Simple Minded Investor

You aren't smarter than the market. It really is that simple. The idea that you can "take money" out of your home is a common myth that gets a lot of people in trouble in a hot real estate market. It is a myth that is based on several misunderstandings that are often repeated. Myth 1: When an investment you own goes up in value you have "made money." In fact, you only make money from an asset's appreciation when you sell the asset. Until then, the current valuation is just an estimate of how much money you will make when you actually sell it. As long as you still own the asset, the value you will get is still in play. It isn't money. This is particularly important with a home. If you want to take your profit out of your house you have to sell it and that usually means replacing it with another home. Myth 2:  Refinancing  "takes your equity" out of your house. This myth is particularly pernicious. In fact, the description of people ...

You aren't smarter than the market. It really is that simple. The New York Times had an article about the stock market's recent gains. The story noted that while the market had gone up 11% since the election, the dollar had dropped 10% against a basket of foreign currencies during that same period. They described this as "almost a mirror image." Unfortunately it is exactly a mirror image for people who hold those foreign currencies. Lets say they paid a $100 for a share of stock the day of the election and they exchanged 100 units of their own currency for that $100. Now if they sell that stock they will get $111 dollars, but when they exchange that $111 dollars, they will get back 100 units of their own currency. They have earned nothing, in their own local currency's terms the price hasn't changed. In a world investment market, the price of stock is set by what people around the world are willing to pay for it. Most people are still paying the same pr...

As often happens when the markets are bouncing up and down, some people are turning to the "safe haven" of gold. But how safe is gold? Gold has several attributes that make it attractive: 1) Gold is durable. In fact, some of the gold you buy today was probably mined by the Inca's thousands of years ago. 2) Gold is universal. With very few exceptions, gold always has value. This is true historically. And no matter where you go today you can likely trade gold for other goods either directly or by converting it into the local currency. 3) Gold is portable. While heavy, gold packs a lot of value in a small package. 4) Gold is beautiful. You can store it as jewelry or other decorative art. So if you are looking for an investment that will last a 1000's of years and still hold value, gold is a great commodity. Or if you are looking for something that will be likely to survive a complete societal breakdown like a war. However, when you start to look at likely fin...

You aren't smarter than the market. It really is that simple. You know the marketing folks have been out talking when the New York Times does a fluff story on some new way to make more money with your investments. So watch out for the new scam promoted by the same media advisers who told you a few years ago to buy the most expensive house a lender would finance. Paul Sullivan story is about people'e successful investment of their retirement money in real estate using a self-directed IRA. He provides us with several "success stories".  Of course they are all recent converters to this idea and, not surprising, all but one of the people whose story Sullivan tells are also in real estate sales. The problem isn't really Paul Sullivan. Its that there is no one who makes money by digging out the horror stories from people who invested their retirement funds in real estate at the height of the housing bubble. There aren't any public relations firms devoted to de...

The Minneapolis Star-Tribune financial advice columnist, Chris Farrell has an article in the Sunday May 1, 2011 edition that epitomizes the results of over-simplified financial analysis. For some reason, most of the media's financial advisers seem intent on ignoring the complexity of comparing Roth and IRA contributions and the result is often poor advice. Let's take a look at the media's conventional wisdom and how it compares to reality. Most media financial columnists will say that an IRA and a Roth contribution are equivalent assuming that your tax rate is the same on both ends. If you expect your taxes to be lower in retirement, then the IRA will give you a better return. If not, then the Roth is probably a better investment. On one level this is accurate. If you put $100 into a Roth IRA and are in the 25% tax bracket, you will have spent $125 including the taxes. Lets assume your investments break even over the next ten years and then you withdraw the balance of the...

You aren't smarter than the market. It really is that simple. A few years ago, in October 2008 right after the market "crash", I did a post on confusing volatility and risk . Yesterday an article on CNN Money in their "Ask the Expert" column made it clear that confusion about the risk of volatility extends to the media who provide advice on personal finances. You can read the column for details. But the short version is that someone approaching retirement asked for advice on changing the balance between different assets in their retirement accounts to reduce its overall risk. Specifically they wanted to know " Should we rebalance all at once or slowly over time?" The columnist response was all at once. His argument was " by transitioning to the new asset mix over time, you're really postponing (or perhaps more accurately, undermining) your decision to re-set the risk-reward balance in your portfolio. " This is just plain bad advice. ...

There is a media narrative out there about the T-party that it is made up of people who are angry because they lost their jobs or fear losing their jobs. The actual demographics of T-party supporters don't really reflect this at all. Instead, the typical T-party adherent is male, moderately well to do and in his 40's. Of course, not all fit that demographic. But far from being "trailer trash" as some people imagine, the T-party folks have been relatively successful. So why are they angry? Because they fear life is getting worse, rather than better. And they, as individuals, react psychologically to their fears by getting angry, as opposed to other extreme of going to bed and pulling the covers over their head. But to focus on the causes of their anger, which are mostly personal psychology, is to ignore the causes of their fear. Of course, we can't expect politicians or the media to address those causes. Success in politics requires validating that fear and anger...

As I discussed in Friday's article , there is a concerted political campaign to "wean us off" social security, as one of the program's congressional opponents put it. Central to that campaign is the notion that the program is going "bankrupt" and future generations will not receive any benefits. While that argument has little merit, there is some reality to the underlying problemt. Lets look at the reality. The real problem facing Social Security is demographic. That huge group of baby boomers born after World War II is approaching retirement. This means they are ready to leave the workforce and start collecting social security. That demographic bubble means more people will be receiving benefits and relatively fewer people will be paying for them. This problem has been anticipated for a while. The solution hit on 25 years ago was to switch to having current workers pay more in social security taxes than the costs of paying benefits to current retirees. Th...

The current media narrative is that "social security" is not reliable. It has gotten to the point that this urban myth has become an accepted part of unrelated discussions of retirement. Here is one on article on retirement planning that is an example. This repeated media driven mantra has lead many young people to adopt the attitude that, as one told me 15 years ago, "I don't expect to get any social security." But in fact that is wrong. Even once the social security trust fund is gone in 30 years, continued revenue is expected to cover at least 75% of the projected benefits. And even that is based on projections that assume US workers wages will continue to represent a declining proportion of any increases in productivity. And reducing benefits to 75% of those promised is only one of many options, if in fact social security taxes don't cover all the promised benefits. The reality is that for many people Social Security is the ONLY reliable leg of the stoo...

The AARP newsletter this month has a story about property taxes that seems to share many people's confusion about how the amount of property taxes they pay is determined. Once you understand the system, you realize there is no reason to expect your property tax bill to decline when property values decline or for it to increase when property values increase. Many people think that local governments budget like they do. First you figure out how much money you have and then you decide how to spend it. But that isn't the case. In most jurisdictions, they start the process by deciding what to spend. Local elected officials decide what services they will provide and at what cost. This becomes the basis for making a levy of taxes against local property values. The total local budget is divided by the total assessed value of taxable property. This establishes the tax rate. That rate is then applied to each property owner's value to determine their individual tax bill. What is impor...

There seems to be a lot of discussion to who is to blame for the financial crisis. But an awful lot of the media coverage is highly misleading. Here is synopis: 1) The meltdown in the financial market had little to do with people getting mortgages they couldn't afford. The collapse of the mortgage backed CDO's was caused by the collapse in the value of the houses which provided the collateral. It turned the mortgages behind the "collateralized debt obligations" (CDO's) into mostly un-collateralized debts. The result was that they went from AAA rated bonds to junk. 2)So what caused the housing bubble and collapse? Many people blame the fed, but don't have the story right. The fed did play a role. By keeping interest rates on Treasury Bonds low, they provided a market for alternative bonds that would pay a greater return. But the major cause of the housing bubble was the creativity of the investment banks. These are not the retail banks that make home mortgages ...

You aren't smarter than the market. It really is that simple. There have been a few articles recently on the financial meltdown with the same theme. That is that the housing bubble lead to the collapse of the financial markets. The reality is a little different. The financial markets, specifically the creation of derivatives based on real estate loans, created a housing bubble. Beginning in the late 1990's trillions of dollars poured into the housing market, forcing prices well beyond what people could afford for housing. In most parts of the country, the median price of a home was no longer affordable to someone with a median income. Renting was far cheaper than owning. How did that happen? Where did the money come from. The answer is that the Wall Street bankers had figured out a way to hedge most of the traditional risk of real estate. Instead of directly investing in real estate themselves, they loaned money to people who were buying a home. Then they took the resulting l...

You aren't smarter than the market. It really is that simple. There are a number of places on the internet and in the media where people have questioned the value of "cost averaging". Cost averaging is investing in regular amounts over time, rather than in one lump sum all at once. It has been standard investment advice, but now some critics are arguing that, since the market in the long run tends to go up, the earlier you invest the better. Cost averaging will reduce your return in the long run. They are, of course right. On average, you will get a lower return. But cost-averaging is not done to maximize returns. Its used to minimize risk. It is a strategy to make sure you get an "average" return instead of hitting just one peak or one valley. Think about it this way. Suppose someone offered to flip a coin and pay you $51,000 if it was heads, but you would have to pay them $50,000 if it comes up tails. Would you take that bet? On average, you would come out ahe...

You aren't smarter than the market. It really is that simple. One of the interesting aspects of the recent collapse in stock values is that it makes it a good time to consider rolling your traditional IRA over into a Roth IRA and paying the taxes on the lower valued stock before they go back up. Of course, that assumes they will go back up before you retire. For people who don't pay attention to this sort of thing, the basic difference between a Roth IRA and a traditional IRA is how you pay taxes on them. With the traditional IRA you put your money in an account for retirement and you don't have to pay any taxes on it. Or, looked at another way, you can deduct the contribution from your income taxes. You also don't have to pay taxes on any of the earnings from the investment while they accrue. But when you go to take money out of that account, you have to pay income taxes on the money you withdraw just as you would any other income you had earned. So, while you save mon...

You aren't smarter than the market. It really is that simple. This article in the New York Times, You Try to Live on 500K in This Town , makes it easy to make fun of the perils of having to live on only the $500,000 Obama is suggesting be the limit for executives of failing banks who take federal dollars. But there is really something far more disturbing in the discussion as it takes place throughout the newspaper. It becomes apparent that there is the sense that even if you have lost trillion's of dollars of other people's money, you are still entitled to live an extravagant lifestyle. Having left thousands of people losing their homes, jobs and feeding themselves at food banks, these people genuinely don't see why they would ever have to suffer the same fate. In 1929, wall street losers jumped out of windows. They understood that there was nothing to insulate them from their fate. Today's financiers have no such belief. And with good reason. One of the reason the...

You aren't smarter than the market. It really is that simple. The real estate industry is putting on a full court press for the notion that real estate is now a bargain. But the reality is that housing prices still have a long way to fall before they reach historic norms. And there are plenty of reasons to wonder even once they hit those norms, whether that will be the bottom of the market. The bad economy, huge amounts of other consumer debt, the tightening of credit and the hangover from the binge of new houses built at the height of the bubble would all argue that the immediate future is likely to see prices stay well below those historic norms for several years even once the current price bubble has fully deflated. So if you are renting and thinking about buying, you are probably better off waiting until at least 2010 and probably 2011. Buy now and it may be 5 years or longer before your house gets back to the current price you paid for it. On the other hand, if you already ow...

You aren't smarter than the market. It really is that simple. ---------- Update: Here is an article about Yun's predecessor essentially admitting his job was "spin". ------------- Is Lawrence Yun, the Chief Economist for the National Association of Realtors, really an economist? No, I don't mean does he have a degree and training in economics. I assume that he does. The question is what services of an economist does the National Association of Realtors provide. In case you haven't noticed Yun before, it seems every time there is an article about the housing market in the New York Times, Associated Press and other media, Yun appears with his usually rosy prognosis of the future of real estate. That is not surprising, given who he works for, but it is not really the job of an economist. Its the role of a PR flak who is delivering the message that suits his employers. I suspect the job title of "economist" is also a part of that message. Afterall, id...

You aren't smarter than the market. It really is that simple. The recent stock market crash has reminded many people that there is risk associated with buying stock. But that is really the wrong lesson for people to learn at this point. What the crash has shown is that the stock market is volatile, it will go up and down. But how much risk that creates depends on your investment horizon. If you plan to hold on to your stock for another ten years, then the recent crash has few consequences. The price in the current uncertain market says very little about the price you will get ten years from now when you sell the stock. In fact, the stock markets' hourly gyrations have very little import for most investors, regardless of their investment horizon. Volatility is relative. Monthly fluctuations have consequences for short term investors. The decline in market prices since July reminds us why we shouldn't own stock that we will need to sell in a couple months for our immediate li...

You aren't smarter than the market. It really is that simple. The media is filled with plain silly inanities these days as everyone is focused on the crisis du jour on wall street. Here is one that grabbed my eye: "The Depression itself was a dynamic sequence. It wouldn't have happened if the Fed hadn't insanely tightened credit in response to the stock market crash, rather than the correct policy of easing interest rates." First, that monetary policy lead to the depression is a highly controversial explanation favored by money-supply ideologues. But the Fed did not have a policy of "tightened credit". They simply couldn't expand the money supply by printing dollars because, at the time, each dollar had to be backed by gold bars at Fort Knox. Where the government did act to make the problem worse was cutting federal spending in response to reductions in tax revenue. Essentially the folks in charge ran government like a business, cutting expenses in r...

You aren't smarter than the market. It really is that simple. There have been several articles lately that I suspect are part of a determined effort by the real estate industry to get people back into the housing market. The basic pitch is that higher interest rates will eat up any savings you get from waiting for lower prices. Even the New York Times has gotten in on this action. The calculation always goes something like this. Say you have a house for 500,000 and you make a $100,000 down payment today with a $400,000 mortage at 6.5%. Now compare that to a year from now if housing prices fall by 10%, you would make a down payment of $90,000 and borrow only $360,000, but at a higher interest rate. If the interest rate is high enough, you will end up with higher payments and paying more total for the house than if you purchased it now. There are two problems with that calculation. The first is that isn't really how people buy houses. People decide how much they can afford and th...