Friday, October 31, 2014

Homestead Exemption

Property taxes, once considered insignificant, are now enough to price you out of a home!

I recently received an e-mail from our former County appraiser.   He claims that an awful lot of people were overcharged for their property taxes, over the last few years, as their assessments viz-a-viz the homestead exemption, were incorrectly calculated.

This got me to investigating the issue and I found out some interesting things -  including a few that will save me money down the road, on my property taxes.

Homestead exemptions differ from State to State.  Here in Georgia, we call this the Scarlett-Williams Homestead exemption act.   Under this act, if you claim your property as your primary residence ("homestead") your assessed value is capped at the value for the first year you occupied the property.

The controversy (if there is one) is that the County claims this means the first full year you occupy the property, from January 1st.  The former County appraiser claims it is the year you bought, even if it was December 31st.

Needless to say, this has caused quite a shitstorm with the County - which may or may not have been his intent.  He is, after all, the former appraiser for the County.   The County, of course is denying any over-assessment took place.  And if they say "no", well then you have to file suit in Superior Court, and not surprisingly, many homeowners don't think it is worthwhile to go to that effort, particularly if the amount in question is only a few hundred dollars.

We bought in May of 2006, and claimed the Homestead Exemption.   Our assessed value was $131,000 that year.   The next year, the assessed value shot up to $162,000.   The county used that value to determine our taxes.  The former Assessor claims they County should have used the 2006 number and locked us in at the lower assessed rate.

The tax amount is determined by the millage rate (tax rate) for the County, City, School Tax, and the like, multiplied by the assessed value.   Our Homestead law only caps the assessed value, not  the millage rate.  So it is possible our taxes could go up in the future, and indeed, the millage rate has risen over the last nine years.

Of course, since 2006, the assessed value of the home has gone down to the point where it is now assessed at $134,000, or about $3000 more than the value in 2006.   So, other than 2007, our home was not taxed at the higher $162,000 Homestead Exemption assessment, but rather at a lesser value, which has declined until this year.

And yes, it is possible to now "lock in" this lower assessed rate by signing a new homestead exemption form.   However, as you might imagine, the County authorities don't advertise this a lot, as they would prefer you be locked in to the higher amount.  I went to the County office today and signed the papers to lock-in at the lower rate.

I will study the legal arguments made by the former County appraiser and decide whether to file suit.  I have until November 15th to file my claim with the County.   I suspect the appraiser may be misreading the law.   But I appreciate him giving me a "heads up" on this issue, as going forward, my tax bills will be lower.

Why are property taxes important?   Well, in the olden days, they really weren't.   They were an incidental part of your mortgage payment, on a par with your homeowner's insurance.  Since most folks pay these as part of their mortgage escrow, they don't even notice the overall tax bill.   You do notice it when you pay off your mortgage and the bill comes directly to your home, and you have to pay it in one lump sum, though!

And over the years, property taxes have skyrocketed, particularly in the Northeast, in places like New York and New Jersey.   This is why I no longer live in New York, by the way.   Even the South, they can be steep.   The Homestead exemption act there has backfired, allowing a few people (who have lived there a long time) to have very, very low tax bills, while the newcomers and out-of-State residents are socked with the balance.

We recently inherited a house in Florida, and it is on the market.   Under the homestead act, the taxes were a paltry $2500.   If we assumed ownership of the house, the taxes would jump to $10,000 or more.  It simply isn't affordable, even though it was an inheritance!

Why are tax bills so high?   Well, as previously noted, Florida is a special example, as its homestead law makes taxes for some folks low and for others high.   But like in the Northeast, many local municipalities have gone on a spending spree, which makes up the other half.   In New York, the big ticket items were public assistance and teacher's salaries.    The Federal Government forces the States to have welfare programs.  The States in turn, pass this off to the Counties.   The Counties in turn send the bills to the homeowners.   If you are unfortunate enough to live in a County with a large welfare population (for example, one that includes a large, depressed city with a lot of unemployed folks) then your taxes will be sky-high.

And in New York, a teacher can make a six-figure salary with huge benefits and a very comfortable retirement plan.  The unions have pushed this "underpaid teacher" nonsense for years, and have stacked local school boards and Country commissioners offices (by funding election campaigns).  Firemen and Police have done likewise (particularly in California).   And of course, even the most impoverished County needs a new school building with a planetarium (I am not kidding here, the Town of Ledyard, a small "cow town" that doesn't even have enough students to fill one school, has two new schools, one with a planetarium!).  So there are bonds to pay off for the construction of these white elephant monsters.

Hey, every high school needs a swimming pool, right?   Well, not exactly.  We didn't have one in my high school and we did pretty well (although our swim team never made the State finals).

So, suddenly, property taxes shoot up - particularly over the last two decades.   And in a way, it isn't fair.   You may own your home free-and-clear, but that doesn't mean you are "rich" or have a high income.  The tax bill is predicated that if you have a nice house, you must make a lot of money - which isn't always the case.  The bill comes, and you can't pay it.

So, many States have some sort of relief in place.  Homestead exemptions, for example, may exempt part of the home from taxation, and lock in an assessed rate.   Others cap increases in the overall tax bill by a certain percentage per year.  Still others offer relief, but only for those with low incomes, or Seniors, or both.

If you buy a home, be sure to look into this, and sign up as soon as possible.   If your assessed rate goes down (not likely to happen in the near future, I think) be sure to find out if you can lock in at the lower rate.

A friend of mine recently bought a home in Florida, and I asked him if he signed the Homestead exemption papers.  "Gee, I'll have to look into that," he said.   But a year has gone by and no doubt the assessed value of the home has shot up.   He can no longer lock-in at the lower rate.   This is not something to be blase about.

At my age (55) property tax rates matter.  As I lurch toward retirement (ding dong!  Already there!) and my income declines, it is very important to keep an eye on expenses.   And recurring expenses are the worst kind, particularly if they creep up over time.   Lowering property taxes and keeping them low is essential in retirement (as least for middle-class schmucks) as it can be all-too-easy to be priced out of your home, if property taxes start to skyrocket.

As I noted in another post, it costs me about $725 a month to live in this house, without a mortgage.   Between property taxes ($2700) and insurance ($2200), the fire fee ($650), the lot lease ($400), electric ($160 a month), water, sewer and garbage fees ($150 per quarter), car toll decals ($90 a year).  This is enough to pay the rent on an apartment, or indeed, a duplex here on the island.   Property taxes are the single biggest expense in owning the home.  Note that I have not counted routine maintenance in the mix.

When I was a kid, I had no clue about property taxes, and we lived in a house on a lake in a fairly affluent town in Central New York.   One day, the County tax appraiser came to the door and asked if my parents were home.   I told him, "No" and he stared asking me how many bedrooms our house had (six) and how many bathrooms (five).   When my Dad came home, I told him this strange man came by and asked how many bedrooms and baths we had.  And when my Dad found out I told him the truth, he went ballistic.   The County had us down as a three-bedroom, two-bath house, and it was taxed at that level.   Needless to say, the assessment went up that year.

20 years later, my parents sold that house, in part because they could cash out on the equity and in part because it was an expensive house to own, with a high property tax bill.  Waterfront property is usually socked pretty heavily, it seems.   Out-of-town owners are nailed as well.

It is possible to challenge your assessment, of course.   You can go online and look up the assessed value of your home and compare it to your neighbor's homes of similar size and location.   If your house is in line with other homes in your area, chances are, a challenge to the assessment won't go very far.  But some have tried this, with mixed success.   Usually the Tax Commissioner will throw some sort of bone to the homeowner.   But dramatic decreases in assessments usually don't occur (unless someone has seriously overvalued your home!) for the simple reason that if you get a huge reduction in your assessment, then all of your neighbors will want one as well.

Back when property taxes were low, this was not a big issue.  Today, with five-figure tax bills becoming the norm in many States, many folks are even hiring lawyers to challenge their assessments!

Of course, this tax bill issue highlights once again why it makes no sense to buy more house than you need.   You may think the mini-mansion with the granite countertops is within your reach.  But the tax bill will skyrocket the second year you live there, when the property is reassessed based on the resale price.

And indeed, in places like Florida, this was a real issue in the Real Estate meltdown of 2008.  People bought these homes and thought, "Gee, the taxes are pretty low!" because they were based on the value of the house when the previous owner had it.  And the previous owner had a homestead exemption granted in 1973.   The developer bought it from their estate and gutted and remodeled the place and sold it to you.   After the purchase, the house is re-appraised, in part based on the new purchase price (far higher than what the developer paid for the place) and suddenly your budget is whacked by an additional $8000 a year.   It was the straw the broke the camel's back, for many of these "mortgage-stressed" homeowners in the 2000's.

Property taxes matter.  And it is these taxes that the "tea party" people are most mad about.  Federal and State taxes really haven't changed much in the last decade.   Property taxes, on the other hand, have priced the middle-class out of their homes, in some instances.

UPDATE:  I was at the County assessors office getting plates for my car (auto registrations are handled by the County tax office, driver's licenses by the State Police, in Georgia).   I commiserated with her regarding the tax situation and she looked up my property.  Due to the recession, our property was assessed for less that the original purchase price and had been going down for years.  We signed a new Homestead Exemption form, which locked us into this lower rate.  So.... problem solved.

Thursday, October 30, 2014

Opportunity Cost versus Marginal Cost

Just because one activity is not as profitable as an another doesn't make it unprofitable.

I have noted time and time again that Opportunity Cost has no place in personal finances.   The folks who make Opportunity Cost arguments are often trying to sell you something or get you to borrow money.   They know that deep down, you know that borrowing money when you don't have to, is a bad idea.   So they make up these "Opportunity Cost" arguments to get you to spend.

For example, you decide to buy a secondhand Toyota Corolla.   You go to a dealer (which is a bad idea - buy one from an individual and save a lot of $$$) and tell them you want to buy a three-year-old Corolla and are prepared to pay cash for it.   The salesman says, "Well, you could pay cash for it, but you are missing the "opportunity cost" to invest that money!  If you got a car loan, you could invest that money you would have spent, and come out ahead!   Plus, the car loan will help establish your credit rating!"

Now, if you believe things car dealers say, I can't help you.  Yes, they lie - like rugs.   So anyway, once he has you hooked on financing, he points out that for "only a little more per month" you could get a fancier car (the LE model) and so forth.   Before long, you are leaving the lot with a brand-new 15 mpg SUV with temp tags on it, and you sort of wonder how this all happened.   And of course, down the road, as you struggle to make the monthly payments, you begin to realize that you were lied to, big-time.

Opportunity cost makes sense for a company, which has to weigh what projects to invest in and their relative rates of return.   However, companies also consider the effect of marginal cost and marginal pricing as  well.   Simply stated, oftentimes you can make more money by selling a product below its full cost, if the extra sale is above your marginal cost.   In fact, you can optimize your profit income in this manner.

I used as an example before, how Johnson outboards used to make a V-4 outboard (they probably still do) in a number of horsepower ranges.   Back in the day, they sold the same engine as an 85 HP model, a 100 HP model, and as a 115 HP model.   All used the same engine design, engine block, lower unit, etc., and had the same parts count and assembly cost.   They basically cost the same to make.   But if you bought the 115 HP model, you paid a lot more than you would for the 85 HP model.   They were selling Horsepower, not engine parts.

If it cost the same to make all three models, why not simply make them all 115 HP models and make the most amount of profit?   Well, the basic reason is that not every consumer is willing to pay the top price for the engine.   So you offer a lesser horsepower engine in a lower price range to snag those cheaper customers who don't want to spend as much.  You optimize your profitability when you can sell all of your production to as many customers as possible at the highest price each customer is willing to pay.

If you tried to sell only the 115 HP model at the top price, chances are you would not sell as many motors, as the lower-price customers would walk away (and perhaps go to your competitors).   As a result, your overall revenue would decline, and your factory utilization would decline, resulting in higher per-unit costs, and thus profits would drop precipitously.

And over the years, some manufacturers have fallen into this trap.   U.S. car makers decided in the 2000's that since SUVs were so profitable, that they would just sell SUVs (Chrysler, just prior to bankruptcy, had a nearly all-SUV line.  Even the Dodge Neon was replaced with a mini-SUV Caliber).   The problem with that model is, well, not everyone wants an SUV.   When you abandon entire market segments, the competition takes those customers away from you.   And since the reorganization of the American automakers, none are making small trucks - giving Toyota and Nissan free hand in that market segment.

So, it makes sense, from an economic point of view, to seek out all profitable enterprises that your company is capable of.   Why leave money on the table, just because an enterprise is not as profitable as another?   And that illustrates why "Opportunity Cost" is often a fallacious argument even for large corporations.   You may think, "Gee, we make $10,000 every time we sell a Chevy Suburban - let's just change our entire output to Chevy Suburbans!"   But the problem with that business model is, you can only sell so many of those vehicles.   Not everyone wants a gas-hog house-on-wheels, no matter how profitable it is for you.   You have to seek out more marginal transactions as well.

And even within one model line, you see marginal pricing at work.   The car companies sell large quantities of vehicles through their fleet sales programs to rental car companies and utility companies and the like.   They don't make a lot of money on these sales, as the buyers, who are buying in bulk, demand steep discounts in prices.   Why sell a pickup truck to the utility company for a $1000 profit when you can sell the same truck to a consumer for a $5000 profit?   The answer is, of course, that profit is profit, and you leave money on the table if you walk away from fleet sales.   You have an assembly line running, a factory overhead to pay - as well as workers.   Better to keep them busy with a low-profit sale than to lay them off with no profits and no sales.

And in your personal life, this economic theory makes sense.   Yes, if you make $50 an hour at a job (the mythical six-figure salary), it is not as "profitable" for you to mow your own lawn, which may take two hours and could be done with outside labor for $25 an hour.   Although even then, if you figure out how much you'd have to make to pay taxes on the income you'd need to pay the lawn service, it comes pretty darn close!   But that doesn't mean that mowing your own lawn isn't saving you money.   Because it is - about $75 in all, if you figure out how much you'd have to 'earn' at your job to pay the lawn service.

And as I noted in my previous posting, it is not like you can make more money at your job by not mowing your own lawn.   Very few of us have jobs that pay us more money for more work.  Most us either are on salary (which means no increase in pay for increased hours of work) or have fixed hourly work-weeks (as employers are loathe to pay overtime, or even to pay full-time!).

The time you take mowing your own lawn isn't time "taken away" from working at your job.  It can, however, be time taken away from watching television, shopping in the mall, obsessively texting, or surfing the internet.   All of those activities are not "money earning" activities, but rather money-wasting activities.

And for most Americans, this is where the "free time" liberated by hiring people to wipe their ass goes to - the television.   As I noted in an earlier posting for Bath Remodeling, the normative cue set forth in the advertisement is "Why do it yourself?" when you can hire this company.  And happy consumers are shown napping on the couch, watching television, or doing yoga - or other profit-making activities (sarcasm light is ON), instead of cleaning the grout in their bathrooms.

I have a friend who was a stay-at-home Mom.   They hired a maid and a lawn service, as they were "too busy" to do these tasks themselves.   What did she do with her free time?  Sit around and watch television.

Or take one of my old bosses.  He hires a lawn service to mow his lawn.   He then laments that he is getting out-of-shape due to his sedentary lifestyle.   So he pays money to go to a gym to work out.   The time he "saves" by hiring people to do things isn't used to make more money but rather used to spend it.

Walking away from marginal profits is dumb.   Using that energy to spend money is even dumber.   It would be like GM saying, "Let's only sell giant SUVs as they are the most profitable!  And with all the time we are saving, we can set fire to the factory!"   It is, in short, insane.

Now, yes, there are folks out there whose time is so valuable that they hire people to literally wipe their asses (so-called "personal assistants").   Celebrities, politicians, high-power executives and the like, are such in demand that they need to hire people to do a lot of the mundane things that we little people have to do ourselves.

And yes, the very rich can afford to live on estates and hire gardeners and the like, as they are very rich.

This blog is not aimed at Rock Stars or the very rich.   And here's a clue:  You ain't a Rock Star or very rich, particularly if you are reading this blog.

And that is the trap, in a nutshell, for the middle class.   As "strivers" we try to take on the trappings of the very wealthy.   We hire a maid service, or a lawn service, or a pool service.  We pay someone to "detail" our car (instead of washing it ourselves).  We use restaurants as our personal chefs, so we don't have to cook or do dishes (Tony Blair washed dishes, and he was PM!).   

In short, the middle class squanders away thousands - if not tens of thousands - of dollars every year, trying to play "pretend rich" and ends up broke and unhappy.   "Who took all the money away?" we cry.  But the money wasn't "taken away" - we gave it away, freely and willingly.

When you hire someone to do basic things in your life - that you are perfectly capable of doing yourself - then you are throwing money away and leaving a profit that you could have had on the table.

(And note, I said, basic things  that you are perfectly capable of doing yourself.   If you don't have the skills for a job, it makes sense to hire it out.  Not everyone can roof their own house or tile a bathroom.  For some particular jobs, yes, it makes sense to hire someone.   Mowing the lawn, running your vacuum, washing dishes, or washing your car, are not specialty jobs!)

Remember - labor you do yourself is not taxable.  And neither are savings.  For every $1 you save in not spending or doing something yourself, you are saving $1.25 to $1.50 in income (with taxes and all).

Are you sure that incremental profit isn't worth going after?

Wednesday, October 29, 2014

Self-Justifying Poor Lifestyle Choices

More viewer mail....

A reader writes:
"I was wondering if you'd explain the rationale of constantly cooking at home versus ordering take-home instead. There are surely advantages of buying dinner for two at a Chinese place for $28.00. The biggest one being that the dinner-for-two deal will save you oodles of time cleaning dishes, which is time you could use making money.  I have done the math with this thing, and eating out all the time at sit-downs surely is a waste of time and money in the long run, but if you can order something on your way home -- assuming you call it in first and it's ready to pick up -- then take out is by far a better deal in terms of time.

When I lived in Columbus, Ohio, I cooked for myself all the time at home.  I loved to make fried chicken in a pan, but when all was said and done, the kitchen was stuffy, and there was grease everywhere; it was a mess from hell to clean.  Finally, I went to Church's or Popeye's and bought take-out: a 10-piece deal for 12 bucks.  For a couple more dollars, I could get some milk biscuits. That deal saved me tons of time. I don't totally agree that cooking at home all the time is the best deal.  Time is money, and dirty dishes and greasy pots and pans take time to clean.  If you are running a small business and time is of the essence, cooking at home is a lousy deal if you do it all the time.  If you are going to eat at home, the best deal is to buy pre-prepared foods like potato salad, frozen pizzas (the gourmet type), and and an assortment of other things.  That is just my take on it."
This is hard to parse on a number of levels.   First, let's address the "straw man argument".   The reader writes. "I was wondering if you'd explain the rationale of constantly cooking at home..." which implies that I am suggesting you should never, ever, ever go to a restaurant, ever.

I never said any such thing.   What I have said is that using a restaurant as your kitchen - eating restaurant meals five or more nights a week, is a very poor financial choice and horribly bad for your health.   And yet many Americans will eat out several nights a week, and also eat out for lunch at work, several days a week (if not all the time).
A restaurant meal should be a special occasion or an occasional thing.  It should be a special treat (after all, it is so expensive) and it should be good, and preferably you share it with someone special or a group of friends.   Sadly, most Americans use restaurants as their kitchen.  They pull up to the drive-though window with the same attitude they have when refueling their car.   How many calories can I get for my dollar?

And no matter what kind of restaurant you go to, it is a lot of money to spend.   Far more than you need to spend.
The reader continues: "There are surely advantages of buying dinner for two at a Chinese place for $28.00."   $28 for Chinese food?  That is a LOT of money!   You could buy ingredients to make four meals for that $28.  (maybe the reader is trolling me here? I don't know).
If you ate this way, every day, it would cost you $10,220 a YEAR.   Read that again - TEN THOUSAND DOLLARS!   That's a lot of dough.

And let's not forget the health cost - most Chinese food in America (which is not Chinese at all*) is loaded with salt, sugar, and MSG.   This is a health nightmare in a Styrofoam clamshell.

If you throw in lunch and breakfast this way, you could easily be talking $25,000 a year.  Last time I checked, that is a lot of money - enough to buy a nicely loaded Camry.   For someone making $100,000 a year, is it is a staggering amount of money.

And bear in mind, in order to have $25,000 to spend on restaurant meals, you have to EARN at least $40,000 to pay the State, Federal, Social Security, and Medicare taxes.   Is take-out Chinese food really worth an entire car every year?   Is it worth the inevitable type-II diabetes and heart attack?   Sadly, most Americans seem to think so.

The reader continues (digging himself in deeper):  "The biggest one being that the dinner-for-two deal will save you oodles of time cleaning dishes, which is time you could use making money."   I have posted before about "Opportunity Cost" arguments and why they have no place in personal finance.
When you resort to making "Opportunity Cost" arguments to justify a financial decision you've made, it is a sure sign you have made a poor financial decision.
Opportunity cost has a place in business and commercial finance.  If a company invests in plan A, that means they forgo the opportunity to invest in plan B.   Both are potentially money-making ventures.

Personal spending, on the other hand, is just spending.   If you borrow money to buy a car, opportunity cost doesn't enter the picture.   Why?  Because there is no other mythical "plan B" you could invest that money into, as you don't have the money in the first place (most folks, don't anyway - they just want a shiny new Camaro).   And comparing the risk of not paying loan interest (which is a safer "investment" than a government bond) to risks in the stock market, is comparing apples to oranges.
This myth that you could be "making money" instead of washing dishes or cooking is just that.   What are you going to do?  Drive back to the factory and punch in?
Or drive back to the office?  Oh, wait, a salary job doesn't pay you extra for working extra hours, does it?
What you really MEAN when you say "Make more money" is "Watch more television."  Because life and work doesn't work that way.   If I order take-out food from a restaurant (or delivery pizza) it doesn't mean I have "more time" to write an additional Patent or file another Trademark - for the simple reason that I can only do so much of that kind of work in a day before the mind gets fatigued.

On the other hand, I still have the energy to make my own meals, mow my own lawn, or vacuum my own carpets.   The idea that hiring others to do these things will free me up to write Patents 24/7 is just a fantasy.   Hey, why not take methamphetamine and then get back all that time "wasted" sleeping?  Have a colostomy and get back all that time "wasted" on the toilet?   Throw in a catheter while you are at it.  Just strap yourself into your chair and work 24/7.   Makes sense to me!
Now granted, there are instances where sending out for food makes sense.   You are in the middle of an Engineering project with a deadline, and everyone is working late to get it done.   But usually then, the boss sends out for food (if he has any common sense) so that people can keep working.   But that kind of intense labor is not something you can do every day - without burning out.

So, no sale on "opportunity cost."  When you resort to making "Opportunity Cost" arguments to justify a financial decision you've made, it is a sure sign you have made a poor financial decision.   Car dealers, mortgage brokers, and investment counselors will all resort to "Opportunity Cost" arguments to get money out of your pocket.   They want you to borrow as much as possible and go into debt.  These generally are people with economic interests that are diametrically opposed to your own.  So you expect them to make such arguments.   But to use them on yourself?   Who are you deceiving here?

Note there are some other "Straw Man" arguments presented here.   According to the reader, the only thing to compare take-out food with is the messy business of frying chicken - one of the most labor-intensive and messy meals to make.   By selectively picking one particularly difficult meal as representative of all home cooking, he can slant the argument in his favor.

But still, no sale.   I leaned to wash dishes long ago at the Old Tyme Gaslight Restaurant.   It isn't that hard and takes maybe 15 minutes, if that.  I find it easier and faster to hand-wash them than to use the dishwasher.

How do I know all of this?   At one time at my life, I made the same stupid arguments myself - I lied to myself to self-justify self-indulgent behavior.   Hey, I was billing out at $250 an hour as an Attorney!  For any activity that cost less than that to hire someone, I might as well just hire it out!

But two things happened in quick succession.  My credit card debt started to skyrocket - and I began to wonder "where the money all went".   The second thing was, I got fat as a house and started to feel like shit.  And it takes decades, if ever, to lose that weight.

That was, of course, false logic.   While I might bill out at that amount, it did not represent my hourly income.  And an hour "saved" from some more pedestrian task was not another hour billed, in most cases.   You can only do so much work, without losing your mind.   A better approach, I found, was to use my non-working time to attend to my own life - washing my own dishes, mowing my own lawn, and balancing my own checkbook.  After doing these things, I was mentally refreshed and able to go back to more intellectual work.   It also got me out of my office chair.

Restaurant food, fast food, take-out food, and prepared entrees, all have two things in common:  They are very unhealthy for you and they cost far more than making the same meals at home.   Read Anthony Bourdain's Kitchen Confidential sometime.  The "secret ingredient" restaurants use to make food taste good is butter and tons of it.   Order a steak?  They put butter on it.  It tastes more savory and juicy.   And we're not talking a small pat, either.   Some entrees have a whole quarter-pound stick.   And then they load up the meals with empty carbs (bread, rice, pasta).   It is very, very unhealthy, and as I noted in an earlier post, about four times as expensive as cooking at home.

What I learned over the last decade or so was that it is possible to go out and make a boatload of money in this country - $150,000 a year or more - and still end up broke.   And the simple reason is the "logic" that the reader is applying here - that "convenience" trumps cost every time, and that we are all so "busy busy" that it is OK to indulge yourself and stop keeping track of money.

The opposite is, of course, true.   Once you take your eye off the ball, all hell breaks loose.   Wealth - real wealth - is not measured in taxable income, but measured in your net worth.  High-paying jobs and businesses can be a trap, as they encourage you to think in terms of "opportunity costs" instead of real costs.   It is all-too-easy to think, "Gee, I am making so much dough, that I don't need to worry about small expenses anymore!  Let's send out for pizza!"

Such is the road to middle-class poverty.

* An American entrepreneur recently opened a restaurant in China, serving American-style Chinese food.  The Chinese, of course, were mystified.   They had never seen Chow Mein, General Tso's Chicken,  or Fortune Cookies.  These are not Chinese at all - nor is MSG or half the slop they put in "American" style Chinese food.    How our version of Chinese food got the way it did is an interesting question.   However, we've pretty much done the same thing to Mexican and Italian cuisine as well.

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Buying stock based on anonymous e-mails is a really bad idea.

In the SPAM box for the last week has been the above "stock pick" touted by an anonymous sender (who sends under a variety of made-up names, so you know he's legit, right?).  The Pump 'n Dump scheme has been around for ages - even children can play - but what makes this one interesting is that they are using a mainstream stock (albeit one that is nearly dead) as part of the scam.

The scam is simple.   First, find some cheap, obscure stock in the "penny stocks" category.   These are stocks, usually for small companies, that are rarely traded, and are worth little to nothing.   You find one with a name that sounds kind of tech-y and such.  Maybe "Tech-co" is good.  You buy up a lot of this stock - as much as you can afford - at a penny a share or so.   The very fact you have purchased so much stock (maybe only $100 worth!) makes the price go up to two cents.   Suddenly, there is a demand for this sleeper stock!

Next, you buy a e-mail list from some dubious source, such as Russia.   For a few dollars, you can buy a few million e-mail addresses.   You then set up your e-mail account (preferably using some scheme to send the e-mails from an untraceable source, such as a Botnet of Zombie computers.)   Again, your Russian friends may be able to help.  The e-mails tout "Tech-co" as the latest and greatest stock.  They have a new product coming out!   What's more (thanks to your buying) the stock has doubled in price in the last 30 days!   Better jump on the bandwagon before it is too late!

Now you wait.   All the chumpsters out there, who believe in Fairy Godmothers and something-for-nothing (about half the United States) get your e-mail and think, "Gee, this is it!  My ship has finally come in!   An anonymous person is sending me a stock tip that will make me rich beyond my wildest dreams."

And so the chumps buy.   And they buy.   And since they are buying this unheard-of stock which hasn't changed in price in ten years, the price suddenly shoots up to 3 cents a share - then 4, then 5!   Wow, that anonymous e-mailer was right!   This stock really is going somewhere!   It tops out at 7 cents a share.   Meanwhile, you've dumped your shares at 6, making a nice $500 profit on your $100 investment.

Of course, the next time around, you can buy a lot more stock than $100 worth.   Pretty soon, you are buying blocks of penny stocks for tens of thousands - hundreds of thousands - of dollars.   The teenager who popularized this scheme reportedly made millions - while still in high school!

Of course, eventually, the stock peters out and drops back to a penny a share.   As it turns out, there was no "there" there in Tech-co, and once people stop buying the stock, the price plummets.

Well, OK, you say, this seems like an obvious fraud.   Who takes investing tips from anonymous e-mails?   Only greedy idiots would do that, right?  And greedy idiots get what they deserve!

But these schemes are just egregious examples of what happens in the stock market all the time - legitimately.   You see, whenever one of the financial channels or columns or websites, or the shouting guy on TeeVee just mentions a stock, the plebes go out and buy that stock.   Demand for the stock rises, and thus so does the price - the law of supply and demand.  And at least initially, the prognosticators can say they were "right" - as the stock price went up!

The real "value" of the company, however, has not changed overnight.   Prognosticators will say the company is now worth umpteen billion dollars, based on its "Market Cap".   But as I noted before, things like "Market Cap" are bullshit.   The price of the last share bought is not an indication of the overall value of a company.

In fact, stock price often is an erroneous indicator of a company's value - in the short-term or the long-term.  Just because you paid $10 a share for Tech-co doesn't mean the company is "worth" $10 times the number of shares outstanding.   If the founder of Tech-co (who owns 60% of the shares, and you'd know that if you did the research) decided to sell all his shares at once, the price per share would drop dramatically - the law of supply and demand kicks in again.   When you flood the market with shares, there are not enough buyers to snap them all up, so the price drops.

Right there you can see that it is possible to control the price of a stock by controlling how much of it is available for sale.   Certain stocks have outrageously high prices, simply because a lot of people think they are "valuable" and thus hang onto them - rather than sell them - and thus not a lot of shares are available for sale.   Similarly, if a company decides to raise capital by selling more stock, it floods the market with new shares - which can bring down the price of existing shares if there are not enough buyers ready to buy.

In other words, share price is less an indication of a company's overall value than it is an indicia of the supply and demand for the shares.   Stocks are just products - like the items on the shelves in your grocery store.   How much each item costs depends less on how much it costs to make, and more on how much demand there is for the product.   It does not cost a lot to make Caviar.   However, there isn't a lot of it to go around.  Hence, prices are high. 

The price of most commodities works the same way.  The price of oil has dropped lately, because demand is down and there are a lot of distressed Middle-Eastern countries willing to sell it.   It has little to do with the cost of drilling for oil, but rather the supply and demand in the marketplace.  In 1973, when the Arabs shut off the tap completely, the price of oil skyrocketed overnight.

So that is why you see some stocks with outrageous prices.  Linked-In, for example, is selling for over $200 a share, and has a P/E ratio of over 700.   You'd have to hold this stock for 700 years, at today's P/E ratio, to break even.   Apparently there are a lot of people who like this stock - or who think the company will become wildly profitable in the next few years (I'm already sick of Linked-In and its constant needy pitches to join - aren't you?).   But people believe that is will be worth something down the road, an hence have driven the stock price up.   The stock price, however, doesn't represent the real value of the company.

And often, companies can go their entire lives without turning a profit or making much money for their investors.  And tech companies are particularly prone to this.  As I noted in an earlier posting, Nevil Shute Norway, the fiction author, also founded an aircraft company, Airspeed, which made a number of aircraft for nearly three decades, before being acquired by Vickers.   The company rarely, if ever, paid a dividend, and in the end, he noted, the original investors would have been lucky to get their money back, after nearly three decades of investment.

Airplanes were the "high tech" investment of the day, and he recalls that when some shipbuilding companies invested in Airspeed (and put members on the Board) they could not understand the financing of this new industry.   After all, with ships, you made a profit on each one you built.   These airplanes made no sense - the company was building them like mad and selling each one it made, and yet still losing money.

And that right there is a cautionary tale for those who want to invest in tech companies or internet stocks that never seem to earn a profit or pay a dividend, but promise that "right around the corner" huge potential exists.  You see, the problem is, your best-selling biplane of today is outdated in a matter of months, and you have to go back to the drawing board, start over, and possibly sell more stock to pay for the next "latest, greatest, thing".    These sort of investments are not for the faint of heart.   And usually the stock prices reflect people's beliefs about the value of the company - not the actual value in terms of profits made and dividends paid.   Belief is a powerful thing - but one best left to answering questions like, "Why are we here?" and "What happens when we die?" and not "What should the share price of Tech-co be?"

Again, the missive I received (about four times now) is interesting in that it is not targeting a penny stock, but rather what was once a mainline stock of one of the largest retailers in America.   The problems with J.C. Penny are well-known.   Many assume that it will be bankrupt within a few years.  Whether such an old-line "chain" store can "turnaround" its sagging market share, store closings, declining revenues, and cash hemorrhaging, is anyone's question.   J.C. Penny has the same problem that GM did - when a company shrinks in size, it ends up with more people collecting pensions than are employed.  Pretty soon, the retirement costs (for the previous generation, who retired when the company was strong) make up a huge chunk of the overall operating costs.

While it is possible you may see a "dead cat bounce" on this stock, I doubt it will go up dramatically in the short- or long-term.  The problems plaguing old-time retailers are not going away anytime soon.  And this is true for Kmart/Sears as well as Radio Shack, which seem to soldier on, in spite of increasingly difficult and long odds.

Note also that the e-mail above sets a "target price" for the stock.   Now of course, you would say that is a totally specious number that is taken out of thin air.   After all, this is from an anonymous e-mail, right?   But the prognosticators on the financial channels do this all the time - shouting "buy" or "sell" and quoting "target prices" that they pull out of their ass (with both hands).   These "target prices" are never explained in any detail.   What would drive the price of the stock up (other than a pump 'n dump scheme?).   Are profits up?   Are dividends up?   Are sales up?   Has management cut overhead and expenses?   What?

Sadly, these "legitimate" financial news sources are about as reliable as anonymous e-mails.   And that is one reason right there not to listen to them.   If you buy and sell stocks based on what the media says, chances are, you are going to trade yourself right down to nothing, in a short period of time.  The idea that one can outsmart the market with some sort of "system" or trading scheme or tip sheet is flawed.   You might as well go to the horse track - which offer the same systems and tip sheets.  The trading companies will be happy to take your money, though!

Tuesday, October 28, 2014

Financial Black Holes (It doesn't cost me anything to keep it!)

Many middle-class folks have a financial black hole that swallows up their money.

I wrote this blog for my own purposes - to analyze and figure out where "all the money went" as a middle-class person.   This is not a blog about coupon-cutting (which I think is generally a waste) or how to stretch your food budget by using breadcrumbs as a filler.  There are other blogs that cover that sort of thing.   No, I am more interested in why people in the middle class seem to be falling down the economic ladder.

And over the last few years, I have learned a lot.   For starters, there are a lot of little recurring expenses that can bankrupt you - things like cable TV, cell phones, and other subscription services (or repeated purchases) that over time, add up to thousands of dollars.

For example, a friend pays $189 a month for their cell phone bill.   And I think he is being honest about this.  Many others claim to have lower bills, but they quote only the "come on" price, not the regular price (once promotional periods end) and also don't quote the amount they actually pay, with taxes and fees every month, which can be $20 to $50 more than the base price.  Like penis size and gas mileage, men lie about their cell phone bills (and so do women!).   $189 a month is about what it costs to make a loan payment on a car.  And yet, if you asked someone if their cellphone was worth a car they would say, "of course not!"   But yet, they are paying as much as, if not more than, their cell phone than they are for their car.

And the same is true with bad spending habits. Paying $5 a day for coffee at Starbucks comes to about the same amount of money over time.   And that money, invested at 6% interest over 30 years, comes to $152,938.06 in your 401(k).   Or paying $12 a day for lunch at work - or spending $20 on a delivery pizza.   Over time, these things add up.

But those are just a few examples of how small monthly expenses can add up to big costs, over time.   And over the last few years, I have cut these expenses to the bone.  I pay $100 a year for my cell phone.  A year, not a month.

However, there is a second group of expenses that can be a far more serious detriment to your finances.  They can form what is essentially a black hole in your wallet - sucking money out so fast, you don't even know where it went. And many middle-class people have these kinds of expenses, and yet fail to see them.   Often these are the "Sacred Cows" in their lives, that they spend enormous amounts of money on, while complaining about being flat broke all the time.

What sort of expenses am I talking about?  Houses, Cars, Boats, RVs, Airplanes, Motorcycles, etc. - that are purchased and then used for a while and then abandoned.   I am not talking about the mere ownership of these toys (which can be an enjoyable hobby for a while) but how people hang on to these things long after they are "done" with them.  Since the item is "paid for", they believe that "hanging on" to the item in question doesn't cost them anything to keep it.   But in reality, every day they own the item in question, it costs them money, in terms of expenses and in terms of depreciation.

Let me give you a few examples, based on real-life experiences of people I know.   Some of these I have touched upon before in this blog:

1.  Henry owns a boat.   It is a 30-foot twin-engine powerboat that he paid $40,000 for, a few years back.  He and the wife used it a lot, but now he is older and the wife is no longer interested in boating.  He pays $300 a month to store his boat.   I met him at the boat storage place (where I kept my boat) - and his experience is one reason I sold mine.  At the time, he was having the outdrives overhauled (on a boat he no longer used!) which cost him $3000 in parts and labor.

He is spending about $3600 a year on storage, and another $3000 on maintenance, fuel and oil.   That is pretty easy to calculate.   But the boat is now worth about $20,000 - and every five years, it is dropping in value by about half.  So in the next five years, he loses $10,000 in equity in the boat, or about $2000 a year.  That's five dollars a day, right there.  The total cost of ownership is thus $8600 a year (on a $40,000 boat!) or $23.50 a day.

That's a lot of money, to be sure.   And if you figure that in terms of income, he'd have to earn about $12,000 a year in pre-tax income, you can see than $8600 is putting a real dent in his retirement income.

Now again, I am not anti-boat.  Boats are fun and all.   But when you stop using them regularly, they become a huge expense - just in terms of depreciation - and do not provide any real reward in return.

I asked Henry why he kept the boat.   "Pride of ownership" was his reply.  I think Henry may have had a mini-stroke or something.   "Pride of ownership?"  That is about the dumbest thing I have ever heard of.   There is no pride in paying money for a commodity item.

2.  Suzie and Earl own a 40' Boat.   They made the "circle route" in it (up the ICW, across the Erie Canal, across the Great Lakes, and down the Mississippi) many years ago.  After the trip, instead of selling the boat, they kept it, tied at their dock.  They used it a few times, but for the last ten years, the boat has not left the dock.  They now want to sell it, and it is worth nothing.  

Earl says, "I could have sold it ten years ago, but I wouldn't have gotten much for it - maybe half what I paid for it, so I decided to keep it.  It wasn't costing me anything!"

But, au contraire,  it did.   You see, that was an $80,000 boat, and he could have recouped $40,000 if he sold it back then, in working condition.   Today, he would likely have to pay someone to tow it away, or hope the "Boat Angel" people would take it as a donation.

So yea, he lost $40,000, or about $4,000 a year, by keeping this boat on the premise that "it isn't costing me anything!"    It was actually costing him about $10 a day.  But most people don't see that - the money flying out of their wallet on a daily basis, by keeping a "paid for" toy they aren't using.  Depreciation doesn't show up on your bank account, tax returns, or in the dollars in your wallet.   But it is real.

And by the way, how do you think these "donate a boat" places stay in business?   The simple answer is this:  There are hundreds, if not thousands, of such abandoned watercraft, lingering in folks' back yards, at boat hoists, marinas, and storage lots, all across America. These are middle-class people who complain about "living paycheck to paycheck" but yet let these hugely expensive toys molder and depreciate.  Their heirs often have to dispose of these derelicts by giving them away to donation places.  That is how they stay in business!

Of course, many of them are upside-down on these items, so even the donation folks can't help them there!

3.  Fred and Wilma own a 45' Sea Ray.   Fred rented dock space from me in Florida.   He and the wife enjoyed the boat and went to every dockside restaurant on the ICW in Florida - twice.  He took it out on the ocean a few times, but his wife didn't like that - it scared her.  Within a few years, Wilma was bored with boating, and Fred was losing interest, too.

And the twin gas engines sucked fuel with two straws.   Fred was lucky to get 1 mpg in his boat, if that.

Fred stopped using the boat due to health problems.   He kept upgrading the boat, hoping his wife would be interested again, and he could handle the Florida heat.  He upgraded his generator and added two air conditioners.   But Wilma still was bored with boating, and the boat never left the dock.

Again, Fred justified keeping the boat on the grounds that "It isn't costing me anything" as it was paid for.  But the depreciation on this beast was running at least a couple of grand a year (it was pretty old at this point) and I was charging him $150 a month in dock rent.   And a string of mechanics came to work on it, as every time Fred started the engines, something would go wrong.   Boats do not like to sit, particularly in salt water!

4.  Joe is retired and his wife died.  He hasn't remarried, but he has a girlfriend who is a widower.  She has a motorhome that she and her late husband bought for $250,000.   After he died, she decided to keep the motorhome.   She never uses it.   She hires a mechanic to come out once every few months to start the motor and see that everything is still working - and to pressure-wash off all the dirt and grime and mold and algae that forms on it.   She stores it in her side yard, so she says (wait for it), "It ain't costing me anything to keep it, so I might as well keep it!".

Again, she fails to consider the cost of the mechanic (about $200 a visit, four times a year, or $800, plus parts like new batteries).   But depreciation is the biggie - $10,000 a year or more.   Motorhomes can rapidly depreciate, and an older coach like this will still need a lot of work, even though she has it serviced regularly.   New tires for such a bus can cost $3000 or more. 

Keeping an old motorhome as a talisman of your dead husband is an awfully expensive talisman!   Maybe keeping his ashes on the mantle is a cheaper alternative.

5.  Linda's parent die and leave her the family home.   Linda wants to sell the home, but it is full of her parent's possessions.   Every time she goes to visit the home, she breaks down in tears about her parents, and re-lives moments from her tormented childhood.   It has been three years since her parents died, and she has yet to clean out more than a few items from the home, much less prepare it for marketing.

The property taxes are a staggering $10,000 a year.  Insurance is another $2,000.   Then there are trash fees, water bills, sewer bills, utilities, lawn care, regular maintenance, and the like.   The house is easily costing her $15,000 a year (!!!) to hold as a keepsake.

Yet, she complains she is short on money to remodel her new home.   When pressed on the issue, she says, "Well, it will take me a long time to go through all their things, and besides....."

(you guessed it)

"..... it isn't costing me anything to keep it!"

Her husband, of course, disagrees.   And a nasty divorce could be on the horizon if they don't sort this out.  Sadly, I see this game being played for years more, before anything changes.   Linda likes to complain about this massive "burden" in her life - the friend with the easily-solvable perpetual problem.

Her husband prays every night for a house fire.

* * *

The list goes on and on.  Expensive motorcycles languishing in the basement.   Hobby cars under tarps in the garage.    Airplanes gathering dust in hangers.   Houses left unoccupied and abandoned for no reason at all.  And the people who own these things are not "rich" by any stretch of the imagination.   They are middle-class and upper-middle-class people who just don't understand money and how it works.

They think that just because you own something outright, that it is yours forever and it "doesn't cost me anything to keep it."   But that is rarely the case.   These possessions depreciate down to nothing, over time.   And while you cannot see depreciation blowing money out the window the actual cost is there.   And if there are maintenance, storage, registration, insurance, or other recurring costs associated with the unused item, well, then, the costs can be staggering.

Even if you are making $100,000 a year or more, an expense of "only a few hundred a month" can be devastating to your finances.   As I noted before, for someone making a hundred grand a year, maybe 10% of that is "disposable income" (about $10,000).   Thus, even $100 a month represents more than 10% of that disposable income.  And bear in mind that in order to make that $100 a month to pay for your unused toy, you have to earn $120 a month or more to pay income taxes and the like.  It really adds up.

What really fascinates me is how prevalent this sort of thinking is.   I've given five examples above, but I can point to maybe a dozen more, just relating to people I know or have met.   I suspect this sort of "dirty little secret" is quite common in the middle class.  (Just sitting here, I can think of two more friends with boats languishing in their backyards.  The list goes on and on!).

And it is one reason we decided to downsize our lives.   Yes, we had two boats, six cars, and two houses, and it was fun and all.   But after about eight years of "snowbirding" we decided that, well, we didn't want to do it anymore and we sold it all while we could still get something for these "things" in our lives that cost a lot to own, in terms of maintenance, taxes, insurance, registration and depreciation.   Once you have "been there, done that" it is time to sell out and move on.

This is not to say we will never have a boat again.   But if we do, it will be to make a certain trip, and then sell it - rather than keep it and pay for perpetual storage, insurance, and maintenance.

"Things" are transitory in your life, and there is nothing wrong with disposing of a favorite toy, once you are done with it.   Hanging on to "things" is a bad idea, as you are frittering away your income.   The material is mortal error.  What you do with material things is far more important than the mere possession of them.

It is hard to feel sorry for the "put upon" middle class in America.   They make good money, but squander it faster than they make it.  They buy expensive toys and then let them rot.  The blow through money on designer coffees and status smart phones.   And then they whine and complain about how awful the economy is and how it all has to be someone else's fault.

It is not like we are living in Syria or something.   In fact, the economy is doing quite well.   But in order to get ahead, you do have to keep your eye on the ball.


The next time you hear someone (or yourself) say, "It doesn't cost me anything to keep it!" - think again.  Chances are, you are not seeing the full picture, and the item you are refusing to sell is in fact, costing you dollars a day, in depreciation alone.

Monday, October 27, 2014

Fiddly Bits

If you buy a bag of fertilizer, use it all. 
 There is nothing to be gained by saving a quarter of a bag of it.

When my Mother died, my Dad sold their home and moved. I helped him clean things out and he loaded up my truck with a lot of junk from the garage.  There were many small bags of fertilizer, lawn food, pesticides, and the like, that my Mother bought for yard work. For some reason, she would always use about 3/4 of the bag or more, and then "save the rest" for some unknown future need.

Needless to say, most of it was going in the garbage.  The fertilizer was now in a solid brick and not usable.  And of course, throwing such things away is problematic - you basically have a Hazmat cleanup problem on your hands.

The same is true for paint.   Many homeowners do a small painting project and buy a pot of paint.  They use most of it, and then try to "save" the remainder by re-attaching the lid.   What ends up happening, of course, is that the paint hardens like epoxy in the rusty can of paint.   Pretty soon you have a garage full of such crap, and then get depressed trying to clean it all out.

 [as the Simpson family, who are finally together again, are about to leave the Springfield river]
Marge Simpson: So what was it like at the Flanders' house?
Homer: Yeah, gimme all the dirt.
Lisa Simpson: Let's see. Dirt... dirt... well, there wasn't really much dirt.
Bart: There was a bunch of old paint cans in the garage, though.
Homer: [laughs scoffingly] Old painty-can Ned.
[the family also laugh]
Homer: I always knew he'd keep his old cans of paint!
Marge Simpson: How do you like that!
Food is also problematic.  Some folks save the smallest scraps of food - in bits of tin foil, or zip-lock bags, or those foam clamshells from the restaurant.   When you are saving three olives, ask yourself what for.   And why would you want your refrigerator to be clogged with such bits of bad food that could make you sick?

Fiddly Bits.   That is what a Bri'ish friend of mine calls them.   Little containers of tiny amounts of food in the refrigerator.  Or 1/8 of a can of paint, saved for some contingency or "touch up" down the road.   They are wasteful and useless and clutter up your life.

Why do people do this sort of thing?   I think in part it is because people don't like to throw things out.   It is a mild form of hoarding disorder.   Also, too, people tend to view "wealth" in terms of things they own.   So a garage full of paint cans seems like a garage full of valuable stuff.  A refrigerator full of "fiddly bits" of food seems like a cornucopia of delicious treats.   We have an urge to acquire "stuff" and it pains us to part with a 1/4 can of paint or three sticks of celery.

How do you avoid this problem?   Use it up, or throw it out.   If you buy a bag of fertilizer for your plants or lawn, then go ahead and fertilize.   There is nothing to be gained by saving a tiny portion of the bag, as my Mother did (she had five acres of lawn to fertilize - it could take that 1/4 bag, no problem).   If you have a tiny bit of paint left, apply a second coat and then throw away the empty can.   If you have three olives left, make a Martini.

Or throw it out.   You will never find the perfect occasion to use 1/4 bag of fertilizer, or 1/8 of a quart of paint, or three olives.   The fantasy of the bare patch of lawn or the tiny spot that needs touching up, or that perfect topping for the dinner salad is never going to happen, for the simple reason that these "fiddly bits" end up getting lost in your garage, basement, or refrigerator, and you will never use them.   They will just age - but not like fine wine - and then months or years later, you end up throwing them out.

What is the harm in "fiddly bits"?   It drags you down, psychologically.   Keeping things you no longer use or need is just hoarding - not "saving".   And eventually your life gets cluttered and complicated by such nonsense.

And we all do it.   My Dad saved rusty screws and nails in old jars in his "shop" on the premise that "you never know, you might need a nail or a screw for something!".    And sadly, I tend to end up doing the same thing - only using an organizer for such screws and nails.   Yet, whenever I need screws or nails for a project, I end up buying new ones, as I want the correct size fasteners - and all matching, thank you.

A friend of ours had a house fire.  Some kids broke into their home and set it on fire.   It was devastating, of course.   But they admitted it was also liberating.    "We had boxes and boxes of junk in our attic and garage and basement, and half of it we didn't even know what it was.   The other half was just garbage.   But we didn't have time to sort through it all, so it never went away.   The fire made a lot of hard decisions for us!"

They started out new and fresh, with nothing lurking in the back of their closets.  No half-full bottle of motor oil lingering on the tool bench.    No junk that was broken but "too good to throw out".   A simplified and clean life, with less emotional and physical baggage.

We had a similar epiphany when cleaning out a dead relative's house.   All those precious collectibles and possessions were sold at an Estate sale for about $3500.   Not a lot of money in the greater scheme of things.   We think our stuff is priceless, when most of it is junk.   And when you go through someone else's cupboards, you think to yourself, "Why were they saving this 1/4 bottle of wine that is clearly several years old?   It is vinegar at this point!"

But then you realize that if someone went through your house, they'd find similar embarrassments.

And this is part and parcel of how your brain is programmed.  Psychologists have noted before that people tend to value their own possessions more than they value others.   Folks think their used car is worth well over book value, but that the new car at the dealer is overpriced.   This even holds true with regard to health insurance.   Folks value their existing plans and were wary of Obamacare.   They value what they already have more than some new product.   And sadly, when this tendency goes to extremes, this is what leads to hoarding disorder - people think their garbage is priceless and can never be thrown away.

It is hard to toss things away.   Once you "clean out" a closet, the very next day you will say, "Gee, I wish I had kept that left-handed metric monkey wrench, I could use that right about now!"

Periodic garage sales are helpful in eliminating clutter.   Just cleaning out and tossing out is also helpful.   It is not easy to do and it takes up an awful lot of time.   Because once you start digging into that closet, attic, or basement, you find stuff you didn't know you had, and then you start making a "this needs to be saved" pile and pretty soon, you haven't accomplished anything.

Worse yet, you end up going to the big-box store and buying some sort of organizer so you can store these precious pieces of shit in an organized fashion -  convincing yourself that you have "cleaned up" by organizing your half-used bottles of organic herbal shampoo (which  you don't like to use, but hey, it was expensive, and maybe someday you will use it, or a guest would like to, right?).

One reason I like our small camper is that there is so little in it.   It is very simple, clean and straightforward.   Not a lot of stuff to carry - not a lot of emotional baggage.   But after living in it for a month or so, you find that it, too, gets jammed with stuff and things and bits and bobs.   Pretty soon, you can't open a cabinet without things falling out!

Fiddly Bits.   They drive me nuts.   I want to simplify and unclutter my life.   But it is damn hard to do!

Saturday, October 25, 2014

Viewer Mail: Is A Mortgage A Hedge Against Inflation? Huh?

Note:  This is an older draft post that I just got around to editing.

People use a lot of odd self-justifications to justify going into debt.

A reader writes:
"What are your thoughts on this article?   Particularly, what are your thoughts on comment #125 by csdx?  I quote, "By having debt, you’re in effect getting something at today’s price while paying for it with your future dollars which are devalued due to inflation. Thus a mortgage can act as a hedge against high inflation."
Is paying cash for your house always the smartest way to go about it?"
I think I addressed this in my opportunity cost article.  

The opportunity cost argument goes like this:  If you get a mortgage at 5% interest, you could take that money you would have used to buy the home and put it into stocks and earn 10%!!! By paying cash, youa are foregoing the opportunity cost of investing all that money!

There are two flaws in that argument about opportunity cost and hedge against inflation.   Actually three.  Well, really four.

1. Opportunity cost is a great argument for businesses to make, but a lousy one for individuals to use in their personal finances.  Usually people trying to lend you money make this argument.  Don't listen to them.  Why?

2.  Because comparing stock returns, which are very risky, with the guaranteed rate of return of not paying interest, is comparing apples to oranges.  Not paying 4.5% interest on your mortgage is like getting 4.5% interest on a Certificate of Deposit - zero risk involved (ask your bank for a 4.5% CD and when they stop laughing, they will ask you politely to leave).  Stocks CAN have a greater rate or return, or, like my GM stock, they can go down to NOTHING.

3. Let's face it, that mythical money you are going to "invest" doesn't exist anyway.   What you are doing is borrowing - and borrowing more than you need to - and then trying to make yourself feel like a financial genius by tossing around terms like "opportunity cost" and "inflation hedge".  A better idea is to minimize the amount of money you borrow.  Borrow what you need, not what you want.
4.  Because you can end up losing all your money - or a lot of it - in stocks, and at the same time, see your house decrease in value by half, while the mortgage debt remains the same.  Suddenly, you are upside-down on a mortgage, and broke as well.  Whereas you could have had a paid-for house that would be worth something - or at least not be upside-down.  This is why, in the olden days, you had to put down 20% as a down payment.

Is this last flaw a far-fetched scenario?  Not really, it happened to a lot of people in February of 2009. They lost their shirt in the stock market and foolishly sold out, locking in their losses.  They owed more on their houses than they were worth.  So much for a "hedge" against anything.

I could see someone making that argument in 2005.  But today?  We know better.   People use arguments like this to self-justify serially refinancing their home or taking out equity to pay off credit card debt.  Or, more than likely, they are just parroting what some mortgage broker told them.   People selling you debt are the last people you should take advice from!

The "hedge against inflation" argument falls along the same lines as "opportunity cost" arguments.   Yes, for big businesses, such arguments make sense as they are making investments with their cash-flow which in turn generates profits.  For the individual, they make less sense.  When you borrow money to spend you are just spending, not making money.  And no, you don't "make money" on your personal residence - at most you just get your money back.   The average homeowner moves every five years, not every thirty.   As a result, the effects of inflation are not felt by most of us, unless we stay in the same house for at least a decade or more.

And in case you haven't noticed, inflation has been at all-time lows recently - which is one reason interest rates are at all-time lows.   When we had 10% inflation back in 1980, mortgage rates were 14%.   You see, interest rates already factor in inflation.  If banks didn't do this, they'd go broke in a heartbeat.  So I am not sure that a mortgage is a "hedge" against anything.  If anything it is just a risk you take, and risks are not hedging.

Usually, for people who make these "opportunity cost" arguments, the point is moot.  They are in debt up to their eyeballs and have no cash to buy a home.   So they use these types of arguments to make themselves feel better about their situation.

They aren't flat broke - they are hedging for inflation!  Right?  Riiiiiight! 

As people found out in 2009, if you do this, and the stock market tumbles and your home value tumbles, you end up losing all your money AND are now heavily in debt.

Or, you end up with $300,000 in your 401(k) and a $300,000 mortgage.   In theory, you are even-steven, but you can't cash in the 401(k) to pay off the mortgage, without incurring huge penalties.

There are a number of factors involved.  Generally, my thoughts are this:
1.  For self-employed people like me, who never know where the next paycheck is coming from - or indeed if there will be one, signing on to a large debt-train is a bad idea.  That debt has to be serviced, regularly.

2.  For young people starting out, the point is moot - they don't have the money.  They get a  mortgage because they have to, not because of some opportunity cost theory.

3.  If you are approaching retirement, a paid-for house is a safe investment.

4.  Comparing 10% in the stock market (risky investment) with the 5% you save on mortgage interest is comparing apples to oranges.  Stocks fluctuate - they can go down to zero.  Not paying 5% interest is a 100% guaranteed rate of return, like a government bond.

5.  If you pay cash for a house, the $1500 a month you save on interest (for example) can be invested.   So it is not like you will have no savings.  And a paid-for house is one heck of a safe asset.
All I can say is, not having a $3000-a-month albatross around my neck is a great thing.  I can work less now, and not worry if there is no work (a lot of that going around these days).  And as I lurch toward retirement, I am more confident that I will survive.  I can live on a little more than $20,000 a year at this point - if need be.

Granted, few people can afford to pay cash for a house.   That is not my point.  My point is, borrow as little as you can - what you need, not what you want.  Avoid the temptation to serially refinance, but instead, work toward paying down the mortgage over time - with the goal being eventually being debt-free.   Perpetual debt is not a hedge or an advantage.  It grinds on you and limits your options.  It is mortgaging your future, quite literally.

All that being said, mortgage rates are very low right now, and if you qualify for a low, fixed-rate mortgage, it is a good time to do so - if you need to borrow the money.

But the mortgage being a hedge against inflation?  Even at 4-5% interest rates, you will pay twice the purchase price of the house, over time, once for the principal, and once again for the interest.

It is a personal decision, based on your personal circumstances.  My suggestion is to borrow what you need, and avoid the temptation to go heavily into debt for granite countertops and a "look-at-me!" house (or car, or whatever).

I think the fellow who made this argument is really saying that he doesn't have a lot of cash, and "opportunity cost" and "hedge against inflation" arguments are reassuring to him that he is being smart about money.  But he is only deluding himself.

Having money is better than borrowing it - bottom line.