Thursday, June 7, 2012

The Family Financial Plan

A reader, A.N., is in the throes of working out his family’s financial plan and is seeking comments. Here is a lightly edited version of A.N.’s thoughts along with my comments.
I need to have a liquid reserve to support my family for 6 months; money market, savings account, short term real return bonds; with time I’ll keep increasing the amount through regular contributions of 10% of income.
It’s smart to have an emergency fund. The exact amount for the fund depends on how likely you are to lose your job and how long it would take to get a new job. I would say that 6 months of living expenses is toward the high end but may be quite sensible for your situation. A money market fund or a savings account makes sense. I’m not sure that real-return bonds have enough choices of maturities to allow you to limit yourself to just short-term bonds. Keep in mind that this fund is intended to deal with unexpected events and should not be invested in anything volatile.
RRSPs make sense, but may not be enough.
You’re right that even if you make maximum RRSP contributions, your ultimate savings may not be enough to derive the income you want in retirement. If you are able to save more than this, then you should consider a TFSA as well.
I’m considering an asset allocation of 40% bonds, 60% equity (equally divided among Canadian, US and global).
This is a fairly typical allocation for someone who is still at least a couple of decades from retirement. I’ve chosen an all-stock allocation for myself, but this isn’t for everyone. The important thing is whether you are able to keep your head during the next stock market downturn and keep rebalancing as necessary. Note that when stocks drop, rebalancing means buying more of the stock asset class that has dropped the most. You need to choose asset allocation percentages you can stick with when the media is screaming that stocks are dropping to zero.
I’m considering the following equity investments: no load index funds, blue chip for now; when market recovers, add small cap; use currency neutral for global, possibly limit “global” to “BRIC”, though R does not fire up my imagination.
If you wish to use index mutual funds, TD’s e-Series are a good choice, although TD employees will do their best to steer you to their expensive funds. An alternative is broad index exchange-traded funds (ETFs) from iShares or Vanguard. I’m assuming that “blue chip” means a large-cap index. I prefer to own ETFs that cover a full range of company sizes, but this is more difficult in Canada than it is in the U.S. I don’t have the ability to predict when it would be best to jump into small-cap stocks; are you sure that you do? I have no opinion on which parts of the world will give the best returns. By going after the hot parts of the world you risk always buying high and selling low.
I’m considering funds of long-term / low-risk bonds for the time being; when stock market recovers - ?
I find most bond mutual funds to be very expensive. TD e-Series has a low cost bond fund. In the ETF space, iShares has some low-cost bond funds. From your comment, it sounds like you may want to change the type of bonds you own or your percentage allocation to bonds when stock markets start rising. I don’t try to do this sort of thing myself. There are many investment firms that employ brilliant people who try to outsmart each other in this way. I see no upside in playing this game; I just stick to my asset allocation through thick and thin.
I plan to avoid gold – as an investment class it is too specialized.
I avoid gold mainly because it has little inherent value relative to its price. Its industrial and jewelry uses don’t come close to justifying its current price. People buy it in the hope of selling it to someone else for more money. I’m not interested in a high-stakes game of hot potato.
I think the above should allow me to sleep well and still generate reasonable returns through thick and thin – I need 5% to retire. Whatever is left after annual costs and above investments can be invested in something riskier or spent on leisure and hobbies.
I’m not sure what you mean by needing 5% to retire. Does this mean you need 5% investment returns to build up enough savings to retire, or maybe that you will need 5% returns after retiring to derive enough income? In any case, most advice these days is that you should count on withdrawing less than 4% of your pre-retirement savings each year to have a reasonable chance of having your savings last for the rest of your life.

If A.N. manages to build 6 months of emergency savings, maximize his RRSP contributions, avoid expensive forms of investing, and avoid panic selling or chasing hot investments, he will likely have a wealthier retirement than most Canadians.


  1. In addition to my plan:
    - I do intend to stay within e-Series of TD index funds and let professional players watch my balance; iShares and Vanguard may come into picture for fine tuning, so far I have chosen e-Series out of pure convenience - I researched them already
    - to find an "all-cap" index fund is a good idea, thank you
    - thank you for bringing to my attention that in Canada real return bond funds are as volatile as any other bond funds, since they take inflation out of risk, while inflation in Canada is controlled by the state
    - I will stay with TD webbroker service and avoid any employee pressure; previously I have bought back loaded funds with 2.5-3% MER and I will not repeat this error
    - psychological pressure imposed by the need to invest into something falling will be significant, thank you for warning, - will have to work on it to sustain the balance, since whatever falls is deemed to rise
    - we still have 20 years to save for retirement and my Excel exercise tells me that if my portfolio provides a 5% return I shall be able to focus on fishing during my 65-95 period. Modesty of this return expectation results from my plan to gradually increase portion of bonds closer to 65 in order to arrive at retirement with predictable amount.
    - the 6-month reserve fund has less to do with our ability to find jobs and more with our desire to turn away from existing and future jobs if we choose so by whatever reason. As Don Draper said: You want me, but you can't have me. I intend to increase this fund closer to retirement to provide for flexibility in withdrawals from RRSP/RRIF and avoid clawbacks of OAS.

    Now question: would you be able to direct me to a good software to monitor my investments?

  2. @AnatoliN: I just use spreadsheets to track my investments. Perhaps other readers have suggestions.

  3. It's nice to hear there's someone else out there with an all equities portfolio - whenever I mention that on finance boards I am roundly criticized for doing it all wrong. How old are you BTW, and do you plan to change your portfolio at some point to add other asset classes such as bonds, tips, etc?

  4. @Tara: The main reasons not to have all equities or high equities is if you are close to retirement, unable to sleep at night with worry about a stock crash, or would panic sell during a stock downturn. I avoid talking too much about my personal life, but you can guess something about my age from the fact that I have two adult sons. I do plan to shift into fixed income investmetns at some point, but I haven't decided yet. At a minimum, I plan to have 3 years worth of living expenses in fixed income investments once I retire.

  5. That's my plan as well - 3 years living expenses in cash/equivalent, and dial back my stocks when I get into my mid-late 50's (I'm 46 now). I'm hoping there will be some growth in the market in the next 10 years I can take advantage of. I've been through the dot com crash and the latest crash and did not sell, so I feel comfortable holding at 100% equities for now.

  6. The market timing parts of this plan worry me. Waiting until the market "recovers" is like waiting until the prices at the supermarket "recover" after a sale.

  7. @Patrick: Nice analogy. When I see someone pin down what they mean by the market recovering, it is usually something like waiting until prices rise 10% or 15% from their lows. This makes the "buy high" part of the plan more transparent.

  8. My thinking was to wait for the weaker small caps to go under and to buy into the rest. I am aware that I am facing slower growth, but with with lower risk. Would you still say "do not bother"? I am all ears.

    As to an all-equity portfolio - I have my concerns. Some sound hi-tech companies have not recovered their pre-2001 values. Holding them sounds like a "sell low" recipe to me, which can't be fixed even with a 3 years worth of cash. Since I am not capable to forecast which industry will be subject of the next bust, the only option I see is to buffer possible losses by bonds.

  9. @AnatoliN: I spent quite a few years trying to outsmart the market. In the end I concluded that my efforts were futile. So I no longer think about individual stocks or the short-term future small caps or tech stocks; I just own the market and relax. You may make a different choice.

    As for bonds, the vast majority of commentators recommend owning some bonds, so you're in the majority. I don't advise anyone to follow my lead. I think that an all stock portfolio is right for my situation, but it sounds like it's not right for you.