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Reader Mail: Babe in the Woods II

Babe in the Woods has contacted me again with a bunch of questions.  After the last response to her questions, she has gone out and read a couple personal finance books and now has more questions. 

So I've just finished reading The Wealthy Barber for the first time, and am pretty inspired. I'm starting to do research on RRSP's and mutual funds, and doing some goal setting, but am confused about a few things. How is the rate of return determined and what can you do to increase it? What are some of the options to big banks, and could I do better with an alternative institution? How do I research which funds and fund managers are the best?
I became more confused when I came across an excerpt from Smoke and Mirrors: Financial Myths That Will Ruin Your Retirement Dreams by David Trahair

He seems to think that mutual funds and RRSPs may be a bad thing because of the baby boomer factor. This is making me think twice, just as I'm about to start my own financial journey. Is there some truth to what he says or is he just blowing smoke? And if it is true would a high interest account be another good option in saving for retirement? My instinct is to trust David Chilton's advice and I like the idea of the split spousal RRSPs, but want to be sure before I start committing to a twenty year plan of action.

Also what would be the best type of account to set up to save for an emergency fund or for things like vacations? I have an old blue chip account with the Royal Bank, so am thinking of looking into their new high interest accounts that you have written about.

My Response: 

The Wealthy Barber is one of my favorite books of all time and taught me a lot in my early years.  Perhaps this is the book that can be introduced to your children when they start learning about personal finance. :)

The 2nd book though I haven't read, but I've read from RRSP naysayers before.  Nobody knows for sure what the markets are going to return in the long run.  Sure, demographics might be a factor, but can anyone really tell for certain?  I would say that they put their strong opinions/hypothesis out there to sell books more than anything else.

If you are planning on retiring in 20 years, you need to work out exactly the income that you will require and work backwards from there.  If you haven't already, check out my "early retirement series".  I did a number of calculations there that help determine the numbers required to retire.  Note that you will have to account for the age of your children when you to decide to retire and big debts (like the mortgage) should be paid off by then.  One of the best books that I've read with regards to planning for retirement is "Why Swim with the Sharks", which is what my early retirement series is based upon.

With that said, a high interest account that pays 4% within your RRSP is "ok" if you want a small cash holding while waiting for the right investment.  However, if you want to retire in 20 years, investing solely in a high interest account will not work.  With inflation being around 2.5%-3%/yr, it would leave you with VERY little growth and probably not enough to retire on. 

With your husband in a higher tax bracket, an RRSP invested in a balance of equities/bonds would be the ideal choice. When you do start looking into equities, look into index ETF's and/or index mutual funds.  If you are just starting the RRSP, I would suggest that you go with bank mutual funds because it will eliminate your annual account fees. 

If you do go with a bank, they will probably try to sell you their higher MER products.  Don't do it.  Simply tell them that you are interested in their INDEX mutual funds.  Also, make sure that there are no annual fees associated with the account.  I know that CIBC has a bank RRSP account that charges no fees providing that you stick with CIBC sponsored mutual funds.  The other big banks should also offer this.  If you'd like to buy the index funds yourself online, TD offers the TD-E funds which have extremely low MER's for an Index mutual fund with no annual fee.

Now to answer your questions specifically:

  • Rate of return is measured by how well the mutual funds/equities/bonds have returned for the year.  This is basically out of your hands, but over the long term (20+ years), equities have returned 8-10%. 
  • You can research mutual funds through sites like:  morningstar.ca or globeinvestor.com
  • For an emergency/vacation fund, setup a high interest savings account.  My wife and I use a combination of  a high interest savings account (@ PC Financial) and personal line of credit.  The RBC savings account is also a decent choice where it currently returns 4%, and if you already have a regular chequing account there, it makes it even more appealing.

Hope this answers some of your questions.  I don't think the main concern is whether it's best for you (or your husband) to invest in RRSP's or not, I think the real question is what investments are you going to buy within the RRSP.  But that's just my opinion.

Disclaimer:  This blog post is meant to be of entertainment value only and under no circumstances should be it be considered financial advice.  I am not a financial professional so any information that you find on this blog should not be considered financial advice.

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 24 comments… add one }
  • FourPillars January 10, 2008, 3:50 pm

    mmm…I left a long and brilliant comment this morning about 11 am – one of my best! but it might have disappeared…

  • FrugalTrader January 10, 2008, 4:04 pm

    Sorry about that FP, i had something messed up with my comments.php file and comments got scrambled into cyberspace somewhere.

    Perhaps you can summarize what you wrote? :)

  • FourPillars January 10, 2008, 4:28 pm

    My ‘summary’ ended up being longer than the original!

    Interesting question and I completely agree with your answer FT.

    I want to clarify Trahair’s take on rrsps:

    In “Smoke and Mirrors” which was the first FP book I ever read (and I liked it a lot) he says that a lot of people are brainwashed into thinking they have to max out their rrsps or they’ll be living in a cardboard box in retirement. His argument is that you should focus more on reducing debt first before worrying too much about saving for retirement. He also mentions that for low income Canadians that rrsps are not a good idea but they are the best way to save for everyone else.

    One of the other main points of the book is that most people probably need a smaller retirement portfolio than they think – he works through some typical examples of a couple that has no debts and kids have moved out of the house so they don’t really need the $70k that they are netting during their working years. He goes through the fact that CPP & OAS (for Canadians) will cover a good portion of retirement income for an average income. He isn’t saying that you shouldn’t save money but rather that you shouldn’t listen to the BS from financial advisors about how you need “a million” or whatever amount to retire.

    It was the first book I had read that pushes expensed-based retirement planning which was the opposite to most marketing from financial companies.

    “Swim with the Sharks” – I thought this was a really good retirement planning book (except for their horrible investing advice). It’s a great look at the mindset of frugal living.

    • FrugalTrader January 10, 2008, 4:49 pm

      Ah, so the book is decent. I’ll have to pick it up for review. Yes, I agree with the concept of not needing excessive amounts in an RRSP to retire. However, I believe that relying on the govt to support us when we are old is a mistake.

  • FourPillars January 10, 2008, 4:58 pm

    FP – Smoke & Mirrors is a pretty good retirement planning book for Canadians but I doubt you will learn much if anything from it since you have already read many other similar books. Might be worth a libary borrow – it’s not a long book.

    It’s more geared toward someone who is just getting into retirement and personal financial planning.

    As for CPP & OAS – There is not much doubt in my mind that CPP is in great shape – I think it’s a mistake not rely on it. OAS, I’m not as confident in but I’ll have to wait until I get close to retirement before deciding whether to count on it or not.


    • FrugalTrader January 10, 2008, 5:07 pm

      Sorry, when I said it was a mistake to rely on government benefits at retirement, what i meant to have said was OAS. With demographics shifting, OAS will be become a bigger burden on the tax base. Who knows where that will be in 30+ years.

  • Gates VP January 10, 2008, 8:25 pm

    Hey FT, I’d like to highlight a key quote from her last post:

    We’d also like to retire in France (possibly), for my husband to write. I’m an artist so self employed. It’s possible I could keep working till 90 or be earning much more in years to come, but it is nothing I’d like to count on.

    I’m kind of “straight to the point” type of guy. Maybe I’m stealing some of Timothy Ferriss’s essence here, but here’s the big question as I see it.

    What will it cost to live the lifestyle that you want in France?
    What will it cost to move you there?

    It’s like a business plan, what’s the “startup cost”, what are the maintenance requirements? We have lots of information on this blog, more information and opinions than you can shake a stick at ;) And I’m not going to argue with FT’s advice b/c his information is correct.

    Instead, I’m going to change tack and start by figuring out the key number. What monthly income will you need to live the life that you want? Include rent and food and insurance and art supplies and trips to the cafe and transportation, etc. It doesn’t have to be perfect (it can’t be), you just try your best.

    Once we know what that number is and how far you are from that number, then we’ll have tons of advice. The truth is, Chilton’s advice may not be any good for people who want to live as artists. Chilton’s plan is basically to max out retirement funds and then to save even more money than that so that you can do whatever you want when you’re 55 (or 65 or 75…). He figures to make enough money to live off the interest and then die with money to give to the children.

    If that’s your plan, then follow along. But based on your quote above, that’s not the plan. You want to be an artist living in France. So instead, why not shoot to figure out what you need for cash flow to live in France and then ask us how you can get there from where you are now? And let us know how much you can work in-between.

    We love helping to solve problems, but I just don’t feel that I have the right information to help.

  • FrugalTrader January 10, 2008, 10:01 pm

    That’s a great point Gates, one that was overlooked by me. When people talk about those kind of aspirations, I usually discount them unless they are dead set on the goal.

    Anyone know what the lifestyle costs are like in France?

  • Babe in the Woods January 11, 2008, 1:41 am

    These are long term goals, and I really should do the research, and try to account for inflation. It’s one dream. I might be happy to be in Italy, but my husband has had a dream about a small cottage in Brittany for years now. I am just starting to work again, and trying to talk to my dealer about how much I can hope to earn in a year while looking after the children. Until they are in school I’ll be working while they sleep. Ten to twelve paintings a year is a pretty ambitious number, but I’m going to aim for it. Enough to maximize our rrsps and the RESP. Our children are young so I know there will be a lot of expenses even when my husband nears retirement. It looks like it is cheaper for us to rent where we live, and we are shamelessly driving an old reliable clunker to save money on car payments. My husband may get a little bit of a raise over the years, and when have built our credit we are thinking about rental property as an investment. (When the children are a little older and we have a little more spare time to invest responsibly.)We have a little debt (Less than a thousand, but not on credit cards, and a few small personal loans from family members.) Does it make sense to pay these off before we maximize rrsps? Family members say they are in no rush to be paid.

    Also, I notice you can earn more with lump sums at the beginning of the year in RRSPs. Why is this? Does it make sense for my to hold paychecks in a high interest account until the beginning of each year. It would be hard to manage even monthly payments because of the nature of my work.
    (Paintings have to cure and be shipped, and sell more easily at certain times of the year so it can be feast or famine.) Supplies are quite an expense, but if I am still working, the work will cover these. My biggest dream is to travel to museums around Europe and even see more of the world for inspiration, to live in comfort paint, travel, garden and eat healthy food, but not necessarily to live the high life. You are right I should do the math, and work out how much it would be for us to travel and work without too much financial strain. I really should look ahead to the numbers is this dream is to be a reality. It is a genuine goal, but taking care of the children is very much in the front of our minds right now.

    Baby awaits.. so I’m sorry if this is dashed off a little quickly. Hope it makes sense, and thank you everyone for such good advice, and your time.

    A happy and prosperous new year to everyone. You have to love Canada.. for making it possible for a person to turn fifteen thousand a year into a good retirement. Or at least I hope so.

  • nancy (aka money coach) January 11, 2008, 2:19 am

    @Babe In The Woods – regarding high interest savings accounts – check out Citizens Bank of Canada .ca if you’re comfortable with online banking. 4.1% on your first penny, no strings. Plus, their profits go back to the community (the people who bank there, nominate and vote) since it’s owned by a credit union.

  • Babe in the Woods January 11, 2008, 3:23 am

    Just thinking ahead. The “wealthy barber” seemed to to think financing a downpayment through RRSPs might not be the best way to do things. Should we start saving for a downpayment for a future rental property outside of our RRSPs? What would be the best way to save for this kind of thing? Does anyone have thoughts on this? I am interested in the smith manoveur, but need to understand it better before I know if it’s a possibility. Also I hear some people saying it is smart to carry a mortgage to free up money for investment, and other people saying it is best paid off as quickly as possible. This confuses me. What is the best route?

  • Gates VP January 11, 2008, 3:18 pm

    Hey Babe:
    Should we start saving for a downpayment for a future rental property outside of our RRSPs?

    You have to. The RRSP Home Buyer’s Plan is only for people buying a home in which they are planning to live and it’s a one-time thing. If you already own a home I don’t believe that you’re even eligible to use the HBP (worth checking though).

    The reason Chilton doesn’t want you to pull money from your RRSPs to pay for the home is that Chilton’s plan is deeply reliant on saving lots of money (an achieving his amazing returns). Remember my comment above, he wants you to save 18% into your RRSPs (the max) and another 10-20% into your “be rich” savings account. Using an RRSP for an HBP just doesn’t jive with his “save lots of money system”. Under the Chilton method, you want to save for a down payment then you should max out your RRSPs (18%) and pay yourself (10%) and then save for the down payment from the “left-over” money. (clearly I’m a little cynical of his methods).

    Also I hear some people saying it is smart to carry a mortgage to free up money for investment, and other people saying it is best paid off as quickly as possible. This confuses me. What is the best route?

    As is typical in the PF-world, they’re probably both wrong. There are very good reasons to maximize your mortgage and pay it off quickly just like there are very good reasons to minimize your mortgage and invest it elsewhere.

    Anyone who tells you otherwise is probably trying to sell you a book with further explanations of their views on life and why their’s is the “one true way”. But then, most of these authors don’t want to live as artists in Paris, so what the heck do they know?

    It’s all a play on risk vs. reward and good reasons for going either way can be both financial and emotional. Some people find the weight of a mortgage so emotionally stressing that it affects their health if they do anything other than pay it down quickly. Other people can stand to spend any extra money on a 6% mortgage loan when they could be investing that same money for a return of 6.1%

    It’s a lot more than just numbers. So you have to first run the numbers (to the best of your ability) and then figure out what you’re comfortable with.

  • FrugalTrader January 11, 2008, 3:40 pm

    Babe, to answer one of your questions, they recommend to pay lump sums into the RRSP at the beginning of the year is b/c it’ll have more time to compound and grow.

    Gates is spot on, you can’t use the RRSP HBP for rental properties, only your first principle residence purchase.

  • FourPillars January 11, 2008, 3:52 pm

    Lots of good stuff.

    One small point – the Smith Move (I can’t spell the other word) is leveraged investing which takes advantage of the tax deductibility of a loan used for investments. The lower the income tax bracket you are in, the less benefit you get from this.

  • Babe in the Woods January 11, 2008, 6:22 pm

    That is all very useful. Thank you so much. We were debating which bank to go with… I already have an account with RBC, and it was looking good in terms on polls on customer satisfactions and ranked first on returns on investment in a globe and mail poll, and won a corporate knight award for ethics. But I’m curious about this Citizens Bank that Nancy mentions. How does it compare? Their high interest account seems to have less fees off the top of my head, and there is something about it being tied to their rsp plan. (I haven’t had much chance to research it, but wanted to ask peoples opinions while I still had a chance (-:) How well established is this bank to risk a 27 year investment and saving plan? Do some banks offer more options with regards to mutual funds than others, or are all RSSPs equal? Do you find your own investments and plonk them in, or do the banks that house your investment portfolio offer you specific choices?

    As you see I have a great deal to learn about how things work once we get the split spousal account set up. I guess it’s possible to keep a high interest account in one place and move it to another bank to maximize RSSP’s but is this wise?

    That’s a good point about the Smith “move”… and where is spell check when you need them anyway?

    Maybe we could do the loan under my husbands income, and do the investments mine to maximize tax benefits? or could it even work that way? would there be any benefit to the SM for us? I can help save for a downpayment, we’d have to get a mortgage under his name, as I likely wouldn’t qualify with my income (athough I may be wrong about that in a few years and if I’ve done some saving and investing.) Other investments like mutual funds could be done in my lower tax bracket.

    Either way we have to build our credit over the next few years, and save for that downpayments. after we maximize RSSPs, take care of insurance and RESPs. That 10 percent plan may not be as easy as it sounds, but we may try to give it a shot and see if it’s possible (and see how thrifty we can be before it hurts. I think we’ll need a vacation now and then.) I should do the long term math to see how much we will need in our golden years, but I see I have a lot of painting to do. Or consider a part time job to meet our financial goals when the children start school. (We are lucky to live in the part of the country where you can answer phones for 25 dollars an hour, so it’s tempting.) I believe with hard work I should be able to do it with my art alone, and improving my skills is another kind of investment if keep putting the time in. Art appreciates in value. Mary Pratt could more than meet my yearly goal with “one” painting (although I could be a few decades away from that, and even if I could it would be harder to sell, so it’s all moot.)

    Thank you again.

  • nobleea January 11, 2008, 8:11 pm

    some comments:

    they recommend contributing lump sums to rrsps early in the year as it has more time to compound. but also because if you do it in january or february, you get the tax refund right away, rather than having to wait another year (rrsp contributions in the first 60 days of the year count towards the previous year’s tax return)

    i think Chilton’s advice not to use your rrsp money for the home buyers plan is a good idea. but i also think using the home buyers plan is a good idea. use the bank’s money instead! borrow 20K, contribute it to your rrsp, withdraw it after 90 days under the HBP and give it back to the bank. the large tax refund is yours. technically, it’s a interest free loan of future years tax refunds, but i think we’re all about interest free-anything.

  • Babe in the Woods January 12, 2008, 6:43 am

    oops. first lesson. it’s “RRSPs”.. getting it straight before I embarrass myself at the bank. I was never one for acronyms.

  • FrugalTrader January 12, 2008, 2:07 pm

    Babe, as I mentioned in the article, since you already have an account w/ RBC, it’s free to send money back and forth between your RBC account and their savings accounts. For me, convenience is worth more than the 0.1% difference in interest.

    When you do decide to open your RRSP, you may want to consider the TD e-funds. It’s a little more involved where you purchase your own funds online, but they are cheaper than any other bank sponsored index funds. I believe the MERs are around 0.5% where the bank funds are closer to 1%. From the other readers here, there are no annual fees with a TD e-fund account either.

  • Babe in the Woods January 13, 2008, 8:13 am

    God bless your cotton socks! My grandmother always said what you give you’ll get back seven fold. I hope you get lots of great advice. Thanks again…

  • Babe in the Woods January 13, 2008, 9:01 am

    The more I read the more confused I am. Perhaps I should try to do one of these days when I catch up on sleep.

    I just came across this website http://www.efficientmarket.ca/article/ETF_Investing

    there’s a new acronym “ETF” these are better than mutual funds? the wealthy barber didn’t mention this, or i have to reread things more closely.

    Also I was trying to find this out on my own, but at the risk of sounded simple minded, if I set up this account with TD which sounds great, does it mean we have to set up our RRSPs there as well? Do people generally move funds from one bank to another which houses their RSP? or can it, should it, or must it be all done in one institution?

    If I take your meaning, the RB high interest account may make sense to save up for things like emergency funds, a downpayment on an investment property, vacation etc, and the TD e fund would smart for a RRSP account at the TD? I wouldn’t move the TD self direct e funds to RSPs at the RB?

    Even I’m embarrassed to ask this question. Just trying to figure out how these things work. The charts about the ETF looked a little scary, but hoping to make sense of all these things.

  • FrugalTrader January 13, 2008, 11:09 am

    Babe, ETF’s are exchange traded funds. They are basically index mutual funds that trade on stock exchanges.

    The advantages of ETF’s are that they usually have lower MER’s than index mutual funds (except for TD e-funds). The biggest disadvantage of these is that they end up being more expensive for accounts with smaller balances b/c of the commission you have to pay when you buy/sell (since they trade like stock).

    For someone just starting out, and looking to put smaller amounts every month into index based funds, I would go with the td e-funds. It has low MERS comparible to ETF’s, and fees when buying/selling, along with no balance minimum. Perhaps when the account balance gets large enough, then consider switching to another brokerage that will allow you to buy individual stock/etf.

    TD e-funds are only offered by TD, thus you would need to open an RRSP account with them. I’ve never had an account with TD, so i’m not sure if they would require that you have a regular bank account with them also. Those are details you should contact them about when you visit their branch. So yes, use the RBC account to save for emergency etc, but consider TD for your RRSP account.

    You should also look into RBC sponsored mutual funds which having an rrsp account with them would probably make your life more convenient. Their index funds are probably more expensive (~1% MER), but may be worth it if you have an advisor helping you purchase them along the way (IMO).

    The key is not to listen to one person, but to do your own research and come to your own conclusions as to what works for you.

    Hope this helps!

  • Babe in the Woods January 13, 2008, 5:51 pm

    Thank you so much, that gives us some very good options and makes things much clearer to me. I hope this post will help other newbies out there as well.

    Not to pester you with too many more questions, but how big a portfolio is big enough before you’d recommend switching for future reference? 10,000 or `100,000?

  • FrugalTrader January 13, 2008, 9:38 pm

    Babe, check out this article on when to switch to etf’s

  • FourPillars January 14, 2008, 12:53 pm

    Babe – I might have mentioned this in your last post but take your time with the whole financial planning, investment learning. There is no rush and if you want to learn how to do it yourself it can take a while to learn enough to be comfortable.


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