How to invest sustainably (in bonds)

The bond certificate for a train companyLast week, I talked about the safest, most liquid investments you can have: bank accounts and CDs. Bonds are slightly riskier but have better returns and sometimes allow you to fund very specific activities, which makes it easier to make moral investments. Bonds also encourage a long-term perspective since their value doesn’t fluctuate like stocks do. There are three major types of bonds, each with different benefitsa dn drawbacks: federal, municipal, and corporate.

A bond (or bill or note depending on how long they take to mature) is basically a loan to a company or government. You pay them a given amount and they pay you interest and then repay your loan at the end of the term. Some bonds roll the interest into the final payment while others give out occasional (usually quarterly or annual) interest payments. For example, you can put $25 into a savings bond and get $50 from the government in 15 years. Or, you can put it in a corporate bond and receive annual payments of $1 until you get your $25 back in 15 years (obviously, these numbers are totally made up).

US government bonds are some of the safest investments you can make. This lack of risk is reflected in their low returns, however. The current rate for most federal bonds range from 0.07% to 3.7% depending on the maturation date (1 month to 30 years out). Interest on government bonds is also exempt from state and local taxes (although not federal taxes), which increases the effective yield a little. Even though returns aren’t great, you know what you’re funding: the US government. Generally, the government takes a longer view than corporations but there are still some morally sticky areas, depending on your viewpoint. If you’re interested in federal bonds, you can buy them through TreasuryDirect.

Municipal bonds are similar, but sold by local governments. Usually, these bonds raise funds for a specific purpose like improving schools. Here in Bloomington, the city is considering floating a bond to buy a sports complex. To encourage people to invest, they’ve discussed how much money they’ll need to raise as well as how they plan to pay it back (savings from events they’d otherwise have to rent locations for and monthly access fees). This makes it easy to evaluate and decide whether or not it’s a sustainable purpose.

Even better, this money stays in the local economy. Interest rates are usually higher than those for federal bonds, about 1.7% to 6.8% (6 month to 30 year) right now. That’s because of slightly higher risk and difficulty finding buyers (it’s easier to sell to the entire US than to a small town). You also have to invest on the municipality’s schedule and not your own, since they don’t continuously float bonds. Many municipal bonds are tax free at all levels (federal, state, and local) but others offer no tax incentives at all.

Corporate bonds are floated by companies that need additional cash. Many large corporations use bonds to raise money for seasonal expenses or short-term capital expenses like building new factories. Like buying stock in a company, you’re funding all of the company’s activities, which can raise moral problems if the company isn’t one you believe in. Although corporate bonds are riskier than government bonds, they’re safer than stocks. If a company goes bankrupt, bond-holders are paid before stock-holders. Corporate rates range from 1.5% to 11% (2 year to 30 year) depending on the risk rating of the bond (A, AA, and AAA from reasonable risk to almost no risk).

If you buy a corporate or municipal bond, you’ll probably see numbers like the price, coupon, and maturity date. In general, all you really need to worry about is the yield-to-maturity (YTM). This incorporates all of those factors into a simple annual yield. For example, if the YTM is 3% then you know that buying a bond at $1000 will yield you $30 a year. If the bond costs $500, then you’ll only get $15 with the same YTM.

Federal bonds are a little simpler, since you pay a discount and receive face value on maturity. For example, a EE bond with a face value of $50 might cost you $25. In 30 years, you can redeem your EE bond for $50, an annual compound rate of 2.4%.

Bonds are great if you’re looking for tax exemption, low risk, regular payments, or specific projects to fund. They’re not so good if you want to invest money on a regular schedule or you want higher returns. I think that bonds are a great part of a sustainable portfolio, but since they take some work and aren’t always available, stocks have a place as well. I’ll talk more about that in my next article.

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How to invest sustainably

In the past few months, I’ve been thinking heavily about investing for retirement. I’ve never had a job with a 401(k) or retirement plan, so my retirement planning has been entirely on my shoulders. Unfortunately, for a long time that meant no retirement planning. Once my business stabilized a little and we got more important stuff (like health insurance) squared away, I decided that it was time to take my future into my own hands. I opened a Roth IRA and bought a couple of low-cost index funds. According to my research, that was the best approach for a casual investor since it represents a bet on the future of the entire market rather than on the future of a particular company.

The moral drawback is that I’m investing in companies I disagree with, like RJR and Exxon. The mechanical drawback is that our economy can’t sustain the kind of market growth we’ve seen in the past (at least, not without also causing the kind of market crash we’re seeing now). The alternative is sustainable investing.

Sustainable investing has two parts: investins in sustainable organizations and investing in a sustainable way. Sustainable organizations have both sustainable products and sustainable business practices. Obviously, drilling for oil isn’t sustainable because eventually there won’t be any more oil. Problematic business practices are often harder to figure out, but just ask yourself if it could work forever. For example, outsourcing to developing countries for cheap labor isn’t sustainable because eventually prices will increase. On the other hand, supporting a living wage is a sustainable business practice because it can be supported indefinitely (and, as Henry Ford realized, it can help create or expand a market for your product).

Investing in a sustainable way requires treating your money the same way that you’d treate any non-renewable resource. This means taking a long-term view and focusing on growth. Money primarily grows through compound interest, so you want to avoid touching your nest egg as much as possible.

As long as you like your local credit union, the easiest way to invest sustainably is to put your money into a savings account or certificate of deposit (CD). It’s not risky, which means that your principal is safe, allowing you to treat the interest as a renewable resource (think of it as tree farming). This money will also go to work in your community by supporting local businesses and individuals through bank loans.

Unfortunately, saving account and CD rates are currently at an all-time low. The best rate I can find locally is about 2.5%, which is less than inflation. Once the economy picks up, so should rates, but this means that CDs probably aren’t the best investment choice right now.

The two other big options are stocks and bonds. Although they have their own problems, I’ll talk you through the basics of investing sustainably using both in the next couple of articles.

The  second part, on investing sustainably in bonds, is now up!

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A subprime food crisis?

Money propping up a house propping up moneyI’m a big fan of NPR’s This American Life (TAL) even thought I don’t listen to it as much now as I used to. When I was driving to NC semi-regularly, I got a subscription to Audible.com and burned some CDs of old TAL. I also got to see a screening of the TV show, which was amazing. It’s now at the top of my queue in Netflix (and if I could buy just one show through cable, I’d probably do that).

Last week’s episode on The Giant Pool of Money has gotten a lot of attention recently, and for good reason. Despite Ira Glass’s fading voice, it’s a great partnership with NPR’s money section that goes over the subprime mortgage crisis (and ties it all back to the eponymous Giant Pool of Money).

Having listened to it one and a half times (I was playing Mario Kart during one listen-through, so it only half counts), here’s how I think things broke down. Over the past ten years, the amount of money governments have been looking to invest in safe returns has doubled to over $70 billion! In the same period, the number of investments of that type hasn’t kept pace. Alan Greenspan and the Fed made things worse by by keeping interest rates low, making them unappealing compared to things like… real estate!

Of course, real estate is messy. These investors don’t want to have to deal with actual houses and mortgage payments and so on. To make it attractive as an investment, the market used a sort of alchemy to change them from the messy, risky things to AAA rated (the highest rating, shared with guaranteed government bonds) investment “vehicles.” A house-hunter would get a mortgage from a broker, who would sell it to a bank. The bank would then group mortgages and sell that package to larger firms on Wall Street (like the infamous Bear Stearns). Those companies then got the mortgage payments with a 5-10% return (much better than the 1% you could get through the Fed) and sold shares in that collection of long-term income. Investment firms would buy shares in many different packages and sell those to investors. Historically, the default rate on mortgages has been about 2%, so the investments were rated AAA.

In order to keep up with demand, companies kept relaxing their rules about what mortgages they’d buy, leading eventually to loans that didn’t require you to prove your income or your assets. Since 2005, some packages of these types of loans have had default rates of over 50%, rather than the expected 2%.

The problem is that everyone based their ratings on assumptions that they changed. The 2% default rate on mortgages was true only for the types of mortgages that had been given out in the past. By changing what they were selling without looking at how that would affect the larger picture, these companies set up the crisis that we’re seeing today.

Listening to the program, I was struck by how similar this all is to our food industry as described in King Corn. We start with a noble goal (cheap food/savings) and build a system to promote it (farm subsidies/subprime loans) and assume everything’s going along fine. In the long-run, though, we have no idea whether or not it’ll work because we’ve changed all our assumptions. Instead of mortgages to people with good incomes, we’re giving mortgages to anyone. Instead of diverse family farms, we’ve got huge monocultures.

Okay, so maybe it’s kind of a stretch. I still can’t help but feel that the problem in both cases is that to make something work widescale, we’ve turned something very local and personal into a semi-arbitrary set of rules. That’ll work for a while, but eventually, people will start doing what the rules reward them for rather than what’s actually best for them and the rest of us. It’s not about bad people or even greedy people. It’s about setting up a system that encourages people to act badly.

I’m happy buying locally because I know that when they do right by themselves, they do right by my community too.

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Can compound interest save the evironment?

A stock graph bursting out from green paperThe site was down for a while this evening, so Maggie didn’t have a chance to post anything before she went to bed. In lieu of a real post, I’ll leave you with something I’ve been thinking about today. A lot of people feel like it isn’t worth changing their lifestyle because they’re just an individual, so they can’t make a real difference. Think about where we’d be if an individual could make an immediate and obvious difference, though. That world would be in terrible trouble if it was at a point where one person’s additional greenhouse gases or electrical use would be enough to plunge the world into chaos.

Wouldn’t you rather be where we are now, where you don’t have to make a huge difference to do some good?

It reminds me of compound interest. When you hear about Adam who invests $12k and lets it sit for 30 years versus Bob who invests $100 a month for 30 years, the obvious winner seems to be Bob. After all, Bob put three times as much money in as Adam, so he made a much bigger difference, right? Sure, if you’re talking effort. But if you’re talking results, Adam is the real mover and shaker here. His initial $12k is worth over $300k, while Bob’s take is half that even though he put in more money!

If you wait until change is forced on you, you’ll have no choice but to make a huge difference (or die off). But, if you start making little changes now, you’ll make it so that you won’t have to be a super-sacrificing Bob.

Call it the compound interest theory of sustainability.

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Learning About Mortgages

Coin TowerWill and I went to talk to a mortgage broker today at Lotus Mortgage. We’re starting to get serious about buying a house and we figured our next step was finding out if we even qualify for a loan. It turns out that we do, which is very reassuring. We don’t make a lot of money but we have really good credit (the broker told me I have the highest credit score he’s every seen for someone under 40) and we have quite a bit of money in savings – at least as a percentage of our income.

I felt really good hearing that we’re doing all the right things financially but really bad hearing that there are a lot of people out there – of all income levels – who are not doing it right. It is very scary to me that there are people making six figures who have less money in the bank than we do. It’s especially scary as I start to hear more about increasing foreclosures and an impending recession and people being abruptly reminded that credit is not a source of free money.

I think part of the reason we’re doing well financially is that we put a lot of effort into living sustainably and in accordance with our values.  (Part of it is also an ingrained terror of debt.)  We have a strong set of goals we’re working towards and we spend (and save) our money accordingly.  It’s frustrating sometimes and a lot of times I struggle to identify my next goal but in general it keeps me going in the right direction.  I’ve also learned that not buying something very rarely makes me unhappy.  There are moments when I think “If only I had enough money to buy a fancy compost tumbler!” but they honestly don’t last that long.  And those times when I do spend $50 on something I thought I desperately wanted, I generally lose interest within a couple of weeks.

I believe a house will be a satisfying purchase.  Will and I are still debating about some of the details like which house and what features are we looking for but I’m sure we’ll figure it out eventually.  Or perhaps we’ll buy one of those charming country homes with a 1200 square foot detached garage and one of us can just live there.

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The Ecology of Money

Money fishingIn the past year, I’ve become much more aware of how I spend. I started a budget, I’m saving more, and I read a lot of great financial advice at places like Get Rich Slowly. Along the way, I’ve noticed that a lot of the messages hammered home by the environmental movement are the same as those used by the frugal.

Recently, I’ve used the bumper-sticker version of living green (reducing, reusing, recycling) to save some green as well (sorry, no more puns, I promise). Instead of throwing away old T-shirts, Maggie used them to start a rag rug. Others have been cut up and used to clean spills. Not only are we producing less trash, we’re saving money at the same time. This got me wondering about other ecological messages. How do they apply to saving money instead of saving the Earth?

  1. Minimize consumption – think of ways that you can stop spending money. This might be the hardest to do, but it pays the biggest dividends. The best way to save is not to spend. As a bonus, it’s usually also earth-friendler to consume less!
  2. Look for alternatives – don’t get trapped in your current lifestyle. There are often ways to combine alternatives to come up with something that works well for you. For example, dryer balls increase the efficiency of our dryer but a drying rack lets us reduce usage of the dryer entirely.
  3. Look at the big picture – you can save a lot when you take a step back. Large up-front purchases can reduce your long-term costs considerably. Compact fluorescent lights are a perfect example, but things like a crock-pot can save you just as much in the long haul!
  4. Study earlier generations – there are still a lot of people out there who lived through the Depression. Most of them have great stories about how they made do with less. Even if you decide that toilet paper is something you don’t want to do without, these people can often give you a valuable sense of perspective as well as useful tips for reducing costs.

So the next time you’re in a conserving mood, try saving water, heat, electricity… and money.

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