I know someone who has a personal line of credit whose interest rate is prime+2.5%. The “prime” refers to the bank’s prime interest rate. Most banks in Canada have prime at 4.75% right now. So his interest rate is currently 7.25% compounded monthly, which works out to 7.50% annually. What I was curious about is how this rate compares to other unsecured lines of credit. So, I started poking around online to find out. But, it seems that this is a big secret. Every bank and other type of financial institution I checked just said that the amount over prime depends on “personal circumstances”. I understand that the interest rate will depend on income, credit history, borrowing limit, and possibly other factors. However, the lack of available information about what is a good rate and what is a poor rate makes it difficult for consumers to find a good deal. With mortgages, at least you can see the starting point for negotiation with each institution. For unsecured lines of credit, there...

Learning from the best seems like a good strategy. So, I read John Train’s 20-year old book “The Midas Touch” to learn more about Warren Buffett’s approach to stock picking. Buffett says that investors must understand the accounting information that companies are legally obligated to publish. If you can’t understand this information, then your situation is hopeless. Investors may hope to rely on research analysts to interpret the accounting data. However, advice from good analysts gets disclosed to many people at once. There is little hope that the opportunity will still be there once the investor hears about it. Buffett made the following comments at a Columbia Business School seminar: “When managers want to get across the facts of the business to you, it can be done within the rules of accounting. Unfortunately, when they want to play games, in at least some industries, it can also be done within the rules of accounting. If you can’t recognize the differences, you shoul...

We hear about studies all the time. If I’m to believe what I read in the newspaper, I should cap off each meal with a couple of glasses of red wine, a beer, some chocolate, and a couple of cups of coffee. There must be a study out there somewhere showing that heroin is good for me as well. When I’m sceptical of a study’s results as described by a reporter, I sometimes read the technical paper by the study’s authors. Reporters sometimes leave out crucial details. For example, a study might show that coffee improves concentration. You might view this result differently if you knew that the subjects were denied caffeine for two days before the tests were performed. It’s not always the reporters who get it wrong, though. Sometimes the authors of the study mess things up. This is the case with a study by Schleef and Eisinger called  Hitting or missing the retirement target: comparing contribution and asset allocation schemes of simulated portfolios (pdf) . These researcher...

Most of the time I discuss rational approaches to handling money. But people (including me) have irrational impulses. I know I don’t need a cool new car, but it sure is tempting to trade in my perfectly good old car for a shiny new one. The easy part of handling money well is to make a plan. The hard part is to stick to that plan 365 days per year. Breaking the rules a few times for small amounts is harmless, but buying an unnecessary new car can throw off your finances for years. To cut down on impulse buying, try the $100 a day rule described in this post over on the No Credit Needed blog. If you want to buy some gizmo for $100, you have to wait a day before you buy it. For a $200 gizmo, you have to wait 2 days. For a new $700 computer, wait a week. This is a simple rule that forces you to take time to make sure you really want or need the latest new toy. This won’t work for everyone, but it could be just the right idea to help some people cut down on impulse buys that they...

I was pleasantly surprised by the book “It’s All Too Much” by Peter Walsh. I usually don’t get much out of books in the motivational or self-help category, but this one is different. The ideas can be applied to your financial life as well. I thought I was pretty good at getting rid of junk that I don’t need, but Walsh systematically went through the types of things that we own and explained why we keep them and why we don’t need most of them. The feeling that he wrote parts of the book specifically for me was eerie. My house isn’t particularly cluttered, but I realize now that I could get rid of at least half of my stuff and not miss it. In fact, the extra space in my house would make my life better. At a minimum, I would be able to find the things I do need more easily. I work hard to handle my finances rationally, but I realize now that I do some things for emotional reasons. This doesn’t automatically make them wrong, but looking at them in a different light made me realize th...

The US Federal Reserve, the Bank of Canada, and the Bank of England have all cut interest rates. This should be great news for mortgage holders, right? Not so fast. Not all of these interest rate reductions have made it down to the mortgage interest rates charged by banks. The gap between central bank rates and mortgage rates offered by banks has been growing. So, don’t rush in to renegotiate your mortgage assuming that the new rate will be much lower. Take a careful look at the new rate your bank offers and compare the interest savings to any penalties charged for breaking your current mortgage. You may be better off to keep your current mortgage.

Oil prices are up to a record $117 per barrel. This has the obvious disadvantage that we’ll pay more to fill up our cars. But, there are advantages as well. High energy prices create a greater incentive to develop alternative forms of energy. We can’t depend on oil forever. We need other forms of energy, but they are expensive to develop. Higher oil prices increase the chances that other energy sources can compete. Investors will be more willing to sink money into alternative energy development. Another advantage of higher oil prices is that it will spur some businesses that consume large amounts of oil to become more efficient. Closer to home, higher gas prices cause some people to choose not to drive. This means that there will be fewer cars in my way when I’m forced to drive on the highway at rush hour. As we run out of oil, we need prices to rise to induce the necessary changes to reduce oil use and shift to other forms of energy. Governments may be tempted to change tax le...

My wife’s credit card was reissued recently and she had to go through the usual activation process. She placed the 800-number call and was prepared to go through some automated menus to activate the card. To her surprise, an actual human came on the line to ask her if she wanted to buy balance insurance for a little less than $1 per month per $100 of balance. My first thought upon hearing her story was that credit card balance insurance must be very profitable if the bank is willing to pay people to annoy customers while they activate their credit cards. Even though she declined the insurance, I decided to investigate further. The Financial Consumer Agency offers this understated warning: “Credit balance insurance is usually more expensive than regular forms of disability or life insurance.” The insurance charges from the big 5 Canadian banks compound out to between 9.4% and 11.9% per year! The list of conditions that must be met to collect on the insurance contains the following...

The invention of the car lease was a tremendous boon for the car industry. Few people can understand the financial implications of car leases, and at the same time, leases have lower payments than car loans. Many cars would not have been sold if the car lease didn’t exist. Even the word “lease” works well here. It gives the illusion that someone else is taking the financial risks of car ownership, and the driver is just leasing it. But, you are taking the risks whether you buy or lease. The idea behind a car lease is simple enough. With a 3-year car loan, the full car price is spread across 3 years at some interest rate. For a 3-year lease, the difference between the car price and its expected value after 3 years is spread across 3 years of payments at some interest rate. After the 3 years, you have to pay the residual amount (possibly by selling the car back to the car company). Naturally, a lease gives lower payments than a loan for those 3 years making the lease seem attractive. Car...

Ric Edelman runs a financial planning firm and has authored several books including “The Lies about Money.” I also reviewed his audio book “Building Wealth” (see the review here ) and I was interested to see if he would be giving more self-serving advice. It’s obvious that Edelman is very knowledgeable about financial matters. He has the ability to analyze various financial products and options and make sound choices. What is difficult to determine is when his advice is sound and when it serves the interests of his financial planning firm. The biggest change from “Building Wealth” to “The Lies About Money” is that he is no longer a supporter of the actively-managed mutual fund industry. His firm has switched to recommending institutional funds rather than traditional mutual funds. To justify this switch, Edelman goes through a litany of sins committed by the mutual fund industry. This part of the book is excellent. I wasn’t aware of some of the abuses, and his explanations are ea...

Russell Investments reports that up to 60% of portfolio growth may come after retirement (the web page with this article has disappeared since the time of writing). This seems surprising at first. We tend to think that the portfolio growth phase ends when we retire. Of course, it depends on what they really mean by this statistic. They say that money available during retirement consists of about 10% money saved while working, 30% investment growth before retirement, and 60% investment growth after retirement. So, they aren’t saying that your retirement nest egg will necessarily continue to grow substantially after you retire (because of withdrawals). What they are looking at is the total of your portfolio plus all the withdrawals during retirement. The fact that 60% of growth comes after retirement isn’t so surprising if you think about the way that portfolios grow. A portfolio that grows at 10% per year will double about every 7 years, and 60% of the growth is in the past 10 yea...

Found money comes to us in a number of ways. You might find a forgotten $20 bill in an old jacket. You might get an unexpected $1000 bonus at work. Or you might get a $50,000 inheritance from a long-lost aunt. Many people believe that it’s okay to spend found money (or at least some of it) frivolously to bring a burst of happiness into their lives. Let’s examine this line of thinking. We all have things that we like to do, but are forced to limit how much we do them for various reasons. You might like coffee, but you limit your intake for health reasons. You might like hosting huge parties, but are limited by the cost. We tend to look for excuses to do the things we like: “It’s Friday, let’s have a beer.” “I just got a bonus. Let’s blow it all on some fireworks.” “My inheritance just came in. Let’s remodel the kitchen.” For some people, these things could be the best use of money. However, when it comes to found money, we often tend to blow it on things that are not the best u...

Several members of my extended family invest exclusively in fixed income investments, mostly at banks. For many years now they have longed for a return to higher interest rates like they had in the 1980s. They think that they made more money back then, but this wasn’t really the case. They may have earned more than 10% interest per year, but this doesn’t take into account taxes and inflation. To find out the real return, you need to deduct taxes and inflation. This is even more painful when you realize that you have to pay taxes on the part of the return that is eaten up by inflation. Back in the 1980’s people felt like they were making more money, but in reality, their principal was being eroded. This misunderstanding led them to spend more than they should have. An Example Suppose that years ago you got 12% interest, but inflation was 7%, and your income tax rate was 40%. Then your after-tax real rate of return was 12*(1-0.4)-7=0.2%. Suppose that today you are getting 4% interest, in...

An interesting consequence of the proposed Tax-Free Savings Account (TFSA) is a short-term increase in income taxes paid by Canadians. Let me explain. Money contributed to RRSPs is untaxed until it is withdrawn. Any money contributed to a TFSA is taxed immediately. Once the TFSA becomes law, some of the money that would otherwise have gone into RRSPs will go into TFSAs instead. This increases the amount of income tax governments collect in the short term. In the short term, almost all retirement savings withdrawn by Canadians will come from RRSPs and RRIFs. So, the government will collect taxes on part of new savings and almost all withdrawals. Eventually, all this will balance out. Suppose that half of new retirement savings will go into each of RRSPs and TFSAs. In the short term, most of the money coming out of retirement savings will be coming from RRSPs and RRIFs and will be taxed. Over time, though, the mix of money being pulled out of retirement savings will shift to half coming ...

According to Newton, for every action there is an equal and opposite reaction. If the proposed Tax-Free Savings Account (TFSA) becomes law in Canada, we should expect reactions to the changes it will cause. The main factor that determines whether TFSAs or RRSPs are better is tax rates . If your tax rate will be higher when you withdraw money than it was when you contributed money, then you should prefer a TFSA. Ironically, it is often the poorest seniors who fall into this category because of clawbacks. As a senior’s income rises, the Guaranteed Incomes Supplement (GIS), the age credit, and Old Age Security (OAS) all get clawed back, which can make the effective tax rate very high. For example, a senior with an income of $12,000 who withdraws an extra $1000 from an RRSP or RRIF will pay an extra $780 in income taxes, mainly because of the GIS clawback. This is a tax rate of 78%. Effective tax rates can be even higher due to other government programs with income tests. Having a hi...

In a previous post I explained how it is possible for superior investors to beat market averages by focusing on long-term value instead of short-term stock prices. This is the exception to efficient market theory. This can make it tempting to become a stock picker. Confidence can be dangerous. Before you jump in believing that you can beat the stock market average, understand that most people who try to do this will fail. It’s not possible for most people to be above average. Add to this the trading costs and volatility that come with individual stock picking, and most stock pickers will make less than the stock market index. Another problem is that it takes a very long time to tell if you have a talent for judging to true value of companies. An investor could just be lucky for 10 years and then suffer disastrous losses because he really doesn’t know what he is doing. By the time you have invested long enough to know whether you are a good stock picker, much of your investing life...

According to proponents of efficient market theory, it isn’t possible to do better than market averages by picking your own investments. New information gets incorporated into stock prices almost immediately making it impossible to profit from this information. On the other hand, there are a handful of people like Warren Buffett who have outperformed stock market averages for so long that it couldn’t possibly be a fluke. Both sides in this argument make a strong case. But who is right? As usual, the answer is somewhere in between. Price vs. Value At any given moment, the price of a stock is determined by the crowd of people making bids to buy and sell shares. If some good news comes out, the stock’s price will shift upward due to the change in bids coming from the crowd. The crowd isn’t necessarily right, though. A stock’s true value, which is based on the company’s future prospects, could be $20 even though the crowd sets a price of $10. But this doesn’t necessarily mean that yo...

Why does the stock market give higher returns, on average, than bonds or interest on cash? We can observe that this has been true in the past, but why is it true? There are many ways to answer this question, but I’ll pick just one. Everything else being equal, people tend to prefer lower risk investments. Most people would take a sure 5% return over an investment that has a 50/50 chance of giving either 0% or 10%. It’s just sensible to reduce risk if you can do it without giving up anything else. All investments have some type of risk. With an individual stock, the main risk is that the company will produce lower than expected profits. Stocks are riskier than bonds and interest on cash. So, stocks have to offer higher returns than bonds and cash to attract investors. Suppose that most people believe that the stock market will give lower returns than bonds for the next decade. This would cause people to sell stocks and buy bonds leading to stock prices dropping and bond pr...

I finally got around to doing my incomes taxes. I’ve been using QuickTax for several years now, but there are so many other choices now that I almost chose something cheaper. In the end, I decided to stick with the annoying software I know instead of some new, likely annoying, software. For the most part, QuickTax works well as long as you know what you are doing. There is no substitute for understanding the tax system and knowing how different deductions, income, and transactions will affect your total taxes owed. QuickTax will help with getting some choices right, but it can’t save you from everything. Upgraded Versions My main criticism of QuickTax is the constant attempts to get people to upgrade to more expensive versions of the product. I get along fine with the “Standard” version, but the confusing product feature lists make it seem like you need to upgrade to “Platinum” if you have any dividends or capital gains. Even while going through the built-in interview proc...

I like pennies. More specifically, I like old pennies, and other old coins for that matter. I’m not much of a collector, but I have a few coins that are worth $5 or $10 each. A Winnipeg MP, Pat Martin, is expected to introduce a bill to eliminate the Canadian penny. See this Wikipedia entry for US efforts to eliminate the penny. Despite my fondness for old coins, I don’t like getting pennies in my change. Pennies are worth too little now to consider them to be money. We give a penny and take a penny, but it doesn’t really amount to anything. Handling pennies is like worrying about a decimal place in your weight. “I weighed 175 pounds yesterday, but today I weigh 175.1 pounds! Let me just take these pennies out of my pocket. There we go. I’m back down to 175 again.” The truth is that pennies should have been eliminated decades ago. We’ve waited so long that we really should eliminate the nickel and dime as well. We could get along just fine if cash transactions were rounded to t...

A reader, Jay, left comments on my market timing experiment asking specifically about strategies that buy after a market drop, and sell after the market rises. The theory behind these strategies is to buy low and sell high. I ran some experiments to test this approach. As in previous experiments, the investor decides each month whether to be invested in the S&P 500 or not. The goal is to avoid months where stocks drop in value. I ran the experiments on S&P return data from December 1990 to March 2008. The first thing I tried was to assume that the investor would be invested in the stock market at the beginning and would proceed as follows: 1. If the money is in the stock market, and if stocks are priced at least 5% higher than they were one, two, or three months ago, then sell. Otherwise, stay in the market. 2. If the money is in cash, and if stocks are priced at least 5% lower than they were one, two, or three months ago, then buy stocks. Otherwise, stay out of the mark...

I hope that everyone who read this morning’s version of this post (see below) figured out that it’s an April Fools’ joke. All I did was examine past S&P 500 returns and concoct the silly “zone theory” to exactly pick out which months had negative returns and avoid them. Following this theory really would have returned 28% per year. But, anyone could make money knowing future stock prices in advance. Zone theory was tuned perfectly to past data, and there is no reason to believe that it would work in the future. There is also no reason to believe that you can predict what will happen next month by looking at a stock chart for the past few months. What will happen depends on information that just isn’t in the charts. So, forget about zone theory and other crazy market timing theories and invest for the long term without obsessing on short-term fluctuations. Market Timing Breakthrough! After wasting so much time trying to show that market timing can’t work, I stumbled across an amazin...