Friday, April 29, 2011

Short Takes: Who Benefits from TFSAs?, Detecting Ponzi Schemes, and more

Wealthy Boomer makes the case that TFSAs benefit the middle class and not just the wealthy. I agree. I’d go even further to say that TFSAs benefit those with incomes just below middle class levels. However, in discussions of increasing contribution limits, the higher the limit the more the benefit shifts to the wealthy. The first $5000 each year is useful for much of the middle class, but an additional $5000 per year would tend to benefit the upper middle class, and further increases would tend to benefit only wealthier Canadians.

Larry MacDonald observes that the terms of Warren Buffett’s early investing partnerships made them opaque and would trigger fears of a Ponzi scheme if they were offered today. Of course, Buffett never ran a Ponzi scheme, but Larry is right that it seems crazy to trust anyone as much as Buffett’s early partners trusted him. I see this as further evidence that it is very difficult to predict in advance which stock pickers will beat the index over the long term.

A Loonie Saved has a good laugh at a pamphlet from the National Association of Realtors that implies buying a house can make your kids smarter among other supposed benefits.

Million Dollar Journey offers opinions on which credit cards are the best for small businesses in Canada.

Money Smarts gives us the benefit of experience with saving money on hotel rooms using Priceline. The main downside I see is the fact that you need to commit to paying a price for a fixed set of nights long in advance. If you’re sure that your plans won’t change, this could be a good way to save money.

Tom Bradley doesn’t think much of the newest entrants into the Canadian ETF market.

Thursday, April 28, 2011

Cash-Back Mortgages

A type of mortgage that is appealing to some borrowers is the cash-back mortgage where the borrower is paid an additional sum on top of the amount of the mortgage. For example, in addition to taking out a $100,000 mortgage, the borrower may get an extra $5000. This amount is marketed as being for closing costs or other house-related expenses, but it is often used to avoid having to save up part or all of the down payment. Trying to figure out if these mortgages are a good deal can be challenging.

We all know that banks aren’t in business to lose money. So they aren’t giving cash back without getting something in return. Typically, they make up the cash back amount by charging a higher interest rate. The borrower might be made to pay the posted mortgage rate rather than a discounted rate. The amount of the cash back depends on the term chosen. The longer you agree to pay an inflated interest rate, the more cash you get back. So, a 5-year fixed term would attract more cash back than a 3-year fixed term.

Suppose that you’re offered a $100,000 mortgage at 5% with a 5-year term, a 25-year amortization, and $5000 cash back. Your monthly payments would be $581.60. How can you tell if this is a good deal? The interest rate is high, but this is offset by the $5000 cash back. More mathematically inclined readers might see that this mortgage is equivalent to a $105,000 mortgage at some lower interest rate with a different amortization period. If we knew the effective interest rate we’d be in a better position to compare this mortgage to other offers.

I created a spreadsheet to calculate the effective interest rate and amortization period for a conventional mortgage equivalent to a cash-back mortgage. The idea is to match the monthly payment, the total amount borrowed, and the outstanding balance at the end of the term.  You can save a copy of this spreadsheet in Excel to make changes.

For our example, the spreadsheet calculates that this cash-back mortgage is equivalent to a $105,000 mortgage at 3.82%, a 22.3 year amortization, and no cash back. Using this spreadsheet you can enter your own data on a cash-back mortgage to get an effective interest rate to compare to other mortgage offers.

Wednesday, April 27, 2011

Misconceptions about Investing

I find Larry MacDonald’s Me and My Money columns interesting because they give insight into the reasoning people use for making investments. Two recent columns are about an investor who likes preferred shares and another investor who likes professional money management. In the first case I had a misconception about floating-rate preferred shares and in the second case the investor has mistaken ideas at the core of her reasoning.

Preferred Shares

Matt Byers likes preferred shares and says “Floating preferred shares are also a perfect hedge against inflation.” Typically, preferred shares pay a fixed dividend, such as $1.25 per year, and the issuer can redeem them for $25 any time after a particular date. For this example the nominal dividend rate is 5%. The issuer will redeem the shares if it can get a better deal.  However, with floating-rate preferred shares, the rate changes with prevailing interest rates.

When you buy non-floating rate preferred shares, you are owed a stream of fixed-size payments ending with a large fixed-size payment. An increase in inflation reduces the value of these future payments. This is exactly the opposite of inflation-protection. If you believe that we’re headed for a significant rise in inflation, you would not want to own these preferred shares. But, the floating rate preferred shares do give inflation protection assuming that interest rates rise when inflation rises.

Professional Money Management

Elizabeth Hoyle believes in hiring professional money managers to pick stocks. She advises us to “Invest in companies because they make wealth; governments and the index do not.” She is absolutely correct that companies make wealth, but what does she think the index is? The index is a collection of company stocks. Owning the index is the same as owning shares in every company that makes up the index.

The main reason to hire professional stock pickers rather than buy an index is to try to take advantage of bad traders to make trading profits in addition to the profits of companies whose stock you own. Both approaches are equally good at sharing in the capitalist engine of our economy. The differences are in the fees paid and trading profits or losses.

All evidence says that very few professional stock pickers can generate trading returns over the long term that make up for their fees. Further evidence says that we can’t figure out which stock pickers will be the ones to succeed.

Seeking professional financial advice can be a wise thing to do if you get useful advice on how to manage your finances and retirement planning for a reasonable cost. However, the stock-picking part of the package is usually worthless over the long term. The best chance of generating value from hiring a stock picker is to go for one that charges low fees.

Ms. Hoyle also says that “it’s not about fees – it’s about quality of management.” I’d be interested to know how she defines quality of management. By my definition, most professional money management fails miserably.

Friday, April 15, 2011

Short Takes: The Bender Solution, Best Canadian Financial Products, and more

I’ll be taking a brief break from blogging of likely a week or so. Until I’m back at it, enjoy the following interesting articles from other sources.

Man Wakes Up from Bender with Financial Problems Solved. Often just the headlines at The Onion are enough to leave me laughing out loud. This one should make you a little uncomfortable if you tend to avoid facing your money troubles.

Million Dollar Journey offers opinions on which financial products are best for Canadians.

Money Smarts runs down the rules for interest and penalties when paying your taxes late. Of course, it’s better to pay your taxes on time and this article starts with some advice on how to get your taxes filed on time. Keep in mind that you don’t have to pay and file at the same time.

Big Cajun Man quotes the Bank of Canada saying that inflation is expected to rise temporarily. This could mean that interest rates will go up. Or maybe they won’t. I doubt that even the decision makers at the Bank of Canada can say for sure.

Thursday, April 14, 2011

Tax Freedom Day

Those concerned about our growing tax burden like to draw attention to it by "celebrating" Tax Freedom Day, the day when we've earned enough money to cover all our taxes for the year. However, thinking of taxes as front-loaded like this draws attention away from a different problem with our progressive tax system.

The truth is that the first several thousand dollars of income is barely taxed, or even negatively taxed for those who receive income-tested benefits that exceed the taxes they pay. People with upper middle class income get to keep most of their income for the first half of the year, but the incentive to work drops off in the second half of the year. This is because this later income is taxed more heavily. I'd happily trade one-sixth of my income for two months of additional vacation every year because I'd be giving up less than one-sixth of my take-home pay.

I'm a believer in a progressive tax system, but only up to a point. I fear for our country's future if our most talented people have little reason to work more than half of the year.

Wednesday, April 13, 2011

Avoiding WestJet Baggage Fees

WestJet held off from charging annoying extra airline fees for a while, but they now allow fewer checked bags before applying charges. An interesting consequence of their policies is that it encourages travelers to take more baggage as carry-ons.

Travelers used to be able to check two bags up to 50 pounds each. Now only the first checked bag is free. A second one under 50 pounds costs $20. But, you can carry on two bags of 22 pounds each without charge on most flights. For a yearly trip where I normally check 2 large bags, I’m now considering taking 3 bags with the 2 smaller ones meeting the carry-on size restrictions.

I don’t know how many people are cheap enough to try to save $20 this way, but I’m expecting the overhead bins to be packed a little tighter than they were the last time I flew WestJet.

Tuesday, April 12, 2011

Delayed RRSP Tax Slips Cause Trouble

Receiving an income tax refund recently prompted me to make a 2011 RRSP contribution. Not wanting to wait until 2012 to get the resulting tax break, I plan to file a T1213 form to get my employer to reduce the source deductions on my pay. Unfortunately, BMO Investorline insists that they won’t send out tax receipts for RRSP contributions until next year.

Now I’m trying to decide what constitutes adequate proof to send to CRA that I made the RRSP contribution. A call to CRA didn’t help much. I got a couple of levels deep in the help system to someone who had heard of a T1213, but she was just reading the form and couldn’t tell me much more than what was written on the form. She didn’t inspire much confidence by repeatedly asserting that I must have got some sort of receipt when “buying the RRSP”.

I tried to gently explain that one does not buy an RRSP and that a contribution is little more than a transfer between two accounts, but that didn’t help. In the end, all the evidence I have is screen shots from my computer of the transactions in each account. By the end of the month I’ll have account statements showing these transactions as well, but that won’t be much better evidence than the screen shots.

I could go back and yell at Investorline to send me my tax receipt now, but I think I’ll try sending the screen shots along with the T1213 form to CRA. If there are any experts out there who can comment on whether this is likely to work, I’d like to hear your thoughts.

Monday, April 11, 2011

Online Retailers Satisfy Long Tail Demand

In retailing, the “long tail” refers to the great many products that have only a small demand. Bricks and mortar retailers prefer to sell products that everyone wants regularly, but online retailers are better at satisfying the long tail demand. This can cause consumers to be dissatisfied with their traditional bricks are mortar retailers.

When I’m looking for something I need, like many people, I start with an online search to see what’s available. The incredible breadth of retailers available to online searching often results in my finding an item even better for my needs than I first imagined.

The next step is to decide where to buy my desired prize. Buying from an online retailer is often a problem because it is usually in the U.S. and shipping leads to annoying delays and extra charges at the border. This leads me to search local retailers for the item I want.

But, these retailers often don’t have the item I want. They have an apparently weak selection that doesn’t include the item that best meets my needs. The fact that I know a better product exists makes me less satisfied with local retailers. I long for the day when shipping becomes faster and more predictable so that I can give up on local retailers for specialty purchases.

When I’m looking for specialty items related to a hobby or favourite activity, I’m getting addicted to the long tail of online retailers.

Friday, April 8, 2011

Short Takes: Indirect U.S. Debt Default and more

Steadyhand quotes Bill Gross on the many ways that the U.S. is likely to indirectly default on its debt.

Big Cajun Man looks at the advantages and disadvantages of online financial services.

Financial Highway explains how to answer the 30 most common interview questions.

Million Dollar Journey has some fun asking people what is the cheapest thing they've ever done.

Money Smarts is having a tough time in a stock picking contest.

Thursday, April 7, 2011

New Stock Option Tax Relief Slow Getting Sorted Out

Back in March 2010 the federal government announced in the 2010 budget some relief for taxpayers caught in a situation where they had to pay taxes on employee stock option paper gains (also called phantom gains). At long last the tax relief is flowing.

The problem was that the gains on these options were considered a separate category of income from the subsequent capital losses on the shares acquired with the stock options. So, taxpayers were unable to offset the gains with the losses. The result was that many taxpayers owed much more in taxes than the actual shares were worth.

The provision in the 2010 budget allows taxpayers to offset the gains and losses as long as they agree to pay a special penalty tax equal to the full amount of the proceeds from selling the shares. This may seem punitive, but it actually works out to be a big improvement for those whose finances would be devastated by an otherwise enormous tax bill.

Announced budgets don’t become law immediately. In this case the relevant legislation became law in December. Shortly thereafter, CRA made the RC310 form available to allow taxpayers to elect to take the new tax treatment. However, in my case it took about 15 weeks to get my refund. Luckier people got theirs sooner, but complications relating to the Alternative Minimum Tax delayed processing some of these RC310 forms.

I don’t know how many other taxpayers are still in limbo, but the people I know who are in this situation have had their cases resolved.

Wednesday, April 6, 2011

Technical Problem at BMO Investorline gives a Scare

I’ve been quite happy with my service from BMO Investorline, but yesterday morning when I logged in to my accounts, the cash balances all showed zero. The possible explanations ranged from mostly harmless to scary thoughts of identity theft.

Unfortunately, I wasn’t able to get through to Investorline on the phone until a couple of hours later. Eventually I spoke to a pleasant guy who assured me that it was just some technical glitch. He was able to read the correct cash balances to me.

This would have been less disruptive to my day if the system was able to detect that the cash balances made no sense and presented some sort of error message rather than just showing zeros. I still have no idea of how widespread the problem was.

This brings me to another minor annoyance with Investorline: stale account information. The information presented to me online is from the previous day. There are times when the information seems to be more stale than just one day. Most of the time this delay is harmless, but every so often I want to know if a transaction took place and waiting a full day or more is inconvenient.

Overall I’ve been pleased by Investorline over the years, but I’d like my account access to be more stable and more timely.

Tuesday, April 5, 2011

Entering Useless Information on Your Tax Return

Tax time is no fun. I think most people would rather go to the dentist than file their taxes. Fortunately, in this modern era where tax preparation software does much of the work, filing taxes isn’t as painful as it used to be. I’m going to make a case for doing a little extra work at tax time that can lead to a larger refund now or in the future.

Many tax deductions have an income test. This means that if you earn too much, you get no benefit from the deduction. Two examples of this are deductions for property tax paid and medical expenses. There are many others.

Taxpayers who enter expenses year after year only to find that they don’t make any difference to their refund or taxes owed can be forgiven for not seeing the point of the extra work. Eventually, some decide not to bother entering the deductions any more. This can be a mistake.

I was helping a family member file his taxes recently and came across this situation with property taxes. He hadn’t bothered to enter property tax information because “it never makes a difference.” But, it turned out that a change in his situation for 2010 resulted in the property taxes making a substantial difference.

Even if these expenses don’t make a difference right now, this may change if your return gets reassessed. The change that causes the reassessment might result in some expense making a difference when it hadn’t before.

It is fairly painless to enter information into tax software and it may be worthwhile even if you feel sure that the information won’t make a difference.

Monday, April 4, 2011

Worthless Financial Articles

Have you ever noticed your favourite blog include an article that seems out of character with the blog’s usual content? This could be a sign that someone has paid to place the article on the blog. The number of offers I get to place a paid article has grown from a rare email to a barrage of spam.

I don’t object in principle to paid articles if they are useful to readers, but too often they contain recycled fluff that is of little use to anyone. I’m not an idealist here. Bloggers have to get paid somehow for the work they do. The subscription model doesn’t seem to work. I use advertising, but I prefer to make it clear what is advertising and what is content. Paid articles blur this boundary.

In a typical case where an email offer makes any sense at all, I’m offered a unique article on a subject of my choice that will not get reused anywhere else. In return, I’m to let the writer include some links on key words within the article to a web site where they want to drive traffic.

The email offer often contains links to examples of their work, and all too often the articles are just a pile of words with no real point. My articles may not all be gems, but I write them with the goal of conveying useful information.

Many of the paid article offers make little sense at all. Others can be amusing. In one email, the sender claimed to be affiliated with a prestigious publication, but she spelled her name differently in two places. When people use their real names, I don’t think they get the spelling wrong very often.

Another category of offers is money for adding an advertising text link to my blog. In this case, the organization paying for the text link doesn’t really care if the text link is very visible or ever gets used. The goal is to improve the Google PageRank of the target web site. Every link to a site raises its PageRank and the higher my site’s PageRank, the more it helps the target web site’s PageRank.

All these efforts at search engine optimization (SEO) tend to pollute Google search results. Google is constantly working to punish web sites involved in useless paid links that are designed to improve PageRank numbers. I don’t bother with these paid links.

I’m all for trying to make money, and I’m interested in new ideas, but not at the expense of the usefulness of my site for readers.

Friday, April 1, 2011

Short Takes: House Insurance and more

I’ll use the fact that it’s Friday as an excuse for not coming up with something clever for April Fools’ Day this year. As inadequate compensation, I’ve got more opinions than usual about the posts I’m highlighting this week.

Rob Carrick explains that the increasing cost of house insurance is largely due to water damage. An insurance company executive is quoted as saying that the cost of house insurance is actually coming down when measured as the cost per $1000 of coverage. I wonder if this is $1000 worth of house or if it is $1000 worth of property including land. If it is the latter, I’m not impressed. The earth my house sits on has been growing in value faster than my house, but insurance costs are more closely related to the replacement cost of just my house.

Canadian Tax Resource explains the complications that result when withdrawing money from a spousal RRSP less than 3 years after the last spousal contribution. The bottom line is that you should avoid breaking the 3-year rule if you can.

Canadian Mortgage Trends explains the interest rate differential (IRD) penalty that you have to pay when you break a mortgage. The principal behind IRDs is sound in that it compensates the bank for losses on a profitable mortgage. You get the benefit if you lock in and rates go up. The bank should benefit if you lock in and rates go down. The problem is the games that banks play with the “comparison rate” that is used to calculate the amount of the IRD. You could also make a case for taking into account mortgage provisions that allow you to increase payments or make lump sum payments once per year.

Money Smarts explains why Canadians aren’t actually withdrawing money from their RRSPs at an alarming rate. Some scary statistics can be explained by the distinction between RRSPs and RRIFs.

Big Cajun Man isn’t too happy with Pay Day Loan companies.

Financial Highway offers some reasons for keeping your land line. The fact that a post like this exists is evidence that many people are choosing to drop their land lines.