To Buy or Not to Buy at Market Highs

There is always a bit of fear when evaluating buying in at all time highs. The sentiment is understandable. Everyone is afraid of buying in at a market peak and eating the recession that follows. After all, after almost a decade of uninterrupted growth, aren’t we due for a downturn?

However, the data analysis (done by someone else!) and existing scholars such as Tobias Moskowitz supports momentum investing. In other words, when the market or an individual stock is rising, it’s more likely than not to keep rising than to suddenly reverse.

Applied to current market highs, I would still encourage ordinary people to invest their new capital in accordance with prior allocation ratios, to achieve a healthy rebalance despite stock market highs. More likely than not, the market will be even higher (even after adjusting for inflation) in the next decade. If prior trends hold, we may be on the cusp of a 1-2 decade run of sustained all time highs.

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Link Roundup: The Value of Hard Work

During times of plenty, when there are more interesting articles than I can do a feature review of, I will combine them into a single post called a link roundup. Here is one such event.

  1. The value of hard work. This reminds me of my time growing up in the crucible of competitiveness that is the Bay Area. Investments made in oneself through education and knowledge pays compound interest down the road, establishing a solid foundation for improved performance and confidence, that feed off each other in a virtuous cycle. Take for example a high school student taking summer classes to prepare for the next quarter’s math and reading classes. That person will get a leg up in results for the rest of his or her life, because of repeated exposure and increased familiarity, not to mention having an easier time in the class. Compared to someone like this, if you’re not working hard every day, you’re falling behind your peers. Just like in athletics, average is over. Every day you’re slacking or doing something else is a day falling behind your peer competitors.
  2. What do future jobs look like? The thinkers of yesterday and today have a vision for how the future looks, and it doesn’t bode well for some. Unskilled work will be replaced by robots. Technical and computer skills will become more valuable. Good future areas to specialize in include AI, robotics, and VR. At the same time, some jobs like in health care that deal with human emotions, where empathy is essential, will be relatively shielded from the effects of technology. But then again, you would know this from reading my book.
  3. As a corollary to the above, university students increasingly recognize the reality of a tough job market for graduates, and are tailoring their studies accordingly. This means fewer liberal arts graduates and more social science, business, engineering, and “trades” graduates. That’s probably a good thing for individual finances but a tragic loss for the country. After all, from their pen would have come art, literature, and poetry – the stuff that gives colour and meaning to life. That’s what separates us from somewhere like Singapore or India, which are
  4. If you have truly niche technical skills, you can make bank. Just look at blockchain developers. Btw, software is one of the fields where if you have the interest and the talent, you can teach yourself and get a great job without having a degree in the field. That’s the path my dad took.
  5. Here’s a great story of a self made web entrepreneur with the vision to establish a business reselling cheap Chinese toys from Alibaba to American consumers willing to pay more. Wait… why don’t Americans just buy directly from Alibaba? Doesn’t sound like a very sustainable business model but somehow it works.
  6. Concierge medicine is taking off, and whispers are that you can have a lucrative practice with low patient volume, if you cater to the rich and treat everyone like a VIP. It’s not my cup of tea, but I see disruptive potential in different delivery methods for health services. Target mini clinics are good, as is the underutilized format of telemedicine.
  7. I can’t harp on the concept of geographic arbitrage enough. By moving to a cheaper location, your dollars stretch so much further. Not only that, but your kids can grow up multicultural with foreign language skills, interesting life experiences, and a great prebuilt application essay for Ivy League schools telling them how unique you are.
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Luxury Is Cheaper than Land

Of all the innovative uses for geographic arbitrage, one of the most satisfying is monetizing one’s home and trading it for an itinerant life. That wanderlust can be satisfied in a variety of different ways. The online travel blogging community has made being a digital nomad in cheap areas like SE Asia and Latin America so commonplace that it’s become trite.

An interesting choice is to instead live on a cruise ship. It’s not just a way of life for the wealthy to live on a luxury boat like The World, but even worldwide voyages with one of the mass market lines (Princess, HAL, Oceania, etc) can be affordable, when considering all the expenses racked up on land in an expensive place like New York City.

At a certain point, if you own property in NYC and decide to rent it out, it may be able to generate enough income to subsidize all (or a great portion) of the cost of the cruise. And when you factor in food, entertainment, and travel all being bundled into the price of the cruise, it becomes an even better bargain.

Of course, this type of lifestyle is not appropriate for everyone. Not everyone likes life on a ship, whether due to claustrophobia, seasickness, or boredom. But it’s worthwhile knowing about the options to enhance life that others have found worthwhile and workable.

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Secrets to Successful Investing

It feels like we’re always hammering the same points on investing over and over again. Don’t watch your portfolio. Stop tracking the market’s daily gyrations. Focus on the long term. Stay diversified. Don’t try to stock pick or market time. Stick with the asset allocation determined earlier and rebalance. Stick to these tried and true principles based on solid research and you’ll be fine.

Sometimes, we feel that we can be exceptional or lucky and we try for the moon. Humans are poor learners from others’ failures, and rather learn best from a strongly emotional personal experience (like a major loss in the market due to a self-inflicted error). I believe everyone should learn that by starting out playing single stocks with small amounts of play money, ideally earlier in life rather than later, so we can quickly return to the right path having learned our lesson in a way that sicks.

In other words, use the “the martyr system” to your advantage, letting the hippocampus impart the long-term financial scars from personal failures that will leave lasting memories of what not to do.

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No Regrets

My last post touched briefly on the nature of regret in missing out (selling too soon, buying in too late). However, this is not a healthy mindset to have. As Marketwatch pointed out today, very few people have the intestinal fortitude to ride out the market’s gyrations and hold for the 10+ years needed for wealth to compound exponentially. How many of us would have sold out during one of the times when bitcoin or Netflix crashed >50%?

This Morningstar article serves as a reminder that we are our own worst enemies:

Well, it’s really about the target-date funds because they are sort of the confluence of good behavior. In other words, they are boring funds. You’ve got tremendous diversification. They don’t cause fear or greed. They are just boring. But then the other part of it is, in 401(k)s where you see nearly all the target-date money, people are investing every paycheck very steadily. So, they are also kind of shielded from the ups and downs of the market. So, if you go back to ’08, ’09, 2010, people just kept steadily investing, people generally did not panic in their 401(k)s, and so that meant you are really buying low and then staying with it to see those benefits. So, if you think about it, target-date is kind of the intersection of good funds and good investor behavior and it kind of suggests where we might want to go as an investing group as a whole because this is where things really work well.

The best returns actually came from disciplined boring investing. As Monevator likes to say, keep investing as boring as watching paint dry, so you won’t be tempted to buy and sell all the time. As another former mentor once told me, “Don’t just do something, stand there!” That is really the approach to take when investing.

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Take More Risk in Tax Advantage Accounts

The Bond King Bill Gross likes to philosophize about profound emotions such as joy and melancholy in his investment rants, and this post is driven in part by the emotion of regret seeing Bitcoin hit all time highs, and even surpassing the price of gold.

Such is the case for many in my field. When I was finishing my last year at Berkeley, I came upon news reports of the fancy new cryptocurrency idea called Bitcoin. Independently at the same time, so did my fiancee’s brother, childhood friend, and cousin-in law (all techies). We didn’t think much of it, and as risk averse as I was, I didn’t even bother putting $50 or so of play money into there. If I did, it would be worth almost a million! Similarly, my fiancee’s aunt regrets not buying Apple stock when it was down in the dumpster right before Jobs took over (seriously, most smart money was on the company going bankrupt, not staging a phoenix-like revival).

While we can all regret not doing the most “optimal” thing (life doesn’t have a save/reload button) in hindsight, we can also never with certainty predict what the future will hold. What we can do, and it will sound boring, is to make sure we have the right types of investments in the right places, and to stay allocated to assets in a way that allows us to sleep well at night. If we do dedicate a small (e.g. 5%) portion of our portfolio to lottery ticket bets on small cap stocks, that’s fine. Just make sure to do it in the tax advantaged section of the portfolio.

Standard portfolio theory suggests that we should make sure that our money is invested in the way that takes advantage of legal tax shelters to our benefit, as much as possible. Just to recap, there are in general three big categories of holdings: taxable, pre-tax 401k/IRA, and Roth 401k/IRA. Here’s what we should put in each:

  • Taxable: The goal here is to hold for as long as possible and to minimize the number of transactions and income generated, since each sale can generate a huge tax bill for capital gains. The best choice is a low fee total stock market index fund (Vanguard, iShares, and Schwab are all good choices) that is held and not sold until death. Then we can take advantage of the tax free basis step up when we bequeath to heirs. The small amount of dividends generated is taxable, yes, but at a much lower rate than the marginal rate. Bond holdings should be in tax-free municipal bonds as much as possible, doubly so if you’re in a high tax bracket.
  • Pre-Tax: We have to pay tax on the whole thing anyway but not until we cash the money out from the account. That quirk makes pre-tax accounts ideal for traders, stock pickers, and market timers who move in and out of positions with regularity. It’s also a good place to stash taxable bond funds and high dividend funds that throw out a lot of periodic income.
  • Roth: This is where you should make your highest risk “lottery” type bets. Let’s say you could (and want to) invest in bitcoin, startups in their infancy, micro cap stocks, penny/value stocks, turnaround stories, Greek bonds on the verge of default, and foreclosed homes. You would do so here. The bigger the potential gains, the better it will be. Whether you stumble upon a 10-bagger or 100-bagger doesn’t matter. You won’t pay any tax on it at the end.

So in summary, you want to use the right tool for the job. A balanced portfolio should consist of stock funds, bond funds, and maybe a dash of play money. Instead of making each tax category holding the same, we should concentrate our investments in the type of account that is best-suited from a tax perspective. Big gainers should be in the Roth, slow steady accumulator broad market funds should be in taxable, and income spewing investments in the pre-tax account.

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Secrets of Wealthy Millennials

Is it just me or does Business Insider seem to be sliding into a paparazzi version of the staid Forbes magazine? The articles being published these days seem more like a weird hybrid of Moneyish and Gawker, with more sensationalist titles than the Daily Mail and plastered with more inline Instagram posts than TMZ.

Still, despite the descent into frivolity, there are some nuggets of truth and wisdom to be gleaned from their latest series on wealthy millennials.

The first story from BI is that of Ebony Horton. To summarize, she was a newly minted graduate making $38,000 a year in DC. She then went back to get an MBA and racked up a total of $220,000 in loans from undergrad + MBA. She freaked out at the amount, and came up with a plan to pay it all off by moving back to rural Illinois, lowering her cost of living, saving like crazy alongside her husband, buying rental property, and getting some opportune gifts from her family. Now 31, she’s debt free and ready to share her story in a book and go on the speaker circuit to make boatloads of money.

What can we take away from this?

  1. It helps to have rich parents who can support you, either directly financially or indirectly by providing free/subsidized shelter
  2. Being dual income (however miserly), no kids dramatically accelerates your savings trajectory
  3. If you set your mind to it, saving 75%-95% of after-tax income is possible
  4. Control lifestyle inflation (let your standard of living appreciate slowly) or it will ruin you
  5. Investing in the property market uses leverage to enhance the growth rate of your wealth

One of the topics in my book on finance is that in the modern age, there are a few viable paths to success. However, this book focused purely on wealth and its accumulation, the pursuit of which is unsustainable in the long term. One of my upcoming books will instead deep dive into the human mind and explore how we become happy. With that in mind, when thinking of work-life balance, there are two ways to go about it. One is to “finish” a high-paying career, accumulate boatloads of savings, and retire early. In short, this abbreviates the traditional working time and prolongs retirement. It can be very effective, as legions of FIRE (financial independence, retire early) adherents can attest. However, it requires significant discipline to accumulate that much savings so quickly.

The next BI story is that of two 30 year old teachers who managed to save $1 million after 8 years, and are now retired and travel the world. Isn’t that the dream of every young millennial these days? They did it by doing much of the same that Ebony did, only they had the advantage of minimal education debt. Their lucky break was to pick up houses in Las Vegas on the cheap in the depths of the real estate collapse, converting them to rentals. Gradually, the market bounced back and they were able to make more rental profit from the houses, which they used to buy yet more houses. Now they make $10000 per month on average from rent, balanced out against only $2000 per month in mortgage, letting them retire to pursue their passions.

The take away bullet points?

  1. Paying down debt is good, but it’s a lot better to not have debt and to divert savings into investment vehicles
  2. Being lucky (getting into real estate at the bottom, even before hedge funds) is better than being good
  3. Sometimes living in a lower cost of living area beats moving to a high cost area (Bay Area, London) to earn a high salary
  4. Buy a property and rent it out to others, letting them cover the cost of the mortgage (see my analysis of yield on equity here)

The other reasonable approach is to maintain the frugality but to intermix one’s working years with “fun” activities traditionally associated with retirement. This can come from working on cruise lines, at vacation resorts, as an English teacher abroad, etc (more examples of ways to do this are in my book). These jobs may not be high paying, but the cost of living is either low or completely subsidized such that significant savings are possible. Experiencing fun stuff as a tourist is expensive, because you duplicate costs such as housing by having to pay for a hotel and the mortgage back home, and other costs are more expensive (such as having to eat out every day). It’s a lot easier to see the same sights and go to events as a local, relying on cheaper longer term housing, cheaper grocery options, and public transportation.

On this point, BI ran not one but two (oh my how they like to recycle stories) articles about the same girl – Nina Ragusa. She took the fun road, working hard initially in multiple jobs to save up enough money to launch her career as a travel blogger. She gets to roam the world, doing the typical things on the well-trod road of teaching English in Thailand and working in the tourism sector in Australia (the working holiday visa for young people is a great boon). In essence, instead of slaving away at a desk job, she gets to live in vacation paradises, work freelance in a bunch of industries that aren’t that intense, and save a bit to boot. There are two possibilities for how she will end up. If she does well with her travel blog, she can spin that into a brand and partner with tour agencies as a promoter. The worst case scenario is that she returns to the US at some point having had a decade of amazing experiences and a small amount of savings.

You may wonder how young people can spend so much time and money on travel and not exhaust all their income or savings. For one, cost of living is so much lower for most places outside of the US, and low end wages (especially for the service sector in Australia, NZ) can be higher. Finally, many fun activities aren’t that costly. By working at a resort, you’re afforded the privilege of taking the kayak or surfboard out when you aren’t leading a tour, and sometimes can even use the company’s van for personal excursions. In a tropical paradise, many of the most fun activities are free. It’s so easy to get sucked into complacency living in these places.

Take home points for this case:

  1. For young people who want to have fun now and mix in a bit of the retired life with their youth, it’s hard to beat adventure travel and freelance work
  2. Geographic arbitrage wins again
  3. There’s an outside shot that you can create a sustainable brand/blog based around travel and never have to work again
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Why Angular Beats Well-Rounded

It’s appropriate, especially given that this is the time of the year when high school seniors are opening acceptance packets and rejection letters from universities all around the world, to discuss the age old dilemma that many college applicants face: whether to be angular or well-rounded. Certainly it was the raging debate my high school classmates had when trying to sell themselves to colleges. They competed with each other for the most extracurricular activities (speech and debate, business club, sports, volunteering, music, arts, etc.) It became an arms race so ridiculous that we joked that to get into Stanford or the Ivy League, one had to be the captain of multiple sports teams, in student government, get > 4.0 GPA, have perfect SATs, and possess a “major” life accomplishment such as curing a major disease, starting a philanthropic organization, or winning one of the math/science Olympiads.

While being a modern Renaissance man (or woman) can be great for getting into these schools, and it certainly does make for a more interesting person, it’s not a guarantee for finding employment. Employers are looking more for an expert in a particular area, or at most someone with two related and complementary skills.

Just think of it from this approach. If you’re an employer looking at a candidate who has decent skills in finance, accounting, foreign affairs/diplomacy, programming, and photography, you may actually not want to hire that person. One worry is that by spreading him/her self out too thinly, the applicant may not truly be an “expert” in one particular area. Most jobs are defined by boundaries, specificity, and depth (you’re *just* going to crunch numbers), and while breadth is helpful in the upper echelons of management and for insightful business strategists, very rarely do companies recognize that and actually try to hire for those spots. More likely they luck onto a candidate with that vision from hires for other positions. Furthermore, companies like cheap worker drones that fit into narrow holes. A candidate with a diverse skill set is more likely to get bored, leave, or demand higher pay.

Therefore, it’s ok to have side dalliances and hobbies, but if you want to be a top worker bee and advance in a career, you’d better have a profession. Take for example the story of Urs Holzle. He was a pure computer scientist, and as such was able to push the boundaries of his own field, get hired at Google in a senior scientist position, and make bucketloads of money. If he had spent less time in his craft and more in say learning the violin to become “well-rounded” he may not have been as successful as he was.

As a last counterpoint, for those already on the well-rounded pathway, while you may not be the ideal workers, you are excellent entrepreneurs, possessing as you do the strategic thinking capabilities to integrate multiple fields and sense opportunities. Also important in the early days of a startup with limited manpower is the ability to fill and manage multiple business roles.

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Broke at Half A Million

Marketwatch ran an article about how one can still be broke despite earning half a million a year. Preposterous, you say? They do show the breakdown of sample spending for the rich family compared to an average family with $80,000 in yearly income.

Let’s break this down in an itemized manner:

  1. 401k contributions: a good thing, especially given the tax bracket
  2. Taxes: unavoidable, but the rich family should be looking to diversify more into legal tax shelters like mortgage interest deductions and maximizing HSAs
  3. Child care: I can’t explain this discrepancy. Does the wealthy family choose to use a premium service as opposed to the McDonalds of child care? Does that really provide any benefit? Both families have the same number of kids, so there’s no reason for spending to be any different. And besides, those in the know opt for live in Hispanic au-pairs so their kids can get a head start in life
  4. Food: both families eat way too much. I spend $40 per week on groceries (that includes household items like detergent) for myself. Multiply that by 4 gives you $8480 for a whole year. Even if you spend a bit more on eating out, you will still may just top out at what the average family spends. What does the rich family get by spending more? More calories? Whole grain organic quinoa?
  5. Housing: this is a big opportunity to cut back by living in a smaller house for less. A bigger house just adds to the housework, not necessarily truly improving happiness. Likewise, this allows for a corresponding reduction in property tax and insurance
  6. Gas: no reason that this needs to be different between the two families
  7. Life insurance: just self-insure by saving more. This is one of the biggest cons out there
  8. Clothes: do you really need to wear better clothes than the average family? If anything, standing out more in this era of Occupy Wall Street just makes you more of a target
  9. Children’s lessons: I’ll admit, probably a good investment. If anything, Asian families in the Bay Area spend much more in this category
  10. Charity: cut back on this, especially if you’re living on the edge
  11. Debt repayment: probably unavoidable, but you can save on this by studying overseas or in state schools
  12. Miscellaneous: I don’t even know what this means

Notice how I didn’t include vacations on this list? Generally, I will allow one budget busting “splurge”, either in clothing, house, car, or vacations. Among those, the one that gives the most lasting happiness is vacations.

 

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Passive Clearly Beating Active

These past few years have not been good to actively managed funds, or their managers. As this Morningstar article shows, funds are continuing to lose investor money and as a result, they have to lay off their fund directors. Shed no tears for them though, as they’ve had several years of high six figure+ income without providing a corresponding return to their investors.

Let Uncle Warren and Jack Bogle light the way. It’s no secret why the biggest indexer, Vanguard, is growing more than everyone else combined!

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