Deciding when to start taking your CPP is one of those classic personal finance dilemmas. And, like many such dilemmas, there’s no easy answer. Your CPP pension is a cornerstone of your retirement. It provides you income for life, adjusted for inflation, based on the contributions made by you and your employer while you worked. But—unless you’re an actuary with lots of time on your hands—you’re probably not sure how the complicated calculations that determine your pension work. And you may have heard that CPP changes are in the works—and wonder how that affects you.

Years ago, you weren’t able to start CPP early, so it was simple: you usually drew it at 65, and you got what you got. “Now you get a choice, which is sort of nice,” says actuary Malcolm Hamilton, a partner with Mercer Human Resource Consulting. “But you don’t have any easy way to make that choice, which is sort of not nice.”

Fortunately, we can help. We’ll outline how CPP works, describe the coming changes, explain the calculations, and provide guidance about the factors you should consider before making your decision.

The new CPP
Changes will soon make the CPP more flexible. Right now you have to actually quit your job—or at least earn very little—before you can collect CPP. Once you start your pension it’s essentially set, subject to inflation increases. But come January 1, 2012, you can continue to work and also start drawing CPP. If you do collect your pension and work at the same time, you’ll be required to make further contributions that will add to your entitlement. (The contributions are compulsory until 65, and voluntary thereafter.) You might find this handy if you plan to work part-time in your 60s and you need your CPP benefit to round out your income.

But the changes will also force you to accept a greater reduction in your payouts if you start CPP early. Currently your payout is reduced by 0.5% for each month you start CPP before age 65 (that’s 6% per year). Starting next year the reduction will be 6.24% annually, and it will eventually rise to 7.2% in 2016.

The good news is that if you’re into delayed gratification, there’s a corresponding increase to your CPP payout if you start your pension later than 65. (See “What’s new with CPP?" for more details.)

So far, taking CPP early has been by far the most popular option. About 65% of those who are eligible start their pension before 65, another 30% start it right at 65, and only 5% wait until later. But popular or not, does it make financial sense for you to take CPP early?

It’s not that easy to say. The new adjustments to CPP were designed to ensure that if you live an average life span, there is neither an advantage nor a disadvantage to taking it early. The actuaries have done their best to create a level playing field, based on typical circumstances. “If you’re a ‘normal’ person, this should be a matter of indifference,” says Hamilton. If you start CPP early before the changes, you might come out ahead. Even then, the new rates will be phased in so gradually that it doesn’t make a huge difference overall if you’re about to retire.

But what if you’re not “normal” in some way that’s critical to the CPP calculations? In what follows, we’ll describe three major factors that tend to tilt the decision in favour of taking early CPP. We’ll also describe two circumstances that might encourage you to take CPP at age 65 or later.

Reason #1 for early CPP
You’re in poor health. If you’re in your early 60s and your health is poor, your life expectancy may be shorter than average. So chances are you’ll do better by starting your pension early and collecting more payments at a reduced rate, says Hamilton. If your health is poor enough, you may also not be working much and you might need the cash.

Reason #2 for early CPP
You expect to collect GIS. The Guaranteed Income Supplement (GIS) tops up government pensions for low-income Canadians starting at 65. But most kinds of income—including CPP payments—result in a steep clawback: you give up 50 cents of GIS for every dollar of CPP pension. (Old Age Security payments don’t count against you in the GIS calculation.) That’s a good reason to take your CPP entitlement before 65: lowering your benefit after that age may help you keep more of your GIS benefit.

People who collect GIS “live in a perverse world where anything they can do to get their CPP out before 65 is preferred,” says Hamilton. If you don’t actually need the money, draw CPP early anyway and put it into a Tax-Free Savings Account. Taking money out of a TFSA later won’t trigger a clawback on your GIS payments.

Reason # 3 for early CPP
You spent several years out of the workforce. There’s a good chance this little-known technicality applies to you if you spent a lot of time away from work years ago, and you’re now retiring for good. It’s complicated, so bear with me while I try to explain.

Your pension amount depends on averaging your contributions and “pensionable earnings” from age 18 until you start taking CPP. You’re allowed to drop 15% of your lowest-earning years from the calculation, which amounts to seven years if you retire at 65. If you took time off work to raise kids or because you had a serious disability, you get to drop even more of your low-earning years.

The thing is, it’s easy to use up all your drop-out years if you spent a long time getting an education or just “finding yourself.” If you then stop working in your early 60s and don’t take CPP right away, you’ll immediately start adding more years of zero earnings to the calculation. This will lower your average pensionable earnings, which in turn will make your benefit go down. Under these circumstances, you’re clearly better off starting CPP early.

By my estimates, this factor in isolation can reduce your pension by as much as 2% to 3% for each year you delay taking CPP after age 60. So for people in this situation, the overall net cost of starting CPP early is liable to be 3% or 4% per year (that’s the current 6% overall reduction, minus 2% to 3%). That can make early CPP a bargain.

One MoneySense reader was surprised to discover this the hard way. “It makes no sense,” he wrote. “Since my CPP will start shrinking, it would be insane for me to wait any longer.”

Now let’s have a look at a couple of reasons that might encourage you to start taking your CPP benefit at 65 or later:

Reason #1 for later CPP
You have a longer-than-average life expectancy. If you expect to live to a ripe old age, it pays to delay the start of CPP so you can draw larger monthly payments, because you’ll collect more over time. However, it’s hard to tell in your early 60s whether you’re going to be one of those Methuselahs. Having a lot of exceptionally long-lived forebears provides the best clue. “If all your grandparents lived to be 100, then you probably have a long life expectancy, unless you’re in poor health,” advises Hamilton.

Reason #2 for later CPP
You plan to continue working and earning a good income. Starting in January, you’ll be able to start drawing early CPP even if you’re working full-time. But why start your pension if you don’t need it? Delaying the payments not only helps you avoid seeing your payments adjusted downward—it may also keep you in a lower tax bracket. For similar reasons, if you have started drawing a sizeable employer pension early, you probably won’t need the extra income from CPP.

Final thoughts
Any of these factors might encourage you to take CPP early or later, but there’s one that trumps everything: your genuine need of the money. Taking CPP early won’t maximize your lifetime benefit if you live to 103. “But if you have no viable way to live without the income, then you need the income,” advises Hamilton. And if none of the factors we’ve described tilts your decision one way or the other? Well, then you can’t go too far wrong.

Clad in his work boots and a rain jacket he would alternate between stepping outside our basement door, where the rain came down in big sheets of cold wetness, and ducking into our basement to inspect various parts of our foundation. It would take three more rainstorms, the installation of a sump pump and a complete overhaul of our plumbing before we were able to correct the problem.

That was a rough introduction to the world of home ownership, but I don’t regret buying the place. It’s a great century-old row house in downtown Toronto in an eclectic and vibrant west-end neighbourhood. Still, as I watched the balance on our line of credit creep up to the $40,000 mark, I started to wonder: How much does it cost to maintain a home anyway?

After a bit of research, I found out that the general rule of thumb is that you should expect to spend 3% to 5% of the value of your home every year, on average. For a 40- year-old home worth $500,000 that means you’ll need to set aside up to $25,000 every year. I ran that figure by my husband, who is—as it happens—a commercial and residential general contractor, and he said that sounded high. But is it? We were savvier home buyers than many, but we still underestimated the cost of fixing our drainage issues and the expense of tearing down the garage (“Give it a year and you won’t have to,” one broker told us when were out shopping for insurance).

So, to get a handle on the real cost of maintaining a home, I decided to price out all of the major maintenance and repairs you can expect to perform on a typical 2,000-square-foot detached house in Canada myself.

To do this I looked at two different kinds of upkeep. The first is the regular annual maintenance that every homeowner should do to keep his or her home running smoothly. Things like changing the furnace filters and patching the driveway. The second kind of upkeep includes those once-a-decade expenses that tend to result in migraines. Here I’m talking about things like replacing your hot water heater because it rusted through, or replacing all of your outdated electrical wiring.

To get an accurate figure, I divided up the typical home into its seven major components and tallied up the costs for both large and small jobs over 25 years. I then annualized that amount, so you can make sure that you’re contributing enough to your household maintenance budget every year. I also include tips on regular maintenance you can do to keep those little problems from turning into expensive headaches. But I didn’t include jobs such as interior painting, or upgrading your kitchen cabinets. I focussed on the bare bones maintenance you need to do to protect your home and keep it from deteriorating. In short, if you’re wondering why your car came with a maintenance guide, but your home didn’t—problem solved. Because here it is: A complete maintenance guide for your home.

Ford was quick to capitalize on the endorsements in its ads, and the car was soon flying off dealer lots. But then things started to get a little fuzzy for the Focus. Consumers began reporting chronic stalling, unintended acceleration and collapsing wheels. Suddenly, everyone’s Car of the Year was becoming Ford’s biggest nightmare since the exploding Pinto controversy of the late 1970s.

Focus owners were pretty peeved at the automotive experts who promoted this car and with good reason, says Lemon-Aid author Phil Edmonston.

“Car of the Year awards are pure baloney,” he argues. “They are given out by consumer and auto magazines as an inducement to that magazine’s auto advertisers. In fact, new car buyers would be better served by a Ouiji board’s buying recommendation than a Car of the Year designation put out by any publication.”

Veteran mechanic Eli Melnick, of Start Auto Electric in Toronto, agrees. “Most awards have nothing to do with reliability and performance down the road. It’s always the first model year being looked at, and invariably all manufacturers have issues with new models until they get them debugged.”

Edmonston, who has penned 135 of his own car-buying guides over the last four decades, bases his opinions on owners’ reports, government-recorded safety complaints and confidential automaker service bulletins.

Car of the Year (COTY) awards, on the other hand, are usually decided after a few days of testing vehicles that may have been specially set up by the manufacturers and their teams of mechanics. And although the tests themselves may be demanding and thorough, even those who organize these annual awards admit they can’t measure how well a vehicle will hold up in the long run.

“Over the years we’ve looked at trying to build in ways of looking at reliability and durability, but given the fact most of the cars are brand new to the market, it’s pretty hard,” says Gerry Malloy of the Automobile Journalists Association of Canada.

The same can be said of the car reviews in your newspaper’s automotive section and buying guides found on magazine stands, in bookstores or online. In fact, divining a true picture of your car’s long-term performance can be a tricky business, so we decided to compile our own review of the reviewers.

Consumer Reports
Both a magazine and a website, the U.S.-based Consumer Reports (CR) has no outside advertising. It buys the vehicles it tests anonymously, and it doesn’t permit the commercial use of its reviews by manufacturers.

CR bases its ratings on its own testing and annual surveys sent out to its seven million subscribers. It also offers “predicted reliability” rankings based on the experiences of survey respondents who own earlier models of the same vehicles.

Pros: Well-researched, unbiased and largely immune to outside influence.
Cons: Most information available only to paid subscribers.
Rating: 5/5

Consumer Associations
Non-profit groups like the Automobile Protection Association (APA) and Car Help Canada provide unbiased advice and ratings to the public. Both are funded mainly by annual membership dues.

Although both groups represent consumer interests, the APA has a larger organization and publishes free new and used car guides on its website.

Pros: Canadian-based ratings, focused entirely on consumer protection.
Cons: Most information available only to paid members.
Rating: 4/5

Lemon-Aid Guides
Phil Edmonston has been a bee in the bonnet of car manufacturers for 40 years, spilling the beans on their secret warranties and tracking complaints to government safety agencies. His books offer ratings for both new and used cars, as well as proven advice on fighting back and tips on getting the best value.

Pros: Edmonston pulls no punches and has unmatched insider information.
Cons: Each guide costs about $30—almost half the price of a consumer association membership—and goes out of date in a year or so.
Rating: 5/5

J.D. Power and Associates
U.S. Market research company J.D. Power and Associates surveys car owners on reliability and overall satisfaction. Its most popular reports look at initial quality within the first three months of ownership, as well as three years after purchase.

A for-profit enterprise, critics point out that J.D. Power & Associates earns the bulk of its income from selling research to corporations and licensing the use of its awards in advertising campaigns.

Pros: Good feedback on the first three years survey.
Cons: The first three months survey is limited. Some question neutrality.
Rating: 3/5

The Scribes
Whether they are writing for your local paper, car magazine or website, automotive journalists enjoy free cars for up to a week at a time, and their employers are greatly dependant on automakers and their advertising budgets. All-expenses-paid junkets to exotic locations are also part of the perks for the elite writers.

This doesn’t necessarily mean these journalists are co-opted, but you can bet their editors hear about it if an unflattering article appears, or if an advertiser gets left out of a “best car” list.

Pros: Well-informed opinions from writers who drive nearly as many cars as a hotel parking valet attendant.
Cons: Advertisers can exert pressure on published content and long-term reliability is not often addressed.
Rating: 3/5

Much of that internal grappling comes from misunderstanding how the stock market really works. Couple that misunderstanding with our race to become rich, and we do everything wrong. We buy when our mutual funds are soaring, then we sell them or cease adding to them when they slump. We give up much of our gains to pricey fund managers, even though after fees, their funds trail the performance of cheaper investing options such as index funds. We’re confident we can predict where the market is going, though even the professionals have a terrible track record when it comes to forecasting the market’s ups and downs. In short, our greed and confidence can work against us, keeping us from realizing our true investing potential.

I can’t promise to collar your inner doppelganger, but I can help you understand how the stock market works—and how human emotions can sabotage the best-laid plans. Once you understand how your own all-too-human behaviour is affecting your investing, you’ll experience greater financial success.

When a 10% gain isn’t a 10% gain
Imagine a mutual fund that has averaged 10% a year over the past 20 years, after all fees and expenses. Some years, it might have lost money; other years it might have profited beyond expectation. It’s a roller coaster ride, right? But imagine, on average, that it gained 10% annually through all the bumps, rises, twists, and turns. If you found a thousand investors who had invested in that fund from 1990 to 2010, you would expect that each would have netted a 10% annual return.

But on average, they wouldn’t have made anything close to that, because most investors shoot themselves in the foot. When the fund has a couple of bad years, too many investors react by putting less money in the fund, or stopping their contributions entirely. They’re often prompted by their investment advisers, who say, “This fund hasn’t been doing well lately. Because we’re looking after your best interests, we’re going to move your money to another fund that is doing better at the moment.” And when the fund has a great year, most individual investors and financial advisers scramble to put more money in the fund, like feral cats around a fat salmon.

This behaviour is self-destructive. Investors sell or cease to buy after the fund has become cheap, and they buy like lunatics when the fund becomes expensive. If there weren’t so many people doing it, we would call it a “disorder” and name it after some dead Teutonic psychologist. This kind of behaviour ensures that investors will pay higher-than-average prices for their funds over time. Whether it’s an index fund or an actively managed mutual fund, most investors perform far worse than the funds they own—because they like to buy high, and they hate buying low. That’s a pity. And it can make the difference between retiring early and not retiring at all.

John Bogle, the founder of U.S. investment management giant The Vanguard Group, describes in his 2007 book, The Little Book of Common Sense Investing, that the average actively managed U.S. mutual fund reported a 10% annual gain from 1980 to 2005 after fees and expenses, but investors in those funds averaged just 7.3% over the same period. Their fear of low prices prevented them from buying when the funds were low, while their elation at high prices encouraged purchases when fund prices were high. Such bizarre behaviour has devastating financial consequences, as investors give away 2.7% annually because of their knee-jerking alter egos.

As this example shows, over a 25-year period, that’s a pretty expensive habit:

$50,000 invested at 10% a year for 25 years = $541,735.29
$50,000 invested at 7.3% a year for 25 years = $291,046.95
Cost of irrationality = $250,688.34

But what if you didn’t care what the stock market was doing?
As investors, you really don’t have to watch the stock market to see if it’s going up or down. In fact, if you bought an index fund for 25 years, with an equal dollar amount going into that fund each month (called “dollar-cost averaging”) and if that fund averaged 10% annually, you would have averaged 10% or more. Why more? If you put a regular $100 a month into a fund, that $100 would have bought fewer units of that fund when prices were high, but it would have bought more units of that fund when prices were lower.

Most investors don’t do that—they exhibit nutty behaviour
Combine the crazy behaviour of the average investor with the fees associated with actively managed mutual funds, and the average investor ends up with a puny portfolio compared with the disciplined investor, who puts in the same amount of money into index funds every month. The following table categorizes the behaviour of the two types of investors, assuming both will be working—and adding to their investments—for at least the next five years.

I’m not going to suggest that all index investors are evolved enough to ignore the market’s fearful roller coaster, while shunning the self-sabotage caused by fear and greed. But if you can learn to invest regularly in index funds and remain calm when the markets fly upward or downward, you’ll grow far wealthier. Below, you can see examples, based on actual U.S. returns between 1980 and 2005.

The figure on the left side ($84,909.01) is probably generous. The 10% annual return for the average actively managed fund has been historically overstated because it doesn’t include sales charges, adviser wrap fees, or the added liability of taxes in a non-registered account.

Disciplined index investors who don’t sabotage their accounts can end up with a portfolio that’s easily twice as large as that of the average investor over a 25-year period.

Small details like these can allow people with middle-class incomes to amass wealth more effectively than their high salaried neighbours—especially if the middle-class earners think twice about spending more than they can afford. Even if your neighbours invest twice as much as you each month, if they are average, they will buy actively managed mutual funds, and they will either chase hot performers or fail to stay committed to their investments when the markets fall. They’ll feel good about buying into the markets when they’re expensive, and they won’t be as keen to buy when they’re on sale.

I don’t want you to be like your neighbour. Avoid that kind of self-destructive behaviour and you’ll build more wealth.

It’s not timing the market that matters; it’s time in the market
There are smart people (and people who aren’t so smart) who mistakenly think they can jump in and out of the stock market at opportune moments. It seems simple. Get in before the market rises and get out before it drops. This is referred to as “market timing.” But most financial advisers have a better chance beating Roger Federer in a tennis match than effectively timing the market for your account.

Vanguard’s Bogle, who was named by Fortune magazine as one of the four investment giants of the 20th century, has this to say about market timing:

“After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. I don’t even know anybody who knows anybody who has done it successfully and consistently.”

When the markets go raving mad, jumping in and out can be tempting. But stock markets are highly irrational, and characterized by short-term swings. The stock market will often fly higher than most people expect during a euphoric phase, while plunging further than anticipated during times of economic duress.

Doing nothing but regularly putting money into an index fund might sound boring during a financial boom, and it might sound terrifying during a financial meltdown. But the vast majority of people (including professionals) who try jumping in and out of the stock market allow their emotional judgments to hurt their profits, as they often end up buying high and selling low.

What can you miss by guessing wrong?
Studies show that most market moves are like the flu you got last year, or the mysterious $10 bill you found in the pocket of your jeans. In each case, you don’t see it coming. Even when looking back at the stock market’s biggest historical returns, Jeremy Siegel, author of Stocks for the Long Run and professor of business at University of Pennsylvania’s Wharton School, suggests that there’s no rhyme or reason when it comes to market activity. He looked back at the biggest stock market moves since 1885 (focusing on trading sessions where the markets moved by 5% or more in a single day) and tried connecting each of them to a world event.

Seventy-five percent of the time, he couldn’t find logical explanations for such large stock market movements—and he had the luxury of looking back in time, and trying to match the market’s behaviour with historical world news. If a smart man like Siegel can’t make connections between world events and the stock market’s movements with the benefit of hindsight, then how is someone supposed to predict future movements based on economic events—or the prediction of events to come? It’s as improbable as guessing which of the moths frantically flying around your light bulb is going to be fried first.

If anyone ever convinces you to act on their short-term stock market prediction, it could end up being a very expensive mistake. Let’s look at the U.S. stock market from 1982 through December 2005 as an example.

During this time, the stock market averaged 10.6% annually. But if you didn’t have money in the stock market during the 10 best trading days, your average return would have dropped to 8.1%. If you missed the best 50 trading days, your average return would have been just 1.8%. Markets can move so unpredictably, and so quickly. If you take money out of the stock market for a day, a week, a month, or a year, you could miss the best trading days of the decade. You’ll never see them coming. They just happen. More importantly, as I said before, neither you nor your broker is going to be able to predict them.

Legendary investor and self-made billionaire Kenneth Fisher, who writes a column in Forbes magazine, had this to say, about market timing:

“Never forget how fast a market moves. Your annual return can come from just a few big moves. Do you know which days those will be? I sure don’t and I’ve been managing money for a third of a century.”

The easiest way to build a responsible, diversified, investment account is to invest regularly with stock and bond index funds. Many people view bonds as boring because they don’t produce the same kind of long-term returns that stocks do. But they don’t fall like stocks are apt to do either. They’re the steadier, slower, more dependable part of an investment portfolio. A responsible portfolio has a percentage allocated to the stock market and a percentage allocated to the bond market, with an increasing emphasis on bonds as the investor ages.

But when stocks start racing upward and everyone’s getting giddy on the profits they’re making, most people ignore their bonds (if they own any at all) and buy more stocks. Many financial advisers fall prey to the same weakness. But those ignoring their planned allocations between stocks and bonds set themselves up for disaster.

How can you ensure that you’re never a victim? It’s far easier than you might think. If you understand exactly what stocks are—and what you can expect from them—you’ll fortify your odds of success.

On stocks: What you really should have learned in school
The stock market is a collection of businesses. It isn’t just a squiggly bunch of lines on a chart or quotes in the newspaper. When you own shares in an equity index fund, you own something that’s as real as the land you’re standing on. You become an indirect owner of all kinds of industries and businesses, via the companies you own within your fund: land, buildings, brand names, machinery, transportation systems, and products, to name a few. Just understanding this key concept can give you a huge advantage as an investor.

Business earnings and stock price growth are two separate things, but over the long term they tend to reflect the same result. For example, if a business grew its profits by 1,000% over a 30-year period, we could expect the stock price of that business to appreciate similarly over the same period.

It’s the same for a stock market index. If the average company within an index grew by 1,000% over 30 years (that’s 8.32% annually) we could expect the stock market index to perform similarly. Long term, stock markets predictably reflect the fortunes of the businesses. But over shorter time periods, the stock market can be as irrational as a crazy dog on a leash. And it’s the crazy dog’s movements that can—if we let them—lure us closer to poverty than to wealth.

The stock market is a dog on a leash
I used to have a dog named Sue who behaved like we were feeding her rocket fuel instead of dog food. If you turned your back on her in the backyard, she’d enact a scene from the television show Prison Break, bounding over the five-foot-high fence in our yard and straining diplomatic relations between our family and those whose gardens she would destroy.

When I took her for extended runs in open fields, she was able to burn off some octane. I would run in a single direction while she darted upward, backward, right, then left. But collared by a very long rope, she couldn’t escape.

If I ran from the lake to the barn with Sue on a leash, and if it took me 10 minutes to get there, then any observer would realize it would take the dog 10 minutes to get there as well. True, the dog could bolt ahead or lag behind while sticking its nose in a gift left behind by another canine. But ultimately, she couldn’t cover the distance much slower or much faster than I did—because of the leash.

Now imagine a bunch of emotional gamblers who watch and bet money on leashed dogs. When a dog bursts ahead of its owner, the gamblers put money on that dog, betting that it will sprint far off into the distance. But the dog’s on a leash, so eventually it’s destined to either slow down or stop while the owner catches up.

But the gamblers don’t think about that. They ignore the leash and place presumptuous bets assuming that the dog will maintain its frenetic pace. Their greed wraps itself around their brains and squeezes. Without that cranial compression, they would see that the leashed dog couldn’t outpace its owner.

It sounds so obvious, doesn’t it? Now get this: the stock market is exactly like a dog on a leash. If the stock market races at twice the pace of business earnings for a few years, then it has to either wait for business earnings to catch up, or it will get choke-chained back in a hurry. But a rapidly rising stock market can cause people to forget that reality: they pile larger and larger sums into stocks with delusional confidence. I’ll use an individual stock to prove the point.

Coca-Cola bounds from its owner
From 1988 to 1998, the Coca-Cola Company increased its profits by 294%. During this short period (and yes, 10 years is a stock market blip) Coca-Cola’s stock price increased by 966%. Because it was rising rapidly, investors—including mutual fund managers—fell over themselves to buy Coca-Cola shares, pushing the share price even higher. Greed might be the greatest hallucinogenic known to humanity.

The dog (Coca-Cola’s stock) was racing ahead of its master (Coca-Cola’s business earnings). A rational share price increase must be in line with profits. If Coca-Cola’s business earnings increased by 294% from 1988 to 1998, we would assume that its stock price would grow by a percentage that was at least similar, maybe a little higher, and maybe a little lower. But Coca-Cola’s stock price growth of 966% was irrational.

Coca-Cola’s stock price vs. Coca-Cola’s earnings

Can you see what happened to the blazing Coca-Cola share price (in dark blue) when it got far ahead of Coca-Cola’s business profits (in light blue)? The dog eventually dropped back to meet its owner. After blazing ahead at 29% a year for a decade (from 1988 to 1998) Coca-Cola’s stock price eventually “heeled.” It had to. You can see in the chart that the stock price was lower in 2011 than it was in 1998. But, during the past 21 years, when were most people drunkenly pouring money into Coca-Cola shares? In the late 1990s. Why? Because the stock had been “performing well.” And most of those investors haven’t made a penny in profits over the last dozen years. Too many of them either sold or shunned the shares when the stock became cheaper in 2003 and 2004.

Ironically, a $10,000 investment in Coca-Cola stock in 1990 would have been worth nearly $100,000 by early 2011 (in U.S. dollars) with reinvested dividends. That’s an annualized return of about 11.5%. But few Coca-Cola shareholders earned anything close to that because of their giddy preference for rising prices and their fear of discounts.

I’m not suggesting that you should run out and buy Coca-Cola shares. What I am suggesting is that whether people invest in index funds, actively managed mutual funds or individual stocks, most investors significantly underperform the investment products they own.
If you can defeat that enemy in the mirror by investing regular monthly sums—or by increasing your contributions when the markets fall—you can make twice as much money as your neighbour, even if you own the exact same investments.

Excerpted with permission of the publisher John Wiley & Sons, Inc., from Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School by Andrew Hallam. Copyright © 2011 by John Wiley & Sons (Asia) Pte. Ltd. This book is available at all bookstores, online booksellers and from the Wiley website at www.wiley.ca or call 1-800-567-4797. More information at facebook.com/millionaireteacher.

]]> http://www.moneysense.ca/2011/10/03/the-enemy-in-the-mirror/feed/ 1 http://www.moneysense.ca/2011/09/30/fixer-upper-or-money-pit/ http://www.moneysense.ca/2011/09/30/fixer-upper-or-money-pit/#comments Fri, 30 Sep 2011 17:47:46 +0000 Romana King http://www.moneysense.ca/?p=18852 The “fixer-upper.” The “handyman’s special.” The home that needs “tender, loving care.” Some buyers run in the other direction when they see a listing containing those phrases. The handyman buyer starts salivating at the thought of big savings.

After all, if you’re good with your hands you can buy a fixer-upper for a song and transform it into the home of your dreams. It’s a chance to create a custom home that you’d never be able to afford otherwise. At least, that’s how it works in theory.

Problem is, lurking among those handyman specials are the dreaded money pits. These homes have massive hidden problems that suck your bank accounts dry before you even get started on the work you were intending to do. To save your finances, and your sanity, here are four tips on how to spot—and avoid—the money pit.

Beware rock bottom prices
For Joyce Wayton and her husband Craig, that low, low price was the reason they bought their four-bedroom, two-bathroom home in Lower Sackville, N.S. Located in a neighbourhood where homes usually sell for $250,000, the Waytons snapped up their bungalow for only $120,000. (We changed their names to protect their privacy.)

They knew the home had issues: for almost 15 years it had been rented out and, as Joyce says, “it was not well-maintained.” There were broken windows. The garden was overgrown and the kitchen and bathrooms needed updating. But it had potential, says Joyce. “I could definitely see our kids growing up in that house.”

Initially, the Waytons planned to gut the basement and update the main floor, eventually adding a second-floor addition to accommodate their four young children. They had a modest budget of $40,000, but they were willing to do a lot of the work themselves.

Once they moved in and started opening up walls, however, their plans got shelved. Almost immediately they found knob and tube wiring throughout the house. Then they discovered there was no insulation in their ground-level basement. The fireplaces were inoperable. Worse, the basement demolition exposed a big crack in the foundation that ran the length of the house.

Charles Sezlik, an Ottawa-based realtor, says the too-good-to-be-true price that the Waytons paid should have raised big red flags. If a home is much cheaper than other similar homes in the area, “you need to dig to learn what’s wrong with the place,” he says. At the end of the day, dramatically underpriced homes usually mean big problems.

Get it inspected
Joyce confesses they didn’t bother having the home inspected by a professional before they bought. Instead, they relied on her husband’s construction experience. But even if you have some knowledge of home building and repair, it’s worth paying for an objective outsider’s second opinion, says Sezlik.

If you’re looking at a real fixer-upper, he suggests finding a home inspector with a background in structural engineering. “You’ll pay more up front but you’ll save thousands in the long run,” he says, because such an inspector is more likely to find hidden, expensive-to-fix structural issues.

The biggest money-sucking problems to look for during the inspection include foundations built on mixed granular, pervasive musty smells (which indicates a mold-infestation), and foundation cracks that appear to have widened over time.

Is your fix-it-up budget realistic?
You can’t tell if a fixer-upper is a good deal unless you know how much it will cost to turn your diamond in the rough into a gem, so it’s important that you get that estimate right. Your home inspector’s report, along with various online tools, can help you get a grip on what your renovation budget should be. But these tools can’t estimate the complexity of a project—and complexity adds to cost.

So once you’ve created a budget, experienced renovators say you should add another 50% to it, as a contingency fund. Then add that larger budget to the cost of your fixer-upper. If the total is more than the price of similar homes in the area that have already been renovated, it may not be a deal.

Know when to walk away
If, like the Waytons, you have already bought a place and it’s slowly dawning on you that you’ve bought a money pit, at some point you have to decide whether to keep moving forward.

The key here is to be honest with yourself. If you have a history of being overly optimistic about how much it would cost to complete various renovations, get a professional in to help cost it out. Then ask yourself: Do you really have enough time, patience and money to do the renos you need to do? If not, you might want to put that money pit right back on the market.

The Waytons had hoped to do all the work they needed on their house, plus add a second floor for their kids, for $40,000. But they ended up spending $30,000 just to fix unexpected plumbing, electrical and roofing issues. Eventually, they realized there was no way they were going to get the extra bedrooms they needed. So they’ll spend another $15,000 completing the last of the necessary repairs, then list their home for sale. If they’re lucky, sighs Joyce, they’ll at least break even.

However, estate law is extremely complex, says Michael Prsa, an estate lawyer in Brampton, Ont. “I’ve seen many situations where one wrong word in a so-called ‘simple will’ has led to a major mess.” Expect to pay a lawyer around $350 for a garden-variety will, more if detailed tax planning or bequests are involved.

Hunting and gathering
Before drawing up a will, make a list of all your assets, what they cost, what they’re worth, and where they are located. (Assets held jointly, such as a house or bank account, may not be covered by a will.) Then list your intended beneficiaries, their relationship to you, where they live and how old they are. If you want to leave bequests to charity, find out their exact names and addresses.

Get educated
A will is your chance to decide what happens to your stuff once you’re gone. But there are rules limiting your ability to ignore certain people. Children from an earlier marriage or an ex-spouse may have a claim on your estate, even if you’d rather they didn’t. Leaving them out of your will could lead to protracted legal claims and unnecessary confrontations between your heirs later on.

“You should carefully consider the practical and emotional impact of your will,” says Prsa.

The right person for the job
One of the most important decisions is picking the executor who will carry out your final wishes. Most people pick a spouse or adult child, but “this can get very complicated very quickly, particularly in blended families,” says Prsa. In some cases, it makes more sense to pick a neutral third party or a trust company.

It’s also smart to provide alternate choices for your executor, the proposed guardian of any minor children, and your beneficiaries.

Upgrade as necessary
A marriage immediately invalidates any pre-existing will, but a divorce only cancels out any mention of your ex: the rest of your wishes remain valid. These legal oddities make it crucial to keep your will as up-to-date as possible. Simple changes can be addressed with a codicil, but bigger changes will require a whole new will.

So Diaz (we changed her name to protect her privacy) wrote a cheque and her mother agreed to pay her back. But no payments were forthcoming. “I didn’t need the money right away so I never bothered her about it,” said Diaz.

A few months later Diaz’s mother asked for another $600, and Diaz wrote another cheque. But on her next visit to her mother’s house, Diaz noticed a new 42-inch flat-screen TV sitting in her mother’s living room. “Obviously, Mom was confusing needs with wants and probably had no intention of ever paying me back,” says Diaz. “I was hurt.”

Diaz’s situation is more common than you think. It’s difficult to say no when your parents ask for a financial bailout, but sometimes it’s the right thing to do. “Adult children should deal with their elderly parents much the same way as they do with their own adult children,” says Gary Buffone, a psychologist specializing in money matters. “Let them make their own choices. If possible, educate them—and then let them live with the consequences.”

If your parents ever put you in an awkward position by asking for help, these tips will help minimize the damage.

Get it in writing
If you decide to lend your parents money, you should at least create a paper trail. “Write out a loan agreement and specify the terms,” says Barbara Wickens, co-author of Now What? A Practical Guide to Dealing with Aging, Illness and Dying. “If your parents don’t have the cash flow to pay you back, set it up so it’s repaid from the estate upon their death.”

Offer to help them budget
If your parents are problem spenders, instead of financial help, offer to help them with their budgeting. If they have severe spending problems, you could also arrange for them to see a financial counsellor. “This strategy is much more effective than simply writing them a cheque,” says Wickens.

Offer help in kind
If you don’t like the idea of giving your parents an allowance, consider helping in other ways. “I had a friend who brought groceries and a metro pass over to her mom’s house monthly,” says financial therapist Amanda Mills. “Her mom knew that would be the extent of the help, but it left her with a few extra dollars every month to spend as she liked—no questions asked.”

Whatever you decide to do, try to help in a way that allows your parents to keep their dignity, and don’t let an unpaid loan poison your relationship. “By all means give if you can afford it,” says Wickens. “But recognize that it’s a gift, because chances are that if your parents are on a tight budget, they probably won’t be able to pay you back.”

Gerry and Fiona (we’ve changed their names to protect their privacy) have stock investments valued at $1.27 million and a pair of rental properties. After paying off their debts, their net worth would be well over a million. In fact, Gerry thinks he and Fiona can quit their jobs today and live off the income from their investments for the rest of their lives.

“I just finished a sabbatical from my job and it’s given me a taste for life outside the office,” says Gerry, who spent most of his year off being a stay-at-home dad to his two-year-old daughter, Phoebe. “I’m ready to move on to a new phase of my life.”

There is one wrinkle, however—they have another baby due in September. “Fiona and I have always lived on less than one income,” says Gerry. “But we know kids are expensive. Can we continue living frugally with two kids? We’re not sure.”

Fiona, who is 36, earns $22,000 a year as a part-time social worker, while Gerry earns $60,000. In their spare time, they do
volunteer work with the cancer society, several local charities, and with a girls’ orphanage in Costa Rica. “If we have enough money, why not just quit our jobs and do more of what we love—charitable work?” says Fiona.

Gerry has run the numbers and feels his family can live on $45,000 in after-tax income a year. But he’s not sure their investments will be able to generate enough money to cover their expenses for the rest of their lives. “I don’t mind working part-time a few more years if I have to,” says Fiona. “But I really think we may have enough assets to provide us with a good income to old age.”

Even if they have enough, there’s another problem: the couple’s portfolio is full of risky, volatile stocks. Gerry knows he needs to restructure his portfolio so that it is more conservative and tax-efficient. “I know I’m not the one to do that,” says Gerry. “I know nothing about conservative portfolios. It will be our biggest challenge.”

One of their strengths, on the other hand, is the fact that the Gardas have more than their stock portfolio to depend on in retirement. By the time Gerry turns 55, he expects to have paid off the mortgages on his two properties, which will provide $20,000 a year in rental income. He’ll also start collecting a pension of $1,600 a month, earned during his years with the provincial government. But even with all that, Gerry is apprehensive. “I think we’ll need $45,000 a year, but I could be wrong. We need to be certain we’re really ready to go it alone before we leave our jobs. Can you help us?”

Fiona has always been good with money. She grew up in Vancouver, where her mother was a nurse and her dad a car salesman. “My parents’ biggest investment was their home, which they bought in Vancouver for $60,000 in 1976,” says Fiona. “It’s worth $1.2 million today.”

Fiona worked part-time through high school at the local McDonald’s before enrolling at university in Victoria in 1992. During her four years there, she took part-time jobs while completing a bachelor’s degree in social work. By the time she graduated, she had $20,000 in the bank. “I never had student debt,” says Fiona. “I worked constantly, lived frugally and grew my savings the whole time I was at university.”

Gerry’s early home life wasn’t as comfortable. He was born in Regina, and when he was three his father left, leaving his mother to raise both him and his older brother, Matthew. She remarried when Gerry was 12. “Mom worked as a waitress during the day and attended university at night. When I was 10, she graduated with a teaching degree. She taught us kids to be industrious.”

At nine, Gerry had his own paper route. In high school he worked evenings at the local Woolco store and read investment books voraciously. “I just wanted to make money,” remembers Gerry. “Those were the days when you had to call your broker to buy and sell a stock. I wasn’t old enough, so I had my brother place the trades for me.”

Gerry studied for a couple of years at the University of Regina, but quit before earning his degree. Instead, he went to technical school where he studied resource management. All along, Gerry kept investing and his portfolio grew to about $18,000 in 1994. Then the bottom fell out. “I had all my money in gold stocks,” he says. “When the market turned, I lost everything. Even today, I won’t touch commodity stocks.”

In 1995, Gerry got a job with the Ministry of Transportation in Vernon, and with a small down payment he bought a house. That’s also when he met Fiona at a friend’s barbecue. A year later they moved in together. Gun-shy from his losses, Gerry temporarily gave up stock picking and concentrated on saving instead. “Fiona and I parked every penny we made in mutual funds for six years, and we had $150,000 saved by the time I turned 30. We were cheap. We didn’t own a car, we grew our own vegetables, biked everywhere and bought very little furniture.”

In 1997, the Gardas married and received a cash gift of $45,000 from Gerry’s mom. They invested the money, along with $20,000 of Fiona’s savings, in their home and the two rental properties they still own today.

It wasn’t until 2001 that Gerry decided to sell the $150,000 worth of mutual funds that he and Fiona had accumulated and give stock investing another try. “I’m drawn to small caps—especially when everyone hates them,” says Gerry. “If their price drops, I buy more. As long as the stock’s main narrative hasn’t changed, I’ll hold on.”

Gerry is a focused investor. He only invests in sectors that he understands—communications, technology, and health care—and he never owns more than 10 stocks at a time. Most importantly, he stays engaged. “I spend three hours a day doing research. I ignore what’s happening in the daily news—that’s just noise.”

Right now, Gerry’s portfolio includes Cisco, Intel and RIM, as well as a couple of “cloud computing” companies that Gerry believes are the way of the future. “The new direction for tech stocks is in its infancy,” he says. “Tech stocks are just starting a new cycle of growth.” He’s quite happy to wait out a few ups and downs, as long as he knows he’ll never have to sell in a panic. “If I lost all my stock money tomorrow, I wouldn’t worry, but that’s because I earn a good salary. But I can’t invest this way if I don’t have a regular salary. Now that’s risky.”

In 2006, Gerry and Fiona discovered a new love: giving back to their community. They also have a connection with a special charity. “We were in a bar in a tiny town in Costa Rica,” says Fiona. “We asked what there was to see nearby, and one of the locals took us to a girls’ orphanage. We were hooked.”

The Gardas donate about $2,000 annually to the orphanage—enough to send a couple of girls to university every year. “Do you know how rewarding that is—knowing you can change someone’s life for so little?” says Fiona. “It’s a fantastic feeling.”

If the couple retires now, their big concern will be having enough income to pay expenses for the next 15 years, until they can get by on Gerry’s pension and their rental income. “For the near future, our investments have to do all the heavy lifting,” says Gerry. “That’s crucial for our plan to work.”

The Gardas are carrying some large debts. Their mortgage is structured as a $195,000 line of credit, which they service with the income form their stock portfolio. They also owe $313,000 in a margin account at 3%. Their two rental houses have mortgages totalling $410,000, which will be paid off by the time Gerry turns 55.

The couple has always kept their expenses low. With both of them working, they save more than $14,000 a year, which goes directly into RRSPs and Gerry’s stock portfolio. “We’re big do-it-yourselfers—renovations, cooking and gardening,” says Gerry. “It keeps costs down, savings up and us busy.”

One thing is certain: when the couple does retire, Gerry won’t miss his job one bit. “I’m just going through the motions now,” he says. “I want to do something more meaningful with my life. We’re keeping our fingers crossed, hoping a new life is just waiting for us to grab it.”

What the experts say
Karin Mizgala, CEO of Money Coaches Canada, says the Gardas will be relieved when they crunch the numbers. “Over the long run, their income will cover their expenses.” The key, she says, is the couple’s frugal lifestyle. “The less you spend, the earlier you can retire,” Mizgala says. “But few people ever consider a more frugal life until I walk through the numbers with them. They have become convinced by the media that they need $2 million before they can retire. For most of us, it’s much, much less than that.” Here’s what the Gardas should do.

Calculate what they have now
Once they pay off the margin loan and their line of credit, the Gardas’ investment accounts will be valued at about $920,000. This is the money they will have to depend on, at least until age 55, to fund almost all of their $45,000 in annual after-tax expenses.

Start deleveraging
The couple cannot retire with a leveraged stock portfolio. “They are in danger territory,” says Jim Otar, a Certified Financial Planner and author in Toronto. “Their exposure to risk is highly amplified.” Otar notes that a not-so-unusual 40% correction in their holdings means the couple would lose 62% of their net investments. “They should pay off all their debts before quitting their jobs,” says Otar.

Give the portfolio a makeover
Selling their stocks may take the Gardas up to three years, because it will trigger capital gains or losses. The Gardas need to spread these over two or three years to minimize taxes. They should get help from a tax accountant to do this.

Then the portfolio needs to be rebuilt. Laura Wallace, vice-president and portfolio manager with Scotia Asset Management in Toronto, recommends a mix of 50% equities and 50% fixed income. To ensure regular income, inflation protection and tax-efficiency, the portfolio should include at least 20 dividend-paying stocks, as well as government and corporate bonds with staggered maturities. Most of the dividend stocks should be Canadian, as the dividends get favourable tax treatment. “Such a portfolio can be expected to generate an after-tax return of about 5%—enough to cover their annual expenses,” says Wallace.

Consider working six more years
Although Gerry and Fiona could probably retire today, the experts hesitate to recommend this strategy. That’s because as their kids get older, $45,000 in income may not be enough. “The likelihood that expenses will increase substantially after the kids turn five is high,” says Wallace.

That’s why if Gerry really wants to retire now, Fiona should consider keeping her part-time job for a few more years. “They should take only what income they need from the portfolio while Fiona is still working.” If Fiona is bringing in $20,000 after taxes, they will only have to draw about $25,000 from their investments, says Wallace. “This will provide a good financial cushion.”

Otar is more cautious. He’d like to see both Gerry and Fiona work six more years, until Gerry is 47. “If the couple is unlucky enough to experience a worst-case scenario in the coming years—higher inflation, a steep stock market decline, a crash in the housing market—their investments will take a big hit,” he says.

If the Gardas take Otar’s advice, then at age 55 their investment portfolio should still be worth about $1,000,000—even with $45,000 to $50,000 in annual withdrawals over those eight years. At that time, the couple will also have at least $1,600 in monthly income from Gerry’s government pension (a bit more if he works until 47) as well as $20,000 annually from their then fully paid-off rental houses. With CPP payments at 60, that should be more than enough to last the Gardas well into their 90s.