Archive for the 'Personal Finance' Category

David Foster’s post included a link to this column about career risk. The author argues that it’s risky to bind yourself for the long run to an apparently-secure institutional job, because institutions can fail and leave you hanging. You are better off to keep trying new things and accepting failures and short-term uncertainty, in exchange for greater long-term adaptability. I think he’s half right about this.

He’s right that it’s a good idea to accept opportunities and take calculated risks, but he’s a bit off in his framing of the overall issue. What distinguishes the resilient from non-resilient career paths in his examples isn’t risk-taking per se, it’s diversification. Instead of investing all of your career effort in a relationship with one big company that is the sole buyer of your services, you should diversify among multiple, smaller customers, none of which is big enough to put you out of action if they fire you.

This is basic risk management. It is difficult to assess long-term risk going into a venture, no matter how smart or experienced you are. There are too many things that can change over time. The big-company job or big institutional customer may appear to offer security but that’s an illusion. They can be belly-up in a few years for reasons no one can anticipate. The rational strategy is therefore to diversify your income among multiple sources as smart people have always understood. Just as independent professionals know to keep a large enough number of clients that a loss of business from any one client won’t hurt them much, prudent people with institutional jobs may use their income streams to finance investments in real estate or other alternative revenue sources. There is no one career path that works for everyone. As America transitions from its 2.0 institutional model to a more decentralized and individualistic system, people increasingly will need to take account of risk and diversification in managing their careers. That’s probably better for everyone in the long run.

Survivorship Bias

One of the most important concepts in all of investing is “survivorship bias”.  Per wikipedia:

In finance, survivorship bias is the tendency for failed companies to be excluded from performance studies because they no longer exist. It often causes the results of studies to skew higher because only companies which were successful enough to survive until the end of the period are included.

You should view any sort of “theory” on stock selection such as value, small-cap, growth, or dividend payers (generally part of the “value” spectrum) as a “sales pitch”.  When someone tries to sell you on something, they will use whatever data that is available to support their pitch.

The data that is generally available is in the stock market “raw” data.  You can see the price changes, the dividends, and compare these against your selected group or theory in a variety of ways.

Valuing Dividends

In general, it is more difficult to determine total stock returns (i.e. how successful your proposed theory is) when you include dividends.  It is easy to look at the “price” of a stock from 10 years ago and the price of that same stock today and said it “went up 25%” or “went down 25%”.  Or, if you owned that stock and are looking for it, that the stock doesn’t exist in the index any more (it went bankrupt, merged with someone else, or went private).  Even large and sophisticated investors sometimes forget to include dividends in their calculations.

Dividends are harder because they are payouts to shareholders and then you need to determine what happened with those dividends.  For my trust funds, for example, the dividends are received in cash.  Then we take the cash and re-invest it periodically, in our case annually.  Thus you don’t earn a “return” on that money, other than interest (which used to be significant, but now can essentially be modeled at zero since interest rates are so low) during that time.

For most models used by analysts, dividends paid are assumed to be re-invested in shares.  Thus if you receive a dividend of 2%, you essentially now own 2% more in shares, and you also earn dividends on those shares going forward, as well.  To make it a bit more complicated, there are taxes that you have to pay when you receive those dividends, so you may want to reduce the effective value of those dividends by 15% (the current taxable rate) or closer to 30% if that exclusion is taken away when the tax laws are changed in 2013.  Here is a wikipedia article that reviews the taxation of dividends for individuals.

Dividends are important.  Per the “dividends aristocrats” methodology used by the S&P 500 and found  here,

I like writing about things I know little about, because typically I learn a lot from the commenters, and get humbled at times. I am sure that the following will be one of those types of posts.

I have had this thought rolling around in my head for quite some time, and wanted to air it out to see what type of play it will get.

Our entitlement programs steam ahead into oblivion here in the US. In particular Social Security, while not exactly a Ponzi Scheme (but close enough), is on the Highway to Hell, if something isn’t done to fix it.

The only time I remember that something was honestly tried to fix SS was when GW Bush attempted to let a tiny portion (was it 4%?) of new inputs be allowed to be managed in a private account. Not many will remember that debate, but it was ridiculous. Literally, I heard over and over that the OLD PEOPLE WERE GOING TO BE THROWN OUT INTO THE STREETS AND FREEZING COLD. The noise was incredible, and very little logical, well thought out debate was presented. I am still disgusted when I think of how that debate was framed.

Every time that I get my pay stub I look at those numbers leaving my net pay and cringe knowing that MY PROMISE will be broken. This is a system that will most likely be insolvent by the time I get to the age of collecting. I have taken it for granted, and so have many of the folks I have talked to that are my age. My age – Generation X.

Loosely, Gen X is described as the post Boomer generation, the 13th to be raised under the flag of the good ‘ol USA. The birth years (again, loosely) are said to vary from definition to definition, but center between 1961 and 1981. I fall almost smack dab in the middle of it. So does my wife. And most of my friends. We talk about things like this.

This time period saw some of the lowest birth rates in the US. We don’t have enough of us to support all of you (I’m talkin’ to you, Boomers!). We are paying into a system (Social Security) that is designed, mathematically, to fail. Of course SS is just one of our many entitlement programs that are going to be under intense pressure in the future – if nothing changes. That is a big if.

The thrust of my thinking here is that it will be up to my g-g-g-Generation to fix this mess. As I look at all the grey hairs in the Senate and House (there are exceptions, of course) my thinking is that these things aren’t about political parties, they are age and culture differences. The folks I hang around with – Democrat, Republican, Tea, whataver, want things fixed, and done right. This isn’t universal, of course, but I hear a lot more common sense out of younger people and younger CongressCritters than the Old Guard.

Paul Ryan is a Gen X’er. I think the guy is fantastic and a breath of fresh air, and I firmly believe that his message and belief system is held in check a LOT by the Old Guard (I am pointing that finger at you again, Boomers). Sarah Palin is also a Gen X’er. Have you heard anyone else in politics say things like this? Again, this isn’t a party thing, it is a generational thing. I sort of feel like in a lot of respects, we have our own old person combine in Washington DC.

If we stay on the current course there will be hell to pay for anyone who hasn’t saved their dough, as far as retirement goes. But most of us (at least the people my age that I talk to) aren’t that stupid. Some of us are.

I guess I am tired of the Old Guard who screwed up the system telling me and others like Ryan how bad it could get screwed up if attempts are made to fix it. To me, it isn’t about parties, it is about generations. Generation X might end up being the folks that have to fix…everything.

Global transition points like this are so rare, it’s a great time to be alive.

John Robb

Right on. Yes. Yes.

More of this type of thinking, please.

If I could live at any time in history it would be now.

(If you are not a regular reader of Mr. Robb’s Global Guerrillas, get that way.)

(Also check out Mr. Robb’s way cool new Wiki MiiU, which is all about resilience. I eagerly await his book on resilient communities.)

(Here is an xcellent John Robb talk about open source ventures, but full disclosure, a lot of it sailed over my head.)

(And if you have not read his book, Brave New War: The Next Stage of Terrorism and the End of Globalization, go get it.)

Friends, please let me know in the comments, on a scale of 1 to 5, strongly disagree to strongly agree, how you respond to this quote. Put me down as a 5, obviously enough.

I am repairing a gap in my education by reading Thomas Sowell’s classic, Vision of the Anointed, which was written in 1992 but is still, unfortunately, as valid a critique of leftist thought as it was then. As an example of his methods, he constructs an experiment in statistics. This concerns poverty and inequality and, in particular, the poverty of leftist thinking.

He imagines an artificial population that has absolute equality in income. Each individual begins his (or her) working career at age 20 with an income of $10,000 per year. For simplicity’s sake, we must imagine that each of these workers remains equal in income and at age 30, receives a $10,000 raise. They remain exactly equal through the subsequent decades until age 70 with each receiving a $10,000 raise each decade. He (or she) then retires at age 70 with income returning to zero.

All these individuals have identical savings patterns. They each spend $5,000 per year on subsistence needs and save 10% of earnings above subsistence. The rest they use to improve their current standard of living. What statistical measures of income and wealth would emerge from such a perfectly equal pattern of income, savings and wealth?
 

Unfortunately, even with an Excel spreadsheet, I cannot get these numbers to line up properly.

[Jonathan adds: Many thanks to Andrew Garland for providing html code to display these numbers clearly.]

Now, let us look at the inequities created by this perfectly equal income distribution. The top 17% of income earners has five times the income of the bottom 17% and the top 17% of savers has 25 times the savings of the bottom 17%. That is ignoring those with zero in each category. If the data were aggregated and considered in “class” terms, we find that 17% of the people have 45% of the all the accumulated savings for the whole society. Taxes are, of course, ignored.

What about a real world example ? Stanford California, in the 1990 census, had one of the highest poverty rates in the Bay Area, the largely wealthy region surrounding San Francisco Bay. Stanford, as a community, has a higher poverty rate than East Palo Alto, a low income minority community nearby. Why ? While undergraduate students living in dormitories are not counted as residents in census data, graduate students living in campus housing are counted. During the time I was a medical student, and even during part of my internship and residency training, my family was eligible for food stamps. The census data describing the Stanford area does not include all the amenities provided for students and their families, making the comparison even less accurate. This quintile of low income students will move to a high quintile, if not the highest within a few years of completion of graduate school, A few, like the Google founders, will acquire great wealth rather quickly. None of this is evident in the statistics.

Statistics on poverty and income equality are fraught with anomalies like those described by Professor Sowell. That does not prevent their use in furthering the ambitions of the “anointed.”

Lex’s post about the couple who played the Damned at their wedding was pretty timely for me. You see, today is my 16th anniversary.

I started to talk about weddings in general in that comment thread, and as I typically do, I began to think about my wedding. There were a total of four people in attendance. Myself, my wife, a photographer, and a Lutheran pastor. What follows is how we got there and is a personal love story so click below the fold if that is what you want.
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I was doing some work in my basement when I came across the following, tucked away out of sight behind a girder.

It is an old grocery flyer from a nearby store. How old is it?

Okay, so it lists the prices from 1979. But how do those prices stack up against the cost of similar items that can be found on the shelves today?
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Big Brother on the Make….or perhaps, the take….

Outside of specific and targeted investigational contexts for law enforcement and intelligence, the Federal government really does not need to know what products we buy at the grocery store, what books we buy or check out at the library, the magazines to which we subscribe, our car payments, what kind of food we eat, the websites we visit, how we use our credit cards and where. It’s not actually the government’s business, and presumably, the 4th Amendment indicates they need a compelling interest before they are allowed to snoop.

Senator Chris Dodd (D-Conn) is working hard….to make sure the Feds are watching your every move. Unless you are an illegal alien of course.

What passes for Liberalism these days is a strange ideology – American citizens are to be treated as criminals to be kept under continuous government surveillance but if you are a foreigner who enters the country illegally, you should get special dispensations from police questioning. Or unless you are a foreign terrorist overseas or in communication with one. WTF?

Cross-posted at Zenpundit

Ronald Cass’s column about Bernard Madoff is insightful:

The sense of common heritage, of community, also makes it less seemly to ask hard questions. Pressing a fellow parishioner or club member for hard information is like demanding receipts from your aunt — it just doesn’t feel right. Hucksters know that, they play on it, and they count on our trust to make their confidence games work.
 
The level of affinity and of trust may be especially high among Jews. The Holocaust and generations of anti-Semitic laws and practices around the world made reliance on other Jews, and care for them, a survival instinct. As a result, Jews are often an easy target both for fund-raising appeals and fraud. But affinity plays a role in many groups, making members more trusting of appeals within the group.

“Affinity groups” (to use modern marketing-speak) may be particularly vulnerable to fraud because trust works both ways. Group members tend to be more trusting of other group members than of outsiders, and this caution toward outsiders protects the group. But it also means that group members tend to let down their guard against other group members. This is OK most of the time because the extra caution about outsiders keeps predators at bay, and business people who gain admittance to the group are more likely to be trustworthy than outsiders are. However, a sociopath who penetrates the group’s defenses may wreak havoc — the single-point-of-failure problem.

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There have been some recent changes on FDIC insurance limits for CDs and there is a (relatively) new way for time strapped investors looking to buy CDs, which is through a brokerage account. This method allows investors to pick from a variety of institutions online at a single place and receive the income in their brokerage account rather than physically go from place to place to purchase CDs and then receive a pile of paper at year end. There also is the ability to sell CDs in the market during the life of the CD (i.e., you could sell a 5 year CD 2 years into it) at either a gain or loss depending on the direction that interest rates have moved in the interim (down, you will have a gain, and up you will have a loss). You can keep it until maturity and always get what is promised, this is just another subtle opportunity. Read more if this topic interests you.

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Via the usual source, why bright kids should, in many cases, drop out is thoroughly explained at America’s Most Overrated Product: the Bachelor’s Degree. It’s positively Freakonomics-worthy stuff. Turns out I knew what I was doing at age 19 … avoiding a s___load of debt and not compromising my future earning power much, if at all.

(Actually, in my case there is almost no doubt I would be both 1] making less money and 2] living somewhere more expensive right now if I’d somehow stayed in the academic world. Figure student debt into that and my net worth would be perhaps a quarter its present value, and that’s if I were lucky.)

Key passage: “You could lock the collegebound in a closet for four years, and they’d still go on to earn more than the pool of non-collegebound …”

The Talking Heads would agree.

(Related: lengthy six-month old post, Get Out the Hankies, with tons of comments, over on Transterrestrial Musings.)

UPDATE: More food for thought …

My neighborhood, the River North area of Chicago, has seen an explosion of condominium developments over the last decade. Loft buildings and business warehouses were the first to be converted, and then purpose-built high rise condominiums began to populate the neighborhood. While Chicago likely isn’t at the same frenzy level as South Beach in Florida, we certainly have a vast overhang of unsold and in-process condominiums on the market right now. Below you can see some of the recent construction (not all condominiums, a lot of it is office space) including the Trump Tower (on the left) as well as other developments. The “beige” building in front has a forlorn “Condos” sign at the top.

Today I was reading the Sunday Chicago Tribune real estate section when I noticed an article titled “Credit Getting Even Tighter for Condominium Buyers”. If you own a condominium and are interested in its value or are consider buying a condominium I strongly suggest that you research this issue in greater depth.

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One trend in housing is the ever-increasing size of the average American house. A drive through any city or suburb will show that new houses are growing larger, right up to the lot lines, and buyers perceive total square feet to be an important amenity. If you took the typical suburban family and put them in the house that they originally grew up in they’d generally shudder – only one bathroom for all those people, sharing a bedroom, and hardly any closets! Closets are viewed as a key amenity, with the ability to store racks and racks of shoes and clothes for all seasons is a virtual requirement.

In parallel with this is the growth in off site storage. When I was growing up it seemed that few people I knew had off site storage, but it seems much more prevalent today. Storage for furniture, hobbies, collectibles and everything else that people can’t bear to throw out.

While houses are getting larger and in particular storage elements & off-site storage is a growth industry, a different trend is going the OTHER way. Deflation, or chronic price reduction, is occurring with most of the “stuff” that people are storing.

Here is one example – my new “blog” camera with a small footprint (it is pretty slim although the lends does pop out when you turn it on) was only $212 and it has 7 megapixels and a bunch of cool features, like when you tilt the camera 90 degrees the photos switch from landscape to portrait in “view” mode. This camera blows the doors off previous digital cameras that I paid over 600 dollars for just a few years ago. Read the rest of this entry »

Buy goats.

My niece paid something like $2500 for her goat “Cash.” Last Friday she won the 2007 Grand Champion Junior Market Goat at the Houston Rodeo.

The goat went at auction for $108,000! That’s a Clintonesque rate of return!

In any case, I hope she will remember her loving and supportive uncle and forget last summer’s unfortunate attempt at barbecued goat.

Wired had a pretty good article about preventing identity theft. This sort of thing predates the Internet by many decades. It happened to me when someone stole my mail, including my bank statement, some 30 years ago and tried to cash bad checks made out to me, using a fake ID. He happened to use the same bank branch I used and was caught immediately.

There is one more tip I think is worth mentioning: Your credit card company may be able to issue you a temporary credit card number linked to your real account number. This feature is provided by several large US and foreign banks through a company called Orbiscum. Depending on the bank, you can limit the time the number can be used and the amount that can be charged. It can also be restricted to a single transaction, so that once the transaction is complete, your credit card number is useless to anyone else. Consider the one-time use technique when dealing with unknown or dodgy vendors.