Month: August 2018

Insuring your mortgage

If you have a mortgage, then you should have some kind of insurance in place to pay it off just in case you die while the mortgage is outstanding. My suggestion*** is that you get a life insurance policy that is sufficient to cover the full amount of your outstanding mortgage. This way, the life insurance can be used by your named beneficiary to pay off the mortgage debt in the event of your death.

 

In Canada, there is a product called mortgage insurance. While I am not in any way, shape or form an insurance expert, I would urge you to get a life insurance policy instead of a mortgage insurance policy.

 

If you have a life insurance policy worth $750,000 and a mortgage worth $350,000, then the full $750,000 is paid out to your beneficiary to use as they see fit after your death. Your beneficiary can choose to pay off the mortgage and to pocket the remaining $400,000. Your beneficiary can choose to take over the mortgage payments and put the $750,000 towards some other goal. You don’t really care what your beneficiary does since you’re dead. What you care about while you’re alive is the fact that the life insurance policy will pay out its face-value. Presumably, you care that your beneficiary is put in a position to continue to live in her or his home upon your demise so that’s why you’ve obtained an insurance policy that will be sufficient to pay off the mortgage on that home. (If you don’t care where your beneficiary lives after you die, then there’s really no need for either type of insurance unless you simply have a deep and perplexing love of paying insurance premiums.)

 

If you have a mortgage insurance policy, then your beneficiary will be the lender who hold your mortgage. The mortgage insurance policy will only pay out the necessary amount to cover your mortgage at your death. If you die when your mortgage is $350,000, the the insurance policy pays the bank $350,000 because the bank is the beneficiary.  Let’s say that you you die near the end of the mortgage and your mortgage balance is only $7,500, then the bank gets $7,500 as the beneficiary of the policy.

 

If your intent is to have the mortgage paid off after your death, then life insurance is superior to mortgage insurance.

 

With a mortgage insurance policy, you do not get to choose the beneficiary. If you should pass away when you have children who still need to be raised and educated, a life insurance policy is a better vehicle by which to provide money for their future financial needs. The mortgage insurance policy only ensures that they can stay in the home, but there is no additional money set aside for post-secondary expenses, extracurricular activities, weddings, or any of the other experiences that you, their parent, would have liked to have given them.

 

Secondly, life insurance premiums will buy you the same amount of coverage for the life of the policy. If you’re paying $5 per month for life insurance, then you are getting $750,000 worth of insurance no matter when you die during the life of that policy. Your beneficiaries will get $750,000 whether you die one month after buying the policy or whether you die 3 days before the expiration of the policy.

 

With a mortgage insurance policy, you pay the same monthly premium for a decreasing amount of coverage. In effect, the mortgage insurance policy’s premium gets more expensive as the mortgage balance goes down. Again, assume that the premium is $5 per month. At the start of the mortgage, you’re paying $5 to cover the full mortgage balance of $350,000. Near the end of the mortgage, you’re still paying $5 but, should you die, the mortgage insurance policy will only pay out the very small amount owing on the mortgage debt.

 

Dollar for dollar, you are purchasing more insurance coverage for your life’s expenses with a life insurance policy than with a mortgage insurance policy.

 

Few people like to think about their deaths, which is understandable. However, the fact remains that people die and they leave dependents behind. The responsible and kind thing to do for your dependents is to ensure that they don’t have to worry about where they will live as they struggle to rebuilding their lives after you’re gone. One of the most loving things that you can do for your dependents after your death is to ensure that their overwhelming grief is not compounded by financial worries.

 

*** I am in no way, shape or form an insurance expert. This blog post reflects my personal opinion, which is based on my life experience. Insurance is a very complicated product so if you decide to purchase insurance, please get an unbiased opinion from an insurance expert.

Singletons & Money

One of the things that I’ve learned over the years is that the principles for saving money are the same whether you’re coupled or a singleton.

 

Pay yourself first… Live below your means… Invest in the stock market for long-term growth… Always have an emergency fund… Buy the proper insurance… Use low-cost index funds to invest… Take advantage of your employer match at work… Maximize any tax-advantaged investment options… Get out debt… Stay out of debt… Save as much as you can as soon as you can…

 

While these principles work just as well for singletons as they do for couples, the fact remains that it’s more expensive for a single person to pay for the costs of daily living than it is for a couple due to economies of scale. For example, a single person might bring home $2500 and have rent on a one-bedroom apartment for $1000. This represents 40% of the single person’s net income. A couple might bring home $5000 and have rent of $1500 on their two-bedroom apartment. The couple is paying 33% more in rent, but spending only 30% of their net income. The couple has more money – both numerically and proportionally – to devote to their other goals. The couple has 70% ($3500) of their money left over to devote to the rest of their lives after paying rent while the singleton only has 60% ($1500). A monthly difference of $2000 is not insignificant for most people!

 

On the flip side, the single person doesn’t have to discuss her money decisions with anyone. The singleton is free to spend or save or donate money however she sees fit. Couples are required to compromise and make joint decisions about money, lest they fight once too often and find themselves singletons once more. Single money means a lifetime of never having to justify an expenditure to anyone other than yourself.

 

I’ve been a singleton my whole life. The personal finance acronym for people like me is SINK – single income, no kids. And while there was a time when I worried if I would ever find a life partner, that time has passed. I simply don’t worry about it anymore – what will be, will be. I haven’t taken the same laissez-faire attitude towards my money. I apply a laser-sharp focus to that area of my life because I don’t have the insurance of a second income tiding me over if I lose my primary source of money, i.e. my job. I know that it’s expensive to run a house, to make renovations, to replace vehicles, to stock a pantry, to do all those things that my coupled friends do on bigger household incomes.

 

When I look at my married friends, particularly my married professional couple friends, I sometimes get envious of the six-figure incomes that they bring into their homes every year. However, all of these friends have children and they’re spending atleast 5 figures every month to run their households, raise their families and service their debts. While they have the larger – okay, much larger – annual incomes, they are not matching my 40% after-tax savings rate. They simply don’t have the room in their budgets to set aside 40% of their take-home income. When their children are finally raised, educated and launched, my friends will be in a position to save as much or more of their money as I do. Their mortgages will be gone and they will hopefully all be out of debt. They will most likely still have much larger household incomes than me.  Yet the reality is that their investments will not have as much time in the market for their returns to compound – I will have been saving for close to three decades, while they will only have 10-15 years to save before the traditional retirement age.

 

You know those comparisons of twins who invest and one twin starts ten investing years before the other one, then stops investing in year 11 yet still winds up with way more money than the twin who started investing in year 11? I’m the first twin, while my coupled friends are represented by the second twin. I’ve been investing for years longer than all my coupled friends, so the math says that I will have a significantly larger cash-cushion even if they start investing buckets of money after their children are grown.

 

Check out this article which does a damn fine job of explaining the benefits of long-term compound investing growth. My situation is akin to that of Chris, or possibly Susan should I choose to stop investing before retirement. My coupled friends will be Bill. They will do well, since half a million dollars isn’t an insignificant sum of money. However, they simply won’t have the same amount of time to let compound interest work its magic on their investments.

 

My savings & investment habits were ingrained early. My parents saved $10 from each of my father’s paycheques when I was growing up and that money was earmarked for university expenses. This explains how I knew to start my investment portfolio by setting aside $50 every 2 weeks from my part-time job as a grocery store cashier. I was 16 years old when I started to save my own money. Fifty bucks was roughly one third of my net income, but it was enough to get the ball rolling. I continued to save money from every paycheque for the next 30 years. Over time, my income grew which meant that my investment contributions grew too. As I paid off my debts (student loans, vehicle loans, and my mortgage), my bi-weekly investment contributions increased. I used part of my former debt payments to increase my standard of living and the rest of it went to investments for my future. Along the way, I happily celebrated my friends’ weddings and the births of their babies.

 

Let’s go back to the example above of the singleton and the couple. While the couple may have an extra $2000 on paper, that money is more than likely going towards the costs of raising a family. They might not be saving anything as that “extra” $2000 gets eaten up by family-related expenses. The singleton might only have $1500 leftover after rent but she has the choice of putting aside the minimum 10% of her net income towards her investments. This would leave her with $1250 (= $2500 – $1000 – $250) to pay for the rest of her day-to-day life but the odds are that her income will go up over time and give her some breathing room. That little pot of money that was started with 10% of her net income will likely continue to grow too, giving her options about whether to continue renting. She might decide to buy a home and to get a roommate to share household expenses. She might decide to become a house-sitter to eliminate her housing costs. So while it is more often than not more expensive to be single, the fact remains that singletons have more options about how to lower their expenses and to increase their income because they only have themselves to think about when it comes to money decisions. Couples with children do not have that same level of flexibility with their money – their kids need to be fed, clothed, housed, educated and entertained.

 

The fundamental principles of personal finance have allowed this singleton to create a comfortable life for herself and I don’t have many regrets about my money. Thanks to my love of all things personal finance and my commitment to continually educate myself about money, I’ve reached a stage in my life where my portfolio kicks off a four-figure income every month. Is the amount enough to retire? No, not yet. However, I’m earning more money every month because I’ve created a positive feedback loop which automatically increases the amount of cash flow that I earn from monthly dividend payments. I fully expect that by the time I retire, my side income will be over $3500 per month. My coupled friends are not in a position to do what I have done, nor to expect what I expect because their priorities dictated different choices with their money.

 

Singletons who follow the principles of investing steadily and starting early are likely to do just as well as couples who earn more money but are raising families. Earlier I said that the expenses of life are more expensive for singletons because there simply is not as much disposable income leftover after the necessities are paid. I stand by this statement. The added expenses of keeping body and soul together makes things harder in the beginning, but they don’t make the final goal impossible. Singletons can still achieve financial independence should they wish. All they have to do is start investing for the long-term, stay out of debt, maximize their tax-advantage investment accounts… In short, all they have to do is follow the principles of personal finance in order to achieve their financial goals.

Reflections on Financial Infrastructure & Intergenerational Poverty

I recently finished two books about poverty – Evicted: Poverty and Profit in the American City by Matthew Desmond and $2.00 a Day: Living on Almost Nothing in America by Kathryn Edin & H. Luke Shaefer. The stories that were shared within their pages will stay with me for a long time.

 

I’m not an expert on poverty and I’ve been fortunate enough not to experience the kind of poverty described in these books.  After finishing both of them, the thing that struck me most deeply is the idea that intergenerational poverty is something from which it is almost impossible to escape. I say “almost” because I’ve also read Hillbilly Elegy: A Memoir of a Family and Culture in Crisis by J.D. Vance. And who among us hasn’t heard the story of how Oprah Winfrey started out in very, very disadvantaged circumstances yet managed to become a multi-billionaire?

 

My impression after reading these books is that the majority of people who are born into intractable intergenerational poverty do not have anyone in their lives who has money, or other financial resources, that can be given or lent in order to assist them to move out of poverty. Most people in this situation do not escape the desperate poverty in which they live nor are they ever in a position to help their family escape from it either.

 

Intergenerational poverty appears so intractable to me because I interpret it as a complete absence of a financial infrastructure. What do I mean by a “financial infrastructure”? Simply this – it is a person’s ability to access financial resources.

 

On the other side of spectrum is intergenerational transfer of wealth. My definition of the intergenerational transfer of wealth is that one generation in a family transfers wealth down to the next generation, traditionally from parent to child.

 

I’ve noticed that, very often, the concepts of a financial infrastructure and the intergenerational transfer of wealth are very tightly linked. Throughout my life, I’ve had the opportunity to observe and learn from examples of people who have a financial infrastructure and who have benefitted from the intergenerational transfer of wealth. And while I always knew the families in my circle weren’t all equally rich, I didn’t know anyone who did not have the ability to access money from somebody if it was really, really needed. I never would have articulated it this way as a child but I inherently understood the idea that those who have a financial infrastructure and those who can benefit from an intergenerational transfer of wealth are in a position to get money when they need it.

 

My parents weren’t rich, but my maternal aunt had a farm. When my parents were a young couple with a new mortgage and young babies, my aunt would raise some chickens just for them and my parents would fill their freezer with meat. Since my parents had a large backyard, they planted a garden and canned vegetables for the winter. The availability of these financial resources meant that my parents lowered their grocery bill, thereby saving money, while feeding their family. They might not have been living large, but they weren’t living above their means and they were able to set a few dollars aside every paycheque to build a money-cushion for themselves. Eventually the mortgage was paid and those former mortgage payments could be redirected to other goals. The help from my aunt was part of my parents’ financial infrastructure. My aunt didn’t give my parents money, but she was able to indirectly help my parents to accumulate money so that they could meet their financial goals. My aunt was part of my parents’ financial infrastructure.

 

I know another person who worked in a retail liquor business during his undergrad. His graduation coincided with his boss’ retirement so his parents gave him the down payment to buy the liquor store from his boss and they co-signed his business loan. He worked his ass off to repay the loans to his parents and the bank and he is quite comfortable today. This is an example of intergenerational wealth – his parents had the ability and willingness to help him buy an established business so that he could support himself. Thanks to his parents’ financial resources, this person has been able to build a strong financial infrastructure for himself and his young family. This situation exemplifies what I mean when I use the term financial infrastructure – this man had the ability to access financial resources from other people. His life includes people with money. As a result, he is now a person with money and he will be able to both transfer his wealth to his own children and also be a significant part of their financial infrastructure until they are able to create their own wealth. It is this cycle of transferring money from parent to child for the purpose of acquiring assets that creates, maintains and increases intergenerational wealth.

 

Another friend started working a part-time job in her first year of high school to support her household and she’s worked hard ever since. Through her own efforts and her dedicated savings, she created her own financial infrastructure and relied on it to get her though university. Once married, she and her spouse were able to purchase land in the mountains and to build a rental property due to the assistance of her mother-in-law, who runs a business renting that propety on a year-round basis. My friend jokes that she and her family have a hard time using their own property because it’s always booked so far in advance. All kidding aside, my friend has benefited from an intergenerational transfer of wealth and the fact that she has created a strong financial infrastructure for hersefl. She and her husband share in the profits of the rental business. Both of them are careful with their investing. As a result, they are simultaneously strengthening their financial infrastructure and creating more wealth for themselves and their own children.

 

I know of several people whose parents were able to assist them with down payments on their first properties. One of my friends had parents who were able to give her the down payment on a condo when she graduated from university. My friend had a roommate to assist her with the mortgage but she eventually sold that condo when she moved into a larger townhouse. She then moved from that townhouse into her now-husband’s home. They sold that home and are raising their family in a very nice luxury home. Without her parents’ initial infusion of cash, it is unlikely that my friend could have saved enough money from her starting salary to build a sufficiently-large down payment which would have permitted her to buy before real estate prices skyrocketed. The money from her parents allowed my friend to benefit from the rise in real estate prices and to build equity that allowed her, and eventually her husband, to purchase their current home. This is yet another example of both intergenerational wealth and access to a financial infrastructure.

 

Again, I’m not an expert but it seems to me that intergenerational poverty is intractable and it prevents one generation from helping the next because there are no financial resources to be distributed when needed and there are precious few opportunities to accumulate those resources. It is incredibly detrimental to all who are its victims.

 

When I read Evicted, I was struck by the fact that the tenants portrayed in the book had no family with whom they could stay until they got back on their feet. The tenants’ financial infrastructure simply did not exist because they couldn’t access enough money to build one. For the most part, they did not have full-time wages and they did not have their own homes. Their family and friends couldn’t be counted on for help because they were similarly under-employed and they were also renters living in dilapidated structures that were only slightly better than being homeless. The tenants were at the mercy of their landlords, and they were essentially powerless in the landlord-tenant relationship. Their landlords knew that they could be easily replaced by someone who was just as poor and just as desperate.  For a variety of reasons, the tenants could not pool their meagre funds with others in order to create a little bit of a safety net for themselves. In other words, they had no opportunity to create and build a financial infrastructure because they had no money that could be set aside for the future. Whatever meagre income they received went to their rent, their food, the basics of survival. There literally was no money leftover for the proverbial rainy day, and it was always raining in their lives in one way or another. The tenants depicted in Evicted did not appear to have any way out of their abysmal situations beyond winning the lottery. No one in their respective circles had financial resources. The seeds of a financial infrastructure and intergenerational wealth simply did not exist.

 

The story was even worse for the people described in the book $2.00 a Day – which translates into $730 per year for those who like to do the math. These poor people were literally starving, and they were forced to make horrible choices in order to survive from one day to the next. They did not have family members who could help them with a down payment, who could raise food for them, who could help them find a job or to start a business. More often than not, the people of $2.00 a Day were born into poverty and were raising children in poverty. There didn’t seem to be an end to the cycle as there was no way out without cold hard cash. It made me so sad to realize that many of the people living in the horrid conditions described in the book simply couldn’t begin to build a financial infrastructure for themselves or their children because they had to devote so much energy – mental and physical – to basic survival. They did not have the luxury of “big-sky thinking” because they were so worried about living without food, water, electricity, etc…

 

This blog is about money so my comments are limited to the financial impressions that these books left on me. There are many layers to the problems faced by the people in these books, so forgive me for simplifying. All of the people in both books had many issues and challenges that needed to be resolved and I don’t want to create the impression that all of their problems could have been solved with money. However, having money would have meant that their issues and challenges would have been addressed, even if not solved, because they would have had the ability to seek the help that they needed. If the people in these two books been able to access sufficient financial resources, then they would also have been able to address the other problems in their lives without losing their homes, their children, or the basic necessities. They would have had a financial harbour while they sorted things out.

 

Did the books’ subjects have any examples in their lives of people who had made it out of poverty? I don’t know – the authors were silent on that question. In both books, the only people with money were the landlords and they were not portrayed in a favourable light. Neither book gave any indication that any of the landlords had ever been in the position of their tenants. Beyond the landlords, the impoverished subjects of each book appeared not have had any exposure to anyone who had overcome dire financial circumstances or who could teach them how to get out of poverty.

 

Whether you choose to read the books is up to you. What I want to impart to you is that you should carefully consider your own financial infrastructure and assess your own access to intergenerational wealth. If you lost everything in a fire, do you have insurance in place so that you can start over? Do you have family or friends who could put you up until you get back on your feet? Do you have a source of passive income that can tide you over if you lost your employment? Are you the kind of tenant that a landlord wants to keep? Are there people in your social network who could help you find job leads if you needed them? If you wanted to start or buy a business, are there people in your life who could help you fund that dream if necessary?

 

What are you doing to build your own financial infrastructure? Is building intergenerational wealth important to you?