Debt & Frugality

As Didi says in the novel (Findependence Day), “There’s no point climbing the Tower of Wealth when you’re still mired in the basement of debt.” If you owe credit-card debt still charging an usurous 20% per annum, forget about building wealth: focus on eliminating that debt. And once done, focus on paying off your mortgage. As Theo says in the novel, “The foundation of financial independence is a paid-for house.”

Borrowing to invest? Beware of rising interest rates.

Del Chatterson

By Del Chatterson

Special to the Financial Independence Hub

Your financial advisor is probably not recommending it and you may be naturally averse to more borrowing, but it is hard to ignore the basic principles of financial leverage from Finance 101. (The principles have not changed, since I first taught the course in 1972!)

As explained in a chapter on Capital Budgeting, companies and investors should continue to invest in projects until the marginal cost of capital equals the marginal rate of return: assuming you select projects in order from the highest return to the lowest return and that the cost of borrowing increases with the total amount of loans outstanding.

So in the example chart shown to the right, you would borrow and invest up to $1.0 million, which is the point where the expected rate of return declines to meet increasing cost of borrowing at about 5%.

You may have confirmed the theory from your own experience. Your current portfolio has a few investments that are achieving better than 10% or 12% returns, most congregate around the long-term average of 7% to 8% and a few continuing disappointments are returning below 5%, or worse.  Your lowest cost of borrowing is probably the mortgage you signed in 2015 at 2.5% or a car loan at 1.9%, but your subsequent borrowing for a personal line of credit is at 3.25%.

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Half of us fear rising interest rates will be negative for our finances

Now that interest rates have finally appeared to bottom, consumers are starting to worry about the prospect of rising rates and their impact on their personal finances.

This is explored in my latest article, which is in Monday’s Financial Post (e-paper and online). You can access it by clicking on this self-explanatory highlighted headline: Only a quarter of Canadians have a  rainy day fund, but more than half worry about rising rates.

It describes a new Forum Research Inc. poll that shows more than half of Canadians (51%) fear rising rates will negatively impact their personal finances. The national poll of 1,350 voting-age adults was conducted after the Bank of Canada raised the prime interest rate from 0.75 to 1% on September 6th, which in turn followed an initial 0.25% hike in July.

After an amazing run of nine years of ultra-low interest rates, it’s clear consumers are starting to fret the party is over. Anyone with variable-rate mortgages might well be petrified that interest rates could again reach the high teens, as they did in the early 1980s. Little wonder that many homeowners are starting to “lock in” to fixed mortgages while rates are still relatively low.

Of course, as Credit Canada’s Laurie Campbell notes, for the longest time it’s paid to stay variable and flexible, whether with a variable-rate mortgage or a line of credit. It does cost a bit more to “lock in” to fixed mortgages, as Campbell notes, but the ability to sleep well at night in my opinion more than makes up for the difference.

While the poll asked specifically how consumers felt about the second hike, “they are worried more are coming,” Forum Research president Lorne Bozinoff told me. 12% say the negative effect will be extreme. However, 17% believe rate hikes will have some positive aspects:  you’d expect debt-free seniors to welcome higher returns on GICs and fixed-income investments. Another 38% don’t think it will have an effect either way.

Lorne Bozinoff

A quarter have no emergency savings at all

Bozinoff is more concerned that 26% of respondents have no emergency savings, and 40% have a cushion of a month or less: 9% have less than a month and 11% just a one-month cushion.

Financial planners generally recommend three to six months as a hedge against job loss or other setbacks. A minority do: 14% have two to three months, 9% four to five months, and 13% six months to a year. Only 15% have a year or more and predictably, 56% of the latter group are 55 or older. Continue Reading…

5 common senior financial traps and how to avoid them

Scott Terrio’s Twitter feed (@CooperTrustee) reads like a financial horror story. Terrio, an insolvency expert at Cooper & Co. in Toronto, uses the 140-character medium to share the multitude of ways seemingly well-off Canadians end up buried in debt and turning to debt consolidation, consumer proposals, and even bankruptcy.

Canada’s record household debt levels have been a cause for concern for years, but Terrio sees a new problem on the horizon. Canadian seniors are the demographic increasing debt at the fastest rate.

Take Dorothy, an 81-year-old widow who owns a home with a 1st mortgage from a secondary lender. She refinanced a couple of years ago to do house repairs ($18,000), assist her son with divorce legal fees ($37,000), and to help her grandson with tuition ($8,500).

When her partner died she was no longer able to make the mortgage payments. A friend from church referred her to a mortgage broker.

The broker suggested a reverse mortgage,  which would let her stay in her house without the monthly mortgage payment. But the money from the reverse mortgage wasn’t enough to pay out the 1st mortgage after fees and penalties. She needed a private 2nd mortgage at 12 per cent to pay the balance.

Dorothy co-signed a $26,000 car loan for her nephew and co-signed with her son for funeral expenses ($12,000) for her partner. Her son stopped paying, so Dorothy was pursued (100 per cent).

She then ran into tax trouble by not having tax on her OAS & CPP deducted for the first few years. She owes $21,000 in tax, much of it penalties and interest.

This scenario is becoming more common among seniors today.

“Many are in a unique quandary. They’re asset-rich, but cash-poor. Cash flow is tight. Pensions are fixed, and many have underestimated retirement costs,” said Terrio.

So what do they do? Many seniors cash out assets to make ends meet. Others raid their home equity and take out lines of credit. All have financial consequences.

We asked Terrio to share the top financial traps seniors fall into and how to avoid them:

1.) Tax problems

Most seniors were used to being paid by their employers in after-tax dollars. At pension time, many don’t have taxes deducted to offset their Old Age Security and Canada Pension Plan income and therefore end up spending taxable pension income.

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Toronto Rentals vs. Hong Kong: A matter of perspective

There’s been plenty of discussion recently surrounding Toronto’s hot housing market. First-time buyers are being priced out and young prospective home buyers are being pushed further and further away from the city’s desirable centre. With all this talk, it’s easy to get caught up and lose perspective, but lucky for you, I’m here to remind you to count those blessings (however meagre they may be).

Sure, the housing situation in cities like Vancouver and Toronto may be less than ideal, and yes, something should be done to improve the way things are going. However, there are far more dire housing situations in other top-tier cities, which, when compared to Toronto, really make everything here seem — dare I say –breezy?

Related Read: INFOGRAPHIC – July GTA Sales Plunge 40%

Taking A Global Rental Perspective

Take, for instance, Hong Kong. As those who’ve read my posts on Findependence Hub may know, I lived in Hong Kong teaching English. It is one of the most bustling, vibrant cities I’ve ever experienced, but I can only defend it so much once the subject of housing prices comes up. Year after year, Hong Kong tops all the lists of ‘most expensive housing,’ and having rented there for a year, I have to concede defeat on that point. For what you get in Hong Kong, there is much to be desired.

 

Chevreau’s Hong Kong apartment was tight on square footage.

Chevreau’s Hong Kong apartment was tight on square footage

If you’re like most millennials and looking to break into the housing market for the first time –- perhaps in a Toronto condo –- you’ve most likely experienced the disillusionment that inevitably comes when you realize the prices you’re looking at paying, even after this summer’s price correction. In the city of Toronto, the average price per square foot, or PPSF, is around $649 with an average home cost of around $550,000. This number spikes to $800 PSF if you’re looking to put down roots in ‘downtown Toronto’ (anywhere south of Bloor, west of Yonge, east of Bathurst).

Related Read: 5 Ways to Get Ahead in the Toronto Rental Market

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What rising interest rates mean for the stock market, and how to cope

By Matthew Wilson

Special to the Financial Independence Hub

We’ve all seen the headlines: “Interest rates are on the rise.” The United States has raised rates three times since December and the Bank of Canada is now on the move after seven years of silence. Here’s what you need to know and how to prepare:

How high will rates go?

Before we start worrying about how this impacts our investments, let’s first look at how high we can expect them to go.

To do this we simply need to open the history books and look at (on average) how many times the Bank of Canada has raised interest rates when entering an increasing rate cycle. They never simply raise rates once and be done with it; they typically raise in a continuous cycle over the course of several years. Here’s what I mean:

  • 1999–2000: 4 rate hikes
  • 2002–2003: 5 rate hikes
  • 2004–2007: 10 rate hikes
  • 2010: 3 rate hikes

So, on average, whenever the Bank of Canada starts a cycle of raising interest rates we can expect to see approximately 5–6 increases.

It’s safe to say we won’t get back to the days of 16% interest rates as seen in the early 90’s, but we can expect to get back to the 3%–6% range that we saw throughout the early 2000’s.

Between 1990 and 2017 Canadian interest rates have averaged 5.92%, so as we currently sit at 0.75% we have quite a way to go. Here’s what I mean. Please refer to the graph that’s at the top of this blog.  As you can see we are just starting to come off the bottom: early days!

When do higher rates start to impact investments?

Just because interest rates are moving higher doesn’t necessarily mean bad news for the stock market, at least not yet.

Take the US for example. In their last four rate increase cycles they raised interest rates 10 times (on average) during each cycle. The US stock market (S&P 500) moved up an average of 23% during each of these cycles.

So, it’s not all doom and gloom, but there is a point at which we need to start getting concerned.

This tipping point typically comes once we get into the 4%–5% range. Why?Because as we near the end of a rising interest rate cycle it can start to slow down the economy in a number of different ways:

Firstly, it means higher borrowing costs for corporations and consumers, (i.e. higher mortgage rates, auto loan rates, lines of credit, etc). For corporations, this means less profit because they are spending more money on interest.

Secondly, it means more competition between bonds and equities. Right now you can get stock dividends paying a nice 4%–5%, but as bonds get up into this same range we start to see an outflow of cash from the equity markets and into the bond markets – seeing as bonds are incredibly less volatile, and if they are paying the same yield, people will naturally go with the less risky investment.

Essentially, bonds start competing with the equity markets, and with so many baby boomers retiring on fixed incomes they can’t afford the volatile swings of the stock market so they switch to bonds.

How long until we need to start worrying?

As mentioned above, markets don’t typically start to feel the impact of rising interest rates until we reach the 4%–5% range.

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