Credit Improvement Lessons

I’ve learned many things during my credit improvement journey that I would like to share.  By reading this blog post I hope that knowledge will help you on your credit improvement journey.

• For couples, the path to better credit can and should be a shared adventure
• Discussions with you partner can be challenging! (But worth it.)
• There are no quick fixes, except, perhaps for one
• It feels liberating to get reduce your debt burden

My newest learning are largely about the emotions of finance. Whether you are in a relationship or not, money, credit, debt, personal finance, and even wealth management is an emotional process.

When it comes to finance I am extremely logical, almost like a Vulcan.  My wife’s financial personality is more emotional, perhaps like a Romulan’s.  If you don’t relate to the Star Trek references, perhaps you can relate to “Men Are from Mars, Women Are from Venus.”  I’m not saying that all men are less emotional about money, or that all women are more so.  I have seen couples where the roles are reversed.

Either way, it is rare that a couple has little emotion about money.  We all have our hangups, and some are financial.

Now, if you are currently single, I can relate too.  When I was single, I had impeccable credit and finances. I was also lonely.  I went on occasional dates, and I turned off some first dates when I picked them up in my 15-year old Saturn.  I could have afforded a brand new car, but I was too young for that to be in my financial best interest.  Believe me, you are better off without someone who complains about your car being too old!

When I finally met the right woman, my finances remained impeccable, but hers were different.  I would say that about half of our fights over the years have been about money, and that ratio became higher after we got married. My number one lesson about money and love is:

Talking about money is important, listening about money is doubly so. Knowing when to talk, when to listen, and when to postpone the money conversations is critical. Patience is better than pushiness. Your partner is likely listening — it may just take them a few days to process what you are saying.

I realize this post has focused on money and relationships.  When you are single, financial strength leads to self confidence, which leads to not being single (however be choosy… pick someone kind and mostly compatible). When you are in a relationship, realize that talking about money means listening.  If you communicate with patience and honesty you will have fewer arguments and better finances!

I realize I left a teaser at the top. What is the one quick way to improve your credit score?  Simple: pay down your balances, if you can. (And avoid increasing them with dogged determination).

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High-Tech Portfolios

When I think about the phrase “high-tech portfolio”, I don’t think tech stocks.  Instead I think about using technology to build a smarter portfolio.   Most actively-managed portfolios are constructed, in full or part, using 50-year-old “modern portfolio theory” methods.  I’m working to change this by bringing superior portfolio technology to market.

So, while writing for this financial blog remains a passion of mine, I will likely be spending much more time refining software and building a financial software business.  Much of that effort will be off-line at first.  Occasionally, however, I will provide business and software updates on the Sigma1 Financial Software Blog.

Developing portfolio-optimization software combines two of my long-term passions:  software development and finance.

Rest assured, that I will keep this blog up and going.  I think it contains some hidden gems that are worth discovering.  I will also continue to blog here when inspiration strikes.

Is Investment Real Estate Right for you? (So you want to be a landlord?)

Investing in Rental Property

I have been a rental property manager (landlord) for just over two years now.   I’ve learned many things; two stand out:

1. Residential real estate can be a great investment.  Rental real estate can provide steady cash flow, excellent asset diversification, favorable tax treatment… all with modest capital gains potential.
2. Rental real estate can be a real pain to manage at times.  Both tenants and repairs cause headaches.

I currently own one rental property through my LLC.  Because of item #2 above, I’ve recently turned over the property management to property management company.  This choice will probably reduce net revenue about 10-12%, but will help take much of the stress out of finding and screening new tenants and dealing with repairs and tenant issues.  If things work out well, I will consider purchasing a second rental property.

In my local real-estate market it is reasonable to expect about 5-6% net income on a fully-owned rental property.  And over a 30-year period I conservatively estimate 1.5% appreciation.  Further since real-estate prices are a large competent of cost-of-living and inflation, real estate makes a good hedge against real inflation.  Finally, just as property values tend to go up, so do rental rates.  Simply put, residential real estate is the best long-term inflation hedge I’ve found.

The flip side of rental property is the eventual likelihood of landlord/tenant issues ranging from breaking the lease, to late or unpaid rent, to property damage, to eviction — just to name a few. Vacancies without rent can really take a bite out of your cash flow.  Properties can drop in value, and marketable rental rates can fall dramatically.

Somewhat of a wild card is the tax treatment of rental properties.  In the “pro” side are depreciation of the structure which can be deducted, and the fact that “passive income” like other investment income is not subject to Social Security tax.  On the “con” side is that fact that nothing can offset “passive income” except passive losses (and vise versa).  Owner’s of rental real estate (or at least their accountants) will become very familiar with IRS Schedule E of their income taxes.

Rental real estate is not for every investor.  Personally I wouldn’t recommend buying rental real estate until you have a minimum of $250,000 net worth.  Managing a rental property can be time-consuming and challenging.  Alternately, finding a good property management company is also a real challenge.  And unlike infomercials and “Rich Dad Poor Dad” author Robert Kiyosaki suggest, real estate is not a financial panacea.  However, for some higher net-worth individuals, rental residential real estate is worth considering as part of their investment portfolio.

Financial Diversification Beyond Wall Street

There are many ways to diversify beyond Wall Street’s offerings:

• CDs (Certificates of Deposit)
• Bank at a Credit Union
• iBonds and/or Savings Bonds
• Residential Real Estate
• Commercial Real Estate
• Starting a Small Business
• Collectibles (gold, silver, platinum, art, vintage cars)
• DIY home improvement

Paying down debt is also an investment:

• Paying off (or paying down) credit cards
• Paying off auto loans
• Paying off student loans
• Paying down mortgage(s)

These debt-lowering options have the side benefit of improving your credit score and lead to a healthier credit report.

Additionally, there are “investments” that benefit your finances and offer other non-financial advantages.

• Education and training.  Either self-taught or formal. (including reading this blog!)  Increase your earning potential.
• Exercise, and healthy diet.  The longer and healthier you live, the greater your potential to earn and prosper.
• Strengthen your social network.  You will feel happier, more motivated, have more job networking opportunities.

Finally, there are methods to reduce and diversify your cost of living expenses:

• Learn to cook, grill, or otherwise eat at home more often.  If you are persistent you may find you are eating better, healthier, and more economically.
• If you like coffee… brew your own.  It may take time to learn what you like, but when you do you’ll love it.  Whether it is is store-ground hazelnut drip, Vietnamese coffee with Chicory and sweetened, condensed milk, French Roast, or a plethora of other choices you will benefit.
• If you love high-quality craft beer, consider brewing your own.  After the initial investment (~$200) you can brew your own for less than $4 per six-pack.  Share it with friends, and grow your social network.
• Use those DIY skills to make your house more energy-efficient by installing low-E windows, LED light bulbs, and even update weather stripping and doors.
• Grow a garden.

I have employed all of these financial ideas except commercial real estate (not counting REITs), certificates of deposit, and gardening.  My point is that it is possible to invest beyond Wall Street’s offerings.  Wall Street now offers some great investments including ETFs, and excellent brokerage companies like Vanguard, Fidelity, and Interactive Brokers (for sophisticated investors).  Finance and investing extends beyond stocks, bonds, ETFs, and Wall Street.

Millionaire by 40? Inflation says Big Deal!

40 years old is still several years off for me, but I it is very likely I will be a millionaire by the time I reach 40.  In fact, if you count my contributions to Social Security (including my employer’s half), the current value invested in my personal “Social Security Trust Fund” puts me there already.  But I’m certainly not counting on Social Security.

So, I’ll be rich right?  Wrong!   First there’s inflation.   Many economists say US inflation has been about 4% per year over the last century.  There’s a handy rule of 72 that says, for example, 72/4 = 18.  That means 4% inflation means that a million dollars today is only worth $500,000 in 18 years and $250,000 in 36 years.

Second, there’s taxes.  Over $300,000 of my holdings are in tax-deferred accounts such as 401k accounts and IRA accounts.  Sure this money is part of my net worth, but when it comes out at retirement I’ll likely be paying something like 30% tax on it.  That’s about $90,000 to Uncle Sam.  Poof!  Gone!

Back to inflation.  Inflation works like a stealth tax.  According to government CPI figures, US inflation increased just 1.5% in 2010.  That simply doesn’t jive with my experience.  My HOA fees increased 7%, my electric and water bill increased 8%.  Car insurance, home insurance, satellite TV, health-insurance premiums, internet, rooms at my favorite hotel, and meals at my favorite restaurant went up, by 4-10% last year.  Even the local sales tax increased almost 1%, making everything that much more expensive on top of everything else.  In Balhiser World 2010 inflation was about 4-5%, rather than the 1.5% according to the CPI.   Thus I have some new ideas about what CPI stands for…

• Cagey Price Index  (Price? What price?  Prices are relative.)
• Calming Price Index  (Nothing to see here. Relax. Inflation is under control.)
• Clairvoyant Price Index  (Far away someone is substituting chuck steak for Filet Mignon.  Meat is meat.  And prices are low.)
• Creative Price Index (2+2=3 for sufficiently small values of 2)
• Cowardly Price Index (Please don’t be mad, prices aren’t that bad… see?)

Of course CPI officially stands for Consumer Price Index.  Let just say that for the next 72 years the official CPI is 4%, but actually inflation is 5%.  That handy rule of 72 says that at 4%, one million dollars today will be worth $62,500 of buying power.  At 5% buying power is cut in half to $31, 250.  Of a long enough time a 1 percent difference in inflation is a big deal.

So what?  Well, the CPI is used for a lot of things such as government cost of living adjustments, tax bracket adjustments, Social Security benefit increases, and money paid on Treasury Inflation-Protected Securities, to name a few.

It’s bed time so I’ll cut to the chase.

1. One million dollars is not what it used to be, and is certain to be worth much less in the future.
2. To try to remain solvent (and avoid unpopular austerity measures) the US Government has a powerful incentive to under-report inflation.
3. Many investors and economists are beginning to believe that the CPI significantly under-reports inflation. Examples: “CPI Controversy”,  “Bill Gross says so”, “Forbes, pastries, and gold say so too”.

Thinking about Asset Allocation

In my blog post Financial Toolkit: Indexing the World I discussed 5 ETF building blocks for diversified investment portfolio construction.  In this financial blog post I’m going discuss a hypothetical investing situation:

Deborah is a 40-year-old woman with a $100,000 401K who just changed jobs.  She transferred her 401K to an IRA, and has $100,000 now sitting in cash.  Deborah’s new job pays $60K/year and she plans to contribute $10K/year to her new 401K.  How might she invest her IRA funds?

As a proponent of diversified index investing, I suggest the following category questions… What percent  1) Domestic vs. foreign?  2) Stock versus bond?

I put forward the suggestion that Deborah’s choices in regard to these two questions will predict 80-90% of the performance of her chosen portfolio.  (Don’t believe it, then read this asset allocation paper sometime when you are afflicted with insomnia.)

Let’s say Deborah decides that a 80/20 domestic versus foreign allocation, and 60/40 stock versus bond allocation are right for her.  Working out the math that’s $80,000 for US investments and $20,000 for foreign investments.  Applying the second stock vs bond ratio to each yields the following: $64,000 for US equities, $16,000 for US bonds, $12,000 for foreign equities, and $8,000 for foreign bonds.

The US part is pretty easy to achieve.  Plunk $64,000 in a low-cost, broad-market ETF (or mutual fund) like SCHB, and $16,000 into a total (aka aggregate) bond ETF like BND.  The foreign stock component is easy too; but $12,000 into VXUS.  Only the foreign bonds require two ETFs because there are no foreign total bond ETFs (to my knowledge); thus I suggest $4000 in a foreign government-bond ETF like IGOV and $4000 in a foreign corporate-bond ETF like IBND.

There you have it.  A simple example of asset allocation.

My personal opinion is that an initial asset allocation process can be very simple and effective.  Notice that I was able to avoid several secondary asset allocation measures such:

• Value vs Growth (stocks)
• Large-cap vs Small-cap (stocks)
• Sector allocation (stocks)
• Developed vs Emerging markets (stocks and bonds)
• Short-term vs Long-term (bonds)
• Average Maturity or Duration (bonds)
• Government vs Corporate (bonds)
• Investment-grade vs non-investment grade (bonds)
• Average credit rating (bonds)

All of these “secondary asset allocation factors” can be side-stepped by purchasing “total” stock and bond funds as outlined above.  Such total (or aggregate) ETFs seek to own a slice of the total, investable, market-cap-weighted investing universe.  Essentially, a total US stock fund seeks to own a piece of the whole US stock market.  Similarly with a total US bond fund, etc.

In summary, if you have a diversified, low-cost investment portfolio, the two biggest ratios to know are domestic/foreign and stock/bond.    [If you don’t have a diversified, low-cost investment portfolio you might want to think about changing your strategy and your financial adviser!]

Negotiating Financial Setbacks

We all face occasional financial setbacks.  One way to increase feeling of financial loss is to check your portfolio daily.  Since I have a private fund that I manage, I feel obliged to stay on top of it daily.  I’ve noticed that when the fund is up I feel modestly happy, but when it is down I feel doubly disappointed.

Sometimes various financial stresses come together at the same time.  Recently minor financial setbacks have converged for me:  modest potential issues with my rental business, and a few percentage points drop in my fund, and long hours at my day job.  Navigating these financial stresses involves 1) avoiding impulsive decisions, and 2) carefully considering available options.  For example part of me wants to sell the rental property in the next year or so, namely to avoid the occasional headaches of being a landlord and property manager.  Another thought is to contract with a property management company, who charges a fee, but helps manage some of the day-to-day property management duties.  Finally, I impulsively want to deleverage some of my investments.

I am approaching my latest bought of financial stress as I always do.  With contemplation and composure.  At least outwardly I am composed and seemingly unflappable.  Internally, I am stressed and a bit anxious.  This comes with the territory of managing a wide range of investments.   This occasional stress is one of the few things I dislike about finance and wealth management. Of course it too shall pass.

I simply wanted to share the fact that, at times, maintaining a financial course can be emotionally challenging.  I spend a lot of time talking about how successful investing can be easy… and in many ways it can be.  Creating a financial plan can be fairly simple, but sticking to it at times can be stressful and nerve wracking.  Financial discipline is worth it, and financial impulsiveness should be kept to a minimum.  That is what I intend to do; even when it is not so easy.

The Thrill is Gone, but the Love (of Finance) Remains

When I was born, my birthday gifts included US savings bonds ($50 dollar face value, I believe).  I’ve had a savings account since about age 7, and started reading brokerage account statements at around age 9.  My brokerage college fund started with $1000 and nicely grew to about $4000 by the time I started college at the tender age of 17.

Before the age of 10, I was enthralled by the concept of compound interest.   I was curious about the difference between monthly, weekly, daily, hourly, and by-the-second, even instantaneous compounding.  Little did I know at the time that this concept lead to the mathematical concepts of limits, calculus, and the number e, Euler’s  number.

Needless to say, I love math and finance.  But I first experienced a truly heart-pounding thrill when I started online trading sometime in the late 90’s.  I could see the bid and ask constantly moving, and tried limit orders.  The asks kept rising, and I kept inching up my bid.  Eventually my bid got hit and I was an owner of my first online stock.  This was different than buying mutual funds on the phone from Vanguard, and getting quarterly paper statements.  This was in real time and it was exciting.

I’ve read a lot about Peter Lynch, including his books, and I’ve learned some lessons good and bad.  The bad lesson, as I read his words, was “Don’t buy bonds unless they paying at least 8 or 10 percent.”  The good lessons were “Don’t buy what you don’t understand.” and “boring investments are good… boring names, unsexy, but solid investments are good.”

My next financial thrill revolved around options sales and purchases.  I even recall making a 20-option spread trade that was scary, but ended up netting me about $3000 in a very short time.

I have also has some thrill involving real-estate offers, counter-offers, counter-counter offers, and purchases.   Mostly, tension and anxiety are better descriptors than excitement.  Mild disappointment mostly describes failed attempted real-estate purchases.  Moderate to exuberant happiness describes my successful real-estate bids.

In the last year or two, my trades have not elicited an significant cardiac or endocrine event.   While almost always cerebral and well-considered, my trades have occasionally made my heart go pitter-patter and my endocrine system give me a pleasant rush.  But lately the trill is gone.  My pulse is steady and the motions are vaguely methodical and systematic.

My love of research, introspection, and contemplation remains.  Trading, for me, is just a means to an end.   Increasingly dispassionate.   In the end I hope and believe this makes me a better trader.  As always, time will tell.

Softball, Baseball, Gold and Taxes

I’ve been rather unmotivated to update this financial blog lately.  The reason?  Taxes!  I generally like to keep the tone of this blog upbeat, and when taxes are on my mind my tone tends to be closer to beat up.  Speaking of… my tax payment checks are going in the mail today.  My property tax checks will be going out next month.

However, baseball season is now underway, and that is good.  And my softball league will start up next month… one of the highlights of summer for me.  I wonder how much complicated MLB player’s taxes are and how many states they have to file in?  Also US military personnel.  If I made the rules, US soldiers would not have to pay single cent of tax on their wages while in combat tours.

Whoops, I’ve done it again!  Thinking about taxes and spoiling the prospect of a good mood.  So on to the topic of gold.  I can’t seem to go anywhere with out seeing or hearing either “We buy Gold!” or buy physical gold from us because someone thinks gold will go to $2000 per (troy) ounce.

If I had some gold trinkets or coins sitting a drawer somewhere — gold items that didn’t have any sentimental value to me — I’d get some local cash quotes, pick the highest, and sell.  But as for buying gold… nah… I’d rather buy index funds or black gold, in the form of ETFs XLE and/or VDE.  In fact I currently own XLE, VDE, SPY, VTI, SCHB to name a few.

Well, I’ve got to cut off this financial/baseball/gold/taxes blog post early, as I’ve got to run the dog to advance canine training class.  Best investing wishes, and may taxes not bite too deeply this year.

GE and We: A Tale of Income Tax

By most accounts I paid more federal income tax than GE for 2010.  Personally, I paid more in regular federal income tax than I did for my brand new car.   When you factor in social security tax, medicare tax, state tax, and property tax that is an additional $16,700 or so.  I probably paid about another $4200 in sales tax, gas tax, liquor tax, fees, tariffs,  assessments, regional assessments, urban renewal, licensing, and other government fees.  I’d bet I paid more (federal income) tax than GE, and I’d bet almost everyone reading this blog did too, but I’m even more sure that GE paid it’s accountants more than I did.  I wonder how many millions GE spent on accounting, preparing, and filling its 2010 return?

I don’t blame GE for taking advantage of the system… minimizing tax is one of the key responsibilities to its shareholders.  But I am troubled by the corporate tax system.  Why should GE pay 0.0% and IBM pay 24.8%?  Shouldn’t large U.S. corporations play by the same rules?  Shouldn’t the rules be more even across companies?  Who wrote these crazy rules?  Well, that last question is rhetorical, obviously!

I think a 35% base corporate income tax rate is way too high, but 0% (for GE) is way too low.  My opinion is that a 15-25% corporate tax is much more internationally competitive.  But even at 15%, GE’s 14.2 Billion USD profit should be taxed at a little bit more my than my way-way-way less than a million, barely-6-figure, USD income.