Wednesday, December 5, 2012

Rule #23 Automate all Monthly Payments

I have no idea when our bills are due.  I know they are due sometime during the month, usually near the end of it, but I dont fuss with checking the exact due dates anymore.   We have automated all but one of our bills.  When I say automated, I mean that we have set up an automatic payment either through the company itself or through our main bank to ensure the bills are paid on time.  We dont need to go stand in the long lines at bank tellers or ATMs to pay our monthly bills anymore because they come directly out of our accounts on the same day each month.  This way, we never have to worry about missing payments.  The payments are approximately the same every month, and the payment always comes from our checquing account, so we just make sure there is always enough in our account to cover the payment.  I find with money and bill management,  the path of least resistance with the highest amount of certainty usually makes the most sense, so making things automatic is the way to go for us.  No muss, no fuss.  This means we can focus our energy on other aspects of our financial planning instead of spending a couple hours a month in line-ups.

We do this with bill payments, debt payments (when we have any), rent, mortgage payments etc.  We have also applied this automating to investment contributions.  This is essentially the same concept of paying yourself first, automatically.  Each month, a set amount comes out of our account to go into our investments, and/or our savings accounts.  We have coordinated the timing of these particular withdrawals to coincide with our paydays.  The day that our paycheques go in our accounts, is the day the money comes out to make the contribution.  One thing about automating all our bills, debt payments, mortgage payments, and now investment contributions, is that when we look at our bank account balances, we know that most of the money in there is ours... it is essentially our discretionary funds... because all of our non-discretionaries (minus food) is, for the most part, already paid for.  We have learned to live without that contribution money in the first place so it never feels like the money is being taken out of our pockets.

By applying the Automatic Payment method to investments, we never have to choose how much we are going to save or invest that month, because we have already arranged for it to come out automatically.  The automating of the process of investing contributions essentially makes it a compulsory contribution.  It makes it habitual.  Inertia is huge in making a contribution, and anything that will increase the probability that you will continue investing in your financial security is a good thing in my book.

The benefits of automating one's payments are a plenty.  We never pay late fees because we are never late with payments.  If we go away for a week, we don't have to pre-pay any bills or dig through our mail when we come back to see which ones need to be paid right away.  Since our investment contributions are automatic, we know our future is being funded and don't have to carve off part of our paycheque because its already done.  Our credit rating is never in jeopardy because we didn't get a bill in the mail, made the wrong payment amount, or because it somehow got misplaced among the junk mail and went unpaid.  Lots of good reasons.

A the the end of the month, right about when I do our charting, I also leaf through the bills and see if there are any irregularities that may need addressing, but thats the only time of the month that I look through the bills.

There is one exception to this rule around automating, and that is with our credit cards.  Our credit cards may have additional items/services purchased on them from time to time and so an automatic payment doesnt suit us well in this case.  I check the balance every couple of days and pay it off completely.  I dont even wait for a bill to come in.... We treat our credits cards at 1-2 day loans, paying them off right away.  you can read more about how we use our credit cards here.

Tuesday, December 4, 2012

Rule #22 Pay your bills on time.. Every Time!


Want to know how to sabotage your finances in the foreseeable future? How's about screwing up your credit rating, while at the same time building up a deadbeat image of yourself?  Yeah, thats one of the worst things you can do.

It's funny how people do silly things that sabotage their financial wellbeing ... and by funny I mean strange.  An example of this is voluntarily harming their credit rating.  When I was in University, one of my roommates didnt have enough money to pay his cable TV bill but that didn't stop him from going out for a few brewskis with the boys.  Here's how one particular discussion went:

Ryan: "Hey man, your bill has been sitting there for a month... you gonna pay that? It was due last week."
Roommate: "I am getting my next instalment of my student loan in 6 weeks and I will pay it off then."
Ryan: "Dude, you cant just miss a payment.  Maybe you shouldn't be goin' out to the pub til you pay your bills."
Roommate: "They'll get their money, as soon as I get mine. I've done it before, no problemo."
Ryan: "That's gonna bite you in the ass someday"

Integrity is one of the traits that was ingrained into me as a kid, and it is one of my most valued traits in other people today.  Integrity to me means you do what you say you are going to do.  Its as simple as that.  And when you borrow money, you pay it back on the terms that you agreed to, or even earlier!  Growing up in my parents house the rule was: You only borrow money you know you can pay back and you ALWAYS pay your bills on time.  You always sacrifice discretionaries before missing a payment.  Always!  That was a given in my childhood household growing up and it is a given in our adult household today.  That includes bills, mortgage payments, loans, credit card payments, handshake loans with family etc...

Beyond having integrity, there is another good reason to pay your bills on time... maintaining a good credit rating!  When I was a teenager my parents taught me about a person's credit rating.  I've known about it and have been maintaining a good one all my life.  A credit rating is a metric used to evaluate your credit worthiness, or your ability and reliability to pay back debt.  Banks and other lending-related organizations share your income and debt history with each other in order to determine how much to lend you, what rate to lend it to you at, and the duration of these terms when and if you can borrow money at all.  The part you can control the most is how much you borrow and how you pay it off.

Let's focus specifically on the paying it back part and why you should care.  Your credit rating will suffer if you dont pay your bills on time... no matter what the reason, and in the end that hurts you more than anyone else the next time you go looking for a mortgage or a new car loan.  If you were buying a car on credit and you could only get the loan's interest rate at 7% while your brother-in-law was getting the same deal only at 5%, simply because you didnt pay your bills on time, you'd be kicking yourself.... or at least you SHOULD be kicking yourself.   Thats money you are leaving on the table.  If you have any money sitting in the bank and you are missing bill payments, you are likely ruining you future finances by acting so irresponsibly.  If your credit rating is the pits, it means higher interest rates that you are required to pay, or it may result in you getting turned down for a loan altogether.  Paying extra at a later month doesn't make up for missing a payment either, as some people I've talked to seem to believe.  If you ever want to borrow money in the near or distant future, the lender will absolutely be checking your credit rating first, so always keep that in mind when those current loan statements and bills come in the mail.

Come Hell or high water, we never miss a bill payment, we always pay our bills on time. Always.  As a result, we've never been turned down for credit when we've asked for it. and we get good interest rates on the loans that we do have.




Friday, November 23, 2012

Rule #21 Chart your Progress!



I know people who procrastinate starting to save or pay down debt because they believe there is no way they will get out of debt or save enough to be financially independent.  Its like they feel like there is no way to chip away at the task because completing it seems so daunting.  The task seems so great or that saving a couple thousand dollars a year seems so difficult yet insignificant in the big scheme of things, that they simply don't get engaged with their own finances.  We have found that charting our progress is a great motivator for us as it shows progress right away.  Yep, you're going to have to learn some basic spreadsheet skills, but you wont need an engineering degree here... just a friend with entry level Excel should be enough.  If this simple Geologist can figure it out, you can too.  Charting your progress lays out in visual form where we are, and what our financial trend is. From an investment standpoint, we are mainly focused on our assets cash-flow and not its market value, so this makes it super easy to keep track of because we don't need to track our portfolio's current value, but simply the dividend income.  This eliminates the hand-wringing that happens when the market corrects and the TV talking heads are all doom and gloom.  Seeing our investment cash-flow go up and our debt go down month to month or year to year reinforces visually that we are on the right track.  It also encourages us to steepen the slope by adding additional funds and boost our progress.



I used to make projection forecasts where I would make assumptions about how much we could save etc into the future... but I stopped doing that because I almost felt like we had accomplished something when really all I was doing was just fiddling with numbers in a spreadsheet.  Plotting month to month in real time as you do it is proof of accomplishment.  It doesn't take all that much time once you get the spreadsheet set up and running.  Just open it up on the same day every month (we use the first of each month) and tally up any increases/decreases from the previous month.  Post the charts on the fridge so there is a constant reminder that you are going in the right direction.  You can also see where you fell off the wagon a month here or there...

Another nice thing about charting your progress is that after you've been doing it for 4-5 years you can see how far you've come by doing look-backs.  Assuming that you stay on track and have good financial habits, you will also see the power of compounding right before your eyes because the slope of the lines will naturally steepen as exponential growth takes effect from year to year.  You can also feel momentum building, that will act as further motivation and encouragement for you to keep on saving/investing/paying down debt.... and to us that feels pretty darn good.

So... go and embrace your inner engineer and break out the spreadsheets. Not just for nerdy math and science geeks anymore.  




Thursday, November 22, 2012

Rule #20 Set Financial goals

Goals in writing are dreams with deadlines - Brian Tracey

Do you have financial goals?  I just finished Millionaire Upgrade by Richard Parkes Cordock - a great book by the way - and it reminded me of one thing that we have found to be very important for our progress towards Financial Independence and that is:  Setting Financial Goals.  One quote from the book is "A goal without a plan is a dream".... I'm going to memorize that line because I think its a great line.  Back to us... Every year, we set or revisit goals for our annual investment cashflow growth, goals for our savings account, goals for debt reduction, goals for RRSP contributions, and goals to reduce our spending (cut the fat).

For us, there are three things you need to have figured out before you can call your dream a goal:

  1. What do you want to do with your money?  Do you want to become a mulit-millionaire or do you just want live a minimalist work/debt free lifestyle?  Do you want to work part-time halfway through your adulthood or full-time til you kick the bucket?  Do you want to go an a big vacation this year?  Saving for a new car?  Is your goal to reduce debt or become debt free?  If you don't know what you are saving for, you are almost surely destined to fail.  While you could argue the why is just as important as the what, I think the what is probably the thing to keep posted on your fridge as a motivator.  
  2. Why do you want to do this with your money? Here is the deep soul-searching part of having a goal.  Are your goals inline with your values?  Do you want to work til you are 75 or are are you trying to leave the workforce as soon as you can so you can do other things?  Do you really really want what you are saving for or are you doing so because you feel its what you should do?  For us, we like to be in control of our lives.  We want to leave no debt to our children and we dont want to be a burden on them as we age.  Thats why we choose to invest and save the way we do. We want to be good role models to our kids and walk the talk.  That is the Why for us.
  3. How are you going to get there?  Here's the part where you need a plan, or your goal is just a dream.  This part is where you discuss or ponder the sacrifice you are going to make.  Thats right, financial planning involves sacrifice.  Are you going to manually save that money or have it automatically deducted from your account to make it easier?  How much do you need to save? Are you going to increase you income, or decrease your spending to meet the goal.  Will it be a monthly contribution or a once a year event (like at RRSP or tax season).  If you have a spouse, how will you keep this all straight?  Will one partner keep track or do both need to be involved?  

Your goals obviously need to be realistic, but we like to have stretch targets that may be reachable but require some additional sacrifice or creativity.   We assess and set these goals usually around New Years and revisit them at tax-time in March.  Then, we do what almost nobody does... we write it all down.  Thats right, we write it down every year.  There is a saying in the Geologist Community that goes: "A map is just a sketch until it is coloured" or "A map becomes truth once you colour it in".  For us, its the same thing about goals - writing them down makes that goal more official... not just some talk we had over coffee.  Some friends of ours think we should lighten up over this point, as if we're kooks for treating our goals with this kind of official discipline.... but there is never an argument in our house over what we are saving for.  We are always on the same page because the goal is there for us see.   We are committed to it.  We have personal financial goals and we have family financial goals.  We both know what they are and are both commited to those goals.

We've had this approach to setting financial goals for about 10 years and we've missed a few yearly targets, but its not because of lack of trying.  The odd expense has come up that we weren't expecting that threw us off.... but it actually led to us creating an emergency fund as one of our goals the following year.  After doing if for 10 years, we are better now at setting those goals and it has become significantly easier to meet or beat them.

Some of our past goals were:

Max out our RRSP when it makes tax-sense to do so.
Grow our Investment cash-flow by 8% per year
Build an emergency fund in case the car craps out and we have to buy/fix
Pay off our non-tax efficient debt
Save up enough to buy a new bicycle.

The last aspect around having a goal is about executing point #3.  Executing point #3 relies on how committed you to points #1 and #2.  I think its pretty self explanatory from here on so I won't bother you with motivational speak.  Either we follow through on what we say we are going to do or we do not.  Having serious and reasonable goals, and our ability to follow-through has been perhaps the most important thing for our personal finances.  For our age cohort, we are in pretty good financial shape, and I credit a large part of that to having achievable goals and executing the plan.  Do You have Goals or do you have Dreams?


Thursday, September 20, 2012

Rule #19 No Fixed Income.

When the topic of portfolio asset allocation comes up in discussion with financial folks, they will often talk about the ratio of equities (stocks) to fixed income (bonds).  Some advisors recommend a 60/40 ratio adjusted either up or down depending on your age and risk tolerance.  They often use bonds as a type of a hedge against big drops in the market.  If stock values drop, bonds tend not to drop the same amount under the same market conditions.  The opposite is also true in that bonds tend not to rise anywhere near as much as stocks do during bull markets.  Once you take the market value gains or losses out of the picture as we do, are fixed income investments a good fit for our model? Not the way we look it.

We have no fixed income in our investment portfolio and we won't be adding any anytime soon.  Fixed income is defined by InvestorWords.com as: A security that pays a specific interest rate, such as a bond, money market instrument, or preferred stock. This sounds pretty good on paper. Its essentially a near-guaranteed return on your investment over a set amount of time.  A GIC (Guaranteed Income Certificate) is another form of fixed income with the word "Guaranteed" right in the name of the investment instrument. Wow! Guaranteed sounds pretty good, doesnt it?  


Because of the low interest rate environment in recent years, fixed income yields have been historically low.  GICs are currently paying about 1-3% annually depending on the term, and bonds are not paying much better.  These numbers are so low that they dont even keep up with inflation after considering both taxes and inflation.  Outside of Registered accounts, fixed income such as GICs and Bonds are taxed similarly to employment income so the tax rate can be as high as the 49% depending on what province you live in and what marginal tax bracket you occupy.  Corporate bonds pay better, and can be closer to 4-6% but most advisors would say that corporate bonds tend to be higher risk and if you are looking for safety, going to corporates are not the way to go.  They are also still taxed at potentially very high rates where up to half that higher rate is sent to government.  If you are looking at corporate bonds in general, you may have the appetite to go with either preferred or common shares that pay dividends instead.  

Canadian Preferred shares with dividends are the only types of fixed income that we would currently consider since the yields tend to be high and the dividend is taxed the same as Canadian eligible common share dividends which have a significantly lower tax rate.  Preferred shares tend to be a little more risky in their "secureness" compared to bonds, but if you screen your preferred shares with proper due diligence, they are a pretty safe alternative to bonds.

The main reason we do not invest in fixed income is because of the "fixed" nature of the gain and how your gain actually gets smaller over the term of the investment because of inflation.  The amount of gain you get as a percentage is the same at the end of the term as it is at the beginning.  If you buy a 10 year $1000 bond that pays 4% annually, 10 years later you are still getting 4% (pre-tax remember... in after tax dollars its much worse) on your $1000.  40 bucks per year at the beginning of the term and 40 bucks per year on year 10.  In the mean time, inflation is chugging along and all your money (both principle and income) has less and less buying power.  This means that in year 1 your gain might be able to buy a case of beer, but in year 10 will that same gain of $40 get you a case of your favourite ale? Probably not. 

It should come as no surprise that I prefer conservative Canadian dividend-paying stocks as a replacement of fixed income in our portfolio. A company stock with a healthy yield and a record of increasing its dividend at or above the rate of inflation would be a reasonable substitute in my mind with the potential for capital price growth to go along with the tax efficiency of the dividend.  An example of a stock like this would be Fortis. Fortis is in the electricity transmission business mainly in parts of Canada and the Caribbean.  People can't do without electricity, so its one of the safest industries to invest in and the need for energy transmission will continue to go up in the future so there is even the potential for modest growth.  Fortis currently has a dividend yield of about 3.6% and the company has a history of increasing its dividend, mostly at or above the rate of inflation.  Another great thing about Fortis is that with the increasing cash-flow comes an increase in the stock price as well.  As the cash-flow goes up, so too does the stock price.  Bonds do not have that kind of relationship as the yield never changes as you hold the investment.  To us, in comparison to bonds, the upside potential on a stock like Fortis well out-weighs the risk of keeping your money in this type of equity.  

(Full disclosure: I do not currently own any Fortis, but it is on my watchlist and would look to add some to our portfolio if the yield got to be over 4%.  I am not making any recommendation to either or buy or sell Fortis)




By: TwitterButtons.com

Wednesday, September 19, 2012

Rule #18 Don't Diversify... too much.

This one goes against what most Financial Advisors will tell you.  They will tell you that you should diversify among various sectors and investment products because it allows you mitigate the risk of losing all your money if one event wipes out one of those sectors.  This is the "Don't put all your eggs in one basket" approach, except advisors tell you to put your money into lots and lots and lots of baskets by investing in multiple Mutual Funds or ETFs.  I am not a fan of "blanket across the board" diversification like this.  I would rather invest in 3-5 things or sectors that do I understand rather than hundreds that I don't - which is what most people are doing when they buy a broad-based mutual fund or an ETF.

I'm not against diversification per se, but I think hundreds of stocks are too many and is investing "not to lose" rather than investing "to win".  I also have the ambition to learn how all these companies operate and run their businesses, and invest in the ones that meet my risk tolerance level and long term investment plan.  I want the best companies for us, rather than buying a basket of stocks that include both the good and the bad.  Also, since I focus on cash-flow and not capital appreciation as the backbone of our strategy, I prefer to track financial statements of specific companies rather than of indexes where the data is more difficult pick out exactly whats happening to individual stocks.

Here is my rationale for taking a more focused approach.  It works for us, it may not work for everyone.  Have you ever heard of folks who invest solely in "Bricks and Mortar" Real Estate?  I have, and they often do quite well for themselves.  They have focused on learning the ins and outs of real estate investing and put all/most of their eggs in that basket.  Thats how real estate barons like Donald Trump make their fortunes.  They focus on one sector and do it very well.  I know other people who work in the High-Tech sector and they are constantly checking out their competitors and are aware of all the new trends developing within the sector.  Should they diversify in things they dont know or should they invest in what they know and live every day?  Mining Geologists I know invest in precious metals because they understand the supply and demand dynamics of the commodities industry better than anyone else.  All of these types of focused investors leverage their day-to-day professional knowledge towards their personal investments.  They have become experts in their fields and then apply that expertise to further their personal wealth through continuing to investing in their field of work.  Another way to approach or look at this is to invest in what interests you or what you understand based on your day-to-day experiences.  Does it makes sense to invest in hundreds of stocks that you don't understand or a select few that you do? I choose the latter.

I spent 17 years studying and working in the technical side of the Oil and Gas industry. I worked as a specialist for a Super-Major Oil and Gas Operating Company that explored for, and developed, hard-to-get-at resources.  Its a highly competitive industry and there are lots of players in both the Operating Company side as well as the Service Company side.  I understand many of these aspects of the industry because I lived it day-in and day-out for many years.  I still know people working at many of the companies and I am in communication with many of them on a regular basis.  Would it not make sense that I leverage that knowledge towards my investing practices?  I would think so.  I am also generally interested in money management, economics and wealth creation... and I am continually reading up on books about this kind of stuff, because thats what I'm genuinely interested in.  I am also interested and have some experience in the real estate market as we have owned 3 different properties in the past, and made offers on three other real estate deals that did not go through.  I've seen how these industries operate, studied them more, and understand them better than others.

Based on my expertise and interests I have chosen to invest in about 15-20 stocks in 4-5 sectors with respect to equities.  Those main sectors are: Oil and Gas, Commercial Real Estate, Energy Transport and Transmission (pipelines and electricity), Consumer Staples, and Banks/Financials.  I specifically do not invest in a number of sectors because I either don't like the sector itself, or because I don't understand how the businesses work or what their prospects are in the future.  Those sectors would include high-tech, retail, pharmaceuticals, consumer discretionary, transportation, commodities and agriculture.  I am slowly educating myself on a few of these sectors but until I understand them, I am in no rush to buy into them.

So as you can see, I am not against diversification because my portfolio is diversified, just not diversification to the point where I can't tell whats going on.  I like to invest in things I understand, and not invest in things that I don't.  Every investor has to determine what level of diversification is comfortable for them and how much they really need to know.


Tuesday, September 18, 2012

Rule #17 Save/Invest ALL windfalls or bonuses

Windfall: (n.) An unexpected legacy, or other gain.

We use our weekly or monthly paycheques to pay for our day-to-day lifestyle and we live within our means based on that income.  We have a set amount that we save and invest every month - an amount that comes out of our monthly cash-flow.  This is the discipline part of our money plan... However, every spring there is a chance we get a tax refund, I sometimes get a bonus from work, and at some point we may get an inheritance but we dont know when or if that will ever occur.  We don't know how much (if at all) any of these windfalls are going to be, so we never consider them when planning our monthly or yearly budgets.  We essentially treat them as found money.




Have you ever had a one of these sizeable windfalls that you weren't expecting come in?... a significant amount of cash that isn't part of your regular paycheque, and you were faced with the question "what should you do with it?"   Should you use that money to renovate your kitchen?  Buy a new car?  How about a motorcycle? Some people take their bonus and go on big vacations or pay off large credit card debts that they've racked up.  I even know people who spend like crazy at Christmas and then plan on having their tax refund in the spring pay for the credit card bill... Yikes.  But I digress... Assuming you're not breaking my credit card rule, what should you do with such found money?  Should you use it for a one-time consumer purchase or should you put that money towards something that would make you life easier every day to infinity... such as to pay down debt or invest in assets that will continue to send you a cheque for the rest of your life every year?  Ahhh now thats starting to sound like me.

Whenever we have one of these windfalls we apply it to our investment strategy so that we continue to benefit from the windfall for the rest of our lives, through predictable cashflow... usually dividends.  Its sort of like a a shot of adrenaline to our portfolio's cashflow and can make a significant difference over time.  We ALWAYS use bonuses, tax refunds and any other "found money" to further our progress towards financial independence.

Lets assume a quick example of a $10000 windfall from something.... say a bonus at work because your company had a banner year.  Invest that money in a company such as Bell Canada (BCE), who pay a quarterly dividend equal to about 5.3% annually at today's stock price.  That dividend will now pump an additional $530 into your annual cash-flow this year and next year and likely every year after that so long as people keep buying their phone, cable and internet services through Bell.  Another way to look at it is that that $44 ($530 divided by 12 months) of your monthly budget is now paid for each month from your Bell investment.  Its interesting that the one definition of windfall is an unexpected legacy, because that is what you're setting up when you invest this way... it is  legacy cashflow that is potentially for the rest of your life.  What you do with that $44 each month is up to you.  You can re-invest it, or spend it on something else like paying for your internet through Bell.  See what I did there? Investing windfalls is certainly not as sexy as buying a motorcycle, but reaching financial independence has some pretty good perks as well.


By: TwitterButtons.com

Friday, September 14, 2012

Rule #16 Plan on Financial Independence without CPP

(Note: FYI, this post is mostly relevant in Canada as it talks about the Canada Pension Plan. I am not familiar with other government run pension plans in other countries but I would bet many of the points I raise here are similar.)

I generally don't trust that the government will do what is in my best interest.  I am usually skeptical of any incentive that they offer us as citizens and taxpayers, and I usually challenge whether whatever they are "offering" is truly good for me and my family or not.  I value my freedom and don't take kindly to being coerced or forced into doing things I don't like or want.  An example of this is the Canada Pension Plan.



The Canada Pension Plan takes 4.95% of your first $42000 of earned income and sends it to a government office to manage your money for you.  Thats about $2000 a year.  If I am an employee, I am required to pay into it annually. I am not permitted to opt out of it.  To us, this a bad deal.  The other kick in the teeth is that your employer has to match your contribution... so there is about $4000 per year being funnelled into the CPP each year per employee making over $42K.  But Ryan, why wouldn't you want a government managed pension?  The government has decided to look after you, isn't that a good thing?  No, it isn't.  Not for us.  I would rather manage that money myself.

The maximum amount that CPP pays you if you were to retire in 2012 in before-tax dollars is $986.67 monthly. Not much, eh?  You have to be aged 65 and have worked 40 or more of those years, while maxing out the contributions, in order to qualify for the max pension.  If you didn't make the max contribution, your amount goes down. If you take your benefits early at age 60, your amount goes down.  If you didn't work 40 years or more, for whatever reason, your amount goes down.  Now me, I went to Graduate School so I didn't start working 'til I was 28.  I've also taken two Leave of Absences to be with our boys when they were born.... So fat chance I'm going to get the full $987.  My wife always planned to take some time off and raise our kids so odds of her making that maxed amount is also nil.

There are some other reasons why I am not a fan of the CPP.  If you are single and you die before you are old enough to collect a pension - age 60 I believe for a reduced amount for example - no residual value is left to your estate or your heirs.  If you die the day after your first pension cheque, your surviving spouse may, from what I understand, get up to 60% of it, but if you have no spouse or they have already died, poof your pension is gone.  Again, there is no residual value to pass on to your heirs.  Its essentially an insurance plan that the government forces you to pay into... and not a very good one at that.  You will have paid into if for all those years and gotten very little or none of it back if you expire early.  I can think of a better way to use my own $2000 per year AND have some residual value left over.  Remember Mr Gunter?

When I look at the CPP, I see it as a retirement savings vehicle for people who are not savers.... and to some extent another example of the government encouraging people not to take responsibility for their own well-being.... Or, as in our case, the government not letting people take care of themselves.

When we started planning our finances years ago, we looked at the above CPP conditions and said to ourselves "These are way too restrictive!" For one, we won't be working 40+ years.  If one or both of us want to take a few years off here or there, that small amount gets smaller and smaller.  Then we said "Do we really want to work continuously 'til we are 65" The answer to this was a resounding "No."  Its not to say that we won't work 'til 65... or even beyond... It was that we would be required to work that long because the government would be holding this carrot over us to make us continue to work.  "Screw That!"  So our plan is to make sure that we can look after our monthly liabilities without relying on the government managed CPP. We plan to stop working when we want, if we want.... not because we were forced to work until a certain age. When making up our master plan, CPP doesn't even factor into it.

So our solution is that we plan our finances as if there will be nothing in CPP for us when we get there. If there is anything for us in CPP we would take any benefits into a system that we were forced to pay into, regardless or how poorly it fits for us.  Based on our plans we expect to be just loose change.


Thursday, September 13, 2012

Rule #15 Don't try to "Beat the Market"

Do you know the only thing that gives me pleasure? 
It's to see my dividends coming in. -John D. Rockerfeller

Have you ever heard anyone talk about beating the stock market?  Its what hotshot investors talk about at cocktail parties.  What they mean is that if the stock market has an annual return of 10% in one year, they have had a better return than that 10%.  Very impressive indeed!  They will try to achieve this by building and adjusting a stock portfolio, mutual fund portfolio, or with index funds.  Beating the market is all well and good if the market goes up, but what if the market goes down? If the market has a loss of 5% the next year and the investor only lost 3%, then they have also beaten the market because they have done better than the market has done that year.... but people don't tend to brag about losing money "Yeah! I only lost 3% this year!".  The market (and by market I mean Dow Jones Index, S&P 500 index, or TSX index etc...) has historically returned 8-12% returns annually but those numbers are smoothed out over decades of data, so you certainly couldn't count on a 10% return every single year... as has been the case the last decade.  One thing about measuring returns in the market this way is you only realize these returns when you sell the investment... and that brings on the issue of timing, and few people have mastered that.

I don't really care if I beat the market or not.  Beating the market is not my objective.  I am not in competition with the market, My objective is to build a portfolio that will eventually result in me being financially independent.  Who cares if you beat the market if the market has lousy or negative returns?  If the market loses 25% in a year, I feel no pride in only losing 20% that year.  And if the market were to make 25% in one year, its ridiculous for me to worry that I only returned 22% instead.  I feel this "beat the market" mentality is a waste and makes people take their eyes off the prize, or chase capital returns instead of stable cashflow.  People shop around for stocks or sectors hoping to get a winning year or to follow advisors or mutual funds because they have a few good yearly returns.  That just seems dumb to me.  I prefer a system that provides stable and somewhat more predictable results.

We have our own metrics.  We don't compete with the market, and we sure as hell dont try to beat it.  Our goal is to grow our cash-flow on existing assets by 8% a year... We get this by reinvesting the 3-5%-ish dividends that we get in cash-flow and then plan on a 4+% increase in dividends annually.  We generally don't pay much attention to stock prices once we own the stock because they tend to fluctuate due to world and political events rather than be based on actual company financial metrics.  Tracking growth of cashflow is pretty easy to understand and we don't have to follow the stock prices or compare with how the market is doing.  In fact, since we are reinvesting dividends to buy more stocks for cash-flow, we don't mind when the market takes a dive because it means we can pick up good stocks with even higher yields than before.



Every year for the last 10 years, our cashflow from existing assets has increased.  Every year! And Every year it has gone up above the rate of inflation.  The lowest growth rate was about 5% in 2009 and the highest has been about 15%.  Thats a pretty good record if you ask me.  This year is turning out to be a good one, we expect about a 10% increase in total this year if we keep going the way we're going.  Three quarters of our dividend producing stocks have increased their dividends this year and the rest probably will within the next 3-6 months, and we just keep rolling those dividends back into the portfolio buying more cash-flow-producing stocks, furthering the compounding.  This increase also does not include any new monies that we put to work in this strategy.  Include the new monies, and our conservative leveraging strategy and we're increasing our cashflow above our 8% per year target relatively easily.  Do I care how this all compares to what the stock market performance is doing these days?  No, I don't.

Wednesday, August 29, 2012

Rule #14 Live on one salary.

I'd like to live as a poor man with lots of money.  ~ Pablo Picasso

This post is mainly relevant for couples working towards saving or paying down debt. We live on only one salary when we have two coming in. If you are not part of a couple, I would still recommend living well below your means if you can.

So if you are following along, you've probably guessed that we are very aggressive savers. When we started our careers 14 years ago, we were living in a small one bedroom apartment. I was in Grad School TAing Undergraduate classes and Kim was working an entry level front line position at a Social Services Agency.  We werent making very much money but we were very happy.  Our lives were simple and we didn't define happiness by how much stuff we had.  Pretty much all of my TA income was going to servicing and paying down our Student debt, and we were living on Kim's small salary.  We have always believed in NOT living beyond our means, and believe certain types of debt are anchors that weigh you down, so becoming debt free was a priority for us.  By the time I was done Graduate School in 2002 and had only worked about 3 years, we had tackled $58000 in joint student debt and were debt free.  I had entered my "adult" career phase and began making a fairly decent salary in 2002.  After out debt was paid off, we began saving every dollar of my take home pay.  Its amazing how much you can save if you don't let the cost of your lifestyle creep up as your income goes up.  We were still living a lifestyle that was paid for with only one salary.

We were informed that our apartment was being turned into condos so we were required to move, so we bought a house in 2002.  It was a very modest house on a very walkable inner city neighbourhood.  It seemed expensive at the time, but today it would be a screaming bargain.  Even though we could have "afforded" to take on a car loan, we chose to do without a car for another 4 years until we had saved enough to pay for it in cash.  My employer paid well so we began living solely on my salary and banked Kim's.  I worked in a boom-bust industry so while I was employed at the time, there was no guarantee that I would always have work, so we established a general rule that when both of us were working, we lived on only one salary and we saved the other, just in case one of us found ourselves without work or income.  We've done that every year since about 2002 unless Kim or I were taking some time off from working either for a Parental Leave or a personal Leave of Absense.  There was never a need to change our lifestyle since we were accumstomed to living on only one salary.  Easy Peasy.  The other great thing that happened is that as we saved and bought cash-flow producing assets, those assets began providing us income as well.  That investment income started small, but over time has compounded to a meaningful amount of income.  Its not easy to live this way if you are accustomed to a high consumption lifestyle, so it wont work if you aren't prepared to make sacrifices now.  If you haven't began keeping up with the Joneses, don't start.  



This "Live on one salary" strategy obviously works when you, as a couple, have two good sources of income.  If you don't have two good sources of pay, then getting two good source of pay is probably a bigger priority.  Once you are at that point, imagine how quickly you could amass a large nest egg if you as a couple saved half of what you brought home. To this day, we bank/invest about 40% of our joint net take-home income. We do not live lavish lifestyles so there is no shock to the system when either Kim or I, or both, are not employed. Since we've been living this way for about a decade, we have built up a substantial financial base as a cushion and we maintain a lifestyle that is somewhat modest compared to others in our age and income cohorts.

I've heard a lot of people say that they couldn't live on just one salary.   I believe most people can do whatever they set out to do, and that most couples choose to live on both salaries.  They have adjusted their consumption and lifestyle level to their joint income level which leaves very little wiggle room if one of the earners loses a job or wants to do something else like go back to school, or start up a business.  You are now trapped in the "I must work to sustain my lifestyle" vortex.  This is fine if it works for you, but don't use it as a crutch for why you can't save.

Monday, August 6, 2012

Rule #13 Take Accountability. Stop Whining! Go Read a Book already.

"You will get what you want, when you stop making
excuses on why you don’t have it."  - Unknown

Rule 13 is part rant, part rule.

A lot of people are lazy about money. They'd rather watch The Simpsons or Mad Men than figure out a way to make their lives better.  Thats fine with me but there is one nagging thing that I can't stand about many of these folks.... I've had it with their whining!  "My life is lousy, I can't get ahead, The Man is keeping me down, There is no way out!"  This is pure bullshit.  There are many things most people can do, but will they actually do it?  In many cases, no.

Jim Rohn is credited with saying "Poor people have big TVs, Rich people have big Libraries." I love this saying. I think it epitomizes a major problem in society these days.  Its not that people don't know what to do with their money to make their lives better, its that the don't want to know, and that they would rather spend their free time doing things that rot their brain instead of making their life better through gaining knowledge.  There are plenty of free resources on the web or at the library to educate ones self in basic money management or investing, but the it seems people don't seek them out.  My iPod is full of e-books and audiobooks on economics, time management, and finances.  Its also full of more light-hearted stuff just so you know.  I think part of this attitude is due to the fact that many people do not want to make the sacrifices needed to get ahead, so the bury their head or make excuses for not opening a book or asking for help.  Financial Success does not come quickly and generally does not come easily.  It also doesn't happen if you lack the knowledge and rely on dumb luck to help you make it through life.  80% of North American millionaires are self-made, and they got there because of knowledge, and hard work, not because they are any more special than you or I, or because they had rich parents.  They didn't buy into the mantra that someone else should make their life better.  They had the ambition to learn what it took and then went for it.

I'm not suggesting you need to manage your investments yourself or go start a business, or that you shouldnt get help to set up a proper portfolio or debt management plan, just that you need to be engaged with your own money and take steps to make your life better financially.  There is loads and loads of free knowledge out there waiting for you to learn it.  If you need help learning something, ask for help.  If you don't understand what company stock is, Google it.  Don't just sit there saying "My financial IQ sucks so I am screwed!"

Here are some books I recommend if you are looking to get acquainted with saving and investing money, or understanding how the economy works:
Stop Working by Derek Foster
The Cashflow Quadrant by Robert Kiyosaki
The Millionaire Next Door by Thomas Stanley and William Danko
Naked Economics by Charles Wheelan and Burton Malkiel

None of the books are a financial silver bullet, but they will get you thinking about money, if you aren't already doing that, its a good start.  I like all of these books because they are easy to read and they take the jargon out of finances, economics and investing.  I have either found them at the library or borrowed them from friends for free.  I'd start with Stanley and Danko first if you are just starting to think about money.  Happy reading.


Tuesday, July 31, 2012

Rule #12 Use Leverage for MORE positive cash-flow!



Under the right conditions, we are very comfortable using leverage to buy stocks.  Big amounts too.  A lot of people will warn against doing this.  I don't advocate that you necessarily do it, unless you understand the risks and are comfortable knowing what the possible outcomes are, and of course if the investment makes sense in the first place.  If the investment value craters, you are still obligated to pay your debt, so do your due diligence and make sure your really understand what you're getting into before borrowing to invest.    An example of a trade gone wrong would be Research in Motion.  If you borrowed to buy RIM a few years ago you would have lost your shirt on that trade by now as the stock is down 95% off its 2008 high, yet you would still be required to pay back everything you borrowed with literally nothing to show for it. Yes, it really can be that bad.  I would not have invested in RIM because they pay no dividend.

If you are starting to use leverage I would suggest you start in very small amounts until you become comfortable with it.   With all of that said I still don't consider it quite as risky as most will tell you it is, IF you pick stable conservative investments and NOT put all you eggs in one basket.  I have also observed that most people have been conditioned to believe that leverage on investments is risky, yet borrowing (leveraging) to buy a home is not.  I view leverage on a house to be just as risky as using leverage on stocks, perhaps even more risky.  This has to do with my view of a home being a liability.  It pays you nothing, and if it drops in value you are still on the hook to pay for it.  Buying something that is overpriced or built on shaky ground, whether its a house or a stock, can lead to a loss, and leverage can amplify those losses if you sell at the bottom.

I will tell you how I use leverage to increase our cash-flow and pay for itself, while minimizing the risk of the loan over time.  I do not try and hit home-runs with large capital gains, I try and hit base-hits.  Lots and lots of base hits, by creating a cash-flow positive situation while borrowing money to juice it up.  To be clear, what I am talking about is borrowing money, most likely from a bank, to purchase income producing assets.  I prefer Canadian stocks that pay dividends, but you can use a similar strategy to buy an income producing property such as a house or multi-family building, or any other investment with an income stream.  Usually its difficult to find investments with a high enough yield to use the strategy I use, but do your research and you may find some opportunities out there.   Note that I have no experience in rental properties, so I will give an example from a stock that I watch.

There are four basic criteria I use when using leverage.
  1. I typically leverage for 50-60% of the position... that is to say that I only borrow when I am willing to put up 40% of the money myself
  2. The dividend/distribution must be stable, preferably growing, and never have been cut.  
  3. The cost of borrowing must be relatively stable or be going down in the next 1-2 years.
  4. The leveraged investment portion must have a positive and growing cash-flow that covers the cost of borrowing today. If it doesn't make sense today to make the investment, I don't rush it.
So here's an example of a leveraged position I might take.  I will use an example for a corporation I follow call Leisureworld Senior Care (LW on the TSX).  They own Retirement Luxury condos and Full-Service Retirement Homes.  Full disclosure: They are on my watchlist, but I do not own any LW and I am NOT suggesting you buy any...  I am just using them as an example.  Lets go down my criteria

#1 I am willing to put up $4000 to purchase some LW stock, I will also borrow $6000 from the bank to make a total investment amount of $10000.  

#2 The retirement home industry is a stable one and will likely grow in the future as Boomers move into retirement lifestyle living centres, I would expect the dividend to be stable and likely grow at or near the rate of inflation.  At present, the dividend yield is 7% 

#3 At present, I dont see interest rates rising much, if at all, within the next 1-2 years due to the slow growth situation right now with the economy... rates are at all time low.  Now may be a good time to use leverage.  RBC currently has a Home Equitly Line of Credit that is set at prime +0.5.  With Prime at 3%, thats an interest only loan for 3.5%.  Thats pretty low.  You could also lock in a rate of some sort through other lending products at the banks, but I typically use a HELOC as you tend to get the best rates, although they are almost always variable and may fluctuate abruptly.

#4 I would get paid a dividend of 7% annually, and use that cash-flow to pay the loan interest of 3.5%, leaving a spread of 3.5% in positive cashflow. This means on the $6000 that I would borrow, I am making $210 annually.  Congratulations, the leveraged portion of this investment is is cash-flow positive!  The Dividend would have to be cut buy 50% or the loan interest rate double before it becomes neutral to cash-flow negative.  Sounds safe in the near term.  

Now that I've established this as a candidate, how might this look with respect to cash-flow?  In most cases I use the cashflow from the total position (both borrowed portion and my own portion's cashflow to pay down the loan).  As the cash-flow pays down the loan, no additional monies need to be injected into the position.  We treat the whole position as a closed system until it pays off the loan.  You can essentially start saving new monies for your next investment as this one pays itself off.  Here's a  spreadsheet showing what happens whey you use the money to pay down the loan assuming no change in dividend or interest rate.  



After 10 years, the loan is paid off and you have $10000 of LW stock.  This spreadsheet DOES NOT consider the likelihood that LW will increase the dividend, or that the annual interest rate will rise into the future.  Both considerations are quite likely... you can test different scenarios in your own spreadsheets.  This spread just shows that if left alone the dividends will pay off the loan in about 10 years and then you will have about $700 a year in free cash-flow from your initial personal contribution of about $4000.  Thats a 17% yield on the money you put up.  Not bad. Not bad at all.

This strategy works well on stocks that are in conservtive sectors with healthy stable cash-flow and if you don't go hog wild with leverage all at once.  I would never use this strategy on a company that doesn't have a healthy balance sheet, a sustainable dividend or if its in a volatile sector like high tech.. its just too risky.  With that said, I believe using leverage conservatively and under the right conditions can be very profitable.

Monday, July 30, 2012

Rule #11 Dividends - Buy Stocks for the Cash Flow

A major part of our financial independence plan is to build a portfolio of income producing assets.  These assets will be our income into the future and will replace our need for other types of income such as employment.  Our preferred type of income is Dividend Income from stocks that we own.  Dividends are a form of passive income that provide cash-flow with virtually no "work" on our part to maintain the asset.  The dividends are paid by the corporations to shareholders over a set period, usually quarterly, throughout the year.  The corporations take a portion of their earnings and send a cheque to shareholders as a benefit to owning the stock.  While it is a strategy that has risk - and don't forget every strategy has some risk - if you choose stable companies that provide goods and services that people use everyday, the risk is greatly reduced to almost nothing... note that I said almost.  There are many companies, with decades worth of dividend-paying history, that will continue to pay dividends well into the future.  Another great thing about dividends is that many companies make it a point to increase their dividend at or above the rate of inflation each year.  These are the companies we want.  If the company increases the annual dividend by 5%, and inflation is 3%, we've just gotten a raise that out paces inflation.  Ultimately this means we have increased your buying power that year.

The sectors that we invest in are primarily sectors in which goods and services used by people will either continue or increase in the future such as: Real Estate, Oil and Gas, Energy Delivery (Pipelines and Electricity Transmission), Banks, Insurance, Consumer Staples, Booze etc... We generally stay away from High Tech, Food Retail, Clothing Companies, and Consumer Discretionaries, because these companies are built on ever-changing innovation, thin margins, or primarily good economic times (non-recession proof).

One stock that I have owned for the last 8 years is Bank of Nova Scotia or BNS on the TSX.  It has payed a dividend for 179 years, without ever having cut it.  Most years it has increased its dividend above the rate of inflation, some years increasing the dividend by 10% or more.  ThePassiveIncomeEarner.com did a great summary of BNS last year that does a better job than I ever could could at explaining why its such a great company to own for dividends.  You can check that summary out here.

We view buying dividend stocks as akin to buying mini-pensions that will pay our way into the future.  If, at age 25, I buy $10000 of BMO stock today, with a 5% dividend, that stock will now pay me $500 a year this year and every year after that until I sell the stock.  What if I hold this stock until I am 85 years old?  Great! I get to collect that little mini-pension for as long as I hold the stock.  I can do whatever I want with that money along the way... spend it, re-invest it, earmark it for Christmas, whatever.  Sweet!  BMO has never lowered or missed a dividend payment in the past, and there is a pretty good chance that they will keep paying it into the future... and they will likely increase it inline with or above inflation under normal economic conditions.  This way of looking at dividend stocks is different than how most people have been taught to look at stocks.  They look at the price at which they buy the stock and then fret over what price they are going to sell it at.  Timing of the buy/sell trade is particularly important.  We buy the asset for the cash-flow and and then sit on it as long as the company can meet its dividend payments.  We don't fuss on when to sell it, because we have no intention of selling it.

Thats one of the great thing about owning shares specifically for their dividend is that it removes the day-to-day worrying that goes with watching a stock portfolio go up and down in volatile markets.  Because I own the company primarily for the cash-flow, if the stock goes up or down it makes little difference to me, because I don't intend on selling it any time soon  What I do keep track of is the company's ability to pay me that cheque now and in the future.  So long as the company is healthy and selling their goods, I am happy to own the stock.  During the 2008-2009 financial crisis, only 1 of the 20 or so stocks that we hold cut their dividends, the others either held their payment at the same level or a few even increased their payments.  So our dividend income actually increased overall during the financial collapse because the stocks we owned kept chugging along, regardless of the economy.  Capital appreciation will most definitely happen gradually as earnings and growth continue with the company, and if we really need the money we can liquidate some stock to free up some capital, but thats only under emergency conditions.

During our working (employment) years we roll all the dividends back into the portfolio to buy more stocks, so the dividends also act as a source of income to continue buying even more stocks... Hey, this sounds a lot like the compounding affect.  The bigger our dividend income gets, the more our portfolio grows as we plough it back in with more income.  The longer you can leave it alone, the bigger the cash-flow will be when you pull the plug on working.  When we are finished working or if we are taking a mini-reirement, we stop re-investing the money and just turn on the dividend spigot for our day-to-day cash-flow.




Thursday, July 26, 2012

Rule #10 Thumb your nose at the Joneses


One book that has influenced me a lot, with respect to finances, is  The Millionaire Next Door by Thomas Stanley and William Danko. In it the authors discuss how American Millionaires accumulate their wealth, how they handle their money, what neighbourhoods they live in, what cars they drive, what beer they drink and so on....  Its a bit dry and it states and restates the same basic themes over and over, but it has loads of useful data and anecdotes that show the true self-made-millionaire way of living.  I have it on audiobook so I listen to it on my iPod when I'm out for a walk or a skate.  Yeah, I'm just that cool, longboarding down the street listening to self-help tapes.

Anyways... a significant amount of the book focusses on lifestyle choice, and how "Keeping up with the Joneses" makes it very difficult to accumulate wealth.  There are those that live like millionaires, to impress friends or colleagues, who cant afford it (The Jones keeper-uppers), and then there are those who really are millionaires.... and they dont get that way by buying a new iPhone every time Apple makes an upgrade.  They get that way be being frugal and not buying crap to impress other people.  The book shatters all the typical stereotypes that the wealthy drive expensive cars, live in big swanky houses, and drink expensive champagne.   All these perceptions are typically not true for the truly wealthy... People who do live like that typically have lousy balance sheets.


Impressing other people seems like one of the stupidest reasons to buy or upgrade things that are fully functional or still modern.  I know a couple that bought a really big $1000 barbecue when they had a 4 year old fully functional one already.  The catalyst for that purchase was that their neighbour backing on to their yard had just bought a fancy barbecue himself, and our friend just couldn't live with the barbecue they already had once he saw his neighbours... He was being outdone.   So now they have a shiny fancy new barbecue, yet all they do is grill meat with it... well, their old barbecue already did that and it was in fine shape.  So there is $1000 spent on a needless item.  I wouldn't tell them how to spend their money - the earned it, they can do whatever they want with it - but for us, impressing others is very low on what motivates us to buy anything.

A rule-of-thumb that we live by is that we don't compete with friends of family on things we own.  We dress, drive and live in what's comfortable or what our profession dictates is a minimum - that's it.  Why drink expensive wine, when beer is what we like to drink?  Have we been financially successful? We've done okay.  But we don't flaunt it and we don't try and meet a standard of a particular social class... that's just not our scene.  This "not looking the part" is one of the best ways to save money.  In general, a consumption-based, status-driven lifestyle makes it very difficult to accumulate assets , no matter what your paycheque is.


Wednesday, July 25, 2012

Rule #9 Spousal Financial Compatibility is VERY Important.


"It takes two to make a marriage a success 
and only one to make it a failure." - Herbert Samuel

There is a married couple in our circle of friends who are definitely NOT financially compatible, and their marriage has almost ended in divorce a few times. They both have reasonably good paying employment, but he is a spender and she is a saver.  It has caused a lot of friction between the two of them.  Both of their credit ratings were shot because he didn't pay the family bills on time.  She basically had to take complete control over the couple's finances to make sure they didn't end up in the poor house, and now he resents her for controlling all of the money.  It certainly is not a great situation.



It's pretty important to find a life-partner who shares the same values as you do with respect to money.  This may sound like something your Uncle Jack says to you, and then you brush him off as some old fart who doesn't know what he's talking about.... Old People... What do they know about love anyway?  The fact is, whether you like it or not, finances will play a huge part of the day-to-day operations of a household, and you better make sure that you are both on the same page or it can kill the mood (if you know what I mean).

Money issues is one of the top 5 reasons couples split up, so it's pretty important.  If one of you is a saver and the other is a spender, and there is no agreed upon financial plan in place, it can be really hard for a couple to be pointed in the same direction to achieve your financial goals.  We look at OUR relationship as being similar to jointly owning a business called Fraser Holdings.  We both do what's right for the 'business' so our family can become more financially stable and meet our long-term needs.  Most people would never enter a business relationship with someone who spends the company money like a drunken sailor, so why do people not make sure they are in alignment when getting hitched or shacking up?

Tuesday, July 24, 2012

Rule #8 Your Home is not an Asset.

This is one of the topics where people tend to get a little bent out of shape with respect to our perspective on what makes something an asset or a liability.

If you buy something that pays YOU to own it, it is an asset. If you buy something that YOU PAY (net) to maintain or own, its a liability. Those are two definitions that WE use to describe almost everything we own or think about buying.  By these definitions a bought home is not an asset, it is a liability.  A lot of people have bought in to what they've been told by Realtors, Banks, Big Box Home Centres and HGTV - that their home is the biggest asset they own...  It certainly is one of the biggest purchases that people make, but is in an asset?  A home, whether it be a condo or a stand-alone house, does have intrinsic value, but the bricks, wood, fencing, and countertops if neglected or without maintenance, are most likely depreciating in value over time.  The only thing that is truly increasing in value is the land value.... because God's not making any more land.  It is a scarce and limited resource.

Then there are the monthly costs.  Lets have a look at a $300000 house that someone might purchase... What kind of expenses does a house of that size have? That home owner would now have to pay the following things... these things are pretty much non-negotiable... they must be paid: Mortgage, Property Taxes, Insurance on the home, Utilities, and General Upkeep.  If you buy a house or condo with monthly fees, you can add those in as well, but lets assume there are no monthly condo fees. We'll also ignore Land Transfer fees and all the other costs that it takes to make a Real Estate Transaction.




If you add all those costs up, the house costs about $2150 per month to keep it in your name. Of that $2150, only about $400 of the monthly mortgage payment will go on the principle in the first few years or so.  Lets also not forget the 25% downpayment or $75000 that needs to be put down in order to keep the CMHC fees low... I hate extra fees.  After the $400 is deducted from the $2150, that adds up to about $1750 of monthly costs.  So for the initial $75000 that you put up, you now will pay $1750 a month in costs that will fill other peoples pockets.  Its actually quite an expensive liability that you've purchased.  This is not to say that you shouldn't buy a house, because we all have to pay to live somewhere, but if you think of it as a liability and a lifestyle choice as opposed to an asset, you begin to view it quite differently.



Another path you could take with that $75000 would be to invest it in something that has a higher growth rate than a house, and pays you either a rental cheque, distribution or a dividend as a shareholder.  It should be reasonable to rent a house for the same amount... lets say $1750 all in and then save the $400 per month that would have gone on the house principle and invest it somewhere instead.  It certainly adds more flexibility if you wish to move within a few years and don't want a significant amount of your equity tied up in a house.

What about appreciation of my home/property?  Well, the average appreciation of real estate has been about 3.5-4.5% per year in Canada for the last few decades.  This is in contrast to the 2-3% typical inflation we have in Canada.  What this says is that either housing has been very undervalued in Canada and the market values are steadily catching up, or housing prices are, or will be, overpriced and due for a correction.... I tend to believe in the latter case.  Much of this market appreciation has occurred due to historically low interest and bond rates, which control mortgage rates, and the sustainability of low rates is always in question.  There are hotspots like Toronto, Vancouver, and Calgary that may be due for a correction, and local markets will vary, but lets not fall into the trap that real estate values always go up... because as we've seen with our neighbours to the South, house appreciation is not a given.  If you are banking on the house appreciation game, then you are also playing the timing game, and timing can be a difficult game to play....

There are lots of reasons people might want to own a house: pride of ownership, control over where they live and for how long, the ability to modify a home to make it their own.  These are all good reasons to buy a home for your own living... But by my definition, it is not an asset.

from tinyhouseblog.com


Sunday, July 22, 2012

Rule #7 Maximize income in AFTER TAX money.

If, as a big severance package, your company offered you $60000 in any of the following income streams: pension income, capital gains income, employment income, or dividend income, what kind of income would you choose?  Did you think about the taxes?  Most people don't.

I hate paying income taxes. I wont go into it in any detail because it gets political... and I only talk politics if I have a beer in front of me, and I don't right now, so you are spared the rant.  But with that said, we all hate paying taxes, especially on income.  Doesn't it make sense then to try and minimize the amount of tax one pays on your income?  Sure it does. This is called tax avoidance and it is perfectly legal... structuring your income in such a way as to be tax efficient.  I was introduced to this way of thinking about a decade ago when I came across a blog talking about the virtues of dividends... Canadian Corporation Dividends in particular.  There is something called the Canadian Enhanced Dividend Credit, and I won't bore you with details of it, only to say that it results in a lowering of the marginal income tax rate on those dividends.  You can find out more about it here.  

For those who don't know what a dividend is, its a when a company shares a portion of its earnings with shareholders by sending them a cheque... usually quarterly throughout the year.  Those companies have already paid taxes on those earnings, so you don't have to pay as much taxes as you would if it was standard employment income.  Let's have a look at a couple scenarios, where income could be from one of these different streams...  Employment, Capital Gains, RRSP or RRIF withdrawal (remember its taxed when you take it out), Dividends from American Corporations, Dividends from Canadian Corporations (those eligible), and other income.  "Other Income" could come in the form of a pension, rental property, royalties, typical government benefits, some income from REITS, servers tips etcetera.... all of which are taxed at the same rate as employment income.  I don't include business income as I have no experience with owning my own business, nor do I know the intricacies that go with it. 

The two scenarios are $60000 and $100000 in annual income.  The income tax regime is Federal and Ontario, Canada.  The basis of the calculations is from the taxtips.ca calculator page where you can run your own scenarios.



So the Total in-pocket amount is the most important column because thats the one that tells you how much you get to keep.  Notice the big difference in taxes from the Investment rows such as Capital Gains and Canadian Dividends (eligible) in comparison to the Employment, RRSP/RIF Withdrawal, and Other Income rows.  Markedly different isn't it. If you made $60000 in Canadian Dividends you would get to keep 97.6% of it, vs the 80% you'd get to keep in employment income.  Note that as an employee you would also be required (don't get me started) to pay CPP and EI premiums which will run you another $3000 a year or so in tax obligations that you wouldn't have to pay if you made your income from dividends or capital gains.  Again with $100000 income, the investment income rows fair substantially better in tax treatment.  When I recognized this a decade ago, I started thinking that there was a type of income that I wanted more of, and other kinds of income that I wanted less of.  It was one of those "Eureka!" moments for me.

So... 

Guess what kind of income I prefer. Then guess what I look for when I'm building an investment portfolio.




Friday, July 20, 2012

Rule #6 Forget the Latte, Its the Car/Vacation/Renovation Factor

"Screw giving up your Latte!" - me.

People who have read David Bach's books will be familiar with the Latte Factor.  Its the idea that cutting out small expenditures such as your daily cafe-bought latte, and socking the money away to save and invest, can add up to a really large pot of money further on down the line.  You know, save $5 dollars a day and it adds up quickly.  I don't disagree with this strategy... It intuitively makes sense.  Making your own morning jet-fuel can cost pennies a cup as opposed to paying $3 for a large black coffee at Starbucks.  But if I get some good social interaction while drinking that Starbucks coffee, it might be money well spent, at least thats the way I see it.  After work drinks are another example.  Not having a social life, or eliminating the simple pleasures in life, is not the cure for troubled finances.... And if it is, you probably have an income problem, not a spending problem.

In general, while we agree with the concept of the Latte Factor, we do not subscribe to the practice.  Rather than focus on cutting out the daily small costs, we focus on the bigger things that we can cut out.
If the objective is to save money, people who scrutinize every little purchase, but then drop $5000 on a family vacation, would probably be better off cutting out the vacation if they want to get ahead.  To me this is "not seeing the forest for the trees".  For us, lots of small daily luxuries can be paid for by just cutting out one big one.  Some of the big-ticket items that we have cut out of our lives, while still maintaining our daily coffee or happy hour fix with friends, are a second car, a motorcycle, a second home or cottage, vacations, and cosmetic house renovations.

Imagine how much money you could save if you got rid of your second car, your motorcycle, or that cottage you only go to 3 weeks of the year.  "The kitchen we have now is functional, but dammit I want stainless steel everything... and I'm willing to pay $20000 to get it."  That just sounds silly. Cut back the second car and if you only put away half of what you would typically spend on it, you'll still be saving more than most people do.

Here's mud in your eye... and in your cup!