Retirement planning mistakes- Part 1

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Planning for retirement is a very complex task. For many, including myself, it can be daunting. The road to retirement can also be paved with traps. Let’s look at a few of them.

Mistake # 1: not having a (retirement) plan

What makes retirement planning so daunting and difficult is that we have to think about a future that does not exist.

But, in order to plan for your retirement, you need to think about what you would like it to look like: when, what, where. If you want to travel or live in an upscale retirement community, you will need more money than if you plan to live in a condo and spend time with your children and grand-children.

If you are a couple, communication is crucial, as your retirement goals and dates may be different. Both of you need to be involved in the process.

Once you have an idea of what you want your retirement to be, you can start planning financially.

mistake # 2: assuming the process will be linear

Unfortunately, times have changed. Gone are the golden days of steady employment, regular salary increases and generous company pension plans. Today, only 20% of Canadians have a pension plan through their employers. Job hopping is the norm and wages are stagnant.

Be realistic and ready to adjust your plan a few times over the course of your life. There will be times you won’t be able to save anything, perhaps due to a job loss or an illness. Other times, you will be able to save more.

mistake # 3: solely relying on the federal government

The average monthly CPP pension amount Canadians receive is $600.00. Both the OAS and GIS are subject to claw-back and income threshold, i.e. if you make more than a certain amount of money, you either have to reimburse the government (OAS), or no longer qualify for the benefit (GIS).

Want to take your CPP pension before 65? It will be minored. Retiring overseas? Your GIS payment will be suspended after 6 months. Spend less than 40 years in Canada? Your OAS amount will also be minored.

Beyond the paltry amounts, there is no way to know for how long the system will be viable.

mistake # 4: underestimating longevity and healthcare costs

With progress in medicine and living conditions, a lot of people live well into their nineties, if not 100. In my humble opinion, longevity is what you should focus on when planning your retirement. You should assume income needs of at least 35 years post-retirement if you retire in your sixties. If you retire early, you need to increase that number.

Contrary to popular belief, you will still have expenses when you retire, including big ones such as a new car and home repairs if you own. You will also need some new clothes and shoes from time to time.

One of the expenses that is guaranteed to increase is healthcare. Even if you eat healthy and exercise daily, aging will result in various health issues. The older you become, the higher your insurance premiums will be. As a reminder, many items are not covered by provincial health plans, such as vision and dental.

mistake # 5: waiting for too long to start saving

The best time to start saving for your retirement is in your twenties. If you start young, you actually don’t need to save that much on a monthly basis, as time is definitely on your side. You can also take more risks with investing and earn higher returns.

The longer you wait, the more you will need to save in a reduced time frame. You may not be able to do it. You will have to take on more risks, which could result in greater losses you may not be able to recover from, if the markets tank.

final word

Stay tuned for part 2!

Valuing a stock with the Graham formula

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There are several ways to assess a stock, besides the stock table. One of them is the Graham formula, created by Benjamin Graham.

graham is the father of “value investing”

His book, the Intelligent Investor is considered a classic in the financial industry. Despite being published in 1949, its principles still hold true today. Graham hired Warren Buffet so we can safely say the guy knew what he was talking about!

what is the graham formula?

The formula was created to assess how rationally priced a stock is. In today’s market, when it is becoming more and more difficult to find fairly valued or undervalued stock, the formula is very relevant.

For you math-diggers out there, the formula was initially as follow:

V*=EPS\times (8.5+2g)

V as the intrinsic value, EPS as the company’s Earning per Share over the last 12 months, 8.5 being the ratio for a company not making any profit, g being the company’s estimated growth for the next 5 years.

Later, it was revised to: V*={\cfrac {EPS\times (8.5+2g)\times 4.4}{Y}}

Y being the current yield on 20 year AAA corporate bonds. Graham thought taking interest rates into consideration would give a more accurate intrinsic value (V).

how do I use the formula? 

Don’t worry, there are plenty of calculators that will give you the intrinsic value of any stock. There is a good one here.

Once you have the intrinsic value divide it by the stock current price. If the result is below 1, it means the stock is overvalued. If it is above 1, the stock is either fairly valued or undervalued.

final word

The graham formula is an helpful way to assess a stock. That being said, it should not be the only one way used. It is important to do research on the company and to read – and understand-its financial statements.

 

The dog years of compounding (in investing)

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Albert Einstein dubbed compound interest the eight wonder of the world. It truly is when looking at the concept: investing money, earning interests/dividends/capital gains on investments, reinvesting said interests/dividends/capital gains/ thus earning more interests/dividends/capital gains.

It seems simple, yet it is a tad more complicated than it seems

Most people in the financial industry do not talk much about the time factor, when it comes to compounding.

You see, compounding is actually very slow to start. That’s why conventional wisdom says one should start saving as early as possible. But I almost digress here.

with COMPOUNDING, time is actually not of the essence

For the sake of simplicity, let’s assume an initial investment of $ 10 000, with an additional monthly contribution of $ 100. Let’s assume a constant return of 5% for 25 years, and that interest is compounded monthly.

I am aware this is really unlikely to happen in really life, but I am writing for the sake of simplicity here!

After said 25 year-span, the $ 10 000 will turn into around $ 94 364. Great!

But when looking at the timeline, you realize your investment will take over 5 years to double, and an extra 4.5 years to triple.

it takes at least 15 years…

15 years is the mark where your investment starts to grow faster and another 3 years for cruising speed. Before that, progress is actually fairly slow.

patience is the key word

A lot of people become discouraged, long before the 15 year mark. If the market becomes bearish, it can be even easier to give-up, but don’t!

By doing so, you will only have principal with very little interest/capital gains/dividends. Over the years, interest/capital gains/dividends will exceed the principal amount, and that is the beauty of compounding.

Managing lifestyle inflation

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“Lifestyle inflation” is a very popular topic amont financial planners and personal finance bloggers. But what is it exactly?

lifestyle inflation is increasing your spending when your income goes up

This is the very definition of lifestyle inflation. And yes, we are all pretty much guilty of lifestyle inflation.

This is particularly true when transitioning from student to employee. Most students have to get by with very little, and most make do.

But once the first real paycheck arrives, boy, oh boy!

lifestyle inflation is not always bad

Once you make more money, it is perfectly normal and acceptable to want to live and enjoy life more. Actually, it is not expected of anyone to keep living like a student or a pauper for the rest of their lives!

It is normal to think about having your own place, going on vacation, buying new clothes vs.second hand ones etc…and to actually do those things.

Lifestyle inflation becomes a problem when your spending causes you to live paycheck to paycheck, prevents you from paying debt off and from saving for retirement and other goals.

lifestyle inflation can be managed

Yes, you can still have your cake and eat it too. Here are a few tips.

figure out your new compensation to the penny

If you landed a higher paying job or a promotion, figure out how much you will make on each paycheck. Keep in mind salaries are always gross amounts in North America. After taxes, you may be surprised to realize it is not as much as you thought.

revisit your budget, particularly the “fun” category

Give yourself permission to spend a set amount each month on things you really like and that makes you happy. Don’t worry about what other people think. It is their problem not yours.

revisit your goals

I found it also helps to focus on short-term, medium-term and long-term goals. When you have saving goals, your save towards them instead of spending mindlessly.

If you are about to charge something to your credit card, ask yourself whether this purchase is in line with your goals and within your budget.

forget about the joneses

They are probably broke anyway! Not to mention your material possessions do not define who you are as a person.

final word

I personally do not believe lifestyle inflation can be completely avoided. I also believe it is normal to somewhat spend more when earning more. However, it is possible to manage lifestyle inflation. Like everything else, it does require some discipline.

How I increased my savings by 850% in 4 years

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I have been in both contemplating and calculating modes lately. I realized I have come a long way financially, since my old days of  being in denial about my monetary situation  crisis.

It took 2 major events to really galvanize me into action: realizing I had hit 25K of consumer debt & student loans and becoming a home owner. These did not happen simultaneously.

When I bought my first condo in 2013, I became house rich but also cash poor. Pretty much all my savings went towards the down-payment and closing costs. On top of that, I had to spend an extra $ 1 400 to replace 2 appliances that died within 3 weeks of me moving in. And, I still had debt to pay off….yikes!

But, I did it.

No, it was not always easy, and yes, I also had a little help from the sale of my first condo. That being said, only a tiny portion of the proceeds went towards my savings. Most of them were used to buy my current condo and pay-off my consolidation loan.

Before I start explaining how I accomplished this, let me clarify and be honest on a couple of points:

  • 850% is a big percentage. However, in 2013, the balance of my various savings’vehicles was very low. I did not become a millionaire.
  • As indicated above, the majority of the proceeds from the sale of my condo is not included in that figure.

i drastically increased my income

This is the number one reason I was able to increase my savings while paying-off debt and being a home owner. If you were hoping for a get-rich-quickly scheme, sorry to disappoint you! Only a very few personal finance blogs insist on this, but earning more is actually the best way to achieve your goals and dreams.

I didn’t buy too much house

Living in the Lower Mainland, I had to adjust my expectations. Owning in the city Vancouver will never be a possibility, and I am fine with it. That being said, with the amount that my mortgage broker qualified me for, I could have bought a bigger place. I didn’t, as my housing costs would have been way too high. Right now, they are sitting at 34% of my net income.

i didn’t buy too much car

Quite frankly, I don’t understand people spending an astronomical amount of money on a depreciating asset. A car looses value the moment it leaves the dealership. I also don’t understand people trading-in cars every 2 or 3 years thus staying trapped in a perpetual monthly payment cycle. Did I mention anything about people taking on 7-8 year long car loans? Or rolling old car loans into a new one, therefore owning more than the vehicle is worth?

My subcompact car will be paid off in 13 months. I plan on keeping it for at least 5 to 7 years afterwards.

i was -and still am-very disciplined

I always pay myself first. I have automatic withdrawals from my chequing account to both my TFSA and RRSP aligned with each paycheck. I am paid on bi-weekly basis, meaning I receive 26 paychecks per year instead of 24. Over the last 4 years, I was also blessed with work bonuses and tax refunds. I have reinvested the huge majority of these easy financial boosters. Many times, I was tempted to blow these away. I am glad I didn’t.

but wait, what about your other expenses?

You might ask. It is a legitimate question. I definitely do my best to keep them at reasonable levels. That being said, with all the above points, I don’t sweat that much over them.

final word

It was not always easy to simultaneously save and pay-off debt and pay for regular expenses. But, I am proof it is doable. Now I am almost debt free, I feel like the best is yet to come, financially speaking.

 

Choosing a Financial Advisor

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Over the last week or so, 3-time Olympian Harold Backer has made headlines here, in British-Columbia, and not for the right reasons. After retiring from rowing, Backer became a Financial Adviser and Mutual Fund representative. He mysteriously disappeared in 2015 amidst allegations of defrauding former clients. He turned himself in last week and has since been charged with two counts of fraud over $ 5 000.

this story illustrates how badly the financial services industry needs to change

The industry is largely unregulated. Anyone can set-up shop and call themselves a Financial Adviser, a Financial Consultant, a Money Coach, a Personal Finances Expert. You do not need any particular qualifications or experience.

Unfortunately, most canadians do not seem to care and are far too trusting

I don’t know which one I find scarier here, to be honest. A lot of personal finances bloggers also call themselves “experts” when they are anything but. This a post for another day.

So, how do you choose a Financial Advisor?

first, look for the following credentials

The Financial Services landscape is full of designations that can be very confusing. Unlike the Accounting profession, there is no talk of “unifying”.

  • Certified Financial Planner®: this is the “Gold standard” of the profession. This designation is international. To obtain it, candidates need to take classes in Financial Planning, pass exams and have a minimum of three years of relevant work experience. In Canada, the CFP® designation is administered by the Financial Planning Standards Council.
  • Personal Financial Planner®: this an alternate designation, administered by the Canadian Securities Institute. It is very similar to the CFP® designation.

A lot of Financial Planners also have one or more of the following specialized designations:

  • Chartered Investment Manager®: a CIM® usually handles and manages portfolios of wealthy clients.
  • Chartered Financial Analyst®: a CFA® also handles and manages portfolios. They also do research and analysis on companies, stocks and other securities.
  • Trust and Estate Professional®: a TEP® is very knowledgeable in estate planning and management, trusts, wills and taxation. Note a TEP® does not replace a lawyer or notary.
  • Chartered Professional Accountant ®: a CPA® prepares and analyses financial records for companies and non-profit organizations. They also do tax returns.
  • Chartered Financial Consultant®: a CH.FC® specializes in retirement planning and wealth accumulation.

The five above designations are very good complements to a CFP® or PFP® designation. However, as stand-alone, they are not enough to provide comprehensive financial planning.

Ignore the LLQP and Mutual fund license

The LLQP is for people who want to sell insurance products. These two credentials do not cut it to provide sound and objective financial advice.

Then, LOOK FOR A FEE-ONLY ADVISER

In my opinion, this is the best way to receive unbiased advice. A fee-only planner will charge you for their time. Some will charge you a percentage based on the total value of your assets.

It will definitely be more expensive than meeting with an adviser at a bank. The main difference is that a fee-only planner will not sell you any products and will put your interests first.

Experience is a bit more relative. Education is key when it comes to choosing a Financial Planner.

 

RRSP myths debunked

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As 2016 is slowly but surely coming to a close, it will soon be tax season again.

I want to broach on the biggest RRSP myths that are still circulating around.

  • A contribution equals a tax refund. Sorry to disappoint you here, but this is simply not true. A contribution will lower your income tax payable, but does not necessarily trigger a refund. It depends on your income and situation in general. Also, your refund will never be for the full amount you contributed.
  • RRSPs are tax free. No, they are not. An RRSP is a tax-deferred account. It is like “contribute now, pay later”. You only pay taxes when you withdraw from the account. The only 2 exceptions when you won’t pay taxes is within the Home-Buyer Plan or the Lifelong Learning Plan. That being said, under these 2 programs, you have designate a minimum repayment amount each year when filing your tax return. If you don’t, you will be taxed accordingly.
  • Dividends and capital gains within an RRSP are not taxable. This is by far the biggest myth around. If you have stocks, ETFs or mutual funds, you may be paying taxes on any dividends or capital gains. It all depends on the country the stock/ETF/mutual fund is from. If Canadian, then yes, you will not pay taxes on any dividend or capital gain. Canada also has an agreement with the United States regarding dividend-paying US stocks held in a Canadian RRSP. These are not subject to taxes either. For the rest, the area can definitely be more gray. Many countries levy a tax on dividends paid to non-residents. If there is no tax treaty with Canada, CRA will levy additional taxes. Because an RRSP is a registered account, you won’t be able to claim the Foreign Tax Credit.
  • Everyone needs an RRSP. If you are in a low tax bracket or have a pension plan at work, you won’t benefit from an RRSP. If you are in a high tax bracket, you need to figure out what your tax bracket will be when you retire. If it is expected to remain the same, the RRSP is probably not the way to go either. With the clawback on the Guaranteed Income Supplement, you may end-up paying more income taxes! The RRSP is best suited for medium or high earners whose tax bracket will be lower upon retirement, and who don’t have an employer pension plan.
  • An RRSP loan is a good idea. Not necessarily. As I indicated above, your refund will never equate the amount you contributed. Unless you can reimburse your loan in full quickly, you will pay interests on said loan. You also can’t deduct the interests paid on the loan, because you can’t do so on registered accounts. Your RRSP also needs to return quite a bit more than the interest rate on your loan.

There are plenty of other misconceptions about RRSPs, but these 4 are probably the most common ones.

Save

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Retirement basics in Canada

The government of Canada has a great little tool to determine how much you will need to retire and how much you will need to save to achieve this. The tool also allows you to calculate your retirement income depending on the age you want to retire at.

I found it very interesting for my case. The tool looks at all possible sources of income: CPP, OAS, RRSP, TFSA and employer pension scheme.

The majority of Canadians don’t have an employer-provided pension. These are very expensive for companies, but they are the golden ticket for employees.

All Canadians are entitled to CPP and OAS when they retire. The rules and amounts are different for these 2 government programs.

The Canada Pension Plan – CPP- is a program based on age and the contributions to the Canada Pension Plan via employment or self-employment. You can apply for CPP if you are 60 years-old. Note if you apply when you are less than 65, your pension will be discounted. On the other hand, if you apply after turning 65, your pension will be increased.

Service Canada will look at your contributory period and the amount contributed. Some periods with zero or little earnings will be dropped under the “drop-out provision”. If you had children and stayed home to raise them, these periods can also be dropped under the “child-rearing provision”.

The average monthly amount is about $665.00. The maximum current amount is around $ 1 100 per month.

Old Age Security -OAS- is not linked to the CPP contributions. To receive OAS, you need to have lived for at least 40 years in Canada. The OAS is subject to a “means test”. If you exceed a certain threshold of income, you will have to repay some or all of it. The maximum current monthly payment is $ 570.00.

If you receive OAS, are single and earn less than $ 17 000 per year, you are eligible for the Guaranteed Income Supplement -GIS-. A couple has to earn less 23K a year to be eligible.  The maximum monthly payment is in between $ 510.00 to $ 775.00 depending on your situation.

As you see, all these amounts are really modest. It is crucial to build our own retirement savings!

Now that I am well into my mid-thirties, I have become even more aware of how crucial this is. The government calculator has estimated I need to save $ 500 per month if I want to retire comfortably at 65.

Right now, I am not saving that much, as I am still repaying my debt and my car. In the next 2 years, I will be able to do this. In the meantime, I am saving as much as I can and top-up my contributions with potential bonuses and 2 additional paychecks a year.

My ways to save money

Since I have started taking a long, hard look at my finances, I have definitely become more frugal and minimalist. However, I do not consider myself as frugal or minimalist.

In this post, I want to share some of the ways I save money.

  • Always ask for a discount/never pay full price: This has kind of become my “financial motto”. Recently, I called my internet & phone provider to review my services. I thought the price was too high and I asked for a discount, mentioning that I have been a long time customer. The company took $ 10/month off my bill. This is a saving of $ 120 per year and all I had to do was asking. By doing so with pretty much everything I can think of, I do save a lot of $$.
  • Don’t be a brand snob: I am not particular at all as to the products’brands. I always buy the cheapest, whether it is toothpaste or pasta. You can’t actually taste or feel the difference in most cases.
  • Repair instead of automatically replacing: since when do we throw a shirt away simply because a button fell off?
  • Do-it-yourself: I do my own cleaning, cooking and laundry. Convenience has a high price tag. I have also tackled minor home improvement projects such as painting my condo.

What about you? How do you save money?

Target date funds explained

This financial product has been growing in popularity, but what is a target date fund?

A target date fund is a basket of different assets -mainly bonds and equities-  structured for a specific event in the future, such as retirement or post-secondary education. The name of target fund contains a year, for example “target fund 2025”. As it nears its date, the fund gradually shifts its asset allocation towards fixed income to preserve the capital.

Target funds are also known as “fund of funds” because they are usually made of other mutual funds or ETFs from the institution selling it.

Just like all other financial products, it has its pros and cons.

Pros:

  • Convenience: when investing in a target fund, you don’t have to manage it or figure out re-balancing.
  • Diversification: a target fund invests in a wide variety of bonds, equities and sectors worldwide. You may not be able to achieve this level of diversification on your own.
  • Starting point: target funds can be a good start for beginner investors or young adults who don’t have a lot of money to invest. This product can yield returns you also may not be able to achieve on your own.

Cons:

  • Lots of research: you will usually have to do a lot of research before choosing the right target fund for you. Because this product is made of other funds, you will need to research these too to check on their performance.
  • Gliding path or re-balancing: You will have to investigate this as well. You don’t want a fund that would become too conservative too early. On the other hand, you don’t want  a fund that becomes conservative too late either. Many people lost a lot of money in 2008 because their target date fund of 2010 was still heavily invested in equities.
  • One investment only: if you buy a target fund, you usually can’t have other investments, as these would simply defeat the purpose of your target fund.

As with all financial products, there are no guarantees that a target fund will deliver when its time is up. You could loose money.

You also need to check on the MER or TER, depending on what the fund is made of. This impacts your return. Because target funds are made of other mutual funds or ETFs that also have MER or TER, you might end-up paying underlying fees.