April, 2020 - Millionaire on the Prairie

Right of Offset

Over the past few weeks, I’ve heard people talking about the right of offset. As I understand it, the bank who lends you money has the right to take money out of your bank account, held at the same bank, if you don’t pay your debts on time.

Wait! What? Start from the beginning, Blue Lobster…

Allow me to paint you a picture. Let’s say that you have an outstanding loan at Bank A for $7,500. And you also have a bank account at the same bank with a balance of $3,500. We can call this $3,500 your emergency fund. Or it can be your hope-to-one-day-get-on-a-plane-again fund. Call it whatever you want. The point is, this $3,500 is money in an account held at Bank A.

Right now, we’re living in COVID-19 times. You have to prioritize your money since your income has been cut or eliminated. Maybe you’re one of the lucky ones who still has a steady paycheque coming in on a regular basis, but you’ve heard rumours of layoffs at your place of employment. You wisely choose to spend your money on shelter, food, and utilities. And maybe you’ve decided to cut certain expenses from your budget in an effort to save money. You may even have chosen to not pay your loan right now.***

*** To be extremely clear, I am not advocating this course of action. I think this option causes more problems than it solves, but you know your circumstances far better than I do. Go forth and handle your money however you think is best in your situation. ***

Let’s say Bank A notices that you’ve stopped making payments on your loan. They also see that you have money in an account at their fine institution. Bank A chooses to offset your debt with the money in your bank account. Again, the bank to which you owe money has the right to take money out of your account to pay your debt. It’s the right of offset, and its application stings!

Blue Lobster, is there anything I can do to stop my bank from taking my money?

Of course there is. The first method to prevent the bank from exercising the right of offset is to make your loan payments on time. Prevent your bank from ever wondering about your capacity to repay your debt. Banks like to get payments so pay them.

The second method is to move your bank accounts to a bank where you don’t have any loans. For example, you can move your $3500 to Bank H. Your money will be there when you need it. Of course, you will still owe the debt to Bank A and you should do everything in your power to pay off that loan.

Again, I’m going to be annoyingly explicit about this point. Moving your money to Bank H doesn’t eradicate your debt obligation. You still owe $7,500 to Bank A. Moving your money simply eliminates the risk of Bank A taking money out of your account to satisfy your debt if you stop paying your loan.

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Weekly Tip: Do what you have to do so that you don’t pay bank fees. For the vast majority of people, this means opening an account at an online bank. There are free bank account out there. If you’re still paying bank fees, it’s because you’re choosing to do so. Make a different choice and keep those fees in your own pocket. Use them to buy stock in the bank instead.

Beware the Minimum Payment!

Right from the get-go, I’m going to ask those of you who already know this to forgive me for stating the obvious. Minimum payments benefit the lender way, way, way more than they benefit the borrower.

Beware the minimum payment!

When you borrow money from the lender, you’re taking out a loan. And when you do so, you’re agreeing to pay interest on the money borrowed. The loan is governed by a contract, so the very best time to amend the terms of the contract – and thereby the terms of the loan – is before you sign the contract!!! In other words, don’t take a loan if you don’t believe that the terms of the loan will be beneficial to you.

The repayment terms of the loan are set out in the contract. If you don’t like them, or the lender won’t change them, then don’t take the loan. This is the most effective way for you to avoid having repayment terms in your life that may cause you financial grief in the future.

And for those wondering how to buy what you want without a loan, the answer is that you will require a combination of cash and patience. Save up your money then make the purchase. You’ll get what you want. You won’t pay any interest. It’s the ideal situation so strive to make it your reality.

However, there are times when you simply need to borrow money to get what it is that you want. If this is the situation in which you find yourself, then I want you to be very aware of the trap of minimum payments.

Making minimum payments benefits the lender because they can charge you interest on the outstanding loan balance for the longest period of time. If you take out a 5-year car payment, then the loan is structured so that the lender earns as much interest as possible off the loan. In other words, you as the borrower will pay back the maximum amount of interest.

The legal way to minimize the amount of interest you re-pay on the loan is to make extra payments. Get a second job – sell some stuff online – cut some subscriptions from your life. However you choose to find extra money is up to you. The bottom line is that you take that extra money and apply it to your outstanding loan. Go back to the car loan for a hot minute. If you can make extra payments on the loan and pay it off in 2 years instead of 5, then you will keep three years of interest payments in your pocket rather than sling that money into your lender’s pocket.

As of the date of publishing this blog post, the banks in Canada are allowing mortgage holders to apply for a six-month deferral of their mortgage payments. If approved, people who have mortgages won’t have to make mortgage payments for six months. It’s called a mortgage deferral.

This deferral means that the people who took out a mortgage will have to repay the money, eventually. (I’m not an expert on how the program works. If you need the details, please contact your bank.)

Make no mistake. The banks want their money back. The banks lent the money to borrowers at an agreed-upon rate of interest for an agreed-upon period of time. That the banks are allowing borrowers to defer repayments on their mortgages is quite unprecedented in my experience. What I wonder is whether the borrowers understand that a deferral of their mortgage payment is not the same as a waiver. The deferred payments are still outstanding. And borrowers will continue to owe interest on those payments until the money is repaid to the lender.

Again, the banks want their money back. So if a borrower receives a deferral from their bank, the borrower still has to repay that money. And guess what? Interest will continue to accrue on that deferred payment.

What? Are you surprised? Did you think that the banks would stop the interest clock from running? If so, gently hit yourself on the head with a hammer. Of course, the banks are going to continue to charge interest on their loans.

This is not a debate about the morality of the banks during the COVID19 pandemic. What I want to impart in this post is that the second best option is to get out of debt as fast as possible. Minimum payments are not your friends. In the case of a mortgage, the numbers are a lot bigger so a deferral is going to mean a much higher amount of interest will be charged during the deferral period.

If you’re considering applying for a mortgage deferral, keep the following in mind. A deferral means that the money is not being paid back as agreed upon in the loan. It does not mean that the money remains outstanding without interest being charged by the lender.

Allow me to state this concept another way. The interest only stops accruing when the loan is repaid. Paying later means paying more interest. The only way to avoid the interest charge is to repay the loan.

Beware the minimum payment! It never benefits the borrower.

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Weekly Tip: Once you’ve finished making debt payments to a lender, continue making those same payments to yourself. Re-direct your former debt payments to a high interest savings account. You were living without the money when you had a debt, so continue to live without that money when the debt is gone.

Experience is a Great Teacher

How are you doing today? I hope that you’re ignoring the gyrations of the stock market and going about your business of self-isolating, washing your hands, and self-distancing. They might not be the most exciting activities, but they will flatten the curve and help to avoid overburdening our hospitals.

As I approach my golden years, I’ve come to accept the maxim that experience is a great teacher. Additionally, I’ve also realized that I can learn from other people’s experience as well as my own. I need not make every single mistake myself. Watching others’ mistakes can be just as instructional.

Today, I’d like to share one of my investing mistakes so that you don’t have to make it yourself.

Back in 2008, the stock market tanked. I remember hearing about the demise of Bear Stearns, and I was shocked. I don’t recall why it was so upsetting since I wasn’t a hedge fund manager at the time, nor was I an economist or any other kind of expert. All I know was that Bear Stearns was a major investing bank and that it’s demise meant that something very bad was happening in the stock market.

So what did I do? I made the second worst mistake available to me. I stopped investing while the stock market plunged.

I’ve made no secret of the fact that I’m a buy-and-hold investor. My investment plan is simple. First, save money from each paycheque. Second, transfer those savings to my investment account. Third, buy units in my chosen exchange-traded funds. Fourth, rely on the dividend re-investment plan to invest the dividends. Fifth, go back to the first step.

I’ve designed the plan to take advantage of dollar-cost averaging. Each month, I invest in my ETFs regardless of the unit price. I completely avoid trying to time the market. “Is this a good time to buy?” is a question that I never ask myself. When I have the money, I buy into my ETF – easy peasy lemon squeasy. This method of investing is know as dollar-cost averaging. I first learned about it in The Wealthy Barber, a great book authored by David Chilton.

Back in 2008, I was not as smart as I am now. Twelve years ago, I freaked out and I STOPPED INVESTING!!!

This was a huge mistake! I should have continued to dollar-cost average into the market during the six months between the demise of Bear Sterns and the recovery which started in March of 2009. I would have been buying during the downturn.

Buying during the downturn is a fancy way of saying that I would have been buying when the stock market was on sale.

It’s good to buy things when they’re on sale. If you want a new pair of shoes, aren’t you happier making the purchase when they’re priced at 35% off? I have a feeling that if you had a choice of buying the identical pair of shoes for $100 or for $65, you’d opt to buy them for $65.

The stock market is no different. On February 22, 2020, the value of the stock market plunged. In other words, it went on sale. The Talking Heads of the media could barely keep from peeing their pants with glee! They had so much to talk about, so much fear to stoke in their viewers and readers. Buy this! Don’t buy that! It’ll be a V-shaped recovery! No recovery for 2 years! Avoid cucumbers!

Okay … maybe they didn’t say anything about cucumbers. But the rest of the statements aren’t too far from the truth.

Once again, experience is a great teacher. I’d already made the mistake of listening to the Talking Heads in 2008-2009. As a result, I did not take advantage of the cheaper prices on the stock market that were available at the time. As the recovery wore on, the stock prices didn’t fall but I did start contributing to my portfolio again. However, I could not overcome the error of not buying stocks when they were super-cheap. My failure to make the right choice 12 years ago means I’ll be working a little bit longer than I’d projected.

I see no sense in making the same mistake this time. So while I’m self-isolating, while I’m washing my hands, while I’m social distancing, I am also continuing to invest in my chosen ETFs. Yes, you read that right. I’m still investing even through this period of excess volatility.

Did the value of my portfolio plunge in February of 2020? You bet your sweet ass it did! And did the value continue to drop throughout March as the stock market roiled due to the COVID19? Again, that’s a big 10-4!

It’s been just 5 weeks since the plunge. My portfolio is recovering, just like the stock market is.

The Talking Heads won’t ever encourage others to follow my simple plan. Despite its effectiveness, my way of doing things is boring and boring isn’t good for ratings.

You see, the stock market is supposed to go up and down. It always has. It always will. Never in its history has the stock market only ever gone up, just like it has never only ever gone down. If you’re going to invest, then do so consistently and automatically. Do your research. Find a broad-based equity exchange-traded fund (or mutual fund if you insist on paying higher management expense ratios). Invest on a regular basis. Ignore the Talking Heads. They can’t tell the future any better than you can.

And in case you were wondering, the biggest mistake you can make right now is to sell your stock market portfolio. For the love all that you deem holy, do not sell! Right now, the prices are low and that’s why you should be buying them.

Like I’ve said, experience is a great teacher. You can learn from mine instead of making the mistakes yourself. Don’t stop investing right now. Stick to your investing schedule and build your portfolio while the stock market is on sale. The second biggest mistake you can make is to halt your investment contributions.

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Weekly Tip: Pay cash for your next car by making a monthly car payment to yourself for as long as possible before you head to the dealership. The payments to yourself will be the down payment, if you’re forced to finance your vehicle. Ideally, you’ll stay out of debt completely because your accumulated savings will be sufficient just pay for your next vehicle with cash.

Take a Break

I don’t know about you but sometimes I need to take a break. The world is currently caught up in a pandemic – a very bad thing. The news outlets are constantly issuing new articles – another very bad thing. It’s impossible to know who to believe, who to disbelieve, what’s true, and what’s not so true. Part of me suspects that the drive for ratings is still deeply driving the amount of pandemic “information” that is being spewed at us from all directions all day long.

Following the media from sun-up to sun-down is a recipe for anxiety and stress, so I’m going to tell you that it’s okay to take a break. Put down your phone or turn off your TV. Trust me when I say that your mind will appreciate a few hours or days of not being forced to think about the pandemic. Sadly, the bad news will be around for a little while longer.

Do something very different with your mental energy. Think about how you want your life to be structured when the pandemic is over.

Over?

Yes, over. This pandemic is not like the rising sun, which will always be there tomorrow morning. Nope – this pandemic is a global yet temporary circumstance. It won’t last forever. And every new day brings the world that much closer to a vaccine or a shot that will turn COVID19 from something to be feared into something that can be tamed.

So, again, what do you want your life to be once this pandemic is over?

And since this is a blog about personal finance, I suggest that you reflect on how this pandemic has changed your perspective on money.

If you had an emergency fund, was it enough? Do you want a bigger one for the next unexpected emergency?
Did a reduced paycheque forced you to re-assess your needs vs. your wants? Will you go back to how you spent before once if your paycheque goes back to its former size?
Are you as risk-tolerant as you thought you were? Or has the recent & extreme volatility of the stock market caused you to lose sleep at the same rate that your portfolio has lost money?
When the pandemic is over, what will you do to repair or bolster your financial buffers?
Will you seek out employment in “essential” industries? Or will you stay where you are because it’s what makes you happy?

Now’s the time to think about these kinds of questions because we’re staying at home to flatten the curve. That should give many of us Singletons plenty of time to make some tentative money plans for our future.

At the very least, figuring out the answers for these questions should take our minds off of COVID19 for a little while at least. The pandemic is going to cause a lot of sorrow for a lot of people. It’s impact will be deep, widespread and long-lasting.

That said, it shouldn’t force you to stop dreaming and planning for your future. The game isn’t over until it’s over.

Never forget that this too shall pass.

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Weekly Tip: Read books – as many as you can. Libraries are a treasure trove of information and entertainment. And in today’s digital world, you can download books to your e-reader.