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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75340  
Subject: New passive investor looking 4 strategy critique Date: 2/4/2004 10:30 PM
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First off, THANKS for the great boards! And THANKS to The Motley Fool for teaching me enough to feel comfortable going Broker Free!

I'm sorry for this being long, but the shorter posts asking big questions tend to get a lot of requests for more info. I'll try to concisely answer most of the questions you've asked others. I'm still relatively new (< 3 years) to investing, and my strategy has been evolving...

I'd really like to hear what those of you with more experience think about what I'm doing!

Basics...
24 years old, married (5 great years), single income, two kids ( newborn twins :) ), own a very modest house. I started investing around 3 years ago, and I have been increasing the rate of investments (now ~20k/year). I'm not sure if we'll be able to keep up the rate of contributions indefinitely.

Background...
Grew up working in a small family business - I am very comfortable taking on risk when there is a reasonable expectation of long term payoffs.

Financial Liabilities...
Student loans, No credit card balance, Home mortgage, 1 car loan.

Investment Horizon...
~35 years till retirement - maybe less if things go well :)

Investment Strategy...
Try to stay close to a predefined asset class allocation - rebalancing once a year if necessary to create a buy low/sell high effect. For the near future, I expect to be able to rebalance without selling anything by directing future contributions.

Investment Allocations...
As much as possible (given 401k options) I put equity that I hold in passively managed index funds, ETFs, etc. I'm trying to avoid uncompensated risk (individual stocks/sectors). But due to my age, I'm trying to find and emphasize compensated risk (diversified small cap/emerging markets, etc). I'm trying to use funds with no weighting to any one sector.

Account types...
401k & ROTH. Leftovers in Ameritrade brokerage account. (Hoping for LSAs & RSAs next year!)

Goal...
To have a substantial portion of my investments in moderate to high risk, high return, low correlation investments. I hope that by holding multiple fairly volatile low correlation assets types, I can increase the buy low/sell high effect of rebalancing to a predefined allocation annually.

Target Allocation Percentages...
I do not hold separate funds for each of these asset classes. I've just made estimates from allocation data on morningstar.com for the funds I have, to determine how much of each of the funds I hold, I need to get to this allocation.
25% Domestic Large
30% Domestic Small
5% Bonds/Money market
10% Foreign Large
20% Foreign Small
10% Emerging Markets

I didn't give the breakdown, but I have a little more value stocks than growth. I thought about explaining why I've chosen each asset type, but this post is way too long already.

I think this is a risky allocation, so anyone who doesn't know what you're doing: Please don't take this as advice.

Any feedback or recommendations would be greatly appreciated!
Joe
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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38933 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 1:58 AM
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Sounds like you're on track.

Your mainly stock portfolio isn't risky if the investments are long term- stock portfolios have actually been less volatile (if that is how you choose to measure risk) than bonds when the hold period has been over 20 years or so.

If you measure other types of risk, such as "the risk of not beating inflation", or "the risk of not retiring on schedule", stocks are less risky still.

The three ways to mitigate stock risk: diversification, time, and steady deposits of new money into the portfolio.

Nick

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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38934 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 10:00 AM
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"I do not hold separate funds for each of these asset classes. I've just made estimates from allocation data on morningstar.com for the funds I have, to determine how much of each of the funds I hold, I need to get to this allocation.
25% Domestic Large
30% Domestic Small
5% Bonds/Money market
10% Foreign Large
20% Foreign Small
10% Emerging Markets "

LOoks like a good allocation for stock.

I would suggest the following reading

Bernstein, Wm The Four Pillars of Investing. The BEST book in my opinion on modern portfolio theory. Excellent....and very well thought of. You can buy second hand for 20 bucks or less at

http://www.addall.com/

click on 'used books' and do search. New is like $40. There is only one edition out , and pub date is after the crash of 2000, so it includes the dot.com meltdown. Superb! Mandatory reading!

After you read it, you will have good idea of risk/reward.

Also, another excellent book is by Roger Gibson, Asset Allocation, latest edition in 2003. ALso available second hand for $20. New is 40-50 bucks. Be sure to get latest edition.

Or check them out of your library if they have, or ask them to get them.

My feeling is that at age 24, you can be aggressive, but with only 5% in bonds, you are pushing things a little too much to the equity side. I would consider going over time to 80% equities, 20% bonds, and doing it through an index fund, and holding the bonds in the 401K.

After you read the above two books, you will see why.

Enjoy

T.

also highly recommended: Malkiel, A Random Walk Down Wall Street (pub date after 2000) - lots of earlier editions out there

Stanley - The Millionaire Next Door.

www.efficientfrontier.com good for up to date investing thoughts.



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Author: JLC Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38938 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 12:18 PM
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25% Domestic Large
30% Domestic Small
5% Bonds/Money market
10% Foreign Large
20% Foreign Small
10% Emerging Markets


Here is my critique FWIW, i.e., $0.02.

There is such a thing as over-diverisfication. That is, you have 6 different funds. That is alot of additional fees that over time add up. IMHO, too much emphasis is placed on foreign vs. domestic. Almost any large company has an international presence. Also, I would not hold a bond fund, I would go strictly money market for cash/income portion.

To me the simplest allocation would be a total market index and money market fund. Or if you're really set on it, have 3 funds, total market index, international market index, and money market fund.

JLC


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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38941 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 1:07 PM
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25% Domestic Large
30% Domestic Small
5% Bonds/Money market
10% Foreign Large
20% Foreign Small
10% Emerging Markets

comment:

To me the simplest allocation would be a total market index and money market fund. Or if you're really set on it, have 3 funds, total market index, international market index, and money market fund.


That is, you have 6 different funds. That is alot of additional fees that over time add up. IMHO, too much emphasis is placed on foreign vs. domestic. Almost any large company has an international presence. Also, I would not hold a bond fund, I would go strictly money market for cash/income portion.



I diasgree on several counts

1) If you invest in Vanguard type index funds, if you are above the minimums, which for most IRAs are 500/fund, you pay no per year fee for being in the fund if your total account with them is 10K or more.

2) You pay a fee for the mutual fund based upon your assets in the fund. If you pay 0.18% fee, typical of Vanguard, that is based upon the value in the fund. If you have five funds, you pay ONLY on the value in the fund. Thus, you pay absolutely no more for having more index type funds

3) Bernstein and many others recommend 5 to 7 asset categories (I recommend you read The Four Pillars of Investing, by Bernstein). You need to diversify both domestically and internationally, across value and various cap funds. They perform differently at various times in the market cycles. You reduce volatility.

4) The US stock market is well under 40% of the world capitalization (25%?). Thus, owning US stocks,even though many are multi-nationals, still ties you to companies doing a large percentage of their business in the US, and ALSO subject to the fate of the dollar.

Owning stocks overseas, in foreign currency denominations (EUROS, for example), give you dollar/euro change protection, and give you exposure to companies doing much of their business OUTSIDE the US.

5) A money market fund should hold your emergency fund (and not be in an IRA), and not much else..use it to park short term money. With MMF funds paying 0.8% interest, you are losing 2 percent a year if inflation is 3%, hardly a recommendation for doing well over time. Guaranteed loss of a couple percent per year.

Any cash should be in CDs (now paying about 4.3%), TIPS (treasury protected inflation securities) or corporate (short term) bond funds or conventional bond funds. YOu might wish to consider REITS or GNMAs as well for part of your cash position.


Both Roger C. Gibson(Asset Allocation 2001) and William Bernstein (2003) cover this well.

I think the original poster is right on target, other than considering holding at least 20% in NON equities (bonds, bond funds, CDs, TIPS).

FOr those not wishing to spend more than 10 minutes a year watching their portfolio, and rebalancing, and still doing well, I suggest the Couch Potato portfolio at http://www.dallasnews.com/business/scottburns/ . IT has done remarkably well, and takes 10 minutes a year to manage.


t.


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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38943 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 1:36 PM
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"The three ways to mitigate stock risk: diversification, time, and steady deposits of new money into the portfolio."

How much time diversifciation is necessary? I contribute bi-monthly to my 401k. But on the ROTHs, I put in the full 3k at once (6k this time for my wife's since I did 03 and 04 contributions at the same time). Their held at Ameritrade, so I'm trying to pay one commision per year.

I know I could set them up at a fund company and do monthly contributions, but I like having the extensive fund options at Ameritrade. I've been selecting funds/ETFs by choosing an asset class, then looking for the lowest fees, lowest turnover, equal sector weighting, with a high number of stocks.

Thanks!
Joe

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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38944 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 1:49 PM
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telgraph,

Thanks for the book recomendations. I'll look into ording at least one of them tonight.

My "bonds" are a bond/money market fund available in my 401k.

I recently read "Successful Investor Today: 14 Simple Truths You Must Know When You Invest" by Larry Swedroe (pub Sept 03). I found it very useful, and appreciated long term analysis used to back up its positions. If your familiar with it, I'm curious what your thoughts on it are?

Thanks,
Joe

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Author: 2old4bs Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38948 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 5:33 PM
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How much time diversifciation is necessary? I contribute bi-monthly to my 401k. But on the ROTHs, I put in the full 3k at once (6k this time for my wife's since I did 03 and 04 contributions at the same time). Their held at Ameritrade, so I'm trying to pay one commision per year.

Most folks do the same with their IRA contributions (lump sum) because it's a small amount. I think in the case of an IRA, once a year for twenty years or so is sufficient time diversification.

I also agree with t on the book "The Four Pillars of Investing" by Bernstein--it really helped me a lot. I have a similar portfolio allocation as you. Yes, it's riskier than all index, but I've made some substantial gains in those others (emerging markets, foreign large and small, etc.). As long as you stick to rebalancing annually, I don't think it's too risky. Of course, Bernstein is the first to point out that when a fund has been climbing 5% a month for 6 months, it's awfully hard psychologically to sell some of it to rebalance because we all get greedy! You have to fight that urge!

My only suggestion is that unless you're paying less than 2% on that car loan, pay it off! Even if you have to reduce your savings for a while to do it. But I'm sure there are others who would disagree with me (not Suze Orman though!).

If after a minimum of five years, based on your returns, you feel that this allocation is too risky, you can slowly adjust it in increments over the next five years. But, as I said, it doesn't sound too risky to me for someone your age.

Good luck, it sounds like you're on the right track.

2old





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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38953 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 8:07 PM
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>> IMHO, too much emphasis is placed on foreign vs. domestic

I disagree here. If the US goes to hell in a handbasket, and your house, career, and US stocks end up worthless, your only saving grace will be foreign investments. A 25%-30% foreign allocation sounds healthy to me.

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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38954 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 8:14 PM
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>>How much time diversifciation is necessary? I contribute bi-monthly to my 401k. But on the ROTHs, I put in the full 3k at once...

Forget trying to time your contributions and the market. You're going down the wrong track here. Just invest what you have when you have it, assuming the amount is enough that the transaction costs aren't more than .5% of the total invested.

Time diversification just means holding your equity investments for the long term, as in 20+ years. If you'll need the money in six months for a house, stocks aren't the way to go.

Nick

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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38957 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 8:41 PM
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I recently read "Successful Investor Today: 14 Simple Truths You Must Know When You Invest" by Larry Swedroe (pub Sept 03). I found it very useful, and appreciated long term analysis used to back up its positions. If your familiar with it, I'm curious what your thoughts on it are?


Not familiar with the book.

You can stick money in your IRA/401K money in once a year....early is usually better since you have another year's worth of growth on it, but the key to 'time diversification' is that over time, the market trends up, and you want to keep buying at all points of the cycle, because you never know when it is 'low' or 'high' to time it.

It is the discipline to maintain reasonable asset allocation (and some will tell you that in taxable accounts doing too much rebalancing buys you nothing because of tax considerations (see Bernstein on this)), and not jumping from 'hot' sector to 'hot' sector chasing last year's best funds, which likely won't be this year's best fund choices, you'll do better than the average investor.

The 'average' stock market investor over the past 15% did something like 3% compounded growth. If that average investor had bought into an index fund, he would have done 10.8%.

If you want to 'play' with some stocks, take 5% of your money, set it aside for speculation, and have some fun trying to beat the other 95%. maybe you'll get lucky and find a 10 bagger (10x growth), but most folks don't even beat the index. But it takes some of the pressure off, when you have say 1 million in assets, and get the urge to 'play'. Keep 95% in index funds or sector funds, like you have done, and set aside 5% for your own ideas, maybe particular stocks or stock sectors.....that will satisfy your urges...

I've played with my 5%...some years do well....had one or two real winners...also lost on several.....in the end, would have been better off likely...but the other 95% stayed diversified. Now, if I had only sold at the peak....oh well...the story of ten million speculators lives.....

But not taking profits on some of the 5% and reaping the rewards sure beats seeing 80% drop in most of the portfolio!....

As to bonds, those with a 50/50 stock/bond fund allocation (ie, Couch Potato portfolio www.scottburns.com ) saw less than a 10% drop in total value through 2000-2003. Bonds rose 35%. Stocks fell 40%. Let you sleep a whole lot better than those who lost 80% on Nasdaq.

As you head toward retirement, you'll likely want to up your percentage in bonds.

Keep in mind that even if you retire at 50, you will likely still leave at least 60% of your portfolio in stocks for the next 20 years....so if you start in your 20s, you will be holding those stocks (funds) for 50 plus years.

t





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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38958 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 8:41 PM
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>>Forget trying to time your contributions and the market. You're going down the wrong track here. Just invest what you have when you have it, assuming the amount is enough that the transaction costs aren't more than .5% of the total invested.

I agree 100%. I've read the stats about the average of mutual fund cash holdings was 3%-4% right before the tech crash, and around 11% at the bottom before the recovery started. When the "experts" lose so badly trying to play that game, I won't even try :)

I was thinking more along the lines of dollar cost averaging, etc. But it's easiest for me to put in 3k at a time since I've been using cash from selling ESPP stock (which I'm selling immediately after it's put in my account). I'll probably keep doing what I'm doing...

Thanks for the feedback!
Joe

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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38959 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 10:09 PM
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>> Not familiar with the book.
A lot of my strategy originated or was tweaked by Swedroe's book. Some of the major points he made, in my own words are:
1. Strong support for EMH - the only way one could know better than the market is with (illegal) inside information.
2. Strongly Anti-Active Management - He gave many long term comparisons.
3. Strongly against investing in individual stocks, or even sectors.
4. When investing in riskier asset classes, he suggested choosing several with a low correlation (domestic small cap & foreign small cap). By rebalancing annually, the overall volatility of the portfolio is reduced, and in his long term examples (some up to 75 years) the portfolio return is higher than that of any of the individual asset classes.
5. Strongly against chasing yesterdays hot thing - the market has already incorporated in the current situation and all that's left is a higher greater risk.

My first investment was buying sunw at 12.41 (luckily just 100 shares). I rode it down to 2.38 before it started back up. Since something like that would almost certainly happen to me eventually, I'm glad it was my first investment. It drove home the need for a disciplined approach.

I'm well aware of the psychological challenges with rebalancing, but as an engineer I appreciate in depth long term analysis of strategies (Swedroe did a lot of that). When I'm convinced of the long term mathematical effects, I can do things that otherwise feel counterintuitive. So I'm confident I can make myself rebalance annually.

I just ordered the Berstein book (new) for 17.39 including shipping from overstock.com.

For the most part your comments, and those of others, have been pretty close to the conclusions I've reached. One notable exception is on cds/bonds. I was thinking that for the next 10+ years, I'm primarily holding a small bond position to reduce volatility help harvest gains with rebalancing. So I was thinking short term (~1 year) bonds would be best due to the lower correlation with equities. It looks like in order to get the 4% return you mentioned I would have to use 5 year cds. So do you disagree with holding shorter term bonds?

Oh, and the car loan is 0%.

Thanks for the comments everyone!
Joe

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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38962 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/5/2004 11:23 PM
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If you are going to have a ladder, I find CDs very useful if the amount in your ladder is under 500K. Above that, you might wish to start buying bonds.... as you run out of banks paying high interest rates and FDIC insured.

If you have a ladder, you track interest rates up and down. I'm still smiling with the CDs I bought in 99 and 2000...paying 7.3%. I did have to buy a CD this year at 4.3%, but the average of my CD ladder is about 5.5% now, and slowly declining. Once interest rates kick up again, I'll be getting more interest each time I renew a 5 year CD.

Let's say in 2000 I felt a whole lot better having the CDs..knowing there was 5 years plus annual money in CDs that weren't going away....and knowing most 'dips' last on the order of 18 months..makes a downturn easier to stomach.

I use the interest as part of my living money, as they are in taxable accounts, and you pay taxes on the interest. I have no pension (I took a lump sum and am doing better) - it wasn't much anyway.

A ladder will never have the 'best rate' or the worst rate.

I would not buy currently a long term bond fund..they get hit the worst when interest rates rise. If I had to put money into bonds, right now it would be short term corporate bond fund, paying about 3% or so. It will have the least impact from interest rate rise/if when.

I have some money in TIPS in my tax deferred account, as well as some in GNMA and REITS. Mostly in Vanguard total bond fund, with 20% in TIPS.

I didn't get to stash that much tax deferred..less than 15% of my net assets are tax deferred. So I am just letting it grow.

You need to consider some hedge against inflation. Imagine an economy where energy prices climb higher than today..the economy doesn't grow much at all, maybe stalls out.... the deficit rises more and more....interest rates start to rise, but GDP growth doesn't. Stocks stagnate, or worse, drop. People are hemmed in by their debt, but salaries aren't rising - and costs are. Where does that leave you?

t.



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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38963 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/6/2004 12:16 PM
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rookieJoe: "Oh, and the car loan is 0%."

You are an engineer, so I will assume that you ran the numbers, but 0% car loans where you forego a large rebate are not truly 0% (there is an inplied rate of interest resulting from the opportunity cost of foregoing the rebate) and are not even necessarily better deals than taking the rebate and financing elsewhere.

To calculate the implied rate of interest, take your loan payment and term, change the price to reflect the rebate, and then solve for the interest ratewould amortize that lower amount over the same term with the same monthly payment.

You simply hit one of my pet peeve issues.

Having said that, once the deal is closed, the 0% loan borrower has prepaid all the interest and rarely benefits from refinancing.

Regards, JAFO




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Author: Watty56 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38964 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/6/2004 12:17 PM
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Just a few comments,

You may be more overweighed in foreign investments than you are planning because a good percentage of large cap companies earnings come from international operations. I don't have a reference handy but as I recall about 30% of the S&P 500 companies' earnings come from international operations. Combine that with some fraction of the revenue for small cap companies operations being from international operations and you have above 50% of your portfolio in international stocks. That seems high.

I didn't see any mention of collage savings for your kids. Likewise I didn't see any mention of an emergency fund of at least six months take home pay. You should have both of these.

Consider on paying off the car loan early.

Greg


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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38965 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/6/2004 1:09 PM
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You are an engineer, so I will assume that you ran the numbers, but 0% car loans where you forego a large rebate are not truly 0% (there is an inplied rate of interest resulting from the opportunity cost of foregoing the rebate) and are not even necessarily better deals than taking the rebate and financing elsewhere.

I am not an engineer but we did exactly that when we bought my DW's car. The dealer seemed shocked we did not want to go with the 0% financing and we just nodded that we would prefer the rebate as we had secured our own financing.

It came out cheaper for us, as you mentioned, to take the rebate and utilize a low financing rate. I was surprised how many people thought we were foolish to pass on the 0% financing.

It pays to do your calculations....

dt

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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38967 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/6/2004 1:51 PM
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>>You are an engineer, so I will assume that you ran the numbers, but 0% car loans where you forego a large rebate are not truly 0% (there is an inplied rate of interest resulting from the opportunity cost of foregoing the rebate) and are not even necessarily better deals than taking the rebate and financing elsewhere.


Yup, I was checking numbers on the other vehicles we looked at. At the time a rebate was not offered as an alternative for the one we bought.

Don't forget another cost of the low financing instead of taking a rebate: The payoff is higher if the vehicle is totaled. That's more difficult to quantify since taking the rebate with a higher monthly payment (if it is higher) is similar to buying insurance so you won't have to pay more than its worth. To me having the principal be a few thousand dollars less during the high depreciation years is worth a few dollars a month to me.

-Joe




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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38970 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/6/2004 2:52 PM
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joe: Don't forget another cost of the low financing instead of taking a rebate: The payoff is higher if the vehicle is totaled. That's more difficult to quantify since taking the rebate with a higher monthly payment (if it is higher) is similar to buying insurance so you won't have to pay more than its worth. To me having the principal be a few thousand dollars less during the high depreciation years is worth a few dollars a month to me.
\


Huh?

The insurance company could care less what you paid for the car, or if you owe more than the car is worth.

Many insurance companies will give you 'replacement' costs in the first year. After that, they give you wholesale book value. REgardless of what you paid. And that replacement value is what they can negotiate with the dealer, not including zero down.

They could care less whether you rolled financing into 'list' price (and didn't take a rebate), got a 20% discount when you bought it, or didn't. Or whether you have zero down or not.

Your principle is higher since you didn't get a discount in lieu of apparently zero percent financing.

I think your reason on replacement for totalling the car is bogus.

And likely you could have gotten a rebate, only the dealer gets more kick back for getting you to finance, and didn't tell you the truth about the discount he would have offered you. They'll go through all sorts of manipulation to get you to finance, as part of the 'you need fabric protectant' and 'underbody rust protection' and 'paint sealant' and all sorts of other 500% markup ploys.

It's amazing how wrong they can be on financing, trying to convince you that taking their financing is always a great deal, not matter what.

For a lot of folks, that zero percent down results in 4-6-8-10% or more actual interest, if you do the calcuations, sometimes more.

Tens of millions of folks squander most of what they could save a year on repeated 'new car fever' and trying to keep up with the JOneses on purchases, house furnishings, clothing , stuff for the babies, etc.


Next time, if you want to save those high depreciation you might take this advice
http://www.dallasnews.com/sharedcontent/dws/bus/scottburns/qa/2004/stories/020504dnbusburns.2482e.html

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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38971 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/6/2004 3:38 PM
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>>The insurance company could care less what you paid for the car, or if you owe more than the car is worth.

Yup.

>>Many insurance companies will give you 'replacement' costs in the first year.

I think mine just pays wholesale book value.

>>After that, they give you wholesale book value. REgardless of what you paid.

Yup that's my point. They pay wholesale, but the lender is owed the principle.

A hypothetical situation using some round numbers... Choice A: $20,000 at 0%, B (with rebate): 17,000 at 5%. Lets after a year it is totaled, and depreciated wholesale value (what the ins co. pays) is 13,000.

If the vehicle were financed using choice A, it might have a remaining principle around 16,000, while choice B might have had a remaining principle of around 14,000.

If the vehicle was financed with choice A, you owe the lender 3,000 in addition to the insurance payout. But if the vehicle was financed with choice B, you owe 1000 in addition to the insurance payout.

So I view the rebate options as providing some level of "insurance" against owing more than it is worth. Its not worth paying an extra 100 per month, but if the rebate option is a couple dollars per month more, I would do it.

With the exception of the first year for people with the type of insurance coverage you mentioned... Do you agree, or am I missing something?

-Joe

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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38972 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/6/2004 4:20 PM
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Disagree

If you go to http://www.bankrate.com/gookeyword/calc/rebatecalc.asp

you can calculate the difference between taking a rebate, and paying interest rate.

THe current interest rate on new car is under 4% (3.85 at bankrate).

I used 4% vs 0%, with a 3000 rebate, and 48 month term.

You save $1400 by taking the rebate.

As to wrecking the car after 1 year, you might be taking worst case. I've been driving for 40 years, never totalled a car..never had more than $1300 in a car accident, and that once from a hit/run driver. Driven 500,000 plus miles. Knock on wood.....

I'd have to look at the amortization tables, but you are basically paying the same interest rate, and the 0 percent loan is most likely front loaded (meaning you pay more than half the interest in the first year).....so I doubt you would be paying it off at a much faster rate. Also, the zero down might require 'life insurance' on the remaining balance, and other crap added in to protect the car company in case you totally it, and die in the process..they want to get all their money back, even if you don't have it.

I aslo fail to see where this $100/mo more comes from. The zero down loan costs more, you pay more per month...you pay $1400 more for the privelege of thinking you got a good deal by zero percent financing. You are paying LESS per month by taking the rebate. (if you pay $1400 less over the life of the car loan, obviously you are going to pay less each month!).

In fact, at 4% vs 0%, you would be saving 29.16 per month on a 48 month loan.

Or put in perspective, if you live in California, and pay fed and Calif taxes equal to 40-45%, you have to earn more than $55 per month extra just to pay for the privelege of zero percent down financing.

Hmmmmm.......

At a 5% loan for 48 months, you would save $1000 over the life of the loan, or $20/mo. OR in California, you would have to earn nearly $40-45 per month, or over $500 each year to make the extra payments for 'zero down' financing.

ISn't it amazing how the math used by car dealers always seems to show that the 'best' solution is always the one that makes them the most money? Just who do you think pays for all the money the auto salesmen/finance manager get on commissions by selling you 'zero percent' financing?



t.







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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38973 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/6/2004 8:41 PM
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t,

I think we may not be communicating well...

I agree that in the example discussed, the rebate option is better because of the calculator you reference. And that in many other cases it will be better too. I see how you got the 1400, and agree there too.

I was taking all that as fact, and was trying to point out that if loan must be paid off early, this too affects the total cost differences. And that this difference is in favor of taking the rebate option. Although the chances of this happening due to a crash are low... If it does happen, the advantage of the rebate option could be substantial.

Assuming both loans under consideration are for the same period of time... At the beginning of the loan, the amount of the advantage (with the rebate option) is equal to the amount of rebate. Over the term of the loan, the advantage diminishes to 0 with the final loan payment.

Certainly the primary consideration should be: which is better if the loan is not paid off early. In some cases, the calculator tools say it doesn't matter. Then another point to consider is the implications of the loan ending early.

As for the $100/month... Like all the numbers in my example, I made that up. I was trying to point out that the advantage of the rebate option from an early loan payoff was not worth paying a lot of money for. But depending on someone's personal situation, it might be worth paying a little extra. Especially if the person is considering the overpriced insurance the "finance guy" offers for if the car is totaled while owing more than its worth. I wouldn't buy that insurance, but if someone wanted it... it would be worth grabbing a depreciation chart for the vehicle, and charting the additional payout over the term of the loan Vs cost. By making a similar chart to compare the principal differences between financing options ("payout") Vs how much the calculator said the 0% option saved ("cost"). Even if calculator said the the 0% option is best, taking the rebate option may be more cost effective than buying the insurance. Hopefully this expansion of my logic didn't add to the confusion...

I'm having trouble figuring out if I'm being unclear, if you're disagreeing that this is an advantage of the rebate option, or you're just trying to say the comparison of the calculator is most important.

-Joe

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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38974 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/6/2004 9:06 PM
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Most people aren't going to 'buy' insurance in any form for 'totalling' a car within a year....the probability of that happening, unless you are a terrible driver, is small enough as to not be significant.

I don't buy house insurance with the expectation of total house loss...maybe $5000 in hail damage every 10 years in Texas....

Most car accidents are fender benders...if you total a car, you might be totalled as well.....

It is a possibility that seems only obvious to a car salesman when trying to foist high expense insurance on you....like the salesman at the appliance store who insists 'you gotta have this extended warranty for only the amount equal to your purchase......

or, for that matter, at the car dealership trying to sell you an extended warranty..... gosh, if the dealer is so concerned about you totalling your car, you'll never get to the extended warranty part..... <grin>

When they pull that 'extended warranty' on me, and tell me how much I need it, then I say, maybe I just shouldn't buy it if it is so unreliable...and start to walk away....you'd be amazed at suddenly how they insist that it's really very reliable and trouble free........

Done that with car dealers too...tell them I won't buy the car if it is so unreliable...........that it needs an 'extended warranty'....tell them I'll buy a Honda because they never break.... ho ho (not true) but it is good anti-car salemen ammo....

Best yet is to pay cash for your next car..then you don't have to worry about financing at all!....

My first used 3 year old car was financed....paid off in 1 year....second car was half financed (1 year old used).....3rd car was bought for cash, 7 years after I graduated from college..not married with kids, so that makes a difference.....


t.

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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38975 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/6/2004 10:20 PM
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t>> Most people aren't going to 'buy' insurance in any form for 'totalling' a car within a year

I hope your're right. But they (Saturn dealership) tried to sell it to me. I was polite about it, but nothing more. They had already tried to increase the purchase price 1k over what we agreed. That was when I was rude.

t>> tell them I'll buy a Honda because they never break.... ho ho (not true) but it is good anti-car salemen ammo....

t>> Best yet is to pay cash for your next car..then you don't have to worry about financing at all!....

t>> My first used 3 year old car was financed....paid off in 1 year....second car was half financed (1 year old used).....3rd car was bought for cash, 7 years after I graduated from college..not married with kids, so that makes a difference.....


Yeah.. Car salesmen are fun to play with. I read a book "What Car Dealers Don't Want You to Know" It was really good. You might like it.

My first 3 cars I paid cash for (I fixed them up and sold 2 of them for more than I paid). The 4th (first one I financed) was a totaled 95 civic I bought in 98. I put it back together, and it will turn 190k in a week or so. I do all the routine maintenance, and the only non-scheduled items were the CV shafts and battery. Its still on the original clutch. Gotta Love Honda! Got the 5th (the new one that is still financed) for my wife so there would be room for kids.

-Joe

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Author: rookieJoe Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38977 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/7/2004 12:05 AM
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Greg>> You may be more overweighed in foreign investments than you are planning because a good percentage of large cap companies earnings come from international operations.

This is a good point. I've thought about this when I was deciding on allocations, but I'm assuming that the foreign large cap have a similar domestic exposure to offset this affect. If I did reduce any of the foreign stuff, it would be the large cap...

Greg>> I didn't see any mention of collage savings for your kids.

I didn't mention it, but its on the near-term agenda. What I'd really like is to set up LSAs for them if they get passed this year. If in a few months passage doesn't look likely, I'll probably set up a 529 or one of the other college savings accounts.

Greg>> Likewise I didn't see any mention of an emergency fund of at least six months take home pay.

Yeah, I know :) Depending on your criteria, I probably don't strictly follow that rule. The amount of cash in a savings account is considerably less than 6 months worth. But the amount of money I have access to if necessary is considerably more than 6 (or 12) months worth.

Most purchases are done for cash. If money became tight, we would stop buying a lot of optional stuff. We do have some cash (~2 months worth). If I really needed it... I could withdraw the contribution to the ROTHs for the current tax year without penalty (I think?). That sure wouldn't be a good routine practice, but for a true emergency... We plan ahead and haven't had an "emergency" ever. I also have vested but unexercised stock options that are worth a lot on their own. The options of course could decline in value, but I don't expect to ever use the options in an emergency situation. They're just another of potential source... Also most home/auto repairs necessary I am capable of doing myself if necessary (I do almost everything when its not financially necessary anyway).

If the LSAs are passed this year, I'll put in the max quickly, and have some of it in a more stable investment just in case... I would view part of that as an "emergency fund"

If you're not familiar with the LSA proposal, check out this site explaining it: http://lifetimesavingsaccount.com/ It's similar to a ROTH IRA in that contributions are after tax, and all withdrawals are tax free. It is different in that (partial or full) withdrawals can be made at any time for any reason without penalty. Its like a "ROTH savings account"

I've considered paying off the house, its fixed 6.74%. But its only got about 4 years left anyway... In the past, we have paid extra on it. Which gives another option for emergency cash. We have some credit cards with high maxes (but 0 balance). If an emergency required cash tomorrow, I could get a cash advance on the cards, and pay it off with a home equity loan before the bill came due (0 blemish credit, so it wouldn't be a problem). In fact, this was our strategy for several years. We paid extra on the mortgage for just this reason, but never had a need to get the cash. In the mean time, instead of having "emergency cash" earning a low interest rate.... It was paid towards the mortgage where it provided a risk free return of 9.9% (home loan rate for a 19 yo) for the first few years, and 6.74% (refinanced rate) since.

I view debt as essentially a short mm/bond/cd position. It can be offset by holding mm/bonds/cds, but the difference between the rates will be at least 1% or 2%. So basically, rather than holding a short and long mm/bond/cd position at the same time, for the most part I reduce the "short position" (except for mm/bond stuff in the 401k)

Many would not approve of this thinking, and for most I would not recommend it. It certainly leaves less cash setting in the savings account. But our track record makes me think this is fine for us. The only credit card balance we have ever had was a $100 for 2 weeks. And that was (back during college when money was tight) because over a couple months we had: several large planned expenses (car/remodeling), one unplanned and optional large expense, and what kicked it over the top was the next week the $100 microwave died.

I am curious what the rest of you think about this...

Thanks for the feedback.
Joe

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Author: JLC Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39003 of 75340
Subject: Re: New passive investor looking 4 strategy crit Date: 2/7/2004 5:32 PM
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I disagree here. If the US goes to hell in a handbasket, and your house, career, and US stocks end up worthless, your only saving grace will be foreign investments. A 25%-30% foreign allocation sounds healthy to me.

Here is a graph of an international index fund. Pretty much patterns the U.S. stock market bubble/burst. Besides, if the U.S. goes to hell in a handbasket, there is more trouble than the value of my stock portfolio.

http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=fsiix&sid=45824&o_symb=fsiix&freq=2&time=13

JLC


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