Tag Archives: financial education

Wrong For 25 Years

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I try to protect myself, and my family, from the fact that we’re collectively clueless on the future. I also know that my memory rarely extends back more than three years. So, from time to time, I force myself to consider history, and what happens if we revert to the mean.

What does a chart of short term rates tell me about my unconscious influences?

Federal Funds Rate

The chart tells me that, at some level, I’m acting as if interests rates are going to stay at zero forever. In my case, this means that I’m prone to taking more portfolio risk than I would back in, say, 1981 (when cash was king).

How would a return to normal, as well as, a continued period of abnormal impact my family?

What would I do differently if I knew that rates were likely to move upwards over time?

What’s appropriate for a younger investor?

At 45 years old, a higher rate environment would see me take less financial risk. For most of my financial life, I was happy to have money sitting in a savings account. In this extended period of zero interest rates, it’s been painful to have a savings account and I’ve moved out of cash.

Despite telling myself that I’m conservative, my cash holdings are the lowest percentage of my portfolio in my adult life.

What’s normal?

The short-term rate chart (above) covers most of my life, let’s borrow a chart from Ritholtz’s blog and see what normal looks like across many generations. The chart below looks at long-term rates, which are less volatile than short-term rates.

Long Term Rates

It’s worth pulling that chart up on a big screen so you can ponder. The chart is over 200 years of interest rates. Thinking in generational terms:

  • Grandparents’ generation – 30 years down, 30 years up, 30 years down
  • Parents’ generation – 35 years up, 30 years down
  • My generation – 15 years up, 30 years down
  • My kids’ generation – ?

Looking at the chart, I note that there are periods (say, 1935-1955) where rates can stay low for a long time.

  • Long-term fixed rate debt seems like a good idea
  • Cash won’t always have a zero yield
  • Equity and real estate returns could be low for an extended period of time if long rates start trending upwards

How can I reduce portfolio risk in a way that protects my family if rates stay low for longer than we expect?

  • Pay off variable-rate debt and leave banking facilities in place
  • Lock in fixed rates and longer maturities
  • Open low-cost lines of credit
  • When considering a move to cash (or a lower family net debt position), rank portfolio holdings in terms of yield and exposure to future capital gains.

The lowest return assets in many personal portfolios are condos, large main residences, vacant vacation homes, surplus land and luxury items. Right now, the “cost” of holding these low-return assets appears to be far lower than historical norms.

Would I hold these items if cash could earn a low risk 2.5% per annum? 5.0% per annum? 7.5% per annum?

If you’re highly leveraged with short-term or floating rate debt then it’s worth considering if your life would change if rates moved up.

Over the last two years I’ve downsized my main residence, sold non-core low return assets and max’ed my long-term fixed rate borrowings.

In 25 years of investing, it’s been a paradox that the best time to sell is when I’m most tempted to hold on.

The Billion Dollar Dinner

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2014-09-20 17.17.34Early in my finance career, I was invited to a very nice dinner. The occasion was to celebrate the firm passing the $1,000,000,000 mark for assets under management. In the early 90s, a billion dollars was a lot of money…

Roll forward 25 years and a billion dollars has become a salary for the best hedge fund managers. What an amazing industry.

In my article on fees, I introduced the concept of a “two and twenty” fund. The partnership received 2% of the assets under management (annually) and 20% of the gains. I didn’t run the numbers at the time, but the partners were celebrating ~$400,000,000 of fees and potential profit sharing. Huge sums of money created by the smartest room of people with whom I’ve ever shared dinner.

I can’t remember much about the dinner but I probably drank too much. I had some bad habits in my early 20s and the partners warned me to dial down the boozing! I wouldn’t discover the medicating effect of exercise until five years later.

Fortunately, I had good habits that balanced the bad.

Always make the needs of your boss your #1 priority. The only exception to this rule is if your boss’s boss makes a request!

When I started in London, they carved off a piece of hallway to create a cubicle for me. My chair was the only desk that could be seen from the Managing Partner’s office. When my boss had a task for me, he’d lean forward and yell,

Byrn, Heel!

Yes, I was treated like a dog.

And I loved it.

I’d stop whatever I was doing and scamper into his office for instructions.

The other habit that served me well was saving 50% of everything I earned between 12 and 30 years old.

My parent’s divorce left me with a deep fear of running out of money. As a result of my fanatical savings, I had capital to invest later in my career. In fact, I invested so much in the partnership that the regional heads changed the rules to restrict the investment of junior partners! Envy is part of the finance game and it worked out well for everyone.

With the size of the numbers bouncing around, you’d be forgiven for thinking that I’d retired a wealthy man. I made good money but decided to leave most of it on the table to try my luck at triathlon. It was a decision which, rightly, seemed totally bizarre to my family. I left the firm with a net worth of 20 years living expenses.

Always compare financial wealth to spending and remember life’s about time, not money. I didn’t become a wealthy man until I cut my spending, moved to a low cost location and began to pay attention to what gave me satisfaction.

Far more valuable than money, perhaps the moral of today’s story:

  • Save as much as you can, and work your tail off, early – the freedom later is worth it
  • Everyone needs to learn basic financial accounting and the time value of money – in a world dominated by greed and envy, financial literacy is invaluable. I use these skills every day.
  • Getting paid a lot didn’t satisfy me. I had no idea what motivated me until my life was reset via divorce, unemployment and massive financial loss. I could have made a ton of money sticking with the status quo and that would have been a mistake. Finance could have cost me my health and turned me into a dick.

The best advice I received on my career was from a man, now gone, that was at the dinner that night (link is to my blog about my mentor).

Learn, make money, remember to leave.

When most everyone was telling me that I’d make partner if I stayed in London. An honest man took me out to breakfast and shared advice about living a good life. A good person in an amazing industry. He wasn’t the only one and I miss the team from my early career.

To my friends in Private Equity, thanks so much for the good times and memories we shared.

Hare-Brained Schemes

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I’ve found that if you create something trivial to be anxious about, it cancels out serious things that you might be anxious about.

– Malcolm Gladwell, WSJ

The patriarch of a family that I advise gave me a call to ask my advice on an investment with a very low probability of success…

“Am I crazy to do this?

Should I simply toss it in the trash?”

We think alike and his questions were a reflection of my own thinking… no way you’re going to make this work, it’s likely a waste of money, yada yada yada…

My advice?

Go for it. Absolutely.

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Here’s why…

The deal was in an area that’s far outside his core competency. Having the opportunity to learn, to make mistakes, to create is a lot of fun. When I’m having fun, I do all aspects of my life better (husband, father, consultant).

The deal has a limited financial and time downside. The risk of time is often overlooked – time spent worrying, time spent seeking to fix a low performer, time not spent working on a strength. My pal is very good at his strengths and has a young family. Spending additional time learning new skills is “worth” the small downsides.

As Gladwell notes, when we’re working on a modest hare-brained scheme, we are far less likely to dream up something that risks a material chunk of our net worth, have an affair, quit our job, or pursue any of the other areas of Human Misjudgment.

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Related to the above, if you have trouble being financially sensible, or get a thrill from risk, then a smart way to manage yourself is to allocate a small portion of your net cash flow towards casino-type investing, or actual trips to the casino!

You’ll find that your brain doesn’t require a large stake to excite itself with anticipation and you can stay open to the creative side of your personality.

Call it your “Fund of Fun” and use if for Vacations, Luxuries and Hare-Brained Schemes.

Allocate a portion of your cash flow (and time) towards these schemes.

Keep the rest of your life sensible and run it on autopilot.

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Personal note – I always know that I’m holding onto my “rules” too tightly when my wife starts telling me to “be more fun.”

Truth be told, I’m terrified of breaking the rules because there’s nothing I like better (in the moment) than a massive binge!

I need a “fun budget” more than anyone.

Binging is a clear sign of holding on too tightly.

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Finally, pay attention to how “the things that you think will make you happy” make you feel. I’ve noticed a HUGE difference between what I think I need and what makes me content.

  • I’m fond of adversity in hindsight
  • More food, more alcohol, more sleep, more money, more fatigue – MORE is not my answer
  • It doesn’t take much of a hangover to negate the small marginal gain from extreme living.
  • We are naturally loss averse – the trick is to frame choices to take advantage of this tendency
  • I’m prone to forget the joy of serenity, stillness and simplicity

Anyhow, that’s my list. I sincerely hope that you take the time to write your own.

Don’t wait to start living.

Quarterly Review

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boat2Completed my quarterly review last week and wanted to pass along a few observations that could save your family money.

My default stance with personal expenses is “stay variable.” Renting, rather than owning is a good way to live. In-and-out of a property costs you a minimum of 15% of the gross capital value and being tied down geographically reduces your human capital.

That said, the best deal that I’ve done in the last few years was the purchase of my current house. It’s a half block away from a great public school and my mortgage/taxes/insurance cost me 65% of my owner’s equivalent rent. While I have a large amount of equity tied up, it’s increased 30% in the last two years (see – how I value real estate for a calculation method).

Three factors dominate my cost-to-own being less than my cost-to-rent:

Mortgage interest rate – these remain historically low. My rate is fixed for another 28-years – a valuable asset for my young family.

Cost to insure – Ten months ago, I realized that my home was grossly over-insured. As part of a 2nd mortgage restructuring, my place was appraised. I used the appraisal value to get a more realistic level of insurance in place.

Local Taxes – In 2013, the county reassessed my property at a 30% increase in value. I reviewed the county assessor’s website, pulled together more appropriate comps and requested a do-over. The assessor agreed with my comps and cut my taxes significantly.

The above, combined with an incorrect escrow calculation, means that my monthly payment has been resetting downwards all year. Starting October, I’ll be paying 20% less than two years ago.

The lesson is to be pro-active with checking the components of your mortgage payment. It takes times to get things right but there’s likely money to be saved. Everywhere I poked, I could save money.

Be patient with property purchases – great conditions happen once a decade and it’s nearly always better to wait.

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In my portfolio, three main adjustments:

  • Sold US Equity Index to rebalance and raise funds for a property deal. This came out of a taxable account and I’ll pay CGT on the sale. Normally, I’d avoid the CGT but the account is a minor custody account that we’ve decided to spend on the kids before they’re 18.
  • Exchanged International Bond Index for US Bond Index to simplify my portfolio, lower my total cost and because the fund manager wasn’t able to convince me of any benefits of the product. Non-taxable exchange.
  • Staying the course with asset allocation ratios but will tweak if I sell an investment property.

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Our long-term care insurance provider increased Monica’s premiums by 45% so we dropped the policy. Due to my cycling, it will be a tougher decision if they seek the same with me.

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Our largest discretionary expense is preschool and childcare. We started tracking this weekly and comparing against my spouse’s gross income from working part time.

  • This calmed my mind because it showed that we were more in balance than I thought.
  • It gave us a weekly snapshot of how we were doing with cost control.
  • It showed us the trade-off between more work and more childcare.

 

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Overall, we keep chipping away at making our family a little more efficient each month.

How Am I Fooled By Fear?

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Monsy in Boulder

The best antidote I know for fear is a good laugh that is followed by asking myself, “What’s best for my wife and kids?”

Once we can see our fears, we discover their impact on every decision in our lives – relationships, office politics, athletics, contract bidding, you name it.

This thinking comes from Your Money and Your Brain, which was recommended in If You Can (link to free eBook). Turns out that I’m a case study for how we fool ourselves.

Extreme Loss Aversion

Periodically, I’m stalked by a fear of being wiped out.

An antidote is to view the world through a bigger lens. Evaluate bad news with regards to my life – most “bad” news has no impact on me but I transfer remote fears into my home life.

Strike It Big!

The flip side of my risk aversion is a feeling that striking it big would solve all my problems. The voice in my head tells me, “then you won’t have to worry about anything.” However, that’s unlikely. I’ve always had fearful feelings.

The antidote is to point out the obvious:

  • we’re in a good position
  • keep doing what we’re doing
  • inappropriate, and unnecessary, risk is one of the few things that can screw us up

It’s a message that I give to others, and I’m repeating it to myself, here.

 

Better Thinking About Taxes

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Taxation is a topic that’s guaranteed to tip most people over the edge of rational thought.

Let’s see if I can help you make better decisions by slowing down your thinking.

The first thing you need to do is add up all the taxes that you’ve paid in the last year. Your total might include:

  • Federal, state and city income tax
  • Payroll taxes, worker’s compensation premiums and unemployment insurance contributions
  • State, county and city sales and use taxes
  • Real estate taxes and rates
  • Transfer taxes and stamp duties
  • Value-added tax (for my non-American friends)

The first step is painful. It’s a big number for almost everyone.

In fact, this step alone creates a level of pain that drives many smart people to over-react. Wind farm investments, geographic relocation and massive personal overheads are often reactions to a sense of injustice with regard to tax policy.

When I moved to Colorado, I was surprised to discover that it’s a low-cost place to live. In fact, it’s a far, far cheaper to live here than London, Hong Kong or Bermuda – all locations where I’ve paid significant taxes.

Taxes are best considered in light of our total cost of living. The cost of which includes education, housing and healthcare.

At the end of 2000, I left the low-tax environment of Hong Kong and ended up in New Zealand. In New Zealand, my marginal tax rate increased significantly but my core cost of living dropped by 95%.

Years later, working in Bermuda, I spent a small fortune on travel and living expenses to keep my average tax rate down. Eventually, I did the calculation that I’m sharing in this article and had an “a-ha” moment.

Today, in Boulder, my total tax bill (all of the bullets above) is roughly equal to the cost of a single private education in London, Hong Kong or Bermuda. With three kids, the life of an expatriate would be expensive. In fact, I’d have to work so much, I’d rarely see my family.

While an American city with a good school district is a low-cost location – even better was New Zealand. Moving to NZ, I lived with roommates, was covered by single-payer health care and worked for European / North American clients. I read about young people doing similar arbitrage with a bases in Asia, South America or small North American towns.

If you’re motivated then you can find opportunities to optimize your cost of living. Rather than worrying about your marginal tax rate, focus on the best location for your current life situation.

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As for the psychological impact of a tax increase, I often let my emotions get the better of me.

To understand your true exposure to tax rates, take your total tax bill and divide it by your net worth. That percentage is the true “take” of taxes from your family.

For example, consider a young woman earning $70,000 per annum. Her total taxes are  $17,500 and her net worth is $40,000. With an average tax rate of 25% (17,500/70,000), she’s paying 44% of net worth in taxes each year (17,500/40,000). She has a significant exposure to tax increases.

Compare the above to an older woman who’s been saving for many years. Her gross income is $165,000, her total tax payments are $50,000 and her net worth is $3.5 million. Despite having a far larger tax bill, her taxes represent 1.4% of her net worth. Her exposure to rising tax rates has been limited by decades of living below her means.

Smart savers free their families from exposure to tax policy.

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Takeaway points:

  1. Taxes are a component of living in a civilized society
  2. Analyze your cost of living in the largest possible context
  3. Healthcare, childcare, education, housing and real estate expenses must be incorporated in any discussion of taxation
  4. To understand your true exposure, consider taxes (and all other spending) relative to your family net asset statement

Should I Own Shares In My Employer?

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In the late-90s, I committed half my net worth into an investment scheme sponsored by my employer. The scheme was effectively leveraged 20:1. The deal worked out and was part of how I doubled my net worth within 24 months.

Emboldened by my success, in the early 2000s, I ended up with 100% of my net worth in a startup that was effectively leveraged 30:1. Taking out a home-equity loan, to cover my living expenses, triggered a desire to sell down my exposure.

The second deal worked out OK but it was painful. My returns fluctuated between +100% and -65% per annum. The ride up was fantastic, my net worth swelled 1,500%. The ride down was far less fun. In four months, the company crashed, I was unemployed and I watched 50 years’ living expenses go up in smoke.

So my answer, about owning your employer, is, “it depends.”

Depends on what?

Age – How old are you? What’s the implication of losing everything in the company, including your job? How long will it take you to earn your capital back?

The first time that I “bet the farm” I was 28 years old and able to save five years living expenses for each year I worked.

The money that I lost with the second gamble is gone forever. I’m grateful that I restructured my life to sustain that sort of loss.

Total Net Worth – What is your exposure as a percentage of your net worth? What is your exposure in terms of years living expenses?

Annual Free Cash Generation – Put your exposure in context. Based on the cash that you can save this year, how many years savings are tied up?

ProTip: the free cash generation check is a good way to review personal debts as well as the capital that you have tied up in your home. As our earning/saving potential changes, many of us are more exposed than we realize.

The above is an important cross check. If you’re sixty years old and 10% of your net worth represents ten years worth of savings… then you’re in a very different position from a twenty year old where 30% of net worth might equal six months worth of savings.

Reserves & Undrawn Bank Lines – after you make the investment, what are your liquid reserves and undrawn bank lines? Look at these in terms of gross annual salary, core family cash needs and your family cash flow forecast. How long can you last if everything blows up?

In my case, 50 years of living expenses went up in smoke but I knew that I had five years to figure out what to do.

Not wanting to make my life too easy, I had three kids in that time, which tripled my core cost of living. I didn’t anticipate that shift, but you can.

Contingent Liabilities – Does the investment have the ability to make further cash calls? Housing Associations, home ownership, private equity funds, partially paid shares… all can make cash calls at short notice.

Finally, be ruthlessly honest when you estimate your true exposure:

  • Salary
  • Bonus
  • Vested Equity (Shares & Options)
  • Unvested Equity (Shares & Options)
  • Pension / Retirement Account Exposure
  • Cash that you’ll spend if your employer disappears

The employees of Enron, Arthur Anderson, Lincoln Savings & Loan, and Lehman Brothers experienced a severe shift in less than six months. There are many more stories but it’s human nature to talk more about the boom, than the bust!

A Fiduciary’s Reading List

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I’ve completed William Bernstein’s recommended reading from his eBook, If You Can.

The reading humbled me. With a 1st Class degree in Econ / Finance, and 20 years experience in international investing, I was left feeling intellectually arrogant and ignorant. Each of these books challenged my beliefs while explaining financial history.

I’d recommend making these books compulsory reading for your advisers and key family members.

Good people can be found in the field of finance. I appreciate the significant time that each of the authors spent to educate willing readers.

The Millionaire Next Door – introduces the key concepts of wealth, saving, investment and taxes

Your Money & Your Brain – a solid summary of the latest on behavioral psychology as it relates to finance and investment – why I will always fool myself

The Great Depression: A Diary – an inside look at what it is like for a conservative, professional family to live through a depression – 2008-2010 was easy compared to the 1930s – could your family survive on minimal income for multiple years?

All About Asset Allocation – the early chapters were the most useful – simple explanations of the role that volatility plays within a portfolio – reading this book, you’ll be tempted to seek the perfect portfolio mix – my decision has been to keep it simple

Common Sense About Mutual Funds – a wealth of information – Bogle picks apart the industry by making his case for simple and low-cost investing – the book makes one wonder how brokers and financial advisers can sleep at night – readers will learn about the industry structure that silently fleeces its customers

Side Note: if you worked in finance from 1980 to 2000 be sure to adjust your brilliance for volatility and leverage using Bogle’s updated charts. We had one heck of a tailwind. Humbling!

How A Second Grader Beats Wall Street – don’t be fooled by the child-like title – this book will save your family tens of thousands of dollars in fees and taxes

Devil Take the Hindmost – a history of financial speculation – hedge funds in the 1860s & derivatives in the 1600s (!) – as Taleb says, we’re never going to get rid of greed, the challenge is to build the system so the greedy don’t inflict suffering on the good

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To Bernstein’s list, I’ll add Estate & Trust Administration for Dummies – a good primer to get you thinking outside of your own self interest.

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If you are in an advisory, or trustee, relationship then tick off one book per meeting with your professional team.

Read a book, take notes and discuss how the book impacts your family (or your firm).

Challenge yourself with exposure to the best ideas available.

Studying new approaches can be painful but we all benefit from a bit of cognitive dissonance.

My Financial Domain and Legacy

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You can find my Part One here and Paul’s thoughts on Part One here.

#3 – What are the other things in life that are critically important to me, and for which I will be financially responsible?

This is a great question.

Be sure to run your answer by your therapist.

Why?

Because people that are high-achievers and good savers tend to take on responsibilities outside of their domain. I’ve watched families make themselves miserable by taking ownership of the financial wellbeing of adult relatives.

What’s my financial domain? Myself, my spouse and my minor children.

Watching people that I love struggle is no fun at all. However, I respect the people that had the courage to let me suffer as a result of my own choices.

#4 – What are the risks in the universe which may prevent me from fulfilling my responsibilities to myself and to others, and how might I defend against them or at least mitigate their impact?

Another great question!

Humans are lousy at assessing risk and statistics. An excellent investment you can make is reading Taleb’s Antifragile – please don’t use the book as motivation to set up a personal derivatives strategy!

Pro Tip: use insurance products to insure an identifiable risk, not make investments.

#5 – If I have accumulated wealth that exceeds all of the above requirements, how might I best utilize that wealth to derive the most personal satisfaction available from life?

It’s a shame that it takes so much money for people to realize they had won before they even started.

Value your time, more than your money.

Diversify your time towards helping people that have less of what you think you need. Specifically, teach what you’ve learned.

Improve your family’s human capital, starting with your health, your manners and your gratitude to the society that enabled your success. Start with small, simple changes:

  • Physical movement AM and PM
  • Get strong
  • Eat real food
  • Be a little more kind
  • Be a little more fun
  • Optimize your health markers via diet and exercise (blood pressure, cholesterol, blood glucose, body composition)

If you are a self-made person then love the people closest to you by ensuring that they have the opportunity to prove their self-worth via their own initiative and through their own passions. Tell your kids when they impress you.

Be willing to constrain yourself to create harmony within your family and community.

Laugh out loud.

Don’t Know, Don’t Care

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Lexi's Pink BootsA story that runs far beyond your portfolio.

Like most of us, I tend to shun painful thoughts, people, experiences…

However, in reading a book on finance, Your Money & Your Brain, I discovered a better way to think, and live.

Don’t Know, Don’t Care

Rather than getting rid of whatever seems to be bothering me. Why don’t I move my life towards a position where I’m OK either way.

In the finance book, the author was making the case for passive investing.

  • What’s going to happen to… ?
  • Should I sell?
  • Should I buy?
  • Where will interest rates be next year?
  • Corporate profit margins, availability of bank credit, tax policy, insolvency risk, terrorism, politics….

There is no end of worries available to you.

If you’re following a passive strategy with a fixed monthly investment then none of the above matter.

Another benefit is I don’t have to follow the noise that’s constantly pouring out of the media.

Once I saw the logic of changing one area of my life, I started to consider the other areas where I trade happiness, for worry.

Step into the mind of young woman:

  • Will they like me?
  • What will they think about my shorts?
  • Do my shoes match my outfit?

Sweetie, I don’t know but I think you’re terrific.

The “don’t know” strategy doesn’t make me immune to the opinions of others, but it gives me a mantra to occupy my mind on something more useful than worry.

Life is none of my business.