Politics and Investing

During the last presidential campaign, one thing that came up that bothered me was a statement by one candidate that he was going to close the loophole for companies to ship jobs overseas, in order to save job.  (Sounds good right, who wouldn’t want to save jobs? – except of course his opponent… who is obviously boneheaded!)

After a little research earlier, i found that this “loophole” that was mentioned is purely because the US has one of the higher corporate tax rates of all the countries, so if a US company pays taxes at a lower rate in another country for a good or service that they sell in that other country they have found a loophole.

Just today, I was reading this article from PricewaterhouseCoopers on the implications of the president’s proposal to close this loophole, and a bit of a discussion on if it is a good idea and how the proposed plan would affect US companies (and consequently your investing decisions). The article is called “10 minutes on…”, so its a pretty quick read.

pwc-10minutes-tax-increases.pdf

So, besides the article content which i wanted to highlight, its also a reminder to question politicians when they promise something that sounds so good, before you jump on the euphoric wagon.

For other “10 minute” articles by PwC click the following link.

http://www.pwc.com/extweb/pwcpublications.nsf/docid/62BD6CCECDE0D12D852573E0000C623B

Present Value

I have a basic financial concept to share today.  The concept is Present Value (PV) and its brother, Future Value (FV).  I think everyone has a basic inkling of this concept, they just may not apply it to their decisions in a conscious way.

The best way to illustrate the concept is thinking of a friend that wants to borrow money.  Lets say your friend wants to borrow 100 dollars (assume no risk).  What if your friend says that he will pay you back next week, what if he says that he will pay you back in 2 years?

At this point there is another concept that is important to discuss, opportunity cost (the benefit that you give up by making a choice).  In this case, you give up the use of this 100 dollars for 2 years, you are giving up the opportunity to use the 100 dollars now.  If you are saving up for something, you will now have to put that on hold.  If the delay is only one week, its not as of big deal, as if it was 2 years.

Getting back to our topic, would you rather have 100 dollars today, or in 2 years?  If you said today, then you have illustrated present value.  The value today is greater than the same amount in the future.  Now what about 100 dollars today or 150 dollars in 2 years?  Now are you be willing to wait for 2 years?  What this proves is that timing of cash receipts affects the value today.  If you invest 100 dollars today, your hope is that next year you will have more, so if you invest at 10%, you would say that the future value of my 100 dollars is 110 dollars.  The present value of 110 dollars in the future (at 10%) is 100 dollars.  Here is the math behind that.  100 (PV) * (1 + 10%) = 110 (FV).

The implications of future value is not limited to your lending / investing, but also taxes and how you spend your money (because of the opportunity cost).  Because of the investment growth and time, the future value of money today is quite great.  Going back to our math, lets say that you invest 1,000 dollars today, and you are 30 years old.  When you are 65, assuming a return of 0% (spending today), 5%, 8% and 10%, here are the results.

1000 * (1.00)^35(years) = 1,000 dollars (or an old computer, really old).

1000 * (1.05)^35(years) = 5,516 dollars

1000 * (1.08)^35(years) = 14,785 dollars

1000 * (1.10)^35(years) = 28,102 dollars

Which would you rather have? This is a stupid question, but really, what would you give up to get it?  It’s why investment fees are so important to consider, and making sure that money you spend today is worth it to you.

moneyclamps

Financial Links

There are many financial calculators out there in my opinion you have to know about the underlying assumptions for them to be of any use.  So, I have an idea, I am going to give you a link to the Harris Financial Group site that has more options of financial calculators than you probably have time. My wish would be that you would go to the site, use a few of the calculators, and then let me know the questions you have (eg. what pre-tax return do I expect on my IRA investments? or what is inflation?) As an added bonus, there is even a Financial IQ test. See below for the link.

http://www.harrisfinancialgroupinc.com/index.cfm?type=C&source=calc_hdr.cfm

Also, as long as I am submitting links. I found this interesting page (see below) on the Key Bank website, that has a lot of information on buying a house, the process and different types of mortgage products.  Hope that you enjoy.

https://www.key.com/html/MOL-10.html

Thanks for reading this moneyclamps post!

Conversational Finance

To kick off this topic, i would like to mention that there is one main target audience for this blog, that is “non-finance” people. That means that while many others may enjoy reading, i really want to reach those who have questions and who do not have formal instruction through a class of finance or have the opportunity to work in a finance/ money / investing field. An idea that was requested was a section called “conversational finance”. Similar to a class in Spanish or French by the same title, conversational finance will be for those who at a backyard barbecue or picnic or conversation at work want to follow or participate in a conversation that is taking place about investing or houses or debt. With the idea that you will at least be able to follow along if someone else is talking about any of these topics. That said, please give me questions or “theories” that you would like explained, and ill do my best.

Since i was at a barbecue this last weekend, i thought i would go ahead and throw out the first topic that came up… Housing. You may have noticed that its a popular topic these days, and let me give you some of the key players in the housing economy and the key drivers of the growth and decline cycle of the last several years.

Key Players:
Banks (those who actually loan the money)
Government (in charge of setting interest rates – see previous post on interest rates, and also federal oversight of the housing agencies and housing policies)
Housing Agencies (eg. Freddie Mac and Fannie Mae – federally chartered private organizations that create liquidity in the housing market by buying mortgages from banks)
MBS – or Mortgage Backed Securities (Investments that are purchased in a fashion similar to bonds, that receive cashflows [money or interest payments] from payments made on underlying loans)

So, not to be too complicated, let us stop there, but here is the quick cycle for a home buyer (we will call him Bob, and the flow of his mortgage loan).

Bob walks into his bank and wants to buy a house. He fills out the application and then the bank approves him for a loan, and then he goes and buys a house. Bob then every month pays his bank his mortgage payment. The bank may hold the title to Bob’s house, or sell it to Freddie Mac. If Freddie Mac buys the loan, then they pay Bob’s bank, and then Bob’s bank gives another loan (to Sue this time). Now, Freddie Mac by doing this over and over will get a lot of loans, and they are able to “pool them” [combine] and then sell the underlying cashflows (Bob is still paying every month), to investors. This investment structure is called a Mortgage Backed Security. So a mutual fund or pension fund will buy this MBS as an investment, and every month will receive some of the cash that is paid from Bob.

The risk is for the investor, that Bob does not pay his mortgage, but the real trouble happens when all of Bob’s friends and neighbors do not pay their mortgage, because there is a margin of safety in MBS transactions, and the problem today is that more and more of Bob’s neighbors are not paying their mortgages and the margin of safety on these investments is very low or does not exist anymore.

Interest Rates

As promised, we will talk about interest rates today. And, it is appropriate, as the federal reserve just made a change to one of the interest rates that it controls, which in turn influences the rate your bank charges you.

I did however have a hard time writing this. I started off a few times now, and what i realized is that Interest rates aren’t all that interesting, so ill try to do some quick high points (or medium points as the case may be) and we will move on.

Interest rates are implicit in most financial transactions that you do – so they are very important, just the mechanics may not be that exciting.

It is supply and demand that determine the rates (save for some federal influences). And basically, its the price we pay for money. You may say, oh dear i think pencil clamps has gone mad, but if i may hold you off for a minute, its true. The interest on your home loan or your car loan is the price you pay for “renting” your money from the bank, and its the price that they are willing to charge you for it, instead of someone else, based on your risk. And when you put your money in a savings account, the bank pays you interest as the amount they pay you to lend them money (they are not just keeping it safe for you, but much more).