Becky and I refinanced our house this week, locking in a 15-year rate. This should be great news, since we will be paying less interest over the life of the loan by retiring the 30-year, and our monthly payment is close to what it was. Yet, somehow, it doesn’t feel like a great move, especially after waving goodbye to a sizable chunk of cash to get the deal done and signing a mountain of documentation. Since when do you have to sign a copy of a copy just to make sure they can prove you got the copy? That was new to us, and we hesitated and then continued signing away with the enthusiasm of a baseball player at a card convention.
As is often the case with good investment advice, it does not feel great at the time. Believe me, I am not jumping up and down over this “investment” move. I have read the recent housing reports. Real estate is a risk, and the waiting is not exactly fun. Yet the emotional benefit of working towards the eventual ownership of our home is rewarding.
This week, I was reminded that investing, after all, is not supposed to be fun. That has helped a little. What reminded me was my rereading of Warren Buffett’s interview with Fortune’s Carol Loomis and his simple definition of investing: Investing is laying out money today to receive more money tomorrow. That is what Becky and I did with the refinancing by saving on interest payments. I know what you are thinking: Buffett does not like debt, period. But this seems to be a good investment decision for me and my family according to our current situation.
Your situation may be different from mine, but what ties us all together are interest rates. Buffett compares interest rates in the financial world to what gravity is to you and me in the physical world. They affect everything, including real estate, bonds, and stocks. As he points out, “If interest rates are, say, 13%, the present value of a dollar that you’re going to receive in the future from an investment is not nearly as high as the present value of a dollar if rates are 4%.” Not exactly stuff you talk about every day, so let’s use an example: A decade from now, the present value of $50,000 at 13% is around $15,000, whereas at 4%, the present value is over $30,000. When interest rates go up, all else being equal, the present value declines. With the ten-year treasury yield at 2.63%, I’m not expecting much higher values from lower interest rates. They can’t go below zero.
The other critical Buffett variable is how many dollars investors expect to get from the companies in which they are invested. How do you feel about the future outlook for corporate profits, especially after the downward revision in second-quarter GDP growth to only 1.6%? Not great, I am sure. Look at how rising interest rates and weak expectations created stagnation from 1964 to 1981, even though there were improvements in GDP.
Buffett’s favorite stock market barometer is to show the relationship between the stock market and the economy. Below, I have taken the market value of all publicly traded U.S. equity securities as a percentage of the country’s business, GNP. As he points out, if investors priced the stock market to grow 10% per year and the economy grows at only 5%, this chart would go through the top of your computer. Warren Buffett famously purchased stocks when this ratio was around its low back in 2008. Even to him, I am sure it did not feel great at the time. Buffett might consider today’s market fairly valued, but that does not rule out its becoming an undervalued market and remaining so for a long, long time.
Becky and I may not be thrilled about putting more cash into our home, especially while watching real estate prices decline further, but we can live with our decision. You need to make investment decisions that you can live with, too, even though it may not feel great all of the time. That is something Buffett has shown he is comfortable with, especially when the market sentiment is weak.
