Going on vacation...

I'm leaving tonight to go up to our family cottage, so I won't have computer access again until August 7. I hope you all have a safe and happy Civic Holiday.

See you soon...

Small-scale arbitrage

Dedicated to Financial Freedom has a new post today with a technique for maximizing the rewards of regular spending. Essentially, the method is

1. Get paid


2. Send "unused" cash to an online savings account


3. Make your usual purchases on your credit card


4. When your credit card payment is due, transfer money from online savings to pay the bill in full

If the card used is a no-fee rewards card, then this approach pays off in two ways:

1. You earn interest on the "unused" money you set aside on payday


2. You earn rewards on dollars that you would have spent anyway

This technique reminded me of my own cash flow setup, but it adds another layer, in that the "unused" cash earns high interest until the purchase is made on the credit card. I think this is a great enhancement to my own technique, so I'm going to try the following "hybrid" cash flow:

1. Get paid


2. Send "unused" cash to online savings (ING Direct in my case)


3. Make the usual purchases on my credit card


4. With each purchase, transfer money from ING to pay down my line of credit balance


5. When my credit card payment is due, pay the bill in full using my line of credit

This milks my spending habits for about as much free money as I can think of. Of course, an even more lucrative method would be to send the "unused" money directly to the line of credit (which has a higher interest rate than my savings account) on payday, but my fear with this is that it makes tracking spending slightly more difficult. I like the fact that, with the approach above, I have a declining balance in my ING account that tells me at a glance exactly how much more I have available to spend.

Another Mortgage Milestone...

I posted two weeks ago that we had finally finished paying off the CMHC premium on our mortgage. This meant that the principal on our mortgage was finally below the $316,000 that we "really" borrowed to buy our condo.

Well, the daily interest on the mortgage took our outstanding balance back above $316,000, but with today's payment, we are finally at the point where that will never happen again. From now on, our mortgage balance will do nothing but move down from the $316,000 mark.

This is really just a psychological thing, but it's good to be making real headway on the mortgage.

Time for some goals...

Well, I've been at this for over a month, and I thought it was about time that I actually committed to some goals. So far, my aim has been to get my head on straight, and stop digging myself deeper into debt. I feel that I'm making progress with this; I've started an Emergency Fund and a Freedom Account, and I've spent nearly three months with a positive savings rate, spending less than I make. Hardly something to shout from the rooftops, but it's a major improvement from where I was three months ago.

Now, I've been doing some thinking about what specific, tangible goals I can set for myself. Here is a short list of goals I'd like to accomplish by December 31, 2007:

Savings

• Build my Emergency Fund to $1,000


• Fully fund my Freedom Account to $3,000

Debts

• Reduce the total balance of my line of credit and credit cards to below $22,000 (a decrease of $5,610.74 from April 30)

Investments

• Re-allocate my retirement portfolio to reflect my target asset allocation

I like these goals because they are so specific and actionable. I'll report my progress on these goals each month, and the first three will also be tracked in the sidebar (since each goal can be represented as a single number).

Wish me luck...

Free credit reports in Canada

Taking steps to prevent identity theft is an important part of personal finance. Tricia from Blogging Away Debt has put together a great list of tips on protecting your identity. A lot of these focus on physical management of personal information, but she also provides the crucial "check your credit report" advice. Tricia links to the American "AnnualCreditReport.com" site (which is only available to American ISPs), and I thought I would take a minute to gather the equivalent links for Canadian consumers.

Canadians can obtain credit reports from either Equifax or TransUnion. Although both of these agencies provide free credit reports to consumers, this option tends to be hidden behind the numerous fee-based options they provide. Basically, you're paying a fee in order to request and receive the report online; the free report must be requested and delivered via snail mail. Here are links to request a report from the two agencies:

Equifax
Credit report options
Free credit report request form (PDF)

TransUnion
Credit report options
Free credit report request form (PDF)

Note that neither agency provides the actual credit score as part of the free report. Equifax provides the score as part of their "deluxe" credit report package, for $23.95.

** UPDATE **

There's a third reporting agency in Canada:

Northern Credit Bureaus
Credit report options
Free credit report request forms (print and fill out IDENTITY and DECLARATION forms)

*** UPDATE ***

Experian Canada now offers credit reports directly:
Credit report options
Free credit report request form

**** UPDATE ****

Experian Canada is ceasing operations after April 17, 2009. From their website:

Effective April 17, 2009, Experian will unfortunately discontinue its Canadian consumer credit bureau operations as a result of the very difficult economic environment in Canada and around the world, which Experian believes will persist for some time. This means that as of April 18, 2009, Experian will no longer be providing credit reports out of its Canadian database regarding any consumer in Canada.

We will continue to respond to ongoing consumer requests for copies of credit reports, as well as handle disputed items and other consumer assistance until April 17. After that date and upon completion of any disputes in process, all consumer information will be deleted from our database and will no longer be available to consumers or creditors.

If you have not previously obtained your credit report from us or initiated a dispute on your Experian credit report, you may wish to contact one of the other credit bureaus for assistance.

Canadian Black Book®

I found a link to the Canadian Black Book® Web tool, which estimates the current Black Book® value of trade-in vehicles in Canadian dollars (like Kelly Blue Book for Canadians). The link is available through manufacturer websites (I found links for both GM and Toyota).

I'll be using this in the future to come up with more realistic values for our car in my net worth calculations.

Enjoy...

GM Canada Black Book® portal
Toyota Canada Black Book® portal

One Heck of a Dip

Well, the consolidation loan has funded. I now have $26,000 in "new" debt.

Of course, this is anything but new debt; I just haven't been including my better half's holdings in my net worth calculations. Calculating net worth as a household number will give me a much more accurate picture of where we stand. It also means that including our condo and mortgage in the calculation may make more sense, since "we" can liquidate the asset in a pinch, whereas "I" could not.

This is ultimately a good thing; we have a great rate on the consolidation loan, and we'll have it paid off in less than five years. It also brings four separate loans under one umbrella, making the tracking much easier.

It just makes me a little queasy seeing my total debts jump by 75% in one month.

Allocation on the Brain

I've been contributing to my employers' retirement savings plans ever since I started working six years ago, and have been receiving the full employer match since day one. The nice thing about this is that, when I look at the performance of my RSP, the combination of stock returns and 50% matching gives me a growth of 136% on my money invested. The downside is that, since my retirement savings make up most of my investable assets, I now have a concentrated position in two stocks. The stocks in question have done very well during my investment tenure, but the fact that I've done well so far doesn't mean it's a sound strategy going forward.

As a result, I've been thinking about how to allocate my retirement savings to position myself better for the long haul. Given my level of market savvy, and the amount of time I'm willing to invest in this venture, I think index funds are the way to go. I've been skimming Morningstar pages this past week, trying to get a handle on which baskets I want to put my eggs in. TD seems to have some decent index funds, with reasonable MERs and good index tracking, and I think this is probably the way I will go.

If I cash out out my positions in early August, then I'll be ex-dividend, so I can get started on "re-allocating" my portfolio. It scares me to be making decisions like this, but it scares me more to leave my entire retirement savings concentrated in two stocks.

It has a name!

When I re-vamped my budget at the beginning of May, I decided that I needed to get better at planning for "unplanned" expenses. I had just been hammered by over $2,000 in car repairs, and a $1,400 income tax payment, and it was clear that I needed to start socking money away for these "surprises".

I had read plenty about emergency funds and their importance in a sound financial footing, so I finally took the plunge and opened an ING Direct account to begin building this safety net.

What occurred to me, however, as I made my first transfer into the emergency fund, was that not all expenses that catch me unprepared are actually "surprises". To be honest, in the past, virtually any "less-than-monthly" expense has found me scrambling. Despite the fact that our hydro bill is consistently $100 every two months, I always manage to spend the $50 per month that should be earmarked for the bill. Although Christmas and birthdays fall on the same day every year, I always end up paying for gift purchases on credit.

My solution to this was to open a second ING account, which I would use as my "periodic expense" fund. For each of these expenses that I had identified, I determined how much I needed to deposit each week in order to have the amount on hand when it came time to pay. For example, I estimated that I would have $500 in car maintenance every four months (hopefully, this is being pessimistic). Therefore, I decided I would need to deposit $125 each month in order to fund my maintenance needs. Vehicle registration is $75 every five years, so I would deposit $1.25 per month to fund this category. I repeated this for every category, until I had a total dollar amount that would be deposited each month. I essentially made this a "bill" that I would pay automatically at the beginning of every month, to ensure that I stick to the deposits.

I was very proud of this innovation. To date, I've made three months' worth of deposits, and have withdrawn only for gift purchases. Granted, it's still early days, but there's a great deal of comfort in knowing that, when it comes time to renew my passport or shop for Christmas gifts, I will have the necessary amount sitting on hand, earmarked for just that purpose.

Well, it turns out that this is hardly a new idea. Apparently, this fund is commonly known as a "Freeom Account". Michael at Money Musings is a strong advocate of this approach, which is championed by author Mary Hunt in her book "Debt-Proof Living". Michael even provides links to a really cool Excel spreadsheet that tracks the balance of the Freedom Account.

On the one hand, I'm disappointed that I'm not the first to come up with this approach. However, the fact that I did come up with the idea independently, and have since had it validated by other sources, is very encouraging, and makes me think that I'm really on the right track.

There's no "I" in "Personal Finance"

Well, technically there is an "I", but I've been reminded this week that the "we" is much more important. It may not be "personal fwenance", but it probably should be.

My better half has decided to consolidate her student loans with my bank, in part to take advantage of the great staff rate she can get by having me as a joint applicant. We're waiting to hear on the decision, but our ratios and credit history are good enough that we shouldn't have any problems.

One direct result of this consolidation is that her student loan amount will suddenly appear in my net worth calculation. I've previously been omitting her student loans from my calculations, and this additional debt will certainly put a dent in the overall number. This is fine, as it is not really new debt, it's just suddenly drawing attention to itself.

Starting this month, I'll be looking at our household net worth when I report on financial progress, rather than just focusing on my own. This means I'm being completely honest with myself, and that the progress I show will not come with any hidden caveats.

I'm not looking forward to seeing our net worth when I factor in the consolidated loans, but I am looking forward to having everything on the table.

So long, CMHC

We made our final CMHC payment today.

For those who don't know, CMHC (Canadian Mortgage and Housing Corporation) is the agency that insures "high ratio" mortgages against default. If you have a down payment of less than 25% when you purchase a home in Canada, you pay a premium of 2-4% of the total amount borrowed. I think this is similar to PMI (Private Mortgage Insurance) in the US.

The CMHC amount is usually tacked onto the mortgage amount, and you spend your first year as a homeowner working to pay off that premium, without touching the actual purchase price at all.

We bought our condo last June, and today we paid off the last $66.76 of CMHC, along with $286.22 of the purchase price. This means that, for the first time since we moved, we have actually made real progress on our mortgage.

And it feels good.

Demystifying Mortgage Rates

I'm a die-hard "numbers guy". I've always loved using spreadsheets to lay out and track various scenarios, typically related to personal finance. I like to know exactly what the numbers in my life mean to me. This doesn't mean that I'm particularly good at acting on what the numbers tell me (refer to my total debts in previous posts for proof of this), but it does mean that I'm always "tinkering" with the data in my life.

One thing that has always fascinated me is the tracking of loan payments over time. I had the basic exposure to simple and compound interest calculations in high school, but these calculations almost always focused on a starting principal that remained constant over time. For example, "Sam has $1,000 that earns interest at a rate of 4.0%, compounded monthly. How much money does he have after two years?" The answer to this is very simple ($1,000 x (1 + 0.04) ^ 24 = $2,563.30), because the interest is the only source of change over time. However, when periodic payments, either toward an investment or against a debt, are brought into the picture, the answer gets more complicated, and is harder to express as a single formula (there are, in fact, "simple" formulas that take these payments into account, but their form is not exactly intuitive to the average person).

For every loan I've ever had, I've created a spreadsheet that details, over time, how much interest is accruing from one payment to the next, and how much principal remains over time. These are usually pretty accurate, but when I set up a spreadsheet for my mortgage, I found that my interest calculations were consistently higher than the actual interest charged, resulting in a longer calculated amortization. It turns out that this is due to the way mortgage rates are reported in Canada.

Canadian lenders post mortgage rates that are "compounded semi-annually, not in advance". Well, that clears it all up, doesn't it? It turns out this is actually very simple, but we need to sort out the jargon.

The "compounded semi-annually" part means that the rate is posted assuming that interest will be calculated every six months. The "not in advance" part means that interest is charged after it accrues, so you don't start out your mortgage owing six months' worth of interest. That is, if you have a $100,000 mortgage with a posted rate of 7.0%, then after the first six months, you would see an interest charge of $3,500 ($100,000 x 0.07 / 2). Note that this is actually equivalent to an annual rate of 7.1225% ((1 + 0.07 / 2) ^ 2 - 1), as opposed to the posted 7.0% rate.

In the real world, however, no one pays their mortgage semi-annually; most mortgagees make monthly payments. In the example above, this means that the rate of 7.1225% needs to be converted to monthly compounding, so each month, we would expect an interest charge of 0.575% ((1 + 0.071225) ^ (1 / 12) - 1). Multiplying this rate over twelve months gives us a true effective annual rate of 6.90%. Using this calculated rate, mortgage interest works out to within a few cents of what is actually charged by the lender.

The calculations here may seem a bit confusing, but here is a summary:

R = Annual rate posted by lender

r = Effective annual rate charged by lender

r = 12 x (((1 + R / 2) ^ 2) ^ (1 / 12) - 1)

Note that this formula is based on semi-annual calculation of interest. In the United States, interest is calculated monthly, so we would end up with the following:

R = Annual rate posted by lender

r = Effective annual rate charged by lender

r = 12 x (((1 + R / 12) ^ 12) ^ (1 / 12) - 1)

r = 12 x (1 + R / 12 - 1) = R

Therefore, in the US, the posted annual rate is actually the same as the effective rate.

I was quite shocked the first time I worked this out, because I could not figure out why lenders would advertise mortgage rates above what they actually end up charging. It turns out that financial institutions are required by law to express their interest rates this way, so that consumers are able to compare "apples to apples", since all lenders are advertising their rates on the "semi-annually, not in advance" scale.

So now you know.

Canadian High-Interest Savings

It's impossible to read a personal finance blog without seeing myriad references to high-interest online savings accounts. ING and HSBC are probably the most commonly cited, and since most of these blogs are based in the US, they refer to these banks' 4.50% and 5.05% APY (respectively). This can get a little frustrating to us Canucks, as we simply don't have access to the same rates that are available south of the border. I thought I'd do a quick write-up of the deals that are to be had in Canadian online banking.

ING Direct

ING currently offers Canadians an everyday APR of 3.50% (calculated daily, this is equivalent to a 3.56% APY), with no minimum balance. They currently have a promotion rate of 4.25% on new balances until August 31, so it's a good time to try them out. If you e-mail me for a referral, you'll also receive a $13 bonus when you deposit at least $100 into your new account (a nice complement to the incentive rate).

HSBC Direct

HSBC also offers 3.50% APR, with no minimum balance. They currently have a signing bonus of $50 for new customers, but this is only for accounts opened by Monday. With an HSBC account, you can use any HSBC or BMO bank machine for free.

PC Financial

PC Financial offers a 4.0% APR (equivalent to a 4.08% APY) if you maintain a balance over $1,000, but only 1.0% if the balance is $1,000 or less. With a PC account, you can use either PC or CIBC bank machines for free.

Other Options

I found an article from last fall that goes through the various Canadian options in detail. The author seems to recommend PC Financial overall, but ICICI receives positive mention as well. Check it out...

Fun with Negative Net Worth

I was tooling around with my net worth calculations, and something occurred to me.

I use three "net worth" metrics to track my financial progress:

• Net Worth: Total assets (retirement and non-retirement savings, home, and car) minus total debts (including mortgage)


• Net Investable Assets (NIA): Total financial assets (retirement and non-retirement savings) minus total non-mortgage debts


• Net Liquid Assets (NLA): Total non-retirement savings minus total non-mortgage debts

The first two are currently positive, since I've been contributing to RSPs since I graduated in 2001, but my NLA is significantly negative. This is because virtually all of my savings to this point have been in RSPs, so I have no truly "liquid" savings.

I always find negative numbers interesting when it comes to calculating percentage change. During the month of May, I increased my NLA by $2,306.85. Since my starting point was negative, this technically represents a negative percentage change. That is,

$2,306.85 / ($35,298.09) = (6.54%)

It's clear that this is actually a positive change, so it's trivial to convert this to a 6.54% increase, but an interesting question is raised if I consider doubling my NLA. Technically, this would mean decreasing my NLA to ($70,596.18), which is clearly not what I'm looking for. However, another way to look at "doubling" is in terms of a 100% increase. So, in a way, I will have doubled my NLA when it hits $0, or when my non-retirement savings are equal to my non-mortgage debts.

Neat.

Of course, doesn't this then mean that any increase in NLA after I hit the "break-even" point will represent an infinite increase?

Yes, I'm a geek.

Thoughts on Cash Flow

Looking at the change in my debts over the last month, I thought it might be a good idea to go through how I've decided to structure my cash flow.

From May 31 to June 30, my credit card balances rose from $1,056.55 to $3,945.72, while my line of credit (LOC) balance decreased from $25,298.84 to $22,647.79. That is, my LOC balance went down by approximately the amount that my cards increased. The reason for this is that, every time I make a purchase using a card, I make a payment in the same amount to my LOC. When I receive my credit card statement, I then use the LOC to pay the card balance in full. This has two results:

• My credit card balance always has 0% interest, since I pay in full


• I pay less interest on my line of credit, since for the duration of the month, the amount of my card purchases is not accruing interest on the line of credit

Essentially, what I'm doing is using a credit card to make a temporary payment against the LOC, thereby reducing the amount of interest that accrues on the LOC. Given that my LOC has an APR of 6.25%, this represents automatic earnings equivalent to 6.25% APR on every dollar I spend on the card. For as long as I have a balance on the LOC, this is the method I will use for managing credit card purchases.

Here's an example to illustrate the process in action:

Suppose I have a LOC balance of $20,000 (6.25% APR) at the beginning of the month, and make a $100 credit card purchase. If I wait until the end of the month to pay the credit card, then my LOC balance at the end of the month will be

$20,000 x (1 + 0.0625 / 12) = $20,104.17

However, if I immediately pay the $100 against the LOC, and use the LOC to pay off the card at the end of the month, then my ending LOC balance will be only

($20,000 - $100) x (1 + 0.0625 / 12) + $100 = $20,103.65

Either way, the credit card charges no interest, since the balance is paid in full at the end of the month. The savings in this example only amount to $0.52, but with hundreds of dollars in credit card purchases each month, this can add up.

Obviously, the major assumption here is that income for a given month will, at the very least, cover the purchases made on the card. If I spend more than I make in a given month, this approach runs off the rails, as I end up increasing my LOC balance at the end of the month. This happened for me in June, although it's only temporary, as I'm waiting for travel reimbursement which will more than cover the $238.12 gap. Also, it is important to remember to make a "real" LOC payment in addition to all the "temporary" payments throughout the month; otherwise, the LOC balance will continue to grow as interest accrues.

When I have paid off my LOC, I will most likely continue this approach, but by temporarily socking each purchase amount away in high-interest savings instead, so that I effectively earn interest on my credit purchases.

Vacation Aftermath

I've been tallying up our expenditures from our trip to Illinois, and thought I'd post my June month-end results. The exchange rate during our trip was about 10%, which is far more favourable than the 55% we faced when we visited Chicago five years ago. This "near-parity" of the Canadian and US dollars seems to have sent us into a bit of a spending frenzy, but overall the results aren't as bad as they could have been.

Here's the story:

Assets:
Online Savings - $635.80
Self-Directed RSP - $5,904.69
Employer Group RSP - $33,201.78

Debts:
Credit Cards - $3,945.72
Line of Credit - $22,647.79
Student Loans - $7,400.98

Net Investable Assets: $5,747.78
Net Liquid Assets: ($33,358.69)

Essentially, debts went up by $94.66 vs. last month, while assets went down by $425.19. The asset drop was a combination of vacation spending and poor stock performance (my overall RSP balance declined by $152.40 despite making nearly $600 in contributions). The debt increase is not really accurate, since I will be reimbursed for $600 in travel costs, which I will then apply to the debt, for a net decrease of $505.34.

Not great performance, but the good news is that debts are going down, and although assets decreased, I essentially paid cash for our vacation, which is a victory in itself.

Happy belated Canada Day! (on Independence Day)

OK, so nearly a month between my first and second posts may not be an auspicious start, but here I am with post number two. June was a hectic month, as my better half and I spent the end of the month visiting friends in Illinois. We drove back to Toronto on Sunday, and managed to take in the Ashbridges Bay fireworks with some friends of ours. It was a nice welcome back to our home and native land.

Let's get down to business.

I have a good job, with a good salary. However, like so many other young professionals, I have been slow to develop a true picture of what this salary can actually buy. I have spent a number of years living well beyond my means, chasing raises and bonuses to try to catch up to my spending. This lifestyle inflation has really hurt my financial picture, as I now find myself in my thirties with huge debts and no liquid savings.

At the end of April, following a hefty tax bill and several months' worth of pricey car repairs, I finally took a hard look at where I stood financially.

Here was the gist:

Assets:
Self-Directed RSP - $5,889.52
Employer Group RSP - $30,197.91

Debts:
Credit Cards - $3,267.26
Line of Credit - $24,343.48
Student Loans - $7,687.35

Net Investable Assets: $789.34
Net Liquid Assets: ($35,298.09)

Our condo (with mortgage), and our car (owned outright) are not included here, in order to focus on "real" dollar amounts, and I consider the condo and mortgage as offsetting each other.

So I'd been out of school and gainfully employeed for six years, and I had $789.34 to show for it. Not to mention that, in terms of actual liquid assets, I was over $35,000 in the hole. That realisation sent me scrambling to set things right, beginning immediately in the month of May. I decided that my biggest problem was poor tracking of credit card expenditures, so I began diligently recording every purchase I made on credit, and setting cash aside to pay that amount off when the statement came. I opened online savings accounts with ING and HSBC (HSBC is giving a $50 bonus for new customers until July 9), and I took advantage of the three paydays in May to throw extra cash at my debt. I also worked out a new budget, one that plans for periodic (i.e. less frequent than monthly) expenses, such as car repairs, license renewals, and gift purchases, by setting aside a fixed amount each month. On top of this, I really reined in my spending on eating out, one of the single biggest drains on my finances. For the first time in years, I was actually living within my means.

At the end of the month, when I took another look at my finances, here is what I saw:

Assets:
Online Savings - $908.59
Self-Directed RSP - $6,141.96
Employer Group RSP - $33,116.91

Debts:
Credit Cards - $1,056.55
Line of Credit - $25,298.84
Student Loans - $7,544.44

Net Investable Assets: $6,267.63
Net Liquid Assets: ($32,991.24)

I was speechless at the difference one month had made. Granted, the stock market accounted for a big part of the asset growth, and the debt reduction was largely due to a third paycheque in May, but this was a huge motivation to continue on this path. I still have a long way to go, but I've seen what one month can do, and I'm excited to see where this road takes me.