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Mental Accounting and how we spend money

Posted By Robb Engen | September 9, 2019

We all have quirky behaviours when it comes to managing money. One trick we fall victim to is called mental accounting. We separate our money into different types of mental accounts, with different rules, depending upon how we get it, how we spend it, and how it makes us feel.

An easy example is when you have a fund set aside for something like a vacation or house down payment while at the same time carrying high-interest credit-card debt. Or how you decide to spend a $1,200 tax refund versus what you’d do with $100 per month if you had the right amount of tax coming off your paycheque in the first place.

I’m guilty of mental accounting every month when I budget $1,000 for groceries, $200 for dining out, $125 for clothing, and $75 for alcohol. I manipulate those mental accounts all the time, like when I overspend in one category and just take it out of another (shifting a meal from ‘dining’ to ‘entertainment’ for example).

The Mental Accounting challenge

Why do we assign money to these mental categories? One answer is to control how we think about it. If we were perfectly rational and could figure out the opportunity costs and complex trade-offs of every single financial transaction then it wouldn’t matter how we label our money: it would just come from a big pool called ‘our money.’ It’s just money, after all; totally fungible and interchangeable.

But because we’re human with cognitive limitations and emotions we need help with our money decisions. That’s where mental accounting comes in and acts as a useful shortcut for what decisions to make.

Another interesting way we classify our financial decisions has to do with the length of time between when we bought an item and when we consumed it.

Nobel Prize winner Richard Thaler studied wine purchases and consumption and found that advance purchases of wine are often thought of as investments. Months or years later, when the bottle is opened and consumed, the consumption feels free, as if no money was spent on wine that evening. Continue Reading…

Making the most of CPP and the Guaranteed Income Supplement (GIS)

Posted By Financial Independence Hub | September 6, 2019

By Graeme Hughes, PFP, for Cutthecrapinvesting

Special to the Financial Independence Hub

Note from Dale Roberts: This is a guest post by invitation, from Graeme Hughes, PFP. Thanks to Graeme, this is a wonderful follow up post to The 3 Most Common Mistakes of Canadian Investors. Over to Graeme …

Canada’s tax and benefits system is a convoluted tangle of programs, rules and exceptions that can be a genuine challenge to navigate. Like all complex systems, having some knowledge of how it works often reveals opportunities to benefit. And as a taxpayer, it only makes sense to ensure that we are accessing all the benefits our tax contributions have made possible.

One of the greatest areas where this type of planning pays off is in structuring our early-retirement income to maximize pension benefits. Here we will be looking at two benefits in particular, the Guaranteed Income Supplement (GIS) and the Canada Pension Plan (CPP).

Accessing the Guaranteed Income Supplement (GIS)

Often, the GIS is viewed as being strictly a benefit for seniors who are living in poverty. However, recent studies show almost a third of Canadian seniors are receiving this benefit, and it can add substantially to your total retirement picture.

The GIS is an add-on payment to Old Age Security (OAS). It provides a maximum monthly benefit of $907.30 for single OAS recipients, and $546.17 each for married and common-law OAS recipient. Benefits are income tested, and clawed back at a rate of at least $1 for every $2 of taxable income for singles, and at least $1 each for every $4 of combined income for couples. The clawback rates are variable depending on total income, and more detailed tables can be found here.

The GIS is a non-taxable benefit, and OAS amounts are not included in the income calculation. Once annual income reaches $18,408 for individuals, or $24,336 in combined income for couples, the GIS benefit drops to zero.

How to maximize the GIS if you have modest savings

Knowing this, if I were a retiree with modest savings and no employer-sponsored pension, I would be tempted to ensure I reached age 65 without any RRSPs. Given the GIS clawback would apply to taxable RRSP withdrawals, the RRSP becomes a very inefficient way to fund additional retirement spending.

For example, if I am a single retiree, aged 65 or older, and I receive 70% of the maximum CPP amount ($808/month), I will be entitled to an additional $363 per month in GIS payments, along with my $607 OAS benefit (assuming 100% OAS eligibility).

While that may not seem like a lot of money, the GIS benefit represents 20% of my total income. For every dollar I take from an RRSP, I am going to lose at least 50 cents of that GIS benefit, and that would be a waste of my precious savings.

However, this clawback does not apply to TFSA withdrawals or withdrawals from non-registered accounts, since they are non-taxable. Keep in mind that in non-registered accounts, any interest, dividends or capital gains that are earned would result in GIS clawbacks, but these would likely be much more minor unless the balances are sizeable.

So for many retirees, it may be beneficial to liquidate their RRSPs prior to age 65, or shortly after 65, and move the proceeds to a TFSA first, with any excess amounts going to a non-registered account. This will maximize the value of the money they have worked hard to save, and optimize their entitlement to government benefits.

Of course, the tax consequences of liquidating RRSPs need to be carefully considered and compared to the GIS benefits likely to be gained. The larger the RRSP balances, the harder this strategy is to justify.

How to benefit from GIS if your Retirement Savings are more substantial

The GIS options become even more interesting for retirees that have larger amounts of savings and limited sources of retirement income outside of government pensions. In this case, appropriately structuring your affairs can provide a real advantage in increasing the longevity of your retirement assets. Continue Reading…

Is it time to time the market … this time?

Posted By Financial Independence Hub | September 5, 2019

By Steve Lowrie, CFA

Special to the Financial Independence Hub

Has recent market news got you thinking it might be time to rethink your market positions? It’s certainly understandable if the economic uncertainty unfolding in the daily news has left you wondering – or worrying – about what lies ahead. No matter how you feel about the U.S. entering into a trade war with China, it’s hard to deny that the prospect is currently causing considerable market turmoil. It is also hard to avoid the recent financial media obsession with an “inverted yield curve” (a rare situation when short-term bond maturities are yielding more than longer-term maturities).

You might have heard that each U.S. recession since the 1970s has been preceded by an inverted yield curve. However, perhaps for the sake of sensationalism, not all articles correctly report that this relationship does not always hold true. In reality, every yield curve inversion does not lead to an imminent recession and/or lower equity prices. Recent analysis by professors Eugene Fama and Ken French tested this very hypothesis. Using data from the U.S. and 11 other developed markets, they found “no evidence that inverted yield curves predict stocks will underperform bills (bonds).”

Regardless of how the coming weeks and months unfold, are you okay with gritting your teeth, and keeping your carefully structured portfolio on track as planned? This probably doesn’t surprise you, but that’s exactly what we would suggest. Unless, of course, new or different personal circumstances warrant revisiting your asset allocation for reasons that have nothing to do with all the tea in China.

That said, the recent news is admittedly unsettling. If you’ve got your doubts, you may be wondering whether you should somehow shift your portfolio to higher ground, until the coast seems clear. In other words, might these stressful times justify a measure of market-timing?

Here are four important reminders on the perils of trying to time the market: at any time. It may offer brief relief, but market-timing ultimately runs counter to your best strategies for building durable, long-term wealth.

1) Market-Timing is undependable

Granted, it’s almost certainly only a matter of time before we experience another recession. As such, it may periodically feel “obvious” that the next one is nearly here. But is it? It’s possible, but market history has shown us time and again that seemingly sure bets often end up being losing ones instead. Even as recently as year-end 2018, when markets dropped precipitously almost overnight, many investors wondered whether to expect nothing but trouble in 2019. As we now know, that particular downturn ended up being a brief stumble rather than a lasting fall. Had you gotten out then, you might still be sitting on the sidelines, wondering when to get back in. The same could be said for any market-timing trades you might be tempted to take today.

2) Market-Timing odds are against you

Market-timing is not only a stressful strategy, it’s more likely to hurt than help your long-term return. Over time and overall, markets have eventually gone up in alignment with the real wealth they generate. But they’ve almost always done so in frequent fits and starts, with some of the best returns immediately following some of the worst. If you try to avoid the downturns, you’re essentially betting against the strong likelihood that the markets will eventually continue to climb upward as they always have before. You’re betting against everything we know about expected market returns. Continue Reading…

Sharing for Profit: 7 lazy ways you can earn money through the Sharing Economy

Posted By Financial Independence Hub | September 4, 2019

By Sienna Walker

Special to the Financial Independence Hub

Sharing is caring. Sharing something you own, sharing a little bit of your time, or sharing a skill you’ve cultivated can amount to a pretty decent payday. In fact, this is the very foundation of the sharing economy idea that has taken world by storm.

The best part about sharing economy gigs is that many of them are often easy. Since you set your own schedule and choose the way you participate, you can engage whenever you feel like it. If you want a boost to your income on your own terms, the sharing economy might be a perfect fit for you.

1.) Deliver Stuff

Sometimes, people want specific food, but for whatever reason, they can’t prepare it themselves or drive out to go get it. If you join an app as a delivery driver, it can become your job to drop fast food at someone’s doorstep. It’s as simple as that.

Most delivery jobs will score you a little money from the app company and a tip from the delivery recipient. If you limit yourself to your local area and make yourself available on the weekends when people might be a little too – ahem – tipsy to drive, you can make a decent amount of money for relatively little effort.

2.) Rent out stuff you aren’t using

You can rent out almost anything you aren’t currently using. People who only need something for the short term don’t want to purchase it: they don’t want to be stuck with it after it outlives its brief purpose.

You can rent bikes, skis, surfboards, cameras, or even clothes. Over time, you might even make more money than if you had chosen to sell the item. As long as it stays in relatively good condition, you can rent it indefinitely.

3.) Rent out your house while you’re away

You’re going on vacation for two or three weeks. That leaves your house vacant for an extended period of time. It’s just sitting there, not making you any money. Unless, of course, you rent it. A rental property calculator can help you determine how much you can realistically charge as a rental fee for your home.

If you have extra space even when you’re home or your trip is going to be short, you can use short term rental apps to help supplement your income.

4.) Drive people places

If you don’t mind driving, you can always sign up with a ride hailing service. You’re essentially making money from your driveway. Some people make enough money becoming a driver that they make it a full time job. Before you sign up, compare and contrast the differences between services to be sure you’re choosing the best one for you. Much like food delivery, ride hailing app drivers typically make great money on the weekends if their coverage area includes a lot of busy bars. Help people get home safe and make some extra cash. Continue Reading…

The best bank accounts for Students

Posted By Financial Independence Hub | September 3, 2019

By Zack Fenech, RateHub.ca

Special to the Financial Independence Hub

As a new or returning post-secondary student, finances probably lean on the less exciting side of this new or continuing life chapter.

Be that as it may, properly managing your finances is still something you’ll have to do at one point or another.

Finding the right student bank account can help you save some money. In some cases, you can earn unique student tailored benefits: if you choose the right chequing account or savings account, that is.

After all, would you rather spend money on school supplies and experiences or pay monthly account fees or transaction commissions?

That said, the best student bank accounts offer a wide variety of options and advantages tailored to student living, and provide students with more financial freedom.

The other side of the coin for student bank account options might be using a free bank account. Free bank accounts allow you to use the account beyond graduation, in exchange for student tailored perks.

This article will detail the difference between the two types of accounts and which account is best for each category. It’ll also help you get a clearer understanding of which type of account is best for you.

Student Bank Accounts vs. free Bank Accounts

Student bank accounts are regular bank accounts that offer unique advantages to students. Some of these advantages include no monthly or annual banking fees, unlimited transactions and e-transfers, and sign-up promotions or point programs.

Another option fitting for students is free bank accounts offered by digital banks. Though not student accounts by definition, free bank accounts are entirely free and limitless, making them ideal for anyone, whether you’re a student or not.

The only difference from paid accounts is that they do not include many of the student-tailored advantages previously mentioned. Continue Reading…