April 6, 2010, 5:00 am

Fear is Not an Argument in Personal Finance (but it’s always used!)

by: The Financial Blogger    Category: Personal Finance
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Have you ever pictured your brand new TV crashing in front of your eyes and you didn’t take the extended warranty? Have you ever thought of going bankrupt because interest rates went up by 10%? Have you ever thought the worst can happen? Look your children straight in the face and tell them you are sorry that you cannot take them to Disney World as promised…

So what motivates you to pay for an extended warranty, a 5 year fixed mortgage, a 5 year GIC, a huge universal life policy and pay a real estate agent to sell your house? Fear!

We often make irrational decisions based on fear. We fear the H1N1, we fear the great depression, we fear earthquakes… I think that our “primal” survival instinct has transformed into an irrational fear of everything that could ever happen. We are now living in a world of 2 very powerful words: “What if”.

Salespeople have really delved into this niche market; they now take more time to explain the different benefits of an extended warranty or insurance. Often, more time is devoted to this aspect of the sale than the item we are purchasing!  At first, we rarely want to pursue it. But when they plant the seed of doubt in our mind; the seed grows and become overwhemed by a big plant full of fear!

The sad part is that fear is important aspect of being  human. We may want to be as rational as possible, but “what if’s” always come to mind and toy with our emotions. We have the capacity to create the worst case scenario in our mind’s eye and play it over and over  in a loop to make sure we don’t forget about it. When it comes to personal finance, we should definitely be able to raise our guard, a mental shield against fear and look at the situation rationally. Here are a few personal finance topics where you should use your brain instead of using your heart:

Life insurance:

As a financial planner, I can tell you that we all need life insurance. However, life insurance should be used to cover for:

#1 your personal debts (if you want to leave something to someone)

#2 your financial dependants (if you die today, who will miss your income in the next 10-20 years? If you don’t have a spouse or kids, you probably don’t need much insurance).

#3 play Santa (wanna give a gift to someone? Life insurance can do it 😉 ).

Extended warranty:

As I mentioned previously in my article about how stores make money from an extended warranty, you are better off paying with a credit card offering the same service and save yourself hundreds of dollars.

Investment:

If you are thinking about investing for your retirement, please, forget about GICs. They offer a poor rate and they are locked for the time being… definitely the worst type of investment.

Mortgage:

Looking for a 5 year fixed mortgage? Man, you haven’t learned a thing… Look at any chart for the past 10,15,20,25 years, you will see that variable rates have always cost less in interest. You are probably not planning to pay your mortgage over the next 3 years, you will have to make payments for the next 20-25 (and maybe 30!) years. Think long term; think variable rates.

Selling your property:

The fear of not selling fast enough may encourage you to go with a real estate agent… I doubt this service is really worth 5% of your property! This is probably most of your profit that you will give away for the sake of fear!

Final Thought:

As you can see, fear can make us hesitate and make the questionable decisions. You may never regret your choices based on fear, but just calculate how much those choices actually cost you over time just to buy a little peace of mind. I can tell you, peace is the most expensive thing in the world!

Author: Mike.

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Comments

What if you had locked in a fixed rate at 3.85% or so over the next 5 years? Though, if the variable rate only reaches 4% in 5 years, the variable rate still would have been more worth it!

OTOH there are those who consistently point to the late 70s/early 80s and the 20% interest rates we had then… I keep getting asked “how do you know it won’t go that high?”. There is a lot of fear and uncertainty out there.

by: The Financial Blogger | April 7th, 2010 (12:29 pm)

@ Kevin,

technically, the guy who locked in at 3.85% is paying 1.60% more (and probably near 2% as I have seen P-.25% to P-.50% recently) until variable rate goes back up. If it takes a year, this means that the variable rate would need to go back by 1.60% over 3.85% for another year to get it equal. this is how, on 5 years, you will always paymore on fixed rate than variable.

If you want to consider apocalyptic scenarios, you should also consider what happen in Japan for more than 10 years ; interest rate near 0% as we have right now…

Everything is possible, but I don’t think you should plan your finance based on the 80’s or the Japan 90’s… both are extreme scenario that happened only once…

In the end, if you act on fear, you will always end-up paying more…

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