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.”

Leveraging life insurance: a smart financial planning strategy

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By Michael Pilz

Special to the Financial Independence Hub

Life insurance policies can represent a significant, untapped source of capital. While life insurance is often strictly thought of as a death benefit, many permanent policies also have a cash component. This cash component can be leveraged to secure a line of credit that can be used for a variety of purposes, such as a means of supplementing retirement income or to access upfront capital quickly, perhaps to take advantage of an investment opportunity.

An insurance policy that has cash value should be on the table as an option for those who either need or want to access cash by using some of the assets built up over their lifetime. Thinking of insurance differently – and communicating how it can be used to create a living benefit – can open up a world of possibilities.

Rethinking Whole Life Insurance

Insurance policies are great investment vehicles for those who have an immediate need for death benefit coverage, and would also like to park and protect capital in a tax-sheltered vehicle during their working years. But what happens when those who are older, a sizeable chunk of cash has accumulated over the years, and there’s a better use for this cash now instead of passing it on to beneficiaries down the road? And what if they want to leverage the cash value of their policy while also leaving their policy intact?

The Equitable Bank Cash Surrender Value (CSV) Line of Credit enables borrowers to convert the value of their insurance policy into cash. It is a non-amortizing loan product secured against the cash surrender value of a whole life insurance policy. Unlike a traditional loan or line of credit, the interest from the CSV Line of Credit capitalizes and is typically repaid through insurance proceeds at the time of policy redemption. However, a borrower can also opt to make ongoing payments or to repay the entire loan at any time without incurring a penalty.

Does a CSV Line of Credit make sense?

Leveraging a life insurance policy’s cash value can help fulfill a variety of different needs or wants.

Many can benefit from tapping into the cash value that has built up within their policy during their working years to supplement retirement income later in life. High-income earners who run out of RRSP and TFSA contribution room and have excess cash may find their insurance policy especially valuable for this purpose. Think of it as killing two birds with one stone: during prime working years, a whole life insurance policy meets an immediate death benefit need while serving as a mechanism for building up a nest egg that can be leveraged in the future when there’s a need for cash. Continue Reading…

Canadian ETFs versus US ETFs

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By Michael J. Wiener, Michael James on Money

Special to the Financial Independence Hub

When it comes to investing, we should keep things as simple as possible. But we should also keep costs as low as possible. These two goals are at odds when it comes to choosing between Canadian and U.S. exchange-traded funds (ETFs). However, there is a good compromise solution.

First of all, when we say an ETF is Canadian, we’re not referring to the investments it holds. For example, a Canadian ETF might hold U.S. or foreign stocks. Canadian ETFs trade in Canadian dollars and are sold in Canada. Similarly, U.S. ETFs trade in U.S. dollars and are sold in the U.S. Canadians can buy U.S. ETFs through Canadian discount brokers but must trade them in U.S. dollars.

Vanguard Canada offers “asset allocation ETFs” that simplify investing greatly. One such ETF has the ticker VEQT. This ETF holds a mix of Canadian, U.S., and foreign stocks in fixed percentages, and Vanguard handles the rebalancing within VEQT to maintain these fixed percentages. An investor who likes this mix of global stocks could buy VEQT for his or her entire portfolio without having to worry about currency exchanges. It’s hard to imagine a simpler approach to investing.

Investors who prefer to own bonds as well as stocks can choose other asset-allocation ETFs offered by Vanguard Canada, BlackRock Canada, or BMO. But the idea remains the same: we own just the one ETF across our entire portfolios. For the rest of this article we’ll focus on VEQT, but the ideas can be used for any other asset-allocation ETF.

Why would anyone want to own a set of U.S. ETFs instead of just holding VEQT? Cost. It’s more work to own U.S. ETFs and trade them in U.S. dollars, but their costs are much lower. To see how much lower, we need to find a mix of U.S. ETFs that closely approximates the investments within VEQT. Readers not interested in the gory details of finding this mix of U.S. ETFs can skip the end of the upcoming subsection. Continue Reading…

How Real Return Bonds compare with regular Bonds, protecting against unexpected rises in Inflation

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Real Return Bonds (RRBs) pay you a rate of return that’s adjusted for inflation, but that’s not always as promising as it seems.

When a real-return bond is issued, the level of the consumer price index (CPI) on that date is applied to the bond. After that, both the principal and interest payments are typically adjusted every six months, upwards or downwards from that base level, to compensate for a rise or fall in the CPI.

In general, Government of Canada real-return bonds pay interest semi-annually, on June 1 and December 1.

How a real-return bond works: A theoretical example

The Bank of Canada issues $400 million of 30-year bonds maturing on December 1, 2049. The bonds have a coupon, or interest rate, of 2%.

If after six months from the date of issue, the new CPI level is, say, 1% above the level of the CPI on the issue date, then each $1,000 of bond principal is adjusted to $1,010 of bond principal ($1,000 x 1.01). The semi-annual interest payment is then $10.10 ($1,010 x 2% / 2).

If after 12 months, the level is 2% higher, then the bond principal is adjusted to $1,020 ($1,000 x 1.02), and the interest payment rises to $10.20 ($1,020 x 2% / 2).

Three important considerations to recognize with real-return bonds

1.) The price you pay for real-return bonds reflects the anticipated rate of inflation. In other words, if investors feel that inflation will rise 2% over the long term, the price of the bond will reflect that future inflation increase and its effect on the bond’s principal and interest payments. So, when you buy a real-return bond, you are only protecting yourself against unanticipated rises in inflation.

2.) When the inflation rate falls over a six-month period, the principal and interest payments of a real-return bond fall. In times of deflation, the inflation rate turns negative. In a prolonged period of deflation, the principal of a real-return bond could fall below the purchase price. Interest payments would fall, as well.

3.) As with regular bonds, holders of real-return bonds must pay tax on interest payments at the same rate as ordinary income. That income gets taxed at the investor’s marginal rate. In addition, holders of real-return bonds must also report the amount by which the inflation-adjusted principal rises each year, as interest income, even though you won’t receive that amount until the bond matures. That amount is added to the bond’s adjusted cost base.

If the CPI level falls, that reduces the inflation-adjusted principal. You deduct the amount of that reduction from your taxable interest income that year, and also subtract it from the adjusted cost base.

Real-return bonds in comparison to regular bonds

In simple terms, a bond is a form of lending whereby you lend money to a corporation or government. In return, a bond pays a fixed rate of interest during its life. Eventually, a bond matures, and holders get the bond’s face value—but nothing more. Receiving the fixed interest and face value at maturity is the best that can happen. Note, though, that in some cases, corporate bonds can go into default. As well, inflation can devastate the purchasing power of bonds and other fixed-return investments. Continue Reading…

Mental Accounting and how we spend money

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We all have quirky behaviours when it comes to managing money. One trick we fall victim to is called mental accounting. We separate our money into different types of mental accounts, with different rules, depending upon how we get it, how we spend it, and how it makes us feel.

An easy example is when you have a fund set aside for something like a vacation or house down payment while at the same time carrying high-interest credit-card debt. Or how you decide to spend a $1,200 tax refund versus what you’d do with $100 per month if you had the right amount of tax coming off your paycheque in the first place.

I’m guilty of mental accounting every month when I budget $1,000 for groceries, $200 for dining out, $125 for clothing, and $75 for alcohol. I manipulate those mental accounts all the time, like when I overspend in one category and just take it out of another (shifting a meal from ‘dining’ to ‘entertainment’ for example).

The Mental Accounting challenge

Why do we assign money to these mental categories? One answer is to control how we think about it. If we were perfectly rational and could figure out the opportunity costs and complex trade-offs of every single financial transaction then it wouldn’t matter how we label our money: it would just come from a big pool called ‘our money.’ It’s just money, after all; totally fungible and interchangeable.

But because we’re human with cognitive limitations and emotions we need help with our money decisions. That’s where mental accounting comes in and acts as a useful shortcut for what decisions to make.

Another interesting way we classify our financial decisions has to do with the length of time between when we bought an item and when we consumed it.

Nobel Prize winner Richard Thaler studied wine purchases and consumption and found that advance purchases of wine are often thought of as investments. Months or years later, when the bottle is opened and consumed, the consumption feels free, as if no money was spent on wine that evening. Continue Reading…

The best bank accounts for Students

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Photo by Dan Dimmock on Unsplash

By Zack Fenech, RateHub.ca

Special to the Financial Independence Hub

As a new or returning post-secondary student, finances probably lean on the less exciting side of this new or continuing life chapter.

Be that as it may, properly managing your finances is still something you’ll have to do at one point or another.

Finding the right student bank account can help you save some money. In some cases, you can earn unique student tailored benefits: if you choose the right chequing account or savings account, that is.

After all, would you rather spend money on school supplies and experiences or pay monthly account fees or transaction commissions?

That said, the best student bank accounts offer a wide variety of options and advantages tailored to student living, and provide students with more financial freedom.

The other side of the coin for student bank account options might be using a free bank account. Free bank accounts allow you to use the account beyond graduation, in exchange for student tailored perks.

This article will detail the difference between the two types of accounts and which account is best for each category. It’ll also help you get a clearer understanding of which type of account is best for you.

Student Bank Accounts vs. free Bank Accounts

Student bank accounts are regular bank accounts that offer unique advantages to students. Some of these advantages include no monthly or annual banking fees, unlimited transactions and e-transfers, and sign-up promotions or point programs.

Another option fitting for students is free bank accounts offered by digital banks. Though not student accounts by definition, free bank accounts are entirely free and limitless, making them ideal for anyone, whether you’re a student or not.

The only difference from paid accounts is that they do not include many of the student-tailored advantages previously mentioned. Continue Reading…