Taking Risks and Reaping Rewards

3 Ways To Relieve Financial Pressure

Financial pressure runs rampant these days.

If you aren't feeling it, you know someone who is.

In a 'do better,' 'accumulate more,' 'keep up or catch up,' and 'whatever you do don't let them see you sweat' culture, pressure is accepted as a given. But when a major crisis happens, the pressure is magnified.

More people lose jobs, all assets tank, debt increases and pressure mounts to very unhealthy and unproductive levels. For those feeling excessive financial pressure, here are three ways that you can find some relief.

1. Communicate: Under stress, it's more comfortable to sweep the problem under the rug and only clean up the mess when it gets out of hand. This increases the pressure, especially in couples. To relieve that pressure, clean house, and get the problems out in the open.

When communication opens up, get beyond griping and venting about the past, and move toward forgiving past actions, both in others and in yourself.

Where you are now and how you move forward is what really matters. Relief for many can stem from just talking it through.

2. Plan: If your previous financial plan worked, you wouldn't be feeling pressure. So the obvious thing to do is revise and update your plan and begin working it.

Analyze what happened, where you are now, and update where realistically you want to be and can go in the future. While the path to this new future will still have some bumps, moving forward should relieve feelings of hopelessness and despair.

This may start with a cash flow statement, a new budget, a net worth calculation, or something less mathematical such as reviewing credit card statements or discussing job options. Just having new goals will allow some forward movement and that can relieve the quandary about what to do.

3. Work: Idle minds dwell on past events, often reliving them, which can lead to increasing pressure.

One way to relieve this pressure is to stay focused on what you are doing and work harder to be more productive. Increasing your output will not only take your mind off your troubles, but it will also move you toward improving your situation.

If you are working at capacity, then consider what you are working on and its impact on your situation. You might find that you could be more productive doing something else.

A sense of accomplishment works wonders for relieving pressure. While the common advice of laughter and exercise will work wonders for relieving pressure, more specific actions may be more useful in this current financial environment.

The macro economy is beyond your control, but the things you do control can make a big difference. By increasing your communication, revising your financial plan, and increasing your productivity, you may find relief from your current financial pressures.

Eye of the Housing Hurricane

After the first wall of the hurricane passes, there's a lull.

You're in the eye of the hurricane. 

It may feel like it's over, but it's not. It just feels better because the wind stopped blowing for a minute. But when the second wall comes through, it could be just as bad as the first.

In housing, we weathered the storm - BARELY. 

But that was just the first wall. The second wall is approaching and some us need to take cover. 

Here's a chart that shows the impending mortgages that are going to reset in the next year or so. 

 

 As you can see, the second wall is coming. The first was the subprime loans, shown here in green. The second is the Option Adjustable Rate (Option ARM) loans, shown here in beige.

An Option ARM loan is often called a pick a payment loan as the borrower can decide what type of payment they want to make. Typically they can choose between a fixed rate of 15 or 30 years or interest only or a negative amortization minimum payment. 

The first two options are basically regular loans, so while the option exists, no one chooses it. The second two are where the problems come in.

Interest only provides a lower payment as you aren't paying the prinicpal back. But eventually, you have to start paying back the principal and when that happens the loan payment resets potentially sharply upward. 

If that wasn't enough of a problem, the other option is a negative amortization payment where not only have borrowers avoiding paying on the principal, they haven't even been paying the full interest due on the loan. So the balance due has been increasing. 

For example, if you borrowed $400,000 on a house, paid less than the interest on the loan each month, you could owe $440,000 now years later, and that home might only be worth $250,000.

88 percent of Option ARMs originated between 2004 and 2007 are going to adjust higher between now and 2012. Those option ARM borrowers could see their housing bills go up as much as 63 percent, according to Fitch ratings.

 

With house values still struggling, when this next wall of payment resets hits, who's going to stay in their house with that kind of payment increase and little hope for an increase in value?

Some reports are citing almost 500,000 option ARM loans in California that will reset between now and 2012. With the state already struggling, people won't be able to make the higher payments, putting a huge block of inventory on the market, which will simply kill prices in the "Golden" State.

What's even worse is that the Federal Reserve is going to start raising interest rates to offset potential inflation. Many option ARM loans will go up with them so the payments just get bigger.

Why this matters to you

You may be thinking that this doesn't impact you because you aren't in one of these crazy loans. You may even think that some people deserve to lose their home because they acted recklessly and this should be a lesson to them. 

Well, a lesson it is, but it does impact you too. Why?

Because another wave of housing foreclosures will impact the overall economy and will certainly impact residential real estate prices.

Going from "owning" a house to renting an apartment may not be the disaster of a lifetime, but no one does it, and then goes out and throws a party. And those watching it happen on TV and talking about it around the water cooler, don't throw parties either.

Consumer spending is almost 70% of the economy and if consumers are seeing people being thrown out of their homes, their own home price falling still, and the economy slowing again, it's likely they will tighten their purse strings. Which means the economy slows just that much faster.

We rarely get such a glimpse out the foggy windshield to the future. But in this case, it sure seems like the fog parted and it's pretty easy to see the road ahead. 

The next wall of the hurricane is approaching. It's on the radar and we can see it.  Batten down the hatches, and hold on. This could be a rough ride.

This is not a drill.

Greenspan's Right

On Meet the Press yesterday, former Federal Reserve Chairman Alan Greenspan said a U.S. economic recovery is "going to be a slow, trudging thing," and that he "would get very concerned" if stock prices continue to fall.

He went on to say that a drop in stock prices is "...more than a warning sign. It's important to remember that equity values, stock prices, are not just paper profits. They actually have a profoundly important impact on economic activity."

He's right.

And we should be worried about this.

The masses that feels like they are hanging on by a thread, but at least their 401K has recovered somewhat, could easily become very discouraged at significant return to lower stock prices.

The result of that would be to spend less, which in turn would slow the economy, which in turn would lower stock values further, which would push people to spend even less.

If the downward spiral isn't broken fairly quickly, which is easier said than done, then the description of the economy recovery being "a slow trudging thing" would start to sound good. 

Downward spirals can last a long time. Look at what happened to Japan over the last two decades.

In the last 20 years the Nikkei 225, the broad measure of the Japanese stock market, has fallen from a high of 40,000 to around 10,000 today. The last 20 years in Japan show clearly that a major modern industrial nation can go long periods in a downward spiral. 

Will we slide this much or this long? 

We already lost a decade as the Dow is basically at the same place it was 10 years ago and the NASDAQ is down over 50% from 2000 highs. So one could view this as 10 years down, 10 years to go. 

Looking out the foggy windshield doesn't often provide clarity, but it's where we should be looking nonetheless.

Greenspan's right. If the markets continue to slide, the economic road ahead may be not only twisty and bumpy, but downhill.

Top Story on The Financial Edge

I just started writing for an online publication called The Financial Edge. It's an offshoot of the Investopedia, which I write for as well. Both are owned by Forbes.

And I just checked and my latest article is the top story!

Here's the link to the site http://financialedge.investopedia.com/

And here's a link to the article itself as the top article will eventually change.

http://financialedge.investopedia.com/financial-edge/0509/Hows-Your-Mood.aspx

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Ethical Emulsion

In a AP article today, it was pointed out that some of the clients of Bernie Madoff actually made money as a result of what were probably fraudulent efforts on the part of Madoff. This was because they invested for a long period of time and periodically took some money out. So they did get their initial investment back and maybe more. It's unclear what the courts will have to say about this, apparently they can demand part or all of the money back, but let's put aside the legal issue for the time being and ask this:

Is it ethical to keep the money gained from a fraudulent act, even if the act wasn't of your own doing?

From the point of view of an outsider with nothing to gain or lose, most would likely say no, it's not ethical to keep ill-gotten gains, especially when some that lost were charities. But that leads to another question.

Will those that profited from dealings with Madoff actually be willing to give some or all of the money they pulled out of the Madoff investment back?

It would be shocking if any were so inclined. Perhaps someone that really didn't need the money anyway might be more concerned about their reputation than some pocket change. But for those that saw significant money disappear, the very likely response will be to get a lawyer and try to keep every dime.

What can we learn from this?

When it comes to money, many, probably most, people will say one thing and do another. Their views on ethics and values apply to every situation they can think of except the situations where they themselves would lose money. "That's different," is often the retort when presented with the contradiction.

Ethics and money are like oil and water, they don't mix together very well. Sure we can put the two in a bottle, shake vigorously, as in making oil and vinegar salad dressing, and a emulsion will result. It may even taste good for a while. But the natural tendency is to separate again, which begins as soon as the shaking stops.

Knowing this can be a tremendous help in dealing with others, including close friends and family. The example that comes to mind is settling estates among family. Loving sibling relationships are often shredded when the parents die as the money clouds their view and changes their otherwise ethical behavior.

The key to avoiding problems like this is to accept that the natural tendency for oil and water is to separate and plan for it.

To make an ethical emulsion, assuming the worst will work the best.

Signs of the Times

In a recent survey by the AARP, they found the following startling information:

• 4 of 10 parents over 45 have had to help their kids with their bills
• 33% of retirees have had to help their kids with their bills and have stopped putting money into their retirement account.
• 14% have cut back on medications.
• 60% said they had to cut back on eating out and entertainment.
• 25% are in trouble with the mortgage or rent

There may be some issues with the validity of the number due to the survey instrument and such, but even so, these numbers would be a far better sign of the times than GDP, CPI, etc. Sure people are making it, but not by as much as macroeconomic indicators would show if these are even close to right.

But the better question here is what baseline did we start with. For example, how many of the people that are cutting back on eating out and entertainment were living beyond their means to begin with thinking that their house would go up in price forever? Or how many that are in trouble with their mortgage bought too much house in the first place? Or how many that have stopped putting money into their retirement account have plenty of money in there already? After all this was a survey by the American Association of Retired Persons.

What can we learn from this?

It’s always dangerous to accept numbers at first glance because the press is only giving us the sensational details to get our attention. But that doesn’t mean the numbers should be dismissed either. These stats are signs of the times, even if we can’t accept the actual numbers and need more data to verify their validity.

Also, if you haven’t received any money from your parents recently, feel free to use this article to say that it’s now commonplace. They probably won’t doubt the statistics like I do. :-)

What Will the Fed Do?

The Federal Reserve is meeting today and tomorrow and the money is on a 25 basis point cut in rates, down to 2%, and then a pause from the rate cuts. As the fed knows that this is the expectation, and there isn't any fed noise about it being wrong, it's likely that it will occur. But that begs the question, if the economy is still getting worse, why would they signal a pause in rate cuts?

As we know, the Federal Reserve is responsible for the economy and financial system. They have already used some unique and rare measures during this crisis. But their primary gun is running out of bullets. If they go to low right now with interest rate cuts, firing off too many of their limited bullets, they have no where easy or good to go if things continue to get worse. By keeping another 100 basis points or so in the gun, they will have an option that is more traditional if they need to fire another shot.

What can we learn from this?

Holding back a bullet or two is a wise strategy. In a portfolio, it's keeping some cash available. In a household budget, it's keeping some emergency savings. For the fed, it's keeping some room for future rate cuts. Keeping a cushion keeps options open. Do you have a cushion for your next crisis?

Today’s My Birthday

Economics is the study of how to allocate scarce resources. Finance is the study of time, risk, and money. On one's birthday, the most precious of resources, and the key to finance, comes to the forefront: Time.

Individually, we don't know how much we have, but we know it's limited in quantity, and once we use it, we can't get it back- it's non-renewable. Essentially our lives, and our finances, are made up of how we allocate this resource.

Today's I am going to allocate more of my time resource to golfing and less to working. After all it's my birthday!

Feel free to do the same.

Why Buy a Newspaper?

Today Forbes.com ran an article asking, "Will Newspapers Tempt Another Billionaire?" with a report from Newsweek that NYC Mayor (and billionaire) Michael Bloomberg might buy the NY Times. The article correctly suggests that the internet is killing the business model of traditional newspapers and ponders why all these bright, wealthy people are interested in a shrinking business. But the article never really answer the question at hand...why?

Let me take a crack at it. POWER, that's why. If you own the NY Times, or as Rupert Murdoch does Fox and the WSJ, you are, by default, very powerful. You only have to see Citizen Kane once to grasp the importance of newspaper ownership. And if you are already a billionaire, so what if you don't make money? It's not about money at that point anyway. It's about what you enjoy. And it's clear that Mayor Bloomberg enjoys power.

Martha Stewart made a mistake because she kept acting poor even though she was very wealthy. No billionaire in their right mind worries about a few thousand shares of stock and certainly doesn't risk jail for a few thousand dollars. She made a HORRIBLE decision, several actually.

Bloomberg thinks like a billionaire. He's got money and as mayor has power. But he is not going to be mayor forever, so it's time to look for another source of power. The NY Times fills that role nicely. Who cares if it's profitable? The Mayor's salary isn't profitable either, but I'll bet the perks are pretty cool.

He's interested because it's one way that he can remain in the spotlight, staying powerful and influential. That's what owning a newspaper does for you, especially the NYT.

(Of course, so does being Governor.)

What can we non-billionaires learn from this?

If you find that you're acting out of habit long after the habit has ceased to be useful, your making a Martha mistake.

If you simply accept the conventional wisdom without question, in this case buying a firm is about making more money, then you will avoid/ignore/miss the Bloomberg opportunity to fill a need.

Turn the autopilot off and put your thinking cap on.

He did, she didn't, you should.

A Great Idea for Making Twice the Money…or is it?

The best newspaper in the world, The Financial Times, ran an article about leveraged index funds. These sound really good at first glance. They essentially give you 1.5x or 2x or 2.5x the return of the index. So if the index is up 10% your position could be up twice that. Sounds good considering the long term trend of all equities is up, it would appear that this is exactly where you should put your long term holdings and the result would be twice as good. BUT...

The catch is that several fold.

First, your losses are multiplied down. That would be fine but we have to remember that losses cost us more than gains help us. For example, $1.00 up 10% then down 10% isn't a dollar any more. It's less. (1.00 x 1.1 = $1.10 and 10% of that is 11 cents for a totally of 99 cents!)

Second, this loss is bigger than gains hurts over the long term too. A study (I forget who did it) showed that over 30 years they do beat the index but not by much, certianly not by twice. So the potential for gains before taxes is misleading, after taxes is probably not good at all.

Third, although they are index funds, they aren't index fees. Those fees normally avoided with index funds can be almost 2.5%!!! Wow, I know what I should be doing for a living now as 2.5% sounds like I'd be Rolling in the Dough!

Having said all that, this is a way to play the volatility we are seeing recently. If you have that need to play an overbought or oversold market, these can increase your return in the short term, maybe even intermediate, but long term, I urge caution. Like many things involving money, they aren't as good as they look. Too bad the long term doesn't look as good. I, for one, would love double the market return over the next 20 years!