Month: September 2017

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Variable vs. Fixed Rate Mortgages: An email correspondence

Subject: So You’re an Economics Kinda guy…
Boba Fett <bfett@slave1.com> Sun, Sep 24, 2017 at 5:37 PM
To: Mr CIQY <me@caniquityet.com>

hey man,

Mrs. Fett and I were talking mortgage after the Bank of Canada raised rates, and realized we don’t really know squat.  and we thought, who does know squat? and the answer was: maybe Mr. CIQY?
As one of a very few economics minded friends, wondering if you had any thoughts regarding rate increases and fixed mortgages?
Mr. CIQY <me@caniquityet.com> Mon, Sep 25, 2017 at 7:37 AM
To: Boba Fett <bfett@slave1.com>

Oh I have thoughts on a lot of things. Doesn’t always mean they’re right though.

I guess it depends on a lot of factors. Are you asking because you guys currently have a variable rate and you’re debating whether/when to lock in to a fixed? If that’s the case, then it kind of depends on the spread. We’re in that situation now ourselves. Last time I checked, for us the spread was 0.55%. So in our example, that basically represents two more rate hikes, or close enough. meaning that in two more rate hikes, assuming our lender passes both those hikes along to us, we will be paying the same rate as if we locked in to the fixed rate now. There’s a school of thought that says you’re better off going with the variable because in the interim, you’re still paying less interest. Which makes sense to me. Of course, then it becomes a question of when the hypothetical third rate hike will be, at which point you’re worse off than if you acted today. But again, you will have paid less interest in the interim.

Some people really like certainty and knowing exactly how much they’ll be paying for X years and if that’s you, then going fixed might make sense. But in most cases you’ll end up paying more interest by going fixed.

What specifically were you guys wondering about or wanting to know?
 
Boba Fett <bfett@slave1.com> Mon, Sep 25, 2017 at 8:48 AM
To: Mr. CIQY <me@caniquityet.com>

Brother, you nailed it in one.

Effectively, we’re going through the variable–>fixed should-we? talk based on essentially the numbers you’ve got there; around a .5% difference.  So, as you say, we’re looking at a likely 2-hike equivalence in the rates.
Mrs. Fett’s read that the rates could go up as much at 1%, in which case, locking in a fixed rate now would make sense.  But she’s also read that a hike like that would put a bunch of people out of their homes because people think a mortgage is a free house from the bank.
Based on your reply, can i assume you guys will remain variable?  We’re trending in thinking that way, but hoping we won’t regret it if the rate keeps climbing.
sigh.  I remember when finance talks were “should i get that comic book, or the creamsicle”.  Thanks for the thoughts (right or wrong) – it’s good to hear.
 
Mr. CIQY <me@caniquityet.com> Mon, Sep 25, 2017 at 9:14 AM
To: Boba Fett <bfett@slave1.com>
Well for us, we’ve got 3 more years left before we get to renew our mortgage. Our strategy has been and continues to be a) make minimum payments; b) save as much as we can and invest in TFSAs, hoping to earn some nice returns; c) on the eve of mortgage renewal, make a lump sum payment from our savings and investment income to the mortgage principal to try and get our monthly minimums lower for years 6-10. Trying to predict what will happen to the economy is a mugs game and if I knew how to do it properly… well let’s just say I don’t.

That said, there are reasons to believe that interest rates might not continue to climb uninterrupted over the next few years. For starters, inflation just isn’t that high yet, which suggests maybe more rate hikes might not be a sure thing. Secondly, all it takes is for another recession to hit and then we’re definitely not likely to see rates climb higher. And recessions tend to happen every so often for all sorts of reasons. It’s possible we’re about due for one soon. Looking for reasons why? I dunno… an end to NAFTA? Other major catastrophe? Start of a new war? Another big drop in oil prices? A strong Canadian dollar that crowds out manufacturing exports? A major housing collapse due to rising interest rates (irony!)?

Or who knows? Maybe we’re at the start of a historic economic boom? I’ve been wrong about lots of things before. Anyway, we’re going to stay variable for now I think. But check back with me in a year when I’m paying 5% on my mortgage and kicking myself for not locking in.

[
Boba Fett <bfett@slave1.com> Mon, Sep 25, 2017 at 10:42 AM
To: Mr. CIQY <me@caniquityet.com>

Thanks for the sanity check – i think we’re largely in the same boat, but your one-time lump sum payment makes way more sense.  We have the opportunity to pay down the principal via acceleration, but it would make more sense to invest those payments and then use the resulting interest as well.  See, you’re the economic guy for sure.  Also, thanks for the context – it’s easy to freak the f out when you hear “rate increase” but what you say also makes sense.  and some of that context is TERRIFYING.

Thanks again homes!
 
Mr. CIQY <me@caniquityet.com> Wed, Sep 27, 2017 at 10:55 AM
To: Boba Fett <bfett@slave1.com>

Hey, so uh, I started a blog a little while ago, and it’s about personal finance, frugality, etc.

I was wondering if you would mind if I mined this email thread and made a blog post out of it? I would be obfuscating your identity as well, but I kinda thought an email exchange about fixed vs variable mortgages might be a semi-interesting way to address a topic that fits within my blog’s subject matter.

Would you mind if I published this exchange, lightly edited with all identifying information scrubbed? I’ll even let you pick your alias, if that appeals to you. 😉

 
Boba Fett <bfett@slave1.com> Thu, Sep 28, 2017 at 8:01 AM
To: Mr. CIQY <me@caniquityet.com>
Yeah, absolutely, go nuts!
As for aliases, is in like the Dear Abby write-ins?  “Worried in Weston” or “Scared in Scarborough”?  or just a name? In which case, can i get ‘Boba Fett’?
 
Mr. CIQY <me@caniquityet.com> Thu, Sep 28, 2017 at 8:14 AM
To: Boba Fett <bfett@slave1.com>
You can get whatever you want. Boba Fett is a good choice.
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Lessons about money from mom and dad

This post was inspired by something similar I read at She Picks Up Pennies. Thank you Penny for the idea.

I think we can all agree that we have all learned a lot from our parents. I certainly have. Some of the lessons I learned from my parents were intentional on their part. Other things I just picked up from observation. Most crucially, some of these lessons had to do with doing the right things, while other lessons I learned from them were prime examples of what not to do.

My parents were both immigrants to Canada. Mom came as a teenager in the 1960s with her family. Dad came solo as a young man in the early 1970s. But one thing they had in common is that they both grew up poor.

I have found this to be pretty common among people I know in my parents’ generation. Especially in Europe after World War II, most people were poor. My parents grew up in poverty. They both have many stories about hunger, about not having enough, about having to share meager rations with their families and doing whatever they could to scrape by. They both left Europe in search of a better life. And they both found one.

We all know the phrase “know the value of a dollar,” but that means different things to different people. My parents weren’t the type to spend a lot of money on expensive big ticket items, like fancy cars or gadgets or what have you. They knew exactly how many hours they would have to work to pay for those things. My dad always bought used cars and would fix them himself whenever he could. And he was clever enough not to spend way too much on brand new technologies. He would tell us stories of colleagues of his who would spend thousands (in the 1970s and 1980s mind you) on brand new Betamax machines or CD players. Our family was never the first to get the latest new toy. We waited for the prices to come way down before we bought them. So to my parents, spending too much on things they considered to be luxury items was just silly. Wasteful even.

On the other hand, there were a couple of things my parents would spend money on without giving it a second thought. The two biggest examples are food and clothes. And I think the reason why is because they were two things that they had to do without for a lot of their upbringing.

My parents seemed to measure wealth in shoes a lot of the time. I’d hear stories about how my dad had one pair of shoes that lasted him many years and had to be used for every occasion. He had to take care of his shoes and have them resoled time and time again because there just wasn’t enough money for another pair.

Same thing went with clothing. There was one story I remember about my dad putting on his Sunday best to go to church, and then having his suit ruined by a flock of birds passing by and doing what flocks of birds that pass by do. There was no church for him that day because he had to turn around, wash his one suit and have a bath.

So after moving to Canada and amassing a little wealth, he never hesitated to spend money to ensure his family was well clothed. He didn’t want his children to feel deprived or embarrassed so he was happy to spend the money. My mom was exactly the same. If as a kid I asked for money to buy candy or hockey cards I was out of luck, but if I asked for money to buy clothes or shoes, there would be money in my hand before I even finished speaking.

It was the same with food. I have touched on this subject a bit in a previous post, but there was always more than enough food to be had at our house. Do you know what happens when people who grew up poor and hungry start earning decent incomes and have children of their own? They have fat kids. In my parents’ mind, the biggest sin was for a child to go hungry. So gosh darn it, they made sure their kids never were hungry. We never even got close to hungry.

At the same time, we weren’t rich. My parents knew the value of a dollar and while they always wanted to make sure their family was well fed and clothed, they didn’t want to waste money either. So while they didn’t necessarily have any “rules” in place about spending money, it was easy to discern their outlook and their values from how they approached money and spending. And not just when it came to clothes and food either. I’m talking about the lessons I learned from my parents from nearly forty years of observing how they handled money.

Some lessons came from both. For example, both my parents thought spending money on labels was stupid. Their belief was that one should never pay extra for a brand name, especially when it’s a fad. (No Vuarnet t-shirts for this cool cat when he was in school). On the other hand, they felt that spending a little extra on quality is wise, especially if it means you’re less likely to have to replace the item, or will replace it less frequently.

But other lessons were specific to one or the other. And they came in both the “what to do” and “what not to do” varieties.

First off, there’s work ethic. Neither of my parents were ever afraid of hard work. When my mom came to Canada as a teenager, she was the first member of her family to find a job and provide for the rest of her family. Mom started putting food on the table even before my grandparents did.

My mother also always seemed to know the price of everything. As the parent who did the lion’s share of the grocery shopping, she always knew what was a good price for any given item. And mom read flyers. She would read the flyers and look for the deals. If something we consumed regularly went on sale, mom would go to that store to buy it. If it was something that stored well or could be frozen, she might even buy a lot of it.

Unfortunately this also meant that some days she would go shopping at three or four different grocery stores because there were different items on sale at each store. This might seem like a good idea and maybe you applaud my mom’s commitment to thrift, but like my dad always loved pointing out to her, you could argue that the money she spent on gas going to all those stores might not have been worth the pennies she saved from buying those items on sale.

The other way my mom wasted money was by buying too much food and allowing it to spoil. I remember especially when my brother and I were teenagers, we used to eat a lot. Like, a lot a lot. And like I have said before, my parents always liked to have a little extra on hand in case we had any visitors, which happened often enough. But as us kids grew from teenagers into adults, we started eating less. And then we all moved out and into homes of our own. But my mom still shops and cooks for a family of five. And because she always liked to buy fresh healthy food and plenty of fruits and vegetables, it means a lot of the food she buys goes from the store, to the fridge, to the trash. The way my mom wastes money is akin to death by a thousand cuts.

My dad’s primary approach to frugality is by not consuming. He tries to spend as little as possible. He is great at not buying things.

To this day, my dad’s knee-jerk answer to the question “would you like a sandwich?” is “no”. Why? Because for years when he was working, he would pack a lunch to bring to work, and the cheapest lunch he could think of to bring was sandwiches. For years and years he ate food he hated five days a week because it was an inexpensive thing to eat. To the point that now he’s still sick of sandwiches over 20 years later.

My dad was also pretty good at math, and keeping track of things. My mom would spend small amounts here and there, and not realize how quickly these small amounts were adding up. Not dad. He knew the danger of the “oh, it’s only a few dollars” mentality to spending.

I remember one time our family took a trip to Disney World. My dad estimated how much the trip would end up costing us, and when he told my mom, she didn’t believe him and accused him of exaggerating and being miserly. So on the day of the trip, he showed her the cash in his wallet and made her count it. At the end of the day, he made her count what was left over. Sure enough, his estimate wasn’t too far off the mark. She was shocked and he was smug.

But while mom’s most likely method to waste money was like a leaky faucet, my dad’s way of losing money was by being penny wise but pound foolish.

Here’s an example. I’m in the middle of a bathroom renovation. My dad is very handy and he’s been a big help with the reno. We’re putting in a custom shower with a niche. Something like this:

Something like this.
Because this particular project is new to me I decided to watch some YouTube videos about how to make a niche like this. And in the videos one common recommendation is to use a liquid membrane to seal the tile backer and make sure it’s waterproof. My dad’s input? “You don’t need that sealer. Your grout will make it waterproof enough. That sealer could run you almost $200!”

Maybe he’s right. Maybe I’m too risk averse. But I’ve seen grout cracks before. Haven’t you? Call me crazy but I feel like extra peace of mind might be worth $200. Especially when it comes to my own home and when the alternative could be water damage and a repair bill in the thousands, or weeks of easily avoidable work and inconvenience.

I have always admired my mom for knowing the price of everything. Likewise I’ve always admired my dad’s talent for anticipating the amount of any bill.

But I’m equally grateful for my mom teaching me not to be wasteful by buying more than I need, and my dad for teaching me when it’s wise to spend a little extra to avoid future trouble. Even if those lessons weren’t intentional.

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Savings and Investment for Noobs

A friend recently came to me with a “problem”. He had recently come into some money. Prior to this my friend didn’t really have anything in the way of savings, nor any knowledge of what to do to put this money to good use. This is one of those good problems to have. He had money, but needed knowledge. Money can be hard to come by. Knowledge is easy to acquire. You just need to know where to look.

So this post is basically an answer to my friend, as well as a handy guide to others in similar situations who maybe know they want to save and invest but have no idea how to start.

Up front, I’ll just say I understand how daunting this all can be to anyone who has never learned anything about investing or banking or finance at all. There’s a lot of factors to keep track of. I’ll do my best here to try and make it simple enough to follow.

Factor #1: What type of account

Regardless of what types of investments you are looking to hold, those investments need to be held in some kind of account. For the purpose of this piece for beginners, I’ll address four different types. Once again for my readers, this is Canada-specific. If you don’t live in Canada then the particular account options will be different and have different names, but the concepts may be similar. I have already touched on some of these considerations in a former post, but I’ll give a bit more detail here:

  1. Normal, non-registered accounts. Most if not all banks will have some investments they will happily sell you. If you happen to hold these investments in a non-registered account, then they will be subject to tax of some kind. So if the investments pay dividends or have some other income stream, then you will have to pay income tax on that income in the year in which it is received. Likewise if you sell any assets in a non-registered account and make money on the sale, you will pay tax on the capital gains. Capital gains just means profit when selling investment assets. This is the “normal” situation, so to speak. If you make money, the government wants their share of the tax on it.
  2. Tax Free Savings Acount (TFSA). This is a registered account. The main thing to be aware of here is that there are limits to the amount of money you can put into this account. The details of contribution limits are explained here. The tax benefits of this account are right in the name; any income or profits earned in this account are tax free, which is great. You are free to withdraw money out of this account at any time, but you have to be very careful about putting money back in, to make sure you don’t breach the contribution limit. This makes this account great for short-to-medium term investing if you are looking to earn a little income on your money and want access to it before you retire.
  3. Registered Retirement Savings Plan (RRSP). This is also a registered account, as it says in the name. It also has contribution limits, but those limits are much greater than the limits for TFSAs. Its main benefit is for deferring tax. What this means is any contributions made this year will reduce this year‘s taxable income. So if you contribute $1000 now, your taxable income for this year at tax time is reduced by $1000. That is because this type of account is geared toward retirement. Tax will be paid on any money taken out of it during retirement, as if you had earned it in the year it was withdrawn. Because it is designed with retirement in mind, there are witholding tax penalties if you withdraw money early. This type of account is great if you are currently in a higher tax bracket and want to reduce your tax payable this year, but not so great if you plan on using the money before you are 65 because it is locked away.
  4. Registered Education Savings Plan (RESP). This account is a bit unique because it is designed specifically for saving for a child’s education. If you have no children (or your children are already over 18) then this account doesn’t really apply to you, but I’m including it here because if you do have children under 18 then this account is a no-brainer.  Why? Because the government will match 20 cents per dollar on the first $2500 invested each year to a maximum of $500 per year, up to a maximum amount of $7200 per child. This extra money is called the Canada Education Savings Grant (CESG). This is free money, and a 20% return on your investment without doing a single thing. Of course, if your child doesn’t go to college or university then you do have to give the CESG portion back, or transfer it to a sibling who still has contribution room, but why not take that money in case your child does want to pursue post secondary education? An RESP can stay open until the child is 36, just in case he or she isn’t sure they want to go to school right away. If they definitely don’t, then the money (after returning the CESG portion to the government) can be transferred to an RRSP.

All four are useful and have their respective merits and flaws. RRSPs are great, especially when your employer also contributes to one for you, but only if you don’t plan on using that money before age 65. TFSAs are great but they don’t really do anything for your income taxes in the current year, and there are limits to how much you can put in. If you’re lucky enough to have maxed out your registered account contribution room, then you have no choice but to use a non-registered account. You get the idea.

Once you have decided which type of account you want to open and hold your investments in, it’s time to decide what to put in it. But before we get in too much detail about the different options, we have to address two major concepts: volatility and diversification.

Volatility

If you’ve ever taken an economics or finance class, and probably even if you haven’t, you might be aware of the “risk vs reward” trade-off. The idea is simple; the riskier an investment is, the greater the potential returns. The classic Economics 101 example of a risk-free asset is a government bond. So a sovereign government issues a bond and that bond has a yield of say 3%. The reason this is risk free is because the government is guaranteeing you that you will get your 3% return. The only risk in holding this bond is the risk in the government going broke and not being able to pay you your 3% (or your principal back!), but since most governments are also in the money-printing business, this risk is pretty darn low. Some countries are on shakier financial ground of course, and maybe their risk of default is greater than that of other countries. Well guess what? Those countries will have to offer a higher yield on their bonds in order to get people to buy them. That is your risk vs reward paradigm in action; riskier bond, higher yield. Corporations also can issue bonds and they tend to be a bit riskier than government bonds, which of course means they offer even higher yields. But once again, the only real risk to the investor is if the company goes broke. Bonds are safe because outside of the rare event when a country or company goes belly-up, you get your yield, guaranteed.

On the other end of the volatility spectrum, you have the corporate stock. Stock prices go up and down all the time. For the most part when you’re talking about stable, major corporations, prices do go up in the long run. But between now and “the long run”, their stock prices can go way up or way down, depending on a lot of factors. They are volatile. So say you invest $1000 in ABC Corp today, and promptly forget about your investment. Two months later you look at their stock price and realize that it has gone down and your initial investment is only worth $800. Boo! That’s terrible! You’ve lost money. But you hold onto your stock, because you’re a lazy investor. A couple of months later you check back and see that the stock price has gone up again! Now your investment is worth $1100! You’re a brilliant investor because you have earned a 10% profit on your investment and now you are rich. Bully for you!

Of course, one day, ABC Corp could get mired in a major scandal and reveal that they are completely broke, making your investment worth essentially $0.

This is the concept of volatility. Riskier assets will pay greater returns, but they are also a bigger gamble. If you can stomach watching your investment go down for a while in the hopes that it will recover and not go broke, then you are okay with risk and are capable of seeking higher returns. Historically, stocks are a better bet for making money than unrisky bonds. The danger is that in the interim, risk averse people watch their investment shrink in a crisis and want to cut their losses by selling while things are low. This is very common. It is also the wrong thing to do, because historically, most companies don’t go broke, and most company’s stock prices recover. Most. The majority of investors hold stocks and bonds, but mostly stocks. The higher your appetite for risk, the higher your proportion of stocks in your portfolio.

Diversification

This is a word that gets used a lot but I wonder how many people don’t understand what it means? Basically this is the “don’t put all your eggs in one basket” principle. Again, let’s go back to Econ 101…

Imagine you lived in a world with only two types of fruit: apples and pears. Some people only eat apples, some only eat pears, and some people eat both to varying degrees. Now imagine some event has done great damage to the apple crop. There is an apple shortage and consequently the price of apples has gone through the roof. What do you as a consumer do? Well, if you’re wealthy and you hate pears, then maybe you just pay through the nose for your apples and gripe about it. But if you’re most people, you change your consumption and buy more pears until the price of apples comes down again.

Now assume instead that rather than being a consumer, you’re the owner of Apple Co. (okay, maybe this was a bad example… Apple Corp? No, that’s no good… Granny’s Apples Inc? Whatever, you get the idea). Your supply has been hit and you’ve had to raise your prices. Consequently your sales are terrible because now everyone is buying pears instead. Well if you own this company’s stock, then guess what? You effectively are one of it’s owners. In this scenario, the share price for this company would tumble and your investment and net worth would take a hit. Meanwhile shares in Pears Inc. are probably getting a nice healthy boost from all those additional sales.

So how do you avoid this potential calamity? Well, you own both companies. By buying shares in both the apples company and the pears company, you hedge your bets and reduce the volatility of your portfolio. This is what diversification means.

In the real world, sometimes individual companies suffer. Sometimes entire industries suffer. Sometimes the economies of entire countries suffer. A well diversified portfolio spreads around your risk so that your investment can withhold certain shocks and keep things even keel, in the hopes that if one part of your investment goes down, another might go up, or at least go down to a lesser degree. Diversification can occur within a market (owning stock in both Coke and Pepsi), within an economy (owning Canadian mining stocks, banking stocks, manufacturing stocks, etc.), and also internationally (owning investments in Canada, the U.S., Europe, Asia, etc.).

Diversification is essential. It is also a lot of work. You want to pick a number of assets from different industries and countries, with varying levels of risk to make your portfolio relatively stable while also taking enough risk to get some return on your investment. Well good news: you can get others to do that for you. The downside is that everything comes at a cost. Which segues nicely into our next section.

Factor #2: What type of investment

Once you have chosen the right type of account for your situation you will want to decide what to put in it. Well, you have some choices. Once again there are trade-offs. Here is a list of investment types in order of lowest return (and risk) to highest.

A savings account

Technically I suppose this is also a “type of account”, but I’m putting it in this list here because you can get both TFSA savings accounts and non-registered savings accounts at your bank. Under most circumstances, I would not advise someone to keep a lot of money in a vanilla savings account at their local bank. The exception would be if you had some money that you absolutely 100% needed all of within the next couple of years. Most commercial banks in Canada will offer these accounts and most of them will offer 0.5-1.0% on these accounts. This isn’t very good, but still better than having your money in a chequing account that offers no interest. Want to do better? Skip the bank and open an account at a local credit union. Not all credit unions are created equal so you’ll want to do your research but their banking fees are lower and their savings accounts can offer more in the 1.5%-2.5% range, which is better than the banks offer.

Mutual Funds

Mutual funds are great for beginner investors. Why? Because someone else has already done the diversification for you. Mutual funds are managed to be balanced investments, so one share of a mutual fund is like a tiny basket of assets featuring investments in different countries, industries, and asset classes. But this management and balancing has a cost. This is why each mutual fund has a Management Expense Ratio (MER), which represents the cost. Most mutual funds will have an MER of approximately 2.5%, give or take. So what does this number mean? Well lets say your little basket of goods of a mutual fund appreciates by 7% over the course of the year. If the MER is 2.5%, then your investment returns will end up being 4.5% (7-2.5=4.5). It is this MER that gives mutual funds a bad name among many investors, because you’re not getting your full rate of return.

I would argue that if you’re a beginner investor who isn’t really sure what he or she is doing, then the MER is worth it. 4.5% is better than 1%, which is better than nothing. Really, savings of any kind is the most important thing, so complaining that you’re “only” getting 4.5% return is silly when you used to earn nothing on your money. The other great thing about mutual funds? Every bank or credit union or investment firm has them. All you need to do is approach a financial advisor or ask someone at a bank. They will then ask you a few questions to assess your risk tolerance and help you pick the fund that is right for you. Then you buy that fund (hopefully repeatedly and regularly through regular contributions) and watch your savings grow. In my mind, it’s more important that you save, rather than waste too much time worrying about exactly whose mutual fund is the best choice. Just buy one. If you find a better one, then at that point start buying that better one instead. Don’t delay!

Exchange Traded Funds (ETFs)

So let’s say you’ve been squirreling away your pennies into mutual funds for several years and watching your savings grow. You’re pleased, but also aware that maybe you have some colleagues who are talking about their own investment portfolios and they’re doing even better than you. Suddenly, you’re starting to question if that 2.5% MER is really worth it. Enter the ETF.

ETFs are actually similar to mutual funds in that they also represent baskets of assets. The main difference is that they are more focused, less balanced, less managed, and therefore have lower MERs. Maybe before, you were buying a single mutual fund with all your savings and it was doing everything for you. By switching to ETFs, now maybe you have to buy 3-5 different ETFs to achieve the same diversification that your one mutual fund gave you. So you have to do a bit more work yourself. On the other hand, you’re saving money now because while before you were paying a MER of 2.5%, now you’re only paying 0.2%. Your 4.5% profit based on 7% return has now become a 6.8% profit in exchange for you doing more of the work yourself.

But there is another catch, and it represents another cost to you. Recall that ETF stands for Exchange Traded Funds. That means they are traded on a stock exchange, like the NYSE or the TSX. How do you as an investor access those exchanges? You need a brokerage account. Getting brokerage accounts is easy enough. There are several to choose from. But the catch is you usually need to pay a commission for each trade. There may be some newer brokerages that have reduced commissions but in general in Canada the going rate is about $9-10 a trade. It might not seem like much, but think about the investor who tries to save $500 a month. Once a month, he goes to his brokerage and has to buy 3 ETFs (one for domestic stocks, one for foreign stocks, one for bonds). Once a month, he has to pay $30 in trading commissions. That’s 6% of his investment amount going to commission. And $30 a month can add up. Clearly, ETFs aren’t for everybody. This is why if you’re just starting off, mutual funds might be a better option for you since they’re less work.

(Worth mentioning: some brokerages will offer a list of commission-free ETFs. If you pick a brokerage that offers one and can come up with a nice asset mix, then the worry about commissions goes away.)

The other thing to keep in mind if investing with ETFs is that at least once a year you need to re-balance your portfolio. What does this mean? Well, let’s say you’re shooting for 70% stocks and 30% bonds. At the end of the year, let’s say your stock ETFs have outperformed your bond ETFs (the value of your stock ETFs has gone up by more than the value of your bond ETFs has).  The stocks in your portfolio now represent 80% of its value and the value of your bonds is therefore 20%. Now you need to buy relatively more of your bond ETF to get back to 70-30% and have things properly balanced. Again, this is something that the managers of mutual funds will do for you which helps to justify their larger MERs.

Individual stock and bond trading

You are confident in your abilities to pick a stock based on sound market principles. You know how to craft a well diversified portfolio to protect yourself against risk and maximize your return. You’re pretty sure you can beat the market. Congratulations! You’re far better at this than most people are. You are probably also not reading this blog entry right now. If this doesn’t describe you, then you should not do this. Stock trading is a great way to go broke and/or turn yourself off investing. Do not do this.

Final thoughts

One thing you’ll notice I haven’t done is recommend any particular funds or ETFs or assets of any kind. There are plenty of online resources for you to pick investments you think are worth buying. I like Canadian Couch Potato, so feel free to give him a try. But the online investing community is quite large and it’s typically pretty easy to find recommendations.

Everyone has their own things to consider. We all have to look at all factors. Why are you investing? When do you want access to your money? Are you looking for a way to reduce your tax bill right now, or is it not a huge problem for you? And crucially how much work are you willing to put into managing your investments? Hopefully for anyone who is able to answer all these questions for themselves, this blog post has been helpful. If not, feel free to ask me questions in the comments, via email, Twitter, or however you wish.

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5 Tips on throwing a Frugal (but not cheap) party, including my secret weapon

Growing up I remember my parents hosting a lot. Ours was the house within the extended family that was large enough to accommodate everyone and my parents were always willing and welcoming hosts. In fact, we pretty much had a year-round open door policy, not just on holidays. Anyone and everyone was always welcome. There was always food for everyone and always beer and wine for those who wanted it. My friends eventually came to realize that they would get fed if they were at our house during meal times, sometimes by force, if necessary. Sometimes for some events we would end up with more guests than expected. Other times we would have people spontaneously stop by, and then some more, until a party would be born out of nothing. I remember there were times after my siblings and I were old enough drive when one of us would be discreetly taken aside by one of our parents and told to sneak out and go buy more beer, food, or whatever they were worried was in too short of supply. But for the most part, my parents always tried to make sure the cupboards and fridges were always full and prepared for just such occasions.

As I got older I would start to play a bigger role in party planning and preparation. I would get sent on errands to buy provisions and in so doing, I started to become aware of just how much my parents would spend to host. It was a sobering realization. Over the years my parents spent thousands and thousands of dollars entertaining family and friends for holidays, special occasions, birthdays, etc. And I’m quite certain they don’t regret spending a single penny of it. These are the things, I’m sure they would tell you, that make life worth living. I tend to think they have a good point, But then again, they are my parents and they raised me so it’s not surprising that I feel the same way as they do. I should also add at this point that we weren’t rich. They just thought that celebrating and hospitality were things worth spending their hard earned money on. They would squabble over pennies for everyday expenses like a lot of families do. Just not when it came to entertaining (especially for holidays).

For people who try to live frugally, the idea of hosting can be downright scary. You want to be a good host while entertaining friends and family but if you’re living on a budget and worried about money, trying to do so while watching the purse strings can lead to stress and anxiety. It can be a delicate balance. But there are ways to pull it off if you try.

Allow me to offer a case study in frugal party planning: My daughter’s first birthday party. It wasn’t necessarily all planned with frugality in mind but as I look back, I can see a lot of useful lessons and tips on how to host on the cheap.

5 Tips on how to host frugally (but not cheaply!)

1. Limit your guest list

“Large” or “small” as adjectives to describe parties and guest lists are completely relative. To some cultures, a wedding of 200 people is considered downright intimate while to others it’s obscenely huge. So it goes for babies’ first birthday parties. I’ve been to first birthdays with 80+ guests before. But I’m sure in some households there are a grand total of two people in attendance.

Obviously providing food and drink for fewer people will cost you less in the end, all else equal. This of course goes against my parents’ open door policy (and my own, frankly), but it can make a big difference. That said, I have also come to realize in my wise old age that sometimes people view invitations as obligations more than a thing they want to do. There are people who just might not rather be invited. In the end if there is someone you want at your event, then you should invite them. But once you get into “well we invited X, so we should probably invite Y”, well now you’re playing with fire.

What did we do? We realized that the party was more for us than it was for our daughter, who would of course not remember the event at all. We decided to limit the guest list to our immediate families and 2-3 close friends who also had young children. We still ended up with a guest list of about 30, one third of whom were children or toddlers. This number included my wife and I and our little guest of honour. You might be thinking this seems like a pretty big guest list for a one year old, but like I said, I’ve been to much bigger.

2. Host during the day

Most people tend to eat the most at supper time. Likewise, most people tend to do most of their drinking at night.

So hosting an event during the afternoon means your guests are most likely going to eat and drink less than they would if you asked them to arrive in the evening.

I’m not suggesting you should plan a party in such a way that you don’t have to feed or properly lubricate your guests. That would be silly. But the nature of the event which you are hosting will likely dictate appropriate times to have your party. In our case, it was a one year old’s birthday party. What time would you expect us to have that? For us it was more circumstance than anything, but it did help keep costs down.

3. Accept help!

There are lots of guests out there who will offer to help. Accept their help! If someone asks you whether they can bring something, give it some thought. Chances are they can help in such a way that will save you some time and also maybe save you a few dollars.

Does that mean you should ask one of your generous guests to bring lobster or prime rib for everyone? Of course not. You definitely shouldn’t impose a big financial burden on these lovely guests. The goal here is not to shift your financial burden onto others. On the other hand, little things can add up. If you have a few helpful individuals offering to bring something, collectively they can make a bigger difference for you while not individually costing each of them very much at all.

What did we do? My mom brought a veggie tray. My mother-in-law brought a fruit platter. My sister brought coleslaw and a salad, each of which she lovingly made herself. I don’t know if you’ve noticed the cost of cabbage and lettuce lately but it’s not very much. The cost to each of these family members was likely in the $10 or under range. Collectively though all this help probably saved Mrs. CIQY and I close to $40 and a lot of time and effort. Also in my experience people often will overlook vegetables as sides. Asking a willing guest to bring a vegetable side dish can be a great way to round out a meal and it won’t cost your guest very much at all.

4. Choose to serve the right food (a.k.a “My secret weapon”)

As I alluded in the previous point, serving your guests prime rib and lobster will set you back a fair bit. On the other hand, my parents would certainly not approve if their son invited people to his home and didn’t make an effort to provide more than enough good food to eat. That’s just bad hosting and it’s definitely not how they raised me.

But as any frugal grocery shopper will tell you, you can feed a lot of people for very little if you’re clever about what you serve. Choose wisely and shop carefully and a dollar can go farther than you might expect.

Well I have a secret weapon in these circumstances. Unfortunately it won’t necessarily help everyone who might have some dietary restrictions, because my secret weapon is pulled pork. (Sorry to my Jewish, Muslim, and vegetarian friends). If you’re a barbecue specialist, then this should come easy to you. If you aren’t, then go to Pinterest or Google and search for “slow cooker pulled pork” and choose from one of hundreds of recipes. You basically need pork, sauce, a slow cooker and time and you’re all set. We bought a whole pork loin, about 6 pounds of meat, for about $18 at Costco. We spent another $10-15 on buns.

Don’t like pulled pork? How about souvlaki? All you need to do is take that same 6lb pork loin, cut it into cubes, marinate it, skewer it and grill it. Sub out the buns for pitas and voila, you’ve got a Greek feast to feed lots of people. The point is, pork is cheap and versatile. And darn tasty (for those who eat it).

And we also got an extra large, party size vegetarian pizza for a little variety (and for our guests who don’t eat pork specifically or meat generally) which cost about $13. There was way more than enough food. For about $45 we fed almost 30 people and had leftovers for a few days.

5. Don’t go overboard

Because I am my parents’ son, this is the lesson that has been the hardest for me to learn. Our family’s philosophy on food and hosting was that it was better to have too much than not enough. But “too much” for us didn’t just apply to quantity of food. It also applied to variety. Over time and with the sobering influence of Mrs. CIQY I have come to accept that sometimes less is better.

I’m a big fan of variety. People like choices. I’m no different. But I also remember the stress my mom used to go through when preparing for big events. She would choose to do so many things and inevitably find herself short on time. She would manage to get everything done but she would sacrifice on rest, so when it was time for the event she would often find herself exhausted and unable to really enjoy herself with her guests. This always seemed kind of silly to me. I mean isn’t the point of it all to spend time with loved ones and have fun?

And truthfully a lot of the time she was just going overboard. She would decide to cook roast beef. But then she would also make some chicken, in case some people don’t like beef. And then a ham, in case some people don’t like chicken. And then cook a lasagna in case… you get the idea. And in the end none of her guests would be picky. Everyone would try a little bit of everything and consequently everyone would overeat. Not exactly a healthy approach either. Sometimes learning when you have enough is the key to saving time, money, effort and caloric intake. As a chronic overeater, this has been a hard lesson for me to learn, but a valuable one nonetheless.

For our little celebration, we had the pork, the pizza, some salads, veggies and fruit. And of course birthday cake! (Which we also bought at Costco for $24 and was way more than enough for everyone and then some.) We didn’t go overboard but we had a really nice spread and everyone was happy. It didn’t cost us much, because it didn’t need to.

So there you have it. Those are my tips. I’m not suggesting we threw the world’s most frugal party. I know there are other great and inexpensive ways to feed people, but this is what we chose for that particular occasion. Everyone had a great time, we didn’t go overboard, and because we made a few clever choices, we were able to keep the costs nice and low. And since my daughter’s birthday is in late December, a fun but affordable event was exactly what we needed.

What about you? What are your frugal party tips?

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Real Estate vs Investing Part 2: Time to talk about tax… wait, why are you running away?

For Part 1 of this post, start here if you would like to get caught up.

There are a lot of reasons why I like investing in securities. For one, you can invest as much as you need or can, in whatever increments you choose, and whatever frequency you choose. With a house, you need to save up enough for a down payment before you even get started. Then once you have a mortgage, you’re beholden to your bank’s mortgage payment schedule. If you happen to hit a rough patch and cash flow is tight, you still need to make those mortgage payments, or risk losing your property (and running into serious credit trouble). If you hold stocks, bonds or mutual funds, you can put a hold on investing if you find yourself short on cash for a while.

Do I think that real estate can be a good investment? Absolutely. But under the right conditions. If you have enough for a decent down payment and the rent you’re collecting is enough to cover your costs and be a source of monthly income for you, then that’s great. But consider this: in the meantime, while you’re saving for that down payment, why not put those savings into some securities and earn a little interest income on them so you can save your down payment faster? To me that’s win-win.

There’s one other issue that I must address here though, and that is tax. With a head nod to the Dividend Diplomats who did a good job here of pointing out the tax benefits of dividend investing, this is another thing to consider. For any non-Canadian readers out there, these specific considerations I’m going to mention might not apply to you, but rest assured that your own local tax jurisdiction will have its own points to consider for the tax treatment of certain types of income. If you’re in the US, that Dividend Diplomats link will be useful to you.

Let’s talk about tax

I live in Canada, so for me, any income I earn from rental properties is taxed as regular income, just like I would earn from a 9-5 job. So the additional income earned from rentals is subject to your marginal tax rate. I don’t want to get too technical here, but that basically means that whatever tax bracket you find yourself in will dictate the tax you pay on any additional dollars of income. Unless of course that income puts you in an even higher tax bracket, meaning the income you earn from that rental will be subject to even more tax than your regular pay. So while you thought your rental was making you an extra $1000 a month, it’s actually only earning you an extra $700 (assuming a 30% marginal tax rate). Still $700 more than you had right? Not bad.

Maybe now you’re thinking “but wait, can’t you deduct expenses from this income so your taxable income on that rental is lower?” Very good! This is true. In Canada, you can deduct the interest (but not any principal) from your mortgage payments on a rental, plus any maintenance costs, expenses like utilities if you pay them as the landlord, taxes, advertising expenses, etc. But you’ll still get taxed on whatever is left over at your marginal tax rate.

“But can’t you make it look on paper like the rental is losing money, so your taxable income goes down for the year?” Well look at you! You are a savvy one aren’t you? First of all, don’t commit tax fraud. You will likely get caught, and it makes you a bad citizen. Secondly, if you’re maxing out any and all legitimate expenses and deductions on your property and it shows that you’re operating at a loss as far as the taxman is concerned, then I’m afraid that means you’re not holding an investment that is earning you much money either. You can only fudge your taxes so much. Those expenses you deducted are real expenses! Your taxable income on your rental property will end up being pretty close to your actual income on your property once you have taken care of your expenses.

Now assume instead you held investments like stocks, bonds or funds. First of all, you could arrange to hold these investments in a tax deferred account like a RRSP (for my American friends, I think this is the equivalent to your 401(k)). This means that anything you put into this account will actually reduce your taxable income for that year. So all else equal, you’ll get a tax refund come tax time. Alternatively, you could hold your investments in a Tax Free Savings Account (TFSA), and in that case you will never have to pay any tax on any of the income earned from those investments, ever. Those are both pretty good options! But let’s forget them for now, because there’s even more good news.

Let’s assume for now that you hold investments in a normal, non-registered account and you have to treat everything normally from a taxation perspective. Say you own stocks. The only time you will have to pay income tax from holding those stocks is when you sell them. So if you’re buying and holding your assets and watching your savings grow over time, you don’t really need to worry about your net worth being taxed away as it grows. When the time comes for you to sell them and use the money, that income is treated as capital gains, not normal income. And while you will have to pay your marginal tax rate on those capital gains, you only have to pay it on 50% of those gains. So you’ve already cut your tax bill in half. Good for you!

Here’s an example: You buy some fund and later that year it has appreciated and you sell it for a profit of $1000. Your capital gains are therefore $1000, just like our previous example where we had $1000 of rental income. Of your $1000 capital gains, you only have to pay tax on 50%, or $500. If you’re the same person in our rental example who has a 30% marginal tax rate, then the government will take $150 (that’s 30% * $500), leaving you with $850 from your $1000 capital gains. You’re already ahead of the rental income guy by $150.

“But what about dividends?” Good question! If your stocks pay dividends then you will have to pay tax on that income in the year it is paid. But the dividend tax rate is 15%. So if your marginal tax rate is 30% for example, your dividend income is still worth more on an after tax basis. $1000 in dividend income will cost you $150 in tax, leaving you with $850. (The tax numbers are slightly more complicated than this, but I don’t want to get too deep into the taxation weeds and lose too many of you. Suffice to say that the actual numbers are close, and dividend income is going to be treated better by the tax man than any income earned on labour). In this example, taxes on dividends is the same as taxes on capital gains, but if your marginal tax rate is higher than 30%, dividends become more attractive, because dividend income is always taxed at about 15%. And again, remember that if your investment account is a registered TFSA, you will pay no tax on any of the profits.

I’m not trying to tell you that taxes are bad and that you shouldn’t pay your taxes. But let’s be honest while we’re at it and admit that nobody wants to pay any more tax than they have to. And taking advantage of these tax benefits is something that all taxpayers are entitled to. Nobody is pulling a fast one here. We’re just all trying to make the most with what we have and keep as much as we can while still playing by the rules.

“But you said your parents lost a bunch of money by buying stocks!” Yes I did, and that’s true. But the simple truth is they were doing it wrong. What my parents was doing was essentially gambling. They weren’t diversifying a portfolio or sticking with low risk funds. They bought a few stocks based on friendly advice, got unlucky, panicked and cut their losses. In other words, they did all the things you’re not supposed to do. Unfortunately they didn’t know any better. I have the benefit of learning from their mistakes. There are better ways to go about it. For example, you can buy mutual funds or ETFs and your risk will go way down. You won’t get rich overnight, but you should get a nice steady rate of return over the long term.

Finally, I do want to address that I realize for a lot of people, the idea of investing is completely foreign to them. They might like the idea in theory, but have no idea how or where to start. Real estate is just so much easier for a lot of people because they understand houses and rent. I get that, I really do. I will take some time in future blog posts to help explain things to my friends who don’t know the first thing about investing. If you have any questions about a topic you would like to know more about, please let me know and I will happily do my best to write a post about it.

For now, I’ll just say two things on the subject. First, it’s not as scary as you think, or at least it doesn’t have to be. Secondly, the sooner you start the better. There is a Chinese proverb about the best time to plant trees that often gets paraphrased for investing (thanks to My Own Advisor for helping me find the original source and quote): the best time to start was yesterday; the second best time to start is today.

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Real Estate vs Investing Pt 1: The S&P 500 doesn’t complain about pigeon poop

Mrs. CIQY has accused me of being “verbose” before. She’s probably right, but it’s who I am. So I decided to break this post in two, just to keep the length reasonable and palatable. Part 2 is here.

As I said before, i was brought up thinking real estate was king. My parents, because of their experiences, always seemed to use it as a measure of wealth. There were always stories of wealthy past acquaintances of the form of “he was so rich he owned 5 houses!” or “he had enough money to buy apartment BUILDINGS! Not just apartments, but apartment BUILDINGS!” There were also attempts at imparted wisdom in the form of lamentations like “If I had someone to show me the way when I was young and single and earning decent money, someone to tell me to start buying rental properties…” I think the implication was always meant to be that we would be sitting pretty, my parents would have retired early, and my siblings and I would have been proper spoiled, rich kids who could live their lives on easy street, never having known struggle.

I completely understand their thinking. My parents bought their first house in the 1970s. I’m guessing they probably paid something in the neighbourhood of about $15,000-$20,000 for it. (Mind you their mortgage rate on that house was also probably about 15%.) Within a generation the value of that house and others like it had increased about 10x. Meanwhile they also got to take advantage of high wages at the time; wages that have since stagnated in real terms. So if they had saved more, maybe they could have paid their mortgage off much faster and bought a second property to rent, and then a third, etc. etc.

And why not? Being a landlord was easy money, right? Instead of slaving away at a job for 8 hours a day you just showed up once a month to collect rent. Sure, once in a while you had to fix something that broke, but most of the time, ideally things were on autopilot.

At the same time, my parents didn’t know anybody who was rich from investing. Stocks and bonds were things that super wealthy (and usually villainous) people in the movies bought and sold. “Normal” rich people in their experience got that way either through inheritance or property. Or both.

By the time the 1990s rolled around and the masses started migrating online, investing became much easier with online banking and brokerages. My parents started having conversations with friends who actually did dabble in investing and eventually decided that they also wanted to dip their toes in that pool. Other people were making money, so why not them? They were at a stage in life where they felt they maybe had a little money they could afford to use for investment purposes. They signed up for an online brokerage and started buying small amounts of a few stocks.

It did not go well for them. Lesson learned: investing is for idiots. Or very clever people who knew what they were doing and had time to do their research and due diligence. I.e. not them.

This basically confirmed what they already believed, and that was that the best investment is real estate. They don’t say “safe as houses” for nothing.

I am not my parents. My experiences have been a little different. Let me tell you my story…

When I first moved to the city for my current job, I rented. In fact, I rented a furnished apartment that was a five minute walk from work. It was about as turnkey as can be. It was glorious too… I would roll out of bed, shower, have breakfast, and be at work in five minutes. Reliable and traffic proof. But I digress.

After a couple of years, my little studio apartment started to feel… well, little. I wanted more space and I wanted to have my own stuff. After looking at some other rental options, I did some math and figured out that I could actually afford to buy my own place instead. Instead of “throwing away” money on rent, I could “pay myself” by getting a mortgage and building equity. I spent a good amount searching and eventually found myself a condo that was walking distance to work, cheap to maintain, and well within my budget. I was pleased as punch with my purchase.

And then I met the future Mrs. CIQY, and things changed. As I mentioned in a previous post she and I worked and lived in different cities. When it came time to cohabit, we decided to compromise and get a place in the ‘burbs in between where we each used to live. At first, we decided to rent, for a number of reasons. I kept my condo, and rented it out, and we rented a place of our own in the ‘burbs. The rent I was collecting for my condo was the same as the rent we were paying for our new home, so things worked out reasonably okay. The plan was, when it came time to buy a place of our own, we would sell my condo and use the money to buy a house. In the meantime, while we weren’t earning any income on the rental, we were building equity that we could use for our future house. And this is pretty much what happened.

Sounds easy right? Smooth and simple right? Well, it wasn’t.

During the time I was a landlord, I had to fix a broken washing machine. I had to make three separate trips to the rental (which remember, was in a different city) to deal with a faulty heat/ hot water boiler and have it replaced. I had to miss work while I waited for service calls. I had to compensate my tenant who couldn’t have a hot shower in the dead of winter after working outside all day. I had to deal with complaints about pigeon poop. Yes, pigeon poop. And that all happened in less than a year. And that’s not to mention the cost to me to paint the entire place before the tenant even moved in because I was having trouble getting it rented. When it eventually came time to sell the condo, I had to deal with inquiries and concerns about Kitec plumbing, which caused the property to take a lot longer to sell than it should have (btw, do NOT buy a condo with Kitec plumbing).

(I just want to pause for a moment and say that my tenant was actually a very good tenant. He was perfectly reasonable, dependable, and an all around decent guy. I definitely don’t mean to suggest otherwise.)

In addition to all that, it just wasn’t a good investment for me, because the rent I was receiving wasn’t enough to cover the mortgage payments plus taxes and fees. Keeping the condo was costing me money.

Despite all this, we actually did still consider keeping the condo after buying our own place, for the sake of the equity we were getting from it. We thought about the fact that we could potentially raise the rent a bit over time so that renting it was at least covering all its costs. But in the end we decided we would rather use the equity we had built up as a better down payment for our own house, to keep our mortgage payments lower. We figured there were better investment options out there that would give us better return. And the condo had turned out to be more work than we were hoping for.

The S&P 500 does not complain about pigeon poop.

In Part 2, I will highlight some of the benefits I see with investing. Hope to see you there!