Weekend Reading: Tighter Mortgage Rules Edition

By Robb Engen | June 6, 2020 |
Posted in
Weekend Reading_ Tighter Mortgage Rules Edition
Canada Mortgage and Housing Corporation (CMHC) made headlines last week when its housing market outlook predicted that national housing prices would fall 9-18% over the coming months due to the coronavirus crisis. This week, Canada’s largest default insurer took significant steps to change its underwriting policies for insured mortgages. 

The following changes, which take effect July 1, will apply for new applications for homeowner transactional and portfolio mortgage insurance:

  • Limiting the Gross/Total Debt Servicing (GDS/TDS) ratios to our standard requirements of 35/42 (down from 39/44);
  • Establish minimum credit score of 680 (up from 600) for at least one borrower; and
  • Non-traditional sources of down payment that increase indebtedness will no longer be treated as equity for insurance purposes (no more borrowed down payments).

Rob McLister of RateSpy.com reports that CMHC’s new debt-ratio policy will cut homebuyers’ purchasing power by up to 11%.

“For example, someone earning $60,000 with no other debt and 5% down could afford approximately 10.9% less home under CMHC’s new rules.”

Despite crackdowns against zero-down mortgages and cash-back mortgage schemes, a Mortgage Professionals Canada survey reported that 20% of down payment funds from first-time buyers came from borrowed sources.

From CMHC:

“Starting July 1, 2020, borrowers must pay the down payment from their own resources. These eligible traditional sources of down payment may include savings, the sale of a property, non-repayable financial gift from a relative, funds borrowed against their liquid financial assets, funds borrowed against their real property, or a government grant.”

Not only is CMHC forecasting a major decline in house prices, it also sees the ratio of household debt to disposable income (already at record highs of 176%) climbing to more than 200% in 2021. In a statement, CMHC said these new measures are intended to curtail excess demand and household indebtedness.

The bleak housing outlook and tightened lending standards are all in response to the economic fallout from COVID-19 that saw Canadians lose more than 3 million jobs in March and April. Statistics Canada reported a bounce back in May, with Canada’s economy adding 290,000 jobs last month.

But University of Calgary associate professor Trevor Tombe says the effective unemployment rate, which includes the drop in hours and labour force participation, looks much worse than the official unemployment data suggests:

The economy will recover. There’s no doubt about that. The question remains, what type of recovery will we see? An economy that rebounds as quickly as it crashed is known as a V shaped recovery and that would be considered an optimistic best-case scenario.

Other possibilities include a U shaped recovery, which includes a longer period of economic pain followed by a gradual improvement, or a W shaped recovery with starts and stops over many months as we struggle to contain the virus.

Finally, there’s the dreaded L shaped recovery that indicates a long and slow path back to normal. This path may be reserved for the hardest hit industries such as tourism and entertainment.

This Week’s Recap:

I wrote about tackling changes to your retirement income plan, using a real life case study from a Wealthsimple client.

Over on Young & Thrifty I answered the question: should I move my investments during the stock market turmoil?

In my debut writing for Greedy Rates I explained how to start investing for beginners.

I also wrote about how to start investing in oil

Promo of the Week:

Big banks pay next to nothing on their so-called high interest savings accounts. Savers looking to keep pace with inflation often turn to promo chasing – moving their savings around to various online banks and credit unions who offer short-term teaser rates.

If you’re like me, though, you’d prefer to leave your savings in one bank that pays a high everyday interest rate. For me, that has been EQ Bank’s Savings Plus Account, which currently pays 2% interest. 

EQ Bank recently reached $3 billion in deposits, and sign-ups for new accounts have tripled in the three months since the pandemic hit.

They’ve also introduced a refer-a-friend program where new customers will receive a $20 bonus when they set up and fund an account with $100 within 30 days. That’s like earning a full year’s interest on a $1,000 balance, just for signing up.

Open an EQ Bank Savings Plus Account with my referral link, get a $20 bonus, and start earning a higher everyday interest rate on your savings.

Weekend Reading:

Our friends at Credit Card Genius look at credit card trip cancellation insurance and how the author saved $1,282 by making a claim.

Five year fixed rate mortgages are the most popular mortgage term in Canada and, as one Ontario real estate agent learned, there are stiff penalties for breaking these mortgages – this one to the tune of $30,000.

The Globe and Mail’s Rob Carrick reintroduces his Real Life Ratio as a simple tool to help the next wave of home buyers from overspending. 

If you follow the mortgage market then you’ve likely noticed HSBC often leading the way with some of the lowest rates in Canada. They’ve just introduced the lowest advertised five-year fixed rate ever at 1.99%.

Of Dollars and Data blogger Nick Maggiulli tackles the racial wealth gap in this deep look into economic inequality in America.

Why does this wealth gap exist between black and white households? Systemic racism is at the heart of the problem. This video explains what systemic racism is, how it affects all aspects of life in America (and, let’s face it, here in Canada too) and what we can do to solve it:

From panic buying to hoarding, Preet Banerjee shows us how COVID impairs our financial decisions.

My Own Advisor Mark Seed explains why the 4% rule is actually still a decent rule of thumb for drawing down your portfolio.

Why distinguished finance professor Ken French uses a financial advisor:

“It’s just somebody who can act as a sounding board — clarifying the trade-offs we encounter in lots of areas of our lives. It saves us time and an enormous amount of anxiety. There are lots of questions we wouldn’t even know to ask without the help from our adviser.”

The S&P 500 fell 34% in just 23 trading days, reaching its low on March 23. Since then, the market has rallied by 40%. What gives? A Wealth of Common Sense blogger Ben Carlson shares why massive up and down moves in the same year are more common than you think.

Ben’s Animal Spirits partner in crime Michael Batnick explains why automating your purchases is the simplest and most effective way to invest for your future.

Finally, Erica Alini of Global News looks at why dividend stocks have stumbled amid the coronavirus crisis. Indeed, the dividend aristocrats index (represented by iShares’ CDZ) is down more than 18% YTD compared to the broad market (TSX) which is down just 7.10% on the year.

Have a great weekend, everyone!

Tackling Changes To Your Retirement Income Plan

By Robb Engen | June 3, 2020 |
Posted in
Tackling Changes To Your Retirement Income Plan
Spending money is easy. Saving and investing is supposed to be the difficult part. But there’s a reason why Nobel laureate William Sharpe called “decumulation”, or spending down your retirement savings, the nastiest, hardest problem in finance.

Indeed, retirement planning would be easy if we knew the following information in advance:

  • Future market returns and volatility
  • Future rate of inflation
  • Future tax rates and changes
  • Future interest rates
  • Future healthcare needs
  • Future spending needs
  • Your expiration date

You get the idea.

We can use some reasonable assumptions about market returns, inflation, and interest rates using historical data. FP Standards Council issues guidelines for financial planners each year with its annual projection assumptions. For instance, the 2020 guidelines suggest using a 2% inflation rate, a 2.9% return for fixed income, and a 6.1% return for Canadian equities (before fees).

We also have rules of thumb such as the 4% safe withdrawal rule. But how useful is this rule when, for example, at age 71 Canadian retirees face mandatory minimum withdrawals from their RRIF starting at 5.28%?

What about fees? Retirees who invest in mutual funds with a bank or investment firm often find their investment fees are the single largest annual expense in retirement. Sure, you may not be writing a cheque to your advisor every year. But a $500,000 portfolio of mutual funds that charge fees of 2% will cost an investor $10,000 per year in fees. That’s a large vacation, a TFSA contribution, and maybe a top-up of your grandchild’s RESP. Every. Single. Year.

For those who manage their own portfolio of individual stocks or ETFs, how well equipped are you to flip the switch from saving to spending in retirement? And, how long do you expect to have the skill, desire, and mental capacity to continue managing your investments in retirement?

Finally, do you expect your spending rate will stay constant throughout retirement? Will it change based on market returns? Will you fly by the seat of your pants and hope everything pans out? What about one-time purchases, like a new car, home renovation, an exotic trip, or a monetary gift to your kids or grandkids?

Now are you convinced that Professor Sharpe was onto something with this whole retirement planning thing?

Changes To Your Retirement Income Plan

One solution to the retirement income puzzle is to work with a robo advisor. You’ll typically pay lower fees, invest in a risk appropriate and globally diversified portfolio, and have access to a portfolio manager (that’s right, a human advisor) who has a fiduciary duty to act in your best interests.

Last year I partnered with the robo advisor Wealthsimple on a retirement income case study to see exactly how they manage a client’s retirement income withdrawals and investment portfolio.

This article has proven to be one of the most popular posts of all-time as it showed readers how newly retired Allison and Ted moved their investments to Wealthsimple and began to drawdown their sizeable ($1.7M) portfolio.

Today, we’re checking in again with Allison and Ted as they pondered some material changes to their financial goals. I worked with Damir Alnsour, a portfolio manager at Wealthsimple, to provide the financial details to share with you.

Allison and Ted recently got in touch with Wealthsimple to discuss new objectives to incorporate into their retirement income plan.

Ted was looking to spend $50,000 on home renovations this fall, while Allison wanted to help their daughter Tory with her wedding expenses next year by gifting her $20,000. Additionally, Ted’s vehicle was on its last legs, so he will need $30,000 to purchase a new vehicle next spring.

Both Allison and Ted were worried how the latest market pullback due to COVID-19 had affected their retirement income plan and whether they should do something about their ongoing RRIF withdrawals or portfolio risk level.

Furthermore, they took some additional time to reflect on their legacy bequests. They were wondering what their plan would look like if they were to solely leave their principal residence to their children, rather than the originally planned $500,000.

What would their maximum attainable after-tax income be going forward under this new scenario? Lastly, they wondered about the risk of their assets being prematurely depleted if they were to follow this strategy.

Providing Alternative Strategies

Wealthsimple pairs human experience with artificial intelligence to produce an updated and tax-optimized withdrawal strategy that is tailored to their clients’ goals and ever-changing circumstances.

In this instance, Allison and Ted should withdraw the $50,000 required this year from their $150,000 non-registered portfolio, as well as the $50,000 needed next year from the same bucket.

“Luckily, the market downturn of December 2018 allowed us to systematically implement tax-loss harvesting strategies on Allison’s and Ted’s joint non-registered account, and the majority of the unrealized capital gains accumulated since can be offset using prior realized capital losses.”

Furthermore, the $100,000 which will be needed over the next 12-18 months can be temporarily parked in a Wealthsimple Cash account earning a competitive interest rate while eliminating any downside risk associated with funding of their new short-term goals.

This would allow Allison and Ted to fund their new expenditures without increasing their overall taxable income, therefore not risking any Old Age Security (OAS) clawbacks or sacrificing tax-preferred growth in their RRIF or TFSA accounts.

Despite being invested in a balanced portfolio at Wealthsimple, Allison and Ted felt uneasy during the most recent market pullback in March 2020. It was the velocity of the market downturn which took them by surprise.

Conversely, they were pleasantly surprised when comparing their performance with that of their previously owned bank brokerage portfolio.

“More importantly, however, their new estate goal allows them to explore some interesting options which may enable us to better align their true risk tolerance to their new aspirations.”

If they were to leave $280,000 in liquid assets to their children instead of the originally planned for $500,000, they would do just fine with a more conservative 35% equity and 65% fixed income portfolio. Alternatively, they could increase their annual after-tax spending from $80,000 to $90,000 per year with the same conservative allocation and deplete their investable assets by age 95.

Probabilities of Success

The first alternative would offer a higher probability of success, since the portfolio’s returns would be less volatile over Allison’s and Ted’s retirement horizon, due to the more conservative asset allocation.

This would reduce the dispersion of potential outcomes and lower the risk of experiencing a significant drawdown of investable assets, especially during their early retirement years.

A steep market correction in a retiree’s early days can have an amplified impact when examined over a 30-year retirement horizon (a concept known as sequencing risk).

Under the first scenario, the probability of success would be approximately 90% with a 10% risk of ruin (i.e. depletion of investable assets before the age of 95).

In the full asset depletion scenario, with a $90,000 after-tax retirement income, the probability of success would be closer to 70%. The latter may not be acceptable to Allison or Ted as they feel strongly about not having to rely on their principal residence to fund any shortfalls (aka the nuclear option).

Furthermore, they believe that the associated longevity risk is too high (i.e. living past age 95) – based on their family’s history of a long and healthy lifestyle.

Final Thoughts

Retirement planning can be hard enough in the initial stages. It also takes great care to tackle changes to your retirement income plan as you move through retirement.

In my conversation with Wealthsimple’s Damir Alnsour, we agreed that highlighting case studies and analyzing other scenarios can provide invaluable information – not only to clients like Allison and Ted, but also to any Canadian currently faced with the “nastiest, hardest problem in finance.”

He said risk-based insights help empower their clients to make more informed, educated, and statistically backed decisions, resulting in a set of clear trade-offs.

I agree, and when my own fee-only planning clients end up moving their investments to Wealthsimple I know they will be presented with options that are sensible and objective for their unique circumstances, enabling them to achieve what truly matters to them and their loved ones.

Curious about moving over to a robo advisor? You can book an appointment to speak with a Wealthsimple portfolio manager today about your personal retirement scenario.

Weekend Reading: Housing Market Crash Edition

By Robb Engen | May 30, 2020 |
Posted in
Weekend Reading: Housing Market Crash Edition
Will we see a housing market crash in 2020 and beyond? The Canadian Mortgage and Housing Corporation (CMHC) published its housing market outlook this week and, well, their forecast for home sales and prices look pretty bleak.

Housing starts are expected to see a decline of between 51% to 75%, and not begin to recover until the second half of 2021. Existing home sales are likely to decline somewhere in the range of between 19% to 29% before a recovery in late 2020. And, finally, the forecast for existing home prices is a decline of between 9% and 18% before a recovery in the first half of 2021.

As real estate tends to be regional / local, the greatest expected decline will be felt in Alberta and Saskatchewan thanks to the negative impact of low oil prices. Ontario is expected to see larger declines in sales and prices this year than in BC and Quebec. The Atlantic provinces will see a more modest correction.

The average price for a home in Canada was $488,203 in April 2020 – down about 1.3% from a year ago. But national home sales fell by 56.8% from March to April this year, and the number of newly listed properties decreased by 55.7%.

The bottom line, according to the CMHC housing market outlook, is that the real estate market will feel the effect of COVID-19 until at least 2022.

You can download the CMHC housing market outlook report here.

Since the report’s release, CMHC’s president and CEO Evan Siddall has faced severe backlash from, you guessed it, real estate agents who claim the outlook was “panic-inducing and irresponsible.”

RE/MAX believes real estate prices across Canada will remain stable or experience a modest decline. In other news, your barber thinks you need a haircut, your investment advisor thinks you need to save more, and your insurance broker thinks you’re under-insured.

Evan Siddall defended CMHC’s position in a Tweet.

“They’re whistling past the graveyard and offering no analysis. Here’s ours. You decide.”

Siddall also encouraged readers to question the motives of anyone suggesting that house prices “always go up.”

Obviously forecasts are just that, a best guess as to what may happen in the future. Real estate advocates argue that even though housing starts and sales have plummeted, many sellers will simply wait out the pandemic until the housing market picks up again. They won’t accept an 18% decline in their asking price.

But housing prices have declined by as much (and more) before COVID-19, and this time some homeowners may not have the luxury of waiting.

More than one million homeowners applied to defer their mortgage payments. Eight million Canadians have applied for the Canada Emergency Response Benefit (CERB). Airbnb asked the federal government to bail out its hosts in Canada, a request that was dismissed with a one word response: “No.”

Something has to give, and many of these homeowners will be forced to accept whatever offers come their way.

This Week’s Recap:

No new posts from me this week, but I’m working on another retirement income case study that I hope you’ll enjoy. 

Over on Young & Thrifty I wrote about the difference between Canadian and U.S. listed ETFs.

Mutual funds with deferred sales charges (DSC) are being gradually phased out but many investors are still locked in to this insidious fee schedule. In this post from the archives, I argue that it’s probably best to rip off the band-aid and get rid of your DSC mutual funds.

What I’m Listening To, Reading, and Watching:

I won’t lie, I’ve watched a lot of television since the pandemic hit. We have a treadmill in our basement and when the weather is bad I watch TV while I run. I’m so glad we have Netflix and Crave to pass the time.

I’m catching up on some shows that I never got around to watching while they aired. I’m near the end of season three of The Wire, which has been excellent. My wife and I started also watching Westworld and finished season two. It’s a bit of a mind bender.

For podcasts, I’m thankful that my usual lineup of Animal Spirits, Rational Reminder, and Freakonomics have continued to put out new episodes weekly. Episode 100 of the Rational Reminder featured professor Ken French and is a must listen for investors.

The new season of Against The Rules with Michael Lewis is out. While the first season was about referees and fairness, this season is all about the rise of coaching. It’s probably my favourite podcast at the moment. You should check it out.

My book reading has been in a decline lately. I guess I’m secretly hoping that George R.R. Martin will finally finish Winds of Winter (wishful thinking, I know). If you have a good book recommendation please leave a comment.

Weekend Reading:

Credit Card Genius looks at travel rewards and expiration dates – how to avoid losing your points.

Are you booking or changing a flight? Erica Alini explains all the rules for major Canadian airlines.

Budget travel expert Barry Choi explains why credit card travel insurance may be overrated:

“I personally never rely on my credit card travel insurance for anything travel medical related.”

The Globe and Mail’s Rob Carrick finishes off an excellent series called Pandemic Personal Finance with a 10-point checklist of things you should have done by now to protect or improve your money situation.

One thing every investor should have is an investment policy statement to keep your portfolio in check in good times and bad. Maria at Handful of Thoughts shares her personal investment policy statement and what you need to know about creating your own.

Similarly, Gen Y Money shares how she’s investing during a pandemic

Million Dollar Journey offers a guide to Canadian investing taxes: dividends, interest and capital gains.

Finally, here’s Squawkfox Kerry Taylor with a sobering take on masks, money, and how COVID-19 is changing social norms.

Have a great weekend, everyone!