5 Tried and True Financial Fundamentals [via SavingsAdvice.com]

Posted by Tad Johnson - Mar 27th, 2008 at 22:03

Phoning this one in, folks. Click through for the full story.

http://www.savingadvice.com/blog/2008/03/23/102071_tried-and-true-financial-principles.html

Five Tried and True Financial Fundamentals - SavingAdvice.com Blog via kwout

First Time Charitable Giving

Posted by T.W. Hanson - Mar 20th, 2008 at 21:03

charity

Out from under the guidance of parents and maintaining a steady source of income, many people give their first autonomous charitable financial gift as a vicenarian. Done in the right way, this is healthy for all parties involved. There are clear and tangible benefits to the organization receiving the gift and intangible gains for the giver. Benjamin Franklin framed what he believed to be the noblest question, “What good may I do in the world?”

I have learned a few things from my previous gifts.

  • Find a cause about which you feel passionately. Focusing giving on a subject where you have a real interest increases the impact of your donation. Spreading funds widely has no moral flaws, but if it causes you to lose interest and stop giving, it isn’t good.
  • Don’t choose a cause for social status. You can worry about that when your last name is Kennedy or when you marry into a family that came over on the Mayflower.
  • Spread your gift out throughout the year. This protects you from unforeseen events that may put you in difficult financial shape. You also get the excitement of giving on a monthly or quarterly basis as opposed to once a year.
  • Don’t give beyond your means. There are seemingly an infinite number of worthy causes all of which would benefit from your charity. However, taxing yourself into a state of misery is ill advised. Use your budget to compute what you believe to be a reasonable amount and stick to it.

Giving should not be a chore. Your gifts should dovetail with your interests, making them a natural extension of your life.

A Market Bubble Collapses: The Slow Motion Train Wreck Version

Posted by T.W. Hanson - Mar 16th, 2008 at 20:03

train wreck

Vicenarians don’t have much practical experience with the troughs in the business cycle. There was the savings and loan crisis in the late 80s and early 90s, but many of us were learning how to read during those years. The Internet/.com bubble collapse of 2000 is our primary frame of reference for distressful economic times. This crisis is appears very different. Although characteristics like increased unemployment seem to reappear each cycle, there are rarely perfect parallels from one downturn to another. One of the macro differences is the speed. The rate at which this credit markets are contracting is much slower than the rapid implosion of the Internet companies in 2000.

Unlike in 2000, today’s irrationally overvalued assets are homes and properties.  Prices for these assets are sticky.  Most are unique and take weeks, months or years to sell.  One result of this is that the securities tied to the value of these properties have fallen at a similarly and painfully slow pace.  Write downs of assets on bank balance sheets haven’t occurred all at one but have been stretched from quarter to quarter to quarter.  This is forecast by some to continue for quarters to come.

bubbleDuring the Internet bubble, company values were wiped out overnight.  Equity values disappeared, companies shut down, people and families felt pain and the economy took a hit.  However, it was over in a relatively short period of time.

The industry this is hitting the hardest is slowing down the bleeding even more.  The financial institutions provide and source the capital for all other industries.  Each day they are operating in a weakened state, other businesses and individuals aren’t getting the financings or financing terms that a fully functioning free market would provide.

When will the market recover and economic expansion resume?  When the financial sector reaches a catharsis resulting from both the final write down and the replenishment of tangible assets on their balance sheets.  Don’t hold your breath.

Manage your personal finances like a CEO

Posted by Tad Johnson - Mar 15th, 2008 at 6:03

Google vs Costco. Two giant businesses, both very profitable, (both from California) but with a fundamental difference in strategy. Google is all about revenue growth–they release many new products each year and add customers to drive top line growth. Costco, while also focused on growing revenue, places a larger emphasis on driving down cost for bottom line growth.

accountingpic.jpg

Each strategy has its benefits and constraints, but both produce results. As a vicenarian, you too should be thinking about both strategies. As CEO of your personal finance, you need to manage both revenue (your paycheck) and cost (your expenses). You’ll never achieve your financial goals unless you take both into account.

Most of us like to think of the revenue side of the equation first. Everyone dreams of the big fat paycheck coming at the end of the month. The problem is, that’s only half of the equation. Ask the hundreds of movie stars, pro athletes, and rock stars who’ve gone from million dollar paydays to broke–when your expenses exceed your income, you’ve got a problem.

Borrowing another term from corporate finance, consider your personal margin–the difference between income and expenses. If you can arrange your lifestyle to provide a healthy margin, you should consider yourself rich, regardless of your income. Since you have more direct control over your expenses than your income, it’s easy to see where to start. A unifying theme among all the get-rich books and blogs out there is to live below your means. To put it a different way, focus on maximizing your margin, not maximizing your income.

T.W Hanson discovered this in his first year out of college, working in an industry that paid well but required high personal expenses as well (emphasis mine) :

When picking out my New York apartment after undergrad, I had heard that approximately 1/3 of your income should go to rent. Rules of thumb like this do not account for student loans. I unfortunately took the 1/3 advice, and my first 12 months in the city were difficult. I was in more debt after twelve months of work than before I arrived.

You’re the CEO of your personal finance and you’ve got shareholders to satisfy (which, conveniently, are also you). Don’t blind yourself by thinking only about growing your income–it’s the margin that’s most important.

Confused Crisscrossing Markets

Posted by T.W. Hanson - Mar 12th, 2008 at 21:03

 directions

Since the current financial trouble started in the summer of 2007, stock, credit, currency and commodity markets have moved severely.  Interesting is the lack of coordination.  The past 48 hours are a good illustration of this phenomenon.  Equity markets found the $200 billion in lending from the Fed to be fabulous news while the bonds of some of the very same equities didn’t really move.  Traders in the currency markets were convinced early today that the Fed action would fail in its purpose, and pummeled the dollar.  It took the equity market until the end of the day to react in a seemingly similar fashion.  What is the cause of this confusion?

Analytics and quantitative models have lost the faith of the market.  Tools used to value everything from the value of a mortgage to probabilities of corporate defaults are coming scrutiny.   The equations, machines and historical correlations that have typically governed market behavior broke down over the summer.  The variations of models used to value everything from bonds to mortgages to credit default swaps are more disjoint, leaving traders with less uniform valuation techniques.  Think of a heard of buffalo all losing their sight while barreling across the Serengeti.  One example was the lack was the lack of any consolidation of opinions on what the quantitative impact of the Fed’s $200 billion infusion will be.

Without the unifying models and historical correlations, specialization in training on Wall Street becomes another force decoupling the markets.  As my former superiors in investment banking liked to say, “The days of the generalist are over.”  Foreign exchange, corporate credit and equity people work on separate floors; it is even rare to see them at the same social functions.  With all of the current turmoil, each of these worlds is interpreting data differently.  For example, credit analysis often focuses on the past performance of a company while equity markets usually value securities based on future cash flows.  The equity world is much more likely to forgive big write downs and look to the future while credit investors have their attentions squarely on the trauma of the past half year.  We have seen more than a handful of days in 2008 where equities have traded higher while bond spreads have increased, truly irreconcilable moves in “efficient markets.”

What this will bring in the weeks ahead is volatility.  Until it is somewhat clear in what direction the economy is moving or at least what the general effect of Fed policy will be, the markets will continue to move in confounding directions.  Rumors will continue to fly, which have already almost brought down institutions like Bear Stearns.

Tomorrow, we get to see how the markets will interpret retail sales numbers.  Consumer spending makes up over 2/3 of the economy.  The number isn’t likely to be pretty, but how much of that is already priced in to the market?  Wait, how much of that is priced into which market?

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