Don’t Feed the Alligators

A Personal Finance Blog from a Small-Scale Landlord’s Perspective

Archive for the 'financial crisis' Category

That's all that's left!

Creative Commons License photo figure credit: pfala

The May issue of Money Magazine has an article with poll results about how people have been changed by the current financial crisis.  The results seem to indicate that there will be many lasting effects of the crisis in much the same way that the Great Depression changed the relationship that almost all of its survivors had with money.  Savings rates are up, consumer spending is down, and people report that they value their families more and money less than they did before the crisis started.  If this is the case, maybe the crisis isn’t such a bad thing?

From the poll:

  • Nine of 10 respondents said they have changed the way they manage their money as a result of the economic crisis
  • Seven of 10 said their priorities are shiftng as well
  • A “whopping” 94% said the recession will have a lasting impact on the way they handle their finances

Naturally, I started to think about whether and how the crisis has affected how we deal with money.  I think that the basics of our money management system have not changed.  We still make monthly contributions to our Roth IRAs, put aside some money for charity, add to our emergency fund, and plug away at our car loan, business loan, and mortgage.  Because we are relatively young, we continue to invest most of our retirement money in stock market index funds (which have gained 30% in value over the last month, by the way…) diversified across a number of different global markets.  Our monthly contributions are taking advantage of dollar cost averaging.

After ScrapperMom’s layoff in October, however, I became far more concerned about how long we could get by with no income — i.e. the size of our emergency fund.  Currently all of the money that’s technically allocated for emergencies gives us a 3.75 month buffer (up by 1.45 months since August) and 4.9 months of savings if you count all of our cash on hand.  This is still a pretty nice cushion, but in a tough economy it could take a year to find a job to support our current lifestyle (see Avoiding Lifestyle Inflation to keep yourself out of this situation in the first place).  It took me 9 months to find work after the terrorist attacks of September 11, 2001.  Few places were hiring at the time simply because of uncertainty.

So, if anything has changed in the last 6 months in the way we deal with our money, it’s that we have been putting more of an emphasis on building a larger emergency fund and lowering our fixed monthly expenses.  Little by little we have been socking away more money to roll into our emergency fund CD ladder.  At the same time, we have been paying down the debts that require us to make monthly payments, such as our business and car loans.  Once these debts are paid off, then the “size” of our emergency fund will “grow” overnight by virtue of the fact that the same money will last longer should the need arise when we have fewer monthly obligations.

What about you?  Have you changed the way you deal with money since the beginning of this crisis?  Have you changed your investment strategy at all?  If so, how?  If not, why not?

Risk Management

Creative Commons License photo figure credit: Cold Cut

A lot of Americans are mad right now.  They’re mad at bankers and CEOs for causing such a mess in the financial markets.  They’re mad at the government for seemingly throwing good money after bad in bailouts of all sorts.  Many are even mad at themselves for living large for so long on borrowed money or the equity in their homes.

I get that.

What’s been bugging me lately, however, is this notion that some of these large banks and financial institutions should be left to fail.  I’ve seen this idea repeated in newspapers, on TV news, on blogs.  I’ve heard it from my coworkers, on talk radio, and at the coffee shop.  Well, the truth of the matter is this: The banks in question here have failed.  They’ve failed spectacularly.  They’ve lost almost incomprehensible amounts of money. Their stock prices are worth next to nothing.

What they haven’t done, except for Lehman Brothers, is gone bankrupt.  We, the people, have been spending hundreds of billions of dollars to keep these institutions afloat.  And that’s a good thing.  Here’s why:

These institutions all have deposit accounts, brokerage accounts, and other types of custodial accounts.  They take your money, pool it together with other peoples’ money, and invest it in various vehicles according to your instructions.  People are always adding to the pool and taking away.  So normally the pool stays the same size or changes very slowly, and this keeps things on a pretty even keel.

If many people either want to put more money in or take their money out of the pool quickly, the pool is forced to buy or sell stock in large quantities, or to call in debt obligations from others.  Buying or selling in very large quantities is ultimately detrimental to customers because it causes the price of the underlying stock or mutual fund to rise or fall very quickly, meaning the you’re either overpaying when you buy in or not getting the full value when you cash out.

If a large financial institution is unable to meet its debt obligations and has to declare bankruptcy, the first thing that is going to happen is that most, if not all, of its customers are going to want to get their money back.  This will trigger a run on the money causing a massive drop in share prices for the underlying securities.  If this price drop is big enough, the rest of the market could react at the same time, causing the whole market to drop.  This is bad news for everyone who has money in the market, not just those who have money in the pool.

This is why it has been necessary for the government to step in to reassure customers of many troubled financial institutions that their money is secure.  By keeping the institutions solvent, the government is preventing a massive run on money that could have far reaching effects on the whole economy.  This is why some of the largest institutions are being called “too big to fail.”

While I certainly worry about what the long term implications will be with respect to taxes to pay for these bailouts, I don’t see any way around propping up these companies by partially or fully nationalizing them until things calm down for a while.  What I would like to see implemented immediately, however, is a plan to put regulations in place to:

  1. make sure that companies that are “too big to fail” are accountable for their business practices to be sure that they don’t fail
  2. make sure that companies going forward can never become “too big to fail”
  3. or some combination of these two.

What are your thoughts?  Are you angry about the bailouts?  Do you see them as necessary or a waste of taxpayer resources?  Do you think we need more or less regulation to prevent these circumstances in the future?

If you liked this article, you may be interested in seeing some related articles:


Killington

Creative Commons License photo figure credit: Derek Purdy

This past Friday I used some comp time at work to take advantage of some non-weekend skiing at Killington Mountain in Vermont.  My host for the day was an old friend who sold a company during the Dot-Com boom and has been, for the most part, living off of the interest and dividends provided by his investment of the proceeds of the sale.  We talked about a lot of things while riding the ski lift, from parenting philosophy to Wall Street bailouts to the whereabouts of our mutual friends.

My friend challenged me in many ways, not the least of which was in trying to keep up with him on the slopes.  But as the memories of freshly groomed courderoy fade away, I’ve been chewing on a number of the things I learned or relearned in our ski lift discussions.  Please excuse the fact that some of these are broad, and some are narrow, but that’s how the conversation went.

  1. Citigroup is not going back to $45 - Throughout most of the 2000s, Citigroup’s stock price was in the $40 to $50 range.  It closed at $1.03 on Friday.  There are two important lessons here: A. You should not own individual stocks unless you own enough and varied stock to be able to weather problems in one particular market segment, like banking or energy — in other words you should be diversified enough to mitigate non-systemic losses.  B. Even if you believe that the market will bounce back, it will have to do so without Citigroup, GM, and any number of other well established, large companies whose stock is now all but worthless.  Money invested in Citi at $45 is gone.
  2. Koreans make bad pilots – There’s a book out now by Malcolm Gladwell called Outliers.  In it, there is a story about the problems that Korea Air had keeping their planes in the sky in the 80s and 90s.  Apparently the problem stemmed from a cultural requirement for co-pilots and other crew members to respect their elders by not questioning their authority and decisions in the cockpit.  It seems to me that a lot of the financial mess we’re in today stems from people not asking enough questions when they didn’t understand the terms of a deal, be it a mortgage or a credit default swap.
  3. This is not the first time the government has bailed out a “too big to fail” company – Do you remember a company called Long-Term Capital Management?  I didn’t either.  But I learned that this was a hedge fund that failed “spectacularly” in 1998 and was bailed out by a consortium of banks.  This fund was “too big to fail” in that its quick liquidation would have led to a collapse of financial markets.  You can’t sell large stock positions all at once since it causes the price to fall sharply, and you certainly can’t do so for many stocks all at once since it causes entire markets to fall sharply.  My ski buddy wonders why we put ourselves into a position again in which unregulated entities were allowed to become too big to fail.
  4. When you can’t find value in something that you need, you can always go for cheap – I was eyeing the sushi bar at lunch time, but a $15+ dollar lunch was not worth it to me.  Instead I went with a $4 hot dog.  This is similar to why I choose index funds instead of managed mutual funds.
  5. Giving up a little can be worth a lot – A season pass at Killington cost $999.  A season pass with 14 blackout days costs $650.  By giving up less than 10% of the available days during the ski season — which also happen to be the days with the longest lift lines — you save 35% on the pass.  This works the opposite way as well.  I’m reminded of the fact that most of the gains in the stock market happen on VERY few days.  If you had invested $10,000 in 1996 in an S&P 500 Index Fund, you’d have $17,280 in 2008.  If you had missed the 10 best days during that period, you would have just $10,748.  If you had missed the 20 best days, you’d have lost money and be left with just $7,360.  (Source)
  6. The government should not have let Lehman Brothers fail – It was distasteful to the American people that the government bailed out Bear Sterns, so it let Lehman Brothers fail to appease the taxpayer rather than do what was right with respect to fiscal policy.  In all likelyhood this has cost the taxpayers far more than it would have otherwise in the form of bailout after bailout.  The failure of Lehman Brothers began a downward spiral which seemingly has not yet found it’s floor.
  7. Don’t take the experts at their word without doing your due diligence – The weather.com “ski index” for Killington on Friday was a 1 out of 10, with 1 being the worst.  I decided to make the 3+ hour drive and see for myself.  At the very worst case it would be a long way to go for a couple of beers.  My friend says that he would have given the day a 4.5 overall (5 in the morning, 4 in the afternoon).  I would give it a 7, since my bias is towards smaller, less challenging mountains with generally worse conditions.  Check out this clip from The Daily Show which features a great quote from Jon Stewart: “If I’d only followed CNBC’s advice I’d have a million dollars today…provided I’d started with $100 million.” (Thanks to David at My Two Dollars for posting the link earlier this week.)

I had a great time skiing, and a great time chatting on Friday.  I like to think they were both somehow good for my soul.  I like to hear your opinion on any of these points.  Leave a Comment below.

11.13.2008
Rainy Window

Creative Commons License photo figure credit: Nictalopen

Having just settled in to the reality of ScrapperMom’s layoff, we learned this week that our tenant for the last year will not be renewing his lease.  Assuming that ScrapperMom gets no new work and that it takes us at least a month to rent the apartment, this leaves us with 38% less income in December than in November.  The only thing keeping us even next month will be the raise that I got last month.  This means that all of our savings and discretionary spending has gone to zero in the upcoming budget month.

Thankfully, we have planned well, and have an emergency fund that can get us by for quite a long time under the present circumstances.  Having just received that raise, there is no reason to expect that my job is not secure for some time to come.  Though with a paying down low interest debt in favor of boosting our savings and emergency fund.  We are still overpaying a couple of our loan accounts, and while it’s not by much, I may still have to bring these down to the minimum payment until our income rises again.

  • I’m glad that I have resisted the urge to invest given the down market.  While a great long term opportunity, this would have tied up cash that we may need to have available in a long term investment.
  • I wish that we had made it a priority to increase our savings sooner, despite the fact that we still have some debt.  This would have given us more confidence and breathing room in the current economy to know that we can weather the storm.
  • I wish that we had not bought an alligator.  We’re now feeling more stuck than ever, and I’m amazed out how quickly our fortunes have turned.
  • We’re not ruined yet, so we’re going to be looking for new ways to trim our expenses.  Many of our recurring expenses, like our Netflix or DirecTV plans can be trimmed by $5 or $10 per month.  Two months ago I would not have thought that this would make much difference, but now that every dollar matters so much more it may be worth doing.  On the flip side, we’ll be looking to stir up new business in the form of a new tenant, as well as looking for ways for ScrapperMom to bring in some new engineering work, or perhaps investigate some new opportunities.

    Have you or your families been affected by the economic downturn?  Do you have any ideas for us to trim our expenses or boost our income?  Let us know what you think in the Comments Section below!

    10.14.2008
    Overhang

    Creative Commons License photo figure credit: Akuppa

    With the recent market turmoil, there has been a lot of talk in the press and even around the water cooler about the nature of risk.  Most people seem to understand that investing in the stock market is risky.  They also understand that the more risk one takes, the greater the possible upside and downside of the investment.  What many don’t seem to understand is what, exactly, is risky about investing in the stock market as well as how risks can be mitigated.

    A great book on this subject is A Random Walk Down Wall Street by Burton G. Malkiel.  This book details, for example, why a well diversified stock portfolio is less risky than a single stock.  Malkiel shows that it takes a minimum of 20 to 30 stocks across a number of asset classes to provide sufficient diversification for a typical investor.  For example, if one holds the 30 companies in the Dow Jones Industrial Average, a typical market cycle might have Coca-Cola announce a new product offering which boosts its stock price, while 3M announces layoffs.  These types of stock movements are offsetting and are generally the reason why a diversified portfolio is less risky than individual stocks.

    A diversified portfolio is still exposed to “systemic” effects on the market — effects that are spread across the whole market.  This is most easily observed in the current market turmoil.  Clearly it’s not possible for every company to be doing poorly right now — somebody must be making money in a Bear market.  But the market average is down, and as a result, many good companies are getting hit hard on their stock prices simply because of the financial crisis.

    Another aspect to risk, and the one about which I have been trying to remind my coworkers and friends, is the time factor.  When purchasing an investment, one has to be aware of both the time one can afford to tie up money in the investment, as well as the typical time for the investment to achieve the kind of return being sought.  This is fairly easy to see with a Certificate of Deposit: you buy a CD that pays a certain percentage yield and that has a limited lifetime of months or years.  There are penalties for withdrawing money early.  The equation is less well defined when it comes to investments such as houses, stocks, or tulips.  The risk with investments such as these (well, not the tulips as much…) is not that the investment won’t hold value or yield a return, but rather over what time period the investment will pay off.

    Conventional wisdom suggests investors be prepared for minimum investment times to substantially reduce the chance that the investment will depreciate while held.  The purchaser of a house, for example, should be prepared to hold the house for 5 years or longer to have a high degree of certainty that the money invested can be recovered in full.  Diversified stock portfolios are more like 10 years of holding time.  In fact, (according to Malkiel) there has never been a 10 year period since 1926 in which the stock market has returned a negative yield, and there has never been a 25 year period in which the return was less than 8%.

    The point in all of this is that you should not panic about the volatility of the current market.  In fact, the less you pay attention to it the better off I expect that you’ll be.  If you are investing for retirement and you have ten years or more left to invest, you shouldn’t even sweat during this crisis.  If you have less than 20 years until retirement, or are retired already, you should have made and be making annual or semi-annual changes to your portfolio to reduce your risk exposure by locking up your stock gains in less risky vehicles like bonds.  This is what’s known as rebalancing your portfolio.  If your time horizon for a certain pile of money is shorter than 10 years, then your exposure to the stock market should be minimal.

    The absolute worst thing that you can do right about now is to get scared and change the way you are investing because of the market fluctuations.  Selling off stock now is the opposite of what everyone knows is the key to investment success: buy low, sell high.  Selling now is “selling low” and locks in your losses.  I have not lost any money in the current market, and I say this because all my losses are on paper so far.  I still own the same number of shares this week as I did last week.  Only by selling shares now can I be sure to lose money in this market.  History tells us that some of the greatest days in the stock market follow some of the worst, and Monday’s stock market performance is certainly evidence of this.  Selling when the market is low takes your money out of play and eliminates any chance of regaining the value lost in your portfolio as the market rebounds.

    Are you concerned about the loss of value in your 401k plan?  Have you made any changes to stem your losses, or are you just gritting your teeth and bearing it?  Do you find yourself checking the value more frequently or less frequently because of the volatility?  How much risk can you stomach? I’d like to read your perspective on the situation in the Comments Section below.