Marketplace

TIPS and deflation

Question: I called my broker to buy some TIPS. He told me to be very careful because they could lose value in a deflationary environment. Is this true? Steve, Minneapolis, MN

Answer: Not really. To be fair, some people use the term "deflation" to mean a trend toward a lower rate of inflation. And in that environment regular Treasury bonds will likely outperform their TIPS peers. But the trend toward lower inflation is what economists and Wall Street financiers call "disinflation."

Deflation is another matter altogether. It is the mirror image of inflation. Deflation is a fall in the overall price level. Inflation is an increase in the overall price level.

U.S. Treasury inflation protected securities (better known as TIPS) are default-free securities that protect the investor from the ravages of inflation. The inflation-indexed bonds come in 5, 10 and 20 year maturities. All offer a fixed interest rate above inflation as measured by the consumer price index (CPI). The bond's principal is adjusted as the CPI changes. I'm a big fan of TIPS since they offer a safe haven in times of trouble and they make sure that the value of a dollar saved today is worth a dollar--plus some interest--5, 10, and 20 years from now.

But here's an additional advantage of TIPS: They also offer owners protection against deflation. TIPS come with a "deflation floor" that protects the holder's principal value if the depression scare turns into a deflationary episode. In other words, if the Consumer Price Index is falling the floor guarantees the TIPS owner either the inflation-adjusted principal or the par value at maturity--whichever is greater. TIPS do not lose their value during deflation.

12/01/08 by Chris Farrell

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Penny stocks

Question: Thank you for your insightful financial advice on Marketplace. I enjoy your commentaries.

I had WM in an individual stock portfolio. Embarrassed - yes...
I was wondering if it would be better to: A. Sell all that stock and take the tax savings this year?, or B. Hang on to the new WAMUQ penny shares and hope that they will eventually make it back to around $12.00 a share? I'm thinking answer A because I don't anticipate those shares reaching those levels again for a long, long, long time. What's your two cents? Eric

Answer: Look at it this way: you have plenty of company owning Washington Mutual. You can also tell people that you owned one of the worst investments of 2008.

But then again, I don't understand the lure of penny stocks. I can't figure out why anyone would playing the penny stock market, especially in the case of a company like WaMu since there isn't any real remaining stock market value to it. There are plenty of good blue chip stocks to invest in. The value of WaMu is now with its new owner--JPMorgan Chase--that took over the company in a deal engineered by the Fderal Despoit Insurance Corp.

So, as far as I am concerned, I see the real value of the these shares for you is taking it as a tax loss.

12/02/08 by Chris Farrell

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Frontload 401(k) contributions?

Question: I am a married 31-year old. I am a corporate lawyer and my husband is an entrepreneur. I'm in the process of setting my 401(k) contributions for 2009. In the past, I've always contributed up to the annual limit (my employer does not match, but it does invest profit-sharing in my 401(k) account) spread out over the course of the year. This year, I'm considering front-loading my contributions so that my annual contribution of $16,500 is taken out of the first 8 or so paychecks of the year.

I'm considering this because (1) I'd like to take advantage of the market's current low prices; (2) we have enough in liquid assets that I can afford to take home a smaller paycheck for the first three or four months of the year; (3) I'd prefer to make the contribution while my job and income are stable -- who knows what could happen as the year progresses?

In addition, about half of my annual contribution will be in the form of a Roth 401(k), rather than a traditional pre-tax 401(k).

Are there any risks with this plan? Should I avoid frontloading my contributions? Emily, San Francisco, CA

Answer: I can't see anything wrong with what you want to do, but there is a trade-off. If you keep making the same contribution throughout the year, you're dollar cost averaging. That means you're putting the same amount of money into your 401(k) on a regular basis. The true advantage of dollar cost averaging isn't financial, bit psychological. Dollar cost averaging takes emotion --fear, greed, and panic--out of investing.

What you want to do is make a small bet by frontloading your contributions that the market is currently undervalued, and that you'll come out ahead compared to regular dollar cost averaging. I'm sympathetic to your point of view. If you're right, and the market does rebound over the course of next year, you'll come out ahead. If you're wrong, you'll be slightly worse off. That's the risk or trade-off.

There is a wonderful passage in Reminiscences of a Stock Operator written in 1923 by Edwin Lefevre. (It's a fictionalized biography of Jesse Livermore, the famed 19th century speculator.) Lefevre tells this story: Somebody asked Baron Rothschild, the great merchant banker, wasn't it difficult to make money on the Bourse (the French stock market)? The Baron replied that, "on the contrary, he thought it was very easy." "That is because you are so rich," objected the interviewer. "Not at all," said the Baron. "I have found an easy way and I stick to it. I simply cannot help making money. I will tell you my secret if you wish. It is this: I never buy at the bottom and I always sell too soon."

In a sense, whether you frontload your contributions or stick with the normal payment schedule, you're following Baron Rothschild dictum. Good luck.

12/03/08 by Chris Farrell

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Investing a windfall

Question: I am 63 and have enough to live on from Social Security, some bonds, the rental of a small cottage and the annuity I purchased when I bailed out of the stock market in March. (My intuition about things to come was causing pretty high anxiety when I'd wake up in the middle of the night, because I had half of all I possess in mutual funds.)

Last year my brother and I inherited 2/3 share of a house from our cousin. It's now worth approximately $270,000 but for many reasons probably won't be sold any time soon.

I asked my brother, who is a wonderful and generous person, if he would buy me out so I could use the money for investment, charitable giving and travel. (One further note about my situation: I don't own a home but live in a rent-controlled apartment I love in the busy, interesting downtown area of my small city.)

Long story short, soon I will have some $45,000 to invest! I feel happy and grateful and sometimes even giddy.

Chris, I really admire your knowledge, insight and wisdom. If you were in my place, what would you do with the money in this economic climate. I've thought about putting $5,000 into gold just in case things get much worse. Thanks SO much for any help you can give. Sarah, Berkeley, CA

Answer: I'm going to give you a very conservative answer (no surprise there, I guess!). First, however, I would strongly recommend taking some of the money and start planning for and then going on a trip that you've dreamed about for years. Enjoy a portion of this windfall.

Then I would take all or most of the remaining money and put it into a certificate of deposit at an FDIC insured bank (or a federally insured credit union), an online savings account with a good yield (again, backed by federal deposit insurance), or a mix of short-term Treasury bills. All of these options will preserve the value of your principal, and earn you a slender amount in interest payments. I would then use the year to figure out how you want to invest this money, what might be the right trade-offs between risk/growth investments and safety/income investments. What about owning some blue chip dividend paying stocks? How about Treasury inflation protected securities? Another annuity? Or keep it in easily accessible, safe investments? There's no rush to decide, and at the end of the year (or some period of time) you'll figure out what's the smart financial decision for yourself.

Last, you mentioned putting a sliver of the money into gold. Here's my two cents: I'm not a fan of speculating in gold. Eyeballing a one year chart, the price of the precious metal is down from its March peak of around $1,000 an ounce to about $777 as I'm writing this. To be sure, the price of gold has risen dramatically in recent years. But if you want to speculate on future prices, I'd prefer that you make a comparable bet on a blue chip stock market index. Yes, the index may go lower--a lot lower as the economic gets worse--but the index will reflect real earnings, employees, profits and markets in the underlying companies. Investors will eventually decide prices have been beaten down too far, that there is value in the market, and start investing more aggressively.

To me, buying gold is simply a bet that you'll be able to sell the precious metal at a higher price in the future than what you paid for it. You might win. You might lose. Other people are more comfortable with that kind of bet than me.

What do listeners and readers suggest she do with the money? (To send us your ideas, just scroll up to the top of the page and click on "Contact")

12/04/08 by Chris Farrell

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Charitable giving

Question: If I only have XX dollars in discretionary funds this year, what's the best way to spend them? Local food banks? International aid? Just a favorite charity, for a favorite cause? Split the dollars among all of these? I have some funds earmarked for charitable giving, and I know other donors (like corporations) are reducing their gifts, so I want to know how to make my giving really count. Joan, Moscow, ID

Answer: This is a really important question with the economy in a recession that is getting worse by the month. Employers slashed 533,000 jobs in November, and the unemployment rate has jumped to 6.7%. The broadest measure of unemployment, a figure that includes marginally attached workers and employees laboring part-time, stands at a dismaying 12.5% or 19.3 million workers, up from 8.4% a year ago, or 12.9 million employees. These numbers are dry reflections of hard times, from a family losing its home to foreclosure, a 50 year old worker getting a pink slip after a quarter century on the job, a recent college graduate working at temp jobs all over town, a single mother facing a sharp cutback in the number of hours at work, and so on.

It's also December, a traditional time for giving, partly because of the holidays but also for tax reasons. Uncle Sam gives you a tax benefit for charitable giving, but it has to be done before the end of the year to claim the deduction on your 2008 tax returns.

Of course, Americans get together all the time to share their concerns and passions, especially when it comes to improving their communities and society. We give money and time to support the arts, contribute to schools, build affordable housing, and tackle all kinds of social problems. We do all this activity through all kinds of charities, nonprofit organizations, and religious institutions that range in size from small groups of volunteers working out of a basement office to national fraternal organizations with several hundred thousand members to multi-billion dollar enterprises with skyscraper headquarters and global ambitions.

To me, what to give to at this time of need is a very personal decision. Hunger is a real problem. So is homelessness. But many community arts organizations also are facing financial pressures. What you want to give to may change over the course of the year. The problem most of us will face is having too little money to give. I know I'm not giving any specific guidance, but I think there are many worthy causes at a time like this. I do tend to like concentrating my charitable giving, but again, I don't think there's a right or wrong here.

Before giving, though, I would check on the of the watchdog groups that are available once you've focused in on an area. For instance, the Better Business Bureau has long kept a close eye on nonprofit organizations. The American Institute of Philanthropy promotes informed giving. These organizations prize financial openness. They frown on charities that operate with steep administrative costs or cozy insider dealings.

But this is a good question to open up to listeners and readers. Any thoughts on where to give during the recession?

12/05/08 by Chris Farrell

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No income and an IRA

Question: I have a Roth IRA and traditional IRA, both with Vanguard. I am not employed at this time but I would like to contribute to an IRA or somehow take advantage of the down market with indexed mutual funds. Can I do this without having earned income? Lynn, Mooresville, NC

Answer: You need to have earned income in 2008 to contribute to an IRA of any kind. (If you were employed earlier in the year, however, you got a wage or salary and you can then contribute to an IRA even though you aren't employed at the moment.) The important exception to this general rule is the so-called spousal IRA. A stay-at-home Mom or a stay-at-home Dad can put money into an IRA even if they haven't earned an income during the tax year. (They've certainly worked, however!)

By the way, even if you don't qualify for an IRA and you want to put some money into index funds to take advantage of a down market, why not do it in a taxable account? The annual tax bite of a broad-based equity index mutual fund like the S&P 500, the Russell 3000, and comparable indexes (assuming that's what you are interested in) is relatively small since there isn't a lot of churn with the portfolio by design. You can always tap the money when you need it without paying the 10% penalty that comes with a premature withdrawal of money from a retirement account.

12/08/08 by Chris Farrell

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No more 401(k) match

Question: Can a company that has been contributing matching funds on a 401K plan created by the company, suddenly stop contributing claiming economic conditions? Bert, Chatsworth, CA

Answer: Yes, a company can cancel its match. There's no legal requirement that companies offer a match, and firms are free to reduce it, suspend it or even eliminate it at any time. For instance, at the beginning of November the troubled automaker General Motors suspended its match into the company's 401(k). Other companies have followed suit. Right now, many people are getting hit by a double whammy with their retirement savings plan. First, their portfolios are in the tank thanks to the 40% decline in the stock market from last year's peak, and now they're losing the match, which is the real financial benefit of a 401(k), 403(b), and other so-called defined contribution savings plans.

That said, very few companies have eliminated the match. What's more, looking at the list of companies that cut down or suspended their match during the 2000-2001 recession nearly all of them resumed payments once economic conditions improved.

You should still continue saving for retirement in your 401(k) plan even if your company does stop contributing to it. A 401(k) plan is still an easy way to save for the long haul and it's a tax advantaged way to salt away money for later in life.

12/09/08 by Chris Farrell

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Invest and borrow?

Question: Hello, I love the show. I'm a bit of a personal finance geek and I look forward to it every week. I'm 25 years old and I'm returning to school in May for a year long program. Since I left college I've been making maximum contributions to a ROTH IRA (biweekly). I'd like to stockpile some additional money to help minimize the loans I need to help pay for school, so I'm thinking maybe I should stop my IRA contributions. However, I hate the idea of stopping contributions right now, when all the stock prices are so low and right after I've just lost quite a bit of money in the downturn.

So my question is: how do I prioritize this? Is it more important to minimize debt, or to continue to contribute to the IRA until I stop working to maximize my retirement money? Also, if it makes a difference I'll be entering the health-care field so I don't anticipate any problems finding employment after graduation. I'd appreciate any input on this dilemma. Thanks for your time, Peter, Buffalo, NY

Answer: We've been getting variations of this question from people wondering about how to think through the trade-off between debt and saving. For many people, the answer is don't take on debt--especially in light of the terrible economy. It's the right starting point for maintaining your financial freedom and flexibility when you graduate. Still, here's a way to think through more carefully the trade-off you're facing.

First, come up with some realistic numbers. What will be the full cost of school and how much would you have to borrow if you fund the Roth IRA? What will be your budget while in school? What will be your monthly debt burden when you graduate--and for how long? How much can you expect to earn when you graduate, and what kind of pay hikes or raises are common in your chosen career? I realize that the job market is tough right now, but you'll still need to research this part of the equation. (The health care market has held up well during the recession, but there's always a risk that jobs will be less plentiful when you graduate.)

Of course, you could make this even more complicated by making some assumptions about rates of return on investment. For instance, a recent paper by Christopher Carroll, professor of economics at Johns Hopkins University delves into the work of the legendary investor Benjamin Graham, as well as more current work by economists John Campbell and Robert Shiller, to judge stock market values over the next 12 years. He make a good case for assuming a 6% average annual rate of return on equities (net of inflation).

But you can't control return. What you can control is the amount of risk you take. That's why I would stay in the world of budgets, salary, and borrowing.

With these figures you can start playing with different scenarios. For instance, let's say starting salaries are low and your debt burden will be high. (That would raise a question in my mind whether the degree is worth it, by the way.) In that case, I wouldn't fund the Roth but focus on limiting your borrowing. However, if starting salaries are good, and the debt after graduation won't eat up much of your income (perhaps you'll be able to pay way more than the standard repayment schedule) then the case for funding the Roth is more persuasive.

Of course, the answer could lie somewhere in between the extremes--fund the Roth, but less than the maximum, and borrow less to pay for school.

The bottom line: Manage and limit your risk. Reduce the downside and weigh the odds. And then decide which trade-off you're more comfortable living with. . .

12/10/08 by Chris Farrell

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Debt and borrowing

Question: Is it better to pay down debt (ie. mortgage or car loan) during periods of inflation or deflation? I understand that it's a good idea to invest during deflation (because the interest rate is added to the deflation rate) and take on debt during inflation, but if an individual took on a mortgage in 2005, is it more financially advantageous to make extra mortgage payments during a period of deflation or inflation? Rebecca, St. Cloud, MN

Answer: First, let's look at the impact of inflation and deflation on borrowing. It only becomes significant at the extremes. When inflation is raging at double digit levels, such as in the late 1970s and early 1980s it does make sense to borrow since you're paying back the lender with depreciating (less valuable) dollars. When the fall in the overall price level is steep--like the Great Depression--the real cost of those debt payments is surging. You don't want debt during a severe deflation.

But during periods of low inflation (such as what we had for much of the past three decades) or mild deflation (which was the case for much of U.S. history before World War II) the message is the same: It's equally advantageous to make extra mortgage payments. You lower your debt burden and reduce the amount of interest you pay to own your home. The main reason not to accelerate payments has nothing to do with the direction of the overall price level. Instead, the concern is putting too much of your money into one asset--a home. Before making those additional payments my standard recommendation is to make sure you have set aside enough in emergency savings and a well diversified portfolio for retirement.

How about investing in a deflationary environment? Let's look at fixed income securities. Interest rates and bond prices are two ends of a seesaw. When bond yields are rising (usually from investors anticipating higher inflation), bond prices go down--and vice versa. Bond prices soared as bond yields came down sharply during the Great Depression. For instance, the prime corporate bond yield average went from 4.59% in September 1929 to 3.99% in May of 1931. By June of 1938 the average corporate bond yield fell to a new low of 2.94%. Government bonds returned about 6% during the 1930s, and short-term bills returned almost 3% over the same time period. Stocks did poorly for the decade.

Still, even fixed income investors are wary of deflation since unwary creditors absorbed huge losses during the 1930s as cash-strapped corporations and municipalities defaulted on their debts. That's why we are seeing a rush into default-free U.S. Treasuries.

Again, the kind of deflation matters. Prices fell at a frightening pace during the Great Depression. The investment record is different when deflation is mild. In many cases deflation and hefty investment returns in both stocks and bonds have co-existed. For instance, from 1802 to 1870 consumer price inflation averaged 0.1% a year. Stocks returned 7% during this period, according to Jeremy Siegel, finance professor at the Wharton School. Short-term government bills returned 5.1% and long-term governments bonds returned 4.8%. No matter how you slice the data the message remains the same, says James W. Paulson, chief investment officer at Norwest Investment Management. "Stock and bond returns run neck-and-neck when inflation is not a worry."

12/11/08 by Chris Farrell

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Trading in Lehman

Question: So, I'm confused as to why people are still buying and selling Lehman Brothers stock. They're bankrupt, why are people trading it, the stock reached as high as 30 cents after filing for chapter 11 protection. Why do their quotes online indicate a dividend (of nearly ten times the share price), why, why, why? I'll gladly buy you guys a round lot of Lehman brothers for an answer. Corwin, Cleveland, OH

Answer: Gee, thanks, Lehman Brothers wallpaper. I think not.

The stock closed at $0.04 today, and year-to-date its performance is -99.9%. It fell from a high of over $84 a share in January 2007 to pennies today. Take a look at this chart, courtesy of Marketwatch:

The Lehman bankruptcy in September--the largest in U.S. history--shook the global capital markets this year. According to news stories at the time, it had $639 billion in assets and $613 billion in liabilities. It's a complicated bankruptcy, and the firm is being dismembered in pieces.

The dividend information you see refkects the last dividend payment by Lehman for the third quarter of 2008, and paid toward the end of August.

By the way, thanks to Emily Brandon's blog at U.S. News & World Report, I see that the Pension Benefit Guarantee Corp. the government agency that insures private-sector pensions, filed today to take over Lehman's pension plan. The pension covers more than 26,500 employees and retirees, and it's 95% funded. If there is a shortfall the PBGC will make good on it. In its statement the PBGC said:

The pension insurer's move comes ahead of a Dec. 22 bankruptcy court hearing on the sale of Lehman subsidiaries that make up the firm's investment management business. The agency acted to end Lehman's pension plan prior to the sale so that the subsidiaries being sold remain liable for the pension plan's unfunded benefit liabilities.... The PBGC acted to end Lehman's plan because it stands to be abandoned following the liquidation of substantially all the firm's assets, and the increased financial risk to the PBGC if the subsidiaries involved in the current sale exit the controlled group and escape liability for the pension plan....

You're right. Shareholders have been wiped out. There's no value left in the equity. The company's stock no longer trades on the New York Stock Exchange. The PBGC is taking over the pension.

But we've seen this trading in bankrupt companies over and over again. Shareholders are out of luck, yet the stock trades as a "penny stock." A penny stock is essentially funny money for speculators and unwary investors. Buying penny stocks is not an investment. It isn't a sensible speculation. It's a mystery to me why anyone would buy a penny stock.

12/12/08 by Chris Farrell

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Bail on 401(k)?

Question: I'm 54 years old with a 401k plan that is pretty much all my savings. I'm married and together we make approx. $80.000/year. We just recently put our two girls through college. In the last year my 401k has lost a third ($90,000)in a conservative very diversified fund. My question; do I cash out my 401k, pay the 10% penalty and put the money in my checking account that gets 5.00% interest? Thanks for your help. Jim, Clarksburg, MA

Answer: No one likes to see their hard-earned money fall sharply in value. It's tough to watch. But I'd leave your retirement savings alone. I certainly wouldn't pay the 10% penalty to get at the money unless I was standing on the financial precipice and it was the only way to prevent my family from falling. After all, you're still young and time remains on your side. You have a long time before it's time for you to consider retiring, let alone start making withdrawals.

A couple of thoughts: First, you could put new contributions into conservative fixed income investments. Second, you could stop funding the plan for a bit if you need to build up emergency savings. Again, it would be preferable if you did continue to save for your retirement. Hopefully, with your two children out of college you have some extra cash around to save outside of your 401(k). Third, I would take advantage of this experience to decide what you want to invest in with your retirement savings once the economy rebounds and the market turns up. (Yes, I am an optimist.) Last, it would still be better if you went even more conservative with the money in the fund--but still not take it out.

In the future, it seems to me that you might want to allocate more of your money into conservative options--such as Treasury Inflation Protected Securities--that preserve the value of your savings.

I think any of these options would be better than taking the money out of the 401(k) and putting it into a checking account.

12/15/08 by Chris Farrell

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Avoiding a "Madoff"

Question: I have Roth IRA accounts with Vanguard and T. Rowe Price. I get transaction confirmations and quarterly statements from each. From what I understand, the people who invested their money with Madoff got the same thing, plus checks that cleared the bank. My question is: How do I know I can trust Vanguard and T. Rowe Price? What prevents those companies from doing what Madoff did? Thanks for your time. Callie, Miami, FL

Answer: It's a chilling thought, isn't it? Scam artists thrive during boom times when caution is tossed aside. For instance, in the 1920s the stock market boomed, and the bust caught many wealthy investors by surprise. Comedian and singer Eddie Cantor supposedly lost a million dollars. Songwriter Irving Berlin didn't heed the advice of Charlie Chaplin to get out and lost a bundle. Irving Fisher, widely ranked among America's greatest economists, damaged his reputation by loftily predicting shortly before the 1929 crash that stock prices had reached "a permanently high plateau." Worse, a large part of his wealth disappeared in the crash.

The reputations of Wall Street's leading lights were also tattered in the aftermath of the crash. For instance, Richard Whitney, acting president of the New York Stock Exchange during the crash and a famous broker with the prestigious firm J.P. Morgan as his client, grandly lived well above his means. When insolvency loomed, he defrauded customers, his wife's trust fund, and the New York Yacht Club. He was caught, convicted, and sentenced to Sing-Sing prison. Charles Mitchell, known as "Sunshine Charley" and head of National City Bank, relentlessly pushed the salesmen in his financial supermarket with branches in more than 50 cities to peddle junk bonds and junk stocks on to an unsuspecting public. He was forced to resign in 1933, and indicted for income tax evasion the following year, although acquitted.

Now, most money managers run legal operations and, largely thanks to the scandals of the '30s, there are checks and balances to the system that work most of the time. The most important is that the money managed by broker-dealers and mutual fund companies is kept in separate accounts, custodial accounts, monitored by the Financial Industry Regulatory Authority or FINRA. These account offer fraud and malfeasance protection up to $500,000 through the Securities Investors Protection Corp. In other words, if you've invested your money in mutual funds managed by Vanguard or T. Rowe Price (to use your examples) or if you trade securities through their broker-dealer operations, you're safe from the kind of Ponzi scheme run by Madoff.

In today's Wall Street Journal a story on how to avoid doing business with future Madoff's highlights the red flag this way: "The key one: Look out for an investment manager who wants complete control of your money, and asks for checks to be made out to him or a company he controls." If someone did that to you, run--don't walk.

Another well known red flag that gets revealed over time: If returns are too smooth and good to be true year in and year out--well, something fishy is going on.

So, all of us need to get familiar with the protections and information offered through the Financial Industry Regulatory Authority at www. Finra.org. The Securities & Exchange Commission offers some good consumer protection information at its website, www.sec.gov. But that agency hasn't distinguished itself at all since this financial crisis began, well over a year ago.

12/16/08 by Chris Farrell

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Buy a home now?

Question: Is now a good time to purchase my first home in Santa Cruz, California? Buying in this area has never been an option until now. I have watched closely as house prices drop. Some properties, not particularly nice ones, have dropped to just about where my husband and I can afford to buy. My husband and I are worried that house prices in general will continue to fall, thus causing the fixer-upper we can buy now, which is already a financial stretch, to lose much of its value in the future. Lindsay, Santa Cruz, CA

Answer: More and more people are asking themselves: Is this the time to buy? Home prices are down sharply over the last two years, and mortgage rates have recently trended lower, too.

Take California. The Golden State's housing boom earlier in the decade was phenomenal, and the subsequent bust has been scary. Over the past year, according to the Shiller-Case index, prices in Los Angeles have dropped by 28% and in San Francisco by 30%. A recent article in the Santa Cruz Sentinel says the median home price in Santa Cruz County fell to $433,000 in November. That's down 41% from a year ago.

The price of a median home is still high, however. I don't know where the residential real estate market's bottom lies--let alone when the housing market will stabilize. My best guess--and it's a guess--is that there are additional price declines in our future.

A home is a good purchase for many people. The key is that your finances shouldn't be stretched. If that's the case, a home is a low return long-term investment with some tax benefits and, most importantly, a lifestyle--a neighborhood and a nesting place.

Price matters. What concerns me is that you'd have to make a "financial stretch" to buy a home. That's how people get into money trouble. I'm less concerned that prices might go lower than I am about what owning a home might do to your financial health.

It isn't just the cost of paying the mortgage principal and interest payments, real estate taxes, and homeowners insurance. A home is expensive to run. You may love tending to your garden and taking care of the lawn, fixing the roof and maintaining the garage, but that pleasure costs money. A good rule of thumb for the average homebuyer is that annual maintenance costs range from 1.5 to 4 percent of the home's original cost. It sounds as if you and your husband are handy since you're looking at fixer-uppers. Sweat equity is a good way to build value, but there is still a cost to repair and improvements.

It's no fun being house poor. That's why I lean on the conservative side when it comes to home ownership. Run the numbers carefully. Be comfortable with the fact that a home typically only pays off over the long haul. Make sure that owning doesn't prevent you from meeting other important financial goals, such as saving for retirement. If your okay by these measures, then buy by all means. If not, I'd be wary.

12/17/08 by Chris Farrell

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Refinance, or not?

Question: In 2006 we bought a house in a pretty strong real estate market with a 30 yr fixed rate that wasn't stellar, (6.75%). We have no problem making the payments and putting away ~10-11% into retirement funds. We have student loan debt (<30k, @2.45%) and are paying those down on a 10 yr plan with no problem as well. My question is with the recent fed rate cuts, and our mortgage being our biggest debt, shouldn't we consider refinancing, and should we be sinking more money into our retirement funds, or into the principal? I've been quoted 30yr rates as low as 4.75% for our situation with closing costs of ~$3.5k, so the savings on the interest rates seems substantial. If its relevant, we plan on keeping the house for at least 5 more years, no matter what, after that it is total unclear. Luke, Baltimore, MD.

Answer: The Federal Reserve Board made history this week by cutting its benchmark interest rate between 0% and 0.25%. Since Thanksgiving weekend the impact of the Fed's campaign has been noticeable with mortgage rates--and a pick up in mortgage refinancings. The gap has widened enough that for many homeowners it makes financial sense to refinance. However, the pool of qualified applicants is relatively small compared to previous refinancing booms because lenders are limiting their interest to those with a good credit score and equity in the home.

First of all, I would run some numbers. There are a number of good calculators. Check out the ones at www.dinkytown.net.

While there is nothing wrong with accelerating mortgage payments, here's why I am cautious about the strategy: You end up putting too much of your financial nest egg in one basket--a home. That's why I still prefer building up a well-diversified portfolio, even in a market like this one. I would still save for the long run in a diversified retirement savings plan.

For many people a reasonable way to shorten the life of the mortgage without cutting back on retirement savings is to make an extra monthly payment a year. I've recommended this before. By writing 13 monthly mortgage checks instead of 12 you'll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal.

12/18/08 by Chris Farrell

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First time homebuyer

Question: What is your suggestion for finding up to date information on all I would need to know about mortgages for the first time buyer. I would assume that most books on the subject are now out of date with the current market. Paul, Valley Cottage, NY

Answer: One of the resources I like is www.hsh.com. It offers up to date information and thoughtful articles on the basics of buying a home, refinancing and the like. Another good source for information is www.bankrate.com.

12/19/08 by Chris Farrell

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Join retirement savings plan?

Question: Hi Chris. I have the option to enroll in a retirement plan at the company I work for. In light of the current stock market turmoil, I am a bit weary to enroll and wonder, is it worth it? I do have options of safe, moderate or risky investments, but they all seem a bit risky now. I am a 29 year old, earning about 41000 a year and the only debt I have is student loans, lots of student loans. Thank you for your insight. Janet, Minneapolis, MN

Answer: It's definitely worth it to participate in the retirement savings plan at work--especially if your company matches at least part of your contribution. I think even those financial planners and market forecasters that expect years of low returns and bad markets ahead of us would agree with that. The "match" is where much of the return comes from in a retirement savings plan.

Still, even if your company doesn't match your contribution, I would join the plan. For one thing, it's pretax dollars that goes into the retirement account. For another, the automatic withdrawal from your paycheck makes it remarkably easy to save, something most of us find difficult to do even with the best intentions.

I feel less strongly about which investment option you choose, although I want to stress the importance of building up a well-diversified portfolio. It's impossible to know if the market is hitting bottom now--or might do so in a year or even two. That's why the old proverbs that preach diversification and dollar-cost averaging remain wise counsel to anyone investing for the long haul. Diversification isn't a hedge against any financial crisis over a short period of time, but it's a smart strategy over any length of time. By mixing stocks, bonds, and other assets you can earn the highest potential return for the amount of risk you're willing to accept.

The benefits of diversification in reducing risk have long been recognized. A passage from the Talmud says, "A man should always keep his wealth in three forms; one third in real estate, another in merchandise, and the rest in liquid assets." Antonio in the Merchant of Venice slept soundly because, "My ventures are not in one bottom trusted, nor to one place; nor is my whole estate upon the fortune of this present year." Ideally, some of the assets in your portfolio will zig when others zag. Since no one really knows which markets will soar or sink, investing in all the major asset classes creates an opportunity to limit the damage from a downturn and to be in a position to catch the next big market upturn.

However, if for now your not sure what to do, join the plan, put the money into very safe assets, and then figure out over time how you'd like to create a diversified portfolio.

12/22/08 by Chris Farrell

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Ginnie Mae

Question: We've heard so much about the problems with Freddie Mac and Fannie May, how are they difference from GNMA's. Our investment in them seems to be holding its value when all else has declined. Why? Robert, Clinton Township, MI

Answer: Fannie Mae and Freddie Mac were hybrid companies, part private and part public. They were "profit-driven corporations, owned by shareholders and, in theory, beholden only to them," wrote James Surowiecki in a New Yorker column. "But they're also so-called 'government-sponsored enterprises,' set up by the state with the explicit mission of fostering homeownership, by buying and selling home mortgages." Fannie Mae and Freddie Mac had the implicit, but not explicit backing of the federal government. However, that implicit guarantee allowed the companies to raise money cheaply on the capital markets. The corporations were also exempt from most state and local taxes, as well as free of many Securities & Exchange Commission requirements. In the end, the hybrid structure allowed for management to fund too rapid growth with cheap money and gargantuan private sector pay and bonuses. Of course, as we all know the house of cards fell apart this year. The federal government had to make its implicit guarantee explicit by bailing out the two mortgage giants over the summer, and then, in essence, nationalizing them.

The Government National Mortgage Association--better known as Ginnie Mae--was established by Congress in 1968. It is a government-owned corporation within the Department of Housing and Urban Development (HUD). It was never partially privatized. It was never a hybrid private/public corporation (or what Surowiecki aptly called "the duck-billed platypuses of the financial world.") As a government agency the full faith and credit of the U.S. taxpayer has always been on the hook with Ginnie Mae. The federal guarantee was explicit all along. That meant it was conservatively run and managed with the risks it absorbed under control. Indeed, the agency's business model is conservative. It guarantees the timely payment of principal and interest on mortgage backed securities and the underlying loans are insured or guaranteed by other agencies--the Federal Housing Administration, the Department of Veterans Affairs, the Department of Agriculture's Rural Housing Service, and HUD's Office of Public and Indian Housing. By the way, Ginnie Mae's traditional edge on its better known rivals was erased after the federal government took over Fannie Mae and Freddie Mac.

Still, considering the simplicity of the Ginnie Mae business model it's hardly surprising it has largely stayed out of the news. That's not the same thing as saying there isn't any risk asscociated with its mortgage-backed debt. For one thing, like all bonds the value of its securities fluctuates with changes in the interest rate environment. For another, as with all mortgage-backed securities, when interest rates fall the owners of Ginnie Mae securities will probably get their investment money back earlier than expected. That's because the securities are made up of lots of mortgages. When rates fall, homeowners refinance, and the mortgage is paid off. Investors get their money back early forcing them to reinvest that money at a lower rate.

Nevertheless, these risks are relatively small compared to the safety of the security--something everyone worries about these days.

12/23/08 by Chris Farrell

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Happy Holidays

Happy Holidays to everyone. It has been quite a year. And I really enjoy your questions and comments as we try to figure out how to manage our way through the turmoil.

Several years ago, I read the Stanford University commencement address by Steve Jobs. I was recently doing some research, and I came on the transcript again. It's really worth reading, especially at the Holiday season and with a New Year looming,

Here's the last part of his talk:

Your time is limited, so don't waste it living someone else's life. Don't be trapped by dogma -- which is living with the results of other people's thinking. Don't let the noise of others' opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary.

When I was young, there was an amazing publication called The Whole Earth Catalog, which was one of the bibles of my generation. It was created by a fellow named Stewart Brand not far from here in Menlo Park, and he brought it to life with his poetic touch. This was in the late 1960's, before personal computers and desktop publishing, so it was all made with typewriters, scissors, and polaroid cameras. It was sort of like Google in paperback form, 35 years before Google came along: it was idealistic, and overflowing with neat tools and great notions.

Stewart and his team put out several issues of The Whole Earth Catalog, and then when it had run its course, they put out a final issue. It was the mid-1970s, and I was your age. On the back cover of their final issue was a photograph of an early morning country road, the kind you might find yourself hitchhiking on if you were so adventurous. Beneath it were the words: "Stay Hungry. Stay Foolish." It was their farewell message as they signed off. Stay Hungry. Stay Foolish. And I have always wished that for myself. And now, as you graduate to begin anew, I wish that for you.

Stay Hungry. Stay Foolish.

I'll be back on Monday taking your questions and reading your comments.

Chris

12/24/08 by Chris Farrell

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Wachovia

Question: We have inherited a substantial amount of stock's from Wachovia, (value around $50,000). Our question is should we keep these stocks knowing how unstable the market is, or, should we liquidate the stocks and pay off our credit card debt. Our current balance is approximately $25,000. So far we have spent around $35,000 of this inheritance from other sources. Thanks, Bev & Mike, Augusta, KS

Answer: I can't say if it makes more sense for you to hold or sell the stock. There are a lot of factors that go into a decision like that, from how patient you can be with the stock to how pressing is the financial needs you currently face. However, in the current environment (actually in any economic scenario) getting rid of credit card debt and staying out of credit card debt is a good thing.

That said, I want to highlight a critical aspect of the answer: Do you want to be a shareholder in Wells Fargo over the long haul? That's what you shortly will be since on Dec. 23rd the shareholders of Wells and Wachovia gave the thumbs up to a previously negotiated merger agreement.

The merger creates one of the country's largest banks with over $1.42 trillion in assets and some $800 million in deposits. The merger is part of a wave of consolidation sweeping the banking industry in response to the ongoing financial crisis. Vulnerable and weak institutions (like Wachovia) are seeking shelter by hooking up with sound and strong banks (such as Wells Fargo). San Francisco-based Wells struck the government brokered deal for Charlotte-based Wachovia back in October after a brief but bitter battle for control with Citigroup.

It's not surprising that the value of the merger has fallen since last October. It was originally estimated as a $15-plus billion deal, or around $7 a share. (Wachovia shareholders will receive 0.1991 shares of Wells Fargo common stock for each share of Wachovia they hold. ) But as I am writing this, Wachovia's stock is down to $5.43 a share, putting the value of the merger at a bit under $12 billion.

Again, if you hold on to the stock your making a bet on the long-term future of Wells Fargo, and that it will succeed over the next several years in integrating the operations of the two companies. The other factor is that you're betting you will earn a higher return on the equity than the "return" you would get on your money by paying off the credit card debt.

12/29/08 by Chris Farrell

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Negotiating credit card rates?

Question: do you think paying for a service to lower interest rates on credit cards can work? AFL Financial Services charged 990.00 to negotiate with my credit card companies, to lower interest rates. I have personally been able to negotiate with the companies in the past but now they aren't working with me. thank you karen, Seneca Falls, NY

Answer: More and more people are falling behind on their debts, thanks to the twin pincers of a financial crisis and a deep recession. That said, I'm not a fan of paying big fees to any outfit to renegotiate consumer credit card charges.

Here's a checklist for anyone carrying too much debt and looking for help. (My assumption with this list is that the debt burden has created a financially precarious situation calling for strong remedial action.):

First, check out a branch of the National Foundation for Credit Counseling (NFCC). It was founded in 1951, and it's the biggest and oldest national nonprofit credit counseling service. The website is www.nfcc.org and the toll free number is 1-800-388-2227. For example, I looked at the branch nearest you, which is in Syracuse. It offers Internet, phone and in-person counseling and the fees range from zero to $30. Low fees matter. You're already cash-strapped.

Second, for anyone that can't see their way out of debt (and it seems to me from your email that isn't you) consult with a bankruptcy attorney. Sometimes bankruptcy is the best path toward getting a fresh financial start. Sometimes it isn't. But you should be able to make an informed decision. A good source of unbiased information on bankruptcy and other avenues for getting out of debt is www.nolo.com.

Third, don't give up yet on renegotiating rates with lenders. Right now, it appears that your experience is fairly typical. But there is growing pressure on financial institutions benefitting from a taxpayer bailout to work with customers rather than take a tough stance. I'd get back in touch with your creditors in the New Year.

Last, whatever you do to get out from under your debts, congratulations. But the real trick is to make sure you stay out of debt. Create a plan--and stick to it..

12/30/08 by Chris Farrell

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Mortgage rates

Question: According to the Market Gauges in today's New York Times, the federal funds interest rate has dropped from 4.25% to 0.25% in the past year. Yet the rate charged homeowners for a 15 year fixed mortgage has dropped only from 5.33% to 5.05% in the same period of time. I wonder whether such discrepancies are historically typical, and what might be the typical time lapse before the mortgage rate drops proportionately to a reduction in the rate that banks charge each other to borrow money. Alternatively, does the discrepancy reflect the reluctance of banks to loan despite their receiving the TARP funds? This is of practical interest because I am contemplating refinancing my home mortgage and wonder how advisable it is to wait, assuming mortgage rates are likely to drop further as the effects of reduction in the prime rate will eventually trickle down to benefit consumers. Eric, Amherst, MA

Answer: If history is any guide, mortgage rates should drop farther, even though they are already at their lowest level since Freddie Mac started publishing the data back in the early 1970s. For instance, as I am writing this the yield difference between a 30-year fixed rate mortgage and the 10-year Treasury bond is 3.11 percentage points. (The 10 year Treasury bond is the benchmark interest rate for pricing mortgages.) The quick rule of thumb is that gap is normally about 1.5 percentage points, suggesting that the yield on the 30-year should be 3.61%. That's way below the current rate of 5.27% on the 30 year fixed rate. The interest rate on the 15 year mortgage would be even lower, closer to 3% instead of its current 4.83%. (Rates have come down slightly since you emailed your question which accounts for the different interest rate figures.)

History is one reason to suspect mortgage rates could go lower. Emerging signs of deflation or falling prices is another. And the government appears eager for mortgage rates to head lower. It's a good way to support the housing market since lower rates encourage refinancing and new home buying.

That said, we're living through a period where common rules of thumb are suspect. What's more, the government's ability to manipulate long-term bond yields is limited. Investor wariness about securitized mortgages is hampering the market's recovery. Lenders are wary of anyone with less than a stellar credit score. The housing market continues to deteriorate. All these factors are keeping mortgage rates historically high relative to Treasury yields. There's also the risk that at some point all the money the government is pumping into the system will ignite inflation fears.

What's the homeowner to do? Think through the downside. What if you wait for lower rates, and mortgage yields go up instead? How much of a difference will that make to your household finances? In other words, does it pay for you to bet on lower rates because it doesn't matter much to your overall finances if rates stay where they are or go higher and you can't refinance? Or is there a wide enough gap between your existing mortgage and current mortgage rates to make a refinancing financially sensible? if that's the case, why not refinance even if you do miss bottom? These are the kinds of questions and scenarios I would run through, always with an eye toward protecting yourself agaisnt the downside.

12/31/08 by Chris Farrell

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