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Millionaire Teacher Andrew Hallam

Tonight I give a wrap-up talk for the online discussion of Millionaire Teacher by Andrew Hallam conducted via the Howard County Library System in Howard County, Maryland.  As one part of the presentation, I will give the following overview that hopefully will help people as they think about saving for retirement.

How to Invest

• Asset Allocation - Percentage in Stocks/Bonds/Cash. Most important decision for investors. Pick asset allocation and stick with it.
• Low Cost Index Funds - forget market timing and stock picking. Understand the cost of the funds you use and minimize those. Use index funds. 
• Monitor - keep track of performance. Performance should be close to market returns. Understand that, in accumulating assets, declining markets are your friends.
• 10% Max Play Money - You are introduced to 3D printing and want to invest. You eat at Chilpolte's and want to invest. Limit these investments to your "10% play money."

Organize 

• Taxable, Qualified (401k, 403b, TSP, IRA), Roths - Put accounts statements in this order. This, by the way, is generally the order you'll spend in retirement.
• Consolidate - Many people have accounts with several brokers and banks. Simplify as much as possible. It helps in getting the big picture and monitoring the overall results.
• Bonds in Qualified Accounts and Roths/Stocks in Taxable and Qualified Accounts-Two tax rules:  defer taxes and pay as little as possible. Understanding the idea behind location of investments helps along these lines.

How Much to Save and Invest?

• Add Social Security + Pension + Nest Egg * .04 + Other Income - The idea is to estimate potential income  when you stop drawing a paycheck. Online calculators will help you with this by putting in estimates of inflation and market returns.
• Income should typically  = 80% to 110% of current lifestyle expenses - Estimate living expenses at retirement and get within the range. 

What Can Upset the Apple Cart?

• Lose Breadwinner Income - Carry term insurance. 
• Health - Think about long-term care insurance.
• Lawsuit - Carry umbrella insurance.

This outline is intended to get the wheels turning.  People need wills and trusts.  People need to consider what it would cost to replace a homemaker.  People need to understand how to rollover 401ks and educate their heirs how to title inherited IRAs.  This outline isn't intended to suggest that dotting all the i's and crossing all the t's is easy but, hopefully, get people started on the right path. Reading the Millionaire Teacher goes a long way down this road.

Thoughts on Bitcoins

Satoshi Nakamoto.  Know the guy?  Or it could be a woman?  No one apparently knows.  All  we know is that Nakomoto created the digital currency Bitcoin in 2008.

Bitcoins are catching on as a means to transact globally as well as a speculative vehicle, given their volatility.  Some people see bitcoins as money of the future.  Uncontrolled by central bankers, they are limited in supply to a specified amount to be available at a given future date.  Bitcoin comes into existence by computers solving problems, referred to as mining the currency.  Bitcoin miners have the incentive to create ever faster chips to solve the problems involved in mining the currency.

Some of you may  have questions.  Let me take a shot at anticipating some of them.

First off, are Bitcoins money?  Well, partly so and partly not depending on conventional definitions. Conventionally, money is defined in two ways.  First, money is defined as that set of assets acceptable for the payment of goods and services in the economy.  Bitcoin is on the way to satisfying this requirement.  The list of companies willing to take payment in Bitcoin is clearly expanding.

The second definition is by function, and three functions are typically listed.  The first function is medium of exchange, and we've already said Bitcoin is acceptable in a lot of places.  The second function is that money is used to price goods and services.  If you go to Tokyo, you'll find coffee costs 400 Yen.  In New York coffee is $4.00.  OK, clearly the Yen and the dollar are money.  As far as I know, nothing is priced today in Bitcoin.

 I just recently heard an interview on the radio of the CEO of Overstock.com, who is a huge proponent of Bitcoin. The interviewer asked him how he handles the risk of receiving Bitcoin given its volatility and he responded. "Oh, we immediately convert the Bitcoin into dollars."  This CEO has a big problem with the value of the dollar but immediately jumps into dollars by converting his bitcoins?  OK then.  It  indicates to me the fear of trying to find a chair when the music stops.

A third function is that money has to be a store of value.  Clearly you can forego consumption today by putting $100 in your dresser drawer and have purchasing power in the future. The same can be done with Bitcoin, albeit as an account on some mobile device.  Your Bitcoin may be worth $30 or $300 in the near future, sort of like some stocks.

Another question is whether bitcoins should be regulated?  Should bitcoin players be protected from themselves?  To me, a sign post saying the ice is thin and could be hazardous is sufficient.  This reminds me of  the infamous "liar loan" type of mortgages from 2006.  Bitcoin users should be warned but not expect taxpayers to bail them out when and if their market implodes.  As far as I know, no one jumped to the aid of the late comers to the beanie baby fad.

What About the Fed?

Presumably Nakamoto (or whomever or whatever) created Bitcoin out of disenchantmet (I'm being polite here) with central bankers.  Central bankers represent power and have been a target for conspiracy theorists since even before the present incarnation of the U.S. Fed in 1913.  And, not without reason. Big banking has a history of abusing power and engineering games where, in the end, the average person suffers.

In agreement with the bitcoiners, I am not a fan of the U.S. Fed.  Along with Bitcoin advocates, I believe the Fed should control the amount of money in the economy and let the market determine the price of that money (i.e., interest rates).

Still, though, I think Bitcoin advocates misrepresent and fail to understand in an important way how the Fed operates.  I'll get some push back here, but let me give a simple example.  In the file of "repeat something often enough and people will believe it," there is the notion that the Federal Reserve creates money out of thin air.

First off, where did this notion arise?  It probably comes from a prescription, offered tongue in cheek, for an instance where economy needed stimulation, such as the 1930s, to drop money from a helicopter. In fact, Bernanke mentioned this and got hit with the moniker of "Helicopter Ben."  But this isn't, contrary to public opinion, how the Fed gets money into the system.

Instead, the Fed typically buys Treasury securities.  Hmm...think of this. It is trading a liquid asset (a demand deposit) for a non-liquid asset (a Treasury security).  Where did the Treasury security come from?  Someone had forgone income, saved, and bought a Treasury security.  When banks get the deposit, they have funds to lend.  Who do they lend to?  Those with good prospects of paying back the loan with interest.

I'm not saying this process can't have problems.  Indeed, with a fiscal policy gone bonkers, it can potentially set the stage for rampant inflation.  The point is that it is not the same as willy nilly writing checks to big banks, as is commonly perceived. 

Contrast this with a different setup in relation to bitcoins.  Suppose I had a riddle and I said that I will create "Robert Bucks" to the tune of $10,000 for every person who could solve that riddle.  Suppose, further, that Robert Bucks became acceptable for a medium of exchange.  Surely there is a significant  economic difference between the Robert Bucks setup and what the Fed does, and I would argue that the Robert Bucks situation is close to how bitcoins operate.

My bottom line is that bitcoins are a fad, and the ever-present "gold rush" part of the population speculating as an easy way to get rich will end up otherwise.

Avoid Tipping Over the Apple Cart

OK...you've had a great harvest.  The cart is filled, the horses fed, and the driver is sober.  You're ready to go to market and realize the rewards of your careful planning, but you're not quite there.  You have to take steps to avoid the proverbial tipped over apple cart. Watch for the potholes.

I'm an investment guy.  I can help you think about your asset allocation, the pros and cons of various investment approaches, how to locate your investments to minimize taxes, etc.  I can put you on a path that, based on historical data, gives you a high probability of achieving your retirement goals with your investments.  I can even direct you to blogs that will inspire you to become more frugal.

Still, EVEN WITH THE BEST LAID PLANS, YOU MAY RUN INTO BAD LUCK.  I'm not talking about markets--I'm talking about health, lawsuits, and general emergencies.  These will tip over the investment apple cart!

For this reason, I spend considerable time talking with clients about possible events outside the realm of direct investing.  Emergency funds, managing debt, term life insurance, etc. are part of this important conversation.

Another huge pothole that can tip over the whole apple cart is a major lawsuit.  Life can be going swimmingly, accounts can grow at a surprising pace, you've learned to have a lobster dinner at home along with a nice bottle of wine rather than at a posh restaurant, and a beautiful retirement can be seen on the horizon.  And then, out of the clear blue, a major lawsuit pops up.  Maybe someone got hurt at your house, or you were involved in a multiple car pile up.  It doesn't matter.  You could have someone coming after you for all you are worth.  Apples start to cascade out.

Some contingencies are not easy to deal with.  For example, the whole area of long-term care insurance is difficult to navigate.  It is expensive, its premiums change, and it is difficult to determine how much a couple needs.  Term insurance, by comparison, is fairly simple.  It is inexpensive and easy to ballpark the right amount.  Another relatively easy one is the potential life upending major lawsuit.  What is needed is umbrella insurance.  The good thing is that it is relatively inexpensive to get sufficient coverage.  Here is a good article on what it is about:
Do One Thing:  Buy an umbrella liability policy by Kate Ashford.

Once these cart-upsetting contingencies are dealt with, you are in a considerably better position for appropriately structured investments to get you a desirable retirement.

Monster Game Babeeeeee!!!!!!!!!!

This ain't me!

Monster game this past Sunday.  Not Michael Jordan monster, but personal monster.  3-for-3 from the 3-point arc and 5-for-6 from the field - 19 in total - blew them out of the gym.  Start the bus up, the team is on a roll.

So what did I do?  Did I do an NFL endzone dance?  Did I make the motion to move the chains as footballers do when they eek out a first down?

Nah.  I passed on all of these and not just because my dance would be horrible.  The fact of the matter is that the game was not the goal.  The goal is to win the championship, and this was one small step.

You're probably wondering what all of this has to do with investing.  Well, fact-of-the-matter is I'm being run over by more and more people doing a victory lap after last year's monster year in the stock market.  Some are the same people who, of course, were walking the ledge in 2008 looking for a good spot to jump head first.

You know what's coming.  YOU HAVEN'T MADE ANYTHING OR LOST ANYTHING UNTIL YOU SELL OR START DRAWING DOWN THE NEST EGG!  In fact, one day I'm going to write a post titled "I didn't lose anything in 2008 even though I was 70% in stocks."  Maybe this will fool some people into thinking I'm the world's greatest stock picker ;)

As it turned out, I stuck with my asset allocation and accumulated funds at bargain basement prices, as many people did, and today we are way, way ahead of the low point in 3/2009.

If you're getting the message here, you are understanding that victory laps here can very well be premature. I n fact, if you feel the need to do something, this is a good time to review your asset allocation and make sure it is where you want to be.  It is a good time to review your bond positioning to make sure it is where you want to be.  Save the high-fiving for down the road.

A tidbit for the older crowd as you do this:  New York Life is advertising a 6.3% payout rate on single premium annuities for 66-year-old males.  For $100,000, you get $525/month as long as you live and, if you kick the bucket soon, your beneficiaries get back what you paid in.  As always, you should limit the amount of assets you put into annuities because you lose control of the money!  Just as important - know what you want going in.  Insurance sales people are some of the best on the planet at selling you what you don't need!

Disclosure:  This post is solely for educational purposes.  Investors should do their own research before making investment decisions.

Book Review: Walden on Wheels

Walden on Wheels is Ken Ilgunas' story on how he ran up $32,000 in student debt getting an undergraduate degree and then paid it off by living frugally working at low-paying jobs, including stints in Alaska.  As happens with many young people, he started college by pretty much following social convention and then found it fulfilling only as he came close to graduating, whetting his appetite for graduate school.  The kicker is that he made up his mind to pay for graduate school (at Duke, no less) by not going back into debt - hence, living in a van (his Walden on Wheels) on the Duke campus.

Ilgunas is a really good writer who does a great job describing many interesting characters and experiences in his journey.  Readers who have run up student debt getting a degree that the market doesn't value will surely relate to his story. Others will find it amusing as well.  There are some heavy, thoughtful philosophical arguments made throughout that will get all readers to question their values and, if read with friends, will surely generate debate.

From my perspective as an economist, I do, however, always have to question people who put their value judgments on others.  It is fashionable today, as Ilgunas does, to assume that people working in a corporation are leading miserable lives and that fulfillment comes from living in a shack in Alaska. Here's some news for those who believe this:  IT ISN'T NECESSARILY TRUE!  Many who work for corporations are leading very satisfying lives!

Another point along these lines:  he takes some good pot shots at Duke graduates who migrate towards Wall Street and Goldman Sachs, etc. - another popular theme, especially given events of recent years. As in the recent hit movie The Wolf of Wall Street (I don't consider myself prudish, but I recommend not attending the movie with a date or any of your children), it is commonly accepted that buying and selling stocks creates no value.  Actually a casual understanding of history reveals that the "invention" of the joint stock company, whereby people could invest in risky ventures and participate and liquidate as they choose, was instrumental in creating material wealth.  Please understand that I am sympathetic to the view that the free market, capitalistic system has gone too far in creating material wealth and that some serious work needs to be done on reining in materialism.  But this is because Wall Street does too good a job at creating wealth--not because it doesn't.

Finally, those who have visited Walden Pond will surely enjoy Mr. Ilgunas' take on Thoreau.  All in all, this is an easy read that presents some interesting philosophical arguments - especially a great read for young people and those facing a long plane trip.

Portfolio Performance - 2013

Source: Capital Pixel

HAPPY NEW YEAR!

Regular readers know my favorite investment chart is the BlackRock 20-year sector performance.  It details the relative ranking of asset classes on an annual basis as well as the performance of an easily replicated low-cost diversified portfolio comprised of 65% stocks, 35% bonds.  The diversified portfolio returned 12.2% over the 12 months ended 12/31/2012 and 7.9% on an average annualized basis over the past 20 years.

The diversified portfolio allocation is an appropriate benchmark for individuals in their 40s and even early 50s, depending on risk tolerance.  The table contains sufficient data, however, to construct a benchmark and analyze performance for any specific allocation; and, in fact, the allocation can be changed over time--as it should be as the individual ages.

Voluminous data from unbiased academic studies have been presented over the years showing that a diversified portfolio of low-cost funds outperforms upwards of 70% of active managers over the longer term after all costs are taken into account.  These studies cover various time periods, countries, asset classes, and investment methodologies.  In line with this data, the low-cost diversified approach warrants consideration as a benchmark for investors.  It shouldn't go unnoticed that the approach economizes on the investor's time.

Here is an update showing the approximate performance of the diversified portfolio for  2013:

Weight	Fund	Return (%) 12 months ended 12/31/2013	Expense Ratio
35	AGG  (Barclay’s Aggregate Bond Index)	-2.15	.08
10	EFA (EAFE Index)	22.62	.34
10	IWM (Russell 2000)	38.85	.24
22.5	IWF (Russell 1000 Growth)	33.19	.20
22.5	IWD (Russell 3000)	32.18	.21

 
The overall return of the diversified portfolio was approximately +20.09% for the year.

Disclosure:  This post is intended for educational purposes only.  Past performance is not indicative of future performance.  Individuals should consult a professional or do their own research before making investment decisions.