Put your hard-earned savings only in ultra-safe GICs -- and rest assured that you are earning returns on par with those in the stock market. Don't listen to conventional advice that it's never too early to start saving for retirement -- wait till you are over 50 to start your RRSP.
That's the word from chartered accountant David Trahair, who has written books on personal finance such as Enough Bull: How to Retire Well Without the Stock Market, Mutual Funds, or Even an Investment Advisor and Smoke and Mirrors: Financial Myths That Will Ruin Your Retirement Dreams.
Mr. Trahair took part in an online discussion. Thanks to everyone who submitted questions.
Mr. Trahair has given talks and taught courses for the Institute of Chartered Accountants of Ontario, the Certified Management Accountants of Ontario, the Human Resources Professional Association of Ontario (HRPAO), the Purchasing Manager's Association of Canada, several provincial government small business associations, a consortium of C.A. firms and university classes.
He was born in Toronto and grew up in Oakville, Ontario. He received his undergraduate degree - a Bachelor of Science and Business from the University of Waterloo - in 1981. He received his C.A. designation in 1985 while working for the firm of Clarkson Gordon (now Ernst & Young). Mr. Trahair is a board member of the Credit Canada, a registered charity dedicated to providing consumer-oriented credit counselling services to families and individuals.
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Claire Neary, Reportonbusiness.com: Thanks very much for joining us, David. To start off, I'd like to know, what pushed you to write this book and offer such contrarian advice? What kind of response have you been getting to your ideas?
David Trahair: I simply got tired of hearing from people who have suffered financially because they followed "traditional" retirement planning advice. For example, many people seem to have tried to get ahead financially by making RRSP contributions each and every year no matter what - even if they were in credit card debt.
They often compounded the problem by believing that they had to invest in the stock market to make the illusive 8-10% a year return to build their retirement savings quickly. Many have been devastated as a result - especially many seniors that have little time to make up for their losses. I wanted to write a simple book that would show people how to retire with as little risk as possible.
The response so far has been very positive. I think people appreciate hearing simple advice from someone who isn't trying to sell them a financial product.
Andrew: As an experienced financial advisor, your idea seems entirely implausible. What are your assumptions for inflation, nominal returns, annual investment amount (starting from age 50), and withdrawals per year?
"Put your hard-earned savings only in ultra-safe GICs -- and rest assured that you are earning returns on par with those in the stock market." How do you justify that statement? All available data CLEARLY shows that this is an absolute fallacy, and that stocks will return many times the return of fixed income investments over any viable investment timeframe.
David Trahair: Thanks Andrew - I get this comment a lot! Here are the statistics as I have calculated them for the S&P/TSX Composite Index and the S&P/TSX Composite Total Return Index (that includes reinvested dividends and income trust distributions). I have calculated them to August 31, 2009. I also have shown what GICs did.
Average Annual Rates of Return:
S&P/TSX Composite Index
- 10 years to August 31, 2009 - 4.54%
- 20 years to August 31, 2009 - 5.11%
- 30 years to August 31, 2009 - 6.39%
- 40 years to August 31, 2009 - 6.15%
- 50 years to August 31, 2009 - 6.08%
S&P/TSX Composite Total Return Index
- 10 years to August 31, 2009 - 9.41%
- 20 years to August 31, 2009 - 8.86%
- 30 years to August 31, 2009 - 10.76%
- 40 years to August 31, 2009 - 9.77%
- 50 years to August 31, 2009 - 9.80%
- 10 years to August 31, 2009 - 3.35%
- 20 years to August 31, 2009 - 5.11%
- 30 years to August 31, 2009 - 7.28%
- 40 years to August 31, 2009 - 7.71%
- 50 years to August 31, 2009 - 7.35%
As you can see GIC returns seem to be competitive - in the long term not much lower than the TSX Composite Total Return Index. There are a few important differences however.
One, there is no risk. You will never get a minus 30%, 40% or 50% return with a GIC like you can in the stock market.
The second issue is fees - if you take off 2% MER for a mutual fund you are down to near GIC territory.
The last issue is you would need to be 100% in equities (in the stocks in the index) to achieve the Total Return rates.
The last point is emotions - were you able to hold on when your equities lost almost 50% of their value from June 18, 2008 to March 6, 2009?
Robert: Are most people saving enough to reach their goals by going it alone (no advisor) and avoiding growth? Sure, no stocks avoids the common mistake of buying high (on the way up) and selling low (after a crash), but it doesn't necessarily help people be disciplined in increasing savings and reducing debt. What do you suggest?
David Trahair: It seems most people aren't saving enough but figuring out what "enough" is can be quite difficult. I think the bigger issue, as you mention, is the other side of the balance sheet - how much debt are they in? I always tell people to aim for debt-freedom by retirement - they will need MUCH less saved if they don't have to continue paying the mortgage and other debts. People with credit card debt at 20% interest should not be making RRSP contributions - making a 20% after-tax rate of return is simply too tough to beat. But the more important issue is that someone in credit card debt has most likely been spending more than they make - in many cases for years. How is someone with this over-spending habit ever going to be able to afford to retire?
If they continue to do that their entire life, they are going to be in serious financial trouble later on in life. They spend more than they make now - forget the 70% of pre-retirement income to maintain their standard of living after they retire - they'll need 100%+.
Put bluntly - if you spend more than you make, you'll never get ahead financially unless you win the lottery - or maybe are lucky enough to get a large inheritance. And don't bet on the stock market to make up for your over-spending either, you could end up in worse shape than ever if the markets don't co-operate - remember stock market investments may crash but loans don't!
Online commenter Lance UpperCut: Why would you wait until you are 50 to save for retirement? This seems to go agaisnt the very simple financial principle of compound returns.
David Trahair: Because during what I call your "Spending Years" when you are paying for the house, cars, clothing, feeding and educating the kids, there simply isn't any money left to save for many people. I realize everyone is different and not all have kids but for the many that do, the only way they can make an RRSP contribution is to borrow to do it. In other words, if you have any debt whatsoever and you make an RRSP contribution you are effectively borrowing to do it at the highest rate on your debt because your alternative was to pay down the debt you already have. Even if you use your RRSP tax refund to pay down the debt - you are borrowing the net amount of the RRSP contribution. Being in debt means compounding is working against you - not for you.
This is why it makes sense to me to focus on paying off all debt including the house mortgage before investing in RRSPs. For most people that will be age 50 or later. That is not going to be easy. But that's the point - getting your finances under control and retiring well is not going to be easy and never was. This will take discipline and sacrifice.
But after you are debt-free, imagine how much money would be available to invest in RRSPs then? For many people their mortgage payments alone could be thousands of dollars a month. Your RRSP room will also have carried forward so you could start making large RRSP contributions and then could afford to reinvest the RRSP refunds. You would also (probably) be in your highest earning years and therefore highest tax bracket for maximum refunds.
I call this the "Tax Turbo-Charged RRSP strategy" in the book.
Online commenter Modiano: What do you think will be the interest rate for 5-year GICs bought this year? Do you think the high returns will continue?
David Trahair: According to Fiscal Agents, a deposit broker based in Oakville, you can currently get a 5-yr GIC with a CDIC-insured financial institution (Manulife I believe) making 3.2% a year. This is with interest rates at historical lows. I wish I could predict the future, but they can't go that much lower. Some people are predicting gradually rising rates as the government tries to slow inflation (if it becomes a concern).
I am no economist, but it seems unlikely that interest rates are going to rise quickly given the massive amount of government debt as well as consumer debt that exists today. I wouldn't bet on GIC rates rising that much very soon. Better to be conservative when making assumptions about GIC rates going forward.
James P: I'm a 28-year-old professional, and joined the workforce full-time last year after spending most of my twenties in school. I have few expenses - I am single, and have no dependents - and make enough money to put a few hundred dollars aside every month, and have about 5000 in my RRSP right now. But I am not sure where to put my savings, and I wonder if RRSPs are the right choice anyway. I am reluctant to invest in mutual funds because I think I may need money in a few to put a down payment on a home. Do you think GICs would be a good choice for me?
David Trahair: Good question. I think it makes sense in your case to look at a Tax Free Savings Account (TFSA). The interest on your GIC will not be taxed and you can put up to $5,000 in for 2009 and another $5,000 in 2010.
I agree with you regarding equity mutual funds - they may work out but the risk of losing and therefore having your home purchase delayed is too much of a risk as far as I'm concerned.
David in Burnaby, B.C: I have been investing in GIC's for over 10 years and have never lost a penny and I am mainly satisfied with my returns. At present, however, rates are extremely low. What do you think of the GIC investments that are guaranteed but also linked to stock market growth, etc., such as the GuaranteePlus Term Deposit offered by credit unions in B.C.?
David Trahair: I am a fan of simplicity and therefore not a fan of market-linked GICs. You have to check the fine print, but I think a lot of them pay zero interest if the related stock market goes down. That's too much of a risk for me. I'd rather be guaranteed the 3% or whatever the rate is.
Vince: Most charts I have seen show Equity Markets portfolio returns outpacing GIC's over the long term except for a brief period in the early 1980's. Are there some special GIC offerings that offer better returns?
David Trahair: Not that I know of. But it may be worth investigating having a Registered Deposit Broker ( https://www.rdba.ca/) do your looking for you. I have heard from people who found that a deposit broker could get a better rate than they could at the same institution. If so, you may be able to beat the published GIC rates in the charts.
James: My wife and I are both federal public servants in our mid-thirties earning $90 and $95K respectively. Our pension plan pays 2% of our best five years pay and we are eligible to retire at 55 (when we both will have met the minimum thirty years of service) with a 60% pension. In addition to our pension plan, should we be putting money in RRSPs/GICs?
David Trahair: It depends on how much money you'll need in retirement to do the things you want to do. If you decide to have kids that will have a major impact too as you'll have less money left over to save.
It will also depend on what your net worth is when you retire. For example, if you retire at 55 debt-free including your house mortgage (if you own a home) and don't plan an expensive retirement of say, travelling around the world, you may be fine with 60%. I strongly suggest, however, that people do save more than the minimum they think they'll need as a contingency for things like medical and other issues.
Paul: I am thinking that it would be a good idea to build a "GIC Ladder" in my TFSA in order to tax-shelter the interest. Assuming I have $5,000 in my TFSA now and will max out my contributions in each year, and I won't need access to the cash for 6 or 8 years, how would you recommend that I construct such a ladder?
David Trahair: It's pretty simple - divide the amount you have to invest each year by five - that would be $1,000 - and invest in a one, two, three, four and five year GIC at the best rates available. Then when each matures, invest at the best five year GIC rate you can find at that time. After five years you'll have a ladder of five year GICs maturing a year apart. Typically five year rates are the highest and the strategy reduces the risk you'll invest all the money at low five year rates.
Beth: Do you agree that inflation, typically used as the boogey man to scare people into the stock market is a paper dragon? What investment dealers don't tell you is that inflation hits the market just as hard...increased costs of goods sold, rent, salaries etc. Does inflation ever hit seniors? If a staggering 10% inflation occurs, wouldn't we be getting GIC's at 8-10%? If 10% inflation hit my grocery bill - I'd be paying $110./week. Big Whoop! I already own my major appliances/furniture/house. Can't I just hunker down and buy long term bonds that will pay me 8%? I have yet to meet a banker/investment dealer who will agree with me. Do they make more money off stock market investments as opposed to bonds?
David Trahair: Good questions Beth. I think to some degree inflation is used as a paper dragon/red herring to convince people they need to be in the stock market to beat it. I don't buy that argument. If I had $100,000 in June of 2008 I'd rather have $102,000 today in a GIC than $75,000 in some equity mutual funds. $102,000 helps me fight inflation better. You also make a good point - if inflation rears its ugly head, interest rates will almost certainly rise to offset it so GIC rates would rise too.
Not sure about how much dealers make off stocks versus bonds as I am not a licensed broker/dealer. I have, however, seen that those that charge a percentage of market value (instead of commissions and DSC fees) will charge more for stocks than bonds.
Tom: Should I withdraw from or borrow from my investment funds to pay off existing debt (currently $10,000@ Prime)? I don't have any mortgage other than secure line of credit?
David Trahair: Assuming it's outside an RSRP and the DSC (Deferred Sales Charges) fees (if they are mutual funds) aren't too onerous it may make sense. You'll also need to consider the tax effect. If there is going to be a capital loss remember it can only be used against capital gains this year or carried back to any capital gains over the last three years.
Of course if you believe the investments are going to do well going forward (i.e. better than prime) you may want to hold on.
Vela: I'm a young professional and want to start saving some of my money for travelling, retirement and whatever other "joys" life brings. I was thinking of a short and long term investment plan because I want my money to be easy to access without penalties and have a chance to earn interest. Recently at the bank they suggested mutual funds and RRSPS. What do you suggest?
David Trahair: I would suggest GICs in a Tax Free Savings Accounts (TFSAs - up to $5,000 per person over 18 per year starting in 2009) for the short term things and GICs in your RRSP for long term goals. I am not a huge fan of mutual funds for many reasons including high fees and the risk of a negative return if the timing is wrong on equity funds.
Doug: Please ask your guest to comment on the risk due to the lack of diversification particularly globally of having all of your money in one asset class, in one country and in one currency over the long run of 10+ years.
David Trahair: The main reason people diversify is to reduce risk. Usually that is the risk of a negative return. But diversification did not work too well over the last year or so did it? I have heard from many people who followed "the rules". They diversified by asset class. They diversified geographically. They even diversified by financial institution and by using more than one investment advisor. But they still got slammed financially. A lot of them are seniors with little time to recover. What should they do now?
Since we live in Canada and seem to have the strongest banks in the world, I'm not too worried about having my money invested in simple Canadian Dollar GICs that are 100% guaranteed by the Canadian Federal Government through CDIC.
Claire Neary, Reportonbusiness.com: That's all the time we have for today. Thanks very much for joining us, David, and thanks to all of our readers who sent in questions. Sorry if we didn't have time for yours - we received many, many questions on this topic today.
David Trahair: Thanks very much for all your questions - they've made me think!
One last point: When it comes to personal finances, remember it's not so much about whether you make 6% or 8% on your investments, it's more about the big thing - avoiding personal financial disaster.
Before doing anything that affects your finances - think "Could this lead to personal financial disaster of one type or another?"
If so, run like .... heck.
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