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2008-08-06T20:09:00.001-07:00

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Strapped: College Education

2008-07-21T09:49:00.001-07:00

Because I looked at the book The Two Income Trap on Amazon, Amazon suggested that I also read Strapped: Why America's 20- and 30-Somethings Can't Get Ahead. It's a popular theme lately. They say that the younger generation today are worse off than their parents in the 1970s. Other books with similar thesis include Falling Behind, The Big Squeeze, and (Not) Keeping Up With Our Parents. So I decided to check it out and see what the buzz is all about.

The author Tamara Draut is a Director of the Economic Opportunity Program at Demos, a national think tank in New York City. The main theme of the book is that young adults, born between 1971 and 1987, are worse off than their parents a generation ago because of these usual suspects:

high costs for college education (tuition rose much faster than inflation)
low starting salaries, especially for people without a college degree
high student loan and credit card debt
high rent and home prices, especially in big cities on the coasts
high costs for child care

After presenting the evidence for obstacles faced by the 20- and 30-somethings, Ms. Draut gave a list of recommendations for public policy changes. Although I missed the author's cutoff for being a "young adult" by a few years, I'm still able to count myself as a member of Generation X. I can relate to some of the challenges mentioned in the book. These challenges and how to overcome them warrant a serious discussion. So I'm going to take them up one by one and write down my thoughts. The book includes many real life stories. Those stories are much more interesting than dry statistics. I will try to do one topic from this book every week.

Let me start today with Chapter 1 Higher and Higher Education. It says the younger generation can't get ahead because college education has become more expensive. Some aspiring young adults and their families can't afford it. They have to settle for community college. Because they also often have to work full time to support themselves, graduation rate is low. Without a college degree, they are stuck with low paying jobs.

It starts with this story:

Renee's parents couldn't afford to pay for her college, so she attended community college while working full time and supporting an unemployed boyfriend. A new job created conflicts with her class schedule. She dropped out with $4,500 in student loans. Four years later she's still paying the loan. Without a college degree, Renee works as a legal secretary earning $28,000 a year. Renee regrets not being able to earn a four-year degree.

Renee missed the traditional window for college. She can still get a degree if she really wants to though. But I'm not sure the lack of a degree is holding her back. Usually after a few years on the job, people don't care whether you have a degree any more. What matters is whether you do a good job. You learn much more on the job than what you can in school. Renee can get ahead, but she has to let her boyfriend support himself.

Natalie chose to go to a small private college which cost $27,000 a year. She only stayed one semester because it was too expensive. After taking classes at a community college for one term, she went to an art school she really liked. 3 years later, she got an AA degree in multimedia and video production. She now earns $37,000 a year but she's often short on cash because she has $20,000 in student loans and a car payment. She goes through a list of people she can call to borrow $10 for something to eat.

Going to a small, expensive private college is a luxury. If you have the money, great. If not, forget it. Just like I'd love to drive a Lexus but I don't like the price. I settle with a Honda. I'm not sure what this story is supposed to show. Is it that bad for a single person to live on $37k a year? She had to borrow $10 for food? Something doesn't add up here.

The third story:

Shaney got a scholarship which covered tuition for four years at the state university. She worked part time for room and board. She turned down internship opportunities because they don't pay as much. She was a French major and she chose to study in France for a year, which she paid with student loans. She borrowed more from student loans because tuition increases made her scholarship run out sooner than she expected. By the time she graduated she had $25,000 in student loans. She couldn't find a job because the job market was weak.

Did Shaney research career prospects before she chose to major in French? Studying in France is also a luxury which she took upon herself. Again, if you have the money and you think it's worth it, go for it. But don't complain about the student loans if you make that choice.

Later in the book the author Tamara Draut recommended that federal and state governments give more grants, as opposed to loans, to college students. Is the high cost of college education a problem? Yes, we should make higher education more affordable to more people. But I think more grants is the wrong solution, because it only addresses the paying part of the equation. With more grants, college education is just as expensive. What changes is who pays for it. One can even argue the additional grants will be absorbed by the increase in college tuition really fast in the same way having a gas tax moratorium won't lower gas prices.

If we really want to lower the cost of higher education, we have to look at the supply and the demand. Either increase the supply or reduce the demand. That will make the cost lower instead of shifting the cost to somebody else. For example letting community colleges grant four-year degrees will increase the supply. Creating more career training programs which won't take four years will reduce the demand. The program Natalie went to sounds like a good one. Let's face it. If your only goal is to have a good salary, many four-year degrees are not so cost effective. I never used a lot of stuff I learned in college. If we take a narrow view, those classes were a waste of time and resources. If I only learned what I needed for doing my first job out of college, I could've been done in two years max. I would be just as productive and my employer wouldn't see any difference. There seems to be a mismatch between what our education systems teach and what knowledge and skills employers need.

In a cost benefit analysis, college education isn't that different from any other product people buy. Some colleges and degrees are a good value; some are not. You have to spend your money wisely like you do everywhere else. Not all schools or majors will lead to the same starting salary. If getting a good salary is the concern, pick your school and major carefully. If someone insists on getting a degree which doesn't lead to a well paying job or they insist on attending an expensive private college for the experience, then it's their personal choice. Money isn't everything after all.

What do you think? Are colleges to be blamed for jacking up their tuition? Are more grants a good solution to the college education cost problem?

More to come. Next week we will look at the problem of low starting salaries.

Who Really Robbed FDIC $6 billion

2008-07-16T09:46:00.001-07:00

I asked on Monday who robbed FDIC $6 billion from the IndyMac Bank failure. Too bad more of you didn't chime in. Come on, don't be shy. It's not fun if it's just me yapping all the time. Anyway, here are my thoughts.

1. Defaulted Borrowers. IndyMac took in deposits and lent out the money as home loans. That's what a Savings & Loan does. Every borrower signed a promise saying they will make payments by the payment schedule. Not all borrowers are fulfilling their promise though. Because of these defaulted borrowers, IndyMac collapsed. Since FDIC has to make the depositors whole, the defaulted borrowers in effect took money from FDIC. Some borrowers may not have wanted the money in the first place. They've been marketed to by IndyMac, misled by realtors, mortgage brokers and what not, but that doesn't change the fact that they took the money from IndyMac and they are not paying the money back as promised. In the end, they took and kept the money from FDIC. Imagine if all IndyMac's loans were current, the bank would not have failed.

A related interesting question is, will FDIC do wholesale loan modification for IndyMac's borrowers? Sheila Bair, the head of FDIC, often criticized banks for not doing loan modifications fast enough. Now that FDIC owns IndyMac's mortgage portfolio, will it foreclose on defaulted borrowers? If it doesn't, will that become an open invitation for more defaults? Or will it forgive loan balances and keep the borrowers in their homes? If FDIC doesn't do anything differently than another bank, then all the criticisms on other banks are just empty talk. Other banks must be watching closely what FDIC does to IndyMac's loans now that FDIC's own money is on the line.

[Update] A Google search found this on the Wall Street Journal: FDIC’s Bair Halts Some Foreclosures in IndyMac Portfolio. If I have a mortgage with IndyMac, I'd stop paying immediately, knowing that Bair will not let IndyMac Federal foreclose on me. I'd wait until IndyMac Federal comes to me with a principal reduction offer. Then I start paying again.

2. Depositors. This may be a surprise, but depositors also robbed FDIC. Before it was closed by the authorities, IndyMac's rates on deposits were among the highest in the country. People flocked to IndyMac for the high rates. The interests IndyMac paid to the depositors actually turned out to be FDIC's money. IndyMac had $19 billion deposit when it was closed. If those deposits earned on average 2% a year more than say what Bank of America offered in the last five years, that's $1.9 billion of FDIC's money right there. Although it sounds unfair to the bank customers, if a bank wants to be strong, it cannot pay super high interests to its customers.

FDIC should change its policy and add a risk sharing component to its insurance. If a bank fails and FDIC has to cover the loss, then all current or past depositors should pay back the excess interest they earned from the bank X years prior to the failure. This is not too hard to implement. The bank has records on who the customers are. This risk sharing does not diminish the value of FDIC insurance either. The principal and regular interests are still protected. Only the excess, above-market interests have to be paid back. This way the customers will not chase the high rates as much as they do now.

Let's also take a look at some other players who had a role in the bank collapse but didn't necessarily take FDIC's money.

3. IndyMac Management. IndyMac Management took the wrong risk. It thought the Alt-A mortgages were a well-compensated risk but it turned out that the risk was vastly under-estimated. Although IndyMac Management's poor decisions caused the bank's failure, I doubt that the management took in much substantial amount for themselves relative to the $6 billion number. Even if we claw back 100% of management's salary and bonus for the last five years, it's probably just a small percentage compared to the $6 billion cost of the bank failure. They took some of FDIC's money, but not much.

4. Senator Charles Schumer. Senator Charles Schumer is like the child who yelled the emperor had no clothes. He publicly released a letter in June questioning IndyMac's viability. This publicity prompted a lot of depositors to withdraw their money from IndyMac. IndyMac wasn't able to withstand that kind of bank run. Senator Schumer might have pushed IndyMac over the edge but he didn't take FDIC's money.

5. Short Sellers of IndyMac Stock. A reader pointed to short sellers who drove IndyMac's stock price to the pennies. Short sellers profited from the stock decline but their profit came from other investors who bought IndyMac's shares at higher prices. They didn't take FDIC's money.

6. Office of Thrift Supervision (OTS). OTS is IndyMac's primary regulator. It should've watched more closely on IndyMac and either rein it in or close it down before the problem got out of hands. If it had taken actions sooner, FDIC's loss wouldn't be so large. However, OTS didn't take FDIC's money.

7. FDIC. FDIC is a secondary regulator for IndyMac. It provides deposit insurance to IndyMac. A threat of pulling IndyMac's insurance would have stopped IndyMac dead in the tracks. But FDIC didn't do that. They stood by watching IndyMac handing out its money to borrowers and depositors. If FDIC were a private insurance company, I bet they wouldn't be that passive. Because by definition you can't incur a loss by taking money from yourself, FDIC didn't take FDIC's money.

8. Allan Greenspan, George Bush, ... The policy may be wrong which caused IndyMac's failure and FDIC's loss, but they didn't take FDIC's money.

9. Real Estate Sellers. This one is a little tough. The real estate sellers sold their homes in arm-length transactions for market prices at the time. The prices they got turned out to be pretty good in retrospect. To the extent they sold to IndyMac's borrowers who now defaulted or will likely to default soon, you can argue that the defaulted borrowers passed FDIC's money to those sellers. But because money is fungible, you can also argue everything the defaulted borrowers bought was bought with FDIC's money. And those who accepted FDIC's money from the defaulted borrowers bought a lot of other stuff with FDIC's money. By six degrees of separation, even my salary has a small part of FDIC's money. But I won't go that far. The real estate sellers didn't have control over which lender the buyers chose or whether the buyers would default. Between two sellers, say one sold to a buyer who borrowed from Bank of America and didn't default and the other sold to a buyer who borrowed from IndyMac and defaulted, if we say the former didn't take FDIC's money but the latter did, that's just a luck of the draw. So I say stop at the defaulted borrowers and not chase the money further down the chain.

Embrace the Bear Market with Overbalancing

2008-07-15T07:35:00.001-07:00

After two false starts in January and March 2008, the stock market finally crossed over into bear market. The bear market is great because everything is cheaper. I quoted Warren Buffet in How Low Can It Go? Part 2 in January. It's worth repeating:

"If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices." -- Warren Buffett, Berkshire Hathaway Inc., 1997 Chairman's Letter

I welcome the bear market with a 5% increase to the allocation to stocks in my portfolio. As mentioned in Cascading Asset Allocation Method, my regular allocation is 60% stocks, 40% bonds. That allocation fits the rule of thumb that stocks allocation should be (100 - age)%. Because stocks are cheaper now than what they were a year ago, I'm increasing my stocks allocation from 60% to 65%. From here on, I'm planning to increase it by 5% for every additional 10% decline until the stock market goes to 40% off its high, then I will accelerate to 5% more for every additional 5% decline. By this plan I will be 85% stocks, 15% bonds when the market goes to 50% off. Will it ever get there? I don't know. If it does, my allocation will be more aggressive than my regular 60/40 allocation but it's still not as aggressive as some of the target retirement funds for my age. For example Vanguard Target Retirement 2030 Fund has more than 85% in stocks now. Here's how my plan looks like:

Stock Market	Allocation to Stocks
-5%	60%
-10%	60%
-15%	60%
-20%	65%
-25%	65%
-30%	70%
-35%	70%
-40%	75%
-45%	80%
-50% or more	85%

Is this market timing? Yes and no. Yes I'm changing my allocation to stocks when stocks become cheaper. No I'm not predicting whether the market will go up or down or where the top or bottom will be. Nor am I getting in and out of the market. I'm just reacting in the same way when hamburgers are on sale. It's called overbalancing in an article by William Bernstein, the author of great books The Four Pillars of Investing and The Intelligent Asset Allocator.

"Think of it this way: even the most devout efficient marketeers rebalance; trimming a portfolio back to policy is nothing more, and nothing less, than a bet on mean reversion. Taking the process one step further and adjusting the policy allocation itself opposite valuation changes is merely a way of amplifying a rebalancing move -- "overbalancing," if you will." -- William Bernstein, Mamas, Don’t Let Your Babies Grow Up To Be Timers

Why am I not 85% stocks now? Because I'm not willing to take that level of risk. But I will be when stocks go 50% off. Is overbalancing for everyone? Probably not. If you started with a high allocation to stocks, there's not much room to add on the way down. Keeping the allocation is already painful enough.

Dear Bear Market, please stay with us for as long as you can. I will feed you honey.

Who Robbed FDIC $6 billion?

2008-07-14T00:57:00.001-07:00

On the way back from work last Friday, I heard on the radio IndyMac Bank was closed by authorities and taken over by FDIC. IndyMac Bank had $19 billion in deposits. This failure is the largest in recent history. It matched in size the Bank of New England failure in 1991.

In previous bank failures, FDIC usually let other banks bid for the failed bank and pick a winner to take over the failed bank's assets and deposits. For example when NetBank failed, it was given to ING (see previous post NetBank Shuts Down, ING Takes Over). This time it's different. No other bank raised their hand. I guess nobody wanted IndyMac's questionable mortgage portfolio. FDIC set up a brand new bridge bank. It will manage the assets and liability itself until it can find an acquirer later on.

According to FDIC's press release, this IndyMac Bank failure will cost FDIC $4 to $8 billion.

"Based on preliminary analysis, the estimated cost of the resolution to the Deposit Insurance Fund is between $4 and $8 billion."

Let's take the middle and just call it $6 billion. So FDIC is out $6 billion. The question is who has it? In other words, who robbed FDIC $6 billion? I have a few candidates in mind but I'd like to hear from you first. I will give my thoughts on Wednesday.

TIPS Auction Step By Step: Read the Results

2008-07-10T10:38:00.001-07:00

This is the fourth installment in my TIPS auction series. The previous posts in this series were:

The auction for the 10-year TIPS is completed today. The Treasury Department publishes the official auction results on their website. The results for this auction show that the yield is 1.485%. Because this is a new issue, the coupon rate is rounded down to the nearest 0.125%, which is 1.375%. Each bond of $1,000 face value will cost $989.81282.

This is within my previous estimate of between $988.82 and $1,000. It also matches the result calculated by my TIPS pricing spreadsheet if you plug in the 1.485% yield (of course you don't know this number until now).

The auction results also show some other interesting data points. Total $8 billion worth of bonds were sold in this auction. Total bids received were $14.6 billion. The orders from retail investors ("noncompetitive bids") were only $88 million, which were 0.6% of the total bids or 1.1% of the total bonds sold. Yet this 1.1% of orders received the same price as what the big guys received. That is a very good deal to individual investors.

We can also see that from the Treasury Department's point of view, selling TIPS is a hundred times more efficient than selling Savings Bonds. They were able to sell $8 billion worth of bonds in one morning. According to this news article, the total sales of savings bonds (series I and EE combined) in the last ten years were:

Fiscal Year (Oct. 1 - Sept. 30)	Sales
2007	$3.4 billion
2006	$8.3 billion
2005	$6.3 billion
2004	$7.9 billion
2003	$11.8 billion
2002	$9.8 billion
2001	$6.6 billion
2000	$5.2 billion
1999	$4.7 billion
1998	$4.8 billion
Average	$6.9 billion

If you were in charge of selling bonds at the Treasury Department and you know you can sell more TIPS in one morning than what you can sell I Bonds in an entire year, plus you don't have to print or mail those paper bonds, what would you prefer to do? No wonder they set the rate on I-Bonds so low (currently at 0%). TIPS are a win-win for both the Treasury Department and the investors.

Next step: If you placed an order in this auction, you will receive the bonds on July 15, 2008 (Issue Date) and pay $989.81 per $1,000 face value. If you didn't buy in this auction, a new announcement for a 20-year TIPS will come out on July 17, 2008.

TIPS Auction Step By Step: Place Order

2008-07-08T07:26:00.001-07:00

[Updated on July 11, 2008: added related posts in the series.]

This is part three of the TIPS auctions series. Other posts in this series are:

If you are interested in TIPS but you don't want to be bothered with auctions, you can buy TIPS in a mutual fund or ETF. See Individual TIPS Or TIPS Mutual Fund.

Say you decided to buy some TIPS from the auction. How do you place your order? Although it's an auction, you don't really enter a bid as you do in an eBay auction. Only financial institutions who buy TIPS in the millions bid in the auction. You get to tag along with a so called "non-competitive bid" which you means you accept the final price from the auction no matter what it is. And that's not a bad thing. Because all orders -- from the big guys, and you -- get the lowest price (highest yield) from the auction, your small non-competitive bid for $10,000 is treated the same as a $100 million bid from a bank. Isn't that nice?

If you are going to buy TIPS in a taxable account, you can buy them from TreasuryDirect. If you want to buy in an IRA, you have to use a brokerage account. Fidelity and Schwab are good brokerage choices because they don't charge any fees for buying TIPS at auction or on the secondary market. You can also buy from Vanguard Brokerage Service, but you may have to pay a $10 fee unless you have over $100k with Vanguard.

I don't have an account with TreasuryDirect so I can't show you how to place an order there.

In Vanguard Brokerage Service, it's under View and trade bonds or CDs, then Treasury Auction. Vanguard Brokerage Service requires a minimum order of 10 bonds or $10,000 in face value.

In Fidelity, it's under Trade Fixed Income, then Search Inventory, then TIPS (Auction). The minimum order size at Fidelity is 1 bond or $1,000 in face value.

Enter the number of bonds you'd like to buy (1 bond = $1,000 in face value). You cannot specify any price limit because your order will be a noncompetitive bid.

The official closing time for this 10-year TIPS auction is 12:00 noon Eastern Time on July 10, 2008. If I were to buy from this auction, I'd make sure that my order is placed before 4:00 p.m. Eastern Time on July 9, 2008. That is before the end of the business day prior to the auction date.

Next step: read the auction result.

TIPS Auction Step By Step: Read the Announcement

2008-07-07T22:39:00.001-07:00

[Updated on July 11, 2008: added related posts in the series.]

This is part two of the TIPS auctions series. The other posts in the series are:

If you are interested in TIPS but you don't want to be bothered with auctions, you can buy TIPS in a mutual fund or ETF. See Individual TIPS Or TIPS Mutual Fund.

The Treasury Department publishes auction announcements on their website. The announcement for the upcoming 10-year TIPS auction on July 10 came out today (link). It's close enough to the auction date now. If you've been thinking about it, you should decide now whether you want to buy from this auction.

1. Estimate the Yield. You will not know what the yield will be until the auction is over, but you can take a guess using the current yield on existing bonds which are traded on the secondary market. I use the Daily Treasury Real Yield Curve Rates published by the Treasury Department and the yield charts by Federal Reserve Bank of St. Louis: 5-year, 10-year, and 20-year.

The current yield on a 10-year TIPS is 1.43%. The yield from the auction should be around that number. Remember this 1.43% number is the real yield, which is above and beyond the reported inflation number. The current real yield is below the average real yield we've seen in the past few years, although the reported inflation number is higher than before. You have to decide yourself whether this is a good yield for you or not. For me, I decided to skip this auction and look at the 20-year issue coming up in about two weeks. Sometimes the yields on 10-year and 20-year TIPS are close to each other ("flat yield curve") but at this time there is a large difference ("steep yield curve"). As you can see from the chart below, the 10-year (blue line) was close to the 20-year (red line) in 2006 and most part of 2007. Lately it has dropped below the 20-year by quite a bit.

If you decide to buy the 10-year TIPS and you'd like to get a handle on how much money you will need, you will need some data from the announcement to do the calculation.

2. New Issue vs. Reopening. The 10-year TIPS this time is a new issue, which means it's a brand new bond the market has never seen before. If it were a reopening, it will say so in the announcement. The next auction for a 20-year issue is going to be a reopening, which means the Treasury Department will issue additional bonds with the same terms as the existing bonds they sold before. A difference between a new issue and a reopened bond is the stated interest rate or the "coupon" rate. The coupon rate on a new issue is determined by the auction. It's set to the nearest 0.125% below the high yield in the auction. The purchase price is also adjusted accordingly. For a reopened bond, the coupon rate is fixed. The auction will determine only the price. Another difference between a new issue and a reopened bond is the inflation adjustment. Because a reopened bond has been on the market for some time, it has accumulated some inflation adjustment. A reopened bond typically costs more in nominal dollars unless its coupon is significantly below the current market yield.

3. Important Dates and Index Ratio. The announcement contains many data points but only these are relevant for estimating how much a bond will cost.

Issue Date: the date you will officially own the bond
Maturity Date: the date they will pay you back
Dated Date: the date from which the interest payment will be calculated
Interest Rate (reopening only, not applicable to new issues): the coupon rate
Index Ratio: the principal adjustment factor

4. Estimate Dollars Needed. Plug in the data you gathered from above together with your yield estimate into my TIPS pricing spreadsheet. You will see roughly how much you will need for each bond. By my estimate, with the yield within +/- 0.10% from 1.43%, you will need between $988.82 and $1,000 per $1,000 face value.

Next step: place order if you are going to buy it.

Wharton Professors On Subprime Credit Crisis

2008-07-02T06:07:00.001-07:00

The subprime credit crisis isn't over yet, but everybody is coming up with their analysis on how it came about and what should be done to fix it and prevent it from happening again. Knowledge@Wharton has a series of interviews from Wharton professors about the subprime credit crisis. The cool headed professors are so much better than your typical news reporter. Of all the interviews, I liked the one from Professor Todd Sinai the most.

Have a great 4th of July! I will take a short vacation. When I come back, the 10-year TIPS auction announcement will be out. I will continue my TIPS auction series as the auction unfolds.

My 401k Hidden Fees Experiment

2008-07-01T07:28:00.001-07:00

Back in March, I wrote Uncover The Hidden Fees In Your 401(k) Plan. Because the hidden fees are so hard to pin down, I gave a method which helps find out if there are hidden fees in the plan and if so how much the hidden fees are.

Find in your plan's menu one fund that you are not using.
Do a one-time transfer and move $100 to it. Do not include this fund in your periodic payroll contributions.
Wait until a full quarter passes. On your next quarterly statement you should have the beginning and ending balance for that fund.
Calculate your gain/loss in that fund. Compare your actual gain/loss with the fund's reported performance in the quarterly statement.

I did this test in my own plan. Before the end of the first quarter, I transferred a small amount to a fund I wasn't using. During the second quarter, I did not add any more money to the fund. The money sat in the fund untouched for the entire quarter. Now I'm able to calculate my gain or loss and compare it with the performance reported by the fund.

According to my online account information, I had $99.77 in the test fund as of March 31, 2008 and $97.04 as of June 30, 2008. My gain/loss in the 2nd quarter was 97.04 / 99.77 - 1 = -2.74% in that fund. According to the mutual fund's web site, the fund's performance in the 2nd quarter was also -2.74%. My loss in the fund wasn't any larger than what the fund reported. That means there were no hidden fees deducted from my account during the quarter. Yay!!!

Did you also do this experiment? Do you know if there are hidden fees in your plan?

Free Garmin Nuvi GPS, Oursourcing, and the Role of Speculators

2008-06-27T10:18:00.001-07:00

Here are some links that I found interesting this week.

Free Nuvi with TD Ameritrade deposit (The Financial Engineer) - Open a taxable account with TD Ameritrade, transfer $50,000 and receive a Garmin Nuvi 660 GPS (~$330). I can use a Nuvi. Very tempting to do an in-kind transfer and just hold the positions there for a year. Link to offer.

Economics of Shared Living: Estimated Savings From Having Roommates (My Money Blog) - Renting a larger place with roommates saves money.

OC Register to outsource some editing to India (Business Week) - How do you like your local newspaper edited and laid out by people in India? We should know by now even the traditional white collar jobs are subject to direct competition from abroad.

In Praise of Speculators (My Two Cents) - After bubbles are over, the society is left with some great things, built with speculators' money. Are speculators good or bad?

TIPS Auction Step By Step: Know the Schedule

2008-06-25T20:04:00.001-07:00

[Updated on July 11, 2008: added related posts in the series.]

There will be two auctions for Treasury Inflation Protected Securities (TIPS) in July. I will follow these auctions in a series posts. This is the first post in this series. Other posts in the series include:

Tentative Auction Schedule. How do you know when they will hold an auction for what? The Treasury Department publishes a tentative auction schedule a few months in advance. Although it is said to be tentative, the schedule is pretty much set once it's published. I've never seen an auction being canceled or moved. The schedule includes auctions for Treasury bills, regular ("nominal") Treasury notes and bonds and TIPS. The TIPS auctions are shaded in blue so they are easy to spot.

There are three dates in the schedule.

1. Announcement Date. The Announcement Date is when they publish a formal announcement. The announcement will contain more detailed information about the bond being auctioned. You can't place an order until the Announcement Date.

For the next two auctions, we know the Announcement Dates are Monday July 7, 2008 for a 10-year TIPS issue and Thursday July 17, 2008 for a 20-year TIPS issue.

2. Auction Date. The Auction Date is the date when they actually hold the auction. The cutoff time is specified in the announcement, usually around 12:00 p.m. Eastern Time. Your order must be received on or before the auction cutoff time on the Auction Date. If you place order through a brokerage account, the brokerage firm may impose its own cutoff time before the official cutoff time to allow itself time for transmitting your order to the Treasury. For example the current cutoff time at Vanguard Brokerage Service is 9:30 a.m. Eastern Time for online orders or 10:00 a.m. Eastern Time for phone orders. To play it safe, I usually place the order at least one business day before the Auction Date.

For the next two auctions, the actual Auction Dates are Thursday July 10, 2008 for a 10-year TIPS issue and Tuesday July 22, 2008 for a 20-year TIPS issue.

3. Settlement Date. The Settlement Date is the date when you actually pay and receive the bonds. You must have enough cash ready on this date.

For the next two auctions, the Settlement Dates are Tuesday July 15, 2008 for a 10-year TIPS issue and Thursday July 31, 2008 for a 20-year TIPS issue.

Next step: read the announcement on July 7.

Book Review: The Smartest Investment Book You'll Ever Read

2008-06-24T07:58:00.001-07:00

This is a book review for The Smartest Investment Book You'll Ever Read by Daniel Solin. The book has an arrogant title. The title is also a knockoff from the popular book The Only Investment Guide You'll Ever Need by Andrew Tobias. Andrew Tobias didn't say his book was the smartest. He only said it was the only investment guide you'll ever need, meaning you'll be OK if you just read that one book but everything else will be extra knowledge. I first came across this book last year while browsing at Barnes & Noble (I wrote about the misleading chart in the book). So the arrogant title worked as intended. It grabs people's attention.

Now that I had a chance to read the whole book, it isn't too bad. This is another book about investing in index funds (or ETFs). Basically another person "discovered" indexing. If you are a regular reader of this blog, you probably won't find anything new in this book. For someone new or who didn't pay much attention to investing, the book conveys that a simple strategy can be very effective and stress-free. For people who are still trapped by brokers and advisors (it's hard to believe, but there are still so many!), this book can be refreshing. The author Dan Solin is a securities arbitration lawyer. You can tell he has big problems with brokers and advisors because more than half of the book is about what not to do, i.e. don't listen to brokers, advisors, or the media. It says if you just invest in 3 broadly diversified mutual funds (U.S. stocks, International stocks, and bonds), you will be all set. The portfolio construction comes down to answering just one question:

"How much do you want to allocate your portfolio to stocks?"

The book gave four choices: 20%, 40%, 60%, 80%. After that, split the stocks to 70% U.S. and 30% international and you are done. It's basically the first two steps in my Cascading Asset Allocation Method. The book gives specific examples using Vanguard, Fidelity, and T. Rowe Price funds.

While the ideas in the book aren't anything new, the presentation is different from many other books. This small book (177 pages) is divided into 44 chapters and two appendices. The longest "chapter" is 4 pages. The shortest "chapter" is half of a page, shorter than a typical blog post you find here. I guess it was written with today's short-attention-span readers in mind. This style coming from a lawyer is a surprise to me*. For someone who is new to investing, this book is less overwhelming, although it feels to me just repackaging of what others have said all along. I have more original content on this blog than what's in the book. If you are looking for a book for a newbie, I would recommend Smart and Simple Financial Strategies for Busy People by Jane Bryant Quinn, the #1 book on my Recommended Reading List in the Basics category.

Final verdict: 2 stars out of 4. Skip; you won't miss anything.

* Only until the very end of the book, the tail of a lawyer finally showed. It says in tiny font and long sentences:

"The author and publisher specifically disclaim any responsibility for any liability, loss, or risk, personal or otherwise, which is incurred as a consequence, directly or indirectly, of the use and application of any of the contents of this book."

... ...

"The author does not assume any responsibility for actions or nonactions taken by people who have read this book, and no one shall be entitled to a claim for detrimental reliance based upon any information provided or expressed herein."

... ...

Who's MERS and What Do They Have To Do With Me?

2008-06-18T20:31:00.001-07:00

I received a notice yesterday from my county recorder's office. It has something to do with my recent mortgage refinance. Here's what it says:

"KNOW ALL MEN BY THESE PRESENTS, that certain Deed of Trust described below provides that the holder of the Note secured by said Deed of Trust may appoint a successor Trustee to any Trustee thereunder appointed; and,

"WHEREAS, the indebtedness secured by the Deed of Trust, described below, has been paid and satisfied;

"NOW, THEREFORE, Mortgage Electronic Registration Systems, Inc., it's address being, [MERS address], being the present legal owner and holder of the indebtedness secured by said Deed of Trust, does hereby substitute and appoint [Loan Serving Bank], it's address being [Bank address], as successor Trustee, and the Trustee(s) under said Deed of Trust, having received from the Beneficiary under said Deed of Trust sufficient directive to reconvey, detailing that the obligation secured by said Deed of Trust has been fully paid and performed, does hereby reconvey unto the parties entitled thereto, but without any covenant or warranty, express or implied, all rights, title and interest which was heretofore acquired by said Trustee(s) under said Deed of Trust."

Oh boy. Basically it's saying because the loan has been paid off (refinanced), they have released the security interest in my house. You think they can just say that in plain English?

The notice says Mortgage Electronic Registration System, Inc. (MERS) was the legal owner of my loan. I don't think I have ever dealt with them. I wonder what they have to do with my mortgage. So I did a little bit of research. I dug up my original Deed of Trust, which was the security document by which I gave my house as the collateral for my home loan. Lo and behold, they are right there! The Deed of Trust says

"MERS is a separate corporation that is acting solely as a nominee for Lender and Lender's successors and assigns. MERS is the beneficiary under this Security Instrument."

So instead of listing itself in the country records, the lender puts down MERS as its puppet. When they sell the loan, MERS keeps track of who the new owner is. They can sell and resell the loan many times. As far as the county real estate records are concerned, MERS still remains as the nominal owner.

Book Review: While America Aged

2008-06-16T07:10:00.001-07:00

I'm a fan of author Roger Lowenstein because he is able to turn complex business issues and events into something everybody can understand. I already reviewed and recommended his other books When Genius Failed and Origins of the Crash. Roger Lowenstein published a new book While America Aged in May. Once again, this new book lived up to the high standard I come to expect from him.

The book is about the challenges of private and public pension and retiree health care programs. It consists of three long case studies: General Motors, New York city subway system, and the City of San Diego. It showed how there is such a big gap between the funding and the benefits liability in the pension and retiree health care programs. The book chronicled how the gap was formed. It also gave some recommendations on how to reduce or eliminate the gap.

If you'd like to hear the author tell the stories himself, here's a video of a book talk he gave to a small audience at a bookstore. More than half of the 37-minute video is Q&A's, which are excellent.

The book is thoroughly researched. Every chapter has more than 50 references in the end notes. The story telling is amazing. For anyone interested in the history and the future of pension and health care programs, I highly recommend this book.

Although the book is not about Social Security and Medicare, I can't help but think about how Social Security and Medicare are in similar situations. The most I can relate to is what happened at General Motors. GM emerged after World War II as the dominant player in the auto industry. The industry was also growing rapidly. GM had great profits year after year starting in the 1950s. Over time it added more and more pension and health care benefits for its employees in order to buy their cooperation for not striking and disrupting the great business. In its hay day, GM represented a nation we crave for today. It had universal health care -- all employees and retirees, plus their families, are covered, for free. It had unemployment insurance -- 95% of pay for 6 months. It had a rich pension program. Workers could retire in their early fifties and receive on average $42,000 a year (in 2008 dollars) plus automatic cost of living adjustment ("COLA") for the rest of their life. After a worker or retiree died, the surviving spouse received a survivorship pension too. Blue Cross became GM's largest supplier. People jokingly said GM was actually a pension plan on wheels or a HMO with showrooms.

Then the game changed. Facing foreign competition, GM cratered under the weight of its long-term obligations. Because it paid out so much cash toward pension and retiree health care, it couldn't invest enough in R&D. Had GM thought about it carefully, they would've seen that the benefits programs were clearly not sustainable. Workers who retired while the times were good fared really well. Workers who weren't retired yet lost their jobs.

Social Security and Medicare also had a similar history of expansion. Social Security started in 1935. Over the years, dependent and survivorship benefits were added (1939). Disability benefits were added (1956). Benefits were increased many times and, in 1975, Cost of Living Adjustments became automatic. Average benefit check increased from about $400 a month to $1,100 a month today (all in 2008 dollars). Medicare started in 1965. It didn't cover prescription drugs. Then prescription drugs coverage was added in 2006. Because of the rapid increase in the cost of health care and the increase in longevity, Medicare is projected to be in serious deficit. Are Social Security and Medicare sustainable in their current form? No. If they are not sustainable, we should scale them back, now. I'd rather have a smaller sustainable program than a program which benefits one generation but bankrupts the next, like GM's rich benefits programs did to GM. Raise the retirement age. Slow down the COLA. Implement means-testing and make the program benefits a sliding scale relative to income and wealth. Make the programs last.

Misery Index, Zappos and Expensive Loans

2008-06-13T15:19:00.001-07:00

I'm catching up with some reading because I've been busy with work lately. Here are some interesting articles I liked:

Hedonically-Adjusted, Well-Spun, Nominal Misery (The Big Picture) - Are the reported inflation and unemployment numbers artificially low compared to what were reported years ago? Maybe. But what can you do about it?

Credit/Debit/ATM Cards and Foreign Exchange (FlyerGuide Wiki) - All you want to know about spending money and getting cash when you are in a foreign country.

Why Zappos Pays New Employees to Quit And You Should Too (Harvard Business) - Zappos sells shoes online. I've always had great service from them. Although their prices are not always the lowest, unless they are much more expensive, I always choose Zappos. Great service is worth a few bucks.

The End of Entitlement (Newsweek) - Be prepared to deal with the new economic reality.

Why Is This Legal? (Credit Slips) - How do we strike the balance between consumer choice and consumer protection? Should expensive loans be illegal? What about other expensive stuff? Should we regulate prices?

In 2028, 1.40% EE bonds will earn 50% in one day (Savings Bond Advisor) - The 1.4% EE bonds are a rip-off. Why is this legal?

Farmers Market and Brown Eggs

2008-06-09T08:37:00.001-07:00

I don't know why I missed out for so long. I visited the farmers market in my town for the first time last weekend. What a pleasant experience! There are a lot of vendors selling produce. The fruits and vegetables don't look as neat as those in the grocery stores but they taste a lot better. You are buying what's in season, not fruits stored in a warehouse for six months. And you can shop different booths and compare quality and prices. When I shopped from grocery stores, I just go to one and buy everything there. It doesn't make sense to drive to different stores for different things. At the farmers market, everybody is at one spot.

One thing I'm not sure of is that whether the vendors are actually farmers or are they just small resellers who buy from the farmers and sell at the farmers market. Does anybody know? I guess it doesn't really matter that much because even if they are not real farmers I'm still getting fresh local produce. Just curious.

One vendor was selling eggs. Large white or brown eggs for $2.50 a dozen. It's a good price. If I didn't have enough eggs in my fridge already I would've bought some brown eggs because I thought brown eggs are better than white eggs and he was selling them for the same price. I never really knew what the difference is between brown eggs and white eggs. All I knew was that brown eggs are more expensive in the stores. So I searched on the Internet. It turned out that it's just the breed of the hen. Some breeds lay white eggs and some breeds lay brown eggs. Other than that, there is really no difference. According to the American Egg Board,

"Shell color is determined by the breed of hen and is not related to quality, nutrients, flavor or cooking characteristics. Since brown egg layers are slightly larger birds and require more food, brown eggs are usually more expensive than white." (FAQ #3, Learn More About Eggs)

So why did I think brown eggs are better all these years? Because they are more expensive. You get what you pay for, right? This again falls into selling hope. Only because something costs more to produce does not make it more expensive in the stores. The consumers have to perceive some additional value. If consumers don't perceive any benefit, they will never pay more for it. If consumers don't pay more, egg farmers will not raise the larger birds which eat more food and lay brown eggs because the farmers' profit margin would be smaller. If consumers are all well informed, there should be no brown eggs in the market. That's why branding is so important in the business world. It creates difference when there is none.

It's an interesting economic phenomenon. Businesses can sell something at a higher price with absolutely no additional value to the consumers. Or they can create some perceived value (like branded prescription drugs versus generics) and sell at a higher price. What other examples can you think of? Vitamin Water?

By the way at farmers market I saw arugula for the first time. I read some references to arugula and Obama in Newsweek but I didn't know what it was. Now I know.

Bought 20-Year TIPS

2008-06-05T06:08:00.001-07:00

I bought more TIPS today. For people not familiar with TIPS, they are inflation indexed bonds. See previous post TIPS: Inflation Linked Bonds for more information.

Like everybody else, I feel the threat of higher inflation. A tank of gas cost me $58 last week. For the longest time it was $30-35. I still remember the exact gas station where I filled up when it crossed $40 for the first time a few years ago. Pretty soon it will be over $60. I don't even have a big car.

The price for inflation protection actually came down lately. The following chart shows the yield on 20-year TIPS (click on it to enlarge). A higher yield means a lower price.

Source: Federal Reserve Bank of St. Louis.

I bought some 20-year TIPS at a yield of about 2.2% (red line in the chart). Although it's way below the 2.8% peak level in summer 2007, the yield has been much lower this year. It was at a low of 1.6% just 3 months ago. 2.2% is in the middle between the recent peak and trough. So I think it's a reasonable price for more inflation protection. I chose 20-year TIPS because they have the highest yield (lowest price) and they offer inflation protection for the longest time.

I bought on the secondary market through Vanguard and I had to pay a $40 commission. It's OK because I want to lock in to this price now. Fidelity and Schwab don't charge a commission for buying TIPS online. The next TIPS auctions will be on July 10, 2008 for 10-year TIPS and July 22, 2008 for 20-year TIPS. If the yields remain attractive, I will buy more then.

Book Review: The Two Income Trap

2008-06-04T10:48:00.001-07:00

A few weeks ago Jonathan at My Money Blog posted a video presentation by Harvard Law School Professor Elizabeth Warren, The Coming Collapse of the Middle Class. It turned out to be a summary of her book The Two-Income Trap. The video presentation piqued my interest so I got the book and read it.

Professor Elizabeth Warren specializes in studying personal bankruptcies. She often appears before congressional hearings against credit card companies. She's also in the documentary Maxed Out. She and several other law professors blog at Credit Slips which I read and sometimes comment on. The subtitle of the book is "Why Middle-Class Mothers & Fathers Are Going Broke." The basic premise of her book is that families go bankrupt at a higher rate today because housing, health insurance, and education have become much more expensive than they were a generation ago in the 1970s. Families commit two incomes to these expenses today. Therefore they are vulnerable to any disruption of their income, like job loss, illness, and divorce. In the previous generation, the stay-at-home mom served as a valuable reserve. If dad lost his job or became ill, mom could enter the labor force and the family would survive without having to file bankruptcy. Today's two-income families don't have this reserve. They are worse off than the one-income families a generation ago. Hence the title of the book "The Two-Income Trap."

Because Professor Warren studies personal bankruptcies all the time, she probably developed great sympathy toward the families involved. In this book, she and her co-author (her daughter) spent a lot of time dismissing the myth of over-consumption, saying that families today don't spent more on unnecessary stuff than families did in the 1970s. After adjusting for inflation, the spending went down in many categories. It's the big item expenses -- housing, health insurance, cars, and education -- that are throwing these families over. And the reasons people file bankruptcy are dominated by the big three causes -- job loss, medical problems, and divorce or separation. Although the authors didn't necessarily say it out loud, I get the impression they are saying it's not these families' fault because it's out of their control. I'm not convinced. Here's my naive view of personal bankruptcy:

People have to file bankruptcy because their expenses exceed their income for an extended period of time which outlasts their available insurance, savings, and credit.

Think about it. If your expenses are always below your income ("live below your means"), you will never have to file bankruptcy. Or if you have high expenses (medical bills for example) or low income (job loss for example) temporarily, but you have insurance, savings, or credit that can tide you over until your income exceeds your expenses again, you won't have to file bankruptcy. How someone manages their expenses and incomes is their personal responsibility. While they don't have control over whether they will lose our job or become ill, they do have control over whether they will have insurance or how much they will save for a rainy day. They also have control over a long list of family finance decisions which directly affect how much cushion a family creates for itself. In other words, you don't have to live on the edge and leave no room for contingencies. If you live below your means, buy insurance and save for a rainy day, I don't see how you can put yourself at risk of bankruptcy. Make no excuses. We are all responsible for our own destiny.

I don't like it when people don't take responsibility for their own actions. There's too much of that going on in America. Whenever something goes wrong, it's always somebody else's fault. Over-consumption is a problem. It directly contributes to the bankruptcy problem. The book showed that since the 1970s savings went down and credit card debt went up. If people didn't save, then by definition they over-consumed. That's not a myth.

The book showed that housing, education and health care have become much more expensive from a generation ago. It attributed the increase in housing prices to two-income families entering into "bidding wars" for houses in good school districts. The book didn't offer any proof for that theory other than casual observations that houses in good school districts are more expensive (remember the authors are not economists). Considering that houses in average school districts also increased in value by a lot and commercial real estate which has little to do school districts also appreciated dramatically since the 1970s, I doubt the "bidding wars" are a significant factor. Housing, education, and health care are more expensive today because there is more demand and because there is high expectation. We are buying more housing, more education and more health care. Family sizes became smaller but house sizes became bigger. Preschools are no longer a luxury. More people are going to college. Health care industry is coming up with more and more expensive drugs and treatments. Consumers never say no. In order to revert this trend, we have to consume less housing, education and health care. Buy smaller houses in lower cost areas. Go to state universities and community colleges. Cover the basic health and forego expensive drugs and treatments. "Health care rationing" is not a dirty phrase. We just can't afford to give the health care industry a blank check.

We are in a different kind of economy today. In the post World War II era (1950s - 1970s), the United States dominated the world. American companies were prosperous. Jobs were well paid and more secure. Benefits were generous. Today we are competing with lower paid workers in a global economy. American companies are no longer in a position to offer secure and well paid jobs with generous benefits. The good ol' days are gone. Either you upgrade your skills for higher paying jobs or you have to change your lifestyle expectations. There's no other way around it.

Professor Warren made some public policy suggestions in the book. They may help a little at the edge but I think unless we reduce the aggregate demand for housing, education and health care, the prices won't come down. She suggested that credit card interest rates should be capped. OK, it will help a little. With less credit available, there won't be as many dollars chasing the limited supply of housing, health care or education. She also suggested that families should be given vouchers so they can send their kids to any public school. I'm afraid that does not change the overall supply and demand for education or housing. As long as there are good schools and there are bad schools, no all kids will be able to go to good schools. The premium on houses in good districts may disappear but the houses in other areas will go up. In aggregate families will still pay the same if everyone feels they are entitled to a big house.

It's difficult to give a star rating to this book. I can feel the authors' bleeding heart, although I disagree with their economic analysis. We don't need more books making excuses for people. Nevertheless, there is still a lot of good information in the book about the landscape of personal bankruptcies. So maybe 3 stars out of 4.

Finally, the "math question of the day" for all of you. The book says the bankruptcy filing rate for families with kids is 15 per 1,000 in a given year. So over a course of 20 years (from the time the first kid is born until the time the last kid reaches 18), what is the chance of this "family with kids" filing bankruptcy at least once?

How Do You Find Good Home Improvement Contractors?

2008-06-02T08:50:00.001-07:00

This is a question for my readers who are also homeowners. Help me out here. How do you find good contractors for home improvements and repairs?

I know the standard answer is "ask your friends and neighbors." But how do they know if someone is good? I've used a few different people for different things for my home but if someone asks me, I will have to say "I'm not sure" because I have no basis on which to evaluate their quality of work or whether their prices were reasonable. For each kind of work, there are perhaps hundreds of service people in my local area. For example my garage door opener broke a while ago. I found somebody on Yahoo! Local. He fixed it and charged me $120. It's working now -- that I can tell. But did he use a cheap part that's likely to break again in a year or two? Could another person have fixed it for $60? I have no idea. Yes you can get estimates from a few people for comparison, but how do you know if the few people you get estimates from are not all well above average? To borrow an analogy from investing in mutual funds, if you only look at prices from Merrill Lynch, Smith Barney and Putnam, you may think you are paying a fair price. You will never know you should invest with Vanguard. And if materials are involved, how do you know if you are comparing apples to apples? How do you know if the low bidder is not short-changing you with shoddy materials? I feel like I'm totally in the dark when I hire service people for my home.

I know there are a few places people rate and post reviews on service providers. Angie's List is one of them. Even there the providers typically don't have many reviews. Should I hire someone based on only 10 reviews? I question whether the reviewers are qualified to give a review if they are in the dark just like I am. It's like blind leading blind. I also have a problem with having to pay Angie's List in order to read reviews. I'm so used to people sharing information for free. That's what the Internet is about, right? That's why I sometimes looks on Yahoo! Local and Yelp.

If you are a homeowner, how do you find good service people and how do you know if the price is fair?

Imported Spreadsheets to Zoho

2008-05-30T11:38:00.001-07:00

I mentioned in another post that I started using Zoho recently. Zoho offers a suite of "office" software online. They have online word processor, spreadsheet, presentation and many other types of software that traditionally resides on a local computer. Having these software online lets me access my documents from anywhere. It also lets me share my documents with the world without requiring Microsoft Excel. My experience so far has been very good. I have created a few Excel spreadsheets and linked to them on this blog in the past. Zoho's spreadsheet program correctly imported them without glitch. Here they are if you'd like to use or bookmark them:

ESPP Rate of Return - Calculates the annualized return from Employee Stock Purchase Plan (ESPP) purchase and sale. See previous post Employee Stock Purchase Plan (ESPP) Is A Fantastic Deal.

TIPS Pricing - Estimates how much cash you will need for buying TIPS at auction. See previous post TIPS: Inflation Linked Bonds.

Notes From an Overseas Vacation

2008-05-27T09:10:00.001-07:00

I didn't post to my blog last week because I was on vacation in another country. It was really refreshing even though the weather wasn't 100% cooperative. Now, here are some random personal finance related notes from my vacation.

Exchanging money. The best way to get the local currency is still using the ATM card, as long as you don't pay a foreign ATM surcharge. Banks and money exchange services post two rates -- a "buy" rate and a "sell" rate. The lower "buy" rate is used when you exchange US dollars into the local currency. The "sell" rate is used when you exchange the local currency back to US dollars. My Fidelity mySmart Cash account does not have any surcharge for using the ATM card overseas. Visa charges 1% extra on top its wholesale exchange rate, which is better than the retail rates posted by the bank branches. The all-in exchange rate I received from using the ATM card was close to the "sell" rate posted at local banks and money exchange counters. If I exchanged my US dollar bills at a bank, I would get the "buy" rate which is 2-3% less.

I charged a hotel bill to my American Express card. American Express charges 2% for foreign transactions. But because American Express also gives me a rebate for using its card, it evens out to a wash between the exchange rate surcharge and the rebate.

Crazy prices for convenience. Although I was in a developing country, I wouldn't know it if I just looked at the prices. Hotels know it well. They've got you on their premise and you don't have many choices. If you want convenience, you'll have to pay dearly. $4 for a small bottle of water in their restaurant. $25 per person for a breakfast buffet. $1 a minute for *local* calls. $25 a day for Internet access in your room. $10 per day per person for using their gym. All these services are optional. The prices are disclosed up front. If you don't like the prices, you don't have to eat there or use their Internet access or gym. But it still leaves a bad taste in my mouth. They may call you guests but they really see you as trapped profit generating subjects. What are you supposed to do? Bob Sullivan in his book Gotcha Capitalism suggested that before you make a reservation, you should call the hotels you are interested in and ask about their prices for the services you will likely use, such as parking, Internet access, fitness gym, breakfast, etc. You then add up all the prices and compare the bottom line between hotels. It's too bad you have to go the extra mile like that.

Taxes included in prices. I really like how other countries show the prices. The sales taxes are included in the price on the tag. What you see is what you pay. There is no surprise. The United States and Canada are the only two countries I know that add extra sales tax at checkout. If the sales tax is mandatory, why not include it on the price tag, like the way gas prices are displayed at the gas stations?

No evidence of consumers clamming up. I read and heard in the news media about American consumers being hit hard by foreclosures and high food and gas prices, but I didn't see any evidence of their clamming up from my casual observations. Most of the tourists at the place I went came from the U.S. The flights were full. I saw many happy middle class American families at the airport, in the hotel lobby and pools, at restaurants, on the streets wandering about, and at tourist attractions. Perhaps there are fewer tourists than before, but there are still more than plenty. Don't believe the doom and gloom. American consumers are still kicking alive and well.

Roth 401(k) for People Who Contribute the Max

2008-05-15T11:42:00.001-07:00

Back in March I wrote The Case Against Roth 401(k) in which I said I think for most people the majority, if not 100%, of the contribution should go to a Traditional 401(k). I gave these reasons:

Fill in lower tax brackets in retirement
Avoid high state income tax
Leave the option open for Roth conversion in the future
Avoid triggering phase-outs and AMT

I still believe these are valid reasons in favor of contributing to a Traditional 401k instead of a Roth 401k. A few comments to that post said Roth is better because a Roth 401k lets you effectively shelter more from taxes than a Traditional 401k. That is true. My response was that the higher effective maximum comes into play only if someone actually contributes the maximum allowed, currently at $15,500 per person per year. According to a study by Vanguard, only 10% of people contribute the maximum. It's not surprising because in order to contribute the maximum, you need either a high income, a high savings rate, or both. Consider a married couple. The combined 401k and IRA maximum contributions are $41,000 per year. At 25% savings rate, this couple needs $160,000 of income. At 15% savings rate, this couple has to earn $270,000.

What if you are one of the 10%? People who read finance blogs probably earn more and save more. What is the value of the higher effective contribution limit in a Roth 401k?

It turns out that for the marginal dollar, a Roth 401k is worth about 5-10 percentage points in marginal tax rate. That is if you contribute the marginal dollar to a Roth 401k and your marginal tax rate drops 5-10 percentage points between now and retirement, you are still better off than contributing that same marginal dollar to a Traditional 401k and put the tax savings in a taxable account. Say you are down to the last $100 which you can either contribute to a Roth 401k or a Traditional 401k. If you contribute to a Traditional 401k, you also get a tax deduction. But because you already hit the max, you cannot put the tax savings into the Traditional 401k. Your only choice is a taxable account. The Roth is compared to Traditional + Taxable because the assumption is that you maxed out the contribution limit. If you are not maxing out, you can always gross up the contribution to the Traditional account.

How much exactly is a higher effective contribution limit in a Roth 401k worth depends on a number of assumptions. I made this spreadsheet on Zoho. You can plug in your own assumptions and see the result for yourself. Plug in some different assumptions and see how the results change. That's what a spreadsheet is for. Zoho is nice because it's all online. You don't need Excel or any other spreadsheet program. You don't have to register for Zoho either if you just want to use the spreadsheet.

For example, here's one set of assumptions I used.

For tax rates, I'm assuming the Bush tax cuts will expire after 2011. Dividends will be taxed as ordinary income and long term capital gains will be taxed at 20%. I also put in a factor for the cost advantage in a taxable account because 401k plans often have higher cost funds and higher admin costs. And here are the results.

Roth 401k and "Traditional 401k + Taxable" break even if the marginal tax rate at retirement is about 28%, versus the current marginal tax rate of 35%. That means the higher effective contribution limit is worth about 7 percentage points.

Here's the link to the spreadsheet again if you want to play with your own assumptions.

Traditional Or Roth 401k

Finally, please note we are still talking about the marginal dollar here. The reasons for favoring the Traditional 401k are still valid for the majority of one's retirement dollars. If you max out all your tax favored contributions, you still have to decide how much should go to traditional. Those dollars in traditional will fill in the lower brackets after you retire. They will also be converted to Roth along the way if you have a window of opportunity.

Free Digital TV Over the Air

2008-05-12T08:22:00.001-07:00

Don't laugh. I finally got TV in my home. I have a TV, the physical device. I use it for watching DVDs. I just haven't had TV programming in the last few years. I canceled my cable subscription because I found myself not watching at all for weeks on end. Occasionally I wanted to watch something like the Oscars or the Olympics. I also missed the PBS programs although I don't understand why they keep having Robert Kiyosaki and Suze Orman on their personal finance shows. Because I live far from the broadcast towers, the signal quality from an indoor antenna isn't very good. So I didn't bother.

A couple of months ago I read on the Bogleheads forum that you can get a coupon from the government for a digital TV converter box if your TV doesn't have a digital tuner, because broadcast TV will move to all digital in February 2009. You can ask for up to two coupons, each worth $40. It took them two months to send me the coupons. I went to Circuit City and bought myself a converter ($60 plus tax, minus $40 coupon) and an indoor antenna. I hooked them up and voila, I got TV! I receive about 20 channels, not counting the ones which broadcast in languages I don't understand. For the channels I receive, the signal is crystal clear. There is no static or distortion. I guess that's the benefit of digital broadcasting. But out of the major network stations, I only get Fox, not ABC, NBC or CBS. I'm not sure whether it's because they are not broadcasting in digital yet or their signals are still too weak for me. I'll go to Radio Shack tomorrow and try some different antenna.

Free digital TV over the air gives me one more reason for not dealing with a cable company.

Book Review: Gotcha Capitalism

2008-05-07T08:13:00.001-07:00

I'm reviewing the book Gotcha Capitalism today. I first heard about the book on public radio. The author Bob Sullivan was interviewed on Fresh Air by Terry Gross (36 minutes) and on Marketplace by Tess Vigeland (7 minutes). This book is about the annoying fees and the disingenuous pricing and marketing schemes we face every day from many places. You know those fees. They are everywhere. I also wrote about a few of them in the past: ATM surcharges, bank overdraft or NSF fees, credit card late fees, 12-month-same-as-cash deferred interests, finance charge in insurance payment plans, 401(k) plan admin fees, and numerous fees in VUL policies. There are also many more I haven't touched on: airline excess baggage fees, cell phone early termination fees, hotel parking fees, many mysterious line items on rental car contracts and telephone bills, etc. etc.

Some of these fees are more of a nuisance while some (like 401(k) plan admin fees and VUL fees) are more serious. The author puts it very elegantly:

"Sneaky fees peck away at us like a swarm of mosquitoes that ruin an otherwise beautiful summer evening. And like mosquitoes, an individual bite might seem trivial, barely more than a nuisance, but repeated bites can actually change the way you live. They chase you inside, make you build a screened porch, and in extreme cases make you sick." (p. 4)

The book primarily serves two purposes: (1) expose the various fees; and (2) provide tips and strategies for fighting back on these fees. It's not a surprise that most of the fees the book talks about are from services, not physical products, because when you buy physical products, if you don't like the final amount, you can return them (most of the time, except when you buy a car). A lot of the services involved are also sold by a monopoly or an oligopoly, for example land line telephone and cable TV. Why are there so many fees and what should we do about them? The author says there are a lot of fees because businesses engage in "shrouding" which attempts to make the true cost of their service look lower than it actually is. They put in these fee traps to catch the "myopes." Myopes are customers who are drawn to the headline sticker price -- "free checking" or "$39.99 a month" -- but who can't understand the total cost before they sign up or who are not able to navigate through the minefields of fees and after-charges. People are usually overconfident. They think they won't bounce a check or they will always be able to refill the gas tank before they return the rental car. But for all consumers as a whole, some people eventually fall prey to those gotchas.

The art and science of complaining are a big emphasis of this book. In the author's own words,

"This book is designed to make you an expert complainer. Not a whiney complainer, not a bitchy person, and not a penny-wise and pound-foolish consumer. A well-informed, successful, efficient complainer." (p. 31)

The book provides estimated rate of success on reversing different fees so you can pick your battles. It also provides sample call scripts, letters and information on regulatory agencies for different industries.

This small paperback (selling for $10.46 on Amazon) is packed with good information. It is very worthwhile reading. If you can't get hold of the book yet, you can at least listen to the interviews I linked at the beginning of this post.

If I have to criticize it, I have to say the author didn't emphasize enough a very important weapon consumers have. That is voting by your wallet. Don't buy the service if you think the pricing is unfair or too complex. Favor businesses that have more transparent and straight forward pricing. For example I don't subscribe to cable TV. I have no appetite for signing up for a promo rate for 6 months and calling the retention department every 6 months for a lower rate. I simply refuse to play their game. Netflix is much more straight forward. I also don't subscribe to any cell phone contract. I use a prepaid service. The per-minute cost is higher but I pay for what I use. There's never any surprise. I fly Southwest Airlines, which doesn't charge a change fee, even if their fare isn't always the lowest. Most of the time, there are alternatives to tricky prices. If banks are evil, use a credit union. Burn me once, shame on you. Burn me twice, shame on me. If you stay away from businesses with unfair or complex pricing schemes, you are less likely to be charged those fees in the first place and you won't have to worry about how to stage your complaint and get your fees refunded.

Also, because it was written by a journalist, the examples in the book are sometimes on the sensational side. Take credit card fees for example. The book told a story about a Mr. Wesley Wannemacher, who charged $3,200 for his wedding on a credit card and never used the card again. Because he went over the card's $3,000 credit limit, he was charged an over-the-limit fee. And because he didn't make enough payment to bring the balance below the credit limit, he was charged an over-the-limit fee again in the next month, and the next month. All told, he was charged the over-the-limit fee 47 times. Because he was also consistently late in making the payments, he was also charged a late fee more than 30 times. I mean, come on, if it stings, stop doing that. Pay it down, ask for a credit limit increase, or transfer the balance to another card with a higher credit limit. If nobody is willing to offer you a higher limit, that tells you something, doesn't it?