Month: February 2022

Pension or Not, Feather Your Own Nest!

It’s up to you to feather your own nest, regardless of whether you have a pension. The first step is to take responsibility for Future You by investing some of today’s money for tomorrow. It is both risky and foolish to rely on your employer for your retirement income needs. You shouldn’t assume that your employer’s contributions to your retirement plan are going to be sufficient when you can no longer work for a living.

Simply put, a pension is a promise from your employer that there will be money for Future You when you quit working for that employer. While you’re employed, your boss sets aside money for your retirement. That money goes into the pension. It is then distributed to the former employees each month.

Under a defined-benefit pension, the employer contributes money to the plan and promises to pay you a fixed monthly amount when you retire. This is your pension payment, and it is calculated by a formula. The payment is derived from your years of service and your salary. In other words, you can figure out how much you’ll receive in advance of retirement. The longer you work, the higher your salary, the bigger your pension will be. Your employer takes responsibility for ensuring that there will be enough money to pay you a pension until the day you die. Your benefit is defined.

The defined-contribution pension works differently. Your employer promises to contribute to your pension plan. There are no promises about how much you’ll receive when you retire. Under this plan, it is the employer’s monetary contribution that is defined. Your employer takes no responsibility for ensuring what your pension payment will be when you retire. Determining the size of your pension payment is a responsibility that lies on your shoulders. You’re the one who has to ensure that the money is properly invested for the long-term. Your choices will determine if your pension payment will be big enough to pay your bills once you’ve stopped working. Under this pension, two employees working the same length of time for the same salary can receive vastly different pension payments when they retire. The difference is attributable to how each employee chose to invest their pension contributions.

Hedge your bets when it comes to funding your retirement.

No matter what kind of pension you have, you need to feather your own nest. Why? Simple – a pension is a promise, not a guarantee. If your employer goes out of business, your pension will be impacted. It may take years for you to receive the pension payments that you were promised. Just talk to some former retirees from Nortel or Sears Canada. They all saw their pension payments cut when their employers went bankrupt. What would you do if 30% of your paycheque disappeared today? Now imagine losing 30% of your pension payment when you’re too old to return to the workforce. What options would you have for replacing that chunk of your promised pension?

Having your own investment portfolio is like having insurance for your pension. Investing for the long term increases your chances of being able to live off the income from your portfolio. If things go in your favour, dividends and capital gains might eventually exceed your annual pension income. Every dollar earned by your investments is one that can replace a dollar from your pension just in case the worst happens to your pension. Think about it. The Nortel and Sears Canada employees with personal investment portfolios weren’t as badly impacted when their pension payments were cut. The income from their investments was available to replace the money cut from their pension cheques. Had they planned on spending the cashflow from their investments? Maybe, maybe not. The reality is that having that investment cashflow dulled the impact of the reduced pension.

Do Better for Future You

I know how seductive the pension promise is. It would be lovely to cast aside all responsibility for Future You’s financial health, to let “someone else” worry about that. It’s the path of least resistance, but it might be disastrous. You wouldn’t even know how disastrous until it was too late. Imagine working for decades then realizing that you won’t have enough money. You’ll be out of time to earn more money. At 70 years old, do you really believe that you’ll eagerly anticipate working another 10, 15, 20 years just to make ends meet?

And I recognize how persuasive the AdMan is! In a world where you’re constantly exhorted to live your best life, it’s hard to save for a future that is decades away. After all, living your best life is generally code for open-your-wallet-and-give-me-your-money. The AdMan won’t be there to pay your bills in your dotage. Trust me on that!

Again, a pension is only a promise. This is why you have to feather your own nest! Err on the side of caution and invest some of your own money for Future You. No one is suggesting that you become a miser. I don’t want you to give up all the things that you love in order to save for tomorrow. I recognize that no one is promised tomorrow. However, I do want you to admit that there’s little to no harm in investing a portion of today’s money for tomorrow’s needs. Having a pension and cashflow from your personal investment portfolio would be the best of both worlds. Why deprive yourself of that?

Start Today

The reality is that you have to worry about Future You. Living below your means isn’t a punishment. It’s an admirable way of governing your financial life. Doing so will maximize your comfort when you no longer can, or want, to work. Money invested for the long-term will generate annual income for you, regardless of the pension plan you’re in.

Shave a little something off of each paycheque and invest it for tomorrow. I would advise saving 25% of your net income, but you know your finances better than I do. If you can only start with $10, then start with $10. Every penny counts, but you have to start somewhere. As your income grows, as your debts are eliminated, increase the amount that you’re investing. Once you’ve saved a portion of your paycheque for the Care and Feeding of Future You, then spend whatever’s left however you see fit.

Feather your own nest. The worst thing that can happen is that your pension shows up every month. In addition, your investment portfolio would be churning out dividend and capital gain payments every year. You’ll have two sources of income in retirement. How could Future You have any complaints about that?

No Easy Answers

Forgive me in advance, as this post is going to touch on several things. I don’t have all the answers, but I have lots of questions.

Today, I watched a couple of YouTube videos about poverty in Europe. They could’ve just as easily been about North America, but The Algorithms suggested videos about Europe. It hardly matters what country I was viewing. The story is nearly universal. Once a person falls into debt and/or poverty, there are precious few ways out of it.

The first video involved young people who’ve graduated from university and cannot find a job. It’s not for lack of trying. The jobs simply aren’t there to be had. So young people who can do so are leaving their home countries to build lives everywhere. Why wouldn’t they leave? How do you create jobs that will motivate people to stay, to put down roots, to start families? What kind of a future does a country have when its young people have to move away in order to fulfill their dreams and ambitions? What has to happen to entice the young people to return? Will the country be around 100-200 years from now if their best, brightest and most talented leave to build satisfying lives elsewhere?

That same video also discussed how increasing interest rates skewered the incomes of those formerly in the “middle class”. Countries borrowed money and the terms of the loans required a decrease in labour costs. This is economist-speak for employers reducing salary costs. The good folk that believed they were solidly in the “middle class” saw the value of their paycheques plummet while their debt obligations remained the same. More than a few lost their homes and businesses. When incomes are slashed and debt stays in place, how are people supposed to recover from that particular double-whammy? What do you do when you realize that your economic status was tenuous at best? More myth than reality?

There are no easy answers to my questions. You can have the 12-month emergency fund to “tide you over”, but there has to be a job waiting for you at the end of those 12 months. If there’s no job, then you’ve simply exhausted your emergency fund. Without another job to go to, you’ve only delayed the inevitable results of being unemployed: homelessness, couch-surfing, losing friends, deteriorating networks, separation from family, etc… It’s grim.

Getting out and staying out of debt offers some protection from rising interest rates. Payments that used to go to creditors can stay in your bank account. You can use those funds to pay for the rising costs of food, housing, utilities, and any other price hikes associated with inflation’s impact on the economy. Yet if your paycheque doesn’t go far enough, what choice do you have other than credit to pay the minimum monthly bills? When your rent eats 75% of your paycheque, can you really be faulted for using credit to pay for the necessities that the remaining 25% doesn’t cover?

For most of us, the reality is that getting out of debt generally means having a steady income from which payments can be made. When it takes 25 years, or even 15 years, to pay off a mortgage, a borrower is making a huge bet that they will have income over that long period. In today’s world of contract workers and gig-workers, there’s a whole swath of people who might be better off not taking that bet. After all, a bank can just as easily foreclose for failure to pay at the 20 year mark as it can at the 2 year mark. Can you imagine how awful it would be to make 20 years of mortgage payments then lose your home if something permanently reduced your income?

Yet, at the same time, owning a home is still one of the few ways for a not-rich person to build wealth. Talk to the people who bought houses in Vancouver and Toronto as recently as 5 or 10 years ago. The values of their home have skyrocketed. Some lucky folk have houses that have earned more in equity growth than their owners have earned through a paycheque. Buying a home in a city with a strong economy and paying it off is still one of the ways to build wealth for your dotage.

And speaking of your retirement, what recourse is there if your retirement is adversely impacted by market forces beyond your control? If going back to work is not an option for you due to your health, age, or lack of job openings, what do you do?

These are the questions that keep me up at night. We always hear about the success stories, the people who’ve made it. They should be celebrated – they’ve overcome the odds and they can serve as a hopeful example of what’s possible. Yet there are countless others who did not achieve that same success. They worked hard. They saved. They followed the rules, yet they didn’t get their happily-ever-after on the financial front. What are the answers available to them?

Like I said at the start of this post, there are no easy answers. If there were, these problems would’ve been solved by now. All I know is that there are serious structural problems that are encouraging and reinforcing income inequality on a global scale.

Will you be prepared when it’s time to renew your mortgage?

According to the various talking heads in financial media, mortgage rates are set to rise over the next two years. They’re predicting that almost everyone is going to see their mortgage payments rise on renewal. If you’re on your last mortgage term, then you have my heartfelt congratulations. You don’t have to worry about your mortgage payment going up because it will be going away. You will get to keep your current mortgage payment instead of sending it to your lender. Hooray for you! Take a chunk of it – no more than a third – and use it for day-to-day spending. The rest of it should be invested for long-term growth. Enjoy your money and the comforting feeling that comes from knowing that your disposable income has gone up, way up!

If you’re one of these lucky ducks, you need not finish this article. The increase in mortgage rates will have little to no direct impact on you.

For the rest of you, keep reading. If you’ll be renewing your mortgage at some point in the future, you’d be wise to ask yourself how your budget will accommodate an increased payment. The only pertinent question that you need to consider is the following one. Will you be ready when they do?

Fortunately for you, there are many online amortization calculators. These little beauties will tell you how much your new mortgage payment will be if your mortgage rate changes. I urge you to find one immediately! Then I want you to add 2% to whatever rate you’re currently paying, figure out how much your remaining mortgage debt will be on renewal, and determine what your new payment will be at the higher rate. The sooner you have this information, the better.

Should you be fortunate enough to have access to Excel or Numbers, then you have the ability to create your own amortization table. This spreadsheet will break down your payments into the principal and interest portions. You can then play around with the interest rates and mortgage debt to see the impact on your future payment.

Armed with this new information, you can turn your attention to your budget and figure out where the money will come from to fund the higher payment. Remember! If you don’t pay your mortgage, then your lender can take your house. No one wants this to happen to you.

If your budget can accommodate the new, higher payment without trouble, then hooray! You’ll be fine and you need not worry about the increase’s impact on your life. Your house won’t be at risk of foreclosure, and you won’t need to worry about declaring bankruptcy. You can stop reading here if you choose.

Should you be in the position that your budget will balk at the increased payment, consider the following option to prepare yourself for the inevitable.

One way to keep the same mortgage payment, even if rates go up, is to make a lump sum payment at renewal time. After all, your payment is based on both the prevailing interest rates and the remaining mortgage debt. The smaller the debt, the smaller the payment. If you can accumulate a few thousand dollars between now and renewal, then do so! You’ll have the option of making a lump sum payment at renewal time. Doing so will keep your payments from inflating more than your budget can bear.

You could even start sending extra payments to your mortgage in advance of your renewal date. Doing so chips away at the mortgage’s principal balance even sooner. Every dollar of principal that is repaid is a dollar on which your lender can no longer charge you interest. Prepayments are a fantastic method of ensuring that your increased mortgage payment isn’t as high as it could be. Revisit the terms of your mortgage contract and see what options are available to you for making prepayments.

Be prepared for the day when your mortgage lender asks you for more money. Mortgage terms in Canada are rarely set for 25 years. You’d be wise to assume that mortgage rates will continue to increase. If they don’t, then you’ll have done yourself absolutely no harm by being prepared.

A Primer on How Banks Make Themselves Rich

The first thing you should know is that I am not a banking expert. I worked in that industry on a part-time basis while going to university. That was 20+ years ago. Currently, I am what you would call “just” a customer. I don’t have access to private banking, nor is my business significant enough for the executives at the banks to care about me. This primer on how banks makes themselves rich is based entirely on my personal experiences as a customer and my part-time job at ATB before moving into my current career.

Savings Accounts

Customer A: “I should start saving some money.”

Banker: “Great idea! We can put you into our Never-Fail, Best-Option savings account. It pays you interest. The more you have in there, the more you earn.”

Customer A: “I like earning interests on my money. I’d like to open one of those accounts please.”

Banker: “Easy-peasy-lemon-squeezy.”

The account is opened. The customer goes away. The banker has the customer’s money and is wondering how to make it grow. After all, Customer A was promised that interest would be earned on her funds. The banker certainly wasn’t going to pay the customer with money from the bank’s own pockets! A lightbulb goes on as the banker realizes that money can be made from lending. An idea begins to germinate. If the Banker only had to pay out a fraction of the interest charged to lend, then the bank would make buckets of cash!

But how to make that happen?

Mortgages

Customer B: “I need to borrow some money to buy a property.”

Banker: “I can help you with that. The interest rate on our mortgages is very fair.”

Customer B: “That sounds good. Where do I sign?”

The banker is gleeful. Two customers! One brings in the money to be lent to the second. The bank only has to pay Customer A an interest rate that is a tiny portion of what’s being charged to Customer B. The difference between the two rates will be spent on administrative costs & other expenses, but any leftover is profit. How many other ways could the Banker come up with to make money?

Lines of Credit

Customer C: “I’d like to borrow money, but I’m not sure when or how much I’ll need.”

Banker: “Not a problem. We’ll set aside some money just for you. If you don’t use it, then there’s no charge. If you do use it, then the interest rate will be the prime rate + 3%. We’ll start charging you interest from the minute that you use your line of credit, but you only have to make the minimum monthly payment. You can pay it off whenever you want to.”

Customer C: “Awesome! Thank you!”

Auto Loans

Customer D: “I want to borrow money to buy a new vehicle.”

Banker: “I can help you with that. We’ll secure the loan with the vehicle. If you don’t pay the monthly note, we’ll repossess it.”

Customer D: “Sounds fair. Thanks!”

Credit Cards

Customer E: “I’d like a credit card please.”

Banker: “Done. Now, it charges a double-digit interest rate.”

Customer E: “Double-digits? That’s kind of expensive!”

Banker: “You know what? You’re right. So I’m going to do this for you. We won’t charge you any interest at all so long as you pay off the full balance when the statement is due. Think of it as a grace period. If you don’t pay it off in full, then I’ll charge you interest… and other assorted fees for late payment.”

Customer E: “Okay. Can I have my credit now please?”

Service Charges

The Banker wants to make even more money. The spread between interest paid on savings accounts and the interest earned on mortgages and other debt products is pretty good… However, the Banker is convinced that there is a way to increase its profits. Customers had always paid for drafts and certified cheques, but those instruments were often rare and not guaranteed income to the Banker. In a world of electronic transfers, fewer and fewer people need such services. Yet, everyone still needed to pay their bills, send electronic transfers to each other, make loan payments, and clear cheques.

Banker: “I could charge them just for having an account! Or I could offer them a so-called free account, but charge them by the transaction. People are inherently lazy about switching banks. I might lose a few customers but most of them will stay with me…and will pay me every single month to use their own money!”

The Banker add service fees to its bank accounts. Presumably, these are to cover the costs of providing services like utility payments. The Banker tell people they can pay per transaction, or they can pay a flat monthly fee for unlimited transactions. Better yet, customers can leave several thousand dollar in their account at all times in order to have the monthly fee waived completely.

Customers: “This sucks!”

Banker: “What are you going to do?”

If you’ve ever wondered…

…how banks make themselves rich, I hope this post gave you some insights. Banks make money because they have a vested interest in getting customers into debt. They profit when people borrow money. That’s the heart of their business. Everything else is a detail.

The vast majority of us will need to borrow money at some point. Assuming you’re interested in paying as little as possible to do so, here are some things to consider:

And should you be in a position where you cannot avoid owing money to the bank, then do yourself a small favour. Start buying shares in the banks! In Canada, banks pay out dividends every single quarter. Their profits are going up and their shareholders are benefiting. If you become a shareholder, then atleast some of the interest and fees that you pay is coming back to you every year. After sufficient period of time, all of the money that you’re paying to the bank will be returned to you in the form of annual dividends.

Now you know.