4.50% Interest Rates…Hold Your Horses

A report leaked last week that the Federal Reserve was considering lowering the 30 year fixed rate to 4.50%, over a percent lower than the current market, in an effort to stimulate home buying.

The Wall Street Journal reported the following:

- “The plan, which is in the development stage, would temporarily use the clout of mortgage giants Fannie Mae and Freddie Mac to encourage banks to lend at rates as low as 4.5%.”

- “The plan remains in discussion and may not be made final before the Bush administration’s term ends in January.”

- “The lower interest rates would be available only to borrowers who are buying a home, not those refinancing a mortgage.”

- “Borrowers would have to qualify for a mortgage guaranteed by Fannie, Freddie or the Federal Housing Administration. Those guarantees apply to loans where borrowers can document their income and afford their monthly payments, steering the government away from backing loans considered risky.”

How would this happen…and would it work?

Fixed mortgage rates are tied to Mortgage Backed Securities (MBS) which are similar to stocks except that they are tied to mortgages as the security whereas a company is the security for a stock. Both stocks and MBS are priced based on supply and demand. The more investors want a stock the higher the price goes and vice versa. MBS function the same way.

Because the  price is determined by supply and demand, the Fed would have to artificially drive the rates down to 4.50%. In plain terms, they would pay to get them down. The only source of cash I know about would come through borrowing or printing the money needed to pay the difference between the current market rates and the new target rate.

When the government borrows and/or prints money, it is inflationary. Inflation simply means that the dollar you have now will not go as far in the future because it is worth less. By artificially driving down rates they will be stoking the inflation fire.

The reason this is bad for interest rates lies in the mechanics behind how rates work. As mentioned before, rates come from an investment vehicle called MBS. Investors who choose to put their money in MBS instead of stocks do it because they are looking for a safe, fixed return. If the return they want is say 4.50% and inflation strikes, the return of 4.50% is actually worth less than that. In other words, if your 4.50% investment paid you $1000 month and the inflation rate goes up, due to the government borrowing or printing money (which it will), then your $1000 will only buy you $900 worth of goods and services. Now the investor needs a 5% return to buy the equivalent to $1000 worth of goods and services. This is a vicious cycle and will work against the very mechanism used to artificially drive down rates.

In summary, can the government artificially drive down rates? Yes.

If they do, will it last long? I do not see how it could based on the mechanics of the market I have described above.

If they do it, who will benefit? Because it will take money to drive the rates down the Feds would need to identify some parameters on what loans they would offer this on. It will certainly only be purchase loans as mentioned in the WSJ and I speculate that it will be for a specific target market, maybe a certain loan amount range and quality of buyer. They do not have the money to open it up to all loans of any size or type and any and all borrowers.

If it happens, great. If it does not, rates are fantastic now and more importantly, the big money is made on a purchase through negotiating the right price, not a little lower interest rate. What makes buying now so appealing is the phenomenal deals you can get. If 4.50% comes and everyone jumps in, don't you think sellers will hold more firm on their prices with buyers swarming everywhere?

Don't Be a Fearmonger

If you look around you will notice that nearly everyone around you is scared. They are not sure what will happen with the economy and more importantly their jobs. Will they ever be able to recover from the 45% haircut the stock market drop has given them?

A very insightful article came out in the New York Times on Sunday titled In Hard Times, Fear Can Impair Decision Making. It is written by Gregory Berns, a neuroeconomist and directs the Center for Neuropolicy at Emory University. In the article he makes the following observations:

“And while fear is a deep-seated and adaptive evolutionary drive for self-preservation, it makes it impossible to concentrate on anything but saving our skin by getting out of the box intact.”

“Ultimately, no good can come from this type of decision making. Fear prompts retreat. It is the antipode to progress. Just when we need new ideas most, everyone is seized up in fear, trying to prevent losing what we have.”

Take some time to observe your own behavior and test what he is saying. It is certainly true with me. Now is the time to go against the grain and create opportunities for ourselves. You may be thinking, easier said than done. You may be surprised.

“The most concrete thing that neuroscience tells us is that when the fear system of the brain is active, exploratory activity and risk-taking are turned off. The first order of business, then, is to neutralize the system.”

“This means not being a fearmonger. It means avoiding people who are overly pessimistic about the economy. It means tuning out media that fan emotional flames. Unless you are a day-trader, it means closing the Web page with the market ticker. It does mean being prepared, but not being a hypervigilant, everyone-in-the-bunker type.”

I would suggest a couple of more things that you can do to “neutralize the (fear) system”:

1. Spend 10-15 minutes each morning visualizing your ideal life
2. Spend 20-30 minutes reading something uplifting (personal growth book, poetry, human victory story)
3. Workout for at least 30 minutes per day
4. Start a gratitude journal, taking careful inventory of all that you are blessed with
5. Set goals and clear daily and weekly objectives so you have a clear path of the life you are designing. This will take you out of the helpless victim role that often accompanies fear.

            

My Wife Was Right... Again

As is true to the relationship my wife and I have, she was right, but I wouldn’t accept it until someone else told me.

I had tried to get her to read more business and personal growth books for a number of years as she read a bunch of stuff that would surely never make anybody any money. She reads a wide variety of literature including the classics and poetry.

Wise old me had spent the last decade reading the business bestsellers along with every financial book I could find. Although I have learned a lot over the years, it was not the secret formula.

It was then that I was introduced to an article in the New York Times titled C.E.O. Libraries Reveal Keys to Success.

Michael Moritz, venture capitalist and owner of a huge library, says he can’t discard books.

The article is summed up best by a line in it that declares, “Serious leaders who are serious readers build personal libraries dedicated to how to think, not how to compete.”

To be really wealthy I cannot copy or mimic what others are doing and expect to get top 1% results. In other words, if I spend my time attempting to do what others have done I will always be one step behind. I must learn to think for myself.

What do the best thinkers in our country read?

Read the article and see for yourself, but don’t tell your wife that this is where you learned it!

I.O.U.S.A.

If money plays a role in your life then I highly suggest watching the movie I.O.U.S.A. Roger Ebert said, "...it accomplishes an amazing thing. It explains the national debt..."

Visit the official movie website

Reuters said "I.O.U.S.A." "may be to the U.S. economy what 'An Inconvenient Truth' was to the environment."

We must educate ourselves on the forces that will determine our ability to live the American Dream.

Watch the 2 minute trailer

Or watch the Byte Sized 30 minute version of the movie

http://www.youtube.com/watch?v=O_TjBNjc9Bo

To get involved I recommend 

http://ww.pgpf.org/getinvolved/signup/

Seems So Obvious

In every choice there are two elements of the equation, pain and pleasure. In this lies one of the great secrets of life: we have the free agency to choose which one comes first with the great caveat, the element not selected will always come second and last longer. Let me say it another way, the element we choose first has a short duration and the second element will last far longer.

Here is what I mean; not long after I was introduced to this principle I was driving home from Seattle to Portland with a few colleagues. A short distance into the drive I pulled over to get some gas. I broke from the lively discussion on this very topic to go into the quickie mart and proceeded to buy a 44 ounce soda and a 3-packer of cupcakes. You know the really healthy Hostess type. Back in the car and two and half cupcakes down it dawned on me that I had just scheduled pleasure (sugar high) first with the pain (gut ache and life of flab if continued) to follow. What was just as eye opening was that it did not matter whether I was aware of the principle or not. It is a mechanism or principle that functions just the same.

What if I had scheduled pain first by way of water and a Power Bar? Consequently I would have benefitted from long lasting energy and a show stopping six-pack, pleasure! Far better decision.

This principle is highly active and visible in personal finance. I can schedule the pleasure (new outfit from Nordstrom’s) now and the pain (lack of savings for retirement and/or college fund for children) will most certainly follow and last well beyond the awe inspiring confidence of some new digs.

Where in your life are you ignorantly scheduling pleasure first, unaware that a long period of pain is waiting to pounce?

Take an inventory of your personal finances and identify at least one change you could make today by reversing the order of pleasure and pain.

From experience, the short term pain of saying “no” results in long lasting pleasure in the form of great peace and possibility.

Seven Simple Rules to Follow in Life

Joshua Wooden, father of the great John Wooden, gave him a little white note card for his elementary school graduation (back then, graduation of elementary school was a big deal as many did not graduate high school). He wrote the creed he had so often shared with his kids: 

Seven Simple Rules to Follow in Life

1.    Be true to yourself

2.    Help others

3.    Make each day your masterpiece

4.    Drink deeply from good books, especially the Bible

5.    Make friendship a fine art

6.    Build a shelter against a rainy day

7.    Pray for guidance, and count and give thanks for your blessings every day

As he read the card his dad said, “Johnny, try and live up to these and you’ll do alright.”

In a world that is ever-changing and at a rapidly increasing pace, I have begun a quest for principles that are timeless. What can I be sure of in building my foundation?

This was advice given before 1920 and is quite possibly more valuable today than it was then.

It helped build a foundation for John Wooden that led to 53 years of marriage and made him the greatest college basketball coach of all time. He led UCLA to win 10 National Championships in 12 years.

What would the integration of these principles do for your family, career and life? I have no doubt that they will make me a better, more successful and happier person.

Lifetime Winner

“When you improve a little each day, eventually big things occur. When you improve conditioning a little each day, eventually you have a big improvement in conditioning. Not tomorrow, not the next day, but eventually a big gain is made. Don’t look for the big, quick improvement. Seek the small improvement one day at a time. That’s the only way it happens—and when it happens it lasts.”

- John Wooden

This quote is coming from arguably the best college basketball coach of all time. He won the National Championship 10 out of 12 years at UCLA! What a philosophy to live by.

I don’t know about you, but the “get rich quick” or “buy now, pay later” messages of the day are sure seductive. They certainly offer an easier road to travel. (That LypoDissolve pill that makes all of your fat magically disappear with no change in diet or without ever working out is tempting, but come on, really?) No hard work, self discipline, or persistence required.

After years of reflecting on these two varying philosophies I am reminded of a statement from a business course I took:

All interpretations are valid; however, they are not equally powerful.

As I reflect on all of the people I most admire, none of them were a one hit wonder. They were people who persevered. They kept after it, never giving up. It is through the very un-sexy work of discipline and persistence where the most valuable attributes are developed. It is these very attributes that build a foundation for future success. This cycle, if repeated over the years produces lasting success.

Don’t shirk the hard work if you really want to be a lifetime winner!

College Costs What?

College costs keep rising. How much and how do you possibly fund it?

First, the newest numbers:

On October 29, 2008, the College Board released college cost figures for the 2008/2009 academic year in its Trends in College Pricing Report. Not surprisingly, costs went up in every category. Here are the highlights: To view the 2008 Trends in College Pricing report, Downloand College Cost 2008.

Public colleges (in-state students):

Tuition and fees increased an average of 6.4%

Room and board increased an average of 5.2%

Total average cost for 2008/2009: $18,326

Public colleges (out-of-state students):

Tuition and fees increased an average of 5.2%

Room and board increased an average of 5.2%

Total average cost for 2008/2009: $29,193

Private colleges:

Tuition and fees increased an average of 5.9%

Room and board increased an average of 4.8%

Total average cost for 2008/2009: $37,390

"Total average cost" includes tuition and fees, room and board, books and supplies, transportation, and other miscellaneous costs.

The College Board stated, however, that average cost is not necessarily representative of what most college students pay. The Board noted that there is considerable variation in price among institutions, and that almost two-thirds of undergraduate students enrolled full-time receive grants that reduce the actual price of college.

I suggest two different ways to insure you are prepared:

1. Maximize an ESA College Savings Fund – ESA stands for Education Savings Account. ESA allows for a maximum annual contribution of $2,000 per student. The earnings in the account grow tax-free as long as distributions are used for eligible expenses, which are not limited to college costs.

$2000 invested annually at 8% for 18 years equals $74,900

2. Buy a rental property –when your child is young, buy a property for multiple reasons:

§   it will appreciate at 3-5% for ten plus years before college money is due

§   rental rates will increase at 3-5% producing some cash flow to help with expenses

§   use it as a teaching tool for your child; help them learn to care for it, find and screen renters, manage the finances of the property, pay taxes, etc. This will be a life altering experience that will give them a leg up in a financial education deprived world we live in

$200,000 house appreciating at 4% over 10 years will be worth $296,048

$1200 in rent increasing at 4% over 10 years will climb to $1776

A Cheesy Sweater?

Years ago when asking my mother what she wanted for Christmas I was perplexed at her request. She said she wanted us three kids to memorize a quote on attitude by Charles Swindoll. It was a quote that I had read a number of times over the years by virtue of seeing it every time I went to the fridge.

In my infinite wisdom, I concluded that memorizing a quote was not a good gift, what she really would enjoy was a nice sweater from the Gap. I never spoke to my younger brother or sister about this and had frankly forgotten the original request.

Christmas morning rolled around and I of course watched her open a cheesy sweater that she would not be caught dead in now. She faked her satisfaction, gave me hug and we were on to the next gift. As we went around the circle it was time for my brother and sister to give their gifts to mom. In unison they recited the cherished quote,

"The longer I live, the more I realize the impact of attitude on life. Attitude, to me, is more important than facts. It is more important than the past, than education, than money, than circumstances, than failures, than successes, than what other people think or say or do. It is more important than appearance, giftedness or skill. It will make or break a company...a church...a home.

The remarkable thing is we have a choice everyday regarding the attitude we will embrace for that day. We cannot change the past...we cannot change that people will act in a certain way. We cannot change the inevitable. The only thing we can do is play on the one string we have, and that is our attitude.

I am convinced that life is 10% what happens to me and 90% how I react to it. And so it is with you...we are in charge of our attitudes."

With tears running down her face she thanked them for their effort. Looking back, it is now crystal clear that the emotion she was feeling was her ability to foresee the lasting impact on my siblings of memorizing those words. What a valuable lesson from a loving mother.

With so much going on around us that we cannot control, the empowering words of Charles Swindoll ring in my ears almost daily. We are in charge of our attitudes!

You Won't Know Unless You Measure

I have a new practice of inviting at a minimum, two influential people to lunch every month. Yesterday I took a guy to lunch that is an ex-accountant. 30 years ago he left one of the big eight firms (at the time) to be a partner and acting CFO and COO of a Cummins distributorship. 3 years ago, after years of diligent effort, he and his partner sold the business. It was rumored to have sold for well over 100 million. Not bad, eh?

Over lunch, I asked him, "What was the factor that most contributed to your success?" He shared a philosophy that they lived by:

        You don’t know what you don’t know

        You can’t do what you don’t know

        You won’t know unless you measure

        If you value it, measure it

        If you don’t value it, don’t measure it and don’t do it

They used this philosophy to dramatically increase profit margins in every department of the company.

That is an extremely pertinent and powerful philosophy if applied to personal finance as well as business. A vast majority of people have no clue what their numbers are. I’ll prove it.

-           How much money did you spend on gas last month vs. what your projections were?

-           How much money did you spend on entertainment last month?

-           What percentage of your income did you invest or save last month? how much was that? (if the number is 0%, don’t get thinking you are too smart for knowing your numbers=)

-           What is your net worth? what is the year over year increase or decrease?

-           How much money will it take for you to retire at your desired retirement age to maintain the lifestyle you currently have?

How to apply the philosophy to personal finance:

1.  Budget – track your expenses (all of them), eliminate unnecessary “wants”, make sure your “needs” are less than what you earn,  go to a cash system and when the money is out, stop spending (McDonald’s per transaction sale went up 47% when they began accepting credit cards)

2.  Net worth – what is the value of all of your assets minus all of your liabilities. The difference is your net worth. This is an important number as it will be an indicator of your capacity to stop working someday

3.  Capital at Work – how much money is working on your behalf each day? This is determined by summing up the value of your stocks, bonds, and investment accounts.

Stay tuned for a more detailed explanation of each – how to track, utilize and improve them for the sake of improving your financial situation and ultimately reaching your financial objectives.

Saved By Zero

While watching Monday night football last night I couldn’t help but laugh at Toyota’s new car commercial. The catchy tune they sing during the commercial consists of a chorus only, with the words “saved by zero” sang over and over again promoting their new 0% financing on a majority of their models.

I am not sure if they mean that their revenues and therefore 4^th Qtr will be saved if enough people buy because of 0% financing or if they are saving “us” by providing 0% financing?

In researching new car depreciation for this entry I discovered that a vast majority of experts agree on depreciation figures. In year one you can expect 15-20% depreciation and 10% each year after that.

Here is what Toyota’s “Saved by Zero” financing is really costing:

        brand new          $32,155

year one            $24,000 value

        year two            $21,600 value

        year three          $19,440 value

        year four            $17,496 value

To confirm, I priced out a new Camry on the Toyota site and also found a used one on AutoTrader.com. The results are strikingly similar:

Brand New Camry XLE fully loaded                 $32,155

2004 Camry XLE fully loaded                         $16,150

Interesting that even a Toyota Camry, a very reliable car, keeps pace with average new car depreciation rates.

Your “Saved by Zero” deal costs you $333.44 a month or $76.95 a week in depreciation.

A lot can be learned with a little research so that you can decipher who is really saving me and who is looking to save themselves.

Cash is King

A couple of years ago a wise, old, financial mentor of mine said to me after reviewing my financials, “I am very impressed. You have built up quite a net worth at a young age and are on a path to go far in life. However, if there is any advice I could give you it is that cash is king!” 

At the time I had good equity in a growing company, lots of real estate holdings and very little cash reserves. Although I understood what he meant, I did not know what he meant. I use the word know to mean - understand it to the point of creating powerful thought and action.

Fast forward three years. What if I had taken his advice to heart and been on a quest to accumulate cash? Everything is on sale right now!

Real estate as evidenced by the Case Shiller report shows discounts approaching 20% off in the nations largest 20 cities.

Stocks and bonds (at home and abroad) have had their prices slashed dramatically this year:

Dow Jones Industrial Average -- over 35% down

Nasdaq -- over 40% down

S & P 500 -- over 40% down

Emerging Market Stocks -- almost 60% down

REITS -- over 40% down

Welcome to a buyers market without any buyers!

Very few have cash right now. They may have equity but cannot get to it. This is the time you want to be buying, in a buyers market without any buyers. If you have cash, now is the time to be building your fortune like those in the time of the Great Depression did.

Warren Buffet was quoted as saying, “When the prices are right, I can buy companies faster than Imelda Marcos can buy shoes.”

Lessons I will apply the next cycle:

1. Don’t get greedy when everything is racing up – remember Nordstrom has the Twice Yearly Sale, real estate and stocks have a Twice a Decade Sale

2. Take money off the table - it is not necessary to go all in, every hand. get comfortable with the coffers full of cash, poised for the next big sale

3. They are called cycles for a reason – prices go up and prices come down, round and round they go. be a buyer in the down cycle

4. Be a contrarian! 

5. Start now - now is the time to begin preparing for the next great opportunity. be a student now. build your wealth habits now.

A Crisis is a Terrible Thing to Waste

“A crisis is a terrible thing to waste”, said the CEO of Merck, Richard Clark recently.

What a refreshing statement to hear! 

In Chinese philosophy, the concept of yin and yang is used to describe how seemingly opposing forces are bound together, intertwined, and interdependent in the natural world, giving rise to each other in turn.

I believe this to be true. At a time of great danger and fear lies one of the greatest opportunities to build wealth we have seen in decades.

Are you looking for opportunities or hiding under your kitchen table? Is it possible this is the break you have been waiting for?

Did you know that there were more millionaires created per capita during the Great Depression than at any other time in our country's history?

Maybe it is time to adjust your belief systems to a more powerful way of thinking. You will find exactly what you are looking for. Are you looking for opportunities or looking for danger and despair?

Chains of Habit

“Chains of habit are too light to be felt until they are too heavy to be broken.” - Warren Buffett

It is my belief that a vast majority of the economic struggles we are experiencing today have been brought on by poor habits and a disregard to the fundamental laws of money. The NY Times reported that “For decades — from the 1950s through the 1980s — Americans spent about 91 percent of their income, on average, and put away the rest. In the last few years, they have spent close to 99 percent and saved only about 1 percent.” Recent government data shows the personal savings rate has been negative for the last two years. At some point the merri-go-round has to stop. 

Where would we be today if we had adhered to the Five Laws of Gold from the classic book, Richest Man in Babylon?

FIVE LAWS OF GOLD

1. Gold cometh gladly and in increasing quantity to any man who will put by not less than one-tenth of his earnings to create an estate for his future and that of his family
2. Gold laboreth diligently and contentedly for the wise owner who finds for it profitable employment, multiplying even as the flocks of the field.
3. Gold clingeth to the protection of the cautious owner who invests it under the advice of men wise in its handling.
4. Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those skilled in its keep
5. Gold flees the man who would force it to impossible earnings or who followeth the alluring advice of tricksters and schemers or who trusts it to his own inexperience and romantic desires in investment