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Penny-wise investor may get new challenges from life changes

Hey there, time traveller!
This article was published 20/1/2012 (2037 days ago), so information in it may no longer be current.

Shane loves to save money. He's so good with a buck, his friends often poke fun at him.

"People call me cheap and say that I don't enjoy life," he says. "I think I enjoy it."


Of course, nothing makes life more enjoyable for him than saving money.

"You know that show Extreme Couponing?" says the 32-year-old, who earns $88,000 a year as a manager in the private sector. "I've done that since I was 18."

It's hardly surprising then that Shane has considerable assets. He owns a cottage and a home, on which he only owes about $36,000. And he has about $147,000 in cash and invested in stocks and mutual funds.

"Ideally, I would like to grow my net worth and cash accounts to retire at 45," says Shane, who claims he can easily live off $1,000 a month, excluding his mortgage payment.

Once he reaches his retirement date, Shane says he'll likely spend more -- about $3,000 a month.

But he doesn't intend to fully retire. Instead, he plans to work as a consultant, part-time, earning about $3,000 a month. Then, at 65, he will fully retire, spending the same monthly amount of money -- and still working just a little.

Like many savers, Shane is also a bit of a worrier. He has about $52,000 in a savings account because he fears losing his job. At the same time, he is concerned he has too much money in savings and it won't keep pace with inflation. Combined with the lacklustre performance of his mutual fund portfolio of late, he is also concerned he won't have enough to semi-retire in his 40s -- or maybe even 65.

Further muddying his vision of the future is the likely possibility of marriage and kids.

"If I do end up getting married, it's pretty safe to say my spouse won't be in the same financial position as me," says Shane, adding he doesn't like to pay for advice. "I'm looking for alternatives to grow my money."

Investment adviser Alan Fustey is a managing principal at Winnipeg-based Index Wealth Management, a firm specializing in exchange-traded fund (ETF) strategies.

He says since Shane doesn't like to pay for advice, the first thing he might want to consider is simplifying his portfolio into two manageable components.

One part would include his TFSA and cash savings.

"Given his ability to save from his monthly salary, the current amount of his savings should be sufficient to cover any unforeseen major expenses in the near term," says Fustey, author of Risk: Financial Markets and You.

Some experts suggest the TFSA -- a tax-sheltering account -- should be used for long-term investments like stock.

But Shane will likely use his TFSA for emergencies and large expenses, so he should look at interest-bearing investments such as GICs or a high-interest savings account.

"Interest is investment income taxed at the highest marginal rate," Fustey says, adding capital gains and dividends receive preferred tax treatment.

Not to mention that using the TFSA to invest in stocks -- when he may need that money in the near term -- has its obvious perils.

"The problem with stocks is ideally it goes up in value, but if they don't, you have a capital loss that you can't use anymore," he says, adding investment losses outside a TFSA can offset taxes on capital gains.

Instead, Shane should maximize RRSP contributions, investing in equities for the long term. This is the second part of the simplified portfolio, but he needs to do a little more work to streamline his RRSP investments.

Shane has more than a dozen mutual funds in his RRSP. Even though he doesn't like paying for advice, Shane still pays a lot for fund-management expertise and advice. Every fund in his portfolio comes with management costs. These costs are expressed as management-expense ratios -- or MERs. The MER generally costs a few percentage points of the money he has invested in each fund, paid to the fund-company management whether the investment makes or loses money.

Within the MER, he could also be paying a trailer fee as compensation to an adviser who helped him buy the fund.

"The ongoing advice portion of the MER can be as high as one per cent, depending on the type of fund," Fustey says.

"As an alternative, he may want to consider replacing his mutual funds with exchange-traded funds (ETFs) that have similar investment objectives."

ETFs are units of a trust that hold a portfolio of securities -- stocks and bonds -- which closely tracks the performance of a financial-market index or sector. ETFs are similar to index mutual funds, which make up part of Shane's portfolio, but they have even lower MERs. And unlike mutual funds, ETFs are traded on stock exchanges like shares of a publicly traded company.

"The ETF structure allows for a diversified, low-cost, low-turnover index investment," Fustey says.

"In many cases the embedded management fee of an ETF can be two per cent lower than that of a comparable mutual fund."

The main reason many ETFs have significantly lower MERs is they do not have to pay a fund manager to pick stocks. The ETF only contains stocks in proportion to those found on the related index.

If Shane moves his main RRSP portfolio of $62,000 into two ETFs -- saving about two per cent in annual management costs -- his money would grow an additional $280,000 by age 65.

This figure is based on Shane continuing at his current job until age 65. If he continued earning as much as he does now, contributing the RRSP maximum, he would have about $1.6 million in his RRSP at age 65, based on a five per cent annual return. This total includes his defined contribution work pension, with six per cent annual contributions.

But since he wants to semi-retire at 45, and then earn about $36,000 a year until age 65, his RRSP and pension would be about $960,000 and he'd save about $125,000 in fees using an ETF strategy.

"This is still a significant amount and he can also draw upon the value of his real estate assets," Fustey says, adding his RRSPs easily fund $3,000 a month in retirement spending.

"Even if this payment is adjusted for two per cent inflation over the next 33 years, it only becomes $5,800, and that's not a significant amount to fund from $960,000 in capital."

Investment returns, however, are really an afterthought because Shane is a habitual saver.

"Usually, it's the other way around," Fustey says. "Someone can't save enough so they try to make up for the shortfall by stretching for the extra rate of return, and that usually backfires."

Yet the one 'X' factor for Shane is life itself. While he might be able to get by on the cheap as a bachelor, his finances will certainly change once he gets married and has children.

"That being the case, he might have to delay some of his goals."


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