Family Financial Strategy – December 2021

Everyone completed the “summer” reading challenge!
Across the time period, our oldest became a teenager.
I’m probably done trying to “push” her at anything. Although, there has been discussion of a cash prize for getting to know the local transit system via 100 bus rides to middle school. 🙂

Like all my stuff => this is not advice to your family. Speak with local experts before making tax, legal and portfolio changes in your life.


Iñaki asked, “what to do when the world seems crazy?”

I build my life so I don’t need to be right.

Related, I want to be able to unplug for 72 hours, without worry, whenever I feel like it.

This strategy is based on knowing that I’m prone to error and don’t want to spend my life connected to the matrix.

Further, even if you have 100% confidence in yourself, your kids/spouse are going to need something robust for when you’re gone.



Across 2019, I wanted to lean into equities but there wasn’t an event that gave me an opportunity. So I rolled along, rebalancing and living my life.

In March 2020, the pandemic created an opportunity. Personally, I leaned in (fairly hard) by increasing %age exposure to equities, at a time when rebalancing alone would have triggered buying.

In a fiduciary capacity, we only leaned a little. Two members of my investment committee, with wider views of the world, advised caution. Using the principle, most conservative view rules, we were conservative with allocation.

  • Both decisions made sense at the time and worked out.
  • Time matters. “Good enough” becomes more powerful the longer your time horizon.
  • Returns across generations are driven by a famous Munger-ism => “just try not to be stupid.”
  • The family’s position, 10 years past every generational transition, is impacted more by what you burned than what you earned.

At the end of 2021, given the whacky stuff I’m seeing around me, I don’t plan in leaning in at the next correction. Rebalancing will be good enough.


Recreational Capital and Associated Spending

A dominant focus on return/allocation in your financial portfolio, misses an important source of value creation => efficient use of “recreational” capital, and associated spending.

Recreational capital is any asset that’s held for non-financial reasons. This is a material slice of many balance sheets:

  • Boats, RVs, Cars
  • Offices
  • Second homes, vacation properties
  • Sizing up personal residences
  • Renovation projects, furniture, collectibles and art
  • Charters, vacation spending, travel spending
  • Any asset with a negative yield

You’ll see I included a line for the expenses associated with those assets. Some assets, when bought, lead to more spending.

By way of example, INVERT and consider…

When you sell all your assets in a remote location then… the spending associated with the location will plummet. Now that we spend our summers “at home” vs commuting to/from Canada, we cut spending by a big number.

Even if you don’t buy… for skiing, we stopped renting a condo in Vail. Our 2021 ski season cost will be less than what my last rental cost me. Skiing is a choice with a stack of associated spending, and negative-return investment opportunities.

It would be nice to think that these decisions were driven by being smart. That would be a mistake! The Canadian exit was driving by local tax policy and COVID forced a change in approach for skiing.

We did not realize the true cost of our “recreational” choices. We had to remove them, and watch for a couple years.

The choices above:

  • Create a larger working portfolio
  • Reduce annual spending
  • Increase the flexibility to change one’s mind
  • Don’t involve admin, maintenance or exit costs

In our financial portfolio, conservative nature means we “missed out” on much of the run up. However, because we adjusted our recreational capital, and associated spending, we greatly increased wealth over the last five years.

The wealth gain, from shrinking the recreational portfolio, is locked in. These gains are hidden from conventional metrics, that your advisor might show you.


Now we move along to KC’s questions

GB: total debt will remain modest relative to assets and cash flow

KC: How do you define “assets” and “cash flow” here?  Completely paid off asset or total value of asset? All assets – or just the assets on the investment side (excluding primary home?) Cash flow from all sources after expenses? What do you define as a modest target? 

I have a spreadsheet that shows me… gross asset value, deferred taxes, tax basis (as at last tax filing year) and deferred agent’s fees (for real estate). So I can quickly look at real estate from gross to net after-tax realizable value. I compare those figures to gross rental income, and net cash flow (from my tax return).

I’m conservative with gross asset value on real estate, a discount from Zillow and my real estate agent’s estimate on value.

I assume 6.3% cost to exit, from real estate gross value, then tax the realized value at 25% of the gain over basis.

++

Cash Flow

I look at… total debt service, core cost of living, total cost of living => each of those numbers gets a little bigger, and I have less control over delaying payment/spending.

Then I look at the inflows by source…

  • real estate (net and gross — consider vacancy risk)
  • employment (by role and client — consider concentration)
  • passive (royalties, dividends, distributed gains)

I want to understand my concentration in expenses (what I can cut/control) as well as income (where the risks lie). I never want to be placed in a position of being a forced seller.

My total family debt stays under 10% of net assets. Assets calculated net of all taxes and agent’s fees.

++

The Role of Time

My thinking in my work, and family, is multigenerational… I look at assets, leverage, cash flow and spending at many levels…

  • What I actually own, owe, control, earn => me
  • Family level
  • Family & Corporate level => me, my family, my business
  • Multi-generational level => consolidated, over time

I think about expenses, earning power, saving power, asset utility (what benefits members) over time. I have a spreadsheet that projects the age of all living family members over time (2021, 2035, 2050). This helps me consider family asset strategy and consider when generational transitions are going to occur.

KEY for assets and cash flow => When generations stop working/saving, when kids start working/saving?

It’s not just “what you own.” It’s also when you own it, and when you sell it.

I see many people buying assets they will HAVE to sell in ten years time, mainly real estate. Now, if it’s your main home, then I get it. See below for the option value in the mortgage.

In this market, Boulder up 30% this year, it’s easy to convince yourself that you are silly not to supersize your balance sheet.

But if it’s a secondary market…

  • 10% in/out cost for the real estate
    • vs…
      • Less than 1% cost to go variable (AirBnB, Hotels.Com)
      • Total flexibility with capital (you don’t deploy into a low-occupancy, negative yielding asset)
      • No admin hassle (I really dislike organizing maintenance and cleaning)

Why are you doing it?

If you want to dazzle peers, suppliers and key relationships… …then you might be better off with a high-end club membership.

Your mind may try to convince you the joining fee is a waste of money. Note that the club joining fee is usually < 5% of a condo cost, and club dues run <10% of the condo’s cost to own.

With leasing we compare to “do nothing” => most people with ready finance will “do something.” If you’re going to do something, regardless, then something smaller can be a better option.

Your mind doesn’t see the rest of your portfolio performing better, with less hassle, by not owning an asset that’s a drag on return.

And… my mind at least, doesn’t remember how much I hate cleaning and dealing with remote maintenance issues!


KC: Tax bill as a %age of net assets-Where do you think a healthy range should be? 

Every year, I look at the tax bill relative to net assets on a consolidated basis. This lets you consider the impact of tax policy on your portfolio – smart savers free themselves from exposure to changes in tax policy. Taxes paid, as a percentage of net assets, should trend downwards over your working life.

I don’t think the taxes vs net assets number, itself, is important. What matters is trending down and asking yourself if you are worrying about the right things in your life. Lots of (wealthy) people fail to recognize how little impact the Feds have in their financial life. Others could use a nudge to save more, spend wisely.


GB: At that point, you’ll have built yourself an inflation-proof, tax-effective retirement annuity

KC: Can you help me understand the inflation-poof aspect of this strategy? Is it the income producing asset that is locked in at an low interest rate? How is RE more inflation-proof than other assets?

Real estate isn’t “more” but it can be “different”.

Local rents are influenced by local real economic growth. I like the prospects of Boulder, the Front Range and Colorado.

Local real estate values are influenced by macro (national interest rates, credit cycle) and local (replacement cost, demand) factors.

So a slice of local real estate can create an element of hedging between national, regional and local conditions. There are some other benefits…

++

Hidden Options

Here in Boulder, Colorado, I believe our real estate values have a hidden option. There is a chance the best neighborhoods explode upwards towards the highest valued parts of: the Rockies (Vail/Aspen), California (Bay Area) or NYC. 

Now, I don’t have the $$$s to own trophy properties, but I don’t need to. As I wrote in The Next Doubling, it’s good enough to be nearby. For the option to pay out, we don’t need to get to the highest prices per sf => we merely need to close the gap, a bit, over time. That sort of option doesn’t exist in an index fund.

Another hidden option => we own a two-unit rental. We always have the option to move into one of the units and “live for free” by renting out the other unit.

++

Option Value of Fixed Rate Debt

30-year fixed rate debt, with an option for the borrower to repay, is a valuable (oneway) option in an uncertain world. Unlike margin debt, the lender can’t call the loan on a whim.

Long rates have been declining for 40 years, so the value of this option is overlooked by many. In an inflationary environment, having a multiple of my core cost of living in low-cost fixed rate debt is a useful position.

A mortgage on a personal residence seems like a good deal to me……and if it turns out to be a bad deal then I exit via repayment or refinance.

++

Saving 2% p.a. and giving Goldman an option to close you out…

Quick note on margin debt, even at <1% p.a. cost, seems like a very bad idea.

Smart people borrowing money they don’t need, to make money they are unlikely to spend in their lifetimes. Everyone figuring they will be able to unwind their financial structure before anything bad happens to them.

This strategy never ends well and only makes sense when you are playing with other people’s money.

A general principle, some things only make sense when you ignore the rebound. Fasting, margin debt, intensity-bias for endurance sport… I have found one gets a better long-term result from building smarter habits.

++

Optimize over time. When I started paying attention to myself, I realized I needed a whole lot less spending, which implied less capital, which gave me much more time.

INVERT that last sentence => spending you don’t need, increases the capital you think you need, to spend more time doing what you want. I broke that cycle in 2000, got wrapped back up in it in 2005, got tossed back out during the 2008/2009 recession and, these days, cycle in/out depending on my moods!

Nearing 53, I laugh because “less” is being forced on my physical life, by time.

In my early 40s, “less” happened due to kids and a nasty recession.

In my early 30s, “less” felt liberating, and made time for a lot more self-directed time.

“Less” is a useful process!

The Next Doubling

I was 12 years old at the peak.

A good question to consider with major assets in a portfolio…

Would I buy at current prices?

Like most real estate in Colorado, Boulder capital values have been on a 7-year upswing. According to Zillow, the capital value of where we live is $2.5 million, up 36% since the start of 2020. The only way to describe how this value feels is “too high”.

One way to consider capital values is to express them in terms of cash flow and time => with real estate, the proxy is cost to rent.

With our current address, comparing rental costs with gross capital value…

  • $3,000 per month rental => 69 years equivalent
  • $4,500 per month rental => 46 years equivalent
  • $6,000 per month rental => 35 years equivalent

With the run-up in prices, homeowners have been rewarded for properties that are larger than their needs. Like-for-like rental, doesn’t look too crazy right now. However, we could easily fit ourselves into a location that’s 40% smaller than where we live at present (implying a gross yield of less than 2%).

On to the next example…

++

In 2021, some friends exited the Boulder real estate market. Their net sales proceeds (after taxes and agent’s fees) equate to ~100x their first year rent in their new location.

Worth repeating: they are taking a century of rental-equivalent off the table.

Put another way: by selling into this market they can do the following (in current dollars):

  • Cover their future cost of living on a joint-life expected basis;
  • Put their kids through college;
  • Buy an apartment as a hedge against future rental rates; and
  • Treat future earned income as fully discretionary.

Compelling, especially if your house is the primary asset in your balance sheet.

They aren’t “set” by any means: inflation, illness, increased spending or investment losses might derail their plan. However, the asset sale greatly reduces their financial stress and buys them a tremendous amount of time.

Stress, time and the risk of ruin.

++

Another example, vacation properties.

The house we rented in Vail (2019/2020) is valued at more than 100x the rental we paid. The condo we rented in 2018/2019 sold for 50x annual rental.

There’s never been a better time to rent assets you don’t need. 😉

If you own assets in secondary locations, or are considering buying, then the above calculation is a useful one to consider. The numbers above are using gross rental figures. From the landlord’s point of view, the net rental income would be tiny (relative to capital).

Also consider the benefits of being variable…

Rather than lock in a single location for the winter, I’ve decided to try an AirBnB season. I booked in 22 days of skiing, the dates tie to school holidays => Vail, Telluride and Jackson.

Adding a bit of airfare, gas and mileage… total cost will be $15,000 to use properties with an average value of ~$1 million. VTSAX dividend yield is 1.25%.

By not owning, it was cost-free to change strategy.

++

Other questions I like to ask:

  • Assume things go well and this asset doubles in price (again), who’s going to buy?
  • What’s going to drive the next doubling in value?
  • Where’s my family exposure: (a) benefiting from the next doubling; or (b) harm from the risk of a halving?

Who’s going to buy? A smaller place in a great neighborhood is much easier to sell than the best place in that neighborhood. The top places in Boulder are now selling for around $5 million. Who’s going to buy when the market goes to $10 million? Might “ability to purchase” create headwinds for appreciation in the market?

Prime Colorado real estate benefits from buyers coming from “even more expensive” markets. Boulder remains a great place to land from one of our coastal Metros. City-based housing markets benefit from local economic growth.

Vacation-markets, at 50-100x gross rental income, are reliant on continued balance sheet appreciation for the Top 1% of society.

A comparison I follow in Colorado… Boulder rental property (house with land, no HOA) vs Vail vacation property (condo w/o land rights, HOA). In the last recession, I tracked this comparison in Arizona – unfortunately, I bought condos down there instead of houses.

What’s going to drive the next doubling? See the chart at the top of this post => there’s been a multigenerational tailwind due to declining interest rates. Every store I enter, and every manager I talk to, gives multiple examples of tight labor & inflationary pressures.

Negative real interest rates might keep the party going for a bit. With Social Security COLA adjustments over 5%, it seems nuts to buy into property that’s trading on 50-100x rental income.

Family exposure. For me this is kind of like the “who’s buying” question.

If you’re a double-income family with a diversified portfolio then sticking 10-15% of assets into a vacation market is a different choice than a single-income family with 90%+ of assets tied up in a mortgaged home. The context of the choice is worth considering.

One final point, despite living at 5,500 feet (and training year round up to 14,000), I don’t sleep well above 9,000 feet. For many, ability to sleep at altitude changes as we age.

Climate, altitude, neighbors, convenience, community, quality of local schools/governance… good reasons to rent locally before you buy.

Hope this helps.

Family Spending Principles

West Ridge, Eldora

An observation that I am trying to pass along to my kids.

My never ending desires are rooted in a false idea of what will make me happy. I have a clear idea about the structure of the days that are “better.” Achieving better is easier, and more rewarding, than chasing pleasure from purchases.


To help me achieve “better”, I have a series of principles.

1/ Visible spending for wife, first // This works on a number of levels.

  • Don’t buy something for yourself that you wouldn’t buy for your entire family.
  • It easier to be value conscious when I remove myself from the purchase equation.
  • It’s just good policy.

2/ The minimum outlay to meet the underlying need

Strangely, I got this via Joe Friel on coaching masters athletes => the minimum, and the most specific, training to get the desired physiological adaption.

Capital takes time to acquire and is easily squandered (spendthrift heirs and lottery winners are common examples).

A default to the minimum reduces the scale of my (inevitable) errors and increases the ability to change my mind later.

3/ Do not sweat the small stuff – set a Give A Hoot threshold (links to Marriage Money article)

Set an annual plan, track the cash quarterly and promise you will not sweat the small stuff. Good people are made miserable by tracking every nickel.

Stay out of the weeds so your mind is able to think and get the big things right.

4/ Avoid Choices That Have A Material Cost to Hold => this applies across domains (assets, leases, friends, family, commitments, Facebook/eMail). The math from yesterday.

There are many ways to find yourself over-extended… debt service, cash flow, emotion & time.

Exit bad decisions => they crush you on all levels.

Mark Allen on pacing…

just because you’ve made a bad decision, doesn’t mean you have to continue it


Combine these principles and you’ll find the sum is worth more than the parts.


Dropping into West Turbo. Pali Chair, A-Basin.

My son asked about the last big purchase I made, other than real estate.

My off-the-cuff answer was “we don’t spend much money” but that didn’t line up with what I know about our cash flow statement.

So I spent January thinking about it. Next time, the best financial choices I’ve made across my marriage (16 years this summer).

Family Financial Review: Portfolio Allocation


Thursday, I shared my thoughts on the real risks I face. That’s where the action happens in my life.

Still, this is a financial review, so it’s the right time to consider asset allocation.

Having spent 30+ years locking in my Core Cost of Living, the main choice I face is how much cash/bonds/no-return assets to hold.

Here’s how I approach that topic.


There is a cost to holding cash, especially today. Zero, or negative, yield.

Cash is exposed to the “ravages of inflation” – on one side.

Cash earns nothing, while you watch bitcoin, prime real estate and other asset classes skyrocket – on the other side.

Against those costs there are benefits. The three biggest (for me) are:

  • a call option to benefit from a future crisis
  • serenity
  • cash/bonds dampen the volatility of my portfolio.

Now, here’s the questions I ask..

1/. How many “years” do I need to feel serene? This will depend on your psychological make-up, earning capacity, earnings diversity and age.

Getting my net-cashflow-burn down is the only way I’ve been able to feel serene. I just don’t have the psychological make-up to soothe myself via luxury spending, more assets or more income.

2/. How many dollars might I need to capitalize on the coming apocalypse? Being able to buy real assets in a down market will make you happy for a long, long time. I’m still happy about a couple purchases I made in 2010.

My financial assets provide me with an opportunity to get out there and live my life. Financial assets provide very little inherent satisfaction – this is a good thing as I can remain (mostly) detached in downturns.

Our actions in the real world provide satisfaction => share experiences (ideally in nature) with people you respect and love.


BTW, here’s a 2019 article I wrote about wealthy people talking about cash. Back in 2019, many wanted to be in cash. Roll forward to 2021, some of the same folks want to be out of cash! Personally, I’m about the same. I spent the intervening period paying off my mortgage and clearing my car loan.

Family Financial Review: Risk, Worry, Ruin


I ended Wednesday by asking, Am I worried about the right things?

It’s easy to get distracted by the noise surrounding our lives.

Do you know your key risks?

It varies between people and over time => focus on habits that might lead to ruin (leverage, lack of impulse control, smoking, substance abuse…).

See also my review from 2019.

Set your financial life up so it runs on autopilot.

Did you read the PDF from yesterday? Good reminders at any age, as well as an embedded reading list.

Things I focus on more than my portfolio…

  • Near-term: keeping up with my teenagers – what is it going to take to share the outdoors with my family when I’m 60?
  • Medium-term: personal engagement when my kids are gone – what will I do with more time, and less energy?
  • Health: poor choices increasing my risk for cancer and other health issues
  • End of Life: my body outlives my brain

My actions today reflect awareness of the real risks in my life.

My portfolio? Good enough is good enough. Avoid unforced errors and keep on keeping on.

Don’t assume these answers.

Do the calculations from Wednesday, reflect on your life, write it down, review annually…

Then get out there and enjoy 2021.

Family Financial Review: Time


Tuesday’s post ended with the observation that I pay myself in time.

So, how much time have you got?

Let’s find out.


Scale It => Relate Your Exposure To Your Balance Sheet

I recommend you look at things a few different ways. Print this out and write your numbers on the page.

Make it real, especially if you’re financially fearful.

  • Gross assets / Core Cost of Living = years
  • Net assets / Core Cost of Living = years
  • Net assets / Net annual cash movement = years
  • Net assets / Net annual cash movement (excluding active income) = years
  • Cash / Core Cost of Living = years
  • Cash / Net annual cash movement = years
  • Cash / Net annual cash movement (excluding active income) = years
  • Cash / Gross assets = percentage
  • Cash / Net assets = percentage

I include bond holdings in cash. I focus on the BOLD, while considering each line.

Armed with the above, you can get a feel for how much time is available to you, based on how you are living today.

It’s easy to get fixated on income/spending and lose track of time. The best investments I made in my 30s involved trading money for time.

We tend to over-value money vs time => you can do great deals for yourself once you prove your worth to your firm.

Related => it doesn’t take much time to greatly increase the quality of your personal life. As a triathlon coach, I’d get my athletes to carve out one weekday morning per week where they’d start work late. This would enable us to make Sunday life-focused and spread their training load.

Discretionary/Luxury Spending – will fall outside your Core Cost of Living. My advice here is “pay yourself first” – slice your investment program off the top of each paycheck before you get a chance to spend it.

Don’t borrow any money (personally) until the first credit crisis after your 30th birthday. Then, borrow modestly to purchase real assets that are being priced down due to a banking crisis.

Across the 40-50 years of your working life, you will not miss luxuries not purchased.

As for overall strategy, there is a great PDF here. As the PDF will explain, don’t get distracted, by those who want to profit from complexity!

Focus on what matters: (1) spending vs new capital saved; (2) learning to think in time, not money; and (3) good enough is good enough (low cost, persistent investment, across long time horizons).

Maybe I should add #4… the best stuff in my life happens between people – shared experiences with those I love.

People, not portfolios.


To get ready for tomorrow…

Ask a confidant… When I talk about money, what do you hear?

With your financial concerns… Am I worrying about the right thing?

Family Financial Review: Winning


Monday’s post here – tomorrow we will start using the data you’ve prepared.

Before we get into the analysis, let’s discuss the game.

My game is NOT won by building income, assets and spending.

Something I hope to teach my kids about money:

Any choice made to appear rich has an underlying effect of reducing family wealth.

My game => increase discretionary time while getting the net burn to zero.

I’m willing to wager you will not feel free, or serene, until you get close to that point.

“That point” being where you can sit back and not care about the ups and downs of the world. Being able to sit with equanimity will improve your thinking, and your relationships.

It’s going to take a while to get there. Here’s something I wrote in 2016 about the process.

I hope you read the link – I chipped away for 31 years and am a better man, on a smaller balance sheet.

The main thing to remember is each time you get an attractive opportunity to lock in a piece of your core cost of living, take it.

Pay yourself in time.


Philosophy of Status

Don’t think I have transcended my human drive to compete for status.

What I’ve done is (try to) channel it away from external approval, virtue signaling and consumption.

Needing a place to allocate this drive, it goes into my writing, marriage, quality of thought and daily actions. For a long time, my drive went into my sport.

Redirection is a whole lot easier than transcendance.

Family Financial Review: Set Up


The picture is what it cost to send a first class letter when I married my lovely wife. The 55c cost today (+34%) is a reminder that inflation ticks away one penny at a time.

When it comes to inflation/deflation, I like to maintain a neutral position. More broadly, I seek to avoid the need to pick winners.

I also avoid making predictions about an unknowable future. Most importantly, because it’s impossible (!) but also because I have no idea what my life is going to be like ten years from now.

What follows is present-focused.


Quantify Your Exposure

Start with your core cost of living – that’s what’s going to inflate and outliving your money is a key risk.

What’s in my Core Cost of Living?

  • Healthcare ($19,300 of premiums and $7,200 to a family HSA for a plan with a $14K family deductible) – this sector is ripe for disruption, I get little for my spending
  • Taxes, Utilities, Car Costs and Insurance
  • Food, Clothing and Kid Activities
  • Childcare – a massive line item 2009 to 2019, now a source of income for the family, our middle-schooler is a sitter
  • Mortgage, rent, car loans – my main project from 2010 to 2020 was getting this down to zero – once that was achieved, I went a step further and turned it into a source of income

Next, consider your sources of passive and active income. Rents, royalties, dividends, interest (at least in the good old days), consulting and any other forms of income. Write it all out.

Compare your Cost of Living with the Sources of Income and calculate your net burn rate, or your net annual surplus.

Net annual surplus gets routed to discretionary spending, luxury items and/or new investment capital.

The best investment decision I ever made had nothing to do with asset allocation. From 1990 to 2008, I routed 50% of my gross income to new investment capital.

In my early 20s – healthcare costs were peanuts, no childcare costs, living in a shared apartment… I saved a ton. Good thing, too. I had no idea how much my cost of living would pop when I had kids.

My 40s (2009 to 2018) saw unexpected unemployment combine with a big jump in childcare, healthcare and housing costs. This resulted in a burn rate that forced us to make a series of changes, and choices, which proved quite useful in hindsight.


Also write out your balance sheet – assets and liabilities.

Include a liability called “deferred tax and agent’s fees“. Estimate this liability as 6% of the gross value of all the real estate you own plus 25% of all the capital gains in your portfolio (exclude the exempt portion of the gain on your primary residence). Making this number real will help you avoid incurring unnecessary expenses by tinkering with your assets.

The best time to sell great assets is never.

Let it roll.