How Does Quitting Your Job Before 65 Affect Your Retirement

Lots of people dream of being able to retire before age 65. Not only can working be stressful, it may not be that much fun. It definitely can’t compare with your vacation time, which for many people, if how they imagine retirement will be.

If you are convinced that early retirement is for you then you will need to save more money while you are working to make sure you have enough money for the rest of your life. Not only will you have less time to save money, you’ll also spend a longer time depleting your savings.

In The Real Retirement by Fred Vetesse and Bill Morneau (Fred is an actuary and Bill is now the Minister of Finance for the Government of Canada), the authors spelled out the extra costs of retiring early. Their conclusion is: It’s quite expensive to leave the work force before age 65. Here’s why:

You will receive a smaller Canada Pension Plan payment because you don’t have as many qualifying years. Remember C.P.P. is guaranteed for life and indexed for inflation so this will affect your retirement income for the rest of your life.

You will need to significantly increase your savings rate while you are working and raising your family to pay for your decision to retire before age 65. Remember according to our experts, you need to save 6-10% of your family income for 40 years to have as much money in retirement as during your working years (minus fixed costs like mortgages and child rearing expenses).

So how much extra will you need to save for those 40 years? Vetesse and Morneau concluded you would need to increase your savings rate by 3% for every year you want to retire early. See the chart below for some examples.

If you want to retire at age:                          Your yearly savings rate will be:
65                                                                        10%
62                                                                        19% (10% + 3 years x 3%)
60                                                                        25% (10% + 5 years x 3%)

Remember, this calculation is to balance the amount of money you have to spend while retired with the amount of money you have to spend while working. So if you want out by age 60, plan to save 25% of your family income for 35 years.

People who plan to retire by age 50 or earlier really have to dramatically increase their savings during their working years. On some “Retire at 40” sites I’ve visited, people are saving 50 or 60% of their incomes in order to get out at a young age. Many of these folks don’t have children or have 1 child. I’ve already mentioned, let’s hope not everyone follows their life plans, or we won’t have much of a country in 50 or 60 years.

Investing Well. If it’s so simple, how come almost no one does it?

Easy recipe for investing success:
  • Save 10% of your income.
  • Every once in a while buy the Vanguard product with the symbol VGRO.
  • Do this over and over again, every year for 40 years and there’s a really good chance you won’t have to worry about money when you stop working.

It seems so simple.  This is the sort of advice I’ve been dishing out to friends, family, students and casual acquaintances for years.  The problem is almost no one follows it.

I never really found out why it was almost universally ignored. I just assumed either it wasn’t important enough for people to actually do it or they were so worried about messing things up, they were willing to pay a bank or financial advisor to do it for them.

Maybe they couldn’t believe that investing for themselves would be a better bet than paying a financial advisor or perhaps they just needed reassurance from time to time from that advisor.

Faced with a choice of learning something that is probably as interesting as watching paint dry or going to your bank and having it done for you by a smiling confident salesperson, most people are going to chose the smile.

That’s too bad.  Does it really matter if you have $500,000 instead of $800,000 to retire on?  Maybe not, but it still does seem like a bit of a shame you couldn’t have spent the extra $300,000 yourself instead of slowing dolling it over the bank decade after decade.

Fees you pay to the bank or an advisor do matter.  The average mutual fund in Canada charges a yearly fee slightly over 2% per year.   This is not a one time fee.  You pay 2% ever year and if your mutual fund increases in value, you pay the 2% on the profit as well.   This never ends until you sell.

Contrast this with the fee for buying Vanguard VGRO (mentioned above) which has a yearly fee of 0.22% or about 10 times less than your bank’s mutual fund.

When you’re 24 years old and barely saving, the difference between 2% or 0.22% doesn’t really add up to much. However, as you age and continue to invest, the difference between 2% and  0.22% becomes huge.  Hundreds of thousands of dollars huge for lots of people with middle class salaries.

And for what?  The annual sit down to tell you to keep on keeping on?  The Christmas cocktail party or gift basket.

Doing it yourself is not difficult.  Anyone who can hold down a job that will allow them to save some money for retirement can do this stuff.

Find someone who can sit down with you and show you how this works.  Or take a one day course at your local library or community centre.  Join a DIY investing club.  Read more blogs like mine to build your knowledge.   There are lots of ways to learn to DIY and you will never regret knowing more.

Last resort, I consult on DIY Investing with my fellow Canadians.  $199 for up to 3 hours of one on one lessons that should be more than enough time to get you up and running.  If you’re interested, contact me.



Is 10% to New 6%?

Part of the plan to retire well requires you to save 6% of your income each and every year of work between the ages of 25 and 65. This advice came from actuaries who studied the spending habits of Canadians during their working and retirement years. The 6% figure, it was concluded, meant that Canadians could save enough for retirement to maintain the lifestyle they had become accustomed to while working and raising a family.

The 2 actuaries who came up with this number, working independently, are Fred Vettese and Malcolm Hamiliton. Recently Fred Vettese wrote a follow up book to his The Real Retirement, this time called The Essential Retirement Guide. I just finished reading the book and I’d like to provide a summary of the key points that you may find interesting.

First, and probably most surprising, Fred seems to be moving away from his belief that saving 6% of your income would be enough to ensure a comfortable retirement at age 65. The primary reason for this is his forecast that stock and bond returns will be lower in the next 25 years due to demographics trends. Basically, an aging population worldwide will reduce economic growth which will, in turn, reduce stock market returns.

An aging population will also crave the relative security of high quality bonds which will further reduce bond returns as more investors seek them out. Based on this forecast, he believes a 10% savings rate would be safer to protect retirees from the potential to run out of money.

So what are readers supposed to do? Save 6%, 10% or some other amount. My take on this is simple.

First off, remember that Malcolm Hamilton still recommends 6%.

Second point, know thyself. If you are more of a worrier then boost your percentage to 8% or 10%. If you are more concerned about living for today, keep it at 6%. We’ll call this the chicken index. The more of a chicken you are, the more you save.

In any case, deciding on 6% or 10% is like icing on the cake. Bake the cake first, by setting aside your percentage every month in low cost index funds, keep yourself valuable to you employer or your customers. Then you can worry about the icing. The important thing is you won’t starve.

The other interesting part of the book deals with his writing about risks of illness as you age, as well as the potential need for long term medical care, either in your home or a long term care facililty. To be honest, I found this section of the book quite depressing, but ultimately necessary to contemplate. Fred wrote quite frankly about his relatively minor health issues (he was 63 years old when he wrote the book), his fitness and lifestyle regiment to reduce the risk of illness, and his experience watching his parents age. There is lots of good advice on how we can all improve our chances of living longer without suffering a major illness and keeping up our spirits along the way. Much of the advice would not be new to anyone who keeps up to date on healthy lifestyle recommendations, but he did provide some solid information on the percentage risks associated with certain lifestyle choices (smoking, drinking excessive alcohol, etc.).

He also spend some time discussing the benefits of annuities and how they need to be marketed better because they really are a valuable product that could greatly reduce the stress retirees may have about running out of money. He also writes about sustainable withdrawal rates, long term care insurance, and gives his views on the current state of the stock and bond markets in the developed world.

Most of the rest of the book is similar to The Real Retirement, although it is told more like a story with real couples who have different income levels and different needs for retirement savings.

Overall, the new book is more accessible for everyday readers and I think most people would really benefit for reading it. I came away from reading this book thinking it must be tough as an actuary to know the odds of all these bad things happening to you. It’s probably much better to be blissfully unaware of the odds as long as you have a solid retirement plan in place.

Dividend vs Index Investing. Which is better?

In a previous blog post, I wrote about how successful dividend investing has been in the past 20 years in Canada.  I wanted to provide a little more colour on how dividend investing has performed vs. index investing so I did a little number crunching to see which stocks outperformed the S&P 500 and which did not.  I looked at total returns for 5, 10 and 15 years (assumes you paid no tax and reinvested all dividends back into the companies or index.   The stocks I looked at are all large cap Canadian companies with a long history of paying dividends.  They are fairly concentrated in a few sectors (no health care, technology, consumer staples) but that is the nature of the Canadian market and one reason why I don’t think it was wise to only dividend invest in Canada.

Here is what I found:

5 Year Returns:

S&P 500 (CDN):  11.7%

Companies that beat the S&P 500:  Enbridge, Sun Life, Loblaw, BCE, Metro

Companies that trailed the S&P 500:  All the banks, Fortis, TransCanada Pipeline, Manulife, Power Corp, Imperial Oil, Empire, SNC Lavalin, Riocan, Rogers, Thomson Reuters

10 Year Returns:  S&P 500 (CDN) 6.5%

Companies that beat the S&P 500: Royal Bank, Fortis, TransCanada Pipeline, Enbridge, SNC Lavalin, Riocan, Metro, BCE, Rogers

Companies that trailed the S&P 500: BMO, Manulife, Power Corp, Sun Life, Imperial Oil, Empire, Loblaw, Thomson Reuters

15 Year Returns:  S&P 500 (CDN) 2.9%

Companies that beat the S&P 500:  All the banks, Fortis, TransCanada Pipeline, Enbridge, Power Corp, Sun Life, Imperial Oil, Empire, Loblaws, SNC Lavalin, RioCan, Metro, BCE, Rogers

Companies that trailed the S&P 500:  Manulife, Thomson Reuters


As time has passed the percentage of companies that beat the S&P 500 has increased.  However, some of the companies who beat the 15 year results of the S&P 500 only did so because of the strength of the Canadian dollar today compared to the past 15 years. This reduced the 15 year performance of the US index by 2.7% (the 5 and 10 year results were not effected much by currency changes).  If you remove the currency boost, you can add Power Corp, Sun Life, Loblaws, and BCE to the  under performed column vs. the US index.

As a compromise, if you insist, you may consider investing your one third Canadian stocks in high quality dividend payers, but keep your one third world stocks in the Vanguard VXC all world index fund. I still don’t know if dividend investing is going to be so successful for the next 15-20 years if interest rates start to rise again.  We’ve had a fantastic 35 year bull market in government bonds and if rates rise, dividend stocks should become less coveted by income seeking investors.  But that’s a big if.  So far bond rates continue to fall and in some cases are actually negative (Japan, Switzerland and Germany) so what do I know?

What Kind of Returns to Expect Going Forward

In a nutshell, some stocks and all government bonds are expensive today, probably because interest rates are so low. That pushes investors to buy stocks and bonds which means that future returns will probably be lower than they were in the past 25 years.

Canadian and European stocks are actually not too over valued especially compared to US stocks. Canadian goverment bonds however are really where we should expect reduced returns in the future. So if you are investing your retirement savings in our recommended way (1/3 Canadian stocks, 1/3 World stocks, 1/3 Canada governement bonds), what kind of returns should you expect? Look at the chart below and you see a 60% equity, 40% bond mix should return about 5.5% before inflation. Since our preferred portfolio includes 66% stocks vs. 33% bonds, somewhere around 5.8% is a reasonable expectation.

Canadian Couch Potato just released their view on future returns. Here are their expectations and I think they make a lot of sense.

To summarize, here are some highlights.

Estimated long-term returns

Asset class                                         Expected return

Inflation                                                      1.80%
Canadian bonds                                        3.30%
Canadian equities                                     6.50%
U.S. equities                                              5.00%
International developed equities          7.20%
Emerging markets equities                    9.80%

Equities/Bonds                  Expected Total Return (before inflation)

0% / 100%                                                 3.30%
10% / 90%                                                 3.60%
20% / 80%                                                4.00%
30% / 70%                                                 4.40%
40% / 60%                                                 4.80%
50% / 50%                                                 5.10%
60% / 40%                                                 5.50%
70% / 30%                                                 5.90%
80% / 20%                                                 6.30%
90% / 10%                                                 6.70%
100% / 0%                                                 7.00%

Source: PWL Capital

Investing in Dividend Stocks vs. Vanguard Index Funds

Many Canadian investors believe that you can obtain market beating returns by investing in companies that have a long history of paying dividends. It’s even better when these companies are increasing their dividends year and after year.
In Canada, suitable stable dividend companies are found in a few sectors like financial services (banks and insurance), utilities (electric and pipeline), food and drug retailers, telecom, and transportation.

Over the past 30 years these companies have in fact been better investments than the broader Toronto market which includes more volatile sectors like oil and gas and mining. Investors who bought these large companies such as Royal Bank, TD Bank, Power Corp, Fortis, Enbridge, Loblaw, Sobeys, BCE, Rogers, CN Rail, CP Rail and held them have seen growing share prices and dividends.

When I started investing 25 years ago, there were no broad market index funds. You either had to buy an actively managed mutual fund and pay the very high fees or do it yourself. Good quality dividend stocks were an excellent alterative to high priced funds.

Does that mean that you should stick to picking individual dividend stocks today or should your consider investing in index funds that buy the whole Canadian market, Vanguard’s VCN?

My personal take on this is despite the success over the past 30 years, whole market index funds are the way to go looking forward. I can think of a couple of reasons for this:

1. We are in a 35 year bull market for bonds, meaning interest rates have been falling consistently for the past 35 years. In 1981, the rate you received for buying Canada Savings Bonds was around 19%. Today, the rate is less than 1%. In an environment where interest rates are falling, dividend stocks outperform. The value of the growing dividends is greater since people are looking for alternatives to falling interest rates. We’ve reached a point where interest rates can either stay low or go up. There really is no more room to go down. If they start to go up, then dividends become less valuable to investors as bonds compete for investor attention. There is a reasonably good chance this will happen at some point in the next few years. If you believe that everything eventually reverts to the mean, then interest rates should be higher in the future and dividend stocks could underperform the overall market. Beware that things could always be different this time.

2. There are only a few sectors in Canada that offer steady dividend growth over years or decades. In the past year or so, many investors have lost huge sums of money when oil and gas companies, who had paid dividends for a few years in a row, had to reduce or eliminate their dividends. Companies that operate in very cyclical industries like oil, gas, mining, and manufacturing are not good candidates for long term dividend investing. As a result, Canadian investors are forced to keep their money concentrated in 5 or 6 sectors. In some cases, there may only be 1 or 2 players in the sector. The Canadian market is just not that broad compared to American or European markets and there are sectors that don’t really exist much in Canada (technology, pharmaceuticals, consumer staples). This increases long term risk as there could be a catastrophic event or major technology change that decimates a whole sector and, in the process, seriously damages your retirement plans. No one predicted that many large American banks would be on the verge of bankruptcy in 2009. Many of these companies eliminated dividends and their share prices have not recovered 7 years later.

Consider how much easier and less risky it is to just buy the whole market including the good dividend payers and forget about it. Historically buying low cost index funds have performed very well, especially for your international stock exposure which, according to many experts, should be about 1/3 of your portfolio.
For the Canadian component of your retirement savings, you may do better with dividend stocks, assuming the past is like the future, but why take the risk? Buying the whole market makes it less likely that you will make a big mistake.

A Fantastic Calculator to Help You Decide How Much to Spend In Retirement

If you are close to retirement, I recommend you try out this retirement spending calculator created by Morneau Shepell, a large Canadian human resource company.  It’s the most involved and accurate calculator I’ve discovered for Canadians.

The man behind the calculator is the recently retired chief actuary at Morneau Shepell, Fred Vettese, (author of The Real Retirement, a fantastic book I highly recommend to everyone who wants to retire one day).

Like any calculator, the results are only as good as the data you type into it.  You will need to know how much you have in your  TFSAs, RRSPs, work pensions, and other savings to get useful recommendations.  Once you’ve finished inputting your numbers, the calculator figures out how much you are able to spend each year of retirement under a couple of scenarios.  It’s also easy for you to change some of your answers (Eg. retirement age) to see how that changes your allowable spending.

I’ve run through the calculations several times under different scenarios and I think the results are spot on.

Many retirees are afraid of running out of money before they die.  For that reason, I hope Morneau Shepell keeps the calculator live on their website for a long time.  The results provide data to help people make better spending decisions after retirement.

Good luck. 


Is The Stock Market Overvalued? Does it Matter?

If you spend any time watching or reading about the stock market, I’m sure you will often hear debate on whether now is a good time to invest.  Some will argue that the market is overvalued and is due for a drop, while equally intelligent sounding people will argue the market is not expensive and now is a good time to invest.

We’ll they can’t both be right, can they?  And does it really matter in the end whether the market goes up or down 10 or even 20% in the next few months?

Question #1:  Is the stock market overvalued?  We’ll focus on the USA and Canada for now.

The case for overvalued:  Robert Shiller from Yale University believes the markets are overvalued because the price to earnings ratio of companies that make up the S&P 500 is very high relative to its 136 year average.  His price to earnings ratio is averaged over the past 10 years to smooth out super strong and super weak years.  It’s commonly called the CAPE 10.

The case for not being too overvalued (no one is really arguing stocks are cheap today):  Larry Swedroe from believes that Robert Shiller’s CAPE 10 is flawed for a variety of reasons.  His main argument is if you remove the horrible 2008-2010 years when earnings collapsed in the US, the numbers look a lot better.  Secondly, the data that Robert Shiller uses in his historic calculations is just not that accurate.  Instead Larry thinks the data used should start around 1960 instead of 1871.  Using Larry’s data set, the S&P 500 is not as overvalued as Robert Shiller suggests.

In Larry’s camp is Warren Buffett who also believes the market isn’t cheap but considering how low bond interest rates are, he doesn’t see the current valuation as being that problematic.

Conclusion:  Who the heck knows?  Probably not cheap but your guess is as good as mine.

Question #2:  Is it worth worrying about answering question #1 above?

Probably not, because a guaranteed answer is not available.  If you are worried that future returns will not be the same as past returns, you could always increase your savings from 6% to 10% of income.

Secondly, in any given year, the stock market can be up or down 15 or 20%.  If you have the courage to wait and then buy in a dip, you can turbo boost your returns.  For example, from April 24, 2015 to January 20, 2106, the TSX was down 23%.   If you were worried that stocks were too expensive last year, you could have bought them for a 23% discount a few months ago.  Since the January low, stocks have rebounded and are up 20% from the lows.  Do you have to courage to buy when the world is telling you to sell?

Lastly, none of these month to month gyrations will matter much if you invest faithfully for 30 or 40 years.  Far more important is sticking to a plan year after year, decade after decade, then re-balancing as required and forgetting the market noise.

“If You Can” by William Bernstein

William Bernstein is a well know personal finance writer who tries his best to convince people to save for retirement using low cost broadly diversified index funds.  He has written a few books on the topic but recently released a short e-book for young people who need help investing.   You could read this book and learn quite a bit on how to DIY.

The book’s advice in incredibly easy to follow and it works.  Here is really all you need to know.

The book is written for an American audience so I’ve changed it to meet a Canadian’s needs.

1. Save 15% of your pretax income, each and every year from your first year of working until retirement.  So if your yearly salary is $60,000, save $9000 per year.

Remember our Canadian experts Fred Vettese and Malcolm Hamilton think 15% is too much to save.  It means you will have more money to spend in retirement than when you were busy working and raising a family.  But, the decision is yours.

2. Invest this money in 3 things equally:
1/3 in a low cost Canadian etf like Vanguard Canada’s VCN.
1/3 in a low cost international etf like Vanguard Canada’s VUN
1/3 in a low cost Canadian bond fund like Vanguard Canada’s VAB

3. Once a year, re-balance your 3 etfs so that they each stay at 1/3 of your total portfolio. For example, if bonds do well one year, you may sell some VAB and buy some VCN and/or VUN.  Or else, don’t buy any VAB next year but instead purchase only VCN and/or VUN.  Just keep the 3 etfs at equal value.

That’s all folks.

Now that Vanguard has introduced their all in one product, you don’t even have to worry about buying 3 etfs and rebalancing each year.  Vanguard does it all for you.  The job is even easier now.  Your job is to set up a self directed trading account with any of the big banks and save.  Once a year, buy some VGRO or VBAL or VCNS and forget about it .

Do this every year for 40 years, and you should have a superb retirement.

If your company offers you a pension plan and together you contribute at least 15% of your pay to it,  you don’t have to save anything more for retirement.  Just make sure you are out of debt before you retire.


Do I Need To Save For Retirement If I Have A Pension Plan At Work

First of all, consider yourself lucky that you are one of the few remaining workers in Canada that can still count on a pension plan at work. The once common defined benefit pension plan that paid out a guaranteed amount to a retiree every year until death is quickly dying out. In its place, most employers will offer to match any retirement contributions you make to your RRSP, up to a certain amount and then it’s up to you to decide what to do with this savings.

If you are extra lucky, your defined benefit pension pension also increases its yearly payment to you based on the rate of inflation. An “indexed” pension is the gold standard and very few people have one.

To answer the question above: if you have an indexed pension plan and you will have qualified for a full pension, usually after 30+ years of continuous service, there is no need to save further for retirement. Pensions use different methods of determining what your yearly payment will be, but after 30+ years of working, your pension will most likely be around 60% of your working years income. This is more than the 50% rule that we are striving for, so you don’t need any other savings.

Just make sure you have paid off all your debts, including your mortgage before your retire.

If you do not have enough qualifying years for a full pension, because you started your career late or took time off to raise a family, you may or may not need to suplement your pension plan savings to make sure you have enough to retire comfortably.