Sentient Money

I know I have been focusing on oil, but it seems to be the main market factor at this time.

Here are a few links to some quality articles on the current oil crisis:

• Bye, Bubble? The Price of Oil May Be Peaking - Barron’s
• Oil Conspiracy Theorists: Rev Your Engines - Salon
• Gas Prices Edge Lower - CNN Money

The price of oil is starting to stir the big players:

• China plans raise gas, diesel and aviation fuel prices for their citizens by 8%. The Chinese government controls price, so they are reducing their subsidy to increase the price of basic fuel. http://money.cnn.com/2008/06/19/markets/oil/index.htm?cnn=yes
• Saudi Arabia will increase oil production by 500,000 barrels a day in the next few weeks. http://www.independent.co.uk/news/world/middle-east/saudi-king-we-will-pump-more-oil-847830.html
• India, Indonesia and Malaysia cut government fuel subsidies. http://www.examiner.com/x-325-Global-Warming-Examiner~y2008m6d4-Further-Government-Cuts-in-Oil-Subsidies-Will-Help-Lower-Oil-Prices
• U.S. drivers have reduced their driving by roughly 4%. http://money.aol.com/news/articles/_a/driving-drops-as-gas-prices-hit-4/20080527124509990001
• U.S. oil companies are in final stages of negotiations for a deal to bring them back to Iraq. http://www.nytimes.com/2008/06/19/world/middleeast/19iraq.html?_r=1&scp=1&sq=iraq+us+oil+companies&st=nyt&oref=slogin
• U.S. to set new limits on oil trading on overseas markets. http://www.nytimes.com/2008/06/18/business/worldbusiness/18oil.html?scp=1&sq=oil+speculation+congress&st=nyt

The good news all of these contributed to the almost $5 drop in oil on Thursday. The news out of China will be credited for most of the drop, but this is only part of the good news, and the least important part. The big news is that the biggest player on the supply side (Saudi Arabia) and biggest players (U.S. consumers, China and India) on the demand side have implemented measures that have a chance at reigning in the price of oil.

Also, another piece of good news, there was an attack on Thursday against a Royal Dutch Shell oil field in Nigeria. Usually this would have caused a slight increase, but the positive news easily overwhelmed this negative news. http://www.msnbc.msn.com/id/12400801/

Analysis: A slow medium-term (6 months or so) drop in oil prices is likely. This drop will probably start sometime over the next 2 months if major events continue to work to move oil lower. However, it probably won’t cause a major drop in gas prices.

Note: The proposal to open up new areas for drilling in the U.S. is not affecting the price, as the traders know it will be many years before this oil would hit the market.

The big question up before congress right now is whether or not to open up more areas of our country to the oil companies (offshore drilling and drilling in protected). The answer to this question should be easy for anyone who pays attention to how things actually work. The answer is an emphatic NO!

Why won’t it ease the pain at the pump? Well, one of the biggest reasons is the time it will take:

It takes a long time to extract oil under any conditions. First, oilers must drill one or more exploratory wells on the basis of their seismic data. Even if a rig is staffed at all hours, that doesn’t mean the drill is in continuous operation. The bit might turn for half of each day or less, depending on the hardness of the rock. Workers have to stop the drill periodically to run pipe down the hole. Every once in a while, a drill bit will wear out; replacing a bit can take more than a day.

A typical 10,000-to-20,000-foot oil well takes between one month and three months to excavate. Exploratory wells take even longer because petroleum engineers stop the drilling every once in a while to take a core sample for analysis. It might take eight months (more than two winters) to drill an exploratory well in ANWR and another couple of years to plan and build the infrastructure for more substantial drilling.

It’s hard to say how long it would take to get oil out of ANWR. Some experts say 10 years, but others suggest it might be done in half that time. It all depends on how the oil company decides to approach the site. They can start slow, with extensive surveys and exploration, or they can jump in at the most promising spot and hope it all works out for the best. http://www.slate.com/id/2130022/

It will take 5-10 years for the wells to start producing oil in sufficient quantities to make a dent in the 14 million barrels of oil we import everyday. Ok, so we wait 5 years right? Unfortunately, in 5 years the demand for oil from developing nations will likely outstrip any new capacity brought on-line. We would be back where we started.

But wait! Wouldn’t the new oil produced in the U.S. stay in the U.S. since it’s ours? No, why would it? The companies (Exxon, Chevron, etc.) producing these new oil wells will want to sell it to the highest bidder, not provide a guaranteed full tank for every American. They are in it for the money, as they should be. Thus, the oil will go on the world market and since demand is matching the new supply the price will be at best unchanged.

The real solution still lies in another energy source for our vehicles, be it hydrogen, cellulostic ethanol (corn ethanol is bogus), or battery powered cars attached to a new wind, solar, thermal and tide national power grid. Prolonging our dependence on oil only prolongs our pain. (I realize building these things will take time, but every time part of it is completed our need for oil would drop.)

Some would say converting to alternative energy costs too much, but it should be noted that Iceland is completely energy independent and is one of the top 10 richest countries in the world. This was all done by a country which does not have good natural resources and it lacks a dynamic economy like the U.S. Just imagine what the U.S. economy would do with energy independence.

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Update: I found a new source showing how negligible the “extra” drilling would be. http://www.eia.doe.gov/oiaf/aeo/otheranalysis/ongr.html

It is interesting this quote comes from one of the wealthiest and most oppressive moguls of the modern era.

• There is no class, so pitiably wretched, as that which possesses money and nothing else. - Andrew Carnegie

Why does it seem certain people make money, as if, by magic? The funny thing is when you finally find out how they made it, the reason is so simple it dazzles us.

• I have ways of making money that you know nothing of. - John D. Rockefeller

This is getting sorely tested with the devaluation of the Dollar.

• All Money is a matter of belief. - Adam Smith

I guess we are screwed either way.

• The sinews of war are infinite money. - Cicero
• The lack of money is the root of all evil. - Mark Twain

If there was ever a quote that applies to our current economy this is it.

• I sincerely believe that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale. - Thomas Jefferson

Is a 70 hour week really worth it?

• Money often costs too much. - Ralph Waldo Emerson

My absolute favorites:

• Money doesn’t buy happiness, but it’s like having a half-off coupon for it. - No idea
• Be fearful when others are greedy and greedy when others are fearful. - Warren Buffett
• Can you imagine what I could do if I could do all I can? - Sun Tzu

There are many ways to get money to start a company, some better than others, but for this post I plan on focusing on one type of financing: credit cards. Yes, I know this sounds risky, but if used in the right situation the risk is minimal.

A good example is my current start-up. I needed $20-25k for my half of the partnership, which I had in cash and investments outside of my retirement. I could use this cash as the initial investment, but the investment would drain my current non-retirement savings. I never feel comfortable without some easily accessible assets, so I decided to use my current credit cards and a couple new ones to cover 80% of the partnership investment.

Of course, it would be foolish to put this money on a 15% interest credit card, as you would be severely restricting the profitability of your venture. However, because I have a good credit score and I am breathing, I get the usual 0% financing options from credit companies for 4-8 months.

The 0% financing from the credit card companies isn’t always free. A good portion of the offers have a balance transfer fee of 3%. This is a one time fee and it will be the only cost associated with these transactions, if the monthly payments are made on time and the balance is paid off before the 0% offer ends.

The beauty of the 0% financing method is the matching time frames between the 0% rate and the time it will take for business inventory to turnover. This means I will be able to use business sales to pay off the 0% loan before the rate jumps to a killer 10-20%. I will then roll over the cost of the new inventory onto the 0% financing offers, while using the profits to expand the business. All of this means I have to put very little of my own cash directly into the business, which allows me to keep it invested in the market.

I know this seems risky, and it could be, but it is almost impossible for the value of the inventory to drop more than 20-30%. This really limits my losses and means I can easily cover any unpaid debt with my own cash, even if the business does not become profitable.

Key Points:

• 0% offers are never free. Find out the cost and factor it in to your calculations. In this case it’s 3% for some of the cards and much lower for others.
• Never use this method for high risk venture. For instance, don’t use this method to put $30k on an upcoming IPO.
• Ensure you have enough cash to service the debt, even if you don’t make any money on the investment.
• Make sure you can pay off debt before the 0% offer period ends. Hardly any business can survive on 15% debt.
• Make all payments on time, even if you have to use your own money. This will prevent the rate from jumping up before the 0% offer period ends.
• Keep the cards with the business balances separate from your day-to-day card, as it will be easier to track payments and expenses.

Well, it all began in kindergarten…seriously. The partnership is with a friend I have known since kindergarten. We have been talking about starting a business or buying a business for a long time, as we both bring different talents to a business. He is good at getting connections and using them, and I’m good at the logical side of the business.

Neither one of us can stand working for someone else. The lack of control and a ceiling on what you can accomplish is very demoralizing. We hate the idea of working until we are 55 or 60 and then slowly fade into an age restricted retirement. Why not get to enjoy your life before you get too old?

The only way to do this is to make sure your money comes from something you control. This could be investments, but you need a lot of money to pull enough from investments to live on. So, the only real option open to us is to start a business. I also have a novel in the works, but the odds of that getting published aren’t especially high.

We have discussed everything from brewing our own beer, I’m still not done with this idea, to junk yards, but nothing really caught our eye or seemed the answer. Until, we realized he had a decent idea for a sports based business.

The great thing about this business is neither one of us has to quit our jobs. This allows us to continue to add capital to our new business, from our jobs, while maintaining a steady income to live on. It also allows us to be part of something that interests us greatly. I can’t tell you how many hours we have wasted discussing sports.

We have committed $20-30k a piece and have purchased what we need. Now all we have to do is make this thing work, and wait for the money to come flooding in. Well, maybe not flood in, but a steady trickle would be nice.

Walk into any bookstore, take a look at half hour commercials, or look at any personal finance/self-help blog and what do you find?…suggested inspirational reading. Everyone has a favorite book they promote, but do they really work?

The Secret has sold several million copies just in North America, as had Robert Kiyosaki’s Rich Dad Poor Dad series. You would think with this large of an audience there would be millionaires all over the place, but there aren’t. Why is that?

The books make everything seem within reach, and all you need to do is think positively and/or think like a rich person. Yet, no one ever seems to become rich because of these books (note: this includes more than the aforementioned books). What these books do is make you feel good and give you the illusion of power over your life, but it’s just an illusion. Just thinking positively doesn’t do anything. Sure it improves your mood and may increase your confidence a little, but real action is what creates wealth or success. The action is the hard part. Thinking about the action is the easy part.

I personally experienced this yesterday. It finally came time to commit $20-30k to a real business partnership. Thinking positively about the potential success was easy, but actually parting with that cash was hard…very hard. You wonder if the positive thoughts are misleading. So, you sit down and run the numbers again. Turns out they still look good. You wonder if you will be able to do the extra work to make the business work. Again, the positive thoughts are easy, but actually performing the work will be difficult, but once you commit you have to do it.

I’m not saying books with positive reinforcement messages don’t have a place, but that place is a minor one next to any action moving you towards your goal. Next time you are ready to add yet another inspirational book to your bookshelf, stop and ask why the other inspirational books haven’t succeeded in getting you to your goals. Then outline actual actions to reach your goals, and begin the first one. Remember the old saying, “Actions speak louder than words.”

No bonds! No bonds! No bonds! Why would you include bonds in your portfolio if you aren’t within a few years of retirement? Yes, I know bonds provide a less volatile portfolio with a minor reduction in return. Why would anyone want that?

Most people have the majority of their retirement in their 401k or IRA. Assuming that who cares about volatility! If you are 20, 30, 40…even 50 you probably won’t be pulling any money out of these vehicles any time soon. These accounts are not being used to save for a house, a new car or a vacation, so what do you care if your account goes down 20% this year. A loss in an account you aren’t going to touch for 20 years…big deal.

Of course, along with larger potential loses come larger potential gains. Maybe you get a 30% return the next two years and easily outpace the 7-9% target on a “properly” allocated portfolio.

So, let’s take a look at the returns produced by different mixes of stocks and bonds. These numbers are from 1980 to 2004, so the overall return is a little higher than normal due to the huge bull market. However, the curve is very consistent no matter what time period you use, so the chart is applicable.

As you can see the more stocks the more risk/volatility, but as we have already discussed who cares. The difference of return between an 80/20 stock/bond portfolio and 100% stock portfolio is roughly .5-1%, based on the above graph. This doesn’t seem like much, but it adds up over time.

Also, how much are the bonds really protecting? Let’s assume you are 2-3 years from retirement and the worst happens. We experience a stock market disaster equivalent to the worst in modern history (after the Great Depression), which would be from January 1973 to December 1974 and results in a 45% drop in your stock portfolio. Now assume two people have been consistently saving and investing $10,000 a year for 30 years. One person did the 80/20 method, so they averaged a 7% return per year. The second person invested in 100% stocks and averaged an 8% return per year. As you can see both returns are easily within historical norms, so no wild assumptions have been made.

After 30 years person one, with the 80/20 portfolio, has $1,005,750, while person two, with the 100% portfolio, has $1,216,005. Unfortunately, one year before retirement, in year 31, a huge bear market occurs causing a 45% drop in the market. Person one is pleased they were “smart” enough to have allocated 20% of their portfolio to bonds, so they get a 4% return from the bonds and are hit with a 45% loss on 80% of the portfolio in the stock market. All of this brings person one’s retirement to $651,726 from $1,005,750, which is only a 35% loss for the entire portfolio.

Person two with a 100% stock portfolio gets hit with the full 45% drop. Well, this should be pretty bad…right? Nope…their $1,216,005 portfolio is now worth $668,903.

Hmmm…person two with the “risky” 100% stock portfolio had $17,076 more for retirement after the largest market drop in 40 years and the second largest drop in 80 years. How is that possible when person two failed to maintain a conservative portfolio? It’s because you can’t make up for years and years of poor returns by investing like the world is going to collapse every year. Being conservative doesn’t improve your odds of retiring; it increases the risk you will not have enough money to retire on by lowering the total return of your portfolio.

I’m not advocating holding 100% stocks a few years before retirement, I’m saying don’t even think about bonds until your within 10 years of retirement…even then, think about waiting a little while longer.

Don’t accept below average returns in a portfolio when volatility doesn’t matter! A 100% stock portfolio is the only way to go.

We have a contrary indicator on oil! The Economist cover this week features a story on oil. This cover, along with the inability of oil to continue its gains, suggests we might have seen the worst for the short-term.

I’m not the only one who thinks this. Barry Ritholtz at The Big Picture and CEO of FusionIQ, a person whose opinion I respect, believes this as well. This makes me feel more comfortable, as this guy does this kind of stuff for a living.

I know it’s probably hard to believe, but everything has to take a breather at some point. However, I by no means am suggesting that oil prices will hold or decline for the long-term. Supply and demand still suggest that oil will remain expensive and continue to increase in price over the next few years…and maybe longer. I’m only suggesting that it might take a rest for a while. How long? I’m not sure.

We all have heard them. Anything from, “if you plan on living there for 3 years it’s better to buy than rent”, “you should contribute up to the max in a 401k”, or “index funds are the best way to go.”

I hate rules of thumb. Why? They provide a hint of truth with a quick and simple pseudo solution to a complex problem. The hint of truth is key, as it enables people who benefit from your decision to provide what seems to be legitimate expert advice. Of course, this advice is really not advice at all, but a means to ally your fears or cause you to doubt your own reasoning. You’re asking yourself, “How can a mortgage payment 3 times my rent be financially beneficial in 3 years?” At the same time someone who has been in the business for 15 years is telling you it will fine, so you start doubting yourself. Don’t doubt your own reasoning in these situations.

Here are some examples of rules of thumb, and why they are useless and dangerous to your finances:

• If you plan on living in the area for at least 5 years (it used to be 3) you will do fine financially by buying a house. This is one of the most ridiculous financial rules of thumb. Why? First, a house is probably the largest amount of money you will spend in your life by at least a factor of 5, but probably more. A 5 second sound bite shouldn’t determine if you’re willing to spend $300k on a house. Secondly, the amount of variables that go into determining if it’s better to rent or buy is huge (house cost, property taxes, interest rate, closing costs, points, utilities, monthly HOA fees, house appreciation, cost to rent, yearly rent increases, investment returns, etc.). Any one of these variables can drastically change the equation. Don’t rely on your real estate agent, rely on yourself. Here is good rent vs. buy calculator form the NYT. http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html#
• Contribute up to the max in your 401k. Not as bad as the rent vs. buy rule. However, you don’t want your retirement to rest on a 5 second sound bite. Examine what you get from your 401k. Does your company match contributions? Most will up to a certain percent of your salary, and if they do it’s almost always a good idea to contribute up the maximum amount matched. A 100% return is hard to beat. After you contribute enough to get the match take a long hard look at the investment vehicles offered in your 401k. Do they have expense ratios of at least less than .5% for domestic funds and below 1-1.5% for foreign funds? Are the historical average returns for the funds in your 401k comparable to the benchmarks associated with each type of fund? Is it easy and free to switch to different funds in the 401k? Don’t rely on anyone else to answer these questions go find the answers for yourself. Your retirement depends on it.
• Index funds are the best way to go. Not necessarily. If you don’t want to commit any time at all to your investment decisions, then by all means use them. However, if you are willing to put in the work, you can pick quality managed funds and pick individual stocks. You can get a higher return than an index fund, but it requires work. I don’t have any index funds in my portfolio.
• Save 10% of your salary for retirement. Maybe you want to live it up in retirement, or maybe you had kids and didn’t start saving until you were 40. Either way, you will probably need to save more. Here is decent calculator: http://finance.yahoo.com/calculator/retirement/ret-02
• Bad debt (credit card, car loan, student loans, etc.) shouldn’t be more than 20% of your income. I stumbled on this while researching this article and was amazed someone thought this was ok. Under no circumstances is credit card debt ok. Using a credit card is fine, but pay it off each month. Do not carry a balance. A car loan should be extremely minimal if you have to have one. Ideally if you can’t pay cash for a car you shouldn’t get it. However, this is difficult when you are starting out, so a small loan on a USED car is acceptable. If you need a loan for a luxury vehicle (BMW, Mercedes, huge ass SUV, etc.) you can’t afford it. Some student loans are ok, but make sure you think before you go in debt too far. Going in debt for $100k to be a lawyer, doctor or to work on Wall Street, is probably ok. Going in debt $40k to be a social worker is just plain foolish.
• Give away at least 10% of your net pay every month. This should not even be a rule. You should only give if you are covering all your basic financial goals with ease. Being virtuous and in debt isn’t a good way to live.

Nothing is too complex to figure out for someone who truly thinks for themselves. Your own thoughts are more valuable for any financial situation than some random arcane rule of thumb.