Interest rates and real estate
Cleaning up an old box of things, I came across some documents of my dad's from the mid-1980s, regarding the purchase and sale of a condo in New York, and a house in Virginia. Wow. 10.125% I remember in the 1980s my mom was paying something in the double digits for our house mortgage. It got me thinking about real estate investing and about expectations. Saw this article yesterday. The author blames the fiscal policies of Alan Greenspan for, in effect replacing an equities bubble with a housing bubble.
Where I live, the median single family home is near $1 million. We're not talking "a million dollar home" here, we're talking mediocre construction, poor insulation, old appliances. For a million bucks. Unaffordable, unsustainable. And the market here has been flat or slightly falling over the past year. In 2001, my wife and I had bought a small condo here. Small, meaning just a hair over 1000 sq ft. Two bedrooms, 1-1/2 baths. It was expensive then, but under $250k, which was our self-imposed limit. We sold it two years later for a profit of nearly 60%. That was welcome luck.
When we purchased it we barely had enough for a 5% down payment. But, as we had calculated, the cost of owning was only slightly more than we were paying in rent, and the potential benefits, both financially and in personal satisfaction, were well worth it. We took an 80% 1st mortgage at some reasonable interest rate (somewhere in the 6.75% range as I recall), but were talked into taking a second mortgage for the remaining 15% (at an interest rate of 9%) to avoid paying PMI (private mortgage insurance).
As it turned out, in that case, we were lucky. The property value grew at about 30% a year, allowing us to refinance at a lower interest rate, bundling both mortgages (as well as a car loan) into one package, reducing our monthly payments by several hundred dollars, and retiring our auto loan. Another year, and we sold it. Two years after we sold, it was worth more than a half million dollars. Too bad. We lived off the proceeds for over a year, as a fellowship took us overseas with our 18-month old (at the time) first son. The income from that fellowship covered our expenses overseas, but wasn't enough to cover the mortgage back home on our first house (where my dad had been living, with off again/on again tenants since we had moved out to California for my PhD program).
That first home, which we owned for about 8 years, finally sold a few months ago, at a price significantly reduced from our expectations. We had put it on the market nearly a year earlier, at $350k, as per our realtors recommendation. Trickles of interest. After about a month (or 6 weeks) we talked about a price reduction. We asked: "how far must we come down to get an offer, that's what we want to know." "Oh Let's just drop it $10k for now, and see" BAD IDEA. About four tiny reductions later, we took it off the market for a couple winter months, looked into renting it, then finally got a new agent, and dropped the asking price to $300k. We wound up with an offer around $285k which we accepted grudgingly.
We still did okay, but instead of about 9% per year gain, we realized only about 6.5% annualized. No crystal balls I know, but we've got a new rule when it comes to selling a house (unless the market is clearly seller biased), price the house 1-2% below fair market value (as best as we can figure), and hope that more than one person bids on the house. Worst case, we've taken a few percent less than we'd have liked. In the end, from pricing too high, and taking too long to reduce, we wound up with about 20% less.
The trick is always knowing the risks, and calculating them. What's the rent-to-buy ratio? Is it about the same cost to buy as to rent, or more, or less? What sort of gain is necessary on the entire value, to warrant the investment of the down payment. For instance, if we were to buy a $600k house today, comparing my historical annualized return on investments (currently around 8% since we started investing in 1999), and assuming a 20% down payment, the property would need to grow at around 1.6% for the growth to equal what I might expect outside of real estate.
[That is .20 x $600k = $120k; 120 x .08 = 9.6; 9.6 / 600 = 1.6%]
Next, we've got to calculate the monthly costs. If we get a mortgage at 6.5% (the currently advertised rate for E*Trade customers), and we add in insurance and property taxes, and about 1% for maintenance and repairs, minus the savings from our tax right off of the mortgage interest, well, our monthly outlay is somewhere in the range of $3500. If a rental would cost us that much, well, we're in the ball park. If not, we have to consider the added costs, the added benefits of owning versus renting, and the added risks.
What if the market remains flat, then we haven't realized that 1.6%. What if the market grows at an historically sluggish 3%? Well, then we're in the swim. But these days, I'm not sure we can be certain of any growth for a few years. So, the question falls almost entirely to the rent vs. buy calculation, and whether we're willing to risk the downpayment on a potentially more risky investment than the broad allocation I can maintain in equities, mutual funds, and bonds.
Asset allocation target
I'm 38. My wife is 34. We have two boys: 4 and 2 years. We currently rent our house. We moved about a year ago from a moderately priced market, to one of the highest priced housing markets in the country, where the median single-family home goes for somewhere north of $1.2m. We ran the figures, renting is about 40-50% cheaper on a monthly basis. The growth rate of housing costs has stagnated here lately, staying essentially flat or falling slightly over the past year. Not buying also affords us the additional advantage of not tying up a huge sum in the downpayment, funds which will likely grow much faster elsewhere.
In the long term, I think real estate is a good investment. Besides, I hate renting, not having control over our living arrangements, not being able to freely upgrade appliances or flooring, the windows, the paint. There are downsides to renting. But right now, for us, in this market, it makes the most sense.
When we sold our house, a few months ago (finally, after nearly a year on market) we had a handsome influx of cash to divvy out. Our gain was about 65% growth over 8 years; not as high as I would have liked (our timing was bad, and the agent's marketing was atrocious, so the timing only got worse). But ~8% annualized growth for real estate isn't too bad historically.
My target asset allocation is:
35% domestic large caps
25% international equities*
25% small caps**
10% bonds (evenly split, 5% domestic/5% international)
5% cash/money market
*Money doesn't recognize this category, so I have to manually reset the asset classes for these holdings to "other"
**15% small/10% mid as Money divides it out
Currently, I'm at:
31% cash/money market
31% domestic large caps
15% international equities
13% small cap
7.5% mid cap
2.5% bonds (about evenly split between domestic and international)
I had set up some automatic investments into mutual funds, and scheduled others to execute manually, dollar cost averaging in toward my target allocation over the next five months. I put everything on hold for the moment, since there's a chance we'll be moving in the next couple months, possibly to a more reasonably priced housing market. We wanted to keep our remaining cash on hand, in case we decide to buy a place. Currently, most of our cash is parked in an E*Trade money market account at 4.75%. For the time being, that's something. We should know in the coming few weeks whether a move is imminent. Meantime, it'll be mostly watching what I've got, and determining if it's a good time to sell anything.
Quicken vs. Microsoft Money
I recently made the switch from Quicken to Microsoft Money. Bear in mind, I had been a loyal Quicken user since version 1, back in the 1980s. I'm no big fan of Microsoft. About a year ago, I made the switch to an open source office suite, and haven't been happier. The one product I still really on at times is PowerPoint, since it offers a better interface than OpenOffice has yet managed. I suspect that will change in the next year or so, and I'll fully make the switch.
With Quicken, I upgraded faithfully every year or two, sometimes skipping an update if I felt it was unnecessary. But Quicken got more and more complicated, with more frequent troubles. I'd have to rebuild the files a couple times a year, sometimes more frequently. Data was often corrupted. Finally, I was ready to upgrade from Quicken 2004, so I did a little reading. The reviews were almost universally negative. One of the big issues was Quicken's dropping of support for .qif files in preference to a format which required merchants to pay additional for. No, I thought, this is the end.
I considered moving to open source financial packages, but I 1) feared that there might be security issues I wasn't yet willing to risk, and 2) thought I'd be happier with the interlink downloadability of all my online financial data, which I couldn't find available in any of the open source products on offer.
The jury is still out, but mostly I've been satisfied. I confess, I have reopened my old Quicken a few times, to access their online research tools, which allows me a comparison. I like to see all the disagreements and contradictions between the different analysts and methodologies, so I have a better sense of the stochastic nature of investing. It keeps me a bit more risk averse, and more settled to the prospect that I may as likely lose at times.
Eastman Kodak
About a week ago, NPR had a
segment on Eastman Kodak, presenting opposing views about the company's prospects. To say, true, I'm more convinced the company will fade away. Don't get me wrong: Kodak was a pioneer, bringing photography to the masses. I'm a great fan of photography, used to have an old fashioned darkroom. I studied up years ago on the history of the Photo-Secession movement. It's great stuff.
Only, it's innovation has been superseded. Time has passed, and new technologies have come to the fore. The masses no longer want the photography that Eastman Kodak helped usher into the last century. And frankly, here's where my philosophy comes in, I believe a company should focus, focus on its core, innovate, but in the end not be afraid to pack up shop, or start afresh. Kodak should cash out on what it's done, split into several groups, or simply leave to the new generation, new horizons.
Think of it this way, if someone starts a small business, say a retail shop or a small manufacturer. When it's time for the founders to retire, there's cause to assess whether the torch should pass to their children, or whether the time has come for their children to strike out in new directions. Some companies are good to last, others are best suited to be remembered.
Vonage
I subscribe to phone service through Vonage. It works well enough. Annoying that we have no service when the cable goes out, but that's Cox Communication's fault, not Vonage's. Some odd difficulties, however, as for instance the quite often trouble when calling or receiving calls from other Vonage customers. They can't hear us, or we can't hear them. But, for the most part, I'm pleased with the alternative to a landline. We tired of the high cost, the near monopolies, and especially the expense and complications when calling overseas.
A few months ago, they offered a special in for subscribers to their IPO. I considered it. I'd say I was even leaning toward taking advantage of the offer. But I dragged my feet. I didn't want to jump in unless I understood the entire deal. I was curious, but not interested enough to do the homework. Then, the offer expired.
Ah well, I thought. Then the IPO came, and I was glad I hadn't been quicker. Today, the shares trade for about half what they IPO'd at. Ouch!
I'd like to say it was foresight on my part. But the truth is muddier than that. On the one hand, I trust my instincts; on the other hand, it's best to be cautious when I'm entering new territory.
Czech Republic & Central Europe
Because my research involves the Czech Republic, I have spent a good deal of time there over the past decade. There are problems, for sure. Somehow, whenever there is a study or report about corruption, the Czech Republic winds up on the list somewhere near Nigeria and Haiti. Not a promising sign. But I have a great deal of confidence that the economy there, and in the region, will continue to grow. For one thing, there's not much down it could go.
In the beginning of February 1999, I purchased 100 shares at around $10.45/share of the closed-end fund CRF (then known as the Czech Republic Fund). A few weeks later, I purchased another 50 shares at around $9.85. The expenses were low, and it was the only fund I could find that specialized narrowly in the Czech Republic. Unfortunately, the fund was taken over by a private group of shareholders, who gutted the fund's erstwhile focus, and transformed the Czech Republic Fund into the Cornerstone Strategic Return Fund, with little or no holdings in Central Europe.
In early 2000, I sold off all of my shares, around $12.45, dissapointed with the shift in focus. This, I learned, is one of the problems with a closed-end fund, that a small group of investors can hijack it, and redirect the management and focus. What I like about closed-end funds is that they allow a small investor the opportunity to target smaller sectors or regions that are not always available through larger mutual funds. They're a bit tricky though, so you've got to do your homework.
I stayed out of investing in the Czech Republic for a while, unsure where to park my funds. I had noticed the fund EUROX (now U.S. Global's Eastern European Fund) way back, but was scared off by the high expense ratio. I kept watching it though, year by year. The returns were quite impressive. Finally, in October 2003, I bought in. I bought in at the minimum initial investment, then dollar cost averaged in over the next couple months (mostly around $20/share). I sold off a bit in 2004 and 2005 (at a handsome profit, ranging around $27.50-40/share), then started buying in again earlier this year, again dollar cost averaging in. Today, EUROX is our top holding accounting for nearly 10% of our equities-invested funds.
The one thing that makes me nervous is the fund's heavy weighting in Russian oil (especially Lukoil and Gutneftgaz), amounting to about 20% of the funds investments. However, 20% of 10% is still a mere 2% of our holdings. A risk, but not an unacceptable one by my standards.
No more worldwide funds for me
I started investing in earnest in 1999, just before the crash. I guess it was as good a time as any to learn the ropes, without having too much of a nest egg to see lost. My brother wasn't so lucky. On paper, he had been a millionaire. He had been working for a major software company with beaucoups stock options. Unfortunately, he got carried away with the dot-com bubble, believing the upside was endless. He bought Ebay and Cisco on margin. When they tanked, he had to sell all his stock options to cover the margin calls. He's not yet recovered.
In 1999, I was naive but not such a gambler. Nonetheless, I got burned pretty bad by a heavy investment in Janus Worldwide Fund. I bought in during the spring and summer of 1999, at around $52-55/share. I watched it go up over $80/share in less than a year. I kept buying, dollar-cost-averaging month-by-month. By March 2000, it was trading around $90/share. Then I watched it drop, precipitously. March 2001, it was below $50; March 2002, it was in the low $40s. It could have been worse, but I lost about 40% by the time I sold it all in August 2003. I had simply had enough, and I learned my lesson.
It amounted to about 1/3 of our holdings at its peak, down to about 18% when I sold. Although, part of that was due to continued saving and investing, clearly a good part of that was simply it's loss in value. What I learned from that experience is that noone is good enough to watch all markets, and all trends, for long. I took away the idea that I would target investments. For funds, I would seek managers who honed expertise in a single area, either an industry or a small country or region of the world. No more worldwide funds for me.
The Economist
I read the
Economist. I began reading it occasionally whenever I passed through an airport, picking up a copy to read on the plane. I like the international perspective, which is too often lacking in American journals. I spent a year in the Czech Republic, and subscribed to the paper as my root on English-language news. Upon my return, I renewed my subscription. I find an affinity with the magazine's social liberalism and fiscal conservatism (which seems in stark contrast to the current U.S. government).
Another advantage I find is that, unlike many of the U.S.-based financial journals, the information is not intended as stock tips for the gullible. Yet, because of its economic focus, there is a great deal offered that is relevant to the investor, about companies, about markets, about trends. What I tend to do, when I read something interesting, say about a company, is add the stock to my watch list, read up on what they do, research their fundamentals, take under advisement analysts' opinions, then simply watch it for a few months before doing anything.
One of my recent purchases from this technique is Intuitive Surgical (ISRG). I bought it about a month ago , once it dropped below $100, at $99.94/share. It shot up about 20%, but is now trading just below the price I bought at. The P/E ratio is in the 40s last I checked, high for most of my investments, but perhaps reasonable for an innovative and relatively young company. We'll see where it goes from here.
I've been tempted to add to those holdings, but I'm comfortable taking a risk with a small amount of my holdings, currently about 2% of the money I manage. I don't count my wife's 401(k) since it's not actively managed, and as is the case with most 401(k) accounts, the investment choices are limited. We mostly use those funds as a means to rebalance our overall asset allocation when I'm not wanting to move large sums around in the other accounts.
Cultivated naivety
Cultivated naivety is a principle I have adopted for many aspects of my life. It is the living embodiment of two Socratic principles: the first,
to know oneself; the second,
to know one's own ignorance. The idea is very simple, the more you know the more you realize how little you know. This is a crucial aspect of learning. If you are able to recognize the areas where you are least knowledgeable, you are able to actively pursue improvement in them. If you foolishly believe in your own infallibility, you will inevitably meet up with your own failing.
It is a difficult balance to manage between self-confidence, and self-awareness, between the strength to trust one's own opinions, hunches, educated guesses, and a realization that much of life is outside our own control. The financial markets can be much like this. They may defy rationality. We may gain the most, when we are least cognizant, and we may lose a great deal despite expenditure of time and effort in research.
The main power of
cultivated naivety is the ability to allow oneself to accept ignorance, to permit oneself to state "I simply don't know". At that point, one can begin to explore possible explanations, without the ego-based blindness induced by our own self-assurance.
About
I'm an academic in my late 30s, married, two children. At present, I'm serving as a Visiting Scholar in a related field to my PhD, seeking more permanent employment, and suffering the difficulties of the
two body problem. Investing is something I do, like cooking, as a hobby, but also out of necessity. I have no formal training in this area, and pretend to no special knowledge. This blog is a place for me to clarify and articulate my investing philosophy and choices, to be held accountable for those choices, to share them with others, and to get feedback from those in similar situations. None of this should be construed as professional advice to buy or sell anything. I hope you enjoy, and that together we can hone each others investing to better attain our life goals.
