Decumulate & Downsize

Most of your investing life you and your adviser (if you have one) are focused on wealth accumulation. But, we tend to forget, eventually the whole idea of this long process of delayed gratification is to actually spend this money! That’s decumulation as opposed to wealth accumulation. This stage may also involve downsizing from larger homes to smaller ones or condos, moving to the country or otherwise simplifying your life and jettisoning possessions that may tie you down.

Retired Money: Americans cashing out of employer Retirement plans could benefit from Canadian approach

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My latest MoneySense Retired Money column, which has just been published, looks at an interesting study on trends in cashing out Retirement savings when American workers leave their jobs. You can find the full column by clicking on the highlighted text here: Should you cash out your workplace pension when you leave a job?

The paper, titled Cashing Out Retirement Savings at Job Separation, is co-written by a Canadian, Yanwen Wang, associate professor at the University of British Columbia’s Sauder School of Business. The study, which is fairly technical, is also featured in a more accessible version in the Harvard Business Review. The article that ran on March 7, 2023 is titled Too many employees cash out their 401(k)s when leaving a job.

Canada and the United States differ in how retirement plans are treated on leaving jobs, so most of the column applies mainly to the United States. But there may be lessons for the US retirement system that can be drawn from the Canadian treatment.

Average American has more than a dozen jobs over a career

In the US, the average American worker will have 12.4 jobs over a career, prompting the report’s authors to write that “Employers should recognize that most people working for them will change jobs before retirement.” Unfortunately, it’s all too easy for their workers to cash out of their 401(k)s when leaving a job, instead of rolling them over and letting the money continue to grow in a tax-deferred manner.

A UBC press release issued early in April carries the alarming headline that “Americans are cashing out the retirement savings at an alarming rate.”  The study identifies a “key” problem: when they switch jobs, 41.4% of employees are cashing out of those funds — even though the U.S. Internal Revenue Service (IRS) imposes a 10% per cent penalty on anyone younger than 59.5 years old.

Here’s what Wang said via email about the implications for Canadian retirement: “Canada has some different fundamental rules around retirement savings withdrawal. It is hard or probably impossible to speak to the Canadian RRSP withdrawal based on our US-based study.”
Canadian plans have locked-in feature

In particular,  many Canadian RRSPs have a locked-in feature, Wang added: “which means that even at job changing cash withdrawals are not allowed unless the individual becomes non tax resident. The locked-in feature is a key feature not present in most US retirement savings accounts. I don’t have data but I believe the illiquidity feature substantially reduces 401(k) leakage. I think the U.S. can learn from the Canadian retirement system and consider something similar — a locked-in 401(k) on top of an emergency savings plan — to satisfy the long-term retirement needs as well as short-term liquidity emergency.”

Unlike Canada, American employees can cash out at any time whether they’re working or leaving a job: the only developed economy that does. As the article points out, “other countries require many months of unemployment and evidence of clear hardship before allowing someone to tap defined contribution retirement savings.”

 Researchers also found an interesting phenomenon whereby the more a generous employer “matches” employee contributions, the more the departing employee is tempted to cash out and spend what it regards as “house money” or “free money.” Thus, the authors write, “Right now, cashing out is the path of least resistance. People choose what is easy, not what is wise.”

The column closes with some findings from a recent H&R Block Canada survey released on April 3, 2023. It  found nearly half of Canadians are unprepared for retirement and more than a third (36%) between ages 18 and 54 believe they won’t ever retire.

How to stay motivated while Pursuing Financial Independence

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Image courtesy of Terkel

From setting specific financial goals for success to having someone hold you accountable, here are 18 answers to the question, “What are your best tips for how to stay motivated and disciplined in the pursuit of financial independence?”  

  • Stay Disciplined and Goal-Oriented
  • Tie Your Goals to a Tangible Item
  • Stay Educated
  • Equate Money to Your Time
  • Celebrate Small Wins Along the Way
  • Develop an Action Plan
  • Create a Budget
  • Invest in Yourself
  • Develop a Strong “Why”
  • Have Fun With It
  • Set Specific Financial Goals for Success
  • Balance Spending Now and Saving for the Future
  • Start Tracking Your Progress
  • Focus On the Big Picture
  • Be Present
  • Build a Support System
  • Set Yourself Micro-Goals Along the Way
  • Find a Financial Accountability Buddy

Stay Disciplined and Goal-Oriented

Staying motivated and disciplined while pursuing financial independence requires commitment. One approach to remaining committed is to practice goal-setting, breaking down big goals into smaller goals that are based on achievable objectives. For example, if you want to save $1,000 in 3 months, break your bigger goal of saving money into a series of monthly phases, setting benchmarks each month as you inch closer to achieving your end goal. This helps with momentum and development while moving towards your desired result. — Michael Alexis, CEO, swag.org

Tie Your Goals to a Tangible Item

One often overlooked way to accomplish this is to tie your goals to a tangible item, such as a savings jar or bank account. Visualize yourself with it when planning out what you need to do today and watch as your small contributions add up. 

Having this visual representation can be just the thing you need on days when you feel unmotivated and looking for an excuse not to save money. Taking ownership of your financial goals is the first step towards realizing those dreams – that’s what staying disciplined will help you achieve! — Tasia Duske, CEO, Museum Hack

Stay Educated

Continually educating yourself about personal finance is crucial in staying motivated and disciplined as you pursue financial independence. Of course, this starts with knowing how to budget and set boundaries for yourself. 

As you strive toward financial independence, it’s important that you know where your money is going and identify areas where you can cut back on spending. There are a variety of ways that you can budget your money, so explore those options and find a way that works for you. 

If you are one who likes to invest, stay up to date on current market trends so you don’t take any enormous risks that could cost you a lot of money. As you continue to stay informed and educated about personal finance, you will make informed decisions and avoid costly mistakes, which will ultimately help you achieve your goals. — Bill Lyons, CEO, Griffin Funding

Equate Money to your Time

Whether you make minimum wage or $100 an hour, we all trade time for money. Spending less money is one way to achieve greater financial independence. But when you’re struggling to cut expenses, one way to stay motivated is to understand how much time your money costs you. 

For example, if you’re toying with the idea of a $50 purchase, think of how much of your time it would take to make back that $50. How far would that put you behind? Would you be willing to spend that time getting that item?

Thinking about money in terms of minutes/hours of your life can help you exercise some restraint on impulse buys or unnecessary purchases. If you feel like it would be a waste of time, it’s probably a waste of money, too. — Alli Hill, Founder and Director, Fleurish Freelance

Celebrate Small Wins along the way

Achieving financial independence can be a long and difficult journey, and it’s easy to become discouraged if you only look at the result. You can keep your motivation and momentum going by celebrating minor victories along the way.

Set attainable short-term goals, such as paying off a credit card or increasing your monthly savings by a certain amount. When you achieve these objectives, take the time to recognize your accomplishments and reward yourself‌. 

As a reward for sticking with it, give yourself a small treat or indulge in a favorite activity. This will help you in maintaining your motivation and discipline, as well as making the journey to financial independence more enjoyable. –– Johannes Larsson, Founder and CEO, JohannesLarsson.com

Develop an Action Plan

It is important to develop a plan with realistic goals. Start by setting short-term goals that are achievable, such as saving a certain percentage of each paycheck or paying off the debt within a certain timeframe. 

Then, set longer-term goals for retirement savings or other goals related to financial independence. Having a plan will help keep you motivated and on track to achieving your financial goals. — Martin Seeley, CEO, Mattress Next Day Continue Reading…

The benefits of Early Retirement

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By Billy and Alaisha Kaderli, RetireEarlyLifestyle.com

Special to Financial Independence Hub

Retirement is something that many people look forward to in their later years, but what if you could leave your career earlier?

The idea of retiring before the typical age of 65 may seem like a pipe dream to some, but it is becoming more and more of a reality for many people whether by choice or through layoffs. There are numerous benefits to this decision, both financially and in terms of lifestyle.

Financial Advantages

One of the main reasons people strive for early retirement is the financial benefits it provides.

To prepare, it’s important to have a solid financial plan in place. This is a great way to learn the skills of creating a budget, tracking your spending, and paying down debt. We learn the value of maximizing retirement contributions and investing in non-IRA accounts. It’s the time to build up retirement savings before beginning to withdraw from them. You can do this on your own, as none of this requires a professional advisor.

Acquiring these tools makes us financially strong and builds our self-confidence which then carries itself forward into other areas of our lives.

Of course there is the need to factor in the potential for unexpected expenses, such as medical bills or family emergencies. Which is why we recommend a few years of cash held in a highly liquid account such as Fidelity® Government Cash Reserves, FDRXX, currently paying over 4%. Access to this cash can also help in market downturns so you are not forced to sell at lower prices in order to live your lifestyle.

Another financial advantage is the ability to minimize taxes.

By retiring early, you may be able to reduce your taxable income and utilize tax-efficient investment strategies. For one thing, you will no longer be paying payroll taxes. Withdrawing money from your retirement accounts in a strategic manner, such as using Rule 72T before you are eligible, can minimize your tax burden in the future and potentially save you a significant amount of money in taxes over time. We did this as a monetary bridge until our Social Security was available. Once we started to receive these payments, we let our IRAs build back up again.

Lifestyle Improvements

Leaving your job or career early also offers a number of lifestyle improvements. For one, you will have more free time to pursue your passions. You could travel more, take up new hobbies, and spend more time with loved ones. We used this opportunity to give end-of=life care to our parents when that time came, something we could not have done while maintaining a full work schedule.

Early retirement can also allow you to lead a healthier lifestyle, with more time to exercise, cook healthier meals, and prioritize your mental health. You could even volunteer and give of your expertise and talents, something you never had time for while working your 9-5.

If you choose to become financially independent outside of your paycheck, you have the ability to avoid burnout. Many people feel overwhelmed by the demands of their jobs, and early retirement can provide a much-needed break while opening up new vistas for you. You are able to take a step back, reflect on your priorities, and perhaps even discover new interests and pursuits.

We did!

Taking advantage of options that seem to just appear

In our case we chose to travel the world, which gave us new perspectives on how to live our own lives. There is no one singular way to do anything, and seeing how other cultures approached community, family, and even the cooking of their food and the learning of a new language, opened up our eyes as well. Continue Reading…

A volatility play for the US bank sector

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Portfolio Manager explains why US banks have struggled, where opportunities might appear, and how investors can benefit from short-term volatility.

Image from Pixabay: Wendy Soon

By James Learmonth, Senior Portfolio Manager, Harvest ETFs

(Sponsor Content)

The US banking sector is facing uncertainty. In the wake of the collapse of Silicon Valley Bank in March of 2023 — and deposit liquidity issues at other regional banks — the whole US banking sector has suffered some significant stock market setbacks.

In those setbacks, however, investors may see opportunities, especially when we consider the scale and importance of the US banking sector. Of the 30 banks included in the global list of systemically important financial institutions, colloquially referred to as “too big to fail,” eight are based in the United States.

With those titans as ballast, investors may be able to find growth opportunities in US banking, if they understand why the sector is struggling now, where the upside could come from, and find a strategy suited to short-term volatility.

For someone seeking to take advantage of the dislocation we’ve seen in the US banking sector, a diversified approach is absolutely something you may want to look at. Adding a covered call strategy would give the opportunity to monetize the high volatility we’re seeing on the market now. It’s hard to say when the upside might come in US banks given all this uncertainty. But, there’s an argument to be made for someone who wants exposure to these US banks that a covered call strategy could make sense.

Struggles and risks in US banking today

The US banks’ stock market setbacks are due in part to a fear reaction from bank-specific failings at institutions like Silicon Valley Bank, but also reflect some structural headwinds for the sector.

The systemic issue comes down to deposit costs. As market-based interest rates rose sharply in 2022 and into 2023, the rates offered by banks to their depositors remained relatively low. Depositors, especially larger businesses, have begun to demand higher interest rates on their accounts, raising the cost of funding for many banks. Some of those depositors started transitioning some capital into other interest-bearing vehicles, such as money market mutual funds, which offered a higher interest rate as well. The whole banking sector is now facing some challenges to profitability growth due to the rising costs of deposits.

Those deposit costs can be more accurately described as a structural headwind, rather than an existential risk. While deposit costs contributed to the fall of Silicon Valley Bank, it’s notable that a range of company-specific factors played a role: Silicon Valley Bank’s high proportion of business clients, meaning its depositor base was concentrated and held high average account balances. When word spread across social media of venture capitalists sounding alarm bells to their investment companies, withdrawals cascaded. Continue Reading…

Retirement investments to avoid? Here are our thoughts on this critical subject

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Retirement investments to avoid include everything from bonds down to stock options. Here’s why.

Image courtesy TSInetwork.ca

Our best retirement planning advice is to invest early and often — and don’t forget to use our three-part Successful Investor philosophy.

But if you’re heading into retirement and are short of money, you should move your investing in the direction of safer, more conservative investments. That’s a far better option than taking one last gamble on retirement investments to avoid like the ones we look at below.

Investing in bonds will hurt your retirement finances

As some investors near retirement, their advisors recommend switching to bonds and other fixed-income investments instead of holding stocks.

To some extent, this is an understandable retirement investing strategy, since bonds can provide steady income and a guarantee to repay their principal at maturity.

Unfortunately, we don’t think using bonds for retirement is the best strategy for Successful Investors. Bond prices and interest rates are inversely linked. When interest rates go up, bond prices go down, when interest rates go down, bond prices go up — and with inflation still high, there is pressure for interest rates to keep increasing.

We continue to recommend that you invest only a small part of your Successful Investor portfolio — if any — in bonds and fixed-income investments.

Investing in annuities can fall into the category of retirement investments to avoid

Here are 3 key drawbacks you should keep in mind when deciding whether annuities are a good choice for your retirement investment options:

  • It may be hard to get out if you change your mind: Unlike stocks, it can be difficult or impossible to sell an annuity if you decide it no longer meets your needs. Moreover, you will likely get a low price for your annuity because the date of your death is uncertain.
  • Link to interest rates makes today a poor time to buy annuities: The rate of return you receive on an annuity is linked to interest rates at the time you buy it. That makes periods of still relatively low interest rates an especially poor time for buying annuities. However, if you want to buy annuities, you could buy one annuity a year for the next five years. That way, your returns will increase if interest rates rise, as we expect.
  • Tax treatment: When you own an annuity, the income payments you receive are made up of interest and a return of your principal. The return of your principal is tax free, but the interest portion of the payment is taxed as ordinary income.

Retirement investments to (especially) avoid include penny stocks, junior mines, and stock options

Penny stocks: Penny stocks are cheap and that’s why many novice investors think they make great investments when they don’t have a lot of money. Here’s some insight: it’s much easier to launch a seductive penny stock promotion than it is to create a successful, lasting business. Most penny stocks are over-hyped. Penny stocks tend to be speculative, and are engaged in such things as finding mineral deposits that can be mined at a profit, commercializing an unproven technology or launching new software. They are unproven companies that have very little chance of becoming a sustainable business. You’ll also have to be on the watch for unscrupulous stock promoters who will over-inflate earnings and talk up a stock for their own best interests. If you’re headed to retirement, stay away from penny stocks.

Junior mining stocks: One rule of thumb for mining stocks is that you have to look at 1,000 “anomalies” to find one “prospect,” and that fewer than one “prospect” in a thousand turns into a mine. In other words, finding a mineable deposit is a million-to-one shot. Continue Reading…