would be bought inside tax advantaged accounts such as a TFSA or RRSP. There’s little reason to use a non-registered¬†(taxable account) if there is still contribution room remaining in our tax free or registered retirement accounts. However¬†its possible to purchase more investments than what our tax advantaged accounts will hold. If that’s the case then investment income that is typically taxed at higher rates should take priority inside a TFSA or RRSP.¬†So with that in mind let’s get down to the nitty-gritty. ūüôā

Which Investment Vehicles to use: TFSA, RRSP, or Non-Registered

Where is the best place to put stocks, bonds, mutual funds, and ETFs? Should they go in an RRSP or a TFSA? There is no categorically correct answer but here are some general guidelines that I follow.

  • Use RRSPs for interest producing investments¬†and U.S. dividend paying companies.
  • Use¬†non-registered accounts¬†for Canadian dividend paying companies and preferred shares.
  • Use TFSAs for everything else.

For a deeper look, below are two charts that go into specifics. The first chart shows how different types of investment income is taxed in different kinds of accounts for someone in the 31% marginal tax bracket. The second chart suggests the best accounts¬†to buy different types of specific investments in. ūüėÄ

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Additional notes to consider:

  • If we¬†hold U.S. dividend stocks in a taxable¬†account we’ll pay the 15% U.S. withholding tax off the top. But we can claim¬†a foreign tax credit on our tax returns to recover some or all of this amount. However we’ll pay tax at our marginal rate on the full amount of the U.S. dividend.¬†The net result is that U.S. dividends held in a non-registered account will be taxed at the same rate as interest income.
  • Dividend income from U.S. dividend stocks in a Tax Free Savings Account (TFSA)¬†is also¬†subject to the 15% withholding tax, however this tax is non-recoverable. But the remaining dividend and any capital gains is not taxed.
  • Dividend income from U.S. stocks in an RRSP are exempt from the 15% withholding tax. But this only¬†applies if we directly hold a stock or ETF traded on a U.S. exchange. If the¬†U.S. stocks are held in a Canadian mutual fund or ETF, we will need to¬†pay the¬†unrecoverable 15% withholding tax on the dividends.
  • Keep in mind that although many investment incomes are tax efficient while being held in an RRSP, any money withdrawn from¬†the RRSP or RRIF later on will be subject to income tax at the full marginal rate and could trigger claw-backs for income tested government benefits like OAS.
  • Tax efficiency should not be the only factor when deciding which account to put an investment into. Simplification of record keeping, personal financial situation, risk tolerance, and retirement goals all have to be considered.
  • For most intents and taxation purposes RESPs behave the same way as TFSAs. RRIFs and LIRAs behave similar to RRSPs.

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Aug 142014
 

The level of financial risk we can tolerate depends on our savings: The less money we have the more risk we can afford to take on. If you have worked with a financial advisor before then you’ve probably seen a risk tolerance chart like the following.

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Each portfolio from A to D represents a different risk tolerance of maximum expected returns and¬†losses. Choosing a model portfolio can help one’s¬†financial advisor determine the best funds for the client based on his risk assessment. Conservative portfolios tend to hold more bonds, GICs, and¬†T-Bills. Aggressive portfolios may hold more technology and energy stocks, which are more risky but also more potentially profitable.

If we are currently in our working years and¬†only have $100,000 of savings, then we should have an aggressive investment plan that mimics the expected rate of return as Portfolio D in the image above. High risk, high reward. Like Ms. Frizzle always says, “take chances, make mistakes, get messy!” This is because losing $20,000 in the worst case scenario is no big deal since¬†we are still actively working. $20,000 is only 6 months worth of salary for many people, so the loss can be quickly recouped ūüėÄ But if things go well then hot diggity dog! we’ll make¬†a $50,000 profit. The key to compound interest is to start as early as possible so if we can make our portfolio value 50% higher at a younger age it will give us a huge advantage over the long run.

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But if we have recently¬†retired and have $1,000,000 in savings then our investment goals would be different. We can’t be¬†in¬†Portfolio D because a potential¬†$200,000 loss is a lot of money, and could prevent us from having a comfortable retirement. At the same time the potential return of $500,000 doesn’t sound that appealing when we’re already millionaires. At a certain level of wealth any extra money we save will face diminishing marginal utility which means the lifestyle of a¬†senior who is worth $1.5 million isn’t going to be drastically different from another senior with only $1 million. So in this situation it would be better to choose¬†the more defensive Portfolio A.

When we’re young our spending often depends on the product of¬†our¬†human capital and time, both of which we have an abundance of. But when we’re retired our human capital becomes diminished, so lifestyle¬†needs to depend on our savings instead. This is when capital preservation takes priority over investment returns and we have to decrease our exposure to risk in order to make our portfolio last as long as possible ūüėČ

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Random Useless Fact:
Humans don’t have natural enemies. So we fight with each other.