The Decision Strategist

Disclosure: I hold a small position in an ING bond fund (IDBOX). I’m also not a professional investor. Please don’t take my word for anything you do with your money.

I started looking at investment about six months ago when I realized I would soon achieve my goal of eliminating credit card debt. It is a bewildering world, and back in August I wrote a 2 part series about investing in a recessionary economy (and part II). This post is in a similar theme. Here’s a few basic rules I follow when deciding how to invest:

1. Don’t Buy After a Rally

First off, I never buy an asset (stocks, mutual funds, real estate) when the price has increased. There is no hard and fast rule on how much it has to have increased for me to avoid it, but basically if it’s being hyped by the media or talked about by people, I stay away.

You might miss some really strong growths in specific stocks by not buying in a rally, but it’s also possible that you’ll buy in near the top and only see the value decline substantially. It’s too much of a game for me. I haven’t bought in to tech stocks like Google and Apple for the same reason.

2. Don’t Sell After a Slump

In the same vein, don’t sell when the price drops. A lot of people see a stock’s value going down and sell hoping to avoid losses, but in effect they are locking in price decline that has already happened. Here again it seems like it’s just as likely that you will sell when the value reaches the bottom and so won’t benefit from following gains.

The Current Economic Climate

These rules can be hard to follow though. As fears of inflation (the fed cuts rates again, though read Global Economic Trends for an argument of why inflation is not related to federal interest rates as much as production capacity) mount and the dollar loses it’s value, a lot of people are shifting to gold and silver or foreign markets with their investments. But where do those of us stuck in dollar based investments turn?

I could shift out of dollars into gold or other commodities, but doing so would violate rule #1 given the meteoric rise in the price of gold

In fact, any shift out of US dollars now that dollars have declined heavily would be violating rule #2. Yet I have real fears that the economy is going to be in a substantially worse position in the coming year or more and I suspect that the value of the dollar is only going to decline further.

And if inflation is really occurring at much higher rates than reported, then the situation is worse because inflation is just eating whatever returns my investments are earning and then some.

So the real question is whether it’s better to stay in stocks, risking financial loss when the inevitable burst happens, stay in bonds with low earnings being eaten by inflation, or violate rules #1 and #2 by selling off dollars and buying something relatively more expensive in the hopes that a foreign asset or commodity won’t decline?

About a month ago I shifted my meager investments from a tech mutual fund (IDTOX) to a bond fund (IDBOX). This protects from a coming stock decline, but not from a further decline in the dollar. It’s sort of a middle position in which I’ll lose some value either way:

If stocks decline, the economy worsens and the value of the dollar further declines, I’ll lose value due to inflation

If the value of the dollar recovers, then I won’t be left with commodities I purchased at their peak.

Still, fear is a powerful emotion. If ING Direct Investment had a commodities fund, I’d be hard pressed not to violate my rules and shift into commodities to whether out the storm.

Of course, the value of my investments at the moment are only roughly $500, so it wouldn’t be a disaster in any situation.

I’d be interested in hearing from any readers who have investments or are facing similar decisions. You can flip the situation around to consider debt as well. If the fed is spurring inflation in an effort to stave off financial crisis, it makes no sense to pay more than the minimum on student loans that were consolidated at 3.5% interest (if you were lucky and graduated in 2002).

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Technology is really about information, and our ability to interact and store information has been making some major changes for the past several decades.

Those of us who are researchers have been blessed in the past several years with an explosion of available information for examining nearly every topic we want to look at.

But at the same time, there has been a shift away from objective analysis toward studies completed by organizations with a vested interest in the outcome.

This has resulted, as noted at Overcoming Bias, in a crisis of faith in the use of statistics. No one believes any numbers that are released because they figure that the people who did the analysis have a hidden agenda. This is the most demoralizing aspect of being an analyst.

The problem is essentially that the analysis process is still closed. We don’t trust the numbers because we don’t know the process that went into obtaining them. Until the process of analysis is opened to a public that can understand and take part in a dialog about the methods, we can continue to write analytical work off as a waste of money and resources because someone else will always have a study saying the opposite.

We need the democratization of data analysis.

And I have high hopes for the future. One of my ideas has been to create an online data warehouse and analysis website, and a few groups such as Swivel and Many Eyes are doing just that.

The services are still fledgling, but in a fairly short time I think we’ll see the ability to perform analysis via the web, and to upload and share data. Hopefully this will result in the standardization of data sets and eliminate the monkey work of downloading a text file and formating it in excel.

I cry when I think how many people have done the very same thing with the very same data.

For a time there will be a lot of confusion, attacks, and some really bad work, but ultimately a community of devoted analysts performing essentially open and peer reviewed work will develop. Because it’s been through trial by fire from all sides of the issue, it will be the most objective approach to messy data analysis that we have ever obtained.

The new analytical hotshots will be the people who have weight with communities at Swivel and Many Eyes and others and are known for doing quality work. These people will engage in very public analysis and will be extremely valuable to everyone wanting analysis that can be seen as objective.

Hopefully that means that shoddy and lazy work will slip to the sides and we can regain confidence in numbers that we see.

I guess it could go the other way. That people don’t want objective analysis and we’ll shun those whose results we can’t know ahead of time. We’ll see even more extreme partisanship.

But that way lies certain death.

-zot, pretending to be a futurist.

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Disclaimer: I am not a financial professional and this should not be taken as financial advice. I don’t own a house either. I am only discussing what I would do in a situation in which housing prices are dropping, supply is at an all time high, and I was facing a mortgage rate reset.

A while ago I talked recently about the financial and emotional aspects of buying a house, but in today’s market, it’s probably better to consider the decision to sell your house. Specifically, the decision to sell your house if you are having financial problems.

The situation that a lot of people are facing right now is one in which they face reseting mortgage rates that will increase their monthly mortgage payment above what they are capable of paying. The chart below is from an IMF report (pdf link) on world credit that I found through Dr Housing Bubble.

Not all of that is going to default, but if these numbers are any indication, a whole lot of people will be wondering what to do when they get their new higher mortgage bill.

It’s a tough situation. If housing prices were still rising, you could sell your house, pay off your mortgage, and be free and clear.

But housing prices are not rising, they are falling; in some cases drastically. There are really only two options:

Option 1: Sell you house

If someone is in danger of defaulting, they can sell their house. In today’s market they probably can’t sell it quickly or for as much as they paid for it. Since the purchase is recent, they probably have very little equity built up. Selling at a lower price means they are still going to owe the bank the difference between what they paid on the house and what they were able to sell for. That doesn’t include all the commissions and cuts that have to be paid, so it will actually be slightly more than that.

In other words, they are in the same position as they would be if they had rented, only they’ve been making higher monthly payments and still owe a sizable chunk due to the difference in prices. On the other hand, their credit isn’t absolutely terrible, since they avoided foreclosure.

Option 2: Cut and run

Instead, this hypothetical person could just stop making payments and let the bank foreclose on the house. Credit score would go down the toilet for several years, but they’d walk away debt free.

In fact, the result of this option isn’t that different from the first option: they are just exchanging the leftover debt from the difference between the buy and sell prices for a terrible credit score.

So then the question is how much debt is it worth incurring to avoid a bad credit score?

Maybe one of the personal finance bloggers could answer this question. I’m inclined to say that no amount of debt is worth it, and so the second option is an obvious better choice.

Sunk costs at play

Though there is some suggestion of people walking away from their houses (maybe from patrick.net?) , sunk costs are coming into play here in a big way. People will consider all the money they’ve already put into the house, and won’t want to lose that. In fact, the sunk cost effect is much stronger in this situation because of the emotions involved in the idea of owning your own house. The effect will be strong enough to keep most people from giving up on their house until they are forced to.

But if you’re facing certain foreclosure, whether now or a couple of years, and you won’t be able to sell your house for more than you bought it, it makes more sense to me to stop paying now (why sink more money into a lost cause?) and walk away.

qualifier: I don’t really know how the foreclosure process works. Are you still liable for whatever value the mortgage has that the bank can’t recover? If so then it doesn’t seem like it matters much what you do.

-zot

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After a year and a half of hard work to pay off my credit cards I am finally making the last payment this morning. My only remaining debt is school loans at 3.5% interest and a car loan at 4.5%. Getting out of debt has been one of my primary goals, and I’m really excited to have achieved it.

So how did I eliminate my credit card debt?

To be honest the single biggest factor in paying off my credit cards was making a significant (to me) amount of money. Slightly less than two years ago I was just out of a masters program and was making a paltry salary as a part time adjunct faculty to a state college in Massachusetts. But in January of 2006 I moved to New Mexico for a great job doing economic analysis and began making significantly more.

I can’t directly take credit for that, but I can take credit for not allowing my lifestyle to expand to meet my income. I’ve done a number of things to fight the desire to buy things that have cut my expenses pretty drastically:

• Living with roommates. Though I didn’t really know anyone in Albuquerque, I always moved into places with roommates. This was less enjoyable than living alone until my girlfriend and I got a place together, which is the best of both worlds.
• Resisting big ticket items. I’ve succumbed to an Ipod shuffle and a first gen Ipod nano, but have resisted buying an Xbox 360, a Playstation 3, a big flat screen TV and a speaker system (I really wish I was playing Halo 3 though). I haven’t upgraded my Toyota Corolla to a more expensive car with a bigger monthly payment.
• Cutting back on small luxuries. I’ve been less successful at this. My chai consumption is still out of this world, and I typically spend more money per month eating out than I do buying groceries. I’ve made improvements, but I could do even better.
• Tracking my expenses. Tracking your money does have any direct money-saving effects, but it put me in a much better position to know how much I was spending on different things. What I saw initially appalled me and provided me with much of my motivation to reduce expenses. Aside from living with roommates, this has been the most important factor.
• Discussing finances. I’ve gotten some good ideas and motivation from personal finance blogs like The Simple Dollar, Digerati Life and Get Rich Slowly, but I’ve also talked a lot more about money and finance with family and friends, sharing ideas and providing further motivation to reduce spending.

The Story of Frugality

I’ve talked a lot in the past month about metaphors and how the stories we tell about ourselves affect many of our decisions. A big part of my journey to being credit card debt free has been re-aligning my view of myself to be more frugal and fiscally conservative. This is probably a natural progression as I get older, but I’m much happier with a story about myself as a frugal simple living advocate than I was with the self-story of a consumption-driven post-college kid.

-zot

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