Canadian Investors Unite: Self-Managed Pension to Retire 15 Years Earlier

I absolutely love being able to provide free, impartial and efficient access to financial strategies that you can take advantage of right now – today – without spending your hard earned cash at the outset. For the U.K. version of this article please click here.

It took me nothing short of sixteen years to completely decode how investing works, where it spectacularly doesn’t work, what the risks are, and how I can cut out the thousands of advisers and middlemen who sit between me and the market. Now I get an above-average return for myself and my family. Even more important: I understand what I am invested in.

So how can you actually retire 15 years earlier? I will give you basic example: let’s imagine you have $75,000 in investments today and get a 3% real rate of return for 30 years. Real rate of return means, after inflation and taxes. You deposit $200 every month in the account and you re-invest the income. After 30 years you have a balance of $301,101.91 in today’s money. Not bad[i].

How much do you have if you take that same $75,000 in investments, but get a 5% real rate of return (by reducing fees and getting slightly better investment performance as per the below) Same $200 monthly deposits. The result is significantly higher: $502,226.10.

It actually takes you nearly 45 years in the first example to get the same balance at a 3% growth rate. So 15 years longer working.

So minimising fees and slightly increasing performance has a dramatic impact on your finances in the long term. If I can provide guidance that gets you there in 10 minutes, or a few days or weeks of your time, then we’ve won together and set you on the path to financial independence.

Current Situation in Canada

According to the Bank of Canada Pension Plan Annual Report (2018) and the Fraser Institute – the expected rate of return for CPP retirement benefits has declined to a real return of 3.6% per year. In plain English, that means pensions are forecast to grow (after inflation and costs) by 3.6% in the medium term.

The expectation even further into the future is sobering: it falls to 2.1% per year for those retiring in 2037 and beyond. For millenials with a decent amount of lead left in their pencil that’s not brilliant and means you’re going to be working for a long time because your pension isn’t going to grow by much! This isn’t simply the governments fault: there are a lot of factors at play.

Passive investment giant Vanguard agrees: as of 2019 the average real rate of return for the next ten years in the U.S. stock market is expected to be 3% to 5% (after fees and inflation are taken into account).

We expect to enter a slower-growth environment, as interest rates rise and government policy looks to restrict the easy-money policies of the last decade. As a result, fees are really going to matter. Canada, relative to the rest of the OECD countries, has a history of opaque and obfuscated fees and practices in its banking sector. In fact just finding figures on this was a difficult job.

The average all-in fees for the CPP have grown from 0.54% of assets to 1.15% over the past seven years[ii]. They don’t report that widely. The average pension fees in private pensions are considerably higher and sit between 1.85-2.0% per year. How expensive is that? Well, it’s nearly half of your average expected real rate of return.

In other words: your money may grow by 3% to 5% per year, and behind the scenes one of the main drags on your return is fees. Keep my example above in mind – that makes a difference to the tune of 15 years more work!

What can you do about it?

Relying on the government to fund your retirement, in Canada, the U.K. or the U.S. is generally not sufficient. If it were up to the government, in order to account for poor investment returns and people living longer, as a millennial you will probably be working until 72-75 by the time you retire. To avoid that fate you need to ensure that you are maxing out on your employer pension contributions and taking advantage of the tax policies that support saving for retirement.

In Canada making regular RRSP contributions and, in addition, opening a TFSA to build a war-chest of tax free savings is essential. You are going to need more than that to retire comfortably.

If you want to retire at 67 with an annual pension of $50,000 per year, then given CPP is capped at $1134.17 per month, you’ve got a $36,390 per year income gap to plug! (Hint: assuming CPP gives you $13,610 per annum by then). Using the 25x rule that means you require a pension pot of $909,749 to give you a $36,390 income after retirement (provided you receive maximum CPP benefits).

What’s an efficient way to get there without burning excessive cash on investment management services, fund and ETF fees? How do you get great investment performance without going through your government and employer pension plans?

Vanguard Asset Allocation Funds – VBAL

Vanguard Canada has an excellent solution: they have created a single pension-like product that you can buy using an investment account. Exactly like a pension. Even better: they have built 5 separate offerings that are tailored to your risk appetite and you can choose from any of them.

What Vanguard have done is fully automate the various fragmented ETF investments that people had been using to create their own sustainable investing strategies. This single fund does a lot of the work for you, so instead of purchasing, say, 10 ETF’s and line-balancing money between them, you just buy one product on a monthly basis and it automatically allocates your money to those 10 ETF’s, which in turn buy thousands of diverse equities and stocks across the globe. Remarkably simple and exactly like the funds you see in your pension statements (if you ever read them!)

Self-investing in stocks and equities is much safer than, say, crypto-currencies like Bitcoin. What you invest in is covered by all of the major banks and backed by the government itself. Whereas every crypto-currency exchange out there can go bankrupt and leave you with nothing. For a full breakdown on what the Canadian Deposit Insurance scheme is and how the government protects your investments for up to $100,000 please read here.

Let’s have a look below:

Vanguard Balanced ETF Portfolio (VBAL)

This product aims to achieve your investing objectives by allocating your capital to various equity and fixed income securities on a global and balanced basis. And it includes fixed income. Just like a pension fund. In fact, it is scary how much this has automated the job of a pension fund.

In principle all you need to do is to open an account through a major bank or provider (CIBC, TD, Royal Bank all offer stocks and shares accounts) and fund it. I will do a separate article on how this works.

The funds are eligible for RRSP, RRIF, RESP, TFSA and non-registered accounts. Beyond my workplace pension, the key benefit here is that you can self-invest through an RRSP and TFSA with only the minor inconvenience of having to place the trades yourself.

Fees

The major advantage here is on fees. The all-in cost of these ETF’s is 0.22% per year. Compared to the average private pension in Canada, which charges close to 2% per year, that’s a cool saving of about 1.78% in fees. This adds up over time: it could mean you retiring 10-15 years earlier if the Vanguard product has the same performance of a standard pension.

If you open an account with CIBC Investor’s Edge (I use them personally) trades for buying the VBAL etf cost $6.95 per trade. Remember to factor this in: it means that if you planned to invest only say $5000 per year, then in year one you’d be paying an extra 1.7% in fees (12 trades per year at $6.95). For that reason self-investing in an RRSP or TFSA is better suited to $8,000 – $10,000+ accounts and a pool of your investments. The more you have over $10,000 the lower the trades are as a % of your wealth.

Capital Allocation

Here is what the Vanguard Balanced ETF Portfolio is invested in:

The ETF is pretty much exactly split between 60% equities and 40% income securities. It is geographically diversified with key holdings in the US Total Market (not just S&P 500, but mid-cap and small-cap exposure), Canadian TSX index, and the developed world across the EMEA, alongside a smaller exposure to Emerging Market economies. There is a lot of science behind the scenes as to why geographically diversified portfolio’s perform better, and this fits the bill.

Performance

The 1-year return for the Vanguard Balanced ETF (VBAL) is 11.09% as of the end of October 2019. This is within touching distance of the 1-year return on the TSX index which is 12.66% over the same period. Remember that these are not real rates of return and 2019 has been an above-average year.

In accordance with Canadian law Vanguard is not able to provide back-dated performance, because the funds are only a year old. However I have taken the liberty and gone back to give myself an estimate of how the fund has performed longer term. Looking at the underlying ETF’s for VBAL the results are:

Please note: this independent analysis is not supported by Vanguard and it is for reference only, using publicly available information.

The approximate performance excluding fees is 7.41% return per year since 2009, and a very healthy 14.06% return year to date in 2019. After fees and inflation the adjusted average real return would be about 4.79% – that works out to higher than CPP and will out-strip most private pensions because it is inclusive of fees, which are extremely low.

Dividend Income

The internal dividend on the Vanguard Balanced ETF is 2.6%, although if you were buying today the 12-month trailing yield on the current price is about 2.20%. The discrepancy is due to the share price because the 12-month trailing yield is based on an investment ‘today’. Compared with the S&P 500 (which yields about 1.58%) and Canada’s TSX index (which yields 2.84%) that is pretty good.

This means that your desired rate of capital growth is around 5%, to give you that healthy real return after inflation of approximately 4.75% (inflation is running at 2.24% and fees 0.22%). If CPP ends up growing at 3% then this rate of return would have you retire 12 years earlier!

For further information on the Vanguard Balanced ETF Portfolio please see here. Frugal Investors is not affiliated with Vanguard and we don’t receive any compensation for recommending them. This is simply a great product that the Frugalist Investor (i.e. me) invests in for the purposes of automating my investments and receiving great after-tax returns in a well-balanced portfolio.

Asset Allocation – Picking a Risk Profile

For further reading on how to choose an appropriate asset allocation strategy for your age and financial situation, have a look at our Risk Profile article here. Vanguard’s website has plenty of information on what the asset allocation strategy is and how to choose the right fund.

I encourage you to truly understand what you are invested in and why, and to pick a strategy that allows you to sleep at night. Happy investing and please do comment and ask any questions below!

[i] I arrived at these figures using a compound annual interest calculator here: [https://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php]

[ii] Fraser Institute – Philip Cross

[https://www.fraserinstitute.org/article/once-all-the-costs-are-counted-the-canada-pension-plan-isnt-a-model-of-efficiency]