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Thursday, July 30, 2015

Lack of Value

Posted by Tim Stobbs on July 6, 2015

Perhaps the most common question I get about our financial situation is something along the lines of: how do you save so much?

Well to be honest saving 65% of your income gets easy after a while, so perhaps the easier way to answer the question is simply: I value what I’m saving for.

People often have good intentions with savings so about once a year around RRSP time they think a bit more about it and consider if they are saving enough.  Yet they fail to realize something critical….if you aren’t saving now that shows me you can have good intentions until the end of time and won’t save you a dime.

Look where you are spending your money now and they shows me what you value.  Do you value comfort over convenience?  So you might end up buying more comfortable furniture rather than meals out. Or the other way?  Perhaps you value your appearance over your substance?  Then maybe you buy a knock off designer purse rather than saving for a real one.  Either way isn’t right or wrong, but merely shows you what you value in life.

Me?  I value freedom over comfort, honesty over appearance and love over convenience.  Yes it sounds a little bohemian, but it is true.  These values drive my habits and thoughts more than a spreadsheet to live the life that I do.

Which is perhaps why I drive people I little nuts when they try to understand my success.  They get confused by my willingness to spend over $300 on some higher quality wine kits, but I will rarely buy a book even when I love them.  Or the fact we only have one car when it fact it is a bit of an inconvenience once in a while.  On the surface the issues can look odd, but mainly because the values the under pin them are likely different then your own.

For example, I dress moderately nice at work, but I refuse to wear a suit.  I hate wearing suits so even when I present the highest people in the company I still wear a only a tie, not a suit jacket.  I don’t care about appearance to others that much.  Or the fact I love good food, but rarely eat out…I like to cook instead.  I value quality over convenience.

This of course leads a person to consider who exactly they are.  What are you values?  Then after that painful process of self discovery you can then push yourself to align your spending with your values.  At this point something utter fantastic happens: life gets easy.

Pardon?!?

Yes, when you are spending with your values (rather than the values of others) the decisions you make become obvious.  You know what you value so the choice to save now or spend later is obvious to you.  You spend enough to be happy in life, but know that you wants will exceed your income on a permanent basis.  So once you have arranged your spending to align to your values, saving the remainder isn’t a chore or even an effort….it merely makes good sense.

The real difficulty I’ve found is combining your family values into something that everyone can life with.  So you learn the art of compromising….a LOT.  In my case, it means we spend much more on hot water than I would ever like to, but my wife gets to enjoy her luxury of very long hot showers.  Rather than debate it every day, I got her to agree to a lower flow shower head and now shut up about the water bill.

On the flip side she has put up with my odd little projects like collecting raspberries from the backyard all summer long into a bag in the freezer so I can make a little five bottle batch of raspberry wine from scratch.  It would have been much easier to just buy the bloody berries in the first place, but I wanted to make my wine from local ones.  So we agreed, we would save half the berries.  She rolled her eyes and did it anyway…then proceeded to roll her eyes again when she tasted the first bit of the wine.  It was one of my best yet and now I’m saving berries all over again this summer.

The real trick to combining values is to know the core ones are in agreement. They don’t have to be the same, but enough alike for you to both be happy with the spending that you do.  After nearly 15 years of marriage my wife and I have that down to an art form, which is reason we stay married.

So what do you value?  Does your spending align with it?

The Game Changer – Expanded TFSA

Posted by Tim Stobbs on April 22, 2015

With the cat finally out of the bag we now know a few details of the much rumoured expansion of the TFSA contribution limits from yesterday’s Federal budget (page 232 if you want to read the official text). First off it isn’t a actual doubling of the limit rather it is rising up from the current $5500 per person per year to $10,000.  Still that is a huge increase in room, and it takes effect this year.  The only downside of the announcement was the fact that they stripped out the inflation adjustment on the accounts contribution room.  So enjoy that increase because we are likely not going to see another one for a VERY long time.

Of course a change in Federal government leadership might also trigger this to be a single year event with a roll back in the plan down the road.  But for now it is going to happen this year, so let’s look at the potential implications for this in your retirement plan.

To say this is a game changer for some people is a bit of an understatement.  A couple can now put away $20,000 per year in TFSA and never pay a dime of tax on growth in those accounts.  So the holy grail of retirement planning just got a bit easier: the zero income tax retirement. I’m not sure if you realize this is about your life, but your single biggest bill is likely not your mortgage, but rather your tax bill.  Your income tax portion of it can often be a big chunk of change so if you can reduce that in your retirement years you can often speed up your retirement date.

The trick has often been that while the TFSA’s are great ways to invest they don’t often have enough contribution room to make them your sole retirement investment account.  For example, if you made $75,000/year as a family your RRSP limit is 18% of your previous year’s income or $13,500.  So while the old TFSA limit was close at $11,000 for a couple, now it becomes possible to skip the RRSP entirely for most people and pour everything into a TFSA.  (For those with math inclined minds, if your family makes $111,000 per year you can shelter the same amount in your TFSA as your RRSP now).

But what about the RRSP tax refund?  Well while that is a nice thing to get you do still have to pay tax on your growth of your RRSP at the other end when you take the money out.  While a TFSA you can shelter all the growth from getting taxed.  So imagine you have saved well in your life and have a cool $1 million in retirement savings and a paid off house.  Now imagine never having to pay a dime of tax on that and not having it reduce your Old Age Security benefits.  Cool eh?

So to compare you take our $40,000 a year of income from that in an RRSP you would have to pay tax on that money.  The final amount will vary by province but if only one of you take the money out you would lose anywhere from $5800 to $7700 in income tax for 2015.  Leaving you with a net spending amount of $32,300 to $34,200.  Or you could have put it all in a TFSA and got $40,000 to spend.

In our particular case this means I will likely skip putting money in taxable investing accounts and instead just shelter everything in RRSP and TFSA accounts.  While I might need to keep some contributions aside for the last year or two I can then stuff it all in get caught up in no time (ie: likely two years after retirement).

All in all, there is a fair amount of potential in this announcement for your retirement plans.  Of course, you should still do some numbers for your particular case to ensure it would be worth it to you.  So are you making any changes your plan because of this change?  Or you don’t think it will last?

Don’t Keep All Your Eggs in One Basket

Posted by Tim Stobbs on April 8, 2015

Well the other day I requested a post ideas and I was asked to provide some thoughts around my couch potato portfolio and specifically this article, which points out the good times for that portfolio won’t last forever.  So while I’ll do that,  I also thought I would expand the focus to discuss my overall portfolio approach.

You see I don’t ever believe in putting all your eggs in one basket (yes, it was Easter and eggs are stuck in my head).  Most people believe that statement applies to just one stock or perhaps one stock index.  I instead expand it to also include any given investment style.

That article I previously linked to pointed out rightfully that the couch potato portfolio is going to have some down years.  Now when you saving up for retirement, this isn’t a particularly big issue other than to slow down the rate of savings for a while.  Yet when you are living in retirement these down years can be outright critical.  After all if your portfolio takes a 20% decline one year and you take out another 4% on top of that you just increased the downside to 24%.  If that continued for a few years you would be in some serious trouble as you likely won’t have enough cash to allow you to recover in the long haul.

So what do you do?  Keep multiple streams of income so you can ease off pulling out money during these major dips in your portfolio.  There are multiple options out there for people to have other income streams including, but not limited to: part time work, workplace pensions, government pensions, investment portfolios, cash savings or rental income.  Another less obvious way to expand that list is to also splice your portfolio into different investment styles to balance their risks.  I’ve previously mentioned my plan include all of those above except rental income (I prefer to keep REITs instead of rentals).

In my case, our actually overall portfolio consists of three different subsets of investments: my workplace pension, my couch potato in our RRSPs and finally dividend investing in our TFSAs.  So while the couch potato has a weakness of pulling out money during a big drop, this doesn’t exist in the dividend investing portfolio since I plan to never touch the principle and only take out the dividend income.  Therefore you might be tempted to believe dividend investing is superior to the couch potato, which isn’t true.  The price you pay for that level of security is often lower returns so you often need a MUCH bigger portfolio value to retire if only used dividends.  For example, if your dividend portfolio only generated 3% instead of using 4% withdrawal rate for a couch potato your portfolio to generate $30K in income goes up from $750,000 to $1,000,000 for dividend only portfolio.  So security is offset with much bigger savings targets.

This is why I think you should actually consider a blend of investment portfolio styles to balance out the risks and positives of each.  So in our case, our target spending is around $30K a year.  We plan to generate that income from various streams.  In the beginning of our retirement, for example, my wife plans to continue working for a few years after I quit which should generate at least $6000/year.  Then I’m aiming to have the dividends in our TFSAs generate another $6000/year.  That leaves $18,000 to come out of our RRSPs.

Yet what happens if the stock market tanks just after I quit my job?  I could reduce our withdrawal from the RRSP up to zero by using other income streams instead.  Perhaps I pick up a part time job or contract work for a few months or we could just using our cash savings to fill the void for a given year. For a year, this isn’t a big deal…the issue becomes if all of your portfolio was just in couch potato you would be a much harder spot.  Since you need to take out the full $30K, it would have a bigger one time impact which depending on the size of the drop you may never recovery from.

The other complication for income streams is your access to given stream will vary through time.  So for example, I can’t collect Old Age Security until I’m 67 and my workplace pension is locked until I turn 50.  We could also downsize our house to bring in a one time shot of capital into the investment accounts.  But once some of those time locked steams kick in I need less of my other streams to cover the remaining.  So over time you can over draw from one stream, if you can make it up from another one later on.  So in theory I could take out too much from the RRSP, but I better be damn sure of my offsetting future income stream to cover the difference.

You are likely just realizing that mapping out all the options do get a bit mind numbing with the amount of possible combinations.  So rather than try to do that I would suggest you merely map out fully your default plan and then be prepared to make adjustments as you go.  Predicting the future isn’t a real option so plan for what you expect and be prepared to adjust as you go.

I should also point out while I’ve mainly have been discussing the negative side of your portfolio that upside is just as important.  So for example, this most recent wave of good returns for the couch potato portfolio (9% for the last six years) when you are retired would be a great time to withdrawal a little extra money to increase your cash savings or perhaps add to your dividend portfolio.  Don’t just blindly spend the extra returns as you are going to need those to cover your down years in the future.

So in summary, don’t put all your eggs in one basket.  Be prepared to have multiple income streams and be willing to balance them off each other in the good and bad times.  The details after that are up to you.  Just remember…there isn’t just one right answer, but rather thousands of ways to do it.  Find out what works for you and go with it.

How you balance your income streams?  Do you keep more than one investment style in your portfolio?