Over the past 26 years, I dealt with over a thousand financial planning clients. Over these many years, I gained a great insight into what works, 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, essential advice or action plan for your financial success:

• It is not how much you make what the most critical factor, by far, is to achieve your financial planning goals. It is how much you save.

Over and over again, I saw that no matter how much you make, your long term financial success is mostly dependent on how much you save, if at all. Many, no matter how much they make, spend all of it – or almost all of it. A few spend even more.

• Have a monthly household budget and stick to it.

The chances are that having no monthly budget means that it is little if any, savings left. Having a budget done is essential. Record all expenses listed in the order of their monthly payment dates and also add your monthly reasonable variable expenses. Cut all unnecessary costs.

• While it is essential to focus on the growth of your investments, it is even more important to have proper insurance in place in case there is a death and/or disability or a major illness by the or one of the breadwinner(s) in the family.

No matter that you are saving the proper amount to be able to fund your retirement income, your plan may collapse like a house of cards if there is no protection for the death of (one of) the breadwinner(s) in the family. This can be especially hard on your family while your children are young but could also be a major lifestyle-altering event for your surviving spouse, working or not,  without young children. Consider the amount that you need to insure for and the time frame for how long you need this coverage. For the same reasons, it is equally important to determine whether you need critical illness and long term disability insurance.

• First, you should start paying off high-interest debt like credit cards and store credit cards’ debt.

In most cases, credit cards charge over 20%, sometimes even 30% or more. Paying off debt on what you pay 24% annual interest is the same as having a 24% yearly return on your investment. While I have seen over 24% calendar year rate of return in clients’ portfolios, I have never seen such a high average annualized rate of return over any 4 years period. The expected average annualized Canadian stock market return is between 6% and 8% before fees. Paying off your high-interest debt has a minimum of 12% advantage, assuming your credit card has a relatively low 20% annual interest, compared to the strategy of keeping your debt intact and instead: invest. Before you implement any savings plan, pay off your credit card debts. It is improbable that your after-tax return on your investment will be higher than the percentage of interest you pay on your credit cards’ debt.

• Be mindful of the total combined cost of investing (hidden and “visible” management fees, commission and any other fees).

If your average annualized before fees rate of return on your investment is 7.00% and you pay, on average, 2.25% annual management fees on your investment, your average after fees rate of return is only 4.75%. If you can reduce your overall costs to 1.25% a year, your net, before tax, rate of return would rise to 5.75%, a significant, over 20% higher, increase in net performance.

• Carefully determine what your reaction would likely be under significant market stress.

Before you set out to invest, carefully determine how well you behave under significant market drops. If you invest for 10 years or longer, it is almost a 100% certainty that sometimes in the future you will experience a more than 25% decline in your equity investment within a short period, between 6 months to 2 years. Your overall average annualized performance will significantly be lower if you sell under significant market stress. Therefore it is wise to carefully determine how likely that you will bail out after a substantial drop in the market. The more uncomfortable you are with significant declines, the less you should invest in equity type of investments or learn to accept higher volatility.

• If you already own your house focus first on investing in your TFSA. Note that there are some exceptions when investing first in your RRSP makes more sense.

Typically TFSA is the best investment tool for any middle class Canadian. At least, for those who are likely would have higher or about the same marginal income tax rates in their retirement years because of the combined effect of significant income from their RRIF and company and government pensions. Besides, TFSAs are exceptionally flexible compared to RRSPs.

• After you contributed the maximum to your TFSA, invest in your RRSP.

RRSP investment, although typically not as advantageous as TFSA’s, is beneficial as it allows you to save for your retirement while reducing your taxes significantly. Nevertheless, it makes perfect sense to invest in them if you are in the highest income tax bracket or close to it. However, if you believe your marginal income tax would be much higher during your retirement years due to your expected mandatory withdrawals from your RRIF being too high, their advantage will diminish. 

• Invest mostly in capital gain earning investments in your TFSA and invest the portion of your assets you want to invest in interest-earning investments in your RRSP or RRIF.

Investment in your TFSA should have the highest potential return and risk within your total portfolio. There is no tax to pay when you withdraw from it and therefore, it is an excellent vehicle placing your most promising potential “big-time” winners. If you win big you will be glad that the investment was held within your TFSA. For example, if you invest a particular $10,000 from your existing TFSA funds and your marginal tax rate is and is expected to be in the future, 50%, and your investment went up to $50,000, then when you withdraw this money you pay no taxes. Your cost was $10,000 and gain $40,000.

On the other hand, if you invested $10,000 from your existing RRSP funds into the same investment and made the same amount, and you withdraw all of it from your RRSP, after-tax you will only receive $25,000. Your TFSA gave you a 5 fold increase ($50,000 vs. $10,000 cost) while within your RRSP the same investment would have performed only 2.5 times, after-tax. Also it is noteworthy that if there is a substantial increase in your RRSP it might increase (or maintain your high pre-retirement marginal tax rate) your marginal tax rate during retirement to a much higher number. Investing in the TFSA is marginal tax rate neutral.

• Consider investing a portion of your assets in private 1^st, 2^nd, and maybe 3^rd mortgage investments. These types of investments can earn you between 8% and 20% interest a year. You could invest in individual private mortgages or in a pool of them through MICs (Mortgage Investment Corporations).

At the time of this writing, including lenders’ fees private 1^st mortgages typically yield 8% to 11%, 2^nd mortgages 10.5% to 17%, while 3^rd mortgages between 15% to 20% mainly depending on the equity to value ratio of the properties they are secured on. If you consider private first mortgages with no more than 50% loan to equity ratio, these investment vehicles offer an excellent rate of returns with minimal risks. Private 2^nd mortgages with no more than 75% combined 1^st and 2^nd mortgage balance to value provide high returns with acceptable risk level. The drawback on these investments is that, especially for private first mortgages, the amount you need to invest in a single investment could be running to hundreds of thousands of dollars. As an alternative to investing in individual mortgages, you could invest as little as $5,000 through MICs in a pool of 1^st, 2^nd and 3^rd mortgages and by so doing reducing the risk of high exposure to any one individual mortgage. Typical returns on MICs range between 5% to 9.5% usually.

• Unless you are relatively risk-averse, invest 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 (“HELOC”).

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 your HELOC and invest in either dividend or interest-earning or a combination of these two types of 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).

• Take advantage of government grants and invest in Registered Education Savings 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 an annual 20% grant calculated on the annual contribution up to a yearly $500 limit, subject to the lifetime limit of $7,200, to boost the value of the RESP even more.

• 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 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 drastically change within a short couple of years or even faster.

• Be mindful of capital gain taxes on your assets and if you do care about taxes payable on capital gains after death and consider buying a permanent type of life insurance with a death benefit equalling the expected size of the future tax on them.

Uncrystallized capital gains on your cottage, rental properties, private business shares and on your not registered investments could in some cases be hundreds of thousands or even millions of dollars. If you failed to buy proper insurance to cover for the substantial taxes on these gains your family may be forced to sell some or all of the investments what otherwise they prefer to keep but forced to sell due to the large tax bill upon death. 

• 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 to devise a proper personalized financial plan for you. Sometimes there is no limit of money what one can not totally mismanage to the ground.

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

Rules Of Financial Planning

The views expressed in this material are the opinions of  Miklos A. Nagy through the period ended 09/03/2019 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.

All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law. For permission requests, write to Miklos A. Nagy at nagy@fin-plan.ca.