Thursday, December 17, 2009

Free AudioBooks on Investing!

I just found out that I can download tons of investing books from my local library's website - from home.

I love audio books because I can listen to them with little effort when I'm doing otherwise mundane things - standing in line at the airport, waiting in a doctors office, riding the bus in the morning, diving, working in the yard.

Sure, you could read in many of those cases, but not all of them. And, I can listen a lot faster than I can read. It just takes less effort to listen than to read - perhaps I have dislexia, perhaps I have bad eyesight, or perhaps it is just more effort to read than to listen. For whatever reason I can get through ideas faster when spoken than when I have to do the optical processing myself.

Finding the link to download the audio books can be a bit of a task, but if you call they're usually quite helpful.

Tuesday, December 15, 2009

Good Insurance vs. Bad Insurance

Here's the dirty secret of insurance - it is a loosing bet for the person purchasing it. Always*.

Insurance companies will usually have a loss ratio of 50 to 60%. The loss ratio is just another way of saying, how much they pay out in claims for every dollar they take in. They also have expense ratios in the 20 to 40% range (the cost to run the business- claims adjusters, salesmen, marketing, electricity, rent, etc) so don't think they're making out like bandits.

But from a consumer perspective the average insurance policy has about the same expected value as a lottery ticket - you can expect to get back about 50% of the money you put in.

But everyone in personal finance says you should make sure you are adequately insured.

There seems to be a tension between these two statements - 50% expected value, but still buy it? The resolution to this tension is the word "adequately."

Quite simply put, you should only buy insurance against those things you couldn't afford to bear the cost of yourself were they to happen.

Medical insurance - in the US today medical insurance is a hybrid of three things - prepaid consumption of health care, volume discounts for health care, and catastrophic medical expense insurance. Even if you are a healthy 25 year old male - with expected cost to see your personal doctor once a year of about $300 to $500 - it still would make sense to pay $400 a month for medical insurance because if you are in a car accident you could quickly rack up $50,000 or more in medical bills from the intensive care unit. Even though you expect to loose almost $4,000 a year on the wager, you can't afford the $50,000 if it were to happen. Thus you should buy it.

Car insurance - you pretty much have to have this to drive your car anywhere. But, what kind to get and how much should be dictated by the question "can I bear the cost if this were to happen." Chances are you can afford to pay $150 to a tow truck in the 1 in 10 years event that you get a flat tire and are stranded. So the $3 per month = $36 per year = $360 per ten years proposition of "roadside assistance" is a loosing bet, and one that you don't have to make.

Life insurance - Why do you need it? Could your family survive were you to die and not provide income? Chances are, the answer here is, probably not. What if you have a stay at home spouse? Should they not be insured because there would be no lost income? Not if you have kids. A stay at home parent is engaging in "invisible" productive activities - there is no money coming in for them, but there is usually a substantial savings in money that would otherwise have to be spent. So, what would the cost be to get childcare if that spouse were to die? That's how much life insurance the stay at home spouse needs. What about 10,000 coverage for babies? Unless you can't afford the basic costs of a funeral, stay away. Same for married dual income no kids, unless you have a mortgage that requires both incomes.

Cell phone insurance - You should insure yourself here. If you keep loosing your phone, either stop drinking so much, become more responsible, or learn how to google "Refurbished __your_phone_here___." You think of it as "it saves me from paying $200 for a new phone" but, they send you a $50 refurbished model - and charge you $3 per month to do so. This is one of the biggest wastes of money. Cell phone insurance is the WORST kind of insurance.

Disability insurance - This is going to cost you peanuts, and be happy every month that you're paying so little even while expecting to loose money. This means the chance of you becoming disabled is vanishingly small. Be happy about this fact, and by all means make sure you are covered.

Good insurance buys you security. Bad insurance is like buying a lottery ticket. Think about it so you make sure you know what kind you are getting.

* I said above insurance is always a loosing bet. I should restate - it is always a loosing bet if the insurance companie's actuarial tables are correct. That is, you can only profitably take on insurance if 1) you know something they don't about your risks, and they don't ask or 2) they've done their math wrong. Now, I know some guys who do math for insurance companies, I wouldn't bet against them.

Special proviso on "gimick" coverage. Sometimes insurance companies intentionally under price small elements of their coverage - i.e. laptop breakage. They do this because they know that having this gimick is going to make their insurance more desireable - it is a classic loss leader. They loose $10 on laptop insurance to make $100 on the homeowners policy. It is a sales cost for them, and you should by all means take it. But, if you can't do the math, you should always assume that gimick add ons are correctly priced because 9 times in 10 they are.

Saturday, December 12, 2009

The Tao of Personal Finance

From the Tao de Ching, I found a fantastic quote that summarizes at least half of responsible money management:

He who knows he has enough is rich.

That is satisficing! When you ask yourself "what do I need" vs "what do I want" it puts your spending into the right perspective.

When you buy fewer things, you don't have to pay as much attention to price. This frees up space in your brain for more productive, or more pleasureful things, like thinking about the next blog post you are going to write.

The first question you should ask when you are buying something is "do I need this." The second question is "can I afford it." If the answer is yes then no - you better be talking about food, basic clothing, or shelter - if you aren't you need to reconsider how you define need. If the answer is yes then yes - great, buy. If the answer is no then yes, it is an affordable luxury and you have to ask yourself the question - do I want this?

Shockingly, after a few years of "do I need this" you find yourself wanting fewer and fewer things, while being able to afford more. And every item you don't buy feels freeing - you aren't trapped by illusory desires, and you aren't wasting your resources.

But, be reasonable. We don't technically need cars, computers, the internet, or cell phones for basic survival. But, they are enabling devices - or, thought of another way - they are investments.

Why do I need a car? Because it saves me at least 40 hours a month in transportation time. Even at $5 an hour - that's $200. Most of my readers are going to be making substantially more than that per hour. I need a car because it is a good investment.

And good investments are one of the most critical needs in modern life.

Tuesday, December 01, 2009

What is an Investment

Most people will answer this by saying "Saving money," or "Stocks, Bonds, and mutual funds." And, these are most certainly investments.

However, they represent only a small subset of the investing universe. No, I'm not going to talk about Hedge Funds, Futures, Options, Real Estate, etc. Those are also part of the same sub category of investment - they are financial investments.

What then is the essence of an investment? It is putting to action today something of value with the reasonable expectation that by doing so you will receive more value in the future.

It doesn't have to be money that you put to action, and it doesn't have to be money that you receive.

You can invest time in order to get more time back. Assume you spend two hours each week watering your lawn and garden. You think about this and realize that by setting up the sprinklers you already have in your garage you can cut that time in half. Say it takes you 3 hours to find and set up the sprinklers. You've invested 3 hours today, to save 1 hour per week in the future.

You can invest time and money to get more money back.

You can invest money to get time.

You can invest money to get security (i.e. insurance).

What is important is that you are getting more value out than you are putting in. If you are, you are making an investment.

Look around, what simple investments could you make? You might be surprised how many hours you can get back for each hour you invest in streamlining your life.

Sunday, November 22, 2009

Business Plan Archive

I just found out about a site that is trying to create a collection of old business plans. It is called (shockingly)

I have only just gotten a chance to read over a few of them, but this site is outstanding. For me the hardest part of writing business plans is just deciding what format to use. In the past, I have found reading over 10 or 20 samples to give me a much better grounding to start from. Now, as soon as I find my Million Dollar Idea, I've got a resource of failed companies to guide me. (irony?)

The other cool thing about this site is that it includes a plethora of complimentary material (powerpoint presentations, screenshots, news clippings, etc) that give the business plan context. The site is centered around the dot-com boom and bust.

If you're an entrepreneur, or want to be one some day, should be a good tool.

Tuesday, October 14, 2008

Fundamental value in the housing market

An asset has no value absent three things: what people are willing to pay for it, what people can pay for it, and it's fundamental value (i.e. an NPV of all present and future dividends and costs)

With housing "ability to pay" is the only factor that matters - it either drives the rent price or the sales price. Rent is a fairly liquid market, so it is a good indicator of long term "ability to pay."

Here is how you can calculate the fundamental value of housing:
Start with income * percent allocated to housing = housing budget

Take housing budget, factor it by interest rates, percent loan and term and you have the maximum loan you can support.

Maximum loan + down payment = house price.

(in excel, use this formula to get maximum loan =pv(rate,years,yearly housing budget) )

Some notes:
- percent allocated to housing is complicated as it varies from person to person, but there are hard caps on what people will spend on housing - it is physically impossible to spend more than 100%, lenders usually won't allow you above 40%.
- down payment is complicated as well, since you have to assume the down payment was either saved or borrowed
- housing budget has two parts: investment + lost payments. Rent is 100% lost payments, mortgages start out mostly lost payments then switch over time to mostly investment. This helps explain why mortgages should be more expensive than rent for the same size place.
- since inflation increases salaries it should pass through to houses, so over the long term absent any increases in salary or other changes, housing prices will track inflation.
- amount you can afford doesn't respond to changes in supply and demand.
- what responds to supply and demand is the size of the space you can afford (so in NYC you pay more for square foot, and in places where there is lots of available land you get as much space as you can afford to build)

The only long term drivers of house prices are 1) inflation 2) increased wages and 3) increased demand without corresponding increases in supply.

Short term fluctuations can be caused by:
- Required down payments (or the converse, amount you can finance)
- Interest Rates
- Expectations and other noise

For many places in the US, housing prices have already equilibriated. But in Seattle (where I now live) they have not yet. Based on median income (I assume $63,856, and growth of 4% per year), long term average interest rates (7% for the past 15 or so years), and current house prices (~440 median price) - don't be surprised to see another 10 to 30% drop in Seattle prices -- no appreciation for 5 to 10 years -- or worse.

PS I know, I've been gone for a really long time. This deserves some explanation, but I'm not going to provide it right now.

Tuesday, February 14, 2006

Free $5 and a cool new payment system -

I just read over at wired that somebody has created a payment system that uses text messages to send money - much like what paypal should be doing. The service is currently only available via SMS messaging, but I would be shocked if they don't offer a paypal esque system in the future.

If you sign up now, you get a free $5 signup bonus. Check it out here.

Full disclosure, if 36 people sign up using that link by the end of february, I get an xbox 360. I'm not much of a gamer, but I do like xbox 360s. So, help a guy out - sign up with that link.