How to FI

Quarterly Progress Update #2-Q1 2021

Welcome to my second quarterly update.  I decided to start providing quarterly updates on my own financial position so that you can follow me on my Journey to Be Financially Independent. The reason for this is threefold:

  1. To be upfront and transparent with my readers to show that I am practicing what I preach in my blog posts and coaching curriculum
  2. To share my successes and failures along the way, and be held accountable on my goals and aspirations
  3. To be an inspiration to others on their path to financial independence.

Since I’ve decided not to remain anonymous, I don’t plan to post specific dollar amounts to maintain some level of privacy, while still sharing enough to show a good overview and directional changes over time.

I landed on a quarterly updates instead of monthly updates since my financial position doesn’t change too much from month to month.  Also, most of the Exchange Traded Funds (ETFs) that I own pay quarterly distributions so a quarterly update is a better reflection of my current investment income.

I hope you all like charts as much as I do!  Here we go:

Networth since 2011 (I started tracking my finances in January 2011):

What do I mean by “as a multiple of December 31, 2010 networth”?  My current networth is 16.3x what it was on December 31, 2010.

Change in Networth over the last quarter:

  • Income
    • Pretty standard quarter from an employment income perspective
  • Taxes
    • Pretty standard quarter from a tax point of view
    • I do what I can to reduce my annual tax bill by making maximum contributions to my Registered Pension Plan (“RPP”) at work, Registered Savings Plan (“RSP”), and Tax-Free Savings Account (“TFSA”) – I wrote a post on these tax-advantaged vehicles here.
  • Discretionary expenses
    • Will discuss more under “spending and saving” below
  • Essential expenses
    • Will discuss more under “spending and saving” below
  • Bonus adjustment
    • I get paid an annual bonus each year and include 1/12th of that bonus in each month’s “income”
      • Since it is only paid once during the year (in Q2), I needed to add an adjustment column so that the networth calculation will reconcile and my investment gains wouldn’t be over or understated.
  • Income gains (losses)
    • A more normal month for investment gains (losses) – more to come on this in the “ETF Performance” section below
Earnings for Q1, 2021 (January 1, 2021 – March 31, 2021):
  • Employment income
    • As you can see, most of my income currently comes from employment
  • Investment income
    • I track my investment income on a cash basis (only record a dividend / interest income when cash is received)
    • My total investment income was healthy in Q1 given all four of my Equity ETFs paid distributions in Q1 (paid in January / March / June / September each year)
      • Equity ETFs pay quarterly distributions.  Current annualized yields as of May 24th:
        • XIC = 2.59%
        • XUU = 1.18%
        • XEC = 2.09%
        • XEF = 1.63%
      • I also have some equity funds within my RPP, however, those investment vehicles do not pay distributions (rather they are re-invested)
      • Fixed income ETF pays monthly distributions.  Current yield:
        • VSC = 1.2%
      • High interest savings accounts pay monthly interest.  Current yield:
        • Tangerine High Interest Savings account = 1.75% (promotional rate until July 15th) – regular rate is 0.10% right now
        • TD Waterhouse High Interest Savings Account = 0.20%
      • My private investments do not pay dividends
      • My GIC portfolio does pay distributions, however, I have these compound annually rather than pay out every year, therefore, will only log these upon maturity of each 5-year GIC
        • The average rate I am receiving on my GIC portfolio is 2.38%
  • Credit card rewards
    • I have a few credit cards that allow me to optimize cash back and travel rewards.  These are the four credit cards that I have for now:
      • TD First Class Travel Infinite
      • BMO World Elite Mastercard
      • Tangerine Mastercard
      • Scotia Passport Visa
    • I plan to write a post on credit card rewards in the future so stay tuned
    • Credit card rewards are not for everyone!  I would not recommend having multiple credit cards (or any) if you plan on holding a balance from month to month and not pay the card off in full
  • Other income
    • No other income this quarter
Spending for Q1, 2021 (January 1, 2021 – March 31, 2021):

  • Essential expenses
    • Significantly higher than normal “essential expenses” in the last quarter due to costs associated with buying a house (we moved at the end of April so we were still paying rent during Q1).
    • Top 3
      • Housing – Home improvement / Rent
        • We bought new vanities for each of our 3 bathrooms, replaced all interior doors including trims, and replaced flooring in 2 of the bathrooms
      • Food – Groceries
      • Life Insurance – paid a year’s worth of premiums in March
  • Discretionary expenses
    • Another low quarter for discretionary expenses – aligned with the COVID lockdown!
    • Top expenses
      • Household
      • Car – mostly insurance and registration paid in Q1
      • Gifts
      • Takeout – definitely increased as we prepared for our move
Savings for Q1, 2021 (January 1, 2021 – March 31, 2021):
  • Savings rate
    • My overall savings rate for the quarter came in at 78.9% (of net/after tax income)
      • This was just below my 2021 target of 80%
    • Yes, this number is high, however, let’s not forget that it has taken me a decade of hard work to get here.  If your current savings rate is on the lower side, don’t be discouraged!  Be encouraged!
YMOYL wall chart

  • This is my version of Vicky Robin’s “Your Money or Your Life” wall chart.  I explained the chart above in my post, “Household Inc. – Tracking Your Household Finances Like a Business”
    • Each bar represents my overall financial position for one month
      • Whole bar for each month = total income or money into my life for the given month
      • Blue segment = mandatory deductions (e.g. federal and provincial taxes, CPP contributions, EI payments)
      • Everything below the blue segment is “net income after taxes”.  This is money that is available to be either spent or saved:
        • Black segment = essential expenses (e.g. rent, utilities, groceries, clothing, etc).  These should generally be stable from month to month
        • Red segment = discretionary expenses (i.e. for the purchase of items that are “wants”, not “needs”).  These expenses tend to be more volatile from month to month
        • Green segment = savings (i.e. money left over after deductions, essential expenses, and discretionary expenses)
      • Black line = investment returns.  This is a very powerful line as it shows how much of my expenses would be covered by my investment returns, assuming my portfolio’s total return was 4% per year.  The goal of financial independence is to get to the point where your investment returns cover your essential expenses (i.e. lean FI), and eventually all of your expenses (full Financial Independence).  This is similar to the “crossover point” concept that Vicky Robin introduced in “Your Money or Your Life”
        • As you can see, my current portfolio, invested at 4%, covered my fixed and discretionary expenses in January and February, but not March
        • This will be the new normal for me with a house and a kid.  That said, we will see how things change over time
      • Purple line = net savings rate for each month within the quarter
Other Financial Metrics for Q1, 2021 (January 1, 2021 – March 31, 2021):
  • Current Portfolio Yield as of March 31, 2021 = 1.26% (weighted average)
  • Cash Interest for Q1 2021 = 1.28% (annualized)
  • Essential Expense Coverage (Yield ÷ Essential Expenses) = 21.7%
  • Total Expense Coverage (Yield ÷ Total Expenses) = 18.7%
  • Cash Investment Income ÷ Essential Expenses = 38.3%
  • Cash Investment Income ÷ Total Expenses = 32.9%

Total Return vs. Yield vs. Cash Interest

  • First of all, it is important to note that the above financial metrics are based on portfolio yield and cash interest, not total return.  Total return includes all sources of investment return (both cash flows from interest and dividends) and capital gains or losses over time, whereas the yield and cash interest numbers that I quote exclude capital gains and losses
  • There is a difference between what I call “Yield” and “Cash Interest”.  I choose to track both since as you can see from above, the two metrics can vary quite significantly from one month/quarter to the next
    • “Yield” is forward looking (based on the weighted average dividend / interest income rate of my investments going forward)
    • “Cash Interest” is based on how much cash interest (e.g. dividends/interest income) my portfolio generated during the quarter.
Asset allocation as of March 31, 2021

  • Private vs. Public vs. Cash
    • Private investments
      • Real Estate – I had a 25% allocation to Real Estate in Q1 that was earmarked for a house purchase (which closed in April 2021).  I decided to sell the REIT in my RPP given that I will have a significant amount invested in real estate via the purchase of my principal residence
      • Personal Loans – I have a few personal loans that are still outstanding
      • Angel Investments – A few years ago, I was a member of an angel investing club and made two investments in early-stage private ventures.  It is important to note that angel investing is not for everyone.  Investing in early stage companies is a high risk / high reward proposition.  I invested in these ventures knowing very well that I could lose 100% of what I invested.  That said, the experience was a great learning experience and I felt like I was on Dragons’ Den.  I decided to take some time off angel investing after making my first two investments since I committed to angel investments being less than or equal to 10% of my overall portfolio (I didn’t want to be tempted by new investments that could potentially tilt the risk of my overall portfolio to a level that was higher than I wanted it to be).  I will likely go back to angel investing in the future (when I exit one or both of my current positions).  So far, both investments that I made are doing extremely well (on paper, not yet realized) as they have both brought in additional capital at much higher valuations relative to my initial investments.  That said, I have kept these investments at cost/book value in my networth calculations until I realize the value through an eventual sale
    • Public investments
      • Fixed Income
        • Other fixed income exposure
        • Guaranteed Investment Certificates (GIC) – Although several individuals pursuing financial independence use a 100% equity allocation rather than having any fixed income exposure, I’ve decided that I prefer having some money in fixed income investments (specifically, Guaranteed Investment Certificates and a short term corporate bond ETF).  I realize that rates are low right now, however, I value having a lower level of volatility when things go sideways (or down) in the equity markets
          • I started building a 5-year GIC ladder in February 2018
          • This means that I bought a 5-year GIC every month since then and will continue to do so until January 2023
          • I buy GICs that compound interest over the 5-year period and then pay out principal plus interest at maturity
          • Starting February 2023, I will have a GIC maturing every month (initial principal plus accrued interest will be paid out)
          • Currently, I don’t include the interest accrued to date in my networth calculation since the GIC’s are not redeemable prior to maturity
      • Equities
      • Cash
        • 35%+ cash! You must think that I am mad keeping that much cash on the sidelines (not invested) at this time, given my highest rate High Interest Savings Account (“HISA”) is only paying 1.75% right nowThis high allocation was only temporary in the first quarter as my wife and I bought a house in April.
Investment changes (change over the quarter)
  • New investments
    • In addition to purchasing a 5-year GIC every month, I also purchase one of the four equity ETF’s listed above
    • I practice what I call “dynamic rebalancing” – effectively rebalancing my portfolio by buying whenever something is underweight in my portfolio
      • If I am above my target equity allocation, I will not purchase an equity ETF that month
      • If I am below my target equity allocation, I will purchase an equity ETF that month (I select the ETF that is most underweight vs. my target)
    • I paused my ETF purchases in the first quarter to build cash for the house purchase
  • Investments sold
    • I try to not sell investments (especially in my taxable/non-registered account) to avoid triggering capital gain tax.  I prefer to take a long term approach and defer the capital gains for as long as possible
    • I did sell some of my non-registered ETFs for the house purchase.  I did so in a way that minimized the amount of capital gain tax I will pay.
ETF Performance:

  • Another pretty big quarter performance-wise, with my Equity ETFs up between 2.4% and 7.4% and my short-term corporate bond ETF down 1.4%
  • A note on performance:
    • I decided to exclude the “since inception” performance on my ETF holdings since I didn’t think it would be meaningful to readers (I started buying each of these funds at different times and continued buying along the way through the “dynamic rebalancing” process I described above)
    • For more thorough numbers on fund performance, please see the various hyperlinks above that reference the iShares and Vanguard websites
  • Fees – the overall fees on my portfolio was 0.06% (6 basis points on an annual basis).
Conclusion:
  • Overall, I am pleased with my FI progress for the first quarter of 2021.  My increased essential spending (mostly due to purchases related to the new house) will remain for the next few months but I expect this will level off eventually.  I am still very happy with my overall 78.9% net savings rate.

I hope that the above quarterly update gives you a good sense of how I track my income/expenses/networth and how I take a simple approach to investing and tracking my asset allocation from month to month.  The fundamentals of my financial coaching program are based on lessons that I have learnt from tracking my finances religiously for the past decade.  If you are interested in learning more about the program and/or booking a free consultation, please visit my financial coaching page.  My program includes access to a proprietary tracking template (Excel and Google Sheets versions available) so you can have charts / visuals similar to what you’ve seen above.  This provides a high level of transparency to your financial position and and tracks how you are progressing towards financial independence.

Disclosure: Everything provided above is for informational purposes only so you can see the approach that I take with my portfolio.  DO NOT TAKE THIS AS INVESTMENT ADVICE.  I’ve set up my portfolio according to my very personal risk and return preferences.  If you are not individually qualified to set up your own investment portfolio, please consult a qualified investment professional for assistance. 

My First Year of Car Ownership – How much does it really cost?

Last April, I bought my first car at the age of 32.  More on that in this post on how to buy a used car.  Before that, I tried to save money on transportation costs.

Now that a year has gone by, I thought it would be interesting to analyze how much it really cost to own the car in the first year.  Let’s roll through the various components in descending order of amount spent:

Insurance & Registration
  • Insurance: total for the year = $1,702.95 (average of $141.91 / month for my wife and I for a single car)
  • Registration: $86.00 for the year (average of $7.17 / month)  

Depreciation

  • As I wrote in my post “How to buy a used car”, we tried to buy a used car that had already passed the steepest part of the depreciation curve – so that it would maintain its value fairly well going forward
  • The all-in cost to purchase our car was $15,105.82.  This included:
    • Cost of the car: $14,000.00 (negotiated down from $15,000)
    • New summer tires (Costco): $814.71 (the car came with winter tires)
    • Pre-purchase inspection: $165.93
    • Rental car and gas to go pick up the car from Calgary: $67.48
    • Pre-purchase CARFAX report: $57.70
  • Without selling the car, it is difficult to estimate depreciation over the ownership period.  So what I did was look at comparable cars that are for sale (the exact same year / make / model / trim – 2012 Toyota Camry XLE).
    • I found 3 cars in Alberta
      • one with 155,000km listed for $14,900
      • one with 196,000km listed for $13,000
      • one with 128,214km listed for $18,888
    • Obviously this isn’t perfect since list price doesn’t always equal transacted price (due to negotiation).  That said, I feel pretty good that so far we have dodged depreciation given that our car only has 76,473 km to date (much less than the comparable cars for sale).  I am quite confident that we could sell our car for the same price we bought it for a year ago, $14,000.  Not to mention we bought new tires for it (and have both summer and winter tires)
  • If we sold the car for $14,000 today, total depreciation for the year (including the various costs listed above such as tires) would be $1,105.82 (average of $92.15 / month)
  • I am interested to see how depreciation will trend going forward.  With increasing interest in electric cars, I am curious what is going to happen to the secondary market for good old gas guzzlers.  Time will tell!

Maintenance

  • We completed the following maintenance on the car in the last year:
    • Alignment, rear brake replacement, brake fluid flush, and battery terminal service: $914.84 (this was recommended during the pre-purchase inspection)
    • Oil top-up: $14.01 (bought 2 bottles of synthetic oil – still have these)
    • Changing tires: $104.92 (switched summer tires to winter tires and then back to summer tires)
    • Car washes: $14.00 (I’m embarrassed to say that I only washed the car 3 times)
    • I tried to change the oil twice during the year, however they said that it didn’t need to be changed yet both times.  Thanks to the honest folks at Jiffy Lube on 104th Avenue!
    • Total maintenance: $1.047.77 (average of $87.31 / month)

Gas

  • We didn’t drive much during the year, mostly due to COVID-19.  Total kilometers  (“km”) for the first year of ownership was only 6,175km.  See the chart below:
  • As you can see, our km usage was quite linear / steady throughout the year (the two spikes in June and August were trips we took to visit family / go camping last summer)
  • Gas prices – The variability of gas prices was truly amazing.  Gas prices ranged from a low of $0.589 per litre at the beginning of the pandemic to $1.159 per litre most recently.  See the chart below:
  • Fuel economy
    • Total km: 6,175
    • Total litres used: 672.137
    • Average fuel economy (L/100km): 10.9
    • Total cost: $625.04 (average of $52.09 / month)
    • Average cost per litre: $0.93
    • Average cost per km: $0.10
  • See the chart below:
  • This chart shows the average fuel economy for each time I filled up the car with gas.  As you can see, the fuel economy for the highway trips (bringing the car home from Calgary, visiting family, going camping) is solid (less than 8.0L/100km), however it is pretty bad for city driving.  This was known when we bought the car (we chose to buy a six-cylinder rather than a four-cylinder)

Licensing and Emergency Roadside Assistance

  • My drivers license wasn’t up for renewal in the last year so I didn’t pay any licensing fees
  • Emergency Roadside Assistance: $176.40 (average of $14.70 / month) for a Premium AMA membership (in hindsight, we probably didn’t need the premium membership, but the extra towing km does give me peace of mind when we do our little road trips)

Parking

  • We paid $19.75 (average $1.65 / month) for parking during the year
  • This will likely be lower than the average year since we didn’t go out much due to COVID-19

Summing it all up:

The total cost for the first year of car ownership was $4,763.72

  • $396.98 per month
  • $13.05 per day
  • $0.77 per km

I was a bit surprised to see how high this was.  Especially given we bought a used vehicle that barely depreciated and didn’t drive much at all throughout the year.  I can’t imagine what the numbers would look like if we bought a new vehicle and drove more; not to mention if we were a two car family instead of a one car family.  May write a post on that down the road.

Pie chart breakdown of vehicle expenses:

Well, that’s it for the first year of car ownership.  I’ll report back next year to see how things have changed.

Financial Coaching the Average Canadian Household (Part 6 of 6)

Part 6: The After Picture – How the Average Canadian Household’s Finances look like after JBFI Financial Coaching

This is the sixth and last post that walks through a theoretical exercise of financial coaching the average Canadian household to see how we could improve their financial situation.

In the first post, we did a deep dive into the average Canadian household’s finances – looking at their income, expenses, and net worth.

In the second post, we did a deep dive into the average Canadian Household’s essential expenses.

In the third post, we did a deep dive into the average Canadian Household’s discretionary expenses.

In the forth post, we looked at aligning earnings with your values.

In the fifth post, we walked through how the average Canadian household could go about constructing a savings and/or debt paydown strategy.

Now we will wrap it all together and see the potential impact if the average Canadian household were able to save on essential and discretionary expenses, and earn more!

Let’s look at three hypothetical households that decided to make different levels of changes to their pursuit of financial independence:

  • Household A – Household A is quite comfortable with their current jobs and current levels of essential and discretionary spending; they decide to only focus on earning a bit more.  Let’s assume that they:
    • increase their after-tax income by 5%
  • Household B – Household B is willing to try to earn more and tweak a couple of major expenses.  Let’s assume that they:
    • increase their after-tax income by 10%
    • cut their housing expense by 10%
    • cut their transportation expense by 20%
  • Household C – Household C is sold on the concept of financial independence and is willing to make some pretty major adjustments to reach financial independence sooner.  Let’s assume that they:
    • increase their net income by 15%
    • cut their housing expense by 25% by renting out a room in their house
    • cut their transportation bill in half by deciding to only have 1 car 
  • Household D – Household D wants to take financial independence to the extreme.  They are motivated to save aggressively now to reduce the time it takes to reach financial independence as much as possible.  Let’s assume they:
    • increase their net income by 25%
    • cut their housing expense by 25%
    • cut their transportation bill by 75%
    • decrease all other expenses by 25%.

How does each household’s decision impact their finances?

  • Household A’s savings rate increases from 2.0% to 6.7%!
  • Household B’s savings rate increases from 2.0% to 16.4%!
  • Household C’s savings rate increases from 2.0% to 27.9%!
  • Household D’s savings rate increases from 2.0% to 48.3%!

What do these increased savings rates mean for each household’s time to retirement?

  • Recall from my article on savings rates (the most important factor when pursuing financial independence), if you only save 2% of your net income you will have to work 85 years to reach financial independence (ignoring government benefits such as Canada Pension Plan and Old Age Security)
    • Obviously nobody is going to work 85 years but this is a good exercise to see how long it would take to build a portfolio that would allow you to be fully financially independent
  • Household A’s time to retirement decreased from 85 years to 60 years
    • They shaved 25 years off of their working years by earning 5% more!
  • Household B’s time to retirement decreased from 85 years to 41 years
    • They shaved 44 years off their working years by earning a bit more and optimizing a couple of key expense categories 
  • Household C’s time to retirement decreased from 85 years to 30 years
    • They shaved a whopping 55 years off of the time it takes to be financially independent by earning more and making some short term sacrifices to reach financial independence sooner 
  • Household D’s time to retirement decreased from 85 years to 18 years
    • They shaved 67 years off the time it takes to be financially independent by earning more and making some aggressive short term sacrifices. 

A few key points to summarize:

  • The speed at which you approach financial independence is completely up to you.  If you love your job and are happy at your current level of expenses, then maybe no need to make dramatic changes
  • Increasing your savings rate can dramatically decrease the number of years that you need to work to reach financial independence
    • The sooner you get compound interest working for you (compounding your savings and investments), the sooner you will reach financial independence
    • Avoid consumer debt where compound interest works against you (often at a higher interest rate than what you will earn on your investments) 
  • Even small changes to big expense categories like housing and transportation can make a massive difference.  Big changes to big expense categories can shave off years of working / trading time for money (even decades!).   
  • If you don’t want to cut your spending, you can still significantly increase your savings rate and cut down the time it takes to reach financial independence by earning more!  The best part about earning more is that there is unlimited upside (whereas on the expense side, you can only cut so much before you start to feel that you are depriving yourself).

If you liked what you read in my six-part series and are interested in taking my Financial Coaching program for a test ride, get more information on the program here and sign up for your free consultation.  Remember, my program is 100% risk free – client value is one of my core values so I will not charge you unless it is clear that you received value over and above the cost of the program.  The program will go through a personalized version of what was discussed in this six-part series, including:

Financial Coaching the Average Canadian Household (Part 5 of 6)

Part 5: Constructing a Savings and/or Debt Paydown Strategy

This is the fifth post in a series of six that walks through a theoretical exercise of me financially coaching the Average Canadian Household (as defined by Statistics Canada data) to see how we could improve their financial situation.

In the first post, we did a deep dive into the Average Canadian Household’s finances, looking at their income, expenses, and net worth.

In the second post, we did a deep dive into the Average Canadian Household’s essential expenses.

In the third post, we did a deep dive into the Average Canadian Household’s discretionary expenses.

In the forth post, we looked at aligning earnings with your values.

In this post, we will talk about how the average Canadian could go about constructing a savings and/or debt paydown strategy.  If you have high-interest consumer debt (let’s put aside mortgage debt for now since we will talk about it later in the post), you should look to pay that off before saving.  Whether you have debt or not, a good first step is to establish an emergency fund.

Emergency Fund
  • An emergency fund can be used to cover expected and/or unexpected expenses if for some reason your income sources are temporarily halted (e.g. laid off, injured and unable to work, etc.).  It is generally recommended that you keep 3 to 6 months of expenses saved in this fund.  I would look toward the upper end of that range (or even more than 6 months of expenses) if you have a job where income is significantly variable (e.g. self-employed, entrepreneur, etc.)
  • I recommend to my clients that an emergency fund is kept in cash in a high interest savings account or money market fund
  • It’s best to keep this cash cushion separate from your day-to-day chequing / operating account – the idea is to create a “barrier” to access (only to be used when in dire need).  I recommend that my clients place their emergency fund in an online savings account that is not with their primary financial institution.  This usually means that you can still access the funds in 1 to 2 business days if you need them (but it’s not as easy as just transferring from one account to another at your primary bank)
  • An emergency fund is particularly important if you don’t have low-interest credit (e.g. a home equity line of credit, “HELOC”) at your disposal.  If you do, you can choose to use that as your backup plan if you prefer to keep the majority of your portfolio invested.  Although I have low-interest credit available, I still prefer to keep some cash on the side to cover unexpected expenses if they were to come up.  The last thing I want to do is to be forced to sell investments to cover day-to-day expenses (and potentially trigger capital gains)
  • Ideally your emergency fund is in a non-registered account or a tax-free savings account.  I don’t recommend using a Registered Savings Plan (RSP) since you will be subject to tax when you withdraw the money and will lose your RSP contribution room forever
Employer Match
  • As you are funding your emergency fund, it is a good idea to look into whether your employer offers an employee savings fund.  It is quite common for employers to match employee contributions to a savings plan up to a certain percentage of their income (e.g. 5%).  An employee savings plan can also be used as an emergency fund if need be (as long as it is a non-registered account or a tax-free savings account).  I know I said above that it is probably best to pay off debt before saving, however, this can be the one exception given an employee match can often have a benefit that exceeds the carrying cost of debt (e.g. a 1-for-1 employer match is an instant 100% return on your money).  Often times, if you miss out on your employee match, you lose it forever (if you aren’t signed up one month, it won’t carry forward to future months)
Debt paydown
  • Next is debt paydown.  There are two main strategies – which one you choose is up to you:
    • The debt snowball – make the minimum payments on all of your debts each month.  Use any money left over to pay down the debt with the smallest balance.  This is good for people who are motivated by momentum.  The idea here is that once you extinguish a couple of smaller debts, it will motivate you to keep paying off debt aggressively
    • The debt avalanche – make the minimum payments on all of your debts each month.  Use any money left over to pay down the debt with the highest interest rate.  This is more suited for mathematical optimizers who want to make sure that they are paying the least amount of interest as possible 
Savings strategy
  • After you have set up your emergency fund and paid down your debt, the next step is to look at contributing to a tax-advantaged account, e.g. a Registered Savings Plan (RSP), or a Tax-Free Savings Account (TFSA).  Which account to use ultimately depends on your personal tax situation and when you will likely draw down the money
    • Given the complexity of RSP’s and TFSA’s, I’ve written a separate post specifically on these two tax-advantaged vehicles.  Read more here 
  • Once your tax-advantaged accounts are funded, the next step is to invest in a non-registered / taxable account
Pay Yourself First and Automation
  • Pay Yourself First – whether you are paying down debt or saving, it is best to “Pay Yourself First” (i.e. pay down your debt, or contribute to your savings account BEFORE you spend on discretionary items).  This concept is so important that I wrote a separate post on “Pay Yourself First” 
  • Automation – I am a huge fan of automation.  Nowadays, most companies allow you to automate your bill payments (e.g. utilities, cell phone, internet, etc.), debt payments (credit cards, line of credit, mortgage, loans, etc.), and savings (automatic contribution to savings accounts, etc.).  Automating saves you time monthly on “life admin,” in addition to making it easier to “Pay Yourself First”
Pay down mortgage, or save/invest?
  • Those of you who have mortgage(s) will have to make a decision to either allocate your extra cash to paying down the mortgage or saving.  There is no right or wrong, so I suggest that you do what feels best for yourself and based on your risk/return preferences
    • Pay down your mortgage
      • Pros
        • Pay off your mortgage faster
        • Peace of mind from having less debt
        • Pay less interest
      • Cons
        • If the expected rate of return (after tax) on investments is higher than your mortgage interest rate, this is not the financially optimal option
    • Invest
      • Pro
        • Potential to earn more from investing (after tax) vs. your mortgage interest rate 
      • Cons
        • There is no guarantee that your investments will outperform your mortgage interest rate on an after-tax basis
        • Takes longer to pay down your mortgage
        • May be less comfortable having more debt
        • Pay more interest

In the next post, I will wrap up this six-part series on Coaching the Average Canadian Household.  We will tie it all together by taking a look at how the Average Canadian Household could improve their financial situation by tracking their finances like a business, aligning their essential expenses, discretionary expenses, and earnings with their values, and constructing a debt paydown and/or savings plan.

If you are interested in my Financial Coaching Program, get more information on the program here and sign up for your free consultation.

Your Largest Expense: Taxes – RSP’s and TFSA’s for Canadians

When the average person is asked what their three largest expenses are, they probably say Housing, Transportation, and Food.  What a lot of people miss is the fact that their single largest expense may be tax.  Especially when you add it all up – federal income tax, provincial income tax, sales tax, capital gain tax, dividend tax, etc.  When I look back on 2020, my personal income tax (not including other taxes) exceeded my total expenses (essential and discretionary) by 2x.  That’s right, my tax bill was twice as much as ALL OF MY EXPENSES COMBINED!   I know I am not alone here.  As has been said before, the only sure things in life are death and taxes.  You aren’t able to avoid paying taxes, however there are numerous legal ways to pay less.  The government of Canada has created tax-advantaged savings vehicles that Canadians can use to reduce their overall tax bill.  You can tell that most of these vehicles are worthwhile since the government has capped the maximum amount that you can put into each of these.  If they didn’t save you tax dollars (decreasing dollars going to the Canada Revenue Agency), they wouldn’t have maximum contribution limits.  I have outlined the two key plans that Canadians can use to reduce their tax bill below:

Registered Savings Plan (RSP)
  • How much can you contribute?
    • 18% of your earned income in the previous year up to an annual limit (for 2021, the annual limit is $27,830 – note that the limit changes every year)
      • Unused RSP contribution room can be carried forward indefinitely
    • Your personal RSP contribution room can be found on CRA online, on your notice of assessment, or on Form T1028
      • It is best to check your personal contribution room since it can be different from the contribution limit noted above due to Past Service Pension Adjustments and Pension Adjustments (complicated adjustments that go beyond the scope of this post)
  • What is the benefit of an RSP?
    • Deferred tax! – Contributions within the limit are tax deductible (i.e. reduces your taxable income in the year of the contribution).  Tax will eventually have to be paid upon withdrawal, however between contribution and withdrawal, the investments can grow tax-free
    • Some employers offer RSP contribution matching – Check with your employer if you aren’t already signed up!
    • Home buyers plan – You can take up to $35,000 out of your RSP to put towards the down payment on your first home and you won’t be taxed on it.  However, you do have to pay it back into your RSP over the next 15 years (keep in mind that if you do this, you will miss out on the growth during this period of time)
    • Lifelong learning plan – you can take up to $10,000 in a calendar year (up to $20,000 in total) from your RSP to finance full-time training or education for you or your spouse or common-law partner.  However, you do have to pay it back into your RSP over the next 10 years (as above, keep in mind that if you do this you will miss out on the growth during this period of time)
  • What can I invest in?
    • An RSP is an account (not an investment).  You can hold various investments within an RSP account
    • According to the Canada.ca website, RSP is “an investment in properties (except real property), including money, guaranteed investment certificates, government and corporate bonds, mutual funds, and securities listed on a designated stock exchange”
    • An RSP can be self-directed (you can manage it yourself) or professionally managed (using a professional money manager)
  • What to watch out for?
    • This is a LONG TERM savings vehicle – don’t contribute to an RSP unless you are sure you will not need the money until you plan to take it out (e.g. don’t use an RSP as an emergency fund)
      • If you have to withdraw your RSP early, your withdrawal will be subject to tax – the withdrawal will be added to your taxable income for the year
      • If you withdraw, you lose that contribution room permanently
    • Optimize your contribution by thinking about what tax bracket you are in and how a tax-deductible RSP contribution may reduce your income and put you in a lower bracket
      • Example (using made up numbers for simplicity)
        • Assume
          • Taxable income of $52,000
          • You have unused RSP contribution room of $9,000
          • Tax rates (Canada has progressive tax rates whereby your tax rate increases as your income increases).  The below are illustrative only
            • 25% up to $50,000
            • 30% above $50,000
        • If you contribute the full $9,000, your taxable income will reduce to $43,000
          • Your total tax savings will be $2,350 (calculation below)
            • 30% x $2,000 = $600 (you get 30% benefit until your taxable income drops to the bracket threshold of $50,000)
            • 25% x $7,000 = $1,750 (once your taxable income drops below $50,000, you only get a 25% benefit since you have dropped a tax bracket.  In this case you may be better off making a partial contribution this year, e.g. only contributing enough to get you to the $50,000 threshold where your tax rate increases from 25% to 30% and then carrying forward the rest if you expect to be in a higher tax bracket in the future)
      • This is a bit more complex so please reach out to me if you need help
    • The deadline for RSP contribution is always 60 days after the end of the previous year (to be eligible for a deduction for the 2020 tax year, you would have had to contribute to your RSP by March 1, 2021
    • Don’t overcontribute – steep penalties apply
    • When you withdraw money from your RSP, the amount that you withdraw is added to your taxable income that year.  The idea is that you contribute when you are working and are in a higher tax bracket, the money grows all throughout your career tax-free, and then you get taxed when you withdraw it during your retirement – when your income is lower and you will likely be in a lower tax bracket
    • When you turn 71, you have to convert your RSP into a Registered Retirement Income Fund (RRIF) and are required to make minimum withdrawals each year
  • More here
Tax Free Savings Account (“TFSA”)
  • How much can you contribute?
    • You start accumulating TFSA room the year you turn 18 years old, and you continue to accumulate contribution room until you die
    • The annual TFSA dollar limits by calendar year are as follow:
      • 2009 to 2012: $5,000
      • 2013 to 2014: $5,500
      • 2015: $10,000
      • 2016 to 2018: $5,500
      • 2019 to 2020: $6,000
    • Unused contributions can be carried forward to future years
    • You will not accumulate contribution room if you are a non-resident
  • What is the benefit of a TFSA?
    • Investments within a TFSA grow tax-free, and are not taxed when you withdraw them (however a TFSA contribution is made with after-tax dollars)
    • Suitable for short term savings – withdrawals from TFSA’s are not subject to tax and you don’t lose your contribution room permanently (your withdrawal in a given year is added back to the following year’s contribution room)
  • What can I invest in?
    • Similar to RSP, TFSA is an account (not an investment).  You can hold investments within a TFSA account.  The “Savings Account” part of the name is quite misleading
    • You can invest in the same types of investments that are permitted for an RSP
    • Also similar to RSP, TFSA can be self-directed or professionally managed
  • What to watch out for?
    • TFSA contributions are made with after-tax dollars (you do not get a tax deduction for contributing to your TFSA)
    • Don’t overcontribute to your TFSA as penalties for overcontribution can be very steep
  • More here
RSP or TFSA?
  • You may wonder whether it is more advantageous to contribute to an RSP or a TFSA
  • Optimally, I say do both!  I max both my RSP and TFSA every year.  That said, this may not be feasible for everyone.  Whether to contribute to your RSP or TFSA first depends a lot on your individual circumstance
    • If you are a high income earner now and paying tax at a higher marginal tax rate now than what you expect to pay in retirement, contributing to your RSP first probably makes more sense
    • If you are a low income earner now and are likely to pay tax at the same or lower marginal tax rate in retirement, contributing to your TFSA might make more sense
  • Liquidity
    • Don’t fund your RSP unless you are absolutely sure you won’t be needing the money for a very long time.  If there is any doubt, contribute to your TFSA instead – where withdrawals and deposits are flexible
      • With the RSP, you get hit with tax when you withdraw.  In addition, you can’t put money back in – you lose the contribution room forever

Disclaimer: Please note that I am NOT an accountant / tax professional and all of the above are only my opinions, NOT tax advice.  Please make sure you consult with a qualified tax accountant / professional before executing any tax strategies. 

Financial Coaching the Average Canadian Household (Part 4 of 6)

Part 4: Aligning Earnings with Values

This is the fourth post in a series of six that walks through a theoretical exercise of me financially coaching the Average Canadian Household (as defined by Statistics Canada data) to see how we could improve their financial situation.

In the first post, we did a deep dive into the Average Canadian Household’s finances, looking at their income, expenses, and net worth.

In the second post, we did a deep dive into the Average Canadian Household’s essential expenses.

In the third post, we did a deep dive in to the Average Canadian Household’s discretionary expenses.

This post we will talk about aligning earnings with your values.  What do I mean by this?  I want everyone to understand that they are in control of how much they earn and they should adjust how much they earn based on what kind of life they want to live, how fast they want to reach financial independence, and what kind of balance they want to have along the way.  It’s also important to point out that there are several ways to increase your employment income and/or earn money outside of traditional paid employment.

If after going through the first three posts of this series, you feel that you can’t cut expenses anymore without depriving yourself or decreasing your quality of life, you may not have a spending problem.  Rather, you may have an earning problem.  If this is the case, you may want to spend some time thinking about how you can increase your income to create a larger gap between income and expenses, thus saving more.  As mentioned at the end of the last post, I view cutting expenses as “playing defense” and earning more as “playing offence”.  Unlike expenses where you can only cut so much without decreasing your quality of life and/or being deprived, there is no upper limit on the amount of money you can earn.  Let’s talk about a few ways that you can earn more.

Eliminate limiting beliefs!
  • This is extremely important.  I feel that a lot of people limit the amount of money that they earn by having limiting beliefs (they don’t believe that they are capable of earning more).  Examples of limiting beliefs are:
    • I’m not smart enough to do that
    • I’m not cut out to be a manager
    • I could never earn more than $100,000 a year
  • If you have limiting beliefs, it is important to work on disproving limiting beliefs and replacing them with empowering beliefs
Take ownership of your current situation
  • I love this quote:

“You are where you are and what you are because of yourself.  Everything you are today -or ever will be in the future – is up to you.  Your life today is the sum total of your choices, decisions and actions up to this point.  You can create your own future by changing your behaviors.  You can make new choices and decisions that are more consistent with the person you want to be and the things you want to accomplish with your life” – Brian Tracy

  • It’s so easy to shift the blame to others when you are not where you want to be (either financially, or in other parts of your life).  Maybe you think your boss is a horrible person and it’s their fault you don’t make more money.  The reality is that you decide where you work and if you’re not happy, you can leave
  • If you aren’t where you want to be, invest time and money to improve your situation.  This may mean making some personal sacrifices.  For example, maybe you spend time studying or researching new jobs or ways to earn more money rather than watching TV at night (don’t worry, you can add the TV back when you are where you want to be!)
Traditional employment
  • How can you earn more in traditional employment?  Make yourself more valuable to your company.  There is a good book called the “Go-Giver” that illustrates two principles that apply here:
    • The law of value – your true worth is determined by how much more you give in value than you take in payment
      • You are in control of the value that you produce for your company – you can make yourself more valuable to the company you work for by increasing your skills that are relevant to your job (e.g. take continuing education courses that can make you a more valuable employee, or find a mentor in your company that is in a position where you want to be so they can help you get there).  The more valuable you become, the harder it is to replace you and the more an employer will be willing to pay you
    •  The law of compensation – your income is determined by how many people you serve and how well you serve them 
  •  If you really feel stuck (with limited upside to compensation) and/or don’t enjoy working in your current company / team / field / industry, consider whether changing companies or taking a career pivot makes sense.  Maybe take some night classes on the side to try to switch to something else? 
Earning money outside traditional paid employment
  • Side hustle – there are various levels of “side hustles” that anyone can do to make money aside from traditional employment (or instead of traditional employment)
    • Entrepreneurship – start your own business!
      • This can either be a full-time endeavor or “on the side”.  It’s not for everyone since starting a business from scratch takes a lot of hard work and dedication
      • My advice to somebody who wants to start a business is to find their
        “Ikigai”.  This is what led me to start this website and a financial coaching / guest speaking business
      • What the heck is Ikigai?
        • Ikigai is a Japanese concept that means “a reason for being”.  The word refers to having a direction or purpose in life, that which makes one’s life worthwhile, and towards which an individual takes spontaneous and willing actions giving them satisfaction and a sense of meaning to life.  This colourful diagram sums it up quite nicely:
      • If you find a business idea that aligns with your Ikigai (something you love doing, something that you are good at, something the world needs, and something that you can be paid for), it won’t feel like work at all
    • Work on the side – if being an entrepreneur doesn’t run in your veins, you can always do some work on the side, trading your time for money alongside or instead of traditional employment.  Generally the easiest place to start is where you already have experience.  Examples of this would be an accountant who does tax returns on the side, a mechanic who works on cars on the side, or a roofer that does some other roofing work outside of work hours
    • Gig economy – there are all sorts of “gig economy” jobs (“gigs”) where you can make money from the comfort of your home or your car and have an extremely flexible work schedule.  Examples of this:
      • Driving, or delivering food (e.g. Uber, Lyft, Uber Eats, Skip the Dishes, etc.)
      • Turo – renting out your car
      • Airbnb – renting out part or all of your home
      • Freelancing – check out Fiverr or Upwork
      • Rover – dog sitting / walking
  • Investment income – once your start to accumulate an investment portfolio, your portfolio can start to work for you, each dollar acting as one of your “employees”.  The great thing about these dollar employees is that they will work round the clock to earn money for their keeper.  As you portfolio matures, these dollar employees gradually take over, allowing you to work less and eventually not at all (the point at which your portfolio is sufficient to cover all of your expenses, i.e. financial independence)
    • Public investments – traditional asset classes such as stocks, bonds, guaranteed investment certificates (including products that aggregate these investments such as exchange traded funds and mutual funds)
    • Private investments – other asset classes such as real estate, private businesses, private lending, timberland, farmland, etc.
Working too much?
  • Although most people are probably in the “not enough money and want more” camp, there are others that have plenty of money but may be working so much that work has completely taken over their lives and they don’t have balance in their life
  • I’ve personally heard many stories of people who are paid very well (e.g. investment bankers, lawyers) but fail to be happy.  If you feel this might be you, I encourage you to read the story below about a Mexican fisherman.  Take time to step back and think about why you are working so hard and what you are ultimately trying to achieve.  The key message here is that sometimes you can achieve a very good quality of life with less

The Mexican Fisherman:

An American investment banker was at the pier of a small coastal Mexican village when a small boat with just one fisherman docked.  Inside the small boat were several large yellowfin tuna.  The American complimented the Mexican on the quality of his fish and asked how long it took to catch them.

The Mexican replied, “only a little while”.  The American then asked why didn’t he stay out longer and catch more fish?  The Mexican said he had enough to support his family’s immediate needs.  The American then asked, “but what do you do with the rest of your time?”

The Mexican fisherman said, “I sleep late, fish a little, play with my children, take siestas with my wife, Maria, stroll into the village each evening where I sip wine, and play guitar with my amigos.  I have a full and busy life.”  The American scoffed, “I am a Harvard MBA and could help you.  You should spend more time fishing and with the proceeds, buy a bigger boat.  With the proceeds from the bigger boat, you could buy several boats, eventually you would have a fleet of fishing boats.  Instead of selling your catch to a middleman you would sell directly to the processor, eventually opening your own cannery.  You would control the product, processing, and distribution.  You would need to leave this small coastal fishing village and move to Mexico City, then L.A. and eventually New York City, where you will run your expanding enterprise.”

The Mexican fisherman asked, “But, how long will this all take?”

To which the American replied, “15 to 20 years.”

“But what then?” asked the Mexican.

The American laughed and said, “That’s the best part.  When the time is right you would announce an IPO and sell your company stock to the public and become very rich, you would make millions!”

“Millions – then what?”

The American said, “Then you would retire.  Move to a small coastal fishing village where you would sleep late, fish a little, play with your kids, take siestas with your wife, stroll to the village in the evenings where you could sip wine and play your guitar with your amigos.”

Source: https://bemorewithless.com/the-story-of-the-mexican-fisherman/


I hope you all found this post encouraging.  For those of you who are already able to save a significant portion of your earnings or are close to financial independence, maybe you don’t need to focus so much on earning more.  Most people can benefit from the offensive strategy of earning more, whether that is from additional employment income, something on the side, or an entrepreneurial venture.  This can allow you to increase your spending and/or increase your savings and decrease the amount of time to reach financial independence.  I think everyone can benefit from taking a step back and evaluating your overall situation to ensure that you are happy where you are, and doing what you like doing.  If not, you all have the power to change your situation for the better.  Find your Ikigai!

Now that we have covered an overview of the Average Canadian Household finances, aligning essential expenses with values, aligning discretionary expenses with values, and earning more, in the next post, we will discuss constructing a debt-paydown and/or savings strategy.

If you are interested in my Financial Coaching Program, get more information on the program here and sign up for your free consultation.

Financial Coaching the Average Canadian Household (Part 3 of 6)

Part 3: Aligning Discretionary Expenses with Values

This is the third post in a series of six that walks through a theoretical exercise of me financially coaching the Average Canadian Household (as defined by Statistics Canada data) to see how we could improve their financial situation.

In the first post, we did a deep dive into the Average Canadian Household’s finances, looking at their income, expenses, and net worth.

In the second post, we did a deep dive into the Average Canadian Household’s essential expenses.  Now on to discretionary expenses.

What do I mean by discretionary expenses?  If essential expenses are the “needs” (recognizing that our essential expenses often go way beyond our basic needs), discretionary expenses are the “wants”.  These are things that (hopefully) add value to our lives beyond the basic needs.  Everyone has very different views on where they should spend their money in discretionary categories and everyone is different.  I’m not here to judge anyone, more just to make sure that their spending is aligned with their values.  People need to understand that they are ultimately trading their time to buy stuff or experiences, so the stuff or experience better be worth it!.

It’s not about deprivation!  But being in debt can be a unique circumstance

I’m not the kind of financial coach that is going to tell you to stop buying your $5 coffee every day.  I’m all for it it as long as you get value from it.  That said, I believe that if you have outstanding high interest consumer debt (e.g. credit cards, payday loans, etc.), it may warrant cutting back on discretionary expenses temporarily in order to disentangle yourself from that vicious web as soon as possible.  Every extra dollar that you can put towards your debt load counts and small amounts add up over time.  The financial independence blogger, Mr. Money Moustache wrote a great post about referring to debt as an “emergency”.  Here it is: https://www.mrmoneymustache.com/2012/04/18/news-flash-your-debt-is-an-emergency/.

Here’s the breakdown of discretionary expenses for the Average Canadian Household (based on Statistics Canada data):

Travel

  • I am actually happy to see that travel is the #1 discretionary expense category for the Average Canadian Household.  I love to travel and think that travel expense is closely aligned with the values of many Canadians.
  • General savings tips on travel:
    • For flights, I use google flights
      • This allows you to find the lowest prices across various airlines
      • Generally, I find you can save a lot of money if you can be flexible with your dates (e.g. for a vacation, sometimes you can save significantly on flights if you depart and arrive mid-week rather than on a Saturday or Sunday when everyone else is travelling)
    •  Accommodation
      • I look for the best hotel deals on an aggregator site like Expedia or Booking.com
      • I have had great success staying in Airbnb places as well.  It is often similar or cheaper than staying in a hotel.  In my experience, you get a lot more space (relative to a hotel room) plus the added benefit of meeting other people.  Every host that I have stayed with using Airbnb was fantastic and really gave me a sense of how it is like to live in different areas throughout the world
      • These aren’t for everyone but can be very budget-friendly alternatives:
        • Hostels – I love staying at hostels because I find I meet so many new people.  This isn’t for everyone, but that’s okay.  There are hostels everywhere, particularly in expensive cities
        • Camping – I’m a big fan of the outdoors and will often choose sleeping outdoors over inside
    • Package trips
      • Sometimes you can save a bundle buying a package trip that includes flights and accommodation.  I did a few of these during university and my early working years for a quick and easy getaway to a sun destination.  It’s sometimes nice to book everything as a package to avoid the analysis paralysis associated with booking flights and accommodations separately
    • Travel rewards
      • I’m a big fan of using credit cards that give me reward points or cash back for travel purchases.  This isn’t for everyone and I would only recommend doing this if you can pay your credit card off in full every month.  If you can’t pay off your credit card in full every month, I don’t recommend using it as the interest charges will likely outweigh any benefit that you will get from points.  My travel expenses have been significantly reduced from using travel reward dollars
    • Loyalty programs
      • Most airlines and hotel chains have loyalty programs.  If you travel a lot, it really makes sense to sign up for the loyalty programs as the benefits can accrue quite quickly.  Sometimes loyalty points and travel rewards from credit cards are also interchangeable / exchangeable
Entertainment

  • Recreation services
    • TV & satellite radio
      • Consider switching from more expensive cable TV package to less expensive streaming services like Netflix / Prime Video / Disney Plus
      • I don’t watch a huge amount of TV but a good show or movie can be a great way to unwind!
    • Recreational facilities
      • I know a lot of people love going to the gym and other recreational facilities (for the exercise benefit and social interaction with others).  I prefer to do most of my workouts outdoors (hiking, walking, cycling), but occasionally enjoy the gym, especially in the middle of winter!  Some people are guilty of signing up for gym memberships and hardly using them – if you are one of them, use it or cancel it!
    • Live events
      • Concerts and sporting events can be a great way to spend money and something that can provide lasting memories
  • Electronics
    • With most electronics, rather than buy the latest and greatest, I usually consistently stay a couple years behind the newest technology.  This can save you big bucks.  For example, the newest cellphones right now are around $1,500, however you can get a brand new older model for less than half of that price.  Same goes for TV’s, computers, etc.  I absolutely don’t feel deprived or like I’m missing out by using an older model
  • Recreational vehicles
    • I’m not a huge fan of RV’s (more of a tent guy myself) and various toys (e.g. boats, ATV’s) but I know many Canadians get tremendous value from these purchases.  The only thing that I would say here is to make sure that you consider rent vs. buy (whether you will get enough use out of these items every year to justify the capital required and additional work associated with owning these items – e.g. maintenance, storage, etc.)
    • I would love to get a motorbike but unfortunately both my mom and my wife are against it.  I know better to mess with these two women!
  • Reading materials
    • I’m personally a big fan of the library – a good way to save money on reading material and avoid cluttering your home with hundreds of books
Food – Fine Dining
  • The average Canadian Household spends just over $200 a month eating out at restaurants.  I don’t think that average sounds bad at all.  I quite like eating out occasionally.  My general principles are:
    • If I can do it better at home for less – do it!  For me, this applies to most things barbecued.  It pains me to pay $40 for steak at a restaurant if it isn’t cooked to my liking.  For other things that I don’t know how to make, or would take too much time to prepare, or would have to spend a lot to buy the ingredients (e.g. sushi), I am always happy to go out and pay for these meals
    • Don’t eat out alone (unless you enjoy it) – part of eating out for me is the company / social aspect, so I generally don’t eat out alone
    • Only eat out occasionally – I find that I enjoy eating out more if I only do it once or twice a month.  That’s just me since I find that if I eat out too regularly, it just becomes the new normal
Communications
  • Canadian’s pay WAY to much for communication (cell phones, home phones, internet) due to the oligopoly that exists with the big players (sometimes I really think they collude and raise their rates in tandem), the geographic sprawl of the country, and the low population density relative to other countries.  There have been studies done that show that Canada has one of the most expensive rates for wireless voice and data rates
  • The Average Canadian Household pay over $100 per month for cell phone alone
    • I have heard of many people that pay over $200 per month for a single cell phone plan!  I definitely recommend looking at cheaper alternatives.  There are certain companies (e.g. Public Mobile, Fido, Koodo) that offer much cheaper plans than the big players (Telus, Rogers, Bell).  These alternatives often provide the exact same service as the big players for a lower cost (mostly because they are owned by the big players)
  • Same goes for internet – there are cheaper plans available from smaller companies that use the same networks that the big players use.  I recently switched my internet service to Lightspeed from Telus.  Doing this, I was able to save more than 40% and get a faster service compared to what I had with Telus.
Gifts
  • I personally get a lot of value in gift-giving.  This is probably one of those categories where you can spend relatively guilt-free.  That said, you have to make sure you are keeping within your means – for example, maybe don’t buy your kid a car if you have significant consumer debt that is dragging on your own financial situation.  If your strapped for cash, less-expensive sentimental gifts can go a long way and can sometimes mean more to the recipient than something material or expensive.
Alcohol
  • In my younger years, I spent a significant amount of money on drinking especially at bars and restaurants.  In hindsight, I wish I had poured that cash into index funds instead!  That said, live and learn – was fun while it lasted.  The mark up on alcohol at restaurants is among the most ridiculous (e.g. paying $10 for a beer, or $13 for a glass of wine when you know you can buy the bottle for less than $10 at a retail store).  When you do drink out with your buddies, watch out for deals, e.g. 1/2 price wine Wednesdays, happy hour, etc.
Financial Services
  • There is no need to pay for financial services.  I’ve never paid a bank fee or interest charge in my life.  There are a couple options here for low-cost / free banking:
    • Go with a no-fee chequing / savings account like Tangerine or Simplii
    • Go with a full service bank that will waive the monthly fee for a chequing account if you maintain a certain minimum balance.  This is what I chose to do – I have TD’s best chequing account and don’t pay the ~$30 monthly fee since I maintain a minimum balance of $5,000 at all times.  I realize that there is an opportunity cost to having that $5,000 tied up, however, I do feel that the other benefits that I get outweigh the costs (e.g. annual fee waived on my TD First Class Travel Visa card, free safety deposit box, free bank draft and cheques whenever I need them, unlimited transactions, etc.)
Donations
  • I think donation is a very important discretionary expense that most people should try to increase over time as their wealth accumulates.  Don’t forget to keep the receipt if the donation is tax deductible since it can save you some money during tax season
Pets
  • This is expense category that I’m not going to mess with.  I know of many people who love their pets like children.  I think pets can be a very worthwhile discretionary expense as far as bringing happiness to lives
Gambling
  • I would advise that you only gamble occasionally for entertainment and only in small amounts that you are 100% okay with losing if things don’t go your way.  I personally enjoy playing a little bit of Blackjack when I’m in Vegas (at least there you get the benefit of free drinks!)
Tobacco
  • I don’t smoke, so don’t have too much to say here.  I do have family members and friends who quit smoking and noticed significant financial and health benefits by doing so.  That said, some people truly get enjoyment from smoking and choose to do so regardless of health and financial implications.  To each their own

At this point, we have analyzed the Average Canadian Household’s financial situation and talked about potential ways to decrease essential and discretionary expenses.  I view decreasing expenses as playing defense.  There is only so much you can cut without depriving yourself.  To have a happy life, you need to figure out what level of expenses are right for you (not so high that they will impair your ability to save for financial independence, but not so low that you feel deprived and not enjoy the journey).  Next post, we will talk about playing offence by earning more money.  Whereas the amount of expenses you can save is limited, there is no cap on the amount of money you can make!

If you are interested in my Financial Coaching Program, get more information on the program here and sign up for your free consultation.

Financial Coaching the Average Canadian Household (Part 2 of 6)

This is the second post in a series of six that walks through a theoretical exercise of coaching the “Average Canadian Household” to improve their financial situation.  In the first post, we did a deep dive in to the Average Canadian Household’s finances – looking at their income, expenses, and net worth.

In my coaching program, once we obtain some data from tracking the client’s income and expenses (essential and discretionary), we work together to figure out where we can focus improvements in their financial situation, generally prioritizing changes that are likely to to have the greatest impact.  In this post, let’s deep dive into the Average Canadian Household’s essential (vs. discretionary) expenses.  Why start with essential expenses?  Looking at the two donut charts below, “Essential Expenses” is 55.5% of the Average Canadian Household’s Gross Income (“gross” means before deductions such as Tax, Canada Pension Plan (“CPP”), and Employment Insurance (“EI”) contributions).  At the Net Income level (only the amount that is left over after paying mandatory deductions), Essential Expenses is a whopping 71.5% of overall net income.  This is why we will start here.  When we think about “essential” expenses such as food, home, and vehicle, it is not surprising to overlook them as high potential saving areas since they are deemed necessities.  However, how much you spend on housing, and what kind of car you drive will have a huge impact on how much you actually spend on essentials, which flows through to your savings rate and impacts the amount of time that you need to work to reach financial independence.  The other thing I want to note and say again on this blog is that I’ve listed a bunch of ideas on how somebody may go about decreasing their expenses.  That said, the whole list is not meant for everyone!  Each individual and family has to decide what are important to them and then spend on those accordingly (aligning spending to values) – guilt free, as long as they consider the “time for money” and “money for stuff” tradeoffs that we make each day (often times, unconsciously).

What are Essential Expenses?

Now, let’s dive a bit deeper to see what really makes up “essential expenses” for the Average Canadian Household.  Here is the breakdown for 2017:

Not surprisingly, the three largest essential expenses are Housing, Transportation, and Food.  Generally, it is a good idea to start optimizing the largest expenses first since even marginal changes in these big categories can make a huge difference to the household bottom line (savings).

Housing

As mentioned in my last post, using data on the Average Canadian household isn’t perfect.  In the housing category, it clearly shows that some Canadians own their own homes and some choose to rent.  Obviously with an individual household it would only be one or the other, however, I will discuss both here.

Whether you decide to rent or buy, the key to minimizing costs in the housing category is to not buy or rent more than you need / can afford.  There is a good quote that illustrates the benefit of this:

“If you will live like no one else, later you can live like no one else.”-Dave Ramsey

My personal situation is a good reflection of what this means.  I very intentionally chose to live below my means throughout my 20’s.  For housing, I chose to:

  • Live with my parents during University rather than live on campus (I was fortunate to study in my hometown of Edmonton, AB)
  • Live with my parents for a few years after graduating
  • When I eventually moved out, I rented a place that was well below my means

Because I did the above, I was in the position in my early 30’s to buy a car with cash and a buy a house without a mortgage.  I chose an unconventional approach initially and “lived like nobody else” so that I could “later live like no one else”.  Certainly not saying that nobody else owns their car and house outright, however, it is rare for those in their early 30’s.

When choosing where to live, consider what you value more:

  • Pay more to be closer to work and save time / money on your daily commute
  • Pay less by living further away from work and spending a bit more time / money on your daily commute

When comparing buying vs. renting from a financial standpoint, it is absolutely critical to consider sunk costs of ownership beyond just your mortgage payment (e.g. property tax, maintenance, insurance).

When buying a property, consider the following:

  • What percentage does your house make up in your investment portfolio?  This was the key reason why I chose not to purchase a home in my 20’s – I didn’t want a single, illiquid asset to make up >100% of my networth.  Now that I have accumulated more wealth, the purchase doesn’t look so big relative to my overall portfolio
  • Make sure you do your due diligence so you are less likely to have surprises down the road.  For example:
    • If you are buying a home, I have detailed my due diligence process in this post
    • If you are buying a condo, research the condo’s reserve fund and read the engineering studies that detail expected capital expenditures going forward – I have heard many horror stories about people who bought condos and later received “special assessments” for unexpected repairs to the buildings – sometimes to the tune of $20,000-$30,000 per unit
  • It costs more than just the mortgage payment (my point above on sunk costs of ownership)
    • As you can see below, when you own a home or condo, your mortgage payment is only part of the donut (54.8% on average).  You must not forget about property taxes, other expenditures, homeowners’ insurance, repairs and maintenance and condo fees – they really add up!

When renting a property, consider the following:

  • To evaluate whether you are getting a good deal, think of the rental from the landlord’s perspective by calculating the rate of return they are earning on their investment.  To do this:
    • Take your gross monthly rent and multiply by 12 to arrive at your annual gross rent
    • Figure out the property value – generally this can be easily found using city property value assessment maps online or by looking at comparable properties on a real estate search website like realtor.ca
    • Take your annual gross rent and divide it by the property value to get a percentage.  This percentage is the gross rate of return that the landlord is getting (before expenses).  To get a net return, you can decrease the numerator by property taxes (can usually be found online), maintenance expenses or condo fees (can be estimated or found online), and insurance.
  • If the return is sufficiently high and you plan to stay in that location for a significant period of time (5-10 years or more), then you may want to consider buying

Live alone or live with others

  • One way to decrease your housing expense is to live with others.  This isn’t for everyone and some people value their independence more than the cost and/or income associated with having a roommate or tenant.  There are a few ways to do this:
    • Live with a roommate and share the costs for a place – for example, it is generally cheaper for 2 people to share the costs for a 2 bedroom property vs. 1 person having a 1 bedroom property
    • Rent out part of your principal residence (e.g. bedroom, basement, etc.) – some people call this “house hacking”
      • I’ve heard of some people being able to rent out their basement and the rental income from their tenant cover their entire mortgage
      • Others take this to the next level and buy a multi-bedroom house or a multi-unit residential complex and rent out rooms or units – in some cases, the owner was able to completely offset their own living expenses and bring in additional income (effectively negative housing costs!)
Utilities

According to Statistics Canada data, the Average Canadian Household spends ~$2,484 on utilities each year.  From a house perspective this seems a bit on low, however, don’t forget that the “average” in the data includes not only houses but also rented or owned apartments and condos.  Some utilities in this case would likely be included within the monthly rent and condo fees.  My view on utilities is that if you can decrease your use of electricity, natural gas, and water without negatively impacting your life, why wouldn’t you!  There is a double benefit to your bank account and the environment from doing so.  Here’s the breakdown of the average utility spend per year:

I started putting down various ideas to reduce utility usage / increase efficiency and plan to write a whole separate post about that.  For now, check out the EPCOR website for some great efficiency tips that can save you money and the environment:  https://www.epcor.com/learn/efficiency-conservation/Pages/default.aspx

Transportation

The average Canadian household spends $12,707 on transportation each year – that is over $1,000 a month just to get around!

Here’s the breakdown:

Vehicle Operations

  • Similar to house ownership costing more than just the mortgage payment (e.g. property taxes, maintenance, insurance, etc.) the cost to keep a car on the road for the Average Canadian Household actually exceeds the average cost of the car itself!  Let’s break it down further:

A few ideas to optimize vehicle operation expenses:

  •  Gas
    • Drive a more fuel efficient vehicle
    • Use an app like Gas Buddy to optimize fuel costs – be careful about spending too much time on this since it usually isn’t worth your time (or gas) to drive across town to save a few cents per litre on a 50 litre tank.  I fill up at Costco only when I’m there – I never make a special trip
    • Drive less
      • Try to plan where you need to go to minimize driving
      • Try cycling or walking to destinations that are close to home – good for your health too!
  • Insurance
    • Get quotes from multiple companies
    • Bundle your car insurance with your home or tenant insurance to get a discount
  • Maintenance and repairs
    • Perform scheduled preventative maintenance on your vehicle so that you lessen the chance of larger things coming up (e.g. regular oil changes, etc.)
    • When you do need major work done, shop around – I like to do this in an efficient manner by sending the same e-mail to several shops requesting a quote for the work that I need done
  • Registration fees
    • No getting around these unfortunately
  • Tires, batteries, and other supplies
    • Shop around for deals
    • I ended up getting tires at Costco since they were high quality and good value – Costco also ended up being WAY cheaper than other shops for the semi-annual switchover (in Canada, we have winter tires for the ice/snow and summer tires)
  • Parking
    • Try to park further away – save a couple bucks and get some exercise
  • Licensing
    •  No getting around this unfortunately

Vehicles themselves

  • Looks like most people in Canada purchase their vehicles, however, some do lease

  • Purchased vehicles – here is the breakdown of average annual expense by vehicle type.  My advice here is to try to buy what you need.  Maybe you don’t need a Ford F-350 if you are just picking up groceries once a week from the store (I know, not really an Albertan thing to say).  Also, if it is possible for a family to get away with only having one car, it can lead to very significant savings (obviously this is a tradeoff though, and if it really decreases your quality of life having only one vehicle in the household, it may not be worth it) 
    • Trucks & SUV’s
      • I’m from Alberta and with the number of trucks I see on the road, it doesn’t surprise me to see that this category is #1 (exceeding cars and vans on a combined basis)
      • In my experience, I find that trucks and SUV’s are generally more expensive than cars – not only during the initial purchase but from an operational cost perspective (since they aren’t as fuel efficient)
    • Cars
      • My family of four grew up having 4-door sedans for the most part so I ended up buying a 4-door sedan.  People say that you “need” a van or an SUV for a small family, however, so far it has been working out great for us.  Let’s see what happens when we have two kids – maybe I’ll change my mind?
  • Leased vehicles
    • I’ve heard some people make the case for leased vehicles.  I guess if having a very new vehicle is something you value and you don’t drive a lot (able to stay within the km restrictions and not have to pay too much in overage charges), maybe this does make sense for you.
  • Rent
    • Don’t forget – you can always rent a vehicle if you don’t need it very frequently.  Maybe don’t buy a Yukon XL if you only need the extra space once a year for a trip to the mountains – just buy something less expensive and more fuel efficient for everyday use and rent that SUV for your annual mountain trip

Public Transportation

  • Public transit
    • The fact that the Average Canadian Household spends only $276 per year on public transit suggests that public transit is underutilized
  • Taxi / Other local passenger
    • Consider ride share services like Uber / Lyft to save cash on local passenger travel
  • Household moving
    • I’ve always moved without hiring help.  That said, I’ve only moved 3 times in my life.  My wife has declared that we will be hiring professional movers for our move to the house – she has moved 14 times so I guess that is fair.

Please see my related posts on ideas to reduce transportation expenses and buying a used car.

Food – Groceries & Household Items

We will talk about “Restaurants” in the next post on Discretionary Expenses but just so you know, here is the break down between Groceries and Eating out

Groceries

Some ideas to optimize:

  • Meal plan – plan your meals in advance to minimize wasted ingredients and the need to run back to the grocery store to pick up a missing ingredient
  • Take advantage of quantity discounts for non-perishables – a Costco membership has a pretty short payback period for a regular household
  • I’m all for spending on groceries since I get a lot of value and enjoyment out of high quality, home cooked, nutritious and delicious meals
Other Essential Spending
  • Rather than going into too much detail on the other essential categories (household, clothing, healthcare, education, life insurance), I’ll give some general tips here and write separate posts in the future going into more detail on how you can potentially save money in these categories:
    • Household / Clothing
      • Buy quality products that will last longer rather than cheap products that will have to be replaced regularly – this is also more sustainable for the environment
        • My go-to example here is hiking boots.  I paid $350 for a good pair of hiking boots because I know that they will last me 10+ years – I will get a lot of use out of them, and I value the comfort (waterproof and blister free) over price
      • Take care of the things you buy (preventative maintenance)
      • Think carefully about what you add to your household – we all have a lot of things we don’t even use that just take up space and will eventually take energy to donate / sell / dispose
        • I was watching a show on minimalism the other day and really liked the minimalist approach to building a wardrobe.  The minimalist featured said that every piece of clothing that he owned was his favourite.  So rather than having 100 shirts, he might have 5 but they are all his favourites
      • Buy in larger quantities to get quantity discounts (e.g. Costco)
      • Buy on sale (e.g. past season apparels)
    • Healthcare
      • Compared to our friends south of the border, healthcare is less of a financial consideration for us Canadians due to our public healthcare system (although we certainly still pay for it through taxes!)
      • For anything that is not covered (e.g. prescription medication, dentistry, etc.), if you have a work plan, get familiar with it
      • If you don’t have a work plan, weigh the costs/benefits of signing up for a healthcare and/or dental insurance plan 
    • Education
      • Save for your children’s education using a Registered Education Savings Plan (RESP)
      • Encourage your kids to get good grades in high school and college and maximize extra curricular activities – this sets them up well to apply for scholarships and looks great on resume!
      • I may be biased, but I am a big believer of staying local for your college / university education if you can.  You can save a significant amount of money on living expenses by living at home, and not to mention out-of-state tuition for some countries
        • If you want to go to an Ivy League school, consider doing your undergraduate studies locally and then going to a more prestigious school for your Master’s degree (if you choose to do one)
    • Life insurance
      • I am a fan of term insurance instead of whole life as I figure that my need for life insurance will decrease as my networth increases.  I plan on writing a dedicated post on insurance to detail my thoughts and analysis on the subject soon
    • Childcare
      • This category was minor for the Average Canadian Household (it wasn’t even big enough to justify a label on the donut chart on Essential Expenses at the beginning of the post).  This is likely due to the fact that childcare is only applicable to the subset of Canadian households that have kids.  Furthermore, it is only applicable to those who choose to put their kids in childcare and whose kids are of the age that they need childcare.  That said, it is a major expense for the small subset of Canadians who have young kids and require childcare!  Another thing that this expense category ignores is those parents who decide to decrease their work down to part time or take time off completely to raise their children.  The opportunity cost of those parents not working is definitely not reflected in the numbers and could very well be the largest “expense” of all
      • Ideas to decrease childcare expense:
        • Look at less expensive options like dayhomes
        • Share a nanny with a friend
        • Baby sitter swap – if you choose to work part time or not at all, take turns with a friend to care for your child and your friend’s at the same time

I hope this gave you some helpful takeaways on how to decrease your essential expenses.  We will shift gears and talk about Discretionary Expenses (if essential expenses are “the needs”, then discretionary expenses are “the wants”) in the next post.

If you are interested in my Financial Coaching Program, get more information on the program here and sign up for your free consultation.

Financial Coaching the Average Canadian Household (Part 1 of 6)

Fun fact: I took this picture at the top of Sulphur Mountain in Banff the day I proposed to my wife.  She passed the challenge of climbing to the top (no gondola allowed), so she was rewarded with a ring. Now she has to put up with me for the rest of her life!

I thought I would take the chance to run through what coaching the average Canadian Household would look like.  Through this process, I hope to give my audience a preview of what part of my financial coaching program looks like and some ideas of how they can make positive changes to their own personal finances.

As discussed on my homepage, Canadian’s aren’t saving enough!  Here is the proof:

I know, the chart is small and hard to read.  Let me give you a few highlights:

  • The average savings rate has been trending down for decades (see blue trend line)
  • The 2018 savings rate was the lowest on record since 1961

For a chart you can actually read, let’s just look at the last 10 years.

Key observations:

  • Savings has dropped substantially in the last 10 years
  • Savings rates recently are nowhere near where they need to be for Canadians to reach financial independence!  This means that the average Canadian will likely have to work longer and rely on Canada Pension and Old Age Security in their older years to get by.

It is my sincere hope for the average Canadian Household to increase their savings rate since you know from a previous post that savings rate is the most important financial metric that will determine if and when you reach financial independence.

Please note that this analysis is based on data from Statistics Canada.  This analysis is not perfect because there are certain limitations to using average data.  For example, it assumes the average household has 1.23 kids, rents 44% of their home and owns the other 56%, drives 1.5 cars, etc.  Obviously this doesn’t make sense, however, let’s look past these limitations for now and just focus on the big picture – the fact that Canadians aren’t saving enough.

Part 1: Tracking the Average Canadian Household Finances like a Business

Generally after the free consultation / meet and greet session, the first thing I like to do with my coaching clients is to start tracking their finances like a business.  I’ve detailed some of what I like track in this post.  For most people, it takes a couple months to get used to tracking expenses and start to get some meaningful data.  In this case, for the average Canadian Household, data is plentiful so I was able to get 8 years of data.  Here is what I came up with:

Income & Expenses Table

I was able to leverage my personal finance geek / spreadsheet skillset to come up with the table below that succinctly details the average Canadian Household’s income and expenses.  As you can see, income is positive, expenses are (negative) and the “grand total” at the bottom represents savings -unfortunately not so “grand” in the case of the average Canadian Household.

Networth Chart

Another important metric I encourage my clients to track is networth (that is, total assets minus total liabilities).  This is a good measure of total wealth that can be very motivating to track over time.  Here is where the average Canadian Household came up on networth (grouping in to different age groups and the overall average):

Financial Independence Chart

The following is what I like to call the “Financial Independence Chart”.  It visualizes the subtotals from the four categories in the Income & Expenses Table above and overlays a green line that shows how much of the client’s expenses would be covered if their networth was invested at a 4% annual rate of return.  As you can see, if the average Canadian’s networth was invested at 4% return, the investment income wouldn’t even cover their essential expenses, let alone their total expenses (what is required to reach financial independence).

Summarizing the data table and charts above – the average Canadian Household, in 2017 had:

  • Gross income of $87,341
    • Paid $19,541 in taxes, CPP, and EI (22.4% of gross income)
    • Spent $48,463 on essential expenses (55.5% of gross income, or 71.5% of net income)
    • Spent $17,981 on discretionary expenses (20.6% of gross income, or 26.5% of net income), and
    • Saved a measly $1,356 (1.6% of gross income, or 2.0% of net income )
  • Networth breakdown:

Networth = Assets $861,802 – Liabilities $142,302 = $719,500

After reviewing the data and charts above, I come to a few preliminary conclusions:

  1. Based on the average net savings rate of 2%, ignoring CPP and OAS, the average Canadian household would have to work 77 years to reach financial independence
  2. Real estate represented 42.3% of total assets and 50.7% of networth
    • It’s important to note that from a portfolio perspective, you should think about your real estate exposure as the total value of the real estate assets (not just the equity amount after deducting your mortgage) divided by your total networth (not total assets).  In my opinion, having 50%+ of your networth in a single, illiquid real estate asset in a single market is risky and limits your ability to invest in other investments that are likely to outpace real estate.  This is part of why I decided to rent vs. buy in my early 20’s and held off on buying a house until my early 30’s
    • Most of the data used above is based on the “Average Canadian Household”, however, I also have the ability to cut the data by age group and income quintile.  I couldn’t resist looking at the break down by age group here:
      • What I found was that households in the “less than 35 years” age bracket on average had real estate assets that exceeded their networth! 104% to be exact (using 2017 numbers)
      • This means that the average young household in Canada is extremely exposed to real estate.  That’s all fine and dandy when real estate is booming, however, a retraction in real estate could really deal a blow to these young households (don’t forget if real estate depreciates, the “asset” on your personal balance sheet goes down, but your mortgage doesn’t!).  Not to mention that these young households are probably pouring most of their capital into servicing mortgage debt and other expenses that come along with home ownership.  In some cases, this forces young households to take on additional consumer debt to cover other expenses (higher interest credit card debt, etc.)
  3. I am a bit concerned about the $50,000+ of “other liabilities” as this is likely high interest consumer debt (student loans, credit cards, unsecured lines of credit, payday loans, etc.)
    • Digging further into the data here, and not surprising, younger households and lower income households have a higher percentage of “other liabilities” relative to their overall networth
  4. Based on the amount of tax the average Canadian pays (combined with the low savings rate), it is likely that they aren’t taking advantage of various tax-advantaged accounts that could save them a significant amount of tax expense (specifically, Registered Retirement Savings Plans and Tax-Free Savings Accounts)
  5. Both the fixed and discretionary expense categories seem high relative to total income – this suggests the need to earn more and/or spend less.

There is a lot of room for improvement in the average Canadian Household’s finances.  In my next post, I’ll go through some action steps that could be taken to reduce essential expenses.

Here’s what I have planned for the 6-part series:

Part 1: Tracking the Average Canadian Household Finances like a Business (what you just read)

Part 2: Aligning Essential Expenses with Values

Part 3: Aligning Discretionary Expenses with Values

Part 4: Aligning Earning with Values

Part 5: Constructing a Savings and/or Debt Paydown Strategy

Part 6: The After Picture – How the Average Canadian Household’s Finances Might Look like After JBFI Financial Coaching

If you are interested in my Financial Coaching Program, get more information on the program here and sign up for your free consultation.

Sources:

We bought a house!

Well, we did it!  We pulled the trigger on our largest single expense yet – a house!  I’m not going so far as to calling it an “investment” just yet given it is our principal residence.

Why I chose not to buy a house in my 20’s: (in order of importance to me)
  • Concentration risk: I didn’t want a house (single, illiquid investment with high maintenance and transaction costs) to make up a significant amount of my overall networth / portfolio – in my early 20’s, the value of a house would have likely exceeded my networth!
  • I valued the lower cash costs associated with renting vs. buying
    • In hindsight this ended up to be HUGE since I diligently invested the cash savings from renting vs. buying.  However, if one didn’t save the cash cost differential from renting, he/she would have been better off buying earlier as it would have created “forced” savings
  • I valued the convenience of being close to work / downtown
  • In my singlehood, I valued not having to cut the lawn, shovel the walks, and do everything else that is involved with having a house
So why did we decide to buy a house now? (in order of importance to us)
  • The key reason is that our values have changed.  Now that we are married and have a son, our values have shifted away from the convenience / low maintenance of a downtown condo toward wanting more space and a nice neighborhood
  • It felt right – buying a house is a very emotional decision! A big part of why we bought is because we really liked the house we saw, and just wanted to have a home of our own
  • We’re not as concerned with “concentration risk” noted above given that the house now makes up a much smaller proportion of our networth compared to if we bought in our 20’s
    • One important thing to note here is that we did not overextend ourselves financially.  We ended up buying a house that was well within our means (around 25-30% of what we would have qualified for at the bank)
  • We wanted to feel motivated to make improvements to the place that would benefit us over the long term (if we rented, we probably wouldn’t feel as settled in as if we were to own).  We also found that a lot of houses on the rental market were not well taken care and not necessarily in places that we wanted to live
  • Tax-exempt capital gains!  Since we are using this property as our principal residence, we will not be subject to capital gain tax when we sell it.  Per the Canada Revenue agency website:
  • We have a long term time horizon and plan to live in this house for at least 10+ years.  This makes the economics of the purchase more favourable since various one-time and transactional costs are amortized over a greater number of years (for example, realtor cost, legal costs, and inspection cost)
  • COVID has made our apartment feel smaller!  With three adults and a newborn in a 2-bedroom condo, you can imagine that working / studying / caring for baby can be challenging at times
Our due diligence process:
  • The search
    • My wife and I sat down together to figure out a list of “needs” and “nice to haves”, including preferred vs “blacklist” (less safe) neighborhoods
    • In finding the right neighborhood, I did geek out a bit to try to use “big data” to isolate neighborhoods that met our criteria
      • The City of Edmonton website has data files available for download that show every single property tax assessment in the city (we are talking >100,000 homes!)
      • I filtered out the type of home that we were looking for (e.g. single family detached home)
      • I filtered out homes that were on large lots since a large yard was important to us (> 600 m2)
      • I sorted the list by average distance to downtown (each individual assessment data point gave GPS coordinates so I was able to use math to approximate the average distance to my workplace).  It is important that I am decently close to downtown since I plan on riding my bike to and from work for most of the year
      • Obviously, the neighborhoods closest to downtown (shady “blacklist” neighborhoods aside) sold at a premium to comparable neighborhoods further out
        • After filtering out the shady neighborhoods and then searching for neighborhoods with an average assessment value that was within our target price range, I started to get a really good idea of which neighborhoods we should be targeting
    • We set up a search on realtor.ca that identified homes in our price range in our preferred neighborhoods
    • After looking through hundreds of properties online, we set up viewings and worked with a realtor to view 6 properties
    • The house we ended up making an offer on stood so far above the others we viewed that we put an offer on it right away
      • I don’t know if it was just a coincidence, but we ended up buying in the neighborhood that was at the top of the list once we applied the various filters described above
  • Rent vs. buy analysis
    • Although we had a strong preference for owning a home going forward, we still looked at the rental market to assess value and if there was a deal to be had.  Through our analysis, we found that rental properties in our price range had gross annual rents (before expenses) of between 2.3% and 8.4% of the assessed property value – this equates to net rent (after considering estimated property taxes and maintenance costs) of between 0.3% and 6.4%.  For our place specifically, the estimated gross rent equates to approximately 5.0% and 6.0% (between 3.0% to 5.0% after considering property tax and maintenance).  Therefore, it made sense to capture that return by owning instead of renting.  If we really saw a stellar rental deal and a place we loved, we definitely would have considered renting for a bit longer before buying.  Also, it was nice to have such flexibility.  My wife and I agreed that unless we found something that we were 100% comfortable with and excited about buying, we would continue renting until then
      • We did find one property on the rental market that looked like a stellar deal but it was indeed too good to be true.  It was a $1.3 million house in a fantastic neighborhood that was renting for $2,250 per month (that is around 2.0% of property value, and only about 1.0% after considering the ~$1,000 of property taxes that the owner had to pay).  After maintenance, the owner would probably lose money!  We later found out that the owner was only renting it out for a short term (3 months) before demolishing it to build a new house in the summer.
      • On other homes that had lower “rental returns”, after further inspection we found that in a lot of cases, the places were just expensive due to their location (and not necessarily a house that we would enjoy living in)
      • The other interesting observation from this analysis was that generally, the lower the house value, the higher the rental return in percentage terms.  This is interesting:
        • Out of the houses that met our # of bedrooms and bathrooms criteria, the range in
          • rents was $1,395 to $2,500 (the most expensive was ~1.8x the least)
          • assessed values was $215,000 to $940,000 (the most expensive was ~4.4x the least)
          • It seems that there is a fairly clear “floor” and “cap” on rent prices, however, the relative “floor” and “cap” on values is much different
          • Based on this analysis, if I were to look at purchasing a rental property, I would likely look in the lower price range in order to realize a higher rate of return.  That said, I’m sure there is more to the story here – for example, if you buy a low priced home in a less than desirable neighborhood I’m sure you are more likely to run into issues (e.g. tenant turnover, vandalism, etc.) that increase the risk profile of the property – I guess it is true what they say: the higher the risk, the higher the return
          • If I were looking to buy a rental property, I would also try to broaden my search to include other cities and even countries.  I’ve heard of many people in the financial independence community being able to buy rental properties and realize as much as 12.0% in gross rent (or 1.0% per month)
  • The home inspection
    • I can’t believe that some people choose to skip this important step!
    • Our inspection report cost $575
      • On a percentage basis, this represented less than 0.12% of the overall purchase price of our home
      • I’m MORE than happy to pay 0.12% to make sure that there is not a significant issue with the house that could cost several percentage points to fix later on!
    • Luckily our inspection report came back very clean based on my discussion with the home inspectors.  Just a few minor maintenance items and non-urgent repairs were recommended but nothing large enough for us to request a price adjustment from the sellers
  • The mortgage
    • Although I decided to pay cash for the house (more on this below), I still engaged a mortgage specialist to set up a home equity line of credit “HELOC”
  • The current owners
    • Although our realtor mentioned that it was not usual practice, I requested to speak with the owners to directly ask some questions that we had about the house.  Not only did this give us a feel for the current owners of our house to be, it gave us perspective on the house that we wouldn’t have had otherwise.  Here are some of the questions that we asked (and responses):
      • Have you or the previous owners ever had any water problems or electrical issues?
        • Luckily the answer was no
        • Also, we found out that the house was owned by the same group of family since it was built in 1983
      • Please provide a list of maintenance and improvements done over the years, and the names of companies that completed the work
        • The owners were meticulous in this respect – we found out that they had invested over $90,000 in the house in the last few years and had very good record keeping (cost, who did the work, etc.) 
        • I also asked if they had extra paint and hardware since they recently repainted and installed hardwood – they did and agreed to leave these behind for us 
      •  How much are the utilities every month?
        • Again, the owners were meticulous in this respect and were able to provide several years of utility bills (this was good so we could get a sense of heating and cooling costs).  The meticulous record keeping reminded me of my own expense tracking spreadsheet
      • If you still have the manuals for the appliances, can you please leave them behind?
      • Do you have a trusted neighborhood tradesmen that you would recommend?
      • Any lights that require non-standard bulbs?
      • Any issues with crime in the neighborhood?
      • Any trouble with rodents or insects?
      • Anything that should be fixed before we move in?
      • What do you like / dislike about the neighborhood (any favourite places?)
      • How many kids come by at Halloween? (an unconventional way of figuring out the demographics in the neighborhood)
        • They said 50-90 kids!  I was very surprised by this since I know some other neighborhoods in Edmonton get less than 10 kids
      • In addition, we asked a handful of house-specific questions that I won’t list here
        • They also graciously agreed to give us a walkaround to show us various things about the house – e.g. working the irrigation system, showing us where the shutoff valves are, etc.
  • The lawyer
    • We received a few recommendations from our realtor and mortgage specialist, reviewed google reviews, sent a few e-mails for quotes, and then landed on a firm that we were happy with that agreed to a fixed price engagement.  They also gave us a discount since it was a referral from our mortgage specialist.  What does the lawyer do?
      • Review draft documents and work with the sellers’ lawyer to prepare final documents to complete the sale
      • Handle the transfer of funds via their trust account
      • Land title office search, transfer registration and mortgage registration
      • Tax search
      • Review Real Property Report and advise on whether Title Insurance is required / advised
Paying cash?  Are you mad?
  • I chose to pay cash for my half of the house
  • I am 100% certain that I will be criticized by those in the Financial Independence community and will likely hear things like:
    • “Why would you pay cash when interest rates are so ridiculously low?”
    • “If you can invest for a rate of return that exceeds your mortgage interest rate, why don’t you just do that?”
  • So why did I pay cash?
    • I felt like it wasn’t a bad time to take some cash off the table in the equity markets (time will tell!)
    • I set up a HELOC so I am able to borrow back the money (up to 80% of property value) to opportunistically invest (in public or private markets) whenever it made sense – when I do so, my borrowing to invest will be tax deductible, effectively converting my mortgage to be tax deductible (in Canada, we call this the “Smith Maneuver” – more on this below)
  • I do feel a bit silly right now with my equity allocation sitting around 30%, however, will look to aggressively deploy cash over the next several years – this should be easy to do without a mortgage payment or rent
The Smith Maneuver  
  • Since mortgage interest on your primary residence is not tax deductible in Canada like it is in the US, I decided to perform what has been keyed the “Smith Maneuver” when buying my house
  • Effectively what this involves is:
    • Buy the house with cash and then open up a home-equity line of credit (“HELOC”) that can be used (secured by the home) to buy investments
  • Luckily, per my last quarterly update post, I had quite a bit of cash on the sidelines in anticipation of buying a house soon.  I also ended up selling some of my non-registered portfolio to make the purchase – was able to do so in a way that avoided triggering significant capital gains
  • Disclaimer – borrowing to invest is an advanced personal finance strategy that is not for everyone.  Before considering this for yourself, think carefully about your risk tolerance, time horizon, and consult investment and tax professionals to make sure you do it right! 
  • Initially, I plan to just own the house outright.  To be honest, I’m in no rush to deploy the available credit on my HELOC based on where equity markets are right now.  That said, I will look to opportunistically do so when I feel the time is right (either back in the equity markets or in private investments)
    • As noted above, I calculated that I am effectively getting a 3-5% after tax / low-risk return on my equity by choosing to own instead of rent at this point (based on what a comparable house would rent for).  That said, I won’t be in too much of a hurry to redeploy the funds into an alternative investment unless I feel that I could exceed this return on a risk-adjusted basis
  • Even when I do decide to enter the equity markets with a portion of my HELOC, I don’t plan to push the limit.  Technically I can borrow up to 80% of the home value to invest, however, I think I personally would only be comfortable going to 30-50%
  • More on the Smith Maneuver here: https://smithmanoeuvre.com/what-is-the-smith-manoeuvre/