Archive for April, 2008

I have been on the verge of literally pulling all my money out of the banking system and moving into US Treasuries because every month, we keep discovering how deep the hole is in the financial system. We’ve gone from Bernanke telling us that everything was “well contained” back in August of 2007 to G7 intervention and the collapse of Jefferson County.

With the FOMC today, who knows what to expect next.  More interest rate cuts?  Higher rates?  Does it matter?

There are still billions more in losses to come so I’m skeptical that the CNBC talking heads and others claiming that we’re past the sub-prime problem is anything but realistic.

I’ll likely be out of town when this article posts so perhaps some new developments will negate my concerns but as I write this, I’m very skeptical and extremely concerned about the viability of some banks.

Let me officially state that Indexes probably do return 10% per year on average but that doesn’t mean you’ll be getting that return personally.    The assumption that is made is that a large lump sum of money is invested at period x and 30 years later that lump sum of money is worth x * 30 * 10% ^t.   The often quoted myth also makes certain assumptions about individual investors such as:

An investor will never touch the money invested in an index fund.

Let’s face reality, most people end up cashing out their 401k after they leave an employer.   Most people end up borrowing or withdrawing some of their money at some point in their life for a reason or two.

An investor will make consistent and permanent contributions to an index fund to dollar cost average over the long term.

Let’s face reality, most people will change their job at least four or more times over the course of a lifetime.   One 401k will get rolled into another 401k and the investment structure and fees are not always the same much less the “lost” time in between jobs.  Suppose you are unemployed for 6 months, not exactly dollar cost averaging are you?

So what’s my beef in with index funds?    I actually don’t have any problems with index fund except for one big fundamental issues:

Index Fund creators and sellers have a huge incentive into steering you into them.   The most valuable incentive is information arbitrage.   Let’s run through some bean counter math:

If you have a working population of 50 million people and we assume that 50% are making 401k contributions and we assume that each are contributing 6% of their salary which we assume is an average 50k/year then that means that:

Each week, an index fund manager can expect inflows of about $300 million biweekly.   There’s some math that can go into the withdrawals but let’s keep this simple.

So if you absolutely knew that you would have $300 million coming in every other week and you knew that the money would be destined for an index fund how would you arbitrage that information?

You can get a spreadsheet and use a pivot table to play out any scenario you want.   One scenario that I would definitely advise you to make is the one where 78 million boomers retire and stop contributing 401k money into the system.  I think when you do that in any number of ways the implications will terrify you.

Years ago when I was heavily into Forex trading, I was a member of a rather large forum where people would post comments and exchange ideas on the currency markets.    You would think my most memorable experience would have been learning about forex charts, fundamentals, technicals or even how to read the news and Federal Reserve minutes but you would be wrong.

The most memorable experience was with a poster named “Flying Eagle” who was a die-hard American patriot.  There was nothing wrong with his patriotism except that it was leading him to losses.    The freshly minted Euro was just taking the world by storm and Mr. Flying Eagle kept shrugging it off and insisted that the US Dollar would always reign supreme.   As months passed and the USD started slipping against the Euro and other currencies, Mr. Flying Eagle kept placing heavier and heavier bets on the premise that the USD would rally.

Mr. Flying Eagle would post articles, link to sites and create long convoluted arguments  to defend his position that the USD would rally.   We would get into frequent heated discussions about the fact that the US had huge growing trade and fiscal deficits and there would be no way the USD would rally.   I explained that Europe had a populous of 700 million and it would be increasing difficult to compete against a united europe and their standard currency, the Euro.

After about 14 months it became apparent to Mr. Flying Eagle that the USD was not going to rally and I never knew how much money this guy lost but playing in the currency markets takes a bit of capital even when trading mini’s.    I was sure of one thing though, patriotism killed his profits.

Over the past months, I’ve been shopping at Costco and been purchasing items by the case load and storing them at home. I purchased cases of corn, soups, beans, rice, wine and other non-perishable products. My wife always questioned the wisdom of storing so much food in our house since we really didn’t have enough room for it but with some Costcos now rationing rice, flour and oil, I think it’s all beginning to make sense.

I’ve been warning about rampant inflation for quite some time now here, here, and here. Some bloggers even called my analysis bad and yet here we stand with the world rioting over food just a few short months later.

People will wake up and find that the $2000 emergency fund they saved up won’t be able to buy them much food, gas or much of anything else in the near future if inflation keeps climbing the way it is now. The US Dollar is at all time low against most major currencies and no one seems to care about that at all.

Don’t think that things will all return to normal next month either; People keep hoping that gas prices will go back down to $1.40/gallon – I hate to be the one to break it to everyone but that ain’t gonna happen – those days are long gone. There are 1+ billion Chinese and 1+ billion Indians that have tasted the good life and they’re not going to go back to their old ways – those days are long gone too. The days of cheap food and cheap energy are coming to an end unless some technological innovation shows up real soon.

I’ll be going to Costco again this afternoon to pick up some more food 😉 and remember Soylent Green is people!

The perpetual debate over whether someone should buy a new car or used car will never end but in honor of Earth Day this week I decided that what I am trying to do is reduce my carbon footprint. So how does buying a new car reduce my carbon footprint?

I purchased my first new car at age 25 and it was a gas guzzling SUV but I did so knowing that I would be getting married soon and hopefully starting a family. Flash forward 11 years later and I still owned that same SUV but it was time to move on to a new car as our family needs changed. So at age 36, I’ve now purchased a new vehicle which I will undoubtedly own for the next ten or eleven years.

At this rate, I will likely buy my next new vehicle at age 46 or 47, then a final one at age 57 or 58 which should last me till I’m 67 or 68. I don’t think I’ll be driving much beyond age 68 and I’m anticipating that cars in the future will likely last more than 10 years anyway so it may have a useful life beyond my own.

So if 10 million Americans purchased a new car today and vowed not to buy a new one for 10 years, I would imagine this would be better than 10 million people buying new cars every 3 to 5 years or used cars every 2 to 4 years.

There will be someone who will claim that buying used cars helps “recycle” them but I find this to be a little disingenuous. In an ideal world, a car that has been used for 10 years should be taken to a recycling center and have all the materials stripped and recycled. There is no point in continuing to operate a 10 year old car with inferior environmental controls and possible environmental hazard: leaky oil, bad gas caskets, etc.

Buy Green! Switch to Hybrid! Buy! Buy! Buy! Consume! Consume! Consume!

I’m getting tired of seeing those Wal-mart commercials asking us to buy compact fluorescent bulbs promoting so called “environmentalism.” So let’s look at this request from a purely logical point of view:

1. Rip out you existing bulbs which consumed a great deal of resources to make (more on this later).

2. Replace with new compact bulbs and save the world! Easy right?

Let’s review the real process:

1. Elements, such as Mercury, are mined from the ground and processed as a component of compact flourescent bulbs in addition to the glass, copper, and other materials used in making and packaging the bulbs.

2. The finished product (most likely made in China) is placed in a gas-guzzling diesel container ship and shipped to the US.

3. After arriving in the US, the shipment is loaded into a gas-guzzling diesel 18-wheeler where it travels a long way to get to your local Wal-mart.

4. You get into your gas-guzzling vehicle and drive to Wal-mart to buy the product.

5. You get home, rip out the old bulb (repeats step 1 – 4 for resources used to make old bulb), throw away the old bulb and packaging for new (this goes in a landfill or ocean right?)

I left out the steps where the mercury mining company uses a ton of fuel for drilling rigs, transportation, shipping, etc as well as all the other fuel burned to make the product. Ditto for copper, aluminum and glass used in the product.

I checked out Al Gore’s We Can Solve It website and clicked on the Solutions page to find these ideas:

  • Wind Power
  • Solar Turbine
  • Solar Photovoltaics
  • Geothermal Power

All of these “solutions” require consumption of more and more materials to be consumed to “save” the environment. If you looked at your Sunday’s newspaper fliers you might have noticed all the “green” products that you could buy to save the environment this week. It is the ultimate irony since there way not a single word on reducing your carbon footprint which would be primarily achieved by buying NOTHING.

Where’s the full page ad asking you to buy NOTHING? What’s next, the Earth Day shopping holiday?

I am an avid gardener. I have an appreciation for lush green environments and over the years I’ve grown all sorts of veggies along with flowers, bushes, and trees but there seems to be a myth lurking in the pf blog sphere that growing your own food is a way to save money. Over the years that I’ve grown my own food, I can tell you that the math simply won’t add up.

Consider the two ways you can obtain food: buy from a grocer (or farmers market) or grow your own. Who do you think has the advantage in either scenario?

A farmer will typically grow food on a large scale leveraging land, equipment, seed, water, and labor on a wholesale level where a home gardener will pay retail prices for most of those things on an un-leveraged basis. You can crunch the math numbers any way you want but at the end of the day the economies of scale do not favor the individual home gardener and I’m not even including tax payer subsidies!
tomato3.png
What really concerns me about home gardening however is that if millions of people decided to grow their own gardens, then the demand for water would increase dramatically. A farmer will cautiously use water to maximize the growth of his fields where a consumer will haphazardly water his/her plants to the point when a home gardener may let their “crops” fail due to poor over/under watering resulting in waste.As a person who gardens, I can tell you that I’ve been in situation where I’ve gone on vacation for a couple of weeks and come back to see some of my plants die. There have been situations where I forgot to “harvest” some of my yield and come back to seen it decay on the ground.
tomato2.png
As you can see from the photos, I have a few tomatoes plants growing in containers and the yield has been anything but spectacular. Actually, I think two of my tomato plants in one bin are dying while the others are yielding some finally!

tomato1.png
I would guess that the tomatoes in the plastic above cost $40 in fertilizer, water, potting containers, mulch, and soil. I’m not including labor! I grow roses, bell peppers and other items in my home but I don’t do it to “save” money because if anything home gardening is an expensive hobby. I do it because it helps me unwind after a grueling day at the office and it’s the one hour in the day where I don’t have to think about mergers and acquisitions, international travel, project schedules, budgets, bills or anything else and I’m willing to pay $$$ to get that hour of solitude.

I was reading an interesting article this weekend over at Slate.com discussing the next wave of housing foreclosures that will likely involve prime borrows vs. sub-prime borrows.   The one paragraph that really caught my eye is below:

Consider, too, that, yes, going through a foreclosure kills your credit rating and makes it a lot harder to buy a new house—but as more and more prime borrowers go into foreclosure, it’s perfectly possible that buying a new home a year later will in the near future be as routine and unsurprising as the once inconceivable idea that you can get a whole batch of new credit cards two years after a bankruptcy.

If millions of people are foreclosed on, there is an essential loss of millions of home “consumers” and the only way to get them to consume that inventory would be to re-issue credit to them.   So walking away from a home isn’t such a bad idea as everyone suggests as this is ultimately the way to “short” your house just like you would short stocks that you think are going to go down in value.

The other intriguing piece of information from the article,

Just two banks, Washington Mutual and Countrywide, wrote more than $300 billion worth of option ARMs in the three years from 2005 to 2007, concentrated in California.

Just two banks in one region wrote $300 billion and prime borrows may start walking away makes my spine chill because many of the assumptions about the foreclosure debacle is that only sub-prime borrowers would default.  What if prime borrowers start defaulting?  We’re looking at 2+ trillion dollars in losses!

I was combing through some old posts gathering research for an entirely different topic when I came across an old post that connected so many dots, I figured I had to write this post to try to paint a picture for everyone.

Back in September 2007, Trent over at the Simple Dollar wrote this post about grilling your own burgers at home vs. buying a $0.99 double cheeseburger at McDonalds. It was right around the time I started tracking inflation in my “basket of goods” category too so hopefully this will make sense (connect the dots).

Using Trent’s math

3 pounds hamburger @ $1.99 lb. = $5.97
16 slices cheese, store brand = $1.99
16 hamburger buns, actually 2 packs of 8 = $3.98
1 small bottle ketchup = $1.50
… for a total of $13.44. One doesn’t have to pay sales tax on these products as they’re staple foods. 16 McDonalds double cheeseburgers, on the other hand, cost $17.12.

These numbers were taken from the post back in September 2007 so flash forward to April 2008. Using my numbers for steak (sorry I’m not tracking ground beef), I have written this post outlining how beef prices have increased 7.7 percent from September to today and bread has gone up 13 percent.

So if we do the adjusted math,

3 pounds hamburger @ $2.14 lb. = $6.42
16 slices cheese, store brand = $1.99
16 hamburger buns, actually 2 packs of 8 = $4.49
1 small bottle ketchup = $1.50

So the new cost with just the two items changed is now $14.40. I’m not sure how much cheese or ketchup have gone up and I’m making a ratio assumptions on the buns and beef similar to the regular bread loaf and steak.

So if these ingredients are now $14.40 then the homemade cheeseburger is now $0.90. Getting real close to that $0.99 price and you didn’t have any cooking labor involved huh? If cheese and ketchup went up then it’s now a wash but even if it isn’t a wash, all you have to do is wait until September 2008 rolls around and do the math again and you’ll find that cooking your own burger is more expensive than buying a $0.99 Double Cheeseburge (assuming McDonalds doesn’t raise prices).

But what is the point of revisiting this anyway you ask? The Digerati Life pointed out the whole frugalism vs. capitalism debate and I pointed out that as long as we live in an inflation based economy, it is impractical to focus on frugalism as a way to get ahead economically because it erodes your quality of life. Instead of spending 10 minutes at McDonalds eating, you waste hours grocery shopping, cooking, and cleaning on the premise you’re “saving” money when that time should be focused on earning income or researching investments that will yield returns greater than the time invested. It boils down to a basic ROI/TVM calculation.

The actual post I was researching was on home gardening. I’ll probably post that next week but it is similar along the lines of this post comparing an industrial farmer to a home gardener – there’s no contest!

Most people have an intuition about whether something is of good value or not and the success of McDonalds (billions served) is an indication that this company knows how to provide good value to their consumers and explains why their stock price has increased 14 percent from $50 in September to $57 today but they’ll eventually struggle with inflation too but they have a much wider set of options to mitigate prices increases (leverage purchasing power, reduce labor, put pressure on vendors, etc).

I hope Trent posts a follow up on September 12, 2008 to factor inflation into the equation.

What tastes bitter in the morning, sweet and delicious in the afternoon but poisonous & fatal in the evening? Hint: In American society, this will ALWAYS be with you regardless of what anyone tells you and it relates to personal finance of course.

The answer is debt.

Most people get themselves in trouble during their youth, typically after college with student loan debt and credit card debt and quickly learn the “bitterness” of debt. Some have such a sour taste in their mouth from their experience that it takes them a long time to finally find the “sweet” taste in debt. They find the sweetness when they utilize debt to purchase their first home, raise children, and send them to school amongst other things. Those that do not take care of managing their debts in their elder years will find debt poisonous and fatal both in a metaphorical and literal sense.

Before anyone tells me that they have ZERO debt, let me emphatically say that the debt-free state does not exist in America. If you own a home, you will always owe property taxes; if you collect social security you will owe income taxes, if own a car, you will owe fees (e.g. taxes) on it. Remember, Webster defines debt as “something owed” and in this country, you will always owe someone (usually the State) something. Even a bum on the street that panhandles will owe taxes on the income he receives even though he may never file a return; The debt is still there, just unpaid. The only exception that I can think of pertains to Native American reservations but that likely doesn’t apply to 99% of the populous.

Someone asked me why my blog was “Intended for Individuals with Net Annual Income of $100,000 or more” as written on the header of every post and the answer is similar to the Riddle of the Sphinx. We are all in different phases in our life with different resources and priorities. Like others, I had my brief troubles with debt in my youth but moved on to understand investing and income generation as a priority. Today, there are plenty of pf bloggers who are wrestling with various issues such as debt and those that have conquered it successfully. Those pf bloggers are much closer to the issues that relate to them from which I am far removed from at this point.

I am at a stage where I find debt as sweet as any candy out there and I find it so because I have the resources and skills to reasonably manage it.