Usenet 1993 July/InfoMagic USENET CD-ROM July 1993.ISO/answers/investment-faq/general/part2

Text File | 1993-06-21 | 47.7 KB | 995 lines

Newsgroups: misc.invest,misc.answers,news.answers
Path: senator-bedfellow.mit.edu!enterpoop.mit.edu!xlink.net!rz.uni-karlsruhe.de!stepsun.uni-kl.de!uklirb!bogner.informatik.uni-kl.de!lott
From: [e-mail] (Christopher Lott)
Subject: misc.invest FAQ on general investment topics (part 2 of 3)
Message-ID: <[e-mail]>
Followup-To: misc.invest
Summary: Answers to frequently asked questions about investments.
         Should be read by anyone who wishes to post to misc.invest.
Originator: [e-mail]
Keywords: invest, stock, bond, money, faq
Sender: [e-mail] (Unix-News-System)
Supersedes: <[e-mail]>
Nntp-Posting-Host: bogner.informatik.uni-kl.de
Reply-To: [e-mail]
Organization: University of Kaiserslautern, Germany
References: <[e-mail]>
Date: Sun, 20 Jun 1993 00:02:37 GMT
Approved: [e-mail]
Expires: Sun, 1 Aug 1993 00:02:01 GMT
Lines: 972
Xref: senator-bedfellow.mit.edu misc.invest:44891 misc.answers:113 news.answers:9602

Archive-name: investment-faq/general/part2
Version: $Id: faq-p2,v 1.6 1993/05/21 09:56:38 lott Exp lott $
Compiler: Christopher Lott, [e-mail]

This is the general FAQ for misc.invest, part 2 of 3.

-----------------------------------------------------------------------------

Subject: Investment Jargon
From: [e-mail]

Some common jargon is explained here briefly.  See other articles
in the faq for more detailed explanations on most of these terms.

bottom fishing:        purchasing of stock declining in value
going long:        buying and holding stock
going short:        selling stock short

(others?  -Ed.)

-----------------------------------------------------------------------------

Subject: Life Insurance
From: [e-mail]

This is my standard reply to life insurance queries.  And, I think
many insurance agents will disagree with these comments.

First of all, decide WHY you want insurance.  Think of insurance as
income-protection, i.e. if the insured passes away, the beneficiary
receives the proceeds to offset that lost income.  With that comment
behind us, I would never buy insurance on kids, after all, they don't
have income and they don't work.  An agent might say to buy it on your
kids while its cheap - but run the numbers, the agent is usually
wrong, remember, agents are really salesmen/women and its in their
interest to sell you insurance.  Also - I am strongly against insurance
on kids on two counts.  One, you are placing a bet that you kid will
die and you  are actually paying that bet in premiums.  I can't bet my
child will die.  Two, it sounds plausible, i.e. your kid will have a
nest egg when they grow up but factor inflation in - it doesn't look
so good.  A policy of face amount of $10,000, at 4.5% inflation and 30
years later is like having $2,670 in today's dollars - it's NOT a lot
of money.  So don't plan on it being worth much in the future to your
child as an investment.  In summary, skip insurance on your kids.

I also have some doubts about insurance as investments - it might be a
good idea but it certainly muddies the water.  Why not just buy your
insurance as one step and your investment as another step? - its a lot
simpler to keep them separate.

So by now you have decided you want insurance, i.e. to protect your
family against your passing away prematurely, i.e. the loss of income
you represent.

Next decide how LONG you want insurance for.  If you're around 60
years old, I doubt you want to get any at all.  Your income stream is
largely over and hopefully you have accumulated the assets you need
anyway by now.

If you are married and both work, its not clear you need insurance at
all if you pass on.  The spouse just keeps working UNLESS you need
both incomes to support your lifestyle (more common these days).  Then
you  should have one policy on each of you.

If you are single, its not clear you need life insurance at all.  You
are not supporting anyone so no one cares if you pass on, at least
financially :-)

If you are married and the spouse is not working, then the breadwinner
needs insurance UNLESS you are independently wealthy.  Some might argue
you should have insurance on your spouse, i.e. as homemaker, child
care provider and so forth.  In my opinion, I would get a SMALL policy
on the spouse, sufficient to cover the costs of burying them and also
sufficient to provide for child care for a few years or so.  Each case
is different but I would look for a small TERM policy on the order of
$50,000 or less.  Get the cheapest you can find, from anywhere.  It
should be quite cheap.  Skip any fancy policies - just go for term and
plan on keeping it until your child is own his/her own.  Then reduce
the insurance coverage on your spouse so it is sufficient to bury your
spouse.

If you are independently wealthy, you don't need insurance because you
already have the money you need.  You might want tax shelters and the
like but that is a very different topic.

Suppose you have a 1 year old child, the wife stays home and the
husband works.  In that case, you might want 2 types of insurance:
Whole life for the long haul, i.e. age 65, 70, etc., and Term until
your child is off on his/her own.  Once the child has left the stable,
your need for insurance goes down since your responsibilities have
diminished, i.e. fewer dependents, education finished, wedding
expenses done, etc

Mortgage insurance is popular but is it worthwhile? Generally not
because it is too expensive.  Perhaps you want some sort of Term during
the duration of the mortgage - but remember that the mortgage balance
DECLINES over time.  But don't buy mortgage insurance itself - much too
expensive.  Include it in the overall analysis of what insurance needs
you might have.

What about flight insurance? Ignore it.  You are quite safe in
airplanes and flight insurance is incredibly expensive to buy.

Insurance through work? Many larger firms offer life insurance as part
of an overall benefits package.  They will typically provide a certain
amount of insurance for free and insurance beyond that minimum amount
is offered for a fee.  Although priced competitively, it may not be
wise to get more than the 'free' amount offered - why?  Suppose you
develop a nasty health condition and then lose your job (and your
benefit-provided insurance)?  Trying to get re-insured elsewhere (with
a health condition) may be *very* expensive.  It is often wiser to have
your own insurance in place through your own efforts - this insurance
will stay with you and not the job.

Now, how much insurance?  One rule of thumb is 5x your annual income.
What agents will ask you is 'Will your spouse go back to work if you
pass away?' Many of us will think nobly and say NO.  But its actually
likely that your spouse will go back to work and good thing -
otherwise your insurance needs would be much larger.  After all, if
the spouse stays home, your insurance must be large enough to be
invested wisely to throw off enough return to live on.  Assume you
make $50,000 and the spouse doesn't work.  You pass on.  The Spouse
needs to replace a portion of your income (not all of it since you
won't be around to feed, wear clothes, drive an insured car, etc.).
Lets assume the Spouse needs $40,000 to live on.  Now that is BEFORE
taxes.  Lets say its $30,000 net to live on.  $30,000 is the annual
interest generated on a $600,000 tax-free investment at 5% per year
(i.e. munibonds).  So this means you need $600,000 of face value
insurance to protect your $50,000 current income.  These numbers will
vary, depending on interest rates at the time you do your analysis and
how much money you spouse will need, factoring in inflation.

This is only one example of how to do it and income taxes, estate taxes
and inflation can complicate it.  But hopefully you get the idea.

Which kind of insurance IMHO is a function of how long you need it
for.  I once did an analysis of TERM vs WHOLE LIFE and based on the
assumptions at the time, WHOLE LIFE made more sense if I held the
insurance more than about 20-23 years.  But TERM was cheaper if I held
it for a shorter period of time.  How do you do the analysis and why
does the agent want to meet you?  Well, he/she will bring their fancy
charts, tables of numbers and effectively snow you into thinking that
the biggest, most expensive policy is the best for you over the long
term.  Translation: mucho commissions to the agent.  Whole life is
what agents make their money on due to commissions.  The agents
typically gets 1/2 of your first year's commissions as his pay.  And
he typically gets 10% of the next year's commissions and likewise
through year 5.  Ask him how he gets paid.

If he won't tell you, ask him to leave.  In my opinion, its okay that
the agents get commissions but just buy what you need, don't buy
some huge policy.  The agent may show you compelling numbers on a
$1,000,000 whole life policy but do you really need that much? They
will make lots of money on commissions on such a policy, but they will
likely have sold you the "Mercedes Benz" type of policy when a Ford
Taurus or a Saturn sedan model would also be just fine, at far less
money.  Buy the life insurance you need, not what they say.

What I did was to take their numbers, review their assumptions (and
corrected them when they were far-fetched) and did MY analysis.  They
hated that but they agreed my approach was correct.  They will show
you a 12% rate of return to predict the cash value flow.  Ignore that.
It makes them look too good and its not realistic.  Ask him/her
exactly what they plan to invest your premium money in to get 12%.
How has it done in the last 5 years? 10?  Use a number between 4.5%
(for TBILL investments, ultra- conservative) and 10% (for growth
stocks, more risky), but not definitely not 12%.  I would try 8% and
insist it be done that way.

Ask each agent:
1)-what is the present value of the payment stream represented by the
premiums, using a discount rate of 4.5% per year (That is the
inflation average since 1940).  This is what the policy costs you, in
today's dollars.  Its very much like paying that single number now
instead of a series of payments over time.
2)-what is the present value of the the cash value earned (increasing
at no more than 8% a year) and discounting it back to today at the
same 4.5%.  This is what you get for that money you just paid, in cash
value, expressed in today's dollars, i.e. as if you got it today in
the mail.
3)-What is the present value of the life insurance in force over that
same period, discounted back to today by 4.5%, for inflation.  That is
the coverage in effect in today's dollars.
4)-Pick an end date for comparing these - I use age 60 and age 65.

With the above in hand from various agents, you can see fairly quickly
which is the better policy, i.e. which gives you the most for your money.

By the way, inflation is slippery and sneaky.  All too often we see
$500,000 of insurance and it sounds great, but at 4.5% inflation and
30 years from now, that $500,000 then is like $133,500 now - truly!

Have the agent do your analysis, BUT you give him the rates to use,
don't use his.  Then you pick the policy that is the best value, i.e.,
you get more for your money.  Factor in any tax angles as well.  If
the agent refuses to do this analysis for you, get rid of him/her.

If the agent gets annoyed but cannot fault your analysis, then you
have cleared the snow away and gotten to the truth.  If they smile too
much, you may have missed something.  And that will cost you money.

Never agree to any policy unless you understand all the numbers and
all the terms.  Never 'upgrade' policies by cashing in a whole life
for another whole life.  That just depletes your cash value, real cash
available to you.  And the agent gets to pocket that money, literally,
through new commissions.  Its no different that just writing a personal
check, payable to the agent.

Check out the insurer by going to the reference section of a big
library.  Ask for the AM BEST guide on insurance.  Look up where the
issuer stands relative to the competition, on dividends, on cash
value, on cost of insurance per premium dollar.

Agents will usually not mention TERM since they work on commission and
get much more money for Whole Life than they do for term.  Remember,
The agents gets about 1/2 of your 1st years premium payments and
10% or so for all the money you send in over the following 4 years.
Ask them to tell you how they are paid- after all, its your money they
are getting.

Now why don't I like UNIVERSAL or VARIABLE?  Mainly because with Whole
Life and with TERM, you know exactly what you must pay because the
issuer must manage the investments to generate the appropriate returns
to provide you with the insurance (and with cash value if whole life).
With UNIVERSAL and VARIABLE, it becomes YOU who must decide how and
where to invest your premium income.  If you guess badly, you will
have to pay a higher premium to cover those bad decisions.  The
insurance companies invented UNIVERSAL and VARIABLE because interest
rates went crazy in the early 80's and they lost money.  Rather than
taking that risk again, they offered these new policies to transfer
that risk to you.  Of course, UNIVERSAL and VARIABLE will be cheaper
in the short term but BE CAREFUL - they can and often will increase
later on.

Okay, so what did I do? I bought both term and whole life.  I plan to
keep the term until my son graduates from college and he is on his
own.  That is about 9 years from now.  I also bought whole life
(NorthWest Mutual) which I plan to keep forever, so to speak.  NWM is
apparently the cheapest and best around according to A.M.BEST.  At this
point, after 3 years with NWM, I make more in cash value each year
than I pay into the policy in premiums.  Thus, they are paying me to
stay with them.

Where do you buy term? Just buy the cheapest policy since you will
tend to renew the policy once a year and you can change insurers each
time.

Also:   A hard thing to factor in is that one day you may become
uninsurable just when you need it, i.e. heart attack, cancer and the
like.   I would look at getting cheap term insurance but add in the
options of 'guaranteed convertible' (to whole life) and 'guaranteed
renewable' (they must provide the insurance).  It will add somewhat to
the cost of the insurance.

Last thought.  I'll bet you didn't you know that you are 3x more
likely to become disabled during your working career than you to die
during your working career.  How is your short term disability
insurance looking?  Get a policy that has a waiting period before it
kicks in.  This will keep it cheaper.  Look at the exclusions, if any.



-----------------------------------------------------------------------------

Subject: Money-Supply Measures M1, M2, and M3
From: [e-mail]

M1: Money that can be spent immediately.  Includes cash, checking accounts,
    and NOW accounts.

M2: M1 + assets invested for the short term.  These assets include money-
    market accounts and money-market mutual funds.

M3: M2 + big deposits.  Big deposits include institutional money-market
    funds and agreements among banks.

"Modern Money Mechanics," which explains M1, M2, and M3 in gory detail,
is available free from:
        Public Information Center
        Federal Reserve Bank of Chicago
        P.O. Box 834
        Chicago, Illinois 60690

-----------------------------------------------------------------------------

Subject: One-Letter Ticker Symbols
From: [e-mail]

Not all of the one-letter symbols are obvious, nor does a one-letter
symbol mean the stock is a blue chip or even well known.  Most, but
not all, trade on the NYSE.  The current list of one-letter symbols
follows.  I'm not sure about "H" - has that been reassigned recently?
Also "M" might have been reassigned.

A  Attwoods plc
B  Barnes Group
C  Chrysler Corporation
D  Dominion Resources
E  Transco Energy
F  Ford Motor Company
G  Gillette
H  Helm Resources [ ?? ]
I  First Interstate Bancorp
J  Jackpot Enterprises
K  Kellogg
L  Loblaw Companies
M  M-Corp ( defunct - absorbed by BancOne )
N  Inco, Ltd.
O  Odetics  (O.A & O.B  - no "O")
P  Phillips Petroleum
R  Ryder Systems
S  Sears, Roebuck & Company
T  AT&T
U  US Air
V  Vivra Inc
W  Westvaco
X  US Steel
Y  Alleghany Corp.
Z  Woolworth

-----------------------------------------------------------------------------

Subject: One-Line Wisdom
From: [e-mail]

This is a collection of one-line pieces of investment wisdom, with brief
explanations.  Use and apply at your own risk or discretion.  They are
not in any particular order.

1.  Hang up on cold calls.

    While it is theoretically possible that someone is going to offer
    you the opportunity of a lifetime, it is more likely that it is some
    sort of scam.  Even if it is legitimate, the caller cannot know your
    financial position, goals, risk tolerance, or any other parameters
    which should be considered when selecting investments.  If you can't
    bear the thought of hanging up, ask for material to be sent by mail.

2.  Don't invest in anything you don't understand.

    There were horror stories of people who had lost fortunes by being
    short puts during the 87 crash.  I imagine that they had no idea of
    the risks they were taking.  Also, all the complaints about penny
    stocks, whether fraudulent or not, are partially a result of not
    understanding the risks and mechanisms.

3.  If it sounds too good to be true, it probably isn't.
3a. There's no such thing as a free lunch (TNSTAAFL).

    Remember, every investment opportunity competes with every other
    investment opportunity.  If one seems wildly better than the others,
    there are probably hidden risks or you don't understand something.

4.  If your only tool is a hammer, every problem looks like a nail.

    Someone (possibly a financial planner) with a very limited selection
    of products will naturally try to jam you into those which s/he sells.
    These may be less suitable than other products not carried.

5.  Don't rush into an investment.

    If someone tells you that the opportunity is closing, filling up fast,
    or in any other way suggests a time pressure, be *very* leery.

6.  Very low priced stocks require special treatment.

    Risks are substantial, bid/asked spreads are large, prices are
    volatile, and commissions are relatively high.  You need a broker
    who knows how to purchase these stocks and dicker for a good price.

-----------------------------------------------------------------------------

Subject: Options on Stocks
From: [e-mail]

An option is a contract between a buyer and a seller.  The option
is connected to something, such as a listed stock, an exchange index,
futures contracts, or real estate.  For simplicity, I will discuss
only options connected to listed stocks.

The option is designated by:
    - Name of the associated stock
    - Strike price
    - Expiration date
    - The premium paid for the option, plus brokers commission.

The two most popular types of options are Calls and Puts.

    Example:  The Wall Street Journal might list an
                IBM Oct 90 Call @ $2.00

    Translation:  This is a Call Option

    The company associated with it is IBM.
    (See also the price of IBM stock on the NYSE.)

    The strike price is $90.00  If you own this option,
    you can buy IBM @ $90.00, even if it is then trading on
    the NYSE @ $100.00 (I should be so lucky!)

    The option expires on the third Saturday following
    the third Friday of October, 1992.
    (an option is worthless and useless once it expires)

    If you want to buy the option, it will cost you $2.00
    plus brokers commissions.   If you want to sell the option,
    you will get $2.00 less commissions.

In general, options are written on blocks of 100s of shares.  So when
you buy "1" IBM Oct 90 Call @ $2.00 you actually are buying a contract
to buy 100 shares of IBM @ $90 per share ($9,000) on or before the
expiration date in October.   You will pay $200 plus commission to buy
the call.

If you wish to exercise your option you call your broker and say you
want to exercise your option.  Your broker will arrange for the person
who sold you your option (a financial fiction:  A computer matches up
buyers with sellers in a magical way) to sell you 100 shares of IBM for
$9,000 plus commission.

If you instead wish to sell (sell=write) that option you instruct your
broker that you wish to write 1 Call IBM Oct 90s, and the very next day
your account will be credited with $200 less commission.

If IBM does not reach $90 before the call expires, the option writer
gets to keep that $200 (less commission)   If the stock does reach above
$90, you will probably be "called."

If you are called you must deliver the stock.  Your broker will sell
your IBM stock for $9000 (and charge commission).  If you owned the
stock, that's OK. If you did not own the stock your broker will buy
the stock at market price and immediately sell it at $9000.  You pay
commissions each way.

If you write a Call option and own the stock that's called "Covered
Call Writing."  If you don't own the stock it's called "Naked Call
Writing."   It is quite risky to write naked calls, since the price of
the stock could zoom up and you would have to buy it at the market price.

My personal advice for new options people if to begin by writing
covered call options for stocks currently trading below the strike
price of the option (write out-of-the-money covered calls).

When the strike price of a call is above the current market price of
the associated stock, the call is "out of the money," and when the
strike price of a call is below the current market price of the
associated stock, the call is "in the money."

Most regular folks like you and me do not exercise our options; we
trade them back, covering our original trade.  Saves commissions and
all that.

The other common option is the PUT.  If you buy a put from me, you
gain the right to sell me your stock at the strike price on or before
the expiration date.  Puts are almost the mirror-image of calls.

-----------------------------------------------------------------------------

Subject: P/E Ratio
From: [e-mail], [e-mail]

P/E is shorthand for Price/Earnings Ratio.  The price/earnings ratio is
a tool for determining the value the market has placed on a common stock.
A lot can be said about this little number, but in short, companies
expected to grow and have higher earnings in the future should have a
higher P/E than companies in decline.  For example, if Amgen has a lot
of products in the pipeline, I wouldn't mind paying a large multiple of
its current earnings to buy the stock.  It will have a large P/E.  I am
expecting it to grow quickly.

P/E is determined by dividing the current market price of one share
of a company's stock by that company's per-share earnings (after-tax
profit divided by number of outstanding shares).  For example, a company
that earned $5M last year, with a million shares outstanding, had
earnings per share of $5.  If that company's stock currently sells for
$50/share, it has a P/E of 10.  Investors are willing to pay $10 for
every $1 of last year's earnings.

P/Es are traditionally computed with trailing earnings (earnings from
the year past, called a trailing P/E) but are sometimes computed with
leading earnings (earnings projected for the year to come, called a
leading P/E).  Like other indicators, it is best viewed over time,
looking for a trend.  A company with a steadily increasing P/E is being
viewed by the investment community as becoming more and more speculative.

PE is a much better comparison of the value of a stock than the price.
A $10 stock with a PE of 40 is much more "expensive" than a $100 stock
with a PE of 6.  You are paying more for the $10 stock's future earnings
stream.  The $10 stock is probably a small company with an exciting product
with few competitors.  The $100 stock is probably pretty staid - maybe a
buggy whip manufacturer.

-----------------------------------------------------------------------------

Subject: Renting vs. Buying a Home
From: [e-mail], [e-mail]

This note will explain one way to compare the monetary costs of renting
vs. buying a home.  It is extremely predjudiced towards the US system.
Small C programs for computing future value, present value, and loan
amortization schedules (used to write this article) are available on
request from the compiler of this FAQ.

SUMMARY:
 - If you are guaranteed an appreciation rate that is a few points above
   inflation, buy.
 - If the monthly costs of buying are basically the same as renting, buy.
 - The shorter the term, the more advantageous it is to rent.
 - Tax consequences in the US are fairly minor in the long term.


The three important factors that affect the analysis the most:
    1) Relative cash flows; e.g., rent compared to monthly ownership expenses
    2) Length of term
    3) Rate of appreciation

The approach used here is to determine the present value of the money
you will pay over the term for the home. In the case of buying, the
appreciation rate and thereby the future value of the home is estimated.
This analysis neglects utility costs because they can easily be the
same whether you rent or buy.  However, adding them to the analysis
is simple; treat them the same as the costs for insurance in both cases.

Opportunity costs of buying are effectively captured by the present value.
For example, pretend that you are able to buy a house without having to
have a mortgage.  Now the question is, is it better to buy the house with
your hoard of cash or is it better to invest the cash and continue to rent?
To answer this question you have to have estimates for rental costs and
house costs (see below), and you have a projected growth rate for the cash
investment and projected growth rate for the house.  If you project a 4%
growth rate for the house and a 15% growth rate for the cash then holding
the cash would be a much better investment.


Renting a Home.

* Step 1: Gather data. You will need:
    - monthly rent
    - renter's insurance     (usually inexpensive)
    - term             (period of time over which you will rent)
    - estimated inflation rate to compute present value (historically 4.5%)
    - estimated annual rate of increase in the rent (can use inflation rate)

* Step 2: Compute the present value of the cash stream that you will pay over
the term, which is the cost of renting over that term.  This analysis assumes
that there are no tax consequences (benefits) associated with paying rent.

Long-term example:
    Rent          =  990 / month
    Insurance         =  10 / month
    Term        =  30 years
    Rent increases    =  4.5% annually
    Inflation         =  4.5% annually
    For this cash stream, present value = 348,137.17.

Short-term example:
    Same numbers, but just 2 years.  Present value = 23,502.38


Buying a Home.

* Step 1: Gather data. You need a lot to do a fairly thorough analysis:
    - purchase price
    - down payment & closing costs
    - other regular expenses, such as condo fees
    - amount of mortgage
    - mortgage rate
    - mortgage term
    - mortgage payments (this is tricky for a variable-rate mortgage)
    - property taxes
    - homeowner's insurance
    - your tax bracket
    - the current standard deduction you get
  Other values have to be estimated, and they affect the analysis critically:
    - continuing maintenance costs (I estimate 1/2 of PP over 30 years.)
    - estimated inflation rate to compute present value (historically 4.5%)
    - rate of increase of property taxes, maintenance costs, etc. (infl. rate)
    - appreciation rate of the home (THE most important number of all)

* Step 2: compute the monthly expense.  This includes the mortgage payment,
fees, property tax, insurance, and maintenance.  The mortgage payment is
fixed, but you have to figure inflation into the rest.  Then compute the
present value of the cash stream.

* Step 3: compute your tax savings.  This is different in every case, but
roughly you multiply your tax bracket times the amount by which your interest
plus other deductible expenses (e.g., property tax, state income tax) exceeds
your standard deduction.  No fair using the whole amount because everyone
gets the standard deduction for free.  Must be summed over the term because
the standard deduction will increase annually, as will your expenses.  Note
that late in the mortgage your interest payments will be be well below the
standard deduction.  I compute savings of about 5% for 33% tax bracket.

* Step 4: compute the future value of the home based on the purchase
price, estimated appreciation rate, and the term.  Once you have the
future value, compute the present value of that sum based on the
inflation rate you estimated earlier and the term you used to compute
future value.   If appreciation > inflation, you win.  Else you lose.

* Step 5: Compute final cost.  All numbers must be in present value.
    Final-cost = Down-payment + S2 (expenses) - S3 (tax sav) - S4 (prop value)

Long-term example #1:

* Step 1 - the data:
    Purchase price   =  145,000
    Down payment etc =  10,000
    Mortgage amount  =  140,000
    Mortgage rate    =  8.00%
    Mortgage term    =  30 years
    Mortgage payment =  1027.27 / mo
    Property taxes   =  about 1% of valuation; I'll use 1200/yr = 100/mo
            (which increases same as inflation, we'll say)
    Homeowner's ins  =  50 / mo
    Condo fees etc   =  0
    Tax bracket         =  33%
    Standard ded     =  5600
  Estimates:
    Maintenance      =  1/2 PP is 72,500, or 201/mo; I'll use 200/mo
    Inflation rate   =  4.5% annually
    Prop taxes incr  =  4.5% annually
    Home appreciates =  6% annually (the NUMBER ONE critical factor)

* Step 2 - the monthly expense, both fixed and changing components:
Fixed component is the mortgage at 1027.27 monthly.  Present value = 203,503.48
Changing component is the rest at   350.00 monthly.  Present value = 121,848.01
Total from Step 2: 325,351.49

* Step 3 - the tax savings.
I use my loan program to compute this.  Based on the data given above,
I compute the savings: Present value = 14,686.22.  Not much at all.

* Step 4 - the future and present value of the home.
See data above.  Future value = 873,273.41 and present value = 226,959.96
(which is larger than 145k since appreciation > inflation)
Before you compute present value, you should subtract reasonable closing
costs for the sale; for example, a real estate brokerage fee.

* Step 5 - the final analysis for 6% appreciation.
Final = 10,000 + 325,351.49 - 14,686.22 - 226,959.96
      = 93,705.31

So over the 30 years, assuming that you sell the house in the 30th year for
the estimated future value, the present value of your total cost is 93k.
(You're 93k in the hole after 30 years ~~ you only paid 260.23/month.)

Long-term example #2:  all numbers the same BUT the home appreciates 7%/year.
Step 4 now comes out FV=1,176,892.13 and PV=305,869.15
Final = 10,000 + 325,351.49 - 14,686.22 - 305,869.15
      = 14796.12
So in this example, 7% was an approximate break-even point in the absolute
sense; i.e., you lived for 30 years at near zero cost in today's dollars.

Long-term example #3:  all numbers the same BUT the home appreciates 8%/year.
Step 4 now comes out FV=1,585,680.80 and PV=412,111.55
Final = 10,000 + 325,351.49 - 14,686.22 - 412,111.55
      = -91,446.28
The negative number means you lived in the home for 30 years and left it in
the 30th year with a profit; i.e., you were paid to live there.

Long-term example #4: all numbers the same BUT the home appreciates 2%/year.
Step 4 now comes out FV=264,075.30 and PV=68,632.02
Final = 10,000 + 325,351.49 - 14,686.22 - 68,632.02
      = 252,033.25
In this case of poor appreciation, home ownership cost 252k in today's money,
or about 700/month.  If you could have rented for that, you'd be even.

Short-term example #1:  all numbers the same as Long-term example #1, but you
sell the home after 2 years.  Future home value in 2 years is 163,438.17
Cost  = down&cc + all-pymts - tax-savgs - pv(fut-home-value - remaining debt)
      = 10,000  + 31,849.52 - 4,156.81  - pv(163,438.17 - 137,563.91)
      = 10,000  + 31,849.52 - 4,156.81  - 23,651.27
      = 14,041.44

Short-term example #2:  all numbers the same as Long-term example #4, but you
sell the home after 2 years.  Future home value in 2 years is 150,912.54
Cost  = down&cc + all-pymts - tax-savgs - pv(fut-home-value - remaining debt)
      = 10,000  + 31,849.52 - 4,156.81  - pv(150912.54 - 137,563.91)
      = 10,000  + 31,849.52 - 4,156.81  - 12,201.78
      = 25,490.93


Some closing comments:

Once again, the three important factors that affect the analysis the most
are cash flows, term, and appreciation.  If the relative cash flows are
basically the same, then the other two factors affect the analysis the most.

The longer you hold the house, the less appreciation you need to beat renting.
This relationship always holds, however, the scale changes.  For shorter
holding periods you also face a risk of market downturn.  If there is a
substantial risk of a market downturn you shouldn't buy a house unless you
are willing to hold the house for a long period.

If you have a nice cheap rent controlled appartment, then you should probably
not buy.

There are other variables that affect the analysis, for example, the inflation
rate.  If the inflation rate increases, the rental scenario tends to get much
worse, while the ownership scenario tends to look better.

Question:  Is it true that you can usually rent for less than buying?

Answer 1:  It depends.  It isn't a binary state.  It is a fairly complex set
of relationships.

In large metropolitan areas, where real estate is generally much more expensive
then it is usually better to rent, unless you get a good appreciation rate or
if you are going to own for a long period of time.  It depends on what you can
rent and what you can buy.  In other areas, where real estate is relatively
cheap, I would say it is probably better to own.

On the other hand, if you are currently at a market peak and the country is
about to go into a recession it is better to rent and let property values and
rent fall.  If you are currently at the bottom of the market and the economy
is getting better then it is better to own.

Answer 2:  When you rent from somebody, you are paying that person to assume
the risk of homeownership.  Landlords are renting out property with the long
term goal of making money.  They aren't renting out property because they want
to do their renters any special favors.  This suggests to me that it is
generally better to own.

-----------------------------------------------------------------------------

Subject: Retirement Plan - 401(k)
From: [e-mail]

A 401(k) plan is an employee-funded, retirement savings plan.  It
takes its name from the section of the Internal Revenue Code of
1986 which created these plans.  An employer will typically match
a certain percent of the amount contributed to the plan by the
employee, up to some maximum.  Note: I have been looking at my 401(k)
in pretty good detail lately, but this article is subject to my
standard disclaimer that I'm not responsible for errors or poor advice.

Example: the employee can contribute up to 7% of gross pay to the
     fund, and the company matches this money at 50%.  Total
     contribution to the plan is 10.5% of the employee's salary.

Pre-tax contributions: Employees have the option of making all or part
of their contributions from pre-tax (gross) income.  This has the added
benefit of reducing the amount of tax paid by the employee from each
check now and deferring it until you take this pre-tax money out of
the plan.  Both the employer contribution (if any) and any growth of
the fund compound tax-free until age 59-1/2, when the employee is
eligible to receive distributions from the plan.

Pre-tax note: Current law allows up to a maximum of 15% to be deducted
from your pay before federal income and (in most places) state or local
income taxes are calculated.  There are IRS rules which regulate
withdrawals of pre-tax contributions and which place limits on pre-tax
contributions; these affect how much you can save.

After-tax contributions: If you elect to save any of your contributions
on an after-tax basis, the contribution comes out of your pay after
taxes are deducted.  While it doesn't help your current tax situation,
these funds may be easier to withdraw since they are not subject to the
strict IRS rules which apply to pre-tax contributions.  Later, when
you receive a distribution from the 401(k), you pay no tax on the
portion of your distribution attributed to after-tax contributions.

Contribution limits: IRS rules won't allow contributions on pay over
a certain amount (limit was $228,860 in 1992, and is subject to change).
The IRS also limits how much total pre-tax pay you can contribute
(limit was $8,728 in pre-tax money in 1992, and is subject to change).
Employees who are defined as "highly compensated" by the IRS (salary
over $60,535 in 1992 - again, subject to change) may not be allowed to
save at the maximum rates.  Your benefits department should notify you
if you are affected.  Finally, the IRS limits the total amount contributed
to your 401(k) and pension plans each year to the lesser of some amount
($30,000 in 1992, and subject to change of course) or 25% of your annual
compensation.  This is generally taken to mean the amount of taxable
income reported on your W-2 form(s).

Advantages: Since the employee is allowed to contribute to his/her
401(k) with pre-tax money, it reduces the amount of tax paid out of
each pay check.  All employer contributions and fund gains (or losses)
grow tax-free until age 59-1/2.  The employee can decide where to
direct future contributions and/or current savings.  If your company
matches your contributions, it's like getting extra money on top of
your salary.  The compounding effect of consistent periodic contributions
over the period of 20 or 30 years is quite dramatic.  Because the
program is a personal investment program for you, the benefits may
not be used as security for loans outside the program.  This includes
the additional protection of the funds from garnishment or attachment
by creditors or assigned to anyone else except in the case of domestic
relations court cases dealing with divorce decree or child support
orders.  While the 401(k) is similar in nature to an IRA, an IRA won't
enjoy any matching company contributions and personal IRA contributions
are only tax deductible if your gross income is under some limit (limit
phases in at $40,000 in 1992).

Disadvantages: It is "difficult" (or at least expensive) to access
your 401(k) savings before age 59-1/2 (see next section).  401(k) plans
don't have the luxury of being insured by the Pension Benefit Guaranty
Corporation (PBGC).  (But then again, some pensions don't enjoy this
luxury either.)

Investments: A 401(k) should have available different investment
options.  These funds usually include a money market, bond funds of
varying maturities (short, intermediate, long term), company stock,
mutual fund, US Series EE Savings Bonds, and others.  The employee
chooses how to invest the savings and is typically allowed to change
where current savings are invested and/or where future contributions
will go a specific number of times a year.  This may be quarterly,
bi-monthly, or some similar time period.  The employee is also
typically allowed to stop contributions at any time.

Accessing savings before age 59-1/2: It is legal to take a loan from
your 401(k) before age 59-1/2 for certain reasons including hardship
loans, buying a house, or paying for education.  When a loan is obtained,
you must pay the loan back with regular payments (these can be set up
as payroll deductions) but you are, in effect, paying yourself back
both the principal and the interest, not a bank.  If you take a
withdrawal from your 401(k) as money other than a loan, not only must
you pay tax on any pre-tax contributions and on the growth, you must
also pay an additional 10% penalty to the government.  In short, you
can get the money out of your 401(k) before age 59-1/2 for something
other than a loan, but it is expensive to do so.

Accessing savings after age 59-1/2: At age 59-1/2 you are allowed to
access your 401(k) savings.  This can be done as a lump sum distribution
or as annual installments.  If you choose the latter, money not withdrawn
from the 401(k) can continue to grow in the fund.  401(k) distributions
are separate from pension funds.

Changing jobs: Since a 401(k) is a company administered plan, if you
change or lose jobs, this can affect your savings.  Different companies
handle this situation in different ways.  Some will allow you to keep
your savings in the program until age 59-1/2.  This is the simplest
idea. Others will require you to take the money out.  Things get more
complicated here.  Your new company may allow you to make a "rollover"
contribution to its 401(k) which would let you take all the 401(k)
savings from your old job and put them into your new company's plan.
If this is not a possibility, you may have to look into an IRA or other
retirement account to put the funds.

Whatever you do regarding rollovers, BE EXTREMELY CAREFUL!!  This can
not be emphasized enough.  Recent legislation by Congress has added a
twist to the rollover procedures.  It used to be that you could receive
the rollover money in the form of a check made out to you and you had
a period of time (60 days) to roll this cash into a new retirement
account (either 401(k) or IRA).  Now, however, employees taking a
withdrawal have the opportunity to make a "direct rollover" of the
taxable amount of a 401(k) to a new plan.  This means the check goes
directly from your old company to your new company (or new plan).
If this is done (ie. you never "touch" the money), no tax is withheld
or owed on the direct rollover amount.  If the direct rollover option
is not chosen, the withdrawal is immediately subject to a mandatory
tax withholding of 20% of the taxable portion which the old company
is required to take.  The remaining 80% must still be rolled over
within 60 days to a new retirement account or else is is subject to
the 10% tax mentioned above.  The 20% withholding can be recovered
using a special form filed with your next tax return to the IRS.
If you forget to file that form, however, the 20% is lost.  Check with
your benefits department if you choose to do any type of rollover of
your 401(k) funds.

Epilogue: If you have been in an employee contributed retirement plan
since before 1986, some of the rules may be different on those funds
invested pre-1986.  Consult your benefits department for more details,

Expert (sic) opinions from financial advisors typically say that
the average 401(k) participant is not aggressive enough with their
investment options.  Historically, stocks have outperformed all other
forms of investment and will probably continue to do so.  Since the
investment period of 401(k) savings is relatively long - 20 to 40
years - this will minimize the daily fluctuations of the market and
allow a "buy and hold" strategy to pay off.  As you near retirement,
you might want to switch your investments to more conservative funds
to preserve their value.

-----------------------------------------------------------------------------

Subject: Round Lots of Shares
From: [e-mail]

There are some advantages to buying round lots (usually 100 shares)
but if they don't apply to you, then don't worry about it.  Possible
limitations on non-round-lots are:

 - The broker might add 1/8 of a point to the price -- but usually
   the broker will either not do this, or will not do it when you
   place your order before the market opens or after it closes.

 - Some limit orders might not be accepted for odd lots.

 - If these shares cover short calls, you usually need a round lot.

-----------------------------------------------------------------------------

Subject: Savings Bonds (from US Treasury)
From: [e-mail]

Series EE Savings bonds currently pay better than bank C/D rates,
and are exempt from State and local income taxes.  You can buy up
to $15,000 per year in US Savings Bonds.  Many employers have an
employee bond purchase/payroll deduction plan, and most commercial
banks act as agents for the Treasury and will let you fill out the
purchase forms and forward them to the Treasury.  You will receive
the bonds in the mail a few weeks later.

Series EE bonds cost half their face value.  So you would purchase
a $100 bond for $50.  The interest rate is set by the Treasury.
Currently the interest rate is set every November and May for a
period of 6 months, and is credited each month until the 30th month,
and credited every 6 months thereafter.  The periodic rates are set
at 85% of 5-year US Treasuries.  However, the Treasury Dept currently
guarantees that the minimum interest rate for bonds held at least 5
years is 6%.  Bonds can be cashed anytime after 6 months, and must
be cashed before they expire, which for current bonds is 30 years
after issue date.  Since rates change every 6 months, it is not too
meaningful to ask when a bond will be worth its face value.

A bond's issue date is the first day of the month of purchase, and
when you cash it in the interest is calculated to the first day of
the month you cash it in (up to 30 months, and to the previous 6
month interval after).  So it is advantageous to purchase bonds near
the end of a month, and to cash it near the beginning of a month
that it credits interest (each month between month 6 through 30,
and every 6 months thereafter.)

Series E bonds were issued before 1980, and are very similar to EE
bonds except they were purchased at 75% of face value.  Everything
else stated here about EE bonds applies also to E bonds.

Interest on an EE/E bond can be deferred until the bond is cashed
in, or if you prefer, can be declared on your federal tax return as
earned each year.

When you cash the bond you will be issued a Form 1099-INT and would
normally declare as interest all funds received over what you paid
for the bond (and have not yet declared).  However, you can choose
to defer declaring the interest on the EE bonds and instead use the
proceeds from cashing in an EE bond to purchase an HH Savings bond
(prior to 1980, H Bonds).  You can purchase HH Bonds in multiples of
$500 from the proceeds of EE bonds.  HH Bonds pay interest every 6
months and you will receive a check from the Treasury.

When the HH bond matures, you will receive the principal, and a
1099-INT for that deferred EE interest.

Savings Bonds are not negotiable instruments, and cannot be transferred
to anyone at will.  They can be transferred in limited circumstances,
and there could be tax consequences at the time of transfer.

Using Savings Bonds for College Tuition:  EE  bonds purchased in your
name after December 31, 1989 can be used to pay for college tuition
for your children or for you, and the interest may not be taxable.
They have to have been issued while you were at least 24 years old.
There are income limits:  To use the full interest benefit your
adjusted gross income must be less than  (for 1992 income) $44,150
single, and 66,200 married, and phases out entirely at $59,150 single
and $96,200 married.  Use Form 8815 to exclude interest for college
tuition.  (This exclusion is not available for taxpayers who file as
Married Filing Separately.)

Effective March 1, 1993 the guaranteed interest rates were lowered to
4% for bonds bought on March 1, 1993 or later and held at least 5 years.
The 4% rate is currently guaranteed as the minimum rate for 18 years.
(The former rate -- 6% -- had been guaranteed for 12 years -- and
continues for bonds bought when the 6% guarantee was in effect.  Prior
to the 6% rate, the guaranteed rate had been 7,5%.)   The actual semi-
annual rate on March 1, 1993 is slightly over 5%.

-----------------------------------------------------------------------------

Compilation Copyright (c) 1993 by Christopher Lott, [e-mail]
--
"Christopher Lott   [e-mail]   [phone], -3331 Fax"
"Post: FB Informatik - Bau 57, Universitaet KL, 67653 Kaiserslautern, Germany"