Author: A.T.

You may recall my recent advice to Terry, the D.I.N.K. (double income, no kids), who hates debt and wanted to know if it was dumb for him to continue prepaying an extra $500 a month on his 8.5% mortgage. I told him to keep it up. He’d be getting the equivalent of a risk-free 8.5%. Not stellar, to be sure, but not at all bad, either — and, based on his query, something that will, rightly, make him feel good.

(Note that the 8.5% would be the equivalent of “tax-free,” too, if he doesn’t itemize deductions, because he gets no tax benefit from the mortgage interest. Tax-free, risk-free 8.5% is a stellar return. Note, too, that this same notion applies even if he does itemize — to the extent his other deductions don’t fully exhaust the standard deduction that he would have been allowed to take anyway. Say the standard deduction for him is $6,700 and that other than mortgage interest, he has only $3,500 in deductions, leaving $3,200 on the table. On that portion of his mortgage interest — $3,200 — he gets no extra tax benefit beyond what the standard deduction would have provided anyway, so on that portion 8.5% is really 8.5%, tax-free, risk-free.)

Well, as usual, you went me one better. Wrote Doug from St. Louis:

Wouldn’t the “DINK” be better off refinancing that “high rate” 8.5% loan down to the current 7.25% rate available for 10 year fixed loans in much of the country? If he just pays an additional $500 per month on his current mortgage, he’s still paying the higher interest. Or am I off base in my perception?

No, you are exactly right. He would be lowering the rate as well as paying it off sooner. Excellent suggestion (so long as the points/fees involved in the refinancing are not too high and there’s little likelihood of his moving soon).

Similarly, from Dr. Brent Wurfel:

Freddie Mac reported on August 21st that 15-year mortgages are at an average of 6.99 percent. Perhaps the DINK could refinance his 20-year loan for a 15 year one. The principal and interest payment are almost the same! For $80k the payments come to $694 (20-year 8.5%) and $718 (15 year 6.99%). Of course there are the refinance charges, but my mortgage broker has a streamlined refinancing program and maybe his company or bank does too. From the letter it didn’t sound like he is moving, so I would expect that he would be ahead after a year or two. I did the calculation at http://www.smartcalc.com/cgi-bin/smartcalc/hom15.cgi.

Exactly. Same excellent suggestion.

Which then raises the question: at a 7% interest rate, does it still make sense to make extra payments to pay down the mortgage? And the answer is: maybe, but it’s obviously less compelling than at 8.5%.

Once the interest rate is low enough, it’s really kinda dumb to pay it off any faster than you have to. Just what “low enough” means depends on your investment alternatives, tax situation and your own personal preferences. And requires you to make some guesses about the future. There’s no hard-and-fast rule.

With a really low-interest-rate loan, a 30-year maturity might actually be better than a 10-or 15-year pay-off — especially if the mortgage were assumable. Imagine how nice it would be if, unexpectedly trying to sell the house 6 years from now, when mortgage rates had, let’s say, zoomed, you could advertise that your house came with an assumable low-interest mortgage.

Dr. Wurfel also reminds Terry to check to see whether he is paying mortgage insurance and, if he is and he can, get out of it. Many homebuyers have to take out mortgage insurance to get a loan. Once they’ve paid it down and/or the value of the property has risen enough to meet the lender’s requirements, they should be able to have this extra fee dropped. A lot of people forget to do so. (And a lot of lenders don’t make it easy.)

And here’s another idea. In refinancing, Terry should consider the lower rate he could get with an adjustable rate mortgage. Yes, they require somewhat shrewder shopping; there are more pitfalls to avoid. But basically, a good honest ARM is going to cost even less than a fixed-rate mortgage, because with the fixed-rate mortgage you are in effect paying the bank (which then lays it off on bond investors) to take the risk of rising interest rates. You can pocket that premium if you’re willing to take that risk yourself — and since you can afford to pay $500 a month more than you currently pay, you certainly could afford that risk.

Finally, a question from Berkeley:

Following up on today’s column, my partner and I are in the market to be first time home buyers. We are DINKS with a good investing plan in place. Here in Berkeley, CA, housing is, of course, ridiculously expensive. So I’m curious if you advise paying down a mortgage generally, or only if one can’t stand debt or has oodles of extra money. I’m inclined to invest the “extra” cash in the market, and see our mortgage as our never-ending housing cost. Am I on the right track here?

There’s no one right track in this situation, but you’re on a perfectly good one. Especially at today’s modest rates, and if you’re in a high tax bracket (which is all but unavoidable if you live in California), a mortgage clearly is not debt that needs to be paid down quickly. Unlike a car loan or credit card debt, the interest is tax deductible and the thing you’ve borrowed for may actually appreciate rather than depreciate (in the case of a car) or disappear (in the case of a dinner). But if you happen to be in one of those rent-controlled apartments Berkeley is famous for, and if the houses you’re considering are indeed ridiculously expensive (and don’t forget the cost of earthquake insurance, fire insurance, repairs and so on), maybe you should consider staying put and using the enormous savings to buy a vacation home someplace that’s ridiculously underpriced.

Tomorrow: Offshore Funds

Coming Soon: Top 10 Reasons to Buy (Multiple Copies of) My New Book

Gasoline prices should be dropping a penny or two pretty soon. The leaves should be turning up north. Time to begin planning one of those great autumn weekends.

When I took my Great Narthern Tar, I plotted the trip with the help of the Internet — www.theultimates.com/trip/. Quite helpful.

My good friend Kenneth Nolan recently went me one better. Where I had just entered city-pairs (if you can call Rangely, Maine, a city), he actually was able to get door-to-door directions. His report:

When I called Laurie and told her of my plan to come see their new home, she was thrilled and immediately started to rattle off the directions. “It’s very easy. You take I-95 all the way to . . . .” I interrupt, “Laurie I already have the directions, it’s all taken care of.” You see I had already logged on to one of my favorite Web sites, www.mapquest.com, and chose the TripQuest option. I entered my home address in New York City then Laurie’s on Heatherwood Drive in Madison CT. Then I clicked on calculate and in a few minutes my screen was filled with maps pertaining to the trip, as well as turn by turn directions to Laurie’s house, starting at the end of my block and ending at the turn onto Heatherwood Drive. The Magic of the Internet! I print it out, in color, boy won’t Laurie and Joe be impressed with this! Laurie still wants to give me directions. “It’ll take you a little over two hours . . . .” Once again I stop her. “I already know how long it will take.” My print out tells me it will take 1 hour 37 minutes. I think, Gee Laurie must drive really slowly!

The day, given the speed I usually drive (not exactly legal), I’m fairly certain that if I leave my house at 11:00 a.m., I’ll be at Laurie’s by 12:30, in time for lunch.

I set off, everything goes along smoothly, Henry Hudson, 684, I-84 . . . I’m making great time, I get off the highway it’s 12:15. According to TripQuest I have less than two miles to go! I don’t want to be too early, so when I see a car wash, I figure, Why not? I also fill my tank then set off again. But wait a minute. Newtown Road changes into White Street instead of Stony Hill Road. I must have missed something. I go back to where I exited the highway. I retrace my drive without going in the car wash. I still don’t see where I’ve gone wrong. I repeat this exercise about five times to no avail. Finally I give in. I’ll just call Laurie. She’ll explain what I’ve done wrong.

“I’m right near your house, but I’m having a problem,” I say. “Newtown Road is changing into White Street instead of Stony Hill Road.” There is silence on the other end. Then, “Where are you? I’ve never heard of those streets before.” I explain that I’m near Danbury. She tells me she lives an hour from Danbury. I think to myself not only does she drive really slowly, but she doesn’t have a very good sense of where her new house is, I’m practically around the corner! I tell her I’ll see her soon. Then I go to the gas station that I’ve now passed about ten times. I find out I’m headed the wrong direction on Newtown Road. I turned right coming off the highway instead of left.

It’s now about 1:15, a minor set back from my original plan but I’ll be there in ten minutes. I’m off again, a whole series of turns on country roads then, TaDaa!, I’m there. Heatherwood Drive. I turn and drive to the number of the house. All of a sudden panic sets in. I’m in the middle of a very lovely housing development, rows and rows of town houses, exactly the kind that Laurie and Joe lived in before they bought their new stand-alone house. I must have entered the old address into the computer when getting the directions from TripQuest. I check the print out, check my address book . . . no this is their new address. Could it be that there are actually two Madison Connecticuts? Either that or there is a glitch in the program that negated the town name and directed me to the 66 Heatherwood Drive, CT of its choice! Either way I’m now faced with the embarrassing task of calling Laurie and asking for directions to her house. She tells me to get to I-95 and gives me very simple and precise instructions from there. She thinks it should take about one hour. As I’m pulling into her driveway two hours later, I’m thinking Laurie must drive really fast!

It took me a total of four and a half hours to get to Laurie’s new house. The next day it took me one and a half hours to drive home.

“I’m an attorney, and I sympathize with your frustration with California trial attorneys as displayed in one of your recent comments. Practicing law is not a profession anymore in the large cities; it’s a cutthroat business. Combine that fact of economic life with the very traits that make trial lawyers successful — aggressiveness and thick skin — and the results in California should not be surprising. Although the law schools would lose a substantial amount of profit (and law schools are tremendous cash cows for most Universities), the country would be best served by a substantial reduction in the number of available seats available for each new law school freshman class.” — Thad from Texas

This is actually an interesting idea, although one hesitates to interfere with the free market — if an extra million kids want to become lawyers, and have the brains and resources to make it through law school, so be it. One even hesitates to cut off scholarship aid, as it would be unfortunate if only rich kids could get law degrees.

The alumni of Emery Dental School did a fascinating and, I think, enlightened thing several years ago. Basically they decided that the country was producing more dentists than rotten teeth and that it would be in everyone’s interest to right that balance. So they persuaded the university — bolstered by some substantial financial support, if I remember right — to close Emery Dental School. A fine institution — coincidentally, one of the best dentists who ever drilled inside my mouth was an Emery grad — it no longer exists.

I’m not sure how you cut back law school enrollment. (Might freezing new law-school accreditations be a small start?) A large proportion of practicing lawyers actually hate their jobs, and a large proportion make much less money than people imagine — but by and large, that’s not what kids see on TV or in the movies. They see Tom Cruise reducing Jack Nicholson to blubber so that justice triumphs in A Few Good Men. Or Sandra Bullock working late with Matthew McConaughey in A Time to Kill. They see LA Law (at least the current crop of law students did when they were growing up) and Arnie’s Lamborghini.

OK, maybe they hear some lawyer jokes, too. But maybe, like all the badmouthing smoking gets, it just serves to make lawyering seem all the more attractive. If the lawyers didn’t have money and power, the subliminal message may read, people wouldn’t be making all these jokes about them. And I want money and power.

Maybe what we need to do is lay off the lawyer jokes and start telling schoolteacher jokes. (And having schoolteachers tell kids they think smoking is cool.)

This is my 400th comment. Every 100th one, I indulge myself in some way. On my 300th, I told a couple of cheap lawyer jokes. It was a lapse in taste for which I apologize. You will find no hyperlink to that puerile comment here. This time, I indulge myself doubly: (a) by being brief so I can run out and play, and (b) by daring to edit Benjamin Franklin, everyman’s mentor, one of the five greatest Americans who ever lived. It was he who said: “Neither a borrow nor a lender be.”

(OK, it wasn’t Franklin, it was Shakespeare, although I’ll bet Franklin was sore Shakespeare got to it first. Thanks to Pam Reynolds at AmeriTrade Holding Corp.[parent company of Ceres] for pointing this out – I could have sworn it was Franklin – and for coming up with this nice Franklin quote instead: “He that goes a-borrowing goes a-sorrowing.”)

I know what he meant of course. The surest way to lose a friend is to say “yes” when he asks to borrow money. But financially speaking, Franklin, which is to say Shakespeare (which leads some to say Bacon, but I don’t believe it) was all wet. “A creditor, not a debtor be,” is what he should have said. Maybe not a creditor to your friends (though an almost equally certain way to lose one is to say “no”), but apart from that, c’mon: far better to be a bank’s liability than its asset. (When you deposit money in a bank, it is accounted for as a liability of the bank, because they owe it to you. Your car loan is an asset of the bank — you are the debtor and it is the creditor.) Better to be owed than to owe.

May you bat .400. May you make (or not feel the need to make) the Forbes 400. May you encounter The 400 Blows only as a film classic and never on your backside.

And now, into the pool for a late-summer water volleyball game.

OK, OK. (And I want you to know I heard this one from a precocious ten-year-old.) “Why is New Jersey filled with toxic waste and California filled with lawyers?”

Give up?

scroll down . . .

scroll down . . .

“New Jersey got first pick.”

Hold the ball! I’m coming!

Monday: The Case Against Lawyer Jokes

“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)