Author: OnceUSave

Warren Buffett run Berkshire Hathaway paid a 10 cent dividend once in that one fateful year in 1967. Buffett, unarguably one of the best capital allocators ever, later joked that he must have been in the bathroom when that decision was made.

Because of all the ways a business returns the harvested profits back to its owners, cash dividends is the least efficient. And here is why.

When a business earns a profit, it has some decisions to make:

• Reinvest all of it back into the business.
• Reinvest some, return the rest in the form of dividends.
• Return all of it in the form of dividends.

The choice between the three will depend upon whether the business needs capital (money) to grow. And not just that, it needs to be able to deploy that precious capital at a respectable enough growth rate.

Say that growth rate is 10 percent. So as a shareholder, would you then want that business to return some or all of the profit back to you?

Probably not because now you will have to find another investment that will earn equal to or greater than that growth rate. There is hence that uncalled for reinvestment risk for you.

And if you own the shares in a non-tax favored account, you will be taxed on those dividends. So not only do you face reinvestment risk, but you’ll also incur a tax drag every time dividends hit your account.

But if reinvestment opportunities back into the business are limited, the management (the folks running the business on your behalf) will have no choice but to return some of the profit to you and to the rest of the owners. The business at this stage is in a moderate growth phase and is generating more profit than it knows what to do with.

And only when all possible avenues for reinvestment are exhausted will the management decide to return the entirety of profits to the owners. There is no more growth left. The business at this stage is a bond-like investment. And the bond market is not where you go looking to get rich.

All businesses go through these phases and when all is said and done, they either merge with other businesses or go extinct. That is capitalism.

But all businesses eventually must pay out all their profits, past and present, to the owners in some form or the other. That is by design.

But when we focus exclusively on the kinds that pay dividends, we miss out on a big chunk of the still growing businesses. Nothing wrong with that but the long-range returns are unlikely to outpace the returns of a portfolio that owns all kinds of businesses.

And I’d especially be wary of businesses that pay unusually high dividend yields. Because there will be a catch. There will always be a catch.

But even with dividends, there is a better way that the likes of Buffetts practice to return profits back to the owners. And that is through share buybacks and this is how it is done.

We first start with the market value of a business…

Market value of a business = Number of shares outstanding x Price per share

So, say a business has 1,000 shares outstanding in the marketplace today and each share trades at $1,000. The market value of that business then is 1,000 shares x $1,000 = $1,000,000.

Now say in a year, that business earns $100,000 in profits which the business for now retains on its books. So, with all things being equal, the value of that business should rise to $1,100,000. And the share price should now reflect the new value by rising to $1,100 per share.

But say the business as it stands today has no reinvestment opportunities left. It has hence no need to retain the profits that it earned.

The folks running the business on your behalf will then decide to issue the entire $100,000 profit in the form of a dividend. That would amount to $100 for each share you own.

The share price post dividend distribution reverts to the original $1,000 apiece. And you are then left with the tax consequences of that dividend hitting your accounts whether you wanted it or not.

What could have been better? Buying back shares in the open market from the current owners and retiring them in earnest.

$100,000 buys ninety-one shares at the new share price of $1,100 and once the shares are purchased and retired from willing sellers, there are now 909 shares outstanding with each share trading at $1,100 apiece. The total value of the business post-share buyback reverts to $1,000,000 (909 shares x $1,100 share price).

But even though the total value of the business did not change, your stake in that business grew by 10 percent. Or to put it another way, the value of your shares increased by 10 percent with no immediate tax consequences for you at that.

You now get to decide when you want to take distributions by selling shares at your convenience instead of being forced to accept distributions on a preset basis in the form of cash dividends. And that is what you want. That is what most people in the know would want.

So dividends are nice but they should not be your sole focus when designing a sustainable pension plan. Because when you focus too much on them, you’ll end up with a portfolio that will remain long-term inefficient.

Thank you for your time.

Cover image credit – Giuseppe Russo, Pexels

During World War II, researchers at the Center for Naval Analysis were trying to decide on where to add reinforcements to damaged aircrafts returning from their bombing missions. Reinforcements add extra weight so not all sections of the aircraft can be reinforced.

So, if you were given the task to decide, where would you add reinforcements? You’d add them to the damaged red parts of the aircraft, right?

Abraham Wald, a mathematician, and a member of the Statistical Research Group at Columbia University proposed otherwise. Because what you were looking at were biased samples of only the aircrafts that survived the battle. An aircraft got hit evenly across all sections of its body but the ones that got hit in their most vulnerable parts did not return.

The sections of the aircraft that suffered damage and were still able to return meant that they were not the weak spots you wanted to reinforce. You want to reinforce the areas that were still intact because if those areas got hit, the aircrafts did not return. The Navy followed through on Wald‘s advice which ended up saving countless lives.

This is a classic case study on how not to fall prey to survivorship bias. Because our brains are wired to take shortcuts and reach false conclusions by looking at only the samples that survived. We don’t notice the bulk of the failures – in business, in life and in war.

There are millions who play basketball but there are only a few Michael Jordans. There are millions who try their hand at acting but there are only a few Shah Rukh Khans. There are millions who drop out of school but there are only a few Mark Zuckerbergs.

Our perception of the world is completely backwards because everything we see around us is the outcome of survivorship bias. When we go to a restaurant we like, that is an example of survivorship bias. Running a restaurant is a tough, tough business and the only ones we see left standing are the ones that survived while the remaining 99 percent failed trying.

That in fact is true with businesses in general. Most businesses that start never make it past the first few years. But entrepreneurs keep trying because of the disproportionately large rewards at the other end if a business succeeds. That is a good thing, and we want more entrepreneurs to wildly succeed else no one would try.

There is a huge survivorship bias in stock investing. We see the people who did well and what sticks in our minds are the folks who bought Amazon or Microsoft at their IPOs and held their shares. But what we don’t see are the other 99 percent of the IPO investors who had their heads handed to them.

There was this story doing the rounds that goes something like this…Uncle Fred buys EMC stock twenty-five years ago and dies. His heirs discover the stock certificates in the attic, and they are worth like six million dollars. It makes the headlines, and everyone is talking about it.

What nobody talks about are the other 99 percent of Uncle Freds who bought GM or Lehman Brothers or JCPenney, and when their heirs discover the stock certificates that are now worthless, nobody tells the newspapers, and no one hears about it.

Mutual fund companies play these games well. They incubate like thirty funds and quietly wind down most of the unsuccessful ones while keeping the star performer alive. They use that fund’s performance record as a marketing gimmick to attract new money. And novice investors pile in as in anyone who invested in Cathie Wood‘s ARK set of funds lately.

The stock market is the largest creator of wealth for individual investors, but most stocks lose money through their entirety of existence. That is the nature of capitalism working its magic where a tiny minority of businesses are responsible for the bulk of the wealth that has been created in the stock market.

So, when you hear about how much this or that stock gained and how rich you would be had you bought and more importantly, held that stock, what you don’t hear about are all the losers that you also bought that you lost your shirt in.

For every Walmart, there was once a Kmart. For every Apple, there was once a BlackBerry. For every Facebook, there was once a MySpace.

Diversification is the only free lunch in investing so piling into a single stock or a sector is a statistically bad deal. That holds truer if you have already won the game. Diversification is an acceptance that the future is inherently unknowable, and that it can take many different directions. 

Diversification also means not falling prey to survivorship bias because it is the failures that teach us the most important lessons – in life and in investing.

Thank you for your time.

Cover image credit – Ruyan Ayten, Pexels

Bonds are safer than stocks. Cash is safer than bonds. Investing in startups is not for the faint of heart. On a risk-return spectrum, we see an upward sloping line as we go from safe investments on the left to increasingly riskier ones on the right. Finance nerds call this the Capital Market Line.

But even within bonds, there is a spectrum of what is considered safe. Short-term government bonds, also called Treasury bills, with maturities of less than a year are a baseline of safety. They carry no credit risk because they are U.S. government-backed bonds.

And they have no timeframe risk as these bonds have maturities ranging from four weeks to fifty-two weeks. They make a great alternative to holding cash in a savings account so use them liberally for your emergency reserves.

What intuitively comes next on that risk-return spectrum? The same level of risk as in government-backed Treasury bonds but with an increasing timeframe for which you are required to hold these bonds. So where is the risk?

The risk comes into play when market interest rates change, and you need to cash out of the bonds before they mature. No one is going to buy your five percent yielding bond if the prevailing market interest rate is six percent. You will then have to discount the bond (lower the price) to a point where the yield matches the prevailing interest rate and hence the risk.

And because these bonds are riskier as in you have to hold them for a longer timeframe, you expect to earn more on them.

The next set of investments on that Capital Market Line with steadily rising risk profiles are municipal bonds, high-quality corporate bonds, emerging market bonds and junk bonds. Along with the timeframe risk, there is now a potential default risk where the borrower (you lend money when you buy a bond) could renege on his promise to pay. So as a bond’s credit quality worsens, its risk again rises.

This describes the bond side of the Capital Market Line.

Stocks are long duration assets which means you need to own them for a long, long time to reap enough rewards for taking on the added risk. And stocks are riskier than bonds because direct and indirect cash flows (dividends and share buybacks) that stocks deliver are more unpredictable than interest income from bonds. A business only pays dividends or does share buybacks when it earns a profit and profit is never guaranteed.

Plus, in the event of that business going bankrupt, bondholders get paid first before stockholders get anything.

So naturally, stocks are riskier and because they are riskier, you will demand more from them than bonds. And hence they lie to the right of most bonds on the Capital Market Line.

And even with stocks, we have domestic stocks, international stocks, emerging market stocks, small company stocks and so on, all on that Capital Market Line with steadily rising risk and return profiles.

To the extreme right, we find things like private equity and venture capital. That is assuming we can get a broad enough exposure to them as an asset class which is not the case yet, so they remain uninvestible. Anyone pitching them to you means you won’t see your money again.

That completes the Capital Market Line.

But just because you took on more risk with your savings does not mean you are owed a reward because if riskier investments were guaranteed to earn more, investors would bid up the prices of those investments to a point where no excess return exists.

The correct formulation then is that to attract capital, riskier investments have to offer the prospect of higher returns¹ and not a guarantee.

And that is when we get into the world of ranges or distributions instead of point estimates to re-form that risk-return relationship.

The revised Capital Market Line hence…

Point estimates for a given category of investments don’t make sense because returns do not precisely land on a straight line. They bounce around that line depending upon the timeframe and hence we need to think about them as distributions instead of points on a line.

But all this discussion is before taking inflation into account. There is no free lunch in investing so beating inflation with safe investments is a pipe dream that seldom comes through. Not all risks are rewarded but educated risks while considering all possibilities is how we beat inflation and set ourselves up on a path to financial independence.

Thank you for your time.

Cover image credit – Alexandre Zanin, Pexels

¹ Howard Marks. “The Most Important Thing Illuminated“, Columbia Business School Publishing.

Cornelius ‘Commodore’ Vanderbilt, the American railroad and shipping tycoon, died in 1877 and left behind a $95 million fortune to his eldest son, William H. Vanderbilt.

$95 million might not put you anywhere in the Forbes 400 list today but that was more money at the time than was held in the United States treasury. What happened to that great fortune is chronicled in a fascinating tale by Arthur T. Vanderbilt in Fortune’s Children, The Fall of the House of Vanderbilt.

William, having watched his father handle money, learned a thing or two about wealth management. He took the $95 million that he inherited and turned it into $194 million by 1883. That made him the richest man alive at the time. That’s like 500 billion dollars today if invested at a conservative 6 percent rate of return each year.

And 6 percent is conservative because the money, if invested, had the tailwind of the United States growing from an emerging economy back then to the powerhouse it is today.

What is the current state of the Vanderbilts and how come we don’t hear much about them?

This fabled golden era, this special world of luxury and privilege that the Vanderbilts created, lasted but a brief moment. Within thirty years after the death of Commodore Vanderbilt in 1877, no member of his family was among the richest people in the United States, having been supplanted by such new titans as Rockefeller, Carnegie, Frick, and Ford. Forty-eight years after his death, one of his direct descendants died penniless. Within seventy years of his death, the last of the great Vanderbilt mansions on Fifth Avenue had made way for modern office buildings. When 120 of the Commodore’s descendants gathered at Vanderbilt University in 1973 for the first family reunion, there was not a millionaire amongst them.

That colossal wealth was squandered on colossal homes…

Her second demand was that it be bigger than Marble House. And it was, with its four stories, seventy rooms, thirty baths with hot and cold fresh water and salt water piped in from the sea, and thirty-three rooms for the servants. The eleven acres surrounding the mansion were covered with sod imported from England, and numerous thirty-ton trees planted around gave the place an appropriately venerable look.

Construction began in the spring of 1893. With the work of two thousand laborers and artisans and artists, some working during the day, others at night with the aid of electric lights, The Breakers was ready for occupancy in the summer of 1895, an amazing accomplishment in a day when all work was done by hand, by pick and shovel, and with horse-drawn carts. Limitless wealth could indeed accomplish anything.

It had been worth the $7 million it cost (plus the millions more to furnish it).

That is an easy all in $10 million at the time. The present value of $10 million at 6 percent a year is about 15 billion dollars, making it one of the priciest homes ever. And her in the excerpt above refers to Alice, the grand-daughter-in-law of the Commodore who wanted to build a bigger, better house than her sister-in-law Alva’s Marble House.

That was just one home amongst several others.

And when you have that kind of money, you host the best of parties. For instance, Alva spent $250,000 in 1883 dollars on a single night hosting the who’s who of society at the time to proclaim the arrival of the Vanderbilts. Present value of $250,000 compounding at 6% for all those years ~ $800 million.

A substantial chunk of the wealth was also literally gambled away.

On December 19, 1901, his twenty-first birthday, Reggie inherited $7.5 million outright under his father’s will, plus $5 million from another trust fund.

Reggie, the great-grandson of the Commodore

The present value of the money Reggie inherited ~ 15 billion dollars.

And of course, when there is inherited money, family feuds and rivalries follow which make each outspend the other to a point that leads to this…

The sale of Idlehour…

For $460,521, Harold sold Idlehour, the eight-hundred-acre estate on Oakdale, Long Island, with its three-story marble and brick manor house containing thirty master bedrooms, its large conservatory, and its tennis court under glass, all of which had cost Willie over $10 million.

The sale of Marble House…

But finally she relented, and in 1932 sold it to Fredrick H. Prince, the head of Armour Company, for the Depression price of $100,000 – less than one hundredth of what Willie had paid for Alva’s thirty-fifth birthday present.

The eventual financial state of Alva, the grand-daughter-in-law of the Commodore, in 1933…

At the time of her death, after a lifetime of buying and building, she was down to her last million. Her estate was valued at $1,326,765.

When all was said and done…

The Fifth Avenue mansions, gone. The New York Central, gone. And the country homes, how did they fare? Idlehour. Marble House. The Breakers. Belcourt Castle. Biltmore. Beaulieu. Wheatley Hills. Vinland. Florham. Not one was used by the next generation.

The fact that it took precisely three generations to complete the rags to riches to rags cycle makes a lot of sense. The first generation starts somewhere at the bottom, works hard, saves, and invests diligently to a point where worldly comforts become the norm.

The second generation, watching their parents’ metamorphosis from struggling upstarts to affluence, start to incorporate some of what they saw and learnt growing up into their own lives. But the fact that the first generation did everything right meant that quite a bit of that behavior trickled down to the generation next.

But the second generation does not need to try as hard, and abundance is all they experience. But because there is no struggle there, by the time the third generation rolls around, it is all The Rich Kids of Instagram. No hard choices to make, no corners to cut, life is easy.

And regardless of the size of the inheritance, it does not take much to spend through all of it and more and hence by the time the fourth generation rolls around, all is gone, and the cycle starts over again.

This is not just anecdotal evidence based solely on the story of the Vanderbilts or how I perceive this bust-boom-bust cycle transpires. Data compiled by The Williams Group in a study of more than 3,200 families found that 70% of the wealth dissipates by the end of the second generation and almost 90% by the third. Hence the old saw, “shirtsleeves to shirtsleeves in three generations.”

But along the way, the book dispenses some important life takeaways. First, wealth management is hard.

By his early sixties, he was tired and worn out. “The care of $200,000,000 is too great of a load for my brain or back to bear,” he confessed to his family. “It is enough to kill a man. I have no son that whom I am willing to afflict with the terrible burden. There is no pleasure to be got out of it as an offset – no good of any kind. I have no real gratification or enjoyments of any sort more than my neighbor on the next block who is worth only half a million. So when I lay down this heavy responsibility, I want my sons to divide it, and share the worry which it will cost to keep it.”

This is William H. Vanderbilt, the successor to the Commodore’s fortune, lamenting his state to someone close.

And realizing how difficult it is to hold on to wealth, the Commodore himself at one point confides to a friend of his with this quote from the book…

Any fool can make a fortune. It takes a man of brains to hold on to it after it is made.

Second, inherited wealth seldom leads to happiness and life satisfaction.

Willie indeed had it all: good health, good looks, good friends, and good fun, and an ever-growing fortune that enabled him to do anything anyone could do. He also had the intelligence to perceive that perhaps having everything left a lot to be desired. On one of his trips back to the United States from his French stables, he talked with reporters in extraordinarily candid terms about what it meant to be rich. “My life was never destined to be quite happy,” he told them. “It was laid out along lines which I could not foresee, almost from earliest childhood. It has left me with nothing to hope for, with nothing definite to seek or strive for. Inherited wealth is a real handicap to happiness. It is as certain death to ambition as cocaine is to morality.”

He continued lecturing the astonished reporters: “If a man makes money, no matter how much, he finds a certain happiness in its possession, for in the desire to increase his business, he has a constant use for it. But the man who inherits it has none of this. The first satisfaction and the greatest, that of building the foundation of a fortune, is denied him. He must labor, if he does labor, simply to add to an oversufficiency.”

That is Willie, the grandson of the Commodore describing the perils of inherited wealth.

Morgan Housel, one of my favorite personal finance writers, says that he wishes his son experiences poverty at least once in his life. 

Jonathan Clements, in one of his many books, lamented the fact that he feels providing a life of relative comfort to his kids has somehow deprived them of their ability to hustle and make things happen. That lack of ambition is a real handicap to achieving lasting happiness, the happiness one derives through hard work and relishing the fruits of one’s labor.

Celebrity chef Nigella Lawson has no intent of leaving a substantial inheritance to her children because she knows that not having to earn money ruins lives.

And then we have the Buffetts of the world who have pledged to donate all their wealth rather than leave large inheritances. As Warren Buffett famously said, he wants to give his kids enough money so that they have the freedom to do anything they want, whatever it pays but not so much that they do absolutely nothing.

And if you want to see what life was like growing up in the Buffett household, I highly recommend a book by his son Peter Buffett, Life Is What You Make It: Find Your Own Path to Fulfillment.

Working hard and overcoming some of life’s struggles provides satisfaction that inherited wealth cannot. We should want our kids to experience some of those struggles to help provide meaning and purpose to their lives.

I grew up in India and life is an unimaginable hardship being poor in a country like that and I think there is a distinction between being poor in India versus say, being poor in any of the Western countries. It is a monumental task for a kid born to a family living on the streets in a country like India to break out of that cycle as opportunities for upward mobility are limited.

But then affluence and a path towards upward mobility was not always a given in these United States either…

Before the Civil War, there were fewer than a dozen millionaires in the United States. In 1892, the New York Tribune published a list of 4,047 millionaires, over 100 of them having fortunes that exceeded $10 million. It was estimated that 9 percent of the nation’s families controlled 71 percent of the national wealth. As the self-indulgent old rich and the new rich flaunted their wealth, paying on average $300,000 a year to maintain their city mansions and Newport cottages, $50,000 to keep their yachts afloat, and $12,000 each time they wanted to give a little party, hundreds of thousands of immigrants were jammed into tenements not far from the fabulous Millionaires’ Row. Thousands of child laborers worked in sweatshops for $161 a year. Common laborers made $2 to $3 a day, with the average worker earning $495 a year. Two thirds of the nation’s families had incomes of less than $900; only one family in twenty had an income of more than $3,000.

But even in a country like India, that cycle of rags to riches to rags persists because all it takes is one generation to come along that has no clue how it is done and then it is back to square one.

So, some more takeaways…

First, my perspective on leaving a legacy behind has evolved greatly. That would be an understatement. I would say the more I have read on this, the more convinced I am that there is no point killing ourselves in our day-to-day life if in the end we leave a pile of cash behind so that our next of kin gets to ride easy. There’s this very famous father-son interaction in a hit Bollywood movie where the father wants his son to live his part of the good life as he, the father could not because he was too busy making money. Fine because there is a certain amount of pleasure we derive seeing our kids enjoy the wealth we were fortunate enough to create.

But that does them more harm than good in the long run in light of all the evidence that is out there, and the way human nature works. So, the best use of our money is to plan it in such a way that we get to spend it all. And bequeaths to our favorite charities are included in that spending bucket.

That is not to say that we don’t do nothing for our kids. Paying for their education, providing them with options to pursue their passions etc. are all things we can buy for our kids. But outright raising trust-fund babies is not going to turn out good.

Second, getting our kids involved in the little and big decisions we make with our money is a great way to impart some of what we have learnt onto them, age no bar. The more action they see, the better off they’ll be. And we hope they do the same with their kids.

Third, financial literacy is a skill our kids must learn to thrive in the current state of our economy. We see everyday implications of not knowing this stuff with the level of student loan, credit card and mortgage debt out there. Plus, no more pension plans coupled with longer lifespans mean that the retirement thingy is not looking that hot either for a vast majority of people.

Last, it is easy to inflate our standard of living in line with our incomes but cutting back on the good life when the time comes is not going to be as easy.

And we think that the next pay raise or that hot new car or a sprawling home will make us happy but then we hedonically adapt to all that stuff. So, as we make more money, our desires and expectations rise along with it, and we are back to where we were on the happiness scale.

I say design in occasional splurges but a life of permanent affluence, even if you could afford it, is no fun.

To the Vanderbilts again, not all was lost of that great fortune as a tiny piece of it funded the inception of Vanderbilt University. Then there is the Grand Central Station in New York. And last, we got CNN’s Anderson Cooper, son of Gloria Vanderbilt and a direct descendant of the Commodore.

As a parting note, here is Cooper on the prospect of inheriting her mother’s $200 million fortune that she built all on her own…

His branch of the Vanderbilt dynasty no longer considers inherited money anything but a “curse” that drags kids down and wastes adult lives.

Thank you for your time.

Cover image credit – Wendelin Jacober, Pexels

There is seldom a parent who hasn’t gone through the tantrum-throwing phase of their kids’ lives. You walk into a store; your kid sees a toy and she must have it. The moment you say no and the next thing you see her rolling on the floor.

I went through that phase as well.

When my daughter was about four, I learned this neat trick from a book called The First National Bank of Dad by David Owen. It helped put an end to all her tantrums. The essence of it was allowing kids to control their own spending.

And it starts with giving them an allowance. Sizing the allowance is subjective but at age four, I’d give $4 a week and raise it by a dollar on each birthday. So, if she wanted to buy a toy that cost $20, she’d have to wait five weeks to save up the cash to afford that toy. There are two benefits:

• It teaches kids about delaying gratification. A seminal study and several follow on studies highlight the importance of being able to delay gratification as a key ingredient for success in many areas of life.
• And almost always, in a few weeks, she would change her mind about getting that toy or completely forget about it.

And a heartless dad that I was, I would hand out the allowance in small denominations and then have her store that in a transparent jar. So, on occasions that she would follow through on a purchase, she’ll feel the weight of emptying a sizable chunk of that piggy bank for what we all know would amount to literal junk that you’ll soon be trashing away anyway.

I would also have another jar that would serve as the dad’s bank where if she moved her savings to, I’d double the transferred amount on one condition: any cash that would move to this savings jar must remain invested for 6 months minimum.

Every Saturday would be a pocket money day where she would receive new allowance. That would also be a day where she would tally up all her savings. And then display her hoard on a whiteboard as well as track the amount in a spreadsheet for some pretty plotting as she watched compound interest take hold.

Granted, this is more work for busy parents, but it is a great bonding exercise with all the pluses and literally no minuses.

Grocery shopping is a great avenue to teach kids on how to make smart, responsible consumer decisions. Minimizing waste, making trade-offs and not being beholden to brands is a great way to teach them on how to stretch a dollar.

And as they get older (teens), you discuss household finances and credit cards and interest rates and the benefits of using debt responsibly. You start to involve them in bigger purchase decisions like car buying, paying for college etc. You talk to them about compound interest, the stock market, opportunity costs and the rest. Use every chance you get to talk to them about all these things before you send them out to face the mean bad world.

And kids do what you do. They don’t do what you say they should do. If your own house is in disarray, no amount of lecturing will fix their relationship with money. You might inadvertently be making things worse as they get conflicted messaging.

My daughters are now old enough to tell me that they know everything, but I know much of that experimentation worked. I see them make decisions and they are qualifiedly fine. They have learned to be empathetic. They are good students. They work hard. They don’t get easily influenced. But regardless, it is still experimentation because each kid is different. Even the two sisters, growing up in the same household, are different.

Money is not everything, but you get behaving with money right and life gets easy.

Thank you for your time.

Cover image credit – Cottonbro, Pexels

What you feel is a good investment because of what you see and hear is seldom a good investment. A good investment is usually the one you don’t hear much about. Or if you do, you only hear disgust and shame.

Because when an investment feels disgusting to own, its perceived risk is higher and because of that, the availability of capital (money) flowing into that investment gets scarcer. It becomes an undercapitalized situation. No one wants to buy into its stock or bond.

To attract capital, that investment needs to offer a better rate of return. Expected return hence for that investment is higher because the risk is higher. That is another way of saying that future cash flows for that investment are discounted at a rate higher than that for a perceivably less risky investment.

Risk is about the range of expected future outcomes (returns). Bank CDs are the safest. Bonds are riskier. Stock investments are the riskiest. The venture capital bar is added for completeness sake but is not considered investable unless you are running a pension fund or an endowment.

Bull markets in stocks see returns on the higher side of the average (green line), bear markets on the lower. And when a hot new theme like artificial intelligence comes about, stock prices in that corner of the market tend to go nutty. Everyone wants to buy into that theme because it is perceived as a guaranteed money-maker. Investor capital follows by the truckload, and it quickly becomes an overcapitalized situation.

Richard Bernstein of Richard Bernstein Advisors describes this as being in a town with a thousand banks and one borrower. And when you are the only borrower and you have all these banks competing for your business, you are going to set the interest rate. And you are going to make out like a bandit because you are going to set those rates to be as low as possible.

Turn it around and now say you are the only banker in a town with a thousand borrowers. You are going to mint it because you get to set the interest rate on each and every loan. And you are going to set them as high as possible.

So, when it comes to the hot themes of the day, it is hard to argue that they are starved for capital. There are a thousand banks flooding the market with capital.

And it is simple supply and demand of capital that sets the long-term return on investment. So, if you want to score big or if you don’t want to be left holding the bag, you want to look for situations no one wants to invest in.

The question you should be asking hence is that everyone knows about artificial intelligence. It is going to change the economy. And quite a lot of that and more is likely already priced in.

So where is that opportunity where you get to be that one banker against a thousand borrowers? That is likely staring in your face in some corner of your plan and that is where you’d want to invest.

Thank you for your time.

Cover image credit – Jplenio, Pexels

President Dwight D. Eisenhower was once quoted as saying that in preparing for a battle, I have found that plans are useless, but planning is indispensable.

There is no perfect plan because change is the only constant. But that does not mean we do not plan.

I like simplicity which means that that 50-page binder you get from that neighborhood finance guy is out the door. Your plan should be so simple and yet comprehensive enough that a 5-minute glance at it and you know what is going on with your money.

That is the design I build into the plans you receive and a big part of the inspiration behind it comes from a book by Carl Richards called The One-Page Financial Plan. The essence of the book is to distill the complex into simple to help keep clients vested into their plans while stressing on the need for ongoing planning.

And ongoing planning is important because life circumstances change, family dynamics change, markets evolve, your savings rate ebbs and flows – all these impact your plan.

But an ever-evolving plan does not mean it has to change every day. There are tools out there that provide real-time updates on your money but that is way overkill. In fact, they can be downright detrimental as they suck you into watching micro-second level updates about your money on what is supposed to be a decades-long game.

So apart from implementing tweaks here and there to keep the plan within its pre-defined guardrails, any more effort and we make things worse.

But there might still be gaps that develop and that is what I want to address here. Take a goal like saving for retirement for example. There are two kinds of gaps we track there.

The first is the required annual savings rate that is fundamental to your plan. That is derived from the amount of savings you have today and the amount that it needs to grow to to support your expenses in retirement. There is some behind the scenes net present value math and cash flow projecting that needs doing but nothing complicated.

Running out of money before running out of time is the biggest fear retirement savers have so the required savings rate I like to design into your plans has a built-in conservatism to account for longevity and sequence of returns risk.

But you meet the required savings goal outlined and everything and I mean everything falls into place.

Your plans typically track a couple different retirement income scenarios to afford some optionality which then means you’ll see savings rate curves like these…

This is the most important part of your plan. It tells you how the required savings rates have trended historically and what their state is today. You want to see these curves stay flat or trend down and there are only two ways to make that happen –

• If the markets and consequentially your portfolio do better than the expectations built into your plans. That is possible but that is not something we get to control much beyond building a good portfolio for your station in life. Market forces decide the rest.

• What is very much in your control is how much you save. So, if you see these curves perk up, you know what to do.

And during the early part of your journey to financial independence, it is the savings rate that makes all the difference. So be deliberately maniacal about it.

The second kind of gap we track is more structural and that relates to how your portfolio is divvied up between different categories of investments. A good portfolio means that there will always be some corner of it that is temporarily underperforming so that will create a gap from the desired portfolio targets.

We fill that gap with new money that feeds your plan. But there are situations where contributions to your retirement plan at work is all you can do so we go looking to fill that gap in your 401(k).

But say we don’t find that investment in your lineup there. Or if we do, the available option is so inferior and expensive that it would be better to leave that category unfilled.

The other option is to rebalance into that investment to fill that gap outside of your 401(k) but that involves selling investments that have done well and buying the ones that have not. Selling means capital gains and capital gains means taxes so again, not something we’d want to do.

Worst case, we leave that gap as is and use the dividends that trickle in to fill that up over time.

But filling both kinds of gaps means you’ll be buying investments that are temporarily marked down with new savings which then means that when they eventually mean revert, you’ll be set sooner than planned.

By failing to plan, you will be planning to fail so plan you must. You meet the key defining metrics that are part of your plan and life gets easy. The rest is all icing on the cake.

Thank you for your time.

Cover image credit – Elina Sazonova, Pexels

You’d see these clickbait stories every now and then. They let you dream about the easy riches you would have earned had you wagered on this or that stock. Dreams are great but acting upon them is Chernobyl deadly for your money. Let me explain why.

Apple today is a three trillion-dollar business. A one-time investment of $100 in Apple stock when it went public is worth $150,000 today.

But I bet none made anywhere close to that kind of money investing in Apple stock. In fact, I am willing to bet that a vast majority of Apple investors lost money or significantly underperformed a global market portfolio during their ‘ownership’ phase.

How is that possible? How could anyone have lost money investing in one of the best stocks ever?

Because what none of these stories talk about are the horrendous, business extincting stock price declines you’d have to live through and still come out at the other end holding the shares.

Let us talk more about Apple. The company went public on December 12, 1980, and within months, it lost 60% of its value. You do see drawdowns (declines) in red in the plot above, but you don’t see much about the $ value performance for the first half of the company’s existence. Zooming in for a better picture…

Two things stand out:

• You barely made any money for the first 23 years of being an investor in Apple stock.
• To add salt to that wound, you’d have to live through numerous forty, fifty and a few eighty percent declines in the interim.

What does a stock price decline of eighty percent mean? It is a way of the market telling you that there is a significant risk that the business might not survive.

And that almost came through with Apple. You think you would have hung on through all of that? Not a chance unless of course you get struck with amnesia right after buying the shares (more on this later).

It is the same story with shares of Netflix.

Nvidia is all the rage these days but so was Cisco Systems back in the day. Similar growth themes were embedded in Cisco Systems stock as they are in Nvidia today.

Cisco went public on February 16, 1990, and in a mere span of ten years, it became the most valuable company in the world. Had you invested $100 in Cisco stock at its IPO, you’d have $100,000 ten years later.

Then the Dot-com bubble burst and Cisco has yet to reclaim the highs set twenty-five years ago.

Talk about Nvidia, you get the same story of living through gut-wrenching declines and then getting extremely lucky to have the growth in AI intersect with their products.

Or you could have been an Intel investor instead. Same sector eyeing the same set of opportunities but a completely different outcome.

Microsoft is riding high on the AI wave as well. But had you bought Microsoft stock in March of 2000, you’ll be sitting on dead money for 15 years. That is a literal eternity in the world of investing.

The point of all these stories is that armchair quarterbacking looks great until you are in the middle of experiencing what it takes to own these stocks.

So, who is likely to hang on? An extremely lucky person who bought the ‘right’ stock and forgot. Not trying to forget but actually forgot.

Here is an excerpt from a news story dating back to the Dot-com days that talks about the role luck plays in not only happening into owning the hottest stock of that era but also forgetting to have owned it.

The man, who lives in Boston, said he purchased 3,000 shares of stock in 1987 on the advice of a cousin. Sometime during the 1990s he sold 2,000 shares of the stock to pay for his children’s college tuition and forgot about the remaining 1,000 shares.

Some 13 years later, the value of 1,000 shares had ballooned to nearly $4 million.

The forgotten shares were discovered by the treasury’s Abandoned Property Division. By law, brokerage firms must turn over to the state stocks which show no activity by their owners after three years.

Forgotten Stock Makes Man Millionaire, ABC News, November 30, 2000

And all of that before discounting the fact that most companies experiencing big drops in market value never recover. While stocks in aggregate outperform other investments over the long run, most individual stocks don’t. I’ve talked about this study by the Arizona State University professor Hendrik Bessembinder before but let me reiterate some of the key points again…

• Of the nearly 26,000 companies that went public between 1926 and 2019, only 42 percent of them created net wealth for their shareholders. The remaining 58 percent (15,000 businesses) destroyed wealth in all their existence.
• Five firms accounted for 12 percent of the total wealth created in the stock market.
• Eighty-three firms (0.3 percent of the total) accounted for 50 percent of all wealth created.
• And 1,000 stocks (4 percent of the total) created all the net wealth above what Treasury bills would have paid you.

Coming into one of these stocks that go on to multiply manyfold in a relatively short amount of time is a lottery type outcome. In fact, it is worse because with a lottery, a winner is declared rather quickly. It is black and white, and it is quick.

But individual stocks that go on to deliver lottery type outcomes can take decades. And you have to persevere through the interim roller-coaster of heartaches and ulcers.

So, when you hear these what-if seductive stories, remember that there is a huge amount of survivorship bias built into them. Do not let these stories sway you away from your plan.

Cover image credit – Jon Collier, Flickr

Mary Hunt profiles three types of people in her book 7 Money Rules for Life on how they handle money and how it impacts their well-being and happiness.

So, say they all made the same kind of incomes since they started working…

Nothing spectacular. Their paychecks rose as the cost of living (inflation) rose. But a big chunk of their paychecks rising came from them honing their respective crafts in a field the economy values.

To that income, we now add spending…

This is the first category of people Mary Hunt profiles. Their spending rises as their incomes rise – classic lifestyle inflation. They are doing great in the now and yet are a paycheck away from becoming debt slaves. A good life is hard to give up on.

And when the outflow of money is more than the inflow, misery is what we get.

Talk about misery, economist Daniel Kahneman differentiates between what he calls momentary happiness and happiness that is deeper and longer lasting.

Momentary happiness comes and goes. A good night out with friends makes you happy in the then. But the memory of that night eventually fades, and you are back to your initial state.

Lasting happiness, as Kahneman describes, is about life satisfaction. It is built over time through achieving goals and building the kind of life you admire. It is when you get to do your life’s work, free from the financial pressures of doing that work.

So, from the happiness perspective, it is life satisfaction we are after. And if you are lucky, you’ll find your life’s work in the work you are already doing. And if the money is decent, wealth building then becomes a side show. You still need a plan but there is no hurry.

But if you haven’t found your life’s calling, your job number one should be to get to a base-level wealth that generates enough passive income as quickly as possible. And then you can go explore how you want to spend your time.

Charlie Munger once said that like Buffett, he had a considerable desire to get rich – not because he fancied mansions or Ferraris. He wanted independence. He wanted to control his time the way he wished, which is what wealth allowed him to do.

There is this tiny movement of die-hard minimalists who want to bag work in their forties. It goes by the name of FIRE or Financial Independence, Retire Early. Folks in the FIRE camp, though not Munger-rich, have the same Munger mindset. They are the engineer-types, making good incomes but what sets them apart and what sets them free early in life is their ability to sock away half of what they make into savings and investments.

This is what Mary Hunt describes as the third category of people. Though they set themselves up to retire early, they are not the types who give up on work. These are driven folks. Most continue working but now they get to work on their own terms. It circles back to that happiness construct around life satisfaction and having a sense of control.

Use money to gain control over your time, because not having control of your time is such a powerful and universal drag on happiness. The ability to do what you want, when you want, with who you want, for as long as you want to, pays the highest dividend that exists in finance.

Morgan Housel

And it is not like you have to commit to a lifetime of pinching pennies to get to financial independence. You can get there even after baking in a good deal of lifestyle inflation as shown by the gradually rising red curve above.

What you do not want are dramatic ups and downs in spending as your income changes. That is a stressful way to live not to discount the untold amount of psychological damage it does to kids growing up in that environment.

So, where is the most difference you can make on your journey towards financial independence? More income for sure helps but only when spending is kept in check.

NYU professor Scott Galloway talks about a friend of his who runs a 700-person division at a large investment bank. He makes somewhere between five and nine million dollars a year. Between paying for New York city taxes, alimony to his ex-wife, home in The Hamptons and a master of universe lifestyle, he spends almost all of it. He describes him as poor.

Prof. Galloway‘s father on the other hand, between his Royal Navy pension and income from Social Security makes $58,000 a year but spends forty-eight. He describes him as rich. He has got passive income greater than his burn. That is the definition of rich.

Rich is a function of not having to worry at night that the music might stop. And if the music were to stop, you can support your lifestyle without working.

So where is the biggest dent you can make with spending? Housing of course takes up the lion share. Then cars and then comes the other itty-bitty stuff.

Personal finance experts love to rail against spending on the itty-bitty stuff that in the grand scheme of things is inconsequential while the biggest boondoggles of the monthly spend remain unaddressed.

And a lot of it comes down to being able to differentiate between needs versus wants.

Let us go back to housing for example. In the 1950s, the average new home was a thousand square feet. By the 1970s, that home size grew to 1,700 square feet and these days, it is around 2,600 square feet. All this while, the average family size dropped from 3.5 people in the 1950s to 2.5 people today.

So, we have less people living in almost 3x the amount of living space. That is a lot of extra spending that could instead be used as a fuel to shorten the path to financial independence. That does not even count for all the more we pay on everything – property taxes, insurance, electricity, water plus all that time spent cleaning and maintaining that extra space.

Big homes also mean more stuff so a perpetual drain on our wallets from all angles.

And cars? How did we normalize buying $50,000 cars?

Most of the needless spending we get seduced into doing is all due to our attempts at keeping score. We want to live, drive and dress better than our neighbors or whoever we get into this comparison game with.

Comparison is the death of joy.

Mark Twain

Carol Graham in The Pursuit of Happiness talks about what constitutes the economics of happiness. Stable marriage, good health and enough income is what it takes to be happy.

What? Is income ever enough? Why would making more money not make us happier?

That is because the relationship between money and life satisfaction is not linear. Income matters to well-being only up to a point. Beyond that, other people’s incomes start to matter more. So, a rise in other people’s income hurts our happiness. That of course is dumb.

The truth is that folks with enduring personal finance success are inclined to not give a hoot about what others think about them. And this is where our focus in life should be if happiness and life satisfaction is our goal.

On the surface, personal finance looks like a field that helps you optimize money. Once you peel back the layers, you see that it’s actually a field that helps you optimize happiness. Money is simply the tool it uses to do so.

Morgan Housel

And finally, this tweet. It says in a few words that I’ve been trying to say all along.

A big part of happiness is reaching FI (financial independence), and FI is mostly a function of being happy with what you have, spending less than you make and letting time and compound interest do the heavy lifting. Plus, relationships and experiences but never things.

Thank you for your time.

Cover image credit – Pixabay

William P. Bengen, an aeronautical engineer turned financial advisor, first articulated the 4 percent safe withdrawal rule in a 1994 paper in the Journal of Financial Planning. But to his dismay, that rule transpired to become a widely used hack to guesstimate one’s retirement number.

Though more a rule of thumb than a rule, it says that if you could live on 4 percent of your money starting with the first year of your retirement and inflation-adjust that withdrawal amount each year hence, you’ll never run out.

But that was 1994 when 10-year Treasury bonds yielded 8 percent. There was no way to fail unless you did something truly dumb.

That same Treasury bond yields about 4 percent today¹. That matches the safe withdrawal rate as just described but does not factor in inflation, so you must do more work than just buying Treasury bonds.

And that inflation-adjusted safe withdrawal rate must last longer than your joint (you and your partner’s) life-expectancy.

But say you are 20 years out from when you think you’ll retire, and you know what your expenses are today. There are some big-ticket items in there like mortgage and college costs and then there are the trinkets like paying for food and travel.

But you shouldn’t assume your expenses from today to last forever. You need to think about what your expenses will be 20 years out.

The two big spends – mortgage and college costs – would be done by then. What will remain are costs that are relatively tiny in the grand scheme of things and that is what we’ll use as a guidepost to plan for.

So, say those trinkets cost 80,000 dollars each year today. That is quite a chunk to spend on food and travel but say that is what you want. There is spending on healthcare in the future but you’ve planned around that by funding say a Health Savings Account.

So, 80,000 dollars is what you need today. Subtract 30,000 from it that will come from Social Security and now you have to plan for 50,000 dollars in income if you were retired today.

But your planned retirement is 20 years out. Assuming historical inflation rates, if you need $50,000 in income today, you’ll need $100,000 in income 20 years from now to afford the same quality of life.

So, you would want to plan for 100,000 dollars in income draw each year from your portfolio when you retire and inflation-adjust that amount for the remainder of your joint lives.

A 4 percent safe withdrawal rate hence means you’ll want to build to a portfolio value of $100,000 divided by 4 percent = $2.5 million.

A big number, yes, but you have 20 years to get to it.

But say you want to make your plan bulletproof plus leave a legacy behind, you can then plan around a safe withdrawal rate of 3 percent.

That means you will need to plan towards a portfolio value of $100,000 divided by 3 percent = $3.33 million, a 33 percent increase for a mere one percent decrease in safe withdrawal rate. But that is what a 100-year joint life expectancy costs. And you should plan for that.

But if you want to plan for generational wealth (it will not last though), use a 2 percent safe withdrawal rate. You now have to plan for a portfolio value at retirement of $100,000 divided by 2 percent = $5 million. The portfolio structure will be different than the usual balance portfolios you will use for say the 4 percent safe withdrawal rate though the bigger deal is to equip the next generation to manage all that wealth. Doable but not easy and hence one of the reasons inherited wealth dissipates quickly.

And $5 million might look like an insurmountable goal but plausible for folks who got this far reading this. Plus, you have 20 years to get to it.

Thank you for your time.

Cover image credit – Julie Aagaard, Pexels

¹ March 31, 2024