As the Big Cajun Man at Canadian Personal Finance pointed out, car companies are shying away from leasing cars . This may seem puzzling, but will make sense after looking at the true nature of car leases. The term “car lease” was great marketing. It gives the illusion that the dealership takes the risk, and you just rent the car for a while and get a new one when it suits you. The truth is that with a car lease you take much the same risks as if you buy the car. If something happens during the term of a car lease that makes the car worth less than expected at the end of the lease, you’re on the hook and will have to make up the difference. The best way to think of it is that you own the car, but owe a lump sum at the end of the lease. If the car happens to be worth as much as this lump sum owed, then you’re okay. If not, dig into your wallet. When leasing a car you have lower payments than if you took out a loan, but this just means that you’re paying it off more slowly. In fac...

The sensitivity range of our senses is quite amazing. We can hear a whisper, and a scream that is a million times louder doesn’t overwhelm us. The scream may not seem a million times louder, but that is the magic of our sense of hearing. This sensitivity range works well for hearing, but in financial matters, it can get us in trouble. If we hear a sequence of sounds with each sound ten times louder than the previous one, we perceive the volume as growing in equal size steps. It’s hard to believe that the energy in the last sound is about nine times more than the total energy in all the other sounds combined. When it comes to spending, we can sometimes see similar things happening. “I haven’t bought any coffee or donuts for a week now; so, I’ll treat myself to a new iPod.” If you don’t have a good sense of scale, saving small amounts several times may seem to balance with one large purchase. But the savings on coffee and donuts may be only $20, and the iPod may cost $200. Another...

I’ve always thought that if you need a financial planner, a fee-only arrangement is better than commission-based; you’ll likely pay less in fees, and the planner won’t have the glaring conflict of interest pushing him to select investments that pay the highest commissions. Canadian Capitalist contacted two fee-based financial planners. Both charged $100 per hour and would take 10 or 15 hours to create a comprehensive financial plan. This sounds reasonable enough. Investors can easily pay much more than this in commissions on mutual funds. But then I started thinking. What if I insist that the financial planner do all his work with me present? I'll bring all my relevant records in and answer questions, and the planner will work out a plan in front of me. I won’t object if he takes 5 or 10 minutes a few times to look up information in books or on the internet. The planner shouldn't object to this because I'm paying by the hour, and the process should take longer w...

I coach youth baseball, and we’re in the middle of the provincial championships. Last night we fell behind 4-1 late in the game. Things were looking grim, but not hopeless. As a coach, it was tempting to try to take some chances to “make something happen”. Fortunately, we stuck with the game plan and asked each of our hitters to relax and approach the game the same way they had all season. We were lucky enough to score 13 runs in the last inning to win 14-4. What has this got to do with investing? Well, just as we resisted the temptation to throw away our game plan when things weren’t going well, investors need to stick with their plan when investment returns are lower than they hope for. Many investors abandon a sound plan and sell out when prices are lowest. This can be a very expensive mistake. The most compelling reason I’ve heard for holding bonds for the long term is to lower portfolio volatility so that investors won’t panic at the wrong time and sell everything. Persona...

The marketing for financial planning companies stresses that you need to have your investments specially tailored to your financial situation. There is a certain amount of truth to this, but it is overstated. Deciding how much of your savings should go into long-term and short-term investments will of course depend on your individual needs and tax situation. But, once you have chosen to invest a sum of money for the long term, there isn’t much need to take into account your special situation to select investments. If you choose a stock or fund for very smart reasons, you will get exactly the same return as someone who chooses it because it has a nice name. I’m not advocating choosing investments for trivial reasons, but your investments won’t perform any better for you just because you are somehow special. Investment advisors will take a different view of all this because their primary concern is that you stick with whatever plan they choose for you. They need to take into account ...

With oil dropping down below $125 per barrel, we get a lesson on the dangers of extrapolating from recent history to predict the future. No trend continues forever. We’ve heard many predictions about oil prices over the last several months. Commentators have told us when they think a barrel of oil will reach $200, $250, and higher prices. However, these predictions are often based on little more than blindly extrapolating from recent price movements. Just because oil may have gone up $20 per barrel one month doesn’t mean that it will go up by $20 in each of the next 12 months. Such a prediction has to be justified by some sound reasoning to be worth anything. Oil prices may yet climb sharply again, but you can’t tell this by studying an oil price chart. If oil rises from $120 per barrel to $140 over the course of a month, it may be reasonable to guess that the price was close to $130 mid-month, but it isn’t reasonable to guess that it will be $160 at the end of next month. This i...

Many people include inherited money in their plans for retirement. In my limited experience, the amounts inherited are often much smaller than people expect. But, when great wealth is concentrated in one family, what stops that family from staying wealthy for many generations to come? Here are a couple of explanations I’ve heard: 1. When people inherit money without having to work for it, they waste it all. 2. A person may create enormous wealth in business, but the next generation may have little business skill, and they will run the business into the ground. I’ve never heard what I think is the most powerful explanation: when population levels are stable, the average couple has two children, and the family fortune gets cut in half each generation. So, a family may start with enormous wealth, but 5 generations later, 32 families are sharing this wealth. So, this gives a partial explanation why you will likely inherit less money than you expect. Don’t count on the lottery either. ...

Preet Banerjee wrote an interesting article about Sub-Prime CEO compensation . It seems that during 2007 many CEOs were richly compensated for presiding over orgies of loans that would never be paid back. Stockholders of financial companies have been very poorly served. Now that we know that these CEOs did not deserve their 8-digit compensation during 2007, shareholders would like to get the money back. But, it is too late. Just like the lowly salesman who gets an immediate commission for selling a mortgage whose profitability won’t be known for years, CEOs get their compensation long before we can know for sure that they deserve it. I have a fix for this problem to suggest to the board of directors of these firms: spread executive compensation out over 5 years. So, each year the CEO would be paid one-fifth of the money earned over each of the last 5 years, continuing after the CEO leaves the company. If a major CEO blunder from a given year comes to light, the compensation tap o...

The Big Cajun Man wrote about the worst financial advice he had ever given , and he challenged other bloggers to admit to bad advice they have given. I had to think about this one for a while. The truth is that while I have opinions on just about every financial subject, I don’t advise people directly very often. For example, although I often say that trading stock options is a very bad idea for most people, it could be right for a particular person. Then again, most of the people who think it is right for them are mistaken. There was one period of time where I suggested a way of thinking about investing that didn’t work out the way I thought it would. During the high-tech boom, I worked for a company that had given almost all employees stock options. The stock rocketed skyward making these options very valuable. Employees spent a lot of time discussing when to sell and how much. I suggested to several coworkers that they imagine that the options were exercised and the stock sold...

Yesterday I saw the biggest one-day jump in my portfolio value in some time. Days like this are comforting. These gains may drain away in the coming days, but right now it feels good to be fully invested. By “fully invested” I mean that all the money I won’t need for at least 3 years is in the stock market. I only use cash and fixed-income investments for money I will need to spend in less than 3 years (including university costs for both of my sons). Most commentators recommend holding a fraction of your long-term portfolio in bonds so that you won’t panic during market declines. However, market advances outnumber market declines, and I’m more likely to panic if I don’t take full advantage of market advances. Of course, there are worse things than investing a quarter of your retirement funds in bonds. One such bad idea is market timing. There are plenty of people who have pulled their money out of the stock market and are waiting for the right time to get back in. All these peo...

Preet over at Where Does All My Money Go? wrote an interesting post about compound options . It shows that the financial world has become very complex, but I think I can simplify it a little. A stock option is a side bet on stock performance. We can also think of it as a form of insurance. To get a call option you pay a small amount of money (say $2) called a premium to buy the right, but not the obligation, to purchase stock at a certain strike price (say $50) at some time in the future. If the stock goes above $50, then you will exercise your option to buy the stock at $50 and then sell it for the higher price. If the stock stays below $50, then your option will expire worthless. Now that we have call options figured out, what happens if we have options to buy other options? These are called compound options. This may seem far-fetched, but our financial world has all sorts of such side bets. So, we can buy a compound option for, say $1, which gives us the right to buy a call o...

The performance of the stock market affects the way people talk about stocks in interesting ways. In my roughly 20-year investing career, I’ve seen the kinds of discussions the average person has about stocks go through several phases. During the bull run of the latter 90’s, everyone was a stock picker. Even if they didn’t actually invest any money, they had strong opinions about which stocks were the right ones to buy. Few people looked at anything other than recent stock performance, but they had opinions on the future of stock prices anyway. After the bubble burst, people still talked about stocks, but discussions centered on the question of when the stock market would start going back up. Many people had unjustified confidence in their guess of how long it would take. The next phase was where people didn’t talk about their investments at all. When their account statements came in the mail, many people didn’t even open them. We are getting into this phase again now that the st...

Let’s face it. It’s hard for most people to understand why they should care about conserving species. It’s not politically correct to say it out loud, but most people don’t care whether the world loses yet another species. For the conservation movement to improve its chances of success, it needs to stop preaching to itself and start appealing to the average person’s self interest. Only committed conservationists care very much about saving exotic frogs; the average person wants to know what’s in it for him. Consider the following two arguments against continuing to pollute the river flowing through the fictitious town of Birdville. 1. We need to stop polluting the river to maintain biodiversity in and around Birdville. 2. Pollution in the river is killing the species that our more exotic natural birds eat. The traditional bird-watching tourism to Birdville is way down because of the loss of birds. At this pace, we’ll lose another 400 jobs this year. We need to stop pollut...

Most people would rather not think about money. They’d like to have more of it, but failing that, they would just like to know if they will be OK financially. Francis D’Andrade’s book Am I Going to be OK? deals with this emotional side of money. Apart from a few commercials for some high-priced financial products, the book does a good job of explaining our fears. Unlike financial books that preach advice that just makes most people feel worse about how they handle their money, many readers will feel that the author understands their fears. The book offers no real magic for a better financial life. If it’s possible for a book to listen to the reader without leaping to solutions, this book does it. D’Andrade steers readers to the standard sensible money strategy of spending less and saving more, but with a much gentler approach than you’ll find elsewhere. If other money books make you want to stick you head in the sand, then this might be the book for you. The best part of t...

When we’re uncertain, we tend to look at what others are doing to guide our choices. Most of the time this works well, but it can get us into trouble when it comes to finances. If you’re at a banquet and you’re not sure whether to eat the strange orange stuff on the side of your plate, looking at what others are doing can be helpful. But, deciding to buy a hot stock because everybody else is buying it is usually a very bad idea. Advertising tries to exploit our tendency to follow the crowd by giving us the sense that “everyone is doing it.” If it looks like all the beautiful people are drinking a certain beer and driving a certain pickup truck, then we’ll want these products. When it comes to retirement, most people will have only a modest amount of money to live on. This is because there simply isn’t enough wealth to go around. I can’t say for sure who will retire in style and who won’t, but I can say for certain that the majority of people will have little savings and low income...

Recent news about the BCE takeover seems good for those who want the buyout to take place. However, Larry MacDonald gives the contrarian view explaining the difference between a Definitive Agreement and an Agreement for Purchase and Sale (the web page with this article has disappeared since the time of writing). So, the deal is still up in the air. We might wonder what the odds are that the deal will finally take place. We can’t know this for sure, but we can look at what the market thinks the odds are. The expected deal price is $42.75 per share in 5 months. However, BCE stock closed at only $39.09 on July 9. At a risk-free interest rate of say 5% per year, this works out to $39.89 in December. The gap between this amount and the deal price of $42.75 indicates that the market doesn’t think that this deal is a sure thing. It’s time for some more assumptions. Let’s say that there are only two possibilities: either the deal will go ahead as planned, or the deal will die and...

I used to be a customer of Bell’s Sympatico internet service. For some reason, Bell is trying much harder to get me back as a customer than they ever worked to keep me as a customer. My most recent mailing from Bell trumpets a very low monthly price of $22.95. Of course, the fine print says that this is for a level of service far below what I used to have with Bell. The real cost to me would be about double this figure. However, I’m actually not very price sensitive when it comes to internet service. I just want it to work. I haven’t really noticed my Rogers’ internet service because it works and is fast; just the way I like it. I know that other people have had trouble with Rogers, but I’m one of the lucky ones so far. I know a little about the technology Bell uses, and the quality and speed of service depends greatly on the length and quality of the phone line connection into the home. So, some people will have no trouble, and others will have no end of trouble. Unfortunately...

The part of the subprime mortgage crisis that is hardest to understand is how so many people were able to get mortgages for amounts that they couldn’t possibly pay back. One case in Massachusetts sheds some light. Kenneth Garabedian, a mortgage broker, is charged with selling fraudulent “verification of deposit” documents to make it seem like mortgage applicants had more assets than they really had. The purchasers of these documents knew they were committing fraud, and the mortgage applicants were either incredibly naive or they knew they were breaking laws as well. On the surface, it might seem that the lenders were innocent victims of this fraud, but I don’t think this passes the sniff test. By allowing low-documentation and no-documentation loans, these lenders were essentially inviting fraud. The fundamental problem comes down to how people are compensated for mortgages. Each mortgage is presumed to produce a certain amount of profit over its lifetime. The amount of this prof...

After all the legal turmoil, the buyout of BCE is proceeding nominally at the original price: $42.75 per share. However, the real buyout price has actually been reduced by about $1.50 to $2.00 depending on how you do the accounting. The big changes are that BCE won’t be making any more dividend payments, and the deal closing is delayed until December. Between the dividend amounts and the interest on the delayed payment of $42.75 per share, the deal is worth about $1.50 to $2.00 less per share than the original terms. However, BCE closed at $39.64 on Friday, which is below what you would expect if this was a sure thing. So, there is room for more gambling. Just as it was gambling to trade in BCE back in May , it’s still just gambling to trade in BCE now. The probabilities have changed since then, but I still don’t know for certain that the deal will happen, and I doubt that any other non-insider knows either. If you’re tempted to buy now and pocket the $3 profit in December, ...

During the tech boom, employee incentive stock options were widely used by companies to provide extra income to employees. Management justified stock options by saying that they aligned the interests of employees and shareholders. Aligning the interests of a company’s owners and employees is very important to the survival of the company as I explained in this post about alignment of interests . On the surface, it would seem that stock options can do the job. After all, if the company’s stock price goes up, it benefits both the shareholders and the employees holding options. Unfortunately, closer examination will show that stock options do a very poor job of aligning interests. To begin with, most employees do not have enough influence within a company to affect the stock price perceptibly. From middle management down to the workers, stock options are just lottery tickets whose payoff is unrelated to the employee’s performance. Stock options do almost nothing as an incentive f...

Patrick at A Loonie Saved did an experiment with historical stock data to determine the value of dollar-cost averaging . His results were that spreading investments out over short periods of time seems to make no difference. This is because the usual way of explaining dollar-cost averaging is based on a myth. Here is the usual way of explaining dollar-cost averaging. Suppose that you spread the investment of $1800 in a stock over three months ($600 per month): Month 1: Share price $30, 20 shares bought. Month 2: Share price $60, 10 shares bought. Month 3: Share price $30, 20 shares bought. In the end you have 50 shares at an average price of $1800/50=$36. But the average share price over the three months has been (30+60+30)/3=$40. Through the miracle of dollar-cost averaging you have saved $4 per share. The problem with this reasoning is that the average share price calculation is simply not relevant to anything. If you had spent the $1800 all at once, you would have got eith...

At the suggestion of the moneygardener, I’m writing about the method I used to pay my kids an allowance with stock dividends. This method of paying allowances was also suggested in the book The Lazy Investor (see review here ). Back in the year 2000, I decided to stop giving my kids an allowance out of my pocket. I bought 100 shares of the Bank of Montreal for each of them. Initially it paid them $50 every 3 months, a modest allowance. A nice side effect of this is that instead of having to lecture them about the value of stock ownership, I actually had them coming to me with questions about where the money was coming from, and whether the dividend would increase, and so on. Anything that reduces the number of speeches I have to give to kids who aren’t interested in listening is a good thing. My kids were always happy to see the account statement when the dividends came in, particularly if the dividend had increased. Fortunately, the Bank of Montreal increased the dividend ...

Happy Canada Day! We Canadians tend to be understated about celebrating Canada Day compared to July 4th celebrations south of the border, but we do set off some fireworks. Each Canada Day I’m reminded of my previous corporate life where I often had to explain to American colleagues who wanted to get a meeting in before July 4th that I wouldn’t meet on July 1st. It often took some effort to explain that our Canada Day is similar to Independence Day and that it matters to us. Maybe we should consider ourselves citizens of North America and take both days off work. I know I will.