All posts by Financial Independence Hub

The Real Cost Of Personal Debt

MarieEngen
Marie Engen, Boomer & Echo

By Marie Engen, Boomer & Echo

Special to the Financial Independence Hub

We are constantly reminded about the rising level of outstanding personal debt carried by Canadians. Every few months we hear about the perils of rising interest rates that may leave many in financial difficulty.

The reality is – debt is not all bad. Most of us wouldn’t have been able to purchase our homes without a mortgage, or buy a car, or pursue secondary education. Even credit cards are not evil in and of themselves no matter how they are often portrayed.

To never (ever) borrow money is to live in the land of the already rich, or to always be a renter. At the other extreme, using other people’s money to fully finance your lifestyle is ridiculous and precarious.

Most of us don’t fall into these extreme circumstances. We hold a reasonable amount of debt, make our payments on time and have good, to very good, credit ratings. That being said, most people fail to optimize their overall debt management strategies to pay the least amount of interest.

Consolidating debts

We no longer hear about the “all-in-one” mortgages offered by financial institutions such as the Manulife ONE and National Bank All-in-One. These accounts combine chequing, savings, and borrowing into one account. If used properly, consumers could simplify their debt and lower their overall interest paid.

These won’t work for most people because they like to keep all their accounts separate. They have multiple liabilities at different interest rates:

  • Home mortgage
  • Car loan
  • Line of Credit
  • Student loan
  • Credit card to use for discounts at your favourite store
  • Credit card for other rewards.

When I worked in banking, I gave out many consolidation loans. I confiscated and cut up credit cards, cancelled overdraft protection, and closed out other loans and lines of credit. Invariably, within a couple of months, more than half of these clients would reapply for their credit cards, reinstate ODP, and sneak off to a different branch to get another line of credit.

More personal debt mismanagement

Here are some other ways people don’t think clearly about managing their personal debt.

  • Mike and Molly are determined to pay off their mortgage (2.7%) in less than 10 years. They put every available dollar towards the principal. They also have two car loans at 4.5% and 8% and purchased a “don’t-pay-for-six-months” entertainment system. It makes more sense to address these debts first.
  • When their mortgage came up for renewal, Fred and Ethel rolled the balance into a new Home Equity Line of Credit. However, they continue to finance their lavish life style with their credit cards. They pay off the cards each month from the HELOC on which they make the required minimum payment of accrued interest. After all, they have a huge balance still available to them. They think they are managing their debt well by paying off “bad” credit card debt and having “good” mortgage debt.
  • Jess went to her favourite home décor store to purchase some sheets. There was a store promotion that gave 20% off purchases when opening a new store credit card. Excited by the discount, Jess picked out a whole bedding set from duvet to accent cushions. The balance is too high to pay when the bill arrives so she makes minimum monthly payments while incurring interest charges of 29.9%. Meanwhile, she has enough money in her low-interest savings account to pay the entire bill, but chooses not to.
  • Leonard works on commission and his paycheque amounts vary. He makes up the difference in lean months with his overdraft protection at 24%. Until he learns how to budget for his irregular income, he should use his credit card for purchases, even if he carries a balance for a month or two.
  • Ross receives a credit card offer with a “teaser” 0% interest on balance transfers. He transfers the balance from his high interest rate card and cancels it. He uses his new card for future purchases, not realizing that the 0% only applies to the amount of the transfer. His payments go to the new purchases he made which carry a much higher rate. He would have been better off to continue using his old card for his occasional new purchases, pay the monthly balance in full, and avoid using the new card at all.
  • Barney and Betty have a systematic plan to pay off all their debt. They are using the “snowball” method popularized by author Dave Ramsey, which states that it is psychologically satisfying to first rid yourself of the smallest debts first, regardless of interest rates. The reasoning is they would be better prepared – and more enthusiastic – to stick with the strategy. But, once the small debts were done they took their foot off the gas and paid random amounts on the higher debts whenever the inclination hit them.  

Final thoughts

Instead of speculating about the direction of future interest rates, we should be examining our own habits.

Take a look at how you think about – and manage – your personal debt and see if you can minimize your borrowing costs.

Also read:

Marie Engen is the “Boomer” half of Boomer & Echo. In addition to being co-author of the website, Marie is a fee-only financial planner based in Kelowna, B.C. This article originally ran at the Boomer & Echo site on Feb. 9, 2016 and is republished here with permission.

 

FWB Video: Should Stock investors rotate between different industries?

 The latest video from FWB TV’s Evidence Based Investor Video blogs has been posted: Should stock investors rotate between different industries?. 

In the 3.5-minute video Cambridge stock market historian Elroy Dimson (pictured left) observes that  Investors (and consumers) have a tendency to be attracted to the latest “hot” technology, such as driverless cars or 3D printing.

That might be fine for purchasing cell phones and flat screen television sets but it is not necessarily the best course of action when it comes to investing choices.

Sometimes the emerging “Hot” industry can be a money loser, as occurred early in the 20th century when many auto manufacturers went bankrupt. On the other hand, the “old” staid industry of railways actually performed well for many investors.

Dimson concludes that simply rotating from one hot industry to another is a bad idea for most investors, arguing instead for diversifying both across industries as well as across various regions of the global economy.

After watching the video if you want to learn more, download the free guide, 12 Essential Ideas For Building Wealth

 

Building Your Financial “Stop Doing” List:  Stop Chasing Dividends

 

stevelowrie
Steve Lowrie

By Steve Lowrie, Lowrie Financial

Special to the Financial Independence Hub

During the 20+ years I’ve been a financial advisor, I’ve noticed how often the market keeps playing the same devilish tricks, each time in a guise that differs just enough to fool us all over again.

Today’s “Stop Doing” post exposes one of these more common tricks of the trade: Investors who are seeking a reliable income stream for retirement should STOP building their investment strategy around dividend-paying stocks (or higher-interest-yielding bonds) in isolation, without considering them in the context of their total wealth management.

Speaking of devilish acts, let’s revisit the Wall Street Journal columnist Jason Zweig’s “The Devil’s Financial Dictionary” (emphasis is ours):

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Why you should be wary of index-linked GICs


patmckeough
Patrick McKeough

By Patrick McKeough, TSINetwork.ca

Special to the Financial Independence Hub

Index-linked GICs (Guaranteed Investment Certificates) provide the buyer with a return that is “linked” to the direction of the stock market in a given period. A quick look at the rules on these deals may give you the impression that the investor can profit substantially with little risk. However, the link depends on a formula or set of rules that is buried in the fine print.

These investments are marketed as offering all of the advantages of stock-market investing with none of the risk. But banks and insurance companies aren’t in the business of giving customers something for nothing. The capital gain that holders get depends on an ingenious formula which is cleverly designed to sound generous while minimizing the potential payout.

Index-linked GICs fail to offer the big tax advantages of stock investing

Another drawback is that returns on index-linked GICs are taxed as interest. That’s because you’re not actually investing in the stock indexes themselves; you’re just getting paid interest based on the change in the indexes. That’s a drawback because interest is the highest taxed of all investment returns.

Usually, stock-market investing produces capital gains and dividend income, both of which are taxed at a much lower rate than interest. (Of course, if you hold the GICs in an RRSP, all income is tax deferred.)

These GICs do protect your principal. But few investors if any make a good return on index-linked GICs. Most make less (at times substantially less) in index-linked GICs than they would have made in old-fashioned GICs.

If safety is your primary concern, you’d be better off with “plain vanilla” stocks and bonds. If you already own index-linked GICs, our advice is to cash them in at the earliest opportunity. If you don’t own them, we recommend that you stay out.

No matter what kind of stocks you invest in, you should take care to spread your money out across the five main economic sectors: Finance, Utilities, Consumer, Resources & Commodities, and Manufacturing & Industry.

By diversifying across most if not all of the five sectors, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or investor fashion.

You also increase your chances of stumbling upon a market superstar—a stock that does two to three or more times better than the market average.

Our three-part Successful Investor strategy:

  1. Invest mainly in well-established companies
  2. Spread your money out across most if not all of the five main economic sectors (Finance, Utilities, Consumer, Resources & Commodities, and Manufacturing & Industry.)
  3. Downplay or avoid stocks in the broker/media limelight.

Note: This article was originally published in 2012 and has been updated. Here is the most recent version that ran at TSINetwork.ca. Permalink: http://www.tsinetwork.ca/?p=53526

Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books.

Q&A with Mawer’s Jim Hall: Deflation and rising interest rates

MAWER_Cameron-Webster-4x6-Formal-blue-bg
Cameron Webster

By Cameron Webster, CFA
Institutional Portfolio Manager, Mawer Investment Management Ltd.

Special to the Financial Independence Hub

At Mawer, we spend a great deal of time asking and answering the question: So What? A company’s share price is down 6% … so what? A central bank moved interest rates up … so what?” Google re-named itself Alphabet … so what?”

It is not always an easy question to answer and often leads us to ask even more questions in an effort to develop key investment insights.

“So what?” is one of the questions that can lead us to investment action (or inaction) in our process of building well-diversified, resilient portfolios. In an effort to pass on our “so what” learnings, I interviewed our Chief Investment Officer, Jim Hall, with specific questions pertaining to his views on risks in the current environment.

Cameron Webster: Jim, Mawer conducts a quarterly risk review, rating macro risks on both probability of occurrence and degree of severity. I see a few with 9/10 on probability but lower severity and a few with the opposite profile, high severity, lower probability. Help us understand the way Mawer is viewing some of the broader risks at the top of the list right now.

MAWER_Jim Hall 4x6 Formal blue bg
Jim Hall

Jim Hall: It is not enough to just look at the rankings. We need to ask ourselves is it something we need to do something about? Is this something upon which we need to act? Is it a biggie? Is it important? That’s the value in evaluating these risks on both probability of occurrence and severity of consequence.

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