Advanced Personal Finance

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.

Share This

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.

Share This

Now is not a great time to be a saver.  In fact, it’s a down-right lousy time.  Rates on everything from high-yield savings accounts to CDs are way down.  In the meantime inflation is up (though still moderate by historical standards), by even the federal government’s dubious accounting.  Mix that together and what you get is negative real interest rates.  I’m going to explain exactly what that means to you and your finances.

My use of the term ‘negative real interest rates’ refers to the phenomenon when the return from completely safe investments is lower than the Consumer Price Index (CPI) - commonly known as ‘inflation.’ 

So you know exactly where I’m coming from, let me specify a couple of the elements.  I consider ‘completely safe’ to be FDIC insured or US government backed.  For our simplified purposes, let’s take that to mean a high-yield savings account.

While the term ‘inflation’ isn’t technically correct in this context, it’s close enough.  Inflation for our purposes is the increase in year-over-year consumer prices.

Here’s where the numbers are for these elements right now:

• CPI 2007: 4.1%
• Typical high-yield savings account represented by ING Direct: 3.4% APY

If you keep your money in this savings account, after inflation, your real return is a negative 0.7%.

Strategies

A couple of thoughts on how to deal with the situation:

1. Consider saving using TIPS.  Treasury Inflation Protected Securities are essentially savings bonds that guarantee a real rate of return after inflation.  There are all kinds of things to consider when thinking about TIPS (like the tax implications), but for some situations they work.
2. Pay down debt.  I know this may seem counterintuitive but consider paying off high interest debt (think credit cards) at an accelerated rate instead of saving more money.  Sure you need an emergency fund, but if it just gets smaller in real terms, you’re losing.
3. Shift savings/investments into retirement accounts.  If you save and invest outside a retirement account, now might be a good time to bump up the amount you put into that tax-advantaged retirement account if possible.  Your investments inside those accounts will likely be slanted toward a more aggressive allocation.
4. Don’t try to ‘make up the difference’ by seeking out unnecessary risk.  So your super-safe savings are returning a negative real rate.  Don’t lose sight of what those funds are for and why they’re in a safe place to begin with.

That’s just what I could come up with.  Anybody want to chime in with other suggestions?  I’m interested to know how other people deal with negative real interest rates in practice.

Share This

Flexo at Consumerism Commentary posted the latest inflation numbers the other day. I’d forgotten they were coming out until I read his post and then, later, saw articles in the paper.

Like you need to be told, inflation was up this past year - 4.1% to be exact. And that’s if you believe the federal government’s numbers, which I believe underestimate true inflation.

Take a look at the following figures for 2007 and see if you can spot what’s wrong with this picture.

Food +4.8%
Health insurance +10.1%
Gas +8.2%
Electricity +3.9%
College tuition +6.2%
Clothing -0.4%
Natural gas -1.4%

Average weekly earnings +0.9%

Awesome! The average person in the U.S. is getting poorer! (I say this because for the vast majority of Americans, non-wage income is miniscule.)

I gotta lighten up my posts. This is getting depressing.

Share This

I don’t write resolutions at the beginning of the new year. In fact, I’m kind of anti-goal in general, but that’s a topic for another post. Even so, it does help me to periodically remind myself to not focus on things related to personal finance that I can’t control.

Things fall into two categories for me - things I can affect and things I cannot. Things I can affect largely end at my skin and I find putting energy into things I cannot affect is just a waste of effort. I didn’t come to this conclusion easily or early in my life and it’s something I can forget. But it helps to remind myself from time to time.

Here are just a couple of things I cannot affect I’ve kicked around in my own head recently.

1. Interest rates. Regardless of what I think about the Fed, foreign investors, or the U.S. government, I know without any doubt I don’t have any bearing on interest rates. Those other groups of people do, but I don’t. Thinking about how this or that event might affect rates or making investments based on what direction I think rates are going to move isn’t smart for me. None of this means I don’t care what interest rates are. Far from it. As a soon-to-be mortgagee, I care deeply. I just don’t get to decide what rate I get, so why worry about it.
2. Economic indicators. There are as many economic indicators as there are economists - and that’s a lot. Whether it’s inflation, job growth, GDP or whatever, I know what I think about them means nothing. Low unemployment rates mean nothing if you’re unemployed. You have no say on unemployment. You most certainly do have a say in whether or not you are unemployed. Focus on what you can do and ignore the rest.
3. Housing prices. If there is one thing on this list I should care about, it’s this one. We recently sold our house very quickly, but for arguably less money than we could have a year ago. Does that matter? Not a bit. We weren’t selling our house a year ago; we sold it last month. Focusing on or worry about the value of your home doesn’t do any good. In a market like this, it only makes you miserable. What’s the point of that?
4. Gas prices. I don’t drive much and that’s about to change to ‘almost none.’ Nevertheless, even if I did drive more, I wouldn’t complain about gas prices. What good does it do? What are you going to do - drive less to work? not pick up the kids after school? visit your in-laws less? Well, maybe that last one, but the fact is most people don’t do a lot of discretionary driving. You can drive a more fuel efficient car, properly inflate your tires, and combine trips. You most definitely can’t change gas prices by boycotting or complaining.
5. The direction of the stock market. If you think you know what direction the stock market is going in tomorrow, this week, or this year, you’re deluding yourself. I don’t care who you are - you can’t predict it and you can’t affect it. What you can do is invest in it, month after month, year after year. Over the long haul, you’ll make a great deal of money. In the short run, who cares?
6. Taxes. I don’t know whether my personal taxes will go up or down this year. I do know I’ll be paying taxes. Do I get a say in how much? For all practical purposes, no. Worrying about taxes is pointless. (Planning for taxes, however, is decidedly not.)

I don’t know about anyone else, but I try to spend my time and effort on things I can do something about. And these things don’t fall into that category. Shouting at the tide never works. You just end up wet and hoarse.

Share This