CommunityLend Pre-Launch Site Revealed

CommunityLend is now closer to launch, with the unveiling of their new pre-launch website. CommunityLend is the Canadian version of Zopa (from the UK, but has now expaneded to other countries) and Prosper (from the US), which are P2P lending sites. In theory, by reducing the middle-man (the bank), lenders and borrowers alike should get better rates then they would through the bank.

Peer-to-Peer Lending Coming to Canada

Following in the footsteps of UK’s Zopa and the U.S.’s Proper, Canada’s own CommunityLend is set to launch some time in Fall 2007. If you check out for example, you can get some handsome rates of return if you’re willing to lend someone a bit of money. Even lending to someone with an AA credit rating can net you 12.5% return. I would expect that both lender and borrower gain some advantage here as they avoid the spreads from the middle-man (the banks). Instead the middle-man is a website that probably charges some low rate fee in addition to collecting revenue from advertising.

Record Tax Refund

We just did some preliminary tax calculations and thanks to carried-over tuition/education amounts from previous years, and our RRSP contributions from last year, we will be getting a tax refund of around $9500. Sorry you can’t “act now to receive my amazing tax secrets.” We just had a lot of tuition credits to use, but we have now used up all our tuition/education amounts so that will be the last time we have that kind of a refund. We will either be putting that refund into our RRSPs, then reducing our monthly RRSP contributions over the next 12 months, thereby increasing the amount we can put down our student line of credit each month, OR putting it down on the line of credit thus reducing the amount of interest we have to pay on the loan each month, thereby increasing the amount of principal paid each month. Either way, it doesn’t really matter too much. I figure the risk-adjusted return on the RRSP compared to the line of credit is about the same. Although the student line of credit is at prime so the return there is really low.

Financial Lessons Learned Through Parents

Canadian Dream had a post called “Parents Influence Over Their Kid’s Money.” Part of it reminded me of my own experience:

The other thing my parents did for me that really hit home was during my second year of university they stopped paying the bills. They had decided to buy a cottage instead of funding the remainder of my education. So they co-signed some loans and I was now living off debt to pay my school. I hated it, but it taught me to pay attention to my spending. Needless to say I reduced my spending at school by 10% the next year and I started paying down the debt with every dollar I could after leaving school.

This reminded me of a similar event in my life. My parents had bought some Canada Savings Bonds for me when I was a kid, as a college fund for me so I would not have to worry about paying for university. When I was maybe 12 my parents wanted to buy a cabin at a nearby lake as an investment/rental property. In order to afford the down payment, they cashed in those Canada Savings Bonds. So when I went to university, I was on my own. It turned out I had a scholarship anyways that covered most of my tuition but I had to pay for everything else. My parents bought me a $2000 used car right at the beginning of university and besides that I was on my own for any vacations I wanted to take during my summers, any “toys” I bought, gas, car insurance, textbooks, and everything else. So I worked part-time through most of university so I could pay for everything and have some money left over for long-term savings as well. So my situation was not the same as most as I had no debt. It wasn’t a case of either my parents supporting me or going into debt. It was a case of finishing university with only a little money leftover vs. having a lot more leftover or spending more, and not having to work (had they had not cashed in those bonds to buy a rental property, but instead given them to me). There is no guarantee that they would have given me those bonds. I had a scholarship so I didn’t really need them, but you never know. They had earmarked those bonds for my time in university so it might have gone to me in some way, maybe it would have gone toward an unnecessarily larger car, a more expensive vacation than the cheap ones I did (mostly camping), or toward my other expenses, meaning I would not have had to work. In hindsight I was so glad that after high school I was basically on my own. I worked hard at my part-time job as a grocery store clerk on weekends, tutoring in math, and my job at a local movie theatre and learned that the only way to make money is through hard work. Like “canadian dream” above, “it taught me to pay attention to my spending.” It is best to learn those simple lessons as early as possible.

While I was in high school I was always a little bit annoyed at my parents for cashing in those savings bonds. I had heard about other people having a “college fund” and I was annoyed that I didn’t have one, or rather, at the fact that they cashed them in for a cabin we rented out and never used. But later on I realized that not having a college fund is one of the best things they did for me. Cutting me off from their finances early on was great as it allowed me to become financially independent and to learn how to look after my money. It forced me to make more mistakes early on, mistakes that I learned from. More recently, over the past few years my wife’s parents have mentioned that they want to help pay down my wife’s line of credit leftover from school. We have been refusing their offers of help because we think that paying down this massive debt on our will be a great experience, like preparation for having a mortgage or a car loan (actually this line of credit debt makes me NOT want to ever have a car loan). We have done an excellent job so far at maximizing our RRSPs, while at the same time paying down our debt as much as possible. In order to do that we have had to limit our expenses in some areas, live in a place that is a bit smaller than we would have lived in otherwise, and live without that fat wad of cash that is currently getting sucked away to interest every month. But we’ve already learned a huge lesson, about the burden and cost of debt, and we’ve figured out what our priorities are as far as expenses go.

So, what did you parents, guardians, or other do financially to you that you didn’t like at the time, but that in hindsight, now seems like a blessing?

Family Housing Story From 1982

I just had an interesting conversation with my dad a while back about the housing bust of 1981. They bought their house in 1977 for about $40,000 with a $471 monthly mortgage payment for a 25 year mortgage (Those numbers don’t work out quite right for an interest rate of approximately 10% at the time, but it doesn’t matter). They somehow also managed to put down 10% of the house’s original value every year (I think their tax rebate due to RRSPs may have helped out here), so in 1981 when the crash hit they were ok. When they went to renew their mortgage in 1982, they were quoted a 18.5% interest rate (just shy of the 20% peak). They didn’t have that much left on their mortgage after paying down 10% of the principal every year for the past 5 years, so they went to my grandfather (my dad’s father) for a loan. He loaned them about $10,000 at 14.5%. He was definitely not gouging them though; this was worse than the 19% he could get on Canada Savings Bonds at the time. They then took out a line of credit and paid the rest of the mortgage off using that. That was supposedly done to simplify the repayment terms (no longer stuck with a mortgage, can switch between loan-from-dad and line of credit more easily, and can pay down more principal whenever they wanted).

I don’t really have anything insightful to say there. Just that it’s an interesting story. The only thing I will bring up though is that I think everyone should consider the possibility of borrowing from a family member, or lending to a family member. You should be careful and think about that negative consequences if the borrower was unable to pay back the loan or make their payments. My parents payed back the loan to my grandpa, and then when they bought a rental property in the 1990s as an investment they borrowed money from my grandpa again. So it worked out well for them.

Things You’ll Never Hear Me Blog About

A lot of investing and personal finance blogs talk about certain topics that I purposefully stay clear from because I really don’t like them and am not interested in them. I often remove blogs from my blogroll if I notice they talk about these things too much.

  • 0% balance transfers and the like. Seriously, what is up with this craze?
  • Kiyosaki or Cramer (at least, in a positive way).
  • Rewards programs. Not a fan. I finally got rid of my Air Miles card and went to the cashback option for our one credit card. I hate points programs, customer loyalty programs, or anything of the sort.
  • Trading, daily stock prices, etc… I focus on the long term. I couldn’t even tell you right now what the trend in the markets has been in the past month. I don’t follow the market.
  • Promotions. Promotions serve only one purpose, to get new customers. Their purpose is not for you to make $15 or whatever it might be.
  • Talking about how to make money blogging, or how much money I made from ads last month, etc… This blog will never be a for-profit operation. Never take advice from a blogger who is trying to blog for a living (or most journalists). How do you know if his/her advice is really coming from the heart if she is getting a kickback every time they right a post? To prove I don’t blog for bucks, download AdBlock Plus for Firefox and please block my ads (I do). Then tell your friends. The only reason I have ads is to cover hosting costs.

So if you are interested in reading a blog that swears to steer clear of the above topics, you have come to the right place.

On the topic of annoying things, I have been receiving an incessant amount of offers these days via email for link sharing, collaborations, requests to demo debt consolidation software, and a number of emails that start out like this one did: “My name is XXX XXX, I recently came upon your blog. I read a few entries and liked it. I work in the financial services industry and as a side project my company has…” Delete!

12-Year Old Financial Blogger

You gotta see this. There is a 12-year kid giving financial advice on his blog

Some of his advice is questionable, like this one:

“Ya, hi, I’m over 150,000 in debt, not including my mortgage. I’m fearing that I’ll have to give up my lifestyle and everything I own. Is there anything I can do?” Well, I do have one piece of very good advice, find a really tall building… No, I’m just kidding! but seriously, the one thing you can do to take evasive action on that kind of debt is to, hold your applause, go further into debt! Ya, as crazy as it sounds, if you go another 300,000 dollars in debt and buy a condo, you can rent it out and slowly pay of that debt, plus the mortgage with the rent. And once you’re almost out of your financial rut, you can sell the condo for a profit and be completely debt free!

That seems like a sure-fire way to make your situation worse rather than better. Especially in today’s housing market. The guy is $150,000 in debt, plus he has a mortgage (let’s say $200,000 left), and he’s suggesting to take on another $300,000 in debt (if you can get approved for that, which is doubtful with the debt load he/she already has). Good luck trying to rent that condo for enough to make up for the mortgage (let alone having extra to apply against the $150,000 debt). And good luck selling the condo for a profit if housing prices tank (which they will).

He sort of explains himself in his next post, but there are still some assumptions I don’t like, like the one where the second house grows from $400,000 to $500,000 (timeframe not given).

Either way, this kid is one smart cookie and I’ll be keeping my eye on him.

Paying Down Debt vs. Contributing to an RRSP

The Canadian Capitalist had a link to article by the Smoke & Mirrors guy, David Trahair, called “Don’t Invest in an RRSP Before Paying Down Your Mortgage (Link no longer available).” He starts off by saying that the conventional wisdom of investing in an RRSP then applying the tax rebate to your mortgage every year is hard to do. Instead, he says, don’t contribute to an RRSP, but put down more principal on your mortgage. If you want to talk psychology about what is “harder to do” I would suggest that contributing your maximum room to an RRSP is a better forced savings plan than applying an extra lump sum on the principal of your mortgage ever year, but that’s just me. Or maybe he’s suggesting you re-amortize for a much shorter period (after forgetting about RRSPs) but he doesn’t say that explicity. His second argument is that banks just want your money for RRSPs so they can charge you “commissions and fees on your contributions,” and because the banks’ ideal is for you to be in constant debt. I don’t buy any of that as a reason to pay down a mortgage instead of an RRSP. What I care about is which one is better for me (regardless of whether the bank benefits). Just like I don’t care about MERs in principle. What I care about is the returns after costs.

In the latter part of the article, he argues why you should pay down your mortgage before contributing to an RRSP by showing an example of a couple in two scenarios. Scenario 1 has them paying their monthly mortgage payment and contributing to an RRSP $4000 each per year and investing the tax refund generated. Scenario 2 has them paying their monthly mortgage payment and instead paying $4000 each year onto the principal value of the home. 11 years into Scenario 2 the home is paid off so they redirect what was their mortgage payment into their RRSP (and they invest the tax refund generated into their RRSP). I’ll give you the punchline:

The debt pay-down scenario shows a net worth slightly higher than for the RRSP scenario—a difference of $14,590. So, after 20 years, the Harts would arrive at a similar point but would have taken a very different journey. The debt pay-down option, however, has two major advantages: it reduces the risk that the Harts could lose their house during the nine years of mortgage-free living, and there is less risk related to investment returns. How much confidence do you have that the markets are going to post better returns than the interest rate on your debt? Are you willing to stake your future on it?

This sounds very reasonable but I am very disappointed in his article for a few reasons. He assumes a rate of return in the RRSP of 5%. This seems unbelievably low to me. There might be a reason for that. Since paying down the mortgage (he assumes a fixed-rate of 6%) is low-risk he’s probably trying to match the risk in the RRSP and the mortgage. I am not sure why you couldn’t at least get 6% in the RRSP for almost the same risk. Secondly I would assume that the majority of people with large mortgages or any mortgage are younger rather than older. We can take on a little risk right? I mean we could at least put half our RRSP in equities and half in fixed income/bonds. A 5% return in an RRSP seems unrealistically low. And this is coming from someone (me) who sets his expectations fairly low (7-8%). Thirdly, he doesn’t explain what would happen if the rate of return were even a bit higher yet the difference in Scenario 1 over Scenario 2 is tiny compared to the other numbers involved. “The debt pay-down scenario shows a net worth slightly higher than for the RRSP scenario—a difference of $14,590.” Clearly his cooked up his numbers so that they work out to be better for the mortgage pay-down scenario. Because it’s not even a difference worth mentioning. He even says in the next line that the end points are similar: “So, after 20 years the Harts would arrive at a similar point but would have taken a very different journey.”

I tried to replicate his calculations in a spreadsheet of my own so I could try out some other combinations of rates. (You can now skip to the next paragraph if you get bored easily). I was pretty much successful, only off by a small percent. This is due to the complicated way that he decided to handle the tax rebates. When Joe and Karen each contribute $4000 per year to their RRSP they get a tax rebate equal to $4000 multiplied by their marginal tax rate (40% in this case). They take that $1600 tax rebate and contribute $4000+$1600 to their RRSP in the following year. Then they get a $2,240 tax rebate and contribute $4000+$2240, then the following year, $2,496 extra, eventually converging to some value. I already talked about this “snowball effect” before. Note that it is non-existent if you maximize your RRSP contributions every year anyways. (Do not NOT maximize your RRSPs just so you can get this effect. It’s not that exciting.) Anyways, another way to handle this in the simulation would have been to just assume the max contribution room every year was $4000 for each of them or whatever, and contribute the excess cash available into a non-RRSP account. Personally I would do the latter since we maximize our contribution room every year. Any excess monthly cash (that might come available after paying down a mortgage) would go into non-RRSP investments.

Anyways, if you just increase the RRSP rate of return a little bit, as you can see in this modified spreadsheet, the RRSP case beats the pay-down-debt case. If you increase the rate it beats it by a wider margin but never by much.

I think the takeaways here are:

  • That paying off a mortgage is a great low-risk investment.
  • Make sure you look carefully at any assumptions used in calculations by accountants and financial advisors. Are they realistic?
  • When looking at a return, never forget about the risk associated with that return.

My Investment Advice for Young Adults

Rather than just bash Rob Carrick’s advice for young people, I’ll offer up my own advice:

  • Start investing as early as you can. The earlier the better.
  • As soon as you have some money, invest some of it. If you have a paper-route or a part-time job, invest 10-20% of it for the long term. Get in the habit. Invest monthly. You won’t miss that money.
  • If you are babysitting for cash, tutoring for cash, earning tips, basically if you earning ANY employment income, file a tax return and declare all your income to build up RRSP contribution room.
  • If you have RRSP contribution room, start an RRSP and contribute to it. Find a company that will not charge you any annual RRSP fee. I recommend something like TD’s Mutual Fund Account. Set up an automatic monthly contribution if you have steady income. Max out your available contribution room every year.
  • Set up one or more ING Direct Savings accounts or one ore more savings accounts at your bank. If there is anything big that you want to save up for, use that to save up for it.
  • Don’t get a credit card unless you have to. Keep your credit card limit low. Pay off your balance every month. Don’t be dazzled by rewards plans.
  • When you get a large chunk of money from a birthday, a scholarship/bursary, a tax refund, don’t put it in your chequing account or convert it to cash. Deposit it into a savings account. Sit on it for a bit. Don’t make an impulsive purchase.

Think any of my advice is bad? Think I am missing something? Let me know.

Down to One Credit Card

I mentioned a while ago how I had an AMEX Gold Card that (unbeknownest to me) had an annual fee. Well I finally cancelled it today, on a Sunday. I had no idea that I could do something like that on a Sunday, but looks like I can and it only took about 2 minutes. Now I am proud to say we only have one credit card, our no-annual fee BMO Air Miles Mastercard.