Extra Mortgage Principal Payments + Moving Soon = Good Short-Term Investment?

I received an interesting reader question last week about a scenario where you are very sure that you’re going to sell your house in a few years. In that case, would paying down your mortgage principal create an opportunity for a relatively high return with minimal risk? The e-mail:

Your blog is very insightful. I had an idea that I wanted to run by you. I plan to list my condo for sale in about 14 months. Currently I have a 2nd mortgage with an 8.875% rate. I want to have the most net cash at the time of sale, so I’m thinking the safest investment I can make over the next 14 months is to pay down this mortgage. If my math is correct, I would get a 4.9% return on the avoided interest (less what I would have gotten back from deductions). Am I crazy, or does it seem like I’ve found a good place to put my cash until I leave?

I’m not a mortgage professional, but it would seem to me that in theory this should work. When you make the additional principal payments, every future mortgage payment will also include less interest and more towards paying the loan balance down even faster. When you sell the house, you’ll get your “return” from this lower loan balance.

The annul return from paying down your principal should be roughly equal to the annual interest rate of your loan. The reader had an 8.875% second mortgage, which would seem like a pretty great short-term return over 14 months. The exact return might be a little off to the amortization schedule, it should be close. The mortgage interest may be tax-deductible, but remember that interest from a bank CD outside an IRA is also fully taxable. Check out these related posts:

Within the posts above, based on the amortization schedule of a 30-year fixed mortgage at a 5% interest rate, I plotted both the effective interest rate paid and the annual investment return from prepaying below:

I suppose that one big risk in doing this is that you don’t end up selling the house, so your cash is now stuck in the home’s equity and will be more difficult to access. So you’ll have to be fairly confident that you will be selling the house, or at least be okay with the possibility of just having a smaller mortgage balance.

80% off Restaurant.com: $25 Certificates for $2

Restaurant.com is offering a 80% off with the coupon code CHEF, resulting in a $25 “certificate” for $2. Offer ends September 30th.

Contrary to my skeptical remarks(I’ve never used one of these before), many readers responded that they indeed found these certificates very useful in savings some money.

Here’s a sample positive scenario. You find a restaurant on the list that you like that usually runs around $20 + tip per person (~$48 for a couple). You buy a $25 certificate for $2, which usually comes with a $35 minimum purchase + 18% required gratuity on full price.

Dinner for two = $40 regular menu priceMinus $25 certificate = $15

Plus cost of certificate ($2) = $17

Plus 18% gratuity on menu price = $7.20

Total price w/ tip = $24.20, or $12 a person + taxes

In that case, you can save around 50% on the total bill. Good thing I’m married and don’t have to worry about going on dates with coupons! 🙂

Gogo Inflight Internet Coupon Code

Gogo Inflight Intertnet is now offering WiFi internet on select Airtran, American, Delta, and Virgin America flights. See here for participating flights. I signed up for their mailing list, and got a code for some free WiFi in case anyone is flying in the next few weeks. Here’s another code good until 10/31, but I can’t tell if it’s one-time use only: 222wifi21940a.

Jonathan, first timers surf the internet in flight with a free gogo session this month. Just look for the “gogoinflight” Wi-Fi signal at 10,000 ft and keep up with the world below.

Enter SURFGOGOFREE when you are prompted to purchase your session through October 15, 2009.

*Good through 10/15/09. Offer available on select American Airlines and Delta Air Lines flights. Offer is good for one use per person, may not be combined with any other Gogo promotional codes and applies only to single sessions, such as Gogo Flight Pass and Gogo Mobile Pass. Use of Gogo service requires registration. Terms and Conditions

Creating a Completely Automated Financial Household

Meet Bill and Jan. They are my imaginary couple that loves putting their personal finances on auto-pilot. They don’t worry about bill due dates, they never visit the bank, and only check their balances online once a month if there are no e-mail alerts sent to them. (Apparently they also don’t have lips or eyes, so it works well for them…) Let’s take a look at how they do it!

Income
Bill and Jan both elected to receive their regular income via direct deposit, so there are no checks to deposit. Even though Jan does some freelancing, she gets paid via PayPal, which she sets to automatically sweep any money into their bank account at the end of each business day. This feature is called Auto Sweep and is not heavily advertised, you must contact PayPal directly to enable it.

Long-Term Savings
Like everyone else, their 401(k) plans are funded via an automatic deferral each payday. For their Roth IRA, they simply take out $500 per month via an automatic transfer from their checking account for 10 months, which can be set up easily at Vanguard.com or any other major mutual fund provider. If you like individual stocks or ETFs, try automatic investing at ShareBuilder.

Short-Term Savings
For their annual vacation and other savings goals, they have an automatic transfer from their checking to an online savings account like the original Capital One Consumer Bank.

They do keep a certain buffer amount in their checking account, similar to this simple budgeting method. If the balance falls too low for any reason, an e-mail and text message alert are sent to both of them.

Housing
If they had a mortgage, most lenders will happily set up an automatic ACH from bank account each month. If they wanted to set up a biweekly payment plan and it isn’t free, they could simply take out 1/12th of their monthly mortgage payment each month automatically into Capital One 360. Once a year, they send one full mortgage payment to their lender.

If they rented, they would set their Online Billpay service to send a snail-mail check automatically each month and deduct the amount from the bank account.

Utilities
Most utility companies will allow to you sign up for them to automatically withdraw the full bill amount from your bank account. Contact them directly, and when available use your credit card to earn some extra rewards.

Insurance
Instead of dealing with large payments either annually or semi-annually, they have signed up for State Farm Payment Plan (SFPP), which groups their insurance premiums and divides them into one single monthly payment which is taken from their bank account. Check with your insurer to see if they have something similar.

Credit Card Bills
Most large credit cards issuers allow you to sign up a service like Citi’s AutoPay, where you can have the full amount sucked out of your bank account each month. Since the Citi Forward Card gives you 5x rewards on restaurants and Amazon.com, this most of their disposable income as well. To find it, go to CitiCards.com> (Login) > Payments Tab > Enroll in AutoPay.

What else?
With all this set up, all Bill and Jan have to do is show up for work and spend their money wisely. Is there anything else that could make their life even more easy? I thought about using an online grocery store like Peapod, where you can access past orders and possibly create default orders which you only tweak slightly each month.

New myFICO Coupon Code

Here’s a newly released coupon for 25% off real FICO scores and all other credit products at myFICO.com. Use the promotional code FINANCIALHELP25 to get 25% off and a FICO score for less than $12, the best discount currently available:

The code is good until September 30th (although try it anyways and see if it works after that date), so be quick about it. For the Equifax credit score only, you can get it for $10.95 using the code SW94608, which is over 30% off. You enter the promo code relatively late in the buying process, right before entering your credit card information. Look for this:

Experian no longer allows Fair Isaac to sell FICO scores to consumers at all (even though lenders still buy and use them). They sell their own “FAKE-O” version now. Lenders almost always use FICO scores in their decisions, so those are the only ones you should pay for.

For the diligent, a cheaper alternative is to sign up for a free 30-day trial of ScoreWatch, which includes two free Equifax scores and reports. Just remember to cancel as soon as you decide you don’t need it anymore. You are allowed to cancel online, without having to even call in.

You can always request your credit reports (not scores) once every 12 months at AnnualCreditReport.com. If you’ve already done that, you can still try these other direct methods for the unemployed, those denied credit, and victims of identity theft.

Personal Rates of Return: Money Weighted vs. Time Weighted

There was a good question in my last retirement portfolio update about how my personal rate of return was 41% YTD, which was actually higher than any individual mutual fund in my portfolio*. The reason for this is mainly due to terminology, which can be especially confusing since the definitions seem to have shifted with time.

The two primary types are money-weighted and time-weighted returns, listed below with commonly associated names. Both have been called “personal rates of return” in the past.

Time-Weighted Returns Money-Weighted Returns
Reported returns
Portfolio returns
Investment returns
Geometric mean return
Dollar-weighted returns
Internal Rate of Return (IRR)

Time-Weighted Return Details
This methodology does not account for any cash inflows or outflows. In a way, finding your return using this method assumes that you don’t make any transactions at all. For a year-to-date calculation, it’s the same as asking how $100 invested on January 1st would end up today.

My favorite term for this method is Investment Return, because it essentially tracks the performance of your investments, and nothing else. If you have 30% US Stocks, 30% International Stocks, 30% Bonds, and 10% Orange Juice Futures, such a set of investments will have a unique performance from January 1st until today. Along the same lines, this time-weighted performance is what you get when looking up the total returns of a specific mutual fund (example). This also makes it easy to compare to a benchmark, such as the S&P 500 Index.

Money-Weighted Return Details
This methodology does account the size and timing of any cash inflows or outflows into your portfolio. Here’s an example of the difference. In your brokerage statements, look for any reference to accounting for “deposits and withdrawals”. Below is a chart of the S&P 500 index for all of 2009. Let’s say you started with $10,000 invested in the S&P 500 on January 1st. Then in early April before the tax deadline, you hurry and purchase $5,000 more worth.

As you might imagine, your $5,000 inflow was some good timing, and the performance of that money is a lot better (+25%) than the performance of your $10,000 from January 1st (+17%). If you managed to get your money in around March 9th, the return of that money year-to-date would be over 50%.

I prefer to call this methodology the Personal Rate of Return because it is truly personal. It is unlikely that any people have the exact same transaction amounts and dates as you. However, while this number may seem more accurate, it’s harder to compare against a benchmark and use for future investment decisions. As seen above, luck in the timing of your investments can swing the numbers either way.

I have an older post on how to calculate this dollar-weighted rate of return, but the Zohosheets aren’t displaying ideally right now. You can click on “Full Screen View” or try this page instead if you have Excel and the XIRR function installed.

What method do major investment firms use?
When Fidelity first started including “personal rate of return” in people’s 401(k) statements, it was a time-weighted rate of return. According to this 2000 LA Times article, Fidelity thought it was more appropriate to allow comparisons to published mutual fund numbers. At that same time, a spokesperson from Vanguard thought investors would be too confused either way, so they published nothing:

“We have several reservations about such reporting,” says Vanguard Group spokesman John Woerth. “Among them: Personal returns and fund returns are likely to differ, and perhaps substantially, which could confuse–even mislead–investors.”

How about today? When I checked my statements, both Fidelity and Vanguard use the money-weighted method for their “personal rate of return”. Our other 401(k) provider did as well, so it seems like things are shifting. I guess Vanguard thinks we’re smart enough to see the number now. 😉 In the end, as long as you understand the differences, I think both stats can be useful.

* This is mostly true, but actually my small allocation to an Emerging Markets fund (VEIEX) is up 60% YTD.

Starbucks: Price-Targeting, iPhone App, Free Birthday Drink

For some reason, I’ve managed to collect a bunch of random Starbucks news. Granted, I’ve been going there more often recently for the ability to read and work in a comfortable atmosphere outside the distractions of home. I’m okay with paying about $2 for some caffeine plus an few hours of productivity once in a while.

Price-Targeting
First, I found out that last month Starbucks lowered the price of their basic drip coffee and lattes, while increasing the price of their “complex” drinks like Frappuccinos. This is classic price targeting, which involves company extracting the maximum money out of the most customers possible.

People who are frugal and pay attention to prices will now find that a large drip coffee from Starbucks costs just about the exact same amount as a large coffee from a place like Dunkin Donuts. Result: Starbucks gets more price-comparing people. A person who was paying $4 for a Frappuccino before was already paying 100% more for extra sugar, whipped cream, and 5 seconds in a blender. They most likely won’t mind paying another 25 cents. Result: Starbucks extracts more money from non-price-sensitive person.

iPod Touch/iPhone App
Want to buy coffee? There’s an app for that. The Starbucks Mobile App, from what I can gather, tries to make your iPhone or iPod Touch act like your Starbucks card. And right now, if you use it to reload $25 or more using your Visa card, you can earn a one-time $5 bonus. That’s two free drinks for me… too bad I don’t have an iGadget.

Free Birthday Drink
I’m usually not big on gift cards, but there are some decent perks with using a registered Starbucks card. You get 2 hours of free Wi-Fi per day, unlimited refills on drip coffee, and now you also get a free drink on your birthday. I like the first two features better, but free is free.

Getting Value For Your Food Dollar: Nutrition vs. Cost

In the doctor’s office, I saw the cover article of a recent issue of Time magazine was Getting Real About the High Price of Cheap Food. Inside were some interesting facts. For one, people in the U.S. actually spend less on food now than 30 years ago:

For all the grumbling you do about your weekly grocery bill, the fact is you’ve never had it so good, at least in terms of what you pay for every calorie you eat. According to the USDA, Americans spend less than 10% of their incomes on food, down from 18% in 1966. Those savings begin with the remarkable success of one crop: corn. Corn is king on the American farm, with production passing 12 billion bu. annually, up from 4 billion bu. as recently as 1970. When we eat a cheeseburger, a Chicken McNugget, or drink soda, we’re eating the corn that grows on vast, monocrop fields in Midwestern states like Iowa.

I was most concerned with the actual nutritional value we get from our food. If you look at calories vs. cost, again we see that the foods with the most nutritional value cost the most. This is similar to my popular post exploring What Does 200 Calories Cost?, which found bread and pasta on the cheap end, and fresh fruits and vegetables on the expensive end.

Result: The cheap and filling food has way too many empty calories.

A study in the American Journal of Clinical Nutrition found that a dollar could buy 1,200 calories of potato chips or 875 calories of soda but just 250 calories of vegetables or 170 calories of fresh fruit. With the backing of the government, farmers are producing more calories — some 500 more per person per day since the 1970s — but too many are unhealthy calories. Given that, it’s no surprise we’re so fat; it simply costs too much to be thin.

So what is there to do? The Time article suggests that organic is one way to go:

Organic food continues to cost on average several times more than its conventional counterparts, and no one goes to farmers’ markets for bargains. But not all costs can be measured by a price tag. Once you factor in crop subsidies, ecological damage and what we pay in health-care bills after our fatty, sugary diet makes us sick, conventionally produced food looks a lot pricier.

Personally, I think we should start with finding the foods that provide the best balance between cost and nutrition. I’m still learning, but am trying to incorporate things like lentils, beans, and whole grains into my white-bread-and-rice world. Also, we’ve started buying a “box of vegetables” from a local organic farm (see Community Supported Agriculture). We don’t get to choose what goes in the box and are thus forced to be creative, but on a per-pound basis it costs less than half what a grocery store would charge for non-organic equivalents.

100-Year Floods Are More Common Than You Think

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I hope that all of you in the Atlanta metro area are safe and dry right now. I’d also like to take this chance to correct a common misconception, which is often promoted by the media every time a flood occurs. As just one example, take this CNN article:

He hustled out of bed and rushed to the door. There were his neighbors, surrounded by floodwaters the neighborhood is supposed to experience only once every 100 years.

The highlighted sentence is not accurate, and gets people thinking strange thoughts like “Oh the last flood was in 1969, I should be good until 2069 or so”. The fact is there is a reason we hear about such floods all the time. Let’s look at what FEMA has to say:

The term “100-year flood” is misleading. It is not the flood that will occur once every 100 years. Rather, it is the flood elevation that has a 1-percent chance of being equaled or exceeded each year. Thus, the 100-year flood could occur more than once in a relatively short period of time.

Again, if you live in a 100-year floodplain, you have 1 percent chance of being flooded every year. Think of how concerned you’d be if you were told there was a 1-in-100 chance of your house burning down every year. The way the math works out, this means that over a 30-year mortgage, there is a 26% chance you’ll have a 100-year flood during that time period (1 – (0.99)30). This is also why most people with home loans in such areas are required to buy flood insurance.

Many people are in 500-year flood plains, which gets people even less worried. “The last flood was in 1909, we’re good for another 400 years!” Actually, having a 0.2% chance of a flood each and every year works out to a 6% chance of occurring at least once over a span of 30 years, or 1-in-17.

If you haven’t already, take some time and check if you are in a flood plain here. Some may consider buying flood insurance even if you are not required to by your mortgage lender. We ended up buying a modest amount of building coverage from the NFIP.

2009 Q3 Investment Portfolio Update – 9/21/09

2009 Q3 Portfolio Breakdown
 
Retirement Portfolio Actual Target
Asset Class / Fund % %
Broad US Stock Market ($64,794) 33.8% 34%
VTSMX – Vanguard Total Stock Market Index Fund
DISFX – Diversified Stock Index Institutional Fund*
FSEMX – Fidelity Spartan Extended Market Index Fund*
US Small-Cap Value ($17,554) 9.1% 8.5%
VISVX – Vanguard Small Cap Value Index Fund
Real Estate (REITs) $18,004 9.4% 8.5%
VGSIX – Vanguard REIT Index Fund
Broad International Developed $46,820 24.4% 25.5%
FSIIX – Fidelity Spartan International Index Fund*
International Emerging Markets $21,678 11.3% 8.5%
VEIEX – Vanguard Emerging Markets Stock Index Fund
Bonds – Short-Term $4,484 2.3% 3.8%
VFISX – Vanguard Short-Term Treasury Fund
Bonds – Inflation-Indexed $18,568 9.7% 11.3%
VIPSX – Vanguard Inflation-Protected Securities Fund
Total Portfolio Value $191,902
* denotes 401(k) holding given limited investment options.

Like many others, for most of this year I’ve just been trying to keep my head down, make my regular stock contributions like a good boy, and not looking at my statement balances too much! There’s been a lot of “wow, my portfolio isn’t so bad anymore” talk due to the recent market run, so I figured it was time for a checkup. You know of course, that this also means the market will tank today… 🙂

Contribution Details
So far in 2009, we have made the following contributions:

  • $5,000 x 2 for 2008 non-deductible IRA contributions
  • $5,000 x 2 for 2009 IRA contributions
  • $33,052 for both of our 401k contributions, including salary deferral and company match. One is maxed out, the other has a little left to go.

2009 Performance
In my last update back in April, I had found our year-to-date performance to be about -15%. According to my spreadsheet, the 2009 year-to-date dollar-weighted performance of our personal portfolio is now 41% YTD.

For reference, the Vanguard S&P 500 Fund (VFINX) has returned 20.52% YTD, their FTSE All World Ex-US fund (VFWIX) has returned 35.72% YTD, and their Total Bond Index fund (VBMFX) is 5.11% YTD as of 9/18/09. The Vanguard Target 2045 Fund (VTIVX) has returned 23.4% YTD, which as a similar stock/bond breakdown to our portfolio, but less international exposure. Part of the good relative performance (which was previously relatively poor) is also likely due due to the timing of my large lump-sum investments.

Investment Changes
We have used our new contributions to keep us close to our asset allocation target, with a 85% stocks/15% bonds split. Right now, we are not too far off. The target percentages for each asset class are shown above as well. Currently, with the run-up in equities, we are a bit underweight in bonds.

You can view all my previous portfolio snapshots here.

Best FDIC-Insured Interest Rate Roundup

I haven’t done an interest rate update in a while, as sadly there just hasn’t been that much to write about.

Reward Checking Accounts
These are checking accounts, usually through local credit unions, that pay a very high interest rate if you jump through some hoops each month. However, if you make a mistake you’ll forfeit virtually all your interest for that month, so it can be tricky. But for the very diligent, their rates are still averaging around 4-5% APY on balances up to $50,000. Here’s a recent example at 4.01% APY on up to $25k, which requires 10 check card purchases each month, a direct deposit/auto-withdrawal, and online statements.

For more, see my review of rewards checking accounts and also this list of accounts by state. I’d stick with small local credit unions with limited membership eligibility if possible, as the rates tend to be more stable. I myself got burned with nationally-advertised Evantage Bank that dropped its rates shortly after opening.

Online Savings Accounts Rate Updates

  • EverBank is offering 1.10% APY for the first 6 months for new accounts. This rate is higher than any 6-month certificates of deposit currently available.
  • Discover Bank is offering 0.85% APY on its new online savings account.
  • Ally Savings is offering 0.85% APY as of 11/12/13.

Certificates of Deposit
As stated above, for 6-months or less go with EverBank. In general, CD rates have been very low, and given how fast rates can rise as compared to how much further they might fall, I don’t see the benefit in locking up for money for a long period of time. Even a top 3-Year CD might get you 2.76% APY, according to MoneyAisle.

Remember, the new $250,000 FDIC & NCUA insurance limits per titled accounts are currently extended through 2013.

Online Business Savings Accounts

Someone e-mailed me about high-yield savings accounts for businesses. These can be a helpful tool to maximize interest income for all kinds of businesses with idle cash, including sole proprietorships, partnerships, LLC’s, and corporations. Here’s a quick rundown of some favorites.

Capital One 360 

The Capital One Consumer Bank for Business Savings Account pays 0.40% APY and has no minimum balance requirements or monthly fees. The benefit of this savings account is that you get the “it just works” factor of Capital One 360. There are no bells and whistles, it simply pays you a good interest rate, and provides easy and fast transfers to/from your existing business checking account.

Capital One / Costco
If you can open with at least $1000 and will keep at least $100 in your savings account, you can get a slightly higher interest rate of 1.40% APY with the Business Money Market Account from Capital One Bank. The perks of this account include checkwriting ability (you are limited to 6 withdrawals per month, 3 of which can be checks) and the sign-up bonuses for Costco users. Executive members can get $60 and Gold/Business members can get $20 after you open your first account and deposit $5,000 within 30 days.

(Considering upgrading to Executive? Buy a Costco membership certificate and get over $50 in coupons.)

Fidelity Investments
For maximum flexibility, you can open a Fidelity Account for Businesses and invest in anything from a money market fund to bond mutual funds to individual stocks. (Online stock commissions range from $8 to $19.95.) You’ll need $2,500 to open, but there are no minimum balance requirements or annual account fees. Currently, money market yields in general are very low. The Fidelity Cash Reserves fund currently has a yield of 0.28%. But if you were so inclined, you could invest in Treasuries, municipal bonds, inflation-protected bonds, or even dividend stocks.