Tag Archives: retirement

First Rule of Investing in Stock

first tip investing

If you had invested in Microsoft back in 1986, when they went public with their Initial Public Offering (IPO), you would have made 44,000% return on your investment (ROI). If you had invested $1000 in Microsoft then, it would be worth  $44 million today. This is why Bill Gates is still the richest man in the world, he owned the majority of Microsoft when it went public some 29 years ago.

Stories like this aren’t uncommon. Pretty much every publicly listed silicon valley company started off like Microsoft, and consequentially has amazingly wealthy founders. And thanks to stock markets, the ability to invest in other people’s good ideas and hard work is available to anyone.

There are many books, websites and careers based on investing in the stock market. So for this introductory post on the subject, I will simply say this: Invest in what you know.

To better illustrate this concept, consider this story that took place in the 1930’s. It was a party that a celebrated banker was throwing, he invited his business clients and colleagues. At the time, women weren’t involved in money matters much, especially the money matters of their extremely wealthy husbands. But the banker’s wife had inherited a small fortune from the death of a relative and wanted to grow the money herself.

She knew from listening to her husband and his friends talking about investing all the time that putting her money in the stock market was the best way to grow it. She saw one of her husband’s investment friends, Benjamin Graham, who at the time was a well respected investor (who later went on to define value investing, and teach other greats, like Warren Buffet).

The banker’s wife asked Benjamin, “What should I invest my money in?” to which Benjamin answered, “never invest your money into something you don’t understand. Invest your money in something you not only understand, but use every day.”

No one knew what the banker’s wife did with her money. Decades later, after her death, it was discovered that she had made a massive fortune, much more than her husband ever made, on the stock market. As it turned out, she followed Benjamin’s advice directly and invested in a revolutionary idea that she was uniquely positioned to appreciate, Tampax, the first makers of modern tampons.

If you don’t know what you’re investing in, you are literally relying on luck. It is possible that some solar panel company that just started up is going to go somewhere, but unless you know about solar technology, or how that industry works, all you can do is hope to get lucky, because you don’t understand what needs to happen for a company to be successful in the solar energy market.

I can’t tell you how much the concept of investing in what you know has changed my money outlook. I have invested in Google, and Visa because I use their products almost every day and I understand how their business models work. I love Netflix, and am very happy that I invested in them 5 years ago, before everyone had a subscription.*

In fact, all my dud investments (and there are a lot of them) have all been in companies I didn’t use or understand.

If you have some extra money you want to play with, and a couple good investment ideas that you personally use daily, then there is no shortage of companies for you to invest in. This means that if you love comic books and video games, invest in Disney (as they own Marvel now, and Star Wars, and have bankrolled all the big superhero movies in recent years). Like playing video games? Put your money where your mouth is, EA and Activision are on the Nasdaq, so is Sony and Xbox. Making lots of money with your home made goods business on Etsy or eBay? Maybe your unique experience makes investing in those companies a good idea to you.

A little more grown up than games and comics, and short of ideas? You should pay for an annual subscription to a publication that analyses individual companies for you. I have subscribed to the Motley Fool before, and indeed, that’s where I first read about investing in Netflix or Marvel. It is a great way to read about what other investors have to say about a lot of popular, and up and coming companies.

* As a full disclosure, I currently own shares in Disney, Google, Netflix and Visa. Though they have been a good investment for me over the years, they might treat you differently tomorrow.

RRSPs – The Taxman Giveth A Bone

taxtreat

Deciding to invest your retirement money in something like the S&P 500 is an important step in setting up your personal finances. Being able to safely grow your money is important, but so is avoiding paying as much tax as possible when it’s time to retire and begin withdrawing from your savings.

Taxes are one of the three main agents of money corrosion (fees and inflation are the other two). If you follow the law, you will always pay some taxes. The trick is to figure out how to pay as little as possible.

Because the Canadian Pension Plan (CPP) pays out so little (currently $640 – $1060 per month), the government has given Canadians an incentive to take care of their own retirements by introducing Registered Retirement Savings Plan (RRSP).

RRSPs are a type of investment account that is registered with the government, they are designed to defer tax payments until you retire. They are not themselves accounts, but an account designation. That means that many types of bank accounts can be used as an RRSP: savings accounts, web broker accounts and mutual funds can all be designated as RRSPs.

The idea behind RRSPs is this:

When you are working, you are making much more money than when you retire. That means you are also paying more income tax too. By putting your money into an RRSP, you get a tax break next time you file your income taxes. If you make $100,000 per year, and you invest $18,000 into RRSPs, the tax break you get is the difference in tax you would pay if you made $82,000 instead of $100,000. The government lets you pay less income tax when you put money into your RRSP.

But later in life, when you retire and start tapping into your RRSPs, you pay regular income tax on whatever you withdraw. Because what you withdraw when you retire is likely to be less than what you made while you were working, you would be paying less income tax on that retirement income. Withdrawing $50,000 a year (for example) will still require you to pay income tax as though you had a regular income of $50,000. But a $50,000 income is in a significantly lower tax bracket than $100,000, you would end up paying far less tax overall.

Not only are you paying less tax when you invest in an RRSP, the money you get back allows you to immediately invest it so that you have even more money that can grow over the years.

Some RRSP facts:

  • The maximum amount you can contribute for 2015 is $24,930, or 18% of your income, whichever is lowest.
  • You can buy and sell equities (stocks) and take a profit in an RRSP without paying any taxes.
  • You cannot contribute if you are 71 or older.
  • You can withdraw up to $25,000 to help with the down payment on your first home, but you have to pay that amount back within 15 years.
  • If you can’t contribute the maximum amount, the difference will be carried over to the next year.
  • You will be charged 1% per month if you contributed more than your contribution limit.
  • When you are ready to retire, you need to convert your RRSP into a Registered Retirement Income Fund (RRIF). You can do that at any time.

Because the money you get back from the government when you contribute to your RRSPs is based on what income tax bracket you are in, the higher the tax bracket, the greater the tax break. But if you are in a lower income tax bracket, the benefits of contributing diminish. You can use an RRSP contribution calculator to see what you would get back from the government if you contributed to your RRSPs.

Using an RRSP calculator, you will notice that if you live in Ontario, make $40,000 per year and contribute $5,000 you will get a return of $1003. But if you make a salary of $100,000 and contribute $5,000 your return more than doubles to $2170.

RRSPs are a great way to help grow your money tax-free, but they are designed for average to above average income earners or households. If that’s not you, that’s OK, because Tax Free Savings Accounts (TFSAs) offer an even better way to save your money, and the benefits of TFSAs apply equally to everyone, as I will explain next week.