Adjustable Rate Mortgages - Limits

In a comment to a previous post on Adjustable Rate Mortgages (ARMs), a reader asked, “Is there some kind of a interest rate cap for ARMs ?” Here was the answer:

Yes, there are limitations to interest increase and decrease (in a declining rate environments) amounts. There are usually two caps, one for each adjustment and one for the life of the loan. The adjustment cap is the maximum change that can occur for the periodic changes – typically around 1-2% but can be as high as 5%. For example, if a loan has a 2% adjustment cap and interest rates rise 4%, the loan interest is only increased 2%. The life of the loan cap is the maximum change from the initial rate that can happen over the full term – typically around 5%, I think. So if your initial rate is 5.5%, the minimum and maximum rates anytime during the life of the loan are 1.5% (we wish:-) and 10.5% (arrgh) respectively.

There are also limitations the frequency of adjustment.

Fixed Rate Period. ARMs typically have a period when the interest interest is fixed. Typically, it is 1, 3, 5 or 7 years. The longer the fixed period, the higher the intial interested rate.

Adjustment Period. After the fixed rate period, ARMs will adjust once or twice a year. Usually, 1 indicates a yearly adjustment, and a 6 indicates an adjustment every 6 months.

For example, an ARM with a 3 year fixed period and adjustment every year after 3 is a 3/1 ARM.

The issue is that many people use an ARM because it has a lower payment than a fixed rate mortgage, and they could not afford or qualify for the fixed rate mortgage. With interest rates rising over the last 3 years, some of these people are experiencing the same affordability difficulty again, even with caps.

This is not financial or real estate advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC

Carnival of Investing #46

The 46th Carnival of Investing is up and running at My 1st Million at 33. There are thirty-one posts on stocks, real estate, and gold. The posts also cover investment strategies, leverage, and specific recommendations. It’s worth a read to find ideas that may interest you.

This is not financial advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC

Investing 101 - Managing Risk Successfully

“October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” - Mark Twain

To successfully build wealth, one needs to understand the concept of risk and manage it well. For several detailed mathematical and psychological definitions of risk, see Wikipedia. Here are my working definitions for risk:

Individual Risk. That is the risk associated with your specific investment. An example of Individual Risk is a biotech stock declining even though most biotech stocks are rising.

Market Risk. That’s the risk that is associated with the area in which you are involved. An example of Market Risk is the current real estate “bubble.” In general, all real estate will experience the same issue, i.e. declining, when the bubble breaks. If you own real estate when a real market declines, you will likely experience a decline.

Risk Tolerance. This is describes the level of risk with which one is comfortable. When risk is below your risk tolerance, you sleep comfortably at night. When risk is above your risk tolerance, you are constantly on edge.

To be a successful investor, one must take steps to manage the risk in each of the areas. Here are approaches I’ve used to help manage risk:

Reducing individual risk can be achieved by diversifying within an asset class. For stocks, that means choosing stocks in different industries. Minimum risk can be achieved with as little as 10 stocks. For real estate, that may mean buying different types (residential, multi-family, commercial) of properties.

Reducing market risk can be achieved by investing in different assets that are negatively correlated. For example, real estate and gold tend to be negatively correlated with stocks. When stocks are rising, gold and real estate tend to be stagnant or declining. When gold and real estate are rising, stocks tend to be stagnant or declining. By diversifying across several asset classes one can minimize downside risks. However, diversification also tends to limit upside gains, for the same reason.

While the first two have statistically based solutions, increasing risk tolerance addresses an emotional challenge. One way to manage risk tolerance is to minimize the negative impact of any downside risk. A second way is to build you risk tolerance over time. A third way is to ignore it :-)

I have a low risk tolerance and am most comfortable when my investment strategies are preserving my principal. My investments tend to have low risk for loss of principal and only a small amount is invested in speculative opportunities (e.g. options and turnaround stocks).

Mitigate the negative impact of a market downturn by creating a savings foundation on which you can fall back. Only invest funds after you have paid off non-mortgage debt and created an emergency fund. Invest funds which you won’t need in the short term and can afford to have fluctuate.

Build your risk tolerance over time. I split my investments among low, medium and high risk areas. I have the majority of funds in low risk investments (e.g. CDs) and portion in higher risk investments (e.g. stocks). I know most advisors recommend a 75/25 or higher split of stocks/fixed income. I began with a 0/100 stock/fixed income split. I have moved to a 40/60 stock/fixed split over time. It’s a split with which I am comfortable, and therefore, can sleep with at night.

Understand your risks. Build your knowledge about your investment options, hire professional advisors to provide guidance, or learn from a successful experienced practitioner. With knowledge, one can make better and more successful decisions on investments and risk. My father successfully invested in stocks and real estate. He taught me many of the basics. Value Line Investment Service has a demonstrated successful stock investment methodology. I have also established a relationship with a local real estate agent. All have been helpful references with my investments in stocks and real estate.

As you master the management of risk, you will increase the probability of your investment making money.

Here are the current posts in the Investing 101 series: Part 1 - Getting Started; Part 2 – Managing Risk Successfully

This is not financial or investing advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC

Reduce Spending - Use Your Company’s Corporate Rates

Some companies allow their employees to use the company (hotel, car rental, etc.) Corporate Rate ID for personal use. Using the Corporate Rate can often result in significant savings. It is worth checking if your company has such a policy in place.

My company allows all employees to use the Corporate Rate ID for any hotel stay or car rental. I have found our Corporate Rate to be the lowest rate about 90% of the time. If the Corporate Rate is higher, it usually will include more benefits than the lower rate – e.g. our Corporate Rate includes insurance on rental cars for no additional cost.

Weekend hotel stays are the one instance where I found Corporate Rates have little benefit. Since most business stays are during the week, weekend hotel rates are often lower than the Corporate Rates.

This is not financial advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC

Stock Market - Short Term Assessment

The stock market is having a good uptrend. The number of new all time highs is at 408 versus new all time lows at 17. Yesterday, the 52 week new high/new low ratio was 343/12 on the NYSE and 247/31 on the NASDAQ. The DOW is hitting new highs. Oil prices and interest rates are lower. All these measures are favorable for stocks.

Since I believe the upward move will be short-lived, I will try to sell some stocks into this rally. I have already sold Motorola (MOT) at $24.84 for a 7% short term gain and am looking for opportunities to sell Alcon (ACL) and Chicos (CHS). I will continue to hold Google (GOOG), Apple (AAPL) and Gilead (GILD) since they have performed relatively since the recent market dip.

This is not financial advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC

Personal Finance Carnivals to Read

The current editions of three Carnivals I regularly read, the Carnival of Personal Finance #70, the Carnival of Debt Reduction #57, and the Festival of Frugality #44 are up and running at Make Love, Not Debt, My New Choice, and Free Money Finance, respectively. There are a number of excellent posts on all three Carnivals.

For those new to the concept, Carnivals are a great smorgasbord of ideas, discussions, and experiences submitted by bloggers on a specific topic area, in this case, Personal Finance. As with any smorgasbord, there are some new and novel items that will delight and many items that one has already experienced. In any case, you will be exposed to a greater variety of posts than in any one blog. Hope you find this week’s Carnivals as interesting as I did. Enjoy!

This is not financial advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC

New Carnival - Fast Cash

There is a new personal finance Carnival in the blogsphere. The inaugural edition of the Fast Cash Blog Carnival is hosted at Cash 101. There are four categories: Earning, Spending, Saving and Investing. Specifically, I enjoyed the posts on career advice (in Earning by Free Money Finance) and on low tech ways to develop your child’s mind (in Spending by The Learning Umbrella).

This is not financial advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC

Saving Money When Making a Charitable Contribution

If you usually make charitable contributions by cash or check, you may want to consider donating appreciated securities instead. It’s a great way to maximize you contribution while minimizing your out-of-pocket cost. The benefits are:

1. Maximizing tax savings.
2. Reducing your actual cost.
3. The charity gets exactly the same level of contribution.

Here’s how it works:

You contribute shares of appreciated securities that have been held for over one year directly to the charitable organization. Your broker or financial institution that holds your shares can do this for you. The charity that receives the securities will sell them immediately. You get to deduct the full sales value of the securities on Schedule A of your tax return.

Below are three options for contributing $100 using cash or appreciated stock and a comparison of the net cost to the contributor. The calculations assume a 25% marginal income tax rate and a 15% long term capital gains tax rate . It also assumes an 87% gain for the appreciated stock.

Option 1 - Cash
Donate $100 cash. Deduct $100 on your tax return. Tax savings = $25. Net cost = $75.

Option 2 – Sell Appreciated Stock and Donate Cash
Sell $107.5 (with $50 capital gain) stock. Pay $7.50 in taxes on the $50 capital gain. Donate $100. Deduct $100 on your tax return. Tax savings = $25. Tax on gain = $7.50. Net tax savings = $17.50. Net cost = $90. This is the highest cost option due to paying taxes on the realized capital gains. In addition, you may need to pay a commission for the sale of the stock.

Option 3 – Donate Appreciated Stock Directly
Donate $100 (with $46.51 gain) of appreciated stock. You may deduct the full $100, even though you haven’t paid taxes on $46.51 unrealized capital gain. You also have a tax avoidance of $6.98 since you pay no taxes on the $46.51 gain. Net tax savings = $31.98. Net cost = $68.02.

Brokerages (and I believe other financial institutions) will typically waive the transfer fee (typically $50 to $90) for a charitable contribution transfer, making the donation of appreciated shares even more attractive.

Personal Finance 101 - Are You a Saver or Borrower?

Are you a saver or borrower and what will you do about it? Knowing which you are can help you develop a good personal finance strategy. Here are my working definitions of savers and borrowers:

Savers defer gratification today in return for future gratification. Savers choose to have a lower standard of living than they currently can afford.

Borrowers use debt to enable higher levels of immediate gratification. They choose to have a higher standard of living that they can afford currently with cash. Debt enables them to achieve that goal.

We all are savers and borrowers in different situations. For our home, I am a borrower since I have a mortgage and, therefore, have used debt for the purchase. We chose earlier gratification for our house. For cars, vacations, furnishings, everyday living, and home improvements, I am a saver. I pay for each of these with cash from prior savings.

Here’s a quick test of whether you are a saver or borrower. Choose whether you are a saver or borrower for the following list of items:

1. Home
2. Education
3. Car
4. Home Furnishings
5. Vacation
6. Entertainment (Eating out, Movies, etc.)
7. Gifts (Christmas, Birthday, Special Occasion)
8. Everyday Livings Expenses (Clothes, Groceries, Gasoline)

Add up the number of times you answered “saver” to get your Wealth Builder Saver/Borrower assessment.

8 = Extreme Saver. You are debt free, not even a mortgage on your house. You use a credit card only for convenience and pay off the balance every month. You have an excellent credit rating. You are likely saving a significant portion of your income each month.

6-7 = Saver. You likely have two out of the three major debts – mortgage, auto loan, or education loan. You are reducing debt in all areas and are increasing your savings every month. You are also saving some for retirement.

4-5 = At crossroads. You are at a critical junction of potentially falling into a downward debt spiral or choosing a path towards becoming debt free. Currently, you depend partly on debt to maintain your lifestyle. A significant portion of your income is used to pay for debt. You have some savings but not as much you need.

2-3 = Borrower. You are highly dependent on debt and borrow using credit cards or HELOCs to purchase many things. You carry a high debt load which is likely increasing. You are able to cover debt payments by working extra hours or extra jobs. However, changes are needed since you cannot continue this situation for a long period.

0-1= Extreme Borrower. More than your income is already committed to “must pay” items – mortgage/rent, car loans, student loans, credit card payments, utilities. You may be in this situation temporarily, due to job loss, or this may be your lifestyle. Either way, you must make some significant changes since this situation is not sustainable.

Knowing your saver or borrower assessment can help you develop a better plan to address your situation. For example, extreme savers should continue their plan, while extreme borrowers need to seek advice and do something different. If you are a saver, some additional guidance will likely help you to make progress. If you are a borrower, your actions will depend on how long you have been in this situation. If you are at crossroads, you will have an important decision to make that will significantly impact your future - which direction to go?

This is not financial advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC

Using a Financial Advisor

Although I enjoy doing my own investing, I decided to hire a financial advisor in 2004 to manage part of my savings and investments.

It took me several months to find the right advisor that met my needs. The advisor I chose gave me confidence because of their track record through several market cycles, their investment style and the recommendation of several people who had retired from my company. After attending several of their seminars and having one-to-one meetings, I decided to hire them.

Here’s how I think about my relationship with my advisor:

My advisor’s investment style supports my personal financial goals. His investment strategies and approaches are consistent with my conservative, wealth preservation investment goals. Also, he is or has direct access to resources that are more knowledgeable than me in estate planning, retirement planning, and tax laws.

My advisor makes recommendations but I ultimately have the final decision. I can agree or disagree with his choices, although I usually follow his recommendations. I am ultimately responsible for the outcomes. I briefly look at my investment results on a daily basis to know the status of my investments.

My advisor will handle my finances if I can’t. I have seen cases of elderly people, who no longer managed their finances well, and having a trusted financial advisor would have been helpful. Whether the reason is age, incapacity or death, I trust my advisor to continue to steward my wealth in a way that benefits my family or survivors.

In the two years we have worked together, I have been satisfied with the results. After fees, he has returned slightly above the S&P benchmark. In addition, he has provided a review of our estate planning documents (wills and trusts), recommendations on educational savings accounts, retirement options analysis, and guidance on investments in my 401K. For me, the financial advice has been worth the asset management fee that I pay.

This is not financial advice. Please consult a professional advisor.

Copyright © 2006 Achievement Catalyst, LLC