Canadians\u2019 household debt loads may be at record levels, the housing market could well slow or even fall in some hot markets such as Toronto and Vancouver, and economic growth is expected to throttle back next year. But in spite of all that bad news, Toronto-based Bank of Nova Scotia chief economist Warren Jestin declares that the outlook could be a lot worse \u2014 as it was two decades ago, to be precise.
\u201cToday\u2019s situation is much different than the early 1990s when corporate, household and government balance sheets were simultaneously imperiled and monetary policy was much more restrictive,\u201d Jestin argues in a November report entitled Canada\u2019s Balance Sheet & Economic Advantages Mitigate Household Debt Risks. <\/i>
Although household debt is at an all-time high \u2014 the result of rising housing prices and historically low interest rates \u2014 Jestin does not believe this debt will trigger a U.S.-style housing collapse. That\u2019s because, after almost 20 years of federal fiscal restraint and debt deleveraging, Canada is in far better shape now than it was in the early 1990s. In addition to rebuilt government finances, Canada is also benefitting from strong corporate balance sheets and a \u201cworld-class banking sector,\u201d which proved its resilience in the recent global recession.
The Scotiabank economist says that record high debt-to-income ratios are approaching U.S. and British averages, a source of concern, but not of panic.
In addition, relatively stable inflation and interest rates have allowed Canadians to successfully manage greater financial risk. At the same time, rising household debt has been accompanied by rising household wealth; in fact, average household net worth \u201cis still close to record highs,\u201d Jestin concludes.
As a result, households today are more comfortable carrying a higher debt load relative to their annual income flow \u201cin part because they have greater wealth,\u201d the report says.
Perhaps because the Canadian economy has fared better than those of many other developed countries, household borrowing has continued to \u201cramp-up\u201d over the past year and a half. That contrasts with consumers in countries such as the U.S. and Britain, who are cutting spending, trying to reduce their debt and save.
However, Jestin is now seeing some signs that Canadians are starting to curtail their borrow-and-spend habits. Home sales have cooled this year, consumer discretionary spending is slowing, and the personal savings rate is moving up.
That\u2019s a good thing, because the era of ultra-low interest rates is coming to an end, a development that could curtail the financial flexibility of millions of Canadian households.
As a result, Jestin says financial advisors should be thinking of where interest rates are headed when talking to their clients: \u201cPay attention to leverage because the gift of low interest rates is not going to be around forever. These interest rates are not normal, he says. \u201cFor people who have a lot of leverage on board [and are] looking out two to three years, what would happen to their financial flows if the cost of their borrowing was going up by another couple of percentage points?@page_break@\u201cWe have been given the gift of time but taking on more leverage to get to maximum leverage is probably a bad idea,\u201d Jestin says.
Regulatory changes may also reduce the power of your clients to borrow, Jestin cautions. Consumer credit is expected to become more expensive in the wake of coming financial regulations that, over the next five years or so, will require financial services institutions to tighten up their lending standards.
These tougher regulations, which will force large banks and other lenders to keep more capital on hand and give out less risky loans, are expected to make it tougher and more expensive for highly leveraged, less creditworthy households to borrow.
Scotiabank\u2019s prediction of a less leverage-friendly future should play into the strengths of financial advisors who can provide clients with the strategies to get back on track after a period of bingeing on cheap credit.
\u201cI think that sometimes people seek out technical or complicated solutions when sometimes a back-to-basics message is needed,\u201d says Jane Olshewski, manager of financial life planning with Investors Group Inc. <\/b> in Winnipeg. \u201cFundamentally, there are only two things people need to do to create wealth: pay off their debts and save as much as they can for the future.\u201d
Olshewski adds that, for most households, cash management is the highest priority: \u201cHow you manage your cash, how you manage your money, is king. Really, when you think about it, everybody is looking for control.\u201d
So what can financial planners do? \u201cGo in and take a look at how [clients] are spending their money and help them understand how they can manage that going forward,\u201d she says. \u201cThat is a huge value service that financial advisors can provide to people and I think that is what people are looking for.\u201d
One strategy she recommends for advisors is to have clients divide their spending into three buckets labeled \u201cyesterday,\u201d \u201ctoday\u201d and \u201ctomorrow.\u201d Debts and other fixed long-term financial obligations go into the \u201cyesterday\u201d bucket while the \u201ctomorrow\u201d bucket is geared to future expenses such as retirement, children\u2019s education, vacations and planned big-ticket purchases, such as a new car.
Says Olshewski: \u201cThose two buckets take care of the two fundamental things that people need to do: pay off their debt and save for tomorrow.\u201d
The \u201ctoday\u201d bucket is for short-term, variable living expenses such as gas, hobbies and dining out. With this model, \u201cthe only thing that you are really managing, as a person, is the \u2018today\u2019 bucket.\u201d
This \u201cfinancial cash 101\u201d approach that Olshewski preaches is a big part of the message that cash management and budgeting should be easy to understand and prompt changes in behaviour.
The true test of the three-bucket strategy comes when clients find themselves in front of a display of flat-screen televisions and can consider the true cost of buying on credit. \u201cOnce people understand their buckets and they know that they are borrowing from the \u2018today\u2019 money that they use for everyday expenses, or they are going to take something away from the future, then they know the real cost of something,\u201d she explained. \u201cNow they are making informed choices.\u201d\t IE<\/b>
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