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Interest Scams and How to Avoid Them – Mortgage Madness!

 

Last week we talked about Predatory Lending.

This graphic (click to enlarge) gives a good diagram outline of the basics to avoid.  Most of them make their money by charging fees that seem reasonable but turn out to be insane: Payday Loans that can hit you with 360% interest, Rent-To-Own arrangements that have you paying two to three times more than the item costs and, of course, the second greatest scam of them all – Credit Cards – particularly the ones that are supposed to help people "re-establish" their credit.  What is a greater scam on the American consumer than credit cards, you may ask?  Why your home mortgage of course!

Now I know you, my sophisticated readers, find it obvious that ARMs and Balloon Payments are bad ideas but, in my previous life in the real eastate title business, I found that even the most savvy investor often fails to consider the long-term costs of even a conventional mortgage.  Many people make poor home investing decisions because they don't fully understand the debt they are taking on or the alternatives available to them.  

This did not matter when homes went up and up and up because even a bad investment made a little but "this time it IS different" and we may be in for an entire decade in which we may not see ANY rise in the value of homes – this is what has happened to Japan for the last TWO decades.  I'm going to go over some of the numbers, give you a few tools and see if we can't find some ways save you $100,000 on a $200,000 loan and show you how to set your kids up for life - does that sound interesting? 

Home Costs

Currently homes are, at least, reasonably priced in many parts of the country and the government is offering a first-time home buyer tax credit of $8,000, provided that you stay in the home for 36 months. This isn’t a tax deduction like your mortgage interest, which reduces your taxable income – a tax credit actually reduces your total income taxes owed. In addition, some states, such as California, are offering tax credits for home buyers that will further reduce your tax liability. Keep in mind that the federal program ends on April 30th of this year, and while it could end up being extended, it isn’t a given.

As a long-term investment, homes are not terrible as they are not likely to drop more than another 20%.  So, as long as you REALLY want to live in that home for 10 years or more – buying may make sense.  Rates are also very low at the moment, even though they ticked back up slightly in the past few days, with full income documentation and good credit, you can easily get down to 5% on a conventional 30 year fixed if you have 20% down, and if you want to get into an FHA loan, you can more typically get around 5.25% with a down payment of only 3.5%.  Generally there is a 1% (point) fee for the loans which is $2,000 of your $8,000 credit out the window.  

There are many home costs that first-time home buyers fail to take into account and some of them are also missed by people who are moving into bigger homes.  Items like taxes, insurance, association dues, mortgage insurance, maintenance should be fairly obvious but many people fail to consider that when they move from a $200,000 neighborhood to a $500,000 neighborhood – suddenly a sandwich at the local deli goes from $5 to $8 and snow removal jumps from $30 to $100 etc…  It's nice to finally get a pool but have you ever taken care of one? 

When home repairs need to be done, a renter picks up the phone and calls the landlord. When repairs need to be done and you’re the owner of the home, you’re on the hook. You are the one who has to replace the hot water heater when it busts, you are the one who has to change the filter in your central air unit, make sure the gutters are cleaned out and replace broken appliances and carpets, you have to buy a lawn mower, a snow shovel and salt when it snows.  All of these things cost money — and they add up (big time).

Foreclosures are happening everywhere today because people borrowed the absolute maximum they qualified for so they could get into the biggest house they saw. They could barely afford their mortgage payments and that left no money to do repairs or even routine maintenance so tmake sure you consider everything that goes along with the "joys" of home ownership.

A big mistake many people make is getting into a home too early in life or spending too much on their first home.  Talk to your parents, many of them lived in a "starter home" at first and, when they had built up equity or made a profit on that home, THEN they moved into a larger home – a very sensible approach to building home equity.   Unfortunately, many people today fall prey to the standard marketing ploy of getting "as much home as they can afford" rather than as much home as they can COMFORTABLY afford – a VERY big difference.   

Mortgage Math

People save up their whole lives in order to have $50,000 to put down on a $250,000 home with a $200,000, 30-year mortgage at 6% so they can make 360 monthly $1,200 payments ($432,000) while maintaining the home and paying all the taxes on the land.  If they pay nothing to repair the home and just $5,000 in taxes that’s still $1,600 a month plust the $50K down.   You can play with these figures as they apply to you using this nice Bankrate Mortgage Calculator and this Compound Interest Calculator

If those same people could find a place to rent for $1,200 a month and put the $50K + $400 a month into something that just made 5% a year, they’d have $550,000 at the end of 30 years.   That’s at 5% compounded once.  If they got the 8% historical stock market average,  that would be over $1M!  A lot of people today have homes since the 70s that haven’t doubled, let alone gone up 4 times and I’ll bet they spent a good $2K a year on repairs minimum.  Another $200 a month added to the $50K at 8% is $1.4M after 30 years.

Isn't this getting interesting?

Remember To Tell People PhilStockWorld Saved You $100,000

I promised we could save you $100,000 on a $200,000 home loan and let's get to that.  Once we do, you can subscribe to our newsletter HERE.  In the mortgage calculator, you can plug in $200,000 as our example loan amount for 30 years (360 months) at 6% interest and, when you hit "Calculate," you should see a monthly payment of $1,199.10.  If you then click on "Show/Recalculate Amortization Table" at the bottom you'll see that you will have paid, over 30 years, $231,676.38 in interest on your $200,000 loan

So the home you buy for $250,000, putting $50,000 of your life savings down in order to stop "wasting" $1,200 a month in rent actually ends up costing you $481,686.38 or $1,337 a month plus taxes, maintenance, insurance and repairs, which we will VERY conservatively estimate at $800 a month (good luck), which means your new home will cost you $2,137 a month or 66% more than the rent you are trying to get rid of.  Do you really think "tax credits" will make up for that?  360 monthly payments of $2,137 comes to a grand total of $769,320 paid to live in your $250,000 home for 30 years.  

Before I tell you how to knock $100,000 off your mortgage, first consider whether or not it makes sense to have a mortgage at all?  We have been conditioned, through many years of rising home prices (much of it the result of scams it turns out) to think that homes ALWAYS go up in value.  That means it will be hard for me to get you to believe that, at the end of 30 years, you may not even get your $769,000 back.  First of all, the home will be 30 years older and you only budgeted $800 a month for taxes, REPAIRS, etc.  I live in NJ and just painting a small home is about $5,000 and they say you need that every 15 years minimum.  Also, we got a lovely 30% tax increase this year – isn't that amazing?  Imagine paying $600 a month for taxes alone on a $200,000 home (already crazy) and then being told it's going to be $800 in June.  Another 30% rise just 3 times over 30 years and your taxes alone will be $1,757, or almost as much as your mortgage and other costs were when you started. 

Meanwhile, if you keep renting at $1,200 a month and (now using the Compound Interest Calculator) put your $50,000 deposit into Principal and added just 1/2 of the extra $400 a month (MINIMUM) it will cost you to own a home ($4,800 a year) over the same 30 years at just 5%, compounded monthly (12 times annually), you will end up with a GUARANTEED $557,677.77 in cash.  Of course your rents will go up but so, as I pointed out, will your home costs so we'll call that a wash.  Remember, cash is flexible but homes are not.  If the housing market collapses during the next 30 years (again), with a home you are stuck but with cash, you are in luck!

Don't forget we only saved 1/2 of the $800 a month we saved NOT buying a home.  You can treat yourself to some nice dinners with the extra $400 or you can move to a 33% bigger apartment or (and this is radical) you can save that too and live like paupers in your $1,200 apartment but save a total of $800 per month ($9,600) for 30 years.  How much cash does this saintly existence yield you in year 30?  How about $891,968.32?  Saints preserve us, that's a lot of cash! 

Now, try changing that 5% to the historic S&P returns of 8.5%.  Now you have $1,964,543.51 – do you really think you'll be getting that much for your house?  The chart on the right from Forbes is a little old but just consider that the S&P may be back at 1,050 but homes are off over 20% from 2005.   Homes do NOT outperform the market, even in the best of times. 

There is our first PSW bonus gift to you – $1,964,543.51 delivered to you in 2040 if you take $50,000 and add $800 a month to it and average a return of 8.5% over that time.  Heck, we have dozens of stock and option strategies that do better than that!  What homes do do is give to the average citizen something us top 10% investors take advantage of every day - leverage.  If you qualify for a cheap 4% loan, then your monthly payment is "just" $954.83 on a $200,000 loan and you'll "only" pay $143,739,01 in interest over 30 years – that's one way to save $100,000 – get an FHA or Veteran's loan! 

Other Ways We Can Save $100,000

If I couldn't talk you out of buying that home and saving the extra money, I hope at least I have led you to consider buying a more affordable home and saving that extra money.  And by the way, for you parents out there, please consider putting $800 a month into your child's account from the day they are born.  Even without the $50,000 deposit, saving $9,600 a year for 30 years gives them a nice $1,329,918.57 to buy their own first home with (or deposit for the next generation if, hopefully, they don't need it).  With an 8.5% annualized return, putting just $300 a month into your child's account until they are 18 gives them $153,266 for that first car (or one hell of a prom night!). 

Teach your children well and perhaps when they turn 18 you can arrange to match them 2:1 and they come up with $150 and you with $300 and you maintain that deal for 12 more years.  Using the Calculator, put the $153,000 as an initial deposit and add $5,400 a year ($450/month) for 12 more years at 8.5% and what do we get?  $535,587.12 to get your kid or grand-kid started in life at age 30.  All you have to do is commit yourself to $300 a month and, aside from the cash, perhaps you will also teach your children a very valuable life lesson in investing that will be passed down to generations of wealth builders in your family.

We have looked at saving $100,000 by getting a low-interest loan and saving hundreds of thousands of dollars by "right-sizing" your home purchase or not purchasing at all and putting the extra cash in the bank.  We have also looked at how you can help your children (or yourself) save hundreds of thousands of dollars by simply making a small commitment over time and sticking to it.  Now let's look at how we can knock $100,000 off your existing $200,000 mortgage.  

Reducing Your Mortgage Payments By $100,000

People don't realize this but a 15-year mortgage is usually at least 0.5% cheaper than a 30-year mortgage.  If you can afford to make the extra payment this is, perhaps, the best way to reduce your total payments.  Using the Mortgage Calculator and our $200,000 loan at 6% example ($1,200/month), let's change that to 15 years (180 months) at 5.5%.  That raises the payment to $1,634.17 a month (up 36%) but it drops your total interest paid from $232,000 to just $94,150.04.  Not bad, right?  Not only that but you have paid off your ENTIRE home in 2025 rather than 2040 so it's 15 years newer when you can look to "cash in" your investment.

So what's it going to be, take out a $270,000 loan (36% more) and pay $1,618.79 a month for 30 years, giving $312,000 of interest to the bank by the time you own it in 2040 or find a home that you can buy with a $200,000 loan and pay $1,634.17 a month to have the bank tear up your mortgage as you make your last payment in 2025?  Going back to the Interest Calculator (I know, financial planning is a pain in the ass, isn't it?), let's take that $1,634.17 a month ($19,610.04/year) mortgage payment you no longer need to make and put that in the market at 8.5% for the remaining 15 years.  That's another $595,408.22 AND you have a free house – all because you wisely tightened your belt to the tune of $434 a month back in 2010. 

An even easier way Philstockworld can show you how to save $100,000 on a $200,000 mortgage WITHOUT any modification or refinance is to simply use the 2nd section of the Mortgage Calculator.  Going back to our $200,000, 30-year loan, simply add an extra monthly payment of $300.  PRESTO!  We have reduced the total interest paid down to $130,000 from $232,000 AND we have paid off the entire mortgage by July of 2028, 12 years early!  As with our 15-year example, you can then take your early terminated mortgage payments and start saving those up, netting you a lovely $350,000 bonus in 2040. 

The advantage of the extra payment system is you can choose NOT to add the additional cash if you need it that month.  It even works if you make irregular payments (like 1/2 of your Xmas bonus, birthday money, the penny jar…), only not as well.  If you do insist on owning a home, you may very well be better off putting $300 a month into your existing mortgage than into an IRA - $300 a month over 18 years at 8.5% nets just $153,266.38 – that is $300,000 less than we net in the above paragraph!  Why?  Because by putting the $300 in the IRA for 18 years you will NOT be paying off your mortgage 12 years early and that will cost you an additional 144 $1,200 payments, which is $172,800 right there and then there's the $1,200 a month you DON'T invest in years 19-40, a $900 a month difference over your $300 monthly IRA contribution.  Am I making your time worthwhile now?

Here's one last one that will really blow your mind.  How would you like to save $80,000 on your $200,000 mortgage without paying one extra penny?  Now will you SUBSCRIBE?  I'm not even going to ask you to, I just want you to AT LEAST do this and then make sure you tell 3 people about us and maybe one of them will subscribe.  OK then – Deal!  There is such a thing as a Bi-Weekly Mortgage Calculator but ask your average bank or broker and they will deny it.  Use the calculator and see what happens.

By simply making 2 monthly payments of $599.55, rather than a single payment of $1,199.10 on a $200,000 loan over 30 years, we manage to pay off our mortgage over 5 years early!  May of 2034 is your freedom date if you simply write a check to your bank 2 times a month instead of 1 (some banks do not allow this – change banks!).  Why?  It's the simple reduction of an average of 2 weeks worth of interest per month on 1/2 your loan payments.  Crazy stuff, right?  Does it seem strange to you that none of your "mortgage professionals," the people who have shaken your hand and pocketed your fees – have ever mentioned these things to you?  That's because it lowers their commissions, which are based on the bank's expected earnings off of you! 

Our Debt Society

This is not a trick, this is not a scam.  I am not selling you mortgages.  This is something you can do, right now, with your existing home mortgage, starting TOMORROW.  The scam is the fact that no banker or mortgage broker will ever tell you this stuff because the $138,000 worth of interest you save over 15 years is money the bank is trying to collect from you and the $301,000 you make by saving your money at 8.5% is money the bank doesn't want to pay you (if saving interest) or the top 10%  don't want to compete with you for as a fellow investor.

I'm sorry to have to tell you these things.  I am not a Communist but this IS the mechanism of the Capitalist system.  If YOU save money and build wealth then YOU will be able to lend money and earn interest or invest money and earn capital returns.  The more people who compete to make those returns, the lower those returns will be (supply of money vs. demand).  So it is VERY much NOT in the interest of those who have wealth to allow you to accumulate any.  This is why virtually everything in this country is geared towards placing the bottom 90% (and whatever portion of the top 10% that can be suckered into this foolishness and knocked down the pyramid) into permanent, lifetime debt. 

If there wasn’t such a massive effort to stuff every breathing person into their own home, we wouldn’t use 1/2 the resources we do now and everything would  be cheaper for everyone, again allowing the bottom 90% the POSSIBILITY of geting just a little bit ahead in the game.  68% of the families in this country live in their own home – that’s nuts!   In Germany it’s 43% – that’s why they are so much richer than we are!   You know what country has the least home ownership?  Switzerland at 31%.  Who needs homes when you have money? 

There are lots of countries with high ownership rates, Ireland is 83% and they are almost bankrupt – just like our country!  America is simply run by banks and they have, for 100 years, shaped a culture in which we feel that we are failures if we don’t have houses, cars and appliances we can barely afford to make payments on.  The more we buy, the more we borrow and the more we borrow, the more the banks make.  It’s a great plan – until it all falls apart

Why do schools not teach the math of home ownership or auto payments?  There are cars that work perfectly well for $20,000, even less (so I’m told) – Paying an extra $20,000 for a car you don’t need for 40 years at 9% is another $75,000 of retirement money out the window.  Buying an extra $5,000 worth of stuff a year at 18% on credit cards is another $36,000 down the drain over 40 years.  If we explained this to kids in high school they wouldn’t need Social Security, especially if they took that extra money and put it into something that paid a return.

How about if we just teach young parents that if they put $100 a month into a 5% savings account for their kids from the day they are born and teach their kids to keep putting in $100 a month for their whole lives, that they would retire at 65 with $625,000 in the bank?   If they were lucky enough to get market rates of 8.5%, that would be $3.5M – USE THE CALCULATOR – TEACH YOUR KIDS TO, NO ONE ELSE WILL! 

Why don’t they teach this in school?  Because the last thing "THEY" (the top 1% specifically) want is to have a nation full of 50 year-old millionaires who put $100 a month in the bank instead of wasting it on spinning hubcaps or 3 rooms for each person in a house (which has to be heated, furnished, cleaned, maintained and taxed).  Those people wouldn’t have to work for whatever wages they were offered or be forced to spend their entire lives slaving away in debt.  $100 a month now may not change your life but it will GUARANTEE your grandchild retires a Multi-Millionaire (at 8.5%). 

"THEY" do NOT want this to happen.  With that sort of head start, your children or your children's children could become entrepreneurs and start their own businesses and compete with the grandchildren of the top 1% on a more even playing field.   The whole system is designed to make sure the children of the bottom 90% never learn how to manage their money except enough to pay their bills to the top 10% and, of course, once those debts are in place, the full force of the law is there to make sure those bills do get paid, even though outrageous PayDay Loan fees. 

Look what happened last year – There was a systemic failure in which the banks were in danger of not getting paid and millions of Americans were in danger of losing their jobs and their homes.  The government leapt to the aid of the banks, making the survivors whole (in fact, many had their best year ever) while millions of people still lost their homes and their jobs and, even better, the government did that by putting our grandchildren $113,243 into debt, EACH!

So make a late New Year's resolution – resolve to find at least that first $100 a month and please, please give it the time it needs to work.  There is a video we assign to New Members called "The Man Who Planted Trees" that is a parable for what you can accomplish with small, methodical, consistent investing strategies – I recommend it highly and I highly recommend you take the time to seriously consider my proposal to work towards a better future.  Our government may not be able to control it's finances but surely we, the people, can do better! 

 


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  1. Great stuff Phil!  Honestly, you are a prolific writer and I appreciate your practical advice.  Where do you find the time?  My hat is off to you.  Please keep up the good work.
    Best Regards from Raleigh, NC
    JW


  2. Great commentary! 


  3. Phil, great read. Where do you find a 5% savings account ?


  4. Time/JW – I’m one of those no-sleep kind of people, it gives me about 4 extra hours a day to get things done!   Thanks. 

    5% Account/DK – Go down to your local branch and wait until about June 15th.  We should be in enough trouble by then to get 5% out of them.  I was actually thinking more of a 10-year at 5% or whatever – obviously the market or a well-manged fund is going to be the best place but look how many corporate bonds are paying huge rates or just some dividend stocks.  Keep in mind that if you buy PFE for $17.80, say 5 shares a month, they pay a 4% dividend.  After 20 months you can sell (assuming you had accumulated 100 shares today) the 2012 $15 calls for $4, giving you $400 with which you can buy 22 more shares of PFE so you have 20% of the upside and $3.20 of net protection per share with an effective 4.8% dividend. 

    You never need to get called away, you can just keep rolling the caller.  Over 30 years (and of course you should have more than one stock) the price of your stocks and dividends should keep up with any inflation and you are on track.  That’s the "for dummies" way to get 5%, obviously we have 100 better ways to do it but that’s because we’re in the top 10% and we’re meant to have access to wealth-building strategies that are denied the lower classes ($25,000 to day trade, $125,000 to get Portfolio Margins, $1M liquid  to invest in a hedge fund, etc…) so enjoy them. 

    Savings accounts are for chumps – go out and buy CM, who pay a 5.4% dividend and you can buy them for $62.17 and sell Sept $60 puts and calls for $10 for net $52.17/56.09, which is 15% if called away AND you get the dividends – try punching that kind of return into the compound interest calculator for 30 years! 


  5. Hi Phil, how NXZ?  tax free 6% + yield.  there are a few out ther like that. whats your opinion? Phil


  6. Phil, is CM on your watch list? Phil


  7. Dang Phil – Great article. Worked in the mortgage industry, but never heard of the bi-weekly mortgages … no wonder why no one talks about it …


  8. Happy Valentine’s Day! 

    NXZ/Phlit – I think the risk of municipal default exceeds the 6.5% commission.  Last year, at $8, with a 10%+ commission, I would have felt differenctly but there’s no growth at this price and no options to protect you so it’s just a risky play for 6.5%.  I think you are better off with a good REIT or and energy trust. 

    CM/Phlit – It sure should be on my watch list.  It only hit my radar this week but I very much like what I’ve seen so far. 

    Speaking of things to watch, Cramer called GRMN dead and hopefully they’ll test $30, where they do get pretty attractive as there is still the in-vehicle sales market, which should turn up this year, especially in China, where not too many people have smart-phones with GPS’s.   How Cramer can go ga-ga over China on almost everything but call GRMN dead just because 50M people worldwide may buy smart phones with GPS’s next year (vs 2Bn drivers) is beyond me.  Long-term, GRMN is probably dead but it’s a lot longer than 2010!

    Thanks Trad.  Yeah, they tend not to really spend a lot of time discussing products that generate LESS fees, right?

    Interesting performance chart, all sectors are down – so much for diversification keeping you safe!:

    I’m liking XLU (more dividends, yum!) so I’ll be looking at some of those. 

    Bruised Toyota (TM +1.4%) is reportedly looking at strong measures to win back consumers, including rebates of thousands of dollars per vehicle and warranties of as much as 10 years – but not until after congressional hearings scheduled Feb. 24-March 2. (previously)

    Toyota (TM) recalls 8,000 Tacoma trucks over a crack in the front propeller shaft. The cars were built between December and February.

    There are no problems with its electronic throttle control system, Toyota (TM) tells the House Oversight and Government Committee, but the company will reexamine complaints about unintended acceleration in certain Tacoma pickup trucks. (see also)

    "[The individual trader] has no idea the forces that are arrayed against him" – Scott Patterson, author of The Quants, on just how machine-based trading has taken over Wall Street. (video, 5:47; John Mason on the book).  This is good, Scott’s a great writer and hopefully this mainstreams my ranting and raving a little!

    The Volcker rule is gaining ground, with a first-term Democrat from Oregon drafting legislation that would extend the ban on proprietary trading to nonbank financial institutions large enough to be considered "systemically critical."

    The Treasury is working on new rules that will stop banks from draining millions of dollars in fees from the Social Security benefits of elderly clients.  About time!

    Some people will gladly pay $1.7M to sit down and dine with Warren Buffett. And then there’s 29-year-old hedge fund manager Cara Goldenberg, who sent some stock research to the Oracle and was bade: Come to Omaha for dinner on me. (That’s her on Facebook clutching the Buffett billfold.)

    Commodities took some early hits today after China looked to cool down its economy, but the silver lining is that Chinese moves may benefit markets in the long run without hurting growth too much in the near term. (ETFs: PGJ, FXI)

    Another sign there may be a top in crude is rappers getting into the exploration business, heads tattooed with oil wells.

    Part 2 of a nice series by Rortybomb crunches numbers on how long you’ll be underwater on your mortgage, and argues modifications are failing: "You know what is good at handling these situations? Bankruptcy courts. Can we get mortgage cramdown already?" (Part 1, and more on how homeowners might be getting held underwater)

    Daniel Indiviglio says the move by Fannie Mae (FNM) and Freddie Mac (FRE) to buy delinquent mortgages could keep interest rates low even after the Fed stops buying MBS. If $200B from the purchases goes back into real estate as allocated, some new activity in MBS could keep rates down.  So the Fed stops and the GSE’s start – what a coincidence!

    CNBC contends that Nouriel is ignoring the evidence of recovery all around us. I feel like taking the little video player and shaking it… hello CNBC hosts, COST-BENEFIT analysis! Do you realize you are celebrating bounces off of multi-decade lows? Bounces that cost a few trillion dollars worth of stimulus/handouts/morphine to engineer? And yet they are still extremely limp? We are citing 33.4 hour work weeks as recovery when all-time lows are 33.2 hours? Is the logic just that "you need to start somewhere?"

    Speaking of starting somewhere – good thing it’s a long weekend as the Economic Report of the President is 451 pages!  They are projecting some massive wage inflation, check out the chart on p34.  Have I mentioned I like TBT lately?  Chart on p 48 shows Fed bought about $1.2Tn in long-term treasuries last year, that was MOST of them.  Have I mentioned I like TBT lately?  I’ve gotta tell you, reading this report, it sounds like Obama actually wrote it.  Very much in his style of communicating.  I hope he didn’t as that would be a bit obsessive.


    Page 62:  Inventories of vacant homes for sale remain at high levels, and many vacant homes are being held off the market and will likely be put up for sale as home prices increase. This overhang may lead to some additional price declines, although prices are unlikely to fall at the same rate as they did during the crisis. Thus, the recovery of the housing sector is likely to be slow. Of course, we should neither expect nor want the housing market to return to its pre-crisis condition.

    Hey, that’s pretty damn sensible!

    P 67 –  The figure also shows the large role of inventory investment in magnifying macroeconomic fluctuations. When the economy goes into a recession, firms want to cut their inventories. As a result, inventory investment moves from its usual slightly positive level to sharply negative, contributing to the fall in output. Then, as firms moderate their inventory reductions, inventory investment rises—that is, becomes less negative—contributing to the recovery of output.

    This one bothers me because no one considers the fact that inventories also rise when sales are worse than expected and inventories were 4% of our GDP gain.  Also, the build in inventories was mainly autos and that came after Cash for Clunkers artificially depleted inventories – it’s all just silliness really.  Oh well, it’s a big report but I’m done reading the first two chapters and still pretty optimistic. 


  9. Thanks Phil,
    I know that you like TBT (you mentioned, A FEW TIMES, LOL).  I can see the upside potential, long term and I would like to establish a long term position in it.  What % of my portfolio should be invested in TBT as I scale into it, and how do you suggest I do it, buy the stock ot the leap and sell the call and the put monthly?  Interest rayes have no place to go but up, at some point. Please advise.  Thanks. Phil


  10. TBT/Phlit – TBT is one I feel can be aggressively owned so I WANT 10% (and I don’t consider it a hedge, I consider it a position I believe strongly in) and I’m willing to play it to the point where I may have to commit more funds, even after 10% (so very aggressive).  Meanwhile, that does not mean I don’t cash out or scale back if I get stopped off a 20%+ gain because that would go from aggressive to foolish. 

    So, as an entry off a $100KP, I’d want to go with the Sept $44/48 spread at $2.30.  Since TBT is a little high from the last run, I’d go with 10 for $2.30 to start.  That makes $1,700 at $48, which is, by itself, a fine profit on my intended $10,000 allocation so I won’t be crying if it "get’s away from me."   Also, and I should include this in some strategy post, don’t forget that, if something does go in the money early in the cycle, it then (using this example) releases the other $7,700 for another trade – that’s not a terrible thing.  Once your 1x, 2x or 4x positon gets over 20% and you set a stop, you no longer need the cash to protect it since the position either makes more or becomes cash itself (when you stop out).

    The 50 dma is $48.50 so that’s the line where I’d sell 1/2 the March $50s, now 88 for about .75.  I only need to collect .23 per month to have a free position and, since we feel the rate situation will pressure over time, it’s better to be more aggressive with sales early on, and hopefully be uncovered or less covered moving forward. 

    Should TBT fly up, we have a DD roll for the callers so I don’t anticipate too much trouble there AND we have plenty of firepower left in cash to add more longs (or perhaps another, higher spread. 

    Should TBT head lower, I have no reason to think $46 won’t hold so I’ll be looking to sell the 1/2 the Sept $44 puts now $1.95 for $2.50+.  That will knock the long net basis to .55 and, if the calls expire worthless (more likely if I’m forced to sell puts) then the long basis is down to about .20!  Not bad for a first month’s work on a $4 spread! 

    Of course we need to keep track of the possibility of a good roll.  The $44 puts are $6.90 and the $40s are $9.90 so that’s .75 per $1.  The $48s were $4.60 so that’s .58 per $1 so we’d consider .55 a very good price for a roll down and we can just offer $1.10 for the roll to the $42s GTC right off the bat because we’re early in our scale and we know we want it.

    That would change our profile to the $42/48 spread at net $3.30, less the .37 we sold in March (and we’d likely sell .30 more if things are going so badly that we have to roll lower) and we’d also have the 1/2 short Sept $44 puts but we won’t be worried yet because they can be rolled to 2x the $40 puts and TBT was only ever below $40 for 3 weeks (Dec 08) when the 20-year actually went negative! 

    So that’s our entry position.  We have a trade and we have a plan.  That lets us move on to other positions without worrying about what we’re going to do on this one. 


  11. AFSI very interesting play.  I’m liking the Sept $10s at $2 (stock at $11.77).  Would sell March $12.50s for .50 (now .15) on a good run but I think this is a very solid long-term play (and a 2% dividend payer).  Another AM Trust Bank was taken over by FDIC and it seems to be keeping people away from AFSI, who have nothing to do with them.  Here’s a good review from John Moreland at Real Money (not one of Cramer’s typical idiots). 


  12. Mortgages- Excellent advice. It’s all about the "magic" of compounding. Also, could not agree more about how important this principal is to be drummed in to kids at an early age. Some might say that the application of such conservative financial practices would constitute assuming personal responsibility so that one could become more self reliant. What a radical idea that is!  :)


  13. Phil
    The latest on CIC ( China Government) sentiment re US Treasuries – They are not only talking about moving out of them, they are. They reduced their holding by 10 Bil recently. Our Fed will be taking their place, I guess. I am allocating 300K to plays on TBT and will wait for this to play out. I am structuring some plays with an expiration beyond 12 months for capital gains treatment. You did mention you like TBT, didn’t you?


  14. Phil:
    As a follow-up to my comment re TBT, I would like to ask your advice on some hedging/income issues: I currently have 150 Short puts June 45′s and 150 Short puts on Jan’11 45′s. I am buying 6,000 TBT (stock), and would like to sell some calls (March) as a cover that could be rolled. My objective is to capitalize on a long term gain and earn income hedging month to month as the investment scenario plays out. Thanks!


  15. Personal responsibility/Pstas – That’s an interesting concept!  Like the fact that, since 1945, $3Tn of surplus has been taken by the government, most if it in the decade since GW2 broke Al Gore’s lock box and redistributed that money to the top 10% (although really the top 1%)?  What really bugs me about SS is they take in $800Bn a year and spend $600Bn a year in payments and people act like it’s the people who contributed their whole lives who are robbing someone. 

    If we go back to 1945 (65 years) and compound an average surplus of $40Bn a year (and I’m not being generous it was ALL surplus for the first 10 years) at an average rate of just 4% there should be $12.5Tn right now, which at 4%, would still be funding a huge surplus. 

    Another problem with SS, of course is that, even a worker had just put in $2,000, matched by their employee at $2,000 at just 4% interest for 65 years – that would have given them $605,000 at 65!  So, had they not robbed the program, things would be fine or had they never had the program at all but forced people to have some kind of individual IRA with matching contributions, things would be fine but what we have now is a crime scene where Trillions have been stolen and the suckers who are now putting in as much as $6,000 a year plus $6,000 from the company should be getting $1.5M at the end of 45 years at 4% or $6.2M at 8.5% but will most likely get nothing or, at most $2,500 a month (but only until they die, then nothing).  

    TBT/Gel – Yes, I may have mentioned them…   On your plan.  You are already oblgated to 30,000 shares of TBT, what do you gain from buying the stock but a bit more upside than the $1.25 and $3 you get at $45?  Spending another $292,000 doesn’t do too much for you when you can just buy 150 2012 $45/65 bull call spreads for $5 ($75,000) and use all that spare margin money you have left to sell 75 June $50s at $2.50 ($18,750) which keeps you out of trouble if the June puts start paying off.  You can put a stops on the calls (or roll, of course) with 25 at $3 and 25 at $4 and 25 at $5 for a loss of ($11,250) but that would expire your $18,750 worth of putters worthless and you’d be $5 more in the money at least on the longs (+$75,000). 

    Seems like plenty of money to make to me on a much lesser commitment and you can always add more Leaps if you like the trend with that $225,000 of sideline money!  To the downside, of course, you are no worse off than with the stock but your max loss on the Leaps is $5 and you can always roll to 2014 by then.


  16. February 14th, 2010 at 7:37 am | Permalink  
    Thank you Phil for all your detail and just to clear on my part I will now identify areas that are not crystal to me
    TBT/Phlit – TBT is one I feel can be aggressively owned so I WANT 10% (and I don’t consider it a hedge, I consider it a position I believe strongly in) and I’m willing to play it to the point where I may have to commit more funds, even after 10% (so very aggressive).  Meanwhile, that does not mean I don’t cash out or scale back if I get stopped off a 20%+ gain because that would go from aggressive to foolish. 
    So, as an entry off a $100KP, I’d want to go with the Sept $44/48 spread at $2.30.  Since TBT is a little high from the last run, I’d go with 10 for $2.30 to start.    WHICH MEANS……….
    "I will enter an order to buy the 44 call and sell Sept 48 call for a net debit of $2.30 and then at 48 I have $1.70 net x10, $1,700."  
    That makes $1,700 at $48, which is, by itself, a fine profit on my intended $10,000 allocation so I won’t be crying if it "get’s away from me."   Also, and I should include this in some strategy post, don’t forget that, if something does go in the money early in the cycle, it then (using this example) releases the other $7,700 for another trade – that’s not a terrible thing. 
    Once your 1x, 2x or 4x positon (this means a DD and another DD?) gets over 20% and you set a stop, you no longer need the cash to protect it since the position either makes more or becomes cash itself (when you stop out).
    The 50 dma is $48.50 so that’s the line where I’d sell 1/2 the March $50s, now 88 for about .75
    (means I will enter an order to sell 5 of the March calls@ .75) 
     I only need to collect .23 per month to have a free position and, since we feel the rate situation will pressure over time, it’s better to be more aggressive with sales early on, and hopefully be uncovered or less covered moving forward. understood
    Should TBT fly up, we have a DD roll (roll to following month and double the the number of calls?) for the callers so I don’t anticipate too much trouble there AND we have plenty of firepower left in cash to add more longs (or perhaps another, higher spread.  good
    Should TBT head lower, I have no reason to think $46 won’t hold so I’ll be looking to sell the 1/2 the Sept $44 puts now $1.95 for $2.50+.  That will knock the long net basis to .55 and, if the calls expire worthless (more likely if I’m forced to sell puts) then the long basis is down to about .20!  Not bad for a first month’s work on a $4 spread! 
    Of course we need to keep track of the possibility of a good roll.  The $44 puts are $6.90 and the $40s are $9.90 so that’s .75 per $1.  The $48s were $4.60 so that’s .58 per $1 so we’d consider .55 a very good price for a roll down and we can just offer $1.10 for the roll to the $42s GTC right off the bat because we’re early in our scale and we know we want it.
    That would change our profile to the $42/48 spread at net $3.30, less the .37 we sold in March (and we’d likely sell .30 more if things are going so badly that we have to roll lower) and we’d also have the 1/2 short Sept $44 puts but we won’t be worried yet because they can be rolled to 2x the $40 puts and TBT was only ever below $40 for 3 weeks (Dec 08) when the 20-year actually went negative! 
    So that’s our entry position.  We have a trade and we have a plan.  That lets us move on to other positions without worrying about what we’re going to do on this one.
     
    Thanks again Phil and I am sorry to be asking for mundane clarifications but better now than during open market time.


  17. Phil/TBT
    Thanks!
    I asked the question because I knew you had far better strategy than I, and I do believe the timing for a strong position is upon us, as there is so much talk in the markets, presently, about Treasury yield issues. With this better deployment  of funds, I now can actively short the Euro, that I think is vulnerable. My plan is to short the Euro against the AUD on my FX account, and to buy puts on FXE.


  18. Phil
    I’ve got another one for you, and I hope I am not interfering with your weekend plans. I can not help but think the Euro is headed for trouble. Greece is but 2% of the Eurozone GDP, and will have to be sucked up by the other members, but the combined weakness of Italy, Portugal and Spain and the probability of a bailout there, as well, will stress out the Euro. I believe the Euro is possibly headed toward parity with the Dollar, as the European countries are looking at diminished GDP, as they de-leverage. I would like to place a Leap ( 2012 ) bearish position on FXE and would appreciate any suggestion you might offer as to a good strategy. Thanks!


  19. Utilities weakness,  possible states defaulting and foreclosures. gel, i thought rates would sky rocket last year but the Fed has extraordinary powers. We are ever closer to the day of reckoning. Feb 11th failed auction is surely a sign and i believe every currency is trouble. Wild swings from bonds to commodities, we aren’t in Kansas anymore Dorothy.


  20. TBT/Phlit – Sept $44/48 is a bull call spread where you buy the $44s for $6.90 and sell the $48s for $4.60 for a net of $2.30 so you can see where, without you guys taking the time to learn the shorthand, I would probably rather just quit making these picks than tediously write them out over and over again.  Another DD – see strategy section on scaling in.  This is how we should be buying everything.  You allocate a portion of your portfolio, which should never be more than 10% of your cash, to a new position.  Once you have determined that amount, you work backwards to your first entry so if you allocate $4,000 to a full position, you EXPECT to buy in at $1,000 (1x), $1,000 (2x TOTAL) and $2,000 (4 x TOTAL) for a $4,000 full position. 

    Even if you are a trading genius of the highest magnitude, it is very, very likely that 40% of your entries will go the wrong way on you.  If 60% make 20% and go off the table, you make 12% of a 1/4 position (3%) quickly and you are done.  The 40% that go against you by 20% are doubled down to 2x at -10% and let’s say 40% come back to 20%.  Now you made 20% on 16% of the portfolio in 1/2 positions or 1.6%.  Of the remaining amount, you are 2x committed to 60% that are down 10% (-3%) vs cashed out 4.6% – It’s a self-regulating system, especially if you don’t trade idiotic stocks and ultra ETFs that are likely to move faster than you can make adjustments. 

    Of course, to the upside, we’re not taking into account better than 20% gains which is another self-regulating system for non-greedy people.  Let’s say you have DISCIPLINE and never allow more than a 20% loss on a position.  If you take 10 posiitons at 10 each and one gains 50% (+5) and one gains 30% (+3) and 2 gain 20% (+4) and 3 flatline between +10% and -10% and cancel each other and the other 4 lose 20% (-8), you are still up +4 and you only picked 3 winners out of 10!

    If you limit your losses to 20% of a full position, to get there 1x has to drop 20% and you DD to 2x (-10% avg) and then that has to drop 20% again (option now 40% lower than your entry) and you have STILL decided to pursue it rather than take the 2x x 30% loss (1.5% of portfolio, assuming a 10% full allocation) so you DD to 4x and now you are in a full position at a 15% avg loss.  At that point, ANY 5% downward movement is a stop out with a 20% loss of a full position (2% of portfolio) so you need to learn to be damned sure you WANT to make that last DD, which is why you usually see me advocating a roll back into a spread, rather than a DD at those points. 

    Look back over a few wrap-ups and consider how vastly improved your trading performance would be if you simply cut the losers at 20%.  The first DD is easy, when we enter a straight option position, we expect a 50% chance of it going the wrong way and that’s WHY we scale in in the first place.  I want to buy the TBT Sept $44/48 bull spread $2.30 and I want a full position to be $5,000 so I buy 3 at $6.90 for $2,070 and sell 2 $48s for $4.60 ($920) for a net $1,150 entry.  If TBT head up $2 I have 3 $44s at $8.30 (the price of the $42s now) and 2 $48 callers at $5.70 (the price of the $46s now).  That’s net $1,350, more than 20% up but early in the scale and on track so I DD my calls at $8.30 for an average entry of 6 at $7.60 ($4,560) and I sell 3 more $48 calls for $5.70 ($1,710) plus the original $920 I collected is $2,630 for a net of $1,930 on a 6/5 spread. 

    At that point, if my callers drops 20%, to $4.56 I will have to decide if I want to add the 6th cover, which would drop my net to $1,474, back to about a 1/3 commitment or whether to take a chance and look to take out some callers or possibly roll down my calls cheaply or some combination.  It’s kind of like chess, the more moves ahead you look the more possibilities there are and the more difficult it becomes to describe as there are also more moves your opponent (the market) can make, opening up even more possibilities.  Like chess, you need to learn to look one move ahead before you can look 2 moves ahead and learn to look 2 moves before 3 etc.  Also like chess, if you practice and practice and practice, you will get better and better at seeing those moves ahead and more comfortable making that first move, because you already see all the things that can happen for the next move or two. 

    March calls @ .75 – If you don’t have the memory (or sticky-note capacity) to remember to sell the March $50s when they cross .75 then yes, put in a STOP order to sell them there but that is a FALL BACK sell.  In other words, we expect it to go higher from here and we don’t WANT to cover but we also aren’t going to be idiots and not cover if we break levels.  If you put in a hard sell at .75, you may as well sell them now for .88 as any quick spike down will trigger you anyway so why not take the .13.  WHEN IN DOUBT, SELL HALF is Rule #2 (and there only are 2 Rules, so it’s probably important) so you can put a hard order in to sell a few and let that be your alert when it drops (as in, say, what are those couple of short March $50s at .75 doing in my portfolio – oh yes, I remember…) so you can watch them more closely and decide if it’s really time to cover. 

    I REALLY hope it’s obvious that, if we go up $1 and the March $51s, now .60, go over .75, that THEY become our new sell-stop and if that doesn’t trigger, then the $52s, now .45, when they cross .75 are the ones we will sell.  Each time your underlying stock moves 2.5%, it’s time to take a very hard look at what you think it will do next and adjust accordingly. 

    DD Roll – Either up or the following month or 3 months down the line, whatever makes sense based on the move that happens.  If you have sold a 1/2 position (10, for example) of $50s at $1 and they go to $1.75 and you look to roll and the $52s are $1.25 – do you NEED to do a 2x roll?  No, you have a $1,750 obligation you’d like to see all in premium so you can roll it to 14 $52s even – you don’t NEED to do a 2x roll.  I can’t write a 5-page essay for every single trade, of course, which is why these discussions are good sometimes because you need to focus on the GOALS we have (selling premium, staying flexible) and, once you internalize that, a lot of these adjustments seem more obvious.

    Hopefully that helps! 

    FXE/Gel – I don’t think Europe is particularly worse off than we are or Japan is so I’m not expecting some major collapse of the Euro.  What the hyenas are taking advantage of actually, is Europe’s much stricter fiscal discipline, which forces them to take action, rather than put their foot on the accelerator and drive off a cliff like our country is doing.   Don’t forget the root of the Greek "crisis" is the fact that GS encouraged Greece to go over the EU limits on debt and hide it by cooking the books.  When the old government was thrown out a few months ago, the new government came in and said "Holy crap, this is way worse than we thought it was!"  THEY went to the EU and said, "Dudes, we are in deep doo-doo over here, what do you suggest?" 

    So the EU has rules to make sure their countries (unlike our states) don’t run unsustainable deficits and everything that as happened since is the result of a control mechanism going into effect that, if anything, indicates STABILITY in the EU.  Yes, they can bail them out, Greece is 2% of the EU GDP but the whole country isn’t going to zero is it?  The EU has a $14Tn GDP and Greece needs $42Bn to wipe out this year’s deficit.  That’s 0.3% of EU GDP, not 2%.  I think, in a panic, you may get the Euro down to $1.20 but I doubt it would go lower.  Also, they are mandated to fight inflation first and foremost so if the US continues to print money (it’s either that or default and either would boost the Euro) then the EU will tighten, which will raise the Euro.  If this happens on a US default, it would suck for Europe as their exports will suffer but, if it happens against US hyper-inflation, then they will be fine as we’ll still be able to buy their stuff as everyone in this country becomes a Billionaire, possibly a Trillionaire as everything rises and we wipe out our debt to GDP ratio.

    If you do want to go with a short FXE position, I’d go with something conservative like the 2011 $120 puts for $2, which pay 5x if you are right but, meanwhile, you can work your way into a free trade by selling just .20 per month so 1/4 the March $132 puts at .80 would do it and they have a .24 delta and you have a .18 delta x 4 = .72 so you out gain them 3:1 on the way down as you work your way to a free trade.  This is still aggressively short and doesn’t mitigate your downside risk and I do not believe it’s a winning play but – if you MUST short the Euro, I can live with giving you that one.  As to 2012, the $130s are the lowest strike (because NOBODY believes they will go lower) and they are $7.50 so I would MUCH rather go year by year than pay that kind of premium. 

    It’s a twister/Kustomz – I think you are right but, as I just said to Gel, I don’t think we are much worse off or better off than anyone else in this messed up planet so all we can do is stock up the storm celler and ride it out.


  21. Phil/FXE
    Terrific analysis… I have since thought of one other set of facts that might have relevance in making a decision to match the dollar against the euro, and that is the euro has historically been the bastard child that was in the minds of many doomed to die. At one point most currency players thought there was little chance for the concept of the euro to prevail. It is like a cat with nine lives with a few more left to go. I think I will, in the interest of avoiding unessary risk, pass on a short position, as the dollar is facing a few headwinds as well. Maybe that video helped me form a decision, as many years ago, I was caught in a tornado in the midwest, and had a barn cross the road in front of me. (no kidding). Thanks, Kustomz – you are my comrade!


  22. Phil,
      That was a great article on mortgages last week! However, I didn’t see the argument take into consideration that mortgage interest is a large tax deduction which would be lost by renting. In a sense, you can give that money to the IRS or have it lower the actually ownership costs. I do agree with 15yr mortgage. Also, in markets where real estate doesn’t really appreciate all that much, it makes more sense to rent. Would like to hear your thoughts on the tax piece. Thanks.


  23. Phil,
      What are your thoughts on oil trusts such as BPT? I was in them a couple of years ago but sold b/c I wasn’t sure there was enough oil in the ground to continue to sustain the dividends they were paying out (clearly I was wrong). Thanks


  24. Tax/Japar – I think I made a passing reference to it above.  It’s a little too complex of an issue to get into but I always find the logic faulty anyway – If you are going to pay $230,000 of interest over 30 years then deducting that interest (assuming a 35% bracket and you are able to fully deduct each year) will ?save? you $80,500.  If you don’t pay $100,000 of that interest by pre-paying your morgage or getting a lower interest mortgeg you still ?save? $45,500 on the $130,000 you do pay so it’s a net ?cost? to you of $35,000 in "lost deductions" to save $100,000. 

    I mean, I guess you can go out and ask the bank for a 12% loan – then you can REALLY save big on your taxes, right? 

    And, of course, the key isn’t really just $35,000 one way or the other but stopping your entire $2,000 monthly paymnet 5-15 years early for $120-250,000 less payments and then you need to consider the ability to generate an income off the other end so, even if you profess to LOVE your mortgaqge deduction so much that you’d rather pay more interest, it’s still, more than a wash-out compared to just the first 2 years that you stop paying your mortgage and, presumably, that would come at a time when you have less to deduct. 

    Also, I probably should have mentioned, much like options, you can ROLL the benefits of paying a home off early into your next home so it’s not like you need to only do this if you plan on being in a home for 20 years.  I don’t know the exact deal but pretty much if it’s your primary residence and you have a "profit," you don’t pay taxes on those gains unless you don’t buy a new home within a certain amount of time with that money. 

    BPT/Japar – They generally work until they don’t.  I try to stay away from the big money ones as they are harder to protect in the event the dividend is cut or tax laws change but, on the other hand, you do get a 16.5% dividend so you could buy them at $87.41, sell the Sept $85s for $4.50 and buy the Sept $85 puts for $7 and that puts you in for net $89.91, which costs you $4.50 of your expected $8.70 in dividends (7 months) and leaves you a still-healthy 8% return and a guarantee of getting $85 back.  As you can see though, that’s less appealing than the plays we set up on the "cheaper" trusts because they all have the same crappy options premiums to sell but .50 goes a lot furher on a $20 stock than it does on a $87 stock – which is why I stick to the small ones.  Also, from a scaling perspective, when round 1 is no less than $8,991 plus margin – there aren’t really as many people who find it useful for their portfolios. 


  25.  Phil,
    Not sure if someone pointed this out already but you made a mistake talking about the biweekly and bimonthly payments. You claim that  "By simply making 2 monthly payments of $599.55, rather than a single payment of $1,199.10 on a $200,000 loan over 30 years, we manage to pay off our mortgage over 5 years early"
    There is a problem here. Making 2 monthly payments is 24 payments per year. HOWEVER, making bi-weekly payments yields 26 payments per year. That is like paying 13 months payments per year instead of 12. So, it does make sense that we save a bit of money by avoiding interest payments on a larger balance but 2-3 years worth of extra payments are simply accrued over that 30 year period. The point being that you may not actually avoid 100,000 in interest payments.