updated 7/22/2004 3:59:11 PM ET 2004-07-22T19:59:11

May 28, 2004

With housing prices rising relentlessly, Robert is wondering if maybe it's time to sell his house and invest the proceeds somewhere else – like the stock market. He may be surprised to see what happens when you do the math. Meanwhile, Carlos in Caracas wants to know why bond prices go down when interest rates go up.

As always, if you'd like to write to us, please include your first name and hometown.

Cashing in
Should I sell my primary residence and invest the equity in stocks for retirement purposes? The house is appraised at \$350,000. The mortgage balance is \$158,000. I could live in another property I own in a lesser quality neighborhood nearby. It has appraisal value at \$180,000. The mortgage on it is \$85,000. It would require about \$30,000 in repairs for me to occupy. I am 40 years old and single and wonder if I should take advantage of the equity value now in my primary residence. What do you think?
Robert P.

You’ve actually got two questions here: First, is it time to take advantage of high housing prices by selling my home? And second, is now a good time to invest in the stock market? Since our crystal ball is still in the repair shop, we’ll politely duck the second question and answer the first. (As always, we leave stock market advice to the “pros.”)

It’s true that a home is probably the biggest investment most Americans own, but it’s also a place to live. In other words, if you’re considering cashing in, you need to figure out how much money you’d be paying in rent if you sold your house. (In your case – a bit unusual – you already own two houses, but the principal is the same.)

So let’s do the math for a “typical” \$170,000 home (about the current median price). Suppose you have \$100,000 in equity with a mortgage balance of \$70,000. We’ll figure monthly payments would be about \$650 for a 30-year fixed mortgage at 6 percent, including \$230 for taxes and insurance. If you paid off the loan, you’d have \$100,000 to save or invest, but you’d still need a place to live.

Let’s assume you could find equivalent rental housing for \$650 a month (which is unlikely, since the median rent is more like \$900, according to the latest data from the U.S. Department of Housing and Urban Development). In order to generate that much retirement cash (and replace the value of the housing you just sold) you’d have to invest \$147,169 in a 30-year bond — yielding 5.3 at this writing. (Or you’d have to divert an equivalent amount of other investments to pay rent.) Either way, you'd need more than the equity you'd get by selling to make up for the "housing value" that you'd give up.

(As an alert reader correctly pointed out shortly after this column was published, the idea of selling might work in your favor if you plan to keep working in retirement; since you wouldn't be relying on just your home's equity alone to pay the rent, you'd have \$650 a month of extra income you'd save by not making mortgage payments. That would give you \$1,090 a month to apply to replacement housing; a close call, but it might tip the math in your favor. )

But there are other factors to consider: You won’t be able to deduct mortgage interest payments from your taxes. And you’ll give up the chance of further, tax-free appreciation in the value of your house.

True, no one can say whether home prices are moving higher or lower from here — even the guys down at the crystal ball repair shop. But, with the prospect of rising inflation looming, it’s worth noting that homeownership was an excellent hedge against inflation in the 1970s, the last time prices rose rapidly in the U.S. That wasn't true of stocks.

Major Market Indices

Interest in bonds
Why do bond prices drop when interest rate rise?

Carlos G. - Caracas, Venezuela

There are two ways to buy bonds: Either when they're first issued by a government or corporation or when they're traded by investors on what's called the secondary market (the “bond market” to the rest of us) where billions of dollars worth of paper are bought and sold every day.

Suppose you bought a bond for \$1,000 when it was first issued by the U.S. Treasury and it paid, say, 5 percent interest — or \$50 per year. (Interest is actually paid quarterly, but we'll make the math a little easier.) That 5 percent rate is determined by competitive bids by all sorts of investors — banks, pension funds, individual investors, etc. Those bids reflect the “yield” those bidders hope to get — based on the relatively low risk of Treasury debt and the return they could currently get if they put their money in other investments.The government is trying to borrow money at the cheapest rate, so it accepts the lowest bids.

Once the bid is accepted, that payout rate is fixed for the life of the bond, even if interest rates later go up or down. (The rate is also known as the “coupon” rate — because you used to have to clip coupons attached to the bond and mail them in for payment.) At the \$1,000 price the bond sold for (or "par" in trader-speak), the coupon rate is the same as the "yield," which is how much money you get back for your investment.

Now, suppose interest rates go up, and the payout (coupon rate) on a newly-issued bond goes to 6 percent, or \$60 in interest, per year. New bonds are "yielding" 6 percent. But your old 5-percent bond is still paying (and "yielding") just \$50. If you tried to sell it, no one would pay the \$1,000 full price your paid — why should they when they can get a better deal with new bonds?

So the price of your bond falls accordingly. That discount makes up for the lower coupon, so the yield is now competitive with market rates. If you do the math, the price should fall to about \$833 — which effectively raises the yield to 6 percent (\$833 x .06% = \$50)

The reverse is true if rates fall – a bond trading in the open market becomes more valuable because it’s paying more than a newly-issued bond.

May 21, 2004

From time to time our e-mailbox overflows with one topic; this week, everyone seems to have an opinion on rising gasoline prices. So we've decided to turn this week's column over to Answer Desk readers to let them sound off.

People will not stop buying SUV's and switch to more efficient transportation… Sure we may feel a little guilty from time to time but hey; don't it feel good to roll up to the nearest McDonald’s drive-through in our \$80,000 Escalade and order a #1 with Coke?

My name is Ashley Hall and I'm 16 years old. ...The story that most seem to overlook is how the gas prices affect the teenagers. I make \$6.00 an hour working 30 hours a week on top of school. With insurance prices as high as they are, I can barely afford gas and insurance to get me to and from work. While it may be an inconvenience to those adults, it's more so to the teenagers. By the time summer rolls around and gas prices rise even higher, I won't be able to afford to have transportation to work to earn money.
Ashley H. -- Arizona

Its time the damn “Federal Government” takes OPEC by the nose and teaches them a lesson.  ...  I had enough of this kind of rhetoric in the 70’s when Esso became Exxon, that really stood for the “NIXON” administration, that allowed this kind of theft to start.  We middle class are being ripped off and I am tired of it.  Why don’t you tell the truth as to why the prices are rising?  Whose pockets are being lined?  I do not want to hear about fuel shortages because that is a crock.

(Anthony: OPEC is currently pumping to within 5 percent of capacity, and only Saudi Arabia could increase production enough to have any real impact on oil prices. The truth is that gasoline prices are rising because oil is selling for \$41 a barrel. And that's because there’s barely enough oil to meet growing world demand and buyers of oil are afraid that terrorists may attack oil facilities and cut off critical supplies. On top of that a patchwork of state-by-state summer clean air requirements have created tight supplies of "reformulated" gasoline blends in some parts of the country. If you find evidence of another explanation, please let us know.)

In Good Old England we pay \$6.75 a gallon. You have got it good.

Simon

In Sweden, gasoline prices are now at 10.66 SEK per liter. That's 5 (FIVE!) U.S. dollar per gallon. ...The price we pay here in Florida now \$1.96 per gallon is so low compared to Sweden. It's like the prices from year 1970-1975 in Sweden. On the other hand, the insurance for your car in Sweden is around \$150 - 400 dollar per year. So, the total price of owning a car a year, is what we need to look at here.
Mikael -- Florida

I feel like someone is trying to force me to buy a Yugo. If Europe wants to drive a Yugo let'm. ... Americans are not easily pushed into something they don't want to do. In this case the average American trying to work two jobs raise a family pay bills and live will simply need to file bankruptcy more often.

I would like to know if there are any petitions out there disputing these "outrageous gas prices"! I am a consumer fed up with the gas prices continuing to rise and would like to start a petition and send it to the "right" government to take proper action against any future increases!
Heather,  California

(Heather: Here’s one forwarded to me by a number of readers.)

It has been calculated that if everyone in the United States did not purchase a drop of gasoline for one day and all at the same time, the oil companies would choke on their stockpiles. At the same time it would hit the entire industry with a net loss of over \$4.6 billion which affects the bottom lines of the oil companies. Therefore May 19th has been formally declared a "Stick it to them day" and the people of this nation should not buy a single drop of gasoline that day.

(Christiana: Judging by how well this proposal made the rounds on the Internet, it was a popular idea. Unfortunately, there are three basic problems with this protest. First, stockpiles are well below normal for this time of year, a boycott would only help build them to more favorable levels. Second, the math is wrong. There are roughly 9.1 million barrels of gasoline consumed every day in the U.S. (times 42 gallons per barrel equals 382.2 million gallons.) So even if we all stopped buying for a day, at \$2.00 a gallon, that would only represent \$764.4 million, of which only a portion ends up as oil company profits. (The rest of that your \$2 a gallon goes to taxes, dealer profits, the cost of refining, crude oil costs, etc.) Last, and most important, shifting gasoline purchases from one day to the next will have absolutely no financial impact on oil companies — people will simply fill up the next day and make up for what they didn't buy on the day of the "boycott." For such an action to have an impact, Americans would have to permanently reduce consumption by driving less or getting better mileage — or both. Which is why May 19th came and went with no impact on oil company profits.)

Up here in Edmonton, Alberta, Canada we are the Texas of the North. Our Oil Sands up in Fort McMurray have more oil than Saudi, except it has to be essentially manufactured oil (i.e.: extracted from the sand). Then we also have regular oil reserves and natural gas reserves. We are surrounded by Oil! Yet for regular gasoline we pay 88.5 cents per litre in Edmonton, 96 cents per litre over in Vancouver. ... Are gas prices too high? Apparently not if you look at the drive thru line-ups at Tim Horton's Donut Shop. This morning, I observed approximately 20 cars/SUVs/pick-up trucks in the line-up. They all have their engines idling of course, with the purpose of waiting to purchase a donut and coffee. Gasoline, according to the consumers of donuts and coffee, is still a cheap commodity!

I’ve read & seen dozens of reports about the rising gas prices. Not a single word has been mentioned regarding a very simple solution: PUMP MORE DOMESTIC OIL! Alaska was targeted for oil exploration.  The lying liberal-scum made it sound like we wanted to obliterate Denali National Park. The liberal-scum even showed a picture of Denali in their anti-oil industry ad. The liberal organization that showed that photo was the Eco-Nazis at the Sierra Club. …PUMP THE C--P OUT OF THE ALASKAN WASTELAND!

(Tom: After nearly 100 years of production, overall U.S. output is declining, as aging oilfields yield less and less each year. That means we have to import more every year to meet demand, which is currently running at about 20 million barrels per day. The Dept. of Energy estimates that the Alaska National Wildlife reserve could produce about 1 to 1.4 million barrels of oil a day, which would replace about 10 to 14 percent of current U.S. imports.)

May 14, 2004

Today's inflation report has people wondering: What does higher inflation mean for me? For Georgia and Dick in Colorado, it means trying to figure out what inflation means for their retirement plan. (Actually, the math isn't that bad.)

The inflation factor
We know how to figure how long our nest egg will last using a selected interest rate.  …  That is, we know what kind of yearly income we can get for our remaining lifetime (say of 30 years) from the nest egg using a certain interest rate, while gradually using up our principal.

But how do we factor in a selected inflation rate?  Do we just subtract it from the above interest rate?  Thus, if we can get a 7 perfect interest rate on our nest egg, and inflation is (say) 2.5 percent, is the interest rate we should use (in the above table) to calculate our yearly income 7 percent minus 2.5 percent = 4.5 percent?

And then, what interest rate should we use to account for yearly taxes, say with a yearly income (including the above income from our nest egg) of about \$55,000/year?  And should we subtract that "tax interest rate" from the 4.5 percent of the previous paragraph to get the interest rate we should use to calculate (with the table) the yearly income from our nest egg?
Georgia and Dick G. -- Westcliffe, CO

There are several ways you can look at the effects of inflation on your retirement. First and foremost, inflation will have two major impacts on your finances: It will reduce the “real” rate of return on your investments and it will increase your costs — meaning you’ll need to generate more income to maintain the same standard of living. (It will also hurt the performance of some of your investments — higher inflation would likely erode the value of bond holdings, for example — but those impacts are beyond the scope of the basic budget calculations you’re trying to make.)

Calculating your “real return” is the simplest: You take the total return you expect to get from your investments and subtract what you think inflation will be. So if your mutual fund is yielding an average of 8 percent a year, and inflation is running at 3 percent, you’re getting a 5 percent “real” return. If your current living expenses, including taxes, come to \$55,000 a year, you’ll need to generate a real rate of return that covers that amount.

You can also calculate your retirement plan by looking at the impact of inflation on your expenses, which may provide you with a more accurate picture. Using this scenario, you’d take that \$55,000, apply an estimated inflation rate to it, and see how much more you’d have to generate from your portfolio every year to pay the bills.

These two approaches are really two sides of the same equation. So if you apply the inflation rate to your spending forecast, you don’t need to subtract it from your return estimates; inflation doesn’t “double dip” on your retirement budget.

One reason it may help to focus on spending forecasts is that you have a lot more control over your spending than you do over your investment return. You might also break down your spending into basic categories: Necessary expenses (housing, food, utilities); discretionary expenses (dining out, entertainment) and “extras” (trip to Mexico, flying lessons, etc.) By “tiering” your spending plan this way, you’ll have an easier time cutting back one year if inflation heats up or investment returns disappoint.

As for factoring in taxes, you should certainly take them into account. Increases in property taxes in some part of the country (California comes to mind) are capped; in other areas they’ve risen fairly predictably and will probably track (roughly) your inflation forecast, like any other expense. You may end up in a lower tax bracket if your income goes down in retirement, or you may have higher deductions for medical expenses, for example. And if you have stocks with large capital gains, you may want to book those gains before 2008 when the law that cut those rates expires.

But if you can figure out where income taxes are headed, please let us know. We’d like to borrow your crystal ball for awhile.

May 7, 2004

Today's monthly jobs report is sure to become political fodder for the presidential campaign. And that has Walter in Boston wondering: Just how much impact does any president have on the U.S. economy? Does it really matter who is in the White House?

Who's economy is it, anyway?

My friends and I often debate the "real effect" a President can have on the economy.  While certain aspects such as tax increases or cuts and government spending increases or cuts can have some palpable influence, can it really make a huge bump?  It seems hard to credit President Reagan or Clinton for a robust economy just as it hard to blame President Bush for running a high deficit.  It would seem easy to praise a President who balances a budget following a recession if that balanced budget occurs shortly after they took office.  Conversely, it would seem popular to blame President Bush for a large deficit after he took office and inherited a terrorism attack and a minor recession.  It seems to me that it is more the ebb and flow of the economy with the President at the time pushing their agenda while putting the appropriate "spin" on the current economic trends.  The claimed impacts to the economy would seem to take longer than the four and eight years a President is in the Oval Office.  Adjusting for huge events such as war and separating political demagoguery, what "real" impact, if any, can a President have on the economy (taxes, government spending, etc.)?
Walter M. -- Boston, Mass.

This is not exactly your average bar bet, but the question is certain to have a big impact on this fall’s election. (By the way, you and your friends wouldn’t happen to be a bunch of economists, would you?)

The obvious answer is that — if things are going well — any incumbent president would like you to believe that it's because his policies are working so well. If things are going badly, that same president will tell you its because it takes a few years to undo the mistakes of his predecessor.

In this case, it seems clear that the “Bush” tax cuts enacted last year are now circulating throughout the economy, helping to solidify a fairly convincing recovery (one that may have happened anyway regardless of who was sitting in the Oval Office.) After all, if you give every American consumer a few hundred bucks, it’s a pretty easy bet they’ll spend it. That spending now seems to be giving the economy a lift — just in time for the November election.

Beyond that kind of short-term stimulus, however, the economic impact of presidential policies gets a little murky. The president does (or should) have a big impact on the budget deficit — it is, after all, the president’s proposed budget that Congress rewrites and sends back to the White House. The Bush administration argues that the unforeseen cost of the war on terrorism makes balanced budgets impossible at the moment. His opponents argue that his tax cuts produced the current deficit; that balanced budgets are never easy, and that the strong growth during the Clinton administration was due, in part, to better management of the federal budget.

It’s also not clear just how much deficits — by themselves — help or hurt the economy in the short-run. Sometimes deficit spending is a good thing if it's needed to reverse a stubborn recession. At other times, deficits suck up so much cash that it makes borrowing more costly for private enterprise — hurting growth.

But other forces — well outside the president's control — can have a much bigger impact. Low inflation and low interest rates (set by the Fed) may have had much more to do with the “Clinton boom” than balanced budgets. And it’s hard to see how the Clinton administration could take much credit for the Internet boom (though Al Gore gave it a try.)

Even if a president proposed a balanced budget and Congress behaved itself and approved it, the U.S. economy is subject to too many forces over which our government has little or no control. The benefit of the Bush tax cut, for example, has been all but wiped out by the sharp increase in energy prices engineered by OPEC. On the plus side, the recent rapid growth in China has helped boost demand for American products there. And the long-term slide in the value of the dollar — which has helped U.S. companies sell their products abroad — is beyond the control of any American official.

The one economic lever that any president would love to be able to pull is job creation, but no one has yet discovered the magic formula for boosting those monthly payroll numbers. Tax cuts help; so does increased government spending, but too many other things can go wrong. In the end, voters care much less about deficits and dollar policy than they do about their employment status. So keep an eye on those monthly employment reports. If payrolls keep growing by hundreds of thousands of jobs each month from now until November, President Bush will have much easier time keeping his job. If payroll growth is weak, he’ll be running into a pretty strong headwind.

GOT A QUESTION?

Any question is fair game, with one exception: no questions about specific investment recommendations, please -- we'll leave the stock picking to the "pros."

Each week, we'll take some of the most-frequently-asked questions and answer them here. We may not be able to answer every question, but over the weeks and months we will provide a comprehensive resource for you, explaining some more puzzling aspects of business and finance.

You can mail in questions at any time and then check this column every Friday for the answers.