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By Bruce Gillespie
Financial Post Business
Family Finance Issue
February 2007
Should you load up on all the investments, insurance and credit your planner recommends? Or just what you need?
If you did exactly what a typical financial planner told you to, you would put every extra cent you had into your RRSP. You would forgo trips abroad and plasma TVs and eating out. You would build a vast portfolio, not just of stocks but of insurance policies. And just in case of a hardship or illness that is not covered by one of your policies, you would have tens of thousands of dollars sitting idle in your bank account. Money that did end up in investments would be in funds that offer fat kickbacks to the planner. But at the end of the day, is following all this advice the best route? You could save more money than you realistically need, and a big chunk of that would end up in the pockets of the financial planner.
Adrian Mastracci, fee-only portfolio manager at
KCM Wealth Management in Vancouver, says, "But if you start early and you put away whatever you can afford on a regular basis and actually do it, you can get there."
Here, we take a critical look at the standard advice that experts give you. How much do you really need to save for retirement? How much insurance and emergency funds should you have in case something unexpected happens? How big a mortgage should you take on? And lastly, how much expert advice from professionals do you really need to successfully manage your family’s finances?
What you’ll find is that the advice offered up by financial planners needs to be customized to fit your lifestyle, personal goals, income and family size. Some pieces of advice offered by professionals are, in fact, words of wisdom, and should be followed as closely as possible. Other recommendations, however, should be chucked out and replaced with plans that better reflect your current situation and your goals for the future.
RETIREMENT SAVINGS
The standard sales pitch
Whether they admit it or not, financial planners do a lot of guesswork when deciding how much money you need to save for retirement. Trying to pin down what kind of lifestyle you’ll want 20 to 30 years from now is tricky, considering how much may change between then and now, from your health and financial obligations to interest and inflation rates. That’s why many planners err on the side of caution, assuming you’ll want to approximate your pre-retirement income as closely as possible and that you’ll live to the ripe old age of 100. They say it’s better to end up with too much money than not enough. (This also protects the planner from liability for giving irresponsible advice.)
“Everyone has different wants and needs in retirement, but the rule of thumb of 60% to 80% of your pre-retirement earnings is a good guideline,” says Brent McKay, a certified financial planner and insurance agent with McKay Insurance and Financial Services Inc. in Simcoe, Ont. However, most people go into retirement debt-free, without mortgages or kids to look after, so should you really be squirrelling away all that money?
How much you really need…
If you want a luxurious retirement. If you have your heart set on a retirement spent following the sun, you’ll definitely need to aim high. So let’s say a couple making the median annual income of $64,800 today wants to save enough for a retirement income of $50,000 a year (about 77% of what they currently make). Assuming the husband is 40 and the wife is 38 and they expect to retire at age 60, they’d need a nest egg of about $1.35 million, says Adrian Mastracci, of KCM Wealth Management Inc., in Vancouver. He admits his figure may be higher than most, given that he adds five years to normal life expectancy for planning purposes (83 for men and 88 for women) and uses an average inflation rate of 3% in his calculations. “I don’t want to come up with a small number and say to everybody, ‘This is a piece of cake,’ because it may not be a piece of cake in every instance,” says Mastracci. “But if you start early and you put away whatever you can afford on a regular basis and actually do it, you can get there.”
If you want to maintain the lifestyle you had when you were middle aged. If you envision a retirement that looks a lot like the rest of your life or includes downsizing your home or travel schedule, you can probably aim lower. “In my own mind, 50% is closer to what people need than 70% or 80%,” says Malcolm Hamilton, a pension consultant with Mercer Human Resource Consulting in Toronto. That’s because most retired Canadians are happy to maintain the standard of living they had when they were middle aged and they had children and a mortgage to pay for.
Because most senior citizens never come close to spending their retirement earnings, Hamilton questions the wisdom behind a lifetime of scrimping and saving. “If you spend 30 years counting nickels and dimes and saving every penny so that you’re rich when you retire, you’ll hit retirement, and the idea of travelling around Europe and spending 300 bucks a night on hotel rooms and 10 bucks on a cup of coffee will be so alien that there’s not a hope in hell you’ll enjoy it,” he says. Don’t forget that the government will kick in a little extra through the Canada Pension Plan (CPP) and Old Age Security (OAS). Payments for each one currently average about $5,600 a year. However, OAS is currently clawed back for pensioners with annual incomes of more than $62,144, so saving too much may, in fact, cost you.
If you’re a low-income earner. No financial planner will ever advise you not to save for retirement, but if you make less than the national median income, Hamilton says you may be better off doing just that and letting the government fund your golden years. If you did somehow manage to save a whack of cash, your government pensions would be clawed back. Because low-income seniors are eligible for the Guaranteed Income Supplement (GIS) to top up their pensions, it may be better to enjoy what disposable income you have during your working life rather than sticking it in an RRSP and facing clawbacks in retirement.
INSURANCE
The standard sales pitch
Conventional thinking among brokers and agents is that you should buy life insurance that pays out about 10 times your salary. “Our earning potential is arguably our greatest asset,” says McKay. That may be true, but considering you yourself will never see a penny of that payout, is it really worth it?
How much you really need…
If you’re single. Unless you own a business or rack up some impressive personal debt, you probably don’t need much life insurance. You just want enough to clear your debts, so you don’t saddle your heirs with a big headache, and enough to pay for a funeral. So, a policy worth between $5,000 and $10,000 is all you need.
If you have a mortgage. Buying a term policy — life insurance that’s valid for the length of your mortgage — makes more sense than buying actual mortgage insurance from your lender. That’s because the term product will pay out the full amount over the life of the policy, whereas mortgage insurance will usually only pay out whatever is still owing on the mortgage. So, for about the same price, you might as well go for the bigger payout.
If you’re the primary breadwinner. If you support a spouse or children, you probably do want a life insurance policy that pays out 10 times your salary. Tina Tehranchian, a certified financial planner and insurance underwriter with Assante Capital Management Ltd., in Richmond Hill, Ont., also suggests getting critical illness insurance, a relatively new product. Unlike disability insurance, critical illness pays out a lump sum that can be used any way you wish. It’s pricier than life insurance, but if you die without experiencing a critical illness, the premium is refunded to your estate. You won’t see the money again, but at least your heirs will.
EMERGENCY SAVINGS & CREDIT
The standard sales pitch
Everyone should set aside an emergency fund equal to between three and six months of living expenses, in case you lose your job and have to look for new work, says Stanley Kershman, a bankruptcy lawyer with Perley-Robertson, Hill & McDougall LLP, in Ottawa, and author of Put Your Debt On A Diet. “Safety nets are also appropriate for retired people,” he says. You might need to replace your roof or deal with a health crisis, so having liquid assets available is better than having to dip into your RRSPs or RRIFs and pay the associated penalties.
How much you really need…
If you’re single. If you’re relatively debt-free and either have someone to fall back on, such as your family, or are supremely confident in your employability, you can probably get by with three months’ worth of living expenses.
If you have dependents. If you support a spouse or children, you probably want to have a full six months’ worth of living expenses tucked away. It’s also a good idea to have a line of credit at your disposal for emergency purchases. A secured line of credit will give you the best interest rate.
If you’re retired. Heading into your golden years, Kershman suggests securing a home equity line of credit for retirement while you’re still working and are a more appealing candidate for financing. He says having $25,000 to $30,000 available should be enough to cover any unforeseen expenses that crop up. “But I wouldn’t go $50,000 or $100,000,” he cautions. “This is for a new roof or a new washer and dryer, that kind of thing. It’s fine to have a line of credit as long as you aren’t going to use it for your lifestyle, only for an emergency situation.”
MORTGAGES
The standard sales pitch
Bankers and mortgage brokers will pre-approve you for the biggest mortgage you qualify for so you can buy the biggest house you possibly can. The general rule of thumb is that you shouldn’t spend more than 32% of your income on housing, including property tax and maintenance costs. But while homes are generally a good investment, buying the biggest house you can afford is not always in your best interest.
How much you really need…
If you’re a single, first-time buyer. If you don’t have at least a 10% down payment, you’re better off paying rent for a few more months and saving more. Don’t be tempted by so-called cash-back mortgages, which give you a line of credit for the downpayment, because they can bury you in debt. If you do have at least a 10% down payment, make sure you can afford not just the mortgage, but also the additional expenses, such as property taxes and maintenance costs. Bankers or mortgage brokers might try to talk you out of making as big a down payment as you can, but don’t follow their advice. A smaller mortgage will reduce your debt load and help you build more equity.
If you have a growing family. Even if you have some equity in a your current home, you’re still better off buying a bigger place that’s within your means and doesn’t push your limits every month. Use the equity from your previous home to make at least a 25% down payment to avoid lender insurance fees. Look for a mortgage that you can pay off before you intend to retire, so you can enter your golden years debt-free.
EXPERT ADVICE
The standard sales pitch
You may not receive a bill spelling out the charges, but the biggest product that advisers sell is their own advice, which is often buried in the cost of insurance and financial products. Experts will always say their advice is essential for you to reach financial serenity.
How much you really need...
If your financial needs are simple. If you only have a house and a car and some retirement money, you probably don’t need all that pricey advice. With a little research, you can invest in mutual funds using a discount broker, which will be much cheaper than using an adviser or working with a full-service broker. You might put your money into exchange-traded funds (ETFs), which mimic the major stock indexes and provide a similar rate of return. Whereas the average Canadian equity mutual fund carries a management fee of about 2.4%, most ETFs cost around 0.5%. In the end, you may find that you’ve made as good a return or better than equity mutual funds, plus you’ll have saved yourself all the money you’d have otherwise spent on experts’ fees.
If your financial needs are complex. If you’re a business owner or have a large, complicated estate, chances are you need professional help. Ask trusted friends and family for references; then interview them and ask what their services will cost you. Don’t be embarrassed to ask for cheaper alternatives to the products they suggest, and if you think you’re getting a bum deal, get a second opinion. With countless financial experts out there, it pays to take the time to find one who will give you good advice at a reasonable cost. |
