Investment Update

On Thursday, after the Fed announced a rate cut and indicated future rate cuts were on a hiatus, the market reacted unexpected, crashing after about 30 minutes of upward momentum. I thought this was the wrong way to react to such a positive economic indicator, and I bought more Dow Jones Industrial Average ETF Call Options.

Today, the market thought about the news, and reacted very positively, ending over 13,000! This helped me make a quick one-day profit. The following is my current position:

In the month of April, I've netted $555.24 in trading profits, or about 6.5% of my original loan, surpassing my monthly 6% return goal.

I will be taking my profits out around middle of May to pay back principal, and fees on the loan.

Borrowing cheaply to fund investments - Pt. 1

Yesterday I talked about the possibility of using the cheap loans banks have been offering to fund investments. Based on an offer of $8,500 for either a 6-month loan at 0.99% or a forever loan at 6%, with a 3% fee on each, here are the numbers:

Instead of accounting for the "forever" loan, I just assumed a 36-month loan. Taking into consideration the interest rate and fees, choice 1 is clearly the lower costing loan.

However, just because the dollar cost is lower doesn't mean it is actually better. The 36-month lower has a lower required return rate of 4.25% compared to a return rate of 6.78% for the 6-month loan. Risk is increased greatly whenever higher returns are required in a shortened time frame.

While either return rate is doable in a normal stock market, given the current economic environment, I am leaning toward a longer time horizon. The smaller per month payment also allows me to payout of my pocket earlier on, before I've started generating any real investment income.

Tomorrow, I will work out what I need to make in order to make this venture worthwhile.

Can debt be good?

The classic answer to any finance question is always, "It depends."

Consider Chief Clancy Wiggum (PS - I love the Simpsons). Clancy probably makes about $55,000 a year, plus the fringe benefits of all-you-can-stuff donuts and coffee. He's faced with a tough decision: He wants to join a gym, but gym membership costs $200 / month, and he'll need to pay for 12-months up front.

He can: A) Save up $2,400 and pay it in cash, B) Put it on his credit card with a high-interest rate, or C) Find some mix of A and B.

If he goes with A, it can take quite a while before he gets that much money, and in the meantime, he may end up spending that money for other things.

If he goes with B, he runs the risk of maxing out his credit for what isn't necessarily essential, and paying high-interest rates.

If he goes with C, there is a lot of headache time, as he figures out what he can do. But, it gives him time to weigh (no pun intended) how much time he is willing to wait before getting the membership and how much the credit cards will charge.

But, Clancy may even have a plan D. Say Homer Simpson finally comes up with his killer invention that will make the family millions, but he needs a small loan to get it going. Homer goes to Clancy and says, "Hey, I'll pay you 20% APR for $2,400" If Clancy has a good credit rating, his credit card APR will probably be about 16-18%. Now Clancy can loan the money, go to the gym, and still make money off the 2-4% APR difference!

It's called making your money work for you. On a side note, I once interviewed with a wealth management division of a major bank. In our discussion, we talked about how much money it would take to before the bank will do business with you. Their lowest rank started at $100K cash.

I mention this because many of these rich folks have their money fully invested in the bank, and actually take out loans to pay for items such as cars and homes. Many times, these people are making 10% returns on their money. When they need money, the bank loans it to them for about 7%, so the customer is still making a 3% return on the money he spends (the difference between what he has invested and what he borrows)!

To answer my initial question: Debt can be both good and bad. Having a little is always good; having too much is always bad. Being debt-free is worry-free, but you're not putting your money to work.

Another Strike Against My Goal

As I get closer and closer to my first job, I've realized there a lot of expenses involved. Some of them are necessary, ie. suits, computer, etc. Others are just because I suddenly have more money that I've ever had before coming to me, ie. car.

Oh yea! But not just any car. Just like any 22 year-old, in the words of Ricky Bobby, "I wanna go fast."

I've got my eye on this beauty:
the new 2007 350Z.

MSRP with the options I want? $36,500. It's red cause its going to decrease the speed at which I reach my goal.

Now why I do tell you about it? Well for one, its a really cool car. But, more to the point of my blog, is to discuss the financial considerations that go into a car purchase.

When it comes down to it, cars are terrible investments. Few cars appreciate in value. But we have to have them. So what should go into the calculations in getting a car?

Things to Consider

1. Sticker Price of the car - the most obvious expense is the upfront cost of the car
2. Maintenance costs - regular oil changes, tune-ups, tire rotations, etc.
3. Gas - its expensive now, and there's no real end in sight. This can really add up.
4. Insurance - the faster, sportier, more luxurious it is, the more you'll pay
5. Other expenses - such as taxes, parking fees, car wash, etc
6. Resale value - the only real return. Most experts would say you lose 20% of the car's value just by driving it off the lot.
   

Once you add up 1-5, and then subtract 6, you'll find your real cost to own the car. But that's assuming you can pay for it all. If you need financing, you'll probably add at least another 5% to the total bill.

How Does Financing Work?
There are a few terms you should know before you get into any kind of financing:

• Loan Term - how long you have to pay back the loan, usually listed as number of months
• Interest rate - your annual rate to borrow is. This rate, divided by 12, is the interest rate you are charged every month.
• Principal - the amount you actually borrowed
• Down payment - how much you need to pay of for the car before the bank is willing to loan you the money

On loans in general, and car loans more specifically, a down payment is necessary to assure the bank that it can make some profit off the loan if you were to default, that is, be unable to pay off the loan.

A complex formula is used to determine your monthly payment. You can find a calculator here. Essentially, every month you are paying a portion of the principal as well as interest. Initially, you will be paying much more interest than principal. As you get closer to the end of the loan, more of your monthly payment will be devoted to principal.

A lot of people would suggest paying off loans as quickly as possible, to avoid the interest payments. However, I come from a school of thought that there is never a single right answer for all circumstances. Sometimes, a little debt is a good thing.

Are you unsure about when you should pay off debt? Feel free to leave a comment for me to address.