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  • 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

  • Top 10 Manufacturing Countries 2006

    Here is updated data from the UN on manufacturing output by country. China continues to grow amazingly moving into second place for 2006. UN Data, in billions of current US dollars:

    Country 1990 2000 2004 2005 2006
    USA 1,040 1,543 1,545 1,629 1,725
    China 143 484 788 939 1096
    Japan 808 1,033 962 954 929
    Germany 437 392 559 584 620
    Italy 240 206 295 291 313
    United Kingdom 207 230 283 283 308
    France 223 190 256 253 275
    Brazil 117 120 130 172 231
    Korea 65 134 173 199 216
    Canada 92 129 165 188 213
    Additional countries of interest – not the next largest
    Mexico 50 107 111 122 136
    India 50 67 100 118 130
    Indonesia 29 46 72 79 103
    Turkey 33 38 75 92 100

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  • Politicians Again Raising Taxes On Your Children

    So yet again everyone in Washington DC wants to raise taxes on your children and grandchildren to spend money today. We might be going into a recession because the bubble of financing real estate led to people spending money they couldn’t pay back. So now home construction is decreasing, banks are having trouble meeting within capitalization requirement without huge inflows of capital from abroad, excess housing supply…

    The government has been spending huge amounts of money it doesn’t have for a long time. So what great ideas do our leaders have: put more burden on the children and grandchildren to pay for our spending today. What a sad state of affairs. And almost no-one seems to question this behavior.

    Is the idea that we would go into a recession so remote these leaders never imagined it could happen? No, of course they new it would happen. So what should a country, company, individual do if they know they have some expected event in the future they might want to spend money on? This isn’t really tricky. I would guess many 8 years olds understand the concept. You put the money in the piggy bank for when you will want to spend it.

    If you decide to spend not only all the money you have but borrow huge amounts that will tax your future earnings to pay back your current spending that is your choice (as long as you can find someone to lend you money). But as many parents have told their kids you have to live with the decisions you make. You don’t get to spend your money today. Spend tomorrows money today. Spend your kids money today. And then when, tomorrow comes, just spend all that money all over again. How can a country allow leaders to so transparently tax the future of the country?

    It is a sad state of affairs. The country chooses not to sent aside funds for obvious future needs. Then instead of accepting the hole they have dug for themselves decides to tax their children even more to continue the spendthrift ways. I think we not only need to have politicians actually read the bills before they vote (they refuse to pass such a law) they need to read about the ant and the grasshopper.

    I have no problem with the country choosing to set aside funds to use when they want to try and stave off a recessions (to pay for tax cuts or more spending). I do have a problem with: running enormous deficits every year, raising taxes on our children and grandchildren year after year, and then deciding to raise taxes even more on the future when the obvious happens and perfectly predictable desired expenditures present themselves. The get another credit card school of financial management (that everyone in Washington DC seems to practice) is not workable for a country over the long term. As anyone that has used that strategy personally will tell you – it works for awhile but eventually there are serious consequences.
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  • 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

  • Philanthropy on a Large Scale

    Warren Buffett and Bill Gates are two of the richest people on the planet (though many are gaining on them recently). Both have pledged to give away nearly all (over 99%) of the money they have earned to charity. Both have spoken out against the harm to children and society (and the capitalist system) when huge wealth is provided by lottery of birth to a few instead of provided to those who earn the money.

    Melinda Gates goes public

    Ray French, Melinda’s dad, stretched their budget to pay for all four children to go to college. An engineer, he started a family business on the side, operating rental properties. “That meant scrubbing floors and cleaning ovens and mowing the lawns,” Melinda recalls.
    …
    Melinda and Bill will very likely give away more than $100 billion in their lifetimes. Already the foundation has disbursed $14.4 billion – more than the Rockefeller Foundation has distributed since its creation in 1913 (even adjusted for inflation).
    …
    Bill, who is nine years older than Melinda, plans to spend more than 40 hours a week on philanthropy, leaving 15 or so for his duties as chairman of Microsoft.
    …
    Early on she and Bill agreed to focus on a few areas of giving, choosing where to place their money by asking two questions: Which problems affect the most people? And which have been neglected in the past? While many philanthropists take the same tack, the Gateses, who love puzzles, apply particular rigor. “We literally go down the chart of the greatest inequities and give where we can effect the greatest change,” Melinda says. So while they don’t give to the American Cancer Society, they have pumped billions into the world’s deadliest diseases – most importantly AIDS, malaria, and tuberculosis – and failing public high schools in the U.S.

    Charity is important. As is understanding that capitalism is about people earning their wealth not getting it from Mom and Dad. Unfortunately many politicians don’t know what capitalism is and think that providing huge inheritances to some kids of rich people is capitalism. Providing resources to those that didn’t earn them is the opposite of capitalism. They need to learn. If they oppose capitalism and would rather assure the kids of the rich get huge inheritances that is fine, they just shouldn’t get away with claiming they support capitalism.

    Related: Estate Tax Repeal (a very bad idea) – Helping Capitalism Make the World Better – charity links – Multi-millionaires giving to charity not creating later day idle nobility

  • 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

  • Emerging-market Multinationals

    It is not your parents world. In case you hadn’t noticed the economic power in the world has been changing quickly. Many are missing the magnitude of these changes. One visible example is explored by the Economist in Emerging-market Multinationals:

    By 2004 the UN Conference on Trade and Development (UNCTAD) even noted that five companies from emerging Asia had made it into the list of the world’s 100 biggest multinationals measured by overseas assets; ten more emerging-economy firms made it into the top 200.
    …
    By 2006 foreign direct investment (including mergers and acquisitions) from developing economies had reached $174 billion, 14% of the world’s total, giving such countries a 13% share (worth $1.6 trillion) of the stock of global FDI. In 1990 emerging economies accounted for just 5% of the flow and 8% of the stock.

    This is just one visible sign of shifting economic power. And it shows no sign of slowing down. Our 12 Stocks for 10 Years portfolio is heavily invested for overseas growth. Close to 20% directly in emerging markets (through Templeton funds). PetroChina, Google, Toyota and Tesco all are very well positioned to grow quickly in emerging markets. And other stocks are likely do do well too – I am not clear on how well Pfizer, Amazon and Dell are positioned at this time.

    Emerging stock markets will continue to be very volatile I believe. However looking decades out and at a pool of 20 countries it is hard to imagine they won’t do very well: China, Singapore, Mexico, India, Thailand, Brazil, South Africa, Vietnam, etc.

    Related: Growing Size of non-USA Economies – Why Investing is Safer Overseas – South Korea To Invest $22 Billion in Overseas Energy Projects – Changing Economic Clout and Science Research

  • Home Values and Rental Rates

    One way to evaluate the real estate market is to compare rental rates to home values. This can provide a comparison of an approximate cost of buying a house versus the cost to rent. As the ratio of monthly rent to home price increases, at least on this measure or real estate value, the market can be seen as becoming more expensive.

    Several points to keep in mind:

    1. This does not take into account things like tax rates (in higher tax areas the rents will be higher [since the owners will pass on that cost that is not reflected in the home price] – the ratio lower)
    2. This is only a comparison measure – it can be that rents also experience a bubble. So if rents experience a bubble then the ratio could stay low and fail to indicate an “expensive” market.
    3. Don’t rely on one measure – this is one useful measure there are plenty of others that matter for real estate prices (income levels, job growth, interest rates, zoning regulations…)

    The Rent-Price Ratio for the Aggregate Stock of Owner-Occupied Housing

    We show that the rent-price ratio ranged between 5 and 5-1/2 percent between 1960 and 1995, but rapidly declined after 1995. By year-end 2006, the rent-price ratio reached an historic low of 3-1/2 percent. For the rent-price ratio to return to its historical average over, say, the next five years, house prices
    likely would have to fall considerably.

    This paper is well worth reading. I would like to point out another factor here though. When those investing in real estate were focused largely on capital gains (say a few years ago) there could well have been an increased demand for rental property (which increased prices). That effect also moved extra supply into the rental market (that previously would have been sold to owners that would live there instead of investors). Those investors were more concerned with capital gains and it seems to me could well have been willing to accept lower rents just to have some cash coming in to help pay the expenses.

    As those investors no longer believe they will receive large capital gains in the short term it is possible they will be more focused on cash flow – and seek increased rents. I will not be surprised that rent prices increase as investors focus more on cash flow and stop assuming such large capital gains will be where their profits are made. Thus the ratio will close both by real estate value declines and rental price increases.

    Related: Explaining Rent-Home Price Ratios – True Rent-to-Price Ratio for Housing – articles on the real estate market – Real Estate Median Prices Down 1.5% in the Last Year – Rent Controls are Unwise