How to FI

What has COVID-19 done to personal finances in Canada?

Over the last week or two, I have been preparing a series of upcoming posts where I will walk you through a deep dive into the average Canadian household’s personal finances.

During my research, I stumbled upon an interesting tidbit that I figured warrant a short post.  The Canadian household savings rate in the second quarter of 2020 was the highest it has been in the history of available data from Statistics Canada (since 1961)!  28.2%!  During a pandemic!?  See the chart below:

What happened here?  From what I have read and can tell, although employee compensation dropped in 2020, generous government support programs such as Canada Emergency Response Benefit (CERB) likely exceeded income decrease.  At the same time, Canadians were forced to pare back their expenses as various restrictions (work from home, travel restrictions, businesses not being open) prevented people from spending what they normally would on transportation, travel, fast food, fine dining, etc.  Economic uncertainty also generally result in an increase in savings as people become more cautious and want to build some cushion to weather the uncertainty.  The opposite is true when the economy is booming – people are more comfortable with saving less and spending more.

Government transfer payments aside, I think this massive spike in savings during a global pandemic is a good illustration that Canadians do have the capacity to increase their savings above pre-pandemic levels – the average savings rate for the 5 years preceding the pandemic was a meager 3%.

More reading:

https://www.fraserinstitute.org/blogs/spike-in-household-savings-rate-only-temporary

https://www.fraserinstitute.org/blogs/spike-in-household-savings-rate-only-temporary

https://www.bnnbloomberg.ca/canadians-focused-on-savings-and-debt-not-spending-poll-1.1547281

Canada’s Household Savings Rate Plummets Lower After Government Supports Slow

Quarterly Progress Update #1-Q4 2020

I’ve decided to start providing quarterly updates on my own financial position so 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 broad overview and directional changes over time.

I landed on a quarterly update instead of posting monthly 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 shows a better reflection of my current investment income (without too much monthly fluctuations / noise).

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 “as a multiple of December 31, 2010 networth”?

  • My current networth is 15.9x 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 plan to write a post to walk through these different tax-advantaged vehicles in the near future so stay tuned!
  • Discretionary expenses
    • Will discuss more under “spending and saving” below
  • Essential expenses
    • Will discuss more under “spending and saving” below
  • Income gains (losses)
    • An unusually high month for investment gains – more to come on this in the “ETF Performance” section below
Earnings for Q4, 2020 (October 1, 2020 – December 31, 2020):
  • Employment income
    • As you can see, most of my income currently comes from employment income
  • 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 on the low side in Q4 given my Equity ETF’s do not pay distributions in Q4 (pay in January / March / June / September each year)
      • Equity ETF’s pay quarterly distributions.  Current yields as of January 14th:
        • XIC = 2.69%
        • XUU = 1.76%
        • XEC = 1.64%
        • XEF = 1.97%
      • I also have some equity funds and a real estate fund 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 = 0.90%
      • High interest savings accounts pay monthly interest.  Current yield:
        • Laurentian Bank Digital High Interest Savings Account = 1.50%
        • TD Waterhouse High Interest Savings Account = 0.25%
      • My private investments do not pay dividends
      • My GIC portfolio does pay distributions, however, I will only log these upon maturity of each 5-year GIC
        • The current average rate I am receiving on my GIC portfolio is 2.47%
  • Credit card rewards
    • I have a few credit cards that I use to try 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 Q4, 2020 (October 1, 2020 – December 31, 2020):

  • Essential expenses
    • Slightly higher than normal “essential expenses” in the last quarter due to costs associated with having a baby during the quarter!
    • Top 3
      • Rent/Utilities
      • Groceries
      • Baby
  • Discretionary expenses
    • A pretty low quarter for discretionary expenses – I sure don’t spend very much during a COVID lockdown!
    • Top 5
      • Gifts – always elevated in Q4 for Christmas
      • Car – insurance/gas/parking
      • Household
      • Fine Dining – only takeout due to COVID
      • Fast Food – mostly coffee out and about
Savings for Q4, 2020 (October 1, 2020 – December 31, 2020):
  • Savings rate
    • My overall savings rate for the quarter came in at 84.3% (of net/after tax income)
      • This exceeded my 2020 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 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%, is more than sufficient to cover my current fixed and discretionary expenses
        • Since I expect my fixed and discretionary expenses to increase over the next few years (increasing the size of my family, moving in to a house, etc.), I am confident this will change over time. I will continue to track as these changes unfold.
      • Purple line = net savings rate for each month within the quarter
Other Financial Metrics for Q4, 2020 (October 1, 2020 – December 31, 2020):
  • Current Portfolio Yield as of December 31, 2020 = 1.25% (weighted average)
  • Cash Interest for Q4, 2020 = 0.25% (annualized)
  • Essential Expense Coverage (Yield ÷ Essential Expenses) = 76.2%
  • Total Expense Coverage (Yield ÷ Total Expenses) = 50.3%
  • Cash Investment Income ÷ Essential Expenses = 15.3%
  • Cash Investment Income ÷ Total Expenses = 10.1%

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 December 31, 2020

  • Private vs. Public vs. Cash
    • Private investments
      • Real Estate – I have a 25% allocation to Real Estate for now that is earmarked for an eventual house purchase.  For now, my only exposure is a Real Estate fund that I own within my RPP
      • Personal Loans – I have a few personal loans 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 it 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 (likely 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 GIC’s 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
        • 17% 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 1.50% right nowThis high allocation is only temporary as my wife and I are actively planning on buying a house in the near future
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)
  • Investments sold
    • I try to avoid selling 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
ETF Performance:

  • Performance was stellar in Q4 2020.  As you can see, there was a bit of a dip in October, however a significant rally in November drove gains that held up through the end of the year
  • 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 0.12% (12 basis points on an annual basis)
Conclusion:
  • Overall, I am very pleased with the fourth quarter of 2020.  The combination of low discretionary spending / high savings and strong investment performance increased my networth by a whopping 7.0%.  Certainly don’t see that kind of increase every quarter!  Setting the bar high for my first quarterly post.

I hope 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 similar charts / visuals to ensure you are fully conscious of your financial position and 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. 

 

Why Systems and Habits are More Important than Goals

2020 is over

Reflecting over the last year and trying to focus on the positives, I am very grateful that I was able to work from home for most of the year (not in the office or out on business travel) so I could be there for my wife during her pregnancy and spend time with my newborn son who arrived in November.  My heart goes out to those of you who have been negatively impacted by COVID-19 over the last year.  I’m looking forward to when this virus is behind us and we can continue with the new normal. 

A new year brings new resolutions

It’s the time of the year where people set audacious goals to lose weight, save money, etc.  Unfortunately, a lot of people who set goals are unsuccessful in their pursuits.  A likely cause of this is that most people are too focused on the end-goal itself and aren’t giving enough thought to the habits and actions that it will take to get there!  

When thinking about your New Year Resolution, I encourage you to think beyond the goal itself – focus on the system that you can put in place that will allow you to achieve the goal.  To quote James Clear, “You do not rise to the level of your goals.  You fall to the level of your habits”.  Simply put, the goal itself is not enough to get you there, you need a system whereby you create habits that allow you to take action towards your goals.  Habits that involve taking action towards your goals are crucial to make progress towards those goals. Similarly, bad habits that prevent you from taking action towards your goals will definitely hamper progress.   Habits and individual actions can seem small on a day-to-day basis, however, they can compound over time to produce great results (or the opposite if we are talking about bad habits).   

Success is nothing more than a few simple disciplines, practiced every day; while failure is simply a few errors in judgment, repeated every day. It is the cumulative weight of our disciplines and our judgments that leads us to either fortune or failure.” ― Jim Rohn

The concept of smaller actions compounding into great results is called “the aggregation of marginal gains” and was popularized by Sir Dave Brailsford who turned around the British Cycling team.  The team went from having a single gold medal in its 76-year history to winning 7 out of 10 gold medals in track cycling in the 2008 Beijing and 2012 London Olympics.  He also led Britain’s first professional cycling team to win several Tour de France events (The more complete story here if you are interested: https://hbr.org/2015/10/how-1-performance-improvements-led-to-olympic-gold)

So what is my advice when thinking about your 2021 resolutions?
  1. Identity: Start with the kind of person you want to be (your identity) – not necessarily just in one year but several years down the line
    • It helps to visualize your future self and think in present tense like you are already there.  For example:
      • I am financially independent 
      • I spend plenty of time with my family and friends
      • I contribute to causes that are aligned with my values
      • I am healthy  
  2. Set SMART goals (explained below) that will serve as “stepping stones” to get to your final identity.  Some people say to scrap goals altogether, however, I am of the opinion that it makes sense to have some milestones / goalposts as you move towards your ultimate identity above.  Goals allow you the opportunity to celebrate small wins along the way.   
  3. Create daily habits and actions (i.e. a system) that align with your goals and your identity – this is the most important step.  Without daily habits and actions, you will never achieve your goals or identity.  Examples:
    • Side business: commit to working a minimum of 1 hour a day on my side business 
    • Health: run a calorie deficit every day (calories in < calories out) 
  4. Don’t spread yourself too thin: When setting goals, it is important that you keep the number of goals to a reasonable level.  Given each of your goals will be competing for your most valuable resource, your time, it is important that you focus on only the most important things you would like to accomplish. 
  5. Don’t just focus on your finances and your diet: In my post “Enjoy the Journey through a Balanced Approach“, I tried to emphasize that Health, Wealth, Love, and Happiness are all required for a fulfilled life.  People tend to overemphasize the “Health” and “Wealth” goals and forget about the “Love” and “Happiness” goals.
  6. Play the long game: Bill Gates once said “Most people overestimate what they can do in one year, and underestimate what they can do in ten years.”  Don’t be discouraged if you don’t accomplish as much as you expect in a single year.  Similar to compound interest, it takes a while to realize the full benefit of the aggregation of marginal gains.
What are SMART goals?
  • Specific
    • Bad – I want to reduce my debt
    • Good – I want to reduce the total balance on my credit cards by 50% by the end of 2021
  • Measurable
    • Bad – I want to save money
    • Good – I want to save 50% of my after-tax income in calendar year 2021
  • Achievable
    • Bad – Be the richest person on earth by the end of Q2 2021  
    • Good – Reach financial independence by 2030
  • Relevant
    • Bad – Goals that are not aligned with your identity 
    • Good – Goals that are aligned with your identity 
  • Time bound
    • Bad – I want to save 50% of my after-tax income 
    • Good – I want to save 50% of my after-tax income in calendar year 2021

I’ve designed my coaching program as a system that can be used to reach financial goals.  The system focuses on:

For more information, reach out to me at jonathan@jbfi.ca.

 

How to Buy a Used Car

I didn’t buy my first car until my early 30’s, 32 to be exact.  This doesn’t mean that I didn’t drive.  Read my post here on how I optimized my transportation expenses through my 20’s.  Shortly after we found out that my wife was pregnant with our first child, we decided that we would value the convenience of having a car.  I did a bit of research and less than a month later, we had a car.  Here are the steps I took to buy the car:

  1. Figured out what kind of car we wanted.  We wanted a larger four door sedan that was safe, comfortable, and reliable.  My wife and I landed on the Toyota Camry. That said, we decided we certainly didn’t need a new car so we looked for used. Having a single make and model in mind makes the search WAY easier since it really allows you to compare apples-to-apples (maybe not Royal Gala to Royal Gala since there are different trims and years, but close enough and not Apples to Oranges – e.g. a Hummer and a Prius).
  2. While watching a movie one night (I like to do things like this while watching movies), I tried to find every single used Toyota Camry in the province of Alberta.  My main sources of information were Kijiji, Facebook Marketplace, Autotrader, and a template e-mail that I sent to every single Toyota dealership in Alberta.  I found 162 cars.  I started a spreadsheet (as any good financial geek would) and inputted the following data on each car:
    1. Year
    2. Model trim (e.g. in this case LE, SE, XLE, Hybrid, etc.)
    3. # of kilometers
    4. Asking price
    5. Website link
  3. Knowing very well that cars depreciate in value but not necessarily in a linear fashion (generally depreciate the most in the first year or two of ownership), I thought I would plot data points to see if I could model the depreciation curve of the Toyota Camry.

A few observations from this exercise:

  • As you can see, there is a clear inverse correlation between number of km and price (generally as the number of km increases the price decreases – that makes sense and is aligned with what everyone knows about depreciation)
  • You can see a bit of a trend line of downward movement between 0 and 100,000km and then it seems to flatten a bit around that $15,000 mark (I noticed that there were some cars going for $15,000 that had 100,000kms and others in the same price range with 200,000km)
  • So how did I find value
    • To me, good value meant low price per km
    • Cars below the trend line you could say were undervalued (their price being lower than the average car with comparable mileage)
    • I found the market wasn’t pricing in the premium trims – when you buy a brand new Toyota Camry, you can pay twice as much for the premium models (e.g. XLE, XSE) than for the base models (LE and SE).  Based on my analysis, the used car market was not pricing in the premium trims (in some cases, I was able to find premium models that were selling for less than basic models in similar mileage range)
    • Looked for inefficiency in the market
      • Generally from what I saw, the dealerships were always around or above the trend line (i.e. higher pricing).  The dealerships also didn’t deviate too far from the trendline (they know the market)
      • The private sellers were all over the place and these made up a lot of the outliers that were way off the trend (either asking way above or below the market value implied by the trend line)
    • Ultimately, the car I ended up buying was a 2012 Camry XLE (the large gold bubble on the chart above)
      • This car was for sale by a private seller (trying to exploit the inefficiency!)
      • The car plotted below the trendline even though it was the “premium trim”
      • The car was listed for $15,000 and had 70,000 km on it (we negotiated down to $14,000 fairly easily)
      • There were comparable cars (same make/model/year) in the same price range that had DOUBLE the number of km on them.  Given this car was at the point on the graph where the depreciation curve flattened, it suggests that I may be able to drive this car for a few years and sell it for a similar value!  I’ll take it!

Once I negotiated with the seller, I quickly did the rest of my due diligence to make sure everything looked good and there were no red flags:

  1. Ran a quick Carfax report with the VIN# https://www.carfax.ca/
  2. Had an inspection done at a local Toyota Dealership
  3. Got a bank draft from the bank
  4. Took it for a test drive
  5. Bought it
  6. Registered it
  7. Drove it home

The only thing I will try to do differently next time is to get a car that is slightly more fuel efficient for city driving.  I find that the Camry gets very good fuel efficiency on the highway (especially for a V6) at about 7.0L/100km, however, the city gas mileage is not great (~10L/100km).  Though overall, we are really enjoying the car – no regrets on the purchase! 

Ideas to Reduce Transportation Expenses

After taxes and housing, transportation is generally up there on the list of significant household expenses.  Similar to some other parts of my life, I took an unconventional approach to optimize my transportation expenses.  I’ve detailed this below, not for people to use as a guide, but more to share my experience and how this approach has and will continue to save me a lot of money.  A lot of people don’t realize how much a car actually costs when you add it all up: 

  • Depreciation
  • Insurance 
  • Maintenance
  • Interest (if financed)
  • Opportunity cost on equity tied up in the car 
  • Roadside assistance 
  • Parking
  • Gas 
  • Registration 
  • Opportunity cost on renting out the parking stall 

For some people, not having a car is a non-starter – they need a car (e.g. due to their work or where they live) or they just really value having a car.  That’s perfectly fine, to each their own.  

I chose not to buy a car until I was 32 years old.  I thought that if I could eliminate a major expense category (even if it was just for a few years) I would be able to kick start my savings and accelerate my journey to financial independence.  It was never my plan to be car-less forever.  Looking back I am quite surprised I was able to go as long as I did without a car (16 years since getting my drivers license).  

How did I get around without a car? 

  • I lived close enough to work to walk
    • When I originally moved out of my parents house, I was very intentional choosing where to live.  I found a place that was within walking distance from work – with a grocery store on the way home.  This eliminated a need for a car for most of the week!
    • If you live in a city and relatively close to work/family/friends, this can save you a boatload of money.  Not only did I not need a car (hundreds of dollars per month savings), I didn’t even need a bus pass (~$100 / month in Edmonton)
    • When choosing to live downtown, I paid a premium over the rent I may have paid being further out (or could have paid the same and got a nicer place further out), however, I decided that I valued my time more and being closer to work and not having to commute were important to me
    • An added benefit of walking was the exercise.  My daily walk to and from work allowed me to get a baseline of 30-45 minutes of exercise each day and was a good time to think on the way to work and unwind on the way home
  • I rode my bike
    • I love cycling and chose to ride my bike all year round in Edmonton (yes, I’m one of those crazy ones).  A picture from 2017 to prove it: 
    • I once cycled to work when it was -46°C/-50.8°F with the wind chill.  At that temperature, I wore my snowboard goggles so my eyes didn’t freeze!
    • After University, while I was still living at my parents house, I would ride my bike ~10 km each way to and from work, all year round.  Similar to walking, I thoroughly enjoyed the added benefit of the exercise and the fresh air – the best way to start and end my day!  I found that, even on the snowiest and coldest of days, I could still cycle to work in less time than it would take for me to take public transit (bus alone or bus/light rail transit combo)
    • Nowadays, even though I have a car, I still ride my bike for leisure and to visit family and friends within the city
  • I used public transportation
    • All throughout University and the early years of my career (before I figured out I could cycle to work or just live closer!), I took public transit, specifically the bus and the light rail transit system in Edmonton, or “ETS”
    • In my view, the worst part of taking the bus was the waiting time – I found that the bus was very often not on schedule (not necessarily the fault of the drivers, but rather often weather / traffic related).  Technology has improved this significantly through time as the buses are now equipped with GPS trackers so you can check the status of the bus before you leave home
    • Some people are above taking the bus and even embarrassed to take public transit.  If you are one of those people, I think you care a bit too much about “what other people think”
    • I found the bus ride itself was quite enjoyable. I would often enjoy a cup of coffee while I read the news or a good book or catch up on e-mails 
  • I used rideshare services / taxis
    • I mostly stuck to public transit unless I was in a rush, in which case I would take a taxi or an Uber
  • I borrowed my parents’ cars – given my parents lived close by in the city, I would sometimes borrow their cars when needed.  Unlike when I borrowed their cars in high school, I filled them up with gas and occasionally washed them.  Thanks Mom and Dad! 
  • Lastly, I rented cars
    • Just because I didn’t own a car, it certainly didn’t mean that I didn’t want to drive around.  I love driving and going places on weekends   
    • I rented cars very often – since I lived downtown, there were several car rental companies within walking distance from my apartment
    • Similar to my housing “rent vs. buy” analysis, I ran the numbers on car ownership.  I concluded that it was cheaper to rent a car every single weekend vs. owning a car and parking it downtown.  When you rent a car, you have:
      • A nominal per-day rate – I generally only rented on weekends where the per day rates were much lower (~$15-$30/day)
        • In my case, depending on the month, my costs were mostly or completely offset by the fact that I rented out the parking stall that was included with my apartment for $175 / month (heated / underground parking close to a nearby university and downtown)
      • No car payment 
      • No insurance cost (I used a travel rewards credit card that included free rental car insurance)
      • No money tied up in a depreciating asset  
      • No maintenance costs 
      • No annual registration fee
    • Other benefits of renting cars:
      • Always get a newish car that is full of gas when you pick it up
      • Never have to wash the car or maintain it (no twice a year tire rotations, oil changes, etc.)
      • Can tailor what type of car you rent based on your needs (e.g. I got a big SUV when I had multiple people to transport, got a nice Mercedes to drive down the coast of California, got a van for moving, got a hybrid if I wanted good gas mileage, etc.)
      • A great chance to test drive various cars before buying one

Here is a collage of various cars that I rented over the last several years:

If renting was so great, why did I buy a car?

  • Convenience eventually took over – I always knew that once I was married and had kids, I would value the convenience of having a car.  I made a guilt-free decision to buy a car in April of this year, a month after we found out my wife was pregnant with our son.  Definitely no regrets so far, it has been great
  • I’ll detail my used car buying experience in my next post 
  • I’ll still consider renting cars in the future if I need a specific vehicle (e.g. a van or a truck) or if I will be putting on a significant number of kilometers – since the depreciation of the vehicle for a long mileage trip may exceed the cost to rent:
    • I once rented a brand new Volkswagen Golf and put on 8,132km over 23 days (drove it down to Arizona and back up the West coast of the US)
      • Cost for the rental = $538.36 = $23.41 / day = $0.06620 / km
    • Another time, I rented a Toyota Yaris in Australia and drove 6,270km from Sydney to Cairns and down the East coast of Australia – another great road trip!
      • Cost for the rental = $498.41 or $0.07949 / km

As a car owner, there are still yet a few things one can do to minimize transportation expenses – for example: 

  • We chose to be a 1 car family instead of a 2 car family (so far!) – obviously this is a significant saving
  • We bought a used car rather than a new car to avoid the initial steep depreciation in the first couple of years 
  • We paid cash for the car rather than financing it and incurring financing charges and interest 
  • Maintenance
    • We bought a reliable car that is less expensive to maintain (Toyota Camry) 
    • We take it easy on the car – for the most part, we avoid putting the pedal to the floor and slamming on the breaks
    • We conduct regular preventive maintenance 
  • Fuel economy
    • We fill up with gas at Costco – generally we find that the cost of gas at Costco is 10 cents / litre less than elsewhere.  That said, we only fill up at Costco when we are there anyway
    • We are smart about driving – when we have to go multiple places we will route out to try to minimize backtracking.  Also we don’t drive across town to save $2!
  • Insurance
    • We bundle our tenant and automobile insurance policies to save money
    • We don’t drive to work – I still walk to work and my wife works from home.  This saves gas, parking, and insurance costs (generally your insurance premiums are less if you do not commute daily and if your mileage is lower)
  • Parking
    • We have parking included in our apartment rental and don’t drive to work

Other ways that you can save money on transportation are:

  • Carpool – if you choose not to live close to work, carpooling with a co-worker or a spouse can save a significant amount of money and is better for the environment

I hope this article gave you some ideas of how you can potentially save money on transportation expense!  

Enjoy the Journey through a Balanced Approach

I once read a great post on the site “Wait but Why” that illustrates how finite our lives really are by displaying our lives in years/months/weeks.  Here is the post for your reference: https://waitbutwhy.com/2014/05/life-weeks.html.

This helped shape my view on how to go about approaching financial independence.

First let’s talk about the two extremes:

  • Work very hard and save aggressively to hit financial independence as soon as possible
    • I’ve read about some people in the financial independence community that were so focused on hitting a specific networth / financial independence number quickly, they worked and saved to the point where they deprived themselves of any day-to-day enjoyment – which led to depression in some cases.
  • Spend aggressively since You Only Live Once, “YOLO”
    • It may be fun in the moment but this could mean a lifetime of working to fund the spending.

I decided that a balanced approach fit my life and values best and that I wanted to spend my time on things that were most important to me.  For this, I think about my life in four main categories – Health, Wealth, Love, and Happiness.  This is what the breakdown looks like:

If my life were a table, these would be the four legs.  If one leg breaks, the table falls over.  To make sure that my table / life doesn’t fall over, I set goals based on these categories and track my progress to ensure that I am maintaining balance in my life.  If I were just to focus on the accumulation of wealth at the detriment of my health, love, and happiness, what would be the point?  Life needs to be more than working for the weekends.  You need to consciously set aside time for the big things in your life that are important to you.  I hear so many people say that they are “too busy” for this or that.  The truth is, if something is important, you can make time for it.  Let’s run some quick numbers on this:

  • Let’s say you work 40 hours a week
  • It takes 1 hour a day to commute to and from work
  • It takes 1 hour a day to get ready for work
  • You sleep 8 hours a night

Sounds pretty jammed right?  Probably not much time for yourself?

WRONG – There are 168 hours in a week (24 hours x 7 days)
(-) 56 hours sleeping
(-) 40 hours working
(-) 5 hours commuting
(-) 5 hours getting ready
= 62 hours (that’s enough time to work 1.5 more full time jobs! It works out to be 9 hours a day on average)

Of course there are other things that have to be done throughout the week (e.g. grocery shopping, cooking, cleaning, etc.), but still there is a lot of time left over at the end.  I would encourage everyone to think about what is most important to them and prioritize the most important activities.  Put them in your calendar if it helps.  If you’re like me, this includes things like spending time with friends and family, cycling, walking, playing the piano, and working on a passion project.

One time saving tip is to look for synergies.  A “synergy” is an interaction or cooperation giving rise to a whole that is greater than the sum of its parts.  What this means in practice is finding ways to increase your time efficiency by combining activities.  For me, an example of this would be going for a bike ride with a friend.  This covers health (exercise), love (time with friends), and happiness (doing something I love, cycling).  If we talk about work/investing/entrepreneurship along the way we can even cover off my fourth category (wealth)!

So for those of you who are pursuing financial independence, try your best to balance working and saving aggressively with spending time and money on things that are important to you – this will allow you to enjoy the journey much more.  I personally prefer to have a slightly longer journey to FI if it involves a much more enjoyable ride.

Housing Expense: Rent vs. Buy?

As I wrote my last post on My take on rental properties, it got me thinking about another related topic – the question of whether to rent or buy a house.

For the average household, housing is the second largest expense (after tax of course).  That said, it is important that we all spend some time thinking about our decision to buy a house or rent.

Most people assume that it is always better to buy if they have the means since they’ve probably been told one of the following:

  • If you rent, you are just throwing money away / paying your landlord’s mortgage
  • You better buy, so you can build equity!
  • Home prices only go in one direction – that is UP!  So don’t miss the boat

There is a great book I read a few years ago that goes through this decision in quite a bit of detail – it is called “The Wealthy Renter”.  It goes through the decision in a lot more detail than I plan to go through here.

The common “myths” above imply that owning is always the optimal decision, however, it is important that we run the numbers to ensure this is true.  Home selection (especially when deciding on a primary residence) also goes beyond the financials – there are other emotionally driven factors that we should consider.

First, let’s weigh some of the pros and cons of owning and renting:

  • Pros of owning:
    • You have a home that is truly yours that you can do whatever you want with it
    • You can’t get evicted from your own home (as long as you can make the mortgage payments!)
    • Forced savings – for those who are not disciplined in saving money, owning a home and making mortgage payments “forces” you to save and build equity (through the initial down payment and the ongoing principal portion of the monthly payments)
    • Potential for appreciation of home value
  • Cons of owning:
    • Significant upfront and ongoing financial commitment
    • Significant real estate market exposure (often people, especially young people, will buy a house that has a value that is greater than their total net worth).  This seems okay because everyone is doing it, however it is pretty risky from a portfolio diversification perspective
    • Significant transaction costs – you have to pay a lawyer every time you buy or sell a property, and potentially a realtor when you sell a property
    • Ongoing maintenance costs – roof, windows, plumbing, furnace, etc. 
    • Annual property tax – for example, 0.9% of the property value every year in Edmonton
    • Illiquid asset – can sometimes take a while to sell a property
    • Potential for depreciation of home value
  • Renting pros:
    • Lower financial commitment
    • Can invest the money that would otherwise be tied up in home equity
    • Flexibility to move/ travel for an extended period of time without having to worry about selling a house
    • Option to try out different neighborhoods
    • Switch from place to place without incurring significant transaction costs
  • Renting cons:
    • Don’t get that warm / fuzzy feeling from owning your home on your own land
    • You can be forced to move at a time that’s suboptimal for you if your landlord chooses to vacate you
    • Less flexibility to “make it your own” – your landlord might not be as excited about orange walls as you are

Now on to the financial analysis:

As I stated in my previous post on “My take on rental properties“, my wife and I are currently renting a 2 bedroom, 2 bathroom apartment.  Since we recently had our first child, we too have been talking a lot about moving into a house, and whether we want to rent or buy.  As part of this analysis, I built a comparison tool using Google Sheets.

  • To do this analysis, I picked a house for rent in Edmonton and compared the “renting” scenario to the “buying” scenario
    • Renting assumptions
      • Cost to rent (per month) = $2,100
      • Tenant insurance (per month) = $50 (tenant insurance is generally less than homeowner insurance since you are only insuring the contents rather than “contents + structure”)
    •  Buying assumptions
      • Property value: $643,000
      • Annual property tax: $5,996 (0.9% of the property value per year, $500 / month)
      • Time horizon: Let’s assume we plan to hold this property for the long term (say 20 years).  Generally a longer time horizon makes the economics of owning more favourable since one-time costs will be amortized over a greater number of years
      • Mortgage: for now let’s assume that we use leverage since this is the norm for most people buying a home.  Assumptions:
        • Down payment: 10%
        • Mortgage term: 20 years (let’s assume the mortgage is completely paid off by the end of the time horizon to make the math easier)
        • Mortgage rate: 3.50%
          • I know interest rates are low right now, however, we need to consider what our borrowing costs may be over a longer term.  As far as I know, unlike the US, it is quite rare to get a 25-year fixed rate mortgage in Canada
      • Appreciation: per my last post on rental properties, the appreciation over and above inflation over a 40 year time horizon in Edmonton was 0.5%
        • I would be careful about including significant inflation over and above the rate of inflation.  The price of housing in real terms (adjusted for inflation over time) will fluctuate based on the supply and demand for housing in each region / community.  Let’s also not forget that past performance is not indicative of future performance.  Just because one neighborhood or city may have had significant appreciation over and above inflation historically, it doesn’t mean that this will continue forever
      • Maintenance costs: $4,500 / year (works out to ~0.7% of the purchase price per year)
      • Taxes: Given there is a principal residence capital gain tax exemption in Canada, there is no tax payable on capital gains on your principal residence.  Unlike the US, mortgage interest is not tax deductible in Canada
      • Realtor cost to sell: 3.0%
        • I’ve read that the typical range is 3-7% in Canada
      • Legal costs to buy and sell: $1,000
      • Homeowners insurance: $150 / month
    • Common assumptions (applicable to both the buy and rent scenarios)
      • Utilities: $350 / month (for power, water, gas, and garbage pickup)
      • Inflation: I have excluded inflation in this example so everything is based on real terms   

Results of the analysis:


When comparing the cost of renting to the cost of owning, it is clear that renting is significantly cheaper in this example:

  • Total cost to rent over the 20 year time horizon = $600,000
  • Total cost to own over the 20 year time horizon = $1,214,471
  • At first glance it appears that renting is cheaper than owning by $614,471 over a 20 year period

Now this isn’t exactly fair, why? Because there is a big difference between what the renter has at the end of the 20 years and what the owner has:

  • The renter has $0 (when he moves out, he gets his security deposit back from the landlord and moves on)
  • The owner has a house at the end of the investment period!
    • Recall that the owner paid $643,000 for the house
    • At the end of the 20 years, the house is worth $710,448 (recall that we said the house appreciates at a rate of 0.5% over and above the rate of inflation)
    • We said that the owner would pay 3% to a realtor to sell (3% x $710,448 = $21,313)
    • We said that the owner would pay $1,000 in legal costs when selling the property
    • The net proceeds from a sale would be $710,448 (-) 21,313 (-) = $688,134  

Recall we initially said that renting was cheaper than owning by $614,471.  Now if the owner were to sell the house at the end of the 20-year period, he would receive $688,134 based on the assumptions above – effectively making him better off owning (see calculations below).

  • Adjusted cost of ownership =
    • Total cost to own from table above = ($1,214,471)
    • (+) sale proceeds of house = $688,134
    • Total net cost to own the house = ($526,337)
    • Comparing to the total cost to rent over the 20 year period ($600,000), it now looks like owning is ahead by $73,663

Now this is more in line with traditional beliefs that owning is less expensive than renting in the long term.  That said, we are still ignoring one very significant consideration – the fact that when you own a house, a significant amount of capital is tied up in the equity of your home.  If you are a renter, rather than this equity being tied up in your home, you can invest the excess cash.   

The cash required to own a home is significantly higher than renting:

  • Initially – when you first buy a home, you are required to fund a down payment (generally 5-20% of the market value of the home).  This amount is significantly more than the up front cash required to rent, generally just a one-month security deposit.
  • Ongoing – Your monthly cash requirements are also much greater when you own a home.  This is due to the fact that there are significant sunk costs (that you will not get back) when you own a home (e.g. mortgage interest, property tax, maintenance, insurance).
    • As you can see, the monthly cash cost of buying a home ($4,750) is almost double what it costs to rent ($2,500)

For a true apples-to-apples comparison, let’s say that the renter invests the excess cash.  Assume that the renter can invest the excess cash at an after-tax return of 3% over and above the rate of inflation (a conservative assumption given that it is below historical returns for a balanced portfolio).  

  • Initially, the renter invests the same amount as the buyer’s down payment
  • On a monthly basis, the renter invests an incremental ~$2,250 (the amount of cash it costs to own over and above what it costs to rent)

Now let’s look at the numbers again at the end of the 20 year time horizon:

  • Red line: Recall the owner had net proceeds of $688,134 from selling the house
  • Blue line: The renter, given that he invests the excess cash in other investment instruments yielding a 3% return, would have $852,194 in his investment account

Now let’s look at the total net cost of renting vs. owning: 

This implies that renting is $164,060 cheaper over the 20-year time horizon ($684 / month).

Going back to the reason for writing this post, ultimately what we want to find out is whether it is financially more sensible to rent or to buy.  When you buy a house, in addition to the sunk cost of home ownership, you also invest equity in the house (initial down payment and principal payments on the mortgage).  It is important to consider that if you chose to rent instead of buy and you invested the cash differential, you could be significantly better off (assuming a 3% return on your investment portfolio vs. 0.5% home value appreciation – disregarding inflation).  These assumptions reflect the fact that a balanced portfolio of stocks and bonds has generally outperformed average residential real estate appreciation historically.  

Quickly, a comment on each of the myths stated at the beginning of the post: 

  • If you rent, you are just throwing money away / paying your landlord’s mortgage
    • Not necessarily true – as you can see now, the sunk costs of home ownership can be close (or higher in some cases) than renting
    • In this example, the sunk costs of owning the home (which are not recoverable) average $2,381 / month (close to the $2,500 all-in cost to rent)   
  • You better buy, so you can build equity!
    • You can build significant equity by renting – IF you are disciplined in saving to invest the excess cash that you would have otherwise paid to own.  Furthermore, you can choose to invest in a more diversified portfolio (e.g. stocks / bonds / ETFs) that potentially has less risk than a single real estate investment in a single market.  A portfolio of public investment securities would also have superior liquidity, given the lower transaction costs and higher ease of converting the portfolio into cash when needed 
  • Home prices only go in one direction – that is UP!  So don’t miss the boat
    • We all know this was disproven during the 2008 global financial crisis where homes in certain locations decreased in value by 50%+

I’m not saying that renting is always better than buying.  The single biggest takeaway from this post is that when you are comparing renting vs. buying, you need to compare apples-to-apples and take in to account ALL factors, including investment income that a renter could earn by investing the cash that he doesn’t have to fork out for a down payment and more expensive monthly expenses along the way.

Like everything else in personal finance, the decision to rent or buy is very personal and there is no right answer.  A financial optimizer may look to do whatever the numbers say, however, somebody who prioritizes other qualitative factors in their decision may have another view.

My wife and I chose to rent an apartment for now (mainly because we valued the close proximity to work and didn’t value a yard or a bigger living space before having kids).  We will look to purchase a house eventually, not only because the numbers are likely to look favourable with a longer time horizon, but emotionally, we do want to own a house – a place where our family can truly make our own.

Either way, I think you should at least look at how the numbers stack up before making your decision between buying and renting.  For many of us, this is usually the largest financial decision of our lives.  As usual, if you would like help running the numbers, or just to chat/debate on this topic, feel free to reach out to me at jonathan@jbfi.ca.

    My Take on Rental Properties

    This is one of those posts that might stir the pot in the financial independence community.  I want to be clear that I am certainly not opposed to real estate investing, I just think that people need to be careful and fully aware of the various risks associated with real estate investing before they dive in head first and buy six properties.  I personally have not made any real estate investments (other than Real Estate Investment Trusts) to date, however, I may look to do so in the future if I decide to purchase a principal residence (instead of renting which I am doing now) or if I find a rental property that has a risk adjusted return that I think is high enough to justify the market exposure and illiquidity.  I’ve seen a lot of people in the personal finance community succeed with real estate investing, in addition to those who invest in traditional asset classes and run their own businesses.    

    I’ve spent most of my career working in institutional private investments where a large portion of my time is spent performing due diligence on potential investment opportunities.  Applying my institutional investment knowledge to smaller retail investments (such as rental properties) gives me an interesting perspective.  

    Why does everybody think real estate is such a good investment?

    • Short answer – real estate always goes up (until it doesn’t – remember the 2008  financial crisis?)
    • Leverage – real estate is the only asset class I know of where you can lever up 20 to 1 (maybe only 10 to 1 these days given tightening mortgage requirements).  To properly compare real estate to other asset classes, it is necessary to compare apples-to-apples and adjust for leverage, and other associated costs 
    • Forced savings plan – a lot of people who don’t have the discipline to save money are able to still do so through the purchase of a home (since the principal portion of their monthly mortgage payment is effectively savings)

    A lot of people buy rental properties after doing some quick back-of-the-envelope math that may not take into account all of the considerations.  I’ve tried to think through a reasonably complete list of things that you will want to think about when buying a rental property:

    • I decided to use our apartment as an example to see what type of return my landlord is receiving by renting to us:
      • Rental income: $1,650 / month
        • What we are currently paying for a 2 bedroom + 2 bathroom condo in Edmonton, AB, Canada
      • Property value: $350,000
        • This is the average of three condo’s like mine in the building (based on current list price) 
        • To find the value of a house, I usually check out the City of Edmonton’s property tax appraisal website (https://maps.edmonton.ca/map.aspx?lookingFor=Assessments\By%20Address).  The property tax appraisal value is not always equal to the market value of the property, however, is generally a good proxy  
      • Annual property tax: $3,264, which works out to 0.9% of the property value per year (or $272.00 / month)
      • Time horizon: Let’s assume we plan to hold this property for the long term (say 20 years).  Generally a longer time horizon makes the economics more favourable since one-time costs will be amortized over a greater number of years
      • Mortgage: for now let’s assume that we are using leverage since this is the norm for most real estate investors.  Assumptions:
        • Down payment: 20%
        • Mortgage term: 25 years
        • Mortgage rate: 3.50%
          • I know interest rates are low right now, however, we need to consider what our borrowing costs may be over a longer term.  As far as I know, unlike the US, it is quite rare to get a 25-year fixed rate mortgage in Canada
      • Appreciation: let’s assume 2.0% per year (the long term Bank of Canada inflation target)
        • In Edmonton, most people of my age have parents who bought a house in the 80’s for around $100,000 that is now worth around $400,000.  Seeing this, you probably think to yourself – wow, 4x my money, where do I sign!  But let’s dive deeper into this.  If you bought a house in 1980 for $100,000 and it is worth $400,000 today, what is the actual compounded rate of increase over that 40-year period?
          • The answer?
            • 3.52649% BIG WHOOP
          • Really?
            • Yes 
          • How?
            • Well the math based on a simple future value calculation is (1+0.0352649)^40 x $100,000 = $400,000
          • The other thing to consider is that this is a nominal increase (i.e. includes the impact of inflation over time).  The actual real (inflation-adjusted) increase in the value of the home is much less (especially considering that inflation was very high in the 80’s).  When I ran the numbers, even I was surprised. The following numbers are from https://inflationcalculator.ca/alberta/ , however, there is also a good inflation calculator on the Bank of Canada website: https://www.bankofcanada.ca/rates/related/inflation-calculator/

          • This basically shows that a $100,000 house in 1980 is equivalent to a $328,118 house today.  This means that out of the 3.5% property appreciation I mentioned above, 3.0% of that was inflationary impact, leaving a real return of only 0.5%!  
      • Property management: 10% of gross rent
      • Maintenance costs: $497.75 / month (condo fees per the real estate posting – works out to ~1.7% per year)
        • I’ve read that maintenance costs average 1-4% of the home’s value per year  
      • Taxes: 30% of net income, 15% capital gains tax (see disclaimer below – I am not an accountant)
        • Unless held within a corporation, I believe (don’t quote me) that net income from renting out real estate (after expenses) is added to an individual’s income at their marginal tax rate 
        • In Canada, you will also have to pay tax on the capital gain of a real estate investment if it appreciates over time.  Here I have assumed that the tax rate on capital gains is 50% of what it is on income.  The actual calculation is a bit more complex but this is a good proxy
      • Vacancy: 2.8%
        • I’ve assumed that the house will be vacant for 1 month every 3 years
        • Some people forget to consider the fact that the place may not be rented 100% of the time.  Chances are once you purchase a place it will take some time to get the first tenant in and there may be some downtime between tenants   
      • Realtor cost to sell: 3.0%
        • I’ve read that the typical range is 3-7% in Canada 
      • Legal costs to buy and sell: $1,000 

    Based on the assumptions above, here is the math I worked out using a Google sheets template that I built:

    Scenario 1: Internal rate of return with 20% leverage
    Scenario 2: Internal rate of return without leverage (assumes 100% cash purchase)

    A few observations:

    • The “unlevered gross” return has two key components
      • Income return from gross rents (e.g. $1,650 x 12 = $19,800 / year)
        • $19,800 ÷ $350,000 = 5.65%
        • I have assumed that this percentage of the property value sticks (so the rent will increase in dollar terms over time to keep up with inflation) 
      • Appreciation return: assumed to be 2% (inflation, to be conservative)
    • Leverage has a huge impact
      • As you can see, leverage is accretive to your overall returns as long as your borrowing rate is less than your expected investment return
      • In the scenario with leverage, each of the costs have a bigger negative impact on overall return (since the initial investment amount funded in cash is smaller) 
    • Maintenance cost is the largest negative contributor to returns, however, it is often overlooked in back-of-the-envelope calculations (this is generally more front of mind with a condo investment since the condo fee is a significant monthly expense; but not as transparent with houses since they are usually more lumpy costs – e.g. roof, windows etc.)
    • Taxes – in this example the tax drag is just under 1% – again, often overlooked
    • Overall the nominal (includes inflation) “net” return is between 3.3% (unlevered) and 4.1% (levered)
      • At a 2% inflation rate, this implies a real return of only ~1.3-2.1%  

    The bottom line is, if you are buying a house, I think you should run a detailed analysis of the numbers.  Where I think you need to be careful:

    • Leverage
      • If used correctly, it can be a very powerful wealth building tool.  When your expected investment return exceeds your borrowing costs, leverage can really increase your returns given you are able to capture that spread on the money that is borrowed.  Additionally, interest paid on debt used to lever an investment is often tax deductible, which effectively lowers your borrowing cost on an after-tax basis (widening the spread further)
      • Where I think people need to be extra careful, it to really think about their exposure in terms of total exposure (not just the cash that they need to fork out as down payment, but the total value of the property).  For example, if you are buying a $400,000 home and putting 10% down, that is a $40,000 investment for you.  But when you think about market exposure, all $400,000 is exposed to market fluctuations.  That said, if there is a 10% market correction after you bought the $400,000 home with a 10% down payment, that entire original equity investment  is gone.  I question whether some real estate investors are thinking about their exposures this way (especially those who have several rental properties).  A longer time horizon does generally help as it increases the likelihood that the market will recover after a downturn
    • Liquidity –  Some properties provide cash flow that is barely positive, or worse yet, negative cash flow.  If your original assumptions change (income decreases, expense increases, or worse, both), then you could be in trouble and forced to sell at a bad time if your overall liquidity position is poor
    • Income projections – Current rent does not necessarily equal future rent.  When market conditions change in an area (supply and demand), the rents too will change
    • Expense projections – Current expenses do not necessarily equal future expenses.  If you can pass through increases in expenses to the renter then you are generally okay, however, if you can’t then your return takes a hit.  For example:
      • Maintenance costs could be higher than what you had originally budgeted (assuming you budgeted for maintenance in the first place)
        • In the case of a condo investments, the condo fees could go up or you could get hit with a special assessment to cover a deficit in the condo’s reserve fund – this can happen when major work needs to be done to a building and the reserve fund is insufficient to cover the costs 
        • In the case of a house, there will be big expenses that come up every now and then.  Examples would be replacing the roof, replacing the windows, replacing the furnace, updating electrical / plumbing, etc. Best to get an inspection prior to purchasing a property and estimate future capital expenditure / improvements required.
    • Interest rate variability – As discussed above, interest rates can increase  
    • Appreciation projections
      • I would recommend that people be conservative in their appreciation projections 
      • It’s good to remember that past appreciation is not an indication of future appreciation.  Future appreciation will be driven by forward economic fundamentals – supply and demand of properties
      • I prefer to view appreciation over and above inflation as upside rather than bake it in to the base case when buying a property
    •  Think about exposure in terms of your broader investment portfolio
      • Obviously diversification is one of the best ways to mitigate risk in an investment portfolio.  When you buy a rental property, you have to consider your market exposure as the full value of the property (not just your down payment) relative to your overall investment portfolio
      • For a lot of people starting out, this number can be close to or greater than 100%.  This scares me a bit and is one of the major reasons I didn’t purchase real estate in my 20’s (principal residence or rental property).  I didn’t want a single rental property (a chunky illiquid investment that has significant transaction costs) to make up a large portion of my portfolio. As you get older and your net worth increases, this becomes less of a concern since real estate investments will make up a smaller percentage of your overall portfolio 

    What to consider when comparing real estate to traditional asset classes like stocks and bonds:

      • Traditional asset classes (equities, fixed income) may be more volatile than real estate  
      • Liquidity – A market investment is more liquid and can be bought and sold instantly for a very low cost, whereas when you purchase physical real estate, it takes time and money to buy and sell 
      • Leverage – Don’t forget to adjust for leverage to make a proper comparison.  Leverage has the ability to add to your returns but can also greatly increase the volatility of your cash flows
      • Passive or active – The purchase and management of real estate is not a passive activity, it takes significantly more time and effort relative to purchasing traditional investments

    In my opinion, the real estate example above does not compare too favourably to other traditional, more liquid investment alternatives.  That said, the gross rent on that example was low to begin with (only 5-6% of property value).  There are still markets where great real estate returns are achievable.  I’ve heard of several investors being able to achieve the 1% rule (whereby the gross monthly property rent is equal to 1% of the property value, or 12% per year).  I’m not saying that you shouldn’t invest in real estate.  Just make sure you do your homework – run the numbers, and compare the net return to other investment options / asset classes available to you on an apples-to-apples basis. 

    I realize that this is one of my more technical posts – if you have any questions/thoughts or want me run the numbers for you on a potential real estate investment, feel free to reach out to me (jonathan@jbfi.ca). 

    Disclaimer: Please note that I am NOT a registered investment advisor and all of the above are only my opinions, NOT investment advice.  When making your investment decisions, if you don’t have the expertise, make sure to consult the relevant professionals (accountants, lawyers, realtors, financial advisors, etc.).

    Pay Yourself First

    This is a very simple concept, and therefore a very short post!

    Pay yourself (save) first, before you have a chance to spend all of your money.  Although it is simple, most people don’t do it.

    Prioritizing your savings (before your discretionary expenses) is all it takes to successfully start saving money!  

    A few notes:

    • The government is smart – they make your employer withhold tax on your paycheque before you are paid each pay period.  They truly get paid first because they know if they don’t take their cut off the top, there is a good chance it might not be there at the end of the month.
    • Pay essential expenses first.  Obviously you aren’t going to be too interested in saving if you don’t have a roof over your head and food on your table.  That said, it makes sense to fund your essential expenses first, prior to saving.  That said, I don’t view living in a 5,000 square foot house and eating out at expensive restaurants as “essential”.  If you find that your essential expenses are so high that you have nothing left to save, there is a big chance that you’re living beyond your means.  This means that you either need to earn more or spend less (or maybe both!) so you can afford to fund your savings and your discretionary expenses.
    • When you fund your savings, you will want to set a savings percentage that aligns with your lifestyle and financial independence goals.  There is a fine balance between saving too much (and depriving yourself of enjoying the journey to financial independence) and saving too little (and having to work forever). If you haven’t thought about this yet, read through my post on savings rate.
    • Once your savings are covered, don’t feel bad about spending the rest on discretionary expenses – spend guilt-free as long as your spending is aligned with your values.

    There is a great quote that illustrates this lesson:

    A part of all you earn is yours to keep. It should be not less than a tenth no matter how little you earn. It can be as much as you can afford. Pay yourself first.
    ― George S. Clason, The Richest Man in Babylon

     

    The Magic of Compound Interest

    I first learnt about compound interest as a kid.  My Uncle taught me this concept while our family was visiting him and my Auntie during summer vacation.  I was fascinated.  I spent the rest of the week with a calculator, a pen, and paper, performing countless manual calculations on how much $1,000 would be worth in 5 years / 10 years / 20 years.  Unfortunately at the time I didn’t know that there was an easy “Future Value” formula that could be used to simplify the math.  The 5 minutes my Uncle took to teach me this fascinating concept completely changed my life.  I went on to read my first personal finance book, “The Wealthy Barber”, and started buying Canada Savings Bonds and Canada Premium Bonds in $100 increments (I was too young to open up a brokerage account).  This then gradually led me to the world of personal finance and to pursue a degree in Commerce / Finance – and eventually working in Investment Management.  

    Have you ever heard the saying “A dollar saved is two dollars earned”?  The premise behind the saying is that you need to earn more than a dollar to save a dollar given that in order to save an after-tax dollar, you need to earn more in before-tax terms and then pay tax.  Taking this a step further, I would argue that a dollar saved is even more than two dollars earned.  This is because that dollar saved becomes your employee, working 24 hours a day, 7 days a week to provide you with investment income.  

    “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” – Albert Einstein

    Let’s start with a simple example:

    • Let’s say you have $1,000
    • Assume you can earn a 5% rate of return on your investments 
    • What this $1,000 looks like in
      • 5 years: $1,276
      • 10 years: $1,629
      • 20 years: $2,653
      • 50 years: $11,467

    Now a more comprehensive example (apologies in advance if your name is William):

    • Supersaver Steve starts putting away $1,000 a month at age 25 and continues doing so until age 65 (40 years of saving!) 
    • Waitandsave William isn’t as intentional or disciplined as Steve, so he puts away $4,000 a month at age 55 and continues doing so until age 65 (10 years of saving) 

    Let’s again assume a 5% rate of return

    • Note that they both contributed the same amount to their portfolios
      • Supersaver Steve contributions = $1,000 / month x 12 months per year x 40 years = $480,000 (started earlier and contributed less per month)
      • Waitandsave William contributions = $4,000 / month x 12 months per year x 10 years = $480,000 (started later and contributed more per month) 

    Let’s take a look at how their retirement portfolios look at age 65:

    • At age 65, Waitandsave William will have $621,129
    • At age 65, Supersaver Steve will have a WHOPPING $1,526,020! 

    Here are the charts showing the difference over time:

    Supersaver Steve (starting at age 25)

    Waitandsave William (starting at age 55)

    A few observations and insights:

    • Even though they both contributed the same total dollar amount, Supersaver Steve was able to retire with ~2.5x more since he decided to start early (he made his savings work longer and harder for him) 
    • Waitandsave William’s final retirement balance exceeds his contributions by a mere $141,129, whereas Supersaver Steve’s final retirement balance exceeds his contributions by a WHOPPING $1,046,020
      • This is the magic of compound interest (shown in darker blue on the charts above)
    • If Waitandsave William wanted to catch up and match Supersaver Steve’s retirement amount of $1,526,020 (all else equal), he would need to save $9,827 (vs. $4,000 in the original example) per month between age 55 and 65.  In this case, here’s how Steve and William’s savings and interest income stack up:
    SuperSaver SteveWaitandSave William
    Savings$1,179,240$480,000
    Investment Income$346,780$1,046,020
    Total$1,526,020$1,526,020

    The table clearly illustrates that if you don’t start putting your money to work early, you’ll have to work significantly harder in the later years to catch up – all due to compound interest!

    If you don’t feel like doing the math yourself, why not run some numbers of your own using the following compound interest calculator:

    Potential upside:

    • We’ve been quite conservative here.  There is a tonne of potential upside in these calculations.  Imagine if the return on your investment is greater than 5% – instead of ending up with $1,526,020 in the example above, Supersaver Steve would have ended up with:
      • $1,991,491 if he made 6%
      • $2,624,813 if he made 7%
      • $3,491,008 if he made 8%
      • $4,681,320 if he made 9%
      • $6,324,080 if he made 10%

    Lessons of this post:

    • Teach your kids about compound interest, it could change their lives!
    • Make sure compound interest is working for you (compounding savings and investment income), rather than against you (compounding debt and interest payments)
    • Start early to enjoy the benefits of compounding: the best time to start would have been 10 years ago but the second best time is TODAY!
    • Think of where your investment portfolio could end up if you are able to save more than $1,000 a month!  Anyone can! 

    Wealth, like a tree, grows from a tiny seed. The first copper you save is the seed from which your tree of wealth shall grow. The sooner you plant that seed the sooner shall the tree grow. And the more faithfully you nourish and water that tree with consistent savings, the sooner may you bask in contentment beneath its shade.

    – George S. Clason, The Richest Man in Babylon