Buy vs. Rent Calculators

If you've read some of my other posts, you'll know that I hate financial truisms like "You need to be able to generate 80% of your pre-retirement income to live comfortably in retirement" or "Invest in stocks because you'll get 8% returns." Why do I hate these sayings? Because they purport to be true for all individuals when, in reality, financial planning is such an individual-specific exercise. And, as these sayings become accepted as truisms, people are effectively discouraged from challenging these ideas and thinking for themselves.

One of the most annoying financial truisms to me is the whole "renting is throwing away money" and "you should always buy instead of renting" line of thought. I accept that owning property is hardwired into our collective DNA as one of those quintessentially American ideals like mom and apple pie, but taking these truisms as the truth can result in some horribly bad financial decision-making. And, I'm not just talking about the people who took out sub-prime mortgages. The way to figure out whether this particular truism is, in fact, true for you is to sit down and crunch the numbers to accurately assess your situation. I realize for a lot of people, the joy of math probably ended somewhere in high school, if not before then, and putting a rent versus buy analysis together may be beyond the scope of their desire, ability and/or free time. One solution to this problem is to use one of the many online calculators that provide a rent versus buy analysis. The problem for me was that I found most of the online rent versus buy calculators to be overly simplistic - most contained too few variables for consideration, and as a result, I ended up spending way too many hours putting together my own rent vs buy spreadsheets.

However, just last week, the New York Times released its own online rent vs. buy calculator (registration may be required - but it's free!), and this is one of the first calculators that I've seen online that I think captures most of the major variables that should go into a rent versus buy analysis. In addition to accounting for many of the most basic variables that other calculators include (monthly rent, mortgage interest rate, etc.), it includes many other variables commonly ignored, such as annual HOA/assessment/maintenance/upkeep charges in owning and insurance/broker fees from renting. Most importantly, the calculator accounts for investment opportunity costs when you make a particular choice, and you can see the consequences of your choices depending on the rate of home price appreciation and rental price increases.

What the New York Times' calculator does is it puts you the consumer in the position of making an informed choice. That is, it doesn't just give you simplistic "buy" or "rent" answers, but rather it forces you to actively think about and consider your assumptions. The beauty of all this is that given the same set of facts for two individuals, one person might choose to buy and one person might choose to rent, and it would be the rational decision for both. For example, let's say you are looking to move to Irvine, California. Searching online, you find this beautiful new 2 bedroom, 2 bath apartment with a pool for $1850/month. You're also considering buying a home as well and find this beautiful new 2 bedroom, 2 bath townhouse for $479,900.

Going to the New York Times calculator, here are the other figures I will input (jump to the next paragraph if numbers are going to make your eyes glaze over): On the main page, I assume a 20% down payment, 6.25% mortgage rate, 1.5% annual property taxes, and annual rent increases of 2%. On the Renting tab, I assume 1 months deposit, 0% rental broker fee (this isn't New York City after all), and 1% renter's insurance. In the Buying tab, I assume $100 in condo fee/common charge with 0% deductibility, 4% buyer closing costs, 6% seller costs, 30 year mortgage, 0.5% annual renovation and maintenance costs, 0.46% homeowner's insurance, $500,000 in capital gains exclusion, and $100 in additional monthly utility charges. Finally, on the General tab, I assume 8% return on investments, a 31% effective income tax rate and 2.5% inflation rate.

So, what's the answer? Do I rent or buy? The answer is it depends because I still haven't entered in an assumed annual home appreciation rate yet! So, if I'm following all the doom and gloom in the news and think the housing bubble is upon us, I'll put in a lower home appreciation rate, say 2%, and the calculator tells me that buying is never better than renting over 30 years. Thus, I should rent. But, if I'm bullish and optimistic and believe that lots of people are going to keep moving to Southern California where the weather is perfect and there just isn't much room left to build houses, I might put in a more optimistic appreciation rate, say 6%, and the calculator tells me that buying is better than renting after just 4 years.

So, what's the lesson? The first lesson is that there is no easy buy versus rent answer and that not all renters are losers! The second lesson is that your assumptions and beliefs play a huge role in the analysis. If you're a young 30 year old couple looking to start out, you're probably also putting your investment funds into stocks expecting higher returns. If you're on the cusp of retirement, your funds may be in more conservative investments. Thus, the 30 year old and the retiree would have different assumptions to punch into the Times' calculator. So many different factors can impact the calculations.

And, all of this isn't to say that there aren't problems with the Times' calculator. A more robust calculator might take into account future effective tax rates (e.g. are you climbing the corporate ladder with annual salary raises and thus higher income tax brackets? Do you think a future President Hillary might increase taxes?), the impact of non-traditional mortgages like 80-10-10s or 80-15-5s, variable rate mortgages, expected growth in HOA/assessments as the property ages, etc. Also, more generally, who really knows what the inflation rate should be or what rate home prices will appreciate at? But, the bottom line is that going through the exercise of punching in some numbers into the buy vs. rent calculator will at least make you informed enough to know that renting isn't always throwing away money!

Hedge Funds 101

What do hedge funds have to do with personal finance? Not much unless your idea of personal finance involves figuring out what to do with with the idle millions of dollars sitting in your bank account.

But, with more and more capital being managed by hedge funds and with the growing influence of hedge funds on global capital markets, it's certainly worth at least knowing what a hedge fund is and is not. Just a couple years ago, if somebody asked me what a hedge fund was, I would respond by saying that a hedge fund is basically a mutual fund that is allowed to short stock, employs quantitative PhDs who create complex trading algorithms, and charges its clients outrageous fees due to its ability to create above-market returns. I suppose those types of hedge funds still exist out there, but more and more, you see hedge funds acting like private equity shops (crude definition: an investment firm that raises money, often through highly leveraged debt, to buy out operational companies, make financial and/or operational changes to those companies, and then flip the companies back out on the market to other investors - see the Wikipedia entry on "private equity" for a slightly less crude explanation) or serving as activist insurgent shareholders. Venerable companies like Goldman Sachs, which one might use to describe as an investment banking firm, now looks more like a giant hedge fund and makes far more money in its proprietary trading than it does in banking.

So, then, what exactly is a hedge fund? Whether you're curious to know or you just want to sound smart at dinner parties, I recommend checking out this New York Magazine piece which offers a good basic introduction to hedge funds. Here are a few selected passages from the article:

It’s only a vehicle for investing, albeit one that happens to be less constrained than most. Your run-of-the-mill mutual fund, for example, buys stocks and bonds, and that’s pretty much it. Most are not even allowed to employ short selling, a way of betting that the price of a security will fall. Hedge funds can employ whatever investing tools they want, including leverage, the use of derivatives like options and futures, and short sales. The New York Times decided years ago to incessantly refer to hedge funds’ use of these instruments as “exotic and risky,” thereby adding to their aura of mystery. The funny thing: Practically all financial institutions use these “exotic” instruments.

There’s a much simpler way of putting it, offered by one of the industry’s luminaries. According to Cliff Asness of AQR Capital, “Hedge funds are investment pools that are relatively unconstrained in what they do. They are relatively unregulated (for now), charge very high fees, will not necessarily give you your money back when you want it, and will generally not tell you what they do. They are supposed to make money all the time, and when they fail at this, their investors redeem and go to someone else who has recently been making money. Every three or four years, they deliver a one-in-a-hundred-year flood.”

Save Money: Passport Photos

The next time you're looking to renew your passport, save the $9 or $10 that it costs to take a passport photo at your local pharmacy, and do it yourself with a digital camera. Have someone take four or five shots of you from various distances against a white background and upload those pictures to your computer to figure out the right size you need. Or, just head over to the pharmacy to print out your pictures at $0.19 each and pick the one that looks right. All in all, it shouldn't take too much more time than getting your photo taken at the pharmacy.