Retirement can seem like an out-of-reach dream for many Canadians. With so many immediate expenses that demand to be taken care of today, it can be really difficult to wrap your head around retirement planning — a time when work is no longer necessary and a strategy that requires effort to understand all those investing buzzwords and the math involved.
The truth is that unless you had a really money-savvy mentor in your life at some point, you likely find the idea of investing so overwhelming that it makes setting up a savings plan (*cough* budget) that much less of a priority. It’s not your fault that no one taught you the unique terminology of the money world or introduced you to the math associated with building a retirement nest egg. As a personal finance teacher, I can say that we’re starting to get better at teaching financial basics in schools, but we still have a lot of room to improve! In the meantime, each of us really only has two choices.
- Continue to be paralyzed by the thought of having to learn an entirely new vocabulary and perform arcane mathematical analyses.
- Take a deep breath, acknowledge that some degree of focus and effort is necessary to ensure future success. But then also take comfort knowing that this investing and retirement planning stuff really doesn’t have to be that hard.
I’m talking Grade 9 math difficulty level — not NASA-level hard here.
What Can You Control When it Comes to Investing?
After helping hundreds of people understand how to DIY their own investment portfolio, I have found that identifying what a person can and cannot control helps ease a lot of anxiety.
Perhaps the hardest thing for most of us to wrap our heads around is that you cannot control the returns of the stock market. You also can’t control the price of gold, whether Bitcoin goes up or down, or the performance of any other investment. No matter what the headlines say, you won’t be able to predict these price movements better than the people who do it for a living (and they get it wrong most of the time too).
Simplify your investing life by continuously reminding yourself that no matter how many investment books you read, you cannot control how an investment will do. You’re much better off putting your valuable time and energy into mastering the following areas.
- Gaining a big picture understanding of the three asset-building blocks that make up most investing and retirement plans for most Canadians.
- Identifying and understanding your risk tolerance.
- Cutting down on all the fees and costs involved with investing.
- Sheltering your growing investments from taxes as much as possible.
- Setting up automated processes that will ensure you stick to your investment plan despite behavioural potholes.
What’s An Asset?
Money geeks love to use words like “portfolio,” “asset class,” and “compounded returns.”
It’s all just lingo to make ourselves sound smart. When it comes to investing in Canada, it really boils down to three different types of investments that then get “dressed up” in many different ways.
Bonds and GICs
Relatively safe investments are often called “fixed income.”
The idea is that you are going to loan money to a business or a government. The government or company will pay you for the privilege of borrowing your money each year, and then at the end of the bond or GIC, they’ll give you your original amount (called the principal) back again.
For example, when you invest in a bond from the Canadian government, you are essentially lending the Canadian government your money.
Of course, there are bonds that are not nearly as safe as loans to the Canadian government, but most Canadians keep it pretty simple by just investing in government bonds and bonds from super big companies like RBC.
Stocks
Relatively risky investments are often referred to as “equities” or “shares.” Stocks represent actually owning a piece of a company. A stock market is a place where hundreds or thousands of businesses allow people to buy and sell small pieces of their company. So you might buy a share of Apple — and that means you own a small piece of the massive company.
Owning stock in some companies is less risky than others. But generally speaking, the value of stocks tends to go up and down in value much faster than bonds do.
Everything Else
The vast majority of Canadians build an entire investment portfolio out of stocks and bonds. These asset-building blocks often come in other “wrappers,” such as a mutual fund or an exchange-traded fund (ETF), but at their core, they are just different collections of stocks and bonds.
Now, there are dozens of other assets out there that one could purchase and hope they go up in value over time. Real estate, cryptocurrencies, precious metals, etc. And hey, if you want to eventually learn more about these — good for you — but for most people, stocks and bonds represent a pretty good diversification of their retirement nest egg.
How Much of Each Asset Should I Buy?
Now you know a bit about the building blocks of retirement planning and investing for the future. The next step is determining how much of your money you should invest in “safer” assets and how much you should invest in “riskier” assets.
Over the long-term (think 10+ years) riskier assets (i.e. investing in stocks) will usually rise in value more than safer assets. But before you go rushing off to put all your money in stocks, you really need to understand that along that long-term highway, there can be some really big bumps in the road!
If you’re going to invest 100% of your retirement plan investments in stocks, you need to be prepared to see the value of your portfolio go down 40% to 50% in a single year. In the worst years of the stock market, this is what investors had to go through. These years are rare, and most years the stock market will go up, but you need to be prepared for fairly drastic moves up and down if you’re going to be successful in sticking with this whole investment thing over the long term.
Fixed income, on other hand, offers a much more steady rate of return, but the average returns each year are not as high. Consequently, most investors find it appealing to hold some of each group of assets so that they don’t have to stomach very volatile yearly returns, but can still grab some of the long-term higher return potential of stocks. Perhaps the most difficult decision involved with building your own retirement investment portfolio is deciding the appropriate amount of bonds and stocks that you should have. Professionals can help you determine your risk tolerance, or you can find a variety of questionnaires online designed to help you pin down what sort of investment portfolio is appropriate for your risk profile.
Keep Your Money Working For You
Investment gurus love to show charts of compounded investment returns and say things like, “Did you know that if you invest $500 per month, and the stock market averages its usual return, you’ll have over $3 Million 40 years from now?!”
While that’s technically true, it ignores the effect of investment fees that you pay along the way. (It also ignores how inflation works, but that’s a problem for another day!)
If you opt to build a retirement investment account in the traditional manner of most Canadians, then you will likely be invested in mutual funds that charge you roughly 2% per year in fees. Two percent sounds like a small number, but those fees will cut your total nest egg almost in half! That’s the mathematical reality of sacrificing money in the early years, that could have been working for you for the whole time. These mutual funds are almost always just different combinations of the stocks and fixed income building blocks that we started with.
When we focus on the parts of investing that we can control, investment fees are usually the “low hanging fruit” when it comes to maximizing the amount of cash you get to spend when you reach retirement.
The absolute cheapest way to invest is to open up a Canadian online brokerage account. With the current competition between Canadian brokers, you are unlikely to pay very much in annual account costs or per-trade fees. If you opt for a super simple solution such as an “all in one ETF” that is like a ready-made retirement investment portfolio full of hundreds of stocks and bonds, then you’ll pay about 0.2% per year in fees. (Roughly 10 times cheaper than mutual funds!)
Shelter Your Investments From the Tax Storm
If you have a very large investment portfolio, then finding room underneath your tax-shelter umbrella for all of your stocks and bonds might be hard. For most Canadians though, it’s pretty straightforward.
Basically, the government wants to help you save for retirement, and because they want to help you, they have set up the Tax Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP). Each of these accounts allows Canadians to put their investments inside of them, and keep them away from the taxman as they grow in value. This is a great deal!
Now, far too many Canadians spend endless amounts of time reading about the minutiae when it comes to the differences between these two tax shelters, and which one is best for them. Make it easy on yourself — just open up both accounts, and each year start with the TFSA, and once you max it out, move over to your RRSP and start building that one up. The current TFSA maximum for the 2021 tax year is $6,000 and the RRSP maximum is 18% of your income up to $27,830. If you can create a plan to max out both — awesome, you’re in great shape.
On the other hand, if you can’t afford to put the maximum amount in both (not many Canadians can), then keep it simple to start with and begin investing within your TFSA. If you invest $500 per month within your TFSA, that is a really solid start toward building your retirement nest egg. If you want to learn more about the RRSP vs TFSA decision – and do some reading on whether it’s better to pay tax and then invest with a TFSA or to use an RRSP, reinvest the tax refund, and then pay tax later — that’s a great idea. But the real key is to get started sooner rather than later. I cannot emphasize enough how important it is to avoid constant delay and procrastination by saying that you have to learn every single personal finance fact before you invest your first dollar.
Rinse and Repeat Your Way To Success
Constantly making decisions about anything can be a draining process. If you are always having to think about saving money to contribute to your retirement investments, then you are less likely to stay the course when it comes to building your nest egg over the long term. Statistically speaking, you have much higher odds of success if you create a plan for yourself that is as automated as possible.
By setting up an automatic contribution to your online brokerage account or robo advisor platform for the day after you get paid, you will be removing many of the psychological barriers to success. Obviously, there is some sacrifice involved whenever you’re talking about saving for tomorrow instead of spending today. But, it’s much easier to stick with a plan when you don’t have to think about it month after month.
Next Steps
Whether you choose to open a brokerage account and cut costs to the absolute bone or you decide to go with super user-friendly options like a robo advisor (robo fees are still roughly three times cheaper than a traditional mutual fund), the important thing is to get started immediately. Investing in stocks in Canada in order to build your nest egg has never been easier or more affordable, so you have a major wealth-building advantage over past generations.
Just remember to keep it simple, focus on what you can control, and don’t be afraid to start sooner rather than later because you can learn as you go.
