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The Wealthy Barber

A review by Andrew Forward, of David Chilton's book on building financial independence

Self-Analysis Financial Planning Test

  1. Do you have the proper amortization for your mortgage?
  2. Is your will up to date?
  3. Could your dependents live comfortably on your death?
  4. Are you looking to retire early? Do you have a suitable savings program in place?
  5. How are you going to pay for your childs education?
  6. About 50% of Canadians retire in hardship, how can you guarantee you will not be one of them?
  7. Are your debts structured properly?

Fincial planning is about the proper handling of your cash flow and assets to mee your life objectives. It is not just about budgeting.

Time is your greatest asset

You must take responsibility for your own future as no one cares as much about your money as you do.

Invest 10% of all you make for long-term growth

The power is in interest. Interest on your principle, as well as interest on your interest.

Let's start simple, $2 a day turns into $1 million dollars in about 45 years (if you average a 12% return). So, if you make $40,000 a year, and can put $11 dollars a day (yes it is doable), then you will have over $7 million dollars.

Be patient, you will soon learn how to save 10%, and how to get a rate of return around 12%. Saving money is not easy, but it is also not about a budget. To truly save 10% of all that you make you must simply:

Pay yourself first!

Budgets work well for businesses because business noly has to budget for needs. Budgets are difficult for individuals because we must budget for needs and wants - and wants quickly turn into needs. It is human nature to spend our entire disposable income. Adhoc savings does not work as there is usually no money left at the end of the month. Budgeting rarely works as there is a blurry line between needs and wants. The only fool proof way to save if to pay yourself first.

This savings can work for anything, a house, a car, a vacation - the point is to save it before you get a chance to spend it.

Open up a separate bank account and deposit 10% of paycheck (automatically is even better) on payday. Then use this investments-only account to invest in stuff.

Try it. The key is that you will probably not notice a change in your lifestyle. In fact, some may even forget that you are living on 90% of your income.

Now, how about 12%? To get hgh rates of return you need to be an owner, not a loaner

The 10% savings is not for common stocks. It is a difficult game to buy when others sell and sell when others buy. Stock brokers are salespeople just like any other retail business.

Let your profits run and cut your losses

Mutual funds (are more recently Exchange traded funds - for this revue will we consider them the same, if only to save on typing):

Dollar Cost Averaging

Dollar cost averaging is the process of buying a mutual fund at regular intervals with a fixed dollar amount. When the stock price goes up, yipee. When the stock price goes down, you get more bang for your dollar ( i.e. the same fixed dollar amount invested buys more stocks).

The key to picking a mutual fund is the manager. Assess past records, what were her average returns, ask the experts, watch your costs (MER), does that fund manager still work on that mutual fund.

Mutual funds make money from:

Always re-invest earnings and adjustments to see the compound effect.

If anything, mutual funds are good because they are less accessible making it harder for those with low will power not to spend their savings.

Real estate can also be a good investment. Of all the millionnaies, 90% earned their wealth through real-estate. It is more difficult because there is timing involved in the market, no notion of dollar cost averaging and little safety net. The process is also much more of a hassle than simply owning mutual funds.

The only thing worse than a bad investment, is one with borrowed money.

Consider starting with mutual funds, build a nest egg, then switch over the real-estate. That initial nest-egg can help you to be patient in downturns.

Save 10% to be wealthy, maximize RRSP to retire.

Many receive advice, only the wise profit from it

Estate Planning

Estate planning is what you do before you die to make suer that the people and things you care about are well taken care of after you die. Living state is assets minus liabilities plus available insurance coverage.

Get a will in the next 30 days

Insurance fills the money gap to execute your will. Life insurance is important until your living estate is big enough. Life insurance is more like income replacement insurance. Like car insurance, why buy it if you do not have a car (similar if you have no dependents, why have life insurance).

Insurance should

  1. pay off all debt
  2. handle lump sum obligations like funeral, college fund
  3. supplement income to your dependents
  4. take inflation into consideration

Always insure both spouses for outstanding debt to reduce stress and free cash flow

Don't forget about wacky scenarios like

Buy renewable and convertable term insurance - nothing else.

Term (cheap) is better than cash-value (expensive) insurance, because you can better invest the difference in cost. Renewable means that you can keep being covered even if you get a disease while being insurance (you should also get a cap on the premium increases). Convertible means you can convert it to cash-value - not sure why, but it is always better than non-convertible.

Pensions are limited

Pensions are not (or only partially) indexed to inflation. Old people do spend money, so you will most likely need an equivalent income replacement when you retire.

RRSP are registered savings programs for your retirements. They grow tax free, and are subsidized by the government. Every $1 you invest in an RRSP is a $1 less that you have to pay taxes on - so if you tax bracket is 40%, then invested $1000 in RRSP will give you a $400 tax refund in April.

Your marginal tax rate is the % of taxes on your last $1 of income. Absolute is an average of all the income tax you paid (taxes are a sliding scale - i.e. your first $8k is 0% tax, the next $10k is 16%, etc).

If you have a good pension, then you will not be able to contribute as much to your RRSP. Should you leave your pension, then you get a pension adjustment removal to give you back some of that lost RRSP contribution room that you missed over the year.

Try this math. I invest $2000 dollars a year for the next six years and stop. You then start to contribute $2000 a year for the next 37 years. At 12% return, both are worth about 1.2 million. I invested $12,000, you invested $74,000 - my extra 6 years made all the difference!

Start saving today, start saving now!

RRSP need not be too conservative - but sleeping at night with a 5% GIC is better than worrying about your 12% mutual fund. Mutual funds are for investing when you have at least 10 years to play with. Once you approach 5 - 7 years of needing your money, cash out in the "good times".

Do not cash out your RRSP to buy a house, unless under the first time buyers plan

Open a self administered account to manage your RRSP. This will allow you to buy a wide range of investments (GIC, Mutual Funds, ETF, Canada Savings Bonds) and not just what your bank offers.

If you are married, then name your spouse as a beneficiary for your RRSP so you roll is over without incurring a tax hit.

If Jane makes a lot more money than Joe, then Jane should open a spousal RRSP in Joe's name, so that Jane should contribute money to it. Jane gets the tax receipt (she makes more money, so she pays more tax) and when Jane and Joe retire Joe pays the taxes on withdrawal (he makes less money, so he pays less tax). Be sure that spousal RRSPs are in your account for at least 3 years.

Renting is not necessarily "throwing" money away

Shelter is a basic need, and renting is one way to achieve it. Most people that say "A home is your best investment", probably only has one investment (their home). Real-estate acts as a nice forced pay-yourself-first approach to saving, but there are circumstances where renting is financially a better deal.

You primary residence can be sold "tax free"

Home ownership provides leverage, and that is why it is an unbeatable investment.

The power of leverage. Put a downpayment of $10k on a 100k property. In one year, the property goes up 10% and is worth $110k, let us assume the cost of renting and your mortgage are the same. What is your rate of return for that year?

100%! - Your mortgage is for $90k, the property is worth $110k which is a 20k difference. Of that, only 10k was yours, so you turned 10k into 20k - 100%.

For the non-sketics, life is not that easy. For the sketics, good for you. The major assumption is that renting costs the same as buying and this is usually not true (buying always costs more). Apart from the mortgage you have utilities, property taxes, repairs, utilities. To truly compare renting versus owning you have to compare:

Home ownership is the ultimate forced savings program. It is easier to not pay yourself than it is to not pay the bank.

Home ownership is excellent, but not perfect

Overall, home ownership provides leverage, tax free gains, forced savings and pride in ownership.

When buying a home, be sure that the home fits

To fit to your needs, you will need to search within, to fit a good requirement consider

The basics of mortgages

Mortgage term is how long your agreement is binding with your bank (i.e. how long until you have to talk to your banker again to get a new rate). Ammortization is how long it will take to pay off your debt. Please remember that each time you renew your mortgage be sure to drop your amortization - otherwise you will be paying the bank interest for ever.

Five year term is safe. But, four times out of five going variable beats fixed rate. Keep in mind that that one time could get ugly.Amortize for 15 years. Mortages are the reverse of compound interest, paying an extra $100 a month can take 10 years off your mortgage - that's a lot of interest. Pay weekly - the sooner you pay the less interest you pay. Shop the market for the best rate - 0.5% can make a difference.

It is not about being thrifty

No one listens to the words of

Day-to-day things like budgets, avoiding credit cards and self control are ignored by people. Why? Because it is hard to implement. If you consider the other strategies to date including 10% pay yourself first, get a will, get the right life insurance, go for shorter amortizations, maintain your RRSPs then you will see that they are

The above works even if your approach to day-to-day finances is undisciplined. And, that is the point. It is not trying to save the scraps at the end (i.e. the day-to-day stuff), it is about maximizing the off-the-top, pay yourself first moneys - what's left at the end can be fully used to satisfy your needs and those crazy wants.

Again, most people have it backwards. Do not budget to have money left over at the end to save, pay yourself first and let life spend the left over. Trust me, you will not even miss it. And if you do not trust me, then try 1% for a month, then 2% the next and so on. Once you hit (and maybe even surpass %10) you will barely have noticed that you are not living life as you did prior to paying yourself first.

What if I want to better manage my day-to-day finances

A dollar saved is two dollars earned. If you received a $2 bonus at work, how much would you take home? Think of the taxes, CPP, employee benefits and you see that the $2 usually gets knocked down to a just a $1. So, if you can save dollar - that is just like you earned an extra $2.

So, if you buy a liquidation DVD player and save $150 DVD, that is like working overtime to earn an extra $300. Nice, eh? Being thrifty does not imply being cheap. Thrift is the disciplined, econimcal, and common-sense approach to money.

Credit cards are usually trouble not because of the high interest rates, but because of their convenience - instant gratification is the problem, we want too much of it.

Even if you pay off your credit card bills every month, credit cards are still not that good of a deal. You buy a lot of stuff with your credit card that you probably would not with cash. Why? Because cash is very real, if you save to buy something substancial you will have a much greater sense of its worth to you. It is easy to go out and pick up a new TV and put it on the credit card. But, if you saved up all the required money (lets say $1300) over 6 month, you now can compare the true cost of that TV. Is six month of extra hard savings worth having a few extra inches. And if so, you will feel much more gratified because you earned it - literally.

The same applies to bigger items, like a car. If you saved up $35k, meticulously for 3 years, you would probably think twice about that Series 7 BMW - is a car really worth all that real effort and maybe instead turn your head to a cute little Toyota Echo or Yaris.

The successful implementation of your financial plan is not dependent on expert investment management by financial planners. To be good at complex investments requires time, specialization, knowledge, discipline and an eye for value. Stocks are low when there are too few buyers and too many sellers. Stocks are high when you have a lot of buyers and not that many sellers. It takes courage to follow the opposite of supply / demand.

The best investment - pay off consumer debt

Paying off consumer debt is by far the best thing you could ever do. This includes paying off your mortgage.

Interest in consumer stuff is not tax deductible. Paid with after tax dollars every $1 in interest you save is $2 in interest earned. So to beat paying off a 5% mortgage requires an investment that returns more than 12%

Create a low risk GIC to fund your high risk Mutual funds

Once you have over $10k in money, place it in a GIC that pays monthly interest. Instead of rolling the interest back into the GIC, have it put into a mutual fund to get the power of dollar-cost-averaging.

No need to be a tax expert - just tax aware

A dollar saved is $2 earned. That is either your sacrifice (i.e. being thrifty), or if can be the governments sacrifice (i.e. tax savings). Accountants are not selling a product, but their expertise - so they are fairly unbiased. To reduce your taxes, you can maximize your RRSP - but what else can you do?

Income splitting - Tax break

Move the high tax bracket (40%) to the lower tax bracket (25%). A $1000 in the high tax bracket costs $400, if you move that to the lower tax bracket it only costs you $250 - a savings of $150. A few tips to help split income, is to have the higher tax bracket spouse pay for all the expenses, bills and stuff. The lower tax bracket does all the investing (and pays all the taxes on it).

Buy and read a tax bracket tip book

You do not need to be an expert, you just need to be aware of what is available.

Dead people don't need to be fed

Disability insurance is the most neglected but most critical. About 1 in 4 are disabled for at least 1 year. Your biggest asset is your earning power and you must protect it. If you had a machine in your basement that produced 40,000 $1 dollar bills a year wouldn't you insure it?

If you are injured you become a liability. Not only do you need to supplement your income, but you also need to provide for yourself. Things to look for when you consider disability insurance:

Talk to your insurance broker. Also not that benefits from disability are tax free - so you only need to suplement your disposable income (after-tax) not your gross income (salary).

Save for your childs education

So, maybe you want your kids to learn hard work and have to pay for their own education. Well, if you save for it now then when Andrew Jr. is ready for college you have the choice to either help or enjoy the money. If you don't save, you only have one option. So save!

Put $25 - $50 away a month. Put your dollar-cost-average to work in a medium to high risk vehicle for 15 years - the last 3 years should be safe (I love GICs).

Emergency funds are over-rated

Not really, but do you really need $10,000 in extra cash just sitting there? Apart from job loss or small business owner down-turns - $3000 should be enough to cover those unexpected (but not too unexpected) things.

It works, trust me!

If you are 20 - 45 years old, work at any job, in any income bracket, any amounts of skill in math, investing and accounting. It works because it is simple and takes human nature into account.