Canadian Consumers – Spending ‘til it Hurts

Canadian consumers are confident – really confident.

The credit crisis, which caused home prices to plunge and unemployment to soar in the U.S., was merely a blip on the radar screen in Canada. It isn't that Canadian homes weren't overpriced, or that debt levels weren't high: it's just that low interest rates re-inflated the bubble before it ever had a chance to pop.

Since the credit crisis began, the Bank of Canada has been playing good-cop-bad-cop with consumers. While stating clearly that the reduction in interest rates was intended to stimulate the housing market & related purchasing to help pull the country out of recession, the BOC has been simultaneously warning Canadians not to stretch themselves financially by taking on too much debt.

In Dec 2009, Bank of Canada Governor Mark Carney warned Canadians so bluntly about the dangers of debt that it garnered the headline, "Bank of Canada warns of debt peril" on CBC news. In January 2010, with the housing recovery well under way, David Wolf (on behalf of Bank of Canada’s Timothy Lane) noted that “the current rebound in the housing sector is taking place in tandem with a very rapid rise in household indebtedness.” In February, Finance Minister Jim Flaherty issued another strong public statement, warning Canadians about using their homes as ATMs and against the dangers of variable rate mortgages. The advice made headlines for a few days before being confidently ignored.

Instead, like cattle running to the slaughterhouse, Canadian consumers are engaged in a “buy now before its too late” real estate shopping frenzy. Terrified of being priced out of the market - or of missing today's low interest rates - consumers are buying whatever they can (barely) afford, as quickly as possible. They do so knowing full well that the properties they are purchasing are expensive or even overpriced, yet with confidence that prices will further soar.

The short-lived recessionary ride convinced Canadians that their economic system is better, their banks superior, and real estate investing acumen greater than the rest of the world - and that therefore “it can't happen here.” The rise of the CDN$ relative to the USD has only added fuel to the fire.

In short, for Canadians the credit crisis has inspired a sense of economic godliness. Consumers have been aptly warned, but, due to fear and greed, have chosen to put on their rose-colored glasses and continue shopping.
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http://www.cbc.ca/money/story/2009/12/10/carney-financial-system-review.html
http://www.bankofcanada.ca/en/speeches/2010/sp110110.html
http://www.financialpost.com/story.html?id=2547222
http://www.fin.gc.ca/n10/10-011-eng.asp
http://research.cibcwm.com/economic_public/download/feature3.pdf
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"Living a life of simplicity is not simple. Rather, trying to simplify one's life is a constant challenge to embrace discipline - to edit out unnecessary items and to minimize desires that fuel their acquisition." Sri Chinmey

The Patriotism of Debt

aka THE JONESES ARE IDIOTS

The Federal Reserve stated today that U.S. consumer borrowing fell yet again in February, the 12th month of decline in 13 months. In other words, for the past year consumers have been paying off their credit cards and purchasing using cash.

In the short term, it is "bad" when people pay off their credit card debt, because that money was not spent on the economy. On the practical side, citizens with low levels of debt build an economy that is more stable and with real prosperity. Nations of savers become nations of creditors, and nations of creditors rule the world. So, in a sense, it's your duty to pay off your debts and save money.

Most advice one hears about paying off debts includes things like, "pay off your highest balance cards first," or "get a second job," none of which get to the heart of the issue: psychology. Thus, the advice you will find here is not of the traditional variety, but is instead straightforward advice that you may not want to hear, with no punches pulled.

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Rule #1 - F**k Appearances

One of the most remarkable things I see as a banker is how many people are drowning in debt and worried, yet who continue to spend lavishly. In cities they host dinner parties, travel, and go on shopping sprees. In rural areas, they buy pickup trucks and motorbikes. That is, they act like they are rich, except of course that they aren't. If this describes you, read on.

Keeping up appearances is a financial killer. At the next opportunity, say to your friends, "You know, I've been spending so much money recently, I can't afford to do that." The first time you say this to your friends they may be surprised. But the fact is, everyone has a limit to how much they can spend. You may find that people encourage you and say, "We wondered where you were getting the money from!"

Are you worried that your friends will think less of you if you can't keep up your current lifestyle? If so, then they weren't really your friends in the first place.

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Rule #2 - Keep Your Housing Costs Low

You should spend no more than 32% of your household's pre-tax income toward housing (ex. mortgage and taxes, or rent). For instance, a single person who earns $5000 per month should spend no more than $1600 a month on housing. A person who spends more than this level will find it difficult - if not impossible - to save money and still have a life.

If you are currently spending more than 32% of your income on housing, you have to move. Sell your house and downsize if you have to. If you are already in the cheapest housing available and still spending more than 32%, you need to look for a new job, because yours doesn't pay enough.

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Rule #3 - Read your Statements

Many people - especially those in debt - have a habit of opening their credit card or bank statements and only reading the balance (if they open the letter at all). Ignoring your statements won't make the debt go away. Instead, check every single line on your statements. You may be surprised to find hidden charges, extra fees, or simply that your last night out cost more than you remember. Reading your statements will give you a clear and honest look at your monthly spending.

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Rule #4 - Forget about Monthly Payments

"Low monthly payments" have a way of making large purchases seem insignificant: don't fall for it. If you owe $10,000 and your monthly payment is only $50, you still owe ten thousand dollars.

As a rule, never buy anything on credit that declines in value, except for a basic automobile. That means no stereos, no sofas, no washing machines on credit. No dinners or movies, either.
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Rule #5 - Do a Walkaround

Before you make small purchases, do a store walkaround. That is, leave the item on the shelf, walk around the store, browse, chat, and if 5 minutes later you still want to buy the item, go ahead. You will find that after a few minutes of contemplation, what you thought you wanted may not be so desirable after all.
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Rule #6 - Calculate HTB

HTB stands for "Hours to Buy." Take a look at your pay stub, and see how many hours you worked and what your final pay was. Then, use the numbers to calculate your hourly income after all deductions. For example, if you get paid $1500 every two weeks (after taxes and deductions), your hourly income would be $1500/80 Hrs = $18.75, or roughly $19 an hour. When you want to buy a large item, think about how many hours you had to work to pay for it. If a $1200 television takes 63 hours of work ($1200/$19 = 63) to buy, is it worth it? If you think so, then you can buy it with your savings. If you don't think it's worth so many hours of work, don't buy it.

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Although spending money on credit is fun at first, seeing your savings grow and savoring the possibilities is even better. You owe it to yourself to enjoy life while at the same time preparing for the future, and once you start you'll find it isn't hard. In fact, it's amazing how quickly you can "get ahead" once you really try with no excuses.
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"What you don't spend, you don't have to earn." Lou Krieger, The Poker Player's Bible.

Should you Lock it In?

Today’s interest rates -- the lowest since the 1950s -- were the response to a worldwide credit crisis and never meant to last forever. With both the Federal Reserve and the Bank of Canada hinting that rates will soon be increasing, is now the time to lock in your mortgage rate? Or, should you keep your rate variable and ride it out?

Since the late 1980s, variable rate mortgages have saved homeowners money over fixed rate mortgages. That is, on any given year, you would have been financially better off to take a variable rate mortgage (which has a lower rate) instead of a fixed rate mortgage (which has a higher rate but that is guaranteed not to increase). Variable rates could and sometimes did rise, but never enough to make the fixed-rate option worthwhile. As a result, many advisors now state unequivocally that variable rate mortgages are superior to fixed. The recent past, however, is not necessarily a good indicator of the future; and money is not the only consideration.

The next twenty years are unlikely to be the same as the last twenty. Countries around the world have run up huge deficits to combat global recession and have expanded their money supplies. The possibility that interest rates will rise dramatically to fight inflation is still relatively low, but it is real. If a hyper-inflationary scenario plays out like it did in the early 1980s, a fixed-rate mortgage will be a lifesaver.

Another consideration for a fixed rate mortgage is the psychological aspect, which is huge but often ignored. Financial prowess involves making practical decisions and planning for the future. Variable rate mortgages make long term planning difficult. How can you accurately budget, for example, if you don’t know what your next mortgage payment will be? There is also the serenity that comes with hearing an announcement that interest rates will rise, and not caring. You may pay for this economic certainty, but the psychological benefits are tangible.

The final consideration is protecting your downside risk. If mortgage rates rise only modestly, you may regret fixing your rate. But really, the worst that can happen is you don't save as much as you could have. If rates climb far above and beyond your fixed rate, however, you will be eternally grateful that you locked yours in. A fixed rate is, in effect, a form of insurance against events that could upset your financial security.

In short, I am advocating locking in to a fixed rate. With present rates at historical lows, the downside risks (such as rapidly rising interest rates) are far greater than the upside risks (such as missing out on a 1-2% rate discount). And, the ability to plan for the future, knowing that your monthly payment will not increase, is a valuable asset in itself.

Unless you like gambling, lock it in.
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"Beware the investment activity that produces applause: the great moves are usually greeted by yawns." Warren Buffett, 2008 Berkshire Hathaway Annual Report.