Friday, November 30, 2007

Personal Finance Carnival 128 Features Home Finance Freedom's "Savers Are from Mars. Debtors Are from Venus. Episode 5"

Home Finance Freedom's "Savers Are from Mars. Debtors Are from Venus. Episode 5" was featured by the 128th Carnival of Personal Finance at Stock Trading To Go in an "Investment Truth" edition, along with a number of good articles from fellow PF bloggers. Thank you.

Sunday, November 25, 2007

Personal Finance Carnival 127 Features Home Finance Freedom's "Payoff Mortgage v. Invest Stocks: Housing Myths Part 12"

Home Finance Freedom's "Payoff Mortgage v. Invest Stocks: Housing Myths Part 12" was featured by the 127th Carnival of Personal Finance at Moolanomy with a "Wonders of the World" theme, along with a number of good articles from fellow PF bloggers. Thank you.

Saturday, November 24, 2007

Savers Are from Mars. Debtors Are from Venus. Episode 5

Turning Gold into Lead:
How To Lose $100k, and Your House, and Your Family

"Wendy's home had appreciated in value by about $100,000, only months after she and her husband bought it. So, they took out a second mortgage for almost $80,000 to enhance their new home. It was at 8% interest. When the housing bubble burst, that $100,000 in equity evaporated. But, the interest on that second adjustable rate mortgage by now had climbed from 8% to almost 16%, creating a monster of a monthly payment they couldn't handle. 'Then, it just gets pulled from right out underneath you.' Wendy says her marriage even broke-up over this. Now the couple faces possible foreclosure on the house" (KVOA).
Debtors often display this unfortunate tendency to turn even a $100k windfall into more debt, to eliminate increases in net worth, to eradicate any trace of even accidental equity.

Remember that the $100k was only a paper profit, not real wealth, because they did not sell the home at the high price (they ignored the basic, old "sell high" truism).

They ignored the chance to increase their income and instead increased their outgo (spending)--the opposite of basic financial advice to increase income and decrease outgo.

Wednesday, November 21, 2007

Avoid Holiday Travel Costs with Virtual Visits

Look Who's Coming to 21st-Century Dinner

National Public Radio (NPR) yesterday interviewed a woman who could not afford airfare to visit family. High fuel prices raise the cost of air and road travel.

Better than a card or phone call:

Use a webcam to virtually visit for almost free.

You might already own the computer, internet connection, and webcam needed to virtually visit distant family (and webcams are cheap now).

You can park the monitor like another seat at the dinner table (fun gimmick).

A large TV display beside the table might feel like another table.

Virtual visiting also can help when little Billy might be bored at Grandma's house but can play with his cousin across the country.

Sunday, November 18, 2007

Personal Finance Carnival 126 Features Home Finance Freedom's "Home Decorating Costs: Housing Myths Part 11"

Home Finance Freedom's "Home Decorating Costs: Housing Myths Part 11" was featured by the 126th Carnival of Personal Finance at Million Dollar Journey, along with a number of good articles from fellow PF bloggers. Thank you.

Monday, November 12, 2007

End of Privacy Sought by Government

"Privacy no longer can mean anonymity, says Donald Kerr, the principal deputy director of national intelligence. Instead, it should mean that government and businesses properly safeguard people's private communications and financial information" (Associated Press (AP), Yahoo! News).

Privacy (noun) = the government knows everything about you--but keeps it a secret from you.

Thursday, November 8, 2007

You Owe 9 Trillion Dollars

Congratulations, the United States gross national debt now exceeds $9 trillion.

You owe $30k. Your baby owes $30k. Your family of 4 owes $120k.

Your government put you in all this debt to make you richer, in case you were wondering why your life has felt so easy and virtually cost-free all these years.

Remember that when choosing a presidential candidate.

Why stop at $9 trillion?

Should the federal government make us all even richer by borrowing $18 trillion (so a family of 4 owes $240k) and leverage-investing it in the stock market for a higher return?

After all, Ben Stein recommended that you stay in debt to get rich: Payoff Mortgage v. Invest Stocks: Housing Myths Part 12

Wednesday, November 7, 2007

Payoff Mortgage v. Invest Stocks: Housing Myths Part 12

Previous: Home Decorating Costs: Housing Myths Part 11

Hock Your House?
Beware Over-Hyped Benefits of Leveraged Stock-Market Investments

Free Money Finance (FMF) responded to a pro-debt, pro-leverage Ben Stein article. Stein and some FMF commenters unfortunately repeated a number of false assumptions about stock market returns and dubious expectations about arbitrage net returns.

Sustained real returns near double-digit rates prove elusive.

People trick themselves into believing that low inflation (officially) under 3% is normal, that mortgage interest rates under 6% are normal, and that long-term, indexed stock market annual returns on investment (ROI) of 9-12% are normal. None of that is true.

Real (inflation/price-adjusted) stock/mutual fund ROI can be flat or negative over most of a decade. (Update 6/25/08: Remember that you are bleeding your mortgage interest even if your stock is "flat" and remember what a flat or negative first decade means for the long run in the world of compound interest.)

Hyped nominal stock returns near double digits often include periods of high inflation such as when consumer prices rose over 13% in 1979 (little real stock growth). (Update 6/25/08:...and the real growth can become real LOSSES when you remember your borrowing costs (see next paragraph).)

The periods of high nominal stock returns often coincide with high nominal debt costs (little arbitrage room): One measure records average mortgage rates of over 9% in most of 1991 and over 15% for about a year 1981-1982 (US Federal Housing Finance Board’s Monthly Interest Rate Survey (MIRS) National Average Contract Rate for purchase of previously occupied non-farm single-family homes, by combined lenders). The common apples-oranges mistake is comparing a recent short-term snapshot of low mortgage rates to past long-term inflation-contaminated stock returns, which is just as misleading as comparing a short-term stock-market crash returns to high long-term mortgage rates. The pro-leverage cheerleaders parrot the past 30-year S&P500 historical average but rarely mention the concurrently high 30-year fixed-rate mortgage average that leveraged people paid--because the 2nd half of the reality undermines their "easy money" sales pitch. (Update 6/25/08: Note the hypocrisy of people who drone on about decades-old "historical performance" until you remind them that they are leaving out the historical performance of COSTS, at which point they insist that old data is irrelevant because "that was then, this is now": Fine, then never mention past performance again, start with a clean slate on BOTH gains and costs, and we are left with a future, guaranteed mortgage loss compensated by nothing guaranteed on the plus side, and even a 5% mortgage could result in a double loss, as described later.)

Those hyped stock returns are sometimes intentionally inflated using a misleading method (arithmetic average annual return) in another improper apples-oranges comparison to mortgage rates: Use the proper annualized return (geometric mean) to compare directly to compounded mortgage-interest negative returns.

The popular major-market indicator Vanguard 500 S&P500 index fund (VFINX) cost about $30 in 1987 (20 years ago) and $140 today (late 2007), which is an annualized return of not 9-12% but only 8.01%--before taxes (Update 11/12/07: A VFINX $30 purchase and current $133 price puts the 20-year annualized return at 7.73%) (Update 7/13/08: A VFINX $30 purchase in 1987 and the current $114 price puts the 20-year annualized return at 6.90%. There are many other pluses and minuses such as dividends which might add 1.6% to the 6.90% for 8.50% BEFORE COSTS but a 0.15% expense ratio reduces that to 8.35% and a possible 0.5% mortgage PMI (often overlooked on the leveraged cost side) reduces that to 7.85%, plus possible mortgage points, dividend taxes, etc., before we even get to subtracting the main "mortgage rate").

The S&P500 20-year average performed about the same as an 8.xx% bond (before tax differences), and the US 30-year Treasury bond's yield was about 8% for most of the first decade after 1987 and peaked over 10% in 1987.

Borrow at 11% to earn 8%?

Anyone who in 1987 had cash to buy a house in full but decided instead to take an average 30-year fixed-rate mortgage (FRM) to invest the cash in an S&P500 index fund might have crucified him/herself on a (July) 10.5% mortgage interest rate to earn 8% in stocks/mutual funds, for a clear loss.

The poor sap could pay more in additional fees to refinance when mortgage rates decreased but average rates fluctuated near 8% for most of the 2 decades (finally breaking below 6.5% about 2002). Even a small negative arbitrage percentage can cost you tens of thousands of dollars. (Update 6/27/08: You could get a 5.xx% mortgage in 2005 but VFINX price since 2005 performed about 3.2% (5% with dividends) so your 2005-2008 leveraged investment gave about a 0% net return. VFINX price since 1998 performed about 1.8% (3.xx% with dividends) but 1998 mortgages cost about 7% so your 1998-2008 leveraged investment bled a LOSS of NEGATIVE 3.xx% per year for a decade. Pro-leverage cheerleaders say things such as "up 20% since 1998" to conceal the dismal 1.8% annualized returns but remember that negative 7% compounded for a decade results in a 50% loss (DOWN 50% since 1998).)

(Update 6/28/08: The borrow-to-invest plan to lock in a low mortgage rate for 30 years often fails in the real world for a number of reasons: (1) the average American mortgage lasts for an average of only 7 years (according to ING) due to moving or other reason, so the average person does not keep a low rate for 30 years; (2) banks advertise ideal rates that apply to few people but the more realistic rate is the report of average rates actually obtained by borrowers (6.62% for 30yr fixed-rate $165k mortgage according to's 6/25/08 weekly national survey of large lenders, or 6.45% plus 0.6 points for 30yr fixed-rate mortgage according to Freddie Mac's 6/26/08 Primary Mortgage Market Survey (PMMS)); (3) people like to quote their rate but forget total costs such as points yet 0.6 @ $200k is an instant $12,000 loss before you earn a penny in the stock market; (4) people like to quote their mortgage RATE but their actual, annual debt cost is the APY (Annual Percentage Yield, which is higher than the rate because APY accounts for compounding during the year); (5) internet forum users claim to have a 5.xx% or even 4.xx% mortgage but best credit in ideal market conditions is rare so telling the average person, "Leverage your house in the stock market. First, get a 4.xx% fixed-rate 30yr loan," is like saying, "Make a million dollars. First, get $900k.")

The Iron Rule of Debt

Borrowing usually costs more than investing earns, given equivalent risk (with borrowing, you pay inflation + risk + someone’s salary/bank’s overhead; with investing, you (hopefully) earn inflation + risk – fees - taxes; therefore, with borrowing-to-invest, inflation and risk cancel out and you are left with transaction costs at both ends). Even the abnormally low mortgage rates of recent past coincided with the stock market crash of negative annual returns, so someone could have borrowed at 5% to lose 20% in the stock crash (-5-20), for a net 25% loss.

Investing in income-generating enterprises rather than attempting pure price speculation might help your odds but leveraged investments remain risky even with income-generating investments.

Hope Springs Eternal: Everyone Wants To Be above Average

Even people who know that the average active stock/mutual fund picker will underperform the market by a percent or 2 (e.g. 6-7% instead of 8%) think that they will be the ones who will outperform the iron rule of debt, by both picking and timing both debt and investment correctly, and therefore earning more than their debt costs. Every leveraged investor believes that he/she brilliantly will borrow at 8% to earn 11% when we know that quite a few people will be like the poor sap in 1987 who borrowed at 11% to earn 8%.

Those who beat the odds will be the "poster children" to recruit an army of saps. Even many of the saps will recruit more saps by falsely thinking they earned 11% when they actually earned 8% and by falsely thinking they had a positive net return when they actually had a negative net return. Take the cheerleading leverage/arbitrage hype with a grain of salt and learn the true risk and math before you act.

Good luck to all.

Tuesday, November 6, 2007

Ron Paul Sets Financial Record for Presidential Candidate

Amusing Theme Yields Impressive Funds for Presidential Candidate Ron Paul

Air Force veteran, Congressman, and obstetrician Dr. Ron Paul is one of the most interesting presidential candidates for the 2008 election. Ron Paul inspires energetic loyalty and outperforms other alleged "frontrunners" in some respects. Paul's supporters ("Paulites") spontaneously organized an earnest if humorously named "Guy Fawkes Day" "money bomb" of 1-day fundraising yesterday which apparently set a record:

From Baltimore Sun:

It is people voting for someone other than the establishment, odds be damned.

Paul already had raised a stunning $5 million in the last quarter, and he has set a goal of $12 million for this final quarter of the year. And, according to his campaign Web-site, Paul raised more than $3.1 million in 19 hours on Monday, marking the single largest fundraising effort of the 2008 election cycle.

As of 4 pm, the campaign maintained, it had raised $2.7 million, surpassing the record for the largest online presidential primary fundraising effort in a single day, and by 6:30 pm, the campaign said it had surpassed Republican Mitt Romney’s $3.1 million record for single-day fundraising this year. This morning, the Web-haul was reported at $3.8 million-plus.

Commenters asserted that the final tally was $4.2 million.

(Update 11/13/07: CNN reported Ron Paul's 1-day total as $4.38 million.)

Sunday, November 4, 2007

Home Decorating Costs: Housing Myths Part 11

Previous: Homeownership Cost Cliches: Housing Myths Part 10

The Million-Dollar Paint Job
Peculiar Priorities To Justify Spending a Million Dollars

Those who concede that homebuying is not always financially better than renting often switch the argument from financial bottom lines to unquantifiable personal preferences that cannot be tested by Excel spreadsheets.

One of the favorite intangibles that you “can’t put a price on” is the “freedom” to do no end of unpaid labor, such as painting walls.

Bone Is Freedom. Eggshell Is Slavery.

This obsession with painting houses is very strange:

  • Others consider painting to be a chore, on par with having to empty the chamber pot if there was no indoor plumbing ("But if I rented I wouldn't be able to empty my chamber pot and the landlord would get to do it every time.").
  • Few people confess to jealously resenting the landlord’s “freedom” to repair the plumbing or shovel the driveway yet we hear people eagerly protest the cruel fate that denies them the right to spend their free time spreading liquid on a wall.
  • These color-minded people must be very highly accomplished in life to be able to say, “Darn it, I spend way too much time playing with my children. Spreading liquid on a wall is a much higher priority.”
  • Few people express the same compulsion to change the color of their car yet we see people shake their fist against the tyranny that denies them the right to spread liquid on a wall.
  • Few people express the same compulsion to trim the hedges in particular shapes yet we can imagine people pacing their floor while seething with burning resentment at the anti-artistic conspiracy that denies them the right to spread liquid on a wall.

Oh, the repressed self-actualization.
Oh, the humanity.

A House Is the World's Most Expensive Canvas

Customizing your home, whether rented or not, is understandable.

Less Expensive Solutions for Frustrated Artists:

  • Even extremely customized/specialized decoration does not require paint at all: Most people would guess that a room with beige walls and pink drapes, pink sheets, a pink dresser, and a pink telephone is a girl's room.
  • The fixation with hammering holes in walls, instead of the “tyranny” of placing your pictures on a mantel or bookcase, is equally perplexing. Given that houses often cost several times their “sticker price” (initial value) by the time they’re paid off, how many thousands of dollars per hole is that (more expensive than wildcat oil drilling?)?
  • Compulsive painters could rent while changing professions to become house painters/remodelers to get paid for their hobby, or volunteer to paint walls at homeless shelters or Habitat for Humanity.
  • Even if a landlord does not allow temporary color changes, the color-obsessed occupant might find that forfeiting the renter's security deposit is much cheaper than the million-dollar paint job of buying a house.

(Even a non-"jumbo loan" house can cost a million dollars after you add the mortage interest costs to the initial price: $400k @ 8% 30yr = over $1 million.)

Cheaper than a House:
Landscape painter Bob Ross' The Joy of Painting Basic Paint Set

The Myth of Landlord Color Tyranny

Some landlords let you paint and add picture holes. Some landlords let you repaint to a weird color as long as you return to a neutral color before you leave.

Homeowners Do Not Escape Color Tyranny

The irony is that homeowning is no different from renting and experts recommend that you the homeowner behave exactly like a landlord and repaint your purple kitchen to a neutral “landlord-approved” color if you wall to sell your home. This expert recommendation exposes the basic economic fact that color was never a landlord tyranny and always has been a customer tyranny.

Yes, the tyrant was YOU when you were the customer.

The homeseller is slave to the homebuyer.

The average American moves every 7 years (according to the real estate industry). The housing karma is that you were the tyrant when you were buying so you get to be on the receiving end when you try to sell.

Next: Payoff Mortgage v. Invest Stocks: Housing Myths Part 12

Friday, November 2, 2007

Ben Bernanke on South Park?

Gangrene on the Greenback: The Falling US Dollar

If South Park did Ben Bernanke and Federal Reserve monetary policy:

Personal Finance Carnival 124 Features Home Finance Freedom's "Did this Couple Do Everything Wrong or Everything Right?"

Home Finance Freedom's "Did this Couple Do Everything Wrong or Everything Right?" was featured by the 124th Carnival of Personal Finance at Millionaire Mommy Next Door with a reader participation poll, along with a number of good articles from fellow PF bloggers. Thank you.

Friday, October 26, 2007

Did this Couple Do Everything Wrong or Everything Right?

Two Wise Acres wrote about an older couple who succeeded in the real estate investment rental business by doing "everything wrong" by violating these "rules":

  • 1. "Leverage Your Investments to Maximize Growth" (instead, they paid off a property before they bought another).
  • 2. "Always Make Sure You Have Well-Drafted Leases with Tenants" (instead, they rented month to month with no lease).
  • 3. "Maximize Rental Income" (instead, they charged 30% under conventionally-accepted "market rates").
  • 4. "In Your Lease, Make Sure that You Contain Appropriate Restrictions on Tenant Alterations to the Property" (instead, they allowed renters to paint even the exterior of the building).
However, the couple followed these rules instead:
  • 1.Minimize costs (debt)--and pass the savings to the customer without lowering your profit (low producer costs=low consumer prices).
  • 2.Serve the customer, find a niche, and build loyalty--the biggest cost/effort/risk is spending for the initial setup and then (tick-tock-tick-tock) eating your costs while waiting for a 1st-time customer to "walk in the door" (this why companies spend so much to advertise and to track and profile customers) so the holy grail for renting is "finding your market" (flexible leases) and no vacancies (less turnover, less frictional losses, maximum utilization of your infrastructure, on the edge of your economic "production possibilities curve"), provided by tenants' loyalty and tenant-provided free word-of-mouth advertising/recruiting.
  • 3.Undersell the competition--#1 leads to #2. Low price also increases the landlord's applicant pool so he/she can select and keep the cream of the renter crop.
  • 4.Build/allow customer identity/community with your product--customers will lower your costs by doing free maintenance (paint the rental house) or will create new content or products for you (free R&D). A recent book argued that most innovation comes from the bottom up, from users who invent something new for their own use first (necessity is the mother of invention, and the customer/user knows his/her own needs better than existing companies know his/her needs) and then the big companies mass-produce what the customers invented for them.
Real-life example: Another landlord (not Two Wise Acres' couple) offered low rent with no lease, let a renter nail/drill holes, and even added a major amenity without being asked or raising the rent. The renter returned the favors, paid to fix the apartment's (landlord's) refrigerator without bothering the landlord, and paid professional cleaners to clean the apartment when he moved out.

(I will write more about renter modifications in a future installment of my "Housing Myths" series.)

Did these Landlords Do Everything Wrong or Everything Right?

Personal Finance Carnival 123 Features Home Finance Freedom's "Homeownership Cost Cliches: Housing Myths Part 10"

Home Finance Freedom's "Homeownership Cost Cliches: Housing Myths Part 10" was featured by the 123rd Carnival of Personal Finance at The Dough Roller in a Halloween theme, along with a number of good articles from fellow PF bloggers. Thank you.

Monday, October 22, 2007

How Much Is Your Blog Worth?

Single Ma's Fabulous Financials posted these helpful links:

Someone added my blog to Blog Shares: The Fantasy Blog Stock Market. Apparently, I have 2 investors.

Have you valued your blog?

Friday, October 19, 2007

Homeownership Cost Cliches: Housing Myths Part 10

Previous: House Depreciation-Maintenance: Housing Myths Part 9

Housing Clichés Can Cost You Dearly

The last article mentioned that counting just 2 factors (inflation and maintenance/repairs) can cancel any supposed real-estate “investment” appreciation but there are many more costs that can turn home ownership into a loss: mortgage interest, taxes/insurance/fees, and opportunity costs of missed investments.

Your mortgage costs DO increase every year and these increases disprove the "payments never go up," "payback with cheaper money," and "good debt" cliches.

“Your rent goes up but my mortgage payment does not” is just another way of saying that the "fixed" mortgage payment starts too high, in real (inflation-adjusted) terms (plus, rents DO NOT always go up). The mortgage-holder tends to assume that the first mortgage payment is the “just right” size and everything later is discounted (by inflation) but rarely considers that the last payment might be the “just right” size and everything earlier is at a penalty rate.

“I get to pay back my mortgage later in cheaper money” is another common cliché that undermines the first cliche: If postponing repayment is so lucrative, then you would want to pay little at first and more later, so mortgage payments that do not increase over time would be bad. The “cheaper money” slogan argues for the ultimate balloon-payment plan of paying $0 for 29 years and paying everything (several times the purchase price) in the last year.

Both of these common quotes misread the mortgage situation:

All mortgages have annual cost increases built-in but people overlook the increases by looking at the nominal payment rather than the accrued cost. If your mortgage rate is 5%, each year your new, extra cost is an additional 5% of the year’s debt. The mistaken belief of no payment increases is an illusion simply because the bank has pre-calculated your 30 years of cost increases and front-loaded your money-up-in-smoke interest costs.

You are repaying your mortgage with more expensive money (not cheaper money) because the interest rate is almost certain to increase the debt cost at a rate faster than the official inflation rate. The repayment would be "cheaper" only if the mortgage had no interest rate (or one less than inflation), but I have not seen any mortgages like that, so I think the banks have figured out that loophole. Unless you find a bank that is so stupid that it lends for less than its costs decade after decade, you are losing more money each year that you keep a mortgage.

A $225k 5% fixed-rate mortgage is about the same as taking 30 years to pay off a $225k 5% credit card debt. Debt is debt. Compound interest compounds.

Pre-paying principal is so powerful at lowering your costs because it reduces the compound-interest increases.

The only escape from annual mortgage-cost increases is to end the mortgage.

Non-debt home-ownership costs increase too and these costs disprove the "but eventually I'll have free housing" cliche.

Owning has many costs such as taxes and insurance that can increase faster than the inflation rate and faster than rent increases. Experiences vary from person to person but consider these real-life examples: One person rented for 7 years without a penny increase in rent while another person during the same period bought a house and saw property taxes skyrocket 50% in 5 years. Even with no mortgage, a homeowner’s costs can increase faster than a renter’s costs.

Opportunity costs of missed investments disprove the "renters end up with nothing," "at least I have home equity," and "mortgages are forced savings" cliches.

Neither borrowing 100% nor paying 100% cash to buy a house necessarily beats renting:

Borrowing $225k at 5% costs $11,250 in interest in the first year ($937.50/mo), not counting loan origination “points,” closing costs, taxes, repairs, and other fees/costs--none of which creates a penny of equity.

Anyone who likes to pay principal on top of the consumption costs can just as well save/invest on top of paying rent, so "owning" and renting offer similar equity opportunities.

Building equity depends primarily on the individual. Spendthrifts can find a way to stay in debt whether they rent or "own."

0% downpayments, interest-only loans, HELOCs, reverse mortgages, and other house-as-ATM "equity harvesting" all prove that home-"owning" is no guarantee of "forced" savings. An automatic payroll deduction into a money-market account might be a cheaper "forced" savings plan. A renter's security deposit has more equity than some no-money-down homebuyers do.

Renters might beat homeowners in the equity-building race because renters are more likely to have lower early payments and therefore benefit from the renown compounding magic of saving early (contrary to "mortgage payments do not increase" and its backward logic of high costs/low equity-building now and low costs/high equity-building late in the game).

Paying $225k cash for a house will avoid paying interest but then you have nearly a quarter-million dollars tied up in an illiquid asset that might appreciate nominally at 5% but can have zero or negative real “appreciation” after all input/carrying costs are considered.

You instead could invest the $225k cash in stock or other investments to earn net 5% ($937.50/mo) and keep your $225k stock equity while the interest/dividends/appreciation income pays your rent, maybe in perpetuity (depending upon exact rent, inflation, etc.).

The Good Cliche: There Is No Such Thing as a Free Lunch in Housing

Housing is consumption when you own as well as when you rent so do not be surprised by the possibility that homeowner’s net costs might be similar to renter’s net costs.

More Misleading Housing Cliches (Parts 1-9, in reverse order):
"Renting doesn't build equity like my house payments do!"
"I'm debt-free! . . . with a $500,000 mortgage."
"My mortgage rate is really 1/3 less and I want to get as big a tax deduction as possible!"
"Buy as much house as you can afford!"
"My mortgage is free because I'm renting to myself!"
"My mortgage doesn't count as an expense because you have to live somewhere!"
"I really increased my ROI by leveraging as much as possible with no-money-down!"
"Never prepay your mortgage!"
"I borrow against my house to invest in the stock market!"

Next: Home Decorating Costs: Housing Myths Part 11

Thursday, October 18, 2007

Personal Finance Carnival 122 Features Home Finance Freedom's "House Depreciation-Maintenance: Housing Myths Part 9"

Home Finance Freedom's "House Depreciation-Maintenance: Housing Myths Part 9" was featured by the 122nd Carnival of Personal Finance at Mighty Bargain Hunter in a fanciful Dr. Seuss theme, along with a number of good articles from fellow PF bloggers. Thank you.

Tuesday, October 16, 2007

Birthdays without Presents?

Birthdays without Pressure claims,

"If you think children’s birthday parties are getting out of control, you’ve come to the right place."
What do you think?

See also: Is Your Baby Cost-Free?

Sunday, October 14, 2007

House Depreciation-Maintenance: Housing Myths Part 9

Previous: The "Debt-Free" Deception: Housing Myths Part 8

The Accidental Money Pit:

Do you have a few hundred thousand dollars lying around to sink into a 0% investment?

Real Estate marketing hype is that you sit back and smoke a cigar while your home value goes up, up, up--but the reality often is that you drag yourself home from work to find that you have to bail water out of your basement before black mold takes root.

The repair problem is not limited to the current housing-bubble price crash. Even “normal” maintenance and repairs of 1-2% of home value total $2k-$5 for a $225k median-price home and thousands more for more expensive homes.


Consider these 2 real-life examples:

  • A condo buyer in the first year suffered water damage costs (a problem that damaged a neighbor’s unit), re-roofing costs, and fencing costs to add on top of the regular condo fees, mortgages, and taxes (regular condo fees cover frequent, small expenses such as lawn-mowing but large repairs often require extra “assessments”).
  • A home buyer suffered a single structural problem that cost $9,000—an entire year’s rent for many people—to add on top of all the normal maintenance, mortgage, and taxes.

No Escape from Housing Consumption (not Investment)

You can see the false assumptions:

  • A condo buyer thought that he/she would escape surprise maintenance bills by paying regular condo fees but then finds that he/she must pay the condo fees and then still pay big maintenance bills too.
  • A home buyer thought that he/she would escape paying thousands of dollars of consumption housing expenditures that do not build equity but then finds that he/she must pay hundreds of thousands for the house “sticker price,” plus taxes and fees, plus (usually) mortgage interest, and then still pay more thousands in housing consumption to counter depreciation.

Imagine if people used real finance rules to calculate their housing “investment”?

Repair=Input: Repairs Increase Your “Cost Basis.”

Repairs are input costs, similar to a delayed addition to the purchase price. People like to stop counting their costs after “closing day” and pretend that years of additional costs never happened.

Tax rules recognize that repairs lower return on investment (ROI), i.e. eat away your "profits," which is why people keep repair records for tax returns, to prove that they did not make that much money after subtracting expenses.

I suppose that theoretically you could prevent your car from depreciating if you poured enough extra cash into it but those infusions would lower your return on investment (ROI), not increase it.

Houses Are a Depreciating Asset?

Try this: Buy a house and then abandon it completely for 30-50 years (no heat, no lawn-mowing, no re-roofing, no sump pump, no security, no insurance, etc.). Go find it when you are ready to claim/sell your nest egg to retire. Is that a winning investment?

(Anyone can be a Monday-morning quarterback and name past performance of a particular location, like saying, "If you bought Stock X in 1930 . . .," but it is harder to predict which markets will be hot a half-century in the future.)

The long-term US residential real estate nominal appreciation has averaged 3-6% per year but inflation plus regular, boring maintenance/repairs means that your house might return 0% real growth after 30 years—and that is before considering mortgage interest cost.

Next: All costs combined can make homeownership a negative investment and possibly worse than renting: Homeownership Cost Cliches: Housing Myths Part 10

Friday, October 12, 2007

Personal Finance Carnival 121 Features Home Finance Freedom's "The "Debt-Free" Deception: Housing Myths Part 8"

Home Finance Freedom's "The "Debt-Free" Deception: Housing Myths Part 8" was featured by the 121st Carnival of Personal Finance at Mr. Credit Card in a fanciful presidential debate theme, along with a number of good articles from fellow PF bloggers. Thank you.

Sunday, October 7, 2007

The "Debt-Free" Deception: Housing Myths Part 8

Previous: Home Mortgage Tax Deduction Snake Oil: Housing Myths Part 7

The entire rent/own/mortgage debate is thoroughly confused, misguided, and backwards.

You are NOT debt-free if you have a mortgage. Mortgage is debt.

The love of mortgage debt is so bizarre that some people try to deny that mortgage is debt--and then accuse debt-free people of being in debt.

Have you ever had anyone tell you that they are "debt-free" only to learn that he/she carries tens or even hundreds of thousands of dollars of mortgage debt? The person might be justly proud of reaching some milestone in debt reduction but it is quite a feat of denial to pretend that the largest debt of his/her life does not count as debt.

RENT is debt-free for the tenant.

Someone once doubled the "up is down" mistake by asserting not only that mortgages did not count as debt but that rent did count as debt.

The person confused houses with housing, confused consumption with debt, and confused purchasing with financing.

  • Housing is consumption, an ongoing necessity like food, but recognition of a future necessary consumption is not "debt" unless you want to tell everyone that you are heavily in debt to the grocery store because you will need to eat lunch 50 years from now.
  • Debt is when you consume/take-title before you pay (becoming a debtor to the seller/provider), as opposed to pay-as-you-go (provider and consumer walk away even), or paying in advance (becoming a creditor to the provider).
The rent v. own debate is a false "opposite" and crippled by a logical flaw.

Renting and buying housing with cash are 2 forms of paying in advance. The question is if it is cheaper to pre-pay for 30 days or 30 years.

Renting and buying with cash are similar to each other and it is the mortgage that is the complete opposite. Too many people make a leap of logic of confusing paying-in-advance with spending money that they do not have, which is an entirely different kettle of fish.

The landlord is debtor to the tenant.

The tenant pays in advance by paying on the first of the month for housing in the coming month, which puts the landlord in debt to the tenant. The tenant is the creditor and the landlord owes a month of housing.


A lease is a mutual obligation on both parties. Technically, you might argue that you are in debt to the electric company because the company does not bill you until after you consumed the electricity, but by that logic you are in debt when you are eating at a restaurant before the waitress brings the bill. The distinction with restaurants, electric bills, and credit cards is that they provide a grace period with no interest charge (treating the transaction as pay-as-you-go).

The practical test for "debt-free": You are in debt if you are paying interest. You are debt-free if you do not pay interest.

Next: The Accidental Money Pit - House Depreciation-Maintenance: Housing Myths Part 9

Friday, October 5, 2007

Personal Finance Carnival 120 Features Home Finance Freedom's "Home Mortgage Tax Deduction Snake Oil: Housing Myths Part 7"

Home Finance Freedom's "Home Mortgage Tax Deduction Snake Oil: Housing Myths Part 7" was featured by the 120th Carnival of Personal Finance at My Retirement Blog, along with a number of good articles from fellow PF bloggers. Thank you.

Sunday, September 30, 2007

Home Mortgage Tax Deduction Snake Oil: Housing Myths Part 7

Previous: Hidden Burden of Overbuying: Housing Myths Part 6

The Home Mortgage Income Tax Deduction NEVER Saved ANYone ANY Money

Taking the Mortgage Deduction Always LOSES You Money

Mortgage Tax "Savings" Are Always Losses

Taxes are losses. "Tax savings" are NOT real savings. Tax reductions reduce tax losses of your initial "pile" of income from, say, negative 10% to negative 9%--but still negative (still a loss). In most tax cases, the best you can do is break even by keeping what you started with (0% loss). There is almost never a chance of real gain or real savings.

The mortgage-interest tax deduction is worse than many tax deductions.

Mortgage-interest "tax savings" are NOT savings. Mortgage-interest "tax savings" are losses because you pay more to qualify for the "benefit" than you get in return. The economic illogic is stark. Would you start a business to make a widget that costs you $10 to make and sell it at $1? Would you borrow money at 10% interest to put it in a bank account that earns 1%? The simplest example of the mortgage-interest tax deduction is that you must pay $10 to "earn" $1 (at a 10% marginal tax rate) for a net loss of $9.

That is a return on investment (ROI) of negative 90%, a 90% loss. A 25% tax rate would return a loss of negative 75% ROI. Does working to "get" or "keep my mortgage deduction" sound like the road to wealth?

Even the "net loss of $9"/"90% loss" way of thinking is too optimistic (for the following reasons):

The standard deduction makes a mortgage an even worse deal.

Tax Deduction Cancellations: The government giveth with one hand and taketh with another.

Assuming for a moment that mortgage interest is the only itemized deduction:

  • A 2006 single person could pay $5,150 in mortgage interest and not save a single penny in income tax.
  • A 2006 married couple could pay $10,300 in mortgage interest and not save a single penny in income tax.

Everyone gets these $5k-$10k tax-deduction amounts regardless of housing situation.

  • A couple who paid $10,300 rent gets a $10,300 tax deduction (standard deduction) without having to pay a penny of interest.
  • A couple who paid cash for a house gets a $10,300 tax deduction (standard deduction) without having to pay a penny of interest.
Update 5/6/09: The new 2008 IRS property tax deduction without itemizing means that a couple under 65 years old gets a $12k standard deduction and a senior-citizen couple age 65 or older gets a $14k standard deduction.
"Estimates suggest that approximately 40% of homeowners do not itemize" (Congressman Baron Hill D-IN).
The mortgage holder can deduct mortgage interest instead of taking the standard deduction. A mortgage holder only gets an extra discount on the extra marginal amount of itemizations that exceed the standard deduction.

(The total itemized amount can include other items such as property tax but I will refer only to mortgage interest for simplicity. If a couple already has $10k of itemizable spending even without a mortgage, that level of spending might explain the lack of savings--and perhaps a reduction of spending would help more than the addition of debt.)

The mortgage-interest tax-deduction effective rate is NOT your top marginal tax rate.

The effective rate accounts for the trade-off of losing the standard deduction to take the itemized mortgage deduction instead.

If a couple with a 10% top tax-bracket paid $20,300 in interest, the relative income-tax reduction (compared to not taking a mortgage) would be only the marginal rate of the marginal amount, 10% of the $10,000 ($20,300 paid - $10,300 standard deduction), a relative tax reduction of $1,000.

The so-called "tax saving" is:
  • NOT at the full, top, marginal rate. It is less than half of the top rate, not a 10% discount but a 4.9% discount ($20,300/$1,000).
  • NOT a net saving. The couple has saved nothing and in fact lost at least net $19,300 ($1,000 - $20,300).
  • NOT a real gain. It is only a tax-drain shift from negative $1k to $0 (vis-a-vis the IRS) so the real loss of wealth is the full $20,300 ($0 - $20,3000).

Households at the highest marginal rates, who might think that they would merit the biggest tax reduction, might find their deductions canceled by the Alternative Minimum Tax (AMT) at $42,500 income levels for singles and $62,550 for married couples in 2006.

Any way you slice it, the borrowing cost always overwhelms the tax reduction.

Net Loss: Mortgages Harm Net Worth

Consider 2 couples facing the earlier scenario who start the year with $20k cash:

  • The one who denied $1k to the IRS by paying $20k interest to the bank lost all $20k and has $0.
  • The one who paid the extra $1k taxes to avoid paying $20k interest lost $1k and still has $19k.

What a difference a year can make.

Would you rather be negative 5% (lose 1k of 20k) or negative 100% (lose 20k of 20k)?

The mortgage tax deduction is 20 times worse than borrowing from Peter to pay Paul.

Borrowing $1k from Peter to pay $1k to Paul is a classic example of going nowhere fast.

However, the mortgage deduction is much worse and actually puts your finances in reverse because you are avoiding paying $1k to Peter only by paying $20k to Paul.

"Hey, what happened to my $1k tax-deduction money that I wanted to keep in my pocket?"

Sorry, your mortgage-interest deduction goes in the bank's pocket, not yours.

IRS "Teaser" Rates:
The evaporating tax discount races to zero.

The effective tax discount, if it existed at all at first, diminishes each year as the amount of mortgage interest paid decreases each year (the "mortgage payment" is mostly interest at the beginning and mostly principal at the end of the loan--and the principal is not deductible).

Therefore, not only might you not get an advantage on the full amount of interest paid in each year that you do itemize, the diminishing interest payments mean that you might not itemize for the full 30 years (not in later years).

If you itemize only for the first 20 of 30 years (because the diminishing interest eliminates the itemization advantage in later years), and during the 20 years your average itemizations exceed the standard deduction only slightly, you get very little tax advantage.

You can pay tens of thousands of dollars of mortgage interest with no itemized deduction for the costs.

Deduct half a million dollars without paying a penny of interest.

The biggest mistake that a person can make is to multiply his/her lifetime total of mortgage interest by his/her top tax bracket, which can grossly overestimate the tax advantage and underestimate the costs (as explained above). Do not make the mistake of assuming that you get a tax advantage on 100% of all mortgage-interest paid when you might get a relative advantage on, say, only 20% of all the interest you paid.

Compare the dollar amount from itemized deductions to $300k of a couple's standard deduction over 30 years or $500k over 50 years.

Why not take the $500k of deductions without paying interest?

Next: The "Debt-Free" Deception: Housing Myths Part 8

Friday, September 28, 2007

Personal Finance Carnival 119 Features Home Finance Freedom's "Hidden Burden of Overbuying: Housing Myths Part 6"

Home Finance Freedom's "Hidden Burden of Overbuying: Housing Myths Part 6" was featured by the 119th Carnival of Personal Finance at Blunt Money in a puzzle edition, along with a number of good articles from fellow PF bloggers. Thank you.

Sunday, September 23, 2007

Hidden Burden of Overbuying: Housing Myths Part 6

Previous: Do Not Confuse Houses with Housing: Housing Myths Part 5

Would You Pay $250,000 for a Room?

The Housing Bubble: Historical Growth in Houses Square Feet per Person

4 Reasons People Overbuy Housing--and How To Avoid It

  1. Expected Duration of Use: People who borrow, say, a lawnmower are not inclined to scour the city to borrow from the person who has a mower with all the exact, ideal features of the borrower's tastes. However, a decision to purchase often launches people on the slippery slope of pursued perfection to find a mower with the highest horspower and best cup-holder.
  2. Timing of Use (Now V. Future): People who make small, instant-total-consumption purchases, such as buying lunch, are likely to buy just enough to do the job. That sizing job gets harder with longer time horizons and increasing risk or uncertainty of how much you will need years in the future. Imagine if you had to buy all your food for the next 30 years today.
  3. Uncertainty and Insurance Premium: People tend to pay extra to overbuy as insurance against future unknowns, which is why long-term, fixed interest rates usually are higher than short-term adjustable interest rates over time (overpaying as insurance against future unknowns).
  4. Infrequency and Information/Experience Deficit: People also tend to overpay when they do not buy an item frequently and therefore lack cost-benefit knowledge, so they overestimate both their needs and the value of the product, such as the case with choosing a college and buying a college degree.

House purchases are both infrequent and long-term (or at least many buyers treat them as such) and so people are prone to overbuy to compensate against future unknowns. Mission creep adds dens, offices, exercise rooms, decks, and saunas. House size doubles from 1,500 to 3,000 square feet—“just in case.”

Upsizing the house is like buying the $50k camper or boat that you use once every few years. People tend to imagine the temporary time of maximum needed space and then go into decades of debt for infrastructure that is rarely used.

Know Your Life-Cycle Needs

A newlywed couple might go 5 years with no children and even a baby does not require a new bedroom. It is not historically unusual for several children to share 1 bedroom (even boys and girls together). Teenagers tend to need more room but that is why they get drivers licenses and go away to work or college. Long life spans indicate decades of life as “empty nesters.” So, people tend to overbuy the largest purchase of their lifetime based on a brief 5-10 years of peak usage.

The Marginal Cost of an Extra Bedroom

The price difference between 1 house and another house with an extra bedroom might be $50-100k, which costs $100-250k for that 1 room after today's typical finance charges of a 30-year mortgage to pay for it (ballpark figures). If you only truly need the room for 10 years, you are paying maybe $10-25k per needed year for that 1 room (not counting the luxury use of the spare room before and after the peak).

Basic finance rules say that it might make sense to buy what you need daily for 50 years but to rent what you need briefly and occasionally. Another option is the pay-as-you-go method to add-on to a house as needed. Buying and selling houses is problematic both because of the high transaction costs and because of government regulations about public-school districts which can prevent families' smart housing choices.

Do Not Buy Too Early

Why borrow and pay interest for extra space over a decade before you need it? Why not save for over a decade and then pay cash for extra space exactly when the need arises? Do you borrow to finance an extra car when your baby is born because the baby will be driving age 16 years later?

The best financial choice is the opposite of what most people do.

The best financial choice for a lifetime house purchase would be a smaller house geared to the minimum points in the lifecycle (because you will have smaller needs many more years than you will have larger needs), with temporary conversions within the original house dimensions (no additions) to accommodate temporary needs for “increased” space. The Brady Bunch’s Greg Brady made an attic room for himself and today’s smaller families average only about 3 persons each (either 1 child or 1 parent) so that fleeting teenage bubble of demand for space will not require much change.

If you want to live in the “perfect”-size home at each stage in your lifecycle, renting might be the best choice for many of the years.

Your Choice Makes a Big Difference:

How much health insurance could you buy by not spending an extra quarter-million dollars for 1 extra room?

Next: Home Mortgage Tax Deduction Snake Oil: Housing Myths Part 7

Friday, September 21, 2007

Personal Finance Carnival 118 Features Home Finance Freedom's "Do Not Confuse Houses with Housing: Housing Myths Part 5"

Home Finance Freedom's "Do Not Confuse Houses with Housing: Housing Myths Part 5" was featured by the 118th Carnival of Personal Finance at Money, Matter, and More Musings in a "Fun Money Facts" edition, along with a number of good articles from fellow PF bloggers. Thank you.

Personal Finance Carnival 117 Features Home Finance Freedom's "Ignore Average Annual Return Rates: Geometric Mean V. Arithmetic Mean"

Home Finance Freedom's "Ignore Average Annual Return Rates: Geometric Mean V. Arithmetic Mean" was featured by the 117th Carnival of Personal Finance at Kmull, along with a number of good articles from fellow PF bloggers. Thank you.

Wednesday, September 19, 2007

Bernanke's Zimbabwe Plan for the US Economy

Fed Raids Your Paycheck and Bank Account To Bailout Banks, Wall Steet, and Mortgage Delinquents

Tuesday, September 18, 2007

Ben Bernanke Music Video

Here is a Columbia Business School (CBS) spoof of Ben Bernanke's appointment as Chairman of the United States Federal Reserve, based on "Every Breath You Take" from The Police Synchronicity Album:

See more Fed spoofs:
Canada Forces US Federal Reserve To Raise Interest Rates?
Alan Greenspan: Fun with Financial Armageddon and Famous Movies

Monday, September 17, 2007

Canada Forces US Federal Reserve To Raise Interest Rates?

Here is a Saturday Night Live (SNL) Golords spoof of foreign frustration with "Easy Al" Greenspan's loose US monetary policy in 1998:

(Warning: violence and sexual content)

Except for a 25 basis points (bps) hike on March 25, 1997, the Fed only held or lowered the Fed-funds benchmark interest rate for over 4 years after Februart 1, 1995 and until June 30, 1999 while the stock market bubbled. The Fed dropped 75bps in September-October-November 1998 to 4.75% (deja vu now?).

See more Fed spoofs:
Ben Bernanke Music Video
Alan Greenspan: Fun with Financial Armageddon and Famous Movies

Alan Greenspan: Fun with Financial Armageddon and Famous Movies

Which movie best explains Alan Greenspan's tenure as Chairman of the United States Federal Reserve?

Comment on these and post your own choices.

Dr. Greenspan: Or How I Learned To Stop Worrying and Love the Bubble


Greenspan: The Man with the Golden ARM
(ARM=Adjustable Rate Mortgage)

See more Fed spoofs:
Canada Forces US Federal Reserve To Raise Interest Rates?
Ben Bernanke Music Video

Sunday, September 16, 2007

Do Not Confuse Houses with Housing: Housing Myths Part 5

Why Housing Is NOT an Investment
Why Home Mortgages are BAD Debts

Previous: Homeowner Profits Ignore Huge Costs: Housing Myths Part 4

“You Have To Live Somewhere” and Getting Rich by Eating Twinkies

Some people try to close their eyes to the bad investment of a home mortgage by asserting that the bulk of the borrowing costs “don’t really count.”

The common “You have to live somewhere” argument confuses opportunity costs/benefits and confuses houses (durable goods) with housing (the use of the durable goods).

(UPDATE: Economists recognize the distinction between house (asset) and housing (consumption) by referring to housing as a "shelter" "service"--although government's misuse of this valid distinction in its statistics and policies is another matter; see the Bureau of Labor Statistics (BLS) Consumer Price Index's (CPI) Owner's Equivalent Rent (OER) controversy.)

Rental Opportunity Costs/Benefits Negate Each Other

If the house was an income-generating investment, you could offset your borrowing cost with rental income. Living there yourself instead of renting to others (“renting to yourself”) means that you save writing a rent check to a landlord only by foregoing the receipt of a rent from a potential tenant of your own.

Imagine if you rented a house from someone but you bought an identical house next door and collected rent from your new house next door; the rents would cancel each other and net zero (paying rent to a landlord, collecting rent from a tenant). Owning and occupying a single house has the same result, net zero (not paying rent, not collecting rent). Therefore, the entire cost of the house including purchase/interest/maintenace/etc. is still an extra cost and not defrayed by anything. In other words, your savings are “not paying rent” but your costs are “not collecting rent” so you have not avoided one cent of the additional cost of house price and mortgage interest and insurance and maintenance and taxes.

Housing Is Consumption, Not Investment

You do have to live somewhere. That is exactly why housing is consumption, not investment. Do not confuse the house with housing; housing is the use of the house (shelter service). Housing is the consumption of time in a place (the house). When you "rent to yourself," instead of selling the consumption to a renter, you are consuming your own inventory.

No Such Thing as a Free Lunch: You Cannot Have Your Cake and Eat It Too

“Renting to yourself” means that housing is consumption (not investment) because time is money and the value of living in your house yesterday is gone with yesterday, not saved for tomorrow. Further, only one person can use a particular space at any one time and even renting one of your house's rooms to someone or other "shared space" is a reduction in your own consumption of housing, a reduction in your use of your own house (zero-sum game). Do not double-count.

Get Rich by Eating Twinkies?

You constantly consume housing like you constantly consume food.

Buy and eat a Hostess cake without trying to claim that paying to eat the cake is making you wealthy. Likewise, pay to consume housing (time in space) without trying to claim that paying to sleep in a room is making you wealthy.

Borrowing for Consumption Is Bad Debt

A typical rule of thumb is that so-called “good debt” (actually, less bad) increases productivity or generates income more than it costs (e.g. a tractor increases crop yield). “Bad debt” is everything else. Most people would see danger in taking loans to pay rent yet borrowing for instantly-consumed housing via a mortgage is essentially the same type of debt.

A 30-year mortgage is (in principle) no better than taking a 30-year loan to borrow 3 decades of rent in advance.

Think about that. In the first year of a 30-year rent loan, you could invest 29 years of rent in the stock market (a stock asset instead of a real estate asset).

(In practice, the securitzed mortgage and tax subsidies make a mortgage loan cheaper than a rent loan, but the principle is the same.)

The marginal asset value of a house, over and above the consumption cost of housing, is a separate factor that you can treat as a distinct investment.

You can try to use the historically minimal real appreciation of real estate as an investment but the appreciation is often small potatoes compared to the consumption cost/value of the house-for-housing--and the appreciation often is largely cancelled by costs (taxes, insurance, inflation, and especially borrowing costs if leveraged).

Satisfy your housing consumption and then choose the best investment for your surplus money (real estate? stocks?).

Before you borrow a quarter-million or half-million dollars, know if you are borrowing for investment or consumption.

Next: Hidden Burden of Overbuying: Housing Myths Part 6

Friday, September 7, 2007

Greenspan Needs YOU to Bail HIM Out?

Brother, Can You Spare a Trillion?

Greenspan Needs YOU to Bail HIM Out?

Thursday, September 6, 2007

Personal Finance Carnival 116 Features Home Finance Freedom's "Simplify Your Bills and Life: Streamline Paperwork"

Home Finance Freedom's "Simplify Your Bills and Life: Streamline Paperwork" was featured by the 116th Carnival of Personal Finance at Advanced Personal Finance in an NSA edition, along with a number of good articles from fellow PF bloggers. Thank you.

Wednesday, September 5, 2007

Ignore Average Annual Return Rates: Geometric Mean V. Arithmetic Mean

Previous: Vanguard 500 VFINX Loses 20% of Your Money from 8 Years Ago

Protect yourself from slick marketing: This article explains the importance of the geometric mean and how to calculate it to read and report returns on investment (ROI) accurately.

Misleading "Average Annual Returns"

The average annual rate of return tends to overestimate your gains because it is an arithmetic mean (an average based on additive units) which is inappropriate for multiplicative products such as compounded interest.

Using the arithmetic "average annual rate of return" for stock performance is like trying to describe how tall you have grown in ounces or asking, "How many inches do you weigh?"

Simple hypothetical of a $100 lump-sum buy-and-hold:

Year - Investment - Return
0 ............ $100 ......... -
1 .............. $50 ...... (50%)
2 ............ $100 ...... 100%

  • Average annual rate of return: (100 + (-50))/2 = 25%

You started with $100 and you ended with $100 but your $0 gain shows +25% average annual return.

Of course, you actually have 0% gain on your initial value after 2 years.

Use the Geometric Mean Instead

Ignore the arithmetic mean (average annual rate of return) and instead calculate the more helpful geometric mean (annualized rate) to find the factor that, if repeated, would result in your current/desired balance; for n years, the nth-root of the products of the rates-expressed-as-positive-growth-factors. For our example above that halved (*0.50) and then doubled (*2.00) in 2 years:

  • The square-root of (0.50 * 2.00) = a factor of 1.00
So $100 * 1.00 = $100. The factor of 1.00 is equivalent to 0% interest, since you can multiply by 1 forever and still have the same number with which you started (in our example, 0% per year for 2 years). A factor of 1.12 would equal 12% growth (per time period). Note that 3 years would require the cubed-root, etc.

A shortcut is the nth-root of the last-year's-balance-divided-by-the-first-year's-balance. For our example:
  • The square-root of (100/100) = a factor of 1.00

The shortcut shows that you can ignore all the "paper profits" ups and downs (unrealized gains and losses) of your stocks or home equity and concentrate on the end points of initial investment v. final cash-out (assuming no intervening hard cash inputs/withdrawals). The geometric mean simulates a consistent year-after-year interest rate so you can compare a volatile stock to something with steady progress such as a 5-year Certificate of Deposit (CD).

Use Geometric Standard Deviation

Ignore arithmetic standard deviation and use geometric standard deviation. That calculation is a bit more complicated (involving logs) but at least know how to read it. Unlike the arithmetic version which is reported as a quantity (e.g. 5% mean with standard deviation of 3% indicates a range of 2-8%), geometric standard deviation is reported as a factor (e.g. 1.05 mean with standard deviation of 1.03 indicates a range of 1.02-1.08, and the nth standard deviation is the nth power of the geometric standard deviation).

Always use the right tool for the job and do not let Wall Street or Madison Avenue tell you otherwise.

Geometric Mean Calculator for Annualized Returns on Investment (ROI)

Friday, August 31, 2007

Simplify Your Bills and Life: Streamline Paperwork

The paperless society never materialized. A paper trail is valuable in a financial dispute but many people are awash in useless paper. You can keep what you need and shred the rest.

Use might some combination of these options:

  • Keep a shredder where you take in and open mail. Reduce handling by making a keep-or-shred decision the first time you see something. Handling each item 3 times is like asking the mailman to triple your junk mail.
  • Designate a container for what you keep (an envelope for a particular utility or a carry-handle box for everything) and then winnow the contents as necessary to use “make it fit” for inventory control.
  • Save only a key page or part of a page (maybe a summary for the gas bill, maybe the itemized list for credit cards). You might get a 5-page statement of which you need only a third of the page.
  • Save only recent bills (or more of recent bills and less of old bills).
  • Save only “red letter day” details (important milestones).
  • Save only endpoints (opening and closing a loan).
  • Save only records of what you paid (v. what you owe, for which you often find no shortage of people to remind you).

Wednesday, August 29, 2007

Personal Finance Carnival 115 Features Home Finance Freedom's "Americans’ Net Worth in the Federal Reserve’s Survey of Consumer Finances (SCF)"

Home Finance Freedom's "Americans’ Net Worth in the Federal Reserve’s Survey of Consumer Finances (SCF)" was featured by the 115th Carnival of Personal Finance at Free Money Finance, along with a number of good articles from fellow PF bloggers. Thank you.

Sunday, August 26, 2007

Americans’ Net Worth in the Federal Reserve’s Survey of Consumer Finances (SCF)

What if a Quarter of Your Wealth Were Imaginary?

Net worth is a favorite topic in the buck-o-sphere (personal finance blog-o-sphere) and many people pounce on a government or media report to see how they stack up against their fellow Americans. You need to understand the source of the information and know how to read economic and financial reports correctly.

The Federal Reserve’s triennial Survey of Consumer Finances (SCF) and specifically its net worth numbers provide good examples on what to watch.

Time Lag

A report that comes out today might have no current data and instead be based on data from a few years ago. The 2003 SCF report used 1998-2001 data. The 2006 SCF report used 2001-2004 data. Most people will not see 2007 data until the 2009 SCF report.

Forgetting this point can lead to faulty decisions. One blogger recently linked to a 2003 article and compared his/her 2007 net worth to 2001 data.

Real (Inflation-Adjusted) V. Nominal Dollars

The SCF adjusts for inflation but its tables are not labeled as “real” dollars, making it too easy for the casual reader to assume nominal (un-adjusted) dollars. Further, the SCF uses a “current methods” adjusted CPI which assumes less of an inflation bite than the official CPI does.

How Do They Get People’s Financial Information?

The SCF is a survey, not a census. Like much government data, the results depend on “Gallup poll” types of problems such as sampling error, weighting, refusal to participate, and similar issues. The survey firm NORC conducts the survey of approximately 4,000 families to estimate the United States (a statistically significant sample). The accuracy of the Federal Reserve’s SCF depends upon the accuracy of Joe Sixpack’s financial self-knowledge when questioned by NORC.

Whose Net Worth?

The SCF’s “family” is technically the Primary Economic Unit (PEU) of a household. The SCF uses an unusual definition of “family” that includes single-person households. The PEU is a hybrid between other government definitions of family and households. The average US family is a bit over 3 persons and the average household is a bit under 3 persons.

“Age” is the age of “head” of “family” and the age of others in the PEU can vary from that, so 2 “40-year-old” households might have very different average ages (is the spouse 30 or 50?) and therefore have had different amounts of time to accumulate wealth.

What Counts?

The medians of many assets and debts are “conditional medians” that exclude zero to show a typical holding of a family that possesses the item in question (e.g., the median debt of debtors, not the median debt of everyone including debt-free people, which would lower the figure considerably).

The SCF counts a 401k but it ignores a defined-benefit pension (by the way, the proper absence of a defined-benefit pension from “net worth” is another reason why net worth is for measuring current wealth and is not very good at estimating future wealth). The SCF also ignores Social Security. The SCF appears to ignore tax liabilities.

Paper Profits

Net worth includes volatile asset prices (stocks, real estate) that can bubble or crash. Median unrealized capital gains ("paper profits") accounted for about 25-30% of median net worth for all but the youngest age group (under 35) in 2004 (before the 2005-2006 housing bubble apogee). Remember that about a quarter of median net worth is not real yet.

The only bad part about learning all this is that you might get upset more often when you see how other people misuse the SCF and similar statistics.

Saturday, August 25, 2007

Festival of Stocks Features Home Finance Freedom's "Vanguard 500 VFINX Loses 20% of Your Money from 8 Years Ago"

Home Finance Freedom's "Vanguard 500 VFINX Loses 20% of Your Money from 8 Years Ago" was featured by the Festival of Stocks at Fully Stocked, along with a number of good articles from fellow PF bloggers. Thank you.

Friday, August 24, 2007

Personal Finance Carnival 114 Features Home Finance Freedom's "FNBO Blunder: Due Diligence 2nd Request Email"

Home Finance Freedom's "FNBO Blunder: Due Diligence 2nd Request Email" was featured by the 114th Carnival of Personal Finance at The Simple Dollar, along with a number of good articles from fellow PF bloggers. Thank you.

Sunday, August 19, 2007

FNBO Blunder: Due Diligence 2nd Request Email

FNBO achieved the seemingly impossible: It created a run on an FDIC-insured bank.

"Security" Measure Creates Mass Insecurity

FNBO Direct followed its previous threat to keep customers’ money with this new threat:

As part of your initial application, we did not receive information regarding your current employer, occupation or position. In many cases, this is because you have a status of retired, unemployed or self-employed. We are updating our records as part of our on-going due diligence to be compliant with our standards to support the USA Patriot Act.

Due to the importance of the USA Patriot Act, we have placed a hold on your account(s) until we can document this information for our records. No deposits or withdrawals can be made through your account(s) until we receive this information. We will release the hold upon receipt of this information.

Please provide us with your previous employer, occupation and position by sending an email with this information to If this information is not received within 30 days, the account(s) may be closed. Your immediate attention to this matter is appreciated.

If you wish to discuss this further, please send an email to or call 877-370-3707. Please reference your FNBO Direct account number displayed at the top of this page when you contact us.

Thank you for choosing FNBO Direct for your Online Savings Account.

FNBO Direct Customer Service


  • The email does not state that any law requires these actions. FNBO only states that you must comply with "our" (FNBO's) standards (if a law does require them, that topic is for another article).
  • Having money is not prima facie suspicious, unless you want to be subject to interrogation every time you pull a bill from your wallet: Do you have a receipt for that dollar? Millions of people have something called “savings” from past jobs. Maybe some bankers have nothing better to do than interrogate retired Grandma and the self-employed teenage babysitter.
  • The email starts by stating that FNBO does not have your “current employer” but then asks for your “previous employer.” FNBO apparently does not even know what it wants.
  • FNBO’s action is not due diligence. It is closer to no diligence at all. If FNBO is so worried about Grandma’s “suspicious” money, it should verify or deny before accepting her money, not after, so she can take her pension elsewhere. FNBO’s sequence of actions shows that it has few qualms about receiving Grandma’s “suspicious” money; it just dislikes giving Grandma her money back.
  • Some posts on the web claimed that providing more information had solved nothing so the only ray of hope for the customer is that FNBO "may" close your account if you do nothing and do not provide the information, so at least you might get your money back--a month later--maybe (hope you did not need it to pay bills anytime soon).
  • The email reads like a classic phishing scam when a con artist impersonates an institution to steal your identity, this time invoking FNBO and the PA instead of the Bank of Nigeria. Many businesses state that they would never send such an email asking for such personal information by email.

How To Make Things Worse: What FNBO Direct Did with Its Policy

  • FNBO actually managed to damage itself further by taking its bad policy and then mistakenly applying it to customers who already had provided employment information, when on August 10 it sent the above email (with its confusing, out-of-the-blue "2nd Request" title) to an untold number by accident.
  • FNBO then took almost 3 hours to issue an apology email, amidst a flurry of complaints from irate customers.
  • FNBO still did not learn its lesson because its "apology" only told customers to disregard the last email but in the next breath warned that it still could freeze your account and send you a similar email at any time: "If Due Diligence information is required, you will receive a follow-up email."

Meanwhile, FNBO Direct customers peppered internet forums and blogs with announcements that they were withdrawing their money and closing their accounts as soon as possible.

FNBO achieved the seemingly impossible: It created a run on an FDIC-insured bank.

Friday, August 17, 2007

Should Bernanke Resign?

Should Ben Bernanke Resign? Who Should Be the New Federal Reserve Chair?

Tuesday, August 14, 2007

Personal Finance Carnival 113 Features Home Finance Freedom's "Fact V. Emotion in Personal Finance: Do Not Confuse"

Home Finance Freedom's "Fact V. Emotion in Personal Finance: Do Not Confuse" was featured by the 113th Carnival of Personal Finance at My Open Wallet in a "TGINF" edition, along with a number of good articles from fellow PF bloggers. Thank you.

Carnival of Money Stories Featured Home Finance Freedom's "Savers Are from Mars. Debtors Are from Venus. Episode 4"

Home Finance Freedom's "Savers Are from Mars. Debtors Are from Venus. Episode 4" was featured by the Carnival of Money Stories at Bryan C. Fleming, along with a number of good articles from fellow PF bloggers. Thank you.

Monday, August 13, 2007

Carnival of Financial Planning Features Home Finance Freedom's "Inflating Leveraged ROI Can Ruin You"

Home Finance Freedom's "Inflating Leveraged ROI Can Ruin You" was featured by the Carnival of Financial Planning at The Skilled Investor, along with a number of good articles from fellow PF bloggers. Thank you.

Carnival of Money, Growth & Happiness #13 Features Home Finance Freedom's "Leveraged Investments: High ROI Is Not Always Best"

Home Finance Freedom's "Leveraged Investments: High ROI Is Not Always Best" was featured by the 13th Carnival of Money, Growth & Happiness at Credit Card Lowdown , along with a number of good articles from fellow PF bloggers. Thank you.

Friday, August 10, 2007

24-Hour Delay in Posts: Testing

Previous: What Is Your Delay?

Atom feed picked up my last blog post quickly but it took a day to appear on so I am testing the time lag with this post.

Update: This post appeared on Atom feed within minutes and on within an hour.

The fastest lag that I have noticed is about an hour delay but there are periods where performance degrades to a day later, which impairs the "news" value of the aggregator as almost no one will see the article when it posts to a buried position.

To my feed subscribers, do you notice any significant delay to your feed subscription?

Thursday, August 9, 2007

Personal Finance Carnival 112 Features Home Finance Freedom's "Homeowner Profits Ignore Huge Costs: Housing Myths Part 4"

Home Finance Freedom's "Homeowner Profits Ignore Huge Costs: Housing Myths Part 4" was featured by the 112th Carnival of Personal Finance at The Frugal Law Student in a "Best Week Ever" edition, along with a number of good articles from fellow PF bloggers. Thank you.

Friday, August 3, 2007

Vanguard 500 VFINX Loses 20% of Your Money from 8 Years Ago

Beware Vanguard 500 Faulty Logic & False Performance Measures for Investments

Update 8/4/07: This article originally was based on Google Finance Beta's "10y" graph on 8/3/07 but the "10 year" graph did not cover 10 years (thanks, Google) so I re-adjusted the article for 8 years.

When Claims of +160% End at -20%

The Vanguard 500 S&P 500 index fund, often claimed to give a 12% return on investment (ROI) rate, closed today at $132.16, an excellent lesson in real returns.

Misleading "Average Annual Returns"

First, note that average annual return rates tend to overestimate your gains.

Simple hypothetical of a $100 lump-sum buy-and-hold:

Year - Investment - Return
0 ............ $100 ......... -
1 .............. $50 ...... (50%)
2 ............ $100 ...... 100%

Average annual rate of return: (100 + (-50))/2 = 25%

You started with $100 and you ended with $100 but your $0 gain shows +25% average annual return.

Of course, you actually have 0% gain on your initial value after 2 years.

Use the Geometric Mean Instead.

What if you put your $100 in the Vanguard 500 VFNIX 8 years ago?

If you expected 12% per year, you expect to find your $100 investment to have grown to $260 after 8 years, a 160% increase over your initial value.

De Ja Vu: "Hey, this is where I started!"

However, the Vanguard 500 spent the better part of the last decade in the V-graph pattern of our simple hypothetical: The VFINX share price was about $130 about 8 years ago and closed at about $132 today, which is about 0% growth after 8 years.

Real Negative Returns

If inflation were about 3% per year, then the Vanguard 500 performed as if it had been losing your money at -3% per year.

The real value of your initial $100 is now about $80. You lost 20% of your real money over the last 8 years.

Opportunity Costs

Some say, "Invest as early as possible!", but today you can buy VFINX at about the same dollar price (less in real terms) as 8 years earlier and have the same nest egg at retirement as the person who invested 8 years before you--and meanwhile your money could have been accomplishing other things for the past 8 years.

Some say, "Invest instead of paying off your mortgage!", but someone who had a windfall 8 years ago and chose to invest the lump sum in the Vanguard 500 instead of paying off a mortgage would have done even worse than the real 20% loss by adding the mortgage's real negative return to the VFINX's real negative return.

"In the long run, we are all dead." -- John Maynard Keynes

VFINX eventually will rise again and you can find other timeframes with higher returns on investment (ROI) but remember that certain investments or markets can be flat or worse for a decade. Even if Investment A beats Investment B in the long term (several decades), Investment B might beat Investment A in the short- or mid-term. You might have an immediate goal such as paying off a mortgage or other debt that can make you thousands of dollars richer than borrow-to-invest schemes when alternative investments are in--or are about to enter--the doldrums.

Always do the math for your specific circumstance and do not rely on optimistic promises.

Never Prepay Mortgage? Housing Myths Part 1