The Complete Investment Guide to Personal Financial Planning

Karim Premji & Safiya Jamal

We currently find ourselves in a time of immense technological change, greater competition for fewer jobs, increasing clawbacks to various government programs as well as financial assistance and to top it all, a government deficit close to a trillion which suggests that the Canada Pension Plan will not be as generous 20 to 30 years from now. In these trying times, the message is loud and clear: Most of us will have to make provisions to be financially self-reliant as we approach retirement.

The RoadMap to your own personal financial planning has the following 7 critical pillars which must be followed to ensure future monetary gains. They include a personal financial plan, an investment plan, a tax plan, a retirement plan, an estate plan, a will and a power of attorney.

Whether you find yourself in your twenties, thirties, forties, fifties or sixties and beyond, financial planning in these seven areas will take on a somewhat different emphasis but nevertheless, all seven areas must be actively "pursued" to be successful.

Keep Tabs on Your Bucks

A personal financial plan tracks your income and your expenses and analyses how you can maximize your return, and minimize wasteful impulse buying and non-deductible costs.

A personal financial plan is simply an ongoing system for managing your finances to achieve personal objectives based on the "Group of Seven." A complete personal financial plan incorporates seven key elements:

1. Effectively managing daily family expenses.

2. Building a portfolio of investments.

3. Minimizing personal income taxes.

4. Securing your retirement by protecting your income and assets from unforeseen and unfavourable circumstances.

5. Preparing an estate plan.

6. Regularly updating your powers of attorney.

7. Regularly updating your personal will.

The first step in financial planning is to define your financial goals and objectives in life. Without knowing your ultimate destination, it is difficult to know what road to take. Here, you have to decide how important it is for you to maintain a lifestyle, housing, education, income, leisure activities, employment satisfaction and financial security for your family and what commitments you must make to reach these goals.

The second step is to spend some time documenting and understanding your financial inventory. This process includes valuing your assets, identifying your debts, describing your income (and where it comes from) and classifying your expenses.

The third step is to create a personal financial plan with the assistance of a professional financial advisor who will identify products and strategies that are appropriate for your situation, assist you to make complicated financial decisions, and monitor and update your plan on a regular basis.

The sooner you start keeping track of how you spend your money and what your financial goals are, the sooner you will arrive to your destination.

Investment Goals and How to Get There

This plan tracks how you can preserve capital, reduce your risk, and enhance the returns of all the assets you own at the lowest possible tax cost. It also analyses your risk orientation and the level of diversification you need to profit maximize and reduce your risk to capital.

To do this effectively, use the services of a financial advisor.

Some of the cornerstones for effective investing include:

1. Think long term.

2. Buy and hold investing.

3. Asset Allocation.

4. Go heavy on equities.

5. Asset growth until age 75.

6. International diversification.

7. 80% soft assets/ 20 % hard assets.

8. Investing based on knowledge.

The first step is to find out how comfortable you are with different levels of risk. This will determine an investment strategy.

The second step is to determine how much risk you can absorb financially. This involves calculating the debt level you can service based on your current income and expenses.

The last step will be decide which investments to purchase.

Emergency Fund

In these critical times, you should have funds sufficient to cover 3 to 6 months of expenses. These should be invested in secure, short-term investments such as bank accounts, short-term GIC, and Money Market Funds.

Count on Taxes

Tax planning is not something that is done on February 28 every year. Instead it should be revised at the beginning of each year in order to legitimately minimize the amount of tax that you pay each year.

This plan tracks the taxes you currently pay and analyses if there are better investments and strategies to reduce this tax. It also shows how you can reduce your withholding tax and enhance your cash flow, how to eliminate non-deductible interest expense and how to reduce the tax on your retirement and estate.

At retirement, tax must be paid on registered funds such as pensions and RRSPs. If one spouse is saving more in a pension, it is important that spousal RRSPs are used to equalize the retirement funds so that both individuals are tax equally.

Another tax strategy is to choose your favourite charity to be the beneficiary of your life insurance policy, thereby making all life insurance policy payments tax-deductible.

Snow Birds and Flamingos

Retirement planning demonstrates how you can assure a comfortable and secure retirement without undertaking too much investment risk. This plan will also enable you to make provisions for the comfortable retirement of your spouse and reduce your taxes as well as plan for additional holdings you might need beyond the GIS, OAS, CPP, RRSP, and RPP.

GIS or Guaranteed Income Security is a non-taxable benefit paid to some 1.3 million low-income seniors in 1993-94 on the basis of family income. Depending on family income, payments in 1995 were between $11,000 to $26,680.

OAS or Old Age Security is a taxable benefit paid to people over 65 who have lived in Canada for most of their adult life or come from countries with social security agreements with Canada. Individuals who have lived at least 40 years of their adult life (age 18 or over) in Canada will receive full payment subject to a taxable clawback for those earning $53,215 in 1995. Those who have lived less than 40 years will receive a fraction (# of years/40) of the estimated $387.74/month.

CPP or Canada Pension Plan is a taxable pension for retirees or people with disabilities who have paid into it. Quebec runs its own plan. Employees currently contribute 2.8% of their pensionable earnings, with a matching contribution from employers. The maximum benefit in 1995 was $713.19 with maximum contributions of $850.50. Individuals may choose the early retirement benefit (as early as age 60) which has a penalty of 0.5%/month (ie if you choose to retire at age 60, you will have a penalty of 60%, hence you will only receive 40% of the regular benefit for the rest of your life.

CPP has a death benefit of $3,490 in 1995. Spousal Pensions have payments of 392.24 to 427.91/month. Orphan benefits of $161/month are also available.

Tax support for RRSPs and workplace pensions is meant to encourage middle and upper income Canadians to supplement their public pensions. The beauty of RRSPs is not just simply that your contribution is tax deductible but that all the growth in an RRSP is also tax sheltered, hence the growth in an RRSP is much more significant.

Leaving your Favourite Relatives Something they can Remember you By

An Estate Plan tracks how you can preserve your capital and insure it so it safely passes to your beneficiaries at the lowest tax cost. It also suggests what assets to sell, hold jointly with your spouse and the level of insurance needed to insure you will provide properly for all contingencies.

Effective estate planning involves both spouses and children and includes understanding and managing the important legal, financial and tax issues related to protecting the value of your estate following your death and preparing for the orderly handling, administration and disposition of your estate to heirs or designates according to the dictates of your will or a court’s ruling.

A proper estate plan will address the following five key issues:

1. Beneficiaries

Ensure a consistent standard of living and providing for the financial needs of your surviving spouse and dependents or heirs.

2. Control

Ensure that your estate plan is structured to maintain control over the assets to the greatest extent possible.

3. Distribution

Planning and directing that each of the assets covered by the estate plan is ultimately directed to the people or institutions to which you intended they go.

4. Taxes

Minimizing the amount of tax that must be paid by the estate at the time of transfer.

5. Business Interests

If the estate plan includes an operating family business or other type of venture which is intended to continue, the estate plan should outline the principals upon which it can survive.

The Living Testament

The will lists names of beneficiaries and how family assets will be preserved. Without a valid will, an individual is said to die intestate, hence the government may choose how to reallocate your estate in a manner which you may not have chosen.

Your Wish is His Command

The power of attorney will insure that if you are ever incapacitated, your assets will be protected, your wishes carried out, and the right party such as your spouse or children will be empowered to act for you.

Special Circumstances

Education Fund

The best time to invest for your child’s future is the day they are born. Assuming you invested $30/month (equivalent to the old Baby Bonus) each month for 18 years for your children in trust, they would each have over $23,000 today. This amount would be enough to pay for tuition and books for an Undergraduate Degree in Canada. This assumes that you invested the funds in a growth mutual fund. Many have had growths of over 12% per year over the past 18 years.

Risk Management

How much life insurance is enough? The rule of thumb is about 9 times your annual salary. Add to this any additional risks such as additional burial expenses, outstanding loans or mortgages.

The problem with employer group coverage is that if you change jobs, you may be required to provide evidence of insurability, hence it is important that you have independent insurance.

If you do not have coverage at work, you should also look into disability, major medical, dental plans. In addition, home and automobile insurance are a must.

What’s in it for me?

If you are in your thirties and your financial goal is to buy a house with 25% down in 3 years from now, you need an investment plan and you need to stick to it for 3 years. Similarly, if you are thirty years old and you want to retire by the time you are 55, you need to save 17% of your income for the next 25 years, assuming your salary increases by 5% every year and your growth is 9% after tax to maintain your current lifestyle.