Derek Foster is a bit vague in his book on how much he had to save over 12 years that enabled him to retire at a young age with a portfolio much less than a million dollars plus a fully paid-off home. In many articles he says that he has saved and invested at least $200 since his early 20’s until his retirement (Canadian Money Saver, November/December 2006).

To figure out how much you should save to retire early like Derek Foster, let’s assume that Derek ended up with a nest egg of $450,000 over a 12-year period (Source: James Daw, Toronto Star, Sep. 26, 2006). Let’s also assume that Derek was able to post annual returns of 20%, which would make him one of the best investors around. How much would he have to save annually to attain the nest egg? Try $9,500 or almost $800 per month.

With much lower returns forecast in the future, I’m sceptical that someone starting today will be able to do a Derek Foster saving $200 per month. If future returns are in the 7%-8% range and you are able to beat the markets with a 10% return, you need to save almost $19,000 per year to end up with a similar portfolio in nominal terms over the same time period. If inflation runs at a modest 2%, you’ll need to bump up your savings to $2,000 per month.

This article has 41 comments

  1. Just for the record (I got the book out of the library recently for a review), here are some relevant quotes from the first book.

    “… started putting $200/month into mutual funds. I was 22 at the time”.

    “I was also adding any additional money I received like the quarterly GST credit or my income tax return.”

    I thought he indicated how large his portfolio was at retirement but it doesn’t seem to be in the book.

    Mike

  2. Reading the first book I always assumed he invested more than $200 / month. As 4P points out perhaps the $200 was a starting point. It is interesting to note that he would have needed to save $800 a month and garner a 20% return though. If he has never explicity stated the amount he saved per month from age 24 – 34 it is quite possible that he saved $800 per month. The 20% return would be the difficicult part. Perhaps the big bet on MO made up for years of 12% returns.

  3. Canadian Capitalist

    Mike, MG: I was playing around with the scenario pointed out by a commenter referenced in Larry MacDonald’s column and tried to figure out how much Derek would have needed to save. I’m assuming that he made high returns but it is possible that his returns are even higher. $800/month seems to be reasonable conclusion and like you mentioned a few leveraged bets goosed up returns even more.

  4. My first RRSP contribution was in 1997 and I borrowed $10,000 to invest it. My repayments were in the $833/month range. I remember putting it into an Altamira Canadian Equity Fund and by the end of the term my investment had nearly doubled to roughly $18,000. For 1998, I put the money into a TD Science and Technology fund. During that time, my investment climbed to $30,000 or so. Then, out of sheer dumb luck, I took my money out of that fund in 2000 and put it all in bonds (I got engaged and saw a house purchase in the near future). Interest rates fell and my GMAC 10-year bond gained almost 30%. When I got married in 2001, my RRSP was valued just over $56,000 from my initial $10,000 investment. I may be off on some of the dates, but I know for sure 2 things, my initial investment was in 1997 for $10,000 and the final value in 2001 was $56,000. I also never once put a dime into my RRSP over that time.
    Also in 2001, I purchased a house for $164K. I used $20,000 under the HBP and I used $36,000 from personal savings as a downpayment. I doubled my mortgage payments every month until my wife and I had a child in 2004. We now have a $60K mortgage.

    If I had done things a little differently (i.e. putting in an extra $500/month into the RRSP between 1998 and 2001) I may have a Derek Foster story. I had no idea what I was doing at the time, imagine if I had!

    Derek is very vague but I can see how it is very possible to be where he’s at. We just went through an amazing 15 year cycle that saw a lot of weird funds take off and earn well over the 20% he needed (Science and Technology, Gold, Oil, Bonds). If, out of sheer dumb luck, you moved things at the right time you could be well ahead of the game. There were just so many new investors, people borrowing to get into the market, it really put a lot of upwards pressure on some hot stocks and funds. I don’t think that will ever repeat itself but it was an amazing few years.

    Just my 2 cents.

  5. Pingback: Investing » Comment on How Much Should You Save to do a Derek Foster? by Philip S

  6. I really wonder which kind of life he lived by putting $800 a month and taking enough time to average a 20% yield. It is obvious that he had to sacrifice a good part of his life to retire early. I don’t know if it’s worth it. Especially if you can’t realistically expect 20% average yield over 15 years!

  7. According to an article in a previous issue of MoneySense magazine, Derek Foster didn’t accumulate his portfolio from pure saving. He used leveraging and gambled big on some distressed stocks and ended up hitting paydirt. In my opinion, it would be irresponsible to promote that as a method of accumulating that sort of wealth, so perhaps that is why Derek Foster left out such details?

    Unfortunately, our tax regime in Canada discourages people from saving as the accumulation of income producing investments pushes you into a higher tax bracket and then the tax man cometh to take away your gains. For me, I worked in the USA for a couple of years and here in Canada, I was self-employed (with my own corporation) for a while. This has resulted in many buckets of investments stuck in a variety of weird and interesting places making a very complex taxation situation. Luckily I have a good accountant to sort it all out.

    When it’s all said and done, I have about $250K of non-registered investments in a variety of securities which provide me with just barely enough income to pay for my monthly expenses. But I can see how if it were twice the size of what I currently have – at $500K, Derek Foster’s portfolio size – then one might be able to live on it. I probably couldn’t do that living in the Toronto area, I’d probably have to live in a location with a lower cost of living.

  8. FB: From what Derek says in his book, he didn’t suffer at all! He traveled quite a bit and never even actually started a ‘career’ in the true sense of the word.

    I think the more I hear about Derek, the more I hate him. ;)

    The thing I find the most remarkable is that a guy that made some pretty bold and daring moves (buying on margin – essentially betting on one stock) early on has now changed his strategy and invests very conservatively in blue-chip, dividend paying stocks (and some income trusts which aren’t quite as stable). Dumb luck is one thing, but the ability to realize how lucky he was and move to safer investments is pretty impressive actually. Many would be tempted to think they could repeat the ‘dumb luck’.

    There is one factor that has made Derek diligent about saving and going for the big gains early, and has now turned him into a boring investor and I think it’s his greatest attribute – LAZINESS (his desire, from day one of graduating from university, was to NOT work ).

    His book titles are very fitting. :)

  9. Canadian Capitalist

    Telly: I wouldn’t say that Derek made leveraged bets early in his investing career. He did them later when he had a sizable portfolio for the gains to be meaningful. The big fall in MO happened in 2000. I think he also mentioned making leveraged investments in income trusts (I could be wrong). So, really he has made one right call – getting into dividend paying investments at the right time. Good for him, but is it repeatable?

  10. CC said: ” So, really he has made one right call – getting into dividend paying investments at the right time. Good for him, but is it repeatable?”

    That’s a good point. The corresponsing question would then be, if it’s not, will he find the next best investment area?

  11. I don’t think he needs to find the next best investment area – by virtue of his good timing in dividend stocks + his leveraged plays he has enough to live on so why take any chances?

    Mike

  12. Canadian Capitalist

    Mike: I have my doubts if drawing down 4.2% (income of $26,500 from a portfolio of $628,000 according to a Star article in Sept. 2006) is sustainable when one is looking at a long retirement of 50 years. That said, Derek supplements his investment income with book sales, tax credits etc., so he’ll probably do ok.

    If I want to retire today, I’d figure a withdrawal rate of 2%. Let’s say I’ll need an income of $35K per year which would mean a portfolio of $1.75m. At a 3% withdrawal rate, I’d need just over $1m. Of course, nobody is going to buy my book, when I retire :)

  13. CC: I believe the market conditions have changed significantly enough that you can’t take his formula lock, stock and barrel and expect the same results but books are written time and context specific so it would be a little unreasonable to believe that what would work for Foster would work in exactly the same manner for the reader.

    As for Foster’s sense of timing- good to be lucky, lucky to be good.

  14. CC – I’ll have to reread Bernstein’s writings about safe withdrawal rates but I personally think that 4% is plenty safe enough. Don’t forget that the 4% rule was based on 30 year time periods which is already a long time – for a 50 year time frame you don’t have to lower the percentage correspondingly ie for a time period of 60 years you don’t have to assume a safe rate of 2%. I wish I had some actual stats & facts to back this up but that’s what I believe anyways.

    As for Derek Foster I think one of his fallback strategies was that he could easily re-enter the work force because of his young age.

    Mike

  15. Canadian Capitalist

    Mike: You can try out different scenarios using the calculator here:

    Link

    You’ll notice that a 4% withdrawal rate with a 50 year retirement horizon has a 15% failure rate. Not bad, but not 100%. 3% withdrawal has a 100% success rate, so 2% is probably too conservative.

  16. What are you guys referring to when you talk about DF’s withdrawal rate? I had the impression that he was living off dividends/distributions/tax credits/book sales and not touching his investments.

    One thing I wonder is how he managed to pay his mortgage down in 12 years while also contributing a decent amount to his RRSPs. Maybe he got a sweetheart deal on his house.

  17. When I said RRSPs I meant retirement savings.

  18. Rookie – any money that comes out of a portfolio is a withdrawal ie selling shares, interest, return of capital, dividends.

    CC – thanks for the link – the calc is pretty cool.

    I think if I was a super-young retiree I wouldn’t have too much problem with not being too conservative with the withdrawals since I could go back to work pretty easily.

    In my case I’m planning to use the 4% rule (more or less). I’m also putting a buffer into our income so if we hit a bad bear market then we could cut back for a few years. Ie we probably need about $30k/a for basic spending and then I’d like another $10k for travel, spending etc. Part or all of the $10k could be cut.

    Mike

  19. Canadian Capitalist

    Rookie: Since Derek spends all his dividends/distributions his current portfolio yield is the withdrawal rate.

  20. From reading Foster’s first book, I had assumed that he was living only on the dividends/distributions from his stock/income trust holdings. Lets assume that he bought RBC stock somewhere in 1999. At that time RY.TSX was selling at about $17/share. In 2006, it was paying dividends of$ 1.44/share or around 8.5% of his initial price. You can do the same with Riocan — 7 years ago, it was selling for about $10/share. In 2006, the distributions were 1.26/share — or about 12% on his initial price. To get an income of $30K based on an a 8% return through dividends assumes a holdings of $375,000 with no drawdown of the capital. Since we know that both dividends and income trusts distributions have favourable tax consequences, it seems quite possible to live on 30K. If your income was based on straight interest, I would assume that you would need to make ~40K to match this 30K income. He also mentions that he enrolled in DRIPs and DSPPs so his early returns would be re-invested.

    I had also assume that he was living mortgage free by moving from a larger metro area (either Vancouver or GTA) to a smaller area (Barrie comes to mind). Given the rapid appreciation of houses in the GTA, I don’t find it that hard to believe that he could have cleared his mortgage simply with the profits from selling and moving to a different area.

    In the end, the questions I have are could he have done it with $200/month and could it be reproduced by others. I don’t think that the $200/month is realistic. However, I do believe that it could be reproduced by others.

    When reading the book, I was reminded of Your Money or Your Life, except that the strategy there was to use TBills and live only on the interest.

  21. Yes, I think a few are missing Mr. Foster’s point of Dividend income replacement. The favourable tax treatment of eligible dividends you can receive approx. $41k before any income tax is due. This would be equal to a salary in the excess of $51K. One of the few chapters in his first book that’s explained in some detail is this point. Also, finding high quality dividend paying companies that raise their dividend annually, such as those on the Mergent Dividend Achievers list.
    Also, as far as my fuzzy 2year old memory recalls, he is contrary to RSPs since they reward those in the top bracket who expect to work to 65 and lower their income afterwards.

    See http://www.walterharder.ca/T1.html for tax calculations.

  22. I haven’t read the Derek Foster book – but I bet you’d be hard pressed to fine another Canadain who’s retired as young as originally did in Mexico (25).
    It’s funny that many Canadians haven’t figured out that they can retire on what they have between equity in their home + current portfolio. And live well, abroad.
    The added bonus is that Mexico has some of the best performing real estate in the world for price appreciation.

    JG

  23. If I recall correctly (from his first book) he also has a revenue property. Can anybody confirm?

    He has admitted to utilizing leverage in his stock purchases, which would have helped. You pointed out that he would need 20%/a, a leveraged portfolio could easily attain that (or just as easily fall by a similar amount;)).

    Also he was investing during the last trough in the business cycle. So, I have to agree that anybody just starting out right now (at these higher valuations) would have a more difficult time.

  24. Billy,

    I believe you are confusing ‘yield on original investment’ with ‘yield’. Remember that RY’s value in 2006 would be yielding 3.5% or so, not 8.5%. It’s irrelelvant what his original investment was, he does not count his original investment values as his sum of money at the end, he counts his current value…

  25. moneygardener (et al),

    Yes, you are correct that I was loose with current value and purchased value. But only the purchased value makes sense here since we plan to hold it forever. The current value does not matter. I’ll try to make it more concrete.

    Today I could take 375K and invest it all in Algonquin power (APF.UN). It is trading at 8.90 or so right now. This would give me around 42K shares. It is paying out around .90/share/year. This would give an income of 37K/year. If the price of APF.UN dives to $4 or jumps to $18 does it matter? As long as the distributions stay the same (or more correctly increase to at least match inflation) then the share price does not matter.

    The question poised is ‘How Much Should You Save to do a Derek Foster’. I have shown that 375K would be enough.

    Do I think its a good idea to invest 375K in APF.UN right now? Would it diversified at all? Nope. Is it possible to generate the required income on less than $1 million as CC asked? Yes, it is. The problem now is that we have to find the 375K and an investment that pays yields at least 8% every year and increases its distributions by at least inflation every year. This is where the ‘luck’ portion of the world comes in.

    To get the full DF picture, you also need to factor in the dividend re-investment for 12 years and the increases in value of distribtuions — here APF.UN is a bad example as their distributions have been essentially flat. Looking at Riocan instead is more fun here, especially when you consider that you could buy Riocan for ~$10/share in 1998. There was a $1.04 distrib/share in 1999, which increased to $1.30 in 2006.

  26. Canadian Capitalist

    Billy: To do a Derek Foster, you need a portfolio that yields enough to cover your living expenses today and has a very good chance of supporting your lifestyle under different market conditions in the future as well. If you use the calculator linked to in an earlier comment, you’ll find that there is only a 20% chance that you won’t run out of money with a 8% withdrawal rate over 50 years. Note that Derek’s own withdrawal rate is around 4% and has a 87% success rate.

  27. Does the 4% rule assume depletion of capital?

  28. CC

    You are deliberately ignoring his assumption that the dividends need to go up to match inflation. I agree that this is a huge assumption, but it appears to be the one DF used.

    FYI — if you had invested 120K in Riocan in 1998 and enrolled in the DRIP and then ignored it until now, you would have ~32K shares of Riocan now which at $1.30/share will give a distribution of ~40K per year…

    I’m not sure why there seems to be such a large amount of skepticism among PF bloggers about this. Have you read the book?

  29. CC wrote: “…you’ll find that there is only a 20% chance that you won’t run out of money with a 8% withdrawal rate over 50 years. ”

    Am I missing something, why would Derek run out of money?

    He is living off the dividends, and the dividends continue to rise over time. As long as he doesn’t sell any stocks he should never run out of money.

    In fact if he spends less dividends than he earns and invests the rest, his portfolio should continue to grow over time.

  30. Canadian Capitalist

    Billy: Yes, I’ve read the book and I’m sceptical because it is dangerous to assume that conditions far into the future will look like the recent past. It is not fair to say “if you’d invested in RioCan…”. In any case, the example you quoted is a portfolio of $800K today… That’s fairly close to the $1m, I mentioned in the post.

    KS: I didn’t say Derek will run out of money. In fact, I said he has only a 13% chance of running out of money living just off his portfolio with around a 4% withdrawal rate, which is his estimated portfolio yield. The 20% chance of success is for a withdrawal rate double that cited by Billy.

  31. Canadian Capitalist

    telly: The withdrawal rules all assume depletion of capital. Though, if you use a 50 year period, it’s not all that different from capital lasting forever.

  32. CC
    I only asked because you are using your assumptions about the world and not his. As I recall his axioms for buying stock were something like this:
    – buy stocks that have a consistent history of paying dividends
    -buy stocks that have a consistent history of increasing their dividends
    -buy stocks in companies that you feel are ‘recession proof’. I think his examples were big banks, electricity or utility companies and REITs (he seemed to be particularly enamored of reits holding retirement homes/elder care facilities).
    -only buy stocks and never sell them. You want to live off of the passive income (dividends/distributions). You do not need to worry about the current value of your portfolio.
    -only buy stocks that you feel are ‘on-sale’ (and meet the other criteria). I seem to recall an example of the big 5 banks in 2000 which were at a low.

    As well, the book had other advice that very much reminded me of Your Money or Your Life (live frugally, figure out how much your really need when your subtract the taxes, work expenses etc, pay off your mortgage).

    I don’t recall seeing skepticism about YMoYL in the same league as I see for DF. Is it that you disagree with the premise entirely, the claim that he did it on $200/month or the claim that he can live on $25K or so a year?

  33. Personally, I do not think it is unreasonable to assume that dividend growth will out pace inflation. Perhaps I have not beeen around for long enough but I find it hard to imagine a world were companies like JNJ, PG, GE, MCD, RY, TD, MFC etc. will raise their annual dividend at an annual clip of less than 4%.

    When it comes to income trusts, it gets a little murkier, especially with the coming tax laws. Foster must be at least a little bit concerned about what will happen with Trusts such as Pembina, and Canadian Oil Sands, and Penn West or whichever trusts he owns that are not REITS.

    The withdrawal rate problem is not as simple as some people here are insinuating, although with a diversified portfolio of mainly dividend achievers I believe you could confidently withdraw the yield forever and not deplete value.

  34. Canadian Capitalist

    Billy: First, investing in solid blue chips with a long history of raising their dividends is a very good strategy, especially when they are purchased at depressed prices. My problem with DF’s strategy is two fold:

    1. Gathering up a decent nest egg enabling an early retirement is not as easy as he makes out to be. DF himself achieved it by taking risky bets that are not suitable for everyone. The leveraged bets worked for him; doesn’t mean it would work for everyone.

    2. The withdrawal assumptions he is using are quite aggressive. If you are willing to supplement your investments income with a bit of work, early retirement is achievable with a $500K portfolio plus a fully paid off home. If you really want to stop working, I think you really need $1m or more.

  35. CC
    I agree that he could not have done it on $2400/year for 12 years. There must have been more to it than that.

    However, retirement should be possible on 500K — if you are willing to live on 20-25K/year (which DF is). Using your link to FireCalc gives a 73% success rate. Assuming the proper dilligence in choosing the stocks he should survive.

  36. Canadian Capitalist

    Billy: Fair enough. I guess calling a glass half-full or half-empty depends on your perspective. I just take a slightly pessimistic view :)

  37. Some pessimism is a good thing in retirement planning.

    I’m pretty sure that I would not want to try to live on 20K either…

  38. hey guys, derek foster has testicles in his mouth

  39. Hello bloggers,

    I’ve started initiating my 6yr old boy to the finance world. He has his own little bank at home in which he keeps currency from dozens of countries, he has his own savings account in which he follows and deposits funds.

    I want to investigate the possibility of investing directly in blue chip companies(DRIPs). What do you suggest for a 6 yr old? I want to incorporate a ‘fun’ factor, something to get him really excited about it …. more so than he already is.

    Looking forward to your insight,

    Regards,

    Eric

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