Investing Curiouscatblog

Category: Financial Literacy

  • Predatory Lenders’ Partner in Crime

    Predatory Lenders’ Partner in Crime by Eliot Spitzer

    For 140 years, the OCC examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers.

    In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government’s actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.

    But the unanimous opposition of the 50 states did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation.

    It is unfortunate when the federal government chooses to strip states of the ability to protect citizens.

    Related: Credit Freeze Stops Identity Theft Cold – Investor Protection Needed

  • 401k’s are a Great Investment Option

    The title of a recent article asks: Are you a sucker to invest in a 401(k)? The answer is an emphatic: No.

    Let’s say you put $10,000 in your 401(k) and invest in a stock-index fund that earns an average of 8% a year. After 20 years it will be worth $46,610. Withdraw the money all at once and you’ll pay $13,051 in taxes, assuming you’re in the 28% bracket, leaving you $33,559 to spend.

    But what if instead you had bought that tax-efficient stock fund outside your plan? Wouldn’t your tax bill be lower? Yes, but that’s the wrong way to look at it. If you skip your 401(k) in favor of a taxable account, you must first shell out taxes on that $10,000, which leaves you with just $7,200 to invest (assuming the same 28% bracket).

    Plus, over the next 20 years, you’ll have taxes on any dividends and gains the fund pays out. Even though you will get a lower 15% rate on your gains when you sell, you end up with $28,950, or about $4,600 less than with the 401(k). A tinier final tax bill can’t make up for having to pay taxes all along.

    This is a very good short simple personal finance article. It explains an issue that might be tricky for some to understand. Those that read it can learn more about personal finance. And it has several points – some of which, I can imagine, might be hard for some to understand. But it does a good job of explaining things simply. And a few points, made well in the article, are often overlooked or under-appreciated:

    tax rates will go up – we are passing higher taxes onto the future by not paying our bills now
    the tax deferral is a huge benefit – often minimized when people discuss the benefits of IRAs
    401(k) employer matches are another huge benefit

    As I have said before, learning about personal finance is a long term effort. If you don’t understand everything in an article that is fine, over the years you want to learn more and more. Hopefully this is a useful step on that journey.

    Related:
    Roth IRAs a Smart bet for Younger Set     – Saving for Retirement

  • Jumbo and Regular Mortagage Rates By Credit Score

    Example 30 year mortgage rates (from myfico.com – see site for current rate estimates). We have posted twice on this previously – August 2007 – May 2007. Since then rates have decreased on 30 year fixed mortgages but jumbo rates have increased significantly.

    FICO score APR May 2007 APR Feb 2008 – regular APR Feb 2008 – jumbo payment/mo May 2007 payment/mo Feb 2008 – regular payment/mo Feb 2008 – jumbo
    760-850 5.86% 5.53% 6.61% $2,362 $2,278 $4,476
    700-759 6.08% 5.75% 6.83% $2,419 $2,525 $4,579
    660-699 6.37% 6.04% 7.12% $2,493 $2,335 $4,713
    620-659 7.18% 6.85% 7.93% $2,709 $2,620 $4,373
    580-619 8.82% 9.22% 9.40% $3,167 $3,282 $5,834
    500-579 9.68% 10.20% 10.37% $3,416 $3,568 $6,336

    Amounts shown for borrowing $400,000 and rates as of Feb 18th (and May 2007). Jumbo payments are based on $700,000. Previously I could see the assumptions on the site which were (but I see no details on the calculated amounts as of Feb 2008): For scores above 620, the APRs above assume a mortgage with 1.0 points and 80% Loan-to-Value Ratio. For scores below 620, these APRs assume a mortgage with 0 points and 60 to 80% Loan-to-Value Ratio.
    (more…)

  • Sneaky Fees

    The use of sneaky fees by service companies is growing

    It’s a phenomenon that Bob Sullivan, who runs the consumer blog “Red Tape Chronicles” for MSNBC, calls “Gotcha Capitalism” – the title of his recent book, which catalogues the growing use of sneaky fees by service companies from banks to hotels to airlines:

    In early February, United Airlines began to charge customers $25 for an extra bag. Some rental car companies charge an airport concession fee if the lot is conveniently located near the airport. A hotel in Las Vegas now bills customers for any item they take out of the minibar for more than 60 seconds, even if it is not consumed. Some bank gift cards lose part of their value if not used by a certain date.
    …
    banks collect up to a 3 percent processing fee for third-party credit transactions. Most of that 3 percent is called the “interchange fee.” That fee has outraged merchants in continental Europe, where credit card use is sparse and consumers are accustomed to debit cards. In December the European Commission won a case against Mastercard that requires it to eliminate interchange fees within the next six months.

    As I have mentioned before the problems of bad practices by financial companies and the unfortunate truth that they force you to be on guard against them tricking you and taking your money. The Curious Cat credit card tips page provides advice on how not to get tricked by credit card companies into paying big fees along with some other tips.

    It a shame financial companies don’t seem to believe in providing an honest service and making a profit as part of provide good value. Instead you have to watch them with the belief they will take you money if they can trick you (through hidden fees, misleading ads…). And it is sad other companies are expanding such anti-customer methods to other markets.

    Related: Credit Card Currency Conversion Costs – Bad Practice: .05% Interest – Customer Hostility from Discover Card – Challenge Those Credit Fees

  • Covered Call Options, etc.

    Options are a tool that investors can use within their portfolio in various ways. They can be used to speculate and they can be used to provide a bit of extra income (with the cost of potentially losing big gains). Mainly they are for more sophisticated investors. Form the Curious Cat Investing Glossary – Stock Options:

    For example, if you own 100 shares of Cisco you could sell a covered call option giving someone the right to buy your shares at a specific price by a certain date. So, for example, they pay you $200 for the right to buy you 100 shares at $1 more than it is selling at right now anytime in the next 2 months. They might chose to do so, in order to leverage their investment as it only cost them $200 to benefit from the rise of 100 shares of Cisco. Of course, if it doesn’t go up in 2 months you benefit because you get to keep the cash and your stock.

    Selling covered call options allows the investor to earn a bit of extra money but they will lose out if the stock shoots up as then the investor that bought the option can buy your shares at the agreed to price even if it now is $5 a share more. Read more on options including naked puts, naked calls…

    Employees may receive options to buy company stock at a Company’s stock at a set price for several years in the future. In general, those options cannot be traded on the market (the employee must keep them or exercise them – pay the strike price to purchase the stock). Why are options such a nice perk if you must pay the strike price? Because they are often good for years and the strike price is set at today’s price (though this doesn’t have to be the case). On the whole stocks go up over time so most of the time the stock will increase in value over the years and the options to buy it at the price several years ago is very valuable. For startup companies, there is often a high likelihood of going out of business in which case the options are worthless, but if the company is successful the options can be worth a great deal.

    Related: Hedging an investment – Books on Speculation with Investment – Google to Let Workers Sell Options Online

  • Starting Retirement Account Allocations for Someone Under 40

    One of the most important financial moves you can make is to start investing for your retirement early. This post is directed at those in the USA (but you can adjust the ideas for your particular situation). Retirement accounts with tax free growth, tax deferred growth and/or even tax deductible contributions can add to the benefits of such an investment. And matching by your company can give you an immediate return or 100% or 50% or some other amount. With 100% matching if you invest $2,000 your company adds $2,000 to your retirement account. For 50% they would add $1,000 in the event you added $2,000.

    In other posts I will cover some of the other details involved but some people can be confused just by what investment options to chose. Normally you will have a limited choice of mutual funds. Hopefully you will have a good family of funds to choose from such as Vanguard, TIAA-CREF, American, Franklin-Templeton, T.Rowe Price etc.). If so, the most important thing is really just to get started adding money. The details of how you allocate the investment is secondary to that.

    So once you have made the decision to save for your retirement what allocation makes sense? Well diversification is a valuable strategy. Some options you will likely have include S&P 500 index fund, Russel 5000 (total market index – or some such), small cap growth, international stocks, money market fund, bond fund and perhaps international bonds, short term bonds, specialty funds (health care, natural resources) long term bonds, real estate trusts…

    Just to get a simple idea of what might make sense when you are starting out and under 40 and don’t have other substantial assets in any of these areas (large mutual fund holdings, your own house, investment real estate…) this is an allocation I think is reasonable (but don’t take my word for it go read what other say and then make your own decisions):

    25% Total stock market index (~Wilshire 5000)
    25% international stocks
    20% small cap stocks
    10% real estate
    10% high quality short term bonds in a Euros, Yen…
    10% short term bonds (or money market)
    (more…)

  • You Don’t Need an Extended Warranty

    Why you don’t need an extended warranty, Consumer Reports:

    Retailers are pushing hard to get you to buy extended warranties, or service plans, because they’re cash cows. Stores keep 50 percent or more of what they charge for warranties. That’s much more than they can make selling actual products. For the consumer, extended warranties are notoriously bad deals because:

    – Some repairs are covered by the standard manufacturer warranty that comes with the product
    – Products seldom break within the extended-warranty window–after the standard warranty has expired but within the typical two to three years of purchase–our data show.
    – When electronics and appliances do break, the repairs, on average, cost about the same as an extended warranty.

    Related: Save Money on AV Cables – Shop Around for Drugs – Real Free Credit Report

  • Why Americans Are Going Broke

    Why Americans Are Going Broke

    The average household owes 20 percent more than it makes each year. The personal savings rate is in negative territory. Record numbers of Americans are losing their homes to foreclosure, and millions more are struggling to keep up with their monthly bills and obligations. And the nation’s economy isn’t in much better shape. The Treasury Department has estimated that, with the added costs of the economic stimulus plan passed by the House of Representatives this week in an effort to avoid a recession, the federal deficit could rise to as much as $400 billion this year.

    I would say why Americans are going broke is pretty simple: they buy loads of stuff they can’t afford and don’t need. And the political leaders promote this get another credit card mentality of “budgeting”. This stuff is not that tricky. Don’t borrow what you can’t afford. Save money. Don’t buy frivolous stuff that you can’t afford and don’t really provide you value.

    Related: USA Federal Debt Now $516,348 Per Household – Saving for Retirement – Financial Illiteracy Credit Trap – Earn more, spend more, want more

  • Federal Funds Rate and 30 Year Fixed Mortgage Rate

    I have update my article showing the historical comparison of 30 year fixed mortgage rates and the federal funds rate. When deciding whether to lock in a rate for a 30 year fixed rate mortgage (when refinancing or buying a new home) some believe moves in the federal reserve discount rate will raise or lower that mortgage rate directly. This is not the case, in general. The effect of federal reserve discount rates on other mortgage rates (such as adjustable rate mortgages is not the same and can be predictably affected by fed fund rate moves).

    The chart shows the federal funds rate and the 30 year fixed rate mortgage rate from January 2000 through December 2007 (for more details see the article).

    30 year fixed mortgage rates and the federal funds rate 200-2007

    There is not a significant correlation between moves in federal funds rate and 30 year mortgage rates that can be used for those looking to determine short term (over a few days, weeks or months) moves in the 30 year fixed mortgage rates. For example if 30 year rates are at 6% and the federal reserve drops the federal funds rate 50 basis points that tells you little about what the 30 year rate will do. No matter how often those that should know better repeat the belief that there is such a correlation you can look at the actual data in the graph above to see that it is not the case.
    (more…)

  • Municipal Bonds – After Tax Return

    In the USA Municipal bonds are issued by state and local governments and are exempt from federal tax. Therefor if you earn a 5% yield your after tax return is equal to that of a 7.5% yield if you are in the 33% federal tax bracket (7% * .67 = 5%). One way to invest in bonds is using a mutual fund (open or closed end funds). Right now the tax equivalent yields (compared to other bonds) of muni bonds are higher than normal.

    Muni Bond Funds Offer High Yields, Tax Perks Dec, 2007:

    take a look at closed-end mutual funds that invest in high-quality municipal bonds. It’s easy to find a solid national muni fund that pays a yield of between 5.5% and 6%, with no federal taxes at all. It depends on your tax rate, but that’s the equivalent of a taxable fund that pays 7.5% to 8%.
    …
    With so many defaults going on in the mortgage arena, investors are worried that the insurers won’t be there to back up any munis that might get into trouble. A fair point, but the bond insurers are bolstering their own capital structures to deal with these concerns, and historically, as I said before, defaults in munis are few and far between.

    Why are closed-end muni funds trading at a discount? Typical discounts today are about 10%, which is about as deep as such discounts have ever gotten on a historical basis. The typical discount is half that, or less. Closed-end muni funds sometimes even trade at a premium.

    One explanation for the big discount might be the fact that many closed-end muni funds use leverage, in order to increase the tax-exempt returns they can offer investors. In the current credit crisis, leverage is seen as an inherently dangerous thing.

    In general I find bonds to be a less desirable investment. Especially in the low yield environment recently (and really going back quite a few years). But for diversification some bonds can make sense for certain portfolios. Given the current tradeoffs (risk v. after tax yield) muni bonds certainly deserve consideration. I would shy away from long term bonds or funds (intermediate or short term) but of course every investor makes their own decisions.

    Related: Roth IRA (another good tax smart investing tool) – what are bonds? – Alternative Minimum Tax