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I found Whitney Tilson's article today intersting and disturbing. I'm saving to buy a house in the next five years. Most experts advise that if you're investing money to be used in a few years, bonds are the way to go.

This means that right now I'm buying bonds which may be way overvalued so that in a few years I can buy a house which may be still overvalued (I can't bring myself to root for a burst of the housing bubble).

What is one to do? Where are others placing there short term investments?
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What is one to do? Where are others placing there short term investments?

Check TMF's personal finance section, specifically the short term finances section:
http://www.fool.com/savings/shortterm/02.htm?ref=edmain

When I was almost in the same position as you (3 year window), my wife and I first paid off all of our debts. Then we plowed money into a money market fund with check writing privileges as an emergency fund (6 month stash of cash). Then we continued to plow money into the same fund and moved the excess off into CD's or whatever came along that had the same or higher interest rates. Rates were 6% at that time on money market funds which was very good compared to currently (<3%).

Right now, we're building again. This time, we're holding it in a regular old passbook savings account with a credit union that's still running 3%. When the 3% goes away, we probably will too. I know we could boost it higher in CD's and such but our next time window is fairly short (9 months...) so locking it in at this point may not be desirable.

Once it gets back to "comfortable" emergency fund levels again (losing your job and buying a house in a 6 month time period is rough on the cash flow even with a sizable nest egg built up), we'll also begin chipping away at the mortgage payments since right now that will be the short term investment with the highest return. When/if returns on other investments improve, we'll switch off again to something else.

So the short answer is that my wife and I start with known planning horizons and goals. Then we organize our investments around those. So even though (gasp!) we own passbook savings, bonds, AND stocks, there is a clear method to the madness. The first one is geared towards very short term needs. The second one is a cushion against stock market fluctuations for retirement (401K) and has paid handsomely lately. The third is for long term growth.
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I live in a housing bubble city (Vancouver, BC) where a 90 year old "character" home in a decent neighbourhood runs for about C$600,000 (or higher if it has more than 3 bedrooms). Yeah, crazy.

Luckily my townhouse has gone up too.

My question on a housing bubble is; what happens when it bursts? I just can't see these homes dropping $100-200,000 ever. The people with the $500,000 homes (and $400,000 mortgages) just aren't going to be able to afford to sell their homes. To me that means less homes on the market and still elevated housing prices.

Simon

PS: Good article again Whitney.
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"Most experts advise that if you're investing money to be used in a few years, bonds are the way to go."

Hi cranord,

I guess bonds could be a good place to put money away for the short term if the bond matures when or before you need the money.

If the bond's mature at a point after you need the money, your money is at risk as bond prices can go up and down. One sure thing for bond prices to go down is if interest rate's rise. Bond prices can also go down just because the bond market sells off just to put money into stocks. If you get a chance take a look at the pricing of the 10 year US treasury bond over the past couple of weeks and you can see how the price moves around.

My own take is if you're sure you going to need the money in a few years and you don't want any risk to the principle, you might want to make sure that the bonds are very highly rated for safety and they mature at that time and you hold the bond until maturity. Or it might just be easier to stick with safe bank CD's or some equivalent.

ZB
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This kind of nonsense cannot and will not continue -- most obviously because mortgage interest rates are highly unlikely to fall much further (since mid-1990, the rate on a 30-year mortgage dropped from 10.5% to a recent 40-year low of 5.95%). I don't expect a collapse in housing prices -- rather, they will likely return, at best, to the 5% growth rate of the past 30 years. Stocks are likely, I believe, to do a few percentage points per year better.

I'm sure some people in 1986 said that the rise in the market was unjustified because it has increased faster than earnings. If the market starts from an undervalued position, it should rise faster than earnings. If inflation decreases and rates go lower, then multiples, theoretically, should expand even more. The fact that housing has inceased faster than inflation tells us nothing. What if houses were undervalued? I don't know.

This is just like those people who claim NASDAQ would collaspe and cited the high multiples. It wasn't the high multiples (or disregard for valuation) as some have said and think, it was that the assumptions of future growth were bad. In some cases, I don't think investors even cared about what a company could earn. There is nothing wrong with a stock trading at a P/E of 200, as long as, that company can eventually grow into that valuation. After six years of 50% EPS growth, the P/E would be near 17. A little too long for my taste..

The person who deserves a prize for predicting the melt down in tech is the one who wrote about the 150% vendor financing as evidence that things aren't so rosy. Or how all of Nortel's and Lucent's customers are taking on massive debt and earn zero in profits. How most long haul networks only use 40% of their capacity. These stocks were not overvalued, because they simply had a big multiple. They were overvalued, because reality didn't match up with the expectations.

Of course, I was too much of an idiot to see all that was going on to realize JDS Uniphase would go from $3 billion in sales to $900 million.

http://www.lightreading.com/document.asp?site=lightreading&doc_id=2671

I'm stilling waiting for the market for DWDM (dense wavelength-division multiplexing) components to hit $24 billion. LOL!
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My question on a housing bubble is; what happens when it bursts? I just can't see these homes dropping $100-200,000 ever. The people with the $500,000 homes (and $400,000 mortgages) just aren't going to be able to afford to sell their homes. To me that means less homes on the market and still elevated housing prices.

Jobless people can get their homes foreclosed, right when they "can't afford" to sell. Put enough of those on the market and the price can go down 10-20%. Believe it. This "recession" (following the biggest boom in US history) has the lowest unemployment of any on record, as far as I am aware. It would be unusual if the jobless rate didn't go up higher.

-hack

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It wasn't the high multiples (or disregard for valuation) as some have said and think, it was that the assumptions of future growth were bad.

Disregard for valuation was much more a factor than *any* assumption of future growth. In fact, those who bothered to pay attention, during the tech bubble, to the assumptions of future growth that were implicit in the high valuations usually realized that these assumptions would never come true -- so they cooked up all kinds of ideas about why the old rules didn't really hold this time.

There is nothing wrong with a stock trading at a P/E of 200, as long as, that company can eventually grow into that valuation.

If the company's not got some INCREDIBLY solid reason for earnings to grow by a factor of twenty in the immediate future, you'd have to be an idiot to buy a stock with a P/E of 200.

Anyway, maybe I'd feel differently if I hadn't sat out the bubble. :-)

-- Mark
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...I know we could boost it higher in CD's and such but our next time window is fairly short (9 months...)...

Our local Downey Savings Bank is having a special on 9-month CD @ 4%, minimum $1000 provided you also open a checking and maintain >= $500.

I did not find it on their WEB site at the link below but it might be there. http://www.downeysavings.com/

TB
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I'm sure some people in 1986 said that the rise in the market was unjustified because it has increased faster than earnings. If the market starts from an undervalued position, it should rise faster than earnings. If inflation decreases and rates go lower, then multiples, theoretically, should expand even more. The fact that housing has inceased faster than inflation tells us nothing. What if houses were undervalued? I don't know.

That's easy to answer...what's the price of land in the area? And I mean real land, not the overinflated subdivision lots. What's the cost of improving the land...ie, putting a house on it?

That gives you the "value" of the houses.

In the area I'm currently living at, lots were running roughly $20-$30 regardless of the size/quality of the lot if they were 0.25-2 acres, more if it was in an existing subdivision. We then compared the cost of constructing a house on a lot (with that known lot price) and found that we'd get significantly more house if we had a new one built rather than buying one, regardless of whether it was a "market" (speculation) or used one.

So right now we paid about 10-15% LESS than the going rate for a house equivalent to the one we've got simply by going through building rather than buying.
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Just in case there's confusion, I meant $20K-$30K. So used to talking in terms of thousands at work...
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, I meant $20K-$30K...

Rats, I wanted a few of 'em. At $20 - $30, that is.

TB
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Paul,

I agree you can usually get more house for your money having one built vs. buying one already there, but a person also needs to have money available to pay for a place to live on top of the money needed to have a house built.

When you buy a home, you usually switch your rental payments or existing mortgage payments for a new mortgage payment. Going the build-it route, you will still need to pay your monthly rent or mortgage while making the payments on your construction loan.

In my area (northern NJ), lots are a lot more expensive, and the cost of constructing a home can run around $85-$100+ per square foot.

Just something to consider.

Rich
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I agree you can usually get more house for your money having one built vs. buying one already there, but a person also needs to have money available to pay for a place to live on top of the money needed to have a house built.

I had already factored in the "rental problem" as well as the construction loan costs and the real estate cost (which was paid for outright so that it became collateral on the loan)...since it was imperative for me to hold the construction loan and sign off on the draws. This gives you almost complete control over the builder's usual game-playing since "He who owns the gold makes the rules"...ie, we didn't have too many rounds of "I'll get to it eventually" on the punch lists.

These "extra" costs were substantial. I had to have enough cash to float all of them plus downpayment plus all the various fees to pay for crap that is completely bogus but the builder conveniently "forgets". Then there's all the extra change order fees for things that come up but you miss in design.

Still in the end, in this particular area, building substantially outweighed buying when I factored in all the costs. However, in the last place I lived in (central Georgia), the scales were tipped in the other direction. Used houses were not particularly overvalued and with the headaches/time involved in new houses, we were better off buying a used house than a new one, even if we factored in some costs for remodelling (changing carpet, painting, minor/major repairs, replacing really hideous panelling, replacing ancient water heater, etc.). That is partly offset by the fact that I have been spending a lot of money even on a new house since we elected to do the landscaping and some of the decorating ourselves.
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My question on a housing bubble is; what happens when it bursts? I just can't see these homes dropping $100-200,000 ever. The people with the $500,000 homes (and $400,000 mortgages) just aren't going to be able to afford to sell their homes. To me that means less homes on the market and still elevated housing prices.

Jobless people can get their homes foreclosed, right when they "can't afford" to sell. Put enough of those on the market and the price can go down 10-20%. Believe it. This "recession" (following the biggest boom in US history) has the lowest unemployment of any on record, as far as I am aware. It would be unusual if the jobless rate didn't go up higher.

-hack



This is exactly what happened to friends of mine in the early 1980s in Youngstown, Ohio. The steel mills closed, people couldn't make payments on the homes, the banks forclosed and put them up for sale, but unemployment at point hit over 30% - nobody was buying the houses. The prices started to drop. My friends got transfered to another state, and could then they couldn't sell their house - the market was saturated, even at the lower prices, because the jobs weren't in the area. They eventually couldn't make payments on that house and their new one, the bank threatened forclosure and they called the banks bluff! They said, go ahead, foreclose, and the bank decided to give them six more months because they already had too many homes they foreclosed on and figured it was worth maybe having my friends make payments again or sell it themselves.

Remember when the NASDAQ was above 5,000? That wasn't all that long ago. And many people said there wasn't a bubble! (Glad I sold CMGI for a $2 loss at $122 in March '00). If there is a big real estate bubble in your area, the homes could lose a very large portion of their current value, maybe not 75% like the NASDAQ, but I could see them maybe losing 25% of value. And on a $400,000 house that's a $100,000 loss.

Maybe your area has just has high values, but not a bubble, I don't know the particulars, but if it is a bubble, it could really hurt when (if)it bursts.

I guess the consolation is that houses are a bit more tangible and longer lasting than tulips!


Taylor



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