Usually one needs to read the tea leaves to interpret the Bank of Canada’s forward guidance for interest rates and the economy. Not anymore. New Bank of Canada Governor Tiff Macklem was undeniably clear that record low interest rates are here to stay “for a long time.”
It was no surprise to anyone that the Bank of Canada kept its key interest rate at 0.25% this week. More surprising was the unusually strong signalling that interest rates will stay put until at least 2023.
The Bank’s official statement said it would “hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved.”
Governor Macklem said:
“Canadians and Canadian businesses are facing an unusual amount of uncertainty, so we have been unusually clear about the future path for interest rates.”
This level of clarity is important for homeowners, too, as they think about buying a home or renewing their mortgage. Mortgage rates are incredibly low, with five-year fixed rate mortgages available at less than 2% interest, while 10-year mortgage rates are well under 3%.
A five-year variable rate mortgage is still cheaper than its fixed rate counterpart. Variable rates also come with some degree of certainty that interest rates will hold steady for at least the next three years.
The problem is, with the Bank of Canada holding rates at 0.25%, there’s no upside for variable rate mortgage holders. I happened to benefit when the BoC made its emergency rate cuts this spring – it reduced my own mortgage rate to 1.45%. Variable rate holders won’t be so lucky in the future.
Paying off my mortgage early has never been a major priority in my financial plan. I’d much rather max out my tax sheltered investment accounts first before throwing extra money at my mortgage. Lower rates also mean more of my mortgage payment is going towards the principal balance, rather than to interest costs. That means I’ll achieve mortgage freedom faster without increasing my payments.
This Week’s Recap:
My investment portfolio(s) continue to recover and in some cases climb to new heights. My RRSP is only down 2.51% on the year – a far cry from the decline of -41.41% as of March 22. Hard to believe.
My TFSA is now up 2.14% on the year, thanks to the large lump sum investment I put into the account in mid-April.
I opened my LIRA on May 1st and that account is now up 10.07% since inception. Talk about great lucky timing.
The kids’ RESP account is down 0.32% year-to-date. We contribute $500 monthly (including CESG) to this account.
My RRSP, TFSA, and LIRA are all invested in the Vanguard All Equity ETF VEQT, while my kids’ RESP account is invested in TD e-Series funds.
This week I wrote about making rational versus irrational decisions when it comes to personal finance and investing.
One reader suggested I write an article about how to determine your sustainable spending rate in retirement – or what’s the maximum amount you can spend each year to age 95 without running out of capital. I’ve got some ideas to share with you, so stay tuned for that one.
Promo of the Week / Reader Question
I’ve received a few emails this week asking about how I set up my personal banking system to save on fees and maximize the interest rate on savings. This is how I do it, but your mileage may vary:
My wife and I have a joint chequing account with TD Bank and maintain a minimum account balance to waive the monthly account fees. We have the basic, bare bones account with minimal transactions. That’s because we put all of our transactions onto a rewards credit card and limit the amount of debit transactions and ATM withdrawals.
My wife has a separate no-fee chequing account with Tangerine.
I find Tangerine is still good for no-fee banking, but they’ve really dropped the ball when it comes to offering high interest rates on savings deposits. Outside of short-term promotional rates, the rate on Tangerine’s savings account is a pitiful 0.25%.
That’s why we opened a Savings Plus account at EQ Bank for our emergency savings. The account pays a high everyday rate of 2%, which is at or near the top of the market. Open an account here and fund it with $100 within 30 days and you’ll get a $20 cash bonus for free.
Our investments are held at TD Direct (RESP, LIRA), Wealthsimple Trade (RRSP, TFSA), Wealthsimple Invest (wife’s RRSP), and Questrade (new corporate investment account).
It would be nice to have all of our banking and investments in one place, but the fact is there’s no one bank or institution that offers every account type we need, doesn’t charge any fees, and pays the highest interest rate on savings deposits. Until then, we spread out our banking to get a bigger bang for our buck.
Weekend Reading:
Sticking with the mortgage theme, Michael James on Money says to think twice before taking a five year closed mortgage due to severe penalties for breaking the mortgage early.
You’re likely shopping online now more than ever. Our friends at Credit Card Genius share the best credit cards for earning cash back and saving on foreign transaction costs.
The Better Dwelling blog reports that Canadian real estate prices grew 29x faster than U.S. prices since 2005.
The Lowest Rates blog presents six personal finance pros on what it takes to become a ‘money expert’.
Here’s a good piece from MoneySense where four single moms get personal about their money matters and ask a pro for help.
Rob Carrick is spot on with this advice to young, app-focused investors treating the stock market like a game:
“Free-trading apps are a fad that will fade, probably not without damage done to those who have treated investing like a game. The stock-market surge since March is not a test of anyone’s investing ability – everyone looks like a star trader.
But free-trading apps can also be a force for good investing. Here’s how: Use them to build a super-cheap balanced-ETF portfolio.“
Chrissy at Eat Sleep Breathe FI shared a guest post on the Money We Have blog and listed four simple steps to financial independence.
Ted Rechtshaffen says holding cash is a sign of fear, and fear is the worst investment of all.
Downtown Josh Brown and Irrelevant Investor Michael Batnick discuss Gold versus the S&P500, Warren Buffett versus Elon Musk, and more in this entertaining edition of, What are your Thoughts?
An incredibly detailed case study from the Frugalwoods blog on a Canadian family’s plan for the future.
Here’s a great piece from the Wall Street Journal’s Jason Zweig: The South Sea bubble is the classic story of an investing mania. Are investors today any wiser?
Erica Alini reports how this Ontario man was promised a refund – then Sunwing changed its policy.
I loved this article by Des Odjick on how her blog landed her a dream job as a content marketer.
Finally, what many of us have been dealing with for months – the implications of working without an office.
Have a great weekend, everyone!
Economists have long argued that, given the choices available, people will make rational decisions that provide them with the greatest benefit or satisfaction. Then behavioural economics, led by the likes of Daniel Kahneman and Richard Thaler, came along and showed how people behave irrationally all the time due to psychological, cognitive, and emotional factors.
For example, Thaler’s theory of mental accounting reveals how people place greater value on some dollars over others, even though all dollars have the same value. They might go out of their way to save $10 on a $20 item, but not make the same effort to save $10 on a $1,000 purchase.
Looking at my own personal finance views I’ve found a mix of rational and behavioural driven decisions. Here are three that come to mind:
Dividend investing vs. Indexing
In the dividend investing versus indexing debate I’ve tried to (kindly) argue that indexing is what economists would call a rational choice given the overwhelming body of evidence supporting an efficient market that can’t be exploited by investors over the long term.
On the other hand, it “feels better” to receive a portion of your investment returns in cash and so it’s not surprising to see investors flock to dividend stocks.
Efficient market theory states that investors would be better off buying the entire market for a small fee. Dividend investors might say that sounds great in an academic paper, but in practice they’d prefer to receive regular cash dividends instead of hoping that markets will continue to grow as they have in the past (bird in the hand theory). Dividends also help investors weather the storm during a market crash (provided the dividends don’t get cut or eliminated).
Maybe it’s more about the illusion of control. Active management “feels better” because you’re exercising control over when and what to buy and sell, whereas index investors might appear to have given up control and left their investing fate to the stock market gods.
But is your judgement really adding value and leading to a better outcome? In my case I felt it wasn’t. Even though my portfolio beat its benchmark for five years, I chalked that up to timing – a rising tide lifts all ships. If you started dividend investing in 2009 like I did then you probably had some pretty stellar returns. But over the long-term, I’ve put my money on rational outperforming behaviour.
Debt snowball vs. Debt avalanche
Two popular debt repayment strategies are the debt snowball and debt avalanche.
The debt snowball focuses on the psychological advantage that comes from making progress with quick, successive wins. Start by arranging your debts from lowest balance to highest. It feels better to rid yourself of your smallest debt, and the idea is that the snowball effect builds enough momentum so that you’ll be more inclined to stick with the strategy.
The debt avalanche method suggests that math trumps behaviour. The idea is that you’ll pay less interest and become debt-free faster when you attack your highest interest debts first.
With a debt avalanche, simply list your debts from highest interest rate to lowest – regardless of the balance or minimum payments due. Direct all of your extra cash toward your highest interest rate debt while maintaining the minimum payments on the other loans on your list.
Advocates of the debt snowball method say it’s all about creating momentum to get you motivated to pay off your debt. But I disagree. Once you’ve made the decision to tackle your debt I think you should use the method that gets you out of debt faster and saves you the most money.
Rational 2, Behaviour 0
Credit cards vs. Cash
People are willing to spend more when they use a credit card instead of cash. It’s a fact that has been proven in study after study. Yet I still choose to use a credit card for my everyday spending, despite the evidence that using cash is the more rational choice when it comes to sticking to a budget and saving money.
My excuses for using a credit card are all behaviourally driven:
- Convenience – It’s easier to pull out my credit card than to take out money from an ATM (or risk not having enough when you need it).
- Rewards – I earn 2% (or more) back on every purchase. Alternatively, you get nothing back when you pay for items using cash or debit.
- Tracking spending – Using one credit card for every purchase helps keep tabs on my spending better than using cash and forgetting to get a receipt.
- Fraud prevention – I can dispute a credit card charge easily enough, or cancel my card if it gets lost or stolen and have a new one shipped to me within days. None of my money is on the line. If my debit card gets skimmed, on the other hand, I’m out of pocket the damages until the bank or authorities get to the bottom of it.
An MIT study suggested that the credit card premium (the amount people were willing to pay for an item with a credit card instead of cash) was between 59 and 113 percent. That’s not for everyday items, mind you, but for things such as concert tickets or dining out at a restaurant.
I get it. Let’s say I took my family out to a restaurant and only had $75 cash in my wallet and no access to credit. Of course this would influence what we ordered from the menu, whether or not we had drinks or dessert, and even how much we’d tip. But since I know we’ll pay by credit card it becomes much easier to order an appetizer, plus a drink (or two), and watch the bill come in over $100.
My personal issue with carrying cash is that I think I tend to spend more when I have it in my wallet. Almost as if it’s found money.
Perhaps I need to do an all-cash challenge for a couple of weeks and see if it a) helps control discretionary spending, and b) is as big a pain in the neck as I think it will be.
For now, score one for behaviour over rational decisions.
Final thoughts
When I switched to indexing, I sided with math over behaviour. But that doesn’t mean all of my investing choices are rational financial decisions.
For example, my one-ticket investing solution consisting of Vanguard’s VEQT is more expensive than other indexing options. The problem is, a less expensive solution involves more complicated workarounds such as using Norbert’s Gambit to convert Canadian dollars to USD (and vice versa).
And, for years, before I switched to Wealthsimple Trade, I paid $9.99 per trade at TD Direct even though cheaper options like Questrade existed. Reason being that I liked having all of my accounts in one place.
We’ve all heard that personal finance is personal. The point of thinking about all of this is not to determine whether you’re a rational or irrational person. It’s about finding a system that helps you achieve the best outcome. Sometimes that outcome will be the “rational” choice, while other times you might forgo the optimal solution and choose simplicity or convenience instead.
Tell me about a time when you made an “irrational” financial decision.
When the global pandemic became a reality for Canadians in mid-March, the federal government introduced a host of measures to respond to the crisis, including the Canada emergency response benefit (CERB) and Canada emergency wage subsidy (CEWS). The result was a massive spending increase as more than 8 million unique CERB applications were filed and the feds issued more than $13 billion in payroll help for businesses.
What was the cost of these support programs? The federal government released a fiscal snapshot this week that projected an eye-popping $343 billion deficit for 2020. It’s an almost unfathomable figure – 10x the already controversial pre-pandemic projection.
The government has correctly prioritized public health over the economy and used its fiscal capacity to help individuals and businesses stay afloat during this unprecedented crisis. Never mind the fact that we still may very well be in the early stages of the pandemic and will require much more spending to get us to the other side of it.
But, staring in the face of a $343 billion deficit, the question on everyone’s mind is, “how will we pay for this?”
The magnitude of government deficits and debt is not something Canadians are used to, but public deficits have become the norm in Europe, Japan, the United States, and all around the world ever since the global financial crisis in 2008-09.
Now Canada is finally getting in on the act. As part of its pandemic response, the Bank of Canada has pledged to buy at least $5 billion in federal debt every week, and has pledged to do so until the economy is well into its recovery. In addition to federal bonds, the BoC is also buying provincial bonds and corporate equities.
Critics of this type of stimulus argue that it will lead to inflation in the short term and unsustainable debt in the long term that future generations will need to pay off.
Those voices are wrong, according to Dr. Jim Stanford, an Economist and Director of the Centre for Future Work. Dr. Stanford appeared as a guest on the latest episode of the Rational Reminder podcast and provided a fascinating argument for increased government spending even as we move past the pandemic and the economy begins to recover.
“I think we’re going to need a similar, probably 10 year reconstruction vision to rebuild after our war against COVID-19.
It’s going to require not just the short term debts that government ran up to help people through the pandemic and the lockdowns, it’s going to require a long term commitment to mobilizing resources, in infrastructure, in expanded public services, in community services, in direct public sector hiring in order to get back to a place where economic growth can be sort of self sustaining again.“
Dr. Stanford argues that the federal government has to finance a long run process of reconstruction, and with its deep pockets likely needs to support the provinces and even municipalities.
He says that old economic theories about inflation are wrong and points to Japan, whose public debt is 250% of GDP, as a country that should have had hyper-inflation and a collapse of its financial system, but in reality has been able to keep inflation in check with near-zero interest rates.
The Bank of Canada is creating money and facilitating government borrowing and spending, which Stanford argues is critical to both the immediate emergency and the long run reconstruction that’s going to be required.
“Every $100 billion of federal debt, and the other side of it is $100 billion that was invested to help people through the pandemic and help the economy to rebuild. In that regard, more debt is a good thing, not a bad thing.”
The podcast episode is a must-listen to better understand what’s happening in the economy, why deficit spending is not necessarily a bad thing (if used right), why quantitative easing doesn’t cause inflation, and what a post-Covid economy might look like.
This Week’s Recap:
I am incredibly excited to join the board of directors at FAIR Canada. FAIR is the Canadian Foundation for Advancement of Investor Rights. I look forward to helping the organization continue its mission to advocate for Canadian investors.
This week I wrote about sticking to your financial goals during the pandemic. Having multiple savings accounts and an emergency fund certainly helped us.
Promo of the Week:
I’ve helped many clients analyze their investment portfolios and I’m appalled almost every single time.
One portfolio I recently looked at held mutual funds with management expense ratios (MERs) greater than 3%. Many portfolios have duplicate or overlapping funds, others have a dangerously small number of individual stocks – including cannabis and bio-tech plays, while most are simply filled with too expensive mutual funds.
Investors are starting to catch on that they’re paying too much for investment products while receiving little to no advice. Many are afraid to move to a DIY solution because they’re not confident in their ability to manage their own portfolio.
A better solution is often to invest with a robo-advisor. I’ve profiled Wealthsimple many times because it comes with lower costs (0.40% management fee for portfolios greater than $100,000), and can include advice from a portfolio manager who has a fiduciary duty to look out for your best interests.
- Using a robo-advisor in retirement
- Tackling changes to your retirement income plan
- Tax loss harvesting at work
Wealthsimple investors will also pay for the costs of the ETFs held in their portfolio, but that comes in around 0.15% or so. That’s a total all-in cost of just 0.55% for Wealthsimple Black clients (the ones with $100,000+). The fees are 1/4 the cost of a bank managed portfolio of mutual funds. And while the advice may be limited in terms of access, you can always pair the robo-advisor investment solution with a fee-only advisor to get a comprehensive financial plan or retirement plan.
Check out Wealthsimple and get a $50 cash bonus when you open up a new Wealthsimple account and fund it with $500 within 45 days.
Weekend Reading:
Another excellent podcast this week was from Freakonomics – Remembrance of economic crises past.
The Credit Card Genius blog looks at the best options to replace your devalued Capital One Aspire Travel World MasterCard.
Here’s the latest episode of SPENT, which looks at the effect of Covid-19 on credit card balances and payment behaviour:
Financial planning advice is often catered to wealthier Canadians. But what can retirement look like for those with little to no savings to draw on?
Millionaire Teacher Andrew Hallam says to ignore experts who are building coffins for the 60/40 investment portfolio.
Michael James on Money looks at the limits of offering investment help to friends and family.
Late last year the Canadian Securities Administrators proposed to ban deferred sales charges on mutual funds. Ontario stubbornly refused to adopt these measures, caving to industry lobbyists looking to maintain the status quo. Dale Roberts nicely explains why there’s no need for DSC mutual funds.
My Own Advisor Mark Seed shares two expenses that are stealing your early retirement dreams (hint: it’s not coffee).
Rob Carrick answered a number of personal finance questions on Reddit this week, including his biggest financial mistake.
Mr. Carrick also shared how to get from zero to knowledgable on mortgage rates in 15 minutes:
“A low rate is the foundation of a good mortgage, but you should also look into how much you’re allowed to pay down the mortgage every year and penalties for breaking the loan before it comes up for renewal.”
Morgan Housel says to follow these five money rules while you’re still young, or regret it later in life.
Finally, a smart look at how extending free childcare could fuel a huge boost to the economy. Economists must be salivating over the number of real-life experiments playing out in response to the pandemic.
Have a great weekend, everyone!