Math? Nobody told me there’d be math!
Shut it, italics man. We don’t have time for your shenanigans today.
Rant time. I’m sick of seeing people (including those of us who should damn well know better) consistently justifying buying too much house.
We’ve seen all the same arguments. Moving is expensive. I want my dream home. We’ll grow into it. All that matters is I can easily afford the mortgage. Hey, I need a sex dungeon in my basement.
Okay, maybe not that last one.
Most people can’t afford extra space. It comes down to that. Think about the average home buyer. They take out a fat mortgage which takes them 20 or 25 years to pay. If they do save any money, it’s 10-15% of their income. A lot of them are a few weeks without a paycheque away from being screwed.
Low rates have also pushed our expectations through the roof. People regularly pay 3x or 4x their gross income for property, justifying it by saying “hey, at least I didn’t pay 6x!” It’s the low-tar cigarette argument.
Extra space doesn’t even make economic sense (unless you monetize it, of course). If the average house costs $200 per square foot to put up (which is way too low, btw), a 12×12 spare bedroom costs $28,800 just to build in the first place, never mind furnish, heat, or finance. That spare bedroom that you use five times a year could end up costing $50,000 over the life of a house. It would be way the hell cheaper to foot the bill for your mother-in-law to just stay in a hotel five times a year.
The too much house equation
I’m strictly opposed to people who can’t afford it buying too much house. When I am GOD (and I will be one day, mostly likely on Tuesday), I will forbid it from happening.
How can we determine if someone has too much house? I made up a formula. Don’t worry, Italics Man, there’s hardly any math at all.
It goes like this: if your mortgage is greater than your liquid net worth (which excludes your principal residence), you can’t have too much house. It’s that simple.
The condensed form of the formula is: LNW > Mortgage
I don’t care how much you tell me you’re going to grow into the house. Or that it’s your dream home. Or that you can afford it. The answer is still no if you couldn’t conceivably sell off everything that you own and pay for the place.
(That’s a bad idea, of course, but it does nicely guard against people buying too much house)
People tend to forget that real estate you live in is a pretty crummy investment. You have to spend money each year to maintain it. The government taxes it. You can’t deduct any associated expenses. And it tends to only slightly outperform inflation over time.
And then, people make this investment even worse by buying too much house. It truly boggles the mind.
Buying a house isn’t an investment. It’s nothing more than a big-ass consumer purchase. It’s a big purchase that makes sense in certain markets at certain times, while not making sense other times. Like in Toronto or Vancouver today.
This is the end
We constantly rag on people who buy too many video games or finance vacations, but we cheer people who make a similar mistake with their houses. The fact is the easiest way for the average person with only a small net worth to save more is to cut their fixed expenses, starting with housing.
You might think my too much house formula is too strict. Fine. Loosen it a bit, see if I care. The point is we’re all collectively buying too much house, and it’s killing our ability to save.
Let’s talk a little about investing with Investors Group, which is one of Canada’s largest wealth management companies. It has approximately $130 billion in assets under management, or about what I have hiding in the couch cushions for a rainy day.There are some 5,000 Investors Group
advisors sales people spread out across Canada.
The investing process starts with a financial plan, which goes over all parts of your finances from your mortgage to your insurance to your investments. The client is told the process is so their needs can be fulfilled in the best way possible. This is a lie. It’s a sales process, nothing more.
Recently, Investors Group has been in the news for a couple of main reasons. The first is the company’s opposition to Canada’s new mutual fund disclosure rules. Before, disclosure of fees in a percentage form was fine. These days, fees must be disclosed as an actual dollar figure.
The company also made headlines for announcing it was doing away with deferred sales charges. This meant investors who get out of Investors Group mutual funds before a certain time period (usually 5-7 years) don’t have to pay huge penalties any longer. Such generosity! The company also cut fees on many of its in-house mutual funds.
Investors Group is actually really excited about this. Veteran investors know you should never invest with Investors Group, but there are literally millions of Canadians who don’t know any better. This post is for you.
An apples to apples comparison
Let’s take a closer look at one of Investors Group’s largest funds to see just how serious the company is about cutting fees.
The largest IG mutual fund is the Investors Dividend Fund. Because this company likes making things complicated, there are about a million different slightly different iterations of the same damn fund.
After a little clicking around, I’ve come to the conclusion that you’d be most likely to be sold is the Series B. It no longer has a deferred sales charge and the prospectus breaks down what the advisor gets paid in great detail.
The fund has 88% of its assets in Canadian equities, with the remainder in bonds and cash. It has a total of 125 different positions, but 57% of assets are in the top 10 stocks. Top positions include:
- Royal Bank (8.4%)
- Scotiabank (8.1%)
- TransCanada (6.0%)
- CIBC (5.7%)
- Power Financial (5.6%)
- Bank of Montreal (5.5%)
The management fee? It was 2.48%, but the company SLASHED it, proving once and for all Investors Group cares about its investors. The new fee? It’s 2.38%.
OMG YOU GUYS I’D BETTER GET THE FAINTING COUCH.
In 2016, the fund paid a distribution of $0.77, giving it a yield of just over 3%.
Now let’s compare it to the largest Canadian dividend ETF, which is the iShares Dividend Select ETF (TSX:XDV). It has 100% of assets invested in Canadian stocks. The largest positions include:
- CIBC (8.2%)
- Agrium (7.6%)
- Royal Bank (5.8%)
- Bank of Montreal (5.7%)
- Scotiabank (5.0%)
59% of XDV’s assets are invested in the financial sector. The Investors Dividend Fund has 57% of its assets invested in financials. There’s a lot in common between the two funds, not just that. They’re not identical, but damn close.
XDV has a trailing yield of 3.7%, a full 20% higher than the Investors Dividend Fund.
Where XDV really shines is its management fee. Investors are paying 0.55% annually to own XDV. That’s a full 78% less than owning an equivalent product with Investors Group. (And 0.55% is a little expensive in the ETF world. You can find ETFs for less than 0.10%).
We could look at other fund categories, but it would yield similar results. If you invest with Investors Group, be prepared to pay a hell of a lot more for something that can easily be replicated with a cheaper ETF.
Just don’t invest with Investors Group
Investors Group does a great job of presenting themselves in a professional manner and the average advisor will instill a sense of confidence into a newbie investor.
But ultimately, that comes at a huge cost to the client. A 2% difference in fees will make a huge difference in your retirement.
The bottom line? You’re better off to choose a simple ETF portfolio on your own. You’ll save tens of thousands of dollars in fees (if not more!) if you don’t invest with Investors Group.
Back in December, 2014, a bunch of Canadian finance bloggers started to rag on the concept of borrowing to invest. Investing was already risky, they argued. Why add more risk to the equation?
I took a different stance. As long as an investor wasn’t stupid about the whole exercise, borrowing to invest could end up being a profitable endeavor. So I set up a simple portfolio that invested $75,000 into a bunch of dividend-paying stocks. Half of the amount came from hypothetical savings; the other half was borrowed at Prime.
When we last left the portfolio, it was handily beating the TSX Composite. How’s it doing today?
Not bad, kids. Not bad.
A couple of notes about the spreadsheet before I talk about the performance. The total dividends at the end there are off by a few bucks because I originally had Bombardier in the portfolio. I replaced it with Manitoba Telecom, which will now be replaced again since it was acquired by BCE.
You’ll also notice that the amount invested has gone down to $69,826. This is because I’ve had to replace three companies that cut their dividends (Bombardier, Cenovus, and TransAlta) which all went down in value. This explains the lower cost base on the spreadsheet, but in reality the portfolio is still based on $75,000 invested.
Remember, the portfolio was $37,500 of our own money and $37,500 in borrowed cash. Interest costs so far come to $2,318.49, which assume the person borrowing didn’t pay down a nickel of debt. Logic would dictate someone doing this would be using their dividends to pay off the debt.
Remember, any interest charged would be tax deductible. If you were in the 25% tax bracket, borrowing to invest would only have costed you $1,738.86. Plus the tax on the dividends, naturally.
So, did I beat the market?
We’ll use the iShares TSX Composite ETF (TSX:XIC) as a market proxy. It’s not perfect, especially considering a good 20% of my portfolio is invested in U.S. stocks. But it’s a reasonable substitution.
In total, our borrow to invest portfolio is worth $94208.42. We’ll ignore interest costs for this part. That’s a total return of 25.6% in just under 2.5 years.
On December 5th, 2014, XIC shares traded at $22.97 each. They currently trade hands at $24.81. Investors received total dividends of $1.9665 per share in that time. We’ll round that up to $1.97 per share because I’m feeling generous. That’s a total return of 16.59%.
To look at it another way, our portfolio made $19,208.42 in total profits, before taxes. We only invested $35,000 of our own money. That’s a return on equity of 54.88% in just 2.5 years.
This portfolio is on the right track. Excellent.
We only have to punt one stock this time around, which is Manitoba Telecom. Unlike the last three changes, this one came with a happy ending. It was bought for just over $24 per share. It was then acquired by BCE for $40 a share. That gives us $4,800 to invest in something new.
I’m going to stick with the utility theme and pick up Altagas Ltd. (TSX:ALA). Shares trade at a very reasonable price-to-FFO ratio and investors aren’t entirely in love with its decision to acquire Washington-based WGL Holdings. It’s not quite at a 52-week low, but it’s close. It seems like a decent time to buy.
Oh, and shares yield 6.81%. Which will add $327.60 to our annual income total.
Related: How $18,000 invested in Altagas will ensure you’ll never pay another gas bill again
The transaction will be to spend $4,809 of the fund’s cash on 156 Altagas shares which trade for $30.83 each.
Note: if you’re interested in Altagas, the subscription receipts trade at a discount to the common shares. They’re essentially common shares in disguise, as this post explains.
Let’s wrap it up
Borrowing to invest gets a bad rap because some people are really bad at it. I’ve gotten emails from people who are so confident about some undervalued stock they’re willing to borrow money just to put into it. That’s dumb.
You have a much better chance of doing well if you stick to stocks that pay generous dividends, are a little boring, and only use a reasonable amount of leverage. If I had this portfolio personally, I would feel confident to continue holding. Even if stocks go down some, I don’t have much risk here. Meanwhile, it’s going to spin out about $3,000 a year in pretty damn dependable income.
Each year, I ask LITERALLY HUNDREDS of your favorite finance blogs (and Financial Uproar, which we can all agree sucks now) to participate in a stock picking contest. I do this same ol’ preamble even though the contest is almost old enough to drink and y’all clearly know what the deal is.
Anyhoo, for the two of you who don’t know the rules, here’s how it works. Each participant chooses four stocks, ETFs, preferred shares, or whatever else. As long as it’s not too weird, I’m okay with it. The total return of each (including dividends) is then divided by four to get a average return. Any inter-listed stocks automatically default to the Toronto Stock Exchange listing and if your stock gets acquired during the year, you’re locked into that return.
Enough about the rules. Let’s get to the returns. We’ll start with the worst and work our way up.
The returns, yo
22. Financial Uproar
|Hudson’s Bay (TSX:HBC)
|HMG/Courtland Properties (NYSE:HMG)
|Dundee Corporation (TSX:DC.A)
I keep telling you guys that Financial Uproar guy sucks. Why won’t anyone listen to me?
|Knight Therapeutics (TSX:GUD)
|Hudson’s Bay (TSX:HBC)
|Precision Drilling (TSX:PD)
|Manulife Financial (TSX:MFC)
Doug was last year’s champion. Oh, how the mighty have fallen. This happens every year, btw, much to my delight.
20. Asset-Based Life
|First Solar (NASDAQ:FSLR)
|Deutsche Bank (NYSE:DB)
|Egypt ETF (NYSE:EGPT)
These returns aren’t 100% accurate since Deutsche Bank gave investors some rights when it did a big equity raise back in March. But since Paul’s results were pretty crappy I didn’t bother including them.
19. Marty Guthrie
|Coffee ETF (NYSE:JO)
|Natural Gas ETF (NYSE:UNG)
Marty Guthrie isn’t his real name, obviously, but I still enjoyed his coffee and natural gas ETF picks. Too bad they didn’t do better.
18. Don’t Quit Your Day Job
|Bed Bath & Beyond (NASDAQ:BBBY)
|Urban Outfitters (NASDAQ:URBN)
|Spirit Airlines (NASDAQ:SAVE)
|Air Lease Corp (NYSE:AL)
I enjoyed the contrarian retail and airline picks. Remember, Buffett hadn’t yet invested in the sector when these picks were made. Does PK know Warren Buffett? ALL SIGNS POINT TO YES.
My Pennies My Thoughts Janine Rogan
|Uranium Energy Corp (TSX:UEC)
|Prairie Sky Royalty (TSX:PSK)
|Raytheon Corp (NYSE:RTN)
Janine did well going with medical marijuana last year, so it makes sense for her to go back to that well. It did not work out as well as hoped, but pot stocks are plenty volatile. It could easily come back.
16. Canadian Value Investing
|Stella Jones (TSX:SJ)
|Brookfield Asset Management (TSX:BAM.A)
|Diversified Royalty Corp (TSX:DIV)
|Input Capital (TSXV:INP)
Man, these so-called value investors suck, huh?
|Pizza Pizza (TSX:PZA)
|Alaris Royalty (TSX:AD)
|Dreyfus High Yield Strategies Fund (NYSE:DHF)
|American Hotel REIT (TSX:HOT.UN)
My Own Advisor called and he wants his lame picks back.
14. Freedom 35 Blog
|Royal Bank (TSX:RY)
|Fairfax Financial (TSX:FFH)
|High Liner Foods (TSX:HLF)
Another lame quarter. I demand better entertainment.
13. My Own Advisor
|Algonquin Power (TSX:AQN)
|Suncor Energy (TSX:SU)
|General Electric (NYSE:GE)
|Wells Fargo (NYSE:WFC)
It’s fun when punchlines write themselves.
12. Boomer and Echo
|First Solar (NASDAQ:FSLR)
|Canadian Solar (NASDAQ:CSIQ)
|Exxon Mobil (NYSE:XOM)
I’m at least 60% convinced Boomer and Echo throws this contest on purpose by jumping on trends right as investors stop caring. We’ll see if his bet on renewables works out this year or not.
11. Holy Potato
|Genworth MI Canada (TSX:MIC)
|Equitable Bank (TSX:EQB)
|Home Capital Group (TSX:HCG)
Holy Potato’s bet on the Canadian housing market isn’t working out so badly.
10. Vanessa’s Money
|Russia ETF (NYSE:RSX)
|Southwest Airlines (NYSE:LUV)
|Sandridge Mississippian Trust (TSX:SDR)
My wife is beating me. If y’all need me I’ll be forcing her to make me nine dinners a night.
Time for the top nine
|Gilead Sciences (NASDAQ:GILD)
|Norvo Nordisk (NYSE:NVO)
|Domino’s Pizza (NYSE:DPZ)
Good for Mr. Lust, improving on his lackluster performance last year.
8. JT McGee
|Crossroads Capital (NASDAQ:XRDC)
|Interactive Brokers (NASDAQ:IBKR)
|Oaktree Capital (NYSE:OAK)
|Vanguard Short-Term Bond ETF
I took a look at Crossroads Capital a few months ago, but didn’t pull the trigger. That’s looking to be a mistake.
7. Dividend Growth Investor
|Russia ETF (NYSE:RSX)
|Turkey ETF (NYSE:TUR)
|Poland ETF (NYSE:PLND)
|Italy ETF (NYSE:EWI)
I love how this contest brings out people’s innovative side. I guarantee DGI doesn’t own any of these in real life.
6. Ian Bezek
|Brown Foreman (NYSE:BF.B)
|Vina Concha y Toro (NYSE:VCO)
|Formento Economico Mexicano SAB (NYSE:FMX)
Ian’s all booze portfolio is doing pretty well, probably because everyone who didn’t vote Trump are drowning their sorrows as we speak. NO YOU’RE DRUNJ.
5. Blog reader Jeff
|Prometic Life Sciences (TSX:PLI)
|New Residential (NYSE:NRZ)
|LGI Homes (NYSE:LGIH)
All four results were positive. Nice work, Jeff.
4. Financial Canadian
|Brookfield A.M. (TSX:BAM.A)
Financial Canadian has seemingly abandoned his blog, which is a shame. I thought he was one of the more promising new voices in the Canadian blog world.
|Exxon Mobil (NYSE:XOM)
|Bank of America (NYSE:BAC)
|The GEO Group (NYSE:GEO)
I always enjoy it when a documented index investor does well in contests like this one. JOIN THE DARK SIDE MY FRIEND.
|Canopy Growth (TSX:WEED)
Another dividend growth investor who has shrugged off an obviously underperforming strategy for something much better. COME AT ME DIVIDEND GUYS I’LL FIGHT EVERY LAST ONE OF YOU.
1. Roadmap 2 Retirement
|Silver Wheaton (TSX:SLW)
|Ivanhoe Mining (TSX:IVN)
|Junior Gold ETF (NYSE:GDXJ)
|Brazil ETF (NYSE:EWZ)
And a dividend growth guy leads the contest by picking some no-name commodity stock. This is what makes this contest fun.
Joel writes in with an interesting question.
I’ve noticed you’re not a fan of Home Capital Group (TSX:HCG) and from your comments it makes sense to me. On the other hand though, you’ve written about First National Financial (TSX:FN) and their juicy yield. Any reason why you like FN over HCG?
Good question Joel. Unlike all those other questions I get, which are pure dog crap.
Who are you?
What are you doing here?
Why are you taking off your pants?
I DON’T HAVE TIME FOR ANY OF THOSE BAD QUESTIONS, TAYLOR SWIFT. WHY CAN’T YOU JUST SHUT UP AND ACCEPT MY CREEPY STALKING?
First National and Home Capital have a lot in common. They both heavily securitize their mortgages, which means they package them together and sell them to investors. The difference is one packages up (mostly) CMHC insured loans, while the other packages up some CMHC-backed loans and some non-CMHC loans.
Home Capital has just under $26 billion worth of loans outstanding. Here’s how they break down:
Now the way the mortgage market works is Home Capital has traditionally been able to buy bulk mortgage insurance on at least some of its uninsured loans (I explained more about the bulk insurance practice here). But certainly not all of these loans are protected by insurance. There’s also close to $1 billion in credit card loans, lines of credit, and “other consumer retail loans.”
In other words, I’m not a huge fan of the portfolio. There’s too much crap I think gets impaired in a big way when the Toronto housing bubble pops.
Compare that to First National. This is from March, 2016 but is still accurate. Note the last line:
About 80% of First National’s mortgages are backed by a mortgage default insurer. The next 15% are conventional mortgages with more than 20% down. These aren’t much of a risk because First National has focused on AAA customers. That leaves us with just 5% of the portfolio in multi-unit, commercial loans or bridge financing.
Basically, I like First National’s portfolio much more than Home Capital’s. First National deals with prime borrowers. Home Capital doesn’t.
The mortgage servicing business
Both Home Capital and First National heavily securitize their mortgages. The loan is sold off to whoever while the company gets paid to service it. The servicing business is fantastic.
In 2016, First National did $1.05 billion in revenue and made $196 million after tax. This gives it post-tax margins of just under 20%. That is a succulent business.
First National also makes a little money when it sells the loans to investors and also makes money doing bridge loans.
Growth in the broker market
I also like First National as a way to play growth in the mortgage broker market.
The internet has democratized the mortgage process. All it takes is four seconds on Google to see if you’ve gotten a good rate or not. People with good credit will insist on getting the lowest rates possible.
This is good for the mortgage broker market. They’re done a decent job marketing themselves as the low rate leaders. First National is one of the biggest mortgage broker lenders with consistently low rates. It’ll benefit as this trend continues.
I think First National is a somewhat decent value stock, although I don’t own any myself. It trades at less than 9x trailing earnings; it’s obvious the market thinks earnings go down next year, most likely thanks to the new mortgage rules making it tougher to qualify.
Even if earnings do fall, I still think the dividend is relatively safe. The annual payout is $1.95 per share while the company made $3.28 in 2016. That represents a 7% yield.
Disclosure: No position in any stock listed and no plans to buy, either.