Is Owning or Renting Best?

There was a time when owning the roof over your head was considered an attainable and wholesome mark of prosperity for American families.  See, for example, the higher calling for which George Bailey gives up his youth in It’s a Wonderful Life.  (In retrospect, George was making sub-prime loans from a dangerously over-leveraged and illiquid bank.  It was a simpler time.)  Over the decades conventional wisdom on home ownership morphed from wholesome goal to sound idea, then to great idea, and finally to such a great idea that it was practically free money.

Then it all went kablooey, and conventional wisdom started denying that it ever said any such thing.  It’s really not clear what mainstream advice on home ownership is right now.  Big time gurus like Suze Orman and David Bach (author of, among other bestselling titles, The Automatic Millionaire Homeowner) now spend time cautioning people about the dangerous waters of home buying and contradict, without apology or even acknowledgement, advice they gave a few years back to jump in with both feet.  (See excellent article on this at the Wall Street Journal here, and my discussion of Orman’s latest book here.)

So perhaps now is as good a time as any to step back, push aside the headlines of the day, and reconsider if owning the place you live in is a good idea in principle or if maybe renting has gotten a bum rap all these years.  Moreover, it’s worth asking if owning vs. renting is a question that should have a general one-size-fits-all answer.

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Suze Orman’s 2009 Action Plan, Part 2

[This is the second part of a two part review of Suze Orman's 2009 Action Plan. If you haven't already, you might want to read Part 1 first.]

In general, Suze Orman’s lack of candor can only be inferred from the advice she gives. For example, at several points in 2009 Action Plan she brings up the idea of taking out loans from a 401(k) plan and using the proceeds to, for example, pay down other debt. (For the uninitiated, a loan from a 401(k) plan is just what it sounds like. You allocate some of your 401(k) account to a loan to yourself, which you pay back with interest.) In every case she is firm in her rejection of the idea, even to pay off credit card debt charging 32% interest (p. 59.)

On its face this advice is nuts. Taking out a loan from your 401(k) frivolously, to go on a cruise perhaps, is clearly a poor idea. But within the realm of debt a 401(k) loan is almost certainly the best deal going and using it to pay off a loan with a Tony Soprano interest rate is just about as clear a no-brainer as you can find in personal finance.

So why does Suze Orman wave you off this strategy? Is she nuts? She gives the feeble explanation that in these uncertain times the risk of losing your job, which might mean the loan would be due in 60 days, is too great. That would be a lot more convincing if she did not, in the two ”situations” that immediately follow, discuss withdrawing funds from your retirement accounts for living expenses if you become unemployed.

Reading between the lines, the real reason Orman thinks this is a bad idea becomes clear. She thinks that if you take out the loan and pay off the credit card it will only be a matter of time before you run up the credit card balance again, leaving you with both a large credit card debt and a loan from your 401(k) to pay off. She’s not nuts. She thinks you are. But she can’t say that. So she tells a little white lie and moves on.

Very similarly, she calls using a HELOC (Home Equity Line of Credit, or a second mortgage) to pay off credit card debt “a dangerous mistake. You are putting your house at risk.” (p. 30.) That’s a common bit of folk wisdom, but it’s wrong. Short of bankruptcy, you are going to have to pay back all the money you owe sooner or later, and it would be helpful if the debt had a lower interest rate in the meantime. If you do go bankrupt, you may or may not be able to keep your house (and if you do it will be without much equity) but whether the debt in question was a second mortgage or unsecured loan will not change the outcome. Again, Orman gives the advice she does because she assumes you have a serious willpower problem. If you refinance your credit card with cheaper debt you will only start spending even more and dig the hole deeper.

Do all of Orman’s millions of readers have that sort of psychological dysfunction? For all I know, they do. She certainly has a devoted following who apparently find her advice useful. Even so, I would be a lot happier if somewhere near the beginning of her books she said something like “this book isn’t for everybody” and explained the sort of self-destructive behaviors her work was meant to address. Like they say, the first step is admitting you have problem. But Suze Orman admits nothing. She is like the wife of the compulsive gambler who tells her husband she doesn’t want to visit Las Vegas because she doesn’t like the desert climate. While preaching the importance of honesty and being realistic about your finances, she gives advice that is, in fact, an elaborate and disguised work-around to compensate for her readers’ presumed shortcomings.

Suze Orman’s 2009 Action Plan ends with the platitude that you should “always choose to do what is right, not what is easy.” Sometimes what is right is hard and uncomfortable. It might be hard to hear that your favorite money guru occasionally gives bad advice or that you are acting irrationally, but if it is the truth, it needs to be said. Like the lady says “The lies need to stop.”

Suze Orman’s 2009 Action Plan, Part 1

I have only respect and contempt for Suze Orman.

On the positive side, it would be hard not to admire Orman’s talent and achievements. She is undoubtedly the most effective and popular personal finance guru in America today. Suze Orman’s 2009 Action Plan is her seventh consecutive New York Times bestseller. She has won two Emmys. Last year Time named her one of the 100 most influential people in the world. To put that last achievement in perspective, consider that the Pope did not make the cut.

Alas, this highly tuned and powerful machine is used to bring her vast audience fairly mediocre and amateurish advice. At best, what Orman tells her readers and viewers is pedestrian and obvious. At other times it is dangerously specific, assuming unstated facts about the reader’s situation. And once in a while it is just plain wrong. But wasting her abilities with weak content is not the chief reason I have contempt for her. She also has a righteous new-age shtick about courage and honesty which is not only grating, it is hypocritical.

Suze Orman’s 2009 Action Plan is her reaction to the current economic crisis. (Of course, given its success, I would expect an Action Plan to appear annually every January from now on, crisis or no.) It is one of many quickie books on similar themes that have appeared in the last few months. Orman’s was finished on November 19, 2008 and on bookshelves as a paperback by mid-January 2009. As would be expected, it is not very long and lacks much in the way of a coherent organization. The great majority of the book is in the form of an extended FAQ, with “situations” that could have easily been phrased as readers’ questions followed by short answers or “actions.”

The slim volume does contain a few longish bits of advice and explanation. One of these is the second chapter of the book, entitled “A Brief History of How We Got Here.” It is not merely brief (11 pages) but shallow as well, what you might expect from a bright high school student asked to summarize the economic situation based on accounts taken from one of our nation’s lesser tabloids. Admittedly, Wall Street and the economy are not Suze Orman’s fields of expertise, but this section betrays a remarkable lack of knowledge about how indeed we got here.

For example, Orman explains that in reaction to the low interest rates of the middle of this decade, the “too-smart-for-their-own-good minds of the financial sector” “bundled the prime and sub-prime mortgages into one investment, called a Credit Default Obligation (CDO).” Actually, CDO stands for Collateralized Debt Obligation, prime and sub-prime mortgages are generally segregated (not that that helped) and CDOs became the standard method for structuring mortgage bonds twenty five years ago. How CDOs were invented is described entertainingly in Michael Lewis’ bestseller Liar’s Poker (1989) which until recently I had thought everybody involved in finance and over the age of 40 had read.

The Orman view on what went wrong in the global economy begins and ends with American house prices and mortgages. That is like blaming a warehouse fire on faulty wiring without mentioning that the building was full of fireworks and that the sprinkler system failed. But no matter. 2009 Action Plan is for consumers, so limiting the explanation of what went wrong to consumer-oriented factors is not the worst thing imaginable. Orman ends the chapter by summing up that “the mortgage crisis is the most vivid example of how dishonesty and greed leads to financial destruction” and exhorts her readers to become honest with themselves about their own finances.

That’s a sentiment with which it is certainly hard to disagree. Truth and candor is a recurring theme of Suze Orman’s, both in this book and elsewhere. It would be much more convincing if Orman was herself more honest about how her advice about houses has changed over the past few years.

2009 Action Plan tepidly endorses buying a house, saying that “over time a home can be one of the most satisfying investments you can make” (p. 147) and clarifies that your house “will, on average, rise in value at a pace that is only one percentage point above inflation.” (p. 154.) I have no objection to either of those points, but isn’t this the same Suze Orman who called home buying “one of the best known investments” (The Laws of Money, 2003 & 2004, p.131) just a few years ago? In 2009 Action Plan Orman is repeatedly strident about not taking out a loan from your 401(k) or tapping your IRA for any reason short of dire emergency, and yet in The Courage to Be Rich (1999 & 2002) she suggests doing both to raise money for a house down payment (p. 223.) In 2009 Action Plan Orman condemns adjustable rate mortgages and says that a 30 year fixed is a “requirement” for home buyers (p. 148.) In The Courage to Be Rich she discusses both flavors of mortgage favorably and lists reasons you might be better off with an ARM. (p. 254.)

There is no shame in having been much more enthusiastic about houses a few years ago. As far as I can tell, all personal finance writers urged their readers to buy houses in the Good Old Days, and Suze Orman was actually more cautionary than most. And circumstances have indeed changed in the meantime. But for a person who lectures continually about the importance of honesty and speaking the truth about money, would it be too much to expect a modest mea culpa? Wouldn’t her criticism of the “dishonesty” of those who borrowed too much to buy more house than they could afford be more persuasive if she conceded that the chorus of personal finance advisers, Suze Orman included, egged them on?

[Click to the second half of this review here.]

Phil Town’s Rule #1, Part #5

[This is the final part of a multi-part review of Phil Town's book Rule #1, The Simple Strategy for Successful Investing in Only 15 Minutes a Week! If you haven't already, you might want to read Part 1, Part 2, Part 3, and/or Part 4 first.]

Does anybody really believe that they can buy a book containing a sure-fire formula for riches? I do not mean conceding that it is remotely possible, I mean truly believing that Town’s book, or one of its thousands of competitors, will disclose a magic technique to the reader. I am sure that there are a few out there that are that gullible, but I don’t buy the idea that Town’s large readership is made up entirely of such folk.

So maybe my efforts to demonstrate that Rule #1 does not work were a waste of time. If Town’s audience does not really expect his scheme to make them rich, then why bother showing that it will not? Moreover, if we accept that there are very few people out there who are both in the habit of reading books and naïve enough to think that reading a particular one will make them rich, how do these books become bestsellers?

For me, the most meaningful revelation from Rule #1 is just how impractical it is to carry out what Town advises. I expected that his formula for picking stocks would not work in the sense that the stocks picked would not do particularly well. I did not expect that it would not work in the sense that it would barely function, that it would be so hard to use it to pick stocks at all. And you might think that this kind of not working would be a big problem for the sales of the book. A scheme that is easy to operate but does not pick winning stocks at least has the virtue that it could take a year or two before the readers realize it is defective. A scheme that is more or less inoperable from the start would, you would think, be noticed right off and become a hindrance to climbing the bestseller lists.

The flaw in that logic is that it assumes that readers actually attempt to follow Town’s advice and discover it is defective. But just as the vast majority of Town’s readers does not, in the cold light of day, really think that his scheme will make them rich, the vast majority also does not bother to try to follow it. Why would they? They know deep down that it will not work, so why put in the considerable effort required to shatter the illusion that it might work? Which then begs the question, why buy the book at all?

Because Rule #1, like nearly all books (and seminars, for that matter) is, ultimately, primarily a form of entertainment.

Consider television cooking shows, a genre that dates back to the earliest days of the medium. Although nominally instructive, it is clear that almost all viewers will never cook the elaborate dish that the host prepares. They watch not to so they can follow the instructions, but because it is entertaining. If you are into food, watching a skilled chef prepare and discuss a dish is fun. You can, at least in the abstract, imagine yourself preparing and even eating it, and that is enjoyable for many. I know people who buy and read cookbooks on the same basis.

Or consider cowboy hats. Putting one on has no chance of turning you into a cowboy. But it helps with the fantasy of being one. (In reality, it is probably not a great job: long hours, low pay, lots of big dumb smelly animals, and no Internet access.)

The fantasy that goes with Rule #1, and other books like it, is that you will read them and become rich. That any modestly intelligent reader knows, at some level, that this is really unlikely, does not diminish their appeal. A person can read the book and imagine becoming rich just like the ordinary people in the inspirational stories included in the text. That some of the instructions are, in fact, impractical is unimportant. They only need to seem practical to somebody who will never attempt them. Just as the host of a cooking show can get away with using obscure ingredients or a tricky technique requiring years of practice, Town can get away with vague instructions that do not produce the desired result.

So in a narrow sense, I am willing to forgive these books for being as bad as they are. They fill an entertainment role for some, and, apparently, do it well. The problem is that personal finance is still an area that American adults need to master. After you are done watching the celebrity chef prepare Cajun crawfish stew, somebody still needs to cook dinner.

[Links to parts of this review: Part 1, Part 2, Part 3, Part 4, and Part 5]

Phil Town’s Rule #1, Part #4

[This is part 4 of a multi-part review of Phil Town's book Rule #1, The Simple Strategy for Successful Investing in Only 15 Minutes a Week! If you haven't already, you might want to read Part 1, Part 2 and/or Part 3 first.]

This is a strained analogy, but I think it works.

You are driving along on a quiet Saturday night. Phil Town pulls up alongside you in a big flashy car. He leans out the window and says “Hey, for $25 ($35 in Canada) I can take you to the coolest party ever.”

“Uh, I dunno…”

“It’s at this really gorgeous mansion on the beach. There’s an open bar, a huge gourmet buffet, and dozens of beautiful scantily-clad young people of both sexes who are tipsy and really open-minded, if you know what I mean. Also, the Rolling Stones said they would drop by later and play a few sets.”

Now you are pretty sure this is too good to be true, but there is that slim chance this smooth guy in the expensive car is telling the truth, and it is only $25. So why not? You hand over the money and Phil, assuring you the party is nearby, tells you to follow him. Which you do, weaving in and out of traffic at increasing speeds, making hairpin turns on mountain roads, running red lights, going the wrong way on one-way streets, and so on. Finally, Phil drives off the end of a pier, whereupon you discover that his car is actually amphibious. You stay on shore, watching him sail off into the sunset, calling back to you that the party is just a little farther.

So if by some miracle you have gotten through the main stock selection bits of Rule #1 with your sanity intact and a stock or two to buy, Town has just a little more work for you. We are almost there, you can hear him say.

On page 196 of Rule #1 Town introduces what he calls “the Tools” and what the rest of us investment types call technical indicators. Technical analysis is probably older than you think, possibly as old as the stock market, but at least as old as the familiar charts that show stock prices over time as squiggly lines. It is the developed pseudo-science of chart reading, based on the idea that stock prices follow a pattern that allows you to predict their near-term future. The name “technical” is old too, dating from a pre-computer era when the field seemed high-tech and nearly mystical.

Town is agonizingly ambiguous about the role that the Tools play in Rule #1 and vague about the specifics of how to use them, or even which exact tools to use. He instructs his readers to treat them as something they should follow without hesitation or reflection but also says “I’m not married to the specific set of Tools that I’m about to introduce to you.” He recounts how they have made him money, but seems to sell them to the reader primarily as confidence building accessories that will help a person pull the trigger and invest.

I am not going to conduct a backtest of the Tools. This because: 1) You are probably sick of backtests by now. 2) Town does not quite say that the Tools make money, in fact he is clear that as a stand-alone they do not, so finding that they do not work would not be a refutation of anything. And 3) Town is so unspecific about which tools to use, and how, that whatever results I got could be brushed aside by a true believer on the grounds that I did not do what Town really meant.

The three tools that Town recommends, but is not wedded to, are called MACD, Stochastics, and moving average. They are all, essentially, complex formulas that take only past prices of a stock as inputs and attempt to produce a “signal” that will predict if the stock is on its way up or down in the near future.

I have a lot of disdain for these sorts of tools. (Could you tell?) It is not that the underlying phenomena that they try to capture do not exist. They do. Stock prices really do exhibit some “momentum,” meaning that a stock that has been going up over the past three to six months is a little more likely to go up in the near future than one that has been flat. And over shorter periods, a few weeks for example, stock prices really do tend to revert, that is, stocks that have gone up or down a lot over a short period tend to give or get back some of the price movement right afterwards. These are small effects, but they are real and with enough data a person can prove it.

But these effects are not just small, they are simple. Calculations like MACD are not any more predictive than much less complex measures of price momentum. They have a lot of moving parts, in my opinion, just for the sake of having a lot of moving parts. It makes them seem so much more sophisticated and meaningful that way. In fact, these tools are no more subtle than looking a stock chart and saying “Golly, this has been going up all year. I think I’ll buy some.” or “Gosh, this has really been beaten up this week. I think I’ll buy some.”

Moreover, and here is where Town’s car is revealed to be a boat, these technical buy and sell indicators are by their nature short term. If you follow them you will inevitably be buying and selling every few weeks. Town gives the happy story of a couple who successfully used his system to make lots of money over two years in the stock of the Cheesecake Factory. They bought and sold the stock eleven times during that time. That is almost a trade in or out every month. Understanding, very late in the book, that this is what Town has in mind is probably a jarring surprise for many readers. In most of the book he stresses that he buys companies, not stocks, and that he would never buy a stock he was not willing to hold for ten years. Warren Buffet, an investor known particularly for his patience and long-term view, is cited as an inspiration throughout the book (he appears in the index 29 times) and the title is taken from something the great man said.

And yet, when you get down to it, Rule #1 is a form of investing that relies on a lot of short term trading. Look at any stock’s price chart and it is easy to imagine how profitable it could potentially be to trade in and out, buying on lows and selling on highs, provided, of course, you knew when those lows and highs were. The point is that that is true about any stock, not just that one in a thousand that passed the growth and value screens.

[Links to parts of this review: Part 1, Part 2, Part 3, Part 4, and Part 5]