Let me clarify something that many people just don't understand, I like working casual! Why should I work 40 hours a week if I can avoid it? There are much better ways to spend your time off and I'm going to show you how. Now I'm not going to lie, it's going to take a bit of work in the beginning, but once you're set up, you're good to go. First, please get yourself out of any pyramid schemes if you are part of one. Any organizations that asks you to pay a fee, recruit other people to join and pay a fee, and advertises that you'll earn lots of money through recruiting and selling shitty products. In other words, please remove any part of your life that unnecessarily saps money away from you. Second, create a budget that balances (I will create a separate blog for this topic), my favourite budget worksheet is from Gail Vaz-Oxlade; check out the link: Gail's Budget Worksheet. You can download this template on the bottom right-hand corner as an excel spreadsheet to tailor your lifestyle to it.
There's going to be a lot of information. I recommend you print and read over everything once, and complete one step a week. Now we're ready to begin =D.
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The Strategy and its details
1. You need an investment account.
Your investments are going to be the foundation of this strategy. Many of us are new to this concept of investing but don't worry, I'll walk you through it step by step. I highly encourage you to check my blog on investing 101. I've selected videos that have explain all the concepts in its simplest form.
To start, you will need to open either a Tax-Free Savings investment account (TFSA) for Canadians or a regular investment account. If you have room in your budget, you can consider opening both of these accounts to maximize your gains. Make sure the institution sets you up with your online account so you can manage your own money and buy the stocks and bonds on your own.
A TFSA allows you to deposit $5500 a year without the burden of being taxed on the money that grows within the account. You are not limited to the number of TFSA accounts you open however, the total amount you deposit into this account in a year is $5500, plus unused contribution room (you can check http://www.cra-arc.gc.ca/myaccount/ for more information). To optimize this strategy, you should only have one TFSA. All the money you gain from this account will be tax-free and you can withdraw as much as you like from this account without being taxed. Every Canadian needs to have one. This is account is perfect for this strategy allowing those with lower income to take part in the world of investing.
A non-registered trading account is the typical accounts that people use to buy and sell stocks. Every major bank offers this account. A few online companies will also offer this account but please beware and make sure they are legitimate.
**You might start considering using an Registered Retirement Savings Plan for this strategy, which can provide you with some tax protection and potential tax returns for any taxes you've paid during the year. However, like using an umbrella on a rainy day, if you step out of the umbrella you will get rained on. So if you withdraw money from an RRSP before you are officially retired, then you will be taxed on every dollar you take out. Therefore, an RRSP is an excellent product but it is better suited for those who generate more than $40,000 a year in income. If your budget allows for it, I highly encourage you have both TFSA and RRSP accounts. There are many special rules that come with RRSPs so please stay tuned for my future blog on the topic.
2. A software to track your stocks
Using a smartphone or the computer, download a stocks application to keep track of stocks. It's important that we can keep track of the performance of our investments. Google and Yahoo both have excellent platforms for tracking stocks.
3. What is an investment
There are 4 things you can do with money: Spend it, Save it, Borrow against it (collateral), and invest it. Allow me to clarify something for the general public, when people say they're saving for something, like "I'm saving for a car," you are not actually "saving" money. You are actually postponing when you spend that money. When people say they are investing in a product, like "Buying this high quality foundation is a good investment," you need to understand that's not an investment! Merchandise like makeup, bags, shoes, clothes, and cars do not have the ability to make you thousands of dollars, and it does not increase in value over time. The stock market however, is where the real investing happens.
The only way to truly save money is to invest it. The definition of investing is quoted here provided by Investopedia:
"The act of committing money or capital to an endeavor with the expectation of obtaining an additional income or profit."
In other words, you need to treat this like your business and make your money work for you. Make it grow and profit from it. This is the only business is a number's game, your feelings, compassion, empathy, and customer service don't matter. Your emotions will only cloud your judgement. This is why I love investing.
4. Time to buy the indexes
Index funds are a type of stock or bond that contains many different stocks or bonds within it in order to mimic the financial progress a certain market. Think of it as your report card. Your report card contains your grades from every subject that you're taking and it also provides you with an overall average mark. Your average mark will be a reflection of how you performed overall in school, so if you received a terrible mark of 60% in Chemistry and about 75% in all your other courses, your overall average would be around 73%. Your average would not be weighed down by that one course where you didn't do so well. The same goes for index funds. The index fund will be dependent on the average performance of the group of stocks or bonds. This provides you with some risk protection so you won't experience a panic attack whenever a single stock falls.
So what are you suppose to get? Well for Canadians, we need 4 index products to tap into the world markets, using your app or go online and search these ticker symbols:
Index Ticker Symbol
A. Canadian Bond Index XBB
B. Canadian Stock Index XIC
C. U.S. Stock Index XSP
D. Total International Stock Index XIN
Now this concept isn't new, I'm just breaking it down into its simplest form so it can be learned quickly. Each bank or institution will have their own version of these products, you can buy their version or you can buy these funds from iShares. The price of each index will vary and the amount you should buy will depend on your risk tolerance (bonds are least risky). Remember: The riskier the investment, the more money you make, but also the more money you can lose.
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Looking at this example of the US stock index, you can see that over time the stock performs decently well averaging 10% return every year. There will be dips in the graph but it does recover and there's an overall upwards trend in the long term. That 10% return is what allows us to profit and retire early.
Here's an example of a 20 something year old with a decent job. At a younger age you may not mind taking more risk, so this is how the portfolio will look:
15% in Canadian bonds,
25% Canadian stocks,
30% U.S. stocks,
30% International stocks.
Make sure they all add up to 100%. If you want to convert percentage into a decimal number the formula would be: (Number percentage)/(100). For example, 30% = (30)/100 = 0.3. Use this to calculate how to distribute your money.
For example: I have $1000 to invest:
A. Canadian bond index = (15%/100)x($1000) = $150
B. Canadian stock index = (25%/100)x($1000) = $250
C. U.S. Stock index = (30%/100)x($1000) = $300
D. Total International stock index = (30%/100)x($1000) = $300
Whenever you buy stocks or bonds, you are buying a unit of that product, for example, if Canadian stock index cost $24/stock and I want to fulfill that 25% of my total portfolio we will take $250/$24 per stock = 10 stock. So you would buy 10 Canadian stock index. Using your online investing account you can now buy the right amount of index that suits your portfolio.
This chart provides a guideline as to how much money you would want to contribute to each category. You don't have to follow this, but it helps.
5. All you need is $458 a month
Why $458/month? You may ask, it's such a specific number. Well that's because our TFSA account has a maximum contribution limit of $5500 this year. $458 x 12months is $5496. You can max it out if you like. If you have extra contribution room in your TFSA feel free to deposit more. If you log on to http://www.cra-arc.gc.ca/myaccount/ it will display the total maximum you can contribute. If you are using a regular investment account you may contribute more if your budget allows for it.
Next, you need to deposit this $458 into your investment account and divide it into the four indexes. You can either split it again into the different percentages that you've decided on, or you can split it evenly; $458/4= $114.50 for each index. And that will be your routine once a month. Set up your account to automatically transfer $458 on you pay day into your investment account so you won't forget.
At the end of the year you will take a look at your investments to see if the percentages are where they need to be. For example, are your U.S. Stocks still 30% of your portfolio? If it's more, then you can either allocate more money into your other stocks and bonds to even it out, or you can sell some of your U.S. stocks to buy more of the other stocks and bonds that didn't gain as much profit.
So this means all the money management you need for this portfolio is to buy funds once a month, and balance the portfolio once a year.
**Banks such as Tangerine, have products where the bank's portfolio managers automatically distribute the money into the different indexes so you don't have to think too much about the percentages. The management fees for these accounts are a little bit higher but it takes the guess work out of it. If you're interested please take a look at Tangerine Investment Funds.
6. There is one special rule!
With this strategy we usually don't mind if the market falls because we have indexes. However, when the market falls significantly, we need to take advantage of the opportunity. Consider yourself a bargain hunter, when toilet paper goes on sale, what do you do? You stock up! Why pay full price when you can buy it on sale. Same goes for stocks and bonds, when your stocks or bonds drop in price like in the crash of 2008-2009. During this time, many investors chickened out and sold their funds. Those who stayed and continued to take advantage of this liquidation sale are currently over joyed with their gains today. Throughout our lifetime we can expect to experience at least three market crashes, it's a normal part of the market cycle. When it happens we need to be prepared to take advantage of it.
Just as I explained before you can either allocate more money into the other stocks and bonds to even it out, or you can sell some of your funds to buy more of the other stocks and bonds that didn't gain as much profit. And when the market returns back to normal you will own more units with greater value.
7. Be mindful of MER and fees
Whenever you open an investment account at a major bank, you pay a small fee either every 3 months (quarterly), or once a year (annually). Typically, it's about $100 a year. When you buy indexes, mutual funds, or exchange traded funds, they all come with a fee called MER (Management Expense Ratio). The MER is a management fee you pay and is expressed in percentage. For example, Tangerine's investment portfolios typically charge 1.07% of your total account. Speak with the institution for more detail and see when this amount is deducted from your account.
8. So when am I done?
The time frame it takes to achieve your end goal really depends on you. This is why it's so important for you to make a budget, you need to know where every penny goes each month so you have a good understanding of where you need to be in order to start working less.
Here's an example:
My friend Yumo spends about $1700/month on food, rent, transportation, utility bills, entertainment and clothes. That means Yumo spends $20,400/year. However, with inflation you need to account for living expenses to increase, we may also experience another market crash so to be on the safe side, we will double the amount and say Yumo will need an annual income of $40,800/year by the time she's ready to ease into retirement. This amount will allow her to have a monthly income of $3400/month, which is great! The income will be completely tax-free if you use a TFSA account. If you're using a regular account, make sure to withdraw only what you need since you will be taxed on every dollar you take out. If your lifestyle requires more income, then you need to invest more money.
So when will Yumo reach her goal of $40,800/year? Enter these values into the compound interest calculator? Use an online compound calculator and put in your numbers and remember compound annually/yearly:
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Even though this is theoretical, all the numbers generated looks great. Now you need to look at your Year Interest column. This column will show you how much interest you're earning in that year. So if we recall, Yumo should ideally have an income of $40,800/year in order to live comfortably and not worry about unemployment. She will meet that goal between year 22-23 with over $400,000 of cash if she continues to follow this plan. If Yumo realizes she requires more money for her lifestyle, then she will either need to increase her contribution amount every month or save for a longer period of time. (Don't forget to check your maximum contribution room for TFSA accounts).
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9. How to withdraw what I need
Because this is an investment account, the money in your account is actually the value of the stock units you've purchased. In order to withdraw money, you need to sell some of the stock units you own. For example, if you need to withdraw $3000 and one unit = $300, then you will need to sell 10 units. Remember; sell high and buy low. This means, you should sell during a time when the market value of each unit is worth more money. This is why you need to keep a watchful eye on the stock market either with an App or online. It's best to take out the money you need for that year all in one go, take a look at the market history to see when the stocks tend to increase in value and prepare to sell during that time. Don't forget to restructure your portfolio and refer back to this chart:
Keep in mind you need to maintain a certain amount of money in your account so it can continue to generate money for you. For example, if Yumo needs approximately $40,000 each year and the markets tend to increase by 10% each year, then Yumo would need:
$40,000 x 10 = $400,000
She would need a minimum of $400,000 in her account to generate her annual income of $40,000. So don't drain your account.
If you've completed all these steps, then I would like to say "Congratulations!" Having financial freedom is the most rewarding experience you can ever achieve in today's society. Enjoy it! Love life, and contribute back to your community to make it a better place.
Love,
Plush Duck
