Stocks Are A Lot Less Risky Than You Think

The following is a guest post from Rob of A Rich Life. Rob is a long time reader of this blog and a prolific and passionate writer. The “RobCasts” section of his web site contains over 180 podcasts in which Rob describes the Valuation-Informed Indexing investing strategy, an approach to indexing which according to Rob greatly reduces the risks of stock investing by having investors lower their stock allocations at times of insanely dangerous valuations.

This post is one of several guest posts I am publishing while my family and I are living the good life on our family vacation in Costa Rica. I will resume publishing my original articles after the first of the year. Here is the post:

Most people have mixed feelings about stocks. They love the high return. They are not so crazy about the high risk. Stocks without risk -- that would be the middle-class investor’s dream!

The dream is available to us today. That’s my take.

There is nothing inherently risky about stocks. Many of us make stocks risky by believing crazy things about them. But it’s not fair to blame the investment class for that. That’s us. It’s our investing beliefs that make stock risky, not anything to do with the asset class itself.

When people say that stocks are risky, what they mean is that prices jump around a lot. One year you might see a 30 percent price increase. Another year you might see a 20 percent price drop. Volatility scares us. It’s because stock prices are volatile that we have come to view stocks as a risky asset class.

But you know what? The price volatility of stocks is an illusion. It’s not real. Change how you react to it and it goes away. Stop taking volatility seriously and it goes “Poof!”.

You’ve probably heard that the average return on U.S. stocks is 6.5 percent real. That’s because that’s the return justified by the productivity of the U.S. economy. When you buy a share of an index fund, what you are really buying is a share of U.S. productivity. So long as the U.S. economy remains roughly as productive as it has been for a long, long time, your reward for owning a share of an index fund is going to be a return something in the neighborhood of 6.5 percent real.

There’s no volatility in that reality, is there? You buy stocks, you get a 6.5 percent real return. Simple. Safe. Nice.

What causes us to perceive volatility where it doesn’t really exist is the newspaper and television reports that tell us that stocks are up 30 percent or down 20 percent. What if we tuned out the noise? Would that bring an end to volatility and risk? It would.

We have historical data on U.S. stock returns dating back to 1870. There’s a neat thing that happens if you work through the historical returns year by year, subtracting from the reported return to bring it back down to 6.5 percent real whenever the nominal number is higher than that and adding to the reported return whenever it is lower than that. If you take that step, you will see that stocks don’t just provide a return of 6.5 percent on average but each and every year. Yes, stocks provide the same return every year -- so long as the effect of volatility is ignored.

Volatility is not real. Volatility is an illusion. We should be making that adjustment in our returns each year. U.S. stocks have always paid a return in the neighborhood of 6.5 percent real, never more and never less.

Some will say this is crazy talk. They will point out that, if you sell stocks after they go up 30 percent, you really will obtain the higher price for them. That’s so. In this short-term sense, returns higher or lower than 6.5 percent are “real.”

However, the price that applies for a few months or a few years is immaterial to the long-term investor. So long as you have no immediate plans to sell, what practical difference does it make to you if stocks are temporarily selling for a price 30 percent higher than their true value or 20 percent lower than their true value? What matters to you is what your investment is really worth. Your investment is worth 6.5 percent more than it was worth 12 months earlier. That’s always so. Regardless of the current-day selling price.

How do I know?

I know from looking at the historical data that the stock price always returns to what it would be if stocks increased in value each year by 6.5 percent real like clockwork. Price changes that do not last are not real. Price increases greater than 6.5 percent real never last. And price changes less than 6.5 percent real never last. No matter how much crazy volatility we experience in one direction or the other, we always end up with that 6.5 percent number coming through for us in the long run.

That cannot be an accident. The reason why the 6.5 percent number always holds is that that number is the return that the productivity of the U.S. economy supports. You can count on earning 6.5 percent real from your stock investment each year. Any gains greater than that or less than that are a mirage that should be ignored for financial planning purposes.

When you see a gain of 30 percent, you should count 6.5 percent as the real gain and 23.5 percent as a mirage gain. When you see a loss of 20 percent, you should count 6.5 percent as the real gain and 26.5 percent as a mirage loss.

If you did this, volatility would disappear from your stock investing experience. You would enjoy all the benefits of owning stocks but not need to endure any of the downside. You would get gains without volatility, returns without risk. It’s the best of all worlds for the middle-class investor.

You would also come to think about stocks very, very differently than you think about stocks today. Do you remember January 2000, when stocks were selling at a price three times their fair value? Most investors continued buying stocks even at those insane prices, prices at which the chance that stocks could provide a solid long-term return were virtually nil. Those of us who see through the nonsense volatility did not make that mistake. We lowered our stock allocations dramatically when prices went to the moon and thereby avoided most of the pain of the recent price crash.

We saw something that Buy-and-Hold investors did not. We saw that stocks always provide a return of 6.5 percent real. And that, when you pay three times fair value, you are obtaining stocks with only one-third of the money you are putting out; the rest goes to buying cotton-candy nothingness. What you want to buy is stocks, not the hot air created by deceptive volatility. Learn how to see through volatility and you can obtain far higher returns at far less risk. For the first time, you will be seeing stocks as they really are, not as The Stock-Selling Industry (which spends millions promoting Buy-and-Hold Investing) wants you to see them.

The investor who gives up the belief that crazy price increases are real (any price increase beyond that justified by economic productivity is crazy) gains the ability to avoid falling into the traps that cause him to suffer crazy price drops on the other side. The way to avoid the pain of bear markets is to understand the phoniness of bull markets.

If you think 6.5 percent real is a good enough return on your investing dollar (and I sure do), you are set. Just ignore all the volatility junk and it can no longer bother you. For you stocks will carry only a fraction of the risk experienced by investors who follow the Buy-and-Hold model.

[Shadox - I agree with Rob on many things including the fact that indexing is the way to go where stocks are concerned. I also strongly disagree with him on others such as his assertion that stock investing is essentially risk free. I recently wrote a post about stock market volatility. While that particular post discussed daily price volatility, in a coming post I will try to extend the concept to the longer time horizons to which Rob is referring]

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Going Paperless With Your Financial Life

The following is a guest post by Revanche of A Gai Shan Life. It is one of several guest posts that I am publishing as my family and I are vacationing in Costa Rica. Original Shadox posts will resume after the first of the year. Here is the post:

As I dug around in my desk drawer hunting down my checkbook, I reminisced that this time two years ago there would have been no question where it was. I always had it at hand, and was constantly making notes in it. Now, *dig dig* I know where it lives, but it so rarely comes out that it gets buried way in the back. It’s a nuisance, but a startling reminder of how completely my organizational and financial system has changed in such a short period.

For the past several months, I’ve been laboriously scanning and shedding paper waste, either shredding the identity-rich documents, or using the safe junk documents as printing paper for my couponing. My filing cabinet used to be jammed tight with those thick expandable green folders, part accordion, part pronged. Oh, the paper cuts! Going paperless called for a hulking 18-lb All-in-One (my review here), but as it serves to reduce the overall clutter in my little office area I’m at peace with it. At least ten reams of paper have been removed from the system – no small beans!

I’ve always managed banking online, but integrated up to 95% of my financial life online this year. All paper statements have been canceled in favor of emailed PDFs or online access with a quick click or two on each institution’s website. Even checkwriting has gone online, thanks to ING Electric Orange, which means that I can very easily verify that payments have been made online at a moment’s notice (and given free wi-fi!). I still have the checkbook for the occasional purchase, but just carry a single check with me when it’s needed. No sense in putting the whole checkbook at risk of theft or loss.

Of course, all this automation requires a little more in the way of techie doodads for security purposes. I have a Maxtor One-Touch external hard drive where all my records are backed up and safeguarded by passwords. I highly recommend getting at least one form of back-up if you have any significant amount of data on your computer, two if you’ve converted entirely because even your back-up can become compromised or damaged.

Seven years ago, losing the contents of my old laptop was annoying, today it would be disastrous.

I’ll concede that going paperless is kind of a painful process at first, especially if you don’t care for cleaning. There are some great resources online for creating an organizational system that works for you, but I’ve found that the most effective piece of advice I could ever give to someone looking to go paperless is just get started. Pick a pile and start there.

Fabulously Broke has a unique naming convention, while I prefer to use a nesting strategy by categories, like Records > Investments > Vanguard/Treasury Direct/TradeKing > 2009 > Statements.

There are days I’m just not in the mood for it, but when a pile is starting up I’ll just grab a sheaf of papers, scan and discard them. I’ll come back, rename and file the PDFs later. It’s ok not to be perfect in the process, so long as you do a little bit regularly to keep the piles from forming.

Even with the small inconveniences like keeping track of longer lead times on sending check payments, I’d highly recommend going paperless with your records. It’s quite a lifesaver come tax-time because I’ve already organized all my tax-related receipts during the year!

[Shadox - ohhhh, if only I could bring myself to take this advice. Alpaca and I have PILES AND PILES of paper records. Alpaca in particular never throws away anything. You want to see a record of our July 1999 electric bill? She can probably dig it out for you... ]

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The American Dream

The following is a guest post by Ryan of PortfolioBalancer. This week and next I am running a number of guest posts while I am vacationing with my family in Costa Rica. I will resume posting my own original content after the first of the new year. Speaking about new years and new year resolutions, Ryan's guest post is all about making decisions and taking some action. Here goes:

You can achieve anything in this country, or by extension, anywhere. That is the American dream. The American Dream has nothing to do with homeownership. That is a nice goal, but too shortsighted to truly hold the title THE American Dream. Homeownership seems like an easy goal designed to make you relax, feeling that you have accomplished something. Well, I don’t want to relax, pacified, and neither should you. I want to see what one can accomplish in such a free society, that is my goal.

Ah, there lies the true American dream: freedom. Freedom of mobility, across the country, out of social classes, above the norm. There is a beaten path of a standard life, laid out before us. If you follow the path, and convention, you will achieve a reward of comfortable years without work in the future. But what if. . . I always wonder, inserting the financial or health catastrophe of the moment. You only live once, why not impress yourself, let go of the fears. Insure against disaster and move on. You can do anything. You never have to settle, you are never beaten. Time and action can fix all.

You are blessed, to live in a country this free. You can achieve anything, but it will not be given to you. Whatever you want your life to be, it can be. But you must take action. I can attest to the fact that many small steps over time begin to turn into something extraordinary. You simply need to persevere until the achievement becomes clear to you. Time does not stop, and the amount you have on your clock is finite. So, take a concrete step. Decide where you want to be in five years. Is this goal attainable? If not, then you must change something, or face reality. Think where you would be today if you had acted five years ago.

What effect does a one degree change in your life’s path equate to ten years out? How far apart would these two paths be at the end?

What are you afraid of? Failure? Do you think that everything always works out for everybody? You can decide on your level of commitment, but there is no limit, anything you can think of can be done. Maybe you don't have enough income to achieve your goal. How would you survive? Figure out a solution. Maybe you can build investments that produce income, so that you do not need to work, only live beneath the income level. There is a way around every obstacle, so focus on solutions not on excuses.

Reach. Turn off the T.V. and do one thing. Start with one action, one phone call, one budget. The dream is different for everyone, but each is just as relevant and as attainable. Life is a game, and there are some rules, but as long as you follow these rules you can play freely within their confines. Play.

I am nobody special, just someone inspired to attempt what this country is so proud of. Something that the masses seem so disillusioned with the possibility of attaining. Holistic freedom. I am nobody, yet I did one thing today, I wrote this post. What about you?

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Guest Post: Does Your Realtor Care About the House Price?

The following guest post is Part II in a two part superb article by Edwin Ivanauskas. Part I of the article was published yesterday. This week and next I am mostly publishing guest posts, as I am traveling with my family in the jungles, volcanoes and towns of Costa Rica. Hooray!

In part I of this post, I’ve been assuming that houses just cost a flat $200,000. Let’s take this a step further and see if it’s worthwhile for an agent to spend a lot of time getting you the best price. For this I will assume you are selling your house and you are dealing with a listing agent.

Let’s assume if the agent worked hard enough they could sell the house for 10% above its price. On a $200,000 house that would $220,000. That’s a huge difference you might say, and well… it is. But the commission for your agent on that goes from $6,000 to $6,600, still nothing to scoff at.

The trouble we run into is how much effort it would take to sell that house for $220,000. If we are going off the assumption that this agent can sell the house in 320 total hours to make $18.75 per hour, we can use that to see how many hours it is worth working to raise the price to $220,000.

With some simple math we find that if the agent worked 32 more hours to get the price up to $220,000, they will continue making $18.75 an hour. Let’s think about this for a moment, the agent already has to spend 320 hours to sell the house at $200,000; is it really realistic to spend only 32 more hours and increase the price by $20,000, netting himself $600 more in commission? I don’t think so.

In this example, there is no reason for an agent to bid up the house for the seller because it will take far more time than selling the house quickly and moving on to a new one.

Edwin, This Is Just Too Simple and Unrealistic

Wow hold on there, let me explain. I used this modeling to help illustrate how agent’s compensation can affect their incentives when it comes to selling a house. The model is extremely simplified to give a basic representation of the idea.

Some things I didn’t discuss are that an agent working like this would likely have issues growing his client base in the long term because he just uses them and discards them. Good, established agents often work closely with their clients to deal with their needs rather than to make a quick buck. These good agents also tend to become real estate brokers and have other agents working under them to expand their business and their earnings.

My Take

Given how easy it is to become a licensed agent (40-90 hours of coursework plus a certification test) you are likely to be dealing with an entry level agent, particularly if you aren’t in the market for an expensive house. You could easily have to deal with poor performance because they are incentivized to sell houses quickly rather than negotiate the price or help you spend a long time searching.

My view is that the ease of becoming an agent tends to bring in newcomers who are looking for a quick buck. These people will find that they barely get any more money by spending a lot of time helping their clients so find ways to cut corners so they can get houses sold ASAP. When buying something as big and expensive as a house, you should be forewarned that your agent may not have your interests at heart. Don’t be fooled into complacency when dealing with a real estate agent.

Do you have any stories of terrible or wonderful agents? What do you think of the simple model I’ve constructed here, is it accurate or total B.S?

[In the coming days, I will offer my own ideas based on Edwin's excellent 2-part guest post. Stay tuned. - Shadox]

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Guest Post: Is Your Real Estate Agent Out to Screw You

The following guest post is Part I in a two part superb article by Edwin Ivanauskas. Part II of the article will be published tomorrow. This week and next I am mostly publishing guest posts, as I am traveling with my family in the jungles, volcanoes and towns of Costa Rica. Hooray!

When buying or selling a house, most of us hire a real estate agent. They help us appraise the value of a house, market the house to potential buyers, help with the paperwork and assist in whatever else we might need during the sales process.

But all of this effort comes at a price, as it should. Generally the price of the house takes into account the 6% compensation for commission the real estate agents are making. This means if the house is valued at $200,000, you pay $212,000.

Dealing with agents can be quite diverse. Two of my friends who bought houses help illustrate the extremes of good and bad experiences.

One friend, Rich, used an agent who is a long time family friend and has been helping their family and friends buy and sell houses for over two decades. He gave the exact requirements to his agent and the agent worked hard to make sure those requirements were met (only showing listings which fit the criteria, showing houses whenever Rich found the time in his busy schedule, etc.). It was his first home purchase and his interaction with his real estate agent was spectacular

My other friend, let’s call him Scott, had a vastly different experience. He had very specific requirements for the house (particularly location) and gave them to his agent. Scott’s agent was an old friend who he found out was an agent and she turned out to be fairly green. She continuously sent him house listing that didn’t fit the criteria. She even attempted to get him to sign contracts that were screwing him out of money (she didn’t even read the contracts). He hired a lawyer to go over all contracts and agreements because his real estate agent was too incompetent. He ended up dropping that agent and picking up another one, which was also less than he expected.

This goes to show just how different your experience with a real estate agent can be. To help me get to the bottom of this big divide between good and bad I’m going to explore how agents get paid and how that pay structure might affect the way in which they deal with you.

How Agents Are Paid

To help me, I’m going to build a basic model to show agent commissions and how different things can affect their pay.

Let’s assume $36,000 a year is a decent starting wage for a real estate agent. Let’s also assume they are working 40 hours a week. This means they need to make $18.75 an hour to reach that wage (we will ignore taxes to make this simple). Making a few more assumptions will let us better understand what a real estate agent must do:

• The median house price is $200,000
• The commission paid is 6% total, 3% to each agent, meaning the commission is $6,000 per house

Below, I take this information and graph the hours worked on that single house and the compensation the agent makes per hour:

To make the $18.75 required, an agent must work 320 hours per house at the most. However if they spend any less time their pay increases as they can sell more houses that year.

Get Rich Quick?

Now, I’m doubtful a new agent came up with this graph for himself; he tends to use intuition to come to the same conclusion. Here are three different buying agents who have been on the job for just over a year now.

Jane sells a house about every 320 hours for $200,000; this is our baseline and holds up with our above example. Last year, Jane made $36,000. Jane spends as much time as necessary with her clients helping them pick the perfect house.

Tim has found a few things he can do to help him sell houses quicker:

• He convinces his clients that a house is the perfect price even though he knows it could be lower
• He mass mails house listings to his clients without having to spend the time making sure they are houses his clients are actually interested in
• He spends less time showing off houses and doesn’t like to work with his client’s schedule
• To top it off, he makes sure that you sign an exclusive right to sell so his clients are forced to work with him. Even if they don’t work with him, Tim gets the commission on a sale

Well, in this case Tim is being a bit more underhanded than Jane but is managing to sell houses at the same $200,000 price level but cutting out 100 hours per house. Tim is pulling in $27.27 per hour and $52,358 for the year.

Uncle Willy is the slickest son of a bitch around and has had years of experience in the used car business before moving his career to real estate. He employs the same tactics he used on cars to get people into houses as fast as he can. Uncle Willy has cut down the time he spends per house to only 100 hours. This will get them $60 an hour and $115,500 a year!

While Jane may be the one customers like dealing with the most, Willy is the one getting piles of money in commissions. Being able to cut down the amount of hours spent on each house can dramatically increase the amount of money a real estate agent gets paid.

[Stay tuned for part II of the article coming tomorrow, in which Edwin explains other financial incentives real-estate agents have to work against you. - Shadox]

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How Predictable is the Stock Market?

Is the stock market predictable or inherently unpredictable? If you believe Nassim Taleb, author of The Black Swan, trying to predict the market is not only impossible, it is also a very risky proposition. I recently finished reading this thought provoking book and a number of interesting points stuck with me. One of these key points is Taleb's claim that the stock market is "Mandelbrotian" by nature, i.e. daily returns in the market are not "normally distributed", they don't follow a neat Gauss-like distribution, where daily returns don't stray too much from the average daily return.

Taleb's claim - which I tested for myself (but more about that in a second) - is that stock returns are "scale free". While on most days returns in the market remain in a relatively tight range, once in a while, a Black Swan strikes. A Black Swan is a completely unexpected event that greatly impacts the market in unforeseen ways, resulting in dramatic up or down days. These rare but dramatic events account for a large percentage of stock market returns over the long term.

I must admit that my assumption (even though I never really articulated it) was that while on a daily basis the market can swing up or down, these swings are largely confined to a pretty narrow range that would fall more or less neatly on a normal distribution curve. Well, Taleb claims (and I checked) that this is not the case.

Those that dislike statistics can skip this next paragraph, but for the rest of you, here goes: from Yahoo! Finance, I downloaded the daily returns for the S&P500 from January 3, 1950 to December 4, 2009. Almost 60 years of data. Through the miracle of Excel, I calculated the daily returns on the S&P500 (using closing prices in each case). From this population I calculated the average daily return (0.033%) and the standard deviation (0.966%). I then proceeded to calculate the z-score for each daily return figure. I won't bore you with all the results and analysis, but here are a few eye openers:

- I found a total of 90 days in which the z-score of daily returns exceeded 4 or -4. If stock market returns are normally distributed, we would expect to see one such event every approximately 143 year...

- I also found a total of 24 days in which the z-score of daily returns exceeded 6 or -6. Once again, if stock market returns were normally distributed we would expect to see one such event every approx. 4.6 million years...

- now here's a real doozy: on October 19, 1987 the S&P fell about 20.4% which translates to a z-score of -21.2 or one event every approximately... wait for it... 10 to the power of 93 years. For the sake of comparison, the age of the universe is estimated to be approximately 14.3 times 10 to the power of 17 seconds (or about 6000 years if you choose to get your information from certain unreliable sources). Another comparison point: the number of atoms in the universe is estimated to be approximately 10 to the power of 80...

Point spectacularly made. Stock market returns are NOT normally distributed.

Now, what are the implications of this discovery and what are we to do about it? Well, to be honest with you, I don't think I have good answers to this, but I will do my best to take a crack at some sort of answer over the next couple of days. Stay tuned.

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Questions for Your 401K Plan Administrators

Not all 401K plans are created equal - some can be pretty good while others lack important features or impose ridiculous costs on participants. In my previous company I was involved in running my employer's 401K plan (read this post for that interesting story). In my current company I haven't done anything about our plan, primarily because I thought it was reasonable from the get-go, but also because I found my work as a new executive to be extremely interesting and challenging - quite frankly, I just didn't have the time. It has been almost two years since I started my current position (it's amazing how quickly time passes), and I am now thinking about pushing for some changes in our 401K plan. This week a plan representative will be coming to visit us for a "lunch and learn" session and I was planning on bringing up a few issues that I think we need to address. Here they are:

Roth 401K - my company offers only a traditional 401K plan. No Roth 401K. Given prevailing expectations that tax rates will only go up in the coming decades, being able to squirrel away retirement savings without having any future tax liability is a pretty attractive proposition. Alpaca and I "make too much money" to invest in a ROTH-IRA, but participation in a ROTH-401K has no income caps. The mission: get my company to adopt a ROTH-401K option.

Expenses - as far as I can tell, Fidelity has been pretty above board with their disclosure of plan expenses. Checking my 401K account the other day, I was able to find a line that stated very clearly a charge of $30 for plan expenses in 2009. Obviously, this charge is on top of any expenses charged by the mutual funds themselves. Nevertheless, 401K plans are renowned for having all kinds of hidden fees and charges. In my former company even the 401K committee (of which I was a member) did not have clear information about what our employees were paying in fees. We were simply unable to get that data from our plan provider. Fees are a major scourge of the long term investor. They can quietly leech away returns without a lot of evidence that this is happening. The mission: get full disclosure of plan fees.

Index Funds - most of my 401K money (70% of my allocation) is directed towards Fidelity's excellent total market index fund, with an expense ratio of only 0.1%. However, this is the only index fund available in the plan. International index? Nope. Bond index? Niet. REIT index? Better luck next time. Once again, it goes back to the issue of expenses. I don't believe that fund managers can beat their benchmark indexes in the long run, and if that is the case, why should I pay them for the disservice they are doing to me? The mission: Let's have more index funds and fewer fees.

Automatic Re-balancing - Fidelity offers automatic re-balancing of plan funds, but it only allows this on an annual basis. I re-balance my funds quarterly (I think it's particularly important after such dramatic asset price increases as we've had in recent months), but I need to do this manually. The mission: can we have quarterly automatic re-balancing options?

Opt-Out Enrollment - I am a big believer in the concept that employers need to nudge employees to make the best long term decisions. Automatically enrolling people in the 401K plan unless they opt out is a great way to send a signal to people that they should be thinking about saving for their retirement.

My company's 401K plan is run by Fidelity and overall, I am very happy with the plan. Documentation is plentiful and simple to understand, the website is easily accessible and manageable, and fund choices (for the most part) are reasonable. Still, there is always room for improvement.

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Guest Posters Wanted

For the holidays this year the family and I are going to Costa Rica for 10 days. Insanely expensive, but I am told that we only live once, so what the hell, right?

Anyway, while we are gone, I would hate for Money and Such to go completely dark, so I am opening the floor to anyone who would like to write a guest post on this blog. Of course, I reserve the right to accept, reject or edit submissions. Your post can include links to your own site or other external sites (all within reason). I will not be accepting any commercial posts.

If you have an idea for a post which is somehow related to personal finance, I would love to hear from you. Send me an email to shadox1 at the domain name gmail.com.

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The Benefits of Unhappiness

Last week I hosted an important customer visit for the entire week. This extended visit allowed me to get to know my customers well and to also chat with them about non-business issues. One day, one of my visitors told me how a few years ago he had to do a biopsy to rule-out the possibility of lymphoma. Happily, the biopsy came back negative, but for the few days he was waiting for the results, my customer was understandably freaking out. This experience changed his world view, at least for a little while. He realized that every day he was able to get out of bed was a gift to be cherished. However, after a while this new found perspective wore-off and he reverted his old, stressed and busy self.

So what?

Humans can't go-around being thankful and happy all the time. That's contrary to our basic nature. It's not a bad thing. In fact, I would argue that it's a pretty good thing. You can't go about your daily business, constantly being aware of your mortality and of your fragility. That way lies madness and depression. What makes us function as humans is our ability to ignore the inevitable. What makes us better as a society (and as a species) is the fact that we refuse to be happy with what we have. We must have more. It is in our nature to strive.

If we were all happy with what we have, we would all still be living in caves, subsisting off of random berries and spearing antelopes for dinner. Hey, I like living in a house. In fact, I like my own house, but that doesn't mean that I don't want a bigger and better one. I enjoy my work, but that doesn't mean that I will be satisfied with it forever. I am happy with who I am and what I have learned over the years, but that doesn't stop me from wishing for more knowledge and more learning. What's wrong with that?

Of course, as in everything else, moderation is needed. Being constantly thankful that you are not dying of cancer will make you a very strange person. Constantly obsessing that you don't make enough money will make you a very unhappy (and probably unpleasant) person. A moderate level of dissatisfaction is a good thing. It has many names, two of which are ambition and aspiration.

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How to be a Millionaire... Not!

Every personal finance, business and self help shelf in your local book store is filled with books that offer to tell you the secrets of how to become [insert desirable attribute here]. Good to Great offers to unlock the secrets of how to build the next great company; The Millionaire Mind promises to teach you to think like a millionaire, and so on and so on. I would like to direct your attention to another book I recently finished reading, called The Black Swan. I must admit that The Black Swan is written in a rather annoying way, but it contains a number of highly valuable concepts and ideas. One such concept, "looking at the graveyard", does a lot to discredit a vast range of self-help and "instant insight" books.

To understand this concept, let's discuss a non-existent book whose ambition is to teach readers how to become rich by looking at millionaires and identifying the characteristics that all of these individuals share. Let's say the author does a great job of collecting and sorting through information and comes up with a list of three critical attributes shared by all of these individuals: frugality, education and generosity. One of the points Nassim Taleb makes in The Black Swan is that this information is insufficient to draw the conclusion that the way to become a millionaire is to be frugal, educated and generous. Why? Taleb explains that to validate your theory, you would need to look at the population of non-millionaires and make sure that it does not contain a large percentage of individuals who share the exact same attribute, i.e. look at the population of "failed experiments" that does not support your theory. Taleb points out that people rarely do this - for example in trying to identify what made a certain company successful they fail to look at all the companies who did the exact same thing and failed miserably...

That's not to say that in my example above frugality is not a worthwhile pursuit. All I am saying is that in that hypothetical experiment the data collected is not sufficient to draw the conclusion that if you are frugal you will become wealthy. There are plenty of frugal people who never become rich.

So what's Taleb's point? Unfortunately his conclusion is somewhat discouraging. His book is primarily about the role that luck plays in the outcome of the game of life. We all like to think that we control our destiny, but Taleb points out that the real control we exercise is very limited... a sobering thoughts.

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A New Job for Alpaca

After about 7 months of unemployment - and just after she received her final unemployment check - Alpaca has landed a new job. I sort of let the cat out of the bag in a twitter posting last week, but now it's official, today she received and signed the offer. This is a very welcome development. The current job market is nothing short of demoralizing for job seekers. Jobs are few and far between, but at least in our case the story has a happy ending.

A few interesting pieces of information to share about this new job. First, the compensation package is a good one. Alpaca's salary will actually be about 10% higher than in her last full time position (which was over a year ago). Given the rotten job market, I was mentally bracing for a pay cut.

The company she will be joining is a public one, and they offer a range of benefits, including an employee stock purchase plan (ESPP). For those who are unfamiliar with the term, an ESPP is a program by which employees can purchase company stock for a discount - typically 15% - without any obligation to hold onto the stock. Previously when Alpaca participated in such plans, we sold the shares immediately after they were purchased, in essence getting a 15% boost on the amount invested. I am all for immediate and guaranteed returns... who isn't? We plan to use the same strategy.

Also, while my start-up offers medical coverage for my family, the cost of this coverage to me is about $200 per pay period or $400 a month. Being able to remove Alpaca from this plan will save us some cash, and depending on the cost of insuring the kids through Alpaca's company, there may be some additional savings possible.

Another interesting thing about this job: Alpaca landed it through... wait for it... an online job posting. No networking involved whatsoever. After all my talk and preaching about networking, it turns out that the lowly and much maligned online job board can actually help you land a job. Who would have thunk it? To be fair, Alpaca did a lot of networking, and even I was able to land a hand on a small number of occasions, helping her get some interviews. In the end, the swing that connected was a random job post response. It just goes to show you, in your search for a job you have to fire with every gun in your arsenal, and not rule out any options in advance.

Alpaca's first day of work is this Thursday. She is reporting a lot of nervousness about getting back to work and about having to prove herself in a brand new place. I can report that my stress level has gone down dramatically. While my company is financially solid for a few more months, we are a start-up, and are always reliant on fund raising to finance our operations. There are never guarantees that our investors will pony up the cash. Now, at least, the prospect of both my wife and I being unemployed simultaneously, seems to be more remote. Happy, happy, joy, joy!

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Taking the Initiative After a Lay-Off

A few weeks ago I wrote about how I "almost lost my job", when my old position in the company I left 18 months ago was eliminated and my replacement, who also happened to be a good friend, was let-go. After I published that post, I was able to help my friend get a temporary job with my own company - one advantage of being an executive. My friend has been doing a very good job in this temporary position and there is now talk of potentially hiring him for a full time job. Nevertheless, my friend isn't waiting around or counting on good fortune to work-out for him. He actually started a side business, which I think is quite brilliant. This business has the potential for growing within a matter of months to become my friend's full time job.

My friend is using his career set-back as an opportunity to move in a direction he's wanted to pursue for a long time, but never actually had the time or the drive to follow. Good for him!

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House Appraisals: How They Get It Wrong

When we were making our ill-fated attempt to buy a house a couple of months ago, as part of our mortgage application process we had our target house appraised. The appraisal came in about $40K higher than the sale purchase price on which my wife and I agreed with the seller. How strange is that?

Unlike the stock market, where all transaction prices are immediately made known to the public at large, real estate is one of those inefficient markets, where prices are not immediately apparent. To add complexity, prices are very much location based, such that identical houses can fetch wildly different prices only a few miles from each other. In addition, months can pass between similar transactions in a close enough location. With all this in mind, a real estate appraisal strikes me more as black magic or art, than science. Yet, the appraiser provides a POINT appraisal. He doesn't say "the house is worth between 0.9X and 1.1X", he says, "the house is worth x". An exact dollar figure... pseudo-scientific accuracy... delightful.

Clearly the bank needs an appraisal to make sure that buyer and seller aren't in cahoots (yeah, I said it) to defraud the bank. Buyer and seller could, for example, agree on a much higher purchase price than the true market price and then take the money and run, leaving the bank to hold a crappy asset.

With all of that in mind, it seems to me that the best way to determine the market value of a house is to look at... the price the buyer and the seller have actually agreed upon. Our appraiser gave the house a value that was $40K above the agreed upon price. If this appraisal was true, would the seller have been willing to sell the house to us for a lower price? Wouldn't other buyers have come in to give a better offer? Clearly the seller agreed to take that price because he couldn't get anyone to bite at a higher price.

It seems to me that appraisers should focus primarily on two things: (i) is the sale an arms-length transaction, i.e. are the buyer and seller each truly trying to get the best price that they can for the house (each from their own perspective) or are there some unique circumstances (fraud, family connection etc.); and (ii) is there something that makes the property uniquely valuable to the buyer to make him willing to pay more than others would for the same house (e.g. maybe the house belonged to his great-grandfather). Unless something fishy is going on, the sale price IS the market value for the house.

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The News Driven Economy

In recent months the economic situation has gotten decidedly better. Volatility in the market - as measured by the VIX index for example - has decreased considerably, nevertheless the economic headlines are still screaming at full blast. It's as if the news outlets are run by vocal manic-depressives. One day the recovery winds are blowing strong, the next day hopes are dashed and everyone is supposedly heading for the hills.

The best examples of manic-depressive economic news reporting can be seen on days when the stock market starts low and ends high, or vice-versa. I typically check the CNNMoney website a couple of time throughout the day, and often find that the very same news is interpreted in opposite directions depending on which way the stock market is heading at that very moment. The lack of consistency as the headline is changed but the story itself includes only minor corrections is amusing.

These days I am reading The Black Swan, by Nassim Taleb. A thought provoking and interesting read, even if it's written in a somewhat self important and needlessly complex way. It looks like I am not the only one who is bothered by these inconsistencies in the economic reporting. Taleb has been tracking them for years. In his book he gives the following example from reporting by Bloomberg news, relating to the capture of Saddam Hussein in 2003:

"US Treasuries rise; Hussein capture may not curb terrorism"

Followed 30 minutes later by:

"U.S. Treasuries fall; Hussein capture boosts allure of risky assets"

The same fact interpreted in exactly the opposite way, depending on the movement of the markets (in this case treasury prices).

Taleb ascribes these inconsistencies to the fact that people demand an explanation or narrative to facts, and to the news outlets' wanting to deliver what their customers want, even if they don't actually have anything to deliver. That's probably true, but I think that no less of an explanation is the fact that drama and crisis increase viewership & circulation. How many people would tune in to hear that just another random day went by?

Be that as it may, this rampant inconsistency and tendency towards drama makes financial news a particularly poor source on which to base economic and investment decisions, and it's not limited only to electronic media, these tendencies pervade printed financial media as well. The media tends to report that things are really awesome when they are merely OK, and tends to report catastrophes and when reality calls for some mild showers. That also happens to be true for Weather Channel reporting, but that's a topic for another day...

This is yet another reason, if you needed it, to have your own well thought-out economic and financial plan, and to stick to it.

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Spending My Bonus: It's Tech Time!

I have made my big bonus decision. A few weeks ago I wrote about how I got an unexpected bonus and was trying to make up my mind about what to do with the windfall. The decision has been made: an upgrade to our computer and home theater system.

As a first step, we bought a fully loaded new PC: quad-core Intel processor, 9 GB of memory, a 1.5 TB disk, 2.7 inch monitor and a bunch of software. $2200 from Costco, all in. Really, really expensive, yes, but given that our previous computer lasted for 8 years, and that we hope to get the same mileage from this machine, that's not a completely reckless decision. This computer will also play an important part in the next phase of the plan: connecting our TV to the Internet.

For months I have been plotting a wireless assault combining TV, media server, computer & Netflix. Netflix now has a massive collection of movies and shows that can be instantly streamed over the Internet. The only problem: connecting the TV to the Internet has been a challenge. It turns out that this can be done in several different ways: certain TiVo machines, Blue Ray players and XBox consoles can be wireless connected to the Internet, and be used to stream content to the TV. That's the sole missing component in my scheme to upgrade our home entertainment system. I'll probably pick the TiVo or XBox and my master plan shall be complete! Muahhh-ha-ha-ha-ha..... Wow, that's almost as good as taking over the world...

One other nice thing about our new fancy computer is that it has a built-in TV tuner and DVR which I intend to connect to Comcast cable. That way our 1.5TB hard disk will become a massive new DVR.

A final note on the new computer: this is a Windows 7 machine and so far I like this new operating system. Some problems with software that's not yet compatible with the new operating system, but generally speaking, Microsoft did a good job making sure that accessories and most software install and operate smoothly. Very nice. Ironically, the only problem we experienced with migrating to the new machine has been with Apple... migrating my iTunes, iPod and iPhone to the new computer has involved days and days of work. Because the old computer crashed and we had no access to the old copy of iTunes, I had to recover my music from our home back-up. This process resulted in the loss of all my playlists, song ratings and customizations. As I said, it took me DAYS of work to recover, and all this while my iPhone retained a PERFECT record of all my data that could have been easily recovered and migrated to the new computer if Apple cared at all about it's customers. I love Apple's products, but abhor the company and it's philosophy. What a pointless nightmare.

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The Best Job You Can Apply For

The best job you can apply for is one that doesn't exist yet. Many people looking for a job make the bad mistake of basing their hunt on job postings. This is a great strategy if you want to minimize your chances for landing a job and to maximize the number of interviews you get without actually getting a job offer. Think about it: if you see a job posting, thousands of other candidates are seeing the very same posting. In these days of high unemployment, you know that each job posting garners dozens or even hundreds of applications, many of these by well qualified candidates. Your application, if it is seen at all, is considered among many others and should you be lucky enough to get invited to interview for the position, you will be one of several candidates, each striving to be the last one standing at the end of the process. Too many steps. Unattractive odds.

There is a better way. How about a job that is tailor-made just for you? Seems like too much to ask for in an economy where jobs are scarce? Well, I got news for you. This is a tried and true strategy that works a lot more often than you think. In fact, this strategy worked for me twice in my career - my current job and my last one. Unfortunately, getting such a job involves the "N word". That's right, networking. I know everyone says it's necessary, and pretty much everyone hates doing it, but this is a special kind of networking, it's networking at the top.

Here is how it goes:

Step I - pick an industry or market

Step II - make sure you understand it well (ideally, this is a market you already know)

Step III - network your way into meeting CEOs in this industry

Step IV - make your pitch

Of course, the trick is step III - CEOs are busy people and are not sitting around waiting for your call. In fact, the only viable way to meet a CEO is to be introduced to one through a mutual acquaintance. That's where the whole networking thing comes in. Don't even think about cold calling or spamming. That's not going to get you hired.

Why a CEO? The good thing about a CEO is that he has no boss (technically it's the board of directors, but they don't deal with such things). If he likes you, he may very well create a position for you where none existed previously. Presto, a position out of thin air. What's more, the position is yours. You don't need to interview against hoards of qualified applicants. Another possible outcome is that the CEO will refer you to a member of his staff to interview with them. That's what happened to me in my previous job. After meeting with the business unit CEO for a networking meeting, he liked me enough to recommend me to his VP of Marketing. A recommendation from the CEO is almost as good as an offer letter... almost...

By the way, before the angry comments start flying my way, I am not against applying for jobs you find on the Internet. Someone has to be getting all those jobs, right? All I am saying is that this is a very competitive and impersonal process and that many applicants (myself included) feel that it's difficult to shine or stand out from the crowd in an e-mail application. I have never gotten a job from an online post. Your results may vary.

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Efficiency and Effectiveness in Hunting for a Job

Alpaca is still looking for a job - it's been a few months now, which is not surprising in these economically challenging times. On Tuesday I met for breakfast with an old friend who works for a venture capital firm. We were chatting about our families and I mentioned Alpaca's job hunt. My friend immediately asked what kind of job she was looking for, and after I explained he asked me to forward her resume to him by email. I did, and a few hours later he sent an e-mail introducing Alpaca to all the partners in his well respected VC firm. Later that day, one of the partners sent Alpaca an e-mail. Yesterday they spoke on the phone and a few hours later he introduced her by e-mail to the CEO of one of their portfolio companies that had recently raised funds and that was looking for help on the marketing side. I don't know if this will end in anything concrete, but it's definitely a step in the right direction, yes?

Saying that networking is the key to finding a job is an old cliche, but that doesn't make it any less true. Which belatedly brings me to the topic of this post: in business school I took a class in building distribution channels. The professor explained that making your sales targets is largely the function of two parameters: (i) the efficiency of your sales channel; and (ii) its effectiveness. Efficiency is the number of customer contacts you make - or how many sales calls you make. Your effectiveness is a measure of how successful you are in converting each customer contact. Calculating your success is a simple multiplication exercise: how many customer contacts you have, multiplied by your success rate with each contact.

Today it struck me that success in a job search is subject to the exact same performance metrics. Your success is a combination of the number of job interviews you land (or the number of random networking contacts you make), and of your ability to convert those interviews (or random networking contacts) into job offers.

The implication for this is simple: you just need to be out there and meet with as many people as possible. Even if you are a particularly poor batter, if you take enough swings sooner or later you will hit a home run. The important thing is to keep swinging no matter how many times you miss the ball.

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Imaginary Personal Finance Cages

Once again I am on a business trip, this time I am visiting Texas. Yesterday I went out to dinner with a colleague in a local restaurant and we got into a conversation with our waitress - who happened to be on her first day on the job. The conversation lasted about 5 minutes, but we learned some very interesting thing about her which I wanted to share with all of you.

Our waitress, a nice woman in her late 20's, whose name I don't remember, is an Illinois native, but she lived in many places around the country, including South Carolina and now, Texas. She has a college degree in "culinary arts" and a passion for wine. Before moving to Texas, she was thinking of moving to California and to work in the wine industry but decided that this was too risky, and instead moved to Texas where she "has some family". Her dream is to go to Italy, travel the country and experience the culture and the people. I don't know this for a fact, but I got the impression that our waitress is not married, and I am pretty sure that she does not have kids.

My colleague and I were perplexed. I asked her why she's not chasing her dream? Why not go to Italy? Her reason: she doesn't have the money. My response to that was "why don't you go to Italy and work there?" After all, if she can be a waitress in Texas, she can be a waitress in Italy as well. She explained that she wants to go to Italy when she has enough money to experience the country and its culture without being worried about every dime she spends. In a different part of the conversation, she mentioned that the restaurant was paying her a salary of $2.25 / hour, not including tips.

I am not going to sit in judgement on a hard working waitress, but both my colleague and I were amused by her attitude. I am in my late thirties and my colleague in his early forties. Both of us traveled the world extensively, on tiny sums of money. Backpacking and hitch hiking our way across continents, when we were more or less the waitress' age. I didn't work during these extended trips, but I met many backpackers who did. And what better way to experience the land and its people than to live among them? We both recall those times as some of the happiest in our lives. For me these were times of adventure. Of freedom. Of peace of mind. Imagine waking up in the morning in a strange part of the world, for months at a time, with the only thing on your mind being the next big surprise that is waiting for you around the corner.

I compare those times to the life I lead today, tightly constrained by the daily necessities of raising a family and nurturing a career, and I marvel at the adventures I had. I am tempted to look at our waitress and wonder at the imaginary personal finance cage that she put herself in. Not pursuing your dream until you have the money!? "Break free", I want to shout at her. From my vantage point it looks like the barriers standing between her and her dream are all in her mind. But then I wonder whether someone with a different vantage point could say the exact same thing about me. Even though those cages exist only in our heads, the barriers we set-up for ourselves govern our lives.

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Home Insurance: The Big Picture

As part of our ill fated house purchase late this summer, we did a lot of thinking about home insurance policies. A truly riveting topic, to be sure. Nevertheless, we discovered a few interesting things about the subject:

Most home insurance companies offer about the same rates for the same coverage. This is not terribly surprising when you think about it. These guys' jobs is to estimate risk and then to price their plans a bit higher than the expected pay-out, such that they generate a profit for their companies. Since this is an extremely competitive market, prices should gravitate to more or less the same level, and they more or less do.

The biggest impact on your home insurance premium seems to be your deductible... that stands to reason as well. The insurance companies are in the business of making money. If you can sue them for every little thing that goes wrong with the house two things happen: one, you are more likely to sue. Small things go wrong all the time. Second, when you sue, they not only incur the cost of paying you for your loss, they also have a considerable administrative cost. However, if you are willing to take a higher deductible, things look much brighter from the insurance company's perspective: you are less likely to sue and you are less likely to be able to manufacture false claims. In addition, the insurance company knows that you are motivated to reduce the likelihood of damage, since you bear a larger percentage of the cost.

The difference in insurance premiums is dramatic. We found that by increasing our deductible from $2,500 to $5,000 we could roughly double our liability coverage for the same premium.

My philosophy about insurance is a simple one: you insure only risks you cannot afford to bear yourself. The window is broken? No problem. Repair it yourself. You don't need insurance coverage for that, and you certainly don't need to pay for the insurance company's profits. However, most people (ourselves included) can't afford to replace a entire house lost to major disaster. That's what insurance is for.

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How I Almost Lost My Job

About 18 months ago I got a new job. I left a large, established technology company, for a small start-up in the same field. There was a certain amount of trepidation involved in leaving a solid company for a tiny one with only a few months of cash in the bank. Last week my decision was vindicated, in the most nasty of ways. My former company eliminated my old position. In fact, they eliminated the entire team that I ran.

OK. I admit it. That wasn't even close to my losing my job. Still those cuts hit close to home. Some good friends of mine lost their jobs, in what is a very nasty job market.

I believe that I would have kept my job, had I stayed with the company. I had very good relationships with my management and I believe that they would have found a new role for me in some sort of a re-org scenario, but I can't help but feel that I made the right decision to take a risk and move to my current position.

There are a couple of lessons to be had here. First, no job is safe in today's corporate culture. Next time you have any feelings of loyalty or warmth towards your employer, remember that those feelings only go in one direction. If the need arises, your company will let you go in the blink of an eye. I am not saying this in a pejorative way. In fact, just a few weeks ago I had to let someone go in my company. However, what I am trying to say is that "every man for himself" is the reality in today's business climate, and I don't know that it was ever different.

Second, job security is a very ephemeral thing. Some of the financially strongest companies in the world are laying people off, left and right. Some small businesses and companies are retaining their employees and are even hiring. Big business is such an impersonal thing. You could be doing a phenomenal job, but if someone at the top decides to lop-off a business unit, you would lose your livelihood just as the slacker in the next cube would.

At the end of the day job security exists no-where in corporate america today. I believe that a new term is needed: Career Security. It's not about keeping your current job, it's about making sure that if you do lose your job your long term earning prospects are not diminished. Career security is about recovery and resiliency more than it is about maintaining a specific employer.

I think there's a book in there somewhere.

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Are You an Up Day Addict?

I have noticed something interesting about myself: I am more likely to go into Quicken and check the state of our finances on days on which the stock market does well. I am an up day addict. It's not that I make investment decisions or change our financial strategy based on the vagaries of the market, but I am just loathe to look at the paper losses that accumulate on days in which the market goes down.

During the height of the financial meltdown, I kept myself away from Quicken for days at a time. I would check stock quotes online semi-obsessively, but I would not go into Quicken to tally up the damages. Since the market started heading back north in March, I have been turning to Quicken more often, taking pleasure from the fact that the losses were diminishing at a breath-taking pace.

You could look at this in two ways, one good, the other not so flattering. You could say that I am reducing my level of anxiety by not checking the Quicken tally on down days, and thereby lessening the risk of impulsive action that would hurt us in the long term. You could also say that I am too squeamish to face reality. I suppose you would be right in both cases. Nevertheless, at the end of the day, what counts are the real steps that I take (or not take) in response to the data which Quicken so graciously gathers for me, and on that front I am proud to say that squeamish or not, I was able to stick to my plan so far.

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Credit Buyers are Undisciplined Consumers

Buying things on payment plans is an insane idea. I know, what I am saying is practically un-American, but nevertheless that's where I stand. A great example of that all prevalent insanity is car payments. A car is the classic depreciating asset - you buy it today and it's value can only go in one direction: down. However, tens of millions of Americans buy their shiny, cash draining machines on credit, burdening themselves with financing changes and negative cash flows. Some would say that they have to buy a car on credit because they can't afford to buy it straight out. If you can't afford to buy your car with cash, you can't afford to buy it on credit either. You can't afford to buy that Lexus? Spend $8K and buy a second hand compact car. Believe me, it will get you to work and back, just like that fancy car would. Yes, I know, you won't look as cool, but think of all that cash rattling in your piggy bank.

Are all payments bad? Of course not. Credit is a good thing if it is used for the right things, and there are primarily two types of things that are worth buying on credit: (i) appreciating assets (or at least ones that are not expected to lose value) - a house is a great example that falls into this category; and (ii) assets that generate a positive cash flow after the financing charges - for example, a profitable business.

Financing consumption through credit payments does not make your consumption more affordable, it simply robs your future self to pay for things you want today. Show me a payment buyer and I will show you an undisciplined consumer.

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Our House Purchase Fell Through

Well, we have terminated our house purchase contract. This is very disappointing, but it was the right thing to do. How did we get to this point? It all boils down to one thing: the seller did not disclose to us that at the time we signed the contract he had a firm lease with a tenant. While at some point the tenants supposedly expressed a willingness to move out, there was never a firm commitment with a firm date.

The sellers and their agent are clearly the bad guys in this story. The tenants did nothing wrong - they were supposedly willing to cooperate, but understandably were not willing to give up the house before they found a different place to rent. Can you blame them? I can't. The idiot sellers actually threatened to initiate eviction procedures against the tenants - which they clearly had no cause to pursue. That's when I started having serious second thoughts about buying the house. If the sellers were unethical enough to try to evict an honest tenant without cause, could I trust their word on anything else? For example, could I trust them that they made repairs and improvements to the house which my inspectors could not see for themselves (e.g. roof repairs, pipe replacement etc.)

I believe that we may have been able to close the deal if we had chosen to aggressively pursue it. However, going for closing would have carried serious risk for us, as well as immediate costs. For one thing, I would have had to liquidate part of our investment portfolio, thereby immediately incurring a capital gains tax liability, whether or not the deal went through. In addition, we would have had to give notice to our own landlord and may have lost our own house. Finally, the tenants' supposed proposal to move out was conditional on their finding a different place. If they did not find a place, the deal would not go through and my mortgage financing would lapse. The risks in going to closing were just too high.

What next? We've decided not to try to sue the sellers. According to legal advice we got, our only way to sue them would be to demand closing, and to do so, we would have had to transfer all our cash to the escrow account. As I mentioned above, this would carry immediate costs, and would lock-up most of our net worth in an account we could not control, for a length of time that was not immediately clear. As much as it pains me, the ******* sellers and their lying agent will get out of this without the punishment they so clearly deserve.

Could we have avoided this result? I have been asking myself this question for the past week. My honest answer is that I can't think of anything we could have done differently. Occasionally in life you run across unethical characters. It's just the way things are. I just wish I could make sure that they received the punishment they deserve.

As a final note, we have had a major rain storm in California last week, and in one of the final e-mails sent to us by the sellers' agent, he wrote (god knows why) that the tenants complained that the roof was leaking. The sellers told us they replaced the roof. I guess they didn't do a very credible job on that either.

It's back to square one. We're in the market for a house. :-(

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Financial Incentives & the Weather

In honor of Blog Action Day, whose topic this year is climate change, this post is dedicated to the impact of financial incentives on the weather. Yes, financial incentives can and do effect the weather. Granted this effect is subtle and is only noticeable over a period of decades, but it’s real and it’s happening.

Over the past 150 years or so the world has been rapidly industrializing. This industrialization has been an exceptionally good thing, vastly improving standards of living, dramatically lengthening average life spans and giving a huge number of us a comfortable way of life. Of course, while making this great progress we have been enjoying an unfair advantage. We have been using the atmosphere as our own personal dump. The reason for this is simple. It costs nothing to pollute and since industry is about maximizing profits, industry’s economic incentive was to ignore the cost to society that such pollution causes.

Because of its sheer size, our emissions have take over a century to make a noticeable impact on the atmosphere, but scientific consensus now tells us that our actions are changing the atmosphere in a way that could lead to catastrophic results. The good news is that the financial incentives that brought us to this point, can also take us in the opposite direction and help clean up the planet.

Congress is considering several ways to cut global warming causing emissions, cap and trade being one of those proposals. Under such a system, government would cap the amount of green-house gas emissions, give “pollution permits” to certain industries, and allow firms to buy and sell those permits according to their needs. The thinking is that the “cap” would be reduced over time. While this is a good fall-back plan, it is complex and somewhat circuitous. A simpler way: carbon tax.

A carbon tax would be very easy to administer. Set a price per pound of CO2, and tax every activity according to the amount of CO2 it generates. You buy gas? The cost of CO2 would be added to your bill. You buy a computer? Same deal. You buy transportation services? Pay for the CO2 you emit into the atmosphere. The cost would be very transparent and immediate to the buyer, and when strong financial incentives exist, behavior changes.

What would we do with the funds generated by a carbon tax? We could do several things. One possibility: return it to consumers in the form of lower income tax rates – this way the net impact on the economy will probably be close to zero. Another possibility: use the money to subsidize alternative energy and energy efficiency projects. Or, here’s a thought, how about we reduce the federal deficit so that each of us owes less money to the rest of the world?

Economics got us into this climate change mess, but the good thing is that it can also go a long way towards getting us out. Hooray for carbon tax!

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Do You Cheat Yourself? Apparently I Do...

CNN-Money recently offered it's readers the opportunity to take a financial risk tolerance test. I am a sucker for personal evaluation tests, so I went ahead and clicked on the link. The test is comprised of 25 questions designed to ascertain how risk averse you are as an investor. Unlike most tests that give you two or three pretty transparent questions and then throw your answers back at you, this test is fairly sophisticated. As I was taking the test I was noticing something very strange about myself: I was cheating. Even though I was the only person who was ever going to know or care about the results, I was trying to game my answers to make sure that the test score came out the way I wanted it to come out.

To be fair, this wasn't a completely premeditated act of deceit. In a couple of places, after I chose one answer, I noticed that this wasn't really a truthful answer. I went back and changed the answers I had first given. In the end, the answers I submitted were sincere, but I am not sure why my initial reactions were not honest. I have been thinking about this for a couple of days and I think I have a good theory. I believe I know myself very well, especially in matters of personal finance. I also think that I understand my tolerance for risk and my behavior under pressure. Here I was, taking a test that was supposed to tell me something about myself that I did not already know. Damn arrogant test. It thinks it knows me better than I do? I'll show it. I'll give the answers that will generate the results as I know them to be.

Not very smart or mature, I admit.

Still, I did catch myself and fix the erroneous answers, so give me small credit please.

The bottom line is that I scored a 68 on that test, with the following description for my risk tolerance:

"Most commonly they think of "risk" as "opportunity". They have a great deal of confidence, if not complete confidence, in their ability to make good financial decisions and usually feel very, or at least somewhat, optimistic about their major financial decisions after they make them.

They are prepared to take a large degree of risk with their financial decisions and are usually, if not always, more concerned about the possible gains than the possible losses.

When faced with a major financial decision you are usually, more concerned about the possible losses."

Actually, that's pretty good. This is very close to the view I have of myself and my tolerance for financial risk. In the end, after trying to cheat the test, I have to admit that it did a pretty good job at what it was designed to do.

A final word on my risk tolerance and our asset allocation. The best measure of your correct asset allocation, in my opinion is this: if you went through the most recent crisis and held onto your asset allocation strategy, you have a good understanding of your tolerance for risk. If you bailed out when things got rough, you are probably taking on more risk than you can handle. Remember that next time the market turns up and you are tempted to jump back into stocks (as in, now, for example). If you want the ups, you have to be able to live with the downs.

So, dear readers, let me know what you think of this test and let me know what your test scores turn out to be. I am also curious to know if anyone else finds themselves cheating on personal assessment tests that only they will ever see the results to. Humans are strange beasts.

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Health Care Inflation & My Wallet

Health care inflation is here again. Our open enrollment season for health care plans at work is upon us, and this week I received an e-mail from our benefits administrator informing me (and the rest of the team) that our premiums this year are up about 4.9%. My per paycheck deduction will now increase from $253.25 to $265.75, or a total of $325 per year. Nope we are not any sicker, and no our plan didn't get any better. It's the same old coverage for the same old plan.

So what's going on? Inflation. But this is the smart bomb equivalent of inflation - it's affecting only very specific sectors of the economy. In fact, if you take a look at government statistics, total inflation at the consumer level from August 2008 to August 2009 was - brace for it - negative 1.5%! So even while the rest of the economy was showing serious signs of deflation, the cost of our health care plan increased by about 5%. Does this make sense to anyone? How can anyone delude themselves into thinking that this is sustainable?

Before you bring up this issue, let me add that my employer is not sending more of its coverage costs to the employees. Our benefits administrator sent us all a detailed chart showing that the company's cost per employee is also increasing by about 5%.

The US health care system. The good news just keeps on piling up.

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A Few Links

I am back in the blog carnival game, and this week I participated in two of them: Carnival of Money Hacks hosted by The Dough Roller and Festival of Frugality hosted by Improve the Quality. In fact, my article titled: Mortgage: Everything You Buy Costs Twice as Much was selected editor's choice. Sweet.

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Medical Insurance: Small Battles of Attrition

Forget all about the big philosophical questions of reforming the health care system. Let me tell you a couple of small medical insurance stories that my family has gone through over the past two months.

Chapter I - the twin mix-up - we have twin boys. When one is sick, the other quickly follows suit. It's the whole contagion thing. Anyway, some weeks ago both twins came down with a nasty cough, that progressed to the point where the doctor prescribed them both antibiotics. The two prescriptions were delivered within a couple of days' difference from each other, and while we had no problem filling the first prescription, our health insurance refused to authorize the second prescription, assuming that this was for the first child. An hour on the phone with the insurance company while at the pharmacy was not enough to correct the problem, and eventually we paid for the prescription out of pocket and waited several days while the insurance idiocy was worked out and we got reimbursed for the fiasco.

Chapter II - my wife took the kids to the dentist the other day - regular check-up and cleaning. She paid the dentist and filed a claim with the insurance. The insurance company sent us an explanation of benefits, but didn't send us a check. Alpaca called them to figure out what was going on. Turns out they sent the check to the dentist. They will now cancel the checks they already issued and send new checks to us.

Two small incidents. Nothing earth shattering, just tedium and annoyance. But there's more to it than that. Think of all the money that our health care system just wasted in the process of providing routine service to a generally healthy family. Now multiply that waste by 100 million households and you get some staggering amounts of waste. What a burden on the system. What a burden on health care premium paying consumers.

Folks, there is no reason on earth why we should put up with this insanity. What is Congress waiting for? Where is meaningful reform?

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Where is the Economy Going?

In recent weeks some folks have started voicing concerns about the nascent economic recovery. I am not one of them. I believe that the economy is bouncing back and that the recovery is going to be robust. Yes, unemployment is still on the rise, and indebted consumers are keeping their money in their wallets, but I see signs of economic recovery virtually everywhere I look.

At least here, in Silicon Valley, companies are beginning to hire again. When I talk to customers and vendors and ask how business is going, people tell me that they are seeing a nice up tick in sales. Our realtor says that the market for sub-million dollar houses is positively booming (this is the San Francisco Bay Area. In decent neighborhoods houses under $1M are cheap). Life is flowing back into the system.

Considering the economic near death experience we lived through in the past year, this is a miracle. It's also no surprise that there is still a lot of economic pain. However, the bottom line is that the economy is in better shape than we have any right to expect it to be.

Credit for the economic recovery belongs with the government. Yes. I said it. Ouch. Both the Bush administration and the Obama administration have done an outstanding job (so far) of staunching the bleeding and restoring confidence in the markets. There are many Monday morning quarterbacks out there criticizing each administration's policy decisions, but given the speed with which things collapsed, the tremendous uncertainty involved and the unprecedented magnitude of these events, I think that our policy makers deserve rare praise.

Let's hope things continue to improve.

Unfortunately, in the longer term, deficits, inflation and a decline in the value of the Dollar all threaten the US economy. Let's hope our leaders have the vision and fortitude to avert that future economic disaster in waiting. Sadly, I think that this will be tougher to accomplish.

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