Tuesday, October 15, 2019
How to Retire Relevant Step 5: Investing
My 7-Step Relevant Retirement System is a comprehensive guide to coming out on top during your golden years. The society we live in does not set you up to win in retirement, in fact, it is quite the opposite. My industry is full of complex jargon meant to confuse you, all the while you are unaware of how to live comfortably when your paychecks stop. When we think of living an abundant retirement life investing is often the first thing that comes to mind. There is a reason for that. Most people think that wealthy people inherited a ton of money or got lucky with some magical stock tip. The reality couldn’t be further from that. Sound long-term investing principles are what create a Relevant Retirement. Coupled with the right mentality, right protection, and right plan, investing is what will get you from a decent retirement to a remarkable one. The foundation must be in place first however and that is why Step 5 is about investing and not step 1 or 2. It is my goal with my clients to show them that having your investments grow requires patience, prudence and of course a little hard work. It is your money that will ultimately determine your success. You have to make it and then you have to use it properly. This step is the sexy part of my system. It’s the part where your eyes will light up and the clouds will part. It is also the scary part. Let’s make our money work for us. Let’s reap the fruits of our labor. Let’s get started investing properly.
Why investing is so important your retirement
There is no way around it. You must save and invest your money in order to retire comfortably. Quite simply, life is too expensive, and your working years are too short to just save your money. You must make it grow. If you go back one generation this was not the case. Back then, most people only lived 10 or 20 years while retired. A simple savings account, well-stocked, would suffice. With interest rates in the 10-20% range, it was actually prudent to have your money just sit. Today the tables have turned completely. Interest rates hover in the 2-4% range and don’t appear to be going higher anytime soon. Also, life expectancy is in the 80-85 range and it is not uncommon for people to live well into their 90’s! This leads to some people being retired for more than 30 years! If you do not have enough retirement savings that is a recipe for disaster.
There is also the major, and I mean MAJOR, problem of inflation. We all get the concept of inflation but let’s recap.
“Inflationary risk is the risk that inflation will undermine an investment’s returns through a decline in purchasing power.” – Investopedia
Everything next year and over time will cost more than it used to. Picture your Grandpa saying, “I used to go to the movies with a dollar and came home with change.” Now a trip to the movies requires a small loan. Over time our money is worth a little less than it used to be. This is why getting regular raises at work is so extremely important. This is also while having your savings keep pace, but also exceed inflation is vitally important. Quite simply, keeping your money in cash, or just sitting in your bank account, or under your mattress, is costing you money. This is evident with these stats:
$100 today will be worth:
$128 in 2029
$164 in 2039
$210 in 2049
$269 in 2059
Using a 2.5% inflation model, the standard inflation rate over time has been about 2-3%, you LOSE $28 in purchasing power in 10 short years. That is 28% of your money flushed down the toilet. In 40 years, your dollar is essentially worthless. Think of Grandpa again. Back in 1979 you could buy a home for 20K, fill up your car for a couple of bucks and your grocery cart for $15. Think of what that will cost you in 2049? This is a serious problem that requires vigilance and a plan to counteract. It requires sound investing practices.
Your “Magic Retirement Number”
In order to invest properly, you must know how much money you will need. This is where many people fall short. They simply feel as if they save anything, they will be okay. The truth is you have to understand how much you will need all the way throughout your working life in order to reach a relevant retirement or else you will more than likely fall short. In Step 1 of the Relevant Retirement System: Budget, I discuss how you have to truly understand what it takes to run your household on a monthly basis. This is what a budget is, simple clarity as to what is going on. Mastering the Budget will also help you understand what YOU WILL need in the future as well. Let’s just say it costs you $4000 every month to properly run your household. That equates to 48K annually. If you use those same numbers for what you will need in retirement, you will need $1,440,000 to retire and maintain the same lifestyle. This is based on living for 30 years while retired, ie: age 90. The math is quite simple in fact.
- Determine what you will need to live the life you wish in retirement (The Budget)
- Determine when you would like to retire (Your ideal retirement age)
- Subtract that ideal age from 90 (Always plan to age 90)
- Multiply 1 x 3 (ie: $50,000 x 30 years in retirement, if age 60 is chosen to retire)
- The amount you have is your “Magic Retirement Number”
There are a few factors missing in this equation that I will go over right now. Firstly, what you need on a monthly basis needs to be inflation-adjusted. A simple inflation calculator can help you do that. You may notice that the number needed to “live comfortable” now balloons. 48K needed annually become 100K in 30 years! This is double what you need now. Also remember that if you go through the 7 Steps to a Relevant Retirement System, you will have secured a base from which to grow. Your home will be paid off. Your emergency fund will be fully stocked. You will have no debts and will be debt-adverse for life. This will make the “burden” of retirement saving much, much easier.
Another missing factor is the returns you will get on your investments. We will get into that shortly. Also, government plans, employer retirement plans, and additional savings opportunities are not mentioned. We will touch on all of those as we proceed. Remember. Your “Magic Retirement Number” is supposed to scare you. It should scare the crap out of you. It is what’s needed to drive you into action and focus on getting your money right before the day you stop working.
Your monthly savings rate
Knowing your “Magic Retirement Number” will help you determine what you need to be saving on a monthly basis for retirement. If you are saving nothing right now, this number may shock you a little bit. Most financial minds will say to aim for 15% of your income as a benchmark for what you should be saving every month for retirement. This means that if you make 50K annually, you must save $7,500 annually for retirement. That equals $625 a month. I like the 15% benchmark, but I prefer to know exactly what I need for my own Relevant Retirement. If you determined that you will need 1.5 million for your retirement, (30 years in retirement x 50K annually = 1.5 million) and you have 30 years until you would like to retire, you must save roughly $1230 per month. That’s a pretty big number! That is almost 30% of your annual income! Let’s focus on how we got this number. This number is based on a rate of return on investments equal to 7%. If you achieve an 8% rate of return, you would only have to save $1010 per month. A 9% rate of return would only require $820 per month in savings. A 10% rate of return would only require $665 a month in savings. This is also based on retiring at age 60 and living to age 90. Waiting to age 65 dramatically changes the number. Having a spouse help you contribute also radically changes the number. Having a company matching program also dramatically changes the number. Remember, I said this number was meant to shock you.
Government Retirement Plans
Here in Canada, we have 3 government retirement programs. The first and most simple is Old Age Security or OAS. The requirements are purely residency. If you have lived in Canada for 40 years following turning age 18, you receive full OAS, which is $607.46 per month or $7,289.52 annually (2019). If you have lived elsewhere during those years, you can still qualify for partial OAS based on the years you were here. The amount for OAS changes annually, based on inflation, so check periodically at The Government of Canada Website for the most up to date information.
The next government-sponsored plan is the Canada Pension Plan or CPP. This plan can be taken as early as age 60 or as late as age 70 and is based on your contributions throughout your lifetime. As of 2018, the maximum one could receive from CPP per month is $1,134.17 or $13,610.04 per year. It is important to understand that not all people receive this amount. In fact, most do not as CPP takes your 39 best earning years and blends them together to make your average income. You will have needed to make more than the Yearly Maximum Pensionable Earnings or YMPE for those years. For 2019 the YMPE is $57,400, meaning that if you make less than that for any of the 39 years your CPP benefit will decrease. I explain CPP more in this post or you can check out the Government of Canada Website for the most up to date information.
The last benefit is called the Guaranteed Income Supplement or GIS. The GIS is basically a monthly benefit for those not earning much from CPP during their retirement, or any other source. There are income thresholds for receiving the GIS. For a single person in 2019, that level is $18,600 annually or less. That person would receive $916.38 per month or $10,996.56 annually. The amounts change based on marital status, so please check out this post I wrote on government benefits or go to this one below that lays it out very concisely.
Simply put, government benefits are not adequate to live a comfortable retirement, let alone a relevant one. I mention them because they are a solid base from which to draw some income from. Keep note that the maximum income the government will ever give you in retirement is a little less than 21K annually. I don’t know about you but living on that little does not interest me at all. Also note that government retirement benefits require one key element to function, THE GOVERNMENT. When is the last time they did anything with great efficiency or advocacy? Given their current financial state, and to a lesser degree political and social state, should we trust them with providing us our sole retirement income? I don’t think so. Rumors of a CPP collapse have been in the pipeline for years. I personally don’t believe it will happen but if it did it wouldn’t surprise me. Let’s plan for ourselves to make OUR OWN retirement relevant.
Company Sponsored Retirement Plans
Do you remember when we got the sticker shock of what you need to save every month for retirement? Well, one way to lessen that burden is to take part in a company-sponsored retirement program. This is where your company matches your contributions to the retirement account up to a certain amount. Typical matches usually range anywhere from 2-8% but from my experience, most fall around the 5% range. This type of program will help you save more for your retirement and lessen the monthly burden you face. For example, if you make 50K annually and your employer matches up to 5% of your retirement contribution, that equates to $2500 annually in FREE MONEY. Compounded over 30 years and that amounts to $246,109.06 at a 7% rate of return. That is pretty sweet! That greatly helps lessen the monthly burden of retirement savings. Read the next part very carefully: YOU SHOULD ALWAYS, ALWAYS CONTRIBUTE AT LEAST UP TO THE COMPANY MATCH OF THE GROUP RETIREMENT PLAN. Read that again. If you are not doing that you are wasting your chance at free money. Worst of all you are wasting time and compounding ability. Furthermore, finding a job with a retirement program should be a key part of your job search. Group Health and Retirement benefits save you vast amounts of money over time and should be considered diligently. That being said, simply putting in as much as the match will not bring you to a relevant retirement, but it is a good start.
Full Ride Pensions (Defined Benefit Pensions)
These style of plans are becoming more and more rare, but they do still exist. The full-ride pension was a mainstay back a generation ago but started to go away as we lived longer and longer. Companies simply could not afford to be paying pensioners for 30-40 years in some cases. If you do happen to have a full-ride pension plan at your place of employment, please pay attention to this part. You don’t want to be pension poor. I encounter many people who work for a place that offers a full-ride pension and they live life like it was a scratch-off lottery ticket. Accumulating debt, not saving any money and never paying down their home. A full-ride pension is a great thing but waiting for the first of every month to get paid in retirement is not. Using that pension to make mortgage or rent payments and surviving on the rest is not. Using that pension to pay off car leases and loans is also not. That my friends, is what I call pension poor. If you want a relevant or a remarkable retirement you must save money and invest even if you have a full-ride pension. While it gives you a solid base, it does not make you wealthy. You need liquidity in retirement, meaning you need access to cash. A pension doesn’t provide that. Truly understand what your pension will provide as you go through your working life. Also, understand that your company is not required to provide you with one at all. Also understand that your company may not always be around, think Enron, Sears, etc. Also understand that your company may not always have you around. Are you prepared for a reduced pension because you got canned 15 years before retirement? Hope for the best, but plan for the worst my friends.
Where you put your money is vitally important when you are saving for retirement. The key factor for this point is TAX-EFFICIENCY. We all know that taxes eat away at our paychecks. We should also understand that they will eat away at our investments too. For most Canadian’s, the 2 main retirement savings vehicles are the Registered Retirement Savings Plan or RRSP and the Tax-Free Savings Account or TFSA. These 2 vehicles can be thought of as buckets of which to put your savings into. The main differentiating factor with both is how they are taxed. There are some other differences too, of which I will go into now.
Registered Retirement Savings Plan (RRSP)
Key points for the RRSP and TFSA include taxation, contribution amount, and withdrawal age.
- Taxed upon withdrawal at the holder’s marginal tax rate. Essentially considered income
- Money inside the RRSP grows tax-free
- The holder receives an RRSP tax deduction annually when money is deposited. It brings down the taxable income of the holder dollar for dollar, creating tax savings
- The maximum annual contribution is 18% of the holder’s annual income up to an amount of $26,230 (2018)
- RRSP withdrawals MUST occur the year the holder turns 71
Tax-Free Savings Account (TFSA)
- No taxes upon withdrawal, funded with “after-tax dollars,” meaning you already paid tax on the money you have put into the TFSA
- Money inside the TFSA also grows tax-free
- There is no tax deduction annually when depositing into the TFSA
- The maximum contribution for the TFSA is $6,000 annually (2019) and is adjusted periodically for inflation
- The cumulative amount that can be deposited into the TFSA is $63,500 (2019) if the holder was 18 in 2009, the year the TFSA was introduced. The amount lowers by year for those who weren’t 18 in 2009
- If you withdraw from your TFSA, you regain your contribution room the following year in January
- There is no age limit to when a person must withdraw from a TFSA, unlike the RRSP
Both the TFSA and the RRSP can hold a variety of investments such as:
Exchange-Traded Funds (ETF’s)
Guaranteed Investment Certificates (GIC’s)
Various other investments
When deciding which vehicle to use, some background knowledge should be known. Firstly, I believe everyone should have a TFSA. The reason is simple, it’s TAX-FREE. You cannot beat the value of being able to invest in whatever you want, have it grow tax-free and then not pay taxes upon withdrawal. For younger clients, the TFSA provides an amazing retirement vehicle that has the potential to make their retirement extremely relevant. For older holders, it is a great place to maintain liquidity and supplement current retirement income. It should be EVERYONE’S goal to have a maxed-out TFSA.
That being said, as one’s income grows, the tax deduction received with the RRSP becomes more and more appealing. When starting out, one’s income may be so low that the deduction is not very appealing. As your income grows this amount can become quite substantial and then the RRSP becomes a real player in the game. Also, if you have maxed out your TFSA, the RRSP is the next best place to put your extra money. I would speak with a credible investment advisor to see which is best for you, but as a default, start with the TFSA then shift to the RRSP. If you can max out both of these vehicles you will be quite wealthy during your retirement years.
As I mentioned you can put a variety of investments into your retirement accounts. My preference is mutual funds that have a track record of long-term growth. My reason for this is simple: If the right funds are chosen and the right advisor put in place, one cannot match the growth and service provided by managed investments like mutual funds. I like to focus on 4 key areas when investing my client’s money for the long-term. They include:
- Growth and Income
- Aggressive Growth
You may recognize this style from Dave Ramsey. The reason I believe it works is that it provides a solid base of diversification amongst many regions (countries) and sectors (industries). In order to weather the storms of the market, diversification is key. If the Canadian market is underperforming, we still have exposure to international and emerging market funds. Mutual funds provide you with access to dozens of companies within a fund managed by a team whose mandate it is to outperform the market. If they have not continually outperformed the market, simply do not invest in that fund. Your investment advisor should be able to show you the track record of their funds. Choose ones that have continually outperformed the market over the long-term, 5-10 years or more. By investing with this style, and putting in the proper amount annually, there is no question that you will reach your retirement goals. Always keep in mind the fees associated with your investment accounts and that information should be readily available to you from your investment advisor.
Choosing an investment advisor
Choosing an investment advisor may seem like a daunting task so I will break it down as easy as possible. As my main man Dave Ramsey puts it, “Your Investment Advisor should have the heart of a teacher.” What that means is that it is THEIR JOB to explain the benefits of your investments clearly and concisely. If they cannot or will not do that, they should not be your advisor. It is not your job to know the ins and outs of the market or to stay on top of new legislation and rules regarding investments. That is their job and they should be willing and able to teach you. Their role is essentially to lay out what needs to be done in order to achieve your goals and then allow you to make an informed choice. The industry is full of “suit dummies” who try to make you feel like the dumb one. If you feel dumb after you meet with an advisor fire them. You should feel at ease, empowered and confident.
Your advisor should also be transparent about the money that they make. We all know that advisors and the companies they work for are making money. This isn’t a non-profit let’s get real. That being said, what they make should be known by everyone involved. Most funds have what is called an “embedded fee,” and the advisor should explain that to you thoroughly. If they cannot or will not explain it, fire them. They should also work for a reputable company. Fly by night investment firms often do not hold their advisors to high standards. I know this because of the massive amount of compliance I must adhere to. Yes, it can be annoying, but I realize how necessary it is. You should be able to walk into a building to complain about the advisor if you have to of course.
Above all, your advisor should be trustworthy and should know you and your circumstances. That should be at the heart of all their recommendations, not what they feel is right and certainly not what makes them the most money. If you do not feel comfortable recommending your advisor to everyone you know then they are not the one for you. If you follow these guidelines you should be able to find an advisor who services you well and will work with you for many years to come.
A note about the big banks
I am personally not a fan of the big banks. The reason is simple: You are a number and not a person. Big banks often have dollar amount thresholds that you must reach in order to have a dedicated advisor. Below that you are at the whim of a recent college grad who was a bank teller the day before. They are also not fully invested in your success. If you are debt-free it matters not to them and in fact they tend to push debt products on you. If you are mortgage-free it matters not to them and in fact, they tend to push re-mortgages and 2nd mortgages on to you. If you have the proper amount and type of insurance it matters not to them because the cost and quality of insurance they offer are simply that, what they offer. You deserve a dedicated advisor who is ready to work for you. Remember their business grows as your wealth grows. You deserve to be more than a number.
Investing is a vital part of my 7-Step Relevant Retirement System. It is what will get you to the numbers you need to have the retirement you want. Once you have this part down you can focus on creating a remarkable retirement, of which I will address in steps 6 and 7 of the system. This includes taking advantage of opportunities such as real estate investing and creating a lasting legacy for your loved ones. It is getting the investment side of things down that provides those opportunities. A simple concept about investing I will share with you is this: Never invest in something you do not understand. While we cannot predict the markets, we can predict our temperament. If you do not understand something, you will run at the first sign of danger. This leads people to leave their investments when they go down, only to miss the subsequent rebound. This cements their loss and even worse jades them from investing period. You cannot operate this way. The only way to counteract this is to know as much as you can about your investments and have an advisor you trust working with you and your family. Remember, you are in it for the long-term. Also remember this important fact: SAVING FOR YOUR RETIREMENT IS A BILL. It is a bill you owe to your future self. If you operate this way you will be amazed at the power your money can have working for you!
“Beware the investment activity that produces applause; the great moves are usually greeted by yawns.” – Warren Buffett
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