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.

Week in Review (8-Sep-2017)

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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

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.

Week in review (1-Sep-2017)

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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?

Harvey

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.

To Roth or not to Roth

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As you enter the world of investing, one of the first decisions you need to make it whether to open a Traditional IRA or a Roth IRA.  Of course, I’m taking for granted that you’re using an IRA to save money, because we know that being smart with taxes is one of the most important things you can do.  As you read this, remember that I’m not a tax expert, but here is how I look at this issue.

These IRA cousins are both tax advantaged, but they go about it in different ways.  With a Traditional IRA, you are allowed deduct your contribution from your taxes that year; however you pay taxes on the money when you withdraw it in retirement.  Conversely, with a Roth IRA you contribute with after-tax dollars but then when you withdraw the money in retirement it’s tax free.

So basically with Traditional and Roth IRAs, you’re making a choice between paying taxes now or later.  If you lived in a world where your tax rate didn’t change over time, there would be no financial implications in the choice between the two IRA types.  The math would work out the exact same.  However, we don’t live in that world.  We live in a world where your tax rate goes up the more money you make.  In this world, we want to pay taxes when our tax rate is at its lowest.  So where does that leave us?

I did some quick estimates of what someone’s marginal tax rate would be in a high tax state (California—where the Foxes used to live) and a low tax state like Florida.  I did this at three different income levels: $50,000 (when you’re just starting out), $100,000 (after you’ve been working for a while), and $20,000 (when you’re in retirement—remember you’ll spend more than that but only $20k will be taxed as income).

MARGINAL TAX RATES

High-tax state

Low-tax state
$50,000 (early working career)

33%

25%
$100,000 (later working career)

37%

28%
$20,000 (retirement)

17%

15%

Wow!!!  Look at that.   We all knew that we would have the highest tax rate when our income peaked.  But did we really expect that we’d be paying double the tax rate when we were starting out compared to when we were retired?  That’s a huge difference.

Now, remember that the major difference between a Traditional IRA and a Roth is when you pay your taxes.  For a Traditional IRA, you’re getting a deduction while you’re working so that $5000 you contribute in your early years gives you a $1667 tax deduction ($5000 x 33% tax rate), and a $1850 deduction ($5000 x 37% tax rate) in your middle years.  Of course you’ll have to pay taxes on that money when you retire, which would be about $850 ($5000 x 17%).  Compare that to a Roth IRA where you’re paying taxes on that $5000 during your early years ($1667) and your middle years ($1850) in order to avoid paying taxes in retirement ($850).

In a world where we want to maximize our portfolio by minimizing our taxes (legally, of course), the answer seems clear—GO WITH A TRADITIONAL IRA.  The back of the envelop math says that going with a Traditional IRA will save you about $1000 per year that you contribute.  Remember that $1000 per year over a working career of 40 years, adds up to about $150,000.  Those are pretty high stakes for what seems like a pretty innocuous choice.

So why do so many people instead go with a Roth IRA?  Why did Stocky Fox himself open up a Roth IRA instead of a Traditional IRA?

  • Don’t understand rules: A major culprit is that many investors don’t understand the tax rules all that well.  Because of that they don’t have a strong opinion on which type of IRA to pick so they go with the one that others tell them is better (which leads to the next reason).
  • Roth IRAs are marketed better: For some reason it seems that Roth IRAs are marketed better than Traditional IRAs.  I don’t know if it’s because “Roth” sounds like an actual name and that draws investors, or what.  But my experience tells me that the average investor would pick a Roth just because that “feels right”.
  • Uncertain tax future: As my loyal readers Mike and Rich have pointed out in the past, the future tax rates are uncertain.  Today we know that a current tax rates make a Traditional IRA a better option, but what if those tax rates change in the future?  It could definitely impact the decision, but who really knows what will happen?  If I could predict the future I would own my own Caribbean island.
  • Get the pain done with: As a kid I used to eat cupcakes upside down; start with the cake and finish with the best part, the frosting.  Some use my cupcake strategy to get the “hard part” over and done with; they choose a Roth IRA because they get the taxes out of the way and then it’s smooth sailing.  This is following your heart instead of your head which may not make sense financially but we all do it.
  • Bad advice: You’ve heard me rail about investment advisers who maybe aren’t all that good.  A lot of people might take advice on which IRA to choose from someone who really hasn’t done the analysis, so they say “yeah, go with the Roth.  Just as good as any.”

I’m sure there are many more reasons but that’s my list.  At the end of the day I think Traditional IRAs are the best choice for most people just because with them, when you do finally pay taxes in retirement you’re probably paying at a lower rate than any time during your working career.  And that choice can be of the six-digit variety.  Yikes!!!

Of course, you there are special circumstances where maybe a Roth IRA works better.  Maybe you’re a kid with really low income (less than $10,000 like from a summer job), but those are probably more the exception.

Let me know what you think in the comments section.

The Trump stock bubble

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The normally very calm and thoughtful T. Lee (a good friend from my Medtronic days) expressed some strong anti-Trump feelings in a comment a couple days ago.  That puts him in good company with a large portion of the country.  But then he asked the following question:

“At what point, if there is one, should we consider pulling our money out of stocks and investments and holding cash, based on the disorder, confusion, and unbelievable uncertainty this tiny man of a president is causing domestically and abroad? Are there any telltale signals? I also ask because the housing market and stock market are at historic highs, and seem due for a pullback. I know it’s impossible to time the market this way, but just wondering perhaps there is an exception under extraordinary times.”

Let’s dig into this and see what we come up with.

 

Things aren’t that bad

Times are insanely partisan right now.  If you don’t like Trump it’s easy to think we are on the brink of oblivion, but things aren’t really that bad.  Let’s look at some times when things were REALLY bad and how stocks did (some of this is from a post I did a couple years ago so you can check that out here).

Let’s think of the worse times in the past 100 years.  A short list probably includes the start of WWII, the atomic bomb dropped, and the assassination of MLK.  In each of those things look bad, really bad, and maybe we would have thought that things were about to fall apart:

When Hitler invaded Poland and started World War II (Sep 1939)

When the US dropped two atomic bombs on Japan and started the nuclear era (August 1945)

When Martin Luther King was assassinated setting of some of the worst race relations since the Civil War (April 1968)

The civil unrest that’s going on in the US right now is a drop in the bucket compared those examples.  Even so, when things looked darkest, being an investor turned out to be a good thing.  That table looks at if you invested $1,000 per month starting at that bad event in the Dow Jones index, and how you would have ended up over different time periods.   Over a 20- or 30-year time horizon we know that we almost always come out ahead.  That definitely held true even in these examples.

I don’t think we have anything to worry about as investors because of Trump or all the current drama.  It’s important to keep things in perspective.

 

Pullbacks do happen

Definitely there will be a point when stocks will pull back.  That’s just the nature of the stock market.  Given that Trump has taken so much credit for the rise in the stock market, it will be interesting to see how he tries to avoid blame when it has a bad few months or a bad year.  Of course, he has shown his ability to grab credit and shed blame as well as any politician, so I’m sure he’ll come up with something.

In my post where I proved I was smarter than a Nobel Prize winner, I based that on the fact that two years ago Robert Schiller predicted stocks would not do well.  I disagreed and was much more optimistic.  Since then stock have been on a major tear, so there you go.

But it can’t last forever.  Here are the stock returns for each of the last nine years since the Great Recession: 28%, 17%, 8%, 9%, 29%, 9%, 0%, 13%, and 12% so far this year.  That’s a dream, and eventually we’ll take a pause from that incredible pace, but of course we don’t know when that will happen.  Robert Schiller, one of the very smartest people in the world, predicted it a couple years ago.  Maybe it will be this year (I did suggest maybe we’re seeing some early signs), or maybe it will be two years from now.  If it’s two years from now, there could very well be another 10% or 20% upside that you don’t want to miss.  As always I recommend holding tight and doing the long-and-steady investment strategy.

 

Bubbles

Despite the craziness going on in the White House right now, things actually seem fairly strong in the economy which makes me think a huge bubble burst unlikely.  If you look back over the past major financial bubbles in the US three come to mind—the Great Depression (1929), the Dot com bust (2001), and the Great Recession (2008)—the issues that caused those don’t seem to be in place.

Of course, it’s impossible to predict what will cause a bubble but if we look at those in turn I think we’ll see that things look okay.

Great Depression—That was the big one that was caused by a perfect storm of bad stuff.  You had an insane asset bubble that captivated the nation and was held up by fraudulent companies.  It was so bad that most of the SEC laws came about afterwards.  What is going on now isn’t anywhere close to that.

Dot com bust—Again we had an asset bubble where stocks that had no profits, and no prospect of getting profits any time soon were being valued through the roof.  Maybe there’s a bit of that now, but it seems fairly tame compared to back then.  Now companies like Amazon and Apple dominate the news, but those are very profitable companies.

Great Recession—This actually had little to do with the stock markets but more to do with the big bets banks were making backed up by small amounts of equity.  Things went bad for a bit, but then rebounded quickly.

That’s a quick rundown, and there’s a lot of detail we could go into for each of those, but none of those telltale signs seems to be with us now.  Banks are stronger than they were, there doesn’t seem to be widespread fraud, and the stocks driving the market are profitable.  But bubbles by their nature are hard to predict, so who knows.

That said, I will give you the steady advice that I always do which is to sit tight, do dollar cost averaging, and in the end you will very likely come out ahead.

Week in review (25-Aug-2017)

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Yawn.  What a boring week for the markets.  There weren’t any meaningful headlines or blockbuster deals that dominated the financial media.  Stocks just trudged along.  At the end of the week we were up 1%, Europe was up a bit more and Pacific a bit less, but still up 1%!!!  That’s really the perfect scenario, no?.  Nothing too crazy happened, the companies just created value in anonymity, and investors were rewarded.

Of course, there were some stories.  Here are the interesting ones that I think drove the market:

 

Home sales are softening

Data came out that home sales were slowing, particularly new home starts.  This is a bit of a big deal in that homebuilding and construction are a fairly large part of our economy.  If that slows that means fewer construction workers have jobs, less building material is being used, etc.  That will impact earnings of companies.

Second, and maybe more important, is that new home builds tend to reflect overall confidence in the economy.  Ultimately, these houses will be bought by someone almost certainly borrowing money with a mortgage.  Those people need to be confident enough in their financial prospects to take that on.  If that confidence is eroding which ultimately makes it to fewer houses being built that might portend the end of our pretty spectacular bull run.  That’s not to say that will happen, but it might be an early hint.

Somewhat related, durable goods orders fell more than expected.  Again it’s a similar calculus.  Durable goods represent a long-term investment so if people are less confident that might be the cause.  Stay tuned on this one.

 

US limits trade of Venezuelan bonds

What is going on in Venezuela is a tragedy.  You may recall I did a post with a former classmate of mine looking at how investments are done in that country.  At the time it seemed very pessimistic, but compared to now those probably seemed like the good ole days.

It’s so sad.  The real tragedy is the humanitarian toll the Venezuelan government is imposing on its people.  Kids are starving, people are going without medicine, simple products can’t be bought, and the currency is becoming tissue paper.  So sad.

The US government imposing these new restrictions is obviously an attempt to break the current Venezuelan government and get something better, ideally capitalist, in there.  It’s a long road but if that could happen a tremendous amount of investment would flood into the 32 million person country with the largest oil reserves in the world.  Companies could make a lot of money capitalizing on those opportunities.  Oh, and by the way, it would help all those millions get good jobs, fill their bellies, educate their kids, and get back to normal.

 

Amazon cuts Whole Foods prices

No week is complete without a story about Amazon changing the world.  On Monday the merger with Whole Foods will be completed.  Amazon made waves by saying they would drastically cut prices at the grocer.  This definitely follows Amazon’s playbook by bring logistic excellence to their operations and passing the savings on to the consumers.

Some have complained this might start a price war with grocers.  I say “bring it on.”  Who loses there?  Maybe grocery stores that haven’t invested in improving their operations so they can’t compete.  Sorry about your luck, but you need to keep up.  Who wins?  We do.  We get better service at lower prices.  Amazon can definitely create tremendous value which makes them money and saves us money, which we can spend or invest in other things.  All that’s good for the stock market.

 

Debt ceiling war

It’s a long time before it would happen, and it’s far from certain that it would, but a debt ceiling showdown looks like it might be coming.  These things are always high drama, and then always have a way of resolving themselves either right before the government would actually shutdown or shortly after it did.

A government shutdown has huge economic implications.  Federal government spending is something like 20% of GDP so it’s a big deal.  Last time this happened, during the Obama administration, stocks fell about 4% when the government shutdown.  After it was quickly back up, stocks regained all that back.

 

Hope you all have a great weekend.

Democrats are the best party for the stock market except . . .

Stocky 3 Comments

. . . when Republicans are

 

“Politics suck” –everyone on Facebook

Given the incredibly bitter political partisanship affecting the country right now, it only seemed right to throw fuel on the fire by asking an incredibly incendiary question like: which political party is better for the stock market?

The stock market is a tricky mistress to the political parties.  Republicans seem to openly court this mistress with their pro-business and more capitalist policies.  When the stock market does well that is seen as a success.  Ronald Reagan’s trickle-down economics would have the stock market winners, who tend to be clustered among the wealthy, spend more and benefit everyone.

Most recently, Donald Trump has hailed the tremendous bull market during his presidency as a sign that his policies are working.  In case you’re curious, the S&P 500 is up over 15% since he was elected.   That’s pretty good, but certainly not the best.  Since 1950, of the 10 presidents who became president after being elected (I’m not counting Johnson or Ford), Trump ranks 3rd highest, behind John Kennedy (23%) and George HW Bush (25%) over similar time periods.

It’s a bit more complicated with Democrats with their more progressive agendas and socialist policies.  But make no mistake, Democrats want stocks to do well too.  Good stock markets are correlated with low unemployment.  When the stock market does well tax receipts are up.  One of the core bastions of Democrat ideology, the pension fund for public employees is nearly totally dependent on a strong stock market.

Whatever, that’s all politics.  You can agree or disagree with my thinking, but I don’t think there’s any doubt that both parties want the stock market to do well.

 

Republicans or Democrats?

So that leads to the big question: which political party does better with the stock market?

Here’s a table with a lot of data.  It shows the average return as well as the number of years since November 1950* for each scenario:

  Congress      
President

Republican

Democrat

Split

TOTAL
Republican

12%

(7 years)

3%

(22 years)

4%

(8 years)

5%

(37 years)
Democrat

16%

(8 years)

10%

(18 years)

15%

(4 years)

12%

(30 years)
TOTAL

14%

(15 years)

6%

(40 years)

8%

(12 years)

8%

(67 years)

 

There have been 37 years of Republican presidents and 30 years of Democrat presidents.  The average return for Republican presidents is 5%, for Democrats 12%.  Clearly DEMOCRATS are better, but wait . . .

Republicans have controlled both chambers of Congress 15 years, Democrats 40 years, and it has been split 12 years.  The average return for Republican Congresses is 14%, Democrat Congresses 6%, and split Congresses 8%.  Clearly REPUBLICANS are better, but wait . . .

Republican presidents have had a Republican Congress for 7 years where the average return was 12%.  Democrat presidents have had a Democrat congress for 18 years with an average return of 10%.  Clearly REPUBLICANS are better, barely, but wait . . .

Republican presidents have served with Democratic Congresses for 22 years with an average return of 3%.  Democrat presidents have served with Republican Congresses 8 years with an average return of 16%.  Clearly . . . wait there’s nothing clear about this one.  Who should get the blame for those below average Republican president/Democrat Congress years?  Who should get the credit for those really, really good Democrat president/Republican Congress years (that was mostly during Clinton’s administration)?

There’s a lot of ambiguity here, and I don’t think there’s a clear answer.  We could argue about it on Facebook, but that’s about as fun as a root canal.  No thanks.

 

There must be something in the water

Since 1950 the US stock market has done really well, amazingly well.  In November 1950, the S&P 500 was at 19.51; today it’s at 2480.91.  Let that sink in for a minute.

All that data I showed you was valuable to see in that it confirmed we are on a bit of a fool’s errand.  Asking if Republicans or Democrats make the stock market do better is the wrong question.  The important observation is that the stock market does well no matter who is running things.  If you’re an optimist that means either party is filled with good stewards who keep things going in a positive direction.  If you’re a pessimist that means the the American economy is so strong and robust that the idiots in Washington, on either side of the aisle, can’t screw things up.  Either way, that is a tremendously powerful and important and comforting insight.

The day after Trump was elected, the stock market had a really good day, rising 1.1% (Reagan’s day-after-election rise was 1.8%).  That was based on expectations of tax reform, reduced regulation, and healthcare reform, to name a few.  So far, pretty much none of that has come to pass, yet stocks are up 15%.

How different would that have been if Hillary Clinton was elected?  Maybe she doesn’t sign some of those executive orders on the Keystone pipeline.  Maybe she doesn’t rollback some of the regulations Trump has, maybe she adds some he hasn’t.  All maybes.  But those are all drops in the bucket compared to the gargantuan size of the US economy and the stock market which reflects it.

My absolute belief is that a strong US stock market reflects a strong US economy and business environment.  Awesomely, that goes beyond the power of one person in an oval office or 535 people down the road a bit.  We will win no matter who is there, and that makes things a lot easier.

So my answer is: Republicans are better for stocks but Democrats are better for markets.  Wait, maybe Democrats are better for stocks and Republicans are better for markets.  I forget now.  Damnit.

 

*All analysis in this post is based on the S&P 500 since the midterm election in November 1950.

Plumber Fox or Electrician Fox

Stocky 1 Comment

For the past two posts, you’ve heard me rail about college, fundamentally questioning whether the astronomical tuition costs are worth it (here and here).  The real test is what I do with ‘Lil and Mini Fox.  Here are my thoughts:

 

Saving in a 529

Currently we are saving $1,000 per month in a 529.  That will build to about $400,000 which will allow both cubs to attend a public college (like UNC-Chapel Hill) with a fair amount left over, both to attend a private college (like Duke) but we’ll need to come up with more money, or one to go to a public college and the other a private college and we’ll pretty much spend it all.

If you are planning on your child getting any education beyond high school, 529s are a no-brainer.  They act like a Roth IRA in that they invest after tax money, but then all the investment returns are tax free.  That can really add up to some significant tax savings.

 

The best or . . . something really good

Foxy Lady and I have been blessed to have good jobs that have allowed us to build a comfortable nestegg.  One of the things we want to do with that is afford our cubs the opportunities to help them succeed.

If either ‘Lil Fox or Mini Fox turns out to be super smart and super hard working and super ambitious and is able to leverage those to get into one of the very best colleges in the country, we want to make the financial considerations a non-issue.

However, “best colleges” is a tricky term.  If either got into Harvard or Stanford, they would go and Foxy Lady and I would come up with the money, no questions asked.  You can include U of Chicago (where Foxy and I got our MBAs), MIT, Duke, Penn, Princeton, and CalTech as similarly expensive schools that we would swallow hard but also pay to gladly send our cubs to.

Beyond that, it’s hard to think of private colleges that would justify the 3x money that a public school would cost.  That’s not to say there aren’t great private colleges that didn’t make my list of eight, but are they worth the extra cost?  I don’t think so.

 

Local public college, but only if . . .

We’re lucky that in North Carolina we have some really great public universities.  UNC-Chapel Hill is regularly rated as one of the very best.  As a North Carolina tax payer we get access to that fine institution at a substantial discount.  Also, NC State is very strong, especially in STEM.  ‘Lil and Mini could get world class educations there.

Yet, Dad’s going to put some strings on that.  If that’s the path they take they have to major in STEM, business, pre-law, pre-med, or some other area that can reliably offer jobs that justify the educational expense.  I was a finance major and that has paid off.  Foxy Lady was a marketing major and that paid off.

UNC is a great school and I have no reason to believe their drama and literature and sports science and art history and music and Asian studies and creative writing departments are great, being taught by dedicated professionals.  But none of those majors offer good-paying jobs to the average graduate.  The main point of my last post was looking at the significant expenses of college and making sure the job you get with that degree offsets those costs.  For all those majors and many, many more, it’s not even close.  I’m not about to spend a hundred grand so my cub can get a journalism degree then become a host at Applebees.

 

Trade college for a trade

This is the one I really get excited about.  If our cubs aren’t Harvard material and aren’t interested in STEM, pursuing the trades is something Foxy and I are really going to push.  Follow my logic:

Being a plumber or electrician has some great things going for it.  First they make really good money.  A plumber makes on average about $51,000.  Remember that an average college graduate makes about $60,000, so they’re pretty close.  Add in to that our discussion last post about “smart non-college kids” and if our cubs are smart enough and hard enough workers to average $60,000 as college graduates if they got that degree, they’ll definitely be able to make more than $51,000—probably fairly close to $60,000.  That makes the salary a wash.

Also, the cubs can hit the ground running right out of high school.  It takes about a couple years to get your license and a few years after that to become a master plumber.  But you’re still being paid during that time, not paying tuition during that time.  Big difference.  Plus, by the time they would have finished college and entered the workforce making about $33,000 they could be a master plumber earning substantially more than that.

When you choose your education, you want to get something that will be in demand.  It’s hard to say what the future will hold, but people will definitely continue to poop.  Joking aside (although I do believe they will), there are a lot of reasons to believe that plumbers and electricians will continue to be in demand.  First, those vocations currently skew older because that’s when the trades were taught more widely.  There are a lot of 50- and 60-year old plumbers and electricians.  It’s not a sexy job that kids today want to pursue, so those who actually do will make a killing.

Second, the world is changing in ways that will probably need that skillset.  Plumbing and electrical wires are constantly breaking down so that will always provide steady business.  Plus, changes are coming that play right into their hands.  Two years ago we installed solar panels on our roof, and you know who did a lot of that work?  California just went through a major drought which caused everyone to roll back their water usage; you know who installed those water-efficient showerheads and toilets?

 

An ace in the hole

You can tell I have an interest here.  So it’s probably not surprising that whenever a plumber or electrician comes to our house (and charges about $200 for 20 minutes of work—not bad) I ask a lot of questions.

One thing that often comes up is what success looks like for them.  Like everyone in any job, there are always those things that remain just out of their reach, but “man, if I could get that I’d have it made.”  For a lot of tradespeople, it’s being able to go out on their own.

There was one electrician I talked to a lot when we installed our solar panels.  He was about 35 and had been working for this company for about 8 years.  He said he made about $50,000 a year and he was happy with that but he knew he could do better.  He’d love to start his own business.  When I asked him what was stopping him, he rubbed his fingers together.  MONEY.

He just didn’t have the money saved up to go out on his own.  I asked more details and he said it came down to having a truck and all the necessary tools (there are a lot).  Once he had that, he could do his own thing, be his own boss, and keep everything he made instead of a portion going to his boss.

How much were we talking to get him set up like that?  Between $80,000 and $100,000.  That’s a lot of money, no question.  For this guy, as well as most Americans whether or not they have a college degree, that’s an unattainable sum.  That causes him to continue to work for someone else and not realize his full potential.

Do you know who does have $100,000?  A kid like ‘Lil or Mini, whose parents have saved more than that for their college education.  If ‘Lil Fox foregoes $100,000 (or $280,000 at a private college) of college costs, that money will be there and could be used for setting him up as an independent plumber.  That puts him at a huge advantage, and isn’t that what Foxy Lady and I want to do with the education money we have saved for our cubs?

You could easily imagine our conversation with him: “We have saved $200,000 for your college, and we know you would be successful there if you wanted to be.  Instead, become a plumber.  In two years you’ll be licensed and three years after that you’ll be a master plumber.  When that happens, as a ‘graduation gift’ we will get you the best work truck with the best tools, plus we’ll cover your business’s expenses for the first six months.”

 

Who knows how all this will pan out.  These are my ideas right now.  We have 13 years until ‘Lil Fox needs to make this decision, and a lot can change in that time.  Also, there’s the little thing of what he want to do.  But as of now, unless he gets accepted to Harvard or wants to become an engineer, I am really liking the plumber idea.

However, this post particularly the two before it really shed light on this enormously important decision and how all of us as loving parents can think about it a bit differently than we have been brainwashed to.

Week in review (18-Aug-2017)

Stocky 1 Comment

It was a bit of a roller coaster for stocks this week.  After stocks were down big last week, stocks shot up over 1% on Monday but gave all those gains back and more on Thursday.  The week ended with US stocks down 1% for the week, Pacific stocks up 1% for the week and European and Emerging stocks in between.

 

Merck CEO quits President’s advisory team

Similar to last week, the biggest business news story was a very important social story that cast a shadow over everything: The despicable neo-Nazi terrorist attack that left one woman dead horrified the country.

However, the real story became President Trump’s response.  His delay in overtly condemning white supremacists lead to public outcry.  Merck’s CEO, Kenneth Frazier, was the first of several leaders who cut ties with the president by leaving his American Manufacturing Council.  As the story continued to spiral, Trump eventually disbanded the council.

Given the racial overtones here, Frazier’s departure is particularly notable in that he is one of only five black CEOs of Fortune 500 companies.

 

Chinese company tries to buy Chrysler

Rumors circulated on Monday there was a Chinese suitor looking to buy Fiat Chrysler.  This is interesting just because Chrysler has been bought and sold a few times, first to Mercedes and then to Fiat.  I’m not sure any of those transactions worked out well for the buyer.  Now it might be a Chinese company.

Second, and more broadly to the market, I think merger and acquisition activities are generally positive.  If a purchase is made, it will certainly be at a premium over Fiat Chrysler’s current market value.  That’s good for Fiat Chrysler’s shareholders in particular, but it’s good more broadly in that it shows that there are companies out there who look at assets and think they can do it better, and they’re willing to put their money where their mouth is.  It will be interesting to see how this unfolds.

 

Amazon creates pickup locations

Amazon continues to change the world.  They announced this week that they are piloting locations where you can order something online and then go pick it up minutes later.  It’s easy to see how this can be tremendously convenient.  It’s also not a big leap, if this is successful, to see this concept expanding to the point where we eventually get on-demand, nearly instantly-delivered products.

I kind of feel like twenty years from now this is how the world we’ll go, and we’ll be telling our kids how things were before 2017.  They’ll look at us like we were crazy to have to wait a couple days to get stuff online.  From a stock perspective there are going to be huge winners that are going to enjoy tremendous value creation as they make our lives easier.  Who knows if Amazon is going to be one of those winner, but it’s certainly hard to imagine them not being there based on their current winning streak.

 

China’s Alibaba shows tremendous growth

Amazon may be taking over the world, but there are other companies that are playing in the game too.  Alibaba, which is basically China’s version of Amazon, has been growing tremendously.  On Thursday they announced they grew over 50% to have quarterly revenue of about $7 billion.  That’s a far cry from Amazon’s $38 billion a quarter, but who knows?

The world of retail is changing in unimaginable ways.  The world of international commerce is also changing and the opportunities presented in China are unimaginably promising.  Like the note above on Amazon, I think Abibaba is also good news for the stock market.  Obviously shareholders of Alibaba are doing well, but this is a real rising tide raises all ships.  As Alibaba does well they are serving new and richer consumers who really haven’t been served before.  That’s a lot of upside, and that translates to good news for the companies that are involved in that and by extension their shareholders.

 

Foot Locker plummets

Since we’ve spent so much time talking about retail and how it’s changing, it seems appropriate that the week ended with an old-model retailer, Foot Locker, missing earnings big and their stock plummeting.  It’s pretty amazing to see such a colossal transition happen so quickly.

Foot Lockers were staples in the mall, where a teenage Stocky and his friends would marvel at the new Jordans, wishing our parents would give us a $150 to spend on a pair of shoes.  Foot Locker’s employee uniforms (black and white striped referee shirts) entered the sports lexicon when fans would complain that refs who made a bad call should “go back to Foot Locker.”

And now it looks like it’s ending.  Another brick and mortar retailer is being replaced by a better, faster, cheaper online buying experience.  As consumers, we’re benefiting and as shareholders we are (so long as you don’t own Foot Locker).  While the tide is rising, there are individual winners and losers, and it’s a bit nostalgic to see one of those titans from yesterday in the process of crumbling.