FLM and the Wonder Bread Abomination

November 1st, 2017 by Potato

Financial literacy month is upon us, and I have another stretched metaphor for you.

Bitches Get Riches had this post in the summer on learning to cook for yourself, which will help kick this off. Even if you don’t become good at cooking or build a large repertoire, out of necessity most people are going to learn to cook a few things at some point in their lives. Parents will teach kids what is and is is not food – often one of the first things they teach them after “hey, I’m Daddy. Say ‘Daddy’.”

So then you’re well prepared for when this horrific ad appears in your feed:

An ad for Wonder Bread suggesting the reader put pizza sauce (or ketchup) on a piece of bread, lay down strips of -- quote unquote -- white cheese, and toast until barely melted to make what they term is a Mummy pizza.

You’ll just know, because you have some measure of food literacy, that this is not a recipe you should attempt. And that any smiles you’ll be enjoying will be at your own expense for attempting to pass this off as food. Or you’d just know that if, for shits and giggles, you did make it to throw up on your Instagram, that you’d never give it to a kid as “food” and never, ever, ever give it to a kid calling it “pizza”. That ketchup and barely melted cheese on a piece of bread is an abomination and is in no way a pizza, let alone one deserving of a made up -acular adjective, and that even if you used pizza sauce a) you wouldn’t put it on a piece of wonder bread and b) you’d at least leave it in there long enough for the cheese to bubble you monster. (Wayfare notes that ketchup and cheese is kind of like a grilled cheese sandwich and this might not be so horrific if they passed if off as that instead of pizza, which I would still not eat)

Anyway, this is pretty clearly the sort of ad you would instantly know is just a bad idea because of food literacy. If you never really bothered to learn about what makes food good (or what makes pizza the High Food of the Special Day rather than something other than a slice of bread with sauce and barely melted “white cheese”), you might get taken in by this perfectly legal ad. And indeed, though all would instantly recognize the moral repugnancy of the act, there is no actual law against calling a piece of bread with ketchup on it “pizza”. Though perhaps there should be, consumers are completely unprotected against predatory recipes such as this, and attempting to protect them would be a big regulatory hassle1

And of course, so it is for financial matters. Except that’s not something we all learn proficiency with. If you saw an ad for a monstrous mash-up product like a market-linked GIC, it might look neat, the ad copy might even sway you into putting some of that in your children’s portfolios. And you might even call it a “good investment”, never knowing what true pizza, I mean investments, taste like without developing your financial literacy.

Looking for a place to start? I’ve got a reading list here.

1. And even then, you might end up with protections such as nutrition labels and ingredient lists that help protect against some form of abuses but will not solve all the problems and sometimes require their own, different form of literacy to parse.

Early Withdrawal from RRSP for Low Income Year?

October 9th, 2017 by Potato

A common myth is that you can’t withdraw from your RRSP until retirement (except for programs like the HBP or LLP). There’s actually no such restriction: you can withdraw at any time, but the withdrawal will get added to your income for the year, and you will lose that room. Now, most of the time that means you’re going to want to wait until retirement before withdrawing anyway.

But what if you’re in a period of your life where your income is temporarily low? Mat/pat leave, or a job loss, for example? It may make sense then to pull some of your money or investments out of the tax shelter when you can do so at a lower tax rate.

Reminder: The RRSP is beneficial in two basic ways: it provides tax-free compounding of your investments, and lets you contribute with pre-tax money, so you can engage in tax arbitrage by deferring the tax until later, when you might be in a lower tax bracket. Much of the time the tax arbitrage is not much of a benefit, as clawbacks of various programs can make your effective tax rate in retirement higher than raw income might suggest. But, if you have a year with minimal income (because of job loss, mat leave, etc.) then you may find yourself in the lowest possible tax bracket — lower than when you contributed the money — so there’s an advantage to withdrawing then. But you’ll be trading away the one benefit for the other. Is it worth it?

There are a few basic scenarios to consider, and your own different tax rates and rates of return will play a role, too.

The biggest question to start with is whether or not you have excess RRSP room. For many younger people who start saving early, getting 18% of your pay in RRSP room and a chunk of TFSA room (~10% of the YMPE) means that you’ll have more tax shelter space than you will fill. In that case, burning some of it up to withdraw in a low-income year is an easier decision: you pay tax at a lower rate, then put it back in when you’re in a higher bracket. The benefit from tax-arbitrage just between the bottom rate of 20% and a middling ~30% is a one-time gain of ~10%, which is going to far exceed one or two years of tax on investment growth (assuming you don’t actually need the money to pay for your expenses while out of the workforce).

If you have excess RRSP room, it’s a pretty easy choice to withdraw during a lower-earning year. You can even plan in advance for this where possible. For instance, you may ordinarily use your TFSA for long-term savings, but if you’re pregnant and expecting to be off work the following year, you might choose instead to use your RRSP (or even withdraw some funds from your TFSA to contribute to your RRSP), then withdraw those funds when your earnings are lower the next year.

We’re not all in that boat though — if you started building up a non-registered account before the TFSA was introduced, or if your RRSP room is used up by a pension, or if you have earnings that don’t generate RRSP space (like grad school stipends or dividends from your small business), or if you just simply have a high savings rate (which may be needed for early retirement plans or because you wasted your 20s in grad school and have to play catch-up or because you’re renting-and-investing-the-difference), then you might not have any available RRSP contribution room to put back what you take out in a low-income year. In that case, you’ll want to be more careful and certain that a withdrawal in a low-income year will really help you before you go through with it and burn the space.

Now it’s harder. You could get the one-time benefit of pulling money out at a low rate, but then you’re going to have non-registered investments that grow more slowly due to the tax drag than registered ones — and if you expect to be in a low bracket at retirement anyway (or for several more years as your disability takes time to resolve), then taking the money out early is of no real benefit to you.

There are going to be a number of factors at play: you’ll have a higher rate of compounding on your RRSP investments than non-registered ones (made even more complicated by the fact that some capital gains can be deferred a long time even in a non-registered account). The length of time to consider will matter, too: if you’ll have to pull the money out in a few years anyway, then it may make sense to withdraw early, as the difference in growth rates may not add up to much compared to the difference in effective tax rates of the withdrawal. If it would be a few decades before you would otherwise take money out of your maxed-out RRSP, then even a modest tax drag can add up to a large effect and you’d be better off just leaving things alone in your off year.

To help look at a few scenarios, I’ve put together a spreadsheet available here. You can play around with it to see which is better, and also how much you’d be off by in different scenarios if your assumptions are wrong.

For example, we can run a scenario where Wayfare is 37 and would be in the 20% tax bracket this year, but in a few years is able to return to work and get back to the 30% tax bracket, and then will stay in that bracket until the money is needed in 18 years (retirement at 55). Let’s assume her investments grow at 7% inside the RRSP, and at 6.5% outside. In that case, she is a bit better off to withdraw early (~$122 extra in the future for $1000 withdrawn today). If instead the disability is permanent, and the later withdrawal would also be at 20%, then she would have been better off leaving the money in her RRSP. The optimism costs ~$193 (in lost growth in future dollars) for $1000 withdrawn today (about 8% of her future investment value). If her non-registered investments are less tax-efficient and only grow at 5.9% (because her earnings power returns, for example), it’s an even worse deal to withdraw early.

It’s a tough call — you have to know the future to say for sure how much (if any) you’ll save.

And for the case of someone with no spare RRSP room and non-registered investments, there’s a similar dilemma of whether to realize the gains now in a low bracket, paying tax now so you have less to continue investing, but resetting your cost basis higher for the future. The second tab of that spreadsheet looks at some cases for that decision.

Of course, we’re actually facing these decisions. While going in I thought it would make sense to take advantage of a low-income year, after looking at a few scenarios we’re not going to burn any RRSP room as long as there’s still non-registered investments standing behind the emergency fund.

OMERS AVC

August 24th, 2017 by Potato

The Ontario Municipal Employees Retirement System (OMERS) is one of those big pension funds you hear about, providing sweet defined benefit pensions to government workers, and buying up companies and assets to help fund those pensions.

A reader asks:

Because I participate in an OMERS’ pension fund at work, I have the opportunity to invest in Additional Voluntary Contribution (AVC) within the same fund. This fund has been doing quite well so should I consider this?

The AVC is a neat option at OMERS: you can treat them like a mutual fund or ETF and invest in the same investment portfolio they’re using to try to meet their members’ pension obligations, on top of what they’re investing for you for your pension. It’s widely diversified with reasonably low overhead/MER-equivalent (~0.6%), and you can set it up to automatically take contributions straight from your paycheque. As a one-fund solution, you don’t have to see the performance of individual asset classes or worry about diversification and rebalancing decisions, you’ll just see the smoothed over-all performance.

I should note that this is not buying additional service or pension credits — it’s an investment managed by them, with no guarantees about what the funds will pay for in retirement (unlike the DB pension itself). The fact sheet also mentions limitations to the timing of withdrawals that limit the liquidity, which appears to limit you to only withdrawing in a 2-month window in the year, and then only 20% of what you have invested, which can really limit flexibility if these funds are for anything other than retirement.

Now, if anyone could waltz in and sign up to invest in the OMERS AVC, this would be a really interesting option to present alongside Tangerine, robo-advisors, and TD e-series. However, only people who are already OMERS members can do it. And that’s where my natural paranoia suggests this is not the way to go. OMERS has a great management team, the portfolio is diversified, and has competitive past performance relative to a passive index fund portfolio… but you’re already depending on them to come through for your DB pension, which is likely a big part of any member’s retirement plans. And as great a basket as it may be, you’ve already got a lot of eggs in that OMERS basket. In the unlikely event that they fall on their faces and have to trim DB benefits, you wouldn’t want the rest of your investment portfolio with them, too. And it adds one more thing to transfer (or think about transferring) if you get another job.

What do you think, would giving the AVC a pass be prudence or overly paranoid?

Edited to add: Over on Twitter, Sandi adds this:

I’d want to know what % future income relies on OMERS before cautioning against. (“It depends!!”)

And of course, that’s a good extra factor to consider. If you have 30 years of service with OMERS, your basket with them is going to be much bigger (and the over-exposure may be more of a concern) than if you have 5, and most of your retirement needs are funded elsewhere (where doubling up for some additional investments may not be a big concern).

Advisor vs Adviser Silliness

August 16th, 2017 by Potato

In a widely seen CBC Marketplace report, the reporters spread the unhelpful tidbit that there’s a magical difference between the spelling of advisor and adviser. They say:

“Advisers” are regulated and have a legal responsibility to act in your best interest. “Advisors” are … not the same.

And since then I’ve seen that “tip” repeated many times when people are looking for advice: “go find an adviser” they may say, not having one themselves. However, it is missing the broader lesson and is unhelpful: job titles are misleading and unhelpful in the financial services industry. More importantly:

Advisor may not be regulated, but adviser is not used.

In what appears to be the original report kicking off the mini-controversy, of 121,932 registrants they looked at, only 17 across the country used the title of “Adviser”. Basically nobody uses that title, so when people repeat the “o” vs “e” issue and suggest that you go find an adviser — such a creature (effectively) does not exist! In an article at advisor.ca they did a check, and of 26 people who did use the term on their LinkedIn profiles, 24 did so in error; others may also use it under the aegis of another licensing body (such as insurance sales).

I’ve seen too many times people repeating the “o” vs “e” spelling difference as though it’s a helpful tip when looking for advice. It’s a distraction, nothing more. The real lesson is that most job titles (whether it’s advisor, vice president, or portfolio doctor) don’t actually tell you anything about whether the person you’re sitting across from is licensed to sell a particular product, experienced enough to provide you advice, or regulated to act only in your best interest. Indeed, some of the least regulated titles (like coach, planner, planning-farmboy, or instructor) may be the best people for you, who would put your needs ahead of any commission (’cause there isn’t one), even if there isn’t a regulatory framework and force of law to make it so.

A Framework for Estimating “Am I On Track?”

July 20th, 2017 by Potato

A very common question people ask is “Am I on track to retire?” It’s usually a good starting place for an engagement with a planner, especially if you’re within a decade or so of your planned retirement date. That plan is going to come with a lot of good discussions of your goals, some contingency plans, how you use your money, etc., etc. It’s also going to cost a few thousand dollars for the support and those conversations (and I’m deliberately avoiding saying “for the plan” as though the document in isolation is valuable outside of the process).

But for some of us, we just want to get a ballpark idea of whether we’re on track or not, and we want to do it ourselves with a whiteboard and spreadsheet. So here’s how I think about approaching the problem:

    1. Define your goals
    2. Add up your resources
    3. Project forward to see what might happen
    4. Analyze
    5. Repeat/Try to break it

Now each of those phases can be more work than the few words make it sound: even “just” defining your goals can be a lengthy conversation about what you want the rest of your life to look like. There is definitely room there for a planner or coach to provide a lot of value in the process, but you can get a large part of the way there yourself.

Unfortunately, the process isn’t going to return a really clean yes or no answer. Instead we’re going to get shades of “maybe, if” or “probably, I think.”

Define Your Goals

Part of defining your goals is the straightforward part: figuring out the kind of lifestyle you want in retirement, and then translating that into a dollar amount for your spreadsheet. But it also involves thinking about trade-offs: would you be ok with a more variable income/spending profile, or do you want a steady stream of retirement income? Will your spending decline as you age (less travel?), stay fairly level (with inflation adjustments) or increase (more health/support needs)?

And when thinking about the future, how much lifestyle inflation will you face? Back in grad school, I was pretty sure I would be perfectly content retiring to a nice, quiet one-bedroom apartment somewhere and would only need $30,000/yr or so. Needless to say, my target has risen over the years, and now I use a figure that assumes a little more lifestyle inflation.

There can be a lot of moving parts that can quickly overwhelm a simple DIY approach.

But for the sake of example, let’s say that Elrond Example has had those conversations, and boiled it down to three numbers: he wants to have at least $40,000/yr in retirement income, but would like to aim for $55,000/yr, and Elrond would like that retirement to start at age 65 (assuming he’s 40 now). I also have to be careful to understand how I’ve framed these numbers. For example, if I figure that Elrond makes $70,000/yr pre-tax now, and in retirement will have a few fewer expenses and won’t have to save $7,000/yr anymore, I get to $55,000/yr pre-tax — Elrond will still be taxed on that income and have a perfectly fine retirement, so I can use pre-tax numbers in my later calculations. But if I mean after-tax dollars, as in the amount he can actually spend, I’ll have to account for the taxes. Or, maybe using a different method I can figure that he’ll want $45,000/yr after-tax to spend in 2017 dollars (with a floor of $34,000/yr). Various tools and methods will use different amounts.

Either way will work for you, you just have to be clear with yourself what it is you’re doing. Same for inflation: it’s easiest IMHO to think about real dollars: when retirement actually comes Elrond may be spending $100,000/yr in 2040 dollars, but I can think of that more easily as $45,000 in 2017 dollars — but I will have to adjust my rates of return to be real rates of return (i.e., subtracting out inflation).

One last number to consider is how long you’ll need this support to last. Living to age 95 is a decent rule-of-thumb to use.

Add Up Your Resources

I’m not going to have to fully fund my retirement goals on my own — I’m going to have CPP, OAS, and possibly a pension to help out. Enumerating how much support I get from those guaranteed sources may go a long way towards setting my mind at ease. If reliable, inflation-adjusted income from secure sources like a defined benefit pension, CPP, OAS covers a large portion of my spending needs, I’m automatically going to be closer to being on track. What’s your ratio of spending needs to secure retirement income look like?

I also need to figure out where I stand already in terms of how much I already have invested.

For the sake of the example, let’s say that Elrond can count on the maximum OAS support (in 2017 dollars that’s just over $7,000/yr), and that I’ve used the CPP calculator to estimate Elrond’s CPP income at $8,000/yr in 2017 dollars. Elrond also has a small defined benefit pension. He looks up the statement, which tells me that at age 65, with a bunch of assumptions, he’ll be eligible for $15,000/yr in (pre-tax, real) pension income.

Elrond can also look at his investment statements to see that he has $60,000 in TFSA, $20,000 in RRSP, and $20,000 invested in a non-registered account, all invested in a “balanced” portfolio. He’s also saving (on top of his pension) $7,000/yr.

I’m not necessarily looking for a net worth statement here. For example, I wouldn’t subtract a mortgage from the amount invested, as I’m already accounting for that in the cash flow: the amount Elrond has to save for retirement is after the mortgage payment is made, and the debt will be paid off several years before his planned retirement age.

Project Forward to See What Might Happen

Once you have your needs and your resources, you can start to play with a variety of tools to see what will happen and try to approach an answer about whether you’re on track. If you’ve got time and an inordinate amount of patience, you can do it all by hand on paper.

If today my example person Elrond has $100,000 in total nominal investments and I assume a 4.5% real return (net of fees), then next year Elrond will have $104,500, plus another $7,000 that he has saved. I can keep projecting forward like that up until retirement (though I’d likely track each account separately, as each dollar in an RRSP is not the same as on in a TFSA).

Then when he hits retirement, I can use a rule of thumb like the ~4% figure for a sustainable withdrawal rate to see if the portfolio will last, or I can model drawing it down based on a more conservative asset mix.

Then I can do it again using different assumptions about whether Elrond might not hit his savings goals in a few hard years, or if returns are different. We’ll come back to the point about using different assumptions.

Analyze

Now I’ve done a lot of work and really want to know, am I on track?

Well, a quick analysis says that Elrond is at least not in serious trouble: in this example, he had such modest needs (income floor of $40,000/yr / spending floor of $34,000/yr) and enough guaranteed support (CPP, OAS, defined-benefit pension, total of $30,000/yr) that he doesn’t need to draw much from his portfolio. Using a 3.5% version of the 4% rule-of-thumb (to be conservative about rates of return and the effect of real-world investment fees), he only needs a portfolio of $285,715 to support his minimum spending, and in my projections his TFSA alone would get him there.

What about his more ideal target retirement lifestyle? Using the same very simplistic method, he’d need a portfolio of $714,285 to cover the $25,000/yr beyond any guaranteed sources of income, but my simple math and assumed rate of return only puts him at $613,000 by age 65. That’s pretty close, especially with all the assumptions involved, and maybe I was being a bit conservative with my rates of return, so maybe he is on track? Hmm, he’d have to save an extra $2,250/yr to hit that number, which is a pretty big change to his budget… Perhaps I can be a bit more aggressive because the bulk of his investments will be in his TFSA in this example, which won’t have a tax drag… and we quickly see how a black-and-white answer is hard to come to.

Repeat/Try to Break It

Sometimes we just want to be reassured. But often it’s more useful to be better prepared. So try a couple of different assumptions in your planning and see if you’re still ok with the answer — if not, you may have to start adjusting your course (or expectations) now.

A big thing to consider is the rates of return you use: there’s a lot of uncertainty in what your investments might return, and it ties deeply into the core of your saving/investing projections. Professional planners will sometimes use Monte Carlo software that will run thousands of simulations of future scenarios to try to see how robust your plan is. IMHO, when you still have over a decade before retirement, that can be overkill, but you definitely want to look at at least a few scenarios with your straight-line/constant return tools (best guess, good, bad) to see if you need to be more conservative.

When you get closer to retirement, things like sequence of returns risk will be important to consider, and that’s why paying a planner to help can really be worth it. But from afar a bad sequence with decent average returns is still a “bad scenario” that can be approximated as a scenario with just an overall lower straight-line return.

For this example, I used the Ballparkinator (click here to download the spreadsheet with the numbers for this specific example), which lets me get a quick look at a few simplified retirement scenarios in one go (though the straight-line methods are a bit optimistic when looking at when the money runs out).

I can see that Elrond Example can meet his floor spending even under a fairly poor worst-case scenario (0% real bond yields, 2% real equity returns, and paying e-series rates of investment fees). Even if he has to retire 3 years earlier than planned for health reasons (assuming a modest decrease to his pension and CPP benefits), under our base case returns he’s in good shape on his current path to at least meet his minimum spending needs.

However, he’s not guaranteed to be on track for his more ideal retirement: sure, he’ll get there with a rosy scenario where his bonds have a 2% real return and his equities an 8% real return (before fees), which has happened in some points in the past, but even in our base case scenario he’ll run out of money before turning 95 in this example.

Again, a strict yes/no answer is hard: with a relatively optimistic outlook for investment returns over the next few decades, sure, he’s well on track; even with a fairly realistic base case he’ll have money for his ideal retirement goals for longer than he’s likely to live (sometime into his 80’s). But he’s not so solidly there that he can afford to retire any earlier if his ability to work fails a few years early, and a bad few decades for his investments could also put a crimp on his retirement plans. Though he may never see a birthday cake adorned with 90 candles, he wants to prepare for that opportunity.

It’s also hard to come up with an exact amount extra he needs to save. To get his base case scenario to give us 95 as an age where he runs out of money, we have to increase his savings from $7,000/yr to $8,250/yr. But even at that higher savings rate, he can barely cope with an early exit from the workforce at 61 (with associated decreases in CPP and pension income), and an exit at 60 would compromise his minimum spending target, even under the base case investment returns. Is that enough of a cushion?

And there’s no realistic way for Elrond to support his ideal retirement spending level even after worst-case investing returns. How conservative is too conservative?

We can also try a different way of analyzing the numbers. At the bottom of the Ballparkinator is the so-called “backwards method”, which uses a set sustainable withdrawal rate (variations on the 4% “rule”) plus any gaps in spending to see how big a nest egg Elrond needs at the beginning of retirement, then figures out how much he needs to save each year to get to a nest egg that size based on the various real return rates (note that this ignores taxes). If Elrond wants to be somewhat conservative and use 3.6% as his sustainable withdrawal rate, then under the base case scenario, he needs to bump his current savings rate of $7,000/yr up to over $9,500/yr. While under the best case scenario, he’s saving more than he needs (a nice problem to have), it’s not possible for him to save enough to meet his ideal spending needs under the worst-case investment returns scenario. But, using this method and his minimum spending needs, he is saving more than the tool returns for worst-case scenario.

So looking at it from several angles and with a few different assumptions, Elrond appears to be most of the way towards being on-track for retirement. Even if a few things go wrong, he will quite likely still be able to meet his minimum retirement income goals. His ideal retirement is possible for the track he’s on if things go well (he can continue to work to his target age without having to take time off from savings due to an emergency or leaving the workforce early, decent investment returns, etc.). But he may want to re-examine his plan to see if he should start envisioning something a touch more modest (but still well above his minimum), or start finding a way to save and invest more.

And of course, there are other possibilities too. In this example, we used the “balanced” portfolio for Elrond, which in the spreadsheet is a simple 50-50 mix of fixed income and equities. If we believe that equities will have a higher return over the next 25 years, and if Elrond has the personality for more investing risk (certainly he has the time horizon), then moving to a higher equity weighting (like the age-10 rule-of-thumb from the investing course) may also help him achieve his goals — but this is not a solution to take lightly, and it’s all too easy to just be more optimistic on your future rate of return assumptions to magically get back on track.

Summary

There’s no simple formula for answering the very simple question of “am I on track?” There’s lots of uncertainty between now and retirement, from what your investment returns will be to how much you’ll be able to save or even how much you’ll want to spend. But if you can meet your minimum needs even under a “bad” scenario and get into a happy range for your spending with a more realistic base case scenario, then you’re probably on the right track.

And as you get within a decade or so of retirement, it can be worth meeting with a planner to examine these questions in more detail and discuss the trade-offs involved.