Archives For November 2009

The Little Book of Safe Money

The latest book in the “Little Books Big Profits” series is Jason Zweig’s The Little Book of Safe Money: How to Conquer Killer Markets, Con Artists, and Yourself*. As you can probably tell from the title, this book is about keeping your money safe. Flipping through the book, I came across Jason’s Three Commandments for Investors:

1. Thou shalt take no risk that thou needst not take. Don’t overinvest in the company you work for. According to Zweig, you’re already taking a risk by working for the company in the first place (due to the chance of getting laid off or the company going under).

2. Thou shalt take no risk that is not most certain to reward thee for taking it. According to Zweig, investing in individual stocks or sectors of the market is taking too much risk. Instead, invest in the total market and forget about betting on one stock or sector to outperform another.

3. Thou shalt put no money at risk that thou canst not afford to lose. Depending on your circumstances, you may not even need to invest in stocks at all. I think this is a bit drastic but I suppose if you’re wealthy enough, you don’t have to own stocks.

One other thing Zweig mentions in a different chapter in the book, he makes a big deal about the fact that stocks were outperformed by bonds over the last 30-years (because 2008 was such a horrible year to be invested in the stock market). I don’t refute what Zweig is saying but I do wonder what the numbers look like on a dollar-cost-averaging basis, which is the way MOST people invest. More on this later.

*Affiliate Link

I’m Back…

November 30, 2009

I hope everyone had a great Thanksgiving.

I was busy the week before Thanksgiving and we left to go out of town last Monday for Thanksgiving week. It was nice to get away and not worry about anything.

Waiting for me on my front porch when I got home was a copy of John Bogle’s Common Sense on Mutual Funds: Fully Updated 10th Anniversary Edition*. It’s hard to believe that the original book has been out ten years!

The first edition of the book was so good that I thought it would be interesting to do a chapter-by-chapter review of the book. I’ll start with chapter one tomorrow.

In the meantime, stay tuned… I need to get my feet back on the ground.

Just watched this video clip on Larry Winget’s facebook page:

Regardless of what the guy does, he’s in deep doo doo. He paid $340,000 (financing $272,000) for a house that is now worth between $120,000 and $140,000. He can afford the payment but is still thinking about walking away since the purchase is no longer in his favor. I wish I had more details regarding his situation but I don’t. That one advisor who talks about the after-tax cost of the mortgage makes some sense in that the true cost of the mortgage is less than this guy thinks it is.

Still, using a current value for the house of $140,000, at a 3% appreciation rate, it would take 30 years for the house to appreciate back to the purchase price. An appreciation rate of 5% would take 18 years. Bottom line: this guy’s going to be underwater for a long time.

My old Dave Ramsey posts regarding comparisons between the 15-year and 30-year mortgage still receive comments from time to time. This afternoon I noticed the following comment (on this post) that I want to address:

In the comparison above the amount in savings is only listed for the 30 year mortgage. Where does this number come from? Multiplying $458 times 180 (months) come to $82440. Nonetheless, one really important peice is missing. If I am in the 15 year category, and I just paid off my last payment of $1696. How’s about I save $1696/mo for 15 years and then let’s compare savings accounts. At the end of 15 years of saving $1696 (as I paid off my mortgge after 15 years), my savings account reads a sweet $305,280. Did I miss something?

His comment refers to this graphic:

Mortgage Comparison Snapshot

Let’s look at this reader’s questions, one at a time:

In the comparison above the amount in savings is only listed for the 30 year mortgage. Where does this number come from? Multiplying $458 times 180 (months) come to $82440.

The savings is the difference in payment amounts between the 30-year and 15-year mortgages. I went on the assumption that the person could afford either mortgage and that the payment difference would be saved and invested.

Simply multiplying $458 by 180 ignores the potential investment growth. In the example, I used an 8% growth rate. Granted that rate has turned out to be high given the bad markets we have had recently. But the 8% number is well within reach over the long-term.

The reader then goes on to say…

Nonetheless, one really important peice is missing. If I am in the 15 year category, and I just paid off my last payment of $1696. How’s about I save $1696/mo for 15 years and then let’s compare savings accounts. At the end of 15 years of saving $1696 (as I paid off my mortgge after 15 years), my savings account reads a sweet $305,280. Did I miss something?

Yes, he missed something. If you look at the graphic, you’ll see that I do in fact assume that after the 15-year mortgage is paid off the payment ($1,696) is invested at an 8% rate of return for the next 15 years. That’s why the savings account balance at the end of 30 years is $587.009 rather than the $305,280 that the commenter mentions ($1,696 x 180 months).

Anyway, I won’t go into all the details of that post. You can read it here along with all the very thoughtful comments that followed.

I received this email yesterday:

Hello,

I am recently divorced and I recently filed bankruptcy and discharged. I needed transportation so I had to take what I could get under my circumstances. This is what I got which is not too good, but I needed something.

Loan $23,108.93
APR 19.50%
72 months
Payment $546.84 which will make my total of payments $39,372.48

Should I double (or more) up on payments and try to get this paid off sooner?
Should I make my payments for awhile (2 years) to build up my credit and then try to get a better loan?
Should I put the extra money into some type of account to draw interest?
I need help, what would you recommend?

Thank you in advance for your help,

D

There’s no way around it…a 19.5% interest rate on a car loan is crazy! If you kept the loan for the entire 72 months, you would be paying over $16,000 in interest! That’s roughly 70% of the price of the car. In other words, that’s almost like paying for 2 cars.

What’s done is done but I think I would have looked for a cheaper car.

Okay, now to answer your questions…

Should I double (or more) up on payments and try to get this paid off sooner?

I ran an amortization and found out that if you doubled your payments and payed $1,092.85 per month, you could have the car paid off in 27 months (26 payments of 1,092.85 and one payment of $128.05). This would bring your total interest payed to a much-easier-to-stomach amount of $5,435.23. It’s still a lot considering you are paying nearly $1,100 per month. Doubling up on your payments isn’t a bad idea if you can afford to.

Should I make my payments for awhile (2 years) to build up my credit and then try to get a better loan?

The problem I see with this strategy is that at the end of two years, you’d still owe over $18,000 on the car. It would be hard to find a loan with decent terms for a two-year old car that has depreciated 30 to 40%.

Should I put the extra money into some type of account to draw interest?

I do think you need an emergency fund of some sort…say $1,000 to $2,0000. Beyond that, it simply makes no sense to have extra cash sitting in a bank account drawing pennies in interest while you’re paying off a 19.5% loan.

So, here’s what I would do:

1. Put back a little money for a bare-bones emergency fund.

2. Pay as much as you can on the car loan to get rid of that debt. Just make sure that there’s no pre-payment penalty and make sure your lenders applies the extra payment to the principal on the loan.

3. After the loan is paid off promise yourself to never get involved that kind of loan again.

4. If you didn’t miss that payment, then put it towards your retirement once the car is paid off.

Taxation of Dividends

November 11, 2009

BG left the following comment on one of my previous posts:

“JLP won’t like me saying it, but even the ultra-rich play this game where their “income” (dividends & investments make up the majority of their income) is only taxed at 15%, whereas I’m in the 25% bracket. That is their gain, my loss.”

The reasoning for this is simple: dividends are taxed at the corporate level and again at the individual level. That’s why they are taxed at a lower percentage at the recipient level. If the “ultra rich” are getting all of their income from dividends and investments, that tells me that they probably already paid their fair share into the system in the first place.

This is one of the reasons why I like the flat tax. Charge everyone the same percentage on ALL INCOME regardless of what type of income it is. I would even concede a certain threshold (a first for me) in which individuals and families falling below a certain level do not pay taxes at all. The threshold would have to be low as I think EVERYONE should pay their fair share.

It’s not going to happen but I can dream…

I was doing some work on the family budget for 2010 and looked up income subject to Social Security taxes in 2010 on the SSA website. I was pleasantly surprised to see that the income subject to social security taxes is not increasing in 2010. That means the amount subject to social security taxes is going to stay at $106,800, leaving the maximum an individual pays into social security at $6,621.60 (twice that when the employer’s amount is included).

Of course, this also means that recipients are not getting a raise this year.