How Small Things Can Make a Big Difference

Many of our clients reading this will recognize  some, or most, of these insights, techniques, or principles in their own planning, but in the spirit of continuous improvement, experience tells me there may be a few things that could be fine-tuned for optimizing your outcomes. Those who have planned  well still have concerns for those in  their circle of care (family, friends, co-workers…) who, when seeking advice, may need a mentor to pay it forward for them.

The biggest single  determinant  of your financial success is not your rate of return: it is your own behavior. This starts with the principle of “deferred gratification”: spending less than what you earn and prioritizing what you want or need. Most of our clients have some pre-disposition toward “saving something for a rainy day” and although commitment to this principle varies in groups (couples, families, businesses) and in personality types, “savers” tend to be forward-thinking and planning- oriented. Deferred spending for higher value priorities (home repairs/renovations, new car, vacation) is an important element in “deferred gratification”,  but it is not really saving!

At some point, savers realize they need to think longer term than what comes naturally. Many self-select to seek advice on mentoring good behavioral habits and applying techniques they can harness to optimize the second principle of “compounding growth”.

A financial plan can help break down the artificial behavior barriers and biases of immediacy and recency to see past life transition periods and optimize effective wealth allocation over a lifetime. 

During our employment years, we spend most of our earnings, while saving some for our retirement. These savings (RSPs, TFSAs, pension funds,and other investments) taken together, provide our retirement income. Our retirement time horizon can often be 40 years or so (in many cases, about the same amount of time we were employed). Note - one in three women aged 65, and one in five men aged 65, will reach age 90.

Contribute to financial independence savings regularly to build a system to pay yourself first. Save with the same frequency as you are paid, either monthly or sporadically, to develop a savings and lifestyle habit based on a consistent percentage of income and avoid procrastination and the potent inevitable distractions that lead to too little savings. In my experience, those without a systematic savings plan often don’t save enough to bridge the lifestyle gap when they want or have to stop work. This leads many to be overly focused on rate of return, pursuing unrealistic return targets, and behaviorally stretching their risk capacity until a downturn forces them to capitulate and break their long-term plan.

Another principle is diversification. This applies to tools, methodologies, and investments. Start by taking a satellite or “Google Earth” view of what you have that is unlikely to change. Most people have a domestic bias as to where they live and what they do. When your human capital reflects geographic, currency, economic or business risk, and you have a home subject to many of the same forces, it is likely wise to diversify globally around these core assets rather than overly concentrating in related or rhyming risks. When you consider government pension entitlements and employer pensions, also payable in local currency, many people’s largest assets are all in their home country! Follow CPP’s and other large pensions’ lead and diversify globally. Of course, take advantage of employer pensions and matching contributions because the structure works. Mandatory contributions into the public system also work and create a valuable longevity-protected lifetime benefit that few people would save enough for on their own. Business owners should avoid dividend-only strategies that can be changed with the stroke of a pen, but exclude CPP contributions,tax-preferred employment benefits, and the creation of RRSP and IPP pensionable service room.

Diversify strategies and tools to diminish, defer and divide taxes wherever possible. Take advantage of the limited window of opportunity to maximize allowable contributions to deductible savings (RRSP, RPP) that allow years of earning money on the government’s share in your pocket,as well as income splitting and the Pension Income Tax Credit.

Contribute at the beginning of the year to TFSAs and RRSPs to maximize the deferral and compounding. Of those who contribute regularly, many add a year after they can, based on the prior year’s room. Changing the habit to move up one year, and doing it for many compounding years, can make a big difference.

Contribute monthly, which invests your funds six month earlier on average than making contributions in arrears. This also allows you to benefit from dollar cost averaging into more opportunistic and volatile assets. The rate of return on a moderate growth mix of investment assets can be enhanced by selectively placing higher tax rate interest earners in registered plans (RRSP, RPP,TFSA) while capital assets that grow and pay dividends can be placed in registered or open accounts for savers whose capacity and gratification disposition exceed the registered plan limits.

Each of these seemingly small things, from paying yourself first, letting tax-preferred compounding grow your money in a globally diversified portfolio built for the long game, to controlling your own behavior in reaction to life’s events, can all add up to make a big difference in integrated wealth management.

Plan well.Live happy.