Should you Lock it In?

Today’s interest rates -- the lowest since the 1950s -- were the response to a worldwide credit crisis and never meant to last forever. With both the Federal Reserve and the Bank of Canada hinting that rates will soon be increasing, is now the time to lock in your mortgage rate? Or, should you keep your rate variable and ride it out?

Since the late 1980s, variable rate mortgages have saved homeowners money over fixed rate mortgages. That is, on any given year, you would have been financially better off to take a variable rate mortgage (which has a lower rate) instead of a fixed rate mortgage (which has a higher rate but that is guaranteed not to increase). Variable rates could and sometimes did rise, but never enough to make the fixed-rate option worthwhile. As a result, many advisors now state unequivocally that variable rate mortgages are superior to fixed. The recent past, however, is not necessarily a good indicator of the future; and money is not the only consideration.

The next twenty years are unlikely to be the same as the last twenty. Countries around the world have run up huge deficits to combat global recession and have expanded their money supplies. The possibility that interest rates will rise dramatically to fight inflation is still relatively low, but it is real. If a hyper-inflationary scenario plays out like it did in the early 1980s, a fixed-rate mortgage will be a lifesaver.

Another consideration for a fixed rate mortgage is the psychological aspect, which is huge but often ignored. Financial prowess involves making practical decisions and planning for the future. Variable rate mortgages make long term planning difficult. How can you accurately budget, for example, if you don’t know what your next mortgage payment will be? There is also the serenity that comes with hearing an announcement that interest rates will rise, and not caring. You may pay for this economic certainty, but the psychological benefits are tangible.

The final consideration is protecting your downside risk. If mortgage rates rise only modestly, you may regret fixing your rate. But really, the worst that can happen is you don't save as much as you could have. If rates climb far above and beyond your fixed rate, however, you will be eternally grateful that you locked yours in. A fixed rate is, in effect, a form of insurance against events that could upset your financial security.

In short, I am advocating locking in to a fixed rate. With present rates at historical lows, the downside risks (such as rapidly rising interest rates) are far greater than the upside risks (such as missing out on a 1-2% rate discount). And, the ability to plan for the future, knowing that your monthly payment will not increase, is a valuable asset in itself.

Unless you like gambling, lock it in.
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"Beware the investment activity that produces applause: the great moves are usually greeted by yawns." Warren Buffett, 2008 Berkshire Hathaway Annual Report.

Two Stocks I Like – Alternative Energy

Although people continue to debate the existence of global warming, good investors should leave the debates aside and focus on reality: demand for alternative energy has risen significantly in recent years, and will likely continue to do so. Clean energy solutions are more practical and cost effective than ever before, and industry is embracing the savings and public relations improvements that clean energy offers.

Two companies that stand to gain large amounts of new business as demand for alternative energy increases are the well-known companies General Electric and Dow Chemical (I own both).

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General Electric (GE) is one of the largest companies in the world, and the only remaining original component of the DOW 30 Index. It is a technologically sophisticated company with diverse fields of business, giving it an annual GDP larger than the entire country of Israel. GE is a leader in (among other things) nuclear power generation, wind turbines, hydroelectric power, and components for many sources of alternative energy.

GE suffered during the credit crisis of 2008 (especially due to the investment arm GE Capital), and although the stock has come back 100% from its lows it is, in my opinion, still selling well below its true value.

GE Statistics (at time of writing):
Price $18.30 USD
P/E 18.15
Return on Equity 10.11
Dividend Yield 2.19%

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Dow Chemical (DOW) was incorporated in 1897 and now employs over 52,000 people. DOW is already a huge supplier of residential and commercial insulation and weatherization products (including the ubiquitous Styrofoam®), and is always working on new and innovative energy-saving solutions. In 2009, Dow introduced solar shingles. Dow is also currently developing advanced Carbon Dioxide scrubbers for commercial use.

Dow stock has tripled since its low in 2009 in anticipation of the return of substantial revenue, giving it a ridiculously expensive-looking P/E ratio of 93. Nevertheless, DOW has incredible revenue generating capabilities, and I believe that in a few years today’s price will look like it was a bargain.

DOW Statistics (at time of writing):
Price $18.30 USD
P/E 93.2
Return on Equity 3.16
Dividend Yield 2.00%

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Disclosure
Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

Alternative Energy – Cap and Trade

You’ve heard about Cap and Trade, but what is it?

Before talking about Cap and Trade, one first has to understand pollution control. Note that I am using the term “pollution control” (a tangible, measurable phenomenon) as opposed to “climate change” (a debatable, difficult-to-measure phenomenon).

When talking about pollution control, one has to be sensible. Americans are not going to park their cars and start cycling to work any time soon. On the other hand, it doesn’t make sense to drive your SUV two blocks to buy milk, either. Any good economist will tell you that to control pollution you have to control behavior. This means either putting incentives on green, putting disincentives on brown, or both. And you have to do it without killing the economy.

Say that you own a company that produces 1 tonne of pollutants per day of production. If you were to build infrastructure to reduce that pollution, it would cost you $50/tonne. Since there is a cost with no equivalent savings, there is no inventive to implement pollution control measures. But, if the Government were to start fining you $60 per tonne of pollutants, suddenly there is an incentive not to pollute: your company saves $10/tonne to build the anti-pollution infrastructure. The point is, while free market economics takes care of most issues of industrial production, pollution is rarely one of them. Pollution control has to be mandated.

Measures that have been already been used to control pollution include taxes on gasoline, emissions taxes for corporations, tax credits for buying low-energy home appliances, banning polluting substances (such as DDT and CFCs), and rebates to convert gasoline vehicles to natural gas. So how about Cap and Trade?

Cap and Trade -- also known as cap-and-tax by those who oppose it -- is the name given to a system where a central authority (ex. Government) sets a limit on the amount of pollution that can be emitted. Companies are issued credits, giving them the right to produce a specific amount of pollution (that is reasonably low). If they are efficient (pollute less than their allowance), they can sell their excess credits to other companies for cash. If they are inefficient (pollute more), they need to buy credits from other companies to avoid heavy fines. In other words, there is an economic incentive to meet pollution targets and become more efficient. In theory, it’s a good idea.

The problem with Cap and Trade is that it is complicated and easy to manipulate. If a company manufactures energy-efficient camp stoves, for example, and sells them to African villagers to replace their dung-burning stoves, should they be able to claim credits? If they plant a forest of trees, should they get credits? If a fire destroys the forest, should the credits be taken away? It’s all very opaque. This is not to mention the potential for corruption when big businesses trade credits for cash. And, who decides how many credits to give out, anyway? Will the amount of credits issued rise during an economic crisis, so that businesses can save money?

In my opinion, the best solution is to keep doing what we are already doing. When I visited California as a kid, the smog was so thick it literally made my eyes water. After California passed a law requiring low-emission mufflers, the smog cleared up. When I visited England as a child, households burned coal for heat and buildings looked filthy. Since the government expanded the infrastructure for natural gas and gave incentives to switch, the same buildings now look pristine. When my mother was a child, DDT was a common pesticide. After it was determined to be dangerous, DDT was banned.

The American Clean Energy and Security Act, now in Congress, includes many elements similar to those that have already proven successful; for example, increasing standards of energy efficiency for buildings, modernizing the electrical grid, giving incentives for energy efficient appliances, and requiring large utility companies to obtain some of their energy from renewable sources. But Cap and Trade is also a primary element of the bill.

Cap and Trade isn’t a terrible idea, I just don’t believe it is the best idea. Contrary to some news reports, most major companies support pollution control: it is good for public relations as well as the environment. But they want the playing field to be fair. Existing pollution control measures work and should be expanded. The Cap and Trade portion should be removed and replaced with carbon control measures, tailored to local areas and individual industries.