Monday, February 8, 2016

Understanding Bank Profits

Every 3 months we get to hear again about how Canada’s banks made billions of dollars in profits for the quarter. Most Canadians are disgusted by it all. But there are a few simple things we need to know to understand why banks behave as they do.

Suppose a normal person, call her Jen, comes into a large inheritance, say $500,000. Jen would likely use the money in some way to try to improve her life. If she’s near retirement, she might retire a little earlier. She might change to a more fulfilling job that pays less. Whatever she does, it will likely consume the money over time.

Few people like Jen would react by trying to find a way to get even more money the next year. We tend to carry this thinking over to banks. If banks made so much money this year, why don’t they give us a break on interest and fees? Why do they need even more money?

The answer is that almost all of those bank profits get paid out to the bank’s shareholders as dividends. And shareholders want more dividends every 3 months. In fact, they want those dividends to rise over time. Whatever the banks earned this year, their shareholders want more next year.

While a big windfall for Jen reduces some of the pressure in her life, big profits for banks just create pressure to earn even more next year. You’d think bankers would be doing high fives and taking a break after earning $10 billion in a year, but this just makes them desperate to find ways to earn $11 billion next year. And if they don’t, they’ll be seen as failures.

Does this mean we should feel sorry for the banks? Absolutely not. The most important takeaway is that it’s a waste of time to wait for banks to grow a heart. The never ending new fees, fee increases, and debt promotion isn’t meanness; it’s desperation.

The cost of delivering banking services just keeps dropping as technology keeps improving. This should translate into cheaper banking and much lower bank profits. So far, it hasn’t worked out this way for the average Canadian, but the pressure remains on the banks to keep profits rising.

My response to all this is to expect banks to try just about anything to extract more fees and interest from me and my family. But I plan to pay as little as possible.

Wednesday, February 3, 2016

The Way I Think about Insurance

There are a tremendous number of different types of insurance. It can be difficult sometimes to decide which types to buy. Here I describe the way I think about insurance and how it guides my choices. I encourage my readers to come up with their own ideas to guide them when it comes to insurance.

The core of my thinking about insurance is that it is a way to protect myself and my family from low-probability events whose costs would be devastating to our finances. This means I specifically exclude high-probability events and low-cost events.

An example of a high probability event is needing dental work. As it happens, my employer gives me “insurance” to cover this, but I don’t consider it insurance because it is capped at a low level. It’s just extra pay because it’s not protecting me against a large loss.

After I retire, I would never buy typical dental or health insurance. Insurance companies employ smart people. They would never let me buy coverage that costs less than the expected benefits I would get. They’d also add extra to the cost for their own overhead and profits. I’ll be better off just paying directly for dental work. If I could get insurance that covered high-cost dental work or health costs, that could be useful to me.

An example of a low-cost event is when some consumer item like a television breaks. I never buy extended warranties. For one thing, retailers often find a way to avoiding honouring them. But, even if retailers did honour warranties, I wouldn’t buy them because I can afford to replace a broken item. I was once even offered an extended warranty on a $5 battery! What a waste of time.

So, what kinds of insurance make sense? Liability insurance for your car and home come to mind first. Getting sued for a couple of million dollars would certainly be devastating for almost all of us.

Insurance against damage to my home also makes sense. I wouldn’t want to have to pay for a rebuild if my house burned down. However, I choose a very high deductible. I wouldn’t make a small claim anyway, so paying a higher premium for a low deductible makes no sense. The same applies to deductibles for collision insurance on cars. I don’t even bother with collision insurance on my car once it’s worth less than $10,000, but I do keep the liability insurance.

Life insurance makes sense to protect anyone who depends on your income. However, I look for the cheapest term life insurance I can find that has the term length I need and is convertible and renewable. I’m not interested in the various forms of permanent insurance such as whole life and universal life because they just bolt an expensive investment component on top of term life insurance.

Disability insurance makes sense as well. Most of us are more likely to become disabled than we are to die. However, this is a tricky area. It can be difficult to determine whether a plan has reasonable coverage for its cost.

Many of us have various types of insurance through our employers. Health insurance is just extra pay because it won’t pay for anything truly expensive. Disability insurance through an employer can work well, but life insurance may not. If you get cancer and decide you don’t want to spend your last reasonably healthy days working, you may find it difficult to convert your employer life insurance to an individual plan because you’ve become uninsurable. Some employer plans offer convertibility, but there are deadlines and the insurance company is motivated to make such a conversion difficult for anyone with an elevated chance of dying.

I never link insurance to a financial product like a mortgage or credit card. Few people realize that the underwriting for mortgage life insurance doesn’t take place until there is a claim. This means the insurance company doesn’t check whether you’re covered until you die. You can bet they’re willing to put some effort into finding a reason to deny your coverage.

So, there you have my personal philosophy on insurance. I look for ways to protect my finances from devastating losses. I ignore all forms of insurance that cover losses I can handle. Your mileage may vary.

Monday, February 1, 2016

The (Honest) Truth about Dishonesty

We know people lie and cheat sometimes, but can we predict when and why? Dan Ariely has researched this question and reports the results in his entertaining and enlightening book The (Honest) Truth about Dishonesty—How We Lie to Everyone—Especially Ourselves. This book is very accessible, yet gives deep insights into dishonesty.

The most important thing to understand about cheating is that it involves a tension between our self-image and the benefits of cheating. “We are all capable of cheating, and we are very adept at telling ourselves stories about why, in doing so, we are not dishonest or immoral.” “We cheat up to the level that allows us to retain our self-image as reasonably honest individuals.”

I would have thought that lying and cheating involved conscious evaluations of trade-offs at least some significant fraction of the time, but Ariely says this isn’t so. “There are rational forces that we think drive our dishonest behavior—but don’t. And there are irrational forces that we think don’t drive our dishonest behavior—but do.”

Ariely’s experiments show that “it is very difficult to alter our behavior so that we become more ethical.” A consequence is that he suspects “that this ineffectiveness also applies to much of the ethics training that takes place in businesses, universities, and business schools.”

In one amusing section, Ariely “studies” the link between his students writing exams and “Dead Grannies.” He finds “that grandmothers are ten times more likely to die before a midterm and nineteen times more likely to die before a final exam.”

Something I’ve noticed before is that my self-control is a limited resource, similar to my ability to focus on tasks, or my physical endurance. “Simple, everyday attempts to keep our impulses under control weaken our supply of self-control, thus making us more susceptible to temptation.” So, the chocolate bars and cupcakes constantly available to me at work are making my life worse, even if I never eat them.

The ability to lie to ourselves is an important component of our dishonest behaviour. “We are all very good at rationalizing our actions so that they are in line with our selfish motives.”

In one interesting experiment, women were asked which of four nightgowns they preferred. Most subjects picked the one on the far right and gave their reasons why it was best. The most interesting part of the experiment came when the subjects were told that the nightgowns were identical. They insisted this wasn’t true.

In another experiment, the researchers found that more creative people cheat more. “Creativity can help us tell better stories—stories that allow us to be even more dishonest but still think of ourselves as wonderfully honest people.” So, more creative people are more dishonest, but they would deny this fact.

There were a great many factors found to increase dishonesty, but two surprising factors that had no effect were the amount of money to be gained and the probability of getting caught. Factors that increased honesty included making a pledge, signatures, moral reminders, and supervision.

Overall, this book is a fairly easy read, but gives deep insights into the nature of lying and cheating. I highly recommend it to anyone who wishes to better understand the actions of others, and more importantly, to better understand yourself.

Friday, January 29, 2016

Short Takes: The Big Short Gets it Right, Common Sense, and more

Here are my posts for the past two weeks:

Financial Dreck

Getting Rid of Excess Money: Binary Options

How Should New Investors Enter the Market?

Identity Theft for $6668.49!

Here are some short takes and some weekend reading:

Barry Ritholtz says the movie The Big Short gets it right. I agree with him.

Canadian Couch Potato reviews Ben Carlson’s book A Wealth of Common Sense.

Preet Banerjee uses this video to explain employer matching in retirement plans.

Boomer and Echo say that indexers are terrible at indexing. It’s definitely true that most people who call themselves indexers invest quite actively.

The Blunt Bean Counter lays out the elements of a messed up estate plan (or non-plan).

Big Cajun Man is now coming up with plausible sounding names for investing strategies designed to confuse investors. I don’t think financial institutions need help with this, but maybe this post will help to make people more wary of investing strategies they don’t understand.

My Own Advisor profiles a retiree with no financial worries. The main takeaway is that investing becomes a lot less important when you have a valuable pension.

Million Dollar Journey looks at how taxes vary by province when trying to retire on non-eligible dividend income.

Wednesday, January 27, 2016

Identity Theft for $6668.49!

I don’t get a lot of meaningful paper mail any more. It’s almost all junk mail. I thought this was the case with a Rogers’ envelope, but for some reason I opened it anyway. It turned out to be a bill for $6668.49. That got my attention.

It turned out to be a bill for a Rogers Wireless account. Flipping through the pages trying to figure out what was going on, my eye was drawn to a green box telling me “You saved $0.32 on your Wireless services this bill.” I was thinking I’d better save a lot more than that.

My first hope was that this was a bogus bill not sent by Rogers. But everything appeared legitimate. The web address and telephone numbers were all authentic. So, I called Rogers Wireless to see what was going on.

A helpful woman named Cynthia confirmed that this really was a bill from Rogers. She then confirmed that none of the information used to set up the account matched my information except for my name and address. So, she knew this was fraud.

It turned out that the account was only active for 2 days because the Rogers’ anti-fraud department had already shut the account down. But in those two days the fraudsters used about 3000 minutes on each of two phones.

I certainly would have preferred it if Rogers hadn’t sent me this bill at all given they knew it wasn’t my account. The bill arrived 3 weeks after the account was shut down.

My wife kept her sense of humour through this. The bogus account was a joint account in my name and someone named Maria. My wife said “So the truth finally comes out about your other wife and family.” The only part of all this that sounded good to me was that the fraudster gave a year of birth that makes me 13 years younger. I’d pay the bill if it made that true.

Cynthia directed me to Rogers’ anti-fraud department to speak to Jesse who confirmed he knew the account was fraudulent. Apparently, they see this pattern a lot where bogus accounts are used for overseas calls. It turns out that the fraudsters only needed a name and address to open the account. All the other information they provided about me was wrong. It doesn’t take a sophisticated criminal to open a phone book.

Jesse assured me that I’d get no more bills and that they would tell the credit agencies that this was fraud. I don’t have any immediate need to borrow, but I don’t need the credit agencies telling businesses that I’m a deadbeat.

So, it appears there wasn’t much I could have done to prevent this from happening. I carefully burn all paper with sensitive information on it, but it’s hard to keep people from finding out my name and postal address. Rogers doesn’t set a very high bar for preventing identity theft.

I’d prefer it if creditors were more careful giving out credit. Rogers may find it profitable to open credit accounts with no meaningful proof of identity, but the cost to me to sort this out should count for something as well. I can only imagine how much more difficult this would have been if the fraudsters had another one or two correct pieces of information about me.