Category: analysis

Bitcoin—Top 5 WTF

Stocky 1 Comment

A few of you have written in asking what I think of Bitcoin and its crazy ride.  Here are my Top 5 observations on Bitcoin.

 

5. Unprecedented wild ride

What has happened with Bitcoin in 2017 is really unprecedented.  Its price has risen about 17x which obviously is a lot.  To me, the more astounding point is that it has risen that high given it has a market cap of $300 billion (that is the total value if you added up all the bitcoins in the world).

If you think of bitcoin as a stock, that combination is pretty incredible.  A lot of stocks have had crazy good years where they increased 17x.  However, most of those are off a really low base: so maybe a $50 million company grew to a $1 billion company.  Obviously, that is much easier to do off a smaller base.

However, with Bitcoin, continuing with that analogy, it grew from a $15 billion company (that’s about in the top 2000 globally) so that isn’t exactly small.  Then it vaulted to $300 billion which would put it at about top 10.  Think about that for a minute.  Crazy.

 

4. I still don’t get it

I feel like some old man who doesn’t get the world around him.  Damn kids won’t get off my lawn.

I couldn’t tell you with any specificity what Bitcoin is (there are buzzwords like “blockchain” but I don’t know what that means either).  I certainly couldn’t tell you how I could “buy” them or “mine” them.  I don’t know a single vendor who would accept Bitcoins, and if they did I wouldn’t know how you do that transaction.

And I think I tend to be fairly knowledgeable about these things.  I can pay for stuff using my watch which proves I’m at the forefront of technology, but Bitcoin is just beyond me.  I think that applies to most people—the story of Bitcoin is exciting but the details are pretty fuzzy.

 

3. Not surprising run-up

Given the incredible run-up, I am not surprised of it’s continued push higher in the past couple weeks, thanks to it’s listing on the Chicago Mercantile Exchange earlier in the month.

Being listed (or having your futures listed) on a very legitimate financial exchange obviously lends some credibility to something that up to this point had very little of it in respected financial circles.  Also, it somewhat addresses #4.  You can buy Bitcoin futures on the CME and I think many more people know how to do that than knew how to buy Bitcoins on their own two weeks before.

I still think Bitcoin is built on quicksand and will eventually collapse (more on this in a second), but in the short term it’s not surprising that it’s value has gotten a huge bump as it has been listed.

 

2. Ticking timebomb

There are a lot of people extremely bearish on Bitcoins, and many can give you a ton of reasons why it’s just an eyelash away from collapse.  I predict that eventually a central bank will crush it like an elephant finally getting annoyed by a gnat.

What would provoke such action by the US Treasury?  A terrorist attack.  It seems likely that given Bitcoins anonymity features, it will be used to fund some type of terrorist attack that will kill innocent Americans.  When that happens you can easily imagine the headlines, and then easily imagine the government’s response.

Bear in mind the whole premise of Bitcoin is that governments aren’t responsible stewards of their fiat currencies, so society needed some type of currency that the government can’t screw up.  That’s a bit of a “Screw-you” to Washington, so I think if there’s any connection between Bitcoin and a terrorist attack, the government will come down HARD.

 

1. Go left when everyone else says “go right”

There’s a famous saying in investing that saying when everyone believes one thing, the opposite tends to happen.  Right now, EVERYONE is saying that Bitcoin is a bubble and its value will crater.  People have been saying that when it was at $1000 and then the chatter exploded when it crossed the $10,000 threshold.  Now it’s at about $18,000.

Seriously, can you think of one serious, respected analyst who is bullish on Bitcoin?  I can’t.  Can you think of highly-regarded financial people who said Bitcoin is a crazy bubble that will crash HARD.  I can think of about a thousand.

Given that, it makes me think that Bitcoin might still have some upside.

 

Who knows with all of this?  I know I certainly don’t.  Personally, we don’t invest our money in Bitcoin, mostly because of #4 and a bit because of #2.  That said, I am enjoying the crazy ride that makes for fun reading in The Wall Street Journal.

 

You missed the boat

Stocky Leave a comment

We all know that stocks have been on an absolute tear lately (that’s the reason I’m smarter than a Nobel Prize winner).  In fact, if you look at 11 months since Donald Trump was elected, stocks are up about 20%.

On election night the S&P 500 was at 2140 and now it’s at 2550.  It’s blown through major milestones like 2200, 2300, 2400, and a few weeks ago 2500; all in fairly short order.  If you are fully invested you’re loving it and obsessively looking at your spreadsheet to see how your net worth is climbing (okay, maybe that’s just me).

If you aren’t invested, this is a definite missed opportunity.  There are a couple ways you can go with that:

  1. Just don’t invest because you feel you missed the boat already.
  2. Go all in now to not miss any more.
  3. Hold off to wait for the market to fall again, and then invest on the dip.

As you can probably guess, I think #1 is a bad idea and I would recommend #2.  However, what about #3?

 

Waiting for the downturn

We all know that stocks have been on an unrelenting upward path.  The S&P 500 started at 17 in 1950.  Today it is over 2500.  Of course, it’s never a smooth path.  You’ve had bumper years like this one, really since 2008, all of the 1980s and 1990s, etc.

You’ve also had your downturns.  Some have been long grinds like the 1970s while others have been sharp like the Great Recession.  However, even with those, we’ve definitely done well.  That said, if you missed out on a good run, should you just wait for the next downturn to get back in?

First, I believe that it’s impossible to time that well.  But let’s say your crystal ball is working really well. How often will stocks fall back so you can get back in at the lower levels you missed before?

I looked back at the S&P 500 since it started in 1950, and I looked at all the major milestones for the index.  On January 1, 1950 it started at 16.66, so the first major milestone was 20.  It passed that level in Oct 1950 and it never looked back.  Never again did you as an investor have a chance to get in at 20*.

Same story for milestones 30, 40, and 50.  In the 1950s the stock market did its relentless march, and every time it passed those levels they were never seen again.

It was a different story in the late 1960s and early 1970s.  A MAJOR milestone was hit in June 1968—100 on the S&P 500.  You could imagine this was accompanied by the usual fanfare of surpassing such a level.  The 1970s proved a lousy time for stocks, and the S&P 500 had major moves above and below 100 eleven times.  That’s a lot.  It wasn’t until the Reagan bull market of the 1980s that the stock market broke the trend.

For milestones 150, 200, 400, and 500 there were no pull backs (300 had a pullback thanks to the crazy one-day plunge in 1987).  So again, just like the 1950s, the 1980s and 1990s had a stock market that just blazed through, and if you missed it you missed the boat.  Never again would those levels be seen again.

Milestone First time Revisited
20 Oct-50 0
30 Jul-54 0
40 Jun-55 0
50 Sep-58 0
75 Dec-63 2
100 Jun-68 11
150 Mar-83 0
200 Nov-85 0
300 Mar-87 2
400 Dec-91 0
500 Mar-95 0
750 Nov-96 0
1000 Feb-98 3
1500 Mar-00 6
2000 Aug-14 3
2500 Sep-17 0

Since the 2000s we’ve crossed four major milestones—1000, 1500, 2000, and most recently 2500.  All of those were revisited, mostly due to the Great Recession where the S&P fell from about 1565 all the way down to 670.

Since the Great Recession, the market has been blazing, but it’s been crazy in the process.  The market cleared 2000 in August 2014, but has gone through some brief downturns with fast recoveries like January 2016.  I think more recently we’ve experienced greater volatility in the market, so revisiting might be more common.

 

Bottom line

That was a gripping history lesson, but what does that mean we should be doing now?  Overall, I think the data shows that stocks always go up.  Sure there will be bumps, but if you invest now, the data shows that, at least based on history, you’ll make money.

On the other hand, despite this crazy good bear market recent years, there have been revisits of these levels.  Are we going to see the S&P 500 at 2000 again?  Maybe.  Based on recent history, I wouldn’t be surprised.  However, I certainly wouldn’t bet on it.  I mean that in the literal sense—I wouldn’t wait to invest my money until I saw a market downturn.  I think it more likely things will keep cranking along and 10 years from now we’ll remember the good ole days when the S&P was at 2500 the same way we think about $0.10 hamburgers from McDonald’s.

You might have missed this boat, but you don’t want to be on the sidelines when the next boat (S&P 500 at 3000) comes around and miss that one too.

 

 

* I defined “revisited” is going under the milestone at least 100 days after it passed it.  This is to keep from counting times when it gyrates above and below the milestone over the short term.  For this we wanted to look at times where the market was comfortably above the milestone and then at a later time period fell below it.

Vacation homes—don’t do it

Stocky Leave a comment

Summer has come and gone, and it’s one more year that I haven’t surfed a 15-foot wave.  I blame the move from LA for a lot of that because I just can’t get out to the ocean as often as I need to (now we’re about 3 hours from the Atlantic).

The obvious solution is for Foxy and I to get a beach house.  This is something we have talked about seriously, off and on, since we moved to North Carolina over two years ago.  The clear benefit is we would have an awesome second home on the Atlantic Ocean: it would be beautiful and peaceful and a blast for the cubs as they grow up, plus the SURFING.

Why wouldn’t we do that?  As with many things the answer is—cut to Stocky rubbing his thumb and middle finger together—money.  It would be a huge expense, but just because something costs a lot doesn’t mean it’s not worth it.  After all, vacations and leisure time are very important.  We’re fortunate that it is a possibility for us.

Ultimately, I think vacation homes tend to be lousy ideas for most people because of two main reasons: 1) They are expensive compared to other options.  2) They really limit what you can do (or want to do) for vacations.

 

Breaking down the numbers

A vacation house is typically not cheap.  Let’s say a decent beach house right on the water would cost $500,000.  Definitely they can vary widely in price, but we’ll see that the price really doesn’t change our calculations.

Based on some of our recent blogs, we know that you’d typically buy a house with a mortgage, although vacation homes have mortgages less frequently than primary residences.  For simplicity’s sake less assume we bought it outright (again, this won’t really impact our decision).  If we sink $500,000 into a vacation house that means we wouldn’t be able to invest it at a market average of about 7%.  That comes to about $35,000 per year.

Also, owning a vacation home comes with considerable costs.  There’s property taxes—let’s say $4,000 each year.  We’d also have utilities, including luxuries like internet and cable—we’ll put that at $500 per month or $6,000 annually.  Then, because the ocean is such a harsh environment you have a lot of upkeep.  Air conditioners rust, wood needs to be restained, and on and on; I asked a neighbor who used to live on the beach and they said that was probably another $5,000 annually AT LEAST.

The expenses come to $15,000 a year plus the investment potential at $35,000 a year, so now we’re talking $50,000 annually.  My, oh, my.  What we could do with $50,000?  More on this in a second.

Of course, as we talked about a lot in looking at rental properties and your house as an investment, there are some upsides.  Our beach house could appreciate, but national averages put that at about 0.4% annually, so that comes to about $2,000 each year.  Not a big deal.

Plus, I think (I haven’t found a lot of hard data on this) prices for vacation homes are much more volatile than primary residences.

Also, we could rent it out.  That’s what most people do with vacation homes.  There are some major risks with that.  Best case someone else is putting their butt on my toilet seat.  Worst case is someone turns my slice of heaven into a meth lab.

 

The fun we could have

If we look at all the calculations above, we can simplify it to thinking we have $50,000 annually on vacation.  Think of all the things we could do with $50,000.

If we were super committed to the beach to fulfill my surfing dream, we could rent a place on Airbnb.com.  After a few minutes of searching I found similarly sized places to the one that cost about $500,000 which are also right on the beach.  We could rent those for $6,000ish for the month of July.  Throw in June and August, and we could rent a beach house for the entire summer for $18,000.  If you annualized that $6,000 per month it comes to $72,000 which is more than the $50,000 we were saying owning a beach house would cost, but there are some problems with that.

Since it’s a beach house aren’t those three summer months really the most important?  Honestly, how often would you be going to the beach in November or March?  Maybe a little bit but probably not that much.

You could imagine a similar scenario with a ski cabin in the mountains.  You’d love it during the winter months when the snow was there, but the other times probably wouldn’t be as awesome.

Oh, and there’s that little thing called . . . the cubs.  We have two little cubs who have school and friends and all that.  So it’s not realistic for us to be away from home during the school year.  Maybe we could pull off a whole summer away at a beach house, but if it was a mountain cabin how often could we spend there?

Add in things like sports, friends’ birthday parties, boy scouts, and on and on.  It just doesn’t seem realistic that we could spend enough time there to justify the $50,000 cost.  That leads to the idea of renting it out when we don’t want to be there, that creates a conundrum too.

We’d want to be at our vacation house during the best times (summer months, holiday weekends) when the rental demand would be the highest.  We could get high rents during those peak times, but then that kind of defeats the purpose of US having the place.  We could rent it out when we didn’t want to go (think March), but that’s when most other people wouldn’t want to go either.  You can see the problem.

There’s a huge connection between the amount of time we’d spend at the beach house and the “goodness” of the decision it would be to buy—the more time we spend the better it would be to purchase.  We just talked about how it’s not really realistic to spend all our time there or even most of our time there.  For a beach house you’d probably max out at all three summer months, and maybe 5 weekends scattered throughout the rest of the year.  That’s the absolute most.

Call that a total of 18 weeks or 4.5 months, and that’s really pushing it.  At $6,000 per month (which is inflated because that is all high season), your rental expenses would come to $27,000 a year.  Doesn’t look good.

 

Tied to an anchor

In some way, if we bought the beach house it would seem like a sunk cost.  We’d be paying for it whether we spent time there or not.  That would really motivate us to spend every possible moment there, certainly every vacation there.

Yet, that would be a bit of a miss, no?  Beaches are awesome, but what if we wanted to spend a week in the summer visiting Mimi and Grandpa Ocelot in Michigan?  That’s a week we wouldn’t be at the beach house.  Or Disney, or going up to the mountains, or a trip to Washington DC or California.  Just owning that place would put us in a weird spot where we would feel we’d have to go there all the time even if we wanted to go somewhere else.

Now if we rented, we could go to the beach when it suited us but also anywhere else that caught our fancy.  Plus, apparently there is more than one beach in the world.  If we rented we could go to the beach we would have bought at, let’s say Surf City, but also Virginia Beach, Myrtle Beach, Nags Head, Florida, and on and on.  I understand that going to the same place would be nice to get comfortable there, but variety is the spice of life too.

 

For those main reasons, I think that a vacation home for us doesn’t make sense.  It’s too much, and it ties us to one place.  But I do think there are situations where it does make sense.

If you don’t have little kids, a vacation home makes a lot more sense because you don’t have your calendar dictated by school.  After kids, we could spend the summer months at our beach house but also April and May and then September and October.  Those are beautiful months to stroll on the sand and watch the sun rise over the water.

Plus, as you get older I think you tend to shift from wanting to see a lot of different places to knowing what you like and just wanting that.  My in-laws, Mimi and Grandpa Ocelot are at that stage.  As an example, they have gone to the same timeshare in Florida ever since I’ve known them.  They like the place, like the people, know there won’t be any surprises or anything.

For someone like them you could imagine a vacation home would make sense.  It’s predictable and they could spend enough time there to justify the costs.  Just for Foxy and me, at our age, when we still have an itch to see a lot more of the country and the world, plus with two little cubs, I think you can get a lot more bang for your vacation buck buy NOT buying a vacation home.

Invest in 401k before you payoff student debt

Stocky Leave a comment

“The longest journey begins with a single step” –Laozi (580 BCE)

Investing is a long-term game.  As that really smart Chinese philosopher said, that long-term game needs to start with your first move.  For most people, investing will start when they get their first “adult” job after college (you already know how I feel about college).

Some people start with a clean financial slate when they leave college, but many have student debt from all the loans they took for that degree.  That sets up an interesting question as they get their first paychecks: what to do with the money?  You can even make the question more precise and ask: should I use my savings to payoff my student loans or start investing?  Let’s dive right in

My niece Starty Fox just graduated with her engineering degree from State U.  She has $20,000 in student loans that has an interest rate of 4.45% (I think that’s the current rate for government backed student loans).  Because she listened to her wise uncle, she got an engineering degree which presents many job opportunities.  She took a good job paying $54,000 per year (luckily her salary is divisible by 12 so this post is a little easier to write).  Plus, they offer a 401k which matches her contributions up to 6% of her salary.

After she accounts for rent (her parents made it clear she could visit, but not live with them), her car payment, food, and other living expenses  she is able to save 10% of her income each month.  She makes $4,500 per month and has $450 left over at the end of each month (let’s ignore taxes for a second, but just a second).

So what should she do, payoff that nagging student debt as fast as she can or start investing in her company’s 401k?

 

A match lights the world on fire

Let’s say Starty has a neurosis about her debt.  She was raised never to have any debt (although maybe that’s not always the best idea—here and here), so she wants to pay it off as quickly as she can.

If she applied all $450 each month to her student loans, she would pay off that whole $20,000 in a little over 5 years.  There would be a couple things she wouldn’t like.  First, that $450 would be taxed (just like the rest of her income).  Let’s say her marginal tax rate is 20%, so that means the $450 she has set aside is really only $360 after she pays Uncle Sam.  Taxes are unavoidable, so while that’s a bummer for Starty, she accepts it as a fact of life (although maybe she shouldn’t—more on that in a second).

When it is all said and done, she will have paid everything off by the time she turns 27, which isn’t bad.  Through it all she would have paid about $2,300 in interest.  That interest is tax deductible, so it would only feel like about $1,840.  After everything is paid off, she can start investing in her 401k with a clear conscious.

Let’s take the other extreme, and assume that Starty watched Wall Street a lot with her adoring uncle when she was little.  She’s not too concerned about debt, especially when there are other good investment opportunities out there.  She pays her minimum payment on her loan ($150 per month before taxes, $120 after taxes) and then invests the rest in her 401k.

Obviously, the downside of this is it takes her a lot longer to pay off her loan; instead of being done by age 27, she’ll have the debt until she’s 40.  That sucks.  But she more than makes up for that with her 401k.  Every year she contributes $3,600 to her 401k.  When she does this she has three really big spoonfuls of awesomeness working for her:

  1. Tax free—her 401k contributions are pre-tax so just off the top she is saving $30 per month that would go to taxes if she used that money to pay off her loan. That’s enough to buy a new Lululemon outfit and splurge on extra spin classes each year (Foxy Lady just took over my computer for a second).  Sure, eventually she’ll have to pay that in taxes, but there are a lot of things she can do to minimize that when the time comes.
  2. Match—the big one is that Starty gets to take advantage of her company’s match. They match dollar-for-dollar up to 6% of her salary.  Since she’s contributing more than that, she takes complete advantage of the match, and that comes to $270 each month.
  3. Investment returns—obviously this is why we do invest money. On average Starty is going to earn a 6-8% return on her 401k.

If you put that all into the pot and mix it, you’d have a 27-year-old Starty who is debt-free but with nothing in her 401k, or you could have a 27-year-old with $41,000 in her 401k and still with $16,000 in student loans.  Obviously, the 401k option is much better. She has a net worth of $25,000 on her 27th birthday (versus $0 if she paid off her student loans first).

 

The cause of it all

Those numbers tell a pretty powerful story that from a mathematical point of view, paying off your student loan at the lowest level is best so long as you put that money into your 401k (and not spend it on stupid crap).  However, there are some fairly big assumptions there.

Match—obviously the match is a big part of it all.  Without the match the numbers don’t look nearly as good, but the 401k option still comes out ahead.  On her 27th birthday, she would have a net worth of $5,500, without the match.  Many people may complain that this example isn’t realistic because Starty’s 401k match is so generous, but without the match she still comes out to the good.  And we know a 401k without a match is basically like a traditional IRA which is available to everyone.

Liquidity—when Starty chooses to go all in on her 401k she’s losing a lot of financial flexibility.  At 27 she’ll still have $15,000 of debt that she’ll have to pay off plus she’ll have a lot of her money tied up in her 401k which is very hard to access.  If something happened at ages 22-27 she’d be in pretty much the same boat either way, but after age 27 she’d have a little more flexibility if she had killed the college debt.  This becomes a question very similar to the one we raised with the post on the emergency fund.  Personally, I would be willing to roll the dice for that extra $5-25k over five years, but risk aversion is different for all of us.

That’s all good, but fundamentally this boils down to Starty being able to borrow money at 4.45% (3.6% after taxes) and being able to invest it at a higher rate, 7% for argument’s sake.  Over a 20 year time horizon (about how long it takes her to pay off her student loan), stocks have historically done much better than that 4% hurdle.  For all these reasons, it does make a lot of sense—in Starty’s case thousands of dollars each year—to slowly pay off her college debt and put that money into her 401k.

Emergency fund

Stocky 2 Comments

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

Stocky Leave a comment

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

Stocky Leave a comment

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

Stocky Leave a comment

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)

$785,000

$785,000

$785,000

$500,000
Money “invested”

$785,000

$250,000

$785,000

$250,000
Sale price of house (2015)

$1,150,000

$1,150,000

$1,511,450

$595,375
Profit

$365,000

$365,000

$726,450

$345,375
Gross return

46%

146%

93%

138%
CAGR

8%

20%

14%

19%
Adjusted CAGR

9%

21%

 

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.

Is your house a good investment?

Stocky 5 Comments

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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.

Investing let me get my new car for free

Stocky 5 Comments

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.