In many aspects of personal finance, you have a choice of whether to protect yourself with a safety margin or with some form of insurance. This won’t make much sense until we look at some examples. Mortgages Many homeowners worry that interest rates will rise and make their payments unaffordable. This can make long mortgage terms with fixed interest rates seem more attractive. However, long-term fixed rates are higher than variable interest rates. As Jim Somerville explains in this post , the extra interest is a form of insurance against future interest rate increases. Suppose that your bank says that you can get a mortgage for up to $300,000. If you get a mortgage this big, then you may need to lock it in for a long term because a spike in interest rates might ruin you. But, if you get a smaller house with a $200,000 mortgage, you’ll have a margin of safety that makes it possible to save interest costs by taking a variable-rate mortgage. If mortgage rates remain steady, then the...

While driving for about 11 hours to bring my son home from university, I was struck by the fact that high gas prices don’t seem to have reduced the number of cars on the road very noticeably. You can’t tell much from one day, but I haven’t noticed much difference in day-to-day driving either. Gas prices have risen about 50% in my area over the last year and a half. Some days I imagine that there are fewer cars on the road, but other days I’m not so sure. It’s likely that more people are taking the bus, but the difference hasn’t been enough to shorten the duration of my commutes perceptibly. Either demand for gasoline is less elastic than I would have guessed, or the effect is delayed. Perhaps, even if gas prices were to stabilize at current levels, demand would continue to drop as people feel the cumulative pain of paying high prices for a long time. I had hoped that a small benefit of rising gas prices would be less congested roads. Has anyone else noticed a difference?

Warren Buffett’s company, Berkshire Hathaway, has sold put options on four stock indexes including the US S&P 500. These are essentially bets that the value of the stocks in the indexes will go up. This is curious considering that Buffett was quoted in the rest of the article saying that stock market returns will be less than people think. This isn’t necessarily contradictory, though. The put option prices may have simply been too good for Berkshire to pass up. In these transactions, Berkshire is providing insurance to stock investors. Berkshire has collected option premiums from the investors and has promised to cover these investors if their stock doesn’t rise to agreed upon prices at some point in the future (between 2019 and 2027). Given Buffett’s lifetime investment record, it seems safe to assume that these put options were mispriced and that Berkshire collected large enough premiums that these transactions are expected to be profitable for Berkshire. I wonder if ...

The Big Cajun Man over at the Canadian Personal Financial Blog asked for insights into his spending habits in this post . Like many people, he’d like to spend less and save more, but reality is not exactly matching his wishes. The best way I know of to do this is to shorten the time from spending money to when you realize that you’ve spent too much. Most of us know the futility of yelling at a dog hours after it misbehaves. Controlling the way a dog behaves requires that rewards and punishments come right away. People are more sophisticated than dogs, but similar principles apply. When using credit cards, people can overspend for about a month before the statement arrives giving feedback on what they’ve done wrong. Even then, the minimum payment is manageable and the real problem can be ignored. Many young people go for years overspending until various interest payments build up to the point where they can’t keep up. Most people need negative feedback about their overspend...

The question of whether the economy is in recession always seems to be more confusing than it should be. Can’t someone just add up all the right numbers and tell us? According to Wikipedia’s Recession page , the standard definition of a recession is when a country’s gross domestic product declines for two or more successive quarters. This means that we can’t say for certain whether we are in a recession until 6 months after the recession starts. This gives pundits and experts at least 6 months to speculate on whether we are in a recession before the matter is settled. This is like having 9 innings to argue about which team is going to win a baseball game. No amount of careful study can say for certain who will win the game until it is over. Similarly, no amount of careful accounting can say for certain that the economy is in recession until the 6 months of decline have happened. The U.S. Commerce Department says that the economy grew by 0.6% (annualized) in the first quarter. Thi...

Yesterday I asked why anyone would get a mortgage with one of Canada’s big 5 banks considering that their advertised interest rates are much higher than other lenders . I got some useful responses from readers. Like most things in life, the price of a mortgage is negotiable. The big banks do give mortgages at rates much lower than their advertised rates, but you have to negotiate to get these low rates. Using the ideas from the reader responses, here is one possible strategy for getting a good interest rate on your mortgage: 1. Go to a financial institution that offers low advertised interest rates and negotiate a mortgage rate. Choose an institution that you would be willing to actually use for your mortgage; you may end up coming back if you can’t get a better deal anywhere else. 2. Armed with a firm offer of a low rate, go to your preferred big bank and try to negotiate a better deal. But, be willing to walk away if you don’t get what you want. 3. If you get confused, walk a...

Thanks to everyone who commented on yesterday’s post with their unsecured line of credit interest rates. The results are hardly scientific, but I have enough data to give people some idea of how their own interest rate compares to others. The average interest rate was prime+1.7%. Most of the interest rates were between prime+1.5% and prime+2%. There were outliers at prime+0.5%, 1%, and 2.5%. (I didn’t count the response from the anonymous reader who has a line of credit at prime because it seemed to be connected to a brokerage account and I wasn’t sure if it was for margin.) I didn’t get any responses pointing me to resources to explain what rates consumers can expect. Maybe such resources don’t exist. I suspect that consumers would get better deals if they had some way to compare lending institutions on the interest rates they charge for unsecured lines of credit. Mortgages It’s a different story for mortgage interest rates. There are many sources for advertised mortgage...