Warren Buffett's 2010 Letter to Berkshire Shareholders

So as of a couple of weeks ago, the market was up almost 100% since the 12 year low reached in March 2009. It was also up 7% since the beginning of this year. I have to agree with the headline in the linked article though- this feels like "the unhappiest bull market ever."

Maybe it is just what I focus on, but despite the numbers on the big board, all of the other news seems pretty negative for the average US investor. In fact, it's downright depressing if you think about it. For example, some of the major themes that have pounded into our skulls for the past couple of years are:

1) The FED has been printing money and flooding it into circulation, devaluing the US dollar
2) China's economy is going to overtake the US economy by 2018
3) We are entering a "New Normal" era of low stock returns, low GDP growth, deleveraging, etc. I think this view is most convincingly espoused by Bill Gross and his colleagues at PIMCO
4) The US government has bailed out shareholders at the expense of taxpayers, (more about that here and here, here (it bailed out people who couldnt pay for their mortgages also)). It also put other costly programs into place,
5) Based on pundit's views, state governments are headed for bankruptcy also
6) Stocks are overvalued  - note this is a more recent trend
7) Unemployment is high in the US. We are losing manufacturing jobs hand over fist. We no longer make stuff in the US, we are a "knowledge economy"
8) The rich are getting richer, at the expense of the poor

Oh, not to mention the social security crisis starting now as the baby boomer generation reaches retirement age and global warming (to anyone on either side of the debate, im not taking a stance on global warming, merely saying it is often in the news). These are all off the top of my head.

Combine these with the myriad personal financial problems each of us might be having - job security, sickness, disability, disease, divorce, credit card debt, foreclosure, car repairs, taxes, home maintenance, rent (which is too damn high by the way)- and it seems like the situation is pretty hopeless.

However, among this host of negative news, Warren Buffett's 2010 letter to shareholders arrived this weekend as a beacon of hope.

I suggest you read the letter yourself, but I just wanted to give you my $0.02 and call out some of the more interesting/informative parts of the letter.

Almost right off the bat, Buffett wrote something that you won't hear very often from the talking heads on CNBC in the current unhappy environment:

I agree with Warren and I don't share what seems to be the prevailing sentiment that the US is doomed to failure. This is why I invest the biggest portion of my retirement savings in US equity index funds. Put simply, I believe in the American system.

"Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Yet our citizens now live an astonishing six times better than when I was born. The prophets of doom have overlooked the all-important factor that is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders

for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective.

...We are not natively smarter than we were when our country was founded nor do we work harder. But look around you and see a world beyond the dreams of any colonial citizen. Now, as in 1776, 1861, 1932 and 1941, America’s best days lie ahead."

The next part of his letter that I liked (and anyone who has studied Buffett will be familiar with) is the section entitled "Intrinsic Value - Today and Tomorrow." In it, Warren talks about the three components of intrinsic value (which is the only value you should care about), specifically as it relates to Berkshire. You're better off getting the details from his letter, but I'd summarize the components as 1) Investments (stocks, bonds, cash equivalents) 2) earnings from sources other than investments and insurance underwriting and 3) (the most subjective category) "the efficacy with which retained earnings will be deployed in the future." I recommend you check that section out.

The highlight of the letter came near the end, however, in a section entitled "Life and Debt." Buffett reprinted a letter from his grandfather Ernest to his uncle Fred. In the letter, Ernest tells Fred that he has saved him $1,000 cash and is giving it to Fred on his 10th wedding anniversary. Ernest recommends Fred keep this money as a reserve in a safe deposit box so he can easily get at it. He writes "You might feel that this should be invested and bring you an income. Forget it -- the mental satisfaction of having $1,000.00 laid away where you can put your hands on it, is worth more than what interest it might bring..."

I checked an inflation calculator, and $1,000 back in 1939 would be the equivalent of about $15,425 today.

Buffett says they take a similar philosophy at Berkshire and will always keep $10 billion of liquid funds on their balance sheet in extremely safe but low yielding investments such as treasuries and other short term securities. He quoted investment advisor Ray DeVoe who said "More money has been lost reaching for yield than at the point of a gun."

Truer words have never been spoken, and although you hear it from most financial advisors, I'll say it again- build up your own reserve fund and put it somewhere you know you will be able to get at it. You will earn basically nothing for investing in treasuries or in your typical FDIC insured savings account right now, but you will sleep safely at night knowing that a financial setback won't knock you off your feet.

The rest of the letter hit on a number of the usual Berkshire areas: the difficulty of continuing to grow given Berkshire's huge size, the story of how he met Lorimer Davidson at GEICO, reviews of all of Berkshire's businesses, the often meaningless figure known as GAAP net income, Berkshire's culture, repeated requests to spend money at the annual meeting etc...

All in all, another great letter from the Oracle and well worth your time. I like to say that if I was only allowed to read one investment newsletter a year, it would be Buffett's shareholder letter. If you care about investing or saving, do yourself a favor and head over to http://www.berkshirehathaway.com/ and read this year's letter.

If you haven't read the previous years' letters, do that too.  

Richard Bernstein's Investment Guidelines

A blurb in the Wall Street Journal's "Heard on the Street" section caught my eye as I was on my way in to work last week:

"Overheard - Most people gush thanks (or occasionally spit bile) in their farewell address. Richard Bernstein, whose 20 years at Merrill Lynch drew to a close on Wednesday, went 10 steps further. In a final note, having thanked colleagues and clients, the bank's chief investment strategist signed off with 10 guidelines. All are worth remembering, but perhaps the last resonates strongest: 'Leverage gives the illusion of wealth. Saving is wealth.'"

This caught my eye and I made a mental note to see if I could find the complete list of 10. Lo and behold, through the magic of the Internet, I found the guidelines on seeking alpha.

They are the following: 

1. Income is as important as capital gains. Because most investors ignore income opportunities, income may be more important than capital gains.

2. Most stock market indicators have never actually been tested. Most don’t work.

3. Most investors’ time horizons are much too short. Statistics indicate that day trading is largely based on luck.

4. Bull markets are made of risk aversion and undervalued assets. They are not made of cheering and a rush to buy.

5. Diversification doesn’t depend on the number of asset classes in a portfolio. Rather, it depends on the correlations between the asset classes in a portfolio.

6. Balance sheets are generally more important than income or cash-flow statements.

7. Investors should focus strongly on GAAP accounting and should pay little attention to “pro forma” or “unaudited” financial statements.

8. Investors should be providers of scarce capital. Return on capital is typically highest where capital is scarce.

9. Investors should research financial history as much as possible.

10. Leverage gives the illusion of wealth. Saving is wealth.

I thought these were some pretty good observations. Number 1 definitely hit close to home for me. As I've grown my savings more over time and seen the impact a huge market downturn can have on the value of certain stocks, I've begun to pay a little more attention to income. Although I still believe capital gains are where the big payoff comes from in stocks, income is something tangible and shouldn't be overlooked. Number 5 is pretty important as well... over the past 2 years, people have seen every single asset class in their "diversified" portfolios sink almost in unison. Many were operating under an illusion of diversification and when the tide went out, we saw who wasn't wearing a bathing suit. 

I cocked my head sideways when I read number 4 because I think nothing fuels a bull market more than cheering and a rush to buy. I kind of see his point though. He is saying bull markets are more the result of assets being unfairly punished and undervalued prior to the bull market than the actual enthusiasm during the bull market. In my opinion, you can't have one without the other so this is kind of a circular argument.

This list reminded me of another post I made a while back on nine market lessons from John Dorfman, a Bloomberg columnist who retired a while back. For the sake of completeness and comparison, I list Dorfman's lessons here:

1) Out-of-favor stocks are the best road to capital gains.

2) Don't be swayed by what Wall Street analysts say.

3) High portfolio turnover is not necessary for good results.

4) The investment value of a stock is independent of whether it has been moving up or down.

5) Predicting the market with consistency is extremely difficult.

6) Predicting the economy is probably even harder.

7) High valuations alone aren't a good reason to sell a stock short.

8) High profits alone are no reason to invest in a stock.

9) Dialog with readers was one of the best parts of my experience as a columnist

Maybe one day I'll come up with my own list, but I have no plans to retire anytime soon :)

Is now a good time to buy stocks?

I get this question a lot: "Is now a good time to buy stocks?"

It's actually pretty easy to answer this right now. But first you have to ask yourself a few questions: 

1) Do I need the money I would be using to buy stocks? Your answer should be no. If you are planning on using this money for a down payment on a house in less than 5 years, then you should not be buying stocks with it. If you need to live off this money and couldn't afford to live your life without it, then you should not be buying stocks with it. Stocks are risky and you could lose every cent you put into them (not the most likely scenario, but a possibility that you can't completely ignore). Another way to phrase this question would be "Do I have a long time horizon of 20-30 years?"

2) Do I understand the difference between investing and speculating? Most people do not. If you want a good explanation, read The Intelligent Investor by Benjamin Graham. (I actually own this version of the book, which is hardcover and will hold up better over time, but the one I linked to first is cheaper.)

3) Do I have the time and skill to research individual stocks? If your answer here is "no", this does not rule out stocks as a whole but to me it would rule out purchasing anything but a small amount of individual stocks. Instead, I would personally invest in index funds and look for the lowest fees possible.

You'll notice I didn't mention anything about the market. This is because I don't know if it is high or low right now as compared to where it will be in a couple of months or years from now. I do know that equity investments look more attractive to me (and to Warren Buffett and Scott Adams) than they did a year ago, but I'm not going to make any forecasts.

And yes, the rumors are true: you have me to thank for the recent market declines. One of my 2006 year-end wishes was for lower stock prices in 2007 and although it took until 2008 for the market to fully grant it, my wish was fulfilled. Thank you, Mr. Market. You really helped my retirement years by allowing me to buy your shares so cheaply in 08 and hopefully for the next couple of years as well.

Please invest responsibly.

Oh, and for the majority of my readers who rely on a salary like me, you should worry more about your job than where you invest your money. Now is not the time to be slacking off at work trading stocks when you should be working to dodge the next round of layoffs. That said, there are some great bargains out there.

Warren Buffett Recommends Buying American Stocks

I started this post on October 11th and never got around to finishing it. Fortunately, Warren Buffett himself finished it for me with his op-ed in the New York Times on October 16th. I can't say it any better than he did, so I'm not even going to try. Let me first show you what I wrote, then I'll add a link to Buffett's letter.

"I feel like I need to preface anything I write about investing in stocks with the following disclaimers:

1) You should only invest money you can afford to lose in the stock market

2) You should not have a high allocation to stocks if you are close to retirement

3) You should be prepared to see the value of your holdings drop 50% without worrying

That said, I want to make the following statement: now is a good time to buy stocks. And bonds.

How can I say this, when the markets are at 10 year lows and when we've had the worst week in history? Who am I to contradict the headlines?

Let me put it this way: were you happy buying stocks a year ago, when the market was at its peak and the dow was above 14,000? Chances are, you were. (I wasn't.)

When I see Tiffany & Co. selling for $22 a share.. it makes me happy."

I'm not calling a market bottom, and neither is Buffett. That said, people are now fearful and I'm happier in equities right now (see the three disclaimers above) than I am in anything else.

To see how he finished my post for me, I highly recommend you read Warren Buffett's Op-Ed in the New York Times.

What is the best money advice you've ever received?

I recently read an article on Yahoo about the smartest money advice some people ever got and I found it interesting. I always enjoy reading things like that. My favorite was "Don't Follow the Herd" by Robert Schiller:

People do not trust their own judgment but go along with the crowd, even when they can see truth. In a world populated with such people, there are investing opportunities for people who make the effort and do the work see clearly for themselves.

After reading it, I started thinking to myself - what's the best money advice I ever got? I thought back to the books I read that first got me interested in investing years back and all of the Warren Buffett and Peter Lynch nuggets I know by heart. I thought about Peter Lynch's admonishment not to put any money you will need in 3 years or so in the stock market. I thought about Buffett's quote that "investing is most intelligent when it is most businesslike." I thought about a book I read recently- The Richest Man in Babylon by George Clason and the simple investing lessons it offers. (By the way, I liked this book.)

I thought about all of those things, then I realized they weren't really advice, they were just things I read in books. Then I realized the best advice I ever got was the example of my parents while I was growing up. They never had big salaries, but they were frugal and worked hard to send my brothers and sisters and I through school. They never wasted money on fancy things like new cars. They never got me the newest fad in sneakers, and I was always one of the last people to get the new video game console. I didn't like it then, but I appreciate it now.

What is the best money advice you've ever received? I welcome you to share it below. And before you point it out- admittedly, my answer was kind of a cop out but trying to come up with the best single piece of advice I ever received would be kind of like trying to pick the best movie I've ever seen, or the best book I've ever read... way too difficult to pick one but I could rattle off the top 20 or so if I took some time to do it.

To get the juices flowing, here are some more "best money advice" articles, in no particular order:

The Best Financial Advice Ever
Advice from the always-interesting Free Money Finance
The Best Investment Advice I Ever Received - this one is a link to a book on Amazon that I'm thinking about either getting or borrowing from the library. Check out the "Search Inside" feature for some previews.

Online Banks: Stop With The Ridiculous Savings Account Rate Comparisons

I got a flyer in the mail from eTrade financial today, advertising the "complete savings account". It showed a chart that has become all too familiar to me as I've been shopping around for another online bank recently.

On the left was a big bar the size of the empire state building, it had 4.70% in HUGE PRINT at the top of the bar. This is the rate on E*Trade's Complete Savings account. Next to it was this tiny little bar that said 0.50% at the bottom, in tiny print. This was labeled "National Average."

For years, online savings and moneymarket accounts have been making this ridiculous comparison. They compare the rates on their high-yield accounts to this puny "National Average," which the E*Trade footnote says comes from Informa Research Services, Inc.

To put it simply, this is a ridiculous apples-to-oranges comparison, but it seems like every single online bank does it.

What if BMW started running commercials where it raced its newest model against a 1997 Buick Regal, then proclaimed victory when it won the race? We would all laugh at that, because it's a ridiculous comparison.

The "National Average" includes rates that almost nobody in their right mind should be accepting on savings deposits. It includes all of the brick and mortar accounts like my Chase savings account, which currently yields a paltry 0.7%. Do you want to know how much cash I keep in that account? Practically zero.

If you're promoting yourself as a high yield savings account, don't compare yourself to a different category (the broad universe of savings accounts). Compare yourself to your peers just like any consumer with half a brain will do. For example, JD at Get Rich Slowly has a great survey of 12 online high yield savings accounts with rates current as of December 3, 2007. Taking an average of these rates gets me 4.66%. Want to guess why E*Trade isn't using this average in its marketing materials? That's right. It's hard to make .04% look sexy when you put two columns next to eachother in a chart.

Sorry to go off on a rant, but online banking industry, it's time to stop this. I'm calling you out!

In fact, I propose (if it hasn't already been done) that bankrate.com or some other high-visibility banking organization come up with a more appropriate standard average against which online banks can compare their high-yield savings account yields against. I know the banks must be doing this internally already. I think it's time for it to catch on in the consumer world so crazy comparisons like the one I got in the mail today stop getting sent around.

Where to park short-term cash?

I've been shopping around for a new online bank account (savings or money market). It's been a while since I've done this and even though my goal has been to simplify my finances this year, it also makes sense for me to diversify banks now that I have more than $100,000 in deposits. FDIC insurance only covers deposits up to $100,000 so I figured I would start looking for another place preferably with a higher rate than ING Direct's current APY.

Sofar, I'm going crazy. There are so many banks out there looking for your cash these days that it's hard to figure out which one is the best place. What I'm looking for is the highest yield possible, but it seems like every account has certain restrictions and introductory rates and so forth. I guess they devise all of these schemes (limit 3 transactions a month without fees, no check writing, check writing, you must pay bills through our site etc...) to try to get and retain customers.

Over the next few days im going to try to find some quiet time to sort through the noise myself. You would think there would be one easy place to find this info, but this is not the case. Even the blogosphere can't keep up with all of the latest deals, twists, tricks and traps. ( And don't get me started on bankrate.com I like the site but I swear sometimes it panders too much to its advertisers and it seems like one big infomercial.)

If anyone has any advice, feel free to let me know.

The Cost of Market Timing

I've come across a bunch of studies that show how costly it is to try to time the market by buying and selling stocks in the hopes of buying "low" and selling "high," and they've been very convincing. I've never come across such a clear example as what happened in my own 401(k) account not too long ago.

On September 17th of this year, the value of my 401(k) was $52,000. I had enjoyed an ok 6.6% return for the year, based on the strong performance of my international funds and the pretty good performance of my domestic equity index funds. The common stock index fund that represents 60% of my assets in that account was up 6.1% on the year.

Those of you who follow the Fed pretty closely will remember what happened on September 18th. Ben Bernanke cut the discount rate and the fed funds by 50 basis points, 25 more basis points than forecast, and the market ate it up. I posted briefly on it here.

When I checked my 401(k) balance at the end of the day on Sept. 18, it was worth about $53,330, a gain of $1,330. My return was now 10.3% on the year, as the equity index fund rose to a 10.4% return on the year (International stocks hadn't had a chance to respond to the cuts during the day so they underperformed, relatively speaking).

What a difference a day makes. If I hadn't been invested on the 18th, I would have been kicking myself. Of course, there will be days the market takes a big hit in the other direction and I would have been better off with my money in cash, but I believe the big long-term trend is higher and I'm willing to take some volatility along the way in order to build a big nest egg for my retirement. (And based on what's happening with social security, it looks like I will definitely need a big one.)

I guess the moral of the story is, yet again, don't try to time the market. You'll miss out on the big days.

Pretty Good Paycheck Calculation Site

I recently stumbled across www.paycheckcity.com, a nifty little site that lets you calculate your paycheck. It's good if you're trying to figure out what your take-home pay would be if your pay increased or declined. You can fill in state, city and local taxes, payroll deductions, etc... and it does the calculations for you. Just figured I would pass it along. Again: this is not a paid post, just something I've used!

ING Direct Lowers Rates

I figured it would happen sometime after the Fed cut rates, but I wasn't sure when it actually did happen, but I happened to check the rates being credited to my ING Direct accounts this morning and they were lowered.

My 100k+ balance in my Electric Orange checking account is only getting 5% APY now, vs. the 5.30% I was getting previously. My savings account is now getting 4.30% APY vs the previous rate which gave me a 4.50% APY.

This is another reason why I'm not such a big fan of the rather large recent rate cut. Less interest income on my down payment savings.

I'll look around at options such as Certificates of Deposit and other potential alternatives as I decide where I should be keeping my money, but the difference isn't huge and chances are the alternative rates have declined as well so I probably won't do anything in response to the cut (except collect less interest every month).

On the positive side, the rate cut provided a pretty good boost to my 401(k) account, so at least "I got that going for me."

What if the doom and gloom scenarios come true?

If you're an American and you've read the newspaper, or Web sites, or heard people talking lately, chances are you're aware of the major "doom and gloom" economic themes that have surfaced over the past couple of years, and in many cases, intensified over the past few months.


I would put them into three broad categories, which are all interrelated. The first is the housing market collapse, the second is turmoil in the credit markets affecting the international financial markets, and the third is the decline of the dollar (which many say is caused by the budget deficit).


As I was driving home from Dunkin Donuts on a cool Sunday morning in New York City, I passed a bank and recalled a story I'd read the previous Friday describing an old fashioned "run on the bank" that happened in England last week. I thought to myself "What if all of these dire predictions come true?"


I don't think everything is going to collapse like everyone says it will. The US economy has survived a huge number of similar scares in the past and over time our standard of living has increased, stocks have gone up, and people who have worked hard and had some luck have been able to become successful. I consider myself one of these people. For as much as I feel like I'm priced out of the home buying market, I am fortunate enough to have worked my way through college and grad school and into a relatively high paying job as compared to average salaries thorughout the country as a whole.


However, as a thought exercise, I wondered, if someone knew now that all of these things were going to come to fruition, what could they do in advance of the coming crash?

Problem: The declining value of the US dollar.

Fallout: USD paper money is nearly worthless. As confidence in the dollar declines, it will take more dollars to buy the same amount of goods and stores will raise prices to the extent that it would take a barrel full of them to buy a loaf of bread. The government will print up even more dollars and compound the problem. Your bank accounts and 401(k)s, which are denominated in dollars, are worth nothing. Banks fail and depositors lose their life savings.

What you can do now: Put half of your savings in non-USD denominated accounts and buy gold and other assets that will not depreciate along with the dollar. One place to open up an account denominated in a foreign currency is Everbank. Research the economies of different countries, but if I was going to put money into 3 currencies right now, I would probably pick the Canadian dollar, the Australian dollar, and Japanese yen, with other candidates being the Euro and the New Zealand dollar. Put another portion of your savings into gold. I did an entire post about buying gold that you might want to take a look at.

This Motley Fool article has another suggestion- buying stock in companies whose earnings are denominated in foreign currencies in order to squeeze more gains out of the weakening dollar.

Problem: The rising price of oil.


Fallout: It becomes prohibitively expensive to use oil. You won't be able to heat your house in the winter. You won't be able to afford to drive a car.

What you can do now: Investigate moving to a more temperate climate, such as the southern part of the country, where you won't need heating oil. Start riding your bike to work to strengthen your leg muscles and increase your aerobic capacity. Buy shares in an oil company, oil futures or oil HLDRS, so that when the price of the commodity increases, the value of your holdings also increases. Explore the use of solar power (which looks expensive now, but won't when oil doubles or triples). Maybe give one of these solar showers a shot.


Problem: Falling Housing Prices


Fallout: The value of your home drops. The value of your investment property drops. You don't want to live there anymore, and nobody wants to buy it from you. You can't sell it for enough money to pay off your mortgage.

What you can do now: First of all, let me just say that if you bought a house you couldn't afford, you're dumb. If you're fortunate enough to be able to keep up the payments and just live there, then don't worry about the value of your house declining. If you're not selling or buying something, you don't care about what its value is, you care about the cost of ownership. So, ignore the news about home prices if you like living there and can make your payments.

If you have to sell for some reason, I can't really think of anything special beyond the basic real estate ideas to increase your home's curb appeal and stage it etc...

The other thing you can do now is to carefully evaluate real estate prices and mortgage options BEFORE you buy a house. Don't pay the ridiculous prices. Don't get an adjustable-rate mortgage that can reset to a rate that will be unaffordable for you. Put simply: don't buy something you can't afford.

Those are just some brief thoughts I had. Of course you can also just go the direct route of shorting the dollar, buying oil and gold, buying credit default swaps (if you have enough money- these products are more for institutional investors), and shorting the stocks of home builders and mortgage lenders. I'm sure there are a ton of other options. If you think of any good ones, or disagree with the above feel add comments on this post.

Market Turmoil

I love the recent market turmoil. Yes, the value of my 401(k) has been going down, but I am not looking to access those funds for another 30 years or more, so I don't give a toss about these little intra-year selloffs. The DJIA broke through 14,000 a few weeks ago, and it closed under 13,000 yesterday for the first time in a while. People are flocking to invest their money in treasury bonds, causing yields to drop. There is also some speculation that if the market weakness keeps up, the Fed will lower interest rates at its next meeting.

I think that falling yields bring up an interesting scenario for someone with an ING Direct or an Emigrant Direct savings account. If the fed does lower rates, there's a good chance that these banks will lower the interest rates they credit on their savings accounts and the interest rates they offer on their CDs. If you think that this is going to happen, and you have some cash that you aren't going to need for a year or so, you might want to think about putting your money into a one-to-two year CD right now to lock in the higher rates.

I won't say that's definitely the move you should make right now because I don't even try to forecast the way interest rates will move in the next year given how impossible that stuff is to predict with any reliability. All I'm saying is this is something that could happen and you might want to consider doing with a portion of money that you're not going to need for the next year or two. I'm still debating doing it myself, but I don't think rates are going to fall dramatically.

Just wanted to mention one other thing. A stock that I wish I'd bought a long time ago, Moody's Corp (NYSE: MCO) has fallen on hard times lately. Moody's is basically a monopoly-type business, the kind of business that Warren Buffett loves (and he owns a good chunk of MCO stock as well). Investors have sort of been losing confidence in Moody's and other rating agencies lately due to percieved conflicts of interest and quality of ratings. (Do a search for "constant proportion debt obligations" and "moody's" to see an example of this.) It bears further investigation!

Anyway, don't worry about the market's decline. Just watch as you accumulate even more shares of your S&P Index fund.

How Long Should I Keep My Bank Statements?

I keep all of my files in labeled folders in one of those file box contraptions. If you have a job, you're in school, or you have some credit cards or similar accounts, I recommend getting yourself one of these to keep everything straight. I've had something like this for years now and i put all of my important papers in there. Right now I have folders for my car (title, bill of sale, maintenance records etc...), my wife's car, my auto insurance, my renter's insurance, my school records (transcripts etc...), a big file on my current job info, a smaller file with my previous job info (pay stubs, offer letters etc...), my last seven tax returns, my phone bill, my cable bill, my gas and electric bill, my wife's employment records, my retirement accounts, my bank accounts, and my investment account. Plus a few "misc" folders for random things. I also keep a big fat manilla envelope stuffed with reciepts for higher priced merchandise and manuals/warranty info.

I went to take the box out from under my desk the other day and realized that I could barely lift it. I realized that I needed to take two drastic steps. First, work out more, and second, clean out that box. I haven't been very good at getting rid of old stuff, so I reviewed Bankrate.com's list of what financial records to keep, and how long to keep them. I realized that I could shred a bunch of my old bank statements, phone bills, expired auto insurance policies and things like that, so I fired up one of my favorite machines, the Fellowes PowerShred I bought a few months ago and reviewed here.

By the way, this shredder is still cranking through papers like it's nobody's business. There are few things in life as satisfying as dropping a credit card offer (complete with immitation credit card inside) directly into the shredder without even bothering to open it.

So anyway, I spent a good half hour going through everything, and I ended up filling the entire seven gallon container with the shredded remains of my ageing and useless statements and financial records. February 2004 was a great period in my life, but I will never need my Chase WorkPlace Savings Account statement from back then ever again.

Yes it is good to keep records, but at a certain point it becomes overkill, and your March 2003 phone bill, while interesting, only makes it more difficult to get to the records you really need.

Keep those file boxes clean!

Mid Year Review

I like to sit back and reassess my savings and investment goals every now and then. Today being the first of July, I did my mid-year review of my house savings, retirement accounts etc...

Looking back at my year end review - the markets had extremely solid returns in 2006 (the S&P returned about 15.8% last year) and these returns have slowed just a little in 2007, although the year isn't over yet. The bulk of my retirement assets are in an S&P Index fund, which is up just a bit more than 9.3% on the year. Amazingly, my emerging markets fund is up 22% so far this year. This compares with a 30% return last year. If I had put all of my money in this fund (instead of only 5%), I would be a very happy man today. However, I stuck to what I consider to be a more prudent long-term allocation scheme, and I'm sitting around the same percentages as I was at year end.

Some people have asked me for some specific numbers...I do track them, but I don't publish them very regularly. I now have $50,000 in my 401(k) account, and I contribute 15% out of every paycheck (pretax) into the account.

I have also been saving for a home down payment, and that has been progressing nicely. Since we live off my wife's paycheck, I have been fortunate to be able to deposit my entire paycheck into a separate account we have earmarked for a home purchase. Currently we have about $125,000 in that account, which puts us very near our goal of $150,000. We plan on purchasing a home for $300-$400k, and in addition to a down payment, I want to have a good cash safety net, as well as some extra cash for incidentals such as furnishing and repair.

The news on the housing front has been very positive for me lately. Sales are down, foreclosures are up, and hopefully this will lead to a more meaningful price correction. Bad news for homeowners and sellers is usually good news for potential buyers. However, interest rates have been climbing lately, which almost cancels out price declines. I wrote a post about this recently.

I work in finance and I consider myself to be pretty good with numbers. If conditions don't seem favorable to me (home prices and mortgage interest rates), I am happy to sit on the sidelines until some normalcy returns to the market. I think this is beginning to happen, but I am not convinced yet.

My home savings are now in an ING Direct Electric Orange checking account earning 5.25% APY, or about $440 a month in interest. You might recall a previous article where I decided against opening up an electric orange account. However, given the favorable rate of 5.25% for balances above $100k, and the fact that I have been able to get my balance above $100k, I decided it was too good (and too liquid) to pass up. My previous objections mainly centered around a suspicion that the rates were just "teasers" that would go away quickly, however they have remained high for a while. Also, even though I have been trying to keep fewer accounts outstanding, the electric orange account integrates nicely into my ING Direct accounts page, so it is not much work to keep track of it. Finally, I'm only using my Electric Orange account as a savings account so I am keeping my Chase accounts to make bill payments and write checks out of.

So to sum it all up, I've been able to add about $15k to my down payment fund in the first six months of 2007, and $10k to my retirement accounts (these figures include both mine and my wife's accounts). I hope to be able to top this and add $20k and $15k over the remaining six months of the year. We had some large expenses in the first half of the year, including a large charitable donation, car repairs, a hefty tax bill and some generally wasteful spending. I hope to be able to cut down on these things over the rest of the year!

401(k) Rollover Update

It takes nerves of steel to get through the 401(k) rollover process. When we last visited my rollover, I had sent my paperwork out, along with my check, to get processed and deposited into my new account.

A week or 2 went by and I still didn't see the amount show up in my 401(k). So I emailed my plan sponsor.

They told me I left out one of the documents and that I should send this document to them soon, or else they will send my check back to me. The implication there was that they would be sending me back into my 401(k) rollover nightmare.

I know I sent them this particular document, because right before I sent them all of the documents, I photocopied every single one, in order.

I spoke with them on the phone, and they asked me to fax them the document. So I did, earlier this afternoon. I got so busy at work that I wasn't able to call and see if they received it. I am going to be sure to follow up with them tomorrow, though.

If all goes well, that should be the last piece of the puzzle and by this Friday or next Friday, I will have my rollover complete.

If the funds were deposited in my account last Friday as I expected them to be, it would have worked out extremely well for me because that was the end of a bad week for the market. My funds are up a percent or so since then.

My opinion is that this process is a lot more complex than it should be. I'm transferring money from one account of mine into another. It should not require multiple paper forms to be filled out for multiple parties, multiple phone calls, faxes, and it should happen in days, not months.

But I think it will be worth it because when it's all over, I will have one less account to worry about.

A lot of people will tell you about how great it is to do a direct rollover of an old 401(k) balance:

The Motley Fool
The ever-wacky Suze Orman

But they aren't writing from experience. They are writing to you about the theory behind the rollover. In theory it's a great thing. In practice, it is not fun (unless you like paperwork). I guess the difference between a blogger and a journalist/financial advice person like Suze Orman is that bloggers are more likely to do something, then write about it, whereas a journalist will just read about it, then write about it. There's a big difference!

Starting Up A Roth IRA

A friend of mine who is 24 years old and still only a couple years out of college recently made an excellent decision to open up a Roth IRA at TDAmeritrade.

He'd read a bunch articles describing Roth IRAs (rothira.com), he looked at the tradeoffs between investing in traditional vs. Roth IRAs, he asked me some questions about where I thought social security was going to be when he retired in 2047 (don't count on anything, I told him) and most importantly, he found a bunch of retirement savings calculators through Google and saw how much his savings could grow over time if he started today.

He funded his account with $500 (it still counts as a 2006 contribution since he's doing it early in 2007), and the next question he had was: what the hell do I do now? He logged onto TDAmeritrade's site, but being an investment newbie, he had no idea what any of the words meant, and no idea where to go from there.

So I gave him some advice that I would give to anyone in his situation.

First of all, I told him that his money was currently sitting in a money market fund at TD Ameritrade, so even though it isn't earning him much, he can take his time figuring out where to go from there and not feel like he has cash rotting idly away.

He asked me if he could put it in an investment that was guaranteed not to lose any value. I told him he could find something similar to that, but that nothing could ever really have such a guarantee attached to it.

I also told him that, given his 40 year time horizon, he could afford to take on more risk and most likely earn much higher returns over the long run. I recommended he use his $500 to buy shares of an Index Fund, particularly, an S&P 500 Index Fund and even more particularly, the Vanguard S&P 500 Index Fund. I felt that an individual stock would be too risky for him, since neither of us have been following individual stocks lately, and I felt that an actively-managed mutual fund would more likely than not underperform the S&P 500 over the next 40 years, and charge him high fees in addition to all of that.

Before I suggested he log on and make the trade, I asked him another question: are you planning to put any more money in soon? He said he would be able to put another $500-1000 in sometime over the next couple of weeks. As a result, I recommended he wait until he put that next deposit in, then buy the fund shares using a single trade. TDAmeritrade charges $10 for Internet equity trades, and given the relatively modest sum he was talking about, it was worth saving the extra transaction fee.

So that's where he's going to go. Over the next few years, I think he is going to educate himself a lot more about investing, and I'm going to recommend he add some other asset classes to his Roth IRA portfolio, in particular small-cap funds (I am a big fan of Dimensional Fund Advisors index funds in this category) and international funds. I am going to recommend he set target weights, stick to these over time, and strive to keep costs down wherever possible.

When he gets more steady employment (he currently works without benefits), I'm going to recommend that he participate in his employer's 401(k) program, if it gets offered to him, and that he do this via automatic deductions from his paycheck.

I'm also going to give him my copy of The Motley Fool Investment Guide : How The Fool Beats Wall Streets Wise Men And How You Can Too, which is an easy read investment primer. If it interests him, I have a library full of books he can use to explore from there.

The most important point I wanted to get across to him was that investing isn't some kind of black magic. It is something anybody can learn, and, given the right set of expectations (that stocks will perform better than the alternatives over the long run, offering returns somewhere in the neighborhood of 10% per year), it is something anybody can excel at.

Mobile Banking

I've been hearing more and more about mobile banking lately, and I'm on the fence. On the one hand, it would be really handy to check your account balances, pay bills, and make transfers from the comfort of your mobile phone. On the other hand, I'm not too sure how secure it would be, how the Internet speed would be, and whether or not I would actually want to make transactions on that tiny cellphone screen I have.

Bank of America recently announced that it is going to be offering mobile banking this year, with initial rollout expected in March.

The Wall Street Journal also had a good piece on mobile banking today, and from that story, it is clear that this is soon going to become a standard service offered by most banks. Among other potential pitfalls, the Journal mentions that unencrypted text messages (which some banks would use to update customers with account balances) are prone to being intercepted by hackers, and that mobile devices such as blackberries are increasingly becoming targets of viruses.

I'm a big believer in technology, though, and I think mobile banking will catch on and over the next few years, it will become more popular, particularly in the US. The Journal notes that "fewer than than 1 percent of Americans use mobile-banking services, compared with 3 percent in Western Europe and Japan." While I think it is strange to compare 1 percent with 3% and act like that is a big difference, I definitely think there is plenty of room for growth in the space.

Would I want to be an early adopter? No way!

401 (k) Rollover Update

Another milestone in my 401 (k) rollover process has been reached today! I received an email notification today that my rollover application has been accepted and my former employer's plan has cut me a check that I should be getting in 7-10 days. I tried logging on to the site to check if my balance had gone down to zero, but it would not accept my logon information. Hopefully this means I am now done with this account forever.

Now I have to get the paperwork for depositing the check into my current employer's plan ready so that I can deposit the check as soon as it comes in.

Update on 401(k) Rollover

I received an update on my 401(k) rollover today, and it was not great news. Turns out I forgot to fill out one section of my rollover application. They sent that page back to me highlighting where I was supposed to sign.

I think the problem is with their instructions. They actually sent me a form letter that had "forgot to sign section X even though you said you are married" as one of the possible mistakes I made, and that box was checked. Apparently there are about 5 common errors people typically make when filling out this document, and I made one of the 5. It made me wonder: why don't they make it clear that you need to fill out that section if you are married? I guess they find it easier to just have a form letter ready for when you make that mistake.

Anyway, I filled it in promptly and I have it wedged behind the coathanger inside my door (where I keep all the envelopes I intend to mail because it is right in my face as a reminder when I go out). I will mail it out soon. I hope to hear back in another week or so from them. They aren't exactly quick on the turnaround.

When I receive the check from them (around $15k), I will just put it into my new employer's account using the exact same allocation I currently use, so it doesn't throw my percentages off. Then I can forget about it, and I will officially have one less account to worry about!

My High FICO Score

So as part of our whole New Year planning kick, my wife and I looked up our FICO scores online yesterday and they were remarkably similar.

We started off by going to http://www.annualcreditreport.com/ to get our free once-a-year credit reports to make sure we had no errors on our reports, that our identities hadn't been stolen, and in general to make sure that all was well in credit land.

Then we decided to pay the $8 each to get our FICO scores because, as I have mentioned before, we are hoping to buy a house within the next couple of years and we wanted to get a better idea of the kind of interest rates we would be looking at.

To my chagrin, she beat me with an amazing score of 798. I wasn’t too far behind at 782, but that didn’t keep her from doing a victory dance around our livingroom.

We both received the same congratulatory paragraph from Equifax:

“Your score is excellent, and a wide array of loans and credit cards will likely be available to you, often at attractive rates. It is unlikely that your credit application would be denied based on this score alone. The fact that you have received such a high score implies that you scored the maximum (or very near the maximum) possible points for many of the aspects that are evaluated by the FICO score. As such, you should not consider the factors discussed later in this analysis to be any serious flaws with your credit history. They simply indicate the few factors on which you did not score the absolute maximum possible points. And while the guidelines associated with the first few reasons may help you improve your score by a few points over time, you should already have a wide array of credit products available to you.”

A quick lowdown on FICO scores for the uninitiated: a FICO score is a credit score provided by a company called Equifax, and it is used to judge how risky it would be for someone to lend you money. Scores range from 300 to 850, with 300 being the biggest risk and 850 being the smallest risk. Someone with a score of 300 is less likely to repay their debts than someone with a score of 850. Lenders use this score to determine whether or not they will lend you money, and if they do, the rate they will charge you.

Generally, if you have a score of 720 or more, you will be able to get the lowest rates a lender offers on things like car loans and mortgages. Once you get below that general level, lenders identify you as a higher risk, and they will charge you higher interest rates to compensate them for the additional risk they are taking on by lending you money.

So how did we get such high scores?

We never missed any payments, for one. My wife and I both have a few credit cards, and we have never carried a balance on any of them, paying them off in full every month. This is due to the fact that we only used credit cards to purchase things we had the money to pay for. The other main accounts that showed up on our credit cards were our car loans. Neither of us ever missed a payment on those loans, and in fact we both paid off our loans early. Our cars are very modest sedans. In addition, she had a student loan that she paid off shortly after she left college. I have never taken on any student loans.

For another, we have high credit limits and low current balances on our cards, so our ratio of debt to available credit is very low.

What kept us from getting perfect scores of 850? The credit reporting agencies never disclose exactly how their models work, but they gave us some general negatives on our accounts.
My wife got these four nuggets at the end of her report:

1) The time since your most recent account opening is very recent

2) You have a relatively high number of accounts with balances

3) The length of time your accounts have been established is relatively short

4) The proportion of balances to credit limits (high credit) on your revolving/charge accounts is too high

I can explain number one. We recently got a new charge card that pays us frequent flyer miles. That negative should go away in a year or two.

Number two is kind of weird to me. She has 3 credit cards and two have very low balances on them.

Number three is the kick in the face that most people under the age of 30 will get. I think they are looking for you to have had cards/accounts open for 10 years or so.

Number four is a mistake, in my opinion. One of her credit cards (the one she shares with me) shows up as having a credit limit of $0, and we have about $100 charged to that account. I think (but am not sure) this is the reason why she is getting that red flag. Otherwise, her proportion of balances to credit limits is like 3%.

I also had four explanations for my score at the end of my report. #1-3 were the same as hers, but my fourth was “the length of time your revolving/charge accounts have been established is too short.”

Since we are already in the highest credit category, I am not worried about these small black marks against our credit record, and most of them will go away over time. If I was on the borderline, I would definitely try to get her #4 fixed. I don’t know why her credit limit would show up as zero for that one account when I know it is much higher, but it is not something I feel I need to waste my time on at this point.

Anyway, when we do our computations regarding how much house we can afford, knowing our credit scores makes us confident we can use the lowest advertised rates we see out there to make a decision.

There are a plethora of debt reduction books/websites/flyers/podcasts/videos/1800 numbers/interpretive dance troupes/television programs/seminars/booklets/pamphlets/radio shows/bobbleheads etc… etc… They all promise you methods to “improve your credit score fast” and other jibberish like that, but you don’t need them.

I have relied on one secret to keep my credit score high: I only bought what I could afford to buy. Tape that above your desk… “Only Buy What You Can Afford to Buy.” You don't need a flashy new car, you don't need brand new leather furniture with a built-in refrigerator, and you don't need a giant TV. The cheap stuff works just as good. If you have the money to get the big stuff, by all means do it, but don't borrow that money from your credit card company if you don't have it. You'll enter the debt spiral if you do.