Should I Pay Down My House Early If I Can?

Assume you just inherited a bundle of capital from your long lost uncle and you could pay off your house today; should you do it? I don't think there is really a right answer to this question, but what I will do here is walk you through how I think about it.

First, what is the current rate you are paying on your mortgage ? Take this rate and then multiply by 1-your tax rate. This should be your after tax cost of debt. So let's say you have a fixed mortgage at 6%. If you are in the 25% tax bracket then your after tax cost of debt should be 6% * (1-25%) or 4.5%. You need to have a safe investment that has a better after tax return than to justify not paying off your house.

Next, consider your investment options. I would look only at nearly risk free investments. For instance 10 year treasury bonds trade at 4.58%. Multiply this by (1-25%) to find your after tax return which would be 3.43%. Based on this analysis you are better off paying your house off than putting money into 10-year treasuries because you get an after-tax risk free return of 4.5% by doing it. Likewise, it looks like most CDs don't have enough of a yield today to suggest that you shouldn't pay off your house.

But what about putting the money in the stock market? After all doesn't it return 8% or so on average? In general the answer is yes, but the reason that you get an 8% return instead of 4.5% from treasury bonds is that there is more risk associated with this decision. In general if you were to just invest the money and pay off the house later you should be better off in the long run. However as a conservative Armchair Fiduciary, I feel like doing this would be taking too much risk. You can always pay off the house and then take what you would have been paying in monthly payments on the mortgage and invest it in the market. This may lead to somewhat less long-term wealth on average, but it is the much less risky option in my opinion. Better safe then sorry in my opinion. Got a better idea? Leave a comment.

Scalable Professions: Big rewards for the same amount of work

I recently read an interesting book called The Black Swan by Nassim Nicholas Taleb. Most of the book centers around the concept of fat tails. It is a bit of a dive into philosophy as well, which in my humble opinion made it tedious in parts. Overall though, it is a great read if you have some spare time. One part that was particularly interesting was a discussion about "scalable professions." Scalable professions are the ones that have big upside for the same amount of work no matter how many zeros start to follow the first $.

As I was browsing the Forbes 400 this weekend John Arnold struck me as the quintessential example of someone with a scalable career. At 33, he was the youngest member of the Forbes 400 this year. He has parlayed some good success in his Enron days and $8 million that came with it into a rather large fortune of $1.5 bil; greater than the GDP of Sierra Leone (population ~6 mil). John is an energy trader and his profession is highly scalable since it would require roughly the same amount of work to run a $100k portfolio as he would to run his $3 billion Centaurus Energy portfolio.

Non-scalable professions include dentists, doctors, and pretty much any profession where the rewards are directly tied to the time you put in. Taleb points out that it is the existence of scalable professions that has led to such a lopsided distribution of wealth in the world. It really does make one wonder. What happens when no one wants to be a doctor, or a lawyer, or a teacher because they could use their time and effort to get into more scalable careers? I don't have any profound answers as to what should be done about wealth distribution worldwide (though Jeffrey Sachs does) or how we keep people motivated to enter necessary but non-scalable professions, but if you do feel free to leave them in the comments. If you have some time read The Black Swan and spend a few minutes thinking about it.

Brain Candy for Economics/Finance Geeks: The Economist

One of my favorite publications is the Economist. I think it is better than the New Yorker, New York Times, Wall Street Journal, or Financial Times. While it isn't cheap at about $100 per year if you get a good subscription deal, I do think it is money well spent.

The top five reasons I like the Economist are:

1. Global coverage. Unlike most US-based publications the Economist reminds me every weekend that we live in a big world with many countries and points of view. George W. Bush would have been well served if someone forced him to read the Economist each week since he has been in office. Or, at the very least, he might not make so many mistakes when giving speeches.
2. A focus on the big picture instead of the day to day (a benefit of being a weekly publication).
3. A balanced mix of poltical and business coverage. I generally hate politics, but these guys usually put an interesting financial spin on what is going on.
4. The Science & Technology and Books & Arts sections which help keep me from being a total economics/finance dullard.
5. The Big Mac Index. Gotta know how much it costs to kill yourself in nearly 50 countries.

So if you are intrigued pop over to their subscription page and sign up for the free 6 week trial they are running right now. You won't be sorry. (Note: Armchair Fiduciary gets no personal financial benefit from you signing up for the 6 week trial; this link is merely provided as a service to my readers.)

Life Insurance: Do You Need It? What Kind? and How Much?

Life insurance is one of the more unpleasant things in life to think about. No one wants to imagine being hit by a bus. However, these risks are a reality and you should view life insurance as "income protection" insurance in the event of an untimely death.

When do I need it?
For most people the time to start thinking about life insurance should be about the same time they start thinking about having kids. After all, if you are single or newly married to a spouse with significant earnings potential of his or her own, no one is likely to miss your income too much if it suddenly goes away. However, when there are little mouths to feed, that's a different story. With lots of expenses including food, housing, healthcare, and education there are lots of things that little ones couldn't cover if you weren't around. The time to buy life insurance is when you are trying to concieve.

What kind?
Generally the only kind of life insurance that makes sense if you are trying to insure your income is term life. Term life provides a fixed payout in the event of your death for a fixed fee per month or year for a fixed period of time (i.e. 30 years). When the 30 years is up you have no insurance anymore. If you have been socking away money into your retirement account this should still leave you with a healthy nestegg if you have a problem after the term insurance expires or at least that is the goal. Most other kinds of life insurance (like whole, or return of premium term) are more akin to investment vehicles and while they may make sense for some people, they generally don't if you are young and just trying to protect your family. These other products can sometimes offer coverage until you die regardless of how long it takes.

How much?
I'm still trying to figure this one out. I have heard a general industry rule that says you should by 6-10x your annual income. The way I am thinking about it today is how much income does each person bring to the family today? Are we living comfortably off that income (or will we be when the munchkins arrive)? If so, then you should generally look to buy a policy that could provide that level of income from day one assuming conservative investment returns. So if you make $75k per year and you are getting a 30 year policy you want a policy that will assuming very conservative investment returns like 5% be able to produce $75k income per year (with some room for inflation at maybe 3%) for 30 years from investment gains and principal reduction. If you manage to live beyond day one of the policy that's a good thing and you will be more than covered, but if you don't at least your family will be taken care of. In the example above the amount required would be $1.65 mil in coverage, that's significantly more than the rule of thumb, but my assumptions are probably a bit hyper conservative. I have included the spreadsheets I used here in openoffice and excel formats. Just click on the format type to download. Once you know how much insurance you need, go get quotes on some policies at IntelliQuote.com.

Get Your Grocery Bag Rebate!

The Armchair Fiduciary spent the last week in Ireland on vacation. One thing that is abundantantly clear is that the Emerald Isles are green in more than one way. The landscape is, of course, incredibly green after what appears to have been a summer full of nothing but rain according to Irish radio stations. However, what is also clear is that this is a country full of recyclers. There are blue and red and green bins everywhere to recycle pretty much everything. Indeed, on a trip to the grocery store I discovered that they don't even offer grocery bags. You are supposed to bring your own. If you do want a bag you have to pay for it (I think it is a government levied tax). Now my hat isn't totally off to the Irish. I'm not entirely sure this policy is having the ideal effect because it seems like everyone makes 1,000 trips to the grocery store per week with only one bag in hand. What they are saving environmentally by using less plastic bags they are probably spending in gas for all those trips.


However, this got me thinking. Indeed bags probably do cost grocery stores a lot of money. In the U.S. how simple would it be for a grocery store to offer you a rebate to bring your own bags (the 10 a typical once per week U.S. shopper has)? The rebate could even be slightly less than the cost of the bags so it would be win-win for the store and the customer. Well the green geniuses at Whole Foods have already thought of this. If you bring your own bags to Whole Foods they will give you a 5 cent per bag rebate. Why doesn't every grocery store in the U.S. do this? This is a no-brainer. Write your local grocery store (if you can't afford only Whole Foods) and lets start saving some money and the environment people!