Advanced Personal Finance

Moving to a lower cost of living location is a popularly advocated means to cut expenses and live below your means.  But does moving to a cheaper area really save the kind of money most people would need to save to make such a dislocation worthwhile? 

Maybe not.

People interested in personal finance advocate lots of different methods to either increase income or decrease expenses.  There has been a plethora of stuff (too much) written about the ever-ellusive ‘alternative income streams’ to do the former.  The latter garners an even greater amount of attention.  Free Money Finance has written several times about the idea of moving to another city to cut expenses.  My family just did it earlier this year.  Now David at My Two Dollars is planning on moving to a much cheaper area this summer.  But there’s excellent evidence from behavioral economics research that this isn’t the money-saving move people think it is.

One of the basic principles of the new field of behavioral economics is something called ‘anchoring.’  Basically, anchoring means once you’ve gotten used to the cost of something, you compare similar things to that cost.

Anchoring is relevant in this context because when people move to a lower cost of living area, they’re expectation of the cost of housing (among other things, I suppose) is anchored to their previous (more expensive) location.  So it’s been shown that when people move to a place with cheaper housing, they keep sinking the same amount of money into where they live.  A family moving from Dallas to Des Moines spends what they used to pay for their old house; they buy more house in Des Moines because they’re used to a certain mortgage payment.

Interestingly, it also works the other way.  If they move from a cheaper area to an expensive one, people typically just squeeze themselves into a smaller house and keep roughly the same size mortgage payment.

So maybe the advice to move to a lower cost of living city isn’t as automatically beneficial as I thought.  I can tell you, though, that in our case we did cut our payment by a third for a similar house when we moved.  Of course, everyone thinks they’re the exception to the rule, don’t they?

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Here’s a new spin on debasing the currency.  According to this story, a Congressional bill due for a vote soon would instruct the US Mint to start stamping pennies and nickels in steel instead of their current alloys.

The cost of a penny is currently over one cent (1.26 cents) and a nickel costs 7.7 cents to mint - 50% more than it’s worth.

The rising cost of metal commodities is to blame.  Copper is near record high prices and zinc costs four times what it did in 2003.

So not only in the Fed debasing the currency, so is Congress, in a manner of speaking.

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Warren Buffett is well known for a couple of things - his love of hamburgers and Cokes, his folksy whitticisms, and being one of the world’s best investors.  That last one is why, when he says something, I listen.  I read about Berkshire’s latest annual meeting recently and, as always, it was enlightening.  And, like a bucket of cold water, sobering.

Buffett and his partner Charlie Munger said flat-out that the days of Berkshire returning far superior returns are over.

“We would be very happy if we earned 10%, pre-tax” on the additions to Berkshire’s equity portfolio, said Buffett. “Anyone that expects us to come close to replicating the past should sell their stock; it isn’t going to happen. We’ll get decent results over time, but not indecent results.” Added Munger: “You can take what Warren said to the bank. We are very happy at making money at a rate in the future that’s much less than the past… and I suggest that you adopt the same attitude.”

This follows in line with some other things I’ve been reading from well-respected writers like Peter Bernstein and Kevin Phillips (whose new book, “Bad Money” I’ll shortly be reviewing).  These people, not known for gloom-and-doom perma-bear sentiment are saying things will be middling to bad for a good while. 

Bernstein believes the economy won’t turn around until after 2009 (!) and when it does, it will be a long, slow recovery.  I tend to believe him.

Kevin Phillips lays out an equally dim view of the situation going forward.  He is even more pessimistic than Buffett and Bernstein.  Ditto for bond king Bill Gross of PIMCO.

When heavy hitters like these guys tell you to adjust your expectations down, you’d better do it.  I know I am.

 This article published only at Advanced Personal Finance.

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Your mutual funds and ETFs are flagging.  The 401(k) balance is dropping almost daily.  Surely there’s a way for you to align your investment strategy to counteract these trends, right?  Well, once again Wall Street comes to the rescue.  There’s a new fad rippling through the mutual fund industry - the 130/30 fund.  Is this the common man’s hedge fund or just another money-losing gimmick?

The 130/30 Fund

So what the heck is a 130/30 fund?  It’s a mutual fund that is ‘long’ 130% of net assets and ’short’ 30%.  (An investor is ‘long’ a stock if he/she has purchased it in the hopes that the price will increase; a ’short’ is when the investor is hoping the price will decrease.)

That adds up to 160%; how, you ask, do they own 160% of net assets.  The short answer (no pun intended) is that the short position and part of the long position kind of cancel each other out.  It works like this.  When you short a stock, you borrow the shares and sell them into the market.  That nets you cash.  A 130/30 fund takes those proceeds from the short sale and reinvests them ‘long.’

Confused?  Don’t be.  In simpler terms, what a 130/30 is doing is just using leverage.

The idea behind the 130/30 fund is an alluring one.  By intelligently choosing which stocks to short and which to hold long positions in, you hedge against adverse price movements.  Just like the big boys at the hedge funds do!

Is a 130/30 fund for you?

Likely not.  There are a couple of serious negatives to 130/30 funds. 

First, they’re actively managed funds.  As we all know by now, actively managed funds never beat index funds over the long term.  They can’t - no advisor gets it right all the time.  Statistically speaking, you’re much worse off in actively managed funds.  Besides that, actively managed funds have higher expenses than index funds.  Expenses are one of the few ways you can truly influence your investment returns.

It’s even worse than that, though.  The second reason 130/30 funds are a bad idea is that their expenses are likely to be even higher than other actively managed funds for a couple of reasons.  First, when you short a stock, you have to pay dividends to the person you borrowed the security from in the first place.  Second, there are additional trading expenses associated with the ‘extra’ 60% of assets.

Another reason you probably don’t want to own a 130/30 fund is their whole reason for being - leverage.  As people learned in the recent real estate crash, leverage is great when prices are going up but murder when they’re going down.  Boiled to its essentials, what a 130/30 fund is doing is really just borrowing money to leverage up their exposure.  This is a way of end-running the mutual fund prohibition against buying on margin.

Though the idea is nice, I’ll personally be staying away from 130/30 funds.  But then again, I don’t invest in anything but index funds and ETFs, so I’m not exactly their target audience.

This article published only at Advanced Personal Finance.

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As a Gen-Xer, I know well the burden of student loans.  My wife and I, like millions of others our age, had to deal with a rather sizeable debt burden right off the bat when we left college.  But there’s a way to ease the weight of that burden.  Very soon, it may be the best time ever to consolidate student loans.  It can save you hundreds or thousands of dollars over the life of that loan.  Here’s how.

Student loan consolidation - what it is

If you have variable-rate federal student loans, you can consolidate them all into one fixed-rate loan.  This is totally above board.  In fact, it’s federally managed and regulated.  If you’ve exhausted your forbearance period and you can’t get your student loans cancelled, consolidation might be for you.

After consolidation (which is free, by the way), you have one payment per month.  There are four different repayment plans with various terms.  You might also qualify for a new deferment if you’ve already exhausted yours.

Who should (and shouldn’t) do it

If your monthly payment is a stretch and you have variable-rate loans, you might do well to consolidate.  On the other hand, if you’re aggressively paying off the loans and the end is in sight, consolidation is not a good option.  You should also know that, like a home refinance, consolidation might increase the total amount you repay, since it extends the number of years of repayment.

To consolidate, you must have Direct or Federal Family Education Loans (FFELs).  You cannot consolidate if you’re still in school, but you can if you’re in any other status, including default.  I’d like to note here that student loans cannot be discharged in bankruptcy, so if you’re in default, consolidation may be a good option.

Why soon it will be a great time to consolidate

The fixed rate on consolidations is set each July and it’s based on the three-month T-bill auction at the end of May.  I’ll spare you the charts and graphs, but T-bill rates are rock bottom, so it’s likely that when the new rate is announced, it will be an all-time low (we’re talking in the 3.5% range for Stafford loans and 4.25% for FFELs).

How to consolidate your student loans

Since consolidation is through the government, you must use their methods and they make it easy.

• Online at https://loanconsolidation.ed.gov/appentry/appindex.html
• By Phone at 1.800.557.7392

• By paper by downloading a form at: http://www.loanconsolidation.ed.gov/forms.shtml

This post published at Advanced Personal Finance.

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