Here’s a Q&A about Financial Independence conducted with Money on Trees. The first part of the interview was posted Thursday morning here, with the second part scheduled for next Tuesday.
Note that I’ll be giving a similar talk about Findependence, real estate and personal finance tonight in Brampton (Pearson Convention Center) for the Real Estate Investment Network (REIN). REIN members attending will receive an e-book version of the MoneySense Beginner’s Guide to Personal Finance, plus the just-published April issue of the magazine, and possibly a copy of Findependence Day.
One of the first acts of the new year for our family was topping up our Tax Free Savings Accounts or TFSAs. You’ll see a number of TFSA stories running this week on the MoneySense.ca web site, some of them from the most recent edition of MoneySense magazine, which I edit. Julie Cazzin’s feature story on the Great TFSA Race should whet your appetite on the potential of this vehicle, with the winner racking up an incredible $300,000 in his TFSA, and runnerups at $72,212 and $61,700.
Of course, such returns can come only from capital gains on shrewdly picked stocks, and probably concentrated positions in relatively risky smaller stocks. If you make the mistake of parking your TFSA in GICs or some version of cash, your growth will be negligible. Assuming you put in $5,000 in January 2009 and maxed out every year thereafter, with $5,500 a year ago and $5,500 early in 2014, you would now have $31,000 cumulative contribution room: six years worth. Of course, if you’re one half of a couple, then your spouse also has $31,000 room for a combined $62,000. That’s what I would call significant money: enough to buy a luxury new car or to put a down payment on a first home.
TFSAs are too good to use on spending
However, the tax allure of TFSAs is such that it seems a terrible shame to have to actually spend the money, when its potential to grow into a huge nest egg is such an enticing alternative. Fortunately, the bitter pill of breaking into capital is sweetened somewhat by the fact you can replenish the TFSA, so you’re not actually losing contribution room. Because you can’t repay until the following year, however, you’ll keep more tax-free growth by cashing out towards the end of a calendar year, rather than early in the new year.
Note that in the case of the big winners of the TFSA Race, the bigger the TFSA when you cash out, the more contribution room you’ll eventually have when you recontribute. So in the case of Jim Nykyforuk, if he were to take his entire $300,000 out this year, in 2015 he’d be able to recontribute the same $300,000, plus of course the new $5,500 room he and everyone will qualify for by January 2015.
Those are big numbers but as I wrote in the editor’s note for the current issue (Dec/Jan 2014), it’s unlikely that most TFSAs will have grown anywhere near that much, even if they are in stocks. The risk-takers who won the contest had plenty of other money in other vehicles and they were willing to risk the TFSA capital for a big win, fully understanding it’s as easy to strike out as hit a grand-slam home run.
Diversified equities more prudent
I wouldn’t even recommend that most people emulate those aggressive strategies. From my correspondence with the kind of readers who gravitate to a “Couch Potato” portfolio so often seen in the pages of MoneySense, a typical all-equity TFSA would have grown from the original $25,500 contribution room to somewhere in the low $30,000 range at the end of 2013. In our family, for example, our TFSAs ranged from $32,000 to $34,000 and as of the January 2014 top-up would be just shy of $40,000 each. (This includes our daughter, whose aggressive investing strategy was unveiled in MoneySense in an earlier feature by Julie: How TFSAs can make your child a millionaire; Dec/Jan 2013)
The temptation to dip into such growing nest eggs must be considerable for younger people but when you consider the power of tax-free compounding, I’d still urge most to keep their hands off their TFSA for 30 or 40 years. Yes, those who have maxed out to this point now have enough to buy a brand new car, but I’d urge them to instead go with a used vehicle or take advantage of zero financing or ultra low interest rate deals on new cars. The other big temptation would be to dip into TFSAs for a down payment on a home but here again, I’d look first at the Home Buyer’s Plan provision of RRSPs first, or perhaps hit parents up for a down payment.
TFSAs should be priority for those with modest incomes
I’d think most MoneySense readers are in a position to do BOTH an RRSP AND a TFSA contribution but for those who aren’t, the TFSA should probably get the nod. If you can’t do both, odds are your income is relatively modest, in which case you may be in a lower tax bracket, which in turn makes the RRSP argument less compelling. By the same token, if your salary is relatively low and you want to maximize future sources of government retirement income like Old Age Security and/or the Guaranteed Income Supplement, then again the TFSA is compelling: all withdrawals will be totally tax free and not trigger dreaded “clawbacks” of OAS or GIS. Say you’re currently 47 years old and have $10,000 saved in a TFSA. In 20 years, you could contribute $5,500 20 times, for another $110,000 (and probably more if the government keeps adjusting the limit to inflation.) Even if growth was negligible because it’s invested in laddered 5-year GICs or a bond ETF equivalent, let’s assume you can get 2.5% interest (a figure that will likely be much higher 20 years from now.)
Even with no employer pension or other sources of income, someone living on some combination of CPP, OAS and GIS taken at age 67 would be able to generate some $3,250 a year of safe interest income from a nest egg that (conservatively) might have grown to $130,000 over that time. That’s almost $300 a month, guaranteed and tax free.
If you put it into Canadian blue chip stocks, you’d have a much bigger nest egg but either way, it’s nice to have an emergency fund and a source of regular income that’s independent of what government authorities provide — my idea of a modicum of financial independence even for those with modest means. Yes, I realize it’s tough for some to put aside even $5,500: if that’s the case, then at least shoot for $2,000 or $3,000 a year, even if it means going without expendable luxuries like alcohol, tobacco, fine dining, lottery tickets or even the much maligned daily latte habit at your local coffee shop. Find just $50 a week for your future and you’ll be on your way!
As for dual-income couples making good money, to me it’s a no-brainer that the TFSA should be maximized each and every year, and managed for maximum (or balanced) growth. The moment you make your January contribution, you should start accruing for the next year’s installment, even if it means parking in short-term cash vehicles and paying a little tax for the balance of the calendar year.
What I call the “Findependence Day Model” dervived from the book is simply the combination of three things.
All three deal with cutting investment costs or brokerage costs. The first is using a discount brokerage to make your own trades, typically at $10 per transaction. The second is to take advantage of broadly diversified, tax-efficient and low-cost exchange-traded funds (ETFs), which can also be purchased at a discount brokerage.
And the third is to use a fee-for-service financial planner, that is, a planner whose services are billed either by time (usually by the hour) or by the project (as in a one-time financial plan) but NOT via annual fees levied as a percentage of client assets under management. The problem with the latter is it gets prohibitively expensive as wealth grows, unless the fees are tapered down accordingly. I recently heard from a reader complaining that a 1% fee on a $4 million portfolio cost $40,000 a year — an amount many people could live on. Clearly in such case, you should negotiate a lower fee: say 0.5% for starters, or look for another firm that will negotiate, or go the DIY route described in this blog and find a true fee-for-service planner.
What the heck does “fee-only” really mean?
Note there is much confusion over the term “fee-only.” As Preet Banerjee writes in the current issue of MoneySense — here — the term fee-only does not necessarily mean fee-for-service. All that fee-only means is that it is NOT old-time commission-based, levying commissions per transaction. In fact, commission-based is not that bad a deal, particularly if you’re a buy-and-hold investor.
Sadly, many journalists and even advisers themselves have used the term “fee-only” when they really were referring to fee-for-service. As a result of the definition used in the US NAPFA, an asset-based financial planner (like the one charging our reader 1% of a $4 million portfolio) is well within their rights to refer to themselves as “fee-only.” Fee-only can mean EITHER fee-for-service OR asset-based financial planning, rendering it almost meaningless. And mea culpa, even in the two editions of Findependence Day, I use the term fee-only when I should have used “fee-for-service.” Future editions will fix that and editions of MoneySense magazine will going forward make this distinction clear.
MoneySense’s new Fee-for-Service online directory
Because of this, we at MoneySense have revamped the previous online directory of “fee-only” planners. Click here for the new directory, or rather TWO directories: one for true fee-for-service (i.e. by hourly or project billing) and one for financial planners who are primarily asset-based (at least 60% of revenues) but who do offer clients the option of time-based or fee-for-service billing.
I might add that other aspects of the Findependence Day model have also been rolled out in MoneySense throughout the year 2013. Our Feb/March issue on RRSPs introduced the ETF All-.Stars, which will be revisited in the Feb/March 2014 issue. And our June 2013 issue introduced MoneySense’s first survey of Canada’s best discount brokerages, a second version of which will run next summer. Both features were written by MoneySense editor at large Dan Bortolotti, more about which can be found below.
For those who missed those two issues of the magazine, here’s a tip. It costs only $20 a year to subscribe to MoneySense magazine (7 issues), which also gets you free access to the web site at MoneySense.ca PLUS the iPad edition. We recently went behind a paywall (or technically a pay fence) but the iPad edition also gives you the back issues, including the ones mentioned above and in fact all the issues since I became editor starting with the June 2012 issue.
Upcoming iShares educational event in partnership with MoneySense
Finally, those in the greater Toronto area may find an event coming Saturday, November 16th of interest. Dan, mentioned above and pictured on the left, will be talking about ETFs and portfolio construction along with “Ask MoneySense” columnist and broadcaster Bruce Sellery, and various iShares ETF experts from BlackRock Canada . Dan will be taking readers through some of the concepts I’ve described above, as outlined in the book he authored for the magazine: the MoneySense Guide to the Perfect Portfolio, copies of which will be given away at the event, along with the current issue of the magazine, parking and breakfast. (more than recouping the $25 charge).
I might add that Dan is in the process of becoming a financial planner himself. He is already working with PWL Capital, whose firm is listed in the new directory as primarily asset-based. Dan himself is in the fee-for-service camp.
Details for the iShares/MoneySense event can be found here.
My latest Financial Independence blog at moneysense.ca looks at BMO Retirement Institute’s study showing there is a big discrepancy between the retirement aspirations of young Canadians and their savings habits to date. Click here for my take on it.
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