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Friday, May 6, 2016

It’s About Risk Management, Not Elimination

Posted by Tim Stobbs on April 25, 2016

Perhaps one of the more confusing things out there for people planning their retirement is what to do about risk.  What happens when you live longer than you planned? What if you kids needs help paying for a wedding?  What if your investments have a lower return than expected?  What if inflation is higher than you planned?  The potential problems are basically endless if you want to keep thinking about it.

As a result most people tend to be conservative when they start their planning for retirement trying to account for those risks.  They include a lower than expected investment return, inflated spending estimates and even high inflation values.  Yet this line of thinking can get out of control and people end up leaving the world of risk management behind and try to eliminate all the risks.  Why? Because they are frighten that something will go wrong.

Yet that really isn’t a healthy approach to the problem.  The main issue is life never goes according to plan.  Think about your last weekend, did everything happen just the way you wanted it to?  Likely not, now take that problem and magnify it over 40 years or more.  Ah, you likely see the full scope of the problem now.  Focusing on eliminating all risks creates a situation where your odds of retiring earlier keep dropping as you work longer trying to cover every remote possible thing that could go wrong in your retirement plan.  You are so focused on the next risk, you end up over saving for your retirement and thus have now increased another risk of not getting enough time to enjoy your own retirement.

On the other hand, I’m not suggesting you go in with nothing done about risk, that would also be foolhardy.  Instead I suggest you shift gears from removing or eliminating risk to just managing it.  When you manage risk you do try to be defensive on some items and account for them in your planning.  While others may in fact be too remote of a possibility or too minor of a problem to bother managing at all.  In those cases, you accept the risk and do nothing.  This might seem odd, but in fact in business this happens all the time.  For example, you can accept a contract with the default wording for a small purchase and accept that if something goes wrong you will just deal with the issue and perhaps be out some money.

For example here are a few items in my retirement plan and what we are doing about managing the risk:

  • The End of the World – Frankly if that happens my plan likely won’t matter so I’m just going to accept that risk and not even bother trying to plan for it.  If society ends, you likely have other issues to worry about – like getting food rather than tax issues with RRSP withdrawals.
  • The End of the Stock Market (aka 80% decline in stock values) – The odds on this occuring for EVERY stock is beyond remote and similar to the above.  So again, I’ll accept the risk on this one.
  • The Stock Market declines 10 to 20% – Alright, this is a reasonable possibility in a given year.  So the plan here would be to cut back on spending where possible, keep of float of cash for a year’s worth of expenses to avoid selling in a major downturn and if need be I can do some part time work to cushion the blow to our finances even further.
  • My spouse dies early and I no longer receive their Old Age Security (or vice versa) – Again, with an accident this is possible, which is why I only included 50% of our total estimated Old Age Security payment in  our plan.  That way if things go well we have some extra money, if not, this won’t put us in the poor house either.
  • Our car breaks down and needs to be replaced, the house roof is damaged in a storm and the fridge dies (all in the same year) – While individually these aren’t a big deal in a given year the compounding effect of having all of these at once may drain the extra cash to very low levels.  So a few options exist like using a line of credit to borrow some of the money to spread the payments out over a few years.  Yes this costs some interest, but it allows us to keep some cash reserves in case something else occurred. Also there is insurance to cover the car and the house if the event true accidents occur for the cost of the deductible.
  • We need major dental work after retirement – In theory I could get some insurance to smooth this cost out or have the option to just self insure (ie: don’t pay any premiums and accept the risk).  In our case, we have fairly good teeth overall and I don’t see much risk here.  So I’m going to just ignore this one and self insure.

The idea of course is to put your mind at ease by going through some of the more obvious problems and determined ideas in advance on how to solve them.  Then of course you can also accept the odds on the more exotic situations and do nothing.  Just keep a few management tools in your back pocket like: one year of spending saved in cash, appropriate insurance coverage, the option of picking up some part-time work when you are younger, selling stuff you don’t use anymore, the potential solutions are like the problems: endless.  Just make sure you have several of them ready to go in case you need a few.

The Last Stroll

Posted by Tim Stobbs on April 8, 2016

I feel like I should almost be walking around my office with a sign on my back that says “The End is Near,” so I can stop talking around the issue of how much longer I plan on working.  While I don’t plan to formally commit to a given date I am thinking of something in the range of late 2017 to spring 2018 which of course even talking about to people gets them a bit nervous.  It’s like they suddenly all realize that when I talked about taking an early retirement for the last decade I was actually serious about doing it.

I don’t provide an exact date because it depends on several variables like how much renovation work we do before I quit on the house or do we do that afterwards, how the stock and bond market does in the next few years and what other opportunities come up in the mean time.  So for now I’m keeping things vague and plan to give more formal notice when I get closer.

What has been interesting as I start to close in on my last two years or so of my engineering career if that fact I’m actually already starting to shift gears in my head to my post full time day job life.  I’ve signed up for a online writing class and I’m working on a series of novels right now.  Then I have to get back to editing the novel I finished last year and wondering when I should start putting out the submission letters to publishers. I’m also thinking about when I should start up a new writing blog and when I should finally shut down this one.  I do want to provide some post-retirement updates to those that are wondering how it all turns out but at the same time I can’t see keeping this blog going indefinitely.  Then I’m also working on plans on how exactly to pull the money out which accounts and when.  Then also deciding what exactly I’m going to tell people at parties when they ask what I do for a living: do you go with ‘private wealth management’ or ‘writer’?

Yet oddly enough the one pain point I realized during this last stroll was: I will no longer be an engineer at some point.  I will likely cease membership in my professional association after a few years post work and no longer even bother wearing that iron ring and the thought of this actually scared me.  Why? Because that title as been a particular part of my identity for twenty years now.  I’m so used to thinking of myself as an engineer and introducing myself this way that breaking that habit will be particularly painful for me to do.  After all saying it was an excellent short hand for how to describe me to others, so I could say “I’m an engineer” which would translate to: smart guy, good with numbers, geeky, and may have issues with social situations.

On the other hand, dropping that title from my identity will provide an opportunity to define myself without the usual baggage.  This of course is rather good since I in fact do well in most social situations and aren’t so geeky that I can’t talk to regular people.  In fact, one of my highlights to employers has been you get the geeky engineer who can actually explain stuff to the non-technical crowd.  So when I free from that title I can be just who I am rather than my old stereotype.

In the end, I can to really ask myself: who do you want to be?  I don’t need to conform to a stereotype so I’m free to just be myself with all the complexity that implies.  It’s a bit of an exciting time to have that opportunity to reinvent yourself, but of course also a bit confusing to reshape an identity that has been core to my life for 20 years.

When the Government Thinks Your Poor

Posted by Tim Stobbs on March 4, 2016

I have a confession to make to you all.  I generally ignore our Child Tax Benefit statement that comes in from the federal government each year.  Why? Well with our combined income we don’t really get a whole lot of money from it and second all of the money I do get, plus some of our own, goes immediately into the kid’s RESP.  So from my point of view the money doesn’t really exist since it only passes through my bank account on the way to the RESP account.  I think of it as my kid’s money and not mine.

So when I did all my retirement planning I generally ignored any potential tax perks I may get when I leave full time work and our income sinks like a stone.  I knew we would be paying less tax but I didn’t really consider that we may qualify for any other benefits programs like an increase to our Child Tax Benefit.

Yet the other day it did occur to me finally that we would get a bit more Child Tax Benefit, so I finally sat down and plug our projected numbers into the government calculator.  Then my jaw hit the table when I saw the result.  See the screen shot below.

Child Tax Estimate

In my head I was expecting perhaps $100/kid per month, so $2400/year.  I certainly was not expecting $8,873 a year.  So how the hell did that happen?  Well it appears that there was a high degree of dumb luck on the numbers when I looked into it.  I figured we would end up between my wife we would have a taxable income of about $26,000/year between RRSP withdrawals and some work (recall my wife will keep running her daycare after I leave work which is her choice).  The rest would come from TFSA accounts so won’t impact our qualification for government programs.  That $26,000/year number is just under the threshold to tie into the National Child Benefit Supplement which for two kids under 18 is fairly generous (over $350/month), then we would also qualify for a few other programs like the GST credit which would give us a bit extra money.

Of course all of this is set to change with the next federal budget as they have previously promised to overhaul these particular benefits during the election campaign.  So I can’t depend on these numbers but it does provide me with some useful input towards my retirement planning.

First off it tells me that I will likely get enough government benefits that I shouldn’t need to save any additional money to finish funding the kid’s RESP account.  I had previously estimated I would need around $20,000 stashed away for that prior to leaving my day job (I had assumed five years of contributions at $4000/year).  But now it entirely reasonable that we should get enough government funds to cover that amount.

The second particular useful fallout of likely getting more benefits than I thought would be the fact this provides a minor cushion to my plan.  As you may be aware one of the particular risks of retiring early and living off of investment income is if you get a series of bad returns on your investments in your first five years, you may end up running out of money in the long run.  So to combat this issue I have a series of backup plans on the ready to help cushion the blow should anything go wrong during those critical five years including: being able to cut back on some spending, having a year’s worth of spending money put aside, being willing to pick up some part time or consulting work in those first five years…you get the idea.  This unexpected money just provides an additional cushion, if we ended up needing it.  On the other hand, if things go well, I would continue to not depend on the government benefits and just put the money aside for the kids.

Ah the joys of having a government think I’m poor based on income, just because I don’t tend to spend a lot regardless of our income.  So this was news to me, did anyone else out there with kids look at this when planning their early retirement?