Monday, July 13, 2020

Think Twice Before Taking a 5-Year Closed Mortgage

The internet is full of debates about whether to take a mortgage interest rate that is fixed or variable.  However, what gets less attention is whether the mortgage is open or closed.  The most common fixed-rate mortgages are closed, and this means you’d have to pay a penalty if you break your mortgage.

I can already hear most people saying “but I’m not going to break my mortgage, so I don’t have to worry about penalties.”  However, the future can surprise us.  If breaking a mortgage cost us a finger, we’d think a lot more carefully about what might happen to make us break our mortgage: job loss, job moves to another city, divorce, health problems, bad neighbours, and more.

Mortgage penalties aren’t as bad as losing a finger, but they can be bad enough.  Suppose you took out a 5-year mortgage at TD Bank 2 years ago, and it has a remaining balance of $300,000.  According to Ratehub’s mortgage penalty calculator, the cost to break your mortgage would be $16,463!

Lenders deserve some compensation if you break a closed mortgage, but a penalty this big far exceeds any reasonable compensation.  The way they justify it is to do the calculations based on “posted rates,” which are much higher than the interest rates people typically pay.  The gap between the posted rate and the real rate is highest for 5 year mortgages, and gets smaller for shorter mortgages.  This declining gap size is what pumps up the mortgage penalty calculation.

So, when you’re trying to decide whether you’ll come out ahead with a fixed or variable rate mortgage, think carefully about what might happen that would force you to break your mortgage.  A mortgage penalty can easily be larger than the cost difference between fixed and variable interest rates.

Thursday, July 9, 2020

The Limits of Offering Investment Help

Family, friends, and blog readers often ask me for investment advice.  The challenge with helping these people is that even if the advice I give is good, the results they get can end up being disappointing.

Many times I’ve agreed to look at a person’s portfolio.  The most common problem I see is high mutual fund costs with little meaningful financial advice given in return for those costs.  Another problem that’s less common is a portfolio that is too concentrated in a small number of stocks.

In most cases, it’s obvious that the investor would be better off in the long run with a very simple portfolio holding nothing but one of Vanguard’s asset allocation ETFs (VEQT, VGRO, VBAL, VCNS, and VCIP).  This isn’t the only good way to invest, but it’s better than most people’s existing portfolios.

So, if I were to give one-time advice, in most cases it would be to sell everything and buy an asset allocation ETF.  I might add some advice on not timing the market and avoiding tinkering.  However, this would leave a big problem.  Dan Hallett explained the problem well on a recent Moneysaver podcast:

“I have long been convinced that I could lay out exactly what somebody needs to do, and the vast majority of them would get in their own way.”

If the people coming to me for advice are willing to change their entire portfolios to match my suggestions, what will happen the next time the stock market is down and they ask someone else for advice?  The answer is they’d make another big change in portfolio strategy.

Jumping around from one strategy to another is a bad idea, even if we’re jumping from good strategy to good strategy.  We tend to want to make changes after our current strategies have had a bad period.  We end up in a buy-high-sell-low cycle.

These problems place limits on who I’m willing to help with their investments.  Unless I’m confident I’ll be around to stop people from getting in their own way, my advice becomes part of the problem instead of a solution.  So, I’ve only helped a modest number of people very close to me.

Some financial advisors might applaud my choice saying that financial advice should be left to the professionals.  However, only a minority of financial advisors are part of the solution rather than part of the problem.

Friday, July 3, 2020

Short Takes: Tesla, Reducing Stock Allocation, Retirement Strategies, and more

I had to laugh watching Elon Musk gloat on Twitter about Tesla’s recent success and rising stock and the effect it’s had on short sellers.  “Tesla will make fabulous short shorts in radiant red satin with gold trim.”  He’s not a fan of the U.S. Securities and Exchange Commission (SEC): “Will send some to the Shortseller Enrichment Commission to comfort them through these difficult times.”  “Who wears short shorts?”

Here are my posts for the past two weeks:

Investing Perfection

Talk Money to Me

Here are some short takes and some weekend reading:

David Aston says now is the time to reduce your allocation to stocks if you couldn’t stand the recent stock market turmoil.  The best advice is to stick to a financial plan and its asset allocation percentages, but for those who’ve learned that they just couldn’t stomach the 30% drop in stock prices, the best move is to wait until stock prices have recovered before selling off some stocks.  Today’s higher prices are giving these investors their opportunity.  Unfortunately, it was when stocks were low that social media was filled with bad advice to reduce your stock allocation.

The Rational Reminder Podcast interviews retirement expert Fred Vettese who has done excellent work on finding retirement strategies that can work for you rather than working for banks, insurance companies, mutual fund companies, and their salespeople.  I’ve written before about some areas where I disagree with Vettese, but I consider these differences to be minor.  Following his advice is very likely to give a good outcome.  The main area of disagreement concerns spending patterns as we age.  I’ve read the same studies Vettese references, and what I see is data that mixes together retirees who made their own choices of how much to spend with some retirees who were forced to spend less as their savings dwindled prematurely.  The net effect is that if we back out data from forced spending reductions faced by some people, retirees’ natural tendency to spend less as they age will start later and be less severe than the full data set appears to show.  This is disappointing news for people looking for the green light to retire with less saved and to spend freely in their 60s.  However, we need to ask ourselves whether we want to model our own retirements on the experience of others who made their own choices, or whether we want to include a component of forced spending reduction from dwindling savings.  All that said, though, Vettese’s retirement plans are better than most I’ve seen.

Christine Benz
has some excellent advice for young investors just starting out, as well as a few words for more experienced investors.

Robb Engen at Boomer and Echo says COVID has eliminated any chance of meeting his stretch goal of becoming a millionaire by the end of 2020.  But, he says “I won’t get kicked out of the personal finance blogger guild if it takes a few extra months to make it.”  The housing and stock markets may have something to say about it taking only a few extra months.  This illustrates the problem with getting too tied to net worth goals.  Robb has the right attitude of not being too concerned.  We have some control over our incomes and saving rates, but no control over the prices of volatile investments.  In the long run a net worth target can be a reasonable goal, but in the short run, it’s more of a hope.

Big Cajun Man gives an overview of the Registered Disability Savings Plan (RDSP) along with links to more details.

The Blunt Bean Counter
describes his experiences working from home.

Friday, June 26, 2020

Talk Money to Me

The best financial advice I’ve heard sounds impossible to most people.  To reach these people, you have to offer them small improvements to how they handle their finances, and you have to avoid making them feel bad about their past choices.  This is the approach Kelley Keehn takes in her book Talk Money to Me: Save Well, Spend Some, and Feel Good about Your Money.

The best car advice I know is to pay cash for cars.  The financial benefits of saving up for cars and buying modest cars are enormous.  However, most people think this is impossible.  And once they’ve built a lifestyle with debt, paying cash for a car may well be impossible.  Keehn’s focus is on steering her readers to doing research on cars and car financing before entering a showroom.  This will have her readers making somewhat less financially damaging car choices.  So, she’s looking to help people a little with advice they might follow instead of giving great advice that few will follow.

A more extreme example of good but useless advice is to not be a shopaholic.  Keehn offers practical steps to spending less money while scratching the shopping itch.  The book covers several other areas with advice designed to steer people to better choices.

Keehn mentions an interesting issue that never occurred to me.  As companies gather information about our spending histories, we could be forced to share these spending histories.  For example, we could be forced to share our spending history at the U.S. border to see if we’ve ever bought cannabis.

On the subject of asset allocation, Keehn treats your career and future income as a component of your portfolio.  How steady your income is affects how you should invest the rest of your money.  One caution I’d add is that we tend to underestimate how risky future income really is.  Few jobs and careers are as safe as people think they are.

There are a number of details in the book that I found confusing or where I disagreed.  On credit reports: “If you order a free report …, your score will not be listed, so it won’t be as useful; I’d suggest always paying for the full report.”  I think it’s better to learn how elements of your credit history affect your score, and work on improving your financial habits.  As your credit report improves, your score will take care of itself.  I don’t see the need to pay to see a score.

On making credit card and line of credit payments, I found “Always pay the minimum every month” jarring, until I realized the intended meaning was “at least the minimum.”  Apparently, some people think that if they make a payment of double the minimum one month, they can skip the next payment.  As the book explains, it doesn’t work this way.

Among the ways of holding some available cash, Keehn includes money market mutual funds.  These aren’t as safe as they seem.  A high-yield savings account is a better idea.

Despite repeated mentions of the importance of an emergency fund, we get this advice: “If you’re able, then it makes sense to invest those funds and rely on a line of credit if an emergency were to arise.”  Just two pages later we get “Your lender can even take your credit away entirely if your credit score drops dramatically.”  Counting on borrowing money in an emergency is how many people get themselves into big debt troubles.  Emergency funds matter.

In a checklist for different types of insurance, the book includes “Do you have insurance on your credit cards, and is it right for you?”  Naive readers could be left thinking that they should get credit card insurance.  In reality, the question should be whether you’ve made sure you don’t have credit card insurance.

The book refers to the “miss a payment” option on a mortgage as a “handy feature.”  This feature of a mortgage feels more like another tool for banks to keep people permanently in debt.

In answering the question about houses “What can you afford?”, the book goes through the usual explanations of gross and total debt service ratios.  Unfortunately, these ratios leave people thinking they can buy a far more expensive  house than is best for them.  Banks lend money without caring whether you’ll end up house poor.  It isn’t until a few pages later that the book mentions that you might not want to borrow as much as a bank will lend on a mortgage.

On the subject of mortgage insurance, the book fails to mention post-claims underwriting.  The insurance company doesn’t check if you qualify for insurance until after you’re dead.  Not knowing if you’re really covered is a huge negative for mortgage insurance.

Numbers in a few places didn’t seem to make sense.  In one place, the annual interest rate on a payday loan is over 500%, but only 47.71% in another place.  In another figure illustrating costs on a 14-day $300 loan, the figures for lines of credit, overdraft protection, and a credit card cash advance imply annual interest rates of 50%, 62%, and 64%, respectively.  Even if we make the loan period a month, the annual percentages are 23%, 29%, and 30%, which still seem too high.

The book includes a glossary with some definitions that seem strange.  For example, a dividend is “A financial bonus for investing in a company (when you buy a preferred share).”  This seems like an attempt to write for the masses, but it didn’t work out well.

This book is useful for helping people who don’t handle money very well, which is most people.  I found a number of things that seemed odd, but none are central to the mission of giving people practical tips for improving their finances.  For anyone looking for financial advice that doesn’t seem too extreme, this book fits the bill.

Tuesday, June 23, 2020

Investing Perfection

Perfect is the enemy of good. – Voltaire quoting an Italian proverb, 1770

In my career as an engineer/mathematician, I worked with some people who had trouble declaring a design “good enough.”  They’d want to keep tinkering endlessly.  They couldn’t stand to stop work knowing that some part of the design could still be improved.  This drive to tinker and improve things served them well in some ways and hurt them in others.

When it comes to investing, it’s a bad idea to get paralyzed seeking the perfect strategy instead of just getting started.  Perfecting your investment strategy is quite unimportant when you’re just getting started with small amounts of money.

I’ve been investing my money for decades now, and there’s never been a time when I thought I was doing it perfectly.  Sometimes I’ve just had a feeling I wasn’t doing something right.  Other times I knew exactly what I wasn’t doing well, but didn’t yet know how to improve it.

I’ve always been at ease with this situation as long as the “mistake” wasn’t too severe.  Fortunately, while my portfolio was small, mistakes weren’t too painful.  Paying high mutual fund MERs today would eat at me, but it wasn’t that big a deal when my portfolio was 5% of its current size.  I’ve given myself a pass for past mistakes and have never been in a panic to correct them along the way.

But this doesn’t mean I don’t bother to improve things.  As my savings have grown, I’ve figured out various improvements (reducing MERs with U.S.-listed ETFs, reducing foreign exchange costs with Norbert’s Gambit, improving my asset location strategy, etc.).  I learned about these things at my own pace and didn’t agonize over past inefficiencies.

This attitude makes it easier to learn new ideas.  If you have a strong emotional need to do everything perfectly, then finding a good new idea requires you to admit that your old ideas weren’t as good.  Some people prefer to defend the status quo rather than improve.  Often new ideas aren’t really improvements, but I like to remain open to the possibility of genuine improvements.

By being at ease with the fact that your investment history isn’t optimal, it’s easier to adopt good ideas.  It’s quite freeing to simply say, “what I’m doing now isn’t as good as I thought it was, and I plan to make improvements in my own time.”  For those just starting out investing on their own, it’s okay to learn as you go.