This blog contains some simple tips and advice from two regular guys. We're not accountants, financial advisors, or brokers, so follow, ignore, or discuss our ideas as you see fit.

Friday, October 31, 2008

Topic Revisited: Mortage Backed Securities

Posted By Paul

Considering the recent economic times I thought it would be a good exercise to revisit some of the earlier Frugalize posts regarding various investment vehicles. My goal is to look at the post and see if the information in it is still accurate considering the very different economic landscape from just a short year ago.

I thought I would start with the posting about:

Mortgage Backed Securities

If you've read the earlier post, one specific item I mentioned was:

One problem is what if Joe B can't pay his mortgage? Well you have the house as collateral so that helps, and of course in a real MBS you are just one small part of a large conglomeration of mortgages so the risk of any one person defaulting on their loan is diluted."

This statement seems especially interesting in current times.

When I wrote the first article I found my information by doing some simple research on google. I did a similar thing today and an article on riskglossary.com had a very interesting paragraph that specifically mentioned how MBS were behaving in the last 8 years:

"Starting in the early 2000s, private label MBS were increasingly issued with little or no credit enhancement and on pools of risky sub-prime mortgages. For the first time, MBS posed significant credit risk. Because credit risk made these instruments fundamentally different from earlier mortgage pass-throughs, many market participants avoided calling them MBS, preferring to label them asset-backed securities instead. Volume in these risky instruments grew rapidly until 2007, when defaults accelerated and the market values of the instruments plunged. This caused a liquidity crisis that spilled into other segments of the capital markets. A number of hedge funds with leveraged exposures to sub-prime mortgages folded."

(for the full article that this came from click here)

It seems that the risk level of MBS were in some cases much higher than people suspected. I never invested in MBS but it would seem that people who did would have had a very rough time in the last year. I guess it just goes to show you that one year can make a big difference in the perceived risk of a particular investment.

If anyone out there has experienced the MBS roller-coaster first hand I would be very interested in hearing about it.

Wednesday, October 22, 2008

Where the rubber meets the road

Posted by Matt

I just had new tires put on my car and thought I would share the details of my shopping experience, which was much more complicated than I initially expected. Before I get into that, however, I wanted to point out that maintaining your tires properly prolongs their lifespan, which is the easiest way to save money on them. I have recurring reminders on my google calendar to check my tire pressure monthly (see the box on "Tire Inflation" here) and get the tires rotated and brakes inspected (annually, which corresponds to every 7500 miles) at my favorite local shop.

The shop mechanic who last rotated my tires was the person who actually recommended new tires, but I didn't take his word for it. I checked the wear bars and also used the coin tests. My tires hadn't worn perfectly evenly, but they were close and one of them definitely needed replacing.

So, I went back to the tire shop and they gave me a list showing tires from their inventory that were compatible with my car.

I ask whether any of the tires on the list were designated as "low rolling resistance" tires, as I had heard that this could save money by improving gas mileage, but the clerk didn't seem to know anything about this. I also asked about the age of their inventory, but was reassured that the shop sold enough tires that they didn't have a problem with tires aging on the shelf.

The list of available tires was short, but unfortunately, I wasn't quite sure how to comparison shop. I found a very helpful article on HowStuffWorks that helped me interpret the sidewall codes used by the tire industry to categorize their tires.

Here's an example from my shopping list: P195/60R15 87T M+S
P - Type of tire (passenger)
195 - width of the tire across the tread in millimeters
60 - Aspect ratio of the sidewall compared to the width
R - Radial construction
15 - Diameter of the rim in inches
87 - Tire's load rating
T - Tire's speed rating
M+S - Mud+Snow, meaning the tire is suitable for all-season driving

All of the codes my shopping list were similar (because they primarily describe sizing) but I noticed one important variable: the speed rating. The "T" in the code for these tires means that they are rated as safe to drive up to 118mph. The other tires on my shopping list were rated "H", meaning they were safe up to 130mph. This didn't really concern me, as I don't plan on driving anywhere near 118mph, much less 130, but the shop told me that the T-rated tires would last for 70k miles, whereas the H-rated tire sets would last between 40k and 50k miles. The explanation from About.com:

The faster a tire can go, the softer the rubber compound they use to make it (softer rubber grips dry pavement better), so the tire will wear out faster than a "slower" rated tire.
The T-rated tires were priced a little higher, but only until I made the comparison fair by computing how many dollars it would cost me per mile of service life:
Warranty (Miles)PriceMiles per dollar

Based on this, the high mileage tire looks like a great deal. This is just what the shop clerk told me, but I'm always skeptical of the sales pitch, of course. I also worried that I would sell the car before going another 70,000 miles (which equates to about ten years of driving for me) but decided to gamble. Who knows how long I'll have to wait for an affordable electric car?

Next, I decided I should check online prices, but I didn't find any cheaper deals, especially considering that I would have to pay for shipping (around $50) and then pay to have the tires mounted/balanced/installed.

The tire shop also wanted to sell me siping for an additional $50, but I declined based mostly on a Consumer Reports article indicating that siping was most helpful in snow and ice conditions, which I don't encounter often.

The only real bad news in this story is that the quotes that the clerk initially offered me had expired by the time I had finished doing all of this analysis! Luckily, it was very simple to apply the lessons learned to pick from their current inventory list and I'm satisfied that I still found a good deal. Barring any advances in tire technology in the next 10 years (what are the odds?), I should be well prepared for the next set, too.

Sunday, October 19, 2008

Is Your Money Where It Should Be?

Posted By Paul

If I can find any silver lining in the current crazy economic times it is the fact that it has provided me with a reminder that I need to be careful about where my money is.

Here are some examples I've been hearing about where people learned lessons by the current fall in the market:

1) I have friends who were hoping to retire soon, but their nest egg was in very aggressive funds. When the stock market dropped, their nest egg shrunk, so now they need to postpone retirement until they can afford it.

2) I have other friends who have a 529 college savings plan for their child. Their child will be off to college soon so they were surprised when their college savings shrunk dramatically right when they were hoping to use it.

3) As I have mentioned in earlier posts, I keep part of my "rainy day fund" in what I view as pretty conservative stocks. Though conservative, these equities are still part of the stock market and they have not been immune to the recent drops.

It's one thing to fill out questionnaires about 'risk tolerance' and quite another to actually watch your investment shrink day after day.

So here are some things that I've been looking at as I do a risk tolerance gut-check for my investments.

1) For retirement funds, I'm where I should be. Sure it's hard to watch the balance of my retirement accounts fall, but I am going to try to keep in mind that it's not like I have plans to access that money any time soon. I need to think long term. One way to make sure that your investments match your retirement timeline is to use a target date retirement fund. Another choice is to periodically view and re-evaluate where your money is relative to your retirement timeline.

2) As a new father I've been looking into 529 savings plans. I noticed that the 529 plan that I'm looking into has a target date fund as well. You give it the expected years until college and it transitions the contents of the funds to less aggressive investments as the years go by. I plan on trying this as a way to make sure that my risk tapers off as we get closer to the time where we'll need the money.

3) There was a great comment on a previous post: Economic Chaos: So Now What? The comment was that it wasn't a very good idea to count securities as part of my rainy day fund. I can't argue with the sense that the whole point of a rainy day fund is to have money available at a moment's notice when you need it, which means that you should have it in a very low risk investment. So I'm going to stop viewing my stocks as part of my rainy day fund, and instead I'm going to work on increasing my rainy day fund by adding to my savings account and CD's. I'm going to keep my stocks because they are still doing fine for me, I'm just not going to count them as part of my rainy day fund.

So hopefully no one out there has been burned too badly by the stock market drop, but if nothing else this drop has been a great object lesson on making sure that your investments REALLY match your risk tolerance.

Thursday, October 16, 2008

Insurance Agents and Financial Advisers: Getting Dinner From the Vending Machine

Posted By Paul

I used to have a job where I traveled a lot, and sometimes I wouldn't get to my hotel until 2AM local time. I'd usually show up tired, but also hungry, hoping to find someplace that served dinner.

I remember once where I found myself standing in front of the hotel vending machine with a stack of coins, trying to make a dinner out of what was offered.

I'm sure we'd all agree that a pack of peanut butter crackers, a couple of cookies, and an orange soda is a very poor dinner, but it was the best I could get from the machine. I was back in my hotel room munching away and looking out the window when I saw a Denny's practically next door to the hotel that I hadn't noticed when I came in. I ditched my vending machine meal and dashed to the diner where a club sandwich awaited.

This situation made me think of insurance agents and financial advisers. Sometimes people have experiences where they feel like their adviser or agent has been dishonest or is trying to swindle them out of a few bucks. I think that more often than not it's just that expecting to get the best deal for you out of your agent or adviser is like trying to get dinner from a vending machine.

After all, let's say that you can save some money on your car insurance by increasing your deductibles. It's not fair to expect your insurance agent to suggest that. After all, they're just trying to provide you coverage based on the products they have to offer. If the monthly savings versus the potential risk of paying a higher deductible is the better choice for you, then YOU need to make that decision.

Life insurance is also a great example. If it were free, then the more life insurance the better, and , your agent will almost certainly offer you a large amount of coverage. Your agent doesn't know at what point the cost outweighs the benefit to you. That decision has to be made by you.

The best example though are financial advisers. They generally represent a specific brokerage company and if you tell them you are interested in a Large Cap Value fund (or if they recommend that you invest in one) then they certainly have one (and often only one) to offer you. They of course offer you the one that they have, it's up to YOU to consider if that fund is worth it versus other options.

My point is that far too often people expect their insurance agents and financial advisers to do what's best for them, and I think that in general most insurance agents and financial advisers try to do just that. The key point is that you can't expect your agent or adviser to comparison shop for you, or try to weigh costs versus benefits for you. Just like a vending machine, they have a specific set of products that they can offer you. They may not be aware of your overall financial situation or your risk vs. cost preferences, you need to decide that for yourself.

By taking an active role in insurance and financial decisions your agent or adviser can be a
great benefit to you. However if you end up following their guidance blindly you may find yourself doing the financial equivalent of getting dinner from a vending machine when there's a Denny's across the street.

Friday, October 10, 2008

Article: The Perfect Mark

Posted By Paul

This article might not be within the subject of this blog, but I found it so interesting that I decided to post it:

The Perfect Mark

An amazing story of a person who fell for a 419 scheme (a.k.a advance fee fraud), and how it resulted in financial losses and criminal prosecution.

It does a great job of describing how this person fell victim to the scam. How the scammers kept asking for "one final fee" and how the more money he gave the less willing he was to just walk away from the scam.

Perhaps a good lesson in these crazy economic times to be cautious of any deal that looks too good to be true.

Tuesday, October 7, 2008

Economic Chaos: So Now What?

Posted By Paul

I'm sure I don't have to tell all of you about the crazy things going on in the economy right now.

The stock market is going crazy, mutual funds are all over the place (mostly down). I had one of my funds drop nearly 8% in one day! That is a tough thing to see and not do something!

So I keep trying to think of something useful to put in this blog to address this. So here is my best two-bit opinion of what's going on:

1) The economy in general is in a crazy time.
2) No one knows how long it will last (least of all me).

So based on those two facts here is my plan for dealing with the current landscape:

1) I'm not going to make a run on the banks. Currently my money is in financial institutions that seem stable, so I'm not going to rush out and try to take all my money out in cash.

2) I'm not going to dash out of the stock market. I COULD take everything I have invested in mutual funds through my 401k and sell them all immediately. The problem with this is that I'd be selling my funds at a low based on what is hopefully a short term situation (see my earlier post Article: Don't let the crisis spook your 401k).

3) I'm going to try to view this as an opportunity. Warren Buffet is a big believer in the idea that when the market is down its a great time to buy stuff (since everything is cheap). Of course this assumes that the market eventually recovers, but this is the risk inherent in the stock market. I'm going to try to view the stock market with this attitude.

4) I'm going to make sure that my investments are where I want them to be. If there's a bright side to this crisis, it's a great reminder that you should make sure your money in where it should be based on your plans for accessing it. For example...I have most of my rainy day fund in low-risk savings bonds, CD's, and savings accounts. Since this is money that I might need to access at any time, I don't want it in anything high risk. Part of my rainy day fund (about 15%) is also invested in the stock market, in what I consider to be some pretty conservative stocks. This for me is just fine. In all of this turmoil 85% of my rainy day fund continues to collect it's small but no-risk interest. The other 15% still fluctuates, but the fluctuations are small enough that I can live with it. Also with my retirement funds I need to remember that I don't plan on touching this money for decades so I shouldn't worry too much about market fluctuations. Yes, things are going crazy now, but I REALLY hope that in 20 years it's all an unpleasant memory.

5) I'm going to try to beef up my rainy day fund. Even though the value of my rainy day fund is pretty stable, I'm hoping to add a little more to it for a while, just for my own peace of mind.

Not the most dramatic plan. Essentially I plan to bulk up the savings if I can, but I will continue to invest in my 401k in anticipation of a stock market rebound.

How are other people out there dealing with the craziness?

Monday, October 6, 2008

Article: 7 'psycho' money traps and how to beat them

Posted By Paul

I love articles about the psychology of money and spending, so I found this article:

7 'psycho' money traps and how to beat them

very interesting.

I especially liked The lure of free' and the suggestion that you use the word 'free' as a warning to slow down and make your decision carefully.

The Bailout And My Second Podcast Recommendation

Posted By Paul

If anyone read my earlier post:

The Housing Crisis And My First Podcast Recommendation

Well this week there is a new podcast that is also really interesting.

It's called:

Another Frightening Show About the Economy

I have listened to part of it, and it was really interesting. I tried listening to it all, but since the material they talk about is pretty complicated I found that I couldn't work and listen to it at the same time, so the rest of the podcast will have to wait for later.

From even listening to half of it, I discovered that there are whole words of finance that I am unaware of. If nothing else, I recommended listening to the section that is 20 minutes into the podcast which talks about "Credit Default Swaps". I had never heard of this before, but this podcast in 10 minutes explained it in such a way that I felt like I understood it and I was generally freaked out about the fact that this sort of thing is going on throughout the financial world.

I wanted to post about this ASAP since currently you can download the podcast for free.

Saturday, October 4, 2008

Article: Retirement Planning For Mom and Dad

Posted By Paul

An interesting article on the often touchy subject of dealing with the retirement status of your parents:

Retirement planning for mom and dad.