When it comes to financial planning, it’s fine to hope for the best, as long as you also expect the worst.
It would be great to retire at 55 – and apparently it’s easy as pie if you just put money away monthly and get a 10 per cent rate of return. We would love to get those 10-per-cent projections you see quoted in compound growth examples, but the likelihood of attaining those rates of return decade after decade is pretty low. A 5-per-cent projection would be much more prudent.
Financial planning expectations can be pretty far removed from reality at times. Some people, for example, will put off getting life insurance or having wills and powers of attorney drawn up because they think they won’t be dying for a long time. By that rationale, you shouldn’t buy life insurance until the day before you die, but how would you know when that’s going to happen?
Similarly, some investors give up flexibility in exchange for the highest potential net worth. But what might be the best strategy from a mathematical point of view may not be the best strategy from a financial planner’s point of view.
For example, a reader asked me if he should pay down the rest of his mortgage with his RRSP as he is currently unemployed. He assumes the rate of return on his RRSP is going to be very low, whereas he knows his effective rate of return for paying down debt is guaranteed. Since he has little income being reported for the tax year, the taxes owing on an RRSP deregistration will be minimal, he assumes.
He may have himself convinced the strategy is best from a numbers perspective, but from a planner’s perspective, it puts him in a very precarious position if everything doesn’t go according to plan. What if he has an emergency and needs access to cash? Deregistering funds from an RRSP account could be easier than trying to get money from the bank if they require a credit assessment update, which includes looking at his employment status.
Further, when markets have been choppy or in decline, many people feel less strongly about being invested and are more inclined to sell off their portfolios and deploy the funds elsewhere. Generally speaking, if you can buy when everyone is thinking it’s time to sell because of prolonged malaise in the market, you’ll do pretty well as an investor. You’re supposed to buy low, sell high, after all.
I suggested he talk to a financial planner and discuss some of the curveballs that life can throw. He could look at a middle-of-the-road approach. In his case, that might mean paying off only half of his mortgage balance and retaining some of his RRSP assets.
Contingency planning is an important part of personal finance. It might not be fun to expect the worst while hoping for the best, but you’ll be less likely to get caught out when life happens.
Preet Banerjee, B.Sc, FMA, DMS, FCSI is a W Network Money Expert. You can follow him on twitter at @PreetBanerjee