Can Locums Doctors Qualify for a 20% Tax Deduction?

The new tax bill has become law and accountants are eagerly poring over the details, dissecting it for loopholes. One of the biggest giveaways is to small businesses, allowing a 20% deduction for income that is passed through (called “pass-thru” in the law) to the individual. It’s called Section 199A, and I expect that this will become a household name as famous as the 401k. The intent of the addition is to benefit small businesses (larger ones tend to go for C-corp style taxation) that employ the bulk of Americans but would otherwise be penalized at higher individual tax rates versus C-corps. To avoid incentivizing too many of these entities to be forced to convert to C-corps, it was decided to offer some token tax cut to pass through businesses. Ron Johnson largely pushed this addition through by himself, given slim margins for Republicans in the Senate.

Remember, this website isn’t interested in debating the ethics of the law or the politics behind its passage or ramifications. Rather, we want to be more practical (or nakedly capitalist if you will) – can I exploit this loophole for my own gain? This will be a more fine tuned analysis geared towards medical professionals, due to my own expertise in this area, but the principles are largely applicable to other professional service businesses as well.

To qualify, first you must be taxed as a pass through business. This includes:

  • Sole proprietors. If you’re taxed by filling out Schedule C reports of your 1099 independent contractor income, you count in this category. It’s the default if you haven’t gone out of your way to form a more advanced business structure.
  • Partnership. Basically a few sole proprietors working together on the project, each owning a portion of the firm. Each passes through income proportionally. Note that a married couple can be counted as a sole proprietor because they file together.
  • S-corp. This is where things get fun. This business model can scale as big as you want. You have all the responsibilities of a big corporation in terms of payroll, offering 401k, health benefits, getting a corporate board, and filing quarterly tax payments. It’s a big setup and reporting hassle and can be expensive to maintain. Luckily there are software packages out there that can make it easy for you to create one.
  • LLC status is a legal distinction that doesn’t matter to the IRS.

Contracted physicians (this includes the locums category) tend to be either sole proprietors or S-corp. Many have opted for the latter because you can choose to structure some income as wage income (W-2) and the rest as a pass through business distribution that is not subject to payroll tax. The IRS closely scrutinizes the proportion that is in each category to prevent people underpaying themselves and taking almost everything as a distribution. The generally accepted principle is that your income should be close to the national average for your profession and the type of work you do. Given the high incomes of physicians, this won’t save you anything in Social Security (unless you work part time) once you pass the income limit, but it will only save you the 2.9% Medicare portion of payroll tax that is applied to all earned income. It’s up to you to determine whether the tax savings outweigh the setup and maintenance costs as well as tax reporting hassles.

When crafting this carve out, politicians were careful to limit its benefits to favoured categories of individuals. They like businesses that own real estate, employ people, and invest in capital equipment. They most definitely did not want this loophole to benefit high income professionals who don’t employ others. Politically that would be depicted as overly favouring the rich, who presumably don’t need this loophole. Thus the law featured two “tests” – the income test and the profession test.

The Income Test

If you’re single and your total taxable income (this includes all other investment, side job, and interest income) is less than $157,500, great! You can take this deduction no questions asked. If you’re married, the same limit is $315,000. Mind you, if your income is higher than this threshold, it doesn’t mean you can’t take it. Rather, there’s a phase out period up to $207,500 for singles and $415,000 for married individuals. The phase out is essentially linear. What it means is if your income is above the phase out thresholds, you can’t use *any* of this 20% deduction. It doesn’t mean that you can still deduct the portion that’s under $315,000.

Ironically, this creates significantly negative incentives around the phase out line where one’s marginal tax rate goes up temporarily to ~50-60% because of rising brackets and losing benefits. Greg Mankiw may chime in in five years and say that it’s a “upper middle class” income trap with bad incentives.

Don’t fret if your income is above either threshold (lucky you!). Remember this test just wants to check your total taxable income. Anything that reduces this number can make you thin enough to squeeze under the bar and claim the deduction. This includes SEP-IRA, 401k, and business expenses, all of which reduce what’s visible as taxable income.

The Profession Test

If you make more than the income cutoffs, you can benefit from the law if your business fits into one of these categories:

  1. Anyone who is in the business of being an employee (yes, being an employee is considered being in a business), and
  2. Any “specified service trade or business.” 

The IRS will spend several years filing lawsuits and refining this broad definition, but for now you can consider that if your business features your skills and services as opposed to owning property and selling goods, you’re one of the undesirable types. You will fail the profession test. Law, medicine, “consultant” and accounting are some of the professions that are explicitly mentioned as failing this test.

Somehow there are exceptions for architects and engineers. No one knows why but presumably their professional societies lobbied hard.

The Recap

So for our locums physician to take advantage of this benefit, he or she needs to satisfy the income test, because we know that medicine will surely fail the profession test. This is easier to do if you work in one of the lower paying specialties, work part-time, and are married. For our friends with S-corp setups, since the income test evaluates you on your overall income, it doesn’t matter if you slice your earnings as salary or a business distribution, they both will be counted for purposes of the limit. This obviates a big advantage of S-corps relative to sole proprietors.

Some of the more astute readers will note that there is another test called the W-2 test, which is supposed to limit abuse by preventing really high income people from quitting their jobs and becoming a consultant working the same job. Forbes explains better than I can:

I’m a partner at a BIG, PRESTIGIOUS ACCOUNTING FIRM. I am also, however, an employee; one who collects a wage. Now, let’s just assume that my annual wage is $800,000 (it is not). With the new rules coming down and offering a 20% deduction against my income, what would prevent me from quitting my current gig, and then having my firm engage the services of “Tony Nitti, Inc.” a brand new S corporation I’ve set up specifically to facilitate my tax shenanigans? Now, my firm pays that same $800,000 to my S corporation, and my S corporation simply allows that income to flow through to be as QBI. I, in turn, take a 20% deduction against that income, reducing my income to $640,000. See the problem?

My role at my firm hasn’t changed. I provided accounting services before, I provide accounting services now. But before, I was receiving wages taxed at ordinary rates as high as 37%. Now, by converting to an S corporation and foregoing wages in favor of QBI, I am now paying an effective rate on that income of only 29.6% (37% * 80%). That’s not fair, is it? Compensation for services should be taxed at the same rate, whether it’s coming to me as a salary or flow-through income.

To prevent these abuses, Congress enacted the W-2 limitations. Because, in my example, Tony Nitti, Inc. does not pay any wages, in both scenarios my limitation would be a big fat ZERO, meaning I get no deduction. Like so:

My deduction is the LESSER OF:

  1. 20% of $800,000, or $160,000, or
  2. The GREATER OF:
    1. 50% of W-2 wages, or $0, or
    2. 25% of W-2 wages, or $0, plus 2.5% of the unadjusted basis of the LLC’s assets, or $0, for a total of $0..

It’s a lot of calculation and looks complicated, but we can actually disregard it all as this limitation will only come into play if you fail the income test. Since we’ve already determined that a physician who fails the income test will automatically fail the profession test and be prohibited from taking the deduction, we shouldn’t even worry about this section.

As Forbes explains:

Section 199A(b)(3)(A) provides that if your TAXABLE INCOME for the year — not adjusted gross income, not QBI, but TAXABLE INCOME — is less than the “threshold amount” for the year, then you can simply ignore the two W-2-based limitations. The “threshold amounts” for 2018 are $315,000 if you are married, and $157,500 for all other taxpayers. These amounts will be indexed for inflation starting in 2019. And quite obviously, you determine taxable income WITHOUT factoring in any potential 20% deduction that we’re discussing here.

The Payoff

Phew. You’ve waded through all of the above because you’re eagerly salivating over seeing how much you can save on your taxes, right?! Let’s crunch some numbers.

Our example physician is married, works as a contractor (paid as 1099), and is set up as a sole practitioner (in the end, S-corp calculations won’t be too different from this) for simplicity’s sake. Assume no kids. This person is based in Texas and to avoid troublesome state income tax calculations performs contract work in Washington, Nevada, Texas, and Florida only. Yearly income starting in 2018, the first year the new law will apply, is estimated to be $400,000.

To fit under the threshold, we maximize our SEP-IRA contributions, which are $54,000. We accumulate $22,000 in deductible business expenses. Then we also take the standard deduction of $24,000 for a married couple. That leaves us with $300,000 exact in visible taxable income. All of it is eligible for the 20% deduction.

Let’s use Marketwatch’s calculator to calculate our total tax under the new bracket system for 2018:

  • $40,179 for federal income tax
  • $0 state income tax
  • $15,958.8 Social Security (double because of 1099)
  • $12,114 Medicare (including surtax)
  • Total of $68,251.8

For comparison, if we earn that $300,000 as W-2 income (employed physician), our total tax will be:

  • $60,578 for federal income tax
  • $0 state income tax
  • $7,979.4 Social Security
  • $6,633 Medicare (including surtax)
  • Total of $75,190.4

There is a net savings of $6,938.6 with business income as opposed to wage income. The numbers are close but not exact, since the business owner will be able to deduct business expenses and half of the payroll tax that the W-2 earner can’t itemize.

I haven’t included calculations for S-corp owners because there are complex rules depending on how much you take as W-2 salary and how much is a distribution. The same thresholds apply, and you are only allowed the 20% deduction on the portion that is a distribution.

 

(Much of the details are from the source text, as well as Forbes Tax Geek and Evergreen Small Business)

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When it Makes Sense to Commute by Plane

True story. I was in Vietnam a few weeks ago and on a street food tour of Hanoi, I met an Australian expat. She was a lively conversationalist and told me the nugget of a story: there are Australian resource workers who choose to live in Bali and commute to Perth to work in the mines.

It’s true (the internet proves it so!) and it makes total sense for those involved.

  1. They get to live in paradise, or at least a place that most people pay thousands to travel to
  2. The flight is cheap (Google Flights shows direct round trip tickets to be $180 if you book a month out)
  3. At 3 hours and 40 minutes, the flight is doable given that the work schedule was described to me as 5 on 5 off
  4. Cost of living is lower in Bali than in Perth
  5. Living expenses are covered at the worksite in Western Australia, which avoids the unpleasant need to maintain two residences
  6. Enough people do it that the visa/residence aspect in Bali must not be a problem

Calculating that the cost of a flight 2-3 times per month is still less than the difference in rent between Denpasar and Perth, the miner comes out way ahead. Of course, this works best if you’re single, mobile, and without significant family attachments to keep you in Australia. But if you are single or can otherwise make this work by moving your spouse to Bali, it can work out really well.

Can this type of arbitrage be applied to other situations in life? Of course! In fact, the cost of housing in most major American cities has become so exorbitant (see $3500 per month rent in SF for a one bedroom apartment) that it’s cheaper to commute to work, even on a business class flight! It’s true. I’ve been investigating this for my own professional life and came up with one such arrangement.

  1. Live in Tokyo, where the monthly rent is about $1200 in the city itself, even cheaper if you live in the suburbs
  2. Catch a direct flight to a west coast city in the US for a job as a locums nocturnist (bonus if the job is in Washington state where there is no state income tax)
  3. Work 7-10 days straight and then take the rest of the month off

Mind you, the living expenses stateside are of course all covered by virtue of being locums, absolving the nocturnist of maintaining a costly car and pied-a-terre in the city. There is a secondary bonus. Normally night shift workers are paid a premium in the US, due to the unsociable hours. However, Japan is far enough away from the US such that accounting for time zone difference, our nocturnist will be working a daytime schedule back home! By keeping the number of contiguous shifts high and the number of trips back and forth low, our nocturnist gets to maximize his # of days off, pay per shift, and minimize overhead expenses (time, money) involved in the commute. With a round trip ticket from Tokyo to Seattle about $850, rent in the US will just need to be more than $2000 per month for this commute to be worthwhile. That’s not even accounting for how much cheaper and better life is in Japan compared to the US.

Of course, one can think of similar arrangements for a British locums physician seeking to live in SE Asia and commute to the UK to work night shifts on an as needed basis.

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Get Out of a High Cost Area

You probably know that coastal cities are expensive. Actually, if  you’re reading this blog, chances are better than not you’re an educated person living in an urban area. It’s also not surprising that the high cost of living serves as a wall that prevents the migration of poor workers from e.g. Ohio or West Virginia. Interstate mobility in the US has decreased, and part of that can undoubtedly be explained by pull (family ties) and push (cost of living) factors. This has contributed to political polarization, overall wage stagnation, class-based segregation, and increased resentment all over the board.

The key tenet in my book is that wages are not going up, at least not as fast as cost of living. This article makes it abundantly clear that it’s driven by housing:

Housing costs have grown much faster in high-income places than low-income ones since 1960. Housing has always been more expensive in high-income places, but the difference is getting more extreme. In 1960, on average, US states with 10% higher incomes had housing costs that were 10% higher. In 2010, states with 10% higher incomes had 20% higher housing costs.

I would also add labour to that mix. As part of overall price pressures, you have to pay more for help, since they need to be able to afford to live there or otherwise be compensated for a long commute in from the exurbs.

So if you’re living in an expensive city, carefully examine your own life and entertain the notion that you may have more disposable net income after moving to the sticks. (Note: this doesn’t factor in the potential for career advancement and networking opportunities in the big city)

Better yet, take advantage of geographic arbitrage using techniques from my book.

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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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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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Advice for a Young Investor

Warren Buffett says that today’s crop of babies are the luckiest ever. This may be true in some respects – technological advancements have certainly improved the quality of life. Today’s commoners live a life undreamed of by previous monarchs. However, in other respects, young people today have it harder than ever.

Take for instance public comments Morningstar’s advice to a young investor:

Check out the vesting options on your match in the 401K before you let that match influence what you do. My own Millennial daughter has worked at 3 places now with generous matches on paper. She has yet to get any of her matches to vest because they all have 3 year cliff vesting. She got laid off (in one case just before 3 years) before any of her matches vested.

and

That should be a wake-up call to today’s 20/30-somethings. Were those terminations part of some evil, greedy attempt to cut corporate costs? Just the fact there was a long “cliff” should say something: corporate America is desperate to wash its hands of any responsibility for their employees’ retirement.

That means: save, save, save your money. Retirement is in your hands, more than ever! Each dollar wasted on alcohol, pot, tattoos, new cell phones every year, data plans, new cars, bar tabs, trips to Mexico, music festivals, is actually ***two or three*** dollars you won’t have for retirement.

That’s the time value of money. Blowing money on toys and “experiences” early on in life, is what’s killing the retirements of many a baby-boomer today. Forcing older boomers to reverse-mortgage their homes for money to live on.
Don’t repeat your parents’ mistakes.

With how perilously insecure jobs are today, it’s more important than ever for young people to have multiple income streams. This means side gigs (e.g. Uber, independent tutoring, Etsy), monetizing resources (e.g. Airbnb), investment income (rental, stocks, bonds), and entrepreneurship (low cost digital startups). Without a diversified stream such as the above, we will fall prey to the whims of an unscrupulous employer who can can us at a moment’s notice in the name of cost savings.

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Follow Your Passions, After Your Career

The story of the Hong Kong banker who quit his job to work in humanitarian aid is truly inspiring and definitely relatable.

One question that Asian children (probably others as well, but I’m speaking from experience here) agonize over when growing up is whether to pursue something profitable (often at the behest of their parents), or something that they’re truly passionate about. It’s rare that these intersect, unless your passion is money. Many times, these kids get so immersed into their studies in school that they don’t even find their passion until much later in life. Then they are filled with regret and resentment.

My approach is to have the best of both worlds. Grind through school in your 20s and get out into a great career. Work overtime and make tons of money early. Guaranteed high income fields like banking and medicine are very suitable for this. The reason is that it’s easier to learn new things quickly when we’re still young. Also, money earned when young is more valuable because it has time to compound.

Do this when you’re young enough and you can emerge in your mid 30s with enough money to retire and live purely off your investments. Then it’s time to find and focus on your passion. I suggest at this point some combination of travel, volunteering, philanthropy, teaching/mentoring, and entrepreneurship. More details on this to come in my upcoming book on happiness.

Doing the opposite by finding your passion when young generally means you have a brief happy time in your adolescence, but at the cost of potential financial destitution in mid life. You also lose out on important things like compounded savings and moving up the career ladder. This can make you profoundly unhappy. One caveat remains. This option may be a good choice that maximizes happiness if you know you’ll die young.

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NYT Discovers What the Rest of Us Already Know

NYT publishes an article on the superstar effect, only this time applied to firms and not individuals. Let’s take a look.

For much of the last century it seemed that the slice of the total economic pie going to workers was — like the speed of light — constant. No matter what the economy’s makeup, labor could collectively depend on taking home roughly two-thirds of the country’s total output as compensation for its efforts. Workers’ unchanging share, the economist John Maynard Keynes declared in 1939, was “one of the most surprising, yet best-established, facts in the whole range of economic statistics.”

But in recent decades, that steady share — which includes everything from the chief executive’s bonuses and stock options to the parking-lot attendant’s minimum wage and tips — started to flutter. In the 2000s, it slipped significantly. Although the numbers have inched up in the last couple of years, labor’s portion has not risen above 59 percent since before the recession.

The decline has coincided with a slowdown in overall growth as well as a stark leap in inequality. “Labor is getting a shrinking slice of a pie that’s not growing very much,” David Autor, an economist at M.I.T., said. It is a development that is upending political establishments and economic policies in the United States and abroad.

Some economists argue that technological advancements are to blame as employers have replaced workers with machines. Others point to trade powered by cheap foreign labor, a view championed by President Trump that particularly resonated among voters. 

Alternate culprits include tax policies that treat investment income more favorably than wages; flagging skills and education that have rendered workers less productive or unsuited to an information- and service-based economy; or a weakening of labor unions that has chipped away at workers’ bargaining power and protections.

(…)

The article goes into superstar firms briefly.

The idea of superstars vacuuming up a majority of goodies is perhaps more obvious on the individual level. Because of technology like cable and satellite television and the internet, music luminaries like Beyoncé and Taylor Swift or sports phenoms like LeBron James or Cristiano Ronaldo can reach a much larger audience and gain a greater proportion of the revenue generated.

Writing about the advent of superstars in the modern era, the economist Sherwin Rosen noted in 1981 that there was “a strong tendency for both market size and reward to be skewed toward the most talented people in the activity.”

What was once true of pop stars can now be seen in more mundane industries. “Over the past several decades, only the highest earners have seen steady wage gains,” a report from the president’s Council of Economic Advisers concluded late last year. “For most workers, wage growth has been sluggish and has failed to keep pace with gains in productivity.”

This is more interesting. He cites the Sherwin Rosen paper that I reference in my book. The examples cited also are entertainment (media and sports) sensations, with an indirect contribution from technology making it easier to share that with a wider audience, allowing superstars to take more and more of the overall spending pie on entertainmment. That’s exactly what I wrote in my book.

It feels good to be vindicated.

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