Monday, December 28, 2009

How to Pay Less and Keep More for Yourself

Have you ever had the feeling that you pay more fees to your bank than you should, but you’re not sure what to do about it? If you’re a Canadian and answered yes, then Rob Carrick’s book How to Pay Less and Keep More for Your$elf: The Essential Guide to Canadian Banking and Investing may be for you.

Whether your concern is savings and chequing accounts, credit cards, loans, mortgages, or investing, Carrick has useful suggestions for reducing fees and getting better interest rates. He also has good insights into working with financial advisors and the ins and outs of do-it-yourself investing.

Unlike many writers, Carrick doesn’t bother to preach about the evils of debt or mutual fund fees. Instead he focuses on how to reduce interest rates on debt and fees on funds. For example, he says that debt is “an essential financial tool” in a world of expensive homes and cars. I agree when it comes to homes, but I think people should pay cash for cars. If they can’t pay cash for a car now, they should be formulating a plan to save enough to pay off this car and pay cash for the next car.

Perhaps Carrick’s approach is more useful than preaching to people already buried in debt. Warning a young person to avoid debt is one thing, but middle-aged readers who already have significant debts are probably better off learning about the advantages and disadvantages of consolidation loans.

When it comes to mutual funds, Carrick describes MERs of 2.38% for a Canadian equity fund and 1.07% for a bond fund as “reasonable”. I find them very high when much lower MERs are available, but to an investor who cannot leave the psychological safety of a financial advisor, modest reductions in fees are better than nothing.

The book does cover ways of investing with significantly lower fees (indexing), but the author doesn’t bother to try to make those who stick with mutual funds feel guilty.

Here are some thoughts on specific parts of the book:

Debt Consolidation

One thing I would add to Carrick’s discussion of debt consolidation is a potential pitfall. Once all your credit cards and other debts are paid off with the balances rolled into a home-equity line of credit, the balance-free credit cards may be too much of a temptation to spend. Unless borrowers change their ways, they end up with the consolidated debt plus a pile of new credit card debts. This may ultimately lead to losing a home.

Mortgages

“Don’t even think about accepting a mortgage at the posted rate.”

“Never simply renew a mortgage without trying to arrange a better deal.”

Carrick goes on to give concrete suggestions for how to follow this advice.

Mortgage Brokers

“Mortgage brokers almost always charge nothing for [their] service.” This is misleading. There may not be any explicit charge, but the broker’s fee is built into the mortgage rate and is ultimately paid by the client. It may be true that the broker is able to save the client more than the cost of his fee, but this still doesn’t make the broker’s service free.

Tied Selling

“It’s illegal for banks to require that you bring them a certain piece of business [like an RRSP account] if you want to get a mortgage.” I didn’t know this. However, you may be able to negotiate a better mortgage interest rate if you bring other business.


Flexible Mortgage Accounts

The author makes two strong points about mortgage accounts that combine the features of a mortgage, line of credit, and chequing account: The interest rate is usually higher than what you can get on a standard mortgage, and it becomes too easy for many borrowers to borrow more and never pay off their mortgage.

Mutual Funds

“Ignorance about mutual fund fees is bliss for fund companies. Wise up to the fees you’re paying to buy and own your mutual funds, and make sure you’re getting good value.”

Indexing in Down Markets

Carrick repeats the oft-made claim that active equity funds outperform index funds in down markets. The evidence for this is scant, but to the extent that it is true, the reason seems to be that active funds are forced to hold a percentage in cash to deal with uncertainty of fund inflows and outflows. This cash obviously performs better than stocks when stocks are dropping in price, and a fund with more cash will have a small edge over the fund with less cash.

To compensate for this, an investor could just ever-so-slightly increase fixed-income allocation when using an index fund rather than an active fund. For this reason, in Carrick’s model portfolios, I would substitute index funds for most of the active funds to save on MER costs.

Conclusion

This book is written in an easy-to-read style, and many readers are likely to find something useful for their dealings with banks.

5 comments:

  1. Another pitfall of transferring a balance from a credit card to a home mortgage or line of credit is that it converts unsecured debt to debt secured by a residence.

    Someone can't lose their home if they default on their credit cards. However, if they default on their mortgage, they better watch out, or they could get foreclosed.

    There was a good discussion of this in a book you mentioned awhile back (which I subsequently purchased): "Maxed Out".

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  2. Gene: Very true. There is definitely more to consider than just getting a lower interest rate on debt.

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  3. I may be a little biased, but the comment on mortgage brokers is a little unfair. Of course profit is built into the rate.

    The banks operate the same way. A bank rep must be compensated on top of that banks have much higher overheads than all brokerages.

    Just my two cents!

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  4. No Debt Guy: Mortgage brokers bring good value to their clients if they're able to get a better rate than the clients can on their own. My only point is that it's misleading to say that mortgage brokers work for free. Anyone who is naive about finances, but not naive about the ways of the world would find a claim that someone works for free very suspicious. I think mortgage brokers are better served by explaining how they are paid accurately. It's certainly true that mortgage rates carry all sorts of other built-in fees related to bank costs and profits.

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  5. I agree with you 100%.

    It is unfortunate for our industry that there is still very little known about how we work.

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