Debunking David Trahair’s Smoke & Mirrors: Myth #1

Canadian Capitalist recently had an article discussing the “smoke & mirrors” guy’s “Myth 1: If I had a $1,000,000… I Could Retire”. I hate guys like Mr. Trahair who rant about the financial services industry and their “vested self-interest in telling people they need more” and flame about how the banks try to scare people into putting more money away for retirement. All the while ignoring the fact that the individual also has a vested self-interest in saving for retirement. It’s the stupidest reason to not invest as much as possible that I have ever heard. It’s like taking a lower salary so you can receive the GST credit.

He talks about how once you retire your expenses are much lower because you will hopefully no longer have a mortgage to pay down, no more kids’ education to pay for, etc… So what? Your expenses could go up too if you want to travel more than before you retired. You could go out for dinner more. You might want to go buy a dream house, buy a cottage, a boat, hire a maid when you are 60, hire someone to help you out when you have a stroke at the age of 70, etc… But no, Mr. Trahir tries to explain how you’ll be just fine with 40% of what you made in your 40s.

The question of how much you need when you retire is irrelevant (if you can easily satisfy your needs). The question is how much do you want? For most people, the more the better. Of course you need money now too, but no one will instinctively starve themselves now to have more money later. Nor will you ever starve yourself now by putting away too much for later. You can always take money out of later if you need it now. One thing I don’t need is Mr. Trahair telling me that I can “get by” on only 30% of my current income in retirement. I’d rather have some balance between now and later. Maybe do some travelling and enjoy the money when I am older on a boat or a condo at Whistler or on Vancouver Island. Not scrape by on 30% of my current income.

It seems his only reason in debunking this “myth” is to “start relaxing a bit.” I think saving up more for retirement than I would actually “need” is a perfect way to “relax a bit.” The stock market and/or interest rates might go through a bad slump and your investments won’t compound as much a your thought/predicted they would. Targetting 100% of your present income (in tomorrow’s dollars) in retirement is playing is safe.

The Canadian Capitalist adds “of course, those planning an early retirement need a larger nest egg.” Another perfectly good argument for saving as much as you can. The more you save, the earlier you can retire.

Smoke and mirrors “is a metaphor for a deceptive, fraudulent or insubstantial explanation or description.” Describes Mr. Trahair very well.

To NETFILE or Not to NETFILE

I did a NETFILE once, or maybe it was a telefile (over the phone), I’m not sure. But then for many years I could not because I had some non-RRSP investments and there were some foreign dividends or something like that on them and that made me ineligible for the simpler T1 and NETFILE and telefile. So then I went back to paper returns but using software such as TaxWiz and Ufile.ca to create the return and then printing it. Nowadays, I no longer have those non-RRSP investments so I could use NETFILE but I choose not to because with NETFILE you don’t have to send in your receipts, so I figure that with NETFILE a) I’ll have a greater chance of being audited (I assume), which is a pain; b) all the receipts are with me, which means there is a danger of them all being destroyed which might be a bad thing (if I were audited); and c) there is no way for Revenue Canada to correct certain mistakes if I make one (and I have made some in the past) as they won’t have the receipts. The main advantage of NETFILE is that you get your tax refund sooner. If you don’t wait until the last minute to file a paper return you will get your refund fairly quick as well. If you are really that concerned about the quicker refund, you should consider getting your employer to take less tax off your paycheque in the first place.

Why I Probably Won’t Ever Pack a Lunch

Here’s why I won’t start packing a lunch any time soon (except if I have leftovers that is). This article on lifehacker.com: “Save $988 per year by packing your lunch.” $1000 saved by packing a lunch!? That’s a lot lower than I thought. If you’re making $50,000 gross that’s only 2% of gross income. Make $100,000 and that’s 1%. That seems pretty insignificant to me. I used to think about bringing a lunch to save money but I’m not so sure anymore. There are some big advantages to going out for lunch with coworkers: Networking, talking about work-related ideas but outside of work, and socializing, and if the difference is only $1000 per year I don’t have any huge motivation to change. You also have to factor in the extra time spent preparing decent-tasting lunches and extra grocery shopping. As far as efficiency goes, leftovers are a smarter idea because you just have a cook a bit more than usual the night before which doesn’t take any more time.

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.

Don’t Squander Your Tax Refund

A reader that goes by “David” provided a link to an article from AIM called “RRSPs versus non-registered accounts.” Here I quote part of his comment:

There are opinions all over the place on these calculations. A study published by AIM Trimark states that RRSP only come out ahead if the refund is also invested. IF the refund is used for other purposes then the un-registered investment is a better choice. RRSP vs. Non-Registered.pdf. This is what Martin Gale also states — you have to invest the whole $1000 (the $640 you have in hand, plus the refund you get).

This was my reply:

David, thanks for AIM link. Totally makes sense and thanks for bringing up the fact that the refund must be invested, not squandered. This is implicit in Martin Gale’s calculation, as you pointed out “This is what Martin Gale also states — you have to invest the whole $1000 (the $640 you have in hand, plus the refund you get).”

I am writing this blog post just to emphasize this point again. The reinvestment of the RRSP refund was implicit in Martin Gale’s calculations and I sort of missed it the first time I read the article. I understood how he used $1000 in the RRSP and $640 outside (pre-tax and post-tax amounts respectively) but hadn’t fully realized the significance. Remember that you are deferring your income tax until later. The government gives you back some tax that it collected throughout the year but you’ll need that for later, when you withdraw from your RRSP and have to declare it as income. So you better invest the tax you saved now to offset those income taxes you’ll be paying later. As “David” above pointed out, IF the refund is used for other purposes, like a new TV, then the unregistered plan is a better choice. And when we say better choice, we mean a better choice for the long term… but if you get a new TV now, that’s better for the short term (well, if you think TVs are a good thing). Like Jerry Seinfeld said when comparing medicines at the pharmacy “do I want to feel good now, or later?” I think it’s best to try to find a good balance of both.

I have written a lot of old articles having to do with putting your tax refund to good use, so I won’t belabour this point and further.

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 http://www.funnymunny.ca.

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.