The Walrus - Personal Finance Blog & Investment Resource

Mind your business: a motto to live by

January 23rd, 2008 Posted in Blogs | 1 Comment »

I’ve been asked before why “some people have it” and others do not. Why is it that some people can balance their check books in their heads while others aren’t able to make a simple budget? It’s a simple fact that this country does not teach business education at an early age and it probably never will. Americans grow up with a limited knowledge of money, how it works, and what makes it grow. The consumer economy teaches us only one thing: how to spend. The country wasn’t always like this, however. Entrepreneurship was once a prestigious attribute the nation prided itself on. We championed our competitiveness and encouraged the individual. You need to look no further than the penny for evidence of this. “Mind your business”, a saying used on the penny as far back as 1787:

“Mind Your Business” is not just cheesy text added to the earliest coins minted in this country but a motto every person should live by. Your life should be looked at as if it’s a business. Everything you do affects how this business is run. You want to make sure you maintain organization in your life to eliminate wasted time and resources. You want to keep your expenses low to preserve cash. And of course, you want to maximize your income.

You should always be looking at ways to improve your situation and your business. Money is always to be made outside of work. There are ways to glean income from side jobs with your unique talents. There are income generating assets that can supplement your salary. There are rental properties that can bring in large amounts of cash over time. The important thing to do is to look at your life as if it was a business. Where can you improve, what can you do better, and how can you expand?

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Fed cuts interest rates: now what?

January 22nd, 2008 Posted in Blogs | 1 Comment »

The market opened today with an unexpected announcement from the Federal Reserve: a reduction of its federal funds rate to 3.5 percent from 4.25 percent. That amounts to the steepest decrease since 1984. Most major banks reduced their prime lending rates by the same amount shortly after.

Who will this affect, and how?

The picture I link to below, courtesy of the Wall Street Journal, illustrates how each party is effected. It mentions an earlier rate cut but all of the factors remain the same:

Click to see an enlarged picture

Now, here is where I decide to rant for a bit.

Part of the reason we are entering troubled economic waters is the availability of money in the last 6 years. The mortgage industry issued money to whomever it deemed worthy without doing better checks into whether or not they could get repaid. They did this because much of the money being issued was now being raised through mortgage bonds instead of their own cash reserves. They weren’t risking their own money so it was more advantageous. Historic low interest rates meant homeowners could cash out enormous amounts of home equity to pay for goods and services. That helped our consumer economy stay strong while the underlying fundamentals in the economy were adequate at best. When the mortgage well ran dry and consumers were tapped out of disposable income to help fuel the economy, stock markets began to shake. In the last few weeks, they rattled. And around the world in the last few days, they dropped. The move by the federal reserve is an attempt to lower borrowing rates by banks, which theoretically pass the savings onto consumers, and thus allow people access to “cheaper” borrowing. The idea is that the more Americans can borrow, the more they will spend. That’s the exact reason we got into this mess to begin with. Most Americans now have a negative savings rate. That’s correct, we borrow more than we save! Our indebtedness to banks and credit card companies can only fuel the economy so long before massive waves of bankruptcies and foreclosures halt the unparalleled economic growth we have seen in this country over the last 50 years.

While it’s not doomsday, we have serious problems and too many wrong answers.

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Paying off mortgage early VS. Saving

January 21st, 2008 Posted in Real estate | 3 Comments »

I used to visit a small forum that discussed ideas and strategies in personal finance. One of the topics that got a little divisive was the issue of paying off your mortgage early. A majority of the people who argued for paying off mortgages early were well-off white collar workers with extra cash to spend. They would ask the question with a predisposed position and really wouldn’t stand for having their minds changed. We are told to pay off debt first and invest later, and they stood by that.

But why not do both?

I was in the minority in this debate and I argued for something different. My stance was this: If you are looking for added comfort and a little less weight on your shoulders, work to pay off your mortgage early. If you are looking for the best investment decision, invest the excess money.

Before I present my case, let me present an example.

John doe has $100,000 left of mortgage to be paid off at 5%. He expects this to be paid off in 10 years and 2 months. He is paying $1060 a month but has extra cash to spend. He decides that he can pay out $3,000 a month, paying off his mortgage in 3 years. Doing this will save him $19,450 in interest over the life of the loan. Traditional financial planners would tell him that this is a wise decision. For most Americans, it is. But what is the better investment choice? Can John get a better return for his excess money by using it elsewhere? The answer is yes.

To compare and contrast investing vs. paying off mortgage early, let’s assume averages. The stock market has historically returned 10% to investors and therefore we will use that as our benchmark.

Paying off mortgage early:
-Savings in interest: $19,450
-Loss of interest writeoffs in tax season assuming a 30% tax rate: ($5,835)
-After John pays off the house, let’s assume he invests for the remaining 7 years that he would have been paying off his mortgage. He invests $3,000 in the stock market each month. After 7 years of investing his contribution at 10% would yield $375,691

Total cash at the end of ten years: $389,306

Investing excess cash
- John invests the excess $1,940 in the stock market instead of paying off his mortgage early. That equates to $23,280 a year in investments and once again we assume a 10% return.

Total cash at end of ten years: $408,125.57

Conclusion
John would have made almost $19,000 more by investing his money instead of paying off his mortgage.

Comments
The example was basic and interest rates are closer to 6% than 5% these days. However, It is a fundamental fact that using historical returns as a guide, you can make more money by investing your excess cash. Debt is not a bad thing to have if you can manage it.

What most people base their decision on is this: What’s safer?

I truly believe investing your money is safer than paying down your mortgage.

If you put all of your extra reserves into your home you are SEVERELY restricting your capital in the case of an emergency. In order to take care of a catastrophe or a dire medical need, you will need to BORROW against your home through a HELOC or you will need to refinance. Even worse, let’s pretend you lose a job in year two and cannot afford to pay even the MINIMUM amount of your monthly mortgage. You still owe the bank a monthly check, no matter how far in advance you are in principal payments!

Each person’s scenario is different. If you aren’t cash strapped and you are making your decision based on economics and rate of return, consider this article. It can help guide you in the decision making process.

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Mortgage calculators for investment purposes

January 21st, 2008 Posted in Investment Resources, Real estate | 6 Comments »

I’ve attached an excel file of a mortgage calculator I used to buy my first house as well as my first investment property. I customized it to fit my needs and it’s quite easy to do so if necessary on your end. It’s pre-loaded with data that I will use in my example below.

The file: Mortgage calcultor for investment purposes

One word sticks out when buying an investment property: cash flows. That’s the single most important word you need to know when trying to value a property. Will it make a profit? Is it worth the investment?

To answer these questions we need to find out two things: Revenue and Expenses

Expenses
It’s quite easy to figure out expenses ahead of time. There are only a handful of factors to consider and each one can be inserted into the excel spreadsheet that was attached.

Purchase price: how much will the home cost?
Real estate taxes: public knowledge. can often be found on Zillow.com or sites like www.propertyshark.com
Interest Rate: ask your bank what rate you can get for a loan
Insurance: call your insurance company or check online for an estimate

Knowing those four attributes and using the attached calculator, you can come up with a very accurate and realistic assumption of the expenses you will incur with your target property. Enter in each of the four values to come up with your “Monthly mortgage”, the total amount of cash you will send out monthly to the bank.

Revenue
Finding out the average rents has become easier over the years thanks to sites like Craigslist. If your not familiar with Craigslist then your local paper and a Google search for your area can accurately give you average rents in your area. These averages are typically based on the size of the home or the number of units/rooms. If you are renting out a single unit, put a conservative estimate into the attached rental calculator and compare it to your expenses from above.

The idea is to bring in more cash then you send out. The mortgage calculator will help you find properties that will instantly bring you a profit.

Here is a real life example of how to use this file
I am going to randomly choose a university in Philadelphia, an Urban city not so far away from where I live in NJ. I’m choosing Philadelphia because it has a large college presence and a not-so-inflated real estate market. It’s also a renter’s market.

Step 1: Find a target market. I’m going to pick “Temple University” in Philadelphia.
Step 2: Find out average rents “per room” in this area. I’m going to search the Philadelphia section of Craigslist and type in “Temple” for a keyword. As you can see, this brings up housing near Temple University and the rates being advertised.
Step 3: I have concluded that the average rent is about $450-$500 per room. Buying a 3 bedroom house could therefore net you at least $1350-$1500 in revenue.
Step 4: I searched realtor.com for homes near Temple University and picked a random four bedroom house that appeared to be in good shape (For Philadelphia standards). I came across this one. It’s a 4BR house selling for $209,000. My conservative guess is that I can get this for $200,000.
Step 5: Put figures into calculator.

Expenses:
Purchase price: $200,000
Down payment: 10% ($20,000)
Interest rate: 6.25% (the highest I think I would have to pay)
Insurance: I entered in $600 for the year, which is an educated guess on my end

Revenue:
I put in $475 for all 4 bedrooms

Total Expenses: $1,324/mo
Total Revnue: $1,900/mo

Total profit: $575/mo

This is the mentality I have when I am considering an investment. What are my expenses, and what can I expect my revenues to be. It took me ten minutes to scour free internet resources to find a property that can net you a $575 profit instantly with only 10% down. If you change the formulas and put 0% down (which isn’t generally allowed, but let’s pretend) you would still get $450 a month in profits.

Questions about this? Want to apply it to your local renter’s market? Let me know!

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Volatile market? Straddle it.

January 20th, 2008 Posted in Investing | No Comments »

Trying to figure out ways to make money in a volatile market? Try using a Straddle. When you straddle, you believe that the stock you are trading is going to move significantly in one direction, but you are unsure of what direction it is going to move. A good example of a situation where you might want to Straddle would be the XM/Sirius merger debacle. If a pending announcement regarding their merger was scheduled for a certain day, odds are the stock would react strongly to the news on that day. It might soar if a merger is approved or tank if the merger is rejected. We can almost guarantee a significant reaction, but we can’t predict which direction. So… Straddle it!

To straddle, we need to make a simultaneous purchase of an equal number of both calls and puts on the same stock with the same expiration date. You’re looking for a significant move of the stock price before the options expire. If the movement in stock price results in the option or put having a premium more than the amount of the combined premium paid for both options, you would realize a profit. If only a small movement in price occurs, then a loss is realized.

Here is an example using an imaginative company, “Walrus gas company”.

Example
Walrus gas is selling for $40. You have a gut feeling that a recent investment in arctic drilling is going to yield a gas field worth billions of dollars. The results of this investment will be evident in a month’s time, give or take. You decide to buy 100 call and 100 put options with an expiration date a few months ahead. Both the call and the put options cost $5. The put is for $35, the call is for $45. The straddle in this scenario takes place when you purchase a put option, hoping the price drops, and a call option, hoping the price increases.

Scenario #1: price drops to $20
The news was bad, and the stock tanked. You make money on your put option and sacrifice the premium on your call option. Take the original strike price of $35 and subtract the new market price of Walrus gas, which is $20. That’s a $15 profit. However, you must subtract out the premiums paid for both the call and the put at $5 a piece, $10 collectively. Your profit is now $15-$10 = $5. Your total investment was $10 and your profit was $5. That’s a 50% gain on investment.

Scenario #2: price soars to $80
The news was excellent and the stock price soars. You make money on your call option and sacrifice the premium on your put option. Take the new market price of $80 and subtract out the original strike price of $45. That’s a $35 profit. Now you subtract out the premiums paid for both the call and the put at $5 a piece, $10 collectively. Your profit is now $35-$10 = $25. Your total investment was $10 and your profit was $25. That’s a 250% gain on investment.

So where is the risk? Assume the stock price doesn’t change much. You would sacrifice the $10 in premiums paid for the call and put options and essentially lose 100% of your money. Risky investment? Of course. But it’s an adequate investment strategy to use and practice in times of volatility and it could bring you nice rewards if used properly.

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