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Financial tips as you climb the financial ladder

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This article is the sixth in a series on personal finance and investing at different stages of your life. As some issues may overlap the different stages of life, they could be covered in a prior or subsequent article. For the full series go here.

You are in your thirties or forties, moving up to higher levels of income in your career. Your children are growing up and you are making good progress paying down liabilities such as the mortgage.

Overall, it's becoming easier to put money aside and invest for future needs, particularly retirement. Here are 10 financial tips to consider for this stage of life.

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1. Build a retirement fund If you anticipate a shortfall in retirement income relative to your requirements, you may want to think more seriously about building up your retirement fund. The two main pathways are: a diversified portfolio with a high allocation to stocks, or a portfolio of safe, conservative assets.

The first approach has the higher expected return since stocks historically have been the best returning asset over the long run, registering an average 3- to 4-per-cent annual premium over bonds. But it comes with more volatility. "If you can tolerate some uncertainty, you can likely fund your future goal with significantly less savings," notes Christopher Jones, author of The Intelligent Portfolio .

The second approach has lower returns but comes with lower volatility through time and in final outcome. "The only way to be more confident of reaching a financial goal is to invest more conservatively and save more," Mr. Jones explains. Moreover, if you need only "a modest rate of return to reach your goal, it's unnecessary to take on the risk of a large stock weighting," suggests Warren MacKenzie of Weigh House Investor Services.

2. Taking stock Many investors use bonds and other assets to smooth out the ups and downs of the stock market. "We know that by simply changing our allocation between stocks and bonds, we can lessen the amount of volatility in our portfolio until we reach our comfortable sleep level," writes Taylor Larimore, Mel Lindauer, Michael LeBoeuf and John C. Bogle in The Bogleheads' Guide to Investing .

Some individuals are comfortable with placing their portfolio entirely into stocks. Excluding money needed within three years, this is the option chosen by Michael J. Wiener, author of the blog Michael James on Money. He doesn't need other assets to smooth out the volatility of stocks because he's confident he can stay focused on the long term.

The Invest for Life series:

  • Part 1: Ten money tips for young people
  • Part 2: Ten money tips for people entering the work force
  • Part 3: Getting married? Ten money tips
  • Part 4: Having kids? Pull out the wallet and get set to invest for the future
  • Part 5: Married, with kids? Ten investing tips
  • Part 6: Financial tips as you climb the financial ladder
  • Part 7: Preparing for retirement: 10 tips
  • Part 8: The retirement years: 10 financial tips

Other investors seek to hedge against the possibility of long-run returns not panning out as advertised. "Invest as if stocks are likely - but not certain - to beat all other assets. Keep some money in bonds, cash, and real estate just in case they do better," recommends Jason Zweig in The Little Book of Safe Money .

3. Be lazy When it comes to investing in stocks, numerous studies and financial scholars have found that it's best to avoid picking stocks and timing markets. "Accept the fact that you are unlikely to beat a market where prices are set by the consensus of thousands of professionals and where you have to pay a steep price for every attempt," warn Greg Baer and Gary Gensler in The Great Mutual Fund Trap .

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And don't bother with stock tips, say seasoned investors. The blogger at Thicken My Wallet recounts: "I bought too many penny stocks when I first started investing, based on recommendations from friends. Do not rely on other people's recommendations." And Doug McLarty, managing director of accounting firm McLarty & Co. in Ottawa, discloses: "I made a number of mistakes when I started. I expected to beat the market with hot tips … Eventually I learned the hard way."

The average person busy with family and work will likely fare best with the passive investing approach, such as the Couch Potato Portfolio mentioned in the previous instalment of this series. It involves buying and holding low-cost index funds and/or exchange-traded funds (ETFs) and requires relatively little time and effort. Studies show its cost advantage beats the stock-picking skills of most individual and professional investors. The Easy Chair and Simple Recipe are other examples of lazy portfolios; the One-Minute Portfolio is based on just two ETFs, one tracking stocks and the other bonds.

Investor Education:

  • All about ETFs
  • The bad boys of the ETF world
  • Are ETFs your cup of tea?
  • How do ETFs fit my investment strategy at this stage in life?
  • How do Exchange-Traded Funds (ETFs) work?

4. Keep your balance Rebalancing your portfolio at least once every one to three years to your chosen asset mix of stocks and bonds controls for risk and compels you to buy low and sell high. It requires discipline to add to your equity position in the midst of a bear market and subtract from it in the midst of a bull market - something that's not always easy to do. "My worse investment mistake was failing to rebalance my portfolio in 2007 after stocks had gone up so much," reports Marc Ryan, a retired lawyer who runs an educational website for independent investors at

There are other ways to rebalance besides using the calendar. For example, in his book, The Only Guide to a Winning Investment Strategy You'll Ever Need , Larry Swedroe recommends a "threshold" approach, which calls for adjusting weightings whenever an asset allocation deviates more than 5 percentage points from a set level.

5. Life-cycle asset allocation and location As retirement or other funding needs draw closer, many investors and life-cycle mutual funds follow the convention of shifting out of stocks into bonds according to predetermined calendar dates. However, a study by researcher Anup Basu and others, called "Dynamic Lifecycle Strategies for Target Date Retirement Funds," found it was better to "dynamically alter the allocation between growth and conservative assets based on cumulative portfolio performance relative to a target." Translation: stay in stocks if your portfolio is underperforming (as is likely during a bear market); shift into bonds according to calendar dates when targeted returns are being met (as likely during bull markets).

In terms of asset allocation, the greater savings rates and larger portfolios of middle aged people open up more doors. Dollar-cost-averaging into mutual funds can be replaced by lump-sum purchases of ETFs and stocks in order to lower costs. Transferring into a self-administered registered plan might also be in order for the do-it-yourself investor. Contributions to registered retirement savings plans make more sense when you are in a higher tax bracket. And it may be time to "catch up on unused RRSP room," says Adrian Mastracci of KCM Wealth Management Inc .

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6. Diversifying eggs into baskets

Diversification is not about having a lot of different stocks, bonds and funds. It's about how those different investments move in relation to each other: Some should be moving up when others are moving down. Having your eggs in many baskets won't work if the baskets all fall at the same time. Sufficient zigging and zagging will minimize fluctuations around expected returns, and especially the odds of extreme setbacks. At the asset level, many investors supplement the basic stock-bond allocation with cash, real estate investment trusts, real-return bonds, foreign equities, precious metals and other assets.

One asset sometimes overlooked, in the opinion of York University professor Moshe Milevsky, is the investor's own human capital - the talents, training and experience that earn them a stream of income over their working life. "While conceptually this asset is different from your tangible, financial assets, it should be considered and diversified in tandem with your financial capital," notes Mr. Milevsky, author of Are You a Stock or a Bond? This holistic approach to diversification yields a number of interesting scenarios.

Stockbrokers should load up more on bonds because their human wealth is tied up in stocks. Investors with a lot of their portfolio assigned to their employer's stock are not well diversified. And investors with predominantly bond-like human capital (have secure jobs and defined-benefit pension plans) may need to go "short" bonds and leverage their equity allocation to 200 per cent or more in order to fully diversify. "I myself … am leveraged to the tune of 2-to-1 [every $2 of stock held = $1 his money + $1 borrowed money]" reveals the tenured Mr. Milevsky in his book.

7. Living off dividends

Tom Connelly, editor of the Connelly Report newsletter, has long urged investors to buy value-priced "common shares of companies with a good record of dividend growth and hold them for the rising income." Other devotees of stocks with growing dividends include bloggers at Triaging My Way to Financial Success, The Dividend Guy, and moneygardener.

The rising dividend pushes up the share price over time, and within 15 years or so, may be generating income yielding more than 15 per cent on the original funds. (Mr. Connolly's website illustrates this with his purchase of Fortis Inc. in 1995). Automatically reinvesting dividends during the accumulation phase adds substantially to returns - indeed, for any approach involving stocks. Dividend income is the most tax advantaged and well suited to building a retirement fund outside of registered plans. Dividend stocks are seen by some investors as a way to pursue the goal of early retirement.

8. Getting real with bonds

As mentioned above, there are two pathways to building a retirement fund, one based on an emphasis on growth assets and the other on conservative assets. The latter method gets relatively less attention perhaps because it doesn't earn as much commissions for financial advisers and planners, suggests Boston University professor Zvi Bodie. By way of an offset, this and the next two tips deal with the conservative path to retirement income.

"According to the conventional wisdom … stocks become safe in the long run because of time diversification," says Mr. Bodie in The Future of Life-Cycle Saving and Investing. "But if the risk premium [the return stocks earn over bonds]is the payoff for bearing the uncertainty of risk, how can the payoff be certain? The reality is that the simplest way to reduce risk is to hold safe assets."

Mr. Bodie thus prefers constructing retirement portfolios using inflation-indexed government bonds, which in Canada are called real-return bonds. It is unlikely the federal or provincial governments will default on their debt obligations and there is protection against loss of purchasing power because principal and interest payments are adjusted for inflation. Simply buy bonds maturing near the dates that your retirement funds will be needed.

9. Climbing bond ladders

"My best investment move was investing 100 per cent of our RRSPs in ladders of provincial government strip bonds" remarks Mr. Ryan. "Over time, the power of compounding pre-tax interest has been awesome … It's a true portfolio for dummies since there are typically only one or two trades per year."

Bond ladders are collections of bonds with maturities staggered over annual or other time frames. They help guard against interest-rate, inflation and other risks (if interest rates rise, the portfolio rolls over into the higher rates). A convenient alternative is bond exchange-traded funds.

10. Government-guaranteed funds

Many people don't climb out of debt and begin putting aside money until well along in the life cycle. They consequently may not have 20 or more years to go until retirement. Even if they did have more time, their risk tolerances may be such that they value capital preservation over growth. Bonds could be an alternative to stocks but are not as user friendly as other interest-bearing assets such as guaranteed investment certificates (GICs), term deposits and high-interest savings accounts.

One advantage of these vehicles, in the opinion of Enough Bull author David Trahair, is that they are guaranteed by the federal government through the Canada Deposit Insurance Corp. Moreover, there are no fees to pay and their simplicity means the probability of missteps is low. Mr. Trahair proposes a ladder of GICs within a registered plan to protect against the risks of fluctuating interest rates while compounding returns tax free.

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