Wealth Inequality in Canada

WE NOW LIVE IN A WOLRD OF HAVES AND HAVE NOTS

  • Canada is in the bottom quartile of peer countries in terms of wealth disparity.

 

WE ARE ENTERING A NEW ERA OF MASSIVE INEQUALITY

  • Wealth inequality in Canada has increased over the past 20 years.
  • Each year the Canadian middle-class loses its’ share of total income while wealthier income groups increase its’ share.

 

THE 3 BIGGEST COSTS FOR CANADIANS: 1) TAXES, 2) HOUSING AND 3) LABOUR

 

THE AVERAGE MIDDLE-CLASS CANADIAN PAYS 27% INCOME TAX

THE WEALTHY PAY PAY ON AVERAGE 15% INCOME TAX

 

THE MIDDLE-CLASS IS OBSESSED WITH CUTTING COSTS BUT THE TRUTH IS THAT ONLY THREE MATTER: 1) TAXES 2) HOUSING AND 3) LABOUR

THE ONLY WAY TO ESCAPE BEING A HAVE NOT IS TO REDUCE THE ONLY THREE COSTS THAT MATTER.

THE MIDDLE-CLASS SHRINKS BECAUSE IT HAS NO PRIORITIES AND WASTES ATTENTION (DECISION FATIGUE) ON DECISIONS THAT MAKE LESS THAN A 10% CHANGE IN THEIR TOTAL INCOME.

Priorities

  1. Sell something worth buying, with a story worth telling
  2. Target it for small groups of people (you can not compete with Coca-Cola)
  3. Tell a story (like above) that matches the delight of those small groups
  4. Promote the word
  5. Produce at an elite level, in terms of both quality and speed to build up the brand (personal and business) and inspire confidence and trust.
  6. Plot the worst possible outcome and reverse engineer the opposite outcome.
  7. Get paid by project but pay others by the hour

Qualitative > Quantitative

$3 million earned through investments (real estate, stock, crypto) will never have the same value as $3 million earned through the diligent execution of your craft because of the uncertainty in the former.  Therefore, the only investment that matters is the money you spend into turning your craft into a business.

 

 

 

 

 

 

 

 

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4 Focuses to make $200+/hour after-tax

Even without fast food or a salon, you can still make $200+/hour AFTER-TAX as a middleman.

What do you sell?

You either sell software (including SaaS), equipment (industrial/medical/data center), houses, vehicles, or something scalable online.

After processing over $2.8 billion in transactions over 10 years, four definitive conclusions is that you need to focus 1) your inventory and 2) your market while optimizing 3) alternatives for your customers and 4) your outsourcing.

 

  1. INVENTORY MANAGEMENT: LESS VARIETY MORE FOCUS

Marginal cost bisects average cost at the minima of the average cost.  If you can reduce inventory you will improve your profit by maximizing your output variables.  Inventory turns, is a measure of how many times inventory turns over in a year. The higher the number of inventory turns-or the lower the inventory days–the tighter your
management of inventory and the better your cash position. As long as you have enough inventory on hand to meet customer demands, the more efficient you can be.

Inventory is “frozen cash” the faster you can get it out of the door, the better off you will be. The longer you keep inventory, the more money you lose in opportunity cost. Low inventories will also mean you can afford to sell your product at comparatively low prices. You would be able to sell your product cheaper because you would be able to sell them more quickly.

Everything in life operates on first and second order derivatives. The second order derivative shows that with each added different item in your inventory, the curve in relation to the cost will get steeper as your costs increase but not pro rata with the different items you add. Each different item/product line takes time and effort to sell (the most expensive things), so trying to sell more different items is like trying to fill many pools with 1 garden hose. Its easier to fill 1 pool rather than 2. The solution is to sell less variety but to make more money off of each product line. Consequently rather than spending $100,000 on X different categories of inventory, you can spend the same money on half the variety.

2. ONLY 2 MARKETS: WOMEN AND RICH PEOPLE

  1. Women
  2. Rich people (people who earn over $137,790 per year in Edmonton) – they control 70% of Alberta’s wealth.

What about men who earn less than $137,790 per year in Edmonton? They simply don’t count – their women control their money – if you’re not selling houses over $500,000 or vehicles over $50,000 then sell what women want.

It’s important to choose your market and your customer. You have to know what the ideal customer wants. Everyone can get want they need, but you will earn more if you can give the customer what they want. When someone wants something they
will pay higher margins compared to when they need something.

3. GIVE YOUR CUSTOMERS ALTERNATIVES 

Not having any reasonably similar alternatives will mean you lose customers.

Brand your company with a compelling and focused mission that leverages your combined special skills. People get rich by adding value to other people’s lives, rather than just acting as a middleman/retailer.

The path to success is not as clear as the path to failure. So by doing the opposite of 90% of your competitors, it will ensure you will succeed. There is always a choice between status and money. Most people choose status and have more variety rather than being content with a smaller presence and more money.

4. OUTSOURCE WHEN APPROPRIATE

Now that you make over $200/hour AFTER-TAX (calculated by taking your after-tax income and dividing into the hours you work. ) you know should enforce it. Like Naval Ravikant iterates in his famous tweet storm, “If fixing a problem will save less than your hourly rate, ignore it.  If outsourcing a task will cost less than your hourly rate, outsource it.”

If your problem is business related than you can use your pre-tax hourly rate since business expenses are paid with pre-tax dollars, while residential repairs and maintenance are paid for with after-tax dollars.

  1. Build scalable brand leveraging algorithms and/or employees.
  2. Invest in real estate

How much taxes should I expect to pay?

  1. Remit the net of the GST you collect on your invoices less the GST you pay on purchases every quarter (or if you are eligible and it works out for you remit 3.6% of your total invoices every quarter in accordance to the quick method accounting.
  2. Prepare to pay 12% corporate tax on your net income.
  3. For personal taxes, the rate changes depending on how much money you transfer to your personal account.  Below, you’ll find the rates listed beside the amount of money transferred to your personal account within 1 fiscal year:
  • 3% on the first $30,000 of money you transfer out
  • 14% on the next $11,000 your transfer out on top of the $30,000
  • 20%  on the next $9,000 you transfer out on top of the $41,000
So you if you take out 30k in the year it costs you $872 in taxes, $41k costs you $2450 and $50k costs you $4266.  Try not to take out more than $50k out in a single year per spouse but email us if you are at this stage and we will send you some analysis.
  1. You can optimize your 2 biggest expenses: taxes and housing by balancing your draws from your corporation
  2. Once you have a business you love (1st) and a home that you love (2nd since your business determines where you’ll live),
  3. 3rd you prioritize health and fun. Assuming you have a spouse you can pay yourselves a combined $100,000 = $250/day in after-tax spending.  With a mortgage out of the way, $50k per year on basic living expenses and $50k per year on extras everything is possible without having to write-off corporate vehicles
  4. You can expect to pay an overall 16% on $200K of profit and less with each additional dollar of profit. Here is the math:
Corporate Income $300,000.00 $200,000.00
Small business tax @ 12% -$36,000.00 -$24,000.00
Net cash retained after-tax $264,000.00 $176,000.00
Dividends payable $100,000.00 $100,000.00
Net personal tax on dividend -$8,532.00 -$8,532.00
Net cash to Shareholders $91,468.00 $91,468.00
The total taxes -$44,532.00 -$32,532.00
Net cash to Shareholders $91,468.00 $91,468.00
% of combined taxes of net cash 48.69% 35.57%
% of combined taxes of earnings 14.84% 16.27%
Corporate Income $300,000.00 $200,000.00
Wages -$100,000.00 -$100,000.00
Co. portion CPP -$4,603.50 -$4,603.50
Income before taxes $195,396.50 $95,396.50
Small business tax @ 12% -$23,447.58 -$11,447.58
Net corporate cash retained after-tax $171,948.92 $83,948.92
Personal T4s $100,000.00 $100,000.00
Income Tax -$22,542.00 -$22,542.00
CPP -$4,603.50 -$4,603.50
Net cash to Individual $72,854.50 $72,854.50
The total taxes not including CPP -$45,989.58 -$33,989.58
Net cash to Individual $72,854.50 $72,854.50
% of combined taxes of net cash 63.13% 46.65%
% of combined taxes of earnings 15.33% 16.99%

Rather than staying upset, let’s keep things in perspective and even without vehicle write-offs, we still have it better:

$50,000 has $6,857.50 cash advantage to being earned as a T5 vs T4 (viewing CPP as a tax)
Personal T4 $50,000.00
Income Tax -$11,271.00
CPP ($2301.75 each paid by employee and company) -$4605.50
Net to employee $34,125.00
Corporate Income $50,000.00
Small business tax @ 12% -$6,000.00
Net cash retained after-tax $44,000.00
Dividends payable $44,000.00
Net personal tax on dividend -$3,017.00
Net cash to shareholder $40,983.00

The more you personally pay yourself the bigger the advantage of earning dividends rather than a salary (up to a point). As with all convex mathematical functions, there is only one minimal value that describes the combined taxes in terms of its variables. Our job is to find the global minimum of this function, that is, we find the point such that f(x ) < f(x) for all in the domain of the function.

THUT anticipates changes rather than reacts to them. Optimising combined corporate + personal taxes depends sensitively on draws, income, and dividend-salary mix.

 

Math to Escape the Middle Class

Being part of a certain profession, or earning a certain amount of money does not ensure your exit from the middle-class.  Most people are stuck there because of math.

We focus on the only 3 sources of negative cash flow that matter: taxes, housing and in the case of a scalable business – payroll.  Even the highest earners stay middle-class if they don’t focus on taxes and housing.

Taxes: Everything you pay for really costs you 1.5x-1.8x more since you would be paying for it with after-tax dollars rather than pre-tax dollars. The only expenditures exempt from this rule are business assets and expenditures bought inside a corporation.

Housing: In combination with the taxes above, depending on your tax bracket, your mortgage and your interest rate, a $1 million house will cost you at least $1.5 million (no mortgage and extremely low level of living requirements) and as much as $4 million of gross earnings.

Now Here’s the Math

Regression To The Mean & Bimodal Extremes:  How is that so many high-earners are trapped into the middle-class mediocrity of trading their limited time for money?  In any group, people of high-value/high net worth/high IQ are dragged down by people of lower-value/lower net worth/lower IQ due to osmosis.  If you take advice tailored to the middle-class, by a middle-class advisor, you should not be surprised if you end up middle-class. You need to find someone who is living a life that you want and take guidance from there.  So in short, ignore anything average, and advice from/for average people are to be avoided at all costs. The solution is bimodal approaches from the extremes.  90% safe investments + 10% high-risk investments vs. a mediocre portfolio with limited upside and a possible unlimited downside.  Or mediocre jogging vs. extreme high-intensity training. Other bimodal strategies with exponential benefits: intermittent fasting. The framework to pursue bimodal extremes involves ranking your options in descending order of optionality and open-endedness of pay-offs.

Dunbar’s Number & Via Negativa: The solution to this is to be mindful of the upper limit to how many interpersonal relationships your brain can process (150).  I can never have more than 150 contacts (this does not apply to mass-market businesses, but something so sensitive as advisory to HNWIs can never be mass-market). Most problems are better addressed with subtraction (Via Negativa – Nassim Taleb) To keep negative osmosis from happening in my life, I removed the bottom 50% of people from my life and doubled-down my time on the top 50%. I repeated this process many times until I was down from 1000+ to 150 contacts.  Everyone in my life is either moving up or moving out of my life.  This eliminates the negative osmosis that would otherwise cloud my thoughts with middle-class thinking.

Chaos Theory Feedback Loops: Its nearly impossible to remain middle-class if you focus your actions on receiving a recurring benefit. The best way to start is to reframe all your problems as a function of time and improve year over year (YoY). This means you will get richer due to superior/scalable abilities and your riches will beget more riches. This will result in a knee in the curve non-linearity compared to the linearity of the middle-class.  All decisions compound (both for and against you), and this makes money eventually become perpetual so the path is clear: prioritize the maximum effort to get compounding on your side (make sure your inflows compound more than your outflows).

Chaos Theory and Dynamics: The middle-class think in simple terms of cause and effect, when the reality is that the outcome in sensitively depending on initial conditions, so the cause will result in empirically complex 2nd, 3rd, 4th, …. nth steps. It’s better to fix systems  Via Negativa – Nassim Taleb, since the middle-class solution to add more things to their life make things worst.

Inversion: A famous problem-solving technique in mathematics can be easily used to re-frame everyday problems.  Whatever question you ask yourself – ask yourself the inverse question. The path to success is not as clear as the path to failure. So by doing the opposite of the path of failure ensures you survive, and as Taleb reminds us you first must survive in order to succeed.

Pareto’s principle: The majority of a given effect is due to a minority of the possible causes.  You have a limited store of attention and time, so to create the aforementioned feedback loop you need to prioritize high-impact activities. Maximize the results by minimizing the stuff that doesn’t count: don’t check your e-mail more than 3 times a day, stop watching TV, surfing the net,  playing video games, and taking unnecessary vacations.  Make your own life great instead of engaging in escapism.  Make your life so good you don’t need a vacation. The more you shift your attention/time to high-impact activities the higher your overall benefit due to the compounding.

Game Theory and the Prisoner’s Dilemma: Will allow you to recognize and exploit the irrational decisions of others.

Calculus: Marginal cost bisects average cost at the minima of the average cost. The optimal point of production in terms of profit by maximizing your output variables can be determined by cost and revenue functions.

Here are some more math hacks for your scalable business.

 

 

 

 

 

 

 

 

 

Investing Philosophy Updated for 2018

For the past 10 years, I was a strong proponent of dollar cost averaging. But our bull market will come to an end in this 4th turning.

As of this writing,  Bank of Canada rate is only 1.25%. In 7 months we expect it to be at 1.75%.  With historically low-interest rates housing prices have been increasing as it was easy for Canadians to afford more expensive homes than they should have. It also discouraged people from saving money in savings accounts and GICs in favor of riskier investments (Cannabis, Tesla, Facebook, Netflix). All of this has artificially stimulated the economy and created jobs but as with any intervention in an empirically complex system, it is not a simple cause and effect but a multiplicative chain of unanticipated effects.  Increases in government and household spending keep the masses from the pain of living beyond their means.

Still, at 1.75% there is no reason to panic.  But 5% by 2019, higher interest rates will have a series of multi-dimensional interactions the

1st order effects:

  1.  It will cost more to borrow: increasing your mortgage payment and increasing the number of people that can not get financing (an increase in the rate by 40%  would result in a 20% increase in people who can not get financing).
  2. There will be more incentive to pull out of riskier investments and earn sub-4% in a CDIC insured GIC

The 2nd order effects:

  1. Real estate prices will go down
  2. People will feel less rich

The 3rd order effects:

  1. Household spending and stock market investment decreases

The 4th order effects:

  1. Global equities will be down 20-40% from the maxima
  2. Consumer products more expensive due to inflation and depreciation of the Canadian dollar as the trade deficit widens

The 5th order effect would be a total trade-war, that will lead to a currency war which will transform everything.

Recommendations

  1. Prioritize building a scalable business. Only acquire business vehicle if it makes you more PROFIT than it costs.  Consider selling a business at its ATH.
  2. If you know which city you will be in for the next 10-years, buy a home no more than 4x your gross annual household income with no less than 30% down. If you don’t have 30%, either continue to rent or buy a home 2.5x your gross annual household income with 20% down.  If you put down significantly less and are worried about your monthly payments then considering selling now.  For 2018 $500K-$1M seems appropriate in Edmonton. Anything more will be more difficult to sell.
  3. After investing as much as you can in your business first, multi-tenant real estate (higher rental yields per square foot/unit) second, a paid-off house (third), then just collect money in GICs.  Just don’t upgrade your house and your car so that you need to work.
  4. Since only half the gain is taxed, and you can pay yourself tax-free dividends out of your Capital Dividend Account, capital gains are the most tax-efficient corporate passive investment. Even pre-crash there are distressed properties. In this example put down $100k on a $500k purchase price to avoid CMHC.  Put another $125k of labor and materials if you can sell it for $750K, thereby double your $125k investment.  If your transaction does not add value to a distressed property, then ensuring your income is twice your mortgage payment will hedge against any drops in value.
  5. Once your net worth exceeds $6 million CAD then consider setting up a trust.

Pre-­crisis Framework

  1. Cash in all your shares/mutual funds, the surplus real estate now at the ATH and protect the proceeds by CDIC protected by staggered GICs.
  2. Protect your Dunbar’s #  – You are the average of the 5 people you spend around with most, so choose your employers, staff, and friends carefully. Cut the bottom 50% over everyone you know out of your life for good. Double down on the top 50%. To be polarizing is a good problem to have. I lose bad contacts and obtain good ones.
  3. If you are young, skip school and exhaustively learn code online or a trade.

The future will belong to:

  1. People who are the best at what they do through 90%-doing & 10%-learning.  Hone useful skills that allow you to deliver a service/product that people want and you can create opportunity regardless of the economic environment. Switzerland’s strong apprenticeship system has made it the most competitive country 7 years in a row.
  2. People with money. Strive to save 90% of your income.  Buy your car using metrics for yourself and not prestige for others. (12.7% of Switzerland’s population has a net worth over $1M vs. 1.4% in Canada.)

Post­crisis Framework: “Buy when blood flows in the streets.”  – Freiherr von Rothschild

  1. Buy small-cap stocks and multi-tenant real estate after the market crashes.

Background of the 4th Turning

  1. Canada’s trade deficit increases to $2.7B!This further confirms what reports have been saying for years. Canada is losing its competitiveness
  2. Canadians are living beyond their means and accumulating too much debt (Canada has the highest household debt of the G7 and the ratio of federal debt to GDP is the deepest within the G7)
  3. High demand for imports means more jobs are going overseas.
  4. As our exports continue to decline so will the value of our currency which in turn contributes to already rising inflation which will compound the housing cycle which is already in progress.
  5. The Canadian government is now heavily based on the Keynesian map – the road taken for a risky strategy.  The Fraser Institute has shown in a study that the debt of the Federal level and the provinces have clearly increased again over the last eight years after a good eleven ­year period of the economy. If the total debt in the years 2007/08 was at around 834 billion USD.  On several years low, it has grown again since then. A debt for all jurisdictions of around 1300 billion USD is expected for 2015/16. This corresponds to a growth of 54%, with the increase in the Federal level alone being 34%.
  6. Canada and its provinces have paid interest totaling $ 61 billion in 2014/15, which accounted for 8.1% of total income.  The amount Canada pays in interest was only slightly smaller than what is spent on all primary and secondary schools throughout Canada.  The amount Canada pays in interest was greater than all the pension plans of the Canada Pension Plan (CPP) and the Quebec Pension Plan (QPP), which amounted to around 51 billion USD.  In the province with the highest debt, the interest payments this year are expected to be about three times the expenditure on health care and education.
  7. Other organizations such as the International Monetary Fund (IMF), the OECD, the rating agencies and the Bank of Canada have also warned that the indebtedness of the Canadian private households appears to be at a serious level, especially thanks to record interest rates. If this trend continues for a while, then a disruption of the interest rate is likely to be more serious.
Foreign demand for Alberta’s natural resources contributed to our current situation.  Canada’s abundance of natural resources has interesting side effects. The trickle-down of wealth erodes productivity and created a nation dependent on Alberta.  Adaptability and productivity stay low while increasing costs, inflation, and unemployment. While consumption in Canada continues to overtake production, we will continue this downward spiral. 

After 12+ years our blog is still the least influential financial blog on the internet, and our 100+ customers is a tiny fraction of millions of small business corporations in Canada.  We are not driven by money and popularity, rather we driven by legacy, greatness, and hyper-focused on adding value.

Math Hacks for Your Business

Location

Due to mathematical clustering and conformity, the closer you are to your highest-grossing competitor, the more likely it is you will get half their customers upon opening. If you follow the rest of the advice in this blog and have multiple sources of income, to begin with, you ride out the zero-sum game until you are the only one left.

Your competitor’s revenue can be estimated by multiplying their traffic and their average ticket price.

Is it worth hiding cash/claiming questionable expenditures?

Risk<Reward x Probability of getting caught

In 2018, the answer is a clear NO.  The reward (~20% combined income & sales tax saved on underreported income) is far less than the risk (100% penalty of the taxes evaded + the taxes) multiplied by the high probability of getting caught by the Canada Revenue Agency’s advanced algorithms. Your accountant should be able to tell you which of your financial ratios/metrics would flag your return for a limited review.

Investing

the estimated benefit x the probability of gain = value of the transaction

You must take the chance of a 100x return if you had a 1/10 chance of success.  So if you have a 1/10 chance of something that would make you $100,000 better off, the value of the trade is $10,000.  For this reason, it is worthwhile to understand the underlying technology of crypto assets.   As an exercise, I  even built my own blockchain in Python.

For crypto assets, it is fairly common to have a 10% chance of a 100x return. Even at only $10,000, the value of the trade is $1,000. Even if you value your time at $500/hour, it will take less than 2 hours to set up your accounts on Kraken/Binance and begin buying.

In contrast to crypto investing, due to the normal distribution Brownian function of the stock market, unless you are “playing” with enough money it is often not worth your time.  If you lose 25% you need to gain back 33% just to break evenIf you are young, you are better off dollar cost averaging into CIBC’s balanced index fund (the one without the S&P 500) and anyone would benefit by loading up on small caps after a crash.