The majority of reader’s questions I get tend to be situational like: can I retire, do we have enough for me to stay home from work?  So it was a bit of surprise to get a question that was looking purely for my  speculation on a topic:

I would love to read an article about your opinion of a future “generational housing bubble” regarding our aging baby boomers and our current population growth not turning over enough people to replace them.  What happens to house prices when baby boomers start selling their homes and moving into senior friendly housing?

The past 30-40 years of baby boomer house buying has fueled demand and driven up house prices creating an affordability barrier for the next generation, which in turn caused the lax mortgage rules.  They made mortgages cheaper instead of homes, and that only gave prices nowhere to go but up. Now a 3 bedroom home is just barely affordable for the average income family. If the gov’t is going to deflate this bubble  instead of waiting for it to burst then they will have to tightly reign in the growth in house prices that people have come to expect.

Well this question came in right after my post on the new measures to deflate the housing bubble.  So obviously the government has tried to take a bit out of this housing bubble, but not too much.  Why? I’m strongly speculating here it has to do with not pissing off the baby boomers by causing their housing values to crash right after the 2008 stock market correction.  After all the majority of them do vote (compared to other age categories) so the new rules I suspect are walking a fine line of doing something to cool housing, but not too much.  The decision was more of  a political one than a practical one.

So what will happen to the housing market in the long run?  I still think we are doomed to a large house value correction on average (how it plays out in regional markets is impossible for me to guess at).  Why?  It’s the basic balance of supply and demand.  There are too many boomers with non-starter houses and second houses (cabin or investment property) and too few buyers that can afford to pay what they want for those properties.  As they age and want to get rid of those homes (or more likely need to get rid of since they don’t typically have enough saved for retirement) it will put too many houses on the market all at once.  For a while the boomers might try to stick to their guns and ignore the reality but in the end some might start getting a bit desperate to sell and that would trigger a spiral down in prices.

Yet there is a large hole in my speculation.  It assumes that the majority of  boomers just stop working, since there has been a lot of talk about doing some work in retirement you may end up with a more balanced exit of the boomers from the market.  In this case it might avoid a crash in housing prices and we might just end up with a more gentle correction that goes slightly down followed by a leveling off in prices as incomes need to rise up to a more equal footing to house prices.

So that’s my speculation on the market.  Right now I would guess at about 50-50 odds for either case occurring.  The boomers are not typical in a lot of ways so trying to predict their overall movement in a market is gamble at best.  What’s your thoughts on this generational bubble?  Will it correct or not?

Another day and another interesting question from a reader.  This one comes from Andy Royer who wrote:

One question I hope you haven’t answered yet. You (and several others) keep
mentioning it’s not worth it to invest in RRSPs if you will be in the same tax
bracket or higher.

“Now in this income level you will most likely want to avoid RRSP’s as you
likely to be in the same tax bracket in retirement.” — Your March 27, 2007 blog
posting for example.

Has anyone ever done the math on this? I’m thinking the Tax Credit gives you
more money to invest now, plus the money grows tax free into retirement. So even
though you may pay more tax later are you really worse off?

My personal plan is to have 100% of my income when I retire, so this is quite
relevant to me. If you don’t have the numbers I may have to sit down and figure
this out when I get some time.

Damn I hate when I write things that come back to haunt me, but Andy brings up a good point that I shouldn’t be using a blanket statement.  In that post I was referring to the fact you need to be careful about assuming a RRSP is a good thing.  In some cases it isn’t, it depends on the numbers.  For example, a TFSA might make more sense when you are just starting out in investing than an RRSP, since it is more flexible to be used for saving for a house down payment or retirement.

In that specific case I was referring to the fact that depending on the type of investment you make it might make more sense to hold something in a taxable account rather than an RRSP.  For example, a Canadian dividend paying stock if your marginal tax rate on dividends are negative.  This happens for my wife, she gets a tax credit that is greater than the tax owning so hence the negative tax rate. When that happens you are hard pressed to make up that advantage.  If you don’t believe me check out my math here (I just assumed a zero tax rate on the dividends to try and make the results closer.  Also anyone is free to copy the sheet and play around.  Please advise me if you find a formula error).  If on the other hand you were taking about interest income you likely would be correct, an RRSP would likely be better.

So really the answer should be: it depends.  Check out the math for your specific case and see what makes sense to you.  Hope that helps more than it confuses people.

Well after this post I suspected I would have to provide some follow up.  One comment from Jordan summed it up well with:

I’d be really interested in reading an update on your household balance sheet, how you’ve managed to swing this so soon. Maybe give me some tips to get closer to the same goal.

So I’ll try to answer that question.  First off my year end net worth post is coming up next week so I won’t jump into specific numbers on each account, but I’ll provide a brief overview of the items that make up what happened.

First off it’s important to recall I have a low cost lifestyle, so if you added up everything I typically need about $3100 a month to cover my costs, but that includes a larger mortgage payment than required.  My normal mortgage payment would be around $750/month, but I’m currently paying about $1100/month.

Then you need to add up my non-day job income which includes:

• Distribution and dividend income  from TFSA and taxable accounts which is about $2200/year
• I assumed a return off my RRSP’s and other retirement accounts of 4%, so that’s another $2200/year (based on my last Net Worth post)
• My wife’s daycare clears approximately $6000/year in profit
• My school board job pays about $23,400/year
• Total $33,800/year or $2816/month

So from here it is simple math.  If I lowered the mortgage payment to the $750 my income from other sources is greater than my expenses.  Or if my wife takes another kid in the daycare and clears another $350 a month in profit we also get to the same place.

Obviously there are a few holes in this crude analysis.  Income taxes have not been considered on that income so that will lower the monthly amount a bit and it isn’t sustainable since it doesn’t include cash for retirement savings or expenses that are currently covered by my dental/health coverage at my day job.  Yet once the mortgage is paid off in the next three years I’ll firmly be fine without the day job regardless of taxes and other expenses.

So by looking at the numbers you can see the major driver for this is my school board trustee job, which ironically I took without caring about the pay at all.  So it brings for an interesting conclusion: following your passion will sometimes lead you to where you want to go sooner than you thought possible.

For many years I’ve been focusing on the expenses and savings part of the early retirement, but the other side, income, is ultimately what go me to this milestone.  So this leads the path of semi-retirement which I intend to investigate in the New Year a bit more.  Perhaps the issue isn’t that I want to retire early, but rather leave my day job and work on other things instead.

Well welcome back to part II of the family profile.  Well last week it was determined the couple could easily have kids, but what about early retirement?  Could they leave the working world at 55?  Well to crack that nut we need some net worth information.

Assets

Her RRSP (including locked in) = $60,000
His RRSP (including locked in) = $60,000
Her non registered = $190,000
His non registered = $190,000
Her TFSA = $5000
His TFSA = $5000
House (no mortgage) = $400,000 (approx worth)

Debt

Her investment loans = $130,000
His investment loans = $120,000

Net Worth = $660,000

So that looks good given their ages (35 her, 37 him).  Now those investment loans are suppose to be paid off in 20 years, so that would be just in time for retirement (I’m making the assumption that since his is a lower loan that he can pay it off in 18 rather than 20 years).  I’m also assuming they retire when he is 55, so they have 18 years to get things together.

Now I wasn’t given a average rate of return to use, but based on what income is coming in on those loans I’m going to estimate their rate of return at 8%.  Then let’s shave off 2% for inflation and 1% extra to be a buffer.  So I’ll use 5% real return in these calculations.

Rather than try to determine estimate their saving rate I’m going to do this backwards assume zero extra savings for now and define the short fall if there is any.

So let’s grow these accounts forward.  The RRSP’s will both grow to $147,000 in today’s dollars each.  Then the investment loans I’m assuming 4% of the return goes to paying down the loans with 1% left over for growth.  So those would grow to $227,500 each.  The TFSA’s would grow to about $12,300 each.  Which isn’t much so I’m going to just treat those accounts as extra vacation money and not worry about them.  So without adding anything to the accounts they would have $749,000 at age 55.

Other income will be OAS at 65 for $12,400 a year total.  CPP I’m going to assume he gets the average pension of $5777/year and she will get half that at $2888/year at age 65 (I’m assuming she is staying home with no income from post baby onwards).  Therefore they will take in $21,065/year after 65.

Assuming they keep their spending the same as I proposed last week.  The would need about $38,736/year in retirement income.

Now let’s draw down their accounts.  I’m going to assume they shift to a bit more conservative portfolio at 55 and they are only earning 4% real return at that time.  So from 55 to 65 they drawn down $3228/month.  That would leave them with $641,300 at 65.

Then continuing the drawn down at a slower rate since OAS and CPP are now off setting some income requirements.  So now they are taking out $1472/month.  Which of course to those with handy calculators would realize is less than 4% of their remaining $641,300 at 65.  So they won’t run out of money.

So in conclusion, yes they can have kids at once.  Yes, she can stay home with the kids and yes they can retire at 55 if they are willing to stop using the cleaning lady and drop their travel budget down to $6000/year once the car payment is done.

Of course there are so many assumptions in these calculations I could be completely wrong, but from a high level analysis it does look possible.  Also they could down size the house and free up some cash if need be and the TFSA accounts give them a little extra saving for a few bonus trips in retirement.  All in all they look like they will be fine.

Well I’m typically not in the business of offering specific advise to a person’s situation, but when someone recently asked me to have a crack at their numbers I decided I would have a look and try for a change of pace.  I made it known I’m not an expert on this, but will rather be just giving them my thoughts of the situation.  Then much to my amusement I was told they both worked in the financial planning industry.  So they already are experts compared to most people.

The couple has several questions including if they have a baby will they be alright during her maternity leave and afterwords would she have to go back to work (full time, part time or not at all).  The second set of questions was could they retire early at 55?  She is currently 35 and he is 37.

Ok before I even look at dollar number I’m already struck by something.  They are waiting too long to have kids.  After age 35 your odds of medical problems with your kids start increasing dramatically for woman.  So to avoid things from getting worse for odds in a health sense you need to start having a baby RIGHT NOW.  Do not pass go, do not collect $200 go straight to the bedroom and have sex.  We will sort out the money after the fact.  Also people generally assume you can get pregnant at the drop of the hat, which some people can.  While other can not.  You don’t want to find out the hard way it takes you over a year to conceive.  Therefore get busy having lots of sex.

Now with that out of the way, let’s get onto sorting out the money issues.  She makes $70,000/year while his is a bit more variable so I’m suppose to use the lower number of $50,000 to be conservative.

Expenses are currently as follows:

Expenses - Basic (monthly)

Car payment = $500 /month (will be done in April 2010)
Transit pass = $96
Groceries = $300
Toiletries = $100 (includes cleaning products)
Property tax = $280/month
Heat, hydro, water = $200/month
Cell phones, cable, internet = $200/month
Insurance policies (critical illness, health, life) = $200
House and car insurance = $200/month
Parking pass for husband = $100/month
General maintenance for car = $42/month
Gas for car = $100 month

Total = $2318/month or $27,816/yr

Discretionary Expenses (monthly)

Clothing = $150
Travel = $1200
Restaurants = $300
Entertainment = $100
Cleaning lady = $160

Total = $1910/month or $22,920/year

Grand Total = $4428/month or $50,736

Ok obviously they have a serious love of travel (they take a lot of cruises) and for those reading the above carefully would note they also own their own home free and clear.  Instead of the traditional mortgage they pulled off a Smith Maneuver so they just have very large taxable investment accounts and very large investment loans to match.  Yet for today I’m generally ignoring their assets to focus on their first baby related question.

Because of their Smith Maneuver I can’t predict their after tax income.  It’s just too complex for me to even guess at.  So after being assured that they get enough income from their investments to cover the loan interest and pay it down in  20 or so years I’m going to ignore it.  Instead I just plugged in their regular income into a tax calculator and assumed no deductions and got rough estimates of after tax income of $52,800 for her and $39,150 for him.

So during baby’s first year when mom is off, life is fairly good.  Mom would get about $400/week from EI and that with Dad’s income could cover their normal expenses and leave some extra to cover baby related costs.

Yet after that if she wants to stay home full time they are going to have to cut back a bit.  Currently the difference between his income and their expenses is about $11, 500/year or $965/month.  So the obvious solution would be drop the cleaning lady to cover off the baby expenses and then drop the travel budget to zero until the car payment is done.  Then make some or all of the car payment money your basic travel fund.  So then net their spending would be down $1200/month.  That would leave a bit extra wiggle room since I don’t see any retirement savings in the above.  The couple can use their Child Tax Benefit money to fund the kid’s RESP.  Then if the husband has a good year they can bank it up in a travel fund for an extra trip or throw money at their retirement plan.

Now the above doesn’t consider yet the whole early retirement plan or the fact mom might decide she doesn’t want to stay home with the kid all the time.  I know many mothers who like to work part time just to have a bit of their own life that doesn’t involve the kids.  So just because you don’t have to work doesn’t mean you don’t want to work a bit.  Consider part time work or even trying a home based business.  I’ll touch these options a bit more next week when I look at the early retirement question.

So to summarize: yes have kids now, you can afford to stay home if you give up some travel and are willing to make it a bit more of variable expense to match the fluctuations in the husbands income.  Any one else have some ideas for this couple so far?  If so please share in the comments.