About the Book
Smoke and Mirrors is divided into two parts:
Part One: Understanding and Exploding the Five Big Myths of Financial Planning
Part Two: Fighting Back
In addition, a bonus CD-ROM includes Excel spreadsheets that you can use to track your finances according to the instructions in the book.
Here’s a summary of what you’ll find in part one:
Myth 1: If I had a $1,000,000… I Could Retire
There is a myth perpetuated by many investment advisors that you will need approximately 70% of your pre-retirement income after you retire to maintain your current lifestyle. Some go as far as 100%. They say this for one simple reason: the more money you need to retire on, the more you w ill need to hand over to them and that means more commissions and fees in their pockets. In this chapter I show that this myth is often way off base. In fact, based on a detailed example in the book, I show a family of four could be just fine with only 40% of what they are making in their 40s.
The reasons are simple. First of all, after retirement, you won’t have many of the expenses you do before. Consider house mortgage payments, auto leases, children expenses such as education, food and clothing, interest on consumer and investment loans etc. Furthermore with lower income, come lower income taxes. I also point out that the government helps out with Old Age Security and the Canada Pension Plan income. Read on and start relaxing a bit!
Myth 2: RRSPs are the Holy Grail of Retirement
There is a question that comes up every year: Should I invest in an RRSP or pay down my mortgage? I used to be of the opinion that building up a retirement nest egg instead of paying down debt was the way to go. Over the past 20 years I have changed my point of view 180 degrees. The recent market declines have cemented it.
If you pay off your personal debts instead of investing, you are locking in an after-tax rate of return equal to the interest rate on the debt. For anybody with credit card debt, this rate of return could be as high as 19% to 28% per year. You simply cannot beat that rate of return on a consistent basis. Anyone with this kind of debt should forget about RRSP investing until all such debt is paid off. The same logic applies to loans at lower rates such as mortgages and car loans.
Perhaps even more significant than rates of return, if you pay off all your debts you will own your house, your car(s) and everything else. Since you won’t owe anything to anyone, there is no one that can take things away from you. Even if you were to lose your job, the bank or finance company couldn’t repossess your home or car. Think of it as free disability insurance.
Well, at least an RRSP provides you with that “emergency fund” were all supposed to have, right? Think again. An RRSP makes a lousy emergency fund because to get at it you will first have to pay income tax on any withdrawal. Your emergency fund is really a lot lower than the value you see on your statements. Secondly, the rate of return on your investments is not guaranteed unless you lock into a low-rate fixed income instrument like a GIC. Investing in the stock market is often the only way to generate a sufficient returns and that is risky. What if returns over the next 10 to 20 years don’t reach the historical rates of approximately 8% per annum? What if you need your emergency funds when the market has just hit bottom?
Read on and discover why getting totally debt-free including the house mortgage beats the RRSP game hands down.
Myth 3: Don’t Worry About Your Investments; You’ll Be Fine In The Long Run
If you look at a typical RRSP investment statement, you will see a listing of the investments, the current number of shares or units of each as well as their market value. You will also see last month or quarter’s market value. The statement will also list the book value, which is the cost plus any reinvested dividends for each investment. They don’t give you this figure to help you determine how well you are doing – they do it because they are required to do so by the foreign content rules. Your foreign content book value can’t exceed 30% in Canada. Consider what the statements don’t tell you:
- Overall rate of return for the year-to-date;
- Overall rate of return annually for the last year, three years, five years and since inception;
- Comparison of your rate of return to various market indices.
In this chapter I describe how to use the “Personal Rate of Return Calculator” a simple Excel spreadsheet that comes on the CD with the book. It can determine your personal Rate of Return for any portfolio or combination of portfolios for any period. The only information required is the dates and amounts of money put in and a current market value.
Once you actually know what you have been making in your RRSP, it often becomes clear that paying off debt is a much better alternative.
Myth 4: We Have Met The Enemy and He Is The Tax Collector (with apologies to Walter Kelley)
Let’s face it nobody likes to pay tax. The problem is that investment and financial sales people know this and often use it against you to sell products you should avoid like the plague. Your dislike of taxes also can lead to bad business decisions:
Examples:
Say you owned $1 million worth of Nortel stock at the peak of the market. That would have been 8400 shares at $120 = $1,008,000. You didn’t sell because your broker warned you about the dreaded capital gains tax of several hundred thousand dollars. Today with the stock around $5.00 your portfolio is worth $42,000 (8400 shares x $5.00). Well, you no longer have a tax problem, but you’ve lost a pile of cash!
Tax shelters are another trap. In this chapter I detail a donation scam that sounds too good to be true, and guess what, it is. Those that fell for it are now out-of-pocket their whole investment and in deep with the Canada Customs and Revenue Agency (CCRA).
In this chapter I describe in detail why you should avoid tax shelters at all costs – no matter how much income you earn – and what you should focus on instead to make your retirement dreams a reality.
Myth 5: Secure Your Financial Future: Buy Life Insurance
Life insurance has its purpose – it should allow the dependents of the breadwinner in a family to maintain their standard of living should the income-earner die. If you talk to many life insurance agents, however, you may get a different idea. Often they will try to convince you that a universal life, or worse yet, a whole life policy is the way to go because of the “savings” component or because you don’t want to pay all that tax upon your death. Don’t fall for this ploy.
If you look at the details of a “whole life” policy the traps become visible quite quickly. The fancy charts usually project a Cash Surrender Value (your “savings” component) as well as the death benefit (the amount received on the death of the insured). What they don’t make clear is that you get the Cash Surrender Value or the death benefit. You don’t get both. Effectively, the excess amount you are paying is being held by the insurance company as a prepayment of future insurance premiums. Where’s the savings in that?
Another trick – look at the Cash Surrender Value at the end of the first year. Its usually a very small number despite the fact that thousands of dollars have been paid in. Why? Because your friendly broker makes a commission of almost your entire first year’s premiums. Now you know why life insurance sales people are so aggressive.
This chapter explores in detail the features and pitfalls of whole, universal and term life insurance in layperson terms. Read it, and don’t get fooled (again).
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