Kids investing in real stocks

For those of you who have been following the Summerfield Open, you know that those tests for 4th and 5th graders had a major focus on applying mathematical principals to personal finance.  Many of the kids got interested in investing because of those questions which led parents to ask me how their kids can start investing in stocks.  Here is how I would approach it.

Of course, remember this is just friendly advice.  I am not an expert and you should call the broker (I suggest Vanguard) or work with a paid advisor.  With that out of the way, here’s what you can do:


Fun or boring

We’ve talked ad nauseum on this blog about the best investing strategy being buy and hold index mutual funds.  This is a tried and true approach, but it’s boring.  When you’re thinking about how to get kids excited about and engaged in investing, that’s a conundrum.

You want investing to be exciting for the ankle-biters to hold their attention.  If you’re an ankle-biter who is looking to start investing, the point may be less to make a lot of money.  Rather, it might be to gain experience investing.  Yet, you want them to develop good investing habits that will pay dividends (haha, do you see what I just did?) for the rest of their lives.

With all that, I think you want to have a foundation of correct investing principals (boring), and then try to mix in some fun into that.  Let’s look at those investing principles and see which should apply to the padawans:

  • Diversification—This is a critical concept that you want to have early on. Investing in individual stocks might make it a bit more tangible for the munchkin (you’re investing in Apple which is the type of phone mom has), but I think you can do something similar with a mutual fund or more likely ETF (more on that in a minute).  Individual stocks will be more volatile which will translate to more exciting for a munchkin, but ETFs will definitely have plenty of action.
  • More diversification—As you look to diversify an important concept is “total coverage”. You want to have investments everywhere.  That might be a bit harder for individual stocks because it’s not always easy to know the exposure that a company has geographically (you’re investing in Ford because that’s the car dad drives, but how much of their business is in the Middle East?).  With ETFs you can overtly pick US funds or European funds or Pacific, etc.  That gives a bit of a built in geography lesson too, so there you go.
  • Minimize costs—We’ll have a whole section on this, but costs are especially important for the half-fries. They probably don’t have a lot of money to invest (remember, investing is probably more for the experience than the wealth creation).  With a smaller portfolio a $5 or god-forbid $15 transaction fee to buy some shares of stock would have an outsized negative effect on a $100 portfolio compared to a $100,000 “adult-sized” one (but even adults shouldn’t pay transaction fees).
  • Hold investments for long term—This is critical for wealth creation, but I think we sacrifice that for the tadpoles. Trading is “exciting” and keeps them engaged.  Fortunately, because of the Random Walk there’s no reason to believe that more active trading will negatively impact the portfolio beyond the transaction costs (mentioned above, and again below).  So here I say have a lot of fun and dip your toe in and out of the different investments somewhat frequently to keep it exciting.
  • Track your investments—This is probably even more important for the spuds. As an adult it’s actually a bad thing to be looking at your portfolio all the time.  However, here I think it’s good.  Everyday something will happen with the investments—it’ll go up a lot or down some or something.  There are amazingly great math lesson here—calculating returns, making graphs of what’s going on.  If you want, as a parent you could really dig in and make this a huge adjunct math course.


Setting things up

Fair warning, the advice I am giving here might be illegal.  I strongly recommend you talk to an investment professional as you do this.

Unfortunately, to set up a brokerage account that allows you to trade in stocks or ETFs or what ever, you need to be 18.  So that’s a problem for the half-pints.  As a parent you would need to take said half-pint’s money and invest it in your (adult’s) account.  Technically, the money will belong to the adult, but perhaps you can make a deal with your half-pint to “promise” it will go back to them.  Seriously, the IRS does allow gifts between people (I think the limit is $10,000 per year), so I don’t think it should be too big a deal, but do understand the technicalities.

All our investments are at Vanguard, and that is where I would go.  You can go to, select “Open an account”, say you’ll fund it with a check, and then pick a “general savings account”.

There will be a lot of questions that you’ll need to fill out and then with things like your social security number, a username and password, and other stuff.  Get all that done, and then you can call them up and ask for deposit slips so you can send them a check to fund your account.


Minimize costs

Once everything is set up and the money is in your account, you will get to the fun part which is picking your investments.  Here I would suggest ETFs, which basically act like stocks—you buy them in whole shares and they trade throughout the day—but they are really like a mutual fund in that they invest in hundreds of companies.

This is where Vanguard really shines.  You can open your account for no minimum and then invest as little as one share (each share is typically between $50 and $150).  If you invest in a Vanguard ETF (they have a ton of high quality ones—here) they don’t charge any transaction fee.  So you can trade and out of them as much as you want.  Obviously, you don’t want to be silly, but that works well for juniors who want to experience the trades.

If you want to invest in individual stocks or non-Vanguard mutual funds there is a fee (I think $7 per trade), but I don’t really think there’s any reason to do that.

There are ETFs for everything.  For a little dude, I would suggest equities, and here are a few that you might consider:

  • VTI—all US companies
  • VB—small US companies
  • VT—all companies in the world
  • VXUS—all international companies
  • VDE—energy companies (industry specific)
  • VHT—healthcare companies (industry specific)


As you know, I have a huge passion for investing and helping kids.  If you’re doing this and need some help navigating things, please let me know.

Top 5—Financial moves when the stork is coming


A lot of our readers are starting their families or have younger kids.  Foxy Lady and I have been so blessed to bring two wonderful little cubs into the world.  As you embark on parenthood and rearing little ones, what are the financial considerations you need to make?  Surprisingly, I don’t think there are all that many:


5. Set up your health insurance. Depending on when you find out your pregnant, the chances are you will have an enrollment period with your health insurance.  Foxy Lady and I screwed this up twice since both of our boys were born in October (we found out we were pregnant in February so we missed the open enrollment while pregnant), but let’s imagine that found out that we were pregnant in October and the baby was due in June.

When open enrollment comes around every December and goes in effect in January, we would have bought the primo policy that gives the best coverage.  Normally, we don’t pick the Cadillac policy that our work offers because we’re relatively healthy and don’t go to the doctor a lot.  Under normal circumstances we get a middle-of-the-road policy.  If we happen to have a medical issue (like with ‘Lil Fox in 2014) we know we’ll spend a little more in out of pocket, but that doesn’t happen very often so we generally come out ahead.

However, when you’re expecting you know for sure you’re going to spend a lot of time in the hospital and you’re going to have a lot of doctor’s visits, and that gets expensive.  If you know this is coming, get the insurance policy that has the higher premium every paycheck but then covers most or all of those expenses.  Had we done this with our boys, we probably would have saved $3000-4000 on each little guy.  As it is, I’ve told both boys they owe us that money and it should be treated as a loan accruing interest, but neither has acknowledged the righteousness of my claim.


4. Set up your flex spending account. Similar to #5, if you’re having a baby you know you’re going to have some medical expenses. Make sure at open enrollment you set up your flex spending account to pay for those.  With flex spending accounts you can pay for medical expenses using before-tax dollars.  So that $2000 you had to pay with pre-tax dollars only feels like $1300.

Also, once you have kids, you can use a flex spending account to pay for childcare.  The government allows up to $5000 per child to be tax deductible (I’m not a tax expert, but that’s my understanding) if you use a flex spending account.  Spending $5000 in pre-tax dollars instead of after-tax dollars is pretty sweet.  And for childcare it seems like a no-brainer that amounts to about $1500 per year.  Most of us know for sure that we’re going to have childcare expenses.  Why not spend the hour it takes to save that money (if $1500 isn’t worth an hour of your time, then I’d like for you to help me with my finances).


3. Steel yourself against crazy “baby” spending. Definitely when you are going to have a baby there is a lot of stuff that you need, and this is especially true for your first child.  But for everything item that you do need there are probably 5 that you don’t need.  Baby stuff has become a big business and the people who market this stuff are smart.  They know you want the best for your child, and they aren’t above pulling on your heart strings to let you think that you “need this to be a good, loving parent.”

We did get the diaper genie and are glad we did.  We never got the bottle warmer, and never missed it for a second.  We got a pee tent (when you’re changing your son’s diaper and keeping him from peeing everywhere between diapers) and never used them.  We got three strollers with our first—a regular that the car seat fits into, a jogger, and an umbrella stroller—and used all three but we never have really used the tandem stroller once Mini Fox joined his brother.  There are a million more examples but you get my point.

This isn’t a baby blog, so I’ll stop there.  Just understand my point is that you can spend hundreds and thousands and tens of thousands of dollars on baby stuff, much of which you won’t need and none of which will make you love your baby any more.


2. Start a 529 account. If you are planning on paying for some or all of your child’s education (that’s a big “if” and one I covered here), a 529 is a no-brainer.  Basically, a 529 allows you to take after-tax money and invest it for your kid’s education.  That money can grow tax free so when you take it out you won’t pay any taxes on it.  In that way it’s very similar to a Roth IRA.

Doing back of the envelop math, if you saved $500 per month for your child’s education that would give you about $200,000 after 18 years.  Of that $200k, about $110k would be what you put in and $90k would be what you gained on your investments.  Without a 529 you would be taxed on that $90k gain; depending on your tax bracket that could be $30-40k you would owe Uncle Sam.  With a 529 you get to keep that.  Think about that for a second—basically the tax advantages of a 529 buy you another year of college.  It’s like buy three years, get the fourth year for free.


1. Love. This is a finance and investing blog so I always focus on money, but with your baby your love is a million times more important than anything you can do that has a dollar sign attached to it.  There will be some costs, a few of which we discussed above, but not as many as you’d think.  You’ll spend some on diapers and formula, as much or as little on clothes as your fashion sense (or lack thereof) allows, and you’re pretty much set.

Very often, somewhat to your chagrin, they’ll find more joy in the box that expensive toy comes in than the toy itself.  Library books are free, and children’s books in general are pretty inexpensive, so reading to your kids (one of the best things you can do according to child development experts) is pretty cheap and really rewarding.  And walks to the park and rides on the swings are still free.  As is keeping your cool when your kid puts one of his rubber balls under the treadmill, having it sucked into the motor so now it makes a funny noise.

As you embark on parenthood it’s a crazy rollercoaster.  Sure there are a couple financial bows you have to tie, but I don’t believe near as many as a lot of people would have you believe.


Happy parenting.  For those parents out there, what were the major financial items you had to take care of when your bundle of joy arrived?

Federal reserve makes markets dive

Nothing gets stock markets so excited as the Federal Reserve.  Here is a chart of the S&P 500 yesterday.  Quick, when do you think the Fed announced that it was going to raise interest rates?  Everything was going fine—it was a pretty smooth day and then at about 3pm the Fed made its decision and the bottom fell out of the stock market.  Why is the Fed so important?  What is it doing that can make a calm market move to much so quickly?

Basically (and this is very basic, as there is a boatload of nuisance in this) the Federal Reserve, and for that matter the central banks of any country, control the core interest rate.  That single, yet enormously powerful tool, allows the fed to influence the economy in a major way.

The guiding mission of the Fed is first and foremost to maintain a healthy level of inflation.  In the US that is around 2-3%.  Being too low has some problems that reasonable people can debate, but pretty much everyone believes that when inflation gets too high, that’s when really bad things happen.  So more than anything, the Fed is tasked with keeping inflation low.  Then a secondary goal is to promote a healthy and growing economy that keeps unemployment low.  So basically the Fed has two jobs, keep inflation low and keep the economy strong.


How does the Fed impact the economy?

Let’s imagine a really simple economy.  There are ten companies named A and B and C all the way down to J.  Just like in real-life, not all companies are created equal, with some being much more profitable than others.  Here A is the most profitable (maybe like Apple) while J is the least profitable (maybe like JC Penney).

Interest rates will play a big part in the profitability of these firms.  As interest rates go up, the amount they spend on interest for all their debt goes up as well.  Because A is so profitable, it would only start to lose money if interest rates went really high, up over 10%; however J is much more vulnerable and will become unprofitable if interest rates go over 1%.  All the other companies have a similar situation as shown in the graph.

So this is where the Fed comes in.  Let’s say the Fed sets the interest rate at 6%.  Firms A, B, C, D, and E are all profitable even when the interest rates are that high; but firms F, G, H, I, and J are not.  Because of that things won’t look good for firms F-J.  Maybe it’ll be so bad that they’ll go bankrupt or maybe they’ll lay off people or put a hiring freeze on.

At 6% interest, you have five firms that are doing well (A-E)—growing, hiring more people, expanding, etc.—and five that aren’t (F-J).  And at 6% the economy is performing at a certain level.  But what would happen if the Fed lowered the interest rate from 6% down to 5%?  One more firm (F) would be profitable, and in general it would benefit all the firms.  The profitable ones would be doing even better, and the unprofitable ones wouldn’t be quite so bad off.  And that would lead to a strong economy: more “stuff” would be produced and more people would be employed.

So there is very clear relationship that lower interest rates led to a stronger economy.  Having a strong economy is one of the Fed’s goals, so that begs the question, “Why doesn’t the Fed push rates all the way down to 0%?”

This is where it starts to get interesting.  It’s my favorite topic: Inflation.  Remember that the Fed’s first job is to control inflation.  Let’s look at the Fed’s decision to move interest rates from 6% to 5%, but now look at it with an eye towards inflation.

In our pretend world, let’s assume at 6% interest rates the economy is doing well.  Things are growing and unemployment is fairly low.  When interest rates go to 5%, firm F will become profitable so they’ll want to hire some people—makes sense.  But remember that unemployment is low, so F is going to need to tempt people who are already working for A or B or C or who ever to come work at F.  How does F do that?  They pay them more.

F starts to pay people more, but A doesn’t take this lying down, so A starts paying more.  This wage increase trickles through the economy.  But A and B and even F need to make money, so the increase in compensation they’re paying to their employees gets passed along to consumers in the form of higher prices.  When prices start rising, that’s INFLATION.  And controlling inflation is the Fed’s #1 goal.  So that creates the difficult balance for the Fed—they want the economy to do well but not so well that it triggers inflation.

So there you go.  You just completed a course in “Introductory Macroeconomics”.


What’s going on today?

Now that you have that little lesson under your belt, how does that relate to what’s going on with the Fed right now?  For the past couple years, the Fed has interest rates at historic lows, at about 0%.  Then about two years ago they started slowly raising interest rates to more normal levels, although even now the interest rates are still low by historical standards.  Obviously that’s super low, so shouldn’t the Fed be worried about inflation?

Remember the circumstances of how interest rates got that low.  At the beginning of 2008 the economy was going strong and the Fed interest rate was at over 5%.  But then the financial crisis hit, blowing up the banking industry, and sending the world economy into a very sharp recession.  A ton of people lost their jobs (unemployment went up) so prices stayed flat or even started to fall a little bit.

With all this going on, the Fed threw a life raft to the economy in the form of near 0% interest rates.  In the intervening years, the economy has rebounded and unemployment has fallen, but inflation has remained pleasantly low.  This is kind of the best of both worlds for the Fed—the economy is strong and there’s no inflation.  The two things they have to balance are both in happyland, so they have kept interest rates low.


What does it really mean when the Fed changes interest rates?

With all of this, are we just a bunch of idiots?  Should we really be so happy if the Fed is keeping rates low, and should we be so bummed if the Fed raises rates?

As the parent of two boys who one day may start sponging off Foxy Lady and me, I think the parent-child relationship is a good analogy.

Imagine you have parents (the Fed) who have a grown child (the US economy).  Times are tough for the child (the economy is doing poorly) so the parents help out (the Fed lowers interest rates).  The good scenario is that the child starts doing better to the point where he doesn’t need his parents’ help (the economy strengthens so it can withstand higher interest rates).  The bad scenario is the child becomes dependent on his parents’ help and is never able to make it on his own.

In this analogy the parents reducing the amount of help they give (the Fed raising rates) is a good thing, isn’t it?  It means that the kid is getting things on track and is standing on his two feet.  For this reason, I actually think it’s a good thing if the Fed raises interest rates because it means that the economy is strong enough that it doesn’t need insanely low interest rates any more.  Yet the markets react in the exact opposite direction.

I get it.  Just as the kid would be bummed if the parents said, “hey pal, since you’re starting to make some money now, we won’t be sending those monthly checks”, the companies are bummed that they can’t borrow money so cheaply.  But that isn’t sustainable.

I chalk this up to yet another of a million examples of how the stock market acts in a goofy manner in the short term.  And another reason why I NEVER try to time the market.  I just keep my head down and invest for the long term, regardless of what is going on with interest rates.  But watching everyone hang on Janet Yellen’s every last word does make for perverse entertainment.


As the current debate unfolds, what do you think?  Is the economy strong enough for the Fed to continue to take away the credit card?

Thinking about your home equity in retirement

Sometimes my logic just doesn’t add up.  When ever I think about the Fox family’s retirement, or when ever I work with clients and discuss their retirement, I never consider the value of our/their home.  That seems crazy, especially when you look at national statistics.  The average American has a net worth of $80k, of which about $55k is their home equity!!!  That means that for the average American 70% of their net worth is in their home, yet that’s something I don’t incorporate when I think about retirement.  What gives?


Your home as an investment

To start, it’s worth thinking about your house as an investment.  As investments go, especially over the long-term, houses don’t perform nearly as well as other types of investments like stocks (I did a whole blog on this point).

You’re always going to hear stories about people who made a killing when they sold their house.  Like fish stories, you only hear about the “wins” and not from the people who didn’t do that well.  Also, a lot of people think about the “gain” of the sale, comparing what they originally bought the house for and what they sold it for, yet they don’t factor in all the maintenance and home improvements they put in.

The point is that I think most people and certainly the mass media tend to romanticize the idea of houses as an investment.  I think the performance is much more modest.


Your home as a shelter

Obviously, your home serves a very practical purpose as a shelter.  It keeps the rain off your head, protects you from the bad guys (as Mini Fox would say), provides storage for your crap, etc.  That’s the rub, and makes your home fundamentally different from other, more traditional investments like mutual funds or other securities.

Even in retirement you need that shelter, so it’s not like you can sell your home and use the proceeds to fund your lifestyle (actually, maybe you can, but there’s some deep water there that we’ll talk about in a few minutes).  So you’re stuck in the middle—you need the shelter your home provides, but your home represents a large portion of your savings nest egg.  What to do?


Options (and why they are problematic)

As we’ve discussed, you’ll probably need about $5000 to $10k per month in retirement to support a moderate, middle-class lifestyle.  That will go to food, vacations, healthcare, and all the other stuff you’ll need.  Oh, by the way, you’ll also need shelter—a roof over your head—so let’s think about how that would go.

Option 1—At some point, maybe when the kids leave the house, you can sell the home you own, take all the equity and put that into your investments, and rent for the rest of your life.  This isn’t a very popular option, yet I think it has a lot of really positive features (see my comparison of renting versus buying).   The proof of the pudding is in the eating, and very, very few retirees with at least a moderate investment portfolio do this.

Option 2—When the kids leave you can downsize, selling your larger family home for a smaller one that accommodates two older people rather than a nuclear family.  This allows you to get a less-expensive home, pocket the equity and put that money in your investment portfolio, and go forward.  This allows people to use that home equity to support their retirement, but the problem is still there, albeit smaller.  You still will own a home that ties up a bunch of your net worth.

Option 3—Do a reverse mortgage.  This is a bit of an obscure strategy with a number of complexities that probably deserves its own post.  Basically, you take your home equity and borrow against it—let’s say taking out $3000 per month to fund your lifestyle.  There are a lot of details here with a lot of fees (that make it less attractive), plus it “forces” you to stay in your home which may be a good thing or a bad thing.  That said, this solves a lot of the problems we discussed.


What does it all mean?

It’s clear there are some complexities with this, and I don’t think there’s a clear approach that you should take.  Counting your home equity in your net worth can definitely expose you to not having enough liquid funds to pay for things like food, healthcare, etc.

On the other hand, not counting that money at all seems to be really, really conservative.  After 30 years, our mortgages will be paid off and we’ll have an asset that is potentially worth hundreds of thousands of dollars.  That needs to be incorporated somehow, right?

Basically, I calculate everything as though there is no home equity.  When I look at the Fox family’s financials or those of the clients I help, I know that what ever those numbers (just the investments) say, there’s some upside.  It’s a stupid game we play with ourselves, but that’s how I do it.  If our finances were so close (what I had was right at what I needed), I would definitely start dissecting the home equity value more.

Usually, though, I set the goal for myself and my clients that their investment accounts (brokerage, IRA, 401k, etc) should be enough to fund their retirement.  Then their house can be upside which gives a bit of a cushion for posher retirement or for unexpected expenses which may arise.

Sweet—a really important item in personal finance that defies an easy answer.  That’s how I do it.  How do you think about your home equity?

Problem solved: Race Relations

We are living in a country where race relations are at a multi-generational low.  Despite decades of approaches and policies meant to improve things, up to this point it doesn’t seem to have gotten better (it actually seems to have gotten worse).  Maybe personal finance can move the needle?  Admittedly, personal finance isn’t going to solve every issue, but I think it is uniquely positioned to make a major impact, all the while without redistributing wealth in a way that makes it a dead-on-arrival policy.  Let’s dig in:


Income (and net worth) inequality

Data show that there is a huge difference between the haves (whites, Asians) and the have-nots (hispanics, native Americans, and blacks).  Just for simplicity, for the rest of this post we’ll contrast the black/white differences, although this entire post could easily be about black/Asian or hispanic/white or hispanic/Asian and the concepts would be nearly identical.

Race Income (2015) Net worth (2013)
Asian $80,720 $112,250
White $61,349 $132,483
Hispanic $46,882 $12,458
Native American $39,719 N/A
Black $38,555 $9,211
TOTAL $57,617 $80,039


The median income for whites is $61k and the median income for blacks is $39k.  That’s a big difference, but the difference becomes even more pronounced when you look at net worth–$130k for whites and $9k for blacks.

The income disparity gets A TON more press than the net worth disparity, and that’s a big miss.  You don’t eat income or use income to buy a house or pay for college: you use net worth for that.  Obviously they are closely related, yet they are different, and the data shows just how uncorrelated they are.

Racial challenges are multi-dimensional, very complex, and nuanced.  There’s no single path to address all of them, but I think you get the biggest bang for your buck by closing the income/net worth gap.  Obviously, by definition, closing the income gap addresses the income gap (incredible insight there, Stocky) and also goes a long way in addressing the net worth gap.

It also addresses a lot of other racial issues: interactions with law enforcement—police have infinitely fewer negative interactions with rich people than poor people. Education—rich people have much better access to high-quality education at every level than poor people.  Healthcare—exact same statement as education.  Political voice—exact same statement as education.  And on and on.

So the challenge is how to increase the income, and more importantly the net worth, of blacks to get it closer to the levels of whites?


Net positive, not sum-zero

This becomes a delicate subject.  An obvious solution is wealth distribution based on race.  To address the net worth issues, we as a society could tax white people and give those proceeds to black people.  This actually has a name: Reparations.

Michigan congressman John Conyers had introduced a reparations bill in every Congress since 1989.  Every single time, the bill never came to a vote and “Died in a previous Congress”.  Given it didn’t even have the support to come to a vote it’s hard to imagine having the support to pass both houses of Congress and get the President’s signature, plus withstand the legal challenges.   I would certainly be opposed to such legislation.

While people can have a lively debate about reparations in particular, they are extremely unlikely.  Broadening that out a bit, I think the idea of punishing/taxing/taking away from one race of people to give to another just isn’t realistic or moral.

That speaks to net worth disparity (give net worth from one race to another), but there is a similar train of thought on income disparity.  We could take certain high paying jobs and force companies to employ blacks but not whites.  This again causes similar challenges.

Actually, this played out in real life recently at Youtube.  Allegedly, they excluded white and Asian men from consideration for some roles.  I’m not certain to the legality or illegality of this, but from a PR perspective this is a practice that Youtube (they are owned by Google) vigorously denied.  They said they hire “candidates based on their merit, not their identity.”  If a private-sector company in an at-will state won’t publicly say they do this, there’s zero chance such a practice would be codified with legislation.

Getting back to the task at hand, that means we can’t address the income and net worth gap by taking from whites and giving to blacks.  We have to find a way to increase the income and net worth of blacks that has no impact (or dare I say a positive impact) on whites.


It’s what you do

If you read this blog, you know I am an enormous advocate of personal finance, and “doing the right thing” with your money, whatever that means.  We live in a country with very low financial literacy, which means that people don’t really understand concepts of compound interest, appropriate asset allocation, tax avoidance strategies, and much more.  That applies to all races.

That ignorance comes at a huge cost.  Take two twins, Bill and Jill.  Bill represents your average American who isn’t too financially savvy, while Jill knows the best ways to invest her money.  If they are identical in every way—same job, same salary, same income growth, etc.—Jill will end the game much, much wealthier than Bill.

Just to put numbers to it, let’s assume they each start at 22 with a $50,000 job that grows to $150,000 over time, and they save 10% of their income.  At age 60 Bill would have $630,000 and Jill would have $2,640,000.  Read that again!!!  Jill ends up with a full $2 million more than her twin.

How does such a thing happen?  They both made the same incomes, and they both saved the same amount.  The short answer is Bill wasn’t smart and Jill was.  Bill saved all his money in a brokerage account with a mix of stocks and bonds.  Jill saved her money in a 401k (tax avoidance), got the match (free money), and invested in all stocks (asset allocation).

Those are all fairly simple strategies for personal finance, certainly they are ones we have talked about on this blog quite a bit.  Those couple gems translate to millions of dollars, literally.

But what does this have to do with race?  Unfortunately in our country, personal finance participation is much lower among blacks than whites.  That’s short hand for: blacks tend to act more like Bill than Jill.  “Personal finance participation” is a tricky term that loosely means having investment accounts, having retirement accounts, investing in stocks, and generally doing what personal finance theory says you should.  Make no mistake, it’s an impossible term to define and calculate (which is probably why it’s such a hard problem to tackle).

Certainly you can look at the difference in “personal finance participation” as a function of wealth.  Whites are richer than blacks so of course they are going to have more brokerage accounts and 401k’s and all that other stuff.  That’s true, but even when you control for jobs and income and the other factors like that, black “personal finance participation” is significantly lower, 35% lower by some estimates.

That impact is ENORMOUS and devastating if your broad societal goal is reducing net worth disparity.  If you believe the studies, and use our example of Bill and Jill, the average black person is getting 35% less of the investment gains that Jill got.  That’s could easily be a difference of $600k (in reality is probably even more) and that’s HUGE.

GOAL 1—Increase black “personal finance participation”


It’s what you know

Education is a pretty powerful tool, and one that certainly plays a role in the black “personal finance participation” issue as well as the broader income inequality issue.

In college there is a striking disparity between the majors that black students and white students pick.  Statistically, black students tend to pick majors which lead to much lower salaries than their white peers.  That alone can address the income gap in a major way.

However, we’re going to go deeper into the world of finance.  Finance is a pretty good college major, as majors go.  I proudly earned my bachelor’s degree in finance from Pitt.  The average salary for finance majors is $120k.  In a country where the average income for the whole population is $58k, being a finance major seems to be a pretty sweet deal.

Breaking down that by race tells a profound story.  About 14% of all college students are black, in line with the total population—that’s a good thing.  A similar 14% of all business majors are black—so far so good.  However, only 2% of finance majors are black—Houston, we have a problem.  Similar to the issue a couple paragraphs above, finance is a high-paying major and black students are picking it way too infrequently.

That leads to two major problems:  First, those classes for finance majors are a great way to learn the skills critical to “personal finance participation”.  Remember, that accounted to $2 million that Jill had which Bill missed out on.  If you take finance courses, you’re much more likely to be a Jill than a Bill.

Second, finance majors get high paying jobs—remember the average salary is about $120k.  More to the point of this post, finance majors can become investment advisors (much, much more on this in a second).  Data is hard on this, but most estimate that only about 1% of investment advisors are black.  As it is, the decisions black college students are making when choosing a major are cutting them off from all of this.

GOAL 2—Black college students major in finance


It’s who you know

Let’s start bringing all this together, shall we?

About 45% of blacks are in the middle class.  Add rich blacks to that as well and you’re talking at least 20 million people.  That’s a lot.

Based on the “personal finance participation” statistics we know a lot of those people aren’t investing the way they should, and they are missing out on a lot of money because of that.  This is true among all races.

I am a financial advisor (I passed my series 65), and my experience tells me that the vast majority of highly-successful professionals, independent of their race, aren’t doing near what they should be doing with their finances.  On a scale from 1 to 10, I see a lot of 3s and 4s among people who are incredibly smart and successful.

Fortunately, those people who would be a 3 or 4 on their own can hire someone, and for a small fee bring them up to a 9 or a 10.  Jill showed us that being a 9 or a 10 can be worth $2 million (and really it’s a much, much larger number), so if you aren’t there on your own hiring someone to help you seems like a good idea.

Understandably, if you hire a financial advisor, that needs to be an incredibly trusting relationship.  Personally, all my clients I knew for at least 5 years before I ever started advising them; also, they’re all white and my age, plus or minus a couple years, and live in my time zone.  Once you start working with a client it becomes a very intimate relationship.  You learn all sorts of super personal things about your clients—what they spend money on, what are their goals, what do they try to do but fail at, etc.  I think it’s even more intimate and personal and trusting than a doctor or a lawyer or a minister/rabbi.

The point of all this is: who are those rich and middle-class blacks going to go to for financial advice?  It’s reasonable, and not racist in any way whatsoever, that they would have a preference (possibly unconsciously) for a black financial advisor.  Not because of skin color per se, but because of shared experiences and understandings.  Someone who grew up how you did, had a similar family dynamic, have similar likes and tastes, prioritizes things in a similar way—those are all really good reasons to pick one advisor over another.  Those all correlate strongly with race.

A black person is probably going to have a lot more in common with a black financial advisor.  It’s not that you can’t pick someone from a different race for your financial advisor, but there’s an undeniable level of comfort for many.  Here’s the rub, at least based on my experience, if you don’t find a financial advisor you’re really comfortable with you don’t often pick the “next best thing,” but rather you don’t use anyone.  “Not picking anyone” tends to lead to “not doing anything” and you start to look much more like Bills than Jills.

Let’s be clear, a good financial advisor of any race can help a client of any race.  No question.  But we live in the real world, and here those personal relationship and trust dynamics are powerful.  This isn’t racism, it’s just being comfortable and having a trusting relationship with someone who is dealing with an incredibly personal part of your life.

Clearly the data show this is happening.  Blacks participate in personal finance at much lower rates—they’re closer to Bills.  And that costs them millions.

GOAL 3—Black financial advisors to work with black clients


Everyone wins, no one loses

Black college students become finance majors and then financial advisors.  Because they can relate to middle-class and wealthy blacks better, they get those clients and increase their wealth (becoming Jills instead of Bills).

We wanted to close the income gap.  We just found thousands of really high paying investment advisor jobs for blacks.

We wanted to close the net worth gap.  We just converted millions of black families from Bills to Jills by connecting them with highly skilled financial advisors.

Clearly, those are two winning cohorts, but there are no losers.  As blacks become better investors, that really doesn’t impact the investment returns of whites.  The stock market is more like a club with room for everyone, than it is like a high school basketball team where there are only so many spots and if you get a spot that means I don’t.  Also, those black financial advisors aren’t taking clients away from white financial advisors; those black clients weren’t using anyone before so it’s all upside.


My local plan

I’ve been trying this with very limited progress so far.  I haven’t gotten past step 1, but I’m not giving up.

  1. Find a couple black college seniors from UNC-Greensboro or North Carolina A&T who are finance majors. Unfortunately, as I mentioned, there aren’t a lot of these and I haven’t had luck so far. But I’m still trying.
  2. Teach the protégés the ins and outs of investing, not necessarily investment advising but just investing. Actually, it would really just be telling them “read all the posts I’ve done in my blog, understand the concepts inside and out, and then come to me with questions.” We’d work together and get them extremely financially literate.
  3. Go to a large gathering of rich and middle-class black people (a church, an NAACP meeting, fraternity alumni meeting, whatever) with my protégés . Tell the audience the story of Bill and Jill, and say I’m here to help.
  4. Work with a couple clients, taking my protégés to every meeting. Legally, the protégés wouldn’t be able to talk or do anything since they aren’t certified, but they could observe and build a non-investment advisor relationship with the client.
  5. Protégés would graduate, then pass their Series 65 or Series 7, and get a job with some investment company. Completely out of left field 😉, the clients I had been working with in the presence of the protégés would leave me for them.
  6. Protégés would take my clients to their new firms. Given most financial advising jobs are meat grinders where getting new clients is the toughest part, my protégés would have a HUGE head start. That would translate to a higher income, faster promotions, and altogether a better career.
  7. Rinse and repeat.

International perspectives–China

Kim Wang and Foxy Lady worked together at VF after he and his family moved to Greensboro from Shanghai.  He and his family are awesome.  They have a 6-year-old daughter (Lil’ Fox’s age) and a 3-year-old son (Mini Fox’s age), so our families really mesh well together.

Kim was nice enough to sit down with me to discuss how investing happens in China.  So without further ado, here is the International Perspectives—China edition:


Stocky Fox:  Kim, thank you so much for taking the time to tell us how investing works in China.

Kim Wang:  My pleasure.  I enjoy reading your blog, and it always makes me think about how similar some things are in China and how different other things are.  Bear in mind, as we chat, China has a lot of people with different perspectives.  My experience is probably fairly representative of a middle-class Chinese person from a large city like Shanghai, but there are always going to be differences.

SF:  Absolutely.  Good reminder.  Now, let’s get started.  I think a lot of Americans think of China as a communist country where private companies and stocks and investing don’t really happen.  How does it really work?

KW:  Today, investing for middle-class Chinese are very similar to what you describe in your blog.  However, that has been a huge change over the last 50 or so years.  China has had an amazing transformation from the image you described which was fairly accurate when my parents were young, but today, we look a lot like America.

SF:  How was it like for your parent’s generation?

KW:  When my parents first got married, they were each making about 65 yuan per month (about $10).

SF:  That seems really low.  How did they get by?

KW:  You’re right, that is very low.  But you have to remember that was when the entire economy was socialized and run by the government.  They worked in factories, but then their healthcare, pension, and everything else was all provided for the government, and the cost of food and house rental is low so they really didn’t have to buy a whole lot.  

SF:  So what did they do with that money?

KW:  They saved a lot of it.  Back then, the savings rate was really high, like 50%.

SF:  Wow, that really is high.  How did they invest it.

KW:  Back then they weren’t too sophisticated, so it was usually just buying CDs through the bank.  The other thing a lot of people did was buy gold bars or gold jewelry, and then they’d keep it in their house.

SF:  But then you said things have changed now?

KW:  Yes, by the time I was in college [about 15 years ago] the economy had liberalized a ton.  The government was providing less, but people were making more, so it started to look a lot more like the US.

SF:  What does investing look like in China now?  Let’s start by asking how people learn what they should do, what types of investments they should make.

KW:  Investing has actually become a bit of a cultural phenomenon which I think is a bit like in the US.  There are some books like Rich Dad, Poor Dad that were extremely popular.  That talks a lot about savings and how to invest, covering a lot of topics that you address in your column—how much to save, what types of mutual funds to buy, how to find the lowest fees, etc.

SF:  So walk me through how a middle-class Chinese person like you would invest?  Do you go online and open up an account at the Chinese version of Vanguard, or something like that?

KW:  Funny thing is that that first step is very different in China.  Culturally, our relationships with our parents are a bit different.  Most younger Chinese people give their savings to their parents, and then it’s up to the parents to do the investing for the kids.  So in that way the parents are making most of the investing decisions.

SF:  OK.  So how would mom and dad do it.

KW:  Like I said, they learn their basic investment philosophy from books, and also from talking to each other.  Moms talk to other moms and dads talk to other dads about the best investments to make.  Then most people do their investments at their local bank.  The commercial bank where you have your checking account also offers brokerage services where you can buy stocks and mutual funds.

SF:  So that’s a bit different in the US.  Here those tend to be separate.

KW:  Yeah, so you just go to your local bank.  However, because there tends to be a bit of a suspicion about these things, it’s very common for people to set up accounts at several banks just because people are afraid a bank might go under or rip you off.  So it’s common to invest in very similar mutual funds, let’s say the 500 largest Chinese companies, similar to your S&P 500, but have those similar mutual funds held by several different banks. 

SF:  I know in the 1930s there were a lot of problems in the US with bank runs and banks failing.  Is something like that what causes people in China to do that?

KW:  I can’t really point to anything specific like that, but in general the Chinese culture has a suspicious eye to things where “giving” your money to someone else is involved.

SF:  Got it.  So you’re parents do a lot of your investing.  Which funds to they pick?

KW:  Similar to the US, broad mutual funds of Chinese companies are popular.  However, there is a lot of marketing that goes on in China, more than in the US.  salesperson from the bank are constantly talking to you about their mutual funds.  Sometimes it seems a bit shady, like a lot of those American movies where people are trying to “unload” bad investments on people.  In reality I don’t think it’s that bad, but it doesn’t seem like the right way to do it.

SF:  Do stuff like that lead to a lot of fraud?

KW:  Not really.  There are scandals in China just like the US, but I think that happens everywhere.  But I think a major problem is that people like my parents’ generation, who probably aren’t the savviest investors, probably don’t always make the best investment decisions.  They are probably swayed more by these telemarketers than they should be.

SF:  That certainly happens a lot in the US, people falling prey to less-than-scrupulous investment sales people.  So it sounds like China has really come a long way in investing.

KW:  Definitely.  Actually, in some ways I think we’ve even passed the US.  Now it’s very common to have investing accounts set up on your phone via Alipay or Wechat Pay.  You can invest any time you want, and for as little as 1 yuan [about $0.15].  There’s some good things to that and maybe some not so good.  But it’s definitely advancing.

SF:  You said earlier that your parents’ generation was saving something like 50%.  That’s much, much higher than in the US.  Given that China’s economy has started to look at lot more the US, are people from your generation able to save that much?

KW:  No, not even close.  I think people from my generation save about 25% which is still fairly high, but then young people today in their 20s are probably saving 5% or so.

SF:  That’s a similar number to US people that age.  Given that Chinese people are making a lot more money what are they doing with it?

KW:  Real estate is rooted in Chinese culture and that makes it a big investment, especially in the bigger cities.  It’s common for three generations of a family to all pool their money and buy an apartment.  Actually, it’s a bit of a necessity, especially if the family had boys.

SF:  What do you mean?

KW:  Culturally, a man needs to own a house in order for a woman’s family to agree to them marrying.  So in that way, if a family wants to have their kids “grow up” they need to save a lot of their money to buy an apartment or house.

SF:  That doesn’t really seem like an investment as much as a purchase.

KW:  That’s true to some degree, but over the past 10 or so years, real estate prices have gone through the roof, especially in the top-tier cities like Beijing and Shanghai.  Prices in Shanghai have risen about 30% each year for the past 5 or so year.  So it definitely becomes an investment.

SF:  What are some other things the young people are doing with their money?

KW:  There’s a huge push in China among the younger people to self-improvement as an investment.  So people spend money at the gym and at night school and things like that.

SF:  Again, is that really an investment?

KW:  Definitely.  Take the gym for instance.  Jobs are so competitive in China right now and people have to work such long hours.  Many people look at the limited free time they have, and want to improve their health so they can continue to work at that pace.  They will spend money on trainers and things like that to make sure they are getting the maximum benefit of the limited time they have. 

SF:  OK, I can see where that makes sense.

KW:  Also, a lot of people take self-improvement courses.  It’s very common for someone who has finished college and got a degree to take classes at night to improve their English or to learn computer programming or something similar.  Those are very much investments in themselves, and I think people very much think of it that way.  I can invest so much money and it will have a return, or I can spend it to improve my skills and that will have a return.  Which one will benefit me more?

SF:  It really does sound like China is very similar to the US when it comes to investing and personal spending.  Certainly, it’s much closer than I would have ever thought.

KW:  Yeah, in the past 50 years I think we’ve closed the gap with the US in this regard.

SF:  I want to thank you so much for sharing this perspective with me and our readers.

BREXIT—when experts were idiots

On June 23, 2016, the UK voted to leave the EU—Brexit.  The outcome of the vote was unexpected and EVERYONE freaked out.

As it turns out, nearly all those dire predictions were totally overstated.  A more objective view shows that the UK and the broader world are doing JUST FINE, probably even better than fine.  This is a good lesson that just because experts say something, especially in this world of 24-hour news cycles where crazy proclamations get the headlines, doesn’t mean they’re going to happen.

Brexit is a really good example were most experts, at least the loudest experts, got it totally wrong.


Let’s everyone totally freak out

The general consensus among mainstream media was this was an unmitigated disaster.  The imagery of UK self-inflicting a fatal wound was pervasive.

CNN described the impending “Brexit hangover” as though the British were a bunch of youngsters who did something immature and thoughtless like vote to leave the EU (or go out on a drinking binge).  In the light of day they would realize their error and suffer economically for their folly (hangover).

CNN also had the headline “Brexit + Deep Uncertainty = Market Chaos”.  The first line claims, “One of the foundations of the political world was thrown in disarray.”  The world in disarray????  Maybe a bit melodramatic on that one.

Magazines and newspapers had provocative headlines and covers.  The Economist called the vote “tragic”; the New York Daily News called it “foolish”; the New Yorker equated it to a suicidal leap off a cliff.  Let’s be serious for a second.

Even President Obama lent his voice to the echo-chamber chorus, warning Britians before the vote that Brexit would put them at “the back of the queue” when doing trade deals.  Clearly this was meant to scare British as a threat to their economy and livelihoods.

Making it more local, my Facebook feed was filled to the brim with dire Brexit predictions.  Nearly all these posts are from graduates of the University of Chicago’s business school.  These are people who have studied economics MUCH MORE than your average Joe.  Look at some of those comments.  Equating Brexit to World War II???   Really???

The point is Brexit was fairly universally acknowledged as a total disaster in the making by the loudest (but not necessarily the smartest) voices.  It’s easy, just based on the volume and frequency, to imagine there was something to that.  It’s been almost two years, so let’s look at what has actually happened to the UK since its citizens voted for Brexit.


Just the facts

For all the talk that Brexit was going to tilt the ENTIRE WORLD into financial disaster, let’s be real.  First, the UK isn’t that important.  It’s 21st in terms of population (a country with 0.9% of the world’s population), and it’s 6th in terms of GDP (3.4% of world’s GDP).  Let’s not overestimate the impact, ambiguous at best, that such a political move might have on the world.

In case your curious, the world’s GDP grew about 2.5% last year.  Equity markets are up about 25-30% since the vote happened.  That seems pretty darn good to me.

Looking at the UK in particular, it seems like things are going okay too.  There’s no totally objective way to assess the “strength of an economy”, especially among people whose political views predispose them to think one way or another.  That said there are some widely accepted metrics to look at.


UNEMPLOYMENT—UK unemployment since the vote has fallen pretty much in lockstep with the rest of the EU.  In June 2016 it was at 4.9%, and now it’s at about 4.3%.  That’s very slightly above Germany (widely regarded as the strongest economy in the EU), and much lower than the other major EU countries who have embraced EU-ism: France (9.2%), Italy (10.8%), and Spain (16.4).  VERDICT: not total disaster.


GDP GROWTH—UK GDP growth has been at about 0.4% quarterly since the vote.  That’s fairly middle of the road.  As usual, Germany’s metric is a bit better (0.6% growth), while France’s and Italy’s are in line (0.4-0.5%), Spain’s is higher (0.7%).

GDP growth is a very fickle metric in that it looks at changes, not absolute values.  Were Spain’s higher numbers because it is doing well now or that it was doing so poorly a few years back, and today’s number just look favorable compared to crappy numbers.  You can see the challenge.  Either way, it’s pretty clear that the UK isn’t performing at substantially worse level than the other major EU players.  VERDICT: not total disaster.


STOCK MARKET—The UK stock index (FTSE) is up about 20% since the vote.  That’s a bit less than the US (33%) and Europe (26%).  Maybe that’s evidence that the stock market thinks the UK made a mistake.  First, being up 20% definitely defies the idea that the UK is a disaster.

Second, just like GDP growth, there are a lot of factors that make it a bit challenging on how exactly to interpret it.  Right after the vote, the UK’s stock market well outperformed the others, and then it decelerated.  I chalk it up to general market gyrations.  VERDICT: not total disaster.


EXCHANGE RATEAfter the Brexit vote, the exchange rate for the British Pound to the Euro fell from about 1.25 down to its current rate of 1.12.  Definitely you can see a clear move down.  Often times a depreciation in your exchange rate reflects negative circumstances for the country’s economy (see Venezuela).  Yet, that’s way too simplistic a view.  In the past year, the US dollar is down about 15% compared to the Euro, and I don’t think anyone seriously thinks the US economy is in a state of disaster compared to the European economy.

Also, if you look at the Pound/Euro exchange rate over a longer time period, the 1.15 range is actually where it has spent most of its time.  It was there in the early 2010s (when the UK was part of the EU), then it rose dramatically in 2015 when Greece’s drama unfolded as it nearly toppled the EU’s common currency (hmmmm . . . maybe that’s a reason why the British voted for Brexit).  Now it has fallen back to those previous levels.  VERDICT: not total disaster.


The point of all this is that it’s definitely not CLEAR that the UK’s Brexit vote was a total disaster.  Despite the incredibly smart people with a firm grasp of macroeconomics at CNN and the New Yorker among many, many others (I’m totally being sarcastic here—I think they’re idiots), just because they say something doesn’t mean it’s true.  They have the loudest voices in media today, but that doesn’t mean they have the smartest.  Remember, I am smarter than a Nobel Prize winner, and I do think Robert Schiller is really smart.

If you were Rip Van Winkle and slept through the last two years, and then upon waking were asked which Top 20 economy voted on an economic policy that was tantamount to “Tragically foolish suicide that pulled the world into chaos”, I’m not sure you’d zero in on the UK.  Actually, you’d think things look pretty good there, not nearly as horrible as that description would lead you to believe.

There’s a bit of a lesson here.  Keep this in mind when everyone in the media and on your Facebook feed starts talking about how obviously good or obviously bad something is.  Quick things that come to mind are: economic impact of Trump’s tariffs, inevitability of China overtaking the US in GDP, the impact/harm of the Trump tax cut.  These things are highly complex and very nuanced; rarely are they unambiguously good or bad in the manner that grabs headlines in our oversaturated media landscape today.  Don’t be a sucker.

Championship—Asset allocation v. Tax optimization

Basketball hoop

This is what we’ve all been waiting for.  After two weeks of amazing investing tournament challenge action (just indulge me, will you?), in this post we will crown the champion of investing strategies.  Here we have Asset allocation taking on Tax optimization.  In the Final Four, Asset allocation pounded Index mutual funds with higher returns early on and limiting risk as you approach retirement.  Tax optimization made it two thrillers in a row, beating Savings rate on the strength of major tax savings with a little bit of work and education, but not a lot of monetary sacrifice.  As always, see the disclaimer.

bracket-game 6

Obviously both these strategies have tremendous upside, otherwise they wouldn’t be here.  So how do you pick between them?  It’s no easy task, but for you, my loyal readers, I’m ready to take it on.  Let’s see who cuts down the nets.


Reasons for picking Asset allocation:

In some ways Asset allocation seems really easy, since all you’re doing is figuring out what percentage of your portfolio goes into stocks, bonds, and cash.  90% Stocks, 10% bonds, and 0% cash; there, I’m done.  That didn’t seem so hard.  Obviously it’s more complicated than that.  We already know that Asset allocation is critically important throughout your investing time horizon.  When you’re younger you probably want to be mostly in stocks (even now the Fox family is 99% in stocks).  As you approach and ultimately enter retirement you want to be more in bonds, but stocks still probably need to be a significant part of your portfolio.

About 10 or so years ago, the mutual fund companies came out with a really cool innovation called target-date funds.  The basic idea is that these handle your Asset allocation for you.  Imagine today you’re 35 and you want to retire when you’re 60, in 2040.  You could invest in a fund like Vanguard’s Target Retirement 2040, and it will automatically shift your Asset allocation from mostly stocks today (currently it’s about 90% stocks, 10% bonds) to gradually less stocks and more bonds as you get closer to retirement.  It’s been a wonderful innovation that has proven extremely popular among investors.

So there you go.  Problem solved, right?  Well, not so fast.  I actually don’t think these really solve the Asset allocation problem because they figure everyone retiring in 2040 is in the same situation, but that’s definitely not the case.  Let’s say you and your twin retire in 2040, but you will get $1000 from Social Security while she’ll get $3000.  What if she had her house paid off completely while you have always rented?  What if you worked for a company with a 401k and she worked for a company with a pension?

All those scenarios are very real for investors, and require more individualization than knowing you want to retire in 2040 can give.  For all those, conventional wisdom would say that your twin should take on more risk (French for “invest in more stocks”) than you because she has other “assets” that are generating more cash.  Reasonable people can debate that last point, but clearly the idea is that Asset allocation is much more complex than just picking a year and being done with it.

So where does that leave us?  I am a firm believer in investing DIY, and Asset allocation is no different.  But I think this is one of the areas where the degree of difficulty is much higher just because you’re balancing a couple opposing forces and there’s never a clearly “right answer”.  You want to be in stocks but not too much in stocks, and then that changes over time.  Oh yeah, and the stakes are super-high.  Getting it “right” whatever that means could give you an extra few percentage points in return and it could also save your nestegg from catastrophic failure if another 2008 rolls around.  When I work on the Fox’s nestegg, this is probably where I spend the most time.


Reasons for picking Tax optimization:

As we’ve said ad nauseam, Tax optimization is important and can lead to enormous savings.  What makes taxes so difficult is that the tax code is constantly changing and the stakes are super-duper high (the stakes for Asset allocation were only “super high”).

Every year there are hundreds of changes to the tax code which keeps accountants employed and programs like Turbo Tax (the Fox family uses Turbo Tax) flying off the shelves.  With the new tax reform bill that just passed, there were major changes to your taxes like the deductibility of mortgage interest and local taxes.  Those changes have massive implications on choices of where to live–both at the level of which state to live in but also whether to buy or rent.  These were huge and made the news.  What about the others that do hit the media’s radar and you never hear about?

There’s always talk about more changes, perhaps profound ones like a wealth tax.  You have to keep up.  Also, it can get really confusing.  I think I’m fairly knowledgeable on these matters but I am still befuddled by the Alternative Minimum Tax, and I know I screw up the foreign interest paid on my international mutual funds.  This stuff definitely isn’t easy.

Also, look at the stakes.  If you screw up on your taxes, theoretically you could go to prison.  If it’s an honest mistake I don’t think the Internal Revenue Service will push it that far, but horizontal stripes are definitely in play as Wesley Snipes can attest.  What is more likely is the IRS will hit you with a fine composed of a penalty plus interest.  Oh, by the way, that interest rate is about 6%; that’s not “Pay-day Loan” high, but it’s still pretty freaking high these days.  That certainly can make someone cautious about how far to push Tax optimization, even when they’re clearly in the right.

However, there is a silver lining.  If you want professional help, there are thousands of Certified Public Accountants who are there to help you out.  For under a few hundred dollars most people can probably have their taxes done by a CPA who can make sure that you stay on the IRS’s good side.  Unfortunately, when it comes to developing creative Tax optimization strategies, my experience says there’s a huge range in quality that you’ll get from CPAs.  Several years back I had a horrible experience with H&R Block and thought they were border-line incompetent.  No way would I trust them to advise me on the finer points of maximizing the tax advantages of investing.  But there are amazing CPAs out there right now (like David Silkman who did our small business’s taxes when we lived in California) who I do think can really help.  But this is a real caveat emptor situation.  Maybe Angie’s List might help.


Who wins it all?

It all comes down to this.  In the end, I have Asset allocation pulling it out 76-70.  Obviously both investing strategies are amazingly important and getting them right can have an exponential impact on your portfolio.  For me I gave the nod to Asset allocation over Tax optimization for a couple of reasons:

First, if I met a total train wreck of an investor (he was just stuffing cash in his mattress) and I could only give him one piece of advice, I think it would be to get that money invested in some combination of stocks and bonds.  Tax optimization strategies like an IRA or 401k are nice, but first things first.

Second, I think the big rocks for Tax optimization seem to me better understood and more accessible than for Asset allocation.  Most investors probably know that investing in your 401k or an IRA is a good idea, and probably most could tell you why (at least be able to say “it helps with taxes”).  I think that’s different for Asset allocation where you have a lot of investors who are totally off on what is probably appropriate for their situation (age, income, other assets, etc.).

Third, there’s no real “right” answer for Asset allocation.  I could have a lively debate with my dear friends/loyal readers who work in the financial industry like Jessamyn and Mike, where we argued whether the Fox family should be more in stocks or more in bonds.  But there’s no right answer (other than if stocks go up a year from now, then you know you should have been more in stocks).  It depends on so many variables as well as risk tolerance which are super-hard to quantify.  With Tax optimization you can get closer to a right answer—either the tax code allows you to do that or not.  Of course, you typically sacrifice ease of access to your money for tax benefits, so that does add a complication.

Finally, I think it’s easier and cheaper to get expert advice on Tax optimization.  As I mentioned, a good CPA can probably really help guide you on Tax optimization.  Sure, the quality of CPAs is pretty wide, but good ones are out there, and probably they’ll charge you something with in the three-digit range.  With Asset allocation if you want professional help you typically need a financial adviser.  Unfortunately, and this is just my opinion, it’s a little more Wild West for financial advisers than CPAs.  A really good financial adviser is probably worth her weight in gold (140 pound of gold is worth about $2.6 million, so maybe they aren’t worth quite that much), but the range of quality is staggering; there are some real shysters out there.  Also, they’ll probably charge you in the four- or five-digits range.

So there you go.  Put that all together and I think Asset allocation comes out on top 78-71, finishing the sentence, “if you only do one thing in investing make sure you get Asset allocation right.”



I hope you have enjoyed reading all these posts on investing as much as I have enjoyed writing them.  While Asset allocation “won” remember that all eight of these are important and should be definitely be considered as you think about bulking up your portfolio.

Final Four—Savings rate v. Tax optimization

Basketball hoop

Welcome to the second game of the Final Four of my investing strategies tournament.  Here we have Savings rate taking on Tax optimization.  In the first round, Savings rate beat Mortgage just on the sheer power that saving more money can have on the ultimate size of your nestegg.  Tax optimization squeaked by Starting early due to the enormous value created with minimal sacrifice by setting up the accounts to minimize your taxes.  As always, give the disclaimer a peek.  With that out of the way, let’s see who wins.

bracket-game 5


Reasons for picking Savings rate:

Savings rate is a simple but overwhelming force, maybe like Patrick Ewing when he dominated the Final Fours during his years at Georgetown (I don’t mean to call Ewing’s game simple, but you’ll see what I mean).  Ewing just owned the basket—any shot you put up he blocked, if you did get the shot up he got the rebound, when he got the ball you weren’t stopping him.  It all revolved around Ewing, and his dominance on the inside covered up for his shortcomings (outside shot, passing) as well as those of his teammates.


In the investing world, the sun really rises and sets with Savings rate.  Without any savings, you can’t invest so it really doesn’t matter what you do with things like Index mutual fundsAsset allocation, or Free money.

Also, unlike any other investing strategy, Savings rate can make up for any other mistakes you make along the way.  It’s a lot like Ewing protecting the rim on defense; if your guy beat you, you could be pretty confident that Ewing would bail you out by blocking his shot.  You could completely screw up Asset allocation and stuff all your money in a mattress—just crank up your Savings rateand there’s no problem.  Don’t participate in your 401k and walk away from the Free Money—save a little more and you’re okay.  You get my point.

Let’s use the same example of Mr Grizzly starting out at age 22, making $50,000 which will eventually rise to $100,000, and who wants to be a millionaire by the time he’s 60.  Let’s say he does everything right, plus he has a horseshoe growing out of his rear end, and over his investing career he averages a 10% return; he would only need to save about  3% of his income.  That’s probably a breeze.  Now, instead he has an average investing track record with returns of about 6%, he would need to save about 9% of his income.  So Savings rate was able to make up for his lack for tremendous luck.  Keep going down that path and let’s say he put all is portfolio in a local bank earning 1% interest, which I think we would all agree is a pretty terrible investing strategy, and he still becomes a millionaire so long as he saves about 24%.


Return Savings rate
10% 3%
6% 9%
2% 20%
1% 24%
0% 29%


So you can see that Savings rate can make up for all manner of investing sin.  Pretty much any other investing strategy has its limits to how far it can take you before you exhaust its benefits.  But of course there are no free lunches.  Increasing your Savings rate comes at a much higher cost than other investing strategies, namely all that money you’re saving means you can’t spend it on other things.  So when Mr Grizzly needs to crank up his Savings rate, that money has to come from somewhere—he passes up on that salmon fishing trip, or buying Mrs Grizzly some artisan honey from the farmer’s market, or getting some detangling shampoo for his coat.  We can debate whether those purchases are worth the money, but to Mr Grizzly they are (cut to Lady Fox nodding and pulling out a Pottery Barn catalog).  Sure, you can start by cutting away the layer of winter fat, but the higher you make your Savings rate the more you start cutting into muscle and eventually into bone.  That, my friends, is the rub with Savings rate.


Reasons for picking Tax optimization:

Taxes are to investing what water damage is to a house—unwelcome, can really ruin stuff if not attended to, and it gets into everything.  The tentacles of taxes traverse tremendous territory to touch your total transactions (I challenged myself to see how many “t-words” I could use in a sentence).  Seriously, taxes pretty much affect everything in investing.

There are the obvious big rocks, some of which we’ve already discussed, like a 401k and an IRA; using those accounts to defer taxes can save you hundreds of thousands of dollars.  Medium-sized rocks like 529s and tax-deductible interest on your mortgage can save you tens of thousands in taxes over a shorter time span.  Then there are tons of small rocks which can certainly add up—flex spending accounts and dependent care spending can save you thousands.  Add all that up and that’s a lot of clams (if you didn’t read yesterday’s post, I am trying to use as many slang phrases for money as I can).

And then you can get into the really obscure Tax optimization strategies.  “Loss harvesting” is when you sell investments at a loss so you don’t have to pay taxes on your winners.  “Dividend location” looks to put your high-dividend investments in tax deferred accounts like a 401k, so you don’t have to pay taxes on the dividends during your high-income/high-tax rate years.  There are millions of these little loopholes and strategies that allow you to pay less taxes.  A major part of the accounting industry is based on this fact.

Just to illustrate the point, I’ll share a story from Medtronic.  If you’re a high-compensation employee (I do not qualify, so I can’t take part in this) you can participate in the Capital Accumulation Program (CAP) which allows you to defer a portion or all of your bonus into a tax-advantaged account—think of it like an extra 401k without the match.  This is a veritable tax goldmine, and sadly very few of the people I talk to take advantage of this.  Let’s assume Mr Executive makes $300,000 per year, with $100,000 of that being his bonus; and assume that he’s working hard to build his nestegg, so after maxing out his 401k he saves $50,000 in his brokerage account.  That’s probably pretty close to the people I’m describing.

What Mr Executive could do but probably doesn’t is defer his entire bonus.  He’s already saving $50,000 per year and since he’s in a pretty high tax bracket, that’s probably pretty close to what his take-home would be on that $100,000 bonus.  However, by deferring his bonus he avoids paying the 40% on taxes now and only pays 5% in taxes when he pulls the money out in retirement.  If you do the math, that’s a potential savings of $35,000 ($100,000 x (40% – 5%)) on top of what he’s already saving.  When I ask executives why they don’t do CAP they tend to say they never thought of it or they didn’t understand it.  When I show them the math says they’re leaving at least $35,000 on the table, their eyes bug out and they need to sit down.

That’s just one example of the power of Tax optimization that is out there that goes largely unutilized, even by really successful people, even by those who have tax advisers helping them out.  And there are thousands of other examples like that out there.  That’s $35,000!!!  That’s a lot of money, even if you are pulling in $300k.

My point with this and the others is that in the US (and probably every other country) the tax code is super convoluted.  Add to that that when you’re making more and more money, you pay more and more in taxes, so the stakes start to get pretty high.  That’s a perfect recipe for hidden 1% coupons; some of them are easy to find, some a little hard, and some require serious digging—but they’re there.


Who goes on to the championship game?

Just like in the Elite Eight, I think Tax optimization pulls out a squeaker over Savings rate, 71-68.  While Saving rate has unlimited potential, it comes at a real cost of foregoing purchases today.  Tax optimization isn’t necessarily unlimited.  There are only so many wrinkles and loopholes you can take advantage of, but there are an awful lot of them and I bet you’d run out of time and energy before you’d run out of tax strategies.

bracket-game 6

But what tips the scale is that most of the Tax optimization gambits are free.   You’re already going to save for your retirement so why not do it with a 401k and not pay taxes on it right now?  You’re already going to save for your kids’ educations so why not use a 529 and not pay taxes on the appreciation?  You’re definitely going to need to pay for childcare so why not use a Flex spending account and do it tax free?  You and the family are going to get sick so why not use a Flex spending account for that, too?  None of those cost any more than you would have paid already, but you’re cutting Uncle Sam out of his 40% (legally, of course).

Thursday we will see who wins it all, Asset allocation or Tax optimization.

Final Four–Asset allocation v. Index mutual funds

Basketball hoop

Welcome to the first game of the Final Four of my investing strategies tournament.  Here we have Asset allocation taking on Index mutual funds.  In the first round, Asset allocation blew out Diversifying mostly due to the higher returns that younger investors can get by investing more in stocks early in their investing career.  Index mutual funds upset Free money on the strength of lower management fees that can apply throughout an investor’s career and across every account type.  As always, check out the disclaimer.  With that out of the way, let’s see who wins.

bracket-game 4

Reasons for picking Asset allocation:

Last round we saw how being too conservative with Asset allocation can really reduce the returns of younger investors who aren’t as heavily invested in stocks as they should be.  If you go to the other end of the investor’s time horizon, when he or she is older and nearing retirement, you can make equally harmful mistakes.

On one end of the spectrum older investors can become way too risky.  As the years tick by and people get closer to retirement, they begin to take stock (pun intended) of where they are probably a little more closely than they did in their 20s or 30s.  If they aren’t quite where they want to be, knowing that on average stocks have higher returns than bonds, one natural response is to allocate more of their nestegg to stocks to “catch up”.  According to generally accepted investing theory, this is the exact wrong thing to do—as we get closer to retirement you should be reducing your allocation of stocks to lower your risk, not increase it.  Here you’re stepping away from the world of investing and into the world of gambling.  Maybe you’ll get lucky and ride a bull market up to get your portfolio back to where you want it, but you’re definitely putting yourself at risk of hitting a market pothole and putting yourself further behind.

On the other end of the spectrum, they can become way too conservative.  Some people have the natural instinct to want to get completely off the investing train in retirement because they don’t want to have any risk, so they put all their money in bonds or cash.  This is understandable because they’re going to be depending on that nestegg, so it’s got to last.  But the problem is that even in retirement, many people still need the higher returns that stocks provide to balance out the relative safety of their bonds.  This is especially true in a world where people are living longer and it’s not unreasonable to expect retirement to last a few decades or longer.  And actually, that time element also makes the case for stocks being a significant part of your retirement portfolio—you have time to ride out the storms, just not as much time as you had before.

These are what make Asset allocation one of the harder investing strategies to get right, because it’s changing over time and there are shades of grey (at least 50 shades of grey).  Other strategies like Diversification and Free money are much simpler because your strategy is absolute.  Diversification—you should be diversified at all times.  Free money—you should get as much of it as you can at all times.  But with Asset allocation, the right thing to do gradually changes from being mostly in stocks during your early years, and then slowly switching to more bonds and cash as you start to near retirement, but never shifting completely to bonds.

There’s no strict rule on what your Asset allocation should be at different stages of life, but I always look at Vanguard target retirement funds as a bit of a guide (although I’ll write about some of my issues with these types funds in a future post).  With 40 years until retirement, right around when you’re first starting out, Vanguard suggests about 90% stocks and 10% in bonds.  Once you hit retirement Vanguard suggests 40% stocks and 60% bonds.  Notice that even in retirement a very significant portion is still in stocks.

Vanguard target date funds % in stocks % in bonds
2055 (40 years to go) 90% 10%
2035 (20 years to go) 85% 15%
2025 (10 years to go) 70% 30%
In retirement 40% 60%


So what does that all mean?  Well early on Asset allocation done properly can get you higher returns over the long run, historically about 3-4% higher than if you completely screwed it up.  Later on, it’s going to help protect you from any market crashes, market corrections, or general market zaniness that occurs.


Reasons for picking Index mutual funds:

We know from the Elite Eight round, that one of the major advantages of Index mutual funds is their lower management fees, which are on average about 1% less than actively managed mutual funds.  We also know from The power of a single percentage that saving 1% of your portfolio year after year can lead to some serious ducats (I’ve decided to use as many slang terms for money over the next few posts, so prepare yourself).  But we’re in the Final Four now so we need something more than that.

Not above a little chicanery, Index mutual funds is going to steal a page from Asset allocation’splaybook.  Often with actively managed funds, they keep a significant portion of the fund’s assets in cash so they can buy an investment when the opportunity presents itself.  Of course we know from above that holding cash over the long term leads to lower returns than holding stocks.  Index mutual funds are able to be almost 100% invested in stocks (or whatever asset class you want) because they aren’t picking investments so much as just following the index.  Just doing some simple math, if actively managed funds have 5% of their assets in cash, and over the long term stocks return 6% more than cash let’s say, that comes to a long term benefit of about 0.3% (5% x 6%).  That’s not going to change the world, but even those little bits compounded over decades can make a huge difference.

Index mutual funds is also copying Tax optimization.  When your mutual fund sells shares there are tax implications on that (death and taxes, baby).  That’s why you get that statement every year from your mutual fund telling you what you need to report to the IRS. The more frequently your mutual fund trades stocks, the more likely it is that you’ll have short term gains which are taxed at higher rates.  But with Index mutual funds, trading is minimized because the fund is only following an index like the S&P 500 which doesn’t change that often.  That leads to lower taxes which we know can add up to some serious cheddar (see, I did it again).

There are also people who argue that Index mutual funds do better than actively managed funds because they take the human element out of it.  This is pretty controversial, and if you believe in the theories from A Random Walk Down Wall Street, which I unabashedly do, then shouldn’t active managers do just as well as a passive index?  Hmmm, that sounds like fodder for another post.  People debate this all the time and I’m not convinced that this really drives the needle.

The final major benefit of Index mutual funds is that they’re super easy, especially compared to some of the more difficult investing strategies like Asset allocation.  You can go to a place like Vanguard (that’s where the Fox family’s money is) or Fidelity or a dozen other places and sign up for one of their index funds, then as Ron Popeil says, “you set it and forget it.”  That means you’re getting pretty incredible value for a relatively small amount of work.


Who goes on to the championship game?

Index mutual funds pulled out all the stops, but in the end Asset allocation was just too strong.  Index mutual funds will definitely help build your nestegg, probably juicing your returns 1% compared to actively managed funds and maybe even 1.5% if you’re feeling charitable.  That’s nothing to sneeze at, but we’re talking about punching your ticket to the Championship round here, people.

Let’s say you completely abandoned the idea of Index mutual funds and went totally with actively managed funds.  How bad would that be?  It wouldn’t be ideal (just my opinion and one not shared by my good friend Mike), but you’d be fine in the end.  Actually this is what millions of people do all the time and it tends to work out.

Compare that worst-case scenario to Asset allocation’s and you see why they won.  Screwing up early on and investing too much in bonds and cash instead of stocks can cost 3-4% on your returns.  That dwarfs what Index mutual funds bring to the table.  Screwing up closer to retirement can put your whole financial plan at risk.  Ask near-retirees who were to heavily invested in stocks before the 2001 or 2008 crashes what they think.  In the immortal words of Winston Zeddemore “I have seen s%$t that will turn you white.

bracket-game 5

With Asset allocation the stakes are just too high.  I have Asset allocation pulling away, 68-59.  Be sure to come back tomorrow to see who they take on in the final, either Savings rate or Tax optimization.