Recent news about the advent of rapidly rising gas prices has brought the subject of energy into the forefront of public opinion.  Unfortunately, the majority of the discourse occurs over typical “political football” issues such as profits from oil companies and proposals for higher taxes.  Recently, the topic has shifted toward the topic of exporting domestically produced oil to other countries.  Naturally, this is being portrayed as unpatriotic greed on the part of the oil companies who are subverting the national interest of the United States for their own selfish interests. What this phenomenon really represents is a signal.  It is a signal to the United States that the “loose money” policies of permanently low interest rates and perpetual monetary expansion has consequences.  The government is clearly attempting to inflate values in the stock market and real estate sector by pumping money into the economy.  The problem is that this has the net effect of reducing the real value of dollars that are already in circulation.  It also has the effect of making products & services we sell to other companies less expensive, while making products & services they sell in the United States more expensive. One of the products made less expensive by a loose money / weak currency policy is oil.  When the US intentionally devalues its currency to support government spending programs and financial markets, it increases the relative purchasing power of other global currencies.  As the purchasing power of these other currencies increases, it allows them to purchase more energy than they otherwise would have bought.  This translates to increased incentives for oil companies to export their product instead of sell it domestically, unless the domestic price increases. Thus, the phenomenon we are seeing is not any kind of conspiracy or the result of evil intentions by corporate plutocrats.  It is nothing more or less than the predictable result of loose money policies.  It is certainly convenient for politicians to blame the usual suspects of “corporate greed” or “big oil” … however, the current situation is one that has been intentionally created.  It was not created to reward oil companies, it was created in an attempt to avoid a double-dip recession and conceal the sluggish growth of the US economy.

Canary in the Coal Mine

In years past, coal miners would take a canary down a mine shaft as a signaling mechanism.  If the canary died, it meant the air was becoming toxic and that they need to vacate the mine … quickly.  Similarly, these rapidly rising gas prices should be viewed as an indicator of what is going to happen as a result of continued easy money policies by the government.  It is an indicator of what the future holds for our economy.  Unfortunately, addressing the underlying problem that causes these higher prices carries with it separate problems.

A Rock and a Hard Place

The most certain remedy to the recent rash of price inflation is to begin tightening the money supply.  By raising interest rates and pulling-back money from circulation, it will increase the relative purchasing power of dollars.  This will make it (relatively) more profitable to sell oil in the United States than in other countries, so more supply will be attracted to the US.  This increase in supply will drive prices down to a new equilibrium.  The same effect will happen for food, which has also experienced a dramatic run-up in its price over the past few years.

The problem is that if interest rates are not constrained, and if money is removed from circulation, it will place significant downward pressure on both real estate prices and stock market values.  Increasing the cost of borrowing will also suppress business investment in new plants & equipment.  The unfortunate truth is that inflation has become the price we are paying for cheap money.  The irony of this observation is that the result of this policy, which is being pushed by the self-proclaimed champions of social justice is to disproportionately impoverish those at the bottom of the wealth and income ladder.

Since people who earn less income or are dependent on government subsidies tend to spend a higher percentage of their income on things such as food and energy, inflating the prices of these commodities to artificially reduce the costs for stock market investors and home buyers results in a net transfer of real wealth from those at the bottom to those at the middle and the top.

An even more concerning fact is that the current government entitlement liability has grown so large that long-term inflation is all but inevitable unless significant changes are made within the next few years.  Since entitlement programs are very popular with the people who receive the payments, it has become a matter of political suicide to propose any changes to these programs.  Unfortunately, the people who rely on these ‘safety net’ programs are the same ones who will be the most intensely impacted in the future when prices continually increase as the government prints money in an attempt to meet their financial obligations.

In the end, we must all decide what we will personally do to ensure that we are able to personally resist the coming inflationary wave.

 

Inflation is typically a hot-button political topic, but it is important to note that the ‘real’ rate of inflation is different for everybody.  The reason for this is because all products & services do not rise & fall in price equally, and people all purchase products and services in different proportions. Most people pay attention to the published consumer price index, which is based on a defined “basket” of goods and services.  This basket is intended to represent an “average” urban consumer, but is not necessarily representative of everybody.

Generally speaking, commodity products (Bricks & Sticks) such as oil, gold, food, and building materials tend to rise in price over time.  Generally speaking, monetary inflation impacts commodities first.  The reason for this is because commodities are purchased in large amounts with cash on a regular basis.  This means that as more cash moves through the economy, the first place it typically lands to drive up prices is commodities.  Over the long-term his price rise tends to be linear, unless a market bubble temporarily pushes prices up or crashes down prices.

Conversely, technology products (Bits & Bytes) such as computers, cell phones, televisions, smartphones, etc tend to decrease in price over time for a relative level of technological performance.  Another way this phenomenon manifests itself is when new technology products are introduced at the same price as the prior generation, but with more features or better performance.  In this case, the price per unit of performance is decreasing even though the total price may be staying the same.  The dramatic price declines of technology are a primary driver new business models that consistently emerge, based on new digital economics.  Consumers benefit greatly from the technology curve, since it allows them to consistently buy things that are better for the same amount of money or less.

The average level of market inflation is based on a presumed mix of commodity products that are increasing in price and technology products that are decreasing in price.  (This average is publicly reported through the Consumer Price Index, which has a fair number of its own quirks concerning how inflation is comprehended)  The way that this phenomenon translates into our life is that the level of inflation we personally experience depends on our pattern of consumption between commodity and technology products.  By and large, a person is more susceptible to inflation when the relative amount of commodity products they consume is higher.

In this way, inflation typically impacts people of lower incomes the most significantly.  The way that this happens is by inflating the cost of commodities such as housing, food and energy.  Since people of limited means typically spend a larger portion of their income on housing, food, and energy it means that they feel the effect of inflation much more sharply.  Conversely, people who spend a lower portion of their income on housing, food, and energy are less directly impacted by inflation since their personal basket of consumption is weighted more toward technology products that naturally deflate.

Since individual people don’t have the ability to affect market prices, it is not possible to change the level of market inflation.  However, since each of us has the power to choose how we consume products & services, we DO have the power to change the level of our personal inflation.  When oil prices increase, we have the ability to carpool, purchase a more fuel efficient car, move closer to work, or use public transportation.  Conversely, we can also choose to shift more of our purchase decisions toward products and services that benefit from advances in technology.  These types of changes are not always desirable, but they do give us power to influence the impact of inflation on our lives.

In this way there is a personal rate of inflation for both me and you that we can influence at the margins.  In the torrid journey of life, it is easy to become upset about inflationary government policies that push-up prices.  And in many cases, this anger is well founded.  However, it is not something that any of us have the power to directly change.  Each of us only have the power to change the decisions that we make as individuals.  In that way, the most important change to make is one that changes your personal situation and the situation of your family.

 

Taking a loss is hard to take. But avoiding a loss can be much worse.

U.S. stocks have lost some $4 trillion since their peak in October 2007, but investors aren’t fleeing the market en masse. So far this year, according to investment-research firm Morningstar, investors have taken $14 billion more out of U.S. stock mutual funds and exchange-traded funds than they have added. That is less than 0.4% of the total assets of U.S. stock funds.

Can losing money feel good? Recent experiments show that reward circuits in the brains of investors who have losses will fire intensely whenever money-losing holdings have an uptick in price. Jason Zweig has details on The News Hub.

In other words, while some investors have taken their losses, most are grimly sitting on them.

That could be a mistake. Research published in 1998 by behavioral-finance professor Terrance Odean of the University of California, Berkeley, showed that individual investors are 50% more likely to sell a winning stock than a loser—even though, on average, the stocks these investors sell go on to outperform while those they hold onto underperform.

Why the reluctance to bail? Selling an underwater asset, says Mr. Odean, “isn’t primarily about economic loss, it’s about emotional loss.” Once you sell below your purchase price, he believes, you can no longer tell yourself, “I still made a good choice, and it’ll come back.”

Individual investors aren’t the only ones who can’t make peace with their losses, according to numerous academic studies. Mutual-fund managers who cling to losing stocks underperform, by roughly four percentage points annually, the managers who cut their losses.

Christophe Vorlet

While some investors have taken their losses, most are grimly sitting on them.

On average, professional futures traders and stock traders hurt their returns by clinging to their losers. Real-estate investment trusts hang onto properties that are losing money longer than they keep those that are in the black.

Unpublished research presented at the annual meeting of the Society for Neuroeconomics earlier this month sheds new light on this old problem. Neuroeconomics is an emerging field that combines the techniques of neuroscience with theories from psychology and economics to study financial behavior.

In one study, led by Gregory Berns of Emory University, people lay inside a brain scanner while deciding to hold or sell an investment; the price of the asset changed randomly up or down. The researchers focused on the ventral striatum, a region of the brain that has been shown to respond to rewards, particularly when they are unexpected.

When an asset was underwater and its price rose, activity in the ventral striatum of the typical person in the experiment was “blunted,” or insignificant, rather than robust. “Many of the participants told us they had hope for a rise,” says Andrew Brooks, a co-author of the study. Perhaps because these people got what they expected, an uptick in price “wasn’t surprising,” Mr. Brooks says, and therefore didn’t excite this part of the brain’s reward center.

That suggests that many investors who are losing money may automatically assume—rightly or wrongly—that their position is bound to recover.

Other research at the meeting pointed to a second flaw in how investors might think about losses. A study led by Camelia Kuhnen of Northwestern University found that people are much worse at estimating whether a bad investment will produce mild or severe losses than they are at predicting whether a winning investment will generate small or large gains. “Learning [about probabilities] is particularly faulty,” Prof. Kuhnen says, “when people are in a bad environment with losses left and right and they have their own money at stake.”

There are several steps that can help you dump your losers.

First, get a second opinion, from a financial adviser or an investor you respect, on your money-losing positions. Ask not whether you should sell the investments, but rather if they are worth buying at today’s price. If the answer is no, consider selling.

Measure how long you hold your losers and your winners. If you hang onto your money-losing positions much longer than your winners, then put yourself on a regular schedule of looking for losses to harvest. (You don’t have to wait until December.)

Taking a loss is easier when you think of it as a swap—in which you replace a loser with a new investment in a similar (but not identical) asset—rather than a sale. That makes taking action easier, since you aren’t forced to admit that your original judgment was a complete failure.

Finally, realize that a loser can change from a liability to an asset when you close it out at a loss, since you can use losses to offset up to $3,000 of ordinary income on your tax return.

“Think about the term ‘harvesting your losses,’” suggests Meir Statman, a finance professor at Santa Clara University. “That should put you in mind of strolling in an orchard picking ripe peaches rather than rotten losses.” Just be sure to check with your accountant to make sure the loss is worth taking.

Article source: Wall Street Journal

 

One of the ideas that has become quite pervasive within the minds of investors is the notion of a “good stock” or a “good property” to own.  This notion stems from a general desire on the part of most people to own things of quality.  In our personal life, this frequently manifests itself as a desire to own a comfortable home, and a reliable automobile.  Quality gives us a feeling of safety and security.  Thus, it seems completely natural to want our investments to be the stock of a high quality company, the bonds of a high quality corporation of government, or a property that is desirable in both its quality of construction and location.  The problem with this view is that it only provides one half of the information that you need to determine whether an investment is a good deal.

The second half of this investing puzzle is price.  Put bluntly, the quality of a stock, bond, or property investment only matters in relation to its price.  This means that a ram shackled, blighted property can be a phenomenal deal at a certain price.  The stock of media darling companies such as Apple, Google, and Amazon can all be terrible investments at a certain price.  It is certainly true that high-quality investments can frequently justify a higher price than lower quality investments.  However, it is equally true that any investment can be a spectacular deal if the price is right.

The key for investors is to determine when the price of a high-quality stock, bond, or property is over-valued, or conversely when the price of a lower quality stock, bond, or property is under-valued.  Any investment is a good deal at one price, and a poor deal at a different price.  Unfortunately, it is frequently very difficult to determine exactly where these two boundaries are drawn for any particular investment.

When estimating the appropriate price for a particular investment, there are two relevant factors that need to be considered.  The first is the expected future price, the second is expected future cash flow, and the third is taxes and inflation.  When combined, they will create a holistic picture of the value for any particular investment.

Expected Future Price

• In the world of stock and real estate investing, this is referred to as appreciation.  Fundamentally, it represents the expectation that the future price of an investment will be higher than the price you paid to purchase it.  This is frequently referred to as the ‘buy low, sell high’ philosophy.  For most investors, this is the primary source of value that they see.  Stock market tickers report the price of securities, and the Multiple Listing Service reports the price of properties.
• However, the ubiquitous availability of price information frequently causes people to over-emphasize price appreciation as a source of value.  It is most certain that price appreciation is an important source of value for investments, but it is certainly not the only value vector.  The fact that so many people focus on market prices has made them become very volatile over the past few years.  Values for stocks, bonds, and real estate have all fluctuated significantly.  This has made future price appreciation very difficult to predict.
• In addition to all of this, there is one further characteristic of price that investors must take into consideration.  In order to capture the benefit of price appreciation, you must sell the investment.  This means that watching the value of your stocks or real estate skyrocket means absolutely nothing unless you sell and lock-in the gain.  Thus, in order to realize the full gains from future price appreciation, it means that you must sell at the right time.  In practice, this is very difficult to do and frequently results in selling while values are still going up.

Expected Future Cash Flow

• Another key characteristic of what makes a good vs. bad deal for investors is the cash flow that is produced.  In the case of stocks, this comes from dividends.  In the case of bonds, this comes from interest payments and the future return of the bond face amount.  In the case of real estate, this comes from rents that are paid by tenants for the use of your property.  The importance of cash flow to the value of an investment is that it represents a current, tangible return.  Typically, investments that produce the best cash flow don’t always have the best appreciation.  However, they also tend to be less volatile since the price tends to be more highly correlated with the rate of cash generation than the market expectations for future price increases.
• The way that most investors articulate the future cash flow of an investment is through its yield.  In simple terms, the yield of an investment represents its annual cash flow divided by the price paid for the asset.  In the case of stocks, the “dividend yield” is the annual dividends divided by the current market price.  In the case of rental real estate, the “capitalization rate” is calculated by dividing the annual net operating income of the property by the purchase price.  In the case of bonds, the discounted future value of all payments is compressed into an internal rate of return, which is articulated as the bond yield.
• In most cases, the rate of cash generation for an investment is much less volatile than the market price of that investment.  Stocks that pay dividends tend to adjust their dividend rate at a much slower rate than the market value gyrations of its price.  Rents from income properties tend to shift much more slowly than the value of the property.  Bonds typically feature a fixed interest and repayment price, with their market value being determined by the movement in yield rates for similar instruments.  When market yields increase, the price of bonds currently on the market go down.  When market yields decrease, the price of bonds currently on the market go up.

Taxes and Inflation

• The final key characteristic that differentiates good vs. bad investments is inflation and taxes.  Inflation represents the erosion of you investment’s purchasing power and taxes represent the amount of your gains that need to be paid to the government.  One of the oldest and most important concepts in finance is that “It’s not what you make, it’s what you keep” … fundamentally, this means that the “real” rate of return for your investments is much more important than the “nominal” performance.
• Starting with inflation, it is important to understand that when the amount of money in circulation expands more quickly than the amount of goods and services being traded, it creates upward pressure on prices.  For some asset classes, the effect of inflation is relatively benign, for others it is beneficial, and for some it is devastating.  By and large, property values tend to be lifted in proportion with inflation, while cash flows from dividends and rents are also increased by inflation.  Some stocks move up with inflation, but certainly not all.  On the other hand, bonds with a fixed interest rate are destroyed by inflation since it de-values the interest payments.  Conversely, fixed-rate debt that you owe is wiped away by inflation as the dollars you use to re-pay the loan become less valuable.
• Another key characteristic to understand is taxes.  Different types of income are subject to different rates of taxation.  Generally speaking, income that is earned from a job encounters the most taxes.  Income that is earned passively encounters less taxes, and income earned from capital investment encounters the least taxes.  Astute investors also understand the impact of legitimate business deductions, non-cash expenses such as depreciation, and deferring capital gains through a 1031 exchange to reduce their tax burden down to the legal minimum.  In many cases, it is tax advantages that turn a good investment into a great investment.

Ultimately, it is the responsibility of each person to determine what constitutes a superior investment deal.  Since people have different appetites for risk, there will always be a variety of investors bidding for a variety of assets.  What is most important for the individual investor to do is take an honest assessment of their personal investment tolerance and make decisions that incorporate all of the major value factors.  By balancing the future price, future cash flow, inflation risk, and tax characteristics, it will allow you to build a strong portfolio of optimized deals.

 

Recent news has been ablaze with news of commodity price volatility.  Prices for gold, silver, and oil have all taken a sharp drop after rising significantly over an extended period of time.  These rapid price fluctuations demonstrate the effect to which commodity prices are being driven by leveraged futures contracts and speculation concerning future price movements.  The situation that has emerged in major commodity markets is one where upward movements have resulted in more people purchasing futures contracts to profit from future price increases, but any weakness in prices is met by a rapid rash of selling by investors who are looking to limit their losses

The implicit problem that is uncovered by this recent price volatility is that returns from commodity investment singularly flow from price increases.  Naturally, the only way that prices rise is if an imbalance of buyers vs. sellers pushes up the price at which people buy.  If this trend continues for too long, a ‘bubble’ results where people buy simply because they believe others will continue to buy and drive up the price.  During bubble markets, many investors will begin to make leveraged investments on anticipated price movements through instruments such as futures contracts.  A futures contract is where two parties agree to exchange a specified asset of standardized quantity and quality for a price agreed today but with delivery occurring at a specified future date, the delivery date.  People who correctly predict upward price movements when using futures contracts can make a lot of money very quickly by selling the contract before its delivery date for a profit.  Conversely, if prices move counter to what an investor anticipates, a lot of money can be lost very quickly.

The ability to buy/sell contracts for future delivery allow investors and speculators to employ a tremendous degree of financial leverage.  This leverage increases the perceived returns of asset bubbles since increases in prices are seen as pure profit to futures traders who simply flip a contract and make money.  This phenomenon then attracts more people seeking easy money until prices are driven so high that nobody can be found to take physical delivery of the product in question at the inflated prices.  At this point, the investors who have no desire to take physical delivery of commodities must sell quickly to cover their position.  If many investors end up liquidating their positions simultaneously, price crashes can occur.

In recent months, “speculators” have been a popular political target for attempting to draw attention away from turmoil in the Middle East, a continued ban on US offshore drilling, and money printing by the Federal Reserve as drivers of increased energy prices.  However, it is important to note that speculators can only capture profits if somebody else buys the other side of their contract.  In other words, they can only profit from the price of oil going up if people reasonably expect the price of oil to escalate in the future.  It would be very difficult to find people willing to pay increasingly higher delivery prices for oil if new exploration contracts were approved and drilling resumed on existing offshore wells.

The important thing to understand in regard to commodity price fluctuations is that they move in accordance with the number of people who are willing to purchase the commodity in question at a given price.  The advent of price collapses is nothing more than a by-product of chasing profits with leveraged futures contracts.  The same forces that compel people to pursue big money in commodity trading also compels people to sell their positions rapidly when prices decline, because of the high leverage they are using for their transaction.

Ultimately, price bubbles and price collapses are two different sides of the same coin.  All bubbles eventually end in a collapse, and collapses do not occur unless prices become disconnected from fundamentals.  In the end, market prices will always regress back to fundamentals over time.  It may take a series of gyrations, but the one principal that has born out throughout financial history is that no bubble can endure indefinitely.

 

Most people who have not been taking up residence in a cave are aware of Groupon, the web’s #1 group buying site and fastest growing company ever.  The notoriety of the company grew even greater when it turned down a $6B takeover bid by Google.  Many consumers are aware of the extremely low prices that are available through Groupon daily deals, but there is a basic problem implicit in its business model that may so the seeds of disaster for the small businesses that Groupon depends on for its revenue stream.

The Groupon business model is relatively simple, but quite powerful for generating profits.  The company sends out daily deals to its massive list of subscribers.  Those deals are from local businesses offering discounts that are typically in the range of 50% or more off of the retail price for their product or service.  The way that Groupon earns revenue from this is by collecting a share of the revenue that small businesses receive from their group advertisement.  Typically this fee is on the order of 50%.

The way that Groupon sells its services is by positioning a win-win proposition where local businesses get to attract a large wave of customers and Groupon earns half of the discounted revenue stream.  This basic concept has vaulted Groupon to the heights of media stardom.  However, there is a secondary effect of the Groupon business model that could spell disaster for local businesses and potentially for Groupon itself.  These dangers fall into two principal caregories.  The first is dead weight advertising, and the second is small business commoditization:

Dead Weight Advertising

Doing the math concerning Groupon’s business model shows a startling fact for business owners … namely that offering a 50% discount on your services, and then paying half of that discounted amount to Groupon means that you will only be left with 25% of your normal retail price.  In many businesses such as restaurants or other competitive business segments, this is not enough to cover variable costs and each Groupon customer results in a loss.  Thus, discounts through Groupon end up acting like advertising with a super-low sale price.  Typically, the desire on the part of business owners is to attract customers who will come back for a string of repeat business.

Unfortunately, what frequently happens is that the people attracted by Groupon are aggressive deal-seekers who will simply move on to the next low-priced promotion when yours is finished.  In this way, Groupon can become “Dead Weight” advertising, because it accomplishes nothing but attracting people who would not otherwise pay full price for your products or services.  In this case, the business would have been much better served with traditional advertising that emphasized the value of their offerings so that the people attracted to your business are those who will pay a higher price than what Groupon shoppers have come to expect (and in some cases demand).

Small Business Commoditization

The extended impact of the group buying phenomenon exemplified by Groupon is the fact that small business services have become commoditized.  With a consistent volley of deep discounts in people’s inbox from Groupon and all of the other group buying services, customers have become trained to expect substantial price reductions from small business vendors.  Thus, the “repeat customer” who previously came back regularly is now asking if you can meet the price of a competitor who is advertising a special deal through Groupon.  In this way, the extremely low prices funneled through Groupon have lowered the perceived value of small business services for customers.

Ultimately, this has become a textbook example of classical pricing theory … namely the dangers of deep price discounting to increase volume and grow market share.  When you establish a precedent of discounted prices, it lowers the customers perception of your product’s value.  You can most certainly gain more volume from discounts, but that additional volume results in lower profits.  Furthermore, most businesses find that if they attempt to start walking their customers up to previous price levels, they will begin to leave for competitors.

In the end, success as a small business is (and has always been) about providing a product or service that your customer values more than the price you charge.  This creates a perpetual win-win where the customer receives a product or service of value at a reasonable price and the business owner receives revenue that generates profits after the operating costs have been paid.  Attempting to short-cut this process through business fads like group buying at deep discounts can spell disaster for small businesses.

As time goes by, there is a risk that this small business disaster could become a Groupon disaster if enough businesses decide to stop offering their services through Groupon and the quality of their deals deteriorates.  As the deal quality declines, there will be less transaction volume, and lower profits.  If the trend continues too long, we could end up with a future Harvard Business Review case study for MBA students, warning them of the dangers implicit in trying to short-cut the ladder to success.

 

Recent news that the rising cost of food and energy has brought the topic of inflation back into the forefront of public awareness.  Specifically, food prices jumped 3.9% in February, which was the highest since November of 1974.  In addition to this, housing starts are at the lowest level since April of 2009, and are the second lowest in the last 50 years.

All of this adds up to some very interesting economic dynamics.  The “core” component consumer price index has food and energy removed, meaning that government statistics are currently showing very low rates of inflation.  However, these reports are coming in the midst of rapid price increases for many items that are considered ‘necessities’ of living a normal life.

In the economic environment that is emerging, we are seeing two simultaneous opposite movements in prices.  One set of movements is coming in commodity products such as food and energy that are purchased with cash, and the other movements are coming in the realm of technology, luxury goods, and assets that are purchased with credit.  Put another way, the price of things that people “need” are going up, while the price of things people “want” are coming down.

Things We Need Getting More Expensive

The important thing to understand about price movements for things like food and energy is that they are commodity products people purchase with cash, and that are bought on a very frequent basis.  This means that when new money is created by the Federal Reserve, its impacts are felt first and most intensely by the items that are traded frequently and bought with cash.  This is the reason why inflation hits food and energy first and hardest.  As the government continues to use monetary expansion as a way of financing its operations, it will continue to place upward pressures on necessities such as food, energy, and other consumable commodities.

Things We Want Getting Less Expensive

In contrast to food and energy, we have technology products, luxury goods, and credit-based assets.  Technology products are driven by Moore’s Law, which describes how the transistor density of integrated circuits doubles every 18 months.  By extension, this means that the cost of compute power drops in half every 18 months.  This has enabled fantastic advances in technology at continually declining prices.  However, in a recent media event by the Federal Reserve, it was pointed out that the iPad 2 is twice as powerful as the original iPad, but at the same price.  In response to this, one of the people in attendance stated:  “I can’t eat an iPad”.

In addition to technology, we have luxury goods and credit-based assets.  The reason why these two items are becoming less expensive are very similar.  In the case of luxury goods, there has been a dramatic decrease in the number of highly affluent people.  This has resulted in an imbalance of luxury goods available relative to the number of people who are willing to pay for them, which is placing downward pressure on price.  In the case of credit-based assets such as houses, the stringent tightening of lending standards by government lending agencies has constrained the availability of credit.  This constrained ability of credit means that many potential buyers have dropped out of the marketplace, and prices have adjusted downward.  This trend has been accelerated by a proliferation of foreclosures that are suppressing prices even further, and triggering more defaults.

What Can I Do?

The current economic environment is one of correction.  For many years, lending standards were too loose and people simply borrowed to spend and assumed that they could continue re-financing their home indefinitely to absorb this additional spending.  Borrowing to consume is an unsustainable economic trajectory, and always results in a period of adjustment.  In this case, the problem was allowed to grow very large, so the adjustment is proving to be very painful.  (There are many who believe that the current trend of government borrowing to finance entitlement spending will precipitate an even larger adjustment in the future)

While we are going through this period of correction, it is important to understand the fundamental economic drivers so that we can make more informed decisions.  When it comes to food and energy, little can be done to address the base cost inflation, but individuals can realize considerable savings by ‘cutting out the middleman’ and buying un-processed or lightly processed food.  The reduced processing means less cost (in addition to less convenience).  Many people can trim their food budget considerably by substituting meals at a restaurant for cooking at home.  In the short-term, there is also little that we can do to directly address the cost of energy.  As costs continue to escalate, it is likely that car-pooling will increase and people will choose to run their appliances less.  None of these actions can directly stop rising energy costs, but when combined they can help to avoid excessive budgetary strain from rapid price shocks.

In the midst of cost increases, there are also many cost decreases that people can take advantage of.  With technology products becoming perpetually less expensive, it has never been easier to create a web-based small business.  In addition to this, the price reductions in many real estate markets have resulted in superior investment opportunities.  It is important to understand that every period of adjustment or correction creates opportunities.  The people who capitalize on those opportunities are the ones who will emerge from our current economic slump with brighter prospects for their personal, professional, and economic lives.

 

Recent years have seen a torrid pace of new products from Apple, including but not limited to the ipod, ipad, and iphone.  During the mid 1990′s, many had assumed the Apple business model was on borrowed time, but the company has come back to life with renewed vigor.  The success of recent products has vaulted the market capitalization for Apple stock to the top of the charts.

This renewed success has caused many people to ask questions about the business model for Apple, since they seem to be the only company in the marketplace who is able to generate value in the way that they do.  It is especially intriguing to people, because of Apple’s culture of secrecy where information is not widely communicated either within the company or to the press.

The fundamental cornerstone of Apple’s business model revolves around products that are extremely simple, visually elegant, and guaranteed to work together without any problems.  The way that Apple accomplishes this goal is with a combination of highly talented designers and total control over the product solution from hardware to software.  Every Apple product ships only with apple software.  This strategy nearly eliminates compatibility problems, but also forces consumers to convert all of their technology products to Apple or risk having issues with the compatibility of their products.

Traditional business theory predicts that this is a bad idea, because customers will not want to be forced into paying a large price premium for products that only one company offers.  By and large, this is true, but it can be surmounted if the products and services are good enough to overcome the significant price premium that is charged.  In practice, the community of Apple users has created a circle of common interest that is sometimes referred to as the “Apple cult”.

From a branding perspective, this is the perfect storm of opportunity for Apple.  By developing a base of devoted followers, Apple can continue to earn large margins on their products if they can continue to deliver new innovations that are ahead of the market.  This is largely why Apple is so secretive . . . their designs and ideas are the only protection they have to maintain their profits.  In the 1980′s, Apple produced innovations that shaped the form and function of personal computers, but nearly fell into the abyss as the pace of their innovation slowed in the 1990′s.

When Steve Jobs came back to Apple, their rebound began with the iPod, and has been driven by strong innovation ever since.  It is not certain that Apple will be able to continue their torrid pace of innovation indefinitely, but it is definitely true that they have a large base of followers that value the simplicity, aesthetics, and prestige of their products with an expressed willingness to pay big price premiums in exchange for it.  In short, the only entity who can ruin Apple is Apple.

The only way that its vast pool of devoted followers can be broken is if its new innovations become unimpressive.  If the marketplace is allowed to catch-up with Apple, then price competition will thin their customer base down to only the most thoroughly devoted of the so-called “Apple Cult”.  Until or unless this happens, it is reasonable to expect continued impressive results from Apple’s continued drive to drive consumer technology.

 

One of the most true axioms of life is that all things have their price.  This is true for things we want to buy, and also true for things we want to achieve.  For all things that we want in our lives, a price must be paid.  Sometimes this price is paid in money, other times it is paid in effort, but at all times it is paid in lost opportunity.

Any time that we take one action, it means that we are implicitly choosing not to take a different action.  Over time, these choices shape and define our future.   We decide to pursue our ambitions or we decide to stick with what feels safe.  We choose to prioritize our families or we allow the urgency of whatever we are doing at the moment to take precedent over that which we tell ourselves is most important.

As we go throughout our lives, each of us will need to forge our own definition of the success that we are seeking and the price that we are willing to pay in exchange for it.  These conscious decisions regarding the priorities of our life are what determine how we deal with conflicts between our personal, professional, and financial goals.  When two objectives are standing in opposition to one another, we must first seek a smarter solution that does not sacrifice one for the other.  When a smarter solution is not possible, we must ultimately choose.

Most people desire to maintain a successful family life and a prosperous career or business.  In most cases, these two goals compliment one another.  However, they can come into conflict if a particular family event conflicts with business.  In these cases, we must ultimately decide which tenet of our personal vision to pursue.  The important point to communicate is that this is a choice we should consciously make, lest we fall into the unconscious trap of prioritizing the seemingly urgent over that which is truly important.

This insidious form of lazy thinking is how many people end up extremely busy, but not remotely productive.  Decide what your vision of success looks like.  Decide what price you are willing to pay in order to achieve that vision.  Decide what price you are not willing to pay.  Actively do that which brings you closer to your vision of success.  Actively avoid that which takes your time, but does not achieve your goals.  Turn everything that you do into a conscious decision that consistently propels you closer to your goals.  By paying the price for success, you will also be laying the foundation for a more prosperous and fulfilling life.

 

When many young people endeavor to purchase their first automobile, they face a wide variety of choices.  One of the choices available is to lease or buy.  If buying, you can purchase the automobile with cash or finance it.  It is highly important to make the right decisions when purchasing a car, since the wrong move can turn that shiny new street cruiser into an automotive prison that locks up your financial resources for years on end.

Most people who are deciding how to purchase a car on paper will reply that it is best to buy with cash.  This is certainly true for people who have enough disposable cash to buy their cars outright, but what about people who need to finance?  The first and most important point of consideration is to make certain that you are not buying more car than you can afford.  One rule that many people support is called the 20/4/10 rule.  Namely that if you are financing a car, put 20% down, finance it for 4 year or less, and make sure the payments do not exceed 10% of your income.  This will ensure that you have positive equity when you drive the car off the lot, which can prove very important if the car is wrecked or stolen.

There are many traps that people can get themselves into with automobiles:

• Lease Trap: Leasing a car sounds great at the beginning, but you rarely get a good deal on the price and there are typically fees and charges that are due when your lease matures.  If you do not have the cash to ‘buy out’ the lease at its expiration, the nice people at the dealership will be happy to ‘bury’ the charges you owe them into a new lease.
• Dealer Financing Trap: Many dealers attract buyers with 100% financing, zero percent interest, easy qualifying, or some other gimmick.  All of this sounds great and induces many people to buy cars at or near the full retail price.  (When you are being financed by the dealer, you have very little power to negotiate a lower price)  However, if something happens to the car, your insurance will reimburse based on market value, which will most likely be less than your car is worth.  Now you have a bill that is due for the remainder between the price you paid and the car’s value when it was wrecked or stolen and that beautiful financing has suddenly evaporated.
• Friends and Relatives Trap: This one almost goes without saying, but great danger can lurk when you purchase an automobile from friends or family.  Before engaging in this sort of transaction, make sure to have the car checked by a competent mechanic or mentally prepare yourself to potentially absorb some unexpected expenses without complaining.

The optimal situation for a person who must finance is to arrange for their financing ahead of time.  This allows them to walk into a dealership knowing exactly how much car they can afford to buy, exactly what the rate will be, and exactly what the payments will end up at for a given price level.  This allows you to negotiate the ‘price’ instead of the ‘payment’ with the sales representative.  If the best deal they can offer isn’t to your liking, you have the power to walk out and go somewhere else because your financing is not captive to one particular dealer.  Even if the rate you get from the bank is higher than the one offered by the dealer, you will have the ability to negotiate down the price and reduce your risk of loss if the car is damaged or stolen.

In the end, it is highly important to avoid turning our car into an automotive prison.  By planning ahead and making prudent decisions, this goal can be easily accomplished while walking down the path of financial success.