Where the stimulus money is coming from

I've said this to many people in several different ways, but what this recession really means for most North Americans is that they won't retire as early as planned or that they'll have to continue working at least part time to buffer their savings.

Well, here's some talk from Calculated Risk with a great quote courtesy of the NY Times.

“What the average citizen doesn’t explicitly understand is that a significant part of the government’s plan to repair the financial system and the economy is to pay savers nothing and allow damaged financial institutions to earn a nice, guaranteed spread,” said William H. Gross, co-chief investment officer of the Pacific Investment Management Company, or Pimco.

Of course, this basically screws over fixed-income retirees, but it also damages prospects for those close to retirement. If you're 60 and planning to retire at 65, you're basically making no money in safe investments, but you also don't have any time to "ride out" highly volatile investments like stocks. Unless, of course, you wait until 70 or 75 to retire.

It sounds absurd, but what else are you going to do? We've put ourselves into a really tight spot here. The Obama plan (for better or worse) is to inflate the money supply, which is going to be done at the expense of those people who want to retire. To be fair, the McCain plan wasn't really any different.

I guess the big question is really if this is simply to be expected? Personally I think the whole concept of everyone retiring at 65 and living to the ripe old age of 90 is also pretty absurd, so though I blame the US for making some pretty bad financial decisions over the last 3 decades, I also think that we have to get over our delusions of multi-decade retirements for everyone.

Irrational Pessimism

This is in reply to a post on MillionDollarJourney.

@Ed:This recession is, of course, not over yet and may deepen, but none of these statistics are expected to get as bad as the prior recessions.

There are several logical flaws in the comparisons here:

#1: The interest rate on today's mortgages cannot reach the level of those previous recessions. There is already an excess of available homes and lots of people still on ARMs. Interest rates that high would absolutely destroy the economy.

#2: The interest number in 1981 was high b/c of inflation. Volcker, the Fed Chairman, wanted to wring out inflation by slowing the growth of money. He basically raised interest rates until the stagflation stopped.

#3: Your S&P 500 and TSX lines are both based on nominal differences. For a fair comparison you should calculate net change plus inflation. Either way, it's still pretty clear that the drops last year are in line with the drops in the other to recessions.

#4: Inflation, what models do we have stating that this isn't going to sky-rocket?

Clearly, the 0% inflation is due to the fact that the gvmt "printed" money approximately equal to the amount of money that was simply lost via bankruptcies. Of course, the 0.1% number dates back to January, but the most recent number that we have is from February.

Since the end of February, Obama has agreed to a trillion dollars.

The US is likely going to run a $2,000,000,000,000 deficit this year. That's two Canadian GDPs. Much of that money is going to come from Quantitative Easing, i.e: simply inventing money. In fact, that's the goal, the government wants to create inflation. From Paul Krugman of the NYT:

...having some inflationary effect — is what the policy is all about

So we're going to have inflation. We have to, but you haven't seen it yet b/c the money is being invented right now.

What's more, Obama has promised more trillion dollar deficits. Without a dramatic increase in US production, these deficits are going to cause significant inflation.

#5: The numbers are still getting worse.
An average of 55 forecasters in the January 15 Wall Street Journal survey expect real GDP to eventually reach only -2.1%

January 15 predates the enstatement of the Obama administration. Obama has likely seen the most active 100 first days of any president ever. He has produced several plans that simply did not exist in any way on January 15. You need to get more recent data than this.

Industrial production appears to have bottomed in September 2008.
Industrial production in 2009 has been down for 4 months.

The numbers I'm reading are even lower: From February 2008, industrial production has declined by 11.2%.

The news is full of stories of massive lay-offs, but unemployment is only expected to rise to 8.9%
Unemployment numbers are currently at 8.1% (from 7.6% the previous month). And across all sectors:
In February, job losses were large and widespread across nearly all major industry sectors.

The US national debt is into record highs outside of WWII.

The US is operating a tremendous trade deficit and has been for 25+ years. That number will not turn around.

The only politically feasible way out of the mess is (sadly) the printing of money combined with real economic growth. Of course, China's not really happy about the part where the government prints away its debt (and Canadians should be pretty peeved as well).

But the US has to find a way to convert their dollars into real assets and frankly they have some of the most expensive assets in the world, so they're not doing really well in that category.

#6: Everyone is wondering how low the stock market will get, while trillions of dollars sit in cash on the sidelines waiting for the right time to jump back in.

Where does this data come from?

From what I can see, the banks and insurance companies are tragically under-capitalized (i.e.: lacking in cash). The banks don't want to mark their assets to real market values b/c they're complaining that there is a lack of liquidity in the market. The current US plan with the "private/public partnership" is founded on the concept that these assets would be under-valued if sold at current market prices b/c of a lack of competition and liquidity. So the US government is betting a 500 to 1,000 billion bucks and providing massive leverage to private investors in an attempt to heal the banks. And while this is happening you're claiming that many trillions of dollars are sitting around just waiting to be invested.

If these trillions are waiting to be invested, why does the US government have to cook up plans with 12:1 leverage?

@ED, I don't think that you've made a very good case for yourself with one chart, old data and zero hyperlinks. It's obvious that your data doesn't add up. It's also clear that you're missing something really key about the US economy.

If they do not reverse the trade deficit, the economy will collapse. It's very key that we understand the size of the deficit. The US has been on a 25-year credit card spending spree and they don't have an easy way to even start paying back the money without dramatically "tightening their belts".

Even then a trillion dollars represents $33,000 for every US citizen. That's one median income here in Kansas City. That's a lot of debt, it's not going to be easy to pay off.

I'm going to posit that we're actually under-estimating the breadth of this financial crisis but that we'll have to wait until 2010 for it to widely understood.

The "Time" has yet to come

Last week Time Magazine ran a special on the US financial crisis.  The first article is House of Cards: The Faces Behind Foreclosures. The article is centered on two Kansas City homeowners both facing foreclosures. I think that a few choice quotes from the article really speak to the root of this US financial crisis.  People simply don't get "it".

The crisis is fundamentally about wanting too much at once.  But the face it has consistently shown is one of over-leverage. Over-leveraged people, over-leveraged companies and an over-leveraged government (ostensibly all the same thing).  

This article tries to paint a picture of those getting those getting the short end of the stick, but all I see are over-leveraged people out of time.

A few choice quotes:

We have entered the one-strike-and-you're-out era. One lost job. One medical emergency. One bad risk or misjudgment of the heart...

We're geared to believe that risk begets reward and our tomorrows are brighter than our todays. One-strike-and-you're-out is a neck-snapping reversal for a culture accustomed to assuming that fate is a welcome friend...

People like Paula Stevens and Joseph Zachery weren't flipping houses or lying on their loan applications. They didn't pile up mountains of credit-card debt. They worked hard for what they had and shared their modest portions with others...Their bitterness stems from a feeling that they've held up their end of the social contract, but now the terms of the deal have been rewritten by malign forces....

Not everyone who has fallen behind on a mortgage is a loser complicit in the housing collapse.

That last line is from the closing paragraph. (emphasis mine) So the big question here is "are these two people 'losers'?"  Are these two really innocent bystanders in the housing collapse? I think the answer is no and the reason should be clear simply by analyzing the risks under-taken by both parties.

Joseph Zachery

Occupation: Firefighter from 1986 to recent. Ended at $60k / year.  

House:  $100k house, needed renovations

Worked a second job: Like most firefighters, he always had a second job...he started his own business, demolishing houses condemned by the city.

He used the equity from his house to buy demolition equipment, resulting in a mortage where "he owed nearly twice the original purchase price."

Crisis: he gets into an accident on the job.

He's shuttled around between hospitals, he gets full disability from the fire department (plus some electroshock treatment?) and he's now living on pension. He get $50k / year. It costs him $800 / month for medical, leaving him with $2,400 for everything else.  But get this, his mortgage is $1,600! On a 100k loan that doesn't make any sense.  But the problem here is that he actually owes 190k which he's paying off at 9%.

So why did he end up here? Was it the work accident? What did he do wrong? What are the risks he took?

1. Leveraging non-existing home equity:
   He didn't pull out just the home equity he "actually had" from his down payment or his mortgage payment.  He pulled out "speculative" equity that the bank extended based on the prevalent housing prices at the time.  He wasn't borrowing "his own" equity, he was borrowing equity that he hoped the house would have.
   Rather than taking out a business loan for his small business, he took out a loan against his home meaning that a crisis in his life would likely cause his to lose his home.
   
2. Leveraging his ability to fix the home:
   As stated, the home was a fixer-upper. He was banking on his ability to fix the house in order to prop up the value of the house.  Of course if he wasn't able to fix the house for some reason, it's value would bleed from lack of maintenance.
3. Leveraging his second job:
   He knew his pension income and he knew his medical payments, he knew the money he had to work with. Based on the fact that he's losing his home, it's pretty obvious that he wasn't going to be able to keep his home on just his pension.  He needed that second job to keep him going.
4. Under-insuring:
   This is a really big point.
   There is no indication that he has disability insurance on his second job.  Here he has a second job that he needs to keep in order to remain solvent. He's dependent on his own mobility and capacities. But he's not insured if he loses them.
   Yes he had disability from the fire department, but that was only for his fire department salary.  Where's his insurance for his other business?
   He buys 100k in equipment, but doesn't buy 100k+ in disability to cover his potentially catastrophic liabilities.

So if you look at the risks, he was basically gambling that this wouldn't happen.  He's unmarried, he's supporting his mother, his kid is in college, he's has no "backup support". 

He's a firefighter, he runs into burning buildings for a living and he's gambling his livelihood and his home on the fact that he won't be injured.

So he got injured and lost his home.

Paula Stevens

Occupation: Gateway tech support. No college degree, serial "entry-level" worker. In her best year she grossed 42k  

House:  3,000 sq ft, purchased in 1994. Re-financed 3 times, now owes 159k (@ 9%!)

Crisis: lost her job at Gateway and can't find one that pays as much.

So the obvious risks:

1. Living without a buffer:
   "It takes $14 per hour for me to meet my bills...That's what I was making at Gateway when I was laid off. But no one wants to pay that much..."
   If you're making $14 / hour, you need to be living off $11 or $12. How else are you going to save up cash for retirement or even just emergency expenses like job losses?
2. No professional development:
   She made it to 56 and somehow doesn't have the skills that she can market for $14. There's no sign that she took college night courses or professional training.
3. Where did the equity go? the savings?:
   She's 14 years into a mortgage and she owes 159k. The median home price in Kansas City during the last recent peaks was just under 190k.
   But she bought in 1994, close to the bottom, 14 years ago.  She most likely owes more on the house than its original asking price. And she's paying 9% on it to the tune of $1,400 / month.
   And where are her savings? It doesn't seem like she had retirement plans of she would have money right now.
4. Family Obligations: 
   ...but her oldest daughter, Maggie, 28, has a new baby and is enrolled in nursing school. "I just have to get her through that," Stevens explained

To put #4 in context.  I am currently living in the heart of Kansas City in a luxury apartment in a premium location. I have 1100 square feet, 2 bedrooms and 2 full baths. In-suite washer/dryer/dishwasher and a few other luxuries.  You could very comfortably have two people and child here.

I pay less than $1,400 after utilities.  That's less than her mortgage and this is a luxury suite. You can get an older apartment or a townhouse down the street for $600 to $900.  That would make it a lot easier to balance the bills.

So where does that leave Paula?  She's obviously over-extended, but all of the signs are pointing to her basically not having savings.  Her telling quote is this defeatist line: "That's how it works. You just keep starting over."  Rather than spending her life accumulating, she just kept starting over.

My personal opinion (because it's my blog): neither of these people should be in their homes.  They should both be renting, either really close to family or really close to public transit.

Disagree? I'd love to hear other thoughts.

Enough to Retire?

Just came across the 10/10/4 model as presented at Mint.com. It demonstrates a pretty tenuous grasp of reality.

Comments below.

Jess:the life expectancy in the US is only 77 years according the the CDC

Is the current life expectancy or the life expectancy for people who are currently 20 and won't hit 77 for another 50+ years? Do we have a link for this?

Even if we change the model to 80 years (let's give medical science a little credit), that still leaves us with 45 years of working to 35 years of not working. That leaves us with 45 people working for 35 people not working.

Imagine that you're living in a (global) village with 80 people. 45 of those people do all of the hunting / gathering / farming / house-building. The other 35 people are either non-productive children or old people who sit around smoking pipes and eating food brought in by the other 45 people.

Either way.

If you save 10% / year for 45 years, and receive no effective pay raise between 20 & 65 (i.e.: pay raise = inflation). Then you would need ~3.25% real returns (that's returns above inflation) for basically the entire 45 years to meet the goal of having 10x your annual income. That doesn't sound like much, but here's some perspective.

Right now TIPS bonds are offering 0.7% real returns (they were offering 0.0% returns just a few months ago). Real Stock market returns over the last decade are into the negative. If you earn 0% real returns one year you have to make 7.5%+ real returns the next, just to make it up, that's not easy.

What's more, you're subject to a very critical period. At year 30 you have about 5x of your 10x. From year 30 to 45, you're only going to save 1.5x (putting you at 6.5x), which means that you're relying on 15 years of solid returns to make up that other 3.5x. If you have a 5 or 10-year drought, you could end up way short. And a 5 or 10-year drought is going to happen somewhere in those 45 years.

Finally, we made the very unsafe assumption that your "real income" doesn't change. Realistically, your income increases over time.

According to the 10/10/4 model: "...by the time you are 65, you will need 10x your income immediately prior to retirement to retire at the level you want.."

So you need 10x your final income, not your starting or even your average income.

Let's say you're 20 and making 30k today. Your "10x" number is 300k. You save 10% for 10 years and save just over 1 year's worth of income (say 31k). At the end of 10 years you make the big switch and find a new job earning 45k (again, no inflation). Awesome for you!

However, now your "10x" number is 450k, but you only have 31k in the bank. You're behind, right? You're at year 10, you should have at least 10% of your target number, but you only have 6.8%. So what if you continue to plow along for another 10 years and then get another pay raise to 60k? Now your 10x number is at 600k, you're 20 years in to the plan but you're way behind the curve. You should have saved 120k (+ interest), but you're nowhere close to that number.

And then you have to account for medical. If you're earning 60k but receiving 10k in medical benefits (may be low-balling in the US), you now need 700k in savings (not 600k).

You can see where I'm going with this. If you follow the 10% savings route and you also follow a normal pattern of increasing income throughout your career, the 10x goal is very difficult.
- Your increasing income makes previous savings insufficient.
- High medical expenses inflate your "10x" number.
- You need consistent returns well above inflation and you need them at the right times.

Don't get me wrong, I'm a savings advocate. I save 10% and then some in tax-advantaged accounts.

But I make no pretenses of making it to 10x without saving more, getting lucky or making some savvy investments.

Again, the model presented above is very broken. Readers can follow this at their own risk.

Housing illusions

MillionDollarJourney had a post about Cash Back Mortgages.

Instead of the usual comment, I've devolved into one my blog replies, original comments included.

@Nolan: However it does not change the fact that if you buy a house to live in it, and the payments are reasonable for your income, then you are better off owning than renting in the long run.

This has been hashed and re-hashed on this forum and elsewhere. The data in no way supports your thesis and I would urge not to spread such dangerous information.

At best, owning a home is a lifestyle decision with a set of associated risks. We can argue this elsewhere, but there are a dozen guys who've run the spreadsheets. You've successfully listed a few of the risks:
... the ones who can’t afford their payments, speculators (like you said), and the ones who panic and sell when housing prices fall.
but there are more:

• Risk - People with jobs that are heavily dependent on some local resource (mill-towns, mining towns, etc). This is actually doubly risky, b/c if you're losing your job it's likely that nobody else is moving in which means that your housing "investment" won't be doing well at the very time you need to sell.
• Risk - People working in highly transient / mobile fields. If you're in IT and changing jobs every 3-5 years (quite common), being tied to a location can be quite costly. If you're an athlete, a long-haul trucker, etc. similar logic would apply.
• Risk - purchasing a high-maintenance house. Even if you can "reasonably afford the payments", you still need to afford the maintenance. A 20k basement repair on a 120k house is a realistic risk and would definitely wreck your financial plans.
• Risk - property tax increases. As independent homeowners you're still on the hook for these taxes, Yes there are processes, but it takes personal time (read "money") and you don't necessarily have a lobbyist group on your side.
• Risk - school district changes: This is primarily in the US where people pay premium home prices for "top-rated" school districts. A certain % of value is actually tied to the continued school district prosperity. Buying a house for your 5-year old could be a liability by the time they're 18 and it's time to "downsize".
• Risk - Energy Costs: once you buy a place you're locked in to paying the energy required to keep that place running. If your rental place sucks up too much energy (due to size or just poor maintenance), you can move at the end of the lease or request changes (you're income, you have a good bargaining chip). If your own home leaks heat (or cold), you're on the hook for this cost. I don't know if you've noticed, but energy costs are going up almost universally. Right now, 50% of the earth's population is using about 4% of the world's energy, and we still haven't figured out that whole "cold fusion" thing. That's a lot of pressure for energy costs to continue to rise.
• Risk - Politics: don't like that new factory that's being built just around the corner? Think it will influence your house price? Well, the ball's in your court now, b/c it won't be easy to move, especially with that factory weighing down on your home value. (also, see property taxes)

I want to echo one of Jordan's comments here: ...ignorant customers just desperate to get in before they’re “priced out forever” or other such non-sense.

If you are making above-average income you will not be "priced-out forever". The rules of supply & demand still apply. Either house prices will deflate drastically or the salary prices will rise to match the growing cost of living. House prices do tend to be stubborn, but since 1990 we've since house prices grow well beyond the rate of inflation, with people re-investing the money from their first place into the second (and third and so on). Barring government interference they're going to dip like every other investment.

Personal aside: I expect this dip to happen when the average baby boomer retires and "downsizes". But it may be happening sooner, check out this blog on Edmonton housing market (with lots of pretty charts). Notice the Supply vs. Demand and the Price and Inventory Comparisons?

If you want a home and can't afford one, just keep saving your ducats and investing elsewhere. Especially the 20-somethings and 30-somethings with "good jobs" (i.e. average or above-average income).

Did I miss any home-owner risks?
There are definitely some renters risks, but that's a different post.

American economics and the USD

This whole post started with the following post on MyMoneyBlog.
Hedging Against The Dollar: Opening A Foreign Currency Bank Account vs. Buying A Currency ETF » My Money Blog

Look guys, I've mentioned this before and there are some great links already posted. The US economy has some serious issues and barring a massive war to claim vast booty and slaves, the purchasing power of the dollar will decline.

What does this mean? It means that means that more Chinese people will be able to afford the 10th generation iPod and less American people will be able to afford the same iPod. Peter Schiff pretty much nails it: as the value of the USD goes down and goods become relatively more expensive, other buyers with stronger currencies will swoop in and buy those goods.

Why is this happening? That's very complex, but here's a very simple explanation: You are fat and in debt. (same thing) You import more goods than you export and you've been doing it for years. You bring in 10 bananas each worth a dime but you're only bringing 90 cents to the deal. You then give out an IOU for the other 10 cents.

This basically means that you owe people lots of money (40% of the US national debt is foreign-held), but people aren't going to just take cash, b/c the value of that cash keeps dropping. They want stuff. They want oil, gold, food, they want services (skilled american workers), etc.

Cash is just trust. The US handed out a bunch of IOUs for cash, but they're not worth anything if nobody can cash them in for stuff. Of course, the world has been accumulating these IOUs, but they haven't been able to cash in b/c all of the American stuff is so expensive. But that's part and parcel with the whole import/export thing. For USD $100 I can buy 2 Russian programmers for 3 days or I can buy one american programmer for one hour. I can buy one bottle of "American pharmaceutical" or 10 bottles of "Indian Pharmaceutical" (both made from the same stuff).

Nobody wants to buy American stuff b/c it's too expensive; but everyone has these American IOUs that they want to cash in. Of course, everyone's in on the deal now and nobody thinks that these American IOUs are any good. So the solution is simple: the American economy will suffer until they can start paying off the debts and letting people cash in their IOUs. Again, money is just trust. It's pieces of paper or computer bytes with promises attached. The world does not trust the American economy, it does not trust that the American IOUs are worth anything. Until the dollar drops to the point where other countries can "get their money's worth" when they cash in the IOUs, then the dollar will continue to drop.

Jonathan: you said: As long as I can still buy what I need with the dollar, I don’t care if it trade 3:1 with the Euro.

But this is what you're missing, if the Euro goes 3:1 you won't be able to buy what you need with your dollars. Your salary will be the same, but the cost of the iPod will double. Your food will be more expensive as foreign markets start buying your produce with the money you owe them.

Yeah, yeah, this is happening right now on a small scale, we call it inflation. But you've just seen minor inflation, almost a side effect of the reserve banking system. Underneath all of this, the citizens of the US (whose very birth certificates back the money that is printed) are in debt to the world and they continue to live beyond their means. The US consumes more energy and gas than it can produce, while hinging its entire economy on those very resources. US labour is too expensive for all but the western european countries and manufactured goods are likewise too expensive. The only thing the US can "afford" to export is the food, but nobody else really needs the food at American prices.

When the whole thing falls, then you'll see real inflation, gas & food will suddenly cost twice as much and you won't be making any more money. Once it's fallen, you won't be able to "buy what you need with your dollars", your purchasing power will be drastically reduced. This is the cost of globalization, the world is catching up and the US is at the top of the ladder, so the only place left to go is down.

The US is the richest country in the world living a lifestyle on credit. Take all of these "credit card debt ruined my life" stories and scale that out to a whole country. That's what going to happen to the US. We're already seeing record foreclosures which means that people are being forced to sell their biggest asset/investment, in some cases their only real investment. People are skipping vacations to make extra money, they have their kids working at 16, then 15, then 13 & 12 just to keep up the pace. Elderly people are coming back to work greeter jobs at Wal-Mart and the workforce continues to churn harder and harder to keep up.

These are not the signs of prosperity, prosperous people work less not more. These are the signs of a people stretched too thin and ready to pop.

Book Review: Rich Dad, Poor Dad

OK, so it's an old one, originally printed in 1997, but it's been popping up on lots of my blogs so I figured I would give it a read. Truth is, I wish I had read it in 1997, when it was new and I was 17, then it would've been news to me.

The book itself is basically the explanation of his life with two "dads" (the second dad is actually his best friend's dad, but we get the point). One dad is "highly educated" but never rich; the other dad is your prototypical "dropped out of school, got wealthy" type of guy. He typefies the behaviour of both fathers into a "Rich" and a "Poor" mentality. The book is a basically a compare and contrast of the two philosophies centered around his six lessons that his Rich father taught him. The lessons are:

1. The Rich don't work for money


2. Why teach financial literacy?


3. Mind your own business


4. The history of taxes the power of corporations


5. The rich invent money


6. Work to learn - don't work for money

OK, so they don't all sound like lessons, a bunch of them actually sound like chapter titles (hello #4?) and they are. But hey, the history of taxes? The power of corporations? Man sounds pretty complex, pretty powerful... yeah... it's 10 pages long, maybe like 4000 words, it reads like a short essay without the footnotes or references.

Still we can do justice to the history of taxation in America in 10 pages, right? Not really, not when half of it has to be tied in to your vision of the world. And that's the fundamental failing of this book, it's basically 200 padded pages of pump you up, go out and learn. He's basically all about eschewing the establishment and focusing your learning on how to make money. He's very focused on stating how the "old ways" of school, work (house, car, kids) and retire are all gone, without really mentioning that they were never there in the first place.

He talks about how schools don't teach what it takes for people to be independently wealthy as if schools actually had that purpose in mind. We don't build schools to teach the leaders of tomorrow, it's not really a secret, we run schools to build more efficient peons, but hey one visit to my high school would've made that evident. My family had dinner table discussions about this stuff in high school. The smart kids make it through despite the system not because of the system, we knew that, I knew that, I still went to University. Then again, we also talked about the general death of pensions and the "pointlessness" of retirement (see Die Broke). Yeah, so maybe he's right, the smartest kids learn stuff at home as well as at school, but then, my parents aren't Rich either.

Long story short (not that the book is very long), Kiyosaki has some potentially novel ideas. There are tons of people who have never thought in the ways that Kiyosaki is espousing. So I guess that's good for them, it's just terribly unfortunate that he's not really a good writer. His book is like fragments thrown together where the same stories are repeated and the same points belaboured. It's like a series of bad essays with no supporting documents and no footnotes and the same point to all of them: become more financially savvy and you will become "Rich" instead of "Poor". But he doesn't bother with history, he just gives you the short "Kiyosaki"-esque version, he mentions the gold standard in passing and never follows up. He talks about his Cashflow game in basically every chapter but doesn't bother to even provide an Appendix with details or rules of the game. Some of paragraphs read like rewrites of paragraphs from other sections (they probably were), he just repeats himself so much.

And maybe that's my big issue with the whole book. Kiyosaki is not trying to provide you with "information" so much as "inspiration". He wants you to read his 200 hundred pages and subscribe to his philosophy. Some call this their PF bible, but to me it is to personal finance what Rocky is to boxing training; it's all sizzle, no steak. Of course, great steak needs some sizzle, just like great boxers need heart, but reading this book won't make you rich, it'll just make you want to be rich.

If you want to actually be rich, then look elsewhere, he simply doesn't provide any more details: pay yourself first, make your money work for you, hire people smarter than you, blah, blah, blah. He doesn't list a book on hiring skilled people; or point you to specific books on where to start investing and where to finish investing; or send you to guides on being frugal; he doesn't give you the top 10 wealth ways of ordinary people. All of this important, actual information, is left as an exercise to the reader. He just wants you to agree that he is right about wealthy people. He simply doesn't provide any real direction on any of these things, he's not interested in teaching PF 101 he just wants you to agree that he's right and then he wants you go out and teach yourself.

Yes Mr. Kiyosaki, you are correct. There it's done, now go read something with information like Tom Hopkins: "How to Master the Art of Selling" or Stephen Covey's 7 (or 8) habits.

PS: If you want to know a lot more about the Gold Standard, look here, and check out the first two videos. They have propoganda issues, but it's a good run at understanding money and the banks and the actual history behind the whole deal.

Paying down the mortgage early?

OK, there have been a couple of posts on the blogs that I read discussing the benefits of an early mortgage paydown vs. an alternate investment.

And me, well I'm kind of a chump, so I ran the numbers quickly. For reference, this is a 200k fixed mortgage at 6% over 25 years. Here's what the monthly breakdown looks like for the standard mortgage. That Purple Stuff is the money the bank is taking for interest which, as you may know, is mostly taken first. And the Light Tan stuff is what you're actually paying down. For the last two, I've taken an equal size payment (~$4600), off the principal at different points in time. So that Blue Strip on the last two is the amount of interest that you save each month as time goes on.


When you pay down interest early on, things change like so:


Paying things down late gives you something like this:

Now, the original posters were talking about applying extra money against the principal and calculating the interest saved as a percentage of that principal. So if I paid down 10k on a 6% mortgage with 10 years left, I'd basically be saving $600/year or $6000 in interest.

However, the graphs would seem to imply that something terribly different is going on here, I mean, you can only save chunks of the purple stuff and if you're paying down the mortgage later rather than sooner, there's a lot less purple stuff to save on.

Imagine it this way: say you took out 100k @ 10% for 10 years and made your regular monthly payments ($1321) for a full year. Then, magically at the end of the year you win the lottery and pay down the house in one swoop, how much would you pay? A quick run to my information source, indicates that you still owe $93.8k, you were going to pay $58.5k in interest on that mortgage, but you paid $9.7k in interest in the first year alone, the bank took 16.6% of the money you owed them in the first year. In fact, in the next year, they would've taken $9.1k which was 15.5% of what you owed them, or 18.6% of what was left. By the end of two years, they have 32% of what we owed them, that's 32% in only 20% of the time.

So let's back off and go to our equation. Both posters are saying: if I drop 10k on a 10% mortgage I'll get a return of 10% times the number of years, and I'm saying that the calculations are flawed. So we'll use the 100k @ 10% for 10 years example to make life easy, if I put down 10k, it will "earn" 1k/year. Let's say that I get to my final year and decide to put down the 10k. With 12 months to go, we've paid 57.7k out of 58.5k in interest and we owe 15k on the place.

Wait, hold on right there! we're supposed to save 1k in interest, but we don't even have that much owing in interest. If I put down my 10k, I'll still owe 5k on the house, but I won't have saved 1k in interest, there's not even 1k in interest to save! What if I do it the previous year? At this point I owe 28.6k on the house and I have 3k left in interest to pay. So now the model is telling me that I can save 2k (or 2/3 or the remaining interest) by paying 10k of the 28.6k principal that I still owe (or more than 1/3)?

If the numbers seem weird, it's b/c they are, I mean, they're clearly wrong. You're not going to save 66% of the interest over 2 years by paying down 35% of the principal, that's pretty clear.

What's going on here is equally clear, if you're at the end of the 10% mortgage, you're not actually paying 10%. In the last 2 years of the 100/10/10 example, you will normally pay 31k into the mortgage and only 2.3k will go towards interest, i.e.: you only pay 2.3k/28.6k or about 7.5% interest. If you're in the last year, that number drops to like 5.5%. Here's the "effective interest" chart:


At the start of year 2, the 100/10/10 mortgage owes 93.8k, but will only pay 9.1k, which is actually just under 10%. So where did the original posters go wrong? Well, you can't "save" 10% interest if you're only paying 7.5%. The other problem is that the 6% is relatively small, so it's easy to gloss over the math. In the 200k @ 6% for 25 examples (the first graphs), you're actually paying between 5.15 & 5.95% "effective interest" for the first 22 years, so you can basically just gloss over the number (even if it's wrong) b/c you're still within a percentage point. If interest rates go to 10%, then suddenly you're losing whole percentage points and the bad math becomes evident.

So after a few hours of number crunching, what do I think? Well, the basic premise of both posts is actually still good: where am I going to get better returns? And the simple answer is that all things equal you'll get better returns from whatever is paying/charging the higher "effective interest rates". (where the "effective" part is key)

However, right now, things are pretty muddled b/c today's interest rates are yesterday's mortgage rates. This is complicated by tax law. You see, in Canada, we get tax breaks for RRSP investments and in the US you get tax breaks for mortgage interest. So in Canada if you have room to contribute to your RRSP (they do have caps), then you actually get an immediate 20-40% return on putting the money in the RRSP. In the States you'll only get a tax break for a certain period at the beginning of the mortgage, and then the interest will become too small. All in, the numbers could really "go either way" so there's no clear winner.

Personally, I'd rather have the money in something liquid and diversify. "Cash is King" and your home isn't bringing in any cash (unless you're renting rooms). Give the cash to someone who can make you more cash and if you're still itching to pay down the home then use the income from that cash to help with payments. At least this way you're making and spending money rather than just spending it. That way you can redirect the cash flow if you need to.

Multiple streams of income

Here's a neat one worth talking about:
FTA: My question is, should I be focused on smaller multiple streams of income? Or focus on larger, single projects?

I'm hearing financial jungle here, but I'm going to take him one step further. There is no passive income.

A 9-5 requires well 8-10 hours/day (let's not forget commute). Rental properties usually suck up all kinds of time, if you have a 9-5 you end up losing weekends left and right. Rentals require repairs (contractors), you have to find new tenants, make newspaper postings, file all of the related paperwork, etc. To maintain a rental "income" that's actually passive, you need lots of rental property, which eventually becomes it's own job. Blogging for money is no more or less a job than the above, at best it's just more fun, but it's not guaranteed that you'll keep doing it, check this one out.

Now it seems that everyone thinks stock investment is actually passive, but really it's still actually a lot of work. Want to make an 80k salary? Oh that's easy you just need 2 MILLION dollars in the bank at 4%. Of course, after the government's share you'll still only end up with 40k, but I guess that covers the bills (and let's not forget 1% interest rates). Now if you don't have that much money (which most of us don't), but still want to make an income, then you're definitely going to have to work at it: financial readings, market watching, moving investments, finding money to invest, taking out loans to leverage your gains, however you do it, it's definitely work. I mean you'll have to do something to find a way to make better than average returns off less money.

(As an aside, finding 2 million dollars is quite the issue. The average Canadian family income was about 55k in 2001 and about 60k in 2005. That 33 years of the average family saving the entirety of their income! I don't think the 2 million dollar retirement plan is really that viable)

So here's the way I like to look at it. You don't get to take any money with you, none. At best you get to leave some to your kids, which is no promise they won't just piss it away. And at that point, you might as well give them most of it while you're still alive to help them manage and possibly respect it :)

Now the bigger question is "If you actually had a passive income stream and didn't have to work at all, how big would it need to be and what would you do with your time?". You see, unless you have no drive, will or interest of any kind then you'll end up doing something. And that something is the really important part.

You have things that you love to do and somewhere out there is a job for some aspect of what you love to do. You can make all the excuses in the world it "not being a job" or how "nobody makes a living at that", but that's all just BS. You like blogging, someone's making a living on it, you like carpentry? reading books? doing Tai-Chi? flying hang gliders? running long distances (started at 30!)? eating food? Ok that last one's a little weird... point is somebody is taking the thing they like to do and they're making a living out of it.

Diversifying yourself can help keep money coming in when one market dries up. But I think that there is so much more to investing than just throwing money into the markets or housing and assume that you're leveraging enough of yourself. Maybe I just read the wrong blogs, but it seems to me that the easiest and simplest investment is really yourself (but that's a whole other post).

The investor's primary goal is to generate as much wealth per time unit (day/month/year) as possible. The person's primary goal is to generate as much pleasure per time unit as possible.

Unless you get a real kick out of generating wealth (and not spending it), then these two goals are in some kind of conflict. So the real question is "how much money do I need to make to do the things that make me happy?". Money is really all about what you want do with it.

So do you need multiple streams of income?

How about "do you love what you're doing to generate money"? If you don't love what you're doing then make really sure that the money is letting you do something that you do love. I mean, we can talk all we want about wealth generation and pros/cons, but that's not the goal. The goal is to have the money to do the things that make us happy.

What you probably want are multiple streams of happiness, the rest is irrelevant. If you're like the Frugal Trader and have four different "jobs", then the question isn't really should I do "more or less", the question is actually two related parts:

1. How would I rather spend my time?
2. How much money do I make that way?

Answers to one will influence the other, b/c lack of money will limit your options. But spending too much time on things you don't enjoy will limit your life. If you graphed this out (Happiness vs. Money), you'd quickly realize that the graph is not a straight line, or even a simple polynomial function. It's not easy to find some "max point" of happiness. Especially when things change, as they always do, with time. If you make less money, but love your days more, then where are you at? If you make more money and love each day a little more then are you on the right path?

So back to the start "one stream or multiple streams?", well this is fundamentally the same questions as "what the hell do I want to do with my life". So that seems as good a place as any to start.

An opening on Finance and Investing

In reply to:
http://www.mymoneyblog.com/archives/2007/05/why-arent-money-managers-paid-purely-on-performance.html

Jonathan says:

"but I don't see any evidence that investing skill has the same permanence as
poker skill"

OK, clearly there are two issues at play here.

1. By pure stats, a certain percentage of people will end up on either end of the win/loss scale in a zero-sum game. Now, winning poker players are playing a game of "incomplete information" (not unlike the markets). These players are winning b/c they are making the "correct call" more often than the opponent(s). Now it could be argued that the "correct calls" are actually dictated by chance. I mean, somebody's got to make a decision and if you give enough people the opportunity to make the decision *someone* will make more correct decisions. Johnathan is saying that poker and investing are different b/c poker players demonstrate skill at making the right calls and investors don't. But he's not really backing that up.
2. "Permanence", Johnathan is trying to undermine the "zero-sum game theory" by inserting the term *permanence*. And this is where he wins (kind of). You see, "good poker strategy" is more or less static. So poker players can evolve their strategy by learning the basics (don't fold pocket Aces pre-flop) and then tweaking the details (tighter/looser, more or less aggressive, calling/reading specific players). But markets are not this simple, the "rules" and strategies are constantly evolving. Trying to find permanence in investing skill is inherently complex b/c "investment" is inherently complex. I mean, "investing" in/of itself is really a meta-game of games and the investment "game" spans lifetimes.

Point is poker and investment are variants on the same game. So if there can be "poker skill", there must be "investing skill". Just b/c the investment game has more layers doesn't mean that it's suddenly lucky, it just means that it's a lot harder to learn.

To understand permanence, take a look at the very vein of discussion in the link above. Lots of talk of mutual funds and how indexing is better. This is based on the "Random Walk Down Wall Street" concept, which basically found that the distribution of indexes vs mutual funds was the same, except that mutual funds performed worse by about a factor of their management fees. So if you just wanted to make money on stock (equity) trading, then you might as well index b/c the average money manager is costing you 1%.

Of course, this is only true b/c of the ubiquity of mutual funds. There was a time when investing in a mutual fund was actually an edge not a liability, but not today. Today, the investors on Johnathan's board are trying to find a 1-2% edge by indexing instead of using mutual funds. But if 60% of the market starts indexing, then this strategy stops working.

And so that's kind of my point, you can't have permanence in the markets, because the markets are not permanent. Yesterday's great move is just tomorrow's status quo.