Frugality and Fighting Against Renting Injustices

August 28, 2008

I was originally going to blog about my upcoming mortgage or the condo buying process or IRA limitations, but instead I’m going to rant about an injustice with my security deposit. I’m so glad that on October 3rd I will be done saving for my condo, moving for at least a few years and dealing with apartment people. I received my security deposit (or what was left of it) by mail today. The security deposit started off as $150.00 and a whopping $0.62 was added for interest (a whole 0.4%). Charges valued at $76.88 were deducted from the security deposit.

INJUSTICE

There were a few places where I thought we could lose some money from our security deposit. Some of the walls were dirtier than when we moved in. There were dirt and oil smudges that did not come off the wall. Additionally, there were holes in the walls from the Comcast cables. The holes were not made particularly stealthily, but they will provide utility to the future tenants.

I was not expecting to get all of my security deposit back. I did not, however, expect to be taken advantage of. Our deposit was charged for a rip in the screen door to the balcony and broken blinds. My roommate and I barely used the balcony for anything, which makes it highly improbable that the screen was ripped while we were renting. The blinds were definitely not new blinds and they were not abused in any way. We opened and closed the blinds as they are meant to be operated.

RANTING

Shouldn’t broken items during the normal wear and tear of a living place, such as blinds and a ripped screen (which was most likely not from us), be covered in the rent. Isn’t that what the rent is for? Shouldn’t the security deposit be for leaving the apartment less clean than entering the apartment? Shouldn’t the security deposit be for putting a hole in the wall or something to that effect? If your fridge breaks, shouldn’t the apartment management repair your fridge? So why do you get charged for broken blinds? How are blinds any different than a fridge? If they are broken, the rent should cover the repair or replacement.

Additionally, when we moved in I noted that the microwave handle was broken. Not only did management never repair the microwave handle, I spent an hour of my own time fixing it. It was not an easy fix as the whole inside of the door had to be removed. Later in the year our garbage disposal broke. Management did not fix this either. I got tired of waiting and fixed it myself, which was another hour of my time. Instead of complaining over and over I spent my own time repairing things that I should not have to. Then I am repaid by management charging me for broken blinds and a questionable broken screen.

FRUGALITY

This is where frugality comes in. Some people may consider this being cheap by arguing over $60. I just don’t like getting charged for things that I should not be charged for. This is how the management company makes some extra money. It’s just like giving free trials for subscriptions and hoping people forget to cancel the subscription and new income is generated. I was sent a copy of the move-in move-out inspection agreement. There is a space for management and resident signatures on the move-in date. There is a space for management and resident signatures on the move-out date. There is only one blank signature on the sheet, which is the resident move-out sheet. Basically, you fork over a security deposit before you are allowed to move-in. Then you get no help inspecting your apartment for damages. Finally, you move out and aren’t around when management finds damages and charges it to your security deposit. I’m sure the management company is banking on former residents receiving a partial security deposit and being grateful they received any money at all, or they’re too lazy to argue.

PLAN

I plan on arguing this injustice. I can take them to small claims court, which I will most likely lose. I can report them to the better business bureau. I think the most effective means of fighting the injustice is by calling and arguing my points from above. Also, I should only be charged for the remaining useful life of the broken product. The screen doors were very old. They often were hung up on the track when opened. The lock barely worked. I’m assuming the screen is equally old and the screen material is super cheap. Based on the fact that I have already put two hours of my time into repairing various parts of the apartment I feel as though they have to listen to my complaints. Finally, the last thing I can do is to threaten to write bad reports in every forum I possibly can after this poor of an experience. Saving $60 is well worth the effort to correct this injustice.

I will take one important lesson from this experience. Everybody is trying to get their hands on your money. Whether it’s the apartment manager or your car insurance company irrationally raising rates, you have fight for every last penny.

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Index Investing Is A No Brainer

August 27, 2008

In a previous post I wrote about John Bogle’s 8 rules for selecting actively managed mutual funds. That post detailed the best ways to reduce costs and maximize returns when selecting actively managed mutual funds. The best way to minimize costs and risk, while maximizing returns is to invest in index funds rather than actively managed mutual funds. John Bogle beats this into your head over and over again in his book. I’m also a subscriber to the belief that index investing is the best way to invest your retirement nest egg when comparing index funds to actively managed mutual funds.

Operating Expenses

A simple comparison of an index fund (Wilshire 5000 Equity Index) and actively managed mutual funds that have similar weightings to the index fund, will show the effects of operating expenses and the inferiority of active managers. Managers that actively track the markey should beat the market 50% of the time and lose to the market 50% of the time. The following chart compares the number of funds with the performance (gross return) relative to the index fund over a 15 year period ending in 1998.

As you can see from the bar graph, roughly 50% of all actively managed mutual funds out performed the index fund when comparing gross returns. The graph above is very similar to the standard bell curve. The only problem is that investors do not receive the gross returns. Investors only get to take home net returns, which are diminished by operating expenses. The following chart compares the number of funds with the performance (net returns) relative to the index fund over the same 15 year period ending in 1998.

As you can see from this bar graph after removing operating expenses, only 16.5% of actively managed funds provided returns greater than the index fund. Clearly the benefits of having an active manager, like timing the market, do not compensate for the added operating expenses of investing in an actively managed mutual fund.

Sales Charges

The above data does not even take into account sales charges. Any actively managed mutual fund that charges front end or back end sales charges also diminishes your return on investment. 12b-1 fees are another way for active managers to dip into your retirement nest egg.

Survivorship Bias

Survivorship bias (and as much as it sounds like a good ole George W. Bush created term like strategery) in this instance is the tendency for past mutual fund data to not include failed mutual funds. The data used in constructing the two graphs only represents the mutual funds that were liquidated or merged into another fund. Most of the time funds are liquidated or merged it is because of poor returns and the fund complex doesn’t want to keep funds with poor returns in the market. Survivorship bias most likely decreases the number of actively managed mutual funds whose returns fell short of the index fund.

Turnover Rate

Turnover rate is only an issue if you are evaluating funds held in non-tax sheltered accounts. The turnover rate for index funds is very low as turnover is only created if companies drop out of the index being tracked. The turnover rate for actively managed mutual funds is much higher as managers try to time the market or remove losers to make the fund more marketable. Turnover rates for actively managed mutual funds can average as high as 80%. Turnover rates are important in non-tax sheltered accounts as higher turnover rates lead to more capital gains taxes.

Conclusion

I’m a huge fan of index investing and believe most of your retirement nest egg, if not all of it, should be in index funds.  This is especially the case when comparing index funds to comparable actively managed mutual funds. The operating expenses, sales charges, survivorship bias and turnover rate all tip the scales in favor of the index fund. One major drawback towards index investing is that you can never beat the market. If you’re ok with tying the market, but beating the average investor, including most of your friends and family with minimal effort then index investing is for you.

* All of the data from this post came from John C. Bogle’s book “Common Sense on Mutual Funds”, which I highly recommend reading.


Free Money with PayPal and Blockbuster

August 27, 2008

I love free money and I love watching DVDs. This Blockbuster and PayPal combo deal is perfect for me. Basically, you sign up for a free two week trial in Blockbuster’s Total Access program and remain a subscriber for one monthly billing cycle, and you get $25 cash back if you sign up to pay with PayPal.

Eligibility

You must be a new Blockbuster online subscriber. I’m not sure how they define a new customer. If you are a current customer, but want to take advantage of this deal you might have to open a new account with both Blockbuster and PayPal. Also, you might have to use a seperate credit card or seperate mailing and e-mail address to qualify for this offer.

You’re required to have internet access, a valid e-mail address and a valid method of payment. I’m assuming that you have at least two of these requirements covered if you’re reading this blog. This e-mail address must be confirmed by PayPal in order to receive the cash back offer from PayPal.

You must have a current United States PayPal account. This PayPal account must be in good standing. It can’t be restricted, locked or closed.

Offer Description

You sign up for a free two-week trial to Blockbuster Online at this link. You must choose PayPal as the payment method. You agree to a two-week trial followed by one month of the standard billing cycle, however, you will not be billed until the two-week trial is complete.

To receive the $25 cash back, you must remain with Blockbuster Online while using PayPal as your payment method for one monthly billing cycle. The first day after the two week trial is considered the beginning of your one monthly billing cycle. If you cancel your subscription prior to the end of the first billing cycle you will not receive your $25. Any Blockbuster Online plan qualifies for this deal as long as you remain a subscriber for one monthly billing cycle.

Gotcha

PayPal and Blockbuster are offering this deal with the hope that people will subscribe for the free trial and the $25 cash back and will not cancel the subscription after the requirements are met. PFblog readers know that one of the best ways to reduce spending and save more is to eliminate subscriptions. If you are not interested in the Blockbuster Total Access service then sign up for the offer, enjoy your free trial, endure your one month paid cycle, cancel your subscription and enjoy your $25 cash back.

Conclusion

I signed up for the smallest monthly payment plan. I signed up for the $3.99 monthly payment plan that includes 1 DVD at a time with a limit of 2 per month. I plan on canceling my plan after the first billing cycle is over. In total, I will receive probably 4 DVDs, pay $3.99 (plus tax) and receive $25 cash back (6-8 weeks after my first billing cycle ends) for my “troubles”. In the end I will end up with roughly $21 in my paypal account and four DVD rentals without having to waste any gas in renting them. Hurry up if you want to take advantage of this free money as it ends on August 31st.


Detailing My Company’s 401k Plan and Why I Don’t Participate

August 25, 2008

I have been at my current company for two years now and have yet to participate in my company’s 401k plan. First and foremost, my company doesn’t match at all. If my company matched, I would be deferring the minimum amount necessary to receive the full match. Passing up on any portion of a company’s 401k match is the same thing as passing up free money.

Second, I didn’t have a strong need to reduce my taxable income as I will probably be in a higher tax bracket when I retire. Additionally, taxes will most likely increase in the long-term future. For these reasons, I decided to open a Roth IRA to contribute after tax dollars towards my retirement savings.

Third, I decided I really wanted to purchase a condo when my apartment lease ended. In order to meet my 20% down payment goal, I had to put all of my savings towards this down payment and would not be able to fully fund my 401k anyways. Additionally, I had to take on a second job, which resulted in self-employed income.

Fourth, in order to avoid as much double taxation as possible, it is more beneficial for me to invest in a solo 401k instead of my company’s 401k. Also, in a solo 401k I get to chose who my administrator is and what funds I invest in, which is important for my final reason to not participate in my company’s 401k.

Finally, I am not overly excited about the funds available in my company’s 401k, which is provided through ING. In the following table I have broken down the available funds, the category of the fund and the expenses of the fund.

As you can see, the expenses are much higher than what I consider acceptable. I am a huge supporter of index fund investing, which typically have expense ratios of around 0.20%. If my company did offer a match I would be able to mix and match with these funds to create an acceptable asset allocation. I would invest in some combination of the Vanguard Large Cap Value fund, ING Intermediate Bond Fund, Ariel Small Cap Value Fund and Fidelity VIP Overseas Portfolio.

The 401k also offers the equivalent of a life cycle retirement fund. The following table outlines the ING investment solution portfolios available in the 401k.

These life cycle retirement funds come with expense ratios greater than what I consider acceptable. Additionally, the stability of principal category is introduced too early for my risk preference. Also, the percent of bonds and stability of principal in the latter stages of the life cycle is too large.

All of these reasons mentioned above combine to make it an easy decision for me to avoid participating in my company’s 401k. I’ll take my chances with my Roth IRA and soon to be opened solo 401k.


Carnival of Personal Finance #167

August 25, 2008

I recently participated in the Carnival of Personal Finance #167 that was graciously hosted by Broke Grad Student. This was my first carnival and I’m hoping to see some sort of traffic spike and maybe a new subscription or two, but I also realize I’ve been blogging for less than one month, so my expectations are tempered.

Broke Grad Student is a recently graduated grad student who had $22,000 in student loans. BGS blogs about the adventures of balancing the repayment of student loans with other financial ambitions. I enjoyed the small amount of the blog that I read and would recommend it.

Here were a few of my favorite blogs from the Carnival of Personal Finance:

  • Alpha Consumer blogs about how much bloggers make in varying stages of development.
  • Fire Finance details the YAWN philosophy to becoming a millionaire.
  • Realm of Prosperity explains how to set up an automatic savings account at HSBC.
  • Money Smart Life breaks down the pros and cons of students with credit cards and some smart options.

Now that my first carnival is out of the way, the next milestone is submitting an article that is selected for editor’s choice.


8 Rules for Selecting Actively Managed Mutual Funds

August 25, 2008

I’m currently reading John C. Bogle’s book, “Common Sense on Mutual Funds”. In his chapter on simplicity he stresses a buy and hold investment strategy to best keep pace with average market returns. To attain as close to average market returns as possible, Bogle recommends simply owning the entire U.S. stock market via index fund, holding asset allocation constant and minimizing transactions. Bogle makes a very compelling argument for investing your retirement funds in index funds over actively managed mutual funds. He claims only one of every seven actively managed mutual funds outperforms the market index after taxes. Bogle outlines 8 simple rules if you do decide to go with the actively managed mutual fund investment route.

Rule 1: Select Low-Cost Funds

Bogle argues that the expense ratio is the most important factor in the performance of a fund’s overall performance. It’s pretty simple really, high cost funds have to achieve a return equal to the difference in expense ratios just to obtain the return of a low cost fund, with all else being equal. With the unpredictability of a mutual fund’s performance, starting at a disadvantage equal to the difference in expense ratios is just plain unintelligent.

Rule 2: Consider Added Costs of Advice

This rule is extremely similar to the first rule. Many mutual funds have loads associated with the purchase or sales of shares. There is absolutely no reason to purchase a load fund for the same reasons mentioned in rule one. If you absolutely have to purchase a load fund, at least maintain the fund for a reasonable period of time, as the longer you hold the fund, the more you minimize the effect of the load fee.

Rule 3: Beware Past Fund Performance

For various reasons, statistics show that past performance of mutual funds does not provide an indication of future returns. Bogle states that two forecasts can be made about future returns. First, he states that funds with really high expenses are likely to underperform the corresponding index. Second, he states that funds with substantially superior returns will regress towads the market mean.

Rule 4: Use Past Performance to Evaluate Consistency and Risk

Bogle does recommend using past performance to evaluate the past consistency and risk of mutual funds. The past consistency and risk of a mutual fund is indicative of future consistency and risk. Bogle recommends selecting mutual funds with consistent results and risk along the lines of what has been determined acceptable for each individual. Morningstar provides the necessary data to study the past consistency and risk of mutual funds.

Rule 5: Beware of Star Funds and Manager

Bogle recommends staying away from “star” mutual fund managers. The average portfolio manager remains with the fund for five years. Considering retirement savings takes place over a much longer time period than five years, following a mutual fund manager can become quite costly due to fees from switching funds and does not gaurantee sucess. Additionally, the mutual fund managers that have had staying power and great success such as Peter Lynch, were unknown until after providing that great success.

Rule 6: Beware Asset Size

The asset size can severely limit returns for mutual funds. There is no magic asset size that is too large, as a fund investing in large cap stocks can handle more in assets than a fund investing in small cap stocks. The reason for the diminished returns with increasing asset size is that it becomes harder and harder to manage the assets. Either the manager has to find more stocks that will provide above average returns or the manager has to invest more assets into the same stocks. Making large stock purchases or sales results in an increase and decrease in stock price, respectively. The change in stock prices diminishes returns. Bogle recommends avoiding funds that have no history of closing funds to new investors or appear willing to let funds grow regardless of size.

Rule 7: Limit Number of Funds

Bogle provides a statistical analysis from Morningstar Investor that analyzes the effect of the number of funds on risk. Adding more than four funds does not reduce the risk by a significant amount. Adding more than four funds does not diminish returns, but Bogle recommends a four or five fund investment strategy to maintain simplicity, while minimizing risk.

Rule 8: Buy and Hold Funds

Bogle recommends a buy and hold strategy to maintain simplicity and reduce costs. He argues that if you select your mutual funds correctly to begin with, rebalancing once a year is all that is necessary to maintain your retirement portfolio. Barring a major event such as the introduction of new fees, merger of its management company or change in investment policy, Bogle recommends a buy and hold strategy.

Overall, Bogle recommends investing in a total market index fund. His 8 rules for selecting actively managed mutual funds tend to make your retirement portfolio as close to an index fund as possible. I personally believe index funds are the way to go when investing for retirement, but if you’re the type of person who believes that the intelligence of a mutual fund manager can outperform the market, these 8 rules will help you select a decent portfolio of actively managed mutual funds.


Double the Taxes for Self Employed Income and Social Security Wage Limits

August 20, 2008

Ever since I started working as a summer intern, I have always been depressed to open up my check and see the amount of my salary that was going towards taxes. Currently, 29.2% of my salary goes straight to the government. The majority of my taxes are federal income taxes, with social security tax and state income tax coming in second and third. Medicare taxes are a distant fourth. The magnitude of the downsizing of my income due to taxes is even more readily apparent on my self-employed income.

Double the Taxation

As a part-time self-employed contractor, I am responsible for federal and state income taxes, as well as a double taxation on the Federal Insurance Contributions Act (FICA) taxes, social security and Medicare. The employer and employee are each responsible for paying half of the Medicare tax and social security tax. As a self-employed contractor, I am responsible for both the employer’s and employee’s portions of the Medicare tax and social security tax. This double taxation is the major reason why I set the goal to put all of my self-employed income into a solo 401k. I wanted to defer the taxes on my self-employed income, since it will be taxed at such a high rate due to this double taxation.

Breaking Down the Tax Rates

The combined tax rate for the FICA taxes is 7.65% for regular income and 15.30% for self-employed income in 2008. The social security portion of the FICA tax is 6.20% for regular income and 12.40% for self-employed income in 2008. The Medicare portion of the FICA tax is 1.45% for regular income and 2.90% for self-employed income in 2008.

Social Security Wage Limit

The Medicare tax has no income caps, however, the social security tax has an income cap of $102,000 for 2008. This means, that if your combined income exceeds $102,000, the portion of your income above $102,000 is not subject to the social security tax. This is a very critical income cap to exceed if a portion of your income is self-employed as you are saving 12.40% of the taxes on your income, instead of just 6.20%. The wage limits for the social security cap increase yearly based on a Cost of Living Adjustment (COLA). The following table shows the increases in the wage limits over recent years.


As you can see, the wage limit has increased every year since at least 2000. The average increase in the wage limit is 3.7%, however, the average COLA is 2.8%. The difference in almost one full percentage point means that if you are getting annual salary increases that match the cost of living, you are falling further behind the wage limit and further away from decreasing your tax rate on your self-employed income.

Conclusion

Currently, my salary does not exceed the wage limit, and I don’t make enough self-employed income to fret too much over this ever increasing wage limit. I have thought about trying to extend my self-employed income as a tutor, however, I am about a year away from trying to do that. The wage limit is definitely something I’m shooting for as it is critical to self-employed individuals and I’m hoping I have significant self-employed income in my future.