Guest User

March 2, 2023

Episode 242: Erica Alini: Personal Finance Tactics for the Real World

Guest User

March 2, 2023

Erica Alini is a personal finance reporter at the Globe and Mail and the author of the bestselling book "Money Like You Mean It, Personal Finance Tactics for the Real World." Erica started out her career in journalism as an economics reporter, chronicling the ripple effects of the financial crisis of 2007-2008 for the Wall Street Journal in New York. That background is why she's always exploring how larger trends -- from the housing affordability crisis to the impact of climate change on insurance -- affect Canadians' money struggles.

Her book argues that economic, social and technological changes have complicated personal finance for everybody, but especially for Millennials and Gen Z. She then provides practical tips on how young Canadians can achieve middle-class financial goals despite the challenges they face.

The intersection between economics and psychology makes the subject of personal finance complex. To help us elucidate this topic is personal finance reporter at the Globe and Mail and the author of the bestselling book "Money Like You Mean It, Personal Finance Tactics for the Real World.", Erica Alini. Her journey into finance journalism began when she started working for the Wall Street Journal immediately after the financial crisis of 2007/08. Since then, Erica has become an accomplished writer and journalist, having worked for many respected organizations. She is also the author of a best-selling book, Money Like You Mean It, which provides readers with a nuanced understanding of the economic forces that shape financial struggles and how to overcome them. In this conversation, we talk to Erica about the importance of knowing yourself and your debt, the money bucket system, and the definition of financial abuse. We also discuss the various types of debt traps people should avoid, the dangers of micropayments, and what to be aware of when looking for a mortgage, as well as advice for finding a reliable mortgage broker, the avalanche versus the snowball model, and much more. Tune in to discover how to take back control of your finances and avoid the burden of debt with personal finance expert, Erica Alini.

Key Points From This Episode:

Why Erica thinks Canadians have so much household debt. (0:02:24)
Strategies that people can implement to avoid the debt trap. (0:04:58)
Erica’s opinion on budgeting as a tool to manage spending. (0:08:34)

How the ‘bucketing model’ changes for a couple as opposed to an individual. (0:12:10)

How couples with different incomes should share expenses. (0:14:17)
Signs of an unhealthy financial relationship between partners. (0:17:06)
The amount of money an emergency fund should have. (0:21:17)
What consumers should know about the different debt products available. (0:24:08)
Discover the downside of taking a mortgage with the lowest interest rate. (0:33:55)
Whether or not an independent mortgage broker is better than a bank. (0:38:05)
Important insights about credit scores. (0:39:51)
Whether people should rent or buy property. (0:45:13)
How the traditional sense of a good job with sufficient income has changed. (0:50:34)
Erica’s approach to explaining the risk of investing in stocks. (0:56:46)
Insights about the math of a financial decision versus the psychology. (0:58:25)
How Erica defines success in her life. (1:00:29)

Read The Transcript:

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We are hosted by me, Benjamin Felix and Cameron Passmore, Portfolio Managers at PWL Capital.

Cameron Passmore: Welcome to Episode 242. This week, we dive into personal finance, which is something we've not spent a ton of time on as a specific subject. In this, we had a great guest join us from The Globe and Mail, which is Canada's national newspaper. We actually had the personal finance writer from The Globe, Erica Alini join us. You might recognize her name. We reviewed quickly her book, Money Like You Mean It: Personal Finance Tactics for the Real World as part of our top book recommendations in November for financial literacy month. That was back in episode 227.

I thought Erica was a terrific guest. Terrific amount of experience communicating with people about personal finance. That imparts a lot of information in her, but what's really going on on the ground with things about credit and credit scores and debt and investing in general and managing money as a couple.

Ben Felix: Erica has experience as a journalist, she started out in economics, economics journalism at the Wall Street Journal. Right after the financial crisis, that's where she started. In terms of the timing of her start, it's just an interesting experience to have.

Cameron Passmore: True.

Ben Felix: Then she was with Global News here in Canada for quite a while, and then now The Globe and Mail. But she has a very interesting breadth of experience in writing about economics and finance. Her personal finance audience is quite different from our audience. She's used to communicating a lot of these ideas in a way that is different than we would typically communicate them. I think that gives her a very unique, to our audience, perspective and approach to all of this. In addition to this being on personal finance topics that we don't tend to cover too extensively, Erica also has a different way from us of communicating a lot of these ideas. Overall, I thought it was a very nice conversation.

Cameron Passmore: Absolutely. With that, let's go to our conversation with Erica Alini.

***

Erica Alini, welcome to the Rational Reminder Podcast.

Hi. Thanks for having me.

Erica, to start off, why do you think Canadians have so much household debt?

There's a tendency in personal finance and a lot of personal finance, I think, to boil everything down to individual choices. In my book, I really wanted to push against that, because I think there are a number of macro trends that can very well explain why household debt has exploded the way it has. Where now, we owe something like 2.8 trillion dollars, which is pretty much equivalent to the value of our GDP. That's really mind-boggling. What happened?

What I argue in the book is like, it’s not like someone put something in the water and we all suddenly became, spend more than you make, brainless zombies. There are some major changes that happened that pushed us as a society towards taking on a lot of debt. I argue, one of them, of course, is interest rates, which have gone up a lot over the past year. They have been very, very low for a very long time. That made debt cheap, cheaper than it had been for previous generations.

At the same time, and obviously, low-interest rates went hand in hand with low and stable inflation, again, for a very long time, pretty much until I started to write a section of the book that’s all true. That was a very good thing. There were a few things that when you talk about prices that are really shot up and that's housing. Then I would also point out tuition, and the cost of higher education. Neither of those are really discretionary spending that people can do without. That also explains the need for people to take on a lot of debt.

Also, there's financial and technological innovation. Borrowing didn't just get cheaper. It also became easier. Credit cards became really, really popular, starting in the 1980s and on. The number of credit cards and circulations exploded. Now we can pay with our phone. There's the new version of buy now, pay later. There are all kinds of innovations that make it easier to take on debt. This is not to say that personal agency no longer is an issue. Of course, it's not inevitable to end up with unmanageable levels of debt, but it is that much easier for people to fall into a debt trap that they're going to struggle to get out of.

You mentioned the debt trap. What strategies can people use to avoid falling into that trap?

Psychology and relying on some of what behavioural economics has taught us really helps. The whole argument of the book is, you're trying to – when you're managing your personal finance these days, work against these larger trends. Often trying to push you in the wrong direction. If you're trying to push back, I am very skeptical of relying on willpower. I don't trust willpower very much. I really like the arguments that the behavioural economist, Dan Ariely and such, make that it's like, try to make good choices as easy as possible for you.

Part of it when I go through bulk is, you have to know yourself and you have to know your debt. The knowing yourself part is understanding how the human brain works, and then trying to structure things so that saving becomes easier so that it becomes easier for you to stay on track and pursue the financial goals that you've set for yourself. The first step is obviously, to set those goals. It's very hard to save when you're not clear on what you're saving for. That's far from enough, especially when you have very ambitious goals. Maybe you're trying to get out of a lot of debt and it will take you a while.

It's really helpful to take those goals and cut them up into smaller, more manageable targets. Set yourself intermediate targets, because it's easier to stay motivated if you have the target in sight, if it seems doable and then you achieve it and it's a small victory and you've done that, and then you can move on to the next target. Maybe if you have a lot of credit card debt, and looks like it will take you many months, maybe more than a year to get out of it, set yourself a monthly goal. Then that really helps you stay on track and track your progress and feel like you're accomplishing something.

Then I would say, it's very important, obviously, to get a handle on your inflows and outflows. The good old-fashioned budgeting. It doesn't have to happen necessarily with a budget, but it's an essential stepping stone. You really have to have a handle on that. There are several methods for doing that. I've found in years reporting on personal finance, that it really is a matter of personality, often, what method works best for you. For example, there’s spreadsheets work very well for a lot of people. A lot of people like my dad, love to track every send and they thrive on that kind of discipline.

Then there's a lot of people who, they start budgeting with too many categories. They don't have the time. They're not disciplined enough. I'm in that category. I just don't even have enough time. Find a method that works for you. Figure out how much you can spend, and how much you can set aside on a sustainable basis. Then you've got your goals, your intermediate goals, set things on automatic pilot as much as you can. All deposits into your savings account, all of the deposits to your debt payments. Automate as much of your bills as you can. Then that takes away the brain — you make a one-time good decision to set up those payments and you don't have to make that decision over and over again.

Yeah, that's good advice. You mentioned it and you also mentioned that it's personal, but what do you think in general about budgeting as a tool to manage spending?

It's been interesting because personal finance goes through trends. You guys know this. It is in which everybody was against budgets. Budgets are awful. I find like, yes, they're awful for some people, but they're not awful in general like I said. If you find that budgeting, again, the old-fashioned way doesn't work for you, another system that has become very popular and that's the one that I use. Generally, people who don't like budgeting do well with this other system. It doesn't really have a name. I didn't invent it, but I call it the money bucket system.

That consists of assigning your different bank, or investment accounts to fixed expenses to long-term savings, short-term savings and emergency funds. Most of us do some version of this anyways, people will have. Definitely accounts for some of their long-term savings. We were talking about TFSA, RRSP, RESP, if you're saving for kids’ education. Then they will have a checking account and a savings account. I think that's a pretty basic, common setup. This system brings it a step further.

You may want to have, for example, a different checking account that you use just for paying your bills. So that whatever is left is your discretionary spending for the month or variable spending for the month. In addition to that, I find it super useful to have emergency funds in cash set up in another account. I actually have two, because I like to have one emergency fund for the mother of all emergencies, which would be unemployment. Mine, my husband's, whatever. Then I to have a separate account for house emergencies. I feel like, renters don't necessarily need this, but if you own a house, I think that's a shocker for a first-time homebuyer just how much money goes down the drain.

Oh, yeah.

It has repairs that come up all the time, no matter how new your house is. I like to have both. Then you basically have different – you can use savings accounts for short-term savings, like maybe a home renovation, maybe a vacation. Then irregular expenses, which are really what trips up a lot of people trying to budget. Things that come up seasonally, for example, summer camps, or it could be during the year, your kids’ extra-curricular activities, or it can be Christmas. You set up these various accounts. This method requires knowing and having a sense of what expenses are going to come up for you throughout the year.

It can be a bit of a work in progress. If you are pretty established in your lifestyle, then every year is going to start to look pretty similar to the previous one. Then you can anticipate these irregular expenses as like, “Okay, so I'm going to need, I don't know, $2,500” which is shocking for a summer camp for my kids. Maybe I started saving in the fall and I have X many months, and they need to have that money by a certain date. Then you automate your savings. This way, you don't need a budget. You don't need to track cents, but you're channelling your money and you're achieving your savings goals and you're managing unexpected expenses and irregular expenses, which are usually, again, what trips people up using budgets.

You mentioned your husband. How does this bucketing model change for a couple as opposed to for an individual?

The money bucket system can work very well for two people. In the book, I have a chart called Money Bucket for Two. What you do, because this is also something that people really struggle with is budgeting as a couple. This can work very well. It can be a midst of joint and individual accounts. Usually, obviously, your TFSA and RRSP will be individual accounts. Then you can have joint accounts for handling the fixed expenses. Maybe your paycheque lands in your own personal accounts and then whatever share you contribute to fixed expenses, you move automatically into the joint account from which your bills are paid. Then you can contribute to the various joint savings goals that you have by channelling money from your own checking accounts through these various accounts that you've set up.

I should add, because sometimes people, it feels like it's daunting like you have to have so many accounts, so how do you do it? For me, I usually relabel, for example, a certain account. Once I'm done saving, usually for summer camps, I will change the name and call it Christmas spending. Then I change it back. I translate the amount of accounts that I have. This method can get really expensive, for example, if you're working with a big bank that will charge you just for having an account open, but there's an easy way to get around it. There are all kinds of competitive credit unions and online-only banks that will have no-fee accounts.

Another thing that’s very important, unlimited free interact transfers, which is what I use. I rely on three institutions. One is just my long-term emergency, which I don't really touch. I managed with two banks and I just – when I have to move funds, I just interact with myself, and I choose which bank I want to put the money into and it cost me nothing.

How do you think couples who may not have the same incomes should share expenses?

A lot of couples, I find, start with sharing everything 50-50 and then stick with it. A lot of the time, that becomes a problem. It can become a problem if there's a significant disparity of income, in which the lower-earning partner feels like they can't save, they can't keep up and then they blame themselves. I've often heard from – obviously, I don't work with couples myself, but I've interviewed a number of financial planners who told me that, yeah, it can become a self-blame thing like, “Oh, I'm bad with money.” It's like, no, you're not bad with money. You're just contributing 50% when your income is down much lower.

Also, take into account that if you get together with someone who makes a lot more money than you, it is much more likely that your lifestyle will adapt to theirs and vice versa. You're effectively unwittingly living outside your means. Also, a lot of people find that it works well when they actually contribute proportionally to their income, to expenses, and to shared savings. Some people have strong feelings, I've found, about contributing 50-50 to certain things, like the mortgage. They really feel like, as if contributing 50-50 sort of ascertain that they own 50% of the house, which is in fact, you own 50% if you live together and you bought it together, you own 50% and your own title. It doesn't matter who's paying the mortgage. You're just as entitled to the house.

The ownership stake really doesn't have any relationship to how much of the mortgage you're paying. I think psychologically, that's very important for some people. I want to say, even if you're earning exactly the same amount as your partner, the 50-50 split can become problematic, especially in a heterosexual couple, women often work fewer years. They take more time off when they have kids. Then later in life, they also tend to take more time off to be caregivers for elderly parents. You have to be careful. It's something that you have to constantly revisit, whether it’s a setup that you have of how you divide expenses is equitable because equal doesn't necessarily mean equitable.

I've also seen this happen with a disability. When someone had to go on disability and their income dropped, the couple stuck to the same arrangement that they had before. Lo and behold, this person wasn't able to put money into their TFSA, or RRSPs anymore. It's an ongoing conversation about what is equitable.

Very interesting. Erica, what are some signs of an unhealthy financial relationship between partners?

The classic signs, I would say, are lies and secrecy. Telling outright lies about what's going on financially, or withholding information. That seems pretty obvious. The red flags in a dysfunctional financial relationship in a couple can be more subtle than a lot of people think, especially what's really delicate is, it will often be the case in a couple of that someone is into managing the money and the other partner is not. It does make sense in a lot of cases for one person to being the admin. Admin is fine as long as you check in regularly with the other person. There should be no, “I make decisions for everybody because I know what's best. I don't need to consult you, or I don't need to keep you informed.”

This is a generalization and I have certainly seen the opposite as well. But in most cases, what you see in cases that then can become very problematic is men, traditionally, that's the role. They take charge of the family finances. Then you can end up with two problems. One is, and this you see more and heard many financial advisors tell me that when they work with elderly couples, especially women who become widows, the past generation, the husband has been in charge of the finances for decades, and they've never been involved. Now the spouse is out of the picture and they don't have any idea how to manage their finances, or even what the assets and liabilities of the household are.

Sometimes, it was no ill intention. It's just how things used to be set up. Then it becomes a problem when the spouse who used to be in charge is no longer around. Sometimes this can really lead to something that's called financial abuse, which is still where we really don't have nearly enough awareness of in Canada. Financial abuse tends to be part and parcel of abusive relationships because it's all about control and controlling money is part of exercising control over someone else's life.

You'll see often one partner saying, “I'm not good at money. I don't like to be alone in this stuff. You do it.” This can open the door to abusive behaviour with the other spouse hiding assets, concealing liabilities, concealing debt that they're taking on. The extreme cases that I've reported on, are cases of domestic abuse, that don’t always involve violence, but you can get to the point where I’ve seen the abusive partners forbidding. I've seen it with women doing it, but the vast majority tends to be men, as far as the statistics that we have. They'll forbid the woman from going to school, or working, so she has no income. She has no credit card of her own. She is added on the husband's credit card, so she has no credit history of her own.

There will be maybe a joint account, and then the husband will have several accounts, but the woman has no account of her own. Then at one point, the woman recognizes the relationship becomes abusive. Maybe it becomes violent at some point. But then becomes very, very difficult to leave that relationship, because you don't have a job, you don't have a bank account, you don't have a credit history. You can't even get a place to rent these days without a credit history and without a good credit score.

There are extremes that are things that seem obvious, but I have also seen some women who realized only when there was a separation, or divorce, that, “Oh, my goodness. My finances are in shambles. All these years, I didn't realize.” It makes it that much more difficult to rebuild after.

You touched earlier on having an emergency savings bucket. How much do you think people should keep in their emergency fund?

It's funny, because I started out as a personal finance reporter almost six years, seven years ago. I remember, there's so much advice going around saying, “Who needs an emergency fund? You're okay with just the line of credit.” Now the interest rates have gone up so much, and lines of credit have variable interest rates. Now that we have gone through the pandemic, I think the shock, those was shocking months of the spring of 2020, there's been a much wider recognition that yes, no, it's a really great idea to have some cash set aside for emergencies.

The typical rule in personal finance that you hear all the time is to have between three and six months worth of living expenses set aside. Now, I find that often can be daunting for a lot of people, especially very young people who are just starting out in the labour market. I would say, if you're a total beginner, especially if you're very young and just starting out, start with a goal that seems achievable. Maybe start with one month of rent. That's another rule that I've heard several times that makes a lot of sense. Work your way up from there. Don't stop there. As a first target, that makes sense to me.

For myself, I feel like, I use a slightly different role and different process that I think can help a lot of people gauge because I feel like, how much you need to set aside really depends on your situation. Take a look at, for example, if you were to be laid off, would you have access to BI? How much severance would you be entitled to, which often is a function of how long you've been at the company? I would argue, for example, that if you've just taken on a new job, or if you're thinking about switching jobs, I would always ensure an emergency fund, because you're going to have less severance if you're ever going to be laid off to react to being hired, which we're seeing happening, for example, with the tech layoffs right now.

I think it's also a matter of what industry you're in. For example, as a journalist, it's a bit of a blood sport to find a job in a newsroom. You can take a really long time. If you lose your job, like how long will you be unemployed? That also depends on the economy, but it really varies a lot on the industry. For me, I'd like to be able to get by at least for eight to nine months. It's only like I have that much sat aside because by now, I would have severance, I would have BI. I also know that as a journalist, I would be able to earn some income freelancing. Probably not replace the income that I have as an employee. I calculate. I set out a worst-case scenario that is possible, and then try to figure out what is the difference that I wouldn't be able to make up and try to save up towards that. That's how I do it.

What do people need to understand about the different types of consumer debt products, like credit cards, lines of credit, and student loans?

That's the second part of trying to resist these bigger trends that push us all towards borrowing too much. Yes, you need to understand human psychology and yourself. You also really need to understand debt. Debt is not created equal. There are many different ways of borrowing. Becoming a bit of a debt connoisseur will help you borrow wisely. There are some strains of personal finance that are all about avoiding debts at all costs. I find that that's just not realistic. In the world we live in, you're going to have to borrow to buy a house, if you got to buy a house. Very likely, you've had to borrow to finance your education. Frankly, without borrowing, and you're not going to have a credit history and a credit score, which these days are becoming just essential.

Again, if you want, here in Toronto and even a lot of smaller towns across Ontario, I just spoke to undergrads who told me that they need to have a credit history in order to be able to find a room in a shared apartment. Landlords are demanding credit scores from 20-year-olds because it's so competitive. How do you borrow wisely? In the book, I go over some of the most common types of debt and the various things they're useful for and things that people should watch out for.

Credit cards are an obvious one. They have a really bad rep. Everyone knows that credit card debt is expensive, but it's really helpful, I think, to think about credit cards and psychology. Going back to behavioural economics, we know that the human brain tends to worry less about negative things that are going to happen in the future. We also know that we tend to process paying for things as painful. Emotionally painful, not physically painful. But the parts of our brains that light up when we pay for something are very similar to the parts of the brain that light up when we experience emotional distress.

What credit cards do one way and why they're tricky for a lot of people is that they allow you to have the immediate gratification of buying something right now, but they decouple that from the emotional pain that comes from paying. It's very important for people to keep this in mind when they use credit cards. Lines of credit do pretty much the same. They're often thought of as a benign version. They're also revolving in credit. They work very similarly to a line of credit. A lot of the time, people emphasize the fact that lines of credit have much lower interest rates than credit cards. You can also borrow that much more with a line of credit.

When you speak to licensed insolvency trustees, and they talk about some of the craziest cases that they've seen, it often involves a line of credit, or even more, like a home equity line of credit that's backed by the equity in your house. That's when people really can pile on massive amounts of debt, and then it becomes very difficult to get out of it. Also, there are a number of surveys, including one done by the FCAC, Financial Consumer Agency of Canada, that found out – this was a few years ago, so maybe now people have caught up a bit, but I think it was 2016 and they found that lots of people didn't know the lines of credit were callable loans, where the bank can change the terms of a line of credit. People sometimes dismiss it as, “Oh, it will never happen.”

I've seen it happen. I've been around for seven years as a personal finance reporter, which is some time, but not decades. I've seen it happen twice, two cycles of banks calling out some borrowers and being like, “No, you need to pay more than the minimum payment,” or tweaking the terms of lines of credit. It tends to happen when things in the economy are starting to go south. Exactly the wrong time for borrowers.

Auto loans are another huge debt trap for a lot of people. They used to be this plain vanilla, very straightforward financial product. Then after the financial crisis, we started seeing auto loans with longer and longer terms. What that does is it means people are going to be in a negative equity position for that much longer. You're in a negative equity position when what you owe on your loan is more than what your car is worth. It's common when you buy a car because it's a depreciating asset. It tends to lose about a third of its value in the first year that you drive it off the lot if you're buying new.

It's not unusual unless you put down a really big downpayment to be in a negative equity position for a couple of years. A couple of years, it's fine. You're usually covered by insurance if your car is stolen, or is declared a total loss in an accident. Often, it's easy to get coverage where you will get back the value of the car. You go beyond the first two years, you can do yourself alone, that's seven, eight years long. That means you're taking that much longer to pay off that loan. That means you're making much slower progress toward reducing what you owe. That means you're going to be in a negative equity position for that much longer. The thing is basically, the pace at which to explain to people how negative equity with a vehicle works.

You have to think about the depreciation curve for a vehicle is very steep at the very beginning and then it flattens out. Vehicles lose most of their value at the very beginning. But then that depreciation rate really slows down. Whereas, the pace at which you're paying off your loan stays the same. If you're paying off your loan slowly and taking eight years, for example, versus the traditional five years, you're going to be many more years in a situation where something happens to your car, you're going to owe more on it than the car is worth. If you trade in that vehicle, say maybe at the five-year mark with an eight-year loan, and you get yourself another car, you're probably going to have a balance left over, and that balance is going to be tagged on to your next loan. That's how you end up with some people who are – I've interviewed, for example, a single mom once, whom I believe owed $29,000 on a $16,000 second-hand car.

Wow. Yeah, that's crazy. On a similar line of the debt question, what do you think the downsides are of the buy now, pay later online micropayments that have popped up everywhere?

That was another interesting one, in terms of human psychology and behavioural finance. I think at this point, most people know what the new buy now, pay later is, but just in case, so the old-fashioned buy now, pay later was get yourself a washing machine and maybe you don't pay for a year and then you start paying after a certain period of time. The financial innovation that really – it was already popular in Australia, but really took off in Canada during the pandemic, when everyone was stuck at home and shopping online, was buy now, pay later for online shopping and for very small purchases.

That, for example, I can get myself a $300 pair of shoes and pay it off in three instalments of a $100, or six instalments of 50 bucks. That's really tricky. Proponents of buy now, pay later point out that a lot of the time, you can just pay in instalments without fees. Like a credit card, there's no huge interest rate, unless you miss payments. But buy now, pay later does something similar to what credit card does, where it’s like, it separates some of the pain of being from the purchase. It also tends to focus your attention on, the brain tends to zero in on like, “Oh, great. I can afford a $100 this month, and I don't have to worry about the $200 that's the rest of my purchase.” I tend to evaluate whether or not to buy the shoes based on whether I can fit a $100 in my budget this month, rather than whether I should spend 300 bucks in a pair of shoes to begin with.

The other danger that people have flagged is that this generates a number of small payments for people. If people use buy now, pay later over and over again, are they going to be able to keep track of the fact that maybe now I'm spending – I have three payments of a 100 bucks for the shoes. But maybe last month, I signed up to buy myself headphones and already have 50 bucks coming out of my account for the headphones. Because that also, we know that we have a hard time keeping track of small payments. I find that a lot more of people's spending these days consists of micro-transactions. It's not just buy now, pay later. It's also subscriptions. Everything is becoming a subscription. Then you have this $3, $4, $5 charges that are really starting to add up. That's very difficult to keep up and people underestimate all the time, what they're spending through small transactions.

That's a great point. I have a mortgage question for you. A lot of people go mortgage shopping and solely focused on the interest rate. What's the downside to that?

I have to say, that already was a step forward. I remember when I started, this was more than seven years ago, it was more like 14 years ago, I was an economics reporter, but still looking at these things. I remember the conversations about people going to their parents’ bank and just getting the first thing that the bank would come up with in terms of interest rate. Then I have to say, Canadians have become much more discerning and they really – a lot more people know to shop around for the best interest rate.

I have to say, a hyper-focus on the interest rate has landed people in with the wrong mortgage. I've seen that a number of times. Though, the other thing to consider if you're shopping around for a mortgage is penalties. In particular, the penalty that you're going to have to pay to your lender if you need to break your mortgage, for example, if you need to get out of your mortgage before your term is up, that is something that I think a lot of people tend to not think about and not worry about, but we know, like I’ve spoken to countless mortgage brokers who tell me, life happens much more often than people think. Having to break a mortgage is actually pretty common.

Wow. Really?

That's what people have to be really careful, about because mortgage penalties can be in the tens of thousands of dollars. We saw that at the beginning of the pandemic. I don't know if you guys remember, but there were some headlines of some borrowers getting landed with 30,000. I do with one case of someone who had to pay $30,000 in mortgage penalties. The mortgage penalty is meant to make your lender whole because you're getting out of the loan sooner. You're going to stop the repayments. You're going to go maybe with another lender, or they're not going to earn the interest on that loan that they expected. That's why the penalty.

The question is, how is that penalty calculated? As a lot of people know, variable-rate mortgages have more flexibility and much lower penalties often, than fixed-rate mortgages. Generally, it's three months worth of interest. You look at the amount that you have left on your balance and then the interest rate, and then you multiply by three months, that's usually what you're going to have to pay. That is sometimes the rule, even for fixed-rate mortgages.

If you go fixed, it really matters whom you're borrowing from. That's where the big banks and some credit unions use a complicated formula that can result in extraordinarily high penalties. All of the big banks, as my last reporting, were doing this and some credit unions. If you want to go fixed, it really pays to look for a lender that will apply a fair penalty, if you have to break your fixed-rate mortgages.

A lot of people at this point have learned that there's flexibility with variable rate mortgages, but I find that there still is limited awareness that you don't have to go variable in order to have flexibility. There are definitely a lot of competitive offers out there, where you can sign up often with a mono-line lender who focuses only on mortgages, or some competitive credit unions. You're going to be able to get out of your fixed mortgage with a very reasonable penalty, without the need to go variable, which has also caused a lot of trouble and lost sleep for a lot of people recently.

Yeah. It’s such a common one, though, for people to go to a big bank and look for the lowest possible rate.

If people really want to go with the bank, and it happens to be a big bank, at the very least, shop around. See what else. Get a serious offer from another competitive lender and then take it to your bank and see if they'll match it. Be aware that if you go fix with a big bank, mind the penalty.

What do you think about an independent mortgage broker versus going to a bank?

It depends on the mortgage broker.

That’s a good point.

Some mortgage brokers, it adds in every profession can be very good and really gouge you. They can find really the most competitive offer that really fits your needs and they can ask all the right questions and really help you land on the best possible mortgage product available to you. I've also seen some mortgage brokers who didn't even realize that their clients didn't have a credit history. There's a lot of variety out there, which is very unhelpful for someone who doesn't know where to start, I realized, do a lot of research.

That is a tough one, though.

It's a tough one. I have a list of questions to ask the mortgage broker in my book. (Erica’s list of questions is in the links section of this page). That's the best to really read up on how to gauge how qualified the mortgage broker you sitting in front of is. I've also had very mixed experiences.

Yeah, that's interesting. Of course, it makes sense. I just wasn't thinking about that, because I've been lucky enough that we have a very good mortgage broker that we refer clients to, and so that's – I just went to her and it was super easy. Of course, that's not going to be everybody's experience.

No. Yeah, it can vary. If you're trying to figure out who's a good mortgage broker, really reading up on mortgages, interest rates, penalties and some other things that we didn't get into, like portability, and other features of mortgages. If you have done the research and you know your stuff yourself, then you're going to be down much more able to gauge the quality of the professional that you interact with.

Great point. What do you think people need to understand about credit scores?

That's another huge one. It's one of the top 10 questions of personal finance, I would say. It's super important to understand credit scores, but so few people really understand how they work. Everybody knows that they're important and that you need a good credit score to be able to borrow at lower rates. That's about it in terms of the common understanding. It's easy to understand why there's so much confusion because it is a complicated product and it's opaque by design.

Credit bureaus cannot explain exactly how the sausage is made. That makes it difficult for people to explain how they work. I find that very common misconceptions about credit scores are – especially among young people, there's this assumption that you start with a perfect score, and then you lose points if you make the wrong decisions. It's a point system. Then the other very common misconception is that there is a secret formula for improving your score. There are very specific maneuvers that you can make financially that will improve your score.

In fact, I find that it's really for me specifically, I found it really helpful to think about insurance when I think about credit scores, because they're very different products, but there are significant similarities. A credit score is a gauge of your riskiness as a borrower. Lenders want to know, what are the chances that you're going to repay what you owe in full and on time. Insurance does the same. Insurance relies on a gauge, or an estimate of how risky your behaviour is likely to be based on data points that they've collected from often, millions of other people and other behaviours.

For example, that explains very well why you need to have a borrowing history, in order to have a credit score. When you're starting out, you've never borrowed before, you don't have a perfect score. You are a total unknown quantity for lenders. That's why the longer you've been borrowing generally, that helps your credit score, like how long history of low risk and borrower behaviour helps your credit score. The same way that a new driver will be considered very risky by auto insurance companies, as opposed to someone who's been behind the wheel and had very few accidents over a decade. I find out that really helps.

It's very interesting. In the book, I asked Julie Kuzmic at Equifax. She's in charge of or has been in charge for a long time of dealing with consumer issues. I'm like, “Can you explain the best possible way how credit scores work?” One of the points that she made is people should be very skeptical of overly specific advice about how to “fix your score,” because the very same action done by two borrowers who have a different profiles can have very different impacts on their scores.

For example, take someone who takes out a new credit card. If this is someone who the algorithm already knows has some debts in collection, taking on new debt, the algorithm goes like, “Uh-oh. This is a bad sign.” It will probably hurt your score. Or it might. I shouldn't say probably. It might. Depends. If you are someone who has a long history of paying everything in full and on time and your credit score is already high, the fact that you're taking on a new credit card might not affect your credit score at all.

When you hear, it’s like a lot of advice online, there are products that are marketed as credit repair loans. The whole marketing spiel is, “Take on this loan, start making payments and this will help your score.” Then when you look in the fine print, it says, there's actually no guarantee that this will help your score. Because if your score is already bruised and you're borrowing more money, who knows? You might actually hurt your score in the short-term that you're taking on more debt. Be very skeptical.

Really, the only generalizations about how to improve your score and maintain a good credit score is you have to borrow, which is counterintuitive for a lot of people. Just make your payments in full and on time, all the time. Then the only other thing that can be said is generally, a little bit of variety, the ways that you're borrowing. Having some revolving credit, like a line of credit, or a credit card and maybe an instalment loan, a mortgage, that generally helps. But anything that starts to get like, this is how much you need to borrow, or how much you can borrow against your credit card, or you need to have an auto loan and a mortgage and that instalment loan, just like, no. Always be skeptical about stuff.

Let's shift to housing for a bit. How do you think people should approach the rent versus buy decision?

That's become really the impossible question of personal finance in Canada, isn’t it? I've revised my answers on this question over the years. Here's where it stands now. I gave people a process for thinking it through. This is generally a response that holds for someone who is young, who is wondering about, will I be a forever renter? Or should I really try to get into the housing market? And who doesn't have unlimited financial resources.

I would say, the first thing to think about is what is your time horizon? Especially if you're young, how settled and committed are you to the place you're living in right now? Because if you think that there's a chance they're going to be moving in the next five years, then I'd say automatically, the answer is rent. Don't buy. Because even if you have the opportunity to buy, the transaction costs involved in buying and selling real estate are so high, that no matter what happens to housing prices, forgetting the fact that right now, they're stagnating, or declining in most of the country, even if the appreciation is crazy, in that a short time, transaction costs are just going to eat up so much of it.

Then I would say, it's a really good exercise to do a little bit of the math of renting versus buying. I really like the 5% rule that Ben has been talking about through the years. The 5% rule is really all about comparing the unrecoverable costs of owning a home to renting, because there's this common idea that renting is throwing money out the window, right? You're just paying money to the landlord and you're not building equity. People often forget that owning a home, there are all kinds of ownership costs, all kinds of things that are not going to build equity. The interest you're paying on your mortgage, the property taxes, and the inevitable repairs and maintenance costs. Then the cost opportunity of parking a lot of your money into real estate assets, versus investing it somewhere else in the financial market. That's all things that need to be considered.

I really like the 5% rule, because it forces people to think about these things and think about the unrecoverable costs of owning a home. Then the 5% rule, then should explain it. Generally, it boils down to looking at two comparable homes and the place where you want to live and say, like it's a two-bedroom apartment, look at the yearly rent for that apartment and then look at the market value of a similar home. In the same market, if the yearly rent is equal to or less than 5% of the market value of that similar home, then renting is a financially attractive proposition.

There’s all kinds of caveats and assumptions. They tend to the 5% rule, which, especially right now, we're in a period of high inflation and high-interest rates, you might want to look at those assumptions as an exercise, I find it very useful. However, I find that often, even people who really stress the fact that there is nothing wrong with renting, tend to start with, “Oh, you can be a wealthy renter.” Just make sure that you're saving regularly and that you're investing your money in the financial markets with a well-diversified portfolio, and long-term investing strategy. You can build your wealth. Owning a real estate asset is not the only way to build wealth, which I'm like, yes, 100%. But let's not forget that the other thing that people need to look at is rent versus their own income.

Right now, rents are so high, that a lot of people risk ending up being forever renters and not being able to set aside nearly enough for retirement. That's really the debt trap. Even if you decide, “I'm going to rent,” you have to be able to save as a renter. If you can’t save, then you really have to move on to some larger life questions of, “Can I live where I am?” A lot of young people right now are facing this dilemma of, can I afford to live in a big city? Maybe the answer is move to a lower cost city or town, which again, is also becoming in and of itself challenging, because even in smaller towns, at least here in southern Ontario, rents are crazy, or maybe the choice is, do I need to switch to a higher earning career?

I don't want to minimize these choices. These choices can be very difficult for some people. I think that it is important for people to face them because the last thing you want to do is a few years down the line, you're facing the same choice, except you're broke.

I want to keep going on that idea, the traditional sense of getting a good job with sufficient income for your lifestyle. How do you think that's changed over the last, I don't know, 50 years?

I think it's really changed. I think, again, it's interesting of personal finance sometimes has this hangover from a bygone era. I think, still, people talk about jobs. There's still this idea of the good job being usually a salary job with good benefits and job security, which, by all means, it's still a coveted thing. Salary jobs aren't necessarily all they're cracked up to be. You can have a low wage and your benefits are not worth it. Maybe your job security isn't all you think it is. Maybe you'd be earning a lot more and having a much more fulfilling career as a freelancer.

I find that even gigs, which are always thought of as terrible way to make a living, and often are, but sometimes a gig can be useful in certain cases. I really argue that work is work is work. Don't get caught up too much in the stable job, versus freelancing, versus gigs. Just the real focus should be in making sure that however you're working, you're getting your work’s worth. In order to help people gauge that, I find the first step is to estimate your actual net pay, which sounds obvious if you're getting a paycheque, but I would argue that it isn't, even if you're getting a paycheque.

By your net pay, the classic mistakes that people who begin freelancing make is they underestimate their taxes, or they don't even calculate the taxes. That's number one and that's obvious. Obviously, if you get a paycheque, you don't have that issue. Another thing that can really trip people up is think about, you're getting a paycheque, and you have a stable job. If you're spending four hours per day commuting, I would argue that it's time that is linked to your work. You should include that into your net pay when you're trying to figure out how much time comes out of your day for work and what are you getting in return?

That can also be very tricky if you're juggling multiple gigs. Or if you're a freelancer, you have to account for dead time, the time that you're sitting in an Uber, waiting for the next client, the time saying if you're giving language classes that you are moving from one of your students to the next host, that all is time in which it's not free time, and so I would count it towards your net pay. There's a little formula in the book, too. It's a back of the napkin formula, but it's a helpful starting point.

If you're thinking of going freelance, how much would you have to earn per hour to have the same earnings, net earnings and if you want to take the same time off as your current full-time job? Often, you have to be earning quite a bit more as a freelancer for the same comparable financial outcome. That only comes to gigs. I'm not a fan of hustle culture and this idea that, “Great. I can't make enough money for the lifestyle that I want with one job, so I'll just have two jobs.” I find that that over the long-term leads to often, misery, and burnout.

Gigs can be useful. Certainly, they can be useful in a financial emergency. There's just some income that comes in. You have to be careful with gigs about what are the entry level costs. Even becoming an Uber driver, I looked into it once and I was shocked. I shouldn’t say, Uber. I should say, any –

Any ride share.

Drive share service. They're often significant, absurd costs. If you can pick up a gig that doesn't cost you very much and that's a quick income supplement in an emergency, that can be very useful. I find that gigs can also be a really smart way to explore a different career. If you're not happy in your job and you're thinking, “Maybe I want to do something else,” you can start maybe doing it part-time as a side gig. You can really, first of all, figure out if that's really what you want to do because it can be hard to tell.

Then if you're already, maybe you're in your 30s, or 40s with a family and all kinds of financial commitments, it can be really difficult and financially risky to switch careers, a gig, something that you start to do on the side and then grow, can be a really low-risk way of gradually transitioning. I've interviewed a few people who've done it. They started doing something else, and then they liked that something else very much. Then they gradually grew the side gig, so that when they finally moved full-time to what used to be their side gig, they were already quite established. They were all of a sudden, abandoning a career in which they were established and then starting from zero. I find that that can be really useful.

Then the other thing is, if you have a hobby that you can monetize, that can be great. Can be a way of reaching some of your financial goals faster. The only thing though is, I've seen this happen many times, where it starts out as a fun hobby and then people get really stressed out about it. Maybe you’re baking on the side and then you're successful. Then it used to be something that you would do maybe in the evening after work to relax, and now you have 10 cakes that you need to make by Friday.

That's the thing. There's a name for that. I don't remember what it is.

The E-Myth.

The E-Myth. I think it's Michael Gerber's book. You have a passion for a product like baking, and then it ends up ruining your life because got to keep making all these pies.

I didn't know that. I'm going to have to look it up.

Classic book. How would you explain the risk of investing in stocks to one of your readers?

I generally do two things. I talk about risk and reward to explain why stocks have a higher expected return, generally than maybe other investments like bonds. Generally, I start with, okay, stock versus bond. They say, with the stock, you’re a mini-share owner of the company, and so you are participating in the risk that that enterprise takes on and it can be very successful, or maybe it doesn't.

With a bond, your lender. You're lending some money, you're going to get it back. The risk is lower, the reward is likely going to be lower, too. Then the other thing that I tend to tell people about stocks is that volatility. If you look at it, obviously, as the classic line of the stock market, I like it moves up and down a lot in the short term. Over the long-term, it trends up. Then bonds is like, maybe a line that doesn't move quite so much. That can be helpful in helping people also understand why you may need to readjust your asset allocation as you get closer to needing to take money out of your portfolio.

You don't want to have to guess the crazy line that's going up and down in the short term. Is it going to be up, or is it going to be down when I have to take money out? That's how I tend to approach it.

We've talked about behavioural economics a few times. How do you think people should prioritize the math of a financial decision versus the psychology?

The classic case, when it comes up is debt repayment and the snowball versus avalanche model. Snowball being, where you start with. If you have multiple debts, start with the smallest one, and pay it off. Then work your way up to bigger and bigger debts, which is very popular. Then the avalanche model, which is prioritize your most expensive debt, and work your way down to the early six months of debt. The avalanche model is the one that makes no sense mathematically, because they will save you the most in interest costs.

A lot of personal finance planners that I've spoken to, and credit counsellors swear by the snowball method, because they say, it tends to work better in terms of psychology, because people who may be demoralized, that they have ended up with so much debt and doubting themselves are able to pay off one of their debt and get a psychological victory. It gives them a little bit of momentum and confidence to keep going. There are studies that there's one study in particular who found that the psychological effects of the snowball method didn't really pan out in their study.

My best guess is that perhaps, the snowball method doesn't work that well if someone is working on their own, versus working with a professional who encourages them and keeps them going. That maybe it. My ultimate take on math versus psychology is, I would say, psychology trumps math in the end because if you can't stick to it, that is going to cost you anyways. Just do what works, even if it's not the mathematically optimal solution. Sometimes you may be able to find a solution that works well with psychology and that takes the best of both.

Final question, Erica. How do you define success in your life?

That is not a personal finance question. Personally, my guiding light has been avoiding regret. I really want to make sure that at one point, I will turn back and be happy with the decisions that I've made and also know that I gave it my all and didn't hold back. I periodically look back and assess. That's how I tried to define success. But no regret life is my goal. It's been proven very useful. Then what I can control I can control and the rest, que sera sera.

Good answer. Other than the statement, no regrets, Dan Pink who we have coming up on a few weeks would agree. He doesn't agree with saying, no regrets, but he does agree on understanding what people will regret in the future and using that to guide what a good life is. Great answer to the question, Erica.

Thank you. Then you know that there’s also Shannon Lee Simmons just came out with a book, No-Regret Decisions. I haven't read it yet.

Oh, no. Dan Pink's going to disagree with her, at least on the premise of the title. All right. Thanks, Erica. This was great.

Thanks. Bye, guys.

Is there an error in the transcript? Let us know! Email us at info@rationalreminder.ca.

Be sure to add the episode number for reference.

Extra: Questions to ask a mortgage broker:

What kind of penalty will you have to pay for breaking your contract?
Is the cap on your lump-sum payments 10 percent or 20 percent of your mortgage balance?
Will you be able to make lump-sum payments any time or just once a year?
Can you double your payments?