Personal Finance Lessons: What To Avoid

People often ask me for tips on how to improve their finances and I’m always eager to help. But rather than focusing on mundane money saving tips or talking about where the stock market is headed, I prefer to share lessons on the kinds of products and services to avoid.

By steering clear of these personal finance traps you’ll be sure to have more money at your disposal to save, invest, and build wealth.

High fee mutual funds

If you’ve set up an automatic savings plan to invest in mutual funds through your bank or an investment firm like Edward Jones or Investors Group, chances are you’re paying too much in fees. That’s because Canadians pay some of the highest mutual fund fees in the world – a cost that’s typically between 2 and 3 percent for an equity mutual fund.

I made this mistake back when I first started investing, piling money into high fee mutual funds – one as high as 2.76 percent! To be fair, there weren’t many alternatives back then, and the high fees didn’t make that big of an impact on my relatively small portfolio.

But high mutual fund fees can do serious damage to your investment returns as your balance grows each year. Think of it this way: a 2.5 percent fee on a $10,000 balance only shaves $250 off your returns, but take 2.5 percent off of a $100,000 portfolio and you’re looking at a cost of $2,500 per year.

Do this instead: For do-it-yourselfers like me you’ll want to switch out of expensive mutual funds and get into index mutual funds or ETFs. Here’s a list of model portfolios to get you started.

If you’re unsure about investing on your own and prefer to take a hands-off approach, try investing with a robo-advisor. You’ll cut your investment fees in half or better, since most robo’s charge less than 1 percent to manage your investments online with a basket of low cost ETFs.

Mortgage life insurance

You’re about to close the deal on your first home and now your bank is recommending you take out a life insurance policy that will pay off your mortgage in the event that you or your spouse dies with a balance still owing on your home. It sounds like a good idea, and in most cases your bank can approve you on the spot. But mortgage life insurance is almost always a bad deal and should be refused when offered by your lender.

I fell for this when I bought my first home, again because I didn’t know any better and wasn’t sure if I should or even could decline the insurance. When it came time to renew my mortgage I got wise and declined this coverage.

There are several problems with mortgage life insurance. Premiums are expensive – a 36-year-old with a $350,000 mortgage would pay $73.50 per month or $882 per year. The lender is the beneficiary on the policy, not your spouse or other person of your choice. Perhaps the biggest problem is that your premiums stay the same as the balance on your mortgage decreases. That’s called a declining benefit and it’s a major reason why mortgage life insurance is a bad deal.

Do this instead: Buy a term life insurance policy and make sure the coverage is sufficient to pay off your mortgage and other liabilities, as well as replace your income for a period of time. A 36-year-old male non-smoker can get a $575,000 term life insurance policy for around the same cost per month as a $350,000 mortgage life insurance policy – and he gets to name the beneficiary.

5-year fixed rate mortgage

While not as big a deal as interest rates have fallen in recent years, historically Canadian homeowners have paid a big premium for the security of a five-year fixed rate mortgage.

Two-thirds of Canadians choose a five-year fixed rate and indeed that’s what I chose when I bought my first home. Later on I discovered Moshe Milevsky’s research on mortgage rates which showed that since 1950 homeowners were better off with a variable interest rate mortgage nine times out of 10.

Do this instead: Instead of paying a premium for the peace of mind of a five-year fixed rate mortgage, go against the grain and save money by opting for the cheapest of the 5-year variable rate mortgage or a short-term one-year fixed rate. Our current mortgage is a five-year variable that came with a big discount off of prime rate. When our mortgage comes up for renewal this summer I’ll negotiate for another big variable rate discount or else take the best short-term fixed rate.

Get rich seminars, MLM or Direct Sales companies

You’ve likely heard of businesses promising easy income working from home, or seminars offering the chance to make big money flipping houses or investing in real estate. Heck, you’ve probably heard of a friend of a friend who made a killing doing something like this.

Avoid seminars that offer a unique opportunity to invest like rich people. They’re a waste of time and likely just a sales pitch to get you to buy into a more expensive training course in the future.

Same with MLM or “direct sales” companies. It’s fine if you’re into body-wraps or tupperware and want to become a distributor so you can get free or discounted products. Just don’t expect to get rich selling It Works or Herbalife to your friends and neighbours.

“Seniors, immigrants, the financially unsophisticated including students as young as 14, are/have been victims of these massive, unconscionable MLM pyramid frauds.” – anti-corruption crusader David Thornton.

Do this instead: Anything else.

(Dis)honourable mentions

Other products that should be avoided include;

Market-linked GICs, which are hyped by the big banks as a way to get stock market exposure for your low interest rate GIC. But the purpose of a GIC is right there in the title – guaranteed income – and with a market-linked GIC you might only get your principal investment back if the market performs poorly. Meanwhile the upside is often limited by a complicated formula that delivers nowhere near what the stock market actually returned.

Stick with plain vanilla GICs for your fixed income needs. Related: Five-year GIC ladder vs. One-year rolling terms

Extended warranties are big profit centres in retail, especially when it comes to electronics and furniture. I’ve been offered a $250 extended warranty on a $700 television. Not a good deal! Consumer Reports says to skip the service plan for a number of reasons, namely that repairs may be covered by manufacturer’s warranty, products rarely break within a two-to-three year window, and most repairs simply aren’t that costly.

Your credit card may have you covered. Many cards automatically double or extend the manufacturer’s warranty by up to a year. Outside of that, there’s always your emergency fund.

Group RESPs or Scholarship Trusts are aggressively sold and marketed to new parents but these plans are often highly restrictive and come with hidden and higher fees than an individual or family RESP plan set up through your bank. With a group RESP, your money is pooled with contributions from other investors and invested on your behalf. You have to make regular contributions according to a fixed schedule, and opting out or terminating the plan early can cost you big dollars.

Open an RESP through your bank so that you can decide and control how much money to contribute and when, plus decide how to divide the funds amongst the beneficiaries.