Why the smart ones still live at home

Recent American college graduates are each year off to the "real world," as the transition from holding a part-time college job for booze money turns into a full-time job with alcohol-related purchases taking back seat to making money for rent and things like - gasp - groceries. These new (boring?) spending habits are probably a good thing, as besides not being very healthy drinking can also be tough on the wallet. But if Americans could look past the hurry to enter the "real world," and ditch the negative stigma that is sometimes attached to "living at home," parents could gift to their recent college grads an extremely valuable present at almost little cost to themselves: the gift of free rent.

It is no secret that rent is expensive. Judging from cities where this author has friends and depending on the roommate situation, living in Austin, Texas could put you out $400-$900 a month, Boston, Massachusetts could stick you $600-$1400 a month, while San Francisco and New York can ruin you for well over $1500. This author has the honor of forfeiting over $2500 per month for a very small apartment in Hong Kong, eight months out of college. These aren't swanky digs (nor are they dingy); these are the types of places you'd expect for a recent grad with an entry-level position. Doing a little math, an annual figure of between $6,000 and and $30,000 could go purely to rent, with a slightly higher opportunity cost thanks to monthly or up-front payments. That's a lot of money.

For the recent four-year graduate interested in attending graduate school, living at home is a reasonable option to save some serious cash, especially if is entry-level employer is unlikely to pay for future schooling. The same holds true for recent grads eager to get a leg-up on their personal savings. Looking beyond the annoying but inevitable late-night questions from the parents and the potential dulling of one's social life, what is that abhorrent about living at home? Home can't be that bad; who knows, maybe without the tuition payments the parents went wacky and invested in new hot tub or car. Yet even without these (unlikely) incentives, with the extra cash a recent grad may have enough money to put an additional $10,000 towards long-term savings and take that long trip overseas to visit a good friend in, say, Hong Kong.

This article isn't calling for the abandonment of life after college, or the forfeiture of independence so many college grads stumble into (and seem to enjoy) after living on the lam. But the economic benefits just seem so painfully obvious that, if a recent grad is comfortable with the idea of moving home after college (and if the parents and siblings can tolerate it), why the stigma for those who choose to do so? Ironically those recent grads may very well be the smart ones; indeed, the $30,000 annually this author pays for 500 square feet of personal space in Hong Kong doesn't include the luxury of a refrigerator that magically restocks itself every time mom goes to the grocery store.

Home sweet home. . .after the tuition payments?

iPhone looks cool, but you may not want to buy. . .

. . .stock in Apple. Right now there are millions of articles about the iPhone. But a few of those articles have odd pieces of advice, chummy rumblings like "you better buy Apple stock." One young respondent in an informal San Francisco Chronicle survey half-jokingly wondered if he should open an online stock account just to buy Apple.

Benjamin Graham, the founder of value-based investments, would grimace. He differentiates investment - buying shares in a financially-sound company whose market value is discounted from the fair value, giving the high probability of long-run positive return - and speculation, or buying shares in a company for any other reason. Investors make money in the long run. Speculators can make wild returns, but they can also make wildly bad bets leading to very poor financial results.

A little about AAPL, the four letters that are Apple's ticker symbol. AAPL is trading at a Price/Earnings ratio of around 41.5, well ahead of Microsoft's 26 (Google is roaring along with a P/E ratio of 68, Research in Motion is 62.53). What does this mean? The P/E is stock price, now between $94 and $95 per share, divided by Apple's earnings per share, a very respectable $2.27 in October 2006. EPS is calculated by dividing Apple's net income ($1.99 billion for Oct05-Oct06) by the total shares outstanding (877 million). The P/E can be seen as the market's view of a company's future growth - a company with no growth should trade at its net book value, aka the value of assets (including cash) minus liabilities (like debt and depreciation), + the value of its annual profits, ideally paid in dividends. Valuations above a company's book value (virtually all stocks on the market) are thought to be incorporating future returns. With Apple's P/E of 41, it will take Apple 7.5 years to reach the future level where investors value (or rather, anticipate) Apple to be, if Apple's annual growth retains an average of 50% over the next 7.5 years*. If Apple maintains "modest" annual growth of 25% (an enormous task of any company), it will take Apple 15 years to reach that valuation.The P/E ratio is also a good comparative ratio, allowing the market's perception of Apple's future to be juxtaposed with competition.



An important man


Comparing Apple and Microsoft is not a perfect comparison, but it seems an oddity that the market is more bullish about Apple than Microsoft. To explain this author's view why buying AAPL is more speculation than investment, here are 10 reasons:

1. Apple is not Benjamin Graham's definition of a financially-sound company, because Apple has experienced wild fluctuations in profits and revenue. iPod is the latest revenue fad, which gave Apple in the year ending Oct2004 a 287% increase in net income, 500% in 2005 and 50% in 2006 (25% would be considered very commendable). Yet many consumers have already forgotten that in 2003 Apple only increased net income by 4.6% over 2002 (in 2003 actually lost operating revenue, and only made money on interest off its float), and in 2001 Apple actually lost money. This probably points to the high degree of Apple's linkage to consumer sales, which are exacerbated by market conditions (2001-2002 were trying times for many companies). Further, Apple's recent drop in growth rate (to 50% from 500%) is part due to saturation of iPods in the market, part slowing consumer sales overall, and part the law of large numbers. Microsoft was not hurt like Apple during the 2001-2002 downturn (see below).
   
2. Microsoft has not lost money in any of the last 13 years researched for this article (since 1994). In fact, Microsoft increased net income every year except 2002, when it's $5.36 billion net income was below the $7.35 billion net income in 2001. Apple, in turn, has lost money in three years since 1996: in 1996 Apple lost $816 million, in 1997 Apple lost $1.1 billion, and in 2001 Apple lost $25 million. These are not positive signs for sustainable long-term uninterrupted growth.
   
3. Steve Jobs has a very small, but real, chance of being removed as CEO due to a backdating scandal. He also may have a recurrence of cancer or be incapacitated in a way unforeseen by investors. Steve Jobs seems more vital to the future of Apple than other executives are to the future of their companies.
4. Apple's current business model is the "wow" model. A beautiful product wows consumers, who buy (including Wall Street). This is a dangerous precedent: it's hard to keep impressing consumers (and Wall Street), over and over and and over again. The computer business and iTunes store are nice supplementary ways around this model and Apple should be commended for these, but they do not make up a large enough part of Apple's revenue stream.
   
5. The iPhone, if successful, may compete with the iPod (an Apple cash-cow) for sales.
6. More on the iPhone. The market is betting that the iPhone is a hit like the iPod. This may be true. However, iPod practically created the market for MP3 players and slowly morphed (and improved drastically) from cult hit to must-have accessory. The iPhone doesn't have this opportunity; expectations are already sky-high. Apple has to hit a home-run on the first try.
   
7. Apple makes excellent products, but those products still exist in a fiercely competitive field littered with manufacturers who, although it doesn't seem likely now, could produce a "hit" product which could slice Apple's market share from their valuable iPods. Consumer electronic buyers are notoriously fickle and cold-blooded.
8. Microsoft, not nearly as hip as Apple (see clunky picture), has a near-monopoly on PC operating systems and oogles of software. Monopolies stink for consumers, but make investors lots of money. PC computers come loaded with Windows (Vista will have problems, but people will buy it anyway, for lack of choice). People use MS Office. And as Apple tries to take tiny chunks away from Microsoft's monopoly by selling Apple computers, Microsoft is also working against Apple, creating the not-so-popular Zune and Zune music marketplace, and the Xbox, which may compete with Apple more than the consumer thinks. The Xbox360, and a possible second-generation Xbox360, will attempt to thwart Apple's eventual push to the living room.
9. Microsoft doesn't have to do the work Apple does, and makes lots more money because of it. This means Microsoft can try ventures and cheerily fail at them; Apple isn't quite so lucky. Apple's cost of revenue as a percent of gross income is 71%. Microsoft's ratio is an almost-comical 16% (indeed, Apple's revenue is almost $20 billion, almost double what Microsoft takes in. However, after cost of income, research and marketing, Microsoft is left with with nearly 9x the net income).
   
10. Microsoft pays a regular dividend, and has so since 2002. Apple's last dividend payment was in 1995.
    

No cost of revenue, eh?


This doesn't mean Apple stock won't shoot up tomorrow. Steve Jobs may introduce the iRobot, iMassageTherapist and iToilet, and speculators may continue to boost Apple's share price with their fingers crossed that the iPhone will be the next cash cow. It very well may be, because Apple has done so in the past. It's just not as certain as its stock price may suggest.

This also doesn't necessarily mean Microsoft is a great value, it just seems a better one that Apple. The AAPL story doesn't seem to make sense for value-seeking, long-term investor. It's not that there's something wrong with Apple, Inc. - it's that there's something wrong with the way the market values it.



*To calculate, take the natural log of 41, and divide by % expected earnings.

A Christmas lottery windfall

What a better holiday present than winning one of the country's largest lotteries: the Powerball lottery (currently at $75 million), the Megamillions lottery (currently at $60 million) or the California lottery (currently at $30 million). Even wimpy sums of $5 or $1 million would do for most people, propelling them into the financial stratosphere for a life of exotic villas, Italian cars, servants and. . .bankruptcy?



It's probably not surprising that lotto winners, usually not filthy-rich beforehand, can blow their winnings quickly after getting a windfall of cash. This New York Times article from 2005 comically yet sadly details how two lotto winners, a blue-collar Kentucky resident who shared a $65 million Powerball winning ticket (a cash value of $34 million) with his estranged wife, didn't fare too well. After the husband bought a "Mount Vernon-sized estate," horses and plenty of cars, his wife stocked up on Mercedes cars and bought an equally enormous house that she filled with cats (they lived separately). The husband, when shopping for groceries, would pay in $100 bills and pass the change, sometimes upwards of $80, to the customer standing behind him. He was also swindled out of $500,000 drunk one night at a bar, and two years after winning the lotto died from complications due to alcoholism at age 45. His wife's body was found some weeks later decomposing in her own home, apparently dead from a drug overdose.

Yes, these stories may be the epitome of lottery disaster. But instant wealth doesn't seem to provide instant gratification, and it may be best to take a deep breath if faced with an influx like a Hummer-sized pile of cash. A column in the New York times this morning discussed this intelligent waiting approach, and used the recent Survivor: Cook Islands winner Yul Kwon as a positive example. Mr. Kwon said to the New York Times: "I have tried very consciously not to get too ahead of my self on what to do, I plan on sitting on the money for a while so I can get my feet on the ground. I don't want to be rash about it." The article is the antithesis of the article about the Powerball winners; this time, it seems the winner is making the smart choice.

In the California lottery's "Winner Handbook" (here in .pdf form), they recommended speaking with Boston Globe columnist Charles Jaffe, who advises recent winners to spend 10% of the initial payment on ridiculous purchases to get it out of their system, and then to not spent anymore until taking a long peaceful vacation to think about what's important in life. Mr. Jaffe tries to impart the idea that free time, not material goods, are most important to people. If you play your cards right, you can use that lottery money not to buy Aston-Martins and 12 ranch-houses, but to buy yourself the freedom from a job you don't like or the flexibility to visit your parents and kids whenever you want. Yes, it seems that controlling your own time is a handy way to raise your own level of happiness.

An article on October 8, 2006 in the Wall Street Journal also explains this idea ("Nine tips for investing in happiness"). The Journal - which relishes the role of playing Wall Street cheerleader - makes the un-Journal-like opening claim that "If you want to be happier, forget spending dollars -- and focus on how you spend your time." Among the things that can genuinely increase happiness, according to the journal: volunteering, spending more time with friends, challenging yourself (by not watching TV after work, and instead doing things like projects or working after personal goals), not trading up to a more expensive lifestyle (it can seem desirable to move to a better neighborhood, but once there you realize your neighbors have lots of fancy cars, extra houses, and a lifestyle that you still can't afford), and reducing your commute (according to the Journal, a commute is universally seen as one of life's least pleasurable activities).

Great lottery thoughts: If you created a chain of people holding hands at earth's equator, and if those people stretched all the way around the world more than twice, and if you gave each person in that long chain a different Megamillions ticket, you still wouldn't be guaranteed to have a winner. Alas, people are not deferred from playing - not even yours truly.

(odds of winning Megamillions are slightly more than 175,000,000, people standing around the world assuming 2 feet of space for each person front and back, based on 25,000 miles around the world at the equator).

Pensions or benefits? Read this

Those of us who just graduated from college now have jobs (or maybe not). With a job, chances are we'll also encounter benefits. What are some ways to maximize wealth given to us from those benefits? I'm not expert, so I can't tell you what stocks to invest in, but if you utilize a few common sense points when dealing with direct monetary benefits (like a pension, 401k, any other retirement package, matching, etc), you can have your money work harder for you.

A.)
At the minimum put in as much to your pension/401k that your company will match. That's free money, and a surprisingly small amount of Americans take advantage of this incentive to help themselves in the future because they spend so much money (at a local trucking company in the Bay Area, just ONE employee out of over 50, including both truck drivers and office staff, take advantage of a corporate 25%-100% match given to them up to 8%, the tax-free amount, of their salary). It's understandable that bills/rent/utilities whatever are expensive, and maybe you don't want to put a full 8% into your 401k. But you really should take advantage of the free money if you can, and cut down on spending now. Monthly subscriptions are especially costly - see what you pay for (cable, magazines, movie rentals etc.) and try to cut down on them so you can meet your employer's maximum match.

B.)
A better strategy, "Dollar-Cost Averaging"
This is a great investing strategy, and it will guarantee you generous income accrual over a long period of time (aka, 30 years). How to do it:
1.) Decide upon a set amount each set period (like each pay period, each month, etc.) that you want to invest in a long-term investment account (401k, pension, personal account, etc.).
2.) Then, select a fluctuating but historically stable market to invest in that historically gives more generous returns (like the NYSE, NASDAQ, S&P 500, DJIA, etc.)
3.) Invest a set amount (not a set number of shares) each period. Regardless of market fluctuations, invest the exact same amount each time period.
4.) ***Only utilize this strategy if you don't pay commission or fees every month for investing. Paying commission each month or fees will take a great chunk of your principle, and hence will greatly diminish expected returns***

What does this do? It enables you to invest in more shares when the market is down, and invest in less shares when the market is up. This way you buy stocks when they're cheaper, and fewer when they're more expensive. It sounds blindingly simple, and possibly because it's so easy Wall-Street analysts poo-poo this idea as being simple minded and boring. People who use this strategy are even dubbed "turtles." But the funny thing is, dollar-cost averaging works out better than many mutual funds because there are no fees involved, meaning you don't have to pay for the fund manager's Mercedes and house in Cabo.

Smarter money

Getting results without much time or effort seems like a hallmark of human emotion. I always think of health ads on TV, usually promising results as fast as possible while making the work seem minimal. Or those "work at home" advertisements, showing people making huge $$ every week (yea, you can tell the type of TV I watch by the great advertisements I'm exposed to). I think (hope?) deep down, everyone knows these "get rich quick" schemes or "too good to be true" promotions are just that. We just wish they weren't. A recent article in the San Francisco Chronicle in the business section, not really having anything to do with this topic, made me decide to write down more sensible possibilities.

I think some people may overlook the fact that they can get modest results - in this case, financial ones - without doing anything at all and without taking on any risk. All it takes is to reorganize their finances, and put their money on autopilot. How?

In a nutshell, there are many risk-free bank accounts that offer considerably higher interest rates than your current bank. Here are a few (rates as of 12/4/06):
*ING Direct (4.5% APY)
*Citi e-Savings (5.0% APY)
*Emigrant Direct (5.05% APY)
*eTrade Complete Checking Account (5.05% APY)

Make sure you read all account details (including fee and rate schedules) before signing up. Also know that some of these accounts (like ING) give you $25 for signing up if a friend refers you, so take advantage of that if you can. These accounts have no annual fees (the Citi one will if you sign up after December 31, 2006), they are all 100% backed by the FDIC up to $100,000 (which means if the bank goes bankrupt, highly unlikely as it is, the US government will give you the amount in your account up to $100,000) and offer a lot more bang for your buck. Why? Simple middle-school math should be able to explain this. Say you have $5,000 in a no-fee free checking account, and for some weird reason, decide not to spend any money for an entire year. At the end of the year, you have $5,000, and thanks to inflation at roughly .8-2%, you've actually lost money thanks to the depreciating value of the money in your account. However, imagine you kept $500 in your checking account and transferred $4,500 to an ING Direct online account (which offers unlimited free electronic transfers in and out of the ING account). Suddenly you're $202.50 richer by the end of the year ($4,500 * .045, the interest rate of the account), and have not only beaten inflation but have a little extra on the side as well. You're always free to transfer the money back into your main checking account at any time from your ING account.

Remember this statement: free checking isn't free. That checking account you're paying no fees on but is giving you 0.0% interest? That's costing you income. It's not advisable to pay fees on accounts, especially if you have a rather low balance (like me, say under $50,000) where fees can eat up remarkably large percentages of your total net worth, but it is best to maximize the opportunities afforded you by other banks and use their offers that allow for unlimited free electronic transfers of funds.

Don't be afraid to try something new! I know many people who are fickle with their resources, but keep their finances in shambles. Consider not having decently organized finances (aka not earning appropriate amounts of interest) like gleefully burning up multiple $100 bills with a lighter. Not exactly a good idea, right? This isn't exactly rocket science here, and don't be afraid! This is simply reorganizing to take advantage of people offering you more money for the exact same product. Everything I list on this page, with the exception of index funds below, guarantee your return of principle and interest.

Another thing to check in to (shorter term, easier liquidity):
*Treasury bills (http://www.treasurydirect.gov/) You can purchase T-Bills online from the US Government, the going rate as of 12/4/06 was 5.21% for a 14 day bill. Again, guaranteed income.

For someone looking for a little more, check out:
*Index funds ("stocks" that are really a small piece of every stock on that exchange. The NYSE has the Wilshire 500 (wfivx), the Nasdaq has the Nasdaq 100 (qqqq). Unlike the other possibilities I listed on here, with index funds you are not guaranteed returns nor even the return of your principle investment.

More on this later. . .