Category: Personal Finance

Thicken My Wallet recently made the brilliant statement “The Financial Industry Preys on Inertia”. Tied in with Money Gardener’s Relationship Banking post I think this single statement summarizes a great deal of the problems of banking and personal financial management, and at the same time points out a simple solution.

When a bank offers a teaser rate, what they’re basically saying to you is “you’re so stupid and lazy, we don’t even need to offer you much of a deal. We’ll offer you a good deal for a short time, then milk you for the rest of your life. Ha ha, ha ha, ha ha”. The pathetic part is they’re right – we are stupid and lazy. Apparently bank’s love sending out mortgage renewal forms right before the end of a mortgage term (I’m not sure exactly how this works, I’ve never renewed a mortgage), so that you don’t have time to shop around. Most people sign the form, get the mortgage from the same institution again, and pay a higher rate then what that institution is offering new mortgage applicants!!! If you do this I hate you (as Ramit Sethi would say). Inertia makes the bank money (at your expense).

A buddy of mine is a teacher and didn’t even know what his salary was (he made two guess, $10K apart and said it was “one of those, I think”). I can’t criticize him too much, as I’ve lost checks a few times and discovered that I missed payment (once for around $1500). He didn’t bother contributing to his RRSP, because one of his colleagues had told him “it’s better not to”. I asked him what her reasoning was for such advice and he had no idea (the only thing I can think of is that their pension is so good they can rely on that for retirement planning – I’m not so sure about this myself, but I’m not a teacher). Its great when we work a job we love, and earn enough money that we don’t need to think about it, but we’re stupid and lazy beasts (things might change in the future, why not spend a bit of time planning for it).

We work very hard for our money (in most cases). It blows my mind how willing people are to throw away thousands of dollars (often many, many weeks of labour once you factor in taxes and living expenses) rather than think about something for a couple of minutes or make a 30 minute phone call.

The advantage to this is that if we’re willing to correct our behaviour: to take advantage of the teaser rates then move on to the best deal once its finished, to get pre-approval for a mortgage renewal 120 days before it comes due, and to keep track of our on-going finances, catch money that disappears and plan for retirement, you will be paid handsomely for your time – regardless of what you earn or your lifestyle.

I had a discussion last year with my wife where we talked about whether to give our home buyer’s plan debt priority over rrsp contributions.

Although it initially seemed like a good idea to pay the HBP back as soon as possible since it was a smaller amount (about 30k combined), it occurred to me that if you have any rrsp contribution room then you are much better off just paying the minimum HBP repayment amount each year and use any extra money that you want to put into the rrsp for a contribution.

The reason behind this is that whether you are paying back HBP or making an rrsp contribution, the amount that gets added to the rrsp is the same so since the rrsp contribution will give a tax rebate, that is generally the better choice.

For example, let’s say if I have $5000 that I want to put into my rrsp and my minimum annual HBP payment is $1333 and my marginal tax rate is 40%.

If I were to make the minimum HBP payment and contribute the remaining $3667 into my rrsp then my rrsp would have an extra $5000 in it and I would get a tax rebate of $1466.80.

If I were to put the entire $5000 into a HBP repayment then my rrsp would have an extra $5000 in it and I would not get any tax rebate. I would however owe less money to the HBP and future minimum payments will be smaller.

So it’s pretty clear to me that if you have the choice between contributing to your rrsp or extra repayments into your HBP – the rrsp is the winner.

The CEO of Vanguard posted a rebutal to allegations that financial services create a climate of fear in order to encourage over-saving.

I’m a saver, so I think I’m in the same camp as him that the risk of saving too much money isn’t the worst threat in the world. On the flip side, I think some people spend time in real fear and anguish worrying about eating dog food in their golden years, and preying on those fears (especially to make a buck) isn’t the most noble of sales techniques.

I think the ideal situation would be rather than give people fixed answers (“you need 1 million to retire”) or roughly-customized answers (“you’ll need 60% of your pre-retirement income”) it would be better to educate them on what they’ll need. Encourage them to track their consumption, realistically plan how it will change in retirement, provide some easy-to-use monte-carlo simulation software and help them input their variables, and help them explain what the numbers mean (your savings will have a 90% chance of lasting you until you’re 90 years old).

This might make a good workbook too, you read through, follow the exercises about tracking and estimating your expenses, use some bundled software and come out with some truly customized, realistic retirement goals.

Obviously this would be a lot more work then telling people they need to save a million dollars (and many people wouldn’t be willing to go through the process), but I think it would be a great way for the financial planning industry to serve their clients.

As discussed yesterday, we laid out a retirement calculation for Bob, and concluded that he won’t have enough money to reach his desired gross income of $45k in today’s dollars.

What to do? Well either Bob can cut out a few lattes and spa treatments in retirement or he increases his annual contributions or he works a few more years or some combination of all three. The spreadsheet linked below, shows in the first tab named “increase contributions” that he would have to increase his contributions in today’s dollars from $10k to about $19k in order to meet his requirement of $45k in retirement. This amount of contribution probably isn’t realistic given that it’s a huge increase and if he has to double his contribution then he probably has to cut back a lot on his pre-retirement life which might affect his desired spending in retirement. For example if he can live on less money while working then he can live on less money on retirement.

The next two alternatives cover the options if he wants to work later or wants to reduce retirement income.

The second spreadsheet tab named “work longer” – Bob decides that that he can’t live without the lattes and spas either before or after retirement so the only other option is to work longer than age 60. In this case he need $1.1 million in today’s dollars to meet his requirements and has to work until the end of the year in which he turns 65 to fulfill this scenario.

In the last example named “compromise” – Bob says that he can cut some expenses so he will only require $40k in retirement, he will contribute $14k per year but still wants to retire by age 60 – in this case he will have a gross income of $40,690 upon retirement.

So to sum up, Bob can keep his $45k gross income requirement in retirement but he has to work an extra five years to age 65 or increase his contribution from $10k to $19k. Another solution is to work to age 60, increase his contribution to $14k and live on just over $40k in retirement.

Some future posts will deal with more realistic retirement scenarios. If there are two parties involved, Canada Pension Plan, OAS, pension income, and taxes then the scenario becomes a bit more complicated but it’s still relatively easy to calculate.

How to Predict the Future Part I

Retirement SpreadSheet

That’s right – predict the future! Ok, this method won’t help with lottery tickets, horse racing, stock prices or anything else that will make you rich quick, however it does apply to retirement planning, particularly with predicting the future values of your retirement income and retirement expenses which of course is all you need to calculate to predict your retirement. Planning your retirement is not as simple as tying your shoes but it’s not so complicated that you have to pay an advisor thousands of dollars to figure it out for you.

Everyone has heard all the scary stories about how you will need one million dollars to retire, or two million…or whatever. These numbers sound unreachable for someone who might only have a retirement portfolio of $100k (or no retirement portfolio for that matter) but it’s important to remember that these are future dollars. One million dollars in twenty years is the equivalent to $560,613 dollars right now assuming 3% inflation. This is admittedly still a large number but it’s a lot less than a million dollars.

In the past, to calculate my retirement scenario, I had assembled a complex retirement spreadsheet that involved using the future value of all contributions, withdrawals, taxes, income etc. This worked reasonably well except that it was complicated and didn’t lend itself to change very easily. One of the things I learned from Four Pillars of Investing was to calculate retirement scenarios using today’s dollars to greatly simplify things. The way this is accomplished is to subtract your estimated inflation rate from your estimated portfolio return to get a “real return” and to use today’s dollars for everything else such as portfolio contributions and anticipated withdrawals.

I’ve created a relatively simple retirement scenario in the spreadsheet below, which is for someone (Bob) who is turning 40 this year, has a $250k portfolio and contributes $10k per year. He desires $45k of gross income in retirement at age 60. His expected investment return is 7% but I will subtract 3% inflation to get a real return of 4%. We will also assume that he will get no other income other than from this portfolio and that contributions are made at the end of the year. He will retire at the end of the year in which he turns 60. The goal of this exercise is to determine if he is contributing enough to meet his goal of $45k (in today’s dollars) gross income in retirement. We will also use the “4% rule” which basically states that the initial annual withdrawal from a retirement portfolio should be 4% of the portfolio. This will be discussed in many future posts as it is a particular favourite subject of mine!

If you check out the spreadsheet you will note some interesting things. By age 60 his $250k portfolio has grown to $889k in today’s dollars. Twenty years from now that portfolio will actually be $1,654,516 in year 2027 dollars. This sounds like an incredible amount but it isn’t enough to meet the Bob’s requirement of $45k gross income in today’s dollars. I calculate the portfolio each year by multiplying the previous year value by 1.04 and adding the contribution to that.

As you can see at the bottom of the sheet, 4% of $845k is only $35,575 which falls far short of Bob’s expected gross income.

Tomorrow we will look at a couple of solutions for Bob so he can achieve his goals.

How to Predict the Future Part II

Retirement I

Ever get a traffic ticket and just paid the full fine and accepted the points? If you wanted to try fighting or reducing the ticket, there’s always been the option of booking a court case and showing up and either pleading down the ticket with the assistant DA or actually going to trial and hope the cop doesn’t show up. Both of these methods can be successful but they can take up a lot of time and be somewhat stressful – especially if you’ve never been on trial before.

Well my wife got a ticket last year and decided to take advantage of the City of Toronto Court Services process in which you can “plead guilty with an explanation” and basically plead down the ticket with the assistant DA. Actually the cop who gave her the ticket told her to go and plead it down.

According to the website it sounds like a quick easy process, but in practice she showed up and got a number (you have to line up to get the number first). The room was hot and crowded. After about a one hour wait she talked to the customer service rep. Then she went into another room (through security) and waited longer to talk to the assistant DA. Once that talk was over she waited some more and then got a sheet from the assistant DA with the new deal – then she went back to the first room and got another number and waited to pay – this was a different line so it didn’t take long.

Bottom line is that she was there about 2.5 hours, got the ticket reduced from $110 to $80 but she paid $20 for parking so net savings (not counting gas & lunch) was $10. The two points were removed which apparently is the main thing. I’m not sure if two demerit points has any effect on your insurance but I guess if you keep getting them then your insurance will go up.

Tip #1- If you are doing this and are going to the downtown Toronto court then go before nine in order to get the early bird parking which is only $10. It gets crowded later in the day as well so earlier is better

Tip #2 – Don’t bring your young child with you (if you have one).

Tip #3 – Since you have to go through security, don’t bring any knives or Swiss army knife key chains.

Please note!

To get a $25 bonus with a new ING account then use the referral code 33089336S1.  This is also called the  orange key code.

To the guy with the accent and his two curvy henchmen:

To begin with I’d like to thank you for entering, and shaking up, the Canadian banking industry. When I first heard about you, in 1997, I thought “what a great idea” and was happy to open an account with you. I was delighted to refer friends and family to you, and the referral bonuses you offered were a cherry on top of the sundae.

People were reluctant to bank with an entirely Internet based bank. I understood that concern, and did my best to reassure them that you wouldn’t run away with their money in the middle of the night (and you haven’t). Showing them that you are FDIC insured, just like the big banks went a long way to reassuring them. The fact that you offered higher interest rates on your SAVINGS ACCOUNT then the big banks offered for GICs went a long way to getting them to switch.

I was working down in the US in 2000 and evangelized you south of the border too.

As a banking revolutionary, I salute you. Unfortunately you seem to have recently lost the fire in your belly.

When PC Financial opened its doors, I was suspicious at first. I assumed that their higher rates would be mere teasers and expected within a couple of months for them to drop below yours. I was perplexed when months went by and they stayed higher than ING Direct. Your commercials kept playing, telling us to keep our money and get paid top interest, but they started to ring false in the face of the ongoing interest rate disparity.

In December of 2006 I applied to you for an un-mortgage. Being self-employed, I expected that it might be a little tougher to arrange, but we’d been together for so long, I expected it would happen one way or another. In the end your representative turned me away completely (not even offering a mortgage with a high down-payment or higher interest rates, just a refusal to do business with me). That same week both PC Financial and Scotiabank offered me mortgages.

You’ve changed man. You used to be about turning the bank industry on it heads and connecting with the littler guy. You streamlined your operations and passed the savings on to us. Now you’re turning your back on us, at exactly the time PC Financial is welcoming us with open arms.

My last GIC at ING direct came due in May, and after moving the money from it, there’s a sad 56 cents sitting in my ING Direct account. I hope the winter that has fallen on the orange giant thaws, and on that day I’ll happily return (although sadly you’ll have to outdo PC Financial now, when before all you had to do was match them to keep me).

Please let all the drained accounts sitting with pennies in them be the sparks that re-ignites your belly fire. Become what you were in 1997 again: charge into battle again. For your shareholders, yes, but for us little guys too!

One of the efforts I had thought about doing for retirement planning was to measure my personal inflation rate in order to have a more accurate value to use than the CPI value. Realistically it’s not going to work – there are too many variables and potential changes in lifestyle. For example over time, our interests may change from cheap hobbies to expensive hobbies, our young son will probably eat more as he gets bigger and will require more money for activities. It will be difficult to separate the basic “retirement spending” from normal spending. The other problem is that there is a fine line between personal inflation rate and plain old overspending. At some point if you are going to retire you have to be able to live within your means even if that entails reducing or eliminating expenditures on activities that you enjoy.

Fabrice Taylor writes in the Globe & Mail about the fact that the CPI doesn’t necessarily match up to the inflation rate that you or I might experience within our lives. This figure is very important for retirement planning since the real rate of return of your investment portfolio is the actual return minus the inflation rate. Taylor refers to a study done in the US which says that the real inflation rate is twice as much as the official rate.

Another good example is financial planning for education costs. I’ve read that post-secondary tuition has gone up about 5% per year over the last decade. If you are doing projections for your education fund then using the CPI will understate the actual inflation since tuition is a big part of the school costs.

Since I’m still a few years away from retirement I don’t worry too much about my assumptions for rate of return and inflation. Personally I use 3% inflation in my calculations which is probably a good enough estimate for my purposes.