Reader Case Study: Scoring Big in Toronto

Some time after my last case study on B in Alberta (who now reads friendlier blogs, haha!), I am ready to do a second case study on a different financial situation.

In their early 30s, the A family is starting their investment journey a little later than myself. But I readily admit I am a financial nerd who started early and was determined not to live the cash-strapped lifestyle I was raised in.

Both of the A's are relatively new to Canada. With less than 10 years in this country each, they are absolutely killing it! These are the kind of ambitious migrants that every country should want!

Scoring Big in Toronto: The Goal & Current Situation

The A's are getting ready for their first child, so they are wanting a second opinion on their financial journey as big changes are coming their way.

They have three main goals:

  1. Retire in 25 years with an annual dividend income of $100,000 in today's dollars;
  2. Pay for their children's university education (likely two kids); and
  3. Explore adequate insurance to take care of the family in the worst scenario.

The A's are earning a very solid income, combined at over $190,000 per year. Mr. A is older and more experienced in his profession and earns a little over $100,000 per year. Mrs. A earns somewhat less, but her compensation is growing more rapidly and will meet Mr. A's in the coming years.

One of the concerns the A's have is if they will be able to meet their goals working in Canada. Jobs in their field in the U.S. pay more so they are tempted to move down into Trump-land to reap those financial rewards.

Right now, the A's are worth a bit less than $200,000. Here's the breakdown...

His RRSP (Work Plan):  $55,000
His RRSP (Self-directed):  $61,000
Her RRSP (Work Plan):  $19,000
His Self-directed TFSA:  $24,000
Her Self-directed TFSA:  $34,000
Vehicle:  $6,000
Total Assets:  $199,000

Car Loan:  $6,000 at 2.99 percent
Total Debt:  $6,000

Current Net Worth:  $193,000

Both of the A's benefit from a matching RRSP workplace plan. They contribute 6 percent of their gross salary, the employer puts in 6 percent. Although the workplace plans only offer expensive, crappy life insurance company mutual funds, the dollar-for-dollar match makes it worthwhile to contribute.

In their workplace plans, the plan managers don't like the employees making them work too hard, so tinkering and making changes to asset allocation is frowned on.

The A's have 70 percent of their workplace portfolios in stocks and 30 percent in Canadian bonds, re-balancing about once per year. The stock portion is evenly divided into U.S. stocks, International stocks, and Canadian stocks in a classic Couch Potato approach.

In addition to their workplace plans, the A's try to save $2,500 a month in their personal accounts (TFSAs and RRSP). Most months they are able to hit their savings target.

In Mrs. A's self-directed TFSA, she holds a classic 60-40 portfolio using low-cost ETFs. In both of Mr. A's self-directed accounts, he runs the Dual Momentum strategy.

Broken down into dollars per asset, they invest $108,000 in buy-and-hold strategies and another $85,000 in the Dual Momentum strategy.

That's roughly $24,000 each in U.S. stocks, International stocks, and Canadian stocks with $36,000 in bonds. The DM signal is currently in U.S. stocks, so another $85,000 is sitting there.

The A's are currently renters in super-expensive Toronto. In preparation for the coming kids, they recently moved to a bigger 2 bedroom 1,500 sq.ft. condo in a great neighbourhood that's just 20 minutes from work. The rent on this place is $2,500 monthly.

Renting in Toronto is a great move! At just $2,500 a month, including property tax, condo fees, insurance, and maintenance costs, the A's are getting the place for a steal. Ownership would easily cost an extra $1,000 a month and the downpayment would drain their liquid assets.

If I Was in Their Shoes

The A's are both high earners who have avoided making any big financial mistakes. They wisely did not get sucked into buying an overpriced property during Toronto's real estate boom. They also have no significant debts.

However, there is a big financial squeeze coming and, despite their apparently reasonable path, the A's need a big financial reality check.

Given their gross income of $190,000, the A's have a tax bill of approximately $45,000 each year in Ontario. They also contribute $11,500 in workplace RRSP plans (matched equally by their employers). That leaves them with a net income of $133,500 to work with each year.

One of A's misconceptions is to focus on dividend income as a goal. Dividends are only a portion of total investment returns. Instead, look to total assets and withdrawal rates.

If a retiree wanted to be extremely cautious, they should have 30 times their annual spending in productive investment assets. At the age the A's are targeting for retirement, even 25 times annual spending is prudent. Especially if they live in Canada and expect to benefit from CPP and OAS.

Using this more sound methodology, if we allow for a tax rate of 15 percent, the A's will need $3.0 - $3.5 million in productive assets when they retire to realize a net income of $100,000 a year. However, as I will show later, this amount is way too high considering their total financial timeline.

Given their current assets, the A's will need to save at least $4,000 every month for 25 years to hit their retirement goal. After the combined gross workplace RRSP savings of $1,900 per month, they should be putting another $2,100 in their personal accounts every month to achieve their income objective.

While they appear to be doing well at their current savings rate of $2,500 a month, the problem is coming. Kids reduce income and raise expenses. Chances are Mrs. A may go part-time or even take a few years off when the bambinos are not yet in school.

This means they need to maximize the savings now! Before kids are in the picture reducing family income and increasing family expenses. Don't forget, at their household income levels the A family is not going to see those potentially big Canada Child Benefit cheques.

They will also need to save around $60,000 in 20 years to pay for education costs for both future kids. This means once the first kid comes they will need to save $1,500 per year in a family RESP to pay for their kids education. That number does not include the government's CESG grant.

I believe it's important for kids to have skin in the game for their own education. Plan to cover tuition costs and maybe some extras, but encourage them to work part-time to pay for their fun money. Also, kids education savings should always and only come after your own retirement security.

Step 1: Sell the Rolls-Royce

The vehicle is a real killer in the A family budget. Despite having just one car and driving a mere 10,000 km per year, they spend $100 a month on parking, $480 on insurance, $150 on gas, $300 a month on loan repayments, and at least $100 on other maintenance.

Adding this all up, they spend at least $13,500 a year on this vehicle. That's more than $1.30 per km! If they sold the car and invested the savings, they would be $700,000 richer in 25 years. The A's are not driving a Rolls, but it may as well be one at this cost!

It may be slightly less convenient, but selling the car and buying two decent used commuter bikes is a must. For longer trips there's always Uber or car rentals. Remember, they are living near downtown Toronto.

Even considering some Uber or car rental costs over the year, selling the car should increase their savings by over $1,000 a month in a single step.

Step 2: Cut Down the Daily Spending

Next order of business is to take a hard look at the other daily spending categories. It is way too high and this is very evident by their pitiful savings rate relative to their monthly net income of $11,100.

We know their rent is $2,500 a month. They also pay an extra $100 for hydro and probably $20 for tenant insurance bringing their total housing costs to $2,620 per month. I'm fine with that if it's close to work, avoids the need for a vehicle, and is a comfortable place to live.

But, there should be no reason why the A's would spend more than $2,500 a month on groceries, cell phones, internet, entertainment, clothing, workplace benefits, and vacations.

To get these costs down, dump the cable bill, look at TekSavvy for internet and use Netflix, get data-lite cell phone plans from Public or Freedom Mobile, use older cell phones and electronics, start shopping at Walmart and No-Frills, stop eating and drinking away from home, and shrink the closets and buy clothes only at consignment stores.

Also, examine those workplace extended health/dental benefit plans. It often does not make sense for both spouses to contribute their own plan. Instead, choose the better plan and contribute to one plan only. Have the spouse with the worse plan opt out. This can save $50 to $100 per month in premiums.

With some simple optimization—including the car sale—the A's should be able to save somewhere between $5,000 and $6,000 per month in addition to their workplace RRSP contributions and still enjoy a great lifestyle.

Lets not forget the added benefit of getting in better shape from those bicycle miles!

Step 3: Create an Emergency Plan

With a kid coming in the future, the A's need to put away a cash cushion as soon as they can. If the first child is coming quick, make this a priority and hold off on new personal investment contributions!

I would recommend they maintain a balance around $5,000 in their chequing account and open a High Interest Savings Account, rapidly stashing another $10,000 there.

It will take a few months to get there at an optimized savings rate, but having a cushion that covers several months of expenses is very smart considering a youngster is coming.

Kids mean time away from work for mom (and maybe dad), unexpected expenses, and a little more nerves all around. The last thing the A's should worry about during this stressful time is money in the bank.

Once baby fixtures are provided for, new kid care expenses are reduced, and things are back to normal, they can get rid of or shrink the HISA and maintain a total cash balance of $10,000. This should cover about 2 months of hard expenses.

Now would also be a great time to apply for a personal line of credit at a bank. I would aim for a $25,000 unsecured line of credit. The line of credit plus the enlarged chequing account should cover six months of bare-bones expenses.

As with all emergency funds, don't use the line of credit unless it's absolutely necessary! It should only be touched if both of the A's lose their job or a similar big financial shock comes.

The $35,000 cushion will buy time to adjust to a new lifestyle in the wake of new economic realities. This could mean downgrading the house, job hunting, moving for a new job if needed, or similar measures.

Step 4: Obtain a Life Insurance Policy

Considering a little one is coming, now is the time to take a good look at life/AD&D insurance.

The life insurance industry is full of snakes and potholes, so the goal is to keep this very simple.

Life insurance is only a fail-safe to cover modest family expenses if the worst case scenario happens; the goal is not to make sure that if you die your family will live in the Hamptons eating Caspian caviar!

You should also try self-insure as soon as you can. More money in your bank account, less profits for the insurance companies.

That means saving, investing, and buying a shorter duration term policy only. I'll repeat that, buy a shorter duration term life policy only. Do not buy a whole life, universal life, term-to-100, or a similar fancy and expensive plan.

Right now the A's are already self-insured to the tune of $190,000. This level of assets will generate $6,500 a year for life with an extremely low likelihood of depletion.

Both of the A's also have workplace life insurance plans. Each individual plan will provide a $150,000 benefit to the employee in case of death.

Given that an upper middle class Canadian family will spend about $75,000 per year, we should aim to cover about half that number with each adult's policy until the youngest child is 20. The remaining adult can work at least part-time and both of the A's have good earning power.

To generate an income of $40,000 a year for 20 years, they would need to invest about $500,000. Given their current access to $6,500 per year and the $150,000 workplace plan, they should each obtain a life insurance policy for approximately $300,000.

Obtain a 10 year term life policy to keep premiums down. In 10 years time when the policy is up, the A's are likely to have close to $1 million in their investment accounts and will no longer need extra life insurance coverage.

Shop around for the best rates—there are many life insurance companies! A 10 year term life policy of $300,000 for a non-smoker should cost about $20 to $25 per month.

Step 5: Maximize Tax Advantaged Accounts

Although Mrs. A has her TFSA maxed, Mr. A still has contribution room in his TFSA. Both have some room in their RRSPs since their combined employer-employee contribution is just 12 percent of gross income and allowable RRSP amount is 18 percent of gross income.

Given the high income that Mr. and Mrs. A earn, they should both maximize their RRSPs accounts first. Mrs. A can draw on her RRSP a little when she is at home with the kids if there is an opportunity to do that at a low tax rate.

If Mrs. A is planning on staying home for a few years, Mr. A should contribute to a spousal RRSP benefiting Mrs. A. He gets the tax refund at his high tax rates now, she pulls the money out a few years later at her low stay-at-home mom tax rate. Win-win! She can use this money for TFSA contributions or other investment savings.

Of course the TFSAs should be kept topped up as well. With both Mr. and Mrs. A working hard and earning big dollars right now, they should save nearly $6,000 per month in their personal accounts.

Even after building the emergency account, in roughly a year's time they should both have full RRSPs and full TFSAs. Hopefully they can achieve this before the first kid comes into the picture and incomes take a hit.

Step 6: Pry Into the Workplace RRSP Accounts

Given the workplace RRSP plans have very crappy investment options, it is worth Mr. and Mrs. A's time to take a very close look at optimizing these plans.

First of all, make sure the plans are invested in the lowest cost mutual funds available for their target asset classes. Every year ask the plan manager for a complete list of funds including the total management expense ratios (MER) for each fund.

Next, research if you can move money from your workplace RRSP to your personal RRSP/LIRA account. Although the plan managers don't like it and may put up a fuss and talk circles around the question, at the end of the day many plans actually allow you to do this. Read the fine print if necessary!

Usually a transfer fee of $100 to $300 per transfer will be charged by the plan manager. Given the cost, you should only transfer money out of your workplace plan and into your personal RRSP/LIRA once every year or two.

Always try to manage your own money if you can. You can buy ETFs for 10 basis points per year, so don't calmly sit back and let your RRSP plan managers soak you for 150 to 300 basis points per year!

Step 7: Open a Non-Registered Investment Account

Although this may be a year away depending on the children situation, when the registered accounts are full the A's will need to open a non-registered investment account to keep saving money.

When this happens, take a very careful look at your family income and expenses. The highest income spouse (probably Mr. A) should pay all of the household expenses, including incomes taxes and registered account contributions for the lower income spouse.

In turn, the lower income spouse should save as much of their gross income as possible and put it into the non-registered investment account. Investment money contributed by the lower income spouse will be taxed at the rate of the lower income spouse.

This is very important since investments in a non-registered account are likely to generate taxable income such as dividends and capital gains. It is much better to pay these taxes at the lower income spouse's level.

Step 8: Evaluate the Investment Strategy

Take a close look at the investment strategy across all of the accounts and make sure the overall picture reflects what you want. Enough bonds and safe things, enough stocks, adequate diversification across markets, and not too much home country bias.

I am a big fan of using two unique investment strategies with a roughly equal amount of money in each strategy. This can help your portfolio experience a different sequence of returns, especially providing benefits in poor stock market conditions.

Many models (CAPE, Tobin's Q, Hussman's MA-CAPE, Research Affiliates, P/S, Market Cap/GDP, etc.) are expecting gross annual returns of 3 percent or less for the next 10 years on buy-and-hold portfolios.

These models could all be wrong, but it is pretty safe to say that the returns for a buy-and-hold portfolio are not going to be very high for some time. While far from guaranteed, a large exposure to an alternative investment strategy could drastically change expected returns for investors.

Right now the A's are fairly balanced across two strategies. This should become more balanced as the remaining room in the registered accounts is filled. My main change would be to reduce the exposure to Canadian stocks to maybe 10 percent of the Couch Potato portfolios.

After the First Child

I don't know exactly how far away from children the A's are, but one thing is clear: their financial situation will probably change drastically.

I expect that children will add at least $500 a month in expenses for the first child and another $250 a month for each additional child. This doesn't include education savings or kids activities.

Diapers and baby wipes, baby clothes and double the laundry, a crib and changing table, stroller and baby carrier, baby food and formula do not fall from heaven.

Baby things are not cheap brand new, but almost everything can be purchased used on Kijiji or Craiglist, at consignment stores, or through mom groups and swaps and other informal things. It's very important not to go crazy with this stuff; kids grow out of things extremely fast!

If daycare is involved, this will cost at least $1,000 a month if Mrs. A works part-time and double that if Mrs. A works full-time. That assumes after-tax numbers since childcare expenses are tax deductible.

Scenario 1: Taking Maximum EI Benefits & A Part-time Job

I think the most likely scenario, one that many couples take with more than one child, is that Mrs. A stays home and collects the maximum EI parental benefits for the first year, returns to work earning at least $55,000 until the second child comes, then collects EI again for a year, and finally changes to less than full-time employment.

In this scenario, their gross household income will drop by around $50,000 per year and they will probably lose one employer RRSP match and maybe the better workplace extended health/dental benefit plan.

On the bright side, taxes will decrease and cushion some of the blow. Using a very rough calculation, the A family gross income will shrink to about $140,000 per year. Their tax bill will drop to about $32,000 per year and the workplace RRSP contributions will fall to $6,500 per year.

This means the net income that the A's will be able to work with drops from $11,100 per month to $8,400 per month.

To be on the cautious side, we'll assume that Mrs. A will continue to earn a lower salary when the kids are in school full-time, but will get a better job with RRSP matching plan. Daycare expenses at this point will not be necessary.

After the kids are in high school or off to college, we will assume Mrs. A will go back to full-time work and earn $80,000 a year with a workplace RRSP matching plan. This salary number assumes Mrs. A keeps her skills adequately fresh in the child-raising years so she is very employable.

Scenario 2: Stay-at-home Mom With No Part-time Job

If Mrs. A doesn't go back to work for the entire time their kids are growing up and in school, things will be quite a bit tighter financially for the A family.

Family income will drop to around $115,000 per year after including moderate CCB payments. Taxes will drop to $26,000 and workplace RRSP contributions will be at $6,500.

The net income for the A family will be around $6,900 per month. Expenses will still increase because of the kids, but daycare expenses will not be a factor.

Given the long period away from work, when Mrs. A returns to work full-time after the kids are finished school we'll assume her gross income will be $40,000 with no workplace RRSP matching plan.

Scenario 3: Go Back to Work Full-time

If Mrs. A goes back to work as soon as possible after each child comes into the picture, the family income will be very high. It is likely that the workplace RRSP matches on both incomes will stay.

Taxes and expenses will also be very high. Net daycare costs will be enormous and the overall family expenses are likely to increase because things are that much busier. There will also be after-school care for $1,000 a month when the kids are in school.

The household net income will likely stay around $11,100 a month with two years of reduced income in the EI parental leave periods.

Future Financial Budgets

Scenario 1

Source: TheRichMoose.com

If the A's optimize their spending how I suggest in the above steps, they will be spending a little over $5,000 per month as a couple not including taxes and workplace RRSP contributions.

It is conceivable to estimate their monthly household spending will jump to $7,000 in this scenario including part-time daycare cost while their net monthly income will be around $8,400.

They will be able to save just $1,400 a month minus $125 for RESP contributions. Not only is that less than the required $2,100 goal, they are also going to miss the second RRSP matching program.

Once the kids are in school and daycare expenses are eliminated, their income would allow for around $2,400 per month in personal savings, less $125 for the RESP.

Plugging that into our handy calculator and assuming the first child comes in a year, the A's financial situation will be as follows if they follow my steps and keep their spending in line:

End of Year 1 (baby comes):  $290,000
End of Year 7 (kids in school):  $625,000 + $17,000 RESP
End of Year 18 (college starts):  $1,800,000 + $65,000 RESP
End of Year 25 (retirement):  $3,500,000

The rough projection of $3.5 million in investable assets at retirement age will generate an annual withdrawal capacity of $120,000 to $140,000 per year.

This will be much higher than my recommended budget of $60,000 to $65,000 per year as a couple, allowing room for sabbaticals, an earlier retirement, or a more luxurious retirement.

Scenario 2

Source: TheRichMoose.com

If the A's optimize their spending how I suggest in the above steps, they will be spending a little over $5,000 per month as a couple not including taxes and workplace RRSP contributions.

It is conceivable to estimate their monthly spending will increase to $6,000 in this scenario as no daycare will be required.

Their available monthly income will be around $6,900. This means they will be able to save $900 a month in addition to the workplace RRSP, less $125 for RESP contributions.

Plugging that into our handy calculator and assuming the first child comes in a year, the A's financial situation will be as follows if they follow my steps and keep their spending in line:

End of Year 1 (baby comes):  $290,000
End of Year 7 (kids in school):  $590,000 + $17,000 RESP
End of Year 18 (college starts):  $1,400,000 + $65,000 RESP
End of Year 25 (retirement):  $2,600,000

The rough projection of $2.6 million in investable assets at retirement age will generate an annual withdrawal capacity of $90,000 to $100,000 per year.

This again is quite a bit higher than my recommended budget of $60,000 to $65,000 per year as a couple.

Scenario 3

Source: TheRichMoose.com

If the A's optimize their spending how I suggest in the above steps, they will be spending a little over $5,000 per month as a couple not including taxes and workplace RRSP contributions.

Once the kids enter the picture, it is conceivable to estimate their monthly spending will jump to $8,500 in this scenario including daycare costs. Their available monthly income will be around $11,100 except for the first years of children during parental leave time.

On the personal side, they will be able to save $2,600 a month minus $125 for RESP contributions.

Once the kids are in school and reduced after-school care costs come in, their income would allow for around $3,600 per month in personal savings, less $125 for the RESP.

Plugging that into our handy calculator and assuming the first child comes in a year, the A's financial situation will be as follows if they follow my steps and keep their spending in line:

End of Year 1 (baby comes):  $290,000
End of Year 7 (kids in school):  $750,000 + $17,000 RESP
End of Year 18 (college starts):  $2,400,000 + $65,000 RESP
End of Year 25 (retirement):  $4,400,000

The rough projection of $4.4 million in investable assets at retirement age will generate an annual withdrawal capacity of $150,000 to $175,000 per year.

This will be effectively double my recommended budget of $60,000 to $65,000 per year as a couple on an after-tax basis. This means their lifestyle in retirement would be much more luxurious than their former lifestyle, which obviously doesn't make a whole lot of sense.

Scenario 3 could be an "over-saving" situation, but again it allows for earlier retirement, sabbaticals, job loss situations, etc.

Some Notes on These Scenarios

These are just rough calculations using an assumed long term investment return net of inflation. Within periods the returns will of course be very different.

I shared these three scenarios as they are related to common options that families choose when they start raising children. The facts show household income often takes a dip—usually because mom makes less—and household expenses increase.

I also assume that current salaries will keep pace with inflation and there are no periods of job loss.

If Spending Stays the Way It Currently Is

Although the A family looks like they are doing fine on paper right now and might be tempted not to change a darn thing about their lifestyle, here is the big wake up call.

Right now, the A's are spending more than a whopping $8,600 per month as a couple! Once kids come into the picture, if they don't change their lifestyle, the household expenses will jump to $11,500 or more when both children are in daycare.

They won't earn even a net income of $9,500 a month when Mrs. A is on parental leave, resulting in net spending which is higher than income.

This means they will be forced to deplete savings in the years Mrs. A can't work full-time and they will be stretched to the absolute maximum when Mrs. A does go back to work full-time.

Near absentee parenting will be the routine. Both parents working full-time, both kids in daycare, then after-school care, then after-school activities.

Welcome to a lifestyle of two vehicles, more consumer crap than a condo can handle, whirlwind weekends of insanity, excess take-out and restaurant eating, flabby "dad-bod" and "mom-bod", and fat kids who are spoiled and entitled. Insufferable North American suburbia...

Source: TheRichMoose.com

I'll say that this chart is optimistic. The financial picture could even be worse when they are forced to move to the suburbs, own two vehicles, and I've barely scratched the surface on potential spoiled kid expenses.

If they don't make the necessary spending corrections, during the entire time they are raising their future children the A family will be treading financial water, maybe going into debt, they won't be able to retire early (if ever at their current lifestyle!), and they will certainly be stressed out.

If this bad news isn't enough, the data tells us this financial tightrope lifestyle drastically increases the potential of a very nasty event: divorce. Not only does divorce have the potential to destroy their family and their relationship with the kids, it will also sink them both financially.

Summary

While both Mr. A and Mrs. A are earning very healthy salaries, they are spending way too much money with their current lifestyle. It's not sustainable. The real problems will begin to surface when kids enter the picture.

The easiest spending reduction is getting rid of their vehicle. It's an unnecessary luxury that is costing them an enormous amount of future wealth.

Their discretionary spending is also way too high, I don't know where the money goes (and the A's might not either), but the numbers say they are burning around $5,000 a month on groceries, clothes, entertainment, electronics, phone plans, vacations, and other lifestyle items.

The A's should immediately start building an emergency plan. This means funding a savings account and establishing a personal line of credit plan. The plan should be in place before the first child comes.

After the emergency plan is in place, the focus should return to filling their registered accounts. Be tax smart and use Spousal RRSPs, finishing topping those TFSAs, and invest in a balanced approach across two unique investment strategies.

Rethink the goal of $100,000 in spending money each year in retirement. This is much higher than it needs to be. The only way to achieve this level of spending sustainably is if the A family salaries get quite a bit higher than their current level. Trying to get there could mean significant family sacrifices.

Spending in retirement will realistically land somewhere between $60,000 and $70,000 for a relatively luxurious lifestyle. That requires $1.5 to $2.1 million in investment assets backstopped by CPP and OAS.

If they can get their spending down to a reasonable level, the A's have the flexibility to achieve a fantastic, family friendly lifestyle. They could have a full-time stay-at-home parent, save enough for retirement, help their kids with their education, and live very stress-free.

Reader thoughts on these case studies are always welcome in the comment section!

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.

Reader Case Study: B in Alberta

A week or two ago I was contacted by B in Alberta about doing a case study on his financial situation. I really love B's situation because he has made some classic mistakes often made by many higher income professionals, and he has lots of opportunity to achieve his goals.

This is Case Study is a first for me; I generally talk about financial and investment strategies at large, with a healthy dose of my personal journey.

I'm open to doing more Case Studies on other people in unique financial situations. Although I'm not a financial advisor and don't want to pretend to be one, I hope Case Studies can offer some perspectives on my strategy applied to different circumstances.

B in Alberta: The Goal & Current Situation

B's goal is pretty simple: a paid off house with a $1.25 million portfolio by the age of 40.

That's just 10 years from now, but B is well on his way.

Thanks to B's Alberta-sized income of $200,000 per year, B and his wife have massive savings capacity. They're also running a pretty tight household budget, spending just $50,000 a year after mortgage costs.

B also says his wife is planning to go back to work in a few years, maybe when their two kids are in full-time school. B figures she will earn about $70,000 per year. Oh, and she's under the reach of Uncle Sam's big tax umbrella, so there's a few wrinkles for her courtesy of the IRS.

Right now, B and the wife are worth a hair under $500,000. Here's the breakdown:

Personal Residence:  $450,000
Rental Property:  $300,000
His RRSP (Work Plan):  $140,000
His RRSP:  $90,000
Her RRSP (Work Plan):  $30,000
His TFSA:  $70,000
Total Assets:  $1,080,000

Personal Residence Mortgage:  $300,000 (Prime-0.55% VRM)
Rental Property Mortgage:  $290,000 (2.95% FRM)
Total Debt:  $590,000

Current Net Worth:  $490,000

As for the investment breakdown, B says he is following the Canadian Couch Potato—a popular lazy portfolio strategy—with a 20 percent allocation to bonds. His TFSA is only invested in equity ETFs for maximum growth, while his RRSP account are a mix of bonds and equities.

Like many high income Canadians, B is also a real estate investor—though admittedly a bad one. Not only has his rental property declined in value significantly (he paid $420,000), it is also cash flow negative. B puts in an extra $600 a month just to pay the basic bills.

That's right, B is one of thousands of very generous amateur landlords in Canada who I have mentioned repeatedly in my blog. He is generously willing to subsidize the rent of poor, landless tenants like myself. Thanks B!

I suspect B has long avoided taking a massive paper loss on the sale of his property, hoping things will turn around in the oil business thereby lifting the value of his rental property. A classic case of if I could only sell it for the price I paid, then... syndrome.

Thankfully, B says he has finally come to his senses and realizes the rental property has got to go. Smart move!

Sell the perpetual money losing property, book the six figure capital loss to offset future capital gains, and invest in something that actually makes money without the midnight text messages about leaking roofs or broken stove burners.

If I Was in Their Shoes

This case study is pretty mild because B already has his spending under control relative to his income. While anyone can argue there is always room to cut expenses, I think $50,000 a year plus a mortgage for a family of four is fairly reasonable.

B's total spending lands around $65,000 total. He also pays income taxes costing him over $40,000 per year. Naturally we will try to find ways to keep that down.

Step 1: Deal with Rental Property

B has already identified the first correct move. He needs to sell that rental property and book the massive six-figure tax loss.

If B's valuation estimate is correct, after selling costs I suspect B will probably be able to pay off the rental property mortgage. I doubt there will be anything left after these costs.

I would dive more into the reasons to sell the property if B was determined to keep it, but I won't because he's already realized this move is necessary.

On the bright side, he will no longer be supplementing the costs of running the condo property (which I suspect are actually much higher than B thinks after factoring vacancies and maintenance costs). That's more money available for investing.

Step 2: Maximize Tax Advantaged Accounts

In Canada we have two primary tax advantaged accounts for retirement savings: the TFSA and the RRSP. These accounts should always be maximized first to make the most of tax savings.

In B's situation, his tax advantaged accounts are currently full. He's got no more TFSA room and basically no more personal RRSP room.

B should continue making contributions to his workplace RRSP to take advantage of the company match. They match up to 6 percent of B's gross salary, so B should also contribute 6 percent to this account.

Always invest to get the maximum company match! It's an immediate 100 percent return on your money.

The workplace RRSP plan has two options: fancy mutual funds or passive funds. B has already moved his investments over the lower-cost passive fund option. Not surprisingly, it has outperformed the fancy funds.

For the rest of the RRSP contribution room up to the statutory maximum, B needs to shift his strategy. Instead of investing in a personal RRSP benefiting himself, B needs to open a Spousal RRSP benefiting his wife.

A Spousal RRSP will help B shift assets on paper towards his wife. This can offer significant tax advantages, now and later.

With a Spousal RRSP setup, B will still get the tax deduction he needs right now. But B's wife will legally be able to make the withdrawals in her name later.

Of course B should continue maxing his TFSA contributions each year.

Step 3: Set up a Smith Manoeuvre

If my math is correct, B has the earning capacity to save nearly $80,000 per year beyond his 6 percent workplace RRSP contribution.

If he puts about $12,000 in a spousal RRSP and $5,500 in his TFSA each year, that leaves $60,000 per year in additional savings.

At this massive savings rate, B should set up a Smith Manoeuvre on his personal residence. Although the Smith Manoeuvre sounds complex, once set up it requires just a few hours a month to maintain.

First, B needs to set up a readvanceable HELOC mortgage on his primary residence. The HELOC will be split into two portions.

The current mortgage can be locked into regular mortgage terms and we call this Portion 1 of the HELOC. The interest on this portion is not tax deductible.

There will also be a readvanceable line of credit that provides additional borrowing capacity up to 65 percent of the house value. This available money grows with each mortgage principal repayment made. We call this Portion 2 of the HELOC.

Given B's aggressive savings potential, he should use 1-year fixed mortgage terms with double-up pre-payment privileges on Portion 1 of the HELOC. B should double each mortgage payment penalty free.

At the end of each year, before he renews his 1-year fixed mortgage on Portion 1, B can deposit all the rest of his additional savings against the mortgage balance.

The goal is to get Portion 1 paid down penalty-free as fast as possible. Five years is a realistic goal!

In Portion 2 of the HELOC, B would have a readvanceable line of credit where outstanding balances are charged at Prime + 0.5 percent. B will take this available money for investment purposes.

Using this borrowed money to invest in a dedicated Smith Manoeuvre investment account (non-registered), he will be able to deduct all of the interest costs on Portion 2 of the HELOC from his annual income. That will save him thousands of dollars on tax each year.

Once Portion 1 of the HELOC gets paid off and the HELOC is fully utilized for investing, B will reach an annual tax deduction of more than $12,000 at current interest rates. At his current income level, this will save him $5,100 a year in taxes.

B should open a Smith Manoeuvre investment account in his own name so he can fully benefit from the tax deductions on the Portion 2 interest expenses. He should use this account to invest in ETFs or stocks which pay a very low dividend yield.

Approximately 5 Years From Now

If B follows the plan, at around year 5, when B's wife is ready to consider going back to work, B will have his entire mortgage (Portion 1 of the HELOC) paid off. Assuming 6 percent growth rates, they will be in the following situation:

Personal Residence:  $450,000
His RRSP (Work Plan):  $325,000
His RRSP:  $120,000
Her RRSP (Work Plan):  $40,000
Her RRSP (Spousal):  $70,000
His TFSA:  $130,000
SM Investments:  $350,000
Total Assets:  $1,485,000

SM HELOC (Tax Deductible):  $292,000
Total Debt:  $292,000

5 Year Potential Net Worth:  $1,193,000

At this point, B's wife only should go back to work if she really wants to. It's certainly not a "must do" to reach their financial goals. In five more years of saving on B's income alone, they will easily be over their target investment net worth of $1.25 million.

In fact, they will be comfortably over $1.5 million in their investment accounts. Plus, they will have a tax deduction of $12,000+ for the rest of their life if they choose to continue the investment loan.

Once Portion 1 of the Smith Manoeuvre HELOC is paid off, B and his wife will have to make some more investment account decisions. He will continue to invest in his matching workplace RRSP, the Spousal RRSP for her, and his TFSA.

With the mortgage out of the way, B and his wife should consider opening a family RESP account for the kids. Since B's wife is a tax subject of Uncle Sam, he should open the RESP so Uncle Sam doesn't tax it as a trust. They want the money to go to their kids, not Washington, D.C..

The kids will still be quite young in 5 years, giving them about 10 years of RESP savings for college. Investing just enough to get the maximum CESG grants, they should be able to save around $70,000 before the oldest heads off to college.

That, along with a few scholarships and a part-time job, should easily be enough for junior 1 and junior 2  to go to school without racking up debt.

If B's Wife Goes to Work

If B and his wife decide to goose their savings, or if she's bored at home, his wife's potential $70,000 salary will go a long way to sending the family into the upper stratospheres of wealth.

Saving an additional $50,000 a year (rough adjustment for taxes), they will have a net worth of nearly $2 million in addition to their house, after adjusting for the SM HELOC.

B's wife should immediately begin contributing to her RRSP. With the rest of the money, she should open a non-registered investment account in her name and invest 100 percent of her gross income into this account. She saves everything she makes.

On paper, B will pay all the household bills including his wife's tax bill, RRSP contributions, benefits, and other workplace deductions.

B's wife should invest with tax efficiency in mind, but given her potential income level, she could consider standard ETFs which pay moderate distribution yields. It would still be a good idea to use swap-based ETFs for any bonds in the non-registered account.

If B's Wife Decides to Stay Home

As I stated above, there really is no financial need for B's wife to go to work. They could easily achieve their financial goals by their desired timeline with B's income alone.

If B's wife stays home, they should also open a new non-registered investment account, separate from their Smith Manoeuvre investment account.

They will continue saving that $60,000+ a year they were plowing into their mortgage. B, as the only income earner, will be the sole contributor to this account.

Given B's high income, this account should be invested in tax efficient ETFs like swap-based ETFs for no distribution income.

In B's situation particularly, he is much better off deferring capital gains than receiving dividends each year and paying tax on those at punishing rates.

Other Considerations

I am a big fan of splitting a total portfolio into two unique strategies—as long as they use low-cost ETFs. We know that different investment strategies can provide benefits that a Couch Potato can't. This includes downside protection, or a different sequence of returns.

Using a systematic, rules-based timing strategy like my Time Averaged Dual Momentum model is easy for self-directed investors to manage and has performed well.

I would introduce a second investment strategy to complement the current Couch Potato. Put half of the portfolio into TADM and keep the other half in the buy-and-hold 80 percent equities Couch Potato model.

Since B will have a big $120,000+ capital loss booked with the CRA on the sale of the rental money pit, a timing strategy like TADM could be fantastic in the Smith Manoeuvre investment account. While he is working and in a high tax bracket, B can offset years of realized capital gains.

Less than twice per year on average, the TADM strategy will signal a change in your portfolio holding. This usually means realizing a capital gain on the position. Utilizing the deferred capital loss will keep the TADM portfolio very tax efficient.

As soon as B quits his job, he should explore options to take control of his own money. This means transferring the balance of his workplace RRSP plan to his personal RRSP. The fees are likely to be lower and outweigh any transfer costs.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.