Emergency fund

As you might imagine, I talk to a lot of people about what they’re doing with their investments.  One of the things I hear a lot is, “I’d like to start investing, but before I do that, I need to build up my emergency fund.”  That sounds pretty prudent.  You don’t want to get caught in the lurch when life throws a curve ball at you.  Yet, I actually think this is a really bad move.  I freely admit that the Fox family does not have an emergency fund.  We have investments, and if the unforeseen happens that’s what we’ll use.


How likely is an emergency?

What are the types of things that you’d use an emergency fund for?  Almost by definition, an emergency is something that is unpredictable and somewhat rare.  If your 12-year-old Honda Civic is starting to die and you know in the next couple years you need to get a new one, that isn’t really an emergency as much as something you need to budget for (that was the exact circumstance of the Fox family a few years back).  If you’re having an “emergency” every year, either you’re the unluckiest of people, or probably  more likely you just have a lifestyle that needs to be budgeted a little differently.

When I think of things that you’d spend an emergency fund on it’s stuff like: your hot water heater gives out, you’re 7-year car gets totaled and insurance only gives you $6000 to get a new one, your son goes into the NICU for four days because of croup and your portion of the bill is $4000 (as happened with Lil’ Fox last year), or you are fired from your job.

As I was writing this post, I asked Foxy Lady if she could remember any emergencies that we have faced since we were married 7 years ago.  The hospital thing with Lil’ Fox was the only one we came up with.  There were smaller things like when we had to replace the dishwasher ($500) or fix the clothes dryer ($400), or fly back to Michigan for a funeral ($400), but the hospital thing was the only major one (I’m defining “major” as more than $1000).  So that means we have averaged one emergency every several years.  Once every several years—I don’t know if we’re more or less prone to emergencies than the general population, but that seems about right.

So be a little more cautious and use once every five years as an average—you have about a 20% chance in any given year of needing to tap into your emergency fund.  We’ll use that in a second.


How likely is it you’ll make money in the stock market?

Obviously we put a huge caveat on this, but we can look at historical performance to get a sense for how likely it is that you’ll make money or lose money if you invest your emergency fund in stocks.  Actually, we kind of did this in a post a while back.

Remember that historically, if you have a one-year investment time horizon, you make money with stocks about 70% of the time.  That is actually pretty good odds that investing your emergency fund in stocks would have you come out ahead, just looking at it for one year.  In fact, we can do the math, and the chances of you having an emergency in a given year and losing money in the market are about 6% (20% chance you’ll have an emergency x 30% chance you’ll lose money in the market that year).

But remember, emergencies don’t happen every year—they tend to be much less frequent than that.  For the Fox family, they happen on average once every five years.  Just for the fun of it I put a table together that estimated the chances of having an emergency if you assume in any given years there’s a 20% chance of having one.  Also, I looked at the historic data to see the probability that you would have lost money in the market over different time horizons.

Time horizon Chance of an emergency Chance of losing money in stock market* Chance of emergency and losing money
1 year 20% 28% 6%
2 years 36% 24% 9%
3 years 49% 18% 9%
5 years 67% 13% 9%
10 years 89% 3% 3%


As we mentioned above, there’s a 6% chance that in any given year you would need to tap your emergency fund when the market was down.  Looking at other time frames you get similar results.  Pretty much any time frame has a less than 10% chance of you needing that emergency money at a time that you would have lost money in the market*.  You need to decide if you’re willing to take that risk, but to me that seems like a no-brainer.  If I have a 90%+ chance of coming out ahead on something, I’m doing it.

You can see where I’m going with this.  First, emergencies don’t happen all that often (if they do, you probably need to come up with another name for them other than “emergency”).  Second, if you give yourself a few years in the stock market, the probability of losing money goes down a lot (of course, it never goes to zero).  That seems like a perfect combination for investing your emergency fund the same way you invest any of your other money.  $10,000 invested in stocks with an average return of 6% would give you about $13,300 after five years; keeping that same amount if your savings account at today’s interest rates would give you about $10,050.  Seriously, that’s ridiculous.

I get that many people look at that and say, “the whole point of an emergency fund is you never know when you’ll need it, so don’t put the money somewhere where you might lose it.”  That’s a very understandable concern, but it’s also where a lot of people are leaving a ton of money on the table.  Over the past 150 years, investing in stocks has a really good track record, and the more time you give it, the better that track record becomes.  You’ll never eliminate all the risk from investing, whether it’s your 401k or US bonds or the cash in your checking account, there will always be some type of risk.

It’s the successful investors who understand that risk and understand how to decrease the risk (expanding that time horizon to five years cuts in half the likelihood of losing money), that are able to get the most bang for their buck.  This is definitely one of those areas where you can get a 1% coupon.


The Fox family eats on our cooking on this one.  We don’t have an emergency fund.  When emergencies do happen like with Lil’ Fox, we pay for it out of our investments, absolutely believing that over our lifetimes there may be one or two instances where we lose money but there will be many, many more where we come out ahead.


Let me know what you think.  Do you have an emergency fund?  Do you think I’m crazy not to have one?

*I used the same methodology for this table that I did for my post “Will you lose money with stocks?”

North Korea not a problem, so says the market

A few days ago, a client called me a bit freaked out.  He wanted to sell out of stocks because of fears that the issue with North Korea could escalate into something terrible, possibly World War III.  Of course I told him to sit tight, because even in the darkest times stocks tend to do well over the long term.

Even so, what makes me so confident that the problems with North Korea won’t lead to a global catastrophe?  Simply put . . . THE MARKET TOLD ME SO.


The stakes are very high

Certainly, the stakes with North Korea are very high.  If things went bad, the outcomes could range from the Korean peninsula being destroyed to a nuclear war enveloping the globe.

If armed conflict broke out, almost assuredly North Korea would attack South Korea and particularly Seoul with a deadly barrage of artillery.  The human cost would be immense.  Also the damage to companies and their property would be vast.  That doesn’t seem important when compared to all the lives that would be lost, but more on that in a minute.

If the conflict spread, Japan would probably be the next victim of North Korea before the US and its allies took control.  Then the two absolute worst case scenarios would be a) North Korea realizing its nuclear-tipped ICBM dream and hitting the US mainland or b) China and Russia being drawn into a war against the US.  Those last two scenarios would lead to unparalleled loss of life and destruction of company property.


Destruction is bad for the stock market

Why do I keep saying “destruction of company property?”  That seems to pale in importance compared to the thousands or millions of lives that could be lost with the doomsday scenarios we’re talking about.

If war broke out a lot of company property, plant, and equipment would be destroyed.  Also a lot of company employees would be killed.  Potentially, if we went to a wartime economy like in World War II, companies would stop making cars and phones and shirts, and start making fighter jets, military gadgets, and uniforms.

All those things would be horrible for the companies’ profitability and therefore their stock price.  Here’s the punchline—if war broke out, that would be terrible for the world’s stock markets overall.  That terribleness would be most acute where the fighting was taking place.


The stock market is pretty smart

There has been a lot of academic study of the wisdom of groups over the individual.  I took a class with Nick Epley at the University of Chicago that looked into this, and that’s one of the lessons that has really stuck with me over the years.  The idea is that if you have a bunch of people with a bunch of different opinions, the “average” opinion is going to turn out to be more right than most of the individual opinions.

Where is the biggest, most organized collection of opinions? In the stock market.  It is fundamentally people with opinions (will things be good and stocks go up, or will things be bad and stocks go down?) betting against each other.  The result of all the bets results in the general movement of the stock market.  If more people bet good things will happen, stocks go up.  If more people bet bad things will happen, stocks go down.

Stock markets have a lot more credibility than talking heads because the former involves people putting their money where their mouth is.  It’s easy to say you are certain that something is going to happen; it’s another bet your money that something is going to happen.  That’s why the stock market tends to get it right, because greedy people who want to make more money are betting.

With regard to the Korean conflict, it’s easy for guests on news channels to say how bad that nuclear test is or how much closer that missile launch puts us to war.  But are those concerns credible?  Does the talking head or the new network really believe that, or is it just a flamboyant statement meant to capture viewer’s interest?


Divining the markets’ message

We’ve talked about geopolitics and stock markets and the destructive potential of a war with North Korea.  Let’s bring it all together.

If war breaks out, a lot of destruction will occur, and that will be horrible for the stock market.  That’s particularly true as you get closer to the epicenter—things will be worse for South Korean stocks since they’ll be the first victims of the war, probably followed by Japan, and then the rest of the world.

If things were REALLY bad, you should see that reflected in the stock markets, yet it isn’t.  If you compare the S&P 500 and a broad Pacific Index (Japan, South Korea, Australia, etc.) and a South Korean stock index, none show signs that a horrible event is going to happen.  In fact, of those three, the South Korean index has VASTLY outperformed the other two.  So much for a real concern that unparalleled destruction is imminent.

That’s not to say there haven’t been reactions.  In the beginning of July (point A) North Korea tested a long-range missile.  South Korean and Pacific markets reacted a little (about 1-2%) and US markets were unfazed.

Later in the month, North Korea tested a second missile that put Guam within range (point B).  Again, there was a reaction from the markets, this time larger and this time the US markets also reacted.

Finally, at the beginning of September, North Korea tested its largest nuclear device yet (point C).  Again, all three markets reacted.

So what does it all mean?  The market did react downward every time one of these tests occurred which means that more people (or more accurately more money) think there is something to be worried about.  However, the shallowness of the dips show that the bad things that “are likely to happen” really aren’t that bad and are more than offset by the good things going on with companies, profits, employment, etc.

Particularly interesting is the South Korean stock market.  If conflict did break out, they would be on the front line and they would suffer the most devastation.  Their reaction to North Korea’s developments are the largest which makes sense.  But like the rest of the world, the South Korean stock market quickly shrugs off the threat and moves on.  As I mentioned earlier, the South Korean stock market has done really well this year, which must mean that they don’t view the threat of war to be that likely.


I hope this gives you comfort; it does to me.  It’s not hard to get wrapped up in all this crap.  Trump and Kim Jong Un certainly don’t make things calmer, and those missile tests keep flying longer and longer distances.  When someone gets on CNN saying we are on the doorstep of Armageddon, it’s easy to believe it, but I think those people are full of crap.

The stock market has a powerful collective wisdom that has a really good track record of being right when individuals are dead wrong.  I think looking at how the stock market has reacted to all of this, and particularly how the South Korean stock market has, should give us all some comfort.


How to invest a windfall

This is a first-world problem for sure, but many of us at one point or another will get large amount of money all at once.  We know from asset allocation that we should invest it in stocks, but the questions becomes one of timing.  Maybe it’s an insurance payout, a tax refund in April, a bonus check, or a bunch of cash you’ve accumulated in your checking account.  In fact, when I was still working at Medtronic every July the Fox family would face this exact scenario when I get my bonus check.  Let me tell you my thoughts on the matter (which of course is not an expert opinion, and which looks at historical price movements but makes no prediction on future stock movements).

When I would get my bonus, and what I would have suggested, is to take the big chunk of money and invest it in equal pieces over a couple months.  Vanguard and most places will let you set up an automatic investment, so in the words of Ron Popeil “you can set it and forget it.”  So let’s imagine someone would invest equal amounts each week for the next 10 weeks.   Why do I do it this way?  Because I’m a spaz.

If I invested all the money at once, I would be totally freaked out that I would buy at the wrong time—either I would buy the day after stocks went up 1% or I would buy the day before stocks dropped 1%.  Using simple scenario of $10,000 to invest, that would mean I could “lose” $100 by investing at the wrong time.  That would totally tie me up in knots and I would be looking at the stock market trying to find the exact right time to jump in, like a kid on the playground playing jump-rope.  Of course we know from A Random Walk Down Wall Street, that all that stuff is random so there’s no point trying to time it, but I’m not totally rational when dealing with that much money.

For the blog, I did a little analysis and found that 12% of the time stocks* lose at least 1% in a single day; if I bought the day before that happened, I’m out at least $100.  On the other side, about 13% of the time stocks rise 1% or more in a day; if I bought the day after that I’d similarly be out $100.

My fragile nerves just can’t take that so I want to “diversify” the timing of my purchases to even out those big ups and big downs.  This is a strategy called “dollar cost averaging”.  So as I said, initially I would have recommended is to take the cautious path, take $10,000 and split it into $1,000 chunks, and invest those each week for the next 10 weeks.


windfall analysis 2

But then using the magic of spreadsheets and the internet, I decided to see what the actual data said.  I looked at every week for the market since 1950 and did a comparison of the two scenarios:

  1. Invest your entire chunk of money all at once
  2. Spread your investment evenly over 10 weeks (dollar cost averaging)

Wouldn’t you know that on average it’s better to invest your entire chunk at once?  I’ve been doing it wrong this whole time, so thank you Stocky Fox.  In fact it’s not even close—historically it has been better to do option #1 about 61% of the time.

The thinking is that historically, stocks have always gone up.  Sure there have been some rough patches, some of which can last a really long time, but the general trend is definitely upwards.  So if you wait to invest your money over a longer time period, you’re missing out on some of that upward trend.  I looked at every week since 1950 (if you were curious, there are about 3400 weeks) and on average you gain about 0.7% by going with option #1 instead of option #2.  0.7%!!!  Holy cow.  Remember that post on The power of a single percentage?  We just found a 1% coupon right there.

So my advice is to pick a day this week and invest it all in one fell swoop.  You might get hit with bad luck, but the odds are better that you’ll get hit with good luck to the tune of about 0.7% (which in your case is about $700).  On the day you do it, don’t even look at the stock market and have several tablets of Alka Seltzer on hand.

*For this analysis I am using the S&P 500 data going back to 1950.

Your house–the leveraged buyout

Last week I did a post looking at if your house was a good investment or not.  A classmate named Karthee from ChicagoBooth made a really smart comment:

“Isnt the house purchase a Leveraged Buy out? You didn’t actually put in all the $785K, but took all the profits (1.15M – 785K) – so shouldn’t the return math be based on your down payment rather than the cost of the house (unless you paid for the house in full – which most people don’t)”

Before we dive into the issues, a quick thought: Karthee and I got our MBA together 10+ years ago.  He was a tremendously smart guy and has been very successful since we were at U of Chicago.  When I did my post looking at the value of college, I left out the value of personal relationships that you can develop with your classmates and the network you can build.  I did that deliberately because so many college grads are struggling to pay student debt and make ends meet.  A strong personal network that doesn’t translate into professional opportunities seems like a bit of a luxury.

That said, the people I met at ChicagoBooth are absolutely the smartest and most talented people I ever spent so much time with.  I don’t know if that alone was worth the cost of attendance, but as I get older and my professional career takes on a new look and feel, being connected to so many really amazing and scary smart people becomes the more dominant value I enjoy from my MBA experience.  You know, other than meeting my wife and the mother of my children there.


On to Karthee’s comment

I think he’s mostly right, but a little bit wrong.  Let’s talk about how he’s wrong first and then we’ll get to how he’s right.

His comment has less to do with the performance of the asset (did the house increase in price?) and more to do with how the purchase was financed.  Definitely in that he was right that we bought the house with a mortgage, paying a 25% down payment.  The house cost $785,000 and we had to “invest” $196,250 as the down payment.  Then every month we made a mortgage payment of $2,811, of which about $1,000 went to paying off our mortgage (the rest was interest).

He’s absolutely right that if you look at our investment as $196,250 and our gain as $365,000 that changes the numbers substantially.  But should you?  Maybe.  More on this when we talk about how he’s right.

If you just look at the assets’ performance—the house compared to the stock market—the house didn’t do as well.  In our particular case, our house increased about 46% over the five years we owned it; the stock market increased about 76% over the same time period (about 90% if you include dividends which you should).  The broader data shows that houses on average return about 0.4% annually while stocks have historically returned 8-10%.


How Karthee’s right

Should we consider how you finance an asset purchase when you make an investment choice?  Certainly, money is money.  Again, if we were doing apples to apples, you could put 25% down to get a house and compare that to if you bought stock on margin and leveraged it 3:1 (put $1 of your own and borrowed $3 to invest).  In that scenario you would have the same results that the stock market does better.

However, that’s a bit of a theoretical construct and Karthee’s point is much closer to reality.  Not many ordinary investors buy stock on margin; I certainly don’t.  About half to two-thirds of people borrow money when they buy a personal residence (I was shocked that it wasn’t higher).  So in that way, the default for home tends to be “leveraged” while that’s not the case for stocks.

Furthermore, interest rates when you borrow for a mortgage are much, much more favorable than if you bought stocks on margin.  Our mortgage is 2.2%; if I bought stocks on margin the rate would be about 6-9%.  Also, our mortgage is tax deductible which brings it down to an effective rate of about 1.5%.  I’m no tax expert so I don’t know if interest on margin purchases are tax deductible.  If not, that further supports Karthee’s point.

Certainly in a practical example of making the choice between buying a house and renting and then investing the money, reality is closer to Karthee’s point.  That said, most of the return comes from the decision on how you financed your house, not that you bought a house that increased in value.

We can put a little table together that figures this out.  The last row includes an adjusted CAGR which accounts for all the costs—realty fees, home improvements, plus the “value” we got from the house acting as a shelter.  We’ll also include the returns if we invested the money in the stock market and invested on margin (maxing out at 1:1 margin ratio at an 8% interest rate).


House paid with cash

House paid with mortgage


Buy stocks

Buy stocks on margin

Cost to house (2010)





Money “invested”





Sale price of house (2015)










Gross return










Adjusted CAGR




This leads to some pretty insightful results.  To Karthee’s very correct point, when you look at your house as a leveraged-buyout, the profits are greatly magnified.  In our case, instead a 9% return assuming no mortgage, when you factor in our mortgage we would have a 21% return.  That’s enormous, and that’s really Karthee’s whole point.

You can compare that, as I did before to investing in the stock market.  The stock market had about a 14% return, so a house with a mortgage would have done much better.  However, if you leverage your investment in a similar way to how you did with your house, they end up about equal—the house is at 21% and stocks bought on margin have a return of about 19%.

19% and 21% are close, but the house is slightly ahead.  That speaks to some inherent advantages you get when borrowing money with a house.  For the stocks on margin, I assumed the most you could do is borrow at a 1:1 ratio (you could only borrow as much money as you were investing).  Keep in mind for a mortgage, we got a 3:1 ratio; we borrowed $3 for every $1 of cash we brought to the table.  Also, I assumed that when you borrow on margin you pay an 8% rate; that is much higher than the 2.2% rate we have on our mortgage.  Those two factors—ability to leverage at a 3:1 ratio and to borrow at such a low rate—give the house a great advantage.

So with all of this KARTHEE IS RIGHT.  If you consider a house as a leveraged investment, our housing experience did outperform the stock market.


What if we weren’t so lucky?

Our house appreciated at a particularly high rate, but most houses only increase at about 0.4% when you strip out all the home improvement and other stuff we talked about last week.  But to Karthee’s point, your house is a leveraged investment and we know that should increase the returns you experience as a home owner.

If we assume a very vanilla situation, if you put 20% down on your mortgage and the house appreciated 0.4% annually, the math would tell you that you would realize a 2% return per year due to the leverage you have on your house.  Obviously 2% is significantly lower than you could get in the stock market, on average.

Plus, that 2% number is a bit of a best case.  Over time, you’ll be paying off your mortgage so your investment will creep up over 20%, decreasing the impact of the leverage.  Also, as we mentioned last time, when you sell your house you’re likely going to have realty fees which basically act as a massive transaction fee which can really zap your profits.


We’re at 1500 words.  Karthee had a really great point that we should look at our house as a “leveraged” investment and that definitely enhances the positive returns if you house does increase in value (we didn’t touch the nightmare scenario of an underwater mortgage ☹).  In our case, the leverage put us ahead of what we could have done in the stock market, so that did make our house a good investment, I suppose.

However, the data shows that even with leverage houses tend to underperform the stock market pretty drastically.  As I said last time, that doesn’t mean you shouldn’t own a home.  We do.  There are a lot of great reasons beyond the investment angle to do so.  Let’s just be weary of thinking they are these great investments.

Teaching personal finance in schools

If any teacher wants to convert their math problems to have a financial element, please email ([email protected]) and I will be happy to do it.  If you know any teachers, please share this with them.

Prepare for a rant.  However, I will include a solution at the end, so maybe that makes it a little easier to stomach.

As a loyal Stocky Fox reader you know succeeding with personal finance can be extremely beneficial (no kidding).  Also, personal finance is a skill learned just like any other skill.  It’s not really hard to learn the basics—asset allocation, tax optimization, long-term view—but you definitely need to know them.


Financial literacy is low among adults

There are a lot of challenges we face as a society.  We all have our own lists.  At or near the top of my list is financial literacy, or the lack thereof.  Not knowing this has a crippling impact on someone’s ability to achieve their life’s goals.

FINRA, which is the governing body for financial advisors (when I took my Series 65 it was administered by FINRA) has a handy little quiz you can use to test your financial literacy.  I have listed the questions at the end of this post if you want to take it.

There are five questions (plus a bonus question that is quite a bit harder) that have to do with finance, but really they are math questions dressed in financial clothing.  They fundamentally test addition, multiplication, and division.  We were all taught the mathematical skills needed to answer these by 5th grade.

Do you know what the average adult scores on this test?  3 of 5.  60% correct.  Knowing the answers to these questions will mean the difference of hundreds of thousands of dollars.  Knowing these answers will help keep people out of the nightmare death spiral of credit card debt that will limit their opportunities for their entire lives.  Knowing these answers can allow people on a moderate income to build generational wealth.

Yet people don’t know these.  What’s even worse is the problem is getting worse.  In 2009 people got at least 4 of the questions right 42% of the time; in 2015 that number dropped to 37%.  YIKES!!!

Reasonable people can debate, but I can’t think of a life skill that can have a more direct and enormous benefit on someone’s life, but which is lacking across such a wide swath of the population.


Status Quo

School got very real for us this year since ‘Lil Fox just started elementary school.  We love the school and his teacher (Mrs Sheppard-Jones) is awesome.

I have volunteered at his school the past three years, and several years before that at the local elementary school when we lived in Los Angeles.  I work on advanced math concepts with 3rd and 4th graders.  I am no expert, and certainly I am not as close to it as the dedicated teachers who do it all day every day, but I have been struck by how little personal finance (let’s say that’s anything with a “$”) comes into the math curriculums.

That’s not to say that it’s not there at all.  There are some math problems that involve money and finance, but I wonder if it’s enough.  Why doesn’t every single math problem incorporate finance.  Every.  Single.  Problem.

I’m not talking about hard core personal finance concepts; students are welcome to come to this blog for that ?.  If you have an addition problem like 3 + 5, why not make it $3 + $5?

Suzie has five apples, and she gives 3 to Steve.  How many apples does she have left? Could easily become Suzie has $5, and she buys a toy for $3.  How much money does she have left?

Byron has already filled 6 buckets with water.  If he can fill 2 buckets per minute, how long until he has 20 buckets filled?  That could just as well be: Byron has $6 saved.  If his weekly allowance is $2, how long until he can buy a $20 video game?

Obviously, each of those questions are identical, testing the exact same mathematical concepts.  The difference is for the second of each pair, there is a financial layer that also gets the student thinking about money, saving, investing, etc.  Those financial layers are going to pay major dividends, literally and figuratively, if the student retains them.

The questions on Suzie and Byron are real questions that I have seen given to students.  As important as counting apples is or filling buckets of water is, managing your finances is much more important.

Pretty much every math problem can be written as a math/financial problem, with the possible exceptions of some geometry and trigonometry concepts.  Even then, I think if you are creative enough you could pull it off.


The mother of all concepts

This is obviously up for debate, but I think that compound interest is probably the most important concept in personal finance.  If you are a borrower, it’s impact can be devastating.  If you are an investor, it’s impact can be liberating.  Thanks to this little jewel, I was able to quit my job in my mid-30s and live off our savings.

As powerful as it is, it’s a purely mathematical concept.  We’re first taught it as exponents like 34=?  It starts to look a little more like finance with something like 1.085=?  This isn’t a hard concept to learn.  Most scientific calculators have a specific button for this, so all you have to do is enter the numbers.   

My major complaint here is exponents tend to be taught in a very sterile environment, at least in my experience.  Sure, you can do all the mechanics of 53, 76, 28, 34.6, and on.  As a high schooler I remember doing pages of them.  I became a robot punching buttons on a calculator, producing answers that I wrote on my paper.

What if instead you had questions which involved $1 of debt at different interest rates for different lengths of time like 1.15, 1.0820, 1.210, 1.25, 1.0920?  You still pushed the exact same buttons, but now there is some upside.  Worst case is the student learns exactly what he would have anyway.

Best case is that a student notices that 1.0820 is surprisingly larger than 1.0720.  If she makes the link that a 7% interest rate over twenty years produces a much lower amount than an 8% interest rate over the same time frame, she’s learned a powerful concept.

Right now it would just be a seed, but eventually that seed will grow.  That exponent problem shows the difference between a 7% return and an 8% return over 20 years.  That’s the difference between using an index fund with a low management fee and an actively managed fund with a high fee.  That’s the difference of several hundred thousand dollars over her investing lifetime.  If that seed never grows, she’s no worse off than she was.  If it does, then when it’s time to pick her investments for her 401k, she will realize how big an impact one little percentage can have when compounded over time . . . well, you know how I feel about that.

This is real—we live in a world where millions of homeowners could refinance their mortgage at lower interest rates to save billions, but they don’t.  I guarantee you the biggest reason is that most people don’t realize how much money they could save by lowering their mortgage rate a measly 0.4%.  Why aren’t we teaching that very thing when we teach exponents?


I am ready to do my part

There’s nothing I like more than when people find a problem but not a solution.  It’s awesome to hear people bitch on Facebook about some difficult issue, and then implore other people to do more.

So we have this big problem and I am going to ask everyone other than me to do something about it.

JUST KIDDING.  For all the teachers, educators, parents, or anyone else out there who works with kids in math, I am here to help.  I’m being totally serious.  Email ([email protected]) me any questions you have in a regular format, and I will change them so they are finance-related math problems.

Financial literacy is a huge problem, but it also has a really easy and costless solution.  Incorporating math won’t take away from any other learning; it won’t consume time that right now is spent learning other skills.  The kids are already doing the math, let’s just put a financial watermark on all those math problems.


FINRA quiz

  1. Suppose you have $100 in a savings account earning 2 percent interest a year. After five years, do you have more than $102, less than $102, or exactly $102?
  2. Imagine that the interest rate on your savings account is 1 percent a year and inflation is 2 percent a year. After one year, would the money in the account buy more than it does today, exactly the same or less than today?
  3. If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or is there no relationship?
  4. True or false: A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage but the total interest over the life of the loan will be less.
  5. True or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.
  6. (BONUS) Suppose you owe $1,000 on a loan and the interest rate you are charged is 20% per year compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double?

Is your house a good investment?

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For most Americans, their home is the largest purchase they will ever make in their lives, and it is their largest asset.  A lot of people call a person’s home their largest “investment”.  That begs the question: Is your home a good investment?


Definition of an investment

We need to remember what an investment is, particularly for this.  An investment is where you pay for something and then either get payments, like a dividend, or you are able to sell it at some point in the future for a profit.

For houses, you don’t really get a periodic payment.  That may be the case for rental properties which I’ve discussed here.  But for this post, let’s assume you use your home for your personal residence.  That means for the idea of an investment to work, you need to sell your home for more than you bought it.

Now that we have that out of the way, let’s figure this out.

Our story

A lot of times in personal finance, it’s better to be lucky that good.  Foxy Lady and I were very fortunate when we bought and sold our Los Angeles house.  It turned out to be an awesome investment (or so we have always thought, but let’s wait until the end of this post for a final verdict).

Shortly after we were married in 2010 we moved to LA.  That was pre-cubs but we knew we wanted to start a family, so we bought a cozy 3-bedroom house for the low, low price of $785,000.  What?!?!?  Los Angeles real estate is insane.

In 2015 I retired and we moved from LA to North Carolina.  As insane as housing prices were in 2010, they got even more insane in 2015.  We were able to sell our house for $1,150,000.

Wow!!!  That’s a heck of a profit.  Definitely that shows that in our case, our house was an awesome investment.  Not so fast.  Let’s look at the numbers and really figure out how good of an investment it was.

Our $785,000 investment grew $365,000, so that’s a 46% increase.  That seems like a really high return, but wait . . .

That was over 5 years, so on a compounded annual basis that’s about 8%.  Still, that’s a really good return, but wait . . .

We did a fair number of home improvements to our house.  When we bought the house there was a bit of water damage on one of the outside doors, so we replaced those plus a few of the windows.  Plus we decided to paint the outside because it has a hideous white color.  Also, we did a lot of landscaping work and had to fix the sprinklers.  Let’s say all that came to $20,000.

Later in 2014, Foxy Lady completely redid the kitchen and bathrooms.  It was one of her crowning achievements, and a bit of her died when we moved just a few months later.  That all cost about $40,000.  If you factor that in, then the return falls to 7%.  Most people will take 7% any day, but wait . . .

We were really lucky in that we sold our house as part of Foxy’s relocation package for her new company.  Normally, realtor fees are about 6% of the house’s selling price.  That would come to about $77,000.  Fortunately, we didn’t have to pay that, but under most circumstances we would have.  Had we factored that in the return falls to 5%, but wait . . .

Then there were other costs like property taxes (about $10,000 annually) and regular repairs like when we had to replace our dishwasher (let’s call that $3,000 each year).  If you factor that in, the return bottoms out at about 4%.  That is a far cry from the 46% we originally had in our head.

Maybe we’re being too pessimistic.  There’s some upside, right?  Sure there is.  It did act as shelter for us.  Let’s say it would have cost us $4,000 per month to rent a place like that.  In a way that acts like a bit of a dividend; owning that house gave us $4,000 of value each month.  That is a huge factor which has a major impact, raising our return from 4% to over 9%.

Plus, on the upside, selling your home has some nice tax advantages depending on the circumstances.  If you owned the house and used it as a personal residence for at least a couple years (to avoid flippers), then any profits on your house up to $500,000 ($250,000 if your single) are not taxed.  If you had profits for stocks those would be taxed like a capital gain whose rates are around 15-20%.  That is actually a pretty ENORMOUS advantage.  In our case, we had a profit of about $300,000 after you accounted for the home improvements we did; a 20% tax rate would have come to $60,000.  As it was, we didn’t pay any of that.

Looking to the data

We had our story, but I have this nagging feeling that we got fairly lucky with the house.  Imagine an investor whose only experience with stocks was buying in 2012.  They would have had a annual return of about 11%.  Hopefully they would have the perspective that that isn’t normal for most investors over most periods of time, and they just happened to have really lucky timing.

For housing it’s a bit tougher to figure that out.  In the stock market we have all sorts of data that bloggers (whose kids just went back to school, so they have more time on their hands) can parse a million ways.  Not the case with housing.

First, there’s just not that much data out there.  Second, the calculation becomes complex for all the reasons we discussed in our situation.  You have to control for things like home improvements, repairs, etc.

That said, my BFF Robert Schiller in all his smartness has the authoritative data on the subject.  Going back to 1950, the same year the S&P 500 started, housing prices have increased 0.4% annually.  That seems crazy low.  We know that houses are more expensive now than they were back then.  Did the Nobel Prize winner get it wrong?

No, he got it right.  That 0.4% is the increase if you hold everything else constant.  Since 1950 houses have gotten a lot bigger, made with better materials, with more features, and all that stuff.  Using some hard-core statistics, you can strip all that stuff out and find out how much the house on it’s own increased in value.  That number is 0.4% annually.

Just in case you were wondering, the S&P 500 has increased 11% annually since 1950.  BOOM!!!

During that same period of time that we owned the house, stocks were up over 12%.  Granted, that was during a decent market run, but that kind of makes it apples to apples comparing that to a really strong run for California real estate.  Just from a numbers perspective, it would have been better for us to rent and put all that money into the stock market than what we actually did.

Putting it all in perspective

9% seems like a huge return for our house (4% if you just count the house), given that I typically use 6-7% as my expected return for stocks.  That should be a vote in the “yes” column for the question: “Is your house a good investment?”

However, based on the data it seems like we had really, REALLY good timing.  If normally houses appreciate 0.4% when you strip out all the other stuff, then our experience where we got a 4% return seems like a major outlier.  Conversely, stocks had a return of 12% when they historically have a return of 11% or so.  We could debate which was MORE lucky, but I definitely think the appreciation of the house was a greater outlier.

What does it all mean?  Houses tend to appreciate about 0.4%, but if you include the value it provides as shelter while you hold it as an investment, maybe that bumps it up to 5% or so.  It also has favorable tax treatment so those are all really attractive.

However, stocks on average return about 8% per year.  So even with the tax benefit, ON AVERAGE (which is a crazy term in and of itself), houses aren’t that good of an investment compared to the stock market.  Even in our case, where we had an awesome run with our house, the stock market did better.

Does that mean that we should never buy a house, only renting and then using that money in the stock market?  No, I don’t think so.  There are really good reasons to buy a home beyond the investment angle.

In my opinion, the most important element is self-determination.  I weighed the pros and cons of home ownership here, and the one thing that transcends money is when you buy a home you control your future.  In that post I mentioned how our neighbors who were renting didn’t have their lease renewed and had to move.  Also, people who rent don’t tend to upgrade their house to make it as nice as they want.  Those are important considerations that, at least for us, tip the balance towards homeownership.  But what doesn’t make a very compelling argument is the fallacy that homes make great investments.

Week in Review (8-Sep-2017)

It’s been an up-and-down week.  US stocks ended the week down 0.6%, Pacific stocks were pretty much flat (we’ll tell you why in a second), and European and Emerging stocks were up over 1.0%.


North Korea tests another nuclear bomb

Over the weekend, North Korea captured headlines with another bomb test.  What made this different from previous tests was this bomb was much, much larger.  North Korea’s previous tests were in the 10 kiloton range or lower; this one was at about 100 kilotons.  That’s a far cry from 25 megaton nuclear bomb in the US’s arsenal, but it’s still troubling that North Korea is making steady advances both in nuclear and missile capabilities.

The news clearly rattled the markets.  When trading opened on Monday (Tuesday for the US since Monday was Labor Day), stocks tumbled.  Hardest hit was Pacific which makes since given the two biggest components there are Japan and South Korea.

Who really knows on this.  This has the potential to be more sabre rattling and potentially a mortar shot or two that freaks everyone out before things return to normal.  Or, it could start World War III between the US and China.  Obviously, WWIII would devastate the stock market (think down by 50% over 10 years—ouch).  There’s a lot of risk right now.


One-two hurricane punch

As Houston recovers from Harvey, Florida is bracing for Irma.  Just like last week, this is a human story and my heart aches for all the people whose lives have been turned upside by these storms.

However, there is also a major economic and financial impact.  It’s estimated that Harvey recovery will cost about $180 billion.  Irma is expected to hit this weekend so we don’t know how bad that will be but a lot of people who think Irma could be worse than Harvey.  Let’s hope not.

In dollars and cents, that means another 12-digit expense.  Those things add up.  The markets largely wrote off Harvey without a blink.  I wonder if the US markets are down because another hurricane with the potential to do so much damage is coming.  If the US needs to spend $400 billion in a recovery effort, that is a MAJOR component of GDP.  It becomes significant.


Rockwell Collins bought for $23 billion

In a story that looks more like traditional business an investing fare, United Technologies announced its intention to buy Rockwell Collins for $23 billion.  That is a big deal just because it’s a BIG DEAL.  You know all the coverage and energy that surrounded that?  It was a $14 billion deal.  This one is almost twice as big.

Again, I always look at these types of mergers as a good thing.  It shows confidence that things can be done better.  United Technologies thinks they can create value, the lifeblood of the stock market, in the merger.  They are putting their money where their mouth is by making spending $23 billion.  It even has an instant impact given that before the merger was announced, Rockwell Collins was only valued at about $20 billion.

So just a simple view shows that they think there’s at least $3 billion in hidden value there.  Probably more to make it worth their while.  That’s the stuff of investing and business—companies seeing opportunities where they can make something better and more valuable than it was.


There you have it.  It seems like a lot of uncertainty, both political and natural disaster-wise, has kept things a bit off balance.  Everyone have a wonderful weekend.


Investing let me get my new car for free

A few years back our old Honda Civic went to heaven.  It had a terminal case of transmissionitis.

We bought a new Honda Fit which cost about $17,000.  However, when it was all said and done we got it for free.  This isn’t some scam or a crazy thing where we had to drive around with the sides painted as a billboard or anything like that.  This is how it worked:

In September of 2011 we bought our new car.  Our Civic had been struggling for a while so we had been saving money knowing that sooner or later we would need a new car.  Because of that we had the $17,000 in cash ready to purchase the car outright.

However, Honda offered a fairly generous financing program at 0.9% interest.  That’s a super low rate so it was very tempting.  There’s always the nagging idea that you shouldn’t borrow money if you don’t have to, but as low as it was we figured we had to consider it.

It was bit more complex, but for the sake of simplicity, let’s assume we had these two choices:

  1. Pay for the car in cash.
  2. Finance the car at 0.9% for 6 years and then invest the cash.

As you can guess from the tone of this post, we went with option 2.  Our plan was to finance the car, and then invest that $17,000 in a stock mutual fund (VTSMX).  Every month when a payment was due we could sell a few shares of the mutual fund.  At the end of 6 years we would either end up ahead, making this a really smart move, or behind making this a really dumb move.


Looking at the numbers

A 6-year loan for $17,000 at 0.9% interest requires a monthly payment of $243.  Back in September of 2011 the S&P 500 was at 1,131 (today it’s at 2,471).

Over the course of those 6 years, the market mostly went up, but it certainly had some rough moments.  2012 and 2013 were really good years for the stock market so I felt like I was a bit of a genius for doing this.  Then in 2015 stocks fell plus there were a few of those really crazy months like January 2016, when the market was in total freefall, and I felt like I was an idiot.  Stocks recovered in 2016 and then really took off after Trump’s election.

Needless to say, there were a lot of ups and down.  The smart thing would have been to just ignore the daily/weekly/monthly variations in the stock market and not get stressed, but that’s not in my character.  I did look at it every day, and I did get totally stressed out.

Foxy Lady and I stayed the course, and this month we sent our last check in to Honda.  Now we own that $17,000 car outright, the same way we would have had we paid cash for it 6 years ago.  However, the account we were using for all this still has about $16,400 of mutual funds in it.

That’s awesome.  We bought a $17,000 car, but we ended up with a car and $16,400!!!  In a way the car was very nearly free.  We started this process with $17,000 and no car.  We ended this process with $16,400 and a car.


Were we lucky or good?

Our story had a happy ending, which begs the question how likely does it turn out this way.  The six years from Sep-11 to Aug-17 were a good run for stocks but by no means the best.  Going back to 1950 when the S&P 500 started, you can see how things stack up.

There are a couple important points.  First, success isn’t guaranteed here.  You would lose money (have to pay more than your original $17,000) about 18% of the time.  We know that over the long-term stock almost always do well.  This is a bit trickier because when you start this, you invest all your money at one time, so you don’t benefit from dollar cost averaging.  Had you invested right before a huge market downturn (think late 1960s to early 1970s or Mar 2001 or Aug 2008) that would really be awful timing.  Still, you come out on top 82% of the time, so those are pretty good odds.

Second, our timing was pretty good, but certainly not the best.  We would have done better 13% of the time.  The absolute best timing would have been if we did this scenario starting in September 1994 and ending August 2000.  Basically, that timed the investment just before the internet boom of the 1990s kicked off, averaging about a 24% each year.  If you’re curious, with that timing you would have ended up with a car plus about $25,000.

We can’t be lucky all the time but you don’t really need to be either.  You can look at a more average performance, let’s say starting in September 2002 and ending in August 2008.  You would have ended up with a car and $8,000, so basically you got a new car at a 50% discount.


Take free stuff

The other really important piece to this is the really low interest rate we were charged.  0.9% is not a normal interest rate.  As we discussed here about debt, sometimes it’s a good thing to take on debt.  Honda gives their car buyers an artificially low interest rate as an inducement to try to increase sales.  It could just as easily be cash back or lowering the cost of the car.  As it is they decided to give a really low interest rate.

Some car buyers would need to finance their purchase no matter what, so that 0.9% was just a bluebird.  Others, like us, had the choice: do we pay in cash or finance.  Had we paid in cash, we would have basically been leaving this sweet perk from Honda on the table.

We can pretty easily see the impact of using a more normal interest rate on our experience.  At 0.9% we ended up with the car and $16,400.  However, if we use 5%, then we still come out ahead, but not as much.  Instead of $16,400 we ended with $13,000.  Actually, I was a bit surprised that the impact wasn’t greater, but that’s why you have spreadsheets, right?

When all is said and done, hopefully this illustrates the point that being smart with investing, and really understanding what is likely to happen based on history, can really be lucrative.  Obviously this will apply to things like your 401k and IRA, but it also applies in more unexpected places like buying a car.

Week in review (1-Sep-2017)

Similar to the last two weeks, this week is dominated by a social (and weather) story.  Before it was the Google memo and then the unrest in Charlottesville; now it’s Harvey in Houston.  The difference as it relates to this blog is that the impact Harvey is having on Houston also has some major implications for the financial markets.

In the end, curiously, the markets had a steady climb this week, rising almost 2% in the US and almost 1% for the other global markets.  What gives?


Obviously, Harvey has dominated the headlines.  The hurricane pummeled Houston, putting it under several feet of water.  It has been a human tragedy that we have all seen on television, but in a way it’s oddly encouraging.

Houston is the 4th largest city in the country and it has just suffered a massive body blow.  As bad as it is: 1) There is no doubt that Houston will recover and after a bit of time (probably much less than most would expect) the city will be back to normal.  2) The rest of the country has been cranking along just fine.

From a financial and investing perspective, that means we’ll feel a bit of a blip as Houston gets knocked down and then gets back to it’s feet, but it should be short and shallow, and then after not too long it will be like it never happened.  That’s truly a testament to the amazing diversity and robustness of our economy.


Gas prices go up

Outside of Houston, the rest of us are feeling Harvey’s impact at the pump.  About 20% of all gasoline is refined in the area impacted by the hurricane.  Here in Greensboro, that has caused gas prices to jump from about $2.19 to $2.59.

This won’t last very long, as those refineries are going to be back online soon, but in the meantime, it will have an impact.  This is a bit of a bummer, because the extra we are all paying for gas really isn’t going to anyone.  People aren’t getting higher profits that they can spend or anything like that.  One way to think of it is that extra money it’s being “swallowed up” by the closed refineries.

That’s what economists call a dead-weight loss, and it’s never good.  Fortunately, it will be over soon.


Chemical plants blow up

Harvey’s destruction has obviously caused a lot of damage, in homes and businesses.  The one that has hit the news is the peroxide plant which lost power and then blew up.  Obviously that one instance is going to cost millions of dollars to repair.

The total tab for Harvey’s destruction is expected to come in at about $190 billion.  That’s a tremendous amount of money, about the total GDP of an entire country like Greece.  However, for the US that’s a bit of a drop in the bucket.  That will come to about 1% of our nation’s GDP.  One way to think of it is that every American will need to pony up about 1% this year to pay for Harvey’s damage.  That’s a lot but definitely doable.


US revising GDP growth upwards

With all that damage from Harvey, how are stocks up so much?

The economy is strong, innovation is happening, and things are just plugging along.  In fact, the economy just clocked in a 3% growth rate.  In the past several years it has been pretty volatile but averaging more in the 2% range.

If this 3% growth becomes sustainable that’s a huge deal.  That extra 1% pays for Harvey’s damage by itself.  That extra 1% is a will really turbo boost the stock market.  I think the optimism for that is keeping things at record levels.


So there you have it.  With the dominate story being bad news, stocks were up, and that’s really a testament to how strong things are for the stock market right now.