Scott On Money: October 2005 Archives

Where are Housing Prices Going?

Owning a home in San Diego I'm deeply interested in trends in the housing market. We've certainly seeing the prelude to pricing leveling or declining in the lengthening of time on market of the homes here. The Happy Capitalist gives his take on the housing prices. I think he's right on with the underlying drivers.

I think the supply and demand factor is localized factor in real estate. Ten miles east of me homes are about half the cost of mine. Ten miles west of me they are about twice as much. These localized markets make prediction a little bit tougher.

I'm spending some time getting prepared for whichever direction the market goes. If it goes down I'm going to look at REITs or maybe buying my own rental property. If rates come down I'll look to take money out of my place to invest elsewhere.

Using Index Funds

If you are just getting started investing you may want to look into index funds. Most mutual funds have advisors that are constantly monitoring the market and trying to make decisions that help the fund perform better. For a variety of reasons this is not often accomplished once the fees that the funds charge are accounted for.

Index funds don't rely on a manager to decide what stocks to own. Instead they simply try to match a market index like the S&P 500.

There are several advantages to this approach. This means that there is no money in research costs and expenses can be kept very low. The fund structure ensures your performance will closely track what the market does. You typically get a lot of diversity from the wide range of stocks own. It is also nice to hear on the news how your funds are doing (almost every news broadcast quotes what the Dow Jones and S&P 500 did every day).

There are disadvantages to consider. By spreading your funds over such a broad array of stocks you've increased your safety but you've limited your ability to achieve very large returns. If you are investing a significant amount of money you need to be sure to spread your purchases out over a period of time to avoid the risk you assume by investing all at the same time. If you are close to retirements, or whatever other investment goal you have, stock market risk may not be appropriate for you.

All things considered these funds are a good way to get used to the market while you decide what your philosophy looks like.

Diversify

Diversification is critical to ensuring your financial security. After doing all your research and picking your investments there are still threats to your financial security. Executives lie, lawyers sue, the government regulates and disasters strike. There are many forces that you can't avoid with research. Diversification offers us a defense against the unexpected.

Diversification means distributing your funds among investments with different characteristics. How does this help? In the event that disaster strike diversification helps to limit your losses.

There are many different aspects of diversification you should consider.
Industry diversification - If I invest in Intel and AMD I've chosen two different stock but there are many cases where the stocks will react the same. In this case perhaps a totally new computer technology that renders both companies useless. I avoid having more than 20% of my funds in any one industry.

Investment class diversification - All too often people have a majority of their net worth in the equity of their home.

Job diversification – Be very careful investing in the company you work in. There are many good reasons to invest in the stock of your employer, but you need to strictly limit these investments. If your company experience problems you could lose your job and your investment.

Size diversification – There is a tendency (much less than for a stock's industry) for stock of the same size to trade together.

Diversification is not much more than common sense, "Don't put all your eggs in one basket." But you ignore this principle at your peril. If you aren't diversified a single unexpected event can wipe out all your hard work. Luckily it is both inexpensive and easy to diversify.

Good luck,
Scott

Moving Your 401k When You Leave

When you leave a company with a 401k plan you have to decide what to with that money.

You could leave it where it is. This may not be your best option. I've rarely heard of 401k plans with a great choice of low fee, high performance funds.

You could roll it over into a 401k with your new employer. If the new employer has a great selection of low fee, high performance investments that you like there is no harm. Again, I haven't heard of very many cases like this.

You can also roll your 401k over into an IRA. This is what I have done. This lets me choose what company I'm dealing with and allows me to invest in a very broad range of mutual funds and stocks. I like the flexibility and good performance this option gives.

If you do elect to roll over your account to an IRA make sure you roll it over to a new IRA account and you don't put any other IRA contributions into that account. Why? If you do this you are likely eligible to roll this money back into a 401k at a later time. You may decide to do this because some 401k plans allow you to borrow against your plan. This can come in handy in certain situations like dealing with a significant health problems or paying your children's college bills.

For Your Reading Pleasure

There is a great weekly collection of personal finance blog entries that rotates around various blogs. It is called the Carnival of Personal Fiannce. This week's entry was at My Money Blog.

Enjoy.

Savings/Money Market Account Rates

Over the past few years interest rates have been abysmal. I was opening a checking account a few years back and was asked if I wanted to open an account. I said no. A few minutes later she asked why I decided not to. I told her that the rate was probably about 1% and that just wasn’t interesting. She lauhed me off “You are so cute, it is only 0.4%”.

Now, thanks to the fed raising rates, we have a few enterprising institutions offering good rates (so long as inflation stays reasonable).

As of this writing a few of the better looking ones are:
Emigrant Direct has a 4% rate.
My Banking Direct also has a 4% rate. It looks like there terms and restrictions are a bit more onerous like a $5000 minimum to get the rate.
ETrade and INGDirect had promising rates but they seem to have fallen off for now.

It is important to remember that these account types are still only appropriate for short term reserves.

As always you should thoroughly research these yourself. There can be many gotchas in the fine print.

Don't Get Fooled by Winning or Losing

In 1999 everyone was a great investor. The NASDAQ zoomed through the roof. Yesterday everything was ugly. Today was great. Did I do a lousy job yesterday and a great one today? No.

When I first started investing in stocks I picked five companies. I didn't know nearly enough about investing or the companies I was investing in. I don't remember all the details this many years later but two of the five stocks I bought were Amazon and StorageTek. I bought Amazon because I used their service and it was great! I bought StorageTek because I was in the industry and saw the explosion coming in data management. I worked with StorageTek products and they were well built and technically solid products.

I made money, lots of money, in Amazon. I invested about $800 in each of the stocks and several years later I took out several thousand dollars to put a down payment on a house.

I was lucky. I work hard to earn my money. I put far less thought and effort into my decision to plop down $800 on Amazon than I did when I bought a $70 microwave.

Don't get me wrong, I'll take luck when it comes my way.

But spend some time researching your investments. You don't have to be a guru or a math wiz to get started. Try MSN's Research Wizard. It will guide you through much of what you need to know.

And above all, whether you make money or lose money, think about what went right and what went wrong. Just because you made a lot of money doesn't mean that you did the best you could. Just because you lost some money doesn't mean there wasn't merit in your work. Always be intellectually honest and examine why you ended up with a win or a loss.

Gap Insurance, From Your Lender?

I previously posted on the gap insurance my dealer offered when I was purchasing my car. I finally got around to signing the loan documents yesterday. I was pleasantly surprised that they included something called “Total Loss Protection”. What is it? It looks a lot like gap insurance to me. Who did I get me loan from? USAA. Definitely add your lender to the list of places you look for gap insurance.

Why is Saving Such a Difficult Thing to do?

Why does saving seem to be such a difficult thing to do?

Personal Finance Advice offers up a few ideas ranging from the friction with commercial messages to the difficulty of giving up on things we enjoy.

I think those points are valid. Additionally I think that there is often a lack of balance. There is a lot of focus on giving up. Give up eating out. Give up buying a new car. Give up coffee. Give up cable tv. … There is nothing at all wrong with these suggestions. I applaud those that execute on them. Sharing these ideas sparks my thinking.

I also must realize that I must cope with my own mind.

I need to understand what I am going to achieve.

I need to weigh this against what I’m giving up.

I’ve failed too many times by setting a goal that causes me to give up something too dear for a gain that is either too nebulous or too small.

Strike a balance. It is not: give up. give up. give up.

Always understand the reason that you are saving. If you are just giving on something without understanding the reason you are making your life very difficult.

Try to make your goal concrete. Reaching retirement might be too abstract a motivation to compete with the latest model car. Make your goal more real. Something like sitting on a beach in the Caribbean on a sunny, breezy day.

Be creative. Like golfing? Don’t give it up. Try to find a way to do it less expensively. If you really like it think of another way to save money that impact your quality of life less. Better yet find a way to do more of what you like for less money. Like rock climbing? Could you buy some used gear and go climbing outside instead of paying $30 to a rock gym?

There is more to life than money. Find a way to balance your savings with your happiness and I think saving will be much easier.

New or Used?

Of course there are those that suggest not buying a new car. The Millionaire Next Door supports this view. Seems millionares simply don't waste money on buying new.

I hate car trouble. I hate taking the car in for regular service. Because of that I wasn’t comfortable buying a used car on the open market. I looked at the various certified pre-owned programs. While they were mostly impressive in terms of protection they just didn’t offer the cost savings I was looking for. A 5 year old 70,000 mile car is worth less than a new car for a reason. You have to consider wear, the more limited warranty and of course the uncertainty of what the vehicle has actually been through.

I tried to buy a car that can last a decade. We will see!

True cost of owning a car

Nickel gives a pointer to the edmunds.com TCO reports. In my case these didn't help much since the Civics just came out. But if you are looking at a more established car or are looking later in the year these promise to be helpful.

Dealer Gap Insurance

One of the many things I was offered as I was trying to get the deal closed was gap insurance. Gap insurance makes up the different between what you owe on your loan and what your insurance company will actually pay you if you have a claim. In my case if my car was totaled or stolen I might be out $2000 for the lost value in the car (depreciation) $1000 for the deductible and $2000 for the taxes (I financed everything).

The dealer offered me gap insurance for $1600. Is this a good deal or not?

The quick answer that I had from how hard it was pushed was absolutely not. There is a way to look at this that gives you a better idea than just a gut feel. There is a little math but I promise you it is very simple.

Case 1: The car is stolen or totaled
I’m out $2000 for the difference between the cars value at what a new one costs.
I’m out $1000 for the deductible.
I’m out the $2000 I spent on taxes.
Outcome: -$5000

Case 2: The car is not stolen
Outcome: $0

Case 3: The car is stolen or totaled with gap insurance
I’m out $2000 for the difference between the cars value at what a new one costs.
I’m out $1000 for the deductible.
I’m out the $2000 I spent on taxes.
I spend $1600 on the gap insurance.
The gap insurance pays me $5000
Outcome: -$1600

Case 4: The car is not stolen with gap insurance
I spend $1600 on the gap insurance.
Outcome: -$1600

So now we need to decide what the chance of totaling the car or having it stolen are. I don’t know the statistic but I’m sure it is not more than a 5% chance.

Expected result = Chance of occurring * value (for each outcome)

For gap insurance we have:
Expected result = 5% * -$1600 + 95% * -1600 = -$1600

Without the gap insurance we have:
Expected result = 5% * -$5000 + 95% * 0 = -$250

First note that you will always come up with a negative number when doing these insurance expectations since you are paying the insurer to pay their staff, make a profit etc.

Second this is only an example. I didn’t bother with the details of this policy since it looked so bad. Be sure to carefully check the details of any insurance policy. You’ll be pretty upset if you pay for gap insurance, incur a loss, and they have an exclusion preventing you from collecting.

Finally check around. Your financer or insurance company probably has a far better deal than the dealer will give you.

Buying a Car

I just bought a 2006 Honda Civic. The experience was well, interesting. The Civic is redesigned this year. I would have been happy to get one for MSRP, but many of the dealers here in San Diego were quite adamant about marking up the cars by $2000 and then adding on $1000 of useless options (you can buy at an auto parts store retail for just a shade over $100). I probed some of the salesmen about these markups and they didn’t really seem interested in moving.

I finally decided to make the move. I was determined to get the car I wanted for less than MSRP. I took in looked at Edmunds to get an idea of what people were paying at what the dealer invoice was.

I found a dealer that was not insisting on the $2000 markup that had a car in a color that was suitable. After test driving the car I grabbed my Edmunds papers and loan paper work*. The car still had the $1000 of typical options. To give you the full numbers:
Invoice: $16,800
MSRP: $18,700
Options: $1,000
Asking price: $19,700

My goal was to beat the MSRP by at least $100. I opened the negotiation at $18,400. There was talk and talk about the worthless options. Finally, after repeatedly expressing the utter worthlessness of the options, I pressed the salesman for his response. MSRP! No we are getting somewhere! I offered to split the difference with him or leave. He accepted: $18,550. I hit my goal.

My thoughts:
• I beat my goal, but I don’t think the goal was aggressive enough.
• Don’t pay for something you don’t want unless it is somehow to your advantage.
• Research pays. I quoted him invoice from memory and had the paperwork to back it up. I think this undercut a substantial amount of gamesmanship.

To follow:
• Get financing you can trust.
• How far would you go to get what you want?
• The dreaded sales manager.

*I had prearranged this. More on this subject later.

Welcome

There is so much advice that is given by so called experts on financial matters that is, well, garbage. I’ll share my experiences and thoughts here to hopefully give your financial goals a boost.

I’m a software developer in beautiful San Diego, California. I have quite a ways to go to reach my goal of total financial independence. I look forward to sharing what I learn along the way.

Enjoy.

-Scott

Scott On Money

October 30, 2005

Where are Housing Prices Going?

Using Index Funds

October 24, 2005

Diversify

October 22, 2005

Moving Your 401k When You Leave

For Your Reading Pleasure

October 21, 2005

Savings/Money Market Account Rates

October 19, 2005

Don't Get Fooled by Winning or Losing

October 16, 2005

Gap Insurance, From Your Lender?

October 14, 2005

Why is Saving Such a Difficult Thing to do?

October 13, 2005

New or Used?

October 12, 2005

True cost of owning a car

Dealer Gap Insurance

October 11, 2005

Buying a Car

Welcome