COVID Finances

Local fires make for dramatic sunsets. This was last night at swim drop.

What strikes me most about COVID is how little we’ve been asked to do.

For those of us who avoided unemployment:

  • Stay at home
  • Wear a mask
  • Spend a lot of time with our children

I embraced all three, eventually.

Seven months in, our youngest can run her home school:

  • Print daily schedule
  • Follow links to online classes
  • Turn in her work
  • Make lunch and snacks

It’s not ideal but it’s good enough given the underlying reality.

An interesting part of the underlying reality is how well the top of tier of our society has been doing.

The noise of the election has been drowning out this story.


2 out of 3 kids returned to in-person learning on Tuesday and I hit the road for a day trip to the Collegiate Peaks. COVID has enabled me to feel grateful for things that appeared unreasonable at the start of 2020.

I made three financial decisions this year.

  • Sale & leaseback of my house (January)
  • Roll two years cash flow from bonds to equities (March 18-24)
  • Ski local, reallocate ski money into a new car (Q4)

Similar to 2009-2012, I expected to do a lot more.

However, I’ve done enough. Enough to set up the next decade and enable me to focus on what matters.

That’s a lesson.

If you’re focused on “what matters” then there’s not going to be many decisions to make. Most of your focus is going to be on the day to day (exercise, family, admin, relationships, marriage).

If, like me, you are someone who likes getting stuff completed then you’ll do well to create an outlet (other than churning your portfolio) for this aspect of your personality. Otherwise, you’re going to run up a lot of expenses, pay excessive fees/taxes and greatly increase your chance for unforced errors.

In your larger life, if you don’t give yourself something useful to do then politics, social media and petty pursuits will fill your time.

I need to watch out for these distractions => they bring out of the worst aspects of my personality.

Pay attention to who, and what, brings out your best.


The best investment I made this year was the month I spent weaning myself off social media.

It’s difficult to see the net negative return of Facebook/Instagram until you are outside of their feedback loops.

At its core, Facebook makes it easier for bullshit to reach me.

For others, Facebook makes it easy to argue.

For all of us, the algorithms reinforce confirmation bias and reduce our ability to think clearly.

The algorithms are everywhere – they live in every web interaction we have.

Instagram stimulated my desire to buy stuff and reduced my satisfaction with who I am.

Both platforms are pleasurable but what’s the source of the pleasure? The source is external validation on appearances.

Far more powerful is an internal validation for the actions I take, daily, for myself and my family.

True power is the capacity to create a feeling of goodness for the actions you take, daily, in your own life.


My biggest fan

What was your biggest problem of 1, 5 and 10 years ago?

Can you even remember?

I can.

The biggest challenge of my last decade was a little girl who doesn’t exist anymore.

She’s gone and has been replaced by someone who’s an absolute star.

The difficulties of COVID enabled her, and me, to shine.

Parents, children, teachers, students, superiors, subordinates…

What we see, as a problem, will disappear over time.

…and time is the most valuable asset in our portfolios.

Spend it wisely.

Wealth and the price of money

One of my best assets – I always wanted to have hair like that!

I graduated from university in the summer of 1990. I didn’t know it at the time but it was an excellent time to start a career in finance.

The price of money has been falling ever since I graduated (1st Class Honors, Econ/Finance, McGill). My first real finance job was the most junior member of a very successful private equity team in London.

It doesn’t enter into popular consciousness but many of us have had the benefit of a 30-year tailwind. This tailwind impacts every aspect of our lives and, like oxygen, we’re largely unaware of it (while it continues).

For the first half of my finance career, a modest interest rate cut was sufficient to get everyone excited.



At this stage of the cycle, it takes a healthy dose of shock & awe to move, or steady, the markets.

It’s important to remember:

  • It is impossible to know the future in real time. If you find yourself saying the Fed is making, or not making, a mistake then you’re fooling yourself.
  • It is possible to assess the risk in the system => leverage, debt service, off-balance sheet liabilities, derivatives obligations, debt:equity ratios, months of cash on hand vs monthly cash burn rate… there are a lot of useful measures. You should know these measures for your country, state, county, firm, family and self.

I don’t want to comment on right or wrong. I simply want to share observations that, hopefully, will help you think better about money.


In my line of work, I hear a lot of themes.

I’ll share a couple themes and my counter-dialogue.

The market is so high, I need to sell or I will lose money.

  • Volatility isn’t loss – come back to this one in the next down cycle.
  • Constantly tracking the price of anything will cost you time, lower your return and lead to misery. See Fooled By Randomness, by Taleb, for the best explanation of why you should ignore the volatility of a good-enough portfolio (or life for that matter!).
  • My entry prices are 30-60% below current market. Instead of focusing on a fear of loss, I focus on the cash flow being generated from wise past decisions.
  • If you exit then you need to put the money somewhere. The benefit of a good position is you don’t need to figure this question out. The less I need to think, choose and act… the better.
  • Every positive action costs expenses, taxes and introduces the possibility for error.
  • Most the people who worry about money, don’t need to worry about money. Beware of using financial news as a distraction from what you really should be doing with your life.

Price vs Happiness vs Wealth

  • Price is an illusion – all assets move in cycles.
  • Price changes are not wealth changes.
  • If you build a habit of happiness with price increases then you will experience a multiple of pain with the inevitable declines.
  • Equanimity must be trained, and re-trained.
  • Financial wealth comes from productive capacity, which is the ability to give the world what it wants.
  • What does the world want? My world wants…
    • Cash flow generation
    • Saving time
    • Reducing hassle
    • To survive

When you create a lot of money (see chart above and, note our constant, longterm Federal stimulus), the money needs to go somewhere. When money “goes somewhere”, especially when debt is available on top, prices go up.

The effect is not wealth creation, the effect is asset price appreciation.

The first principle is that you must not fool yourself – and you are the easiest person to fool

Feynman’s rule on foolishness

In 2020, all this money creation might be saving us from disaster. At best, we’ll get a chance to argue in hindsight.

Don’t fool yourself by acting as if your wealth has been increased.

The risk in the system has been increased.

Fear and Panic

Yesterday, my local CostCo sold out of Charmin in 15 minutes.

My cognitive capacity is so lit up I can’t remember my daily calendar.

Stress makes us stupid.

So…

#1 – execute my strategy, made before the current crisis

One of the nice things about following a rebalancing strategy is you are very likely to have sold (a little) at the peak. My pre-crisis rebalancing happened January 4th and I sold enough to cushion the psychological impact of recent declines.

I rebalanced on Monday and again today.

Limit down opens => phew!

#2 – lean into fear

Since 2014, my portfolio assets have been 60/40 in equities/bonds. For the last six years, I’ve expected bonds to get hammered by rising rates. It didn’t happen. Been wrong the entire time but it didn’t hurt me.

For my long-term capital, I’d rather use a 90/10 strategy (90% in equities). The trouble is getting there. I have zero confidence in my ability to pick the right time to shift. So I created a re-weighting strategy based on VTSAX/SP500.

A simple rule: as the market moves from 20% down to 50% down, I will rebalance equities upwards from 60% to 90% of portfolio holdings.

Today’s rebalance moved me to 63/37. The 63 is held 42/21 VTSAX/VTIAX.

Simple to execute => each time, I rebalance I check the %age off the peak, if we’ve set a new low then adjust the equity weighting upwards. Otherwise, steady as she goes.

This simple strategy is not easy to do => either I want to rush more money in (FOMO) or hold money back (plain old fear).

#3 – real estate

When your neighbors are stocking up on TP in preparation for the end times… it’s generally not a good time to be selling real estate.

What about buying? Real estate prices respond much more slowly to feelings/sentiment. At the last downturn, local real estate didn’t “get cheap” until 18-24 months after the crisis.

I suspect we’re going to see the residential market stop dead for a few months.

After that? I have no idea.

#4 – family

My family has been watching me stock the house for three weeks. They were amused but now we are ready.

I’ve been reassuring the kids they are going to be OK. There’s a lot of fear around.

At school, our youngest heard that “old people” were dying. She took me to one side and asked if I was going to be ok => Yes, Sweetie, I’m going to make it.

That said, a finance background is useful for understanding the impact of compounding. Our state saw a 33% increase in positive tests today. Keep that going through the end Spring Break and we will have 4,200 positives in 16 days (from 44 at Noon today).

Notwithstanding an absence of positive tests in Boulder County, I’m going to start home schooling on Monday. A significant burden on myself but a small price to slow the spread.

#5 – community

Will Colorado’s experience follow Italy, Hong Kong or Taiwan? I don’t know.

What we know for certain is there will be a large, sudden burden on the lower end of our communities. Consider giving a sizable donation to your local food bank.

We also know we will save lives by staying away from each other.

#6 – immunity

Something simple, but not easy, for readers of this blog => cut your training in half.

Take your program, cut it in half and watch what happens with the infection rate in your state.

If your state is on a log-scale infection rate then it will become apparent far more quickly than any fitness loss.

Your immunity will get a boost from this change and you’ll preserve all the health benefits from exercise.

#7 – cash, debt and leverage

If you have an emergency fund then this would be a good time to make sure it is liquid. I have three-months expenses sitting in my checking account.

Not willing to lean into the market downturn? Consider using surplus cash to pay down debt.

If the downturn persists then do you know what can ruin you? There are many types of leverage => I’ve written about this a lot.

 

 

 

 

Diversity of Thought – Things we can’t imagine

2020-01-05 14.39.11-1.jpgA popular theme in the media is handwringing about the divisive nature of political discussion. Everything would be much better “if we could just get along.”

I’m not sure.

Social systems tend to overshoot, overreact, over-everything. When we have widespread agreement (think totalitarian states) humans tend to drive the bus off the road.

Can you name an area where we have wide-spread agreement across the political spectrum?

I can.

Deficits, borrowing, bonding.

Left-right, north-south, east-west, up-down, local-state-national-continental => near total agreement on the benign nature of government debt.

Because disagreement limits the size of potential errors, total agreement worries me.

A surprise in my 2019 was my state’s voters not approving a change to our taxpayer’s bill of rights. It is the only constraint, on the ambitions of government, I noticed last year.

We should not expect government (or friends & family) to “do the right thing” in advance of a crisis. Human nature isn’t designed to work that way. An increase in our collective tolerance of regulation and taxation (ie pain) doesn’t happen until after a crisis.

Our collective problems won’t be addressed until after they blow up.

My individual risks, however, can be addressed right now.

A collective belief in the benign nature of debt is self-reinforcing. While the debt cycle expands, asset values are inflated, consumption is pulled forward and economic growth is nudged upwards. Because of its ability to feed on itself, debt expansion can continue for a very long time, particularly with interest rates near zero. Ultra-low rates enable lenders to fool themselves about the credit quality of the marginal borrower.

What to do?

Life is not filled with only bad news! Am I able to take advantage of unexpected positive surprises?

It’s counterintuitive but I’m positioning myself to borrow a lot of money. My 2020 project is creating an option to borrowing 30-years fixed at an interest rate that none of us can currently imagine.

How might unexpected negative surprises wipe me out?

Consider who is getting out of hand with their current borrowings. What’s the credit quality of… your employer? your family? your largest customers? your local/state/national government?

Do you work for a high-leveraged company, in a state with massive unfunded pension liabilities, while rolling your credit card balance each month?

Hidden liabilities lie (mostly) hidden. Ponzi schemes, unfunded retirement benefits, promises for future spending, fixed price contracts… think about your life. Where do you have exposure to a single person, CEO, manager, employee, fund, investment? In an easy-money environment, it is possible to hide significant liabilities.

Things we can’t imagine are likely to be underpriced.

Kinda tough to imagine the unimaginable! What seems impossible to imagine? Inflation, interest rates at historical norms, rapid nominal growth, credit crisis in a large sovereign, large hot-war…

For me, the goal is not to predict the outcome. My main goal is to protect my lifestyle from shocks and surprises.

To make it real, I ask, “what could blow up ski season?” Health, injuries, illness => my current risks are more human, than financial. Think beyond the money.

To focus on new ideas requires us to reduce the noise in our lives. Are you engaging in a policy of constant distraction?

There is a lot we can do to manage our exposure to the errors of others. Bad companies, bad relationships, bad government… many of us have the ability to pack up and leave. I’ve lived and worked in eight different countries, on three continents. Gradually working towards a situation where the main person who can hurt me is myself!

As a young man, I spent many years exposed to the errors of a single individual (my bosses and my business partners). More common is exposure to the errors of a single corporation.

With preparation, you can benefit in times of stress, but first you must survive.

Rent vs Buy in Vanity Markets

2019-12-07 09.28.44A vanity market is one where the main benefit you gain from ownership is telling your pals that you own.

Similar to my observation that I was wired to buy a “big” house, there are other purchases our ego gravitates towards: cottage at the lake, ski chalet, big-city pied-a-terre, beach house, farm…

Our ego’s weaknesses depend on our cultural background, childhood memories, current mood and social situation.

My ego can lead me far astray, particularly with non-yielding real estate, and depreciating assets.

I’ve been battling with myself since I first visited Vail, Colorado. I’ll illustrate with real figures from the neighborhood of East Vail. It is a niche market, which I’ve been following for 16 years.

The “buy” => $1 million buys you the opportunity to spend another $375,000 to renovate, and furnish, a property that was build in the 1970s. After your renovation is done you pay ~$25,000 per annum in taxes, insurance, HOA and running costs.

The “rent” => $25,000 to $40,000 all-in rental cost for the same property.

Something we noticed about skiing, most skiers don’t ski.

Put this observation another way… there’s a lot of empty real estate around.

I’m sure every empty place has a history of buyers, who were certain they’d use the property more often than they do.

A useful rule of thumb is to assume that every $1 million, in a vanity property, costs your family $50,000 per annum. Renting makes (some of the) opportunity cost real, and allows you to calculate the cost-per-night of what you’re using.

Above is what you can see and calculate.

What about what you don’t see?

#1 => the option to change your mind, without cost or hassle. This is a powerful argument when framed correctly.

Honey, the kids are going to grow up and leave. When that happens, our life will change in ways that are impossible to predict. We should maintain the flexibility to change our minds.

#2 => the option to buy in a downturn. About once a decade, property values snap downward. Waiting does not feel like a valuable option but it is. I’ve seen brief, 50% markdowns numerous times.

#3 => what I think I will like does not match what I actually like. I am a master at fooling myself. Fooling myself with regard to location, views, amenities, garages, layouts… you name it.

Renting “forces” me into different types of properties. Because mistakes are so expensive, I write down the lessons from every new property.

Here’s the best lesson of all…

Assets don’t create the life you want to lead.

Focus on shared experiences with the people you love.

2019-12-07 13.11.17

Family Real Estate 2019

2019-12-01 17.07.49I like investing in residential real estate for several reasons:

  • The market is dominated by unsophisticated buyers/sellers, who are often driven by external events and emotions;
  • The availability of long-term fixed-rate non-recourse finance; and
  • Favorable tax treatment.

There are some drawbacks:

  • It is extremely expensive to buy and sell => a mistake will cost me 10% (gross), if I am lucky. If borrowing, even conservatively, then I can lose 35-50% of my equity in a year.
  • It is lumpy => if you need the money back then it is very difficult to gradually drawdown your investment.
  • It is illiquid => if we _really_ need to cash out then we won’t be able to cash out
  • Humans are hardwired to over-buy => as soon as I could afford a huge home, I bought one. It took me years to get my capital back. I was very lucky => I purchased with a large margin of safety (no leverage, big site, big building, prime neighborhood).

Taking the above, together, real estate is a useful core holding for money that won’t be needed for 10+ years.

2019-11-14 14.33.15

I follow two types of markets:

Markets where growth in prices is driving by “wealth feelings” in the top 0.01% of society => Vail mountainside homes, Boulder view properties. These properties have done well, appreciating to levels where implied yields are -2% to 2%.

I prefer to invest in traditional markets => markets where price growth is backed by a combination of real-economic growth (ability to pay), construction inflation (replacement cost) and discounted cash flow (net yields above my cost of capital).

Both markets are influenced by the availability of credit. Both markets benefit from scarcity and desirability in location selection.

Remember that even a “cash buyer” is influenced by easy credit. Credit conditions influence the value of ALL assets => wealth effects. These wealth effects cut both ways => highly wealthy people can feel “poor” when their balance sheets are shrinking.

2019-12-02 06.29.25

When I buy, I create a margin of safety by seeking:

  • Land for cheap => is there extra land I could sell off or am I buying in a very desirable location.
  • A lot of square footage for cheap => ideally, I’d like to get the land for “free” by paying less than the replacement cost for the building. Even if you never build, it helps to know building costs.
  • Distressed seller => life happens, often at inconvenient times.
  • Closed credit markets => by ensuring I have the ability to hold through tough times, I can use unallocated capital to buy during down markets.

I’ve been preparing for my next deal by improving my credit worthiness:

  • Building up a capital reserve.
  • Improving my credit rating – paying credit cards early, taking advantage of a 60-month 0% car loan offer, always paying my mortgage on time => taken together these strategies added 80 points to my credit score from 2012 to 2019.
  • Reducing leverage => paying down my mortgage and car loan. Closing out my second mortgage.

2019-11-21 08.02.40

We’ve seen significant house price inflation in Boulder => supported by: (a) rising construction costs, (b) local economic growth, (c) inward migration of wealthy coastal buyers, and (d) easy credit terms.

In 2019, I looked at deals to increase investment in Boulder (buying apartments and renovating houses). In the end, we decided to decrease investment in real estate through a sale-and-leaseback of our home. 

The leaseback costs me some tax (today) and positions me to borrow long at favorable terms. The option also costs me the future capital appreciation of my home, which won’t be mine any more. We retain exposure to the Boulder market through rental properties we own.

I’ve structured the deal with vendor finance, allowing a gradual drawdown of the proceeds. The net monthly cash flow covers our cost of living through my youngest daughter’s high school graduation. Having our cost of living covered protects my ability to control my schedule => highly valuable to my family in a way that’s difficult to quantify.

This is the cheapest way for me to sell real estate and positions us to buy when conditions swing in our favor.

Raise money before you need it.

 

#RWRI Thoughts on the business model and cleaned up notes

RWRI has a fantastic business model.

  1. Make the faculty your friends and investment committee
  2. Get paid to meet for a week each trimester // you have a no-cost central office, you are getting paid to bring your international (virtual) business together for a week
  3. Record your talks to capture new ideas, spontaneous content
  4. Train the students who will take your work forward when you are gone
  5. Receive feedback about how your work is being used in the world
  6. Up-sell your most passionate (book) customers => Robbins model
  7. Create an environment where you expand your network with people likely to engage and help you => HUGE self-selection bias in student population
  8. Invite world-class speakers in areas where you’d like to learn

This business works well for its owners and they are (more than) smart enough to see that.

Keep it small, sell out each meeting, avoid the temptation to expand and remember why you started.

I cleaned up my handwritten notes via the creation of a Google Doc.

Mistakes remain my own.

Considering Wealth at the Real World Risk Institute

2019_HalloweenTo shake up my thinking and expose myself to highly-believable people, I attended the two-day program at Nassim Taleb’s – Real World Risk Institute.

You can find my daily notes here. Cleaned up digital version of my notes here.

What follows is my thinking on wealth inspired by what was presented. Mistakes are my own. I can hear things differently than what was actually spoken, so don’t assume my attributions are strictly accurate.

To prepare for the clinic, I re-read the Incerto and I’m glad I did it. Each pass through Taleb’s work provides additional insight. You can find his lectures and lessons on YouTube => well worth your time!

We live in a world where a single bad decision can have massive costs => a few thousand dollars and four days of my time is a small price to (try to) think better.


One of the aspects of my job is guiding the transition of wealth between generations. This sounds sophisticated but it’s a role played by elders and parents in every family system.

My personal greed makes me too focused on financial wealth. It takes effort to step back to see wealth as including:

  • The ability to say “no” to others
  • The ability to keep promises to myself
  • Control of my schedule
  • Health, athletic functionality and contentment within my body
  • Love and companionship – the ability to share experiences
  • Engagement via teaching (my kids, my students, anyone who’s open to implementing what I’ve learned)

What I’m shooting for is creating a strategy, so effective, so straightforward, that an idiot could execute it and preserve wealth access generations.

This is what Taleb calls “Zero Intelligence Investing” but we are focusing on a broad definition of family wealth, across generations, through time.


The impossibility of prediction

Joe did an excellent job of demonstrating how complex systems (even those built on very simple rules, defined by the observer) can be impossible to predict. More specifically, certain systems can only be understood, defined, by running them forward in time. He laid out a host of reasons, any one of which could prove the folly of prediction.

Consider your own life. Cut your age in half, how would you have defined wealth at that age? In my case (25 years ago) the list might have looked like:

  • Wine, women and song
  • A ton of work that pays well
  • Watching my personal balance sheet grow
  • Being very strong in the gym
  • Travel to new places

There was no way to predict my values (today) without living through the 25 years from then to now (the divorces, the insolvencies, the setbacks, the pain of toddlers, the post-traumatic growth).

Because of the role of time in life, we can not predict the future.

However, we can have useful ideas about what not to do. We can get a handle on what might ruin our families.


So if my goal is to preserve, ideally grow, the collective wealth of my family system what can I do.

  • Be vigilant about ruin (in fat tailed environments)
  • Spot, discuss and remove fragilities
  • Position the family to benefit from positive optionality

One of the things Taleb does best is consider his best ideas across domains, gain insight then translate his insight to the reader via real-world examples. It is the secret sauce of his success.

BUT, reading great ideas doesn’t improve my life! I need to go the next step and tinker with a limited number of outstanding ideas.

Who gets the benefit of your best ideas?

Taleb’s best ideas…

Ruin via the fat tail hitting my fragilities => fancy way of saying don’t blow yourself up! I’ve written about this a lot: Taleb’s written about Russian Roulette => his 1,000,000 chamber gun story in Fooled by Randomness changed the direction of my life.

In the seminar we talked about the non-zero risk of a “zero-risk first cigarette.”  Why does a (near) zero-risk choice have a non-zero risk in our lives?

“In life, you must assume that you’re going to take the risk again, and again, and again.”

This completely changes the calculation with regard to the “first” taste of risks that might ruin you: alcohol, rage, opiates, cocaine, sleeping pills, infidelity, felonies, roulette, recourse leverage, luxury spending, unnecessary capital projects… things with the potential for large and unpredictable downsides. Bad habits are always trying to seep into my life!

So, to preserve wealth, you need a process to remove your fragilities, because these are what’s going to ruin you. My family history has persistent, recurring fragilities that hit us hard.

The first step is to gain control of your schedule and create space so that you’re able to think more clearly about what can ruin you. Simplify.

Another great insight – life is not about avoiding risk…

“Take chances, lots of them, and focus on areas where volatility works for you.”

In an uncertain world, one of the best sources of optionality is non-recourse finance.

My first career (Private Equity) could be described as getting overpaid to hold a call option over other people’s work, using other people’s money, without recourse.

Negative action is powerful medicine, with low side effects.

It’s tempting to ask Taleb “what to do.” I did, twice, and he didn’t seem keen on advising positive action with regard to an unknowable future. That’s probably good, as I’m not equipped to implement, or even understand, his technical advice. However, his negative advice (on what to remove) generated huge wealth for me => my total cost was the price of buying Fooled by Randomness on Amazon ($10.17 in December 2005 – my Christmas 2005 reading list, you can skip the flat earth book, the rest were great).

There are many sources of optionality:

  • where I have limited competition
  • where I understand the domain as well as anyone
  • where the cost to enter is small

A few ideas:

Get married, have kids, then take excellent care of everyone (!) => dementia is in my family tree => doing well by my family is the “cost” of a call option for times of future stress => an option that has a constant payoff in companionship, personal growth and a semi-captive audience for teaching.

Technical education in a robust field => look back in time for Lindy professions => spend time and effort for continuous education

But be careful, the “honors” part of my college education (1st class honors Econ/Fin) proved to be technically useless. However, it helped get me a seat at the table in Private Equity. The overall degree taught me valuable skills with regard to financial accounting, programming, mathematical finance and calculus.

Knowing how to count, and being exposed to the way people seek to cheat you, these are useful life skills to prevent ruin. – quote mine

Other sources of optionality => tinker within your social network, attend conferences (and force your introverted self to speak to people), write (then publish), talk to believable people that disagree with you, donate time to people who might benefit from your technical skills (especially within your local community)…

Your body can be a call option on: future mates, future physical experiences, the ability to lift your carry-on overhead as you age…


So the “how do I stay wealthy” answer is about removing fragilities => cutting back a high cost of living, habits with large potential downsides, physical weakness…

The “how do we best grow wealth” answer is about exposure to opportunities that open up the possibility of growing True Wealth (connection, experience, engagement) => each generation can, and should be encouraged) to, contribute based on their current, unpredictable and changing definition of wealth.

Together the family creates its own definition of wealth.

Each generation re-defines wealth based on its collective values.

I would have learned more if I stayed for the entire week but it’s Halloween tomorrow and I got more than enough from the experience.

Hidden Debt – Hidden Risk

IMG_5565.JPG

This is the debt story of zip code 80301-80305.

As many won’t follow this post, I’ll give you a rule of thumb.

If you are under 50 years old then reduce your social security and defined-benefit pension assumptions by 35%.

…and plan on working an extra five years.

What follows is why.


Back in 2005, I came across covenant free loans => banks lending money without rules or restrictions. That observation, combined with reading Fooled By Randomness, started a process of de-risking my life.

Despite taking a whack to my family’s net worth in the last recession, life has worked out well.

It worked out because I had reserves to get me through the tough years.

Collectively, our reserves are being spent on our behalf.


This fall Colorado is asking voters to approve a modification to TABOR, our state’s “bill of rights” for taxpayers. The supporters have a strong pitch, if you vote in favor then the money goes to schools and roads => I love schools and roads!

At the last recession, I was burned because I increased spending to the top of the cycle. So I’m inclined to keep the state’s powder dry for other uses.

What other uses?


PERA => our public employees retirement fund => we’ve been told the fund was fixed last year. The fix assumed net returns of 7.25% per annum going forward. However…

if PERA’s actual returns are 6.75 percent, the debt grows by $5 billion.

Round numbers, every 1% shortfall in PERA net returns creates a need for an additional $10 billion. As I publish this article the 30-year treasury is trading at 2.24%. A net return of 5% over treasuries strikes me as unlikely.

How does that potential shortfall compare to State Tax & Excise Receipts?

Fiscal year 2019/20 Colorado revenue receipts are forecast to be $12.6 billion.

Now, you don’t need to fund a pension deficit immediately. It can be dealt with gradually with a mix of benefit cuts, increased employee contributions and increased government funding. That’s what all parties did with the 2018 fix.

It’s a safe bet that state taxes are going up and benefits are going down.


In the last recession, my unemployment resulted from the credit markets slamming shut and creating a liquidity crisis…

  • The bank went bust
  • The developer went bust
  • The general contractor (and many of its subs) went bust
  • The management company went bust
  • The equity went to zero (within 90 days)

All of the above, culminated with the CEO going bust.

Chains of debt are lethal in recessions.


Noticing the debt bomb sitting in Colorado PERA, I asked myself, “Where else have people borrowed on my behalf?”

  • School district borrowing => ~$800 million in my district => money very well spent to strengthen our future tax base
  • CU Boulder is my neighbor => ~$1.5 billion on their books => the university has a big impact on my local economy and real estate market
  • City of Boulder => ~$225 million => big ballot initiative coming as they want to borrow big, take technology risk and purchase utility assets on our behalf
  • County of Boulder => ~$200 million at the end of 2018
  • State Level => ~$10 billion at the middle of 2018 => over $50 billion if PERA used a rate of return similar to my own

Sitting above it all => $1 trillion Federal Deficit and $22.8 trillion of National Debt.

There could be some double counting and I might have missed another public entity that can issue bonds on my behalf. The precise numbers don’t matter.

This is what matters…

#1 – there is leverage through the entire taxpayer chain with no consolidated visibility or oversight. No consolidated financial statements for you, the taxpayer. The ratings agencies have the entire debt chain rated as very safe. Does this sound familiar?

#2 – every single government entity that touches me has a debt-financed cash flow deficit and off-balance sheet commitments. This sounds familiar as well.

Debt financed, cash flow negative entities blow up.


I remind myself:

  • As a society, we can’t increase taxes at every level simultaneously. This counters my thought, “it will work out, I’m lightly taxed right now.”
  • 600,000 members of PERA are at risk and probably taking comfort from 2018’s fix.
  • If you are planning on receiving a defined-benefit pension then cut your assumptions and plan on working (at least part time) until you are 70 years old.
  • People are going to be pissed when financial reality hits their benefits.

What to do?

Protect your family by saving, investing conservatively and reducing your “total tax bill” as a percentage of net assets => this limits the government’s ability to hurt you via tax increases. I’ve been doing this since 1990 and it works.

Let’s say that again because your financial advisor will not focus you on this number…

“Total family taxes” as a percentage of “total family net assets” is a number you should manage downwards across your career.

Knowing that the system is highly leveraged:

  • keep personal borrowings low
  • be careful with long term obligations (leases)
  • don’t issue personal guaranties
  • don’t capitalize luxury spending

Being able to take pain => how might these scenarios impact your family?

  • 6 months unemployment
  • retirement benefits being cut by a third
  • social security benefits being cut by a third
  • portfolio value cut by a third

I’ve lost jobs, written down portfolios (65% in 90 days, ouch!), put my employer into insolvency (on my 40th birthday) and muddled through multi-year cash crunches (2009-2012).

Bad things happen and life remains pretty good even when they are happening => my wife’s companionship and leadership got me through.

Be careful out there.

What I Talk About When I Talk About Building Wealth

SuperGirl

When people ask me about asset allocation, I guide them towards family wealth.


Over your life, you will see things blow up.

  • Jobs will be lost
  • Divorces will happen
  • Guarantees will be called
  • Companies will fail
  • Investments will go to zero

Certain habits make us more prone to blowing up:

Debt – fixed obligations can ruin you in bad times.

Lack of emotional control – this runs deeper than, say, anger management.

People who make a habit of rationalizing a lack of control in one domain (elite sport, closing a sale, acting in a client’s best interest) rarely have the capacity to control themselves across domains. If you might get caught, then you’re fragile.

Substance Abuse – it’s more than the cost of sorting yourself out – it is the lost opportunity of a life well lived and the impact on the rest of your family, especially your kids.

Spending vs Cash Flow – personal spending, burn rate and fixed costs => the more spending you have relative to cash flow, the more fragile your finances.

The above is a long way of asking, “What aspects of your life might blow up?

Which is a polite way of saying, “I’m not sure asset allocation is the most pressing issue in your life.

If you work in an ethically-challenged field, have a lot of borrowings, have a high burn rate or are surrounded by peers with issues…

…then tweaking portfolio construction is a lower priority item than immediately removing what might ruin your life.

I’ve done it. You can do it. It’s better on the other side.


How large is your current portfolio when compared to your lifetime portfolio? – AKA you might have more wealth available in your career than your portfolio.

Investing is different at 25, 40 and 55 years old.

The nature of “different” depends on your personal circumstances.

#1 => Consider your Core Capital. The single best thing I did out of college was save four years of personal living expenses, $100,000 in the mid-1990s. It sat in a bank account, while I worked my ass off at my career.

Having that money enabled me to choose better and choosing better became a habit.


Very, very, very (!) few people can be professional investors – AKA can I get rich by beating the market?

Take an honest look at the people that you know in finance. How many of them “got rich” from their own money? Remember these are the experts.

In finance, most people get rich due to the rules of their game and collecting pools of other people’s money (your money, by the way).

With your portfolio, keep it safe, simple and low-cost. A target-date fund makes a nice core holding.

Having my Core Capital enabled me to take more risks in my career path, and life experience => not with my Core Capital.


Once-in-a-lifetime opportunities happen once a decade – AKA great deals happen when credit markets are shut

Here are the assets I own and why I own them:

  1. Index funds => long-term, diversified, not linked to my home real estate market
  2. US Treasuries/Core Capital => 5 to 10 years family expenses
  3. Boulder real estate => A relative value play against California, a cost-effective way to raise a family and a fantastic outdoor life. Think very carefully before locking yourself into any location. As a young man, my lack of ties enabled me to jump at great opportunities.
  4. Cash => my early retirement was funded by three deals I did coming out of the last credit crisis. Once you have your Core Capital (say, five years living expenses) then building up a pool for “great opportunities” is a consideration.

Starting out? Read this PDF.

Be wary of home bias => you can see it in my portfolio => even more risky is having your balance sheet, retirement and job reliant on the success of your employer.


Switching Costs – AKA think carefully before you sell good assets

I have assets in my portfolio that I would not buy at today’s prices. Financial theory tells me I should sell these assets.

  • I have zero confidence in my ability to predict the future.
  • If I sell assets then I pay taxes and commissions.
  • After selling, I have to figure out where to put the capital.
  • I doubt any “new” plan will be better than my current plan, which is simple and low-cost.

Release yourself from constant optimization => good enough is good enough.

Put your efforts into being a better version of yourself.