Bad Advice

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bad idea

Julie’s a lucky woman. BC government pension. Married to a federal civil servant, who’s cute and doesn’t cross-dress. Obedient 7-year-old kid. House in Victoria. Even a financial advisor. But she has a problem. Julie reads this blog.

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“My husband doesn’t. Neither does our advisor,” she says. “It feels like we are investing the right way, but the benefits just aren’t there.”

No wonder. They are deprived. Let’s dive in.

“We have lived in our house for 4 ½ years in Victoria and have a mortgage we plan on paying off in around 10 years (around $250,000 left on the mortgage). Yes, we are paying about $300 biweekly more than we have to in order to pay it off sooner. We also have around $225,000 in RRSPs in mutual funds, $12,000 in investments for our son (not RESPs), and $20,000 in my TFSA.

“I have two questions.
1)      How do I convince my husband to stop paying so much into the mortgage and to invest the $300 biweekly instead? I remember reading an explanation in your blog a while ago about the benefits of investing the $$ instead of paying down the mortgage, but I can’t find it. Our investor provided his own numbers that convinced my husband we are doing the right thing.
2)      The TFSA. In reading your posts you suggest that bank preferred stocks are a good place to invest.  I went to our financial advisor, and he talked me out of investing in Scotiabank Preferred Shares and to go instead to Scotiabank Common Shares. You haven’t mentioned much about common shares that I can remember. I have about 2 weeks before the deal is final. Should I insist on the preferred shares?”

Assuming the house is worth what an average, bloated Victoria property is these days, that’s $485,000. So it sounds like this couple’s net worth is almost $500,000, of which about 46% is in their house. Using my Rule of 90 (ninety minus your age = share of net worth that should be in a house), they’re in good shape in terms of overall asset allocation.

But if they continue to accelerate mortgage payments, this favourable balance might well tip into higher-risk territory. How can that be?, the rabble cries in wonder. Isn’t it a no-brainer, godly-good thing to pay off the mortgage pronto? That’s what all the advisors say, at least the ones who don’t waste their time writing pathetic blogs.

Well, the more equity Julie & Hubs deposit in the house, the more dependent their financial futures become on one asset. If this were 1996, that’d be cool. But the world has changed and real estate’s in for a long-term slide that will surprise and disappoint a lot of people. The average detached home in Victoria lost 7.6% of its value in the past year, while sales have tumbled 21%. There’s every reason to believe the losses in 2013 could be greater.

This raises a simple question: why would you shovel more and more money into an asset that is depreciating, when you don’t have to? What’s the goal?

The rabble roars back, “to pay off the non-deductible debt, you friggin’ idiot.” Then we need to look at the wisdom of doing so. As I mentioned here yesterday, mortgage money is still available for less than 3%, even on a fixed-term basis. That means if you lock up a mortgage at below the inflation rate over the next five years, it’s essentially free money.

More importantly, why would you pay off a home loan at 3% or less when you can invest your funds in liquid assets and make three times as much? That was certainly the experience in 2012, with a moderately conservative, balanced portfolio (60% global equity index and 40% Canadian bond index) yielding 9.25%. Of course just riding the S&P 500 would have given a 14% payback, but smart people fight risk with balance and diversity. In fact, a balanced portfolio over the last three years has averaged about 8%. And over the last nine (including the crash), close to 7%.

Let’s recap. Real estate is likely to lose value. So it’s a lousy place to park net worth. You can borrow almost-free funds to finance a house.  And money’s been growing three times faster in liquid assets. You’re right, Julie. Husband and advisor fail.

Speaking of the money guy, ask him to check out charts of BNS preferred and common stock. While the equity bounces around, the preferreds are a model of stability. They churn out a dividend of almost 5%, are completely liquid, with dividends that must be paid before the common stock and will never change regardless of whether or not bank profits are dunked by a housing crunch. Why would you choose volatility?

Finally, while I am dissecting you: two civil servants with defined-benefit, to-die-for pensions should not have RRSPs. You’ll end up giving half of the money back, and all the while be unable to claim the dividend tax credit or enjoy lowly-taxed capital gains. Stop it. Take the mortgage money and stuff it into fully-funded TFSAs and a joint non-reg account.

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As for the kid, why no RESP? The feds will give you $500 a year just for signing a few papers. The money can grow tax free, and if your boy ends up disappointing you by becoming a billionaire rock star in high school, you can roll most of the money over into your RRSP.

It’s make-over time, Julie. Fix the husband, dump the dud.

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avatarGarth Turner - The Greater Fool posted Wednesday, February 13th, 2013.

1 Comment for “Bad Advice”

  1. Nobody ever listens to me so here goes… I would take all the extra money I had and travel, if I could drink alcohol I may do more of that, i would learn about cooking, raw food, and healthy eating and exercise, Make the most out of every day, spend lots of time with my friends, love every minute of my job, Phone my friends and family freezing in the prairies at least weekly or at least keep up with the nephew’s little league in Ontario. I would first make sure to pretend that Tuesday is Saturday night, that goes for Monday and Wednesday as well. If there was a penny left over I would throw it blindly into a divided paying scheme, with a drop of precious metals, enjoy my house and maybe when I got old I would have a life worth living rather than worrying about every penny and how I made it grow to enjoy when I was 70 and not blow with gratitude when I still had a chance. Remember the term “Golden Years” refers to the colour of your underwear…

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