With the recent negative housing data and Congressional action on tap, it is time to pose one of my favorite questions: why does the IRS treat homeowners better than renters? This may be blasphemy from a financial professional, but there are times when the cost and commitment involved with ownership do not add up. This sentiment was thought to be positively un-American in the past, but given the current state of the housing market, there might be some converts out there.
There was no better cheerleader for the real estate industry than President Bush. In 2002, he introduced the “Homeownership Challenge,” which included policy initiatives that were intended to increase homeownership, especially for minority groups. The rationale was that owning a home made good economic sense and from a sociological standpoint, homeowners tend to be more involved with their communities. (The more cynical would also point out that homeowners tend to vote in greater numbers than renters.) President Bush summed it up when he said that “Owning a home lies at the heart of the American dream.”
That has all of the emotional weight of a good ad campaign, but the admirable goal led to some lousy outcomes. For example, because the message from on high was to allow more people to buy homes, mortgage companies created new products to expand the ranks of potential borrowers. In the era of easy credit and a housing boom, you can understand how quickly we went from enabling the American Dream to lending money to anyone with a heartbeat.
Six years after President Bush’s declaration, the housing and credit bubbles expanded and then popped, putting many homeowners under a mound of debt, or worse, into foreclosure. As a result, the percentage of American families owning their own homes is no higher than it was six years ago and according to the AP’s Jeannine Aversa, “Americans are collectively carrying nearly 20 percent more credit card debt and 35 percent more home mortgage debt than in 2004.”
I never liked the idea that homeownership was subsidized in this country, which occurs through the IRS allowance of mortgage interest deduction. There are many people who should own homes and there also many who should not. Why do we make a judgment about which ones are more deserving of government assistance? It seems unfair that the cautious renter who has not accumulated the means to purchase a home is treated worse than the reckless buyer who slapped down 5% and was able to write off his mortgage interest payments for a year.
I realize that this particular tax gift is unlikely to go away. I could only imagine the revolt that would occur if changes in the tax code included repealing the mortgage interest deduction. OK, I can accept that fact. But its time for us to shift from the myth of homeownership and instead praise financial prudence---I can’t imagine a better concept that could occupy the heart of the American dream.
Wednesday, July 2, 2008
Tuesday, July 1, 2008
Survival Tips
I always love those TV programs that provide you with “The 10 Things you need to know to Survive in the Himalayas (or desert island or wherever there is no cable TV)”. Maybe it’s because that situation seems so awful for a bumbling non-outdoorswoman like me, but you never know when this information will be needed. That said, I was thinking that with the end of the second quarter passing, many investors are in need of some survival tips of their own.
Let’s get down to the numbers: the Dow Jones Industrial Average ended the day at 11,350.01, down 10.2% for the month of June, the worst June performance since the Great Depression – 1930, to be exact. For the second quarter, the Dow dropped 7.4%, its third-straight quarterly slide, the longest stretch of declines since 1978. Additionally, the Dow just about met the definition of a “Bear Market,” down 19.8% from its closing high of 14,165, reached on October 9, 2007.
The two other major US indexes fared somewhat better in the second quarter than the Dow—the S&P 500 closed at 1280, down 8.6% for the month and 3.2% in the quarter and down 18.1% from the October 10, 2007 closing high of 1562. The NASDAQ closed at 2292, a monthly loss of 9.1%, but a quarterly increase of 0.6%. The NASDAQ is 19.8% below the closing print of 2859 on October 31, 2007.
With all due respect to the Fed, earnings, financial companies, dollar devaluation or any other potential catalyst for the downside movement, the major culprit was oil. Yesterday, the August crude oil contract closed at $140 a barrel on the New York Mercantile Exchange, 9.9% higher for the month of June, 37.8% for the second quarter and up a staggering 45.9% higher year-to-date, after ending last year at $95.98.
Here are some things to consider before you get too depressed: According to Ned Davis Research, since 1960, the average bear market has lasted about 14 months and has taken stocks down about 31% before they hit bottom. We are already 8 months into this mess, so we’re statistically closer to the end than the beginning. Additionally, stocks typically snap back from a bear market pretty quickly. According to S&P's chief equities strategist, since 1945, it took 12 months for stocks to regain lost ground. That said, here are five quick reminders for surviving a bear market:
1. Part of being an investor is going through these nasty times. Without the downs, there can be no ups!
2. Assuming that you have a diversified portfolio, you are likely not suffering nearly as much as the overall markets.
3. Since WW II-2007, the S&P 500-stock index has risen by an annual average of 9.1% and there were lots of bad times included in that time horizon.
4. If you continue to contribute to your retirement plan, you are finally buying low!
5. You were smart enough to keep an emergency reserve fund set aside that is not invested in the stock market.
Let’s get down to the numbers: the Dow Jones Industrial Average ended the day at 11,350.01, down 10.2% for the month of June, the worst June performance since the Great Depression – 1930, to be exact. For the second quarter, the Dow dropped 7.4%, its third-straight quarterly slide, the longest stretch of declines since 1978. Additionally, the Dow just about met the definition of a “Bear Market,” down 19.8% from its closing high of 14,165, reached on October 9, 2007.
The two other major US indexes fared somewhat better in the second quarter than the Dow—the S&P 500 closed at 1280, down 8.6% for the month and 3.2% in the quarter and down 18.1% from the October 10, 2007 closing high of 1562. The NASDAQ closed at 2292, a monthly loss of 9.1%, but a quarterly increase of 0.6%. The NASDAQ is 19.8% below the closing print of 2859 on October 31, 2007.
With all due respect to the Fed, earnings, financial companies, dollar devaluation or any other potential catalyst for the downside movement, the major culprit was oil. Yesterday, the August crude oil contract closed at $140 a barrel on the New York Mercantile Exchange, 9.9% higher for the month of June, 37.8% for the second quarter and up a staggering 45.9% higher year-to-date, after ending last year at $95.98.
Here are some things to consider before you get too depressed: According to Ned Davis Research, since 1960, the average bear market has lasted about 14 months and has taken stocks down about 31% before they hit bottom. We are already 8 months into this mess, so we’re statistically closer to the end than the beginning. Additionally, stocks typically snap back from a bear market pretty quickly. According to S&P's chief equities strategist, since 1945, it took 12 months for stocks to regain lost ground. That said, here are five quick reminders for surviving a bear market:
1. Part of being an investor is going through these nasty times. Without the downs, there can be no ups!
2. Assuming that you have a diversified portfolio, you are likely not suffering nearly as much as the overall markets.
3. Since WW II-2007, the S&P 500-stock index has risen by an annual average of 9.1% and there were lots of bad times included in that time horizon.
4. If you continue to contribute to your retirement plan, you are finally buying low!
5. You were smart enough to keep an emergency reserve fund set aside that is not invested in the stock market.
Monday, June 30, 2008
Risk Taking
To close out a positively awful month for stocks (we are on pace for the worst June since 1930!), I thought that a fitting topic would be risk. The loose definition of risk as it pertains to investors is the chance that your portfolio will perform other than expected.
As we all know, assuming more risk increases your chance of BOTH making and losing more money. Still, it has been amazing to see the types of risk to which investors continually subject themselves. I have often ended a conversation with a radio caller, thinking to myself, “I just could not sleep at night if (that were my portfolio) or (if I had that much debt).”
What makes us assume those awful risks and why aren’t human beings better at keeping themselves out of trouble? The answer to this question can be found in the fascinating field of behavioral economics. Behavioral economics applies scientific research on human and social cognitive and emotional patterns to better understand economic decisions and how they affect market prices, returns and the allocation of resources. In other words, behavioral economics combines psychology and economics.
The basis for behavioral economics is Prospect Theory, which was developed by Daniel Kahneman and Amos Tversky in 1979 (Kahneman went on to win a Nobel Prize for this and other similar work) to explain how people make trade-offs that involve risk. These two shocked economists when they challenged the notion that long-held economic view that humans made rational choices based on logical calculations.
Hang on to your hats, but here is the earth-shattering conclusion: real people are not always rational! Through a series of experiments, the two economists attempted to disprove Utility Theory, which maintains that people make trade-offs based on a straightforward calculation of the relative outcome. Some people prefer sure things and others prefer to take chances, but whether the outcome is a gain or a loss doesn't affect the mathematics and therefore shouldn't affect the results. But Kahneman and Tversky found that people have subjective values for gains and losses.
All things being equal, we tend to be risk-adverse when it comes to gains and risk-seeking when it comes to losses. In case after case, the test results proved that humans accept small gains rather than risk them for larger ones, and to risk larger losses rather than accept smaller losses.
This may be why so many investors shoot themselves in the foot when markets move to the extreme highs and lows of a cycle. And of course, Prospect Theory affects ordinary as well as professional investors. The difference is that most pros recognize this fact and abide by some system to override the natural inclination to screw up the reasoning. I have always believed that the hardest part of investing is not the analysis of the economy or even determining which assets to buy; rather it is avoiding the emotional traps into which we all fall prey --- those are the biggest challenges we face.
As we all know, assuming more risk increases your chance of BOTH making and losing more money. Still, it has been amazing to see the types of risk to which investors continually subject themselves. I have often ended a conversation with a radio caller, thinking to myself, “I just could not sleep at night if (that were my portfolio) or (if I had that much debt).”
What makes us assume those awful risks and why aren’t human beings better at keeping themselves out of trouble? The answer to this question can be found in the fascinating field of behavioral economics. Behavioral economics applies scientific research on human and social cognitive and emotional patterns to better understand economic decisions and how they affect market prices, returns and the allocation of resources. In other words, behavioral economics combines psychology and economics.
The basis for behavioral economics is Prospect Theory, which was developed by Daniel Kahneman and Amos Tversky in 1979 (Kahneman went on to win a Nobel Prize for this and other similar work) to explain how people make trade-offs that involve risk. These two shocked economists when they challenged the notion that long-held economic view that humans made rational choices based on logical calculations.
Hang on to your hats, but here is the earth-shattering conclusion: real people are not always rational! Through a series of experiments, the two economists attempted to disprove Utility Theory, which maintains that people make trade-offs based on a straightforward calculation of the relative outcome. Some people prefer sure things and others prefer to take chances, but whether the outcome is a gain or a loss doesn't affect the mathematics and therefore shouldn't affect the results. But Kahneman and Tversky found that people have subjective values for gains and losses.
All things being equal, we tend to be risk-adverse when it comes to gains and risk-seeking when it comes to losses. In case after case, the test results proved that humans accept small gains rather than risk them for larger ones, and to risk larger losses rather than accept smaller losses.
This may be why so many investors shoot themselves in the foot when markets move to the extreme highs and lows of a cycle. And of course, Prospect Theory affects ordinary as well as professional investors. The difference is that most pros recognize this fact and abide by some system to override the natural inclination to screw up the reasoning. I have always believed that the hardest part of investing is not the analysis of the economy or even determining which assets to buy; rather it is avoiding the emotional traps into which we all fall prey --- those are the biggest challenges we face.
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