The market is going for a wild ride, but I have decided to hold my positions. As I’ve created a portfolio that is relatively broadly based, it will hopefully recover as the global markets recover. I have made investments in the economies of the United States, the European Union, Latin America, and Asia. Despite all of the diversification, it is becoming growing clear to me how strong the entire world is connected. A downturn in one market tends to be correlated with a downturn in another. Likewise, the upturns are correlated as well. This likely has to do with the large amount of trade that occurs between nations.

For instance, the FTSE/Xinhua China 25 Index seems to have similar inflection points to the S&P 500:

While many environmentalists have talked to “saving the Earth” and “reducing pollution,” for some people, the greatest motivation is the almighty Dollar. Perhaps, the key to encouraging more people to make environmentally friendly changes is to unbundle the costs of consumption. However, when doing so, it is important to not merely use unbundling as a means of passing along price increases, as if that is done, it has the potential to lead to backlash.

At 7-Eleven convenience stores, customers can save money by bringing in their mugs or Slurpee cups for refills. Refilling a 22 o.z. durable Slurpee cup costs $0.95 in Philadelphia, while purchasing a similar beverage in a disposable cup costs $1.19. By providing customers with over a 20% savings for making an environmentally-friendly choice, 7-Eleven allows its customers to benefit from their behavior. Had 7-Eleven not passed along the savings, customers might experience decreased utility from bringing their own cups due to both the inconvenience and washing required, and may have been less likely to do so. 7-Eleven benefits from this policy, too. Given that the actual cost of the product is rather low, the cost of the cup may be near the size of the savings passed along to the customer. The true cost of the cup should be considered to include the cost of its production, its transportation to the store, and of the labor involved in stocking it in the store. By encouraging customers to bring their own cups, 7-Eleven also reduces the chance that it will have a “stock-out” and have no cups available, resulting in lost revenues.

American Airlines recently decided to charge passengers a $15 fee for checking one bag. While this may also follow the principle of market-based environmentalism as planes with less cargo require less fuel, it is likely to be viewed far more negatively, as it is being cast as a loss, rather than as a gain. Kahneman and Tversky showed that people experience more disutility from losses than they experience utility from gains of the same size. If American had raised its prices, but then provided $15 rebates to passengers checking no bags, the policy might have been viewed more positively. However, American likely chose not to do this, as people typically compare ticket prices among airlines, but not the “Total Cost of Ownership” (which in this case would include the baggage fee).

On April 10th, Jack Bogle came to speak to the MIT Alumni Association of Delaware Valley. Mr. Bogle is famous for having founded Vanguard, one of the world’s largest mutual fund companies, in 1974. Vanguard is well-known for having been a pioneer in the market for indexed mutual funds. Unsurprisingly, Mr. Bogle spent a large portion of his speech discussing the importance of following an index-based investing strategy. During his speech, I wrote down several of his most interesting points:

Bogle on the Global Economy 

• The global economy is anything but new. Chinese tea exports to Britain had an adverse impact on the price of the pound sterling, which motivated the British to find a product to export to China; opium.
• A decade ago, 15% of revenues of U.S. firms came from overseas. Now, 34% of revenues come from overseas.
• Although global stock markets seem to produce similar long-run returns to the U.S. stock market, when the dollar weakens relative to other currencies, they provide American investors with even greater returns.
• In 2007, 92% of mutual fund purchases were foreign; this may be a cases of performance chasing

Bogle on Investing

• When it comes to managing your portfolio, “Don’t do something. Just stand there. Don’t peak.”
• Buying and holding businesses is long-term investment. Speculation is the activity of forecasting the psychology of the market.
• The total return is the sum of the investment return and the speculative return
• Fund turnover is at an all-time high. It was 140% in 1929, around 40% in the 90’s, and reached around 280% in the 2000’s
• We are in a new era with the highest level of speculation in the nation’s history
• This is in part being driven by institutional stock ownership. Individuals own only 8% of stocks. Manager-agents speculate with the money of others.
• Many financial innovations are complex and costly. Innovation, on balance, subtracts value.
• The value of the S&P 500 is $13 trillion, but the value of the futures and options on it are $23 trillion!
• It really doesn’t make sense to have Exchange Traded Index funds. “What kind of nut would want to trade the Standard & Poors all day, in real time? Get a life!”
• There are 690 index funds, but 685 of them are likely to narrow. All people need are a few broad market indices: the U.S. market, the International market, and the emerging market
• In 2018, the Dow will be at 22,500

Bogle on Everything Else

• We need a federal standard of feduciary duty
• Corporate CEOs aren’t really creating much value. As soon as a CEO falls into the bottom quartile of pay, he is moved into the top quartile. This is helping cause the escalation in pay.
• The fiscal stimulus passed by Congress won’t help. Speaker Pelosi said that it is, “A gift to the people.” But, “we the people are doing the giving!”
• A weak dollar is good for U.S. corporations

 All in all, it was enjoyable to hear Mr. Bogle speak. Although he is now retired, he continues to be a vigorous man. He has made a lasting impact on the market by overseeing the introduction of the precursors to the ETFs that I know and love.

I’ve written several times in the past about the problems caused by gift cards. Now, there is yet another reason to avoid them…

Gift cards can be invalidated by bankruptcy proceedings!

On March 3rd, the Associated Press reported that The Sharper Image had temporarily stopped accepting gift cards in late February due to its Chapter 11 Bankruptcy Proceedings. Luckily for consumers, The Sharper Image decided to change its policy towards giftcards. On an update printed on its website, The Sharper Image wrote:

If you choose to redeem your card/certificate, you must purchase merchandise equal to twice the current value of the card/certificate in order to redeem it.

So, what was once a generous gift briefly became no gift at all, only to finally become half a gift. Gift cards are considered low-priority debt by a company. In the event of a bankruptcy, a company may eliminate its gift card obligations while eliminating its other debts. Yet another reason to not give gift cards. Everyone would have been better off had their friends and family members had the sense to select items for them at The Sharper Image, or had they given them cash if there was no obvious choice.

Today, I had an extremely amusing experience while picking up several shirts that I had left at the dry cleaners ten days prior. I had visited four days ago, when I was told that my shirts would be ready, only to be told to come back a few days later. Today, the man at the counter told me that it was unlikely my shirts were ready, as the cleaners had been rather busy. I asked him to check for them, and it turned out that they had been cleaned. I examined the shirts upon receiving them, and the following dialogue ensued:

Adam: It appears that one of my shirts is very wrinkled, and has a spot on it.

Cleaner: You know, you really don’t need to take your shirts to the dry cleaners. I wash all of my shirts, and iron them too!

Adam: But, these aren’t any old shirts. These are special dress shirts that need dry cleaning. I wash and iron my “normal” shirts myself.

Cleaner: Well, I even wash and iron my dress shirts and tuxedo shirts. If you want it done right, you should do it yourself. You don’t need to take them to the cleaners.

Adam: Do you use spray starch? I like my shirts starched.

Cleaner: Nope! All you really need is some water and an iron. Nonetheless, if you really want, we can go back over the shirt for you.

Anyway, the reason that this dialogue amused me is that the man working at the dry cleaners actively tried to discourage me from using the services of his employer. He strongly advocated that I do the job myself, and even suggested that he would not have shirts cleaned by his employer! (I know the man is an employee, as I have met the owners of the cleaners.) Employees like this hurt business. Why would I want to trust a dry cleaner that even the man cleaning my clothing would not trust?

I would bet that the employee is paid some sort of fixed wage, and does not benefit financially from the level of sales of the dry cleaner. If he had, perhaps he would not have made such an active effort to scare away a customer! Perhaps it is a prejudice of mine, but when buying goods and services from small businesses, I really prefer to patronize owner-operated businesses to businesses that are run by employees that do not share in the profits. Owner-operated businesses often provide me with better service because the owners have a vested interested in my returning.

Why Not Berkshire Hathaway?

I used to be quite ambivalent towards Berkshire Hathaway, but I’ve recently decided that it is worth consideration. I’ve never worried about the soundness of Warren Buffet’s investment decisions. Instead, I’ve worried about his health. After all, he is a 77 year old man, whose favorite restaurant is Gorat’s Steakhouse, and whose favorite beverage is Cherry Coke. It is also not clear that he consumes either item in moderation. But, I’ve decided to throw caution to the wind, and give him a chance.

Why Berkshire Hathaway?

Berkshire Hathaway is special in that it is an American chaebol, a type of large conglomerate more often seen in Korea (Samsung is the biggest of the chaebol). In a chaebol, one company uses its collective wealth to make a series of unrelated investments. The head of the company (in this case, Buffett) has the ability to oversee the management of each of the investments. As a result, this form provides the diversification of a mutual fund, but better leadership. When you buy a mutual fund or index fund, you receive a series of separate investments in a bundle. Unfortunately, the person that picked that bundle cannot do anything to improve the performance of each of the investments. This is not so at Berkshire Hathaway; Buffett can change the leadership of his investments as he sees fit, and thus has a form of control that no mutual fund manager has. Even if he were to die, the person who replaced him would be able to exercise this form of control. Furthermore, Berkshire Hathaway can use excess cash from any of its business units to cross-subsidize other investments. Its insurance products provide a particularly large pile of cash. As a result, it has much more affordable access to capital than its competitors. Thus, there is a distinct advantage to investing in a conglomerate.

 Which Shares Should I Buy?

Unlike most companies, Berkshire Hathaway has never undergone a split. As Buffett wanted investors to be able to afford to buy shares directly, without the intervention of a money manager, he decided to create both A shares and B shares. B shares are anchored at 1/30th of the value of A shares, and are similar in every respect, except that they do not have any voting priviledges. Depending on the electronic broker that you use, the shares are listed as BRK-A and BRK-B or BRK/A and BRK/B. At the time of writing, the price of BRK-A was $139,400, and the price of BRK-B was $4,648.

You may notice that this site now contains advertisements. One part of Google’s revolution is that it has enabled small-time content generators to receive advertising revenues. Google is rather vague on its payment terms, but does mention that it pays based upon two standard means: by impression and by click.

 By Impression

When a marketing company pays by impression, it pays the owner of a website for each time that an advertisement is loaded. This form of payment makes sense for many advertisements that do not require an immediate online action by the user. For instance, it would make sense for an advertisement promoting a football game being shown on television at 8 p.m. to pay by the impression, not by the click. As ultimately, the advertisement’s goal is to promote an offline behavior (watching television), whether or not the user takes action online should not matter.

 By Click

Sometimes, a marketing company is only interested in paying by the click. For the content provider to receive revenue, a visitor to his website must click on an advertisement. This mode of advertising makes sense in situations where an immediate online action is required, such as in the promotion of a website or the online sale of a product.

In Conclusion

Google has made it easier for everyone to add advertisements to their websites. As a result, people no longer have to enter independently into contracts with advertising providers. This has leveled the playing-field for generators of web content, as now everyone can monetize!

Recently, Bloomberg reported that the supermodel Giselle Bundchen wanted her contracts to be denominated in any currency but the dollar, as she feared that the value of her dollar-denominated contracts would shrink due to the depreciation of the dollar. Ms. Bundchen is one smart model.

 In July 2007, I created a contract with an outsourcing company based in China. While at the time all of the payments specified in the contract were denominated in both Renminbi (the currency of the People’s Republic of China), and U.S. Dollars, we made the official currency of the contract the Renminbi. Although it is fortunate that our developers have not been harmed by the weakening of the dollar, the contract has become more expensive for us over time. In July, a Dollar bought 7.6 Renminbi, while now it only buys about 7.2 Renminbi. As a result, the cost of our contract has grown by nearly 5.5% due to the weakening of the dollar.

 What can someone do if they hold a contract denominated in a foreign currency and face a weakening exchange rate? The simple solution is to convert money to the stronger currency at the beginning of the contract, and pay from the previously converted currency, rather than to convert domestic currency as payments are due. In the event that the domestic currency strengthens, it may be wise to convert the money back. However, as there is often a conversion fee in the form of a spread, it is best to not convert money back and forth if it is unnecessary. While it is sensible to convert money at the onset of a contract, it is likely not sensible to convert the money back and forth whenever there is a slight strengthening or weakening of the dollar.

Many articles about personal finance contain substantial errors or biases. I recently came across a particularly memorable such article, Why You Might Never Own a Home, by Lauren Barack. The first sentence should be a tip-off:

Cathy Mano, 44, works at a nonprofit in San Francisco. Her husband is an acupuncturist. The two pull in a little less than $100,000 a year together.

Whether or not there is a “middle-class crunch,” the Mano family is bound to be stressed. Barack’s colleagues at MSN Real Estate declared that San Francisco is the country’s second most over-priced city, with a cost of living higher than New York. Nonprofits typically have lower wages than for-profits. Regardless of the economy, if Mano wishes to own a home, it would be wise for her to either leave her present line of work, or to leave San Francisco. It shouldn’t be surprising to hear her state, “We can’t afford to buy a home.”

 Barack then interviewed Linda Sirois. She stated:

 Sirois’ son, at 29, has many of the trappings of middle-class life — a nice car, an iPod. But a home still seems out of reach. “It’s much harder than it was when we were starting out,” says Sirois, who considers herself middle class. “We paid $16,000 for our first house. You can hardly buy a car for that now.”

Assuming that the first home was born at approximately the time of her son’s birth, it was purchased thirty years ago. According to MeasuringWorth.com, a $16,000 home purchased in 1978 would cost $92,000 today if its cost the same relative share of Amercian GDP. While you cannot buy a house or many cars for $16,000, the Sirois family has forgotten that their son also likely earns far more than they earned thirty years ago due to inflation.

While it is obviously clear that Americans are increasingly having difficulty keeping their homes, we must still discuss the issue in a sensible fashion. The real problem is that many people are facing declining wages. Furthermore, expenses are increasing in large part due to the rising cost of necessities. The cost of healthcare has increased faster than inflation, and the price of fuel has risen rapidly in the past several months. There are many problems faced by today’s consumer, but Americans today, as always, are free to live in which ever city or town they wish, and may work in any industry for which they are capable. For those freedoms, we should be thankful.

There are very few stores today in which I enjoy my encounters with the staff. I often shop online because I find the prices lower, and because I do not feel that I could benefit from the assistance of the store employees. I have found many times that employees will know less about the product that I am trying to buy than I do, and that they are mainly there to try to upsell me (”How about a five-year warranty on your iPod for 30% of its price?”) or to prevent me from shoplifting.

 However, there are stores in which I value contact with the staff. One notable exception is Home Depot. I visited a Home Depot last week in order to receive assistance in constructing a box. A helpful tradesman named Leo measured and cut the wood that I needed. He also provided me with both mechanical and creative advice on how I might better complete my project. Through this process, he was able to identify some additional materials that I needed (and to sell them to me). As a result of his help, Home Depot not only sold me wood, it sold me service. I would be willing to pay a premium for such service, as it enabled me to better complete my task. Although Leo “upsold” me a little bit, he did so in an informed manner, which resulted in my buying the suggested items. While extraordinarily helpful, Leo was by no means a unique Home Depot employee. I specifically shopped there because I have in the past encountered many helpful Home Depot employees, and anticipated that I would be able to receive excellent service by shopping there. Home Depot makes the effort to hire skilled tradesmen that are experts in the products that they sell.

RadioShack used to be like Home Depot. As a boy, I loved to talk to their men in red coats about my electronics projects. Back in the early 1990s, RadioShack sold both electronic components and assembled appliances. Their employees were likely former members of the electronic trades, as they were intimately familiar with their products. In recent years, Radio Shack has reduced its stock of components and replaced its old men in red coats with younger workers with less knowledge about its products. RadioShack has transformed itself from a business selling both products and service into a business selling commodities (computers, cell phones, and the occasional spool of wire). I rarely visit RadioShack, as I can often buy these commodities more cheaply online, and I gain little from the contemporary RadioShack in-store experience.

 No, this is not an article on hippy togetherness. It’s an article on the problems generated by subcontracting.

 Whether investing in high-grade tranches of subprime mortgages or contracting a job, it is important to realize that if the other party has a problem, it may become your problem. At one company, a substantial amount of product development was contracted out to another firm. The company was very careful to create a good contract in which its liability would be minimal unless the contractor delivered. Unfortunately, the contractor had subcontracted the project using a contract that was not performance-based. As a result, the contractor experienced substantial losses from its relationship with the sub-contractor. Needless to say, this affected the contractor’s ability to complete the task. Thus, the mistakes of a contractor can adversely affect the hiring firm, even if the hiring firm created a strong and properly incented contract.

This same problem occurred on a broader scale with the United States subprime mortgage crisis. Institutional investors bought various tranches of subprime mortgages, based on faith that the risk associated with them had been modeled correctly. Mistakes in modelling the risk have affected both the investors and those that sold the tranches.

How can one avoid this problem? Unfortunately, the answer is not simple. One must make the effort to analyze all of the downstream issues affecting one’s contracts. This is often hard to do, as contracts often lack the right of downstream inspection. Thus, it would be advisable for people entering into contracts to demand the right to both inspect the firm being hired, and all firms subcontracted by that firm or sub-subcontracted by the subcontractors. Thus, this clause of right to inspection would have to be included in all of the contractors contracts with its subcontractors. This way, you will be aware of the full situation, and will be able to both assess your subcontracts and be able to help your contractors before their problem becomes your problem.

In previous entries, I suggested that high-interest savings accounts were a good, more liquid alternative to certificates of deposit. While I am about to state the obvious, the problem with savings accounts is that they do not provide a locked-in rate of return, unlike certificates of deposit.

 If you have money that you plan on keeping illiquid for a defined period of time, it is probably wisest for you to try to predict whether the interest rate will increase or decrease over your time horizon. If you foresee the interest rate decreasing, buying a certificate of deposit will enable you to maintain a rate of return regardless of the decisions of Ben Bernanke. If you foresee the interest rate increasing, holding your money in a high-interest savings account will enable you to take advantage of the increase.

Some people choose to invest their money in collectibles such as art, trading cards, cars, and items owned by celebrities. Is it wise to invest in collectibles? Well, for any investment to be a good investment, it must have a higher rate of return on average than the alternate investments available to you, for the same amount of risk. If it is more risky to invest in a baseball card than in a Treasury Bill, you would need to expect to receive a higher rate of return from the baseball card due to its higher risk.

 The problem with collectibles is the chance that they will eventually be worth nothing. A trading card salesman once told me, “It does not matter what price a card is worth in a guide. It is only worth the price at which you can sell it.” Whether a collectible appreciates has to do with the demand in the market, and the amount of supply that exists. If there are a lot of the item for sale, prices will be lower than if it is scarce. Also, tastes may change over time. Art that is considered interesting today may be viewed less or more favorably in the future. Items labeled as “collectibles” at the time of production are unlikely to appreciate if they are produced in large quantities, or are of limited demand from the market.

 My computer collection, Magic card collection, and Marvel card collection all have not appreciated. In fact, my collection of historical computers has probably depreciated over time. Why? The computers are not particularly scarce, and their utility decreases as they become more obsolete.

The Skyline of Shanghai, China

For the past several years, I have invested in China through FXI, an Exchange Traded Fund (ETF). FXI tracks the FTSE/Xinhua 25 Index. The performance of FXI has been truly amazing.

Perspectives of the Readers

In the two years that elapsed between October 2005 and October 2007, the ETF’s price quadrupled. As a result of its fast ascent, many investors are worried that China is experiencing a bubble, which will eventually pop. To assess the reactions of everyday people, I asked users of mturk.com the following:

1. Will the Chinese stock bubble burst?
2. If it will burst, when will it burst?
3. If it bursts, why will it burst?
Here are the responses that I received:

1- I don´t think so. 2- It won´t burst. 3- It will not burst because most people think its going to burst. When some kind of stocks have too much volume they fall or stop going up, this is what i think it´s going to happen with chinese stock bubble.

1. Yes I do belive that the chinese stock buble will burst. 2. As soon as america make its demands on quality control over how they make our products and what with 3. Due to the toxins and poisons that they have been putting in products like toys and shipping them here to america and allowing our children to play with lead covered toys, and since a huge part of their economy depands on exporting to us it will deffintly burst the bubble.

Yes it will burst, and it will do so within the next few years. The growth projections that are implied by current valuations are already sky high, and current growth is, in my opinion at least, only being fuelled by investor speculation. Lack of proper financial information about Chinese companies, and a captive home audience are the two major factors continuing to drive the Chinese market higher and this cannot continue indefinitely. When the bubble bursts, it will burst with a very loud bang.

1. Of course it will burst. 2. I would guess it will burst sometime next year 3. It will burst because it is similar to our credit crunch in the United States, they have many assets that are overvalued or they are not sure of the value which means that people are buying securites when they have no idea what they are buying. This is common in all markets. Investors see the run up in price and decide they want their piece, however, most of the time the run up is overvalued, but investors continue to buy.
1. Yes the Chinese stock bubble will burst. 2. I give it roughly 6 months before the Chinese stock bubble bursts. 3. Chinese companies are more and more likely to fail because of faulty products and cheap labor. China has a world wide reputation for cheap products.

1. Yes the Chinese stock bubble will burst. 2. I give it roughly 6 months before the Chinese stock bubble bursts. 3. Chinese companies are more and more likely to fail because of faulty products and cheap labor. China has a world wide reputation for cheap products.

Yes, the Chinese bubble with burst. I have been to China and do not understand how the “build it, they will come” philosophy can be economcially sound. I have seen the government open shops that have items that the Chinese in the small cities where the shops are located (for example, a bedspread that costs equivalent to $200 US )can not possibly afford to buy. There is also a seriously huge gap between the rich and the rest of the people. Eventually, those left behind will be challenged. And there is a huge educational gap between the rich, and professional class, and the rest of China. Those with money can afford education-the rest can’t and do not get education. I can not predict when it will burst, but in my opinion, the stride toward a capitalist type market is not follow by good solid economic fundatmentals. (I was in China in recent years as a teacher of English.)

The Chinese stock bubble, in reality, is not a bubble. We are lookng at a market that has huge potential. Perhaps the fine tuning is not present at the moment, but each week the mass world appeal increases. The only danger of a burst is minute and if it should happen, one could only regard it as a short term correction.

1. Yes it will burst. 2. It will burst in less than 10 years from now. 3. It will burst because the Chinese are dealing with new machinery now and their manufacturing cost is relatively low. They are dealing with a lot of fixed cost and very low variable costs. This allows them to price their products very cheaply. When their machinery gets older and they have to spend more money and time to maintain the same level of production, then their variable cost will increase. This will cause inflation. Their reaction will be to increase prices to cover it; buyers will purchase the product elsewhere causing the bubble to burst.

1. Though the current Chinese stock bubble is quite volatile, it is not expected to burst the way we see elsewhere. 2. It is not expected to burst. 3. The main reason is that the authoritarian Chinese communist regime keeps a close, strict and continuous monitoring of the situation, and defaulters can expect strong backlash and punishment from the regime. So that itself is a strong dis-incentive for them.

My Perspective

I think that the notion that China “will be safe until the 2008 Olympics” will be a self-fulfilling prophecy. If people pull money out of the market as a result of the Olympics, it will inevitably tank. The tanking will be caused in part by the hysteria resulting from the increasing fear that the market will tank. At the moment, I am investing in China. I’ve never seen more construction in my life than I saw in Shanghai. The nation has a lot of room for growth, and an undervalued currency.

Money can be made by investing in China in two ways. First and foremost, stocks will appreciate through the growth of Chinese industries. Secondly, money can be made by owning foreign assets as the dollar weakens. As the U.S. has a great trade imbalance with China, it is useful for the dollar to weaken with respect to the yuan, as it makes American goods more affordable to Chinese consumers. Thus, I feel that it is likely that the yuan will only strengthen relative to the dollar. As an American, I would rather have my money stored in yuan (or Euros or yen for that matter) than stored in dollars, as I feel that the dollar will continue on its downward path. Over the course of two years, the exchange rate has gone from around 8 yuan to the dollar to around 7 yuan to the dollar. Assuming nothing else happened, if I had converted my money into yuan two years ago, and then converted it back into dollars today, I could have made a 14% profit. Due to this phenomenon, I hold very few dollars in American assets. Given the choice between owning two equal companies, it is to my advantage to own the company whose value is denominated in a currency that is likely to strengthen over time relative to my native currency.

Today, I wanted to eat a chicken cheese steak (a Philadelphia specialty) from a food truck. There were two food trucks sitting next to each other. The food truck on the right had a line of about ten customers, and a menu with prices. A chicken cheese steak was priced at $4.50. To my left was a similar food truck, albeit with a menu without prices. The following dialogue ensued:

Adam: How much for a chicken cheese steak?

Hawker: $5.95

Adam: You’ve got to be kidding me. That guy over there is selling them for $4.50. I’ll give you $4.50 for one.

Hawker: Fine.

Simply by contesting the price and informing the hawker of the alternative option, I was able to reduce the price of my meal by almost 25%! The vendor in question was not displaying prices for his menu items, as he was likely making them up on the spot. He probably looked at me, made a quick assessment of my willingness to pay, and then offered me to $5.95 price. I was carrying several bags at the time, so he probably thought that I did not want to inconvenience of walking elsewhere. Likewise, I knew my BATNA (Best Alternative to a Negotiated Agreement i.e. buying from the other guy and waiting), and the hawker realized that my BATNA was credible. As he had no other customers waiting, and still had a substantial profit margin on the sandwich, he readily accepted the deal.

 Many of the items that we buy are negotiable. The two hallmarks of an item that is highly negotiable are:

• Infrequent purchase or unlikely repeat business
• High mark-up

I should add that the hawker was selling his sandwiches next to a tourist attraction. At this location, he likely has few regular customers. Infrequent purchase is often an indicator that a product or service is highly negotiable because in such cases, consumers are less likely to know what the proper price is for the purchase. Vendors can get away with a lot larger spread in the price of a Sealy mattress than the in the price of a gallon of skim milk sold at a grocery store, as consumers are more aware of the proper price for milk than for a mattress.

 This leads to the second point; there is far more mark-up on a mattress than on milk. There is low mark-up on milk because there is a very competitive market for milk; you can buy a gallon of milk on almost every block. The market for mattresses is a bit less competitive, in that some substantial travel is often required to get from one store to the next. The mattress manufacturers delibrately give each store products with different product names to hinder comparison shopping. In the case of skim milk, comparison shopping is easy, as the product is uniform. This uniformity and competition leads to a far lower mark-up.

Adam’s Negotiation Suggestions

• Know the price of an item before you enter a negotiation
• Try to determine what the vendor might have paid for the item, so that you are not unreasonable in trying to obtain the item below cost
• Decide what you are willing to offer before approaching the vendor 
• Ask the vendor the price of the item before making an offer… if you are lucky, it might be lower than your offer!
• Be willing to walk away if the vendor refuses your offer
• Rather than walking away quickly, saunder away slowly, turn around, give the vendor one last look, and then leave
• By leaving slowly, you give the vendor an opportunity to provide a counter offer
• If the vendor’s offers are unsatisfactory, ask, “Is that the best you can do?” This sounds much more polite than, “Is that your final offer?”
• If you have a firm maximum that you are willing to spend, get exact change equal to that maximum, and partition that money from the rest of your cash. An offer is much more convincing if you do not visibly appear to have additional cash to extract. If you were selling an item for $6, would you be more willing to sell it for $5 to the person who handed you a wad of five $1 bills, or to someone who asked you to break a $20?
• People are often more willing to offer a favorable price for a payment in cash (cash payment eliminates a 3%+ Visa fee, and other possible revenue extraction by middlemen)

Products and Services for Which I Have Recently Negotiated

• Carpet cleaning services
• Jewelry purchases
• Unfinished textile purchases
• Street food purchases
• Tailoring services

Where Not to Negotiate

• At a restaurant (although I once had a friend who successfully negotiated getting two glasses of wine at a special price, instead of just one)
• In front of polite company
• At any sort of chain establishment
• At any business in which the people to whom you are speaking are not responsible for setting the prices

Many readers may have money in CDs (certificate of deposit) or savings accounts paying low interest rates (1%-5.5%). Many readers may either have debts, or know others who have debts that have financing charges substantially greater than the return of a CD or savings account. If you have excess capital earning a rate of return that is less than the interest rates on your debts, the obvious solution is to use that capital to pay down your debts. However, if you lack debt, the best thing to do with that capital may be less obvious. The problem that many investors face is that the cost of borrowing capital from a bank is substantially higher than the amount that can be made by lending capital to a bank. Using Prosper.com, or informal means, it is possible for people to narrow this gap.

 If you have a reliable friend or family member in need of capital, it makes sense to offer them a loan with an interest rate that is greater than the rate you would get by buying a bond or CD of the same duration as the loan, but less than the interest rate that the person is currently paying. For instance, if a person has credit card debt that is costing them 14% per year, and the best CD you can find pays 5% a year, both of you would be better off if you provided the person with a loan at 9% a year to use to pay off the debt. The main risk in these circumstances is the risk of default. A bank is virtually guaranteed to meet its obligations to the holder of a CD or savings account, while an individual is not guaranteed to pay back the desired rate of return.

 In order to mitigate the risks of non-repayment, I would suggest two guidelines to the reader. First, only loan money to people whose income exceeds their expenditures. If someone is not in the process of accumulating capital, but instead is continually becoming more indebted, they will never have the excess cash necessary to pay you back. Second, it is far better to loan money to people who plan to invest it in production than to spend it on consumer goods. Investments have the (risky) potential of increasing the borrower’s future income. When people borrow for consumption, it is essential to ask why they needed to borrow, and could not save for their consumption in the first place. If the person has adequate disposable income to potentially save for the consumption, but has not been able to do so, as the consumption must occur in the immediate future, a loan may be warranted. If it is not clear that the person could ever save the money in a reasonable length of time, the loan may be a poor idea.

When providing loans to friends and family, it is very important to keep the terms of the loan both clear and formal. That way, there can be no ambiguity in the expectations of any of the parties involved. Once a contract has been drawn between the parties, it might even help to get it notarized. CircleLending.com has packages designed to help people officiate these types of loans. The loan should be treated as seriously as if it were made with an outside party, so that expectations of repayment are maintained. Also, it is important for the lender to make sure that he is in compliance with usury laws. Usury, the act of charging an interest rate that is too high, is enforced on a state-by-state basis. Thus, the usury limit varies by location. (Banks get around this restriction by placing their loan offices in states that have very liberal usury restrictions.)

Ben Bernanke lowered the rate by 0.50% last week. It’s been great to see my stock portfolio substantially recover as a result. By lowering the rate, Bernanke reduced the cost of credit. But, I’m not entirely happy about the move. What are the downsides to the lower interest rate?

 As I have mentioned in the past, I keep some of my money in a savings account at eLoan. Last month, I was receiving 5.25% APY, and now I am only receiving 5.00% APY. As the cost of credit has decreased, the bank is now willing to pay me less for my money. Likewise, the returns on certificates of deposit (CDs) have been decreased as well. For those that bought six-month CDs last month, you have locked-in whatever rate you got for the next six months. New CDs being originated after the change will be affected by the change.

Those traveling abroad will also be disappointed by the reduction in the interest rate. While the dollar was already weak, the reduction further eroded its value. For the first time since 1976, the Canadian Dollar is equal in value to the United States Dollar. (Many Americans may have in the past been accustomed to seeing magazines marked with prices denominated in both U.S. and Canadian dollars, with the Canadian price being about $1 higher.) As a result of the weakening of the dollar, less goods can be purchased for $1 USD. In Canada for example, most goods probably cost about what they did last month. However, since $1,000 US now buys fewer Canadian Dollars than it did last month, someone buying goods from Canada would effectively be less wealthy. This principle holds with respect to our trade with other nations as well. Thus, merchandise in China and the European Union is now also more expensive for Americans.

 How can someone combat a weakening dollar? Buy assets that are denominated in foreign currencies. For instance, if you had some of your money in Canadian Dollars before the rate change, you would have instantly made a profit as a result of the change, if you re-measured your assets in United States Dollars. One way that I fight the weakening dollar is by investing in foreign companies. When the dollar gets weaker, the companies simply become worth more dollars, as their values are based on foreign currencies in the first place. Thus, the weakening dollar may be a further reason to invest in foreign exchange traded funds (ETFs).

Many companies offer 401(k) plans in which there is a corporate matching agreement. 401(k) plans typically offer employees a menu of investments in which to place their savings. Investing in company stock is typically one of the options offered, and until recently, was the default option. In my opinion, it is unwise for people who do not play a strategic role in a company to have a substantial stake in the company’s performance.

Why diversify?

The problem with primarily investing in your own company is that by doing so, you are further exposing yourself to the risks of that company. Imagine you are an employee at Enron, Tyco, or one of America’s other illustrious companies. Scandal hits. First, you lose your job. Then, to make matters worse, if you are heavily invested in company stock, you lose your savings too.

Why employers want you to own company stock
Employers want you to own company stock in order to align your incentives with those of the company. By owning stock, when the company does better financially, you do better financially as well. This is all fine and sensible for people who control the direction of the company. For the average worker, whom has only marginal impact on the company’s performance, it makes far less sense. While owning shares does psychologically align employees with the performance of the company, if each employee’s performance only has a “drop in the bucket” impact on the company’s financial performance, there is little a single employee can truly do to impact the direction of his company.

What should you do?

I would advise people to diversify their savings as soon as possible, and if necessary, as soon as the employer match has vested and will allow it. It makes sense to keep a token amount of company stock, even if you have minimal control over performance, in order to feel that you have some skin in the game. However, it is probably unwise to have company stock play a substantial role in your portfolio, as your financial future is already heavily dependent on company performance.

When you want to sell a stock at its current market price, usually you can quickly find a buyer. For a market to form, there must be a set of buyers and a set of sellers offering goods at a range of prices. When the minimum amount that a seller is willing to accept is less than the maximum amount that a buyer is willing to pay, a sale takes place. What would happen if you showed up to a market and there were no sellers? It would be pretty hard to buy something.

 Recently, I began investing more in options. I bought an option during a dip in the stock market, and the option quickly became in-the-money. To my surprise, the price of the option did not change. How come, you may ask? The price of an option only changes when a transaction takes place. While changes in the value of an option are occurring every instant of the day, those changes are only recognized in a price change when the option trades. Thus, I watched my $64 call options on EWY remain at a steady $2.00, although the price of the underlying stock swung both above and below during the day.

Why was I investing in options in the first place?

As of the last week of July 2007, the market had been experiencing incredible volatility. In the words of the musician BT, “the only constant is change.” Frankly, I had no clue as to which way the stock market was headed, but felt that it was likely to continue oscillating a lot in the process. My goal was to try to buy some call options when I felt the market was near the bottom of one of its downswings, and then to sell the options once they had appreciated 30%. (Given the volatility of the market, options on many stocks and ETFs were swinging over 100% both ways.) For several stocks, this strategy worked quite nicely.

 Unfortunately, as not all options on ETFs are traded frequently, this strategy has not worked as well on my EWY (iShares Korea) options, as there simply has not been much trading volume. While the price of the underlying shares have swung, the options haven’t been sold frequently enough to experience significant swings as well. If you are wondering by what I mean by a lack of liquidity, on August 2nd, not a single contract of the option that I own was traded! Thus, the price of the option never changed to reflect the August 2nd price of the stock.

Changes in the prices of stocks can induce emotional reactions in the best of us. This last week was quite a rollercoaster. To see how I feel about daily fluctuations in stock prices, check out my latest animation, StockEmotion!

When the stock market begins to soar, sometimes people become interested in betting on a downturn. There are two ways that this can be done, which have substantially different risks associated with them.

Shorting a Stock

When you short a stock, you essentially sell the stock to another person at its current price, with the promise of delivering the shares to them at a later date. In the best case, the company has its share price drop to zero, and you make a profit of the value of the shares at the time you sold them short, minus the transaction fees. In the worst case, you short a company whose stock price goes way, way up. Imagine that you shorted one share of a stock when it was worth $100 per share, and it is now worth $1,000 due to some substantial growth. Well, you received $100 when you sold the short, but now owe a share worth $1,000. By selling this short, you have lost $900. With short sales, the upside potential is limited to the initial value of the shares sold short, but the downside potential is infinite!

In order to prevent people from losing infinite amounts of money, brokerages have margin requirements. People are required to hold excess cash in their account to pay for losses. Once the person runs out of margin, they are forced to settle the short by buying the stock. That way, the broker insures that the person sold the short is able to obtain the share.

 Buying a Put

A “put” is the ability to sell a stock at a given price. When you buy a put for a stock that you don’t own, you are considered to be buying a “naked put.” Why buy the right to sell stock you don’t own at a fixed price? If the price plunges, you can effectively buy the shares on the market, and then sell them at the price agreed to by the put, making a profit equal to the difference between the current share price, the strike price of the put, and the cost of the put. Puts are different than shorts in that they expire on a given date. As that date approaches, the value of a put declines. (Before a put expires, you can resell it if you like.)

So, imagine that a stock is trading at $100 per share, and you think it will go down. To take advantage of this, you decide to buy a put. The put has a strike price of $95. That means, it gives you the right to sell the stock at $95 per share. (Until the stock goes down, you would not want to use this right, as the market is letting you sell for $100 per share.) Since the person that sells you the put is taking on the risk that the stock will dip in price, and that they will be forced to buy it for more than it is worth, they charge you a fee for this risk, which is the price of the put. You can’t just buy one put, but must buy one or more contracts. A contract consists of puts on 100 shares. So, you buy contract costing $2/share, with a strike price of $95. To break even, the stock must go down to $93/share, as $93 = $95-2.

 What would happen if the stock went down to $90/share? You could buy up 100 shares, and use the put contract to resell them at $95/share. This right cost you $2/share. Thus, buying the put has made you $3/share! Since you own a contract that provides this right for 100 shares, $300 in profit have been made. As you never owned the underlying shares, only $200 was placed at risk to make the $300. This investment would have had a 150% return!

The problem with puts is that their value declines over time. If the put expires tomorrow, has a strike price of $95, and the stock price today is $200, it is unlikely that the put will ever be useful, and its resale value is close to zero. The value of a put is determined by the Black-Scholes equation, and declines as the stock moves higher above the strike price, and as the date of expiration approaches.

At times, I have heard from people that it is cheaper to live in Location X than Location Y because “the cost of living is lower.” Usually, when someone says that the cost of living is lower in an area, it means that the wages for a given job are lower there as well. With that being said, does it really make sense to move to Location X to save money?

The answer to this question may be different today than it was a few decades ago. The amount of “wealth” we experience is defined by a combination of our income and the schedule of prices that we face. If prices are lower in one location than another, but our wages are the same in both areas, we will feel wealthier in the location with lower prices. Sometimes, less urban areas are considered to be better values, as they are stereotyped as having lower prices. Is this really true?

 In order to understand much regional price variation might affect us, we must first consider what we buy with our money. Are the prices of our goods determined on a national or local level? The average person spends money on housing, food, manufactured goods (clothing, electronics, etc.), services, entertainment, transportation, and utilities. Some of these categories are more sensitive to regional variation than others.

Manufactured goods tend to have constant prices across the nation. A 4 GB iPhone costs $499 regardless of whether it is purchased in New York City or Little Rock, Arkansas. Services, when delivered remotely, tend to have national prices, while when delivered locally, have regional prices. The price of a haircut is determined by the competition among local barbers, while the price of webhosting is affected by national competition. Entertainment varies in this manner as well; live entertainment likely has local variation, while to cost of buying a DVD is the same for buyers across the nation. As food is often manufactured on a national level, there is often little variation in the cost of food, outside of a fine restaurant setting. (McDonald’s has the Dollar Menu in all locations, affluent and not.)

Housing is often the largest expense in a person’s budget, and is perhaps the most subject to regional variation. Does it make sense to move to an area with lower housing costs? All things being equal, it probably does make sense if you are renting, but makes no sense if you are buying. Assuming an equal rate of appreciation in both settings, buying more house will force you to invest more of your money in real estate. As many Americans have few investments beyond their homes, being forced to make a larger investment can be a good thing. Thus, having to buy a home of a larger value may give you more options once you reach retirement, as you can then potentially sell the home, buy a new home in a cheaper area, and use the remaining money to assist in paying for your expenses. But, the deck is stacked even worse against the regions with low housing costs. If there is a less competitive market for housing (which is indicated by the lower prices), the appreciation rate of housing may be lower. Thus, the investment will grow slower as well.

Finally, sometimes more “expensive” locations have more industry in them than cheaper locations. This can be an advantage for two reasons. First, although you may have a job now, the additional job opportunities in the area are still important. With multiple employers available, you can more easily change firms in order to advance your careers. Also, having additional employers in the area available to you may be useful in the event that your job disappears and you need to seek further employment in the area. Also, if there are more companies in the area, there may be more price competition among firms. This may help reduce the cost of the locally-produced goods that you purchased. Thus, living in an “expensive” area may be cheaper than you think. Do you really buy that many locally-produced goods, beyond housing?

Over the last twenty years, many Americans have shifted from receiving Defined Benefit retirement plans to Defined Contribution retirement plans. Over the next several entries, I will attempt to explore why this has been done and what it means for those trying to save for retirement.

Defined Benefit Retirement Plans

A defined benefit retirement plan is a plan in which the employee is told the precise amount that he will receive over the course of his retirement. Usually, the employee receives an annuity (either monthly or yearly payment) that is based upon both years of service with the firm and previous salary. Sometimes, the payment level is determined by averaging the salary received over the last three years.

Defined Contribution Retirement Plans

When an employer provides a defined contribution plan, the employer guarantees how much it will contribute to the employee’s retirement fund. However, once the money has been received by the retirement fund, the employer makes no guarantee about how much money the former employee will have in retirement. After the employer provides the employee the pension contribution, the employee must choose how to invest it. Employers will often match the retirement contributions of their employees in order to encourage them to save more. The amount the employee receives in retirement is entirely based upon the size of his contributions, his employer’s contributions, and the soundness of his investment strategy.

Why Defined Contribution Plans Are Becoming More Common

You may have heard about employers converting their defined benefit plans to defined contribution plans. There are multiple reasons why this is occurring. First of all, it is good for the employer, as it eliminates the employer’s long-term risk of having to provide a certain level of benefit. With a defined benefit plan, the employer is responsible for managing the pension and ensuring that it grows rapidly enough for the employee to have his promised benefits. With a defined contribution plan, the employer is not liable for how well the employee’s pension investments perform.

Secondly, defined contribution plans are better for the employee. Once an employer has made a contribution to an employee’s retirement plan, and that contribution has vested, the employee essentially owns that contribution. Thus, it is not possible for a defined contribution plan to be “under-funded.” In the past, many defined benefit pensions were under-funded, as the employer did not put enough money away in savings to be able to afford to pay the promised benefit. In the event of employer default, the employee was stuck receiving what he could from the Pension Benefit Guaranty Corporation, the company that employers are legally required to have insure their pensions. Since defined contribution plans require employers to pay in real-time for their pension obligations, default is not possible.

Finally, defined benefit plans are better in that they allow employees to choose the investment strategy for their pension. Employees have varying preferences for risk, and this can be reflected in their pension investments. With a defined benefit plan, it was not possible for employees to fully customize the investment of their pensions to reflect their preference for risk.

These days, many employers are offering their retirees unfunded retiree health benefits. Often referred to as “Access Only” plans, these health plans provide retirees with an opportunity to buy group coverage, but do not fund the coverage. These plans come in two varieties: plans in which retirees are rated with the workforce, and plans in which retirees are rated separately from the workforce. Although both of these types of plans are unfunded, they are still beneficial.

Example Population

Imagine that you work at a company with the following population:

Three active employees that use $500, $1,000, and $1,500 of healthcare per year each

Three retired employees that use $1,500, $2,000, and $2,500 of healthcare per year each

Plans in Which Retirees are Rated with Active Employees

These plans are the most generous unfunded retirement health plans. The active workforce is essentially cross-subsidizing the retired workforce. If the active workforce totally ignored the retirees, they would be paying a premium of $1,000 ([$500 + $1,000 + $1,500]/3=$1,000). However, since the active and retired employees are being rated together, are each paying a premium of $1,500 ([$500 + $1,000 + $1,500 + $1,500 + $2,000 + $2,500]/6=$1,500). Thus, this plan makes active employees pay $500 more than if they were not grouped with retirees. Retirees are likewise paying less than if they were grouped separately.

Plans in Which Retirees are Rated Separately from Active Employees

When retirees are rated separately from the active workforce, the active workforce does not perform any sort of cross-subsidy, but the retirees still benefit from group coverage. Many us cannot anticipate the extent to which we will require medical care. By pooling our risk, we can reduce the chance that we will get the short end of the stick and have unmanagable medical expenses. If the active workforce and retirees are rated separately in this example, the active workforce will have to pay $1,000 per year, and the retirees will have to pay $2,000 per year. Recall that the three retirees have $1,500, $2,000, and $2,500 in medical expenses. If they share costs and all pay $2,000, then one employee is worse off, one employee is better off, and one employee’s wealth is unchanged by the pooling. Even though some employees (those with low medical expenses) are worse off under a pooling arrangement, so long as they are not paying a large amount over their expected expenditures, they may like pooling, as it gives them piece of mind that their costs will be shared in the unfortunate event that they are struck with higher costs in the future.

 Conclusion

When employees must “go it alone” in retirement, they are rated according to their own risk. This places some retirees in tough situations, as they are unable to share their medical expenses with the employees who were once their peers. Pooling arrangements can help reduce the risk that any single retiree will have to pay high medical bills. This benefit persists regardless of whether or not the company chooses to fund the retiree health plan.

Some of my readers have relatives that live in countries other than their own. Many Americans send money to family members living abroad, especially if there is a large income disparity between the United States and the other country. How can money be transferred abroad with the minimum amount of fees?

Carry It

If you are visiting relatives abroad, perhaps the simplest way to give them money is to carry it on your person. I believe that Americans may bring up to $10,000 out of the country without needing to declare it to customs. While the only fees involved in this transaction will be related to getting the money converted to local currency, this method may not be frequently feasible if you do not make regular trips to the other country.

PayPal

PayPal offers a means for quickly sending money for a relatively small fee to other countries. Unfortunately, PayPal cannot convert money to some currencies, such as the renminbi. PayPal’s fees vary from country to country, but typically involve both a percentage charge and a flat fee. As the money can be transferred online, there is very little hassle in the process.

Check

Given enough time, you can send a check to your relative living abroad. Remember that the person will both have to wait for the check to arrive in their mailbox, and for it to clear in the bank. Thus, this is not a good way to transfer money in an urgent situation.

Wire It

Banks can wire money to other accounts. Unfortunately, they often charge substantial amounts for this service, and it may not be instantaneous. You will need to know both your relative’s account number and the SWIFT code of the bank to which you are wiring the money.

ATM Card

If you regularly need to send money to the same person, it may be helpful to send them an American ATM card that is usable in their country. That way, you can add money to the bank account, and they can simply withdraw it with the ATM card. The only fees involved will be the currency conversion fee and the foreign ATM charge. This is a means of providing nearly instant access to funds.

Western Union

If all else fails, Western Union can transfer money almost anywhere. Unfortunately, it charges a steep price for its services. Also, as Western Union is often used in fradulent transfers, it requires you to answer many security questions, making the transfer process rather slow and cumbersome. Western Union works as follows. You tell Western Union the name of the person to whom you are transferring the money, as well as the city in which they reside. Then, Western Union sends you a Money Transfer Control Number (MTCN). The person receiving the money then must go to any Western Union teller and let them know the MTCN, their name, and the amount that has been sent. Thus, the receiver does not need to have a bank account to receive the money through this method, and once the money has been taken, it is nearly impossible to recover or trace.

When transferring money abroad, always make sure that you are doing so in a fashion that is compliant with both the laws of your nation and the laws of the nation of the recipient. In today’s digital world, everything is increasingly being tracked.

What’s a Health Savings Account (HSA)?

A Health Savings Account (HSA) is a tax-advantaged bank account that can be used for qualified medical expenses. Contributions are made to it from pre-tax income, and money is not taxed upon being withdrawn, so long as it is spent on medical expenses. Thus, in some ways, it is better than both a Traditional IRA and a Roth IRA, as no taxation occurs when the money enters or when it leaves. While money is in an HSA, it can be invested, enabling you grow your money. The uninvested money earns interest. If and when you leave your employer, the funds in your HSA travel with you. Thus, the benefit of an HSA is that the money in it is truly yours, and can be invested accordingly.

What do you need to qualify to open an HSA?

In order to open an HSA, you must have a High Deductible Health Plan (HDHP). In return for the higher deductible, HDHPs have a lower monthly premium. The combination of a HSA and a HDHP is often referred to as “Consumer Directed Healthcare”. The way this combination works is that the person withdraws money from their Health Savings Account to pay for their medical expenses until they have reached their insurance deductible. Once the deductible has been reached, the High Deductible Health Plan pays for the person’s remaining expenses. Money in the HSA that is not spent is rolled-over into the next year, and may be invested if there is a sufficient amount of money in the account. 

Consumer Directed Healthcare plans exist for both families and for individuals. As the government does not want to give people two tax breaks for the same purpose, it is not possible to open an HSA if you have a Flexible Spending Account (FSA) that is used for healthcare. (You may still have a FSA used for dependent care, childcare and eldercare, if you have an HSA.) A healthcare FSA is less advantageous than an HSA, as the money that is not spent at the end of the year in an FSA evaporates. FSAs do not roll-over each year like HSAs.

When is a Health Plan a High Deductible Health Plan?

For a plan to qualify as an HDHP in 2007, it must meet the following requirements:

For individuals, the deductible may be no less than $1,100, and the Maximum Out of Pocket (MOOP) may be no more than $5,500.

For individuals, the deductible may be no less than $2,200, and the Maximum Out of Pocket (MOOP) may be no more than $11,000.

These numbers are adjusted each year.

How much money can be placed in an HSA each year?

In 2007, an individual may place up to $2,850 in his HSA, and a family may place up to $5,650 in their HSA. These limits hold regardless of whether the employee or the employer makes the actual HSA contribution.

When can money be withdrawn from an HSA?

Money can be withdrawn from an HSA at any time to cover qualified medical expenses with no income tax consequences. However, if the funds are withdrawn for non-medical purposes before the HSA holder turns age 65, the HSA holder will have to pay both a 10% penalty and income tax on the funds withdrawn. If the funds are withdrawn after age 65 for non-medical expenses, the HSA holder will have to pay income tax on the money withdrawn (in a similar manner to what would happen with a Traditional IRA).

Most of our lives, we often act as employees, rather than employers. When the tables are turned, and we must hire others, we must consider the best payment structure.

Hourly Pay

One means of paying people is by the hour. This mode of payment works best in tasks in which workers have a uniform output per hour of work, and are highly interchangable. As output is proportional to the number of hours worked and not proportional to effort, this mode of pay compensates workers more extensively for producing greater levels of output. Hourly pay is also a good means of pay for temporary workers whose length of tenure with a firm is uncertain. Hourly pay is often seen in the food service industry, and in trades in which consumers hire tradesmen (by the hour) to do short-term tasks. Hourly workers are motivated to produce quality work by their desire to obtain more hours to work for the firm and by their intrensic drive for quality.

Salary with a Bonus

In some jobs, the effort level of the employee matters far more than the amount of hours that the employee has worked. For instance, if two people have been paid to create a marketing campaign, it is quite possible that a campaign produced by an employee that worked on it for 30 hours might produce more revenue than a campaign produced by an employee that worked on it for 40 hours. The quality of the campaign is not necessarily proportional to the time that has been invested in it. 

Salaried positions typically imply a long-term or definite-term relationship between the employer and the employee. A salary helps reduce the problem of the ambiguity caused by paying for the number of hours an employee has worked, when the number of hours worked does not determine the level of output. Salaried employees are motivated to produce quality work by their intrensic need for perfection, and by their fear of being dismissed from the company. Performance-based bonuses can be used to help align the incentives of salaried employees with the overall profit structure of the company. This is only effective if employees do not feel that their efforts are a drop-in-the-bucket. The more tightly a bonus can be linked to an individual’s performance, the more potent an incentive it will be.

Pay for Performance

Pay for Performance (P4P) is often a variation of salary-based pay. A portion of the employee’s salary is withheld on payday. Then, employees are paid the withheld amount based upon whether or not they, their group, or their firm has met its performance targets. This payment structure is in some ways superior to a salaried structure, as it directly aligns compensation with meeting company targets. However, it can cause trouble within a firm if employees place so much effort in meeting measured targets that they neglect to perform on unmeasured but equally important tasks. 

Milestone-Based Pay

When employees are external to the firm, and their time and effort cannot be readily observed, milestone-based pay is often preferable. Milestone-based pay is also often most effective in industries where measuring the time and effort of the employee is inconvenient. In a milestone-based payment scheme, it is pre-arranged how much the employee will be paid once critical tasks are completed. The employee is then paid over the duration of the project as each milestone is achieved. This form of payment is seen in project contracting. However, it is also seen in more mundane forms, such as in the payment of a barber. Before receiving a haircut, a customer typically negotiates the milestone’s specifications (the type of haircut). The barber then assesses the difficulty of reaching the milestone and offers a price. The barber is only compensated after the milestone is achieved, and often expects a performance-based bonus; a tip.

Readers, I could use some inspiration on which topics to cover next. Please comment below with suggestions. What are you interested in learning about budgeting, personal finance, and investing?

Over the last thirteen months, I have lived in Boston and Philadelphia. I will soon be moving to Louisville for the summer. In Boston, buying a box of kung pao chicken from a food truck would cost $4.25, while in Philadelphia, it only costs $3.50. Some cities have overall higher prices than other cities. This is in part a result of the scarcity of land in the city, which affects the cost of renting space. The more demand there is for renting a retail space, the higher the rent will be charged to the vendor. The higher the rent the vendor pays, the higher the prices are passed on to customers. Food trucks are typically licensed to operate only in specific parking spaces. The price of a parking space is a function of the demand for that space.

 Will I be better off if I move to a city with a lower cost of living?

It is not always clear if moving to a city with a lower cost of living will improve one’s life. Cities with lower costs also tend to pay lower wages. If the Philadelphia food trucks are charging less than the Boston food trucks, it is very possible that the food truck workers in Philadelphia are also earning lower wages. If the price difference is simply due to a difference in licensing costs, City Hall is earning less in the cheaper city.

CNN’s Cost of Living Calculator provides you with information on the relative costs of groceries, housing, utilities, transportation, and healthcare in two cities. According to the calculator, groceries will cost 24% less in Louisville than in Philadelphia, but transportation will cost 8% more.

Salary.com’s Cost Of Living Wizard provides you with information on your likely percentage change in cost of living and likely percentage change in salary. Using these two computations, it arrives at your likely change in disposable income resulting from the move. According to the site, moving from Philadelphia to Louisville will reduce my cost of living by 27% and will reduce my salary by 10%. As the drop in salary is less than the drop in cost of living, I will have more disposable income while living in Louisville than while living in Philadelphia.

As some of you may know, I do not study finance. I am currently a Ph.D. student in the Health Care Systems department of the Wharton School of the University of Pennsylvania. Exactly what does my interest in helping people make the most of their money have to do with my interest in health? I guess the primary commonality is that my research and work on this blog are both about developing mechanisms for people to use to control their consumption or make their consumption more effective. One of my major interests is in thinking of ways to help people gain better control of their dietary consumption (i.e. diet). Exactly what is consumption? According to the Merriam-Webster Online Dictionary: con·sump·tion  Pronunciation: \kən-ˈsəm(p)-shən\  Function: noun Etymology: Middle English consumpcioun, from Latin consumption-, consumptio, from consumere Date: 14th century 1 a: a progressive wasting away of the body especially from pulmonary tuberculosis b: tuberculosis 2 a: the act or process of consuming <consumption of food> <consumption of resources> b: use by or exposure to a particular group or audience consumption>   3: the utilization of economic goods in the satisfaction of wants or in the process of production resulting chiefly in their destruction, deterioration, or transformation   

In our case, the most appropriate definitions are likely 2a and 2b. People consume their income by spending it on things, and people consume food by eating it. Although dietary and monetary consumption may seem different, both involve impulse control and mental accounting. How many calories have you eaten today? How many dollars have you spent today? In many ways, these are the same sort of calculation. While people may not have “loss-aversion” when dieting, there are many other commonalities.

All too many penny-pinching advocates talk about the virtues of trying to avoid impulse buys. We all know how hard it is to avoid impulse purchases, so perhaps the better way to save is to try to reduce recurring expenditures-the sums that we pay on a daily, weekly, or monthly basis. These expenses generally are for utilities, rent, and subscriptions. 

The True Cost of a Device with a Subscription

Some subscription-based devices, like cell phones, are unavoidable. When possible, I prefer to avoid purchasing anything that has a monthly subscription component. Imagine that a device has a $10/month usage fee. Over the course of a year, you will have to pay $120 in service. If you keep the device for two and a half years, you will end up paying $300 in service charges. This amount may be far greater than the cost of the device. The reason I do not use a BlackBerry is that I do not want to have to pay the recurring fees associated with data service. At approximately $40 per month, a BlackBerry costs $480 per year to use; nearly $1,000 over the course of two years. The device itself is rather inexpensive, but the service costs are staggering. Instead, I prefer to check my e-mail using WiFi devices. Although they have larger up-front costs, they have no service costs. As I’m rarely in a WiFi-free location and get sick while reading in vehicles, I see no need to pay for data service.

The Impact of Rent/Mortgage Payments on a Budget

Two other large recurring expenditures are rent and mortgage payments. Usually, it is unwise to take a mortgage whose monthly principle, interest, tax, and insurance payments exceed 36% of your income. Renters often pay a far larger portion of their income in rent, as they tend to have lower incomes. As a result, housing is many people’s largest expense.

Budgeting Backwards

I think that the best way to budget is to start by taking your income after taxes, and then to subtract out your annual housing payments and recurring fees. After that has been done, subtract out your annual projected retirement contributions. Divide the remaining number by $365 to determine how much you have to live on each day. If you feel the number is too low, either slash some recurring expenditures or try to find a different job (or an additional job). While it is definitely difficult to slash telecommunications expenses and it may be hard to reduce housing expenses, one place to start may be reducing media expenses. Eliminating your subscription to cable or satellite television may save you between $0.33 and $3 per day, depending on the level of service you are receiving. As an added bonus, eliminating television media from your home will give you additional time for other pursuits, including earning money.