Best of blog posts for week of July 17th

Frank at Bad Money Advice mentioned this eHow article on How to Get a Free Flight by Getting Bumped I don't know if its a tactic I'd like to use since I tend to hate complications with air travel, but it sounds like a good way to try and get free air fare.

Jim at Bargaineering gives 8 Reasons Credit Cards Beat Debit Cards

The Wallet at WSJ has a couple articles this month recounting troubles he's had with AOL billing.
You’ve Got Blackmail: The AOL Account That Wouldn’t Die and the follow up You’ve Got Blackmail II: AOL Responds If you've ever had an AOL account and tried to cancel it then you're probably somewhat familiar with their business tactics.

Billshrink has an interesting chart on the Cost Efficiency of Transportation

MyMoneyBlog passes along an offer from BofA to get $100 for a new checking account: Bank of America Promotion Offer Code: $100 Bonus For New Accounts

Cheap Online Degrees starting at $16,080

Think that a 4 year college degree is going to cost you $160,000 or more total? It certainly doesn't have to. Going to a local public state school and living at home can cut the costs significantly. But even public schools aren't always cheap. Average tuition at public 4 year colleges is $6,585 annually. But thats still $26,340 for 4 years. Whats more you might not have a public college within commuting distance so housing costs might run it up even higher.

One possible way to cut the costs is to go to college online only. There are more and more online study programs from accredited colleges across the country. Some of these can be very inexpensive when compared to tuition and other costs for on campus study.

The site GetEducated features a list of Best Buys in business degrees. Some of the online programs have the same tuition rate for non-residents. Below are a few of the online college bargains available.


Total cost for tuition for an online BS degree for non-residents:

University of Wyoming : $16,080

Fort Hays State University : $19,964

SUNY Empire State College: $21,380

Troy University eCampus: $24,000

Eastern Oregon University: $25,430

Free and cheap magazine subscriptions

This site Lowpricesubs.com is offering free 1 year subscriptions to the following magazines:

• Bassmaster 2 yrs
• Weight Watchers 1yr
• Muscle & Fitness 1yr
• Field & Stream 1yr
• Latina 1 yr
• ESPN Magazine 1 yr

To get the subscription you fill in your shipping info and say which magazine you want in the comments section. There is no credit card required. I haven't tried it and I don't plan to since none of the options is anything I personally read.

But the site also has other subscriptions for other magazines at discount prices. 1 year of Car and Driver for $4, Motor Trend for $3 and Road and Track for $5.

I heard about the offer at Fatwallet.

Dave Ramsey's Overly Optimistic College Investment Growth Expectation

The other day I was watching an older episode of the Dave Ramsey show. In one bit a caller asked about saving for college. Dave's advice to the caller was to open an Education Savings Account (ESA) and put $2,000 a year into it. He said that after 18 years of investing over a childs life you'd accumulate over $120,000. I'm paraphrasing here since I didn't capture the exact quotes. But I remember for sure he was claiming about $90,000 in growth in the investment over the 18 years with $2,000 annual contributions. I did a little math in Excel and checked it with this investment calculator and it appears that Dave is expecting 12% growth in the college savings investments.

I have 3 problems with Dave's advice.

1. I don't know why you'd want to invest in an ESA over a 529 in general. 529 savings plans are newer than ESA's and have a lot of benefits over them. Moolanomy discussed Dave's recommendation of an ESA over 529 and disagreed. Motley Fool also compares the different college savings plans. I do think that sometimes a 529 isn't the best choice especially if your state has a poorly designed one with no tax perks. But in my opinion for most people the 529 should be the better investment option. Dave Ramsey does discuss ESA's or 529's as options on his website. But he seems more in favor of ESA's than 529s due to their flexibility.

2. I think that 12% return expectation is overly optimistic expectation. If you're investing for 18 years its likely you'll hit a good rate of return over so many years. But 12% is pretty optimistic expectation. This post at Get Rich Slowly has some charts on historic stock returns. Using those charts as a reference, historically the S&P 500 had about a 80% chance of hitting 12% returns over a 15-20 year period. So then there is a 1 in 5 chance you'll have had lower than 12% annual returns. If you aimed for a lower 8% return then you would hit that 100% of the time for every 15 or 20 year period in the S&P 500 history. I think you should hope for 12% but expect 8% over a 15 year period.

3. You wouldn't want to be 100% in the stock market 100% of your saving period. Dave's prediction on the investment growth is based on investing your entirely money in the stock market. But what if the stock market has a down period in the 1-2 years just before college starts. If you started investing in stocks in 1992 and your child was just about to go to college this year and you still had all your money in equities then you would have seen your college savings drop about 40% in the past 12 months. Of course 2008 is an unusual year for stocks, but for an individual 1 year period theres a fairly decent probability that stocks will lose money. I wouldn't risk it. To be safe, the closer you get to the end of your savings period, the less you should have in stocks. It would be safe to start shifting your college savings over to bonds and/or cash around 5 years before college starts. That would mean 13 years investing 100% in stocks and then 5 years investing in bonds and a gradually decreasing % of stocks. An impact of safer allocation between stocks and fixed income would be lower investment growth. While you might get 8-12% annual growth while you're 100% the stock market for the first 13 years, during the last 5 years when you shift the % allocation over to fixed income your growth rate will be closer to 4-8% due to lower returns from bonds and cash.

Bottom line:
Of course Dave's basic advice is to put $2,000 a year into an ESA isn't a bad idea really. An ESA is a decent way to save money and saving $2,000 a year is a decent goal. However I think setting expectations too high such high investment growth is not good idea and can leave some people with a false sense of security. And for most people the 529 savings accounts are going to be a better option.

What if the Insurance company holding your Life Insurance or Annuity fails?

I've been looking at annuities as part of a retirement plan. One of the concerns that I've occasionally heard about annuities is the fear that if the insurance company that you buy the annuity contract from fails that you might lose your retirement money. Say that someone retired 5 years ago and had bought an annuity from AIG. What would happen to that persons investment if AIG went bankrupt? Thats a scary idea isn't it? I'd hate to buy an annuity with an insurance company only to see them go under some years down the road and then lose all my money. Thankfully you don't need to worry too much.

There is a guarantee on life insurance and annuity contracts issued by insurance companies that is backed by a state guarantee association. Each of the 50 states and D.C. has a guarantee association. They are organized nationally as the National Organization of Life & Health Insurance Guarante Associations (NOLHGA)

Each states guarantee association acts a little differently. But generally the idea is the same. The state guarantee association acts to back life insurance policies and annuities much like the FDIC backs bank accounts. In the case that an insurance company becomes insolvent the state guarantee association will step in to help cover it.

Here is their informational brochure that addresses consumer questions about how it works.

Quoting from the brochure, here are a couple key points:

"What happens when my insurance company goes out of business as a result of insolvency?
Insurance companies that experience severe financial difficulties are taken over by the insurance department of the state in which they are based,and that state’s insurance commissioner becomes the “receiver.” If the company is determined to be insolvent, it may be liquidated. When a liquidation is ordered by a court, state guaranty associations work with the receiver to pay covered claims directly or transfer the policies to a financially sound insurance company."

"How much protection do I have?
Like the FDIC, state guaranty associations have maximum benefit limits. These limits are established by state law and can vary from state to state, but most states provide at least:
• $300,000 in life insurance death benefits
• $100,000 in cash surrender or withdrawal values for life insurance
• $100,000 in withdrawal and cash values for annuities
• $100,000 in health insurance policy benefits"

Those are the minimums and some states offer higher coverages maximums.

Basically the bottom line is that if your insurance company goes bankrupt then you will be covered up to the amounts listed above. This is certainly some protection so that we all don't have to worry so much about an individual insurance company failing. If for example you had a $75,000 annuity with AIG and you were worried about them failing then you shouldn't sweat it since that amount is guaranteed by your state guarantee agency.

If you have amounts above the limits in an individual insurance company then it would be a smart move to diversify with multiple insurance agencies. Instead of buying a single $200,000 annuity from one insurance company consider buying two $100,000 annuities via two separate insurance companies. That way if one of them fails then you'll be covered to the maximum value of the annuity.

Again, each state is a little different so for the exact details on your state go to the NOLHGA site and find the link to your states agency. Depending on the state, you're going to have at least the protections listed from the QA above but you might have more than that.

Bottom line: Life insurance and annuities are guaranteed by state agencies up to $100,000 for cash value or annuity policies and $300,000 for life insurance death benefits.

Another Example of a Whole Life Insurance Policy

I've talked about a couple previous examples of cash value insurance investments. I gave an example of a universal insurance and an example of whole life insurance. I was watching the Suze Orman show again this weekend and they had another caller ask about their whole life insurance policy. Here are the details about the callers policy:

$150,000 death benefit
$10,000 cash value after 10 years
Premium payments of $261 quarterly
They were told they would have a 4.4% interest rate.

So their cash value in the policy is now roughly a little less than the premiums they've paid over the 10 years. The death benefit of the policy has effectively eaten up all their interest.

I ran a quick test in Excel and found that at 4.4% interest growth you would need to save about $818 annually to accumulate $10,000 in 10 years. They've paid $261 quarterly or $1,044 annually. So they have paid about $226 a year to get $150,000 in insurance in addition to putting $818 away into the cash value investment.

I searched for quotes on term insurance over at QuickQuote and found that a 38 year old man should be able to get a 20 term policy with about $250,000 to $300,000 coverage.

So you have 2 options: the whole life policy the caller bought or buying a 20 year term policy and invest the rest. Lets see how those compare:

Whole life:
Cost: $1044 a year for 10 years
Death Benefit : $150,000 for as long as policy is maintained
Savings: $10,000

Term life + savings :
Cost : $226 for insurance and $881 for savings
Death Benefit : $250,000 for 20 years
Savings: $10,000


Overall I think that in this comparison term life and investing is a better option. Isn't it better to have $250,000 of coverage for 20 years than $150,000 coverage?

This whole life policy isn't a horrible one and they could have done a lot worse. But even this policy isn't as good as term life.

Is owning a Rental or buying a REIT more profitable?

A little bit ago Frank at Bad Money Advice discussed Owning Rental Property or Owning REITs. It was an interesting article. I agree with Frank that for most people buying a REIT is a better choice. Few people are really cut out to be landlords and owning a rental is essentially like starting up a side business or taking on a part time job. But when evaluating the two you really need to compare the investment returns. So I figured I would do that.

Lets look at an example of how both invests would have performed over the past 10 years.

Buying a REIT:
Vanguard REIT Index Fund (VGSIX) would be a good choice to invest in REITs since its a diversified index with low expenses. From June 1999 to June 2009 the fund has paid out $9.15 in dividends per share. Thats a pretty good return. The value of the shares hasn't fared as well in the pas t10 years though. In June-July of 1999 the fund sold for over $11 a share and today its trading at $9.50. Overall if you bought the REIT in July 1999 accumulated all the dividends and then sold today you'd be up $7.65. That equates to about 5.4% annualized return in 10 years.

Buying a rental:
Case Shiller home price index has data on the history of home prices. The composite-10 index went from 92 in April 1999 to 150 in April 2009. Thats a 5% appreciation rate in the property values across the composite index. And thats after the drop in real estate, the index peaked in summer of 2006 around 226. Plus you would get rent from the property. Current capitalization rates for rentals is around 5-6%. Lets say you bought a property in 1999 for $100,000. You'd get rental income profits of say $5,000 a year which would add up to $50,000 over the 10 years. Then in 2009 you could sell the property for $150,000. Thats a total of $50,000 in equity appreciation and $50,000 rental profit for $100,000 increase in the investment. Your money doubled in 10 years which equates to a 7.2% annualized return.

So comparing broad average performance between real estate and REIT industry the direct ownership of a rental comes out a bit ahead in average annualized gains in the past 10 years.

Of course as with any kind of investment the historical returns are no guarantee of future returns. Nobody has a crystal ball to see what real estate will do in the future and how REIT yields will compare to rental profits. But the previous returns are about the best indicator we've got to look at to compare the returns of the two. I'd also like to look at a longer period than 10 years but its hard to find solid data for longer time frames. The Case-Shiller index doesn't go back too far and most REITS haven't been around a long time.

I'm purposefully not looking at tax implications for owning rentals versus REITs since thats an entire topic in itself. Briefly though: REIT dividends are taxed as income and equity growth is taxed at capital gains rate. Rental profits are taxed as income and equity growth is taxed at capital gains rate. Owning rentals does get a big fat deduction due to depreciation. So the tax situation for rental ownership should be better overall than buying a REIT.


Location, location, location.

These examples are basically national averages. A REIT index is the reflection of a wide variety of REITs and the composite price index is a national composite of house prices across the country. But the real estate in your local market is probably not going to act the same as a national average. Location is very important for real estate. Certain areas are going to have better real estate markets and other areas will have worse markets. IN the same 10 year period from 1999 to 2009 real estate values in Detroit dropped 3% annually. Likewise if you bought the wrong REIT it could have lost money. ProFunds Real Estate UltraSector (REPSX) was trading around $21 when it started in 2000 and is now only at $8.47. Their dividends in the past 9 years were about $7.25. So thats about a 3.1% annual loss. A good REIT will beat a bad rental and a good rental will beat a bad REIT.


So, whats the bottom line?

REIT returns appear to be a bit less than owning rentals historically. Of course owning the rental requires more work.

[edit 7/13: fixed grammar error in title]