Welcome to my blog where I discuss money, investing, politics, and anything else import in the world. I find it surprising that most people in their 30s have very little knowledge or interest in these areas. Of course everyone is interested in money, but very few take the time or have the discipline to properly save and invest it for the future or short term. For those who at least have the interest, I'll write about my experiences and methods of investing, and hopefully give you a head start in investing.

Tuesday, January 29, 2008

Bob Brinker MoneyTalk Commentary 1/26-1/27

Some of the more basic questions came up today on the show. These questions almost come up every week:

Pension: Annuity vs. Lump Sum

It almost always makes more sense to take the lump sum and invest it yourself. However, people always like the sound of "guaranteed" money for life. The call on Saturday had the following scenario: lump sum of $1,000,000 or $60,000 per year for life, indexed 3% for inflation. People often think the only risk is how long they will live, but while that is important, the return is equally important. This example shows a 6% return plus 3% indexing, so really about 7.8% return, however this return includes eroding your principle (since you never get that back). Time is a really important and interesting factor here. The longer you live, the more payout you get, but also the easier it is to beat the 7.8% return by investing a portion of that lump sum in stocks. The expected returns of equities over the long term is greater than 7.8% per year. In addition, you still have your original principle. In the annuity, all you get is the return, the principle is owned by the annuity company. More details:
  • You need to live at least 14 years to be paid back the $1M
  • There may be a tax concequence of receiving the lump vs. yearly, it all depends on your other income, but for sure the lump would be taxed at 35%
  • Even if you assumed a very conservative return of 5% on your lump sum, you would have to live 25 years before the annuity returned more. And over that long term I hope you would use a more aggressive approach with your lump sum.

High Inflation

Every week someone calls in to argue that they are seeing high inflation, no matter what the CPI is saying. And every week Bob gives them an ear full. Here is the problem: most people ignore the big and less frequent things and only concentrate on what they do often, buy food and gas. Of course these are seeing high inflation, energy is up 18.1% for the year, and food 5%. However, less frequently purchased items such as housing, apparel, recreation, and education are down or very low inflation. See the whole report here. The point is that despite the higher energy costs, the price of things like apparel are not increasing, in fact they are down -0.4%. This is because the higher costs for food and energy leave less money to buy extras, and thus less of a demand, this keeps the prices in check. If we had true inflation, all of these categories would be higher.

Government Stimulus Package

There were many ideas again on how to best stimulate the economy. Bob still prefers they lower the pay roll deduction on Social Security. He is right that it would be similar in that it does not help people of above a certain high income level, it would only delay slightly how long it takes them to max out the contribution. However, I think the Government thinks sending out a physical check is more tangible. Getting a little bit more money in every check doesn't necessarily make you go out and spend it, like a fat check in the mail would. He also fails to realize that doing what he suggests would give the middle class more than the poor. I might have to call in and explain this to him. For example:

  • If you earn $35,000 per year and they lowered the witholding from 6.2% to 3.2% you would save $35,000 x 3% = $1050
  • If you earn $50,000 x 3% = $1500

Yes, the person making $50,000 still contributes more to Social Security, but this is not the same as having everyone pay 6.2% and send a flat check of $600.

And for the dumb question of the day...
One caller asked about using options to buy stock from his employer at a price above market value. He was trying to justify exercising an option to buy at $47, when the current values was $43. I don't think he understood that those option are currently considered "out of the money" and worthless. There is absolutely no advantage or reason to use those options now. They do give him a ceiling on the maximum he'll ever have to pay for the stock and if the stock goes above $47 then he should exercise, when and only when he wants to sell the position or when the options are about to expire. If they are about to expire and they are equal to or below $47 then let them expire. Likewise, if you want to buy and hold the stock, don't do it until they will expire (unless you really want that dividend income). Bob understood this but seemed to toy with the guy a little and never gave him the straight answer.

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