The debt to disposable income (DTI) ratio represents the ratio of one’s debt to his after tax income. I want to know who’s daft idea it was to make this number the most widely used and talked about metric to determine our financial risk. It’s rubbish.
“Debt” is a balance sheet item (net worth,) but “income” deals with budgeting (income statement.) Debt is simply a static number, while income requires the element of time in order to exist. One has a set monetary value while the other is a reoccurring event. Comparing the ratio of debt to income is like comparing net worth to spending. Or, for the engineers out there, like comparing a scaler against a vector. The two variables that make up the ratio are loosely correlated at best, but it’s not a very relevant measurement for any practical purpose.
The other problem with this ratio is it’s heavily influenced by monetary policy. 30 years ago the typical mortgage rate was 18%. The cost of carrying a loan was extremely expensive, almost prohibitive. Thus the debt to income ratio was under 80%, quite low. But today, the cost of servicing a mortgage is only around 3%, so more Canadians can easily afford to take on larger mortgages. This increases our overall debt levels which skews the DTI ratio. We consumers will naturally increase our borrowing if the cost of credit is cheaper. But that doesn’t necessarily mean we’re at greater risk of insolvency.
This is why the debt to income ratio isn’t a very reliable metric to use over long periods of time. It’s impractical to compare debt and income to begin with. The added effects of changing interest rates only makes the wonky ratio even less valid.
Statistics Canada recently announced that our average household debt to disposable income ratio hit a record high of 162.6% in the third quarter, which has generated a lot of discussion in the media. But giving so much attention to this insignificant ratio is like rearranging the deck chairs on the Titanic. Don’t we have more important data to study?
Alternatives to the Debt to Income Ratio
I believe a much better metric to measure consumers’ financial situation is the debt to net worth ratio. Debt to net worth (or equity) ratio is what businesses use to determine if they are borrowing too much. They use this ratio to determine debt related goals for themselves. Total-debt-service (TDS) ratio is another helpful way to gauge our debt default risk because it measures how much we pay each month towards debt against how much money we make over the same period. Actually, the Americans often use the TDS ratio, but they refer to it as their “debt to income ratio.” If you’re confused this comment should help clear things up.
But if we adapt to our surroundings we should be able to live the lifestyle we want on a relatively modest income Luckily I live in what is arguably one of the most affordable cities in the world – Vancouver, B.C. Canada. I currently make more than $3,000 a month from my 2 jobs combined, but if we exclude my consumer/investment debt-related expenses for the moment, my total cost of living each month is less than $1,500. Here’s the breakdown.
This budget doesn’t feel restrictive because it’s so darn cheap to live here
I don’t even try to be thrifty. Things are just naturally cheap in Vancouver. As I’ll explain below, there is probably no other major city in Canada or the U.S. where I can buy the same degree of security, freedom, opportunity, and general quality of life as I have today, for just $1,500 a month.
Trying to pay for a roof over our heads in large cities like San Francisco or New York City (where the average rent is over $3,000/month.) can be financially challenging But not in Vancouver (^_^) With interest rate so low my monthly mortgage payment on my 800 sq ft condo is less than $900/month
There are lots of cheap options for renters too. Here’s a one bedroom apartment recently listed. It’s only $875 per month and has a really high Walk Score.
Here’s another 1 bedroom suite I found on craigslist recently for just $675 a month.
I hear 1 bedroom suites in Calgary and Toronto (outside city centers) normally rent between $1,000 to $1,200 a month. Phew (^_^;) Glad I don’t live in those expensive cities
Eating well can be quite costly. But not in Vancouver (^_^) I can usually buy 2 full bags of groceries for about $10 at discount produce markets.
Restaurant food and other prepared dishes are cheap too At Yamato Sushi in downtown for example, you can get a 22 piece assorted sushi combo including soup for just $5.95! How are they still in business?
Food courts and bakeries across Metro Vancouver usually drop their prices a lot before they close for the day Often $4 can buy 2 full take-out boxes of food that can last me a full day lol.
Supermarkets like Loblaws and its franchises (Superstore, t&t, etc) will often mark down their pre-packaged foods in stages starting in the late afternoon. Each hour or so lower priced stickers would be applied.
This is the perfect opportunity for busy people like myself, who may not always have time to cook, to conveniently grab something cheap and easy for dinner
I hope the Canada Revenue Agency doesn’t come after me for writing this post If too many people read this article then our government will never have a balanced budget lol. Since it’s that time of year again the topic I’d like to discuss today is income tax, and how rich people are able to dramatically reduce their taxable incomes because they understand that tax brackets are a moving target, and we all have the ability to manipulate our income tax rates as we see fit
Let’s look at an example below. The following chart shows the income tax rates for B.C. Canada. There are only 6 cells we need to be aware of for the purpose of this article, which I’ve highlighted in yellow.
Let’s say a hypothetical person named Tyler works full time at a retail bank branch and makes $43K a year there. Tyler also bartends a few nights a week. He has a small rental property, and some dividend paying stocks in a margin account. And finally Tyler has a small pasture of alfalfa in the boonies that he operates as a small business and is generating revenue via renting it to cattle ranchers.
Here’s a summary of all his annual incomes.
Bank employment T4: $43K
Bartending T4: $10K
Rental unit: $12K
Dividends T5: $5K
Small business income: $10K
___________________________ Total income = $80K
At first glance it appears Tyler is in the $75,213 to $86,354 income range, which should put him in the 32.50% marginal tax bracket according to the tax chart above. But not so fast. Sometimes we need to take a closer look at a situation before we can make an educated assessment.
The more money we make the higher percentage of our incomes should go to the government right? But if that was true, why do some people who earn six-figures have lower tax rates than most middle class people? The answer is because those particular high-income earners are masters at manipulating their tax brackets! #likeaboss
Tyler believes he can use the same tools as the rich and reduce his taxable income in the eyes of the government. Let’s see how he does this.
Bartending $10K: Tyler contributes $10K to his RRSP to buy new investments. Since contributions are deducted from earned income this action essentially nullifies any income tax he owes from bartending
-Rental unit $12K: Tyler’s insurance, mortgage interest, property taxes, and other expenses for the property work out to $12K a year which he can deduct from his rental income and break even. Who knew rental units that are cash flow negative have positive tax benefits?
-Dividends $5K: Since most of Tyler’s dividend income comes from Eligible Dividends, he can claim the federal dividend tax credit. His final tax payable on his dividend income is only a small amount, which is easily neutralized by Tyler’s investment expense tax credit, since he bought some of his stocks on margin.
-Alfalfa business $10K: Tyler was smart enough to run his alfalfa pasture as a small business because businesses pay expenses first, and then pay taxes on any profit left over. After deducting all his expenses, like home office usage, traveling costs, and even interest charges on a business loan, his company will end the year with only a small profit, which will have an insignificant impact when added to his personal income
So by using some clever financial maneuvers 4 out of his 5 income streams are no longer tax liabilities. Tyler is able to effectively lower his $80K of total income to just $43K of taxable income -which is a huge win because only taxable income is used to calculate how much taxes we actually pay, not gross income.
This effectively drops his marginal rate by TWO entire tax brackets from 32.50% to just 22.70%! #winning
So how much savings does a lower tax bracket translate to? Well by using a tax calculator we discover that at $43K of taxable income, Tyler only pays $6,600in income tax. Which translates into a ridiculously low AVERAGE income tax rate of just 8.25% on the $80,000 gross he makes. Now compare that to Tyler’s boss, a senior manager who works in the same office as Tyler. He also makes $80,000 a year. But since his only income comes from his salary, his taxable income is the entire $80,000 amount, which means his marginal tax bracket STAYS at 32.50% and he has to pay about $17,700 in income tax before RRSP contributions/deductions. Wowzers #bigdifference!
Both Tyler and his boss are making the exact same upper-middle class income, yet look at the difference between the the 2 greennumbers above
Now that’s some SERIOUS tax savings!
Doesn’t seem fair does it In fact some of you readers may be inclined to accuse Tyler of not paying his fair share of taxes But unfortunately life isn’t always fair This is the reality of our tax system. This is how some people can earn over $100K, and still only pay an AVERAGE tax rate of 10% or less.
So we can either adapt to make the tax system work FOR us like Tyler is doing, or we can accept the status quo like Tyler’s boss and complain about how life is unfair, taxes are too high, can’t seem to catch a break, blah blah blah
“Two roads diverged in a wood, and I— I took the one less traveled by, And that has made all the difference.” ~Robert Frost
The good news is we can all be like Tyler and take the less traveled path. Every single one of us has the power to choose how much taxes we pay to some extent The first step is to understand the difference between taxable income and gross income. The next step is to apply that knowledge.
Using tax deferred vehicles, leveraging to buy real estate, owning investments that pay eligible dividends, using effective tax credits, sheltering viable income generating operations in a small business, and diversifying our income streams in general, are all topics I’ve covered on this blog. These are just some of the many ways we can tip the tax scale in our favor (^_-) #SorryCRA
—————————————– Random Useless Fact:
Be careful with super glue. If you accidentally get some on your hands you can remove it with acetone (fingernail polish remover.)
In a recent poll commissioned by the Bank of Montreal, 34% of Canadians say they are planning to fund their retirement by winning the lottery. That has to be the most optimistic retirement plan I’ve ever heard of
Most personal finance experts will probably tell you that buying lottery tickets is a waste of money and isn’t worth your time. And they would be right, if for financial reasons only. After all, the odds of winning the jackpot is something like 1 out of 14 million (O_o)
Most investments I blog about are moderate to aggressive in nature. Some readers may feel neglected because they’re looking for a more conservative (safe) way to invest. Well if you’re one of those people then today’s post is for you
Earlier this week I mailed a letter. When I went to buy a booklet of stamps however I noticed they didn’t have any indication of value on them. Instead of “63¢” I only found the letter “P” in the corner of the stamps. The friendly post office lady, Jackie, kindly explained that these are Permanent Stamps They are always accepted at the current domestic postage price. So if we buy a Permanent Stamp today, we can still use it at any time in the future. No more adding those 1 or 2 cent stamps when the postal rates increase Hallelujah ＼(~o~)／
Why have I not heard of this brilliant investment opportunity before? I must have been living under a rock all this time lol These perma-stamps were first introduced to Canada in 2006. Back then regular stamps sold for 51 cents. Today they sell for 63 cents as I mentioned earlier. That means if you bought perma-stamps 7 years ago, they would be worth 24% more today! [63¢/51¢]
On average that’s a 3% return per year [(63¢/51¢)^(1/7yrs)]