Posted by Dave on January 24, 2012
This is a guest post by Dave, who is also looking to retire no later than 45, but unlike Tim has no kids and doesn’t want any. Dave is from Ontario and is working towards his CGA certification.
I am by far the last person to ask about specific investing advice (for now, I hope to change this in the near future). What I can tell you is what I am looking at right now in my future investment plan and why I am going to do it this way.
I have an undergraduate degree in Economics (which doesn’t really mean a whole lot, I do not claim in any way to be an Economist, but I sometimes remember some of the stuff I tried to learn in the four years of school I was paying for) – one of the main facets of Economics is an efficient market, whether it is in a labour market, commodity marketplace or in the case of investing stocks and bonds. The efficient market hypothesis (as it applies to stocks) basically states that prices reflect all known information available. A lot of investing books use this hypothesis to tout index funds, essentially saying “the market is efficient anyways, don’t try to beat it, just own it (through index investments)”. I generally agree with this, and think that index investing is right for most people – it’s safe (or relatively safe, as compared to either keeping cash under a mattress or picking stocks based on a hunch) and pretty easy to do, I just don’t want to do this.
I’m not eschewing index investing due to its simplicity – I’m pretty lazy and would enjoy something like a Couch Potato Portfolio, where I rebalance a few times per year and generally don’t worry about my investment otherwise, compared to a dividend portfolio of single stocks, which require constant monitoring. No, I’m going to invest in things that are going to pay me cash now, not later.
Why is having cash now important to me? There are a couple of reasons:
- I’ll need cash when I retire – a constant cash flow that comes from investments such as stocks, bonds and REITS will replace my salary at some point (hopefully). Having to sell off the stock itself does not seem like a good long-term plan to last through retirement. Dividends (or interest) paid out will allow me to own the original investment (which will hopefully appreciate).
- I don’t really trust the marketplace – This may seem like a silly reason to choose an investment, but for me I would rather have cash in my pocket now and see money coming in rather than investing in a company hoping to pull my money out at some future time. I realize that I am a little crazy for this, but rather than seeing the stock appreciate, I would rather take a portion of my investment off the table.
My first reason is perhaps a little more rational than the second, but they both work for my purposes. To me, investing has a lot to do with personal preference and these are mine.
Do you invest for capital gains, or cash flow, or a mix? How do you decide (or did you decide) on the type of investments you were looking for?
Posted by Canadian Dream on January 18, 2012
Are you sitting down? Yes, then good. If not, you might want to pull up a chair. I’ve got a confession to make. You know that 4% safe withdrawal rate that me and other early retirement bloggers go on and on about, which is suppose to be the amount you can safely pull out each year and not run out of cash over a 30 year time frame. Well it turns out that most of the assumptions used to model that don’t really apply in real life (for full details, you can read this long, but excellent article). The real truth of the matter is that a ‘safe withdrawal rate’ isn’t a constant at all but rather another variable.
What?!?! Then how do you model that into your retirement plans? Simple, you can’t. Depending on the situation your ‘safe withdrawal rate’ can range anywhere from 1.8% to 25%. This all depends on several factors like the amount of fees you pay on your investments, the rate of return on your investments and the sequence of those returns, and your personal rate of inflation. In a nut shell you can’t model it yourself because it becomes a circular reference, which you might be familiar with that error if you have ever had to do complex modeling in Excel. In a nut shell you series of references to other variable results in your last object referring back to your first object, you end up with a closed loop that can’t be solved.
So if you can’t model it why are you telling me about it? Ah, that is the right question. I mention this fact because in reality, when you are actually living on your savings in your early retirement period you shouldn’t have a constant withdrawal rate. Instead you should ramp it up and down depending on those factors I already mentioned. So in today’s current context with low returns, low interest rates and slightly higher inflation you should consider lowering your withdrawal amount below 4%. Then when you hit some good years like those leading up to 2008, you can take an extra vacation if you want.
This really isn’t that hard as people already do this in real life prior to retirement. If you lose a job, your spending doesn’t keep going out at the same level. You adjust your spending to your lower income as much as you can to ride out the bad times until your income level comes back up. Yet doing this requires you to have some fat in your budget to cut back on, if you purely rely on cutting back spending. The other alternative is to increase your income by getting some short term work or selling a non-income producing asset such as your vacation property.
So the lesson in all of this is you don’t want to retire early on the absolute lowest point of your spending, you want to in fact have a bit of fat or safety margin in your plans. This is somewhat obvious risk planning, but you might be surprised how often the obvious isn’t really seen by people. So please have a few backup plans when you retire early including some extras in your budget. That way you can cut back during the lean times if you need to.
Posted by Canadian Dream on January 11, 2012
I came across this article the other day in regards to cost cutting in the next federal budget. While a 5 to 10% cut in department spending is a noticeable drop, what caught my eye was the discussion around government worker pension plans. Why would that stand out for me?
Perhaps of some stats (from The Taxpayer, Fall 2011) that I came across over the holidays on pension plans in Canada for the public and private sectors.
Employees with Workplace Pension Plans
Government Workers
1977 – 75.5%, 2009 – 86.2% for a +10.7% increase
Private Sector Workers
1977 -35.2%, 2009 – 25.3% for a -9.9% decrease
It gets worse when you look at who has defined benefit pension plans.
Employees with Defined Benefit Pension Plans
Government Workers
1977 – 74.8%, 2009 – 81.0% for a +6.2% increase
Private Sector Workers
1977 -31.4%, 2009 – 14.2% for a -17.2% decrease
Holy, S*&$! 81% of government workers have defined benefit pension plan while less than 18% have one in the private sector. Talk about the classic 80/20 split. That isn’t great for a lot of retirements, but what is more concerning is the huge liability the government keeps growing for having those type of pension plans.
I should know. I work at a crown corporation that got rid of defined benefit plans for new workers about 20 years ago. Which is precisely what the government has to be thinking about in the long term with this. By shifting plans for new workers you can then contain the cost to the taxpayer…ie me and you. Not to mention on an early retirement perspective, you really don’t want to be tied to a given employer for the next 20 years. I rather have the cash and be able to leave when I like.
Of course this is hardly just a federal problem, all levels of government have similar cost issues and pension issues. I know there was discussion on my local city council in the last year with regards to not wanting to raise taxes purely to fund pension plans. You can bet that went over like a lead balloon with the unions involved.
So overall, I can see the next few years being very hard on defined benefit pension plans as struggling governments at all levels take a hard look at those increasing costs and shrinking revenues.
What is your thoughts for the future on defined benefit plans? Keep them, cut them or do you wish you had one?
