Stop Working

A review by Andrew Forward, of Derek Foster's book on how to retire early

Crazy, Stupid Ideas About Investing

"Don't even open up your financial statements." Ostrich approach - nice!

"You're in it for the long run." Ignorant approach - bad investments do not get better even in the long run.

Einstein's rule of 72

Compound interest, a great thing, has a special property. Divide 72 by the interest rate of your investment and that's how long it will take to double your investment. So 8% return takes 9 years, but 12% return takes 6 years.

Investing is nothing more than putting money away now to have more of it tomorrow

Available Investment Strategies

Bank Account. Up to 60k is guaranteed, but the interest rates are really low.

Gold. Risky.

Collectibles. Like coins and stamps - risky.

Real-Estate. The power of leverage (borrow to buy) - great investment, but not too liquid and can be a hassle.

Bonds. Sophisticated IOUs, supposed to be safe, but even governments have defaulted on bonds. Does not provide inflation protection.

Mutual Funds / Stock Market. The best investment and returns. The best investments are ownership (not loaning, i.e. GICs, Bonds, etc)

Warren Buffet's Rules for Investment

  1. Don't lose money
  2. Remember Rule #1

Investment Rule #1

Don't ever buy stocks if you do not understand them - they are too risky

To properly invest in the stock market requires a lot of research.

Investment Rule #2

If you do not feel you can invest on your own, buy mutual funds

But, be weary of costs of mutual funds, most important is the MER, which is how much the fund company takes off the top, regardless how well, or poor the fund performs. This rate is usually 1%-3%. After you have 20k to invest you start buying your own stocks.

Investment Rule #3

If you learn how to invest on your own then buy stocks directly to improve your returns.

Only invest in High Dividend Achievers List. A company that can raise its dividends every year is very valuable. Check out Mergent's List of High Dividend Achievers. Do not invest in a company that a little kid cannot understand.

Read anything by Warren Buffet - check out Berkshire Hathaway annual reports. In essence only invest in what you know.

The stock market is like a manic depressive person over the short term. He can be very optimistic and sell stocks at high prices or depressed and practically give stocks away. Although difficult, try to ignore short term swings.

Investment Tenents

  1. Only invest in companies you understand.
  2. Only invest in companies that pay dividends (a bird in the hand...)
  3. Only invest in recession proof companies (We need to eat, be healthy, stay warm, spend money, smoke and do drugs).
  4. Do not focus on foreign companies
  5. Only invest in industry dominant companies (David and Goliath is a great story, but in business the biggest companies succeed)
  6. Only invest in companies with strong brand loyalty (Coca Cola is awesome, if it goes on sale, get in!)
  7. Never sell your stocks in a perfect company (Hurry up, and wait)

The faster you get money back from your investment (i.e. dividends) the faster you can retire. Do not buy stocks to sell them, buy them for the passive income. You will not get rich quick, but it is safe and steady.

"Show me the money." Accountants can hide losses and do some questionable things, but paying out dividends is the ultimate measure of a company, because they cannot just manufacture money. When a stock market crashes, your dividends are not affected. And, dividends from Canadian companies are favourably taxed in Canada.

Buy stocks for cash flow, not for an increase in worth

First, pick a strong company like:

Second, then make sure they are recession proof

Subjective, but history shows that we eat, sleep, consume fuel, stay warm (utilities).

Third, take a look at Value Line

You want to see a strong history of rising dividends. You also want to see healthy rising earnings per share of at least 10% a year on average. Also, you want to see the shares outstanding getting smaller over time. This means that the company is buying back its stock - very strong signal as the company is cash rich.

Fourth (last), check price to make sure you are paying a fair price

Check out the price over the last few years - if you see dividends go up, but stock price go down - good sign. Also check the Value Line (easy once you see the data) and stocks below the line are a good buy.

How to buy stocks - a framework

An example of buying Colgate Palmolive. First question, "Is this company easy to understand?" - indeed. "Is it brand loyal?" - indeed. "Is it recession proof?" - indeed. "Does it pay dividends?" - $0.96, and uninterrupted dividends since 1895. "Is it dominant?" - indeed.

To get the stock cheap, find negative headlines. When the price of the stock goes down, rejoice and buy more.

Location, location, location

Real-estate can be awesome, but it can be a pain. So, try REIT (Real Estate Investment Trust). You own shares in a company, this company invests in real-estate. REIT are hands off, you are just the owner and wait for the money. Similar to mutual funds, you own a little bit of a lot - so you risk is spread out.

Avoid residential REITs, rent controls can hurt your ability to raise rents and stay with inflation. Office REITs can suffer in economic downturns. A Warehouse REIT is also not too good as storage areas do not need a great location - so you can usually build more elsewhere. Hotel REITs can be cyclical, which can be dangerous.

Retirement Residence REIT - North America is getting old, so follow the boomer trend. Commerical REITs (i.e. shopping malls) - espeically those that contain recession proof stores like Wal-Mart, Loblaws, etc. Try Riocan Real Estate Investment Trust. Remember to be choosy and wait for the right price.

Utilities, utilities, utilities

You can stop drinking Starbucks, you can avoid dinners out at the Keg (I hope not, but you could) but you cannot stop heating your home, have running water and make your appliances work 24 hours a day.

Pembina Pipeline Income Fund, Enbridge Income Fund, Algonquin Power Income Fund, Trans Canada Power

These ideas are not the only ones, but adding these types of investments can increase your annual cash flow. Payouts are high and stable.

Black Gold - oil

Pengrowth Energy Trust, Canadian Oil Sands Trust, Encana (hedge for Canadian Oil)

Oil is used everywhere from plastics to pharamaceuticals. We are all energy consumers, so we should all own a piece of the energy producing business.

Simplify Your Spending

You will be able to save more money, and you will require less money to be happy. Simplifying spending should not be a form of self-deprivation. Simplifying spending is not budgeting - few people can budget well, but can still lead simple spending lives.

Break your spending up into essential and non-essential elements. It is the non-essential items that hold the key to retiring early.

Mortgage Payments
Life-enhancing Non Life-enchancing

We love the internet, yes we could live without it (it is non-essential), but it enhances our life (for example, lets us work out of our home, we can play games and read the news). Taxes on the other hand are non-life-enhancing; to a certain degree the more I pay in taxes does not entitle me to better schools, hospitals, etc. We all get the same!

Try to save as much money from non-essential, non-life-enhancing expenses

A dollar saved, is two dollars earned (because of taxes, CPP, EI, etc). So, saving money is twice as powerful as earning money.

Employment income is the highest taxed form of income. Not to mention all the extra costs of having to work: transportation, bought lunches (we all do it some of the time), day care, dry cleaning, union dues, professional dues.

Interest income is the highest taxed investment income source. I love the stability of GICs but please, hide them in your RRSP to avoid the high taxes.

Stocks pay out dividends. Taxation of dividends is complicated, but here is an example:

You own 100 shares of kooki.ca, and it pays out $1 in dividends.
Total dividends:       $100.00
Gross Up (100 x 1.25): $125.00
Income that you claim: $125.00

So, you would pay taxes on $125 at your top marginal rate. Lets say you do not earn that much much, it would be 22.05% (16% federal, 6.05% provincial) or $27.56 dollars.

Income tax:                                   $27.65
Federal dividend tax credit (16.67%*$100):  -($16.67)
Ontario dividend tax credit ($16.67*38.5%): -($ 6.42) 
Total taxes you pay                           $ 4.56

Stocks are also taxed as capital gains (the difference what you bought versus what you sold it for) - only when you sell them. You claim on your taxes, 1/2 the amount of the capital gain.

Captial Gain:                     $100.00
Claimed as income (100*0.5):      $ 50.00
Total taxes your pay (50*22.05%): $ 11.03

Deferring taxes is a great way to accumulate wealth. Examples include RRSP, holding on to your stocks (you do not pay tax on capital gains until you sell) and income splitting.

Your home, your mortgage

You take the time to find a lovely home, you negotiate to get a good price, but do not forget about all the others areas where you can save money. Negotiate the mortgage rate, ask the lender to pay for the appraisal, shop around for a cheap lawyer, try to avoid CHMC fees (if you have less than a 25% down payment, you have to pay fees up to 4% of the purchase price).

Houses put money in your pocket by reducing your housing costs in the long run. They also act as a great forced-savings approach to building wealth - just remember to pay down your mortgage as fast as possible.

Debt, usually more bad than good

Never carry a balance on your credit-card. Ever!

Pay cash for your car, and then make car payments - to yourself. It is a great pay-yourself-first approach, or it can be used to buy your next car.

The best debt (if one really exists) is tax deductible debt - like borrowing money to make an investment.

RRSPs are not an investment - just a shelter

Registered Retirement Savings Plan. It is a separate account where you can hold various types of investments like stocks, bonds, mutual funds, GICs. But, these investments get to grow tax free. And, for ever dollar you invest under an RRSP, you can claim one dollar less of income for that taxation year (so you get an instant tax rebate). As of 2006, you can contribute the lesser of up to 18% of your previous year's salary or $18,000. Now, when you withdraw from your RRSP, that money is seen as income and is taxed as income.

RRSP are not always a good idea. Although it can be good idea, so is paying off your mortgage.

How much do you really need?

So people say you need about 70% of your income to retire well. Others say you need $1 million dollars in the bank. Neither need be true - it is up to you and your living style. Remember that income is far better than savings.

Total Income (salary)
- Work related expenses (taxes, EI, CPP, etc)
- all interest expenses (eliminate all debt before you retire)
+ new lower tax expenses (on investments)
+ cost for new hobbies (that's why you are retiring)
Total amount of income you will need (after taxes)

If you wait patiently for the stock market to offer cheap deals on those awesome stocks - then it could take much less time for you to build up a portfolio to supplement your income. Time is on your side.

Small actions, however insignificant, are infinitely more powerful than even the grandest of intentions.