The Canadian Money Roadmap
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The Canadian Money Roadmap
3-7% Returns, TFSA Multi-Millionaires and What To Do Beyond $100,000
This week, I'm tackling a few topics that were popular on Reddit over the last month.
1. What should you use for return assumptions in your planning?
2. Becoming a TFSA multi-millionaire
3. What should be your priority after building your first $100,000
**For a more in-depth look at expected returns, check out the recent Rational Reminder Podcast episode on the topic
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Hello and welcome back to the Canadian Money Roadmap podcast. I'm your host, evan Neufeld. On today's episode, I'm going back to a segment that I used to do a whole lot last year. This is the Reddit roundup, where I went on to Reddit and I found some of the most popular posts from the personal finance subreddit and I'm going to look at a few of the answers or the ways that I would think about giving an answer to these people asking questions. Today's topics include what should you use for return assumptions in your long-term financial projections? Becoming a TFSA multi-millionaire and I just hit $100,000, what now? This will be a good one.
Speaker 1:Lots of things to go through here, so I hope you enjoy this episode of the Reddit Roundup for April. All right, let's get into post number one. This post says I've seen most financial institutions saying that you should expect a conservative 3% to 4% growth on retirement funds. I've also heard of 6% to 7% on other subreddits and my portfolio, not managed by me that's the original poster saying this, not Evan Neufeld here. The portfolio is currently blowing both of these numbers out of the water. So the question is when running the retirement calculators, what rate should I be putting in? Okay, well, the million dollar question there is what retirement calculators and what other variables are you dealing with in addition to simply rate of return? But going through this one, the main idea here is, if you're looking towards the future, you've got to start using some assumptions. You'd hope that these assumptions are rooted in something that's reasonable and rational, and so, to this poster's credit, they are trying to do the smart thing by trying to create a bit of a plan for themselves using return estimates that make sense.
Speaker 1:So, for me as a financial planner, we are encouraged to use the assumptions provided by FP Canada, or Financial Planning Canada, and every year they put out a new set of guidelines that we can use. They don't deviate a whole lot from one year to the next, which is a good thing. They shouldn't be jumping around too much, but they are guidelines using a variety of publicly available sources, and so it's not a single person or just some opinions or anything like that. They rely on a lot of actuarial reports from the Quebec pension plan and the Canada pension plan as well. So using their guidelines is a good place to start. It's something that us, as financial planners, do as well. They give a little bit of leeway, depending on circumstance, and there's some caveats that we could maybe get into there. But largely speaking, the guidelines here are intended to be used and I'm quoting here as a guide, and they are appropriate for making realistic long-term ie 10 plus years financial projections.
Speaker 1:Predicting the direction the economy will take and how financial markets will evolve is a difficult exercise requiring the integration of a large number of variables and highly sophisticated valuation models, of course. So all that to say, you need to have some basis for what you're using for a guideline, and FP Canada seems like a reasonable starting point that you could use. So just looking at equities so this is just stocks they have guidelines provided for Canadian equities, foreign developed market equities and emerging market equities. These all have different expected rates of return. They also come with different expectations on volatility as well, which are not included as part of the guidelines here. But just pure and simple, here's what you can do and you can add different weights depending on what your portfolio looks like yourself. So, for Canadian equities, the assumptions for this goes back to 2023. They haven't updated them for 2024 yet.
Speaker 1:But 6.2% for foreign developed market equities. Think US markets or the UK or Japan, things like that. I know they're all different, but largely speaking as a group, 6.5% and emerging market equities, 7.4%. So if you have a reasonably typical portfolio that includes about a quarter in Canadian equities, about 50% in the US, about 15% in foreign developed markets outside of the US and about 10% in emerging markets Again, that is not for everybody but that's a relatively common generalization for an all equity portfolio that leads to a weighted average of pretty well, bang on six and a half percent. So if you are a DIY investor and you're building your portfolio using ETFs and things like that, you will need to subtract the management fees from that Same thing with using an advisor or any other fees that might come along with getting access to those investment products.
Speaker 1:So if you are in the ballpark of that 6% to 7% that this person mentions, they've seen that is grounded in a reasonable estimate of forward-looking returns for a globally diversified equity portfolio. There's a lot of jargon there, but hopefully that makes a lot of sense. So now maybe to address some of the other things there. The poster mentions that his portfolio is currently blowing both of these numbers out of the water. So keep in mind that 6% to 7% does not mean that every single year you are going to get 6% to 7%. This is how averages work. You're going to get some years that are great, some years that are terrible, and then, on average, you're going to get six to 7%.
Speaker 1:The devil's in the details on these projections because, as FP Canada suggests as well, that I'm quoting financial planners should also develop sensitivity analysis to illustrate and assess the impact of changes in assumptions on clients' financial position. So part of doing that is something called a stress test, and that's something that I include with my clients and their financial plans. Stress test takes a look in to see what would happen if the order or the sequence of returns is not favorable for that person as part of their retirement plan. Using something called Monte Carlo analysis can be a great way to do that, and it's a pretty interesting tool to take a look at your odds of success, looking beyond just an average rate of return plugged into a calculator, because if you're using a retirement calculator and using even reasonable guidelines, what you're doing is actually projecting straight line returns, not anything that actually includes any volatility or variance, and we all know anybody that's been investing more than a day or two knows that investments don't always go straight up. So, yes, averages are fine. Using reasonable, forward-looking projections is fine. Stress testing is better. Being conservative is also better, because if you're more conservative in your return assessment, then you'll likely develop a plan where you'll be saving more of your money to increase a little bit of wiggle room there.
Speaker 1:So when the poster says that you should expect a conservative 3% to 4%, based on what they've seen from financial institutions, this could be a couple of different things. They might be taking a look at a situation where that might be the expected return for, say, a balanced portfolio. It's probably a little bit low, even for a balanced portfolio. But back to FB Canada's guidelines here the return assumptions for fixed income. So fixed income would be bonds and that's typically the other half of a balanced portfolio. The return assumptions for fixed income in 2023 was 3.2% on a go-forward basis.
Speaker 1:So when you start including some of these assets that have lower expected returns, your return assumptions, depending on how you're invested, should also decrease. So if you are someone that is a balanced investor meaning, say, 40 to 60% of your portfolio is in bonds you should not be using a 6 to 7% rate of return on any assumptions that you make in your financial planning. That just doesn't make sense, because if half of your portfolio is in fixed income, that has a 3.2% expected rate of return, that meaningfully changes how you should be planning and saving your own cashflow. So another thing that you could be seeing if someone says expecting three to 4% growth on retirement funds, that could also be something called a real return. Real returns should probably be more accurately just called inflation adjusted returns. Because inflation adjustments?
Speaker 1:I kind of go back and forth on this because in some ways it doesn't matter at all, in other ways it's the only thing that matters. It's the only thing that matters because you can't spend rates of return. You have to spend absolute dollars, and so if your dollars in your bank account get eroded away via inflation meaning you you can just buy less over time Well then your rate of return doesn't really matter. But at the same time you can't control inflation and you can't really control your rate of return either, and so they kind of are just is what it is factors in the grand scheme of things. So when you're doing a proper financial plan, yes, you should be using inflation adjustments, but those should come throughout your financial plan as well, not just necessarily on your investment rate of return. So anyways, without rambling too much more on that, the 6% to 7% that this person mentions on their post is probably a decent place to go if they are someone who is invested in a globally diversified portfolio of stocks. Only Might be a little bit high if you're a balanced investor or you include some bonds in your portfolio, but somewhere in that ballpark seems completely reasonable.
Speaker 1:The next post here says this is the headline or the title here simply maxing out TFSA every year will make you a multimillionaire before retirement. And this person says, just playing around with some numbers on an investment calculator and plugged in these parameters on a hypothetical TFSA account, if one starts contributing to a TFSA when they turn 18 and put it into an S&P 500 index fund, they reinvest all dividends and never withdraw any money from the account. They assume an annual contribution of $6,000, fluctuates between $5,500 and $7,000. I'll come back to that and assume a rate of return of 10%. Uh-oh, might be a little juicy. So anyways, this person says after 42 years, at 60 years old, the investment will grow to $3.9 million. Even with a 4% withdrawal rate per year. That's over $150,000 in passive, tax-free income. Sure, okay, I'll stop there. I love the TFSA. I think it is a very underused tool. I think it is going to become more and more valuable as time goes on. I think it's a great retirement tool.
Speaker 1:However, there's a few things that I'm going to suggest here as it relates to this person's post. First one should you put everything into an S&P 500 index fund? Me personally, no. Index investing is totally fine. I think the S&P 500 has been a perfectly fine place to invest, of course, because over the last 10 years it's been the best place to invest. So should you, as an investor, assume that the best performing index over its best performing period of time will continue to be the best performing thing on a go forward basis? No, that would probably not be rooted in any sort of evidence, and so diversifying outside of only large cap equities in only one country probably makes sense. Are you going to blow yourself up by investing in only the S&P 500 index fund? No, is it optimal? No, probably not either. So, anyways, we might be splitting hairs there a little bit, but for index investors, including some other parts of the world in your index portfolio would probably be prudent.
Speaker 1:The next part mentions reinvesting all dividends. So here's part of the reason why there's a little minor optimization thing when it comes to receiving dividends or foreign dividends in a tax-free savings account. So Canada and the US do not have a tax treaty with each other as it relates to the tax-free savings account. So any dividends that you receive, even from an S&P 500 index fund even though it's not a dividend-specific fund there are still plenty of companies in there that do pay dividends 15% of the dividends received will be withheld at source and you will not receive them. This is not true in an RRSP, however. So investing in US equities, there might be better homes for it in terms of account types and things like that, and so there are some minor inefficiencies for us as being Canadian investors, and smarter people than me have done a lot of work on actually running the numbers on home bias, meaning that's investing in your home country, and the optimal amount for most countries is in that ballpark of 20 to 30%, which is what I suggested in that previous post. So most of the asset allocation ETFs and mutual funds that you might be familiar with that is a typical allocation to Canadian stocks in those portfolios, and they do that for a reason. So S&P 500 index fund might not be a great assumption on a go forward basis from a diversification and opportunity standpoint.
Speaker 1:The next one person says the annual contribution of $6,000 fluctuates between 5,500 and 7,000. No, it does not. Actually, what the contribution room for the TFSA does is it increases with inflation rounded to the nearest $500. So some years it will go up and other years it will not, but it will not fluctuate between 5,500 and 7,000 currently this year. So if you're investing in your TFSA for this year, the room for 2024 is $7,000 and it has been 5,500 in the past. It has also been 5,000 in the past. It's also been 10,000 in the past. So calculating the appropriate amount of TFSA room that you have will be critical for maximizing the TFSA over the course of your life and also prevents you from over-contributing, which is a bit of a nightmare.
Speaker 1:So the last thing here, of course, is that assumed rate of return of 10%. I think this is problematic for a few reasons, but I think that might be a little bit overly optimistic. If you would like a deeper dive on some of the theory and the empirical evidence around rates of return and projected rates of return, the good people over at the Rational Reminder Podcast, ben Felix, cameron Passmore and previous Canadian Money Roadmap guest, mark McGrath. They go into a lot of great detail on a recent episode about this. I can link to that in the show notes here as well. It's really interesting, but I'll spare you the long listen. And 10% is a little bit ambitious for a go-forward rate of return, even for US equities. It's possible. It's possible and I'm okay with being wrong because I got a lot of money invested in US equities too. But just to assume it on a go-for-it basis is probably a bit much.
Speaker 1:So anyways, use a TFSA. It's a great long-term tool for building retirement assets, tax-free income, all that sort of thing. It's great. It is totally possible to have a million bucks in a TFSA. For those of you that are in the millennial demographic, like myself, that's completely reasonable for someone that has the capacity to invest in the ballpark of the contribution room every year. But that takes a lot of money as well. So it's not going to be for everybody and it's not a no brainer and you have to stay invested to actually realize those assumed rate of returns as well. So if you're jumping in and out of the market, that's just going to be another anchor on your overall returns, but that's another topic for another day.
Speaker 1:Last topic here the title is 100K, what now Sounds like a good problem. So this person is soon to be 27, hit 100K this week $15,000 in a cash account, 50,000 in TFSA. 20,000 RSP 18,000 first home savings account. They make about eight grand a month after taxes. No debt. I helped pay my parents mortgage and recently moved back in with them. No plans to move out until I'm 30, unless life throws an unexpected, probably curve ball. Here. I'm editorializing the missing words, so I'm going to read the next part verbatim here because I think it is kind of interesting, and so we'll get into a bit of a conversation on this Now.
Speaker 1:Not that I expected the $100,000 benchmark to be a grandiose finish line that once I hit I could ride off into the sunset forever, of course, but I did think that I would feel more accomplished and slightly fulfilled After getting there. I'm more so lost in my direction of what's next? 500k, a million, yeah, sure, but then what? Maybe coming to a slow realization that money isn't everything. The more you have, the more you'll want. I can see how this vicious cycle can consume people's lives and sooner or later then realize they're 60 and haven't experienced life itself.
Speaker 1:Anyways, this isn't a find a meaning to life page. So, beyond that, hoping to get some input from people older and wiser than I am on what the best ways to continue to grow my net worth in the coming years, as mentioned, whatever, it doesn't matter. So I would say this person's in a really good position and they're asking some good questions here. Are they kind of coming to the reality of what they should be considering? So no, the post that they're on isn't a finding meaning to life page, but that is a part of the investment process journey, right? So making the pile bigger isn't really a goal or it's a problematic goal.
Speaker 1:From my experience with people, the cool part about my job is that I get to walk alongside many, many, many other people in different stages of life, in different stages of wealth, helping them make better decisions with their money and the people that I've seen that have a goal of making the pile bigger. It just becomes very, very difficult because there's never enough and it's never fast enough, right? If you don't have a goal other than making more money or making the pile bigger, or, in that case, even if you don't think that way sometimes it's like well, when I have 2 million bucks, I'm going to feel good. When I have 3 million bucks, I'm going to feel good. When I have 4 million bucks, I'm going to feel good. When I have three million bucks, I'm going to feel good. When I have four million bucks, I'm going to feel good. They don't feel good. It's never happened. I've never seen that once.
Speaker 1:When people do not have guiding principles or goals for their money beyond just numbers, there's never enough and it's never fast enough. So this can obviously lead to bad behaviors that try to accelerate years of good behaviors. Trading too much, getting into more and more speculative assets, selling when the market goes down, buying after it's gone up All these things actually don't make the pile bigger. They make the pile smaller. So all the good things that you did become less and less relevant in your mind if you do not have any proper goals. So I always tell people okay, so what does your plan actually require? So what is next for this person? Do they even need to be saving any more? I don't know. I don't know them beyond this Reddit post here.
Speaker 1:But part of making money is spending money. I believe it's about being generous with your money If you have the capacity to do so. I think everybody has the capacity to do so in one way or another. You don't have to be putting your name on a hospital to be generous with somebody, but there's so much more to having a job, to earn an income, to just save and invest more. It's fun investing. I like it. Following the markets is fun and interesting whatever, but there's got to be a purpose. There's got to be a reason why everything is happening.
Speaker 1:So if you have a financial plan that says I want to do this with my money on this timeline, you have a financial plan that says I want to do this with my money on this timeline, whatever, okay, now you can consult your plan and say you tell me what's next. Should you prioritize your RSP? Should you invest in a non-registered account? Do you need some insurance? All sorts of things that will guide the actual nuts and bolts of what do you do with the money next, from a practical standpoint, and if you don't get a good answer, the better answer is probably enjoy your life a little bit. You know like if you have so much money on hand and all of your savings goals are achieved and you don't have any debt, go spend it. Go give it away. Make a difference for somebody. It's lots of cool things that you can do, but anyways, to help form some of those things, using the framework of SMART goals might be a good place to start. So SMART is an acronym that says that your goals should be specific, measurable, achievable, relevant and time-based. This is a perfect framework for financial goal setting, and so when we work with clients on their financial plans, these are the things that we try to pry out over time.
Speaker 1:The big one for most people is retirement. So when do you want to be done working? How much money do you need to have of your own at that point? Is that reasonable to do? Is this actually what you want? Is that a timeframe that makes sense? You know, sometimes those retirement goals can be a little bit too far in the future, but if it's like I need a car in the next three years, okay, that's pretty specific. How much do you need? You'll probably need like 40 grand. Cars are so expensive. Even relatively cheap vehicles are really expensive. So that's specific. It's measurable, meaning you actually know how much it's going to cost. Is it achievable? I don't know. Depends on your income and how much you can actually save out of your cashflow. But in theory, yes, that's probably achievable. Is it relevant? Yeah, that's something that you need to get around, so that's a very relevant thing to you and time-based. In three years, awesome. Now you actually have a framework to figure out what to do with your money. Awesome, and you can do this with every part of your financial life if you want. But again, just making the pile bigger and investing for the sake of investing leads to bad behaviors, it leads to confusion, it leads to questions, it leads to uncertainty, and that's the last thing that anybody benefits from when it comes to their money.
Speaker 1:Here's the plug. If you do not have a financial plan, check out my website evanneufeldcom. There's a section for financial planning. I've got very clear pricing available on there for individuals or families and reach out and my colleague Jordan would be your next point of contact to get started with a financial plan. Here at the Canadian Money Roadmap, I am all about giving you the tools to better understand your money so that you know where you're going, and this post is exactly about that. You got to know where you're going in the first place, so having a financial plan can really make you determine what is a good strategy for you on a go forward basis to help you achieve the things that you want to achieve with your money.
Speaker 1:Anyways, I hope this was an interesting episode for you. I kind of like doing this from time to time because if it's popular on Reddit, that means it's probably popular with people who are also listening to this podcast. I appreciate all the questions that I've got. Recently I got an email about something very similar to the last post here about what to do next, and so I'm hopefully going to do a podcast episode about that in the future and get into a little bit more specifics about Canadian financial planning and the options available once you've maximized your registered plans. So anyways, like I mentioned before, if you are looking for a financial plan for yourself, you can check out my website at evanneufeldcom the link is below in the show notes and we'd love to connect with you and hopefully help you get some clarity on where you're going and how fast you can get there on your financial journey.
Speaker 1:Thanks for listening. We'll see you in another episode. Thanks for listening to this episode. See you in another episode making changes to your financial plan. Evan Neufeld is a certified financial planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.
