Greed has a powerful effect on asset bubbles as speculators and insiders try to exploit every available loophole to profit from rising prices.
First we had mortgage brokers behaving badly. Then we had shadow-flipping real estate agents. Now The Globe and Mail has exposed a new scheme where a Vancouver real estate speculator is buying homes financed with investor money from China and mortgaged issued by Canadian banks. Home ownership is obscured, houses are flipped, and profits are concealed from Canada Revenue Agency.
Records link the speculator and his clients to at least 36 properties in the past five years.
“Yet Mr. Gu, 45, paid next to nothing in taxes last year, while millions of dollars flowed through his business and personal accounts.”
From the report it sounds like the CRA doesn’t have the experience or resources to detect and prevent these schemes from happening. How long until it all unravels and this real estate bubble pops? In the meantime, an entire generation may have been priced out of the Vancouver housing market.
This Week’s Recap:
On Monday I explained why my thinking changed around dividend investing.
On Wednesday Marie explained the 50-20-30 approach to budgeting.
And on Friday I offered a twist to the RRSP vs. mortgage debate.
Over on Rewards Cards Canada I revealed how I earned 80,000 Aeroplan miles almost pain-free.
And on Lowest Rates I explained what you need to know about insuring someone else on your car policy.
Weekend Reading:
New homeowners face many problems, but hot markets are tricky for those looking to move up. Should you buy first or sell first?
Jessica Moorhouse revealed a big secret – she’s now a homeowner. Congrats!
Bridget Eastgaard weighed-in on the mortgage pay down vs. investing debate and says you’ll come out ahead investing in a TFSA.
Preet Banerjee gives us the low-down on disability insurance:
Stop screwing your retirement, says Money We Have blogger Barry Choi.
One common argument used by active investing proponents is that if every investor switched to a passive approach then markets would no longer be efficient. Larry Swedroe shreds that argument here.
A look at one of the most successful investors of all time – Bill Miller – and his infamous fall from grace.
Nelson Smith says that mutual fund dealers such as Investors Group are missing out on a massive opportunity to develop their own ETFs and robo-advice services.
Successful investing really isn’t that complicated – an interview with Harold Pollack, co-author of The Index Card.
Meet the parents who won’t let their children study literature.
Why our life in three stages – school, work, retirement – will not survive much longer.
Overeducated and underpaid? The Globe and Mail looks at how to address mal-employment.
Should Julie cash in shares or drawdown on her RRSP? Jason Heath on the best way to fund your retirement.
Michael James shares his misadventures in trying to get his free credit report from Equifax and TransUnion.
Thanks to Ellen Roseman for including my open letter to Air Miles in her recent column about the loyalty company’s shoddy customer service.
Finally, Rewards Canada shared a letter from a disgruntled Air Miles customer explaining why he’s done with rewards programs.
Have a great weekend, everyone!
It’s an age-old financial dilemma. Should you use your extra savings to pay down the mortgage or contribute to your RRSP? A simple answer is to compare the expected return from your investments to the interest rate on your mortgage.
In today’s low rate environment, where mortgage rates sit well below 3 percent, many assume their investments will easily come out ahead. If rates tick higher, the mortgage pay down starts to make more sense.
RRSP vs. Mortgage
But there’s another factor to consider in the RRSP vs. mortgage debate, and it has to do with emergency savings.
What happens if the main breadwinner in the family loses his or her job? Who is more secure: the family that has $100,000 saved inside their RRSP, or the family that has a smaller mortgage but no savings?
Sinking all your free cash flow into the mortgage in hopes to pay it off early can leave you in a tight spot should you become unemployed for a long period of time.
And while you can reduce your payments back to the minimum, and even take a mortgage vacation for a few months, your bank still wants its money back.
A healthy RRSP balance, on the other hand, can help you weather the storm in the event of a long-term income drought. Sure, you’ll pay tax on any withdrawals from your RRSP, but that beats going into debt or losing your home.
An example
Let’s say a family bought a home worth $400,000 and used all their savings – $80,000 – for a down payment. They’ve diligently paid down the mortgage, doubling their monthly payments and adding a $5,000 lump sum each year.
After five years they’ve paid off $165,000 of the principal and owe just $155,000 on the house. They’ll be completely mortgage free in another four years.
This family prioritizes their mortgage at the expense of saving for retirement, thinking that once the mortgage is paid off they’ll start putting money into RRSPs.
He works full-time as a sales manager and she stays home with their two kids, ages 5 and 2.
When he loses his job, the family has no emergency income buffer to see them through the difficult times. After a month, he goes to the bank to apply for a line of credit, but the bank needs his recent employment history and pay stubs from the last two months in order to set it up. Sadly, the bank turns down his loan application.
Even though this family has nearly $250,000 in home equity, there’s nothing they can do to unlock the funds, short of selling the house.
Let’s go back to when the family first bought their home. This time, instead of putting every last dime into their mortgage, they add just $250 per month to their $1,500 minimum mortgage payment. This approach frees-up $20,000 per year to invest in their RRSP.
After five years they have over $112,000 saved in their RRSPs and they’re still on track to pay off their mortgage in a reasonable 20-year time frame.
When he gets laid off from his job, he’s able to draw from his substantial RRSP portfolio instead of turning to debt or being forced to sell the house.
The family has expenses of just under $5,000 per month, and the job hunt lasts five months. They need to withdraw $24,500 to pay the bills and put food on the table.
When you withdraw more than $15,000 from your RRSP the bank holds back 30 percent to pay the government on your behalf (withholding tax). That means the family has to withdraw $35,000 from their RRSP to end up with the $24,500 needed to cover their expenses.
Final thoughts
Even though it might feel like paying off your mortgage as quickly as possible is the most prudent thing to do, it can actually be a riskier move than investing in your RRSP.
In the second scenario, the family ends up back on their feet in a few months and still has nearly $80,000 saved in RRSPs. They continue to make their mortgage payments and won’t be forced to sell their house to get at the equity.
If you still can’t decide whether to prioritize your RRSP or mortgage, you can always go with the tried-and-true Canadian approach of making an RRSP contribution and then using the refund to pay down your mortgage.
Someone who is just starting out in life, or a beginning budgeter, may wonder how they should be allocating their money. Here is a general rule of thumb to consider when budgeting.
Where should my money be going?
Begin by recording your net income and your expenses, and track your spending. Then divide your expenses and spending into three categories. Spend a bit of time determining which of your expenses fall into each category.
1. Fixed expenses
No more than 50% goes toward essential expenses. These are your fixed costs that don’t vary much from month-to-month. They include housing, transportation, utilities, groceries, loan payments and minimum payments on your credit cards.
You also include subscriptions and contracts here (such as cable/internet/phone plans and gym memberships) if you’re committed to paying them on a monthly basis for a certain period of time.
2. Financial priorities
At least 20% goes toward financial priorities which help you secure a strong financial foundation. This is the category that builds your wealth and increases your net worth. It includes retirement savings contributions, paying down credit card debt, and building an emergency fund. Your financial goals can also include larger savings priorities like a down payment on a new home.
These payments should be made after essential spending, but before any other.
3. Flexible spending
No more than 30% goes toward your lifestyle choices. These are your personal and fun choices that can vary from month-to-month. They can include charitable giving, entertainment, hobbies, personal care, restaurants and bars, shopping, weekend trips, short term savings, and other miscellaneous expenses.
They enhance your lifestyle. But, if you are spending more than 30% on “wants” you need to start prioritizing.
Pros and Cons to this budgeting approach
This budget plan is a good starting point. It makes sure you are covering your expenses, saving for the future, and still allowing some enjoyment into your life today.
Budgeting is not just about knowing what your expenses are and whether they fit into your paycheque. This budget directs you to look at your spending and see where it fits, especially if you’ve never looked at the big picture. It can show what you are paying for necessities, which can suggest where you need to make some changes.
It helps you to start building your wealth. Putting an extra $100 on your credit card payment, or saving $500 doesn’t seem like it will help you much today, especially if you are starting out with a negative net worth. Often, people just don’t see the advantage in the near term. The benefit always seems to be 10 or 20, or more years away. That could be a big reason why many people don’t save more money.
Another problem is that we don’t know the difference between necessities and lifestyle choices. For example, you need a place to live, but many of us could significantly reduce our monthly expenses by moving to a smaller place; or the suburbs instead of downtown or by the beach. The same is true for the vehicles we drive and the clothes we wear. We look at these as necessities, but actually spend more than we need to and have turned these essentials into expensive lifestyle choices.
Relying on the experiences of others can help, but only so much, because your income and expenses are unique to you.
Keeping fixed costs under 50% and saving 20% may be unreachable for some people depending on circumstances. Your situation may not fit the mold.
Final thoughts
The 50/20/30 budget provides a framework. It can be a helpful benchmark when you’re assessing where your money is going.
It’s an especially good budgeting system for young adults who are just starting out in life. When you know how to achieve a balanced budget, you can take the next steps to further customize this rule around your own unique expenses and specific goals and help you make the most of your money.