Thursday, October 30, 2014

Dividend income growth... 16 months in review.

If you follow any of my previous posts, you know I am a believer in dividend growth investing.  We've consistently been able to achieve an increase of our portfolio's annual dividend income since we started using this strategy with the lowest annual portfolio dividend income increase of approximately 5%.  We grow our dividend income through dividend reinvestment, new monies added to the pot, and from dividend increases.  This year and a half has been a bit of a special case from past years because we have added NO NEW MONIES to our investment pot.  Therefor the increases over the past 16 months are solely from the pooling of dividends and then reinvesting them, and from dividend increases which have been plentiful this year.   I've also incorporated some covered call writing in our RRSPs to add a little extra cash-flow but those are really small potatoes compared to effect of the reinvestment and increases of the existing dividends.  From July1 2013 to October 30 of 2014 we have increased our dividend income by a compounded rate of 17.5% over those 16 months.. or just over 1% per month.  Our portfolio currently yields about 4.5%, so over the 16 months about 6% of the growth came from reinvestment and the remaining 11.5% is from dividend increases.  This represents an annual dividend growth rate of about 7.5% Not too shabby.

The following chart shows the increase to our annual dividend income for each month, which includes both reinvestment and dividend increases.

Note that every month there was an increase in our total dividend income.  Every month had some form of increase and there were no decreases.  In order to give this chart a bit more meaning, lets assume that July 1st 2013, we made $10000 a year in dividend income.  The monthly increases to that amount would look like this:

... to the point where $10000 in dividend income turns into $11749, 16 months later.

If you've been watching the stock market over any period of time, you know that we always see increases and decreases in stock prices, usually by the second during market hours sometimes with big swings to the upside and the downside.  This watching of the market go up an down can rattle some people as they watch their portfolio value increase or decrease by up to double digit swings within short periods of time.  The above chart is the kind of chart I like.  Our dividend income continues to rise month after month.  Some months we had dividend increases and other months we deployed some of the dividend monies that had built up and bought some more stock.. usually ones that we thought were depressed. on sale, or were due for a sustainable dividend hike in the future.

Tuesday, October 28, 2014

#38 Use good debt wisely, get rid of bad debt completely.

Most people have some form of debt.  Credit card debt, student debt, mortgage debt, car loan, family loans, investment loans, payday loans, rotating lines of credit, and consolidation loans are probably the most common types of debt.  People typically use debt to buy something when they don't have the money for it at that given moment in time.  We as a society don't often save up for things before we buy them, but rather buy them and then pay back the loan over time... that's just the way most people do it these days, particularly younger people just starting out who have no savings to begin with.  The problem with debt is that if taken on for the wrong reasons, or if handled irresponsibly, it can make your life more difficult rather than easier.

But not all debt is bad.  We are quite comfortable taking on large amounts of debt but we only take on what we consider to be "good debt" and that brings us to defining good debt vs bad debt.  We use a fairly simple definition but it has some room for subjectivity.  Good Debt results in a better longer-term fiscal situation for our family as a whole.  Bad Debt results in a worse fiscal situation.

Another way of looking at it would be asking the question:  Does the cost of paying the interest plus the principle make up for it FINANCIALLY in the long run?

Here are my thoughts on what are good types of debt and what are bad.

Credit Card Debt - Bad Debt.  Interest rates are too high and most people use credit cards to buy things that depreciate over time.  If you don't pay your credit card off quickly, the interest will eat up a lot of your money.

Student Debt - Generally Good.  Assuming you are using the the associated education to make more money than you would without the education, then yes Student Debt can be Good.  Once you're done your education, I advise to pay off student debt quickly.  I would however challenge people taking "basket weaving" classes whether those types of diplomas/degrees are worthwhile for the money and interest that they are required to pay back, often for years and years. 

Mortgage Debt - Generally Good Debt.  It allows you to choose where you live and how long you live there by owning property.  Its debatable whether a home is an investment, but the benefit of being in control of where you live and knowing that rent wont be going up every year can help you budget your money more easily.

Family Loans - Generally Bad Debt.  Owing a family member may make sense in some cases, but I'm not a fan of owing family simply because its awkward and usually one side feels they're not getting the treatment they'd like. 

Investment Loans - Good Debt.  If you can make more money on the investment than you are paying for in interest costs, this is definitely good debt in my books.  We regularly use investment loans as part of our investment portfolio.

PayDay Loans - Definitely Bad Debt.  Essentially legal loan sharking. 

Rotating Lines of Credit - Depends on the usage, but I would bet most people are using it for consumer spending.  If you use it for investing purposes, then a Line of Credit can be good debt.

Car Loan - Bad Debt.  New Cars depreciate like crazy the first few years.  Buying a car may be a necessity, but we prefer to pay off car loans very quickly or don't have a loan at all.

Consolidation Loans - Bad Debt.  Usually the lesser of the evils of loans in that consolidation loans usually have lower interest rates than other high interest loans such as credit cards or some car loans. The downside is that this often still consumer debt, just at a different rate.  Pay it off.

Kim and I both had student loans in the 10s of thousands of dollars, which we paid off within a few years once I started working. At present, we have an investment loan and we will be buying a house next Spring which will mean we will have a mortgage again.   Both of these loan-types will help better our financial situation and so we are quite comfortable having them and generally not in a hurry to pay them down.  We have no other types of debt at the moment and we intend to keep it that way.  Whenever we've had other types of debt, we've work very hard to pay it down as soon as possible.  By only having debt that helps our financial situation and doesn't hurt it, it means we don't fuss over our debt as much as other people, and we know that by paying the debt off, we aren't merely pouring our money down the drain, or lining the pockets of others.  We obviously need to make sure that the amount of good debt we have remains at a manageable level that we can be expected to be able to cover with our monthly income.  That is where budgeting comes in.  

Tuesday, June 17, 2014

Buy vs Rent. Why we're okay with renting today.

Conventional Wisdom: "Renting is pouring money down the drain" 

We've rented a number of places, we've owned a few homes and we've speculated on a few property flips.  In two weeks from now we will be back to renting a home rather than owning one.  Now many people may assume that we rent because we don't have the money for the downpayment or that we can't afford the monthly payments that come with owning.  But with us thats not the case.  Since we don't view our home as an asset, we look at home ownership differently than most people.  We generally do not feel the need to own a house.  We do not buy a house believing it is an investment but rather a lifestyle choice.  Sometimes owning makes sense for us and other times it does not.  At present, we have chosen to rent because for our lifestyle, renting makes the most sense for us right now.  It also makes sense for us from an economic sense at this point in time, specifically around month to month costs.  In the future this may change and we fully expect that we will own a home again within the next few years.  But not now.

But what about all that money we're throwing away?  Well, I've done some number crunching on the specific house we are renting and I can tell you we are not coming out poorly by renting.  For other homes it may make sense to buy, but we would calculate these numbers on a case by case basis.  I'm only going to focus on the basic math around the rent/buy choice on a monthly cost basis and not around full life-cycle costs (which would include buying and/selling costs of a Real Estate transaction, capital appreciation, land transfer taxes etc) because many people have psychological reasons to either buy or rent and the metrics also change depending on how long you intend to live somewhere, whether prices go up or not, and how emotionally attached you  are to where yo live... so I will leave that up to you to decide whether those types of reasons and parameters affect you.

The House:
The house we will be renting is a 3 bedroom house in a very desirable neighbourhood within a half hour walk to the heart of downtown Kingston Ontario.  It is about a 5 minute walk to the nearest public school, and within a 20 minute walk to Kim's work.   We really like the area and we are prepared to pay a premium to live in this neighbourhood.  The property taxes on the house are $6750 a year.  Based on the property tax mill rate of about 1% of house value, and surrounding sales which are close to a million dollars, I would estimate the house has a market value of about $675,000 or more, which in Kingston is well above average.  We have agreed to rent this house for $2300 per month plus utilities.

So how much are we flushing down the drain each month by renting this house in this desirable neighbourhood?  Lets do a little comparison math:

To buy this house we would need to have a 5% downpayment which would be about $34000.  The remaining $641,000 would be mortgaged.  Since I would only have 5% equity in the house I would need to get CMHC mortgage insurance.  That would cost 3.15% of the mortgage price which would add an additional $20,000 to the mortgaged amount.  So the fully mortgaged amount would be $661,000.  If I had a larger downpayment set aside,  I could put the money into the house but I am not a fan of putting more money than needed into a downpayment... simply because I like my money to be in liquid form and bricks and mortar real estate is very illiquid.  If I get a 25 year amortized mortgage at the lowest 5 year mortgage rate today of 3%, I can pay a monthly mortgage payment of $3128 per month.   In the first year, about $1500 is going towards paying down the principle and the remaining $1628 is going towards interest payment.  As mentioned above the property taxes for the year are $6750 which translates to $562 per month.  If we bought the house, we'd need to have home insurance or we wouldn't be able to get the mortgage.  For a house of this size and value, I'd estimate it would be about $150 through our current insurance company although I may be able to get a lower rate elsewhere.. but I'll go with what my insurance company would pay.   A rule of thumb for general upkeep (painting, repairs, fix-ups, new shingles etc) of a house is usually around 1% of the value of the property... which in this case would be about $6000 per year or about $500 per month.  This number seems a bit high to me, but there are always things that a house needs that we forget to account for so I am going to leave it at $500 per month even though I think it may be more than what I'd likely pay.   This number is also dependent on the age of the house... older houses sometimes just need more upkeep... and this house is 70+ years old.  So to summarize, the total monthly cost to us after buying this house would be $4340:

During the first few years, about $1628 of the mortgage payment each month goes towards the interest cost, so one could make the argument that each month, the remaining $1500 is going back into your pocket in the form of home equity.  You would get that $1500 back if and when you sell the house assuming the house doesn't go down in value.  So if we subtract the $1500 from the Total cost, we get approximately $2840 that is NOT going to your/our bottom line but to either interest, insurance, property taxes or upkeep costs.  

Now of course there are other monthly costs such as utilities, but I have to pay them each month whether I own or rent so I didn't include those.   Don't forget that if we bought we also would have had to front a $34000 downpayment... so there's also that cost and time that we'd have to consider.  Thats $34000 that isn't in my pocket or investment account.  

So contrast the $4340 (or $2840 if you prefer) with the monthly $2300 rental cost of the exact same home, without having to come up with $34000 downpayment up front and I think we're doing well to rent.  As an aside, if I had a potential $34000 downpayment and wanted rather to invest in Real Estate, I could put it into Killam Properties (KMP on the TSX).  They own and operate apartment buildings and manufactured home communities and the stock currently pays a handsome dividend of about 5.75% per year.  The stock is very liquid and I could sell it at virtually any time which is very different than owning a physical building.  If I bought $34000 in KMP stock, I would collect $1955 annually in dividends or about $162 a month that I could apply to my rent cost if I chose to do so.  If I did apply the $162 monthly dividend to the rent cost, it would lower my rent cost to $2138.

So on a month to month basis, the rent of $2300 comes out better than the $4340 (or $2840) monthly costs involved in buying/owning by about $2040 (or $540) per month.  The winning option, with respect to monthly costs in this comparison is renting, yet it is not so cut and dried in there grander scheme of things.   For our current needs we think we're coming out ahead by keeping the deposit in our pocket and renting this attractive house in this sought after neighbourhood.