The most expensive thing you will ever buy is a house. It deserves more research than just checking that you can manage the payments. Sure, there are a number of non-financial reasons to own a house. You don’t have to deal with a landlord (just the HOA), you can knock down some walls (if they aren’t load bearing, and the city/HOA let you), you are a “homeowner”. These things might matter a great deal to you. They might matter more than the financials. There are also non-financial reasons to rent. You get more flexibility about where you’ll live from year to year. The financial calculation, however, is complicated but well defined. There are dozens of variables involved. Unfortunately for you, this calculation is non-optional. Fortunately for you, the New York Times has taken all of the relevant variables and made a nifty calculator. You officially have no excuse!
You can access the calculator at here. What you’re looking to compare is the final rent price on the right to the rent of an equivalent place after inputting all of your relevant data (I promise one exists, look). As you move through the calculator you’ll see that the slope of the variable is related to how much a variable effects the final rental value. You’ll notice that there are a couple variables that are somewhat hard to get a good value on. For example, how long you plan to stay is sometimes tough one. The entire “What does the future hold?” section is a complete crap-shoot. Worse, some of the values in this section effect the outcome a great deal. My advice is that if you are assuming that you are staying in the house for a long time, you should assume that the money will be invested for the long term in the stock market or a similar high-volatility, high-return vehicle. Over decades the stock market returns about 8%, so that should be your investment return rate. Similarly you should use the long run return of housing in the US which is just a little above inflation (something like 0.2% above inflation) according to Robert Shiller. If you look at the plot on the right, you may be tempted to think that home prices really only started appreciating after World War 2 and that things are different now. That may be fair (this earns you about 1% above inflation, go nuts). Also, look at the amount of volatility we’ve had since then as well. Keep in mind that every time the blue line goes down by a percentage equal to your down payment, you’ve just gotten underwater on your home. A 20% downpayment seems pretty historically safe (except for the most recent
recession fun). A 10% downpayment gets wiped out every decade or two. Don’t give in to the temptation to adjust the knobs on this calculator until you get the answer you want. This is the second most important financial decision you’ll make in your life (Reminder: Fund your Roth). Don’t lie to yourself about it. Also, do NOT simply say, “House prices in my area have historically gone up faster, so I can use a larger appreciation number.” This is approximately as bad as saying, “Historically Microsoft has gone up faster than the rest of the market, so I should buy it and assume I can use its past average growth rate.” So you’ve filled it out? Great! Which is higher, the rent you can get, or the breakeven rent from the calculator?
The real value of this calculator shines through when you work backwards from a known rent. For example, let’s say that I’m trying to decide between buying a condo that rents for $1,800 and is selling for $225,000. I use default values for everything, and change investment return rate to 8%. I also add in monthly common fees (HOA fees) of $400. The last thing I change is the home price growth rate, and I adjust it until the big green number on the right is $1,800. This solves for the growth rate that breaks even. In my case that growth rate is -0.8%. If housing values fell 0.79% per year over nine years (the time I owned the home) I would still come out ahead by buying. By running these sorts of scenarios you can see what works and what doesn’t. Looking at another example, a single family home near my area is selling for $365,000. A very similar home is up for rent at $1,600 per month. HOA fees are much lower in this area, so I adjust for that. The value of this home has to increase by 3.2% per year in order to justify the purchase, this may or may not be reasonable.
I say it one last time. A house is your largest purchase, interest rates are very low and it may therefore seem like buying a house is the right idea, but do the math!
If you purchased certain types of StarKist Tuna in the last six years (and who hasn’t, StarKist Tuna is awesome) you can get either $25 cash or $50 worth of Tuna by participating in the settlement to a class action lawsuit. Basically the lawsuit alleges that StarKist tuna cans contained 3.01 ounces of tuna in a five ounce can rather than the federally mandated minimum of 3.23 ounces. In order to participate you need to go to this website and fill out a form. You don’t need to provide proof of having purchased the Tuna, but you are attesting under penalty of perjury that you have indeed purchased one of the types of Tuna that the lawsuit covers.
What is a class action lawsuit?
A class action lawsuit is a lawsuit that allows a group to collect or be charged damages. The process for participating in the lawsuit generally involves filling out a form and waiting for further information. The claims administrator collects this information and then disburses settlement claims.
StarKist, the stock
The first thing that I had hoped upon hearing about this, is that the bad press may have generated an opportunity in the stock market. StarKist has a very substantial share of the Tuna market and a strong brand. Under-filling tuna cans doesn’t seem to be something that would substantially hurt their brand image in the long run. If there had been a major related sell-off it might be an attractive moment to buy. Unfortunately, StarKist is not publicly traded as a standalone company. It is owned by Dongwon Industries. Dongwon Industries is a public company listed on the South Korean Stock Exchange with ticker 006040. Dongwon Industries didn’t appear to experience a major selloff, and while it might be a good investment on its own merits, it doesn’t seem like there is a thesis here. StarKist has pledged $12 million dollars to this settlement, that represents a small amount of their annual sales (in the neighborhood of $600 million). This is finally a case of: a minor thing happens, and the market reacts as if a minor thing has happened.
If you’ve purchased this tuna in the last 6 years this is basically a free $25. You are not required to provide proof of purchase, but if you have not purchased the tuna in question, do not participate in the class action lawsuit. When you fill out the form you claim that you have purchased the tuna under penalty of perjury. Google “is perjury a big deal”, I dare you. Honesty in these situations matters. It certainly isn’t worth the $25 to lie about the purchase of a can of tuna.
“Alright,” I hear you cry, “I’ve put $5,500 in my Roth IRA and I’ve put $10,000 in that new fangled high interest checking account you’re yammering on about, but I need to put money aside for a down payment on a house in a couple years. I need something safe that will earn me something.”
Quiet your cries. I’m about to introduce you to the safest investment that I’m aware of, the United States series I Bond.
What’s an I-Bond?
A bond is a loan. You give money to an institution of some sort, like the US government and they promise to pay you back, plus interest. Most bonds are for a fixed time period. If you’ve ever heard the phrase “ten year treasury”, that refers to a ten year loan to the United States government. A couple years ago there was some fear that the US might default on their debts. Had this happened the overwhelmingly likely scenario is that the US would have missed an interest payment, then made the bondholders whole after it got its stuff sorted out. The risk that you loan the US money and it doesn’t pay you back is so small that it is often described as a risk-free investment.
What if inflation takes off while you’re holding the bond? You might come out ahead in dollars, but behind when you try to actually buy something with your money. The series I-Bond is special in that you get paid a fixed interest rate like a normal bond, but you also get a variable interest rate payment, depending on what the inflation rate is for that period. The I-Bond offers an additional layer of safety, not just the US guarantee of repayment, but also protection from inflation risk.
Since 1900 the dollar has lost 95% of its value. Every year the price of most things you buy increases by a small amount (averaging 4% since the creation of the federal reserve). The huge advantage of the I-Bonds is that if inflation starts to head up, your money won’t lose value, you get paid the inflation rate! If someone mentioned inflation to you in the last 5 years or so (generally in panicked tones) they probably tried to convince you to buy gold at the end of their spiel. I don’t have an opinion about gold. I do know that the price of gold over the last four years has fell by about 40%. If you invest in I-Bonds you will not lose 40% of your money. I promise. There you have it, my promise and the promise of the US government. How do you beat that?
There always seems to be one. In this case there are two. The first is that you can only buy up to $10,000 worth of I-Bonds every year. I-Bonds are a really good deal, so good a deal that the US can’t just let people purchase an unlimited amount. The second is that for one year you can’t get your money back out, and if you take your money out before five years are up you have to give back the last three months of interest. Last, that fixed interest rate I mentioned? Well, its currently 0%. I-Bonds you buy now will just earn inflation, and nothing more. If you buy I-Bonds in the future, when the interest rate goes back up you might get something extra as well.
There is one thing I almost didn’t mention about I-Bonds. If you use them to pay for qualified educational expenses and you make less than $76,000 (113,950 for couples) per year you don’t have to pay any federal or state income tax on the interest! This makes I-Bonds a great way to save up for those classes you were planning on taking.
I-Bonds offer safety that you simply can’t get anywhere else. Some people worry about what the federal reserve will do. With I-Bonds, you don’t need to. Inflation taking off? I-Bonds have you covered. Fed raises interest rates? Future I-Bonds you buy will have a better fixed rate attached to them. They won’t blow the lights off the wall, but they are safe, and some (not all) of your money should be invested in a way that is totally safe. So check them out at the US treasury’s website: http://www.treasurydirect.gov.
For years now interest rates on savings accounts have been nearly zero. The news for the last few months was that the Fed might raise rates in September, or maybe they won’t. I don’t know what the Fed will do. I do know that I get 3% interest on my uninvested cash, and I heartily recommend it to other folks managing their thousands. I have a high interest checking account. In exchange for a little hassle, these checking accounts pay you an above-market interest rate on a cash balance up to a certain amount.
The checking account I use is at Consumer’s Credit Union. In order to qualify for the higher interest I need to do a couple things. First, every month I have to have a direct deposit or an ACH deposit into the checking account. At my work setting up direct deposit of my paycheck to a new account is pretty trivial, but your mileage may vary. (Seriously though, don’t let filling out one little form stand between you and an interest rate 3x as high as a halfway decent CD). Second, I have to use the debit card 12+ times per month. I occasionally have a little trouble with this, as I prefer to use some sort of rewards credit card for my purchases, but with a little thought it can be quite manageable. Third, I must agree to receive e-statements, rather than regular statements. For me, this is a complete non-requirement, I hate paper statements. Lastly, I have to sign into the online account once per month. With the interest piling up this is more entertaining that you’d think.
For all of that trouble I earn 3.09% on my cash balance in the checking account up to $10,000. I don’t find the limit to be extremely, well, limiting, because I throw everything that I can spare into my Roth and other retirement accounts. One other perk I find huge is that the checking account reimburses ATM fees. I’ve got to be honest, there are times this feels a little like a superpower (I’m so lame). It’s incredibly liberating when you and your friends are somewhere that cash is a necessity and you’re surrounded by high-fee ATM’s. I can’t find a limit to this on Consumer Credit Union’s website, and now I’m a little shocked that no one has purchased an ATM and simply printed themselves money. Let’s see I’ll take $20 out from my ATM for which I charge myself a $2 fee. Then I’ll open the ATM put the cash back in, and make another withdrawal from my ATM…
The Bottom Line
It’s free money. I swear, the amount of time I spend trying to convince people just to take the free money, I’d be making minimum wage if they just took it, then gave it to me (and I’d no longer be allowed to do it in Seattle, San Francisco or Los Angeles). There are several credit unions and small banks that offer a product like this, you just have to search for them. I think Consumer’s is the best, but I’m prepared (and terribly excited…) to be proven wrong. If you think you’ve got a better high interest checking account please sound off in the comments section. (Doubly so if you can explain to me why buying an ATM and plugging it into my basement isn’t a license to print money. Disclaimer – If you do this and get sued/arrested…I can only thank you for providing a test case as I certainly don’t endorse it, but I am a little curious…)
Robinhood has finally made its app available to Android users, and I can say I’m quite excited. Robinhood is a brokerage. If you open an account with them you can trade stocks online. There are two things that differentiate them from other discount brokers. First, regular trades on the platform don’t incur a commission. Second, you can’t place trades on your regular desktop computer. You can’t place them on your laptop either. This brokerage is available only on mobile devices as an app. The signup process is smooth and easy. Funding is a matter of giving the app your bank username and password which could turn off some users. All told completing the signup process took me about three minutes, which is a stunningly short amount of time.
The main selling point behind the Robinhood app is free stock trades. A user may be surprised upon selling a stock that they actually do pay a small amount. This isn’t because Robinhood is charging them, but rather that the SEC (the Securities and Exchange Commision) charges a fee on stock sales, FINRA (Financial Industry Regulatory Authority) also charges a trading activity fee on stock sales. This should work out to pennies and largely isn’t worth worrying about. One of the things I like to check for in a broker is what the rest of their fees work out to be. For example, one fee that is generally overlooked is the fee to participate in a tender offer. This fee is $50 and is a substantial obstacle to participating in tender offers for microinvestors. Other fees include worthless security processing ($30) and various charges for doing things via paper rather than electronically ($5 for statements, $2 for trade confirmations).
The trading universe that Robinhood gives you access to is fortunately much larger than similar services, such as Loyal3. Stocks available only include those traded on major US exchanges. They don’t trade OTC issues. The fortunate part about the setup is that if you don’t know what OTC issues you certainly don’t have any business trading them. Similarly options are disallowed.
Customer service is quite easy to access via the app, it takes you directly to a mobile site. Customer support appears to encourage email over phone. Phone customer service is only available during market hours. I sent an email to their customer service and have not as of yet gotten a reply. Robinhood has sent a couple automated messages claiming that their customer service has been overwhelmed by tickets since the android launch.
They don’t allow them. This is unfortunate, if a dollar can be out of your hands long enough to go into the stock market, it can be out of your hands long enough to go into a retirement account. That being said I’m not sure I would even want my retirement accounts at Robinhood. They seem nice enough but, I’m not convinced that their business model is sustainable in the long term. If it isn’t sustainable, they might get bought out, in which case I may end up at a firm with a totally different fee structure, or they’ll go out of business. If that happens, the good news is that they are covered by the SIPC, which insures securities up to $250,000 from broker failure; the bad news is that this is a hell of a thing. If the brokerage goes under you may not be able to sell your holdings, or do much with them at all. If we’re in the sort of situation where a company like Robinhood goes out of business rather than being bought out you may find it quite upsetting that you can’t trade your holdings.
Situationally, Robinhood could be great. Suppose that you want to have a diversified basket of stocks but don’t want to deal with the fees, tracking error, and turnover involved with an S&P 500 index fund. Instead you could deposit $500 every month and buy $1 of each company in the S&P 500. You would simply never sell to avoid turnover. That’s a very powerful idea and I like that it’s possible with Robinhood. Also, I’ve never had an easier time signing up for a financial account, which was great. The downsides are possibly substantial, as I am pretty skeptical that the company will exist in this form in twenty years. Additionally, not allowing retirement money very likely consigns the app to holding very small amounts of my money for the time being.
Quite often when discussing the virtues of the Roth IRA I am confronted by the same argument regarding retirement accounts. “I want to save money, but I don’t want to wait until I’m old to enjoy it!” This seems quite reasonable. Who wants to set aside $5,500 every year only to see it again in 2045? Surely, won’t robots have risen up and killed us all by then?
The basic idea behind an IRA is that the government gives you some kind of tax benefit to save for retirement. The tax benefit of a Roth IRA is that money in the account can be invested, and gains from these investments will never be taxed. Suppose I put $5,500 in a Roth IRA. When I’m 60, I retire, by then (at a 7% investment growth rate) the $5,500 has grown to $41,000, I can then take $41,000 out and live off of that for a year and pay no income tax. Compare this to leaving the money in a regular account, I will have to pay roughly $5325 in taxes! That’s almost the entire starting amount! (Footnote 1: Using a 15% tax rate, the actual effective tax rate could be much higher if I realized gains more frequently, or was earning money from interest rather than capital gains). There is an important caveat. If I take earnings out early (before 59.5 years of age) I’m hit with a penalty fee of 10% by the IRS and have to pay taxes on the earnings. This is generally where I lose people. Fear not, dear reader, you can benefit far sooner from your savings!
|Taxes||Taxes paid on contributions
No tax on qualified withdrawals
First off, while you are taxed on earnings, you can take contributions out of your Roth IRA at any time without penalty. That’s right, the biggest downside if you decide this whole Roth IRA thing was a bad idea and you need the money to buy the brand new iPhone 9, is that you don’t get to take the interest you’ve earned out. So throw the $5,500 into the roth for two years, take the $5,500 back out to buy your new iPhone, and you’re stuck leaving $800 behind in the account. My heart bleeds for you. If it’s an emergency, (say you need a stylish case for the iphone), you only pay an extra $80 over the taxes you would have had to pay on those investment earnings anyway.
Second, any money you sock away now is money you don’t have to later. If you fund your retirement accounts enough in your 20’s that means decades that you won’t have to fund them in the future. While everyone else spends 30 years playing catchup you have an extra 15-20% added to your paycheck, just because you don’t have the expense of saving for retirement. Here’s a powerful example. A college degree is one of the very best investments you can make, even at today’s costs. However, you would be better off if you’re on top of your retirement savings without the degree than if you wait until your thirties with a degree. The median salary of a high school graduate is $30,000. If you start saving $3,000 (10%) per year at 18, then maybe it gets too hard once you turn 30 and start having kids or other expenses. Now let’s look at a college grad who blew off retirement savings in their 20’s, then he hit 30 had a kid and a bunch of other new expenses, by the time he turns 35 he realises he needs to start saving, he puts away $7,500 every year for 30 years until age 65. You dear reader contribute half as much for half as long and end up with $1,344,466.93 (assuming a 9% return). The college student who puts it off, he contributes far more, and ends up with only $1,114,314.13. Now these numbers weren’t adjusted for inflation and you may find you need more money in retirement. The point, however, is clear: saving now matters.
Furthermore, there are investment situations in which you might come out ahead even if you planned on paying the penalty all along. Let’s suppose that you only invest in bonds that yield exactly 7%. Let’s further suppose that you’re 25, you’re going to $5,500 invested for 15 years, because you know when you are 45 you’ll need to buy your midlife crisis car. Let’s further suppose that your top marginal tax rate is 30%, and you can reinvest your interest. If you save this money outside of a Roth IRA account, you pay taxes on the interest every year, reducing your interest from 7% to effectively 4.2%. After 20 years you’ll be left with $14,371. If you save the money in the roth IRA you’ll have $21,283, you then withdraw the money and have to pay a 40% (30% + 10% penalty) tax on your earnings. This leaves you with $14,969, about 4% more. This is an unusual situation and depends on the tax rate, interest rate, and amount of time involved, but it should underline the fact, that not having to pay taxes annually matters.
If you have a budget and your take home pay exceeds your average annual expenses fund your Roth. It has all of the psychological benefits of a piggy-bank and the drawbacks only affect your investment earnings.