Investoid

As I’ve been buying stuff for my home, I’ve come across quite a few advertisements for 0% financing. Whether it’s for a new sofa, a garage package, or some other relatively large ticket item, many places seem to be willing to offer this ‘costless’ incentive.

Such claims are best met with a fair dose of skepticism. Companies, even retail ones, are not in the business of throwing away money. All companies place some time value on money, meaning that future payments are worth less to them than current payments. As a result, when you see 0% financing they have in fact marked up the price to account for the use of the 0% payment schedule. Here are some things to note when looking at 0% financing deals.

• See if you can get a better ‘cash’ price. As I said above, if the company is offering 0% financing, they are using some rate of return in their internal calculations. If you have the cash up front, you will probably be better off. If you need to finance the purchase, then look at what types of lending options you have available to you outside of the 0% financing. You can use this spreadsheet to see if a negotiated price is actually a better deal versus outside financing.
• Watch for ‘gotchas’ that will increase the true cost. For example, there may be administration fees, application fees, manager consultation fees, etc. Add those costs into your calculations to determine whether the list price is a better deal. For smaller purchases, these costs can be quite significant on a percentage basis.
• See what kind of penalties there are for late payments or non-payments. Typically these penalties are much more severe than they would be using alternative forms of financing. For instance, a late payment may mean that the 0% financing deal becomes null and you all future payments are now immediately due. Or, you will be charged back interest for payments you’ve already made as well as having to pay at a high interest rate for the remainder of the term.

Sometimes these deals are a good way of making some ‘free money’. For instance, our garage package was offered at 0% financing with no additional fees. We were planning on paying cash, but they would not negotiate on the price. So we did the financing package and have banked the cash in a high interest savings account. We will withdraw periodically to pay off the purchase, banking the interest as difference. It will amount to about $100 over the life of the loan.

Since I bought my house we’ve had a lot of expenses/purchases made, a lot of them significant. It’s been a very busy time and as a result I haven’t been as financially disciplined as I’d like. I’ve been wasting a lot of money on food-related items, for various reasons. It’s been hard for me to take the time to make a lunch in the morning. Also, my wife and I have been doing different things at night at least three times a week, so we haven’t been together for meals and are either doing the personal meal/microwave thing or eating out. Lastly, I’ve been having a lot of meal/snack/coffee related meetings, and since I work a regular job most of these have been during suppertime.

On the house side, we had to buy furniture since our last place was furnished, and we also bought a few luxuries for the home. We’ve also been buying lots of little things for the place, some of which are replacables that will need to be added to our typical monthly expenses. All in all it’s been a pretty expensive couple of months, and I haven’t liked how we’ve been going well over our monthly budget and as a result had to dip into the cash we normally would have been saving.

To be fair, we have had a bit more extra money also coming in, from the completion of our travel business as well as through the other consulting work both of us have been doing.

Now that all the major purchases are out of the way, I need to re-institute some financial discipline. For me, it all starts out with regulating my routine. So for food, I am going to select a day and time for grocery shopping and stick to it, and also leave preparation time for lunches at the beginning of the week (I can refrigerate and freeze most of my lunch foods, or otherwise make them ready to go). I will also be trying to re-organize my meetings to fall on weekends so they can be more coffee meetings and less dinners.

We also need to re-evaluate our household expenses, see where we can save and adjust our budget to reflect our new housing.

It can be easy to go overboard financially and then get used to the excesses. But if you want to maintain a strong financial footing, you need to stop and take the time to right your habits when you notice they aren’t what you want them to be.

When I received my mortgage documents last week there was a credit card application included. It’s for the First National MasterCard with Worldpoints. Like many other points programs, you accumulate points on purchases made with the card and they can be redeemed on various things, such as household items or trips around the world. But this card can also do something else - pay down the principal on your mortgage.

For every $125 you spend on the card, you can pay down the principal of your mortgage by $1. So if you spend say $5000 a year on your card, then you can put $40 down toward your principal. While this may not seem like a lot, the savings in interest over time can be quite large. You can pay down the mortgage principal at any time and as many times as you want.

The catch? For one, there’s a $30 annual fee on the card, so you better be spending more than $3750 on the card each year or else the savings is a wash (just put the $30 against your mortgage). Also, if you end up carrying a balance then you’re paying interest at a higher rate than your mortgage, so you’re also not benefiting.

We’ve accumulated quite a bit of Air Miles and Aeroplan points over the past couple of years, since we typically use our credit cards for big purchases and we made a lot of purchases for our small business on the cards as well. While we probably won’t be doing as many big purchases in the future, we do pay a lot of monthly bills using automatic credit card payments (eg. for telephones, cable, gym, etc.). Since we always pay off our balance each month, this is equivalent to cash purchases.

We signed up my wife for one and will transfer as many of our automatic payments over to the card as possible. When it comes to paying down a mortgage, every little bit helps.

As a counterpoint to Cliff Mason’s post on not saving when you’re young, I came across a very good article by Laura Rowley called Earning a Degree in Financial Stability. It is an excellent read and has many good tips that will help you have a financially sound mindest from the get-go. It’s focused on college grads but I think it’s good for anyone at any age to evaluate whether they have these principles in theory and in practice.

Cliff Mason, a thestreet.com columnist (and Jim Cramer’s nephew) wrote last week about the stupidity of saving when you’re young. His long ramblings form a pretty incoherent argument (he self-admittedly got his job because of his connections), but there are a couple of interesting points within his diatribe:

• You shouldn’t save money if you have high interest student loans and the like.
• The miracles of compounding notwithstanding, the amount you’re earning on early savings (in his example, $5000) can be made up for a few years later when you are making more money than an entry-level position and will be in a greater position to save.

I would argue that by putting money towards your debts, you are in fact saving since you are reducing the future amount of interest you would pay. For me saving is all about earning a return on money you are not spending for immediate goods and services. So if your return is higher by paying down debt than it would be on an alternative risk-adjusted investment, then the choice becomes clear.

I can see the logic behind his argument about the relatively small increase in total savings from interest within the first few years. However, I don’t think the absolute return on savings is the main reason people should save early. Saving brings about financial discipline in an individual. If they learn how to save money early, then they are more likely to save money as they get older. The converse is also painfully true - you don’t have to look hard to find someone you know facing some financial difficulties. Unless there was a major disaster (loss of job, sickness, etc.), they can probably attribute some of their current issues to the fact they weren’t very good with money from a fairly early age.

I read an article on Yahoo! Finance yesterday that mentioned that nearly 60% of Americans have less than $25,000 in retirement savings (outside of pensions, etc.). How do they expect to actually retire? Most people have never thought about garnishing a portion of their wages for savings, and as a result never realized the implications of not saving enough until it is too late.

So once you’re out from under the debt heap that is student loans (or all debts whose interest is higher than what you can earn in a high-interest savings account), I think it’s important to start putting money in the bank on a periodic basis. It will set you up for financial freedom over time.

I’ve been doing a fair bit of work on my home in order to make it feel like ‘our place’. Most of the things have been relatively small and only cost a few hundred dollars, but we do have one large expense: the addition of a detached garage.

The house already has a driveway to the rear of the house, but the driveway also has to be extended so that the garage can sit at the back of the lot. This means that we’re looking at a heap of concrete. Naturally, we started to figure out who can make the pad and driveway within our time constraints for a reasonable price.

Being accustomed to competitive pricing in most things I buy (stocks, household items, etc.), I was surprised by the breadth of the range of prices. The range of quotes was well over $5000! This reminded me that in markets with little transparency and with information asymmetry between buyers and sellers, spreads tend to increase dramatically.

As a result, I endeavoured to become a little more educated about the product prior to making a decision, to ensure that I was purchasing something that would be of reasonable quality and price. This was extremely helpful, and as a result I was able to go with one of the lower bids. Part of the reason for the better price was due to the contractor working in tandem with another who will be doing the framing of the garage.

I re-learned that it pays to call around when you’re treading in markets that don’t allow you to easily compare prices. I found that some providers were ‘naming their price’ due to the high demand, and people have been blindly accepting their pricing without doing their homework. By staying informed, you’re more likely to ensure that you will get a fair price.

A lot of the bloggers on my blogroll post periodic (or quasi-periodic) updates on their networth. Typically the networth calculations is straightforward:

Personal Assets - Liabilities = Networth

Assets would include investments, cash, homes, cars, and other long term assets. Liabilities would be things like credit card debt, mortgages, car loans, etc. The Middle Class Millionaire has decided to calculate his networth differently. His calculations produces some interesting results (see his post and the subsequent discussion).

I think it’s great that these people are focused on increasing their portfolio size to reach their investment and life goals, and that they are measuring their current status to ensure they are on track. However, from an investment perspective most of them do not seem to be keeping solid track of their investment returns versus overall portfolio growth.

What’s the difference? Investment returns are increases in the portfolio size due to higher asset prices or returns on investment (ie. dividends or other distributions). They ignore cash infusions and disbursements, to provide an accurate measurement of an asset’s return. Typically, the holding period return formula is used.

Why does this matter? After all, most people will evaluate the performance of their individual stocks or funds a fair bit, particularly in relation to their initial purchase price. But it’s important to measure your portfolio’s performance over time, not just at an individual asset but at an aggregate level. Also, you will be measuring the performance of your assets from the same point in time, rather than from the time of purchase. This is helpful when analyzing asset allocation as well as diversification. Furthermore, people who are saving for retirement may get a slightly skewed view of how their assets are doing if they look at how much their portfolio is growing in total size, but ignore the holding period return.

I think some people tend to avoid doing this because it can get a little complicated. You need to track what happens each time you buy and sell an asset, and account for the changes over each interval. It becomes especially tricky if you want to evaluate holding period returns at an arbitrary granularity - say analyze your monthly returns then roll that up into quarterly or semi-annual returns.

Nonetheless, I think it’s worth putting the time into ensuring that your portfolio is on track investment wise. I’ve looked at using a portfolio management software program like this for my own bookkeeping. If anyone has experience with a good - and preferably cheap or free - software (online or offline) system that allows you to input transactions and then calculate arbitrary time-period returns, let me know.

This is my post for the Canadian Tour of Personal Finance Blogs.

On Friday I talked about how the movie The Pursuit of Happyness demonstrated how it’s important to treat yourself, even if you are trying to be frugal to retire early or if you’re not that well off. I think this idea is very important - if you don’t pay yourself now (not just financially but emotionally and psychologically), your current and future happiness will be negatively affected. The key to a happy lifestyle is balance - ensuring you don’t fall into the latte crowd, while also spending wisely on things that you derive great happiness from.

For instance, my wife likes to travel a lot, and from time to time I like to get gadgets that ‘improve my work’ (read: are cool and fun). These can both be relatively expensive tastes, and if we’re not careful we will be spending an inordinate amount of our income on these leisures that will materially affect our future financial goals. However, we don’t want to go completely without until we are retired, since we derive happiness from these things in moderation.

Thus, my family has instituted a ’save half, spend half principle’. If there’s something that we want, we will do two things. The first is to save up some discretionary funds that we usually spend on a monthly basis. The second thing is to work for extra income. But we are not allowed to spend all the extra income - we must save half of it.

This principle forces us to look at how much value we truly place on an item or experience - if we’re not willing to work twice the monetary amount to acquire it, then maybe it’s not that worthwhile in the first place. This also has the extra benefit of increasing our retirement savings at the same time. So when we work harder, we pay ourselves twice - both immediately (or in the near term) and in the long term future.

The safe half, spend half principle is something that can be used for discipline as well as reward, and we use it for all extra income we receive.

Monty over at the Canadian Money Advisor has decided to start a tour of Canadian Personal Finance blogs, and the first one takes place on Monday April 16. I haven’t decided what I’ll write about yet, but I think this event is a good opportunity to have readers cross over between blogs and find new views on finance related topics.

For me, I look forward to reading some new blogs and see what else is out there. A couple of the participating blogs that I’ve been introduced to are:

• Big Cajun Man - Canadian Financial Stuff
• Customers Revenge
• Be Young and Rich
• Canadian Mortgage Trends

If you want to get involved in the next tour, check out the link below.