Here are some financial planning tools for better stock picks and retirement planning

We do our own stock market research for our newsletters and investment services, and we apply it from a portfolio manager’s perspective. That’s why we advise sticking to well-established companies; they tend to hold on to more value when things go wrong, or at least recover faster.

Here are some tips and financial planning tools aimed at helping investors manage their investments while cutting risk in their portfolios and increasing profits.

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Financial planning tools for assessing debt risk

Many successful investors start researching a company by looking at its financial ratios, including its debt-to-equity ratio. This ratio comes in several variations, but the basic idea is that you measure a company’s financial leverage by comparing its debt with its shareholders’ equity.

A high ratio of debt to equity increases the risk that the company (that is, the shareholders’ equity in the company) won’t survive a business slump. However, this ratio can mislead, because it compares a hard number with a soft one.

Debt is usually a hard number. Bonds and other loans generally come with fixed interest rates, fixed terms of repayment and so on. Equity numbers are fuzzier. They mostly reflect asset values as they appear on the balance sheet (minus debt, of course).

But the balance-sheet figures may be misleading. They may be too high if the company’s assets have depreciated since it acquired them (that is, depreciated more than the company’s accounting shows). In that case, the company will eventually have to correct the balance-sheet figures by cutting them or “taking a writedown.”

Likewise, the equity value may be too low if the company’s assets have gained value since the company acquired them. This can happen with real estate and other investments.

In terms of financial planning tools, debt-to-market cap gives you a better sense of a company’s staying power

Instead of focusing on debt-to-equity financial ratios exclusively, we recommend that you also look at the ratio between a company’s debt and its market capitalization or “market cap” (the value of all shares the company has outstanding).

Like shareholders’ equity, market cap may differ widely from the net value of a company’s assets. However, a moderate debt-to-market-cap ratio will tend to provide a conservative starting point for analyzing a company’s chances of survival.

Financial planning tools for saving money in retirement

RRSPs as part of your retirement planning tools: RRSPs are a great way for investors to cut their tax bills and make more money from their retirement investing.

RRSPs are a form of tax-deferred savings plan. RRSP contributions are tax deductible, and the investments grow tax-free. (Note that you can currently contribute up to 18% of your earned income from the previous year. March 1 is the last day you can contribute to an RRSP this year and deduct your contribution from your previous year’s income.)

When you later begin withdrawing the funds from your RRSP, they are taxed as ordinary income.

RRSP Infographic

(Click to enlarge)

RRIFs as one of your retirement planning tools: A RRIF is a Registered Retirement Income Fund, a tax-deferred retirement plan for your Registered Retirement Saving Plan (RRSP). RRIFs are used by those who don’t plan to cash out their RRSP as a lump sum when they retire, and prefer to extend their investment and take smaller withdrawals by converting to a RRIF. Registered Retirement Income Funds offer more flexibility and tax savings than annuities or a lump-sum withdrawal.

Like an RRSP, a RRIF can hold a range of investments. You don’t need to sell your RRSP holdings when you convert—you just transfer them to your RRIF.

Bonus financial planning tools to try: Dollar-cost averaging builds profit over the long term

Long-term studies show that the stock market as a whole has generally produced total pre-tax annual returns of 8% to 10%, or around 6% after inflation. Over periods of a few years or less, the return is far more variable and always uncertain.

The surest investing strategy for getting around this uncertainty is to start practicing dollar-cost averaging as early as possible, and invest regularly over the course of your working years. Then you can sell gradually in retirement.

In fact, if you invest a fixed sum at regular intervals throughout your working years, perhaps raising that sum from time to time as your income rises, you can largely forget about market trends. That’s because you’ll automatically buy more shares when prices are low and fewer when they’re high, and you’ll benefit from the long-term rising trend in the market.

Additionally, give your investments time to pay off. Resist the ever-present urge to buy and sell. A sound portfolio, built through careful research, needs surprisingly few changes over the years. Trading less frequently is a good thing, because it gives you fewer occasions to make costly mistakes.

What financial planning tools do you recommend for new and experienced investors?

If you had to choose one financial planning tool to prepare for retirement, what would it be?