Archives for May 16, 2018

Variable rate mortgages are looking mighty good right now

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Variable rate mortgages haven’t looked this attractive in years.

That’s not to say they’re the right choice for people buying a home or renewing a mortgage. If you have some financial stress in your life already, a fixed-rate mortgage is a better choice. But if you want to lock down a very low rate today and are OK with the idea that it could rise in the months and years ahead, then consider the variable rate.

I wrote a column talking about the benefits of variable-rate mortgages in late March. One of my arguments was that the penalties for breaking them are typically much less than for fixed-rate mortgages, while the other was that they’re cheaper than the fixed option. Since then, fixed-rate mortgages have become an even better deal. According to Ratehub.ca, the differential between the best fixed and variable mortgage rates recently hit 1.04 per cent, which is the largest gap since Dec. 1, 2011.

A quick check with a few mortgage brokers via their online rate sheets showed the differential between five-year fixed and variable was closer to 0.80 to 0.85 percentage points – 2.41 per cent for variable at one firm, and 3.24 per cent for fixed. But that’s still a substantial savings. It would take four increases of 0.25 per cent in the Bank of Canada’s overnight rate to make a variable-rate mortgage more expensive than the current cost of a five-year fixed rate mortgage. The overnight rate influences the prime rate at banks, which in turn guides variable-rate mortgages.

One mortgage broker wrote this week that the great deals on variable-rate mortgages have changed his thinking. “Over the past few years my advice has generally favoured five-year fixed over five-year variable rates,” he wrote on his blog. “Today, the inherent uncertainty in variable rates remains, but its increased potential saving may now be worth the risk.”

About 68 per cent of mortgage holders have a fixed-rate mortgage, 28 per cent have a variable rate and 4 per cent have a combination mortgage, according to a report issued last fall by Mortgage Professionals Canada, which represents mortgage brokers.

A beginner’s guide to investing

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Personal finance. Hear that and we picture a complex web of taxes, fixed deposits, mutual funds, demat accounts and just a lot of confusion. We want to save money, invest and watch that money multiply but take a long time getting around to it. Maybe we don’t have enough money or make enough money. Maybe we just want to ‘live in the moment’ because all our lives, all our parents did was save. You know you will too, when the time comes, but it would help to know the nuts and bolts of it. So, ladies and gentlemen, welcome to our beginners’ guide to investing.

Anyway, personal finance.

Let’s start with the meaning of that phrase. Investopedia defines personal finance like this: It is the science of handling money. It involves all financial decisions and activities of an individual or household – the practices of earning, saving, investing and spending. Matters of personal finance include the purchasing of financial products, like credit cards, life and home insurance, mortgages and of course various investments and investment vehicles. Banking is also considered a part of personal finance, including checking and savings accounts and 21st century online or mobile payment services like.

Warren Buffet, the one man we think of when we hear the word investments, once said, “Someone’s sitting in the shade today because someone planted a tree a long time ago.” Wise words, those, from the probably the smartest, most no-nonsense investor in the world. The message is – be a forward thinker when it comes to personal finance. When deciding whether to put some more money aside for emergencies, think of a financial emergency actually happening and how much easier your life will be if you have enough money set aside.

Think of the trip you want to take to see the northern lights in Iceland or Norway. Or maybe you want to sail around the world. Or climb all the famous volcanoes. Or invest that $1 million in a government-approved scheme in America to get an EB-5 visa and get citizenship in less than 5 years. See? It could be a broad plan or very very granular. Each plan begins with the same caveat – save money and things can generally get better in life. Let’s discuss some basics of saving and investing.

The most important parts of personal finance that one needs to keep in mind are:

  1. Cash flow
  2. Insurance
  3. Taxes
  4. Savings and investment
  5. Retirement planning

But first, some Dos and Don’ts.

The most crucial thing is to plan your budget. All talk of assets, equity, mutual funds, hybrid schemes, etc etc, are just hot air until you draw up a budget, with specific numbers. A budget is a roadmap that allows you to live within your means, while having enough to save for long-term goals. Traditional wisdom recommends approaches like the 50/30/20 budgeting method. What that means is, 50% of your take-home pay or net income, after taxes, goes towards living essentials, like rent, utilities, groceries and transport. Another 30% for lifestyle expenses, such as dining out and shopping for clothes, etc. The remaining 20% is invested in your future: to pay debts and to save – for retirement as well as for emergencies. Of course, this changes depending on your comfort levels.

Now, with that in mind, remember to limit your debt. This is just common sense but a large number of people ignore this so it is always good to reiterate. Don’t spend more than you earn.
Of course, most people do borrow now and then. Sometimes going into debt can be advantageous, if it leads to accumulating an asset. Buying a house, for example. Otherwise, avoid borrowing. Especially using credit cards, which are debt traps. There are advantages to using credit cards but, in general, avoid maxing out credit cards at all costs, and pay your credit card bills strictly on time, every time. Paying bills late ruins your credit score.

The other important aspects, i.e. insurance, taxes, savings, investments, and retirement planning are what we will cover in detail in this Personal Finance series.

For those who are new to financial planning and investing, let’s count the types of asset classes that investment covers. Wait, what are asset classes? To understand that, let’s understand two terms – Assets and Securities.

Investopedia defines an Asset as a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. Assets can be broadly categorized into short-term (or current) assets, fixed assets, financial investments and intangible assets.

A security is a tradable financial asset. The term commonly refers to any form of financial instrument. Securities are broadly divided into three categories:

  • Debt securities
  • Equity securities
  • Derivatives

Keeping these basics in mind, let’s look at asset classes. An asset class is a group of securities that exhibits similar characteristics and behavior in the marketplace and is subject to the same laws and regulations. Asset classes are of three types: equities, or stocks; fixed income, or bonds; and cash equivalents, or money market instruments. Some experts also include a fourth asset class – Real estate or other tangible assets.

These are what form your portfolio. Stocks are lumped together even though individual stocks—or even mutual funds—can be quite different.

Now that we know what a portfolio comprises, we need to dive deeper into the different working parts. What are stocks? What are mutual funds? What are my other options? Does any of this get simpler at any point?

Travel allowance or company car?

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Which is better: a company car or a travel allowance? It’s a question that perplexes both employers and employees. In light of new South African Revenue Service (Sars) requirements for travel reimbursements, it needs to be carefully revisited, says Jerry Botha, master reward specialist and executive committee member of the South African Reward Association.

Botha is referring to the removal of the 12 000km limit that applied to reimbursements. If travel exceeded this distance and the employee was reimbursed at a per-kilometre rate higher than that prescribed by Sars, or another travel allowance was paid, the total amount had to be reflected under code 3702. A reimbursement paid at or below the prescribed rate was declared under code 3703. Either way, Pay-As-You-Earn (PAYE) tax was not deducted from the employee’s income.

From March 1 this year, if an employer reimburses staff at a per-kilometre rate higher than that prescribed by Sars, it has to split the reimbursement into two components. The portion that falls within Sars’s rate must be declared using code 3702, while the portion above that rate must be reflected under a new code, 3722. If the employer also pays a fixed travel allowance, this is declared separately under code 3701, as usual.

Under this new system, the excess reimbursed portion is subject to PAYE, as is the case with a fixed travel allowance or fuel, garage and maintenance cards. Reimbursement at or below the prescribed rate is not subject to PAYE, as before.

“More important than the new code and method of calculation is the removal of the 12 000km limit and the introduction of PAYE on the excess portion,” says Botha. “These changes affect the reward dynamics significantly.”

Employers, particularly those who reimburse staff well above the prescribed rate, should review the new rule to ensure that their staff are enjoying the best tax and cost benefits, he says.

It may be that a lower reimbursement rate puts more money into an employee’s pocket, because there is no PAYE thereon and the reimbursement does not have to be substantiated by a logbook when the employee files his or her income tax return, Botha says.

Either way, compliance with the new rule makes it important for all employers to enforce compulsory employee logbooks, even where the employee does not claim on a tax return. Sars is focusing on employer PAYE audits, and employee logbooks are crucial evidence of tax compliance, Botha says.

The introduction of the requirements is a good opportunity to decide whether employees would benefit more from a company car. “As a rule of thumb,” Botha says, “if more than 60% to 65% of an employee’s travel is for business purposes, they are losing out by using their personal vehicle.”

Typically, fuel makes up only 50% of the total cost of running a car, he says. There are additional expenses, such as maintenance, insurance, and depreciation on the vehicle, which are not fully covered by travel allowances, reimbursements or fuel cards. Highly mobile employees may also have to bear the costs of replacing their private cars prematurely.

Botha says the vehicle-buying habits of South African employers and employees are rooted in emotion, and decisions are not made based on running the numbers. This results in employers being burdened with high fleet costs, while employees can be significantly out of pocket, often realising the problem only when they want to trade in their vehicle, he says.

He says there is a sweet spot for travel reimbursement, reimbursement with a travel allowance and company vehicles. Employers may offer all three as part of a total-package approach.

Employees who clock up many kilometres on business travel are severely disadvantaged if they do not use a company vehicle. “If employers do the calculation correctly,” says Botha, “they will see that a company vehicle is the best reward strategy in this case.”

Only 37% Of Millennials Have A Retirement Account

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Who’s thinking about retirement when they’re young? Retirement accounts are typically not a priority for young workers – but they should be. That’s precisely the time to take the greatest advantage of compounding interest by contributing as much as your fledgling budget can afford.

A new study from the University of Missouri suggests that millennials, the youngest working generation, are not sufficiently preparing for retirement. Using data from the Federal Reserve’s 2013 Survey of Consumer Finances, just over 37% of working millennials reported having any type of retirement account. Only 17.6% of self-employed millennials have retirement accounts – an important statistic given the role of millennials in the growing gig economy.

These results are in line with previous studies on millennial readiness. A separate 2018 report by the National Institute on Retirement Security (NIRS), using U.S. Census Department data from 2014, found that 34% of working millennials had saved for retirement. Meanwhile, a direct 2017 survey by Earnest, Amino and Ipsos found that only 31% of millennials were saving for retirement. (The lower value may reflect an increasing problem or just differences in methodology.)

Minority millennials are having an even more difficult time. For example, the NIRS study found that 83% of Latino millennials had nothing saved for retirement, compared to 70% of black millennials, 67% of Asian millennials, and 60% of white millennials.

Surveys may disagree on the extent of the problem, but all surveys point to millennials being underprepared for retirement as a group.

Millennials have little slack in building up a retirement nest egg. Many came of age during a strong recession and faced a difficult mix of decreased job opportunities and huge student loan burdens.

As the economy strengthened, millennials began to recover from the slow start – but they still have a lot of ground to cover in a shorter time. Millennials who could not contribute to a retirement fund in the early years after graduation lost out on extra years of growth and compounding of their retirement funds. It’s extremely important that they take advantage of the remaining investment years.

As a millennial, how do you increase retirement readiness? It all starts with a budget that sets realistic spending limits. You can’t contribute to a retirement fund if you have no surplus to invest.

The easiest way to build retirement funds is to take advantage of any employer retirement programs such as a 401(k) plan. Take full advantage of any employer-matching 401(k) program up to the matching limit. The matching funds are essentially free money to you. If you’re self-employed, create your own 401(k) plan or set up a suitable IRA.

The key is to have a set dollar amount or percentage of income deposited in a retirement fund every month, in whatever amount you can afford. Treat the retirement contribution as if it were rent or a house payment – a non-negotiable monthly expense.

Once your retirement fund becomes a part of your regular budget, focus on spending control. Keep debt at manageable levels, especially high-interest credit card debt. Excessive credit card debt will rack up interest charges that leave you less money to devote to something else – and retirement fund contributions are likely to be one of the first things you redirect to paying off debt. Avoid the spending temptation.

So far, millennials have been fairly consistent in their lack of retirement readiness. That must change as millennials advance through their careers. When retirement time nears, don’t be one of the laggards looking for quick fixes to years of poor preparation. Be the shining example of how millennials should properly prepare for the post-working years.

Regardless of where you plan to retire, the number one factor in ensuring that you can retire on your terms is your 401(k). Make sure that your 401(k) is maximizing its potential with this free analysis that checks your fees, fund mix, and other factors to help you hit your retirement goals.