Category Archives: Certificates of Deposit

Why Your Home is a Poor Investment

Image result for homes

A couple we know moved to a new house recently.  They sold their old for a little more than twice the price they originally paid.  Doubling your money sounds like a great deal, right?

Not so fast.

To determine if the house was a good investment we need to make some calculations.  They originally bought their old home about 33 years ago.  That means that the return on their investment was just 2.4% per year.  To put it in perspective, 33 years ago CD rates were around 10%.  Viewed strictly from an investment perspective, they could have made a better return on their money if they had bought a CD.  And that’s to say nothing of maintenance and upkeep, costs not associated with CDs.

On the other hand, you can’t live in a CD.

How about investing that money in the stock market?  Over that same period the S&P 500 grew 8.5% annually.  That means that every $100 invested in the market 33 years ago would have grown to $1476!

The reason that so many people think that their home is their best investment is that they don’t sell their home very often.  As a result, they look at what they paid and what they sold it for.  If they held it for many years, it usually looks like a big number, and it is. But when viewed strictly as an investment, the annual growth rate is small compared to the alternatives.

As we alluded to earlier, home ownership also involves many other expenses.  There are property taxes and insurance.  Homeowners know that repairs and maintenance are expensive and never ending.  After all of the expenses are taken into account, the real return on home ownership may be even less that our earlier calculation.

But a home is much more than an investment.  It’s a place to live, a place to raise a family, a place to call your own.  A home is a refuge from the rest of the world.  The alternative is renting, wherein you often have more flexibility and are not on the hook for all of the repairs and maintenance.  But it also means that your monthly payment to your landlord is not going into equity that home ownership provides.

We are homeowners and advocates of home ownership.  The point of evaluating the true value of the home as an investment is to bring reality to the financial aspects of home ownership. It’s also a warning against investing too much of our resources in the family home, making many people “home poor.”

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What’s Your Risk Number?

risk

Defining how much risk someone is willing to take can be difficult.  But in the investment world it’s critical.

Fear of risk keeps a lot of people away from investing their money, leaving them at the mercy of the banks and the people at the Federal Reserve.  The Fed has kept interest rates near zero for years, hoping that low rates will cause a rebound in the economy.  The downside of this policy is that traditional savings methods (saving accounts, CDs, buy & hold Treasuries) yield almost no growth.

Investors who are unsure of their risk tolerance and those who completely misjudge it are never quite sure if they are properly invested.  Fearing losses, they may put too much of their funds into “safe” investments, passing up chances to grow their money at more reasonable rates.  Then, fearing that they’ll miss all the upside potential, they get back into more “risky” investments and wind up investing too aggressively.  Then when the markets pull back, they end up pulling the plug, selling at market bottoms, locking in horrible losses, and sitting out the next market recovery until the market “feels safe” again to reinvest near the top and repeating the cycle.

There is a new tool available that help people define their personal “risk number.”

What is your risk number?

Your risk number defines how much risk you are prepared to take by walking you through several market scenarios, asking you to select which scenarios you are more comfortable with.     Let’s say that you have a $100,000 portfolio and in one scenario it could decline to $80,000 in a Bear Market or grow to $130,000 in a Bull Market, in another scenario it could decline to $70,000 or grow to $140,000, and in the third scenario it could decline to $90,000 or grow to $110,000.  Based on your responses, to the various scenarios, the system will generate your risk number.

How can you use that information?

If you are already an investor, you can determine whether you are taking an appropriate level of risk in your portfolio.  If the risk in your portfolio is much greater than your risk number, you can adjust your portfolio to become more conservative.  On the other hand, if you are more risk tolerant and you find that your portfolio is invested too conservatively, you can make adjustments to become less conservative.

Finding your risk number allows you to align your portfolio with your risk tolerance and achieve your personal financial goals.

To find out what your risk number is, click here .

 

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A Client Asks: What’s the Benefit of Inflation?

One of our retired clients sent us a question recently.

“I can’t understand the FED condoning and promoting any inflation rate. To me inflation means that the value of money is simply depreciating at the inflation rate. Further, any investment paying less than the inflation rate is losing money. A quick review of CD rates and government bonds show it is a rare one that even approaches the promoted 2% rate. It seems to me to be a de-facto admission of wanting to screw conservative investors and forcing them into riskier investments… Where is there any benefit to the financial well-being of the ordinary citizens?”

I suspect that there are a lot of people who feel the same way. It’s a good question. Who wants ever rising prices?

Here’s how I addressed his question.

Let me answer your inflation question first. My personal opinion is that 0% inflation is ideal, and I suspect that you agree. However, lots of people see “modest” rates of inflation (say 2%) as healthy because is indicated a growing economy. Here’s a quote from an article you may want to read:

Rising prices reflect a growing economy. Prices typically rise for one of two reasons: Either there’s a sudden shortage of supply, or demand goes up. Supply shocks—like a disruption in the flow of oil from Libya—are usually bad news, because prices rise with no corresponding increase in economic activity. That’s like a tax that takes money out of people’s pockets without providing any benefit in return. But when prices rise because demand increases, that means consumers are spending more money, economic activity is picking up, and hiring is likely to increase.

A case can be made that in a dynamic economy you can never get perfect stability (e.g. perfectly stable prices) so it’s better for there to be more demand than supply – driving prices up – rather than less demand than supply – causing prices to fall (deflation). Of course we have to realize that “prices” here includes the price of labor as well as goods and services. That’s why people can command raises in a growing economy – because employers have to bid for a limited supply of labor. On the other hand wages are stagnant or even decline when there are more people than jobs.

But for retirees on a fixed income inflation is mostly a negative. Your pension is fixed. Social Security is indexed for inflation but those official inflation numbers don’t take food and fuel costs into consideration and those have been going up faster than the “official” rate. The stock market also benefits from modest inflation.

Which gets us to the Federal Reserve which has kept interest rates near zero for quite a while. It’s doing this to encourage business borrowing which is supposed to lead to economic expansion but the actual effect has been muted. That’s because other government policies have not been helpful to private enterprise. In effect you have seen the results of two government policies in conflict. It’s really a testimony to the resilience of private industry that the economy is doing as well as it is.

The effect on conservative investors (the ones who prefer CDs or government bonds to stocks) has been bad. It’s absolutely true that after inflation and taxes the saver is losing purchasing power in today’s interest rate environment. The FED is not doing this to hurt conservative investors but that’s been the effect. The artificially low rates will not last forever and the Fed has indicated they want to raise rates. They key question is when, and by how much.

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Living on a fixed income has gotten a lot harder

At one time, living on a fixed income meant you were retired, received a pension and social security, and got some extra income from your savings. For our parents and grandparents, certificates of deposit, otherwise known as “CDs” were a guaranteed source of no-risk income. Back in 1981 you could put your savings in the bank and get nearly 18%. That was a period of high inflation when prices were also going up. But CDs and bonds paid investors high enough rates so that retirees were comfortable with putting their money into CDs or bonds.

But interest rates have been on a downward path since then. CD rates have dropped from about 11% in 1984 to 1% or less today.

CD rates history

 

Today, CDs and bonds, once the go-to choice of the thrifty retiree, pay a small fraction of what they once did, and provide very little income to supplement their other retirement income sources.
The Federal Reserve has been keeping rates close to zero for years to try to jump-start the economy, with limited success. But while it’s been good for businesses and home buyers who have have been able to borrow money at rates that we have not seen since the 1950s, the traditional saver has seen their income dry up, collateral damage of Federal Reserve policy.

Charles Schwab, in an article published in the Wall Street Journal states that:

U.S. households lost billions in interest income during the Fed’s near-zero interest rate experiment. Because they are often reliant on income from savings, seniors were hit the hardest. Households headed by seniors 65-74 years old lost on average $1,900 in annual income over the past six years, according to a November 2013 McKinsey Global Institute report. For households headed by seniors 75 and older, the loss was $2,700 annually.
With a median income for senior households in the U.S. of roughly $25,000, these are significant losses. In total, according to my company’s calculations, approximately $58 billion in annual income has been lost by America’s seniors since 2008.
Retirees depend on income from their savings for basic living expenses. Without that income, many seniors have taken on greater risk to increase the potential yield on their savings, or simply spent down their nest eggs. After decades of playing by the rules, putting off spending and socking away money, seniors have taken it on the chin. This strikes a blow at the core American principles of self-reliance, individual responsibility and fairness.

What’s a retiree to do? Let’s look at some of the alternatives that people on fixed incomes are being offered and what to watch out for. All of them involve risk that may not be readily apparent. There are traps for the unwary.

Continue reading

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Behavioral Finance Lingo

Behavioral finance is the recognition that people often act irrationally, and this can have a deleterious effect on people’s finances.  Here are a few of the terms that are applied to mental perspectives that can lead us into trouble.

  • Someone says that it was obvious back in 2007 that financial stocks would crash as homes became virtual ATMs.  The term for this bias is known as HINDSIGHT.  Using hindsight, facts often appear obvious.
  • Someone is nostalgic for the days of earning 12% interest on CDs back in 1981, forgetting about high taxes and inflation in that period.  The concept that applies is known as FRAMING.  The individual should be framing the situation in inflation-adjusted returns because he had large losses in spending power back then, especially after taxes.

We will have more on this subject in the future.

 

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Key Rates

  • LIBOR (1-month)  0.19%
  • Fed Funds  0.00-0.25%
  • 6-mo CD  0.40%
  • 1-yr CD  0.56%
  • 5-yr CD  1.23%
  • 2-yr T-Note  0.30%
  • 5-yr T-Note  1.02%
  • 10-yr T-Note  2.13%
  • 30-yr T-Bond  3.28%
  •  Prime Rate  3.25%
  • 30-yr Mortgage  4.10%
  • CPI – Headline  1.10%
  • CPI – Core  1.70%
  • Money Market Accts.  0.47%
  •  Money Market Funds  0.02%
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A Deposit In A Bank Is Not A Riskless Form Of Saving

This is a good time to remind our readers of something.    Via ZeroHedge

Cyprus has reminded us of a couple of awkward truths:

  1. A deposit in a bank is not a riskless form of saving.We may not see eye to eye with the FT’s Martin Wolf on many aspects of modern economics and central banking in particular, but he described banks well last week:

    Banks are not vaults. They are thinly capitalised asset managers that make a promise– to return depositors’ money on demand and at par– that cannot always be kept without the assistance of a solvent state.”

  2. When states become insolvent, the piper must ultimately be paid. Fatal, embarrassing insolvency is not a problem that can be perpetually or painlessly deferred.

Why do we have FDIC?  Because banks can fail,, and when they do, without someone else like the FDIC, depositors can lose part or all of their money, which is what happened in the Great Depression of the 1930s.  For a lesson in banks, watch “It’s a Wonderful Life.”

And even if the bank does not fail, if the interest they pay does not exceed inflation after taxes, the money in the bank is worth less over time because you can’t buy as much with the money as you did in the past.  The simple truth is that there is no “safe” place for money, even under the mattress.  Whenever you have money there is risk of loss.  Cash can be stolen.  Banks can go bust and investments can lose money.  For serious money, get professional help.

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Are You Too Scared to Invest?

 

Ellen Schultz has a good article in the Wall Street Journal about people who were scared out of the market and are now sitting in cash, frozen by fear.  She puts the dilemma this way

Most people—if they hope to maintain their standard of living in their old age—know their savings will need to earn more than the roughly 0.5% interest that most bank accounts pay these days or the 1.85% they would get from a five-year “jumbo” certificate of deposit.

Still, it is a risky time to invest. Stocks are flirting with record highs. Interest rates have nowhere to go but up, which will cause bond prices to drop.

Though getting better returns is essential, telling skittish investors to jump back into the market now feels like advising drivers to steer into a skid. But experts have some suggestions to help people get behind the wheel, while minimizing their risk of crashing and burning.

We know how you feel.  We never got out of the market so we don’t have this problem but we do get questions from people who were badly burned by the markets in 2000 and 2008.  There are some people who should simply not be in the market.  They are psychologically unable to cope with the ups and downs and are better off hiding their money under a mattress (or putting it in the bank which at today’s interest rates is just about the same thing). 

But for those who have investable funds, there are a few things that can be done.

  • Schultz refers to “multi-asset funds.”  This is a way of buying a diversified portfolio with one fund.  The problem with this is that while the goal is exactly right, the vehicle is often one of those mediocre hybrids that does nothing well.  At Korving & Co. we prefer to custom build your own diversified portfolio using the best fund in each of its classes.
  • She also suggests “equity income funds” which is a variation of her first suggestion.  See my comments from the first point.
  • Finally she suggests “dollar cost averaging.”  From the aspect of investor psychology, this strategy is actually a good one because people feel they are dipping their toe in the water rather than jumping in.  Statistics studies have shown that the total return over a long period of time is actually not as good, however, we think that it’s probably a good way to go for the really skittish investor. 

If you have been on the sidelines waiting for someone to ring the bell telling you when to get in, it’s not going to happen.  In you need a little help, call us.

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Where can you get a good income?

When the typical investor thinks of income they usually think of bonds.  And much of the time they would be right.  Bonds produce income by way of interest payments.  But sometimes things are turned around.  These are one of those times.  The 10-year US government Treasury bond, a benchmark for many other rates is only paying 1.90%.  In contrast, the S&P 500 has a dividend yield of 2.14%.  No one buys the S&P 500 for income, but it’s instructive that an un-managed stock index produces 13% more income than a benchmark bond.

Of course the value of the S&P500 fluctuates from day-to-day, but so does the value of the 10-year US Treasury bond, just not as much.  

A lot of people are looking for a better income than their bank, credit union or the US Treasury can provide.  It’s one of the reasons why so many people who are looking for income are looking to stocks rather than bonds.

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The Bottom Line on CDs

The Oppenheimer Funds put up a graphic that illustrates the “real” return in CDs (Certificates of Deposit) over the last decade.  The chart shows that the yield on 6 month CDs for people in the highest tax brackets after taxes and inflation is less than zero for all but one year.

For example, in 2012

  • a CD paying 0.2%
  • minus 35% tax,
  • minus 1.8% inflation
  • provides a -1.8% “real return” to the saver.

Over the long term, “safe” investments have generated only a very modest returns except for short periods associated with unusual economic conditions such as the “Great Depression” of the 1930s or the high inflationary period at the end of the 1970s.

This is not to say that CDs and money market funds do not have a place in an investor portfolio.  They are a source of readily available cash, and for people willing to accept a modestly negative “real” rate of return, they provide an asset class that is not going to fluctuate with the stock or bond market.

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