Over the past 26 years, I dealt with hundreds of high-net-worth financial planning clients. Over these many years, I gained a great insight into what the most critical factors are in developing a sound financial plan and the most significant mistakes that people can make in financial terms.
Based on my experience, I developed the following list of, in my belief, core advice for continued and more efficient financial success in the future:
- Wealth preservation is the overriding goal above all else, including overall portfolio performance.
You have already achieved financial independence and your quality of life is already assured. The emphasis must be on preserving your wealth. Increasing it should only be your secondary consideration.
- Have a budget and make sure that on an annual basis, you spend less than what your overall after-tax income is.
That you are well off does not mean you can spend more than what you make permanently. Unless you have a substantial asset base spending more than your income – continuously – will eventually destroy your wealth and ultimately your annual income as well.
- Most of the high net-worth individuals need insurance. This is despite their wealth. Typically this need is for covering the capital gain taxes at death, legacy purposes and or tax planning.
Uncrystallized capital gains on your cottage, real estate investments in other cities and or in other countries, rental properties, private business shares and on equities combined with the potential income tax on your RRSP or RRIF investments triggered by death could, in some cases, be millions of dollars. If you failed to buy proper insurance to cover for the substantial taxes on these gains and RRSP or RRIP terminations, your family may be forced to sell some of the investments that otherwise they would prefer to keep due to the significant tax bill upon death.
- Always have an up to date Power of Attorney and Will.
In my opinion, a properly executed Power of Attorney is the highest importance. If you are stuck with an illness that resulted in you not to be able to make any decision and you are without a valid Power of Attorney no one will be able to make any decision for you, including financial decisions without governmental interference. Also, you must have a Will as otherwise when you die, your assets will likely be distributed totally different than what you would have desired. Power of Attorneys and especially Wills must be kept up to date as situations, including financial can change drastically within a short couple of years or even faster.
- The cost of investment management is a significant factor for the overriding majority of high net-worth individuals as the primary purpose of your investing is wealth preservation. Increasing your wealth comes second. Due to this reason average annualized return on your investment may not be as high as that for someone willing to take more risk. One way to increase your net return is to reduce your investment management costs. If you have millions, overall management fees on your assets should not be more than between 1.00% and 1.50%.
Your overall stock and bond investment portfolio’s average before fees annualized performance will likely be between 5% to 8% in the long term. With average annual total management fees and expenses of 1.00% to 1.50% your average annualized net return is expected to be between 3.50% to 7.00%. With expected long term annualized gross equity returns declining since the late 1990s from around 12%, reduction of your management fees is even more critical for the reasons to either increase your annual income or achieve a greater appreciation on your assets. For example, on a $3 million portfolio, your expected rate of return and possible yearly income before taxes is expected to be on average between $105,000 and $210,000.
- Consider investing a portion of your assets in 1st, 2nd and to some extent 3rd private mortgages. These types of investments can earn you 8% to 20% interest a year.
Private 1st and 2nd mortgages yield 8% to 11% and 10.5% to 17% interest, respectively, while 3rd mortgages between 15% to 20% depending on the equity to value ration of the property they are secured on. If you consider private first mortgages with no more than 50% loan to equity these investment vehicles offer excellent rate of returns with relatively low risk. If you don’t mind to take a bit higher risk with private 2nd or even 3rd mortgages, with no more than 75% combined 1st and 2nd (and 3rd) mortgage balance to value, you could also get higher returns with acceptable risk levels. As an alternative to investing in individual mortgages you could invest in Mortgage Investment Corporations or “MIC”s and invest in a pool of 1st, 2nd and 3rd mortgages and by so doing, reducing your risk of high exposure to any one individual mortgage. Returns on MICs typically range between 5% to 9.5%.
- Contribute your maximum limits to your TFSA and RRSP.
TFSA is the best investment tool for any high net-worth Canadian. They are not only better than RRSPs for high-income earners but are exceptionally flexible compared to them.
Having said this, take full advantage of your RRSP investment. Invest the portion of your total investment what you intend to invest in lower-yielding interest-bearing assets in your RRSP or RRIF so to ensure that rather your TFSA and not your RRSP or RRIF will be much higher in value than their respective total contributions. By doing so you ensure that you will pay less overall taxes.
- Consider investing following the “Smith Manoeuvre” and by doing so, convert your not tax-deductible mortgage interest to tax-deductible interest on your home equity line of credit.
The Smith Manoeuvre is a financial strategy first coined by Fraser Smith a BC financial advisor. In a nutshell it is a strategy to convert, over time, your not tax-deductible mortgage interest payments to investment loan interest payments that are tax-deductible. Dividends and/or interest on your investment and tax savings are to be used to reduce the balance of your mortgage that in turn is immediately reborrowed using a Home Equity Line of Credit (“HELOC”) and invest in either dividend or interest-earning investments. By doing this, it is likely, dependent on the performance of your investments, that you will significantly reduce the number of years your mortgage will be completely paid off and at the same time create a sizeable equity net of your investment loan balance (HELOC). Depending on your situation, you should consider using this strategy on one or more of your real estate holdings.
- Consider buying foreign propert/y/ies and by doing so further diversify your assets.
If you have plenty of assets and intend to invest a significant portion in real estate investments consider investing in different countries as well. Overexposure to Canadian real estate increases your overall investment risk. There are plenty of real estate investment opportunities with excellent appreciation potentials around the world. Many of these offer opportunities for you to enjoy different and vibrant places while drawing significant rental income.
- Consider becoming a retired ex-pat Canadian in a jurisdiction with lower or no income taxes.
There are many things to consider to decide to live as an expat Canadian living in a no-tax or lower-tax country. Among other things when you become a non-resident of Canada all your uncrystallized capital gains will be deemed to be crystallized and this could significantly impact you. Still there could be significant advantages to live outside Canada and enjoy drastically reduced taxes. Whether this is something for you depends on your particular situation. In any case before you decide you are advised to carefully review your tax situation with an expert and only then make a final decision on this.
- Take advantage of the government grant and invest in Registered Education Investment Plans (“RESP”) for your children and or grandchildren’s education.
The cost of education has been steadily rising over the past 50 years and expected to continue to do so. Investing for your children’s and or grandchildren’s education makes sense, especially within an RESP. Returns on RESPs are tax-free and the government will provide a 20% annual grant on contributions, up to a yearly limit of $500, subject to a lifetime maximum of $7,200 per eligible child.
- Unless you are a financial expert and have sufficient time doing it by yourself, consult a trustworthy financial planner to draft a comprehensive annually updated financial plan and stick to it.
Most Canadians are not financial experts, and therefore, it is wise to engage one to deal with all the above-mentioned issues and more to devise a proper personalized financial plan for you. That you are already financially independent does not mean that you can not improve your financial situation even further. Sometimes even making significantly better.
Determining what exact steps you need to take to achieve your financial goals need careful analysis and planning. Fin-Plan can help you in this regard. To ask any question about this article or to book an appointment to look at your particular case, please contact Miklos at nagy@fin-plan.ca. Miklos is a fee-only financial planner, best selling author, finance-related educational course writer, statistician and former Chair of the Canadian Institute of Financial Planners with over 25 years of experience in financial planning for high net-worth and middle-class Canadians. His Fee-Only financial planning website is at www.fin-plan.ca and his Linkedin page is at https://www.linkedin.com/in/miklos-nagy-fee-only-financial-planner/.
Copyright © 2019 by: Miklos A. Nagy
Financial Planning For High Net-Worth Individuals
The views expressed in this material are the opinions of Miklos A. Nagy through the period ended 09/14/2019 and are subject to change based on market and/or other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investing involves risk, including the risk of loss of principal. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.
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