Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

Time running out for Tax-Loss Selling

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Christmas Eve and New Years at midnightNot to put any pressure on anyone trying to finish their Christmas Shopping, but Wednesday, Dec. 24 is also the last day Canadians can sell stocks for tax-loss harvesting purposes.

You need three days to settle trades so next week just before New Year’s will be too late. Christmas on Thursday is obviously a holiday and Canadian markets are closed Friday for Boxing Day.

Americans have a little bit longer, since U.S. markets will be open part of the day Friday.

More details in my current MoneySense blog.

Free to Be: A Lesson in Financial Independence

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The guest blog below by certified financial planner Matthew Ardrey followed a discussion we had on social media about the distinction between traditional retirement and financial independence. Matthew, who is with T. E. Wealth, uses a definition of financial independence that is virtually identical to the one we use on this site, right down to having a paid-for home. We especially like this line: “One can be retired and not financially independent or vice versa.” Over to Matt:

MattArdrey
Matthew Ardrey, T.E. Wealth

By Matthew Ardrey, CFP

Special to the Financial Independence Hub

I was first introduced to the concept of retirement as a young boy, when my grandfather retired from the TTC on his 65th birthday. I understood that he no longer worked, and that this is what you do when you reach 65. From the eyes of a child, it seemed like a far away notion.

It wasn’t until 2000, when I started working in the financial services industry, that I was properly introduced to the concept of financial independence as it differs from retirement. The proprietary financial planning software we used at my workplace did not have a retirement calculator. Instead, it had a “Financial Independence Needs” analysis tool. As I was young and green, I saw it as a fancy way of saying retirement planner. Through the benefit of experience, I would soon discover that financial independence was something else entirely.

Retirement vs. Financial Independence

Retirement, by definition, is the cessation of work with the intent of not returning. Financial independence, on the other hand, is having sufficient financial assets to have the choice about whether or not you continue to work. So, one can be retired and not financially independent or vice versa.

When I explain financial independence to my clients, I let them know that the main differentiator is freedom of choice. If you are not financially independent, you have no choice but to continue working if you don’t want to alter other aspects of your life. Once you are financially independent, you can choose if you want to continue to work in the same capacity – or at all. This freedom to choose is empowering and it’s what I encourage all of my clients to work towards.

How to Get There

I’m often asked how one can get to this wonderful nirvana known as financial independence. The first step is to pay off your home. By having a debt-free residence, you have eliminated what is most people’s largest single expense. Without this hanging over your head, you have freed up significant cash-flow.

The second step is budgeting – both before and after you have reached financial independence. Before, determine what you will need to save to reach your goals, and pay yourself first. After, understand what and how you spend to determine if you have accumulated sufficient assets in the “before” stage.

Know Your Asset Returns

Understand the return on the assets that are funding your freedom. Which assets in your portfolio are generating income or appreciating, and at what rate are they growing? How are taxes affecting these returns? These are questions to which you should know the answer, as small changes in that rate compounded over a long period of time can have a significant effect.

Costs matter, period. Focus on the cost/benefit relationship of your investment structures. Benchmark both what you make and what you pay to make it. If you find that the costs are inordinate while the performance is average or worse yet, lackluster, take steps to fix the cost/benefit. Even better yet, get the jump on “CRM2” by asking your advisor to fully delineate all costs pertaining to your investments and what services are offered in exchange for these costs.

As I guide my clients towards their future goals, I find the word “retirement” is used less and less in my lexicon. When my clients leave the workforce, the pursuits they undertake tend to be much different from my grandfather’s, who retired 35 years ago. What they are pursuing is the freedom to make their life whatever they want it to be.

Matthew Ardrey is a Certified Financial Planner with T. E. Wealth. He can be reached at its Toronto offices here. He is also on Twitter as @MattArdreyCFP. 

Why I Pushed My Findependence Day Back 5 Years

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robb-engen
Robb Engen, Boomer & Echo

By Robb Engen, Boomer & Echo

Special to the Financial Independence Hub

Last summer I thought I’d be financially free by 40. Reality – and unplanned expenses – set in this year and I’ve adjusted that ambitious projection by five years. I’m still on track to reach a net worth of $1 million by the time I turn 41, but financial independence will have to wait a few more years.

Here’s why:

Remember, financial independence doesn’t necessarily mean retirement. It simply means the date your income from investments exceeds your day-to-day expenses so that you no longer have to rely on regular employment to meet your needs.

My initial projection was indeed ambitious – with us having a paid-off mortgage by 2020 and increasing the income withdrawn from our business by 100 per cent (from $3,000 per month to $6,000).

But borrowing $35,000 to develop our basement this year meant we couldn’t continue our aggressive mortgage pay-down, and a four-year car loan has cut into our ability to save as much as we wanted.

That’s okay – on paper the original plan didn’t factor in these expenses, plus I hadn’t fleshed out exactly how I’d make those numbers work. Now I have a better idea, but unfortunately it’ll cost us five years. Here’s our financial Freedom 45 plan:

Financial independence at 45

In late 2016, once we pay off the HELOC and car loan, we’ll have $27,000 per year to save toward our ‘findependence’ goal. With that amount, we’ll put $12,000 into my RRSP and $10,000 into our TFSAs, plus throw an extra $5,000 payment toward our mortgage.

That pushes our mortgage freedom date back to January 1, 2025. At that time, our home should be worth $600,000 (using a conservative 3 per cent annual growth rate), my RRSP should be worth $380,000, tax-free savings accounts should total in excess of $150,000, and the commuted value of my defined benefit pension will be roughly $310,000.

The key to paying our monthly expenses after financial independence will come from our business income. We currently withdraw $3,000 per month from our small business, which includes income earned from three websites, freelance writing, and from my fee-only financial planning business.

My original plan showed business income increasing to $6,000 per month in five years, but without any clear path to explain how to double revenue. And, after losing my main freelancing gig at the Toronto Star, this goal seemed unrealistic.

But the fee-only planning service has gone better than anticipated – earning $10,000 in less than one year and expected to grow to $18,000 in year two as existing clients stay on and I continue to add one or two clients per month.

After completing the CFP certification in two years I’ll have the opportunity to ramp up my efforts and potentially offer fee-only planning services full-time. At that point, between existing and new clients, the service could bring in roughly $36,000 per year.

My three blogs collectively earn about the same – $36,000 per year – after expenses and so if I can maintain or increase that income then I’ll be able to meet my $6,000 per month goal for business income.

Our projected expenses haven’t changed. After the mortgage is paid off we could live comfortably on $36,000 per year, which leaves the additional $36,000 of income to go toward taxes, short-term savings, and retirement.

Final thoughts

A financial plan is just words on a page unless you commit to taking action. Even if your financial independence date seems like a moving target, it’ll become more precise as you monitor and update projections based on your true reality.

While it’s disappointing to push financial independence back five years, it’s comforting to know that I’m zeroing in on a target date that’s based on reality and not a wild projection.

Editor’s Note:You can find the original version of this blog at Boomer & Echo earlier this week, here. Note too the several comments at the bottom. When we can coordinate at both ends, we hope to make Robb or Marie’s blog available here as many Thursdays as we can manage. Also, in his original headline, Robb used the phrase “Findependence Date.” When I asked why not “Day,” he said he “didn’t want to steal your thunder.” I realize that good bloggers respect others’  intellectual property but let me make it clear that I’m fine with people using the phrase Findependence Day and Findependence. Half the point of this site is to bring these terms into general usage and displace “Retirement.” — JC

If you can’t take the pain of plunging markets, don’t watch

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The Financial Post ran this column by me this weekend about my take on the market mayhem of the past week, most of it triggered by plunging oil prices.  While I’ve chosen to put this in the Wealth Accumulation section of the Hub, it occurs to me that the way things are going, it could also be in Decumulation: albeit not the kind of Decumulation we had in mind when we created the section!

For convenience and archiving purposes, I’ve included the full piece below:

Depositphotos_19057551_xsBy Jonathan Chevreau

The worse it gets, the less I look and the less I act. When it comes to market mayhem, I firmly believe that the time to sell is when stocks are up and everyone is buying.

Except maybe in 2008, when it seemed financial Armageddon was genuinely possible, panic seldom serves the investor well in the long run. I understand the psychology of panic as markets sink: fear takes control and investors become convinced that with every passing day, their wealth will vaporize. And yes, if you knew for sure that markets were due for a 10% correction or 20% bear market, then it would make sense to sell.

But we don’t know for sure what tomorrow will bring, and certainly not what stock market averages will be. We do know that interest rates right now are still near historic lows, even if they are expected to start moving higher in 2015. We know that in the long run, stocks are the best-performing asset class, even measured against fixed-income investments that pay more than what is on offer late in 2014. And therefore, for time horizons of five years or longer, investors accept – or should accept – that a significant portion of their wealth should be invested in stocks.

Preferably quality dividend-paying stocks spread across the major economic sectors. Barring that, a broadly diversified “Couch Potato” portfolio of index funds or exchange-traded funds, with exposure to all economic sectors and roughly equal geographical exposure to Canada, the United States and international markets outside North America.

Did they say were plunging or plummeting?

 “But markets are plunging!,” the recent convert to stocks cries. Or worse, plummeting, if indeed plummeting denotes a bigger drop than a mere plunge. You can be sure that headlines will make liberal use of both verbs if this correction continues.

So what to do? If your mix of investments was decided in happier times and you’re comfortable with the amount of risk you had agreed to, then I’d say do nothing. Or, if you have sufficient cash reserves, I’d say buy stocks while they’re on sale. Certain sectors – oil stocks and commodities in general – certainly appear to be on sale. Oil is a cyclical commodity and it seems like only yesterday when the doomsayers were predicting $150 or $200 oil. That day will likely come again but in the meantime many people and companies benefit from rock-bottom oil prices: airlines to name one, and everyday commuters to name a second group of beneficiaries of low-priced oil.

Pros were buying this week

When the mayhem really started to gather steam this week, I was at a meeting with a group of semi-retired professional pension managers and investors. We barely talked about the markets over the two hours we had together, although when it did come up peripherally, one said he was buying the market across the board at these levels, while another was scooping up specific individual oil stocks.

But what if you’ve come to the sickening realization that your risk tolerance isn’t quite as hardy as you thought it was? If you were 90% in stocks but really can’t handle a 30 or 40% potential drop in more than half your portfolio, then you know your optimal asset allocation would be closer to 50% stocks to 50% bonds, not 90% to 10%. But “rebalancing” your investment mix is much better performed when stocks are rising, not falling. You’ve heard the expression “catching a falling knife?” Selling even more stocks into a broadly based general market sell-off is not a recipe for making long-term profits in the stock market.

Consolation of tax-loss selling

However, since it is tax-loss selling season and if you had previously booked gains on some winners in a taxable portfolio, you could sell a few losers right now and get your cash up to a more tolerable level, and tax-wise merely offset the previous gains. That way, at least, the taxman would share your pain and if markets worsened in the coming weeks or months, you’d have a bit of cash to snap up some real bargains, if indeed they materialize.

Of course, the declines could end as suddenly as they began. Personally, I am taking no action at all during this sell-off. And as my financial advisor often reminds his clients, if you’re in dividend-reinvestment plans, as stocks fall you’ll be reinvesting in those stocks at slightly better prices. High-yielding dividend payers will start to pay out even more tempting amounts. When stocks previously paying out 3 or 4% start yielding 5 or 6% (as the stock values themselves fall), I’d be tempted to load up on more, as many did at the depths of 2008.

Until then, try not to overdose on the day-to-day melodrama of crashing markets. Go for long walks, read fiction or otherwise get your mind off paper losses that may prove to be merely temporary.

Jonathan Chevreau recently launched a North American web portal focused on financial independence: http://www.financialindependencehub.com. He can be reached at jonathan@findependenceday.com

 

 

 

How Behavioural Biases Stopped Me from Becoming an Indexer

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We’re delighted to run the first of what we hope will be many contributions from the popular Boomer & Echo blog.  The topic is something I suspect many investors can relate to if they have an intellectual understanding of the powerful reason for indexing but are unable to fully commit to it because of the behavioural biases Robb Engen so eloquently describes. Robb is the “Echo” part of Boomer & Echo and you can read all about him here.  The piece originally ran in September. Link to the original is below.

robb-engenBy Robb Engen, Boomer & Echo

Special to the Financial Independence Hub

I’ve spent the last five years convincing myself – and many of you – that I’m a sophisticated do-it-yourself investor with a sound strategy that will outperform the market over the long run.

My dividend growth investment approach has indeed performed well, returning over 16% per year since 2009. But the stock market in general has also been red hot over that time. It’ll take another bear market cycle to determine whether my investment returns were skill, luck, or something in between.

In the meantime, since launching our fee-only planning business earlier this year, I’ve been recommending a couch potato investment approach to anyone who’ll listen. I truly believe that 99% of investors would be better off indexing their portfolio with three or four low cost, broadly diversified ETFs.

Related: Why investors should embrace simple solutions

So lately I’ve started to wonder, what makes my situation so special? Why stick with a strategy that I don’t even recommend to my clients?

The answer lies in a whole bunch of hidden behavioural biases that cloud my judgement – framing, recency bias, home country bias, and overconfidence.

Framing

It’s difficult to part ways with a successful investing approach.  Selling a portfolio of winning stocks – my babies that I’ve nurtured through this five-year bull market – just doesn’t feel right. But if I were sitting on $100,000 in cash instead of stocks I’d have no problem starting a couch potato portfolio today.

Recency bias

As the bull market rages on and my investments continue to perform well, it gets harder and harder to recall what a bear market feels like and what I might do if my investment returns start to lag my benchmark.

Related: How are your investments performing?

This year my portfolio has trailed its benchmark by about one per cent – not huge, but enough to make me pause and reconsider my approach.

Home country bias

When I started my DIY portfolio, I bought the 10 highest yielding stocks on the TSX. While I’ve refined my stock-picking approach since then, I’ve stuck with Canadian dividend payers even though Canadian firms make up a tiny slice of the global economy.

Making matters worse, instead of keeping my Canadian dividend stocks in a TFSA or non-registered account, they’re held inside my RRSP. Not an optimal strategy when it comes to tax efficiency.

Overconfidence

It’s hard not to be overconfident when you’ve beaten your benchmark by a full 3% per year over the last five years. But even the best investors will eventually suffer periods of underperformance.

Related: 5 lessons learned about investing

Why wait for that to happen before accepting the inevitable? Indexing gives me the best chance of achieving my investment goals over the very long term.

No shame in becoming an indexer

Norm Rothery had a great piece in the Globe and Mail in mid-September about a DIY investor whose U.S. stock picks had under-performed the market by a good 3% per year since 2007. The investor decided to stop picking U.S. stocks and move to index funds instead – opting for Vanguard’s FTSE All-World ex Canada ETF (VXC) to get his U.S. exposure.

Rothery goes on to write:

Scott’s decision to stop picking U.S. stocks is an uncommon one. Most self-directed investors remain far too confident in their abilities for far too long. Instead, disappointing long-term results are often attributed to misfortune or peculiar circumstances rather than the lack of a competitive edge.

There is no shame in admitting that you’re not the next Warren Buffett. The vast majority of investors aren’t. Those who figure it out are likely to improve their returns dramatically by following simple low-cost mechanical methods such as investing in low-fee index funds.”

Speaking of Buffett, the ‘Oracle of Omaha’ has famously touted the benefits of a low cost, broadly diversified investment approach, saying that most investors would be better off in an index fund rather than trying to beat the market by picking stocks or actively managed mutual funds.

Final thoughts

The more I read about, write about, and teach others about investing, the more I’m convinced that passive investing is the right approach.

It’s not that I stopped believing in a dividend growth strategy – it’s a fine approach that many investors will have success with – but it’s not ideal for my RRSP.  And frankly, the time and effort needed to manage it properly may not be worth it in the long run.

I suspect it’s only a matter of time before I pull the trigger and become a full-fledged indexer.

Robb Engen is a fee-only planner and personal finance blogger at Boomer & Echo. He lives in Lethbridge, Alberta with his wife and two children.

This article  originally ran in September of this year.  Even if you read the Hub’s version above, it’s worth clicking through to the original to read the more than 60 comments appended to it.