Most people don’t realize it, but that’s just the beginning. The hard part of DIY investing is really to stay the course and keep going. You need to keep contributing, keep your portfolio balanced, and keep your sanity. 

If you decided on a single ETF for your portfolio (such as an Asset Allocation ETF from Vanguard), ok you get to skip on ahead, you slick sly dog, you are done.  But most people have anywhere from 2-5 ETFs in their portfolio (if not more) and try to keep a certain percentage of their investments in each fund.

Now if you’re in the States, rebalancing is quite easy thanks to spiffy Fintech platforms like M1 Finance out there that make this super easy.  In Canada, our Fintech industry is a few years behind the States so hopefully we will see super slick ways to quickly rebalance in the future and this post will be a mute topic. (I’m honestly shocked at how difficult some of the banking related things are in Canada compared to how smooth it is in the States.  Setting up auto-pay on your credit card is just one example. Anywho, I digress.)

In this post, we’ll cover what rebalancing is, how it works, and how to manage your investments for the long run, without pulling your hair.

What Is Rebalancing

When you first created your investment portfolio, you hopefully determined what asset allocation would be best for you. You chose what proportion of your portfolio would be made up of equities (such as stocks) and what would be fixed income assets (such as bonds). Within each asset class, you probably also determined a geographical or industry split to diversify your risk. Are your stocks only tracking the Canadian TSX?  Are you diversified into the US market too?  Any non-North America developed countries?  Developing countries?

Whatever the allocation you choose for yourself, rebalancing simply means bringing your portfolio allocations back in line with your target. Not all assets will change value at the same rate, so you need to adjust your portfolio regularly, and/or after each big market fluctuation. By this, I mean that some of your funds will outperform the others in a given time frame tilting your holding percentages out of whack vs what your original intentions were.  

Rebalancing is not meant to bring you the highest possible returns. By making buying and selling a process triggered by criteria (your portfolio is out of balance), the goal is to manage risk and emotions, which could derail your investment plan. However, rebalancing makes you buy the underperformer in your portfolio (buy low) and sell the overperformer (sell high), which would still result in profits.  

For example, say you decided you want to be 10% Canadian index stock market ETF, 50% US index stock market ETF, 10% non North American developed index stock ETF, 10% emerging market index stock ETF, 20% Canadian bond index ETF and you had $1,000 to start things off. You’d buy $100, $500, $100, $100, and $200 worth of the above ETFs respectively to get you to your desired allocation. Say you never added in another penny and over the course of a year the Canadian stock market grew by 15%, the US stock market grew by 10%, the developed market was down 4%, the emerging market was up 8%, and bonds were up 1%. Well you now have $115 Canadian, $550 US, $96 developed, $108 emerging, and $202 bonds.

The good news is that your portfolio is up for the year by an average of 7.1% leaving you with $1,071. But now your allocations are out of whack in comparison to your original split.  You are now sitting at 10.7% Canadian, 51.3% US, 8.9% developed, 10% emerging, and 18.8% bonds.

See the problem?

There are two main ways to rebalance your portfolio: 

1. Sell some of your overweight assets and use that cash to buy underweight assets.
2. Contribute to your investment portfolio consistently and keep buying the underweight assets. 

In both cases, rebalancing consists of calculating the number of units to buy and/or sell to maintain the desired allocation of your portfolio, and then place each trade in your brokerage account(s).

There are many spreadsheets available online to help you with rebalancing, and if your portfolio is pretty simple, it might work fine for you. We use a free tool for our investments, called Passiv that can help us stay on track, and save time and worry.

How To Rebalance With Passiv

Passiv works on top of your brokerage. It connects to your account through your brokerage’s official API. Without getting into the details, it means Passiv never has access to your login credentials, and connects through a secure access token instead. 

You can connect as many accounts as you want, so you can be your own family wealth manager if you’d like.

Once you connect your brokerage, you set up your allocation targets to build your own balanced fund. You basically tell Passiv what you want your portfolio to look like.

Based on that, and a number of other settings, Passiv recommends the trades that you need to make to keep your portfolio balanced. 

If you’re good with the recommended trades, you can either login to your brokerage to place the trades, or Passiv can place these trades for you at the click of a button. 

Passiv automates the tedious tasks of managing an investment portfolio. Depending on your situation, for example if you manage multiple accounts, are trying to invest in a tax-efficient way, or in multiple currencies, it may become complicated and time-consuming. Passiv does it all for you, and you can customize the calculations in many ways. 

For example, some people keep their portfolio balanced simply by buying more of their underweight assets when they contribute to their investments. This is why the default setting in Passiv is buy-only, but you can enable selling to perform a full rebalance.

You can set up all your brokerage accounts, and even your spouse’s or your children’s, as one portfolio and rebalance them all together in one-click. If you set up regular contributions to your brokerage account(s), you can essentially build your own customized robo-advisory service and manage all of it in a few clicks per month (and lower fees than what robo advisors charge). 

If you have both CAD and USD assets, like we do, another useful feature is currency separation. It allows you to separate your currencies to avoid forex conversion fees.

It also notifies you whenever your portfolio is out of balance, or when you have new cash (from dividends for example) waiting to be invested in your account(s).

Passiv even goes a step further and also tracks your performance. The Reporting tab shows you your average monthly dividends, total dividend income, contribution history, and investment gains. Not that we are dividend chasers, but for those who are interested in building a dividend income over the years, this is a great way to track your goals along the way. 

Which Brokerages Does Passiv Work With?

Passiv works with both online brokerages and cryptocurrency exchanges, so if you have some coins, you can manage them alongside your traditional assets in your Passiv account. 

In Canada, Passiv works primarily with Questrade. However, they also built an integration with Wealthica, which allows read-only* access to most Canadian institutions with investment accounts. 

In the US, Passiv has built integrations with Alpaca, Interactive Brokers (available internationally), TD Ameritrade, and Tradier.

They also support Zerodha in India.

The supported cryptocurrency exchanges are Bitbuy, Kraken, and Unocoin. 

*Read-only gives you access to most of Passiv features, but you won’t be able to place the recommended trades directly from Passiv into your brokerage account at the click of a button.

How Much Does Passiv Cost?

Passiv has two tiers: Community which is their free version, and Elite, which costs $99. 

However, you know we are all about cost savings so listen up. 

The cool thing for Canadians is that Passiv has partnered with Questrade to offer Passiv Elite to all their clients for free. FREEEEEE. If you’re in the US, don’t have Questrade, or simply want to support this blog, you can use this affiliate link to sign up to get 30% off your first year of Elite. 

Rebalancing is an important task that DIY investors have to deal with on a regular basis (we personally rebalance about annually). It helps to manage risk for your portfolio and can also be used as a reflective time on your investments. However, it can become complicated and time-consuming depending on your situation. Passiv can help you keep your portfolio on target painlessly in under a minute, so you can spend more time doing what you love. Save time and money by accessing Passiv for free, sounds good to me!

Hopefully today’s post helped to clarify what rebalancing is if you had heard of it but weren’t sure what is it or how it works.  Any questions for us about rebalancing?

Support This Blog

If you liked this article and want more content like this, please support this blog by sharing it.  Not only does it help spread the FIRE, but it lets me know what content you find beneficial.  Writing is NOT my strong suit and it honestly takes me hours to write each post so the more encouragement the better!  Engaging in the comments below keeps me motivated.  You can also support this blog by subscribing to receive emails anytime a new post is published.  Thank you FImily!

We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.  Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:

• Investing Newbies: Check out our free Investing 101 Series.
• How much are you paying for your phone plan?  Canadians, learn more about Public Mobile, and see how we are paying $3/mo for our cell phone plan.
• How much are you paying for internet?  Canadians, learn more about the various Independent Service Providers out there to see who services your area so you can lower your monthly bills.
• How much are you paying for home insurance?  We were able to reduce our rates by 25% by switching over to Square One Insurance.  If you live in BC, AB, SK, MB, and ON, check out Square One for your home insurance, landlord insurance, and/or tenant insurance.  Use this link to receive an extra $15 off your quote.  (Note that you must use this link to start the process to get the $15 off even if you prefer to pay over the phone.)
• How much are you paying for your monthly utility bills?  Fellow Albertans, see how you can likely save on this monthly expense.

The post The Easiest Way To Rebalance in Canada: Passiv + Questrade appeared first on Modern FImily.

But first…

THANK YOU!

We’ve been selected as a Finalist for this year’s Plutus Awards (like the Emmys for us little ole personal finance bloggers) in the Best Canadian Finance Content category! This is such an honour to us as we are sitting with such great company.

Ok back to business.

Around here we like to focus on the mindset/emotional/psychological side of FIRE and how to lower your expenses and live a more meaningful life.  We created our 8 part Investing 101 Series way back when but haven’t really focused too much on the investment side since then (because honestly we feel the investing side is the easy part and has been written about all over the internet, it’s the saver mindset that’s hard). So when Kyle offered to chat about DIY vs Robo I thought woohoo yea let’s do it, this saves me one less topic to write about ha!  This is a question I like to talk about with my coaching clients so I’m more than happy to have Kyle on to dig into this topic for us.

Before handing it over to Kyle I wanted to provide a bit of an intro first.  Kyle is the co-owner of the website Million Dollar Journey, which started back in 2006 – wowza! – as well as the co-owner of the Canadian Financial Summit virtual event.  Kyle was teaching business and personal finance in small-town Manitoba and moved last year to Qatar to teach overseas.

For those who are not familiar with the Canadian Financial Summit, I’d highly recommend checking it out this year as it has ~25 of some of the top Canadian personal finance gurus in the space.  And it’s $free if you view the recordings within the first 24 hours! Last year’s impressive line up included Ed Rempel (love Ed), Kristy & Bryce from Millennial Revolution (love me some MR), Kevin McCarthy (creator of the TFSA), Rob Carrick from the Globe and Mail, Robb Engen from Boomer and Echo, Mark Seed from My Own Advisor, and my pals Tom Drake (Maple Money), Maria Smith (Handful of Thoughts), and Bob Lai (Tawcan).

Andddd I’m excited to announce that yours truly will be part of this years Canadian Financial Summit!  Woohoo!  We will be tackling the topic of “FIRE Family”.  I’m so embarrassed I had a total brain fart right in the middle of a sentence during the recording! Am I allowed to use the “mom brain” excuse?!? Oy… I guess it means “I’m relatable”?  Sure, let’s go with that.

This free event is taking place online September 23-25, 2021 so please mark your calendars and sign up!

Ok Kyle, the floor is yours!

Passive Investing Tradeoffs: Canadian Discount Brokerages and ETFs vs Robo Advisors

The math is in.

Passive investing beats active investing over the long term.  You might read some mutual fund sales literature that suggests otherwise, but essentially every personal finance writer in Canada agrees that for the vast majority of people, a simple passive investing strategy will generate the best long-term results.

Where there is still some debate however, is whether the average Canadian would be best served by realizing the benefits of passive investing through opening an online discount brokerage account and using ETFs or by utilizing a completely hand’s off solution with one of Canada’s robo advisors.

A Quick Refresher on Passive vs Active

Before we dive into the pool of specific companies and fund names, it’s likely worth taking a second to review just what would make an investment “active” or “passive”.

The key consideration is: Does the company/person controlling an investment believe that they possess the ability to pick certain assets (such as stocks, bonds, real estate, etc) that will consistently deliver higher returns than the average?

If the answer is yes – then the company/person is very very likely to be wrong – and the investment would be “active”.  Most high-priced mutual funds in Canada fit into this category.

If the answer is no – I’m satisfied with being exactly average, then the investment would be passive.

Passive investment products seek to “own the whole” market – and consequently deliver returns that are the mathematical average.  These products then focus on cutting costs to the bone.

For example, if you wanted to passively invest in Canada’s largest corporations, you would look for a fund that tracks the TSX60 (the 60 biggest stocks on the Toronto Stock Exchange).  A passive investment of the TSX 60 would take $100 of your money and split it up amongst those 60 companies according to how big they are.  That means that:

• $6.40 would go to buy a piece of RBC
• $5.96 would go to buy a piece of Shopify
• $5.75 would go to buy a piece of TD
• $4.02 would to to buy a piece of Canadian National Railway
• $3.60 would to go buy a piece of Enbridge

… and so on until your whole $100 was split up amongst the 60 Canadian giants.

At the end of each day, the fund would see how each company’s shares did, and re-adjust the ETF so that you are mathematically guaranteed to watch your money grow at exactly the average rate of Canada’s largest companies.  No “picking winners” or paying for high-priced Bay Street/Wall Street stock people to buy their next yacht.

Underneath the Hood of Three Passive Investment Vehicles

While you definitely want to travel down the low-free passive indexing highway on your journey to financial independence, the real question that you have to answer for yourself is what type of vehicle you want to ride in along the way.

All three vehicles run on the same fuel – exchange traded funds (ETFs).

ETFs come in all shapes and sizes, but passive investors only use the ones that have no active management, and track a large index such as the TSX60 or the S&P500.  There are useful ETFs for bonds, and less useful ETFs for all varieties of other assets.

The best thing about passively-invested ETFs are that they are super cheap, and they easily invest your money into hundreds – or even thousands – of companies in a quick and efficient way.

The Robo Advisor Easy-Rider has your name on it if you’re looking for the absolute quickest way to get started in investing, or if you want the most simple way to turn your pay cheque into a passively-invested portfolio.

Each robo advisor in Canada has a few unique characteristics, but the basic idea is that when you first sign up you’ll answer some introduction questions.  These answers will determine what risk-adjusted portfolio is the best fit for you.  Based on those answers (and any subsequent follow up communication you have with the robo advisor’s staff) your money will be used to purchase a few passive ETFs.  You might be allocated one ETF for Canada’s stocks, another ETF for USA stocks, a third ETF for all the other stocks in the world, and a final ETF for bonds.

The real headline here is you don’t even have to know how to spell “ETF” in order to make use of a robo advisor.  You can sign up in a matter of minutes, trust in the powers of index investing, hook up an automatic deposit from your bank account the day after payday, and then think about more important things!

Sure, if you want to check how your investments are doing, or ask any questions about stuff like RRSPs, TFSAs, and RESPs – the robo advisors and their excellent online/app platforms can hook you up – but the main benefit is just how easy it all is.

You get all that ease and help for the price of 0.4% to 0.8% of your investment each year (depending on your choice of robo advisor and how much money you have invested).  That percentage is usually referred to a Management Expense Ratio (MER).  When you use a robo advisor, you have to pay the robo advisor’s MER, plus the MER of the underlying ETFs that they use.

The All-in-One-ETF Hybrid Model is built for folks who don’t mind putting in a couple of hours-worth of reading up front, in order to save some money down the line – but they don’t want to be bothered with the rebalancing math that will be required every few months.

The all-in-one ETF is basically a robo advisor portfolio without the rest of the robo advisor package.  You don’t get the advice or the fancy tech platforms.

Instead, you have to:

1) Open an online discount brokerage account.

2) Decide on your investment risk tolerance.

3) Use your risk tolerance to choose a specific All-in-One ETF.

4) Just rinse-and-repeat by wiring money from your chequing account to your discount brokerage account each month, and simply rebuying the same ETF over and over again.

You’re going to pay a fair chunk less driving this baby than you would if you went with the robo advisor – but it’s still a bit more than if you purchased your own portfolio of ETFs.  You’re looking at an MER of .15% to .27% for this simple solution.

The Sleekly-Fuel Efficient Low-Fee Model is perfect for the detail-oriented optimizers out there.

This is the absolute cheapest way to passively invest – but you’ll have to give a little when it comes to doing some of your own research and some re-balancing periodic math.

There is nothing secret about ETFs you should own in order to get excellent portfolio exposure.  You can simply copy the exact ETFs that are owned by the robo advisors and all-in-one ETFs.  If you’re willing to do your own portfolio rebalancing by selling whichever ETF has done well, and buying more of whichever ETF has not, then you can shave a few more MER points and get maximum mileage.  The bill on his strategy comes in at .10% to .20% MER.

There is even a Canadian company called Passiv that will help you rebalance if you choose to go this route (future post coming shortly about reblanacing/Passiv).

Comparing MERs on $10,000

If you want the ease of a robo advisor, combined with the extra help that they offer, it’s going to set you back $40-$80 per $10,000 each year.

That number drops to $15-$27 per $10,000 if you open your own discount brokerage account and purchase all-in-one ETFs.

Finally, if you opt to use your discount brokerage to purchase and rebalance multiple ETFs, you’re likely to pay about $10-$20 per $10,000.

The ranges here depend on the balance of stocks to bonds that wish to have in your portfolio.

So What’s Best for You?

It’s all about trade-offs.

I don’t know how much value you personally put on convenience, or saving a few hundred bucks in investment fees each year – so how can I know what would fit you best?

I will say this much… Ten years ago when I started recommending index investing through handling your own ETF portfolio, the vast majority of my friends would look at me with glazed-over eyes.  They might’ve believed me, and they might’ve sort of understood the math, but they just never took action.  It was too many steps.  There was a little too much fractions-related calculation when it came to rebalancing every few months.

I personally still stick to building my own passive investing portfolio and cutting fees to the bone – but I think there is a ton of merit to choosing whichever one of these three passive investment vehicles that will motivate you to save the most.  The real takeaway you should have after reading this article is to simply pick a ride and start driving ASAP!

Kyle Prevost is a financial educator who writes at MillionDollarJourney.ca and has taught personal finance to high school students for over a decade.  When not on his soapbox at the front of a classroom, you can find Kyle on a basketball court or in a boxing ring trying to recapture something he likely never had in the first place.

Thank you again Kyle for coming on to discuss this topic!  Hope you all enjoyed it and found it valuable.  I love how Kyle came up with the car analogy for these three investment routes.

Here are some of our key takeaways I want to point out:

• For those new to the investing game, the most important factor is to START.  Don’t let analysis paralysis hold you back for months or years (gasp!).  Likely, the easiest way to jump in is with a robo advisor.  You can always change to a DIY type of brokerage once you feel more comfortable.  You will pay a slightly higher fee to go this route initially but it is no where near the 2.5% fees that most actively managed advisors charge.  This is a great entry way into taking control of your finances.
• Once you have a good grasp on some terminology and your risk tolerance, you may feel more comfortable taking control of the wheels.  You can then shave off the extra MER from the robo advisor and instead go the DIY all-in-one fund route which is essentially the same thing as what the robo advisors are doing with just a little more elbow grease from your end.
• For most people, either one of these routes above are more than enough and sufficient to be a happy low-fee passive investor.
• If you want to further optimize/tweak your portfolio you could then select anywhere from 2-5 ETFs (anything more than that is excessive in my books) to really hone in your asset allocation and tax optimization.  This is really mainly for those who understand what they are looking for (via lots of reading/listening to blogs/books/podcasts/YouTube videos and building up that brain power in the personal finance space). If this doesn’t interest you, no sweat, stick with either the robo advisor or an all-in-one ETF. Some combinations for Canadians could be:
  • VEQT + VUN (+VAB)
  • XAW + VCN (+VAB)
• The biggest thing is to invest early and often.  Compound interest will ride you to the FI world over time.  Focus more on your savings rate and actually having money to invest.  Reaching your first $100,000 invested is likely the hardest part of the journey and the bulk of that will come from your contributions as compound interest plays it’s magic over time.  The investing side really does not have to be that complicated.  It’s having the money to invest that’s hard.
• Thanks to increasing competition, the low fee ETF route is definitely the way to go when it comes to investing.  Deciding on which of the 3 routes above to go totally depends on you and your comfort level.

Any follow up questions for Kyle?

And again, don’t forget to sign up for the free Canadian Finance Summit!  Looking forward to seeing you there

Support This Blog

If you liked this article and want more content like this, please support this blog by sharing it.  Not only does it help spread the FIRE, but it lets me know what content you find beneficial. Writing is NOT my strong suit and it honestly takes me hours to write each post so the more encouragement the better! Engaging in the comments below keeps me motivated.  You can also support this blog by subscribing to receive emails anytime a new post is published.  Thank you FImily!

We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.  Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:

• Investing Newbies: Check out our free Investing 101 Series
• How much are you paying for your phone plan?  Canadians, learn more about Public Mobile and see how we are paying $3 / mo for our cell phone plan.
• How much are you paying for internet?  Canadians, learn more about the various Independent Service Providers out there to see who services your area so you can lower your monthly bills.
• How much are you paying for home insurance?  We were able to reduce our rates by 25% by switching over to Square One Insurance.  If you live in BC, AB, SK, MB, and ON, check out Square One for your home insurance, landlord insurance, and / or tenant insurance.

The post The Investing Showdown: DIY Investing vs Robo-Advisors appeared first on Modern FImily.

• You need to determine what type of investor are you
• The best time to start investing was 20 years ago, the second best time is today
• In order to get ahead, you must have a gap between what you spend and what you earn
• Compound interest is the 8th wonder of the world (seriously though)
• Know the difference between a financial institution vs an account vs a fund
• Focus on your tax advantaged accounts first
• Focus on funds with low fees
• Invest for the LONG term

If you haven’t read through the rest of the series, check it out here first as this post is mostly a summary.

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest
• Investing 101 – Part 3: Accounts You Can Invest In (US Edition)
• Investing 101 – Part 4: Accounts You Can Invest in (Canada Edition)
• Investing 101 – Part 5: Tax Advantaged Accounts
• Investing 101 – Part 6: Funds You Can Fill Your Investment Accounts With
• Investing 101 – Part 7: Terms To Know

And for anyone still confused on the US accounts vs Canadian accounts, please check out this awesome US/Canadian FI Glossary by my friend Chrissy from East Sleep Breathe FI.

Examples of Different Financial Institutions, Accounts, and Funds:

1. Financial Institutions
   1. Canada
      1. TD
      2. RBC
      3. Questrade
      4. WealthSimple, etc
   2. US
      1. Bank of America
      2. Wells Fargo
      3. Vanguard
      4. Fidelity, etc
2. Accounts (to open up within the Financial Institutions above)
   1. Canada
      1. Cash
      2. Checking
      3. Savings
      4. High Interest Savings
      5. TFSA
      6. Group RRSP
      7. Individual RRSP
      8. Spousal RRSP
      9. RESP
      10. GIC
      11. Brokerage (aka Non-Registered)
   2. US
      1. Cash
      2. Checking
      3. Savings
      4. High Interest Savings
      5. Roth IRA
      6. Traditional IRA
      7. Spousal IRA
      8. Roth 401k
      9. Traditional 401k
      10. 403b
      11. 457b
      12. HSA
      13. 529
      14. CD
      15. Brokerage (aka Taxable)
3. Funds (what goes into your Accounts above)
   1. Worldwide
      1. Cash
      2. Stocks
      3. Bonds
      4. Mutual Funds
      5. Index Funds or ETFs
         1. Domestic stock index funds
         2. International stock index funds
         3. Domestic bond index funds
         4. International bond index funds
         5. REITs
         6. Marijuana index fund, etc, etc

Let’s Dig A Bit Further

Don’t confuse the TYPE of account with WHAT GOES IN the account.

For example, the question “Should I invest in a Roth IRA or in index funds?” does not make any sense as that’s not a choice you’ll be making.  You can invest index funds WITHIN your Roth IRA.  Think of the accounts as the different buckets available to you and the funds are what you can fill those buckets up with.  The financial institutions are the locations where your buckets are held making sure your money is protected.

So you do your research, pick the financial institution that best suits your needs (aka low fees to save you money), open up an account with them, then allocate money from your current checking account into this particular account instead.

So now you have contributed cash into this account.

THEN you INVEST that cash with a specific fund.

From the example above, you open up a Roth IRA, contribute cash, then invest that cash in index funds.

All those accounts listed above essentially work in the same way.  You open them with a bank or brokerage.  You’ll get an account number.  They hold stuff. They all are slightly special in their own way.

• With a checking account, you can write checks
• With a savings account you often have slightly higher interest rates
• With a brokerage account, you have the most flexibility and can invest in stocks, bonds, mutual funds, index funds, etc.
• With a Roth IRA or TFSA, you have a brokerage account with a great tax break in that all earnings inside are never taxed (unless you withdraw your gains early in a Roth IRA)
• With a traditional 401k/403b/457b/IRA/RRSP, you have brokerage account in which you received a tax deferral break upfront (and the list of available funds are often pre-selected from your employer)
• With a HSA, you have a brokerage/savings/checking account with the triple tax advantage intended for medical expenses
• With a 529/RESP, you have a brokerage account with tax advantages geared towards future education costs

When thinking about your investing, make sure you understand that all your accounts are just empty buckets. The magic happens when you invest INSIDE of those accounts by buying the funds listed above.

As to which funds to select?  That’s again up to you and your risk tolerance.  Personally, we are mainly invested in VTSAX in our US accounts and VUN.TO in our Canadian accounts.

Ok moving on.

Here’s a Simple Rough Guide for an Investing Checklist Without Knowing Anything About You or Your Income:

• Canadians
  • Invest in these accounts (in this order)
    • Group RRSP – up to the company match
    • TFSA (tax free withdrawals) – up to the max, currently $6,000/year but check the CRA website to know your contribution room as any unused room from previous years gets rolled over each year
    • RRSP – now the difference from the company match up to the max, currently for 2020 its 18% of your 2019 earned income with a max of $27,230 – again, check with the CRA to know your contribution room as unused contributions rolls over in your RRSP too
    • RESP – up to the max government match, currently $2,500/year for a $500 match from the government
    • Taxable Brokerage
  • Chose a few (1-5) low fee index funds – here are some examples (note I am only using Vanguard below but there are many other options available)
    • Vanguard FTSE Canada All Cap (VCN)
    • Vanguard U.S. Total Market (VUN)
    • Vanguard FTSE Developed All Cap ex North America (VIU)
    • Vanguard FTSE Emerging Markets All Cap (VEE)
    • Vanguard Canadian Aggregate Bond Index ETF (VAB)
    • Vanguard U.S. Aggregate Bond (VBU)
    • Vanguard Global ex-U.S. Aggregate Bond (VBG)
    • Vanguard Balanced ETF Portfolio (VBAL)
    •  Vanguard Growth ETF Portfolio (VGRO)
  • Turn on DRIP (Dividend Re-Investment Plan) – let the gains stay within the account to let compounding interest work its magic
  • Set up automatic investments (most financial institutions will allow you to automatically fund an account with cash from your checking account and some go one step further to allow you to automatically buy funds with that cash)
  • Rebalance periodically/annually – do not obsess over your accounts
  • You can rebalance, but don’t sell anything until you retire
• Americans
  • Invest in these accounts (in this order)
    • 401k/403b/457b – up to the company match
    • HSA (triple tax advantage) – up to the max, currently $3,550 for an individual and $7,100 for family coverage
    • Roth IRA (tax free withdrawals) – up to the max, currently $6,000
    • 401k/403b/457b – now up to the max, currently $19,500
    • 529 – if it makes sense for you
    • Taxable Brokerage
  • Chose a few (1-5) low fee index funds – again,these are just some examples, there are many more available
    • Vanguard Total Stock Market Index Fund (VTSAX)
    • Vanguard Total International Stock Index Fund (VTIAX)
    • Vanguard Long-Term Bond Index Fund (VBLAX)
    • Vanguard Total International Bond Index Fund (VTABX)
    • Vanguard Target Date Funds
  • Turn on dividend reinvest
  • Set up automatic investments (most financial institutions will allow you to automatically fund an account with cash from your checking account and some go one step further to allow you to automatically buy funds with that cash)
  • Rebalance periodically/annually – do not obsess over your accounts
  • You can rebalance, but don’t sell anything until you retire

Keep It Simple

There is so much noise out there when it comes to investing, but when you cut it out, it really boils down to this:

• Utilize your tax advantaged accounts.
• Select index funds to diversify and keep costs low.
• Eliminate bad human decision making by automating as much as possible and rebalancing. (Note that with VBAL and VGRO in Canada and the Target Date Retirement Funds in the States, the rebalancing takes place automatically (similar to robo-advisors) so you can skip that one step with these funds.  However, they do come with a slightly higher fee. If you’re looking for a completely hands off way to invest, this is definitely a good option, especially for beginners.)

I cannot tell you which funds to invest in.  Determining your asset allocation is strictly up to you and your risk tolerance. For most people, I would suggest to be 100% in stock index funds until you are approaching your retirement date. But again, it all depends on your personal goals and your risk tolerance.

Now, I could dive MUCH deeper on this subject but A.) you’re over complicating things in your head, it really isn’t that complicated when it all boils down and B.) we all make mistakes when we’re new – we made tons – you can’t be afraid to start and sit on the sidelines because you want to be 110% sure you’re making the right decision and C.) a legend has already created an extremely long and detailed series on this.

May I introduce you to the Stock Series by Jim Collins.

Please, if you haven’t read this entire series or his book The Simple Path To Wealth (which is based off this series), stop what you’re doing and prioritize this.  I’ve tried to simplify things down as best as I could but he goes into way more detail but the morale of the story is keep things simple.  Invest in low fee index funds (or ETFs) that track the overall market.

I can let you know what we invest in, which we update you with each quarter, but I cannot tell you if you should invest 100% in stocks or 60% in stocks.  I don’t know you and your situation.

My General Guidance:

• Pay off your debt! LEGIT MURDER YOUR DEBT ASAP! Highest interest gets killed first in my books. No debt snowball nonsense for me.  Kill off that high interest first.
  • I’m ok with with holding on to a mortgage if the rates are low, otherwise I’d say prioritize killing off all other debt.
• While you are paying off your debt, work on building up an emergency fund of at a bare minimum of 1 month of your expenses and also contribute up to the matching percent of your 401k or Group RRSP if your employer offers a match.
• Keep your 3-6 month emergency fund in a high interest savings account.
• If you have any large upcoming payments due in the next 1-5 years (i.e. a down payment for a house), keep those funds within a high interest savings account or another relatively safe account (i.e. money market fund).
• If you are 5+ years away from retiring, I’d personally be aggressive and invest 100% in stock index funds or ETFs.  Totally depends on your risk tolerance and diversification level.
• If you are closer to retirement (3-5 years out), I’d reel back in from that 100% allocation to closer to 60% stocks and 40% bonds as you approach retirement. (Some would argue against this and would remain heavy in stocks, but I’m very conservative and want to have bonds to be able to rebalance over to stocks as I enter retirement to help deal with Sequence of Returns Risk – aka a Glide Path.)
• If you are an early retiree, this 60/40 split has a much lower chance of surviving for 30+ years compared to a 90/10 or 100/0 split and I’d highly recommend reading the Safe Withdrawal Series by Early Retirement Now where Karsten digs WAY further into the numbers on the WHY behind this is true. (This is a VERY long and technical series but a gold mine for safe withdrawal rates.) So for us, within ~5 years of early retirement, we plan to do a Glide Path be back in into 90-100% stock index funds for the long haul.

Here Are Some Things NOT To Do:

• Hold cash within your retirement accounts
  • You are investing for the LONG HAUL within in these accounts.  Just because you contribute into a retirement account does not mean you’re set.  You need to ensure HOW you are investing within that account.  Opening up the account is the first set but you need to ensure that the cash you shift over to that account (from say your checking account) then gets shifted into something other than cahs aka an index fund or ETF.
• Stock Picking
  • While it may seem exciting, by investing in individual stocks you are likely to incur additional risk, under performance, and human error compared to just buying and holding an index fund that tracks the overall market.  Sure put 5-10% of your portfolio into individual funds as your “fun money” if you feel the need but I wouldn’t encourage much more than that.
• Chase Past Performance
  • Past performance does not guarantee future results.  When you chase a fund with a high past performance, you’re essentially buying high after it went up so much in value in the past and now missing out on the fund that likely to go up in the future.  Stop focusing on the past, no one knows what the future will hold and the past is not the proper indicator to try and predict the market or a particular fund.
• Time The Market
  • Listen up, NO ONE can accurately time the market.  Not you, or me, or the best analysts out there.  Jumping in and out to avoid a market crash or changing strategies due to market fluctuations is likely a very costly decision!I’ve received a ton of messages recently asking “Should I buy now that stocks are on sale?” and the answer is “You should always buy when you have the means to do so, regardless what the market is currently doing”. Ignore the noise.  Make a plan and stick with it.
• Pay High Fees
  • I know, I know, I have totally harped on this already but I you to remember that a teeny 2% fee could mean almost HALF of your portfolio is gone 40 years from now.  Please let that sink in.
• Only Thinking About The Short Term
  • It’s so easy to be swayed by short term performance. You may see the market drop by 10% panic and sell everything you have thinking you made the right move. You didn’t. Essentially you did the exact opposite by selling low instead of buying low/selling high. You turned a paper loss into an actual loss.
• Sitting On The Sidelines
  • Investing may seem like an intimidating and scary monster and because of that, you may opt to delay investing for awhile. While I agree you need to read and do your research, you also cannot sit on the sidelines for your entire life. Someone consistently investing $200/month starting at age 20 would have over $750,000 by the time they turned 65 assuming an average rate of return of 7% (~$108,000 of your own money). If you waited until you were 30, you’d have to invest $420/month for 35 years (~$176,000 of your own money). If you waited until 40, you’d have to invest $935/month for 25 years (~$280,000 of your own money). If you waited until 50, you’d have to invest $2,390/month for 15 years (~$430,000 of your own money).

Ok guys, what did we miss?  After reading this series, Beat the Bank by Larry Bates, The Little Book of Common Sense Investing by John Bogle, the Stock Series by JLCollins or his book The Simple Path to Wealth, AND the Safe Withdrawal Rate series by ERN – what additional questions do you still have? If you have Instagram, check out my friend Jeremy over at Personal Finance Club (with almost 100,000 subscribers) who truly does an amazing job at simplifying investing with easy to understand graphics. Not going to lie, this was exhausting to put together but really hoping it benefits many people out there as this really isn’t covered in exhaustive detail in many other places. Would it be beneficial to have step-by-step screenshots of me opening an account within Vanguard and Questrade to show you how to open an account and place a trade?

If you haven’t already, check out the 7 other parts to the Investing 101 Series:

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest
• Investing 101 – Part 3: Accounts You Can Invest In (US Edition)
• Investing 101 – Part 4: Accounts You Can Invest in (Canada Edition)
• Investing 101 – Part 5: Tax Advantaged Accounts
• Investing 101 – Part 6: Funds You Can Fill Your Investment Accounts With
• Investing 101 – Part 7: Terms To Know

Support This Blog

If you liked this article and want more content like this, please support this blog by sharing it.  Not only does it help spread the FIRE, but it lets me know what content you find beneficial.  Writing is NOT my strong suit and it honestly takes me hours to write each post so the more encouragement the better!  Engaging in the comments below keeps me motivated.  You can also support this blog by subscribing to receive emails anytime a new post is published.  Thank you FImily!

We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.  Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:

• How much are you paying for your phone plan?  Canadians, learn more about Public Mobile, and see how we are paying $3/mo for our cell phone plan.
• How much are you paying for internet?  Canadians, learn more about the various Independent Service Providers out there to see who services your area so you can lower your monthly bills.
• How much are you paying for home insurance?  We were able to reduce our rates by 25% by switching over to Square One Insurance.  If you live in BC, AB, SK, MB, and ON, check out Square One for your home insurance, landlord insurance, and/or tenant insurance.  Use this link to receive an extra $15 off your quote.  (Note that you must use this link to start the process to get the $15 off even if you prefer to pay over the phone.)
• How much are you paying for your monthly utility bills?  See how you can likely save on this monthly expense.

The post Investing 101 – Part 8: Putting It All Together appeared first on Modern FImily.

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest
• Investing 101 – Part 3: Accounts You Can Invest In (US Edition) 
• Investing 101 – Part 4: Accounts You Can Invest In (Canada Edition)
• Investing 101 – Part 5: Tax Advantaged Accounts
• Investing 101 – Part 6: Funds You Can Fill Your Investment Accounts With

Asset Allocation

This is your breakdown of how your assets are allocated, meaning your split of stocks and bonds.  Which stocks?  Which bonds?

There is no right answer as to what your asset allocation should be.

Conventional wisdom is that if you are investing for the long term (10+ years) you should be aggressive and 90-100% in stocks and as you near retirement you would shift into more bonds, be it a 80/20 or 60/40 or 40/60 split etc.  Some people do not feel comfortable being 90-100% in stocks even if they aren’t planning to touch their portfolio for years and prefer to be 80/20 or 60/40 during their investing years.  Some people suggest to take 100 and subtract your age and that should be the percentage of stocks in your portfolio.

The point is, your asset allocation is personal and something you need to decide based off your risk tolerance level.

If you’re 100% in stocks and you see your entire portfolio drop by 20%, knowing it will very likely come back up in time (how long exactly? who knows), would you be comfortable with that? What about a 30% drop? Or even 40%?  These types are drops have happened in the past and likely will happen again in the future.  If you can’t stomach that, you may want some bonds.  However, if you understand that you are investing for the long term and a price drop in the middle of your investing time frame won’t impact you unless you actually sell it during that dip (noooooo), then you may feel more comfortable being heavily invested in stocks.

Again, it totally depends on both your risk appetite (can you stomach a drop and buy baby buy when the world is panicking?) and where you are time-wise in your journey (10+ years from retirement or less than 3 years from retirement).

Rebalancing

Rebalancing refers to aligning your stock and bond portfolio back to it’s designated asset allocation over time.

Say your goal is to be 80% in stocks and 20% in bonds so 80% of the time you buy stocks and the other 20% of the time you buy bonds.  If these two assets grew at the same rate, you would never need to rebalance.  However, that is likely not going to happen.  Some years your stocks may skyrocket and grow much faster than your bonds.  This may shift you from an 80/20 split to say a 90/10 split as your stocks are performing better and are now making up a larger portion of your portfolio.  Conversely, some years your stocks may tank and you end up seeing a better performance with your bonds.  This may shift you from an 80/20 split to say a 70/30 split.

Rebalancing allows you to get your asset allocation back in alignment with your goals.  If you are investing in tax advantaged accounts, rebalancing is quite easy.  You can sell your over performing funds and buy the under-performing funds to get you back to your desired allocation without facing any tax implications as long as the net amount is the same.  You simply sell the fund you are too heavy in, that will shift over to cash, and then with that cash you buy the fund you are looking for more of.  Or you may have a rebalancing option within your financial institution that shows your current breakdown (as a percentage) and you can tell the financial institution what you want the percentages to instead be and it will do the shift over for you.

If you are investing in taxable accounts and don’t want to rebalance using your tax-advantaged accounts to easily get you back to your desired allocation, then the best way to rebalance is to purchase future investments in the under-performing fund to slowly build it back up to the allocation you so desire.

Note that if you are comfortable investing 100% in one fund, rebalancing is not needed as you will always be 100% in that particular fund.

There are some funds out there that do a bit of this legwork for you, but at a cost of a slightly higher fee compared if you did a more DIY investing approach.  A lot of Robo Advisors are essentially doing the rebalancing for you.  Essentially, robo advisors have you fill out a questionnaire to try to help determine your desired asset allocation and will rebalance your portfolio to stay at that targeted amount.  Same idea for a target date retirement fund in the states except without the robo assistant, you select your fund based off your target retirement date.  Or in Canada you could invest in VEQT (100% stocks, 0% bonds), VGRO (80% stocks, 20% bonds), VBAL (60% stocks, 40% bonds). VCNS (40% stocks, 60% bonds), or VCIP (20% stocks, 80% bonds).  These are much more hands off and take a lot of the thinking out of the equation for you.  But again, at a slightly higher cost of course. Do the math to see if you would rather do it hands-on yourself or if you are willing to give up some of your gains to let it be handled for you by someone else.  For a new investor looking to get their feet wet, these could be a great starting point.

Nominal vs Real

In finance and economics, “nominal” refers to an UNADJUSTED rate or the change in value where as the term “real” expresses the value of something after making adjustments for various factors to create a more ACCURATE measure.

The rate of return is the amount an investor earns on an investment. The NOMINAL rate of return reflects the investor’s earnings as a percentage of the initial investment, whereas the REAL rate takes inflation into account. As a result, the real rate gives a more accurate assessment of the actual buying power of the investor’s earnings.

For example, if we say “the stock market has grown ~10% on average annually over the past 100 years” – that is a true statement but it’s the NOMINAL rate of return (10%). However, inflation has also existed over this timeframe and has averaged 3% annually over the past 100 years. So 7% is the REAL rate of return.

Another example is if we say ‘hey if you invest $10,000 today and assume the stock market grows at 10% on average annually, then in 40 years you’ll have $537,006 thanks to compounding interest’. This is not a false statement but it’s just missing another feature. Inflation. That $537,006 is the nominal value. That $537,006 in 40 years will NOT be worth what $537,006 is worth today. If you include say 3% annual inflation then you’ll get the real terms of $163,114. This means that original $10,000 will show as $537,006 in your account in 40 years but it will be worth $163,114 in TODAYS dollars (aka what you can actually buy today with $163,114). So maybe a smaller older home in the Midwest? Not a larger home on the coast like $537,006 may imply.

Similar example would be how your grandparents would say “back in my day bread cost 10 cents” and now there is no way you can find a loaf of bread for $0.10. All commodities have increased in cost over time. Inflation eats at your buying power and when you talk in terms of REAL you take that into consideration.

Fees/MERs

As we’ve harped on in the past already, fees matter.  A LOT!  Understand how much you are loosing in fees each year.  MER stands for Management Expense Ratio and is essentially another name for fees. The sad part about fees is that these are not explained well to the every day investor.  And why would the banks explain these?  This is how THEY get paid.  Instead they are misconstrued to seem like a small menial number (1-2%) which doesn’t sound too bad on paper but when you look at the math of what 2% does to your portfolio over a 40+ year time horizon you’d want to punch your banker in the face trying to take that much money away from you. It’s honestly highway robbery.

Don’t believe me STILL?  Check out all of these articles:

• Investment Fees Art Eating Your Returns – Money Sense
• The “tyranny” of fees: How costs kill investment returns – The Globe and Mail
• Don’t Let Fees Destroy Your Investment Return – The Motley Fool
• Investment Fees Will Cost You Millions – Physician on FIRE
• How Taxes and Trading Costs Kill Investment Returns – Forbes
• Give Fees an Inch, And They Will Take a Mile – New York Times
• How Much Of Your Total Returns Are Lost To Fees? – Wall Street Physician

The list goes on and on.  Sure, some portfolios with higher fees may out perform the ones with lower fees.  But consistently, year over year over year over your entire investing time horizon?  Likely not.  And that’s what matters.  Go read Beat the Bank by Larry Bates or The Little Book of Common Sense Investing by John Bogle if you want to read entire books about how fees will impact your portfolio in the long run.

Net Worth vs Income

So many people focus on their income.  I’m not saying it’s not important, it definitely is, but what’s more important?  Your net worth.

What do I mean by that?  Someone making $40,000 and saving $5,000 per year is in much better shape than someone making $100,000 and spending all $100,000 – or even worse, spending even more than $100,000.

If you aren’t tracking your net worth you should be.  At least annually.

Keep striving for that bump in pay, but don’t forget to pay yourself first and put that extra income to use.

Savings Rate

Your savings rate refers to what proportion of your income are you saving.  It’s a pretty simple concept, yet there seems to be many ways to calculate your savings rate.  Big ERN wrote an extensive post on the different ways so I will send you over to his post rather than recreate the wheel.

My thought is, to each’s own.  There is no right way.  What’s important is that whichever way you calculate it, you track it.  Month over month.  Year over year.  This really is the most important figure for you to optimize on your journey.

Try and optimize this and boost it a few percentages each year until you are saving over 50% with a goal to be in the 70+% club (if that’s your thang).  Once your savings rate is 45%, you’re looking at less than 20 years to retirement.  The math really is simple. But again, don’t do this if it means you are depriving yourself along the way.  Instead make money a game and gamify (sp?) your spending to figure out how to enjoy life by spending less.  As you go along, you’ll figure out that a happy life does not need to be that expensive.

Personally, to calculate my savings rate I use my after tax income and add back in any pre-tax contributions I’m making towards my retirement accounts (i.e. 401k or Group RRSP that comes out of your paycheck) and I also add in any company match as that is essentially part of your pay from your employer.  Any investments I am making counts towards savings.  Any expenditures that depletes my net worth is an expense.  Some people argue weather or not paying off debt (mortgage, student loans, consumer debt, etc.) counts towards your savings rate.  You can argue all day of what counts and doesn’t – again what really matters is that you use the same consistent formula and see your savings rate go up.

Sequence of Returns Risk

Sequence of Returns Risk refers to the risk an early retiree faces at the beginning of their retirement when they start to withdraw from their portfolio.

The idea behind it is:

• Assumptions (based off the 4 Percent Rule):
  • You have 25 x your annual expenses in passive income.
  • Your passive income should return 7% returns on average.
  • You aim to withdraw 4% of your portfolio year over year once you retire.
  • You assume inflation will grow 3% on average.
  • Thus earning 7% returns annually and withdrawing 4% annually should be a net neutral (since another 3% is being eroded away from inflation) and keep your portfolio (and spending power) in tact.

The problem is, these are averages.  We all know that the market does not grow 7% every single year. Nor does inflation increase by 3% every single year.  Some years the stock market may grow by 15%, others years it may only be 1%, or worse off there may be a 20% drop.  Same goes for inflation but likely to a lesser degree.  The stock market may average 7% returns annually and inflation may eat away 3% of your portfolio annually over the course of your withdrawal time-frame, but what happens in those first 5-10 years is really important. The order in which you earn your returns matters – A LOT.

Again, I am not the first to dig into this topic, so here’s a list of posts specific just to sequence of returns risk when it comes to financial independence:

• Understanding Sequence of Returns Risk – Safe Withdrawal Rates, Bull Market Crashes, And Bad Decades – Michael Kitces
• The Ultimate Guide to Safe Withdrawal Rates – Part 14: Sequence of Return Risk – Early Retirement Now
• The Ultimate Guide to Safe Withdrawal Rates – Part 15: More Thoughts on Sequence of Return Risk – Early Retirement Now
• Protect Your Early Retirement from Sequence of Returns Risk – Our Next Life
• Sequence Risk: How To Protect Your Nest Egg From Going Belly Up Before You Do – Bigger Pockets   
• How to Eliminate Sequence of Returns Risk – Retire By 40

I suppose we should write an entire post on our withdrawal strategy… luckily for you, dear reader, our amazing friends Ali and Alison from All Options Considered are working on an AMAZING case study analysis on our portfolio which covers in SO much detail our withdrawal strategy. Stay tuned for more on that!

Dividend

A stock dividend is a dividend payment made in the form of additional shares rather than a cash payout. Essentially, for every share of a dividend stock that you own, you are paid a portion of the company’s earnings. You get paid simply for owning the stock.

For example, let’s say Company X pays an annualized dividend of 20 cents per share. Most companies pay dividends quarterly (four times a year), meaning at the end of every business quarter, the company will send a check for 1/4 of 20 cents (or 5 cents) for each share you own. This may not seem like a lot, but when you have built your portfolio up to thousands of shares, and use those dividends to buy more stock in the company, you can make a lot of money over the years. The key is to reinvest those dividends!

Let’s use some numbers to look at an example.  Let’s say you invest $50,000 in a high dividend stock and each unit of this particular stock costs $20 and pays an annualized dividend of $1 per share.  This means you own a total of 2,500 units of this stock ($50,000/$20=2,500). Over the course of the year, you will get paid $2,500 every year simply by owning this stock (2,500 units*$1=$2,500).

Dividend Yield

Dividend yield refers to a stock’s annual dividend payments to shareholders, expressed as a percentage of the stock’s current price.

So in the example above, the dividend yield is 5%.  How did we get that?

Dividend yield = (annual dividend) / (stock price) * 100%

So (1/20)*100=5%

It’s important to realize that a stock’s dividend yield can change over time, either in response to market fluctuations or as a result of dividend increases or decreases by the issuing company.

Dividends are one component of a stock’s total rate of return, the other being changes in the share price. For example, if a stock’s price goes up by 5% this year and it pays a 3% dividend yield, then your total return is 8%. If you’re investing for the long term, be sure to consider a stock’s total return potential in addition to the yield.

And this is the main reason why I don’t invest in individual high dividend stocks and would rather invest in broad index funds tracking the overall market.  From the little research I’ve dug into on dividend stocks, these tend to be steady blue-chip stocks (large company – one of the market leaders in its sector – been around awhile – most people have heard of them – that type of company) which I have found do not have the growth potential as some other companies out there.

A rising dividend yield may simply be masking a money-losing stock. Math and the way dividend yields are calculated is why this happens. Go back to the dividend yield equation.

Dividend yield = (annual dividend) / (stock price) * 100%

Why does this equation matter? A falling stock can make a dividend yield look great.

Let’s go back to our example above. You bought a $20-a-share stock that pays $1 a year in dividends. You might be initially thrilled with your impressive 5% annual dividend yield ($1 dividend divided by $20 stock price). The stock’s yield is ~275% larger than the S&P 500’s roughly 1.8% yield. Go you!

Now, the stock crashes to $10 a share and the company holds the dividend the same. Applying the same dividend yield formula, the stock’s dividend yield doubles to 10%. Looks great. But wait a second, despite the higher yield, you’re worse off because you lost $10 a share on the stock. The stock market as a whole stays steady, but this particular stock takes a tumble.  The dividend looks great but the stock itself may not be worthy of investing in.  If you are looking into dividend stocks, please do your research! This is just a example and I’m sure there are great high dividend stocks out there but I would much rather not have all my eggs in a few baskets.

Emotional Risk

This goes back to the notion of zoning out all the noise that you see on the media.  The media’s job is to bring in eye balls to their programming so that more viewers see their paid advertisements.  Just like any other corporation, their job is to make money. Pair that up with the fact that humans have emotions and things can get crazy.

Today’s investors are bombarded with so much media. The news is received in seconds via smartphone and other devices, and reactions to the negative media often cause negative results for the investor’s portfolio. All too often, money management is influenced by investor’s emotions, emotions that can cause a loss of focus on the financial goals and objectives for both the short-term and the long-term.

When the market is experiencing erratic movements, an investor may panic and sell. On the other hand, if the market is at a peak, an investor may feel elated and buy. This kind of emotional behavior can have dramatic consequences on the performance of your portfolio.

Consumers tend to flock to an item when it goes on sale.  Like wait overnight in a fold out chair on Black Friday to get a TV 60% off. But these same consumers panic when the market dips and funds go on sale and sells instead of buys these undervalued products.  Our emotions get the best of us and dont let us think properly.  Don’t panic!  The value of your funds only matters when you actually sell these.  If there is a dip, this is a signal to buy.

Phew.  Ok we are really getting there!  We will have one last post for this Investing 101 Series wrapping everything up.

Any questions for us?  Do you feel more confident and ready to invest?

Want to check out the rest of the Investing 101 Series?

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest
• Investing 101 – Part 3: Accounts You Can Invest In (US Edition) 
• Investing 101 – Part 4: Accounts You Can Invest In (Canada Edition)
• Investing 101 – Part 5: Tax Advantaged Accounts
• Investing 101 – Part 6: Funds You Can Fill Your Investment Accounts With

Support This Blog

If you liked this article and want more content like this, please support this blog by sharing it.  Not only does it help spread the FIRE, but it lets me know what content you find beneficial.  Writing is NOT my strong suit and it honestly takes me hours to write each post so the more encouragement the better!  Engaging in the comments below keeps me motivated.  You can also support this blog by subscribing to receive emails anytime a new post is published.  Thank you FImily!

We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.  Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:

• How much are you paying for your phone plan?  Canadians, learn more about Public Mobile, and see how we are paying $3/mo for our cell phone plan.
• How much are you paying for internet?  Canadians, learn more about the various Independent Service Providers out there to see who services your area so you can lower your monthly bills.
• How much are you paying for home insurance?  We were able to reduce our rates by 25% by switching over to Square One Insurance.  If you live in BC, AB, SK, MB, and ON, check out Square One for your home insurance, landlord insurance, and/or tenant insurance.  Use this link to receive an extra $15 off your quote.  (Note that you must use this link to start the process to get the $15 off even if you prefer to pay over the phone.)
• How much are you paying for your monthly utility bills?  See how you can likely save on this monthly expense.

The post Investing 101 – Part 7: Terms to Know appeared first on Modern FImily.

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest
• Investing 101 – Part 3: Accounts You Can Invest In (US Edition) 
• Investing 101 – Part 4: Accounts You Can Invest In (Canada Edition)
• Investing 101 – Part 5: Tax Advantaged Accounts

As you are probably aware, there are MANY ways you can invest your money.  Some are riskier than others.  Some require slightly more work than others.

There seems to be so much hub-bub about the terms 401k, IRA, CD, 529, etc in the States and TFSA, RRSP, GIC, RESP etc, which don’t get me wrong it’s great to be talking about these accounts, but once these accounts are open, now what?

We’ve already covered these different types of ACCOUNTS in previous posts of the Investing 101 Series.  This post is to inform you of the different types of FUNDS that you can fill up these different accounts with.

Different types of FUNDS include cash, stocks, bonds, mutual funds, index funds, ETFs, etc.

This post may be dry but it’s important to cover these definitions of the different FUNDS that you call fill your ACCOUNTS up with.  What’s the point of opening up an account if you’re not sure what to fill it up with? Note that all of the information below applies to both our Canadian and American readers – as well as world wide if there’s anyone out there tuning in!)

Cash

Holding onto cash is the simplest form of investing.  If you are able to create a gap from your earnings vs spending, you will find yourself with excess cash.  You can decide to do nothing with that cash, other than hoard it in your home in a jar or under your mattress. The issue here is that there’s this thing called inflation.  Inflation is the general increase in prices and the fall in purchasing value of money.  Can you recall an elder mentioning how “when I was young, a loaf of bread cost $0.05” and now a loaf costs closer to $3?  That’s inflation.  Let’s say you are hoarding $1,000 in your bedroom.  In 30 years from now, you may be lucky to purchase groceries for a week with that.  Don’t let inflation eat away at your hard earned pennies.

Same thought process goes for a checking or savings account with a bank.  As we covered before, have you ever checked to see what interest rate you are earning on your money in these accounts?  I’m going to guess that it’s VERY low.  Like below 0.5% low.  While this is better than 0% interest when the money is just stashed under your mattress, 0.5% is nothing to cheer about.

Yawn, we’ve already covered this in the past. So instead of just holding onto cash, what else can you invest in? Here we go!

Bonds

Grouped under the general category called fixed-income securities, the term bond is commonly used to refer to any securities that are founded on debt. When you purchase a bond, you are lending out your money to a company or government. In return, they agree to give you interest on your money and eventually pay you back the amount you lent out.  The main attraction of bonds is their relative safety. If you are buying bonds from a stable government, your investment is virtually guaranteed.  The safety and stability, however, come at a cost. Because there is little risk, there is little potential return. As a result, the rate of return on bonds is generally lower than other securities.

Some bonds provide zero risk, such as Treasury bonds held to maturity, money market accounts, and CDs (GICs for Canadians) where the federal government backs these types of investments.  Bond index funds are a bit more risky but you can expect to receive anywhere from 2-5% annual return each year (currently, we’re closer to the 2% side of things).  Even riskier would be to buy individual corporate bonds, emerging market bonds, or high yield bonds.  This last batch of bonds has the potential to provide higher returns but they also come with more volatility.  I’m not a fan of any of these latter bonds and this is that last you’ll hear from me on those particulars funds.

Stocks

At some point, just about every company needs to raise money, whether to open up a West Coast sales office, build a factory, or hire a crop of engineers.  In each case, they have two choices: 1) borrow the money, or 2) raise it from investors by selling them a stake (issuing shares of stock) in the company.  When you own a share of stock, you are a part owner in the company with a claim (however small it may be) on every asset and every penny in earnings. Woohoo, go you, business owner, you!

Stocks in general have been solid investments. That is, as the economy has grown, so too have corporate earnings, and so have stock prices. Since 1926 (note, including the Great Depression), the overall stock market has returned close to 10% a year.  (Yes, you read that average right.  Note this is NOT include inflation – mentioned above.)  If you’re saving for retirement, that’s a pretty good deal — much better than U.S. savings bonds, or stashing cash under your mattress as mentioned above. Personally, I use ~6-7% as my estimate of where to expect returns stocks going forward for the longer term. I sure hope I am shown up and the returns continue to come in the 10% range.

Of course, “over time” is a relative term. As any stock investor knows, prolonged bear markets can decimate a portfolio.  Since World War II, Wall Street has endured several bear markets — which is defined as a sustained decline of more than 20% in the value of the Dow Jones Industrial Average (which really only tracks 30 of the large publicly-owned companies trading on the New York Stock Exchange but it gives a rough guideline of how the overall market is performing).  Bull markets eventually follow these downturns, but again, the term “eventually” offers small sustenance in the midst of the downdraft. The main point to keep in mind, is that investing in stocks must be considered a long-term endeavor if it is to be successful.  Compared to bonds, stocks provide relatively high potential returns. Of course, there is a price for this potential: you must assume the risk of losing some or all of your investment.

This is why we prefer to stay away from all the buzz in the media.  If you cannot handle seeing your portfolio drop 20+% in one single day, we would recommend you avoid checking your accounts obsessively as I can almost guarantee a 20+% drop will occur at some point in your lifetime.  Likely even a 50% at some point.  When?  Who knows.

NO ONE can predict when this is going to happen.  No one.  People can do all the guessing they want, but that’s all it is, a lucky guess.

But it likely will happen.  You have to have the willpower to stay the course and not to overreact and sell when the market drops. Over the long term, the market always goes up.

If you can remember that the overall market has provided returns averaging 10% annually and you can continue to throw any extra savings monthly into the market, regardless what happened earlier this week, month, or year – you’re golden.

OK OK I Get It – Don’t Obsess Over The Market – Then What?

So investing in stocks allows you to grow your wealth.  But choosing the companies and industries that will deliver the best earnings is a real challenge.  There are some people in the FIRE community who are into dividend investing which is selecting individual stocks (or dividend index funds/ETFs) that pay a higher than average dividend to its shareholders in hopes of living off the dividend payouts rather than having to withdraw (aka sell) some of their investments which in early retirement.  Most people just don’t have the interest, time, or expertise to pick individual stocks well.  Team that up with the many individual stocks you’ll need for a well rounded portfolio and the complexity adds up quickly.  These higher dividend stocks also tend to have very slow growth over the long term so I personally do not invest in them.

Enter into the picture: mutual funds.

Mutual Funds

A mutual fund is a collection of stocks and bonds. When you buy a mutual fund, you are pooling your money with a number of other investors, which enables you (as part of a group) to pay a professional manager to select specific securities for you. Mutual funds are all set up with a specific strategy in mind, and their distinct focus can be nearly anything: large stocks, small stocks, bonds from governments, bonds from companies, stocks and bonds, stocks in certain industries, stocks in certain countries, etc.

Back in the day, all mutual funds were “actively managed” meaning some smart guy (because let’s be honest women probably weren’t hired for these jobs… eye roll) was paid to take all this money and buy a bunch of stocks with it at his discretion.  People who wanted to invest would put some money into the mutual fund and they would get a piece of all the stocks that smart guy decided to buy.  It was a nice way to diversify your portfolio without having to do all the research and trading yourself. The primary advantage of a mutual fund is that you can invest your money without the time or the experience that are often needed to choose a sound investment.  All mutual funds have expenses including commissions, redemption fees, and operational expenses.

These expense fees really can add up.  Most mutual funds charge 1.5-2% fees which may not sound like a lot but if you are making 6% returns (as it’s been proven mutual funds don’t perform as well as the overall market), the mutual fund company then keeps ~2% of that so in reality you are only see 4% returns.  That is 33.33% of your portfolio (2/6) that you don’t get to keep!!!  That’s in year 1.  And then the double whammy is that 33.33% earnings is now no longer allowing the magic of compounding to occur in your account!  THIS IS HUGE!!!! ABSOLUTELY HUGE. LIKE EAT AWAY MORE THAN HALF OF YOUR PORTFOLIO OVER THE LONG RUN HUGE.

Don’t believe it?  Check out this 20 year chart.  And note this is only for 20 years.  The percentages CONTINUE to grow the longer you invest.

If it wasn’t clear, understand the fees associated to any fund you invest in. Personally, I would steer away from anything over 0.25% these days.

Additionally, research shows how difficult it is for the pros to buy and sell individual stocks (that make up your mutual fund) to keep up with performance of the overall market. If you google “do mutual funds outperform an index fund” you will see time and time again, the resounding answer is NO.

To stress this point, because it needs to be stressed even more, let’s look at an example:

Let’s say Larry uses a mutual fund manager to oversee his investments whereas Lizzy invests in index funds (stay tuned for more on that).  Larry and Lizzy both contribute $1,000/month into their investments for a 20 year timeframe.  Let’s assume that Lizzy’s index funds averaged 7% whereas Larry’s mutual fund portfolio averaged 6% (because most actively managed funds don’t beat the market) but then also had that pesky 2% fee structure (mentioned above) built in.  20 years later, Lizzy would have $520,926 in her accounts whereas Larry would only have $366,744 in his account.  That’s a difference of $154,182!!!! That’s a 35% difference! Let’s say Larry’s mutual fund manager somehow managed to beat the market by 1% (very rare and unlikely), Larry is STILL worse off from Lizzy because of those added on fees!

To go one step further, lets assume after 20 years both Larry and Lizzy stop contributing to their respective accounts and let them sit and grow for another 20 years before withdrawing any money from them.  It get’s worse the further out you look.  Assuming Lizzy’s portfolio of $520,926 continues to average 7% annually, in 20 years it will then be worth $2,103,884 without putting in a single penny more (thanks to compound interest).  Larry, on the other hand, still has his portfolio with his mutual fund manager making 4% net returns after fees (6% returns – 2% fees).  After 20 additional years, Larry’s portfolio of $366,744 will be worth $815,118 without adding another penny in.  This is definitely a sizable portfolio, no doubt about that, but we’re talking a difference of $1,288,766 compared to Lizzy’s portfolio!! That’s a 61% haircut!

So how do you be Lizzy and NOT Larry?

Enter in: index funds.

Index Funds

Building a well-rounded portfolio of individual stocks is complex. That’s why people pay mutual fund managers to try and create a portfolio to outperform the market. However, as noted above, research shows most pros find it difficult to outperform the market let alone match the overall market performance.  Additionally, there’s the other problem that we stressed above that these smart guys charge a high fee for their services. So individual investors are paying these smart guys a lot of money to trade stocks back and forth and end up with less money than those stocks actually would provide.

There has to be a better way!  How do you get the best chances of building a portfolio that is designed to grow and to get invested in as many different companies in as many different sectors as you need to be as well diversified?

Index funds!!

An index fund is a mutual fund or ETF which follows a certain preset of rules so that the fund can track a specified basket of underlying investments. Back in the day, if you wanted to mimic the performance of an index, you’d have to buy shares of each individual company listed in the index in the exact amount specified by the index.  That can really start to add up when you take into account the costs of commissions and having to buy whole shares of each stock.  There are many index funds that have over 3,000 individual stocks listed.

Essentially, an index fund is an easy way to invest in every company in an index (think of it as a list). Instead of paying some smart guy a high fee, an index fund is a type of mutual fund that buys EVERY equity in a list.

Index mutual funds are just a special type of mutual fund.  Mutual funds have a portfolio manager who determines which stocks and bonds to buy and sell.  If you are in an actively managed fund, you are putting faith in that particular portfolio manager to make buy and sell decisions with the expectation that they will outperform their benchmark market index over time.  Index mutual funds are passively managed.  The holdings within the index fund will not change unless the index (list of companies) changes.  In that way, the goal of the index fund is simply to try to meet the index’s performance.

You’re probably already familiar with indexes.  Ever heard of the S&P 500, the Dow Jones, or the Nasdaq? When people are talking about the stock market, they are usually talking about an index.

You can find an mutual fund or ETF (more on these below) that tracks these indexes along with MANY other indexes out there.  So for example, an S&P 500 index fund owns the 500 biggest stocks in the US. This means with that one purchase of that one single index fund, you are now investing in a tiny piece of the pie of the top 500 companies. In any given day, there will be some industries that will go up (say utilities for instance) and some industries that will go down (say tech) – the point is you have an investment in every major sector of the economy.

There are index funds that track the Canadian TSX 60 (Canada’s top 60 companies), or Ex-North American stocks, or Emerging Markets, or High Dividend Yield companies, etc.  There are also bond index funds too that may track the overall Canadian Short-Term Bonds, or US Long-Term Bonds, or Global bonds.  You get the picture.

Simply put, you get the advantage of broad diversification.  You are investing in MANY stocks or bonds all under one stock symbol.

On top of all of that, index funds are offered at MUCH lower fees than actively managed mutual funds. And I mean much lower.  Index fund fees are typically 10-50 times lower than actively managed mutual funds, and their performance is almost always better.  In fact, there are now some index funds with 0% fees, pretty mind blowing.

For example, in the US you can invest in the index fund with the stock symbol VTSAX.  This is the Vanguard Total Stock Market Index Fund Admirals Shares.  It’s fee is 0.04%.  That is INSANELY low!  Buying this one simple stock symbol means you are now investing in ~3,6000 different US companies.  Talk about diversification at a LOW cost.  Fidelity recently came out with two index funds (FZROX and FZILX) at 0.0% fees, crazy!  And more and more companies seem to be following suit with zero fee index funds.

In Canada, index fund fees are a bit higher but still very low comparatively speaking to other Canadian mutual funds.  A similar comparison would be the stock symbols VUN.TO or XUU.TO.  VUN.TO is Vanguard’s version of the US Total Stock Market Index ETF that is offered to the Canadian market and it’s MER (management expense ratio) is 0.15%.  While 0.15% may sound high, it’s MUCH lower than the ~2% you’d be paying for an actively managed mutual fund.  Another great option for Canadians looking to hold onto a total US stock index fund is XUU.TO which is iShares Core S&P US Total Market Index ETF whose MER is slightly lower at 0.07%.  Another option is VFV which is Vanguard’s S&P 500 Index Fund ETF which has a MER of 0.08%. Or XAW which is BlackRock’s iShare Core MSCA All Country World ex Canada Index ETF with a 0.22% MER.  These funds are are slightly different in that VUN holds 3,630 holdings whereas XUU holds 3,470 companies and VFV hold the top 500.  Either way, you can’t go wrong in my books.

Personally, I am a loyal Vanguard fan because Jack Bogle (the founder of Vanguard) was the one who created the world’s first index mutual fund.  Other companies have realized how amazing this concept is (and how it consistently outperforms managed funds) so you can now find MANY companies offering index funds (and like Fidelity and iShares, some at a better cost).  Vanguard also has the first-mover advantage not just in being the ones to have created index funds in the first place but they also seem to come up with the next latest and greatest index funds and the other companies tend to copy cat what they do. I am just loyal to Vanguard as they greatly changed the playing field for us everyday investors and for that I am thankful and show my thanks by investing with them.  By no means am I telling you what to do, I am in no way shape or form get paid for anything I write here about Vanguard, I’m just voicing my opinion.

The other great thing about Vanguard is that they have a fairly unique structure in  that the company is owned by its funds and the companies different funds are then owned by you and me, the shareholders.  Thus the shareholders are the true owners of Vanguard.

Please do your own reading and research and feel comfortable with whatever decision you end up making. If you’re interested in learning more about index funds, read about it from the legend himself by reading The Little Book of Common Sense Investing by John (Jack) Bogle.

To summarize, the two main pros of index funds are diversification and minimizing costs.

Exchange Traded Funds (ETFs)

ETFs have several similarities to mutual funds. Like a mutual fund, an ETF is a pool or basket of investments which can contain stocks, commodities, bonds; some offer US only holdings, others are international.  The main difference between an ETF and a mutual fund is that an ETF trades on an exchange, just like a stock. This means that an ETF doesn’t trade at the end of the day like a mutual fund. The price of the ETF is determined by investor demand at any given time during the trading day.

ETFs are also a great investment suggestion as well, especially ETF index funds. ETF’s tend to have lower expenses then a similar index mutual fund (in Canada at least) and so that is why we invest in the ETF VUN.TO (as mentioned above). Most Canadian index mutual funds have an MER around 1% whereas ETFs tend to have an MER around 0.2%. (Note Canada has some of the highest fees overall of all the first-world countries out there.) ETFs also tend to have lower investment minimums so the barrier to enter is lower (i.e. if you don’t have a ton of cash but you want to start investing, you may meet the minimum requirement to open an ETF but not an index tracking mutual fund).

But investing small amounts or set dollar amounts into an ETF is a little trickier since you are required to buy whole shares making the process a bit more difficult and leaving some cash unused with each transaction. Don’t let that steer you away.

What do we mean by that?

As of today, one share of the ETF VUN.TO is valued at $59.13.  This means that if I want to buy into this ETF, I have to do so in increments of $59.13.  So if I had $100 to invest, I could only buy 1 share at $59.13 as two shares would cost $118.26 and I only have $100 and you cannot buy partial shares.  Thus I would have the difference of $100-59.13=$40.87 sitting in cash in my account (be it TFSA, RRSP, etc) and I would have to wait until I had more cash saved up in that account to buy that second share.  Mutual funds do not work in this manner.  You can select to invest any dollar amount into an indexed mutual fund and you can purchase partial shares of these funds.

In my books, if you’re investing in an index (whether it’s tracking the overall US stock market, overall international market, overall bond market, target retirement date, you name it – it totally depends on your risk profile) that’s a win in my books. Whether the index is within an ETF or mutual fund doesn’t carry much weight to me as long as you’re minimizing fees. You can find ETFs that track the very same indices as an indexed mutual fund.

Index mutual funds and ETFs do the legwork for you, purchasing exactly the number of shares of each company it takes to recreate the indexes weighting. They also use scale to minimize the costs with buying and selling stocks.  Whenever an investor buys a share of an index mutual fund or an ETF, they are buying a portion of the underlying portfolio. That way investors can get by with owning partial shares of each individual security, making it much more affordable than trying to match an index on your own.

A note to add regardless which type of investment fund you choose to go with – while you are in your wealth accumulation phase, ensure that your dividends/earning are being reinvested back into your account as they are paid out by the companies that you are investing in.  The other option is to get paid out in cash from these dividends.  But you want all of the earnings to continue working for you and compounding in the market!  For most financial institutions, this is a simple check of the box when you are setting up your account.

Real Estate

The last investing strategy I will briefly touch on is real estate.  Just like investing in the market, real estate can come in MANY forms.  You can start off small by shifting back to living with roommates instead of on your own if you’re renting to cut your rental costs in half. Or you can house hack like us where we purchased a townhouse and rented out 3 of the 4 bedrooms to pay off our mortgage in 2.5 years. Or you can buy a duplex and live on one side and rent out the other. Or you can rent out a home entirely. Or go to the big leagues with owning and renting entire apartment complexes.  Or you can invest in commercial real estate.  Or you can invest in storage facilities.  I’m sure there are MANY other ways to invest in real estate – point is, there’s no one set way to invest in real estate so again it’s important to read and research if this is something that interests you.

Even though we house hacked our first townhouse and then rented it out for 2 years to a great family, and then sold it for a profit, by no means would I say I’m close to an expert in real estate.  There are other members of the FIRE community who solely focus on real estate and are making a living off of that passive income alone.

If you’d like to learn more from some FIRE real estate experts, I recommend checking out:

• Afford Anything
• Coach Carson
• Bigger Pockets

Afford Anything and Bigger Pockets also have podcasts of their own if you prefer learning through that medium.

If you like the idea of investing in real estate, but don’t want to physically own one property in particular (or you don’t have enough for a down payment), you could invest in REITs.  A REIT (Real Estate Investment Trust) owns, and in most cases operates, income producing real estate.  REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centers, hotels, etc.

And you guessed it, you can find a REIT index fund if you’d like.  VGSLX is Vanguard’s Real Estate Index Fund Admirals Shares that is offered in the states.  For Canadian’s, Vanguard offers VRE which is their Canadian Capped REIT Index ETF.  Of course, Vanguard isn’t the only player in town.  Canadians, click here to read a Canadian specific post for REITs. Americans, click here for an example of some other real estate ETFs.

That’s a Wrap

You now know about bonds, stocks, mutual funds, index funds, ETFs, and real estate (including REITs).  Hopefully this gives you a solid understanding of the TYPES of FUNDS that you can invest in.  Remember, don’t get these confused with the TYPES of ACCOUNTS you can invest in.

Investing really is pretty simple when you think of it.

Find a financial institution, pick an account, and fill it up with funds.

I know there are some reasons why you’d want to pick account A over account B which requires some reading and research.  Similarly, once you decided on the account, then you’ll want to do some reading and research as to which funds to fill that account up with.  Honestly, the harder part really is to grow your gap between your income and your expenses so you can maximize the amount that you can invest. Having money to invest is the hard part.

Personally, I feel it’s best to keep your investment strategy short and sweet.  Maximize your tax advantage accounts (401k and Traditional/Roth IRA in the States and RRSP and TFSA in Canada) with index funds tracking the overall market.  Once you’re reached your max contribution room in your tax deferred accounts (kudos to you), then see if there are other tax advantaged accounts worth investing in (HSA and 529 in the States and RESP in Canada – I’d argue an HSA should be up there with your 401k and IRA if you’re in the States).  Once all of your tax advantaged accounts have been maxed out, open a taxable account and fill it up with more index funds.

Sure, there are alternative investments but they are generally high-risk/high-reward securities that are much more speculative than plain old stocks and bonds. Don’t get me started on crypto! But hey, if you want to invest less than 5% of your portfolio into one-off accounts, go for it!  I call this your fun money bucket.

Did this weeks post help explain the different types of funds you can select to invest in?  Are you enjoying our Investing 101 Series? Any questions? We will have one last post as part of this series to summarize everything we’ve learned.  Thanks for tuning in and feel free to comment below.

Want to check out the rest of the Investing 101 Series?

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest
• Investing 101 – Part 3: Accounts You Can Invest In (US Edition) 
• Investing 101 – Part 4: Accounts You Can Invest In (Canada Edition)
• Investing 101 – Part 5: Tax Advantaged Accounts

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If you liked this article and want more content like this, please support this blog by sharing it.  Not only does it help spread the FIRE, but it lets me know what content you find beneficial.  Writing is NOT my strong suit and it honestly takes me hours to write each post so the more encouragement the better!  Engaging in the comments below keeps me motivated.  You can also support this blog by subscribing to receive emails anytime a new post is published.  Thank you FImily!

We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.  Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:

• How much are you paying for your phone plan?  Canadians, learn more about Public Mobile, and see how we are paying $3/mo for our cell phone plan.
• How much are you paying for internet?  Canadians, learn more about the various Independent Service Providers out there to see who services your area so you can lower your monthly bills.
• How much are you paying for home insurance?  We were able to reduce our rates by 25% by switching over to Square One Insurance.  If you live in BC, AB, SK, MB, and ON, check out Square One for your home insurance, landlord insurance, and/or tenant insurance.  Use this link to receive an extra $15 off your quote.  (Note that you must use this link to start the process to get the $15 off even if you prefer to pay over the phone.)
• How much are you paying for your monthly utility bills?  See how you can likely save on this monthly expense.

The post Investing 101 – Part 6: Funds You Can Fill Your Investment Accounts With appeared first on Modern FImily.

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest
• Investing 101 – Part 3: Accounts You Can Invest In (US Edition) 
• Investing 101 – Part 4: Accounts You Can Invest In (Canada Edition)

So you’re planning for (early) retirement and feeling unsure about which product is the best vehicle to get you there.  These days, few people have access to “defined benefit” plans like the pensions that may have guaranteed your grandparents a certain payout from retirement through the rest of their lives. Instead, most retirement plans are of the “defined contribution” variety, meaning you (and maybe your employer) contribute a certain amount each month, quarter, or year, but the payout you’ll receive during retirement will be based on the market value of the account.

IRAs and 401ks are among the most common defined contribution plans in the States, and both offer tax-advantaged retirement savings. Similarly, it’s the TFSAs and RRSPs that are the tax-advantaged accounts up in the great white north. Another form of defined contribution plans are Social Security in the States and Canada Pension Plan in Canada.

For the sake of not having to keep going back and forth, I will write in US terms first (aka 401k and IRA) but note that a TFSA is the equivalent to a Roth IRA, a Group RRSP is equivalent to a Traditional 401k (funded by an employer), and a RRSP is the equivalent to a Traditional IRA (individual account not tied to an employer).  I will write a separate section for Canadians towards the end regarding TFSAs and RRSPs so it’s clear as there are some differences from the US accounts.

Even though a lot of this post is a recap of what you’ve already learned from the Investing 101 Series, I really wanted to harp on the tax advantaged accounts as these are likely the accounts you should be opening up first and foremost. Any Canadian reading, there is not reason not to focus on our TFSA and/or RRSP before anything else as you can withdraw from these accounts if need be with no penalty (not that we are suggesting you do this unless you’re already retired).

Let’s set one thing straight.  There is a common misconception that a 401k, IRA, RRSP, or TFSA is a type of investment like a mutual fund.  If it’s not clear to you yet, they are not!  They are simply a savings or investing account with certain tax-savings characteristics.  You can CHOOSE what type of investments to fill up these accounts with. Same goes for taxable brokerage accounts.  Those are simply accounts you are opening on your own but then you select the investments that go into those accounts too.  So the questions “Do I invest in a 401k or index fund?” or “Do I invest in a RRSP or individual stock?” do not make sense. You’re comparing an account to a fund within an account.

If you have a 401k/RRSP but are afraid to open up a brokerage account, there is no need to be as you are already investing! Most employee sponsored 401k or Group RRSP accounts have ~10-30 options of investment funds to choose from.  Many 401k plans offer index funds with target retirement dates which consist of a mix of domestic index funds, international index funds, domestic bond index funds etc. which make deciding on which fund to invest in quite easy if you’re looking for a simple way to be in a balanced portfolio.  Or if you are opening up an IRA, RRSP, or TFSA on your own at your bank or discount brokerage, you can put whatever investments you want it in (i.e. cash, individual bonds, individual stocks, ETFs, index funds, etc.). 

We will cover these different types of investments in the next post of the investing series, for now we will focus on the different tax advantaged accounts.

401k vs IRA

There are a few key differences between these types of plans. The good news is that you don’t have to choose one over the other. If you’re planning well for retirement (I sure hope you are!), it’s quite likely that your plan may include both a well-funded IRA and a 401k account.  If so, you’re killing it! If you can really boost your savings rate up, after you’ve maxed out these tax advantage accounts you can then open up a taxable brokerage investment account with a financial institution  (examples include Vanguard, Fidelity, Schwab, etc.) and funnel in any additional money into these taxable accounts. There’s a traditional 401k, a Roth 401k, a traditional IRA, and a Roth IRA.  (There are some other versions too depending on your line of business but these are the main ones).  You can have both a 401k and an IRA but the max annual contribution room in both accounts must be split up between a traditional or Roth, however you choose. 

For both a traditional 401k and traditional IRA, a word “traditional” in this type of account means that you get the special tax treatment the year in which you contribute.  For both a Roth 401k and Roth IRA, the word “Roth” implies that you pay taxes like normal in the year you contribute and you get the special tax treatment down the road when you withdraw from these accounts. It’s a good idea to be informed about the differences so you can make smart choices for your future.  Again, personal finance is not my day job, it’s just a hobby, and I am constantly learning.  So please do your own research or consult a trusted advisor to review your specific situation in detail. However, if you’re nervous, I’d say just pick one and get started!  Sitting on the sidelines is not helping your situation.  

What’s a 401k?

A 401k, as well as a 403b and 457, is a qualified employer-sponsored retirement plan.  If you are self employed, don’t fret.  There’s the solo 401k for you.  If your employer does not offer a 401k or other sponsored plan, you should probably just begin saving in a Roth IRA or traditional IRA.  But if you have access to an employer plan — especially if the employer offers matching contributions — that’s a great place to start. Many employers offer a matching contribution up to a certain percentage of your salary.  For instance, if your employer will match your 401k contributions up to 6 percent of your salary, you should always contribute at least 6 percent. If not, you’re turning down free money! Think of this as part of your salary. Would you willingly give away part of your pay check? I doubt it.

You could also contribute into a Roth 401k in which you pay taxes upfront (if your employer offers it).  If you expect your tax rates to be higher in retirement, if you’re young and have decades of tax-free compounding earnings potential, or if you plan to leave your Roth to a spouse or heirs who can stretch out the tax-free growth this could be an option for you. The decision to choose traditional 401k or Roth 401k is personal (and likely will be a traditional 401k as that’s the account most employers offer). It depends on your current tax bracket and your expected tax bracket when you retire (which is a guess at this point as tax brackets are constantly changing). All the money you contribute to your traditional 401k account is pre-tax money, meaning you will not be taxed on that money during the year you earned it (well you will, but you can claim it when you file your taxes and get it back).  This however does not mean you are free and clear of paying taxes on money in your 401k.  You will pay taxes on it when you withdraw it during retirement.  (Although there is a way around this, enter in long term capital gains taxes.)

What are Long Term Capital Gains?

Long term capital gains are those you earn on assets you’ve held for more than a year.  The long term capital gains tax rates for 2019 are 0%, 15%, and 20%, and they are typically much lower than the ordinary income tax rate. A single person in the States won’t pay any capital gains if their total taxable income is $39,375 or below.  You will pay 15% on those gains if your income is $39,376-$434,550.  Above that, the rate jumps to 20%.  If you are married filing jointly the 0% bracket jumps up from 0-$78,750.  The 15% bracket is $78,751-$488,850 and then it’s 20% if your income is $488,851 or more.  (Short term gains i.e. assets you buy and hold within a year, are subject to the current ordinary income tax brackets.  So for 2019 it would be 10%, 12%, 22%, 24%, 32%, 35%, and 37%.)

Capital gains tax is an early retirees best friend.

What do we mean by that?  For most working people, you are likely earning more than $39,375 and so if you withdraw from your capital gains during your working years you will fall in the 15% tax bracket.  However, for us early retirees, if you can keep your spending below $39,375/year if you’re single or under $78,750/year if you’re married, you can live off your capital gains and not pay any taxes on them!  This is why joining team intentionality and team valuist spending is so important.  Cut the fluff out of your spending habits not only to boost up your savings rate during your wealth accumulation phase but to also fall into the 0% tax bracket once you FIRE. Note that if you’re paid dividends from stocks that aren’t in retirement accounts, those are subject to capital gains as well if they aren’t reinvested.  This is why it’s important to re-invest your dividends in your wealth accumulation phase rather than withdraw them.  Let compound interest do its magic for you!

In Canada, only 50% of the value of any capital gains is taxable.  The amount of tax that you actually pay will vary depending on how much you’re making and what other sources of income you have.  There are also eligible Canadian dividends that pay 0% tax thanks to the Canadian dividend tax credit. This dividend tax credit – which is available on dividends paid on Canadian stocks held outside of an RRSP, RRIF, or TFSA – will further cut your effective tax rate. On top of all of that, there’s the Federal Basic Personal Amount which is a tax credit every Canadian resident is entitled to claim on their tax return (as mentioned in Part 4 of the series).  For 2019, it’s $12,069 and will be bumped up to $15,000 – thanks Trudeau!  You’re also entitled to claim a corresponding provincial basic personal amount, which varies by province.  For example, the Alberta Basic Personal Amount is $19,369 for 2019. What this means is that any Albertan claiming $15,000 of income for the year will pay $0 in taxes. You can claim more than $15,000 if you are withdrawing funds that qualify under the Canadian dividend tax credit. And you can also withdraw $30,000 in capital gains as only 50% of this value is taxable thus bringing you down to the Federal Basic Personal Amount. If you have a partner, they can do the same.

401k Contribution Limits

During 2019, employees are allowed to contribute up to $19,000 of pre-tax income to a 401k, and those over 50 can contribute an additional catch-up contribution of $6,000.  In 2020 the limit will go up by $500 from $19,000 in 2019 to $19,500 in 2020.  And for those over 50, the catch up contribution limit will also go up by $500 from $6,000 in 2019 to $6,500 in 2020. Note that the money contributed by your company does NOT count towards you annual contribution limits for the year (this is different compared to Canada).  If you withdraw funds from your 401k before you reach at least age 59½, you’ll owe not only income tax on the amount you withdraw, but those funds are also subject to an additional 10% early distribution penalty tax.  From a surface, it seems like this is a major downer for an early retiree. However, the FIRE community is full of amazingly bright individuals and a completely legal loop hole has been discovered here: The Roth Conversion Ladder.  I first heard about this from Brandon over at The Mad Fientist – so here’s the link to that post to dig further into that concept.  It does require a 5-year window to access the funds so you have to think ahead as to when you will need to access the money and ensure you hand funds in other accounts for those first 5 years.  The cliff notes version is:

• Contribute to pre-tax retirement accounts (401k, 457b, traditional IRA) during your wealth accumulation phase
• Reach that magic point where you can retire early
• Once you leave your employer, roll your employer’s retirement accounts (401k, 457b, etc.) to a traditional IRA
• Convert from your traditional IRA to your Roth IRA (you WILL pay taxes at this point so figure out the best amount to convert at a time to remain in a low/0 tax bracket)
• Wait 5 years
• After 5 years is up, withdraw the money tax and penalty free

Ta-da!  Brandon also covers another popular early-withdrawal method called the 72(t) SEPP.

Personally, we plan to use our cash cushion first, then withdraw from our taxable accounts in Canada, then taxable accounts in the US (dipping Canada first since these funds have slightly higher fees), then withdraw from our RRSP in Canada (since there’s not penalty to withdraw early), and lastly our tax-advantaged US accounts via the Roth Conversion Ladder for our 401k (if we aren’t 59 1/2 by then, but we should be though). The goal is to leave our TFSA untouched until the end if possible to let that tax free money grow grow grow. Or use it if our bank accounts are fat and juicy and we want to take an unaccounted vacation and no end up in a higher tax bracket.

What’s an IRA?

While the opportunity to contribute to a 401k is limited to people employed by companies that offer such plans, anyone can contribute to a traditional IRA (individual retirement account), as long as they are under the age of 70½.  Like a traditional 401k, a traditional IRA offers tax-deferred growth on your investments, meaning the assets in the IRA will not be taxed until they are withdrawn.  A Roth IRA offers opposite tax advantages from a traditional IRA: you pay tax on income before you make contributions to the Roth IRA, but you’ll pay no tax on the earnings when you make withdrawals in retirement. However, not everyone qualifies for a Roth IRA. To qualify, you must have a modified adjusted gross income (MAGI) that is less than $137,000 if single, or $203,000 for married couples filing jointly.

In Canada, the Roth IRA equivalent is a TFSA which is accessible to anyone over the age of 18 regardless of your income. 

Similar to the note above on the 401k, the decision to go Roth IRA vs traditional IRA is a personal decision and depends on your current income and tax bracket vs your anticipated retirement income and tax bracket.

IRA Contribution Limits

The limit for annual contributions to an IRA is $6,000 for 2019, and an additional $1,000 for people over 50. That limit is the same for both traditional and Roth IRAs meaning that you CANNOT contribute $6,000 to both a traditional and Roth IRA per year. The same limits apply for 2020.  

Similar to a 401k, generally, early withdrawal from a traditional IRA prior to the age 59½ is subject to being included in gross income plus a 10% additional tax penalty.  There are some exceptions to the 10% additional penalty, such as using IRA funds to pay for your medical insurance premium after a job loss, using the funds to pay for higher education expenses not only for you but also for an immediate family member, if you’re in the military and are called to duty for more than 179 days, or both you and your spouse can each use up to $10,000 from each of your traditional IRAs towards the purchase of your first home. You can take money without penalty from a traditional IRA once you reach age 59½ and you must begin taking money out of an IRA starting April 1 of the year following the year when you turn 70½. But again, there’s the Roth Conversion Ladder which is another way to loop through the tax penalty (again, you do pay taxes based off your income level when you convert from traditional to Roth). 

Withdrawals from a Roth IRA are a bit different. You can withdraw the money you contributed into a Roth at any time and for any reason without paying taxes or penalties since you already paid taxes on the money you used to find the account upfront.  This provides much more flexibility compared to the traditional IRA.  However, different rules apply to taking out earnings from your investments.  If you’ve owned the account for 5 years or more you can avoid the 10% early withdrawal penalty as long as you meet one of the 3 criteria below:

1. You’re 59 ½ or older
2. You’ve become disabled or you’ve died and the money is being withdrawn by your estate or account beneficiary
3. The withdrawal is for a first-time home purchase (up to $10,000 max)

So the withdrawals on the earnings are quite similar to the withdrawals of a traditional IRA but the withdrawals on your contributions can be withdrawn tax and penalty free at any time.  There’s also no required minimum distribution when you turn 70½.

Oh Canada

Thank you Canadian readers for your patience going through the US accounts first.  To quote Quit Like A Millionaire, “But what about Canadians?”, said no American ever.  For Canadians, there are a few key differences compared to what’s offered in the states.  The types of accounts are similar, but the contribution limits are a bit different.

RRSP

The total amount you can contribute to your Registered Retirement Savings Plan (RRSP) each year is made up of your contribution limit for the current year PLUS any “carry-forward” contribution room from previous years.  This is great news meaning that if you had room to contribute in the past but you didn’t, it’s not too late to catch up.  Likely you are a higher earner now compared to years past, so it may be even more beneficial compared to if you contributed annually in the past.  This is worth repeating: if you don’t make the maximum allowable RRSP contribution in any given year, Canada Revenue Agency (CRA) lets you carry forward the unused contribution rooms INDEFINITELY and add this to the amount you can contribute to future years.

All this sounds fine and dandy but how do you find out your contribution limits?

I have found the CRA website to be extremely easy to use and you can sign up via a username/password you already have set up with your bank to figure out your contribution room for your RRSP and TFSA.  Note that the number reported on your CRA account online does NOT take into account anything you have contributed thus far for this current year so if you have contributed some money this year you will have to factor that into your calculations when figuring out how much contribution room you have remaining. (Unless of course you are doing this on March 1 when the clock rests.)

Some Canadian employers offer a group RRSP which you can contribute to which would be similar to the 401k offered in the states.  Again, if there is a matching program in place in which your employer will match up to a certain percentage or amount, do that or else you’re giving up free money! 

An Individual RRSP is a non-employer sponsored RRSP (aka you can set it up yourself in a brokerage account such as Questrade) and this would be similar to a traditional IRA in the states mentioned above. Similar to the traditional accounts in the states, an RRSP allows you to receive a tax deduction in the year in which you contribute but you will be subject to paying tax later on once you withdraw from your RRSP.  A common misconception is that this is tax free money.  It’s not, the government will get its pound of flesh later.  (But again, if you’re a validation and reduced your expenses, you can end up paying 0 taxes.) Again, the idea here is to contribute when you’re in a higher tax bracket and take it out in retirement when you have less income and you’re in a lower tax bracket.

RRSP Contribution Limits

The contribution for any given year is up until the 60th day of the year which is typically up until March 1 (of the following year).  For example, February 29, 2020 is the deadline for contributing to an RRSP for the 2019 tax year (hello leap year!). If you contribute in January or February, you can declare if you want it to count for that current year (2020, in this example) or for the previous year (2109). The 2019 contribution limit for an RRSP is 18% of earned income you reported on your tax return in the previous year, up to a max of $26,500.  For 2020, the upper limit is $27,230 (plus any carry forward room you have).

If you have a company pension plan, your RRSP contribution limit is reduced by the pension adjustment.  The pension adjustment is calculated by your employer and reported to the CRA on your T4 each year.

Similarly, if your company offers a match to your Group RRSP, your RRSP contribution limit is reduced by the amount your company provided.  

You can contribute to your RRSP up until December 31 of the year you turn 71.  Then you must convert to a Registered Retirement Income Fund (RRIF) or purchase an annuity to avoid having the value of your RRSP fully taxed that year.

Withdrawals of an RRSP can occur at any time but are classified as taxable income, which becomes subject to withholding taxes.  If you withdraw up to $5,000, the withholding tax is 10%; if you withdraw between $5,001 and $15,000, the withholding tax is 20%; and if you withdraw more than $15,000, the withholding tax rises to 30%. However, don’t let this scare you.  Tax withheld at source is not necessarily the amount of tax that is actually payable on your income earned.  Withholding tax is a prepayment of tax only.  Cashflow planning around RRSP withdrawals are important, especially if you owe more than the tax withheld as source on the withdrawal.  If you’re an intentional valuist and can withdraw the Basic Personal Amount from your RRSP and live off of that without bringing in any other source of income, you’ll get a tax refund of the entire amount you withheld upon withdrawal when it comes time to filing your taxes.   Note that once you have withdrawn you will have permanently lost that contribution room in your account.

There is a loop hole to the system.  You can use your RRSP money to buy your first home or head back to school without getting hit with the tax withholding penalty.  Under the federal Home Buyers’ Plan, you can withdraw up to $25,000 from RRSPs without paying tax.  The catch is that you have to repay the full amount within 15 years.  You can also withdraw $20,000 from your RRSPs tax-free to finance your education, though no more than $10,000 in one year.  However, once again, the money has to be repaid.

TFSA

The Tax Free Savings Account (TFSA) is another way to shelter your money from the taxman.  TFSAs are similar to Roth IRAs in the states in that with an RRSP you get a tax break when you contribute and are taxed when you withdraw but with a TFSA the process reverses. There is no tax break upfront but when you withdraw from your TFSA down the road the taxman can’t get his paws on this money.  Investment income, including capital gains and dividends, earned in a TFSA is not taxed in most cases, even when withdrawn. Again, don’t be spooked from the name Tax Free Savings Account and think that a TFSA has to be a cash savings account.  Like an RRSP, a TFSA can contain cash and/or other investments such as individual stocks or bonds, mutual funds, ETFs, index funds, or guaranteed investment certificates (GICs). Don’t freak out, we will dig into these investment vehicles in the next part of this series.

A really nice part of TFSAs is when you retire, the money you take from TFSAs isn’t considered income so it won’t result in claw backs to Old Age Security and the Guaranteed Income Supplement.  The same isn’t true for RRSPs.  This is awesome news as you can “game” the system to deplete your RRSP but have a nice chunk in your TFSA and still qualify for the maximum OAS payment in your later years. (We’re all about gaming life over here.)

TFSA Contribution Limits

TFSAs are not tied to your income.  ANY Canadian resident 18 years and older can save and invest in a TFSA.  Similar to RRSPs, the maximum annual contribution limit has varied over the years and currently the 2019 max is $6,000.  And similarly to RRSPs, any unused contribution room is carried over year over year!  The TFSA was first introduced in 2009 so if you’ve been a Canadian resident and 18 since 2009 and haven’t contributed anything into your TFSA, you currently have a cumulative total of $63,500 contribution room.  And each year you can add more.  That’s nuts!! Get at ‘er! You also can withdraw from your TFSA at any time without incurring a penalty which is another nice perk (more flexible than the Roth IRA in the states where you can withdraw contributions penalty free but not any gains)!

401k or IRA? RRSP or TFSA?

We get this question A LOT!  “I’m new to investing and not sure if we should invest in our 401k/RRSP or IRA/Roth IRA/TFSA?” The simple answer is, just pick one!  Sitting on the sidelines hemming and hawing over what to do is your worst decision out there.  Remember, TIME in the market is your best friend.  But since many people struggle with this, let’s dig in a bit more.

The question ultimately boils down to which registered account will provide you with the most optimized tax situation?

A traditional 401k/IRA in the States and a RRSP in Canada are tax deferral options, whereas if you contribute to a Roth 401k/Roth IRA in the States or TFSA in Canada you are using after tax income.  When it comes time to withdraw from your 401k/IRA/RRSP, the withdrawal will be ADDED to your income in the year in which you are withdrawing funds from these accounts and you will be taxed accordingly.  The exact opposite is true for the Roth 401k/Roth IRA/TFSA since you ALREADY paid taxes. You pay taxes on these upfront and then any money that is withdrawn is done so tax free.

Note that you should be aware that since withdraws from your 401k/IRA/RRSP are considered part of your income once you retire, it could possibly impact any benefits designated specifically to seniors that you would be eligible to receive (I’m looking at you OAS in Canada). For any non-Canadians reading, in Canada we get TWO different payments as we age; the Canada Pension Plan which is like Social Security in the States AND Old Age Security which is purely income based.  Again, be a valuist, keep your expenses low so your income from withdrawals is low, and reap the benefits from OAS.

Additionally, once you turn 71, your RRSP balance will be transferred to a RRIF (Registered Retirement Income Fund) where you are forced to withdraw a percentage of your balance each year.  Similarly in the States, starting April 1 the following year after you’ve reached 70.5, you must withdraw a required minimum distribution (RMD) on all employer sponsored retirement plans (traditional 401k, 403b, 457b, etc) and individual plans (traditional IRA, SEP-IRA, SIMPLE IRA, etc) which were tax deferred.

So, it makes the most sense to contribute in the tax deferral accounts (traditional 401k/IRA/RRSP) if you are in a higher tax bracket now as it will lower your tax burden this year.  If you are not in a high tax bracket, then the Roth 401k/Roth IRA/TFSA makes the most sense to me. But realize the after tax accounts (Roth 401k/Roth IRA/TFSA) have some very nice perks to them too.  Again, back my first piece of advice, just pick one!

Personally, without knowing a thing about you and your finances, my advice is if you’re not going to get much of a tax benefit from the traditional accounts in the States or an RRSP in Canada, I would suggest going the Roth route in the states or the TFSA route in Canada and not have to worry about taxes again in the future and have more flexibility when it comes time to withdrawals.  

Our Game Plan

We are in a unique position in that I (Court) am a dual US/Canadian citizen so all of these benefits don’t necessarily apply to me because I have to file my US taxes every year even though I no longer live in the States (unless I renounce my US citizenship, damn the man!) and Uncle Sam does not treat funds in TFSAs and RRSPs the same as the Canadian tax system.  So our long term plan is to first withdraw from our cash cushion and taxable accounts (in Canada and then the US), withdraw from our RRSP, then tap into funds in my 401k & IRA down the road, and to also max out Nic’s TFSA contribution room each year (since she is only a Canadian citizen, not dual).  

Key Takeaways

• All of the accounts above are simply tax advantaged accounts. What you choose to invest inside of these accounts is up to you!
• If your company offers a 401k/Group RRSP and matches up to a certain percent, you’re leaving money on the table if you don’t contribute at least that much!
• All of the options above are great ways for you to work towards your retirement goals with very little effort.  Since you’re a super smart bad ass saver you should be maxing out your tax deferred retirement accounts!  If you are unable to contribute the max of both tax advantaged accounts offered to you, the decision of how to contribute ultimately comes down to your current income and your projected retirement income. Typical advice would be for higher earners to contribute to your RRSP or traditional accounts and lower earners to contribute to your TFSA or Roth accounts if you could only fund one. However, I see pros to both types of accounts.
• Just because you contribute to an RRSP or traditional 401k or IRA you are not avoiding taxes completely. You are simply deferring when you will have to pay those taxes. The way to maximize these accounts is to put money in when you’re in a higher tax bracket and take it out in retirement when you have less income and you’re in a lower tax bracket.

Hope you enjoyed today’s post! Did you learn anything new? I feel a bit like a parrot repeating myself here but I thought these accounts deserved an entire post for themselves.

Want to check out the rest of the Investing 101 Series?

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest
• Investing 101 – Part 3: Accounts You Can Invest In (US Edition) 
• Investing 101 – Part 4: Accounts You Can Invest In (Canada Edition)

Support This Blog

If you liked this article and want more content like this, please support this blog by sharing it.  Not only does it help spread the FIRE, but it lets me know what content you find beneficial.  Writing is NOT my strong suit and it honestly takes me hours to write each post so the more encouragement the better!  Engaging in the comments below keeps me motivated.  You can also support this blog by subscribing to receive emails anytime a new post is published.  Thank you FImily!

We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.  Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:

• How much are you paying for your phone plan?  Canadians, learn more about Public Mobile, and see how we are paying $3/mo for our cell phone plan.
• How much are you paying for internet?  Canadians, learn more about the various Independent Service Providers out there to see who services your area so you can lower your monthly bills.
• How much are you paying for home insurance?  We were able to reduce our rates by 25% by switching over to Square One Insurance.  If you live in BC, AB, SK, MB, and ON, check out Square One for your home insurance, landlord insurance, and/or tenant insurance.  Use this link to receive an extra $15 off your quote.  (Note that you must use this link to start the process to get the $15 off even if you prefer to pay over the phone.)
• How much are you paying for your monthly utility bills?  See how you can likely save on this monthly expense.

The post Investment 101 – Part 5: Tax Advantaged Accounts appeared first on Modern FImily.

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest
• Investing 101 – Part 3: Accounts You Can Invest In (US Edition) 

O Canada

First off, let’s go over some Canadian slang for any non-Canadians following along so they can feel welcome here (because being nice is what Canadians do).  I sure wish I knew all of these terms before moving up here.  Let’s see how much of the following paragraph you can understand:

Come on, we’re going to be late for Jenny’s stagette! What’s that? There’s a moose on the loose! It’s about three klicks away.  Let’s call CAA, eh?  Oh come on, don’t be such a keener!  Grab your toque from your knapsack, you never know when we’re going to get some snow…this is Canada. Oh no, all I have packed are my thongs.  I heard there’s going to be a chinook coming in soon.  Who knows, we could be stranded out on Hwy 1 if the moose hangs out there.  I’m going to name her Zara (her name starts with zed).  It’s been confirmed, a family of moose have decided to call Hwy 1 home for the night.  Did you bring your lunch kit? I could use a coffee crisp.  Or even better, some KD.  Ah, sorry you should have told me sooner, mine ended up in the garburator. You have any loonies? I’m going to stop off at Timmies real quick and grab a box of Timbits.  I can’t be stranded out here without my double-double. Might as well grab a serviette while I’m here and stop off at the washroom.  The queue is going to be massive. Oh no, my car got stuck in a ditch. Let me put on my runners and push her out.  Give’er! Phew, got her going again… what a beauty.  Might as well head over to the LCBO while we’re at it to pick up a two-four. Actually, I’ll just grab a mickey – we’re keeping it low key tonight. Want to play a game while we wait for the moose to clear the road?  Sure, I don’t have any games with me (they are all under my chesterfield, not in my car) but I have some pencil crayons. Ah those crazy Canucks, eh?!

Any non-Canadians follow along???

Let’s break this down:

• Stagette: The Canadian version of the pre-wedding bachelor/bachelorette party. Stag would be used for males and stagette for females.
• Klicks: Kilometers.  You gotta get to know kilometers in Canada (and any other country besides the US really). Psst, Americans — one kilometer is approximately 0.6 miles!
• CAA: Canadian Automobile Association – it’s just like AAA in the states
• Eh: Pronounced “ay”. This word is the classic term used in everyday Canadian vernacular. It’s used to indicate that you don’t understand something, can’t believe something is true or if you want the person to respond. Similar to “huh”, “right?” and “what?” commonly found in U.S. vocabulary.  Also, if you used “huh?” or “what?” in Canada this would typically come off as being pretty rude as “pardon?” would be what’s used here instead.
• Keener: Used to refer to someone who tries hard to please others or is overly enthusiastic. Similar to “nerd”, “brown-noser” and “geek”.
• Toque: A toque is a knitted hat used to keep your head warm.  Most people in the States would refer to this as a beanie.  Calling it a beanie in Canada is a big no-no and a definite sign you are just visiting.  I’m pretty sure this word is only used in Canada – does any other country use this word??
• Kanpsack: What Canadians commonly refer to a backpack or rucksack as.
• Thongs: Sandals/Flip-flops people!
• Chinook: A warm wind that comes over the mountains in the dead of winter and instantly melts the snow and raises the temperature.  It’s an Inuit word for “the snow that melts”.  Chinooks are commonly talked about in Alberta (where we get these warm winds from the Canadian Rockies).  And yes, it’s true, we can get 2-3 inches one day and the next day its gone (we don’t typically get the days of 6+ inches of snow which is more common in the east).
• Zed: The letter “z” in the alphabet is pronounced as “zed” in Canada, not “zee”.
• Lunch Kit: A lunch box.
• Coffee Crisp: A Canadian chocolate bar consisting of alternating layers of vanilla wafer and coffee flavored soft candy.  There are TONS of different chocolate bars in Canada vs the States.  I’m not a huge chocolate person but some of them are Smarties, Aero bars, Eat More bars, Crunchie, Crispy Crunch, Mirage, Caramilk, etc.
• KD: Kraft Dinner.  It is NOT referred to as mac and cheese here.
• Garburator: This one gave me a chuckle when I first learned about it.  It’s the Canadian term used for a garbage disposal.  
• Loonie: The silliest word for currency on the planet, next to toonie.  A loonie is a one-dollar coin and a toonie is a two-dollar coin in Canada. Makes total sense for a country to come up with that name once they went from a one dollar bill to a one dollar coin, right?  No.  You have to look at a loonie for yourself and it will make more sense.  It has a picture of a Loon on it.  Ahhh.
• Timmies: Tim Hortons.  It’s the Starbucks of Canada.  You will find a Timmies in EVERY Canadian town.  Like Starbucks, it’s mediocre coffee that Canadians are mysteriously addicted to.
• Timbits: Donut holes from Timmies.  My fav is apple fritter.  Timbits are also little kids sports teams that Tim Hortons sponsors. 
• Double-Double: The standard coffee order by Canadians at Tims.  Two (double) sugar and two (double) cream.
• Serviette: A napkin.
• Washroom: What Canadian’s refer to the toilet as.  To Canadians, toilet seems a bit too vulgar.  And I agree, I like using the word washroom or restroom more.  Is washroom used outside of Canada anywhere? I know toilet and bathroom are common in the states and have heard of the loo and water closet/WC in Europe. 
• Queue: A line up.  If you’re at the grocery store, you’d say “look at the queue at that till”. Oh yea, that’s another one.  Till is the cash register.  
• Runners: Sneakers.  They are not called sneakers in Canada.  Another fun clothing one is Bunny Hug.  This is mostly used in Saskatchewan and is what others would refer to as a “hoodie”.
• Give’er: A slang term that means to give it all you got. Used when referring to work, drinking, sports and any other activity that requires you to buckle down and get it done.
• LCBO: Liquor Control Board Of. A Crown corporation that retails and distributes alcoholic beverages throughout the Canadian provinces.  The LCBO maintains a “quasi-monopoly” on alcoholic beverage sales in Ontario—Canada’s most populous province with over 13 million people, or almost 40% of the nation’s population—and as a result is one of the world’s largest purchasers of alcoholic beverages. Note that you cannot buy alcohol in grocery stores in Canada – it must be purchased at a designated liquor store (called a Liquor Board Store in some provinces).
• Two-four: A twenty four pack of beer.  (And beer is VERY expensive in Canada compared to the States (like double the price, no joke) thanks to the Canadian Sin Tax, which I’m personally in favor of.)
• Mickey: A 375 ml bottle of alcohol (like a flask size). 
• Chesterfield: A couch/sofa. Pretty sure this is British that stuck in Canada?
• Pencil Crayons: Colored pencils, love it  

Also, let’s remember that it’s spelled “cheque” not “check”, “colour” not “color”, “behaviour” not “behavior”, “cancelled” not “canceled”, “tonne” not “ton”, “neighbour” not “neighbor”, and “centre” not “center”.  There are MANY other words that Canadians use the British spelling for (I clearly am still using the US dictionary on this blog). Canadians do NOT “take” a shower or a nap, they “have” a shower or nap. They “phone” someone, not “call” someone.  They pronounce “process” like PRO-ciss.  Pasta is pronounced “past-a” whereas in the US it’s pronounced more like “pah-stah”. Same goes for drama. It’s grade seven, not seventh grade. College and university are not the same thing in Canada whereas both words typically refer to the same thing in the States. Also Toronto sounds more like “tronno” to Canadians.  Same thing for Calgary.  Outside of Canada, people would pronounce this “Cal-GAry” but Canadians mash it all up and say “Cal-gree”.

Phew, ok. Everyone reading this is now Canadian. Send me your address and I’ll mail you your citizenship papers (because it is much sweeter to retire early here than in the States in my opinion, thank you Canadian social system where we will get free healthcare, Canada child benefit, CPP and OAS and GIS come typical retirement age). On to the good stuff (or maybe that was the good stuff….).

Moving On

Similar to Part 3 of the Investing 101 Series, you can keep your cash in dollars under the mattress (no thanks), open a checking or savings account with a big bank or online-only low fee bank (would recommend only to have enough in a checking account to cover your expenses for a 3-6 months), or open a high interest savings account (this is where I would hold money that I’m looking to access within 5 years – for example a new house down payment). As mentioned last week, we use Motive Super Savvy Saver which is a Canadian online-only bank and we’re earning 2.8% returns. And we can withdraw from these funds at anytime if we want/need the cash. This is WAY better than the 0.05% interest rate TD Bank offers for their TD Every Day Savings Account or whoop-di-do 0.5% interest in their TD High Interest Savings Account. Give me a break. Break free from the big banks!

But what comes next?

The following are other Canadian specific types of accounts that you can choose to open up if you so desire:

• TFSA
• RRSP
• Group RRSP
• Spousal RRSP
• RESP
• GIC
• Brokerage (aka Non Registered aka Taxable)

Again these are just the accounts. The type of funds that you can invest within these accounts will get covered in another post. Let’s dig in.

TFSA

A TFSA stands for a Tax Free Savings Account. Don’t let the words “Savings Account” at the end make you think this is like a savings account that you open up at a big bank like the TD example above to save cash which earns a measly 0.05% interest. The name for the TFSA is actually really bad and misleading. And online marketing doesn’t help. You don’t have to put your money in a savings account within a tax free savings account. And frankly, you shouldn’t be. You can earn a MUCH higher return if you instead invested elsewhere in other funds.

You can select ANY sort of funds to invest in a TFSA – be it stocks, bonds, ETFs, mutual funds, index funds, REITs, GICs, cash, etc. all under the TFSA umbrella. These investments will grow tax free until you take them out. The contribution amounts have varied each year since its inception in 2009 (see table below). If you are a Canadian resident and have been residing in Canada since the TFSA inception in 2009, you are entitled to the lifetime contributions for every year after you turned 18. This means, if you turned 18 in 2009 (or were older than 18 by then) and you have not opened up a TFSA yet, you have the FULL $63,500 of contribution room available to you in your TFSA.  And come 2020, your contribution limit will increase even more. (To know your limit, check the CRA website – it’s actually really easy to use as your login is based off your ID/Password from a major Canadian institution (like a bank) that you already have signed up – just keep in mind the CRA website does NOT account for any contributions that you have made in this current year.) The table below summarizes the annual contribution limits since the TFSA’s inception.

Again, ANY unused contribution room under the cap can be carried forward to subsequent years, without any upward limit. I cannot stress how amazing this is. If you have room in your TFSA (or RRSP) this where where you should be focusing your investments – not a taxable brokerage account (more on that below) where you do not receive any sort of tax advantage.

Within a TFSA, you will not pay taxes on any interest, dividends, or capital gains your money earns within the account. Canada gets a bad rap to it’s neighbors down south due to it’s high taxes but hey see Canada provides some tax relief to it’s citizens too! And I’d argue that the TFSA in Canada is much better than the Roth IRA in the States due to the unused contribution room rolling over year after year. There are NO penalties to withdraw and you can withdraw from it at any time.  This can be great for early retirees (woohoo!) but if you are not planning to retire anytime soon, you should be maximizing this power tool and not be withdrawing from it! Let the power of tax free compounding work in your favor! There is no maximum age limit or income requirement to be able to contribute to a TFSA.  It also is not tied to your income at all. Every single Canadian resident over 18 can open a TFSA today. (Since I am a dual US/CAN citizen, unfortunately Uncle Sam down in the States doesn’t view the TFSA as a tax-advantaged retirement account and thus I do not have a TFSA open as it can create a lot of headaches and paperwork.  Instead, we have Nic’s TFSA open (as she is solely a Canadian citizen) and will have that maxed out once we reach our FIRE date.)

The next question we frequently hear is, “where do you open a TFSA (or any account for that matter)?”.  The simple answer is any financial institution that offers one.  We have Nic’s TFSA opened up with our favorite online low-fee brokerage Questrade.

So what’s the downside? If you over contribute, you will have to pay some taxes and fees for your over contribution.

RRSP

A RRSP stands for a Registered Retirement Savings Plan and it’s a great companion to the TFSA. And like the TFSA, every Canadian should have a RRSP because again, tax savings.

Like a TFSA, an RRSP does NOT have to be a savings account with a big bank. And I’d suggest you looking at an online low-fee brokerage, again like Questrade, instead of a larger financial institution for ALL of your investment accounts. Just like a TFSA, you can hold any kind of investment within the RRSP umbrella. In a RRSP, your money is not tax free but it is tax deferred (similar for a traditional account in the States). This means that you do not pay income taxes on the money that you contribute towards an RRSP in the year you contributed it. But you will pay taxes on the income when you withdraw it depending on your income level and tax bracket at the time of withdrawal.

Unlike the TFSA, there is no minimum age requirement to open a RRSP. This means if you are 14 working part time at Timmies, you can (and should) open an RRSP today. You can contribute up to 18% of your gross income to your RRSP each year (max of $26,500 for 2019). If you can’t afford to contribute 18% of your income in a given year that’s ok, like the TFSA, you can carry any unused contribution room forward to future years when you can play catch up. These carry forward perks are so golden, especially to a dual US/CAD citizen like me who did not have such perks while living in the States. Morale of the story, take advantage of your contribution room within both your TFSA and RRSP!

TFSA or RRSP?

It’s hard to say how beneficial an RRSP is to you compared to a TFSA as it depends on your income this year compared to your expected income in retirement. Hopefully you’re a FIRE badass (you are reading this blog so I assume so!) and have a 50+% savings rate and are earning more now than you plan to spend come retirement (same idea applies even if you are saving 5% of your income, not 50%). If you expect your income in retirement to be lower than your current income, it makes sense to contribute into your RRSP to reap the tax benefits today while you are in a higher tax bracket. Pro tip – you can contribute to your RRSP and then when you file taxes and get a refund you can throw that refund money into your TFSA. Double whammy!

However, a TFSA really is an incredible account as your withdrawals as not considered income which is huge when you’re trying to optimize taxes come time to receive CPP, OAS, GIS, and/or a pension later in life.  You also are not subject to whatever tax changes occur over the years.

My greatest advice on this topic of TFSA vs RRSP (or 401k vs IRA vs Roth IRA) is to just choose one!  If you are just starting out, there really is no wrong answer.  The wrong answer is hemming and hawing and staying on the sidelines and not starting your investment journey NOW.  Again, compounding interest is the 8th wonder of the world and you don’t want to be missing out on that.  Pick a tax advantaged account, and go for it.  As you get more and more comfortable over time, you can work on your strategy.  Knowing nothing about you and your set up, I’d say start with a TFSA but again it really depends on your set up as to which really is the best.

This YouTube video provides a simple explanation of differences between an RRSP and a TFSA. As mentioned in our Investing 101 – Part 3 post, we will be going into more detail on these tax advantaged US and Canadian accounts so stay tuned for our Investing 101 Part 5 post on that. I do want to dig a little further here and talk about Group RRSPs and Spousal RRSPs on this post.

Group RRSP

A group RRSP is a company-sponsored plan that an employer offers to all eligible employees (not all Canadian companies offer a Group RRSP). A group RRSP is similar to an individual RRSP except it is administered on a group basis by the employer. This means that you likely have a select list of funds to invest in rather than selecting ANY investment of your choice. (And these select funds likely come with a higher fee than if you opened up an individual RRSP with a low fee brokerage.) Contributions are made by pay-roll deduction, on a pre-tax basis, through a Group RRSP administrator. If your employer offers a company match to a Group RRSP and you are not contributing up to the match, you are giving away FREE money. This is very similar to the 401k company match we discussed in the US edition of this Investing 101 Series.

If you leave your employer, you can transfer the money within your group RRSP into an individual RRSP in your name (no tax consequences for such a transfer – again, we recommend opening a DIY brokerage like Questrade for their low fees) or if there is no locked-in requirements, you can withdraw the money as cash. If you do withdraw from your Group RRSP to cash, it will be taxed as income in the year you receive it and the tax owed will be based off your income tax bracket. Again, this is because an RRSP is a deferred account, not a tax-free account. So instead of doing this, we would recommend rolling it over into an individual RRSP until you retire and are in a lower tax bracket.  

Note that if your company offers a Group RRSP but it does not include a company match, I would opt to open an individual RRSP in Questrade instead where you are able to access more funds and likely at a lower fee.  If you do receive a company match but the fund options aren’t great, you can also contribute into the Group RRSP, get the match, then roll those funds over to your Individual RRSP where you’ll have access to more options and lower fees while still employed with that employer.

Spousal RRSP

A spousal RRSP is a great way for couples to split retirement income, especially if their income is quite different from each other. Just like any other RRSP mentioned above, the money you put into a Spousal RRSP is allowed to grow tax deferred, meaning you do not pay income tax on it until you take it out of the plan. The main advantage is that it can even the playing field of your RRSP account with your partner so that when you withdraw (and pay taxes) you can each withdraw as close to the same amount in a given year to keep your individual tax brackets lower than if just one individual was withdrawing the full amount. Put another way, should one person have a lot of money in their RRSP and the other has less then that amount come retirement, the person with more in the RRSP (and withdrawing more) will end up paying more income tax. Had each person evened out their contributions, they could have potentially paid less income tax in retirement by being in a lower tax bracket overall.

That may be a little confusing so let’s look at an example:

Say you earn $100,000 and your partner earns $50,000. As mentioned above, individual RRSP limits are 18% of your income from the prior year’s taxes, up to a maximum dollar amount that changes annually (for 2019 it $26,500). If you both had RRSPs to which only the owner could contribute, the person earning $100,000 could put in $18,000 into their individual RRSP (18% of their income) while the spouse earning $50,000 could contribute the same 18% of their income, which comes out to $9,000 into their individual RRSP. When you open a Spousal RRSP you can even the playing field out a bit. The person earning more money can contribute $13,500 to their own individual RRSP and $4,500 into their partner’s Spousal RRSP (still the total of $18,000 which they are allowed – note that you still must remain within the overall RRSP contribution limits for the year – meaning you cannot contribute 18% of your income into your individual RRSP PLUS another 18% into your Spousal RRSP!). The lower income partner would continue to contribute their full 18% limit of $9,000 into their individual RRSP. So now they both have $13,500 growing within their RRSPs. The higher income partner can still take the total $18,000 deduction on their income tax for the year and the other spouse will take the deduction on the $9,000 that they contributed. The difference is that both partners have the same amount in their name when it comes time to withdrawing in the future. How this works logistically is that the lower income earner would open the Spousal RRSP and the higher income earner would be the one claiming the contributions on their side when it comes to filing taxes.

Without this Spousal RRSP magic, the higher earning partner would have say $1 million in savings within their RRSP and the lower income partner would have say $500,000. If both individuals were withdrawing 4% from their respective RRSPs each year to fund their retirement this means the higher earner would be withdrawing $40,000/year whereas the lower earner would be withdrawing $20,000/year. The $40,000 withdrawals would be subject to a higher tax bracket than the $20,000 annual withdrawals. By opening a Spousal RRSP, you can even things out a bit in hopes that each partner has closer to $750,000 come retirement in their RRSPs and are withdrawing $30,000/year each which would bump up the tax bracket for the lower income earner but lower the net overall taxes for the couple as the higher income earner pays less taxes.

There’s another nice thing about Spousal RRSPs. They aren’t just for retirement. Say one person decides to go back to school or become a stay at home parent or retire early before their spouse decides to pull the plug. If you contributed to your Spousal RRSP in advance, the partner who is no longer working can now withdraw from their RRSP while unemployed and pay very little taxes on it. Thanks to the Federal Basic Personal Amount, an individual can pay $0 taxes if only earning $12,069 or less in 2019 (although it sounds like the Federal Basic Personal Amount is going to get bumped up to $15,000 after the recent election results– woo hoo this is great news for us!). Similarly, provinces have their own Basic Personal Amounts and Alberta (where we live) offers the highest personal amount of $19,369 in 2019.

And you better believe that this is part of our FIRE plans! We have a Spousal RRSP set up currently since I am still working part time but my wife is no longer bringing in an income. I can withdraw $12,000 from my accounts and my wife can withdraw $12,000 from her accounts and we can pay $0 in taxes for the year. (Also, any withdrawals from our TFSAs don’t count as we already paid our fair share of taxes in the past on the money in these accounts so we can combo withdrawals from our TFSA with our RRSP/taxable accounts to get us to our annual expenditure without paying taxes since we keep our annual expenses low!  Although we are not planning to do this, instead we plan to use our TFSA to optimize our OAS and GIS withdrawals thanks to the 8 year GIS strategy we learned about from Ed Rempel). For any Albertans following along, you can play around with this fun Alberta Personal Income Tax Calculator to estimate your taxes or any Canadian can also play around with this Canada Simple Tax Calculator. If using the Alberta Personal Income Tax Calculator, we selected Spouse 1 = $15,000, Spouse 2=$10,000 and children=2 (we are only planning to withdraw $25,000/year even though we will be spending $35,000 annually in retirement as we will also be receiving ~$12,000 in tax-free money thanks to the Canadian Child Tax Benefit). You can see on the screen shot below the bottom left shows that we will each owe $0 in federal taxes and on the bottom right shows that we will each owe $0 in provincial taxes.

OK I went off on a tangent here (sorry not sorry) and can write an entire post just on our tax strategy so I’ll reign things back a bit here and move on Point is, Spousal RRSP can help even the playing field come withdraw time for tax purposes.

RESP

An RESP stands for a Registered Education Savings Account and it’s an investment vehicle offered to Canadian parents/caregivers to save for their child’s future post-secondary education. Like the TFSA and RRSP, the RESP is a tax sheltered account to help your wealth grow.

The MAJOR UNICORN AMAZING FEATURE of the RESP is the incentive offered by the Canadian government to encourage you to open and save/invest in a RESP. The main one is called the Canada Education Savings Grant (CESG) which MATCHES 20% OF YOUR CONTRIBUTIONS UP TO A MAXIMUM TOTAL OF $500 EXTRA YEAR. This means that if you put $2,500/year (or $208/month) into your child’s RESP (what we are doing) the government will give you an automatic $500 top up meaning you will AUTOMATICALLY SEE A 20% RETURN ON YOUR INVESTMENT. (You are welcome to contribute more, but the 20% grant is only matched by the government up to $2,500 of your contributions per year.) The lifetime maximum of the CESG grant is $7,200… again, this is FREE MONEY. If the caps and bold weren’t enough I’ll highlight it again, this is AMAZING! Where else can you see an automatic 20% return?!?!

You can contribute a lifetime maximum of $50,000 per beneficiary to an RESP but it can grow to much more than that if invested wisely. Again, like a TFSA or RRSP, you do not need to keep an RESP in a savings account earning very low interest. You can open an RESP with a low fee brokerage like Questrade and buy mutual funds, ETFs, index funds, individual stocks, individual bonds, etc. Because your child will not be tapping into this account until they have completed high school (or later), there is a lot of time for this investment to compound and grow. For example if you are contributing $2,500/year for 17 years and the government is contributing $500/year (up to $7,200 – meaning $500/year for 14 years and then $200 in year 15) and you are investing that money in a stock market index fund earning 7% annually, your child will have close to $100,000 towards their post-secondary education ($42,500 came from you the other half came from the government and compound interest).

We understand that post-secondary education is continuing to rise but this account should be able to account for your child’s education costs in Canada. And if not, it will SIGNIFICANTLY help them none the less. Even if you cannot invest the max, every dollar helps. Set aside $50/paycheck and you’ll still earn that 20% government match. When it comes to paying for post-secondary education, everything you can contribute to your child’s education saves them from having to take out student loans and take out debt.

If your child decides not to go to university after high school, don’t give up on them yet. An RESP can stay open for 36 years. This means if your 18 year old decides they do not want to go to university now, they may change their minds when they turn 22 or heck even until 30 and can make use of the funds within the RESP then (ad it’s likely the account be worth more too again thanks to compounding interest). An RESP can also be used for part time education programs or trade schools (more on why I’m pro trade schools later). Also, an RESP can be transferred to a sibling as long they have contribution room. Lastly, if none of the above apply, you can withdraw your contributions tax free (since it was contributed with after tax dollars) and the gains can be transfer to your RRSP tax free as long as you have contribution room.  You’ll lose the government matches but that is because the money was intended to go to education and it never did. 

God I love RESPs, can you tell?  I was honored to be featured as a guest host on the Explore FI Canada podcast where we broke down way more information on RESPs over two podcast episodes.  

• Explore FI Canada Episode 32: All About RESPs (Part 1) | Money in Your Tea and Modern FImily
• Explore FI Canada Episode 33: All About RESPs (Part 2) | Money in Your Tea and Modern FImily

GIC

Similar to a CD (Certificate of Deposit) in the States, a GIC is a Guaranteed Investment Certificate, and yet another type of Canadian investment account that offers a guaranteed rate of return over a fixed period of time. Due to its low risk profile, the return is generally less than other investments such as stocks, bonds, or mutual funds. Typically these investment accounts are invest “$xx” for “yy” months and received “zz” interest rate. In most cases, funds invested in GICs are locked in, meaning the investor can’t access the deposited money until the term is complete. Funds removed prematurely are subject to an early withdrawal penalty aka a GIC is NOT to be viewed as an emergency fund as you cannot access these funds easily if an emergency comes up. 

I’m not a huge fan of GICs and would prefer to invest in high interest savings accounts (mentioned above) which tend to offer very similar interest rates these days and do not lock up your money for a certain amount of time. A quick google search shows that some of the best GICs offered today are in the upper 2% range. Call me cray, but I would rather be earning 2.8% in my Motive Savvy Saver High Interest Savings Account where I can access/withdraw funds whenever I want. If GICs suddenly start to offer 2 times the interest that high interest savings account offer, that’s another story. But if the interest rates are similar, I’m team high interest savings account all day.

Brokerage/Non-Registered

Lastly, we have the taxable non-registered brokerage account. This is the account you want to open up last once you’ve maxed out all of your tax advantaged accounts listed above. A brokerage account is another type of investment account that you open up with a brokerage firm – be it a big bank like TD or RBC or CBIC or an online-only brokerage like Questrade, Qtrade, Wealthsimple, Interactive Brokers, etc. – again…we are team Questrade for our taxable account. Again, do your own research but know that not all brokerage accounts are equal.  Some charge higher fees to both buy and sell funds within your accounts while others only charge a fee to sell (and if you’re investing for the LONG term this should be very minimal).  Some charge higher Management Expense Ratios (MERs) than others for very similar funds and while a 1% additional management fee may not sound like much, IT IS when it comes to long term compounding earning potential – for those too lazy to read this article by Nerd Wallet, see the table below for the Cole Notes (Canada)/Cliff Notes (US) version. Again, I’m going off on a tangent and this is for a whole other post.

A brokerage account enables you to buy stocks, bonds, ETFs, etc. with money you deposit into your account. Within Questrade we have our tax-advantaged accounts (TFSA, RRSP, and RESP) as well as our taxable brokerage account. Some other brokerage account options are managed brokerage accounts with investment management, either from a human investment advisor or a robo advisor (again, see the table above why I personally am not a fan of these but I understand the lure of robo advisors for some people who want a completely hands off approach).

Many brokers allow you to open an account online. You can fund the brokerage account by transferring money from your checking or savings account. You can also roll over funds from one brokerage account to another if you decide to change brokerage firms. We did this when we transferred our RESP from TD to Questrade (thanks Questrade for paying for the transfer fees!) and when we transferred my Group RRSP from Great West to an Individual RRSP in Questrade when I recently left my previous employer (goodbye 1.65% MER fees, holy!). In a taxable account, the main benefit is that you can sell the investments and withdraw your money at any time (no fees/penalties for withdrawing is one of the perks) but since it is a taxable account you will have to pay capital gains on the earned interest (although in Canada you only pay taxes on 50% of the capital gains earned which is another nice perk for Canadian investors.  And then there are eligible Canadian dividend stocks that have even more perks but we prefer to stick with index investing).

Nervous About Investing?

I get it. You’re putting your hard earned cash into the hands of a market that can go up, down, or stay flat and there’s nothing you can do to control it (other than identifying your risk tolerance). However, given a long time horizon, money in the stock market can grow tenfold, compared to cash under your mattress or sitting in a low interest checking or savings account. We are going to continue to chip about at the Investing 101 Series to hopefully make you more comfortable with the idea of investing. The reality is, when you’re investing for a long term goal like retirement, not investing is actually what’s risky. How can you keep up with inflation which makes your cash less valuable year over year?

My general rule for investing is if you need to access this money within 5 years (say for a house down payment you’re saving up for), I would stick with a high interest savings account. If you are looking to invest for the long term, I would invest in a tax-advantaged account and then once that is maxed then a taxable brokerage account.

While everyone should have some emergency cash on hand (we suggest at least 6 months of living expenses in either a checking, savings, or high interest savings account), anyone who keeps excess cash is doing so at a cost.

Hope you enjoyed today’s post and learned something (even if it was just Canadian slang!). Stay tuned for Part 5 of the Investing 101 Series where we will dig further into the different tax advantaged accounts both in the US (401k and IRA) and in Canada (TFSA and RRSP).  Any Canadians tuning in that noticed I may have missed something? If so, please let me know, we’re always trying to learn over here!

Want to check out the rest of the Investing 101 Series?

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest
• Investing 101 – Part 3: Accounts You Can Invest In (US Edition) 

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If you liked this article and want more content like this, please support this blog by sharing it.  Not only does it help spread the FIRE, but it lets me know what content you find beneficial.  Writing is NOT my strong suit and it honestly takes me hours to write each post so the more encouragement the better!  Engaging in the comments below keeps me motivated.  You can also support this blog by subscribing to receive emails anytime a new post is published.  Thank you FImily!

We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.  Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:

• How much are you paying for your phone plan?  Canadians, learn more about Public Mobile, and see how we are paying $3/mo for our cell phone plan.
• How much are you paying for internet?  Canadians, learn more about the various Independent Service Providers out there to see who services your area so you can lower your monthly bills.
• How much are you paying for home insurance?  We were able to reduce our rates by 25% by switching over to Square One Insurance.  If you live in BC, AB, SK, MB, and ON, check out Square One for your home insurance, landlord insurance, and/or tenant insurance.  Use this link to receive an extra $15 off your quote.  (Note that you must use this link to start the process to get the $15 off even if you prefer to pay over the phone.)
• How much are you paying for your monthly utility bills?  See how you can likely save on this monthly expense.

The post Investing 101 – Part 4: Accounts You Can Invest In (Canada Edition) appeared first on Modern FImily.

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest

When it comes to investing, it’s important to note that you’ll need to decide on two things:

1. What type of investment account to open up
2. What funds to fill that account with

That’s really it.

It sounds simple, and really, it is.  Yet because we aren’t taught what to do and there are SO many accounts and WAY MORE funds to choose from, investing can seem intimidating to most people.  Today’s post will focus on the various types of ACCOUNTS you can choose to invest your money in.  Another post will be entirely focused on what FUNDS you can fill these account up with.

Dolla Dolla Bills Y’all

Most people reading this likely have some cash on hand either in their wallet or in a special drawer at their home. There comes a point though when you don’t want to have all this cash on hand from your pay check. So where do you store it?

Enter in the Big Banks

Most people open up a checking and sometimes a savings account with their local big bank of their choosing (eg. Bank of America, Chase, Wells Fargo, etc. in the States or TD, RBC, BMO, Scotiabank, CBIC etc. in Canada). Most of these banks offer direct deposit where your pay check can get automatically funded from your employer into your bank account to save you an extra step of having to deposit the check yourself.

Great, grand. This is nothing new to most people reading this.

But what happens when you are able to grow that gap of your income and your expenses (because you are subscribed to blogs like this to learn how to be a valuist badass) and you see that checking account starting to grow?

First off, pat yourself on the back for not having a negative balance!

Secondly, pay off any debts you may have that have an interest rate higher than 6%. Most mortgages these days have interest rates closer to 3% so no need to kill this off ASAP unless you’re very debt adverse like us. But if you have consumer credit card debt or high interest rates on any student loans I’d suggest tackling those first before trying to become a millionaire in the stock market. Note: if your company offers any sort of company match (be it in a 401k for Americans or Group RRSP for Canadians) make sure you’re investing in that match or else you’re giving away free money!

Third, have a sufficient emergency fund stashed up. My personal suggestion is to have at least 6 months of your current expenses stocked away in a high interest savings account. A savings account with your local branch big bank is not the same as an online high interest savings account. Most big banks offer savings accounts, but have you ever actually looked to see what interest rate they are providing you?

Let’s take a look at two big banks, TD Bank from Canada and Bank of America from the States.

Here is the table for the list of interest rates TD is offering for their savings accounts:

And below is a similar list of interest rates offered by Bank of America for their savings accounts:

Guys, these interest rates are TERRIBLE! The whopping 0.05% interest rate at TD means that for every $1,000 in that account, you will make $5. Five freaking dollars are you kidding me?! Bank of America is no better giving 0.03-0.06% (aka $3-6 for every $1,000) depending on the account.

These banks are taking your money and lending it out to others at 5-20% interest (depending on the product) and then you get a measly 0.05% return for choosing them as your savings account. No wonder why banks have a solid earnings reputation, they literally are making money off of every customer they have! (On a side note, I do understand why investing in individual bank stocks as part of the Canadian dividend tax credit makes sense. These suckers aren’t going anywhere. Although I do hope more and more online-only low fee banks continue to make headway.)

High Interest Savings Accounts

Instead of keeping your emergency fund with a big bank where you can’t even keep up with inflation, I’d suggest Googling “best high interest savings account” and doing some research for your country to see who is offering the best rate (these banks are always trying to one-up each other so the best rate/bank today will be different tomorrow. Ratehub tends to be a good site to compare different rates but look elsewhere too to ensure you’re not missing anything. Beware of ads and sponsored posts/links that may be bumped up to the top of the list but aren’t really that stellar. Personally, we have our Canadian high interest savings account opened with Motive in their Savvy Saver account which we earn 2.8% interest. (No, we are not getting paid by them. Let’s make this clear upfront. We have no financial motive to anything here. We are simply trying to show you what’s out there. Do your own research!)

A lot of these smaller, online-only, banks are able to provide a much higher interest rate because 1.) they don’t have as much overhead having to staff physical locations and 2.) they don’t have to pay rent for any physical locations. Motive’s 2.8% interest is literally 56 times the amount of interest that TD’s 0.05% provides. That means for every $1 you have in your Motive account, you would need $56 in your TD account to see the same return.

I know the next question you’re probably thinking is, “are these banks safe?”

Typically, the answer is yes. Again, do your research.

If the institution is a member of the Canada Deposit Insurance Corporation (CDIC), then your funds are insured up to $100,000 per customer if the bank should go bankrupt. Similarly in the States, you want to ensure these banks are a member of the FDIC (Federal Deposit Insurance Corporation) which ensures up to $250,000 per person if there is a bank failure.

So not only do these online-only banks offer the best interest rates, but they are safe and reliable and typically offer low to no additional fees or requirements.  Many of them allow you to deposit and withdraw a substantial (if not unlimited) amount per month for no extra fee. 

What’s Next?

Ok now comes the fun part. You now have sufficient savings in check to account for an emergency fund or to save for a deposit for an down payment for a home, etc.

What is the next step?

Now it’s time to dip your toes into the market.

Every person is going to be in a different situation and have a different risk profile so unfortunately there is no one size fits all as to what type of account to open up and what to fill it up with.

Here are a list of different accounts you can choose to open up:

US Accounts:

• Traditional 401k
• Roth 401k
• Traditional IRA
• Roth IRA
• Spousal IRA
• HSA
• 529 Plans
• CDs
• Brokerage

Canadian Accounts:

• TFSA
• RRSP
• Group RRSP
• Spousal RRSP
• RESP
• GIC
• Brokerage

Part 5 of the Investing 101 Series will solely be focused on the tax advantaged accounts so we won’t go into too much detail on those types of accounts on this weeks post.  Stay tuned for that – it’s a LONG post and digs into both the US and Canadian tax advantaged accounts (traditional and Roth 401ks and IRAs in the States and TFSAs and RRSPs in Canada). Today’s post will focus on the US accounts and touch on the general definitions of these different accounts. Part 4 of the Investing 101 Series will be a similar post as today but focused on the Canadian accounts.

Let’s dig in.

US Accounts

Traditional 401k

A traditional 401k is an employer-sponsored plan that gives employees a choice of investment options.  Note that the number of investment choices varies depending on what plan your employer is enrolled in (and it is likely limited).  Employee contributions to a 401k plan and any earnings from the investments are tax-deferred.  This does NOT mean tax free. This means that you will get a tax break this year but then you WILL pay taxes on your contributions and earnings when the savings within the account are withdrawn down the road depending on your tax bracket at the time of withdrawal. Depending on your employer, instead of enrolling in a 401k you may instead have the option of a 403b or a 457b or a 457f.   A 401k is offered to employees who work for at a for-profit company.  A 403b plan is typically offered to nonprofit employees and government workers, including public school employees.  A 457b is offered to state and local government employees. A 457f is for highly paid non-profit employees.

Roth 401k

A Roth 401k is similar to a traditional 401k in the sense that it is an employer-sponsored investment savings account however the main DIFFERENCE is that a Roth is funded with after-tax dollars up to the plan’s contribution limit. This type of investment account is well-suited for people who think they will be in a higher tax bracket in retirement than they are now, as withdrawals are tax free. No one really knows what the tax code will be in the future so it’s a bit of a gamble deciding which 401k account to invest in (traditional vs Roth – if you employer even offers both that is) but most people tend to fall in a lower tax bracket in retirement when they are withdrawing from these accounts (meaning they are living off a lower income in retirement vs their current income today, assuming no changes to the tax structure). However, if you don’t want to deal with taxes down the road whatsoever (many could speculate that taxes will be higher in the future but who knows), go with Roth to get the taxes paid upfront and to be done with it. Not all employers offer a Roth 401k, it’s much more standard to have a traditional 401k offered by your employer.

Traditional IRA

A traditional IRA is a type of individual retirement account that lets your earnings grow tax-deferred (similar to a traditional 401k). An IRA is not linked to your employer in any sense but in order to contribute into an IRA you must have earned income in order to contribute. You pay taxes on your investment gains only when you make withdrawals in retirement. There is no age tied to an IRA so technically if your child is employed and earning income, you can set up an IRA for them. And IRA is more flexible in that you can open an IRA account up yourself with any brokerage you chose and can invest in any fund that you choose (whereas the 401k tied to your employer typically has more limited options to chose from).

Roth IRA

A Roth IRA is another tax advantaged savings account. Like the Roth 401k, Roth IRAs are funded with after-tax dollars meaning that the contributions are not tax-deductible for the tax year in which you contribute. But once you start withdrawing funds, the money is tax-free. Like Roth 401ks, Roth IRAs are best when you think your taxes will be higher in retirement than they are right now. Like traditional IRAs, a Roth IRA is not tied to an employer, anyone with earned income can open up a Roth IRA in their own. 

This is a great account for kids/teenagers to open up as their income is likely high very high during these years so they can invest after tax dollars (likely paying $0 income tax for a part time side gig) and have the money grow tax free and pay no taxes when it comes time to withdrawal.

However, there are income limitations so not everyone is eligible to contribute into a Roth IRA.  You must earn less than $122,000 as a single filer or less than $193,000 as a couple to qualify for a Roth IRA.

(Note that there is a completely legal workaround to fund a Roth IRA if you exceed the income threshold – this is called a Backdoor Roth. Essentially the process is that you contribute into your traditional (tax-deferred) IRA, convert the account to a Roth IRA, pay taxes on the amount converted, and file an 8606 tax form. If you already have money saved in a traditional IRA the Backdoor can be a little bit more tricky. Please seek financial advice from a professional for more information.)

Spousal IRA

A spousal IRA is a strategy that allows a working spouse to contribute to an IRA in the name of a non-working spouse to circumvent income requirements. This creates an exception to the provision that an individual must have earned income to contribute to an IRA.

Again, we will dig much further into these tax-advantaged accounts in Part 5 of the series but the key takeaways are:

Traditional vs Roth: Traditional is pre-tax money so you’ll get the tax benefit this year when you file your taxes but owe taxes when you withdraw. Roth is after tax money so you pay taxes on the money now and see the tax benefit down the road when you withdraw from these accounts tax free.

401k vs IRA: 401k is part of an employee plan whereas anyone with earned income can contribute to an IRA on their own.

You can invest in BOTH a 401k and IRA (and we suggest you do). There are limits to the maximum contribution you can invest in a given year (the limits are constantly changing so a simple Google search will tell you how much you can contribute annually). You can contribute to BOTH a traditional IRA and a Roth IRA in the same year if you’d like but you cannot exceed the IRS limit for that year ($6,000 in 2019 +$1,000 catch up for those 50 and older). Similarly, if your employer offers both Roth and traditional 401k plans, you can chose to invest in both. Your total contributions cannot exceed the IRS limits ($19,000 in 2019 + $6,000 catch up for those 50 and older). But within this limit, you can invest a portion in a traditional plan and a portion in a Roth plan (if you choose to do so and if your employer offers both options).

HSA

An HSA stands for a Health Savings Account and some argue that this account is one of the most powerful accounts available to some Americans due to its triple tax advantage.  What I mean by this is that an HSA allows you to put away pre-tax (or tax deductible) dollars into an HSA account and have them grow tax free.  You may use the money tax-free if its for medical costs. You will get hit with a penalty if you use the funds before age 65 for non-medical related expenses.  However, after age 65, you can use the money in this account for anything you’d like, it’s no longer tied to medical expenses only.  Additionally, contributions you make to your HSA on a pre-tax basis avoid Social Security and Medicare taxes.

The 2019 contribution limits for HSA holders is either $3,500 for an individual or $7,000 for a family.  HSA holders 55 and up can save an extra $1,000, so either $4,500 for an individual or $8,000 for a family. For 2020, the limits are going up by $50 for the individual coverage and $100 for family coverage bringing them up to $3,550 and $7,100 respectively.  

There is a caveat.  In order to open an HSA, you must be enrolled in a high-deductible health plan.  So depending on your health (and your family), you may not enroll in a high deductible health plan and thus cannot access an HSA.   

If you pull the money out for non-medical related reasons, you’ll pay income taxes and a 20% penalty which is in effect until your 65.  I’ve heard about a few unique strategies regarding HSA accounts among other members of the FIRE community.  Christina and Amon from Our Rich Journey are in a similar boat as us and are planning to use their HSA account as part of their post-65 withdrawal plans rather than for medical related expenses even if medical expenses come up before then to take the utmost advantage of the triple tax advantage. Personally, I do not even count my HSA account into our FIRE calculations and view it as icing on the cake after age 65 to help supplement any additional costs due to aging.  Additionally, Kim over at The Frugal Engineers wrote a guest post for Go Curry Cracker explaining how they are using their HSA account to pay for their daughter’s education costs.  You can hold on to your medical receipts, pay for these costs not using your HSA at the time to allow for the funds within the HSA continue to grow with it’s great tax advantages, and then years down the road you can withdraw and link the withdrawals to the previous medical expenses from years past.        

529 Plans

A 529 plan is a tax-advantaged savings plan designed to help pay for education. 529s were originally designed to pay for post-secondary education costs, however due to more and more early education coming at a hefty price tag in the States, it was expanded to also cover K-12 education under the Tax Cuts and Jobs Act (which in and of itself is an entirely different rant I could go on as the cost of education in the States is beyond ridiculous).

There are two major types, prepaid tuition plans and savings plans. Prepaid tuition plans allow the plan holder to pay in advance for the beneficiary’s tuition and fees at designated institutions. Savings plans are tax-advantaged investment vehicles, similar to IRAs but earmarked for education (and similar to RESPs in Canada). 

I use the term beneficiary instead of child above because a 529 plan allows a person to grow their savings on behalf of a beneficiary, be it a child, grandchild, a spouse or even yourself. With the insane cost of education in the States these days, I personally view a 529 as a good way to invest in a child’s education. Others would argue that they are too limiting and would prefer to invest on their own terms.  That’s fine too as long as you ensure that other investment truly is for education as it was originally intended to be. If you open up a non-529 plan for your child’s education but end up tapping into it 7 years down the road to fix your leaky roof then that’s where a problem arises.

The average annual cost of in-state tuition plus room and board for 2018-2019 was $21,370 at a public four-year college or university and $48,510 at a four-year private college or university according to The College Board. That’s insane! That is PER YEAR, so you could be looking at $80,000-$200,000 grand after 4 years of college is up.  And that does not take into account any extra costs for graduate degrees, term abroad costs, fraternity/sorority fees, extracurriculars, etc.  And that is the CURRENT costs, college tuition costs are increasing WAY faster than inflation so I can only imagine what the costs will be 18 years from now.  Hopefully politicians are able to control this insane issue.  I bet any reader from Europe (if there are any, please comment below) would have a VERY hard time imaging having this much debt due to education.  I also hope there is a shift away from the importance of a formal post-secondary degree in the near future thanks to so many great free educational resources available online.

And I am proof that these numbers are true. I went to a four year private liberal arts college from 2004-2008 that cost $40,000/year (the annual cost for tuition at this same school now costs $53,019/year + room and board of $13,119, plus $1,500 for books and supplies, and $471 for misc other fees totaling $68,610 per year – like I said, it’s insane). I received a scholarship for half the tuition so that reduced that cost down to $20,000/year or a total of $80,000 for 4 years. My dad didn’t think 529s were worth it back in the day so my parents didn’t have an education fund for me (they did invest in one pre-paid in-state tuition that my brother ended up using). So our deal was that my parents would pay for half of my tuition ($40,000) and I would pay for the other $40,000. And that was just for undergrad. I then tacked on another $25,000 for grad school and ended up with $65,000 in student loans. After 2.5 years of interest, I ended up paying $70,000 in student loans when all was said and done. (Side note: if I just paid the minimum payment of $350/month on these student loans, after 25 years the loans would finally be paid off and I would have paid over $120,000 in interest to Sallie Mae!)

A 529 plan doesn’t just cover tuition. According to the IRS, it covers eligible expenses, including “computer technology or equipment.” These include desktop computers, laptops and any device controlled by the computer (such as a printer). 

There are two main types of 529 plans: the college savings plan and the prepaid tuition plan. Let’s dig a little further…

Savings plans

Under a college savings plan, amounts are contributed up to the dollar limit of the plan ($15,000 per individual in 2019). The assets in a college savings plan may be used to cover eligible expenses at any eligible educational institution.

Savings plans, which are only offered by States, are similar to IRAs in that they are tax-advantaged ways to invest money in the long term. Plan holders usually have the option to invest in a range of mutual funds. These funds may be target date funds to the date the beneficiary is expected to start their education in an attempt to reduce risk exposure as that date approaches. Since the investor (likely you, dear reader) bears the risks of the investments, the amount that is eventually available for eligible education expenses will be affected by the rate of return on the investments.  Aka there is no guarantee that the amount you have contributed over the years will cover the full tuition costs (or fingers crossed, markets do well and/or the beneficiary ends up with loads of scholarships and you have ample amount of coverage).

Prepaid tuition plans

Prepaid tuition plans are offered by States and higher education institutions. In a way, you can view them as futures contracts, as they allow the plan holder to prepay for one or more semesters at designated colleges or universities at current prices. This shields them from inflation in tuition costs, which has historically been much steeper than broader measures of inflation. Check out this article from CNBC, or this one from Forbes, or this one from Business Insider, and here’s another one from CNBC. That then leads to a whole other discussion of if college is even worth it or not.  I’ll be writing a whole post in the future on my thoughts on that.

Unlike the assets in the college savings plan, which can be used to pay for qualified expenses at any eligible educational institution, assets in a prepaid tuition program are usually used toward expenses at a predetermined educational institution, or an educational institution from a predetermined list. Should the beneficiary decide to attend an educational institution that is not included on the predetermined list, the current market value of the prepayments may not be sufficient to cover the cost of comparable tuition at the other educational institution. This means the beneficiary may need to cover the difference out of pocket.

There is one non-state prepaid plan, called the Private College 529 Plan, that allows holders to prepay tuition for a collective list of private schools. One problem with this plan, as with state plans, is that the choice of schools is limited. If the beneficiary does not get into and attend one of the selected schools, the funds may be rolled over into another plan, causing them to forfeit most of their gains. Alternatively, they can be transferred to a family member of the beneficiary or rolled over into that beneficiary’s plans, which involves no penalty.

Earnings from a 529 plan are exempt from federal income taxes, providing withdrawals are used for qualified educational expenses. Distributions that are not used to pay for qualified educational expenses are subject to taxes and a 10% fee, with exceptions for circumstances such as death and disability. Contributions to a 529 plan do not reduce your federal income tax burden by lowering your taxable income. However, more than 30 states provide tax deductions or credits for contributions in a 529 plan.

The type of plan you choose—whether a college savings plan or a prepaid tuition program—is generally determined by which features and benefits you find attractive. For instance, do you want the beneficiary to be free to choose an educational institution that is to his or her liking, or are you happy to have the beneficiary attend an institution chosen from a predetermined list?

Regardless of which 529 plan you choose, the important thing is that you make a choice and start early. For college savings plans, starting early increases the compounding effect of the earnings on contributions. And for prepaid tuition programs, the cost of tuition is usually less if prepayments are made earlier. And again, if you feel either of these options is too limiting and you’d rather set aside money in a taxable account for your child’s tuition, by all means, that’s a great plan too.  The point is to start early and commit to investing into your child’s education (if you chose this is a worthwhile endeavor in the first place).

CDs

A certificate of deposit (CD) is a product offered by banks and credit unions that offers an interest rate premium in exchange for the customer (you) agreeing to leave a lump-sum deposit untouched for a predetermined period of time. 

Similar to the high interest savings accounts we discussed above, shopping around is crucial to finding the best CD rates because different financial institutions offer a surprisingly wide range. For example, your brick-and-mortar bank might pay a very low rate even for long-term CDs while an online bank or local credit union might pay three to five times the national average. Some of the best rates come from special promotions, occasionally with unusual durations such as 13 or 21 months, rather than the more common terms based on 3, 6, or 18 months or full-year increments, so again do your research here.

We’ve found that rates for CDs and GICs (Canadian equivalent) have been very similar to high interest savings accounts so to us it’s a no brainer to put money into a high interest savings account which can be accessed at any time vs a CD or GIC which is tied up for a certain duration. With the current interest rates that CDs or GICs are offering, I’d see no benefit to them compared to a high interest savings account. 

Brokerage Accounts

A brokerage account is a taxable account (no special tax advantages like a 401k or IRA in the States or RRSP or TFSA in Canada) that ANYONE can open at ANY time. The biggest pro to a brokerage account is the flexibility. You can open a brokerage account with any company that you’d like (Vanguard, Fidelity, Charles Schwab, etc. in the States or Questrade, Wealthsimple, Qtrade, TD Direct Investing, etc. in Canada) and select any of their available funds to invest in (be it an individual stock, individual bond, index funds, target date index funds, ETFs, etc. – and don’t worry we will have an entirely separate post on all the TYPES of FUNDS you can choose to invest in).

So you have a ton of options here with a brokerage account. The downside of course is there is no tax advantage to these funds. But you can access (aka sells funds within your portfolio) at any time without a penalty (you just pay taxes on the gains depending on your tax bracket for the year you sell). 

Luckily, for those in Canada and the US there are ways to access your tax-advantaged accounts (some with more loopholes involved than others).  But for anyone reading from Australia knows that only investing in your Super (like a 401k in the States or RRSP in Canada) would not be a wise choice for early retirees as accessing your Super prior to the government mandated age is nearly impossible. 

We are big fans (again) of online brokerage accounts because (again) they tend to have much lower fees.  In the States, we use Vanguard for our taxable brokerage account.  Why?  Because Vanguard’s founder, John Bogle, was the founder of index funds and we loveeeee index funds so we will stay loyal to Vanguard even if these may come at a 0.04% fee vs others being completely free. And in Canada, we use Questrade (more on them in Part 4 of the Series).

This post really got out of control so I will write a similar post next week regarding the different Canadian accounts.  It will look very similar to this post but geared towards our Canadian crowd so stay tuned for that!

Are you familiar with all of the accounts we discussed on today’s post?  Which accounts do you currently have open? Anything I missed? Thanks for tuning in and please comment below  

Want to check out the rest of the Investing 101 Series?

• Investing 101 – Part 1: Introduction
• Investing 101 – Part 2: Compound Interest

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We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.  Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:

• How much are you paying for your phone plan?  Canadians, learn more about Public Mobile, and see how we are paying $3/mo for our cell phone plan.
• How much are you paying for internet?  Canadians, learn more about the various Independent Service Providers out there to see who services your area so you can lower your monthly bills.
• How much are you paying for home insurance?  We were able to reduce our rates by 25% by switching over to Square One Insurance.  If you live in BC, AB, SK, MB, and ON, check out Square One for your home insurance, landlord insurance, and/or tenant insurance.  Use this link to receive an extra $15 off your quote.  (Note that you must use this link to start the process to get the $15 off even if you prefer to pay over the phone.)
• How much are you paying for your monthly utility bills?  See how you can likely save on this monthly expense.

The post Investing 101 – Part 3: Accounts You Can Invest In (US Edition) appeared first on Modern FImily.

• Investing 101 – Part 1: Introduction

How many topics in school did you cover that are actually real world applicable?  Who really needs to know when Columbus sailed the ocean blue or how to calculate long division?  Unfortunately our school system is a bit misconstrued and we are taught how to memorize pretty useless facts (in my opinion) that likely do not have much real world application.  I digress… One math subject that everyone should become very familiar with is compounding.

What is Compound Interest?

Compound interest is interest that earns interest (tongue tied yet?).  It requires two things: the re-investment of earnings and time. The more time you give your investments, the more you are able to accelerate the income potential of your original investment. Let’s look at a few examples:

Example 1: How Does Compound Interest Work?

Suppose you saved $100 a year ago and it grew at 10% meaning it earned $10 in interest last year (100 x 0.10=10). This year, assuming you leave the principal ($100) and earned interest ($10) in your account, you’ll be earning interest on $110. That might not seem like much, but understanding that simple fact can have a major impact on your future financial success.  The key take away is that it can turn just a few dollars today into big money over the course of a lifetime.

Now you may be thinking, “OK sure, but where am I going to see 10% returns?”.  It’s true that banks aren’t paying much on savings accounts (maybe 2-3% for a high interest savings account). However, many index funds tracking the stock market average a higher return, have very low minimums, and low expenses ratios (keep reading the investment series for more info on index funds). Over the past 100 years, the S&P 500 has grown on average roughly 10%.  This does not include inflation, so I like to use 7% on the high end for my estimates to account for 3% inflation.

Example 2:  Slow and Steady

Say you saved $5 per month and put it into an investment account that earned on average 5%.  If you were to save $5 per month continually for 10 years you’d have put $600 into savings (5 x 12 x 10=600). But thanks to that 5% annual compounding, the account would be worth $776. And, even if you didn’t add a single dime after that point, it would be worth more than $1,500 in another 15 years.  The point is, it adds up faster than you may think.

This example shows how something small, like cutting out a morning latte once a month, can help your investments grow.  But we here at the Modern Fimily are not about depriving yourself of the small things you do that truly brings you joy.  You can really see the power of compound interest if you focus on cutting your largest expenses and invest hundreds, if not thousands, a month.

Example 3: One and Done

Let’s say you’ve been saving for some time and now have $10,000 in your bank account but not sure what to do with it.  If you invest $10,000 today and it grew at 6%, you will have $10,600 in one year ($10,000 x 1.06=$10,600). Now let’s say that rather than withdraw the $600 gained from interest, you keep it in there for another year. If you continue to earn the same rate of 6%, your investment will grow to $11,236.00 ($10,600 x 1.06) by the end of the second year.

Because you reinvested that $600, it works together with the original investment, earning you $636, which is $36 more than the previous year. This little bit extra may seem like peanuts now, but let’s not forget that you didn’t have to lift a finger to earn that $36. More importantly, this $36 also has the capacity to earn interest. Assuming 6% growth again, after the next year, your investment will be worth $11,910.16 ($11,236 x 1.06). This time you earned $674.16, which is $74.16 more interest than the first year. This increase in the amount made each year is compounding in action: interest earning interest on interest and so on. This will continue as long as you keep reinvesting and earning interest. If you’ve ever heard of the Rule of 72 and the notion that your investment will double in “xx” years by dividing 72 by the rate of return, it’s thanks to compound interest.  

Let’s say you left that original $10,000 in the market and assume 6% growth, on average, over a 40-year timeframe.  The Rule of 72 would say that every 12 years (72/6=12), your portfolio will double.  So year 1 = $10,00, year 12 = $20,000, year 24 = $40,000, year 36 = $80,000, etc. After 40 years, that original investment of $10,000 would now be worth $109,574.  If it happened to grow at 10% on average, it would be valued at $537,006 after 40 years.

Now let’s say you held off and kept that $10,000 sitting under a mattress for 20 years until finally deciding to put it into the market.  If that $10,000 only had 20 years to grow, it would be valued at $33,102 assuming 6% average annual growth or $73,280 assuming 10% average annual growth. That’s a difference of $76,472 for the 6% growth or $463,726 for the 10% growth. 

THIS is why the saying “time in the market is better than timing the market”.  Sure, the 6% growth will vary year over year, but it’s a realistic return to be averaging.  

Example 4: Monthly Savings Really Do Add Up

Let’s say every month you were able to save and invest $250.  If you never increased the monthly contributions and continued to contribute $250/month for 40 years and it grew at 7% on average, after 40 years your account would be worth $660,281.  If it happened to grow at 10%, you’d be sitting at $1,594,445.

Now let’s say you were able to boost that $250/month saving up to $500/month (because if you’re reading this, you’re likely a life hacking badass and can figure out a creative way to either reduce your spending by another $250/month or increase your income by the same). Assuming 7% growth, after 40 years it would be worth $1,320,562.  Assuming 10% growth, after 40 years it would be valued at $3,188,890.  If you plan to work for 40 years this is the simplest example to becoming a millionaire once you retire.

In the first part above of $250/month of contributions, you’d be putting in $120,000 of your own money (250 x 12 x 40).  In the second part of $500/month of contributions, you’d be putting in double that of $240,000 of your own money (500 x 12 x 40).  That difference of $120,000 yielded $660,281 more in your account 40 years down the road assuming 7% growth or $1,594,445 if assuming 10% growth. That’s nuts!  

Example 5: Time is Your Best Friend

One of the biggest things to understand is that when dealing with compounding interest, your best friend is time. The sooner you can start investing, the better.  Even if it’s just $25/month to start.

Consider two friends, we’ll name them Zoey and Dane.  Both Zoey and Dane are the same age and when Zoey was 25 she invested $15,000 earning an average return of 7%. For simplicity, let’s assume the interest rate was compounded annually (aka growing at a steady rate year over year).  By the time Zoey reaches 50, she will have $85,881.27 ($15,000 x [1.07^25]) in her bank account without adding another penny into the account.

Zoey’s friend, Dane, did not start investing until 10 years later when he reached age 35. At that time, he invested $15,000 at the same interest rate of 7% compounded annually (aka same set up as Zoey but just 10 years later). By the time Dane reaches age 50, he will have $42,734.20 ($15,000 x [1.07^15]) in his bank account.

What happened? They both are 50 years old, but Zoey has $43,147.07 ($85,881.27 – $42,734.20) more in her savings account than Dane, even though he invested the same amount of money! The power of time allowed Zoey to earn a total of $70,881.27 in interest and Dane earned only $27,734.20 in interest from his initial investment. Don’t get me wrong, $27,734 is a GREAT accomplishment but $70,881 seems so much sweeter.  

Example 6: The Double Whammy – Compound Interest + The FIRE Mentality

Here’s where the beauty of FIRE kicks in. While saving $250-500/month is nothing to laugh at, most people within the FIRE community are all about life optimization and figuring out creative ways to slash your expenses or boost your income to increase your savings rate so you can invest even more. 

Let’s say there are two people, Johnny and Jenny, making the same take home pay of $4,500 per month from their day jobs (you can also view Johnny and Jenny as two different families too who combined are making $4,500). Johnny tries to keep up with the Joneses but is not completely irresponsible and spends $4,250/month and invests $250/month (yay for not going into debt!).  Using the 4% “Rule” with Johnny’s monthly spending of $4,250, Johnny would need $1,267,500 to retire ($4,250 x 12 x 25=$1,267,500).  In order to continue living at this current standard of living in retirement, it takes Johnny 49 years to retire assuming 7% average annual growth of his investments.

Jenny, on the other hand, has embraced the FIRE mentality.  Not only has she mastered the big stuff to keep her expenses at $2,000/month but she has also implemented a low stress side hustle that brings in $500/month in addition to her day job.  So she is able to save and invest $3,000/month ($4,500 income + $500 hustle – $2,000 expenses).  That’s a 60% savings rate, nice job Jenny!  Using the 4% Rule with Jenny’s monthly spending of $2,000, Jenny would need $600,000 to retire ($2,000 x 12 x 25=$600,000).  In order to continue living at this current standard of living in retirement, it takes Jenny 11 years to retire assuming 7% average annual growth of his investments.

That’s a difference of 38 years of freedom for Jenny!

Now if instead Jenny was cautious and kept her $3,000/month in savings under her mattress or in a checking or savings account earning 0.05% (or lower) interest, rather than it taking Jenny 11 years to retire, it would instead take her almost 17 years to reach that $600,000 figure ($600,000/($3,000*12)).  By investing instead, she was able to shave off 6 years (or 35%) of her working career to reach her early retirement figure.

Not only does this illustrate the power of compound interest, it also shows the power of FIRE.  Because Jenny was a “weirdo” and deviated from the herd mentality of needing to upgrade her life to keep up with the Joneses, she was able to reclaim 38 years of her life where she no longer has a boss telling her what to do, or TPS reports to complete, or pointless meetings to attend.  People outside of the FIRE community can mock our lifestyle all they want, but THIS is the purpose behind it all.  To RECLAIM our lives back to be able to spend our time however we’d like.

Who Is This Jenny?

Jenny is not “normal” in her spending compared to 99% of her peers.  She understand the importance of reducing her top three expenses.  She house hacks and lives with roommates or has a rental property she is getting rental income from.  She likely has a short commute to work and takes public transit (gasp!).  She has drastically reduced her transportation costs as her reliable car was bought used and paid up front with cash. She doesn’t fall victim to eating out all the time and instead cooks most of her meals at home.  When she does eat out, she orders one of the cheaper meals on the menu because she understands how marked up items at a restaurant are priced.  Then when she goes home she googles a recipe for one of the menu items that sounded unique to try at home (and she then uses more brain power to acquire another skill to her already growing skill set). She doesn’t understand why people feel the need to keep up with the latest trends or own the latest technology gadget.  In fact, she takes pride that her phone is 5 years old and found a mobile plan that only costs $13/month (thank you Public Mobile). (Check out Ting if you’re in the US.)  She hasn’t bought new clothes in over a year and understands how much waste and pollution is created throughout the process of making many materialistic items for sale at the store.  When she does need new clothes, she looks for second hand items online at Craigslist (US) or Kijiji (Canada), or on Facebook Marketplace, or on apps such as Offer Up, Let Go, or Varage Sale. If she can’t find the item she’s looking for, she will head to a discount store like Marshalls, TJ Maxx, or Winners.  To socialize, she prefers to host pot lucks at her house or pick up a bottle of $7 wine to bring over to a friend’s house rather than going out for a fancy meal or to get drinks at a bar / club.  She enjoys nature and spends most of her free time outside.  She reads books while others are glued to the screens on their TV, phones, or tablets.  She listens to others rather than feeling like she needs to be the center of attention.

Most people reading about Jenny would be quick to assume she is living a deprived life.  But it’s the exact opposite.  She has learned to be at peace with fewer wants and needs and is a happier person because of it.  In fact, Jenny is living her best life.  She doesn’t have the stress and worry of living paycheck to paycheck.  She knows that she is living well below her means and her investments are continuing to grow and work for her.  And of course, after 11 years she can call quits on her job. 

We are the real life Jenny.  Literally this is us, I tried to explain what our life is actually like. And we are not the only ones out there living life like this while also maintaining JOY.  So many people can read this and say “oh come on, no one lives like this?!” but it’s so not true.  Break out of your comfort zone, challenge yourself, increase your savings rate, invest, and let compound interest do it’s magic.

Is There a Downside to Compound Interest?

The examples above show how useful of a tool compound interest can be.  And yes, compound interest is wonderful if you’re routinely saving money, but it can be absolutely cruel if you’re borrowing money.  Credit cards and other open-ended accounts use compound interest AGAINST you. Just as the examples above show how much extra money you can EARN thanks to compound interest, the exact opposite is true if you OWE interest to the banks.  That’s why “minimum payments” are likely to keep you in debt forever.  Suppose your interest rate is 14 percent (which is quite low for most credit cards) and you add just $5 per month to your payment. In 10 years, you’ll avoid $1,315 in payments.  We would never suggest investing if you also have debt with a 10+% interest rate.  Contribute to your 401k or RRSP for the company match but besides that, PAY OFF THAT DEBT! 

While some people view credit cards as evil, we love them.  Note however, we would never advocate running into credit card debt.  We use credit cards for travel rewards and have all of our accounts set up on auto pay to pay the balance in FULL each month.

Compound interest requires you to sacrifice today to reap a benefit tomorrow. It’s true that you’ll need to do something to save a few dollars today. But, it’s certain that the future reward will be greater than the sacrifice.  Saving a few dollars a week might not seem like much, but if done consistently it could make a big difference in your financial future.

Hopefully today’s lesson on compound interest helped tweak your view to understand the beauty of delayed gratification (whole other blog post on that in the future) and how important it is to invest as much as you can as early as you can to start letting compound interest work for YOU.  

Hope you enjoyed today’s post.  Honestly, understanding the beauty behind compound interest is SO important.

Any questions for us regarding compound interest?  Thank for reading along and stay tuned for the next installment of the Investing 101 series where we dig into the different types of account you can choose to invest in (US edition and then Canadian edition to follow after that).  

Want to check out the rest of the Investing 101 Series?

• Investing 101 – Part 1: Introduction

Support This Blog

If you liked this article and want more content like this, please support this blog by sharing it.  Not only does it help spread the FIRE, but it lets me know what content you find beneficial.  Writing is NOT my strong suit and it honestly takes me hours to write each post so the more encouragement the better!  Engaging in the comments below keeps me motivated.  You can also support this blog by subscribing to receive emails anytime a new post is published.  Thank you FImily!

We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.  Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:

• How much are you paying for your phone plan?  Canadians, learn more about Public Mobile, and see how we are paying $3/mo for our cell phone plan.
• How much are you paying for internet?  Canadians, learn more about the various Independent Service Providers out there to see who services your area so you can lower your monthly bills.
• How much are you paying for home insurance?  We were able to reduce our rates by 25% by switching over to Square One Insurance.  If you live in BC, AB, SK, MB, and ON, check out Square One for your home insurance, landlord insurance, and/or tenant insurance.  Use this link to receive an extra $15 off your quote.  (Note that you must use this link to start the process to get the $15 off even if you prefer to pay over the phone.)
• How much are you paying for your monthly utility bills?  See how you can likely save on this monthly expense.

The post Investing 101 – Part 2: Compound Interest appeared first on Modern FImily.

Hopefully by the end of this series you will feel more comfortable with investing terminology and be comfortable enough to take the plunge to create an investment account if you don’t already have one open. Once your accounts are opened, you can set everything up to automatically fund your accounts on a monthly or bi-weekly basis so it’s on autopilot set it and forget it mode.

Disclaimer: The information provided on this blog are simply our recommendations.  There is no guarantee the way that we invest our money is the right fit for you and there is also no guarantee you will make money investing in the stock market. 

Historically, the stock market has grown 10% on average over the last 100 years but any wise investor knows that past performance does not indicate future returns.  For example, if there’s an alien apocalypse, we’re all screwed. Personally, I have faith in the stock market for the foreseeable future and will continue to invest in the broad stock market index over the course of my life. 

Does that mean you need to as well?  Absolutely not.  You do you and do what you feel comfortable with.  Just realize that stashing your cash under a mattress or in a checking or savings account with a big bank earning 0.03% interest will become less valuable with inflation. 

Does this mean all stocks are winners?  Absolutely not.  Some stocks will soar and some will fizzle out.  This is why we invest in the overall US stock market index fund to ensure we do not have all our eggs in one basket.  Some of those stocks will fizzle their way down to nothing and will no longer be in the game.  Other stocks however could grow by 100%, 200%, 300%, 500%, 1000%, etc.  The downside is -100% but the upside is infinite.  That’s the beauty of the market.  

Over the last 40 years, the annualized return (dividend reinvested) of the S&P 500 was 9.028% when you account for inflation.  I played around with this fun little S&P 500 Periodic Investment Calculator, and if you invested $10,000 back in October 1979 (40 years ago) and didn’t touch that money again or add another penny into your investment portfolio, 40 years later you would have $789,439 in your account.  That’s a 78x return!  And that accounts for numerous dips in the market over that 40-year time frame.  Yes, there is inflation you need to factor in but that is still a pretty wild statistic.  The key is to not get scared and pull out when there is a dip.  Set it and forget it.  Or better yet, keep pouring money in, especially when there is a drop as that is when you will pick up shares when they are on SALE.  The media portrays these market dips as doom and gloom events which typically spooks people to sell their investments.  As a LONG term investor, the exact opposite it true. This is when you want to BUY. Most people see a market drop and panic and pull out thinking the end is near, but unless that alien apocalypse is happening, there is a very good chance that the market will climb upwards months or years after a market correction.  This is when you want to be pouring as much as possible into the market.     

Sure over the next 40 years there will probably be more of the bad news and the media will bombard us with all of the “world is on fire” headlines to boost their ratings when in reality it’s mostly nonsense.  There’s definitely going to be more companies being profitable and growing.  Don’t be sad you missed out on this 78x return from the past 40 years.  Get in on the next 40 years.  You know how the saying goes “the best time to invest in the market was 20 years ago, the second best time is now”.  

While I am nervous about a market correction happening soon, I know that humans truly are amazing.  The ingenuity and ideas that people come up with to further change and improve our world is insane.  Think of all the advances in the medical field over the last 500 years.  Or all the recent changes in technology over the last 50 years.  Imagine what’s to come over the next 100 years?  Does anyone else think there will be new technology to have a second civilization on another planet in the near future? 

Let me preface this series by noting that investing is not meant to be a get rich quick solution to all of life’s worries.  If you are looking for the next best individual stock pick or the next best investment opportunity like crypto (please do not invest in crypto), you’ve some to the wrong place.  You also don’t have to put your money in the hands of financial professionals who will charge you a hefty fee for their services.  A 2% management fee may not sound like a lot when you’re thinking of it on a scale of 100%. But that’s not how it works. If your investments average say 6% returns (as managed fees typically do not outperform the market) then that 2% management fee is really 33.33% of your returns (2/6) which is HUGE. And then you lose the compound interest opportunities of that 33.33% too! You are the best judge to determine what is best for you and your money.  It requires reading and research from your end.

The easiest way to define “investing” is: putting your money to work for you.  Here’s a great Economics 101 primer for my non-econ and math nerds reading.  Making your money work for you maximizes your earning potential whether or not you receive a raise, decide to work overtime, or look for a higher-paying job. There are many accounts you can open to invest your money and we will cover these in another post.  There are many ways to invest your money such as stocks, bonds, mutual funds, real estate, starting a business, etc.  Again, these will be covered in a future post as part of the Investing 101 series. There are pros and cons to all of these which we will cover later.  

Investing involves risk, and there are no guarantees, but it always requires some analysis on your part rather than crossing your fingers and hoping for the best.  Figure out what type of investor you are.  For example, we held on to our real estate property in Florida while we lived in Western Canada and learned that we do not like being involved in real estate from such a far distance and we would rather focus on investing in the stock market instead.  You may feel the exact opposite and that’s ok too.  Again, what we are doing is not a cookie cutter recipe for everyone to follow.

Many people want to invest their money but just not sure where to start.  The idea of working for the same company for years and retiring with a nice pension are pretty much gone.  Unfortunately, the ability to retire is falling more and more on the responsibility of the individual rather than the state.  Who knows what Social Security or CPP will look like 30 years from now?  Hopefully it will still be there in some sense, but I’m not solely relying on it for my retirement income. 

Investing your money can allow you to increase your personal freedom, sense of security, and ability to retire early.  Put yourself in the driver seat of your future.  With every paycheck you receive, you should be paying your future self first by saving and investing part of your income. 

You know what you call someone who spends everything that they earn?  Broke.  Don’t be broke.  You simply cannot get ahead if you’re constantly resetting yourself back to zero by spending every dollar you make.  Or even worse, spending more than every dollar you make by borrowing money and then having to pay it back with interest.  Set up a system where before you can spend money on anything you invest in your own future.

The larger the percentage that you can crank into your investing portion, the faster you can build wealth and retire early (if that’s your goal).  Common advice in the financial world is to save 10% of your income.  That equates to roughly 41 years until you can retire.  For someone starting out in their early/mid 20s, that means a retirement date in your early/mid 60s.  However, if you can save 60% of your income, it will only take about 11 years for you to have enough invested to never have to work again.  If that’s too aggressive, saving 50% of your income will take you about 15 years to reach your retirement goal.  If it shifts down to 0%, you’ll never be able to quit. 

The math is pretty simple yet it’s so hard for people to fathom how it’s possible.  It is. We are proof that it works.  Reduce your expenses.  Boost your income.  Invest the difference. Your future self will be so proud of you.  Let those little hard earned pennies make money for you while you sleep. I like to think of them as little minions under your empire.

In the next section of the Investing 101 Series we will learn about one of mathematical miracles that investing lets you take advantage of: compounding interest.

Support This Blog

If you liked this article and want more content like this, please support this blog by sharing it.  Not only does it help spread the FIRE, but it lets me know what content you find beneficial.  Writing is NOT my strong suit and it honestly takes me hours to write each post so the more encouragement the better!  Engaging in the comments below keeps me motivated.  You can also support this blog by subscribing to receive emails anytime a new post is published.  Thank you FImily!

We believe in stacking up life hacks to keep your enjoyment levels to the max without depleting your bank account.  Here are some ways to further educate yourself and save thousands of dollars over your lifetime by making some simple adjustments:

• How much are you paying for your phone plan?  Canadians, learn more about Public Mobile, and see how we are paying $3/mo for our cell phone plan.
• How much are you paying for internet?  Canadians, learn more about the various Independent Service Providers out there to see who services your area so you can lower your monthly bills.
• How much are you paying for home insurance?  We were able to reduce our rates by 25% by switching over to Square One Insurance.  If you live in BC, AB, SK, MB, and ON, check out Square One for your home insurance, landlord insurance, and/or tenant insurance.  Use this link to receive an extra $15 off your quote.  (Note that you must use this link to start the process to get the $15 off even if you prefer to pay over the phone.)
• How much are you paying for your monthly utility bills?  See how you can likely save on this monthly expense.

The post Investing 101 – Part 1: Introduction appeared first on Modern FImily.