Wednesday, February 27, 2008

Buying a Home – an In-Depth Look at the Process

Buying a home is probably one of the more major decisions in our lives. I’ve decided to buy a home about a year ago. After a long and tedious year I can gladly say I’m writing this post from my new home. The process of buying a home is tedious, long and difficult both physically and mentally. It can be a bit easier with experience but I don’t think it changes much when you buy your second home later in life. It’s just the way it is.

A year ago my wife and I decided we had enough of renting. We sat down and looked at our options and the process we’re about to go through. We had little knowledge and experience but we compensated for it with common sense and hard work (as everything in life).

You can find your dream home in a short period of time and maybe even get a good deal on an asset with future potential but this is definitely not the case most of the times. That’s why hard work is so important and cannot be replaced.

We eventually bought a 3 bedroom apartment in the heart of the city in a very central location. We renovated it and now live happily in it completely at peace with the choices we’ve made. We had our differences and difficult moments but I can truly say it was worth it.

In order to write a useful post on buying a home I’ve looked back and examined the process we went through phase by phase. I’ve tried to emphasize the more important aspects of it and what could be my added value to you as readers.

The following breakdown of the process is what I came up with eventually:

#1 Considering your personal status

This very basic first step is usually intuitive and happens whether you’re aware of it or not. Buying a home has a lot to do with your personal status and plans for the future. No use buying a 3 bedroom apartment if you’re expecting your family to grow in the next 6-9 years. Buying a home is a major decision usually taken by couple that reached a certain level of commitment in their relationship. My advice in the matter is to carefully examine your current and future personal situation. There is no need to rush into buying a home if you are unsure of anything.

When buying a home your expenses are never ending and will amount to much more than the price of the asset itself. You won’t get the money back if you decide to sell the house after 1 year. Actually you’ll have to pay to close another deal. Think carefully on how ready you are to go through with the process.

As I’ve already written this happens intuitively and most of the times on an unaware level. Being aware is always better and taking 5 more minutes to think things over might save you a lot of money in the future. You could always rent for a couple more months before you commit.

#2 Getting a good grasp of your budget and financial capabilities

you’re dream home will always be one you can’t afford (well, almost always). Deal and closing costs can amount to 3%-5% of the price of your home (Real-estate agents, lawyers, taxes, paperwork and more). Renovation is another bottomless pit. When I finished work on my home and moved in I was over my budget by approx. 10,000$ which took me 5 months to recuperate from. I don’t really think you can stick to your initial budget, much like any project. However, it is important to keep track and monitor your financial ability at all times.

Consider your ability to pay back mortgage payments carefully. How fixed is your income? How much can you afford to pay back each month? Mortgage payments, in general, should not be more than 30% of your monthly income. Avoid biting on more than you can chew.

Buying a home is a complicated financial deal which requires leverage (mortgage and loans) with many implications (Read more about leveraging risks and benefits here). Plan your budget carefully and leave room for error. You will end up buying a more expansive house than you hoped for. It’s natural since you’ll be looking at the better part of homes you’ll be able to afford. Just be aware of your limits and capabilities.

#3 Rent or Buy?

The eternal question of rent or buy has been discussed in length. I’ve personally written two detailed posts on the matter:
1) Should you Rent or Buy a Home ?
2) Understanding Important Hidden Psychological Aspects of Rent vs. Buy Comparisons

Many rent vs. buy comparisons are simply wrong. The financial comparison is not a simple matter at all. The subject of rent or buy deserves some attention and you should get knowledgeable in the financial reason behind it. Two thumb rules to satisfy any immediate appetites:
1) The more equity you have the more financially reasonable it is to buy a house (not always, naturally).
2) The real difference in the comparison comes from your expectations on the future value of your home. As buying with a mortgage is leveraging you will make a decent profit on money you didn’t have to begin with should the house price rise significantly (again, more details in the posts I linked to).

#4 Location, location... location

Location probably affects the value of your home more than any other variable, either real and current or potential. Location cannot be over emphasized. Location is affected by many other considerations such as closeness to family members, public services, personal preferences and more.

Sit down and think about your preferences. Consider your current and future personal status as always. If you plan on having kids soon you might want to consider a property closer to your parents or good schools for example. Are you a city or country person? Do you mind traffic? And so on and so forth.

If you’re buying a house with a partner agree on your mutual preferences together.

#5 Research

Once you’ve decided on location preferences you need to start researching. Usually several areas (neighbourhoods, districts, cities etc.) will fit your preferences. In order to be a smart buyer you really need to start researching each and slowly yet surely narrow down your search.

Each housing market is different. Properties within several miles can have different price behaviour and different characteristics you need to be aware of. Be familiar with price levels, future potential, trends and even the branding of the environment.

Needless to say research should also include all the aspects of living: public services, neighbours, crime, traffic, taxes, comfort, available leisure activities and much more. Don’t be afraid to ask around. People will be eager to help and answer questions. Sometimes small talk with a future potential neighbour can expose crucial information.

#6 Footwork

Good old fashioned footwork (or car work) cannot be replaced. Take the time to compliment your research and choices with thorough explorations of potential properties and areas. I’ve visited over 20 properties in 3 cities before I decided on buying one.

Footwork is required in order reach a level of readiness to buy a property. I’ve never heard of someone who bought the first property he saw. As human beings we will always consider what we are missing on.

The process will often yield surprising results and end in new revelations on your earlier preferences. Seeing many properties adjusts your expectations and your wants and wishes. You’ll realize what you find really important and what you only thought you like but really is just redundant.

#7 Making your choice

After setting your preferences, researching and exploring it is time to narrow and zoom in on: an area, a type of property, personal preferences and more. This will happen naturally it helps to make a conscious decision. Only by narrowing the scope of your search scope will you be able to really be familiar with the property or properties you are about to bid on. It is impossible to get to know 30 properties in 3 different cities each with its own characteristics and housing market.

Without focusing and making a choice you’ll probably continue drifting through the endless amount of properties out there.

#8 Getting professional assistance

I can’t stress enough how important it is to get professional assistance when buying a home. Real estate agents, lawyers, accountants and more are called professionals for a reason. The real estate world is complicated and requires expertise.

Real estate agents can save precious time and help with locating the best assets for your budget. They live and breathe the market and exist because such professionalism is required. A good lawyer can help complete a deal quickly and without risks. You really need the best protection you can get when dealing with a huge expanse such as buying a home.

#9 Negotiating

Negotiating is a very valuable skill. I seriously doubt it can be taught (I myself am a lousy negotiator) but understanding some truths can really help you. Each percent in this deal is significant and well worth the effort.

First of all, be aware the seller has one advantage from the start. He named the price. When you think of it we, as buyers, often treat the seller’s price as a point of reference other then deciding for ourselves what the right price to pay for a property is. Shake off the seller’s price and get a good idea of what the real value of the property is to you. Getting 5% off a property priced at 110% isn’t a good deal.

A significant portion of the negotiations gets done through professional real estate agents. Be aware of their interest in getting the deal closed and use their skills to your advantage while not letting them pressure you into raising your offer “just a bit more” for the 5th time.

There are always other properties. While you should be ready and able to spot a good opportunity and act fast don’t act out of pressure and fear of the property being sold to someone else. The only way to get a good deal is to be patient and ready.

#10 Renovating

To me this step was the hardest of all. Entire libraries can be written on the subject of renovations with more to follow. What makes this step really hard is a combination of the following, in my opinion:

1. Renovating on a tight budget – Usually, renovating after purchasing the property is done under a tight budget as we’ve already spend what we could on buying the property. Each surprise is more crucial and has more impact on your decision making.

2. The uncertain nature of renovation, our relative ignorance and your average contractor – Renovating a home is painful enough without having to learn your electricity needs to be re-wired or that there is a termite infestation in your home. Most of the times we don’t even know what the contractor is talking about, and certainly don’t know why he’s charging what he does and for what? On top of this many contractors are not, let’s put it mildly, easy to get along with. They have a tough profession with tough clients and they will usually outwit you when it comes to money or work.

3. The enormous varieties of designs of all kinds and the length between expectations and reality – When buying a home you have a concept of how it is going to look like and how you will design it. Often reality has other plans. Designing is a high premium market with varying price levels and never ending supply of ideas and designs. Starting from tiles and flooring, bath and showers, furniture, appliances and what not. When renovating painful decisions and compromises are an everyday matter.

Many of the stages and tips I detailed earlier are valuable when renovating. Planning the budget carefully, researching and understanding your wishes and wants, getting professional assistance such as designer and architect can really help (that’s what I did), negotiating with several contractors and choosing a good one is crucial to the success of the renovation.

#11 Moving and making it a home

The final step takes work as well. After completing a renovation you’d probably feel this is the easiest thing you’ve ever did. You will find out soon enough how many things are still missing, how much more money is needed to get everything just perfect, how you’d like to change some things already... and more.

Take a deep breath and relax. Let your new home sink in (and your financial situation as well with seemingly endless payments and loans). Take the time to think of the process you’ve just been through and plan ahead.

You’ll always want another couch, a better oven or TV, a new bedroom and more. Housing expanses are some of the highest there are and there is no need to go crazy over living space. Plan a monthly budget for home purchases and improvements and try to stick with it. The first month or two will be the hardest but you’ll get used to it soon enough.

This concludes my post on the process of buying a home from my recent experience. In the near future I hope to focus more on the major steps and elaborate more on each with more tips and ideas. Your thoughts, questions, comments and more are always welcome and are greatly appreciated.

Images by SantaRosa OLD SKOOL, TroyM, FotoDawg

Monday, February 25, 2008

The Need for Accountability in Advertising and Marketing

I'm working on an in-depth post about the process of buying a home from deciding to moving in. I've recently completed the process myself and would like to share my advice and my experience in the matter. In the meantime I'm publishing this post I wrote for some time ago in the hope you'll find it interesting.

Accountability, according to Merriam-Webster is “the quality or state of being accountable; especially: an obligation or willingness to accept responsibility or to account for one's actions”. Is there a place for accountability in advertising or marketing?

Companies invest in advertising and marketing in order to build a brand, raise awareness to a product or service, target a new audience, increase market share and more.

Intuitively, a more credible and accountable message or advert would better achieve the desired results. However, accountability is not one of the traits usually attributed to advertising or marketing. Most people would say the opposite when asked for the place of accountability in advertising.

Why then, do advertisers make enormous efforts and invest huge amounts of money trying to create a feeling of accountability in an advertisement?

1) There is a lot to gain in an advertisement which creates a sense of accountability and credibility

Advertisers use celebrities, poles, market researches, demonstrations and more in order to create that sought after sense of accountability. By creating this feeling in the target audience the impact of the campaign is highly increased.

Increasing campaign impact does not necessarily require telling whole truths. It requires just that delicate balance which creates a general sense of accountability around the advertisement.

2) There is a lot more to lose if accountability is lost

A marketing campaign which makes use of bold exaggerations or lies will eventually backfire on the product or service advertised and of course on the company as a whole.

Accountability is highly sought after by the public and is more precious then gold. Having a brand name which is associated with accountability is having a brand which appeals to some of the most basic values of western society and mankind as a whole.

Saturday, February 23, 2008

Inflation, Frugality and Vampire Energy – RoundUp

You guessed it. Talking inflation again. The NY Times published an article on Thursday discussing the problems facing the Fed as growth lags and inflation rises. As I’ve written in past posts the dilemma the Fed is facing is growing ever more difficult. With no foreseeable end to the slowdown and with prices increasing the danger of stagflation is becoming more and more real. The article discusses the following:
1. Despite the short-term cut in interest rates home mortgage rates are on the rise.
2. Prices jumped 4.3 percent in January, compared with one year earlier.
3. The Fed adjusts the forecast for growth this year to an anemic pace of 1.3 to 2 percent. Joblessness is likely to climb to 5.3 percent, from 4.9 percent today.

It's worth noting the current rise in prices is more disturbing as it is composed of a rise in food and basic goods. This kind of inflation affects us all more heavily.

This week’s edition of the Festival of Frugality on MightyBargainHunter was exceptionally good and featured my post on how to Save Time and Money with These Tips for Organizing Your Personal and Financial Records.

Vampire Energy
I literally “stumbled” on this site by chance. I don’t know how many of us are familiar with the concept of vampire energy. It was a first for me so I thought it’s worth sharing. GOOD magazine describes itself as “media for people who give a damn”. Anyway, I’ve found this visualization of the concept of vampire energy excellent. It appears that even though they’re turned off household appliances cost US consumers $3 billion a year. Did you know a plasma T.V sucks up $160 worth of electricity each year?

The Personal Financier
I’ve written quite a bit on the economy and on investments this past month. I intend to focus a bit more on real-estate and frugality in the near future (while not abandoning my favorite subjects). Please contact me at: for requests, questions, comments or anything else that comes to mind. Your feedback my prime motivators to keep on writing.

Thursday, February 21, 2008

Inflation Rearing Its Ugly Head

In January I wrote a post about the topics we will be discussing in 2008. Inflation was definitely on the top of the list (commodities and China were on that list too). It appears this wasn’t for nothing. In the last couple of days a series of inflation related news suddenly accumulated. As always I’m here to sum it up in a post:

#1 China’s inflation rose to 11 year high
Another topic staring the aforementioned list was China which has displayed rising inflation levels for some time now. The Chinese inflation rate rose to 7.1% for 12 months ending in January.

#2 American food industrialists are concerned with price levels
Larry Pope, president and CEO of Smithfield foods, was quoted saying “There's going to be real food inflation in this country”. Wheat and meat prices are continually rising.

#3 Oil and gold prices keep breaking records
The price of gold reached another peak at 950$ and oil prices are toying with 100$ a barrel. Gold is traditionally considered a safe haven for times of inflation and oil, oil is just weird (there hasn’t seemed to be any fundamental change that explains the recent rise in oil price).

#4 The Fed has updated Inflation estimates from 2.1%-2.4% to 2.4%-2.8%
The CPI for January was published this week with a surprising 0.4% rise in prices. Apparently the Fed took that into account during their last monetary meeting and updated inflation estimates. It’s a dangerous game the Fed is playing with interest rates in these sensitive times. The European central bank has decided to avoid lowering interest rates so far. Apparently in order to battle rising price levels in Europe.

I’ve recently wrote a post on “How to protect your money from inflation” which I think might shed more light on the situation and on how to deal with it.

Tuesday, February 19, 2008

How does it feel like to lose over $50B?

UBS shareholders have written off over $50B in the last couple of months. I can’t help but wonder how does that feel like? American companies are writing off hundreds of billions of dollar in subprime and alt-a mortgages. Housing prices continue to drop and on average each American citizen has lost more than we want to count (tens of thousands of dollars at the least).

Why do most of our lives seem to go on relatively unaffected? I believe there are 4 basic reasons for this phenomenon:

#1 Concentration of wealth results in concentration of lose as well
O n average the numbers point to almost 80% of the wealth in the US being held by 10% of families in (yet another interesting reference for the 80-20 principle). Naturally, when this is the case 90% of the families don’t take part in either capital gains or losses on that wealth. It appears our part in the greater financial scheme of things is less significant than we had hoped it would be.

#2 The loss is not tangible
Imagine losing 50$ you had in your hand a minute ago and compare that to 0.05% yearly return you could have received on your IRA in another alternative. Which hurts more? With all our sophistication and modern life style our psychology gets the better of us. Tangible losses are easy to grasp and to regret.

#3 Everybody lost
Always comforting but not really helpful is the fact everyone shares our losses. It’s comforting to know we weren’t the only ‘fools’ around. However, when it comes to the bottom line a loss is a loss.

#4 We’re lucky our homes aren’t traded on a house exchange
Imagine your house taking a 20% dive in afternoon market trading. Imagine we had a market price available at all times for our most expansive asset. I would certainly lose sleep over it. I guess ignorance really is bliss sometimes. I’ve written more on this important issue (“A Case of Too Much Information”).

An interesting time line and evolution of the subprime crisis can be found at BBC news here under “Timeline: Sub-prime losses”.

Sunday, February 17, 2008

ETFs and Mutual Funds – The Slowdown Will Teach Us another Valuable Lesson

ETFs have become the investment tool of the 21st century for household investors. It is true, they do have many advantages ranging from lower commission, better performance, tax considerations and more.

With ETFs becoming increasingly popular more investors ask themselves why invest in mutual funds altogether?

I am a big supporter of investing in ETFs. There’s nothing more enjoyable then watching how simple financial assets outperform the big money in mutual funds constantly preaching to the household investor when and what to buy. Mutual fund managers have nearly completely failed in justifying the commissions they charge with very little abnormal returns to show for.

However, and there is always an however, sometimes the judgment and discretion of an investment manager is required. If you’re wondering when that may be the case, please consider the following behavior pattern I believe explains why ETFs outperform mutual funds and why there is a lesson to learn in the current slowdown.

First, I believe we should give grace to mutual fund managers. These are professionals using the best financial tools and data available. Why can’t they beat the market? I believe the answer lies in the market’s psychology. Markets in strong trends tend to overshoot. This phenomenon can happen in either direction – up or down. Mutual funds managers pick great stocks for their portfolios. But in a strong bull market they simply can’t foresee the psychological overshooting effect which affects some stocks and leaves other untouched.

In bull markets we’re all successful investors. Everything you invest in seems to yield unbelievable returns in a short time. I believe huge amounts of money get invested in whatever comes to hand and mind causing an overshooting effect and overpriced stocks. While the market is still bullish no one happens to notice and ETFs over-perform simply because they enjoy the full extent of the psychological effect.

It’s a whole other story when it’s a bears market. The overshooting effect works downwards and ETFs experience the full effect while mutual funds, which have picked some of the better stocks, are less affected.

I believe mutual funds will prove to be the better investment in these bearish times. We should make good use of the managers’ discretion until we’re in a strong bull market again. Then we’ll ride the psychology on the back of ETFs.

Saturday, February 16, 2008

Upcoming Tax Rebates, Spotting Genuine Market Lows and More

I’ve just finished reading a very useful article in Yahoo about the upcoming tax rebates which I think you will find interesting. It addresses the basic questions of who’s entitled to get a check? How much will we get? What needs to be done? When can we expect the money? How to boost rebates? Etc... The article can be found here “Tax Rebate Winners and Losers”.

Another interesting article I thought you’d like was published in “The Economist” titled “Bear Necessities”. This article deals with the notoriously difficult questions of how can one spot the difference between a genuine market low and the staging point for a short-lived “suckers” rally. The article discusses stock dividend yield vs. bond yields, p/e multipliers and the fear factor.

My weekly roundup contains some of the more interesting carnivals I’ve participated in:
1. Carnival of Personal Finance #139: Valentine Edition and Festival of Frugality #112 featured my post on When is it Reasonable to Take a Loan? Consider These 4 Questions.
2. Festival of Stocks # 75 featured my post "Be the Turtle - Why Timing the Market is Impossible"
3. The consumer focused real-estate carnival featured my post “A Case of Too Much Information? Real Estate and Stock Investments Compared

Thursday, February 14, 2008

No Room for Careful Optimism. Not yet Anyway

We’ve seen some interesting developments this week. Some might be considered reasons for careful optimism regarding the chances of a full blown recession hitting the US. However, several less noticed news were also published which we should consider before reaching a conclusion.

#1 Warren Buffet offers to reinsure municipal bonds

The oracle from Omaha, Mr. Warren Buffet, offered to reinsure $800B in municipal bonds to help the deteriorating bond insurance market. Naturally, If Mr. Buffet sees a business opportunity in insuring municipal bonds then it is likely that Buffet considers municipal bonds to be ‘good credit’ caught in a bad market situation.

The insurance companies, Ambac, MBIA and FGIC, were definitely not too eager to accept the offer. One apparently turned it down already. In doing so these companies gave us good reason to believe the situation might be better than we think. Buffer did not offer to reinsure CDO’s however which indicates more trouble may be brewing.

#2 January retail sales up 0.3% vs. 0.3% drop expected

Surprising news of a small surge in retail sales made up mostly of gas station sales and car sales sent the markets soaring after a continued slump. As always, when expectations are not met a response is usually triggered.

#3 Trade deficit falls after 5 records years

The USA’s trade deficit for 2007 was published today and dropped 6.2% to $711.6 billion. The trade deficit with China continued to rise, this time by 10.2%, to $256.3 billion. The decline in the dollar certainly helped reduce the trade deficit. The reduction in the trade deficit is attributed to increased levels of American export to emerging markets and a reduction in consumption of imported goods and cars, especially Chinese.

The reduction in trade deficit is considered a good macro-economic indicator, especially when it is attributed to higher levels of export and lowered import.

#4 UBS revealed new US loans exposure. Slump in credit markets causes write-offs in technology, health and mining

It seems we have yet to hear the whole story when it comes to exposure to bad credit in financial corporations and also, as is recently discovered, in other companies as well. UBS unveiled $26.6 billion in new exposure to risky US mortgages today. These loans were apparently called Alt-a and were of higher quality than subprime loans but the continued slump in housing has made them risky as well.

Furthermore, more sophisticated financial assets are being written-off and not by financial institutions alone. Apparently due to attractive interest rate levels companies invested in ARS or Auction Rate Securities which were hit as well by the subprime crisis. Bloomberg reports that “ImClone Systems, the biotechnology company controlled by Carl Icahn, wrote down the value of auction-rate securities it owns to $109 million from $149 million and reclassified the investment as long-term amid a slump in credit markets. Also Bristol-Myers's $275 million write-off on subprime investments, reported last week, showed the mortgage crisis is spreading from Wall Street to the drug, technology and mining industries, where companies are posting losses on assets once rated AAA”.

Apparently this is not over yet.

#5 Bernanke tells Congress economic outlook has deteriorated

Bernanke spoke in front of the Senate’s Banking Committee today. Apparently the economic outlook, as the Fed sees it, has deteriorated. Bernanke sent a reassuring comment to the stock market and said the central bank is ready to keep on lowering interest rates to encourage the economy. Lowering interest rates further increases the chances of stagflation and is a risky game with inflation on the rise. It is important to note Bernanke’s forecast for the economy is of a “period of sluggish growth”.

Unfortunately, it seems there still aren’t enough justifiable reasons to be optimistic about the chances of avoiding a full blown recession.

Tuesday, February 12, 2008

5 Practical Reasons Why You Should Definitely Learn a Foreign Language

Intellectuals are often recognized by their ability to conduct fluent conversations in several languages, usually English, French and German. Being fluent in a foreign language is a pre-requirement for many academic programs and is often a mark of intelligence and capability.

The majority of the non English world studies English as a default second language (as I have). That’s a step in the right direction. But I insist we should not stop there. I’ve decided to study French as an additional foreign language and urge my dear readers to do the same.

The most common languages on earth are Mandarin Chinese (885 million speakers), Spanish (332 million), English (322 million), Bengali (189 million) and Hindi (182 million). The UN’s 5 official languages are: Chinese, English, French, Russian and Arabic. I believe that one of the basic steps to understanding the world we live in is to accept cultural and ethnical diversity. Language is one of the very basic building blocks of the latter.

There are many benefits to being fluent in more languages. Some are more obvious than others. Here are 5 key benefits in my opinion:

#1 Opening an entirely new potential “market” for yourself

Languages are doorways to worlds and markets. In a recent interview with investment guru Jim Rogers he told about his daughter’s Chinese nanny and the Chinese lessons she’s taking at a very early age to prepare her for the future. Any foreign language opens a doorway to a foreign economy and market, each with vast opportunities of its own.

Needless to say, the expanding globalization in the world’s economy has created a high demand for language skills and cultural diversity.

#2 Creating a competitive edge

A foreign language is one of the best ways of creating a competitive edge relatively quickly. If you have the time you can become quite fluent in a foreign language in a matter of months. If you have only several hours a week it could take a year up to a year and a half but its well worth the investment.

Consider how your resume would look like if you were fluent in another language. Consider how you would be able to differentiate yourself from your fellow colleagues and offer a different added value to potential employers.

#3 Branding yourself differently

Marketing is almost everything these days. Branding yourself is required to succeed in any field of work. Fluency in a foreign language tends to stand out quickly enough and is guaranteed not to be forgotten. Naturally the more exotic the language the bigger the impact but all foreign languages will achieve this effect.

#4 Increasing your networking opportunities

From my own experience the same people who’ve decided to invest their free time in learning a foreign language are the same people you’d like to network with. Nearly all professions benefit from synergies created by speaking another language.

#5 Expanding your horizons

We all live on the same planet. Another language will introduce new worlds and cultures to you. Cultural and ethnical diversity are greatly appreciated and contribute to our evolution as human beings. Understanding the world we live in is invaluable to every metric for success everywhere.

Image by bass_nroll

Sunday, February 10, 2008

The Role of Information in Stock and Capital Market Efficiency

Market efficiency is a concept describing market behavior. The assumption about market efficiency is a basic assumption in many economic and financial models and is required in order to build fundamentals.

At the basis of market efficiency are three assumptions:

1. There is a multitude of sellers and buyers with no one dominant enough to affect pricing.
2. There is homogeneity in products or services offered.
3. Perfect information is available to everyone.

These assumptions are required in order to demonstrate equilibrium of supply and demand which constitute the price and quantity of every product or service. These market dynamics also help in understanding the processes which takes place in inefficient markets.

Capital Market Efficiency

The capital market is often regarded as a market which is close to fulfilling the requirements of an efficient market where prices are determined by supply and demand as a result of the forces mentioned above.

It can be easily seen that the capital market does not completely satisfy the conditions set above but it can not be easily dismissed as well. Let's have a look at the relevance of the market efficiency assumption to the capital or stock market:

1. Multitude of sellers and buyers – It seems the existence of dominant players might not satisfy this condition for market efficiency. However there are some lenient circumstances. These players are regulated and monitored thus limiting their influence on stock prices. Also, if we look at the micro level at the sell and bid price at the end each transaction can be seen as made by any buyer and seller conforming to supply and demand.

2. Homogeneity in products – This condition is met as each company's stock is usually identical to all other sold and bought.

3. Perfect information is available – The interesting twist obviously lies here. Sure, not all players have the same information but as mentioned above the requirement for perfect information can not be easily dismissed as non existent in capital markets.

As aforementioned information plays the most important role in efficiency of stock markets. As information technologies evolve access to information has become increasingly and significantly easier. The household investor can access all the public information regarding a company with a couple of clicks.

To make things all the more complicated some effects have surprisingly endured even though information is available. Effects like the January effect (a rise in stock prices in January) or momentum strategies point to failures in market efficiency as they should have disappeared. Take the January effect for example: common knowledge that stock prices tend to rise in January should have lead to purchases in December and in turn to a rise in prices in December. Knowing December's price should lead to a rise in prices in November and so on and so forth.

Another aspect to consider is that of inside information which is obviously unavailable to all investors and as such reduces efficiency levels. As a result an interesting new concept of market efficiency has evolved: Semi- Efficiency

Let's have another look at the influence of information on stock market efficiency:

Inefficient Market – Prices do not reflect the information of past pricing

A stock market in which the January effect exists is an inefficient market since the only way to keep the January effect going is a lack of general knowledge of it. This lack of knowledge is in contradiction to market efficiency requirements.

Weak Form Efficiency - Prices reflect all the information in past price movements

Since the January effect or weekend effect can be deduced by looking at past price movements they will not exist in weak form efficient markets. Notice technical analysis is based on the fact markets are not weak from efficient.

Semistrong-Form Efficiency – Prices reflect all publicly available information

If you take a careful look at a stock's price behavior in the time before a major announcement you will see a change in prices in a certain direction (either up or down). Usually in the time following the announcement this trend will continue as a result of the announcement. The earlier price change is attributed to inside information which is not available to all players. Assuming all market players would have access to that information would have lead to a price increase in the moment of the publication and not some time sooner. Most stock markets are semi efficient stock markets as they display these price behaviors.

Strong-Form EfficiencyPrices reflect all the information available

Completely efficient stock markets are non-existent of course but this simplification helps us to better understand what is going on in the real world.In the near future I will try to demonstrate (and visualize) how we can tell the stock markets are becoming more and more efficient.

Post Sponsor: Looking for a mortgage? The Thrifty Scot has thousands of mortgages on offer and will put you in touch with a qualified mortgage broker

Saturday, February 9, 2008

Investment Basics Carnival #6 and Weekly Round-up

Welcome to the sixth edition of the "Investment Basics Carnival". We recieved a record 63 posts out of which 24 were chosen and are presented here.

Investment Tips

1. The Dividend Guy presents Investment Ideas from My Fridge posted at The Dividend Guy Blog- There are numerous ways to find stocks to analyze. I started by looking in my fridge.

2. Phil B. presents Short-Term versus Long-Term Capital Gains posted at Phil for Humanity- Short-term investments must have a higher return just to guarantee the same profit over long-term investments because of the differences between short-term and long-term capital gains tax.

3. FIRE Getters presents Our 7 Mutual Fund Investing Mistakes! posted at FIRE Finance- Common investing mistakes in mutual funds

4. The Stock Teacher presents Tips For Cutting Down On Trading Fees posted at Stock Investment- Advice on how to cut down on your stock trading fees and improve your returns.

5. Jose DeJesus MD presents Market Timing - When is the Best Time to Invest New Money posted at Physician Entrepreneur- Examining the results of diversification over time.

6. Investing Angel presents Invest In What You Know posted at Stock Tips- To beat the market, you need to know something that most professionals don't know about the stocks you trade.

7. Warren Wong presents How To Learn To Make A Good Investment posted at Personal Development for INTJs- Describes the most effective method for learning to invest well.

8. Investing Angel presents Tips For Shorting Stocks posted at Stock Tips, saying, "In today's unstable market, many people are considering shorting stocks. This might be because they believe the market is going to get worse, so they want to bet against the market or they just wish to hedge their bets."

9. presents How Much Should You Trade? posted at Forex Strategy Secrets- Forex trading is one of the fastest growing markets. Learn tips and tricks that will help you succeed in this money making market.

10. Warren Wong presents Why Compounding Returns Isn?t That Important posted at Personal Development for INTJs- Some reasons why compounding returns is less important than it seems.

11. Ryan presents Catch a Falling Knife – Buying the Housing Slump posted at Building Millionaire Money Habits- A look at what the better investment is – stocks or real estate.

12. Raymond presents If You Truly Invest For The Long Term, Then Stop Checking Your Stock Prices All The Time posted at Money Blue Book.

13. Dobromir presents Selling Covered Calls for additional income posted at Create Rising Passive Income From Dividend Paying Stocks- A review of covered calls

14. Steve Faber presents - Disount Online Stock Brokers - A Comparison posted at DebtBlog


15. Allen Taylor presents Is Your Annuity Good or Bad? posted at Investing World Today- Annunities are a misunderstood investment vehicle. A break down the good and bad of Annunities so you can better understand them.

16. Ryan-Careonecredit presents Savings Accounts posted at Care on Credit- Savings accounts are safe, convenient, and make your money easily available. Is a savings account right for you?

17. Jeffery A. Smith presents Step 3: Learn where to Invest your Money posted at Discusses the different types of self-directed accounts: Tax-Advantaged vs. Taxable. Suggests an order in which these accounts might be funded.

18. Jesse presents Interest and compounding interest basics posted at The Penny Saved- The basics on what interest and compounding interest are, and what this means for your investments.

19. Adfecto presents Millionaire Rule #7 posted at Adfecto Abundantia - Aspire 2 Wealth- There is no better way to save for your financial future than to take advantage of a 401(k) which is matched by an employer. A primer on the basics of 401(K)'s and a simple example to show their power.

Real Estate

20. Tony John presents Tenant Quality Affects Property Value posted at

21. Mark Runta presents Five Considerations For Refinancing Your Mortgage posted at Smart Investing & Money Management- Consider the following before refinancing your mortgage.

22. KCLau presents Withdraw EPF Money for Home Loan Installment: How it affects your Retirement Fund posted at KCLau's Money Tips- An article on using EPF money for financing a home loan

Personal Finance and Personal Development

23. Tim Gary presents How to Make Time Out of Thin Air posted at Internet Success Bites- Time is something you make.

24. Personal Finance Claims presents Stop Being Fleeced By Your Bank, File Your Claim Today posted at Personal Finance Claims

There are some great carnivals out there. Here are a few in which I've participated over the past couple of weeks:

1. Personal Finance Money Tips @ KClau - Be the Turtle - Why Timing the Market is Impossible.
2. Organize you Life Carnival @ Declutter it! - 10 Tips on How to Make the Most of Time Spent In Traffic – How to Make More Time Post #4
3. The Carnival of Smarter Investing @ boozwatt - 10 Tips and Truths for Successful Option Trading
4. Everything Finance Carnival @ Everything Finance - Avoiding the Slippery Slope of Debt
5. Carnival of Personal Finance @ paidtwice - The 80/20 Rule - Let Pareto Do Most of the Work
6. Cavalcade of Risk @ The Digerati Life - The Problem With Structures — Risks and Hidden Costs
7. Carnival of Personal Finacne @ The dividend guy -The Problem With Structures - Risks and Hidden Costs

Thursday, February 7, 2008

Save Time and Money with These Tips for Organizing Your Personal and Financial Records

Surely you easily remember that one time you couldn’t find the receipt for that pricy camera which suddenly stopped working after 3 months. Where did I put that? Or maybe last year’s tax filings or your marriage license? How about the guarantee for the TV?

In our short lives we create and accumulate mass amounts of documents –never ending piles of paper. Unfortunately, they’re never there when we need them.

Organizing your personal documents can save you precious time and money with little effort. Furthermore, having the history available, especially when it comes to bills and expanses can help you learn a lot about your spending habits and also help you with budgeting and managing expenses.

#1 First and foremost you should defiantly keep the documents
Accumulating mass amounts of paper really makes you want to throw it all away even if you know you’ll regret it soon enough. In order to get things properly organized save your documents.

#2 File often and don’t procrastinate
Naturally documents will stack up if they’re not documents often as a routine. By incorporating an hour a week of handling paper you’ll clear the mess up soon enough. Don’t procrastinate! You’ll be happy to see the mess cleared away from sight as well as from mind.

#3 File by subjects and dates
You’ll eventually have to find one documents or another. File by subjects and dates. This is the most logical method of filing. Creating appropriate filing space in advance and don’t group subjects together. The papers will come, don’t worry. Use different colors for different subjects to help you remember.

#4 File “to do” documents in a separate folder
We always have documents which need follow-up. Keep these in a different folder and move them to their place once the task is done. A desk often gets covered by lists and bills with no reason what so ever creating an eyesore.

#5 Have and incoming and outgoing tray
I know its office like but there’s no other way. Stack documents for filing in the incoming tray and completed forms, mail or what not in the outgoing tray. Remember, these should be handled once a week.

#6 Get a scanner with a feeder and upload everything
There’s no better place to keep your records. Organize your folders and records on your computer for easy sorting and retrieval. Give detailed names to the files and you’ll find them easily and quickly. Less efficient is the need to keep paper records as not everyone moved to the 21st century with the rest of us.

#7 Get a shredder
Shred unneeded documents. It’s efficient and it’s wise. Your personal records shouldn’t be traveling around.

#8 Sort to short and long-term – Not a personal favorite of mine
You don’t have to keep everything forever. However, I don’t see the harm in that other than a couple extra folders. You just might throw away something you wish you hadn’t. I still have to remind this one in case you’re extra careful.

Post Sponsor: The Thrifty Scot offers the latest news and advice on credit cards. Visit today to find out more

Images by MGshelton, niKaraguaXiL

Tuesday, February 5, 2008

When is it Reasonable to Take a Loan? Consider These 4 Questions

I’ve recently wrote an article titled “Avoiding the slippery slope of debt” in which I wrote about how quickly small loans may amount to significant debt and mentioned ways of avoiding it. However, there are cases where we simply must finance ourselves with the bank’s money. As with anything in life the middle way is the right way.

Financing and leveraging by themselves are not bad. They are merely tools which should be put to good use.

Taking a loan or any sort of external finance is reasonable when the return is usually expected to outgrow the financing costs. This return doesn’t need to be measured in dollars. In fact, measuring utility is the correct approach (for further reading: What is the economic value of happiness?).

So when is it reasonable to take on a loan? I believe we should consider the following 5 parameters before deciding:

#1 Is the situation or problem at hand temporary and focused?
Borrowing money should be a temporary solution to a temporary problem. If a situation or problem is here to stay then a change of lifestyle is required. Taking a loan will only worsen things as the problem does not disappear but the money does.

#2 Do you have a clear way out?
Be sure to identify the problem and the causes correctly before acting. If the causes can be treated and the problem solved by taking a loan then it just might be worth it. Make sure you’re not entering the slippery slope of debt by financing yourself with an endless chain of debt.

Have you way out mapped and charted. After taking the loan things might seem better off and the temptation to use the money in another way will grow. Be consistent and stick to the game plan.

#3 Are you sure it’s not luxuries you're financing?
While we need luxuries to make life comfortable financing luxuries with the bank’s money will eventually leave you at an even more uncomfortable place. Remember that vacation you took 1.5 years ago and you’re still paying for? Is that comfortable? Wouldn’t you have rather saved up for 1 year and then take it carefree?

#4 Will the money be invested wisely?
Very basically speaking will the loan’s money yield higher return on investment? Again, we must not regard this in terms of money only. The best investments are in education and infrastructure for example. Invest in the future.

Post Sponsor: When it comes to mortgages Thrifty Mortgages has over 8000 to choose from. Reduce your repayments today

Sunday, February 3, 2008

Taking the Moments to Appreciate Life

I write a lot about investing, business and personal finance. So do many other personal finance blogs. However, we have to keep reminding ourselves money is just a means to an end and not an end in itself.

A recent experiment by the New York Post demonstrates what seems to be our innate inability to appreciate the present.

In the middle of D.C morning rush hour famed violinist Joshua Bell stood in a metro station and played six immortal classical pieces, such as J.S Bach’s "Chaconne” on his Stradivarius violin. He stood and played there for almost an hour with the violin case at his feet wearing ordinary everyday clothes. I believe you can guess the rest.

Almost 1,000 people passed him by, nearly unaffected by the marvelous musician playing before them.

Gene Weingarten discusses this experiment and its results in great detail in his article “Pearls before Breakfast” which I believe we should all read. What really troubled me is one begging question: Would I have stopped and listened?

I am every much a grey bureaucrat as many of the commuters in this D.C metro station. We all survive our daily routine by focusing on the tasks at hand and shutting out almost everything else.

Joshua Bell made 32.17$ for 43 minutes of what is described by Weingarten as heavenly music. No crowd gathered. Only one person out of 1,000 saw the quality in the music being played (while not recognizing the violinist).

Our defense mechanisms have their uses but they are costly. Constantly reminding ourselves what we live for is the only way to make sure we stay focused on what’s important.

Saturday, February 2, 2008

Be the Turtle - Why Timing the Market is Impossible

Sometimes looking at the raw data itself presents very interesting conclusions. This is one of these cases.

One of the basic mistakes many investors do is trying to time the market or buy low and sell high to make quick profits. If you've ever tried that you must have noticed it's hardly as intuitive as it sounds. It appears the statistics themselves are against us in this matter.

In order to see if it was possible to time the market and make relatively quick profits I've examined the daily price change for both the Nasdaq and S&P 500 indices since 1990. I've found very interesting results. I exmained the absolute daily price changes and not just the positive ones under the assumption you can also time the market downwards (sell short).

There were approximately 4,559 trading days between January 1st 1990 and February 2nd 2008. Only 51 of these days yielded a price change of over 5% in the Nasdaq, and a mere 8 days in the S&P. Maybe 5% is too much to ask for? If we suffice with 3% the numbers change to 238 days for the Nasdaq's and 59 days for the S&P.

What are our chances of catching such days? Very basic statistics quickly determines we have a 1.1% chance of catching a 5% price shift and 5.2% chance of catching a 3% price shift in the Nasdaq. The S&P's statistics are even "worse" 0.2% chance of a 5% price shift and 1.3% chance of a 3% price shift.

The long tail or 80/20 principle work here as well. The number are a little different but the principle remains. The majority of days will end in price shifts of under 1% or 1%-3%. That is the long tail of trading days or the "80%".

We already know timing the market is impossible. What other important lessons are here to learn? It seems the only way to enjoy price bursts in the stock market is to constantly be there. In other words - Invest for the long term. If you've bought the Nasdaq Index in 1990 your chances of enjoying 5% price shifts have been 100%.

Succecful investors have long term goals and targets. Timing the market is better left to professionals who do that for a living.

Post Sponsor: Compare over 500 loans and select the best loan plan to suit your finances - only with The Thrifty Scot