31 May 2007

How much does your job factor into your happiness?

I was exchanging emails with a former coworker yesterday, and we have had mutual frustration with my employer. Not that this is rare; I think everyone gets frustrated with their employer at times. Overworked, underpaid, underappreciated, office politics-- something bothers everyone.

But you know, I really don't like my job. It's not just about my employer either, though that certainly factors in. I just don't really like what I do. I never come to work looking forward to it, and often my motivation wanes. Am I miserable? No. I don't dread work every day . . . it doesn't keep me from sleeping, and I don't get terribly stressed out about it. But it is certainly not something that makes me happy. I'm good at it and it pays the bills . . . but for me it's just a means to an end.

Is that bad? Yeah, probably. But how bad is it? How important is job satisfaction to your overall ability to enjoy life? I've wanted, for a long time, to find a job/career that could satisfy me both financially and personally, but it simply isn't happening. Not now, anyway. So I've dealt with it by tossing my energy into other areas of my life that do give me joy: Yardwork and landscaping, and working with my hands in general. My finances and investing. Sports (I'm a big college basketball and football fan). My girlfriend and our puppy. Beer and wine. I devote most of my free time to these endeavors, and it keeps me sane.

In fact, I'd say I'm a pretty happy person, despite the misfortune of being on a career path that does nothing for me except provide a paycheck and some benefits. I am constantly looking for a way to improve that part of my life, but you know-- I can live with it, for as long as I must. At times I haven't felt this way. I've let myself get too worked up about my career, and felt that a career change was a pressing problem that I needed to address. But when I think about things rationally, I realize that things at work aren't so bad, and that the rest of my life is good enough not to fret.

I know that some people feel very strongly about doing what you love and loving what you do. But how important is that, really? If you can pull away from work and at the end of the day do other things that make you happy, doesn't that go a long way toward happiness? For me it does. I won't give up on my goal of self-employment or obtaining a dream job (like being a statistician for a certain athletics program, for example), but in the meantime . . . I'm doing fine.

29 May 2007

Fund managers rule!

Ah yes. All fund companies have something to offer you that nobody else has-- funds that will beat the market! Or so they will tell you. You can beat the market with managed mutual funds-- sometimes. To do this, you either need to be lucky or know something that most people don't-- a fund manager or company that consistently outpaces the market indexes.

Some managers are better than others, but nobody consistently beats the market. You have to pick and choose the right funds from the right people, hoping to maximize your chances. But your odds are still not great. When googling on the subject I ran across the following curiosity, courtesy of Vanguard:

So on average, here's how badly the managed funds lose to the market indices (for the 10-year period ending Dec. 2004):

LCV: 0.86%
LCB: 1.82%
LCG: 2.43%
MCV: 3.54%
MCB: 3.04%
MCG: 5.00%
SCV: 1.05%
SCB: 1.10%
SCG: 1.29%

The managed funds fared best in the small cap blend arena, where they still lose 53% of the time (and by an average of 1.1%). Managers do especially poorly with mid cap stocks.

Why? Well, two reasons. One is that fund managers, in general, do not pick winning stocks very well. The second is fees. Huge, enormous fees. Some managed funds do well enough to beat the market, but fees erode the difference (plus some) and the fund is a loser in the end.

Personally my investments are blended between managed and index, but this is not by choice. I would go entirely with index funds if my options allowed it. The managed funds I do have are at least rated well by morningstar and have relatively low fees.

Let this tidbit sink in for a moment. Fund managers are educated, trained, and experienced in stock picking. And according to this chart, it seems they lose to index funds some 3/4 of the time or more. What does that say about building your own portfolio out of individual stock picks? To me it says, "you'd better get lucky." You may win big, but you also may lose-- and the odds are stacked severely against you.

23 May 2007

Net Worth, Net Investable Assets, and Net Liquid Assets

I'm a big fan of the Net Worth metric. I think it paints a nice picture of what position you are in financially, and gives you an easy way to set goals. But it has flaws, says Nickel. He suggests a similar measure with a different name and one major difference: Net Investable Assets. In a comment, FMF of FreeMoneyFinance goes a step further with Net Liquid Assets. I'd like to take a look at all three metrics because they each have something to offer.

Net Worth. The classic measure of wealth. All of your assets (cash, investments, property, etc.) minus all of your liabilities (loans, revolving debt, etc.). This is a great measurement because it paints the whole picture-- how much MONEY do I have? If I sold it all and moved to South Dakota, how much would I be taking with me?

Net Investable Assets (NIA). Nickel dislikes that the net worth calculation involves the primary residence and personal possessions:

The main reason for my aversion to net worth calculations is that I’m most interested in charting a course to financial independence and, in my view, financial independence doesn’t involve selling our house or getting rid of our cars. True financial independence involves amassing enough wealth that you’re able to live of your investment income with no additional input.
In his view, NIA provides a good measure of this. You simply tally up your assets and liabilities, as before, but eliminate your residence and personal property (side note-- I'm not sure what Nickel would say about an auto loan. Even if I don't count the value of the auto, I think I still ought to count the loan as a liability).

Net Liquid Assets (NLA). FMF says:
I track and record my net worth every month. In addition, I also track and record my liquid assets (the ones I can get my hands on easily and without penalty) which excludes my home and retirement investments.
I think it's wise to continue to leave personal property out of this equation as well. This becomes a measure of how much money I have that I can readily get my hands on without having to start selling my stuff or tap into retirement funds. Another good measure.

Let me just say that I like all three of these very much. They're all similar measures but the purpose of each is considerably different. I have added NIA and NLA to my tracking spreadsheet and think they'll be very informative.

This all leads to a question for me. What percentage of your net worth should be in NIA? In NLA? It's a tough question, and depends largely on your goals. If you have no plans to retire early, NLA can merely be whatever amount makes you comfortable in case of an emergency, since you don't need the liquidity otherwise. But if you plan to retire early (as I do), you'll need assets you can get to without penalty. As for NIA . . . well, that's tough. For a renter this is not a MAJOR issue, as your net worth and your NIA aren't terribly different. For a homeowner, perhaps the percentage is not so important as long as you have goals set with NIA, not just net worth, in mind.

As for me, here's how the numbers break down: 48.7% of my net worth can be classified as NIA, and 5.7% of my net worth can be classified as NLA. So personal property and my residence comprise just over half of my net worth. I knew this already, and getting that under 50% has been a minor goal for me.

The shocker is the NLA. 5.7% of net worth? Just 12% of NIA? That seems really lousy and I'm not comfortable with that number, and if I'm to retire early, it will have to grow rapidly. What this amounts to is cash savings + taxable investments - non-mortgage debt.

When I read other blogs, some people have negative net worth. I always felt good because mine was significantly positive. Well . . . my NLA hasn't been positive until recently. It was probably negative last summer, as I had a car loan with a much larger balance and no brokerage account. If people took a hard look at this, some people with great net worth may not look as rosy, and some with negative net worth might look far worse off (credit card debt would be nasty for NLA).

There is a bright side though, for me and everyone else. NLA can grow rapidly. Probably much more rapidly than net worth or NIA, if you are committed to it. Why? Because all debt repayment will go straight to to this bottom line, and as a %, the growth can be tremendous-- especially early on.

Take me for example. My net worth has grown 17.3% since February. My NLA has grown 83%. Why? Well, two reasons. One, it started small. Damn near zero. Two, debt repayment on my car loan and eye surgery is contained in my NLA, and these account for nearly $800 each month. That's a far larger percentage of NLA than it is of net worth. In the coming months I expect it to continue a rapid ascent. I'll know that my NLA is in better shape when it starts to slow down a little-- this will mean that my debts are gone and my NLA isn't so tiny anymore!

I'll be thinking, in the coming weeks, months, and years, about what percentage of my Net Investable Assets needs to be liquid. There is an answer out there and I just have to do some math to get a good estimate. It's clear to me that this is the weak area of my financial situation. I have to thank Nickel and FMF for their comments on the topic. Without them, it may not have jumped out at me as it has.

21 May 2007

My asset allocation

I've danced around it a bit, partly because I knew I had more changes to make, but I think it's time to go ahead and post my allocation. Silicon Valley Blogger over at The Digerati Life has put up a second post highlighting some bloggers' asset allocations, so I figure this is a good time to share mine as well. I've struggled with this a lot, and am only 90% settled on this as a long-term allocation strategy. Specifically I am still deciding how much I want invested in the international markets.

Keep in mind, this does not include my emergency cash reserve (about 3 months' expenses)-- this is my retirement/investment portfolio. I got these images as screen captures from Vanguard, where I keep up with all of my accounts.

So as you can see, I'm 99.9% in stocks (all in mutual funds with an overall expense ratio of 0.72%) with the 0.1% being unused cash in my brokerage account. My domestic stocks are tilted towards value with an increased position in small cap stocks to help maximize long-term growth.

The value tilt isn't a trend thing. While it's important to have some balance, as growth stocks have outperformed value before, value, over the long haul, has had better returns with less volatility along the way. I will probably keep a significant value tilt in my portfolio unless something makes it less reasonable to do so.

As I said before, I'm considering increasing my position in foreign stocks (perhaps to 30%), but I'll probably do so gradually with increased contributions in my retirement accounts. I briefly had some 10% in bonds, but my research last week convinced me that now was not a good time for me to put my money there; not even a small percentage. So for awhile I will be invested nearly 100% in stocks, ready to ride the peaks and valleys to (hopefully) high returns down the road.

16 May 2007

You're young. Do you need bonds?

Conventional wisdom says everyone needs some bonds. If you don't need them for income, you need them for a diversifier, to balance out those bad years in the stock market. Right?


At least when your investment horizon is at least 10 years it is wrong. I recently came across a spreadsheet with total annual returns for most of the major segments of the financial marketplace, dating back to 1972 . . . it also has a handy tool that calculates what your return would be with a certain asset allocation. I added functionality to see what return would be by 10 year periods, since I am not interested in short-term behavior as a long-term investor.

When looking at the total US stock market and the total US bond market, care take a guess in how many 10-year periods bonds beat stocks? Once. Out of 26 10-year periods, bonds beat stocks once, from 1973-1982, by a score of 8.32% to 7.44%.

In only one period out of 26 did holding bonds enhance your returns over the returns of the total stock market. Not what I would have expected, but then I had never held all the numbers before.

Is there a better option to limit the chance of a "bad" decade in the market? Yes, there is. Let's start with Large Cap Value stocks. In the short term they are clearly more volatile than bonds. But when smoothed out over 10 years, they are never beaten by bonds. Ever. Not once in 26 periods. The worst period for large cap value stocks was from 1993-2002, where it saw 9.27% gains. That was the worst period. Read that again . . . let it sink in. The average return for bonds since 1972 is 8.06%. The worst 10-year period for large cap value stocks is 9.27%.


And Large Cap Value isn't alone. Mid Cap Blend (10.64%) and Small Cap Value (10.92%) also outperformed the average bond return in their worst 10 year period. I didn't have info on mid cap value, but I would be willing to bet that it did too.

So it's clear here that there are better investments when it comes to minimizing long-term risk-- and they return much, much better. But what of the possible return enhancements of diversifying with bonds? Is it possible that in some years, their higher returns over stocks will actually improve the overall return? Assuming you aren't psychic and can't time the market, you'll have to keep some bonds all the time if you hope to accomplish this.

So I took this question and some handy common portfolios to try it out. Here are the portfolios:

  • Swenson: 30% US market, 20% REIT, 20% international, 30% bond. The total return of this portfolio over 35 years is 11.56%. The worst period was 8.35% and the best was 16.78%. What happens when we replace the bonds with
    • Large Cap Value stocks? Total return of 13.00%, worst period of 8.83%, best of 18.55%.
    • Mid Cap blend? 13.89%, 9.48%, 19.05%
    • Small Cap Value? 13.55%, 9.44%, 21.18%
  • CoffeeHouse: 10% large cap value, 10% large cap balanced, 10% small cap balanced, 10% small cap value, 10% reit, 10% international, 40% bonds. Returns of 11.68%, 8.63%, 17.04%. Replace bonds with:
    • LCV? 13.61%, 9.29%, 21.02%
    • MCB? 13.71%, 10.13%, 21.73%
    • SCV? 14.26%, 10.01%, 24.56%
  • My portfolio: 35% large cap blend, 15% mid cap blend, 10% small cap blend, 30% international, 10% bonds. Returns of 12.26%, 8.14%, 18.89%. Replace bonds with:
    • LCV? 12.70%, 8.24%, 19.46%
    • MCB? 12.73%, 8.48%, 19.40%
    • SCV? 12.91%, 8.50%, 19.46%
Hm. So in all 3 of those portfolios, replacing bonds with one of the other 3 asset classes raised returns EVERY time. Overall, in the best times, and in the worst times. So much for the diversification benefits of bonds.

I'm almost convinced that I need to get rid of my bonds and get into something better. I'll do some more reading first. If my investment window were less than 10 years, I would reevaluate bonds over that short timeframe. As it is, my investment horizon is at the very least 20 years away. From the looks of it, I'm only going to lose money by keeping anything in bonds.

14 May 2007

On real estate leverage and paying off a mortgage

JLP at AllFinancialMatters has a disagreement with some arguments on the virtues of paying off a mortgage early. I agree with JLP, and it comes down to some (somewhat) basic calculations. Let's take a quick detour here by talking about real estate as an investment. First of all, my opinion is that real estate is a phenomenal investment. The reason can be summed up in one word: leverage. Leverage, in terms of real estate, refers to the relatively small investments you make each month in order to get the returns on a much larger sum of money. This leverage comes in two basic varieties.

  1. You own your home. You get phenomenal leverage here because the "investment" turns out to merely be a tradeoff. It's what it costs you to buy a home vs. what it costs you to rent. Housing expenses will always be there, whether you rent or buy. So the real "cost" of homeownership is how much more it costs you to buy than rent. If renting costs you $800 a month and owning a $150,000 home costs you $1100 in mortgage payments, taxes, maintenance, insurance, etc., then your investment cost for the real estate property is $300 per month. Historically, real estate appreciation is in the neighborhood of 5%. But do you earn 5% on your $300 monthly investment? NO! You earn it on the value of the house-- $150k. A quick calculation says that 5% of $150k is $7500. So after one year, you've invested $3600 into the house, and the value has gone up $7500-- not to mention the small gains in equity from paying down the principal. You don't have to be a math whiz to know what a phenomenal return that is.
  2. You own rental property. The reasoning here is identical. You pay so much per month in costs, but you get some (or all, or more) back in rental income. So again you pay a small amount (at worst) each month to get appreciation on a much larger amount. Interest rates are higher on rental properties, but rental income usually makes up for much of this difference. Again you get a phenomenal return.
In both cases you are putting in a small amount to obtain growth on a much larger amount. Leverage. In all but the worst housing markets you can get good financial gains using leverage in real estate.

How does all this relate to the argument over paying down a mortgage? The bottom line is that every time you throw extra funds at the mortgage, you are reducing the leverage you have on the property. Think about it this way: if you buy a house outright (no mortgage), you have absolutely no leverage. How long will it take you to see good returns on the investment? Well, unless appreciation is well above average, you never will. You'll merely see a 5% ROI. There is a sliding scale between paying in full and paying only the minimum payment, and the earlier you pay off the mortgage, the closer you are to paying in full. In other words, your returns go down as you try to pile up the equity. It has less to do with the difference in rates between the mortgage and the stock market (though this does matter if you divert additional mortgage payments into the market) and more to do with the reduction in leverage.

Let me give you a quick example. Take the $150,000 house mentioned above, at a rate of 6%. The payment is approximately $900, so assume an extra $200/month for other associated costs. The costs above renting (assume $800) are $300/month. You are paying an extra $300/month over renting to gain this investment. Assuming 5% appreciation per year, at the end of 10 years your equity is almost $118,000 (on $36000 total investment over time). According to Excel's XIRR function, that's an annual return of 22.5% on your money. Not bad!

Suppose instead that you pay an extra $100 toward the principal each month over the same 10 years. Then your equity would be about $134,200. Sounds better, right? But wait-- you paid an extra $100 each month ($48,000 total). What is your annual return now? About 19.6% per year overall. Still phenomenal, of course. How does it compare to investing in the market? When the extra $100 is conservatively invested in the market (assume 8%) instead, your overall rate drops only to 19.8%. With more aggressive investments (12% return) your overall rate climbs back up to 20.3%. If you invest that $100 in another real estate property (say, a rental) your returns are likely to be even greater (again through the power of leverage).

How many investors would shrug off a couple of percentage points? Not many. But that's exactly what you do when you sacrifice leverage for more equity. Paying off a mortgage 5 or 10 years early sounds great for your peace of mind, but it's lousy for your bottom line . . . many higher yield alternatives will make you richer in the end.

Two intriguing blog posts from the last few days

I try to catch up on all the blogs first thing Monday morning when I can. My Money Blog reveals some misinformation (or at least misleading use of information) in Suprising Truths (and Half Truths) About Credit Card Debt. I've heard several times that when looking at more robust measures, credit card debt is not nearly the epidemic that the media makes it out to be, and it's nice to see that confirmed with some hard data. I haven't ever carried a balance, so I'm in that 29% category. It's nice to know that less than half the country carries credit card debt at all-- and I bet a small fraction (maybe 15% overall) are in what I would consider "problem" credit card debt. Great info!

The other strikes me differently. S. Shugars wrote a post at PFadvice claiming that the money-saving result of kicking the smoking habit is a myth. I think this is probably a good point for a lot of people, but not everyone. I'm familiar with the phenomenon of eating, drinking, or some other vice taking the place of the smoking, but I don't think this is by any means universal. I live with a counterexample. My girlfriend quit smoking almost 5 years ago, and to my knowledge she has picked up no nasty or expensive habits to replace it. She was ready to quit and be rid of cigarettes, and once she had done it, she simply became a non-smoker. Perhaps that is the key-- you have to be emotionally and psychologically ready to kick the habit, not just the nicotine. Those are the two components of a smoking addiction and they're both difficult, from what I understand. It's hard to quit unless you can do both, and if you can't, you may develop these other habits that continue to make your life expensive and less healthy.

11 May 2007

How much should we spend on recreation and leisure?

Think about dividing your expenses in this manner:

1) Necessities. Housing, food, gas, clothes, etc.

2) Personal and financial betterment. Taking a class, reading a book, remodeling a bathroom to increase home value, etc.

3) Recreation/leisure/personal pleasure. Everything else, pretty much. Movies, vacations, concerts, whatever.

Note that there is some overlap for some items. for example-- food and clothes are a necessity but when you go out to eat, buy fancy shoes, etc. you are not making that purchase purely out of necessity. It is also for personal pleasure. Beer is probably my biggest overlapping expense.

Now that we have our definitions down, how much is it okay to spend as a percentage of your income? I haven't ever taken the time to break down how much I spend in this area, and if I did I can guarantee that I wouldn't like the result-- and I am a pretty frugal spender for the most part. But why should I get upset about it? Spending in this area is okay to a certain degree. I'm convinced of this. But where is the threshold?

We are probably not taking a vacation this year, for two reasons.

1) I don't have much disposable income since I am paying off a car and a surgery by December.
2) We'd rather save up some money and take a better vacation next year. If we could spend $1500 this year and $1500 next year and take two small driving trips to relatively uninteresting places . . . or we could spend $3000 next year and fly somewhere we can't get to on the road, we'd prefer the latter.

At least those are the two reasons we agree on. I have a third reason . . . I don't want to spend the money! More and more lately, I have gotten obsessed with my bottom line, and my better half doesn't think I spend enough money/energy on fun in the present. We had a bit of a spat last night on this issue after a conversation about my vehicle downsizing effort. She's fine with a vehicle swap but she doesn't want me to go too cheap or too old because she thinks it's just unnecessary and I'll enjoy the car less. She's probably right, and I'd probably get the urge to change cars again sooner than I need to because of it.

We have different opinions on spending, clearly, and we both tug each other toward the middle. I think this is ultimately a good thing-- she'll be better off in 5 years for saving more, and I'll be better off in the present for not being quite as much of a tightass!

But I digress. How much should we be spending in this 3rd category? In the coming days I may subject this question to some detailed analysis and estimate what fraction of my income goes toward this. I'd like some opinions from readers and other bloggers, though, as I know my opinion is skewed in the "less is better" direction.

10 May 2007

Downsizing my vehicle

I currently drive a Honda Pilot. It's a good value, as SUVs go, and I got a decent deal on it when I bought it new in the Fall of 2005. But the financial revolution I have been going through has revealed something to me . . . I don't need an SUV. I didn't then, though I made lots of arguments to myself that justified getting one. I bought the SUV out of desire, not need. In many ways I am ashamed of myself for this, as I always try to be sensible with my money. I thought I was being sensible . . . I couldn't find a used Pilot or Toyota Highlander for less than I was getting this one new. My mistake was thinking I needed one of the two.

Driving this car has hurt me financially. There are no two ways about it. I get about 17.5 MPG city, and maybe 20 highway. Depreciation has not been that terrible, since it is a Honda, but the extra cost of getting an SUV automatically increased the deprecation over other vehicles I could have purchased. Between this and fuel costs, I'd say it was a mistake of several thousand dollars.

That's a mistake I'm going to try to (partially) correct by ditching it for a more sensible vehicle. Gas just keeps getting more expensive, and I'm not far from paying $60 for a fillup. I'm sorry, but that's just not going to cut it for me. I can't stand that kind of expense. So I'm starting to look around at used compact cars . . . Civics, Corollas, Sentras, and any of a number of hatchbacks. If I buy used, I will come out ahead on the deal. My vehicle is worth about $19k and I don't plan to spend more than $15k on a compact car. I still owe some, but it's less than $4k. If I did the deal right now, the swap, after taxes and such, would be even or better, and from here on out I'd be getting some money back in better mileage and depreciation.

Anybody else going through these same deliberations? Fuel costs are just out of hand. It made little sense for me to buy big when I did, and it makes even less sense to keep paying for that mistake.

Five Noteworthy Nuggets

A few great personal finance blog posts from the last couple of days:

I'm going to try to do this once a week-- if for no other reason than for the other bloggers to know that I appreciate what they contribute to the blogosphere and my knowledge/sanity/life. Thanks folks!

Net Worth Update

So I'm impatient! I keep telling myself to wait a full month before updating my net worth, but it's fun to update, so I haven't been able to wait that long. I figure when I back up all the way to the 1st, I'll try hard to stick with the 1st from then on as a measuring point. Anyway, since April 17th (3 1/2 weeks) my net worth has climbed 3.45%. Since I began tracking in February, it has grown 17.3%, nearly halfway to my 2007 goal of 34.8%. Here is a chart of my progress so far:

The strong US market fueled 31% of this month's growth, debt reduction another 36%, and the remaining 33% came from new savings and investment contributions. Pretty good balance! If the market stays strong, it looks I will achieve my net worth goal by the end of the calendar year, which would be nice. Many people are expecting a pullback at some point . . . that could keep me from achieving my goal at all. But that is beyong my control, and if the market dips, that just means I will buy more shares and get faster growth later. It's nice to have a long investment horizon.

I made some changes to my AA

After giving the matter a lot of thought, I made some changes in my accounts that "fix" my allocation problem without forcing me to go all-small or all-big in the accounts. I also discovered that there is a really good bond fund (Calvert Income: CINCX) available in my 401k, so I used that to get my allocation in bonds to near 10%.

I'm going to get on my horse and make several short posts today . . . I have a lot on my mind. Stay tuned.

09 May 2007

Asset Allocation isn't so easy

The last couple of weeks I have been giving asset allocation a lot of thought. Everyone has their own ideas about this topic, and I'm still trying to lock down what I want my target to be. I'm currently thinking 20% international, 10% bond, 35% large cap domestic, 20% mid cap domestic, and 15% small cap domestic. That would get me a lot of exposure to the high risk/reward smaller companies but still diversify me across large caps and bonds. As young as I am I need to be willing to put money into high long-term return vehicles.

That's all well and good, but how does one go about achieving their target asset allocation? I'm a big believer in the efficiency of the market and thus a big believer in index funds. Low cost, good returns, simple to manage. But I'm pretty young, and my employer-related benefits (401k and alternative 401a pension) make up some 60% of my portfolio. That would be okay if my fund options in those vehicles included index fund choices and especially if there were small- and mid-cap options. Those choices are slim, though. I have one S&P 500 index in the 401k, and then small- and mid-cap index funds from ING in the 401a. Beyond that there aren't index funds to speak of, so currently I have considerable assets in managed funds.

The bottom line is, I can get large-cap exposure in the 401k and small- and mid-cap exposure in the 401a, but ONLY if I devote all of my funds that way in the respective plans. I know I should be looking at my overall portfolio allocation, but for some reason having all my eggs in one basket within a plan makes me nervous. What to do? Well, for now I have a Roth IRA with Vanguard and a Rollover IRA with Fidelity, and both afford me many more low-cost options, but those are a much smaller percentage of my total portfolio, so their influence isn't great. I guess if I truly want to achieve my target allocation, I'm going to have to move nearly all my 401k assets to large cap and nearly all my 401a assets to small- and mid-cap. Do my nerves regarding this seem irrational? Maybe those of you with more experience can advise.

07 May 2007

Jumping into the fray: Renting vs. Buying a Home

This has been a hot topic around the blogosphere lately. The most recent entry I read is from Consumerism Commentary: Renting Makes You Richer. He quotes the argument from an MSN article throughout, so these are not necessarily his feelings. The problem with so many of these articles is that the assumption (or argument) is often made that there is a right way to do things. With the housing market there is most definitely not one answer. It is very dependent on local conditions.

For example, where I live, homes are generally cheap and there is not much difference between a mortgage payment and a rent payment on the same property (in fact, the rent payment is usually more). It's also a market that has not declined at all because it never really got overpriced-- $100/sq ft is about average here now, and it only fluctuates a little from area to area. My house has in fact appreciated considerably since I moved in 2 years ago . . . almost 18 percent, using a conservative estimate of the current value.

So, what do things look like if you live in a market like mine? First of all, rent payments save you virtually nothing and often cost you more per month than owning (including taxes and insurance). For my house I think I can state with confidence that rent would be more than my mortgage and escrow payments. But let's assume it's equal. Then renting saves you no money over buying, so there are no additional monies to invest. The only savings from renting would come in maintenance costs. For my house, that has mainly been yardwork and improvements we've made inside and out. I estimate that among painting, mowing, and landscaping, we've probably spent $2,000 in two years. I can't think of any other significant maintenance costs that I wouldn't have if I were to rent. So there's your monetary difference: $2000 over 2 years.

What do I get for that $2k? About $6k in equity from mortgage payments and more than $20k in appreciation, for a net of $24k. If you can find me another investment that would have earned me 1100% in 2 years, I will jump on it. I know what you're thinking-- 18% appreciation in two years is not ordinary. And I agree. So assume that it tracked inflation instead, appreciating 6.1% in those two years. Then my appreciation is only $8k instead of $20k, and my total return is only $12k instead of $24k. So we're talking a mere 500% return on my $2k. Yawn.

That's ignoring the tax benefits of owning the home, which most people get. To be fair, it's also ignoring my down payment. The argument still works, since I could have put down much less than I did without incurring considerable fees (no PMI at my credit union). Suppose I include the down payment in my house investment "costs." Then my extra expense is $15k instead of $2k. But you have to add that $13k to my equity as well-- so my return is $37k. That's a return of 150%. And again, even if you suppose this happened in an average real estate market returning only inflation-- 6.1% over 2 years-- I've spent $15k to earn $25k. That's a return of 67%. It would have taken some really good stock picking to get that in 2 years, and we all know the risks involved in stock picking.

Alright, alright, what's the bottom line? The bottom line is that in my market, renting would have been inferior to owning even with average appreciation. With actual appreciation my returns have been tremendous, and could not have been matched by renting and investing. Not even close. In a market where rent was much lower than a mortgage payment (as in Flexo's example), I can easily see the argument for renting. But it ain't so here.

Several thoughts for a monday morning

Starbucks, why must you tempt me?

Some mornings I just wake up and need a chai latte from Starbucks.A Chai and a blueberry muffin make a terrific breakfast. Too bad it's more than six bucks to get this breakfast at Starbucks, and nobody else makes a chai like they do. So this morning, like most mornings, I resisted the urge. I came to work, sans chai, and now I'll just think about it longingly as I sip my bad coffee instead. I don't want to deprive myself of everything good just because it's more expensive than I'd like, but if I can stop myself, say, 5 out of 6 times, I'll save quite a bit of money. And when it comes to the chai and muffin at Starbucks, 5 times means more than 30 bucks-- or almost two shares of Vanguard's Small Cap Value Index Fund (VISVX).

If only I could be Roger Clemens

Clemens just signed with the Yankees to play another season at the age of 45. He'll start pitching in the Yankees' farm system in about 2 weeks. His pay for a partial season? A mere $18.5 million. Let's not forget that Clemens is a starting pitcher as well-- so not only will he just play for the yankees for 1/2 to 2/3 of the season, but he'll only pitch 1 in every 6 games for them when he does join the team. If you do the math, depending on the assumptions, he'll make somewhere in the $50k and $100k range per batter he faces. Not bad for a couple of minutes of work.

Do you do your own yardwork?

I do. My girlfriend and I mowed the lawn and planted some annuals yesterday. I can't stand the thought of paying somebody $25/hr or more to mow my lawn. It seems that more and more people are hiring lawncare services to at least mow-- and often to seed, fertilize, etc. as well. The lawncare companies make money hand over fist from this. Put your gloves and an old t-shirt on and do it yourself, America. Your savings will thank you.

Gen X and Gen Y woefully undersave for retirement

Big surprise, right? JLP over at AllFinancialMatters talks about this a little in his post Young People All But Ignore Planning for Retirement. English Major also has some words about the same article in
The Kids Are Alright. I have to agree with English Major's points on the subject-- few people under 26 can afford to max out their 401k even if they want to. There's no way I could do it right now. With no mortgage and no car loan? Yes. But that's not exactly realistic.

However, JLP brings up some really important points. First, the table he cites is troubling not in the % who max out their 401k, but in the % who participate at all. Less than 1/3 of those under 26 and less than 2/3 of those under 42 participate in their company's 401k. Second, he brings up the need for personal finance education in our schools. If people, on average, knew a little more about finance, would we have the big rash of foreclosures and the huge credit card debts that we see? I'd like to think not.

04 May 2007

I have an ARM. So what?

Jim over at Blueprint for Financial Prosperity published a devil's advocate piece on adjustible rate mortgages. It was written by Colin Robertson of The Truth About Mortgage.

ARMs are taking a beating right now in the media. There are too many people out there that took out an ARM in order to get into a house they couldn't afford otherwise, saving some bucks every month on interest for the short term and not really considering what would happen when that term ran out. Big Surprise! Foreclosure after foreclosure as the fixed periods on the loan run out.

Like most other financial products, however, there is a right way to use an ARM. In the second paragraph of his Devil's Advocate post, in fact, Colin outlines one such circumstance:

Considering the average time people spend in a home is roughly three or four years, why settle for a high-priced fixed mortgage? You can get a 5, 7, or 10 year hybrid arm that comes with a significantly lower interest rate, plus the safety of a fixed period for longer than you’ll likely stay in the home.
Colin spends most of the blog being a smartass (which I can appreciate), but this is precisely why I got an ARM. I am living in what you might call a "starter home." It's in a neighborhood with only 3 or 4 floorplans and small houses and is peopled largely with young families and retirees. I purchased the house because it was a financial step up from renting (at least where I live) and because I was ready for the responsibility (and perks) of being a homeowner. I knew going in, as I know now 2 years into my 5 + 1 ARM, that there is no way I will end the fixed portion of my mortgage in this house.

What did it save me? Well, it's often claimed that an ARM doesn't make sense when fixed mortgage rates are low. They were pretty low when I got my mortgage; I could have gotten 5.4% from my credit union. Instead I got the 5 +1 ARM at a rate of 5%. Not much difference, right? Well, that depends on your definition of "not much."

Being a "starter home," my house was not expensive, and I live in an inexpensive area for homes as well. My mortgage after down payment was about $111,000. So how much difference does 0.4% make on a loan that small? 2 years into the loan, I've saved almost $1,000 in interest. That may seem trivial compared to the value of the loan, but $1,000 is $1,000. If you could save $500 per year with no trouble, you'd do it, right?

By the end of the 5-year fixed portion of the loan, the difference is about $3,000. I probably won't be in the house for another year, much less 3, so my real savings will be less than that. But money is money, and that's cash I can put in my Roth IRA or use to pay down my car loan. Here's the kicker, though . . . if I had to stay in the house past 5 years, I could afford the increased payment. I knew that going in and I wouldn't have gotten an ARM otherwise. That is where too many people dropped the ball.

Like everything, an ARM has its place. In my case, it has saved me $1,000 and counting. But for thousands of other Americans, it has been misunderstood, misused, and abused, and many people are now in big trouble. The bottom line? Don't bite off more than you can chew. If it adds up in your favor, go ahead and use the riskier ARM. Just be sure you can handle it if things don't go as you expect. Do your homework. Use common sense.

03 May 2007

My current financial situation

A bit about my situation:

Debt: I have a mortgage and an auto loan, and that's all at present. The auto loan should be paid off by the end of the year. The only other "debt" I have is a medical expenditure account with my employer. I set the account up to pay for laser vision correction in January. I have been reimbursed for the surgery and the amount is being deducted from my paychecks through the end of the year. Interest-free loan! I do have credit cards and use them regularly, but I never carry a balance.

Net Worth: I may post specifics in the future, but for now I'll just tell you the progress I've made recently. I started tracking my net worth in mid-February . . . it's positive but I'm nowhere near using the "million" word, even fractionally. I set an aggressive goal for the year . . . 35% growth in net worth. With some frugal spending, aggressive investing, and a fortunate increase in the value of my home, my net worth grew more than 13% over the next two months. I will update again in mid-May, and I expect to be near 50% of my growth goal for the year. The last 50% will be tougher, as I don't expect to see the same kind of bump in home equity to help me along.

Career: I do government research, so the pay is not spectacular, but the benefits are good. I get a lot of vacation and I don't have a stressful work day too often. I try to make the most out of the money I do earn, and now that I am putting it in print I expect to hold myself to a higher standard.

Goals: Like I said, I have set the bar high for the first year. My long term goal is to "retire" at 45. Again, I think this is setting the bar pretty high, and I will have to be smart and careful to get over it, but I think it is doable. I say "retire" because if I manage to find something I love doing (read: something that doesn't have me in an office for 40 hours per week), I may not want to retire at 45. Ideally I can do both; have the money to retire at 45 but continue to do things I enjoy, especially if they pay!

Who am I and what's the point?

I am a 27 year-old statistician with an interest in personal finance and an obsession for research and analysis. I've been out of grad school and in the working world for just under 4 years now, but only in the last 5 months have I really decided to be an active participant in my own finances. I've always been a little tight with money and a good saver, but until recently I didn't consider taking time out to actively monitor my net worth and make decisions that would ultimately make it grow. I'm not even sure I knew what net worth meant. I thought it was a word tossed around by the rich to leave the rest of us wanting.

Why am I blogging? For starters, it's an outlet. My girlfriend, my family, and my friends don't all share my obsession, and frankly they get a little tired of me talking about it. This blog gives me the forum to talk about the financial issues, opportunities, and struggles that affect (or at least interest) me.

It's also an opportunity to learn and share what I have learned. I've been reading financial blogs for awhile now, but I don't think I'm getting the most I can out of the community unless I actively participate.

I hope to stay aggressive in new posting, and I hope that this helps to draw in readers and their comments. This is a blog written from my perspective but I also want to think of it as an open forum for the exchange of ideas. Welcome to Analyzing Wealth!