“One” is usually the best number to be…except when it comes to financial planning. Imagine if you only had one income stream, one investment, one insurance plan, etc. As the saying goes, putting all your eggs in one basket is taking a big risk, and in the financial world, it doesn’t allow for what we call “diversification.” In today’s blog post, I’m going to talk about why I highly encourage you to avoid the number “one” and why it is the worst number when it comes to financial planning and wealth creation.
WHAT IF YOU HAD…
ONE Income Stream?
If you were reliant on only one source of income, you are adding a lot of risk to your retirement plan. The rules can change at any time, so it isn’t smart to rely on a single income stream. What you want to do is to look at the different types of income. Most people have one primary job, but consider looking for diversity in places other than your salary. Include your bonuses, pensions, RIFs, good dividend paying investments, rental income, etc. when you’re listing the variety of sources.
ONE Investment?
What if you had only one single security? Sir John Templeton famously said, “The only investors who shouldn’t diversify are those who are right 100% of the time.” I cannot stress how important nor how true these words are. Don’t have a narrowly focused portfolio. Instead, build a globally diversified portfolio. Here’s a simplified four-step process for taking action against having a single investment:
1. Determine your mix of equities and fixed income, i.e. stocks and bonds
2. Determine your geographic mix of economic opportunities around the world
3. Identify, analyze and invest in the best opportunities of each component in your portfolio’s markets
4. Consider asset classes that have low correlation to one another. This refers to stocks, bonds, and alternative investments such as commercial real estate and private equity.
The most important tip to remember is that you must find the appropriate solutions for YOU. If your paperboy qualifies for the same type of investments that you are in, then you’re probably in the wrong place. Consider migrating your portfolio to a more appropriate investment solution that is better suited and priced for the threshold you are in. See here for more information on the four tiers of investment solutions.
ONE Education Plan?
In Canada, there are a number of options available that can help fund a child’s education: a) RESP, b) an in-trust account, and c) EPSP.
a) RESP—A Registered Education Savings Plan allows you to make contributions that are set aside for your child’s education. A 20% Canada Education Savings Grant gives you 20% of the first $2,500 you put into your RESP each year. That’s an extra $500 that you can take advantage of, so it’s a fantastic return. Do remember, though, to hold off on putting in too much at once because you want to be able to receive that free $500 each year.
b) In-Trust Account—An informal in-trust account allows you to transfer any capital income to your child. The deferral nature of growth-oriented investments means that tax is deferred to the future and any tax on the capital gain income will be taxable in your child’s hand. There are no restrictions as to how or when your child takes out the money.
c) EPSP—An Employee Profit Sharing Plan is a great solution for business owners. This is a plan registered in advance with the Canada Revenue Agency (CRA) and allows you to share your income among your family members. One big advantage lies in the ability for you to transfer the tax burden over to your child and take advantage of the lower marginal tax bracket. A second advantage of this solution is that you can avoid the kiddie tax (tax on a child’s income that is taxed at the highest federal tax rate of 29%) that you face when paying your kids a salary. With an EPSP, you can distribute the profits of the company to them and the money will flow from the business straight to your children to help pay for their education.
ONE Insurance Policy?
Our clients often say that they have group benefits, but group benefits don’t necessarily cover everything that you could be protecting. What you need is a diversified insurance portfolio. The first rule of insurance planning is to solve temporary problems with temporary solutions, and permanent problems with permanent solutions.
a) Dependency Coverage—This is the period of time during which you have dependents, i.e. the time when your children are reliant on you. Typically, this will be the first 20-25 years of their lives. Since this dependency has an allocated time frame, it is therefore a temporary problem. The temporary solution = term life insurance, where one makes regular premium payments in exchange for protection.
b) Estate Erosion on Death of Second Spouse—After the death of the first spouse, assets get rolled over to the other spouse in what’s called a spousal rollover. When the second spouse passes away, the CRA assumes you had liquidated all your assets and performs a calculation to tax you accordingly. In insurance planning, this calculation is performed in advance by your advisor and is based on what you hope to have happened over the course of your life and your spouse’s. Estate erosion is a permanent problem and requires a permanent solution: permanent life insurance.
*Consider adding a tax-sheltered investment account to your permanent life insurance policy. The desire to tax shelter is a lifelong goal. Taking advantage of the only option in Canada that allows you to have tax-sheltered wealth accumulation on nonregistered investments in the insurance industry has one of the biggest benefits for your wealth and estate planning needs.
c) Accident or Sickness Affecting Income
This is another temporary problem since the risk of not being able to earn income occurs during your working years. Essentially, the only solution to this issue is long-term disability insurance. Find out exactly what your long term disability insurance covers and whether or not you are adequately covered during your working years.
d) Risk of Cash Flow
We just mentioned the risk of losing income during your working years, but long term disability insurance isn’t enough sometimes, since it only covers you up to the age of 65. When a serious injury affects your ability to perform activities of daily living, e.g. showering and driving, you will need to find alternate ways to accomplish your tasks. Expenses such as hiring a helper will be paid from your cash flow and other investments, so secure a long-term care plan in place to take care of these costs. Check out these dos and don’ts of long-term care insurance.
While “one” is usually the best number to be, it’s not the case in financial planning. As you transition into retirement and beyond, enjoy the advantages of diversification. Avoid the number “one” in your financial plan—you’ll be better off without it.
