Finance and Stuff

Thoughts on finance and other stuff by Johan Lindén

Tag: risk-avert

Speculative Stocks

Most first-time investors and gamblers seem to focus on high beta stocks or markets, such as oil prospecting companies or the Russian stock market. In the article in the link below there is an explanation why there may be a negative downside to this besides just higher volatility.

[…] People who bet on horse races bet on the long-shot horses more than would be justified by the actual odds of winning (and conversely bet less than they should on the favorite horses). The story generally goes like this: Horse-racing bettors have difficulty evaluating small differences in outcome probabilities, for example the difference between a 1-in-50 odds horse and a 1-in-100 odds horse. That’s a 2% probability of winning versus a 1% probability of winning. This results in a large proportion of bettors placing too high of a bet on the longer odds because the potential winnings appear larger in that case.

The logic behind this behavior is most likely applicable to other markets of uncertainty such as the stock market.

Fixed or Adjustable Mortgage Rate

Two questions regarding mortgage (home) loans.
Why are most people having adjustable mortgage rates on their home loans?
Is it better to have adjustable or fixed rate?

There are mainly two reasons why people choose adjustable mortgage rate:

  1. Because, an adjustable rate is mainly lower, since you have to pay an insurance premium for knowing your rate beforehand and will not end up with negative (or positive) surprises. You have secured your price of living at a certain rate. Secondly;
  2. since rates have steadily gone down for the last fifteen year or so, the bet to secure at a higher rate have been a losing bet. And since most home buyers memory have only seen interests going down and house prices going up, this is what they will define as a normal state of things.

The typical home buyer do now have the knowledge or understanding that interest rates have been much higher historically and most were not thinking of rates when rates were 15%, just back in the 90’s.

Another misconception is that they will be able to change to a fixed rate later on if rates go up. No such luck. If rates are going up, they will not be able to fix their rate at todays low level. They must then fix it at a higher level or continue speculating that rates will remain low, thus ruining the whole idea about keeping the cost of living low and decrease risk. What all this basically means is that when choosing an adjustable rate you are speculating with your home as security that rates will go down or remain neutral.

When choosing a time-period, do not choose 2 or 3 years, since then you are only insured from spiking interest rates for that period. Choose a period for as long as you need to make payments for the house, thus knowing your cost of living for that period instead of running the risk of ugly surprises. The government will not bail you out. They only do that to the really big and stupid risk-takers that have million-dollar-bonuses every year.

When choosing a fixed mortgage rate today, you get the lowest fixed rates in the history of mankind, and pay the smallest premium ever compared to the adjustable rate. So instead of taking the risk to double the cost of your living, fixing your rate seems like a pretty good deal of you ask me.

Below a chart comparing the long 30-year-old rate (blue) and the short prime rate (orange).

adjustable fixed mortgage rate home loan

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