Advanced Personal Finance

I just discovered a great plus side to the inflation we’re all experiencing (well, the inflation regular gas and grocery-buying people are experiencing) - easy weight loss!

I’m nothing if not predictable.  A couple of months ago, I was on a business trip for about a week.  I generally ate dinner at the same couple of places every night.  Moreover, I ate the same thing each time I visited each respective restaurant.  Like I said, painfully predictable.  (To the good, I didn’t ever have the same waiter or waitress.  That’s something, I guess.)

Flash forward a couple of months and I go on another trip to the same place.  I noticed something interesting when I went out to dinner.  The prices were the same, but the portion sizes had shrunk noticeably.  Not just at one restaurant - at all of them.

I guess it’s a nice side-effect of inflation.  Food costs are rising rapidly, which puts a double hurting on restaurants.  People are eating out less because they’re having trouble filling their own pantries and gas tanks.  Compounding the problem from the restaurant’s point of view is that they have their own food cost worries.

It’s an easy weight loss plan for the millions of Americans who don’t eat at home each week.

On a somewhat related note, I read that childhood obesity isn’t as bad as had been previously reported.  It turns out the rate of increase since 2003 has slowed.  Hey, great!  The US has plateaued at only 32% of little kids being overweight or obese.  That’s awesome news.  Kids still have it over adults in the US, though, since 66% of adults are overweight or obese.  Something to aspire to I suppose.

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There’s near unanimity in the belief that you should have a cash emergency fund.  The problem with that supposedly inviolate rule is that in low interest times like we’re now in, your emergency fund gets smaller and smaller every day.  I advocate alternatives to the large emergency fund thesis.

In times of low interest rates and high inflation, there’s an awful effect for savers - negative real interest rates.  Like a job where you never get a raise, negative real interst rates happen when your income (in this case from interest on your savings) declines after the effects of inflation.  For a recent example, consider that in a typical ‘high-interest’ savings account, you are offered 3%.  With official CPI running at 4%, you’re losing 1% of your emergency savings in real purchasing power terms.  To make things worse, I haven’t even included the effect of taxes on those interest payments.  To make things much, much worse, I’m using the CPI put out by the federal government which many, including myself, think is a fiction.  (I believe true inflation is much higher and if you’ve bought food, gas, health care, or day care recently, I think you’d agree.  See Shadow Stats for more information.)

The bottom line is if you have a cash emergency fund, it gets smaller in real terms every day.

Fine, you say, but a 1% decline isn’t so bad.  And besides, what’s the alternative?  I think there are two decent alternatives to an ever-shrinking emergency fund - a fully-funded Roth IRA and ready credit.

Among the great features of a Roth IRA is its withdrawal rules.  Without getting into all the various tax treatments for withdrawals before retirement, for our purposes you only need to know one thing.  You can always get access to your initial investment.  That is, if you fully fund a Roth IRA in 2008, you can always get at your $5,000 initial investment without tax or early withdrawal penalties.

With that in mind, I think a Roth IRA is a very good vehicle for emergency savings (beyond a small to medium size cash account for ‘mini-emergencies’ like car repairs).  You can invest the money with an eye toward growth (i.e. not in a passbook savings account) that should earn a higher return.  But in a true emergency, you can still access the money.  When the emergency passes, you can begin putting the money back into the Roth (for that year only).

The second alternative to a large emergency savings account is ready credit.  Some people will recoil in horror at the thought of using credit in any form as an emergency fund.  But I believe ready credit can make an excellent emergency backstop.  I’d call any widely-accepted revolving credit line ‘ready credit.’  Examples are unused credit card balances and HELOCs.

The great advantage to using ready credit as an emergency backstop is that it puts the interest rate risk onto the bank.  They bear the 1% loss you’d incur if you saved as in my example above.  (Mind you, the bank doesn’t actually suffer a loss.  They obviously invest that money into higher-than-inflation investment vehicles.)

The disadvantage to this technique, and it is admittedly a big one, is the possible sudden loss of those credit lines just when you need them.  Recently, people have experienced a decreasing credit line on their credit cards.  And in the event of a job loss, banks are known to pull or reduce HELOCs.  I don’t deny this is a problem.  However, I would point out that not all emergencies involve the loss of a job (the most common reason for a loss of credit).  Examples of situations where you’d want access to a good bit of money without having lost your job abound.

Do I think you should abandon a cash emergency fund?  No.  I just think, ideally, the ‘emergency fund’ should actually be a set of concentric rings around you.  Closest to you is money kept for day-to-day expenses and any extra in a checking account.  Beyond that is a smallish cash emergency fund.  Beyond that is ready credit and/or saleable investments.

What do you think?  What’s your emergency fund technique?

This post only published at Advanced Personal Finance.

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By one sensible measure, yes they did.

Adjusted for inflation, the S&P 500 is right where it started nine years ago.

Today the WSJ reported something I’ve been trying to wrap my head around for some time.  I’ve wondered on this blog before about what is the best hedge against inflation.  I’ve asked personal finance authors, asked myself, done research, read tons of articles.  Nobody ever had a satisfactory answer for me.  The closest I ever got was “stocks will outpace inflation.”

Well I guess not over the last nine years.  Here a link to a telling graph courtesy the WSJ.

From the article:

Conventional stock-market wisdom holds that if investors buy a broad range of stocks and hold them, they will do better than they would in other investments. But that rule hasn’t held up for stocks bought in the late 1990s or 2000.

That just happens to be the timeframe I’ve been investing.  Awesome.  T-bonds returned 4.7% adjusted for inflation over that time period for crying out loud!

To be sure, unless you bought this month in 1999 and didn’t add to your holdings, you’ve done better than this.  That’s why people like dollar cost averaging so much - it forces you to buy during down markets.  But analysis like this is disheartening.  Inflation’s a killer (and the government’s inflation numbers haven’t even been bad during this time period).

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I’d love to have the opportunity to make investments like this.

By now, I’m sure everyone who reads this blog knows all about JPMorgan Chase’s purchase of what’s left of Bear Stearns.  Supposedly, JPMorgan rode to the rescue to save Bear Stearns and possibly ‘the entire Western banking system.’

Gimme a break.

All JPMorgan did was use your money to make an investment.  If you boil the deal down, the U.S. government is guaranteeing JPMorgan against losses.  I’d love to make an investment like this - there’s no down side risk at all!

Now I’m sure lots of people will argue that doing nothing was not an option for the government.  The thinking is that financial institutions are now so tightly entwined by trading (mostly derivatives) that the collapse of one could bring them all down.  In fact, Warren Buffett and Bill Gross have been saying just that for years, and I agree.  But the way it got this way is from lack of true oversight by the government and years of mistakes by the Fed.

Speaking of the Fed, I’m not sure how many ordinary people realize this, but right now the Fed is accepting mortgage-backed securities as collateral for good-as-gold Treasuries.  More of the same from the Fed.

So today they’re expected to cut a key rate.  It’s all the Fed seems to know - increase availability of money.  And here’s what that means to individuals in a personal finance sense - inflation.  Three in four Americans believe the economy is in recession.  I think they might be watching the wrong game.  I think inflation is a much bigger problem for most people.  And it turns out, according to a CNN poll, 91% of Americans agree.  But like I’ve said before, inflation is not something you can control, but your response to it is.

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As I pondered the latest dismal housing market news, a funny thought popped into my head.  There’s an old saying that goes, “Never borrow to buy a depreciating asset.”  Usually that means something like a car.  With the current climate, though, it could apply equally well to a house purchase.  That’s a bummer.

We’re buying a new house (from the builder).  When we made our counter-counter-offer, we got the price we asked for…if we closed within 30 days.  We couldn’t do that, so they wanted us to pay the carrying (interest) cost for the extra month.  I’ve had the thought since that we probably could have waited a month and gotten an even better deal than what we offered.  Oh, well.

Anyway, it’s pretty clear that we’re violating that personal finance maxim to avoid paying for a depreciating asset (at least near-term) with borrowed money.

Balancing this thought is my strong belief that inflation will accelerate in 2008.  In a time of high inflation, you should get rid of your dollars as fast as possible.  So if I’m right and we are headed for high inflation, we’ll be paying the mortgage with cheaper dollars each month.  I guess it’ll be a race to see if inflation outpaces the drop in home prices.  That’s a curious situation.

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