Weakonomi¢s » personal finance

We Prefer Being Forced To Save

The Weakonomist — Wed, 08 Feb 2012 15:13:57 +0000

A new study says that a significant majority of people would be fine to have their employers temporarily increase the amount the employee contributes to retirement plans up to 10%. I would certainly fall into that category myself as most of you likely would too.

But isn’t that sad? Why don’t people just temporarily increase it themselves? Or permanently if they can afford it. I think most people with disposable incomes don’t have a problem paying for necessary expenses but they don’t want to put an extra dime into something that is mentally considered discretionary. If employers forcefully increase contribution amounts it would fall into that “necessary expense” category. I’m all for giving people the freedom of choice, but I think the automatic option when you start work is 10% going to retirement accounts.

It shouldn’t be the case that employers play any part in our savings. But even today some employers are the sole providers of retirement savings for their employees with pensions. That’s going the way of the dinosaur, but we’re still in a transition phase, which is what the 401k is all about. It’s possible in the future that employers won’t provide any benefits. But if they continue to do so it’s because the labor market demands it.

And as long as the labor market demands it, we should want those employers to help us make the best choices possible. It’s certainly clear that we aren’t good at making decisions on our own.

Making things easier

If you look at the current system for retirement plans out there, it’s clear not enough has been done to make things easy for the consumer. Most of the people working today at least grew up expecting a pension. The first generation of people that only knows 401ks and IRAs is only in the first shift of their careers. Everyone else (and many young people too) are daunted and confused by all the options available to them.

My employer has, in an attempt to make things easier, has made things harder. Going through the systems at work to check the information of my retirement account takes 5 minutes and at least 2 different log ins. Even after that I’m faced with a website that is difficult for even me to read. I can barely tell the difference between my 401k and the token pension based on the titles of the accounts. Nothing is customizable and nothing is easy to follow.

I used to think that idiots deserve what they get but in the last few years have started to fall in line of at least helping people make the proper decisions. For instance, I know nothing about healthcare and health insurance and would love for all of it to be easier for my monkey brain to make the right decisions. I’d rather not have to pay a stupid tax when it comes to health care.

Employers can do a number of things in addition to automatically enrolling employees and increasing their contributions amounts. They can make the websites easy to understand and be proactive about forcing the providers of the plans to make things less complicated. Even something so simple as having the retirement account website automatically bookmarked on work computers could go a long way.

Read: We Have Ways of Making You Save More (WSJ)

Image: 401K

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Our Cars Tell The Story Of Our Consumption

The Weakonomist — Thu, 02 Feb 2012 15:13:49 +0000

Joanne Muller over at Forbes did some interesting digging on the car buying habits of Americans. Less than 40% of rich people (defined in this case as those making $250k+) actually buy luxury cars. And about 8% of people earning less than six-figures do. Now that doesn’t sound all that crazy but Thomas Stanley extrapolated a little bit more from those numbers:

I estimate that there are 2.5 million households or nearly 2.2% of the total that have annual realized incomes of $250,000 or more. Using Ms. Muller’s estimates that 39% of “the rich” buy luxury brands, one can estimate the number who do so, approximately 975,000. Ah, but this population is much smaller than those households who drive prestige makes but have annual incomes under $100,000. About 30 million households have annual incomes in the $50,000 to under $100,000 bracket alone. Translated: 8% of 30 million = 2.4 million who are buying luxury cars but are not in the so-called “rich” category. This population is nearly 2.5 times the size of the high income/luxury vehicle buyer.

In other words, most of the people buying luxury cars make less than $100,000 a year. That alone is interesting but we can go back into the numbers and learn more.

Dr. Stanley discusses in his post that the average price paid for a car by a millionaire is just over $30 grand. For the decamillionaire: $40 grand. So when someones wealth increases by factors, their spending on vehicles increases by fractions. That means that at some point on the wealth stream we stop spending more on our cars. But with so many people buying luxury brands with lower incomes it’s clear that until we reach that point, we’re overspending on cars. It sounds like that many people are faking being rich, until they actually are. Then they scale back.

This implies two things about rich people:

After a certain point projecting status becomes less important and money is spent on things with more value (maybe a second home, private school for the grandkids, charity).
Once we cross a certain point we start saving a greater percentage of our incomes

These two things are not mutually exclusive.

But what does it all mean? These numbers tell me a story about people that live beyond their means, and it’s not just with cars. It’s with purses, vacations, clothes, jewelry, food and even gifts. Most displays of economic status are not likely to be proportionate to the actual status. It is only and indicator of willingness to pay.

Personal Car Advice:

Should you be the type that struggles with figuring out exactly how much money to put towards a car, here’s my little formula. Take your total household income and subtract out any debt payments that aren’t for a mortgage. Take half of that and you’ll have the total maximum value one should ever have for their vehicles. An example is in order.

Say your household makes $90k and after student loan and credit card payments you clear $80k. Half of that is $40k so you should never have cars totaling in value beyond that. For a family with two adults that’s two cars worth $20k each. That is not to be confused always having cars worth that much. Each car should be owned for at least five years and new purchases should have at least 50% down and paid off within 2 years. Buy a car where you can do that. Get all that?

Now, spending more than $30k on any one car should be considered a luxury purchase and made in all cash. If you can’t swing those things then you can’t afford the car you want. If you can’t follow all that definitely just buy a car that costs 25% of your income, all cash.

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Bernanke’s Bologna

The Weakonomist — Wed, 01 Feb 2012 15:26:50 +0000

Last week Fed Chairman Ben Bernanke gave a press conference. In the conference he was asked about a number of things, including the Fed’s target inflation rate eroding away the savings of people. You likely know your bank account it paying practically nothing in terms of interest, say 1% (for argument). But inflation is much higher than that, say 3%. This means that every year you have less and less buying power. What did Bernanke say?

Over time savings rates do cover inflation.

Now if you actually watched the press conference you’ll know Bernanke fumbled with his words a little bit and some people could interpret his statements as implying savings rates always cover inflation. But he’s not so stupid.

Nevertheless, people pounced on the idea to prove they are capable of basic subtraction. Yes, if you look at the current rates offered on CDs or savings accounts and compared that to the current level of inflation, you will find that as of this moment in time you will not get enough returns to cover the inflation.

But Bernanke said that over time savings rates do cover inflation. We certainly know we are not in normal times, but charts always do a much better job of illustrating the point.

What you’re seeing here is the inflation rate (in red) and the rate on a 6 month CD graphed over time. Not only is it clear these two items are closely correlated, but it’s also obvious that for most of the last 40 years even a 6 month CD pays better than inflation. 12 month CDs are usually higher than 6, but that data was unavailable. The difference would have been even wider.

Now why is this? In finance interest rates are made up of a few components. The most basic are the cost of funds, the expected inflation rate, a premium for time, and a premium for risk. In simple terms, if a bank offers you a 5% mortgage, that rate accounts for all of these things. The blue line in the chart represents a cost of funds, and the red line represent inflation. By combing these rates with others banks are able to calculate how much interest to charge (at a minimum) in order to make it worth their time to lend money.

It stands to reason that the cost of funds (the blue line) would be more than the rate of inflation most of the time. This is because when you deposit money at a bank you are essentially lending it to them much like they will lend it out in a mortgage. You aren’t worried about risk due to FDIC insurance, and your cost of funds is zero since it’s yours. So you are compensated for time and inflation.

Even if that doesn’t make sense to you, the chart should. The Fed Chair understands that the interest rates on deposits are practically nothing these days. But, when the economy recovers the rates will go up again and you will again be compensated for inflation.

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You Have Too Much Crap Because We Won The Cold War

The Weakonomist — Tue, 31 Jan 2012 15:54:57 +0000

Welcome to a world where Storage Wars and Hoarding are well watched TV shows. A world where candles serve as decoration, where there are 4 TVs in a house, and we can’t fit cars in garages anymore for all the crap we have. Where did we go wrong? I’ve got older relatives that have been wearing the same sweater for longer than I’ve been alive because they understand what it’s like to having nothing. But most people these days, we have way too much crap. And I blame the Cold War.

It’s quite simple really. Communist China and the USSR were close allies during the Cold War. Of course the US spent much of the cold war trying to spread democracy around the world. With it came capitalism too. In the 1970s some in China started to realize that the Communist system wasn’t going to survive in its current state.

They proposed reforms that through the last 3 decades have lead us to where China is today. Russia stayed the course and suffered a collapse. China slowly reformed its economy and now you can get stuff for next to nothing.

Think about it this way, many manufacturers in the US actually outsource the production to a Chinese factory. Chinese labor is cheap and American companies can enter into a contract with them because of the reforms in China. As a result goods in the US are very cheap. We get free toys with our Happy Meals, Walmart allows you to get whatever you want at whatever price you want so long as it came from China, and every weekend we go out shopping for more crap to put into our McMansions.

Because stuff has gotten so cheap, we’ve been able to buy more of it. If laptops cost $2000 for a basic machine again, we wouldn’t be able to waste money on new trays for the silverware, or that fifth vase.

As China was liberalizing economically, we were growing, physically. We got fatter and our houses got bigger. Laptops dropped to less than $1000, we could get coffee tables for the price of a family dinner at Subway, and our houses got filled with stuff.

If we hadn’t won the cold war, we would probably still be making most of our stuff in the US. That stuff would be pricier and we wouldn’t be able to afford as much crap. But it is just crap, and we’d be perfectly fine, or arguable better, with out it.

Now someone reading this will question whether we won the Cold War. Allow me to clarify. We didn’t win so much as communism lost. Communism was replaced by capitalism, which was a catalyst for globalization.

We could all choose to buy less stuff, but you can’t expect an entire population to do that. What you can expect is that over time the price of crap will become expensive again. Cheap labor is becoming harder and hard to come by. And the cost of a global supply chain is too pricey to ship goods half-way across the globe.

Consider the last twenty years the prize for the consumer winning over the communist. Of course, this all came at the expense of the American manufacturing worker. Enjoy your crap America.

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In The Future, We Won’t Own Anything

The Weakonomist — Wed, 18 Jan 2012 14:31:44 +0000

Do you remember when you used go to the store and buy music? Then you’d go home, put it in your player and listen to it? Then you would own that music forever or until you lost it moving but it doesn’t matter because you weren’t sure what you were thinking when you bought it in the first place?

You owned that cassette or CD or record and no one could take it away from you. These days, when you want music you might get it from a subscription service. Services exist where you pay $x per month and are allowed to download as much music as you want. The catch is when you stop paying the monthly fee you might lose the music. But even if you buy the music from Amazon’s MP3 store or iTunes, you’re really at the command of the service.

Those “stores” could shut down at any time. Or if they went out of business and could no longer support your library, you might not be able to access the music anymore if you didn’t store it locally. Essentially, you’re kind of renting it.

And with services like Netflix giving you access to movies and TV, you aren’t buying movies much anymore either. Heck, even with the housing bust people are reluctant to buy residences. We’re looking at a future of a lot more rentals. And it’s brilliant.

The children being born today will easily live to see the next century. Though few people will say such things, I think the increased lifespan has lead people to be less commital than their parents were. Divorce rates are higher, we get new phones every two years, and we are as loyal to our employers as they are to us these days. Back when a career was 20 years spending it all with one employer seemed like a good idea, and the employer rewarded it. Now careers can last 40 years and there’s little reward for loyalty.

A future that let’s us rent more and own less is supportive of this change as well. We can pay monthly rates and own things for only as long as we intend to use them. I believe a new service called ybuy believes that as well. For $25 a month you can get all the coolest gadgets. You can try them out and should you decide to buy them the $25 goes towards the purchase. It lets you rent, and you don’t have to commit. They have stuff like espresso machines, iPads, and even golf clubs.

I don’t normally talk about specific companies and this is certainly not an endorsement of ybuy, but new businesses like this that capture our issues with commitment interest me immeasurably. I only expect to see this trend continue, especially over the next decade as we continue to sort out our issues with committing large sums of money to anything.

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Kiplinger, Mutual Funds, and Monkeys

The Weakonomist — Tue, 17 Jan 2012 14:30:17 +0000

I’d almost forgotten about how much I loathe the personal finance magazine and site Kiplingers (see here and here). Should you not be familiar with the publication, Kiplingers publishes many articles which I find to be lazy and in some cases, irresponsible. A lot of people subscribe to the site and magazine and probably think the advice is good and properly vetted.

But the problem is that couldn’t be further from the truth. The Editor in Chief is a career journalist who was born into money. The Executive Editor is also a career journalist. That doesn’t matter too much, they surely know what good content is. But to say they know what responsible content is, especially in the space of personal finance, is an aberration.

The Kiplinger 25 is a list of actively managed mutual funds published by the magazine every year. For all intents and purposes, it’s their recommendation of the funds you should be invested in. The Executive Editor published an article at the beginning of the year summarizing the performance of their list in 2011. In general, he seemed quite pleased with the performance of the mutual funds they picked. The table below summarizes the performance.

Nothing to sneeze at, nothing to brag about. But there’s one glaring omission from this table. And I’d expect you to perhaps not notice it, but Kiplinger should.

The magazine publishes this list each year in an issue that doesn’t arrive until the end of March. So 2011 performance matters not since you’re already 3 months off. For the website’s sake, I’ve created a chart showing the returns of these funds against a simple S&P 500 index from April to 2011 last year.

Hmmm, I wonder why they didn’t track performance from the time of publication? Certainly doesn’t make them look as good. And to say nothing of the fact that the simple S&P 500 index fund has about 20% of the fees as Kiplinger’s worst performer. If you want crappy performance and lots of fees, the Kip 25 is the place to go.

Kiplinger could admit they should have measured performance from publication date, but that doesn’t account for the performance of funds that were added or subtracted from the list last year. So let’s look at them.

One was added: BBTEX. As you can see, it handily kicked the butt of a simple index fund. I can’t knock it, even after adjusting for risk and fees, it beats the standard low maintenance benchmark. There are perhaps critiques worth investigating, but I’ll let Kip have a win here.

What about the removed funds? There were two: SLASX and FAIRX. I’ll save you the math, but they just removed two funds that were under performing already. But since you would have bought them from the prior year list you’d already have lost some of the money. The simple index fund outperformed SLASX by 1% and FAIRX by 7% from 2011 before Kiplinger told you to dump them. This doesn’t take away from the fact that these funds blew for the whole year and you would have been right to sell, but it makes them look less omniscient.

If you want, ignore everything before this paragraph.

And for the sake of argument let’s just throw out everything I said and make this as easy as possible to understand. Even by the magazine’s own flawed metrics only 6 out of 13 funds outperformed my simple index fund for the full year (VFINX was up 0.2%). Using the estimated time of publication that number drops to 4 out of 13. Statistically speaking, a monkey should be able to do better than that.

But no one should have to do that. The dirty truth about investing in the 21st century is quite simple. And if you’re a reader of independent personal finance blogs, you already know it. Don’t buy actively managed mutual funds. Track records don’t matter, they were in the past. Active funds are expensive for you and your money. Index funds are dirt cheap, and don’t try to do anything but track an index. If you want diversification, you should be looking for indexes in different classes, but specific funds. But you can’t beat the market year over year. Neither can Kilinger’s list.

Finally, the last time I wrote an article against Kiplinger one of their editors called me out for being a short term oriented investor. Full disclosure: I own three mutual funds (VITPX, VFINX, and VFWIX). I own one stock, about $100 in a former employer that I bought on a whim and am too lazy to sell. I have long term horizons on my investments (with >99% held in retirement accounts) and have never changed fund holdings unless something I own is no longer offered.

If Kiplinger thinks I have a short term horizon when tracking them, it’s only because they change their holdings every year and I just don’t have the time to track their entire portfolio of recommendations through time. Happy to do it, but no one is going to pay me to. But I sleep easy knowing I don’t get paid to give terrible advice and hide it in well-edited content.

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You know I rocked my 2011 predictions

The Weakonomist — Thu, 05 Jan 2012 14:57:24 +0000

If your humble blogger had the time, he would create a database the documents all the outrageous calls people make. Pundits predicting stock market results, economists calling for some kind of statistic, or any idiot that the traditional media calls up can actually shape opinion. But that doesn’t mean they are qualified, or accurate. I’d track every one of them and call them out for their irresponsible actions.

That being said, I’d still make my predictions. Because it’s fun. If for some reason people started thinking I was qualified to make predictions, I’d have to stop. This time last year I made some predictions for 2011. Let’s see how I did. Note: the table looks big but there’s a lot of white space.

2011 Prediction	Details	What I got wrong	What I got right
Gold	In 2010 I called for a gold bubble, WRONG. In 2011 I said we’d figure out if there was a bubble or not. I will concede there is not a gold bubble. The normal price of gold is what it is right now. That said, I still wouldn’t invest in gold.	N/A	N/A
Oil	“I don’t think we’ll see oil go above $130, but I can definitely see oil over $100 again settling around that price point the way 2010 played with $85 oil. Likewise, $3.50 gas will be back.”	Nothing	We saw oil over $100 a barrel last year, but nowhere close to $130. Gas prices aren’t at $3.50 right now, but close enough.
Savings	A year ago the savings rate was 5.3%. My call was that economic recovery would have consumers dipping into savings and the rate would fall to the 3-4% range.	Nothing	November of 2011 was the most recent report as of this writing. The savings rate: 3.5%
Employment	An ugly number for years and difficult to predict. Especially now with so many people permanently leaving the workforce.	I was too optimistic and said 8% would be reasonable, we only just now got to 8.6%	Did make the call the rate wouldn’t fall much, saying 7.5% was impossible
Stock Market	Predictions are no fun without making a call on stocks	Small cap stocks would outperform large ones. Quite the opposite.	I did estimate a PE for the S&P 500 to fall from 23 to below 20. It fell to that mark and below in late summer and settled around 21 in December. PE for S&P 500 source.
Sarah Palin	No comment	I said she’d run.	But clarified she’d only do it to stay relevant. She was able to do this anyway with the SuperPAC. Had I known such a thing existed I might have phrased my prediction differently.
Municipal Bonds	This is what local governments use to raise money. At the beginning of last year people were worried there might be a crisis here.	Called stocks to outperform bonds. Called it wrong.	There would be no crisis, partially wishful thinking on my part.
Interest Rates	We all know they wouldn’t go up, a bit surprising they actually went down. Unless you consider increased demand for American debt which once again seems to be the most stable in the world.	Nothing	Fed would keep rates low, and the rates everyone pays would stay low. I didn’t predict an actual range but also didn’t predict them to fall. Rates won’t move until inflation does.
Inflation	People were still worrying about this. I said there was nothing to worry about.	Nothing	Inflation remained within reasonable parameters.
Europe	2010 was a rough year for Europe, I expected the worse to be over but that the Euro as a currency would be called into question.	Definitely still had a crisis. Still ongoing.	Worry remains for Europe. I said stress and strains would create doubt over the Euro as a currency and that was spot on. Also said that would result in the Dollar strengthening against the Euro. At the beginning of the year a dollar bought about 0.75 Euro. Now it buys 0.77. Not quite a rally but study a chart and you’ll see it.
Surprises	There will be some kind of surprise that no one expected	Nothing	Too hard to make a specific call. Arab Spring counts though.

Not too bad if I say so myself. Keep in mind this is all in good fun. Whether I’m accurate or not doesn’t matter. You should trust my predictions as much as a presidential candidate’s promises.

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Prosumers: From Economic Idea To Company Profit Margins

The Weakonomist — Wed, 07 Dec 2011 15:44:59 +0000

Made up words are my thing. Just a few are Freeconomy, Egoeconomics, Hypotheory, and this blog’s namesake. My childhood, and much of my adult life, has been filled with making up words when the real ones escape me. But I can’t take credit for Prosumers, a word the predates my conception. Prosumers is an awesome word though and I’d like to welcome it to the Weakonomics family.

Prosumers became a word in the economics world a few decades ago, it was meant to describe someone that is both a producer and a consumer. Consumers would specify what they want from producers and have customized goods for themselves. Essentially everything would be built to order. Imagine calling Apple and saying you want an iPhone that has a titanium case and fits the size of your hand perfectly.

This isn’t our reality, the closest thing we’ve really got is ordering a Dell computer with the specs you want. Because the original prosumer idea never really materialized, its definition got hijacked from the nerdy economists by the jocks running corporations. Now prosumers are a high profit customer base for retailers and consumer products companies.

Don’t quite follow yet? Well look around your home, you’ll find a number of products target to prosumers. Personally, I’ve got an expensive mixer in my kitchen that could make cupcakes all day but rarely gets used. You might have a $900 camera for taking pictures of your only moderately cute child. Or maybe you have a $2000 laptop capable of editing video for Hollywood but the most load you’ve put on it was watching YouTube. Not into electronics? That workhouse truck in your driveway that only sees dirt when it rains thinks you’re a prosumer. And you know what, even this website is a prosumer good.

Got it now? Prosumer products are professional grade products targeted at normal consumers. My website has the necessary capabilities to support a lot more traffic and host some crazy media, but I only use a fraction of this capacity. Cameras that go by the name of DSLR largely belong in the hands of professionals, but increasingly these devices, which can set you back $2k or more, are in the hands of point and shoot mothers too cool for minivans. My mixer is great the two times a year we use it, but beyond that it’s kind of a waste. Just like your truck, camera, laptop, or my website.

Most of our prosumer products are purchased under the premise of “hobbyists”. Amateur photographers, barely competent bloggers, and the best selling vehicle in America is almost always the Ford F150. We use very little of the product’s abilities, and the producer is able to charge us as if we were using them all. They love this because you’re pushed into higher priced goods. Not only that, but you aren’t going to really test the warranty on that product if it sits on your counter. Professionals are much more likely to exploit every inch of capability from a truck, or a camera, or mixer. Companies make lots of money marketing to businesses, but they don’t always charge retail prices. You’re paying retail.

As an admitted prosumer, I can attempt to write off my wastefulness on a mixer as a luxury, or even say my website makes enough money to pay for itself, but a prosumer I am nonetheless, because I don’t use these products for a living. It’s okay to be a prosumer, just don’t try to convince yourself or other that you really have any intention of using half the products you own the way they were intended.

Photo: smith_cl9

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Why Retailers Go Nuts For The Holidays

The Weakonomist — Mon, 05 Dec 2011 15:19:43 +0000

The green bars are retail sales in every December since 1992. The red bars are the average monthly sales for the first 11 months of the year. Keep in mind the red bars include Black Friday.

It’s clear that not only are December sales about 30% higher on average, but based on the compression in 2008 a significant portion is discretionary spending.

It’s no surprise why retailers put up Christmas decorations in September.

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The Internet Runs Into 18th Century Law

The Weakonomist — Fri, 02 Dec 2011 15:27:23 +0000

Back when the Constitution was being drafted, interstate commerce was a really big deal. With the federal government being so small, power lived in the states. States established sales taxes to collect revenue from commerce. But the internet wasn’t around and so thanks to old school law a number of online retailers don’t have to pay sales tax.

Look at Amazon. If you ring up an order and are charged a sales tax, that means Amazon does some kind of physical business in your state. It would likely mean they have a distribution center there. If you aren’t charged a sales tax, it’s because they don’t have operations in your state.

Ignoring the price advantage Amazon has over traditional bookstores, many customers get an extra discount because Amazon doesn’t have to charge them a sales tax. If you bought the book from Barnes and Noble or Walmart, you’d be paying the tax. Some people, especially small business owners and brick and mortar retailers don’t think that’s fair.

They have a point. But laws is laws and Amazon doesn’t have to charge a sales tax if they don’t technically do business in your state. All that may be changing as Amazon and eBay are battling it out with policymakers. You’d think Amazon may be pushing for status quo, but you’d be wrong. They’re all for a sales tax for everyone so long as it’s for everyone. eBay is arguing for their customers. Their customers aren’t buyers, but the sellers, many of whom are small companies using eBay as a forum for sales.

As of right now, if a national solution is rolled out (that doesn’t mean national sales tax), a number of small internet retailers will not be subject to collecting the tax. eBay supports this because small companies are already at a disadvantage compared to Amazon, or Best Buy, or Walmart. I say so what, they shouldn’t look towards sales tax policy to fix that problem.

Small companies have been competing with larger ones for a couple of generations now and this is just the reality. Having tax law catch up after 250 years isn’t going to be the solution to this problem.

What you’re likely to see come out of this is a more universal collection of taxes from internet sales. The states will benefit from this by having a new revenue source (largely Amazon) and savvy shoppers will be out a few percentage points of every sale. Sorry, but if you’ve enjoyed the extra discount from buying online, you better enjoy what’s left of it.

Read: Amazon, eBay at odds over Web sales tax; Differing views on whether new law should exempt small businesses

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