Advanced Personal Finance

If you’re like me and invest in an S&P index fund, you might be getting a pleasant surprise. As you may know, there has been a wave of private equity deals taking public companies private. If you own the individual stock of those companies, you’re probably pretty excited as those deals usually have a significant premium to them. But if you just index, there’s a nice upside, too.

What’s going on

When a company on an index goes private, what’s happening is it’s shares are being removed from public trading. As a result, that company is replaced by another so you still have 500 companies on the index (in the case of the S&P 500).

So the money that was invested by index funds in the company being replaced must find a new home. Some of it will go to buy shares of the new company. But since the S&P 500 is market-cap weighted, there will likely be some left over. That ‘extra’ money gets distributed among all the companies of the index, raising the price of each.

What this all means for you

Since all the stocks composing the S&P 500 are rising in price because of the redistribution, your fund will rise in price commensurately. You get a nice NAV increase because a stock you didn’t own much of got taken private.

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Although it’s been popular recently, I’m not one for owning rental property. If you want to invest in a REIT (Real Estate Investment Trust), that’s one thing, but to own property outright is another. I just have no interest in it for a couple of reasons.

First, it strikes me as a riskier way to invest, since picking the correct property is key. Second, I have no aptitude for property selection and that’s obviously key to successful real estate investing. Third, property isn’t liquid enough for me. Finally, property ownership strikes me as a lot of work assuming you also manage it. If you don’t manage it yourself, that takes away one of the good reasons to own property in the first place - cash flow. A lot of the cash is flowing to the management company.

It’s that last one that’s a biggie for me. Like I said, I don’t own property, but I imagine these are some of the job requirements:

• Collect rent checks and deal with late payers

• Maintain the property (either yourself or by hiring someone else)

• Conduct legal proceedings against deadbeats

• Show the place to prospective tenants

• Deal with disputes between tenants

This post by Q got me thinking about this whole thing. Apparently, he’s having trouble with one tenant in particular who’s paying late or not at all (the relevant part is about halfway down the post). Then I read Lazy Man having some issues with a tenant.

I think people who advocate property ownership tend to discount the total cost of ownership. If you truly factored in all the time and money you as an owner put in to the property, I’d be willing to bet your ‘income’ is a lot lower than it looks on paper.

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If you’re like me and you use a 10% return when figuring out investment returns, maybe you shouldn’t be. Whenever I’m using one of those online investment return calculators or whatever, I typically use a 10% return for an all-equity model. I’ve read numerous places (here’s one example) something to the effect of “the U.S. equity markets returned an average of 10% over the last century.” It’s one of those conventional wisdom things in personal finance.

I was looking over the prospectus of an S&P 500 Index fund we invest in. It showed the average annual return over the past 10 years. According to this table, the S&P 500 returned 8.42%, this fund returned 8.11% before taxes, and 6.93% after taxes and sale of fund shares. If I’m not mistaken, 8.42% is still less than 10%. And, yeah, I know the last 10 years is not the same as the last 100. But note that the period 1996-2006 included two significant bull markets.

S&P 500 10 Year Chart

My point is that maybe 10% isn’t a very realistic number for modeling your stock investments. Then I read this post from Lazy Man saying he’s read stuff saying the market returns 12%. How can there be this wide a variance in reported returns? It should be a simple statement of fact that “the S&P 500 returned X% over the last 80 years.”

So what’s the answer? For me, I’ll be using eight or maybe nine percent for my models from now on.

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One of my coworkers was looking at his 401(k) statement online when he clicked on the ‘Long Term Incentive’ tab that shows our stock options. Our out of the money options. The surprise - no, shock - came when he realized they’d been repriced! Apparently, unknown to us drones, the company had revised the strike price down for these options we all got a few years ago.

The company had done something that benefited employees and didn’t advertise it in the daily bombardment of corporate propaganda email. How many times does that happen? Like never. Not only that, but for some reason, the total number of options was slightly higher than it used to be (by around 5%).
What to make of this? My cynical side says there are two possible reasons. One, it’s a mistake that will be corrected by tomorrow. Two, it’s for real and in the unlikely event it benefits us workers, it will benefit management 100-fold.

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I’ve been reading and learning about the Consumer Price Index (CPI), otherwise known in layman’s terms as the ‘rate of inflation.’ The CPI is calculated by the Bureau of Labor Statistics (BLS) and is reported periodically (monthly is the most common number quoted). The original idea of the CPI was to periodically collect the prices for a basket of consumer goods in order to gain information on price increases or decreases. So far so good.

What I’m learning, however, is that the CPI grossly understates actual consumer prices. To understand why, you have to known a little more about how CPI is calculated. Bear with me, this’ll get good.

Here are the components of the CPI:

Notice the three largest pieces of the pie: housing, transportation, and food. Here’s where it gets good. Let’s take a look at housing for evidence of how the CPI understates inflation.

How CPI underestimates the cost of housing

Within the housing category are three subcategories - shelter, fuel and utilities, furnishings. Within the shelter subcategory is our bogey - owners’ equivalent rent.

Every month, BLS polls 50,000 landlords and tenants to come up with owners’ equivalent rent. But because of the recent housing bubble, rents nationwide have been suppressed as more people could ‘afford’ a home and bought one. This caused a glut of unoccupied rental units and hence kept a lid on rents. That’s why people like Flexo at Consumerism Commentary are now comparing the wisdom of renting versus buying.

We know from government census data that the homeownership rate as of 2005, the most recent data available, stood at 68.9% That means 31% of the U.S. population rents. So when the CPI is calculated, 23.4% of the entire number is derived from 31% of the population’s situation. The increased cost of housing for 69% of the U.S. population is ignored. According to the OFHEO (the government agency charged with tracking these things), for 4Q2006 home prices were 5.9% higher than a year earlier. That’s after three years of price appreciation in the teens.

After looking at the situation in this light, I believe the CPI understates actual inflation to a surprising degree. Why would the feds publish this lower inflation number? Oh, I can think of a couple of reasons…

• Lower COLAs for military and other government workers
• Smaller COLAs for Social Security recipients
• Lower payments for Treasury Inflation Protected Securities (TIPS) and similar bonds
• Tax brackets are adjusted more slowly, increasing tax revenue

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