Yes You Should Refinance. But How?

With mortgage rates dropping like a brick, it’s becoming a no-brainer for us to refinance our home loan. Even though we just got a 30-year loan 2 years ago at 5.875%, we can get 30-year loans now for around 4.5% or lower. You might be in a similar situation.

Rule of Thumb

The rule of thumb I hear thrown around a lot is that if you can drop 1% off your mortgage rate, you should refinance. To get a more precise idea if refinancing is good for you, you should really take into account how long you expect to stay in your home and see if you break even on your refinance costs before then. A good tool for this is the Mortgage Refinance Breakeven calculator found here (thanks MyMoneyBlog).

Breakeven Point on Our Mortgage

I plugged our numbers into the tool:

  • $180k original loan
  • $235k appraisal
  • 5.875%
  • 28 of 30 years
  • income tax rate of 25%
  • $175k loan balance
  • 4.5% new rate
  • 30 years
  • 0 origination and points
  • $3000 in closing costs

The tool tells me that I’d break even on this refinance in 18-22 months. We’d save $177* per month on our payments, and so as long as we’ll be here for 2 years we’ll make up the refinance cost and then some. Since we are planning on staying here for at least 2 years, we should refinance.

* The spreadsheet says $147… must have used slightly different numbers.

Yes But

The only real questions now are (1) should we wait for rates to go lower and (2) what kind of loan should we get.

I’ll avoid (1) for now. I think there is a real chance rates go lower, but I don’t want to be too greedy. I want to take advantage of a good thing while we have the chance. So I’ll assume we can refinance at the current rates.

RE (2): if your home loan situation is anything like mine, you have a lot of options to consider when refinancing. In our case, we have a second mortgage for $30k which is interest only at a rate of prime plus 1% (I think about 4.25% right now). We also have more cash flow than we did 2 years ago and can afford a bigger payment if it means we’ll be paying off the mortgage sooner and saving money on interest rates.

So we have questions like:

  • Should we roll the second mortgage (M2) into the new mortgage to lock in this low rate?
  • Should we get a 20 year loan (at 4.25%) instead of a 30 year loan (at 4.5%)?
  • Should we keep the M2 loan as is and make principle payments toward it?
  • Should we refinance the M2 separately?

A Spreadsheet!

Calculating all of this can make your head explode. I created a spreadsheet that calculates just some of the factors, while leaving others out, and focuses on the most promising options for us. You can see it here: Coleman Family Refinance Options.

The main scenarios I focused on are:

  1. The status quo, i.e. keeping our current loans.
  2. Refinancing just our first mortgage (M1)
  3. Rolling our second mortgage (M2) into M1 (we’d pay PMI for 3.5 years since we’d have less than 80% equity)
  4. Refinance M1 for 20 years
  5. Roll M2 into M1 for 20 years (PMI for 3.5 years again)
  6. Refinance M1 and pay difference into M2
  7. Refinance M1 for 20 years and pay extra $2k/year into M2

The columns of the spreadsheet show:

  1. The scenario #
  2. A description
  3. Rate on M1
  4. M1 monthly payments
  5. M2 monthly payments
  6. PMI payment if applicable
  7. Total monthly payments
  8. Term of M1
  9. Annual Payment
  10. Total M1+M2 debt in 2 years
  11. Total M1+M2 debt in 4 years
  12. Total M1+M2 debt in 10 years
  13. Lifetime cost of loan (rough rough estimate)
  14. Notes

Note on the columns. Some of them are updated when you tweak the numbers, but the 2, 4, 10, lifetime columns were entered by me after running numbers in that break even calculator linked above.

The second table has the same columns as the first, but shows the difference in payments/debt/etc compared to the status quo. So it can tell us how much we’d save (or spend extra) on payments and how much more (or less) debt we’d have after 2, 4, and 10 years.


There is also a table at the bottom of the spreadsheet showing expected returns if we made monthly investments at a 6% return. This is to help us calculate what we could be making with that extra $147/etc per month if we didn’t use it to pay off M2 or get a 20-year loan.

Some Pre-existing Notions I Had

Before I pull some numbers out and explain how we’re leaning, let me relay a few biases I had going into this.

1. I’m okay with our interest-only second mortgage. At 4.25%, that is a cheap price to borrow money right now. We’re making more than that on our money that we invest in our business and in our retirement accounts. Paying toward the principle on that loan would be like buying a 4.25% bond. Decent return, but not as good as we’re getting elsewhere. So I’m happy to loan at that amount indefinitely basically. However, I do think that rates will go up in the mid-long term. I don’t want to get caught with higher rates that are a strain to pay. Our idea has always been that we would use some kind of windfall (e.g. if we sell one of our website properties) to pay off that loan in one foul swoop. However, we should at least consider somehow locking in a rate for this.

2. I’m against paying PMI in theory. (That’s why we got a second mortgage before instead of one loan with PMI.) If you have the credit, other options are probably better for you. Some good info on PMI here.

Findings From the Spreadsheet

The key columns to focus on to compare options is the Annual Payments and the difference in debt in years 2, 4, and 10. The second table shows the difference in these numbers compared to the status quo. And so I can see that if I go with option #2 (refinance just the 1st mortgage), we’d save $1,764 per year and have $5,966 less debt/more equity after 10 years. If we held the loan the whole 30 years, we’d pay $21,985 less.

Now if I rolled M2 into M1 and payed PMI, we would still save $435 per year ($1,500 per year after 3.5 years) and have $12,538 more equity after 10 years since we’d in effect be paying principle on that M2 now. However, we would spend an extra $3725 or so on PMI those first 3 years, and sometimes it can be difficult to get PMI removed once you do have enough equity in the house. Overall though, it seems like using our savings from the refinancing to pay down M2 is a good use of our capital. It lowers our debt risk in the future.

You should be reminded here that not only do we have $5-12k more equity after 10 years, we could have invested the saved payments to have an extra $18-24k in our retirement accounts. Refinancing really is a good deal.

One option I really wanted to calculate was keeping our interest-only M2 and making principle payments to it instead of rolling it into the new mortgage or refinancing on its own. This would avoid PMI or additional refinance options. If we are disciplined, we can pay off M2 just as fast… but we’d also have some flexibility if we needed some monthly cash flow. Scenario #6 lays this out. We would end up paying as much per month/year as we do now. So no savings there, but we’re really okay with our current payments. We would however have an $31,336 less debt across both mortgages.

Scenarios #4, #5, and #7 basically come down to paying a little bit (or quite a bit) extra per month in exchange for less debt in the future and less interest payments over all. One nice thing about these plans is that 10 years out, we could have nearly $50k in equity built up in the loan. Combined with an appreciation in home value (I know, but we’re talking 10 years from now… let’s hope) we could have a nice size chunk to use as a down payment on a larger home.


I’ll let you know what we decide when we go through with things. I think I’m leaning toward refinancing just the first loan and making principle payments on our second mortgage/line of credit. Some things we need to think about:

  • Can we really get 6% on investments on money saved? 4.25-4.5% might be a good return for our extra cash in this market.
  • What is the risk that interest rates go much higher in the future, raising our minimum payment on M2?
  • What do we want our debt situation to be 2, 4, 10 years from now?
  • Can we really get the rates/fees I’m assuming here? 😮
  • Are deductions for interest payments, reductions in PMI or M2 payments, or other things I’m leaving out important?

I hope this helps people in a similar situation as me. And as always, I appreciate any feedback or advice you might have based on this. Cheers!

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Free “Avoiding Forclosure” DVD via NFCC

We received an email from Melissa Minkalis of the National Foundation for Credit Counseling (NFCC). They are offering a Free DVD about avoiding foreclosure.

I did not order the DVD or know much more about it. I did quickly verify that the NFCC is a legit organization and doesn’t seem to be simply harvesting contact info, etc.

From the email:

Did you know foreclosure rates rose 81% in 2008, making the housing crisis the #1 issue facing our economy today?

The main problem concerning this crisis is that most homeowners don’t seek help until it’s too late. The key is to get reliable advice as early as possible. Sadly, many people don’t realize that trustworthy help is available and what may seem like a dire financial situation can actually be organized, itemized, and prioritized by a NFCC certified credit counselor.

Today, I would like to offer you and your readers a chance to order a new DVD from the NFCC, Avoiding Foreclosure, which can be ordered, FREE of charge by visiting [our Avoiding Foreclosure order form]

Showing inspiring stories from folks who decided to really take charge of their unfortunate situations, this free, informative DVD will provide viewers with motivation for change. Even the toughest of circumstances can result in positive solutions with the help of NFCC certified professionals. It is the hope that seeing these stories first hand will give others the courage to take action.

We’re Buying a House

A BuildingSo Kim and I are in the process of buying a house. We’re going through a lot and learning tons of stuff that would be great to share with all of you.

Perhaps more importantly, there are a bunch of folks smarter than me who occasionally read this. So I’m hoping we can get some good advice here and there.

But to start I’ll just try to give a little background in this post before I get into some more specific topics later. For those who don’t know, I do web development with my wife Kim. We work for our own company Stranger Studios and work from home (our apartment right now). This is all going very well. Work is good. Making your own hours is great. Spending every minute of every day with the woman I love is truly incredible. I doubt most couples could do it, but Kim and I pull it off with style.

Life is good. Ok.

Because we work from home, we could live anywhere. And we’ve been conscious of this. We’ve considered a number of places to settle down for the next 5 years or so: Arizona, New Mexico, Mexico Proper, San Francisco, Napa, Oregon, Idaho. One fun game we had was to open up Google Maps and just zoom into a random spot on the map. We’d look for lakes, rivers, small towns, or anything else that looked interesting to live near.

We’ve seriously considered Puerto Rico, where I have family and there are incredible deals on ocean-view land. (I think this may eventually turn into a location for our second purchase.)

Our latest idea has been to find a small town, buy an apartment building on a “main” street with a store front, setup our office in the store front, and live in one of the apartments. Here was my reasoning for this approach:

The other apartments in the building will provide income to help with the mortgage.

It seems to me that inner city and main street properties have experienced less of a boom over the past 10 years and so have also experienced less of a pullback over the past 2 years. This is because the rental income of a property puts a bottom limit on how much the property value can drop.

The nature of our work means we can live anywhere. However things could also happen which would require us to up and move to California or somewhere else. If this happens, we can rent out the building as an investment property and won’t have to sell the house at a loss or keep a mortgage we can’t afford.

(I’d love to get some feedback on these assumptions of mine.)

We found something perfect in Columbia, PA, nestled between Harrisburg and Lancaster. It would have worked well, and Columbia seemed like a nice little town to settle down in for a while. The real estate agent we were working with grew up in Columbia and was really passionate about his hometown. Seeing his passion made us get nostalgic and reconsider our own hometown of Reading.

And so after considering just about every place to live within 4000 miles, we went back to our roots and started looking at properties in Reading, PA. And we found one! We’re in the process of getting a mortgage and working through the red tape and paper work. I’ll be posted more specifics on that soon… some insights, some open questions, good stuff.

We’re excited about this move (haha) in our life. We’re excited about being close to our families for a little while longer at least. Since we started our business, we’ve adjusted our schedules a lot to be able to spend more time with our folks and old friends from home. It has been incredibly rewarding, and I’m looking forward to continuing these good times.

What are the Best Online Resources for Beginning Real Estate Investors?

My father-in-law is nearing retirement and looking to get into some real estate plays to diversify his investments. I’ve already referred him to The Millionaire Maker: Act, Think, and Make Money the Way the Wealthy Do and Start Late, Finish Rich: A No-Fail Plan for Achieving Financial Freedom at Any Age (Finish Rich Book Series), both great books on general wealth-building.

I was hoping someone out there might point us towards some good online resources though, especially ones dealing with real estate investing in particular. Thanks for the help. If we get some good info, I’ll do a round up later.

The Fall of the All Consuming Yankee

The consumer is tapped out. After consistent 25 basis point increases to the Federal Funds Rate, we are finally starting to see the effects on the stock market.

Yesterday morning we saw three headlines that caught my attention. The first detailed Sears’ guidance for this quarter – a reduction from $2.12 to from $1.06 to $1.32 per share. These revisions are, at best, a 30% reduction and, at worst, a 50% reduction from their previous optimistic estimates.

Notably, declines were across all categories. If you follow the theory that the consumer is on thin ice, then it is hardly surprising to find big ticket items are not being purchased. Sears is having trouble selling new stainless steel fridges and widescreen TVs because consumers do not feel confident about their financial situation. The only sector that wasn’t hit as hard was women’s apparel and footwear – suggesting stressed housewives may be engaging in retail therapy.

The second headline noted that Home Depot is now expecting a 15% to 18% drop in earnings per share for fiscal 2007, as opposed to their previous guidance of 9%. This is a further example of a, supposedly wise, management team who were unable to predict the severity of the downturn.

All should take note – when pundits tell you the housing crash will be over by Q4 of this year, they are making a foolish guess. Furthermore, even if they are right, do not expect the market to rebound. Burnt fingers will not be so quickly back into the fire.

Home Depot’s response to this downturn was particularly ironic:

Home Depot, which has more than 2,000 stores in the United States, Canada, Mexico and China, said Tuesday it will open approximately 108 new stores in fiscal 2007.”

Lastly, this tidbit was to be found in Yahoo’s summary of the Best of Today’s Business:

More than 2 million subprime, adjustable-rate mortgages will be reset to much higher interest rates over the next several months, raising monthly payments for people with weak credit. In October alone, a record $50 billion in ARMs will reset, said Mark Zandi, chief economist of Moody’s Consumer groups fear this could spark a new wave of foreclosures.” (emphasis added)

Many commentators speak about the small impact of subprime foreclosures (e.g. here) as if somehow the problems stop with subprime. However, the problem is a continuum, beginning in subprime and extending all the way into Alt A.

The housing sector is in far worse shape than the experts on Wall Street realize – yesterday we saw a pull back in the market, and the futures this morning point to a similar flat or down day. However, over the past months, Wall Street has failed to price in the poor economic outlook. Yet, here is an example of the situation consumers face:

Arizona’s only publicly traded home builder must write off $100 million on land and operations after a second quarter in which home orders fell 28 percent and new-home cancellations climbed to 37 percent, according to preliminary numbers released Friday.

New-home cancellations have left the Valley’s housing market with at least 20,000 homes built but unsold. Builders have offered hefty incentives of $50,000 and more to sell the houses, but many potential buyers can’t sell their existing homes.

The result is a glut of homes for sale…”

Granted, Arizona is one of the worst locations, but it isn’t the only region to suffer this problem. While subprime mortgagees have low credit ratings, they don’t necessarily purchase in low socio-economic areas. Subprime foreclosure properties can not be neatly segregated into a single suburb.

We are just starting to see the fall out.

With Wall Street starting to show signs of reduced consumer spending, both due to fear and also due to rising costs (see “M3 money supply”), businesses will be reducing inventory and preparing for leaner times. This will sap at business confidence and reduce capital expenditure. As more home loans reset from teaser rates to rates approaching double digits, consumer disposable income will further decrease. If foreclosures continue to rise, we may witness further financial strain, as seen with Bear Sterns two weeks ago.

In short, the situation is unlikely to improve from here. The next 6 months do not look good.

If you haven’t already, take a look at the S&P500 over the last 6 months – notice the recent double top and the market’s inability to rise to new highs. My thoughts? Consider moving at least a portion of your holdings to cash if you can.

Philip John

This post is for entertainment purposes only. No part of this post should be construed to constitute investment advice. The author is not an investment professional and assumes no responsibility for any investment activities you undertake. Prior to undertaking any financial decisions, you should contact an investment professional.

My Head Says One Thing, But My Gut Says Another Thing!

One of the things that I do to rationalize positions is take the opposite side and create my own debate. I often do this when my head says one thing, but my gut feeling is saying something else. So for this blog entry I am going to spill my guts and hope somebody wants to add their own two cents.

Ok, here is my problem that my gut keeps telling me, and its from from a comment Greenspan made.

Alan Greenspan said the housing downturn is more of a problem than credit quality and said the lending worries would be fixed if house prices rose 10 per cent.

Greenspan has been saying quite a few things lately with some things being that we may have a recession in the fall. I was reading in Business Week Greenspan is behaving the way he is because Bernake can’t tell the truth.

So let’s assume there is this Greenspan and Bernake tag team, what would they be hiding? Well, it seems Greenspan is pre-occupied with real-estate and a recession in the fall. I cannot seem to find any comments where Greenspan is concerned about inflation, and that has me raising an eyebrow. Is Bernake privately concerned about the same things? What if Bernake is giving lip service to inflation, but more concerned about real-estate and the recession? I think, and this is the part that my gut is telling me, Bernake will in the next few  months lower interest rates regardless of what inflation is doing.

My concern right now is inflation, and the inflation data is bad regardless how you look at it. I am a burnt child, what can I say. Yet Greenspan is not saying much about inflation. Of course Bernake has said in the past he wants to fight inflation, but that is the official party line of the Fed.

Let’s say Bernake becomes an inflation dove and talks about lowering the interest rate is that bad? Here is what I think will happen if the interest rate is dropped.

  • The real estate market will begin moving again with prices increasing.
  • The stock market will go up.
  • People will be feeling good about everything and consumers will buy again.

This is good, right? Wrong, because while it might seem like a good idea to drop interest rates people like the linked reference will also get a reprieve. The other and greater problem I see is the lack of attention to inflation.

Inflation is bad because you begin a cycle what I call “competing with the Jonses.” While inflation in some instances can be good for an economy, disregarding it can be devastating for an economy. Prices will increase and people can do one of two things; ask for a wage increase or consume less. People usually ask for higher wages, especially if the labor market is tight like it is now. Thus as people ask for higher wages the company can do one of two things; increase prices, or swallow the costs. If the company swallows the costs they can do one of two things; cut profits or find a way to increase productivity. If companies increase prices we are back in square one with the employee asking for more money.

There it is, my guts are spilled. My head says that I am wrong, and that Bernake will be an inflation hawk, but I wonder… Comments?

NOTE: Bernake is giving some comments this coming week and we shall find out if this blog entry is dumb thinking…

What Gives With Interest Only Being Better Version 2?

My original version of this blog entry has been deleted because I did find some errors in my spreadsheet. I saw them when I was explaining what I thought I had found while doing my calculations. The new calculations are not as I thought they were, but still some interesting things can be extracted from it.

I was reading a blog entry where one couple in Seattle had a hard time trying to find a place where they could take out a mortgage for 15 years. One woman in another blog commented that 15 years is a bad idea, and better would be a 30 year mortgage because it lets you buy more house.

Comments like, “ooh better get a 30 year mortgage than 15 year mortgage” raise my hackles! I don’t believe such comments and decided once and for all to figure out what the numbers are.

There are two variations to this scheme:

1) Get the same mortgage, but invest the monies

2) Get a bigger monies for the same amount that you would pay monthly.

Ok, so I created an Excel spreadsheet that anybody can download to verify if I am right or wrong. Folks, please verify my spreadsheet because I want to know if I accounted for everything, because I found out something very very interesting.

I made the following assumptions for variation 1:

  • 300,000 mortgage
  • 30 year mortgage at current rates (5.75%)
  • 15 year mortgage at current rates (5.52%)
  • Interest only mortgage at current rates (5.53%)
  • Renting at 2,000 per month
  • Income of 90,000 with tax rate of 25% with interest paid deducted from yearly income.
  • 1.5% of 300,000 charge per year for maintenance, etc
  • 9% return on alternative investments 
  • 5% return on the price of housing
  • The difference in monthly payments are invested into alternative funds

For variation 2 I made the following assumptions:

  • 300,000 mortgage for the 15 years
  • 530,000 mortgage for the interest only
  • 420,000 mortgage for the 30 years
  • 30 year mortgage at current rates (5.75%)
  • 15 year mortgage at current rates (5.52%)
  • Interest only mortgage at current rates (5.53%)
  • Renting at 2,000 per month
  • Income of 90,000 with tax rate of 25% with interest paid deducted from yearly income.
  • 1.5% for yearly fees of the original price of the property.
  • 9% return on alternative investments
  • 5% return on the price of housing
  • The difference in monthly payments are invested into alternative funds

Running the numbers I decided to sell after 10 years. At that time I decided that I would buy another house using the same prices.

Here is what I found for variation 1:

It does pay to get an interest only mortgage and invest the monies. At year 10 you pocket with the interest only 374,000, and the 15 year mortgage 323,000. This means you get 50,000 more by investing. However, this implies that you will invest the monies and get 9%. Granted both returns I searched and found on the Internet so they are averages over a time span of about 35 years.

If you only invested half the monies that the interest only gives you then you will be at a disadvantage. If you invest none of the monies then you will be at a massive disadvantage. In other words you will see the same amount less per month whether you use interest only or 15 year mortgage.

The tax advantage of the interest only vs the 15 year mortgage in year 10 is barely 200 USD, which in my opinion is nothing to write home about.

Here is what I found for variation 2:

Variation 1 was not what the original blogger was talking about. Variation 2 where you buy more house for your money was what the original blogger talked about. This means you would be investing nothing, and doing the numbers for this variation the results are not good.

Yes you can afford more house eg 530,000 vs 300,000, but after ten years it means you pocket less money 292,000 vs the 15 year mortgage 322,000. What I found particularly interesting about this variation is the associated risk. Your tax advantage in year 10 is greater (400 USD), but you have more costs since a more expensive house has higher taxes, etc. Additionally if you purchase a higher priced house there is a greater liklihood that you will not be able to sell your house.


In my original blog entry, which I deleted, I said that the money you pocket is greater by paying off the mortgage. When I fixed my calculations for Variation 1 it was not the case, but it was the case for Variation 2. Though, what is extremely important to realize is that interest only or long term mortgages only apply if in the long term the markets and housing prices go up. If during the 10 year period you don’t get the required returns you are buggered. For example I did the calculations when both the investments and housing prices only increased by a mere 2% per year over a 10 year period. At that point the money that you pocket goes way up for the 15 year mortgage, and for the others you are left straddling quite a bit of debt.

So in the end it might cost more per month, but it is better to get a 15 year mortgage…

Six Quick Book Reviews

I was going to write an individual post reviewing in depth each of the six books listed below. But since I’m a bad citizen and have given in to the fact that I will never find enough time to do so, I’m going to give a quick review for each of them here. So in the order I’ve read them…

The Real Estate Coach by Bradley J. Sugars.
This book was kind of hard to read at first. It is written in scenes, staring the made up characters Brian and Sarah as they learn from their Real Estate coach. The dialog is not well written and rather tedious. I’d pick out the best (or worst) example, but I don’t want to spend the time and I probably don’t have to. Here is an excerpt chosen at random from page 16.

As they sat back down with fresh drinks the Coach began again.

“What we are going to look at now are the types of property deals that you can do. You see, they will figure in your rules when you go out looking for properties to buy. So what are the different types of deals, then?”

Brian looked up at the ceiling for a while, and then replied: “I have heard about negatively geared deals, Coach. Is this what you mean?”

“Exactly. Any idea what the other two are?”

First, what do I care that Brian and Sarah have “fresh drinks”? In any other Real Estate book, this section would have looked like this.

Type of Real Estate Deals

  • Negatively Geared Deals
  • Quick Cash Deals
  • Positive Cashflow Deals

To be fair, I didn’t know a lot about real estate before reading the book and I definitely learned a bit from it. I just feel I could have learned as much in 10 pages instead of 200. However, for those of you out there who have a hard time reading textbook like
books about real estate, this might be the book for you. You’ll be tricked into thinking your reading a novel, but you’ll really be learning about real estate!

The content of the book is very introductory and doesn’t go into as much detail as you will need before actually going out there and getting your hands dirty in real estate. And that’s not such a bad thing since the main point of the book is that a “coach” is going to help you more than any book. So after reading this go out and find a coach. Peeps with a basic understanding of real estate concepts can pass on this one or look for education elsewhere.

Become the CEO of You, Inc. by Susan Bulkeley Butler
Susan spoke at an Accenture get together last Summer. Susan had worked for Accenture for a while back when it was Arthur Anderson Consulting and worked in the CEO’s office through the Accenture IPO. She was largely responsible for the establishment of Accenture’s “Change Management” division, which now accounts maybe 1/5 of Accenture’s consultants (just a guess there).

Susan’s message at that get together, and in this book too, was more applicable to women trying to excel in the traditional business culture. However, there was a bit us guys could learn from her too.

We were all given a copy of her book, compliments of Accenture. I read about the first third then lost interest and moved on to other reading. The truth is I put the book down because of it’s focus on women (which is okay if you’re a woman) and because of an exchange I had with Susan at the Accenture meeting. I introduced myself to her and told her I worked on an investing and business blog. I let her know that I could review the book on the site and possibly drive some sales her way. She seem very disinterested and brushed me off. At the time I got this feeling that she just had something against member of the opposite sex. I’m sure she’s a great person when you get to know her and wonderful in her private life, but this is the impression I got from her then. And it dissuaded me from putting too much effort into writing a review for the book.

I’m a punk for airing this in the public here. I know that. But it’s why I don’t have much more to say about this. If you are a woman, working in the business world, Susan probably has a lot to tell you. She could be a role model for you. Her story really is incredible, going from the only woman at Accenture to one of the highest positions in the company. For me, eh…

Built to Last by Jim Collins and Jerry I. Porras
Here’s a good one. This was recommended by Chris, and I read it while on vacation in Maine last Summer. The book relates a study of some of the greatest companies of the last 150 years: GE, HP, 3M, Merk, Ford, Wal-mart, Disney, and a few others. The research tries to get to the heart of what made (and makes) these companies so great. What makes these companies “visionaries”?

For someone who is in the middle of a startup, Built to Last helped me think on a higher level about our company. Activities like writing mission statements and lists of core values are great, but the important part is to actually live up to them. Here are some of the chapter titles, which do a great job of summing up the ideas behind the book.

  • Clock Building, Not Time Telling
  • Preserve the Core, Stimulate Progress
  • Big Hairy Audacious Goals
  • Cult-Like Cultures
  • Try a Lot of Stuff and Keep What Works

The first of that list really resonates with me. Great companies are those that build clocks, rather than tell time. While working on the next new feature for WineLog (telling time), it’s important (and very difficult) to keep perspective and remember to devote time and effort to developing the WineLog company itself (clock building).

The guys at 37Signals are a great example of a company that clock builds instead of time tells. Sure they have a lot of great software applications, but they are focused on building their company into a fine-tuned software building machine. Ten years from now, when Basecamp is but a memory (or maybe a ubiquitous development tool), 37Signals the company will be still chugging along doing their thing.

Built to Last might be a help to investors looking for some ways to sort well-managed companies from poorly-managed companies. There’s even a few stock charts in there. The book is far more useful however to entrepreneurs and business professionals in management positions.

Finding the Hot Spots by David Riedel
I read this book back in Fall 2006. The subtitle for this book is “10 Strategies for Global Investing”. I can’t remember what any one of them is, but the book does have 10 chapters… I guess that fits. Here are the chapter titles/tips:

  1. Invest Internationally for Yourself
  2. Think Globally, Invest Locally
  3. Diversify–Don’t Put All Your Eggs in One Basket
  4. Understanding Relationships: Who is Benefiting from Current Trends?
  5. Invest in Line with Government Goals
  6. Don’t Buy Regulatory Structure
  7. Know the Shareholders
  8. Buy the Banks
  9. The Impact of Currency
  10. Don’t Be the Last One In

FTHS is a quick read, and so a decent book for people who are thinking about getting dirty with international equities. The main points I got from this book were (1) you need to invest internationally since that’s where 20% of stocks are and (2) you shouldn’t be so scared to invest in foreign stocks; in fact it’s easy! The didn’t get much more of substance from the book.

Jim Cramer’s Mad Money – Watch TV, Get Rich by James J. Cramer with Cliff Mason
Confessions of a Street Addict is a great read for anyone. Jim Cramer’s Real Money (my review) is a good read for any investor. Cramer’s most recent book Watch TV, Get Rich is a book to be read by Jim Cramer fans only.

If you watch Jim’s show, you’ll love the book. It goes behind the scenes into the meaning behind most of Jim’s catch phrases and sound clips.

He also details how the lightening round is run and encourages readers to do lightening rounds of their own as a way to train their investing muscles. It’s actually a decent plan and might help you at least sound more intelligent about stocks. It will take a lot of time, but I bet you will have a better “feel” for the overall market if you follow Jim’s plan. If this idea turns you on, go to a book store and read the lightening round chapter; you don’t need the whole book for just this.

The other addition in this book is a new version of Cramer’s Cyclical Investing and Trading chart. The chart has recommendations for which sectors to be rotating into and out of at different times in an economic cycle. If there is interest, I might write a seperate post on this. Again, I’ll try to contact Jim’s crew to see if we can post an image of the chart. We didn’t have any luck last time though.

The Only Three Questions That Count by Ken Fisher
I’m only about two thirds through this whopping 365 page book, but I can already recommend it. It is different from most of the investing books I’ve read, coming at investing from a higher level and yet still managing to be relevant. I won’t keep you in suspense any longer; here are the three questions:

  1. What do you believe that is actually false?
  2. What can you fathom that others find unfathomable?
  3. What the heck is my brain trying to do to blindside me?

The first two questions revolve heavily around efficient market theory and the idea that the best way to make money in the market is to know something that others don’t.

Question 1 involves a lot of debunking of commonly held investing beliefs… like high P/Es are bad for the market, a federal deficit is bad for the market, an inverted yield curve is bad for the market. Fisher gives convincing arguments against these beliefs. And while you don’t necessarily want to go out and bet against these theories when you find they are wrong, you can at least avoid betting with them.

If everyone else is wrong, how do you find a winnable bet? Questions 2 is an exercise for finding “investing technologies” you can use to inform your investing decisions. And the key here is to find an indicator or strategy that no one else knows about. Actually even better is when everyone knows about it, but they’re still not using it. Fisher uses his “discovery” of the price-to-sales ration (or PSR), which was hugely successful for him in the 80s and supposedly a big deal. The idea is/was that low PSR stocks outperformed higher PSR stocks.

When PSR values had to be calculated by hand and were relatively unknown to investors, the strategy worked well. By now the technology has been priced into the market since everyone knows about and believes in it. For this reason, we should always be working to develop our next strategy. Fisher’s book kind of gives you the base tools to do this.

Question 3 discusses behavioral finance and some common mistakes that investors make that results in lower returns for the average investor. Fisher prefers to explain a lot of these concepts in the frame of evolutionary biology. He talks a lot about our “prehistoric brains” and anecdotes around why cavemen would have been more fond of big things than small things for example.

One of the main points Fisher makes with question 3 is about how cavemen (and all of us to this day) busy ourselves with “accumulating pride” and “shunning regret”. Back when we were hunter-gatherers, both pride and regret kept the hunting males hunting. If they caught 2 big mammoths while hunting, their pride would send them back to that hunting ground. If they didn’t manage to catch anything, they would blame the lack of a catch on factors like the weather or a random saber tooth tiger that scared the animals away. If the hunter could convince himself that it wasn’t his own fault he didn’t catch any food, he would try again the next day. I think Fisher explains it all better than I have, but maybe you get the point.

So overall, I think Three Questions is a good book for investors. If you’re well read, a lot of this will be familiar, but I’m sure everyone could learn something from the book. The greatest thing this book will do for you is teach you to think for yourself. And if you can use the three questions to develop and test your own strategies, you’ll be placing better bets and setting yourself up to outperform.

Invest to Win

On Saturday afternoon, a friend of mine called me and said “You don’t have to watch the Illinois game.” I said, “They lost right.” He said, “They were up 25-7 and the quarterback had 175 yards passing in the first half. He ended up with 190 yards passing for the game because they kept running the ball to milk the clock.” I said. “They were playing not to lose.”

I think all fans hate it when teams play not to lose. Every sports fan wants their team to continue pouring it on, go for the jugular, forget the prevent defense!

Then again late night Saturday I was sitting at a No-Limit Texas Hold’em Poker tourney. I had done fairly well to become chip leader with 9 players left. I began to tighten up. I had all these chips and I didn’t want to lose them. An hour later I was the short stack. Wow! How did that happen? I was playing not to lose. I had lost my aggression and was folding almost every hand. Luckily I came back and won the tourney.

What does this have to do with investing? I hate to say this but many investors are investing not to lose. When it comes down to investing, one’s first thought is usually, “Am I willing to lose this money or can I afford to lose this money.” While these are both very responsible questions, they stem from a mindset that limits your potential.

I’ve fallen into this mode. I was very active in real estate over the past 3 years. When the market turned late last year, I sort of went into a shell. I had done so well until then that I began to fear losing my equity and net worth. That mindset was reinforced by all the media bubble-talk, and it made me sit on the sidelines the past 8 months. I am a firm believer that you can make money in any market. I had let my fears get to me.

Yesterday I was sitting and Barnes & Nobles reading the new Kiyosaki & Trump book and came across this passage (from Why We Want You to Be Rich):

One day, during a brief meeting in his office, Donald simply said, “I invest to win. Don’t you?” With that statement the defining difference appeared. He and I invest to win, while others invest not to lose.

We have talked here about the advice, “Save money, get out of debt, invest for the long term (generally mutual funds) and diversify.” Late that afternoon, Donald and I discussed how we did not focus on saving money. In fact, we are both millions of dollars in debt – but good debt. We do not diversify, at least not in the context that most people use the word diversify. And while we are both long term investors, we do not invest in mutual funds, at least as a primary vehicle. Why? Because we invest to win….
Most other financial experts are telling people to play it safe, to live below their means. They are telling people that investing is risky and that they need to save and avoid losing. The experts aren’t focused on winning. They’re focused on not losing.

This just reaffirmed what I’ve been thinking. Maybe it’s a sign. Three different situations, same result. With that, I put an offer in for that duplex in Tucson.

Cap Rates

What is a cap rate? A cap rate (or capitalization rate) is the net operating income divided by the price of a property. If you have a $100,000 property and its net operating income is $10,000 the cap rate for this property is 10%.

What does this mean to you? How have cap rates affected the current real estate boom?

If you pay cash for this property, your cash on cash return will be 10%. How does this tie in with interest rates? Simple math will tell you that if you can borrow money at 9% and buy property with a 10% cap that you have a 1% spread. The maximum return that you can get from a situation like this is infinite. The less you put down, the greater your return is (red line).

What if interest rates were at 10% and your cap rate was 10%? Well, then your return on this property will be 10% no matter how much you put down (blue line).

And what if interest rates are greater than cap rates? Well you will have a negative return until you put enough down to break even. If interest rates were at 11% and your cap rate was 10%, it would be around 10% down or $10,000 (green line). What’s interesting to note is that your return will never go above 10% no matter how much you put down.

Cap Rates Chart

Now you can see why there was a real estate boom in the past 5-6 years. Interest rates were below cap rates and investors could borrow as much as they wanted. In fact, the more they borrowed, the better their return. As more people jumped on the real estate bandwagon, prices went up and cap rates came down. Eventually the cap rates became lower than interest rates. From the chart, you can see that your cash on cash return is limited to the property’s cap rate if your interest rate is above it. So why were people still buying? The answer is potential appreciation. With real estate prices rising so fast, people were ignoring the fact the fundamentals did not make sense. They were content with a 3% cap rate and negative cashflow because of the appreciation potential.

And that was all fine and dandy until about 8 months ago. The appreciation train derailed and now they are stuck with these 3% cap properties and 9% investor loans. In times of no appreciation, we must stick to the fundamentals.