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Comments of the 1st Quarter of 2015 May 27, 2015

Posted by shaferfinancial in Finance.
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I will do this in outline form for brevity:

The stock market continues to rise although at a lower rate than 2014.  At some time in the near future we will see a correction. This is a much needed event as we have not seen a correction in quite a few years.  For those who are invested long term we use these events as an opportunity to pick up bargains.

EIULs continue to perform as structured.  As a group sales of EIULs broke a record and have attracted the attention as a threat to whole life companies as well as mutual fund/stock companies.  New rules will come down that will severely limit the ability to illustrate these policies at anything close to real world experience.  This won’t stop the attraction of EIULs to folks looking to secure their financial future.

The price of oil made a move up this quarter, but has since stalled.  World oil production continues to be a record levels while demand has seen some growth.  China demand for oil up 9% with 6% the result of transportation [SUV sales up 50%].  India up strongly too.  US demand up with strong increase in miles driven and sales of SUVs up.  Even some positive movement in Europe.  Russia and Latin America lag in demand for oil.  Saudi Arabia sees increase in internal use.

North American tight oil [which I don’t invest in], has seen falling production since the first of the year.  This should really take affect in the second half of 2015 reversing the current world wide overproduction of oil.

My energy stocks moved up, but are significantly in the red.  Despite this, I remain confident in their ability to get back in the black over the next 24 months.

Berkshire Hathaway off its highs but continues to do well in this environment.  It produces a huge amount of cash flow each day.

Real Estate rents remain strong in the US.  Prices continue to increase as bankruptcies and foreclosures decrease. Real Estate remains a great place to invest.

The overall dividend environment for blue chip companies is positive as dividends continue to move upward.

If you had followed the strategy [ies] that I advise you would be in great shape for whatever happens next.

1. EIUL [protected against market downdrafts and taxes]

2. Investment Real Estate [rents continue to increase]

3. Dividend producing Blue Chip Stocks [dividends continue to increase]

4. Annuities [for guaranteed life long retirement income]

Fresh Thinking on Investment Real Estate, Rent, Home Ownership July 24, 2008

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Recently had an interesting conversation with a young man.  He was wondering if he should buy a house in his area to live in.  I asked him some basic questions like why he wants a house.  He answered, for an investment!  Further he said he was happy with renting the place he lived in because it was ideally located for him and relatively cheap.  He couldn’t afford to buy into the same area he lived in, so he was looking into some less desireable neighborhoods to buy.

So I suggested he treat this transaction as what it is, an investment.  I explained to him that the decision matrix for investment real estate was very different that for a personal residence.  It was like a light bulb went off in his head.  He had been struggling because he was approaching this decision from the wrong direction.  He really didn’t want to move.  I sent him off to do some research and gave him a couple of names of trustworthy folks that understand investment real estate. 

This is, of course, anathema to my real estate agent friends, but renting can make sense for people.  And since people aren’t trained to think like a real estate investor, they are unprepared to make good decisions about real estate.  Like my client who was paying $600/month for a place he was comfortable in and finding a similiar place to own would have cost him $2000/month.  Now he is free to look all over the US to find a investment property since he is not limited to being close to work.  He can still bike to work and own an investment that will give him double digit returns putting him in good stead for his future!

Real Estate and Mortgage Issues July 8, 2008

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Just wanted to post on the most recent RE and Mortgage Issues.  First as I have been saying for a long time now foreclosure rates are being pushed by the sub-prime loans. Even though sub-prime and FHA loans account for only 20% of loans, they account for 60% of foreclosures.  And even in this class the foreclosures are driven by two states, Florida and California which have 21% of loans outstanding and 36% of the loans in foreclosure.  These two states had the most speculative action and the largest run-up  in prices, so now we see them leading the way back down.  Now here is the important part.  This was a predictable event.  When you see pricing marching upward 20-30%, then you know there is a bubble and the equity returns will descend to the mean.  When you loan money to folks who have no reserves and poor credit scores, there will be a large group of them fail to make payments.  Its not rocket science folks!  Indy Mac, a large lender in the option arm market has now stopped lending and will probably fail.  Regular readers know my opinion of option arms by now.  If you entice folks by telling them they have a 1% mortgage rate and/or they don’t have to pay back even the interest on the loan, then you are going to get folks that take you up on that and end up in foreclosure.

As far as values, outside of a few speculative areas and a few areas where jobs have vanished, values remain pretty decent.  Here is a video on Manhattan real estate for those interested in high end markets: http://www.dottieherman.com/video_mmo2_long.htm

Bottom line, is that lending has gone back to what was standard before 2002 and rates remain historically low.  You are going to need some capital (as well as you should) to buy a home except for FHA loans.  Don’t try to time the market, make decisions based on a well thought out plan.  Remember the calculus for personal residence and investment properties are completly different.  For your home, save some money up for at least a 10% down payment, get credit scores above 700, and take your time (there is much inventory).  Remember people who don’t own their own home rarely have positive net worths at the end of the day.  Investment property figure cap rates, cash flow, local rental histories, and area job growth.  Do your homework and don’t overpay just because the area is hot!

Saving for Retirement May 20, 2008

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If there is one place that there is much misinformation, it is in how much you need to save for retirement.  The mutual fund industry has spent much time and effort to propagandize to folks why they can accomplish this using mutual funds.  The truth is much different.  Now there is one caveat before I go into the numbers.  If you are fortunate to have a defined benefit pension, then you can make it work by putting monthly money aside into a mutual fund inside a IRA/401K wrapper.  Even better if you also qualify for social security.  But, if you really want to accumulate enough to have a comfortable retirement then pay attention.  If you don’t have a defined benefit pension, then it is critical that you understand the following.

Mutual funds have been sold as a safe/low risk investment.  And that is truthful.  But the rule of finance is that the lower the risk the lower the potential rate of return.  Now we know that individuals that purchase mutual funds average 2.5%-4% rate of return.  But for the point of this exercise lets assume a 8% rate of return (the average mutual fund return).

Now here is my rule of thumb.  In order to build enough wealth to have a comfortable retirement you must get 15% rate of return from you investments.  Let me show you why.

Lets say you put away $300/month until your retirement in 25 years.  Let’s also assume you never fail to put this money away.  If you get a 8% return on investment, you would have $285,308 after those 25 years.  This can produce $22,800 of taxable income per year assuming that same 8%.  Not bad.  That puts you in the top quarter of net worth for folks in the United States.  However, you haven’t accounted for inflation. Taking official inflation statistics, which I believe seriously understates inflation, that $285,308 has the buying power of $142,654 or $11,400 year.  But that is on day one of retirement.  The average person will live another 20-25 years.  So by the time you die that $285,308 will only have $71,327 of buying power or $5,700/year.

Now let’s run the numbers with 15%.  Same deal, $300/month for 25 years.  Now you have $973,059 and using 8% of it each year you would have $77,844/year.  But the buying power would only be $38,922 when you retire and $19,461 at likely death.

Now that is more like it!  But you say how can I get 15% without risk?  You can’t.  But you can get 15% assuming less but a different type of risk than you have with mutual funds. 

First, can you spot the risk of investing in mutual funds?  Well it is the very real risk of running out of money before you die.  In fact, 90% of retired folks are financially dependant on the government or family/friends before they die.  Remember mutual funds have been sold to the public for 2 generations and that strategy has been pushed for just as long.  So that risk is extremely high.

Here is the less risky way.

1. Find a stock that has returned over 15% for over 40 years.

2. Use leverage.  If you leverage an investment three to one you only have to have that asset return 5% to get that 15% return.

For regular readers you now should know the answers.  There is only one stock that has returned over 15% for 40+ years.  Berkshire Hathaway.  In fact it has returned over 21% for 43 years.  Over 18% for the last 10 years. I put my bet on Warren Buffett the driving force behind Berkshire Hathaway.

Finally, investment real estate, properly structured in growth areas have historically returned over 6%.  You can leverage this with mortgages.  And you get all the tax advantages of real estate.

Your choice on the risk.  Bet on two things that have proven to give superior returns over the last two generations, or bet on mutual funds which have proven to given inferior returns over the last two generations.


       ***** As always, this post in only the musings of a clearly deranged individual that happens to be good at math.  He has no license to sell securities nor real estate and any advice should be considered for amusement purposes, not expert advice that ones gets from a licensed individual.**** 

Retirement Strategies REdux: Old School v. My Way April 21, 2008

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Mary and Joe are typical folks, they have about twenty years to retirement with two kids fast approaching needing money to attend college.  Joe has been fortunate and has had the same job for over 15 years, while Mary works part-time for a local business and still does the majority of taking care of the kids.  They have accumulated around $100,000 in a 401K and owe $100,000 on a home that is worth $300,000 by aggressively paying off the mortgage and owning the home for 15 years.  Their emergency fund is meager at $8,000.  They know they need to figure out a way to get more money for retirement, but frankly, are at a loss how.  They make an appointment with John, the financial planner.  Mary pulls up in a 7 year old Honda minivan and waits for her husband.  Joe running a few minutes late pulls up in a 4 year old Chrysler 300.  Joe parks next to a new Lexus and admires it as they go into the office.  John meets them at the door and acknowledges Joe looking at the Lexus and mentions he has just leased it a few weeks ago.  Joe is impressed.

John, takes all their information and runs the numbers.  He looks them in the eye and delivers the bad news.  At their present rate they will not have enough to retire on.  They need to do something now!  Mary and Joe are a little embarassed about their situation, but they thought they were doing the right thing, paying off their mortgage and putting 8% of Joe’s salary in to the 401K.  Frankly, Mary knows because the wives talk about this, that they are better off than most of their friends.  So she is a little peeved at John’s rather cavalier attitude toward their retirement savings.  Then John throws in the kicker.  He can help them achieve success.  He starts to talk about asset allocation mentioning that they have all their money in one mutual fund.  He pulls out a prospectus that is for an international mutual fund that returned 28% last year.  Joe is impresses as he knows his fund returned a meager 3% last year.  Then Joe pulls out another prospectus for a Precious Metals Mutual Fund that returned 85% last year.  Joe is fully impressed now.  John suggests he take control of the $100,000 in the 401K to manage it.  He tells the couple to keep up the good work paying off the mortgage, but they need to put away more, much more if they want to retire comfortably.  John also suggests they need some life insurance so he suggests a $250,000 10 year term insurance which he says is dirt cheap now.  Joe and Mary look at each other with the same thought.  They are already pretty thrifty, but there goes the one night a week they eat out together and maybe Mary could work more hours after all the kids are old enough that they don’t need Mary to be there when they get home from school.  But, if that is what they need to do, then they will figure it out.

On the way home Joe is sold but Mary has some doubt about John.  She remembers reading “The Millionaire Next Door” in her book club a few years back, so she is not impressed with John’s car.  Her intuition also tells her that the returns that he showed them for those two funds were a little high, they must be risky she thought.  She thinks  they should talk to someone else.

Can you spot the mistakes?

1.  The assumption that leasing a nice car means that you know what you are doing financially is incorrect and probably the exact opposite.

2.  Mutual funds as a class underperform the market and specialized mutual funds have even more variability which means that those two mutual funds will probably underperform for many years to come to make up for their amazing performance last year.

3.  They use little leverage on their finances and are decreasing it by paying off their mortgage.

4. The majority of their net worth is home equity which gets a 0% rate of return.

5.  Suggesting to a frugal couple that they need to be more frugal is like throwing gasoline onto a fire.  They drive older cars, eat out only once a week and work 1 1/2 jobs between them while caring for two kids.  Life shouldn’t be this onerous for this couple.

My Way:

Move their 401K money to a discount brokerage account and buy $100,000 of Berkshire Hathaway B’s.  Warren Buffett’s returns 21% over 43 years and 18% over  the last 10 years.

Re-finance their home with a $250,000 mortgage now available at 5.75%.  This gives them $150,000 cash.

Take $25,000 and purchase a $200,000 duplex in Dallas, Texas that is cash  flow positive (See my Friend Jeff www.bawldguy.com for details)

Purchase a $450,000 equity index life insurance contract.  Fund it with $25,000 year for five payments.

Reduce the 401K amount to the 3% company match to cover the extra expense of the larger mortgage.

Place the $100,000 left over into a money market fund or high paying savings account to act as an emergency fund and reserve fund for the real estate.

As each year goes by make the $25,000 life insurance premium payment. 

Taxable income goes down as the mortgage interest goes up substantially and the real estate investment throws off tax advantages.

Let’s look down the road five years.  The real estate investment has a cash flow of +$3,000, +$3,000, +$4,000, +$5,000, +$6,000 as rent could be increased.  This $21,000 is held as reserves for deferred maintenance and is not counted for assets.  College aid was applied for the kids and this amount was not counted!

The insurance contract has a cash surrender value of $110,000 since the front loaded fee’s have been paid.  But this works as the couple’s emergency fund available to them with no tax consequences.  The big positive is that this is not counted toward income or assets for college aid.  So they have moved over $100,000 off the college aid books allowing the kids to qualify for more aid.

The Brokerage 401K is worth $228,776 with Warren Buffett continuing the 18% he got the last decade.

The duplex is worth $250,000 getting slightly less than 5% return. They have around $80,000 in equity.

Their home is worth $380,000 getting the same 5% return.  They have over $150,000 is equity.

Their taxes have gone down due to the mortgage interest deduction and the investment real estate.

Their passive income from the real estate is 500/month.

Their kids received large amounts of student aid for college.

They have a emergency fund/reserves over $130,000 so they sleep well at night.

The costs to do this was $5,000 for the refinance, $5,000 to buy the duplex, $12 to buy the stock, and the commission and fee’s for the insurance contract.

There are no ongoing fee’s (other than the insurance contract) payable to a financial planner.

No reduction in life style needed.  In fact as the couples net worth rose, they started to take a nice vacation once a year and Mary will stop working  as soon as the kids are out of college.

Old School V. My Way:  You make the choice!

PS  I used conservative numbers all the way through my way!

PSS  As usual this should not be construed as financial advice with respect to any particular stock or any general investment advice that might come under the auspice of the SEC.  It is only the ramblings of a derelect and a individual that does not have a license to issue stock or mutual fund or real estate advice.  Please see an “expert” for all tax issues.