Where to invest?

[bongo]

I still feel, as I have since 1997, that the stock market is overvalued, and the next several years will see low 5-6% returns at best. Obviously I wasn't right in 1997, but I'm still wary about the stock market. Bonds, unfortunitely, aren't likely to do much better. Is there anywhere interesting to invest these days? Is there anything I can do besides getting my 2-3% short-term rates?

[Dr T Non-Fan]

Try a high-yield bond fund.
Check the list of bonds closely, though. You don't want too many of them going belly-up.
I'd be wary about too much exposure to non-Vegas casinos. And the Vegas Alladin owners.
Or Real Estate.

[Pub Guy]

I went through the same dilemma as the original poster a few months ago. I'm saving to buy a place, but after short term rates dipped to 2% (from 6% BOY), I decided to move into high quality long term bonds. I figured the yield curve was so steep, that certainly it would flatten out over the next few months. Also, I didn't see the economy improving dramatically, so I saw the short term rates staying about the same (therefore raising long term bond prices as the yields dropped at the end of the curve). Incredibly, the yield curve has gotten even steeper over the last few weeks (which is even more amazing considering the Fed dropped the 30 year T-Bond) and I'm getting killed.

I considered DTNF's strategy of junk bonds, but the depressed economy scared me (bad economy = more defaults = bad times for junk bonds).

If you come up with the magic investment (high yield, low risk), let me know...

[Dr T Non-Fan]

I didn't say they were GOOD ideas.
All I know about junk bonds I learned from the 220/6 study note.

[Anonymous]

I would try high dividend stocks and cash.

If what I THINK is going to happen happens, it will be a very good outcome to get a 6% return over the next 12-18 months. Sometimes, and this may well be one of those times, you win by simply not losing your $$$, and emerging as one of the few people that has $ to spend on what will be cheap investments.

The simpler way of saying that is, I would keep my powder dry. 18 months from now there will be alot more worth spending money on. I think. One never knows.

[bongo]

I agree with you (on the other thread) that the market is heading down, but I think it is more likely to be a long-term decline (full of fits and starts, of course), or perhaps a multi-year stagnation while earnings catch up to prices. If that's true, then, as far as I can tell, there isn't really any good place to invest.

On the other hand, if I remember correctly, your market timing has been quite a bit better than mine, so I will give your advice due consideration.

[Anonymous]

I didn't tell you about my Boston Chicken debacle, clearly....

Timing enough to make you cry.

[Numbers Nerd]

One good place for you homeowners to "invest" would be your mortgage. You can get 6-7%, risk-free, by paying down your principal.

[bongo]

There are two reasons why I haven't paid my mortgage down more:
1) the rate is pretty crappy -- 7.5% fully taxable (by giving up the deduction)
2) it's illiquid. If I put money into my mortgage it's hard to get it back out. So if Shekky's right and I want to invest heavily in stocks next year I'm out of luck.

Still, I think this is a good enough idea that I put a few grand this way a week ago, and I'll probably do it more in the future.

[Dr T Non-Fan]

NN, I'd like to see your documentation.
While it might increase future cash flow (paying down now, paying less later), I hardly think there's some quantifiable return associated with this "investment" minus a number of other factors (which are independent of an investment).
Matter of fact, paying down some mortgage only lessens the leverage of the return. It lowers risk, which, all things equal, actually LOWERS the expected return on your investment.

[Anonymous]

Dr. T. NN is right about the incremental return. It is exactly as he said it.

What you are getting at is that the overall return on investing in your house would be lower. If you thought that your house would net you a greater than 7% return on your equity (which most people would like to think), then you two are not disagreeing. You are talking about the overall return. YES, the overall return on your equity is lower when you put in more equity. However, once you've put in that equity, if you have nothing better to do with your money--which in today's market is quite possible--then putting that money into your equity is the optimal decision.

[Dr T Non-Fan]

I still don't think so. I think you're actually strengthening my argument. There are other factors involved in the return on this kind of investment. Paying down is not independent of these factors.

Usually the argument in favor of paying down mortgages is that in 20 years, you won't be paying any mortgage. I expect to have gone through three houses over the next 20 years, so paying down is probably not a good choice of investment or saving tool.

The only agreement I see is if you pay down your mortgage to prevent you from wasting the money on something else (products, services or investments). Out of sight, out of mind.
OK, one more possible agreement: if you are conducting ALM on your personal life. If you plan on not working after age 70, then you will not want to pay a mortgage or rent after
age 70. Paying down now, when you have the cash flow to do so, might be a proper financial decision.

Also, you can use the equity in your home: you can take out a nice loan against it, and invest in or buy whatever you want. I get a "check" in the mail twice a week against the supposed equity in my home.

[Anonymous]

Imagine that your mortgage is a security which you could buy. When you look at the total return you've made, you STILL make the same return on the purchase and sale of the house, BUT you also, with unrelated dollars make 6% on a mortgage security you bought.

The other way of looking at it is that, tax differences aside, paying down your mortgage is the same thing as buying a mortgage from an unrelated 3rd party.

So, the initial investment and the return on it (i.e., the original equity) is unaffected by the return on the mortage buy down (buy back...whatever you want to call it).

[Ms. Re]

<<paying down your mortgage is the same thing as buying a mortgage from an unrelated 3rd party. >>

Not so fast -- if you buy a mortgage from an unrelated 3rd party, you'd be assuming a default risk, no??

[Dr T Non-Fan]

No, I'm little stupid (and that's probably an understatement). Maybe I need to break out the account T's, or something more visual.

If you mean that by paying down the mortgage you will pay less each month thereafter, then perhaps there's some return in that. That return will depend on whether you spend, save, or invest it. Mostly, whether the return will be higher than the tax-deducted mortgage interest rate.
If you got to pay it down at some discount, then I can see the return in that. That would depend on outside factors as well (value of house, for example).

[Anonymous]

Not always. They are usually guaranteed, if bought in the "securitized" form.

Also, it is not germane to my point. My point was just to illustrate that the return on initial equity is independent of the return on the subsequent paydown of the mortgage.

[Dr T Non-Fan]

I'm seeing a little clearer now.

I see that you could pay down your own mortgage, OR buy MBS's. Those are near equivalents, (Ms Re's risk noted).

The decision between these two investments should be based on the difference in the returns.

If you have a higher-than-market-interest mortgage payable, paying down or refinancing might be suitable. If you have a lower-than-market interest mortgage payable, then buying market-level MBS's (if such a thing is available for the smaller investor) would be a wise choice, ALM-wise.

[Intents]

Re: buying MBS. Anybody know the markup inherent in these? For instance, if my mortgage is 7% and the market is offering them for 7%, my intuition tells me that my 7% is better because the market offering of 7% is net of commissions which means the underlying mortgage is higher than 7% and I am really buying either a credit or re-finance risk.

[Anonymous]

MBSs, and other Asset backed securities typically have very low spread, usually measured against federal rates or LIBOR. I think they are almost universally issued at lower rates than the underlying loan (that's how the people issuing the loan make money...arbitrage between the borrower's rate and the ABS rate at the back end).

The reason for the low spread is that ABSs (and MBSs) always have some form of "credit protection". This can come in several forms.

1) A insurance policy (some insurer like MBIA guarantees the ABS)
2) A guarantee by the issuer (I think credit card issuers structure their ABSs as debt, and so remain on the hook for the bad loans)
3) Overcollateralization (meaning that the amount of receivables backing up the ABS exceeds the amount of money in the ABS issue. For example, securing $100M of ABS notes with $120 M of credit card receivables.
4) "Tranches"--where the ABS holder are broken up in to tranches, with the first tranche receiving interest and principal first, and the second only receiving P&I after the first tranche is paid off, then the 3rd, and so on. This way, the first tranche is virtually risk-free (in fact, many such tranches are rated the same as money markets, meaning, that they are perceived as having no risk).

All MBSs and ABSs, FYI, are rated (I think) just like bonds. Most of the ABSs I've ever seen are AAA or some other high rating.

So, in short....the securitization process removes (or attempts to remove) much of the underlying credit risk, and the resulting ABS notes generally have a lower yield than the underlying loans.

Sorry for the long-windedness.

[bongo]

Speaking of paying down your mortgage, I've noticed that the interest rate on my margin loan is quite a bit lower than the interest rate on my mortgage right now (and both are deductible). The interest rate is variable on the margin loan, but I still think the spread is worth putting $20k or so into my mortgage.

I also happened upon a cheap way to refinance. I opened up a home-equity line of credit, and it offers the option to lock in loans at prime + 1.75% (currently 6.5%) for up to twenty years. That's cheaper than you can get a 15 year loan, there are no closing costs, and you don't even have to pay principle!

[Steve Grondin]

Bongo-
The market in the SE for home equity line of credit generally is prime for floating, fixed rate not available unless a loan, not LOC. Zero closing costs if $10K held out more than 6mo. If you're itemizing on income taxes, it's a low cost funds source.

Is your rate fixed for entire period?

[bongo]

The way mine works is floating Prime for the LOC, but at certain times (twice a year, I think) you can lock in a rate of prime + 1.75% on your outstanding balance (convert it to a regular loan) for 20 years. Any further borrowing would still be at the floating rate.