Six Steps to Financial Freedom, Step Three
I apologize for not posting this on the weekend. I know many of you have come to expect my Saturday morning posting but circumstances got in the way this week and things go pushed back. Besides, I never intended to posts only on Saturdays, that’s just a rhythm I have fallen into from time to time, it’s good to mix it up once in a while.
Anyway, here goes step three in the six steps to financial freedom. – Rule Retirement.
Many people think that this should be the first step, or at least the second step but I have placed it as the third step for a couple of simple reasons.
First, if you are deeply in debt, especially high interest debt like credit cards it’s pretty much impossible to make any headway on your retirement dreams anyway. At the end of the day it’s all about your net worth, if you have a negative net worth, meaning if you sold everything you owned you’d still be in debt, or you are paying a higher interest rate on debts than you can earn in savings than it doesn’t make much sense to save. You’re still falling behind in the race, pay off your debts first then save.
Secondly, if you are at risk of losing it all due to dumb luck or crazy circumstances, i.e. death, injury or a prolonged illness, either yours, your spouses, your kids or someone else close to you need to protect your assets as you build them and that infrastructure needs to be in place before you go too far or it might already be too late.
So now, once you have Dominated Debt and Regulated Risk you are ready to start Ruling Retirement.
Step three necessarily begs two questions; how much do I save and where do I put it?
The simple answer is of course, as much as you can and at the highest possible interest rate. But the simple answer is not always easy.
In terms of how much it is difficult to put a number on it. My personal rule of thumb is 15% but it really depends on too many factors, age, risk tolerance, how much money you need to live on in retirement etc, for me to recommend that to everyone. In order to answer the how much question for you we would need to sit down and have a very frank discussion about where you are on the first two steps, where you want to be and when you want to get there. So for now the only answer I can give you that makes any kind of sense is “as much as you can.”
The where do I put it question is a bit easier to answer, but not much easier. In Canada we have two retirement savings vehicles, four if you are lucky. These are not investments, they are tax treatment options, the actual investments they hold can vary but before we get into a discussion of where to invest we first need to decide what vehicle to use. First off we have the TFSA or Tax Free Savings Account that holds after-tax dollars and grows the interest tax free. Second we have RRSPs, or Registered Retirement Savings Plans, which hold pre-tax dollars but are taxable as regular income when you remove the money. Third, if you are lucky enough to work for a government agency or another large employer you might have a pension plan which is taxed in the same way as an RRSP, pre-tax going in, taxed coming out. And fourth, if you are really lucky you have enough money not to need to worry about taxes and you simply invest after tax dollars and pay taxes on the growth you earn along the way, this is what we call a non-registered investment.
If you make less than $40,000 per year the tax advantages of saving in an RRSP don’t make much difference so you’re better off in a TFSA. You can’t put more than 18% of your income in an RRSP or a pension and if you make more than about $125,000 per year the tax deferral amount is capped so you have to put anything over and above that in a non-registered vehicle.
Once we’ve decided how much, and which vehicle to use, the last question is where. This is now a question of risk. The simple answer as I mentioned before is, at the highest interest rate possible. The highest interest rate is usually the most risky however, so you need to balance your risk tolerance with your time horizon and your stomach for potentially losing money in the short term. For most people with a time horizon of ten or more years I recommend a Balanced Growth Mutual Fund. We can usually get about 6-8% return on something like that with minimal volatility. But some people take exception to my recommendation of mutual funds, saying their either too risky or too conservative. A lot of people got burned back in 2008, 2009 because they didn’t understand risk or market cycles and that’s on their investment advisors, I personally take as much time explaining risk as I do anything else, if not more. There is a great saying in the investment business that goes like this, “the only people who get hurt on a roller coaster are the people who jump off”. If you don’t want to take the ride, then don’t get on in the first place.
Mutual funds are the simplest way for most people to get into the stock and bond markets without having to know a lot about how they work. In that regard Mutual Funds are really good, low maintenance, buy and hold investments that offer the most bang for your buck. If you bought in 2008 you lost a lot of money in 2009 but you were back where you started by 2011 and the markets have been steadily rising ever since. The key to all of this is to be able to buy and hold long enough to ride out the market cycles.
If you are risk averse or have a shorter time horizon then there are a number of more conservative options that may return 4 or 5%. But when we start looking at even lower returns, say 3% or less or if you are completely unprepared to accept any short term loses at all you might be better with just a traditional savings account or even using Life Insurance as an investment vehicle, more on that in Step Five and Six “Take Control of Taxation” and “Leave a Legacy”. Conversely if you enjoy a good roller coaster and have a longer timeline we can have some real fun getting aggressive and going for 10 or 12% return, just be prepared from some big swings in the value of your portfolio.
At the end of the day, Ruling Retirement isn’t rocket science. You just need to understand two things, number one, the greater the risk, the greater the potential return and two, the longer you can stay in the more you will take out.
For more information on Meekonomist approved retirement planning vehicles and investments contact email@example.com