My girlfriend, Jane, approached me the other day with that question.
I’m known as a bit of a financial nut so people like to ask me to cast an opinion.
In the private sector only about 20% of Canadians have a company pension plan at retirement. Eighty percent of the lucky retirees that think they are pension rich – those that work for the government or in unions and have defined benefit plans, will discover that they won’t be able to access the money they were counting on because their plans are under funded.
Retire at 99?
Jane had been to her financial planner, and the news was not good.
If she worked until she was 99, she would have enough to retire.
Given that dismal outlook, Jane wanted to know if I had any better ideas.
It turns out that Jane had been using the same money manager for years. The little bit of money that she had been squirreling away from her secretarial job hadn’t seemed to have grown much.
On the advice of her financial advisor the money had been put into various mutual funds.
How good was the investment planner’s advice?
What kind of interest/capital gains had these funds been making a year? Jane didn’t know. She had never been told, and had no idea how to figure it out.
Had her money manager ever offered her other types of investment instruments? The answer to that question was yes! More mutual funds!
Mutual funds are an excellent source of income for financial planners. Fees on mutual funds are called MERs. They average about 2.6% in Canada and are the highest in the industrial world. Part of that MER is the trailer fee which goes to the financial planner.
These fees vary between mutual funds.
This led me to wonder – were these mutual funds that the financial planner chose in the best interest of Jane or the planner?
Jane’s situation isn’t unusual.
It seems to me that there are a lot of people out there that don’t know how to figure out how much money they are making (or losing) nor do they know how their planners get paid. (An important question – after all who works for free?)
How much profit is 8%?
After applying my calculator to her statements, the answer appeared to be “not much”. We have been in a boom market in Canada for quite a while. The average rate of return on the TSX has been 11% for the last twenty years.
Jane’s rate of return had been less than 5%.
Jane pretty well could have thrown darts blindfolded at the TSX index and done better than her mutual fund.
A 3% MER expense subtracted from Jane’s conservative 8% mutual fund leaves 5% profit. Another way of looking at that is that the fees ate up 37% of her profit. Every year.
It is important to note that the amount Jane paid to “manage” her fund went up as the overall value of her mutual fund went up because the MER is a percentage.
But to find Jane’s actual profit you have to do some more calculating. You have to subtract the RRSP expense fee of $125 per year. Then you have to minus an average inflation rate of about 2.5% a year – which is the amount of purchasing power that your money loses every year.
It’s a long hard way to make money grow.
So what to do with this crisis?
Asking the Right Questions
It turns out that the financial planner hadn’t calculated all of Jane’s future potential income when they were doing the “financial planning”.
She hadn’t accounted for the fact that Jane had worked all of her life and was entitled to Canadian Pension Plan and the Old Age Security.
Additionally, Jane will likely get an inheritance from her parents who are very elderly.
Things were looking better and better.
Here were my two suggestions:
1. Sell her mutual funds and put the money into Exchange Traded Funds (ETFs). ETF’s are a basket of securities which track an underlying index. They are similar to mutual funds in as much as they are diversified, but they don’t have the expensive management fees attached and therefore can earn more money and trade far more easily like stocks.
2. Sign up for co-op housing. It takes a couple of years to get in, but once Jane gets in, the cost of her accommodation will be a percentage of her income. Once Jane retires, this will control a significant expense.
If Jane follows my advice I estimated that she would get about $416 a month from her investments. Plus she would have income from her Canadian pensions of about $1200 a month. Additionally her rent would be held in check at no more than $400 a month.
A very tight budget, but retirement is do-able well before 99.
It pays to have friends with calculators!