Ready...Set...Start Saving

Planning for retirement is a daunting task and the hardest part is often deciding where to begin.  Unfortunately for most of us, the challenge associated with taking the first step out of the batter’s box leads to years of procrastination. In the world of investing, time is your friend and you can never have too many friends.  The following is a road map carefully designed to alleviate procrastination from your retirement portfolio:

1.      Develop a personal budget:

In order to determine how much you are able to set aside for monthly saving it is important to have a good understanding of where your money is going.  In today’s electronic age this has been made significantly easier with apps such as Mint, MoneyWiz and Best Budget just to name a few.  Forecasting a budget isn’t sexy and it isn’t an exact science.  Come up with some rough thresholds based on your spending expectations and observe whether you are in fact meeting those expectations on a regular basis.  The real benefit comes with simply being aware of your spending habits; it will impact all future financial decision making.

2.      Pay down high interest debt:

Setting aside money for investing every month makes little sense when you’re unable to pay off your credit card balance.  Most credit cards charge annual interest rates in excess of eighteen percent on their outstanding balance. An investment with a rate of return of twelve percent would be considered exemplary in today’s markets however if you chose this investment over paying down your credit card you’ve lost out on six percent savings.  Saying that, for those individuals certain they can routinely outperform their credit card debt, stop reading you are in a league of your own.  There are a lot of rich people that will pay handsomely for your services.  For the rest of us, the second step to saving is paying off all your high interest debt prior to setting aside savings.

3.      Determine the type of investment account that best suits your needs:

For most individuals that are getting started, their best bet is choosing between opening an RRSP account and a Tax Free Savings Account.  The benefit of an RRSP account is to defer paying income tax in a year where you are at a high marginal tax rate for a year where you are likely to be at a lower tax rate (at retirement).  If you are getting started in your career and not yet earning to your full potential, allow your RRSP room to continue to accumulate and be used in a year of peak earnings.  Use your tax free savings account room first.  However if you are already at the point where you are in your peak earning years, and don’t foresee a significant increase in your overall annual salary for future years, use up your RRSP contribution room first. See ‘Appendix A’ for summary of the properties of the two options:

Most individuals, first getting started, should be using up their accumulated Tax Free Saving Account room first.  It has the benefit of being more flexible.

4.      Determine the level of risk your are comfortable with:

For most that are getting started this is the time in your life where you are most open to risk.  The potential for realizing substantial gains more than outweighs the exposure to realizing significant losses.  This is because you are still young and have an opportunity to earn the income lost back.  However as investors become older and have a family reliant on their income they become more risk adverse.  Remember, that for the most part, the opportunity for high rewards comes with high risk.  Investors should also consider the level of flexibility they require.  Putting savings into long term investments can often have penalties associated with having to withdraw the investment shortly down the road.  Here are some options:

a)      Money Market Accounts:

These saving accounts pay higher interest rates then your traditional saving accounts and typically require minimum balances of up to $2,500.  While most money market accounts only allow you to make three to six withdrawals in a year, most will also allow you to write cheques.  They represent very low risk and have low rates of return with lower flexibility then your traditional savings accounts.

b)     Money Market Funds:

Money market funds are often managed by brokerages and used to store money that isn’t currently being invested.  They collect interest at slightly higher rates than money market accounts.  They represent very low risk and have low rates of return.

c)      Certificate of Deposit:

Certificates of deposit pay higher interest than traditional savings or money market accounts.  They require that you do not withdraw any money for a period as short as 18 months up to 10 years.  They represent very low risk and have low rates of return.

d)     Treasury Securities:

When you buy a treasury security (or bill) you are lending to the government.  When the bill reaches its maturity rate, you receive your interest in return.  They represent very low risk and have low rates of return.

e)     Guaranteed Investment Contracts (GIC’s):

These are insurance contracts that guarantee the owner principal repayment and a fixed or floating interest rate for a predetermined period of time. Guaranteed investment certificates from small banks, trust companies and credit unions are a great choice if you put a premium on a reasonable yield and safety and don’t plan to sell before maturity.  They represent low risk and have low rates of return.

f)      Bonds:

Bonds are endorsed by the issuer and offer guaranteed returns issued twice annually.  They however can be impacted by changing interest rates as their interest rates are locked in.  They represent low to moderate risk and have low to moderate rates of return.

g)     Mutual Funds:

Mutual funds rise and fall with the entire economy instead of just one company.  You can either invest in a mutual fund with or without an active manager.  Mutual fund managers select the stocks and bonds that will comprise the fund.  Actively managed mutual funds can be more expensive since the investors need to pay the managers to select stocks.  Mutual funds that aren’t actively managed function to equal the returns of major stock index and have lower associated fees.  They represent moderate risk and have moderate rates of return.

h)     Stocks:

A stock represents a portion of ownership in an individual company.  The value of the stock is directly linked to the performance of the company.  Therefore if the company exceeds market expectations, in theory, your stock should increase in value and vice versa.  Investing in stocks can represent high risk depending on the company you are investing in.  Investing in start-up companies is considered much riskier than large well established companies.  Again with high risk comes the opportunity for high reward.  The income generated from the ownership of stocks can come as dividends and/or increases in market value. 

5.      Determine the type of investor you are:

There are several different strategies of investing and it is important to understand which one best suits your individual beliefs:

a)     Growth Investor:

A strategy whereby an investor seeks out stocks with what they deem good growth potential. In most cases a growth stock is defined as a company whose earnings are expected to grow at an above-average rate compared to its industry or the overall market.  Companies issuing dividends are not favoured by growth investors who typically prefer the retained earnings to be kept in the company to encourage future growth.

b)     Value Investor:

The strategy of selecting stocks that trade for less than their intrinsic values. Value investors actively seek stocks of companies that they believe the market has undervalued. They believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with the company's long-term fundamentals. The result is an opportunity for value investors to profit by buying when the price is deflated.

Typically, value investors select stocks with lower-than-average price-to-book or price-to-earnings ratios and/or high dividend yields.

c)      Dividend Investor:

The strategy of selecting stocks that offer high dividend yields.  Dividend investors seek companies that pay regular dividends to their shareholders. This means the company is regularly distributing its annual profits to its shareholders as opposed to reinvesting these profits in the company.  These investments can almost mirror properties of bonds with regular interest payouts. 

d)     Index Investor:

The strategy of investing in a market index, exchange traded fund or mutual fund. The idea here is that it provides the investor an opportunity to diversify his/her portfolio and own a small fraction of a large volume of companies without having millions to invest.  Under this strategy the belief is that any losses recognized by one company are likely to be mitigated by gains recognized by another in the fund.

6.     Open an investment account:

For some this may mean going down to your local bank and asking to meet with an investment adviser.  For others (myself included) this means opening up an online investment account.  Should you be using an investment adviser?  It depends.  You are likely more than capable of running your own online investment account.  But it takes research, dedication and self confidence.  If investing doesn’t interest you and you have no desire to educate yourself in the field then consider paying a professional to perform the service for you. 

a)     Choosing an Investment Broker/Adviser:

You must remain cautious when choosing an investment adviser.  It is important you find an adviser you are comfortable communicating with and one who listens and implements your individual goals.  I’ve seen firsthand what it’s like working for a brokerage firm.  It is human nature for advisers to sway you towards their own risk levels.  I’m of the opinion that the profession as a whole lacks the necessary regulation and qualifications that should be expected from those offering financial advice.  This isn’t to say that there aren’t fantastic and knowledgeable investment advisers out there; it’s simply that there isn’t enough self-regulation.  When you approach the customer service desk at your local bank they will be more than happy to set you up with one of their investment advisers.  Think of your initial meeting as a job interview.  The adviser, at this point, is applying for a job and you’re the boss.  Here are some fair questions you should be asking upfront before getting started:

·         What experience do you have, especially with people in my circumstances?

·         Where did you go to school? What is your recent employment history?

·         What products and services do you offer?

·         Can you only recommend a limited number of products or services to me? If so, why?

·         How are you paid for your services? What is your usual hourly rate, flat fee, or commission?

·         Have you ever been disciplined by any government regulator for unethical or improper conduct or been sued by a client who was not happy with the work you did?

·         Can you give me an example of a situation where you were able to exceed the expectations of your client?

b)     Choosing an Online Account:

When considering online investment accounts there are several factors that should influence your decision:

·         What are the associated fees for making transactions?

·         What level of account information is provided regarding your account’s performance metrics?

·         What tools are provided to you as an investor for picking investments?

·         How easy is the web-site to navigate?

I have been using QTrade who are not necessarily the cheapest online broker but are very competitive.  They charge a flat rate of $19 for market orders and a flat rate of $9.95 per trade for accounts with a minimum balance of $100,000.  They also offer discounted trading costs to those investors who make high volume trades (more than 30) in a year.  Registered accounts (RRSP & TFSA) with less than $15,000 in assets have a $50 per year administration fee.  They provide amazing customer service and offer excellent account information and tools for their investors.  If you are trying to decide between your available options an excellent starting point is to review the rankings provided by the Globe and Mail (Online Broker Rankings). 

7.      Get started today and don’t forget to pay yourself first. 

Get in touch with your bank.  Have them transfer an amount every month to your investment account as cash that you will later decide how to invest.  Consider the monthly transfer to be no different than your utility bill.  Once you remove the misnomer that setting aside money for retirement is optional you will be rounding the base paths to your financial freedom.