Categories
ETFs and Funds

5 Actions to Take Before Even Considering Investing

For many, investing sounds like a way to get rich fast. People see insane returns of FAANG stocks and bitcoin and think that’s the ticket to wealth.

For some, it is.

For those who have truly built wealth, there are many things that come before investing.

First of all, most people shouldn’t expect to earn triple-digit – or even double-digit – returns into perpetuity. Depending on how far you go back, the average return for the S&P 500 is roughly 10%. Bond returns, even less. So a well diversified investor holding a balanced portfolio might reasonably expect a 6-8% return over the long run.

For someone with $10,000 to invest, that equates to a $600-800 annual return. Hell, even if that person could accomplish 100% returns he’d only gain $10,000 in year one. Nice, but not enough to become rich unless by some miracle that feat can be repeated numerous times.

Nobody gets rich giving all their money away.

Investing is something you do with accumulated wealth. It’s a way to get your money working for you and to maintain your purchasing power. But before you can do that you must first build wealth through simple, deliberate actions.

Action 1: Spend Less Than You Earn

Seems simple. But many don’t live by this rule and rely on their credit cards to cover regular expenses.

Nobody gets rich giving all their money away. It’s so simple I feel stupid for saying it, but here we are. To accumulate wealth you first need to spend less than you earn.

Action 2: Pay Off Credit Card Debt

If you have a credit card balance you’re likely paying around 20% interest. You’ll never beat that return in the market with any consistency. So do yourself a favor and pay off that credit card debt before investing.

Action 3: Aggressively Save

Simply spending more than you earn isn’t enough. Think about it this way: every dollar you save is a dollar less you have to earn in the future. The more you can save now, the closer you will get to financial independence.

While saving 10% of your paycheck might seem daunting, it’s a standard rule of thumb. However, I suggest saving as aggressively as possible. 10% should be the bare minimum.

Action 4: Don’t Leave Free Money On The Table

Many employers have share purchase or retirement savings matching plans. I’ve known so many people who have lost this free money out of sheer laziness. People walk away from a 20, 30, 50% match – equivalent to a 20, 30, 50% instant return – yet spend their energy trying to invest in the next Tesla.

Moreover, these employee savings plans, once set up, are usually a decision-free way to build wealth since the contributions are taken off your paycheck before you even realize the money even existed.

Action 5: Earn More Money

The average age of Robinhood user is 31, and the average account size is $1000-5000. Such small account sizes suggest these people don’t have alot of wealth.

These young people are wasting their time chasing stocks when they’d get a much higher ROI investing in themselves. At age 31, most people are near the bottom of the corporate ladder. Instead of putting $1000 into Air BnB stock, spend that money on a Python course, Canadian Securities Course or CFA designation.

A little self-improvement at such a young age will pay off multiple times over a lifetime.

Categories
Work

The Raise You Shouldn’t Take

Is there a certain point at which it no longer makes sense to pursue a greater income? Maybe.

I think you must consider the tradeoffs when contemplating a position with more responsibility and pay. Because the more you make the less you keep.

Much of the developed world has a progressive tax structure, in which people who earn more pay a greater proportion (and dollar amount) of their income in taxes. Marginal tax rates for top-earners in Canada are displayed in the table below, and are as high as 54%!

The marginal tax rate is the portion of each additional dollar earned that goes to the government. The more you earn in total, the more each incremental dollar is taken away by the tax man.

Source: BDO

I’m not here to debate whether or not this progressive tax structure is morally right or wrong. My point is that this tax structure creates a rising disincentive for individuals to pursue ever-greater incomes.

Once a person attains a certain income level, I feel the added career risk, burden and responsibility is often not adequately compensated by the extra income from climbing the corporate ladder. For some other perks – extra vacation, corporate perks, ego boost, etc. – offset this imbalance. For many, beyond a certain point pursuing a higher income simply isn’t worth the sacrifice.

Put differently, those who do wish to climb the corporate ladder must require increasingly large dollar increases in pay to rationalize the tradeoff.

Here’s an example:

Let’s say you’re a typical employee of Big Corporation XYZ in Toronto and you’re looing at building your career. You start off at the bottom of the barrel working as a clerk in the back office making $45,000 (and probably living in your parents’ basement). You work hard and after a couple years find a better role within the company that comes with a $20,000 pay increase. To you this raise is everything – to Big Corporation XYZ it’s not a huge deal as they weren’t paying you much to begin with.

At that time, when you earned $45,000, a twenty grand pay increase was huge! Not only did you just increase your pay by 44%, you kept 71% of it because you were in a low marginal tax bracket. In other words, most of that earnings growth ended up directly in your pocket. So you were highly incentivized to increase your gross salary, as you got to keep most of it.

However, this incentive changes as salaries grow. The chart below shows how much of your gross salary (red) that you get to keep (blue) as your gross salary rises. When you earn $25,000 you keep almost everything. But as your gross salary rises the tax man benefits almost as much as you.

This next chart shows similar information, but focuses on the gap between gross and net income.

Finally, this third chart shows the effect of $25,000 pay increases on your total net income. A $25k pay increase is way more impactful to someone earning $50,000 than it is to someone earning $150,000.

Anyone making $150k has a high stress job. Taking on additional stress and responsibility isn’t financially worth it for another $25k. Of course, there’s more to the decision than just money. However, if money is a motivating factor the amount must be considered after tax, and the marginal pay raise worthy of action must rise with total income.

Categories
Wealth

8 Simple Wealth Hacks for Financial Literacy Month

November is financial literacy month so here are some easy wealth-creating hacks:

  1. Sleep on major purchases. This allows time for emotional excitement to ease, so you can rationally consider your actions. Often, either the novelty of the potential purchase wears off or you forget about it altogether.
  2. Consider the pre-tax cost of purchases. Someone in a 30% tax bracket that pays a 13% sale tax needs to earn $161 to buy something that costs $100. (($100*1.13)/0.7)). Take this one step further and consider the number of hours you must work in order to earn that $161. You might re-consider more discretionary purchases.
  3. Immediately allocate your pay raises. For example, if you receive a pay raise of $100 month, you could increase your automatic monthly mortgage payment by $50, investment contribution by $25 and bank the rest. You’ve invested in your future while retaining a bit more spending money.
  4. Consider the ‘real estate’ required for each purchase. If a purchase simply adds to home clutter, perhaps it isn’t really needed.
  5. Start investing at a young age. The longer investments have to compound, the less you need to invest over your lifetime to reach a specific goal. In fact, if feasible, parents and grandparents can provide a 20yr head-start by investing a small amount during infancy.
  6. Avoid unnecessary expenses. Many administration fees, late fees, overdraft fees, etc. are unavoidable with good planning.
  7. Time vs. money. Your time is finite, so it’s important to balance time with money. If a purchase earns you valuable time to spend with family or build a business it might be worth the expense.
  8. Less investing activity is best. For most, the best investing strategy is to invest when you have the money and remain invested as long as possible. Few people – even professionals – are able to time the markets. So keep it simple and stick to a routine.