My Unofficial Market Barometer

I have long said that I don't try to forecast the near-term direction of the market. However, I do have an unofficial market barometer, and that barometer has been showing signs of activity lately. The needle has begun to move.

This barometer is my brother. The last time we had a market top, he was generally considered the stock picking expert in the family. His picks, the companies he followed, and how much he made last week were all subjects of conversation when we would get together for a family dinner every few weeks or so.

Well, his picks are coming back in vogue. It was tech in 1999, but this time it is smallcap stocks, and he is making a killing.

If history is a guide, I should start hearing stock picks from cab drivers and my barber within the next few weeks, and that, for you traders out there, will be a full-on sell signal.

For you investors (ie smart people), I recommend you keep your ear to the ground, but don't change your course. Continue to sock away your retirement savings, be sure you are staying within your targeted allocations, and you will continue to do fine. If the bottom falls out, by all means, don't panic. Just buy the stocks my barber is frantically selling.

Boring Financial Advice

I've been getting sick of a few pieces of advice I keep hearing. This advice has been repeated so often that it is starting to make me physically sick. You don't need to know anything to repeat this advice, yet people act like geniuses when they throw these little nuggets out there. Suze Orman, I'm talking to you. Two bit hack bloggers, I'm talking to you.

The magazines, websites and TV shows are bad, but I think bloggers are the biggest offenders.

Anyway, in no particular order, here are some of the boring pieces of hackneyed financial advice everybody and his mother thinks they are qualified to give out:

1) Be sure to contribute enough to your company's 401(k) plan so your company matches your contribution. If you don't, you're giving away free money.

OH MY GOD! I AM GOING TO DROP DEAD! WHAT GENIUS ADVICE! TAKE ADVANTAGE OF A MATCHING CONTRIBUTION? I THOUGHT I WAS SUPPOSED TO REFUSE THAT MONEY!

Please, financial people! For the love of all that is good, stop repeating this sentence!

2) Buy things that are on sale.

You mean... pay less for something than it normally costs?? You, my friend, are a personal finance maven. I will surely become A MILLIONAIRE now.

3) Don't buy X. X being some incredibly cheap thing that makes no difference in your budget, but the blogger multiplies X by some huge number and shows how it ends up costing you $2,000 OVER YOUR LIFETIME if it was invested at some high rate.

I found the perfect illustration of number 4 while looking at some different personal finance blogs last week. I pulled up this one blog at Getting-Green.blogspot.com. This site’s tagline is “Information for people who want to be millionaires.”

What a great premise for a site. Information for people who want to be millionaires. I figured there would be some great stuff there, but instead, I was met with this post (I kid you not), entitled Say No to Soda. In your quest to become a millionaire, the author suggests that you stop drinking soda because of how much its costs. The following is a direct quote from this post, with no emphasis added. For some reason his apostrophes show up as a bunch of gobbledygook symbols:

“How much is that pop costing you? Let’s say you get one twelve pack a week, plus buy another 4 soda’s from gas stations or vending machines. That’s about $8 a week on pop, or $416 a year, or $4160 every decade. It adds up to be a lot over time. Instead drink nice cold healthy and delicious water.”

I am sure if you could have asked Andrew Carnegie what contributed most to his great wealth, he would probably say it was the fact that he drank water instead of pop.

This is completely useless information! First of all, who buys 16 sodas a week?
Second of all, we already know how much soda costs. The price is often advertised on the shelf, printed on the box, it shows up at the cash register, and you can even see it on your credit card statement if you use your card to pay for it. Where is the information here?

People already know that they buy stuff that costs money. It is no big secret that not buying something lets you avoid paying for it. I can’t count the number of similar blog posts I’ve seen. “Don’t subscribe to magazines you don’t read, because you could save the subscription fees. Don’t buy that expensive new TV because you could save thousands of dollars.”

Are we really that stupid? Do we need to be told that not buying something will save us money?

I looked around the site to find some description of the author… maybe something that would qualify him to give advice to millionaires. A college degree, a million dollars, a successful business, rich parents… anything that would give him some credibility. However, there was nothing. Not even a brief biography. For all I know this could be a 12 year old kid who got pumped up after reading a copy of “The Automatic Millionaire” or something.

4) The budgeting post. Write down what you spend for a month, then make a budget.

You can see a good example of this budgeting advice in this post, entitled staying afloat financially in college. Sorry to pick on that one blogger but man, the stuff he is putting out is just sad.

If anyone out there is tempted to write an article or a blog post about anything in the list above, please do me a favor... don't.

Reader Reactions to My "Get This Man Out of Debt" Post

I received a ton of feedback on my previous post about a New Yorker article that profiled a man with a low paying job and a big chunk of debt, and it was humbling.

This is what I love about the Internet. It is an amazing forum for sharing ideas. A large group thinking about a problem has the potential to come up with so many more ideas than a single person like me ever could by myself. To everyone who responded: thank you.

I couldn't address each comment individually so I figured I would use this post to speak to some of them.

I really liked some of the additional ideas you had that could save that guy money. Someone said he should have a pay-as-you-go cellphone plan instead of a $60 a month plan. This would be a great idea. I got along without a cellphone at all while I was in grad school, so I know it can be done. Someone else suggested he bring cold cut sandwiches to work every day, another great idea. Another said he should get a $76 monthly unlimited metrocard instead of using the pay per ride cards. This would give him significant savings each month.

Others pointed out how expensive it is to live in NYC. I don't disagree with that at all, and it is one of the reasons I might not be here forever. It was something the article also made very clear.

Some people decided to personally attack me. I was very surprised to read about how I am a "rich snob" this morning as I was at work eating the peanut butter and jelly sandwich I brought with me. That's right. I bring my lunch with me to work. I am saving to buy a house to put my children in when I have them one day, so I can go without expensive lunches for the time being. I have been bringing my own lunches in everywhere I have worked and gone to school since the first grade.

Some people suggested I was the lucky recipient of a free ticket, being raised in the suburbs by rich parents and never facing the oppression of ghetto life. They said I could not know what it was like to be raised by immigrant parents.

The last point struck me the most. My parents are both immigrants, and they aren't wealthy immigrants. They were both farmers who came over here in their 20s with high school level education or below. Both got civil service jobs to raise their five kids. Money was tight and if anything, that taught me better financial habits than if I had been raised among free-spending rich folks.

The line of thinking that disturbed the most can be summed up in this comment I received:

"most of his other problems and mistakes seem to be, or have been, out of his control. I'll give two exampels. Firstly yes he got his girlfriend pregnant, but how do you know that he didn't take utmost precautions but the contraception failed? Hardly his fault if that happened, unless you're suggesting he abstain from sex and relationships just because he is poor?"

This really puzzles me. As far as I know, there is only one way for a guy to get a girl pregnant, and that way is always his fault. I could push this argument even further, but it would become wildly off topic.

I didn't talk about my plan to turn around his finances as a way of taking a cheap shot at this guy. I admire the fact that despite all of the poor choices he made and the situation he is in, he hasn't gone off the deep end. I admire the fact that he gets up early every day to make that long trip in to work. I used to ride the subways at that hour to get to a job that started at 6 am. My trip took an hour and a half so I had to leave my house at 4:30. You can encounter some dangerous situations at 4:30 am in different parts of NYC.

But I have to say, I'm not as sympathetic to him as the person who wrote that article seemed to be. The system is not entirely to blame for his situation. The system didn't drop out of high school. The system did not have sex with his girlfriend for him, and the system did not give him that debt. Those were things he chose to do.

What I do hope is that someone in or near his situation reads this and recognizes that they are headed down the wrong path too. In the best of all worlds, that person would read my (admittedly imperfect) plan, the comments from the readers, and use that information to change course.

I don't mean to imply that society should abandon this guy and that it is his sole responsibility to get himself out of poverty. It makes me sick to see the amount of money some people walk around with while others wallow. I have mentioned before how the gap between the rich and poor is getting to be extreme. It is definitely important to make donations to the poor, but it is even better if you can help someone further along the path to self-sufficiency.

Thanks again to everyone who read the post and gave some feedback. I will sign off with my final thought: it is not easy to become rich, but it is very easy to become poor.

Watch your wallet!

A Plan for Getting a Poor Man Back on His Feet

I recently came across a series of interesting pieces on the cost of living in NYC in New York Magazine. I don't normally read New York Magazine because its target audience is pretentious, holier-than-thou snobs, but it occasionally has some interesting articles.

The one that caught my attention was an article about a 31-year-old guy who lives in NYC and makes $338 a week as a security guard. I suggest you go and read this article before you read further.

OK, keep reading it.

OK, I'm going to assume you've read it now. Do you feel sorry for this guy? I sort of did. I'm not a cold hearted capitalist, so I do feel bad for him. The guy does not have things easy. But in a way, didn't he bring it on himself? I think we can learn a ton from the mistakes he made. What did he do wrong?

1) Dropped out of high school in his senior year, presumably to sell drugs

He tried this for a year or two, then moved out to the sticks and started working on a community college degree. I think this was a fantastic move. Get yourself completely away from the bad situation, live the hermit lifestyle for a while, concentrate on your studies, set yourself up for a good job... But then he made another huge mistake.

2) "Near the end of his freshman year, he learned that his girlfriend in the Bronx was pregnant with his baby. Soon, she and the baby and her two daughters from a previous marriage moved upstate to be with him."

I felt the need to quote that. He LEARNED that his girlfriend in the Bronx was pregnant with his baby. Why didn't they say "he took trips down into the city, and on one of those trips, he got a girl pregnant?" This was a choice he made.

3) He took on $4,500 worth of credit card debt and $6,600 of student loan debt

Another bad choice.

There were some other mistakes he made, but I won't get into them here because they were minor in the grand scheme of things. OK, so giant mistakes aside, how could this guy fix his problems (In theory. I don't know everything about him but I will make some educated guesses)?

The first thing he should do is to drastically cut back on his spending. He blew $20 at a movie that he slept through on payday. He could have bought 20 hot dogs with that kind of money. He needs to take a year or two and live like a monk. There is simply no other way. He has had his fun, but now its monk time. This means going to work, spending as little as humanly possible, and coming home to read a book from the library and go to sleep. No spoiling his kids (when he gets out of debt they will thank him for this), no movies, no extras, just the ascetic lifestyle.

By doing this, he should be able to save $50 every two weeks, conservatively, and pay that towards his credit card bill. He's not paying rent. He can probably knock the balance down by about $1,250 in a year that way.

Second, he needs to look for a higher paying job. I know for a fact that there are union doorman jobs in Manhattan that will pay him quite a bit more than he makes right now. Those jobs will give him benefits, vacation, tips around the holidays, and a pension. If not, he can take other civil service tests such as those for becoming a court officer, possibly a policeman, or some other similar kind of city job.

Third, he should open up a new credit card with a zero interest balance transfer option, assuming they will let him do this. He should transfer the balance over, but immediately cut up the card.

If he can't get a new credit card, he needs to call his credit card companies and ask for a break, whether it be in the interest rate he is being charged, the amount he owes, forgiving past fees/interest etc... He needs to be persistent, but not antagonistic when he does this. He needs to explain that he intends to pay it off. This $4,500 in credit card debt could really spiral out of control if he doesn't focus on containing it.

Fourth, he should try to get a second job, part time. No offense to this guy, but he only works 8 hours a day, and he can easily be doing 11 hour days like most professionals put in. He could get a job stocking shelves, bagging groceries, painting houses, or something similar for 8 hours on Saturdays (if that's his day off). This could bring him an additional $50 or more per week, or about $2,500 in a year. He should put it all towards his credit card debt as he makes it, or the temptation to spend it will be too great.

In a year and a half, if he focuses, he can pay off the credit card debt. By that time, assuming he has gotten a new job, he will be making enough to pay off the student loan in another 1-2 years. Three years from now, he could conceivably be debt free. If he does everything right, gets a real second job, and works even more than I assumed, he could be out of debt even faster.

I know you're thinking a life like that takes its toll. Speaking as someone who works 55-60 hours a week (which is more than the 48 hours a week he would be working under my plan), I can assure you it does take its toll. But you know what? When you're working for something, when you're making progress, and when your situation is improving, you feel like it is worth it.

So when he pays off his debt, what does he do then? He can do one of two things . Note I am assuming it takes him 5 years to get out of debt and he will be 36 years old at that point. This is the longest I think it should take him. I think he could do it in 3.5 years if he really applied himself.

The first thing he could do is to continue working at the "better" job that he has found, assuming it is stable and will provide for him and his kids.

If that job isn't enough, he can start taking night classes and get his degree, or learn a trade.

I know you might think my projections are overly optimistic, but this guy needs a plan, and this is the best plan I can think of, knowing what I know from having read the article.

I do not know if he has a drug problem that would impede his job performance. I do not know if he drinks. I do not know if he does anything else that would get in the way, but I hope he doesn't.

He actually has a lot more hope of escaping poverty than most poor people.

I would love to hear if anyone else has more thoughts on this plan, so please, I invite you to comment. Have you been in his situation? What would you have him do?

Credit Default Swaps

One interesting development in the financial markets that has really gathered steam over the past few years is the use of credit default swaps (Wikipedia), or CDS for short.

CDS are basically a form of insurance against a company defaulting on its bonds. Say you lend $1,000 to a company and it agrees to pay you $5 a year for 10 years in exchange for the use of your $1,000. At the end of year 10, the company agrees to pay you your original $1,000 back. This is the way a typical bond works.

However, what if you are unsure as to the ability of this company to pay you the $1,000 back? What if the company is on shaky financial ground? From where I stand, you can do three things.
1) Don't lend the company the $1,000.
2) Charge the company a higher interest rate, say 10%. However, this is still no guarantee.
3) Buy a CDS.

A credit default swap is basically a guarantee that someone else will pay you back the $1,000 if the company defaults on the debt. Let's say for the sake of argument that you can buy a CDS from Banco Gigante for $1 on your $1,000 bond. You pay Banco Gigante $1, you both sign this agreement, and if the company ever misses an interest or principal payment, Banco Gigante will give you your $1,000 back and take the bond off of your hands. If the company never defaults on the bond, Banco Gigante keeps the $1.

Of course there's also the issue of Banco Gigante's creditworthiness. What if Banco Gigante sold 10 million of these swaps, and ends up on the hook to pay out $1 billion when the company defaults? (rhetorical question for you to think about on your own time)

The existence and widespread use of CDS as insurance against bond defaults makes for even more ways for hedge funds and institutional investors to make bets in the market. In general, the price of this CDS insurance goes up as the perceived credit risk of the company goes up. For example, if people thought the company mentioned above was going to be the target of a leveraged buyout, which would add significantly more debt to its balance sheet and thereby make it less likely to be able to pay you your $1,000 back, the price of its CDS might go up to $5 or $10.

Wikipedia points to another article about some fund managers have been able to make risk free returns using a CDS-based strategy.

News stories have been reporting on CDS more and more as people have gotten more familiar with them. For example, this story from Bloomberg about the firing of Home Depot CEO Robert Nardelli today talks about how "The perceived risk of owning Home Depot's bonds rose after the announcement. Credit-default swaps based on $10 million of the company's bonds jumped 22 percent to $25,000, from $20,500 yesterday, according to data compiled by Credit Market Analysis in London. An increase in price indicates deterioration in the perception of credit quality; a decline suggests improvement."

As far as I know, there is currently no way for individual investors to play the CDS market, but I think they are definitely something worth knowing 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.

Kaizen

Back in the 1980s I was a young child wearing short shorts, socks pulled up to my knees, and lighting ants on fire with a magnifying glass, but I vaguely remember hints of this big American obsession with Japanese management styles, and how America was falling behind in the world. If you’ve seen the movie Gung Ho (imdb), then you’ll have some idea of what I’m talking about. That whole era and the literature (Amazon) it produced focused on the old-fashioned, pre-PC, manufacturing-centric view of the business world. NBC put out this seminal work (wikipedia)related to the whole craze, if you’re interested.

While I don't discount everything that came from that school of thought, part of me just squirms when I read books that talk about dictating memos to your secretary, reading stock quotes off of a ticker tape and other old-fashioned workplace relics, and these references are hallmarks of books written about the Japanese management craze. By the way, the craze had sort of a predictable ending - despite all of our admiration for Japan, its economy peaked around 1989 and showed basically no growth for the next 13 years.

One interesting concept to come from that time that continues to be popular today, particularly as a part of six-sigma (wikipedia) training courses and things of that nature. This is the concept of Kaizen, (wikipedia) a Japanese word meaning “change for the better” or often thought about in English as “continuous improvement.”

What Kaizen basically stresses is that small improvements add up over time, and that workers should try to do things a little better today than they did yesterday.

This isn’t a revolutionary concept, but it was something that popped into my head while I was thinking about my 2007 goals, and how I might try to approach things a little differently when I go back to work tomorrow. Sometimes we tend to stagnate, and making a big change seems like a daunting proposition. Why not go for a bunch of small, steady changes over time? I think this is something you can do no matter where you work, or what your position is.

Maybe you can set up a macro to take a few steps out of a task you frequently run in Excel. Maybe you can cut out your morning recap of espn.com and instead use the time to plan out your day. Maybe you can get a file holder for your desk to keep more frequently used files within closer reach. Nothing huge, but just enough to be able to say that you have done things better today than you have yesterday.

Hopefully a focus on little improvements over time, Kaizen, will make you more valuable to your employer, and as a result, more highly compensated.