Investing Curiouscatblog

Category: Personal finance

  • 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.
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  • 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

  • Shorting Using Inverse Funds

    Shorting is selling first and buying later. The idea is to sell high and then buy low. It can be a bit risky. Since there is no cap on how high a stock can go you can loose more than you invest. Still, as part of a portfolio, using short positions can possibly be a useful strategy at times. You can use shorting to do things like hedge against existing gains (without selling those positions and incurring taxes).

    Business Week had an article on Shorting for the 21st Century using inverse funds. These are mutual funds that are structured to behave as short positions – that is to go up if the target portfolio goes down in value. One advantage of using these funds (at this time they are all ETFs – exchange traded funds, I believe) is that you losses are limited to your investment. You do incur additional expenses charged by the fund however.

    Experienced investors may find value in exploring the use of inverse funds. Some funds are engineered to move 1 for 1 with the market (that is the fund increases 1% for every 1% decline in the index) and some are engineered to move up 2% for every 1% decline – which also means they go down 2% for every 1% gain in the actual index. Index funds can also be used in retirement accounts (where shorting is not allowed).

    Most investors need much more experience and to do a great deal of reading before they would be ready to try these funds. Since markets general go up over time and timing the market is extremely difficult it is unlikely novice investors will succeed in trying to guess right. The usefulness is mainly as a hedging strategy when the investors has determined the portfolio could benefit from a partial hedge.

    Related: Risk and reward of exposure – investment speculation books – Ignorance of Many Mortgage Holders – The Greatest Wall Street Danger of All? You – How Not to Convert Equity

  • Your Home as an Investment

    A house is where you live–not an investment

    If you’re living in the house you plan to live in for the rest of your life, you shouldn’t view it as an investment.

    Very good point – as long as you fall into that category of living there until you die. True for some people but far from all. Also, even for those people, it is not a complete view of the financial situation.

    A reverse mortgage will allow you to sell the house and get paid for the rest of the time you live there. So you can build up equity over 20,30,40 years and then take a reverse mortgage and get payments every month (based on your investing in your house). Reverse mortgages, like many financial tools, can be applied poorly and is I would guess unethical behavior related to them is fairly high (so be very careful!). If you think of such an option you need to do your research and actually understand what you are doing – you can’t afford to be like the many ignorant mortgagors. The AARP offers information on Reverse Mortgages.

    Additionally, you lock in a large part of your housing cost (you still have maintenance and taxes but you do not have every increasing rent. Now ever increasing rent is not a certainty but for many it is very likely rent will go up on average over the long term. Ownership of your home removes the risk of being priced out of the area you want to live by increasing rental prices over time. You also lose the potential of benefiting if rent prices fall over time, but I would say the more valuable of those options is avoiding the risk of rising rental prices.

    Related: How Not to Convert Equity – Housing Inventory Glut – articles on home ownership and real estate

  • The Ever Expanding House

    Behind the Ever-Expanding American Dream House

    The average American house size has more than doubled since the 1950s; it now stands at 2,349 square feet. Whether it’s a McMansion in a wealthy neighborhood, or a bigger, cheaper house in the exurbs, the move toward ever large homes has been accelerating for years.

    Consider: Back in the 1950s and ’60s, people thought it was normal for a family to have one bathroom, or for two or three growing boys to share a bedroom. Well-off people summered in tiny beach cottages on Cape Cod or off the coast of California. Now, many of those cottages have been replaced with bigger houses. Six-room apartments in cities like New York or Chicago have been combined, because upper-middle-class people now think a six-room apartment is too small. Is it wealth? Is it greed? Or are there more subtle things going on?

    This is extreme wealth. It is also part of the reason housing prices take an ever increasing multiple of median income. Basically people are buying two houses (not just one). Average square footage of single-family homes in the USA: 1950 – 983; 1970 – 1,500; 1990 – 2,080; 2004 – 2,349.

    Related: mortgage terms defined – Trying to Keep up with the Jones – Too Much Stuff – Investing Search Engine

  • Bad Practice: .05% Interest From a Stock Broker

    Unfortunately it is not uncommon to find companies that choose to line their pockets at the expense of customers. I wish we could find companies that want to provide good value and make some profit by doing so. My stock broker used to allow clients idle cash to be invested and earn a reasonably decent rate (not Vanguard money market fund but you know for a company that doesn’t want to provide the best customer value a least something remotely approaching fair). This year (or last year) they stopped doing so and switched to the following rate structure:

    Dollar Range Interest Rate Annual Percentage Yield
    $0.01-$4,999 0.04999% 0.05%
    $5,000-$24,999 0.04999% 0.05%
    $25,000-$99,999 0.29959% 0.30%

    You might think they make an error and mean 5% and just put the decimal in the wrong place but you would be wrong. It used to be leaving your money in money market accounts with the broker wasn’t great but the 50+ basis point hit was worth the convenience. Now HSBC pays 4.25% for online savings. So at 100 times what the broker pays they would be slightly higher than HSBC. Sorry paying 1/85 of what HSBC pays is not just talking a bit of your clients money for yourself. That is obscene. You can no longer trust that your stock broker will only talk 50+ basis points of you money market earnings. Take a look at your account and setup an account with HSBC, Vanguard (current yield 4.64%) or something similar that pays a reasonable rate for any short term savings.

    If your broker pays less than 2% on a money market account of $5,000 that is a scary sign. What else they might be doing that isn’t so obviously unfair is difficult to know. Getting above 4% for a cash saving account now is pretty good, in my opinion.

    Related: Customer Hostility from Discover Card – Frugality Versus Better Returns – Learning About Personal Loans

  • Freezing Mortgage Rates

    “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.” J. Paul Getty

    Individual mortgage holders are in the first situation; together they are in the second.

    I want to look into this whole situation of freezing some adjustable rates (that are scheduled to increase for adjustable rate mortgages) more – because I don’t really understand what is actually involved in the “agreement.” But my impression is that the government is paying nothing, giving no other incentives (like reducing taxes owed). With that being the case I can’t see why some people think it is bad. some people are saying it is unfair to people that were careful They don’t get this benefit. That makes little sense to me. One of the things you have to learn about investing and personal finance is there are no guaranties. You enter into mortgages with your best guess about what will happen (as the lender or the one receiving the loan).

    From my very surface understanding of what is involved is that the government used some moral suasion to try and get lenders to step up and provide more favorable terms than originally agreed to. I not that confident such a think we end up happening in practice but I don’t have a problem with the attempt. It is an interesting case where no single mortgage holder owes enough to harm the lenders but together the class does hold enough to harm them. So the lenders have gotten themselves into a situation where the problem is not just one for the mortgage holders but one that could harm them (because they have too much lent to the class – risky residential mortgages).

    The risk of a cascading bad impact. One waive of foreclosures triggers another and another… Thus creating huge losses for lenders. For that reason it makes sense to me that if (which is a huge if) they class of lenders can all agree to sacrifice some to avoid starting the runaway cascade of foreclosures they may benefit. Of course each individual lender would likely benefit if just everyone but them sacrificed.

    It seems to me if there really is some significant amount of freezing of loan rates that will have a significant impact on how much harm the foreclosures do to real estate prices and the economy. And so I can see how such an agreement could benefit everyone. But as I say I really need to read more about all this. And I am skeptical that individual lenders will try to limit there sacrifices and as each cuts back there sacrifice the risk of the cascade increases.

    An actually bailout – government money paying off those that took bad financial risks I would be very reluctant to support.

    Related: How Not to Convert Equity – Housing Inventory Glut – mortgage terms explained – 30 year fixed Mortgage Rates – Homes Entering Foreclosure at Record – Ignorance of Many Mortgage Holders – Beginning of the End of Housing Bubble? (April 2004)
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  • Add to Your Roth IRA

    If you haven’t added money to your Roth Individual Retirement Account for this year yet – go ahead and do so now. Given the state of retirement planning for the vast majority of those in the USA there is a good chance your retirement is the area of your financial life that will most benefit from more resources. The other action that is likely worthwhile is to cut your spending but we will leave that for other posts.

    If your employer offers matching on your 401(k) or 403(b) that may well be an even higher priority. There is almost never a decent reason not to add at least 5% of your income to a retirement account matched by your employer. Make sure, as the amount grows above $100,000 that it is invested in a diversified manor (not all in the stock of your employer or…).

    For 2007 the most you can add to your Roth IRA or just IRA is $4,000 ($5,000 for those 50 years old or older). Next year that maximum increases to $5,000 ($6,000 for those 50 and up). If you have already added the maximum that is matched to your 401k and have added the maximum to your IRA for this year get ready to add the $5,000 to your IRA for 2008 in January (you do have to make sure you don’t earn too much to be eligible to add funds – pretty much you have to be over $100,000 in income, $150,000 on a joint return, before you have to worry but look up the details yourself). By adding the money to your IRA early in the year you will get another year or tax free growth (for the Roth or tax deferred growth from the regular IRA).

    For more details on the rules on IRAs see the links we provide on the Curious Cat Investment Dictionary IRA page.

    Related: Saving for Retirement – Roth IRAs a Smart bet for Younger Set – Our Only Hope: Retiring Later

  • Legislation to Address the Worst Credit Card Fee Abuse – Maybe

    Shining a Light on Card Fees

    Senior Democrats on Capitol Hill want to ban excessive credit card fees. Bank regulators are on the verge of forcing companies to give more notice before raising interest rates. And New York’s attorney general, whose investigations transformed the student loan industry, now has his eye on conflicts of interest in the credit card sector.

    After years of complaints about abusive practices that trap borrowers in an endless debt cycle, federal and state officials are shining light on the most controversial practices and preparing changes that would make card companies’ policies more consumer-friendly. The fight between consumer advocates and the banks that issue credit cards has been simmering for decades.

    I used to be surprised how badly the banks would treat customers and how little the government would do to prohibit abuse by banks and the like (those companies that pay the politicians huge amounts of money). However, I have seen how bad things have to get before the payoffs can’t prevent massive abuses from at least getting a decent hearing. But I also have learned you shouldn’t believe sensible legislation will pass if it, in any way, could be negative toward those paying large sums to politicians. It can happen but money the influence of payments is huge (which is pretty obvious and not at all surprising to anyone). Without factoring in huge payments it is hard to understand what is going on in Washington. If instead you look at who paid politicians and then see how they vote it is pretty clear why such abuse is allowed to continue for years.

    Related: Credit Card Tips – Hidden Credit Card Fees – Poor Customer Service from Discover Card – Lobbyist Assure Future Taxpayers Will Pay Taxes Private Equity Deals Avoid

  • Frontline Explores Kiva in Uganda

    Frontline World traveled to Uganda to explore the impact of microfinance and provide some great details on how Kiva is bringing economic opportunity to entrepreneurs. The site includes details and a nice webcast. It is great to see how people can connect directly using Kiva. And it is great to see how people can take small loans and some effort and financial literacy to make a living for themselves. The effort of these entrepreneurs to manage their finances would benefit many people in the rich world plan for retirement…

    As I have mentioned before, if you loan through Kiva send me a link to your Kiva page and I can add it to the Curious Cat Kivans page.

    Related: Make the World Better Using Capitalism – Helping People Help Themselves – Make the World Better – How Rich are You