Author: A.T.

“Thank you for the good advice on variable annuities. But here’s the tough question: 2.5 years ago I bit, I’m now in, unfortunately, it’s up 28% (not 100% as an index fund would’ve been), I’ve got about 15 years before I expect to start withdrawing, what do I do? Or, even, how do I go about analyzing what to do? I’m willing to take some risk; it’s not food & lodging money.” — Steve Lawrence

Well, that’s one of the key problems with annuities. Once you’re in, they’re hard to exit. You may have surrender charges to pay, along with ordinary income tax and, if you’re not yet 59-1/2, a penalty.

Off the top of my head (an even less reliable launching pad than deep within my brain), I’d suggest that unless the amount is large, you just not worry about it. You were smart to save money; it’s up a lot already (let’s hope the reason for its severe underperformance is at least in part more conservative investing that could cushion the blow of a down market); you made some sales person very happy. What’s done is done.

If the amount is significant, and you have the time and are willing to put up with the possible frustration and disappointment, check into the specifics of your annuity. Are you subject to surrender charges? If not, would you be better off switching to a different annuity? (The new one you choose will happily walk you through the government regulations that allow a tax-sheltered, Tarzan-like swing from one tree in the annuity forest to another.) But beware: don’t switch from a conservatively managed variable annuity to an aggressively managed one when the market is high, as it is now.

But in terms of withdrawing the money from annuities altogether to invest directly in the market — especially if you’re not yet 59-1/2 — I doubt it would make sense.

All other comments welcome.

From Kim Ness: “You have written in the past (via a printed medium) about frequent flyer programs where you can earn extra miles by using a certain credit card or long distance carrier. But I cannot recall the logic you used to explain when, if ever, it makes sense to use a credit card that charges an annual fee, instead of using a non-fee card that provides no flyer miles. Could you write about that? I am constantly getting offers that entice me… but so far I haven’t succumbed.”

The miles are worth about 2 cents each to most people, though it varies greatly based on how you travel.

• If you sometimes have to buy full fare tickets for last-minute trips, or wish you could, they’re worth a nickel. Likewise if you fly business class to Europe — now you can buy a super-cheap economy ticket and use 40,000 miles (typically) to upgrade, saving $2,000 — a nickel a mile.

• If you cash them in foolishly, they’re worth just a penny.

• And if it takes you five years to accumulate enough points to cash them in, you need to remember that 2 cents five years from now isn’t worth as much as 2 cents today.

So . . . if you figure you charge $2,000 a year, for which you get 2,000 miles, that’s $40 worth of miles, versus a $50 fee (or whatever) — forget it. But if you charge $20,000 a year, say, then it’s a no-brainer. You want the miles.

Labor. Work. Effort.

Sometimes, you can try too hard. “We don’t just offer you fresh squeezed orange juice in the morning,” crows the hotel. “We squeeze it fresh for you the night before!”

It’s all well and good to labor mightily at investing, but unless you have a great deal of money to manage — and perhaps even then — I don’t think it makes sense. So it’s never particularly bothered me that I have to wait until the market opens to buy or sell a stock. It’s never really killed me that the market’s closed on Labor Day.

But wait!

“What exactly is after hours trading?” queries SuperJeff. “It sounds like the market doesn’t always lock the doors when closing time arrives.”

The answer is that I’ve never paid much attention to this, other than hearing, like you, that such-and-such stock “fell three points in after-hours trading.” After-hours trading isn’t available to us little guys — and just as well that it’s not. Are we really going to know some big news about a stock or the economy before anyone else? No. And once it is known, the price you get or pay in after-hours trading instantly reflects smart people’s assessment of that news.

But SuperJeff’s question made me realize how little I knew about this, so I forwarded it to a pro — he’s had spectacular success on Wall Street — to get the straight scoop.

He didn’t know, either. “I’m a good investor, lousy trader,” he wrote back, “so I asked my trader.” She came up with the following:

1. If you’re an institutional investor hooked into it, you can trade on Instinet — an electronic trading system where institutions can make bids, show offers and execute trades over the computer. This trading lasts 24 hrs, technically with a shutdown between 7 and 7:30 p.m. There is also a blind crossing session around 6:30 or 7 p.m. where buys and sells are matched up and trade at NYSE or ASE last sale price (OTC stocks trade at midpoint of the market).

2. There is also a matching session for the Arizona Stock Exchange (which I think is a computer in New Jersey, although they may have moved it) at 5 and 5:30 p.m., same pricing rules as above — can enter orders after 4 p.m. and orders can be entered on an open book (people can see your bid or offer) or on the closed book.

3. Third-market trading (through Jeffries & Co., etc.) can take place 24 hrs a day, but you can no longer trade when there is a NASDAQ or NYSE halt on a stock due to news pending. (As you can imagine, it used to be like the Wild West over at Jeffries before news announcements.)

4. The NYSE has a crossing session at 5 p.m. where stock is crossed at the NYSE closing price. Enter orders between 4:15 p.m. and 5 p.m.

5. There is also some other weird crossing thing at the NYSE at 5:15 p.m. which involves baskets of at least 15 stocks.

6. There are ways to trade overseas, too — in London, etc.

If you feel left out of the action, you may be trying too hard. Take the weekend off. And when you get back: finally, the cheesecake.

Tuesday: Yes! Fat-Free, Sugar-Free Cheesecake

From Steve Baker: "Funds that charge front-end loads often have lower annual expense charges than no-load funds. How long would someone have to hold a front-loaded fund for the difference to be worthwhile, all other factors being equal?"

First off, why not get a fund with no load AND a low expense ratio? That’s what I’d recommend.

Other than that, it’s simple math (which I will shortly complicate), and the same really as asking: "How long would someone have to live in a house to make it worthwhile to take a mortgage with higher upfront ‘points’ but a lower annual interest rate?"

Let’s assume we’re talking about a low-load fund with a 3% sales fee but half a percent lower annual expenses. Or a mortgage that charges 3 points upfront — 3% — but that bears a 0.5% lower interest charge than the no-points mortgage you’re comparing it with.

The answer your child should be applauded for giving you is: 6 years. That’s the breakeven. (If your child is destined to become a lawyer, or do well on her SATs, she should answer "more than 6 years," to match the wording of the question.)

You pay $3,000 extra on a $100,000 investment (or mortgage), but you save $500 a year, or $3,000 after six years.

(If your child is destined to become a tax lawyer, she might point out that mortgage points are not always immediately deductible where mortgage interest almost always is, which skews the comparison. Looking at it on an after-tax basis, which is the only way that makes sense, you’d have to do more math if the points were not immediately deductible as well.)

But what if your child isn’t 11, as we seem to be assuming here, but 24 and just out of Wharton?

Far from being applauded for a dumb answer like "more than 6 years" — yes, we know 3 divided by .5 is 6, but that’s not why we spent $50,000 sending you to Wharton — he should be sent to the toolshed, or out behind the woodpile, or wherever it is dumb MBAs in colonial days used to be sent for a thrashing.

Because the true answer rests on the discount rate you assign to the time value of money. If none, then a 3% load is indeed neutralized in 6 years by a fund with .5% lower expense ratio.

But of course money DOES have a time value. A dollar today IS worth more than the promise of a dollar a year from now. A bird in the hand IS worth two in the bush. (Three, if it’s a distant bush or the kind whose thorns rend your garment when you go bird-hunting in it.)

So, leaving aside the fact that you might not want to be locked into this fund that long in order to start reaping the benefits of a lower expense ratio, which is another reason to be skeptical of loads, there is also the fact that the .5% you save in Year 6 is not really worth nearly as much as it would be today, assuming you can make your money grow somehow over six years. And that’s also true, to a lesser extent, of the .5% you save in Year 5, in Year 4, in Year 3, in Year 2 and, yes, even in Year 1 (since the load is paid up front, but the benefit of the lower expense ratio is spread out over the year).

There’s a lot to be said about what discount rate to choose in doing a calculation. It’s not a number you’ll find printed in the Wall Street Journal each day (and it’s not to be confused with the famous Discount Rate charged banks by the Federal Reserve). Maybe one day, when there’s a truly personal Internet version of the Journal, there will be a listing for your own, personal discount rate, based on all sorts of confidential personal financial data anyone, and certainly the Journal, will by then be able to pull up on you. But not now. You have to pick one for yourself.

If you currently are paying 18% on a credit card balance, an appropriate discount rate for you to choose for many decisions might actually be that high — 18% — because that’s what you could earn, tax-free and risk-free, on a little extra money. To you, $118 in a year is worth $100 today. You could pay Visa either $100 now or $118 a year from now. Either way works out the same: you’d be $100 less in debt.

Anyhow, back to the issue at hand:

With a 10% discount rate (which is still high), .5% in 6 years is the same as about .27% today. (To check me, multiply .5 by 90% six times. Or do it with $50 instead. Each year, if it loses 10% of its value, it’s worth only 90% as much as the year before — $27 after 6 years.)

So using these assumptions, my financial calculator tells me it would take almost 10 years for the 3% load to be "neutralized" by a .5% lower expense rate. (This requires more multiplications than you would want to do by hand, or even with a regular calculator, because it’s different for each of the six years.)

If you used a 5% discount rate, a little under 8 years. If you were crazy enough to think the two hypothetical funds you were comparing could earn 15% a year, and thus used 15% as your discount rate — 17 years. If you actually do owe $17,000 on your credit cards and pay 18% on the balance, and were thinking of borrowing yet $10,000 more at that rate to make this investment, then it would never make sense to buy the load fund. You would never catch up from your savings on the annual expenses.

But like I say, none of this is necessary. Buy a no-load fund with a low expense ratio and nobody has to go to Wharton, which saves another $50,000.

Cheesecake Lovers: Hang On!

Writes Terry: “I read your comments regards to paying off mortgages and wanted your opinion on my own situation. I am 44 yr old D.I.N.K., with no debt other than an 80k mortgage at 8.5% with 20 yrs left. Spouse earns about 40k (she is 30), my earnings (sales) are very inconsistant [sic] but minimum is likely to be 40-50k/yr. We live conservatively and can easily afford to add an additional $500./mth (towards principal) to our house payment of $855/mth. Our savings are modest, about 50k total.

“The question of course is, should we continue to pay down the mortgage or would it be better to put that $500/mth into savings? I hate debt and without a house payment we could live on about 12k/yr. I will appreciate your insights. Thank you and please don’t use my name or email address.”

A D.I.N.K., I should first translate for the acronym-differently-abled, is no longer the pejorative it once was on the paddle tennis courts of Camp Wigwam and has nothing to do with Donna Karan. Double Income No Kids.

I think your question answers itself, Terry. You hate debt and can easily afford to keep paying down your mortgage. So keep it up! By so doing, you get a well-deserved sense of satisfaction and you in effect earn a risk-free 8.5% — not stellar, to be sure, but not at all bad, either.

I assume you itemize your deductions, so it’s in effect a “pre-tax” 8.5% you’re earning (in that after tax, this interest is only costing you maybe 5.75%, meaning that not having to pay it is like earning only 5.75%). But still, not bad at all.

Of course, the math would tell you that if you can just find a stock growing at 10%, let alone 20% or 30%, a year, you would do better putting your $500 chunks there. True. But Polaroid was once such a growth stock — brilliant scientists nestled between two of the greatest universities in the world, a monopoly on an amazing product. You could have bought it for $144 in 1972, if memory serves, and then, two or three years later, $14. So there’s something to be said for a certain level of guaranteed saving, and this mortgage pay-down scheme of yours fits it nicely.

Tomorrow: A Load, But Low Expenses (Cheesecake Lovers: Hang On)

“Yesterday, you ran a one-word comment. Usually you go on way too long, but now this? One word?”

When this column was first conceived, Ceres simply said it wanted a “daily comment.” Any specific length? I asked. No, as long or as short as you want. Every day? I asked. Well, every day the market’s open. About investing? I asked. About anything you want.

I really had no idea how this would turn out. “The market was generally strong today, with tornado watches in effect for several Internet stocks, and scattered showers over packaged goods.”

A daily comment? Like, “Neither a borrower nor a lender be”? Do you know how long it took Shakespeare to write that? (And of course he was referring to personal loans only, I realized after about twenty years — it’s fine to lend to Uncle Sam by buying Treasury bonds, or borrow against your life insurance policy to help fund tuition.)

I had no idea what to expect (or how much fun it would be, thanks to your feedback). I thought maybe I’d signed on, when you called a spade a spade, to write fortune cookies. “You will be getting small dividend soon. Go on happy journey.”

And it is this topic — fortune cookies — I would like briefly to address.

You eat Chinese from time to time, yes? Well, Confucius say: “When fortune cookie come, and people begin read out loud, require everyone append phrase “between the sheets.” Wok every time.

Try it.

My apologies to those of you who have been using this technique for years. I dazzled one of the founders of modern finance and his wife with this after a fine Chinese dinner one night not long ago, and he said, “Oh, yes. We used to do that during the war.”

Tomorrow: Advice to a D.I.N.K.

From Ultraed over at AOL.com: “Do you think it is a good idea to take an equity line on my house for 10% and invest some of the money in the stock market?”

No.

"I’ve read a bunch of books on personal finance," writes Charles, "but I’m left with a question I can’t answer, although I suspect it should be obvious. Probably, the engineer in me just wants a specific answer instead of the ‘feel-good’ answer. Which is better, borrowing $20,000 for a new car, or paying cash and investing the equivalent of the monthly payments? What I call the ‘feel-good’ answer is: ‘Of course, borrowing is bad, investing is good.’ But, how good? I need some tools to figure out when this makes sense and when it doesn’t. Or is it really so obvious that it ALWAYS makes sense?

"The situation I find myself in is that, for the first time in my life, I can afford to pay cash for a new car. But that cash represents 10% of my (non 401k) investment assets. Where earlier I only thought of the monthly payments, which didn’t bother me, I now find it EXTREMELY difficult to part with that much cold hard cash.

[You could always buy a nice used car for $6,000, Charles.]

"My wife came up with the idea of repaying ourselves the money in monthly installments, as if we were paying off a car loan. But the engineer in me says, ‘how much do we have to pay ourselves to make this a better deal than borrowing?’ Presumably, less than the loan payments would be, but how much less?"

Charles was beginning to lose me with this, and I will spare you the several paragraphs that followed with all kinds of engineering schematics, as it were, trying to get at the right answer.

But of course the right answer is very, very simple (never mind the fact that I can’t even light my grill, let alone engineer a chemical plant).

Not having to PAY 10% (or whatever) on a car loan is precisely the same as earning 10% (or whatever) risk-free, tax-free. (It’s tax-free because, except to a business, the interest on car loans isn’t deductible.) I know of no other investment that comes close to that, so buy the car for cash.

This has the added benefit of reminding you what you’re really paying for the car — not $400 a month, but TWENTY THOUSAND DOLLARS! Which might actually help you focus on your priorities. Maybe, seen that way, you really would prefer — voluntarily, not because I nagged you — a $6,000 used car, putting the $14,000 difference to work someplace else. That way, you save the better part of $14,000 and all the interest you would have paid on the car loan (and something on insurance, because you might decide to skip collision and comprehensive).

If the financing were 3% instead of 10%, then it would be different — except it wouldn’t, because they’d be offering you your choice of 3% financing or "$2,000 cash back," or whatever — so it’s not really 3%, it’s whatever car-loan lenders lend money at these days.

Sure, if you’re starting a business and need a nice car to impress clients and are short on capital, you’d finance the car — in fact, you’d lease it. The payments would be deductible, and while it’s hardly risk-free, your "return" on the $20,000 in start-up capital freed up by leasing could be 100% or 1000% or 10,000% if your business succeeds.

But to borrow $20,000 at 10% in order to keep it in a savings account at 5% (which is to say 3.5% after tax)? Or to put it into the market and maybe lose a chunk of it if the market turns down, or earn 10% pre-tax on it? I’d pay cash and consider "Not-Taking-Out-This-Loan" (symbol: NTOTL) one of your core holdings.

Incidentally, to figure out which car to buy, if it’s definitely going to be a new one, check out www.personalogic.com.

Mike writes: “I’ve moved to Cambridge, MA (quite a change from the Waco, TX I’m used to) so that my wife may attend Harvard Law School. Which brings me to the reason of my writing — what is one to do when everyone around them is fabulously wealthy?

[Quick answer: Enjoy it; send thank-you notes.]

“I’ve got a typical consulting job, but all of my friends (and probably my wife) will in a few short years be making gobs of money (one is already making six figures and none are yet 25). I never intended on being wealthy or hanging out with the elites, but I’ve found that it just happens if you’ve got smart friends and get a decent education. Is that okay? Or should I attempt to stave it off?

[Quick answer: Why would you want to stave off being wealthy or hanging around with elite people? Snobby people, yes. But lots of elite people are anything but snobby. If Steven Spielberg ever invites me up for coffee, I’ll bound up the stairs.]

“I’m not resentful of them. I’ll probably join them if not from my own work, from my wife’s. But I’m not sure how to cope with this change. I always intended on being a starving academic but got disenchanted with academia and then married.

“I know you must have grappled with ‘how to keep up with the Jones’s when their making $500K a year’ and perhaps more significantly whether there is an absolute, maximum standard of living that one should have. I gladly welcome any comments you have, and, hey, you know any good places to get Mexican food in Boston?”

#

Mike: Sounds as if you’re a perfect candidate for “living beneath your means,” which I’ve always strongly advocated. For you, it should be entirely painless. And you will be able to secretly smile, watching at least some of your fabulously gobby friends spending a ton of money and taking on fabulous mortgages while you and your wife are saving. By all means hang out with them. Enjoy their good company and fine hors d’oevres. Reciprocate with your good company and fat-free onion dip. Enjoy going out on their boats. If I may quote from my own forthcoming book (the subtle beginning of what will in the coming weeks be a subtle campaign of shameless plugs for that book, called MY VAST FORTUNE: The Money Adventures of a Quixotic Capitalist, Random House, October, and available at 30% off right now at www.amazon.com): “Boats? The dumbest thing you can possibly do is buy a boat. For one hundredth the money and one thousandth the hassle, you can lavish a boat-owning pal with so many gifts he wouldn’t dream of leaving port without you.”

Make it your plan relatively quickly to accumulate impressive financial security. If your lifestyle is modest, you get a double boost: first, from being able to save more; second, from needing to accumulate less. (Do you know how much capital you need to amass to support a yachtsman’s lifestyle? Fugeddabowdit!)

Don’t remotely try to keep up with these Joneses in terms of spending — why should you? You think Malcolm Forbes invited Fran Lebowitz on his yacht all the time because she was rich? Take your friends out for funky Mexican food. Better still, have them over and serve them chili. One of the most successful hostesses I know in New York almost always serves her famous San Antonio chili. Surely they had chili in Waco, too? I’ve met everyone from Peter Jennings to Barbara Walters at her place, and each time what we get is: chili. Who cares? (And it’s actually very good chili.)

As for whether there’s “an absolute maximum standard of living that one should have,” surprisingly, there is: mine.