8 Big Picture Budgeting Tips

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Budgeting can seem like a mystery to many people, when it’s really very simple.  While this may seem basic to some, these represent principles that I describe in many of my other more detailed posts.  These 8 tips to help you develop a successful and realistic budget, can also help you to start thinking about your finances more successfully:

A budget’s primary goal is to result in ideal allocation of capital for yourself or your family. Oftentimes when we don’t pay close attention to where our money is going we wind up spending money in places we don’t need to and go without in places where we do.  This is simply inefficient.  Imagine for example if you wind up spending $100 on a nice dinner but then deny yourself a $100 kayak, which you would have much rather had.  Ultimately a budget can help you make sure that your money winds up where you want it.

Get your expenses in front of you. To start the budgeting process, get everything you can in front of you:  Credit card statement, bank statements, all your bills and anything else that gives you a picture of your financial situation.  The more complete your picture is of your expenses, the more likely you are to draft a realistic budget.

Re-examine your bills. One great way to help improve your budget is to look again at all your monthly bills.  For example, you might be straining to save an additional $15 per week and you might find out that simply by making a bundling agreement, you can save that much on your phone and television.  These kinds of savings can often come at no cost, or even with an improvement in your lifestyle.  You also should look at your bills with a mind toward capital allocation.   While $30 per month may not seem like much for a game you enjoy playing, would you rather spend that $30 on something else?  If so, reallocate your capital. (more…)

Can We All Just Agree That Price Controls Do Not Work?

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Laying some groundwork for a future post, I wanted to have a quick discussion about a topic that amazes me as a complete disconnect between reality and policy.  Price controls have been suggested as solutions for everything from food shortages, to black markets during sieges; but they have an amazing history of achieving the exact opposite of their intent.  In a recent example, Hugo Chavez has attempted price controls in Venezuela, with disastrous results.1 Before I start talking about some other policy issues, I want to make sure that we all agree that price controls simply do not work.

What are Price Controls?

Price controls are when some entity, typically a government, tries to externally set the price of something.  We most often see this in the form of price ceilings where the government tries to set the maximum price producers can charge for something.  One very common example of this is rent control.  The government doesn’t want property owners “gouging” their tenants, so they set a variety of rules on what the landlord can charge. As we will see, this never has the desired effect.

Keeping It Simple

What price controls advocates never seem to accept is that changing the price of something doesn’t affect the supply of that thing.  The government can say that all Ferraris only cost $50, but that doesn’t mean everyone can have a Ferrari.  In fact, Ferrari will immediately stop producing them.  The purpose of markets is to make sure that resources get to the people who want them the most.  Keeping prices low leads to overconsumption, inefficient allocation of resources, discrimination, and disincentive to increase supply.  Let’s look at some simple examples:

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1. BBC News – Venezuelan Shoppers Face Food Shortages [↩]

The Problem with Uncertainty

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When it comes to government policy it is rarely acceptable for politicians to do nothing.  Even if it’s only to give the appearance of doing something and instilling confidence, the government actually does have a role to play.   While there is certainly a case for stimulus and crisis management, too much government intervention can completely upset the whole purpose of free markets.  Even worse, the fear of government intervention can inject the same uncertainty in the market that it is supposed to help assuage.

The 2008 Crisis

In retrospect there is a lot of criticism about the TARP-the Troubled Asset Relief Program.1 Some politicians complain that the prices paid for the equities were too high.  This criticism is somewhat problematic, since the whole purpose of the TARP was to pay more than the market was willing to pay for distressed banks.2 Others claim that it was unnecessary, and that the market would have sorted things out itself.  These criticisms conveniently forget the abject panic that had beset the markets when the idea was put forth.  There was a tremendous amount of uncertainty as to whether the banking system was going to completely collapse and how the world would react.

With all its flaws the TARP may very well have injected some confidence into the market.  The same can be said of Obama’s sweeping stimulus.  Investors and businessmen knew that a large dose of spending was coming and had broad ideas about what it would include.  Economists may argue, but a case can be made for all these changes, particularly when they’re done quickly and in a sweeping fashion.

The Problem

The problem arises when the government becomes a first resort instead of a last resort.  When people expect the government, instead of natural forces, to correct all the ills of the market, uncertainty is sure to follow.  The government can’t do everything, so the economy becomes a guessing game of trying to determine which programs the government will implement.  Even worse it can become a hotbed of cronyism, where the supporters of those in power get bailouts and the rest watch despairingly.

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1. Wall Street Journal – Panel Steps Up Criticism of Treasury Over TARP [↩]
2. The Economist – Carping about the TARP [↩]

Is the Mortgage Crisis Over?

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The mortgage crisis was clearly one of the dominating catalysts of the recent economic fiasco.  While many other factors contributed, this was one of the most visible and visceral to most people.  Thus many people, particularly homeowners, are now wondering whether they can breathe a sigh of relief.

How Did We Get Here

By now we’re largely aware of the underpinnings of this crisis.  Demand for securitized debt led to tremendous demand for mortgages.   This demand led to lowered lending standards, which led to tremendous demand for housing.   The demand for housing led to soaring housing prices.   When those with the least capacity to pay their loans, who incidentally had the most onerous terms to their loans, couldn’t make their house payments, the whole house of cards came down.  Foreclosures led to dropping housing prices, which led to more defaults, which continued the cycle.

The Subprime Crisis

During all of this we were told the mortgage crisis and the subprime crisis was one and the same.  Many people equate the end of the subprime problems with the end of our troubles in general.  This leads us to wonder if the subprime crisis is truly over.  Signs suggest that this is the case.1 After huge surges, the default rates on these loans have come down sharply, leading many to suggest that the crisis is over.  Of course, that depends on which crisis you’re discussing.

The Real Crisis

Subprime loans may very well be dropping in their defaults, however that statistic neither creates an increase in demand nor says anything about the impending wave of defaults in other types of mortgages. Falling home prices put everyone underwater increasing the chance of defaults across the board.  Although many people who bought houses during the boom bought them with subprime loans, many more did not. (more…)

1. Deutsche Bank – Subprime Chart [↩]

Treasury ETFs

Photo by: Ryan McFarland

U.S. Treasuries surged in popularity during the recent crisis.  In fact at one point people were so anxious to buy up treasuries that the short-term yield dropped to 0%.  At this point Warren Buffet emailed his directors:

This should be bullish for Berkshire. With great foresight, I long ago entered the mattress business in a big way through our furniture operation. Now mattresses have become fully competitive as a place to put your money, and sales will soon take off.1 

People were anxious to find a safe place to put their money, which is one of the strong suits of U.S. Treasuries. 

Treasuries have a very different risk profile than many other investments.  There is a very low risk of default compared to other types of bonds, but you are exposed to risks like inflation.  ETFs can provide a way to introduce this risk profile into our portfolios more easily than actually buying the bonds.  There are several ETFs which allow you to do this and many concepts that can be pivotal to understand before doing so.  

Understanding Yields and Prices

Bond prices and yields can be a bit opaque to those without experience; however they are a fairly simple concept.  When a bond is issued, it pays a certain amount and has a certain cost.  Say for example I buy a $10,000 bond that will pay me $300 per year.  Thus it yields 3%.  Now many would think that since the bond will repay my $10,000 at the end of its life, it would be a risk-free investment.  However suppose that interest rates go down at that 3% becomes more attractive, people will be willing to pay more for that same bond.  As the price goes up, the $300 per year becomes a smaller fraction and the yield of the bond goes down.  Meanwhile if interest rates go up, my bond becomes less attractive and the price will go down.  

This is very important when considering inflation.  Generally if inflation is high, you will see higher interest rates.  As such in an inflationary environment, bond yields tend to increase, meaning the price of any bonds you own may very well go down.  This means that the term of the bond becomes very important.  While over a short period of time, inflation may be predictable; over long periods any number of things can happen to affect interest rates.  Obviously because of this, longer dated bonds tend to pay higher yields.  

Treasury ETFs

There are many treasury ETFs and will likely be many more in the future.  Some of the more popular ones include:

TLT – Long Term Treasuries (more…)

1. Forbes – Buffet Bets On Mattresses [↩]