Asset shift

Before we moved back, our assets were split per the below chart:

Our home made up the majority of our equity (66%), then our Canada ETFs and Irish stocks (Mr. MH’s old work scheme) made up 11% each and our Irish ETF portfolio made up 7%. We kept a cash buffer to cover a few months of living expenses, making up 3% and our car made up 2%.

For now, our new asset breakdown looks like this:

79% of our equity is now made up of our Canadian ETF portfolio. 12% remains in our Irish stock account which we will start to sell off when we start to withdraw from the portfolio. 5% is the value of our car and 4% remains in cash as an emergency fund.

In terms of existing assets, I wasn’t going to sell them off and trigger a tax event unnecessarily so for now our portfolio will look a bit more complicated than it needs to be. Eventually, as we start to sell off funds when we start to withdraw, we will sell off the funds we no longer want to hold first and our portfolio will get simpler over time.

Detailed Canadian ETF Breakdown

Once we moved, we had to decide how to restructure our assets. I didn’t want to have assets in 2 countries as I didn’t want to have to keep filing taxes in both as well as to continue managing multiple investment accounts and portfolios. I’m a big fan of the keep-it-simple approach.

As mentioned in my last post, we decided we would rent instead of buy a new home for the time being and so we wouldn’t be needing any large sums any time soon and even if we do want to buy again, we’ve decided we’d like to save up and start again, leaving the rest of our assets invested to grow.

To start building out our new portfolio, I did up a budget, figuring out how much cash we would need to cover the next twelve months including the purchase of a new car and other setup costs. I also figured we needed to leave some cash in our Irish account as we had plans to travel to France, Portugal and Ireland within the next twelve months and there was no point converting the cash only to convert it back again a few months later. Once I knew how much we needed to leave out, we took the money from the sale of our Irish home, sold our Irish ETFs and moved the money to Canada. From there I took the opportunity to apply the knowledge I’ve acquired in investing so far and made up a new consolidated ETF portfolio.

Initially, I was just going to continue replicating the ETF portfolio I already had. It has performed well enough and has good diversification, but when it came to investing the largest sum of money I will probably ever invest at one time, I thought about all the other long-time FIRE bloggers that I follow. All of the American bloggers have said time and time again to just invest in VTSAX (Vanguard Total US Stock Market Fund) and block out the noise about anything else. J L Collins says he plans to never sell and just live off the dividends.

The bloggers I follow worked to reach their full FIRE number before retiring early but have way more now than they will ever need, partly because they never really stopped working. They just work how and when they want to work now, on things that they are passionate about. Working for money is optional for them but if you have the drive to reach FIRE, you are not going to be the kind of person to sit back and never earn money again. Looking at my investment portfolio and own journey to FIRE in this light gave me new perspective. I decided I would follow suit and take a bit more risk than I previously would have by investing in one ETF with exposure ONLY to the US stock market.

Consideration 1: VTSAX is not available in Canada. After some research, I found a very similar fund. This post gives a good comparison. In summary, if you buy VUN (Vanguard Total US Stock Market ETF), it’s made up of the same underlying stocks as VTSAX but it is purchased in Canadian Dollar. Unfortunately, the annual management fee is 4 times higher than if you were in the US (0.16 instead of 0.04) :(, I suspect this is due to currency conversion costs.

I could have converted my Canadian Dollar to US Dollar and bought VTI or VUS (other similar funds in USD) but that added more complexity, more currency hedge risks and would subject me to US withholding taxes which I’d have to track and claim back at tax time. Again, I’m all for the Keep It Simple approach which just means I’ll pay a slightly higher annual fee.

Consideration 2: Not all of this money is mine alone, some belongs to Mr. MH and so he had to agree with the latest shift. He bought his previous ETF portfolio after me and although his was made up of the same funds as mine, the timing meant that his portfolio dipped for much longer and his best-performing fund during the pandemic was VCE (Vanguard FTSE Canada Index). Because of this, he felt more comfortable keeping at least some of the portfolio invested in a Canadian stock market ETF.

This meant that our target portfolio allocation was going to look something like 95% VUN and 5% VCN (Vanguard FTSE Canada All Cap Index) – this is a newer, broader ETF than VCE.

I started off by investing the proceeds of our house first. I bought mostly VUN and a small amount of VCN per the plan. Then as we were moving over the proceeds from our Irish ETF portfolio my nerves started creeping in about how over-exposed to the US markets we were. I decided I wanted to build back in some regional diversity and looked for another fund or two to help round out my portfolio. As we add more money we will purchase the other funds to balance it out a bit more.

Previously our ETF portfolio was made up of 5 funds. Now I think I can get the diversification I’m comfortable with in 3.

Our new target is something like 80% US, 15% Developed Markets excluding US, 5% Emerging Markets

This should give us a weighted MER of 0.19%, estimated annual growth of 12.02% and estimated annual dividends of 1.58% (based on returns since inception per current fact sheets).

Our current portfolio including our Irish stocks currently looks quite disorganised but I’m ok with that as the estimated returns of the portfolio are slightly better than the above projections. Our current weighted MER is 0.18%, estimated annual returns are 12.28% and dividends of 1.37%.

Once you get to a certain level of funds, you can start to see really fun gains or really scary losses on a daily basis. This has been an interesting experience. Our life’s savings are literally all in the stock market. We signed up to an account which lets you consolidate all of your investment accounts into one dashboard with reports. So far our Canadian accounts have gone like this:

The blue line is contributions and the green line is value of investments. So in August, we lumped in our house proceeds and we saw a nice uptick, very shortly followed by a downturn which didn’t go below our initial contributions but was still a drop of 24,000$ in the span of a few weeks. Thankfully, this has now gone back up to above where it was at the previous peak but before you go putting large sums into investments, be sure you are committed to the buy and hold strategy as the smallest drop in your share price can result in big drops in your portfolio. If you sell when it dips, you are locking in your loss, but if you hold on for long enough it will recover.

The current year to date returns are coming in at 14.53% not including dividends.

Different accounts

Another thing I haven’t gone into yet are the different investment accounts available in Canada. As soon as we got back, we opened up a number of new accounts under each of our names in order to maximise our tax benefits. Below are the different accounts we currently hold in each of our names.

• Tax-Free Savings Account (TFSA)
• Register Retirement Savings Plan (RRSP)
• First Home Savings Account (FHSA)
• Margin Account

The TFSA gives you a certain amount of money you can invest per year tax free. This is after tax income but grows tax free and is tax free on withdrawal. Unfortunately for us, your contribution room stops growing once you are out of country so we only have a portion of the 88,000$ room other Canadians have. Still it’s a great account to have.

RRSP’s are similar to Irish pensions in that they are tax-deferral accounts with annual contribution limits where you contribute to them in your higher earning years to reduce your taxable income, the investments grow tax free until withdrawal, at which time you pay your marginal income tax rate. The benefit Canadian RRSPs have over Irish pensions is that you can easily open an account and manage the funds yourself and there is no minimum age for withdrawal.

FHSA’s are tax-free savings accounts to help people save for their first home. There are annual contribution limits up to a maximum of 40k, contributions are tax-deductible, growth is tax-free and withdrawal is tax-free. Contrary to what the name implies, if you have NOT owned your primary home in Canada in the last 4 calendar years, you are still eligible for an account. If you do not decide to buy a house in the end, you can roll the money into your RRSP without impacting your RRSP contribution limits. Your contribution room only starts growing once you open an account so even if you don’t intend on investing/saving for a home, it might be a good idea to open an account just in case you do in the next few years.

Margin accounts are your usual taxable after tax investment accounts.

As we’ve been out of country for 9 years, our contribution room in our TFSA and RRSPs are not as high as they could be but something is better than nothing. So for now, we have maxed out our TFSAs, RRSPs and FHSAs and lumped the rest in our Margin accounts. As I haven’t worked much this year, this may seem like a waste as I won’t have income tax to reduce but getting the money invested and allowing it to grow as soon as possible will outweigh the tax savings I would have made if I had spread it out over higher income earning years.

There is also a Registered Education Savings Plan (RESP) we may look into for our son but I’m not 100% sold on the benefits vs. restrictions. Should our son not go to third level education in Canada, your marginal income tax is charged on withdrawal PLUS a 12-20% withdrawal penalty. For now I’ll just keep investing in our other accounts and use those funds to pay for college if needs be.

As Forest Gump once said: That’s all I got to say about that.

Time to financial independence

At a high level, it’s because when I crunched the numbers on my quickest path to financial independence, the scenario where I paid off my mortgage before investing was about the same time as the scenario where I paid the mortgage down slowly and invested heavily instead.

The reason the timeline is so comparable is because once you’ve paid off your mortgage you need significantly less passive income from your investments to cover your remaining living expenses.

See the detailed analysis section at the end of this post for a demonstration of this analysis.

Reduced financial risk

While my first objective of the analysis was to find the quickest path to financial independence, the other element is that I’d like reduced financial risk to myself and my family should I lose my job or get sick, especially since we made the decision to go down to one part-time income. This may seem obvious to state but, paying off our mortgage would reduce our minimum expenses by almost 10,000€/year. As our other expenses are already quite low, once the mortgage is paid, we will almost be able to live off one minimum wage job. This reassurance in itself gives us a certain element of financial freedom even before we reach full financial independence.

Guaranteed rate of return

The other thing to consider is rate of return.

A mortgage interest rate will be at least 2-3% for most mortgages in Ireland. Even the newest mortgage provider Avant will only provide 1.95% to very select customers.

Paying down your mortgage is a guaranteed savings of that 2-3%/year.

If that money was in the stock market, you could make 20% in a given year or you could lose 20% in a given year. The average rate of return since inception of the stock market has been 10%. This is PRE tax. If you’re invested in ETFs in Ireland, take off 41% in exit taxes. This leaves 5.9% or 4% after inflation (it’s not that simple as you have compounding and reinvestment of dividends but I’m trying to keep it high level).

In my experience though I have not been so lucky.

I’ve had retirement account investments in Canada since 2013 or so, even in a tax-deferred account (like a pension) I’ve only averaged 3.7%/year or 1.7% if you take out inflation. Though I should say that performance was mostly because I was unaware of the true impact of fees and my provider for most of that time was taking 2.75% of my total investment as their annual fee! Ouch.

In Ireland, I’ve only been investing since May 2019 but so far my initial lump sum is standing at MINUS 4.96%/year after inflation AND I’m still paying taxes on dividends even though I’m at an overall loss since ETFs can’t carry losses forward.

If I’d lumped that money against my mortgage I would have reduced my mortgage payments by almost 100€/month or 1,200/year of post tax money.

Now if I’d started investing at another time where the market performed very well, this could be a very different story but for now this has been my experience and I’m happier focusing our efforts on the mortgage.

Less reliance on market performance in early retirement

The other consideration is for when we reach early retirement. If we still had a mortgage we’d need to withdraw larger amounts from our portfolio to get by. If we no longer have a mortgage, we need to withdraw less from our portfolio and therefore rely less on market performance to fund our lifestyle. This is reassuring as we don’t have to rely on something that’s out of our control to fund a large portion of our living expenses.

Psychological impact of having no mortgage

I recently watched a really interesting interview with Mr. Money Moustache (MMM) and Jesse, the founder of the budgeting software You Need a Budget (YNAB). It’s quite lengthy but has some really great and insightful nuggets in there.

One of which was the topic of paying off your mortgage or not.

MMM said that while mathematically it makes sense to take advantage of lower mortgage interest rates and invest your money in a higher-performing stock market, for him, financial freedom is about building a happy life, not about having the most money. And for him, not having a mortgage makes him feel good and so he doesn’t have a mortgage.

Jesse also made the point that while a lot of people will say “yes it makes more sense to invest than pay down your mortgage”, most people won’t actually invest and so they are neither paying down their mortgage or investing.

The other thing I’d consider here is the psychological willpower it takes to leave money invested in a market that is tanking. While mathematically it makes sense in the long term to invest alongside a low interest mortgage, you need to be really honest with yourself and know that if you saw your portfolio literally halve overnight, would you have the willpower to leave the money invested and allow for it to recover?

You may say so now but until you actually have it happen to you, you will not know how you will react. If you don’t rely on the power of time to recover, and you withdraw your money at a loss then you definitely make a loss AND still have a mortgage to pay off so you are worse off than if you’d put that money against your mortgage from day 1.

Downsides

The only downsides I can think of to this approach are:

We are tying up a lot of our portfolio in an illiquid asset, so if we did fall on hard times, although our expenses would be reduced, we’d also have less access to our money compared to if we had it invested in the stock market. We are reducing this risk by keeping a years worth of living expenses in cash and leaving our existing stocks and ETFs invested as an additional backup.

If the market did outperform our mortgage rate after taxes, we’d potentially have a lower net worth than if we had invested and paid our mortgage off slowly but our main goal is not to have the highest net worth. We are more focused on reducing financial risk and increasing lifestyle options.

As long as we have enough to get by, with a few comforts and even a few luxuries, we are happy. We are also on track to have our mortgage cleared in the next 2-3 years and so that timeframe shouldn’t make a huge impact if we miss out on the market performance during that time.

Detailed analysis

For those of you interested in the analysis comparing time to financial independence by paying off your mortgage first or not. Here it is.

Assumptions:

• 40-year-old married couple with 2 school-aged kids
• Have a mortgage with a few years paid down, 200k remaining
• No other debts and no existing investments
• Earning combined income of 100k (73k after-tax)
• Average of 40k annual expenses (see how our family spent an average of 40k in 2019 and 2020 in Cork)
• Average after tax savings/year = 33k
• Mortgage repayments 1,000/month or 12,000/year
• Mortgage interest rate 2.95% variable (allowing lump sum payments without penalty)
• ETF performance 7.91% after fees and inflation (10% average historical stock market performance, 0.19% fees, 1.9% historical 30-year inflation) – see our ETF portfolio here
• Asset allocation 100% equities/stocks 0% bonds or cash (higher risk and higher volatility but potentially higher rewards)
• Scenario 1: Pay off mortgage as quickly as possible, then invest in ETFs
• Scenario 2: Pay mortgage off slowly and invest in ETFs from day 1

Scenario 1:Pay off mortgage as quickly as possible, then invest in ETFs

Pay existing 12k/year in minimum payments + additional lump sums of 33k/year = 45k/year off 200k mortgage.

Mortgage repayment schedule

ETF investment schedule

Mortgage is paid off in year 5, freeing up 12k in expenses which can be lumped in with the 33k post tax savings for an annual investment of 45k.

Time to FI

Scenario 1 for this couple enables them to reach FI in 15 years (by age 55) starting from 0 investments at age 40. The 706k ETF portfolio allows them to safely withdraw almost 28k/year which is all they need to live as they no longer have the 12k in expenses to pay for their mortgage (40k minus 12k = 28k).

Scenario 2: Pay mortgage off slowly and invest in ETFs from day 1

Mortgage repayment schedule

ETF investment schedule

Time to FI

Scenario 2 for this couple enables them to reach FI in just over 16 years (by age 56) starting from 0 investments at age 40. The 1 million ETF portfolio allows them to safely withdraw 40k/year which is what they need to live as they still have 12k/year in mortgage repayments for an additional 8 years.

Once their mortgage is paid off by age 64, they will still have a larger portfolio and could continue to withdraw 40k/year should they choose but takes them a little over a year more than scenario 1.

Want more of this?

I recently did a presentation on something similar where I showed how a 40-year-old couple with 2 kids starting with no investments, earning a combined income of 100k/year, with a savings rate of 50%, could reach financial independence in 13 years regardless of the approach they took.

The scenarios I looked at were:

• paying off the mortgage and then investing in ETFs
• paying the mortgage slowly, maxing their pension and investing the rest in ETFs, and
• paying off the mortgage, then maxing their pension and investing any remainders in ETFs

If you’re interested in how these options weighed up against each other along with the impacts on each portfolio after 30 years of withdrawals, you can purchase tickets to the pre-recorded event for 20€ here. This gets you access to 4 hours of presentations from other Irish, European and US presenter’s perspectives.

Scenario 1: Invest 200€/month in average growth year

• Invest 200€/month in Irish domiciled ETFs on the last day of each month
• ETFs make gains of 7.91% (assumes 10% performance minus 0.19% fees minus 1.9% inflation)
• ETFs make 2% in dividends
• Purchase charges: Degiro charge 4€/trade plus 0.05% of the value purchased up to a max of 60€.*

*Degiro have a number of commission free ETFs where you can buy up to 200 different ETFs each month for free. If you determine your portfolio to use these ETFs it doesn’t matter how frequently you buy.

Other fees I have found are applied depending on the country the fund is based.

Calculations:

• Fees: 200€/month = 4.10€ in fees per month = 49.20€/year (2.05% net fees per year for your 2,400€ invested) – investing 195.90€/month
• Gains: 102€ (11 of the 12 months as you lost out on gains from Jan 1-Jan 30)
• Dividends: 26€ (11 months)

Value after 12 months: 2,481€

Scenario 2: Invest 2,400€ at the end of the year in average growth year

• Invest 2,400€ lump sum on Dec 31 in Irish domiciled ETFs
• ETFs make no gains as invested at end of the year
• ETFs make no dividends as invested at end of the year
• Purchase charges: Degiro charge 4€/trade plus 0.05% of the value purchased up to a max of 60€.*

Calculations:

Fees: 2,400€ lump sum per year = 5.2€/year in fees (net fees for the year or 0.21% net fees)

Value on Dec 31: 2,400€ minus 5.20€ = 2,394.80€ after fees.

Scenario 3: Invest 200€/month in commission free ETFs in average growth year

If you go with the free commission ETFs then you end up with the full 2,533€.

Scenario 4: Invest 200€/month in bear market year

If it was a particularly bad year, for example you started investing in October of 2007 in the SPDR S&P 500 (SPY) and through the year you lost 37.4% minus 0.19% fees and 1.9% inflation but also made 2% in dividends, your end portfolio would be 1,924€. This is 471€ LESS than if you had invested one lump sum at the end of the year.

I looked at the historical trends of the SPDR S&P 500 (SPY) for Nov 2007 to Oct 2008 (as it’s been in operation since 1993) and figured that if you were investing monthly in that time frame you would have 18 ETFs at the end of the year (taking currency out of the equation for simplicity sake). The prices went down every month and were at their lowest on the last month at 96.83$. Without investing anymore after that date, based on today’s value of 286.28$ your 2,400 would be worth 5,153.

If you’d waited to purchase the lump sum on the last month your 2,394€ would have bought you 24 ETFs, which would be valued at 6,870 today (1,717 MORE than if you’d invested monthly).

Scenario 5: Invest 200€/month in bull market year

If it was a good year, for example you started investing in October of 2012 and through the year you gained 24.4% minus 0.19% fees and 1.9% inflation and also made 2% in dividends, your end portfolio would be 2,685€. This is 290€ MORE than if you had invested one lump sum at the end of the year.

Looking at the historical trends of the SPDR S&P 500 (SPY) for Oct 2012 to Oct 2013 by investing monthly in that time frame you would have 14 ETFs at the end of the year (taking currency out of the equation for simplicity sake). The prices went up almost every month and were at their highest on the last month at 175.79$. Without investing anymore after that date, based on today’s value of 286.28$ your 2,400 would be worth 4,263.

If you’d waited to purchase the lump sum on the last month your 2,394€ would have bought you 13 ETFs, which would be valued at 3,900 today (363 LESS than if you’d invested monthly).

Scenario 6: Invest 200€/month over 2 years with one year in bull market and one year in bear market

BUT since you’re in this for the long haul, how does euro cost averaging fare in these 2 years if you invested monthly during both the bear and bull market years?

After 24 months your 200€/month would leave you with 5,132€.

If you invested a lump sum at the end of each year you would have 4,789.60€ (342.40€ LESS than investing through the year with higher transaction fees).

Number of ETFs owned in each approach?

Looking at the two scenarios, buying monthly over 2 years you would own 33 ETFs. Buying in lump sums once a year you would own 38 ETFs. At today’s value, without investing any further the lump sum approach would leave you with 1,145€ more in market share.

Summary

What this demonstrates is that investing every month is the better option especially if you are investing in commission free ETFs. It also goes to show that time IN the market is better than timing the market. You also have the benefit of euro cost averaging where some months you may lose money and others you may gain ultimately averaging out over the long term.

In the case where your market share was less by investing monthly, the bear and bull market examples were two extreme years to make a point. Over the long term, at least historically, over the last 50 years, bear markets run for an average of 1 year while bull markets run for an average of 6. In the 1 year of bear market though it is typical that it will make almost double the losses than the bear market will make gains but for the one year you are making losses, if you keep investing, the following 6 years you will be making smaller gains and euro cost averaging will win out.

Other considerations

The above is purely the mathematical side of investing monthly vs annually. As with everything else to do with investing, this needs to balance out against the individual’s emotional approach to money.

If you know yourself to be bad at saving and would be tempted to access a lump sum of cash while waiting to invest it at the end of the year, it might be best for your to automatically have it invested each month to safeguard it from yourself.

The other side is the administrative side. From a tax reporting perspective I’ve read that investing small amounts on a monthly basis can make it difficult to calculate the taxes owed at the end of the year. However, I have not been able to confirm this yet as it will be my first year to file taxes this year. From what I can tell, Degiro (and likely other brokers) provide you with an annual report for the purposes of tax which outlines clearly what gains and dividends you have made through the year. This makes it quite simple to calculate but I haven’t been investing regularly so I’ll have to keep you posted on how the tax filing goes.

Also the fees used in this example are probably one of the lowest in the market. If you are using a bricks and mortar broker your transactions fees will likely be much higher which may swing the assumptions in this article in the other direction.

Mortgage rate drivers

Before I get into the pros and cons, a bit of background on how mortgage rates are set.

Fixed

On average, fixed mortgage rates follow the same trend as the government bond yield market.

Bond yields are driven by economic factors such as unemployment, export and inflation.

Looking at a 5 year fixed rate mortgage vs a 5 year government bond yield the trends are very closely linked, with the mortgage rates being between 1 and 2 percentage points higher than the bond yields.

For example: In 2006, the 5 year bond yield rate was 4.18% and an average 5 year fixed mortgage was 5.25%. In 2019 the 5 year bond yield was 1.29% and the 5 year fixed mortgage rate was 2.54%.

Variable

Mortgage rates linked to the Bank of Canada’s prime rate.

Variable mortgage rates are driven by the same factors as bond yields, except variable rates fluctuate with movements in the prime lending rate. This is the rate at which banks lend to their most credit-worthy customers. Variable mortgage rates are typically stated as prime plus/minus a percentage discount/premium.

Worth noting here though is that the Bank of Canada’s prime rate and the prime rate of major financial institutions are NOT the same rate. Also, financial institutions are not obliged to pass on cuts to customers. For example: The Bank of Canada cuts rates by 0.25%, your bank may chose to only pass on 0.15% of that cut.

There is a really great article on this with some charts here.

Fixed mortgage

Now onto the pros and cons of each.

Pros

• Fixed interest payments
  • These mortgages give you a set mortgage repayment in terms of how much interest you will pay for the term you sign up for. If the Bank of Canada’s prime rate has a significant increase, your mortgage interest will be unaffected until you are due for renewal.
  • This gives young buyers a sense of security when budgeting can be tight and you don’t have much wiggle room to make up for unexpected, potentially significant increases. This is an incorrect perceived safety net which I will go into below.

Cons

• Fixed interest payments
  • At the same time, if the Bank of Canada’s and your bank’s prime rate has a significant decrease, this savings will not be passed onto you and you could end up paying much more in interest for a number of years than you would if you had a variable mortgage.
  • Worth noting is that historically, variable rates have proven to be less expensive over time
• Fewer pre payment/lump sum options
  • Most bank’s offer at least some form of pre-payment or lump sum options before applying penalties. Our bank for example allowed you to pay off 15% of the initial mortgage amount per year before penalties would be applied. If you get a raise, a bonus or an inheritance and decide you want to start paying down your mortgage more quickly, a fixed rate mortgage will not allow for much flexibility, though 15% of 200,000$ is 30,000$ so these amounts are usually sufficient for most mortgage holders.
• Larger penalties for pre paying/switching before your term is up
  • If you decide to sell or in a worst case scenario, need to sell before your term is up you could be looking at very large penalties with a fixed rate mortgage.
  • Typically the bank will charge the greater of 3 months interest OR the interest rate differential. I’ll explain the impact of this a little further below.

Despite all of the cons, 66% of Canadian mortgages are fixed terms. This seems to indicate to me, that a large portion of Canadians are:

• not financially secure enough to accept a potential increase in mortgage payments even though it may save them more over the long run
• not aware of the flexible nature of variable mortgages which I will explain below

This seems to align with my notion on a slightly separate note, that people who have more money or are better at saving can get things cheaper where lower earners or bad savers are penalized.

For example: if you pay your insurance premium on a monthly basis, insurers will often charge a premium or admin charge to accommodate this. This can end up costing people who don’t have enough for a lump sum once a year 3-5% more for a lot of services. This can really add up over time.

This same concept seems to apply to fixed vs variable mortgages where the more money you have, the more risk you can take, the better savings in interest rates you can achieve.

Variable mortgage

Pros

• Potential price fluctuations
  • as mentioned above, historically, variable rates have proven to be less expensive over time. If you sign up to a fixed rate mortgage and a month later the Bank of Canada’s prime rate drops, you will be stuck paying more in interest than you would on a variable mortgage.
• More flexible pre payment/lump sum options
  • From what I can tell, variable rate mortgages have the same pre payment limitations as a fixed rate mortgage with the exception that the penalties for making a payment over the agreed amount are MUCH less – see below
• Lower penalties for pre paying/switching before your term is up
  • From what I can tell, variable rate mortgages only charge 3 months interest for an early termination. The interest rate differential doesn’t apply for variable rate mortgages. This can provide massive savings if you need to sell before your term is up.

Cons

• Potential price fluctuations
  • The biggest perceived risk of variable rate mortgages is that your monthly mortgage payment can change should markets shift. This is incorrect! With a variable rate mortgage your monthly mortgage payments will NOT change. It is the percentage of that payment which is paid off the principal that will change.

Pre-payment charges explained

Ok so we now know that if you break a fixed rate mortgage early you pay:

The greater of:

• 3 months interest OR
• an interest differential*

With a variable rate mortgage you pay:

• 3 month interest regardless of what is left on your term

What does this actually mean?

Let’s look at a scenario:

• 5 year mortgage at 3.29%
• Posted fixed mortgage rate on date of contract signing was 3.5% (you got a discount)
• 3 years in you need to sell (2 years remaining)
• Current posted market rate for 2 year fixed term is 2.5%
• Mortgage remaining: 200,000$

Fixed rate mortgage:

*An interest rate differential actually has nothing to do with the interest rate you are currently paying. The bank will take the posted rate for the term you agreed to on the day you signed your contract and take the difference of today’s posted rate for the remainder of your term. Clear as mud!

Annoyingly making something overly complex unnecessarily to keep customers in the dark about what they will actually pay.

So here’s how that works.

Interest rate differential calculation:

Posted rate at mortgage signing minus posted rate for remaining term divided by 12 to covert to monthly rate = interest rate differential factor

then

interest rate differential factor multiplied by remaining mortgage value multiplied by remaining mortgage term = early payment penalty

3.5% (0.035 – posted rate at mortgage signing)

– 2.5% (0.025 posted rate for remaining term)

/12 (to convert to monthly rate)

= 0.00083 interest rate differential factor

0.00083 * 200,000$ (remaining mortgage value) * 24 months (remaining term) = 4,000$

I’m not sure how it works if the current rate is higher than when you signed the contract. I’m assuming then that there is a negative amount in the calculation and then the 3 months interest will be the greater amount.

I’m also not sure if you have 1.5 years left, do they take a one year or a two year term for the current rate in the calculation but assuming they would take the 2 year.

The bank may also have a discharge fee which can vary from province to province, anywhere from an additional 70$ – 270$.

Variable rate mortgage

Existing mortgage rate * remaining mortgage value * 3/12 (3 months) = early penalty fee

3.29% (0.0329) * 200,000$ * 3/12 (0.25) = 1,645$ + any discharge fees (70$-270$).

Calculator

If you need it, there is calculator here that helps with this calculation but its also useful to understand the math behind it so you can sense check your figures.

My mistakes

As you many know, we have a property in Canada.

I am only JUST discovering the benefits of a variable rate mortgage. This makes me so mad! That this is BASIC financial literacy which banks should be informing you about when signing up for mortgages.

I would have considered myself fairly well researched, even at 26, when I signed my first mortgage but am only finding out about this 8 years, and 2 mortgages later!

My understanding of fixed vs variable was that variable meant that your monthly repayments could fluctuate. I wasn’t conformable with having no control over such a big expense and went for fixed. We also weren’t aware of the pre-payment differences.

When we first signed our mortgage, we bought a 1 bedroom condo downtown. Being from the country, I wasn’t sure if I was going to like living there and wasn’t willing to sign a term longer than 1 year as I wanted flexibility to sell if we needed to.

Every year thereafter, there was some question on whether we would stay there. In the second year, we LOVED living there but weren’t sure if we wanted to start a family in the next few years and would need at least one more bedroom.

Year 3 we decided to move back to Ireland and were waiting year to year to see if the market would recover enough to sell.

So we were only ever looking at the 1 year fixed options as even though I was aware that historically variable rates performed better than fixed, the shortest variable term was 3 years and I wasn’t aware that the pre-payment terms were the LEAST of what you would pay in a fixed term.

Selling soon?

Recently, I got an early mortgage renewal prompt from our bank and I was trying to figure out which options would cost us less as we were planning on selling in the next year.

The options I was looking at was

• a 6 month open term at 6.75%
• a 1 year fixed term at 3.44%
• a 2 year fixed term at 2.65%

I wasn’t even considering a variable as again it was a minimum of 3 years, though now there is a 5 year at 2.25% (prime – 0.20%)

The 6.75% option would cost us 1,000$/month in interest for every month we don’t sell but no early termination fees

The 3.44% option would cost us 510$/month in interest for every month we don’t sell but also cost us 1,530$ in early termination + 270$ discharge

The 2.65% option would cost us 393$/month in interest for every month we don’t sell but also cost us at least 1,179$ in early termination + 270$ discharge fee. It is impossible for us to known what the interest differential would be as we don’t know what the rate will be by the time we are ready to sell. In the current market I would expect the rates to go down and so there could be a differential to pay.

The lowest it’s ever been since 1935 has been 2.25% so that would be 1,424$ which is higher than the 3 months and the amount I would need to pay.

Now that I know about the variable option I think I will renew at a 5 year variable at 2.25%

This will cost us 334$/month in interest and 1,000$ in early termination fees + 270$ discharge fee.

So if I sell in month 1 after signing the renewal the 6 month open term wins but only by 333$. Every month thereafter the 5 year variable option wins out.

As I could have renewed early back in February, I could have been spending 154$/month less in interest since then had I known about this. Not to mention how much more I paid in interest over the last 8 years as I thought my only options were 1 year fixed rates for our given circumstances. I don’t have the stomach to do the math but even a fraction of a percentage difference over that term could have cost me thousands.

Here is how the 4 options pan out over 6 months. For example; If I took the 6 month open term and sold in month 1 after renewal I would be out 1,000$ in interest. If I sold in month 2, I’d be out 2,000$ in interest. If I took the 1 year fixed and sold in month 1, I would be out 2,040$ with interest and pre-payment charges and so on.

Don’t trust bankers

My overall feeling from all of my dealings with bankers over the years is, that they either know less than you do OR are trying to get you to pay the most in interest to them for as long as possible. This should come as no surprise really but I think young people that are in a position to buy a house may not have realized this yet.

In my latest dealing with the bank, I explained my situation and asked for guidance on which option would cost me less over all as we were looking to sell in the next year. I asked for the exact calculations so that I could do the analysis myself. They could not answer the question. They had a calculator which told them what it would cost if I sold today but couldn’t give me any more details. When I gave a specific example say: “If we go with a 2 year fixed but pay it off only 6 months in what is the penalty vs if we get a 1 year fixed and pay it off 6 months in”. The banker said with certainty, and I quote “If there is less term remaining, there will be less penalty! So in your example, 1 year fixed will save you more.” This is only partially true and with the rate differential there is no way they could actually tell me what my early penalties would be. Also to state with certainty like that with no caveats or further explanation is so dangerous. If I was the type of person to take their word for it, which a lot of people would be, they would end up costing me almost 1,000$ extra. When I compared the exact scenario I provided, once I understood the calculations, the difference between the 1 year and 2 year fixed after 6 months was 800$ more for the 1 year fixed option. They also did not opt to tell me about the variable mortgage rate which would almost certainly win out in all scenarios, and in the scenario I gave would have cost me 1,600$ MORE to go with the 1 year fixed option.

My previous dealings with another banker were even worse. They tried to get us to sign up to a 5% mortgage when there was one posted publicly on their site for 2.64%. They tried to get us to sign an open form which would allow them to change the terms of our mortgage to avoid us coming into the bank (kind of like signing a blank cheque really). There were a few other things she tried to get us to sign up for which I can’t recall but when we refused all of them, she started to get annoyed with us. Basically we weren’t going to give her an easy commission on whatever it was she was selling. She also tried to convince us that paying 40$ extra a year off our mortgage would make a big difference saying “every little helps”. While there is some truth in this, there were far more helpful tidbits she could have imparted on us if she was really trying to help. Like the difference between variable and fixed mortgage rates for instance.

With 66% of Canadians on fixed mortgage rates I really think we’re all being taken advantage of!

Unless I’ve misunderstood something, and if so please do let me know, but for now I’m sticking to my guns that bankers are not there to help you. They are there to sell products for the banks.

Bonus content

Collateral mortgage

Another thing to be aware of is a collateral mortgage which makes it more expensive for you to switch mortgage providers. Yet another way for banks to make it harder for you to get a better rate elsewhere.

When we first started out there was an offering called a “Total Equity Plan” which allowed us to split our mortgage into various products. For example 30% could be a 5 year fixed, 30% could be a 5 year variable and 40% could be a 1 year fixed. You also had the ability to take out a Home Equity line of Credit if you ever wanted to access some of the equity you had built up in your home.

At the time this sounded like a really cool way to hedge your bets against different interest rate models and allow us to access equity easily should we need to.

In reality, we only ever went with 100% on the lowest rate we could get as that was what was most important to us rather than spreading risk.

What they didn’t tell us was that this type of mortgage needs to be “dismantled” as such by a lawyer so when you go to switch mortgage providers (should you ever find a better rate elsewhere), you will need to have a lawyer process it which makes the cost of switching almost pointless.

Anyway, I’ll leave it there now that I’m all riled up I need some time to calm down before bed.

I hope this post goes far and wide to help people see the big picture math behind their options when it comes to mortgages.

And if I’m wrong somewhere please do let me know! I love to give people the benefit of the doubt but time and time again I have been proven otherwise when it comes to banks unfortunately.

Firstly, before I get into a financial post, I want to acknowledge that people are losing their lives. Front line workers are exposing themselves every day to help fight this pandemic. Our lives are impacted psychologically and emotionally with social distancing and isolation. With balancing childcare with full-time jobs. For those of us lucky to have kept our jobs.

Thank you to everyone who is doing their part!

And now onto a far less important read about how my financial situation has been impacted.

Emergency fund

First and foremost this situation has been an eye opener to my emergency fund approach.

Current approach

When I went on maternity leave I had about a year’s worth of living expenses in savings. Almost a year into my leave I still hadn’t touched most of it as we were able to live mostly off one-income.

In that time I had come across Mr. Money Moustache’s approach to an emergency fund which is basically not to have one.

The premise is that you are on your path to financial independence and saving/investing 50-70% of your income. While doing this, his idea is to invest all your spare cash and if an unexpected expense arrises you just don’t save as much that month. If it’s a big expense, your savings rate may be lower for two months but ultimately you could have your “emergency fund” working for you while you are still earning.

I agreed with the concept and thought I’d invest the spare cash. My idea was that I still had access to the money and if I really needed it I could sell some shares.

The main difference for my situation was that I wasn’t earning and we weren’t saving 50-70% of our income at that time so following this idea was flawed. Still I was confident enough in the market that I could still access the money in a pinch.

You can see where this is going…

Running out of cash

As you may have read, my husband and I took a mini-retirement where we spent 2 months in Portugal at the beginning of this year. I have since returned to work part-time but won’t be paid until the end of April. This means that our mini-retirement budget had to last us 4 months.

We did have some unexpected expenses during this time which stretched our budget and for the first time in many years we are really relying on our next pay check. It’s a surreal and unpleasant feeling. We are checking our budget weekly to make sure we are still on track.

Faulty back-up plan

We still have stocks and ETFs we could fall back on if we were really stuck but we would be selling at a 10-30% loss depending on when we’d need to sell and how the markets are currently performing.

Unfortunately with ETFs you don’t get to carry forward any losses to be used as a credit against future gains. If we did need to sell at a loss, we would sell some of our individual shares which would enable us to carry forward the loss. This is the silver lining for holding individual shares.

That said, by having our spare cash in the stock market I’m less likely to spend it. If I had the cash now I would have been dipping into it as there are a few things I have ear marked to purchase with our first pay check.

Namely, a bed frame (we upgraded to a super king size but currently only have the mattress on the floor), some non-teflon cookware (for health reasons) and some art and montessori type supplies to do some educational activities with our son.

Still lucky

All that said, it’s not wasted on me that many people were living paycheck to paycheck when this hit and lost their jobs overnight. I can’t imagine how they must be feeling especially if they have big debt repayments, big mortgages, car payments and so on. At least we live in a country where we will be supported but it must be a major stress point on top of the other added stresses of social distancing and keeping kids home.

We are very lucky to be in a position to work remotely and that the company’s we work for are keeping us on. If we weren’t we would have needed to start accessing our emergency fund at a loss.

Future plans

My husband and I are on different pages as what to do first once money starts coming back in. Mr. MH wants to invest more in the market as the prices are so low compared to before. I want to re-build a traditional emergency fund as this situation has left me feeling more vulnerable than I thought. We will likely do some combination of both.

In terms of how much of an emergency fund I would like to hold, I think maybe 1-2 months of expenses in cash.

Other than that I’m looking to put income protection insurance in place until I am fully FI. This will protect me in case of loss of income for any sickness, disability or illness. This is different to serious illness insurance which only protects your loss of income for certain illnesses. You can opt for deferred payout periods for lower premiums, similar to a deductible so depending on what I pick (1, 2, 3, 6 or 12 months for example), I may up my cash savings to cover that gap.

Alternatively, one reader suggested I use credit as my emergency cash which I may use as a safety net but even with our Canadian line of credit, the interest on that is somewhere around 7% now which would compound monthly until I could pay it back. That would be worse that taking a 10% once-off hit on a stock market loss if I had to sell at a loss to access my cash in the stock market. But food for thought.

Portfolio make-up

To give you a bit of background our full net worth portfolio looks something like this:

As you can see, a large portion of our net worth is tied up in property. Our Canadian property has been costing us about 2,500€/year out of pocket to maintain after income, expenses and taxes. And that’s with full occupancy and no major repairs.

Time to sell?

We bought the condo when I was 25. Looking back, we paid too much for the it in our young naivety and were holding onto it until the markets would allow us to break even.

We have been keeping an eye on market reports and re-assessing each year whether we would sell or not. Finally one month ago, the market reports were booming and we decided to bite the bullet. We were just about to list our property when the restrictions came in.

We had already informed the tenant of our intent to sell but then had to back track as we didn’t know how to proceed with showings with the new restrictions. Then we started worrying that the tenant might decide to leave and we would be stuck for much higher ongoing costs with neither of us back to work yet.

The government in Canada is supporting it’s citizens financially, similar to Ireland but we were worried that any mortgage supports might not be available to us as non-tax residents in Canada and also that Ireland wouldn’t pay towards our mortgage costs in Canada. We would be in a bit of a grey area for financial support. This was a scary feeling.

Luckily our tenant is a member of parliament and I’m fairly certain the government pays for his rent so even though he is not currently living there, he is continuing to pay rent and not giving up the unit. The downside is that he is out of the province and cannot get back to move his things due to the travel ban and so we are a bit stuck in terms of proceeding with a sale.

What to do with the equity

Until recently my idea was to keep the proceeds of the sale in Canada and re-invest into ETFs there as it is far more tax efficient. However, upon further analysis I discovered that paying down the mortgage in Ireland with the proceeds instead would be a more favourable approach for us.

Here are the scenarios I compared:

Scenario 1:

• I go back to work full-time
• Mr. MH stay home with our son until he goes to school (something I’m still convincing him on)
• We sell the Canadian property to break even and re-invest freed up equity into ETF portfolio there
• I make nothing additional off the blog and consultations
• I do not invest through a private limited company
• We stay in Cork full-time in our current home once we reach FI

Time to full financial independence to cover 38,500€ annual expenses: 10.5 years.

Scenario 2:

• I go back to work full-time
• Mr. MH stay home with our son until he goes to school
• We sell the Canadian property to break even and bring the money to Ireland to halve our Irish mortgage
• I make nothing additional off the blog and consultations
• I do not invest through a private limited company
• Stay in Cork full-time in our current home once we reach FI

Time to full financial independence to cover 34,500€ annual expenses: 10.5 years

The main difference between the two scenarios is that:

In scenario 1:

1. we keep the equity invested in Canada where tax treatment could be more favourable
2. our annual living expenses only decrease by 2,500€ which we spend maintaining the property
3. we have less to invest on an ongoing basis in Ireland as our annual expenses are mostly as they are now
4. we need to grow our portfolio by an additional 108,000€ to cover the additional 4,000€/year in expenses

In scenario 2:

1. we move the Canadian equity to Ireland paying down our Irish mortgage
2. our annual living expenses decrease by almost 7,000€
3. we have more to invest on an ongoing basis in Ireland as our annual expenses are significantly decreased
4. we need a smaller overall portfolio to cover the revised 34,500€ in annual expenses

These difference explain why the time to full FI is the same.

The added bonuses of scenario 2 are:

• we no longer need to worry about vacancies, ongoing rental income taxes, non resident withholding taxes, unforeseen repairs and so on
• we would also save on mortgage interest, which I haven’t factored into the analysis but could be argued that savings could be invested in the stock market
• we get access to better loan to value mortgage rates
• our life insurance premiums may go down if we chose lower cover as there is less owing on the mortgage
• our annual expenses being lowered would give us flexibility to live off one income while still saving towards FI should we chose to
• alternatively, we could both work part-time and still save towards FI
• or yet another option is, should one or both of us lose our jobs we can easily get by on 2 minimum wage jobs or jobseekers allowance in a worst case scenario

We were leaning towards scenario 2 before the pandemic started for all of the above reasons, but now more than ever, with job security called into question and the losses in our stocks and ETFs we are more and more drawn to the option to cut down our expenses and reduce property ownership risks.

Even if we incur currency exchange/transfer costs and lose out on more favourable tax treatment on our investments in future, we really like the added security and flexibility having lower expenses and reduced risk would allow us.

And so, we are going to try and sell our property as soon as we can hoping we don’t miss our window while the market is still strong.

There is a shortage of housing in Ottawa and as the Toronto and Vancouver markets are over-saturated and over-priced, more investors and workers alike are looking to places like Ottawa and Montreal for better value. Boomers are also retiring and looking to downsize. All of these factors will still be in place once the pandemic is over and it will take some time for supply to catch up with demand so we are hopeful that we won’t lose too much from what we had planned.

All this to say, the pandemic has reinforced our idea to re-structure our portfolio in a way that reduces our ongoing costs and risks rather than bolstering our investment vehicles.

Investment approach

I’ve been reading a lot of articles and watching videos by different FIRE blogger’s and vlogger’s based on how they’ve been impacted and their reactions to the current crisis.

One said: “You won’t know what kind of investor you are until you experience your first crash.”

This could not be more true.

When I first bought my ETFs I experienced an 800€ loss the very next day. This was my first test. That certainly didn’t feel good but I held tough keeping in mind the historical stats and trends.

Come February I think my portfolio’s in both Canada and Ireland were up almost 15% for less than a 1 year period. That felt great and reassured me that I was on the right path to early retirement.

Fast forward a month later and I was nearly getting daily emails from Degiro stating that one ETF or another has dropped by 10%, another 10% the next day on another fund and so on. These are mandatory emails Degiro need to send with no option to opt-out.

At one point I was at a 30% loss in both accounts.

Here is a trend of how my Canadian accounts have fared since initial investment last Feb. As my Irish ETFs are loosely following the same markets the trend for my Irish portfolio would look something quite similar.

Considering:

• my Irish ETFs were technically my emergency fund
• my work contract almost got cancelled
• my husband is not due back to work until June…

This. Was. Hard!

Luckily my contract went ahead and I will be getting a paycheck in a few weeks but the experience was definitely a test.

On the one hand I was gutted not to have extra cash on hand to throw into the market when I could get ETFs on sale.

On the other I was trying not to panic. Trying not to cash out. Trying to rely on the historical trends I had read so much about. Trying to remember that anyone that cashed out in ’08 never made their money back but those that held on went on to make way more than they had put in. Trying to remember that it’s only a loss if you sell.

It was a great comfort was reading this trend report which I got in an email from my Canadian brokerage. It looks at the last 30 years of the Canadian Dow Jones of bear (down years) and bull (up years) markets and their respective gains and losses.

So far, we’ve managed to stretch our remaining cash and will rest a little easier once we have a cash cushion built up again.

The markets have even recovered quite a bit and now am at less than a 10% loss.

I am holding true to my plan and hope to invest even a small amount out of my next paycheck.

The best advice I saw was by Our Rich Journey and that was to stick to your plan. If you were going to invest 1,000€ this month, invest it. Saving towards financial independence is a long term game. Don’t try to wait for the market to reach rock bottom (or don’t try to catch a falling knife was a great saying I heard). Full time fund managers aren’t able to predict or time the market 85% of the time. Just stick to your plan. Stay consistent. You will win some and you will lose some, but if you euro/dollar cost average by investing consistently you will come out on top.

And if the market doesn’t recover, then we will have bigger fish to fry!

Morbid Couple Discussions

One night a few weeks ago, I was putting our son to bed and had worst case scenario thoughts swirling around my head. My husband is a higher risk as he has a pre-existing condition and I was trying to think about what I would do if he died. Where would I live, how would I manage financially, emotionally and so on. I came downstairs and we had a very morbid discussion about what the other would do if one of us died.

The outcome of the discussion was that with our current assets and life insurances in place we should be ok financially in that we could, at the very least, pay for funeral costs and continue living in our home.

But the discussion made us more determined than ever to reach our goal of financial independence so that should the worst happen we won’t have financial stress to deal with on top of the devastation of losing a spouse.

Summing up

Going forward I want to:

• Have an emergency fund of maybe 2 months in cash
• Invest any other spare cash and decrease our savings rate if needed to cover unexpected expenses
• Have income protection insurance in place to cover loss of income for any sickness, disability or illness. This is tax deductible. Check out lion.ie for more info
• Continue our life insurance to cover the mortgage and then some if I die
• Lower our ongoing living expenses by halving our mortgage and selling our Canadian property allowing us flexibility and peace of mind should either of us unexpectedly lose our jobs and we need to bridge the gap between getting access to our income protection or finding another job
• Continue investing in ETFs in Ireland as we build towards our financial freedom goals.

As ever, I hope that provided some food for thought. How have you coped with the market volatility and has it impacted your plans going forward? Let me know in the comments below.

Investing

Questrade – The online trading platform I use for RRSP, TFSA and non-registered trading.

Online Shopping

Honey – A Chrome add-on which automatically searches for discount codes. You save money on purchases you were going to make anyway and also gain points from certain websites (like booking.com) which you can exchange for vouchers for places like Amazon.

Mortgage

Ratehub.ca – A great website for comparing mortgage rates come renewal time. They also compare bank accounts, GIC investments, home and life insurance and credit cards.

Expense Tracking

YNAB – This is the tool I use for expense tracking. It allows you to split expenses so I can easily track expenses between my husband and myself. They sync with your bank account as well so keeping it up to date is easy (for Canadian accounts at least). The reports are handy too. I used to use the desktop version which had a once off fee but now they’ve moved to a cloud based paid subscription of 84$/year. I struggled with this cost but I’ve also struggled to find an alternative that suits my needs. I also convert the cost into my hourly wage and figure it will save at least that amount of time per year in maintenance as it has the auto syncing and our historical transactions from the desktop version.

Travel – Accommodation

Air B’n’B – If you don’t already have an account – get 60$ off your first trip!

Booking.com – Great site for finding cheaper accommodation. I usually compare between both Air B’n’B and Booking.com. As mentioned above, if you use the Honey chrome-extension you can earn points which you can convert to Amazon vouchers. So far I’ve earned 40£ just by booking accommodation I would have booked anyway.

Travel – Fights

Google Flights – One of the quickest easiest ways to find flights with easy search filters for max duration, stop overs, price etc. Also really handy to explore destinations by putting in one or two starting airports and seeing where you can get to for little money. Great if you are just getting ideas of where you want to go, or where it’s cheap to get to from your airport. They also have price tracking notifications so you can be notified when prices increase or drop if you have a specific flight/date in mind.

Skyscanner – Similar to Google Flights, easy to search multiple airlines and sometimes has better prices than Google Flights.

Travel – Getting Around

Google Maps – Google Maps is great for showing how to get around a new place, it includes public transport, walking and even Uber prices and times. Street view is also a great way to explore an area before you get there.

Rome2Rio – Sometimes better at the public transport options than Google Maps and even shows much longer journey price and booking options from country to country.

Ex-pat/Cross-border Tax Advice

Trowbridge – When I was struggling to make heads or tails of the non-residents tax filing requirements for rental income from abroad, I received extremely helpful.

I’ve been doing a little reading on more sustainable ETF options and things are looking promising. We may not have to compromise ethics for fund performance.

I do think that eventually the stock market will naturally evolve to be made up of more environmentally friendly companies, as more of these companies emerge to battle climate change, but in the mean time I’m trying to figure out where to put my money to align with my ethics.

There is an organisation called US SIF, a forum for sustainable and responsible investment (SRI) whose mission is to “rapidly shift investment practices towards sustainability, focusing on long-term investment and the generation of positive social and environmental impacts”.

Since 1995 the organisation has been preparing a trend report every 2 years based on survey data on the numbers of institutional asset owners, money management firms and investment vehicles using sustainable investment strategies. It also distills the range of significant ESG issues, including climate change, human rights, weapons avoidance and corporate governance, that investors consider.

The trends

The 2018 report shows that out of the 46.6 trillion invested in US professionally managed assets, 26% (12 trillion) are now falling under the environmental, social and governance (ESG) criteria.

This has grown exponentially year on year including 38% growth since 2016 alone!

25% of that 12 trillion is by individual investors.

Current make-up of funds under management

Of the funds still invested in non-ESG areas here is a breakdown of how much money is behind issue areas:

And of the 46.6 trillion in US assets here is the make up in terms of what the funds support. 26% in sustainable funds, 27% in known listed issues and the remaining 47% isn’t specified in the report (at least in as much as I read).

What is driving more sustainable options?

Client demand is the highest reasons why money managers are considering ESG factors, followed by mission, social benefits, returns, risk, fiduciary duty, UN sustainable goals and regulatory compliance.

You can thank millennials for driving this on as they are the main investors demanding these criteria. With millennials set to inherit a £1.2 trillion windfall from baby boomers in the next 30 years, according to a recent study by Sanlam UK, there’s a clear need for the impact investment industry to develop products and services in order to attract and retain next generation wealth.

What are ESG criteria?

Here are the main criteria which make money managers decide if a fund falls under ESG criteria or not along with how much of the funds under management currently fall within those areas.

And in pie chart form

What funds are available to invest in?

There are likely a lot more but here are a few from my initial research. I have not invested in any of these myself yet but once I am earning again I will likely start to funnel more and more of my portfolio into these types of funds.

In Ireland:

Both ESGV and VSGX follow the below criteria

• Specifically excludes stocks of companies in the following industries: adult entertainment, alcohol and tobacco, weapons, fossil fuels, gambling, and nuclear power
• Excludes stocks of companies that do not meet certain standards of U.N. global compact principles and companies that do not meet diversity criteria

In terms of fund make-up, risk, fees and performance here is a snapshot (click the links for the full fact sheet)

ESGV – Vanguard ESG U.S. Stock ETF

• All US companies
• Fees: 0.12%
• Performance: last 1 year 33%, since inception in 2018: 11.5%
• Risk: 4 out of 5
• ESG Morningstar rating: 4 out of 5

VSGX – Vanguard ESG International Stock ETF

• Tracks the performance of the FTSE Global All Cap ex US Choice Index
• Fees: 0.17%
• Performance: last 1 year 23.48%, since inception in 2018: 7.65%
• Risk: 5 out of 5
• ESG Morningstar rating: 3 out of 5

In Canada:

iShares MSCI KLD 400 Social ETF (DSI)

• DSI tracks a market-cap-weighted index of 400 (US only) companies deemed to have positive environmental, social and governance characteristics by MSCI
• Fees: 0.25%
• Performance: last 1 year 30.38%, last 10 years: 12.47%
• Risk: 5 out of 5
• ESG Morningstar rating: 5 out of 5

Vanguard FTSE Social Index Fund (VFTSX) was another one but seems to now be closed to new investors.

If you have funds in the US or Canada, you may be able to make use of this tool which shows how heavily invested in fossil fuels various mutual funds may be.

How does my current portfolio fare?

According to the Morningstar sustainability ratings, my current Irish portfolio isn’t great with only 1-3s out of 5 (5 being the best)

• Vanguard FTSE All-World High Dividend Yield UCITS ETF (VHYL) = 1
• Vanguard FTSE Developed Europe UCITS ETF (VEUR) = 2
• Vanguard S&P 500 UCITS ETF (VUSA) = 3
• Vanguard FTSE Emerging Markets UCITS ETF (VFEM) = 3

You can read more about Morningstar’s ESG investment ratings here.

What about you? Are you considering shifting your portfolio to more sustainable funds? Have you found any you’d like to share? Please let me and other readers know below!

Investing your hard earned money can be scary! I read up on investing extensively for 2 years before I took the plunge. I suffered from something called analysis paralysis where the more I read the more I was unsure how and where to start. By hesitating I lost out on 2 years of having my money work for me instead of losing money to inflation in my account and so I’m writing this guide as a summary of my findings and experience in the hopes that it will help a few more people get off the fence and start investing.

Warning: This is a LONG post but I wanted it to be a one stop shop so you can check back and re-read all in one place, as you need to, instead of keeping track of multiple links.

To help you skip around, here is a table of contents

Preamble

This post covers a high level summary of investing concepts. A lot of the concepts could have full blog posts of their own so if you want to know more about any of them, you can research further but this post should give you the overall concept at a high level.

There are tons of resources out there for US folk but very few for Canadian specific strategies and even fewer in Ireland. This guide will focus on the Canadian side and as I muddle my way through the Irish side I will share my findings as I go. That said, a lot of what I talk about here, aside from the tax specifics and investing platforms are applicable anywhere.

This guide includes references to reaching financial independence where your portfolio is large enough (25 times your annual expenses) to cover your annual expenses by withdrawing only 4% per year. This may or may not be your goal but this guide applies to everyone who wants to start investing regardless of the end goal.

Start by paying off existing debt

If you have existing debts, it’s best to focus on those first as they typically have higher interest rates than you will achieve in an investment account. For example: If you have 100$ and you pay down your credit card you will save 21$ of interest (at 21%), but if you invest that 100$ instead you may only make 7$ (at 7$ real rate of return after inflation).

Focus on the debt with the highest interest rate first – typically in this order

• credit cards
• car loans
• student loans

Mortgages are usually lower than what you can get in an investment account so mortgages can be an exception to this rule. A good rule of thumb is if your mortgage rate is over 4% you would be better paying it down before investing.

See if you can consolidate your debt into products with lower rates. There are a lot of credit cards that offer 0% interest for the first 6 months or get a line of credit with a lower rate (say 5%) to pay off credit cards with a higher rate (say 21%).

Remember the power of compounding is working against you when you have existing debt. Using the rule of 72 (a calculation used to figure out how many years it will take for your money (or debt in this case) to double), a typical credit card of 21% left unpaid will double every 3.4 years or quadruple every 6.8 years!

What to invest in and why

Why traditional investments aren’t great

A lot of people (including me before I found a better way) think of their home as their retirement plan or invest in products sold to them by the bank or their employer, but there are major downsides to this approach.

Your home can certainly go up in value over time but it can also go down and there are plenty of costs associated with owning a home that you wouldn’t have while renting. I’m not going to go into the rent vs. own debate here as that warrants a post in itself but banking on your home as an investment puts all your eggs into one basket which is very risky. It’s also very illiquid and doesn’t give you many options should you need to free up equity.

Bank and employer investment products are usually products that work out best for the bank or employer rather than for you, they typically have much higher fees or lower returns than you could get on your own using something called index investing.

Fees are often brushed over but they become very important when compounding over time. For every 0.25% of a fee you lose out on 5% of your overall portfolio’s value. So if you pay the typical 2.5% for a Canadian fund, your portfolio will be worth almost 50% less than it would be if you had invested in a fund with lower fees!

What is index investing and why is is better?

Index investing is a way for you to essentially bet on the whole stock market.

An example of an index fund is the S&P500. This is an active index where the value of the 500 largest US publicly traded companies is calculated and tracked. Over 15 year time periods, the S&P500 has never lost money, and has had a median return of 12.2%.

There are many passive funds with lower management fees which try to mimic and track these underlying active funds. There are also many other funds which track other sections of the market so you can pick and choose a diversification you are comfortable with.

Since the inception of the stock market, it has always recovered from every downturn given enough time. If you have time to leave your investments grow, you don’t need to overly worry about market downturns, though you need to have the confidence to leave your money invested, especially in a downturn. That said, there are ways to mitigate losses which I will cover below.

Main selling points of index funds are:

• lower fees
• they outperform actively managed funds by 85%
• they allow for passive investing, in that you can invest and forget (aside from re-investing dividends and rebalancing once a year)
• you can access them as needed without penalty

Figuring out your comfort with risk

The two main elements of a balanced portfolio are stocks (equities) and bonds (fixed income).

• Stocks are shares in a specific company usually with higher risk and higher gains
• Bonds are essentially loans where the investor (you), loans governments or corporations money and they agree to pay you back in fixed income by a certain date. These are lower risk but also lower return. Bonds are used to balance out the risk of a stock heavy portfolio and are one of the ways to mitigate against stock market crashes.

A typical investment rule of thumb is to keep bonds in the percentage of your age. So if you are 30 years old you should have a portfolio with 70% stocks and 30% bonds. This reduces your risk as you near retirement but keeps your portfolio growing with higher percentages in higher performing stocks.

I have read mixed reviews of this for early retirees with some maintaining 100% stock portfolios to achieve maximum gains even in early retirement knowing they plan to keep working in some regard and therefore do not need a mitigation strategy.

Others are more risk averse and even though they are retired in their 30s, maintain a 60% stock/40% bond split for the first 5 years of retirement and then will only go as high as an 80% stock/20% split after that even though they are continuing to make money in retirement from passion projects.

At the end of the day you need to figure out which split works for your own level of risk aversion.

You can see my portfolio, which indexes I have invested in and why here, but here is a summary:

I currently have no bonds but think I will up this percentage to at least 10% of my portfolio after reading how useful it is to weather any stock market crashes (more on that below).

How to Invest

Setup a brokerage account

In order to invest yourself you need to setup an online brokerage account. I use Questrade as it allows free buying of any Canadian or US-listed ETF (exchange traded index funds). Selling an ETF incurs the normal trading commission of $4.95 to $9.95 (depending on the number of shares sold), but the idea with this model is that you will not be selling very often as you are building your portfolio. This essentially allows you free trading as an average long-term ETF investor.

You can sign up to Questrade here.

Select self-directed, standard individual and “no” for options trading. Complete the rest of the application and send in the paper signed forms as required. It can take a little while to complete the process.

If you are transferring from an RRSP or TFSA there is usually a fee of 150$ to transfer funds under 25,000$ but there is an offer on until September to waive this. Read more on how to transfer from these accounts here.

Fund your account

You can transfer money to your Questrade account by adding them as a bill payee on your online banking, this should avoid any banking fees. Test with a small amount first just to make sure it’s setup correctly.

Buy your ETFs

Once you figure out the ETFs you want to buy and the allocation you want, you’ll need to figure out how many of each you can buy with the money you have to invest. Say you have 1,000$ to start with, I did up a spreadsheet with some basic formulas where I entered the current unit price of each ETF and figured out how many shares of each I would need to buy to make up my desired allocation split. This way each time I have money to invest I just update the unit price and it calculates what I need to buy.

For example: For the Global Factor ETF I wanted that to be 33% of my portfolio so 33% of 1,000$ = 330$. If the unit price is currently 32.37$ then I can buy 10 shares (330$/32.27$ = 10.22$). As you cannot buy portions of shares you need to round down all of your numbers in the last column.

To test the waters you can choose to buy 1 or 2 shares and watch it grow for a while to help ease your concerns. In my case, in both my portfolios (Canadian and Irish), I saw a drop in value more or less straight away but over time the market has recovered. You need to be comfortable with your portfolio losing money from time to time and rest assured that the market goes up twice as frequently as it goes down over long periods of time.

Structure your portfolio to be tax efficient

In Canada there are two investment vehicles that allow you to defer and shelter taxes.

RRSP

A Registered Retirement Savings Plan (RRSP) is a tax deferral tool which allows you to reduce your taxable income in your higher earning years so that you can pay less tax when you withdraw at a lower income bracket in retirement. Your investment growth (capital gains) and dividends are tax free but you pay income tax on the final amounts when you withdraw. You have a maximum contribution room of 18% of your previous years salary up to 26,500$ (a salary of almost 150,000$). Check your notice of assessment to see how much room you currently have available.

TFSA

A Tax Free Savings Account (TFSA) is a tool to shelter your investments from taxes but only makes sense to use if you are investing in something. Do not use this account to just store money as it defeats its purpose. You can only contribute after tax money but your dividends and gains are tax free and there is no tax on your withdrawals. You have a max contribution room of 6,000$/year as of 2019. If you don’t have an account yet you can sign up and you get all the contribution room from 2008 when this account type was created.

You can hold both account types in your Questrade self directed investment account so you can choose what you want to invest in.

There is a certain order which you should invest in these accounts:

1. If your employer has an RRSP matching program max that out first
2. If you’re already in the lowest tax bracket (currently up to a salary of 47,630$) then fund your TFSA next as contributing to your RRSP will be a waste of your tax deferral (ie contributing at 15% tax bracket and withdrawing at 15% tax bracket), you are better holding onto your contribution room for a year you may be earning more
3. If you’re in the 20.5% tax bracket and higher, then fund your RRSP
4. If you manage to max out your RRSP then contribute the rest to your TFSA

Using these two tools will make your portfolio accumulation phase as tax efficient as possible. When it comes time to withdraw, there will be another way to structure your investments in order to further reduce or even eradicate the taxes you would need to pay.

How to maintain your investments

Don’t worry about timing the market

When it comes to investing, hindsight is a wonderful thing, if only you could know when the market was going to rise or fall. There are people who spend their days trying to predict this but save yourself some trouble and follow either one of two approaches depending on your comfort with seeing your portfolio drop in value from time to time.

Emotional option: dollar cost averaging

If you are really emotional about seeing your portfolio decrease in value, you can rely on something called dollar cost averaging. The idea is that instead of investing large lump sums on any given day you average it out over time so that you can reduce some of the risk of buying high only for stocks to crash the next day. Instead you buy little and often and you will naturally end up buying some stocks at a high but some at a low and it will average out over time.

Rational option: time IN the market is better than TIMING the market.

If you have gotten to the point where you are comfortable with seeing dips in your portfolio then rely on the fact that time IN the market is better than TIMING the market.

Other interesting stats about the market: (courtesy of www.retirehappy.ca)

1. Markets go up more often than they go down
2. Not only do markets rise more frequently, but they tend to increase in higher magnitude than the drops.

Over the last 90 years:

• Markets have gone up 73.9% of the time
• Markets have gone down 26.1% of the time
• The market gained more than 20% in 33% of the time
• The market lost more than 20% in 4.5% of the time
• The gains in positive years produce more than double the losses in the negative years

(This data is based on calendar year returns of the TSX from 1920 to 2010).

In addition (courtesy of Rob Carrick of the Globe and Mail),

• In 34 of the 37 corrections of 10%+ since 1950, the stock market was up 12 months later by 26.8% on average.
• Average decline for the 37 market plunges of 10%+ since 1950 is 19.7% or almost one every 20 months.

Either way your money will be working for you so pick the approach that works best for where you are at in your investment journey.

Keep adding to your investments

Buy as much as you can, as often as you can and watch your investments grow.

Try not to look at your portfolio too often as it can be off putting to see market dips but if you want to keep an eye on things in a visually pleasing way I use a website called Wealthica to see my overall portfolio progress. You can sync multiple brokerage and bank accounts to it and view the trends over time in nice graphs. It’s easier to see the overall progress of your investments.

Reinvest your dividends every quarter

There are some funds and accounts you can get with robo-advisors that will automatically re-invest your dividends but I have yet to delve into those options. For now I’m keeping it simple and manually re-investing my dividends. All but one of my ETFs pay out quarterly (you can see this on the fact sheet of each ETF), so I check back once a quarter and buy more with the dividends that are paid out.

Rebalance once a year

Throughout the year your stocks will likely outperform your bonds or certain ETFs will outperform others and your asset allocation will shift.

Say you started out with a 70% stock 30% bond split. Through the year your stocks performed really well and now they make up 80% of your portfolios value and bonds have fallen to 20%.

In order to maintain the asset allocation you are comfortable with you will need to sell some of your high performing stocks and buy some of the low performing bonds to rebalance your portfolio back to the original allocation.

This can be done once a year (I read a really good article on why any more than that actually increased your volatility while reducing your return but can’t for the life of me find it again). Keep an eye on trade commissions and creating tax events from sales.

Weathering a crash

When the market is crashing, it is very hard to leave your money invested but based on the facts, the stock market always recovers so the best thing for you to do is wait, alternatively there are two things you can do to lessen the blow:

Sell bonds at a high and buy stocks “on sale”

If you hold bonds as well as stocks, a crash may be a good time to rebalance as during a crash, money flows out of stocks (risky) and into bonds (safer), this devalues stocks and increases the value of bonds. So if you hold bonds now would be a good time to sell (high) and buy stocks (low) and rebalance your portfolio to your desired split. This means that once the market recovers you will own more stocks which you got “on sale” and will benefit more from the upswing in the market. If you don’t own any bonds you will simply need to wait for the market to recover (usually 2 years).

This is why it’s important to hold at least some bonds as you will be in a stronger position to benefit from market recovery than if you only held stocks.

Sell at a loss to offset future gains

This is something called capital loss harvesting (or tax loss selling). This idea is that you take advantage of the downturn by selling some of your assets which have lost value compared to when you bought them. At the same time you should buy back a similar ETF at the lower value so that you maintain your original market exposure to ensure you can take advantage of the future gains when the market does recover. The reason you wouldn’t buy back the same ETF is because there is a stipulation where you have to wait 30 days before buying the exact same thing again, or it is dismissed as a “superficial loss (or gain)”.

Capital losses can be applied to your current tax year, 3 years in the past and indefinitely in the future. This means you can basically “buy tax credits” in the down years which you can use to lower your taxable income in future years when your income may be higher.

How long to financial independence?

For those of you interested in achieving financial independence, you may be wondering how long it will take using the above investment model, well the chart below shows how many years it will take for you to reach financial independence depending on your current assets and different monthly savings amounts. Financial independence (FI) means your portfolio is large enough to withdraw a safe withdrawal rate of 4% to cover your annual living expenses, in this case we are looking at a portfolio of 500,000$ for an annual cost of living of 20,000$ for 1 person. To apply this chart to a couple simply double the monthly savings amount in the first column to reach FI in the same number of years.

Assumptions:

• Amount of time to grow portfolio to 500,000$
• Safe withdrawal rate of 4%
• Annual living expenses on withdrawal of 20,000$ for one person
• No income tax on withdrawal as portfolio will be structured to avoid tax (detailed below)
• Real rate of return used is 6.77% (average stock market performance over its lifetime has been 9-11% so being conservative I took 9% minus the average inflation for Canada over the last 30 years of 2% minus MER fees of my sample portfolio of 0.23% = 6.77%)

So for a single person starting from 0$ in assets and saving 500$/month it will take 28 years to reach financial independence compared to 13 years if you save 2,000$/month.

If you already have 100,000$ in assets and you save 2,000$/month it will take you 9.5 years to reach financial independence.

This just goes to show how much of an impact your savings rate can have. It can shave years off your journey to FI. Not fast enough? There are a few more options on how to reach FI sooner.

Ways to reach financial independence sooner

There are a few other options if your time to FI is too far away. This is a quick list but you can google more on each bullet point to find many resources on each topic if some of them interest you.

You could:

• Make more money with a side passion project in order to increase your savings rate and decrease your time to FI – google side hustles for ideas or check out the book Financial Freedom for a great guide on figuring out profitable side hustles. One exercise in the book is to make a list of your hobbies and a list of your skills and take a step back and see if any side projects appear that make use of a cross between your skills and hobbies.
• Cut expenses to increase your savings rate.
• Do partial FI where you increase your withdrawal rate beyond the safe rate of withdrawal with the caveat that you would need to earn a certain amount through the year which would not require a full time job, offering you and your partner more flexibility. For example: say you and your partner want to live off 40,000$/year – for a safe withdrawal rate of 4% you’d need a portfolio of 1 million but if you decide to take out 6% per year you’d only need a portfolio worth 640,000$ BUT you’d also need to top up your portfolio/investments with another 15,000$ per year to ensure it wouldn’t run out. So you or your partner could work part time or take on contract work for a few months if that was something you’d rather do then wait your full time to FI. This approach practically cuts your time to financial independence in half while still achieving the flexibility you may want.
• Take mini-retirements once you’ve reached some degree of passive income or savings and you can afford to take a prolonged time away from work to pursue other things, be it travel, time with family, going back to school etc. This is a great option if you want a change sooner than later. It also gives you a chance to try out early retirement to see if it’s something you’d actually like to do full time.
• If your job allows you to work remotely 100% of the time, consider moving to a place where cost of living is much cheaper. I know someone who contracts for a company in London, earns GBP and lives in Malta where there is no corporate tax. Other stories I have come across are where a couple moved from San Fransisco to Mexico while still earning US dollar from their silicone valley companies and significantly reduced their time to FI that way.

There are probably lots of other ways but these are the main ones I’ve come across.

How to withdraw

Once you’ve reached your version of financial independence and you’re ready to start withdrawing from your portfolio there are a few things to consider in order to protect your portfolio from something called sequence of return risk and also how to make your withdrawals tax-free.

Protect your portfolio in the first 5 years of retirement

Your retirement portfolio is at most risk of failing in the first five years of retirement. Even if you only withdraw at the safe withdrawal rate of 4% (which has a success rate of 95%) there is a 5% chance it will fail in the long-term and your portfolio will run out of money in 30 years time. This can happen if you retire right when the market crashes and you are forced to withdraw/sell at a loss and even in the upcoming “up” years your portfolio cannot recover and eventually over 30 years you will run out of money (unless you go back to work and top it back up again). This is something called the sequence of return risk. Never fear – there are ways to mitigate this.

1: Least ideal: Go back to work to top up your portfolio

2: Slightly more appealing: Cut expenses or move somewhere cheaper so that you don’t need to withdraw as much to live off of

3: Least impact: Hold a cash cushion of 1-3 years of living expenses that is invested in something outside of the stock market (like a “high” interest savings account). Using this cash cushion for your living expenses in the down years means you do not HAVE to sell at a loss and you can wait for the market to recover keeping in mind that stock market crashes tend not to last more than 2 years of continuous declines.

1-3 years of living expenses can be a lot (say 40,000$ – 120,000$), which would further add to the time to financial independence but there is a way you can reduce the amount needed with something called a yield shield.

The idea is that you temporarily pivot your investments to high yielding (though lower performing) assets for the short term. Things like preferred shares, real estate investment trusts (REITs), corporate bonds and dividend stocks. This can mean that your portfolio goes from returning dividends of something like 2.3% to closer to 3%, which if you have 1 million in your portfolio means the difference between 23,000$ to 30,000$. So if you need 40,000$ to live on you can use the 30,000$ from your dividends and only withdraw 10,000$ from your cash cushion meaning you only need 30,000$ extra as a cash cushion to weather 3 years of a market downturn.

Holding a yield shield means your portfolio is slightly more complicated to maintain as you are invested in a larger number of asset classes but once you have passed your first 5 years in retirement you can pivot your assets back to a simpler spread of ETFs.

How to withdraw tax free…legally

At a high level, there are different tax rates and tax brackets applied investment income than there is to employment income or interest earned from savings accounts. Income taxes are mostly unavoidable if you are earning an income (unless you figure out some life hack where you work remotely from another country with lower living expenses and pay lower tax rates in the country you live in) but if you are no longer earning an income and you are living off your portfolio withdrawals then you can reduce your tax bill by:

1. withdrawing from your tax free account
2. making sure your investments are in the right accounts for tax optimization
3. using your annual eligible dividend withdrawal allowances
4. withdrawing your annual personal exemption from your RRSP
5. harvesting your capital losses

Firstly, to clarify some terminology:

A dividend is an amount of money a company pays out to its share/stock holders at a set schedule (usually quarterly or annually)

A dividend is considered eligible for tax purposes depending on how the corporation structures and pays tax on them. Corporations have to designate each eligible dividend that they pay, before or at the time the dividends are paid, and notify shareholders in writing that the dividend is eligible, as required by subsection 89(14) of the Income Tax Act. A corporation must make every effort to notify shareholders of an eligible dividend. Examples of notification could include:

• identifying eligible dividends through letters to shareholders
• dividend cheque stubs
• on the corporation’s website
  in corporate quarterly or annual reports
  in shareholder publications

A capital gain is an increase in value of shares you own compared to when you bought. So if you bought something for 10$ and when you sell it it’s worth 25$ you have a capital gain of 15$ which you need to pay capital gains tax on. You only realize a gain or a loss once you sell the share/stock while dividends are paid at the set schedule identified in the fact sheet of the fund.

Withdraw from your TFSA

Any gains made in your TFSA are tax free, so you can sell ETFs you have made gains on to fund your annual living expenses as needed.

Put the right assets in the right account to reduce tax

You need to ensure certain asset classes are invested in the right vehicle due to the way they are taxed.

For example: Bonds pay out fixed income which is treated as interest and is taxable the same way employment income is – you can avoid paying this tax if the bond portion of your portfolio is invested using your RRSP as RRSPs grow tax free. Here is a sample of what asset classes should be invested in which tools (courtesy of Millennial Revolution): Read their blog post on this for much more detail as to why each asset class is most efficient for tax purposes as per the table below.

Use up your annual dividend tax withdrawal limits

In Canada, as of 2019, provided you are earning no other income, an individual can earn up to $47,630 per year in eligible dividends and pay no tax, or a married couple can earn up to $95,260 in eligible dividends tax-free.

If your portfolio throws off dividends each year, and you are earning no other income, you should withdraw these as part of your annual living expenses up to the annual eligible amounts so that you do not pay tax. These limits do not carry over so if you don’t use them you lose them.

Use up your annual personal tax exemptions

In Canada, as of 2019, at a federal level you can earn an income of 12,069$ per person (or 24,138 per married couple) each year for which you do not need to pay tax. If you are earning no other employment income, this can be withdrawn from your RRSP tax free. The added bonus is you do not need to be of retirement age to avail of this so works well for early retirees too.

There are slight variations per province so you’ll have to look into each of those for your particular province.

Note that when you withdraw from your RRSP, the government withholds 20% until you file your taxes at the end of the tax year, at which point you should get it back considering you’ve no other taxes due.

A good explanatory post with visuals on how to withdraw can be found here.

Harvest your capital losses

As mentioned earlier in the post you can purposely sell your assets at a loss in market crashes in order to carry the tax “credit” into years when your income is higher. If you need to withdraw more than your personal tax exemption and your dividend allowance per year, you can use your tax losses which you accrued in previous years to reduce your taxable income to zero.

Sense checking for the long haul

At the beginning of each year of retirement, it’s a good idea to re-check the chances of success of your current portfolio. There is a handy calculator called FIREcalc which cycles through 119 different scenarios based on criteria you enter and tells you the current rate of success where your portfolio will not run out of money in the next 30 years.

If the rate of success is lower than you’d like, you can always carry out some of the back up plans mentioned above in the “how to withdraw” section.

ANNNDDD that’s a wrap!

Hopefully this will be a post that you read and re-read through your investing journey. I actually learned more myself by writing it so I got something out of it too

I’d love your feedback, if you found this helpful or if there is something you’d like me to elaborate on in future posts, please leave a comment below.

How I Decided

*Fact sheets updated for 2021

Why ETFs

Firstly a little about ETFs (exchange traded funds). These are essentially funds that bundle a large number (sometimes thousands) of individual stocks, commodities and or bonds under one fund so that you can easily track the trend of the whole stock market with only a handful of ETFs. This makes it easy for passive/lazy investing over longer terms. ETFs also offer low expense ratios and fewer broker commissions than buying the stocks individually. Historically since the inception of the stock market returns have averaged 9-11% so by having a well diversified range of ETFs you can also achieve these levels of returns with little effort.

Why not one simple ETF

After reading many blog posts about various portfolio options I settled with a slight variation to the Escape Artists suggestion explained in full detail in this post. Some bloggers suggest a very simple portfolio where you just chuck whatever money you have whenever you have any extra into one Global ETF fund like the Vanguard All-World fund (VWRL) but the reason I decided against that approach is because that fund is heavily invested in US equities (54%) and I wanted something that was a bit more diversified. According to the Escape Artist, US equities may be overpriced at the moment which may doom long term investors to under-performance (ie: when you buy high you’d need to make massive gains to make up the same returns you would if you had bought low and made smaller gains).

Why 100% stocks and no bonds

Depending on your risk tolerance you may want to put a portion (say 30 or 40% for more conservative or 90% for less conservative) of your portfolio into bonds as these have less risk but lower returns, something like the BMO Aggregate Bond Index ETF (ZAG) but as I have time on my side to let my investments rebound from any downfalls, I decided not to keep any of my portfolio as cash or in bonds. I’m open to the higher risk of a 100% stock portfolio.

Who is this for?

Therefore this portfolio mix is probably for people very early in their investment journey who have many years of contributions ahead of them before they are able to retire.

Once you are about 5 years away from retirement you’d probably want to invest in something like 30% or 40% bonds and 60% or 70% stocks with higher yields/dividends rather than higher returns.

Portfolio Make-up

Below is the make-up of my current Canadian portfolio. All these ETFs are with the Vanguard company (See more about them below). 33% is in a Global fund, 19% in a Canada fund, 19% in Emerging Markets, 16% in the S&P 500 and 13% in Developed Europe. These funds all have varying management fees but this make-up comes to a weighted MER of 0.23% with an estimated weighted return of 8.7% based on each funds’ last 5 years returns.

And in chart form…

About Vanguard

I like Vanguard because their core purpose is “to take a stand for all investors, to treat them fairly, and to give them the best chance for investment success”, their average expense ratio is 0.10% as per 2018 assets under management. As per their website: “Vanguard is owned by its funds, which in turn are owned by their shareholders. Vanguard’s ownership structure means we have no conflicting loyalties. It’s in everyone’s interests—our clients’ and thus ours—to uphold the highest ethical standards every day. When making decisions, we are guided by a simple statement: ‘Do the right thing.'”

ETFs in Detail

Each ETF comes with a fact sheet which you can download from your Questrade account. Below are the highlights of my portfolio make-up so you can get a sense of the range of companies I’m invested in.

FTSE Canada Index ETF (VCE) – 19% of portfolio

This one is only invested in 64 companies where the top 10 make up 40% of the fund. The dividends on this fund are paid quarterly.

Global Value Factor ETF (VVL) – 33% of portfolio

This is a much larger spread with investments in 1,135 companies where the top 10 listed only make up 5.1% of the fund. The dividends on this fund are paid annually.

S&P 500 Index ETF (VFV) – 16% of portfolio

This one is made up of 512 companies where the top 10 make up 31.4% of the fund. The dividends on this fund are paid quarterly.

FTSE Emerging Markets All Cap Index ETF (VEE) – 19% of portfolio

This one is the biggest spread of companies with 5,256 however the top 10 make up 20% of the fund so only fractions of percentages are invested in the remaining 5,246. The dividends on this fund are paid quarterly.

FTSE Developed Europe All Cap Index ETF (VE) – 13% of portfolio

This one is mid-sized with investments in 1,323 companies where the top 10 make up 17% of the fund. The dividends on this fund are paid quarterly.

Performance

After my initial transfer from my RRSP at the end of Jan 2019 (just shy of 3 years ago) I have since made a 40.93% gain which averages 14%/year. See growth chart below.

It’s early days but I am pleased with the results so far. This is an RRSP account so I still need to pay taxes on any withdrawals at my salary rate at time of withdrawal but it’s still performing better than it had been with my old provider.

Variations

Two other portfolio options are:

1. As mentioned above a simple 1 ETF portfolio with an all world fund like the Vanguard All-World Fund (VWRL) or
2. another popular make up for more conservative investors or investors nearing their retirement date would be some mix of:

• iShares Core MSCI All Country World ex Canada Index ETF (XAW)
• Vanguard FTSE Canada All Cap Index ETF (VCN)
• BMO Aggregate Bond Index ETF (ZAG)

I’ll do another post on how to purchase these in the correct proportions at a later date.

What do you think? Willing to try your hand at investing yourself? Leave a comment below.

Why Transfer

As I mentioned in this post you may be paying high management fees with your current RRSP investment provider which could potentially be halving the profits you could be making in a self-directed account.

If you are ready to take the plunge and manage your investments yourself with simple ETFs (exchange traded funds) which automatically invest in a large portion of the stock market essentially following the long-term upward trend of 9-11%, then you can follow the below steps:

How to Transfer

1. Sign up for Questrade – a self-directed online brokerage account which has fee ETF trading (use the link provided to give me a small commission at no cost to you)
2. Once signed up, click on “Open and Account” in the top right corner
3. Select Individual RRSP account (make sure you select this one as you will incur withdrawal taxes in the transfer if you select any other ones)
4. Follow the remaining steps to setup the account
5. Once the account is setup you will have the option to transfer funds into the account, in the main menu select Funds and then click  “Transfer account to Questrade” 
6. Fill out your current RRSP institutions information
7. Select the transfer type of either cash, in kind or partial. In kind can be used if you like what you are currently invested in but want to reduce your management fees. You can only use this if the fund you are invested in is not proprietary to the institution you are currently invested with. Cash means the funds in your current RRSP will be sold and only cash will be transferred which gives you a blank slate on what to invest in. Partial is some combination of the two.
8. Questrade will take it from there, they will contact your institution and complete the transfer. They will also make the transfer as registered which means you will not pay withdrawal taxes as you are simply transferring from one RRSP account to another. They say it can take 20 business days but mine took less than a week. Note there is a fee of 150$ for transfer amounts less than 25,000$, also make sure you are not invested in DSC (deferred sales charge) funds which charge you a certain percentage to sell before a certain number of years, you should be able to see this in your current investment account if they offer a redemption fee calculator. If you are invested in a DSC account you can make the decision to see if the fees you will pay will easily be made up in a shorter time frame if you invest yourself – like I did here.

What to Do Once Transfer is Complete

If you transfer in-kind there is nothing left to do but monitor your account and perhaps rebalance or reinvest any dividends (I will write more on this later) and if you transfer in cash then you need to decide what you will invest in. I will write another post detailing my own portfolio should you wish to follow along.

And that’s it, your first step to investing!