Never Retire Profile of the Week
Dame Jane Goodall
She was 26-years old when she first travelled to Tanzania and today, at the age of 86, Jane Goodall still works extensively on habitat conservation and animal welfare. As a primatologist and anthropologist, she founded the Jane Goodall Institute and the Roots & Shoots program, which engages youth in environmental, conservation and humanitarian issues. While it was her father who gave her a stuffed chimpanzee rather than a teddy bear as a child, it was her mother who most encouraged her to pursue a career in primatology in the late 1950s, when few women were in the field. Her studies of the chimpanzee community in Gombe Stream National Park launched her career, though her observation that primates have individual personalities, now accepted as fact, was considered controversial at the time. She also challenged the scientific community when she observed that chimps use tools and also eat other animals, not just plants. For her pioneering and ongoing environmental and humanitarian work, Goodall has been named a Dame Commander of the British Empire and has earned countless awards—most recently, the Gold Medal of the Royal Canadian Geographical Society.
By now, you know how I view financial independence: it’s not a goal in itself but a means to an end. It’s not about having money for the sake of money. It’s about having the opportunity to turn your attention toward becoming the best version of yourself. It’s about having freedom and choices about how and with whom you spend your time. It’s about creating the self you most want to be, without worries and impediments.
With financial independence, maybe you’ll spend more time with your spouse, children, grandchildren, friends and colleagues. Maybe you’ll build a scale model of the Eiffel Tower, perfect your tennis serve or volunteer at SickKids Hospital. Maybe you’ll look inward for creativity and motivation and discover a book you want to write or a destination you want to explore. Whatever the case, you get to focus on your passions and dreams for a great life.
I’m not saying that self-improvement is not possible without financial independence. I’m saying that self-improvement becomes easier to achieve when uneasiness around money and income is removed.
As a wealth advisor, my job is help clients determine their personal financial independence (FI) number and work on accumulating the required savings.
In When can I retire Part 1, I emphasized that business owners and professionals calculate their FI number as soon as possible, because it guides them in determining their annual savings rates, annual spending rate, and expected date of Financial Independence. Most importantly, the calculation reduces fears about running out of money during retirement and not being able to take care of themselves.
In When can I retire Part 2, I explained the challenges of using a traditional retirement calculator or projection in determining the Financial Independence number. I also provided solutions for minimizing the issues that may arise when making assumptions about calculating the FI number.
In When can I retire Part 3, I offered my personal approach for calculating the Financial Independence number. In short, I believe that Financial Independence is achieved when all expenses (or at least, all non-discretionary expenses) are covered by inflation-protected passive income.
In the final chapter of this series, I will provide examples of investments that can produce that inflation-protected passive income.
Since no investment strategy is guaranteed to work, I suggest diversifying your retirement pool into multiple non-correlated investments, including guaranteed investments like GICs and life annuities.
It would be ideal if your discretionary expenses were covered by income generated from guaranteed investments and your non-discretionary expenses were covered by income generated from non-guaranteed investments, such as dividend paying stocks or rental real estate.
Let’s look at some of the more popular options:
1. Dividend growth stocks
Certain publicly-traded companies distribute cash each quarter to their shareholders, and the cash may be reinvested into additional shares of the company, used to acquire shares in other companies, or withdrawn and used to fund lifestyle expenses.
A very small and elite group of companies has historically issued quarterly dividends that increase each year.
Let’s look at TD Bank’s dividend history from January 1, 2010 to January 1, 2020.
| Year | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 |
|---|---|---|---|---|---|---|---|---|---|---|
| Dividend | 1.22 | 1.34 | 1.49 | 1.665 | 1.88 | 2.04 | 2.20 | 2.40 | 2.68 | 2.96 |
| % change | 0% | 9.84% | 11.19% | 11.74% | 8.5% | 7.84% | 9.09% | 11.67% | 10.45% | 1.69% |
Let me draw your attention to two important conclusions about this chart. First, TD paid a dividend each year for the last 10 years (in fact, it has paid a dividend since 1857). Second, for nine out of 10 years, TD increased its dividend (with average annual dividend increase for this period at 8.2%).
Of course, the next ten years may not follow the same historical pattern. But by implementing a few rules to screen dividend stocks (as per the Richard Dri Dividend Model, I believe an investor can increase their chances of investing in several stocks such as TD Bank.)
Let’s take a closer look at TD shares.
Assume we only bought TD shares for our retirement pool (I don’t suggest this approach – I’m simply illustrating a point) and assume we need $50,000 plus inflation to meet our lifestyle expenses. In January 2010, TD shares paid a dividend of 5%, so let’s suppose my investor bought $1,000,000 worth of TD shares, paying $50,000 in dividend income, equal to their lifestyle expenses.
Have a look at the results:
| Result | |
|---|---|
| Share price at buy date (31 Dec, 2009) | C$ 32.98 |
| Number of shares bought | 30,321 |
| Amount invested | C$ 1,000,000.00 |
| Share price at sell date (23 Jun, 2020) | C$ 61.71 |
| Number of shares sold | 30,321 |
| Proceeds from sale | C$ 1,871,134.02 |
| Total dividend pay out | C$ 635,839.90 |
| Yield | 150.70% |
Recall from Part 3, my Financial Independence strategy works when investment income equals or exceeds lifestyle expenses adjusted for inflation. So, let’s compare. $50,000 per year for 10 years, adjusted for 2% inflation, produces a cashflow need of approximately $548,000. This represents the minimum amount that must be generated from the passive investment to reach financial independence.
As the chart illustrates, TD shares paid a total of $635,839 generated by the portfolio TD stock.
It’s safe to say that my investor’s lifestyle expenses were easily covered by the increasing dividends paid by TD Bank. As well, the initial capital of $1,000,000 had risen to approximately $1,871,000.
Occasionally, dividend-paying companies experience financial difficulties and reduce or cut their dividends. In order to minimize this risk, I suggest following a rule-based investment strategy. However, if you are looking for a passive DIY approach, consider ETFs that invest only in dividend-paying companies.
2. Rental real estate
In many urban parts of Canada (and specifically the GTA), multifamily rental properties have historically provided increasing cash flows and capital appreciation. In Ontario, multifamily rentals are also subject to rental controls, which permits owners to increase rents annually at the rate of inflation.
So rent controls ensure that the first requirement of only investing in assets that generate inflation-adjusted income is met.
If the investor’s retirement portfolio included a triplex costing $1,000,000 and generating a net rental income of $50,000 (covered by rent controls), it would check off all my requirements and would be an appropriate investment to achieve Financial Independence.
Investors may purchase multifamily real estate directly, but direct ownership requires ongoing property management, accounting, tax and perhaps legal work. Alternatively, a passive DIY investor could purchase publicly-traded REITs or participate in private real estate groups which offer hands-off ownership.
To minimize the risk of a “bad” real estate investment, consider buying multiple properties in different cities (or at least, in different parts of the same city) and buying different types of real estate properties (such commercial, residential and industrial). If you don’t have the time or funds for this level of diversification, consider multiple REITs.
Note: Real Estate investments – directly or indirectly – is not without risk and careful consideration should be made as to it’s suitability for your risk tolerance and objectives.
3. Life annuities with inflation protection
Here’s how a lifetime annuity works: instead of paying annual premiums to an insurance company in exchange for your heirs receiving a lump-sum payment upon your death, annuities are bought from insurance companies with a lump sum of cash. In return, investors receive guaranteed annual income payments until they pass away (or for an agreed upon time).
An annuity also has the option of providing inflation protection. Here’s an example based on the following facts:
- 50-year-old man
- Life annuity for $1,000,000
- No spouse
- No minimum guaranteed period, annuity commencing immediately and annual annuity income frequency
- Index annuity by 2% per year
- Non registered funds
Based on the above facts, an investor may purchase a $1M annuity and receive an annual guaranteed payment of approximately $26,000 per year, indexed each year by 2% until death. (Note: the annuity amount is solely for illustration purposes and changes frequently based on many factors including, but limited to, interest rate changes.)
As indicated above, I suggest a portion of your lifestyle expenses should be covered from income produced by guaranteed investments such as an index life annuity. It removes the risk of outliving your money and minimizes the impact of inflation.
3. Guaranteed Investment Certificates (GICs)
A GIC is a popular investment with many Canadians as it provides a guaranteed return of principal and pays a fixed interest rate. (Note: GIC principals are guaranteed by Canadian Deposit Insurance Corporation CDIC up to $100,000.)
Today’s interest rates are historically low, hence requiring larger sums of money to generate the required cash flow. For example, the highest 5-year GIC rate is currently 2.3%. Thus, a $1,000,000 retirement pool generates $23,000 of annual interest (ignoring taxes) and is not indexed for inflation.
An investor would need to save much more if they decided to invest only in GICs. I suggest investors use GIC income to cover a portion of their lifestyle expenses (that is, fixed expenses or non-discretionary expenses).
4) Pensions
Another type of guaranteed and index investment comes from government pensions such as the Canada Pension Plan and Old Age Security. Currently, the maximum CPP one can receive is $1,175.83 per month and the maximum OAS is 613.53 per month (as per Canada.ca).
Some company pension plans are considered defined benefit plans, which also provide a guaranteed pension for life (and in some cases with partial or full indexing).
Okay, so let’s finally answer the question! When can I retire?
Let’s assume that non-discretionary expenses are $35,000 per year and discretionary expenses are $15,000 per year.
Based on the RD Calculator, how much do I need to retire?
Step 1: Use guaranteed investments to cover the non-discretionary expenses
Maximum CPP and OAS pension: $21,472
Company defined benefit plan (with full indexing): $10,500
Buy a GIC for $150,000 at a rate of 2.33% which generates approximately $3,450 of annual income (this produces a little more than you need but covers inflation in the latter part of the five years) or buy a life annuity with indexing for approximately $140,000.
Step 2: Invest in a well-diversified portfolio of dividend paying stocks
For this step, assume average dividend yield is currently 3%.
A starting interest yield of 3% requires an investment pool of $500,000 to generate an income of $15,000.
In summary, financial independence is achieved when you have saved at least $650,000 and qualify for the above pensions. (Note: If the government or corporate pension are reduced due to early retirement, you will need to make up the difference with additional personal savings.)
It only took four blogs and more than 6000 words to answer the question “When can I retire?” But I believe I have provided a method that is not subject to the errors of long-term estimates or requires that you watch and monitor the value of your portfolio on an hourly basis.
In this plan, your fixed expenses are covered by CPP, OAS, GICs and your defined benefit plan from work.
Your discretionary expenses are covered by the dividend generated from a dividend stock portfolio.
Now that we’ve arrived here, what do you think? How does your plan compare? What questions do you have?
Did this article resonate with you? What did I miss? Send me a note and let’s start the conversation.
The process of finding an Advisor can be overwhelming. Our process is designed with you in mind. Its structured framework helps you make an informed decision about engaging an appropriate advisor.
Call me if you in want to map out how you can Never Retire. You can also subscribe to our Never Retire Newsletter, contact us to order a complimentary book, register for one of our events, and call us to meet with a Certified Financial Planner. We offer you a range of services from a financial plan to investment advice or helping you take advantage of our investment models. Call me at 416.355.6370 or email me at richard.dri@scotiawealth.com.
source https://richarddri.ca/when-can-i-retire-part-4-the-final-answer-to-the-question/
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