Monthly Archives: June 2015

Mortgage or 401K?

Had a back and forth today on Twitter with Michael Kitces (I’m a huge fan!) regarding whether it makes sense to put money in a 401k if you have an existing mortgage.  I know.  So exciting! XD (I was actually objecting to the idea that you should pay mortgage before emergency fund, from the originally referenced tweet.  Apparently he only meant the 401k.  But I still disagree, somewhat).  His position is to pay off the mortgage first, because otherwise it is the same as taking out a HELOC to invest in stock market.  Which it kind of is.  Here is his post on the topic:

To understand the paradox, let’s look at a simplified example here. Imagine you have a client with a $500,000 house and a $400,000 mortgage with a 5% interest rate, who also has only $100,000 in investment accounts; the client’s net worth is $200,000 (with $100,000 of equity in the house, and $100,000 in investment accounts). In addition, the client has managed to generate $20,000 of free cash flow by the end of the year, and asks what to do with it: he could either use the $20,000 to pay down his mortgage, or to put into his investment account (or into his 401(k)). The standard advice from most planners would be pretty straightforward: keep the mortgage as long as possible, because it’s only a 5% interest rate, while stocks have a much higher long-term average return, and save the money into the investment account for long-term growth. Had the client used the money to pay down the mortgage, he would have finished with a $380,000 mortgage and a $100,000 investment account; instead, by saving the money for growth, the client has a $120,000 investment account (and still holds a $500,000 house with a $400,000 mortgage).

So what’s the problem? Imagine if the client instead had simply come to us and said “I have a $500,000 house with a $380,000 mortgage; should I take out a $20,000 home equity line of credit at 5% to invest in stocks in my $100,000 investment account?” Almost every planner I know would say “NO!” That’s a little too risky. Keeping your mortgage is one thing, but proactively taking out debt against your house to invest in the stock market is another thing. Even FINRA has an Investor Alert out against mortgaging your house to invest in securities unless you are really comfortable with “betting the ranch” on stocks (which most seem not to be, when framed this way).

The problem is, these are still the same thing!

Well, it’s kind of the same thing, but not exactly the same thing.  Borrowing more against a HELOC to invest is not the same as investing instead of paying down a mortgage.  The HELOC will have to be repaid, so payments will increase, or be extended.  You will have reduced your home equity, and skewed your asset allocation.  In addition, you have in the first scenario a client who is generating $20,000 cash per year extra.  In the second, not so.

So what’s the bottom line? If we wouldn’t tell our clients to borrow money to buy stocks in their investment account (I say stocks, because certainly we wouldn’t be buying bonds that yield less than the cost of the loan) in the first place, we probably shouldn’t be telling them to keep their mortgage and direct savings to the investment accounts, either. Yes, I realize in some cases that can lead clients to have a lot of equity in their house and not a lot in their investment accounts: but the reality is that that imbalance occurs not because they pay down their mortgage, but because they invested so much money into a real estate asset (the house) in the first place! In other words, if your clients are concerned about being “house rich” and investment-account poor, the key is not to keep the mortgage, and debt, and leverage, and risk… the key is to not put so much money concentrated into real estate assets in the first place!

As he noted here, you wouldn’t buy bonds returning less than 5% with money borrowed at 5%.  I would submit that the mortgage itself is a very bond-like financial instrument, even for the payer.  You could look at your home equity as having somewhat bond like behavior, and maybe you prefer to have some money invested in higher risk assets (with presumably higher returns).   If the client has a plan that includes sale of this (presumably high value) home at some  point in the future, and the home and the mortgage are part of the financial plan, then the advisor should be able to determine what really makes the most sense.  Even if the client does not ever want to sell the home, as long as the plan includes retiring the mortgage before the client, it might be a better plan to invest while paying down the mortgage.

Saying that it’s always best to pay down the mortgage first is like saying that you should invest all in bonds while you are young.

It’s also not helpful to tell the client to buy less house.  There are lots of reasons that this can happen other than “I want the biggest McMansion that my salary will allow.”  They may live in an area where they are faced with either paying a lot for a house or paying for private school for their kids.  In some cases, mortgage is held on a second or even third home.  I would encourage clients to pay down mortgages to the point where they are unlikely to go underwater (say, 50% of current market value).  At that point, it really does become a bond like asset.  That mortgage payment feels a lot more like paying rent, rather than risky leverage (because it is).  Why shouldn’t they invest in stocks while paying off a vacation home?

And I would have to look on a case by case basis to see what makes sense as far as amount to pay down mortgage vs. amount to invest.  Don’t forget that compound interest thing for the investments, not just the mortgage.

And of course, there are tax considerations, both with the mortgage and the 401k.

I didn’t do any math at all here, so maybe I’m about to get my butt kicked…

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Freedom to Marry

Why does “liberty” include gay marriage?  If you begin with the assumption that being gay is an in-born trait, like being black, then you have to conclude that either gays must be allowed to marry, or civil marriage has to be eliminated for everyone.  I think this is the choice that the justices faced, and the majority decided that it was impractical to eliminate marriage as a state-sponsored institution.   The minority couldn’t agree on much, I guess, as they each wrote their own dissenting opinion.

Justice Thomas disagreed with that basic tenet (all these dissenting quotes are from CBS News):

Thomas interpreted “liberty” in the due process clause of the 14th Amendment as referring specifically to “freedom from restraint.” With that in mind, he wrote that the petitioners couldn’t claim “under the most plausible definition of ‘liberty,’ that they have been imprisoned or physically restrained by the States for participating in same-sex relationships,” noting that they have “been left alone to order their lives as they see fit.”

What they had not been granted by the states is the formal recognition of their marriages in a formal way, and Thomas argued, “Liberty is only freedom from governmental action, not an entitlement to governmental benefits.”

Chief Justice Roberts kind of felt the same way, but also brought up democracy.  I’m pretty sure judicial review is in place to keep the majority from violating the rights of the minority through democratic processes;  i.e., dude, that’s your job:

“The majority today relies on its own understanding of what freedom is and must become,” he said to the court, and the deepest problem with their decision was “the disrespect it shows the democratic process.”

Scalia was just mad.  In every sense of the word.  His dissent reads like blog post [whatever that means].  Alito brought up child rearing in his dissent.  Which is obviously not a valid argument.

No one argued that being gay is some kind of “choice.”  This is not even argued by the most hateful Christianists anymore, they call it “same sex attracted.”  Many Christians and pretty much all Christianists believe that God intentionally made them with this burden to bear, and never to act on.  For a heartbreaking story about it, see here.  And for a detailed, non-shrieking explantion, see here.  This is clearly a religious belief, not shared by a majority of Americans or even Christians.  They lose me as soon as they whip out Leviticus.

So, why are so many Christians and Christianists so upset about this decision?  I think there are two reasons.  One is that they fail to recognize the distinction between church and state, and the responsibilities of the state, especially as it relates to issues over which there is disagreement.  The second is that they believe that the USA is, in fact, a Christian nation and should reflect (their) Christian beliefs.

The second is easiest to address.  Here is an argument that USA was founded to be a Christian nation.  There are lots of these out there.  I don’t understand how anyone can agree with that, since it’s spelled out pretty clearly in the bill of rights that the state shall not establish a religion.  Not all of our founding fathers were Christians, either.  Jefferson was more of a deist, which was discussed in depth by Barry Grossman at a Jefferson Educational Society speech in Erie earlier this year.  The crowd at that talk pretty much agreed that Jefferson could not really be defined as a Christian, based on his own writings.  Thomas Paine wrote a book about how the Bible was all nonsense.   This argument  isn’t going to go away, though.  Christianists are going to keep trying to take over the government and force us all to live by their rules.  Which is really not very Christian, IMHO.

The idea that the government should regulate stuff that is based on religious principles is one that I’m not too clear on.  I don’t get it why, for instance, Catholic bishops would issue a statement on it.  There are plenty of sinful actions that are perfectly legal.  It’s pretty easy to go anywhere (including church) and see people who are obviously gluttons.  But I haven’t seen any statements about that.  The non-shrieky argument above says “For a Christian to encourage a gay person in the consummation of a gay “marriage” is to encourage their permanent indulgence in a lust of the flesh that Scripture clearly tells us God finds detestable, and to suffer all the spiritual consequences that come with that. It would be like encouraging you to go hiking down a path where we know a deadly wild animal is waiting to devour you. Far from hating you, we’re loving you by warning you of the consequences and urging you to repent – which literally means to turn back and change directions.”  The connection that is not made here is, first, where it says in the scriptures that people are supposed to force others not to sin, and second, where it says in the scriptures that Christians are supposed to make laws of man match the laws of God, as they understand them.

These Christianists are the same people who are Tea Party members, wanting to regulate the behavior of others but at the same time be free from big government.  At least the Catholics are consistent – they believe in regulating the behavior of others AND in big government (clearly seen in the pope’s statements about the government’s responsibilities regarding the environment and income inequality).

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Educating Prospects and Clients

As an advisor, and especially as a fiduciary, we find that education is one of our most important and valuable services, whether the prospects and clients realize it or not.  Why should we do this?

  • A certain amount of client education is inevitable as part of the planning and investment management process.
  • It is our responsibility as fiduciary.
  • It is in the advisor’s best interest as well.  How can a client fend off an unscrupulous sales pitch, if they have a minimum of knowledge?

Taleb, and more famously, Rumsfeld, pointed out that knowledge can be categorized at least 3 ways:  things you know, things you are aware that you don’t know, and the “unknown unknowns.”   This last part is where an advisor can provide very valuable service to clients.

As we begin the planning process, clients expect to hear about things they know are out of their realm.  If we are doing a good job in the initial meeting, we can educate the clients about what an advisor can and should do, so that even if they decide not to work with us (or vice versa,) they are in a better position to evaluate any other financial services provider.  We will be providing “unknown unknown” information much of the time, even at this stage.  This includes how a financial plan is put together, exactly what is included (not just an investment portfolio, but budgeting, determination of insurance needs, evaluation of mortgages and non-financial assets, incorporating changes through time, etc.), and how the legal relationships between us and the client work.  People just do not understand the differences between all the options of financial advice that is out there on the market, and the infuriatingly misleading advertising by those who are not fiduciaries only adds to the confusion.

It is vital for fiduciaries to make this point crystal clear;  anyone paying for financial services deserves a fiduciary level of care, and they need to understand it, or they are not likely to get it.  We include at minimum a reference to information from a professional or other third party.  Resources include:

These resources are often incomplete, or not simple enough for many clients, and so you frequently see advisors writing up their own explanations of the fiduciary standards and conflicts of interest.

Of course the client will receive a complete explanation of what services the advisor will provide, and at what compensation, by law.  We like to include information on any hidden or additional costs (fund fees, trading costs, etc.) so that clients know to ask any other advisor about these costs as well.  It is also important to list what services you will not be providing.  For instance, we will recommend insurance coverages, and we can recommend specific insurance brokers (be sure to discuss potential conflicts of interest here) if the client wants a recommendation, but we are not brokers or agents and do not sell insurance.  Another example would be to inform a client of all the types of insurances that might apply, and then discuss which ones do apply for that client, and which ones do not, and why.

The education continues through the planning process with the explanation of the advisor’s investing methodology.  Clients need to understand how and why we have selected the investments in the portfolio that we propose.   They also need to understand that we are always learning and seeking out new information.  This prevents disappointment when an investment inevitably experiences volatility (our portfolios are diversified, so something is always underperforming).  It also acts as a barrier to other financial product sales people who approach our clients.  Frequently, a client will forward a sales pitch to us, so that we can evaluate it and tell them how it fits in (or not) with the overall strategy of their portfolio.

This education process is a differentiation between a human advisor and a robo advisor.  Certainly, the robos can provide lots of educational material, but we can take clients through it in person, and see when the light goes on for each concept, maximizing the use of these people’s precious time.  We can also see when the client is losing focus, and redirect as needed.  Additionally, the level of information needed is not the same for each person.  Beware:  the client that doesn’t want to learn much is the client that is dissatisfied later with the things they didn’t learn about.

As the relationship continues, there are certain to be teachable moments.  Downturns always require support, to prevent panic selling.  When something “new” is being pushed from all directions, it’s a great time to go over that new thing in relationship to your investment philosophy and asset allocation.  As plans change, the revised plans will present opportunities for the client to learn more about the planning process, as well as the value of an advisor.

What are the drawbacks of client education?  We have found that some clients come to understand the philosophy and see the implementation, and think that they can do it themselves.  And maybe they can.  The good news in this situation is that even if you have a client that leaves because they learned “too much,” they remain on good terms.  There is continued relationship possible there, and they may discover that they don’t really have the time or interest, or have a major plan change, or for some other reason decide that the do it yourself approach wasn’t such a good idea after all.

To summarize specific learning points and when they are needed (these are in addition to the planning and legal documents):

  • Initial meeting, general consumer information.
    • What is a fiduciary?
    • What is in a complete financial plan?
    • How to select an advisor
  • Initial meeting, advisor specific information and general investing information
    • Details of advisor services – what is included and what is not, details of all fees
    • Advisor’s investment philosophy (overview)
    • Expectations for investments (broad and general)
  • After client and advisor decide to work together (planning meeting)
    • Advisor’s investment suggestions for the individual client
    • Expectations for specific portfolio(s)
    • Implementation details (rebalancing, reporting, billing, etc.)
  • Ongoing education
    • Teachable moments (downturns, flavor of the day)

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Economic Theory

Via Mark Thoma:

Simon Wren-Lewis:

Speak for yourself, or why anti-Keynesian views survive:

The evidence for the Keynesian worldview is very mixed. Most economists come down in favor or against it because of their prior ideological beliefs. Krugman is a Keynesian because he wants bigger government. I’m an anti-Keynesian because I want smaller government.

Statements like this tell us rather a lot about those who make them. As statements about why people hold macroeconomic views they are wide of the mark. Of course there is confirmation bias, and ideological bias, but as the term ‘bias’ suggests, it does not mean that evidence has no impact on the views of the majority of academics.

The big/small government idea makes no theoretical sense. Why would wanting a larger state make someone a Keynesian? Many Keynesians, and most New Keynesians, nowadays acknowledge that monetary policy should be used to manage demand when it can. They also know that any fiscal stimulus only works, or at least works best, if it involves temporary increases in government spending. So being a Keynesian is not a very effective way of getting a larger state.

I think that the answer to the question posed is answered in the very next sentences.  If you want fiscal policy to be used to impact demand, then you had better have a pretty large state, as a percent of GDP.  And the bigger the impact you are looking for, the bigger the size of the government needs to be, to start out from.  If government was, say, 15% of GDP, then it might be a real challenge to boost demand by 5%.  That would be a 33% increase.  But if government starts out at 25%, then that 5% looks a lot more manageable.

Another way to look at it:  If you are Keynesian, you want the government to manage demand, which requires more government.  If you are anti-Keynesian, you want government to do less in terms of managing the economy, so less government is needed.

 

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Lyme Disease and FDA

Today’s opinion piece from John Mauldin includes a bunch of pie in the sky wishes on how the government could help the economy.  One of those wishes is that federal agencies would be re-examined with an eye toward current and future technology:

Recognize that many federal agencies are still mired in the mid-20th century if not the 19th. It’s time to design a regulatory system that fosters jobs and growth while protecting citizens.

Let’s start with the easy target: the Food and Drug Administration. The United States is the wellspring of biotechnological research, yet more and more of our original research is being taken overseas for further development, producing jobs outside the US

A bipartisan commission can design a new agency with a new regulatory regime and bring it to the floor of Congress for a vote. Instead of a system that makes drug-creation prohibitively expensive, favors Big Pharma and exports jobs, let’s harness the power of US entrepreneurs.

Streamline the process so healthcare can keep up with research, thereby lowering healthcare costs and providing healthier outcomes for everyone. Then start with the next regulatory agency until all have been updated.

That’s a lovely idea but its undoing is right in there: “favors Big Pharma.”

We are having a banner year for ticks.  Although it was bitterly cold, the deep snow must have sheltered them from the cold, because there are more ticks this year than ever before.  I have picked 2 off my arm in the last week (thankfully crawling, not dug in).  This leads to Lyme disease.  There used to be a vaccine for it, but it wasn’t perfect, and it was pulled from the market, “citing low demand.

Lyme disease is so severe, and so poorly treated, that the CDC recommends “Share your feelings,” as a way to deal with its after effects.  It seems like this is a great candidate for a new or improved vaccine.  Around 40,000 people a year get Lyme, which is really not a lot, but I think a lot more people would want to get the vaccine if it were available, safe, and effective, or at least if the data around safety and efficacy were publicly available.

It seems ridiculous that there is a vaccine out there, and instead of getting the data to make a fully informed choice, we get “share your feelings,” once you are infected.  I blame the FDA and anti-vaxxers.

 

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Liberland

Interesting concept.  My plan is to start a company that exports toxic waste to a small lot that I will purchase there.

In a World of Tax Hells, a New Haven Emerges

It’s not some half-baked attempt to create a new country. It’s the real deal.

Best of all, it’s a country founded on staunch libertarian and free-market principles.

But I don’t blame you if you’re skeptical. I was too. That is, until I spoke with Vit Jedlicka.

Vit is the founder and president of Liberland. It’s a slice of land on the edge of Serbia, Croatia, and the Danube River. Neither country has ever claimed it due to a border quirk. Under international law, that opened up the opportunity for Liberland.

Surprisingly, the reactions of Croatia and Serbia have been cordial instead of resistant.

Vit is in the process of securing diplomatic recognition.

More than 300,000 have applied for Liberland citizenship.

Serious investors have indicated they’d immediately put tens of millions of dollars into the new country.

Liberland has real momentum. Soon it could reach a tipping point.

There is an interview with the founder, Vit Jedlicka, at the bottom of the article, herehttp://www.internationalman.com/articles/in-a-world-of-tax-hells-a-new-haven-emerges.

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