Extended Warranties

I just got back from The Source by Circuit City (aka Radio Shack Canada) and had to share this story. I bought a simple 20′ stereo extension cable for $19.99. I couldn’t believe my ears when the clerk asked me if I wanted to buy an extended warranty for the cable! He said that for something like $2 I could get an extended warranty and that should anything happen to the cable over the next 3 years I could get a replacement. The day they start selling extended warranties for cables is the day that extended warranties are exposed for being the scams that they are. I should have left the store right then but the whole reason I went there is because it is within walking distance from where I lived and I didn’t feel like shopping around, even though $20 was expensive for this cable. One of the reasons I went to The Source is because I don’t like to shop at Future Shop (because I hate their commission sales people and their rebates and extended warranty rackets). It looks like everyone (not just Future Shop) is selling extended warranties these days, to squeeze out every last penny they can. I bought a Palm device for my wife this Christmas at Staples (specifically to avoid Future Shop) and was propositioned with an extended warranty there as well.

I have never bought and extended warranty and never will. It only takes a little bit of common sense to realize that extended warranties are never a good idea. This CBC Marketplace article, “Extended Warranties: Deal or Dud?” examines extended warranties in detail. The final conclusion is pretty unanimous:

As a general rule, extended warranties aren’t considered a good investment. Consumer Reports, the Better Business Bureau, Canadian consumer organizations, and the Federal Trade Commission as well as the chartered accountant we spoke with, all caution consumers against purchasing extended warranties.

The nail in the coffin for me was this data:

Consumer Reports says only 12 – 20 per cent of the money paid for extended warranties is ever used to pay for repairs or claims. The other 80 to 88 per cent of money goes into the profit margin of the third-party/manufacturer.

And some final useful advice,

Our expert, Tod Marks, advises people thinking about an extended warranty to save the money and put it into a repair fund — just in case. “An extended warranty is good for the retailer. It’s not good for the consumer.”

Ten Most Dangerous Things People Say About Stock Prices

There is an article about Peter Lynch, the famous manager of the Magellan Fund from 1977-1990, at Gurufocus.com, written by Kaushal B. Majmudar from The Ridgewood Group entitled, “The Wit and Wisdom of Peter Lynch.” I found the “Ten Most Dangerous Things People Say About Stock Prices” a great reminder about the uncertainty in the stock market:

In addition to the above points, Peter also shared his Ten Most Dangerous Things People Say About Stock Prices reproduced below. Even more than the points above, Peter’s good sense of humor came through when he discussed these old saws:

1.) “If it’s gone down this much already, how much lower can it go?” (answer: Zero)

2.) “If it’s gone this high already, how can it possibly go higher?” (some of the best companies grow for decades)

3.) “Eventually they always come back.” (no they don’t – there are lots of counterexamples)

4.) “It’s only $3 a share, what can I lose?” ($3 for every share you buy)

5.) “It’s always darkest before the dawn.” (Its also always darkest before it goes absolutely pitch black. Don’t buy a business just because price dropped and it is cheaper now)

6.) “When it rebounds to my cost, I’ll sell.” (The stock does not know you own it! Don’t take it so personally Note: this comment is explained by the well documented psychological tendencies called loss aversion and anchoring bias which are talked about in Behavioral Finance. If you liked it at ten, you should love it at 6 so either buy more or sell)

7.) “What me worry? Conservative stocks don’t fluctuate much.” (There is no such thing as a conservative stock – the average stock fluctuates between 50% to 70% from its high to its low price every year. There is a graveyard where all the “conservative” stocks get buried. Companies and businesses change!)

8.) “Look at all the money I lost – I didn’t buy it!” (Don’t beat yourself up about the missed opportunities because it is not productive – when he managed the Magellan Fund, he almost never owned one of the 10 best performing stocks in a given year, but he did fine anyway).

9.) “I missed that one. I’ll catch the next one.” (Doesn’t work that way)

10.) “The stock has gone up – so I must be right” or “The stock has done down – so I must be wrong.” (Technical analysis is not worth much. So many people like something at 20 and hate it at 12 – never made much sense to him).

Peter’s fundamentals, like those of many other super investors are grounded in common sense and an understanding of human misjudgments and failings.

What many of these points tell us is that buying cheap stocks alone won’t get you any success; you have to invest in cheap stocks of good companies. This is very hard to do and takes a lot of work. For me these points serve as a reminder that I (as well as many of you I imagine) should never try to pick stocks myself (unless it’s with a small portion (<5%) of my portfolio). Unless I can devote my entire day to investigating companies, I should let the professionals do it, or stick to investing in indexes.

Canada Student Loan vs. BMO Line of Credit

We have a BMO line of credit and a Canada Student Loan. The interest rate is prime (5.0%) on the former and prime + 2.5% on the latter (7.5%). You would think that it would make sense to put everything in the much cheaper line of credit, but this is the first year that we have started to pay down either, and I knew that we received a federal and provincial tax credit on interest payments for the more expensive prime + 2.5% student loan so I figured it probably worked out to be about even, and besides, our student loan is a lot smaller than the line of credit (although not significantly close to $0 yet to not worry about it). Without looking at the actual numbers, I had no idea. It’s one of things that no one can tell you the answer to (except maybe your accountant if you have one) and there is usually no universally true answer either. Anyways, I finally crunched the numbers and here’s what I got:

The annual interest owed in one year on the line of credit is Q(1+p), where Q is the amount drawn from the line of credit and p is the prime rate. The interest owned on the loan is Q(1+p+0.025), where Q is the amount owed of the student loan. But with the interest payment tax credit, the effective annual interest payment is reduced to Q(1+p+0.025) – Q(p+0.025)0.2105 = Q(1.0197+0.79p), where 21.05% is the tax credit rate, including the federal rate and provincial rate for BC.

So the loan is worse when Q(1.0197+0.79p) > Q(1+p). Re-arranging yields, p < 0.09 or "the loan is worse than the line of credit when p < 9%" Since the prime rate is currently at 5% at BMO, it looks like we are better off paying down the Canada Student Loan using funds from the line of credit. This will not only save us some money every year but will give us one less monthly payment to worry about and simplify our debt into one amortization plan. Simple is always better.

Goals for 2006

This is the time of year when everyone is setting their goals for 2006, and I am no exception. 2006 will be a year with a lot of change for us, completing the switchover to a new bank, a switch to a new full-service broker, and our first year filling out our tax return as a married couple. It’s also a year where I expect the value of our RRSPs to grow 69% from contributions alone, to make a small dent in our line of credit while still saving up for the things we want, like vacations.

  • Investing:
    • Contribute to our maximum allowable RRSP room (18% of income in 2005) by the end of 2006.
    • Transfer my RRSP from TD Canada Trust to Clearsight in February.
    • Invest in value-oriented investments or ETFs at lowest cost wherever possible.
    • Be invested in 25% fixed income and 75% equities by the end of 2006.
  • Personal finance-related:
    • Switch all our automatic deposits and withdrawals to PC Financial from BMO.
    • Limit our daily expense for food, dining, gifts, gas, bus, entertainment, recreation, etc . . . to $300-400/week (this will be regulated by having a second chequing account linked to our bank cards which only contains that much per week).
    • Contribute the rest to ING Direct Savings accounts for vacations and other “wants.”
    • Try to get at least one salary raise this year.
  • Debt:
    • Get rid of AMEX Gold and carry only one credit card (BMO Mastercard). Don’t get any additional cards in 2006.
    • Eliminate all credit card spending except for online purchases (only when necessary and which will be paid off immediately) and dental appointments (which I get reimbursed for later).
    • Pay down federal student loan using our lower-rate student line of credit.
    • Pay at least $700/month to student line of credit.
    • Apply all of our tax refund to student line of credit.
  • Blogging:
    • Try to publish at least one post daily.

Some of these goals are things that we’ve just started doing in 2005, but would like to continue doing in 2006. I have no doubt that we will achieve all of these goals, which is why I’ve called them goals and not “resolutions.”