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Author: Mike Holman
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Saturday Weigh In and Links
Weight today was 179.0 pounds – no change from last week.
Carnival of Personal Finance was hosted by Paid Twice – an upbeat debt reduction blog. She featured Mr. Cheap’s post “Saying no is hard to do” in her Superbowl edition.
Festival of Frugality was hosted by Being Frugal – a frugal type of blog. My book review on the Two Income Trap was included in her competing Superbowl edition.
Gather Little by Little wrote a great article on how to buy a new car. I’ve always been the kind of person who is a pretty easy mark for a good salesperson. I’ve been working on not being that mark, but the result is that now I don’t trust a single thing anybody who I don’t know says to me. 🙂
In keeping with the shady practices theme – Thicken My Wallet wrote a great piece on deceptive sales practices which of course also really hit close to home for me. I need to tape this to my front door (both sides).
The best advice from TMW’s column was “A GOOD CON HAPPENS QUICKLY- ASK A CON TO BE PATIENT AND THEY WILL USUALLY DISAPPEAR”.
Pinyo from Moolanomy had his monthly “Ask The Expert with Larry Swedroe” column – I have to say that Larry Swedroe really knows what the heck he is talking about. I’ve been asking him questions over the last couple of months and I think he is worthy of my questions 🙂 If anyone out there has any investment style questions that they want answered by someone who actually know what they are talking about (vs the yahoos that write on this blog) then feel free to submit any questions you want.
I posted on a reader question regarding buying a stock in Canadian or US dollars some time ago.
This is another question from that reader.
Ian writes that he has a large $US money market mutual fund sitting in a non registered account that for tax efficiency should be registered but he just can’t swallow the forex conversion at below par (he obtained the US$ when it was worth much more than the Canadian dollar).
My answer
As far as keeping your US$ money market in a non-reg account in the hope that it will go up – I would say that is not a good strategy. I’m not saying sell it, but rather you should look at your total investment portfolio, figure out asset allocation which will include different currencies and go from there. If you can fit in the US$ into a non-reg account then great, otherwise forget about the past and just set up the best portfolio you can starting now.
You are doing a lot of investing in US dollar securities which I think is a good move since the Canadian dollar is very high. It may hurt to convert the US dollar cash into Canadian dollars but if that’s the better move then you have to do it.
I saw Peter Lynch speak a number of years ago and one of the points that I remember best was his example of someone who bought a stock at $100, the stock goes down and the investor gets all despondent and just wishes the stock would go back up to $100 so that they can sell it and not lose any money. They refuse to sell the stock or buy more – they just want to sell the stock at the price they paid (ie get a refund). Lynch said that this is not a logical way to invest. You have to evaluate that stock at the new price and figure out if you would buy it at that price (ie keep it) or if not, then you should sell it.
I don’t know much about your overall portfolio but I can’t imagine that having a lot of money in a money market fund in a non-reg account fits in very well. If you were to put that money into an rrsp and buy US$ investments then you are really not converting anything (ignore the double currency conversion) – it will still be US$.
Please note that I am not a financial advisor and you should consult with a professional financial advisor before implementing any financial changes.
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Energy Sales Scams
Energy market de-regulation
In Ontario the energy market (natural gas, electricity) was de-regulated a few years ago to introduce competition in the energy marketplace. This has created a lot of problems because the energy resellers use door-to-door salespeople to sell the contracts and many of them seem to be crooks.
The problem
The biggest danger from door-to-door salespersons of any kind is that if they knock on enough doors they will find people who are vulnerable to making a hasty decision – old people, mothers with a young child or two, someone who is sick. All these groups are people who might normally be able to see through the lies of an energy market reseller but sometimes fall prey and sign a contract that they either don’t want or don’t understand.
My experience
Two summers ago I was relaxing on our back deck when someone knocked on our door. It was quite a loud knock and I originally thought it was one of the neighbours who was making some noise. I ignored the noise and kept enjoying the fact that my new little baby was asleep. Then I heard the knock again – this time even louder. Still I didn’t move – until the third set of knocks and I heard my wife who had been sleeping in the front room with our two week old baby, talking to someone at the door. It was only then that I realized someone had been knocking on our door – immediately I was quite annoyed that someone would keep knocking even though we weren’t answering the door.
The trap
Since I knew my wife was in even more of a sleep-deprived zombie state than I was, I quickly went into the house and talked to the person at the door. The man seemed normal enough and had his two kids with him – probably around 10 years old. He asked me if I had received my “discount” on my natural gas bill yet? I said no since I had not heard of any sort of discount. He then asked me to go and get an old gas bill and he would make sure I would get the discount. Now at this point, anybody who has any sort of intelligence would probably start to smell a rat – but given the fact that I was extremely tired and overwhelmed by the new baby – didn’t suspect a thing. While the “suspicious” part of my brain was taking a rare nap, the “greed” brain portion was wide awake and prompted me to listen to the guy and go an find an old gas bill. When I couldn’t find one I returned to the door and asked the guy if I could still get the discount without an old bill. I asked him if he could look up the account number at his office since I thought he worked for my natural gas provider. He said it shouldn’t be a problem and asked me to sign a document he had on a clipboard. On top of the clipboard I noticed quite a few gas bills that he had obtained from my neighbours for their “discount”.
The awakening
I took a look at the paper (I wasn’t completely brain dead) and noticed right away that it was a contract where if I signed I would be agreeing to a fixed rate natural gas delivery for three years. At that point I knew exactly who and what he was and and that he was trying to rip me off. I told him that this was not a discount but a contract for gas delivery. He said no – it’s for a discount on your gas bill and then showed me a table that indicated that his company’s gas charges had been lower (supposedly) then my provider. I even asked him what company he worked for and he wouldn’t say.
The punishment
Had he not had his two kids with him, I think I would have been quite tempted to literally throw him off my porch since I was quite annoyed by then. I was angry at him for waking up my sleeping family and trying to rip me off. I was also a bit angry at myself for almost letting him get away with it. I did tell him what I thought of him and his lies and told him to get lost.
The lesson
I learned that even if you are as sharp as a tack (or like to think you are), it’s important to remember that sometimes your guard is down whether you realize it or not and people like door-to-door salespersons can take advantage of that. It’s also a good idea to keep in mind that older friends and relatives might have more of those moments where they let down their guard so you should talk to them about not signing anything at the door. This can also apply to people who are looking for charitable donations at the door. Many of them are professionals who’s job it is to solicit donations so make sure that you be careful with them too.
See another post on this problem.
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Analysis Paralysis
I’ve been reading the book “The Paradox of Choice” by Barry Schwartz which is an essay looking at the problems of having too much choice. It’s not a bad book although how he stretches his central idea into an entire book is beyond me.
Some of the ideas he talks about are similar to some decision making ideas that I’ve thought about so I thought I would share them with you in the contexts that I came across them.
Buying a house
Most people have a hard time deciding on a house to buy because there are a lot of different choices to make and there are so many differences between even the most similar of houses, it can be really hard to evaluate if you are getting good value for your money or if any particular house is what you really want.
I think one of the best strategies to deal with this is to forget about buying the “best” house and instead focus on avoiding the worst houses.
When I bought my first house I had no idea what I was looking for and what I wanted – and the fact is, it took me several years of living in that house before I had a clear idea of things that I like and don’t like in a house. This was further complicated by the fact that sometimes things change after you buy a house. Ie in my case I bought a house with a small yard and then developed a passion for gardening.
The fact is that of all the houses I looked at, almost all of them would have been suitable choices for me and I would have been equally happy in all of them. Out of ten houses, if you choose the fifth best house – you will never know what it would have been like to live in any of the four “better” houses so they don’t really matter once you make the decision to buy. The poor decision houses would have involved a lot of renovation work which I wouldn’t have handled very well and a higher price tag which also would have been a mistake.
Bottom line is when choosing a house (or car or vacation etc) – focus on spending a reasonable amount of time on a good choice and avoid the bad choices. Endless dithering to try to get the “best” choice will result in paralysis or a rationalization to spend more than you can afford on the basis that something that is more expensive must be better.
Asset Allocation
Regular readers of this blog will know that I have a big interest in asset allocation with respect to investments. I like reading books about it, reading blogs, talking about it, dreaming about it (at work) with the end result that I ended up spending too much time analyzing something that doesn’t necessarily need a lot of analyzing. In fact the more I read, the more indecisive I got because every new piece of information seemed to contradict and be better than the old information. So what did I do? Simplify!!!
Instead of worrying about whether I should have 5%, 10% or 20% REIT allocation I decided to not buy any at all. I should say that the main reason I did this is because REITs have done so well over the last few years that I didn’t want to buy at an all-time high. Emerging market is another one – it’s been going crazy for the last few years and again, instead of worrying about if it would crash if I bought it – I didn’t buy any. You could argue that this strategy is more of a “head in the sand” avoidance strategy and there is nothing smart about it and I wouldn’t disagree with you. The reason that it worked for me is that I was able to put a simple asset allocation together that I was happy with and I can add in more parts (REITs, emerging markets) later on.
There are plenty of other examples of where too much choice can impair our investment decisions – ever count how many mutual funds and stocks there are? Pension choices are another black hole for a lot of workers where instead of having to choose between one or two black holes..err.. pension choices, they get a slew of black holes to choose from which can result in a lot of them choosing by default to leave their investments in money market funds or the default pension plan which is usually the most conservative.
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Saturday Weigh-In and Links
Weight today is 179.0 pounds down another half pound from last week. I did great on exercise this week as I went jogging three times but also enjoyed too many late night snacks!
I was fortunate this week to win THREE books by Richard Ferri from an excellent investing site called The Dough Roller – authored by Rob whom you might know as one half of that wacky couple known as the Two Wise Acres (just for the record they are not an actual couple). I was planning to read his asset allocation book anyways since I have read rave reviews so I was pretty excited with this win.
Home Finance Series: Mortgages and the Real Cost of Ownership
Rocket Finance did the roundup for the excellent series on home ownership.
Two Wise Acres wrote about avoiding foreclosure by thinking like investors.
My Two Dollars posted My Thoughts On This Whole Mortgage Crisis And Why I Don’t Feel That Bad. This excellent post explains why David is a bit annoyed that people who overbought are getting helped by the government while fiscally responsible people (like him) don’t get anything.
Finance Freelance Life explains how renting a home and buying a home are not as different as they seem in Why renting is right for us right now.
Rocket Finance has a great post about his own real estate mistakes.
My Dollar Plan (yes, the one with 181 financial accounts) tells us a very unusual story of how she has an adjustable rate mortgage (ARM) and not only is she happy with it – she doesn’t blame her mortgage broker, the government or space aliens for the fact that she has one.
Moolanomy explains Debt-To-Income Ratio and Why It Matters. This post covers why you shouldn’t spend too much of your net income on your house.
Millionaire Money Habits tries to decide between investing in stocks or real estate in Catch a Falling Knife – Buying the Housing Slump.
PaidTwice wrote an interesting post on the “Can we afford it” mentality which gets into the problem of people deciding if they can afford something (such as a house) based entirely on the monthly payments.
Debt Free Revolution talks about how maybe it’s not such a good idea to take advantage of increased equity in your house by paying off credits cards with a HELOC. (Home equity line of credit).
Remodeling This Life wrote a post about how she and her husband bought a house and totally gutted it. This post brought bad some unpleasant memories for me because of our own fixer-upper experience. She has a fair bit of advice and warnings for anyone who wants to buy a fixer upper.
Being Frugal wrote Frugal Hacks For Your Home. Looks like a “hack” is a tip.
Plonkee Money asks why anyone outside the US should care about the subprime mortgage crisis.
Cash Money Life explains how mortgage escrow accounts work. These are more common in the US although I have heard of house insurance payments being combined with mortgage payments. In a related article he discusses how his mortgage payment dropped recently because of changes in the escrow liability amounts.
Single Guy Money talks about the real cost of home ownership.
That Damned Rent vs. Buy Question @ Blueprint for Financial Prosperity
Predatory Mortgage Lending and the Subprime Market @ Chance Favors
After Foreclosure Guide to Housing: It Ain’t Easy @ DebtKid
Credit Withdrawal talks about how to avoid foreclosure.
Carnivals This Week
Carnival of Personal Finance was hosted by The Dividend Guy and we made the editor’s pick with our 4% Retirement Rule post.
Festival of Frugality was hosted by Finance Freelance Life and we also made the editor’s pick with our For Sale By Owner – The Wrong Way post.
This post is part of a group writing project with the M-Network bloggers and friends. See the list of other posts in this project at the bottom of the post.
There has been a lot publicity around the subprime mortgage situation in the US. There are quite a few homeowners who have been or are about to be evicted from their houses because of a number of different factors. ARMs, NINJA loan, liar loans, fraudulent lending practices and worst of all…easy credit and low interest rates led to a situation where real estate prices went up and up. People who took the plunge five years ago with flipping houses made so much money that everyone wanted to get in on it. Now that the real estate prices are not going up anymore, the gravy train has stopped cold.
In Canada, we haven’t seen this situation (yet) and I think there are several reasons for this:
- Real estate prices haven’t gone up as much as in the US.
- Lending practices in Canada were stricter than in the US.
- Interest rates are stable.
- The economy is still going strong.
Real estate prices
Real estate prices did not rise as much in Canada as they have in the US over the last several years which might have helped prevent mass speculation. It’s easier to get excited about property investing/flipping when you see 30% annual returns compared to 10% returns which is roughly what we saw here in Toronto. I believe that people who are flipping properties are more likely to use excessive leverage in order to make more money. This works really well as long as the house goes up in value but if the house goes down (which is happening in the US) then the flipper might be in big trouble.
Stricter Lending Practices
The use of the word “stricter” is this case is a relative one. The last few years have seen changes in the mortgage market in Canada where you can buy a house with zero down, get a no interest mortgage and for those who are inclined to pay a smattering of interest there are 40 year amortization terms available. All of these features allow the Canadian home owner to increase the amount they borrow which will increase the odds of problems if any of the above factors come into play.
In the US it appears that anyone with a pulse and no paperwork or job or money could get a mortgage which obviously increases the odds that some of those borrowers won’t be able to make their payments. The availability of ARMs (Adjustable Rate Mortgages) is another product which can be very useful for some home owners but for some borrowers they were a way to get a house (for a few years at least) that they couldn’t afford. It was just recently that the US government passed legislation that makes lenders consider the payment after the mortgage reset (and not during the teaser rate period) when they look at the repayment ability of the borrower. Hard to believe that sort of common sense rule has to be legislated.
Interest Rates
This is another factor that applies to both Canada and the United States. While interest rates are higher than a couple of years ago, they are still fairly reasonable. If rates were to go up say 2% then I think that this will expose some sub-prime borrowers because they might not have any room to cut back in their budget to pay for a few more hundred dollars of interest each month. A borrower with a better credit rating would also feel the pinch with higher interest rates but they would likely have more flexibility in their budget.
Economy
The economy and job situation is still quite good in Canada which is not really different than the US but if we see a recession in either country and unemployment goes up, then that will certainly put more pressure on highly-leveraged home owners and foreclosure rates will go up.
Summary
Loose lending standards and rapidly increasing real estate values were the main reasons that led to some American borrowers taking out speculative mortgages that they couldn’t afford. Because these factors were not as prevalent in Canada I think that there are a lot less borrowers in Canada who are on the edge as far as being able to afford their mortgages. That said, lenders in Canada will still give borrowers a lot of mortgage which some people have taken advantage of, so if unemployment goes up and/or interest rates go up, we could still see a smaller version of the sub-prime mortgage crisis here in Canada.
The Globe and Mail recently had an excellent article ( free login required ) on subprime lending and some of the fraudulent sales methods used.
Finally I will leave you with link to a sub-prime mortgage discussion written by a senior employee at Pimco – it’s very informative and the format (the economist is talking with his pet rabbit) is very entertaining while at the same time, somewhat disturbing. 🙂
Other posts in this series
My Two Dollars posted My Thoughts On This Whole Mortgage Crisis And Why I Don’t Feel That Bad. This excellent post explains why David is a bit annoyed that people who overbought are getting helped by the government while fiscally responsible people (like him) don’t get anything.
Finance Freelance Life explains how renting a home and buying a home are not as different as they seem in Why renting is right for us right now.
Rocket Finance has a great post about his own real estate mistakes.
My Dollar Plan (yes, the one with 181 financial accounts) tells us a very unusual story of how she has an adjustable rate mortgage (ARM) and not only is she happy with it – she doesn’t blame her mortgage broker, the government or space aliens for the fact that she has one.
Moolanomy explains Debt-To-Income Ratio and Why It Matters. This post covers why you shouldn’t spend too much of your net income on your house.
Millionaire Money Habits tries to decide between investing in stocks or real estate in Catch a Falling Knife – Buying the Housing Slump.
PaidTwice wrote an interesting post on the “Can we afford it” mentality which gets into the problem of people deciding if they can afford something (such as a house) based entirely on the monthly payments.
Debt Free Revolution talks about how maybe it’s not such a good idea to take advantage of increased equity in your house by paying off credits cards with a HELOC. (Home equity line of credit).
Remodeling This Life wrote a post about how she and her husband bought a house and totally gutted it. This post brought bad some unpleasant memories for me because of our own fixer-upper experience. She has a fair bit of advice and warnings for anyone who wants to buy a fixer upper.
Being Frugal wrote Frugal Hacks For Your Home. Still not sure exactly what a “hack” is but maybe this post will tell me….
Plonkee Money asks why anyone outside the US should care about the subprime mortgage crisis.
Cash Money Life explains how mortgage escrow accounts work. These are more common in the US although I have heard of house insurance payments being combined with mortgage payments. In a related article he discusses how his mortgage payment dropped recently because of changes in the escrow liability amounts.
Single Guy Money talks about the real cost of home ownership.
Categories
The Two Income Trap – Book Review
The “Two Income Trap” is a financial theory put forth by authors Elizabeth Warren and Amelia Warren Tyagi which proposes that middle class working couples with kids are more likely to stretch their budget to buy expensive houses in good school areas than couples without kids. Because both parents are working, there is no backup plan if there is some type of financial emergency so if one person loses their job then the family’s financial security is put at risk which can end up in bankruptcy.
This book is a well written, extensively researched look at current generation middle class Americans and the reasons why they are not doing as well financially as the previous generation. It debunks the commonly held perception that over-consumption on consumer items and frivolous expenses is the reason why middle class families have increasing debt loads and higher bankruptcy rates than the previous generation. Instead it shows using extensive research that spending on normal consumer items hasn’t changed very much from the previous generation and in fact the main spending difference is on real estate.
Why are they doing this? One reason is that parents want the best for their kids and are willing to spend more money to buy houses in better school areas. The other reason is because they can. Compared to the previous generation a lot more mothers are in the workforce which increases the amount of money a couple can spend on a house. Combined with lower interest rates and the easier credit available to the current generation and you have a recipe for skyrocketing interest rates.
To order this book:
From the United States then please use this link for Amazon.com
If you are from Canada then please use this link for Amazon.ca
The problems occur if a major event happens to the family – divorce, unemployment, medical crisis are all events that in some cases can lead to bankruptcy because the families typically can’t cope with the loss of one income.
Solutions
- The authors suggest that allowing students to go to school wherever they want will reduce the pressure on the parents to live in an expensive area. A voucher system would allow the parents to decide what school would get their funding and could possibly even allow the parents a say in running the school.
- Reduce available credit by regulating the lending industry so that families can’t qualify for loans with high interest rates they can barely afford with no down payment.
Interesting Points
- One comparison I found quite interesting was between a hypothetical family with two incomes who maxed out their credit to buy an expensive house and a second family that can live on one income for the essentials but blows the second income on vacations, big screen tvs etc. In the case where both families suffered a loss of one income, the first family would be hardest hit because they wouldn’t be able to cut back enough on the non-essentials since they have committed so much of their budget to fixed costs like housing. The second family who wastes their second income ironically could handle losing the second income because that money is not committed to anything such as a mortgage. All they have to do is stop going on expensive vacations and buying big screen televisions and they will be fine.
- Subprime mortgages – even though the book was published in 2003 the section on subprime mortgages could have been written this year. They mention how in 2002 Citibank’s subprime lending subsidiary was prosecuted for deceptive marketing practices and fined $240 million.
What I didn’t like
This book is a bit of a downer because it focuses a lot of the research on families that went bankrupt. It tends to really accentuate the negative to the point of absurdity. There was one example that I found a bit ridiculous – “Gayle” who had three kids and was divorced had fallen into the two income trap when still married and bought an expensive house that required two salaries. Once the divorce occurred (after Dad got laid off) there wasn’t enough money for her to keep the house but in her mind it was the most important thing for her kids to stay in the same house even though they were clearly on the path to bankruptcy. I agree with the authors that she was part of the two income trap when the house was bought, but hanging on to something she had no hope of affording is what I call the stupid trap. Sometimes you have to look at reality and make the choices that are best for you and your family no matter how hard they are.
Another negative which was not a major problem but a bit annoying was the authors’ use of statistics. One issue is that they almost always used comparative percentages to make things look as bad as possible and never put the numbers in context. For example they would say something like “The number of single mothers declaring bankruptcy went up 600% from 1994 to 2002” which is fine but how about letting us know the percent of bankrupt single mothers as a percent of all single mothers? Another trick they did was to extrapolate data – using the previous example they would finish off by saying “If this trend continues then by the end of the decade, one out of every ten single mothers will be bankrupt”. Looking at a trend from 1994 to 2002 (how did they come up with that time period?) and then extrapolating to 2010 is not good math.
Conclusion
Quibbles about depression inducing statistics aside, I really enjoyed this book because I thought it made a great case toward its central thesis and disproved the idea that today’s average middle class family is increasing debt because of televisions. There are a lot of thought provoking ideas in the book which made it a very interesting read.
If learning about why seemingly well off families get into financial trouble is interesting to you then I would recommend this book.
To order this book:
From the United States then please use this link for Amazon.com
If you are from Canada then please use this link for Amazon.ca