Author: Blue Lobster

Cash Flow Diagrams & Passive Income

I’m a visual leaner so when information can be presented in a picture, then I absorb it a lot faster. That’s why I was so damned impressed when I came across the following link on one of my travels through the Internet: Cash Flow Diagrams. In all honesty, this is one of the best links I have ever found!  In a few simple diagrams, Jacob Lund Fisker of Early Retirement Extreme succinctly illuminates the basic underlying principles behind the following concepts:

– paying yourself first;
– acquiring assets;
– creating passive income; and
– benefiting from compound interest.

 

Much ink has been spilled and many trees felled to write numerous books to explain these four foundational concepts. Mr. Fisker has accomplished the same goal with a few hand-drawn diagrams that are not overly complicated nor difficult to grasp. Please, please, please take the time to read Cash Flow Diagrams and figure out if your current cash flow is helping you to get to where you want to be or whether it’s holding you back from achieving your personal dreams.

 

The first diagram is a representation of the cash flow in the lives of those of you who live from paycheque to paycheque without going into debt. You are working hard for your money. When you get your money, you pay for your life and you have no money left over. You have to go back to work to make more money. This is called living at your means. In other words, your means are equal to your money and you spend all of your money between each paycheque. There is no room for investing because you spend every cent you make. This is not a good way to live! There is no breathing room – there is no cushion – there is nothing set aside for the day when you can no longer work. If you’re in this situation, I implore you to find a way to get out of it. Get a part-time job and use the money from that part-time job – or side hustle as it is now called – to get yourself into the position of being able to buy assets as displayed in diagram 3.

 

The second of Mr. Fisker’s diagrams applies to those of you who live from paycheque to paycheque and go into debt. You’re in an even worse situation than the people in the first diagram because you’re using credit to fund your life. Using credit means that you are going into debt. This is a very bad cash flow situation because it means that your money is not enough to pay for your life so you’re relying on credit to make ends meet. You are living above your means, and this is a very bad state of affairs.  The reason why it is so undesirable is that you’re paying interest on the credit that you’ve borrowed. If your paycheque is not enough money to pay for your life already, then it’s an absolute certainty that your money is not enough to cover both your life and the interest owing on your debt. (Again, as soon as you use credit it become a debt!) If you’re in this situation, I would suggest that you do whatever you can to get out of it sooner rather than later. Compounding interest is working against you and keeping you from achieving what you really want from life!

 

If you have disposable income after buying whatever stuff you need to keep body and soul together, also known as: the necessities, then your cash flow is reflected in the third diagram. Disposable income is just a fancy way of saying leftover money. If you, my friend, are fortunate enough to have leftover money, then you are in the enviable position of being able to acquire some assets.

 

What’s an asset? An asset is anything that puts money in your pocket by producing an income payable to you. If you are living below your means, then you have leftover money for investing. And when that leftover money is put to good use through purchasing assets, you are well on your way to creating a stream of passive income. This is a very good thing! Ideally, everyone can get themselves to this point, namely having some amount of passive income even though, at first, that passive income isn’t enough to fund your entire life. Passive income will grow if it is diligently reinvested and left to compound over time. You still have to work, but that’s okay because working means that you’re generating more money to buy more assets that will increase your passive income. Eventually, your passive income will exceed the size of your paycheque. The faster you acquire income-producing assets, the faster your passive income will increase.

 

Once you make it to the fourth diagram, you’re laughing. At this point, the reality of your cash flow is that your assets are throwing off enough passive income to pay for your stuff. In other words, you are not required to work. You don’t have to quit your job if you don’t want to – it’s just that working for a salary is now completely optional. This is a wonderful achievement! You can do what you want with your time because your passive income has replaced your wage as the source of money to fund your life. If you’ve reached this stage, then my hat is off to you – congratulations!

 

The fifth diagram represents retirement. As in the fourth diagram, the cash flow from your assets is sufficient to fund your life and you’ve simply chosen not to work for wages anymore. At this stage, your passive income has replaced your paycheque. Hooray!

 

When I found this article online, I was already living the life depicted in the third diagram. Thankfully, I had no debt and my take-home pay was enough to pay for my living expenses – there was money leftover every payday. My student loans were gone. My mortgage was paid off. I no longer had a car loan.  At that point in my life, I knew that I had to absolutely, positively invest my money after maxing out my registered retirement savings plan (RRSP) and my tax free savings account (TFSA), but I didn’t know where or how or what to do. I didn’t trust financial advisors, so I decided to buy units in dividend-paying mutual funds. (At the time, I didn’t know that mutual funds were vastly more expensive than index funds or exchange-traded funds [ETFs] – now that I know better, I do better!)

 

I set up an automatic bi-weekly transfer of money from my chequing account to my investment account so that I could invest monthly and take advantage of the benefits of dollar-cost averaging. Automating my savings meant that I didn’t have to decide whether to set aside my leftover money. Relying on automation to fund my investment account was an exceptionally smart move on my part because I’m sure that I would’ve been tempted to buy something other than investments if I had to think about saving vs. spending every time I got paid.

 

Did I pick the perfect investment? I doubt it. I’m not that lucky nor am I that smart. Also, my accumulating years have taught me that there is no one perfect investment. I invested in a product that I understood – dividend funds – and set up a dividend reinvestment plan (DRIP) so that my dividend payments were automatically reinvested. I had no idea whether this plan would work perfectly. All I knew at the time was that dividends were a form of passive income. I knew I didn’t have the skills or inclination to read company reports and to follow the stock market. I knew that I wanted an investment portfolio that would supplement my other retirement income when I decided to leave work. Dividend mutual funds – and, later, dividend ETFs – satisfied my list of what I wanted for my portfolio so I picked one and started investing.

 

Dividend payments are my preferred form of passive income so I invest my money in dividend-producing assets. As a Singleton, I don’t have the benefits that come with having another person’s income contributing to my household. Having a reliable stream of dividend income soothes some of the risk of living in a single-income household. My goal is for my passive income to cover my monthly necessities. Once I’ve met that goal, then I’ll know that I can survive on my own even if my salary goes away.

 

As a result of my choices to automate my money and to invest it regularly, I’m now in the position of comfortably earning four figures of dividend income every month. My passive income stream is not yet enough for me to live on, so I still have several years of working in my future. However, my passive income is compounding every single month as it’s added to the new investment purchases that I make with the money that is automatically transferred to my investment account when I get paid. I’m comfortably investing the equivalent of one paycheque every month. I like to think of my dividend income as my side hustle income, even though I don’t have to do anything other than breathe to earn the dividends.

 

Where are you now? And where do you want to be in five, ten, twenty years?  How much passive income do you want in order to live the life of your dreams? What steps are you taking to put yourself in the cash flow position that you want for your future?

Building an Army of Little Money Soldiers

One of my life’s goals is to build a nice, solid flow of passive income without getting a second job. The way I decided to do this was by building an investment portfolio using a dividend-paying exchange traded fund (ETF). I think of the individual units in my ETF as Little Money Soldiers whose sole purpose is to acquire more and more dividends for me every month. The dividend income that I earn can be used any way I want, and right now I want it to fund my dream of financial independence.  Every single month, I add to my army of Little Money Soldiers by buying more units in my ETF and I send them out into the world to do their thing – they do it well. I don’t have to do anything beyond sticking to the plan of contributing to my portfolio regularly and watching my dividends grow. My Little Money Soldiers do the rest.

As a Singleton, my paycheque is the primary source of income in my household. Years ago, I’d heard about how smart couples of means would live on one income and bank the other. Ideally, the really well-off couples would bank the higher income and live off the smaller one. I envied such couples! The reality was that I was not in a position to live on 50% of my take-home pay. I wasn’t willing to live that close to the bone because I wanted to be able to socialize with my friends each month and do some travelling. When I learned about dividend income and started doing some blue-sky dreaming about how dividends could be used to supplement my income, I couldn’t buy them fast enough!

Dividends are a second income in my otherwise single-income household. Unlike married people in a single-income household, I don’t have a partner who can go out and earn some money if my main income source dries up. My monthly dividend income is financially akin to having a partner with a part-time job. If I were to lose my paycheque, my dividends could help me survive from one month to the next. Obviously, I would lose the benefit of the dividend re-investment plan (DRIP) because I would need the dividends to pay for my absolute necessities while I looked for employment. As a single person, the dividend income created by my Little Money Soldiers provides a certain level of psychological comfort because I know that, should I lose my current job, I will continue to have income until I find new employment and start getting a paycheque again.

Right now, my investment portfolio produces a part-time income. If I continue to invest on a regular basis and if I refrain from spending my dividends rather than re-investing them, then my investment portfolio will eventually produce a second full-time income for my household. I will have the financial benefits of an imaginary spouse/partner without the real-life drawbacks that come with sharing money with a sentient human. And unlike other side hustles that are regularly touted on the Internet, my army of Little Money Soldiers goes out to work on my behalf thereby allowing me to indulge my inclination towards laziness. I don’t have to do anything outside of my comfortable routine in order to earn this money. It’s all mine – it’s tax-advantaged – it’s automatic – it’s wonderful!

For the past 7 years, I have consistently been investing in dividend-producing assets. I’ve reached a point where I consistently receive a 4-figure dividend payment every month. And since I don’t spend the money, it is automatically re-invested on my behalf. (Check out this awesome article for a primer on how DRIPs are the next best thing since sliced bread: My dividend employee Steve.)

I was very lucky that my parents were interested in the stock market. Both of them invested on a regular basis so I knew that there was a way to make money without actually having to go to work. Of course, my six-year old brain didn’t quite grasp all the intricacies of what each call from my mother’s broker meant but he phoned on a regular basis. (As an adult, I’m quite convinced that he merely churned her account to generate fees instead of acting in her best interests to make money. Nowadays, my mother invests on her own through her self-directed brokerage account and she’s doing quite well!)

My father’s style of investing was much different. He introduced me to the concept of dividends, and bought me several shares in companies that are still around today. When I was in my early 20s, I opened my own self-directed brokerage account and used my initial principal to buy shares in the various Big Banks. Again, betraying my youth and lack of knowledge, my only criteria for which bank stocks to buy was whether the bank participated in a DRIP. If the answer was yes, I bought $1,000 worth of stock in the bank. To this day, those banks still pay me dividends every quarter. I freely admit that this wasn’t the smartest way to pick my investments, but I could’ve done a whole lot worse! Every one of those banks is still around and the stock price has grown over time. Buying those bank stocks was one of the best financial decisions that I’ve ever made, even if the reason underlying the decision was not well-founded.

As we all know, time waits for no one. I learned more and more about investing by reading books, internet articles & personal finance blogs. They were all consistent that the way to earn outsized returns was to be invested in the stock market. I had little interest in becoming a expert in the stock market but I appreciated that the best historical returns went to those who had equity investments. Buying stocks in companies that paid dividends meant I was investing in equity. Dividend payments were a passive way for me to earn money and to participate in the stock market – to me, it was the best of both worlds! I started contributing more regularly to mutual funds which paid me dividends, then I learned about ETFs and index funds and a light went off in my brain. Why should I willingly pay higher management expense ratios (MER) for my mutual funds when I could buy the same basket of assets through an ETF or an index fund for a fraction of the price?

So, after paying off my mortgage at 34 and becoming debt-free, I turned my focus to building my non-registered investment portfolio. I promptly found an index fund that paid out dividends every single month so it was time to say bye-bye to my mutual funds. I was still investing in dividend-paying assets but I would be paying a lower MER to do so. My new index fund would simply pull the money from my chequing account and the investment would be made. Making the switch was a no-brainer! I set up an automatic contribution from my paycheque to my index fund. My first index fund offered a DRIP feature and I was not responsible for re-investing those dividends into new units of the index fund every month. The dividends were DRIP-ped, i.e. automatically re-invested into more units of my index fund, rather than paid out to me in cash. It was fantastic!

Two years ago, Vanguard came to Canada and I started doing some investigating. Vanguard has very low MERs on their products. One of those products was an ETF that paid out dividends every single month, offered a DRIP feature, and had an MER that was much lower than the one on my index fund. This was a hat trick! I could get all the benefits of my previous index fund portfolio while saving money on the MER and accruing even more units of the ETF every single month. Sadly, Vanguard will not simply withdraw the money from my chequing account – I have to transfer money to my brokerage account. Big deal! For $9.95 a month, I’m paying a much lower MER and earning sufficient dividends which more than cover the cost of the monthly purchase. I spent 15 minutes opening my online account. Then I spent another 3 minutes setting up an automatic bi-weekly transfer from my paycheque to my brokerage account to fund each month’s purchase. I haven’t looked back. Every month, I buy more units in my Vanguard ETF after the last month’s dividend payment has been automatically re-invested.

Earning money through dividends is awesome. I don’t have to do anything other than purchase the underlying asset and the dividends flow to me every month like clockwork. In the words of my very wise hairdresser, it’s money that I don’t have to sweat for. What could be better than that?

The Ad Man & the Creditor

Debt sucks, yet people go into debt like they’re the ones earning the interest!!! Think about it for a moment. Financing purchases means paying interest to a creditor in order to acquire things. Whether it’s buying the latest flat-screen TV or acquiring a vehicle or upgrading one’s wardrobe or taking a vacation, a great many people have no trouble using credit to finance their purchases.

 

The credit card comes out, the purchase is made! The bother of paying off the debt is pushed aside to a later and more convenient date… Of course, there really is no convenient time to call yourself an idiot for using a credit card at 18.99% interest (or more!) to purchase whatever it was that had to be acquired at that very second. The creditor, whether a bank or another financing company, is always happy to help people scratch their instant gratification itch because the creditor knows who is really earning the interest on each and every one of those transactions.

 

(If you’re one of those people who saves first, buys with a credit card and pays off the credit card in full every single month, then I’m not talking about you. You’re one of my people and I salute you!)

 

Why would right-thinking people borrow money at very high interest rates to acquire items that are not necessary to their survival? My personal theory is that people would rather be poor than look poor, so they use credit to go into debt in order to create the illusion that they’re doing quite well financially.  A new car every two years – extravagant holidays each year – magnificent home renovations! These are all wonderful things and we’ve been taught by the Ad Man that we will feel better about ourselves and that the world will think better of us if we buy these things because then no one will think that we’re poor. If we buy the stuff that’s being marketed to us, then others will think we have money and that we’re doing well financially. Having the latest and greatest must signal to the world that we’re not poor!!! Psychologically, the Ad Man has perfected a very seductive message. Who doesn’t want others to value them highly? Who truly enjoys feeling bad about themselves? Why wouldn’t a person want to feel good, to be admired? Who wants to be thought of as poor?

 

Unfortunately, the Creditor stands alongside the Ad Man and offers anyone and everyone the credit needed to finance any and all of the enticing offers put out by the Ad Man. Truth be told, the Ad Man doesn’t care if you finance whatever he’s selling or whether you pay cash for your items. His sole purpose is to sell you dreams packaged as stuff. How you pay for it really isn’t his problem…but he definitely benefits from the presence of the Creditor. And the Creditor’s sole purpose is to earn interest off of your debt. The Creditor doesn’t even care what you buy, so long as you borrow money to do so. It’s a financially destructive combination that traps a great many people!

 

The unfortunate debtors who succumb to this two-pronged attack fall prey to the highly successful plots of the Ad Man and the Creditor.  The Ad Man creates the psychological fear that you might not be as happy as you could be, that others might think you’re poor or they might think badly of you because your whatever-it-is-that-the-Ad-Man-is-selling-right-now isn’t the latest and greatest. You decide to remedy this situation by making the purchase, but you don’t have the cash to do so.  However, you’ve decided that you don’t want to live with the psychological fear so you decided to borrow money from the Creditor to fund the whatever-it-is. Whether you know it or not, you’ve made the decision to be poor rather than look poor.

 

The reality is that people who rely on credit to satisfy their desire to purchase things immediately have agreed to sacrifice their future financial autonomy to the Creditor – in other words, they’ve committed all of their future income to paying for yesterday’s purchases.  The Creditor wants loan payments, even if they are only minimum payments.  Failure to make the payments means that credit is eventually withdrawn, which means no more money to buy things to satisfy the seductive call of the Ad Man, which means that the psychological fear of being though of as poor stays firmly in place.  Sadly, the withdrawal of credit doesn’t mean that the original debt goes away.  The interest on that debt steadily and relentlessly grows until it dwarfs the original loan amount.  The debt stays in place until it paid or eliminated through bankruptcy.

 

So what is the remedy, you ask? The solution to this pervasive problem is complicated, but it starts with each person identifying their priorities and figuring out what really makes them happy.  Each person has to figure out how to feel good about themselves without going into debt.  Could you volunteer with an organization that supports something you believe in? This is a way to feel good about yourself that doesn’t involve borrowing money.  If it’s time with family and friends that you crave, is it possible to host a game night at home? What about a movie marathon in the comfort of your own family room? How about a picnic with those whom you love best?

 

Trust me when I say that there are many, many, many ways to feel good about yourself that don’t involve digging yourself into a pit of debt.

Spend Some, Save Some

This most excellent advice came to me from a highly trusted source – my mother.

While we were on our most recent vacation together, I asked her what she believed was the most important lesson to learn about money. In four words, she summed up the cornerstone of every personal finance blog I’ve ever come across: “Spend some, save some.”

For those of you who already peruse PF-oriented blogs, you’ll immediately recognize this alliterative wonder as the admonition to always live below your means. Living at your means, and living above you means, always ends with the result of not having any savings set aside for investing. My mother’s four little words are the bedrock upon which all wealth is built.

Please do not let her mantra mislead you. I can assure you that my mother is is not some penny-pinching old lady who resents the fact that she has to open her wallet. My mother loves fun! She enjoys her family and her friends – she entertains and she travels. My mother is the one who advises strangers at the casino to bet big money, if they can afford it, in order to score the big win. At the same time, my mother doesn’t have a mortgage on her home – she follows the stock market more diligently than seminary students study the scripture – she is always “finding” money that she didn’t know she had. And how does she accomplish this day after day, month after month, and year after year?

The woman lives by her mantra – spend some, save some. My parents were not rich people and they were not university-educated. They were regular people who didn’t earn big money. They had the same struggles as everyone else in raising their family and meeting their goals. When I was growing up, my father put my mother in charge of the household finances. Every two weeks, he got paid and he would sign his cheque over to her. (Back in the day, banks would cash signed cheques without too much fuss. For those of us who’ve known online banking our whole lives, trust me when I say it was a different world – today, no bank would ever do this for its customers!) When his company went to direct deposit, my father’s paycheque went straight into my mother’s bank account and they never fought about money. I’m not being cagey – my parents never had a joint bank account. His money went straight to her bank account, as did the money she earned from her job. It wasn’t until my first full-time job, as a bank teller, that I even realized that joint bank accounts were actually a thing!

So, every two weeks my mother got my father’s paycheque. And every month, she would write out what bills had to be paid. The money came in, the bills got paid, the groceries were purchased, the mortgage was serviced, long-term & short-term goals were funded. It worked like clockwork. Both of them had pensions, but they still ensured that they put money away in their RRSPs every year. They also wanted my brother and I to go to university, so every payday meant that $10 from my father’s paycheque went into our bank accounts so that we could buy Canada Savings Bonds each fall to finance our post-secondary education. As an aside, that $10 bi-weekly contribution grew to be substantial enough to cover 6 years of post-secondary for me and 9 years of post-secondary for my brother. We grew up in the 80s when inflation was high and Canada Savings Bonds were paying double-digit interest rates. Tuition was a lot cheaper in the 90s when we went to school, so our parents “little” investment plan allowed them to achieve one of their biggest goals for their family.

What other benefits came along with the “spend some, save some” philosophy?  If there was an emergency, the money was in the bank to pay for it. Renovations were made to the family home. Birthday parties took place every year without credit cards bills hanging around. There was always money for a movie and snacks with friends. Money was set aside for retirement accounts and investing accounts. (Investment accounts generated dividends that were invested, never spent!) An annual vacation was a given in our household. We spent many an hour in the car driving all over the place to visit family and friends, and to see this great big country of ours. Every few years, we’d even take a trip by airplane. The “spend some, save some” mantra meant that there was a balance between spending money now and spending money later. It also meant that there was always money somewhere: in a wallet, in the bank, in a retirement/investing/emergency account, in the change-jar in the corner of our kitchen.

We live in a world where the AdMan is always, always, always exhorting us to immediately cave to temptation. We’re encouraged to spend every penny we have, and even those we don’t, right away. Personally, I believe that the relentless tide of advertising is one of the many factors leading to the debt burdens of so many people. Adopting my mother’s mantra to “spend some, save some” and repeating it to myself every day is one way to fight back against the tide. It wasn’t until I was grown up that I realized just how well my parents managed their money – they had mastered the art how to live day-to-day while simultaneously saving money for both short-term and long-term goals. Thankfully, I’ve learned to do the same.

What about you? Have you made it a priority to “spend some, save some” in your life?

Lessons from the Teller’s Wicket

After my obtaining my undergraduate degree, I took a year off before going back to school. I got a full-time job in a bank, and boom! My financial education really began. Despite the good example set by my parents, working in a banking institution is where I really learned about banks and how to use them to my advantage when it came to my day-to-day money.

 

My first lesson was that the bank’s products might not be in the customer’s best interest. Each month, there was a marketing promotion where we – the tellers – were required to sell products to customers. The first campaign that I was involved in was selling home-equity lines of credit (HELOC). A HELOC is a debt product where the collateral is your home. By using it, the customer is able to spend down the equity value of their home up to the HELOC’s limit and the customer pays the bank interest for the privilege of spending their own equity. It took me a little bit to understand that the bank was essentially asking people to buy debt, but I eventually got the gist of the product. One of our suggested hooks for selling the HELOC was to tell customers that they could borrow money from a HELOC to invest in their RRSP and then repay the borrowed money in monthly equal instalments. All I could ask myself was: why not simply make that same monthly payment to your RRSP directly instead of paying that same amount to the bank in the form of a loan repayment, which comes with an interest penalty? (Obviously, I was  restricted from asking the customers this question. Doing so might have led the customer to not acquire a HELOC, which meant that the customer wouldn’t go into debt and the bank wouldn’t get paid interest.)

 

It took me a long time to realize that the hook of depositing the money to the RRSP now instead of later was simply a form of immediate gratification. My method of making payments to one’s RRSP over the upcoming year was a form of deferred gratification. Of course, my method meant that the bank didn’t make money from the interest charged on the loan from the HELOC so I was not permitted to suggest my method to the customer even though my method was in the customer’s best interest. Since the bank was paying my wages at the time, part of my job was pretending that what was important to the bank was also important to me. (That particular lesson has served me well in every employment position I’ve had since leaving the bank!)

 

The second thing I learned from my time as a teller is that banks care more about customers’ money than customers do. It wasn’t that the customers didn’t care at all about their money. It was simply that the bank cared more and was far more effective in keeping the money than the customers were. Surprisingly to me, it wasn’t very hard at all to get people to sign up for credit cards and credit products. People craved credit, which is another way of saying that people very much wanted the ability to go into debt to the bank. I don’t know what they did with their credit, but I was always surprised that they wanted credit more than they wanted to have money in their bank accounts.

 

The third thing I learned at the bank was that paying off a mortgage was a smart move. I’ll never forget one customer who came in on a Saturday to make a lump sum deposit of $20,000 against his mortgage. When I asked the loans officer why the customer had done this, I received my very first lesson about how the act of making lump sum payments immediately decreases the amount of interest owed on a mortgage. Right then and there, I promised myself that I would make extra payments against my mortgage once I had one. When I worked at the bank, an interest rate of 7% was not uncommon. This was well before 2001 when rates started dropping to historic lows.  (One of my friends was able to secure a 5-year rate at 2.39% on her rental property – sweet! I doubt I’ll ever see rates drop that low again in my lifetime.) When I obtained my first mortgage in 2001, the rate was 6.5% and I took advantage of prepayment options to pay it down quickly. I then re-mortgaged my property for a rate of 4.79% in 2004. When I re-financed my most recent mortgage in 2015, I was able to secure a 5-year rate at 2.99%! Sadly for me, I’m quite certain that I will be renewing my mortgage at a rate of atleast 4% in 2020 given that the mortgage rates have started to climb.

 

Fourthly, I learned about bank fees and how to avoid them. Essentially, you can keep a large amount of money in the bank as a float to ensure that you aren’t charged bank fees. That float ranges anywhere from $2500 to $7500, depending on the bank and the type of account on offer. Alternatively, you can open an account with one of the online banks. Right now, Simplii (formerly PC Financial) and Tangerine offer free banking. If you aren’t already with them, make the switch and keep your bank fees for yourself. Why are you paying bank fees if you don’t have to? Aren’t you better-served by keeping that money for yourself to be used to achieve your personal goals? Never ever forget that paying bank fees is a choice that you make as a customer. Bank fees are not an addiction. You have the power to open a no-fee bank account and to use it the same way that you use expensive, fee-generating bank accounts. You might have to use a bank but that doesn’t mean you have to pay service fees or interest to do so. As a customer, you have choices and you have the power to keep more of your own money.

 

I worked at that bank every Saturday for roughly three years after I went back to school full-time. It was not a particularly glamorous job and it definitely cemented my belief that working directly with the public is not for me. However, my time spent at the bank was invaluable because it taught me a great deal about how the banking industry systematically and ever-so-efficiently fleeces its customers and what steps customers can take to level the playing field. These lessons will stay with me for a very long time.

Priorities

Based on my own experience and decades of observation, I am convinced without a shadow of a doubt that priorities guide how we spend money. To paraphrase Paula Pant at www.affordanything.com, every spending decision you make is based on priorities because choosing to spend on one thing means that you’re not spending on something else. I think a lot of personal finance problems could be solved if people created their own priorities, but they don’t. Many people allow others to set their priorities for them, whether through marketing or peer pressure or societal expectations. People adopt the priorities of others and spend their money accordingly. Sometimes, this method works for them and sometimes it doesn’t.

Ideally, you create your own set of priorities and you’re in a position to pursue them with the support of your friends and family. I haven’t always been so lucky.

After I finished university and started my first professional job, my closest friends would give me a hard time about how I chose to spend my money. In short, they didn’t like the fact that I didn’t spend money on things that didn’t matter to me. They felt entitled to tell me that I “could afford it” – whatever “it” happened to be at the time. I heard their message loud and clear: my spending choices weren’t the “right” ones in their eyes. At the time, I had student loan debt. I had car debt. I owed money on my mortgage. I chose to allot my paycheque to various spending categories and I was very rigorous about paying down my debt while starting to save for my retirement. These were my priorities, and my closest friends at the time didn’t share or respect them.

Only one friend understood my priorities and supported me wholeheartedly. The vast majority of my closest friends did not. They were definitely more spend-y than I was but I couldn’t let their spending choices derail mine. What was my solution? Well, I didn’t get rid of those friends and I still spend time with them today. Over time, I simply stopped talking to them about my priorities and my money. In essence, I cut them out of the financial part of my life because I didn’t trust them to respect my personal goals and dreams. My goals were to establish a habit of saving for retirement, to pay off my student loans, to pay off my car loan, and to pay off my mortgage as fast as humanly possible. I only had so much money to work with and I wasn’t going to let their opinion that I “could afford it” derail me from focusing on my priorities. I was the only person who knew what my goals were and how I wanted to spend my money to achieve them.

Over the years, I read personal finance books and discovered the world of personal financial bloggers. It was in the books and the blogs that I found a niche where my priorities were the norm, where my goals were supported, and where strategies to achieve my hopes and dreams were shared by people who had already achieved similar hopes and dreams. As a result of what I learned from the books and the blogs, I was completely debt-free by age 34 and had achieved a solid six-figure net worth. By the time I was 40, I’d entered the double-comma club.

I also strengthened my relationship with that one friend who’d totally understood my desire to get out of debt and to pay cash for everything. We talked about money and shared what we learned. I remember when she confided to me that she and her husband would put off any and all purchases to the last possible moment in order to focus on paying off their mortgage. I was as excited as she was when they hit that milestone, just as she had been thrilled for me when I became debt-free at age 34.

It took me many years to craft a money system that funds my priorities with minimal decision-making on my part. Right now, I use automatic transfers to ensure that a portion of each paycheque is allocated towards each of my priorities.

– Retirement accounts? Check.

– Investment portfolio? Check.

– Emergency fund? Check.

– Utilities, property taxes, insurance premiums? Check

– Charitable donations? Check.

– Day to day spending? Check.

– Saving for next vehicle? Check.

– Saving for travel? Check.

– Saving for home renovations? Check.

These are the priorities that I have defined for myself and I have honed them over the years. I’ve learned to put very little weight on the priorities that others try to set for me. Their priorities won’t make me happy, but they will drain my wallet and get me into debt. I don’t want that for myself so I stick to what I know will get me closer to the life I want to live.

Over the years, there have been many times when I’ve had to re-order my priorities to ensure that I was doing what I really and truly wanted. Even today, I’m debating with myself about whether travel is more important than home maintenance.

I love travel, but I also need to renovate my basement bathroom and laundry room. These rooms aren’t in complete disrepair, but they will be if I don’t do something in the next 3 years. However, I realize that if I want to see, taste, touch as much of the world as possible then I have to get out there and do it. These priorities are both important to me right now and I see them in my mind’s eye as the two ends of a pendulum. I’ve been trying to figure out how to pay for both in 2019 and it’s just not going to happen unless I win the lottery or discover that a wildly-benevolent stranger has left me a sizeable bequest. I have to pick one priority over the other. In other words, one of the two is going to take a higher priority for me in 2019. I will still accomplish both goals, just not at the same time. I only have so much money and I refuse to go into debt, so something has to wait until I have the cash on hand to make the purchase. Right now, the pendulum is swinging towards the home renovation…but there’s a very good chance that it could swing back towards travel. All I am certain of right now is that one of my two priorities will be satisfied with the cash that I save up in the next year or so.

I’m not perfect, but I am definitely older and wiser now. I have to bite my tongue until it bleeds when I see others making what I view as “bad decisions” with their money. I remind myself that they’re spending their money in line with their personal priorities and that they’re under absolutely no obligation to have the same priorities that I do. Until they ask me what I think of their choices, I keep my opinions to myself. I do not want to do to my friends what was done to me because I didn’t like the feeling of knowing that I didn’t have their support. I don’t have to agree with my friends’ priorities and spending choices, but I do have to respect them.

The world isn’t ideal and you can’t always count on others to support your hopes and dreams. All you can do is figure out what you really want and go get it.

Credit cards are a tool

Anyone who knows me also knows that I hate debt. I particularly hate credit card debt because most cards carry usurious rates of interest if the balance is not paid in full. So this post is for people who pay their monthly credit card balances in full EVERY SINGLE MONTH!!!

If you carry a balance on your credit cards, then this post is not for you. This post will not help you to stop accumulating credit card interest, which should be your priority if you’re carrying a balance. Credit card interest is a cancer that will stop you from achieving your financial dreams so please start working on how to get out from under the burden of credit card debt. Please come back next week when there will be a new post for you to read. 🙂

Credit cards are a tool. They are not meant to charge me interest. Rather, they are meant to minimize my need to carry giant wads of cash as I go through life buying the things I want. The money stays in the bank until the time comes for me to pay for my credit card purchases. At no point should I ever be in the position that the amount of money owed on my credit cards exceeds the amount of money that I have in the bank to pay off my credit card. That is a recipe for disaster!

To those who never carry a balance, please keep reading. I view my credit cards as a tool. (For full disclosure, I collect cash back on one card and travel miles on the other.) I pay recurring monthly bills with my credit card. I put all of my gas purchases on my credit card. I use my credit card to pay for meals with friends and my annual theatre subscription. Truth be told, I really do enjoy the purchasing power that comes with my credit cards.

That said, I never carry a balance. I’m one of those weird freaks of nature who checks on her credit card’s monthly running total every other day. Once a charge has hit my credit card statement and I’m rewarded for my purchase, in the form of travel miles or cash back, then I go to my online bank and send a payment in the amount of my purchase to my credit card. More often than not, I put several thousand dollars through my credit card each month yet the statement’s balance is only for a few hundred dollars when all is said and done.

Why do I pay my credit card charges before they’re due?

I do it because I’m human and I know my own foibles. I do not yet have the discipline to keep large amounts of money in my chequing account. I’ve had the distinct pleasure of only having $0.01 in my account the day before payday. I don’t encourage this but I share my experience so that you know I’m not the sort who can keep a buffer of several thousand dollars in her main bank account! It works best if I make the purchase, i.e. $50 to fill my tank, wait to see the charge posted to my credit card account, and then pay off the $50 immediately. I owe the money to the credit card company, so why not pay off the charge while I have the money in my account? The bill is paid and I never have to think about it again. I don’t have to worry about something unexpected happening in the future which will prevent me from paying off the charge on the due date. I’ve got gas – I’ve got my reward – I’ve paid my bill – life is good!

I can hear you asking – “But what if you need that $50 for something else before the credit card bill is due?”

Should this happen, then I go to one of my other accounts to find the money. Or I cut back on my groceries for that week. Or I decline an invitation to something fun that I otherwise would have accepted. The bottom line is that I borrowed $50 from the credit card company and they will charge me 17% per annum (or more!) on that $50 if I don’t pay them back. Trust me, I would rather miss out on a dinner and a movie that pay than kind of exorbitant interest to pay for my gas.

My bottom line is that my credit cards are a tool that I use to make my life easier. There is no need for me to pay interest on my purchases. My main responsibility is to stay on top of my charge by checking my credit card statement online every few days and by making frequent payments to cover all my credit card purchases. I’ve been controlling my credit cards this way for over 20 years. My system works for me. Try it out – you might find that it works for you too!

A little something about mortgages

I love talking about money…and the word is spreading at the office. I have two very close friends at work and they have patiently listened to me talk about money for years. One of them has a young assistant who was looking to buy her first house with her fiance. My friend told the assistant to come and see me. I was more than happy to talk to her about mortgages, prepayment options, insurance options, and ways to minimize the amount of interest owing on her mortgage.

 

So I spent about 40 minutes talking to my friend’s assistant. I found out that she was using a mortgage broker.  I tried not to ask for too many details about salary and savings, but I wanted to find out if she had considered pre-payment options (she hadn’t), the difference between mortgage insurance vs life insurance (nope!), rates offered by banks vs mortgage companies (yes), and whether they had considered paying bi-weekly rather than monthly (nope).  I was also encouraging her to wait until after her probationary period at the office had expired, but I lost that battle.

 

a) Prepayment Options Matter

 

If ridding yourself of your mortgage is a priority, then you’ll want to ensure that you get the best prepayment options that you can.

 

In Canada, borrowers can increase their mortgage payments one of two ways. Firstly, they can increase their mortgage payment by a fixed percentage amount every calendar year. When I first obtained my mortgage, I was able to increase my bi-weekly payment by up to 20% once each calendar year.  Some banks allow borrowers to increase their payment by a maximum of 10% or 15%.  There is no need to increase the payment by the maximum, but I encourage people to go with a lender who allows for up to 20%. The higher the payment, the faster the mortgage balance disappears and the less interest that is paid overall. Paying less interest to the bank on a debt as huge as a mortgage is a goal worth striving towards.

 

Generally, once a payment is increased, that increase is in place for the remainder of the term of the mortgage. A bank does not allow a person to decrease the mortgage payment later on down the line.

 

Here’s an example. The original mortgage balance is $100,000. The annual maximum mortgage payment increase is 20% of the original mortgage payment. The bi-weekly mortgage payment amount is $500.  The mortgage term is 5 years.

 

Year 1: $500 x 20% = $100; new bi-weekly mortgage payment = $600 ($500 + $100)

Year 2: $600 x 20% = $120; new bi-weekly mortgage payment = $720 ($600 + $120)

Year 3: $720 x 20% = $144; new bi-weekly mortgage payment = $864 ($720 + $144)

Year 4: $864 x 20% = $172.80; new bi-weekly mortgage payment = $1,036.80 ($864 + $1,036.80)

Year 5: $1,036.80 x 20%= $207.36; new bi-weekly mortgage payment = $1,244.16 ($1,036,80 + $207.36)

 

Of course, there is no requirement on the borrower to increase the mortgage payment by 20% every year. The bank would far prefer it if you simply paid the minimum required amount because doing so insures that they squeeze as much interest out of you as possible over the life of the mortgage! A borrower might only be able to increase her payment by 5% each year, or only be able to increase it in years 2, 3 and 5, or might only be able to increase it by the maximum amount at the very start of her mortgage, or any other combination.

 

It’s a decision that cannot be taken lightly. While making the higher payment as soon as possible is good for minimizing the interest paid the bank, the fact of the matter is that the borrower is going to have to come up with the new higher payment amount every two weeks. As you can see from our example, coming up with $1,244 every two weeks is going to be approximately 2.5 times harder than coming up with $500 every two weeks!

 

The other prepayment option available to borrowers is to make annual lump-sum payments against the outstanding mortgage balance up to a fixed amount. Lump sum payments are in addition to the regular mortgage payment. They are applied directly the mortgage balance. The larger the lump sum, the more effective it is in decreasing the amount of interest paid on the mortgage.

 

In my case, my bank allowed me to make a lump-sum payment of up to 20% of the original balance. Again, there is no obligation to make a huge lump-sum payment. Most banks require a minimum lump-sum of atleast $100.  Further, lump sum payments can be made throughout the year so long as they cumulatively do not exceed the maximum amount.

 

Let’s go back to our earlier example. The original mortgage balance is $100,000. The annual maximum lump sum mortgage prepayment is 20% of the original mortgage balance.  The mortgage term is 5 years.

 

$100,000 x 20% = $20,000;

 

The amount of $20,000 is the maximum annual lump sum mortgage prepayment that can be applied to the mortgage during the term of the mortgage. This means that the borrower can apply lump-sum amounts up to $20,000 to her mortgage in each of the 5 years of the mortgage term.

 

Full disclosure – I never took advantage of the lump-sum payment option. Instead, I chose to increase my bi-weekly mortgage payment by the full 20% every calendar year. I committed myself to higher payments to avoid the temptation of “forgetting” to set aside money for a lump sum payment. A dear friend of mine made the opposite decision. She made lump sum payments every two weeks. She and her husband had a young family and she wanted the option of not paying extra money to her mortgage in case those funds, which would have gone towards the mortgage as a lump sum payment, were required elsewhere in the family budget.

 

b) Bi-Weekly Payments

 

You’ll note that throughout my example, I’ve referred to “bi-weekly” payments. This is because I personally hold the opinion that bi-weekly payments are best for paying off a mortgage. Monthly mortgage payments mean that you, the borrower, are paying the maximum amount of interest on your mortgage loan. While this is good for the banks, this is terrible for the borrower. One of the few ways to pay less interest on your mortgage debt is to repay it as fast as possible. Paying your mortgage bi-weekly will allow you to do that.

 

There are other payment cycles. I’ve already mentioned monthly payments, but there are also weekly mortgage repayment plans. For my part, I’ve always paid bi-weekly on my personal residence. On my rental properties, the mortgage is paid monthly for two reasons. First, rent from my tenant pays down the mortgage. Second, the interest on the mortgage balance is tax-deductible, so it’s to my advantage that the mortgage balance is not paid down as fast as possible.

 

I’m not a fan of weekly mortgage payment schedules. This is because the amount of interest saved on a weekly payment schedule is only marginally less than the amount of interest saved on a bi-weekly payment schedule. To my mind, it’s hardly worth the added stress of insuring that the money is in the bank every 7 days. Play around with a few mortgage calculators on the web and come to your own conclusion. If you’re headset on paying as little interest as possible, then a weekly mortgage payment schedule might be for you.

 

c) Get Life Insurance instead of Mortgage Insurance

 

Most people don’t realize this but mortgage insurance is a rip-off. The insurance pays the bank the amount of the outstanding mortgage balance in case the borrower dies. However, the premium for mortgage insurance stays the same every single month. This is a problem because it means that the borrower is paying the same amount of money for a lower amount of coverage each month as the mortgage balance decreases.

 

Assume that the mortgage balance starts at $100,000, that the beneficiary of the mortgage insurance is the bank, and that the monthly premium on that mortgage is $5. Every month, the borrower will pay $5 to the bank to insure that the mortgage balance gets paid if the borrower dies before the mortgage is paid off. If the borrower dies the day after taking out the mortgage and the insurance, the policy will pay out $100,000 an the mortgage gets paid off.  Ten years into the mortgage, the mortgage balance is now down to $81,000. The borrower is still paying $5 per month in premiums on that mortgage. If the borrower dies ten years into the mortgage, the insurance policy will only pay out $81,000 to the bank.

 

Do you see the problem? The premium stays the same but purchases less and less coverage each month. This is not a good deal for the borrower. The monthly mortgage insurance premium remains the same even though the remaining mortgage balance is decreasing as each mortgage payment is made.

 

Instead of taking out mortgage insurance through the bank, get a life insurance policy on the life of the borrower that is equivalent to the starting balance of the mortgage. If the borrower dies before the mortgage is paid off, the full amount of the life insurance policy is paid to the beneficiary. After paying the mortgage in full, the beneficiary can keep the rest of the life insurance proceeds. This is a much better deal all around and the mortgage balance still gets paid.

 

While I was on holidays, I received a very excited email from my friend. Her assistant and the fiance had put in an offer on a house! And a week after I got back to my office, the assistant came to me and told me that she was only a few days away from taking possession. Of course, I couldn’t resist giving her even more advice – get a locksmith to meet her at the house on the day of possession to have the locks changed immediately – but I was deeply happy that my words had helped them in making one of the biggest purchases of their lives.