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Monday, March 27, 2017

How Compounding Really Works

Posted by Tim Stobbs on June 30, 2016

It is interesting to me that while people sort of understand how compounding works with their investments.  They have been told they should start early and by reinvesting it will grow all by itself. Yet they really don’t get it on some level.  The reality is your first $100,000 in investments will feel like a climbing the biggest mountain in existence and then after that it gets significantly easier to build up your investments.  But rather than discuss this in a broad point of view, I thought it might be useful to go over my investment net worth and point out the time it took to grow between each $100,000 mark.

In the beginning, we have nothing.  Actually with student debt we have less than nothing.  After leaving university and getting married at age 22, my wife and I had debts around the $60,000 mark.  Yet we managed to get some jobs and start paying down our debt and also when I had the option of getting some free money at work via a RRSP matching program I took it.

Now guess how long it took us to save a house down payment, pay off our student loans and save our first $100,000 in investments?  Five years? Nope. Eight years? Nope, keep going.  In fact, I was 32 years old when we managed to hit that threshold.  It took us 10 years  (or 120 months) to save that much money and the thing was we were trying a big harder than the average person.  Now if that sounds like a prison sentence because in some ways it was.  THAT is the difficulty with saving your first $100,000. So when people talk about starting early, this is exactly what they mean.

Depressed yet?  Good, because now we get into the good news.  It gets easier after that first hurdle.  I mean a LOT easier and it just keeps getting easier from there.  Case in point it only took 3 years (or 36 months) to reach $200,000.  Or putting that in context it took 70% less time than the first $100,000.

Then it just kept getting easier.  Hitting $300,000 only took 16 months, so that would be 86% less time than the first $100,000.  Basically that one happened so fast it was like getting investing whiplash as compared to the glacial slow pace of the first $100,000.

Ironically getting to $400,000 took even longer at 19 months, but that did include the collapse of oil prices so somewhat understandable that it would take a bit longer, but still roughly about a 1.5 years.

Finally, while I’m not there yet, my current projection would be to hit $500,000 around Feb of 2017, so that would be only 13 months long, which if correct would be about 90% less time than the first $100,000.  And of course if you keep going it just keeps getting more and more easier to add wealth (no wonder the idea of working just one more year is so popular for people that are almost retired).

The point of all of this is when people give you some well meaning advice to start earlier even with a little bit of savings: PLEASE FOLLOW IT! You will be further ahead in the end and guess what, you don’t even need to consider retiring early when you start out.  Oddly enough you will have lots of time to make the decision in the future and guess what, the worse thing that happens is you have a large amount of savings to make other choices in life.  Some flexibility isn’t a bad thing, after all you never know where you are going to end up so some extra cash to consider starting a business, buying a cottage or taking a unpaid leave from work.  Do what ever you want, just please consider saving something to start climbing that mountain now.  Good luck on your climb.

The Retirement Investments

Posted by Tim Stobbs on June 23, 2016

On my last post, Sherry asked for a bit more details on our investments and how that relates to our plan in retirement.  So basically, now that we have built the money up, how exactly does one use it to live on?

To be honest, while I had some vague ideas on this before I only really got to thinking about this in detail this year.  So I can say I’m not firmly decided on all of this, but this is the current plan. Please note, I’m not predicting the exact amount per account but I will give approximates if I can.  Our money at the end of this will be divided into the following groups:

  • Pension and Locked In Funds – the stuff with age limits on when I can actually use it.
  • RRSPs – Which actually don’t have an age limit, they just function like taxable income when you take the money out.
  • TFSAs – Which can be pulled out with no tax implications.
  • Taxable Investments – So your basic investment account where you pay capital gains if you sell something for a profit.

First up is the pension money, which the vast majority can not be accessed until I’m 50.  The good news on that particular account is when I leave work I am allowed unlock my voluntary contributions and move it to an RRSP.  Crudely this is about 1/3 of that accounts value (current value is ~$140,000).  I do intend to do this to allow the most flexibility on that money.  Yet even with that option I will likely have more than $100,000 when I retire that I can’t use for the first 10 years or so.  So the trick for this account is to basically leave it alone and let it grow until I need it more a more traditional retirement later on.  I intend to leave my  remaining pension right where it is for the long term as the fees are low and I’m not required to move the money out of the pension plan.

Next up is the RRSP accounts (current value is ~ $130,000) which I will be trying to reduce the tax on these account withdrawals as much as possible.  So even if we don’t need the money I will likely take out the full amount up to our basic income tax deduction each year (if our work income doesn’t make us use that up first).  Any unused money would then just get shifted over the TFSA accounts. The other side issue with the RRSP accounts is I’m accepting the fact I may be using some of the principle in these accounts to offset the fact I can’t access the pension money. The RRSPs are all index funds which do spin off some income but the vast majority of the money here will come from selling small amounts of the funds annually (or semi-annually – I’m still debating this point as there is the issue of withholding amounts for tax purposes on money taken out of an RRSP).  So the hope is the mainly use the capital gains in these accounts, but as I mentioned I’m okay dipping into the principle until I turn 50.

The TFSA accounts are a different beast all together.  These accounts are invested in individual dividend paying stocks and the plan here is to never touch the principle amount but rather just harvest dividend payments out of the accounts.  Yields here are averaging just over 5% currently on about $130,000 right now (so that will be slightly higher when I retire).  The longer term plan for this account is to grow it as we draw down the other taxable and RRSP accounts when we have contribution room available in the TFSA accounts.  That additional money will likely get used to cover living expenses, its just a matter of when we use the money.

Then the last pool of cash is the taxable investment account.  Currently this is rather small (~$35,000), but since we are maxed on TFSA and RRSP contribution room so it will grow to be around $60 to $70k.  Yet a portion of that will be our emergency cash float which will allow us to not pull money out of investments for up to a year in the event the markets take a major decline.  In the long term it would be nice to move that cash float into the TFSA from the taxable investment account, but given the low tax implications of that we will likely not do that anytime soon or do it slowly over a number of years. Except for the emergency cash float we will use up this money towards the early part of our retirement to ensure we keep any taxable capital gains to a minimum and again if required I would be okay using some of this principle money.

So long story short, we mainly plan to live on capital gains and dividends, but I am okay touching a bit of the principle if required.  I will actively avoid doing that (by having some employment income during the first five years), but as I previously noted I am fine with downsizing the house in the medium term to shore up the investments if required.

Hope that helps.  Let me know if you have any questions.

The Last $100K

Posted by Tim Stobbs on June 8, 2016

So while I know I owe you all a net worth update with all the details I will provide the following little tidbit of net worth news: we just broke $450K in investments at the end of May.  This number may seem a bit odd to be excited over, but I should provide some context to help you understand it.

First off my floor number for leaving work is to have investments of at least $550,000 (plus the already paid off house), so now I’m officially are on saving the last $100,000 to reach my goal.  Being this close to the end of my goal is interesting as I can now actually make a fairly realistic guess of when I will hit that floor value (late 2017 if you must know).  I do intend to actually keep saving (and working) past that number a bit to add some cushion in for a few items like some renovation savings and a pool of cash to use to pay our expenses in the event the stock market falls right after I leave my job.  So rather than fixing the dollar value when I will leave work I’m leaning instead to merely fixing a date in my head in early 2018 and worry less about the exact number of investments when I leave my day job as long as it is past my floor amount.

The second reason that $450,000 in investments is important is that is actually enough money that I am now financially independent on our basics expenses. So when I talk about basic expenses I mean merely bills paid, food on table and nothing else.  No fun money, no vacation, no luxuries, no wine or beer (gasp and sob)! Obviously I have little to no interest in actually leaving paid employment at this particular level, but it does add to the comfort of knowing that if things went really bad suddenly and I was laid off we would be fine for an indefinite period of time.

Of course, some of you may be doing the math on that $550k value above and think I’m bloody well off my rocker for considering leaving work with only that much saved, but I should point out a few important facts:

  • Our plan is based on a spending up to a max of 4.5% of our principle each year (not the usual 4%).  I’ve investigate the risks of pulling out slightly more money I am comfortable accepting them.
  • My wife fully intends to keep working at her daycare, which provides about $6000/year income to the house for the next five years.
  • I fully intend to earn some money myself by working part time at a fun job earning on average $6000/year for the next five years (after an initial 6 month detox period of no work right after I quit).
  • We will be getting an increase in our child tax benefits which will finish funding our boys RESP accounts for us.
  • We are comfortable downsizing in the medium term (5 to 10 years out) and shifting up to $75,000 from the house equity to investments in the event our investments do worse than planned.

Overall I’m happy with plan and the potential risks.  I’m working out the exact details in a spreadsheet model the is broken down by the month from now until 2023. I’ve also setup myself a list of homework assignments to complete before I leave work to determine any issues I have misjudged like reviewing our spending data from the last four years, checking out extended health insurance options, planning my potential weekly schedule ( answering that question of what do I want to do all day) and more.  I’ll provide a post on that in the future.

So I expect there will be questions on all this, so please leave them in the comments I will attempt to address the in a series of posts coming up.