Free Money Finance: Paying Off Your House Early

This topic came up in class recently so FreeMoneyFinance had impeccable timing:

Free Money Finance: Free Money Finance Top 10 Most Hated Posts/Themes: #8 Paying Off Your House Early:

"Most financial authors, writers, and bloggers would say NOT to pre-pay your mortgage if the interest rate (adjusted downward for the tax savings from having a mortgage) is below what you could earn investing the money instead. They say you'll be better off in the long run doing this, and technically, they're right. If a person has a mortgage at 5% and if they earn 6% on their investments and if they do actually invest the money they would otherwise be using to pay the mortgage (rather than spending it) then they will be better off financially. But to me, that's a lot of ifs."

Which is very well said. Like debt in a corporate setting, committing to paying down a mortgage can reduce the Free Cash flow problem.

I would add that there is also some reduction of risk since it does free up money for other uses AND also some increase in utility from the feeling of having it paid ahead of schedule.

That said, from a risk and return perspective, it does not make much sense in most cases and I would definitely not encourage it in the case of investment property.


If you would like more in this, check out the MortgageProfessor's Paying Early Page.

Update and where in the world have I been

Hi everyone.

What a few weeks. LOL. As Burns would say "the best laid plans of mice and men often go astray." And that is exactly what has happened since the Friday Lunch at the FMAs in Salt Lake City.

While in the luncheon my phone vibrated a few times but I did not take the calls. In Hotel's atrium afterwards I did. The most important call was from Josh one of the BonaRespond leaders. He told of the terrible storm that had crushed Buffalo and asked whether we could do anything about it. That phone call set in motion a series of events that have taken up every free moment of my time.

BonaResponds has been up in Buffalo (about 70 miles N of the Bonaventure Campus) twice already (with more planned), we have had chainsaw trainings, been interviewed about a dozen times, and much more. Coupled with a preplanned trip to NYC with the Finance Club, correcting tests in 5 different classes (and for those of you who know my tests, they tend to be 20 pages each), registration meetings, and of course classes, the blogs simply had to take back burner.

I apologize, but I had no choice if I wanted to save any sanity that I have (which of course is arguably present even under ideal conditions).

While BonaResponds is still very busy, much of the hectic planning has been finished and the correcting is 98.6% done, so I think I can get back on more normal schedule of posting and writing.

Also if you have sent me an email in the past three weeks and I have not yet replied, please be patient. I will get to them.

jim

Online NewsHour: Experts Examine How Brain Makes Economic Decisions -- May 10, 2005

Online NewsHour: Experts Examine How Brain Makes Economic Decisions -- May 10, 2005:

"...as it happens, even economists are getting in on the action, asking how and where we humans think economically by seeing which parts of the brain are most active when we're deciding what we want and how to get it. One lesson thus far: The brain isn't quite as rational as the discipline of economics has long assumed, a finding that could have major implications"

SSRN-Corruption and International Valuation: Does Virtue Pay? by Charles Lee, David Ng

SSRN-Corruption and International Valuation: Does Virtue Pay? by Charles Lee, David Ng:

"Abstract: Using firm-level data from 44 countries, we investigate the relation between corruption and international corporate values. Our analysis shows that firms from more corrupt countries trade at significantly lower market multiples. The effect is both economically and statistically significant. "

Live from Salt Lake City

Hi from Salt Lake City!

I am here attending the Financial Management Association (FMA) meetings. I figured that if I could blog from Biloxi weeks after Katrina, I could make some time to do so from a conference.

Finance conferences are pretty much all day events. Today’s started at 8:00 AM and papers went until after 5:00 at which time there was a reception. (I confess I skipped the reception to run—WOW what a beautiful area!)

The day is broken into 90 minute segments during which time various financial research papers are presented. These 90 minute blocks repeat all day except for an hour break for lunch.

During a block upwards of 30 different “sessions” are held. These take place in various conference rooms in the conference hotels. Each session is further broken down into 3 thirty minute intervals in which a paper is presented and then discussed. The exact timing varies somewhat by conference but the norm at the FMAs (usually my favorite conference) is that the author has 20 minutes to explain the paper (motivation, data, methodology, and findings) and the discussant has about 10 minutes to comment on the paper and suggest possible improvements and extensions that would make the paper even better.

Those not presenting make up the fairly transient audience at the presentations. With up to 90 papers (30 sessions times 3 papers per session) are being presented in any time block, it is obviously impossible to see them all and those in attendance must pick and chose what to see. Thus, popular papers may be filled to capacity while others have only a handful in attendance.

Between each 90 minute presentation block, there is a 15 minute break time. This allows people to get from one presentation to the next (or at least try to make it, today’s wait for elevators was pretty bad!). This time also allows presenters to set up for their presentation and others to mingle while discussing what papers they will see next.

Additionally, throughout the entire day text book publishers and others selling items of interest to finance professors have set up displays in what amounts to a “trade show.” This allows professors to see the newest text books and to also see new class tools.

Oh, and I almost forgot, while all of this is happening, there are also many job interviews being conducted. Most of these occur in the hotel rooms but some schools opt to share a large open room for interviews.

So there you have it, a typical day at a finance conference.

It is sort of easy to see why people complain about conferences: they are quite expensive; they are a lot of work; they involve too much travel.

However, any analysis must also include the benefits. Today I saw 17 papers presented. Think about that for a second. Seventeen papers, it does not get much better than that!

On top of that where but a conference can you meet some of the best and brightest in the field from around the globe, get exposed to new ideas, and learn a great deal on virtually every aspect of finance all in a single day. And then wake up and do it all over again the next day!

To put it another way, conferences are definitely positive NPV projects!

Slow and steady still wins the investing race - MarketWatch

Thanks to the Unknown Professor over at Financial Rounds for pointing this one out.

Short version: Morningstar is going to report the dollar-weighted returns! And shock of all shocks, these are lower than the time weighted returns.

Slow and steady still wins the investing race - MarketWatch:

"...Morningstar, Inc...announced that it was going to start reporting mutual funds' returns in a new way, in addition to all the traditional ways for which Morningstar is already famous. The firm is referring to this new performance metric as the 'Morningstar Investor Return,' and it directly measures the price investors have paid for failing to be patient and disciplined. A fund's Morningstar Investor Return is what statisticians refer to as a dollar-weighted return...."

What is the difference? The dollar-weighted return is closer to what the average investor actually earned than what the fund earned over time. So if a fund is up in one year and attracts much new money, then is down the next year, the simple average will overstate the return investors actually earned (i.e. the dollar-weighted average will be lower than the time average).

The article has a great example to understand the difference between this and what is largely reported. It also makes a strong point against "chasing returns".

Yale's Money Guru Shares Wisdom with Masses

This one is really good! It is an NPR piece on David Swensen who manages Yale's Endowment fund. While Swenson has done remarkably well, his basic strategy is easily replicated and fits very well with the idea of market efficiency and diversification taught in almost every finance class, although not as well as Swenson does it!

NPR : Yale's Money Guru Shares Wisdom with Masses:

On his relative success:

" Yale University recently announced a 23 percent return on its investments, swelling its endowment to a whopping $18 billion. The man behind that investment success is David Swensen, one of the most gifted investors in the world. He's made an average 16 percent annual return over 21 years..."

On market efficiency:

"He says for-profit mutual funds have an inherent conflict of interest. They make money by charging fees that suck profits away from investors in the funds. In fact, over time -- when you factor in the fees, taxes and other costs -- he says your odds of beating the market in an actively managed fund are less than one in 100."

On diversification:

"Swensen teaches a course at Yale in which he airs his unorthodox view of the basics of a well-diversified portfolio. He argues that, by owning not only stocks and bonds but also holdings in real estate, timber, oil and gas, and other investments, you can get strong returns with less overall risk."

Interesting piece with good advice that has the added benefit of audio as well!

A cool way to protect property rights

Ok, this might not strictly speaking be finance, but property rights are always an interesting topic that has financial ramifications (we usually cover them in International finance classes) and htis is just so cool that I had to share it.

It deals with how YouTube is satisfying the Music companies.

YouTube’s Video Poker - New York Times:

"Potentially most significant, Mr. Hurley pointed to a deal signed recently with Warner Music that he hopes will be a model for dealing with Hollywood and record companies from now on. YouTube is developing technology that will identify Warner music used in a video that is uploaded. When the site plays those videos, it will share some of its advertising revenue with Warner and others with copyrighted material that is used."

That is really cool! The copyrighted material is at once both protected and allowed to be used. A win win!

Of course, many do not think it goes far enough (and indeed it may not), but the use of technology to share ad revenue is a step in the right direction and bears more attention.

FRB: Speech, Bernanke--The Coming Demographic Transition: Will We Treat Future Generations Fairly?--October 4, 2006

More on the changes that may be brought about by the retiring of the baby boom generation. This is from Fed Chairman Ben Bernanke.


FRB: Speech, Bernanke--The Coming Demographic Transition: Will We Treat Future Generations Fairly?--October 4, 2006:

Short version: increase savings to increase productivity. And rely on FinanceProfessors to save the day ;) Ok, so maybe that was added.

Some highlights:

"In coming decades, many forces will shape our economy and our society, but in all likelihood no single factor will have as pervasive an effect as the aging of our population."

"The fiscal consequences of these trends are large and unavoidable. As the population ages, the nation will have to choose among higher taxes, less non-entitlement spending, a reduction in outlays for entitlement programs, a sharply higher budget deficit, or some combination thereof."

* Because there will be fewer workers, it is widely expected that Real GDP will decline. Bernanke suggest this problem can be lessened with higher investment now:

"Although some adverse effect of population aging on future per capita output and consumption is probably inevitable, actions that we take today....have the potential to mitigate those effects. One such action would be to find ways to increase our national saving rate. If the extra savings were used to increase the nation's capital stock--the quantity of plant and equipment available for use by workers--then future workers would be more productive, ameliorating the anticipated effects on per capita output and consumption."

This could be done by lowering deficits:

"If, as a nation, we were to accept the premise that the baby-boom generation should share at least some of the burden of population aging, what policy steps might be implied? As I have already noted, from a broad economic perspective, the most useful actions are likely to be those that promote national saving. Perhaps the most straightforward way to raise national saving--although not a politically easy one--is to reduce the government's current and projected budget deficits. "

* This would almost assuredly involve reducing entitlement programs:

"Reform of our unsustainable entitlement programs should also be a priority. "

* And convincing consumers to save more now:

"Increasing private saving, which is the saving of both the corporate sector and the household sector, is likewise desirable.... Unfortunately, many years of concentrated attention on this issue by policymakers and economists have failed to uncover a silver bullet for increasing household saving. One promising area that deserves more attention is financial education.... which may be useful in helping people understand the importance of saving and to learn about alternative saving vehicles. "

See I told you that FinanceProfessors would come to the rescue!!!!

Save early, save often! Pass it on.

Will stocks go Boom?

Canada's National Post gives us all something to worry about it its series on the impact of an aging labor force. In the second part of the series, the paper examines whether as baby boomers retire if they will drive down stock prices.

Will stocks go Boom?:

"In the United States, for example, the ratio of workers to retirees is expected to fall to just 2.6 in 30 years, from 4.9 today. In Japan, the ratio of retirees to active workers is expected to fall even further, to one to one by about 2050.

In other words, the number of potential stock buyers will soon begin a steep decline....No less an authority than Jeremy Siegel, the famous Wharton finance professor and author of Stocks For The Long Run, has sounded the alarm, calling the ageing population the most critical issue facing the developed world."

What about the impact on finance? Not only will the changing workforce impact pension funds, social security, and health care costs, but it will likely drive down the stock market as the boomers end saving and begin to draw down their portfolios.

Now before you panic, the coming tidal wave of retirees in the developed world may be offset by other factors (notably foreign investment as more lesser developed countries develop and formerly impoverished people become investors) but it is something to consider and "gameplan".

Most likely outcome? As baby boomers age they will shift money out of stocks and this will be a factor that keeps returns lower than their historical averages. Which means we should all lower our projected returns. This unfortunately means we will have to save more for a comfortable retirement be it personally, in corporate pension funds, or in government sponsored "social security" accounts.

And if this analysis is wrong and the market continues to earn higher than historical norms? We will have set aside more than needed and you will have more money in your portfolio than expected, which is not the worst thing in the world!

Some past articles on this topic:
Will bomers drive down markets? (October 2004)

Porterba on impact of Boomers (November 2004)

USATODAY.com - Easy credit can mean long-term hardship for college students

I am torn on this one. On one hand it is inarguable that many people (including no doubt a higher percentage of college students) do get into financial difficulty stemming from excessive use of credit cards. However, the ban on marketing of the credit cards on campus does seem a tad much. Credit cards do have their upsides as well: they help build credit and lower transaction costs.

On the other hand, many 18 year olds are not ready for credit cards and do succumb to overspending.
From USATODAY.com :

Easy credit can mean long-term hardship for college students: "College students tend to have less financial experience than older adults, making them more susceptible to these pitches....Nearly a dozen states, including New York and California, have made it harder for card companies to market on public campuses. And a growing number of colleges, on their own, have begun to impose restrictions."

Of course the credit card companies do not want to lose this market.

So what to do? If you are a college student who is mature enough to use (and not misuse) a credit card, I would recommend highly getting one to build credit and for ease of use. However, get one with no fee and pay off the bill completely every month. If you find this progressively more difficult to do, stop using it until it is paid off.

Financial Rounds: Who are My Picks For the Nobel Prize in Economics

It's that time of year again: time to bet on who will be the next Nobel Prize winner in Economics. The Unknown professor over at Financial Rounds does a good job with his two picks.

Who are My Picks For the Nobel Prize in Economics:

"....speculation seems to be heating up for who will get the next Nobel Prize in economics. I'll cast my vote for Eugene Fama of the University of Chicago for his earlier work on market efficiency (and later work on size and market-book effects which seem to contradict his earlier work). If he gets the nod, there's a good chance that his coauthor Kenneth French would share it with him.

A second choice would be The U of Chicago's Richard Thaler"

I would add Michael Jensen although I would say he is more of a long-shot. In reality, and economics (as opposed to finance) person more regulalry wins it. Stay tuned.

BTW does anyone know if there is still a decision market for this prize? I did not see one at Tradesports.com does not have one and the Nobelpreisborse seems to be out of business .

But I do see at Tradesports that the Buffalo Bills are the biggest up mover on the over/under wins market. (yeah, I know it is only 6.5 wins, but still, they are up and playing well, so I will take it!)