The dog years of compounding (in investing)

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Albert Einstein dubbed compound interest the eight wonder of the world. It truly is when looking at the concept: investing money, earning interests/dividends/capital gains on investments, reinvesting said interests/dividends/capital gains/ thus earning more interests/dividends/capital gains.

It seems simple, yet it is a tad more complicated than it seems

Most people in the financial industry do not talk much about the time factor, when it comes to compounding.

You see, compounding is actually very slow to start. That’s why conventional wisdom says one should start saving as early as possible. But I almost digress here.

with COMPOUNDING, time is actually not of the essence

For the sake of simplicity, let’s assume an initial investment of $ 10 000, with an additional monthly contribution of $ 100. Let’s assume a constant return of 5% for 25 years, and that interest is compounded monthly.

I am aware this is really unlikely to happen in really life, but I am writing for the sake of simplicity here!

After said 25 year-span, the $ 10 000 will turn into around $ 94 364. Great!

But when looking at the timeline, you realize your investment will take over 5 years to double, and an extra 4.5 years to triple.

it takes at least 15 years…

15 years is the mark where your investment starts to grow faster and another 3 years for cruising speed. Before that, progress is actually fairly slow.

patience is the key word

A lot of people become discouraged, long before the 15 year mark. If the market becomes bearish, it can be even easier to give-up, but don’t!

By doing so, you will only have principal with very little interest/capital gains/dividends. Over the years, interest/capital gains/dividends will exceed the principal amount, and that is the beauty of compounding.

Managing lifestyle inflation

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“Lifestyle inflation” is a very popular topic amont financial planners and personal finance bloggers. But what is it exactly?

lifestyle inflation is increasing your spending when your income goes up

This is the very definition of lifestyle inflation. And yes, we are all pretty much guilty of lifestyle inflation.

This is particularly true when transitioning from student to employee. Most students have to get by with very little, and most make do.

But once the first real paycheck arrives, boy, oh boy!

lifestyle inflation is not always bad

Once you make more money, it is perfectly normal and acceptable to want to live and enjoy life more. Actually, it is not expected of anyone to keep living like a student or a pauper for the rest of their lives!

It is normal to think about having your own place, going on vacation, buying new clothes vs.second hand ones etc…and to actually do those things.

Lifestyle inflation becomes a problem when your spending causes you to live paycheck to paycheck, prevents you from paying debt off and from saving for retirement and other goals.

lifestyle inflation can be managed

Yes, you can still have your cake and eat it too. Here are a few tips.

figure out your new compensation to the penny

If you landed a higher paying job or a promotion, figure out how much you will make on each paycheck. Keep in mind salaries are always gross amounts in North America. After taxes, you may be surprised to realize it is not as much as you thought.

revisit your budget, particularly the “fun” category

Give yourself permission to spend a set amount each month on things you really like and that makes you happy. Don’t worry about what other people think. It is their problem not yours.

revisit your goals

I found it also helps to focus on short-term, medium-term and long-term goals. When you have saving goals, your save towards them instead of spending mindlessly.

If you are about to charge something to your credit card, ask yourself whether this purchase is in line with your goals and within your budget.

forget about the joneses

They are probably broke anyway! Not to mention your material possessions do not define who you are as a person.

final word

I personally do not believe lifestyle inflation can be completely avoided. I also believe it is normal to somewhat spend more when earning more. However, it is possible to manage lifestyle inflation. Like everything else, it does require some discipline.

Buying a rental property (or not)

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Unlike my previous post, the criteria to decide whether to buy a rental property -or not- are very different. This post may also shed some light if, for example, you already own and have accepted a job in another city/province.

First, understand the tax implications

Although you can deduce some expenses from it, rental income is taxed at your marginal rate, if the property is registered under your name.

In Canada, selling your principal residence for profit does not result in taxes levied. This is definitely not the case with a rental property!

Upon selling, any profit you make is considered a capital gain. In Canada, 50% of the capital gains are taxed at your marginal rate, if the property is registered under your name.

It gets a little bit more complicated if you elected to deduct the Capital Cost Allowance -CCA-from your rental income. CCA is a “wear and tear”amount set by Canada Revenue Agency depending on the type of property, the year it was built etc….

CCA is a tax-deference mechanism. It allows you to lower the amount of taxes levied on the rental income. Note you can’t use the CCA to trigger a loss or if you are already claiming a loss.

Upon selling, the CCA amounts previously claimed become 100% taxable, are added to your income and taxed at your marginal rate. It is called “recapture”.

As an individual, claiming CCA usually does not make much sense, unless you are in the highest tax bracket.

Second, cash flow is king, forget the 1% rule (or almost) 

When you live in your property, land appreciation is important. This is what increases your property value. As an investor, and although this is nothing to sneeze at, this is not what you should be looking for.

As a potential landlord, you need to look at your investment from a business perspective. In other words, will the income generated from the property be enough to cover all its expenses and taxes?

A common principle used is the 1% rule, meaning the rent should be 1% of the purchase price.

Unfortunately, in North America, real-estate has become increasingly expensive. Rents have not necessarily followed that trend. It has become almost impossible to find properties meeting the 1% rule.

Which does not mean you should not consider becoming a landlord.

There is another formula to help you determine if a property has cash flow potential, the Gross Rent Multiplier or GRM:

(gross annual rent/purchase price) X 100

If the number is above 8, the property has potential, if it is under 8, pass. If it is above 10, cash flow is guaranteed. This quick and easy formula takes out all the guesswork and emotions from the search.

Once you have your cash flow number, dig into the details: proposed rent, mortgage payment, property tax, condo fees if applicable, potential repairs, estimated income tax..etc and see if it still adds-up.

As a landlord, you won’t be able to postpone or skip maintenance and repairs. It is best to budget for them. Some utility costs, such as Hydro can be passed on to the tenants.

Third, vacancy rate

The lower, the better for you! It is pointless to buy a rental property if there is little demand for rentals….CMHC provides info on the matter.

Final word

It is crucial to leave your emotions at the door when deciding to purchase a rental property or to rent out your main residence.

There are also lots of other factors that could influence your decision such as how much equity you are able to start-up with or the amortization on your mortgage. In Canada, you need at least 20% down for rental properties.

“Landlord-ing” is not for the faint of hearts. It is actually a lot of work.

 

Buying vs renting a home

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Don’t roll your eyes just yet. This is not another debate as to whether renting is better than buying or conversely. I am actually not advocating for either option. I have been both a renter and a homeowner. In fact, I have rented more than I have owned.

I noticed there is a lot of calculators out there to help people determine which option would make the most sense financially.

Most of these calculators are flawed for various reasons; the biggest one being that they calculate based on gross income instead of net. They also don’t take into account non-financial factors, which could have a huge impact on your decision.

So, I have come up with my own analysis: non-financial factors and financial ones.

buying a home is a long-term project

Where do you see yourself in five years? As a rule of thumbs, five years is the minimum amount of time you need to stay in a property to break even or be ahead financially.

During the first five years, you pay more interests than principal on your mortgage. You also need to recoup the closing costs you paid.

Don’t get fooled by crazy real-estate markets like Toronto or Vancouver. It can be tempting to sell  after a year or two, but you would actually be losing money by doing so.

if you need to buy a car or two, keep renting

Transportation costs in Canada are very high. They can -and will- eat-up a huge chunk of your income.

if you have student loans or credit card debt, keep renting…

…at least for the time being. Pay-off your debt or significantly lower it before looking at buying. Debt repayments are a huge financial burden.

A lot of recent graduates seem to be obsessed with becoming homeowners as soon as they receive their degrees. It sounds a little bit crazy to me.

So, you have determined the above first point applies to you and the second and third don’t. Let’s do some basic math.

35% of your net income is the maximum for housing costs

Lenders always use gross income to qualify people for mortgages and other loans. The problem with that is your gross income is not what is deposited in your bank account.

Always use your net income and really avoid going over 35%.

compare apples with apples

Compare the cost of renting and buying based on similar properties in similar neighborhoods. Renting or buying a two bedroom apartment will cost more than a one bedroom or a bachelor. You can find rental info on Craigslist or Kijiji.

include very comprehensive costs

Buying costs do not stop at the mortgage payment. Unfortunately, too many people can’t seem to look past this.

If you are buying a condo or townhouse, include: mortgage, strata/condo fees, monthly portion of property tax & any other municipal taxes, monthly portion of home insurance, monthly portion of Hydro and monthly portion of maintenance.

If you are buying a single, detached home, include: mortgage, monthly portion of property tax & any other municipal taxes, monthly portion of home insurance, monthly portion of maintenance and monthly portion of all utilities: hydro, gas, water….

a word on maintenance costs

As a homeowner, the biggest difference from being a tenant is that you are responsible for repairs and maintenance. And yes, you will encounter these! The costs will be different if you own a condo or a single detached house.

In a condo building, most of the maintenance costs such as landscaping, snow removal, elevator etc…are usually included in your strata/condo fees. Big ticket items, such as the roof, are shared costs. You are only responsible for repairs inside your unit. Costs are overall lower. Take 0.5% to 1% of the proposed purchase price. That’s your yearly costs. Divide by 12.

For a single dwelling, you are 100% responsible for all the costs and they are usually higher. Use 1.5 % to 2% of the proposed purchase price.

You may not spend the amount in a given month or year, but it is best to err on the side of caution.

final word

If the number you end up with is lower than the renting cost AND does not exceed 35% of your net income, happy house-hunting! Otherwise, keep renting and invest the difference.

If home ownership is important to you, you owe it to yourself to do the above basic calculations.

There will always be opportunity costs whether you own or rent. The answer to this old age question is not so clear-cut anymore.

 

Book review: The Wealthy Renter by Alex Avery

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Please note I did not receive compensation to review this book.

The home ownership dream is very alive and well in Canada. The Federal government estimates about 70% of Canadians own their homes. It seems like the remaining 30% is obsessed with joining-in.

If you do some internet search, there aren’t that many articles, posts or books advocating for renting. This book does exactly that and it is geared towards Canada.

Alex Avery is a CFA® and holds an MBA in Finance. He currently is the Managing Director of Institutional Equities at CIBC. This division provides research and analysis on real-estate companies.

the wealthy renter definitely presents a different point of view….

I like that Avery dispels a few common myths surrounding home ownership and tries to best address the unhealthy obsession Canadians have with it.

There absolutely are benefits to renting, particularly in Canada when tenants are not responsible for home maintenance and repairs. Renting is overall, more flexible….but don’t we all know this already?!

The biggest financial benefit of renting presented in the book is when the tenant actually invests the difference between the cost renting and the cost of owning. I wholeheartedly agree with this…provided renting is cheaper than owning.

….but is overall too pushy

The whole point of this book is to advocate for renting, so I get that Avery would really push for it. Unfortunately, at times, his arguments do not make sense. One of his biggest points is that home owners do not know about the actual costs of their properties. He gives the impression owners are naive and think the only cost is their mortgage….unreal.

Avery also claims repairs costs are not known in advance, which is not exactly true either. A home owner can ask for estimates on various items; a strata corporation can obtain a depreciation report.

unfortunately, the answer to renting vs buying is not so clear cut

And even more so if you live in Vancouver or Toronto, where rents are extraordinary high, including in the suburbs.

Anyone contemplating buying a home must do some serious calculations and look at their personal circumstances as well. Renting is more than OK too!

final verdict: pass

Although the book has the merit of presenting a different point of view, it does not do a good job at it.

Instead of aligning numbers and somewhat confusing analysis, it should have focused more on addressing the stigma around renting.

No fee banking in Canada

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Banks and credit unions in North America have the right to charge all sorts of fees on both business and individual accounts. And boy, they do!

Monthly fees on chequing accounts can as high as to $ 30.00. Many financial institutions will waive the fee if you maintain a daily minimum balance in the account.

Said minimum balance has been on the rise and can easily reach $ 3 000.00. Yes, you are reading right, leaving $ 3 000.00 in accounts that usually don’t earn any interest. Ridiculous!

Monthly fees can and will add-up after an extended period of time. I recently changed banks. My ex credit-union charged me $ 7.00/month for 8 years. It adds up to $ 672.00.

I have done some research to find alternatives to monthly banking fees. I have looked for accounts offering unlimited transactions, not under any age requirement, and of course, with no minimum balance.

“NATIONAL” NO FEE CHEQUING ACCOUNTS

ALBERTA NO FEE CHEQUING ACCOUNT

BRITISH COLUMBIA NO FEE CHEQUING ACCOUNTS

MANITOBA NO FEE CHEQUING ACCOUNT

  • Cambrian unfee : this credit union will refund all banking fees with a recurring deposit such as payroll or pension

ONTARIO NO FEE CHEQUING ACCOUNTS

SASKATCHEWAN NO FEE CHEQUING ACCOUNTS

FINAL WORD

I am sure there are other financial institutions offering no fee chequing accounts. The above list is not exhaustive. Feel free to comment if you know of any other no fee chequing accounts in Canada.

Please keep in mind the mentioned institutions do charge other type of fees such as overdraft or cheques orders.

Another important reason your mortgage is denied

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Please note I am not a mortgage broker. The below is for information purposes only.

You decided to become a home owner, saved for a down payment, got pre-approved for a mortgage, found your dream home and made an offer.

Then, to your surprise and dismay, your mortgage application is denied. Hopefully, your offer was subject to mortgage approval!

yes, it is still possible for a mortgage to be denied after pre-approval

And it is not necessarily for the reason you think. A mortgage pre-approval is the maximum amount a lender would loan you, based on your income, down-payment and credit history.

Once you made an offer, the documents go through an Underwriter. The role of the Underwriter is to assess whether your loan request is an acceptable risk to the lender….or not.

Besides income and down payment, there is a crucial detail the Underwriter will focus on: the property itself.

a mortgage can be denied if there is an issue with the property

Lenders  want to ensure their “investment” will provide a handsome return for as long as possible. They also want to make sure they are not overpaying and that the collateral – i.e. the property- is safe and sound.

In order to determine this, a lender will look at both the physical life and the remaining economic life of a property.

To simplify, it means the current state of the property and how repairs can extend its life. An appraiser is usually used to determine the above points.

If the appraisal doesn’t check out, the application is usually denied. For example, most lenders are wary about financing foreclosures, even if you do and pay for any repair.

the type of property can also cause problems

In Canada, most lenders ask for an appraisal for single, detached houses. If you are buying a condo, you are not necessarily off the hook either.

The underwriter will definitely take a look at the building history, finances and current conditions.

Too many tenants? Your application could be denied. Tenants do not have a personal stake in the building and can be perceived as detrimental by some lenders.

Building needs major repairs? Your application could be also be denied, particularly if the strata corporation does not have the money to pay for them.

Buying on plan? Potentially denied. A lot of lenders won’t finance “non-existent” properties, or will only finance if at least 70% of units are sold.

final word

Mortgage underwriting is a complex process. Different lenders have different criteria. The industry is also heavily regulated and constantly changing.

If one lender denies you, try another one. If it fails, you will have to look at other properties, and although disappointing, it may not be a bad thing in the long run.

Book review: Pound Foolish by Helaine Olen

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Please note I did not receive any compensation for reviewing this book.

As a personal finance aficionado, I always enjoy reading blogs and books on the subject.

this week, I will review Pound Foolish by Helaine olen

Helaine Olen is a journalist, writer and columnist. As she admitted in her book, she did not know anything about personal finances when she started writing about the subject. She does not have academic qualifications in Finance, nor is she a CFP®.

pound foolish does not give financial advice

And it is refreshing. Olen actually challenges some of the conventional, financial wisdom we have been reading and hearing for decades such as the Latte factor or the fact that owning a house is automatically a sound financial plan.

Most of all she challenges the concept of financial literacy, particularly when those who wants to teach it are banks, credit card companies and other financial entities making profits on our hard earned money.

the book was written just after the 2008 economic downturn

It makes its content even more relevant, as it is backed-up by actual events and facts.

even if it is primarily geared towards the US, you can still relate to it

Helaine Olen primarily focuses on the personal finance industry in the US. That being said, some of the concepts she talks about are fairly common in many countries, such as gender inequality, wages stagnation, rising costs of housing, education and healthcare.

final verdict: buy

I gave this book a definite buy. I really like the way Olen challenges and shakes up the personal finance world. Not too mention what she writes is very true.

 

The problem with personal finance blogs

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I totally understand the post you are about to read may confuse you, and even more so since I am a personal finance blogger who has been blogging about personal finances for almost 3 years.

That being said, I believe it is also important to have perspective.

PF blogs are either too generic or too specific

A lot of blogs out there are either about extreme frugality, early retirement, stock investing or becoming debt-free. If you don’t fit in any of these categories, it is hard to relate to these blogs and the bloggers behind them.

Same goes with geographic location. A lot of blogs are written by US residents. Well, I live in Canada so that does not necessarily help me.

It is one of the reasons most people create their own blogs in the first place. I was no exception.

most pf blogs are written by non-specialists

This is a highly sensitive area I am coming to. The majority of people blogging about personal finances have no background in it whatsoever. Quite a few are writers trying to cash in on the popularity of the subject.

Writing is also influenced by personal experience. Bloggers are sharing tips and advice because it worked for them. By extension, it should work for everybody else, right? Wrong!

In order to work, financial advice has to be personalized. You don’t get this in PF blogs. It is crucial for readers to always check facts and not take the advice too literally.

PF blogs are repetitive

How many times have you read that you need to save money for retirement or have a budget?

Don’t get me wrong, basic financial advice is and will always be needed. It is a foundation to build on. But we also need different takes and perspectives in order to progress.

So, that what my blog will be aiming to do from now on. Readers will still see basic advice from time to time, as it allows for a broader audience. But, there is some conventional wisdom that can and needs to be challenged.

 

Book review: Burn your mortgage by Sean Cooper

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Please note I did not receive any compensation for reviewing this book.

As a personal finance aficionado, I always enjoy reading blogs and books on the subject. I decided to start reviewing what I read.

This post will talk about “Burn your mortgage” by Sean Cooper

Let’s start by briefly telling who Sean Cooper is. He is a pension analyst and freelance writer based in Toronto. Most of all, he is an expert at personal branding and self-marketing.

A couple of years ago (2015), he made the last payment on a mortgage he had taken 3 years before.  Cooper managed to grab the attention of a few medias in North America and one in England, after massive campaigns on social medias. He, of course, also caused quite a commotion in the Personal Finance blogosphere.

Since then, he has been surfing the (media) wave and cashing in by writing the above-mentioned book. He also provides fee-only financial advice, without being a CFP® or having any formal qualifications in Finance, at least according his LinkedIn profile and Google search.

his book should have been titled “getting ready for your mortgage” instead

It really is all there is to it, quite frankly. Chapters after chapters of very basic, rehashed financial advice such as how to budget, use a credit card, save for a down-payment, packing your lunch and use public transit whenever possible….!

Some of the advice presented is actually not that great, such as making a free-subject offer on a property. This could end-up being very costly, if things don’t go as planned. Also, being “pre-approved” for a mortgage does not mean being “fully approved”.

there is only one chapter on how to actually “burn your mortgage”

To save you time and money, it all boils down to:

  • Making accelerated payments
  • Using prepayment privileges to the maximum
  • Taking a shorter amortization period
  • Refinancing if interest rates are too high
  • Becoming a landlord if possible

Boom!

final verdict: pass

Don’t waste your money on this book. If your knowledge of Personal Finance is intermediate or advanced, you won’t learn anything new.

If you are a total beginner, you can find all the information presented in the book online for free, including on this blog.

I personally found this book to be very boring. A definite pass!