Uncommon Cents

Welcome to your Link Payday for July 20, 2008. It’s been a busy few weeks as I get ready to head out of town for a week on Monday, so I’ve been hustling to blog as well as to complete some other projects that need to be done for my trip (I imagine I’ll be working on them on the plane!). Here’s some of my favorite blog posts from the personal finance blogosphere over the last couple of weeks:

The always great JD of Get Rich Slowly asks his readers: How to Get Started with Investing? For many it’s a daunting and intimidating task at the onset, even though it really isn’t that hard.

The turbulence in the financial markets (and yes, June was an absolutely horrible stock market month, which we’ll look at soon) may have folks considering getting out of the markets altogether. Fortunately, All Financial Matters warns us wisely: Don’t Run from the Bear.

Much has been made of the disaster known as subprime mortgages; we’ve looked at what subprime means before, and recently Debt Free looked at The ARM: What is an Adjustable Rate Mortgage Loan, and How Did it Get So Many Homeowners Into Trouble.

My buddy Kyle over at Rather-Be-Shopping ponders How Bad Can the Economy Really Be? when people are waiting in line for hours for new iPhones. While as an Apple stockholder I certainly condone the purchase of their products, I worry that people aren’t considering the financial consequences of high end purchases.

And finally, the ever brilliant Mrs. Micah asks What Happens if Your Bank Fails? I had Netbank fail not too long ago and while ING Direct is okay, it’s not exactly the same as Netbank was. Fortunately, I didn’t lose a cent.

And there’s your Link Payday for July 20, 2008!

CNNMoney has a story on a family who lost their home in the mortgage crisis. A grandmother who bought her first house and was getting rent money from her two daughters who “unexpectedly” saw her mortgage payments shoot up hundreds of dollars a month.

No more house.

Yes, I feel horrible that someone who had bought a home–their first home–might lose it to foreclosure. Especially someone who at least had saved a sizable amount–$20,000–as a down payment

But read the story more closely: the house she bought cost $489,000. Her yearly income is $25,000.

Time out!

There’s lots of responsibility to go around on this one. Borrowing $489,000 on a salary of $25,000 a year is totally out of line with reality. And loaning someone with a $25,000 a year salary $489,000 is incredibly irresponsible. There’s no way someone with that kind of salary to reasonably have a mortgage of that size, meaning that not only did the borrower need to know beforehand she couldn’t afford it, the lender needed to let the borrower know that–and there’s no way a lender couldn’t have known that it wasn’t a workable loan. This was doomed from the start, a marriage of a borrower who didn’t know what they were getting into and a lender who wanted to make a loan–and some dollars–in a bad way.

All of that said, while I feel horrible for this lady and her family, I just can’t support a taxpayer bailout of folks who have gotten themselves in deep with mortgages they can’t pay. These are the biggest investments almost all of us will ever make in our lives and we owe it to ourselves–and each other–to do our homework and not get ourselves into situations where we’re in over our heads. We’re not talking about a situation where someone lost their job or had a catastrophic illness or accident; we’re talking about a situation that was 100% preventable beforehand. Yes, I feel horrible, but no, I can’t say bailing them out is the best use of taxpayer dollars.

Speculation is a way of choosing rather high risk investments to try to make a profit from a projected positive price movement. Speculation is different from investment in that speculators acquire much more risk and hope to realize their gains in short periods of time. Speculation is sometimes successful and sometimes unsuccessful; both outcomes can be seen in real estate over the last few years. Those who entered the real estate market in the year 2001 and sold within the next two to four years likely did exceedingly well; those who entered the real estate market in 2005 hoping to make a substantial amount of money by selling their properties today are likely facing substantial losses.

Some speculators hedge their positions to try to protect against substantial losses; in addition, some speculators will use leverage to try to maximize their profits in their investments. For instance, if I believe that oil will continue to go up in price, I may sell my current investments and take out a home equity loan and buy oil with those funds. As you can likely derive from that example, a combination of leverage and an incorrect speculative investment can lead to financial disaster. Some speculators make tremendous amounts of money; others lose the same. Be very careful when considering an investment that’s speculative!

Welcome to your belated Link Payday for June 23, 2008 (since the fabulous Kyle of Rather-Be-Shopping.com returned and wrote his usual Friday post for us–which fell on the 20th–we delayed this payday a few days). Here’s some of the better posts I’ve read in my RSS reader the last couple of weeks.

The always entertaining JD of Get Rich Slowly discusses Why it Pays to Ignore Financial News. This article puts pretty succinctly one of the key tenets of long term investing: daily stock market fluctuations aren’t meaningful to your holdings over the long term–unless you act on them. Pay more attention to the things in your life that give you joy rather than your retirement account.

Can I Get Rich on a Salary asks how to Teach Yourself to Invest In Stocks? by covering MarketWatch’s daily money tips and offers a few suggestions of their own. I wholeheartedly suggest that people learn about investing in stocks, bonds, and funds; if you have the tolerance and taste for stocks, I suggest checking this piece out.

All Financial Matters asks the question that I wish everyone in this country–particularly those in Washington–would ask: What’s the Solution to Our Energy Needs? Gang, ethanol is not the answer (at least not corn based ethanol), but a combination of other types of alternative energy including (yes, I say this as an environmentalist) nuclear is. Let’s all work seriously to do whatever we need to do to get this resolved and get our country off of its dependence on foreign oil.

I’ve Paid For This Twice Already asks How Do You Decide When “The Time Comes”? In this case they are considering if it’s the time to replace their car. This is definitely worth looking at for making financial decisions with regards to some of the things we use every day, like computers.

Finally, Trent over at The Simple Dollar discusses Addiction and Personal Finance. As a professional in human services, I have to say that addiction can be a huge threat to your finances–if not your family, your relationships, your freedom, and your life.

And that’s your Link Payday for June 23, 2008!

A “sunk cost” is a cost that has already been paid for a project or investment–possibly a substantial one–and is very unlikely to be recovered. An example of this may be spending a substantial amount to repair a car that has multiple problems and may continue to incur substantial repair costs in the future. Rather than selling the vehicle or disposing of it and purchasing a different one with fewer problems, the owner may reason that, “If I get something else, everything I’ve invested has been wasted.” While the reasoning may technically be accurate, it’s not a relevant reason to continue to put money into the vehicle. The economically sound decision would be to start over, but many cannot because of the feeling that they will then lose whatever they’ve put in–when the reality is, they’ve already lost whatever they’ve put in.

The sunk cost fallacy can also move into other areas of life, such as time spent on a project (even a large project such as a college degree or job) or emotional investment into a relationship. There is a time when more investment into a losing proposition is simply a way to incur more losses, and it’s at that time that it becomes wiser to call it a day and head elsewhere.

Consider if what you’re getting yourself into deeper–whether it’s financial or otherwise–is a promising investment or a case of sunk costs. It’s not the easiest issue to deal with, but it may help you avoid larger losses in the future.

Welcome to your link payday for June 5, 2008. This week was a great pay week for me because I actually got paid three times (and I’m hoping for a fourth, though likely in vain): once from this blog, once from my part time job, and once from my full time job. The fourth would be my still MIA stimulus payment!

Anyway, some of the better posts of the last few weeks that I’ve read in the blogosphere:

JD over at Get Rich Slowly covers (and advises against) a practice that kills your tax advantages and might indicate you’re in serious financial trouble when he says Don’t Raid Your 401(k) to Make Mortgage Payments.

Mrs. Micah tickles my funny bone when she discusses The Lingerie ROI. Suffice it to say I won’t be investing in Victoria’s Secret anytime soon (I honestly don’t even know if they’re publicly traded!).

Do others judge the frugal? I’m sure there is a lot of that going on; in this intriguing post, SavingAdvice.com discusses The Benefits of Savings Habits that Make You Look Poor. I have a different problem–the benefits of looking old! I really don’t qualify for that senior discount at Jack in the Box (but I’ll take it if they give it)!

Sqawkfox runs a five part series on ways to kick start your job hunt; I particularly like part one on How to Choose a New Career, which addresses something that’s been on my mind a lot recently–pondering your passion.

While it has a rather long title, it has some great points–Trent over at The Simple Dollar discusses Money Magazine’s ‘7 Investments You Need Now’, Portfolio Theory, and My Own Plans for the Future. This discusses some very basic theory on portfolios and covers one of the books I really like, Paul Farrell’s The Lazy Person’s Guide to Investing.

And there’s your link payday for June 5, 2008!

May seems to have been another positive month in the stock market; my initial belief just looking at (but not actually running) the numbers is that it was not quite as positive of April but it was quite decent in and of itself. Let’s take a closer look:

The Vanguard Total Stock Market Index Fund (VTSMX), which makes up the largest portion of my portfolio, ended May at $34.16 a share after closing April at $33.46, a gain of a bit over 2%. The Vanguard Total Bond Market Index Fund closed May at $10.07 vs. $10.18 at the end of April, down just over a percent but putting out that nice 4.86% yield for the fixed income portion of your portfolio. Finally, the T. Rowe Price International Discovery Fund (PRIDX) finished May at $46.23 versus the $45.28 it finished April at, a nearly identical gain of a bit over 2% to VTSMX.

Hopefully, the market continues to stay on course for a positive end to 2008!

An expense ratio is a way to understand the costs of operating a mutual fund. The operating expenses associated with a fund [usually the fee for the fund manager, bookkeeping fees, accounting fees, auditing fees, taxes, and marketing costs (the infamous 12b-1 fee) are some of these expenses] are combined, then divided by the average dollar value of its assets. These expenses are taken from the fund’s assets and, as you would expect, reduce the return investors experience.

Expense ratios are expressed as a percentage. Typically, passively managed index funds have very low expense ratios; for example, the Vanguard Total Stock Market Index Fund (VTSMX) has an expense ratio of .15%–that’s right, well under a single percentage point.

Expense ratios do not include loads, taxes, or surrender charges, which can add heavily to your costs. Sticking to no load, passively managed index funds with low expense ratios is one of the best ways to maximize your returns by minimizing your costs. Pay attention to the expense ratios of your funds and you will help your bottom line!

The last time we looked at “Basics”, I discussed the cash flow equation, which is:

income - expenses = cash flow

Now, once cash flow is positive (and the more positive, the better) the wealth equation is also simple:

(cash flow + sensible safeguards + wise investments) x time = wealth

Simple, but not necessarily easy. Once your cash flow is positive, it’s time to do some smart things with your money and let time do its thing.

What are these smart things?

Sensible safeguards: these are your emergency fund, term life insurance, long term care insurance, and disability insurance. You don’t want to toss money away, but you also don’t want to under insure. Keep a reasonable amount (many say a minimum of $1,000, others say six months of salary–personally, I split the difference and say three months of take home pay) in a money market account with check writing and an ATM card (Capital One Direct is the one I use). If you have dependents, get term life insurance; you may also want to consider disability and long term care insurance.

Wise investments: what we’ve been discussing on this blog forever. Passively managed, no load, low cost, tax efficient index funds and exchange traded funds. High quality bonds and bond funds. Traditional and Roth IRAs, 401(k)s, and their equivalents. Reasonable asset allocations. Investments made at regular intervals. Diversification, diversification, diversification.

Time: you know what this is, and the more you have the better.

Wealth: the dollars you end up with at the very end.

The one other thing that you need will be discipline. We’ll cover that later, but in the meantime, remember that formula. It’s a simple, get-rich-slowly, tried and true over time formula that will help you reach your goals–it’s helped me build a six figure portfolio in less than half a decade!

I firmly believe that the 401(k) and its equivalents are among the absolute best financial savings vehicles to come along ever. However, not everyone agrees with me, possibly including teachers in West Virginia.

According to this CNNMoney.com article, West Virginia teachers essentially got to vote on a “do over” decision for whether they want a 401(k) type plan or a traditional pension. Like the corporate world, some municipalities have gone away from the traditional pension system (which is very expensive for the employer) and to a 401(k) or similar system. The positive side of this is that the 401(k) is a great system for both the employer and the employee; the negative side is so many employees don’t use their 401(k) to maximum effect [and there is also the very real possibility that the custodians of the 401(k) are offering the kind of options that make the most sense in their plans--like no load, low expense, passively managed index funds].

Apparently, many of the teachers in the 401(k) style plan have not done very well with their savings and are now asking for a return to the traditional pension plan, which was voted on earlier this month. There is some feeling that the options offered in their plan were less than optimal and teachers were steered into them. Sadly, this points out a huge issue not just with 401(k)s, but personal finance in this country in general–even college educated professionals don’t necessarily make decent decisions about money.

Another issue is that if this happens, the bill will be footed by–yes, you guessed it–taxpayers. This is one of those things that couldn’t happen in the private sector, but could in the public sector.

This situation bears watching.