Stupidist Thing I’ve Done This Year

Well actually in the past 2 years. In September 2004 I upgraded from an American Express Air Miles card to an American Express Air Miles GOLD card. I have no recollection of why I did it. The only explanation I can come up with is that I somehow thought that there was no annual fee or something. I honestly cannot remember why I upgraded to the GOLD card. I stopped using my AMEX card a couple months ago and have been meaning to cancel it outright (actually I kind of thought I did, ok, so I’m a bit disorganized). Today, I got a statement in the mail saying that I owe them $50 for “Membership Fee.” This next part I feel really stupid about… I called AMEX and asked them why I got charged this fee. The lady didn’t really know but she said according to my account there was a fee, but the call ended quickly because apparently their main servers were down so she couldn’t get any more information. After I got off the phone I opened up Gnucash because I wanted to see if I had been charged this before. It turned out I was charged $50 in September 2005 as well! God dammit I had a $50 annual fee card and I didn’t even know it. I’m so embarrassed about it…anyways, I’m going to pay the $50 fee and cancel the card ASAP.

Tax Refund Finally Applied to Loan

Our tax refunds have finally arrived. It took over a month but that’s to be expected since we filed in April and filed paper returns (printed out from software of course). Over $4700 for the two of us. I have transferred the entire amount against the principal of our student loan. That makes a small dint in the loan but it will reduce our interest payments by about $20 per month. That is not huge, but that is $20 per month for many years to come, not just this year. My wife will also be receiving a one-time retroactive hiring bonus of on the order of $4500 so that is another $20/month savings on interest and next year we can get another $20/month from another tax refund. It will feel good to lower those monthly payments, leaving more room in our monthly cash flow for something like a mortgage payment in the future.

Currently we are just paying interest on the student loan every month. The reason is that our monthly cash flow is pretty tight now. All our money is going somewhere, whether it be RRSP and savings and the amount of disposable cash we have available is very limited. Rather than using the one-time debt payments to lower our interest payments and thus increase the amount of principal paid down every month (ie. constant monthly payments) thus shortening the amortization period, we have decided to take the $20/month savings and we will allocate that to one of our ING savings accounts. Ideally, if we could afford it, I would love to be able to pay interest and principal on the loan every month but it just cannot be done right now. Maximizing our RRSPs is our #1 concern, and I think that is the right thing to do as I expect the return in my RRSP to exceed the interest rate on the loan and secondly, the tax refund every year can be applied towards the loan’s principal anyways.

WestJet Air Miles Gold Card

I was on the phone with a customer service representative at Air Miles recently, and she suggested that I get the Gold Westjet 1/$15 AirMiles Mosaik Mastercard. With this card, every $15 spent earns one air mile, however, there is an annual fee of $70 (which she neglected to tell me, but I knew there had to be a fee). Currently our only credit card is a Mosaik Mastercard 1/$40 card which has no annual fee. For the Gold Westjet card option to break even, the following must be true:

\left(\frac{x}{40}\right)C < \left(\frac{x}{15}\right)C - 70 where C is the value of one mile and x is the number of miles earned in our year. Assuming C=\$0.10 (conservative), solving we get x=\$16,800. Assuming a higher value per mile (C=\$0.2) we get x=\$8400. The latter value works out to $700/month, the former works out to $1400/month. So we would have to spend somewhere around that much per month on our credit card just to break even and make the card worthwhile. I do not think that is going to happen since we have stopped using our credit cards altogether, except when absolutely necessary (online purchases). The Gold Westjet card has some advantages besides the 1 mile for every $15 spent. For example it allows you to fly anywhere WestJet flies for 1,600 Air Miles. The disadvantage of this is that you have to fly on WestJet.

Homeless Man Gets Five Fannie Mae Loans In Florida

Funny news story out of Florida last week: Homeless Man Gets Five Fannie Mae Loans In Florida:

The St. Petersburg Times found a homeless man who had bought a few houses. “After struggling much of his adult life with unemployment, homelessness and drug addiction, Johnny Moon Sr. died last year on a dirty mattress on the floor of a small home near Tampa’s College Hill district. Moon left behind a watch, a flashlight and a wallet containing a solitary dollar bill. And more than a half-million dollars worth of real estate.”

One of the comments caught my eye:

I don’t see why loans to the indigent are such a big deal. In a booming real-estate market, when the vast majority of prices are rising, why shouldn’t banks loan to everyone, and anyone, who wants to borrow against a house? The vast majority of the properties are gaining 20% a year, so who cares if a few outliers are actually duds? You will make money on volume (i.e. there will be quite a few properties that do appreciate). And it doesn’t matter that a given borrower is unable to make good on the payments. Just sell the house six months later, and the loan is paid off. Everybody wins!

Anyway, don’t blame the lending institutions. They only market mortgages that are acquired by after-market investors. It’s the pension funds and foreign invstors who are really eager to give their money to anyone buying US real-estate. They know that US real-estate prices always rise substantially, so any potental losses from loans are minimal.

Should You Borrow To Invest in Your RRSP?

Many Canadians wonder whether or not they should borrow money to help them maximize their RRSP contributions. Never was this idea touted more than in 2002 onward when interest rates were very low. There is no reason why it is not a good idea now, and interest rates are still historically low. This article, “Should clients borrow to catch up on RRSPs this year?” discusses why it can be a good idea.

Even though many experts discourage the use of long-term RRSP loans, most people would actually benefit from them, claims Talbot Stevens, a London-based financial educator, author, and industry consultant.

“If you just look at the math, RRSP catch-up loans always make sense when investment returns match or exceed the cost of borrowing,” explains Stevens. “If you can borrow at 6% interest and get returns of 6% or higher, you will come out ahead by borrowing to catch up on RRSPs, even if it takes 10 years or more to repay the remaining balance of the loan.

He does not go into detail here but the math is fairly simple. If the return in your RRSP matched the interest on the loan, the amount the RRSP increased by in the first year would match the amount you owed in interest on the loan. Once you take into account the tax refund that will be generated due to the RRSP deduction (at your marginal tax rate multipled by the amount of the deduction) you can see that you will wind up ahead. But I am neglecting something. We will be taxed on the RRSP’s returns later, when we withdraw it. This will reduce our effective return inside the RRSP. Not only that but we will be taxed on the contributions we made as well. The math does get a bit complicated, and it is always made even more difficult by the fact that it is impossible to predict future returns on an investment inside an RRSP. As the author of the quoted article says, however, behavioural factors are often overlooked when considering the advantages and disadvantages of borrowing to invest in your RRSP:

Stevens also likes the investment discipline afforded by long term RRSP loans. “When you also account for the behavioural reality that most investors spend their RRSP refunds, the scales tip heavily in favour of long-term RRSP loans, even when returns are half of the cost of borrowing,” says Stevens.

“For most investors, the catch-up RRSP strategy generally produces a larger retirement fund because the loan locks in a higher level of commitment. Once started, the loan becomes a forced savings plan, like a mortgage, where we don’t have a choice but to continue the payments.”

At first I did not understand what “the behavioural reality that most investors spend their RRSP refunds” had to do with the scales tipping “heavily in favour of long-term RRSP loans.” I think what he means is that if you have a long-term RRSP loan, you will be less-inclined to spend (in other words, waste) your RRSP refund. Instead you will be more likely to put it down towards the loan in an effort to lower interest payments and/or get rid of the debt sooner. Of couse it is better to contribute to your RRSP with cold-hard cash, but if you cannot maximize your contributions with cash, there does not seem to be anything fundamentally wrong with getting an RRSP “catch-up” loan.

Of course most of the arguments for and against borrowing to invest in your RRSP also apply to the pay down your debt vs. contribute to your RRSP argument.

Rewards, Rewards, Rewards

Rewards programs, especially cash-back credit cards, seem to be all the rage these days especially on personal finance blogs. I think I mentioned on my blog a while back how a fellow employee of mine charges everything to his credit card because he gets 1% cash back for every dollar of purchases. Does he actually think he is getting ahead? People invariably think that they can make themselves richer by using a cashback credit card, than if they did not have a credit card at all. This boggles the mind but it is something that is not surprising. The 1% cash-back, the Air Miles points, the HBC Rewards Club Points are all easy to measure. Determining how much more you spend by using a credit card vs. cash is something that for most people is impossible to quantify.

I just read one common misconception a few days ago: “Hunting for rewards is worthwhile only if the entire credit card balance is paid in full every month.” While technically correct (in my opinion) for a small minority of the population, as the Wealthy Barber says, “many people who pay off their balance each month are still hurt by their use of credit cards.” Just because one pays of his/her credit card bill every month does not mean that the credit is just acting like a convenient replacement for cash. In fact most people spend more using a credit card without even realizing it, even those who pay it off every month. And if you accept this fact, than hunting for rewards programs is not worthwhile. Which brings me to one of the best blog posts I have read in a long time about cash-back credit cards.

Okay, the hottest thing going today, in the financial realm, is the “Cash Back” credit card. Almost every major credit card issuer is offering one of these “wonderful” things, promising you cash back for the purchases you make. Some promise cash back for groceries, gas, or everyday purchases. You can get bonus miles, bonus cash, and bonus gift cards. Wow! These things are wonderful…

Hmmmmmmm…

Get real. These things are CRAP.

I strongly recommend everyone to read this article in full. He lists several counter-arguments to his position:

Now, there are several arguments against my position. I will list a few here, so that you don’t have to:
But ncnblog, I’m responsible with my credit and I pay off my balance each month.
But ncnblog, I was going to buy these things anyway, so I might as well get some cash back.
But ncnblog, I know how to handle my money, and I always make all my payments on time, and I am never going to be late or miss a payment. Relax.
But ncnblog, Credit cards are “safe” and they provide protection for me when I buy a product.
But ncnblog, Etc. Etc. Etc.

and then refutes them all . . .

One more thing, there may actually be one case where rewards programs are useful For people who are absolutely incapable of saving money, rewards programs are a forced savings programs. I am sure some people are incapable of saving up for a flight, for example. To them, earning more Air Miles by spending more money on groceries is not “spending more” than they normally would because this hypothetical person spends all their disposable cash anyways. They can then redeem a flight every 5 years or whatever, a flight that this hypothetical person would have never been capable of saving up for if their life depended on it. Although such a person would probably also have a tough time saving up their Air Miles for a flight anyways . . . So, on second though, rewards programs are in fact never useful.

Of course we all need credit cards at some point, for example, many online purchases require a credit card. So since at least one credit card is needed for these situations (when I use it for these purchases I pay it off instantly), you might as well get a rewards card rather than a plain jane card. On the other hand, the advantage to getting a plain jane credit card is that you never be tempted again to use a credit card for the rewards.

SNL Get-Out-Of-Debt Infomercial

I just saw a hilarious skit on Saturday Night Live last weekend. Here’s the transcript:

Don’t Buy Stuff You Cannot Afford

Wife…..Amy Poehler
Husband…..Steve Martin
…..Chris Parnell

[ open on couple trying to balance their checkbook ]

Wife: (sighs) I just can’t get these numbers to add up.

Husband: Like we’re never going to get out of this hole.

Wife: Credit card debt, does it ever end?

CP: [walks in] Maybe I can help.

Husband: We sure could use it.

Wife: We’ve tried debt consolidation companies.

Husband: We’ve even taken out loans to help make payments.

CP: Well, you’re not the only ones. Did you know that millions of Americans live with debt they cannot control? That’s why I developed this unique new program for managing your debt. It’s called [presents book] “Don’t Buy Stuff You Cannot Afford.”

Wife: Let me see that… [grabs book, reads] “If you don’t have any money, you should not buy anything.” Hmm, sounds interesting

Husband: Sounds confusing.

Wife: I don’t know honey, this makes a lot of sense. There’s a whole section here on how to buy expensive things using money you save.

Husband: Give me that… [grabs book, looks at it] And where would you get this saved money?

CP: I tell you where and how in Chapter 3.

Wife: Ok, so what if I want something but I don’t have any money CP: You don’t buy it.

Husband: Well let’s say I don’t have enough money to buy something. Should I buy it anyways?

CP: No-o-o-o.

Husband: Now I’m really confused!

CP: It’s a little confusing at first.

Wife: Well what if you have the money, can you buy something?

CP: Yes.

Wife: Now take the money away. Same story?

CP: Nope. You shouldn’t buy stuff when you don’t have the money.

Husband: I think I got it. I buy something I want, and then hope that I can pay for it right?

CP: No. You make sure you have money, then you buy it.

Husband: Oh, THEN you buy it. But shouldn’t you buy it before you have the money?

CP: No-o-o-o.

Wife: Why not?

CP: It’s in the book. It’s only one page long. The advice is priceless and the book is free.

Wife: Well, I like the sound of that.

Husband: Yeah, we can put it on our credit card.

CP: [shakes head]

Announcer: So get out of debt now, write for your free copy of “Don’t Buy Stuff You Cannot Afford.” If you buy now you’ll also receive, “Seriously, If You Don’t Have the Money, Don’t Buy It!” Along with a 12-month subscription to “Stop Buying Stuff Magazine.” So order today!

Excellent satire of life with easy money. We used to be like the couple in the skit, (well not as clueless), charging things to credit cards and figuring out how to pay for it later (usually with a hefty chunk of our paycheques). Now we pay for everything with money we have saved and not only do we have more disposable cash than ever before but it feels great!

Bad Real-Estate Advice

I promise this will be the last article with “bad” in the title in a while. There is never a shortage of bad financial advice though, in fact sometimes I feel like the majority of the advice out there is bad advice. Here is an excellent example of bad financial advice, “Tip For Ignoring Bad Advice In Money Magazine.”

The latest edition of Money Magazine profiles a couple, 46 years old, that together make $120k/year, have a $250k ARM mortgage, a $30k home equity loan, and $12k in credit card debt. The couple is very concerned about boosting their slim retirement savings; to this end, they’d like to leverage the equity on their LA home, which is now worth $1 million.

Here comes some — in our opinion — highly irresponsible advice from a CFA who suggests this ‘extreme makeover’ (Money’s phrase): Take out a new $500k ARM mortgage, pay off the debts, then plow the remaining $200k into the U.S. stock market (80%) and bond funds:

The article then gives several reasons why this is a BAD idea. I’ll let you read the article… The blogger who wrote the article above gives a possible alternative,

How about this approach — sell the house. Retire the debts. Take the remaining $700k and put away a big chunk for savings (invested not only in the US stock market). Then buy a more modest home, or rent until the housing market settles down.

I am amazed at how resistant people are to selling their home outright and renting. I’ve even heard people use the excuse “I don’t want to move because it’s a pain.” Even if you made just $100,000 on the sale of your home (many people in Vancouver have made much more in the past few years), combine that with the mortgage payment you will no longer be paying and that’s a lot of rent! Not only that but you should have plenty to spend on a moving company, making it less of a pain. Moving isn’t so bad. The first few times I did it, it was annoying, but you get used to it. Here’s another blog article I saw recently about buying vs. renting, “Buying vs. Renting a House.” Scroll down to the comments, they are more interesting. Here’s one,

I know lots of home owners who pay more money each year in real estate taxes than I pay in rent. And that’s not including landscaping, maintenance and repairs, expensive furniture to fill the expensive house. I don’t buy into the idea that buying a house now, at what may be the peak of a housing bubble, makes any kind of sense.

I got a bit side-tracked here. Nobody should go and sell their house just because the market has gone up, but if you are like the couple described in the Money article, who are “very concerned about boosting their slim retirement savings,” then make sure you get some “good” advice before doing anything drastic.

Pay Down That Debt With Your Tax Refund

Now that we are all done school, we are now at the point where we need to think about paying down our debt. With on the order of six figures of student loan debt, it’s hard to feel like we’re making any progress towards paying it down. Although we have not been forced into an amortization plan yet by the bank, we have been paying the interest and some principal every month. This will ensure that the principal is at least going down a little. If we only paid the interest every month, the principal would never decrease (although it would decrease in real dollars due to inflation).

We could pay more in principal every month to our loan, and this is not a bad idea. Every dollar paid to the principal is sort of like a dollar contributed into a fixed-income investment which pays interest at the same interest rate as the loan. So paying down principal is like a fixed-income investment. Instead of increasing the principal we pay down every month, we have chosen to maximize our RRSPs first and foremost, which is something I discussed in a previous article. Under the assumption that over the long term our RRSP will achieve a rate of return roughly similar to the loan interest rate, this is a great idea because the return of the RRSP will match the return of the loan (again, treat the loan as a fixed-income investment) but we will also get a bonus: a tax rebate will be generated from the RRSP deductions (because income contributed into an RRSP is tax-deferred).

Since we have made our RRSPs our #1 priority (for the reason mentioned above and described here), we maximized our RRSP contribution room last year and will again maximize our RRSP contribution room this year, at the expense of less principal applied to the loan monthly. In April 2006, we plan to receive a hefty tax refund generated from our RRSP contributions. Since we have already maximized our RRSPs, we do not need to use contribute the tax refund into our RRSPs. Instead we are planning on applying the entire amount against the student loan. This is only possible because we already have an automated savings plan for vacations and other short-term goals, and therefore we do not need the tax refund for any other purpose.

It turns out my parents also used this technique for many years while paying down their mortgage on their home and on a second rental home, allowing them to pay it down faster and become debt-free sooner.