categorySteps

Live Off Passive Income

Here we go. This is the fifth and final post about the Steps to FI. After all, there is a purpose to all this. After lowering our expenses, increasing our income, saving the balance and then investing our savings, we should be getting somewhere, right?

You probably guessed by now that this plan is not a get-rich-quick scheme. It’s a long-term plan. You must apply those principles and stay disciplined over several years to reach your goal. On the other hand, it will also be several years less as a 9 to 5 prisoner. It’s worth it, but you have to be patient and stay the course.

Eventually, your savings, time and the magic of compound interest will do their work. One day, you will reach the amount that will, according to the 4% rule (or another withdrawal rate of your choice), cover your annual expenses. You will no longer need to work.

If you do continue to work, it will be because you want to, not because you have to.

I Quit!

Probably no one handles this step the same way. However, three types of people stand out:

  • Eager people will not wait to reach exactly their magical number. They will quit as soon as possible and will find alternatives to make up for the missing income to cover their expenses. We could call them semi-retired.
  • Patient people will wait to reach their magical number to ensure that all their expenses are covered. They will no longer have to think about working for money, ever again.
  • Anxious people, on the other hand, will be more afraid to quit. What if it doesn’t work? What if they run out of money? What if a disaster strikes? Perhaps it’d be better to work for one more year, if necessary?

Do you recognize yourself in one of these?

Whichever you relate to, don’t lose sight of all the freedom that your wealth will bring you.

Hope for the Best, Prepare for the Worst

I am convinced that if you have the resourcefulness, discipline and the will to achieve FI, you will be able to handle the hazards of a young retiree’s life. However, for the anxious people, it’s important to put certain systems in place to ensure that the plan works smoothly.

No one wants a stock market drop right after resigning. Unfortunately, it can happen. If your portfolio drops by 30%, you will temporarily no longer have 25 times your annual expenses. Your money may run out faster than planned.

Therefore, it’s necessary to plan everything before pulling the plug and know how to manage a crisis.

Solutions

So for the anxious ones out there, here are some strategies to consider:

How to Prepare for the Crisis
  • Choose a “safer” withdrawal rate than 4%;
  • Review your portfolio Asset Allocation (stock/bond ratio);
  • Build an emergency fund;
  • Build a Yield Shield, which involves pivoting some of your assets to earn more dividends during the first few years of retirement. That way, dividends will cover a greater portion of your annual expenses and you’ll avoid selling low during a stock market drop.
How to Manage the Crisis
  • Lower expenses to the bare minimum (as close as possible to 4% of your portfolio’s new value);
  • Work temporarily;
  • Weather the storm in a country where the cost of living is lower (or as the Millennial-Revolution authors put it: “If shit hits the fan, we’re going to Thailand”);
  • Avoid selling your stocks while it’s low by selling bonds instead and using dividends to cover expenses.

 

Of course, it’s not all black and white. There are different opinions on the subject. Notably, financial planner and tax accountant Ed Rempel challenges all these conventional retirement strategies in this article and offers alternative ones. 🙂

If the idea of quitting and living off your investments makes you anxious, even if the calculations work, it’s up to you to think of strategies that’ll give you peace of mind, so you can go for it!

And when in doubt, read these wise words:

There is a way out of every box, a solution to every puzzle; it’s just a matter of finding it.

– Captain Jean-Luc Picard

Gifts From the Government

You now have a foolproof plan. Your investments will generate enough income to cover your expenses forever. On top of that, there are some things that should not be overlooked.

Regardless of your age once you reach FI, you will have access to certain refundable tax credits, provided you have a low enough taxable income.

In 2020, the maximum you can get for the Federal GST/HST Credit is $443.00. The maximum amount for the Quebec Provincial Solidarity Tax Credit is $1,015.00. We are talking about $1,458 per year combined! To generate this amount of passive income by yourself, you would need $36,450 ($1,458 x 25) in investments. It doesn’t mean you can rely on it to fund your retirement, but it can be seen as a significant bonus, as long as those credits are available.

I’m not gonna lie. Our governments are very generous. But they are particularly generous with families.

As a single woman with no children, I am not the best person to explain the advantage a low taxable income can have on the various government family allowances and child benefits. However, this article from Financial Independence Hub might give you some pointers.

Public Pension Plans

Now, you cannot overlook the different sources of income available when reaching the traditional retirement age. I am, of course, talking about Québec Pension Plan (QPP) or Canada Pension Plan (CPP) for the rest of Canada, and Old Age Security (OAS).

It is difficult to estimate what these amounts will look like in several years or even decades. However, the QPP gives access to your own Statement of Participation on their website. Under section 3, you’ll find the current monthly pension amount. That amount is an estimate of the pension you will receive at the specified age, if there are no other incomes added until then.

The SimulR tool is also very interesting since it allows you to see what the QPP and OAS amounts might look like at different retirement ages (60, 65 or 70 years).

In 2020 dollars, the maximum monthly amount of OAS is $614.14, or $7,369.68 per year. In addition, the Guaranteed Income Supplement (GIS) can be added on top of OAS. For example, single persons with less than $18,624 in taxable annual income can get up to $917.29 more per month, or $11,007.48 per year.

So, yes, your investments must fund your retirement for the rest of your life, but from the age 60 (for QPP) or 65 (for OAS), you will have the opportunity to have other sources of income. At that point, you could reduce withdrawals from your investments, as your expenses will now be partially covered by these incomes.

If you need to withdraw 4% of your investments for only half of your retirement, it increases the chances that your money will survive your early retirement and outlast you. 🙂

Unless you simply choose to spend more. 😉

More Tax Optimization

It’s the previously mentioned taxable incomes that make tax optimization so relevant right from the start.

The withdrawal part is a very complex subject, which requires a lot of planning and doesn’t have a one size fits all plan. Considering that I have not yet reached FI myself, I am not in the best position to tell you what to do. However, I want to bring to your attention some of the key tax notions.

In my previous article, I mentioned that it is strategic to choose which registered accounts to maximize first. It will be equally strategic to choose which account to withdraw from first, for the same reasons.

Tap Into Your RRSP Immediately

One might be tempted to dip into that pretty large TFSA from the get-go to get tax-free income. However, that would be a mistake.

If you don’t want to end up with a huge tax bill later in life, you’ll have to start withdrawing from your RRSP (and/or LIRA) right away. Keep in mind that QPP/CPP and OAS will be taxable. If you use your TFSA from the start, you keep the taxable accounts (RRSP, LIRA, non-registered accounts) for later.

Also, the RRSP must be transferred to a Registered Retirement Income Fund (RRIF) at age 71 at the latest and a minimum annual withdrawal is based on age. For example, the minimum withdrawal rate at age 71 is 5.28% in 2020. That is well above the 4% rule. The same principle applies to the LIRA, which must be transferred to a Life Income Fund (LIF). If you’ve never withdrawn from these accounts before then, you will now have significant taxable income, in addition to QPP and OAS income. As a result, all those incomes will be taxable at the same time. This will bring you to a higher marginal tax rate. The tax bill will be brutal!

Pierre-Yves McSween’s book Liberté 45 also addresses the subject in chapter 17. He calls it the amortization strategy or the art of spreading your RRSP withdrawals to reduce your tax. Here is my rough translation:

Most people start withdrawing from their RRSP in retirement, usually around age 65.

However, at age 65, you can have other sources of income: Old Age Security, Quebec Pension Plan (QPP, which can also be delayed until age 70 to increase the monthly pension), a portion of the pension accumulated with an employer, etc. Therefore, the more you withdraw from your RRSP per year, the more likely you are to raise your marginal tax rate and lose net income.

Pay Little to No Tax

For example, by spreading your RRSP withdrawal, you can pay almost $0 in taxes. Indeed, our generous governments provide basic personal tax-exempt amounts. In 2020, the amounts are set as follows:

  • Federal: $13,229.00
  • Provincial (QC): $15,532.00

Of course, these amounts will increase over the years. As a matter of fact, future federal amounts are already known:

  • 2021: $13,808
  • 2022: $14,398
  • 2023: $15,000

If you manage to keep your taxable income below the basic personal amount threshold, you pay $0 in tax. Additionally, refundable credits and family allowances will be maximized and you’ll be eligible for GIS later! Only good things, right?

Of course, if you plan to have higher annual expenses than the basic personal amounts, you will have to pay some taxes. You can do calculations with this simulator and get an idea of your marginal tax rate accordingly. You could also withdraw the balance from your TFSA and then pay no tax.

In addition, while drawing down from your RRSP and LIRA, your TFSA continues to grow. Later, it will become the main source of passive income. This income will therefore be nontaxable, forever. Very convenient when comes the time to receive QPP/CPP and OAS.

Long story short? Neglecting tax optimization is leaving money on the table. You remember what I think of leaving money on the table, right?

My Plan

First, you’re probably wondering what my “number” is. It’s still a work in progress, since I still have to track my expenses over several months (even years), to have a complete picture.

However, I estimate that I would be able to cover my essential retirement expenses with about $10,000 in today’s dollars. In addition, there would be trips and activities of all kinds. I still want to live once I’m retired. 😉 Thus, I aim for $15,000 in annual expenses. With the 4% rule, I get $375,000 ($15,000 * $25) as a magic number.

However, I have to consider inflation (average of 2%) in my projections. Since I aim for FI at 35, at the latest, I have to plan until 2026.

  • 2021: $15,300 * 25 = $382,500
  • 2022: $15,606 * 25 = $390,150
  • 2023: $15,918 * 25 = $397,950
  • 2024: $16,236 * 25 = $405,900
  • 2025: $16,561 * 25 = $414,025
  • 2026: $16,892 * 25 = $422,300
  • So by 2026 at the latest, I would need $422,300 in investments to cover $16,892 in annual expenses. This number includes my DBPP commuted value that I will take once I resign. I estimate that value will be around $100,000.

    That’s when I’ll have to start withdrawing from my investments. After years of piling up money, that’ll feel weird!

    At that time, I am considering applying certain strategies to optimize withdrawals. Here they are, in no particular order:

    There you go. It’s still a very rough draft. I will surely make a whole post on the subject, because some points are already more elaborate than others in my plan. I’m also currently looking into Ed Rempel’s alternative strategies. However, nothing is set in stone. I still have six years to prepare for that moment, and build a foolproof plan.

    Let the Chips Fall Where They May

    Finally, remember that a worker’s life is not without its pitfalls. If there is one lesson to be learned from 2020, it’s that no one is safe from layoffs, bankruptcies or illnesses. Some people are currently experiencing significant financial difficulties and must deal with those situations and find solutions.

    The early retiree’s life will also have its share of obstacles. If tightening your belt, going to Thailand or work temporarily are the worst-case scenarios, no one is going to cry for you. It’s all a matter of perspective.

    The best way to ensure a comfortable financial future over several decades is to have a solid plan and review it on a regular basis.

    Our species can only survive if we have obstacles to overcome.

    – Captain James T. Kirk

    This puts and end to my Steps to FI series. I hope you enjoyed it and you’ve learned something! The idea is to give you as much information as possible to help you take action. 🙂

    I already have a ton of ideas for my next articles, so stay tuned!

    Invest Your Savings

    Ah, investing. That big, scary monster. The cause of countless cases of analysis paralysis.

    There is so much information available about investing, you would assume it’s now easier than ever to get started. In fact, it’s quite the opposite. There is so much information out there, it’s overwhelming.  Since some of the information can be so contradictory, many will simply give up before they even started.

    Does that sound familiar? I’ve been there. 

    So exactly where do we start?

    This article will be littered with links and references. There is a lot of information to consider on the subject and I don’t want to bore you (or scare you). Rather than rehash information, I’d rather send you to excellent sources. 🙂

    Disclaimer

    First, let’s get some things straight. I’m not a financial advisor. I am not licensed to make financial recommendations. This article will not provide financial advice, but will rather provide my personal opinions. I will only try, to the best of my knowledge, to explain how important investing your savings as early as possible is. I prefer to simply refer you to some of the best resources. The goal is to help you avoid analysis paralysis and take action.

    Compound Interest, the Eighth Wonder

    In my last post, I postponed the importance of return until later. When starting to save, you have to focus on maximizing the savings rate first. This is what really makes the difference when starting to accumulate wealth.

    Eventually, return will become your best friend.

    One of the best metaphors I’ve read so far to illustrate the power of compound interest is from Robert R. Brown’s excellent book Wealthing Like Rabbits. I can’t recommend this personal finance book enough. It is loaded with pop culture references (including Star Trek!), and manages to make personal finance really accessible to millennials.

    In the book, you may have guessed by its title, compound interest is compared to rabbits doing, well, what they do best:

    Imagine you’re on a great big island. […] Now imagine that some farmer decides it would be fun to go hunting rabbits on his farm on the great big island. So, he obtains twenty-four rabbits from a distant and foreign land and releases them onto his farm on the great big island. The rabbits then proceed to do what rabbits do best every chance they get.

    Here’s my question:

    Approximately how many rabbits do you think would be on the great big island after about sixty years?

    […]

    Would you believe about ten billion? Yes, you read that right. Ten billion rabbits. Amazing, isn’t it?

    Well, compound interest is like that. The money you invest will make money, which will also make more money, and so on and so forth, exponentially. The most important factor in favour of compound interest is time. The more time you have to invest, the longer compound interest will work its magic. Hence the importance of starting as soon as possible.

    To learn more about compound interest, in addition to reading Wealthing Like Rabbits, check out these articles:

    These articles provide concrete examples with numbers to illustrate the power of compound interest. Enough to make you want to invest right away, right? 😉

    Risk and Return

    Of course, to get return worthy of rabbits doing it like, well, rabbits, you have to be prepared to live with the ups and downs of the stock market.

    As the 62nd Rule of Acquisition states: The riskier the road, the greater the profit.

    If you turn your back on risk, you turn your back on a decent return.

    To learn more about the link between risk and return, I invite you to look at these L’indice McSween segments (French only):

    It all comes back to the riskier the road, the greater the profit. The more risk you are willing to take, the more compound interest will operate.

    Another nice rule to remember to help you visualize the power of return (and why you should take more risk), is the Rule of 72. Dividing 72 by the expected return equals the number of years needed to double the value of an investment. For example:

    • A 10% return will take 7.2 years to double your initial investment.
    • On the other hand, if you settle for a 1% Guaranteed Investment Certificate (GIC), let’s say, your initial investment will take 72 years to double.

    That GIC is suddenly much less attractive, isn’t it? 

    Wealthsimple made it the subject of an entire article, if you want to learn more about it.

    In short, because risk and return are so closely linked, you need to have an idea of your risk tolerance. That will tell you what kind of return you can expect. Fortunately, several online questionnaires are available to help you figure it out. Among others, the Autorité des marchés financiers (AMF) offers a tool to help determine your investor profile.

    Asset Allocation

    Once our risk tolerance is figures out, we can look at our future portfolio’s asset allocation.

    There are two main classes of assets to consider for your portfolio:

    • Stocks are volatile, somewhat risky (depending on diversification, of course), but there is long-term high return.
    • Bonds, on the other hand, provide stability at the expense of return.

    Thus, we can modulate our desired return and risk by adjusting the stocks to bonds ratio.

    A fairly common rule of thumb is to use your age as your percentage of bonds, and invest the difference in stocks. So a 20 year-old would have 20% bonds and 80% stocks. A young investor can afford more volatility, since they have a longer investment horizon than, let’s say, someone in their 50s. A 50-year-old should aim for a 50/50 ratio.

    Another more aggressive rule of thumb is to subtract your age from 120 to get your percentage of stocks. Accordingly, the same 20-year-old would have 100% stocks, while the 50-year-old would have 70%.

    Of course, these are simple rules of thumb. Your asset allocation always comes down to your risk tolerance. An aggressive 70-year-old investor might opt for a 100% stocks, while a (overly) cautious 20-year-old might choose to put his savings into a GIC (remember what I said earlier about GICs?) To each their own tolerance.

    However, I am 100 % sure that risk aversion can be cured with a great deal of financial education. 😉

    RRSP or TFSA?

    This is the kind of question that comes up very often. Anyone thinking about retirement investing will consider the RRSP. However, most people do not even know that it is possible to invest in a TFSA. With a name like the Tax-Free Savings Account, people seem to assume that’s just that: a boring savings account offering 0.10% interest. The government is in no hurry to correct those assumptions, since the TFSA is, in Pierre-Yves McSween’s words, a weapon of mass tax destruction. 

    Any income from a TFSA is tax-free. If part of your portfolio’s passive income is non-taxable, that means less money to the taxman and more money for you. For more details on this real tax gift, I invite you to take a look at this very comprehensive article from Tawcan.com.

    So, knowing this, RRSP or TFSA?

    You may find me predictable, but…

    Both.

    No matter how much you need to cover your retirement expenses according to the 4% Rule (25 times your expenses), I suspect it is at least a few hundred thousand dollars.

    To reach such an amount, you’ll need to save a lot. And while RRSPs and TFSAs are nice tax gifts, all good things come to an end. There is, of course, a maximum of contributions established for each account. You can find your personal contribution limits in your CRA Account.

    Knowing this, your savings will inevitably reach the contribution limits for these two registered accounts. Once both accounts are maxed out, you’ll move on to non-registered accounts.

    However, maxing out these accounts is better done in that order:

    • It is preferable to invest in a TFSA when earning a smaller income in a lower tax bracket. The rule of thumb here would be to invest in a TFSA, and once it’s maxed out, switch to the RRSP.
    • Conversely, it is preferable to invest in a RRSP when already earning a higher income in a higher tax bracket. This helps reduce the tax bill. Once the RRSP is maxed out, switch to the TFSA. 

    But remember that to achieve FI, both accounts will inevitably be maxed out. No need to overthink which one is best.

    Beating the Market Is a Myth

    You may be thinking that since you don’t know what to invest in, it’d be better to let a portfolio manager take care of it. Plus, since they’re professionals, they’ll beat the market, right?

    Do you know how many portfolio managers outperform the market?

    11%.

    You understand, as I do, that the remaining 89% fails. And they’re professionals! How are we supposed to do any better?

    When you think about it, is it really talent, or just sheer luck that makes anyone beat the market? To add insult to injury, these so-called professionals will charge you outrageous fees for their disappointing results! Even if their return is already negative! Thieves! 

    So why not settle for market returns, instead of trying to beat it?

    Take a look at the S&P 500 index (based on the 500 largest U.S. companies). Or at the S&P/TSX index (based on the 60 largest companies listed on the Toronto Stock Exchange).

    Not bad at all, is it? It’s pretty obvious that there is an upward trend in the long-term return. Good thing our investment horizon is long-term too!

    Knowing this, isn’t it great to learn that there are index funds (which hold the same assets as an index), which aim to replicate those returns. And since it’s a boring passive investment method, the fees are lower than actively managed funds. Fantastic, isn’t it?

    Long story short, trying to beat the market is futile and expensive (isn’t it ironic?). Instead, own the market. Choose low-cost index funds.

    You’re wondering which index funds to choose? There are models out there for you! Notably, you can take a look at those index fund portfolio models presented by the excellent website Canadian Couch Potato.

    My First Investments

    My first investments date back to 2014. My then employer encouraged us to contribute to FTQ and Fondaction RRSPs, in addition to one of their own mutual funds. I knew next to nothing about investing at the time, but the meagre pay deduction required to generate a juicy tax refund was enough to convince me.

    After that, I started looking into personal finance and reading (obsessively) on the subject in early 2017. Everywhere I looked, the importance of investing as early as possible kept coming up. I understood that I had to take advantage of compound interests over the next few decades, but I wasn’t too sure how to proceed. I read all about stocks, bonds, ETFs, mutual funds, but I could not make heads or tails of it.

    After reading Andrew Hallam’s Millionaire Teacher, I was finally able to take action. He managed to make investing accessible to me. While he mostly emphasized on buying index ETFs through online brokers (for lower fees), he also recognized that Tangerine offered affordable and accessible investment funds. As most of my banking was already done with Tangerine, it did not fall on deaf ears. 

    Shortly after, I opened my first individual RRSP and I started investing with regular automated deposits in their most aggressive fund (100% stocks). Considering my age (26) and my Defined Benefit Pension Plan (DBPP), I could handle the most aggressive portfolio possible.

    After that, I continued learning on investing and gained confidence. Just a few weeks later, I decided to invest in a Wealthsimple RRSP, out of curiosity. Their fees were lower than Tangerine’s (0.50% vs. 1.07%). However, they didn’t have a 100% stock portfolio. At the time, from memory, the most aggressive they offered was 80/20. 

    It was about a year later that I decided to open an account with Questrade. I was then able to start investing in index ETFs, here and there, with a few thousand dollars. I was learning as I went along.

    It was in November 2018 that I had to take the DIY investing more seriously. A few months earlier, I started a new job for another company. I decided to take my old job’s DBPP commuted value over to Questrade. A portion (approximately $29K) had to go into a Locked-In Retirement Account (LIRA) and the surplus (approximately $13K) would go into my RRSP. 

    I suddenly felt like I had a fortune to invest, all by own self. I learned everything I possibly could and proceeded to invest my money.

    Since then, I have transferred all other RRSPs to Questrade, except for my worker’s funds. These are not reputed to be easy to transfer or withdraw, let me tell you that. I also started investing in a TFSA, once my RRSP was maxed out (thanks to the DBPP commuted value surplus). Once I max out my TFSA, I’ll have to open a non-registered account, also offered by Questrade. I still have $49,000 in contributions to make up for, so that’s definitely not a problem for today. 😉

    My Current Portfolio

    I’ve had different strategies during my few years as an investor, but I’ve switched things around last July. Currently, my portfolio is made up of 94% stocks (XEQT) and 6% bonds (ZAG). It’s a pretty simple, borderline boring, portfolio, but it’s all I really need. On top of that, the fees are about 0.19%. That’s a long way from actively managed mutual funds. 🙂

    Why a 94/6 ratio? Because it was actually 90/10, but during the stock markets little hiccups in September and October, I sold some bonds to buy stocks at a discount. 🙂

    Ultimately, I plan to sell all bonds to have a portfolio consisting solely of stocks. I want to maximize my return during the accumulation phase. I’m playing with the idea for now. The next stock market dip might convince me to make a move, who knows!

    Which Platform to Use

    As you noticed, I now do all my investing through Questrade. If you are interested in opening an account, please use my QPass Key 665709686438830 and we will both get $25.

    However, there are multiple other options available to you. If you prefer to work with an advisor, go right ahead! However, make sure that the professional in question is there to advise you, not to sell you investments that will benefit him more than to you.

    And as there is a ton of platforms, Hardbacon offers excellent comparators, both for Robo-Advisors and for Online Brokers, which could possibly help you make a pick.

    Keep in mind that it is always best to go for the lowest possible fees. One percent fees can make a huge difference on your return. This Get Smarter About Money calculator shows the impact fees can have on your investments. Don’t let the bank take away your return.

    Another interesting alternative for people who want to start investing, without too much thought: Tangerine’s investment funds. Management fees are a bit high (1.07%) compared to online brokers or robo-advisors, but reasonable compared to big banks’ mutual funds (usually more than 2%).

    Personally, I think it’s a great way to start investing without having to think too hard about it. Tangerine keeps it rather simple with only 5 different index funds, modelled according to the client’s risk tolerance (which is assessed by answering a questionnaire). Automate your savings and don’t think about it again!

    If you don’t already have an account with Tangerine and you’re interested in opening one, feel free to use my Orange Key 45955399S1 and we’ll both get $50.

    That’s how I started investing, and I’m really grateful to have had this easy option when everything else seemed impossibly complex. It gave me the opportunity to put my small savings to work, while I didn’t feel confident yet for more complex alternatives.

    Now Will Never Come Again

    Remember that the best time to start investing was yesterday, the second-best time is today, and the worst time is to wait until tomorrow. Whichever path you choose, start investing now.

    Live now; make now always the most precious time. Now will never come again.

    – Captain Jean-Luc Picard

    The worst thing that can happen to you is analysis paralysis, and end up doing nothing. It’s terrifying to make decisions on a subject you barely know. I’m very aware of that. I can only tell you that the important thing is to start. Take the easiest option to begin with, then learn more on the subject as needed, and then make adjustments. Or keep it simple forever. It can’t be worse than sticking your money under the mattress. 🙂

    Thank you for reading my article, which turned out quite lengthy despite all my best efforts. What can I say, I really like investing! 😉

    Don’t hesitate to comment. I look forward to reading and answering, especially if you feel lost and would like to brainstorm. If you prefer a little more discretion to talk about investing, you can write to me directly on my Contact page or with Messenger through my Facebook page.

    See you next week!

    Save the Balance

    Finally, we’re getting down to business.

    It’s good to have lowered our expenses and increased our income, but what do we do with the balance at the end of the month?

    While it is almost shameful to save money in Quebec, it is essential to talk about it (and do it) if we’re hoping to reach financial independence someday. No more saving shaming, to use Pierre-Yves McSween’s dramatic expression.

    You Gotta Treat Yourself!

    If you’re like most people around me, then you’re having a hard time leaving a single dollar in your wallet without spending it. These people constantly justify these expenses on behalf of a “treat” or a “small gift” they make for themselves (a latte, anyone?).

    I don’t know about you, but unnecessary expenses that come back every week (or even every day) are no longer treats, but rather a (bad) habit.

    We have to break this pattern. It’s that kind of mindset that renders people dependent of a job until age 65 (and beyond), with QPP/CPP and OAS as sole retirement income.

    You have to understand that only a few percentages of savings can represent years of hard work!

    Do you know Mr. Money Mustache? I can’t really talk about financial independence and early retirement without mentioning him. He managed to retire at 30, and became one of the first prominent bloggers on the subject.

    If there is one of his articles worth mentioning here, it’s The Shockingly Simple Math Behind Early Retirement.

    In this article, he presents a (shockingly) simple table that predicts the time left before financial independence based on different savings rates.

    The table is based on:

    • An after-inflation return of 5% during the accumulative phase;
    • A 4 % withdrawal rate.

    You can also play around with this online calculator, which Mr. Money Mustache based his chart on.

    Go ahead, see how much time you need to work before reaching FI.

    The Calculation Method

    Perhaps you are wondering how to calculate your savings rate?

    Let’s keep it simple. First, consider how much you manage to set aside from each paycheck.

    If the amount is zero, then the savings rate is obviously 0 %. Unless you have a pension plan offered by your employer, it means you’ll have to work forever, or settle for the QPP/CPP and OAS as sole retirement income.

    Then we’ll use your net pay (after tax). Take the amount deposited into your account every week or two weeks by your employer. Of course, for the self-employed, it can be more complicated. In this case, the best would be to estimate.

    Then you apply the simple mathematical rule:

    (Amount saved / net income) * 100

    Some people like to think of debt repayment as (forced) savings and include it in the calculation. As a result, the savings rate is inflated (and it possibly helps people sleep at night). However, it is not relevant in our calculation. While it does increase your net worth, it will not give you passive income in retirement.

    So, if we keep it simple with the previously mentioned formula, someone who receives $1,500 and sets $300 aside has a 20% savings rate. There is $1,200 left to cover expenses until the next pay.

    According to the calculator mentioned above (or Mr. Money Mustache’s table), someone with zero net worth who starts saving 20% of their net income will have to work for 37 years before they reach financial independence. For example, if that person is 18, they can expect to retire at age 55. That’s already considered early retirement!

    On the other hand, if that same person managed to save 30%, or $150 more per pay, they would only have to work for 28 years, or 9 years less!

    9 years!

    This person would be financially free at 46.

    It might just be worth changing mobile phone plan after all.

    The Power of Saving

    While striving for financial independence, your best ally will be your savings rate.

    Before you read this post, you might have thought that what mattered was investment returns. Although not insignificant, we unfortunately do not feel the effects straight off the bat. It is later in the process that return has an essential role.

    Keep in mind that return doesn’t matter when you’re only just starting to save. Making 10% return on $0 is still $0. So we have to focus elsewhere. That elsewhere being our savings rate.

    For example, my sister only started to save and invest seriously this year (I like to think I have some influence!). Although she’s getting close to $30,000 in savings already, she sees very little return. Indeed, even if she were to make a 10% return, it would still only amount to $3,000 in gain. While it’s nice to realize you made $3,000 without even working, it’s not what really makes your portfolio grow fast.

    In her case, what really makes the difference is the 60% she saves on each pay. By the end of the year, her investments will have increased by $20,000-30,000 only from saving.

    On the other hand, when my sister reaches $200,000 in investment and her 10% return gives her $20,000 in gain, then we’ll talk about the power of investments returns. 🙂

    Savings in Québec

    In November 2019, we were told that Quebecers’ savings rate was at its highest level in 23 years. We were proud to see that Quebecers had never put so much money aside. (French source)

    Wow! Quebecers are getting their personal finances on track! And what would this incredible savings rate be?

    6,2 %.

    Someone starting from scratch, saving this little, can expect to work more than 60 years before reaching financial independence.

    Ow.

    On the other hand, 2020 has given us many twists and turns. Against all odds, the savings rate recorded by L’institut de la statistique du Québec from April to June 2020 was at its highest levels for the past 40 years. Indeed, Quebecers managed to save nearly 35% of their net income in the midst of the crisis.

    Now we’re talking! A 35% savings rate equals 25 years of work. Imagine if that became common? Early retirement would then be the new norm. 😉

    However, this record savings rate is mainly due to mortgage and other debt deferrals. Thus, when normal debt repayment resumes, the savings rate will fall back to the pre-pandemic rates.

    Let’s just hope that Quebecers have taken a liking to saving.

    My Savings Rate

    I have not always been a very conscientious saver. Prior to 2017, my voluntary savings rate (i.e. excluding employer pension/RRSP contributions) was 0%. I didn’t have an individual RRSP. The TFSA I had, I was making withdrawals as I went along.

    After that, I started saving little by little. I didn’t record everything from the get-go, so the best I can do is estimate. I can estimate my 2019 savings rate to be around 27%. In 2020, I estimate I’ll reach 51%. Now I record everything (and I mean everything), so I should be able to give you accurate numbers in my future annual reviews. 🙂

    For someone starting from a zero net worth, a 51% savings rate amounts to about 17 years of work. For someone saving that much at a young age, early retirement is inevitable. 😉

    In my case, with more than $100,000 invested already, we’re talking about 10 years of work before reaching my goal. Leaving the corporate world at 39 wouldn’t be so bad!

    However, my savings rate calculation does not include my (non-negligible) Defined Benefit Pension Plan (DBPP). Currently, my DBPP contributions are about 8-9% of my gross salary, without counting my employer’s contribution.

    After quitting, I plan to take the commuted value and invest it in a Locked-in retirement account (LIRA). My pension’s minimum commuted value is 175% of the employee’s salary contributions plus interest. These “forced” savings substantially brings me even closer to my goal.

    Finally, I estimate that I’ll be able to save at least 60% of my income in the coming years, once my car is fully reimbursed. Plus my salary should continue to increase every year!

    So, considering the investments I already have, my DBPP and a future savings rate of 60%, I actually estimate 6 years before financial independence. We are talking about an early retirement at the ripe old age of 35! 😉

    Financial Independence Is on the Horizon

    Do you understand the power of saving now? Financial independence awaits you! With each additional percentage of savings, you reduce the time you have left in the workplace! The phrase “Time is money” makes perfect sense now, doesn’t it? When $150 every two weeks means nine years of work, it’s worth making changes.

    The best way to painlessly increase your savings rate is to automate. On payday, set up pre-authorized transfers for the savings rate you’re aiming for. Then you only spend what’s left. This is called paying yourself first.

    So, did you do some calculation? Are you closer to your goal than you thought? Financial independence is possible. Don’t doubt it.

    Things are only impossible until they’re not.

    – Captain Jean-Luc Picard

    What’s Next?

    My next post will be about investing. You can save all the money you want, but if you just hide it under the mattress (almost the equivalent of putting it in a GIC, really), then early retirement will not be possible. Without a decent return, your savings would be wiped out long before you die, and we don’t want that. Once we stop working, our money has to work for us for as long as we live.

    I know that investing in the stock market can be terrifying. Therefore, I will try to make the subject as accessible as possible. Anyone who neglects to invest their savings leaves (huge!) money on the table.

    And I don’t like leaving money on the table.

    Increase Your Income

    How was your week? After reading my last post, have you started assessing your level of spending? Have you started tracking every expense? Have you made a few phone calls to get better prices? I’m very curious about your journey!

    Now that we have clearly understood the importance of lowering expenses, it becomes relevant to think about increasing our income. Because as soon as our expenses are optimized, the extra income will only increase our savings rate!

    Of course, that doesn’t mean you can’t save on smaller wages. Again, it all starts with lowering your expenses.

    My Income

    For example, here is my annual income at the end of each year I’ve worked (information obtained from the CRA). This includes the years I worked part-time work during my studies (2009-2014) until now:

    2009 $6,442
    2010 $15,790
    2011 $27,927
    2012 $26,077
    2013 $27,264
    2014 $43,156
    2015 $52,570
    2016 $58,345
    2017 $59,369
    2018 $59,958
    2019 $63,288
    2020 (estimate) $77,640

     

    Between getting my college degree in the spring of 2010 and starting my bachelor’s degree in the fall of 2011, I took a year off to put money aside. Result: I saved more than $10,000. You’ll notice that despite low income, this is a significant savings rate.

    In addition, considering all 12 years in the workforce, my average annual salary rounds up to $43,152, which is still below the average wage in Quebec. And yet, as of today, I have over $100,000 in investments. Of course some of it comes from investment returns, but I estimate $70,000 came directly from my savings. The ability to save clearly does not rely solely on income.

    In my previous post, I talked about people increasing their spending at the same rate as their income, thus never having any money to spare. That is what we must avoid at all costs. So, yes, increasing our income can be a very powerful tool in achieving our goals, but only when we are able to avoid lifestyle inflation. Otherwise, it’s a fool’s errand.

    How to Do It

    Increasing your income is easier said than done, you might say. Indeed, it’s nice on paper. But how do we go about it? Like anything else, it takes hard work, determination and even courage.

    Here are some examples of how to get more income, in order to increase your savings rate.

    • Ask for a raise
    • Get a promotion
    • Change employer
    • Get a second job
    • Work overtime
    • Sell belongings
    • Start your own business
    • Respond to paid surveys (through Swagbucks)
    • Become a mystery shopper
    • Rent a room in your home
    • Participate in clinical trials

    Have you ever implemented any of these strategies? Of course, I’m not saying you need to try all of them. Just remember that every action matters.

    How I Increased my Income

    As you’ve seen above, my income has steadily increased over the years.

    The large variations can mostly be explained by changing employers. Indeed, in 2014, after four years working for the same company, I made the leap to work for a competitor for a better salary.

    Then, after four years of stagnating for that employer, with no hope of advancement on the horizon (I was unionized), I made the leap again in 2018. I did it for roughly the same salary at the time, but the prospects for short-term advancement were excellent. In fact, it only took 9 months for me to be promoted, which explains the increase in 2019. The 2020 increase, on the other hand, is thanks to a raise that I simply asked for.

    My journey so far leads me to make two observations. The first one being:

    1. If you do not ask, the answer will always be no. Go ask for that raise or that promotion you think you deserve! The answer might surprise you. Who wouldn’t be happy to have more money for the same job or hours? Worst-case scenario: you’ll be turned down. And if that’s the case, well, maybe it’ll make you think about your future working for this employer. Ditto for those in a unionized environment who have little or no prospect of advancement. Which brings me to my second observation:
    2. Loyalty benefits only the employer. If you’re dissatisfied with your career working for a company, or don’t feel appreciated or fairly paid, look elsewhere! Again, you might be surprised at what the competition is willing to offer to have you.

    In addition to these changes, I always let my bosses know that I am open to working overtime. It is not always possible, but when the opportunity is there, I seize it. Working for 1.5 times my regular rate? Oh, hell yes!

    I’ve also been doing paid surveys through Swagbucks since 2018, now and then. It’s not big money, but I’ve still racked up over $1,600 in Amazon gift cards since then. It may not sound like much, but it is $1,600 that I did not have to draw from my paychecks. 🙂

    Considering that I am single without children, I have no shortage of free time. I could easily find a second job to increase my income even more. There are plenty of options in the labour shortage we are currently experiencing. It could be as simple as putting my car to use and delivering food via UberEats or Doordash.

    I’m aware of my options, but sometimes it’s hard to choose to work more, instead of knitting in front of a Star Trek episode. 🙂

    It all comes down to choices. 😉

    Do Not Overlook Tax Optimization

    Increasing gross income is good, but increasing net income is even better. No one wants to see their extra income go up in smoke because of taxes. How many times have we heard a colleague refuse to work overtime because they don’t want to pay extra taxes? Too bad for them. This is where it becomes relevant to take advantage of the various deductions and tax credits offered to you.

    The most obvious deduction (and relevant in our path to financial independence) are the RRSP contributions. Each amount deposited into an RRSP will reduce your taxable income. This why you end up with a nice tax refund in April. If you also contribute to a worker’s fund RRSP, such as FTQ or Fondaction, you’d also receive a 30% or 35% tax credit.

    For people with lower income, reducing taxable income could increase access to various credits such as the federal GST/HST Credit and the provincial Solidarity Tax Credit.

    Even better for families: reducing taxable income could increase the various tax-free family allowances. This topic being far from my expertise, I’d rather refer you to an expert in the field, the author of the blog called Se payer en premier, who describes his strategy in this article (French only). I also invite you to read chapter 10 entitled “Québec, le paradis fiscal des familles” (Quebec, Tax Haven for Families) in Liberté 45 by Pierre-Yves McSween (French only too, but hopefully there will be an English version soon enough). It almost makes me want to have children. 😉

    In short, please don’t leave money on the table when it comes to filing your taxes. Knowledge is power. Find out about the various credits and deductions that apply to your situation to maximize your net income and minimize your tax bill, especially if you do your own taxes.

    Bring Home the Bacon

    Those were only just a few examples to help you make an extra buck. In my opinion, with an optimized level of spending, you are already in an excellent position to start saving. If you manage to get a little more income here and there, it’s a bonus!

    On the other hand, this step has an undeniable advantage over lowering expenses. You understand that you can lower expenses only to a certain extent. On the other hand, increasing income has no limit. It all depends on the effort you are willing to make.

    I’m already looking forward to writing about the next step. Now that we have lowered our expenses and increased our income, we will address the power of savings in our goal of financial independence. In the meantime, I invite you to calculate your current savings rate, or the one you intend to achieve once all the right strategies are in place. We’ll talk about it next week. 😉

    Lower Your Expenses

    As promised, here is my first post in a series of five which will focus on the steps towards financial independence. Let’s kick things off with a big one! We will talk about lowering our expenses.

    I’m already starting to lose you, aren’t I? In Quebec, we are so afraid of being perceived as cheap that we spend money like there is no tomorrow. Want proof? The average household debt in 2018 was 170%. You understand, as I do, that this means that for every $1 of disposable income, $1.70 is being spent. This is insanity!

    In addition, these indebted people will tell you how much better it would be if they made more money. Yet, when they get a raise or a promotion, what do these people do? Instead of trying to get out of debt or save, they spend even more. They finance a car. They go on a trip, paid with their credit card. They Buy Now, Pay Later for a Home Theater System. So they struggle to keep their head above water again, with no money to spare, and they’re already anxious for the next raise.

    When, in fact, we should start by applying a very simple concept: spend less than we earn. The statistics cited above unfortunately confirm that people spend (way) more than they earn.

    Where to Start

    Now that I made it clear that earning more does not solve the problem, let’s get down to business. What if we start by lowering expenses? When you think about it, it makes sense. Every $100 we don’t spend is $100 more in our bank account. On the other hand, working more to get an additional $100 ends up being $60-70 after taxes and deductions, in addition to costing you additional time. It’s easy to see which method is the most effective.

    So, what should we cut back on? Here’s a rough translation of something Daniel Germain said in his recent article L’épargne, une déclaration d’indépendance!:

    “It doesn’t mean giving up on a car, a house, children, a cat and a lawnmower. That doesn’t mean giving up on fun either. On the contrary: independence means knowing how to recognize what gives us true pleasure, not illusions and disappointments. Only what’s essential, really.”

    To focus on what expenses are essential, we first need to know where our money is going. It’s a good start to make an approximate budget and assume it’s accurate enough. However, have you ever bothered to track each one of your expenses? And I really mean each and every one. Every morning coffee at the drive-through, every $50 bill at the grocery store while we were “just getting milk”, every lottery ticket bought while paying for gas, and so on.

    If you want to try tracking your expenses, I invite you to read my monthly reviews to see what my own expense tracking looks like.

    It’s Optimization Time!

    Once this exercise is done, it will be much easier for you to target what can be eliminated or optimized. It’s a bit like the principle that Marie Kondo applies to tidying up: we only keep what sparks joy, and we get rid of the rest.

    Does it spark joy to pay $100 a month for your cell phone plan? No. So switch carrier for one that offers a better price.

    Does it spark you joy to know that your neighbour is paying $50 less than you for the same TV service? No. So call your provider and negotiate a lower price (or just cancel the service, because is that really essential?)

    Does it spark you joy to see your car insurance premiums increase year after year? No. So ask for quotes from other companies, increase your deductibles and reconsider your need for collision insurance.

    Does it spark you joy to travel? Oh, that it does! What about the bill, though? A little less. So learn about travel hacking (or how to travel the world on points).

    Once you’ve screened and optimized all expenses, you should be left with more money in your bank account at the end of the month.

    My expenses

    So it’s all good, but what do optimized expenses look like? I don’t pretend to have a perfect level of spending, far from it. However, I’ve already done some optimization over the last few years and I wanted to share the results with you. Additionally, sometimes we simply have no clue that the price we’re paying for service X is way higher than it should be. So, by comparing your expenses with mine, maybe it’ll prompt you to make a few phone calls.

    Currently, my fixed expenses look like this:

    Expenses Amount Annualized
    Housing
    – Rent
    – Home insurance

    $497.50/month
    $14.48/month

    $5,970.00
    $173.76
    Car
    – Payment
    – Auto Insurance
    – Gasoline
    – Registration
    – Oil Change
    – License

    $403.85/2 weeks
    $48.12/month
    $10.00/week
    $227.57/year
    $100.00/6 months
    $86.34/year

    $10,500.10
    $577.44
    $520.00
    $227.57
    $200.00
    $86.34
    Food
    – Grocery

    $50.00/week

    $2,600.00
    Utilities
    – Cell phone
    – Hydro (power)
    – Home Internet
    – Spotify
    – Netflix

    $31.57/month
    $29.50/month
    $28.75/month
    $7.15/month
    $7.00/month

    $378.84
    $354.00
    $345.00
    $85.80
    $84.00
    Donation
    CanadaHelps

    $10.00/month

    $120.00
    Cats
    – Food
    – Litter

    $30.00/month
    $20.00/month

    $360.00
    $240.00
    Total:   $22,822.85

    This does not include impulsive, unforeseen or exceptional expenses, but it does provide a good picture. If some amounts seem abnormally low to you, you must understand that I live in a 2-bedroom apartment with my sister. This way, most expenses are cut in half. Had I decided to live alone, I would have to cover the full expenses myself. It is a financial choice I made that allows me to lower my expenses considerably.

    You’ll notice that $22,822 in annual expenses combined with a net income estimated to $49,000 at the end of the year leaves me with extra money ($26,178) for savings and other expenses.

    Other Optimization Possibilities

    Of course, there is always room for more optimization. Here are a few examples.

    My current expenses for my car are extremely high at the moment. Fortunately, it will optimize itself once my car is paid in full in November 2021. As I mentioned in my September 2020 Review, I increased my payments to the maximum allowed by the bank to pay it off faster. This expense adds up to $10,500 per year, which is huge (46% of my fixed expenses). However, it also means that once the car is paid off, my fixed annual expenses will go down to $12,322!

    Housing is also subject to optimization. It is already somewhat optimized considering that I live with a roommate, instead of on my own. The current price I pay for rent seems to me quite favourable compared to a mortgage on a condo or a single-family home and other related costs. However, moving further away from my work would be additional optimization. Now that we can work from home, I can’t help but reconsider the relevance of paying more on rent to be live near my workplace, even though I have not set foot there in seven months. Even in a post-COVID world, it would be very surprising if I was ever recalled full time in the office.

    Of course, living close to my workplace will be useless once financially independent. At that time, this expense would benefit from Geographic Arbitrage. 🙂

    The 4% Rule

    I really have to insist on this particular step, since lowering your expenses really is the cornerstone of your path to financial independence. Even if you were to earn $200,000 a year, if you spend it in full, or God forbid, 170% of it, you won’t have a penny left at the end of the month. Remember our goal here is to be able to withdraw enough money from our investments to cover our annual expenses. So the fewer expenses we have, the less money we need to withdraw. Therefore, we’ll need a smaller amount invested as well!

    In fact, the 4% rule should be calculated on expenses, not income. Never heard of the 4% rule? In this case, let me direct you to excellent resources on the subject:

    Long story short, 4% is what experts consider the safe withdrawal rate. In order to know how much we need in investments to cover our annual expenses (which we previously calculated) at a safe withdrawal rate of 4%, we have to do the reverse calculation (100 / 4 = 25). That means we need to multiply our annual expenses by 25.

    For example, if we use my annual expenses previously mentioned, we come up with:

    $22,822 – $25 – $570,550

    This means that to cover my current annual expenses (which include payments on my car loan), I would need $570,550 in investments. On the other hand, once my car loan is paid off the calculation will go as follows:

    $12,322 – $25 – $308,050

    See the huge difference? I would need $262,500 less to cover my expenses at a 4% withdrawal rate! If you look at it this way, financial independence suddenly seems much more accessible, doesn’t it?

    To get an idea of what an expense really represents in your quest for financial independence, I find it eye-opening to calculate the amount required in investments to cover one particular annual expense. For example, your cell phone plan costs you $100 a month, or $1,200 a year. With our simple rule, we understand that you would need $30,000 in investments just to pay your cell phone bill. However, if we manage to reduce the bill to $50 a month, then we only need $15,000 in investments. Food for thought! 🙂

    You get it now why I insist on lowering expenses, don’t you?

    Of course, the 4% rule is not completely foolproof. There are many factors to consider, including retirement age, life expectancy, asset allocation, risk tolerance, etc. Some might want to use a more conservative withdrawal rate such as 3%, for example. You would then need the equivalent of 33 times your annual expenses. However, I think the 4% rule is a good enough rule of thumb. From there, you can make your own calculations based on your situation and needs.

    We Need to Take Action

    Of course, you don’t go from a debt ratio of 170% to a savings rate of 50% overnight. It’s a long-term job. Each action you make has a cumulative effect over time (not unlike compound interest!). So one thing at a time, but the important thing is to take action. The sooner you start to lower your expenses, the faster you will reach your goal. Keep in mind that Rome wasn’t built in a day.

    Finally, I leave you with a loose translation of an excerpt from Pierre-Yves McSween’s latest book, Liberté 45, which particularly appealed to me (rough translation):

    The path to financial freedom is theoretically simple. In practice, it takes an iron will to stay the course. Above all, the false sense of deprivation must be transformed into a positive impression, bred from our quest for freedom. It’s all there. It is not deprivation to seek to leave the prison of the mad race to nothing. You just have to change your mindset, let your neighbour go to work in his $50,000 SUV while you’re secretly preparing to leave your prison. Free of charge.

    Bye-bye, neighbour! I’m off to my cottage… Forever!