Learning Investing from My Father


Many families never talk about money (or sex), seeing the subjects as taboo for discussion between the generations.  Schools have taken on the responsibility of teaching sex (although without teaching any of the morals, because that would be judgemental, teaching religion, or old-fashioned), but there is still very little taught in the area of personal finance.  Some students – generally the ones who the schools decide won’t be able to understand algebra,  and are therefore relegated to “consumer math” – may get some of the very basics on the mechanics of handling money.  They get very little good advice on budgeting and investing, however.  In fact, they are often taught how to do things like use credit cards and take out consumer loans – the things that many should really avoid.

Our family was somewhat odd in that we were investors, or at least my father was.  I remember from the age of nine or ten seeing him at his desk in the corner of our livingroom, a desk lamp shining on the sheets of graph paper where he would dutifully write down the closing prices for his stocks each day.  There were no websites to give you stock quotes.  He would use the stock tables in the C section of The Wall Street Journal which had listings for the NYSE, the NASDAQ, the American Exchange, and bonds and other investments.  He would write down the prices on one sheet and then graph them on the next, making a series of dots for the closing prices with a line connecting them.  He would use a four-color ball point pen to plot four stocks on each sheet of paper, each in its own color.  Each sheet of graph paper would last for about three months before he would need to start a new sheet.

I got interested in what he was doing and started asking questions.  Eventually, at the age of 12, I decided that I wanted to invest the money in my savings account – a grand total of $225 – in stocks and asked him to help me.  At that time a savings account would routinely pay 5%, which I thought was the standard rate that such accounts would always pay.  I didn’t know that inflation had gotten way out of control under the Carter Administration and that the Federal Reserve has raised interbank interest rates to 18% or more to try to kill the beast that was devouring savings.

My father pulled out his thick binder that held his Value Line Investment Survey as I had seen him do many times before.  We went to the back of the index section that had the stocks ranked 1 and 2 for Timeliness, a proprietary measure Value Line uses to rate how they believe  stocks will do over the next year.  Those with a “1” are expected to do the best, followed by those with a “2”and so on, down to the 5’s that are expected to lag the pack.  He set the criteria to find stocks that had a 1 or 2 for Timeliness and at least a 3 for Safety, another Value Line measure.  We searched through and settled on Tucson Electric Power, a utility that provided power for Tucson, Arizona.

The next day he called his broker and placed the order for 15 shares of TEP at $15 per share.  I remember how excited I was when the order executed and I was a stockholder.  We got a certificate sent to our home and I admired the elaborate art work with a goddess holding bolts of lightning in her hands.  It indicated that I was the proud owner of fifteen shares of stock.  I folded the certificate and kept it in my top dresser drawer for years until my father decided to take it to the safe deposit box.

My stock did very well, growing from $15 per share to over $75 per share over the next few years.  I signed up for the dividend reinvestment program and sent in additional money from time to time to buy more shares directly through the plan, brokerage-fee free.  I lost track of the prices I paid and my cost basis, making it so that I could never sell the shares since then I wouldn’t know what my capital gain would be for taxes.   I didn’t really care because I would get a dividend check every three months anyway so long as I held onto the shares.

Eventually the company got involved in a scandal.  Allegedly the executives were using the revenues from the utility operations to fund highly speculative ventures that looked good on paper but whose true performance was being masked.  The price of the stock tumbled quickly after the news came out, falling back to about $20 per share.  When I went to college, coincidentally in Tucson, there was a special shareholder meeting to enact a measure that would dilute the shares by issuing a great deal of additional shares in order to pay off creditors.  I attended the meeting and heard the complaints from longterm shareholders who held far more shares than me.  I held on anyway, partly because I didn’t know my cost basis, and saw the shares drop to less than $2 per share.  The dividend was eliminated for several years, but it was eventually restored and grew over the years to a respectable sum.

Along the way through my middle school and high school days I acquired shares in additional companies.  Starting from eighth grade I needed to file tax forms.  I never actually owed anything, but apparently I was above the threshold where I needed to file anyway just to prove to the IRS that I didn’t owe anything.  My family paid an accountant to prepare the forms, so we ended up paying out a couple of hundred dollars each year to file forms that did nothing other than prove we didn’t need to pay taxes.  That is one reason I’m a strong advocate of the Fair Tax.

As I got older my father and mother started putting money for my college and my early adult life into a brokerage account for me.  My father owned a large number of shares of Citizen Utilities that he transferred to me a little each year under the gift tax exemption.  I then sold these shares off and bought other stocks with the money, developing a portfolio of several stocks.  This ended up being a bad idea since I then got his cost basis for the shares, which was very low, and therefore owed quite a bit in capital gains taxes when I sold the shares.  Actually this might not have been a bad strategy overall since my tax rate was lower than his (I think capital gains were taxed like ordinary income at the time), but it resulted in a net transfer of less money to me.  In any case, I was able to pay for college expenses using the portfolio rather than calling home for money each time I needed it.

I also remember in grade school and high school sitting with my father each evening at 5:00 when the Nightly Business Report would come on PBS.  We would watch the show for the first 15 minutes as they went over the movements of the Dow and other indices for the day, the closing prices of several large  and widely held stocks,  and the biggest gainers and losers.  Once in a while I would see a stock that I owned rise or fall dramatically.  If it did not show up on that segment of the show I would need to wait for the next day to read about the closing prices in The Wall Street Journal from the stock tables.

On Saturdays my father would get his issue of Barrons magazine, the weekly sister publication of The Journal.  I enjoyed reading the column by Alan Ableson.  He always had a very witty column that lead the magazine, called “Up and Down Wall Street,” that reviewed the happenings for the week.  I usually had a dictionary nearby because he would use large words not found in normal newspapers that are dumbed down to a fifth grade level.  I found when studying for the SAT that my dad knew every vocabulary word on the list, probably from forty years of reading Barrons.   The column was always very depressing; Ableson was the eternal pessimist who could find the dark cloud in any silver lining.  I can remember very few times when he didn’t think the market was going to hell in a handbasket.  Still, he wrote in such a humorous way you would laugh through the tears.

Sadly my father developed dementia in his later years and became unable to maintain his portfolio.  He also became very concerned that he had lost all of his money, apparently a symptom of the disease since I checked on the value of his accounts (for the first time in my life) and saw that he was in fact doing fine.  My mother was also unable to manage things, being used to having her husband just take care of the finances, so I obtained power of attorney over the accounts and began to manage them for my parents.  At one point I got my own subscription to Value Line but would still periodically flip thorough his old binder when I was home for a visit.

My father eventually suffered a fall, went into a nursing home, and then passed away a couple of years later.  My mother subsequently passed about seven years after him.  This left me in the oldest generation of our family when I was just in my late thirties.  I was certainly able to take care of myself and my own finances by that point, but I miss the connections to our family history that went with them as they left this earth.  There are many questions I never asked and now have no way to do so.

About a year ago I was flipping through the channels on a Monday afternoon and saw that the Nightly Business Report was coming on.  The white-haired host that I remember was gone, replaced by a tag team of anchors.  Still, they followed the familiar format of the show for the most part and I remembered sitting there in our old family room with my father.

Then last year, after not reading Barrons for a while, I picked up a copy and wondered if Alan Ableson was still writing his witty “Up and Down Wall Street” column.  I was greeted by a series of remembrances from other columnists from Barrons and elsewhere and an article on  the passing of Alan Ableson, who apparently had died during the previous week.  I was amazed that he had written that column for so many years, right up to his death and several years after the passing of my father.

With Ableson’s passing, one of the last connections I had with my father was lost.  Barrons still has an “Up and Down Wall Street” column, but it lacks Ableson’s humor and eternal pessimism.  I still think of my father though each time I pull out my thick binder with The Value Live Investment Survey to find new stock picks.  They now have an online version, but I find I like to leaf through the pages in the print edition and look at the price trends.  I also like to go to the tables with the high Timeliness stocks in the back even though I rarely find a stock that way anymore.

Just this last week, I received a notice that the holding company which Tucson Electric Power had become, Unisource Energy, had been bought out in an all cash deal and that I need to send in my certificates to get paid for the shares.  I guess my plan to keep the shares until I died and enjoy the quarterly dividends all the while so that I would never need to find the cost basis has been foiled.  I will probably need to simply set it at zero for many of the shares and pay the extra, unowed taxes since I can’t prove a higher cost basis for many of the shares and it would cost more to track down the basis that I would save.

There is provision in the paperwork that the transfer company sent with the notice of the sale where you can say the certificate is lost, sign a statement to that effect, and forgo$1.80 per share to insure against a certificate being sent in later by another party.  Perhaps I’ll do that so that I can keep the certificate I have for 15 shares, purchased at $15 per share.  That piece of paper with the goddess holding the lightning bolts is worth a lot more to me than the $27 dollars or so I would give up by holding onto it.  It brings back the warm summer afternoon where I searched through Value Line with my father when he was still in his investing prime.

Follow on Twitter to get news about new articles. @SmallIvy_SI. Email me at VTSIOriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Setting Up an Investment Account for Children


Many parents provide little in the way of financial resources directly to their children other than perhaps help with college expenses or initial assets such as a car.  Others provide resources as needed, like help with rent or money for necessities, but continue to treat their offspring as a child with tight control over the financial decisions rather than as an adult who can make their own decisions provided the assets needed.  Providing little may build character and pride for those who succeed, but increases the chances of failure since what would be small events for someone with some money set aside become huge events for those without.  Doing so also increases the chance of them buying many things through loans, meaning that resources gained through work will be lost to interest.

For those parents who are able, meaning those who have lived below their means and therefore have the resources to do so, a better option is to set their children up with an investment account.  If this is started while the child is a tween or a young teenager, the child will be able to learn investing skills under the guidance of a parent, making them better ready to manage their own investing when they leave home.  If they then have a portfolio of assets when they start the adult stage of their lives, they will have a safety net when needed and also have the means to acquire needed items with less debt, meaning that more of their effort at work will go into building assets and providing necessities and less will go to interest.  This will be like making perhaps ten times as much over their working lifetimes.

The steps for setting up an account and getting your children learning about investing are as follows:

1.  Decide whether individual stocks or mutual funds are more appropriate.  Based on the age when they are starting and the consequences of bad investment, this is probably one of the best times to be investing in individual stocks.  Many investors may not want to take the time required to pick stocks or deal with the fluctuations in value, however, in which case mutual funds would be the better choice.

2.  Determine where to setup an account.  For individual stocks or ETF buying, this would be with a broker, either in person or online.  For mutual funds, an account should be setup at one of the mutual fund companies.  Because they are a minor a parent will need to be the custodian and sign things as needed.

3.  Determine how to fund the accounts.  The easiest way to fund accounts is using the gift exemption, which allows parents to give up to $14,000 each ($28,000) per couple to their children per year.  There are also ways to give more without incurring tax penalties, but these reduce the amount that will be tax-free in an inheritance.  See a CPA for more details.  Realize that if they start making money investing that they will soon need to file income tax returns.

4.  Sit down with them and choose investments.  This, or course, involves teaching them how to invest.  You want them to have some say in the selection of stocks or funds so that they learn the skills needed but not make really bad choices.  If choosing individual stocks, one method is to select a group of stocks and then allow the child to determine which of the group to purchase.  With mutual funds, the parent can specify the types of funds to purchase and then the child can select the specific funds.  For example, the parent could specify buying a large cap and a small cap growth fund.

5.  Get them involved with the paperwork and the taxes.  Part of managing their accounts is knowing how to store the needed information and prepare the taxes each year.  Show them how to save and track the cost basis for their investments, what information will be needed should an audit occur, and how to prepare and file the tax paperwork.  Even if they do not do the taxes directly, they should still study the returns and verify that the information is correct.  Note that using an accountant is often a good choice if you invest since the rules can be very complicated.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Is an Initial Nest Egg Better than an Inheritance?


It was found from a recent Pew Research survey that about 36% of adults aged 18 to 31 were living at home with mom and dad.    This has been greatly hyped by the news, but really it isn’t as alarming as they make it out to be.  Digging deeper into the data, we see that 65% of 18-24 year-olds are living at home, but only 16% of 25-31 year olds.  Since a lot of the 18-24 year olds might be going to college or a trade school, it actually makes a lot of sense for them to live at home if they can (since the parents would typically be paying for an apartment for their adult children otherwise anyway while they were finishing school).  If more than one out of three adults were coming home from college and moving back into their old bedroom, that is more of an issue.

Looking at the longer term data as well, we see that a lot of young adults have always lived at home.  Back in 1960 32% of those aged 18-31 lived at home.  The big difference then was that those not living at home were very likely to be married (56 %) versus today (23%) where people are waiting longer to get married.  What the probably means is that a lot more young adults are going to college and then going into careers, putting off getting married until their careers get going.  No doubt the much more liberal attitude towards premarital and even recreational sex plays a role in this trend.

Still, there are certainly a lot of young people coming back home, having completed college and not found a job, or having tried to live on their own.  Others have not been able to maintain an apartment due to a job loss or their hours being cut in preparation for the roll out of Obamacare next year.  One of the biggest issues is that those  starting out have little or no emergency fund and also don’t make enough to build up an emergency fund very quickly.  Perhaps if they started out with enough money to pay for rent and food for six months to a year, they would be able to get back on their feet without coming back home to live in the spare bedroom.

Maybe instead of leaving a big inheritance for children when they are in their fifties and (hopefully) have built up plenty of money on their own, parents who have saved and invested enough to become financially independent in their forties should consider providing their children with starter money for their lives.  This could be done through gifts each year.  Currently the federal gift limit is $14,000 per year.   This means that parents could give their children up to $28,000 per year ($14,000 per parent).  (Although check with a CPA about this.  As the IRS says, this stuff is complicated.)  Start when the child is 15, and they could leave the house with over $110,000.  The investment return from such a nest egg would be something like $10,000 – $20,000 per year), meaning they would have plenty to fund a good portion of their living expenses for years if they get a modest apartment ($300 per month = $3600 per year)  and live frugally ($200/month on food = $2400 per year).

The idea here isn’t to create a trust fund baby that will live on the money for a while, eventually blow through it, and then come back in their mid-thirties looking for more.  The idea is to give them the cushion they need to get started in their careers.  By knowing they have the resources to spend a few months looking for a job, they can find a job that is right for them.  It will also help them in their lives to stay out of debt or at least limit it.  They will have the cash to buy a quality used car and avoid a car payment their whole lives.  Likewise, they’ll be able to put 20% or more down on a house, avoiding PMI.  All of this will mean the ability to keep more of their paycheck, increasing their ability to grow wealthy.

Of course, there are a lot of 18-year olds who can’t handle such a large sum of money.  They will blow it on stuff.  Some will find a boyfriend or girlfriend heavy in debt or with other issues whom they “know they can change” and give a large amount to them.  Some may even get sucked into a cult, get lost in an addiction, or just not  grow up and move on with  life because they think they can just live on the money they have.  The trick is finding out which ones can and setting up appropriate safeguards for those who can’t.  Some ideas:

1) Instead of giving away all of the money to them when they turn 18, continue giving them gifts as young adults.  There is nothing stopping you from giving them half of the money when they leave home and the giving them the other half over a few years once they graduate from college, turn 25, get their first job, or meet some other milestone.  This will force them to do the right things to succeed to get the additional money and also give you time to see how they handle the initial money you give them.

2) Instead of giving the money to them initially, set up a special account in your name, and then send them a check for a portion of the investment return for a period of time.  Show them that they can have cashflow from the money indefinitely if they just spend the interest rather than spend the principle.  This will also reduce the amount they have available to spend, making the need to get employed to add to their income apparent.  Once they are sufficiently mature, you can start giving the principle to them over a period of years.

3)  Start out early as teenagers and involve them in the planning and investing.  Rather than just investing the money and keeping it a secret from them, show them how to invest and have them help with the investment decisions.  Also, have them help with the taxes for their account each year, which will happen when the account value builds up.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Should We be Putting Our Children to Work During the Summers?


Really the whole school schedule has become somewhat antiquated.  In the past school ended in the summer because that was when the children were needed to help raise the crops and care for the animals and the land.  A child might also miss school in the fall if there were crops to harvest or lumber to haul.  Gathering ice in the winter might also mean a few days away from school.  Many children looked forward to going to school since it meant a little time away from their chores.

Today children come home in the summer still even though few work on the farm or even help with the maintenance of their homes and yards.  To make it even worse, there are a lot of families where two parents work outside of the home, meaning teenagers are left alone and younger kids are sent to a sitter or away to camps.  They generally play video games and watch TV and YouTube videos.  Some kids are still glad to go to school again – this time out of boredom.

Still, it would be difficult to change the system.  Children are used to long summers off.  School systems are not ready to cool a school through the summer and most busses have no air conditioners.  Teachers are also used to working only 9 months of the years.  Despite complaining about the low pay only working a 3/4ths time job provides, the truth is many choose teaching in part so that they can have some time off to be with their children and do other things besides work during the summer and winter breaks.  I doubt many would take another job to cover the summer and the breaks if one were available, not that I would blame them.

Still, it seems like children could be doing something more productive to help them get ready for life during the summers.  Obviously older teens can get a summer job, and many have – at least before the rising minimum wages and regulations made fewer jobs available.  It seems like younger children could be doing something more as well.  Maybe not for money, although running and working a pet sitting business of a yard care business could help them learn the value of work, some aspects of running a business, and some skills with money management.

There are other productive, creative things they could be doing as well, though.  Perhaps they could be writing a short story or even a novel.  Maybe they could be tinkering with some old electronics or writing computer games rather than just playing them.  Perhaps they could be doing some science experiments – using the internet to track earthquakes or asteroids, or doing some biological experiments with plants.  Perhaps they could be doing some elaborate art project.  Or maybe they could be going to the office with mom or dad and helping out with things.

Certainly childhood is a unique time and there should be a lot of time for fun and adventure before going into the working life of adulthood.  Still, surely there are a lot more substantial things to do besides watching music videos and playing video games.  Any thoughts?

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Do Middle-Schoolers Really Need a Cell Phone?


Ok, I’m weird.  I think I am one of about a thousand people in the country who doesn’t carry a cell phone.  The main reason is that I like to “be where I am.”   When I am at work, I want to be at work without the distraction of people calling or texting about other things.  When I am home, I like to be home and not have people calling about work (ever notice that you would never call someone at home before cell phones unless it was really critical, but no one gives any thought before calling at dinner time or nine at night to talk about things that could wait for the next day since people started carrying cell phones?).  Also, I really don’t know why someone would pay for a movie and then sit there and text throughout it, or how someone could be so rude to people on stage and fellow audience members to text during a live performance.  Actually, I still think it is rude to talk on a phone (or have it ring and then spent thirty seconds seeing whose calling while your annoying ring tone plays before answering the thing) in a restaurant or to text when you are with other people.  Of course, I understand this is the norm and won’t pretend that I can change the world.  You are all addicted and need your digital fix.

My wife, on-the-other-hand, has moved on with technology and has an iPhone.   This has been fine except that it has changed her view of things.  For example, the other day when I came back from fishing she was complaining that she couldn’t call me to ask about dinner plans or something.  The thought of being out at the river enjoying nature and needing to pick up the phone and talk about dinner reinforced my desire not to have a phone.

There is another annoying trend emerging, however.  My son, who is in 6th grade, has informed me that he is the only one left in his grade who does not have a phone.  This made me wonder less about my decision to not get him a phone than to question other parents’ decisions to get their kids phones.  I mean, I’ve seen kindergarteners with their own phones.  Is this really necessary?  Does a five year old need to be reached at a moment’s notice?

There are also a lot of undesirable things that have come from putting this type of technology in the hands of kids.  We’ve seen a rise in cyber bullying largely because of the number of cell phones in the hands of middle schoolers and high school students.  These devices have allowed kids to spread gossip, take and send embarrassing photos (including nude shots of themselves that will haunt them forever in later years) and videos, and plan mean pranks on other students.  In class they are used for cheating and are generally a distraction.

Financially that extra money being spent on a cell phone may be part of the reason no one seems to have the money for college anymore or to even pay off their homes before they retire.  Growing wealthy requires you to go against the norm because the norm is broke.  This means paying cash for used cars when all of your coworkers are taking out loans to buy new cars every four years.  This means eating in a lot while everyone else is going out five nights a week and doing take-out the other two.  This means buying a smaller house that you can make a big down-ayment on and pay off in 10 years while everyone else is buying a McMansion with a bonus room and an office by taking out a forty-year loan.  It may also mean not having a cell phone, or having a cheap phone with minimal features and not giving your kids their own phones until you have enough saved that it really isn’t a significant expense anymore.

My son has confided in me a couple of times that he appreciates that I care enough about him to not get him a phone because I feel it is better for him to experience “being where he is” while he is growing up.  I don’t know if he realizes or appreciates the freedom he has since he can be with friends or out on his bike without us checking up on him.  (Given that most parents use their kid’s cell phones as a virtual leash, I’m frankly surprised so many kids still want them.)  Note, however, that he still expects a cell phone when he gets to high school.  We’ll see….

Does anyone else out there not have a cell phone?  If so, what are your reasons?  Anyone out there want to explain while anyone under 16 really needs a cell phone?

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

A Tale of Two Home Buyers. Why Waiting Matters.


In the last post I advocated saving a 20% down-payment and putting no more than 25% of your take-home pay towards your mortgage.  I also advocated using a 15 year fixed loan to reduce your interest rate and be able to pay off the house before your kids start college.   Some readers took exception to limiting the mortgage payment to 25 % of your take-home pay.  After all, the standard mortgage has been 30 years, and even in these low-interest rate times 30-year mortgages are more common than 15-year mortgages.  Raising a 20% down-payment, which is needed to avoid paying mortgage insurance each month, is also no longer the norm.  Individuals instead typically take out two mortgages (one which provides the 20% down-payment, and then a second that pays for the rest of the house), put almost nothing down, and go ahead and pay mortgage insurance.  This allows individuals who cannot come up with a down-payment to get into a house right away and start “living the dream.”

A couple of generations ago people started out in small homes or even rented an apartment for a long time before buying a home.  Many couples today, however, are looking for their first house to have everything that the home they grew up in had.  A large backyard.  Three or four bedrooms.  A bonus room.  An office.  They therefore want to jump right into a $200,000 mortgage, but certainly don’t want to wait until they can save up $40,000 for a down-payment.  Loan agencies that qualify individuals for huge loan limits certainly don’t help.

Despite this advice being out-of-the-norm, I still advocate for a 20% down payment and a mortgage no bigger than 25% of your take-home pay. The reason for this is that unless you limit your expenses you will not have money to save and invest.  To illustrate this, take the tale of two guys.  Both guys are 21 and make $50,000 per year and put away 15% for retirement.  After funding their 401K’s and paying taxes they have take-home pay of about $32,500.

The first one, Joe Average, buys a home with a mortgage of 35% of his take-home pay.  He takes out a 30-year mortgage on a $204,700 home.  His payment is $948 per month on a 3.75% fixed rate loan.  He is very normal in his choice of home but abnormal in that he does not take any equity out of his home – he just pays his payments until he pays it off at age 51.  After that, he invests his mortgage payment, getting an average return of 12%.

The second guy, Crazy Fred, opts for a home with a mortgage of no more than 25% of his take-home pay.  He therefore finds a first home for $94,700 and a mortgage payment of $677 per month on a 15-year fixed loan.  Because of the shorter term, his interest rate is 3.5%.  (Note that he could have also opted for paying rent for the first ten years and little would have changed financially, which might have been the thing to do if none of the homes for under $100,000 were in safe neighborhoods.)  He saves the extra 10% and invests, earning a return of 12% on his investments.  After ten years he takes the money he has built up through investing, sells the home he has, and uses the home equity he has built up ($57,486) and the money he has saved through investments ($95,926) and uses the money for the down-payment on a bigger home.  Not wanting to increase his mortgage payment, he takes out another 15-year loan for the same amount ($94,700), meaning that his new home is worth $248,000.  In other words, he puts $153,300 down on this new $248,000 home.

Here are the amounts Joe Average and Crazy Fred will have in investments and in home equity during their lives:

Joe Average Crazy Fred
Age Home Equity Investments Home Equity Investments
21 $0.00 $0.00 $0.00 $0.00
31 $44,805.00 $0.00 $57,486.00 $95,926.00
41 $109,959.00 $0.00 $210,898.00 $95,926.00
51 $204,700.00 $0.00 $248,000.00 $412,519.00
61 $204,700.00 $218,076.00 $248,000.00 $1,457,400.00
71 $204,700.00 $937,815.00 $248,000.00 $4,905,910.00

So, at 51 years old, when Average Joe is just paying off his $204,700 home, he only has the equity in his home.  Crazy Fred, on-the-other-hand, is paid off his $248,000 home four years earlier and has built up more than $412,000 in investments. 

In ten more years at age 61, Average Joe has built up a respectable amount in investments since he has been contributing what he used to contribute to his mortgage to investments (meaning he is not sending kids through college or anything).  Crazy Fred, however, now has more than a million and a half-dollar net worth, including $1.4 million in liquid assets that he can use to generate about a $60,000 per year income easily.  This is in addition to his retirement savings and his job.  Note that Crazy Fred continued to contribute only 10% of his pay to investments when he paid off his home, so he also had his $677 per month that he was paying for his mortgage to spend as he wanted.

By the time they reach 71 years of age, Average Joe has finally become a millionaire, but just barely (not counting his retirement savings, which also would have been a few million dollars since he was putting away 15% per year).  Crazy Fred, however, has more than $5 M just from the money he made from investing rather than buying a big house to start.

But wait, Average Joe made more in equity because he had a larger loan, right?  Assuming that the price of the two homes went up 5% per year, Average Joe would have made $2,143,377 in appreciation on the home value.  Crazy Fred would have made about $1.5 million between his two homes. So yes, Average Joe would have made more on home appreciation, but only $600,000 more.  This is nowhere near enough to make up for the $4 M difference from investments.

So, is it normal to buy a $94,000 house instead of a $200,000 house?  No.  Are there plenty of excuses to buy the larger house to start?  Of course.  But this is why most people don’t become wealthy.  Two individuals can have radically different outcomes given the same middle class incomes.  The difference is that those who become wealthy don’t settle for the excuses and do what is needed to save and invest.  Everyone else doesn’t.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Sympathy for the Boomers


Normally I am not a fan of the Boomers (the Baby Boomers, those born between about 1944 and 1955).  I’m sure there are a lot of great people in your generation who worked hard and did a lot of great things.  But there were also a lot of people who really messed things up.

The trouble was, in rejecting authority and not “trusting anyone over 30,” you threw out a lot of good stuff with the bad.  You threw out great art and gave us dung thrown at a canvas.  You threw out great symphonies with beautiful melodies and gave us songs where musicians beat on their instruments and “performance pieces” where the musicians just sit there.

Financially, your generation has been a train wreck.  Still scarred by the Great Depression, your parents were one of the most financially responsible generations ever.  You made more wealth than any generation before you, and yet many of you are heading into retirement still owing a mortgage on your home.  You bought pet rocks and expensive cars and remodelled your kitchens and bathrooms dozens of times, but never saved for your children’s college or your own retirement.  Maybe at 55 or so you started to get worried and saved a bit, but much too late.  (Again, this is all crass generalization and I’m sure there are exceptions.)

That said, fate has also not been kind to your generation.  First it looked like the vast expansion of the 1980’s which went well into the 1990’s would provide the stock market gains needed to salvage a good retirement despite your spendthrift ways during your youth.  Unfortunately that lead to a bubble that burst and took 50% of the stock market value with it.  For many .com companies, the damage was 90% or 100%.

Next, low-interest rates and easy credit lead to a housing bubble, with homes growing in value more that 20% per year.  Again, it looked like Boomers would be able to sell their homes and downsize.  They would then have plenty of cash for a comfortable requirement.  Again, however, the bubble burst, and many Boomers who used their equity to take vacations and remodel their kitchens found themselves underwater.

At this point, they were hit with low interest rates caused by a Federal Reserve that decided to set fund rates at zero and buy long-term debt to spur the economy.  The trouble, however, was that the very business unfriendly climate caused by unprecedented government intrusion into business affairs, a vast expansion in regulations, and a gargantuan expansion in healthcare requirements that will make coverage unaffordable for most workers, there was very little demand for loans to make use of that loose credit.  Instead, Boomers who were retiring saw their interest returns on CDs fall through the floor.

Now, Boomers have rushed into bonds to try to get some sort of return for their savings.  That has caused bond prices to soar, leading to another precarious situation.  When interest rates rise, which they will once inflation starts growing or a change in policy at the Federal Reserve takes place, Boomers will see their bond investments decimated.

Those who have saved up enough to be able to invest largely in equities — those who have enough in assets to be able to weather a decline and still have enough to meet expenses — will be able to keep enough in cash to meet obligations for several years and then sell equities when prices are up and hold when prices are down.  The rest, however, are in a very risky position, particularly with the Government’s ability to continue to pay Social Security and Medicare claims very much in question.  The next decade may not be pretty.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.