Don’t Feed the Alligators

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

Archive for the 'Risk' Category

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?

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Shaw's Cards

photo figure credit: ScrapperMom

This past Sunday morning ScrapperMom was perusing the grocery store circular when this offer caught her eye (my emphasis added):

Choose your tax refund reward. Customers can purchase gift cards with their Shaw’s Rewards Card (for carded markets) at their local store’s Customer Service center.  No tax form or refund check is necessary.  Customers may purchase a grocery store gift card at $250 or $300.  Each gift card will be loaded with an additional $20 for a $250 purchase or $30 for a $300 purchase.  There is no limit for the amount of cards a customer can purchase. The additional bonus amount cannot be used for the purchase of alcohol, fuel, tobacco, lottery tickets, dairy products, prescription drugs or additional gift cards.  Offer is available March 13, 2009 through April 15, 2009.

Shaw’s is one of our local grocery stores (same company as Star Market), and it ran a similar 10% bonus during last year’s Economic Stimulus check mailings.  Apparently the response from customers and reward for Shaw’s was so great that they’ve decided to run this offer during tax season this year as well.  The limit before was whatever the size of your stimulus check was, and we took full advantage.  But I’m really psyched that there’s no limit on this offer.

Clearly this is a great deal no matter how you slice it.  The offer is for a store that we visit at least once per week, where we spend at least $250 per month, and that sells necessities, namely food.  The only real question is how much advantage we can take.  There are a few factors that limit how many of these cards we should buy:

  • How much cash we have available.
  • What the cost is to tie up this cash for whatever time it will take to use up all of the cards that we buy.
  • Whether this is really a no limit offer.

Because we don’t live paycheck to paycheck, we actually have somewhere between $10,000 and $15,000 available on hand in cash that we could use for this “investment” that is not technically part of our emergency fund.  It turns out that we also gave the government too big of an interest free loan last year, so we’re going to be getting a healthy refund which we can also roll into purchasing discount gift cards.

I ran some quick math to see how soon I would have to spend the gift card before we would have just been better off sticking the money in a CD.  I figured out that if I could earn 3.5%, tax free,  on a $300 investment today, it would take 34 months to earn 10% on the initial investment.  That means that as long as I can spend the gift card within the next 3 years (because with taxes it will take longer than 34 months to accrue 10%) I will be getting a better return by buying the gift card.

I asked myself if there were any down sides to this offer as well.  One that pops to mind is that we’ll be tying up lots of cash that we may need for other things.  The nice thing about these gift cards, however, is that we can easily trade them for cash, and if things ever get that bad, we’ll still have to eat, so having grocery cards is not such a bad thing.  Another thing we’ll need to be careful about is where and how we store the cards.  Having the equivalent of thousands of dollars in cash laying around has risks: fire, theft, loss, etc.  We’ll have to figure out a way to deal with that.  Lastly, what if the store goes out of business?  This is certainly something about which to be concerned, but this is a chain that has been around as long as I can remember, stores don’t usually just all of a sudden stop honoring gift cards, and as above we should be able to liquidate them quickly if it comes to that.

We still haven’t decided exactly how many of these cards we’ll buy in total.  We spent about $5,400 on groceries in 2008, so we can buy a lot of these cards and still come out ahead.  Yesterday ScrapperMom went to the Customer Service desk to buy 6 of them and was told that you can only buy 5 per customer per day.  So there is, apparently, a limit, but I still don’t think it should affect how many we want to buy (though if it did I would argue that the ad does say “no limit”).

What do you think?  Should we stock up on $10,000 worth of these cards (or the closest multiple of $300) and get an instant $1,000 back?  Is this a deal that interests you?  How many will you buy or would you buy if you could?  Are there downsides or risks that we’ve yet to consider? Leave a comment below!

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12.27.2008
___

Creative Commons License photo figure credit: tifotter

Since I’m currently out of work and home during the day I get tasked with tenant turnover and must wear the Property Manager hat. I have to say it’s been fairly successful this time around and I haven’t been too discouraged by the potential tenants. One thing that has been nice is the feedback I am getting from the people at the showings. They are impressed with the apartment and find it to be clean and welcoming. They also have indicated that what we offer for the price is reasonable.

This is the third time we have listed our unit on Craigslist and we also have a simple yard sign for the second time. We found that advertising in the newspaper was expensive and didn’t yield great results. We found that by being able to post photos on the internet, people know what they are getting before they take a look thus saving everyone’s precious time. I have shown the apartment about 9 times. More than half had seen the Craigslist ad and the rest were drive-bys.  I had only one person fill out an application so far and a handful of people take an application. In contrast, last year we had 4 applicants and ended up with the 4th one for a variety of reasons: bad credit, decided not to move, and vanished into thin air! 

We have found in the past that unless someone is willing to fill out the application on the spot, he is probably not interested. This is not always the case. I did have one person view the apartment twice and our current applicant took the application and dropped it off the next day.

Until today everyone who scheduled an appointment has shown up. Today I have had 2 no shows which makes me very angry. Although I did not have any plans, if we did not live in the building it would be annoying and time consuming to have come to show the apartment and have a no show. Common courtesy is a good quality in a tenant. These people, if I hear from them again, now have red flags.

For our applicant screening we have been using a service called Clear Screening to conduct credit and background checks. I have found Clear Screening to have great customer service and they provide a good product for a fair price. We can run credit reports for $14.95 and criminal reports for $21.95 (plus court fees).  Criminal reports do take a lot longer to process than credit reports, which are instantaneous. To qualify to pull someone’s credit, I initially had to prove I was a landlord by providing them with information on me and my property. After approval, all of my applicant checks are conducted online.  We also ask the applicants to fill out a credit report authorization form.  Even though I had not used the service since last year they were able to reactivate my account so I could screen the next round of candidates.  As we have learned in the past credit checks are invaluable tools to screen perspective tenants. We have had to decline an applicant for less than satisfactory credit. More recently we have had instances where perspective tenants operated on a cash only basis making it more difficult to screen. I have to commend them for living a credit-free life in our increasingly credit-full world. Two methods we have used in these cases are verification of bank balances and verification of past payments to various creditors.

Another often overlooked aspect of tenant screening is reference checks. It seems obvious to verify employment, but it is often difficult to call a complete stranger and ask for a personal reference. I have found that although these calls are often awkward to make, they do speak volumes about people. Although your friends may not say a lot if they think you may be a less than satisfactory tenant, people tend to speak volumes about people that they trust and feel are upstanding citizens that would work out well in your building. I have found this part to be very rewarding because these references are typically very telling of how a tenant will work out.

Despite the fact that some people will set up appointments and not show, there are other people that you can get a sense for, from the first meeting. Obviously some part of this job involves your gut feeling. In some sense by having me personally screen the tenants and MITBeta only seeing the written screenings it gives us a balance and objectivity. On paper someone may be questionable but the way they conduct themselves, their dealings with others, etc. are also a great measure of the way they will live in and treat your property.

Epilogue: I believe we have made the right decision with our next tenant and they are moved in as I write this. The end goal of every landlord is to have a longterm tenant that is respectful of her property and pays the rent every month on time.  I hope these new tenants are very happy here for a long time. I know they hope to be and are very excited about the move. I’m happy to be offering housing to someone who is as excited to live in my house as I am. People who are happy to be where they are tend to treat their aparment as if it were their own. But as is the nature of the business… only time will tell.

Lunch

Creative Commons License photo figure credit: kevincole

The last several weeks have been tough and/or busy for us in several ways: the passing of our dog, Thanksgiving, a 4 day business trip combined with ongoing busyness at the office, the hustle and bustle of preparing for Christmas, and — as if that wasn’t enough — preparations for the soon-to-be imminent arrival of Child #2.

So, for my trickle of posts at this space over the last couple of weeks, I apologize.  I give a lot of credit to all the bloggers out there with bigger families than mine who are posting something every day — sometimes on multiple topics and several blogs.  In any event, I want you all to know that I have neither forgotten about, nor abandoned my desire to write about personal finance topics.  So while the near-term schedule really doesn’t show any signs of lightening up, I pledge to at least post more often than I have been.

Now, to get back into the swing of things, I would offer links to several articles that I have been collecting over the last few months:

Juan’s Happy Wife posts here about the economics of home schooling.

Here’s an interesting article that claims an inverse relationship between the age of retirement and ultimate lifespan.  Yikes… I think I’ll retire next week!

Yesterday Boston.com had an analysis that was right up my alley in determining whether it made more sense to borrow from a 401k for a down payment on a house versus paying Private Mortgage Insurance (PMI).

J.D. had a guest post about The Irritation Threshold as it relates to Lifestyle Inflation.

The New York Times had an article on why it’s temping to want to switch to cash, but that risks remain in that strategy.

Lastly, the Wall Street Journal ran a story banks that pay credit card holders to pay off their balances.

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.