Thursday, June 28, 2007

“Savings” Pitch Tricks You into Overspending

More Dark Alchemy:

Free Money Finance cited a finance article about 15% of US households with $0 net worth. The article is a perfect example of tricking you with slick sales marketing that masquerades as news.

First, however, look at the faulty analysis:

  • The article cites 15% of households with $0 net worth but is on thin ice when it converts households to individuals—unnecessarily (what is wrong with simply saying "1 out of 7 households"?).
  • The 2.6 persons per household includes babies and college roommates.
  • The logical flaw is the article's assumption that a $0 household has 2.6 persons each with $0 net worth. Each household member can be wildly different from one another—think if your roommate were Casey Serin.
  • Besides, since about 15% of households are led by a “householder” under 30 years old, 15% of households with $0 net worth is not “shocking” (as the author asserted).

How To Twist “Savings” To Trick You into Overspending

  • The author claims “shocking” news to scare you into “saving” more.
  • Even more importantly, the pitch actually gets you to spend more money.
  • There is no mention of debt reduction. The author ignores the most basic method of increasing net worth (reducing debt), and also ignores basic savings, and skips straight to investments and advertises specific mutual-fund and stock picks.
  • Swallowing his advice means that you probably will be paying fees to someone, probably while paying interest (on unpaid debts) and taxes elsewhere along the way.

The Old Borrow-To-Invest Scheme Again: Who Profits?

It is no surprise when someone advises you to do something that would profit him/her (e.g. to buy a mortgage, student loan, insurance, investment, or anything). The strange part is that people continue to fall for it.

If you pay off debt early, the bank gets less profit off you and the stock market does not get to profit off that money either. It is no surprise when the banking and investment industries (including “free” websites that make money off the stock-market culture) urge you to invest instead of paying off debt; they make money off you coming and going.

When your “impartial” friend makes that same recommendation, you might find that you can trace his/her conviction to advice from the investment industry.

Cast a Jaundiced Eye on the Old Spend-To-Save Advice

Investments are great vehicles for surplus funds but do not confuse true surpluses with amounts above minimum debt payments.

You might do all the math specific to your situation and occasionally find a circumstance where borrowing to invest will (1) profit you as well as (2) profit others—but make sure that #1 is indeed part of the result.

Wednesday, June 27, 2007

Savers Are from Mars. Debtors Are from Venus. Episode 3

Mind-Boggling Personal Story

A middle-class husband and wife live on the razor's edge of deficit and seek advice from Get Rich Slowly (GRS) when their spending habits turn a wrecked car into a financial emergency.

GRS: “Well, what about the cable bill? You’re paying $60 a month for that. That’s an easy one. What about cutting back to basic cable?” [I would add, ". . . or no cable?"]

Debtor (wife): “Yeah, but we can’t cut cable. Tom would have a fit.”

It looks like Tom is going to be very fit from walking to work.

Take the quiz: Is cable a necessity? Answer in comments.

Tuesday, June 26, 2007

How To Measure Prosper Profits Accurately

See "Prosper Private Lending Service: Do You Want To Be a Collection Agency?" for background. lenders are apt to overestimate their profits:

  • Your returns might appear high at first (when borrowers make the first payment because they are still eager and excited about their new money and the novelty of Prosper) but do not be surprised if defaults increase over time as borrowers get bored of paying and the luster of their vacation/wedding/business-that-did-not-take-off is long forgotten.
  • You never know your final profit until the last payment is made (or not made) 3 years later.
  • You can spend 2 years simply hoping that you get your principal back.
  • After that, spend another year seeing if you will get the promised 15% above principal or if the borrower will skip the last year of payments so you net 0% above principal—which would be a real 6-9% net loss after you account for 2-3 years of inflation.
Formula To Track Prosper Return on Investment (ROI)

Therefore, perhaps Prosper profits should be tracked by making the loan, recording a -100% return (100% loss), updating to a -97% return after the first payment, and so forth.

Monday, June 25, 2007

You Decide: The Best Con Artist Is . . .

An amateur or garden-variety fraud or con is when you find out too late that the fraudster emptied your bank account or stole your investment and disappeared. This is sloppy for the fraudster because now he/she is "wanted" by the law.

The "best" con artist is the worst for everyone else's safety.

The "best" con artist is the one who cons you so well that you do not realize that you have been conned, you profusely thank him/her, you eagerly return to be conned again an again, and you enthusiastically recruit your friends as new victims.

Millionaire Artist wrote:

“Girl power”, my [a@@]. I couldn’t decide what was more disturbing. Was it the fact that these women each paid $5K to join a pseudo-sorority for adults? That they felt a need to pay for friends? That they felt a need to pay for compliments? That what they “bought” boiled down to “self-esteem packaged for the idiotic”? And, oh lord, how self-congratulatory they were! They really thought they were doing something to improve themselves and the lot of women. “Your successes are successes for women everywhere,” said the Guru . . . .

What is the best con or who is the best con artist?

Remember that the best con will be very popular in a Gallup poll.

You decide: Is it a government program? "education"? real estate? cars? clothing?

(Uncivil comments are not welcome but "unpopular" comments might be necessary.)

Carnival of Debt Reduction 93 Features Home Finance Freedom

Home Finance Freedom's "The $200,000 Blunder: Housing Myths Part 2" was featured by the Carnival of Debt Reduction 93, along with a number of good articles from fellow PF bloggers. Thank you.

Personal Finance Carnival 106 Features Home Finance Freedom

Home Finance Freedom's "Freezing Credit To Stop Identity Theft: Good or Bad for Savers?" was featured by the 106th Carnival of Personal Finance at The Digerati Life in an "Epic Journey" theme, along with a number of good articles from fellow PF bloggers. Thank you.

Opt-Out of Junk Mail To Stop Identity Theft

Get Rich Slowly posted 2 useful links to stop unwanted credit offers and junk mail. You can use these opt-outs to prevent identity theft since dumpster diving for thrown-out junk mail (even ripped applications) is a tactic of identity thieves.

Credit bureaus opt-out from credit offers such as pre-screened or pre-approved credit cards (Federal Trade Commission (FTA) endorsed), or call 1-888-5-OPTOUT

Direct Marketing Association (DMA) opt-out from junk mail

See also: List of Identity Theft Blockers: How Many Do You Use?

Saturday, June 23, 2007

The $200,000 Blunder: Housing Myths Part 2

Part of a series of articles on housing myths.

Some people will make a $200,000 blunder but think that they are making money.

Chasing Unicorns

Never Prepay Mortgage? Housing Myths Part 1 covered how would-be moguls fail to assess different risk levels when keeping mortgage debt to chase possible investment profits. Some people (real people, not hypothetical people) think that a money market (unlikely to go below 0%) might be the solution to avoid stock volatility. However, less risk means lower possible returns, plus money markets fluctuate too (some crashed below 1% a few years ago). Unfortunately, some people think that they can make money even when their investment rate is lower than their borrowing rate.

Avoid Major Math Mistakes

The first problem is that people apply income tax modifiers essentially backwards, doubling the error. People vastly overestimate their tax reductions by (for instance) applying a 28% discount to every penny of mortgage interest (more on this in a coming article) and then compound the error and also overestimate their investment growth by not applying 28% taxes to their money-market interest. The first step is to estimate a realistic, after-tax return on investment (ROI).

An easy way to account for taxes on compounding interest is to discount the interest rate by your tax bracket (a 28% tax on 5.05% interest is 5.05 x 0.72 = 3.636% effective interest rate). This method is imperfect (it assumes that tax payments/withholdings and compounding occur almost simultaneously) but is much less wrong than ignoring taxes entirely. One blogger who thought that he would have $134k actually would have closer to $119k, a $15k error.

The even bigger mistake is when people make a false comparison at the 15-year mark, which ignores half the costs of the unpaid 30-year mortgage, or they mix up a 15yr scenario with a 30yr scenario. A proper comparison must be at the 30-year mark for both altertnatives.

Our Example (from a real person)

  • $200k 30yr 5.875% mortgage (at calculator).
  • $1,183.08/mo minimum mortgage payment.
  • $500/mo extra available in budget.
  • 5.05% money market investment opportunity (annual interest compounded monthly at
  • 28% federal marginal tax bracket (no state tax included here).

Keeping mortgage to invest loses over $100k

Minimum mortgage payments total $426k ($200k loan + $226k interest), offset by $325k after 30 years of money market for a net loss of $101k.

Paying mortgage early gains over $100k

Paying an extra $500/mo on the mortgage principal would pay off the mortgage after 15 years, for a total cost of $300k ($200k loan + $100k interest).

What people forget to count is that if you pay off your mortgage after 15 years, you then can invest your old mortgage-payment amount ($1,183.08/mo) plus your over-payment amount ($500/mo) for the next 15 years (remember that you paid both these amounts for the whole 30 years in the investment scenario too). In our example, $1,683.08 @ 3.636% for 15 years is $402k, or a net gain of +$102k more than the mortgage cost.

The $200k blunder

So, borrow to invest for a net loss of $101k, or eliminate debt and then invest for a net gain of $102k. That is a difference in fortunes of $203k, the difference between buying a second house or paying twice for one house.

A future article in this series will cover why the vaunted mortgage deduction would not fundamentally change these conclusions.

Home Mortgages Are Bad Investment Tools? Housing Myths Part 3

Thursday, June 21, 2007

Why Do You Have ING Direct (or Not)?

The Sun's Financial Diary mentioned that ING Direct has lackluster rates but a 52% market share and asks why.

Here are some possible reasons for ING Direct's strong market share:

  • Advertising visibility.
  • Brand-name recognition as a "real" bank without having to check FDIC lists.
  • Ease of setup (How many people bailout in the middle of other banks' applications?).
  • Minimal strings attached (do not have to open a checking account with $10/mo fee, etc.).
  • Customer service and ongoing, consistent ease of use, either online or by phone.
  • The quick gratification of the sign-up bonus.
  • People with low balances rationally value the lack of minimum balances and no fees when compared to the small dollar amount of even an extra 1% on a small balance (it will take a long time before the marginal difference of a higher rate on a small balance will exceed the sign-up bonus).
  • People keep token amounts to keep an open account for the referral bonus, which provides social/viral marketing (see advertising visibility).
What is your explanation?

List of Identity Theft Blockers: How Many Do You Use?

Here is a good list of precautions to take against identity theft from

I am still trying to find if various credit blockers will interfere with opening savings accounts.

Wednesday, June 20, 2007

Freezing Credit To Stop Identity Theft: Good or Bad for Savers?

A chastity belt for your financial reputation

Many readers of this blog probably have little interest in taking new debt and might be interested in the "credit freeze" which guards against identity theft by preventing anyone from opening new lines of credit without special permission.

My understanding is that you (or even an identity thief) could use your current credit card as normal but you would have to unlock your credit before getting new cards or opening a mortgage in your name. That sounds fine for people who dislike debt and rarely take new debt or rarely open new credit lines.

Does the credit freeze harm savers?

My question is: Since banks can run soft or hard credit pulls even when you give the bank money, will the credit freeze interfere with opening deposit accounts (savings, money market, CD) to save or invest money?

Do any of you financiers know the answer?

Tuesday, June 19, 2007

You Know Your Identity Thief

The Wolf in the Fold

Victims of identity theft often find that someone they know has committed the crime. Roommates, hired help, and landlords all have access to your home, and it is possible for them to access private information. Identity theft within families is also fairly common. This causes particular difficulties, because victims may be reluctant to notify the authorities or press charges. People are especially vulnerable when ending relationships with roommates and spouses (FRBB).
Handing your credit card number to a waiter or mail-order representative is necessary to charge something but I have raised an eyebrow when hearing that someone lent a credit card to a friend. Honest people sometimes get surprised by fraud because they go about their day without deception in mind. The other pitfall is the relationship that goes sour. Potential spite and revenge are good arguments against joint accounts. The identity-theft issue fits with long-standing debates about lending money to friends and merging finances with spouses.

Next: Freezing Credit To Stop Identity Theft: Good or Bad for Savers?

Monday, June 18, 2007

Personal Finance Carnival 105 Features Home Finance Freedom

Home Finance Freedom's "Is the American Dream Dead? Debunking the Pew Charitable Trusts' Economic Mobility Project" was featured by the 105th Carnival of Personal Finance at Get Rich Slowly in a music-themed "greatest hits" edition, along with a number of good articles from fellow PF bloggers. Thank you.

Friday, June 15, 2007

FNBO Might Decide To Keep Your Money

I mentioned FNBO's assertions that it can keep your money indefinitely and Bank Deals posted that he will attempt to test withdrawals (thank you), although he did not mention the amount.

  • Small amounts will test nothing. People want to know if they will miss their house closing when they need to withdraw 5 figures or close the account.
  • FNBO claims that it can refuse to transfer to accounts that it previously approved and used.
  • FNBO claims that it can refuse to mail a check to your physical address or even hand your money to you in person (the FNBO email warning did not limit itself to bank accounts).

Did FNBO Steal Your Money?

Has anyone been unable to get their money back from FNBO?

Here is what FNBO lets you know in an email after you have deposited money:

Because security of your account is important to us, we want you to be
aware of one of the steps we take to maintain security: We may temporarily
restrict all deposits to and transfers from your FNBO Direct account if we
determine a security risk exists and we may refuse to complete any transfer
based on the existence of a security risk. Please see the "Note about Linked
Accounts" and the "Important Note about Security for Deposits and Transfers" in
the updated Disclosures for your account here. Corresponding changes are
contained in Sections 7 and 12 of the Online Services Agreement and Section 6 of
the Deposit Agreement, all found in the Terms and Conditions here.

Thursday, June 14, 2007

Personal Finance Carnival 104 Features Home Finance Freedom

Home Finance Freedom's "Never Prepay Mortgage? Housing Myths Part 1" was featured by the 104th Carnival of Personal Finance at Getting Green in a nice Minimalist Edition, along with a number of good articles from fellow PF bloggers. Thank you.

Personal Finance Carnival 103's Isle of Misfit Posts

The Isle of Misfit Posts

The 103rd Carnival of Personal Finance did not publish Home Finance Freedom's submission because it did not match the editor's theme of a fictional counter-terrorism TV show.

Therefore, I am inaugurating a new series, The Isle of Misfit Posts, for submissions that met the carnival's requirements (no spam, etc.) but were rejected for the editor's tastes.

If your submission was rejected only for editor's tastes, send your carnival receipt and submission (so that I can post your article's link), and then link to here from a post on your blog.

Personal Finance Carnival 103's Isle of Misfit Posts

No endorsement from The Carnival of Personal Finance is is stated or implied.

Friday, June 8, 2007

Do Not Inflate Net Worth: Ignore Taxes at Your Peril

Hat Tip: Ed provoked this post.

Part of series: Biggest Net Worth Mistakes: Is Your Net Worth Accurate or Useful?

Do not deceive yourself by inflating your net worth.

Yes, it is difficult to estimate some items but it is better to underestimate your wealth and later be pleasantly surprised than to overestimate and lay a trap for yourself.

The taxman cometh.

People often leave taxes and regulatory costs off their liability list but you can be sure that the government will ignore such creative accounting and will not forget to take its slice ("But look, my blog says I don't have a tax liability because I typed it that way.").

Remember what "net worth" is.

Net worth is a snapshot of what you would have if you liquidated now. If liquidating your IRA now would incur a 35% income-tax rate plus 10% penalty, then the accurate net worth of your IRA now is about half of what your account statements say.

To say that you would not liquidate now and things will be different later is to ignore net worth. If you use a non-net-worth measure, do not call it net worth.

It is better to understand the limitations of a measurement than to cook the books.

Even if you somehow accurately predict a $1 million nest egg for retirement and dismiss your tax liability on it as "only" 10%, leaving the tax liability off your books is a $100,000 error.

To estimate what your net worth will be decades from now is a very difficult endeavor because you would have to guess at fluctuating IRA and home values, variable inflation rates, uncertain future income and saving rates, and the competing compounded interest/returns of both investments and debts.

That difficulty is why it is easier to estimate your net worth now with all liablities from current tax brackets and current laws.

Thursday, June 7, 2007

Never Prepay Mortgage? Housing Myths Part 1

This is the first in a series of articles on housing myths.

Should You Prepay Your Mortgage?

“Rule #1” of personal finance is to pay off debts because killing anti-savings is the best savings in terms of real, after-tax, return on investment (ROI). Unfortunately, the complexity of comparing relative interest rates with differing tax rules can confuse people into breaking this rule in the wrong circumstances.

Risk: A Bird in the Hand Beats Two in the Bush

The first problem is that people treat assumptions as if they were measurements. The second problem is that uncertainty is greater on your income side of the equation: The odds of you losing your job or seeing your stocks drop is greater than the odds that the bank will forget to collect its monthly mortgage payment.

You need to consider the risk or likelihood of an ROI. A fixed-rate mortgage has a fairly certain negative ROI. You might compare a 10-year fixed-rate mortgage to 10-years of CDs to compare contractually-guaranteed rates. Bond yields fluctuate but without anywhere near the principal-loss-risk of stocks so you might compare a 30-year mortgage to a 30-year Treasury bond.

Trade-Offs: There Is No Such Thing as a Free Lunch

You will notice that ROIs decrease as they approach the certainty of mortgage debt and it is very difficult to find similar-to-mortgage-certainty investments that pay more than mortgages cost. Risk being equal, debt will cost more than savings will earn (hence Rule #1). This must be so for a bank to make a profit (in a simplified business model).

Investments that appear to pay better than paying-off-debt usually offer possible profits in exchange for more risk, or offer short-term “teaser” rates.

Testing the "Never Pay Off Your Mortgage" Advice

Chazzman2000's comment at The Simple Dollar mentioned this article as an exception to Rule #1, because the article argued that you can make a bundle by investing in the stock market instead of paying your mortgage early. Fortunately, that article was written in 2001 so let’s see what would have happened to someone who read the article, closed on the exact same suggested mortgage that same day, and poured the extra money into an S&P500 index fund ever since (I randomly chose SWPIX, which did its intended job of tracking the S&P500, labeled GSPC in the chart):

The 2001 article claimed that it would estimate only a “mediocre” 12% annual return but SWPIX’s actual 5yr average is now 8.23% and its 10yr average is 7.70%, which is less than the 8% mortgage rate. If you had put the extra $300/mo. on the mortgage for the last 6+ years, by now you would have paid $6,569.45 less interest and have built $29,069.46 more equity than if you had made the minimum payments, for a combined benefit of $35,638.91, which is about the same as and probably better than the SWPIX alternative (if we counted every last detail).

Tax deductions probably would not rescue the SWPIX choice but I will cover tax-deduction myths in a coming article.

Update 6/19/07: My comments to The Simple Dollar did not always get published but his latest post seems to echo what I and others have been trying to say.

Update 6/22/07: The questionable 12% S&P500 promise resurfaced in a June 12 MSN/Money Central article that Mighty Bargain Hunter questioned.

Update 10/28/07: Note that I generously assumed the fictitious 8% S&P500 rate but the actual nominal growth from 3/01 was little above 0% and the real "growth" after several years probably was a negative loss.

Next: The $200,000 Blunder: Housing Myths Part 2

Saturday, June 2, 2007

Take a Break from Car Ownership: Know Your Basic Transportation Options

Money Smart Life knows a guy who lost his car and is staring at 20% interest to finance an emergency replacement.

The burdens of automobile ownership are common enough that this guy's situation is a good invitation for all of us to reject the trapped mindset and remind ourselves of all the options we have. Problems like his are good opportunities to reevaluate monthly expenses and often provide a healthy jolt to put yourself on a better path.

Here was my initial reply:

One option is to take a break from car ownership (including insurance, unless he’d have a renewal problem later), get rides to work, and pay cash for a cheap car in a few months. Whether you can tell him is another matter.
"No car" often means that you spend less on other things by making fewer shopping trips and therefore fewer unnecessary purchases at stores or eating out. Whether you go car-less for a few weeks or for longer depends upon your situation. You might even grow to like it when you see your bank account.

Here are more-detailed options:
  • Get rides from co-workers or friends or family (offer gas money; you still are saving a bundle).
  • Take the bus (an extra hour to conform to the bus schedule might “pay better” than driving to a second job to pay 20% interest so you can drive to the second job).
  • Bicycle to work while the weather’s nice (and no need for gym fees to stay healthy).
  • Stay worknights at a friend’s or relative’s home if they are within walking distance of your work (offer grocery money).
  • Now might be a good excuse to save housing money by downsizing to a cheaper home that is within walking distance of work (or within bicycle or bus distance of work).

As usual, you have many ways to save money if you stop to think.