Teach your kids their financial lives will be about no more than a dozen choices.
Here are mine:
Study finance (class of 1990)
Save 50% of my take home (1990-2007)
Partners investment scheme (late 90s, all in then, equivalent of 1 yr spending now)
Work to build a startup (2000)
Sell into the frenzy (2005-2007)
Move into a low-cost Vanguard portfolio (2008 onwards)
Boulder real estate (2010 & 2012))
Borrow long at 3.25% (2013)
Debt free (2007 & 2020)
Have kids with a kind woman from a humble background (on going)
Every other choice turned out to be noise. What to do?
Focus on actions, not outcome.
What does that really mean?
Do what moves you forward and have faith. Sport, marriage, money, all things… daily action is the fundamental force moving you towards “better.”
Education matters => I was given a chance in Private Equity because I had high marks in a useful field. Between my high school graduation (1986) and my youngest’s (2031) the nature of “useful” will have changed. However, the need for skilled people to “do” will endure.
The most useful part of my degree wasn’t finance! It was financial accounting, programming and mathematics => I learned fundamental knowledge in college. I learned my profession on-the-job. You learn the valuable part by doing work, for the best people you can find.
This keeps popping up over and over again (professors, partners, coaches, mentors, twitter follows). At 53, I’m learning from people less than half my age! Do work to learn.
Avoid Ruin => studying, then working in, financial accounting helps you learn when a situation doesn’t feel right. Embezzlement is an old game and it’s useful to learn the patterns. Financial fraud happens, and will continue to happen. Take steps to reduce your family’s exposure to ruin.
With the accounting, I learned the most with 9 credits spread across three courses. Financial Accounting 1, 2 and 3. Small investment, huge return. Do it when you’re young. Being forced to rely on others to do your financial math is a disadvantage that will cost you.
Let’s pull it together for you…
Starting your working life (in a useful field, with your financial accounting courses done)…
When I moved to the US, I went from a 5 to 30% tax rate.
Because it saved me money.
Taxes are one slice of your family budget
I used to live in Hong Kong, a low-tax part of the world. Thing is, it’s a high cost location – especially for school fees and residential housing.
Landing in in the US, I chose a part of the country with an excellent public school system. With three kids, that choice saved me a lot of money.
But there are trade-offs.
I grew up in Canada and my family’s basic healthcare needs were covered by the provincial government.
Not so in the USA.
My insurance, HSA contribution and dental cleanings mean I pay $25,000 before anyone’s gotten sick.
I run the $7,000 HSA contribution down against my family’s $14,000 deductible.
Anybody breaks a leg, I’m quickly over $30,000 for the year.
In my last year in Hong Kong (2000) I was living in a place that cost $100,000 per annum to rent. The senior partners paid 3-5x that amount.
School fees: friends pay up to $50,000 per kid, per annum. Mine go to public school, a $75,000 saving.
Taxes are the price we pay for living a wonderful life.
Clean air, pleasant climate, easy access to nature, an ability to avoid traffic.
As a friend pointed out, all those Californians moving to Austin are going to find out something… they’re still complaining about taxes, it’s hot as stink, they’re sitting in a traffic jam AND they lost the benefits of living in Cali.
The ability to escape tax policy is 100% in our hands.
Here’s the game.
Take your tax bill and divide it by your net worth.
In my mid-20s, I worked in London. I earned $75,000 and paid $18,000 in taxes. My net worth was $20,000. My tax bill represented 90% of my net worth.
A change in tax policy, or a move to Hong Kong, would have a material effect on my family finances.
Most of us, can’t change hemisphere’s for work.
Many of us, can work remotely from a lower cost location.
My former self, he saved 50% of his take-home pay from 1990-2008.
We are going to play a ten-year game, the purpose is to build an EMOTIONAL attachment to the power of compounding.
You’re going to need the emotional attachment to counter the impulse to spend what you have.
The best way to play is to check your portfolio no more than once a quarter. My kids have gone close to a year without asking me to update.
Give the game YEARS to play out, eventually your students will be amazed.
Investment: each Monday, each player gets $1 for each year they have been alive. I started my kids in Kindergarten so we kicked off with $5 or $6 per week.
Return on Investment: the “bank” pays 10% per annum on invested capital. My template has a little math embedded which converts the annual rate to a daily rate. This allows the player to see, and get excited about, weekly earnings.
Earned Money is Your Money: Most kids have a piggy bank, some kids have side-gigs where they earn spending money. If a player wants to invest that money then they can grow earnings faster.
There are two types of spending from the family account.
Investment spending – if the money came from “the bank” then spending approval needs to include Mom & Dad, or another savvy adult.
Earned income spending – Mom & Dad have no veto rights over money the players earn on their own. This allows real world learning to happen. Lending to friends, pain of crappy impulse purchases…
Teaching this to your kids, or grandkids, will change your relationship with money.
I’m back on Twitter, daily – sharing ideas about living better. The focus is health & wellness with financial education for you and your family.
It’s a good place to ask me Qs on my writing.
Capital over and above the needs of current adult family members can be considered multigenerational.
When I was younger, I focused on building net assets. I started saving out of my first paycheck. If a young adult aspires to a family leadership position then this is where they should start.
Looking backwards from 53, the big gains have come from moderating personal choices, particularly associated with assets that don’t produce cash flow. Being an exemplar, here, is the role of senior family leadership.
A better way of viewing financial wealth…
Assets “divided by” current-year spending => gives you a figure expressed in “years-spending”
$2 million of net assets means something very different when…
There’s $2 million of debt sitting on top of it vs being debt-free
Baseline spending is $125,000 vs $250,000
Average age of the earning membership is 35 vs 55
Time Horizon also matters!
Family is a dynamic process. I visit for a limited period of time. I change continuously while I’m here.
Years-spending can be compared to life expectancy of senior members and working-life expectancy of earning members.
Each adult member pays their own way.
This is HUGE for long-term returns.
First, because there are no “bad” deals in the family system.
Second, because the high-earners are free to live their lives in a way that most benefits the family system
HINT: teaching young members about life generates a higher return than creating more unearned capital within the family system.
Often overlooked => years left until the youngest members take over their own living expenses. Family is a dynamic process with clear generational shifts (deaths, retirements, careers, graduations, births).
Families don’t need to budget for taking care of everyone, forever. When I started my kids’ allowance, I began teaching the concept of pay-your-own-way. They’ve also been raised with an expectation that they will move out. Living nearby is OK!
As a family, you need to decide the split between future-focused and present-focused capital. Until I was 52, I was totally future-focused. A change we are gradually making is shifting some capital towards present enjoyment. I like to call this capital “recreational.”
If you are going to deploy capital in a “recreational capacity” then consider the nature, and likely impact, of a mistake. Mistakes can come in many forms. Here’s what we’ve learned.
Multiple, smaller bets, with the minimum capital deployed to solve the issue.
Make sure you factor in the cost of ownership, forever. A high cost of ownership can turn a gift into a burden. I know families who spent many years unwinding the financial legacies of wealthy elders.
Remember, the highest form of endowment is the TIME of a parent. How will this choice impact the family member’s time? Don’t tie down your most effective members with admin!
More than comfort, consider how you might be able to deliver “time” to future family members. What is it going to take to assist my children in having the time to be great parents?
Related, my children will have a range of financial “success” in their lives. Constraining myself, today, reduces lifestyle friction in the future (at no cost to their nature-loving Dad).
The role of the family is to support its members in living the lives they choose to live, not to facilitate consumption. My current choices will become the (unconscious) baselines for my grown children.
Adults have a preference for individual family utilization, over collective utilization.
From my dentist, “My kids will use my ski place a lot more… when I’m dead.”
From a friend, “They like to visit… when we’re not there.”
Single geographic locations, with separate living arrangements, have proven a popular way to strengthen families.
From a friend, “Close but not too close.”
Choose peers, and location, with intention.
Our environment exerts a powerful, often invisible, influence on our desires and actions.
Vegas, Aspen, Global Financial Centers… these locations strength traits that lead me astray
Far easier to reach-for-better in Boulder, than struggle with my past.
Where will this location, this choice, take our Human Capital?
What sort of people will we meet?
Availability heuristic, in all things – friends, choices, life partners
Zillow & AirBnB enable families to quickly compare capital-to-own with fully variable access.
I did a quick check for Edwards, CO => $5 million homes available for $7,000 per week in August, the summer peak.
The same capital in VTSAX yields $60,000 per annum.
The smallest real estate mistake is usually 10% in-and-out costs. Even a “money-back” error on a $1 million house has a true cost of at least $100,000 (because you might have to have to hold for a decade).
Wise allocation of time is what grows human capital.
Assets are often a distraction from what needs to be done.
Specific tactics, I’m working on in 2022.
SELL an investment property to enable a market neutral move into an asset the family will use for shared experiences.
At 40, I had too much runway left to finance to make this choice.
At 53, I don’t want to wait until I’m old for (some of) my assets to better serve my life.
It might be tempting to borrow and defer the tax/agents’ fees => recourse leverage is a risk we don’t need to take.
An aside… at the back of my mind, I want to purchase an all-season van. I used to own a Sportsmobile and we had a lot of fun.
I worked for a guy who loved cars and a wise investor noted, “It’s better for Ferraris to be bought from carried interest than management fees.”
If you’re going to do something indulgent then: (a) pay down debts, (b) take some money off the table, and (c) limit the size of the outlay.
BUY equities at a reduced weighting.
At this stage of my life, I tend to balance “current enjoyment” with “future protection” on a 50/50 basis.
I’m nervous about current valuations. That said, I’ve been that way, FOREVER!
So… stay invested, at a reduced weighting => buy less.
In March 2020 I increased equity allocations to 72% of my Vanguard portfolio.
Allocating additional capital in 2022, I made a reserve for “an investment that benefits the present”…
…then rebalanced to 60% equity allocation.
This reduced the size of the new investment and got me past decision paralysis, driven by a fear of near-term loss.
“Buy less” got me to “stay invested.”
HOLD quality local real estate
Years ago, my family purchased a quality piece of real estate where my kids are growing up. Holding the asset, for 10-20 more years, would help my kids get on the property ladder. It’s also a good-enough hedge for an uncertain future.
As I wrote a couple weeks ago, the main financial deliverable for my kids is debt-free education.
If I can hang onto to the real estate asset then they will get a bonus above the debt-free educational start in life.
Simple decisions, good-enough decisions, can free your thinking.
Be patient, change slowly and focus on sharing experiences with those you love.
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.
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.
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.
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.
I’m going to write this in the context it arises in my life. I have a hunch it applies more broadly. A variation pops up at least once-a-week in casual conversation.
Ten years ago, a wise preschool teacher shared a quote with me. I liked the quote so much, it’s been on my fridge ever since.
I have used the quote to guide my life for the last ten years.
Give time, not money.
Share experiences, not spending.
There’s another aspect of the quote… If you run into an adult who’s childhood emotional needs were unmet… assets, and spending, will not fill their void.
The void cannot be filled from the outside. This is an area where we need to heal ourselves.
Go further… to the heart of addictions…
Quite often, the attempt to “be a good provider” for these folks, makes their emotional problems worse. Further, they are going to feel crazy because they will be miserable while surrounding by conventional “success.”
Let’s step back from the underlying emotional issues and discuss how parents, and spouses, can guide family spending and investing.
First, we need to sort ourselves.
My spending sets a floor above which everyone will operate. This might sound backwards but it’s my observed reality. My choices anchor “down” everyone around me.
INVERT: constraining myself is less likely to trigger resentment.
I’m the most powerful (spending) role model in my children’s life. I do them a lifelong favor by setting a consumption standard they can easily attain.
Second, be brutally honest with yourself… Am I meeting the emotional needs of those around me?
When you are already a good emotional provider, it is very difficult for someone to trigger your need to be a good “financial” provider.
Rather than a high-stakes bargaining session… discussions about money end up closer to a 7th-grade math problem. An example… the ski-place…
20-25 days spread across five resorts
Total cost of hotels/airfares ~$15,000
Shows the folly of seeking to “save” money in a single location by locking up capital
Clothes => let’s start by wearing everything in our existing wardrobes first
Cars, Furniture, Art => is there a more effective way to scratch this itch?
Recreational assets, out-of-town commitments, 2nd homes => …are you sure you want to give me an incentive to be away from you and the kids?
On and on and on… think past the purchase to overall incentives, habit creation and the impact of repeating the action for the next 5-10 years.
Third, the “what are you going to do with the money” argument.
Related to, “but we can afford it…”
Ability to pay is probably the toughest one to control. It’s hard not to spend money in your checking account.
SIDE NOTE: this is a good argument to move cash out of places where it’s easy to spend. This was a (somewhat bizarre) benefit from a choice to STOP earning so much money when I was a young man. Financial success was making it harder to be who I wanted to be.
Here again, pause and consider,
What game do my actions show I am playing?
What is the game I want to be playing?
What game would move us towards “better” five years from now?
If you have kids then these questions usually point towards up-skilling independence via parental investment of TIME, and modeling behavior.
Fourth, after you’ve done 1-2-3. Sit down and talk it over with the key people in your life.
If you are unable to convince them then have the humility to consider the possibility (albeit remote) you may be wrong!
In family systems, I’ve found it’s better to wait for a consensus to arrive than pulling rank.
Bonus: slower decisions are usually better decisions.
Finally, related to the what will you do with the money discussion…
If you are focused on sharing time with the one’s you love then, hopefully, you will favor “experiences with them” over “making more money for them.”
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
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.
I look at… total debt service, core cost of living, total cost of living => each of those numbers gets a little bigger, and I have less control over delaying payment/spending.
Then I look at the inflows by source…
real estate (net and gross — consider vacancy risk)
employment (by role and client — consider concentration)
passive (royalties, dividends, distributed gains)
I want to understand my concentration in expenses (what I can cut/control) as well as income (where the risks lie). I never want to be placed in a position of being a forced seller.
My total family debt stays under 10% of net assets. Assets calculated net of all taxes and agent’s fees.
The Role of Time
My thinking in my work, and family, is multigenerational… I look at assets, leverage, cash flow and spending at many levels…
What I actually own, owe, control, earn => me
Family & 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
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…
Here in Boulder, Colorado, I believe our real estate values have a hidden option. There is a chance the best neighborhoods explode upwards towards the highest valued parts of: the Rockies (Vail/Aspen), California (Bay Area) or NYC.
Now, I don’t have the $$$s to own trophy properties, but I don’t need to. As I wrote in The Next Doubling, it’s good enough to be nearby. For the option to pay out, we don’t need to get to the highest prices per sf => we merely need to close the gap, a bit, over time. That sort of option doesn’t exist in an index fund.
Another hidden option => we own a two-unit rental. We always have the option to move into one of the units and “live for free” by renting out the other unit.
Option Value of Fixed Rate Debt
30-year fixed rate debt, with an option for the borrower to repay, is a valuable (oneway) option in an uncertain world. Unlike margin debt, the lender can’t call the loan on a whim.
Long rates have been declining for 40 years, so the value of this option is overlooked by many. In an inflationary environment, having a multiple of my core cost of living in low-cost fixed rate debt is a useful position.
A mortgage on a personal residence seems like a good deal to me……and if it turns out to be a bad deal then I exit via repayment or refinance.
Saving 2% p.a. and giving Goldman an option to close you out…
Quick note on margin debt, even at <1% p.a. cost, seems like a very bad idea.
Smart people borrowing money they don’t need, to make money they are unlikely to spend in their lifetimes. Everyone figuring they will be able to unwind their financial structure before anything bad happens to them.
This strategy never ends well and only makes sense when you are playing with other people’s money.
A general principle, some things only make sense when you ignore the rebound. Fasting, margin debt, intensity-bias for endurance sport… I have found one gets a better long-term result from building smarter habits.
Optimize over time. When I started paying attention to myself, I realized I needed a whole lot less spending, which implied less capital, which gave me much more time.
INVERT that last sentence => spending you don’t need, increases the capital you think you need, to spend more time doing what you want. I broke that cycle in 2000, got wrapped back up in it in 2005, got tossed back out during the 2008/2009 recession and, these days, cycle in/out depending on my moods!
Nearing 53, I laugh because “less” is being forced on my physical life, by time.
In my early 40s, “less” happened due to kids and a nasty recession.
In my early 30s, “less” felt liberating, and made time for a lot more self-directed time.
We are living through boom times in our local real estate market. Houses are selling quickly, at the equivalent of 50-100x annual rent.
Everything, other than debt pricing, looks expensive to me. So… I’m looking to move, borrow and increase the assets in my portfolio that generate cash flow.
A simple way to view this… (a) split the equity in your existing house in two parts; (b) borrow 30-year fixed and buy a new place with one part of the equity; and (c) place the other part into a rental property.
The explanation follows, with a 25-year overview at the end.
In 2010, I purchased two rental properties as a hedge. Specifically, I wanted to hedge against the risk of my family being priced out of our home market. I thought I was protecting my kids. Turns out I was protecting myself.
The idea was to get paid (via rental income) to hold: 3 units, 10 bedrooms and 20,000 sf of Boulder land. The locations were excellent, the properties dated.
The 2010 purchases worked out well, not just because they performed. The purchases put significant cash pressure on me. The pressure improved my spending choices and motivated me to sort a business which was hemorrhaging cash. In a sense, having tight cash was a form of forced savings.
In 2013, we downsized, borrowed and moved across town. By staying in the same type of neighborhood, and borrowing modestly, our equity appreciation in the smaller house ended up the same as what we would have earned in the larger, unleveraged house.
My ego likes headline numbers and struggles to accept this reality. Something about real estate => the gross, headline numbers are more emotionally salient than the net cash flow reality.
Once again, I’d like to free up time, and reduce admin, by moving. The price I’m going to pay is time/hassle from the move, bringing some deferred taxes forward and agent’s fees.
With the run up in asset values (2015-2021), my family has a much larger allocation to “dead assets.” Dead assets are assets that cost money to hold => for many readers, this is the house they live in. Given recent capital appreciation, the cash cost to hold has been ignored by many.
Downsizing, and locking in 30-year fixed debt for a portion of the new purchase, enables me to keep the amount of “dead assets” modest within the family portfolio.
My ego is tempted to size up, and add a ski place. The better financial move is to improve the quality of our rental portfolio, while reducing my housework and driving.
30-year fixed debt on the family home is one of the best deals going. Given the borrower’s option to repay, it’s a one-way option that could be worth big $$$ in the future.
A word to the leveraged.
Now, like 2005-2007, is a great time to be heavily indebted. You will take comfort in your ability to unwind any financial difficulties.
You are correct.
However, if you truly “need” to unwind financial positions then we are likely in a market like 2009, unpleasant.
So be cautious with opting-in to risks that don’t add to your long-term strategy. Most particularly, any arrangement where an outside party has the power to force a sale. While I am seeking to borrow, total debt will remain modest relative to assets and cash flow.
Breaking it down, building wealth across decades.
Resist the urge to up-size your life, particularly by adding negative yielding assets.
Rather, seek to build up 2-4 rental units. Pay attention to location, lot size and bedrooms.
Unless you want to get into the hotel management business, rent unfurnished to long term tenants. Inverting I have learned… furnished, short-term rentals bleed expenses, emotion and time.
For your long-term rentals, use a local property manager – their cost as a %age of capital value will be tiny compared to the value they add, and the hassle you avoid. This frees time to make money in a field where you have an edge => whatever you were doing when you built up the $$$ to purchase rental properties. Side Note on taxes: tax bill as a %age of net assets is a number you should track.
Use your personal home for shelter, as an entry in the best public schools in your state, as a cheap source of fixed rate debt and a tax-favored investment. If this asset appreciates to the point where you have “too much” invested in non-yielding real estate then downsize, get a new mortgage and repeat the cycle.
Aside from the roof and HVAC… spend no material capital on any of your properties. Instead, spend time with the people you love (and buy more assets that generate cash flow).
If you start the above when you get married then you’ll have 1-3 moves by the time you are empty nesters. At that point, you’ll have built yourself an inflation-proof, tax-effective retirement annuity. You can constrain your spending and pass it to your grown kids OR run down the assets as you see fit.
That’s the financial overlay. You also have the ability to use trust structures within this strategy. I’ll get to those in a future post. Put simply, when I say “you” it’s possible to put a trust in “your” place. That can protect your assets from the unexpected which, over a 25 year time horizon, is nearly certain to happen.
Ideally, you graduated debt-free from college and made a habit of maximizing your retirement contributions in the first 10 years of your career. Don’t be in a rush to get into real estate, I’d been working/saving for a decade before I had the capital, and geographic stability, for a purchase to make sense. While a favorite form of security for lenders, real estate is chunky, a pain to manage and expensive to sell.
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.
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.
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
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.
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.”
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.”
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…
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”.
“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!
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.
A valuable lesson for them, weekly humility training for me…
We split the house into Five Zones:
Cat Room (dirtiest room in house, done by our youngest)
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