Author: Petros

Do you need an emergency fund? Reflexions on what to do in a high inflation, low interest environment

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Tyler and Claire require $85,000 to renovate their house but started saving late and now want some advice.  So the Globe and Mail enlisted the services of TD Waterhouse investment advisor, Eric Davis.  The first thing, he says, is to establish an emergency fund:

Before they begin their renovations, though, Tyler and Claire should build up an emergency fund of anywhere from $15,000 to $30,000, which could be held in a tax-free savings account, he adds.

The standard wisdom today coming from financial advisors is that everybody needs to have an emergency fund.  Usually this consists of up to as much two-years worth of living expenses to tide one over in case of illness, unexpected expenses such as car or home repairs, or loss of a job.  All is good.  Save for rainy day?  Seems like pretty sound advice, right?

But in my mind, it isn’t sound advice in all circumstances.  Why?  Because the spread between the savings interest rates and mortgage rates is usually about 3-5 %.  So you can get 1% interest in your savings account; but you pay 4% on your mortgage.  Why not make an extraordinary payment on the mortgage, and save 3% in the meantime?  The problem is one of liquidity.  The money one uses to pay down a house is illiquid and you can’t access it in an emergency.  So that is why I recommend instead to get a line of credit, preferably a home equity line of credit (HELOC) because they have the lowest interest rate.  As you pay down the house, the bank will increase the HELOC.  Now use the HELOC only for emergencies and any excess cash can pay down the mortgage, saving you 3% interest in the meantime.  Interest earned is taxable, except of course in the TFSA (Canadian Tax Free Savings Account).  The government gets its cut.  Interest saved is not taxable.  So the home owner makes a double win.

I think it is necessary to be extremely wary of the advice from financial advisors because they don’t work for you.  Do you ever wonder why your advisor will make a trip to your house and spend a couple hours working out a financial plan?  Who pays them?  Our broker from Scotia McLeod did that; and Scotia McLeod earned full standard commissions from us: that means 2% or an $80 minimum per transaction.  One time he wanted me to put a stop loss on RSI.un (Rogers Sugar) saying that I’d made some nice gains, I should try to lock them in.  Well I didn’t want to do it because Rogers was paying a tidy dividend every month.  He insisted and finally talked me into it.  When all was said and done, the stop loss evacuated the stock at a $30 dollar after-commission loss to me, my broker got is his fat fee for selling it, and I lost a source of income.  I wanted the long term position for the dividend, but the financial industry made money churning my position.  Today, RSI has continued to pay (now monthly) and it is trading at 25% higher than my stop loss.  I would have won if I held it for the last six years which was my intention.  But the industry doesn’t make any money when you hold, only when you churn.  This incident is one of the reasons that I become a DIY investor.

Eric Davis would probably offer the couple a TFSA account at an anaemic rate of interest at TD Bank. Such a savings account will help the bank, for banks crave savings accounts, needing of capital these days.  But the inflation rate is greater than the interest rate by at least 2 basis points, and so now Tyler and Claire will lose 2% buying power on every dollar in their TFSA; if hyperinflation hits, and in my mind that is certain, then they could lose double digits or higher–food prices are going up like crazy, I know, I do most of the shopping in my family.  But TD Bank wins.  They will use Tyler’s and Claire’s capital earn  money by lending it to someone else at at 4-5%.  They don’t have to worry about inflation because it is not their principal.  The principal belongs to Tyler and Claire!

I think that its better to pay down the mortgage and make your bank hold your available credit in reserve.  Make them hold the money for you rather than the other way around.  If you need it, you’ll pay a little more than the mortgage rate (my HELOC is at 3% compared to my variable rate mortage at 2.1%), but in the meantime, it has reduced your debt, saving you money.

The taxman says, “Heads I win, tails you lose”: On the unfairness of capital gains tax

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The following video shows why capital gains taxes are unfair.  The taxman measures capital gains in nominal inflatable dollars.  Inflation robs the investor of gains, but it still looks like a gain. Thus, the investor gets killed by inflation then by capital gains tax and could be left with less than what he had before.  Thus, government robs the investor through inflation or through capital gains taxes: pick your poison.

I notice that the government has its hands out in the good times like 2009-10 when my stocks were going up. But this year, when things are going down, what help or reimbursement do they plan to give me?  Actually nothing.  And you wonder why I hate government?

Reflexions on how to invest in an inflationary environment using leverage

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The clear winners during the Weimar inflation were debtors.  This according to historian Adam Fergusson, author of When Money Dies (pdf link).  Indeed, it pays to owe money during inflation and even 2% inflation is theft–stealing from anyone who has lent money.

I have said in previous posts that the only reason that home owners win is because they enjoy a cheap debt product, a mortgage, and that as time passes, inflation reduces the value of the mortgage, while it appears in nominal dollar terms that their house has increased in value.  But if measured in something more stable, like gold, real estate hasn’t really improved in value over the course of the last 100 years.  It is just the dollar that has fizzled out.

Thus, I conclude that leverage that is under control and manageable, is the best weapon against inflation.  What is leverage that is under control?  (1) Keep debt to equity near or below 1:1; (2) Use debt to  purchase of a cash-flow producing investment, such as a dividend paying stock or rental housing, which in covers the interest payments and creates income;  (3) Avoid consumer debt.

In any case, here is the video in which Adam Fergusson explains how debtors win:  they pay off mortgages with “postage stamps” (i.e., eventually, the cost of postage stamps is similar to the total mortgage debt).

Hat tip:  Zero Hedge

Peter Schiff is a mensch II: Interviewing OWS

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Peter Schiff tries to explain that high-wage earners are often the people who provide jobs and if you tax them at too high a rate, they are likely to just stop working hard and stop risking their capital, and people whom they employ will lose their jobs.  It is a compelling narrative if you are an employer, as are both my wife and I.  Craig Carter says something similar (If You are Thankful for Your Job, Hug a Billionaire):

Every time I hear the “Tax the 1%” meme, I feel personally threatened. I feel as though someone is out to destroy the economy and create the kind of conditions in which I could, potentially, lose my job. The war against the rich is really a war against the middle class and it is based on emotional manipulation, rather than reason. The people who are involved in it may be sincere, but they are much too gullible.

Maybe economics should be a compulsory subject in high school and maybe we ought to start purging socialists out of our universities so that free market principles once again dominate the curriculum. OWS and liberal/socialist propaganda is getting out of hand and people are getting hurt.

I don’t think Peter Schiff would argue with Dr. Carter on that point.

Hat tip:  Monty Pelerin

How monetary policy works: Quantitative easing explained

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Monty Pelerin (h.t. Barry Riholz) offers this morning the following video at his blog to explain Quantitative Easing:

Yet I have called into question the usefulness of the metaphor of printing, since central banks create most of the money in our world today through electronic transfers, i.e., they do not print at all, but it becomes oh so much money on debit cards and bank balances.   I.e., no wheel barrows are needed, because banks can create a trillion dollars of money, and it takes up no space.  It much more like the Corner Gas reality as I pointed out in my post “A Canadian explanation of global monetary policy“.