I’m Shocked This Money Myth Still Exists

I’m shocked at how frequently people make this money mistake.

I’m referring to a common misunderstanding of how income tax rates work.

Many people say some variation of the following: “You don’t want a higher income because you’ll jump up into a higher tax rate and end up actually taking home less money after tax.” People have even refused career advancements based on this misconception.

This line of thinking is pure poppycock. Hogwash. It’s a fundamental misunderstanding of how marginal tax rates work.

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I can understand why people make this mistake. After all, marginal tax rates do increase as you earn more income. What people don’t understand is that the higher marginal tax rate ONLY applies to the income earned above certain thresholds.

To help illustrate, here’s a simple example: Let’s say the marginal tax rate on the first $50,000 earned is 20%, and above $50,000 the marginal tax rate jumps to 25%. Based on this tax structure, if you earn $70,000 you pay 20% tax on the first $50,000 and 25% tax on the next $20,000.

What people mistakenly assume is that once (using the above example) they earn above $50,000 they’ll pay 25% tax on everything.

Simply put, regardless of higher marginal tax rates the more income you earn the more you take home after tax.

A Real-Life Example

The four tables at the bottom of this post provide real-life examples of this for residents of each of the ten provinces in Canada. The detailed tables show after tax income, average tax rate, marginal tax rate, etc. on income levels of $50,000, $75,000, $100,000 and $125,000. For the purposes of this exercise, the only column you need to pay attention to is the ‘After-Tax Income’ column.

In case you don’t want to go through each detailed table, I’ve summarized the results for an Ontario resident below. Here are the after tax incomes for all four income levels:

[table id=1 /]

As you can see, as you earn more income you take home more after-tax money, despite a higher marginal tax rate.


Ignore The ‘Experts’

If you’re like most people, you listen to the experts: Economists and investment managers. If there’s anything these folks are good at it’s making predictions about the future and then eloquently explaining why their predictions didn’t come true.

Economics is a pseudoscience that relies on unrealistic models that tend to be completely detached from reality. In case you don’t believe me, below is a list of projections made by various economists and investment managers over the past decade. All of these predictions proved false.

So next time you read a headline or hear a soundbite about the near-term direction of the economy or markets, treat it as background noise.

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So who should you listen to? There are good economists and investment managers. They are the ones who are skeptical about their own conclusions. They tend to have a long view that ignores the day-to-day and week-to-week fluctuations. Instead of making overconfident predictions, they provide a framework for decision making by observing the world around them.

Source: JP Morgan Asset Management

Investing Wealth

Compounding and the Self-Funding Portfolio

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

Albert Einstein
Aivazovsky Shipwreck, 1856, pencil and gouache on paper

Let’s say you’re 20 years old and have 40 years until retirement. If you’ve been reading this blog you know that you need to start saving and investing early to get time on your side.

You’ve also probably seen growth charts – like the one below – showing how an annual contribution of $10,000 to a portfolio that returns 6% would grow over the years. This illustrates the simple concept that time + return on investment provide exponential growth over the long run.

This is the power of compounding

Compounding describes how an investor gets returns on their initial investment plus returns on the returns on that initial investment. Returns on returns – that’s when your money starts really working for you. That’s when it takes a life of it’s own.

When contributing regularly to a retirement nest egg, there is a point after which your portfolio learns to fly on its own.

In the early days, your portfolio is small. So most of your portfolio’s growth is dependent on your contributions. During this time, investing feels like an uphill battle – it’s more an exercise in saving than generating returns. This is frustrating for many, as the dollar value of annual portfolio returns are small during this period. The vast majority of annual portfolio growth comes from your contributions.

However, over time this eventually changes. At an average annual return of 6%, portfolio returns outpace contributions by about year 13. As you can see in the chart below, once this point is passed, the portfolio becomes self-funding in a way, with the dollar value of annual portfolio returns increasingly outpacing the value of annual contributions. Of course, it is best not to think of the portfolio as self-funding, and you should keep contributing to accelerate future growth.

It isn’t until these later stages that you truly start to see the benefits of compounding.

The chart below shows the same thing as the previous chart, except it shows annual portfolio return and annual contribution as a proportion of portfolio growth. I think this really highlights why people get frustrated in the early years of investing. You can see how in the early years, the only growth is due to your own personal sacrifice. Your friends are spending their paychecks on BMW payments, while you suffer in silence to fund your portfolio with little to show for it.

However, while your friends have a negative net worth 13 years later, you’ve built a portfolio that has really started to take off.

Real Estate

Should You Sell Your Toronto House And Rent?

Say you’re 45 and you have $1 million of equity in a house in Toronto. Could you sell your house, invest the money and pay rent on a house solely using your portfolio?

I ran the numbers.

It costs about 3 grand to rent a house in Toronto. Assume a 6% return on a portfolio.

Here’s the plan:

Sell the house and invest the proceeds. Withdraw from the portfolio to pay your rent.

If you assume your rent increases close to the legally controlled rate (about 2%) the idea seems to work well. Between ages 45 and 90 you spend about $1.8 million on rent. But at the same time, your portfolio grows to $2.9 million. No depletion here…

Looks good, right? Keep reading…

The problem is this makes a big assumption: your rent increases actually stick to about 2% per year.

In reality, market rents in Toronto are actually rising about 10% per year. Many landlords – seeing market rents rising faster than the controlled rate – will find ways to kick out renters to jack up rents. As a renter, this means you’d likely 1) be forced to find a new house to rent every few years, and 2) experience sudden spikes in rent as you’re forced to align with market prices. Indeed, over the long term, the 2% assumption simply isn’t realistic.

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Simply increasing the rent increase assumption to 4% per year fully drains your portfolio by age 84. This is a bit more doable, although you’re f@cked if you live past 84. Also, a 4% rent increase assumption might still be low, given it’s less than half that of market rent increases.

Obviously, the story gets worse the faster rent increases. At a 10% annual increase, you’re eating cat food in your senior years. In this scenario your portfolio runs dry by age 65 – just in time for retirement!

In conclusion:

With a long-enough time horizon a $1 million portfolio isn’t enough to cover rent for the rest of your life.


Jeff Gundlach on the Next Economic Collapse

Jeff Gundlach, CEO of DoubleLine Capital predicted the election of Donald Trump and the 2007 housing crash. He is now providing insights into the next economic collapse.

Headshot of Jeff Gundlach

In 2011, he was featured as “The King of Bonds” in Barron’s, and named one of “5 Mutual Fund All-Stars” by Fortune Magazine. In 2012, he was named one of the “50 Most Influential” by Bloomberg Markets magazine. In 2013, he was named “Money Manager of the Year” by Institutional Investor.

When Jeff Gundlach speaks, people listen. Unlike most investment managers, he doesn’t hold back and is willing to tell it like he sees it. Listening to Gundlach is like getting a bucket of cold harsh reality poured on your head.

He was recently interviewed by a Swiss newspaper on what the next recession might look like. Gundlach warns investors to prepare because it will lead to big changes in the market. He argues investors need to reduce risk and own their house free and clear. (in fact, he says anyone with a mortgage should not own stocks.) While there might still be market gains over the near term, when the downturn does come people will be “overwhelmed by problems” with their investments. In particular, he sees big problems with the US corporate bond market.

“This time the liquidity is going to be very challenging in the corporate bond market. The corporate bond market in the United States is rated higher than it deserves to be. Kind of like securitized mortgages were rated way too high before the global financial crisis. Corporate credit is the thing that should be watched for big trouble in the next recession. Morgan Stanley Research put out an analysis about a year ago. By only looking at leverage ratios, over 30% of the investment grade corporate bond market should be rated below investment grade. So with the corporate bond market being vastly bigger than it’s ever been, we’ll see a lot of that overrating exposed, and prices will probably decline a lot once the economy rolls over. Furthermore, central bank policies have forced investors into asset classes that they usually would be a little bit more hesitant to allocate to.”

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Gundlach also sees major problems with the US stock market, arguing it will be the worst performing equity market in the world. Why? Partly because it is currently the strongest.

“The late 1980s saw Japan as invincible with the Nikkei tremendously outperforming every other market to the point where there was incredible overvaluation of Japanese real estate when the recession came in the early 1990s. The Japanese Market was the worst performer. It never made it back to that level. In the advent of the Euro, there was a lot of enthusiasm about the economic prospect of the Euro area, and the stock market in Europe was incredibly strong in 1999, outperforming every other market. When the recession began, it was the worst performing market and never made it back again, broadly speaking. This time US stocks are crushing every other area. It’s due to some fundamentals like the better economy, but also due to tax cuts and share buybacks. In the next recession, corporate bonds will collapse, and buybacks will stop. The dollar has already topped. It may begin falling in earnest during the next downturn and US equities will lose the most. They will probably not make it back to the peak for quite a while. When the US market drops, it will drop a lot.”

The next recession will see deficit spending balloon. The US is already running $trillion+ deficits and this is supposed to be the best economy ever. The next recession could put upward pressure on interest rates, as demand for funding rises. Of course, the Fed will do everything in its power to combat this, but possibly not until after a crisis emerges. The firefighters don’t show up until the house is ablaze.

“Powell said he’s going to use large scale asset purchases to fight the next recession. That’s what he said at his last press conference. He could introduce negative interest rates, but I think Powell understands that the US cannot introduce negative interest rates without the entire global financial system collapsing. Because where’s all that capital going to go? Which markets are big enough? Negative rates are the worst thing that could happen in the US. You can see what negative rates have done to the banking system of Japan and Europe. All you’ve got to do is look at the relative performance of bank stocks. The underperformance of European banks is correlated to the yield of the 10-year German Bund. I don’t know if the politicians understand that negative rates are fatal. It’s fatal to Deutsche Bank and insurance companies in Switzerland.”

So what happens post recession when US public debt levels skyrocket due to massive deficit spending? Suddenly, the problem everyone has ignored could smack the US right in the face, and the US government will look for solutions.

You could create inflation through universal basic income. That would debase everything. Or you could default on Social Security benefits and welfare benefits. These are the options. We’ll do some combination, maybe raise the eligibility age from 65 to 75. I don’t know what’s going to happen, but what we have now is unsustainable. The debt is unsustainable. Interest rates are unsustainable. The wealth inequality gets worse every minute. It’s already beyond the point of sustainability, and when the next downturn comes, there will be a lot of anger and unrest. …the misery is going to be apparent for a considerable fraction of the population. It’s going to be pretty intense, and the response will be money printing. When Ben Bernanke said, we’ll never have deflation because we have the printing press and when he used the word helicopter money, people thought it was some euphemism, some joke. People thought that that could never happen. Now we have candidates running on it. Kamala Harris has a version of it, Cory Booker has a version of it. And for Andrew Yang it’s the centerpiece of his campaign.”

Gundlach is not talking about a garden variety recession. This situation – massive debts, slowing growth, rising wealth inequality – has been building for decades and the world is approaching a point at which seismic shifts will occur.

This situation has taken since 1945 to develop. And it really got going with US-President Ronald Reagan. So I started in this business when the scheme was starting. And we used to think that 8% interest rates were set to last forever, and it was unthinkable that the Fed would buy bonds, inconceivable! And now it’s normal. And free money used to be unthinkable. What people got themselves fooled by was feeling somehow that there’s real stability to societal institutions because they’ve experienced it most of their life. Some still think they’re experiencing it. But they’re not.”

So what does normal look like?

In 1970, there were no credit cards. In 1970, there were no car loans. People saved money and bought things. That was normal. The debt-to-GDP ratio was stable. Economic growth was real. It really happened. In 2018, the dollar growth of nominal GDP was less than the dollar growth of the national debt. That means that there is no growth. We’re having an illusion of growth. It means that we’re issuing IOUs and spending it, and it shows up in the calculations as growth. But spending is not growth.

Real Estate

Toronto Homes: Not Best Investment 2008-2018

I know many people considering real estate as an investment. It is a standard ‘go to’ idea for anyone looking to build wealth.

While you can definitely create wealth with real estate, it certainly isn’t the sure thing many people think. Indeed, real estate investing is high risk (high leverage and high concentration) and a huge pain in the ass (3am clogged toilets, destructive tenants).

To gain perspective, investors need to consider real estate against other investing options.

Toronto real estate is in a bubble. Over the past decade, houses in Toronto have appreciated by over 120%. Many people therefore conclude that a house in Toronto would have been a fantastic – if not the best – investing choice over the past decade.

They are wrong.

The following chart shows 10 year returns for Toronto real estate, stocks, REITs and real estate equities. As you can see, housing price increases lagged.

So how do real estate investors get rich? Leverage. But if you applied the same leverage across the comparison, the relative performance differential would remain.

To be fair, the return for houses was calculated on a price returns basis whereas the other indices are showing total returns. Total returns include the income earned by holding the asset – dividends for stocks and rent for real property. Incorporating rental income would definitely improve the comprison. But would rent have tripled the return to match that of REITs? Probably not. Especially after considering risk, maintenance expenses, taxes and property management costs.

(Note: in an ideal world, I’d incorporate a $ rent assumption to recalculate Toronto real estate returns as a total return. Unfortunately, I don’t have the base data to recompose the returns.)

Despite the wonky comparison, the chart still disproves the incorrect assumption that owning a home was the easy, low risk way to build wealth – even during the biggest real estate bubble in Canadian history.

During the next decade, it’s not reasonable to expect the pace of Toronto real estate returns to continue at the same pace. A more conservative returns estimate would put Toronto real estate at a further disadvantage to other assets.

Moral of the story: do the math, compare against alternatives and factor in all risks before investing in anything.

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Avoid Going Broke Using Grampa’s 7 Tips

Win by not losing.

One of the best ways for the average person with a steady, middle class 9-to-5 job, kids and a mortgage to build wealth and avoid going broke is to not fuck up.

If you want to build and keep wealth, you need to pay attention to the bottom line. That means controlling personal expenses to ensure something’s left at the end of the week.

The average person can build wealth by avoiding massive mistakes that drag them into a spiral of deterioration. Honestly, it’s unfortunate I have to write this because this is the type of advice our grandpa would have taught us. Indeed, they’d probably slap us upside the head for some of the financial choices we make nowadays.

Anyways, here’s a list of things that will seriously fuck up your chance to build wealth. If you want to avoid going broke, stay away from the following:

Gucci taste but H&M income.

Are you trying to keep up with a lifestyle you can’t afford? Perhaps you’re entitled to it? Perhaps you deserve it? Well, you can’t afford it so neither of those are true.

I’m not just talking about clothes here. Vacations, cars, dinners out, bars, weddings and so on. If you’ve got an H&M income you need to be down with H&M. Sorry…no more Gucci for you.

Consumer debt.

Gucci taste requires money. Do you subsidize your income by putting everything on credit?

Everyone knows credit cards charge ridiculous fees so eventually you consolidate that debt into a line of credit. Great, but you’re still in debt for something you’ve probably long forgotten about.

Consumer debt is bad debt. It erodes wealth. Not only are you spending money on things you shouldn’t be, you’re spending money on interest to pay for the loan to buy the things you shouldn’t be. Sounds absurd, doesn’t it? Yet nobody is surprised when they hear a friend is $30, 40, 50k in debt.

Consumer debt. Unless you can pay it off within a month, just don’t.

Payday loans.

Payday loans are pure fucking evil. Once you’re sucked in, you’re trapped forever.

Think about it this way: you’ve borrowed against your next paycheck, which means the next paycheck needs to re-pay the loan. But then you’re left with no more money so you borrow again. And again. To infinity and beyond.

Moreover, the interest rates (sometimes called ‘admin fees’) are astronomical. They make credit cards look like a charity.

Seriously, it’s really difficult to break out of that cycle. Often the only way is to borrow from somewhere with more flexible terms (like mom).

Don’t ever borrow against your next paycheck if you want to avoid going broke.

Marrying the wrong person.

The roads would be much safer if it weren’t for all the bad drivers out there, right? Well, just like car accidents, marriage breakdown is always the other person’s fault, right?

OK, I know we’re more mature than that, but most people lose their rationality in the beginning of a relationship. The first 1-2 years of a relationship are as good as it’s gonna get. But we don’t admit that. Instead, we truly believe we can change people or at least accept their faults.

But what was once cute, becomes insufferable. And what was once “loves the finer things in life” is now “we may be eating cat food in retirement” because you’re lover is flushing cash down the toilet.

Worse yet, maybe your better half now hates your guts and is screwing the gardener, but will still walk away with half your stuff and half your future income. You’d need to clone yourself to come back from that fuckup.

So instead of jumping face-first into marriage, put some rational thought into the massive economic decision you’re about to make. Do your due diligence and know what you’re getting into. Ask some experienced people what they’d do differently. Ask them what red flags they should have seen. It could save you a ton of misery and moola in the long run.

Hard drugs.

If this one isn’t obvious, maybe it’s time for a stay at the Betty Ford Clinic.

Being lazy.

Most people I meet aren’t fundamentally lazy. They may have lazy moments, but they’ll get shit done when they need to.

Most people are able to hold down a job – a source of income. They show up, they take (or fake) interest, they are respectful, they make their boss’s life easier, they get things done. This is all it really takes to have a career and steady income.

Of course, climbing the corporate ladder involves an entire set of additional political skills, but that’s not what I’m talking about. That’s not a requirement.

You can build and maintain a solid source of income throughout life just by giving a consistent 7/10 effort. And that’s all you really need. More money obviously helps you get there faster. In contrast, if you can’t hold down a job you’re never going to build wealth.

Not learning to invest.

People with money constantly get asked to part with their money. As you build wealth you’ll notice if the way people treat you changes. Stay true to your friends and watch out for gold-diggers.

But even the person with average wealth will have people trying to siphon their wealth. Many of these people wear suits and call themselves financial advisors. Some of these people charge exorbitant fees (either explicit or embedded) for the pleasure of investing your money. Over a long time these fees eat up a big chunk of your retirement portfolio.

On the other hand, you might make your own investing decisions. While you could save a big amount on fees, you also could potentially accidentally murder your portfolio.

Watch out for those ‘sure things’. Because there are none. If you want to avoid going broke, assume every investment you hold could go to zero – in other words, only invest in single stock, bond or whatever the amount you’d be willing to lose. Don’t think you’ll be the one to get out at the top. You won’t be.

Also, diversify. Learn how different asset classes can be combined to create a more stable portfolio. This is fundamental to investing.

Finally, look at investing as a long, slow, boring adventure. If you are getting a few percent each year in returns you’re doing well. Don’t chase high returns because you will likely get burned. Most wealthy people didn’t build their wealth in the stock market. They created it elsewhere and invest it to stay ahead of inflation and generate some additional income.

Can’t you picture grampa giving you that kind of advice? Now go ahead and build some wealth. Do it for Gramps!

Real Estate

Is It Worth Buying a Condo to Rent Out in Toronto?

Once in a while I get the urge to buy a condo in Toronto to rent out. Everyone seems to be doing it, right? So it must be a money maker? Right? Wrong! Let’s look at the numbers.

The following is an approximation that leaves out a few minor details for simplicity’s sake. Please feel free to point out things you’d change or add in the comments below.

The Property

Today I’m looking at a 1 bedroom plus den at the luxury condo called “Sky Tower at Eau Du Soleil”, located at 30 Shore Breeze Drive & 2183 Lake Shore Blvd W, Etobicoke.

This is a gorgeous location with AMAZING amenities, including a indoor salt-water pool, hot tub, fitness centre, rooftop deck, media room, meeting room, yoga studio, squash court, rec room, outdoor patio, tennis court, visitor lounge and more. You get the picture. This is luxury living.

Currently, several units are for sale. A 643 square foot 1+1 including parking is listed at $749,000 with a $449 monthly maintenance fee. A couple others are also listed at a similar price.

With a 20% deposit ($149,800) and 25yr mortgage at 2.79%, this property could be yours for $3,221 per month all-in.

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So Would this Make a Good Investment Property?

A similar sized condo on the same floor rents for $2,200 per month. That’s an instant monthly loss of $1,021 per month, or $12,252 per year. Not only that, you’ve suddenly tied up $149,800 in liquid assets and are now $599,200 in debt. Sounds like a shitty place to be. Especially considering you could have been EARNING $7,490 a year from the $149,800 deposit (assuming a reasonable 5% annual return).

But instead of sitting back and watching your portfolio grow, you’re chasing people for rent and fixing toilets at 3am. And basically paying $1,021 a month for the privilege. But some of that monthly all-in payment is going towards building equity in the house, right? Well, because of the monthly negative cash flow you’d only accumulate $27,954‬ in equity over five years. Alternatively, you’d have earned $37,450 on the investment portfolio.

‬To make up the gap you’d have to depend on the condo price to appreciate . Unfortunately, Toronto real estate is in the midst of a massive bubble and it could burst any time. I’d say it’s pretty ballsy to bet your future on the forecast that prices will keep rising.

And that – ladies and gentlemen – is how I eliminate the urge to buy a condo in Toronto to rent out.