Inspired by the FIRE movement, Brandon and Michelle, both in their mid-30s, have built a portfolio of income-producing properties and dividend-paying stocks that they hope will soon free them from having to work. Characterized by extreme saving and investing, FIRE stands for “financial independence, early retirement.” It helps if you get a good income.
Brandon earns $127,000 a year plus bonuses and contributions to the employer’s pension plan, while Michelle earns $92,000 a year. Their combined earnings are $238,000.
Michelle has a partially inflation-indexed defined benefit pension plan. They have two children, one and three years old.
Their aspiration goal is to “become financially independent, not dependent on work income, before age 40,” Brandon writes in an email. Ideally, they could live off their dividends and rental income. Their most realistic goal, perhaps, is to have enough rental and dividend income to allow them to work part-time, “resulting in about 50 percent of current salary,” in five years or so, Brandon writes.
His retirement spending goal is $120,000 a year. Achieving it with half the salary will be a challenge.
“When can our passive income cover our expenses?” Brandon asks.
We asked Matthew Ardrey, vice president and portfolio manager at TriDelta Financial in Toronto, to discuss Brandon and Michelle’s situation. Mr. Ardrey holds the Certified Financial Planner (CFP), Advanced Registered Financial Planner (RFP), and Certified Investment Manager (CIM) designations.
What the expert says
Brandon and Michelle are looking to retire from full-time work in mid-2028, Mr. Ardrey says. “Before engaging in what would seem like a pipe dream for many Canadians in their thirties, they want to make sure they have a secure financial foundation,” says the planner.
In addition to their primary residence, they have four rental properties. They also rent an apartment in their house. His rental properties bring in $1,100 per month, net of all expenses, including mortgage payments, and the unit in his home another $1,600 per month. Brandon earns $400 a month managing a relative’s rental property.
Dividend income from his unregistered accounts is about $2,500 a year, says Ardrey. Brandon’s $15,000 of employer matching contributions will go into a defined contribution pension plan. Plus, they maximize their tax-free savings accounts and contribute $2,500 per child to their registered education savings plans each year. They have no unused quote room in their registered plans.
“After all these savings and their expenses, they still have a surplus of $50,000 a year, which they put into unrecorded savings,” says the planner. He assumes that they split this surplus 50/50 to maximize tax efficiency. “This amount grows annually at a projected rate of 4.9 percent until they hit partial retirement and have to use some of it to supplement their lower income,” says Mr. Ardrey. Inflation is projected at 3 percent.
By mid-2028, he assumes that Michelle and Brandon will cut their work by 50 percent. Brandon will be 39, Michelle 41. Brandon’s bonus and employer contributions to his DC plan end. Michelle’s DB pension contributions are cut in half. Brandon is supposed to maximize his RRSP each year based on 50 percent of his current salary.
Adjusted for inflation, Brandon will earn $78,000 a year and Michelle $56,000. They will have $3,000 in dividend income, $6,000 in property management income, and gross rental income of $93,000.
At the same time, your spending is forecast to rise, says the planner. “They feel that in another five years, things will be drastically more expensive. Also, less work will provide more free time and higher expenses. Therefore, they have requested that we estimate an expense of $10,000 per month beginning when they partially retire in 2028 and continuing thereafter, adjusted for inflation.”
They will still be about 17 years away from full retirement. They continue to work part-time until Michelle turns 58, when she can receive an unreduced pension. “At this point, we assume they go into full retirement,” says Mr. Ardrey. Michelle will be entitled to an estimated pension of $37,845. Her pension is 60 percent indexed to inflation, or 1.8 percent.
In her first full year of retirement, Michelle’s pension will have increased slightly to $38,526, property management income to $10,000, and gross rental income to $154,000. Mortgages will be paid.
At age 65, they will begin collecting Canada Pension Plan benefits (estimated at 70 per cent of the maximum) and full Old Age Security. “Under these assumptions, they meet their retirement spending goal of $120,000 a year after taxes,” says Mr. Ardrey.
“However, when we tested the scenario under the Monte Carlo simulator, its probability of success drops to 77 percent, which is in the ‘somewhat likely’ range of success in retirement,” he says. A Monte Carlo simulation introduces randomness into a number of factors, including returns, to test the success of a retirement plan. For a plan to be considered “likely successful” by the program, it must have at least a 90 percent chance of success.
“In terms of building your portfolio, it’s great for accumulation, but the inherent volatility of a stock portfolio is less desirable for drawdowns,” says Mr. Ardrey. They have a portfolio of exchange-traded funds with a geographic breakdown of 55 percent US, 25 percent international and 20 percent Canadian.
As they approach partial retirement, Brandon and Michelle could benefit from diversifying their portfolio by adding some non-traditional income-producing investments, such as private real estate investment trusts that invest in a large, diversified portfolio of residential properties. , or perhaps in specific areas such as wireless network infrastructure, mainly in the United States, says the planner. Such investments are not affected by the ups and downs of the financial markets.
“By diversifying their portfolio, we estimate they could add at least one percentage point to their overall net return, bringing it to 5.9 percent, and significantly reduce portfolio volatility risk.” In conclusion, Brandon and Michelle are on their way to achieving something only most Canadians can dream of,” says Mr. Ardrey, “partial retirement before 40 and full retirement before 60.”
People: Brandon, 33, Michelle, 35, and their two young children.
The problem: Can they achieve financial independence within six years, allowing them to work part time and still spend $120,000 a year?
The plan: Keep saving and investing. Go part-time in 2028 and fully retire at Michelle’s age 58, when she receives her pension. Add some non-traditional income-producing assets to her investments as they approach retirement.
The reward: Plenty of free time to reap the benefits of their hard work while they’re still relatively young.
Monthly net labor income: $13,910
Assets: Cash $14,000; exchange-traded funds $100,000; your TFSA $153,000; your TFSA $127,000; your RRSP $154,000; your RRSP $44,000; market value of your DC pension $188,000; estimated present value of your defined contribution pension $125,000; registered education savings plan $46,000; rental units $915,000; residence $605,000. Total: $2.47 million
Monthly expenses: Residence mortgage $1,700; property tax $385; water, sewer, garbage $145; home insurance $70; electricity, heat $255; maintenance $200; transportation $435; groceries $900; child care $415; clothing $230; gifts, charity $375; vacation, travel $300; meals, drinks, entertainment $555; personal care $50; pets $80; sports, hobbies $30; health care $75; communications $130; your DC pension plan $1,000; ANS $415; TFSA $1,000; your contributions to the pension plan DB $1,000. Total: $9,745. Surplus $4,165
Passive: Residence mortgage $428,000; rental property mortgages $707,000. Total: $1,135,000
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