Up to Their Eyeballs

Canadians are slowly waking up to the fact that putting the brakes on spending is not enough to battle household debt.

According to the latest debt report from the Certified General Accountants Association of Canada (CGA-Canada), Canadian families are faced with household debt that’s reached a record high.
“The debt of a typical household is rising,” says Rock Lefebvre, CGA-Canada’s vice-president of research and standards and co-author of the report. “And the financial situation of certain groups of households is much worse than average and continues to deteriorate. This is concealed if you focus only on the national or aggregate picture.”
The report illustrates that while consumer spending may be down in the first quarter of 2011, many Canadians continue to struggle with household debt that has reached a new all-time high of $1.5 trillion. The situation has hit those already feeling the pinch of lower or stagnant incomes, or personal circumstances, even harder.
The survey-based report reveals several alarming trends, as single-parent families, retired Canadians, and those with annual household income of less than $50,000 face a bleak financial situation.
“The report confirms that more than half of indebted Canadians are borrowing just to afford day-to-day living expenses like food, housing and transportation,” adds Anthony Ariganello, president and CEO of CGA-Canada “For these individuals, there is little hope for improved financial condition.”
Some of the key findings of the report show more Canadians are carrying debt into retirement, with one-third of retired households carrying an average debt of $60,000 and 17% carrying $100,000 or more. More than half of indebted respondents (57%) singled out daily living expenses as the main cause for their increasing debt. The single-parent family is the only category where debt increases with age.
If household debt was spread evenly across all Canadians, a family with two children would owe an estimated $176, 461.
Lefebvre says that a number of measures taken by the government to address some identified shortcomings have not helped improve household balance sheets.
“It’s important that the dynamics of household indebtedness remain high on the radar of policy-makers,” said Lefebvre, “particularly when it comes to policies and incentives that encourage Canadians to improve their finances.”
With the Bank of Canada likely to delay rate hikes, an effective deterrent to debt can be discounted. At a time when household debt has reached a record high, low interest rates could prove somewhat counterproductive as they may tempt more Canadians to take on debt.
Canadians can expect borrowing costs to remain near record lows for the rest of the year, according to the quarterly economic forecast issued today by TD Economics.
“That’s because the pace of the economic recovery is expected to slow sharply in Canada, the United States and much of the world,” said the report, credited to Craig Alexander, chief economist, TD Economics.
As a result, the Bank of Canada will likely refrain from raising its key interest rates until 2012. This will make it easier for Canadians to continue borrowing, burying themselves deeper in hock which will take years to clear.
Debt is partly contributing to a slowdown in Canadian growth as households are too overstretched to further stimulate the economy, thus creating something of a vicious cycle that many global economies are struggling to break.

Filed by Vikram Barhat, editor@Advisor.ca Originally published on Advisor.ca

Retirement taking a backseat to present: BMO

Why are Canadians dragging their feet when it comes to retirement planning?

BMO says the answer can be found inside their minds. Using behavioural finance research, the bank believes it has uncovered clues as to why Canadians are procrastinating the way they are.
A report from BMO Retirement entitled Retirement Planning: Can I Get Back To You On That? and based on a survey conducted by The Strategic Counsel reveals that Canadians are more mindful of their present financial circumstances rather than their future.

The concepts of "immediate gratification" and "paralysis of choice" have severely affected retirement planning in Canada.

Delving into the psychology behind the competing priorities, the report states that although 82% of respondents understood that saving early for retirement is important, more than 81% are more concerned with their present needs than their retirement.

Canadians are also overwhelmed with too much information and too many options involving retirement planning. This has resulted in frustration and paralysis when action is required.
Thirty-six percent of non-retirees said they are overwhelmed by too much information and this has been an obstacle to them moving forward with retirement saving plans.

"While it's often hard to act against our natural instincts, it's critically important that Canadians take an active role in planning for their future and start as early as possible," says Tina Di Vito, Head, BMO Retirement Institute. "Understanding the psychological barriers to effective retirement saving is the first step to overcoming them."

The report also points to other contributing factors that are delaying many retirement plans. Those who have children under the age of 18 are unlikely to see saving for retirement as an immediate priority, as post-secondary education may take precedence. It is also difficult for those with a heavy debt burden to focus on retirement. Lower income respondents are overwhelmed by the volume of information available.

For those who are interested in saving for their retirement, BMO suggests the following steps:
Save early

• Create a budget
• Set financial goals and monitor your progress
• Sign up for your company's pension plan
• Make full use of tax-favoured investment vehicles
• Set up an automatic savings program
• Seek out financial help

The report was based on a poll of 2,034 Canadians, 35 years of age or older and was conducted using The Strategic Counsel's web panel between May 26 and June 2, 2010.
(07/29/10)

Filed by John Powell, john.powell@advisor.rogers.com
Originally published on Advisor.ca

Personal Finance and Home Purchasing

Something that I haven't quite got my head around is how so many (thousands per month) people can seemingly 'afford' to purchase homes in the Vancouver area considering the prices at which local homes seem to be sold at. Greater Vancouver benchmark for all dwelling types is just about $520,000 as of June 2009.

Let's look at a sample first time home buyer.

Let's imagine John and Jenny want to get started on the property ladder after getting married last year. They have saved $10,000 over the past couple years and they have about $25,000 in their RRSP accounts which they intend to use toward a property purchase under the Home Buyer's Plan. Jenny's parents have offered to help them purchase their first home as well with an extra $20,000 'loan' to be used toward a down payment that may never need to be paid back. They don't have any credit card debt but are making payments of a combined $900 per month on two car loans which have 3 years left on them. Combined down payment = $55,000.

John makes $60,000 per year working in the technology field and his job prospects are very good given his education and work experience. Jenny works in sales and her income has averaged $50,000 per year over the past two years. Although she does okay at work, her job prospects are sketchy as the company she works for has seen business drop off considerably and has laid off a few people in the last few months. Gross Annual Income = $110,000. Net Monthly Cashflow = $6,000.

They are wondering what they are able to afford (apparently they don't have a budget) so they go talk to a mortgage broker about their situation. The mortgage broker punches some numbers into the computer and comes up with a preapproval amount of $430,000. John and Jenny are amazed, they wonder what they have done to make the bank love them so much! This pre-approval emboldens them.

They call up a realtor and begin looking at homes in the $400,000 to $500,000 price range. The realtor shows them several condos and a few townhouses which meet their criteria and they settle on a nice townhouse and make an offer for $450,000 which is accepted and the deal is drawn up.

John and Jenny put $45,000 down by using the parent's money and withdrawing from their RRSP accounts under the Home Buyer's Plan. They have paid CMHC and legal fees of $9,000 which gets added to their mortgage so they owe a total of $414,000 and they have decided to amortize over 35 years (they will be 65 when it is finally paid off if they stick to the original plan with the original rate) with a 5 year term and a rate of 4.5%. They will be making principal and interest payment of $1,950 per month, they have added life insurance to the mortgage ($50) and are paying property tax monthly with their mortgage payment ($200). They now get to pay strata fees of $200 per month as well.

Let's have a look at John and Jenny's monthly budget.

John and Jenny's total monthly obligations are:
Mortgage - $1,950
Life Insurance - $50
Taxes - $200
Strata - $200
Car Payments - $900
Food - $600
Fuel - $400
Home and Auto Insurance - $400
Telephone/Internet/Cable - $300
Clothing/Other/Misc - $300
Entertainment/Vacations - $500
RRSP contributions - $200
Total = $6,000

This couple can have a 'reasonable' lifestyle based on these numbers but let's look a little closer.
Let's test this for several common risks:

Death - The mortgage is life insured, the survivor would be financially okay so long as the life insurance remains in place.

Divorce - They are in bad financial shape if this happens. Neither one of the two could afford the townhouse if they split up and the townhouse would need to be sold quickly.

Children - They are in bad financial shape if they have kids. Not only would they have extra monthly expenses, which they don't have room for in the budget, they would also have less income for a period of time as it is typical for the mother to take some time off work after giving birth. Even if mom went back to work there are daycare costs, which are not small.

Job Loss - They are a financial disaster if one of the two loses employment of any extended period of time. They would be forced to make some significant life changes and likely sell the home.

Interest Rate Rise at Renewal - If interest rates rise by 100-200 basis points they would be extremely rough financial shape. Unless they had an increase in income, they would likely be forced to re-amortize the mortgage and/or make other lifestyle changes. If rates increased more than 200 basis points, they would not be able to maintain their current lifestyle in any shape or form.
1) 100 basis point rise to 5.5%, maintain original amortization, payments rise to $2180 / month
2) 200 basis point rise to 6.5%, maintain original amortization, payments rise to $2420 / month
3) 300 basis point rise to 7.5%, maintain original amortization, payments rise to $2670 / month

Time - This is the most insidious risk of all and the least recognized. As a financial planner, I see many people who have put themselves into this type of scenario and they manage to muddle through life, manage to pay off a modest home by retirement and save a very modest sum of money. They retire at 65 and have a fairly low standard of living since they have no real significant savings and no pensions. If none of the above risks occured and they both managed to work a full career, get regular raises, contribute to CPP, receive OAS and have some modest RRIF withdrawals, they would make it through life without severe financial hardship but as a debt slave. The bank would have made over $400,000 from them in interest payments and they would have never saved much. They would live month to month their entire life and financial freedom would be a mere dream as they play the lottery each week hoping their number is drawn.

The reality is that the risks noted above are very real and for John and Jenny's situation to work out they need everything to work perfect, with no hitches, glitches or problems. This seems unlikely to me. It would be far better for them financially to leave themselves more room in their monthly budget so that they could:
1) Live / survive with only one income
2) Maintain mortgage amortization if interest rates rise
3) Speed up mortgage pay down by making extra payments as they receive raises if things work out well.
4) Increase their personal savings to RRSP and/or TFSA to ensure they have money for the unexpected and for retirement.

There are only two ways for John and Jenny to make the above work in a sustainable manner:
1) Continue renting and saving aggressively
2) Buy a much cheaper home and aggressively pay down the mortgage

What are your thoughts? Do you know John and Jenny? I do.

Bill Gross

Canadians not Saving Enough for Retirement

From the Globe and Mail:

"When the stock market was soaring and the economy was stronger, one hardly heard of any worries about private pensions. Many baby boomers were confidently facing retirement since they were thought to be healthier, better educated and wealthier than their parents' generation.

But now, with the collapse of the stock market as well as the economy, the boomers' easy coast into retirement has changed.Not surprisingly, a number of prominent organizations, including the C.D. Howe Institute, have recently concluded that Canadians are not saving enough for their retirement.

This basic conclusion is correct and seems even more relevant today because the economy is in recession and Canadians are losing their jobs.Simple economic theory, such as the life-cycle savings hypothesis (that individuals should put aside savings in their productive working years to maintain their standard of living in retirement), is useful in framing the policy choice for individuals, but it is not very practical with respect to telling them what they should do when everything goes wrong.

But how much should a Canadian actually save for retirement? The answer is: Who knows? We have no idea how long we'll live. Should we save enough to last until 75 or 95? If we save for a 95-year lifetime, the amount needed is obviously much greater.

One could save enough to buy an annuity at the time of retirement, an annuity that would provide an adequate income for life. But how much should we put aside to buy this annuity?

The amount of income an annuity will provide at retirement depends on the interest rates at the time the annuity is purchased and the income stream begins. Will one save enough to buy an annuity assuming the current level of interest rates? Canadian government bonds now yield from 2 per cent to just over 3 per cent. Or should one presume at the time of retirement that interest rates will be at the level they were in the early 1980s, when Canadian bonds yielded more than 16 per cent? If one assumes the high rate of interest, then the amount of saving needed for retirement would be a fraction of the amount needed with today's much lower rates.

All of these reasons demonstrate the inability of any person to know how much to save for retirement. So what's the public policy response? Do we need more registered retirement savings plan room? Do we need more defined-contribution pension plans? (A defined plan is one in which both the individual and employer contribute a set amount, with the individual investing those funds in some form until retirement.)

The problem with RRSPs and defined-contribution pension plans is that the amount needed for a set retirement income is always unknown. The additional problem is that the whole investment risk is carried by the individual saver. If the investment is successful, more funds are available at retirement; if it isn't, there's less to count on.For the baffled individual trying to plan for retirement income, private defined-benefit pension plans are very attractive, assuming the company that sponsors the plan remains solvent and the plan is adequately funded. (A defined-benefit plan is one that provides a set pension amount at the time of retirement usually based on both years of service and level of income. The costs to the individual and employer are based on those factors as well.)

There is also enormous cost savings and economic efficiency in very large defined-benefit pension plans such as the Canada Pension Plan when they are adequately funded.

The large pension plan knows how long we'll live because it deals in large numbers of people and uses averages for life expectancy. Thus, large defined-benefit plans can estimate fairly precisely the amount of savings one needs for the lifespan of the average pensioner in their plan. The large defined-benefit plan can also take a long-term view of interest rates and market returns, a perspective not often available to the individual investor. This again increases the economic efficiency of such plans as the CPP.

Three obvious public policy conclusions flow from this analysis:

Substantially increase the size of the CPP so it provides for a much larger proportion of income replacement on the retirement of Canadians. Many studies have recommended this idea. An increase in CPP contributions and coverage could be done over several years in a way that ensures the CPP remains fully funded.

Develop a system whereby companies and their employees can buy additional defined-benefit pension coverage from the CPP. These supplementary pensions would need to be fully funded and would be fully portable (as they are held in the CPP). An add-on plan to the CPP would provide companies and individuals with the economic efficiencies and the substantial cost savings that only a large plan can generate.Develop a strategy to get companies that have lost the incentive to provide defined-benefit plans back into the business of offering them. This will not be easy. Companies have moved away from such plans because of complex pension laws designed to protect workers, and their experience that such plans are costly and difficult to manage. In addition, employees are wary of such plans when they see large companies fail to fully fund their plans or go bankrupt with their pension plans underfunded.

A policy of both increasing the CPP and allowing companies and individuals to buy supplementary pensions from the CPP is one acceptable policy move. Another is a much closer monitoring of pension plans by regulators. A positive move in this direction would be the establishment of the proposed national pension guarantee system.Another feature of such a system would be to require underfunded pension plans to pay higher premiums for coverage. In other words, any company that requests relief from its required funding - that is, additional time to make up a pension deficiency - should pay an additional premium for such forbearance."

Doug Peters is former chief economist of the Toronto-Dominion Bank. Arthur Donner is a Toronto-based economic consultant.

CGA Study Finds Canadians Foolish With Money

Where Has the Money Gone: The State of Canadian Household Debt in a Stumbling Economy

Related Information
Media Release
Download Report
CGA-Canada shares its views on indebtedness of Canadian households (March 2009)[PDF — 98KB]

Backgrounder
In the winter of 2008, the Certified General Accountants Association of Canada (CGA-Canada) embarked on a second consumer survey on the topic of household debt and consumption in Canada. A similar survey was commissioned by CGA-Canada in the spring of 2007. The purpose of this particular survey seeks to understand the extent to which the economic and financial crisis worsened financial positions of Canadians having already experienced some financial strains. As we have seen, the topic of household debt and consumption is timely, relevant and critical for Canadians to consider. We anticipate that this new report entitled Where Has the Money Gone: The State of Canadian Household Debt in a Stumbling Economy, will be of significant value to the Canadian public.

Key Report Highlights
Increasing debt load
Household debt is at an all-time high reaching $1.3 trillion in 2008 and the escalation of debt is primarily caused by consumption motives rather than asset accumulation.
The three main indicators of household indebtedness (debt-to-income, debt-to-assets and debt-to-net worth ratios) deteriorated significantly in the past two years and particularly during 2008.
Canadian households are financing consumption activity and fuelling gross domestic product growth with unearned money as families increasingly reach for credit to finance day-to-day living expenses.
The majority (58%) of survey respondents with rising debt said that day-to-day living expenses are the main cause for the increasing debt. This was higher than the 52% reported in 2007.
Lines of credit and credit cards account for the largest proportion of consumer debt, with 85% of indebted Canadians reporting that they have outstanding debt on a credit card.
A large proportion of Canadians acknowledged their debt as increasing. The proportion of respondents with rising debt went up from 35% in 2007 to 42% in 2008.
84% (vs. 81% in 2007) of Canadians are concerned that household debt is rising. 21% of Canadians who are in debt say they are in over their heads and can no longer manage their debt load.
Interestingly enough though, 79% of indebted Canadians are still confident that they can either manage their debt well or take on more debt load.
The majority of respondents (65%) felt that debt limits their ability to reach financial goals in at least one of the critical areas of retirement, education, leisure and travel, or financial security in unexpected circumstances.

Lack of savings
One third of Canadians do not commit any resources to savings and deteriorating economic conditions have not yet had the usual effect of encouraging increased savings.
Even with the temporary relief of a credit card or line of credit, one quarter of Canadians would not be able to handle an unforeseen expenditure of $5,000 and 1 in 10 would face difficulty in dealing with $500 unforeseen expense.
The majority (78%) of surveyed said they would not change their saving patterns in order to build or rebuild the financial cushion.
Economic factors
The Canadian economy has been recession free for 17 years before the events of 2008. The most recent recession took place over a 12 month period between April 1990 and March 1991.
Recent data on the job losses and bankruptcies leaves little doubt that the situation of the household sector has worsened.
Canadians, though, perceive their financial condition to be better than it is and many are not aware of how the economic downturn has impacted their financial situation.
Nearly one quarter (24%) of those surveyed did not think that a moderate decrease in housing or stock market, an increase in interest rates, cuts in salary, or reduced access to credit would noticeably affect their financial situation.

Vulnerable Canadian households
Certain socio-economic groups are particularly susceptible to increasing debt. The most vulnerable are the hardest hit – low income, households with children, young adults, the retired.
Canadian families in particular are struggling with increasing debt. Households with one or more children under the age of 18 reported debt as rising more often than those with no children, with 49% reporting their debt had substantially increased.
Respondents with lower income were much more likely to report increasing debt compared to the respondents in other income groups. And, those with low wealth continue to sink into debt and to experience further deteriorating in their net worth positions.
Debt-free households do exist of course and 88% of debt-free respondents lived in one or two-person households and were significantly less likely to have children under the age of 18.

Regional differences
There are regional differences for those carrying household debt.
As many as 56% of British Columbians told us their debt increased compared to the Canadian average of 42%.
Some 30% of residents in the Atlantic Provinces maintained an unchanged debt level compared to 23% of the total respondents who said their debt remained the same.
Debt-free respondents were more likely to be Ontario residents.

Recommendations

Balanced approach
The current level of indebtedness of Canadian households is a highly disturbing matter, particularly given the extent of the recent economic shocks (income shock, assets price shock and interest rate shock) and prospects for improving household financial security are low.
Although CGA-Canada recognizes the importance of consumer spending for business development and for economic growth, a balanced approach to spending, saving and paying down debt may be more of a desirable option than trying to promote consumer spending as a solution for the current economic downturn.
Canadians long-term financial goals should include accumulation of appreciable financial assets, building of a larger more diversified financial cushion and retirement investment. CGA-Canada urges Canadians to consider such savings vehicles as RRSPs and TSFAs.
CGA-Canada believes debt is rightfully a personal decision, however, it is crucial that Canadians be aware of potential risks of increasing individual household debt.
It is important to remember that risk tolerances of financial institutions should not be exercised as a substitute for the judgment of individuals who must discern between the good and bad of being in debt.

Financial literacy
Financial literacy remains an issue – Canadians frequently don’t understand the effect of carrying debt and the costs associated with servicing debt.
Households’ knowledge and skill to understand their own financial circumstances and the motivation to borrow, to spend and to save become crucial to marshalling households’ financial security and wellbeing.
Canadians need to take very seriously the issue of developing their financial capability, that is, improving their knowledge, skills and discipline when making financial decisions.
There is also an opportunity for government and the educational community to help Canadians improve their financial capability.
More needs to be done in educating the public on money management, spending, shopping habits, warning signs of financial difficulties and obtaining and using credit.

Debt, debt, and more debt . . . .

From the Financial Post.

VICTORIA - Many Canadian households carry debt loads in the "danger zone," says the executive director of the Ottawa-based Vanier Institute of the Family.

Average household debt rose to more than $90,000 in 2008, Clarence Lochhead told a recent meeting of Victoria's Association of Family Serving Agencies. The Vanier Institute is a non-profit agency promoting the well-being of Canadian families.

The total debt-to-disposable income ratio rose to 140% last year, Mr. Lochhead said, referring to the Institute's report, The Current State of Canadian Family Finances.

Last year, the average household income was $65,200, up by 11.6% from 1990. In that same period, spending jumped by 24.4%, total debt went up more than six times faster than incomes, and annual savings shrank, he said.

The median (mid-point) real earnings of Canadians, when adjusted for inflation, show little increases between 1980 and 2005, he said. Meanwhile, many citizens are overloaded at work.
The reward: "We got credit. We got a lot of credit," he said in reference to interest rates dropping in the past several years.

"But there was a whole, I think, really big cultural shift too in the way we think about spending, the way we feel about money, the way we feel about availability of credit - the push to spend when you don't have money," he said.

When spending outpaces income, families end up close to the edge of their monthly budget. Mr. Lochhead said it can be financially painful if they hit a bump in the road, whether it is due to the fallout from today's recession or a personal reason.

It is not irrational behaviour to pull back on spending, Mr. Lochhead added. He said that not all debt is bad, but rising consumer debt as a percentage of annual income is "problematic."
Looking at the examples from past recessions, Mr. Lochhead said it could take a long time to recover from this recession.

He also had advice for governments that plan stimulus spending, "At the provincial level, why don't we do something about social assistance rates?" That money goes immediately back into the local economy, he said.

"Any analysis of spending at the lower income end will show you that every marginal dollar received will be spent and there is a very high probability that it will be spent locally."

When we are talking about infrastructure, Mr. Lochhead urged looking at more than roads and bridges. "Let's talk about providing supports that are going to help families."

2009 Family Budget

It was time for annual family meeting to discuss the budget for the upcoming year.  Click on the chart above to enlarge.  Every year since we've been married, my lovely wife and I discuss our annual goals and limits on our spending for a few hours on New Years Day.  This is the result of this year's meeting.

Some notable changes for this year is the aggressive mortgage paydown strategy.  We currently have a fixed rate mortgage for the next 4.5 years with fairly liberal repayment terms and our goal is to have the mortgage paid down to a level that could see us having it paid completely off through the following five year term.  In fact, if my pay rises and no unforeseen events occur, we could easily pay of the mortgage over a total of 6 years thus allowing us the freedom to use the cash flow for other purposes.  This is extremely ambitious and probably unrealistic but it is something we have set our sights on.

We are attempting to strike a balance between an ambitious RRSP contribution strategy and our aggressive mortgage paydown plan.  We also have allowed for some large one time purchases like a new television and some new furniture.  

Regarding our balance sheet, we expect that the value of our investments will not rise this year and we have planned that the value of our home will fall by 10% or more this year.  We bought it at 20% off peak pricing and I expect it will fall another 10% or more during 2010.  We have an extremely long time horizon (20+ years) for our investments so I am not concerned about the short term value of my retirement savings.

We have also increased our allotment to 'life and health insurance' and 'food and consumables' to account for our increased needs this year with an additional child coming.

Any comments?