Finding the retirement number
Today my wife had me go to a co-workers house to talk about finances. Their financial advisor advised them to purchase an "Aggressive Growth Portfolio" and they were worried about the Management Expense Ratio (MER) the Trading Expense Ratio (TER) and they told me they were putting everything in a Tax Free savings account (TFSA) and were avoid a Registered Retirement Savings Plan (RRSP)
They asked me if they should keep the money in the aggressive portfolio or should they put it in a Robo-portfolio. I asked me to show me their portfolio and looked into the holdings only to find it was a "fund of a fund" which they didn't really understand. I had to explain that their one fund paid its managers 2.13% (the expense ratio) but that it invested in other funds which paid their managers...so it actually paid out fees to additional people.
There is nothing wrong with that
But I said that it made sense if it was aligned with their goals and that the expense ratio wasn't the biggest deciding factor. The biggest deciding factor was if the investment was likely to reach where they wanted to be.
The analogy I used
Then I used an analogy.
Which is the better bus to take?
- A bus with a $10 fare or
- A bus with a $20 fare?
They said "The one with the $10 fare" then I added.
"Are you sure?"
What if the cheaper bus doesn't take you where you want to go?
Of course then it was a little more obvious. Pay the lowest fare that takes you to your destination.
In the real world the FIRST consideration is always : Does this take me to my desired destination.
Only after you know that can you look at things like:
- How quickly will it get me there?
- How likely is it to break down on the way?
- How expensive is the ride?
Then I pulled out the tax tables
That's when I pulled out this table from taxtips.ca
Yes, I could have calculated it from information freely available from government websites but this was just way faster. Then I asked the question: How much do you really need to retire? The more you make the more the government takes. Now the government of Canada takes nothing at low income levels of about $20,000 annually but we all quickly agreed that would be too low for them. Then I asked... How about $50,363? At that level you are maximizing the lowest tax bracket. We decided to call it Making the most of the least. They thought a bit and said "Sure, we think that would work".
We did some back of the napkin math and quickly found that one of them between pensions and other income source would easily clear that bar without any investing. Congratulations: Investing is optional not necessary. Although Canada does have a tax free savings account which could work really well for her.
So we looked at the other spouse and I did a quick number lookup. If you get 9% return from the Aggressive investment how much money would you need to get to $50,363. The number was: $560,000 but then I reminded them that the government would take about 20% so they wouldn't get to keep all of it. I said what if they were all dividends? Then instead of paying 20% they would be getting 10.24% back. I showed them a little bit of napkin math and if you got 9% in dividends then after factoring in the tax rate it would only be $400,000 necessary to save. Then we did more math looking at Canada Pension plan, Old Age Security and more and in the end we came up with a goal that was reasonable.
Then they had a real goal for income, for required amount, and timeframe depending on rate of return and contribution levels.
They then realized that the aggressive investment plan might get them to their goal ahead of time but a more conservative plan might cause less anxiety during downturns and still get them to their desired goal on time.
Then I looked at the MER from their current investment and shows how much time they saved if they could make it lower and how much difference it made if they waited a little bit to make the change.
I never answered if they should or shouldn't keep the investment plan the bank gave them. I did give them a better way to look at how much they needed and how much they would pay in taxes, how much to budget for inflation, different strategies to avoid the income tax and more.
Asking the right questions
We probably spent 4 hours chatting about investments. During that time I showed a couple of example stocks, preferred shares, REIT's, bonds, and even GIC's and High Interest Savings accounts. I didn't recommend any one of them but explained how they worked, how they were taxes, and how they might all fit together at different times and places.
I showed them a framework for a Goal
I showed them tools they could use to get there.
and instead of looking too closely at fund 1 vs fund 2 they understood better why they were investing in the first place and had a better idea of why choose one vs the other.
At the end of the conversation? They felt far more invested in their plan. They wondered why their investment advisor never sat down and explained everything. Then they made me promise I would come back later to talk to them later after they had time to come up with a plan of their own to take to their advisor. Although they were surprised when they found out I used an advisor myself.
Why? ... "You know a lot about this stuff" they said.
Which is absolutely true. I do know a lot. Then I let them know something. I know a lot of stuff but I don't want to spend a lot of time looking at everything every day. In fact, looking at markets too closely can cause a bad "SELL" reaction when things go down which is a sure way to lose. I have an advisor who watches the markets and gives me advice. Then I use my knowledge to figure out if I want to follow that path or get a second alternative.
A Goal lets me know where I want to head
Knowledge lets me know if my advisor is directing me on a path to get there.
And together I think that is a pretty good place to be in
....because if I were to use another analogy? Yes MER is important. Yes rate of return is important. Yes asset allocation is important. But as every hiker knows good hiking boots and gear are very important but being on the right trail is even more important. Figure out the destination first (the goal) and then look at investments and MER's later (the boots).
But that is just my opinion and as I said I'm not a financial advisor. If you have other ideas I would love to hear it in the comments :)