In the USA Municipal bonds are issued by state and local governments and are exempt from federal tax. Therefor if you earn a 5% yield your after tax return is equal to that of a 7.5% yield if you are in the 33% federal tax bracket (7% * .67 = 5%). One way to invest in bonds is using a mutual fund (open or closed end funds). Right now the tax equivalent yields (compared to other bonds) of muni bonds are higher than normal.

Muni Bond Funds Offer High Yields, Tax Perks Dec, 2007:

In general I find bonds to be a less desirable investment. Especially in the low yield environment recently (and really going back quite a few years). But for diversification some bonds can make sense for certain portfolios. Given the current tradeoffs (risk v. after tax yield) muni bonds certainly deserve consideration. I would shy away from long term bonds or funds (intermediate or short term) but of course every investor makes their own decisions.

Related: Roth IRA (another good tax smart investing tool) – what are bonds? – Alternative Minimum Tax

Shorting is selling first and buying later. The idea is to sell high and then buy low. It can be a bit risky. Since there is no cap on how high a stock can go you can loose more than you invest. Still, as part of a portfolio, using short positions can possibly be a useful strategy at times. You can use shorting to do things like hedge against existing gains (without selling those positions and incurring taxes).

Business Week had an article on Shorting for the 21st Century using inverse funds. These are mutual funds that are structured to behave as short positions – that is to go up if the target portfolio goes down in value. One advantage of using these funds (at this time they are all ETFs – exchange traded funds, I believe) is that you losses are limited to your investment. You do incur additional expenses charged by the fund however.

Experienced investors may find value in exploring the use of inverse funds. Some funds are engineered to move 1 for 1 with the market (that is the fund increases 1% for every 1% decline in the index) and some are engineered to move up 2% for every 1% decline – which also means they go down 2% for every 1% gain in the actual index. Index funds can also be used in retirement accounts (where shorting is not allowed).

Most investors need much more experience and to do a great deal of reading before they would be ready to try these funds. Since markets general go up over time and timing the market is extremely difficult it is unlikely novice investors will succeed in trying to guess right. The usefulness is mainly as a hedging strategy when the investors has determined the portfolio could benefit from a partial hedge.

Related: Risk and reward of exposure – investment speculation books – Ignorance of Many Mortgage Holders – The Greatest Wall Street Danger of All? You – How Not to Convert Equity

A house is where you live–not an investment

Very good point – as long as you fall into that category of living there until you die. True for some people but far from all. Also, even for those people, it is not a complete view of the financial situation.

A reverse mortgage will allow you to sell the house and get paid for the rest of the time you live there. So you can build up equity over 20,30,40 years and then take a reverse mortgage and get payments every month (based on your investing in your house). Reverse mortgages, like many financial tools, can be applied poorly and is I would guess unethical behavior related to them is fairly high (so be very careful!). If you think of such an option you need to do your research and actually understand what you are doing – you can’t afford to be like the many ignorant mortgagors. The AARP offers information on Reverse Mortgages.

Additionally, you lock in a large part of your housing cost (you still have maintenance and taxes but you do not have every increasing rent. Now ever increasing rent is not a certainty but for many it is very likely rent will go up on average over the long term. Ownership of your home removes the risk of being priced out of the area you want to live by increasing rental prices over time. You also lose the potential of benefiting if rent prices fall over time, but I would say the more valuable of those options is avoiding the risk of rising rental prices.

Related: How Not to Convert Equity – Housing Inventory Glut – articles on home ownership and real estate

Behind the Ever-Expanding American Dream House

This is extreme wealth. It is also part of the reason housing prices take an ever increasing multiple of median income. Basically people are buying two houses (not just one). Average square footage of single-family homes in the USA: 1950 – 983; 1970 – 1,500; 1990 – 2,080; 2004 – 2,349.

Related: mortgage terms defined – Trying to Keep up with the Jones – Too Much Stuff – Investing Search Engine

It is not your parents world. In case you hadn’t noticed the economic power in the world has been changing quickly. Many are missing the magnitude of these changes. One visible example is explored by the Economist in Emerging-market Multinationals:

This is just one visible sign of shifting economic power. And it shows no sign of slowing down. Our 12 Stocks for 10 Years portfolio is heavily invested for overseas growth. Close to 20% directly in emerging markets (through Templeton funds). PetroChina, Google, Toyota and Tesco all are very well positioned to grow quickly in emerging markets. And other stocks are likely do do well too – I am not clear on how well Pfizer, Amazon and Dell are positioned at this time.

Emerging stock markets will continue to be very volatile I believe. However looking decades out and at a pool of 20 countries it is hard to imagine they won’t do very well: China, Singapore, Mexico, India, Thailand, Brazil, South Africa, Vietnam, etc.

Related: Growing Size of non-USA Economies – Why Investing is Safer Overseas – South Korea To Invest $22 Billion in Overseas Energy Projects – Changing Economic Clout and Science Research

One way to evaluate the real estate market is to compare rental rates to home values. This can provide a comparison of an approximate cost of buying a house versus the cost to rent. As the ratio of monthly rent to home price increases, at least on this measure or real estate value, the market can be seen as becoming more expensive.

Several points to keep in mind:

1. This does not take into account things like tax rates (in higher tax areas the rents will be higher [since the owners will pass on that cost that is not reflected in the home price] – the ratio lower)
2. This is only a comparison measure – it can be that rents also experience a bubble. So if rents experience a bubble then the ratio could stay low and fail to indicate an “expensive” market.
3. Don’t rely on one measure – this is one useful measure there are plenty of others that matter for real estate prices (income levels, job growth, interest rates, zoning regulations…)

The Rent-Price Ratio for the Aggregate Stock of Owner-Occupied Housing

This paper is well worth reading. I would like to point out another factor here though. When those investing in real estate were focused largely on capital gains (say a few years ago) there could well have been an increased demand for rental property (which increased prices). That effect also moved extra supply into the rental market (that previously would have been sold to owners that would live there instead of investors). Those investors were more concerned with capital gains and it seems to me could well have been willing to accept lower rents just to have some cash coming in to help pay the expenses.

As those investors no longer believe they will receive large capital gains in the short term it is possible they will be more focused on cash flow – and seek increased rents. I will not be surprised that rent prices increase as investors focus more on cash flow and stop assuming such large capital gains will be where their profits are made. Thus the ratio will close both by real estate value declines and rental price increases.

Related: Explaining Rent-Home Price Ratios – True Rent-to-Price Ratio for Housing – articles on the real estate market – Real Estate Median Prices Down 1.5% in the Last Year – Rent Controls are Unwise

Response to: The desirability of rent controls

I do not believe rent controls are wise, in general. There are some options I wouldn’t mind – some sort of affordable housing that has breaks from the government (tax…) in exchange for a commitment to keep rental rates down. But wholesale rent controls are very unwise I believe.

A related issue I find amusing. You will hear don’t regulate at all state that it is regulation preventing housing being constructed (zoning regulations) that create rising prices which they imply is unfair. It seems to me the data shows the opposite of what those people claim. People are willing to pay more for the regulated housing markets. That means the market forces value the regulation and in order to increase the economic utility (which is represented by what people will pay) more regulation should be used not less.

Related: articles on real estate investing – regulatory risk (for rent control that would be the risk that investment property rights were limited due to rent control)

London Leads the Biggest U.K. House-Price Drop for Five Years

Related: Fourteen Fold Increase in 31 Years

Fed Plans To Curb Mortgage Excesses, way late but at least they may do something.

Yes the Fed should have taken more aggressive action. But the legislators should not throw stones at others – what have they done? A recent example – they want to lower the down payment required for FHA loans to 1.5%. I can’t take anyone’s opinion, of how others should have behaved seriously, when they vote for such legislation in the midst of a subprime mortgage loan crisis. What are these people thinking. Ok, everyone now says loan standards were to lax, people stopped putting 20% or even 10% down on home purchase. Ok, lets blame the Fed and then lower the down payment required for federal backed mortgages to 1.5% (from the already very low 3%). Did this crazy legislation just barely squeak by? Nope, passed the senate 93-1! Lets have the politicians explain what they have done right before they just criticize others. Their game of blaming others while doing next to nothing positive themselves is sad.

Another real voice of reason. The Mortgage Bankers Association (MBA) really expects anyone to pay any attention to their opinions. They have someone managed to create a threat to the economy so large that $90 a barrel oil is not the threat to the economy people are worried about. I think anyone that reads these opinions from the MBA and doesn’t see them as self serving statements and nothing else should be ashamed of themselves. Shouldn’t the Washington Post at least include some follow up question on why the public should listen to that organization. What was there senior vice president saying 5 years ago to ensure the economy wasn’t threatened by the reckless action of their members? We seem to have forgotten that individuals and organization should be held accountable for their actions. Quote some people that are not only concerned with their benefits without regard for what it does to everyone else. If that is not what they are doing, lets see 5 policy recommendations they have made in the last 5 years that are good for America and bad for you and your members. I don’t think the rest of us believe what is good for the MBA is good for America.

Related: Why do we Have a Federal Reserve Board? – Ignorance of Many Mortgage Holders – How Not to Convert Equity – Washington Paying Out Money it Doesn’t Have – Legislation to Address the Worst Credit Card Fee Abuse (Maybe) – Lobbyists Keep Tax Off Billion Dollar Private Equities Deals and On For Our Grandchildren

If you haven’t added money to your Roth Individual Retirement Account for this year yet – go ahead and do so now. Given the state of retirement planning for the vast majority of those in the USA there is a good chance your retirement is the area of your financial life that will most benefit from more resources. The other action that is likely worthwhile is to cut your spending but we will leave that for other posts.

If your employer offers matching on your 401(k) or 403(b) that may well be an even higher priority. There is almost never a decent reason not to add at least 5% of your income to a retirement account matched by your employer. Make sure, as the amount grows above $100,000 that it is invested in a diversified manor (not all in the stock of your employer or…).

For 2007 the most you can add to your Roth IRA or just IRA is $4,000 ($5,000 for those 50 years old or older). Next year that maximum increases to $5,000 ($6,000 for those 50 and up). If you have already added the maximum that is matched to your 401k and have added the maximum to your IRA for this year get ready to add the $5,000 to your IRA for 2008 in January (you do have to make sure you don’t earn too much to be eligible to add funds – pretty much you have to be over $100,000 in income, $150,000 on a joint return, before you have to worry but look up the details yourself). By adding the money to your IRA early in the year you will get another year or tax free growth (for the Roth or tax deferred growth from the regular IRA).

For more details on the rules on IRAs see the links we provide on the Curious Cat Investment Dictionary IRA page.

Related: Saving for Retirement – Roth IRAs a Smart bet for Younger Set – Our Only Hope: Retiring Later