Will you have enough money to live in reasonable comfort when you retire? That’s the $1-million question for anyone who’s ever given any thought to the financial fortunes of their 70- or 80-year-old self.
Veteran Bay Street investor Larry Bates has a disarmingly simple answer to that.
“Six powerful forces will determine the sum of your future wealth: three ‘Wealth Builders’ and three ‘Wealth Killers,'” Bates, who spent 35 years in the investment-banking industry, predominantly at RBC Capital Markets, writes in his new book, Beat the Bank: The Canadian Guide to Simply Successful Investing.
Wealth builders are the amount you save, time, and your rate of return. The more you save, the longer you save, and the higher your return, the wealthier you’ll be.
Wealth killers are fees, taxes and inflation. They all eat into your money. Minimizing wealth killers can be as important as maximizing wealth buildershe says.
WATCH: Here’s what taxes do to your savings outside an RRSP or TFSA
It all sounds obvious, but too many Canadians ignore these basic principles, Bates told Global News.
“There is still a fundamental lack of understanding of investment basics,” he said.
Fees eat up as much as half or more of the lifetime investment gains of millions of Canadians, Bates writes. And that can easily make the difference between retiring rich and having to penny-pinch your way through old age.
Bates’ inspiration for writing the book was a 2013 conversation with his sister Mary, in which she asked him to take a look at her investments.
Mary was aware of a 2.3 per cent fee on those funds but had assumed that was 2.3 per cent of her annual investment gains. As Bates painfully explained, such fees refer to the total value of her investments and apply ever year – whether or not you make or lose money.
His sister likely lost 30 to 40 per cent of the investment gain on her retirement savings to mutual fund fees, Bates estimates.
Before even penning Beat the Bank, Bates came up with an online tool he called the “T-Rex Score,” which calculates how much of your investment gain you’d get to keep after accounting for fees.
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For example, the calculator shows that a $100,000 investment with a decent annual return of 6.4 per cent would yield a gain of around $371,000 over 25 years. But with a two per cent annual fee, which is common for mutual funds, you’d only get to keep $193,000 of that. A whopping $178,129 is lost in fees.
By comparison, with a 0.5 per cent fee, which is typical for robo-advisers in Canada, your investment gain net of fees grows to a whopping $319,000.
Bates doesn’t mince words about his former employers, Canada’s big banks. But in conversation with Global News he says that, despite the title of his book, he isn’t “anti-bank.”
“You, and only you, have the burden of responsibility to get investing right,” he writes.
With the big banks now setting up their own robo-advisers, Canadians might not even have to leave their bank in order to ditch those high investing fees, Bates said.
But Canadians’ elementary investment mistakes aren’t limited to fees.
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Time and compound interest
Of course, the more you save, the more you’ll have for retirement. But starting to save early gives you a big advantage.
To fully grasp this, you need to understand the concept of compound interest, Bates writes.
Interest on your investments is calculated on the initial money you put it as well as the interest previously earned. If you invest $100 with an annual return of six per cent, in the first year you’ll get to $106. In the second year, your gain will be six per cent of $106, not just $100. In 10 years, you’ll have $179.
That’s why if you start saving at age 25, you’d only have to set aside $100 a month in order to build a $200,000 nest egg by age 65 with a six per cent annual return. Wait until age 35 to start saving and you’ll have to set aside $200 a month.
WATCH: When compund interest works against you
You really need stocks
Ignorance also means too many people are far too afraid of the stock market.
Higher returns will yield more money for your retirement. That seems obvious. But in order to earn decent returns, these days, you’ll have to take the plunge into the market.
“All but the lowest-risk, lowest-return investments produce produce volatile rates of return in the short to medium term,” writes Bates. “Riding out the short-term highs and lows of the market can be stressful, but it is absolutely essential to your ultimate succcess.”
Along with fees, taxes are going to eat into your retirement savings – if you let them.
It’s important to look into whether a tax-free savings account (TFSA) or registered retirement savings plan (RRSP) is better for your financial situation, writes Bates. But even more important is saving into either one – or both – of these tax-sheltered investment vehicles, he argues.
If you must save in a regular savings account, know that different types of investment gains are taxed at different rates in Canada.
Ignorance about the basics of how money works leads people to do things like holding too much of their savings in cash, underestimating the eroding power of inflation.
Even with Canada’s muted average inflation rate of two per cent per year, stuffing $100 in your pillow will cost you, Bates notes. If you pulled it out 30 years later, that $100 would buy you 55 per cent of the goods you used to be able to purchase with it three decades prior.
None of this is new or especially insightful. But Bates has a uniquely simple and engaging way to sum it all up.