Friday, August 24, 2007

Savings Account Rates Going Up

While the fed may end up lowering rates in the near term, banks are beginning up the interest they will pay on savings vehicles. Why?

The collapse of the sub-prime market is having a dramatic impact on the mortgage market. In the past few years, banks and mortgage companies made money the follow way:
1. Provide the mortgage to the buyer;
2. Package the mortgage with others and sell it to other banks or as Mortgage backed securities.
3. By repeating this process over an over, the bank can make more loans over and over without having an increase in deposits.

With new mortgage backed securities basically unmarketable, the only way banks can make loans is to increase deposits.

In particular, companies like Countrywide Bank will be looking for deposits.

Friday, August 17, 2007

Interest Rate Risk and the Saver

For the saver, it is easy to misunderstand interest rate risk and its impact on our strategies. For the purposes of this discussion, I will focus on saving strategies designed to provide access to cash in an emergency and will ignore credit risk by focusing on insured accounts or government securities.

Bond prices are irrelevant to savers, but interest rate fluctuations are not.
• Because bond prices are inversely related to interest rates, bond prices will fluctuate as interest rates change.
• For savers, the bond prices are irrelevant because we can hold securities to maturity.
• BUT – we cannot escape interest rate risk. Although we will get 100% of the security value at maturity, we “lose” interest while our money is locked up.

Example: Bob buys a $10,000 CD from his bank with a 1 year maturity. Based upon current interest rates, Bob will receive 10,675 at maturity. Bob is happy.
• After 6 months, interest rates spike upward. Although Bob will still get his $10,675 back, he has “lost” money with his CD.
• Because Bob cannot reinvest his money at the higher rates for 6 months, Bob has become a victim of interest rate risk.
• Of course, Bob is a winner when interest rates fall (the Fed cut rates today) because he is getting more interest then the market is currently paying.

The Risk Premium: To compensate the saver, Banks and other borrowers must pay savers a premium for tying up their money in longer term interests (CD’s, T-Bills, Bonds)

Recommendations for Savers:

1. First in – the emergency fund should be invested in a high-yield “cash” investment with little or no investment risk. I have a two-tier strategy for this money. My one month emergency fund is in a high-yield savings account with ING Direct. Easily tied to my Electric Orange checking account, I can get to this money almost instantly if needed. Although ING doesn’t pay the best rates anymore, their service is first rate and the convenience/speed saves me the cost of having to keep any money on my credit cards (I pay in full each month). The second tier of my savings strategy is a high-yield money market mutual fund through Vanguard. In addition to the slightly higher rates, it takes 2-4 days to get the money out. This prevents me from spending my savings.

2. Time Money – After the emergency fund, I have a 2 year ladder of CD’s maturing at different times. This allows me to get paid the risk premium for tying up my money for 2 years at a time. By laddering the CD’s, I get paid the prevailing rate on new investments as the CD’s mature and get reinvested.

3. Treasure Bills – TreasuryDirect allows savers to structure a ladder of T-bills with no transaction costs. A good option; however, I prefer the convenience of CD’s.

Convenience Premium: Unless you are the Bank of New York, you are unlikely to have enough money in “cash” to make a huge difference in your finances. While the money is nice, one shouldn’t spend thousands of dollars of time chasing hundreds of dollars of interest. Find a good bank or banks, enjoy the interest, and your free time.

Sunday, August 12, 2007

Market Falls – Increase 401k Contribution

With the market in troubled times, many people think the prudent strategy is to reduce their 401k contributions. At the very least, they want to put all their money in the Money Market Fund or the Stable Value funds.

Although counter-intuitive, the falling market is the perfect time to increase your 401k contribution.

1. As the market falls, you are buying more shares for each dollar you contribute.
2. When the market turns around, you are already invested in a way designed to maximize your upside.

I am increasing my contribution from 9% to 10%. With the company match (we don't have any pension), I am going to be saving 14.5% of my salary.

Engagement Rings – The Big Ripoff

The good news is it looks like I am going to be getting married next summer. The bad news, I had to buy a diamond engagement ring. Although my bride to be is quite understanding and laughed at my threat to get her a “Ziamond,” I did what American men have been conditioned to do. I bought a highly compressed and crystallized piece of coal.

By shopping around, I did my best on getting the most bang for the buck; however, it is hard to shake the feeling that Americans have been duped by DeBeers.

Nevertheless, it is gorgeous and I hope to be looking at it for the rest of my life.

Friday, August 3, 2007

Spend More – Save Money

When we shop, we often face decisions related to different products that do the same thing. For one product, you might have a choice of store brand, value brand, or premium brands. What to do?

When to choose the cheap product:

  1. If the product is disposable or a one-time product, don't pay for extra quality.
  2. Know what brand products are identical to value products.
    1. Clorox Bleach is IDENTICAL to store brand bleach.
    2. Batteries
    3. Baking Soda


When to choose the premium brand:

  1. If you need to use the product for years, it is likely to wear out, and it has a good warranty.
    1. I bought a very nice Fiskar clipper. After a few months of heavy use, it was not working properly. I called their customer service number. They sent me a new one. No questions asked.
    2. When I bought another garden tool with moving parts, I got a Fiskar.
  2. You like the taste better.
    1. If you like taste of Green Giant beans over the store brand, buy the Green Giant
  3. You like the feel better.
    1. If you like the feel of the good toilet paper, there is no reason for the rough stuff.