Tag Archives: financial education

Limits of Knowledge

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A online physics course reminded me of the ways we get ourselves in trouble. I tried to explain this to a buddy and he replied, “there’s simply too much to worry about.”

I’ll give the explanation another shot.

Better thinking is not building the capacity to worry constantly, about more things. Better thinking is about training ourselves to focus on making a limited number of excellent choices, given imperfect information.

  • When to worry?
  • Where to focus?

Limits to Knowledge

Snowflakes: even if a human mind could know everything there is to know about water molecules, it would not be possible to predict a snowflake’s structure.

Mobs: understanding individuals, in isolation, tells us very little about the actions of mobs, or markets, or cities, or nations.

Lots of other examples: DNA to elephants; Neurons to consciousness; the patterns of a sandbar; the shape of a cloud, politics, wars, life sciences.

Clouds are a current favorite of mine – a reminder to stay humble with any bet that requires me to be correct about outcome.

I’m currently debt-free. As a result, I’m able to make more mistakes, be less correct and less impacted by outside factors. The value of this position doesn’t show up in conventional analysis.

Properties that emerge, at scale, make prediction impossible. Joe Norman’s presentation at RWRI helped open my eyes to this aspect of our reality.

I don’t need to become a complexity expert to apply this knowledge. What is essential is understanding the nature of the system in which we find ourselves.

  • Are we in a complex system?
  • Are we in a system subject to extreme events?

To answer my friend’s question, “when to worry?”

Complex systems, subject to extreme events… exposures here are worth the time to carefully consider.

You don’t need to be the CEO of AIG to get bitten on the butt by complexity. If you’ll get fired for the mistakes of one of your direct reports then, given enough time, you’re fired.

Sudden unemployment is one way the nature of universe can come home to roost. Happened to me in 90-days at the end of the last boom.

Here’s another… if you woke up and discovered an undisclosed $20 billion dollar loss in an important counterparty then what would that mean to your life?

What about your family, your employer and your portfolio?

Concentration is a risk we can mitigate. It’s why I have unrelated jobs and several cash flow sources. Here again, conventional analysis fails to capture the value of this position.

In 2021, in a very benign financial environment, we’ve seen multi-billion dollar losses pop up in a week, or less. Rapidly emerging, massive losses are a feature of our system.

Things, that have been stable for a very long time, can disappear quickly.

Prediction: our minds love to predict, to assign causation and to tell stories about the world around us.

Grasping for a “why” is a waste of time.

When operating in complex environments, most importantly when surprises can bite me in the butt, I need to constantly remind myself NOT to make predictions.

For myself, I actually need to go further, I need to implement a policy of NEVER making predictions and NOTING surprises. There is useful information contained in every surprise.

Even further, I shun input from individuals (especially smooth talkers) who make predictions. A reason why I try to never watch videos — too persuasive.

I’ve found that even a little prediction, it leads me down a path of wasting thought.

  • What’s likely to happen – what happens to me if the opposite happens?
  • What’s the worst that can happen – can I mitigate?
  • Does the situation appear reasonable – given the above
  • There are games, investments, relationships and opinions… I don’t need to play, make, engage or have

There are a lot of business where “the burden of the worst” falls outside of the beneficiary class (government, general partners, VC, private equity, OPM, CEO-class, banking).

We can waste a lot of energy railing against the system, I’ve found it much more useful to make sure I understand…

My family cannot afford to take the same risks as my employers, my shareholders and my government.

This is a lesson I learned through, rather expensive, experience when I left Private Equity.

Families…

No Prediction => focus on getting rid of ruin => subject to not becoming a casualty myself… education of youth “buys” more than portfolio returns, or my personal savings rate.

Conventional analysis fails to capture the present value of teaching how to avoid future mistakes.

Risks => practices that make sense for large entities, given time, will wipe out my family

So my point was…

There is more to reality than we are capable of comprehending.

Stable situations can become fragile at scale.

There are certain domains where acting “irrationally conservative” can make rational sense.

We are going to be surprised over, and over, and over, again.

Philosophically, one could say reality is pointing towards a deeper form of intelligence.

From a more linear point of view… the next time you are on an airplane, write a list of your concentrations and counterparty risks. Blow them up, one-by-one, and carefully consider if you need to mitigate.

Crypto

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The capacity to see beauty

I was going to take a break from posting but this topic gives me an opening to share something useful with you.

So here goes.

Sunrises

First, I know next to nothing about crypto.

Fortunately, my life has been set up to take into account that I am clueless about many things!

I think we can start by agreeing that crypto is volatile.

So I’d suggest you start by thinking deeply about how you, your significant other, your family and your coworkers tolerate volatility.

I don’t need to think deeply. My family abhors volatility. They get nervous about stuff we don’t own.

Personally, I tolerate volatility but tend to sell early. By way of example, I am absolutely certain that I would have sold Amazon 20+ years ago. Grateful I didn’t short it.

So, regardless of the fundamentals, I’m not a good fit for the asset.

About those fundamentals, I can’t see them.

I could learn about crypto but, while learning about an asset class that isn’t a good fit, I am not working on something else.

Let’s repeat that… while thinking about one thing, I am not thinking about another thing.

The opportunity cost of mis-directed thought.

Say I get there – I’m comfortable with the asset class, and I’ve gotten myself and my investment committee past the volatility issue.

Will it make a difference?

Buying, not buying, selling, not selling. Being right will not make a difference in my life.

The opportunity cost of incorrect focus. Big one.

Shades of green

If asset classes don’t make a difference then what does?

I was thinking about this on my run this morning. So let’s start with that… dropping fat, maintaining a stable weight, daily movement in nature, improved strength… big difference!

Since shifting my primary focus away from money, my body has had the opportunity to do a lot of cool stuff.

Trying to get more, of what I don’t need, can prevent me from getting something useful.

A flower

Leaving => I wrote about considering if an asset is a good fit for an owner. What about life?

Leaving makes a difference.. every single time I realize I have different values than my peers, I exit => patiently, quietly, doing a good job on the way out.

I need to watch this tendency. Making a habit of leaving is not going to take me where I’d like to go. Stay where I belong.

Building => Don’t look for easy money, build something.

I helped a friend build a business. Unfortunately, he lied to me and stole money from the investors. Interestingly, when the dust settled, that didn’t make a huge difference. If someone isn’t trustworthy then it’s better to know, as soon as possible. In the end, I learned a lot and walked away with 25-years living expenses.

Learning, while building capital => made a difference, up to a point of rapidly diminishing returns.

A reminder of my first kiss with my wife

As you age, I recommend you transition your focus from money to relationships. Because…

Family => marrying well, raising my children to be exceptionally kind and athletic… makes a huge difference, much more than spending the last ten years building wealth would have done.

Having the courage to change, so my kids’ values are a better fit with my own.

My smiling, lovable savages. You have my eyes…

We tend to over-value what we see.

We see crypto rocketing and we think it must be a good idea. It might be. Like I said, I know nothing about it.

But what we don’t see is often more important.

Thinking about that on my run… the decision “to not” has helped in ways I will never see.

Errors not made.

Not smoking, not using scheduled drugs, not taking sleeping pills, not giving into anger, not quitting…

1/. Will this make a difference?

2/. Will “not this” make a difference?

A useful filter on where to focus, and what to avoid.

Vacation Property 2021

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One of the topics from our recent Couples Retreat was vacation property. I needed some time to show-my-work for why I’ve decided to stay variable.

The question, in the context of both buying and not-buying, was…

Will it make a difference?

The question gives me an opening to share some things I’ve learned from 25 years of real estate investing.

1/. I have yet to regret not-buying a vacation property. When vacation markets appreciate, so do investment markets.

2/. The ones-that-got-away have three main attributes: well located, easy to find tenants and decent cash yield. Vacation properties usually only have one attribute… well located.

I’ll share insights about capital allocation:

=> No one in the company is likely to care more about capital allocation than the boss – the CEO sets a cap on how much people will care about capital, and everything else for that matter.

Extend into your marriage, and family….

=> No one will care more about spending and capital allocation than the individual responsible for earning the income/capital in the first place.

Similar to work ethic… the actions of leadership set a ceiling on what to expect. No amount of legal documentation, and pontificating, can overcome this reality.

Don’t waste energy fretting about the way things are.

Be grateful when you’ve been able to create a team that, largely, follows your lead.

Now the math!

I’ve updated my #s for the two markets I follow most closely.

  • A vacation market with an effective yield of -3% (cost to own). I avoid fooling myself that I’ll be able to short-term rental myself to breakeven.
  • An investment market that is generating net cash flow of 2% per annum.

To “get my money back” in the vacation market, the value of the asset needs to grow by 2.5% per annum.

Money back does not mean purchasing power back. The “same” dollars in 15 years time will buy less due to inflation – just look backwards to 2005 in your home real estate market and see what your current place was worth.

We have no idea about what the future holds and 2.5% market growth is probably looking tiny when compared to what you’ve seen over the last year (+30% in my zip code).

You could be right.

I do, however, know markets that are just getting back to their 2008 peaks. In a negative cash flow scenario, that’s a painfully long time to hold.

My goal isn’t to predict an unknowable future. My goal is to answer the question “will it make a difference?”

In the get-your-money-back scenario (2.5% market growth):

  • Take time to calculate your true cost to hold.
  • Make sure you’re OK with permanently increasing your burn-rate, especially if there’s debt service.
  • Know your alternative use of funds => the investment property returns $1.75 for each $1 invested & Vanguard’s VTSAX is currently yielding 1.4%.
  • The vacation property requires an extra $0.45 for each $1 invested. This is before you decide to renovate and burn $$$s on rugs, curtains and furniture!

For that vacation property, here’s what I do…

  • Take the purchase cost
  • Make sure I’m OK with annually spending 5% of purchase cost, forever
  • Consider if I am OK with writing-off the equivalent of 50% for customization, the cost of ownership and agent’s fees

Then remember:

  1. My personal utilization of past destinations has been 15-45 days per annum.
  2. The future risk to my family is we are priced out of our home market (not that my spouse and kids might have to unpack/pack up from a rental).
  3. I tend to change my mind.

Feelings!

One of the challenges with new deals is my feelings are dominated by the expectation of the asset making things better.

I also enjoy the feelings associated with being able to provide for my spouse and kids.

Making things better & doing right for my family => it’s difficult to feel the benefit of doing nothing.

Once I have a good-enough position, the only person who can screw it up is me.

Freedom 2021

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A big motivator in the finance world is the dream of earning “f-u money”.

The universal motivation for this goal is expressed in the Johnny Paycheck song, Take This Job and Shove It.

Trouble is, once you have a goal to tell people to Eff Off, you will never run out of targets for your ire.

You’ve created a habit that can’t be solved by money – and being consistently abrasive will drive good people from your life.

My friend, who changed my view on the UltraRich, demonstrated an alternative approach.

People think the benefit of wealth is f-u money. The benefit isn’t the ability to be rude with impunity. The benefit of financial independence is the opportunity to say no-thank-you to the ever-present drama around us

The goal, to opt out of BS, doesn’t require much money at all.

However, the first $125,000 I saved nudged me in a better direction, eventually, out of finance.

What my younger self found attractive (in wealth accumulation) was a pathway towards serenity. I feel very fortunate that I gave my younger self a chance to look around.

Serenity was found in nature, in connection and in exercise.

Do I want peace or drama?

Own Use Control Acquire Build

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For some, the building (of assets) is the best part of the process.

Last Thursday, I mentioned that my son and I were talking about real estate assets.

My son, like most folks, has a bias towards ownership. This runs deep – the only relationship he sees with assets is own vs want.

Now, as any yachtsman will tell you, when it comes to assets… the person getting the greatest benefit isn’t always the person paying the bills.

Two questions that are fundamental to how you organize your affairs:

  • Who gets the benefit of the asset(s)?
  • Who gets the benefit of your time?
Back to Thursday’s strawberries, a proxy for cash flow

From Thursday’s example…

  • The direct benefit of the renal property goes to the tenant.
  • The cash flow goes towards my cost of living.
  • Not having to earn that cash flow, gives me time to spend educating my kids.

The person, or entity, that owns the rental property doesn’t matter as much as you’d think.

What matters is who uses, who controls and who gets the benefit of… the asset.

The mismatch, between ownership and benefit, is a key source of friction within family systems. To mitigate, each generation should have an opportunity to create and affirm their own values.

Short version: we each agree to pay our own way.

The mismatch is also why our political class does a poor job of picking winners, setting preferences and allocating resources.

Incentives matter.

So, are you a balance sheet builder? Are you someone who enjoys using assets? Do you seek power through the ability to control budgets? Does giving to others bring you happiness? Do you love the thrill of the deal, or is it more about the novelty of a new purchase?

As a young person, these questions can be difficult to answer. Even when you think you’ve answered them… you might think differently later.

Here’s something I’ve noticed about myself. The more I notice others, the more I need to step back, relax and recharge. When I’m getting enough time to recharge then the noise of the world flows by.

Remember time and you will make fewer mistakes.

Let It Ride

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My son has a side-gig shoveling snow.

Side-gig money is his to spend in any way he wants (and he wants a jumbo Baby Yoda).

His surplus money goes into a bag. “Money in the bag” is real to him.

Other forms, less so.

My son’s outlook is very common and, if not addressed, will cost him a lot of wealth (directly) and time (indirectly).

Last Tuesday, he had a cunning plan to help me “get rich” – the scheme was a simple one. Sell everything I own and realize all the gains.

I left the fact that I don’t truly own anything for another lesson.

Instead, I started by pointing out that there are a lot of rich folks in town who don’t have time to ski with their kids.

Time, son. I want you to remember time.

I want you to remember time.

His scheme gave me the opportunity to teach him three things about money:

1/. We’re not going to sell the rental property…

Income, from rent, is a useful type of money – I used the example that the property he wanted to sell covers the cost of his food.

Cash flow buys strawberries.

Cash flow buys food

2/. Selling costs money…

When you sell you need to pay taxes on the gain.

Taxation was taught to him from a young age. Whenever I eat something off his plate, “I’m taxing you.”

If you don’t sell then you can pay taxes later. Pay later is better.

He was on-board so far.

  • Cash flow is food
  • Pay later is better

3/. What are we going to do with the money if we sell?

When you sell, you need to figure out what to do with the money.

The rental property is a great asset and I have no ideas for something better.

I lost him here. I think he wanted to see a _really_ big bag of money.

Opportunity cost and alternative use of funds… fairly advanced for a kid, or anyone for that matter.

How might you get this bag of money to work for you?
  • Cash Flow
  • Deferred Taxes
  • Opportunity Cost
  • Alternative Investments

Good enough is good enough.

Once you get that bag of money working for you…

Let it ride.

Learning From The Well Adjusted

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I’ve been fortunate, to get a look under the hood at the lives of the conventionally successful.

Before we get into tactics for discretionary spending, it’s worth thinking about what our spending might bring us.

What’s the strategy? Where are we trying to get to?

Thinking back to last week => if you think about my childcare spending with this in mind… it makes much more sense. I wanted to maintain my ability to explore nature and create space for a little serenity.

My first boss was a very successful investor. He repeated his success multiple times, with different teams, across a long time horizon. I use what he taught me, every day of my life. A favorite quote:

It’s the first five million that makes a difference.

You’re going to read that line in your own voice. You’re going to overlay your own values. To understand, for myself, I had to watch what he did for a number of years.

He loved what he did and he didn’t like to be told what to do. He was living in London, with two kids, in his early 40s, with limited interests outside work… what money brought him was the freedom to leave any situation he didn’t like. To be his own boss.

Related from another self-made mentor, talking about a family member with cash flow, who left a successful firm, at a very young age.

Nobody ever goes back.

So, if your financial chase means you are beholden to your boss then you’ve missed out on a key benefit

  • the ability to control your own schedule
  • the ability to walk from unreasonable demands

Once you realize the underlying need, you will be able to address it with far less money than you think. The entire point of my financial writing.

What do successful people do when they’re not being successful?

My first boss used to read about accountancy! He’d head off on vacation with a large stack of Accountancy Age (or whatever it was called) and work through back issues. His partners got a kick out of that. If you wanted to learn about financial fraud, he was your man!

My lifestyle aspirations are a better fit with the smart folks I met through sport. There are a lot of high-achievers in masters athletics.

What did I see?

Mastery, novelty, competition, adventure, peril, connection, shared suffering… ideally, combined with heart beats in nature.

Adventure, beauty, variety – there is a ton of it within 90 minutes of my house.

No balance sheet required.

Family Spending Principles

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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).

Different Ways of Looking At Money

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Yesterday morning at A-Basin. My son has developed a taste for narrow chutes.

I’ve had gigs that pay $500 per month. Let’s have a look at what that’s worth.

What is $500 per month worth over a decade?

  • 10 years, 12 months a year, $500 per month => $60,000
  • That’s straight math, no implied additional costs/benefits.

What if I swept the cash from my side gig into a Target Date Fund?

I estimate a 60/40 portfolio returned ~9.7% per annum across the last decade.

  • 10 years, 9.7% a year, $6,000 per annum => $94,250
  • So if I’d invested that money, each month, for a decade, I’d be getting close to $100K

10-15 clients at $500 per month, less a bit of overhead => close to $1M in a decade.

Flipping this example: my condo association charges me an extra $500 per month.

What kind of headwind does that put on my real estate investment?

  • We have an example from above, $94,250 per decade. $94,250 is an estimate of the cost to my balance sheet of sending money to the condo association, rather than a 60/40 portfolio.
  • However, there’s one more step because we pay expenses from after tax income.
  • Do you know your average tax rate? I use 25%.
  • $94,250 / (1 – 0.25) => $125,000 // this is called grossing-up your answer – to pay $500 per month, I need to earn $667
  • So a charge of $500 per month could drag your return down by $125,000 a decade.

Recap of the three ways:

Nominal => $500 per month is $6,000 a year is $60,000 a decade

Opportunity Cost => $6,000 a year not invested implies $94,250 in a decade if the assets earn 9.7%

Grossed Up Opportunity Cost => $6,000 not spent, and invested pretax (retirement account), has an opportunity cost of $125,000 in a decade

The exact numbers are not important. What matters is understanding the concept… repeating amounts become big money over time.

$500 per month is going to cost the family between $60,000 and $125,000 a decade.

Expenses avoided, small gigs (earned then invested), and holding costs… these can have surprisingly large impacts on your financial life.

Seemingly small gigs are worth more than they appear…

  • if they come with health insurance (my unsolved family budget line item)
  • if they come with discounted prices on goods you are already buying (part time work at a business you’re already spending with)
  • if you make a habit of sweeping the income into a Target Date Fund (side gig cash invested to benefit my future self)

Something I like to do in my financial life is look at the line items in my family budget and ask… “What’s it going to take to eliminate that cost?”

If I can’t eliminate then, “What work might I enjoy to mitigate the cost?”

The game being to get my net cash burn to zero, while sustaining a life with meaning.

This morning’s sunrise on top of Eldora Resort.

Enjoy 2021 – there remains a lot we can do, while remaining smart to mitigate COVID.

Live Free Recipe

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This post is about creating the freedom to choose how you spend your weekdays.

Owning a place to live, and being paid to live there, will change your life beyond the financial benefit it brings.

What’s it going to take?

Capital

I outlined the educational aspects here.

The easiest time to build capital is in your 20s. You can live very cheaply because you’re either at work, or carousing. Your health insurance is peanuts and you don’t need to take on any dependents (free birth control saves lives).

Age is not a barrier. Use the recipe below and you can be living free by 2030.

Big Cities remain the best places to build experience, knowledge, contacts and skills.

When I made partner, a wise man took me out to breakfast and reminded me…

Get what you want, then get out

He didn’t tell me why I needed to get out. I learned that for myself…

  • You’ll be tempted to go private with educating your kids => $1 million you need not spend, or earn
  • You’ll be jammed into a little place and/or you’ll have your financial life tied up in a single asset – you won’t care about this after graduation, you will care about this when you have preschoolers!
  • It requires extreme luck to get yourself on the housing ladder before you’re 40 => get your timing wrong and you’ll feel trapped
  • You will be surrounded by social pressure to spend, spend, spend!

Megacities are filled with opportunity and excellent people to whom you sell your skills.

Megacities are a great place to start.

Just remember to leave.

Target Location

Having played this game three times, I think a small city is your best bet.

  • ~250,000 (pop.) in a county with ~500,000 (pop.)
  • Natural Beauty – clean water, clean air, the ability to exercise safely without driving
  • Climate – I gamed this by having a rental in the Northern Hemisphere and a low-cost Home Base in the Southern Hemisphere. Later in life, I moved to a place I didn’t need to leave (Colorado, Front Range)
  • Airport Proximity – needing to take a flight-to-your-flight will get old

Before my first kid was born, I worked in: Canada, England, Hong Kong, New Zealand, Bermuda and Scotland.

The skills to be happy somewhere are the same as the skills to be happy anywhere.

Target Property

My worst deals (financially) have been the most impressive (visually).

Buy space and let the next owner spend a fortune in renovations. The money I’ve spent beyond paint, carpets and replacing worn out appliances/HVAC has been largely wasted.

You’ve probably spent the last decade renting – your younger self is your target market. Choose a location that will be easy to rent (if you leave, if you need income).

Lock off basements, detached units, split floors… earn rental income, maintain personal privacy.

Margin of Safety – your land premium is “total price” less “value of the buildings” – the closer you get the land premium to zero, the safer your deal.

Coming out of the Great Recession of 2008, land premium was briefly negative – this was due to banks foreclosing and forcing the market down. Five bedroom houses, 15 minutes from Boulder, were selling at $75 per sq foot. Condos, apartments and houses in Arizona got even cheaper, under $50 per sq. foot.

Cheap will happen again.

Connection

It can be tempting to go remote. I feel ya.

Escapism is a recurring dream of mine, especially in times of stress. However, you need to be practical – friends, sexual partners, basic services, transport… the practicalities of life.

The purpose of setting up your low-cost base is to provide security within a life with meaning. Go to where there are people with whom you’d want to spend the rest of your life.

Shared values, within an active lifestyle.

Wait For The Fat Pitch

To get this done you’re going to need a trigger that makes the local property market seem cheap to YOU. It won’t seem cheap to the locals, who will be expecting further declines.

  • Recession combined with High Interest Rates (UK 1990)
  • Asian Crisis (1997)
  • Currency Crisis (NZD in 2000)
  • Global Financial Meltdown (2008)

I witnessed all of the above. There is ALWAYS a “next crisis”.

2020 was a boom year in real estate. When you’re living through a boom, your FOMO will be pushing you to take action.

One of the best things your first good deal brings you is a reduction in the pressure to do a deal.

To do great deals, you need to be comfortable doing no deals.