Hunting Happiness

The official definition of a recession is like the word “peruse”. People confidently misuse or incorrectly state the definition of both. Peruse means to read or study in great detail, not to “flip through” or “skim”. See Webster’s.com for confirmation. Similarly, a commonly-stated definition of recession is two or more consecutive quarters of real GDP decline. The National Bureau of Economic Research (NBER) officially declares recessions and their website says:

The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. For more information, see the latest announcement on how the NBER’s Business Cycle Dating Committee chooses turning points in the Economy and its latest memo, dated 07/17/03.

However, both recession and peruse are so commonly misused that the incorrect definition of both has become a de facto definition.

CNN Money has a running story with examples of how various individuals and families are being affected by the economic slow down. I keep a pretty steady watch on the foreclosures in our neck of the woods looking for good opportunities and I would say the pace is certainly holding steady if not inching up. Both of us have also seen the effects around us including substantial layoffs our day jobs. But I have to say that we have not seen any direct effect on our personal financial situation (knock on wood). We’ve noticed increased gas prices but the overall affect on our budget is negligible. We have fuel-efficient vehicles and have fairly short commute distances for our area. Even if gas or grocery prices were to double it would not be the end of the world for us. Unfortunately, many folks are not as fortunate.

Have you had to make any substantial adjustments to your life?

There is a post over on CNN.com fretting over an extended recession.

This quotation just about sums it up:

“What happened in the short space of the last five years was pretty scary — household debt rose to about 125% of income. It hadn’t ever been 100% before that. It took consumers a long time to get into these conditions; it’s going to take a long time to get that fixed,” Hampel said.

One side of me understands how folks could feel “irrational exuberance” and over spend. But, come on, spending 125% more than you make?  Sure, there will be some circumstances where that’s expected (e.g. someone in school), but as a national average?  This seems to be a delayed effect of the lack of personal finance literacy in this country.

Do you know how many people on Earth live on $1 per day?  One billion.   Approximately 20% of the world’s population.  So the next time we are complaining out loud or mentally about our income and expenses, think about that.  If you think your budget is tough now, try it with $30/mo.

Many of the personal finance books and blogs advocate getting a 15-year mortgage and avoiding 30-year ones like the plague. For disciplined households I do not think this is a cut-and-dried decision. Many sources simply quote the interest paid on each loan, completely ignoring the fact that the comparison is unfair since the longer loan payment is substantially lower. So to make it fair, the comparison needs to include extra prepayment on the longer loan to bring the total monthly payment equal to the shorter loan.

True, going with the 15-year will get you a lower interest rate and thus cut the total interest paid by a nice amount. But, it reduces a ton of flexibility and 15-30 years is a LONG time to give up flexibility.

Let’s look at an example. I also have included the detailed Excel I used so you can play with the numbers yourself. I am assuming a $200,000 home purchased with 20% down. The rate for 30 years is 6% fixed and for 15 years it is 5.5%. I am ignoring real estate taxes, insurance, and PMI since those should be equal. The 15 year will have a monthly PI (principle and interest) of $1,307 while the 30 year will be $959. Assume that with the 30-year loan we pay the $959 per month plus an extra $348 to bring the total to $1,307. The 30-year loan will be paid off in 16-17 years with a total interest cost of $94,936. The straight 15-year loan would have a total interest cost of $81,280.

So, the shorter loan does save us over $13,000 in interest. This is due entirely to the interest rate being a half point lower. That is a sum worth considering. However, with the shorter loan you are locked in to paying that $1,307 every month. If you lose your job, change careers, or have a child, you are still on the hook for that payment. On the other hand, if you opted for the longer loan but chose to still pay the 15-year monthly payment, you have the option to drop down to paying only the $959 a month, which is 27% less.

However, I do agree completely that it is critical not to overspend when purchasing a house. I agree that a good way to judge that is consider the 15-year payment. If that is not palatable, you probably need to look at a less expensive home.

And finally, those who play 100% by the numbers will tell you that the best option is to pay as little as possible each month (even to the extreme of using interest-only loans) and funnel all the extra money into a higher-yield longer-term vehicle like mutual funds. This is mathematically the best long term option, assuming current low interest rates and assuming the stock market 20-year average holds.

So what do we do? We have a thirty year mortgage and pay a little extra each month. The current track has the home paid off around 6 years early.

Get the Excel file here to tinker yourself.

Capital One has a new offer for online savings accounts that includes competitive rates plus points based on average balance.  With less than $10K, the rate is 2.75%, over $10K it jumps to a very competitive 3.75%.   In addition, you get one mile for each $20 of monthly average balance.  And if you start with a deposit of at least $500, you get 2500 bonus miles up front.

Sign up here

More details have become available about the Chevy Volt. The Volt is a gas-electric hybrid but it has several key distinctions from anything currently on the market. It is expected to have a 40 mile range without using any gas.

• It can plug into standard 110V household receptacle to charge its batteries
• While is does have a gasoline engine, it is not connected to the driveline.  Instead, its sole purpose is to run a generator to charge the batteries in the event the 40 mile range is exceeded.
• In current spec it uses Lithium Ion batteries

This is potentially a revolutionary shift in automobiles and the hybrid arena in particular. The theory is that most Americans drive less than 40 miles round trip to their jobs and could thus use gas only as a backup. According to the articles, a total range of about 600 miles is expected.

So could it save money? That is a little trickier to compute, especially because there’s a discrepancy in the article. I detail that below but let’s ignore that for now.

Let’s assume that your roundtrip commute is exactly 40 miles. This is a best case scenario for the Volt.

VOLT: In our part of the country, electricity is approximately 8 cents per kilowatt-hour (kWh). The battery is 16kW so a battery “fill-up” costs $1.28 in electricity. So it costs $1.28 per day to commute to and from work, or about 3.2 cents per mile.

Normal Car: Assume 25 MPG and regular gas is $3.50 per gallon. The roundtrip requires 1.6 gallons of gas which would cost $5.60. So it costs $5.60 per day to commute to and from work, or about 14 cents per mile.

Over the course of a year (assuming 240 commutes to/from work),  the Volt could save ~$1,000/year in gasoline expenses.

Even if you plug in a Toyota Prius getting 50 MPG, the Volt is still half the cost. Again this is an ideal situation for the Volt and assumes that it bears no other additional costs that a gasoline car would not.

Potential Issues

The article mentions the battery capacity is 16 kWh, but that it should charge in 6-6.5 hours.  The issue is that a standard US receptacle is 15A which can supply only 1.8kW per hour, assuming a perfect power factor correction (unlikely).  Even a not-unusual 20A would require 6.7 hours, again assuming an unlikely perfect power factor correction.  So either my power math is rusty, the battery capacity isn’t 16 kWh, or there’s some funny business going on with the charging time.  Perhaps it CAN use a 110V outlet, but the charging time mentioned assumes a 220/240V supply.   Who knows.

There is also the issue of the Volt’s use of Lithium Ion battery technology.  These typically pack twice of the energy density of NiMH batteries that Toyota and others use in their hybrids.  There is concern over the reliability of Li-ion and a propensity to fail catastrophically (ie explode).  Chevy is currently undergoing durability testing which could lead to delays or even a switch to older battery technology.

The original target date for market release was 2009 but it appears to be pushed back to 2010 now.

If and when the Volt becomes available, and if its specs are in line with those above, it could be a nice way to cut some costs and to help the environment.  Of course, some will argue that the power-plant production of electricity to charge the car is more harmful than the emissions from a traditional gasoline car but that is a whole other can of worms.

All our state and federal tax returns were completed and mailed on Monday the 14th.  We paid around $400 to have them prepared by a CPA but that was expected and well worth it.  Our taxes are fairly complicated as both of us have multiple sources of income including side businesses.  Our accountant gives us additional reports breaking down income types and amounts, and the same with expenses.  It also gives comparisons of this year versus previous years in a number of categories.  We also review our 1040 and sundry other forms in detail.  In this way I feel we don’t lose any visibility into our financial situation that might otherwise happen because we outsource tax preparation.

Now the “bad” news.  We ended up writing checks to various governmental arms for nearly $10K.  Fortunately we had saved a large chunk for this occasion so it wasn’t a problem but it will still be very depressing to see a hit to our net worth at the end of April.   As I mentioned in our March net worth update, the dip in net worth will be due to factors including income tax payments and additional business-related expenses.

The vast majority of our income had at least some tax withheld.   However, I lean toward under withholding because I don’t like loaning the government money at 0% interest.  We also take every other measure available to reduce taxable income including maxing out retirement options.  Did anyone out there write a bigger check than us?  What were the factors that led to it?

CNNMoney is running a story headlining “Foreclosures jump 57% in March”.  The 57% jump is compared to last March.  Foreclosure rate versus Feb’08 is unchanged.

One interesting fact is that while the number of repossessed homes has gone up 129% versus last year, the number of foreclosed homes going to auction increased by only 32%.  RealtyTrac says this is because more homeowners are just walking away after a default event.  In that case, the bank takes the title immediately.  In a foreclosure proceeding, the home goes up for public auction (often a “sheriff’s auction”), and if it doesn’t sell then the title goes to the bank.

It may also be a less stressful and negative experience for the homeowner to walk away versus being forcibly evicted.  At least under the former circumstance it may feel like the homeowner is leaving on his/her own terms.

They also have a linked article that talks about the pros and cons of options if one is in over his head.  This has some interesting info and tips, particularly if any readers are in such a situation.  One that surprises me is:

Credit scores are hurt much more by missing multiple payments - on credit cards, cars and so on - than by a single foreclosure.

I would not have thought that a couple missing payments on smaller balances would be worse than one foreclosure.  They also mention that the typical minimum time to be considered for a loan after a bankruptcy is three years, versus two or less for simply walking away.  And finally, due to the Debt Relief Act of 2007, if a bank sold a foreclosed property at a loss, the borrower no longer has to pay tax on the difference.

The conspiracy-theorist side of me wonders if all this big media push to simply “walk away” versus grind out through the process is self-serving.  After all, if a borrower/owner simply walks away, the lender gets title immediately and doesn’t have to go through civil court.  This has to save a lot of time, money and aggravation for them.   Not to mention that if the owner walks away he is probably less likely to trash the property to spite the bank.

There is another trend emerging, which I think reflects the increasing attitude of extreme selfishness and lack of responsibility.  Some homeowners in areas with substantially decreased home values are buying another similar home in the same area (now at a much lower price than their current home) and walking away from their current one.   Folks who still can afford their current payments are doing this!  They take a serious ding to their credit, but that ding comes AFTER they purchase the new home and therefore wouldn’t affect their ability to get the loan on the new property.  Obviously they would have to find a way to qualify for both mortgages, although there are ways around that, too.  In effect they are trading say a $100-200K reduction in their mortgage balance for damaged credit.

Net Worth Update March 2008

This is the first net worth update and reflects the end of Dec’07 versus the end of Mar’08. Going forward I will publish it on a monthly basis and add in a comparison of current month to last month. The last couple and the next couple months may show a flat or even dipping net worth. We are paying off some business expenses and loans, as well as what is looking to be a nice hefty $7-8K tax bill in April.

The credit card category has a high balance intentionally and is 0% APR for 18 months. It is being used for a combination of arbitrage and as a short-term 0% business loan. Our cash on hand is well over $100K and covers this card.

My active 401(k) is going up quickly as expected. I am currently contributing substantially more per month than the ~$1,300 required to hit the $15,500 maximum. SomeGal currently cannot contibrute to a 401(k). Look for separate posts on both these topics in the near future.

I have conservatively estimated the value of Rental Property 1 increasing to $140,000 based on substantial repairs and improvements and from comparable solds in the area.

The current issue of The Economist has an interesting article about financial literacy, and the lack thereof. It starts off with a great quotation from John Bryant.

Everybody wants it. Nobody understands it. Money is the great taboo. People just won’t talk about it

He goes on to say that the subprime mortgage mess is a perfect example. Subtract greed as the catalyst and the root cause is massive financial illiteracy.

Some interesting facts from the article:

• In Q4 of 2007, subprime ARMs were more than 40% of the foreclosures but only represented 7% of the total mortgage space.
• 40% of American credit card holders pay less than the full amount due every month on their main card
• Almost 33% do not know what their interest rate is
• More than 50% of Americans felt they had learned “not too much” or “nothing at all” in school about personal finance
• 75% of junior or senior high school students didn’t know that income tax has to be paid on interest earned in a savings or money market account
• 60% didn’t know the difference between a company pension, a 401(k), and Social Security
• 25% of Britons do not know their pensions are invested in the stock market

Attempts at education in high school have generally failed. The only one with much success is the stock market investing game most of us are probably familiar with. The game emphasizes high risk behavior due to the short-term nature of the game. This further enforces the widely-perpetrated mentality of instant gratification and is therefore self defeating in the bigger picture.

I certainly did not learn anything in school about personal finance and probably wouldn’t have correctly answered many or most of the questions mentioned above. And I graduated near the top of my class from a highly-regarded school. I can’t imagine those who had substantially less fortunate educations.

Another camp in the personal finance debate argues that, although depressing, the likelihood of sufficiently educating the majority of students/people is just about nil. Instead, they argue, the focus should be on making it easier through “sensible default options”.

One example is automatically enrolling employees in 401(k) programs and forcing them to actively opt out instead of opt in. Further steps would be to automatically select an asset allocation appropriate to the person’s age, and perhaps reallocate every few years automatically.

Another example given was credit card requirements. What if credit card companies were required to give their customers a file every year detailing the methods use to determine charges, and what those actual charges were. The thought is that numerous websites, probably many like this and other personal finance bloggers, would quickly respond. A consumer could upload his or her file and the website could read that data and then suggest the best card for him or her. This would also increase competition between the various card issuers and further benefit consumers.

So what do you think? Is it better to educate people on the existing system that is fairly complicated, or better to change the system to be more simple? Personally I think a mixture of both should be done. I think schools can and should do a LOT more to teach specifics of personal finance, and I think parents need to do a lot more to teach the key higher-level principles like patience and telling good deals from scams.

Also, how much personal finance education did you receive, and from where? Post in comments!