This week let’s get back to defining common financial terms. As in prior weeks, we’re working our way up the list of terms YouGov polled Americans about. You may know about these terms already, but hopefully this post can add a little extra to your body of knowledge.
Fixed-Rate Mortgage – There are different schools of thought regarding mortgages, but I’ll come right out and state my bias toward the fixed-rate variety. To me, having a fixed interest rate, a fixed term, and a fixed monthly principal and interest payment is the best way to borrow.
Yes, you could leverage an adjustable rate if you thought rates would go down as this would lower your borrowing costs. Perhaps you’re planning to live in your home for only a few years. You could opt for a fixed rate for a that timeframe, say three or five years, and then the mortgage starts adjusting right about the time you’re planning to sell.
Adjustable-rate mortgages can also offer a cheaper entry point, but nothing is free. Again, when I think about a huge purchase such as a house, I want the sense of security that comes from a straightforward fixed-rate loan. I don’t want to gamble.
Another aspect of why I favor fixed-rate mortgages is that we’ve been in a period of declining interest rates for over 30 years. Back in 1981, for example, the average 30yr loan cost over 18%! Currently we’re at about 4.4%. And rates this low will seem oh-so-cheap if (or when?) we move back toward the longer-term average of about 8%. In other words, long-term money is still cheap to borrow so I don’t think there’s much benefit in getting overly creative.
Recession – Strange as it may sound, a recession is always something that happens in the past. The term “recession” is used in different ways by the financial media. Many follow an imperfect definition of a recession occurring when there have been two straight quarters of negative economic growth. It’s more complicated than that so most pundits end up deferring to a small committee of academics working within the National Bureau of Economic Research (NBER) for the final say regarding the timing of recessions.
Some of NBER’s definition of the dreaded “R” word is a “… significant decline in economic activity spread across the economy, lasting more than a few months”. Sounds pretty vague, right? The committee monitors a broad range of economic information, such as personal income and employment data, and how much “stuff” companies are producing and selling. Since this volatile information takes time to generate, the group is always carefully looking (mostly backward) to gauge when the economy was expanding or contracting, if it hit a peak or trough, and whether there was a recession.
What’s always been interesting to me about how NBER dates recessions is that by the time they get around to it the average American’s response is, well, duh! It took NBER about a year to peg the Great Recession, which was news to nobody at the time. Ultimately and obviously, the beginning and ending dates of recessions are important for economists and strategists but does nothing to help the person who just lost their job, their home, or both.
Stocks – Say you have a thriving business. Your customers love your product, your employees are happy, and you see lots of growth potential. The only problem is you don’t have enough money to keep growing. You can always try to borrow more money to finance growth, but this only gets you so far. What’s the next step? Going public.
When a company “goes public” it means they are going through a process to make their business more transparent so that shares of stock can be sold to anyone, not just the insiders who started the business. For the company this can mean a huge influx of cash to finance expansion. For investors, it presents a growth opportunity.
Each share of stock that investors buy is a share of the company’s growth potential and maybe dividends along the way, nothing more. Assuming the company grows, so does the value of your shares, which eventually you’d sell to realize a profit. If the company doesn’t grow, the value of your shares would probably decline. If the company goes bankrupt, well, you can guess what happens then. So, investing in stock is an optimistic act, but so is going public in the first place.
Here’s a link to the YouGov information if you’re interested:
Have questions? Ask me. I can help.
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