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.

Preparing your Portfolio for Retirement? Income Is so Yesterday

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By Billy and Akaisha Kaderli, RetireEarlyLifestyle.com

Special to the Financial Independence Hub 

When preparing for retirement, designing your portfolio for income is over-rated. Oh, it feels good bragging about how much money you make each year, but then you also quiver about the taxes you owe each April.

What’s the point?

To make it – then give it back – makes no sense.

In today’s interest rate environment people are being forced to adjust their thinking.

Our approach 3 decades ago

When we retired over 32 years ago, having annual income was not on our minds. Knowing we had decades of life-sans-job ahead of us, we wanted to grow our nest egg to outpace inflation and our spending habits as they changed too. Therefore, we invested fully in the S&P 500 Index.

500 solid, well-managed companies

The S&P Index are 500 of the best-managed companies in the United States.

Our financial plan was based on the idea that these solid companies would survive calamities of all sorts and their values would be expressed in higher future stock prices outpacing inflation. After all, these companies are not going to sell their products at losses. Instead they would raise their prices as needed to cover the expenses of both rising resources and wages, thereby producing profits for their shareholders.

How long has Coca-Cola been around? Well over 100 years and the company went public in 1919 when a bottle of Coke cost five cents.

Inflation cannot take credit for all of their stock price growth as they created markets globally and expanded their product line.

This is just one example of the creativity involved in building the American Dream. The people running Coke had a vision and have executed it through the years. Yes, “New Coke” was a flop as well as others, but the point is that they didn’t stop trying to grow because of a setback.

Coca-Cola is just one illustration of thousands of companies adapting to current trends and expanding with a forward vision.

Look at Elon Musk. He has dreams larger than most of us can imagine.

Sell as needed

Another benefit we have in designing our portfolio in this manner, is that when we sell shares for “income,” they are taxed at a more favorable rate as a long-term capital gain. Dividend output is low, our tax liability is minimal, yet our net worth has grown.

We are in control of our income stream.

Our suggestion is not to base your retirement income on income-producing investments but rather to go for growth. You can always sell a few shares to cover your living expenses.

Money Never Sleeps

Just because you retire, your money doesn’t have to.

In the words of Gordon Gecko from the 1987 movie Wall Street, “money never sleeps.” And your money definitely won’t once you leave your job.

Reading financial articles about what if retirees run out of money, we get the impression that the authors do not understand that once retired, your money can – and should – continue to work for you.

Working smart not hard

Once you walk out of the 9-5 for the last time, that doesn’t mean your investments are frozen at that point. The stock market is still functioning and now your “job” is to become your own personal financial manager. Actually, you should have been doing this all along, but if not, start now.

You need to get control of your expenses by tracking your spending daily, as well as annually. This is so easy – only taking minutes a day – and this will open your eyes as to where your money is going. Not only that, but it will give you great confidence to manage your financial future. Every business tracks expenses and you need to do the same. You are the Chief Financial Officer of your retirement.

The day we retired the S&P 500 index closed at 312.49. This equates to a better than 10% annual return including dividends. We know that we have stated this before, but it’s important.

Chart of S&P Market Returns January, 1991 to September 2022

That’s pretty good for sitting on the beach working on my tan.

Making 10% on our portfolio annually while spending less than 4% of our net worth has allowed our finances to grow, while we continue to run around the globe searching for unique and unusual places.

But what if you’re fifty?

You need to take stock of your assets and determine what your net worth is, with and without the equity in your home. Selling the house and downsizing may be a windfall for you, again utilizing the tax code to your benefit. Continue Reading…

Another take on 5 Important factors to consider in deciding to Retire

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Image from myownadvisor

By Mark Seed, myownadvisor

Special to the Financial Independence Hub

As I consider some form of semi-retirement in the coming years, I’m learning there is a host of factors to consider in the decision to semi-retire or retire.

For today’s post, I’m going to take a recent quiz of sorts published on Financial Independence Hub with Fritz Gilbert, the founder and mastermind of a popular U.S. blog: The Retirement Manifesto.

After 30+ years in Corporate America, Fritz retired (as planned) in June 2018 at Age 55.

In running a respected U.S. personal finance blog, Fritz has written about pretty much everything on his site, including on retirement, and still does. A few years ago, as he was working through his own decision to retire, he admits some obsession about the transition. After doing his homework and analysis, he successfully made the leap and hasn’t looked back since.

As Fritz puts it when it comes to transitioning to retirement: some folks do well, and some don’t.

I hope to be in the former camp (!) and I hope this post (and answers to Fritz’s quiz factors) helps you too!

Here are 5 important factors to consider in your decision to retire including what Fritz wants to share about the transition process …

5 Important Factors to Consider In Your Decision to Retire

Fritz factor #1: Do you have enough money?

I hope so!?

Fritz comments in his article that having enough is “a necessary factor, but far from sufficient.”

I agree witih Fritz that retirement or even semi-retirement starts with a math problem to solve.

To understand how much you need, you need a process, a formula to outline as many unknowns as possible before you pull the trigger. One of the biggest unknowns in any retirement plan is your potential retirement spending.

You need to consider what you will spend to determine your “enough number.”

After that, you need to consider how to build your retirement paycheque per se to fund that lifestyle.

I’m intending to use a modified bucket strategy to deliver my income in semi-retirement.

Your mileage may vary. 

My Own Advisor Bucket Strategy - December 2022

Bucket 1 is cash savings. It’s simply a large emergency fund we don’t have to use but it’s there if we need it.

Bucket 2 is earning income from dividend-paying stocks. Income will be earned inside some key accounts (such as our non-registered account(s), TFSA(s), and RRSPs) to pay for living expenses.

Bucket 3 is earning income from equity ETFs. This income will come from mainly our RRSPs, as we intend to “live off dividends and distributions” and withdraw capital from our RRSPs/RRIFs over time as we work part-time.

The purpose of having buckets is simple but effective: this retirement bucket strategy is an investment approach that segregates your sources of cash or income into three buckets. Each of these buckets has a defined purpose based on what or when the money is for: now, (short-term), intermediate (near-term) or long-term (multi-year or decade).

My bucket approach, while maybe not perfect, helps for a few reasons:

  • It can help ensure I stay within a reasonable withdrawal plan, starting off retirement or semi-retirement with a low withdrawal rate of 3% or 4%.
  • It can help avoid sequence of returns risk (especially in the early years of retirement)* *Review these graphs below from BlackRock for an example.
  • It can help “smooth out taxation” over time by liquidating accounts, slowly and methodically.
  • It can help offset longevity risk, thanks to preserving capital early in retirement and letting assets compound away.

This is our more detailed bucket approach to earning retirement income. 

*On sequence of returns risk

Exhibit A – pre-retirement:

BlackRock - Sequence-of-returns-one-pager-va-us - December 2022 Page 1.pdf

BlackRock - Sequence-of-returns-one-pager-va-us - December 2022 Page 2.pdf

Fritz factor #2: Are you mentally prepared for retirement?

Yes, getting there, but it’s more semi-retirement for me/us.

As Fritz puts it in his post on Jon’s site:

“Almost everyone thinks about money when they’re making the decision to retire, but far too few consider the non-financial factors.  If I were to choose one point to make from all the things I’ve learned in the 7 years of writing this blog, it’s that the non-financial factors are the most important for putting yourself on track for a great retirement. Important enough that I wrote an entire book on the topic.”

Instead of just focusing on the financial-side of things, I’m really ramping up my mental-game.

I’ve given quite a bit of thought about what semi-retirement might look like, including answering many of these Frtiz-factor questions and more:

How much do you want to travel? (A bit, not all the time.)

Where do you want to live? (In Ottawa, as a home base.)

Are you going to downsize? (Already done!)

Are you going to do more entertainment with that increased free time? (Yes, but also more volunteer work.)

So, to Fritz’s points and recommendations: we dream a bit, we talk a lot, and we keep our mind open to new opportunites. I think everyone should consider the same.

Fritz factor #3: Have you made a realistic spending estimate?

You bet!

As we enter semi-retirement, we essentially intend to “live off dividends.”

Meaning, we will live off dividends from our non-registered accounts as we make some slow, methodical withdrawals from our RRSPs, while working part-time. We won’t touch TFSA assets at all and we’ll be far too young to tap any government benefits.

In a few years, we will be at this Crossover Point [also shown at the top of this version of the blog]:

Including some cash buffer, we figure that’s a good starting point for semi-retirement to begin. Continue Reading…

Accelerating your Legacy Planning by Gifting In Advance

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LowrieFinancial.com

By Steve Lowrie, CFA

Special to the Financial Independence Hub

Most posts about legacy, wills, and estate planning focus on how to settle your estate after you pass: ensuring your intentions are met, your family is cared for, charitable gifts are fulfilled, taxes are minimized, and so on.

Estate planning is important; we help clients with it all the time. But today, I’d like to offer a valuable twist on the theme of estate, life, and legacy planning:

Instead of your excess wealth being distributed after you die, you may find even greater value in giving some of it away while you’re still around.

Properly managed, making gifts and charitable donations while you’re alive can offer solid tax-saving benefits to you and your estate financial planning. In particular, targeted charitable giving can be a powerful tool for business owners and similar professionals who are approaching retirement and facing high-tax events, such as selling their business, or exercising highly appreciated stock options.

As importantly, it can be incredibly rewarding to witness the results of your generosity. Don’t underestimate the value this intangible benefit can add to your life and legacy planning.

Legacy Planning for Quality Living

First, what is “excess wealth?” Is there such a thing as too much money??? Not really.

This is where legacy planning is essential. If you’re thinking about spending, gifting, or donating significant wealth, don’t just guess at the dollar amounts. Instead, you and your financial advisor should periodically crunch the numbers to determine how much you and your loved ones conservatively need to remain well-positioned, even under worst-case scenarios (such as, say, a global pandemic).

After that — if you and your loved ones are indeed set for life — any extra resources become the financial equivalent of gravy on your entrée. How will you use your excess wealth to add flavour to your life and to the lives of others so that you are leaving a legacy you can be proud of?

An anecdote about Lifetime Charitable Giving

To envision what it would be like to make one or more significant charitable donations during your lifetime, consider the story of “John and Jane,” an earnest couple in their 60s who came to me for advice a few years ago. John came from meager roots, but he was determined to make his own way. With a boost from some financial aid, he put himself through college, where he met Jane. Together, they worked hard, scrimped and saved, and raised two kids. Along the way, John started his own business, which prospered.

Fast forward to 2020, when John was able to sell his business for a substantial sum of money. After we ran all the numbers, it was clear he, Jane, and even their kids would be able to live comfortably for their remaining days. Both personally and in a holding company, the couple also owned some taxable investments that had appreciated nicely.

So far, so good. However, there was one challenge (even if it was a nice “problem” to have): even with extensive planning in the anticipation of an eventual sale (purified operating company, multiplying the lifetime capital gain exemption, etc.), the business buy-out would generate hundreds of thousands of dollars in taxes in the year of the sale. As the saying goes, when you’ve incurred taxable gains, you can choose who’s going to benefit the most from the taxable portion: the government, or your favorite charities. I suggested to John and Jane, they could reduce their taxes owed in the year of the sale by instead fulfilling some of their existing charitable intents that same year.

To manage the significant donation they had in mind, we established a Donor-Advised Fund (DAF) in their name. They then donated into their DAF an equal amount to the taxes incurred from the sale of John’s business. This helped them accomplish several goals:

  1. They were able to fully offset the taxable buy-out gains with their charitable contribution.
  2. John was able to fulfill a lifelong dream by using some of the DAF assets to establish a scholarship at his alma mater. By doing so during his lifetime, he has been able to see others benefiting from a solid education, just as he had when he was young. On a personal level, he and Jane have found the experience highly rewarding.
  3. Moving forward, they can donate highly appreciated assets to their DAF to wash away those gains as well.

A DAF offers a few other benefits as well. For example, you can direct how to invest undistributed DAF dollars in the market, potentially increasing your giving power over time. You can also keep your charitable giving anonymous if you’re so inclined. Continue Reading…

The Inevitable masquerading as the Unexpected

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By Michael J. Wiener

Special to the Financial Independence Hub

Rising interest rates are causing a lot of unhappiness among bond investors, heavily-indebted homeowners, real estate agents, and others who make their livings from home sales.  The exact nature of what is happening now was unpredictable, but the fact that interest rates would eventually rise was inevitable.

Long-Term Bonds

On the bond investing side, I was disappointed that so few prominent financial advisors saw the danger in long-term bonds back in 2020.  If all you do is follow historical bond returns, then the recent crash in long-term bonds looks like a black swan, a nasty surprise.  However, when 30-year Canadian government bond yields got down to 1.2%, it was obvious that they were a terrible investment if held to maturity. This made it inevitable that whoever was holding these hot potatoes when interest rates rose would get burned.  Owning long-term bonds at that time was crazy.

One might ask whether we could say the same thing about holding stocks in 2020 when interest rates were so low.  The answer is no.  Bond returns are very different from stock returns in terms of unpredictability.  We use bond prices to calculate bond yields; one is completely determined by the other.  The situation is very different with stocks.  Even when conditions don’t look good for stocks, they may still give better returns than the interest you’d get if you sold them to hold cash.  All the evidence says that most investors are better off not trying to time the stock market.

Most of the time, investors are better off not trying to time the bond market either.  However, the conditions in 2020 were extraordinary.  Long-term bonds were guaranteed to give unacceptably low returns if held to maturity.  This was a perfectly sensible time to shift long-term bonds to short-term bonds or cash savings.

Houses

The only way house prices could rise to the crazy heights they reached was with interest rates so low that mortgage payments remained barely affordable.  Fortunately, the government imposed a stress test that forced buyers to qualify for a mortgage based on payments higher than their actual payments.  This reduced the damage we’re starting to see now.  Unfortunately, there is evidence that some homeowners faked their income (with industry help) so they could qualify for a mortgage.  This offset some of the good the stress test did. Continue Reading…

Retired Money: Direct Indexing has drawbacks but a hybrid DIY strategy may have merits

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Image courtesy MoneySense.ca/Unsplash: Photo by Ruben Sukatendel

My latest MoneySense Retired Money column looks at a trendy new investing approach known as “Direct Indexing.” You can find the full column by clicking on the highlighted headline: What is direct indexing? Should you build your own index?

Here’s a definition from Investopedia : “Direct indexing is an approach to index investing that involves buying the individual stocks that make up an index, in the same weights as the index.”

When I first read about this, I thought this was some version of the common practice by Do-it-yourself investors who “skim” the major holdings of major indexes or ETFs, thereby avoiding any management fees associated with the ETFs. It is and it isn’t, and we explore this below.

Investopedia notes that in the past, buying all the stocks needed to replicate an index, especially large ones like the S&P 500, required hundreds of transactions: building an index one stock at a time is time-consuming and expensive if you’re paying full pop on trading commissions. However, zero-commission stock trading largely gets around this constraint, democratizing what was once the preserve of wealthy investors.   According to this article that ran in the summer at Charles River [a State Street company], direct indexing has taken off in the US: “ While direct index portfolios have been available for over 20 years, continued advancement of technology and structural industry changes have eliminated barriers to adoption, reduced cost, and created an environment conducive for the broader adoption of these types of strategies.”

These forces also means direct indexing can be attractive in Canada as well, it says. However, an October 2022 article in Canadian trade newspaper Investment Executive suggests “not everyone thinks it will take root in Canada.” It cast direct indexing as an alternative to owning ETFs or mutual funds, noting that players include Boston-based Fidelity Investments Inc, BlackRock Inc., Vanguard Group Inc., Charles Schwab and finance giants Goldman Sachs Inc. and Morgan Stanley.

An article at Morningstar Canada suggested direct indexing is “effectively … the updated version of separately managed accounts (SMA). As with direct indexing, SMAs were modified versions of mutual funds, except the funds were active rather than passive with SMAs.”

My MoneySense column quotes Wealth manager Matthew Ardrey, a vice president with Toronto-based TriDelta Financial, who is skeptical about the benefits of direct indexing: “While I always think it is good for an investor to be able to lower fees and increase flexibility in their portfolio management, I question just who this strategy is right for.” First, Ardrey addresses the fees issue: “Using the S&P500 as an example, an investor must track and trade 500 stocks to replicate this index. Though they could tax-loss-sell and otherwise tilt their allocation as they see fit, the cost of managing 500 stocks is very high: not necessarily in dollars, but in time.” It would be onerous to make 500 trades alone, especially if fractional shares are involved.

Ardrey concludes Direct indexing may be more useful for those trying to allocate to a particular sector of the market (like Canadian financials), where “a person would have to buy a lot less companies and make the trading worthwhile.”

A hybrid strategy used by DIY financial bloggers may be more doable

I would call this professional or advisor-mediated Direct Indexing and agree it seems to have severe drawbacks. However, that doesn’t mean savvy investors can’t implement their own custom approach to incorporate some of these ideas. Classic Direct Indexing seems similar but slightly different than a hybrid strategy many DIY Canadian financial bloggers have been using in recent years. They may target a particular stock index – like the S&P500 or TSX – and buy  most of the underlying stocks in similar proportions. Again, the rise of zero-commission investing and fractional share ownership has made this practical for ordinary retail investors. Continue Reading…