Getting this book out is a form of life insurance for my kids. While I hope I’m around to teach them, ideally by example, there are no guaranties.
The book isn’t perfect but will point them in the right direction. Hopefully, I’ll get a chance to improve over the years to come.
You can download for free here.
All my best for a successful 2013.
gordo
Earlier this month, my grandmother turned 88 which, as a Chinese friend will tell you, is a far more auspicious number than 44. That said, 44 isn’t all that bad.
44 is further than I ever considered in my teens, 20s and 30s – it’s a bit of a shock to arrive, which lets me know that my 50s are going to be here before long. With that in mind, I’ve started reaching out to my smart pals, already in their 50s, to hear their advice. I’ll share their best stuff as I gather it.
At the end of 2011, I realized that it would be possible for me to spend another 20 years living in my own personal Groundhog Day – winning agegroup athletic titles; working at my coaching business; and going on extremely pleasant vacations with my wife.
My blog post on A Life’s Work shared the questions that I asked myself across the year and I’ve been brainstorming ideas for the next phase of my life. I’m fortunate to have world class Universities in Boulder and have been considering taking advantage of those communities.
What follows is an end of year braindump. These articles are my historical record to see how I do with forecasting.
Health – I feel better than when I was 39/40 and seeking to hang on to elite level fitness. I can remember being sore, tired and exhausted most of those years. The biggest surprise physically is being happy with a level of exercise that’s half of what I previously considered “maintenance.” Many of my peers still continue to “go big” – if they are reading then consider what you might do if your desire for physical expression moderates. You’re going to have a lot of time – unless you replace sport with children!
Family – after my divorce (early 30s), I was openly hostile to the concept of marriage and spent five years completely self-absorbed. I could say that I worked on my suitability to be a spouse but I’m not sure. Either way, I’m glad I gave marriage another chance. My wife and kids have transformed my life.
Something that I failed to anticipate, but heard indirectly from my friends, was how much I would be willing to change for my family. Parenting is filled with frequent moments of misery but so was elite sport! My athletic life was completely focused on convincing myself that doing-what-it-takes was more satisfying than short-term gratification. Great prep for fatherhood.
Business – Four years after the Great Recession of 2008/2009, I’m bothered by a persistent lack of ethics in peers, sport and finance. However, I have the education of my kids to fall back on and human drama provides motivation to remain vigilant with myself.
Finance – I completely missed how low interest rates would go. I think about the impact of a big burst of inflation but wonder if we will follow the post-bubble experience of Japan. We bought a house in December and took out a mortgage (3.25% 30-year fixed) to provide hedging for a burst of inflation. More on that in January.
Education – Last week, I completed the draft of my next book. I’ll publish on Monday and you can download from this site. In reviewing the book (largely written in November 2011), I realized how much I’ve learned in the last year: mountain biking, family management, babies & toddlers, and international law. Even in my 40s, I can improve my human capital.
Self vs Family – there’s been a shift from optimizing for myself to optimizing for my family. If I had to project into my 60s then I expect my circle will continue expand beyond my relatives. I’d like to improve my participation in community as that’s a practical way to contribute to my kids.
Physical – my calf’s been jacked for a few months, my back is often tight, my eyesight is slowly fading but I can still do neat stuff in nature. A key mistake in 2012 was stopping running. 20 minutes every other day would have saved me a lot of hassle.
An important friend, Henry Simon, passed in 2011 and lived by the motto – Never Stop. It’s been 20 months since Henry died. Wow, that went by quick.
Future – I’ve learned a lot from watching older generations and asking them for advice. Key lessons for 2012:
My marriage brings me satisfaction every single day. Three things that Monica brings me: kindness, a shared sense of humor and a desire to be a better man.
I try to live the life that I want for my children.
A quick post to update with the answer to last Thursday’s question:
How long will it take to achieve a $75,000 portfolio if I can save $1,000 per month and earn 7.5% per annum on my savings. Bonus points – if your marginal tax rate is 27.5% then how much longer do you have to save to achieve your goal?
Answer is 5 years and 2 months – you can find my workings in the google doc that I’ve created for this series.
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To calculate the bonus answer a simple solution is to “tax” the investment return using 73.5% (1 – tax rate) to get an annual rate of 5.4375% and a monthly rate of 0.453125%.
This extends the time required to achieve $75,000 by about three months.
I ended my last article with a question, how long does it take to save $50,000 for a down payment if you save $20 per day and earn 5% per annum on your portfolio?
Remember to change the assumptions and work the answer out by yourself. I have a suggestion at the end if you’re interested in homework.
To ballpark the answer, you could divide the target ($50,000) by the savings rate ($20 per day) and get 2,500 days (50,000 / 20) or about seven years (2,500 / 365 = 6.8).
Throughout this entire series remember that small daily changes can have large long-term effects.
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The value of a series of cash flows is tough to calculate by hand but financial calculators and spreadsheets have formulas to help us out. Let’s work through this example:
We have a mismatch between the period of the savings (daily) and the return on investment (annual). We need the payment period (daily) to match the investment return period (annual).
The easy way to convert is to divide the annual rate by 365 days to get a daily rate. 5.0% / 365 = 0.014%
You could go the other way and say that you were saving $7,300 per annum ($20 per day times 365 days) but all of us do better with smaller, frequent targets. $20 day sounds a lot more reasonable than $7,300 per annum – but they are the same!
Side-note: Your finance professor would tell you that, strictly speaking, to get the exact rate you’d need to use the formula [(1+i)^(1/365)] – 1. That equals 0.013% and reflects the compounding effect of interest on your interest across the year. My advice would be keep it simple and divide the annual rate by 365 to get your daily rate. It will be close enough.
Your future target is $50,000 and is called the future value (FV).
You want to calculate how long it will take to get the future value if you save $20 daily. Put differently, how many periods of saving are required to achieve my future value (FV) if I make a payment (PMT) of $20 per period and earn 0.014% per period (i)?
Now we have all the info…
The formula in google docs is =nper(rate,PMT,PV,FV) // and kicks out an answer of 2,150 days. It is easy to be intimidated by these formulas but most software packages have pop-up menus that help you along (nper = tell me the number of periods).
Our original estimate of 2,500 days wasn’t far off but that little bit of interest (0.014% per day) got us to the down payment one year quicker.
Both the $20 and the 0.014% are an example of how little things can make a big difference over time.
With mortgage rates at a 40-year low, a $50,000 down payment is very useful. In Boulder, it’s now cheaper to own, than to rent – providing you have the down payment and qualify for a low-rate mortgage.
Saving small and frequently creates capital for investment.
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If you’re interested in homework then how long will it take to achieve a $75,000 portfolio if I can save $1,000 per month and earn 7.5% per annum on my savings. Bonus points – if your marginal tax rate is 27.5% then how much longer do you have to save to achieve your goal?
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Side-note: when I learned all this stuff in the 80s, everybody used 10% as the investment rate assumption. The 70s were a high-inflation period that had a lasting impact on people’s choices. Right now, we’re being skewed by a low-rate, low-inflation environment. I’ll share an inflation case study next week. The impact of high inflation was better understood in the 80s than today.
I made the observation to a friend that a million dollars isn’t a lot of money – she was taken aback and, out of context, my statement certainly sounds flippant. What I should have said was, “the time value of money is poorly understood by most people.”
I’m going to share a few different case studies that, hopefully, will improve your understanding of the relationship between money and time. It is an area where I’ve had a lot of training. Remember that what we think about money can have little basis in reality. Finance is wrapped in mystery, fear and misunderstanding for most of us. Perhaps I can be part of the solution for improving your relationship with money.
Having the tools to sit down and work out financial scenarios gives you an edge and will help prevent costly mistakes. Most people throw their hands up and don’t do the math. Quitting gives finance companies an opening to take advantage of you!
Today’s case study is about my friend’s question on a million dollars – it’s useful not because it is common to receive large sums of cash! It is useful because most everything to do with money happens over time and our brains are lousy at seeing value over time.
To get the most out of this case study, read it then change the assumptions and work the answers out for yourself. The time spent learning financial math pays for itself many times over our lives.
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To introduce the concept, we return to my conversation with my friend and assume that $1,000,000 dollars has landed on her lap. BOOM!
The present value (PV) of her windfall is $1,000,000.
What’s she’s going to do?
To keep things simple, let’s not get into her specific investment strategy. Let’s merely assume that she expects to earn 5% per annum. A few years back, you could earn that in a savings account. In finance the rate is abbreviated to “i”.
Now we have:
PV = $1,000,000
i = 5%
For the budget forecast, her investment return is assumed to be $1,000,000 * 5% = $50,000 per annum
To celebrate joining the top 1%, our case study plans to make a few small changes in her life:
None of these changes would be considered extreme and, in Boulder, they probably wouldn’t even be noticed. A couple people would comment on your car and then it would be forgotten.
In fact, there’s probably a few young adults that get this level of support (annually) from their parents. I’m guessing that their parents didn’t do the math. If you’re the beneficiary then realize that you’re rolling through your inheritance. Use this case study to calculate the family’s capital cost of helping. The number might surprise you. I’ll do a future case study so you can check your math.
Back to the case study…
Adding the spending up, $300 * 52 weeks + $1,000 * 12 months + $5,000 = $32,600 per annum of spending.
$50,000 of investment income and $32,600 of spending – seems totally under control.
We need to factor in taxes. For this case study, let’s assume that her state and federal marginal rate is 30%. That is the rate that she will pay on the extra income she gets.
$50,000 * (1 – .30) = $35,000 (net income) vs $32,600 of spending
So there’s a cushion of $2,400 between investment and spending. That cushion could be added to her portfolio and she would end the year with more capital than she started. Pulling together:
Opening Portfolio = $1,000,000
Investment Return = $50,000
Taxes = -$15,000
Spending = -$32,600
Closing Portfolio = $1,002,400
So what happens over time?
A key change over time is inflation. The cost of her spending is likely to inflate. Also, her baseline is going to reset. In other words, most people find that happiness is dominated by changes, rather than absolute levels. So she might find that she’s tempted to increase spending further to get the positive ‘kick’ that she would have felt in Year One.
Let’s focus on inflation. Rather than work out everything by hand, I made a google doc to do the calculations for me. You can see my worksheet here – you will need to make a copy to tinker with it. I extracted a summary of the first ten years from my sheet:
The above example uses an inflation rate of 2.5% per annum. While this rate seems small, it is large enough to start shrinking the portfolio in Year 5. The changes happen very slowly in the first ten years but the compounding effect of inflation (year after year after year) starts to accellerate. Here’s a chart of the portfolio value over time:
The takeaway being that capital will be exhausted in 40 years, not what most would expect from a modest level of spending. She didn’t seem to be “living like a millionaire.”
If you make a copy of my worksheet then you can tinker with the assumptions and you’ll see that the investment return is THE assumption for what’s likely to happen.
When you hear discussions about the discount rate on public pensions, people are talking about the assumed rate of return. This case study is a very simple example of what pension fund managers use to calculate the capital required to meet their obligations. It has a lot of real world uses and trillions of dollars are managed using these principles.
The investment return minus the assumed inflation rate is the real rate of return. In our example, the investment return is 5% and the inflation rate is 2.5% So the real rate of return is 2.5% (5.0 – 2.5). “Real” return is the return after you account for inflation. It is what you really get after you account for changes in prices.
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Coming full circle back to my original comment.
$1,000,000 is a lot of money but it buys less than we expect. The ability to drive a nice car, spend $300 per week and go on a couple of vacations per annum is not what we expect from “becoming a millionaire.” If our case study started “living large” then she’d find her capital exhausted very quickly.
The good news is little numbers become big using the same principles that I’ve outlined. I’ll cover an example of that next week and leave you with a problem to solve…
…if I save $20 per day then how long will it take me to save $50,000 for a down payment if I earn 5% per annum on my portfolio?
That’s a lot more realistic than a million dropping in our lap.
Recently I finished a book called Preparing Heirs (URL) that estimated the chance of a successful generational transition at 30%, success being defined as a transition of the family’s total capital (family values, human capital and financial wealth).
After I read the book, I drew as much of my family tree as I could remember and discussed with my key family. They helped me flesh out the tree and reminded me of various successes, and failures, that I’d forgotten.
When I ran the numbers, I saw that our family is below average for success with transitions, we usually get wiped out every third generation (all but once). One bright spot is a four generation streak down one side of the family. Interestingly, in our family education/opportunity are much more important than financial support.
Back to my observation about $1 million. With a 30% success rate, what’s left for your grandkids, on average?
$1 million lands on your lap
– 70% of that goes (on average) by the time you die
– So $300,000 goes to your kids
– 70% of that goes (on average) by the time they die
– So $90,000 goes to your grandkids
My family is well under the above but nobody is suffering, or complaining. Goes to show that there’s a lot more to human capital than financial capital.
So $1 million IS a lot of money for the lucky recipient (or hard working saver) but it IS NOT a lot of money for most families. Human nature, and my family experience, shows that the capital will be gone in fifty years.
Why is that?
If I spend an extra $25 per day then how long will my $1 million dollars last if my after tax return on investment is 3.75%?
ANSWER
BOOM
Your kids won’t even get the $300,000.
My various careers have provided insight into the men and women that have significant influence over our societies (our leaders, our elites, and the very wealthy). Over time, contemplating their lives has made me grateful, rather than envious.
If I could choose one trait that protects me from envy, it is a desire for freedom over consumption. My key family finds living beyond our means painful. These feelings run deep and across the full socioeconomic spectrum we have in our family tree.
Separate from being biased towards “free and frugal”, I’ve been careful to set my life up with daily “wins”
Arriving at my mid-40s – I see how one can create a deep satisfaction from the basic goodness of one’s life. Service to my marriage, my kids, my family, my athletic team… is deeply satisfying.
It wasn’t always so.
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In 2006, I was advising a friend who was having trouble fitting his triathlon training into a busy life. He was a partner of his firm and had a long commute most days. The solution seemed obvious, I recommended that he hire a driver. The driver would enable him to start his work day when he got in the car, rather than when he arrived at the office. I figured that it was worth at least 9 hours per week and I recommended that he add that time to his triathlon training.
A couple months later, he got back to me and said that he had applied my advice with one slight adjustment…
…he was taking the bus!
He thanked me for getting him thinking. His reply got me thinking… …somewhere between 28 and 38, I had lost my real-world perspective.
When I started my career, I was the most efficient employee in the firm.
How did I lose my way?
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The Great Recession of 2008 was extremely useful to me as it highlighted (somewhat embarrassing) inefficiencies about the way I was living.
I spent twenty years in the financial services industry. A polite way of describing our role to society is that we are excellent at extracting the value we create for ourselves. A less charitable observation is that chronically overpaying people detaches them from reality. A recent US election provided numerous examples of this point.
Like my friend, who takes the bus, the recession provided me with a wake-up call.
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At four my daughter is showing encouraging signs with regard to understanding what I’m writing about this week.
She has developed a habit of picking up spare change and sticking in her piggy bank (which is actually a bunny bank). Putting “money in the bunny” makes her, and me, happy.
The other skill is saving ice cream “for next time” – when I eat ice cream with her, we can make a single pint last over a week vs 12 minutes when I’m left alone!
Happiness from saving and a desire for delayed gratification. These two points reduced the scale, and negative impact, of the mistakes I made in my 20s and 30s.
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In Boulder, we live in a bubble (fitness fanatics), inside a bubble (Boulder socioeconomic level), inside a bubble (Colorado’s limited diversity), inside a bubble (U. S. A. – U. S. A.).
Our life is separate from the reality of the rest the planet – you have to experience the Boulder Bubble to appreciate just how different it is. One of my local role models, makes frequent efforts to get his kids (and himself) out of the bubble. I’m starting to make these efforts with my oldest daughter.
Fortunately, we don’t have to leave the continent for a dose of reality, we merely have to drive to the mountains. We don’t go to Vail (the 1%), or Aspen (the 0.001%). We’ve been going to Leadville – real people, working daily to take care of their families. Some making ends meet, some struggling and some not making it. By way of example, there’s double the level of foreclosures (and far less homes) in Leadville than Boulder.
I’m not sure what they think of us – the guy that’s always wearing bike clothes and his hyperactive little daughter. The locals are welcoming and Lex loves them as much as I do. In fact, she’s working on getting all the guys (coffee shop, bike shop, pizza place) to know her by name.
I’ve been trying to figure out why I love Leadville:
I think about the perceived drawbacks (guns, violence and drunks). Looking deeply, I realize that conditioning is creeping in. We have all those hazards in Boulder and a lot more sexual crime.
In Leadville, our routine is swimming, picnics, pizza, playgrounds and riding. We spend all day together. In some ways it is far from life in the bubble (Buddhist preschool, yoga, swim team, babysitters and gymnastics). In other ways, it is exactly the same – eat, sleep, play, love.
An older buddy, with teenage kids, shared a central truth about family – kids want to spend time, not money.
I think that a more accurate description would be that his kids want to spend his time, not his money. My pal has done an excellent job of passing along a love of the outdoors to his children (while living humbly in one of the wealthiest zip codes in the world).
I’m unlikely to override the influences of Boulder peers, the media and a toxic popular culture towards young women. However, I can lead by example and share alternatives to what may seem to be a fixed reality.
(Trying to) keep it real.
Middle Age
My grandmother is 88 this week and I’m 44 later this month. I’m feeling middle aged and it is far different than I expected. What did I fail to anticipate:
My physical life – I’m a better athlete at 44 than 24. Being the youngest in my class, I was a late-bloomer athletically. I didn’t think of myself as an athlete until my 30s.
Eyesight – I thought it would hold up a lot better – I’m not far off needing reading glasses – I guess it’s an occupational hazard from twenty five years of staring at a computer screen.
Three kids – that is only a moderate surprise – that they appeared in four years starting when I was 40 was unanticipated. When I lived in Hong Kong, I had a friend retire early to start a family – he was in his early 30s and told us that he didn’t want to be an “old dad”. At the time, we agreed that being an ‘old dad’ was something we all wanted to avoid. As a middle aged parent, I can assure you that these concerns are over-blown.
Far more important is to avoid being an ‘angry dad’ because you’re over scheduled – or a single parent because you married prior to making yourself fit for marriage. The last point being applicable to me – married at 29, divorced at 31.
A number of my pals, particularly those who have been in long-term committed relationships lose their way in their 40s and 50s. I see them take a ‘time off’ from their marriages and shack up with an available woman. The women should remember that if he left his wife then he’s likely to leave you. The guys should consider their deeper needs as they can likely satisfy themselves without exploding their home lives and damaging their communities.
More than
moderation – exercise, consumption, alcohol, sex, productivity
I have a very good role model in my father in law with where I’m likely to end up in my 70s –
Feel The Byrn 