Five Pillars To Financial Security

In this post we will discuss, very briefly, the "Five Pillars to Financial Security". Keep in mind, up until January 1, 2009, there were only 4 pillars; however, with the introduction of the TFSA on January 1, 2009, there are now 5 pillars that we can all work with. I'm not going to get into specifics of each pillar, as I've already discussed each pillar in detail in my previous posts, but this will be more of a general summary on how each pillar can affect your financial foundation.

The 5 Pillars are:

1. Home

2. RRSPs

3. Open Money (Non-RSPs)

4. TFSA

5. Cash Value Insurance Policy

As I've stated over and over again, every strategy has its pros and cons, which is why all strategies should be used to compliment each other. There is no 1 strategy that is best for everybody, since everybody's circumstances are different, therefore, everybody should have their own independent financial plan made for them. Below, is a small, simple table with the basics of every type of vehicle.

VEHICLE	CHARACATERISTICS	RETIREMENT USE
HOME	- No Tax Write-off - Low Rate of Return - Equity (usually) is making 0% return for you - Steady value (usually appreciating over time) - Do not pay capital gains taxes for owner	- Generally, NO retirement funds
RRSPs	- - Tax Deduction on Contribution - - Tax Deferred Growth - - Tax Refund given - - There is Maximum Contribution limit	- - 100% Taxable on Withdrawal (but there are ways to minimize or even create net 0% taxation)
OPEN	- May create Tax write-off (if set up properly) - Tax Advantage growth (not tax-deferred growth) - Can set up tax-efficient withdrawals - No Maximum Contribution	- Taxed on 50% of growth, on Withdrawal
TFSA	- No Tax write-off - Tax-Deferred growth - Low Maximum Contribution space (starting at $5000/yr in 2009 – will be increasing gradually over time)	- 0% Tax on Withdrawal
CASH VALUE INSURANCE POLICY	- No Tax Write-off - Tax Deferred Growth (on investment) - Must Qualify - Benefit of having insurance protection for entire life - Leave beneficiaries tax-free income upon death	- 0% Tax on withdrawal (if set up properly)

As you can see, each pillar has its pros and cons; and as you can also notice, the cons in each pillar is made up for by the pros of another pillar, which is why it would make sense to use as many of the pillars as possible to compliment each other, so the financial foundation is set!

This post is just meant to be a brief summary of some of the things that were discussed earlier, just to kind of simplify the main points for each vehicle. It is also meant to make people aware to not put 'all their eggs in one basket', as we've heard many times before. Diversify, understand (the concepts/strategies), and prosper!

I hope this post has helped, even though we didn't touch on anything new. Be sure to consult your financial advisor before making any decisions. Please do not hesitate to contact with me if you have any questions/comments.

The Rule of 72: Doubling of Money

When investing or borrowing money, probably the most determining factor in our decision is the interest rate we are paying, or getting, on our money. As discussed before, there are 2 types of interest: Simple Interest and Compound Interest. Simple interest, as its name suggests, is very simple to calculate. Compound interesting, however, can be a little more difficult.

The great Albert Einstein had come up with a concept called the "Rule of 72". This shows, by the compounding effect, how long it will take your investment or debt to double. What you do is divide the interest rate you're getting on an investment, or the interest rate you're paying on you're debt, and divide that into 72. The resulting # will give you the approximate time it will take for the money to double.

For example: If you're receiving 4% return on your investment, that means that if you held that investment, then every 18 years your investment will double (72 divided by 4 = 18).

Let's take a look at at a few different numbers and see what the difference could be.



As you can see, the potential difference is in the outcomes is astounding. Now, you have to ask yourself, where can you get these type of potential returns? If you look at the above example, the first rate of return of 4% is something you can't really even expect from a GIC, but lets just assume the bank gave you that on your GIC. After 36 years the difference is $600,000, which is potentially what the bank made off of you.

The highest rate of return on the example is 12%; which is probably the average return the bank will get from the money you invest with them (the bank doesn't just take your money and put it into a vault with your name in it, they take your money and re-invest it to make more money). Just think about your credit cards, what sort of rate do you pay? 18%-19%? So, think about it, they're giving you 4% on your investment, and they're charging you 18% on your credit card. Does that seem fair?

Why not do something smart with your money and invest yourself, rather then let someone else make money off of you. Now, there aren't many places you are likely to get average of 12% return, but over time, if you're invested in the market, the chances for getting better then 4% are a lot more likely.

The key is to do your homework, and let your money work for you. Let the compounding affect and rule of 72 work in your favour. If you have any questions, please do not hesitate to contact me. I hope you've learned something from this post!

Investing Early vs Investing Late: Pay Yourself First!

In the 'wealth formula', point number 2 was 'Time'. In any sort of investment you need time to let your money grow and compound over and over. I've done a quick worksheet comparing 2 scenarios with 2 different people.

Person A starts investing $300/month ($3600/year) starting at age 25 and only invests for 7 years and then stop.

Person B starts investing the same amount, $300/month ($3600/year), but starts investing later in his life, at age 32 (the year after Person A stops contributing).

We will assume they are both investing in a tax-deferred account and are getting 8% return.



As you can see, at age 48, Person B surpasses Person A; however, Person A had only made a total contribution of $25,200. Person B had to contribute for 17 years, with a total investment of $61,200, in order to catch up to Person A. That's a difference of $36,000! The affects of compounding were in favour of Person A because he started early and let his money grow.

But lets think realistically, especially those of us who are married and have kids and other responsibilities (i.e. mortgage, taking care of elder parents etc...). Does it become easier to start saving early or start saving later? I think we can all agree that as time goes on it becomes harder to start saving. That's why it's VERY important for younger people, especially younger couples, to start saving as soon as possible.

As you get older it becomes harder to save because more expenses start to come up; for example maybe you just bought a new house and have a mortgage to pay, or your kids are now growing up and college/university expenses are coming up, or you need to start caring for elder parents. Whatever the case may be, something always seems to come up that makes us say "okay, I'll start investing next year". The key is to start investing early and build that discipline.

The above example is just for illustration purposes, so I'm not saying that you should only invest for 7 years and then stop, not at all! Investing should be done over the long term so you can take advantage of market cycles and compounding.

Procrastination is one of the main causes of failure, when it comes to accumulating wealth.

Now comes the point of some people who will say "I don't have $300/month to invest". What if we make some small changes in our life and spending habits that will help you get that $300/month -- $10/day? There's always things you can cut down, such as:

- Sodas
- Cigarettes
- Lattes
- Cable TV
- Games
- Sweets
- New Gadgets
- Shopping
- Driving a Big car
- Eating from outside
- Partying
etc...

You don't have to cut out every single one, but cutting back on a few of these things can be the difference between you retiring successfully, or un-successfully! You MUST have discipline and consistency if you want to win the 'wealth game'!

Now, of course, the numbers given above are for illustration purposes only. Whether someone has $300 a month or $100 a month to contribute, or whether a person is getting 8% or 5% as a rate of return, is not really the point. The main point is that, if we want to have a chance of achieving our financial and retirement goals, we need to start as early as possible and be disciplined as well.

From experience, I have seen that those who start at a younger age are more inclined to keep saving and also will increase their contributions over time. Once the habit of savings is developed, and you see the dollars accumulating in your savings plan, it becomes easier and more fruitful to see your hard earned money at work for you!

Formula for Wealth

Since I've talked about savings/investments already, I thought I'd go back to the basics. We've all heard people talk about wealth and how to accumulate it, but its always been pretty complicated. Here is a simple formula that I show all my clients which is just the bare basics. The "Wealth Formula" or the formula to creating 'wealth' is:

MONEY
+ TIME
+/- RATE OF RETURN
- INFLATION
- TAXES
__________________
WEALTH

1. In order to create wealth, you need to start off with your own money. Whether it be lump sum contributions or regular (monthly, weekly, bi-weekly etc..) contributions, we need to start somewhere.

2. Time is a very important thing. A lot of people wait to start investing, which usually results in them not having enough money in retirement. Some excuses they use are "we'll wait until the kids are out of the house" or "wait until my debt is paid down" or the like. Most people will tell you, that some of those excuses will never pan out. You need to give your money as much time to compound as possible, so that you can live the type of lifestyle you want to live. Accumulating wealth is not done over-night; it takes years, sometimes even decades, to do it. Even if it's a small $25/month, start somewhere and then gradually increase.

3. There is always a rate of return that dictates how much return we get on our investments. You can either have a positive or negative return; obviously we all want a positive one. This kind of ties into point #2 of time, the longer you keep invested, the better chances you have of having a positive rate of return; your money will have time to compound and go through the market cycles.

4. This point is something that the vast majority of people overlook. Inflation pretty much erodes your purchasing power. In English: A dollar today is not worth a dollar tomorrow, as cost of living continues to increase - examples include Gas, Groceries, Clothing, Homes etc.. When investing, you must make sure that you're beating inflation, otherwise even though it might seem that you have a 'positive' return, you might actually be 'losing money'.

** As a side note: We often hear the Government and/or Bank of Canada talk about Inflation levels and what their 'target' inflation is. It would, however, be a little difficult for the government to back up their claims for the inflation numbers they give us (whether its 1.5% or 2.0% or whatever they tell us). The reality is, the numbers the Government/Bank of Canada  use when telling us about the current inflation rate, are not entirely accurate, as they don't take into consideration all the things they should, and they're not all weighted the way they should be. For example, they can tell us day and night that the inflation number is 2.0%, but we all know that prices for goods and services have increased much more than 2.0% -- just check your gas and grocery bills!

5. Like I said in my previous post, the only thing certain when living in Canada is death and taxes. Taxes can take a HUGE chunk out of your investments, especially if the plan is not set up properly. Have a financial professional help you with setting up your portfolio so that you can reduce and sometimes even eliminate taxes altogether. Wouldn't it be unfortunate to have to give 30% or 40% of your hard-earned money to the government when you're ready to retire?

A proper financial plan will take a look at every point discussed here. These days too many institutions are just focused on taking your money and don't set up a proper financial foundation with you. Building a strong financial foundation will drastically increase the chances of you retiring successfully and living the type of lifestyle you want to live!

If you have any questions about anything discussed, please do not hesitate to contact me!