Rule #21 Chart your Progress!

I know people who procrastinate starting to save or pay down debt because they believe there is no way they will get out of debt or save enough to be financially independent.  Its like they feel like there is no way to chip away at the task because completing it seems so daunting.  The task seems so great or that saving a couple thousand dollars a year seems so difficult yet insignificant in the big scheme of things, that they simply don't get engaged with their own finances.  We have found that charting our progress is a great motivator for us as it shows progress right away.  Yep, you're going to have to learn some basic spreadsheet skills, but you wont need an engineering degree here... just a friend with entry level Excel should be enough.  If this simple Geologist can figure it out, you can too.  Charting your progress lays out in visual form where we are, and what our financial trend is. From an investment standpoint, we are mainly focused on our assets cash-flow and not its market value, so this makes it super easy to keep track of because we don't need to track our portfolio's current value, but simply the dividend income.  This eliminates the hand-wringing that happens when the market corrects and the TV talking heads are all doom and gloom.  Seeing our investment cash-flow go up and our debt go down month to month or year to year reinforces visually that we are on the right track.  It also encourages us to steepen the slope by adding additional funds and boost our progress.

I used to make projection forecasts where I would make assumptions about how much we could save etc into the future... but I stopped doing that because I almost felt like we had accomplished something when really all I was doing was just fiddling with numbers in a spreadsheet.  Plotting month to month in real time as you do it is proof of accomplishment.  It doesn't take all that much time once you get the spreadsheet set up and running.  Just open it up on the same day every month (we use the first of each month) and tally up any increases/decreases from the previous month.  Post the charts on the fridge so there is a constant reminder that you are going in the right direction.  You can also see where you fell off the wagon a month here or there...

Another nice thing about charting your progress is that after you've been doing it for 4-5 years you can see how far you've come by doing look-backs.  Assuming that you stay on track and have good financial habits, you will also see the power of compounding right before your eyes because the slope of the lines will naturally steepen as exponential growth takes effect from year to year.  You can also feel momentum building, that will act as further motivation and encouragement for you to keep on saving/investing/paying down debt.... and to us that feels pretty darn good.

So... go and embrace your inner engineer and break out the spreadsheets. Not just for nerdy math and science geeks anymore.  

Rule #20 Set Financial goals

Goals in writing are dreams with deadlines - Brian Tracey

Do you have financial goals?  I just finished Millionaire Upgrade by Richard Parkes Cordock - a great book by the way - and it reminded me of one thing that we have found to be very important for our progress towards Financial Independence and that is:  Setting Financial Goals.  One quote from the book is "A goal without a plan is a dream".... I'm going to memorize that line because I think its a great line.  Back to us... Every year, we set or revisit goals for our annual investment cashflow growth, goals for our savings account, goals for debt reduction, goals for RRSP contributions, and goals to reduce our spending (cut the fat).

For us, there are three things you need to have figured out before you can call your dream a goal:

1. What do you want to do with your money?  Do you want to become a mulit-millionaire or do you just want live a minimalist work/debt free lifestyle?  Do you want to work part-time halfway through your adulthood or full-time til you kick the bucket?  Do you want to go an a big vacation this year?  Saving for a new car?  Is your goal to reduce debt or become debt free?  If you don't know what you are saving for, you are almost surely destined to fail.  While you could argue the why is just as important as the what, I think the what is probably the thing to keep posted on your fridge as a motivator.  
2. Why do you want to do this with your money? Here is the deep soul-searching part of having a goal.  Are your goals inline with your values?  Do you want to work til you are 75 or are are you trying to leave the workforce as soon as you can so you can do other things?  Do you really really want what you are saving for or are you doing so because you feel its what you should do?  For us, we like to be in control of our lives.  We want to leave no debt to our children and we dont want to be a burden on them as we age.  Thats why we choose to invest and save the way we do. We want to be good role models to our kids and walk the talk.  That is the Why for us.
3. How are you going to get there?  Here's the part where you need a plan, or your goal is just a dream.  This part is where you discuss or ponder the sacrifice you are going to make.  Thats right, financial planning involves sacrifice.  Are you going to manually save that money or have it automatically deducted from your account to make it easier?  How much do you need to save? Are you going to increase you income, or decrease your spending to meet the goal.  Will it be a monthly contribution or a once a year event (like at RRSP or tax season).  If you have a spouse, how will you keep this all straight?  Will one partner keep track or do both need to be involved?  

Your goals obviously need to be realistic, but we like to have stretch targets that may be reachable but require some additional sacrifice or creativity.   We assess and set these goals usually around New Years and revisit them at tax-time in March.  Then, we do what almost nobody does... we write it all down.  Thats right, we write it down every year.  There is a saying in the Geologist Community that goes: "A map is just a sketch until it is coloured" or "A map becomes truth once you colour it in".  For us, its the same thing about goals - writing them down makes that goal more official... not just some talk we had over coffee.  Some friends of ours think we should lighten up over this point, as if we're kooks for treating our goals with this kind of official discipline.... but there is never an argument in our house over what we are saving for.  We are always on the same page because the goal is there for us see.   We are committed to it.  We have personal financial goals and we have family financial goals.  We both know what they are and are both commited to those goals.

We've had this approach to setting financial goals for about 10 years and we've missed a few yearly targets, but its not because of lack of trying.  The odd expense has come up that we weren't expecting that threw us off.... but it actually led to us creating an emergency fund as one of our goals the following year.  After doing if for 10 years, we are better now at setting those goals and it has become significantly easier to meet or beat them.

Some of our past goals were:

Max out our RRSP when it makes tax-sense to do so.
Grow our Investment cash-flow by 8% per year
Build an emergency fund in case the car craps out and we have to buy/fix
Pay off our non-tax efficient debt
Save up enough to buy a new bicycle.

The last aspect around having a goal is about executing point #3.  Executing point #3 relies on how committed you to points #1 and #2.  I think its pretty self explanatory from here on so I won't bother you with motivational speak.  Either we follow through on what we say we are going to do or we do not.  Having serious and reasonable goals, and our ability to follow-through has been perhaps the most important thing for our personal finances.  For our age cohort, we are in pretty good financial shape, and I credit a large part of that to having achievable goals and executing the plan.  Do You have Goals or do you have Dreams?

Rule #19 No Fixed Income.

When the topic of portfolio asset allocation comes up in discussion with financial folks, they will often talk about the ratio of equities (stocks) to fixed income (bonds).  Some advisors recommend a 60/40 ratio adjusted either up or down depending on your age and risk tolerance.  They often use bonds as a type of a hedge against big drops in the market.  If stock values drop, bonds tend not to drop the same amount under the same market conditions.  The opposite is also true in that bonds tend not to rise anywhere near as much as stocks do during bull markets.  Once you take the market value gains or losses out of the picture as we do, are fixed income investments a good fit for our model? Not the way we look it.

We have no fixed income in our investment portfolio and we won't be adding any anytime soon.  Fixed income is defined by InvestorWords.com as: A security that pays a specific interest rate, such as a bond, money market instrument, or preferred stock. This sounds pretty good on paper. Its essentially a near-guaranteed return on your investment over a set amount of time.  A GIC (Guaranteed Income Certificate) is another form of fixed income with the word "Guaranteed" right in the name of the investment instrument. Wow! Guaranteed sounds pretty good, doesnt it?  

Because of the low interest rate environment in recent years, fixed income yields have been historically low.  GICs are currently paying about 1-3% annually depending on the term, and bonds are not paying much better.  These numbers are so low that they dont even keep up with inflation after considering both taxes and inflation.  Outside of Registered accounts, fixed income such as GICs and Bonds are taxed similarly to employment income so the tax rate can be as high as the 49% depending on what province you live in and what marginal tax bracket you occupy.  Corporate bonds pay better, and can be closer to 4-6% but most advisors would say that corporate bonds tend to be higher risk and if you are looking for safety, going to corporates are not the way to go.  They are also still taxed at potentially very high rates where up to half that higher rate is sent to government.  If you are looking at corporate bonds in general, you may have the appetite to go with either preferred or common shares that pay dividends instead.  

Canadian Preferred shares with dividends are the only types of fixed income that we would currently consider since the yields tend to be high and the dividend is taxed the same as Canadian eligible common share dividends which have a significantly lower tax rate.  Preferred shares tend to be a little more risky in their "secureness" compared to bonds, but if you screen your preferred shares with proper due diligence, they are a pretty safe alternative to bonds.

The main reason we do not invest in fixed income is because of the "fixed" nature of the gain and how your gain actually gets smaller over the term of the investment because of inflation.  The amount of gain you get as a percentage is the same at the end of the term as it is at the beginning.  If you buy a 10 year $1000 bond that pays 4% annually, 10 years later you are still getting 4% (pre-tax remember... in after tax dollars its much worse) on your $1000.  40 bucks per year at the beginning of the term and 40 bucks per year on year 10.  In the mean time, inflation is chugging along and all your money (both principle and income) has less and less buying power.  This means that in year 1 your gain might be able to buy a case of beer, but in year 10 will that same gain of $40 get you a case of your favourite ale? Probably not. 

It should come as no surprise that I prefer conservative Canadian dividend-paying stocks as a replacement of fixed income in our portfolio. A company stock with a healthy yield and a record of increasing its dividend at or above the rate of inflation would be a reasonable substitute in my mind with the potential for capital price growth to go along with the tax efficiency of the dividend.  An example of a stock like this would be Fortis. Fortis is in the electricity transmission business mainly in parts of Canada and the Caribbean.  People can't do without electricity, so its one of the safest industries to invest in and the need for energy transmission will continue to go up in the future so there is even the potential for modest growth.  Fortis currently has a dividend yield of about 3.6% and the company has a history of increasing its dividend, mostly at or above the rate of inflation.  Another great thing about Fortis is that with the increasing cash-flow comes an increase in the stock price as well.  As the cash-flow goes up, so too does the stock price.  Bonds do not have that kind of relationship as the yield never changes as you hold the investment.  To us, in comparison to bonds, the upside potential on a stock like Fortis well out-weighs the risk of keeping your money in this type of equity.  

(Full disclosure: I do not currently own any Fortis, but it is on my watchlist and would look to add some to our portfolio if the yield got to be over 4%.  I am not making any recommendation to either or buy or sell Fortis)