The road taken

Posted on December 6, 2020 by wiseguide

I often use the analogy for life’s decisions as hiking through a series of paths, with multiple forks leading to uncertain outcomes. The idea is the inspiration for this blog. Hopefully, you live a life replete with options from which to choose: what to study in school, when to change jobs, who to marry, where to live…

The challenge of course is trying to decide which path to choose. Some will say, “Go with your gut” (or heart, or maybe some other body part besides your brain). If your gut is able to take in all available information, weigh it based on your personal priorities, and then act decisively, terrific! For me, I never quite understood why my intestines are appropriate for this task. I go with my brain.

This does not mean everything will always work out as you hoped. I advocate for gaining whatever information you can, using the advice and experience of others you trust, and making a decision that provides the greatest probability of a successful outcome. If you are able to work through these probabilities for life’s decisions, you’ll be right more often than not.

However, this analogy of choosing life’s path to your whim is a little flawed. There will be times that not all options are available to you. A better analogy is paddling a boat in a river, with multiple tributaries leading off in many directions. Yes, you can paddle toward the direction that you wish based on the information you have gathered, but there is also a current, pushing you down certain directions whether you choose them or not. This may be an unfortunate revelation for a young person. Remember those kindergarten days where you were told “You can be anything you want!”. Well, probably not. Sorry. Sometimes life circumstances simply don’t allow you to have total control over everything in your life. This has been a difficult lesson for me to learn, and I still have to learn it more every day.

The situation is not dire though. Is the solution to just sit back, stop paddling, and let the current decide your fate? Of course not. You can and should still steer yourself in the direction you wish to go, but be aware that occasionally there be be dissapointments and paths that are inaccessible to you through no lack of effort on your part.

The good news is that some of my best life “decisions” were not always strictly speaking my choice. Occasionally I’ve paddled as hard as I could in a different direction, but life pushed me somewhere else. At the time, I thought it was a disaster, but in retrospect, ended up even better than had I truly chosen my route. Keep pursuing the direction you wish to go, but have confidence that when life deals you these disappointments counter to your wishes the end result may lead to life circumstances better than you had imagined.

Bond Investing

Posted on August 23, 2020 by wiseguide

dollar-544956_640 Investing in bonds should be one of the simplest form of investing. I lend a government, corporation, or other entity money and it agrees to pay me that money back at an agreed upon interest rate. So long as they don’t default on the loan, I will get that return on your investment. For individually issued bonds held to their maturity, that’s pretty much the deal. However most people invest in bonds via mutual funds or ETFs and that makes things a little more complicated. If you read any article on bond investing, it will inevitably state that the yield of a bond fund (interest it pays you) moves inversely to its price. That might not make sense, if the bond is now yielding more, shouldn’t it be more valuable? Sort of. I always find it is easiest to explain with an example.

Remember a bond is just a loan. Let’s say you lend $10,000 to Bill, at a 10 year fixed rate of 3%. Bill has a history of paying his debts in the past and therefore you have confidence he will pay you back. Let’s say next year Bill is looking for another 10 year loan, but circumstances have changed. Maybe Bill is starting to struggle with his bills (ha!) or the interest rate environment has changed and now the best rate he can get is 5%. Now, let’s say you don’t really want the original 3% loan you made to Bill and are looking to sell it to someone else. Do you think someone will pay you $10k for it? Why should they? Your loan to Bill only pays 3%, you locked in that rate when you made the original loan, but they can issue a new loan to Bill at 5%! The only way you can sell your loan to another investor is if you drop the price. The amount you drop the price of the bond is to make up for the lost revenue that the person would get between your 3% loan and the 5% loan they could make to Bill. The same happens in reverse if current interest rates drop, your loan to Bill suddenly looks even more valuable and you can raise the price. How much depends on the difference in interest rates and how much longer you have the loan. In other words, if you want someone to be saddled with this 3% loan for 10 years, you’re going to have to drop your price more than if it were only a year. This is why interest rates impact the prices of long term bond funds a bunch, and short term bond funds not as much. You might even need to drop the price so much you lose money on the investment, even though Bill hasn’t defaulted! That is not smart investing.

This is another example of why it pays to be long term on investments. You don’t have to sell the bond. You can keep it, be happy with the 3% you’re getting, and as long as Bill doesn’t default, you’ll get all your money back, with the interest you agreed upon. Buying a little bit over time is a good way to even out the ups and downs of the bond markets just like with stocks. It is important to understand that you aren’t buying bonds for these ups and downs in price. A bond is a loan, you are buying it for its yield, This is critical when evaluating loans as investments. This can be illustrated looking a curve of the 10 year US treasury (10 year loans made to the US Government) and the return of the Vanguard Total Bond Market ETF (BND)

The BND return is generally higher because it has some higher yielding bonds in it, but there is a critical conclusion here. As the 10 year US treasury bond yield, and interest rates in general, have declined over the past 35 years, bond fund returns have fluctuated wildly, but the average return pretty well tracks this yield. It has to, the yield of the bonds is what is making you money! The drop in interest rates has been great for home buyers because of lower mortgage rates, great for businesses borrowing money to expand, but a hit to anyone looking to make money by lending it to others. Looking at the chart above, seems clear that you should not expect average bond returns to be more than a couple percent, maybe even lower for the next few years.

Money for nothing

Posted on July 27, 2020 by wiseguide

Rates have dropped! I mean really dropped. As I write this 30 year mortgages are less than 3%. That is really a staggering number. Keep in mind the the Federal Reserve target for an inflation rate is 2%. So banks, and their investors are basically telling you they are willing to lend you money, for 30 years, at a rate that just barely beats inflation. We all probably don’t fully grasp what an opportunity it is to be a borrower (and, how terrible it is to be a saver) in our time. If you have a mortgage, it really means you should take a look at a brand spankin’ new mortgage (Refinance!) but it doesn’t necessarily mean you should pull the trigger and if you do, what flavor of loan should you get? Like many other aspects of the financial world, this can be (intentionally) confusing. (People make a lot of money on the general public confusion over some rather simple math, and try to keep the confusion as high as possible to maintain their utility).

To add to the confusion, there are experts simultaneously advocating completely opposite points of view when it comes to mortgages. Some will argue paying as many points as you can, some paying none. Some argue paying off the loan as early as possible with the shortest possible terms, some say stretch it out as long as you can. There isn’t a uniform rule on when to refinance. How can all of these points of view be right? Well sometimes it really is because one opinion really isn’t very informed, but usually the answer is that there isn’t a one-size fits all approach and what is right for one person is not right for another. It depends on many personal factors, which means what’s really important is for you to understand the process so you can judge for yourself.

Let’s start with the mortgage itself, which is simply a loan secured with your home (actually, if you are getting a mortgage, it’s probably more accurate to say its more the bank’s home than yours…but it sounds really awkward to say you’re heading over to your mom’s bank’s house). There are really three (good) reasons to take out a loan for something you can’t buy with cash. One, because you believe you can make a higher return with the money than the rate at which you are borrowing (this is the essential business of banks). Two, because buying something you can’t currently afford is necessary for life (meaning, a car required to get you to work, not a car that enhances your perceived awesomeness). Or three, if there is a once in a lifetime opportunity, and the benefit is worth the interest payments (careful with this one, I’m thinking more like seeing one of the 7 wonders of the world, not Justin Bieber, but hey, to each their own) . A home generally appreciates in value and allows you to live a lifestyle much greater than you could if you had to pay for your living arrangements with cash, and you need a place to live, so homes generally meet the loan criteria. But important to remember, any time you are taking on loan of any type you are agreeing to pay extra money for essentially nothing. You get no product or service for the interest you are paying. Therefore it’s important that you are very sure about the investment opportunity if it’s reason number one, or the lifestyle improvement justifies the interest payment if it’s reason number two or three.

Once you decide that living in a home is worthy of a loan, and generally it is, then you have some decisions to make on the length of the loan, comparing fees, or paying points up front. Down the road if rates drop,you may also be faced with the decision of whether or not to refinance again, which is simply getting a new loan to replace the old loan.

When to refinance can be a tricky question, but doesn’t have to be. Note, the reason to refinance should be that rates have dropped sufficiently to allow you to have the exact same thing (live in your home) for less money. It is not because it’s a great opportunity to borrow even more money to buy more stuff. The real estate collapse of 2006-2007 really should have only impacted people who were unlucky enough to buy homes in the few years just prior to that who bought a home at the market peak. Instead it swept up many, many more people because as the housing market exploded in price in the early 2000’s, people refinanced with the purpose of “pulling money out of their home” or put another way “took on much more debt for no real reason other than their home price was artificially inflated”.

The easiest way to compare your current mortgage to refinance offers of all different types and all different durations is to assume all of the expenses associated with getting a new loan are going to be rolled into the new mortgage. In other words, the starting point of your current mortgage is your current balance and the starting point of any refinance mortgage is your current mortgage balance plus fees associated with the refinance (everything except the “escrow pre-paids” which usually includes local property taxes and insurance. These are included in the fees, and you have to pay them, but you’d have to pay these anyway eventually, even without refinancing).

Aside on fees. One expensive one is title insurance. This is insurance you pay in case a prior owner that sold you the house doesn’t have a “clean” title–like maybe someone did work for the person who built the house and never gets paid, they come after the homeowner, which is now you. The bank forces you to buy this insurance for them, but your policy is optional, and the closing companies aren’t always very clear that this is insurance you don’t have to buy for yourself. I personally have never seen a good investigation of the risk of these claims and average liability, so don’t have a good way to judge if this premium is reasonable or not…but my sense is that the risk is low and the premium is very high. I always opt out of this coverage.

Back to my refinance calculation. For each year going forward, calculate the total payments made for the year (the PMT function in excel is best for this) and the mortgage balance at the end of the year (the starting mortgage balance minus all the principal payments for the year, which you can get using the PPMT function in excel). Add these two numbers, total payments for the year + mortgage balance at the end of the year. Do this for any competing refinance offer also, including all variants of points you can pay, which as stated above, we’d be rolling into the starting mortgage balance. Repeat this for year 2, 3, 4 out to as long as you’ll be in the home.

Now look across each column each year. The lowest number is the best deal for that year. What you’ll probably see is that your current mortgage might still be the winner after year one or two, but if the competing refinance rate is at least a percentage point lower, you should start to see some of the refinance offers be a better deal. Also, you should see that paying fewer points are a better deal for those early years, but eventually the loans with more points become the better deal. This is done by design.

Mortgage points simply represent interest that you pay up front. Any time you pay for anything up front vs over time you should always be getting a discount. So if you are comparing mortgages for the total interest paid over the typical 30 years of the loan, the ones with the most points should absolutely be the best deal at 30 years. Aha! Easy answer! Why do they even offer those other loans with less points?

There’s one key variable the above calculation forgets. How many people get a 30 year loan and actually pay it off over the 30 years? Almost none. The average time in a home is 9 years. And note, that is the average time in a home, what you really need to know is how long you’re going to be in the loan. Even if you’re sure you are going to live in the home forever, are you sure interest rates won’t drop so much that you’ll be able to refinance again? If you look at the same mortgage comparisons over 2-3 years instead of 30 years, those with less points start looking a lot better.

So now that you have your table, what you need to decide is the length of time you’ll be in the loan. When deciding if to refinance, and after, what offer to use, it is mostly a personal decision on where you think you’ll be living in the near future and where you think interest rates will go in the future. This is why for some people paying nearly no points is smart and for some people paying maximum points is smart. If you feel like you’re going to be in the home for at least 5 years, and all the refinance offers are a better deal at 2 years…it seems like you should probably pull the trigger, but if you think rates will continue to drop, you might want to wait. In any case, look at all types of loans (10, 15, 30 year) and all types of offers (multiple banks with multiple points and fees) using the approach above to determine the best deal.

Refinancing can be a pain, so it has to be worth your time and trouble, but you should absolutely keep an eye on mortgage rates all the time, and be able to understand how to act as they drop.

Best Laid Plans

Posted on April 2, 2020 by wiseguide

Everyone has a plan until they get punched in the mouth
–Mike Tyson

As I write this the world is in lock-down due to the spread of a global virus. I write mostly about financial issues but try to consistently keep the perspective that your time is really your most valuable resource, and your continued health is what enables you to make the most of that time. So, remember that if you and your loved ones are relatively safe from this, consider yourself among the fortunate. My friends and family who are doctors and nurses see it up close and personal, and I don’t know any of them who have their stock portfolio as one of their top 10 worries. Just keep that perspective.

With that as an important backdrop, looking at this as merely a financial impact can be jarring. I’ve talked about this in prior posts, the occasional, even significant decline in the stock market is completely expected, and is actually a positive. One of the other positive things to result from a downturn is it gets you to measure your real response to a crisis. I can ask myself, what would I do right now if this were happening and I was already retired with my 50/50 stock/bond portfolio? If I’m being honest with myself, I’d be freaking out. This is extremely valuable insight into my psyche, and allows me to avoid those freak-out moments as an old man, at least when it comes to money.

I still think the 50/50 portfolio can work for many people, but recall my analysis for that example showed there was a 10% chance of outliving your money using the 4% rule for withdrawals. As risk-adverse as I am, I realize for me, that’s too big of a chance. I also realized that to mitigate the impact of this kind of downturn in the future, I’d want to have a plan that required no stock sales, so as things dropped it wouldn’t really cause any short term panic selling, which as a stock investor is what you have to avoid.

Here’s the difficulty. At today’s interest rates and stock dividend yields, you can’t count on 4% yields. You can’t really even count on 3%. To get to 4% in today’s environment you have to be reliant on some gains of your investments, or be willing to dip into principal–which can be a vicious cycle of reducing your investment assets, which leads to less yield, which causes you to withdraw more principal. I’ve adjusted my plan to try to address this.

In earlier posts, I talked about two buckets of funds, one to sustain your life from age 59.5 using designated retirement funds, and another to get you from whenever you stop working to age 59.5, your “bridge” to retirement. I’m still a believer in the long term value of stocks, so still recommend my asset allocation for those long term assets. I may rethink the retirement age allocation, but I’m sticking with it for now. For the shorter term assets, part of my solution is an asset I’ve tried to avoid up until now, rental real estate. I’ve avoided this not because I think it’s a bad investment, but because unlike other assets classes, it requires work, so to call it passive income is a stretch. It’s a little bit investment, a little bit part time job. But I’ve come to realize this is my favorite income-producing risk-adjusted asset right now. I’ll have a follow up post on this, but I’ve dipped my toe in, I can’t stay out any longer.

For shorter term, bridge assets, I recommend the following. Instead of my prior approach which was to determine the earliest possible date you can retire, take a little more conservative approach and lay out your intended work plan. How long do you believe you’ll work full time? Part time? With that plan, you can estimate each year’s income and with your forward-looking budget you can estimate expenses. You can do this for each year going out to age 59.5, I even try to estimate when I will make major purchases, like cars.

With your short term assets you can also estimate both yield (income produced) of those assets and growth of those assets. The following is a reasonable example, you may want to adjust these based on interest rates, market conditions, etc. Note the yield and growth values for Real Estate vary considerably depending on how much you initially invest. If you buy the property outright, more yield, less growth. If you finance a great deal of it, less yield, more growth.

Asset	Yield	Growth
Stocks	2%	5%
Bonds	3%	0%
Cash	2%	0%
Real Estate	3%	3%

For each year, assume the yield of your investments can be used to supplement your income and add that to any money you expect to earn working. If your expenses exceeds your income (from investments and salary) draw money only from cash and bonds (the ratio of this draw can be varied but one approach is 50/50). If your income exceeds expenses, put the extra into cash and bonds. A reasonable place to start is equal 25% allocation in each of the asset classes above then project out your balances for each of these assets classes for every year until you are 59.5 or whenever is your long-term retirement age. Do you finish with positive cash and bond balances? If yes, then you have a plan to get to 59.5 without needing to sell any stocks or real estate holdings, so when the market tanks again (remember these downturns are nearly guaranteed, the difficulty is predicting when they will happen, not if they will happen), you are positioned to continue to live your lifestyle pretty much as planned. The idea is trying to set up a condition where a down stock market or down real estate market has no significant bearing on your life.

Why keep any money in stocks at all? Well, you could argue that the risk isn’t worth it, but I still believe that you should have exposure to the growth power of stocks. Over the long term this should still finish as your most productive asset.

What if that plan doesn’t work? What if it shows you run out of cash? Make adjustments. Maybe you have too much money in stocks or real estate. Maybe your date to quit working is too early and needs to be pushed back. Keep adjusting until you have a plan that shows positive numbers for all your assets.

Finally, remember that history says fortunes are made during market downturns. Warren Buffett’s famous financial advice to be “fearful when others are greedy, and be greedy when others are fearful” is difficult to execute. However, hopefully this provides you the confidence that investing in stocks for your long term assets is still a good idea, if buying prior to the crash made sense, certainly buying after the crash makes even more sense. These purchases do not care about the price of stocks tomorrow or next week or next year. These purchases are made looking out 10-20-30 years, where if history is a guide, stocks will be a smart purchase.

Small World Problems

Posted on January 11, 2020 by wiseguide

When I was in graduate school, I was given the book Don’t Sweat the Small Stuff, probably because I had a habit of freaking out over every little thing. I love this book. What it is trying to teach is that maybe the fact that your car needs new brakes is not the human tragedy you perceive. The whole point is to try to gain perspective on the adversity in your life. I like to define “small” as any problem where you can throw a reasonable amount of money at it, and it goes away. One snag with this theory, you have to have that reasonable amount of money at your disposal. This is what I mean by money as a misery-prevention device. I understand the theory that money doesn’t buy happiness, but it can certainly solve small problems, which is a good way to get on the road to joy.

Aside. I never understood the expression Mo Money, Mo Problems. My life has definitely been Mo Money, Less Problems or Less Money, Mo Problems. If too much money is the source of your problems, it’s not being used correctly.

Unfortunately, many people get fooled into buying things as a way to happiness (and usually end up disappointed that the thing did not lead to instant euphoria), instead of building their wealth, and as a result end up doing a lot of sweating (and swearing) over some pretty small stuff. Without that financial protection, the new dishwasher, car repair, or other “small” problem becomes huge. Frequently this simply leads to more credit card debt, which only makes future small problems worse! See the study here. A little dated, but still valid, over half Americans can’t handle a $500 expense without going into debt. Having that boulder hanging over your head places enormous stress on you and is a great way of turning small problems into big problems. And, the unexpected will definitely happen (probably should be called the expected)! It’s not if something will break, it’s when.

Think about happiness, true happiness in your life. Is it buying the latest gadget, or first eliminating this burden? This is the main reason why that emergency fund is so essential to your well-being. Remember, the purpose of money is a time enhancer. It’s fine to buy the occasional toy that catches your eye, but don’t be fooled that this will make you happier than financial security. From my personal experience, I can tell you it is extremely liberating to get up every day knowing that any small problem can be handled. For the big $ “small” problems, there’s insurance and for the other small problems, there’s a sufficient pile of money, sitting around and ready when I need it. I like my mountain bike. I like my kayak. I like my truck. But I love worrying less. That peace of mind in itself is an incredibly valuable purchase.

You get what you pay for—know what you’re paying for

Posted on December 28, 2019 by wiseguide

You can buy a handbag for $500. I’ve been told that people really do pay this for an item that holds your crap. You can buy a watch for $5000. It tells time. You can buy a $90,000 SUV instead of a $40,000 minivan which generally will tow around the same amount of kids and crap. Why would you pay this? What the makers of these products will tell you is it’s quality. If you want a really good bag, or watch or shirt or any other high end item going for many times more than it’s competition, that’s just what it costs, but rest assured you’re getting the best. I’d certainly hope that you are getting high quality items, but FYI it’s not always the case. Look at these dependability ratings from JD Power for cars. Some high end luxury cars score well, but for the money they charge, wouldn’t you expect them to all be very reliable? Why do Hyundai and Kia beat Acura, Audi, Jaguar, Mercedes, Volvo, Cadillac, and Land Rover? I know this is only one measure of the quality of the product, but if I were paying double or triple the price, I’d want some assurance that this thing wasn’t going to be in the shop all the time.

What manufacturers of clothes, bags, jewelry, and tons of other things have figured out is we not only want the functional utility of the item and of course, we’d like it to be nice, but we also need a subtle or not so subtle symbol of our wealth or success we can display to the world. It’s similar as the bird that builds a display to impress a mate (for you super nerds like me, check out the bowerbird). You are buying status. Perversely to the laws of supply and demand, the higher price increases demand. You need the manufacturers to get the word out that their stuff is expensive, and need some label or other marking on the outside so we all recognize that expensive thing.

A classic example of purchasing status over quality is relabeling for clothing at discount stores. There is an accepted practice of designer clothing that is not selling well at high end stores to be shipped off to discount stores to be sold at a much lower price. This famously came to light with Ivanka Trump’s clothing being rebranded to be sold at Stein Mart. Think about this. They are putting MORE labor into the item, and LOWERING the price. For. The. Exact. Same. Item. The reason for this is that if your favorite designer is all of a sudden showing up in Target, that item is no longer a display of wealth and status, it loses value!

Same goes for people living in dumpy apartments driving high end cars. Many more people see you in your car even though you spend more time in your apartment. You are making the conscious decision that is not quality or luxury in your life you value, it’s status, or even just the appearance of status.

This isn’t to say buying status isn’t worthwhile for you. There may be times when the appearance of success is important or you genuinely find the increase in quality reasonable. The main thing to recognize is don’t let someone lie to you—or lie to yourself—that you are buying that $500 handbag solely for its quality. You are mostly buying the status symbol that comes with it. Like everything else, if you are budgeting and choose status as something you’d like to purchase, then go ahead, but do it for you, not for the impression on others.

Saving for College

Posted on November 3, 2019 by wiseguide

One of the great recent tools available for college savings is the 529 plan. This allows you to save money where all gains are tax free, so long as proceeds are used for educational expenses. Additionally, if your state offers a good plan it will frequently make some or all of your contribution a state tax deductible, without any restriction on the school your child wishes to attend. For example, the state of Virginia has given me a tax deduction every year of my kids lives, simply as a thank-you for saving for their education. Over 20 years at a ~5% tax rate, this equates to Virginia providing each of my kids $4000 for their education, and this is in addition to the money I contribute and earn on the investments. Not trivial, and if your state offers a decent plan with tax deductible contributions you should jump on it.

What’s a decent plan? Check if your state offers plans with fees well under 1%, hopefully offering low cost index funds . Even if not, if it’s offering a tax deduction there is still a chance it’s your best option. If not, there are several articles on other state’s plans (which you are able to join even if not in that state), a good reference is here. Many of the plans offer an automatically adjusting asset allocation as your child gets older, which I find convenient and forces discipline for asset allocation.

Alternatively, there are pre-paid plans where you pay today’s tuition prices to an in-state school for attendance later, but these are not my preference. These plans offer less flexibility for your child for school choice and only offer an effective rate of return equal to the rate of annual tuition increases for that school Although this rate of inflation is high compared to normal increases of other things we buy (see below), hopefully it still should be outpaced by the return you should get from a bundle of low-cost mutual funds.

How much to save is a tough question with a lot of variables, and you are unlikely to get help by asking your infant or toddler if they are thinking community college or Ivy League, but I have a suggestion for a reasonable approach:

Start the 529 plan as soon as possible, preferably right after your child is born. Tell all proud grandparents the account is open! Maybe a blatant cash grab, but $50 in their account will be way more valuable to everyone involved than a designer little outfit that the little one will outgrow in a week. After he or she has spit up on it.
As a benchmark, look at your state university tuition, room, and board costs today. Then look at the average inflation rate of these things over the past 20 years. You can find all of this online. This might shock you, I’ve used a number of at least 5% and historical numbers are often even higher, well above normal inflation. Doing this, you can take a good guess at what the expense will be for your child when he or she gets there. For example, if the candidate university for your newborn is currently $30K for tuition, room, and board, the suggested targeted expense is:

Year 1 = (1.05)¹⁸ x $20,000 = $48,000

Year 2 = (1.05)¹⁹ x $20,000 = $51,000

Year 3 = (1.05)²⁰ x $20,000 = $53,000

Year 4 = (1.05)²¹ x $20,000 = $56,000

$208,000

That bottom line number is a big ouch, but remember this ignores things like scholarships and other financial aid, this is just a guide to give you a feel for the costs of college.

The best way to attack a big number is like attacking a whole pizza: small bites. I suggest you make regular monthly savings contributions and assume a reasonable rate of return of 7% and contributions for 22 years. Using the PMT feature in Excel this is=PMT(.07,22,-208000)/12 = $1570 per month. Again, ouch, but this is just your target. Each year you’ll be able to look at your actual balance and the new projected tuition (based on the updated numbers) and recalculate your month goal. And you can make adjustments, like your child has recently developed some massive athletic skills, or suddenly takes a liking to that high priced private school.

Your saving for college doesn’t have to be perfect, and if you fall short there is financial aid of all kinds. But it is important to get an idea of what the college costs could be and to use the power of compounding to start right away.

One last editorial note. College tuition is like any other purchase, and you should approach it based on what you can afford, not just what you want. Just because you want a Mercedes, you might only be able to afford a used Honda (and truthfully, that used Honda will likely serve you just as well). For some reason, we tend to throw that decision making out the window when it comes to college. We pick one, and borrow whatever shortfall is needed. (Side note, this may be partially to blame for why college tuition is escalating far more quickly than other things in the economy, lack of demand by the consumer for prices to be kept to affordability). Student loan debt is a popular issue right now, and the hole that some young people have when they are just getting started is staggering. If you graduate with six figures in student loan debt, likely you picked the wrong school. The community college in my state is less than $6000 per year for tuition, without any financial aid. State universities are about twice that. So 2 years in community college and two years at a state school is less than $40k. Assuming you have saved $0 and get $0 in aid. I know you might not want to go to community college, but there is zero wrong with that education (teaching can actually be superior here) and that might be what you can afford. There is a misconception that if instead you go to a fancier private school, whose tuition is close to $60k per year, clearly you most be getting a massive advantage over everyone else. Well, maybe, but largely college is what you put in to it, and the student from State U at today’s tuition rates has a $200,000+ head start. OK, off my soapbox. If you really want your young one to have maximum college choice, the calculations above can give you a guide–and just so you’re aware, for the priciest private schools, and adding in room and board, that is a projected total of over $700,000. Yeah.

Time optimization

Posted on August 25, 2019 by wiseguide

A common theme I fail to emphasize enough is that your time, not your money, is your true precious resource. I spend a lot of energy thinking about how to maximize my financial resources and not nearly enough on optimizing the 168 hours a week each of us has to spend. Think about that number. Assuming 40 is working and 56 is sleeping, 72 is your choice. Nearly double your working time! Where’s it all going? Similar to a financial budget you really should have a time budget. Just like with your finances, this is allocated to things you you consciously prioritize, either by obligation or personal satisfaction. I’d urge you to track your time for a week and see where it all goes. You’ll most likely find you are leaking time to things you don’t value. Where are you leaking time? OK, if you have kids, I get it, they’re grabbing at your time like there is no tomorrow. Including some of that sleep time. But still, 72 hours is a lot of time and SOME of it should be for your enjoyment.

What you will find is there are likely several short periods of time every week that are just time killers (a really appropriate term here). How much time mindlessly scrolling social media or surfing the internet for nothing in particular? Or mindless games on your phone? (Some track this and that result might scare you). Maybe just turning on the TV without any show you really want to watch? This is killing your precious resource. If doing these things is a conscious decision of how you want to spend your time, hey no judgment, Angry Bird-it-up. But if these things are just time ‘junk food’ They are stealing your 72. I have some suggestions on how to better use your 72.

Step one I’ve already mentioned, track your time to see where it’s going
Create a time budget. I find it most useful for me to schedule leisure time just like every other appointment. Saturday at 9? Sorry, busy. It shouldn’t matter if it’s a doctor appointment or you’re meeting a friend kayaking. Both matter. Having this super rigid might not work for everyone, and of course you have to be flexible if something higher priority comes up, but make sure you consciously decide where you are spend your time.
Some of your prioritized activity has to fit in the little gaps in your day. Sometimes you’ll only have a spare 15-30 minutes. My wife is an absolute champion at this. Give her 30 minutes and she’ll review on online class, or practice her music, or pull out her sketch pad, or many other things. There will be gaps that can only be filled with things with low barriers to entry. That’s a big reason why we just pull out our phones in those situations. It’s not that we want to, it’s all we have to fill the gap. Try to be prepared with something else you truly value.
Seek to bunch your time. The above sounds great, but it’s pretty tough for me to go play golf with that free 30 minutes. To free up bigger chunks of time, bunch other activities. Bundle your chores together. If your employer offers a 9 hour day/80 hour week or other flexible schedule, seriously consider it.
Seek better synergy with your time obligations. For example, commuting to work is a typical time suck of very low value. Maybe sometimes you can bike to work (if you enjoy biking). Or listen to your favorite podcasts or book. Again, my wife kills this by watching The Great Courses on her iPad while doing something mindless like cleaning dishes. Our kitchen still looks great and she now can tell you all about Napolean’s rise to power. If you care.

Also, recognize in others when they give their time to you. They are taking there single most valuable resource and giving it to you. You should always be grateful. Similarly, beware of those looking to steal your time. Be generous just like you are with your money, but protect it too.

I’m always reminded of the great equalizer of hours in a day, the same for each of us. A little prioritization can go a long way. For me, my wife is the gold standard. Since we’ve been married she–

Received her PhD while raising our two small kids
Became a pilot
Learned Spanish
Became a competitive CrossFit athlete
Learned Japanese
Learned piano
Learned electric bass
Home schooled our kids
Learned to paint watercolors

She did all of this while dealing with my BS with a giant smile. Admittedly I have fallen well short of this, but this is the goal I seek.

Think Critically

Posted on July 6, 2019 by wiseguide

A key component of making good decisions, financial or otherwise, is learning to think critically. This is especially important when so many people are bombarding you with misleading, flawed logic for their own gain (arguably this is the main role of the advertising industry). You need to be able to recognize these traps and navigate around them, my short list is below:

“If A then B” does not necessarily mean “If B then A”
Correlation is not Causation
A data point is not necessarily representative of a larger trend
The primary motivation for every for-profit company, is profit
Gambling is hoping for improbable outcomes, decisions should be based on most probable outcomes
Data and Information are not the same

We’ll look at these one by one.

“A then B” does not mean “B then A”. This is a concept taught in your middle school math class, but how many have forgotten middle school math (or middle school entirely–thank goodness)? This is easiest to illustrate with an example. If I say “Millionaires invest in stocks”, that does not mean “If I invest in stocks, I’ll be a millionaire”. Confused? Look at it from a Venn diagram perspective (by the way, Venn diagrams are on the Mount Rushmore of diagrams. I know this doesn’t exist, but it should)

In this case, the statement says that investing in stocks is necessary to be a millionaire, but not a guarantee of being a millionaire. FYI, this is just an example, plenty of successful investors invest exclusively in real estate, for example. I see this concept constantly confused, in politics, science discussions, health care debates, and many other arguments. Try to keep this in mind.

2. Related to the above is the causation/correlation debate. In short, correlation is simply showing two things are related (when you see one, you often see the other), without making a statement about if one thing caused the other. This is much easier to show than causation, which requires careful study and accounting for all variables. You can see where this is particularly difficult in the field of nutrition, where there are so many different variables among people’s behavior. For example, what if I say “People who eat fast food have a much higher incidence of poor health”, or in Venn diagram mode:

Again, just a made up example, though I’d imagine the actual data are similar. The above says poor health and fast food are correlated but can we say fast food causes poor health? The above information is not enough to make that statement, because I haven’t shown you how we’ve accounted for other variables. For example, maybe we note that many people who eat fast food are financially disadvantaged (fast food is cheap) and we find later it is their financial position that is the true cause of their poor health. Or, maybe they eat fast food as comfort because of their poor health (the poor health causes fast food!). Now it may very well be that the fast food is in fact causing the poor health, but before we start making cause statements we need to make sure we have done specific study for other potential influences. You can see why this is so important, and why proper science is needed behind anyone’s claims. We often find ourselves in a situation wanting a certain outcome (health, wealth) but can only try to create the outcome indirectly (eat specific foods, make specific investments), so causation is critical. Otherwise, we may end up wasting time, money, and other resources chasing ineffective influences for the outcomes we want. Again, this is constantly confused. Watch any prime time news show and wait for someone to confuse these concepts, you won’t need to wait long.

3. The data point as evidence is constantly used in various advertising campaigns, and is particularly popular with financial seminars/software tools.

“Here’s our great financial system/strategy. It’s great! Meet Joe (close up on Joe): ‘I’ve used the XYZ System for 2 years and crushed the market!’. And Sue says ‘I’ve outperformed the market too!'”

So, many people look at this and figure if Joe and Sue could do it, so could they. But what information do we really have about the XYZ System? We have the following, graphically,

Joe and Sue weren’t lying, they did beat the market, but this really isn’t evidence of the utility of the XYZ System, what we really need is the data from all the users of the XYZ System, and my guess is the results would look more like this:

If we had the full picture, we could see that Joe and Sue’s results weren’t representative of the whole, but actually outliers. In many ads they effectively admit this by putting in the fine print “Results not typical”. If the above chart were the truth, would you still pick XYZ System to beat the market? Of course not. This is why ad companies love testimonials. They can be truthful, but cherry pick the best results, which could be random chance, and conveniently ignore data points that don’t make the results look good. Truthful, but deceptive, which is the essence of advertising.

4. Another common ploy of people selling stuff is they try to hide the fact that their motivation is to make as much money as possible, specifically get your money. This is common in infomercials where a person selling a get rich quick scheme will talk about how they figured it out, got rich, and now all they want to do is help people do the same. No, they don’t. They want to get richer, there are plenty of other ways they could try to save the world if that was their goal. Bill Gates got rich and wants to save the world, do you see him doing infomercials for software? No, he’s busy trying to eradicate disease in Africa.

Remember, corporations aren’t here to help you, be your friend, give you a job, or make the world a better place. If their goal were to help people, they’d sell their product at cost for no profit, thereby getting to the max people possible. The product, employing people, and hopefully moving mankind forward are all tools for corporations to ultimately make money. This isn’t good or bad, just a reality that needs to be understood. This doesn’t mean corporations don’t care about their employees or their greater impact on society, or have other altruistic intentions. However always remember their primary reason for existence is figuring out how to get as much of your money as possible.

5. I’ve written on this before, decision making is based on probabilities, rarely guarantees. This means you occasionally will get a bad result despite making a good decision (and good results from bad decisions). The result is not necessarily always a judge of a decision. Good decision making involves taking in all available information, using prior experience and sound logic, and choosing a course of action based on the most probable outcome, e.g.

You expect to do well if you invest regularly in a diversified portfolio
You expect to keep your job if you work hard
You expect to stay healthy if you eat right and exercise

All of the above are probable but not guaranteed. This is why cash in an emergency fund for unexpected life events (e.g. job loss) is important and insurance against catastrophic loss (life, health, home, auto) is important. Knowing bad things can happen despite your best decision process is the rational for protecting yourself. It’s a small financial penalty for large peace of mind.

6. Data is not information. This is also a classic slight of hand in financial commercials. Look at all these charts and graphs we have! Let’s show you a wise, semi-grey-haired man knowingly (maybe even smugly) hitting enter on his computer, leaning back in his chair with his hands on his head with a smirk on his face, knowing he has charts and graphs. Charts and graphs are definitely data. They might even use proprietary algorithms. (Aside, “proprietary” also does not mean “useful”. Proprietary just means they have established that others can’t use the same approach without their permission. One would presume they wouldn’t do this unless the approach was actually useful, but that is not necessarily the case). The key is what they are giving you is not information unless it’s useful. I could develop an algorithm to buy or sell oil based on Alaskan temperature, but unless that algorithm is consistently predictive of the direction of the price of oil, this is just noise, not information. Financial companies imply their data is useful, but generally don’t outright claim this because likely they can’t. Useful information would mean using these data would allow the user, on average, to consistently beat the market, and study after study shows this is not achievable by almost anyone in the financial industry.

I’m sure I’ll think of more to add to this list, but if you keep the above in mind when listening to a Congressman come into Congress with a snowball as evidence that Climate Change isn’t happening…Wait a minute sir, that’s just a data point…not evidence of a larger trend…can I see the evidence of the larger trend?…Oh. Damn.

The role of insurance

Posted on June 15, 2019 by wiseguide

Insurance is one of those things you buy but aren’t always sure why you buy it. Just seems like the thing to do, adult life on auto-pilot. As a result many people buy insurance they don’t need while skimping on the insurance they do need. So, let’s take a look at what it’s for and from there figure out what to buy.

There are two elements to consider when evaluating insuring against something: probability and consequence. In a sense, a neutral insurance premium is the product of these two things, what is the probability of something happening times what is the financial consequence if it does happen. This is a calculation you can always estimate in your head if considering a premium as cheap or expensive. People insure against all kinds of things, but your focus should be on the things with low probability but high consequences.

Fundamentally, insurance is for really BIG expenses you MIGHT have in your life, that otherwise would be impossible to afford. Let’s remember that every time you are faced with an insurance decision. It’s not for small expenses. It’s not for things that are guaranteed to happen. We’re looking for the big maybes. So….your house might burn down, you might crash your car and hurt yourself or someone else, you might get a life threatening expensive disease, you might die tomorrow leaving your family with no income (if you’re the main bead-winner. Aside, where did we get the term bread winner? Bread earner, sure, but no one is entering some big bread lottery at the office every day). Therefore home, car, health, and life are the typical big 4. Notice things that aren’t in this category. Your TV might break outside it’s regular warranty, or your car might need a minor repair. “Extended warranties” are parts of insurance in this category. They are small, and by definition a bad deal for the average person. Recall one of the first parts of your investment portfolio is your rainy day fund, this should take care of this small stuff.

Here’s why. Insurance is a for-profit industry. The rates are set such that the average person will pay more in premiums then will get out in benefits. Notice, this is for the average person, some people will indeed get more then they put in, but on average, insurance is a money loser for the customer. We have insurance to protect against really big stuff that would cripple us financially. Don’t get me wrong, I like insurance, and have a lot of it. It’s role is to protect me against the small, but still possible financial disasters. Paying for that and recognizing the company is making a profit is reasonable. Paying for appliance repair, car repair, or other minor items is much cheaper paying with your savings or budgeted–in factor one of the main reasons for having savings in the first place.

I was buying my new Honda a little while ago and they couldn’t believe I wasn’t taking their extended warranty deal. “Even my mom gets this”. Well, your mom got ripped off, probably. It has to be this way. If it were truly a good deal for the consumer then on average Honda would be paying out more then they take in for the warranty premiums. They’d be losing money. Would any company really be giving you the hard sell for something where they’d lose money? Buy insurance only for things where the downside is truly unaffordable, and use your rainy day fund for the small stuff. In the end, you’ll come out richer.

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