Simple Pound

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Thanks to Rob @ Money Watch I didn’t miss this comprehensive overview of the credit crunch by the BBC. It is essentially a collection of key graphs to represent the economic changes in the last 12 months and I wanted to cherry-pick my favourites to share with you - but not necessarily because I agree with the message they are intending to bring across (hence the question mark in the title…)

Let’s start with a picture highlighting the key changes in our economy since the start of the credit crunch. The message is clear - petrol and food, two essential cost factors in nearly every household, have increased significantly in price over the last twelve months while the value of our homes has been eroded by approximately 4.4%.

With the rise in petrol prices come further cost increases in related fields such as energy or holidays (think airfares…). But did anyone ever stop to think that this has actually nothing to do with the credit crunch per se? Through an unfortunate coincidence we see a boom in commodities prices at the same time as our economy is already suffering from the aftermath of the subprime crisis - yet that doesn’t mean one caused the other.

Similarly, the food inflation we witnessed in the last couple of months originated in the commodities boom that saw prices in wheat and other agricultural produce reach heights of unprecedented nature. I agree that it has been rather extreme and that certain products seem to have been increasing at the rate of a penny a day, nevertheless that doesn’t automatically mean it’s a direct cause of the credit crisis.

More importantly I’m starting to wonder whether conditions like this couldn’t have been avoided if only people/businesses would have appropriately used hedging. Only today I read that South West Airlines still bought its fuel for $26 a barrel at a time when the market price had reached $80 (slightly old example, but it illustrates my point). How come the likes of Tesco’s, Sainsbury’s or Marks & Spencer’s didn’t come up with a clever idea like that? After all, hedging was introduced for companies to sell their risk in exchange for a small premium and stable input prices.

Before I rant even further, let’s move on to the last category in the summary picture: housing. If you have been reading this blog for longer than just a few days, you will know that I join forces with all the other people struggling to get their foot on the housing ladder and hence eagerly awaiting a double-digit drop in house prices. I totally emphasise with anyone who is worried about negative equity but if you are living in your house because it is your home then you have almost no reason to be overly worried. Hopefully nobody will be forcing you to sell any time soon, hence you can simply wait it out and I’m certain that we will see prices returning to their historic levels (with the only difference that hopefully a few more first-time buyers will have joined the ranks of home owners). And even if you are looking to sell and for whatever reason you cannot wait a few more months or a year until you do so, there are a one-hundred and one things you can do to enhance the value of your home.

In any case, my actual point was related to the graph below. After you got over the fact that house prices have officially been falling since April, have a closer look at the second graph with details of house prices over the last 10 years. Note that it charts the annual change in house prices - that means, as long as the graph runs above the 0 line, your home will have increased in value. Looking at your portfolio or pension account - how many investments can you quote that haven’t fallen in value once over the last 10 years? I doubt there will be many.

What I’m trying to say is that a house purchase has always been a good and solid investment with annual returns of anywhere up to nearly 30%. Now, for the first time in over 10 years we’ve seen a careful reversal of this trend and the world is in panic. As I said before, I totally emphasise with people worried about negative equity, especially as a house purchase is such a major investment, maybe the biggest one many of us will make in our life. However, that put aside, any investment bears the risk of losing as well as gaining in value. Why should property be different?

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When I started to research the risk element of my Portfolio Returns series I had no idea what can of worms I was about to open… from the lack of consensus regarding what risk actually is and how it can be properly defined and measured to an abundance of metrics trying exactly that. The different approaches vary significantly but most of them have one thing in common - a high level of abstraction and greek symbols

Don’t get me wrong - I find this extremely exciting and interesting and I’m certainly going to write about it in the near future, but from a logical point of view it might make more sense to cover a few statistical concepts first.

This is why I will be changing the initial order of the Portfolio Returns series to the following:

1. Post : The Basics  (covered on June 28th)
Arithmetic mean (average loss, average gain), geometric mean, frequency distribution, maximum value, minimum value, positive # of years / months / weeks, negative # of years / months / weeks.

2. Post : Statistics (previously 3rd post)
Standard deviation, semi-variance (semi-deviation), downside variance and below-target probability.

3. Post : All About Interaction (previously 4th post)
Covariance: degree of variability of returns between two assets, correlation coefficient, units of annual return per unit of standard deviation, expected final value of $1.00 / £1.00.

4. Post : First lesson in Greek (previously 5th post)
Beta coefficient or an assets’ degree of responsiveness to market movements.

5. Post : Advanced Greek (previously 6th post)
Alpha or superior returns.

6. Post : More Jargon (previously 7th post)
Sharpe ratio.

7. Post : Risk (previously 2nd post)
VAR: value at risk, M-squared.

I think this order will prepare us nicely for the last topic which also turns out to be the most challenging and complex. The post on Statistics will follow shortly, stay tuned!

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This won’t quite be a conventional Personal Finance post, but the fact that I cannot calculate my portfolio’s performance without converting negative returns into “false positive” ones annoyed me too much to just ignore. Since I couldn’t find a straightforward way around it, I decided to simply code the Excel function I was looking for myself.

While the code is by no means perfect (yet) it does the job nicely and I’m nevertheless pleased with the result. As long as it gets called properly, it converts your negative percentages into a value equivalent to (100 - x) / 100 where x is your percentage. For positive values, it does the conversion according to (100 + x) / 100. These conversions means that a decrease of 10% will be expressed as 0.9 and an increase of 10% as 1.1 which subsequently allows you to compute the geometric mean (which is exactly what it does).

Below is the VBA code you will need to utilise this functionality. Feel free to use it as you please but don’t worry if you have no clue how exactly to do that. I have included a step-by-step description of how to install and call it from your Excel worksheet underneath the code.

Function geometric(data As Variant)
     Dim vaData As Variant
     Dim rnData As Range
     Dim i As Long
     Dim j As Long
     Dim iblank As Long
     Dim jblank As Long
     Dim bblank As Boolean
     Set rnData = data
     vaData = rnData.Value
     temp = 1
     n = 0
     For j = 1 To UBound(vaData, 2)
          For i = 1 To UBound(vaData, 1)
               If vaData(i, j) <> Empty Then
                    vaData(i, j) = 1 + vaData(i, j)
                    ’ compute product for non-empty data cells
                    temp = temp * vaData(i, j)
                    ’ count number of items in list
                    n = n + 1
               End If
          Next i
     Next j
geometric = (temp ^ (1 / n)) - 1
End Function

Follow the steps below to make the above function available in your Excel worksheet:

1. In Excel, open the file you want to use the function in. Note: at the moment the function will only be available on a per-file basis. That means, if you’re planning to use it in more than one file, you will need to repeat this procedure for every single file. I’m working on coding a proper add-on that you simply install into Excel and hence make available to any new or existing file. I told you it was work in progress…
2. In the menu bar, next to the entry “File”, right-click on the Excel icon and select “View Code”
3. The Microsoft Visual Basic Editor opens and you stare at a blank document
4. In the menu bar, click on “Insert” followed by “Module”
5. Copy and paste the above code into that “new” blank space and hit “Save”
6. After you have saved the changes, click on “File” and select the entry “Close and return to Microsoft Excel”. This brings you back to where you started, and your function is ready to use.

Here is how you use the function:

1. Open the file in which you have installed the above function
2. Pick a cell that you want the result to contain and type “=geometric(”
3. Note the opening bracket !
4. With your mouse click and hold until you have highlighted the cell range that contains the numbers you want the geometric mean of. Alternatively, type the cell range yourself as A1:D4 where A1 should be replaced by the coordinates of your first cell and D4 should be replaced by the last cell’s identifier. At the moment, the geometric function only works with a cell range, not individual cells or numbers. I’m working on it…
5. Close the bracket by typing “)”
6. Hit ENTER to see the geometric mean of your highlighted cells

If you format the cell in question in such a way to convert your result back into a percentage (just right-click, choose Format - Number Format - Percentage), the result should make sense in the context of portfolio returns.

Note that the code above has been tested and verified in Excel 2002 and should work with any other Excel version(s) since. The only concern I have regards the compatibility with - you might guess it - Excel 2007. If anyone manages to run it under the new Office version, please let me know!

As usual, if you have questions or concerns, find a bug or just need a hand to get it to work, just give me a shout or leave a comment! I hope you will find it as useful as I did.

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One thing is for sure - reviewing last month’s financial odyssey is not going to be fun. On the other hand, I suppose I should be thankful for keeping such a close eye on my money since otherwise I would have never noticed the appalling truth. Or learnt from it. My point is:

I am now worse off than three months ago.

Despite three months’ salary and pension contributions my net worth is below the March level. I’m absolutely shocked and even a little unhappy since I enjoy seeing the progress bar increase (as opposed to decrease by nearly 2% this month)!

At least I have a pretty good idea what led to this fiasco: an orange coat, a digital piano and a trip to the Caribbean. In hindsight, would I commit these “sins” again? Maybe, yes and yes. The coat, I fully admit, was an impulse buy and a very expensive one at that. Yes I needed a coat, but no it didn’t have to be that one. On the other hand, I still love it as much as I did the minute I walked out of the shop with it and have so far not seen a single person (other than me) wearing it. In a city like London that’s pretty impressive

My piano purchase was an even larger expense than the coat and by no means an impulse buy. In fact, since leaving home I had told my parents I would take my piano with me as soon as I had finished University and had a permanent place to live. Unfortunately it turned out to be prohibitively expensive to ship an item like a piano from Germany to the UK. Hence I decided to get a digital piano in the meantime so that I could start playing (and practising!) again after having not touched a single key during my undergrad studies. The model I ended up getting was only half as much as the Yamaha Clavinova I had set my heart on previously and I got it for £100 less during an end-of-season sale. Regrets? None.

And finally, my holidays. One week on Grenada, a tiny little Caribbean island just north of Trinidad and Tobago. Flights and hotel together came to just over £400 and despite regular dinners out, numerous activities on the island and a day at a local spa, the holiday was definitely on the cheap side. Considering it was the Caribbean anyway Again, I don’t regret this trip at all. On the contrary, I would have happily stayed and travelled much further and for much longer than I was able to. The numerous once-in-a-lifetime memories made it worth every penny.

Regardless of whether I consider this money well spent, it’s time to stop. I am basically exactly where I was three months ago, so for the next quarter I will need to curb my spending in order to get my growth and progress back on track. Given that the house market is still in a pretty bad place, I probably won’t need my deposit money for at least another six months. But by then I definitely will need to have accumulated enough to make this (temporary!) backdrop in net worth unnoticeable.

If you have kept a close eye on my progress page you will notice that I redistributed some of my money between the various goals. I depleted my emergency fund in favour of allocating more money to the house deposit and I also shifted more money into the account intended to cover the outstanding bill I have with my parents. The latter is now fully funded, while my deposit has grown to 70% of my initial goal of £20,000.

Given that we’re halfway through the year, it’s once again time to have a look at how well my budget is working out. The good news is that my interest income reached 73% of my goal for 2008 by the end of June, indicating that my savings are working hard for me while I sleep This is even better news when you consider that this goal was revised upwards twice already this year: from £200 to £300 to its current value of £600. I decided to change it once more to £750, which is definitely fairly ambitious given that I received the interest from a fixed one-year term monthly saver account when it matured in June (hence half of that interest was technically already earned last year).

In the interest of brevity, I will only list the remaining changes to the budget (since I don’t deem them noteworthy enough to dedicate an entire paragraph to each):

• Utilities: new category with £350 since it took our utility provider more than 7 months to get our bill sorted and we hadn’t paid anything until they finally managed to get organised
• Landline: slightly up from £90 to £100 based on usage
• Mobile: down from £220 to £180 based on usage
• Groceries: slightly up from £1,400 to £1,500 - inflation is kicking in
• Dining out: down from £1,000 to £900 to accommodate the increase in food prices
• Clothes: up from £1,000 to £1,200 with the best intentions to undercut it
• Gifts: up from £750 to £1,000 (I’m too generous for my own good)
• Hairdresser / Manicure: up from £500 to £600
• Drinks: pooled with the Category “Clubbing” hence total down from £250 to £200
• Cinema: up from £50 to £100
• Health Insurance supplement: up from £60 to £65 - I blame the bad £/€ exchange rate
• Gym: Down from £360 to £150 because I cancelled my membership
• Contact lenses: Up from £200 to £500 as an eye infection forced me to change my prescription to the more expensive daily disposable lenses
• Life Insurance: Up from £900 to £950 due to £/€ exchange rate
• Broadband: Down from £100 to £90 as we are on a fixed subscription
• Charity: Up from £120 to £150
• Planes: Down from £900 to £800 as my one major holiday is already accounted for
• Holiday Accommodation: Up from £300 to £500 due to major naivety on my part (initially)

That’s all from me for now. Progress page and “Best Of” section have been updated as usual.

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