10 Financial killers

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In my previous post, I shared how F.I.R.E. has an element of privilege to it. I also indicated that for most people, F.I.R.E. will remain a pipe dream.

There are very real obstacles to becoming financially independent and potentially retiring early. Here they are, in my personal order of importance:

FINANCIAL KILLERS # 1 & 2: STAGNANT WAGES AND INFLATION

5 years ago, Statistics Canada published a very interesting study on the evolution of wages in Canada between 1981 and 2011. The study shows, among other things, that hourly wages barely bulged during that period. A full-time worker would earn about $ 21 in 1981 and just under $ 24 in 2011. Not even 15% more.

There were also gaps depending on gender, age and education.

In the meantime, inflation during the same period rose by 149.16%. 

FINANCIAL KILLERS # 3 & 4: DISAPPEARANCE OF JOB SECURITY AND PENSION PLANS

Job hopping is the new normal these days. Most people will have an average of 15 to 20 jobs and 2 to 3 different careers. Sadly said so, most employees are seen as disposables. Job security is a thing of the past, just like companies’ pension plans.

Only 37% of Canadian employees have a pension plan today, primarily in the public sector. It used to be over 50% in the seventies. A company pension plan used to be an important pillar of retirement, making-up for paltry CPP amounts and lack of personal savings. Nowadays, workers need to save more for their retirement. It can be an arduous task when looking at Financial killers # 1 & 2.

FINANCIAL KILLER # 5: POST-SECONDARY EDUCATION COSTS

Canadian students graduate with an average of $ 27 000 in student-loan debt. Depending on the degree and university, this amount can be much higher. Starting adult life and career with such burden is crippling, even more so when looking at the previous 4 financial killers.

FINANCIAL KILLER # 6: UNHEALTHY OBSESSION WITH HOME-OWNERSHIP

Yes, I am aware I am a home owner, thank you very much. That being said, I did not think about buying until I was in my mid-thirties, and after doing thorough calculations. Nothing says you have to buy a property right after graduation or after getting married!

In order to buy, you need to save for both a minimum down-payment and the closing costs. You also need to stay put for at least 5 years, if you want to gain equity and recover from the closing costs you paid.

FINANCIAL KILLER # 7: CAR AND COMMUTING COSTS

A subcompact car will cost on average $ 10 000 per year. This includes car payment, insurance, gas, maintenance and tolls. Since more people have to move to suburbia to find affordable housing and easily need 2 cars per household, these costs can only go higher.

FINANCIAL KILLER # 8: STAGGERING DAYCARE COSTS

If you chose to have children, it is very likely you will have to go back to work, despite the Federal government paid maternity leave and the Canada Child Benefit program.

This is not always a question of personal choice. It is merely based on at least the 5 first Financial killers.

A spot for an infant in a licensed daycare in Vancouver costs close to $ 1 300/month. For a toddler, you are looking at just over $ 1 000.  Prices in other big Canadian cities are similar, with the exception of Montreal. The Quebec government has its own childcare program and costs are way lower.

FINANCIAL KILLER # 9: CONSUMER-DEBT, AVOCADO TOASTS AND LATTES

A lot of people are still trying to keep-up with the Joneses, by constantly upgrading to bigger and shinier things.

That being said, a lot of people are also using credit cards to make ends meet, due to the above financial killers.

FINANCIAL KILLER # 10: LACK OF FINANCIAL LITERACY

Unfortunately, we are not taught at school that we need to save for retirement or for emergencies. We are also not taught how to best do these things. We are not taught how interests on credit cards or loans is calculated. We are not taught about management fees.

This doesn’t help, but it is not what sends someone to a trustee in bankruptcy, contrary to popular belief.

 

 

F.I.R.E. explained and debunked

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F.I.R.E. is a very popular acronym is the Personal Finance blogosphere. It stands for Financially Independent Retire Early. Over the years, this concept has become more and more appealing, and no wonder. With major changes in the workplace, such as stagnant wages, the disappearence of pension plans and a higher unemployment rate, a growing number of people aspires to quit the grind….myself included.

F.I.R.E. IS NOT A GET-RICH-QUICKLY SCHEME

Unfortunately, it will take some time before anyone is in a position of pulling the plug on their dreaded job, as a sufficient amount of money needs to be saved first.

Said amount will require thorough calculations first. Conventional wisdom says it should be 1 million or 25 times your yearly expenses. I say conventional wisdom needs to be challenged! I will save this for another post.

In order to save for the magic number, you need to make money, there is simply no way around this!

F.I.R.E. HAS AN ELEMENT OF PRIVILEGE IN IT

When you take a look at F.I.R.E. bloggers, most of them were making a decent income – well into the 6 figures, combined or not- before becoming financially independent (F.I.) . Some of them don’t have children or had them long after being F.I. Others chose not to buy properties or graduated with no student debt or had no debt at all.

The above definitely gives a head-start to anyone choosing F.I.R.E. It doesn’t mean you can’t achieve F.I.R.E. if the above-mentioned doesn’t apply to you. However, it may be more challenging and take longer.

The harsh truth is that F.I.R.E. will remain a dream for a lot of people.

F.I.R.E. HAS AN ELEMENT OF FRUGALITY IN IT

In order to achieve F.I.R.E., you not only need to earn money, but also to cut down on expenses.

By doing so, you may realize you need less than you initially thought to live on.

Being frugal can be borderline with being cheap at times.

Frugality is not for everyone either. That being said, not being frugal does not prevent anyone from reaching F.I.R.E. either. It will just take longer.

F.I.R.E. IS MORE ABOUT FINANCIAL INDEPENDENCE THAN EARLY RETIREMENT

A lot of people achieving Financial Independence actually do not retire or stop working. They choose to pursue different career paths instead, the most popular being becoming a writer and/or a blogger.

This is where the problem lies, in my not-so humble opinion. A lot of people blogs about retiring early and never working again, when they are actually still earning income instead of drawing from their savings!

The core concept is that F.I.R.E. gives you the ability to choose when and where to work as well as what to work on. Money is no longer part of the equation. This is what I personally find really attractive.

FINAL WORDS

I would love to reach Financial Independence sooner than later. That being said, I don’t know if it is a possibility right now, and it is OK. I fully acknowledge my economic reality and the limitations of the F.I.R.E. concept.

I would also caution anyone not to take at face-value anything read on the Internet from people claiming to be F.I.R.E. We never have the “full picture” of their situations. We don’t have access to their bank accounts, investment portfolio or tax returns. We can never be sure where their income comes from.

 

 

The importance of the emergency fund

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I have heard a lot of names for the Emergency fund: Back-up fund, F-U fund, Opportunity fund, Rainy-Day fund…whatever you want to call it, it is just semantics.

The purpose of said funds is the same: to have some cash in hand when s**t happens. And yes, s**t will occasionally happen, no matter how much we pretend it won’t.

I have written about having an emergency fund before. My views on this matter haven’t changed. With this post, I want to go from theory – i.e. having an emergency fund- to practice -i.e. dealing with an emergency-.

ENTER MY DRIVING WOES

It all started in 2014. That year, I was involved in a minor collision for which I was found 100% responsible. I had to pay a deductible when getting my car fixed. At the time it was $300, no big deal for my wallet.

In British Columbia, it is possible for the at-fault driver to reimburse the insurer for the repair costs to both vehicles, provided there is no injury claim. Doing so also “protects” the insurance premiums of the at-fault driver from increasing.

In my case, the other driver claimed injuries so I could not do this and was assessed a premium surchage over a 3-year period. In any case, I wouldn’t have been able to repay , as I simply didn’t have the extra money back then.

DRIVING WOES-TAKE 2

Fast forward to 2017, I hadn’t had any at-fault accident since then, when I was involved in another minor fender-bender for which I was also found 100% responsible!

My deductible was $ 500 this time, again no big deal for my wallet. However, because of the 2014 accident, I was looking at a hefty premium surchage. The only way for me to avoid this was to pay for the repair costs on both vehicles, AND that the other driver did not claim injuries.

THE CASE FOR THE EMERGENCY FUND

I was extremely lucky that the other driver did not sustain injuries. I was also lucky the collision was minor. The total extra costs came at just over $ 2 800.00, which I was able to repay and this is what I actually did.

All in all, the total amount I forked up-front for my driving mishaps was $ 3 600.00. The upcoming surchage I was looking at was 3 times that amount!

I might be Captain Obvious here, but I am glad  my emergency fund was here to get me out of the hole I had dug for myself! If I hadn’t had one, it would have cost me an extra  $10 000, on top of the regular premiums. That would have been a big chunk of dough!

CONCLUSION

I have yet to hear anyone -including myself- wishing they didn’t have an emergency fund when s**t hit the fan.

Much has been written and said about the good, old emergency fund. There is no question pretty much anyone needs one, including those with a hefty saving rate and those financially independent. A portion of assets should be designated as emergency fund.

Whether one needs $ 10 000, 3 or 6 months of expenses and whether said monies should be held in a plain savings account are discussions for another post.

In the meantime, and in light of these car events, I may need to devote some money for driving lessons….and that is also a discussion for another post!

Time-weighted vs. Money-weighted rate of return

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With the implementation of CRM2, Canadian banks, investments brokers, mutual funds dealers and other financial entities must disclose the method used to calculate the rate of return of a portfolio or investments like an ETF or a mutual fund.

There are 2 methods used: time-weighted and money-weighted. Both are valid and accepted. Let’s take a look at the 2 approaches.

there is only one big difference between the 2

The time-weighted method does not take into consideration any contribution or withdrawal (cash flows) made to a portfolio. It does not take into account any dividend or interest received either.

The money-weighted method, on the other hand, does take cash flows into consideration, including dividends and interests.

the time-weighted method works best for product comparison

In the time-weighted method, all periods’returns have the same weight, regardless of cash movements. For example, if the return for period 1 is 10%, and the return for period 2 is  -8%, the return would always be 1.2%.

This method works very well to compare products such as mutual funds or ETFs. The majority, if not all, of fund managers uses this method. it is also easier for them, as they have no control on cash flows.

the money-weighted return works best at individual level

The money weighted method, as indicated above, takes cash movements into consideration to calculate return.

It  finds the interest rate or rate of return that would have to have been paid for the investor to obtain the actual ending value, given the beginning value and the deposits and withdrawals that occurred during the period.

The result is way more precise for investors, and can help them understand why they might be loosing money.

The money-weighted return will most likely be a different than the time-weighted return.

conclusion

For most investors, regardless of how experienced they are, the money-weighted return is the best method. It gives a more clear picture of how their portfolio is actually performing .

 

The higher tax-bracket myth

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Very often, I hear people complaining about paying more taxes as a result of working overtime, taking a second job or receiving a bonus.

A very common sentence is: “working overtime puts me in a higher-tax bracket, so it may not be worth it”.

there is no such thing as “being in a higher tax-bracket”

People claiming this don’t understand how the Canadian tax system works. I don’t blame them. Taxation is a very boring matter.

That being said, I believe that understanding a few tax basics can help anyone make better financial decisions.

canada has a progressive tax system

Basically, it means that people will pay more taxes as they earn more money….but in a progressive manner or a tiered-manner. Here are the federal tax rates at the time of writing:

  • 15% on the first $45,916 of taxable income
  • 20.5% up to $91,831 
  • 26% to $142,353 
  • 29% up to $202,800 
  • 33% of taxable income over $202,800

For the sake of simplicity, let’s say an employee earns $ 45 000 gross per year. In refering to the above tax rates, our employee will be taxed at 15%.

Now, let’s say that our employee works overtime during the year, and earns an extra $ 5 000. Their gross income is now $50 000. In refering once again to the above rates, our employee will now pay 20.5%, right? WRONG! 

This is not how a progressive tax system works.

Our employee will actually pay taxes of 15% on $ 45 916 and 20.5% on the remaining $ 4 084.

This is where most people are confused. They think that their entire income will be subject to a higher tax rate, when it is not the case.

you can work overtime

As demonstrated above, working overtime will not result in a massive tax bill. Keep in mind you may be eligible for additional tax credits when filing your return.

To combine finances or not?

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When two people are in a committed relationship, the question of moving-in together comes-up at some point. This question actually triggers a series of other questions such as how to share household chores and if all the belongings are going to fit-in in the new place.

However, there are a couple of very important questions that should not be overlooked: how are we going to pay for the bills and are we going to combine finances?

Long before you move-in, you should have had “the money talk”, as a couple. There are crucial details that partners need to know about one another, such as income and debts, as well as goals.

Once you have the basics down, it is time to take your conversation to the next level.

Option 1: partial combination; 1 joint checking-account, 1 joint savings-account

A joint checking-account is used to pay for common expenses like rent, utilities and groceries. More categories can be added, depending on your situation. If you are a one-car household, then car expenses would also be considered as a joint expense.

If you have similar incomes -or close enough-, you can both contribute 50% to the account. If there is a large disparity between your incomes, use the percentage method instead.

Add your respective monthly net incomes. Divide your individual net income by the combined income and multiply by 100. Always use your net income.

For example, if your net combined monthly income is $ 10 000 and one partner earns $ 2 500, their share is 25%.

It is also a good idea to have a 3-month emergency fund for the shared expenses.

Option 2: almost complete combination

With this option, all the money is deposited in a joint-account and a portion is transferred to each partner’s individual accounts.

All the bills are paid from the joint-account, regardless of their nature. The individual accounts work like an allowance.

The most challenging part of this approach is to decide what amount should be transferred to the individual accounts!

Option 3: complete combination

This approach is definitely the most transparent one. When both partners are on the same page financially, it is also the best.

Communication is key. It is best for both partners to sit down and discuss how to consolidate all their accounts, as well as how to manage them on a day-to-day basis. Both need to be actively involved.

As years go by and children come into the picture, the line between “yours, mine and ours” becomes more and more blurry.

Option 4: complete separation

In this scenario, the couple does not combine finances at all and keeps everything separate. I personally find this method counter-productive. Some household expenses are higher than other ones, and it can be tricky to decide who pays for them. It can also be an hindrance to saving goals or paying-off debt.

You may want to revisit why you are not considering combining finances to some extent. Maybe you have done this in a previous relationship and it was a disaster? Maybe you don’t trust your partner? Maybe your partner has an opposite financial style?

Again, communication is key here. Money is a huge stressor for couples and the leading cause of divorces.

Final word

Deciding to combine finances -or not- is a very personal decision. What will work for a couple may not work for another. It is important to find the system that works for both your partner and you. Don’t worry about what outside people think.

My personal tips to save money

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At the Money Savvy Blog, we regularly receive questions on “how to save money”.

Here are my own personal tips to do so. They may surprise you!

DON’T BUY OR RENT TOO MUCH HOUSE

You can save hundreds of dollars each month by doing so. Everything is negotiable, and that includes both rent and mortgage. Not all rents are the same amount. It may be cheaper to move to a different neighbourhood.

Same goes for home prices. Despite being in a raising-rate environment, you can still find low-rate mortgages. It is also important to buy the right amount of space for your needs. Unless you plan on having 10 children, you most likely don’t need a 10-bedroom mansion.

And because a lender qualified you for $ 500 000, does not mean you have to buy a $ 500 000 property! You actually would be better off buying a $ 250 000 one.

DON’T BUY OR LEASE TOO MUCH CAR

A car is a depreciating asset. It starts loosing value the minute it leaves the dealership. I never understand why people would spend thousands and thousands of dollars to buy such item.

And I shake my head when I hear people calling their cars “an investment”….

CAA has a very nifty little tool to estimate car costs. This depreciating asset also happens to cost a lot of money to maintain!

For example, a compact or subcompact car will cost around $ 9 000/year in British Columbia. A pick-up truck will cost around $ 14 000, and an “executive” vehicle (BMW, Audi) will cost around $19 000.

You will see a lot of the latter two in the Lower Mainland….Unless you work in a farm, in forestry or image is a crucial component of your income, you don’t need these types of car.

If you ditched the pick-up truck for a compact car, you will save $ 5 000, right off the bat.

If you are in a multiple-car household, try to see if you could live on 1 or 2 cars, instead of 2 or 3. You will save even more money!

SHOP AROUND

In this day and age, comparing costs of products and services has never been so easy. Unfortunately, most companies also do not reward loyalty anymore. It is always worth obtaining several quotes before purchasing, particularly on products like insurance, cable, cell phone or services like home repairs.

You could save big time. Case in point with my own home insurance: my former provider, with whom I had been for several years, kept increasing my rates; this despite me never filing a claim. I shopped around and switched to my current provider for half the price.

COOK MORE OFTEN

Much has been said about the latte factor and the avocado toast. While I agree that occasionally indulging in these will not put you in financial jeopardy, I believe it is problematic when indulgences become a daily, new necessity.

On the very first post I wrote on this blog, I had estimated someone eating 3 meals out 5 days a week would spend about $10 000 per year.

You can slash that amount in 2 by cooking and eating at home more often. You would still be able to eat out from time to time, just not on a daily basis.

FINAL WORD

By cutting expenses on big-ticket items like housing, transportation and food, you can save 10 to 20K per year fairly quickly and easily.

In comparison, how much do you think it would take to save the same amount of money on your own, solely relying on your income?

Stress-testing your finances

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The Office of the Superintendent of Financial Institutions (OSFI) implemented a new mortgage rule that will come into effect on January 1st 2018.

Any mortgage applicant will have to be put to a financial stress-test, regardless of the down-payment amount. Same goes for renewal and refinancing, unless the lender is the same.

Initially, only high-ratio mortgages were subject to said test, i.e. mortgages with less than 20% down.

Basically, borrowers will need to qualify for a mortgage at a rate 2% higher than the rate they are actually getting or at the 5-year Canadian benchmark rate, whichever is greater.

This measure is put in place to ensure Canadians do not buy properties that they ultimately can’t afford to pay for. We also are in a rising-rate environment, after 7 years of stagnation….and household debt is at an all time high.

Canadians will qualify for lesser amounts, and personally I think it is a good thing.

stress-testing our personal finances is always a good idea

Life is never a straight line. Sometimes, shit happens; things don’t go according to plan. Suddenly, we are out of a job; or we are involved in a car accident.

So, what do we stress-test our finances? Let’s take a look at a few items.

liquidity 

How liquid are you? if something bad happens, you will most likely need some cash right away.

If you are sick, you will probably need to pay for your medication before submitting an expense claim. If you apply for E.I. benefits after being let go, there is a one-week waiting period. It will take 2 to 3 weeks before money is actually deposited in your bank account.

And no, a credit card is not considered as liquidity! Sure, you can charge expenses to it and earn rewards, but at some point, you will have to pay the credit card company back.

Your house and RRSP are not liquid either. It will take weeks, if not months to liquidate these.

insurance

Having adequate insurance coverage can be a life-saver and may avoid you bankruptcy or foreclosure on your home. I wrote this article a while back. Use it to assess whether you have sufficient coverage (shameful plug, I know!).

mandatory expenses

These include shelter, food, debt repayment at the very minimum. Depending on your situation, you will probably have more categories such as transportation and/or various insurance policies.

Don’t think for one second you will be able to skip these. Vacation and entertainment, however, can -and should- be put on hold. This is the basis of your bare-bones budget.

net worth

In extreme circumstances, you may have to sell all your assets to pay for what you owe or to avoid becoming homeless. Your net worth equals all your assets minus all your liabilities.

if after doing the math, you don’t have anything left, or you owe more than you own, you have a problem. Having some net worth is another good safety net.

Final word

Everyone should stress-test their finances at least once a year. Review your savings amount and allocation; review your insurance coverage; live on a bare-bones budget for a month. You don’t need to wait for an emergency to do so.

Why I don’t automate all my finances

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If you are the forgetful type or if organization is not your strong suit, I totally understand why you would choose to have all your bills automatically paid.

After all, once it is set up you can just forget about it. You also don’t have to worry about late fees and interest charges.

Automating finances is hugely popular in the personal finance blogosphere. However, I personally beg to somewhat differ.

nOT worrying and forgetting are precisely the problem

Automating all finances can make you lazy. You don’t necessarily check your statements and bills anymore. It can make you spend aimlessly and overspend too.

service providers do make mistakes

Since they have access to your bank account or credit, it may be difficult for you to get your money back or a credit if you notice a mistake in your bill.

If money is tight, it could put you in a delicate situation if you overpay due to incorrect billing. You may not have the funds to pay for other items.

paying for a bill can mean you agree with the charges

Before setting up an automatic payment, please read the terms and conditions set by the service provider. It is not uncommon to see a full payment means acceptance of the charges.

if you don’t have the money in your account, you will pay fees and interests

Banks are notorious to charge overdraft fees and interests until your account is back in the black.

Your payment will go through but you will be dinged. Most bills are due at different times of the month, and are not always linked to your paydays.

these are the main reasons i don’t automate all my finances

Manually paying my bills forces me to check them and to pay attention to my spending.

The only bills I had to automate were my mortgage, my car payment and car insurance. I wrote “had to” because it is pretty much impossible to send cheques for these expenses.

What about you? Do you automate your finances?

Annuities basics

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Please note I am not a licensed insurance agent. This post is for information purpose only. 

Upon retirement, many people decide to convert their savings into an annuity. But what is an annuity?

AN ANNUITY IS A CONTRACT GUARANTEEING AN INCOME FOR A SET PERIOD OF TIME

Basically, you buy it with your savings and the money is returned to you in the form of set payments as well as any interest earned.

There are different contracts that can match your needs: straight-life, term, prescribed, indexed, insured, variable, joint-life (for couples), guaranteed minimum..etc

ANNUITIES ARE GREAT IF YOU ARE CONCERNED WITH OUTLIVING YOUR SAVINGS

If you buy a straight-life annuity, payments are guaranteed until you die. A number of term annuities can make payments until you are 90.

ANNUITIES TAKE AWAY INVESTMENT CONCERNS

With an annuity, you don’t have to worry about selling stocks, bonds and re-balancing your portfolio. The insurer will do it for you.

ANNUITIES CAN BE A SOLUTION IF YOU ARE SINGLE WITH NO DEPENDENTS

Most annuity contracts will stop payments upon your death and will not necessarily return the excess funds to your estate. If leaving a legacy is not a priority, you can choose a higher payout instead.

ANNUITIES MAY NOT WORK IF YOU ARE IN POOR HEALTH

if you are not expected to live a long retirement due to health issues or a terminal illness, an annuity may not be the best solution for you.

ONCE YOU BOUGHT THE ANNUITY, YOU ARE LOCKED IN

This is the biggest drawback of this product. Once you have signed the contract, you cannot go back. You no longer have control over the money you handed over, nor can you choose how to invest the money.

THE INCOME IS CALCULATED AT THE TIME YOU BUY THE ANNUITY

If interests rates are higher upon purchasing, you can expect a higher payout. If they are lower, your payment will also be.

Age, gender, life expectancy and the amount of money you have also influence the payout.

As a rule of thumb, you are better off buying an annuity when you are 70 or older.

ANNUITIES ARE TAXABLE

If you buy your annuity from an RRSP or a RRIF, you will be taxed at your marginal rate.

If you buy from a non-registered account, you only pay tax on the interest portion of the payment. As you age, the income received will gradually shift to the principal, lowering your tax bill overtime.

A good tax advantage is with a prescribed annuity. The insurer will pay an even amount of both principal and interest,evening out the portion subjected to tax.

YOU NEED TO CHECK THE INSURER’S FINANCIAL POSITION

As annuities are guaranteed contracts, the insurer needs to be in a solid financial position.

Should the insurer become insolvent, Assuris will provide 85% or $ 2 000 of the monthly payout.

FINAL WORD

Annuities are complex products, but they are definitely worth a look. An annuity can be a great part of your retirement plan, but it should never be your entire plan.