Tuesday mornings together. Storm skinning at Eldora Mountain, above Boulder.
January is the month where I pull together financial information and think strategically about how I allocate time, and money.
One of the most useful tools for understanding what’s really happening… as opposed to what we think is happening, or what we budgeted to happen… is an operating account.
I’ll illustrate with a range of examples.
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Cash movements matter.
If you’re going to get ruined, financially, then it will be due to running out of cash.
So, how to track the cash?
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Family Joint Account — every dollar that runs through my household leaves via a single checking account.
Annually: I do a 12 month search on every credit entry into that account. Where did I get my cash?
Monthly: I check total outgoings in the account. How much did we burn this month?
This gives me an understanding of the big picture. While figuring out how to save 20c on a gallon of gas makes me happy (CostCo FTW)… gasoline could be free and it wouldn’t move the needle for my family spending.
Knowing the big numbers, keeps me from making my family miserable by distracting us with the little stuff.
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House Account — From 2008 to 2012, we lived in a very big house.
Aside from the time spent taking care of the place (65 bags of leaves each October!!!), I was curious what this place actually cost me. So I opened a checking account, gave my wife a checkbook and took one for myself. Every-single-thing connected to the house went through there.
Monthly, check the out-goings. Boom, you know exactly what the asset is costing.
You can do this for RV, boats, second homes, you name it.
By the way, the real costs were time, emotion and opportunity cost. We fixed that in 2013.
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Nanny Account – When the kids were little, we spend a ton on childcare. It was the best money we’ve spent since being married. Always remember to structure your childcare so it benefits the marriage.
Preschool, while part of childcare, is where I give consideration to what benefits the child. Everything else runs through the filter of strengthening the marriage.
Get a debit card for the account, run payroll and all other expenses through the account.
Making the cash easy to track saves many ethical mistakes.
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Business Checking Accounts
#1 // When I was running my athletic coaching business, I had a habit of blowing cash that was in the company account. I’d use it for “business related expenses.” When there is a tax deduction, we can justify a lot of marginal spending.
To give myself better spending discipline, I set a target of paying MY WIFE’S account $5,000 a month.
Worked great. The year I started to focus on cash generation, the business saw a $100,000 swing in profitability.
#2 // These days, in my fiduciary services business, I have a brokerage account at Vanguard. Right now, the account invests in a money market fund (VMFXX). To see what the business is _really_ making, I check the account balance at December 31, 2021 vs a year prior.
The business has two checking accounts. I keep the minimum balance in those accounts for free checking, and sweep the excess to Vanguard. The Vanguard balance tells me how things are going.
#3 // I sit on the board of an investment company in Hong Kong. All operations related expenses flow through a single account. Monthly, quarterly, annually… we check the outflows against what we think the operation is costing us.
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Virtual Accounts
#1 // My kids have accounts with the Bank of Dad. These spreadsheets help me teach them the power of compounding (BoD pays 10% per annum).
The first entry into these accounts is October 2016. It’s been a useful teaching tool. I break out the “earnings” component of their weekly interest and they are amazed at the “free money” they earn from investing with me.
#2 // My own Dad lives outside the US and has me pay things from time to time, we have a simple spreadsheet we use to track (Item, Amount, Date, Reference).
We’ve been rolling it for three years. So, much better than when I used to run QuickBooks to track family spending outside my household. We check the total at the start/finish of the year and we know the cash outflow.
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Cash Tracking
Rather than making myself miserable with (endless) low-value bookkeeping, I do a monthly review of every account where money can leave my life.
I enter the closing balances for everything. I compare account balances, and totals, to the prior period. One page.
I also run a monthly cash flow projection (March to February) so I remember to make lumpy payments. One more page.
Federal / State / County Taxes
Insurance
Retirement account investments
All of the above by legal entity, subsidiary and currency
When I create the forecast, I insert calendar reminders (7 days ahead) to make sure I haven’t swept the cash away.
I nearly bounced a payment to the IRS this month, so the system isn’t perfect but it’s better than jamming my head with dates and payments.
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All of these systems let me quickly get a feel for the key numbers in my life. They let me know what’s happening with a minimal investment of time. With accounting, it is easy to spend hours (and hours, and hours) bookkeeping, while generating zero useful information.
The overall system quickly shows me when my expectations are out of whack with reality.
My inability to remember facts does not remove the ability of the past to influence my choices.
I want to move closer to my kids’ schools. The idea is to free up time, enable them to socialize with their pals at our home, and cut my annual car-hours.
Win, win, win.
Thing is… my local real estate market is not acting appropriately.
Median prices up 35% year-on-year (sustained upwards price momentum)
Lowest inventory on record before…
We lost 1,000 homes due to the recent Marshall Fire (constrained supply)
Mortgage affordability at multigenerational lows…
With a near-term expectation of increasing rates
It’s a perfect storm and creating a frenzy of FOMO-driven bidding.
It’s not just in real estate.
Three-year total returns on SP500… 31%, 18%, 29%… a dollar invested at the end of 2018, now priced at two dollars.
If you rode that wave at 2:1 leverage then you’re up 4x. Nice work, especially if you’re taking a share of profits on other people’s money.
The above puts 7% inflation in its proper context.
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I need to allocate capital in 2022. I’ve asked a wide range of contacts for ideas. One buddy responded with a series of questions:
What did you do the last time you had to make this decision?
What did you learn from your prior choices?
What is the impact of being wrong, both today and in the future?
Where are the sunk costs, and FOMO, in this decision?
You have time to make these choices, be wary of collapsing your decision timing, maintain your freedom of action as long as possible.
The questions above are the value for you. The next section is notes for my future self.
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At the last peak, just before the 2008 credit crisis, I bought a really big house (about triple the size of what we needed). I over-bought because I felt flush, after a liquidity event. Fortunately, I held a chunk of my investment capacity in reserve and was able to buy into the recovery (2010-2012).
It would be nice if a “buyer’s market” was around all the time. Life doesn’t work that way. In my lifetime, buyer’s markets happen six months per decade. Families need strategies that work for the other 95% of the time.
One of my goals is to avoid strategies requiring directional calls. In our case this means we will sell an investment property, before purchasing a new residence.
Downsides with selling: (a) the potential to “miss out” on the continued run up; (b) crystalizing tax liabilities; and (c) being priced out of the market if there’s another 35% pop.
The downsides are real but they don’t have any impact on our quality of life. This is a lesson. Identify fears, concerns and risks… write them down, make then real and ask… what are the true costs associated with them and does that matter to what the family is seeking to achieve.
Accepting the downsides enables us to avoid things that would impact our lives: being over exposed in a downturn and risking a future cash squeeze.
Also, think about family “problems” from a non-ownership point of view. Having “ability to own” creates a bias towards ownership. Many goals can be reached without deploying capital.
Take my desire to reduce time spent driving the kids around… $9,000 per annum buys me a lot of driving support, Looking at the problem in terms of money and time, I’m $25,000 away from having a third driver (our oldest) living with us.
I also know that I don’t need to remove a problem to feel a lot better… $100 a week worth of driving support is going to make me feel a whole lot better. So $10,000 of spending could solve a “problem” that’s nudging me to move across town.
…and I don’t need to place a large, new bet
…and I don’t need to go through the hassle of moving
Related to my story about solving problems without capital / ownership…
The joy from “being a coach” is different than the role of running a coaching business.
The satisfaction of teaching is different than the reality of running a school.
Purchasing assets nearly always constrains freedom of future action, in a world that’s constantly changing.
If you are a skilled practitioner then be wary of placing yourself in an administration role.
You don’t need to own it, to benefit from it.
Something about this melt up… Family net worth has exploded upwards but there hasn’t been big changes in family balance sheets.
Put simply… real estate is worth a lot more but it’s the same addresses, it’s the same assets.
The capital stock is the same, all that’s moved is the price.
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Another way I look at wealth, cash flow. Take the SP500… it’s doubled in price.
End 2018, $100 generated $2.14 in dividends.
End 2021, the $100 is now worth $200 and generating $2.54 in dividends
The 100% increase in price, is associated with a 19% increase in cash flow. One could argue that 80% of the increase in “wealth” has been a price move.
Using earnings yield, the numbers are different but the message is the same. There’s been a large price-driven move across our portfolios.
I see the same thing with real estate, a disconnect between price and cash flow.
When we look to the crypto-bros and think their gains aren’t connected to reality… humility could be in order.
Look at family assets in terms of years current spending.
Re-price those assets on a lower-multiple of cash flow, then see the impact on time (measured in years current spending).
You still OK?
Consider: What might this choice cost me, and my family, in terms of time?
My best decision of the last 20 years was moving away from a path that could wipe out my (enviable) lifestyle. I was in the middle of the 2005-2007 boom so the risks seemed very remote.
I made two changes: (a) banked the equivalent of ten years family spending off the table; and (b) removed all personal recourse funding from my life.
Then, as now, I didn’t have to make radical changes. I made adjustments to limit the downside from external financial circumstances.
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My points…
Consistent upward price moves are impacting our collective psychology.
These moves are mostly price driven.
Because price moves can happen in both directions… consider risk in terms of how much time you lose with an error.
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Finally, raise your prices!
If you can generate recurring cash flow (for yourself, or others) then there’s never been a better time to re-price your services.
$100,000 of cash flow is being priced at $3-5 million by many markets.
Our youngest. My kids did their first bouldering competitions this past year. Climbing is a fun way to build upper body strength and gain confidence.
Twelve years ago, I found myself in an uncomfortable position. I had unlimited liability related to a nine-figure (USD) corporate insolvency.
It was a reminder => assets are best protected before they need protection.
After the dust settled, I went to work, adjusting the legal structure of my life.
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Below are ideas for you to discuss with tax and legal experts in your local jurisdiction. Always keep in mind that you are not trying to avoid tax, you are seeking to avoid ruin.
Once you’ve spoken with the trust & tax advisors, invert the situation and spend time with an expert litigation attorney. Find out what they are looking for when they decide to go after someone’s balance sheet and future earnings.
Financially, there are two things I want to deliver to my kids:
Debt free education to the best of their ability (5-20 years time horizon); and
US$ 250,000 (15-25 years time horizon, 2022 purchasing power) per kid
The debt-free education is what I really care about. Get that done, and model wise choices, they won’t need any financial support from my generation.
Aiming for a capital bequest forces me to be conservative with my own choices, greatly reducing the likelihood my generation becomes a financial burden on the one that follows me.
The financial deliverables, to the kids, are done within my life expectancy.
My true legacy will be non-financial in nature.
529 Education Accounts – Our contributions had the benefit of a state tax deduction, which mitigated the increase in expense ratio. Gains and income roll up tax free. The assets can be swapped widely within families, and descendants. Assets sit outside the contributor’s balance sheet, and are treated as a completed gift. This can be an effective way to build assets for kids, grandkids and between extended family members.
=> This provides comfort, today. Having that much capital tied up in a non-discretionary account constrains my action. I ignore these dollars when I plan for the future BUT I can also ignore the contingent liability of wanting to help my kids get educated.
=> I also give them a big financial incentive for figuring out how to educate themselves, for less. In my mind, that money is already “theirs.”
Other tools:
Irrevocable Trust – if you are in a line of work that could result in litigation, or simply don’t want to give a financial incentive to anyone to sue (or divorce) a member of your family, then this can be an appropriate vehicle to establish. Assets within the trust sit outside your balance sheet.
Intentionally Defective Grantor Trust – an irrevocable trust where the tax liability stays with the grantor for their lifetime. A benefit of this trust is the income, and gains, associated with the assets are rolling up outside the grantor’s balance sheet, gross of tax.
=> example here might be a high-earning professional, in a field prone to litigation, setting up a trust to benefit their spouse/kids.
=> another example: I stick an investment property in a Grantor Trust and it rolls up to benefit my kids. That’s the capital bequest I want to deliver. Worried about possibly needing the money? Then one could add their spouse to the beneficiary class as a hedge against future circumstances.
There are other asset settlements, and other trust structures, that can be effective for families. Experts can tell you more.
Contingent Beneficiaries – Talk to an estate attorney about using a trust as a contingent beneficiary of any inheritance you might receive. Wills can be drafted offering you the ability to disclaim assets in favor of a trust. Separate from asset protection benefits, this could be a useful feature if the taxation rules around estate taxation change.
=> example: in 2021, the estate tax threshold is US$11.7 million (double for married couples). Current law has the threshold dropping to $6.2 million in 2025. Go further… what might happen to your potential estate tax liability if that threshold went to zero? Ask your local expert to explain how you can use part of your $11.7 million exemption, today.
Private Trust Company – how does one “run” the entire structure without ownership? Establish a private trust company and have someone reliable act for the corporation, this individual could be a family member, or not. Be very careful with decisions/officers concerning: investment strategy, trust agreement amendment capacity, beneficiary classes and distribution policy.
Move slowly, with intention.
Done well, these structures do not cost much (to establish, and to run) relative to the benefits they offer.
Thinking Ahead – with all this stuff, it’s not about where your family is “today.” Think about where you might be 5, 10, 15, 25 and 40 years from today.
Our 529 Accounts are an example. We set them up when the kids were born, contributed heavily in our high-tax years and did “nothing but watch.” They’re super flexible and my kids could elect to roll them forward.
The Grantor Trust => set up many years ago, it didn’t seem like it received a lot of assets. However, those assets have been compounding for a long time (gross of taxes). Change the tax law, and extend my lifespan, a trust could save real money for my family.
Try to cast your mind back, say, to 2009. Asset values had been hammered. Roll forward to 2021, many assets classes are up by a factor of 3-5x and salaries in your field are likely up 2-5x. If inflation cranks up for a few years then the thresholds will seem even closer.
All Family Is Optional – We’ve built everything with the ability to be collapsed, split and changed… changes will happen after my death (certainly) and late in my life (with my consent). Siblings, blended families, step-parents… anticipating a split into separate vehicles should be the default position.
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Things I learned from the process:
Our structure paid for itself in reduced insurance premiums.
Despite in-family expertise and external professional advice, “getting it right” took years and a few iterations.
Move assets slowly and watch what happens. My kids’ financial education started in kindergarten. Next big step will be discussing allocation of 529 accounts – use, roll forward or trade? When appropriate, discussions about intergenerational capital allocation.
Take advice from an expert in establishing these structures then… take advice from an expert at attacking your proposed structure. Know what can go wrong before you make irrevocable changes to your family’s balance sheet.
Give each generation, and each individual, the flexibility to live their life as they see fit.
Remember, seek local advice. This post is meant to get you thinking, not offer professional advice.
Everyone completed the “summer” reading challenge! Across the time period, our oldest became a teenager. I’m probably done trying to “push” her at anything. Although, there has been discussion of a cash prize for getting to know the local transit system via 100 bus rides to middle school. 🙂
Like all my stuff => this is not advice to your family. Speak with local experts before making tax, legal and portfolio changes in your life.
Iñaki asked, “what to do when the world seems crazy?”
I build my life so I don’t need to be right.
Related, I want to be able to unplug for 72 hours, without worry, whenever I feel like it.
This strategy is based on knowing that I’m prone to error and don’t want to spend my life connected to the matrix.
Further, even if you have 100% confidence in yourself, your kids/spouse are going to need something robust for when you’re gone.
Across 2019, I wanted to lean into equities but there wasn’t an event that gave me an opportunity. So I rolled along, rebalancing and living my life.
In March 2020, the pandemic created an opportunity. Personally, I leaned in (fairly hard) by increasing %age exposure to equities, at a time when rebalancing alone would have triggered buying.
In a fiduciary capacity, we only leaned a little. Two members of my investment committee, with wider views of the world, advised caution. Using the principle, most conservative view rules, we were conservative with allocation.
Both decisions made sense at the time and worked out.
Time matters. “Good enough” becomes more powerful the longer your time horizon.
Returns across generations are driven by a famous Munger-ism => “just try not to be stupid.”
The family’s position, 10 years past every generational transition, is impacted more by what you burned than what you earned.
At the end of 2021, given the whacky stuff I’m seeing around me, I don’t plan in leaning in at the next correction. Rebalancing will be good enough.
Recreational Capital and Associated Spending
A dominant focus on return/allocation in your financial portfolio, misses an important source of value creation => efficient use of “recreational” capital, and associated spending.
Recreational capital is any asset that’s held for non-financial reasons. This is a material slice of many balance sheets:
Boats, RVs, Cars
Offices
Second homes, vacation properties
Sizing up personal residences
Renovation projects, furniture, collectibles and art
Charters, vacation spending, travel spending
Any asset with a negative yield
You’ll see I included a line for the expenses associated with those assets. Some assets, when bought, lead to more spending.
By way of example, INVERT and consider…
When you sell all your assets in a remote location then… the spending associated with the location will plummet. Now that we spend our summers “at home” vs commuting to/from Canada, we cut spending by a big number.
Even if you don’t buy… for skiing, we stopped renting a condo in Vail. Our 2021 ski season cost will be less than what my last rental cost me. Skiing is a choice with a stack of associated spending, and negative-return investment opportunities.
It would be nice to think that these decisions were driven by being smart. That would be a mistake! The Canadian exit was driving by local tax policy and COVID forced a change in approach for skiing.
We did not realize the true cost of our “recreational” choices. We had to remove them, and watch for a couple years.
The choices above:
Create a larger working portfolio
Reduce annual spending
Increase the flexibility to change one’s mind
Don’t involve admin, maintenance or exit costs
In our financial portfolio, conservative nature means we “missed out” on much of the run up. However, because we adjusted our recreational capital, and associated spending, we greatly increased wealth over the last five years.
The wealth gain, from shrinking the recreational portfolio, is locked in. These gains are hidden from conventional metrics, that your advisor might show you.
Now we move along to KC’s questions
GB: total debt will remain modest relative to assets and cash flow
KC: How do you define “assets” and “cash flow” here? Completely paid off asset or total value of asset? All assets – or just the assets on the investment side (excluding primary home?) Cash flow from all sources after expenses? What do you define as a modest target?
I have a spreadsheet that shows me… gross asset value, deferred taxes, tax basis (as at last tax filing year) and deferred agent’s fees (for real estate). So I can quickly look at real estate from gross to net after-tax realizable value. I compare those figures to gross rental income, and net cash flow (from my tax return).
I’m conservative with gross asset value on real estate, a discount from Zillow and my real estate agent’s estimate on value.
I assume 6.3% cost to exit, from real estate gross value, then tax the realized value at 25% of the gain over basis.
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Cash Flow
I look at… total debt service, core cost of living, total cost of living => each of those numbers gets a little bigger, and I have less control over delaying payment/spending.
Then I look at the inflows by source…
real estate (net and gross — consider vacancy risk)
employment (by role and client — consider concentration)
passive (royalties, dividends, distributed gains)
I want to understand my concentration in expenses (what I can cut/control) as well as income (where the risks lie). I never want to be placed in a position of being a forced seller.
My total family debt stays under 10% of net assets. Assets calculated net of all taxes and agent’s fees.
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The Role of Time
My thinking in my work, and family, is multigenerational… I look at assets, leverage, cash flow and spending at many levels…
What I actually own, owe, control, earn => me
Family level
Family & Corporate level => me, my family, my business
Multi-generational level => consolidated, over time
I think about expenses, earning power, saving power, asset utility (what benefits members) over time. I have a spreadsheet that projects the age of all living family members over time (2021, 2035, 2050). This helps me consider family asset strategy and consider when generational transitions are going to occur.
KEY for assets and cash flow => When generations stop working/saving, when kids start working/saving?
It’s not just “what you own.” It’s also when you own it, and when you sell it.
I see many people buying assets they will HAVE to sell in ten years time, mainly real estate. Now, if it’s your main home, then I get it. See below for the option value in the mortgage.
In this market, Boulder up 30% this year, it’s easy to convince yourself that you are silly not to supersize your balance sheet.
But if it’s a secondary market…
10% in/out cost for the real estate
vs…
Less than 1% cost to go variable (AirBnB, Hotels.Com)
Total flexibility with capital (you don’t deploy into a low-occupancy, negative yielding asset)
No admin hassle (I really dislike organizing maintenance and cleaning)
Why are you doing it?
If you want to dazzle peers, suppliers and key relationships… …then you might be better off with a high-end club membership.
Your mind may try to convince you the joining fee is a waste of money. Note that the club joining fee is usually < 5% of a condo cost, and club dues run <10% of the condo’s cost to own.
With leasing we compare to “do nothing” => most people with ready finance will “do something.” If you’re going to do something, regardless, then something smaller can be a better option.
Your mind doesn’t see the rest of your portfolio performing better, with less hassle, by not owning an asset that’s a drag on return.
And… my mind at least, doesn’t remember how much I hate cleaning and dealing with remote maintenance issues!
KC: Tax bill as a %age of net assets-Where do you think a healthy range should be?
Every year, I look at the tax bill relative to net assets on a consolidated basis. This lets you consider the impact of tax policy on your portfolio – smart savers free themselves from exposure to changes in tax policy. Taxes paid, as a percentage of net assets, should trend downwards over your working life.
I don’t think the taxes vs net assets number, itself, is important. What matters is trending down and asking yourself if you are worrying about the right things in your life. Lots of (wealthy) people fail to recognize how little impact the Feds have in their financial life. Others could use a nudge to save more, spend wisely.
GB: At that point, you’ll have built yourself an inflation-proof, tax-effective retirement annuity
KC: Can you help me understand the inflation-poof aspect of this strategy? Is it the income producing asset that is locked in at an low interest rate? How is RE more inflation-proof than other assets?
Real estate isn’t “more” but it can be “different”.
Local rents are influenced by local real economic growth. I like the prospects of Boulder, the Front Range and Colorado.
Local real estate values are influenced by macro (national interest rates, credit cycle) and local (replacement cost, demand) factors.
So a slice of local real estate can create an element of hedging between national, regional and local conditions. There are some other benefits…
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Hidden Options
Here in Boulder, Colorado, I believe our real estate values have a hidden option. There is a chance the best neighborhoods explode upwards towards the highest valued parts of: the Rockies (Vail/Aspen), California (Bay Area) or NYC.
Now, I don’t have the $$$s to own trophy properties, but I don’t need to. As I wrote in The Next Doubling, it’s good enough to be nearby. For the option to pay out, we don’t need to get to the highest prices per sf => we merely need to close the gap, a bit, over time. That sort of option doesn’t exist in an index fund.
Another hidden option => we own a two-unit rental. We always have the option to move into one of the units and “live for free” by renting out the other unit.
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Option Value of Fixed Rate Debt
30-year fixed rate debt, with an option for the borrower to repay, is a valuable (oneway) option in an uncertain world. Unlike margin debt, the lender can’t call the loan on a whim.
Long rates have been declining for 40 years, so the value of this option is overlooked by many. In an inflationary environment, having a multiple of my core cost of living in low-cost fixed rate debt is a useful position.
A mortgage on a personal residence seems like a good deal to me……and if it turns out to be a bad deal then I exit via repayment or refinance.
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Saving 2% p.a. and giving Goldman an option to close you out…
Quick note on margin debt, even at <1% p.a. cost, seems like a very bad idea.
Smart people borrowing money they don’t need, to make money they are unlikely to spend in their lifetimes. Everyone figuring they will be able to unwind their financial structure before anything bad happens to them.
This strategy never ends well and only makes sense when you are playing with other people’s money.
A general principle, some things only make sense when you ignore the rebound. Fasting, margin debt, intensity-bias for endurance sport… I have found one gets a better long-term result from building smarter habits.
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Optimize over time. When I started paying attention to myself, I realized I needed a whole lot less spending, which implied less capital, which gave me much more time.
INVERT that last sentence => spending you don’t need, increases the capital you think you need, to spend more time doing what you want. I broke that cycle in 2000, got wrapped back up in it in 2005, got tossed back out during the 2008/2009 recession and, these days, cycle in/out depending on my moods!
Nearing 53, I laugh because “less” is being forced on my physical life, by time.
In my early 40s, “less” happened due to kids and a nasty recession.
In my early 30s, “less” felt liberating, and made time for a lot more self-directed time.
Summer reading prize – read aloud challenge. I had to offer his older sister a “bonus”… If your boss offered to pay you, AND send you on a vacation, then would you do a 100-day training program that required a mere 12-minutes per day? When she said “hell, ya”, I pointed out that she needed to get the reading challenge done before I would be paying for any out-of-state swim meets.Dressed up and out of the box! Pre-, and post-, flight COVID tests enabled us to enjoy a normal wedding in Cali. So great.
What is the underlying goal of childhood financial education?
=> Self-generated, lifelong financial stability
I’ll run through to tools we use to equip the kids to pay their own way in life.
Allowance => simple formula: weekly deposit into an account with the Bank of Dad, deposit is $1 for each year of age, and the deposit balance earns 10% per annum.
Many families view the purpose of an allowance to teach a kid how to spend.
We don’t.
The purpose of an allowance is to create a positive emotional association with the power of compounding.
Our oldest has been rolling her allowance since Kindergarten. She now earns $7 per week from compounding and $13 from being 13 years old.
Compounding is an ever growing sum. When they enter high school, I’ll run through the math behind it. I have a spreadsheet by week.
In time, I will let them know I grew my net worth by 15% per annum for many years, mainly by saving half of what I earned. This habit bought a lot of time.
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To put off the discussion of “why am I saving?”, I have them pointed at “saving up for a car.” When we get closer, we will sit down and look at the impact of swapping their earnings (from doing nothing) with a set of bills for owning a car (insurance, maintenance, taxes).
Uber is going to look VERY attractive against 10+ years of compound interest. That lesson plan might be: keep depreciating assets variable and stay invested.
Earned money is their money – this has resulted in a house full of Lego
Earned Money Is Their Money
To effectively learn about spending, one needs to earn the money being spent.
This is because spending other people’s money feels different.
Sometimes really different…
Spending other people’s money, with a credit card where you don’t see the bill, feels better than free!
Don’t hook your kids on this form of pleasure. We tell ourselves all sorts of BS to self-justify this situation.
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Our greatest financial achievement in 2021 happened by accident. We got our oldest off the payroll. She started babysitting and stopped asking us for money, for anything!
This opened her up to the real world of: lending money to friends, spending paycheck-to-paycheck, buying poor quality goods on impulse…
…and because it was HER money, she learned very quickly from her errors, and her friends were not (indirectly) placed on our payroll.
Self-Earned Money + Scarcity + Freedom to Err = Learning
Also… “if you want to buy friends then you’ll have to do that with your own money. Your choice. I think you are a star.”
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Our other kids aren’t old enough to babysit, yet. They get assistant sitter gigs, and do yard work in the neighborhood. The work pays well in kid-terms. I supplement with odd jobs.
This is enough to make the whole family “kid rich” => rich enough to buy whatever they want, from their own money.
Quite often, what they wanted was LEGO and it was tempting for me to use my own money to “make them happy” thereby facilitating consumption.
One of our family values is we each pay our own way. Elders are to avoid facilitating consumption. With this in mind, I made a choice to reward my kids with time and I remember…
When you are spending other people’s moneyyou can easily get trapped into dreaming of more, more, more.
This is because we are chasing something stuff can never buy. The journey of adulthood is about discovering our personal “what.”
Quietly, I watched nothing happen with the birthday present…
With the shift towards their own money, supplemented by Christmas, birthday and summer reading prizes… they noticed…
New stuff is fun, but only for about a week, then it sits on a shelf.
I let it sit on the shelf, for years, then one day…
I never play with my Legos, they are kind of a waste of money…
Jackpot!
So the current lesson: we buy luxury goods at retail and sell them at wholesale (if we are lucky!).
Thanks to a very kind cousin, we are in the process of converting Lego sets to cash. Lesson to come will be comparing “cost to buy” against “net realized value from sale”.
Breaking down the sets and preparing for sale
“If you want an iPhone then earn the money to buy it”
In 2020, our oldest sold 200 masks, at $5 a mask, to earn the cash to buy herself an iPhone. No social media on that phone and we financed the sewing machine and materials. She handled marketing and mask production. She shut down the “business” the day after she had enough for the phone!
To recap
Allowance creates a positive association with compounding
Earned money is their money
Listen to their errors, give time and positive attention to their lessons
Celebrate “getting off the payroll” => they also make their own lunches, another big win.
Let scarcity teach and create incentives to reward work.
++
Basic Cleaning
A valuable lesson for them, weekly humility training for me…
We split the house into Five Zones:
Kitchen
Carpets
Cat Room (dirtiest room in house, done by our youngest)
For the families I work with, the information inside is probably worth an additional ten years of self-allocated time. Ten years, the parents could allocate to their kids, rather than building assets. Or even allocate to yourself.
If we slide into the investment world, the information is worth tens of millions. Just sit and listen to any executive who controls a budget over $250 million, or listen to the debates within your city council. Boulder city budget creeping up to $500 million for ~100K pop. Down the road, City of Denver has a ~$1.3 billion budget.
Unforced errors are easy to spot when watching others. More valuable is to teach yourself to notice how you are being pulled into spending more. Personally, my top unforced error is $275,000 and I’ve come across mistakes in excess of $1 million.
Our emotions can lead us astray. Be particularly wary of having sadness triggered… “I wish I could have that…”
Whenever I notice that feeling, I stop!
My first line of (emotional) defense is slowing down the process.
What’s the car off the lot? It’s the deal that gets you onto the lot.
I’ll compress three trips to the dealership and a month of research into a story…
When you arrive, the first thing you see is the anchor.
Or, in the case of fashion, it’s the purses/dresses in the display cases with discreet (but astronomical) prices displayed.
It’s the jacked up Denali Super Max Monster Truck, blacked out, with 48-inch tires, that’s driven onto a rock and visible from the street…
Locally, our Toyota dealership puts out a PRO and prices it $10,000 over MSRP. Thereby setting a $60,000 anchor in your mind. Each year, this car comes out with a unique color scheme, and a special type of roof rack, so connoisseurs can instantly ID the driver’s status.
While they’d be very happy to sell you the PRO, it’s not the lead vehicle. What they really want to sell you is one of the four (!) OFF ROAD parked right beside it. They have $10,000 worth of options and are priced at $49,999 (-ish). They are lifted, with gleaming knobby tires and they have swapped the decal so it is badged “PRO.”
With that $60,000 anchor in my mind, the sexed up OFF ROAD certainly felt like a deal. I could “save” $10,000 by buying it, it was right there…
But where was that basic OFF ROAD that I saw on the internet?
We went into the salesman’s office and pulled up the dealership inventory.
G: Sort the OFF ROAD trims by price for me, thanks.
Salesman: The system won’t let me do that.
G: OK, I’ll just have a look.
Salesman: Sure
G: What about that one?
S: It’s not the color you wanted.
G: That’s OK, let’s have a look at it.
S: It’s at a remote lot.
G: That’s OK, I’ll wait.
30 minutes later, it rolls up. Homeboy was not in a rush for me to see this vehicle!
Eventually, I’m out of there with an extra $20,000 in my pocket.
By the way, the dealership still did well. I was emotionally tired and didn’t haggle the last $$$s out of the car and my trade-in.
Three trips to the lot and a month of thinking it over. Slowing myself down is the best defense against emotional purchase errors. These techniques, and much more, included in Priceless.
In my financial life, I have a system to slow myself down => a disinterested person sits on my investment committee and oversees every proposed change in strategy.
The remote, disinterested mentor => valuable!
Three things to notice in all purchase domains…
What’s the high anchor?
What do they really want to sell?
Where is the “car off the lot” => their best deal?
These three things exist in every purchase offering: Anchor, Target Sale, Hidden Best Deal.
Multi-unit apartment complexes
Home appliances
Luxury retail
Jewelry
Hotel rooms
Ski passes
Groceries
Show homes…
See it for yourself, and always take the initiative to set the anchor.
…then teach your kids.
Yes, you can afford the high anchor. However, your family system will do far better if you invest the money you save, buy yourself time and improve your human capital.
Also remember, every beneficiary, and dependent, sets a low anchor on the value of unearned money.
Unfortunately, we can’t change the reality of being influenced by knowing about it! The only thing that works is building systems around our human nature.
Fortune’s Formula by Poundstone was recommended inside Safe Haven. The book touched on a number of questions/issues I’ve been pondering since attending Taleb’s seminar in October 2019.
Very helpful book!
What follows are a bunch of points I’m writing down so I can refer back later.
Insurance proceeds: Will I be able to access my money when I need it? Applies to everything, especially exotics.
All families are sellers, eventually.
This is an important point because crashes are most damaging when one is forced to sell into them. Ironic point is many (most?) of us choose to sell into them (or in fear of them).
Recently, I came across an article about CalPERS selling billions into a dip – even smart people make poor decisions, most often when they are custodians of other people’s money.
Most institutions have shorter memories than families. Keep reminding yourself of your mistakes – you probably paid a lot to learn your lessons.
Train yourself, and your kids, to be able to tolerate bad news. It saves time, money and emotion.
Counter-party Risk
Payout => who’s on the other side of my insurance trade and are they going to need a bailout to pay me? If my insurance company might need a bailout then am I really insured?
I’ve done my best deals when all buyers have disappeared. A delay in payout can have a huge opportunity cost to me.
Skill => reading financial history, I notice the people on the other side have… better analytical skill, superior computing power, faster capacity to execute, better (and inside) information, favorable leverage terms, assistance with “techniques” to defer/avoid/evade taxation.
These folks are on the other side of everything I do.
Ruin
Steer clear of most bets where there’s a chance you could lose all your money. Many useful examples in the book.
This doesn’t mean to avoid all loses inside a portfolio. Highly volatile bets can make sense when limited in size.
This does mean avoid creating a portfolio (or lifestyle!) with the potential for total loss.
Kelly Criterion
I do not have faith in my calculations of the probably of real-world outcomes. For me to use Kelly, I need to have a feel for the odds of various outcomes.
Using Kelly weighting (even fractional) runs the risk of fooling myself about the total amount of risk I am taking on. There’s probably a way to work backwards and see the implied odds within various prices – I do not have confidence in my capacity to compete with experts in the arbitrage pricing domain.
That said, the key point I took from the discussion, “never bet an amount that results in a chance, any chance, you’ll be removed from the game.” This calculation is simple to calculate and easy to execute.
Downturns & Drawdowns
With this in mind, there’s an important point about investing for long-term wealth. The likelihood of a major drawdown and the cyclical nature of exponential growth.
Put simply, most families, using a long-term wealth maximizing strategy, will spend a lot of time being “less wealthy than they used to be”. Page 228 of the 1st hardcover edition.
BIG POINT: many families trade a ton of return to avoid this reality // OR // over-bet in the short-term in an effort to avoid normal downward wealth fluctuations.
Worth emphasizing! Most people trade long-term return or increase their risk of ruin to avoid natural fluctuations in wealth (and fitness, for that matter).
Very few people have the emotional make up to roll with the punches when it comes to volatility.
One way to hedge yourself is to maintain the capacity to cut spending so you maintain your “net worth / cash burn” ratio. I write about this a lot because it can give you an emotional edge during a crisis.
Buyer Beware
OK, you say to yourself, I don’t understand how to tail risk hedge so I’m going to use an outside expert to do it for me.
Not so fast!
Focus on your day job. Be really excellent at what you know well. In your financial life, be extremely conservative.
Because…
In every field I’ve gotten to know well…
As a class, insiders consume the excess return for themselves.
There’s a straightforward way through the headwall – just take it one step at a time
Last week, Mark Spitznagel’s book came out (Safe Haven). Don’t expect any specific strategies for constructing Safe Haven insurance. Do expect to (re)learn useful concepts:
a reminder of the central role of time in our lives – the capacity to sustain action, cognizant of time, is extremely rare
a reminder that we think in terms of arithmetic averages but experience geometric averages (COVID, portfolio compounding, fitness, nutrition, body composition)
a reminder that downward moves (in %age terms) have the same impact, regardless of their position in the time series – the counter to this => absolute dollar losses are best taken later in the time series (down $100,000 wipes me out at 25 y.o. – not so at 60) // by the way, creating negative net worth early (via education loans) is a very nasty geometric headwind.
a reminder to consider the cost of your insurance strategy, including the decision not to insure. Health, accidents, portfolios, relationships, nutrition => “insurance” comes in many forms.
Also some great parables/examples to help explain mathematical concepts that I’d previously failed to grasp, most importantly, the negative waterfall of financial ruin in a geometric environment.
Related to geometric returns, some useful illustrations of how/when diversification fails, despite its enduring appeal.
Finally, using Eternal Return when assessing risk. With any important choices assume you’ll be stuck repeating that choice over-and-over. I’m not sure I would have been capable of applying this advice as a young man. At 52, my life continues to benefit from this mindset (health, accidents, portfolios, relationships, nutrition…).
++
Today, I want you to think about the past, present and future.
Specifically, I want you to look backwards 10-15 years, as well as forwards 10-15 years. This will give you a 20-30 year time span in which to consider family strategy.
We call 20-30 years a generation. For family leaders, it’s the shortest period we should be considering. Let me illustrate:
2004 – met my wife
2008 – birth of first child
2032 – youngest child graduates high school
2037 – youngest child self-sufficient financially
For our family finances, a generation will be closer to 40 years than 20.
Act with 25+ year time horizons => the Eternal Return is a useful mindset for multigenerational family systems.
++
Family Earning Capacity Over Time
The biggest change of the last 15 years, for us, has been the quasi-retirement of the two largest earners in our family system. Looking forward 15 years, the biggest change will be the addition of new earners into our family system.
The shift in earning capacity every 30 years, or so.
If you are the prime earner, today, then here is a question for you. Does your family system have the assets, earning power and desire to continue to run the overheads you have built over the last five years?
Current choices can create a “geometric” headwind for the next generation.
++
Family Risk Management Over Time
The demographic that seems to worry the most about financial risk is the Top 2%. Makes sense, they own most of the assets and, therefore, have the most to lose.
The easiest way to manage family financial risk is to create a cash flow statement with many different inflows, while having the capacity to painlessly chop outflows. I’ve been working on this for 20+ years, covering fixed overhead categories with a mix of inflows.
The option to shrink cash spending is valuable. Specifically, looking at your cash flow statement and seeing how much of it you could chop, at will.
For example, there are excellent reasons to borrow right now (inflation hedge, low nominal rates, negative real rates). However, the costs and negative-optionality of debt are hidden and difficult to price – particularly in a near-zero rate environment.
What is the correct way to price the ability for a lender, or my fixed overheads, to force me out at the bottom?
How do I price the capacity to invest during the next credit crisis?
What’s it worth to not have a boss?
How much is a lack of financial stress worth?
In my memory, all the remains from the 2008/2009 crisis is a note I wrote to myself to NEVER DO THAT AGAIN. Ten years along, there is no “pain scar” from the stress I endured.
With our next generation a decade out from starting to earn, we’re debt free, and happy to be there. It’s worth more than I can prove mathematically. I do not have the capacity to think in terms of negative optionality. I can’t price ruin.
I’ll finish with another note I wrote to myself:
Moderation is easier when the prime directive is simply staying in the game.
This applies to my appetite for risk, further wealth, spending choices and personal fitness => interestingly, my greed focuses on various forms of external winning, while my quality of experience is internal.
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.
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.
Feel The Byrn 
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