Editor’s note: Be assured, Keith Halliday is not a week behind in his resolutions. This arrived during our hiatus and was lost amid hundreds of offers of Nigerian treasure (if you would be so kind to provide your account information …), cruise ship deals and offers of Viagra samples.
And so, without further ado, here are Halliday’s excellent resolutions for the new year.
Christmas is a good time to give thanks for the year behind. And financially speaking, we have a lot to give thanks about.
2010 raises a big financial question for us: were we really smarter than the thousands of Americans who lost their homes last year, or just luckier?
Plenty of Yukoners took the biggest mortgage a bank would offer without checking if they could afford it if mortgage rates went up. Then they traded in the truck for the latest model, renovated the kitchen on a credit line and bought a new sled when the old one was only two years old.
And as for the country, do we really believe our government was smarter than Ireland’s or Iceland’s?
Which brings us to New Year’s resolutions. I’ll leave it up to you on your resolutions about sex, drugs and fatty foods. But here are some suggestions on the economic side.
1. I will avoid mortgage temptation. Even if the bank says you can afford a giant mortgage, you may not want to lock yourself into decades of payments. And, sorry to say it out loud, what’s affordable now might not be after an injury, a disabled child or a divorce.
Avoid, in particular, the 35-year amortization mortgage. If your mortgage broker offers one, respond as if he just offered you crack. You save almost $200 a month on a $250,000 mortgage at today’s 5.2 per cent five-year rate, which feels good in the short term.
But it costs you in the long run. For example, every $100,000 in mortgage costs you $78,000 in interest payments over 25 years. The 35-year version at the same rate takes an extra $38,000 in interest out of your pocket.
You should also take advantage of your mortgage’s features, such as increasing your monthly payment or making balloon payments at the end of the year. This cuts dramatically into your total interest bill over the years, and builds up equity in the house. This is important for young people, since you don’t want to find yourself trapped in your house with negative equity like so many Americans after a dip in house prices.
2. I will avoid consumer debt temptation. Lots of people get the big decisions right on their mortgages, then mess up the small stuff: payments on that new sled, the line of credit and ongoing credit card balances. It adds up.
We should all pay more attention to Mark Carney, the guy from Fort Smith, NWT, who now runs the Bank of Canada. He recently pointed out that the total household-debt-to-disposable-income ratio in Canada hit 148 per cent in the third quarter, according to Statistics Canada. Our debt-crazed, consumer-goods obsessed cousins in the US are at 147 per cent. In the 1980s, both countries were in the 60 to 80 per cent range.
Many of us are experimenting with unprecedented amounts of debt, hoping that rising wages and house prices will pay it off for us. However, as the Finance ministries of Ireland and Greece are realizing, if your future growth prospects dim then an amount of debt that seemed reasonable last year can become a multi-decade burden.
Yukonomist knows a highly paid Bay Street professional whose principle is to live a lifestyle one promotion behind his current salary. That way he isn’t trapped at his job. Nor does he have to move house if he loses it.
3. I will manage my risk better than Lehman Brothers. This shouldn’t be too hard, actually. But you do have to pay attention. We are currently enjoying record low interest rates.
But are you ready for this to end? Take a look at your interest payments last month. What if another global financial meltdown caused interest rates to jump?
If you have a $250,000 mortgage on a variable rate around three per cent, you are now paying about $1,190 per month. If interest rates hit six per cent then you’d pay $1600 per month. It’s not an unreasonable scenario, since prime has been over seven per cent in the last decade. Do you have a $5,000 cushion to absorb a hit like that over the next 12 months?
Or what if something really unexpected happened and rates hit eight per cent. That’s $1,900 per month.
If you are currently “surfing the yield curve” with a variable-rate mortgage, make sure you have a mortgage with a “lock in” option. And watch the financial pages for when interest rates start to edge up. You don’t want to be like your parents in the early 1980s paying double-digit mortgage rates.
4. I will save. Paying down expensive consumer debt, and then the mortgage, generates guaranteed savings in after-tax dollars for you. But as soon as you can, you want to start taking advantage of Canada’s plethora of tax-sheltered investment schemes: RRSPs, RESPs and TFSAs. (Some people like to pay the minimum on their mortgage and invest the rest, but you should do some research or get professional advice to figure out when this actually makes sense for you.)
Starting early is critical. For example, to have a $10,000 nest egg at age 60 you need to invest $1,741 when you are 30 (assuming a six per cent annual return). But if you wait until age 45, then you need to invest more than $4,000 to generate the same nest egg.
So saving is good and saving early is even better.
But you have to save intelligently.
Which brings up our last two resolutions.
5. I will spend time managing my money every month. At least as much time as I do managing my Facebook profile. There are lots of online resources to learn from, and things like the Canadian Securities Course are worth doing if you plan to have a nest egg to manage. An adviser you can trust can also be invaluable, although one has to be cautious about the fees associated with many investments.
For example, $1,000 invested at six per cent over 25 years will yield $4,290. But if you are in a typical equity mutual fund with a two per cent management fee, then you will only be netting four per cent. That doesn’t sound like much but will reduce your return from $4,290 to $2,660. That’s a lot.
6. Finally, I will avoid investments I don’t understand, especially ones with acronyms. Asset-Backed Commercial Paper, Mortgage-Backed Securities and Collateralized Debt Obligations are out. GICs (Guaranteed Investment Certificates) are the only acronym I will consider, and even there I will avoid ones with words like “market-linked” and “escalator” in their names.
A simple portfolio, with good diversification between bonds, cash, equities and real estate, is all most people need.
Here’s to a happy (and prosperous) new year.
Keith Halliday is a Yukon economist and author of the Aurore of the Yukon series of historical children’s adventure novels.