How I Bank
March 25, 2006 at 5:12 am (Banking)
I actually started online banking back in 1998/1999 when I first read an article on online banking in BusinessWeek. I don’t remember which other bank it compares to, but I chose to give NetBank a try. NetBank was one of the highest yielding banks in the nation at that time according to www.bankrate.com, and has been so until recent last 2 to 3 years. I made sure that NetBank was listed at FDIC http://www2.fdic.gov/idasp/main_bankfind.asp database, and then I started my online banking.
In the beginning, I didn’t have a lot of trust. So I started by depositing some small amount of money, and tried to withdraw money from my account by checks & ATMs. After everything seemed to work fine without any problems, I started to move majority of my cash holdings to NetBank.
Because of the inconvenience of online banking, mainly due to very few free ATMs, I keep accounts at two local banks. In one local bank, I only have saving account to reduce the amount of money that I need to keep for minimum balance to avoid fee, since checking account usually has a higher minimum balance. In another local bank, I have both checking and saving accounts, so that I have at least a checking account locally. And my rationale to have two local banks is to simply increase the total number of free ATMs that I could use in a short distance from wherever I was. Of course, if you don’t have enough cash reserve, you probably want to limit the number of banks you have.
This strategy of having an online bank and two local banks have served me well. I can easily access my small cash need, while I can keep the majority of my cash in a higher yielding online account. Depending on your comfort level for accessible cash, you can put that amount in local banks, and put the rest in online accounts. Since I conduct most of my purchases through credit cards, my need for cash is low. I usually only keep about one thousand dollar in local banks, but it could vary from a few hundreds to just less than two thousands. And to avoid all kinds of ATM & bank fees, I define my accessible cash as any amount over the minimum balance that is required to avoid monthly fee. And I always use the ATMs of my banks.
I also take full advantages of (free) online payment offered by NetBank. Every month or quarterly, depending on the bill frequency, I pay my electricity, gas, water, trash, home owner association dues, and two of my credit cards automatically. My phone bill and auto-insurance is paid automatically through credit card instead of NetBank, since I can get the 1% cash rebate on credit card charges. Having all the bill paying arrangements, I spend probably less than 10 minutes for viewing or paying all of my bills, excluding credit card bills. And I make sure that there is sufficient amount of money for payments by setting up an automatic transfer of an upper estimate of the total bill from my major high-yielding money market account to the checking account that allows unlimited withdrawals.
In summary, I try to achieve the followings for my banking needs:
- Easily accessible cash by having two local banks.
- Higher yields for most cash in accounts at my online banks.
- Avoid any bank or ATM fees by using ATMs of my banks.
- Take full advantage for online bill payments to save time & stamps.
By the way, I opened accounts at INGdirect a few years ago, and now I’m still debating whether it is worth my time and trouble to move my INGdirect accounts to EmigrantDirect for their exceptionally high yields.
Inflation
March 25, 2006 at 12:29 am (Investing)
Modern money is paper money since the world came off from the gold standard in early 1900. One problem with paper money is that it is based upon confidence and trust, which can be fickle and fleeting sometimes. When the confidence is suddenly gone, then you have an Asian currency crisis or Mexican Peso crisis. The other serious problem with paper money is that government can print it in unlimited quantity. Pretty much with any forms of government human can conceive of, all forms of government leads to monetary inflation. The basic reason is that money can translate into power, and all forms of government are power-hungry. With more money, politicians can please their voters in various ways they choose. And so they either choose to print more, or borrow more, and both ways are inflationary. The cycle of more money more power, and then more power more money is self-perpetual. In this process, paper money gets debased constantly, and therefore you have inflation.
Monetary inflation complicates the savers’ goal. Without inflation, the savers can simply save and store his or her wealth in whatever form he or she chooses. He or she does not need to worry about losing purchasing power of his or her dollars in cash. However, with constant inflation, even when it’s low, it’s simply a process during which the government steals from its dollar holders.
With inflation, the price of everything goes up, including the wage of the labor. The lower class people who have minimal savings don’t have much to lose. (Forgive me to use this political incorrect word “class”. ) Their wage is usually behind the curve of inflation, and therefore, their lives are a constant struggle to catch up with the last payment that is due. The middle class people who have some savings face similar situation as the lower class people. In a low inflationary environment, they can try to maintain their purchasing power with the limited venues of investment choices that they have. But the most distinct advantage of middle class compared to lower class is that their major asset is their home which goes up in value via inflation, while their mortgage debt remains constant. The upper middle and upper class people, because of their plentiful resources, usually have substantial wealth invested in assets and/or owning business that will go up in value in an inflationary environment. Inflation always benefits more to the people who get their money first, such as businesses or government, while the inflationary effects propagates last to the wage earners.
Here is a calculator from US Federal Reserve,
http://minneapolisfed.org/research/data/us/calc/
As you can see, from 1913 to 2006, the US dollar has depreciated from $1 to $20.45, an astounding 95.1% loss in purchasing power, but only about 3.3% inflation rate compounded annually. Is your bank account yielding more than 3.3%?
? Investing
March 23, 2006 at 1:45 am (Investing)
Assets
If you think that first step, saving money, is difficult, the second step, investing, is actually more than twice as hard. However, when you get to the second step of the money problem, you should congratulate yourself. Because you have solved the first problem of money of not having enough money for your needs, now you’re onto the second problem of figuring out what to do with the extra money for your immediate needs.
Obviously you can’t begin to invest your hard-earned money, if you don’t know how much you have and what you currently own. To figure out your networth, you should inventory and categorize everything that you own. Here is the table for my networth:
[table for my networth]
Notice that the sum comes out to be 100%, which is my networth. Some people make a pie chart for their assets, which is a little misleading. The pie chart cannot show negative percentages for your liability. You can have very little networth, while having both a lot of assets and liability. In accounting terms, the amount of liability over your networth (which is called equity), or the debt/equity ratio indicates your ability to borrow money. Your financial leverage is directly proportional to the amount of assets over your networth. This leverage is a dual edged sword, and it can either help you or hurt you. I have reserved the details in another section if you are interested.
So the question comes why is investing important to your wealth? There are two reasons: 1. The power of compounding. 2. Inflation. Everyone knows the power of compounding. It’s the time value of the money available today. Compounding for positive returns in time the same money will worth a lot more in the future years. But it’s a lot easier to understand this than actually getting a consistently compounded return. In fact, there are many smart people spending their every second on Wall Street and other financial markets, constantly trying to figure out how to get more money out of existing money. I will continue in why investing, and leave how to invest in another section (Efficient market & frontier).
The second reason that you should invest is because of inflation. Ever since the world comes off the gold standard, we are faced with ever growing and diluting supply of paper money. If inflation rate is zero, then there is no urgent need to invest. Since the creation of the US Federal Reserve System in 1913, $US purchasing power has been diluted by more than 95% ($1 in 1913 can buy $20.45 in 2006). It means that if your compounded annualized return of investment is not more than 3.3%, you would have lost your purchasing power. I don’t know about yours, but my money market account at NetBank (bank websites) only yields 3.52% APY, barely above 3.3%, and it’s one of the highest yields in the nation. Inflation is basically an on-going robbery by governments stealing from middle and lower class people. People in lower class have no other financial resources besides their time and labor which tracks behind the general inflation trend. People in middle class have limited amount of savings to rely upon, but often cannot generate sufficient returns to combat the erosion of purchasing power by inflation. Their biggest asset is often the home that they own which fortunately tracks inflation, while at the same time, their fixed mortgage debts are debased through time and inflation. Therefore, under normal circumstances where housing price tracks general inflation, I will advise anybody to buy a home for both inflation reason and also for the amount of financial leverage that it can provide. The leverage comes in when you make just a down payment for the asset that you purchase. A 20% down payment gives you 5 times the financial leverage, and a 10% down payment gives you 10 times the financial leverage. Your return on your down payment is essentially multiplied by the amount of financial leverage that you have, whether it’s positive or negative! Therefore, under normal circumstances, since housing price always track inflation rate, and that inflation rate is pretty much guaranteed to be positive 2 to 4%, buying a home will be the single best investment that you can make, assuming that you can afford it (Again, I emphasize normal)!
California housing boom or bubble?
March 21, 2006 at 1:51 am (Real Estate)
For the people who don’t live in California, you may be thinking that I got to be joking to have a gain of $260K on a small condominium, which can be more than the price of a single family house in some other states. But for the people in California who are not home owners of a single family house, this is a harsh reality that they need to face everyday. Most people can't ever make up the wealth gap of $300K to even $600K comparing to the lucky homeowners.
For the people who argue for the continuing of the housing boom, their list of upside reasons is endless: California has very good weather, plentiful jobs and diversified economic growth, increasing population & immigration, etc. But none of them can tell me why the housing price was half or even a quarter of the current price eight years ago, when everything that they claim was also true six years ago. It's almost like saying that group A (in 2000) took a placebo pill (which is the good weather & economy), and that group B (in 2006) also takes a placebo pill, but group B recovered from the disease, mainly because of the effectiveness of the placebo.
To me, I believe that the single most influential factor was the interest rate cuts by US Federal Reserve. The list of why California is better may help the boom compared to mid-west, but is definitely not the direct reason. Without holding the short-term interest rate at 1% for more than 1 year, real estate wouldn't never go as high as it did without any doubt.
I'm personally in the bubble camp for 6 years and counting. The entire process of watching the house that I really want to buy for my family, to keep going up without an end in sight, has been simply tormenting. I wish 6 years ago I was either wealthier or had my current salary. Everytime when my networth finally increased by another $100K, the housing price simply has gone up by more than that amount.
So when will the housing stop going up, or will it? According to Didier Sornette, the author of "Why stock markets crash", his prediction is this year in mid-2006: http://arxiv.org/PS_cache/physics/pdf/0506/0506027.pdf
Or click on "Is There a Real-Estate Bubble in the US?" at his web page: http://www.ess.ucla.edu/faculty/sornette/books.asp
I don't know if it's true, but his theory on the mathematical behavior of an unsustainable bubble is the one of the most interesting readings so far that I've come across.
Markets can be temporarily (or for a long time) out-of-synced with the fundamentals. The market price is always the fair price at the current moment between buyers and sellers, but that does not preclude one to come up with a valuation measure on its price. I've constructed a comprehensive housing valuation calculator to objectively assess the price against the owner's equivalent rent (which is used in CPI or Consumer Price Index calculation). I don't know how much fudging the bureau of labor statistics has done in the housing component of CPI. But certainly housing price has out-paced the owner's equivalent rent used in CPI, when almost 70% of the people are home owners, and only 30% are renters. Talked about fudging CPI, if they start to switch over to use housing price while it's in decline, they can certainly produce even lower CPI both at ramp-up and ramp-down of the housing market.
Why is your home the best investment?
March 21, 2006 at 1:50 am (Real Estate)
Well, I should really qualify the title of this, by not buying the home in a bubble. Whether our current housing market is a bubble or not is debatable. Under normal circumstances however, buying a home is usually your best investment. And the reason is inflation. Historically, housing price tracks inflation fairly well. Since inflation is seldom zero, or negative, buying a home is a financial transaction that has two very big advantages, assuming that you acquire the home with some amount of mortgage.
- Leverage: A leveraged transaction means that your return (or loss) is magnified by the amount of leverage that you use. In a leveraged transaction, you use less amount of cash to take control of a much bigger amount of asset with debt. If the asset goes up in value, then you are rewarded with extra returns.
- Inflation: Your home value is almost guaranteed to go up in value in a very long term perspective (I’m talking about 10+ years) because of inflation. Since you repay your mortgage debt by cash gradually, the debt burden actually goes down as your wage gets inflationary increase. $100K owed now will be less burdensome 10 years later, even if you have not paid down a cent in principal. Inflation is the best for debtors, but worst for creditors.
- Tax: At least in the United States, federal tax laws clearly have a preferential treatment for homeowners. You can deduct mortgage interest which is also AMT-deductible. Possibly you can deduct your usage of home as home office. The property tax is deductible too. And the best thing is that the capital gain on the home is usually tax-free under $250K for singles, and $500K for couples.
That is why real estate is often touted as a good investment because it is really true, with the following assumptions:
- You didn’t buy it in a bubble.
- You have sufficient positive cash flow to carry you through enough years for inflation to increase your return.
- You can take good care of the home or property.
I have constructed a Buy vs Rent calculator for you to experiment the outcomes of the two choices.
