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Tuesday, April 20, 2010

Financial Chess

Tomorrow I will make another financial chess move.  We are refinancing the mortgage on our house, to a super-low interest rate, at a shorter term. We close on the deal in the morning.  My father often criticizes me for “always worrying about money,” but discovering a financial advantage and having the guts to take advantage of it have been the ways in which I have gained my economic freedom.

During the nadir of the financial meltdown in March 2009, I was smart enough not to panic, even though I worried about my investments and what my wife and I had achieved, in stock gains, over many years.  As the market came back over the past year, I vowed to take into account that worry.  I sold stock, and Laura and I decided to use those gains to pay down our mortgage and so shorten the years of our mortgage debt.

When I was younger, I had almost 100 percent of my investment money in stocks, stock mutual funds, and only an emergency fund in bonds.  As I have gotten older, and with the experience of 2009 fresh in my mind, I have realized I want to preserve more of what I have, and not to focus only on growing it.  So I adapted.  Adapt or die, I say, to any would-be investor.

Yet the bonds I have purchased have been on the short-end of the yield curve, because I expect interest rates to go up.  They can hardly go down any further, so the best bet is that they will either stay stable for a while, or go up.  When interest rates go up, the prices of bonds go down: an inverse relationship.  So any bond that is long-term (i.e. greater than ten years) will be hurt more by a one percentage increase in interest rates, than a bond that is short-term (less than three years, or just one year).

Another financial chess move I have made over the past three years is to increase my foreign stock allocation.  When I teach an investment analysis course, I always give my class the current total stock market capitalization of the world, and what portion belongs to the United States.  Since the 1970s, the American share of world stock market capitalization has declined.  The world outside the U.S. is growing faster than the U.S.  Brazil, India, China, and South Korea are great growth stories.

Even individual American companies I purchase for my portfolio I examine in light of their foreign revenues: companies with their eyes on foreign markets will simply have less of their eggs in one (domestic) basket.  If you think our budget and trade deficits will have a negative effect on the dollar (I do), then you will benefit by having companies earning their revenues in Euros, Yuan, Won, and Yen.

I also expect taxes to go up.  Why?  We have these gigantic deficits and lack the political will to tackle spending on entitlements and the military nationally, and on state and city government budgets and bureaucracies locally.  I blame both Republicans and Democrats for this situation, and think they will come together when they are forced to come together.  Crony capitalism on Wall Street and dysfunctional politics in Washington have left us in a mess, but I don’t think it’s the end of the world.  I believe the Tea Party activists are overstating their case.  I see reported profits for S&P 500 companies higher than expected, and perhaps there is a chance we can grow out of this deficit hole.

Right now I would vote for Obama again.  Why?  He has been pragmatic when faced with the economic cleanup of the Bush mess.  Obama has forced consumer protections on credit-card companies and is actually regulating, as the government should, the practices of financial institutions which drove the American economy into a ditch.  The laissez-faire, I’m-a-deregulator philosophy of Bush allowed the powerful to take advantage of the weak and uninformed, and the well-connected to seek a public bailout when their crazy risks exploded in their faces.  And ours.  We can’t let that happen again.

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