Real Answers To Largely Real Questions

 

Male bag. Thank God Dwight Eisenhower and Ted Williams aren't alive to see this.

 

 

Dear Control Your Cash:

We came into an inheritance of about $130,000. We paid off all our credit cards and deposited $100,000 in two credit union accounts that each pay 3% on deposits. The balance sits in a non-interest-bearing regular deposit account. Our income takes care of all bills, with a modest margin for savings and/or the occasional repair, travel, etc., without requiring commission income from my job. That situation should be stable for the next 5-10 years (famous last words). In this economic environment, where would you put the cash sitting in the credit union account?

Abigail
Phenix City, Alabama

 

Dear Abigail:

How much is sitting in the regular deposit account?

Control Your Cash

 

 

(no response)

 

Dear Abigail (continued):

Okay, fine. Can’t be more than $30,000.

Put 3-6 months of expenses in the best savings account you can find. Try ING. You can buy a CD, but you can probably get an interest-bearing account that pays a similar rate without locking up the money.

Let’s take a look at Bankrate. Right now, the best 3-month CD rate we can find on there, among banks that don’t require a minimum, is Ally’s .39%. Ally’s own money market and savings accounts go as high as .84%, again with no balance required.

Put the rest in TIPS – treasury inflation-protected securities – and index funds. Vanguard is great for index funds because they keep their fees low and have lots of choices. Here are a few that might work, in descending order of how highly we regard them:

REIT index fund
Total stock market index fund
Total bond market index fund

The REIT fund invests in real estate investment trusts only. Buy in, and you’re holding pieces of companies that own pieces of buildings. $3000 gets you into this fund that has a low expense ratio and that pays quarterly dividends (which totaled 44¢ a share over the past year.)

One positive to the REIT fund – or negative, if you have different objectives – is that it’s got far fewer components than your standard stock fund. The REIT fund has only 112 components, a dozen of which comprise half its value. You’d expect this fund to have relatively few components, since there are far fewer REITs for a REIT fund to be composed of than there are stocks that could make up a stock fund.

The stock fund, on the other hand, has a little of everything. 3319 components, to be precise. When Vanguard says the fund tracks the entire market, they mean it. The fund’s top 10 holdings make up only ⅙ of its value, and those holdings are as big relative to the fund as they are to American commerce itself: in order, those stocks are:

Exxon Mobil Corp. 58,095,543 $4,924,178,225
Apple Inc. 11,077,447 $4,486,366,035
International Business Machines Corp. 14,269,978 $2,623,963,555
Chevron Corp. 23,932,734 $2,546,442,898
Microsoft Corp. 90,097,291 $2,338,925,674
General Electric Co. 126,658,602 $2,268,455,562
Procter & Gamble Co. 32,835,015 $2,190,423,851
Johnson & Johnson 32,743,485 $2,147,317,746
AT&T Inc. 70,807,116 $2,141,207,188
Pfizer Inc. 93,224,076 $2,017,369,005
Google Inc. Class A 3,037,566 $1,961,963,879
Coca-Cola Co. 24,691,491 $1,727,663,625
Wells Fargo & Co. 59,932,087 $1,651,728,318
Philip Morris International Inc. 20,987,803 $1,647,122,779
JPMorgan Chase & Co. 46,588,007 $1,549,051,233
Intel Corp. 62,741,843 $1,521,489,693
Merck & Co. Inc. 36,811,418 $1,387,790,459
Verizon Communications Inc. 33,826,667 $1,357,125,880

 

Finally, the bond fund. It deals exclusively in “investment-grade” bonds, 70% government, the rest corporate. It holds pieces of 4,301 bonds, most of it Fannie Mae and Freddie Mac. (Which, curiously, Vanguard regards as government bonds. Even though Fannie and Freddie are officially private enterprises. We’ve talked about this before. Last month in, fact.)

Either way, you’re doing fine. Look at the returns on even the most conservative choice here, and compare it to what you were making in credit card interest payments.

We’ll say it again – a huge part of building wealth is not destroying wealth. There are a million places to make the analogy, but constructing a skyscraper is a hell of a lot easier if you aren’t setting fire to the building’s foundation every night.

Dear Control Your Cash:

Tax time is coming up. I get my taxes done at Jackson Hewitt, in the mall, because addition and subtraction are hard. And don’t get me started on multiplication and division. Besides, I’m more of a left-brainer. Numbers are soulless and have no place in a creative person’s life. Did I mention that I’m an artist?

Anyhow, I’m expecting about a $500 refund this year. (Yes!!)

So should I get a refund anticipation loan? The tax preparer told me that I’d get the money immediately, instead of having to wait a few weeks for my refund like I normally do. It’s my money, I shouldn’t have to wait for it, right? So unfair! What do you think?

Erika
Scottsdale, Arizona

 

 

Dear Erika:

Thanks. A little comedy always livens up the mailbag. Of course you shouldn’t have to wait for your money, which makes us wonder why you authorized the federal government to confiscate it from you in the first place, only to return it to you with zero interest months later. What Jackson Hewitt squeezes out of you is yours and their business, however. Read this, if you can do it without drooling on your keyboard.

 

Got a question for the CYC mailbag? Email info@ our URL.

How To Go Broke In Real Estate

One month, she tried to pay in canned goods and STDs

 

Every other post, you guys write about making money through real estate. It’s not that simple. 

We never said it was. If your wealth plan consists of nothing more than buying the cheapest house you can find and then placing an ad on Craig’s List for a renter, of course you’re going to fail. Here are some other handy tips to turn passive income into passive outgo:

 

1. Don’t do your homework. 

If you want to become a residential landlord, it takes 5 minutes to determine how much units are going for in your selected neighborhood. And another 4 minutes to see how much competing landlords are charging. Once you do, you can easily calculate cash-on-cash return on your investment (which is your down payment, divided into the rents you receive less the operating expenses and mortgage payment.)

You really do make your money going in, a truism that applies to most investments. Do the prep work before you get started, and you won’t be in the position that so many failed landlords end up in: a couple months later, losing money every month and not understanding why, then running the numbers and realizing that the only way to make cash flow on the property is to charge 3 times market rent. Which no renter will pay, and which you won’t be able to charge until the lease you made the current renter sign expires anyway.

 

2. Maintain a personal relationship with your renters. We know one gregarious, outgoing guy who built his wealth in the glamorous business of hair removal. When the money started coming in, he began buying houses. His pleasant demeanor is killing him as a landlord. He collects the rent personally: that is, when the renters feel like paying. He admits that at least one renter’s kids call him “Uncle Pete”, which means the battle’s already lost. When we asked if he bought the kids Christmas gifts, he laughed but didn’t answer.

How to fix this? Staying detached isn’t that difficult. Friends are friends. Accounts receivable are accounts receivable. There’s no reason why the twain need to meet. Uncle Pete could have saved himself aggravation if he’d hired a property manager.

We can’t say property managers are worth their weight in gold, because many of them are overweight middle-aged ladies who weren’t adept at selling real estate for commission and thus chose to work on what’s essentially salary. But a good property manager will save you myriad headaches.

Property managers usually charge 8-10%. For that they’ll find you a renter, collect the rent, and deal with all the unforeseen problems that come up so you don’t have to (calling someone to fix the dishwasher, et al.) It’s worth their cut just for you to not have to deal with collecting the rent yourself. Not because collecting rent eats up a lot of time, but tracking down even one late tenant will make you appreciate the value of a property manager.

Say a tenant wants to beg you for an extension, or explain to you that he wants the late fee waived because he needed money to buy his daughter a new pair of crutches for her polio. He can’t do so if he doesn’t know how to contact you (or better yet, doesn’t even know your name.) Instead, everything goes through the property manager and it’s not your problem. She’s experienced at this and knows how to keep the relationship purely business. She can be a good cop and shrug her shoulders when the tenant begs for a break; “I really would love to help you, but the landlord’s being obstinate. You’re right, he’s such a jerk.” Or she can be a bad cop and put her foot down. “These are the rules. You’re welcome to leave in the middle of the night and have us hold onto your security deposit, if you’re that kind of person. Did I mention my daughter’s married to a police captain?”

 

3. Don’t do due diligence. 

In the early 21st century, there’s no excuse for not knowing as much as you possibly can about a person who’s in a position to defraud you. Google a potential renter’s phone number, and you might be able to find his long-dormant MySpace page on which his friends have left posts discussing the awesome strain of Panama Red they recently smoked. A simple name search can lead to the endlessly fascinating WhosArrested.com (WARNING: you can spend hours on there.) Confirming that a renter is clean and responsible – or at the very least, isn’t waving any red flags in your face – isn’t that hard to do.

Ultimately, be cold and antiseptic. Remember, it’s business. Save the wimpiness and the malleability for your child-rearing and your other personal relationships. Ruthlessness isn’t a necessary condition for building wealth. But letting yourself be a doormat is a sufficient condition for losing wealth.

This article is featured in:

**The Festival of Frugality #320: It’s Warm Somewhere in the World Edition**

**Top Personal Finance Posts of the Week-The Facebook IPO Edition**

15 Years to Freedom

Thanks to Arohan at Personal Dividends for indirectly helping us out yet again. He’s the guy who graciously lets us guest host the Carnival of Wealth every month, and also let us write this post for his last year. It appears here in slightly updated form on Recycle Friday. Again, updates in CYC Burnt Umber. This week’s topic? Halving your mortgage. Totally legally:

It’s the modern exemplar of fiscal responsibility – the mortgage you pay off in half the time of a standard one. Granted, people who carry 15-year mortgages are generally the same ones who alphabetize their refrigerators and iron their gym clothes. But people like that are worth emulating in a society where the populace now regards mortgages and credit card debt as no more obligatory than rural speed limits.

Obviously, paying a mortgage off in half the standard time means you’re making payments twice as big, or close to it.

But you aren’t. Here are a couple of graphs that show how long it takes to start making a dent in the principal when you finance your house over 30 years, vis-a-vis 15 years. We used standard market rates, which we’ll quantify in a second. The purple line is your cumulative interest payment, which you obviously want to keep as low as possible. The purple line moves in concert with the yellow line, which is your principal balance: you want the yellow line to take as short a path as possible from the northwest corner of the graph to the southeast corner.

Chart 1: A 30 Yr Mortgage
30-Year Mortgage
Chart 2: A Comparable 15 Yr Mortgage
A Comparable 15-Year Mortgage 

That second graph is revolutionary, and indicates how there’s not only never been a better time to buy a house (or houses) than now, but that there’s never been a better time to get yourself into a 15-year mortgage.

Around 1981, 30-year mortgages were going for 18%. Just for sheer horror value, here’s a comparable chart from then. We enclosed it in a thick red border to denote danger:

Chart 3
 

It’s true: There are homeowners whose 30-year mortgages are coming due this year, who as recently as 2008 still had less than half equity in the house. These people might be your parents. Don’t show them this article.

But getting back to the relevant charts, the first two: we’re not criticizing people with 30-year mortgages. Given such variables as human life expectancy, house obsolescence, and wages and salaries, 30 years has always been the historical happy medium for a mortgage term – not so long that you’re on the hook into your senescence, and not so short that you’re forgoing dental floss to make payments.

However, we’re in The Great 21st Century Stagnation and everything’s at least a little askew.

Here are the actual current mortgage numbers. The average 30-year mortgage right now goes for a minuscule 4.33%, which still dwarfs the average 3.85% that 15-year mortgagors are paying. The difference between the rates has never been this big. Ever.

Last summer, the median home in the United States sold for $176,400 according to the first chart on this page.

Aside: some esoterica from that chart.

  • the string of “N/A” in the Detroit row is amusing. What a craptastic town. Nothing there is applicable.
  • the numbers for Ocala and Ft. Myers seem low until you remember that the vast majority of those homes are snowbird apartments.
  • building restrictions in the Bay Area have had the desired effect, if the effect desired was pricing everyone out of the market.

If you bought the median house with an average-priced 15-year mortgage, how big would your monthly payments be? Here come the math:

Mortgage Payment Calculation

You really need to stop complaining. “Waah, I suck at math. I’m no good with numbers (giggle).” It embarrasses us both.

Would you say “Waah, I suck at English. I’m no good with words” in public? Of course not, you’d sound like a tard. How is this any different?

Take your interest rate, divide it into the number of payments you make annually, add 1, take to the power of (negative) the number of payments you’ll make over the life of the loan, subtract from 1, multiply by the number of payments in a year, divide into the interest rate, multiply by the amount of the loan. Wasn’t that easy? You should have learned how to do this in the 6th grade. Clip and save the formula, it comes in handy all the time.

Anyhow, your monthly payment is the product here, which is $1291.58.

10 years ago, the average 30-year mortgage went for 7.96%. Let’s plug that interest rate into the above expression and see how much house we could have bought with such a mortgage back then, given the same monthly payments.

You ready?

A house costing $176,693.34.

Yes, today you can pay a house off in half the time it would have taken to pay off the exact same house (plus a medical supply table) in 2000.

In other words, God wants you to not only buy a house today, but be free of your debt obligation no farther in the future than O.J. Simpson’s not guilty verdict is in the past.

Everything beyond this is speculation, but the Fed chairman has indicated that he wants to keep inflation low and money tight. Maybe taking him at his word is foolish, but it seems as though mortgage rates can’t fall much lower. If you’re looking at a 15-year mortgage, and the economy stabilizes between now and 2025 (which of course it will), your 178th, 179th and 180th payments could be awfully palatable and the checks downright fun to cut.

(Thanks to TheMortgageReport.com, which we didn’t crib from to write this post. But it’s one of the very few well-written and informative blogs on any subtopic of personal finance. And Dan Green, the guy who runs it, makes awesome charts.)

**This article is featured in the Yakezie Carnival-Tour de France Financial Factoids Edition**