Meridian GoodSense – Page 2

Market pullback? Financial planning!

This is the time when financial planning really, REALLY matters

There is no getting away from it: When investment markets turn negative, it doesn’t feel good. Though we know that there will be ebbs and flows in the economy and in our investments, it can feel overwhelming while it is happening.

So, without denying the reality of the market numbers, let’s calmly shift our focus from IT to YOU.

Informed by your financial planning

Your investments are one part of your financial life. And your financial life is one part of your … life. The big tool we have available to manage that journey is the process of financial planning.

That means understanding where you are currently, so that you can live responsibly within your present means. It also means looking to the future and the needs you will have then, saving for that eventuality, and managing those savings in an informed way.

The informed way that we manage savings is more commonly known as “investing.”

Yes, your investments are critical to your life’s journey, but let’s be candid: You are not about to spend everything in your investment portfolio today, just because of market movements yesterday. By the same token, if – or rather when – there is a bounceback, that’s also not a personal signal to you to spend immediately.

Diversification has many faces

Every investor who has worked with a financial advisor will have had the conversation about the benefits of diversification. It’s the ‘not-all-the-eggs-in-one-basket’ wisdom that advocates not overly focusing on a single security, or economic sector or geographic area.

As importantly, the concept of diversification applies to you personally, as much as to what is in your accounts. There is a natural progression over a financial lifetime – learning, earning, saving, investing and spending – but at any given time you will be engaged in more than one of these activities.

To the point, if you have a well-rounded financial plan where each of these is properly addressed, then the current fluctuation of your investments should not throw you into a panic.

Looking even closer at the investments, time is also a diversifier. As your advisor will counsel, your investment approach should always take into consideration your comfort with risk and the timeline for when you expect to use that money. Not only will you not be withdrawing everything right now, you won’t be taking it in a lump sum at any one point in future. Practically, you are setting yourself up for a flow that will carry on over the course of many years.

Maybe you’re in the midst of that drawdown mode now, or maybe it’s years ahead. The good news is that time generally works in your favour to allow your investments to recover, even in the face of a significant market pullback. The key is to have an up-to-date investment policy statement and financial plan so that your portfolio continues to fit your evolving needs.

Stay informed so you can stay the course

In that light, I am certainly not suggesting you ignore market movements. Observe them, inquire into them and learn from them. That includes listening to and learning from your own emotional response.

Some present anxiousness is to be expected, but you still need to have the comfort and confidence your portfolio is constructed to suit your long term needs.

Rudiments of retirement readiness

The route from present-you to future-you

In our early years, retirement isn’t much more than a concept somewhere beyond the curve of a distant horizon. Often it’s portrayed as a time to pursue adventure and realize dreams.

Then as we move forward in our lives, that horizon takes shape. We survey the landscape, chart a direction and take stock of the resources and tools we need for a successful journey. Without completely abandoning the romanticism, we must turn to the practical, and in today’s world that means money.

So while retirement is about more than money alone, it remains at the centre of determining when it’s possible to retire, and what’s possible when you get there.

What does today’s retirement look like?

Individually and as a society we are living longer. Medical advances have reduced infant mortality, eliminated many life-threatening diseases and conditions, and extended lives through better health care. Today, we’re less concerned about surviving to retirement, and focused more on thriving through it.

We will have more years in our retirement, and healthier bodies to enjoy that time. We’re no longer just parking ourselves in rocking chairs and on park benches, so we need to think consciously about how we’ll spend our time, and how we’ll pay for it.

And while health has improved, eventual decline is inevitable. That too will extend out for a longer time, and generally more decisions and adjustments will be required along the way. It’s vitally important to be aware and prepared on many levels: socially, emotionally and financially.

Consider as well that there are more multi-generation families living at the same time now than ever before. Whether you’re an elder, a youngster, or one of the sandwich generations in-between – that interconnectedness will have an impact on everyone.

How do you save within your means?

Let’s consider present you and retired you, and the financial trade-offs between. To take adequate care of both of you, there are three principles that you can use as a guide: Live within your means now, save to fund your future self, and live within your means when you get there.

That may seem patently obvious, but it can be difficult to put into action without a clear picture of your current financial state. That’s where budgeting comes in, but it need not be an overwhelming undertaking. To get started, you need an overall view of major income sources and spending, and then you can get more granular and strategic with your budgeting as you become more comfortable with it.

Most often your principal income source is your own earning capacity. Live healthy to protect this greatest asset, and also consider disability and life insurance for contingences you can’t control.

Do you understand your tax position?

Tax can be a complicated topic. While you don’t need to become an expert, you do need to understand it sufficiently so you can make educated decisions.

For starters, you earn your employment and business income in pre-tax dollars and make your personal purchases in after-tax dollars. As well, your income – and therefore your tax bracket – will usually go from low level in your early working years, up through peak career, and back down in retirement. Knowing this, you can be more realistic and targeted in your saving and spending choices.

This also gives you context for public pension and private savings programs, in terms of what’s available to you, their proportionate value, and the tactics you can use to get the most out of them.

What can you expect from public pensions?

There are two main public pension programs: Canada Pension Plan (CPP) and Old Age Security (OAS).

CPP is a publicly-run insurance plan for workers. You pay premiums out of wages during your working years, for which you are entitled to a retirement pension. The maximum annual pension beginning at age 65 in 2017 is $13,370. You can begin as early as age 60 but if you do that the amount is reduced by about a third, or if you delay to age 70 you can get about 40% more. Presently, the average actual pension is $7,727.

A person is entitled to a full OAS pension after 40 years of Canadian residency after age 18. The full annual pension at age 65 is just over $7,000 (it’s indexed quarterly), though you can get almost a third more if you delay to age 70.

These programs provide a firm foundation for retirement, but most people will want and need to supplement this with private savings.

How do you build your private savings?

Under a registered pension plan, an employer is responsible for making payments to retired employees. The value of the pension is negotiated between employer and employees, and can be quite complex. The employee has no tax liability while working, and simply pays tax on the pension when it is received in retirement.

You may also make tax-deductible contributions to a registered retirement savings plan (RRSP). It is based on your earned income, the maximum contribution room being $26,010 in 2017. Investment growth is tax-sheltered. Withdrawals are taxable, usually taken by moving the RRSP to a registered retirement income fund (RRIF).

If you are a Canadian resident over 18, you may contribute $5,500 annually (current in 2017) to a tax-free savings account (TFSA). Contributions to a TFSA are not tax-deductible, but growth and withdrawals are tax-free.

Where does your home fit in?

Whether you rent or own, housing is usually your largest expense in any given year and over a lifetime. Renting is a pay-as-you-go proposition, exposed to year-to-year market movements. By owning, you can defray a large portion of your future shelter costs by allocating some of your savings into home capital. As a bonus, capital gains on your principal residence are tax-free when you sell, though in the meanwhile that home capital can’t be spent.

Deciding whether, when and how to sell a home can be an emotional prospect, on top of financial concerns.

And as large as that is, there are many smaller decisions that in sum can be equally challenging to contemplate. Armed with a deeper understanding of the retirement rudiments outlined here, you can be better prepared to meet those challenges and more confident in the decisions you make as you head toward and live in your retirement.

My 100,000% credit card interest gaffe

No, no … I wasn’t charged 100,000% interest by my credit card issuer, but I did literally gasp aloud when my own gaffe – which I’ve gratuitously estimated at that crazy figure – came to my attention on my credit card statement recently.

To be clear, a credit card is a powerful tool that offers convenience, efficiency and even some financial rewards. It would be fair to say that understanding and using a card wisely are fundamental financial skills in modern commerce.

In my case, which I will go into in more detail below, it is effectively the hub of our family financial routine. But before I get into the specifics of what sunk my spirits, a little background on the mechanics of credit cards.

Converting your credit into debt

For those new to the arrangement, a credit card is not a cash machine. Rather, it allows you a certain amount of room (your credit limit) to make purchases, the value of which then accumulates as your debt. The way most cards work, you have 21 days from your monthly statement date to pay the balance owing, and if you pay it all off then you don’t owe anything more. Sweet deal, huh?

How credit card interest is calculated

Now if you don’t pay it all off, that’s where interest comes in. You have had use of the card issuer’s money since the date of each of those purchases. Again, if you pay off the full balance, no interest applies. Once more, if you pay off the FULL balance, no interest applies. If you pay anything less, interest is charged for the month as if you had not paid off ANY of it – Check your statement for your particular interest rate.

Our household money management method

My wife and I don’t use credit cards for the credit, as strange as that sounds. Mainly, it’s the convenience of pulling purchases into one place, though we do enjoy receiving a few reward points in the process. We have two cards on the same account for the majority of our expenses, and every day or two we transfer the amount of the purchases into a side account to accumulate a cash reserve. At month-end, that cash is ready to retire the balance, even before the statement hits our inbox as a formal notice.

100,000% interest? Seriously?!

Earlier this year, I received and paid the statement the day it landed. Unfortunately, as I learned when the next month’s statement arrived, I’d transposed two digits in the balance, thereby paying a mere(!) 99.7% of what was owed. That 0.3% shortfall multiplied by the 19.5% interest on the balance, paid on day one of the 21 I had available, works out to 115,097% — But let’s not be ridiculous, so call it a round 100,000%.

The money moral of the story

Of course that’s crazy math, but the point is this: Make sure you understand how your credit card interest is calculated – and wear your glasses when paying the bill. Fortunately for me, my card issuer had mercy on me, crediting back the interest once I’d explained my error. Importantly, their action was based in part on my good past payment practices, which I will conscientiously continue with each future payment.