Thursday, June 30, 2011

Short Takes: Bell Slapped on the Wrist and more

Have a happy Canada Day! Here are this week’s short takes a day early.

Bell Canada will pay $10 million for using misleading advertising. The Competition Bureau found that Bell advertised prices not available to consumers without additional mandatory fees disclosed only in fine print. Bell’s defense is that their advertising is “comparable with common advertising practice past and present in the communications marketplace and other industries in Canada.” Sadly, this is largely true; many other companies advertise misleading prices.

Big Cajun Man witnessed an injury that derailed the future plans of a young athlete which prompted him to look at whether we have a “plan B” for financial disasters.

Money Smarts goes through the basics of how to buy an ETF using a Canadian discount brokerage. This is useful for novices who may feel intimidated by the process.

Retire Happy Blog explains why a “free” consultation from a financial advisor may not be in your best interests.

Wednesday, June 29, 2011

Reader Response on Gasoline Taxes

A reader sent some thoughtful criticism on my article on gasoline taxes. This criticism forced me to organize my thoughts. Her lightly edited remarks follow.
“Everyone gets hurt by gas taxes because they drive up the cost of doing business and the price we all pay for everything. And they’re regressive, because the people who can least afford the increased prices are the poor. Mixing social engineering with tax policy may make the environmentalist and cycling lobbies feel good, but if green energy isn’t competitive (and frankly it never seems to be), manipulating the market with taxes to disadvantage other energies really isn’t the right solution.”
There are several arguments here. Let me take them one-by-one.

Gasoline taxes drive up all costs

This is largely true. However, all taxes drive up costs. They drive up costs by exactly the amount of tax money collected. It’s true that gasoline taxes drive up the costs of almost all goods and services, but so does the HST. Income taxes also drive up costs. I have to earn a lot more than $100 to be able to buy $100 worth of groceries. I see no reason why gasoline taxes are any better or worse than income taxes or sales taxes.

Gasoline taxes are regressive

This is also true. When we talk about progressive and regressive taxes, we’re talking about how much is paid by poor and wealthy people. Our progressive income tax system takes ever higher percentages of your income as you move up in the tax brackets.

However, there is a limit to how much progressiveness is desirable. In the extreme, suppose that the richest person pays all taxes and the rest of us live tax-free. I think we can agree that this won’t work.

At the regressive extreme, suppose that we just demand $10,000 in taxes each year from every adult. This obviously won’t work either. If both extremes are no good, then there is some optimum level of progressiveness. However, we may disagree on what level is optimal.

The fact that gasoline taxes are regressive doesn’t automatically make them either good or bad. We must take a look at the total tax burden we face to judge whether we are at the right level of progressiveness. We shouldn’t just limit all tax changes to those that make the system more progressive.

Green Energy Isn’t Competitive

At present this is true. However, the side effects of polluting energies are externalities. This means that cleaning up the mess caused by burning oil is not paid for by those who burn the oil. To balance the playing field, we need to subsidize green energies. The hope is that over time these energies will become cheaper to produce.

We can disagree on how much the green energies should be subsidized, but I don’t think it is reasonable to compare current green energy costs to the cost of burning fossil fuels without factoring in the fossil fuel externalities.

Tuesday, June 28, 2011

Currency Conversion Costs

For years I freely bought and sold U.S. stocks without giving too much thought to the cost of converting between U.S. and Canadian dollars. I tended to worry much more about the visible trading commissions. After combing through some old trading information, I’ve found that my currency conversion costs were much higher than the commissions I paid.

I looked over all my trades since I began investing on my own about 13 or so years ago. I identified all the trades of U.S. stocks where I settled the trade in Canadian dollars. My discount broker, BMO Investorline, conveniently handled the currency conversion as part of the trade. I eliminated cases where the trade value was less than US$2500 and where I used wash trading. (Wash trading is a way to eliminate currency exchange costs on round-trip currency conversions). This left 49 trades.

For each trade I looked up the fair U.S./Canadian dollar exchange rate on the day in question to calculate how much extra I paid above this fair exchange rate. Of course there were differences between the noon exchange rate quoted in historical data and the actual exchange rate at the time of day I did each trade. However, averaged out over 49 trades, these small differences tend to balance out.

This process gave me the following totals (in Canadian dollars):

$7374 – total extra currency exchange costs
$1813 – total commissions paid (I made many trades before commissions dropped to the now typical $10 or less)

For all the attention I focused on commissions, I was paying about 4 times more for the partially hidden currency exchange costs. This looks even worse with today’s trading commissions: If I had paid US$10 per trade, the total commissions would only have been about $600, which is only about one-twelfth of the actual currency exchange costs I paid.

If the currency exchange method described by Canadian Capitalist (using the ETF DLR) had existed (with $10 commissions) when I made these trades I could have reduced my currency exchange costs to $3011 (saving $4363 compared to what Investorline charged me).

The bottom line is that currency conversions are more expensive than they seem. Investors should pay attention to these costs.

Monday, June 27, 2011

Ontario NDP Announce SUV Subsidy

Okay, the Ontario NDP actually announced plans to reduce gasoline taxes. To me this is an SUV subsidy. Oh, and it’s an oil company subsidy too.

I get that people are unhappy about the high cost of gasoline, but if we reduce gasoline taxes, we’ll have to increase some other form of tax. This would punish the responsible people who have efficient vehicles and reward people who have gas-guzzlers.

Another unpleasant side effect of lowering gasoline taxes is that it indirectly makes it more difficult for green energies to compete. It would also increase the number of cars on the road. The only positive I can see is that it might buy some votes.

Friday, June 24, 2011

Short Takes: 4-Letter Financial Words and more

Money Smarts isn’t as optimistic that these new disclosure rules would help investors much. I’m more optimistic, but I would be happy with this change even if it only makes a small difference.

Scott Ronalds at the Steadyhand Blog bemoans the fact that (mutual) “fund” has become a dirty word and predicts that the same fate awaits other 4-letter words like bond, debt, and gold.

The Blunt Bean Counter explains how CRA applies penalties for failing to report income: two strikes and you’re out.

Retire Happy Blog answers the question of how much debt is too much by explaining debt servicing ratios as well as signs of debt problems.

Big Cajun Man has an amusing list of the top 5 reasons why you are in debt. You’ll notice a pattern.

Thursday, June 23, 2011

Making Sense of Insurance Coverage with Credit Cards

This blog gets a flood of announcements every day that we mostly ignore, but a quirky web site called Credit Card Navigator that seeks to educate consumers about the insurance coverage they get from using credit cards caught my eye. (Disclaimer: We have no connection to this web site and receive no money from them.)

In the “about” section of the site, they tell a story about getting caught without insurance on a car rental and how this drove them to help others avoid the problems they faced. The insurance toolkit section has a “compare cards” section that lets you choose your credit card to see what kind of coverage it offers in many different categories. In the “find the card you need” section you can pick various coverages and you’ll be shown which cards give you what you want.

I found it interesting to see what insurance features various credit cards have. I also found it interesting that it wasn’t obvious how the web site will be monetised. Could they be true believers?

I’d be interested to know whether any knowledgeable readers find the site accurate and helpful. I’m always suspicious of the motives of anyone who has a site connected to credit cards, but I didn’t find this one to be an obvious credit-card promoter.

Wednesday, June 22, 2011

Seeking Perfect Asset Allocation Has Its Dangers

A recent Canadian Capitalist article on Burton Malkiel's Contradictory Advice generated comments discussing what constitutes proper asset allocation for passive investors. I think these worries can lead investors to make bigger mistakes than just having an imperfect asset allocation.

Malkiel advocates an increased allocation to Chinese equities. Some argue that this makes sense because the Chinese stock market is small relative to its GDP. Others observe that Malkiel's advice is self-serving because he is associated with Chinese ETFs. I think the debate about the perfect asset allocation is less important than the benefit of sticking to a plan.

It is true that improving your asset allocation to the best percentages of various assets classes (bonds/stocks, domestic/foreign, large-cap/small-cap, etc.) may give a small boost to returns for a given level of risk. However, any reasonable allocation that matches your risk tolerance is likely to be close enough. The real concern is whether you frequently jump to the latest and greatest allocation.

What might look like clever shifts to ever more sophisticated asset allocations may be just a case of chasing the latest hot trend. If you were persuaded by the arguments to buy more Chinese equities, are you seeking exposure proportional to the Chinese GDP or is the real reason that China seems hot right now?

As Canadian Capitalist says, could you be persuaded to add First Trust NASDAQ CEA Smartphone ETF (FONE) because "Smartphones are pretty hot these days"? The world is full of temptations to deviate from passive investing. Even the prospect of better passive investing can be just performance chasing in disguise if you make frequent changes.

Tuesday, June 21, 2011

Larry Swedroe Makes the Case for Passive Investing

I had the pleasure of listening to Larry Swedroe speak last night about the benefits of passive investing. Swedroe is the Director of Research for the Buckingham Family of Financial Services, is the author of several solid books on investing, and writes the Wise Investing blog.

Many arguments about the merits of passive and active investing boil down to ideology, but Swedroe doesn’t bother with ideology; he looks at data. He is driven by the science of investing and answers his critics with data. If someone comes along with data showing that some active strategy can beat the market, then he can be convinced. But he has seen precious little such evidence.

An interesting statistic Swedroe gave was that while passive investing among institutional investors has gone from 15% to 60% over the last 25 years, among individual investors the number using passive methods has only gone from 1% to 15% over those 25 years. Perhaps institutional investors know something that most of the rest of us don’t know, yet.

Another statistic was that 90% of all trades are made by big institutions. So when you buy a stock, odds are strong that a big institution sold it to you because they thought it was better not to own the stock. Do you really think you can know more about the business you’re buying than a large institution?

Apparently being smart doesn’t help. A Mensa investing club underperformed the market by almost 13% per year for 15 years! This is a brutal result. This means they were left with about one-eighth as much money as they would have had if they had invested in the index.

A closing remark from Swedroe was that active investing “is the triumph of hype, hope and marketing over wisdom and experience.”

Monday, June 20, 2011

Real Estate Loops

When selling your home it’s quite common for a buyer to make an offer that is conditional on the buyer selling his or her own home. Your buyer might then receive a conditional offer on his or her own home. This can lead to a chain of homes that will all be sold like dominos if someone makes an unconditional offer on the first home in the chain. An interesting situation arises when a chain of conditional offers forms a loop.

It’s not uncommon for two people to buy each other’s homes. But what if we a have a loop of three people? Suppose that A makes a conditional offer on B’s home, B makes a conditional offer on C’s home, and C makes a conditional offer on A’s home? If everyone is aware of this loop then all the deals can close. But if nobody becomes aware of the loop then it’s possible for all of the deals to expire and no homes get sold.

Longer loops are possible as well. I’d be interested to know whether real estate brokers share enough information to try to detect such loops. Loops may not be common but brokers are leaving money on the table if they fail to notice them.

Friday, June 17, 2011

Short Takes: Combating IPO-Hype, Motivating Banking Regulations, and more

The Blunt Bean Counter explains enough about IPOs (Initial Public Offerings) to understand why they are best avoided by most investors. I’ve been on the friends and family side of an IPO and I can say that it was nice to know that I had a nice profit built in to the price I paid for shares. But I wouldn’t have wanted to buy those shares on the open market.

Tom Bradley has a short story explaining clearly why we should support banking regulations.

Gail Vaz-Oxlade makes the case for spouses to maintain independent finances (in a post no longer online). I agree, but perhaps for different reasons. I like to know exactly what is going on in my various accounts. Another person making transactions could lead to bounced cheques and other misunderstandings. My wife and I freely give each other money when necessary because we consider all money to belong to both of us. We don’t spend large sums without discussing it first regardless of whose account holds the money. But this sharing of all money doesn’t extend to meddling in each other’s accounts.

Money Smarts explains the differences between a group RESP and a self-directed RESP.

Big Cajun Man has some advice on how to handle yourself at a job fair.

Million Dollar Journey has some ideas on how to maximize your loyalty reward points.

Thursday, June 16, 2011

Hockey Lessons that Don’t Carry Over to Personal Finance

The Vancouver Canucks were outscored by the Boston Bruins 23-8 in the Stanley Cup finals, and yet the Canucks managed to win 3 games and stretch the series to a deciding seventh game. A lesson here is that the margin of victory in each game isn’t important. However, this sports lesson does not carry over to personal finance.

When it comes to your money, the margin of victory (or loss) matters a great deal. A single poor choice when buying a car can cost you more than the total savings in years of carefully finding the cheapest gas prices. It’s dangerous to scrimp on small things and use this as a justification for splurging on something expensive.

Psychology plays a role here. Sometimes when we know that we’re spending money we shouldn’t spend, we think “if I’m going to break the rules, I might as well go all the way.” This way of thinking is just as wrong with finances as it is with diet. Having one cookie or ten cookies may both violate the rules for a particular diet, but small transgressions are clearly better than big ones.

In hockey we only count the number of battles (games) won, but in personal finance, we add up the margins of victory of all the individual battles.

Wednesday, June 15, 2011

Keep the Big Picture in Mind When Minimizing Costs

Many of us work hard to keep our expenses to a minimum. The problem comes when we focus too closely on one type of cost, such as taxes, without considering the big picture.

The Blunt Bean Counter has some great examples of people making big mistakes when trying to reduce their taxes. In one case, an investor managed to avoid probate costs only to get hit with capital gains taxes which were 15 times bigger.

Another example comes from our obsession with gasoline prices. It’s a good idea to look for lower gas prices, but some people take this too far. Saving 4 cents per litre on a 50-litre fill-up saves only $2. If you have to drive across town for the lower price and burn 2 litres of gas, you’re actually behind even before valuing your time and wear and tear on your car.

Saving money often becomes an emotional goal rather than a rational goal. If you’re satisfying your emotional need for certain types of savings but are actually losing money in the big-picture view, your finances may be headed south.

Tuesday, June 14, 2011

Ontario NDP Cannot Violate Economic Laws

Ontario New Democratic Leader Andrea Horwath is promising to address the high cost of gasoline with weekly price caps. This is likely to play well with voters because it sounds like gas prices would be lower. But Ontario cannot really do much about the price of gasoline because it is set in the international marketplace.

Looking at the details of Horwath’s statements, the NDP isn’t really promising lower gas prices. What they are promising is reduced short-term volatility. Horwath says “the point is not to keep prices artificially low” but rather “to stop the oil industry from price gouging.” But most voters will surely see a promised end to “price gouging” as lower prices.

The truth is that forcing prices lower will result in shortages unless the government subsidizes our consumption of gasoline through reduced gasoline taxes or direct subsidy. The classic price-quantity curve of economics applies: if the price is lower than the equilibrium point, then demand will exceed supply leading to shortages.

Rather than complain endlessly about the inevitable climb of gasoline prices, Canadians need to embrace alternative energies. These alternatives are expensive now, but as we learn to exploit other energy sources more efficiently their prices will come down while oil prices continue to climb.

Monday, June 13, 2011

Lines of Credit Undermine Personal Finance

David Chilton, author of The Wealthy Barber, says that “The worst thing that’s happening to Canadians in the last 20 years has been lines of credit.” I think the reason for this is more than just the temptation of available credit.

Chilton popularized the idea of paying yourself first by saving 10% off the top each time you get paid. A big problem with lines of credit is that it undermines your ability to know whether you’re truly saving any money. Moving $500 into your RRSP may not help much if you also borrow another $1000 on your line of credit.

Back when Chilton wrote The Wealthy Barber, the world was a different place. People who saved 10% of their pay and managed to pay their mortgage and any other fixed-payment debts could have some confidence that they were making progress in their personal finances. But today, with a varying debt in a line of credit, it isn’t obvious whether we’re making progress. Over time we can see if we’re falling behind, but we don’t have the immediacy of running out of money before the next pay day to help us curb our spending.

It’s true that many people simply can’t resist the temptation of dipping into lines of credit, but even for those of us who try to do the right thing financially, lines of credit undermine our ability to determine in a given month whether we’ve made progress or have fallen further behind.

Friday, June 10, 2011

Short Takes: User Fees, Misleading Stock-Picking Performance, and more

The Canadian Conservative government is considering user fees as a way to cut the deficit. The claim that this is not a tax hike is annoying because it is a tax hike. There may be important differences between user fees and higher general tax revenues, but both are still tax increases. If I used to get a service paid for by part of my tax payment and later I have to pay a user fee in addition to paying that part of my taxes, then I have experienced a tax increase.

Jason Zweig explores the epidemic of stock pickers who compare their performance with dividends to the index without dividends. My softball team would be doing better if half of our opponent’s runs didn’t count.

Money Smarts explains how to get a guaranteed 20% return with new RESP contributions after your child has started school.

Retire Happy rounds up various opinions on Vanguard’s launch into Canada. Hopefully Vanguard’s investor-friendly practices in the U.S. will carry over to their Canadian operations.

The Blunt Bean Counter explains the interesting conflict between Sino Forrest Corporation and Muddy Waters Research who accuse Sino Forrest of fraud. It’s not clear whether this is a case of fraud or one of deliberate stock manipulation. Blessed by the Potato has also been following this story with a series of posts.

Big Cajun Man is suspicious of a golf pro’s advice to buy golf lessons and new clubs.

Million Dollar Journey asks the question of whether one can save too much at the expense of the present. I think the answer is yes, but this applies to extremely few people. Further, my guess is that many people will use the saving-too-much argument to justify their reckless spending.

Thursday, June 9, 2011

Financial Recovery

This is a book review by Mrs. James who I thought might better understand the emotional side of money and whether this book might actually help people with money troubles, not that she's necessarily nice to people who handle money poorly.

The book Financial Recovery by Karen McCall makes a link between our relationship with money and how that relationship affects how we make money, how we spend money and how we save money.

This book does a good job explaining some of the behaviours I have seen in friends and colleagues concerning how they handle their money and what decisions they make that seem to an outsider to be completely self destructive with respect to their finances but are an undeniable pattern. The wife who buys herself something expensive just because her husband went out with the boys is likely substituting an object for the attention she feels she is not getting from her husband. The person who knows that they don’t have enough to pay the bills so they simply stuff the envelopes unopened into a drawer and hope they go away.

Seems easy to fix, right? Well, McCall says that it is as long as you can change your relationship with money, starting with being aware of what is actually going on. Letting go of the shame associated with feeling like a bad money manager is essential. Being conscious of income and expenses, regular as well as periodic, is the first step to getting out of crushing debt.

One key point McCall makes is that in order to have a healthy relationship with money we need to fully understand the difference between a “want” and a “need”. Her explanation of a “want” is something that entertains us while a “need” is something that sustains us.

Throughout the book, exercises are used to bring awareness to the different aspects of financial matters in a manner not intended to blame the reader for bad habits or poor decisions but to provide information which can then be used to make good choices based on the reader’s individual wants and needs.

The first part of the process to get to financial recovery is to track everything. For expenses, tracking is done for cash, credit and cheques and the amounts are separated into different categories and subsections. For example, food could be broken down into groceries, lunch out, drive through and so on. In some ways I can see this being the most difficult part of the process. For me, it would certainly change what I bought so I wouldn’t have to write down something frivolous on the sheet.

The second part is to create a monthly spending plan. Examples in the book give a good sense of the types of things that should be included in such a plan. The idea isn’t to create an austerity budget but to keep in mind the wants and needs that were identified and to be creative in meeting those desires in a spending plan. A similar exercise follows for an annual spending plan. This seemed to be quite a useful exercise.

The final part is “Saving your way out of debt”. This section seemed to hurt my brain a bit since it recommended building up a savings account before paying off credit card debt. The idea goes back to your relationship with money and credit cards and attempting to change how you use, or more specifically, don’t use credit cards. Her advice is to stop accumulating debt first. So, you build some savings to handle your spending plan (which includes some debt repayment and non-periodic expenses) instead of yo-yo-ing your credit card debt. Once you stop accumulated debt, there will be money to pay off the debt. The idea is that the benefit of changing your habits is worth the interest difference between the savings account and the credit cards.

I think the main take away message from this book is to not bury your head in the sand, to understand what it is you want and need from life, to rationally develop a plan to get you there and to not beat yourself up if you falter. With your head out of the sand, you can compensate for your mistakes. The tools are similar to those presented in other books but the idea of looking at your own personal biases on earning and spending money make this an interesting read.

Wednesday, June 8, 2011

The Many Definitions of Active and Passive Investors

A post over at Boomer & Echo made me realize that the terms “active” and “passive” have multiple definitions when it comes to investing. This can lead to confusion.

The most technical definition of active/passive relates to investor goals for returns:

Defintion 1.

Active Investor: One who seeks to outperform the market averages. This is usually done by either attempting to make better short-term trades or by trying to choose better stocks for the long term. Most active investors fail to beat the market, but each year some succeed.

Passive Investor: One who chooses to own one or more indexes of stocks, bonds, or other assets. This type of investor usually seeks to minimize costs to get returns as close as possible to market averages.

Another definition relates to how frequently an investor makes trades.

Definition 2.

Active Investor: One who makes frequent equity trades.

Passive Investor: One who trades equities infrequently.

A third definition relates to how involved an investor is in the business of investing his or her money.

Definition 3.

Active Investor: One who takes a do-it-yourself approach with investing.

Passive Investor: One who hands control of his or her investments to a professional.

I am now a passive investor in the sense that I invest in broad indexes, and passive in the sense that I trade infrequently, but I’m active in the do-it-yourself sense. Warren Buffett is active in terms of stock picking and handling his own investments, but is passive in the sense of trading infrequently.

It would be nice to have everyone agree to use different terms for all these definitions, but I’m not holding my breath.

Tuesday, June 7, 2011

Vanguard’s Move to Canada Encouraging but Initially Disappointing

Vanguard has made a formal announcement that they will be entering the Canadian investment market, but here are few details yet on what ETF or mutual fund products will be available.

This announcement is initially disappointing because “Vanguard’s initial focus in Canada will be to offer investment products to Canadian investors through investment advisors.” While some investors prefer to get advice from an investment advisor, many of us prefer to save the added cost and make our own choices. Vanguard’s offerings are unlikely to be of much interest to me until I can purchase ETFs directly on a stock exchange.

On the other hand, Vanguard’s U.S. products have been so beneficial to American investors that the prospect of having them do the same for Canada is very exciting. If I were an American, I would likely have all my long-term savings invested in a small number of Vanguard broad index ETFs.

Canadians can buy the American version of these ETFs, but this creates two potential problems: currency conversion costs and U.S. estate taxes. It is challenging for Canadians to invest in ETFs that are bought and sold in U.S. dollars without paying unreasonable fees for converting between U.S. and Canadian dollars. Knowledgeable investors can usually avoid the bulk of such costs with some inconvenience, but many investors simply pay the high currency-conversion costs.

Thoughtful readers might observe that currency conversion is inevitable when buying U.S. equities. If a U.S. stock ETF is bought and sold in Canadian dollars, then a conversion is needed before the fund buys U.S. stocks. However, Vanguard is much more able to convert currencies cheaply than I am.

Note that this currency conversion problem is unrelated to the currency hedging that is done in many ETFs that hold foreign investments. I won’t be interested in any Vanguard products that include currency hedging.

The second problem of U.S. estate taxes applies the larger portfolios. Beyond a certain threshold portfolio size, your estate may have to pay taxes in the U.S. The rules for U.S. estate taxes have changed a few times over the last couple of decades and it’s difficult to predict what will happen in the future. It’s also difficult for me to predict when I’ll die and how much money my estate will have. This makes planning for estate taxes tricky.

I’d be thrilled to have Vanguard bring their investor-friendly products to Canada in a way that do-it-yourself investors can buy directly. Hopefully, they will offer products that minimize currency conversion costs and minimize the likelihood of getting ensnared by U.S. estate taxes. An additional hope is that Vanguard will eventually make it possible for Canadian investors to invest in foreign assets much more cheaply than they can right now.

Monday, June 6, 2011

Market Predictions Encourage Risky Investing

A quote I saw in a recent covered call article got me thinking. Rob Carrick quoted Eden Rahim, who was speaking about a particular Horizons covered call ETF product:

“If you’re a super bull and think the market is going to advance vertically, this product is not for you ... If you think the market is going to do something other than advance vertically, as it has in the past couple of years, then this is something to consider.”

This way of thinking about investing feeds two types of magical thinking. (And to be clear, I’m not accusing either Carrick or Rahim of magical thinking.) The first is more obviously silly when exposed: the market can only have one outcome at a time. It can’t “advance vertically” for me but do something else for other people. If two people have opposite market guesses, at least one will be wrong.

The second type of magical thinking is that we can somehow know what the market will do with certainty. The market will rise, drop, or stay the same with some probabilities. It’s conceivable that some people may have better insight into the probabilities, but nobody can rule out some of the outcomes with certainty.

This means that an investor who thinks the market will go up and makes a large bet on this guess without thinking of the consequences if he or she is wrong may be taking on undue risk. Investors should always be thinking about what will happen if the market moves against them.

This carries over into other areas as well. Homeowners would do well to consider how their finances will handle it if house prices triple or get cut in half over the next decade. We’re most likely to have an outcome in between, but we must consider the full range of possibilities.

Friday, June 3, 2011

Short Takes: Saving the Bank Ombudsman and more

Rob Carrick is drumming up support for the Ombudsman for Banking Services and Investments (OBSI). The big banks are gearing up to do away with the OBSI which may be reason enough for consumers to oppose such a change. OBSI provides a no-cost place to resolve disputes with the financial industry and even if it isnt perfect, it may be worth saving.

Money Smarts answers a reader question about how to make sure that RESP money not used by one child will be available for younger children.

Preet Banerjee explains that almost anyone can call themselves a financial planner in Canada.

Big Cajun Man takes an interesting romp through his life to explain why hes not rich.

Retire Happy Blog explains the retirement sweet spot when it comes to income taxes.

Million Dollar Journey marches ever closer to the end of the journey. I look forward to the name change: Ten Million Dollar Journey.

Thursday, June 2, 2011

Stopping Payment on Cheques is not Guaranteed

Despite the fact that we are in a world of electronic payments, I find I still write some paper cheques. Occasionally I've had to stop payment on a cheque or someone sending me a cheque has stopped payment. However, these stops don’t always work.

My wife did a little research and found that stopping a cheque isn’t cheap: $25 at TD, $10 online at RBC, $15 in a branch at RBC, and $10 at ING (with one free stop per year). These costs won’t break the bank, but for this money you’d think that the service would work.

Over the years my wife and I have been involved in several cases where either we tried to stop payment on a cheque or someone else stopped payment on a cheque sent to us. In 3 of these cases an attempt was made to cash the cheque and the stop worked for only one of the 3 cheques.

This is a very small sample, but 1 out of 3 isn’t a good success rate. I’d be interested to know whether readers have had experience with stopping cheques and whether the stops actually worked.

Wednesday, June 1, 2011

The High Price of Smooth Cash Flow

Most people cannot handle irregular pay and expenses very well. They have a strong need for smooth, predictable incoming and outgoing cash flow and they pay a high price for this predictability. This need is apparent with car purchases, once per year expenses, employer supplemental health insurance, and other areas.


The best way to buy a car in most cases is for cash, but few people do this. Even car loans don’t smooth out the costs enough for many car buyers because the monthly payments last for only the first 3-6 years of the car’s life. Car leases offer a way to reduce periodic payments now and defer part of the car’s cost until years later.

Car leases are sufficiently complicated that few people really know how much they pay for a leased car. When the customer doesn’t understand the numbers, this gives dealerships a big negotiating edge. We pay a high price for low lease payments.

Yearly Expenses

For many types of yearly expenses like property taxes and car and house insurance, we have the option of paying monthly instead of yearly. However, the monthly payments typically add up to more than the yearly lump-sum amount. The implied interest rate is often very high, but this matters little for those in a perpetual cash-flow crunch.

Employer Supplemental Health Insurance

The primary purpose of insurance is to cover very large losses that have a low chance of happening. This is not what is covered by supplementary health insurance provided by Canadian employers. These plans only cover fairly small costs and the total benefit amount usually has a number of different caps so that there is no protection against major health care costs.

It would be much more efficient to simply pay workers more so that they can pay for their own glasses and dentist visits, and have the employer offer insurance against only very large expenses. The overhead of running small expenses through an insurance company is very high. But the problem is that even the cost of new reading glasses can tip the cash-flow balance for many people. These people need the costly insurance for cash-flow reasons even though they’d be better off having their pay increased by more than their expected insurance claims.

Too many financial decisions are driven by short-term cash flow considerations rather than total cost. We are better off when we are solvent in the short term so that we can make better long-term decisions. The simple ability to build and maintain a cash buffer can be very profitable.