What is the best way to save money for a house? This is an interesting question and the old advice might require a new perspective given the reality of the current housing market. Home prices have changed dramatically over the last few years and this is impacting how people are making decisions around home ownership.
Over the last few years we’ve seen the average home price increase faster than our ability to save for a down payment. This can make it difficult to save money for a house and this can push home ownership to later stages in life.
This trend in home ownership has been happening for decades, with home ownership shifting later and later. This may be due to a number of factors but there is a definite trend towards purchasing a home later in life.
In 1981 approximately 55.5% of those who were over age 30 lived in their own home.
In 2016 approximately 50.2% of those who were over age 30 lived in their own home.
With the continued increase in home prices since 2016 it’s reasonable to assume that home ownership will continue to shift into the 30+ age group.
So if purchasing a home is happening later in life, does that change the way we save money for a house? Does that change the way we build up our down payment?
Conventional financial advice would suggest that any savings required in the next 1-5 years should be kept in something safe, like a GIC or a high-interest savings account. Historically this meant that savings for a down payment would go into one of these safe investment vehicles.
But what if someone is starting their career in their early 20’s and isn’t planning to purchase a home until their early 30’s, late-30’s or maybe even their 40’s? Should they still be saving for a down payment in a safe investment like a GIC?
Maybe, or maybe not. In this post we’ll explore a different way to save money for a house. A way that is perhaps more reflective of purchasing a home later in life.
When it comes to retirement planning, one of the biggest fears is often the risk of running out of money. It can be worrisome to think about what could happen if you’re unable to support your expenses in the future.
Sometimes these fears can lead to people choosing a more conservative risk profile, or holding a lot of cash, but taking these defensive measures can often increase the risk of running out of money in the future.
A more conservative asset allocation decreases market risk, the risk we take on when we invest in the stock market. But a conservative asset allocation actually increases other types of risk, like the risk of running out of money, or the risk of being impacted by high inflation rates.
A more conservative asset allocation can actually increase risk in retirement, especially for longer retirement periods. Your typical 30-40 something couple has a very good chance of either one making it to age 100+ in the future. There is a 25% chance that one of them will make it to age 98 and a 10% chance that one of them will make it to age 101!
Without making other changes, like a lower withdrawal rate, more flexibility with spending, part-time income etc, being more conservative can actually lead to a much higher probability of running out of money before age 100.
Let’s explore why this is the case and what you need to consider when creating your retirement plan…
Over the last few years the number of low-cost investment options has exploded in Canada. There are new and easy ways to create a low-cost diversified portfolio that isn’t dragged down by high investment fees.
There were always low-cost, do it yourself options, but they required a fair amount of manual work to make contributions, invest those contributions, and rebalance periodically (and let’s not forget, the stress of keeping yourself on course during a correction or recession).
But now there are new options available. In addition to a low-cost ETF portfolio or a low-cost mutual fund portfolio, there are options like low-cost “all-in-one” ETFs and low-cost robo-advisors.
These new options provide investors with new ways to invest in a low-cost portfolio without necessarily doing all the work themselves.
This has understandably put a lot of pressure on investment advisors who have historically charged extremely high fees on the investment products they sell.
The average investment fee on a mutual fund portfolio in Canada is around 2.3%. This can cause an enormous amount of drag on an investment portfolio. A $1,000,000 investment portfolio would experience a $23,000 annual drag from investment fees! That has a direct impact on how much retirement income you can create from your investment portfolio.
But switching from a high-priced mutual fund portfolio can be hard to do.
Even with the high fees, traditional investment options continue to dominate the investing landscape in Canada, but things are starting to change. For the first time ever, ETFs have outsold mutual funds. More money is flowing into ETFs than into mutual funds (bear in mind that you can also have high-priced ETFs, and low cost mutual funds, so this isn’t necessarily the best indicator).
But… if these low-cost investment options have been around for a while, why the slow change? Why aren’t more people switching?
There are three main risks people face when making a change of this kind, financial risk, emotional risk, and social risk. These risks can be difficult to overcome. Let’s understand each one and why they make breaking up with an investment advisor hard to do…
When we do our own financial planning we’re often too close to our own situation to have an objective perspective. We may focus on the wrong problems… or take a narrow view of the potential solutions… or miss potential issues entirely.
One of the benefits of working with a financial planner is that they provide a second set of eyes for your financial plan. Most people are already on the right path, but there are common issues that may end up working against you. A financial planner can help find these common mistakes that may otherwise go unnoticed.
Financial planning isn’t rocket science, it’s something that can be done on your own. The math itself isn’t terribly difficult, and there are tools available online to help, but one of the major downfalls of the DIY approach is that we can be somewhat oblivious to our own personal biases.
Basically, we’re too close to our own financial situation to be entirely unbiased (This goes for financial planners too!) There are certain financial planning mistakes that we all tend to make if we’re not careful.
These mistakes can lead to potential issues over time. These issues can create more risk, or decrease investment return, or increase taxes, or create a higher risk of running out of money in retirement.
These mistakes are quite common and identifying these potential issues is the first step to creating a stronger financial plan.
What is your risk profile? This is a key question for every investor, yet I suspect it doesn’t get the attention it deserves.
Everyone sees risk differently. Some people don’t worry about risk at all, it doesn’t keep them up at night, it doesn’t cause them any stress. To them, not taking risks seems like a waste of time and resources. They’re risk seekers.
On the other hand, some people are deeply affected by risk. It causes them to worry, to always focus on the negatives, to think about all the things that could go wrong. For them, risk causes stress and sleepless nights. They’re risk averse.
Then there is everyone in-between. People who aren’t risk seekers, but who aren’t risk averse either. They see the benefit of risk, but it makes them a bit uneasy.
Choosing the right risk profile isn’t easy. There are a lot of factors to consider. Going too far one way or their other can cause issues over the long-term. But sometimes it takes some real-world experience before you can safely say what you’re risk profile truly is.
Asset location is the idea that certain assets are more tax efficient when held in certain types of accounts. Different assets classes, and more specifically different types of income, are taxed differently in Canada. Dividends are treated differently than capital gains which are treated differently than interest income. Even certain investments inside “tax free” accounts like the TFSA and RRSP can sometimes lose money to taxes but many people may not realize this.
When you’re just starting out you might hold bonds/fixed income, Canadian equities, US equities, and global equities all in one account (probably the TFSA if you’re just starting out). When you’re just using one account, asset location is less of a concern, but once you start to use a second account (maybe an RRSP), then you may want to ensure you have the right asset in the right place to minimize the drag of taxes.
This becomes especially important after you’ve maximized your TFSA and RRSP and have started to use a non-registered account. Non-registered investments are fully taxable at your marginal tax rate so it’s a good idea to put the most tax efficient investments inside your non-registered account.
Taking advantage of an asset location strategy requires a bit of work. Rather than having the same asset allocation in each account (which is super easy to manage), it means having different assets in each account and managing asset allocation across the entire portfolio.
How much money do you need to have in non-registered assets before asset location adds value? $50,000? $100,000? $500,000? $1,000,000? Let’s take a look…