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Interest Rates and Fuel Economy

Sigma Investment Counselors

January 24, 2013

These two high-profile issues have been receiving a great deal of attention and can materially affect personal finances. However, in both cases, more important issues, critical to the decision process, are getting less attention.

Consider interest rates. Many investors are disappointed in returns hovering around 2-3%, compared to historical expectations in the 4-6% range. As a consequence, there has been a significant increase in strategies that purport to provide higher returns. The problem is that most investors are ill-equipped to accurately assess the increased risk incurred by seeking higher yields in a very low-yield environment.

Is an extra 2-3% increase in yield worth increasing the risk of principal loss? Think about it. A 4% yield on $100,000 amounts to $2,000 a year more than a 2% return. Is that worth putting the principal amount at an undeterminable increase in risk?

Think about vehicle fuel economy. Manufacturers have been highlighting their achievements in fuel economy, both in absolute terms and in comparison to competitors. But how important is fuel economy from a financial perspective? Take two extremes. The Toyota Prius with a combined city/highway fuel economy rating of approximately 40 miles per gallon (mpg) would require approximately 300 gallons of fuel to drive the national average of 12,000 miles per year. This is less than $100 per month and less than many cable bills. At the other extreme, a BMW750Li, with combined fuel economy rating of approximately 20 mpg, would require 600 gallons, costing less than $200 per month to drive 12,000 miles. Not that big of a difference.

The real ownership cost for both the Prius and the BMW is depreciation. Consumer Reports estimates that the five-year ownership cost for the Prius is approximately $30,000, including $5,000 for fuel, and $108,000 for the BMW, including approximately $10,000 for fuel. In both cases, fuel represents a modest percentage of total ownership costs over a five-year period.

In many respects, the financial considerations involved in purchasing a motor vehicle and constructing an investment portfolio are similar. In order to be successful, it is important to focus on the factors that really matter.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA

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