How to build a million dollar portfolio (or close to it)
They say a million dollars isn’t what it used to be. Fine. In my book though it’s still a huge pile of money. Beyond inflationary pressures, workplace pensions disappearing over time. This means you’ll need to rely on you to fund a secure retirement.
Whether you’re just starting out your career as a 20-something or you’re coming in late to the retirement-saving-party, there are different ways to build a magical million dollar portfolio (or close to it). Let’s see two examples today.
Retirement Accounts 101
Regardless if you have a workplace pension or not, I believe all Canadians should know about two key accounts they can use to save for their retirement:
- Tax Free Savings Account (TFSA)
- Registered Retirement Savings Account (RRSP)
While both accounts have the word “savings” in them don’t let that confuse you with how they work and how both accounts can be used to build your million dollar portfolio:
|A tax-deferral plan.||A tax-free plan.|
|Contributions can be made with “before-tax” dollars as part of an employer-sponsored plan or “after-tax” dollars when a contribution is made with a financial institution.||Contributions are made with “after-tax” dollars.
|Contributions are tax deductible; you will get a refund roughly equal to the amount of multiplying your contribution by your tax rate.||Contributions are not tax deductible; there is no refund to be had.|
|If you don’t contribute your maximum allowable amount in any given year you can carry forward contribution room, up to your limit.|
|If you make a withdrawal, contribution room is lost.||If you make a withdrawal, amounts withdrawn create an equal amount of contribution room you can re-contribute the following year.|
|Because contributions weren’t taxed when they were made (you got a refund), contributions and investment earnings inside the plan are taxable upon withdrawal. They are treated as income and taxed at your current tax rate.||Because contributions were taxed (there was no refund), contributions and investing earnings inside the account are tax exempt upon withdrawal.|
|Since withdrawals are treated as income, withdrawals could reduce retirement government benefits.||Withdrawals are not considered taxable income. So, government income-tested benefits and tax credits such as the GST Credit, Old Age Security (OAS) and the Guaranteed Income Supplement (GIS) aren’t affected by withdrawals.|
|You can’t contribute to an RRSP after age of 71. Accounts must be collapsed in the 71st year.||You can contribute to a TFSA after age of 71.|
|The Summary: part of your RRSP is borrowed money.||The Summary: all of your TFSA is your money.|
With those sets of reminders about the powerful tax-deferred (RRSP) and tax-free (TFSA) nature of each account, let’s look at how to build that healthy retirement nest egg.
- Save early and often and never stop
I believe an early and consistent stream of contributions to the RRSP will work out very well for the majority of Canadians, hopefully myself included! While contributing to the RRSP makes the most sense when your marginal tax rate at the time of contribution is greater than your marginal tax rate at the time of withdrawal, this doesn’t mean the RRSP cannot be used by lower to middle-income Canadians or individuals just starting out their careers – although the TFSA may be more beneficial from a future tax perspective.
Let’s use 20-something Saver No. 1 in my post today Early Earl as an example:
- He has $1,000 in his RRSP at age 25 in cash (for now) as current investments.
- He makes annual contributions worth $500 per month going-forward; and will buy mostly equities thanks to reading his favourite blog (My Own Advisor).
- He anticipates his return is about 6% (because he has heard about lower stock market projections long-term and he wants to be realistic).
- He wants to start drawing down his RRSP at age 60.
Here are Earl’s results:
Early Earl will have, roughly, just over $700,000 inside his RRSP at age 60. Pretty good! This is not a million dollar portfolio you might say. Very true – but my calculations above ignore other factors that could help Early Earl (and his future family) reach a million dollar target.
- Earl can contribute more to his RRSP as his income grows as he gets older, over a 35-year career. I will assume Earl will change jobs and get promotions over decades of full-time work.
- These calculations ignore the use of his TFSA. He can and should contribute to that account when extra money is available.
- His long-term returns could be more than 6%; this may or may not happen mind you – since 1980 to present, the U.S. S&P 500 as one stock market index has produced annualized returns of close to 9%.
- Early Earl eventually gets married in his 30s; his partner also adopts the same savings and investing gene; so together they both save and invest to build family wealth thereby making up the $300,000 shortfall to $1 million.
Now, when I was 25, I wasn’t yet saving $500 per month (I recall I was saving at least $100 per month though) so let’s look at another, potentially more realistic example for younger works and savers.
- Save modestly and aggressively later on
We’ll call Saver No. 2 in my post today Late Lorraine.
Lorraine has read My Own Advisor for many years now (thanks for that by the way!) so she already knows about the value of low-cost Exchange Traded Funds (ETFs) for investing; she knows to keep her financial costs low; she understands the power of long-term growth and invests in mostly equities; she knows she needs to make regular contributions to her RRSP and/or TFSA; she has learned to avoid all the talking heads on TV about Bitcoin; the list goes on…
Lorraine was busy having fun in her 20s, finishing her degree; did some travelling (can’t blame her) and waited until her early 30s to get married to her long-time boyfriend from university. She bought a house in recent years and has started to raise three beautiful but very energetic young boys!
With mortgage payments now well in hand, Lorraine (now 35) along with her husband want to get serious about saving and investing for retirement. They want to retire by age 60.
Although Lorraine has only $50,000 in her RRSP, with a revised spring budget that involved cutting out lots of financial waste around the house, she and her husband estimate they can start socking away a cool $1,000 per month for their retirement. Great work!
Lorraine decides to start contributing to her TFSA (she has $0 in that account) but knows with a decent paying job she should also maintain contributions to her RRSP ($500 per month). (She has no workplace pension.) Her husband might also save some money in future years but he’s a largely stay-at-home-Dad who does some consulting work from time to time so we’ll just focus on Lorraine.
Here is what her savings could look like by age 60 assuming 6% rate of return for the RRSP:
Here is what Lorraine’s TFSA could look like assuming she starts with a $5,500 contribution this year, earns 6% for her investments long-term, and the TFSA contribution limit grows with the rate of inflation (2%) for her contributions:
All RRSP and TFSA values approximate for illustrative purposes. You can find great, free calculators and tools here.
Sure, another example that’s short of a million dollars but let’s not forget I mentioned “or close to it”! Besides:
- I’ve assumed Lorraine’s husband barely saves anything over his work career – if he does – the shortfall could be made up.
- Lorraine never maxed out her TFSA account. She still has tens of thousands of dollars in TFSA contribution room left to catch up on since the account was introduced almost a decade ago and she only started to contribute now. Should she decide to maximize the contributions to the TFSA (thanks to a few bonuses at work over the next 25-years) the shortfall could be made up.
Besides that, (Early) Earl and (Late) Lorraine have some government benefits to look to forward to in their golden years due to many full-time years in the workforce. Those benefits will come in the form of Canada Pension Plan (CPP) and Old Age Security (OAS) payments. With almost a million bucks in the bank they’ll have options for when to take their CPP and OAS.
So, after adding in CPP and OAS fixed-income benefits that should average about $1,000 per month in combined income at age 65 or so, even with some assumed million dollar shortfalls, I guess they’ll need to consider Airbnb for accommodations just off the Florida coast for a few weeks each winter instead of having an ocean view room. Tough life.
Whether you are Early Earl or Late Lorraine or any saver and investor in between, I hope this post has emphasized you can have a very healthy retirement nest egg if you strive to do the following things more often than not:
- Save and invest regularly (early on is better, you won’t need to save as much but you can save more aggressively later in life).
- Keep your investing costs/transaction costs/money management costs low so you can earn a reasonable rate of return (close to 6%) after fees/costs are accounted for.
- Stay invested over many decades of investing.
You may or may not realize your million dollar portfolio based on your savings rate and investing choices. How you save and invest is up to you! I do believe you can get close to owning a million dollar portfolio by following 1-2-3 above.
Building a million dollar portfolio can be a very tall order for many Canadians. That figure will probably discourage some investors from trying at all. My suggestion is not to let big numbers scare you from putting a financial plan in place. Focus on those three principles above. In doing so I suspect you’ll be rather pleased with your efforts and your portfolio value over time.
For savers and investors striving to build your retirement portfolio – how are you doing that? For investors who have already realized their financial goals – how did you get there? Comment away. I read every one. Thanks for being fans.