Wednesday, June 20, 2012

Financial Pet Peeves

You all know that I am a person … with opinions. I think I am generally pretty good about admitting when I’m wrong (once I get past my stubbornness and see the light). Generally when it comes to personal finance and money, I recognize that when people do things I find crazy, it’s generally because they have different financial goals, or even more likely because they haven’t thought through the financial ramifications of their actions. Or they don’t care (which is basically the same thing).

There are, however, two lines that I’ve heard more times than I can count (and more times than I would have liked to), that drive me absolutely nuts. They’re my financial pet peeves – grounded in indignation because I think the statements are wrong, but they also cause me an inordinate amount of displeasure. (For reference, my biggest non-financial pet peeves is people using the wrong your/you’re and their/they’re/there – I AM JUDGING YOU AND YOU LOOK STUPID. Ahem.) Here goes: two very very annoying phrases, and one misguided one, and the reasons why I may just punch you if you say them to me.

“Buy stocks now – they’re so cheap relative to bonds.”
The Fed model, in essence, is a tool to understand optimal allocation of equities (stocks) and bonds. It compares the earnings to price ratio of the stock market to that of long-term government bonds. When the earnings yield (earnings to price ratio) is higher for equities than for bonds, investors should shift their money from bonds to equities. Hence right now, you hear the outcry of “stocks are so cheap – buy them now!!!111!eleven”. My financial advisor brought up the value of stocks (especially currently), but for a different reason: dividends, while historically low, have been increasing at a prodigious rate. And with perhaps 50% of future returns coming from dividends, payouts do matter.

I personally find the Fed model to be problematic. One big reason: it lacks predictive power, and is unable to predict long-term stock returns. I’m a proponent of Graham/Dodd’s value investing paradigm, which of course Warren Buffett also follows, stating that you should look for companies that are earning more than their ‘intrinsic’ value. At a very conservative level, this means that a company making 1M that would sell for 2M if it closed and its inventory/components were sold off, would be a better purchase that a company also making 1M but intrinsically valued at less than that.
Point is, the relative changes in earnings yield between stocks and bonds mean something. And really, as far as investing goes, largely anything could be a good investment, depending on the price you pay. For that reason, when people are fearful of the market because stock prices have dropped, that can actually be the best time to buy. (“Be greedy when others are fearful”) Still, people are just spouting off this phrase as though we can now say something definitive about all stocks – if you are one of them, please calm thyself.

“Why rent? You’re just throwing away money.”
Oh, this one makes my blood boil. As with many personal decisions, there are a lot of factors that go into an individual’s choice, and choosing housing definitely involves a large set of inputs. When you buy groceries, cook a delicious meal, and eat all of the food – once you’ve burned those calories, your food is gone. (Let’s not get into energy transfer here.) How come nobody says “why eat? You’re just throwing away money.”? Well, because that would be stupid, and we need food and water to live. Shelter is another basic need, so the fact that I’m paying $X a month for shelter for a month, is simply an exchange of money for a basic need, an appropriate trade-off.

Buying a house/living the American dream/whatever you call it is an emotionally loaded decision. The economics of renting vs. buying differ by region: in some areas, an $800/month rent might get you a 2-bedroom house while an $800 mortgage+taxes+repairs monthly payment might get you a 4-bedroom house with more room. The situation could be reversed in a different location. But really beyond that, it’s not at the heart of it, an economic decision at all. Can you put a price on being able to move somewhere else with little notice? Does it not feel good to not have a 20 year mortgage weighing you down, guaranteeing that if you were to lose your job for any significant period of time in the future, life would become very uncomfortable (barring wealthy parents, fairy godmother, etc)? On the flip side, can you quantify the pleasure of having a permanent home, flexibility to change the space as you desire, and the accompanying stability in your life?

“Why pay off your mortgage faster? You can write it off on your taxes.”
Depending on when you financed, and what your credit score is, the spread of your mortgage interest can vary, let’s say from 4% to 8% (though I’m sure some have much higher interest rates). When you decide to put additional money towards your mortgage, that’s a tradeoff: those $X you now cannot invest in the stock market or put towards a short-term goal. Would your money do more for you if it was invested in the stock market vs. put towards your mortgage for a guaranteed 5% return? I feel that for the average investor, someone without lots of time and energy to dedicate to their portfolios, someone without above-average knowledge of stocks, index funds are the way to go. You shouldn’t expect to beat the market with your individual choices or those of your financial advisor, and should aim instead for lowest cost, diversified funds. You might not beat the average, but the average is actually a pretty great choice over the long run – 5% returns over 40 years isn’t an unreasonable expectation, so that should net you 3% after inflation.

However, though over a lengthy span of time stocks have predictably returned better-than-inflation performances, there are huge risks. As much as your money could go up, it can and will go down at times. And while I might be more conservative than the average 22 year old, I’ll take a guaranteed return of 5% (what you get when you pay off mortgage early and forgo the interest), over a less certain stock market return that could be higher. Besides, a mortgage is a huge burden. I’m an advocate of buying the least expensive house that suits your needs, rather than the most expensive house that you may struggle to pay (or at least will have to forgo potential career changes and schooling options to continue to afford). Along those lines, if I can decrease the time I’m burdened with a long-term mortgage expense, I sure as hell will do so – I hear having your house paid off feels pretty damn good. That peace of mind, to me, overshadows the negligible mortgage tax benefit.


  1. The second one is a hard assumption to get over. I used to think that way too until fairly recently. I think it's what people assume unless they are the kind of person who will spend as much as their creditors will let them to live luxuriously (i.e. don't think about it at all). Before reading up a bit on what it actually costs to own a home or to be a landlord, I assumed that when you own, you are just paying your mortgage, which buys you equity in the house, so all your housing "costs" magically become investments. I think many people who have given it a thought but haven't actually experienced or researched owning a home make that assumption. I liked this guy's post about it:
    It would be nice to own a place at some point that doesn't require a monthly payment, and rent it out when I want to move around. Just have to consider all the numbers.

  2. Yeah, I think when it comes down to it few people buy a house as an 'investment', or shouldn't think of houses that way, once you add up taxes, mortgage interest rate, and repairs. Factor in the cost of buying and selling, and I personally would feel more comfortable with the math if there at least a 7 year span of time before the intended sell date. Sebastien wants us to consider buying an apt when he moves to DC -- we'll see. :)