Archive-name: investment-faq/general/part2ãVersion: $Id: faq-p2,v 1.4 1993/03/27 09:28:33 lott Exp lott $ãCompiler: Christopher Lott, lott@informatik.uni-kl.deããThis is the general FAQ for misc.invest, part 2 of 3.ãã-----------------------------------------------------------------------------ããSubject: Life InsuranceãFrom: joec@is.morgan.comããThis is my standard reply to life insurance queries.  And, I think manyãinsurance agents will disagree with these comments.ããFirst of all, decide WHY you want insurance.  Think of insurance asãincome-protection, i.e. if the insured passes away, the beneficiaryãreceives the proceeds to offset that lost income.  With that commentãbehind us, I would never buy insurance on kids, after all, they don'tãhave income and they don't work.  An agent might say to buy it on yourãkids while its cheap - run the numbers, the agent is usually wrong. ãAnd I am strongly against this on two counts.  One, you are placing aãbet that you kid will die and you are actually paying that bet inãpremiums.  I can't bet my child will die.  Two, it sounds plausible,ãbut factor inflation in - it doesn't look so good.  A policy of faceãamount of $10,000, at 4.5% inflation and 30 years later is like havingã$2,670 in today's dollars - it's NOT a lot of money.  So don't plan onãit being worth much in the future to your child as an investment.ããI have some doubts about insurance as investments - it might be a goodãidea but it certainly muddies the water.ããSo you have decided you want insurance, i.e. to protect your family againstãyour passing away prematurely, i.e. the loss of income you represent.ããNext decide how LONG you want insurance for.  If you're around 60 yearsãold, I doubt you want to get any at all.  Your income stream is largelyãover and hopefully you have accumulated the assets you need anyway by now.ããIf you are married and both work, its not clear you need insurance atãall if you pass on.  The spouse just keeps working UNLESS you need bothãincomes to support your lifestyle.  Then you should have one policy onãeach of you.ããIf you are single, its not clear you need it at all.  You are not sup-ãporting anyone so no one cares if you pass on, at least financially.ããIf you are married and the spouse is not working, then the breadwinnerãneeds insurance UNLESS you are independently wealthy.ããIf you are independently wealthy, you don't need it because you alreadyãhave the money you need.  You might want it for tax shelters but that isãa very different topic.ããSuppose you have a 1 year old child, the wife stays home and the husbandãworks.  In that case, you might want 2 types of insurance: Whole lifeãfor the long haul, i.e. age 65, 70, etc., and Term until your child isãoff on his/her own. Once the child has left the stable, your need forãinsurance goes down since your responsibilities have diminished, i.e.ãfewer dependents, education finished, wedding expenses done, etcããDo you have a mortgage? Perhaps you want some sort of Term during theãduration of the mortgage - but remember that the mortgage balanceãdeclines over time. But don't buy mortgage insurance itself - much tooãexpensive. Include it in the overall analysis of what insurance needsãyou might have.ããNow, how much insurance?  One rule of thumb is 5x your annual income. ãWhat agents will ask you is 'Will your spouse go back to work if youãpass away?' Many of us will think nobly and say NO.  But its actuallyãlikely that your spouse will go back to work and good thing - otherwiseãyour insurance needs would be much larger.  After all, if the spouseãstays home, your insurance must be large enough to be invested wisely toãthrow off enough return to live on.  Assume you make $50,000 and theãspouse doesn't work.  You pass on.  The Spouse needs to replace aãportion of your income (not all of it since you won't be around to feed,ãwear clothes, drive an insured car, etc.).  Lets assume the Spouse needsã$40,000 to live on.  Now that is BEFORE taxes.  Lets say its $30,000 netãto live on.  $30,000 is the annual interest generated on a $600,000ãtax-free investment at 5% per year (i.e. munibonds).  So this means youãneed $600,000 of face value insurance to protect your $50,000 currentãincome.ããThis is only one example of how to do it and income taxes, estate taxesãcan complicate it.  But hopefully you get the idea.ããWhich kind of insurance IMHO is a function of how long you need it for.ãI once did an analysis of TERM vs WHOLE LIFE and based on the assumptionsãat the time, WHOLE LIFE made more sense if I held the insurance more thanãabout 20-23 years.  But TERM was cheaper if I held it for a shorter periodãof time.  How do you do the analysis and why does the agent want to meetãyou?  Well, he/she will bring their fancy charts, tables of numbers andãeffectively snow you into thinking that the biggest, most expensiveãpolicy is the best for you over the long term.  Translation: muchoãcommissions to the agent.  Whole life is what agents make their money onãdue to commissions.  The agents typically gets 1/2 of your first year'sãcommissions as his pay.  And he typically gets 10% of the next year'sãcommissions and likewise through year 5.  Ask him how he gets paid.  Ifãhe won't tell you, ask him to leave.ããWhat I did was to take their numbers, review their assumptions (andãcorrected them when they were far-fetched) and did MY analysis.  Theyãhated that but they agreed my approach was correct.  They will show youãa 12% rate of return to predict the cash value flow.  Ignore that - itãmakes them look too good and its not realistic.  Ask him/her exactly whatãthey plan to invest your premium money in to get 12%.  How has it done inãthe last 5 years? 12? Use a number between 4.5% (for TBILL investments,ãultra- conservative) and 10% (for growth stocks, more risky), but notãdefinitely not 12%.  I would try 8% and insist it be done that way.ããAsk each agent:ã1)-what is the present value of the payment stream represented by myãpremiums, using a discount rate of 4.5% per year (That is the inflationãaverage since 1940).  This is what the policy costs you, in today'sãdollars. Its very much like paying that single number now instead of aãseries of payments over time. ã2)-what is the present value of the the cash value earned (increasingãat no more than 8% a year) and discounting it back to today at the sameã4.5%. This is what you get for that money you just paid, in cash value,ãexpressed in today's dollars, i.e. as if you got it today in the mail. ã3)-What is the present value of the life insurance in force over thatãsame period, discounted back to today by 4.5%, for inflation.  That isãthe coverage in effect in today's dollars. ã4)-Pick an end date for comparing these - I use age 60 and age 65.ããWith the above in hand from various agents, you can see fairly quicklyãwhich is the better policy, i.e. which gives you the most for your money.ããBy the way, inflation is slippery and sneaky.  All too often we seeã$500,000 of insurance and it sounds great, but at 4.5% inflation and 30ãyears from now, that $500,000 then is like $133,500 now - truly!ããHave the agent do your analysis, BUT you give him the rates to use, don'tãuse his.  Then you pick the policy that is the best value, i.e., you getãmore for your money.  Factor in any tax angles as well.  If the agentãrefuses to do this analysis for you, get rid of him/her.ããIf the agent gets annoyed but cannot fault your analysis, then you haveãcleared the snow away and gotten to the truth.  If they smile too much,ãyou may have missed something.  And that will cost you money.ããNever agree to any policy unless you understand all the numbers and allãthe terms.  Never 'upgrade' policies by cashing in a whole life forãanother whole life.  That just depletes your cash value, real cashãavailable to you.  And the agent gets to pocket that money, literally,ãthrough new commissions.ããCheck out the insurer by going to the reference section of a big library. ãAsk for the AM BEST guide on insurance.  Look up where the issuer standsãrelative to the competition.ããAgents will usually not mention TERM since they work on commission andãget much more money for Whole Life than they do for term.  Remember,ãfigure the agents gets fully 1/2 of your 1st years premium payments andã10% or so for all the money you send in over the following 4 years.  Askãthem to tell you how they are paid- after all, its your money they areãgetting.ããNow why don't I like UNIVERSAL or VARIABLE?  Mainly because with WholeãLife and with TERM, you know exactly what you must pay because the issuerãmust manage the investments to generate the appropriate returns toãprovide you with the insurance (and with cash value if whole life).ãWith UNIVERSAL and VARIABLE, it becomes YOU who must decide how and whereãto invest your premium income.  If you guess badly, you will have to payãa higher premium to cover those bad decisions.  The insurance companiesãinvented UNIVERSAL and VARIABLE because interest rates went crazy in theãearly 80's and they lost money.  Rather than taking that risk again, theyãoffered these new policies to transfer that risk to you.  Of course,ãUNIVERSAL and VARIABLE will be cheaper in the short term but BE CAREFUL -ãthey can and often will increase later on.ããOkay, so what did I do? I bought both term and whole life.  I plan toãkeep the term until my son graduates from college and he is on his own. ãThat is about 11 years from now.  I also bought whole life (NorthWestãMutual) which I plan to keep forever, so to speak.  NWM is apparentlyãthe cheapest and best around according to A.M.BEST.ããWhere do you buy term? Just buy the cheapest policy since you will tendãto renew the policy once a year and you can change insurers as each time.ããAlso:   A hard thing to factor in is that one day you may becomeãuninsurable just when you need it, i.e. heart attack, cancer and the like. ãI would look at getting cheap term insurance that is a bit more but thenãyou can keep renewing, even if ill, or you can convert to whole life.ããLast thought.  I'll bet you didn't you know that you are 3x more likelyãto become disabled during your working career than you to die during yourãworking career.  How is your short term disability insurance looking?ãGet a policy that has a waiting period before it kicks in.  This willãkeep it cheaper.  Look at the exclusions, if any.ãã-----------------------------------------------------------------------------ããSubject: Money-Supply Measures M1, M2, and M3ãFrom: merritt@macro.bu.eduããM1: Money that can be spent immediately.  Includes cash, checking accounts,ã    and NOW accounts.ããM2: M1 + assets invested for the short term.  These assets include money-ã    market accounts and money-market mutual funds.ããM3: M2 + big deposits.  Big deposits include institutional money-marketã    funds and agreements among banks.ãã"Modern Money Mechanics," which explains M1, M2, and M3 in gory detail,ãis available free from:ã        Public Information Centerã        Federal Reserve Bank of Chicagoã        P.O. Box 834ã        Chicago, Illinois 60690ãã-----------------------------------------------------------------------------ããSubject: One-Line WisdomãFrom: suhre@trwrb.dsd.trw.comããThis is a collection of one-line pieces of investment wisdom, with briefãexplanations.  Use and apply at your own risk or discretion.  They areãnot in any particular order.  ãã1.  Hang up on cold calls.  ãã    While it is theoretically possible that someone is going to offerã    you the opportunity of a lifetime, it is more likely that it is someã    sort of scam.  Even if it is legitimate, the caller cannot know your ã    financial position, goals, risk tolerance, or any other parameters ã    which should be considered when selecting investments.  If you can'tã    bear the thought of hanging up, ask for material to be sent by mail.ãã2.  Don't invest in anything you don't understand.ãã    There were horror stories of people who had lost fortunes by beingã    short puts during the 87 crash.  I imagine that they had no idea ofã    the risks they were taking.  Also, all the complaints about pennyã    stocks, whether fraudulent or not, are partially a result of notã    understanding the risks and mechanisms.ãã3.  If it sounds too good to be true, it probably isn't.ã3a. There's no such thing as a free lunch (TNSTAAFL).ãã    Remember, every investment opportunity competes with every otherã    investment opportunity.  If one seems wildly better than the others,ã    there are probably hidden risks or you don't understand something.ãã4.  If your only tool is a hammer, every problem looks like a nail.ãã    Someone (possibly a financial planner) with a very limited selection ã    of products will naturally try to jam you into those which s/he sells.ã    These may be less suitable than other products not carried.ãã5.  Don't rush into an investment.ãã    If someone tells you that the opportunity is closing, filling up fast,ã    or in any other way suggests a time pressure, be *very* leery.ãã6.  Very low priced stocks require special treatment.ãã    Risks are substantial, bid/asked spreads are large, prices areã    volatile, and commissions are relatively high.  You need a broker ã    who knows how to purchase these stocks and dicker for a good price.ãã-----------------------------------------------------------------------------ããSubject: Options on StocksãFrom: ask@cbnews.cb.att.comããAn option is a contract between a buyer and a seller.  The optionãis connected to something, such as a listed stock, an exchange index,ãfutures contracts, or real estate.  For simplicity, I will discussãonly options connected to listed stocks.ããThe option is designated by:ã - Name of the associated stockã - Strike priceã - Expiration dateã - The premium paid for the option, plus brokers commission.ããThe two most popular types of options are Calls and Puts.ãã    Example:  The Wall Street Journal might list an ã                IBM Oct 90 Call @ $2.00ãã    Translation:  This is a Call Optionãã The company associated with it is IBM.ã (See also the price of IBM stock on the NYSE.)ãã The strike price is $90.00  If you own this option,ã you can buy IBM @ $90.00, even if it is then trading onã the NYSE @ $100.00 (I should be so lucky!)ãã The option expires on the third Saturday followingã the third Friday of October, 1992.ã (an option is worthless and useless once it expires)ãã If you want to buy the option, it will cost you $2.00ã plus brokers commissions.   If you want to sell the option,ã you will get $2.00 less commissions.ããIn general, options are written on blocks of 100s of shares.  So whenãyou buy "1" IBM Oct 90 Call @ $2.00 you actually are buying a contractãto buy 100 shares of IBM @ $90 per share ($9,000) on or before theãexpiration date in October.   You will pay $200 plus commission to buyãthe call.ããIf you wish to exercise your option you call your broker and say youãwant to exercise your option.  Your broker will arrange for the personãwho sold you your option (a financial fiction:  A computer matches upãbuyers with sellers in a magical way) to sell you 100 shares of IBM forã$9,000 plus commission.ããIf you instead wish to sell (sell=write) that option you instruct yourãbroker that you wish to write 1 Call IBM Oct 90s, and the very next dayãyour account will be credited with $200 less commission.ããIf IBM does not reach $90 before the call expires, the option writerãgets to keep that $200 (less commission)   If the stock does reach aboveã$90, you will probably be "called."ããIf you are called you must deliver the stock.  Your broker will sellãyour IBM stock for $9000 (and charge commission).  If you owned theãstock, that's OK. If you did not own the stock your broker will buyãthe stock at market price and immediately sell it at $9000.  You payãcommissions each way.ããIf you write a Call option and own the stock that's called "CoveredãCall Writing."  If you don't own the stock it's called "Naked CallãWriting."   It is quite risky to write naked calls, since the price ofãthe stock could zoom up and you would have to buy it at the market price.ããMy personal advice for new options people if to begin by writingãcovered call options for stocks currently trading below the strikeãprice of the option (write out-of-the-money covered calls).ããWhen the strike price of a call is above the current market price ofãthe associated stock, the call is "out of the money," and when theãstrike price of a call is below the current market price of theãassociated stock, the call is "in the money."ããMost regular folks like you and me do not exercise our options; weãtrade them back, covering our original trade.  Saves commissions andãall that.ããThe other common option is the PUT.  If you buy a put from me, youãgain the right to sell me your stock at the strike price on or beforeãthe expiration date.  Puts are almost the mirror-image of calls. ãã-----------------------------------------------------------------------------ããSubject: P/E RatioãFrom: egreen@east.sun.com, schindler@csa2.lbl.govããP/E is shorthand for Price/Earnings Ratio.  The price/earnings ratio isãa tool for determining the value the market has placed on a common stock. ãA lot can be said about this little number, but in short, companiesãexpected to grow and have higher earnings in the future should have aãhigher P/E than companies in decline.  For example, if Amgen has a lotãof products in the pipeline, I wouldn't mind paying a large multiple ofãits current earnings to buy the stock.  It will have a large P/E.  I amãexpecting it to grow quickly. ããP/E is determined by dividing the current market price of one shareãof a company's stock by that company's per-share earnings (after-taxãprofit divided by number of outstanding shares).  For example, a companyãthat earned $5M last year, with a million shares outstanding, hadãearnings per share of $5.  If that company's stock currently sells forã$50/share, it has a P/E of 10.  Investors are willing to pay $10 forãevery $1 of last year's earnings.ããP/Es are traditionally computed with trailing earnings (earnings fromãthe year past, called a trailing P/E) but are sometimes computed withãleading earnings (earnings projected for the year to come, called aãleading P/E).  Like other indicators, it is best viewed over time, ãlooking for a trend.  A company with a steadily increasing P/E is beingãviewed by the investment community as becoming more and more speculative.ããPE is a much better comparison of the value of a stock than the price. ãA $10 stock with a PE of 40 is much more "expensive" than a $100 stockãwith a PE of 6.  You are paying more for the $10 stock's future earningsãstream.  The $10 stock is probably a small company with an exciting productãwith few competitors.  The $100 stock is probably pretty staid - maybe aãbuggy whip manufacturer.ãã-----------------------------------------------------------------------------ããSubject: Renting vs. Buying a HomeãFrom: mincy@think.com, lott@informatik.uni-kl.deããThis note will explain one way to compare the monetary costs of rentingãvs. buying a home.  It is extremely predjudiced towards the US system.ããSUMMARY: ã - If you are guaranteed an appreciation rate that is a few points aboveã   inflation, buy.ã - If the monthly costs of buying are basically the same as renting, buy.ã - The shorter the term, the more advantageous it is to rent.ã - Tax consequences in the US are insignificant.ãããThe three important factors that affect the analysis the most:ã    1) Relative cash flows; e.g., rent compared to monthly ownership expensesã    2) Length of termã    3) Rate of appreciationããThe approach used here is to determine the present value of the moneyãyou will pay over the term for the home. In the case of buying, theãappreciation rate and thereby the future value of the home is estimated. ãThis analysis neglects utility costs because they can easily be theãsame whether you rent or buy.  However, adding them to the analysisãis simple; treat them the same as the costs for insurance in both cases.ããComputation of present value is reasonably straightforward and is explainedãelsewhere. Programs to compute present and future value as well as for loanãamortization (pv, fv, loan) are also available from Lott.ããOpportunity costs of buying are effectively captured by the present value.ãFor example, pretend that you are able to buy a house without having toãhave a mortgage.  Now the question is, is it better to buy the house withãyour hoard of cash or is it better to invest the cash and continue to rent. ãTo answer this question you have to have estimates for rental costs andãhouse costs (see below), and you have a projected growth rate for the cashãinvestment and projected growth rate for the house.  If you project a 4%ãgrowth rate for the house and a 15% growth rate for the cash then holdingãthe cash would be a much better investment.ãããRenting a Home.ãã* Step 1: Gather data. You will need:ã    - monthly rentã    - renter's insurance  (usually inexpensive)ã    - term    (period of time over which you will rent)ã    - estimated inflation rate to compute present value (historically 4.5%)ã    - estimated annual rate of increase in the rent (can use inflation rate)ãã* Step 2: Compute the present value of the cash stream that you will pay overãthe term, which is the cost of renting over that term.  This analysis assumesãthat there are no tax consequences (benefits) associated with paying rent.  ã(The 'pv' program can help here.)  ããLong-term example:ã    Rent    =  990 / month ã    Insurance   =  10 / monthã    Term  =  30 yearsã    Rent increases =  4.5% annuallyã    Inflation   =  4.5% annuallyã    For this cash stream, present value = 348,137.17.ããShort-term example:ã    Same numbers, but just 2 years.  Present value = 23,502.38ãããBuying a Home.ãã* Step 1: Gather data. You need a lot to do a fairly thorough analysis:  ã    - purchase priceã    - down payment & closing costsã    - other regular expenses, such as condo feesã    - amount of mortgageã    - mortgage rateã    - mortgage termã    - mortgage payments (this is tricky for a variable-rate mortgage)ã    - property taxesã    - homeowner's insuranceã    - your tax bracketã    - the current standard deduction you getã  Other values have to be estimated, and they affect the analysis critically:ã    - continuing maintenance costs (I estimate 1/2 of PP over 30 years.)ã    - estimated inflation rate to compute present value (historically 4.5%)ã    - rate of increase of property taxes, maintenance costs, etc. (infl. rate)ã    - appreciation rate of the home (THE most important number of all)ãã* Step 2: compute the monthly expense.  This includes the mortgage payment,ãfees, property tax, insurance, and maintenance.  The mortgage payment isãfixed, but you have to figure inflation into the rest.  Then compute theãpresent value of the cash stream.  (The 'pv' program can help.)ãã* Step 3: compute your tax savings.  This is different in every case, but ãroughly you multiply your tax bracket times the amount by which your interestãplus other deductible expenses (e.g., property tax, state income tax) exceedsãyour standard deduction.  No fair using the whole amount because everyoneãgets the standard deduction for free.  Must be summed over the term becauseãthe standard deduction will increase annually, as will your expenses.  Noteãthat late in the mortgage your interest payments will be be well below theãstandard deduction.  I compute savings of about 5%.  (The 'loan' programãcan help.)ãã* Step 4: compute the future value of the home based on the purchaseãprice, estimated appreciation rate, and the term.  Once you have theãfuture value, compute the present value of that sum based on theãinflation rate you estimated earlier and the term you used to computeãfuture value.   If appreciation > inflation, you win.  Else you lose.ã(The 'pv' and 'fv' programs can help.)  ãã* Step 5: Compute final cost.  All numbers must be in present value.ã    Final-cost = Down-payment + S2 (expenses) - S3 (tax sav) - S4 (prop value)ããLong-term example #1:ãã* Step 1 - the data:ã    Purchase price   =  145,000ã    Down payment etc =  10,000ã    Mortgage amount  =  140,000ã    Mortgage rate    =  8.00%ã    Mortgage term    =  30 yearsã    Mortgage payment =  1027.27 / moã    Property taxes   =  about 1% of valuation; I'll use 1200/yr = 100/moã   (which increases same as inflation, we'll say)ã    Homeowner's ins  =  50 / moã    Condo fees etc   =  0 ã    Tax bracket      =  33%ã    Standard ded     =  5600ã  Estimates:ã    Maintenance      =  1/2 PP is 72,500, or 201/mo; I'll use 200/moã    Inflation rate   =  4.5% annuallyã    Prop taxes incr  =  4.5% annuallyã    Home appreciates =  6% annually (the NUMBER ONE critical factor)ãã* Step 2 - the monthly expense, both fixed and changing components: ãFixed component is the mortgage at 1027.27 monthly.  Present value = 203,503.48ãChanging component is the rest at   350.00 monthly.  Present value = 121,848.01ãTotal from Step 2: 325,351.49ãã* Step 3 - the tax savings.ãI use my loan program to compute this.  Based on the data given above,ãI compute the savings: Present value = 14,686.22.  Not much at all.ãã* Step 4 - the future and present value of the home.ãSee data above.  Future value = 873,273.41 and present value = 226,959.96ã(which is larger than 145k since appreciation > inflation)ãBefore you compute present value, you should subtract reasonable closingãcosts for the sale; for example, a real estate brokerage fee.ãã* Step 5 - the final analysis for 6% appreciation.ãFinal = 10,000 + 325,351.49 - 14,686.22 - 226,959.96ã      = 93,705.31ããSo over the 30 years, assuming that you sell the house in the 30th year forãthe estimated future value, the present value of your total cost is 93k.ã(You're 93k in the hole after 30 years ~~ you only paid 260.23/month.)ããLong-term example #2:  all numbers the same BUT the home appreciates 7%/year.ãStep 4 now comes out FV=1,176,892.13 and PV=305,869.15ãFinal = 10,000 + 325,351.49 - 14,686.22 - 305,869.15ã      = 14796.12ãSo in this example, 7% was an approximate break-even point in the absoluteãsense; i.e., you lived for 30 years at near zero cost in today's dollars.ããLong-term example #3:  all numbers the same BUT the home appreciates 8%/year.ãStep 4 now comes out FV=1,585,680.80 and PV=412,111.55ãFinal = 10,000 + 325,351.49 - 14,686.22 - 412,111.55ã      = -91,446.28ãThe negative number means you lived in the home for 30 years and left it inãthe 30th year with a profit; i.e., you were paid to live there.ããLong-term example #4: all numbers the same BUT the home appreciates 2%/year.ãStep 4 now comes out FV=264,075.30 and PV=68,632.02ãFinal = 10,000 + 325,351.49 - 14,686.22 - 68,632.02ã      = 252,033.25ãIn this case of poor appreciation, home ownership cost 252k in today's money,ãor about 700/month.  If you could have rented for that, you'd be even.ããShort-term example #1:  all numbers the same as Long-term example #1, but youãsell the home after 2 years.  Future home value in 2 years is 163,438.17ãCost  = down&cc + all-pymts - tax-savgs - pv(fut-home-value - remaining debt)ã      = 10,000  + 31,849.52 - 4,156.81  - pv(163438.17 - 137,563.91)ã      = 10,000  + 31,849.52 - 4,156.81  - 23651.27ã      = 14,041.44ããShort-term example #2:  all numbers the same as Long-term example #4, but youãsell the home after 2 years.  Future home value in 2 years is 150,912.54ãCost  = down&cc + all-pymts - tax-savgs - pv(fut-home-value - remaining debt)ã      = 10,000  + 31,849.52 - 4,156.81  - pv(150912.54 - 137,563.91)ã      = 10,000  + 31,849.52 - 4,156.81  - 12,201.78ã      = 25490.93ãããSome closing comments:ããOnce again, the three important factors that affect the analysis the mostãare cash flows, term, and appreciation.  If the relative cash flows areãbasically the same, then the other two factors affect the analysis the most. ããThe longer you hold the house, the less appreciation you need to bet renting.ãThis relationship always holds, however, the scale changes.  For shorterãholding periods you also face a risk of market downturn.  If there is aãsubstantial risk of a market downturn you shouldn't buy a house unless youãare willing to hold the house for a long period.ããIf you have a nice cheap rent controlled appartment, then you should probablyãnot buy.ããThere are other variables that affect the analysis, for example, the inflationãrate.  If the inflation rate increases, the rental scenario tends to get muchãworse, while the ownership scenario tends to look better.  ããQuestion:  Is it true that you can usually rent for less than buying?ããAnswer 1:  It depends.  It isn't a binary state.  It is a fairly complex setãof relationships.ããIn large metropolitan areas, where real estate is generally much more expensiveãthen it is usually better to rent, unless you get a good appreciation rate orãif you are going to own for a long period of time.  It depends on what you canãrent and what you can buy.  In other areas, where real estate is relativelyãcheap, I would say it is probably better to own. ããOn the other hand, if you are currently at a market peak and the country isãabout to go into a recession it is better to rent and let property values andãrent fall.  If you are currently at the bottom of the market and the economyãis getting better then it is better to own.ããAnswer 2:  When you rent from somebody, you are paying that person to assumeãthe risk of homeownership.  Landlords are renting out property with the longãterm goal of making money.  They aren't renting out property because they wantãto do their renters any special favors.  This suggests to me that it isãgenerally better to own.ãã-----------------------------------------------------------------------------ããSubject: Retirement Plan - 401(k)ãFrom: nieters@whiteface.crd.ge.comããA 401(k) plan is an employee-funded, retirement savings plan.  Itãtakes its name from the section of the Internal Revenue Code ofã1986 which created these plans.  An employer will typically matchãa certain percent of the amount contributed to the plan by theãemployee, up to some maximum.ããExample: the employee can contribute up to 7% of gross pay to theã  fund, and the company matches this money at 50%.  Totalã  contribution to the plan is 10.5% of the employee's salary.ããPre-tax contributions: Employees have the option of making all or partãof their contributions from pre-tax (gross) income.  This has the addedãbenefit of reducing the amount of tax paid by the employee from eachãcheck now and deferring it until you take this pre-tax money out ofãthe plan.  Both the employer contribution (if any) and any growth ofãthe fund compound tax-free until age 59-1/2, when the employee isãeligible to receive distributions from the plan.  ããPre-tax note: Current law allows up to a maximum of 15% to be deductedãfrom your pay before federal income and (in most places) state or localãincome taxes are calculated.  There are IRS rules which regulateãwithdrawals of pre-tax contributions and which place limits on pre-taxãcontributions; these affect how much you can save.ããAfter-tax contributions: If you elect to save any of your contributionsãon an after-tax basis, the contribution comes out of your pay afterãtaxes are deducted.  While it doesn't help your current tax situation,ãthese funds may be easier to withdraw since they are not subject to theãstrict IRS rules which apply to pre-tax contributions.  Later, whenãyou receive a distribution from the 401(k), you pay no tax on theãportion of your distribution attributed to after-tax contributions.ããContribution limits: IRS rules won't allow contributions on pay overãa certain amount (limit was $228,860 in 1992, and is subject to change).ãThe IRS also limits how much total pre-tax pay you can contributeã(limit was $8,728 in pre-tax money in 1992, and is subject to change).ã"Highly compensated" employees (salary over $60,535 in 1992 - again,ãsubject to change) may not be allowed to save at the maximum rates. ãYour benefits department should notify you if you are affected.ãFinally, the IRS limits the total amount contributed to your 401(k)ãand pension plans each year to the lesser of some amount ($30,000 inã1992, and subject to change of course) or 25% of your annual compensation. ãThis is generally taken to mean the amount of taxable income reportedãon your W-2 form(s).ããAdvantages: Since the employee is allowed to contribute to his/herã401(k) with pre-tax money, it reduces the amount of tax paid out ofãeach pay check.  All employer contributions and fund gains (or losses)ãgrow tax-free until age 59-1/2.  The employee can decide where toãdirect future contributions and/or current savings.  If your companyãmatches your contributions, it's like getting extra money on top ofãyour salary.  The compounding effect of consistent periodic contributionsãover the period of 20 or 30 years is quite dramatic.  Because theãprogram is a personal investment program for you, the benefits mayãnot be used as security for loans outside the program.  This includesãthe additional protection of the funds from garnishment or attachmentãby creditors or assigned to anyone else except in the case of domesticãrelations court cases dealing with divorce decree or child supportãorders.  While the 401(k) is similar in nature to an IRA, an IRA won'tãenjoy any matching company contributions and personal IRA contributionsãare only tax deductible if your gross income is under some limit (limitãphases in at $40,000 in 1992).ããDisadvantages: It is "difficult" (or at least expensive) to accessãyour 401(k) savings before age 59-1/2 (see next section).  401(k) plansãdon't have the luxury of being insured by the Pension Benefit GuarantyãCorporation (PBGC).  (But then again, some pensions don't enjoy thisãluxury either.)ããInvestments: A 401(k) should have available different investmentãoptions.  These funds usually include a money market, bond funds ofãvarying maturities (short, intermediate, long term), company stock,ãmutual fund, US Series EE Savings Bonds, and others.  The employeeãchooses how to invest the savings and is typically allowed to changeãwhere current savings are invested and/or where future contributionsãwill go a specific number of times a year.  This may be quarterly,ãbi-monthly, or some similar time period.  The employee is alsoãtypically allowed to stop contributions at any time.  ããAccessing savings before age 59-1/2: It is legal to take a loan fromãyour 401(k) before age 59-1/2 for certain reasons including hardshipãloans, buying a house, or paying for education.  When a loan is obtained,ãyou must pay the loan back with regular payments (these can be set upãas payroll deductions) but you are, in effect, paying yourself backãboth the principal and the interest, not a bank.  If you take aãwithdrawal from your 401(k) as money other than a loan, not only mustãyou pay tax on any pre-tax contributions and on the growth, you mustãalso pay an additional 10% penalty to the government.  In short, youãcan get the money out of your 401(k) before age 59-1/2 for somethingãother than a loan, but it is expensive to do so.  ããAccessing savings after age 59-1/2: At age 59-1/2 you are allowed toãaccess your 401(k) savings.  This can be done as a lump sum distributionãor as annual installments.  If you choose the latter, money not withdrawnãfrom the 401(k) can continue to grow in the fund.  401(k) distributionsãare separate from pension funds.ããChanging jobs: Since a 401(k) is a company administered plan, if youãchange or lose jobs, this can affect your savings.  Different companiesãhandle this situation in different ways.  Some will allow you to keepãyour savings in the program until age 59-1/2.  This is the simplestãidea. Others will require you to take the money out.  Things get moreãcomplicated here.  Your new company may allow you to make a "rollover"ãcontribution to its 401(k) which would let you take all the 401(k)ãsavings from your old job and put them into your new company's plan. ãIf this is not a possibility, you may have to look into an IRA or otherãretirement account to put the funds.  ããWhatever you do regarding rollovers, BE EXTREMELY CAREFUL!!  This canãnot be emphasized enough.  Recent legislation by Congress has added aãtwist to the rollover procedures.  It used to be that you could receiveãthe rollover money in the form of a check made out to you and you hadãa period of time (60 days) to roll this cash into a new retirementãaccount (either 401(k) or IRA).  Now, however, employees taking aãwithdrawal have the opportunity to make a "direct rollover" of theãtaxable amount of a 401(k) to a new plan.  This means the check goesãdirectly from your old company to your new company (or new plan). ãIf this is done (ie. you never "touch" the money), no tax is withheldãor owed on the direct rollover amount.  If the direct rollover optionãis not chosen, the withdrawal is immediately subject to a mandatoryãtax withholding of 20% of the taxable portion which the old companyãis required to take.  The remaining 80% must still be rolled overãwithin 60 days to a new retirement account or else is is subject toãthe 10% tax mentioned above.  The 20% withholding can be recoveredãusing a special form filed with your next tax return to the IRS. ãIf you forget to file that form, however, the 20% is lost.  Check withãyour benefits department if you choose to do any type of rollover ofãyour 401(k) funds.  ããEpilogue: If you have been in an employee contributed retirement planãsince before 1986, some of the rules may be different on those fundsãinvested pre-1986.  Consult your benefits department for more details,ããExpert (sic) opinions from financial advisors typically say thatãthe average 401(k) participant is not aggressive enough with theirãinvestment options.  Historically, stocks have outperformed all otherãforms of investment and will probably continue to do so.  Since theãinvestment period of 401(k) savings is relatively long - 20 to 40ãyears - this will minimize the daily fluctuations of the market andãallow a "buy and hold" strategy to pay off.  As you near retirement,ãyou might want to switch your investments to more conservative fundsãto preserve their value.ãã-----------------------------------------------------------------------------ããSubject: Savings Bonds (from US Treasury)ãFrom: ask@cblph.att.comããSeries EE Savings bonds currently pay better than bank C/D rates,ãand are exempt from State and local income taxes.  You can buy upãto $15,000 per year in US Savings Bonds.  Many employers have anãemployee bond purchase/payroll deduction plan, and most commercialãbanks act as agents for the Treasury and will let you fill out theãpurchase forms and forward them to the Treasury.  You will receiveãthe bonds in the mail a few weeks later.ããSeries EE bonds cost half their face value.  So you would purchaseãa $100 bond for $50.  The interest rate is set by the Treasury.ãCurrently the interest rate is set every November and May for aãperiod of 6 months, and is credited each month until the 30th month,ãand credited every 6 months thereafter.  The periodic rates are setãat 85% of 5-year US Treasuries.  However, the Treasury Dept currentlyãguarantees that the minimum interest rate for bonds held at least 5ãyears is 6%.  Bonds can be cashed anytime after 6 months, and mustãbe cashed before they expire, which for current bonds is 30 yearsãafter issue date.  Since rates change every 6 months, it is not tooãmeaningful to ask when a bond will be worth its face value.ããA bond's issue date is the first day of the month of purchase, andãwhen you cash it in the interest is calculated to the first day ofãthe month you cash it in (up to 30 months, and to the previous 6ãmonth interval after).  So it is advantageous to purchase bonds nearãthe end of a month, and to cash it near the beginning of a monthãthat it credits interest (each month between month 6 through 30,ãand every 6 months thereafter.)ããSeries E bonds were issued before 1980, and are very similar to EEãbonds except they were purchased at 75% of face value.  Everythingãelse stated here about EE bonds applies also to E bonds.ããInterest on an EE/E bond can be deferred until the bond is cashedãin, or if you prefer, can be declared on your federal tax return asãearned each year.ããWhen you cash the bond you will be issued a Form 1099-INT and wouldãnormally declare as interest all funds received over what you paidãfor the bond (and have not yet declared).  However, you can chooseãto defer declaring the interest on the EE bonds and instead use theãproceeds from cashing in an EE bond to purchase an HH Savings bondã(prior to 1980, H Bonds).  You can purchase HH Bonds in multiples ofã$500 from the proceeds of EE bonds.  HH Bonds pay interest every 6ãmonths and you will receive a check from the Treasury.ããWhen the HH bond matures, you will receive the principal, and aã1099-INT for that deferred EE interest.ããSavings Bonds are not negotiable instruments, and cannot be transferredãto anyone at will.  They can be transferred in limited circumstances,ãand there could be tax consequences at the time of transfer.ããUsing Savings Bonds for College Tuition:  EE  bonds purchased in yourãname after December 31, 1989 can be used to pay for college tuitionãfor your children or for you, and the interest may not be taxable. ãThey have to have been issued while you were at least 24 years old. ãThere are income limits:  To use the full interest benefit yourãadjusted gross income must be less than  (for 1992 income) $44,150ãsingle, and 66,200 married, and phases out entirely at $59,150 singleãand $96,200 married.  Use Form 8815 to exclude interest for collegeãtuition.  (This exclusion is not available for taxpayers who file asãMarried Filing Separately.)ããEffective March 1, 1993 the guaranteed interest rates were lowered toã4% for bonds bought on March 1, 1993 or later and held at least 5 years.ãThe 4% rate is currently guaranteed as the minimum rate for 18 years.ã(The former rate -- 6% -- had been guaranteed for 12 years -- andãcontinues for bonds bought when the 6% guarantee was in effect.  Priorãto the 6% rate, the guaranteed rate had been 7,5%.)   The actual semi-ãannual rate on March 1, 1993 is slightly over 5%.ãã-----------------------------------------------------------------------------ããCompilation Copyright (c) 1993 by Christopher Lott, lott@informatik.uni-kl.deã-- ãChristopher Lott    lott@informatik.uni-kl.de   +49 (631) 205-3334, -3331 FaxãPost: FB Informatik - Bau 57, Universitaet KL, W-6750 Kaiserslautern, Germanyã