Big stuff

Let’s forget the big issues, like Trump disintegrating, alt-right Nazis, climate change, Korean nukes or whether blog comments should continue. What really matters to people? Here’s a sample.

“Love reading your blog and my wife does as well,” says Tom. “We’ve been avid readers for the past couple years. We live in Victoria and the real estate market here has been insane lately (past two years essentially). We bought a condo in 2010 for $230,000 that we still live in today. We now owe $192,000 (2.64% fixed rate until 2020) and have been saving to buy a house but this insanely hot Victoria market has kept us from buying some POS for 600 – 700k.

“My question is: Is it worth putting some of our house savings money towards our existing condo mortgage? We have savings (100k and growing) that we planned to use towards the house. However, now that we are content to stay in our condo for longer and wait for this market to cool down I feel that the house savings money could be put to better use. It’s just making a messily rate from one of the online banks. I understand this is a common question but I wanted your opinion in these interesting times with low rates (at least they’re low for now).”

That’s easy, Tom. No. First, if this is a conventional fixed-term bank mortgage, you probably can’t make a $100,000 prepayment. Second, why would you? Borrowing at barely more than 2.5% is cheap, plus you have payment predictability for another three years. Meanwhile the hundred grand is growing mold sitting inside some unstable digital bank paying less than inflation in fully-taxable pennies.

Good to hear you’ve given up on buying in the tenuous and inflated Victoria market, but keeping the ‘house money’ in a comatose state is dumb. So is using funds which should be earning at least 6% to repay debt costing less than half that. A big prepayment won’t lessen your monthly, and if the condo declines in value (quite likely) all you’ll have done is shovel more into declining equity.

Emotional people pay off cheap mortgages. Logical people invest the money, then have more to put against the loan upon renewal. We only allow logical people on this blog.

Now, here’s Beth, a twice-widowed octogenarian blog dog from a small city in Ontario, who appears to live on air.

“After two marriages I am alone now,” she says. “I am 80 years but look, act and feel about 65. I own my home and live alone. I do not have any children and no relatives in Canada.

“I came to this country from Britain when a young bride but never had the opportunity to save much as my first husband was sick on disability and second one had Alzheimer’s. I do not have any heirs and will probably leave my estate to charity.

“I have a line of credit for $50,000 and that is all I qualify with my pension income which is around $27,000. I do not have much in the bank. I love my home and am an avid gardener but was thinking about a reverse mortgage.  I shrink at the thought of all my money going to charity and want to enjoy life while |I can and upgrade my home. I do not want to go into an apartment as I need the freedom of my garden. Should I do this?”

After talking to her, I learned Beth’s house is worth $450,000, without mortgage, and she has essentially no money. You are living in near-poverty, I summarized. “But I have my garden and my church,” she countered. “So I possess what matters.”

Beth could sell the place, invest the proceeds and double her income – allowing her to rent an equivalent house while retaining over four hundred grand to look after inevitable future medical expenses. Or, she can stay and borrow against it. Since she’d not qualify for a HELOC, a reverse mortgage is an option. Beth can borrow half the value of the house without the burden of repayments. If she invests it, her income will rise by half and she’ll retain some capital for the future. But every month the mortgage principal will grow. Thus, if the house declines in value and the debt expands, her estate could soon be zero. If she had to sell for health reasons, there might be nothing.

We discussed this. Selling is your best option, I said. She was gracious. The garden won.

Terry and Bekki hate me, apparently. But not enough to stop reading.

“I’ve been following your blog for a long while now,” he writes. “As a lower mainland home owner I hate it and I hate reading it! However as a fairly pragmatic person it has definitely given me additional motivation to get my financial house in order the last few years.

“I have a question for you if you have time. I’m 34 and my wife is 32. We have paid off all loans, student loans, car debts, credit cards…. The only outstanding balance on our ledger is 725k in mortgage debt on what is likely (as of this moment) a +/- 1.2 million dollar house.

“While we cleared our debts, we have managed a small savings. Our goal was to have $100,000 cash in the next few years to account for potentially a real-estate crash where we needed to infuse some cash if the family home is a small amount underwater or massive interest rate spike when we renew. I know this is a lot of money that isn’t growing (but is at least equaling or beating inflation). So the question; what kind of cash safety net should my family actually have? I’d love to see that money growing, but investing, no matter how safe and smart is still risk. We’ve been told to have a year’s worth of cash. There doesn’t seem to be any magic number that everyone uses as far as I can see, so 1 year of life sounded pretty safe. Too much?”

No real savings, virtually 100% of net worth in a single asset and $725,000 in debt. Yes, you need advice. For people who eschew risk this could be a recipe for heartbreak. No balance, no diversification and, if the real estate market turns, no liquidity. If you’ve really realized a big equity gain on the place and fear being underwater in a few years, why not get out now? Duh.

As to the question about a non-invested emergency fund – don’t have one. It’s an archaic concept. No rational couple should have a year’s worth of cash lying around doing nothing. This is what lines of credit are for.

Go to the bank. Get an unsecured line for twenty, fifty or a hundred thousand – whatever they’ll give you. The interest rate is immaterial (but should be no more than prime + 3%). It costs zero to arrange, and zero to carry. If a personal emergency hits, just write a cheque. When it makes sense, sell investment assets to pay it off.

And when was the last time you had an emergency? Exactly.

Moister math

Jason has $19,000 in his CIBC chequing account earning 0.05%. “That sucks,” he says, and it does. But there are tens of billions of dollars in Canadian bank accounts on any given day losing money, even with inflation at just 1% (which is 20 times more than Jason is earning).

Maybe you should flip this cash into your TFSA and invest it, I said. Crickets. Then, “How?” he asked.

This 32-year-old has two uni degrees and now works for the federal government in a responsible position wielding semi-judicial powers over citizens’ lives. He has an apartment, a steady GF and a DB pension. Life is good. But J’s a case study in the financial illiteracy that permeates society. When banks are the only place you learn money stuff, and [email protected] is always selling you into GICs or mutual funds, no wonder so many people are pooched. No wonder they see gambling on real estate as the only way to get ahead when their liquid assets lie comatose and softly bleeding in a bank vault.

Jason can open an online trading account with CIBC Investor’s Edge, for example, buy a clutch of ETFs and pay $6.95 per trade. He could try one of the robos, like WealthSimple, where an algorithm invests for him and he pays an annual management fee of 0.5% on his twenty grand plus embedded ETF charges. He could throw his cash in with his mom’s and use her fee-based advisor, paying 1% and getting an actual human to help with tax planning plus decisions about cars, houses and personal relationships (seriously). Or he can go to the bank, get free help and end up with mutual funds costing 2.5%.

Any of those are better than what he’s doing. So, I’m giving the moister a few ETF names (he only needs four) with which to build a balanced and diversified portfolio inside his tax-free account. If he just keeps his hands off them (no silly trading when Trump blows up or the markets correct), and shovels in the yearly max, the result will be sweet.

The math is simple. Start with twenty grand in the TFSA and add a hundred bucks a week. Assuming a 7% annual return (consistent with the past few decades) by age 62 Jason’s TFSA will contain $747,000, of which $556,000 will be tax-free growth. If he retires with his gold-plated, federally-kissed defined-benefit pension, he could draw more than $50,000 a year from the tax-free account to supplement his monthly retirement allowance, still retain the $747,000, be entitled to CPP and OAS without the extra fifty grand being added to his income and taxes.

So if a moister like him learned nothing else, it would be this. Stop saving money and invest it instead. Empty your savings account, cash in all GICs and put the dough into a handful of cheap, liquid, efficient, diversified ETFs. Open only one account – a TFSA – and make the maximum annual contribution ($5,500). Tell mom you don’t want cash for a condo down payment, but you’ll kindly accept a cheque for $52,000 to fully fund your tax-free account. PayPal wold be fine, too. No bitcoin, though.

As for the current moister investment of choice, things just keep getting worse for real estate. A new poll finds 86% of the 25-30 crowd think property is a great investment, despite the fact anyone buying today is probably going to lose money for the next decade. The evidence is everywhere. Even the realtors are screaming it…

Over the next two or three years interest rates will rise slowly, steadily and painfully for those with fat mortgages and skinny equity. The bank stress test will likely be in place this October, just in time for the next round of mortgage increases. By the end of 2017 the price drop in the GTA from April highs could be 30%. Maybe more. That would equal the US housing bust’s low point and approach the 1990 crash, from which the market took 14 years to recover. There will be no major community in Canada immune from higher loan costs, less credit or falling equity. Anyone who buys now with all their savings and big leverage will wish for a do-over.

Yeah, it’s not an easy time to be 32. But it never really was. Three decades ago mortgages cost 12%. Nobody could buy with 5% down. So houses were cheap. But back then there were no TFSAs, online trading accounts or wealth-builders like exchange-traded funds. Inflation was 7% (not 1%). Unemployment was 50% higher.

So, Jason, we inhabit an aberration. The cost of money, like inflation, will go back up. Real estate will come down. The economy will continue to expand and financial assets should do well. But never before have so many people been so indebted, so deluded, nor so willfully imprisoned in their homes. The world, in short, will be the oyster of the liquid, the flexible and the free.

Best start today. Now you know how.