Here is an email from an MDJ reader who has achieved financial success, but is asking for advice on what to do next. He is relatively young with a professional career, and has crossed the $1M in net worth.
My current financial situation is similar to yours, albeit I’m a little older at 42. I also live in the Greater Toronto Area and I am a relatively successful professional, engineer to be exact.
I have maintained basic principles in increasing my net worth by paying off any debt I have (mostly loans to buy company shares and mortgage), contributing to my RRSP, putting money towards my savings account and increasing mortgage payments and RRSP contributions when I get pay raises. That has gotten me over the $1,000,000 net worth this year (mostly from share value ($400,000), home equity ($420,000) RRSP ($85,000) and pension account ($120,000). Pretty simple, straight-forward stuff.
I’m now at a point where I am looking at paying off my mortgage within the next 3 years (this would be accomplished by doing exactly what I did in the last 3 years, so quite achievable). I’m a bit at a tipping point where I am looking towards retirement down the road (I love my job so retiring early is not really in the cards right now). At some point, I would like to own a small home in Florida and/or a small investment property West of Toronto (Burlington, Milton, Oakville, maybe a bit further to keep the investment low).
I would like to know what should be my next steps (I understand that a blanket answer will not work for all). Should I concentrate on finishing paying off my current mortgage, should I use the equity I currently have in my home? I was thinking perhaps I could rent the property in Florida now until my retirement but am a little gun shy about the intricacies of owning a property in the US.
I know I am currently in a good financial position but am very unsure as to my next course of action to reach the next plateau.
As you can read from his email, the reader that we’ll call Keanu, is doing very well financially. He seems to be doing everything right, paying down his mortgage, maxing out his employer matching RRSP, and investing in his own RRSP. There is not a lot I can add to Keanu’s situation except for a few tweaks that I’ll get into details below.
1. Pay off Debt
Keanu is pondering his next steps. Early retirement doesn’t really interest him, but investing in more property seems to be in the cards. But before all that, I would suggest to aggressively pay down debt to be mortgage free. Once he has that obligation out of the way, he will have even more cash flow with which we will move onto the next step.
2. Start TFSA
Keanu has a pension account and RRSP that he is building, but you will notice that he hasn’t started his TFSA. Even if he plans on buying rental property in the future, the TFSA is a useful tool as he can withdraw from it at anytime without penalty. As of 2016, he can contribute up to $46,500. While this sounds like a lot of money, it shouldn’t take Keanu long to max out his TFSA once his mortgage is paid off.
3. More Diversification
The only real concern I have with Keanu’s financial situation is the lack of diversification. While a lot of seriously wealthy people have built their wealth by concentrating their assets, there is probably an equal proportion of wealthy people who have lost their fortunes due to lack of diversification. In this case, Keanu has a significant portion of his net worth tied up with his employer shares. It appears to have paid off for him thus far, but since his primary income is linked to the company, I would suggest to mitigate risk by liquidating some of those shares and investing them in a diversified portfolio.
Keanu doesn’t indicate the asset allocation of his portfolios, but if he is more of a passive investor, I would suggest to globally diversified portfolio by investing in index funds/ETFs across his accounts. He can get global exposure with three ETFs:
- XIC (Canada)
- XAW(US and international)
- XSB (short term bonds)
You can see other variations of simple ETF portfolios here. If buying ETFs and balancing a portfolio is not of interest, then the next best thing are the Tangerine funds. While the management fee is slightly higher (~1%), it’s still much lower than actively managed funds. Simply pick the allocation you want, and you buy one fund that does the re-balancing for you.
4. Buying a Rental
From the email, it looks as though Keanu would like to buy more property and curious about property in Florida. Right now, with the Canadian dollar weak against the US Dollar, it’s an expensive time to buy property in the US. Even without the surcharge, there are also tax and administrative implications of owning a property in Florida.
- Keanu would need to file a U.S tax return on the rental income (assuming he rents it out);
- Capital gains tax if/when he sells (watch out for withholding tax);
- Higher property tax for foreigners; and,
- Estate taxes and an US estate tax return when he passes.
You can find the details of the broad points indicated above in my article on the tax implications of owning a property in Florida. We’ve visited Florida a number of times, and although buying a property down there seems like a good idea, we’ve realized that renting property while we are visiting works best for us.
We’ve spoken to a number of Canadians that own property in Florida, and a number of them say the same thing – your vacations are set in stone every year. In other words, owners feel obligated to visit their property year after year rather than trying something new. This may work for snowbirds, but we are not quite at that stage … yet. :)
Besides the Florida property, Keanu is also considering buying a local rental property. I’ve owned rental property in the past, and I went through an tough self-realization process that determined that I’m not meant to be a landlord. A second property is like buying into a business and is much more work than newbie landlords realize. However, some research and due diligence will help reduce the headaches. If you are considering investing in real estate, here are some key articles that may help:
- The art of tenant selection
- How to attract the best tenants
- Landlord math – calculating cap rate and ROI
- Owning rental property vs owning REITs
- Evicting a tenant
- Rental property income taxes and deductions
- Criteria for purchasing rental property
That’s all I have. What advice to you have for Keanu?