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July 12, 2018 | Ride it

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

It took but moments for the big banks to jack rates after the announcement on Wednesday. The first to move were BeeMo, RBC, the green guys and Scotia, followed by the maroon penguins, Desjardins, National and the rest of the gang of over-extended CUs like Vancity, Meridien and Coast Capital. So the prime is now 3.7%.

“The rate hike will raise clients’ cost of borrowing for loans linked to prime, such as variable-rate mortgages and credit lines,” wrote an RBC private bankers to clients.

“The latest monetary policy report, accompanying the central bank’s rate hike, notes that about one-quarter of outstanding mortgages have variable rates, and that clients with these mortgages will feel the impact of higher rates when they renew their mortgages.

The central bank also discusses the impact of rising rates on clients with five-year, fixed-rate mortgages, up for renewal in 2019 and 2020. Using certain assumptions, the report shows that these clients’ mortgage debt-service ratios will be negatively affected by higher rates. Such effects are part of the Bank of Canada’s projections. Says the report: “Estimates of the impact of higher interest rates are in line with interest rate sensitivities embedded in the [central] bank’s macroeconomic projections for household disposable income and consumption.”

Yes, your line of credit cost went up immediately. Interest is calculated on a daily basis, and the monthly charge is now greater (but four in ten people don’t pay it, increasing overall debt – now at a faster clip). Variable-rate mortgages were also upped, but for most people payments remain the same. More of your monthly now goes to interest and less to principal repayment. Yes, they got ya.

How about GIC and savings account rates? Right. Crickets. No change – with none really expected for days or weeks. You have to wonder why anyone looking for some growth (or safety) would commit a lot of money to a high-interest savings account. For example, one of the best deals around (among the banks) is CIBC, which will give you a monumental 1.6% on your cash – so long as you have more than $250,000 on deposit.

Apart from the fact 1.6% is less than inflation, and all of the interest is taxed at your marginal rate (so, you’re losing money), the deposit is not fully insured. The CDIC (Canada Deposit Insurance Corporation) limit for individuals runs out of gas at $100,000, so if the penguins were to expire – highly unlikely, of course – big HISA depositors are SOL.

Compare that with parking cash at your financial advisor’s shop. A money market fund holding guaranteed securities (short-term government bonds and notes) will pay 1.5% or better, and you’re covered with $1,000,000 in insurance under the Canadian Investor Protection Fund (if your guy is a CIPF member. Ask.).

Of course, a swell option in a rising rate environment is to own preferred shares.

These are a hybrid – part cowboy (equity), part accountant (bonds). They represent an ownership position in the company, but are considered fixed income since they’re much more stable than common stock and pay a fixed dividend. These day that’s about 4% and, of course, you can claim the dividend tax credit meaning far less for Justin & Bill than with a HISA. The bonus is that as interest rates increase, so does the value of preferreds – at least the rate reset variety (which dominate the Canadian market).

The best way to own these is through a well-established ETF, which will give you exposure to a basket of preferreds issued by blue chippers like the banks, insurance companies and big utilities. Most of these increased in price yesterday – so in times such as these preferreds can provide (a) protection from rising rates, (b) a nice, steady, guaranteed yield and (c) tax-efficient income, paid in cash every 90 days and (d) the potential of a capital gain. Try that with your bank account or tawdry GIC.

There could be a lot more to come before the central bank pauses for any significant length of time. The estimate is we’re 1.5% away from that point – six more quarter-point moves. That might take two years or longer. But it looks plausible, certainly as the US pursues its more aggressive course. Inevitably – sometimes reluctantly and hurtfully – we follow.

Real estate will lose more altitude. Savers will benefit modestly. Mortgage borrowers will pay a price. Those with lines of credit will feel it most. The rate-tightening cycle is far from over – in fact, we’re not even at the half-way point, if history’s any guide. So you might as well ride it.

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July 12th, 2018

Posted In: The Greater Fool

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