Sunday, August 19, 2012

Blueprint for getting rich – part III

All the ingredients for getting rich have been presented on this blog over the last number of years. So you have made the plan below and are now looking at the details of implementing it.  You defined your vision for the future; wyou’re saving $10,000 per year. The savings for the first two years were used to buy an apartment or townhouse condo.  The $10,000 annual savings for the next 23 or so years are invested in an ETF portfolio that is tax sheltered in a TSFA. And now we’re ready for step 6.

1.       Your Belize (Vision for the future):
You want to retire 25 years from now at the age of 22 - J 
That means you want to have a net worth of at least $1.5 million 25 years from now so that you can live and work independently of an employer. (In plain English you want to be able to say to your employer “scr/// you!” without losing your meals and house - J - I am having so much fun).
2.       To do so you, as a household, will have to save around $10,000 per year. You do that by living below your means. Saving will initially be difficult but over time with increased pay cheques that will get easier. Maybe you can at later age save $15,000 per year and speed up reaching your ‘financial adulthood’ also known as retirement.
3.       First you save a down payment for your first house using your TSFA
4.       You buy the house
5.       You put your annual $10,000 savings in ETFs which are tax protected in your TSFA
6.       You will work for an employer who provides you with an attractive company savings plan.
7.       That’s all folks. See you in 25 years.

Many employers offer their employees the option to participate in a company savings plan. The deal is that an employee typically is allowed to contribute up to 10% of his/her gross salary in the plan and the employer will contribute the same amount and sometimes up to 1.5x the employee’s contribution.  So, that is a guaranteed 100% to 150% one year return and you, the employee hasn’t done anything yet.  Typically you have to follow a couple of rules – you cannot take out any money for one year or somewhat longer. The money can only be invested in the company’s stock or in a limited number of often mediocre and high commissioned ETF funds or even worse in mutual funds. So let’s do some calculations.
First of all, you may only buy company shares. Thus, your job choice should include a consideration of how the corporate performance is – this is easy when you’re dealing with a publicly traded outfit but a lot more difficult with a privately owned company.  Investing in the latter goes beyond the scope of this post but we can have a look at a publicly traded company. You should look for an average corporation (or better) and avoid working for duds. Duuuh!  We know the average corporation should provide a 9 to 11% ROI including dividends.
Now put in the maximum contribution. This may be difficult when you are already trying to save the normal $10,000 per year but if you show some discipline and frugality early on in your career then this should become easier and easier overtime when your salary increases. If you absolutely cannot save more, then save first for your down payment and next for the savings plan. Then after a year, you can take out your own contribution and put that in the TSFA.  Assuming an average annual income of $60,000 then you are allowed to put up to $6,000 in the company savings plan. Then with next year’s 5% salary increase, you should be able to contribute $6,300 and the following year $6.650 and so on. So the results are shown in the table below:
Click to magnify
We’re assuming that the stock of you company increases at a steady rate of 10% per year. This is not very realistic. Using a random number generator creating an average return of 10% (and thus your annual return varies randomly between 0% and 20%) the outcome can be quite different and ranges between a total savings balance of $2 and $3 million dollars.  Now you will have to pay taxes on this over the years and they are quite substantial. However, most is deducted by your employer from your paycheque and changes are you won’t really notice it. How much tax in total? Well, in Alberta you’d pay $166,633 on your employer’s contribution and when you cash in all at once after 25 years you’d pay another $337,957 in capital gains taxes.  When converting the final balance to today’s dollars (NPV discounted for 3% inflation) you would still have saved $932,923 in NPV.
Whatever the case, combined with the proceeds from your home and your ETF portfolio in the TSFA you cleared the hurdle of an NPV of $1.5 million 25 years from now. That was easy. Now you have to only execute this plan over the next 25 years. And that won’t be always easy. J

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