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ETFs: Too Much of a Good Thing?

admin — Fri, 10 Feb 2012 21:00:00 GMT

By Scott Burns

“ETFs have polluted the indexing industry,” Rick Ferri says, “They have gone from evolution to pollution.”

Strong words, yes. But Mr. Ferri, who manages nearly $1 billion in index fund-based portfolios at his firm, Portfolio Solutions, Inc., can speak with authority on the subject. He wrote a book on it: “The ETF Book: All You Need to Know About Exchange-Traded-Funds” (Wiley & Sons, $30). You should also know that we are not talking about some arcane corner in the investing world. We are talking about a product that is disrupting the financial services industry. Indeed, with an asset pool that has reached $1 trillion, ETFs may rank with the disruptive power of the iPad in media.

ETFs are a game-changer.

So what is an Exchange-Traded-Fund?

It is an investment fund, usually an index fund, which trades on an exchange, so it is priced minute by minute rather than at the end of the day. Most have lower costs than comparable mutual funds and, today, many can be purchased without even paying a $10 discount brokerage commission. Want to buy the U.S. stock market and pay practically nothing for the privilege? You can do it with ETFs. The SPDR S&P 500 ETF (ticker: SPY) costs 0.09 percent a year. The iShares S&P 500 Index ETF (ticker: IVV) also costs 0.09 percent and the Vanguard S&P 500 Index ETF costs 0.06 percent a year.

That’s dirt cheap. The low cost means more return for you and less spending money for Wall Street.

Basically, ETFs are a new distribution channel for financial service firms. And the first firms to market not only dominate it, they are causing money to flow out of traditional mutual fund firms and into the new funds.

One recent indication is the loss of assets from the American Funds group, about $82 billion in 2011. A stalwart of the traditional mutual fund industry, the American Funds group manages mutual funds at very low cost but distributes them through the brokerage industry. American Funds was the largest of all the mutual fund firms as recently as 2007.

But last year both the American Funds group and Fidelity lost assets, about $126 billion combined. During the same period Vanguard gained $44 billion.

Significantly, American Funds has no ETFs. Fidelity has just one. Vanguard has jumped in feet first. It has 64 ETFs that clone most of their index mutual funds.

This enormous shift is not what bothers Mr. Ferri. What bothers him is the number of exchange-traded funds that were created for speculative purposes. These are funds, he says, that don’t represent an asset class. Instead, they are intended as short-term trading vehicles, which is proof positive that Wall Street can’t leave a good thing alone.

“They’re just muddying the water, making life difficult for advisors who want to do basic indexing,” he told me. As evidence, he points to the 685 ETFs (according to Morningstar) that struggle along with less than $50 million in assets. This is about 50 percent of all ETFs. Many in the trade call them “Zombie ETFs” because they are neither dead nor alive. He could also point to the odd names and purposes some ETFs have, such as:

Direxion Daily Energy Bear 3X Shares
ProShares UltraShort DJ-UBS Crude Oil
QuantShares US Market Neutral Anti-Momentum

“The type of indexes being created now has nothing to do with indexing. It’s a form of active management being done with ETFs. It confuses people. That makes it difficult to get the basic idea (of indexing) across,” he observed.

In fact, the problem with the proliferation of speculative ETFs doesn’t end with confusion. Since exchange-traded-fund shares are traded, they must have both size and trading volume to actually be the low-cost blessing they have the potential to be. The lower the assets in the fund and the lower the volume of shares traded, the more likely investors will lose money to a large spread between the bid and asked price. The smaller and more obscure funds can also sell at unpredictable premiums, or discounts, to the net asset value of the underlying securities, just as closed end funds do. That isn’t always a disadvantage— careful investors can work to buy at discounts and sell at premiums— but it is a major distraction from being able to commit, at very low cost, to a fund that invests in America, Europe or Emerging Markets stocks on the way to building a low-cost and tax-efficient portfolio.

Is there a cure?

Yes. Just remember this: Wall Street makes money on complexity. Everyone else makes money on simplicity. If it isn’t simple and cheap, don’t buy it.

How To Make a Vacation Condo Part of Your Retirement Plan

admin — Wed, 08 Feb 2012 21:00:00 GMT

Q. I have considered re-allocating my monthly 401(k) contributions and buying a small condo in Florida. My 401(k) account is down to breakeven (at best) and we are not getting any enjoyment from it. However, if we invested in a condo we would at least get some enjoyment. Wouldn’t such a purchase also be a form of diversification? —H.M., by email

A. If you buy it as a vacation property it would not be diversification. It would simply increase the portion of your assets and net worth devoted to real estate. Since we value home ownership so highly, all but the most wealthy people in America have the bulk of their net worth in personal real estate. Another limitation of this idea is that your Florida condo would be a “consuming” asset, not an “earning” asset. That means it would take your income rather than produce income for you.

You could, however, make this an investment by paying for it over time with the long term intention of selling your primary house and moving to your lower price condo in Florida when you retire. I've had letters from readers whose entire retirement plan was based on selling a house in a high cost, high tax area (think New York, Washington, D.C. or Chicago) and moving to a low-cost, low-tax area such as Florida, Texas, or Arizona.

How would it work? Easily. They could sell their expensive house and retire to the less expensive retirement house. Any cash remaining after paying off the less expensive condo mortgage becomes their retirement nest egg.

You can't do that, of course, if you are moving from North Dakota. But it may really compute if you live in a high cost urban area, selling your house for $500,000 and retiring to a $150,000 condo in a lower cost area.

Q. How quickly— or how slowly— should we proceed in consolidating assets now spread among three institutions, into one financial institution? My husband and I are retired and in our mid-60s. We have assets of about $2 million. Most of it (about $1.5 million) is in stocks and in tax-deferred and taxable accounts holding mutual funds with a trust company. The trust company charges 1 percent a year for management.

A second sum (about $500,000) is in 457 accounts with a second institution. The third account is with Vanguard where I am regularly investing in stock and bond mutual funds. I set up the Vanguard account to consolidate and to reduce management fees.

My questions: Are there any financial benefits (other than temporarily avoiding fees from 3 institutions) of doing the move all at once. Or should it be done more slowly— say, over a period of months, using dollar averaging? What are the advantages or disadvantages?

Second, if I take the slower approach, about how much time should I take to move about $2 million?

Other facts: The capital gains impact, I am told, of the move will be negligible since we will not sell our individual stocks. We will stay in the stock market conservatively over the long haul, or as long as our wits remain intact. —J.S., Austin, TX

A. If the assets in any account will be invested in a similar way in the new account there is no reason to delay making the change. Suppose, for instance, that your trust account is invested in a large cap domestic stock fund and U.S. Treasury securities fund. You could make the move immediately if you invested in similar funds in the new account. You'd be changing manager risk (eliminating it if you move to index funds) but you wouldn't be changing the overall risk of your portfolio.

The harder choice is when you want to invest differently in the new account, as in moving from a portfolio of CDs to a mixture of stocks and fixed income securities. This is changing your risk level and it is psychologically easier to do that over a period of time, such as a year.

It's very easy to let our investments become complicated and spread out. One advisor I know likes to call it “scattered asset syndrome.” That's when confusion sets in. So our goal should always be to simplify. Remember, the advocates of complexity are generally people who are making their living from the complexity they create for us.

When the Underdog Fights

admin — Mon, 06 Feb 2012 21:00:00 GMT

By Andrew Hallam

I was born in a foreign country where sports fans have infamous reputations for home-team loyalty. Their fanaticism has even caused deaths. In 1985, international authorities banned the country’s soccer teams from playing in mainland Europe after a sporting riot cost thirty-nine lives

Where were the fans from? Jolly old England.

Most British sports buffs aren’t thoughtless hooligans, however. And a few of my English friends enjoy supporting the occasional, plucky underdog, even if they’re opposing their own athletes.

Supporting a Jamaican bobsled team, a tiny African country in a World Cup soccer match, or an aging tennis player in the twilight of his Wimbledon career can even be fun. They’re the world’s Davids, challenging Goliath.

Perhaps my affinity for this kind of battle is the reason I scoured bookstores looking for an investment author claiming to defy the odds and achieve–what academics presume– is nearly impossible. I wanted to find someone (other than a mutual fund salesperson) suggesting that they could identify actively managed mutual funds that could beat the market index.

With so many smart money managers watching the economy and trading stocks, it’s sometimes tough to imagine that we can’t find a top money manager who can beat the markets for us. After all, some mechanics are better than others; some surgeons are better than others; and some teachers are better than others. Can’t we identify a few stellar money managers who can produce reliable market-beating returns?

Strangely, after reading more than 300 money books, I couldn’t find a single author claiming to know how to beat the market with mutual funds.

Fortunately, my luck changed in 2008. I discovered Louis Lowenstein’s book, The Investor’s Dilemma. He claimed that, with a few fund-seeking criteria, he could find market-beating funds.

No, I wasn’t going to bet money on his forecasting picks, but I still cheered him on.

I was intrigued by Lowenstein’s assertion that stellar mutual funds could be found. He asked Bob Goldfarb, the chief executive of the legendary Sequoia Fund, to list 10 champion Value funds. Lowenstein then sang their praises; these were among the top funds to buy, he suggested.

Coining them the Goldfarb 10, he then revealed a startling rear-view mirror revelation: each of them had crushed the stock market’s return.

“The ten funds showed positive average annual returns for those five years [1999-2003] of 10.80 percent, or about 11 percentage points per year better than the index...”

Many of Lowenstein’s readers, I figured, poured money into these funds in 2008, when his book was released. But could these actively managed Davids really beat the passively managed Goliaths? Could someone really choose ten mutual funds that, as an aggregate, would beat the returns of the market?

Since The Investor’s Dilemma was published, the U.S. stock market has plunged, then recovered. Overall, Vanguard’s total stock market index rose just one percent from January 2008 to January 25, 2012. This kind of investment climate, according to Lowenstein, is perfect for actively managed Value fund managers: “Value funds are likely to outperform the index when the market is falling, or even treading water…”

But David, unfortunately, got his butt kicked by Goliath. Of the ten super funds listed in Lowenstein’s book, seven of them underperformed Vanguard’s total stock market index since his book’s publication.

The underdog’s supporters are feeling that pain. As a group, the touted funds fell 6.1 percentage points behind the U.S. market.

Their performance also paled when compared to Vanguard’s balanced index fund, with the index beating the Goldfarb 10 by more than 15 percent since 2008.

You can see the funds and their results below, based on Morningstar’s data:

When Many Davids Fail To Beat Goliath

Funds	Total Investment Returns: January 2008- January 25, 2012
Vanguard Balanced	+10%
Vanguard Total Stock Market Index	+1%
Goldfarb’s/Lowenstein’s Ten Value Funds
Clipper Fund	-15.6%
First Eagle Global Fund	-12.9%
FPA Capital	+38%
Legg Mason Value	-31.8%
Longleaf Partners	-11.9%
Oak Value (now RS Capital Appreciation Fund)	0%
Oakmark Select	+14.3%
Source Capital	-21.8%
Tweedy Browne American Value	+5.3%
Average Total Return for the touted Value Funds	-5.2%
Source: Morningstar.com

Perhaps one day, somebody will write another book suggesting how to find market-beating mutual funds.

But I wouldn’t put money on their predictions.

Supporting underdogs is one thing. Losing money, because of them, is an entirely different issue.

A Sloth’s Slick Progress

admin — Fri, 03 Feb 2012 21:00:00 GMT

By Scott Burns

In November we celebrated the 20th anniversary of Couch Potato investing, the power of sloth and the opportunities gained by undiluted investment ignorance. If you missed the celebration, you are not alone. Our friends in major investment centers also failed to take notice. So did the talking heads on TV.

All are still wringing their hands around their cloudy crystal ball. They hope for a sign that will make them rich, preferably overnight. I say invest for what’s probable, not for what’s possible.

To be sure, thinking about the future is an interesting, if idle, exercise. It also pays a lot better than working at Walmart. But the reality is that you and I can do quite well without the great prognosticators. Year after year, decade after decade, the performance figures show that you and I can do better on our own.

How? We can do it investing in very broad and very low-cost index funds. Here’s the latest proof:

Last year was not a great year for investing. But if you had invested in the most basic Couch Potato portfolio, a 50/50 mix of the Vanguard (or equivalent) Total Stock Market index and the Vanguard Inflation-Protected Securities Fund, your return for the year would have been 7.18 percent. Domestic stocks didn’t do much for us but, thanks to our worrisome friends in Washington, inflation protected securities rocked, returning 13.24 percent for the year.

The Couch Potato portfolio would have beaten 98 percent of what Morningstar classifies as “moderate allocation” funds for the year. These funds, also called balanced funds, are typically 60 percent equities, 40 percent fixed income. The basic Couch Potato portfolio would have beaten 97 percent of “conservative allocation” funds—funds that are typically 40 percent equities, 60 percent fixed income. Over the last 5 years this simple approach would have done better than 97 percent of all moderate allocation funds and 91 percent of all conservative allocation funds.

This is not an annual occurrence. But superior performance isn’t a fluke, either. If you had invested $10,000 in the original Couch Potato portfolio with the mutual funds that were available 20 years ago— the Vanguard 500 Index fund and Vanguard Total Bond Market fund— your investment would have been worth $45,796 at the end of 2011. That’s a 4-fold plus increase. It’s a compound annual return of 7.9 percent —with no heavy lifting. If you had replaced the Vanguard 500 Index Fund with Total Stock Market Index Fund and Total Bond Market Fund with Inflation Protected Securities Fund as our tools evolved, your 20-year return would be somewhat higher.

Trust me, rebalancing was worth the effort. According to Morningstar data, the Vanguard 500 Index fund returned 7.71 percent annualized for the 20-year period. The Total Bond Market index returned 6.32 percent. Rebalancing worked to increase your return. It truly added value. Did that little bit of activity put you on top of the investing heap.

Read more about Couch Potato Investing here.

No, some managed funds did better. But most did not. Here are the names, ticker symbols, annualized returns and percentage ranking in deciles of some of the best known of those managed funds:

T. Rowe Price Capital Appreciation (PRWCX), 10.28 percent, decile 1
Vanguard Wellington (VWELX), 9.01 percent, decile 1
American Funds Income Fund of America (AMECX), 8.67 percent, decile 2
Fidelity Puritan (FPURX), 8.43 percent, decile 2
American Funds American Balanced Fund (ABALX), 8.37 percent, decile 2
GAMCO Westwood Balanced (WEBCX), 8.09 percent, decile 3
T. Rowe Price Balanced (RPBAX), 7.49 percent, decile 4

With only 79 moderate allocation funds surviving the 20-year period, Morningstar wisely limits ranking to deciles, so we can only estimate that the original Couch Potato portfolio would have done better than three of every four managed funds. This figure is consistent with multiple studies that have shown managed funds fail to beat their assigned index benchmark about 70 percent of the time.

Still tempted to pin your future on a rare winner? Then think a bit about the odds. When you try to select a winning manager your chance is about 1 in 4. When you take the index route you’ll come out ahead of 3 of 4 managed funds.

A Good Match Can Compensate for Poor Choices In a 401(k) Plan

admin — Wed, 01 Feb 2012 21:00:00 GMT

By Scott Burns

Q. My husband and I are putting $5,000 each in our Roth IRAs. They are with Vanguard and we are using the Couch Potato method. I also have a 401(k) account with my job and I only put enough in for the match. I put in $83 a month. My agency puts in $83. The problem is that the 401(k) plan choices are terrible, with lots of fees. I'm wondering whether I should be doing this at all. The plan is with an insurance company and the fund that I chose is the BlackRock Lifepath 2030. I've thought that it was a good thing to do, because I'm getting a 100 percent match on my $83 investment. Am I right? —A. H., Dripping Springs, TX

A. According to data in the Morningstar database, the issue with BlackRock Lifepath 2030 (institutional shares) isn't their annual expense ratio, it is their performance. The institutional shares have an expense ratio of 0.85 percent a year (other share classes have different, and higher, expense ratios). That's fairly typical for such funds, but higher than comparable funds offered by Fidelity and T. Rowe Price. The performance figures, however, have generally been in the bottom half of the category.

Even so, as long as you collect a 100 percent match, you are likely to do better staying in your plan than looking for greener pastures. Let's hope that your employer will start to realize that using match dollars to compensate for poor fund performance isn't what matching dollars were meant to do. If your plan has a brokerage window alternative you may be able to create a better option for yourself by using a lower cost index fund or exchange traded fund alternative. This would allow you to capture the match and have a better investment option, too.

Q. A number of years ago we put all our investments with Vanguard. We have been extremely happy, and still are, but with current financial situation are wondering if we should make some changes. Here is our situation: I am 80, my wife is 79, we have no debts, paid cash for our house 25 years ago, and retired 19 years ago. I guesstimate the house is worth a bit under $200,000 in today’s. Our investment portfolio with is worth about $826,500. Both of our IRAs are in Wellington fund and total about $413,300. Our taxable joint account is divided between $283,200 in Wellington and about $130,000 in Vanguard GNMA.

Given those figures, it seems that we might be too heavy in bonds at this time. We don’t have any kind of pension income. We have a good income from Social Security and the Required Minimum Distributions from our IRAs. When we want something extra we make a call and sell some shares.

The most recent withdrawal from our IRAs was about $10,000 for me and $6,000 for my wife. That money gets put back into our joint taxable account, to be spent early this year for taxes, travel and other expenses. Any comments would be appreciated. —P.C., Garland, TX

A. Vanguard Wellington fund has about 38 percent of its assets committed to fixed income. So if we do the math and add that portion to your GNMA fund holding, about 48 percent of your $826,000 in financial assets is invested in fixed income. Your two low-cost funds with 5 star ratings from Morningstar have beaten most of their competition for more than 15 years. So what you have presents a good case for "If it ain't broke, don't fix it.”

While some financial planners would suggest that you reduce the portion of your assets in equities, I doubt that the reduction would be very much. Either way, many planners would also suggest that you create a "cash cushion" by redeeming some shares in both funds and keeping some money in cash. It won't earn anything, but it would be available immediately if you had an emergency.

One of the really nice things that you've done is to keep your financial life simple. One of the biggest problems with aging is that financial management can be too complex.

Can Your Dentist Offer A Free Trip to Thailand?

admin — Mon, 30 Jan 2012 21:00:00 GMT

By Andrew Hallam

I’ll admit that I was pretty sceptical. I met two New Yorkers in Chiang Mai, a northern Thai city that’s becoming as famous for its dental clinics as it is for elephant rides and luxurious spas. The young women claimed that they weren’t primarily visiting Thailand for a vacation, but for dental work. The holiday, they said, was the bonus.

We sat on a giant, open air restaurant patio, surrounded by lush tropical greenery as they explained that dental work in Thailand was much cheaper than it is in the U.S. They had boarded an airplane, flew to Chiang Mai, had their teeth fixed, and would fly back to New York after a week of beachside R&R. Total cost, including dental work and the flight? Less than a visit to a New York dentist.

Medical and dental tourism are picking up steam because of the rapidly closing gap between the quality of care in the U.S., compared to places like Thailand and India. You might equate these countries with the third world, but there’s a wealthy elite in these exotic locales that could make a Beverly Hills socialite flush with envy. And these foreign rich folk want the very best—of everything.

In Thailand, for example, you can find some of the best medical and dental treatment available in the world. Their top dentists are trained in the U.S., Canada, and Great Britain, while their clientele extends beyond wealthy Thais to Americans looking for great dental work that won’t break the bank.

I live in Singapore, where there’s a plethora of world class dentists. Services are competitively priced, and the quality is first rate. Yet, many of my friends flee to Thailand when they need to see the dentist. Like the young New York couple I met, they swear that it’s financially worth it. Perhaps it is, from Singapore, where a two hour flight may cost less than a family dinner at Applebees. But from the U.S.?

After asking my American colleagues in Singapore, I found the name of an upscale clinic in Chiang Mai, and compared procedural prices to those in the U.S. The Bureau of Labor Statistics does monthly surveys of American dental prices. And the American Chamber of Commerce Researchers Association surveys quarterly price reports in 297 American cities.

Average costs in Houston, Texas appear to run close to the U.S. national average, so I’ve used their data to compare to that of Thailand’s Grace Dental Care Clinic, where many of my friends and colleagues get work done. Here are some price comparisons:

Anterior tooth root canals average $555 in Houston, while costing $190 at Grace’s Dental.
Molar tooth root canals average $850 in Houston, while setting you back $283 at Grace’s Dental.
Full gold base crowns average $1,030 in Houston, but just $472 at Grace’s Dental.
And composite fillings in Houston average $109, compared to $50 at Grace’s.

Flights to Thailand from most U.S. cities run about $1,400. If your estimated U.S. dental expenses are expected to run into the thousands, and you’d like a tropical holiday, you might consider Thailand.

But I wouldn’t look for the cheapest Thai options. An online search would reveal plenty of cheaper Thai dental clinics with corny names like Tooth Teeth, Big Smile Clinic and Chiang Mai Dental 4 You. They could still be great clinics, but you’ll want to do your research first.

Like the New York couple I met, a rising number of Americans are finding the benefits of Thailand’s top dental practices while fortifying the country’s already famous namesake as the Land of Smiles.

You might want to check it out.

http://www.bracesinfo.com/dentalcosts/

http://www.gracedentalclinic.com/pricelist-eng.html

The “Good Life” Is Also a Long Life

admin — Fri, 27 Jan 2012 21:00:00 GMT

By Scott Burns

Sarasota, Florida. There are, very roughly, three kinds of elderly people in America. There are the people who have already run out of money. They live on their Social Security checks. Then there are the people who are likely to run out of money and worry about it. If reader mail is any indication, they worry about it more each day.

Add the two groups and you have a lot of people. According to the Social Security Administration’s “Fast Facts” book, for instance, Social Security benefits accounted for 90 percent, or more, of income for more than a third of all retirees. Social Security benefits accounted for 50 percent, or more, of income for two-thirds of all retirees.

The numbers for these two groups may be large but they are not visible here in Sarasota for a simple reason. It costs money to leave your house or apartment. And cable TV is a very low cost way to spend time. So the elderly who live cautiously aren’t the elderly you see in affluent places like Sarasota.

Here, work crews scrub down the unused yachts at Marina Jack’s every week. Here, an acre lot on the water on Casey Key, Siesta Key, or Longboat Key is likely priced over $3 million.

In Sarasota the visible elderly are the affluent ones. Here, you’ll find people who’ve come to the giddy realization that they will never run out of money. Not now. Not ever. The sense of ease is palpable. Add a generous portion of sunshine and you are awash in an ambience of raw, joyous indolence. You can feel the spending plans ramping up.

Those spending opportunities, of course, are tilted toward the capabilities of older people, which are quite different from the capabilities of the young. In the bars on Siesta Key the live entertainment is packed up and gone by 10 PM.

Tired of cooking? No problem. Eat out. There is an abundance of restaurants, but most are nearly empty by 9. At the “Sunset dinner hour,” which starts at 4 and ends at 6, a visitor must navigate carefully between the wheelchairs and walkers.

The luxury Lexus 460 sedan is big here. The high-end mall just outside Siesta Key on Tamiami Trail offers 15-minute teeth whitening sessions for people who are more than busy; they are existentially short of time. An opportunity for Botox treatment is nearby. And you’d never have to walk more than a few blocks between pedicures.

For another, more personal, view of aging in Sarasota, read “Retirement Planning, Part 2”.

Yet it all makes me wonder: How did so many people get to be so old? Will the rest of the country feel like this as the boomers continue aging?

The answer, I think, is “No.”

Why?

One reason could be called “the Michigan Effect.” (The same effect works for any state with a long and miserable winter.) Just moving from Michigan to Florida might add a few years to your life. Fewer colds, fewer falls, fewer automobile accidents on slippery roads. And lots more sunshine. Surly New Yorkers have been known to smile here. There’s a good chance people actually live longer because life is easier. There may be some significance to the fact that 8 percent of the population is 75 or older in Florida while only 6 percent is that age nationally and only 3 percent of those in Alaska are that age.

But my bet is the big reason is money.

If you can afford to live in a place like Longboat Key you’ve probably got plenty of money. Ever since the original Whitehall studies of status, income and life expectancy— the studies that found British government employees enjoyed life expectancies that grew with their income, status and authority— evidence has been growing that affluence and social status really do add years to your life. And being poor shortens it.

The most recent examination in the United States, for instance, found that the most affluent people could expect to live 4.5 years longer than the least affluent. If that doesn’t sound like much to you, consider this— the 4.5-year difference is greater than the broad gain in life expectancy for the entire population since 1980. What might be called ‘the longevity gap’ will continue to grow as the gap between the affluent and everyone else continues to widen.

So get ready: Occupy Longevity is coming soon.

iSavings Bonds versus TIPS

admin — Wed, 25 Jan 2012 15:28:00 GMT

By Scott Burns

Q. Are I Savings Bonds better to have than TIPS? They are paying me about 4.5 percent. —G.F., Austin, TX

A. Although both I Savings Bonds and TIPS offer inflation protection (as measured by the increase in the Consumer Price Index) there are some important differences. TIPS (Treasury Inflation Protected Securities) are issued in 5, 10 and 30-year maturities and the yield premium over inflation is determined at auction. Today, the shorter term TIPS are priced at a large enough premium over par that the effective yield over inflation is negative. This works to reduce the benefit of the CPI adjustment to the principal value of the security. Your net yield is something less than the inflation rate. Only by going to longer term TIPS can you get a premium over the inflation rate.

Treasury I Savings Bonds are different. They enjoy the same inflation adjustment to principal but the yield premium over inflation is reset by the Treasury every six months. Since the November 2010 period, that rate has been set at zero. This means new buyers are parking their money and getting a "yield" that is equal to the rate of inflation. The income is also tax-deferred until maturity. This can be a significant benefit over the purchase of TIPS whose coupon and adjustment are both deemed taxable income each year even though one isn't paid in cash. This is why most advisors suggest that you hold TIPS in qualified accounts.

Both securities provided premiums over inflation greater than 3 percent in their first years of issuance. So if you bought your I Savings Bonds or TIPS when the yield premium over inflation was higher, you could still be getting a very nice interest rate.

But that was then. Today new inflation-protected securities are selling with a guarantee of inflation protection… and nothing else. The big limit for I Savings Bonds is that you can only purchase $10,000 in a year. Purchases of TIPS are unlimited.

Inflation protection is better than what is currently offered on conventional coupon Treasury securities. Recently, for instance, the yield on a 5-year Treasury note was about 0.8 percent, well under the 3.5 percent trailing rate of inflation. As a consequence, even recent buyers of I Savings Bonds and TIPS are getting better yields than with conventional Treasury securities. The only way this will change is if future inflation rates fall pretty dramatically.

Q. My question concerns what is the better source of dividends from a long-term investment viewpoint. I am well diversified in my total portfolio. I am invested in Vanguard LifeStrategy Moderate Growth Fund and some fixed-income funds.

I also like blue chip dividend-paying stocks. I have some money invested in Vanguard Dividend Appreciation Index Fund and Vanguard Dividend Growth Fund (Managed). A friend argues that I should seek dividends not by sector investing but by total market index funds.
He points out that the yield on my two sector funds is about 2 percent--similar to the yield on the LifeStrategy Moderate Growth Fund. He believes, from an investment perspective, the LifeStrategy Moderate Growth Fund is vastly superior to the two sector funds. He acknowledges that the current tax code favors qualified dividends, but he insists that the use of the three total market index funds in the Life Strategy fund is a wiser investment strategy. —M.J., Beaumont, TX

Q. Your friend makes good points. Here's the difference between these funds. Vanguard Dividend Appreciation Index fund and Vanguard Dividend Growth fund are 100 percent equity funds. They have no fixed income holdings. They are, however, diversified across many sectors of the economy so I would not call them "sector" funds.

The Vanguard LifeStrategy Moderate Growth fund is a traditional balanced fund. It has about 40 percent of its assets invested in fixed income securities. The equity portion is spread over three major total market indexes. The fixed income portion is why its income yield is about 2.3 percent, while the yield on the dividend funds is about 2 percent.

Over the (very) long term, the expected return of the 100 percent equity funds should be somewhat higher than the return of the balanced fund. The long term, however, is a lot longer than any of us can hold our breath. In addition, the dividend income of the dividend funds is currently taxed at no more than 15 percent while the tax rate on the balanced fund will be a mixture of 15 percent taxes on dividends and full income tax rate on interest.

There is no doubt that you will enjoy far broader diversification in the LifeStrategy Moderate Growth Fund; It will also be less volatile than the dividend oriented funds, so you'll sleep better.

What Cancer and Investing Have In Common

admin — Mon, 23 Jan 2012 21:00:00 GMT

By Andrew Hallam

Two years ago I lay on a sofa, as a new age “hands on” healer stood over me. I was dying, she moaned, as if getting the word from some divine source in the couch. And my only salvation? To visit her as often as possible, for $175 a session.

She knew that I had bone cancer. I had told her when we first met. A friend of mine had hooked us up and I wanted to be polite, so I went.

Yes , this fortune telling healer filled me with fear. But it reminded me of the movie Man On The Moon. In the film, Jim Carrey (who played Andy Kaufman) laughed hysterically while watching the practicing techniques of a quack witchdoctor. Kaufman had cancer, and he hoped that he’d find an alternative cure. Like many people facing a desperate plight, he put his hope in a miracle—for a fee.

Whether we face cancer or have our financial back against a barbed wire fence, most of us do one of three things:

We give up
We put faith in evidence based studies or procedures
We take greater risks to seek a miracle

Before going any further, I want to add that I’m actually fine. Surgeons removed large chunks of three tumour-affected ribs, before cutting out the Chondrosarcoma surrounding my spine. The only good thing about getting cancer—if there is such a thing—is that I started to write my book, Millionaire Teacher, while stuck in the cancer ward of a Singapore hospital. Yes , the nurses thought I was crazy too. But it was a great distraction.

If you or a family member is facing cancer, putting faith in evidence-based studies (and faith itself) gives the highest statistical odds of success.

My favorite read on the subject is Anti-Cancer, A New Way of Life, by Dr. David Servan-Schreiber. He starts by suggesting that we’re all going to die. Not accepting that is crazy. As my oncologist says, if I were creeping around 200 years from now, I’d scare people.

After accepting that revelation, Servan-Schreiber suggests that we do the following:

Eliminate sugars and processed food from our diet. Cancer loves them.
Eat as many dark, green leafy vegetables as possible.
Eliminate red meat
Stay calm, and meditate if you can
Put faith in your medical team and your support network

Is it easy to abandon evidence-based methods in favor of something more “promising” when we’re feeling threatened? It is never easier.

Investors do it routinely. .

We all know people who realize that they haven’t saved enough. Some of them seek alternative investment strategies to make up for lost ground. Perhaps they buy a hedge fund, or they eliminate bonds in their portfolios. Brazilian forestry companies advertising guaranteed returns of 15 percent annually can look pretty tempting. And let’s not forget how easy currency trading is supposed to be. It says so in the online advertisements.

When facing a shortfall in your retirement portfolio, perhaps you could take lessons from those who lean towards evidence, rather than promises.

Keep a diversified investment portfolio of stocks and bonds.
Small cap stocks have higher historical returns; you may want some in your portfolio. But just some.
Rebalance your portfolio to stay on track.
Stay calm when markets fluctuate.
Put faith in your investment strategy, and live below your means.
Remember that quick solutions aren’t. Stay calm, focus on evidence-based procedures, and have faith.

Above all, don’t put your life in the hands of a fortune teller.

Cape Coral and the Recovery of Dreams

admin — Fri, 20 Jan 2012 21:00:00 GMT

By Scott Burns

Cape Coral, Florida. There was a time when Henry Ford and Thomas Edison looked across the Caloosahatchee River from their estates in Fort Meyers and saw Cape Coral as thousands of acres of mangrove swamp. Today, after an improbable development that was chronicled in “The Lies that Turned to Truth”, Cape Coral is everyman’s dream of Florida, retirement and the good life— sunshine, water, fishing, 400 miles of canals, and more sunshine. Not to mention golf.

And much of it is at a price people who actually work for a living can afford. In November the median price of a home in Lee County, which includes Cape Coral, was $106,300, up 20 percent from $88,500 the previous year. More important, the price is far less than the national median of $170,000. Indeed, with the notable exception of cities like Detroit, you could sell your home almost anywhere in the country, move to Cape Coral, and pocket some money.

Check the Metropolitan Area Median Home Price figures here:

http://www.realtor.org/research/research/metroprice

The change may require a few sacrifices. You won’t have the upscale shopping of old Naples or St. Armand’s Circle on Lido Key. You’ll miss the long rows manicured estates of Bonita Springs with a Mercedes CLK convertible in the driveway. You’ll suffer for want of rare unpasteurized cheeses from Whole Foods. And you’ll miss the nifty white anchovy sandwiches you can get in historic Sarasota.

But you’ll still have plenty of sunshine and access to fishing. You’ll still have Target, Wal-Mart, Walgreen’s and CVS. And you’ll still have Publix, the ubiquitous supermarket of Florida. For a few bucks more, you’ll have center console fishing boat with a Bimini— and an insulated well filled with cold beer.

And that’s why I’ve come here. Nancy Dunning, the CEO of the Cape Coral Association of Realtors, deals with what happened straight on. “You can consider Cape Coral to be ground zero for short sales,” she says, referring to the implosion of real estate values that followed the growth explosion of the now infamous housing bubble. In 2005, she points out, Cape Coral was the fastest growing area in the country.

“The staff at city hall couldn’t keep up with the (building) applications,” she says.

Then it ended. Today, lots that sold for $100,000 in 2000 and $300,000 or more in 2004 and 2005 can once again be had for $100,000. Much the same can be said for completed properties. On a recent visit to Realtor.org, for instance, I found 2,502 listings in Cape Coral. Of those, 648 were under $100,000. Many small condos were offered for less than $50,000.

Michele Deal, a realtor newly elected as President of the Association, is cautiously positive. “Cash buyers are buying now,” she says. “But those who need to finance are still waiting for a signal.” The other problem, of course, is actually borrowing money from a bank.

Henry Albrecht, a broker who has been ignoring pings from his phone during our meeting, finally answers a call. He is a self-described military brat, has a German mother, and spent much of his childhood in Germany while his father was stationed there. A good part of his client base is from Germany.

He answers his phone in German. Afterward, he says that a waterfront lot is going under contract and a German family will be building a vacation home on it.

Why build when so many houses are available?

“It’s all about the site and sunlight,” he says. “They want maximum sunlight. It’s what they come here for. They want sunlight on the pool. They will only be here 4— maybe 6— weeks a year so they want it to be right.”

And that leads me back to what I mentioned two weeks ago, the discovery of lots of German phone numbers on Home Away rental listings. According to the Lee County Visitor Bureau nearly half a million international visitors came to the area in 2010, with more expected when the count is done for 2011. Many come from places like Canada, the United Kingdom, Germany, Austria and Switzerland.

They come to vacation. And they come to buy with ready cash. According to the Florida Association of Realtors, over 80 percent of foreign investors paid cash for their Cape Coral property. It isn’t difficult to understand. If you’ve ever been to Hamburg or Berlin during the winter you know why the grass is so much greener in Florida that they will come here and pay cash. It doesn’t hurt, either, that Europe is having a banking, currency and credit crisis.

The crash may have proved that reliable sunshine isn’t priceless, but it also made us forget how treasured it is.

A Note from the Grim Reaper: Lighten Up, Spend More

admin — Wed, 18 Jan 2012 21:00:00 GMT

By Scott Burns

Q. Much has been made about how a million dollars saved for retirement is not what it used to be. It is often said that with safe withdrawal rates of three to four percent, you will have to stretch your money to live well in your later years. What I don't seem to get is this: If you have no children and just your partner to take care of so you don't need any left at the end, can't you just spend the money down faster?

Take a million in savings. Even if you had investment returns of only 3 percent per year on average, and you took out $50,000 per year starting at age 62, would that not last more than 30 years before the amount ran out? Considering that no male in my family has made it past 70 due to health issues, this seems safe to me. I also believe that I will need less at age 80 plus even if I make it that far. What am I missing here? —M.H., by email

A. The only thing you are missing is the destructive interaction of uncertain investment returns, inflation and uncertain longevity. In theory you could search for, and buy, an inflation adjusted joint life annuity and it might provide you and your partner with an income of constant purchasing power until both of you had died. But inflation adjusted life annuities are rare and most people are reluctant to hand over their life savings in exchange for a monthly income, even if it is inflation adjusted.

Failing the life annuity route we are left with trying to extract a rising annual payment from an investment portfolio that can suffer significant fluctuations in value. If the annual payment exceeds the dividend and interest generated by the portfolio, it is necessary to sell a portion of the portfolio, whatever the market price of the assets. Do that in a bear market— as happened to those who retired in 2000 or 2008— and you increase the odds that your money won’t last as long as you do. Worse, the higher your initial withdrawal as a percentage of portfolio value, the lower the odds your savings will last through 20, 25 or 30 years.

There are three under-appreciated realities that reduce this danger. You mentioned one of them— the virtual certainty that our appetite for consumption will decline as we age, particularly after reaching our 70s. A second under-appreciated reality is that in a couple, one will generally die well before the other. In a typical mid-sixties couple, for instance, actuaries will tell us that both will be alive for about 15 years and the survivor will live on, alone, for another 10 years. When that happens, living expenses decline.

The final under-appreciated reality is that across the entire population, there is only a 10 percent chance that a 65 year old will live to age 95. That’s a pretty good argument to relax and, maybe, spend a bit more.

Q. I'm an avid dividend investor. My small IRA has $65,000 in dividend paying stocks that currently produce $3,000 annually, which I immediately reinvest. I have a few blue chip stocks like Coca Cola and McDonalds, a few utilities, and I've expanded into MLP's and REITs. My plan is to continue on this path for the next 20 years and grow my dividends to $25,000 annually at which time I will begin taking the dividends in cash and drawing Social Security at age 67.

Is this a realistic plan? — K.D., Plano, TX

A. You could do a lot worse. Regular reinvestment of dividends is a great way to build your portfolio through thick and thin. Many investors in the 1970s, for instance, bought electric utilities with automatic dividend reinvestment plans. Over the decade their investment grew significantly and continued to rise in the bull market of the 1980s.

The biggest liability here is that you are buying two levels of inadequate diversification. This can happen when you fall in love with a small number of high-yield stocks and end up with much of your portfolio in one or two companies. Those stocks can turn into disasters and have major dividend cuts. (Think GE or, worse, Bank of America.)

It can also happen simply by having a preference for dividend stocks. If you put a minimum yield requirement on the portfolio you will inevitably have a major concentration in REITs and utilities. That isn’t healthy.

Finding the Boom in the Bust

admin — Fri, 13 Jan 2012 21:00:00 GMT

By Scott Burns

Sarasota, Florida. As I listened to Kristen Hertel and Deby Mascolino tell their story I kept thinking of Dr. George Vaillant. I had gone to see Ms. Hertel about her real estate business, but the underlying story is about resilience and adaptation, two human qualities that are a lot more important than money, investing or real estate. Dr. Vaillant is the curator of the only long-term studies of human development, studies that have followed several groups of people for more than 70 years. If those studies have a conclusion it is that resilience and adaptation, rather than anything else you can name, are the difference between being among the “happy-well” or the “sad,-sick.”

Here’s the story. Before the real estate crash Ms. Hertel says she was “a-well paid employee of a large real estate brokerage firm” with 24 years of experience. She did the work related to titles and closings at the firm. So when closings disappeared, so did her job.

Read here for a column about Sarasota during the boom.

She responded by getting a variety of licenses and going out on her own, but with an odd twist. Rather than try to swim against the tide of declining sales, she started four small companies that offer different services in real estate. One offers the title and closing services she did before. Another, Real Estate Assistants, LLC, is a kind of outsourcing service that provides support for busy realtors. Those businesses show her resilience.

But the other two businesses are all about adaptation. In a terrible market, she would participate in the boom that arose from the bust: short sales. She would be part of making things happen. She would provide sellers and their realtors with all the services needed to move a short sale to completion and another company would do the actual negotiations with the bank, relieving both the seller and realtor of the task. One is called Short Sale Referrals, LLC that links short sale buyers with short sales. The other is called Advanced Short Sale Negotiators, LLC. (A short sale in real estate occurs when the sale price of the property is insufficient to pay off the mortgage. When that happens, the seller must bring a check to the closing or the lender must accept a lower amount as payoff. Getting that agreement isn’t easy.)

Ms. Hertel says their success rate in short sale negotiations is close to 95 percent.

The importance of short sales is demonstrated by some of the figures provided by the Sarasota Association of Realtors. In addition to tracking monthly figures of sales volume and median sale price for single family homes and condominiums, the Association divides each category into conventional “Arm’s length” transactions, short sales and REOs, the foreclosed properties known as “real estate owned.”

In November, distressed property sales accounted for 41.3 percent of all sales, down from a peak of 51 percent in the second quarter of 2010. In the same month the inventory-to-sales ratio was about 8 months. That’s more inventory than sellers and realtors want, but way better than forever.

When I ask if there is a profile for short sellers Deby Mascolino shakes her head. “We get people who are only $10,000 short. They can be people who don’t have $10,000 but they have to move for a new job.” She also says that prices vary and go as high as $5 million.

When I ask what the hardest part of the job is, the immediate answer is “the paperwork.”

“People are often depressed. They want to throw in the towel. And it’s a lot of paperwork.” Ms. Mascolino says.

In fact, a short sale takes about as much paperwork for the seller as applying for a mortgage: 2 years of tax returns, 2 months of pay stubs, 2 months of bank statements, a listing of all other financial assets, a hardship letter explaining the reason for the short sale, all the property disclosures, a real estate listing and all the photos for an MLS listing.

Although she has handled short sales in 30 states, Ms. Hertel is aware that she isn’t alone and that banks’ ability to deal with short sales has improved significantly over the last few years. She is particularly positive about equator.com, an online system that Bank of America adopted to facilitate short sales. (If reader mail is any indication, it is a great improvement over the chaos that early would-be short sellers experienced.)

Will she be out of business when the real estate market finally recovers? Somehow, I doubt it. She’ll adapt and find a new way to help make things happen.

The Great Brain And The European Debt Crisis

admin — Wed, 11 Jan 2012 22:00:00 GMT

By Andrew Hallam

When I was a kid, Tom Fitzgerald’s The Great Brain, was one of my favourite book series. The main character was a boy genius growing up in Utah during the late 1800s. He could solve nearly any problem. He once strategized how to find two boys lost in a cave network; another time, he taught a young, victimized Greek immigrant how to whip the schoolyard bully; and he wasn’t above using his powers of observation and psychology to occasionally seek profits.

If the Great Brain were around today, and if he were at least ten years from his retirement, I think he would rub his hands at the thought of the European debt crisis, hoping that it would cause a stock market drop (maybe a big one). The Great Brain, I think, would have had a firm grip on his stock market history. And he’d likely have Warren Buffett’s view on falling stock markets memorized:

“Only those who will be sellers of equities [stock market investments] in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”

As Buffett suggests, sinking or stagnating stock market levels are special treats for young investors; they’re opportunities to load up on discounted stock market assets. Like a collector, you don’t want to see the prices of your desired products increasing in value while you’re trying to collect a room full of them.

But stock markets rarely fall when the economic outlook is hunky dory. They fall or stagnate when there’s some kind of fiscal terror on the horizon. The Great Brain would probably recognize this, and he’d be rubbing his hands together with the bleak fiscal headlines pouring out of Greece, Italy, Ireland, Portugal and France.

With a sense of history, he might point out that the best 17 year period to invest money in the stock markets was between 1965 and 1982. During this lengthy period, the S&P 500 gyrated (sometimes wildly) but it didn’t make any net gains. It was a perfect time for people collecting stock market assets. But, as The Great Brain would point out, it was filled with terror.

The threat of a nuclear war was palpable
President Kennedy was assassinated
President Nixon was impeached
The markets crashed 45 percent from 1973-74
The Vietnam War ravaged the dollar’s value
Gold hit a historical peak as people feared the debasement of currencies
Inflation averaged 10.03 percent between 1980 and 1982
President Reagan was shot in 1981
U.S. unemployment hit 9.7 percent in 1982

Faced with such world uncertainty, paradoxically, the only consolation young investors may have had during that time was a stagnating stock market. Putting fear aside and regularly investing in the stock markets from 1965 to 1982 would have reaped nice rewards. While emotional speculators jumped in and out of the markets during this horror-filled 17 year period, long term investors would have “collected” stock market assets, year in and year out.

And by 1982, their assets would have taken off, averaging more than 17.5 percent for the next 18 years.

If the Great Brain invested from 1965 to 1982, he would have heard the chorus of “this time it’s different; the world isn’t going to recover.” Like a popular Top 40 remix, every new generation thinks it’s a brand new song.

As a young investor, the Great Brain (if he were among the 91 percent of employed Americans) would probably welcome the uncertainty of the European debt crisis. He would invest his money, hoping that the world’s stock markets would stagnate or fall. He’d keep his investment costs low, and dispassionately rebalance his portfolio annually between stocks and bonds.

Retirees wouldn’t welcome a falling market; there’s no doubt there. As sellers of stock market assets, they’d prefer rising markets instead.

But as they say in golf, every putt makes someone happy.

The European Union’s teetering could be one of those putts.

And if the Great Brain were at least 10 years from his retirement, I think he’d be trying to hide his smile.

If You Are Wealthy Enough, 100 Percent Cash Is Comfortable

admin — Wed, 11 Jan 2012 21:00:00 GMT

By Scott Burns

Q. My father is a wealthy man. He is totally risk averse. The only stocks he ever owned were the stock options he exercised at the company where he was an executive. When he retired as President of the company in 1989, he sold all his stocks. Since then he has kept his money in CDs and T-bills.

From everything I have read, this is not a good investment strategy. His theory is that he will be fine if he never loses money. Of course he is losing purchasing power if you consider inflation, but I understand his theory. His assets do not fluctuate with the market. He has enough money and he lives modestly enough that the loss of purchasing power through inflation is not really a concern to him.

But I was shocked to read that bonds have outperformed stocks over the past 3 decades. Since 1981, long-term Treasury bonds have gained 11.5 percent a year on average, beating the 10.8 percent average increase in the S&P 500. Maybe my dad is not so crazy after all. I am curious about your take on that. —E.D., Austin, TX

A. The return you experience in stocks or bonds depends very much on the particular year in which you start. It also depends very much on the length of the investment period. The longer the time period, the greater the probability that stocks will outperform assets like bonds and Treasury bills, according to data from Ibbotson Associates.

It is not surprising that long-term bonds have outperformed stocks since 1981 because in 1981 long-term Treasury bonds had yields that were greater than the average annual total return on common stocks. That made long bonds a very good bet back then. Few, however, were willing to make the bet due to the high inflation rate we were experiencing at the time, 8.9 percent.

Actually, your father didn’t do better than stocks because he wasn’t invested in bonds. He was invested in cash alternatives that seldom gain value and seldom return much more than the rate of inflation.

Most investors enjoy better returns and lower risk by having a very diversified portfolio with a balance of equities and fixed income. They also have a better shot at having their income keep up with inflation. If you were receiving $1,000 of interest income on a bond in 1981, for instance, the purchasing power of that interest income is now about $400.

So your father might have done better. Fortunately, he didn't need to.

Q. In a recent column you did a rough evaluation of Social Security benefits using an immediate annuity web site. You indicated that an inflation adjusted annuity would cost about 50 percent than a fixed annuity to compensate for inflation, as Social Security does. I can understand that an adjustment needs to be made, but 50 percent sounds high. So how did you determine that percentage, realizing it would also be a function of age, and without going into an extensive analysis? —F.E., Plano, TX

A. There are two companies that have offered inflation-adjusted life annuities. I developed the 50 percent figure by comparing the cost of a traditional fixed life annuity for a given income with the cost of an inflation-adjusted life annuity with the same starting income. Yes, intuitively adding 50 percent to the cost of an annuity seems high— but this is just more evidence that all of us tend to underestimate the real burden of inflation.

The companies providing the inflation-adjusted life annuities can't afford to underestimate and it is reflected in what they charge for inflation adjusted income.

As you suggest, the younger you are, the more you will have to pay for an inflation adjusted life annuity. On a recent visit to the Elm Annuities website, for instance, I found that a $100,000 deposit would bring a fixed life income of $420 a month for a 55 year old man. It would bring only $268 a month as a starting income if it were inflation adjusted. So it costs an additional 57 percent to get an inflation-adjusted income at 55. By age 65 inflation adjustment costs only 39 percent more.

Here's a link to the figures: http://www.principal.com/retirement/incomeannuity/elm/income.htm

Rediscovering Florida

admin — Fri, 06 Jan 2012 21:00:00 GMT

By Scott Burns

Siesta Key, Florida. Our rental cottage here is part of an experiment. Found on Home Away, the global vacation home rental site, it is a lovely one-bedroom cottage with tall ceilings. It is entirely white, including the floors and furnishings, with oversize slider-doors that look out to a sun dappled jungle of greenery, heated pool and gazebo beyond, all wrapped in enormous palm trees, dense bamboo and a multitude of flowering plants.

There is a distant sound of traffic on the road that delivers people to and from the island— but we can also sit quietly and listen to the sound of leaves dropping from the jungle growth around us. A crushed shell path takes us by the owners’ house to a bit of beach and a big view of the Gulf of Mexico. Sweet.

The goal of this indulgent experiment is to answer a few questions: Can Florida replace our easy and much loved Mexico, the one lost to the drug cartel wars? Does the Florida real estate market tell us anything about the national market? Can Florida tell us anything about what the rest of the country will feel like in a few decades?

The answer to all three questions, I think, is yes.

Let’s start with the practical question first: Can Florida replace Mexico?

Here are some of the basics. It’s easy to get to Florida. In the post 9/11 travel world this is a big plus. Our flight from Austin to Tampa was 2 hours and 10 minutes, non-stop. It’s nearly as easy from many other cities. A bit over an hour later we were parking on First Street in old Sarasota for a casual lunch at the Mattison’s City Grill. An arrival margarita would have put us in the Puerto Vallarta spirit, but we substituted a quick visit to the hysteria of Whole Foods on the afternoon of New Year’s Eve. It was like a Mardi Gras for food.

Are there many places like the one we have rented? Probably not. But Home Away has 22,443 listings in Florida with “more to follow.” Some 4,311 of those listings are in the South Central Gulf coast area. That’s the vast area of beaches, canals and bays that stretches from Anna Maria Island, past Sarasota and down to Venice. Of those listings, 389 are on Siesta Key, 295 are on Longboat Key and 328 are on Anna Maria Island. So there’s a good chance you can find something you like and, equally important, can afford. And if Home Away doesn’t work for you, it’s possible to be brave and just cruise the area looking for “vacancy” signs at any of the complexes that offer apartments and villas by the week or month. It is way easier than trying the same thing in Mexico, trust me.

The other questions will take some time. But already there are hints. One of them can be found in the phone numbers for some rentals listed on Home Away— they are not in the United States. It seems Brits, Canadians and Germans like Florida enough to buy houses, with eye catching concentrations of non-US phone numbers in places like Naples, Sarasota, and Longboat Key. If Florida looks good to non-Americans, maybe we should think about what they are seeing that we locals are missing. Barring the intergalactic collapse some anticipate, it’s just possible that the time for selling is long over. (Here’s a link to what things looked like in 2004.)

Another answer can be more felt than found. Across the entire U.S. the current portion of our population that is 65 or older is 13 percent. Enter the state of Florida and the figure rises to nearly 20 percent. That’s about where the rest of the country will be by 2020. That’s also when the baby boomer retirement surge will be peaking and the aging of America will slacken a bit. There are smaller areas in Florida, however, where we can examine what might be called Extreme Aging. On Siesta Key, for instance, 44.5 percent of the population is 65 or older. On Longboat Key the figure is 67.3 percent. The rest of the country will never get this old, but we may be able to learn about our national future from such extremes.

Credit Cards: When In a Hole, Stop Digging

admin — Wed, 04 Jan 2012 21:28:00 GMT

By Scott Burns

Q. Here's my situation. I am single (divorced) and turned 61 in December. I have a decent paying job, but plan to work only about 3 to 5 more years, tops. I have only saved about $150,000 in my 401(k) account. I have a small pension (about $400 a month) with a prior retirement plan.

Here's my problem: Over time, I have stupidly and carelessly maxed out three high-interest credit cards. I have a combined credit card debt of about $40,000. I have a monthly mortgage of $1,850. I have a 2004 model car that's paid for, but I have no emergency savings at all. Although I clear about $5,200 a month at my job, I find that I routinely pay minimum payments on my credit cards. This is causing me enormous stress and worry–to the point where my health is suffering for being this much in debt.

Can I, and should I, take $40,000 from my 401(k) balance to pay off these credit cards so that I can start building up my savings again? What are the penalties and tax implications?

With my finances as they are, I am unable to save anything more than my monthly payroll deduction for my 401(k). With the interest that I'm paying each month on the credit card balances, I am not making any progress in paying the balances owed.

I am embarrassed about being in this financial position and, due to that, I have been unable to talk to friends or family about my situation. It is a big, dark cloud hanging over me. —S.S., Sachse, Texas

A. Since you are older than 59 1/2 there will be no penalties for making withdrawals from your 401(k) plan. You will, however, have to pay income taxes on any amount withdrawn. Since the withdrawn amount will be added to your ongoing taxable income, you may be paying taxes at a high rate. For 2012 the top of the 15 percent tax bracket is $35,350 and the top of the 25 percent tax bracket is $85,650. (These figures are for your taxable income— your income after deductions, exemptions, and qualified plan contributions.) As a single person you are definitely in the 25 or 28 percent income tax bracket. That means you would have to withdraw at least $53,333 to have the $40,000 in cash that you need to pay off the credit cards.

After you pay the cards off you can save an additional $800 a month— about what the minimum payment on $40,000 of credit card debt is. At that rate it will take you about five and a half years to replace the withdrawn money— but you will be earning a return, not the credit card company. You may be able to replace it faster, while lowering your taxes, by increasing your 401(k) contribution.

Fortunately, you may be able to borrow the money from your 401(k) plan rather than removing it and paying taxes. Such loans, according to the 401(k) help center website, are limited to 50 percent of your account balance or $50,000. They must be paid back while you are still working. This would reduce the time needed to restore the $40,000 quite a bit. So check with your HR department about borrowing.

Whatever you do, you need to cut up your credit cards and live an "I-pay-cash" life. The lesson most people are slowest to learn is that saving isn’t what’s left at the end of the month. What you save is the amount to put aside before any spending. Once you make that shift, you’ll be in control of your life rather than letting it happen to you. Another reward is the certainty that every step you take toward getting control of your debt and spending is a step toward a more secure life now and when you eventually retire.

Fearless Forecasts, 2012

admin — Fri, 30 Dec 2011 21:00:00 GMT

Yet another year of upheaval and uncertainty bites the dust!

And not a moment too soon. I’m ready for a better year. I bet you are, too. I’m not asking for a lot.

A year when gas prices go down— and home prices go up— would do.
A few moments without screeching from the crumbling foundations of civilization would be nice.
If a cable TV or cell phone offer I could understand came my way, well, it couldn’t get much better than that…
I’d even settle for a week of news embargo on Kim Kardashian.

Alas, my crystal ball says none of that will happen.

In America we refer to years like 2012 as election years. But on a Chinese calendar they would be known as “The Year of the Clowns.” In country and western music terms it is a year whose theme song could be “Ten with a 2”— you know, Kenny Chesney’s song about going home at 2 with a 10 and waking up at 10 with a 2.

So expect that 2012 will be another year of indelicate surprises. Here are my Fearless Forecasts.

The Rise of The Replacement Party.

Tired of the Republidem and Demorep impasse, a new party will arise with no platform and a single purpose: Replace all Incumbents by voting for any candidate who is not currently in office. Bumper stickers are already available, witness “Fight Organized Crime: Don’t Reelect Anyone” on Amazon. The website Zazzle offers a broad selection: “Save America: Re-Elect No One!,” “Recycle All Incumbents”, “Stop Repeat Offenders: Just don’t re-elect them” and “Help Stop Narcissism: Re-Elect No One!”

Europe Will Be Sold To the Highest Bidder.

This won’t happen in a single transaction, of course, but as it becomes increasingly clear that Europe is destined to become an under populated theme park with a tragically low occupancy rate for its castles and palaces, there will be takeover bids and distress sales. Disney will jump start the trend by buying Monaco, inspiring nations to make larger acquisitions. Turkey, once rebuffed by the European Union, will offer to buy Greece, taking the country off the hands of frustrated German and French lenders. Germany, which has always wanted someplace warm to go, will buy Italy. Wall Street will speculate on which country Apple will buy with its ever-growing cash hoard.

The National Association of Upside Down Homeowners

will be created. With at least one home in six financed for more than its market value, the owners are one of the largest unorganized special interest groups in America. With many not paying on their mortgages and hoping for a short sale, one of the group’s first actions will be to create a short-sale home exchange program so that members can move from one area of the country to another.

The Illegal Immigration Problem Will Be Solved

when Arizona, frustrated by the federal government’s inaction, passes a law that legalizes immigration and taxes it. The tax revenue will be enough to improve state finances while suppressing illegal immigration. Border states will be delighted with their new revenue source. Non-border states will lobby Washington for a special Federal Offset for the revenue opportunity they lack. Arizona governor Janice K. Brewer will observe, “If you can’t beat ‘em, tax ‘em,” but the program will fail as rising taxes end immigration to the state.

A Radical Post Office Reorganization Plan

will be offered. Since the Postal Service has lost nearly $20 billion over the last 4 years and is planning to cut mail deliveries, an aspirant politician will recognize that we’re all tired of chicken in every pot. Instead, he will offer “a tablet in every home,” noting that $20 billion is about $177 a household— nearly enough to provide an Amazon Fire at retail for every household in America, more if they buy the weird tablets on sale for $77 at Fry’s. Small Postal Department vehicles will be auctioned off as collector items. Small post offices will become popular as retro neighborhood bars. Stamp collectors will make a killing as the supply of new stamps disappears.

Meditation Will Boom.

The new fans of meditation won’t be picky about whether it is Zen or Transcendental. Meditation (or medication) will be the only way to escape social media.

How To Invest a College Age Daughter’s Inheritance

admin — Wed, 28 Dec 2011 21:00:00 GMT

By Scott Burns

Q. My 19-year-old daughter inherited a healthy sum of money from her father's estate when he passed away. I am not very savvy with the market or investments. I’d like some help figuring out what to do with some of the funds.

First, she is in college now. We want to put about $60,000 in something that, preferably, will not lose money. It must be available to cover school and living costs for the next 3 to 5 years (if she goes to graduate school). The money would need to be available each semester. At this time we have some in a money market account, some in mutual funds, and some in CDs, but with the exception of the money market, they are losing money. Would it be advisable to put it all in a money market?

Second, I am trying to determine what type of investment to put additional funds in ($10,000) for after she gets out of school. This would help fund a move for a job, down payment on a house, new car, whatever the need at that time. This would be something that could grow for 3 to 5 years but then be available to pull out as needed.

Finally, I am looking for some help in setting up a longer-term investment ($100,000) for her retirement. It is hard to think about retirement for someone not even 20 yet, but she wants to put something away for later and not touch it for a long time. I know there is no crystal ball to show where money will be safe for 40 years or so, but perhaps you can provide some suggestions, or at least some "don't do this" help? —C. R., Austin, TX

A. Yields are so pathetically low today that you will be fortunate to get much of a yield at all if you want safety for the $60,000 she will need while completing her education. I suggest that the two of you make this a joint project. Set aside a reserve that is available immediately, then estimate when she will need specific amounts of cash. Next start hunting on a website like www.bankrate.com for term CDs that offer the best yields. You should also check local credit unions. Either way, you won't earn much, but you don't want that amount of money in a coffee can. You should include the $10,000 of after-graduation money in this fund, as the CD with the longest maturity.

That $100,000 is serious money for a young person. It is, for instance, equal to more than 2 years of starting salary for a typical college graduate. If we ever have a return to historical average returns, it could double every 9 years. That means it could double 5 times before she was in her late 60s, giving her a retirement fund of $3,200,000. (Trust me, the number will be a lot less impressive by then since there will also be 45 years of inflation.)

If you want the money managed at very low cost, Vanguard Wellington and Fidelity Puritan are good balanced funds with long and favorable histories. Still another option would be to invest in the Vanguard Balanced Index fund. This is one-stop shopping and is the best place to start. Later, when she has learned more, you can point her toward reading about the Couch Potato portfolios on my website and reading the book I recently reviewed, "The Millionaire Teacher." Both will provide basic instructions for building a self-managed but very simple and low cost diversified portfolio.

Q. My husband and I have Universal Life Insurance Policies from the early 1980s. Each has a cash surrender value of about $35,000. Currently our cost of insurance is $525 a year. That will change due to our age (65) and the premiums will rise rapidly until all the cash value is depleted. His policy is for $100,000 plus the cash value and mine is $50,000 plus the cash value.

We have a large line-of-credit loan against our home – about $60,000. Those payments really cut into our income. I’m still working and earn about $40,000 a year. My husband is semi-retired with a small monthly pension, $1,200, and Social Security of $1,800. He works some and earns commissions which we pay taxes on at the end of the year. The house is paid off, except for this loan. Would it be prudent to cash in these insurance policies and pay off this loan and our other credit card debt? Would we owe taxes on this money? —A.L., Irving, TX

A. As a long-term decision, yes, you very likely will be better off by cashing in the policies and paying off your debt, particularly if you have the ability to save some money afterward. I’m concerned that you did not mention any other assets, such as 401(k) account balances, etc.— money that would help pay your bills later.

Some of the cash value in those policies may be interest earned— money that has accumulated over and above what you have paid in annual premiums. This will become taxable income when you redeem the policy.

Endurance Investing

admin — Fri, 23 Dec 2011 21:00:00 GMT

By Scott Burns

Do investments and saving matter?

It’s a good question for any Christmas Day, but lots of people have particular reason to ask that question now. Barring a long awaited visit from the Tooth Fairy, it is likely the S&P 500 index— the index that represents about 74 percent of U.S. equity market value— will close the year at a loss or near loss.

This is not a new experience. If anything, it is oppressively familiar. The index, today, is barely above the 1,200 level it first reached in December 1998— all of 13 years ago. It is nearly 20 percent below its March 2000 peak of 1,500.

We’re in a new age of Endurance Investing. When Morningstar publishes the Ibbotson returns data early next year, it will be abundantly clear: the current period is close to beating the Great Depression as the longest period of negative return our stock market has ever experienced, measured in nominal dollars.

If we look deeper and measure real, inflation-adjusted returns, the current period is already as bad as the Great Depression. And it is in gunning distance of beating the 15-year loss record from 1968 to 1982. (The inflation adjusted figures include reinvested dividends.)

Should we give up? Is it time to pack it in?

No. History says that endurance investing pays.

If you gave up in the 70s— and millions of people did, putting the entire mutual fund industry into net redemption— you missed the bull market of the 80s and 90s. That’s when a simple investment in large domestic stocks provided a real annualized return of 13.3 percent and a pre-inflation-adjustment return of 17.9 percent. That return would grow $1,000 into $2,000 in 4 years and $32,000 in 20 years. Viewed in terms of a nest egg, it will turn savings equal to one year of income into 16 years of income in 16 years and 32 years of income in 20 years. Either way, that would be more than enough for most people to retire.

If you endured the 70s, the next two decades were a walk in the park.

Will we need to endure in 2012? See your local entrails reader.

What we do know is that whatever the stock market returns in the future, we can invest a lot more efficiently today than we could in 1970 or 1980. This means we get to keep more of the return on our money— when it does, finally, earn a return. Here are some of the great strides that benefited all of us:

Small savers no longer ride at the back of the bus. In the late 1960s yields at thrift institutions and banks were regulated and limited. As a consequence, most people got lower yields on their CDs than a big saver could get on a U.S. Treasury obligation. One Boston economist was so annoyed about the gap that he titled a paper “Shafting the Small Saver.” The paper estimated how much regulation cost small savers. The gap between what small savers could earn and what big savers earned spawned the first generation of money market mutual funds, providing even the most cautious saver with access to higher yields. The same event also opened the door to no-load mutual funds.
Brokerage commissions have almost disappeared. Until the mid-1970s brokerage commissions for the purchase or sale of common stocks were regulated, resulting in very high costs for individual investors. High commissions also prevailed in the sale of mutual funds. These often had 8.5 percent front-end commissions. Today a self-directed investor can buy individual stocks at nominal commission cost. More important, the same investor can also buy mutual funds with no commission at all.
Index funds and exchange traded funds are now abundant. In 1970, according to Investment Company Institute data, there were only 361 mutual funds with only $47.6 billion in assets. Most were common stock funds and 40 percent were contractual accumulation accounts where the saver often experienced no accumulation even after dozens of payments. Low-cost, low-expense index funds did not exist. Today there are hundreds of index funds. We can save for our futures at about 1/10 of the cost most investors faced in the 70s and we can get better results than about 70 percent of all managed funds.

Yes, it’s hard to cheer for the idea of losing money at the greatest cost efficiency in history. But there will be a day, hopefully soon, when endurance and patience are rewarded.

Gifting Our Children the Breaks They Need

admin — Tue, 20 Dec 2011 15:00:00 GMT

By Andrew Hallam

My brother was a professional soccer player. Today, he’s grooming his fifteen year old to earn a soccer scholarship. That’s the first goal, and my brother is doing just about everything he can to give his son’s career a push in the right direction. If he helps him enough, his son might be as good as his father, or better. “With me in his corner,” says my brother, “Niklus could end up playing professionally.” But the competition is tougher than it used to be, he explains. His kid needs every break he can get.

Sometimes, when my nephew lines up to take a corner kick or a penalty, my brother steps in and takes the shot in his place. In his late 30s, and still a stud in his own right, my brother can drill the ball past virtually any 15 year old goalie. Nobody bats an eye and some of the other fathers do the same thing for their kids. “The game’s harder than it used to be,” they explain. Officially, Niklus gets credit for each assist or goal that’s scored by his dad.

The trouble is that the boy, who showed great promise as a younger player, is starting to blow far too many wide open opportunities when he has to take his own kick at the ball. The more my brother helps him out, the worse it gets. He plays half of each game looking at his dad, often begging my brother to steal the ball for a perfect break-away pass. We’re a family of high-achievers, yet my nephew’s confidence is waning, not to mention drive. He’s starting to rely on his dad as a crutch.

Of course, none of this story is true. But you’d probably agree that such friendly fire could eventually scuttle even the soundest vessels. Despite great intentions, however, many of us sink the next generation in much the same way when it comes to money,.

Like the soccer fable, maybe the game really is tougher than it used to be. I won’t argue against that. But Thomas Stanley, author of The Millionaire Next Door, has studied America’s wealthy for decades. And he finds that adult children who receive monetary aid from their parents tend to financially under-achieve those in the same vocations who don’t get handouts. Like a father throwing a kid’s touchdown pass, taking a penalty shot or eyeing down a Little League pitcher, Stanley has found that gifting assets (such as Christmas cash, a down-payment on a home, or passing down the family car) usually has detrimental financial consequences for the receiver.

Naturally, many people expect their kids to be the exception; a helpful hand at just the right time can put their tottering teens or twenty somethings squarely on their feet, they assume.

The Chinese have a proverb. They pass it down in hushed tones. It serves as a spooky sceptre to anyone daring to stuff their children’s nets with fish: Wealth doesn’t pass three generations. The first generation acquires the wealth, the second generation maintains it, and the third generation squanders it. The parents of the first generation, of course, want to make life easier for their children. But the age-old axiom prevails for the majority.
Studies and history seem to suggest that we can educate our children and train them to survive—even thrive—but financial handouts, forgiven loans and material gifts from one Jones generation to the next get wrapped up as prettily as Pandora’s box.

By all means, teach your children to fish. But don’t land anything (a soccer ball or a trout) in junior’s proverbial net. Doing so may cost more than you think.

If You Have Assets, You Can Manage Your Tax Rate

admin — Wed, 14 Dec 2011 21:00:00 GMT

By Scott Burns

Q. I retired at 55 and am now 60. I am a single woman with modest spending needs. I owe $55,000 on my home, which is worth $175,000. My annual spending budget has been steady at $30,000, but I've felt a bit pinched this year. I probably need to up that to $35,000 for 2012. My budget does not include the cost of vehicle replacement nor does it include extravagances like a $7,000 trip. Those big ticket items must come out of savings. Other than my home, my major assets are $100,000 in a taxable Vanguard account, $35,000 in a Roth IRA and $940,000 in a Vanguard Traditional IRA.

Should I withdraw as much as possible out of my Traditional IRA each year to put my taxable income at the upper limit of the 15 percent tax bracket? My projected Social Security benefit at age 66 is $2,199 a month. At age 62, it would be $1,659.

By the way, most of the women in my family live to be 90. I have no Long Term Care Insurance. I may be married a year from now, at which time our shared financial responsibilities should be mutually beneficial. —G.M., Dallas, Texas

A. With a bit over $1 million in financial assets, well-controlled living expenses, and the freedom to take Social Security benefits when it is convenient, you could stay within the 15 percent tax bracket (particularly after you are married). You could draw on your investment accounts to sustain virtually all of your standard of living. This would allow you to defer taking Social Security benefits until age 66 or later, which would be a good bet.

Drawing from qualified accounts until you hit the 25 percent tax bracket is a good idea. You will, soon enough, be facing required minimum distributions on those accounts and it could force you into the 25 percent tax bracket with some of your income.

You also have the freedom to start Social Security benefits anytime between 62 and 66, or even 70. Your benefits are likely to be subject to taxation, so the longer you defer, the more tax efficient your finances will be. If there is some kind of market meltdown, as in a replay of 2008, then you could start taking benefits and reduce your withdrawals from your investments. That's a great position to be in, so you should savor it.

Q. I have a question regarding TIPS in an investment portfolio of people who
are quite elderly. My wife and I are in our late 80's. We are quite comfortably retired, with heavy downside protection due to a large number of single premium immediate annuities purchased a number of years ago. I'm doing some reallocating now. But if I continue to reduce equities as I age, I will have a very large percentage of my portfolio in bonds. I am wondering if adding TIPS would be a wise decision. Do TIPS furnish good inflation protection? And is there anything that might be better? —F.W., by email

A. Let me start with an alternative first. Since you appear to have more than sufficient monthly income, you may not need to continue increasing your allocation to bonds. You can simply let your portfolio continue, as is, knowing that your estate will take the risk, not your immediate standard of living.

TIPS (Treasury Inflation Protected Securities) have been a good investment for many years, including a year to date return over 10 percent. That good performance also means they are richly priced today. Recently, for instance, Bloomberg listed a TIP maturing in 5 years with a current coupon of 0.125 percent selling at a premium. This means it will provide a negative real return, even when your principal is adjusted upward for inflation. With a real return of negative 0.8 percent it would be losing that amount to inflation.

You could, of course, do worse. Over the same period a traditional Treasury obligation is priced to yield 0.92 percent, indicating that it is losing to inflation, which is running more than 3 percent a year.

TIPS provide good protection from inflation as measured by the Consumer Price Index. Whether the CPI measures your personal experience of inflation is another matter. They remain, however, the best instrument available for hedging against inflation.

Confessions of a Timeshare Seller

admin — Mon, 12 Dec 2011 21:00:00 GMT

By Andrew Hallam

I have a confession to make. I’ve sold two holiday Timeshares. And the guilt hurts. Like most people who have done the math on these holiday resorts, I understand that they’re a good deal for salespeople, but they’re usually a bad deal for buyers.

Here’s my story. Eight years ago, I saw an ad in the paper: sit through a two hour Timeshare presentation at a local resort, it suggested, in return for a great restaurant meal and two nights of luxurious accommodation. Timeshares are also called “Fractional Ownership” or “Interval Ownership.” I jumped at it—a small price to pay for a free long weekend, I figured. When I got home, I bragged to my friend about it.

The following weekend, he went into the dragon’s lair himself, looking for the same deal. But he got scorched. He came home the proud owner of a Timeshare. Indirectly, I sold that Timeshare, and I felt awful.

As a travel junkie who has visited more than 30 different countries, I’ll admit that I’ve committed a few holiday bloopers. I once booked a couple of flights online and arrived late to the airport—one month late, to be exact. But I’ve never bought a Timeshare. To me, that ranks with burning your own passport during a Russian holiday. You might get some warmth from the flame, but expensive hassles await the drunken tourist (blame the vodka) who would do such a thing.

The first problem with Timeshares is the upfront cost. My friend’s Timeshare (and no, I didn’t earn a commission) cost $14,000 at the end of 2003. Not having a disposable five figures in his savings account compounded his problem. He had to finance the purchase at a usurious interest rate. “Your investment will increase in value,” purred the saleswoman, in consolation. Instead, he sold it three years later at a loss.

Savvier buyers might pay less for their Timeshares, but the annual maintenance costs, which run as high as $800 a year, can quickly dampen the party.

My friend, Maggie, paid $16,000 for a Timeshare in Cozumel, Mexico, but after a few years of enjoying the resort, she neglected her payments. And the Timeshare company tasted blood. If you fall behind in your payments, they might charge more interest per month than some credit card companies charge in a year.

Overwhelmed by the mounting liability, she gifted the Timeshare to me, after unsuccessfully trying to sell it. I paid the interest-inflated maintenance fees, which had ballooned to $3,500. Wanting to go to Hawaii that winter, I tried to trade my two weeks in Cozumel for two weeks in Maui. Salespeople might tell you that this is easy. But don’t believe them. I eventually sold the Timeshare at a loss to two gentlemen who wanted to share the albatross.

Does this mean you should save your money instead of taking luxurious vacations around the world? No, I think you can do both. Maggie paid $16,000 for her Timeshare in 1993 (not to mention her maintenance fees). If she had invested that money in a S&P 500 index fund, instead of buying the Timeshare, she would have roughly $57,000 by December 2011.

And if you look around, you can find screaming holiday deals for less than a Timeshare’s annual maintenance fees. In May, my parents took a 12 day Royal Caribbean cruise from Fort Lauderdale to England for $500 each.

A week’s accommodation in Hawaii, including airfare from the west coast, is currently offered for roughly the cost of an air ticket.

And next week, I’ll be flying from Vancouver for an all-inclusive week-long Cuban holiday, including airfare, for less than the price of a flight to Havana.

But don’t report me to the U.S. government. I’m Canadian. And after selling two Timeshares, I’m desperately trying to redeem myself.

The Prisoners of PMI

admin — Fri, 09 Dec 2011 21:00:00 GMT

The father of three eased into a chair. He is in his late-thirties. He works hard at both of his jobs. He and his wife, he said, are very careful about spending. They live without a sign of grandiosity. Both of their cars have more than 100,000 miles on them. The cars are good for more miles, but repairs are becoming more expensive. So are the kids.

The problem, he said, is there just didn’t appear to be any relief. Not now. Maybe never. Like millions of other workers, the income from his main job is not increasing. It is stable, which he thought was wonderful, but it isn’t increasing. The career with regularly increasing salary income that he had hoped for no longer exists.

And what about his other job— the one he works at on weekends? It provides some of the money he had hoped would be coming from his main job. It is good work. But it can never grow to replace his main job. It’s piecemeal, nothing to count on.

The only way he can see to create some breathing space, some margin for error, is to refinance their house. He handed me some worksheets detailing the estimated costs for mortgage refinance proposals. They would, he said, cut his expenses nearly $400 dollars a month. That’s the equivalent of a very healthy raise.

“These would eliminate PMI,” he said, referring to primary mortgage insurance. “They would also reduce the interest rate by about 1.5 percentage points. There’s just one problem. I’d have to write a big check at the closing—about $25,000. It might as well be a million. I don’t have that kind of money.”

Very few people do, particularly those with young children.

We’ve become accustomed to real estate disaster stories— stories of homes in foreclosure, of families forestalling foreclosure, of couples making payments while surrounded by a sea of foreclosures, etc.— but millions more people are like this father of three. They trudge on with less drama. They hope something will change their circumstances. Mortgage refinancing is one of those somethings.

But they are prisoners of PMI and prisoners of their mortgage.

This particular example is in Dallas, Texas, an area largely spared from the debacle that has made Arizona, California, Florida and Nevada into disaster areas. Five years ago he and his wife bought a new home in a Dallas suburb populated by other couples with young children. Their motivation was simple and selfless: they were looking for good schools.

They got in with a 10 percent down payment. Because of the low down payment the mortgage also required them to pay premiums on a primary mortgage insurance policy.

The idea, then, was that home appreciation would bring their equity to 20 percent in five years or less. Then they would be able to refinance, perhaps to a lower interest rate. They would eliminate the PMI payment at the same time.

It didn’t happen.

Now they are prisoners of both. They pay PMI and a bit over 5.5 percent in interest when new mortgages were available at 4 percent. For them, it seems like a deadweight loss.

And for them, it is. But the dilemma is really about who has income and who doesn’t. One household’s lunch, it turns out, is another household’s dinner.

The mortgage we’re talking about is part of a package of securitized mortgages. The mortgage securities, in turn, are owned by a mutual fund that specializes in pools of home mortgages. Someone who depends on interest income, probably a retiree, owns shares of that fund. The retiree has seen the interest he collects drop year after year as those who can refinance. At this point the retiree is wondering how long his savings will last. He is spending principal as well as interest to pay his bills.

If the mortgage were refinanced, it would disappear from the mortgage package. The interest income would decline, as it has been for years. One household would enjoy an increase in spendable income. Another would suffer a decrease in spendable income. Who gets to spend money would change, but the amount of money available to spend would scarcely change.

It’s a big zero-sum game— except it doesn’t feel like a game.

How Much Is Your Social Security Worth?

admin — Wed, 07 Dec 2011 21:00:00 GMT

By Scott Burns

Q. I have a good handle on an asset allocation for my situation, but I’m not sure what to include in determining the value of my nest egg. Should I include the value of my Social Security as part of my nest egg by using the interest rate on a 30-year Treasury bond? Social Security is really better than the 30-year bond. I do not have a pension.

My home is paid for. Should I consider some value like the rent I don’t have to pay? —J.B., Lakeway, Texas

A. You can calculate the imputed value of your Social Security income but for what purpose? It won't be part of your estate. It is only an income right, not an asset. Most people, when they do such calculations, find that their imputed assets— the assets they would need to have to replace the income they receive from Social Security or other retirement pension— are a lot larger than the actual financial assets they have.

The only use for this information is as a rough guide to asset allocation for the financial assets you do have. For instance, if Social Security and/or a pension provide 80 percent of income you can take more risk with financial assets than if Social Security and/or a pension provide only 20 percent of income.

You can do a rough valuation of your Social Security benefits by visiting the website www.immediate annuities.com and entering your gender, age and benefit. The website will calculate how much you would have to invest, in the current market, to get that benefit as a fixed payment. You'll need to add about 50 percent to the sum to compensate for the fact that Social Security benefits are inflation-adjusted and the vast majority of private life annuities are not.

The average Social Security benefit in 2012 will be a bit over $1,200 a month. For a 66 year old male without a spouse who might receive future benefits, that's worth about $196,000 for a fixed annuity benefit and about $300,000 as an inflation-adjusted life income equivalent to Social Security.

Your house provides you with an imputed income in the form of shelter services. It is a nice income to have for two reasons. It is not in cash. It is not taxable. If you imagine two people with equal cash incomes living in identical houses, one owned and one rented, the owner would be able to maintain a much higher standard of living because he would not be paying rent. Nor would he be paying taxes on the cash income he needs to pay the rent.

Q. I inherited $140,000. I have left it in a money market account for months not knowing what to do with it. I am 54, single, and chronically ill, but still trying to work. What are your suggestions for what to do with the money? —J. G., by email

A. Join the crowd! Most people are frozen at the switch, unable to make a decision about buying or selling. If they already have a diversified portfolio, indecision may not be a bad thing. In your case, with $140,000 in cash, you are safe but slowly bleeding to death from loss of purchasing power to inflation.

You can overcome indecision by making a conscious decision about how much risk you can tolerate. Suppose, for instance, that you didn't want to face a portfolio loss of more than 2 percent. Well, you could invest 10 percent of the money in a broad market index fund. Then, the index fund could decline by as much as 20 percent and the total loss to your entire portfolio would be only 2 percent. Even if we had another meltdown like 2008-2009 the impact on your portfolio would be no more than 5 percent.

The market would have to decline about 35 percent for your total portfolio loss to equal the 3.5 percent loss in purchasing power you would suffer by being in cash for a year since the trailing inflation rate is about 3.5 percent.

America’s Promise

admin — Mon, 05 Dec 2011 21:00:00 GMT

By Andrew Hallam

We’re all getting smacked with reports about the U.S. economy and how Asia’s young academic tigers are going to hammer home runs against America’s kids, relegating the next generation of Americans to play second string to world-leading superstars in China.

True, U.S. educational cutbacks could have devastating future consequences, but from my perspective, as an international teacher based in Asia, I see something different.

I teach Personal Finance and English in Singapore, a tiny country of just 4 million people, roughly 80 miles north of the equator. Geographically, Singapore is closer to Australia than it is to China. But it’s definitely Asian—and forward thinking. Despite having few natural resources, Singapore’s government has no long term debt. It’s a safe, stable base for many international businesses wishing to extend their reach into the growing economies of India and China.

And when those businesses—such as General Electric, Coca Cola, and Microsoft--bring employees to Singapore from other countries, many of the employees’ kids end up in my classroom at Singapore American School, where more than 50 different student nationalities are represented. With roughly 4000 students, I teach at the world’s largest international school--- and we’re on a U.S. curriculum. In some ways, I see the future far clearer than a U.S. based economist ever could because of my daily access to some of the best and brightest students from a variety of the world’s countries. After eight years overseas, I’ll tell you what I see.

Although there are brilliant, creative Asians being churned out by some of the Orient’s best schools, this part of the world still has a deserved reputation for producing memorizers who can’t analyze or problem solve. They may come from some of China or Korea’s top schools, and they may be some of China or Korea’s top kids, but the vast majority of Asian educated kids are still hard-working memorizers. And from my vantage point, progress towards educational systems that (they hope) will churn out creative thinkers isn’t materializing. I believe that it will take many generations before they turn that around.

That said, put a contingent of young six year old Koreans or Chinese kids into an American school (such as the one I teach at) and years later, they’ll morph into superstars. These are the kinds of kids who could end up mastering the universe. The American educational system teaches them to debate, problem-solve and analyze with the best of America’s kids, and their work ethics usually bring smiles to the lips of even the hardest core Tiger moms.

But what about the kids who are actually educated in China? They might be as proficient in English as a Californian kid, if they come from an elite school. But if they enter an American school, such as mine, at the age of 15, how do they compare?

Although every country has its extraordinary outliers, most Chinese-educated kids would surprise you with their inflexible thinking. For example, after studying an array of classic American novels, you can ask them why Jay Gatsby wanted to grow wealthy. Instead of giving an opinion, they’ll start flipping through the pages of Fitzgerald’s masterpiece, looking for the answer. Ask why Huckleberry Finn wanted to help the slave, Jim, and the same fruitless strategy gets employed.

So are Asia’s students really going to rule the economic world one day?

If countries like Korea and China can teach creativity, problem solving, and analyzing in the future, then an economic monopoly centred in the far-east would be a near certainty. But as I suggested, it isn’t going to happen anytime soon. It would involve a cultural shift, and these can take generations.

The American educational system, for all its flaws, teaches kids the kind of skills that you’d expect future power brokers to yield: thinking, over memorizing. And it’s still the American schools (like Singapore American School) and American colleges like Stanford, Yale and Harvard that carry the most prestige in Asia.

Bash the American educational system if you want, but Americans still have something that the world covets—a core ability to educate, based on an American culture of challenge and thought, over pure memorization. Will the next economic powerhouse be in Asia?

Again, I’m not sure. But I do know one thing: if the United States government begins to make a greater financial commitment to American schools (on American soil) the U.S. could distance itself from its fast closing eastern economic rivals. This would probably surprise many of America’s economists.

But it wouldn’t surprise me.