Cash for Clunkers - Not a Good Idea

Okay, everymen (and everywomen), it's time for a thought about government intervention:

So our spend-and-tax federal government has decided to continue to offer the "Cash for Clunkers" program, which effectively provides up to $4500 to those who will turn in their less-efficient vehicle and purchase a new, more fuel-efficient vehicle.

Don't fall into this trap! Unless you can afford to go and pay for the car up front, you'll end up doing what many participants of this program are doing: taking out an auto loan. Instead of driving that "clunker" - which in many cases is really a pretty good vehicle - that you've had paid off for years, you'll now saddle yourself down with an additional liability - a car payment. There are very few things in this world that this author despises more than a car payment. Not only does the vehicle depreciate with every mile that you drive it, but you also pay interest charges and other financing fees to drive the depreciating asset into the ground (sometimes literally!).

Couple of thoughts:

1. Most people are not going to get the benefit of $4,500. This would entail that your car was literally worthless. If your car was worth $3,000, they are NOT going to give you $3,000 + $4,500 for your car. No, you'll still only receive $4,500. So when you try to justify the purchase of a new car by telling yourself you're getting $7,500 or $4,500 off, don't fool yourself. You're really only getting $1,500 more than you would have had you traded your car in before this program. Is it really worth putting yourself into a position where you have monthly payments to drive a depreciating asset for a $1,500 break on the new car?

2. More directed at the government: say I was driving around a 1987 Caravan (I apologize if some car fanatic out there is saying "they weren't around then!" - I'm not sure when they were first produced, but that's not the point). And my neighbor, who is relatively better off than I am, is driving a 2000 Caravan. While I might be able to get $4,500 for my nearly worthless '87 Caravan, I can't afford to pay for a new car, even with the $4,500 'discount'. Now my neighbor: he can afford to go out and get that brand new car through the "Cash for Clunkers" program. What happens to that 2000 Caravan? It gets destroyed (by law, they must destroy the engine/tranny). Therefore, I'm still stuck driving an even less fuel-efficient vehicle, while a newer one is destroyed. Not only is it a waste, but it decreases the number of used vehicles available - driving the price of used vehicles higher - and giving less work to your local mechanic.

Does anyone else find it interesting that the government is running this program - and they are one of the largest shareholders in the industry? Go figure...

Dialing BACK on Equity Exposure?

I have to comment on this article, found on CNN's Personal Finance site.

The article talks about a "young" couple (38 and 41) that have recently married and are looking for guidance as to what to do with their portfolios. They have a goal of purchasing a new home together in 3 years and make a combined salary of $170,000 per year. So what's my complaint?

The financial planner in the article recommends that they reduce their equity exposure from 80% to 70% of their total portfolio.

WHY? Now if you were planning on doing this a year ago, that would have been a smart choice. However, what you're encouraging now is counter-productive. In essence, they'll need to sell at the bottom of the market cycle to reduce their exposure to equities. If they should be doing anything right, they should keep their exposure at the level they are at or even INCREASE their exposure. Why do I say this?

Equities are at relatively cheap levels. If you've stayed in this far, the WORST thing you can do is to sell. At $170,000/yr, with no kids, they should still be able to reach their goal of $50,000 for a down payment in 3 years time by investing their savings in an online savings account, such as ING Direct.

Disagree? Let me know.

First-Time Home Buyer Tax Credit: Positive?

Real estate professionals, home builders, owners, and many others hope that the new tax credit for first-time home buyers will spur on the housing market out of the state of doldrums it now finds itself in.

While a similar tax credit boosted the housing sector in the 1970’s, a key difference comes with this year’s $7,500 tax credit: it has to be repaid, which turns that credit into the likes of an interest-free loan that must be repaid over 15 years.

According to the National Association of Home Builders website, in order to receive the credit, the closing has to occur before July 1, 2009.

Sounds good, right? I’m not sold…

1) You still have to repay the “credit”. This could end up getting people in trouble if they stretch themselves thinner than they should. Also, many will claim that they did not know it had to be repaid and will likely spend it as such.
2) You don’t receive your “credit” until you file your taxes, unless you change your withholding in the current year (which will raise your take home pay).
3) How much impact will this really have? I don’t foresee home prices halting their decline. I’m going to be potentially in the market for my first home in the near future, but with prices continuing their descent, I’m content to wait for the bottom (even if I do miss the exact bottom by a few months, I don’t feel that we’re there yet). Even Alan Greenspan, the former Chairman of the Federal Reserve believes that we are nine months away from the bottom. Why would someone jump in now? If it turns around, they’ll be right there to jump in (remember, they don’t have houses to sell and can react fairly quickly to market changes).

What would make this work? The answer seems obvious: treat this as a true credit and not an interest-only loan. In other words, don’t require repayment. But is that really the remedy of best choice? To have the government involved in propping up artificially high prices rather than letting the market complete its correction? Not to mention, pumping more money into the economy without production breeds further inflation, does it not?

All in all, I see this tax “credit” as having very little impact and simply adding to the complexity and confusion of our tax code (which is why I believe in proposals to eliminate the income tax and simply go with a national sales tax – but that’s another post!).

So, Everyman, what does this mean to you and your common sense financial decisions? First of all, this whole meltdown should remind us that we shouldn’t overspend our means. People are foreclosing because they thought that if they stretched themselves out, the market would continue to climb and they’d be able to win their gamble by selling for a higher price and taking a profit. But obviously that didn’t work out so well. Instead, it left millions without the ability to pay for their mortgage. And while the government is doing its best to bail out those that were greedy with their money, you shouldn’t put yourself there in the first place.

Be smart with your money. If you can’t afford it, don’t buy it!

Not Everyone Minds Housing Prices Dropping!

Looking through some economic data, I came across what I thought was a very interesting graph (which you’ll see below). It shows that, while housing prices were on a torrid pace through much of the last decade, the percent of income that households are spending on housing is only barely above average since the data set began in 1975.


Because of the housing spike, I expected to see a much higher peak toward the end of this graph, as wages have in no meaningful way kept up with the intense uphill climb of housing prices (and thus, housing would make up a larger portion of household expenses). Why is this? I can think of a few reasons – 1. People couldn’t afford the homes in the first place. Once the introductory rates (i.e. ARMs or Interest-only loans) jumped, they bailed (while leaving the recorded sale price of the home at a record high). 2. More families are relying on dual-incomes. This, naturally, raises the median household income, even though the family is putting in many more hours to be able to afford that same house (instead of 40 hours per week, now it’s 80). My wife and I would like to be able to have one of us at home when we have young kids. But more and more people that we know have found that to be practically impossible.

Asset Allocation - What's That?

You may have had someone tell you, at some point or another, that 90% of the return on your investments comes from asset allocation. Asset allocation? What’s that?

Each investor has a different time frame, as well as a varying appetite for risk (and thus reward). Some people need their money in a few years, while others have decades to ride the markets. Some investors freak when they lose 5, 10, or 20%, while others ride on without being too phased by losses. While these investors have very different profiles, they all need one important strategy: asset allocation.

Asset allocation is, in Everyman’s terms, the way that you divide your investments between various categories of equities, fixed income products, and cash. Taking time horizon, risk tolerance, and other factors into consideration, this breakdown of funds can look very different from person to the next.

Example: Two investors with two very different asset allocations:
1. 23-year-old that understands that he’s in it for the long run and could almost not care less about short-term gains/losses.
2. 52-year-old that would like to retire next year, living off of her investment income, among other sources.

By diversifying their portfolios, each of these investors can buffer themselves against sever market fluctuations. However, the 23-year-old is still much more likely to have a higher risk profile – but will have at least 30 years to make up those losses. If the 52-year-old, however, had the same investments as the 23-year-old and lost 20% of the value of her portfolio, she may have to postpone retirement or live on less than she was expecting to be able to have available for her needs.

Reiterating, the two main determining factors in asset allocation are:
1. Time (horizon)
2. Tolerance (to risk)

If you have the time to make up your losses on some bad years, as well as the stomach to swallow those losses in the pursuit of larger gains, you’ll be more heavily invested in investments that have higher standard deviations of returns (but historically higher average returns as well).

Here is what their sample portfolios might consist of:

23-year-old – Aggressive Growth Portfolio
Category - % of Portfolio
International Equity - 25
Large Cap Value - 21
Large Cap Growth - 17
Mid Cap - 14
Small Cap - 12
REITs - 6
Emerging Market Equity - 5
Short-Term Bond - 0
Aggregate Bond - 0
Cash - 0
High Yield Bond - 0
International Bond - 0

As you can see, the entire portfolio is invested in equities. This would represent a very risky, yet potentially high-reward portfolio. This portfolio is likely to see both large gains and significant losses. Given a large number of years, however, it is likely to have a higher return than the next portfolio.

52-year-old – Conservative Income Portfolio
Category - % of Portfolio
Short-Term Bond - 35
Aggregate Bond - 25
Cash - 10
Large Cap Value - 8
High Yield Bond - 5
International Bond - 5
International Equity - 5
Large Cap Growth - 5
Mid Cap - 2
Small Cap - 0
Emerging Market Equity - 0
REITs - 0

This portfolio have very little exposure to the equity markets and is almost entirely in fixed income and cash. This makes sense, as both fixed income and cash have smaller standard deviations of their returns (and thus, are more predictable in determining what the return will be on the investment).

These two portfolios are more on the extreme edges of the spectrum. The majority of you will fall somewhere in between these two, with a balanced mix of equities, bonds, and cash. Generally, the closer you are to retirement (time horizon) and the more sensitive you are to short term losses (risk tolerance), the more you’ll be invested in bonds rather than equities.

Overtime, both of these two hypothetical investors will want to rebalance their investment portfolios to move them back to their original allocation percentages. This, in theory, also helps investors by forcing them to capture gains (if large cap growth did really well, it may now be at 25% of your holdings instead of the original 17%), as well as purchase securities when they are “cheap”(if small caps had an off year, you need to buy more to get it back up to its original allocation). This follows the basic (yet so psychologically difficult) premise of buying low and selling high. Too often, we tend to buy the “hot” option at the time, only to find out that we missed out on most of the growth and instead have most likely jumped on just before it comes back to normal (thus, a loss for you, Mr. Late to the Party!).

Smart investors use asset allocation strategies. So should you, the Everyman!

To find out what percentage of your money you should have in each category, try out a couple of these helpful tools online:
http://www.smartmoney.com/oneasset/
http://cgi.money.cnn.com/tools/assetallocwizard/assetallocwizard.html
http://www.money-zine.com/Calculators/Investment-Calculators/Asset-Allocation-Calculator/
http://www.nationwidefinancial.com/mm/pub/advice/assetAllocation/assetAllocation.html
http://www.rcu.org/java/AssetAllocator.phtml

Best Time of Day to Book Flights!

Ever wondered if you were really getting the best deal by using some of the online travel site to book your flight?

Just a short tip with this blog post, but it can be valuable!

The best times to book flights online are at 2PM, 4:30PM, and midnight. Why? Those are the most common times that the best deals will be uploaded to the travel sites.

What days should you look for flights? While there is always some debate about this, the consensus is that Wednesday is the best, followed by Tuesday. At all costs, avoid booking flights on the weekends! The demand increases (that's when many others also are booking their flights) and they will be charging more!

If you can, also schedule your departure for Saturday morning rather than Friday night. The airport will be much less crowder, the odds of cancellation are much smaller, and even if you do, you don't have to wait until the next day to get onto another flight.

What kind of tips do you have for airline travel? Leave comments below!

Save over $500 per year - Inflate Your Tires!

According to this page, the majority of cars are running on tires that are only filled to 80% of capacity. What does this mean to the Everyman?

Not only are under(or over) inflated tires a safety hazard, but they also are a hazard to your wallet! According to the referenced study (from the site link above), the typical 12,000 mile per year driver uses an extra 144 gallons each year due to under-inflated tires. 144 x $4.00 = more than $500 savings per year.

The beauty of this tip? It's free! While a few places may charge you to use their air tank (and if they do, you're bound to find enough change underneath your driver seat), the majority (at least here in Minnesota) offer compressed air for free.

In order to find out how much air you need to put into your tires, you'll need to locate the manufacturer's recommendations, which can be found on the outside of the tire. While it may be hard to see, you should find it in raised lettering outside of the hubcap area of your tire. The tire should indicate the recommended PSI, which is the pounds (of air) per square inch.

You'll also need to pick up a tire pressure gauge, which will tell you what the pressure is currently at in the tire (and also allow you to monitor your progress at increments while filling your tires to their correct PSI). This gauge shouldn't cost you more than a few bucks (I even found a digital one at Target a few months ago for about $10).

This simple way to save some money should provide you immediate results at a low (if not zero) cost. Go ahead and give it a try! (Hey, I can think of ways to spend $500 per year - on things other than gas!).