Saturday, October 22, 2011

Why Every Capitalist Should Support Occupy Wall Street

Some intrepid readers may be wondering why I haven't posted in over a month.  No, it is not because I have been camping out in a park in New York City.   It is because of some increased obligations at my paying job.  Contrary to popular belief, blogging is not a profitable endeavor, so my real job must take precedence.  However, that doesn't mean that my brain hasn't been churning out article ideas. 

Unless you have been living under a rock, you know that there is a protest movement called Occupy Wall Street (OWS) which has taken over New York City.  The goal of the protest is somewhat nebulous.  The general concept is that they are protesting the fact that the greed of the 1% is screwing up the country for the rest of us.  While there seems to be many threads of protest running through this group, one of the recurring themes is that Wall Street greed caused the current economic downturn.  However, those that caused the problem were rewarded with millions in bailout money while the rest of us who tried to live by the rules ended up getting screwed.

You know what?  They are absolutely right.

Some on the right might be snickering at what they see as rabble rousers; however, they aren't far off from those darlings of the right known as the Tea Party Movement.  The Tea Party came about as a protest against... wait for it... the Government bailouts.  Sound familiar?  The difference, of course, is that the Tea Party's prescription for America is that Government was too big and had to be cut back significantly.  We ought to cut Government down to size.  No more tax increases.  No more out of control spending.  We need to cut everything:  education, health care, the arts, welfare.  Is this fair?  Not on your life!

The capitalist system is predicated on survival of the fittest.  Those who work the hardest, have the best ideas, make the best decisions, have the opportunity earn their fortunes.  On the flip side, those who fail go out of business.  The bailouts turned this on its head.  The Wall Street firms that screwed up ended up getting propped up at the taxpayers expense while those who did everything right didn't get a dime.

Whether or not you agree with the bailouts, they are over and done with.  That money has already been spent.  Unfortunately, we cannot go back in time and not spend that money.  The Tea Party proposes to pay back this spending through lower Government spending while not raising taxes on anybody.  That seems wrong to me.  Those who caused the problem should have to foot the bill, while those who paid for the bailouts (i.e. the rest of us) shouldn't be punished.  When Government spending is cut to the bone, who gets hurt the most?  The poor and middle class.  Does it seem fair to you that they should bear the brunt of the bill?  Not to me and not to OWS.

The fair thing is that those who made the bad business decisions should have to accept at least some of the bill.  That is capitalism.  You can't go all Ron Paul on us on the one hand when things are going well, meanwhile going all Fidel Castro on us when you screw up.  In a capitalist society, if you do well, you get the keep the rewards.  However, if you screw up, you have to pay the bill.  Not me.  You!  You have to accept higher taxes.  You have to accept more regulation to keep you from screwing up the economy again.

Maybe I should get the tent out of the closet and camp out, huh?

Monday, September 12, 2011

Financial Planning for a Special Needs Child

For most parents, financial planning consists of a few predictable but key items.  First, and most importantly, you draw up a will to make sure that you get to choose the people who are going to take care of your children and manage their affairs.  Next, you buy some form of life insurance to make sure that your family has the funds to get if something unthinkable happens to you.  Finally, you put aside some money each month in some sort of college savings plan to help your child pay for a higher education.  The playbook is pretty standard for most parents.  However, what do you do if you have a child with special needs.

You see, I have been thinking about this question because I have a daughter who is special needs.  She is autistic.  Autism (or more formally autism spectrum disorder) manifests itself differently in every child.  There is a quote I once heard which goes something like this, "If you've met one person with autism, you've met one person with autism."  In my daughter's case, she is non-verbal, does not respond to social cues, exhibits repetitive behavior, has both gross and fine motor delays, and has hyposensitivity to sensory stimuli.  However, she is a wonderful child with lots of spunk and personality, but in her own unique way.

One thing that I've been thinking about recently is what is going to happen to her once my wife and I are gone.  With most children, you only have to answer this question for the first 20 or so years of a child's life.  After that, you assume that your child will be able to take care of himself or herself.  However, in my daughter's case, there is a possibility that she will require care and supervision for the rest of her life.  That means that we will not only have to provide for her until she is 20, but until potentially until she is 80.  That requires a different type of financial planning than what you would do for a regular child.

To be honest, this is something that my wife and I really haven't started thinking about.  We've been so focused on getting her the services that she needs (physical therapy, occupational therapy, speech therapy, etc) that we haven't had time to think about the long term.  I am by no means an expert on the subject, but here is what I have gathered so far.

1. It is key to keep the assets in your child's name small.

If a special needs adult has more than a certain amount of assets in their name, they are disqualified from receiving certain government benefits such as Medicaid.  Therefore, it makes sense to think twice before making your special needs child the beneficiary of any life insurance policy or retirement plan.

2. Set up a special needs trust for your child.

Because you can't leave money directly to your special needs child doesn't mean you can't leave your child out in the cold.  Instead, you can set up a special needs trust, which is a financial account set up for your child's benefit, but which is not counted as part of your child's assets.  Instead of leaving an inheritance to your child directly, you leave it to the trust.  Then the person responsible for the trust (usually a trusted friend or family member) can use the money for the benefit of your child.  The other benefit is that your child may not have the mental capacity to manage this money properly, so it allows his or her financial affairs to be managed by a capable person.  There are some restrictions for what you can use the money, but generally it can be used for extras which are not provided by government services.  Obviously I am not an expert in this area, so you should consult one before you do anything.

3. Consider permanent life insurance.

Remember when I said that most people should consider only term life insurance.  This could be a situation where the other types of insurance are applicable.  In most cases, people require life insurance only during their earning years.  This is because once you hit retirement, you're retirement is paid for and your kids are out of the house, so if you meet an untimely death, your spouse and children won't need the coverage at that point.  Therefore, term insurance covers your needs nicely.

However, in the case of a special needs child, you might want to have life insurance coverage for your entire life, rather than just until you retire.  The premium of term insurance jumps significantly once the "level term" period expires.  For many people, that jump in premium puts the coverage out of reach.  One way around this problem is to buy whole life insurance.  Initially, the premium of whole life insurance is higher than term.  However, the premium you pay in year one is the same as the one you pay for the rest of your life.  Therefore, there are no unexpected premium resets.  Therefore, keeping the insurance in force for your entire life is much easier.

I have also read more "exotic" life insurance strategies, like buying universal life to maximize your insurance amount.  Another is to buy what is called joint life policies, which pay only after the death of both you and your spouse.  The advantage here is that the premiums are less than a traditional policy because you are covering two people instead of one.  Since your child might only need the money when both parents are deceased, this could make sense.

Of course, no matter which type you buy, you should think about leaving the money to a special needs trust instead of your child directly (see above).

There are many challenges to raising and caring for a special needs child.  Because you focus so much on the day-to-day stuff, sometimes you neglect the long term planning.  However, the long term is just as important, if not more so, because you won't be around to implement your plan.  Therefore, you need to be as prepared as you can so your child's needs will be met.  I am going to continue to explore this area of financial planning so that my daughter will be taken care of when my wife and I are gone.

Friday, September 9, 2011

Remembering 9/11: America's Decline Is Greatly Exaggerated

As the 10th anniversary of 9/11 approaches, many are in a reflective mood.  Many news outlets are running stories in remembrance of that fateful Tuesday morning.  Besides the usual "where were you" memories (at work in upstate New York) of that day, my strongest impression of that time was how, in the aftermath, we heard stories of greatness that rose above that tragedy.  We heard about the brave first responders who went into the building when most people's natural inclination would be to leave.  We heard about the search and rescue workers who spent hours upon hours combing through the wreckage, putting themselves at great personal risk.  We heard about the ordinary Americans aboard Flight 93 who averted a fourth attack on that day.  We heard about the millions upon millions of individuals all over the country who put aside their differences to contribute to the relief effort.  In the wake of the tragedy, the best of American came to the forefront and was put on display for all to see.

Ten years later, the mood is much more pessimistic.  We have seen our young men and women die on the battlefield half a world away.  We all felt the effects of an economic collapse the likes of which hasn't been felt in most of our lifetimes.  Jobs which were once done by Americans are done cheaper by people overseas.  Our leaders seem to be at each others' throats, putting politics ahead of the good of the nation.  Our creditworthiness as a nation has been called into question.  Our national debt continues to mount.  Our standing in the world as superpower is being challenged by a rising China.  All the news about American seems so dark that people are wondering aloud whether or not America has passed its prime and is in decline.

Those people are wrong.  In my mind, there are two things that make America great and will continue to keep America great:  opportunity and freedom.

America has always been a Land of Opportunity.  It is a place where hard work and smarts are generally rewarded.  There are stories like that of Andrew Carnegie, who came to this country at age 13, worked as a teenager in a textile factory, and through his hard work ended up as one of the richest men of his time.  However, the bigger story in my opinion is that, for every Carnegie, there are millions of people who came to this country and found a better life, a more comfortable life, for them and their families.  They came here because in their homes, they would have languished in poverty despite their hard work.  However, here in the U.S., our meritocracy allows people who work hard and work smart to get ahead.  Yes, they may not end up billionaires, but they are able to carve out a comfortable life consummate with their efforts.

American remains that land where you generally are rewarded based upon your skills, savvy, and sweat.  Yes there are exceptions as there always are.  Cynics will point to those exceptions and claim that they are the rule.  However, I can't think of many cases where people who are hard workers don't end up rewarded in some way, shape, or form.  Consider the immigrants from all over the world who still come to America to seek their fortune.  In my field (engineering), I work with a lot of people who chose to come to America.  If you ask them why, one huge reason is that America generally is a place where you have the opportunity to make a good living should you chose to take advantage of it.  It is a place where hard work truly is rewarded.  If America wasn't that place, then why do some want to build a fence to keep illegal immigrants out.  If America were that bad, we wouldn't be creating barriers to entry.

The second characteristic that makes America great is our freedom.  We generally have the ability to express our own opinions, worship our own gods, associated with whomever we want, without the Government trying to stop us.  That freedom of expression fosters a vibrant marketplace of ideas.  We are free to debate ideas vigorously without fear that the thought police will knock on our doors and steal us away in the middle of the night.  As such, all ideas are exposed to the light of day where the best can be adopted and the worst can be debunked under the scrutiny of the masses.  By allowing people to say and believe what they want, ideas are subjected to Darwinism, where the worst ideas are cast aside by vigorous debate and the best are adopted.  Obviously, there is still room to disagree, and that's okay, too.  We as a society accept that there will always be differences, but at least by talking about them, we can reach some understand, if not agreement.  Isn't a better to talk about your differences than go to war over them?  When you aren't allowed to express yourself freely, all of that disagreement boils over in civil unrest.  Because we can express ourselves freely, we can influence the course of our nation.  Every few years, we get an opportunity to revolt (peacefully of course) by voting out our old leaders and voting in new ones.  There are many countries where such dissent can only be expressed through a bombs or rifles.

Freedom and opportunity by themselves don't make a country great in a vacuum.  They are facilitators for what really makes a country great:  its people.  After all, a country is just a collection of people.  Freedom and opportunity do two things.  First, they help to attract the best people.  If you are looking for a place to live, wouldn't you want to move to the place where hard work is rewarded and where you can express yourself how you want?  Second, they reward those with the best ideas and the best work ethic, and that helps to elevate the entire nation.  Take the entrepreneur who builds a company from the ground up.  That company not only benefits its owner, but also those who work for the company, and by extension, the community where the company is located.  Consider Mr. Carnegie whom I mentioned earlier.  The foundation which he started over 100 years ago is still benefiting America through its philantropy.

I would ask everybody (including our politicians who seem to be stoking this feeling of gloom and doom) to stop dwelling on what is wrong about America, but what is right about America.  Of course, we aren't perfect; no country is.  However, with freedom and opportunity, at least we have the mechanisms to address our problems.  Because of that, America is not going to decline any time soon.

Monday, September 5, 2011

Going to the Extreme (Couponing, That Is)

You've probably heard about the newest rage to hit the grocery stores:  extreme couponing.  Popularized by the TLC television show of the same name, it is where people use various couponing and discounting strategies to purchase loads of groceries for pennies on the dollar.  After watching the show with my wife on a couple of occasions, I must say that I became quite intrigued with the concept.  I like saving money as much as the next person, but the people shown on the show make me look like a rank amateur.  Therefore, I set off to see if I could learn a thing or two from these pros.  Fortunately, there are a lot of websites out there dedicated to this new rage.  I am purposefully refraining from posting links to these sites for reasons that will become apparent later in this article.  However, a quick google search will reveal some of the more popular sites.

Extreme couponing is quite simple in concept.  For the most part, it consists of four key ingredients:

1. Clip lots of coupons:  This one is pretty obvious.  The best extreme couponers can find coupons from all over the place:  the local paper, Internet websites, home mailers, social networking sites, those little printers that print coupons right at checkout, attached to the products themselves, and so on.  What I've learned is that coupons are everywhere!  Not only that, extreme couponers will obtain multiple copies of the same coupon.  Sometimes that means buying six or more copies of the local newspaper, but they claim that it is worth it.

2. Use the coupons when items go on sale:  Most people use coupons as soon as possible.  However, extreme couponers save them for when the product is on sale at its rock bottom price.  Investors will note that this is the "buy low" rule applied to groceries.  Makes complete sense.

3. Take advantage of store policies:  Extreme couponers will take advantage of things like coupon doubling and stacking.  Coupon doubling is where a store will double the savings of a manufacturer's coupon, up to a certain limit.  Stacking is where you use a manufacturer's coupon and a store coupon on the same item at the same time.  In some cases, the value of the coupons might exceed the sale price of the product itself.  Some stores allow you to use this credit balance towards the rest of your purchase, which an extreme couponers dream come true.  Of course, every store has different policies regarding doubling, stacking, and credit balances.  Therefore, it pays to know what they are before you shop.

4. Stock up:  When events converge to offer an amazing deal, extreme couponers stock up.  They use as many coupons as possible to buy as many of the items as possible.  Then they store the extra items away for when they are needed.  Obviously, some items (think toilet paper) are easier to keep for long periods of time than others (think milk).  Therefore, you better be prepared to use the items.  Unless you are getting paid to buy the items, any deal where you can't use the item is not a deal at all.

Armed with all of this information, I set off to find my own extreme coupon deals!

The first one that I tried was a deal where you could get free single serving bottles of orange juice that was on sale for a dollar by using a dollar coupon available on the Internet.  I drink orange juice all the time.  Therefore, this deal seemed like a no-brainer to me.  Since this particular web site only allowed you to print two coupons from any computer, I ended up printing two copies from my computer, my wife's computer, and our netbook.  Armed with six dollar off coupons, I headed off to the store to claim my six bottles of free OJ.  Unfortunately, I wasn't the only one who knew about this deal.  When I got to the store, there was an empty shelf where (I assume) the bottles of orange juice had been.  As a consolation prize, I bought a gallon jug of OJ using my dollar off coupon, and at the register, the machine printed a $1.50 off OJ coupon for my next visit.  I guess it wasn't a total loss!

Lesson #1:  If a deal is posted on the Internet, it is likely that everybody knows about it.  By the time you find out, it is too late!  That is why I am refraining to reveal my sources on these deals.  (Note that this is similar to what I had said about picking stocks in a previous article).

The second deal that I tried was a buy-one-get-one-50%-off deal on vitamins combined with two $3 off coupons printed from the Internet.  Normally, a 50 count bottle costs $10.  With this deal, I could get 100 vitamins for $9 ($10 for the first bottle of 50 + $5 for the second bottle - $6 for the two coupons).  Armed with coupons in hand, I visited the store.  This time I was in luck because the store still had plenty of the vitamins on sale.  I swiped two just in case the old man behind me was looking to store the same deal, I ran up to the register.  I handed the two coupons to the cashier, and she gave me a look.  She said that since the second bottle was free, I could only use one coupon, not two.  The store didn't allow coupons on free items.  She was an older lady with an air of authority, so I figured that I had misread something and the vitamins were part of a BOGO deal (that's buy-one-get-one free in extreme coupon speak).  I took the coupon back and smiled inwardly at my good luck.  Now I was getting $20 worth of vitamins for $7!  Yippe!  Unfortunately, the authoritative cashier was mistaken.  After I got home and looked at the receipt, I saw that the second bottle was not free - it was 50% off just I had read.

The only consolation was that I got another $2 off coupon for vitamins at the register.  Yay...

Lesson #2:  Don't trust the cashier, regardless of how authoritative he or she might appear.  They don't know all of the sales as well as they think they do.

My conclusion is that extreme couponing is not as simple as it looks.  I'll keep trying to score more deals, but I realize that I still have a long way to go before you see me on TV.

Tuesday, August 30, 2011

4 Tips For Making Sure Your Insurance Is Up To Date

Here on the East Coast of the U.S., we recently were rocked by an earthquake and a hurricane within the span of less than a week.  Hopefully all of my intrepid readers out in cyberspace who live in the affected areas made it through without incident.  In the run up to the hurricane, there were a lot of articles with advice on how to prepare for an emergency.  However, making sure your insurance is updated is something that you have to do far in advance of an emergency.  Many insurance companies won't even issue new policies or updates if there is an impending event.  By the time something is impending, it is too late.  Therefore, it is better to make sure your insurance is up to date before you hear about the next disaster on CNN.  In other words, now is the time to do an insurance checkup.

1. If you are a renter, get renters' insurance

Many renters assume that if their apartment burns down that their landlord's insurance will reimburse them for their loss.  Not true.  Your landlord's insurance will reimburse your landlord for the loss of their property - not yours.  If you want to protect yourself against the loss of your personal belongings, you need to buy your own insurance.  Fortunately, renters' insurance is relatively cheap.  Your first stop should be to the same company through which you have your car insurance.  You might get a discount for having multiple policies.

2. If you are a homeowner, make sure your coverage amounts are up to date

Almost all homeowners have insurance to cover their property and belongings.  Primarily, this is because mortgages require it.  However, many people don't bother to keep it up to date.  The coverage amounts that you had when you bought your house may not be enough ten years later.  It may cost more to rebuild your house now than it did ten years ago.  You may have added an addition, upgraded your kitchen, remodeled your bathroom.   If your coverage amounts don't reflect this, you're going to be in trouble if you need to avail yourself of that coverage. 

Most insurance companies make it easy to update your coverage amounts.  Usually you give them the current characteristics of your house, and they will give you an estimate of how much it would cost to rebuild your house.  Some good insurance companies will even be proactive and ask you periodically if you need to update your coverage.

One thing to keep in mind, however, is that the appraised value of your house may not be the amount of coverage you should buy.  Your appraised value includes the value of your land as well as your dwelling.

3. Make sure you understand your policy's limits and exclusions, and buy extra coverage if necessary:

The biggest exclusion (and the one which affects those affected by the hurricane) is that your homeowners' policy does not cover flood damage.  Flood damage is covered by a separate policy aptly known as flood insurance.  The same insurer who sold your homeowners' policy probably can also sell you flood insurance.

Likewise, most insurance policies don't cover earthquakes either.  If you want earthquake insurance, you will have to buy an add-on to your policy.  Usually earthquake insurance policies have high deductibles, so they will pay in the event of a total loss but not if you just have incidental damage.

Insurance policies also have other limits and exclusions.  Some of the more common ones are limits on claims related to loss of jewelry, computers, collectibles, and other higher value items.  For instance, my policy limits what they will reimburse for jewelry is $10,000.  Therefore, if you have any items which exceed any of these limits, you should consider buying a separate policy to cover the additional value.

4. If you are considering changing or adding to your policy, do it when the sun is shining:

Many insurance companies have waiting periods from the time you buy the insurance to the time it goes into effect.  The most common one is the 30 day waiting period for flood insurance.  That means that you shouldn't expect to rush out and buy insurance just before a disaster the same way you can buy bottled water or D-cell batteries.  You need to buy the insurance that you need when the sun is still shining.

The old adage "be prepared" applies not just to making sure your pantry is stocked, but also to your insurance is up to date.  The time to prepare is now!

Saturday, August 20, 2011

In Defense of Elite Private Colleges

I've posted several times about the value of attending college.  I've even written some advice on choosing a college.  At the risk of beating this topic into the ground, I am compelled to respond to what I consider to be an ill-conceived article about why elite private colleges are not worth the money.  The article starts with the following premise:

"If you’re the parent of a high-achieving high school student prepared to spend whatever it takes to send your kid to an Ivy League college, authors Claudia Dreifus and Andrew Hacker have some unlikely advice: Don’t do it."

The main issue that I have with the article is that it perpetuates the dual myths that elite private colleges are more expensive than their public brethren and the education you get at an elite private school is no better.  I am here to inject some logic into this debate.

First of all, many elite private schools don't cost more.  Of course, if you compare what I call the sticker prices, Princeton's total cost($52,670) is higher than Rutgers' ($24,017 for NJ residents).  Therefore, I could see why, on the surface, one might conclude that Princeton costs more than Rutgers.  It doesn't take an Ivy League graduate to know that $52,670 is greater than $24,017.  However, the operative word in this discussion is sticker price.  Just as with car buying, most students don't pay the sticker price at Rutgers.

Princeton has an aid estimator which allows you to put in your financials and get an estimate of how much you will be expected to pay.  I entered information for a hypothetical family of four where the parents make $150,000 combined and $50,000 in non-retirement savings.  According to the aid estimator, such a family would be expected to contribute $28,300 towards college.  The rest would be covered by grants provided by Princeton (no loans, no work-study).  That is a mere $4,000 more than what they would shell out for Rutgers!  My example family isn't what you would call destitute either.  They are probably in the the upper middle class by most peoples' standards.  However, they would end up paying slightly more for a Princeton education than they would for a Rutgers education.  Families earning less obviously would end up paying less.

Princeton isn't alone in offering such lucrative aid packages.  Other Ivies have similar aid structures.  Consider the myth that a elite private college education is more expensive than a public education busted!

As far as the quality of education not being worth the money, the rest of the article gives reasons why the elite schools will not give you a good education.  Most of these reasons are sheer nonsense.  I'll address some of them:

Research universities are no place for undergraduates.  I do agree with this to a certain extent.  Most universities offer tenure based not upon teaching prowess but on the amount of research dollars brought into the school's coffers.  However, this problem is not limited to private elite colleges.  Most large public universities are also slaves to the old publish or perish mentality.  According to the Chronicle of Higher Education, three of the top five universities receiving the most research money are public universities.  Interestingly, there is not a single Ivy League school in the top five.

Colleges are overrun by administrators.  Again, this is not something that is exclusive to private elite schools.  I am not sure how this figures into the discussion at all.

The star professors touted in college brochures probably won’t be teaching your kid.  I don't have any statistics to prove or disprove this specific statement, although I would imagine that a star professor at any school, public or private, probably has a lighter teaching load. 

Your tuition may be subsidizing a college president’s $1 million-plus salary.  Ohio State's president made $1.6 million in 2009.  Harvard's president only made $775K.  Again, this is not exclusive to private schools.

High-powered athletic programs drain money from academics.  This seems like an argument against large public institutions.  How many large public universities have huge athletic departments?  Heck, the University of Texas (a public institution the last time I checked) is in the process of launching its own sports television network.  I don't even know if M.I.T. even has a football team (editor's note:  a quick google search shows that they apparently do).

As far as the overall quality of education goes, there are many good public universities, so it is hard to generalize about the quality.  However, one thing to consider is that public universities are subsidized by the taxpayers of that state.  The news regarding the financial situation of many states is grim.  With public pressure to cut budgets while simultaneous keeping tuitions affordable, something has to give.  That could mean cutting programs, increasing class sizes, and generally trying to do more with less.  I would imagine that the gap between the elite private schools and public universities is going to grow.  I know that if I could pay the same amount to attend Rutgers or Princeton, I would choose Princeton, no doubt about it!

Sunday, August 14, 2011

Annuities: Insurance For Living Too Long

Given the choice, most people would rather live to be 100 than 70.  By living to 100, you get 30 extra years to spend with your grandchildren (and maybe even great-grandchildren), to travel, to play golf, and generally enjoy life.  However, there is a definite risk to living too long:  the risk that you run out of money before you die.

It used to be that most people relied upon Social Security and pensions to get them through retirement.  Both guaranteed you a certain level of income each month for as long as you live.  Social Security even increases its payments every year to account for the rising cost of living.  No matter if you lived to be 80, 90, or even 100, you were content in the knowledge that you got a check each month upon which you could rely.

However, we have entered a world where people can't rely upon pensions and Social Security.  In the private sector pensions have gone the way of the dodo.  Pensions are still available to those who work in education or government, but even these are chronically underfunded.  Meanwhile, Social Security is under the microscope as the country's debt continues to rise.  What we have now is a situation where most people are reliant upon defined contribution plans (i.e. 401(k)'s, IRA's).  These plans do not guarantee any sort of monthly check.  You are free to spend as much or as little as you want each month.  However, once the money is gone, it's gone!

Most calculators estimate how much money you'll need to accumulate by the time you retire assume that you will live to a particular age (usually 90 or 95).  However, what happens if you are "lucky" enough to outlive this assumption.  If that happens, you'll be in a situation where you will run out of money before you run out of life.  Fortunately, there is a way to "roll your own" monthly pension.  You buy an annuity.

An annuity is an insurance product, similar to life insurance.  However, whereas life insurance protects your family financially if you die prematurely, an annuity protects you if you live too long.  In a typical annuity transaction, you give the insurance company some amount of money.  In return, the insurance company promises to pay you X dollars each month as long as you are alive.  If you live to be 150, you will be getting a check from your insurance company every month like clockwork.  On the flipside, however, if you drop dead the next day, the insurance company keeps your money (some annuities have a minimum payout so that your heirs might get some of the money back).

Just like life insurance, you don't buy an annuity to make money.  You buy it to protect yourself against outliving your money.  In other words, don't think of an annuity as an investment

There are many different types of annuities.  The simplest is an immediate annuity.  This is where you trade some lump sum of cash for a monthly check which starts immediately (hence the name immediate annuity).  In its purest form, you stop getting checks immediately when you die.  However, this situation is unpalatable for many people.  It opens up the possibility that you hand over $1 million on Monday and you die on Tuesday.  If that happens, you've just lost $1 million for your heirs.  In order to mitigate this risk, many annuities come with a feature which guarantees a certain number of payments regardless of how short you live.  You might not get back your entire $1 million, but at least you don't lose everything.  Of course, this option reduces your monthly payments because now the insurance company cover the cost of providing this option.

Another option is a cost of living adjustment.  This option provides for a increase in the amount of your monthly annuity check each year.  This can be based upon the rate of inflation or upon some fixed rate of interest.  Again, this option might reduce your monthly payments at the outset of the annuity since the insurance company has to cover the cost of providing this option.

Another form of annuity is longevity insurance.  In this form of annuity, you hand over your money to the insurance company, and they start paying you a monthly check when you reach a certain age (usually age 85).  If you die before that age, you get nothing.  Because of this waiting period, the amount that you would receive every month if you reach your target age is higher.  However, the probability that you get nothing is higher than it would be with an immediate annuity.

A third form of annuity is called a deferred annuity.  This adds a savings plan to the typical immediate annuity.  During your working years, you deposit money into an account that is held by the insurance company.  The money that you deposit accumulates tax-deferred in the account until you retire.  Once you retire, the money that has accumulated is returned to you in the form of an immediate annuity.

During the accumulation phase of the annuity, the money grows tax-deferred, meaning that you don't pay taxes on any interest that you earn on this money.  How much interest accumulates depends on the type of deferred annuity you own.  Some deferred annuities pay a guaranteed minimum rate of interest.  Others allow you to decide how to invest the money.  These annuities (often called variable annuities) allow you to allocate your money into various investments (stocks, bonds, etc), and the interest you earn is based upon how well your investments do.  However, many still offer some sort of minimum guaranteed rate of interest.  However, these often come with additional fees to pay for this option.

Generally speaking, you should be careful when you buy a deferred annuity.  There are a lot of different moving parts to them which make them hard to compare:  surrender fees, guaranteed interest rates, commissions, investment options, etc.  If you are considering an annuity, it may be simpler to allow your money to accumulate in a 401(k) or IRA and then buy a immediate annuity when the time comes.  The only time you might want to consider a deferred annuity is if you have already maxed out your other tax-deferred investment options.

Friday, August 12, 2011

Lower Credit Rating = Lower Borrowing Rate?

After S&P lowered the credit rating of the United States from AAA to AA+, I posted that I agreed with the counter intuitive theory that the US Government bond rate would drop, rather than rise.  This is counter intuitive because individuals, business, and governments with a lower credit rating generally have to borrow at higher rates because lenders see them as a higher credit risk.  Consider your own life:  if you have a high credit score, you usually have access to lenders' best rates.  On the other hand, if your credit score is "less than perfect", you usually must pay a higher rate of interest when you take out a loan.

However, if you are the United States, you live in a bizzaro world where you can borrow at a lower rate of interest when your credit score drops.  According to this, the 10 year Treasury rate (i.e. the rate of interest the US gets when taking out a ten year loan) started off the week at 2.5%.  However, on Friday, the 10 year rate had dropped to around 2.2%.  Why did this happen?  The most likely theory is that most people took this as a sign of uncertainty.  Therefore, they decided to move their money to the safest investment that they could think of:  US Treasury Bonds.  Meanwhile, although the stock market generally ended the week where it started, the week was filled with enough ups and downs to satisfy any roller coaster enthusiast.

This behavior is typical.  Uncertainty causes people to sell stocks (generally viewed as risky) and buy bonds (generally viewed as less safer).  However, in the context of the lower credit rating for Government Bonds, it does seem incongruous.

Sunday, August 7, 2011

S&P Lowers US Credit Rating: What Does It Mean For You?

On Friday August 5, 2011, Standards and Poor's lowered the credit rating of United States Bonds from 'AAA' to 'AA+'.  To some, this was viewed as a major blow to the U.S.  To others, it was viewed as a non-event.  However, there are some whose reaction was "what's does this mean, and what does it mean to me?" 

S&P, along with several others, are what people in the financial industry call rating agencies.  They "rate" the ability of bond issuers to be able to pay their creditors.  Remember that a bond is just a loan.  Just as a bank might look at your credit score to determine whether or not to loan you money, a bank might look at a companys' or countrys' credit rating in order to determine whether or not to buy its bonds.  Each rating agency has its own scoring methodology, but generally they look at a variety of factors to determine how likely it is that an issuer of bonds is going to not meet its obligations.

S&P gives each borrower a letter grade to indicate their credit-worthiness.  S&P's top rating is AAA.  A AAA rating means that the borrow has an "extremely strong capacity to meet financial commitments."  By downgrading the U.S. to AA+, S&P now thinks that the U.S Government only has a "very strong capacity to meet financial commitments."  They added a plus to indicate that the U.S. has a higher standing relative to other organizations in the AA category.  In other words, a AA+ rating doesn't mean that the U.S. is going to default on its loans anytime soon.  The rating is still quite good, although not as good as it could be.  Also note that both Moody's and Fitch are maintaining their AAA rating of the United States, so S&P's opinion still is in the minority.

So what does all this financial gooblety-gook mean to you.

If an individual were to take out a loan, their credit score helps to determine whether or not they get the "best" loan interest rate.  If you have a sterling credit score, you are likely to get a lender's best rates because odds are that you will be able to repay your loans.  If your score is less than perfect, you might be given a higher rate because there is a higher probability that you won't make good on repaying your loan.  This higher rate is to compensate the lender for the additional risk of lending to you.

In theory, the S&P credit rating could act in the same manner.  There may be some borrows who will demand that the U.S. Government pay a higher rate of interest on their bonds because there is a higher chance (in the opinion of S&P) that the United States will not make good on their obligations.  If this were to happen, that would mean that the United States would have to pay more interest in order to borrow.  Therefore, either they would have to spend less or take in more revenue through higher taxes in order to cover this higher interest expense (or they could just borrow more, but of course this money has to be paid back at some point).  That, of course, affects you right in your wallet or pocketbook. 

In addition, many loan rates are tied to the U.S. bond interest rate.  If bond rates go up due to a lower credit rating, that could cause mortgage rates, auto loan rates, etc to go up as well.  That, of course, also affects you right in your wallet or pocketbook.

A second possibility is that this rating downgrade affects nothing.  Bond investors might say "so what".  They might figure that even with this downgrade, U.S. Treasuries are still one of the safest investments around.  They certainly are safer than the bonds of many other Western countries.  In fact, there is a case to be made that the downgrade might actually cause interest rates to fall, which would be counter-intuitive.  The case goes something like this:

1. S&P downgrades U.S. bonds because they feel like the Government does not have a long term plan to control the size of the national debt.

2. Investors perceive this as a sign that the economy is on the ropes, so the stock market starts to drop on fears of another recession.

3. Investors start to move globs of money from the risky stock market for the relatively less risky U.S. Treasuries.

4. Because the demand of Treasuries spikes upward, the Government can borrow at even lower interest rates than before.

It seems crazy that this should take place, but I feel like this scenario is likely.  Despite the rating downgrade, most people will continue to view bonds as a safe haven for their money when the stock market is going down.  That perception is not likely to change anytime soon.

I do feel, however, that even though the rating downgrade might not have an effect on your money directly, it is a message that people are watching the actions of our politicians very closely to see how they are going to handle our mounting debt.  Hopefully, it will be a (relatively painless) wake-up call that some structural changes need to be made in order to stem the flow of red ink on our national balance sheet.

Thursday, August 4, 2011

Use the Right Benchmark

One of my first posts was about the relationship between risk and reward.  The premise was that if you are going to entice somebody to take a risk, you are going to have to offer them the possibility of a greater reward.  This holds true in all forms of investing.  If you are going to invest in something with risk (like stocks), you are going to demand that you will get a higher return over the long run than if you invested in something risk-free (like a Certificate of Deposit).  This is to compensate you for the additional risk over the short term.  Stated another way, if you earned the same rate of return from a risk-free CD as you would from a risky stock, you would pass on the stock and invest in the CD.  That is common sense.

However, common sense sometimes is uncommon when it comes to determining if your investments are doing "well".  Consider the following statement:

"Last year, the S&P 500 went up by 10%.  However my financial advisor only earned me 8%.  Therefore my financial advisor must be stupid/ignorant/the-second-coming-of-Madoff/etc." 

Is the financial advisor really ripping off our speaker?  After all, he could have earned more by buying an S&P 500 index mutual fund and saved on his adviser's fees, right?

Wrong.  This is an unfair comparison.

The S&P 500 is an index which tracks the stock values of the 500 largest U.S. public corporations.  It is 100% invested in large company stocks (large cap stocks in the investing vernacular).  Therefore, is it fair to compare your investment performance against this benchmark?  It is only fair if your own investment portfolio consists of only stocks from large U.S. corporations. 

Your financial advisor knows, based upon his conversations with you, that your goal is to retire in 10 years.  Since you will be needing to live off of your portfolio within the near future, he probably allocated only 60% of your portfolio to stocks.  The other 40% is invested in less volatile investments (bonds, money market funds, CD's).  Because this 40% is less risky, they returned less than the aforementioned S&P 500.  However, these investments have less risk of losing value, which is an important fact considering that you will need the money in 10 years.  Therefore, it is expected that you would earn less than the S&P 500 in some years.  In other years, the stock market might tank, but your investments won't go down as much because you have that 40% in safer investments.  In other words, you are trading potential upside in some years for less of a downside in others.  Less risk = less return over the long run.

A better comparison would be to compare the large U.S. stock portion of your portfolio with the S&P 500.  Perhaps out of the 60% stock portion of your portfolio, you might have half of that in large U.S. corporate stocks (the rest being in small company stocks, international stocks, etc).  Perhaps that large U.S. stock portion of your portfolio earned 10% this year because your financial advisor was wise enough to invest that part of your portfolio in an S&P 500 index fund.  Smart guy, that advisor of yours!

The lesson here is that you should choose the right benchmark to judge an adviser's performance before you call the S.E.C.

Friday, July 29, 2011

Raising the (Debt) Roof

Unless you are living in a cave, you've probably heard something about this debt ceiling, how it needs to be raised before August 2nd, and how it is causing much angst among politicians.  I've been refraining from posting about the debt ceiling - mainly because I've beaten the whole National Debt horse pretty much to the point where the ASPCA is knocking on my door.  However, the whole situation has reached a whole new low that I feel compelled to speak my mind on this.

For those who are living under a rock, the debt ceiling is sort of like the credit limit for the Federal Government.  It is the total amount of debt which the U.S. Treasury is allowed to borrow.  Currently the debt ceiling is $14.3 trillion.  For those who are numerically challenged, a trillion is one million million.  In other words, it is a lot of money!  However, it isn't enough for our government because it is projected that on August 2nd, they will max out this credit limit.  When that happens, they will no longer be able to borrow money to pay their bills.  They won't be able to pay the salaries of government employees (including our troops).  They won't be able to pay our seniors their Social Security.  They won't be able to pay interest on the money they have already borrowed.  In other words, we'll be a deadbeat country. 

Some people argue that not paying our bills won't be that bad.  However, think about how you would react if somebody who owed you money didn't pay you back.  You probably wouldn't loan that person money again, or at the very least, you'd demand a higher rate of interest.  This is the fate that faces our country.  Imagine if our creditors demanded that the Government pay a higher rate of interest on its bonds.  That's more money out of your pocket and mine.  In other words, the debt ceiling isn't something to mess around with.

Now the problem I have with our politicians holding the debt ceiling hostage is that the whole concept of the debt ceiling is flawed.  Our politicians, including some of the same ones who refuse to raise the debt ceiling, voted for the various Federal Budgets over the years.  They okayed the spending, the entitlements, and the tax cuts which caused us to rack up all of this debt.  If you are going to vote in favor of lower taxes and higher spending and you don't raise the debt ceiling, you are talking out of both sides of your mouth.  In my opinion, if you are going to pass a budget where you are spending more than you making, then you are implicitly approving of borrowing the money.  To come back at a later date and say that you can't borrow the money after you approved of the spending is irresponsible.

Consider this analogy:

You decide that you are going to remodel your kitchen.  You go out and buy the flooring, the cabinets, the flooring, the appliances, and you hire somebody to install it all.  Since you are short on cash, you decide to put it all on your credit card.  A month later, the credit card bill comes, you open it up, and you see that you spent too much.  At this point, the kitchen is done.  The cabinets are installed, the appliances are hooked up, the tile is grouted.  You can't now decide that you shouldn't have bought those oak cabinets and those stainless steel appliances.  That ship has sailed.  The only thing you can do is pay the bill and maybe in the future when you are remodeling your bathroom, you'll pay more attention to the bottom line.

The same thing holds with the debt ceiling.  Our politicians have already voted to spend the money.  Those promises have been made already.  The right thing to do is to pay our debts for our past budget mistakes and consider spending more wisely in the future.  Some politicians feel that maybe they don't have to live up to the promises that we made in our past budgets.  That is wrong.  Yes, our spending is out of control.  Yes, we've cut taxes to the point where our revenue is suffering.  However, that is a problem we need to solve for the future.  What is done is done.  We've already spend the money so now we have to make good on our debts.

Many politicians say that the Government needs to balance its books like any business or any family.  Part of that is making good on your debts just like any business or any family needs to do.

Okay, so we've established that we, as a country, need to pay our bills for our past budget transgressions.  The next step of that is to fix things so that in the future we can keep our debt under control.  If you pay attention to the debt ceiling, you would think that we have $14.3 trillion of debt (and growing).  However, if we were really doing the accounting like a business, our debt would be much, much higher.

The $14.3 trillion number reflects only the amounts that the Government had to borrow in the form of issuing various bonds.  However, the Government also has a debt in the form of other promises that we've made which aren't captured in the form of debt.  Consider the promise of Social Security.  Under the current law, future retirees are promised a certain amount of money a month for the rest of their lives.  We aren't actually paying these future retirees yet, but the law says that we will have to pay these people.  The amount that we have to pay these people is a promise that we owe.  The same thing goes for Medicare heath insurance for future seniors.  The law says that future seniors are entitled to health insurance through the Medicare program which will costs us money.  We aren't paying the money yet, but it is a promise that we owe.

Business accountants use the concept of liabilities to account for future debts like this.  This allows the company to account for the fact that this is money that they probably will have to pay out in the future.  An example of this might be money that will be owed to future retirees for their pension.  If the value of the future pension payments is $1 billion, this gets included on the company's balance sheet as a liability for all to see.  Another example might be money which is expected to be paid out as part of a lawsuit.  When BP spilled oil into the Gulf, they set up a $20 billion fund to cover expected claims against them.  They didn't pay out the $20 billion right away; it stayed in their bank account.  However, they had to account for the fact that they would pay out that money in the future.

Unfortunately, the Government does not have include its future promises on their balance sheet as a liability.  Social Security alone has a liability of $7.7 trillion.  This is the value of future Social Security payments that won't be covered by the Social Security payroll deduction.  This isn't included in the national debt anywhere, but it is money that will be owed by law to future retirees.  The bottom line is that the debt problem goes way beyond the $14.3 trillion that we owe to bondholders.  We've got a spending problem that we have to address for the future.  The debt ceiling is the past; we have to make good on our past promises.  It is the future that we have to be concerned with.

Saturday, July 23, 2011

Paying For Quality

Recently, I got an email in my inbox from a eye doctor offering Lasik vision correction "starting as low as $299 per eye."  While I have no interest in getting Lasik surgery at any price, this email got me wondering about what the price says about the doctor.  I know people who have paid several thousand dollars per eye, so a price as ridiculously low made me think of two possible scenarios:

Scenario One:

I walk into some back alley on the wrong side of town and enter a dark, dingy office (possibly a flourescent light buzzing and strobing).  The doctor walks in wearing a tattered lab coat and a demonic smile.  As he is about to perform the procedure, his hand starts to shake.  I ask him if he's okay.  He pulls out a flask from his coat pocket, unscrews the top, takes a swig, and says that he just needed a little nip to calm his nerves.

Scenario Two:

I sit down with the "sales consultant" and ask about the $299 special.  The sales consultant looks at me and says that, yes, they offer that deal.  That is their bronze package.  However, if I want, I can get the silver package which includes anethesia for "only" $999.  On the other hand, if I want a pre-op examination, post-op followups, eye drops for the inevitable redness and soreness, and a two-year waranty which covers subsequent procedures if they are necessary, I can either pay for those a la carte, or I can order their gold package for only $2999.

Now it could be that this doctor could be the greatest thing since sliced bread.  However, by advertising a cut rate price so prominently, I am left with the impression that he is either low-quality or there is a serious catch.  Neither impression is very good for business.

Economics 101 teaches the demand for a product increases as the price decreases.  This makes perfect sense.  A rational person is always going to want to pay as little as possible for a particular item.  When somebody offers the same product for less than the next guy, that person is going to generate more sales.  However, as my experience with the $299 Lasik offer shows, the real world isn't so simple as it is in a textbook.  A ridiculously low price can be just as detrimental to sales as a ridiculously high price.

How can that be?  Wouldn't you want to pay less?  After all, we all like to get a good deal, right?  Maybe not.  Many people associate price with quality.  We assume that a $100 shirt is more expensive than a seemingly identical $10 shirt because the $100 is a better quality product.  Thus, we might justify the extra expense because we believe that the $100 shirt is going to fit better, not shrink, last longer, etc.

In a large number of cases, this is a facade.  There are some products which cost more but may be just as good as the cheaper item.  However, it is hard to determine which are actually better quality, and which aren't.  Therefore, in some cases, we just assume that the higher price means higher quality.

This $299 Lasik procedure may be just as good as the $2999 procedure from another doctor.  However, who is going to risk their vision to find out.  In the case of the shirt example, I might try the $10 shirt to see if it is really as good as the $100 one.  If it is, then great.  I've found a new deal.  If it isn't, I toss the shirt out.  No harm no foul.

In the case of the Lasik, I doubt that a lot of people are going to take the risk.  I think more people value their vision enough that they probably would feel more comfortable with the $2999 procedure.  Yes, it is more expensive, but the perception that you are going to get a quality surgery for that price is probably going to sway a lot of people to spend the money. 

My advice to the Lasik doctor advertising the $299 surgery is this:  raise your price.  You'll probably get more business.

Wednesday, July 20, 2011

Insurance Is... Insurance!

When I did my series of articles on life insurance, the piece of advice that I stressed was that most people should consider term insurance over all of the other varieties.  The main reasons were that term insurance was the simplest to understand, and it fits the needs of most people.  Many people counter this advice with an argument that goes along the following lines:

If you buy term life insurance and you end up not needing it, you end up with nothing.  On the other hand, if you buy whole life/universal life/variable universal life and you don't need it, you still end up with some cash value.  Therefore, your premiums aren't totally wasted.

To those people I respond with the following:  repeat after me.... 

Insurance is...

(wait for it)


That may seem self-evident, but some people don't seem to get it.  You don't buy insurance as an investment.  You buy it in order to protect yourself financially from some unlikely but catastrophic event.  In the case of life insurance, that catastrophic event is your premature death.  If you die early, you want to leave your beneficiaries the means to carry on without out.  You want to make sure that your spouse is able to pay the mortgage or your kids are able to go to college if you leave this Earth before your time.  The premium that you are paying isn't supposed to accumulate wealth for your retirement; it is supposed to give you the peace of mind that your family will be provided for when you are gone.

The other fact that many neglect to mention is that you are paying extra for the cash value accumulation that occurs when you buy whole life.  Part of the premium goes towards paying for the insurance and part goes into your cash value fund.  If you pay a premium of $100, $20 might go towards insurance and only $80 of the $100 might go towards cash value (these numbers will vary by policy but you get the idea).  In essence, you are buying insurance AND an investment at the same time. 

You can accomplish the same thing by taking $100, using $20 for term insurance on your own and then investing the leftover $80 on your own.  In fact, you might come out ahead since you might be able to invest in a lower cost fund than what the insurance company would charge you.

If you still aren't convinced, think about car insurance.  Why do you buy car insurance?  You don't buy it as an investment.  You buy it because you probably couldn't afford to pay tens of thousands of dollars to settle a claim for an accident that you caused.  You pay a little bit each month to the insurance company (which you can afford) to protect yourself from the catastrophic event (which you cannot afford).  If you don't get into any accidents, then you don't get anything back.  However, who can guarantee that they won't get into any accidents?

The bottom line is that you don't purchase insurance to make money.  You buy it to protect yourself from losing money if some terrible, rare event happens.  Whole life insurance is a anomaly because it isn't really insurance.  It is insurance plus investment.  That's the only reason why you end up with money if you don't need it.

Sunday, July 10, 2011

Sales: It's a Numbers Game

I was talking with a bunch of co-workers about jobs that we had when we were in school.  One of them mentioned that he worked as a telemarketer for a major metropolitan newspaper.  His job was to call up people and convince them to subscribe to the paper (obviously this was awhile ago when a) there was not a do-not-call list, and b) people actually bought newspapers).  Thinking about my own experiences with telemarketers, I commented that this must have been tough to be hung up on by random strangers.  He said that, on the contrary, he actually appreciated it when people hung up on him.  I gave him a strange look and asked him why he would say that.  He started off his explanation by saying the following:

You have to understand that sales is a numbers game

He continued by saying that when you call up random people to try and sell them something (cold calling in the telemarketing vernacular), something like 98% of the people will be totally disinterested.  No matter what you say to them, they are not going to buy a thing.  If you are tele-sales, ideally, you would want to spend as little time as possible with that 98%.  You want to move as quickly as possible to the 2% of the people who are going to give you your commission.  He said that all those people who hung up on him did him a favor.  He probably wasn't going to sell them anything anyway, so those hang ups allowed him to keep going.

He recalled that most of his telemarketing co-workers would get angry at all those hang ups.  They would do anything to keep the call going in the hope that somehow they will find that magical sales pitch that will lead to a sale.  My co-worker, however, would pick up on the fact that the person at the other end wasn't interested and would seek to end those calls as quickly as possible.  To him, a hang up meant that he didn't have to figure out a way to end the call (note that the rules of his employer did not allow him to hang up - only the customer could do that). 

He said that he churned through about twice as many numbers as many of his fellow workers.  If the average person called 50 people an hour, he would call 100.  However, he was rewarded by twice as many sales.  With a 2% "hit rate", he would make two sales an hour, where the average person would only get one.  Nevertheless, many of his co-workers never picked up on this trick.  They continued with the hard sell even when the person on the other end had little chance of saying yes.  He said that human nature is to keep trying in order to avoid the embarrassment of rejection and failure.  However, in sales where failure is common, the best salespeople have to embrace failure as an opportunity to move on to the next prospect.

I tried to impart this lesson to a intrepid door-to-door salesperson this past weekend.  With the advent of the aforementioned do-not-call registry, our local cable company has taken to sending its salespeople door-to-door in order to sell their wares.  At least once a month, we are visited with promises of great deals if we only switch.  Unfortunately, we have a bundled package from our phone company (Verizon) which includes phone service, Internet service, and DirecTV television service.  I am quite happy with the price I am paying and the service that I am getting, so I have no intentions of switching.

Previously, when I was visited by the local cable company representative, I politely tried to decline their offer.  Nevertheless, they kept going on and on about what a great deal they were offering, how it was only available through the salesperson, what great service they have, etc.  Normally, after about 15 minutes, I would make up an excuse to end the conversation, the salesperson would give me his card, and that was that.  However, on this occasion, I really did not have the patience to sit through 15 minutes of reasons why I need to switch.  It was a beautiful Saturday morning, and I was anxious to continue with my day.  When I opened the door and saw that it was my local cable company calling on me again, I immediately cut him off and said:

Look, I know that you are going to try to sell me on your cable service.  I am a happy subscriber to another service, so I have no intention of switching.  You could stand here for 15 minutes and try and convince me but it isn't going to work.  You would just be wasting your time, and I don't want you to do that.  You are better off just giving me your card, saying goodbye, and going on your way to the next house.  That way, you can make more effective use of your time.

This person obviously wasn't an experienced salesperson because, unlike my co-worker, he did not accept failure so easily.  He responding by saying that if I was done talking, he wanted to say something.  I said, "Sure.  Go for it."  He said that the last thing he wants to do is waste my time and especially not his, but his company had some great deals that he wanted to share with me. 


Obviously, he wasn't going to last in sales very long.  I replied:

Look, in a minute I am going to close the door.  I am not going to do it to be rude.  I am trying to do you a favor.  I could let you stand here for 15 minutes and talk to me about your great service, but it isn't going to do any good because I am not buying.  I would just be wasting your time - time that you could spend finding somebody who might be interested.  Instead, I am going to end the conversation.  That way, you don't waste your time on a prospect who isn't going to buy.

He gave me a look as if I had somehow violated some social contract by being brutally honest.  He said, well I am sorry you feel that way but if you would just listen...

At that point, I told him that I wished him luck, and that I hoped he had a nice day.  I closed the door.  As the door was closing, I heard him say "Fine, sir" as he walked away in a huff.  He isn't going to last long in this business.

If you are in sales and you want to be a success, there are two things to remember:

1. Sales is a numbers game:   If you want to make a lot of sales, you need to talk to a lot of prospects.  It's that simple.

2.  Accept failure gracefully:  It goes against human nature to accept failure.  However, in sales where only a small percentage of prospects will become buyers, you need to accept failure so you can move on to the next person (see rule #1).  If you try to hold out against hope that you will turn a no into a yes, you'll only slow yourself down in your goal of talking to as many people as possible.  In addition, you will only prolong the agony for both you and your prospect.  Better to just smile, say thank you for your time, and move on to the next person.

If you follow these two simple rules, you will be well on your way to sales success!

Monday, June 27, 2011

Is College Worth the Money, Redux

I've already discussed at length my thoughts on whether or not college is worth the money.  I've even given some tips for choosing a college without going deeply into debt.  Today on Yahoo! Finance, there were a couple of articles on this subject with opposite views.  The first was this one containing the testimonies of four people who say that college was not worth the debt.  Four people describe, in their own words, why they feel that college was not worth the price.  Their stories are quite instructive, to say the least.

One of the testimonials stood out for me because the person obtained a degree in engineering.  We have all heard stories of people who accumulated massive amounts of college debt only to end up in minimum wage jobs.  However, a degree in engineering generally is viewed to be one of the bright spots when it comes to job prospects.  The demand for quality engineers is always high, and it is a career which not everybody can aspire due to the rigorous course of study.  However, the individual in the story ended up with $185,000 in debt after earning an engineer degree and, as he says, he is earning $15,000 less than he expected.  He hoped that he would be earning $70,000 - $80,000, so I assume that he is earning only $55,000 a year.  Of course, if he had done some research, he would have known that the average starting salary for an industrial engineer is around $58,000.  That means that is salary is right around the average.  Also, if he would have followed my formula for determining how much college debt you can afford, he would have known that he probably could have only afforded to take out a loan of around $25,000.  It goes to show that even if you are doing the right thing and obtaining a degree in a lucrative field such as engineering, you still need to do it in a financially prudent way.

The second article on Yahoo! Finance, which was a good counterpoint to the testimonials, was this one about how investing in a college degree, generally speaking, has a better return on investment than most other traditional investments.  The article cites well known research which shows that college graduates generally make more than those without a degree, and they are less likely to be unemployed.  On first blush, it seems like these two articles are at odds.  How can you say that, on the one hand, college is worth the investment, but on the other hand, hear stories about how people's lives were ruined by college debt?

Of course, neither article is wrong.  On aggregate, a college degree is a good investment.  However, as with all investments, many people still find a way to screw it up.  Think about stock investing.  Generally speaking, if you invest in stocks, you are going to make a return that exceeds inflation.  That doesn't mean, though, that these returns are automatic.  People routinely lose all of their money even in the most bullish of bull markets.  They put all of their money in loser stocks because they heard some talking head pump it up on TV.  They panic sell when the market hits bottom and re-buy only when the market has reached its high.  The same thing with college "investing".  People take on more debt than they can afford relative to their future career.  People make poor choices about what they study.  People think they need a degree when their future career doesn't require one.  In short, just because it is a good deal in aggregate doesn't mean that getting a degree is an automatic meal ticket.  You still need to use your head; otherwise, you'll end up in a future Yahoo! Finance story!

Sunday, June 26, 2011

The Freedom-Happiness Curve

As you know, the silly season (a.k.a the U.S. Presidential election season) has begun in earnest.  A few weeks ago, the first major debate of the season was held in New Hampshire.  As expected, the candidates were asked a variety of questions:  where they stood on health care reform, what they would do to boost the economy, would they have intervened in Libya, and so forth.  While these are important questions, they focus on how the candidates would handle specific issues, rather than what their overall philosophy is.  If I had the opportunity to ask each candidate one question, I would ask them, "how would you draw the Freedom-Happiness Curve?"

The Freedom-Happiness Curve is a device of my own invention, so it probably requires some explanation.  It is a graph which shows the aggregate happiness of a society versus the amount of freedom its citizens have.  Here is what a typical interpretation of the curve might look like:

The left side of the curve makes perfect sense.  In a society with little or no freedoms (think North Korea as an example), most people are going to be very unhappy.  In a "not-free" society, people are told what to do, what to think, who to worship, by the government.  Without the freedom to determine their own destiny, the population as a whole is generally not very happy with their situation.  They will even risk life and limb to escape to a more-free society.

As more freedoms are added, people generally become more happy.  They are allowed to make more choices for themselves and set their own course in their lives.  Thus, the curve rises as society becomes more free.

The right side of the curve might be counter-intuitive at first.  It shows that society's happiness actually declines after a certain point as people become gain freedoms.  Most people think of freedom as being a "more is better" type of proposition.  However, in practice, it is not.  Consider the extreme where people are allowed to do whatever they want whenever they want without any restrictions from the government whatsoever.  There is a word for this:  anarchy.  Anarchy is true and complete freedom, but most people are not happy under anarchy.  Without the rule of law, the person with the most guns and the most money might be happy.  However, everybody else is left to fend for themselves.  A modern example of an anarchy state is the failed state of Somalia.  Nobody would argue that Somalia is a happy place by any stretch of the imagination.  That is why the curve declines after a certain point.

An important goal of any good government should be to provide enough freedoms and yet enough restrictions to maximize a society's happiness.  Naturally, politicians disagree at what level of freedom would maximize happiness.  Politicians on the libertarian end of the spectrum ("that government is best which governs least") might argue that government should provide the bare minimum of services to maintain order and commerce and not seek to restrict freedoms any more that is necessary.  Therefore, they might draw the curve along these lines:

Note how, under this philosophy, the belief is that society's happiness is maximizes at a point where people have quite a lot of freedoms.  The curve still descends when there is too much freedom because even staunch libertarians believe that some amount of government control is necessary for basics like law & order, defense, roads, and the like.

On the other side of the spectrum are those who might view government's role as being more paternalistic, where government needs to step in to provide more than just the basics for people:  a baseline retirement, some form of health care for those in need, and even employment if necessary.  Franklin Roosevelt, with his New Deal during the 1930's, believed that the Government needed to take a role in sustaining the happiness of society even if it meant less freedoms (mandatory Social Security withholding, taxes to pay for job creations, increased regulatory scrutiny of companies, etc). 

Another example is the heightened security which we face as part of the War on Terror.  At the airports, we are restricted in what we can carry past the security checkpoints.  Being forced to buy water at exorbitant prices in the concourse might be necessary to prevent somebody from smuggling flammable liquid on board a plane; however, it is a restriction on our freedom.  Nevertheless, because the thought of exploding at 30,000 feet is not a very pleasant thing to ponder, this restriction on our freedom increases our overall happiness.

The curve of somebody who believed in this paternalistic philosophy of government might look something like this:

Note how this curve peaks out at a level that is closer to "less free" side.  This represents the belief that while basic freedoms need to be maintained, the government needs to provide restrictions on freedom in order to uplift the whole of society.

Asking politicians whether their world view is aligned to the libertarian curve or the paternalistic curve (or something in between) would go a long way in identifying the core philosophical beliefs of that candidate.  It would also help to predict how that person might react to some new issue which arises that the moderator did not have the foresight about which to ask.  The Freedom-Happiness Curve also can provide us with a tool to identify our own political beliefs.  How much freedom do you think we need in order to maximize society's happiness?  How much restriction on our freedom are we willing to endure?  There is no simple answer to these questions, but it is important that we start to ask our leaders and ourselves these questions.  That way we can have an intelligent dialogue on what we want our country to become.

Tuesday, June 21, 2011

Wall Street Layoffs Due To Pay Raises?!

The New York Times had an article yesterday talking about possible layoffs at Wall Street banks.  Of course, some of the same banks booked enormous profits in 2010 so one wonders if any of them have read the story of Joseph, but I digress.  In the article, the pay raises are singled out as the primary reason why layoffs are necessary.

The story goes something like this:

In the past, a significant percentage of ones income at a Wall Street firm was in the form of a bonus.  The idea was that if the company did well, the employees got an extra piece of the bigger pie and when the company didn't do well, the employees got less.  Not only did this provide an incentive to employees to perform, but it provided a safety net for banks as well.  When times got tough and profits were down (or non-existent), banks did not need to pay out big bonuses, and this automatically reduced their expenses.  Makes perfect sense.

However, in the wake of the financial crisis, many people pointed to these fat bonuses as one of the causes of the imposition of the banking sector.  One of the unintended consequences of this was that the bonus provided employees with an incentive to take excessive risks with other people's money.  After all, if you are getting a big bonus for selling lots of sub-prime loans, you are going to sell loans to anybody with a pulse without considering what it will do to your company's balance sheet.

One of the outcomes of the banking crisis was that banks were pressured to reduce the impact of bonuses on ones compensation.  Now that bonuses were being reigned in, banks compensated (no pun intended) by raising the base salary of employees.  After all, if you wanted to retain talent, you had to make sure that they remained well compensated.  Of course one has to wonder why you would want to retain the same "talent" that flushed your company down the toilet in the first place, but I digress again.

Anyway, the crux of the matter is that now that banks seem to be hitting another bump in the road, bank profits are under pressure.  As with any company, banks look to cut expenses when revenue is down.  However, since bonuses have been replaced by a higher base salary, banks say that they cannot cut expenses automatically by lowering bonuses.  Instead, they say that the only way to cut employee expenses is to lay people off.  In economic parlance, they have replaced a variable cost (bonuses) with a fixed cost (salary).

As a student of microeconomics knows, there are two types of costs:  variable and fixed.  A variable cost is one that grows as you have more sales.  On the other hand, a fixed cost is one that stays the same regardless of your level of sales.  Consider a company that makes shoes.  As the company sells more shoes, it needs to buy more leather since the amount of leather it needs is proportional to the number of shoes it sells.  When shoe sales drop off, it doesn't need to buy as much leather, so its expenses automatically go down.  It is a variable cost.  On the other hand, if you make shoes, you need a factory building, and you might take out a mortgage to buy that factory.  Unfortunately, if shoe sales drops, you still need to pay the mortgage on your factory.  Just because sales go down doesn't mean that the bank will all of a sudden reduce your mortgage payment proportionally.  The mortgage is said to be a fixed cost because it doesn't vary with the level of sales.  Obviously, if you are a business owner, you'd rather have variable costs than fixed costs.

In the Wall Street situation, a bonus is a variable cost because it goes up and down based upon how well the company does.  That makes perfect sense.  However, is salary really a fixed cost like the article says it is?

Of course not.

The truth of the matter is that this sounds like an excuse more than anything else.  Who says that you have to consider a salary to be fixed?  There are many examples of companies which reduced employees' base pay in order to avoid layoffs.  If nothing else, the recession has shown that salaries, too, can be considered to be a variable cost that can be lowered in bad times.  I think the real story is that Wall Street wants to lay people off to save money (nothing wrong with that).  However, rather than coming out in saying "we need to pay people off because we have too many people", "we want to streamline operations", they are implying that they are laying people off because of the way the Government has meddled with their compensation policies.  This is an easier story to sell to the public, especially when you had such a good year in 2010.

The moral of the story is that maybe Wall Street needs to go back to college and retake microeconomics again.  Perhaps that is one of the reasons why they are having such a bad 2011?

Sunday, June 19, 2011

Everything I Know About Money I Learned From My Dad (and Andrew Tobias)

First of all, to all of the dads out in cyberspace, "HAPPY FATHERS' DAY!".

Anyone who has gone through the public school system in the United States knows that there is very little practical education regarding personal finance.  I certainly can understand why this is the case.  Schools are under pressure from the powers-that-be to satisfy the requirements of so many interest groups.  Schools have to make sure that children are instructed in so many random things as dictated by society (anti-bullying, condoms, the pledge of allegiance, nutrition, evolution v. creation, etc), while making sure they learn enough to pass the myriad of standardized tests, and still giving them the recess time that they need so they don't become obese.  The pressures on school systems to squeeze all of this into a six hour, 180 day school year is intense.  It is not surprising that personal finance falls through the cracks.

That is where dads come in (moms, too, but today is Fathers' Day so you moms will have to wait your turn).

My dad never sat me down for "the talk" (the personal finance talk, people - not the other one).  However, he set an example for me and my siblings when it came to money matters.  It was inevitable that we would learn from his wonderful example.

1. Don't skimp on education:

My father was very well educated.  He started off by earning a BS in Mathematics, followed by his MS in the same discipline.  Then, he went on to earn another MS in Meteorology (from M.I.T if I may brag).  Now many of you might wonder how he paid for all of his education.  He must have saddled himself with quite a few loans, right?  Wrong.  You see, my father was in the Air Force, so his education was paid for through his service to our country.  The second MS degree was paid for by M.I.T. as part of a graduate fellowship.  By the time he was done, he had zero loans.

Now some might say that he was fortunate to have these opportunities.  I strongly disagree.  His military service was during the Vietnam War when such service could be dangerous, if not deadly.  He paid for his degrees not with money, but by being willing to make the ultimate sacrifice, if it came to that.  In my mind, it was the least the U.S. Government could do.  Now not everyone qualifies for military service, so this avenue might not be available to all.  The point is that there are ways to get an education for those who are willing to work, whether it be through scholarships for superior achievement, or part time studies while working, or other means.

2. Hard work is rewarded:

In his career, hard work paid off for my father.  At a time when it was common for people to stay with one job over the entirety of their career, my dad jumped around from job to job quite a bit.  This wasn't because he was fired a lot; it was because he was always on the lookout for the next great opportunity.  Most of these opportunities came via people with whom he had worked previously.  When they had a need for somebody, my father often was the first person who received that call.  At the peak of his career, he was Directory of Engineering for a telecommunications company.  How did he get that job?  The President of the company was his former manager from one of his previous jobs.  He didn't need to send out a thousand resumes to get that position.  His former boss remembered what a great worker he was and offered him the job based upon that. 

3. Live Beneath Your Means:

My dad wasn't one to spend a lot.  Growing up, we only had one car (until my mom went back to work, but that is another story).  Interestingly, it didn't seem like much of an imposition.   For short trips, we walked.  For slightly longer trips (like to get to my piano lessons), I rode my bicycle.  For even longer trips, we took the bus which went through our town.  The funny thing is that, looking back, I really don't feel like I missed out on that much.  Having one car seemed "normal" to me, because I didn't know any better.  We were able to survive just fine.  Living beneath your means is easy, once you get used to it.

4. Stay out of debt:

My father was never a big credit card guy.  Every week, my parents would withdraw whatever spending money we needed from the bank and stick in an envelope.  They had to ration that money wisely because once it was gone, that was it until the next week.  I remember my parents wanted to buy a piano for the house because they had this idea that all of us kids ought to learn how to play (this goes back to don't skimp on education).  In this day and age, most people would put it on a credit card and pay it off.  However, my parents put aside some of their weekly budget money every week.  They only bought the piano once they had put enough aside.

My dad did the same thing with cars.  I don't think my parents ever bought a car on credit.  If they needed another car, they would buy whatever car fit their budget.  We never had a flashy car like some other families, but we owned all of them free and clear.  In fact, I think the only debt my parents ever had was their mortgage, and even that was paid off as quickly as possible.

5. Andrew Tobias:

When I was in college, I was starting to think about grown-up stuff like investing and the like.  I tried to educate myself, but it was overwhelming to say the least.  There were so many options:  stocks, bond, munis, CD's, etc.  How do I start? 

Since my dad seemed to know a little bit about this topic, I started asking his opinion on what stocks I should buy.  My dad wasn't one to lecture you about stuff.  His teaching style was more along the lines of "I'll point you in the right direction and you figure it out for yourself".  To that end, he didn't answer my question about stocks directly.  Instead he took a book off of his bookshelf, handed it to me, and suggested that I read it.  That book was The Only Investment Guide You'll Ever Need by Andrew Tobias.  He couldn't have pointed me in a better direction.  Tobias has a very simple philosophy which is mirrored in my father's:  be frugal, educate yourself, slow and steady investing, no-load mutual funds.  After a read it, my dad winked at me as if now I knew his "secret".

Thanks to my dad's gift of this book recommendation (he didn't actually give me the book - talk about frugal!), I felt like I knew enough to get myself started.  While I have read other investment books, I always find myself returning to the teachings of Tobias.

Now that I have children of my own, my challenge now is to set an example for the next generation about how to handle money.  Hopefully, I will be able to live up to the high standard set by my own dad.  Here's to you, dad!