Personal Finance: Financial Planning & Investing

[4Q Basket Case]

More on the ease of buying into a Private Equity (or Credit) fund, but difficulty in getting out....

https://www.wsj.com/finance/investing/this-small-town-pension-fund-has-a-warning-for-millions-of-retirement-savers-24ed0112?mod=Searchresults&pos=1&page=1

It's the WSJ, so it's behind a paywall.

Bottom Line: Private Credit and Private Equity accept your investment quickly and easily. They might claim high returns, especially when calculated over an entire business cycle. But their fees are high (which eats substantially into the investors' returns), and they give you your money back whenever they please.

Point being: If you need cash at a time inconvenient for them, they don't care one iota about why you need it.

College tuition? Parent's nursing home? Wife's or child's medical bills? Lost your job and you need the cash to stave off foreclosure on your primary residence? Doesn't matter. They allow you to withdraw what they want, when they want, at asset values that they (not the publicly traded financial markets) calculate -- IOW, just figuring what your investment is worth is an exercise far beyond checking the market.

Clinching quote:

"[Institutions for which PE or PC investments might be appropriate] are likely to be perpetual; you won't be. They have many sources of revenue.....you probably don't. They have in-house specialists who analyze alternative investments; you don't. With billions of dollars [to invest], they get access to the world's best alternative investment managers; you aren't likely to."

And the so-described pros still mess it up.

Unless you're both a Chartered Financial Analyst and a professional in alternative investments, just don't invest any more in Private Equity or Private Credit than the amount to which you can afford to lose access and still say, "Well, dang. But I'm having a good time."

 

[BamaNation]

Unless you're both a Chartered Financial Analyst and a professional in alternative investments, just don't invest any more in Private Equity or Private Credit than the amount to which you can afford to lose access and still say, "Well, dang. But I'm having a good time."

@4Q Basket Case : Thanks for the update! I fail to understand how this makes sense for 99.999% of the folks ... much less how any fiduciary would allow this in a 401k. It is a lawsuit waiting to happen if you're on your company's 401k board / selection team and you select PE/PC as an option. At least when it's been limited to accredited investors then they know (or should know) what the risks are and they have money to lose.

John Doe, a hardworking American (to use the political parlance) working at a job making $50K / year and having a 401k plan, looks at the 1yr return (ie. 30+% per year for some of these PE/PC funds) and says I'm putting all my retirement savings there! Disaster in the making for all of the reasons you mentioned.

In the Bogleheads' Philosophy this is an alternative investment AND is only for those who have "money to lose" AND the amount invested in these should be no more than 5% of your net worth.

Or, go to Vegas or Tunica and put that 5% on red. At least you'll get a free meal, probably.

 

[4Q Basket Case]

In the spirit of Thanksgiving, today's column from Morningstar is a good one.

https://www.morningstar.com/portfolios/10-things-we-can-learn-warren-buffett-that-have-nothing-do-with-money?utm_source=eloqua&utm_medium=email&utm_campaign=MorningDigest&utm_content=None_69471&utm_id=36083

As the title says, it's 10 things Warren Buffett preaches. And they are only tangentially related to money.

They boil down to (1) Keep calm, (2) don't chase trends, and (3) treat people -- employees, peers, business associates, friends, family and neighbors -- right.

Taken collectively, the list of 10 is really a lesson that successful investing naturally falls out from a thoughtful and disciplined approach to life in general, not just money.

I especially like #8 -- Be content. If you follow the approaches of Buffett and Jack Bogle -- they're really similar to one another -- and do that for a working life, you'll retire secure. You probably won't be the richest guy in town. But you'll be both financially set and well-respected in your community. Be content with that, and don't compare your car or house or trips or investment accounts or your wife's jewelry to what others might have.

There will always be people richer than you are. But you're fine and will be until you step off the mortal coil. So why should you stew about somebody else's pile being bigger than yours?

It's a more concise way of phrasing my one of my favorite maxims: Comparison is the thief of joy.

 

[4Q Basket Case]

An excellent article on how regular folks can build true wealth.

Financial influencer tracks 'quiet millionaires': Here's the No. 1 strategy they all share

Financial influencer JC Rodriguez reveals how ordinary people become millionaires through consistency, not flashy investments, in 'quiet millionaires' talks.

www.foxbusiness.com

Two excerpts summarize:

"It really comes down to your behaviors with money, not so much your income… people who don't even have an outlier salary are still able to build wealth through consistent habits and investing into the market…"

I added the underline because this is really important. So many people think their tight financial situation is the result of insufficient income. When the real problem is often an unwillingness to manage their money properly. If they suddenly made more money they'd just spend more, and their spending habits would put them right back in strapped finances in pretty short order. To be fair, this isn't always the case, but it often it is.

I've seen this in my own family. Had a relative who spent more than she made from childhood. If she had a $10 allowance, she'd spend it all the day she got it and beg or bum stuff off of others until the next allowance came. Later, if she made $100, she'd spend $120 and put the overage on credit cards. If she made $100,000, she'd spend $120,000. Not surprisingly, she quickly accumulated far more credit card debt than she could ever pay back. Got an inheritance and bought a nice house, but then bought nice clothes and accessories and cars (which she wrecked with insufficient insurance) and trips and dinners out, couldn't maintain the house, and ended up having to sell it at a material loss.

Note that this is a string of behavioral issues. The unsustainable finances are a symptom, not the core problem. Plus, this sort of thing doesn't happen in a vacuum -- she's been irresponsible on a lot of fronts. Equally unsurprisingly, life hasn't turned out well for her.

Obviously, a decent income is necessary. But if you weren't born with a trust fund, behavior with money is more important in building long-term wealth.

And...

"Nothing about their approach screams overnight success. It is steady and thoughtful."

This is really the hard part. You have to keep on keeping on no matter what your friends are doing or what the talking heads are screaming. And you have to do it for 30 years or so. It's not easy, but anybody can do it.

Another of my favorite adages applies: There are no shortcuts to anyplace worth going.

 

[4Q Basket Case]

OK, we need to stop this nonsense around 50 year mortgages being the solution to buying a house.

The bottom line is that it doesn't help,

It puts the borrower in a worse position than being a renter. That's because it loads the borrower with all the obligations of homeownership, makes negligible reduction in the debt with each payment, yet gives the borrower no benefits of being a renter -- primarily responsibility for property tax, homeowners insurance, HOA fees, and maintenance of the structure and associated systems.

Geek alert: This involves numbers that few of either the talking heads or general public truly grasp. It's a lot easier to rail at "the man" than it is to understand the problem.

Today's interest rate on a 30 year mortgage is about 6.25%.

Say you want to borrow $250K for 30 years at 6.25%. The monthly debt service will be $1,539.
Note: This is debt service alone. It doesn't include property tax and insurance escrows, PMI, or any other charges and fees.

Even if the interest rate on a 50 year mortgage was the same as a 30 year, the debt service is still $1,362. A savings of only $176 a month. Two problems with that.

First, the interest rate won't be the same. There is no established market for 50-year mortgage debt, so we don't know exactly what it might be. We do know that a 15-year mortgage is currently about 5.5% -- or about .75% below the 30 year rate.

The yield curve tends to flatten as you go out far into the future, so let's guesstimate that the 50-year rate would be only .375% higher than a 30 year -- half the difference between a 15 year and a 30 year.

The second problem falls out from that. Now your interest rate is 6.625%. And your monthly debt service is $1,432 -- only about $100 less than a 30 year.

Here's the more insidious side that nobody on the news talks about -- you're essentially paying rent, but with the obligations of homeownership. Property tax, insurance and HOA fees? On you. HVAC craps out? You can't call the landlord. Water heater stops? Repair or replacement is on you. Roof leaking? Again, on you.

What do I mean by, “essentially paying rent”? I mean that you're not reducing your debt obligation by any material amount until a long way in. Here's the geeked-out math.

If you decide you want to sell in, say, 7 years, you've made 84 monthly payments.

On a 6.25% 30 year mortgage, you've reduced your original $250K debt to about $225K -- a $25K reduction after having paid $1,539 every month for 84 months -- that's after forking out, a total of $129K. Plus handling property taxes, insurance, HOA fees, and all other costs of homeownership and maintenance of the structure and all associated systems.

On a 50 year, it's worse.

If you have a 50 year mortgage at 6.625% and want to sell in 84 months, your mortgage balance is still a bit over $244K -- a reduction of a less than $6K after 7 years of paying $1,432 every month, or a total of $120K. Plus all ancillary costs and maintenance.

A 50 year mortgage solves nothing about affordability and creates problems that don’t exist with shorter-term debt.

Increasing the supply of housing solves the problem of affordability.

Late Add: Regardless of how long or short your mortgage term is, homeowners do get the benefit of any increase in property value. And even noting exceptional geographies and economic cycles, homes do generally increase in value.

Problem there is that everybody else's house has also generally increased in value. You benefit from that increase only if you can replace the home at a lower price. For most people, that happens under only two circumstances. One is that you move from a high-priced area to a lower-priced area. The other is downsizing later in life when you no longer need or want a larger home with a big yard and ancillary amenities.

So yeah, your home is worth more, and it feels good to think about that. But how are you going to access that increase without moving? It's not like you can sell off part of your house. And please for goodness sake don't say you'll get a Home Equity loan like the talking heads on TV say you can. You're going to solve affordability by borrowing more? Really?

You increase affordability by increasing the supply of housing. You do that by removing barriers to new construction -- the permitting process (expensive, time-consuming and there are no guarantees you'll get the permit after years and tens or hundreds of thousands of dollars in expense) deporting a big portion of the labor supply, increasing required pay for low-value-added work, requirements for restitution, restrictions on rents, etc., etc., ad infinitum.

I'm not saying you eliminate each and every one of these restrictions in total. We need to understand that it's a balancing act and that there is no free ride either way. With any restrictions, no matter how small, you increase the cost of construction and therefore the price of the home. With every relaxation of restriction, we lose a bit of control.

We need to consciously decide that we're willing to accept $X in increased cost in order to have Y amount of control over what would otherwise be unfettered development. You fill in what X and Y are.

 

[4Q Basket Case]

Good article from Amy Arnott of Morningstar.

She makes the point that what you don't have in your investment portfolio is as important as what you do have. So she lists several types of investments that she steers clear of.

https://www.morningstar.com/portfolios/7-things-i-dont-own-my-portfolio-2?utm_source=eloqua&utm_medium=email&utm_campaign=MorningDigest&utm_content=None_70357&utm_id=36692

I think she does a fine job of explaining why at least six of the asset classes don't belong in most investors' portfolios. I do think she misses on I-Bonds. She's right about the clunky buying process. And she's right in that it takes a while to accumulate enough to move the needle on an established portfolio.

But not everybody has been investing for 15+ years and has an established portfolio. Yes, these things are clunky to buy. And yes, they have a $10K annual cap on purchases. But for a young investor, they can be good vehicles to accumulate an emergency fund that means something (like 3-6 months worth of expenses) in a safe asset with attractive yields that have tax advantages.

Maybe they're not good for Amy. That doesn't mean they're not good for someone in different circumstances.

I also think her 10-year period of analysis for REITs is too short. Real estate cycles are typically longer than the general business cycle. So over the real estate cycle, the correlation with the stock market is lower than she cites.

She's right, though, that you have to have patient money in REITs. When the real estate market goes into a down cycle, it can be a doozy, and you have to have the intestinal fortitude to ride it out. If you panic and sell, you not only lock in a loss, but you un-do the lack of correlation with equities....which is the whole purpose of buying REITs in the first place.

The other asset classes I think range from not good to downright speculative.