The tax refund cometh

For once I filed my tax return in a timely fashion and now I'm reaping the reward. I already have my refund! It was direct-deposited into my ING savings account on Friday. Now the question is what do I do with it? Well I already used it all up (or rather, it's partially used up and partially scheduled to be used up on Monday).

My tax refund was bigger than I expected -- about $1100 total. I put $700 in my Scottrade account, $100 in my emergency fund, and $300 in the Sharebuilder account I set up for my nieces and nephew. In one fell swoop I took care of presents for their birthdays and Christmas! Of course I still have to get them tangible presents, but they can be pretty cheap and thus easy to pick out. For instance, my nephew's birthday is next week and I bought him a jigsaw puzzle of the cover of a Beatles album.

The shocking thing is that the account now has almost $700 in it (including the $50 opening bonus). Granted, that's to be divided between the three of them, but it's a not insignificant chunk of change! Seeing that large figure really validated this idea to me. I could have bought $600 worth of stuff and today there would be hardly anything to show for it. Certainly most of the presents I've bought for them in the past have been put away or forgotten.

Buying patiently

I haven't done much trading in the last few months. I haven't sold anything despite the market falling and showing no signs of stopping. It's a liberating feeling to not be tied to the whims of the market.

I bought some shares of Washington Mutual while it was down (it's still down). I suspect that it will survive, or be bought by a larger bank, and in a 5 years the credit crunch will be a distant memory.

I also bought some more shares of AAV while it was down (it's also still down). It's mysterious in the way it moves, but I think the future for natural gas is strong. In 5 years we'll see if I'm right!

It's interesting to look back and think about the profits you could have had, while also trying to remember what you thought at the time, your hopes for the future. I could have (and desperately wanted to) sell AAV when it was up 40%, but at the same time I thought, well I don't need the money, and 40% is peanuts compared to what it can do over the long term. I still think that's right, although wouldn't it be nice to get both!

Tips are bad, mmkay?

Stealth Wealth wrote an article about why he thinks the practice of tipping has gotten out of hand. I agree and further I think the practice has become counterproductive, at least when it comes to restaurants.

Let's look at some of the effects of the current system.

No special service required -- tipping isn't for special service, it's for standard service. People will pay 15% unless service is truly terrible. Unfortunately, people will only pay 20%-25% for very good service. Since 15% is the norm, that translates to a 5%-10% tip for special service... not very motivating!

Quantity over quality -- Going along with the above, there is an obvious emphasis on quantity over quantity. It's generally more profitable (and definitely more of a sure thing) to give good service to 6 tables than to give excellent service to 3 tables. Waiters always tell the hostess "No I'm not too busy, give me the next table!" They will never say "Gee, give it to X, his last table left quickly and I want to continue providing excellent service to my existing customers."

Service depends on what you order -- Have you ever gone out for lunch, by yourself, and gotten something small like a salad with just water to drink? Your waiter's motivation to provide good service is approximately zero. It takes as much effort to refill your water glass as it does to bring that other guy another $4 beer.

Time is a factor -- Want to sit at the table and reminisce with your friends for 2 hours getting free refills all the while? Most people realize that they should tip more in that situation, but few pay significantly more, meaning a 50% tip instead of 25% or 30%. That's why service trails off.

Waiter takes blame for restaurant mistakes -- Most people recognize when a problem isn't their waiter's fault, but some don't.

Stereotyping leads to self-fulfilling prophecies -- If you look like a bad tipper, you will receive bad service, and you will most likely leave a bad tip. Or if you're a regular customer and you frequently leave bad tips, you will get bad service. I think pretty much every restaurant has some groups like that. When I was a waiter, we would seriously try to avoid getting stuck with a certain group of 6 or 7 old women who came in once a week. Suddenly everybody would be taking a smoke break, going to the bathroom, or whatever. It was funny. The reason was that they would all order fairly small meals, only drink water, and for a tip each one would round their bill up to the next dollar.

All of those issues could be resolved by paying waiters a normal wage. People could still leave tips if they received truly exceptional service. Bad service could be addressed by speaking to the manager (which is almost universally more appropriate and effective than not saying anything and leaving no tip).

Investment update

I thought I'd do a quick investment update. I only own shares in 4 companies right now: AAV, GE, PFE, and JNJ (that's in order of investment size, with AAV being the largest).

AAV has done very well and I have had nice returns both in price and in dividends. With oil so high and natural gas prices heading up for the winter, I'm going to hold this position for the foreseeable future. AAV recently bought another energy company called Sound Energy Trust. This is probably a good move since all of the Canadian Royalty Trusts took a big hit in stock price in the last year (which is why I invested to begin with). So AAV is eating up some of the low hanging fruit, which makes them more valuable in the future.

GE has done better than I imagined, up almost 15%. I wrote before about why I liked GE and some of the issues I talked about have already started to bear out. As the Associated Press notes:

General Electric Co.'s profit rose 14 percent in the third quarter on strong global sales of airplane engines, locomotives and other equipment that have led to a record order backlog.

That's fairly obvious, I guess, but it still is nice to know that I wasn't completely off base. They have over $50 billion in their order backlog, which means they have a pretty safe revenue stream for the next few years. I wonder how big their dividend increase will be this year.

Pfizer has recovered a bit from its low, as I suspected. Recently there have been rumors that Pfizer is going to buy the French company Sanofi, which is the 3rd largest drug company in the world (Pfizer is #1). Well, a lot of people think that's unlikely if only because the French government probably wouldn't allow it. But it seems like Pfizer is definitely looking to buy *something*, which is good since it will give them a future revenue stream once their most profitable drugs lose patent protection. Pfizer currently has about $40 billion in cash just sitting around waiting to be used.

Johnson and Johnson has been rising slowly but steadily. I don't have huge expectations for it since it's a very long term play, and I'm happy so far. One of the silly things I do these days is look out for J&J products at the store. I started using Aveeno shaving cream, which is made by them. When I had to restock on band-aids, I eschewed the store brand for the original BAND-AID brand (by J&J). Every bit counts!

The 401(k) match

I hardly know anything about 401(k) plans because the company I work for doesn't offer them (or any other type of retirement package). But one of the things you hear bantered around the PF world is the "company match." This is typically a scheme where the company will match 50% or 100% of the money you contribute up to a certain total amount of your salary (usually 6% or 3% respectively). People are advised to max out their matched amounts as the first step to retirement savings, followed by an IRA or more unmatched 401(k).

Anyway, what effect does a 50% match have on your savings? It's fairly substantial in the beginning, certainly, but what is the long-term effect? From what I've read, typical 401(k) plans have limited investment choices. Usually you can choose from a mix of mutual funds, perhaps ETFs, and money market funds, but it seems rather limited. Over a 30 year period, how much better do you have to be at investing to overcome the 50% match?

Let's look at how you calculate something like that.

The basic formula for simple compound interest is x = y * (1+z)^t, where t is time, z is your interest rate, y is the initial investment amount, and x is the total at the end.

Well with a 50% match, any y that you invest automatically becomes 1.5 * y. Let's assume that we want x, y, and t to be constant, and we'll see what happens to z. We'll use z for the first interest rate (in the matching 401(k) version) and z' for the second interest rate. Since we're looking for equality, our equation is

1.5 * y * (1+z)^t = y * (1+z')^t

Doing some math...

1.5 * (1+z)^t = (1+z')^t

ln(1.5) + t*ln(1+z) = t * ln(1+z')

z' = e^((ln(1.5) + t*ln(1+z))/t)) - 1

A little complicated. Let's plug in some numbers so we can get a feel for what this equation means. In a short timespan of 2 years (t = 2), if the matched fund returns 10% annually (z = 0.1), our little independent investor would need an annualized return of 34.7% to overcome his disadvantage in not having a match. Over a 10 year period, he would have to achieve 14.5%. Over a 30 year period, he would need 11.5%, a bit easier to achieve.

What does this mean? Well, confirming the obvious, having a company match is a significant advantage in terms of how well your money will grow. However, if you fancy yourself a better than average investor, your 401(k) doesn't provide enough freedom to invest how you like, AND you have a fairly long time horizon, then it may be worthwhile to ignore the company match and make a go of it on your own. As you get closer to retirement age, you would stop your own investments and start taking advantage of the company match. The crossover point could be determined by substituting guessed values for z and z' (based on historical performance perhaps, though remember that's no guarantee of future performance!) and then solving for t.

Equal weight ETFs

Yesterday I explored a new (to me) ETF called the Rydex S&P Equal Weight ETF (AMEX:RSP). The idea is that instead of representing the underlying companies proportionally to their market capitalization, each one is represented, well, equally.

Looking at RSP vs. SPY, the most famous S&P 500 ETF, there are a few things I immediately like. There is a bit less weight given to financial companies in RSP, which is good because at this point I don't really want to invest in them. SPY, on the other hand, has among its top 5 holdings both Bank of America and Citigroup. There's more weight given to sectors I like, such as consumer goods and services, industrials, and basic materials.

Consumer goods is a great sector to invest in right now given the downward spiral of our economy. We should be looking at recession-resistant companies. Consumer goods companies like Procter & Gamble sell essential products like soap and detergent that people buy regardless of how the economy is doing.

I like industrials and basic materials for a different reason -- globalization. Every day, some news comes out about GE's overseas deals. They're building locomotive factories in India, selling jet engines to Dubai, partnering with Japanese companies to build nuclear reactors, selling special furnaces to Chinese steel companies, and on and on. According to GE's Citizenship Report (silly term heh), more than half of their revenue will come from overseas this year. Large industrial companies in the US are in a great position to earn massive amounts of money overseas, especially with the falling dollar. And again with the falling dollar, basic materials companies will find it easier to compete with imports, as well as become more attractive overseas.

Aside from sector allocation, perhaps the best thing about RSP is that their reallocation strategy is more correct. Say a company has a great year and its market cap increases 50% (yay!). SPY will buy more of the company because now it represents a bigger piece of the S&P 500 pie. If the next year the stock goes down a bit, SPY will sell shares. Buy high, sell low -- doesn't sound like a winning strategy!

RSP, on the other hand, will behave better. If the stock goes up, RSP sells shares because it ignores market cap and looks at a fixed percentage. In other words, every company should represent 0.2% (1/500) of the total fund. If a company doubles, it will be above its allotted 0.2%, so they sell shares to bring it back down. Then if the company drops a bit, it will fall below 0.2% and they will buy shares. Buy low, sell high, just what we want to hear.

A frugalish recipe

A few weeks ago, I bought some Pyrex containers so I could start cooking in bulk and freezing food. Another plus is I can take more complex foods to work, keep them in the refrigerator, and have a nice lunch. Before, I was pretty much limited to sandwiches and fruit.

Anyway, for lunch today I had leftover thin spaghetti, a dollop (or two) of olive oil, and some grated Parmesan cheese. Normally when I have spaghetti for dinner, I toss the extra noodles, but this lunch was so yummy I'll probably do it again. I think the total cost of this meal was less than $1, though it's hard to say because I don't remember how much the cheese had cost. It's truly amazing how much money you can save by bringing lunch, and specifically leftovers, from home. And it tastes so much better than a $5 sub or, even the McDonald's double cheeseburger.