I need $14,000. There I said it. But how did I get here? What the hell happened? Did I go crazy at the tables at Casinorama? Did I pull a not-so-friendly Community Chest card in the real-life version of Monopoly? Did I go long the Mexican Peso when Trump was inaugurated? None of those I’m afraid…
One goal I did not mention in my previous post, was to have a well-defined budget. Truth be told, I had a budget planned out in 2016, and for the most part I stuck to it. Budgeting suddenly became very important when I became an independent consultant: as a contractor, you need to know exactly how much money you need, because this ultimately drives the lowest per hour cost that you can live with. If you charge too low, then you will not make enough to cover your regular expenses; so anything you charge over your minimum per hour rate is butter on your bread. Example: if I know that I need to charge at least $50/hour to cover all of my expenses (this includes my personal expenses, as well as corporate expenses), if I can find a contract which pays me $60/hour, assuming a 7.5 hour work-week and two weeks vacation, this means I suddenly have $18,750 more I can play with. But, if a contract paid me less than $50/hour, say, $40/hour, I would be short $18,750. But, I will save the per hour calculations for another post; today, we are here to speak about budgeting!
So, in 2016 I got into the habit of planning out my personal and corporate budgets to the penny. Budgeting is not easy task. You have to ask yourself hard questions, and you have to keep yourself to your budget. If you only budget $100/month for eating out, then you have to be damn well sure that you spend no more than $100/month on eating out! While this sounds easy in principal, it rarely is: easy access to credit, and convenience payment methods such as credit cards, tap-and-pay, paying with your phone, etc., make it all too easy to lose track of your spending.
The hard questions really revolve around what you need vs. what you want. Sure, I want to go out to a fancy restaurant every week, but is that something I need to do? Moreover, when you actually plan stuff out, you realize how much friction discretionary expenses cost you. Case in point: if you go to see a movie every other week, you can spend easily $390 on tickets alone (26 weeks @ $15/ticket). Factor in dinner that you will likely eat when you go out with your friends, the concession stand, gas/transit, etc., and you can easily get up to over $1,000 per year just on going to the movie! Now, consider what other frivolous items you spend your money on!
Our family is growing this year, with a wee one on the way, which will drive a slew of new expenses (diapers! building a nursery! strollers! diapers! baby food! diapers! did I mention diapers???). We also moved, I am 17 months away from paying off our family vehicle, and 53 months from paying off my rental property. When you take into account all of the negative cashflows (e.g. regular expenses, discretionary expenses, paying off liabilities such as mortgage and car, savings, investing), my net income is $14,000 short of my aggregate cash outflows; e.g. if my net outflows are $50,000, I am only making $36,000, $14,000 short.
What does this mean, practically speaking?
Well, when you are budgeting there are really two types of cash outflows:
- Fixed / required costs
- Discretionary costs
Examples of costs which I cannot avoid–no matter how much I would like to!–include:
- My mortgage, and the interest on my mortgage
- Car payments
- Utilities (gas+water+hydro) and property taxes
- Pet care (food, vet)
Costs which are discretionary–I can simply not spend this money if I don’t need to–include:
- Eating out
- Buying books/movies/music
- Donations (e.g. to the Toronto Humane Society, United Way, Kids Help Phone, etc.)
So, while I am “short” $14,000, this is purely from a budgeting perspective. Simply because I have $600 budgeted towards going to the movies/buying new music/buying new books, does not mean that I will have to spend $600. That said, I believe 2017 will be a year of frugality: instead of buying books, borrowing from the library. Instead of buying CDs, *cough* borrowing *cough* them from friends (or the library!). Driving less, etc. Ultimately, I would like to make a complete reversal, and instead of finding $14,000 in new funds to fund my shortfall, increasing my overall savings by some amount. These guys are hella inspiring in that regard! I would relish the opportunity to save 60% of my regular income, alas, that’s not going to happen anytime soon.
With that in mind, one more metric that I will be tracking on monthly basis is my personal budget, and how well I am tracking to it. My goal is to tighten my belt enough that I can avoid dipping into long-term savings to cover the $14,000 shortfall. One thing that I have gotten into the habit of doing is using cash instead of credit. In fact, the only things I use my credit card for at the moment are gas, and online purchases. But, if I am driving less, that implies I will be purchasing less gas, which means I will be using my card less. If I cut down on buying things online (e.g. books on amazon.ca), then I’ll be able to cut down on that avenue as well. Previously I was drawn to the siren song of bonus dollars and cash-back cards (such as the Tangerine Cash-back card, which gives 2% cash-back on three categories; if you are going to sign up for one, please use my referral ID, 16176076S1). However, the problem with cash-back cards is that you really have no idea what you’ve spent until the bill comes in the (e-)mail; on a regular basis I was getting hit with $1,000 bills without faintest idea as to where my money had gone. That said, my frugality principles for 2017:
- Cash, not credit
- Drive less, transit more; even easier since I have a TTC Metropass
- Borrow, not buy, in the case of books
- If I have to buy, buy used, through craigslist, Kijiji, or eBay (although eBay offers less and less in terms of bargains nowadays!)
- Learn to say no: if a bunch of friends wish to go out, if I don’t have physical cash in my wallet, don’t do it
- Look for cost cutting measures around the house
I’d be curious to hear what methods you are all using to cut costs, and generally have more savings on hand!
Onwards and upwards!
It’s that time of year where we start looking at investment goals for the new year.
I didn’t really have any goals F2016, except to become a member of thediv-net.com, which I’m happy to say that I was successful in accomplishing! I also mentioned in several posts in F2016 that up until recently I had lost focus on my investment portfolio. Well, for F2017, I plan on changing that trend.
To that end, the goals!
Goal 1: Increase TFSA Contributions
I have been an infrequent contributor to my TFSA for the past 2+ years. To pay off my business school loan, and to purchase a new house with my family, I made some significant withdrawals. Taking into account the $5,500 contribution limit for F2017, I have a little over $40,000 in contribution room in my TFSA. My goal for F2017 is to contribute to at least 50% of that limit, or $20,000.
Goal 2: Minimize Taxes
My investments fall into five investment books: a taxable margin account, a tax-free account, a tax deferred account, a certificated account, and a LIRA. My second goal for F2017 is to minimize taxes by consolidating investments into my tax deferred and tax-free accounts, where it is sensible to do so.
Selecting which investments go into tax sheltered accounts is not a trivial task. On the one hand, moving investments from my taxable account will defer any taxes payable (in the case of my RRSP), or eliminate taxes completely (in the case of my TFSA). However, tax sheltered accounts have a disadvantage in that any losses cannot be used to offset capital gains. This means that I will have to take a close look at the investments to ensure they are good fit to go into an account where I am unable to do any tax loss harvesting. Put another way: I have to ensure I am comfortable (financially, and psychologically) to move investments, confident that they will not go down in value to the point where I sell them at a loss.
That said, Goal 1 and Goal 2 are complementary: by moving investments from my taxable margin account to my tax-free account, I can easily come within throwing distance of Goal 1.
Moreover, by moving my US investments from my margin account to my tax deferred RRSP, I will reap an immediate 15% cost avoidance: US based stocks are not subject to the (15%) withholding tax on US dividends, which means I will receive the full amount of dividends from my US holdings.
Goal 3: Rebalance my Total Fund to my Target Allocation
When I started investing in earnest in F2012, I had a very rigid target allocation. The past few years I have deviated very far from that. So my third goal (and arguably the most important) will be to revisit my investment policy statement, and determine the appropriate asset mix for my investments.
Goal 4: Increase Passive Income by 5%
As I am a dividend investor, passive income is my primary goal for investing. Following my December 2016 results, I will be baselining my F2016 income, with a goal of beating that income by 5% this year.
I plan on accomplishing this goal through three key strategic activities:
- Re-allocation. I know for a fact that my portfolio is overweighted in some areas. Once I complete Goal 3, I will be reallocating funds to other holdings, to increase exposure to some of my more successful dividend holdings.
- DRIP Investing. I plan on increasing exposure to DRIP investments, as they provide a frictionless vehicle for quickly growing dividend income.
- TFSA Contributions. As mentioned with Goal 1, I plan on increasing my TFSA exposure. This increase will undoubtedly bring more passive income into the total fund.
Goal 5: Update and Expand Investment Research
Many of my investment research posts are horribly out of date. As the calendar year is starting, many companies I follow will be releasing their annual results in the coming months. I plan on updating all of the companies I follow based on F2016 results. Moreover, I am targeting to analyze at least four new companies this year.
And there you have it; the F2017 goals! I would love to hear what everyone else’s goals are for F2017.
Onwards and upwards!
This is part 3 of a 3 part series I have entitled "The Great Pension Experiment", which details my analysis on what to do with a defined benefit pension plan payout. The first two parts may be found here: Part I, Part II.
It has been one year since I started off on The Great Pension Experiment. I feel that this is a useful experiment because it leverages real world results in a closed environment. Because the funds are in a LIRA, I am unable to add or withdrawal funds, so any losses must be recouped “internally” by better investments.
In Part II I made the claim that, based on the Assertive Couch Potato Portfolio, over a 25 year time horizon I would be able to grow the portfolio to a point where I would be able to generate over $600/month in passive income, assuming a 4.00% yield. It has been 12 months since that claim, so lets see how we’ve done after one year.
When the portfolio was first opened, I set it up with a blend of 25% fixed income, 25% Canadian Equities, and 50% of non-Canadian Equities:
Originally I had intended on re-balancing the portfolio semi-annually (i.e. every six months), and in retrospect, this was a stupid idea. Cash was building up in the portfolio slowly, but sitting there idle until I had a chance to re-balance. Due to the already high number of shares, any dividends and/or distributions from the holdings would be in excess of the current price of those shares. Because of this, I should have been using synthetic drips right from the start! Accordingly, in September 2016 I set up my brokerage to re-invest any dividends received directly into additional shares. This ensures that money is not sitting idle, and because the investments are via synthetic drip, I receive additional shares commission free.
That said, as of October 2016 (one year), the portfolio sits at:
For the year ending October 31, 2016, I received $1,485.24 in dividends/distributions ($123.77/month). The portfolio as a whole has grown from an initial investment of $64,723.32 in cash to $68,468.29, which represents a 5.648% total return. This is actually pretty impressive, since the first half of the fiscal year (From November 2015-April 2016), the portfolio was in negative territory:
|Period Ending||Open NAV||Close NAV||Return %||TTM Return %|
I had bought into the portfolio at a peak in 2015, and the market had a clawback shortly after. As a result, the portfolio lost money for the first six months. I did take the opportunity during that period to top off the VXC shares whilst I had some excess cash from distributions, which in retrospect was a wise choice. Buying when the market is in a downturn helps to dollar cost average down, ultimately increasing future returns.
The portfolio is more or less at the target weighting if you round to the nearest whole number, and because of this I see no need to buy or sell additional shares at this time. Hypothetically, if the portfolio were to keep this pace for another 24 years, even at a 5.000% return we would generate approximately $736/month in passive income. So based on simple extrapolation (i.e. assuming constant returns for the next 24 years), we are right on track.
That said, I am going to ignore the portfolio for another six months, and will revisit in May of 2017 to see if any rebalancing is required. Until then, the next update will not be until December 2017. Here’s hoping that the portfolio continues to provide excellent returns at that time.
Onwards and upwards!
Before I begin, there was a minor issue with the October update benchmark numbers. I had made an error in the benchmark passive income: Vanguard’s VAB declared an October dividend, but the actual payment date was in November 2016. This means that my actual income in October surpassed the benchmark income by an even wider margin.
I’ll jump straight to the chase and say that November was a disappointing month. Odd, because following the winning of president-elect Trump, US markets were on a tear. Unfortunately, my Canadian holdings did not do as well.
The benchmark return was 0.912%, but my total fund was -0.413%, more than a 1% difference. My LIRA portfolio came in at a respectable 0.902%, and the 0.010% variance I can attribute to tracking error. The TFSA portfolio dominated at +2.522%, but my margin account was pummeled at -4.918%! Inspecting the margin account, this somewhat makes sense: it is 2/3 in Canadian equities, which came in at -8.898%, which was the primary source of the losses.
But, as a long-term buy and hold investor, you’ve got to take the bad months with the good months. My TTM is still exceeding the benchmark:
Total fund TTM is 7.989%, while the benchmark is 6.705%: so when you take into account all ups and downs over the past year, we are still doing pretty well.
Of course, let’s remember that I am a dividend investor, and that is where I count the majority of my returns. November was a good month: total income was practically double the benchmark income (97.514% more to be exact), and TTM income is also exceeding the benchmark, by 7.918%.
As I have just started to aggressively focus on my portfolios again, I don’t expect to have stellar returns in the short-term. However, as I plan out my F2017 goals, I expect that to change.
Onwards and upwards!
Earlier this year I was helping my brother out with his financial planning, and one key element of the planning was to cut expenses. Cutting expenses is an important factor of any planning session, since any reduction in expenses boosts your disposable income by an identical amount: save $5.00, and you suddenly have $5.00 to redeploy elsewhere. At the time, he was paying $14.95/month in banking fees at a major Canadian bank, which equates to $179.40/year. When I asked him why he paid the fees, he really didn’t have an answer. Like many individuals, he took fees as a given–albeit a horrible one–and paid them every month. With some nudging, we managed to move all of his accounts to Tangerine, and he now has an extra $14.95 every month in his pocket. By the way, if you decide to open up your own account at Tangerine, please use my referral key: 16176076S1 .
Of course, it is not always possible to move all of your banking. I have the lion’s share of my accounts at Tangerine, however I also have an account at BMO because my mortgage is with them, I have a US Dollar Chequing account there, and I use BMO InvestorLine as my discount brokerage. Having an account there just makes things easier. But, even having an account, there are ways to avoid the monthly fees. For my own plan, if I keep a minimum balance of $2,500 in the account, the fees are waived.
Now, I gave that bit of background, because Bank of Montreal is increasing the minimum balance you require to waive fees as of December 1, 2016. Here is a snaphot (as of November 29, 2016) of the proposed fee increases:
|Plan||Current minimum balance||New minimum balance||Difference $||Difference %|
As with everything, the need to pay for fees is all about opportunity cost. As a consumer, I have two choices:
- Pay a monthly fee, and use the minimum balance as I see fit.
- Do not pay a monthly fee, and lock up the minimum balance with BMO.
Let’s look at the annual banking fees, relative to the minimum balance to avoid paying those fees:
|Plan||Monthly Fee||Annual Fee||Minimum Balance (Old)||Cost Yield (Old)||Minimum Balance (New)||Cost Yield (New)|
In the above, the Cost Yield column represents the percentage cost based on the minimum balance, to avoid paying the fees. So, for the Plus Plan, by keeping $2,500 in the account, I am avoiding $131.40 in fees per year, or 5.3% of the locked in money. Put another way: if I can find an investment that pays me at least 5.3%, I would be better off taking the $2,500, investing it in the investment, and using the proceeds to pay off the monthly fees. However, that 5.3% doesn’t take into account taxes. My marginal tax rate on dividends is 25.38% according to the tables on taxtips.ca, so in reality I need to find an investment that yields at least 7.0% (since 7.0%, less 25.38% taxes, would yield me 5.3%).
Now, years ago when I was faced this decision, it was hard to find an investment that would guarantee me 7.0% return (with an acceptable level of risk). The other wrinkle was that many ETFs or companies pay dividends quarterly, which means the income stream from the investment would be “lumpy” relative to the frequency of payments. But with the increase in BMO’s minimum balance, things change. Here are the updated tables using the December 1, 2016, minimum balances:
|Plan||Monthly Fee||Annual Fee||Minimum Balance (new)||Cost Yield (new)||After Tax Cost Yield (new)|
My specific plan is the Plus plan, so I now have two choices: find an investment which gives me a guaranteed 5.9% return on $3,000 (which would give me $177.00, or $132.07 after taxes), or keep $3,000 locked at BMO, and avoid $131.40 in annual fees. Given that this $3,000 is a good place to stash emergency funds, and I wish to preserve safety of principal, at this point I feel it is still safer to keep the “ransom money” with BMO to avoid the fee. It is because of the savings that I call this the “indirect dividend”: I can either claim a dividend by investing the capital, or I can save the fee by locking the money away. Either way, I am “making” money off of locking away a fixed amount of capital.
Of course, there are ways to improve the above analysis. For one, if I purchased the shares in my TFSA, then there would be no tax implications, so I could focus on the Cost Yield, not the After Tax Cost Yield. Another possibility is preferred shares, which I spoke of in an earlier post. Over the next few weeks I will continue this analysis to see if there is a better way to obtain overall higher returns.
Onwards and upwards!
This is part 2 in a 3 part series I have entitled “The Great Pension Experiment”. This will detail my analysis on what to do with a defined benefit pension plan payout, after leaving my previous employer.
I am a big fan of Monte Carlo analysis (MCA). In a nutshell, when performing an MCA we run a test a fixed number of times, using a controlled set of inputs, and observe the results.
I had mentioned on my previous entry that I felt I could do better than the $600 per month defined benefit pension that OPTrust was offering after I left the company. But, how would I quantify this?
I wanted my LIRA to be as simple as possible, to run virtually effortless. Because of this, I elected to use one of the Couch Potato model portfolios, specifically the one using ETFs. Within these options, given my 25+ year time horizon, I elected to use the Assertive Portfolio, which has the following composition:
- 25% of the Vanguard Canadian Aggregate Bond Fund ETF, VAB
- 25% of the Vanguard FTSE Canada All Cap Index ETF, VCN
- 50% of the Vanguard FTSE All-World ex Canada ETF, VXC
The weighted average expense ratio of this portfolio is 0.18% as of November 2016, and the returns are pretty impressive:
- 1-year return: 7.20%
- 3-year return: 12.61%
- 5-year return: 8.91%
- 10-year return: 6.24%
- 20-year return: 7.10%
- Lowest 1-year return (2008-03 to 2009-02): -24.95% (2008 financial crisis)
To perform my analysis, I elected to take the lump sum from OPTrust, and run an MCA on it to see what the projected monthly income would be in 25 years, if I had used the Assertive Portfolio. To do this, I ran 100,000 iterations on 25 years of growth in the portfolio, using randomized returns. Here is an example of one set of returns:
|Year||Start Value||% Gain||End Value||Implied Annual Income||Implied Monthly Income|
In the above, the % gain is a random gain for the portfolio based on an average return of 8.29%, and a standard deviation of 7.96%. The implied annual income assumes I could take the ending value of the portfolio, and buy an annuity or other similar (set of) instrument(s) to generate 4% of annual income. I believe 4% annual income, if you are not concerned with growth, is incredibly doable in the market.
But wait, where did that 8.29% average return, and 7.96% standard deviation come from? And what do they mean?
If you take 15 years of returns for the couch potato model portfolio, and do some statistical analysis on that data, you will end up with an average daily return of 0.032%, which equates to an average annual return of 8.287%. Moreover, those same daily returns have a standard deviation of 0.503%, which is 7.959% annualized. (For annualizing, I assume there are 250 active trading days in the year: 52 weeks @ 5 days/week, less 10 days for various holidays). Now, because the model portfolio asks for VAB, VCN, and VXC, and those ETFs are relatively new, I used iShares Core S&P/TSX Capped Composite Index ETF (XIC), iShares Canadian Universe Bond Index ETF (XBB), iShares MSCI World Index ETF (XWD), and iShares Core S&P 500 Index ETF (CAD- Hedged) (XSP) as proxies:
- For the period of October 29, 2009 to December 31, 2015, I used a blend of 25% XIC, 25% XBB, and 50% XWD.
- For the period of April 15, 2002 to October 28, 2009, I used a blend of 25% XIC, 25% XBB, and 50% XSP.
The ETFs listed are iShares ETFs. The XWD is the equivalent to VXC, but prior to October 29, 2009, there were no ETFs I could find that were all-world excluding Canada ETFs. Moreover, the period I chose covers the tail end of the dot-com bubble, as well as the massive 2008 financial crisis. Doing this provides more real world examples. In fact, looking at the above table you can see that in this iteration, in years 18 and 20 the sample has massive declines of -14% and -8% respectively! I feel this is an accurate representation of what could happen.
The average and standard deviation play into each iteration of 25 years. In the table above, the “% Gain” column will be, on average, 8.29%, and vary with the standard deviation of 7.96%.
Now, if we pull this all together:
- Create the table above 100,000 times
- Take the final 25 year implied monthly income from each iteration
- Plot a histogram
We get the following:
The above histogram shows that we have a 16% probability of having total monthly income less than or equal to $786. Put another way: we have an 84% probability of having implied monthly income greater than $786. If we take this a little further, we have an approximately 7% probability of making at most $600, or a 93% probability of making at least $600.00. But wait, OPTrust’s defined benefit income would be $600/month. I have only a 7% chance of not beating OPTrust’s defined benefit pension! Screw you OPTrust, I’ll take my chances.
So, based on my Monte Carlo analysis, using 13 years of historical returns on a portfolio of 25% Canadian Equities, 50% non-Canadian Equities, and 25% Canadian Fixed Income, I took the plunge to invest all of my money from OPTrust into my LIRA, using the couch potato portfolio. That was almost a year ago. In my next post, I’ll speak to the first year of actual results.
Onward and upward!
October was not a stellar month, but like a ship through a storm, slow and stead wins the race. Here are the graphs for October 2016.
On a monthly basis, I was trending below the my benchmark, The Canadian Couch Potato Assertive Portfolio. For October, that portfolio returned a gain of 0.02%, and the total fund return for my own experienced a loss of 0.70%. However, my certificated portfolio managed to beat the benchmark handily, clocking in at 1.74%, a clear winner.
On a trailing twelve month basis, overall I am still beating the benchmark. The Assertive Portfolio benchmark for the last twelve months returned a gain of 7.14%, whilst my total fund returned 10.20%, a handy 3+% increase over the benchmark. I expect this trend to stabilize over the coming months, as some of my large sales earlier this year to fund some major purchases start rolling off of the TTM calculations. But for now, my key Margin, Total Portfolio, and TFSA measures are beating the benchmark.
In September I set up automatic synthetic DRIPs in my LIRA account to automatically re-invest dividends as they become available. The synthetic drip allows me to constantly grow the portfolio whilst negating commission costs, reducing the overall amount of cash in the portfolio (which I consider a massive point of friction, since the cash sits there generating zero returns). October was the first full month of synthetic DRIP in the LIRA account, and as the months move forward, I expect the LIRA to exceed the benchmark, since the LIRA is investing monthly, but the benchmark is only designed to re-balance every six months (which is an accurate representation of what may happen in the real world).
Reviewing the passive income statistics, the benchmark portfolio returned $204.15 in passive income, and my own passive income exceeded that by 83.74%, which was a great accomplishment.
On a trailing twelve month perspective, I am still exceeding the benchmark in total passive income. Benchmark TTM passive income was $5961.89, and the TTM passive income of my own portfolio beat that by 4.40%. The makeup of my portfolio has changed since I started maintaining it on a regular basis again, however the weightings of major dividend players are still low relative to the portfolio as a whole. I expect TTM passive income to level off relative to the benchmark, but within the next twelve months I expect to be in a position to beat the benchmark on a monthly basis as I re-weight the portfolio for a more even income allocation.
I have set up a number of recurring OCPs to automatically invest in my certificated account on a monthly basis. Specifically, Telus, Emera, Fortis, and Bank of Nova Scotia are now receiving automatic contributions from my paycheque every month. While this is a drag on disposable income, because these are all strong dividend players, I expect the long term gains to far outweigh the short term pain of not having “play money”.
Onwards and upwards!
This is part 1 in a 3 part series I have entitled "The Great Pension Experiment". This will detail my analysis on what to do with a defined benefit pension plan payout, after leaving my previous employer.
Up until 2015, I worked for the OPSEU Pension Trust, a major pension plan in Ontario, and had the benefit of a “golden pension”, or a Defined Benefit Pension. These pensions are considered the gold standard in the pension industry because the total payment that one receives upon retirement is guaranteed, regardless of what happens in the markets.
However, towards the end of my tenure at the company, a new CEO came in, and there were a number of changes with upper management. As a result of these changes, there was a large amount of restructuring as the company made attempts to streamline processes and change the long term strategic goals and organization of the firm. As with any restructuring, there are causalities, and my department was no different: my entire department was explained away, and I left the organization.
Due to pension law in Canada, when an employee leaves a company, they are given three options with the money that is with the company for their future pension:
- Leave the money with the company, and at age 65, start taking a pension.
- Transfer the money with the company to your new employer’s pension plan. In this way, any deductions which were taken off of your paycheque whilst with employed with the former company, would carry forward with you to your new company. The caveat to this is that it is not the actual deductions which would transfer, but the commuted value of those deductions.
- Transfer the commuted value of your pension to a Locked In Retirement Account.
Before continuing with the background information, it would help to get some terminology out of the way..
The commuted value of a pension is an actuarial calculation which states what the total value of your pension in the future is worth today. To give a very simple example, assume you received a pension of $1,200/year ($100/month) starting at age 65, and given your actuarial profile, you would live to the age of 85. Given that, the total payments you would receive would be:
But, that $24,000 is the value of the pension as you receive in the future; to be accurate, you have to discount that back to the present day. If we extend our example to assume that we have a discount rate of 5.25%, and we are currently 50 years old, this means that the first annual pension payment of $1,200 (i.e. when you turn 65) has to be discounted back 15 years at the discount rate of 5.25%, or . The next payment would have to be discounted 16 years, or . If we do this for all of our payments to age 85 (our assumed death age), then the present value of the pension is then:
And if we do the math on this, we find that our $1,200 annual pension at age 65 is worth $7,353.54 in today’s dollars.
The example above is very simple, and a more true calculation would discount each (monthly) payment by the discount rate. Also, the assumption that the pension would last for 20 years is based on a number of actuarial tables, etc. But at the end of the day, the commuted value is the present day value of all future pension payments.
The other item to discuss is the Locked In Retirement Account, or "LIRA" for short. A LIRA functions much like an RRSP, with the following key differences:
- Under normal circumstances, funds in the LIRA are locked in until either your retirement age, or some other specified age as specified by the province the LIRA is registered in. For my purposes, I am basing my calculations assuming the LIRA is locked in to age 65.
- Under normal circumstances, money added to a LIRA can come only from another LIRA, or registered pension. You cannot add money to a LIRA at a time of your choosing as you would with an RRSP.
- Depending on the circumstances, you may be able to transfer your LIRA to your pension plan with another employer in the future.
Put another way: when you open the LIRA, any and all money is inaccessible until the prescribed age of withdrawal, or if available to you, you transfer the funds to another registered pension plan. If the market goes south and your LIRA loses 90% in value, you cannot add money to bring it "back up". Similarly, if it grows in value over time, you cannot withdrawal that money until some time in the future.
For my own personal situation, after leaving my previous employer I elected to incorporate myself and become an independent consultant. This mean that Option 2 was not possible, as I would no longer be employed by a company with a pension plan to transfer the funds into. The other options would be Option 1, leave my money with OPTrust, and Option 3, transfer it to a LIRA.
The formula for OPTrust when calculating the defined benefit pension is:
Based on my years of service, and average salary, the pension I could have expected to receive at age 65 would be approximately $600/month, or $7,200/year. But, that is $7,200/year in 28 years!! The Bank of Canada has an inflation target of 2.00% annually. If we discount back the pension offered by my previous employer at the inflation target of 2.00%, that would equate to $426.67/month in today’s dollars. I’ll be honest: I think I can do much better than that.
That said, because the pension offered by OPTrust would be worth relatively little in the future, and because I did not have an employer to transfer my pension to, I went with Option 3. The second part of this series will outline the quantitative analysis I performed to come to this conclusion.
I am often asked where I get my information, where I start, and what my process is.
The first thing for any investor, regardless of how s/he invests, is to have an Investment Policy Statement, or an IPS. I’ll touch more on IPS’ in a later post, but in a nutshell it describes your investing goals, strategy, how to meausure success, and risk tolerance. Overall, it measures the how and why you invest. I mention this, because one’s investing process is driven by their IPS, and the process in turn drives how and where you start.
As a dividend investor, I try to work smarter, not harder. There are a plethora of information sources out there. The universe of dividend paying companies is huge, and grows even larger when you expand this to income trusts (e.g. REITs), mutual funds, and ETFs. Because the universe is so large, it is challenging to find companies to invest in that meet my specific criteria:
- Companies with strong dividend growth
- Companies which are cheap (by cheap, I mean in terms of valuation, not the actual cost per share)
- Companies which offer a decent yield
- Companies which will help to diversify my exposure to different industries (i.e. not being overly concentrated in one type of company, such as “all banks”)
With that criteria in mind, there are a number of tools that one can use to help whittle down the universe of available stocks to invest in. And once this universe is whittled down, you can start focusing on which companies to take a deeper look at, before pulling the trigger and investing your hard earned dollars. That said, here are some of the tools I use to help in identifying companies to analyze, and hopefully purchase.
- Blogs. I try to read a lot of blogs, but as most readers know, there are many, many blogs out there. It helps to be able to have a shortened list of blogs to peruse on a regular basis. My primary source of blogs is The Div-net, as it is composed of blogs focused on dividend investing. This makes sense, as there are several great bloggers who have already done a fair bit of research on companies to invest in (or not to invest in!). Beyond that, these blogs are a great source of inspiration for my own investment activities, and often help to push me to invest that one extra dollar into my investments.
- Podcasts. I listen to three (four) bogs on a regular basis. These blogs are not all about investing, but they do act as a great source of inspiration for managing money. Moreover, they make the listener really think, which helps when you are doing deep analyses on companies to invest in.
- Market Foolery / Motley Fool Money. These blogs are published Monday-Thursday, and Friday, respectively, and are the podcasts of fool.com. The show features a rotating list of speakers who work at fool.com, and is great for a daily recap of financial events, and an hour long recap on Friday. The host and speakers are great presenters, and I’m often left laughing under my breath on the streetcar home when I’m listening to them.
- Planet Money. While not an investment podcast, Planet Money is a great source of things about, well, money. They cover a breadth of topics, everything from the full process to selling oil (right from pumping it out of the ground, to selling it to a gas station), the odd case of a shopping mall with two different minimum wages, and the investor of the Self-Checkout Counter (who knew that the inventor was a local Torontonian???).
- Freakonomics. I’ve saved the best for last. I love the Freakonomic books, and the podcast is great for a weekly dose of diverse topics on economics. They cover everything to do with incentives, right from why belts are the worst invention ever, to the history of the Nobel prize.
- News. Newspapers, and newspaper websites, are a great source of information. Regrettably, many newspapers how have “pay-walls” around them, so some of the more premium content is unavailable without a subscription. Frequent sites to visit? The Business and/or Investing sections of The Globe and Mail, Yahoo Finance (Canada), and Bloomberg.
- Daily Email News Digests. I subscribe to two daily news digests, which typically deliver an email before 7:00 AM EST so I may read it on my way to work.
- CFA Financial Newsbrief is put out by the Chartered Fianncial Analyst Institute, and is a great roundup of financial and economic events that have occured in the last twenty four hours (or over teh weekend in the case of the Monday edition). Within the email, there are short paragraphs describing the event, and links to longer articles on 3rd party websites such as Bloomberg, or Wall Street Journal.
- Bloomberg Briefs. I actually subscribe to two Bloomberg digests, but they are both different versions of Bloomberg Briefs. If you go to the site, there a variety of daily digests which you can sign up for, for various financial products (ETFs, Bonds), different industries, and general financial and economic news.
- DRIP Investing Centre. The DRIP investing Centre is the heavyweight of all information. On this site, you’ll find the Money Market Dividend Champion lists for both Canada and the US, available in Excel and PDF format. These lists are invaluable to the dividend investor, as they have information going back several decades for each company that pays a dividend in the Canadian and US markets. For my own criteria listed above, I was able to whittle the universe of 700+ stocks down to 15 stocks in less than 5 minutes, just playing with some filters in the spreadsheets. This has saved me countless hours of filtering and searching other websites for the same information. Importantly, it also lists an extrapolated Graham number, which is one of the key metrics I use for measuring the value of a company (e.g. to determine if it is cheap enough to buy). This in itself is a great time saving tool, since it avoids me researching a company, only to find that it is too expensive to invest in!
No investor is an island, and it helps to leverage the work of others! After all, the majority of us are retail investors who are trying to carve out the biggest piece of the pie that they can — and thanks to resource such as those listed above, we can eek out an even larger piece over time.
Onward and upwards!