Three Tips for Holiday Spending

If your outgo is more than your income, your upkeep will be your downfall. --- Unknown

It's the time of year when many spend on others ... and themselves. Without self-restraint, the January bills can be a downer.

Through The Years
Since the days when you could say "Merry Christmas" without offending anyone, we've celebrated the special, joyous holiday season. Good will towards all. We had a tree and presents.

In the early 1980s, I started celebrated Boxing Day instead. At Sam The Record Man where everything was on sale. And stereo equipment stores. Remember these were the days before VCRs, computers and even audio CDs.

Nowadays, even Boxing Day has lost its charm. Retailers like Best Buy and Future Shop start their sales online on December 25th. Boxing Day sales start at crazy times like 7am --- with lineups!

Lessons Learned
Here are three tips to deal with overspending:

1. Know your prices
2. Know your limits
3. Delay opening impulse buys

Know Your Prices
Big ads and long lines don't mean big savings. If you don't know the regular selling prices, you could overpay for an item on "sale". Last year, I indulged in a GPS navigation system. I started researching in the fall and monitoring prices. Prices dipped lowest in late November/early December. That's when I bought. On Boxing Day and beyond, discounts off the normal prices were smaller. On Boxing Day, I saw brands I'd never seen before or since. Retailers must bring in items they didn't normally stock just to mark them down for unwary customers.

Know Your Limits
Naturally, buying is easier than paying. It helps to know how much you can afford before you go shopping. Some items decrease in price or improve in quality. Computers, for example. You can benefit by waiting.

Impulse Byes
If you bought an item on impulse, wait 48 hours before opening the package (assuming it won't go bad, you have self-control, and it's returnable). You can pretend you bought online and are waiting for delivery. If you lose interest, return the item. This works very well for me. Right now, here's what's going back unopened: car DC-to-AC converter, aluminum computer case and a backpack. They may soon be joined by a LED flashlight you can recharge by winding up. The following passed the wait: nonstick cookware, vacuum cleaner. They were worth the wait.

Other Tips
Read other posts on holiday spending from the Canadian Tour of Personal Finance Blogs.

Life on the Road: The Canadian Tour of Personal Finance Blogs Returns

When you're riding sixteen hours
and there's nothing much to do
And you don't feel much like riding,
you just wish the trip was through.
--- Bob Seger, Turn The Page

Life's tough on the road even when you're a big rock star with an entourage. Imagine the plight of a personal finance blogger --- in Canada. No personal jet. Not even a tour bus. Instead, we travel in cyberspace. Here's the good news for you: admission is free. You simply visit one of the sites on the tour and follow the links to the other "performers".

The organizer, Monty Loree of Canadian-Money-Advisor.ca has suggested a timely theme: views on holiday spending as it relates to personal finance. Drop by on Tuesday November 27 and see the results.

And these towns all look the same.
We just pass the time in our hotel rooms
And wander 'round backstage.
Till those lights come up and we hear that crowd
And we remember why we came
--- Jackson Browne, The Load Out/Stay

Attention Bloggers
Do you write about Canadian personal finances? How about joining the joining the tour, here's the registration page.

The Car Mechanic: Paying for Effort or Results?

Oh no! Your car broke down. You've got no idea what's wrong. The problem could simple or major.

Effort
You're told that repairs will take three days but they take four and cost you $1,000. Getting around is inconvenient but you manage. You pay, feeling the bill is reasonable for the amount of time and effort.

You don't realize that the mechanic was average. Most of the time went to finding the problem.

Advice is judged by results, not by intentions. --- Marcus Tullius Cicero

Results
Suppose you go to an exceptional mechanic instead. This mechanic fixes your car in 10 minutes. How would you feel about paying $1,000?

Chances are you'd balk. A $1,000 for 10 minutes of work? Ridiculous! But is it? You got your car fixed in less time than a pizza delivery and you saved four days of aggravation.

Wisdom

One that would have the fruit must climb the tree. --- Thomas Fuller

Wisdom takes years to acquire and has a cost. We can't easily measure wisdom and don't have two identical cars to take to the two mechanics. Our usual solution? Pay for the time expended. So we pay accountants, lawyers and others by the hour. We pay for effort rather than results.

Real Life
When we looking for our first home, we met a real estate agent at an open house. We described our needs and wants: close to public transit, quiet, large, within our budget. The first place our agent showed us was ideal. So we did the obvious --- kept looking.

After a few more days of visiting other places, we bought the first place. We now accepted that our agent was excellent. We didn't know before. The result? Wasted time. Ours and our agent's.

The Rationale for Irrational Behaviour

When I get logical, and I don't trust my instincts — that's when I get in trouble.
— Angelina Jolie

By studying investor behavior, Professor Meir Statman has insights into why we're not rational. Investments and many other items have two components

1. utilitarian: practical, tangible, measurable
   
2. expressive: emotional, intangible
   

Using a car as an example, the utilitarian elements are gas mileage, reliability and safety. The expressive elements are style, status and social responsibility. Our purchases are based on both.



In the US, the 2007 Hyundai Sonata surpasses the BMW 525i

• 19 more horsepower
• superior acceleration
  
• more interior room
• same number of airbags
• half the price ($20K vs $40K)

That's according to a commercial. So it must be true ;)

No, no, you're not thinking; you're just being logical. — Niels Bohr

Buying the Sonata looks the logical choice. Let's look at 2007 car sales to Oct 31st from The Wall Street Journal. Hyundai sales dropped 12.1% to 250,885 cars. In contrast, BMW sales increased 9.2% to 188,845 cars. In October, why did Hyundai sell only 19,214 cars vs 19,084 for BMW, a difference of only 130 cars? There must be plenty of expressive drivers.

The same goes for investors. Statman would like a hedge fund, for example, listed as follows: 6% expected returns, 2% hope, 2% cachet.

Oddities
The same article is published on Nov 7, 2007 with two different titles:

• Why Stocks Are Like Socks ... and Cars, and Wine ... on Yahoo Finance and in Fortune (Nov 12, 2007 issue)
  
• Why you're not a rational investor on CNN Money
  

Strange. Different titles must grab different readers. Whatever the title, the article's worth a read.

The Overlooked Advantages of Universal Life

Universal Life (UL) insurance has three key advantages

1. Tax-deferred growth, potentially permanently
2. Tax-free retirement income through leveraging
3. Tax-free death benefit

Unfortunately, most Canadians are unaware or skeptical. There's a widespread belief that it’s better to buy-term-and-invest-the-difference. So affluent Canadians take advantage of UL with the endorsement of their accountants.

Buy Term and Invest The Difference
This seems like a great idea. Term insurance is cheaper than permanent insurance. So there’s more money to invest outside. Yet astute investors like Warren Buffett buy permanent insurance, especially UL.

Why is term insurance cheaper? Because it’s worth less. Coverage expires before most people do. So term insurance is well-suited for folks with young families and debts like mortgages. Term insurance is used for estate creation by people with little money. They buy term but don’t have money to “invest the difference”. They probably have unused contribution room in their RRSPs.

Life insurance was created to be an instant estate in the event of the premature death of the breadwinner. --- Herb Perone

In contrast, permanent insurance is used for estate preservation and tax planning by people with money.

The Math of Compounding

“The most powerful force in the universe is compound interest.” --- Albert Einstein

Tax cripples investment growth. Conventional investments earn

• interest (taxed at 46.41% in Ontario)
• dividends (taxed at 24.64% or 31.34%) or
• capital gains (taxed at 23.20%)

(For other provinces, see 2007 Tax Facts and Figures from PriceWaterhouseCoopers).

As with an RRSP, the tax rate on growth inside UL is 0% until withdrawals are made (then taxed your marginal tax rate). Tax deferred is tax saved --- a huge benefit.

Here’s a simple example that shows the consequences of tax: What does $1 growing at 100% per year become after 20 years? $1,048,576. Suppose growth is taxed at 35%. The after-tax accumulation shrinks to a minuscule $22,371. With sheltering, tax is applied to the ending accumulated value, giving $681,574. For the math, see the table in $1,000,000 After Taxes on Investment Growth. For another example, read Do You Understand Compound Interest?, which has a live calculator

Tax-deferred Growth
You saw the power of tax-deferred growth above.

UL lets you make deposits well above the RRSP contribution limits (the maximum is limited by the death benefit, which you select). Because withdrawals are not mandated, the savings can be paid out as part of the tax-free death benefit.

Tax-deferred growth has another advantage. Insurance charges are partially paid by investment growth that was never taxed --- the government helps pay your premiums. This can't happen with term insurance because there's no tax-favoured savings element

Tax-free Retirement Income
If you need retirement income, you have the option of getting tax-free income by using the savings as collateral for a bank loan. You can skip the loan payments and have the loan repaid with the tax-free death benefit.

Bonus
If you’re accumulating large sums, do you want to risk losing it to creditors? When properly-structured, life insurance can be creditor-protected.

The advantages of universal life insurance lead to many creative strategies.