How much stock should you have in the company you work for?

Retirement-Planning2

A common question investors have is “How much of my investments should be in my company’s stock?”  Many of us work for publicly traded companies (Stocky worked for Medtronic and Foxy Lady used to work for VF).  Many of those companies include stock as a significant part of their employees’ compensation.  So what is an omnivore to do?  The short answer is: Don’t invest a lot in your employer.

It adds up

The general thinking among companies is that it’s good for their employees to own company stock.  It motivates them to work hard, so then the company does better, which then raises the stock, and that finally makes the employee richer.  See everyone wins.

My sense is that before 2000 compensation in the form of stock was much more prevalent.  I can speak to my experience at Medtronic:  The default for your 401k investments was Medtronic stock.  When they did the 401k match, the match was in Medtronic stock.  They also have a program where you can buy Medtronic stock at a 15% discount compared to the market price.  You had the option to take your bonus in cash or get a larger bonus in Medtronic stock options.  Long-term incentives are given in stock and options.  High performers can get awards of stock or options.

What difference can you really make?

The company wants you to do it because collectively if a lot of their employees own stock, they are probably motivated to do better.  But as an individual, what difference can you really make?  I know that sounds anathema, like when people say they don’t vote because one vote doesn’t make a difference (I do vote in every election, but the way).

Let’s think about that for a minute.  Stocky worked at Medtronic, a company which has about 50,000 employees and earns $20 billion each year.  Actually, I think I did really good work, and let’s imagine that because I worked my furry little tail off, I was able to develop programs that led to an extra $2 million in sales.  That’s a lot actually (I think I might have been underpaid), but compared to the bigger picture, that such a tiny drop in the bucket that it wouldn’t affect Medtronic stock in any possible way.

On the other hand, if I bust my tail and work hard, my bosses will see that and I’ll get a raise and a promotion.  That’s where the real upside for me is.  Not in the impact on the stock.  I’m sorry to say that, but it’s true.  The payoff in owning stock (compared to owning a diversified mutual fund) just isn’t there.  But the downside is very real if things don’t go well (more on this in a second).

Since Medtronic is a really huge company, maybe an individual can’t make much of a difference.  But wouldn’t an individual employee be able to have a bigger impact on the company’s stock if they were at a smaller company?  Maybe it makes sense for people in smaller companies to own more of their company stock for that reason.

The logic is sound—certainly if you work at a smaller company your individual contributions will have an outsized impact.  But the negative is that your risk goes up as well.  Larger companies tend to have greater margins for error when things go bad.  If you’re in a smaller company, the risk of bankruptcy or some other catastrophic event with the stock is so much higher.  And remember, as an investor you’re looking to lower risk not raise it.  So with all this I don’t the think argument for an individual to be a shareowner so they can drive the stock upwards holds a lot of weight, especially when you compare it to the downside.

What happened to loyalty?

If you own a lot of your employer’s stock, you’re violating the first rule of diversification.  The whole point of diversification is to make sure that one company or one sector or one “something” can’t hurt you too much if everything goes to hell.  Think about that with your own company.  The single most valuable “financial asset” you have is probably your career and the future earnings that go with that.

Now imagine that something goes terribly wrong with your company (a product recall, losing a lawsuit, missing the boat on a market trend, etc.).  If you’re an employee that sucks because you’ll probably get smaller bonuses and raises; at the extreme you might get let go.  If you’re a shareholder that sucks because the value of your stock will go down.  If you’re an employee and a stockholder you get the double whammy.  That is what diversification is trying to save you from.

But wait a minute.  I can hear some people say stuff about loyalty and having faith in your company and putting your money where your mouth is.  To that I say “hooey”.  If you’re working hard every day to help your company succeed, isn’t that loyalty and faith?

Remember that your portfolio is ultimately meant to support you in your life’s goals.  For most of us that probably means securing a comfortable retirement.

Just to put things in perspective, every year a few stocks that get removed from the S&P 500 because of “insufficient market capitalization”.  That is French for “the stock went down so much the company wasn’t considered S&P 500 material any more.”  7 stocks out of 500 doesn’t seem like a lot but that’s about 1.5% of the entire index.  And remember that the S&P 500 as a whole was up 29%!!!  That was an awesome year for the entire index, yet still 7 companies couldn’t make the cut.  Imagine what would happen in an average year or even a bad year.

Let’s think about the fate of the employees at those companies for a second.  Being kicked off the S&P 500 is a bit of a slap in the face so you know things at the company aren’t good.  There’s probably a lot of things happening like stores closing, people being laid off, salaries being frozen, moratoriums of new hiring so the existing employees have to work more.  Just a bunch of bad stuff, right?  So if you’re working there life probably isn’t awesome, and the idea of polishing up your resume is probably pretty top-of-mind.

Now imagine all that is happening while a big portion of your portfolio is taking a dive (remember, these companies got booted off the S&P 500 because their stocks went too low).  Ouch.  That is definitely rubbing salt in the wound.  In the investing world managing risk, and minimizing it where you can without impacting your return, is super-duper important.  When you own a lot of stock in your company, you’re just taking on unnecessary risk.

So there we are.  There’s definitely some romantic notion of owning stock in the company you work for.  It seems like the right thing to do.  But you’re just taking on risk needlessly.  My advice is that you should really keep that to the absolute minimum.  In the Fox household, we sell the Medtronic stock when we can.  It’s not that we don’t think it’s a great company (it is) or we don’t have faith in its future prospects (we do).  It’s just we don’t want to bear the risk that something really bad could go down, leading to me possibly losing my job just as your portfolio is doing a belly flop.

How much of your portfolio is of your company stock?

When does it go from gambling to investing?

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I’ve done a ton of posts on how over time stocks are a great investment, and I absolutely believe that.  However, like with all things, if you look at the extremes you start to see funny results.  Particularly, over the very short term, stocks aren’t really good investments at all.  In fact, if you “invest” in stocks and have a really short time horizon, you aren’t investing at all but rather you are gambling.  So investing or gambling, what’s the difference?  And when does stock ownership switch from gambling to investing?

As always, this is when I nerd out and get my handy dandy computer and free data from the internet and see what the numbers say.  Hopefully it’s not surprising that the longer you hold on to an investment, the lower the probability that you lose money.  But it is interesting how the numbers work out.

On any given day, there is a 46% chance that stocks will go down.  That’s not quite a flip of the coin (since stocks go up over the long run, you’d expect them to have more good days than bad), but that’s pretty darn close.  So let’s agree that if you’re investing for only a day, then you’re gambling.

Graph

Obviously, you can contrast that with the other end of the spectrum where historically there hasn’t been a 20 year period where you would have lost money.  0% chance of losing is not gambling, that’s clearly investing.

So where do you draw the line?  If you move from a day to a week, the chances of you losing money drop from 46% to 43%.  That’s a little better, but that still feels like a flip of the coin to me.  Go from a week to a month, and the chances of you losing money drop a little bit more, down to 40%.  It’s going in the direction that you would expect—probability of losing money drops the longer you hold on to the investment—but we’re still squarely in gambling territory.  If you do something and there’s a 40% chance of it coming out bad, I definitely don’t like those odds.

You can follow the table and see that at 5 years, the chances of you losing money on stocks is about 10% and at 10 years it’s at about 2%.  Clearly there is no right answer, and this is an opinion question so everyone is different, but I figure that somewhere between 5 and 10 years is when purchasing stocks ceases to be a gamble and starts being an investment.

Recreational investing

One of the things I try to do with this blog is help people better understand the stock market and how it behaves by looking at historic data.  I think this is a good example.

As I said at the start, the stock market is a great place to build wealth but you have to be smart about it and you have to have your eyes wide open.  If you’re investing just for a month or a week or a day, just understand that what you’re doing looks a lot less like investing and a lot more like gambling.  If that’s what you want to do that’s great.  Just be honest with yourself.

This brings me to an interesting topic which is “recreational investing”.  A lot of people come up to me and say they understand that slow and steady, and index mutual funds, and a long-term view are probably the best way to build wealth.  But it’s boring (a sentiment I totally agree with), and they want to keep a small portion of their money so they can “play,” investing in particular stocks they like, similar to the way someone would pick a horse at the track or play the table games in Vegas.  To this I say: “go for it”.

Life is too short, and that stuff can be really fun.  If it’s fun for you to “play the market” and gamble on some stocks, rock on.  Just know that you’re gambling and not investing.  But I’ll tell you, if you have a gambling bug, I’d much rather do it with stocks than blackjack or the ponies.  With stocks, as we saw above, even over a short time frame, you have the “house advantage”.  With other types of gambling, the house has the edge.  So I totally support recreational investing if that’s what you’re in to.

What do you think?  At what point does buying stocks change from gambling to investing?  I’d love to hear.

The sharing economy helps kill inflation

airbnb
uber

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“Share and share alike” from Robinson Crusoe

We all know that inflation is really important in planning for a comfortable retirement.  We also know that I personally think that inflation fears are really overblown.

In this post I showed that technology is an amazing deflationary force.  A few readers (like Andrew H) have noted that technology, and especially computers, are improving at such a rapid rate that it’s no wonder they are falling so much in price.  But what about things that aren’t technology related?  There are a lot of things we buy that aren’t computers or DVDs or internet browsers, probably spending a lot more on those than the technology-related products whose prices are going down so rapidly.

While I agree that a lot of non-technology products like food, clothing, and such do experience inflation, I think there are some surprising areas that are experiencing DEFLATION.  I just tried out these new-fangled services that seem to be popular with the 20-somethings: Uber and Airbnb.  What can I say?  I never claimed to be on the cutting edge of this stuff.

Uber

Uber has been in the news a lot because it just had its initial public offering (IPO). Basically Uber is a taxi service.  With a regular taxi you’re getting in a smelly yellow “police interceptor” with a driver whose accent is so think you can’t understand him and worry that he doesn’t know where he’s going (along with all the other negative stereotypes).  But with Uber you have regular people who use their own personal car as a taxi.

First, the cars seem to me to be nicer.  They’re newer model cars; I’ve done Uber now probably four times and haven’t been in a car that is noticeably old or worn or uncomfortable.  Plus they are meticulously clean.  It’s like riding in your friend’s car, if you’re friend is a clean freak.  Advantage: Uber.

Second, they use technology well.  You download the Uber app, and when you want to be picked up you click the button.  Then you see a real-time map with your car driving towards you.  If you live in a dense taxi city like New York or Chicago, this may not be a big deal where taxis are literally around every corner.  But for the rest of us, it can sometimes be nerve-wracking wondering when (if) you taxi will be there.  A few months back I literally missed a flight because my taxi never showed up.  I didn’t know there was a problem until it was 10 minutes after he should have been there, and at that point it was too late.  Advantage: Uber.

So there you have a couple nice advantages that Uber offers, but what about the big one: price?  I’m not an expert, but I would estimate that Uber is about 30% less than a traditional taxi, especially on longer trips.  I took an Uber to Charlotte airport (100 miles away) and it was about $150; Foxy Lady took one to Raleigh airport (60 miles away) and it was about $80.  I would guess with a traditional taxi those prices would have been much higher.  For more local trips it’s harder to say, but I figure Uber comes to about $1 per mile (and Uber-aficionados, I would welcome your enlightenment).  Obviously a big part of the savings is they aren’t paying taxes to cities (a taxi medallion in Chicago or New York costs over $1 million!?!?!?  Crazy).  Also, they are just regular people using their own cars to make some extra cash.  No matter how you slice it, it does end in significantly lower costs.

So here you have a better product than we ever got in the past for a fraction of what it used to cost us.  To me that sounds like deflation.

Airbnb

Airbnb is another sharing economy website where people can put up their homes or vacation rentals up for rent.  You go to their website and it’s like picking a hotel.  You pick where you want to go and the days you want to stay there.  There’s an option to pick “a bed”, “a room”, or “the whole place”.  As a 38-year-old, I’m at a stage of life where the only acceptable option there would be to get the whole place, but if you’re younger and strapped for cash or want to meet new and interesting people maybe that’s something you’d want to do.

Anyway, we had a recent trip to Hawaii where we used Airbnb.  We found a really nice condo right on the beach for about $900 for the week (about $140 per day).  There were a couple things that struck me about this.  First, the price seemed really good.  My experience tells me that $140 per night will get you a nice hotel room in a mediocre location or a mediocre hotel room in a nice location.  So we were probably paying what we’d pay for a nice place in a location like Des Moines, but we were in Hawaii, so that seemed like a nice win for Airbnb.

Second, our place was really nice.  It was someone’s actual house.  As it turns out, they travel a lot for some job in the entertainment industry, and they end up being at home about 30 weeks per year.  Those other 22 weeks their place sits empty; they choose to make a little money by using Airbnb on their place, so good for them.  Back to the point, it was a full-on place with a living room, kitchen, balcony, and bedroom.  So compared to a 250ish square foot hotel room, we had a bonafide 800ish square foot apartment.  Big advantage for Airbnb.

Third, you’re dealing directly with the owners.  Our experience, plus what I have heard from a lot of others, is that the people whose homes you rent are really nice and accommodating.  They are letting you have their place for a little bit and they genuinely want it to be a good experience for you.  From our host, we got some nice restaurant recommendations.  Not that people who work for hotels aren’t nice, but you just seem to have a deeper connection with someone when you are taking over their property.  You want to be a good guest and they want to be a good host.

Finally, the place was just more comfortable.  Partly because it was larger, but also because it was someone’s home and that made it easier to be our home.  We were able to have a couple nice dinners at home looking out on to the ocean.  I finished up the last Game of Thrones book sitting on the balcony, and I didn’t feel all crammed up in a hotel.  It was just really nice.

So again, just like with Uber, Airbnb offers what is definitely a much, much better product, and they are able to do it at probably what you’re paying to a medium-caliber hotel.  Put those two ingredients together and you get . . . DEFLATION.

The point of all this isn’t Uber or Airbnb, per se.  It isn’t even diving into the sharing economy.  Rather the bigger picture is looking at how inflation is supposed to be raising the price of everything, and if you look at things closely it kind of is.  Cab fares go up every couple years, and hotel rates are constantly increasing.

But we live in the most innovative and dynamic of times.  People are finding ways to bring us better products at lower prices.  If you broaden that view to “a place to stay while I’m in Hawaii” you don’t have to get that hotel whose prices go up about 5% per year.  If you broaden that view to “safe and clean transportation to Charlotte” you don’t have to go in a cab whose rates the states allow to increase every few years.

And remember that at the beginning of this blog we said that most people agree that technology areas are likely to have prices fall, but more traditional areas will still experience inflation.   That’s true to some degree, but aren’t hotels and taxi pretty opposite of high tech?  And we just showed that their prices are coming down.  This is just another corner of the economy that is giving you more for less—deflation.  Another reason why I think inflation concerns are way over inflated (ha, ha.  Did you see what I did right there?).

Top 5: Future innovations that will make a killing in the stock market

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Welcome back to my Top 10 list of industries that will create new trillion dollar companies.  On Monday we covered 10 to 6 with: marijuana, fake meat, virtual reality, curing diabetes, and sport gambling.  If you didn’t read it, you may want to check it out.

On to the show.

5. Video conferencing:  This is another one of those things we see in science fiction movies all the time, but what we have today still falls flat.  Today’s technology isn’t always reliable, the cameras aren’t that good, they don’t follow the subject (center it), you have challenges with people talking over each other, and even slight delays make it a farce.

That’s a pretty big list of complaints but the potential is there.  Even with today’s very flawed offerings, you can see the promise.  And there is no question of the need.

When I was a consultant we had meetings about once per month that had maybe 40 people come together.  Let’s say half of them had to fly in.  Flights, hotels, meals while traveling come to about $2000.  Plus you have all the lost time.  To get there and back on a plane takes two days lets say.  If each person in that room makes $150,000, those two days, less the time of the 4 hour meeting is about $1000 each.  All said, just to have that meeting with everyone there face to face costs $60,000 or more. 

Once the technology gets there, you can have those meetings at a fraction of the cost.  Plus, as it becomes more convenient, you’ll have a lot more “face-to-face” calls instead of phone calls or emails.  Obviously communication is much more effective if you can do that rather than just have audio or text.

There’s a ton of money to be made here, and I don’t think we’re really that far away.  It’s just making it as streamlined and simple as making a phone call is today.

4. Online shopping:  Many will say this is already there—Amazon, anyone?  In fact, e-commerce only represents about 10% of retail. 

The big rocks I see changing in the next couple years are groceries and prescription medicine.  I know right now they’re there, but it seems pretty limited.  The Fox household cannot get online grocery delivery from Amazon.  We can’t even get it where we order groceries online and them pick them up from the closest Walmart.  So there’s room for improvement there.

Beyond that, especially as you start leveraging other advances (drone technology maybe, and VR #8) you can imagine a lot of other markets opening up.  If I was smarter I could tell you exactly what it would be.  However, with only 10% penetration, e-commerce has already made Amazon a trillion-dollar company.  As penetration drives to 20%, 30%, and on, there’s no reason to think it won’t spawn more trillionaires.

3. 3D printing:  This is a bit of a backwards technology—the solution came before there was a problem to solve.  At Medtronic in 2014 we got a 3D printer and everyone thought it was super cool but it didn’t do anything.  It was huge (about the size of a phone booth, cost $300,000, could only “print” in one material, and only a few of the guys in the machine shop knew how to use it.  Honestly I think the most use it got was making trinkets for the local elementary school who came to our facility for a field trip.

 This year I went to a “STEM in schools” conference and there was one for $2000 that could print in up to 4 different materials (different colors but all the same material).  Clearly the technology is advances.  Now it just needs that “killer app”.

Again, predicting the future is a good way to look foolish.  Long-term you could imagine a 3D printer “printing” food and body organs, but that’s Jetson’s stuff still probably decades off.  In the more short-term I think it can revolutionize some medical device industries like orthopedics (about $50 billion in annual revenue) and dental crowns ($10 billion), just to name two off the top of my head.  You could also imagine more mundane things like plumbers and construction guys always having the perfectly sized piece. 

2. Solar panels:  Our appetite for energy will only continue to increase.  As political forces curb fossil fuels, renewables like solar become an obvious solution.  Over the past few years, solar has definitely gained traction and grown a lot, but it’s still only about a billion-dollar industry.

What makes me optimistic is that the economics work.  We installed panels on our roof about 3 years ago, and they have a long-term return of about 4%.  Since then panels have gotten better AND cheaper, so a similar system today would cost about 10% less than we paid and generate about 10% more.  That pushes that return up to about 6-8%.  For a risk-free rate, that’s amazing.  Everyone should be doing this.

Also, what makes me optimistic is that there’s a ton of room for growth.  It struck me when I flew in Los Angeles.  On the approach you pass over about 50 miles of urban sprawl.  There’s millions of roofs, and only a small, small fraction have solar panels.  And that’s in LA where the political climate is so pro-solar that they require new buildings have solar panels.  If there’s that much opportunity in a place like LA, imagine the rest of the country and the world.

1. Self-driving cars:  This is the biggie.  Just goofing around with Mike, a loyal reader who predicted this as the #1, I thought this could generate $5 trillion in value.  Now I wonder if I underestimated that figure.  Realizing the dream of a fully-automated car has the potential to be as big an innovation as the personal computer or the internet, and those created a few trillion-dollar industries.

Where to start?  First it will allow the current automotive industry (currently about $1 trillion in annual revenues) to offer a product SIGNIFICANTLY better than available now.  There’s a ton of money to be made there.  If you’re willing to pay $25,000 for an Accord today, how much if that same car drove itself?  $40,000 or $50,000?  More?

There’ll also be a real estate boom.  Real estate just in Manhattan is worth about $2 trillion.  Let’s say 5% is dedicated to parking facilities—that $100 billion just in Manhattan that can get redeployed.  Extend that to every city in the world and your talking trillions. 

Also, there’ll be a boom because real estate in outlying areas will increase.  Today, let’s say a person is willing to commute up to an hour.  So communities that are over an hour away from where jobs are lose a lot of value.  If cars drive themselves, people will gladly commute longer because they aren’t driving, they’re just browsing on the internet or watching movies.  Those communities will drastically increase in value due to higher demand.  Imagine that across suburbia and you’re similarly talking trillions.

Plus roads will last longer because computers don’t drive like idiots they way people do.  Tires and other auto parts will last longer for the same reasons.  The auto insurance industry just in the US has about $300 billion in revenue and that will be turned on it’s head.

Oh, and there’s that little thing call humanity.  The 35,000 annual fatalities and 3 million injuries will fall dramatically.  That’s probably worth a couple trillion right there.

I could go on and on for these, and I am sure there are others that are equally promising.  The pint is the future of investing is bright.  There are going to be amazing companies that are going to continue to create amazing value for those who are invested.

Top 10: Future innovations that will make a killing in the stock market

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All the stocks in the world add up to about $80 trillion.  I was surprised it was that low.  $80 trillion is definitely a lot of money, but for every publicly traded company in the world . . .

Interestingly, Microsoft, Google, Amazon, and Apple all have market caps of about $1 trillion.  That’s pretty astounding that a single company could be worth a trillion when all the companies combined are only worth $80 trillion.  It just shows you how big a really innovative company can get.

Second, look at that list—Microsoft, Google, Amazon, and Apple—either they didn’t exist not too long ago (Amazon, Google), or they did but what makes them valuable today are businesses that didn’t exist until relatively recently (Microsoft, Apple).

The point is that there are tremendous innovations that will come that will create tremendous value in the stock market.  As those four companies show, a single company with a powerful idea can really move the needle on the GLOBAL TOTAL.

Here is a list of 10 innovations that I think could easily create more trillion-dollar companies over the next few years.

10. Marijuana:  The past few years have seen a number of states legalize recreational marijuana.  I think it’s just a matter of time before it’s legalized nation-wide.

Right now the stocks of cigarette companies are worth about $700 billion.  The market capitalization for marijuana stocks is a tiny fraction of that.  Once the legal framework takes the brakes off marijuana companies, they are going to have a similar value.

In fact, it’s not unreasonable that marijuana stocks might be bigger than tobacco stocks.  Tobacco stocks are pariahs and they are constantly being harassed by different government agencies.  For what ever reasons, it seems the public is more accepting and embracing of marijuana compared to tobacco, so that removes a major headwind.

Second, there seem to be a lot more products that can be used with marijuana.  This is actually an area where Foxy Lady has been doing a lot of marketing consulting.  Obviously you can smoke it, but there’s also marijuana infused beverages, gummies, oils, and on and on.  It doesn’t seem like a stretch that marijuana could eclipse tobacco, and right now it is starting at pretty much $0.

9. Laboratory meat:  We just saw the IPO for a “fake meat” company.  The global meat market is a $1.5 trillion business annually. 

It’s also tremendously inefficient.  You have cows and chickens eating plants to “grow” the meat.  There’s a ton of pollution (cow farts, anyone?), slaughterhouses are disgusting, there’s the potential for nasty pathogens (hoof and mouth disease).  It’s just a messy, nasty, gross process.

If you can do that with grains and chemistry, you bypass all that.  Plus you use the land a lot more efficiently—you don’t need to grow plants to feed to cows which amass muscle; rather you just make the beef directly from the wheat and cut the cow out of the process.

Also, you can imagine that the process if you’re just dealing with tons of wheat and chemicals is much smoother than live animals and uniquely shaped carcasses.  This should certainly lead to lower prices per pound of meat while reducing tons of pollution.

8. Virtual reality:  VR has been the playground of science fiction nerds and more recently hard-core tech nerds, but it isn’t even close to the mainstream.  Today it mostly exists in the video game world, and even then it’s pretty marginalized.  VR games sell a tiny fraction of popular consul games, and even then the technology is still clunky.

Yet is there any question this will get better?  It seems a lot like cell phones from the 1980s.  Cool technology that just isn’t as good as the status quo, but it’s obvious to everyone that it will advance and once it does it will change the world.  That’s exactly what happened for cell phones, and I think that’s exactly what will happen with VR

Certainty the $160 billion video game industry will be transformed.  Movies and TV too.  But I think the real value will come from applications that people are just imagining right now.  Think of technical training—med school or pilots or the firefighters.  Think about the real estate industry and taking a tour of a home from your sofa.

The tech seems a few years away.  As that happens it will open up entire industries that we can’t even imagine today, just like cell phones did.

7.  Cure diabetes:  This one is near and dear to my heart (or rather my pancreas), after working for Medtronic Diabetes for so long.  Diabetes is a horrible disease.  Yet it’s very treatable and manageable.  Just monitor your blood sugar levels and treat accordingly (if your blood sugar is high, give yourself insulin).

Of course it’s never that easy.  Measuring isn’t always timely and precise.  Synthetic insulin doesn’t always work as well as your body’s own stuff.  And the biggest issue is diabetics aren’t always vigilant—it takes a tremendous amount of discipline to manage it properly and people sometimes let it slide.

Just in the US it costs about $250 billion annually to treat diabetes, and worldwide it’s probably about $750 billion.  Luckily, thanks to Medtronic and others, we are on the brink of curing this horrible disease.  Sensors are getting better, lasting longer and coming down in price.  Pumps are getting better and integrating better with the sensors so those together act more like a healthy person’s body.

As these treatments improve, you reduce the MAJOR costs of diabetes which usually results from not controlling it precisely enough.  You have ER visits, car accidents, blindness, amputations—Yikes.

6.  Sports gambling:  The Supreme Court opened the doors on this one two years ago, and now we’re all waiting to see how things unfold.  Revenue from US sports (college and pro) is probably about $100 billion.  Revenue from American casinos is about $50 billion.

With legal sports gambling, those two behemoths have the perfect baby.  Obviously right now there’s a huge black market that is coming into the legal fold.  Just being legal with expand the amount of sports betting by orders of magnitude.  As sports betting gets traction and becomes more accessible, with more locations or the holy grail—internet gambling—that will similarly increase the total betting total.

Add on to that the considerable synergies that sports betting brings to both sports revenue and casinos, this move seems like there’s easily a trillion dollars of incremental value compared to what exists today.

Here’s the first half of my Top 10 industries that will create trillion dollar companies that don’t exist today.  Again, remember that right now the value of all the world’s stocks is about $80 trillion.  So these 5 ideas could increase the pie almost 10% just on their own (and you haven’t seen the top 5 yet).

Come back Wednesday for the exciting conclusion to this list.

Why you should probably have more stocks and less bonds

buried-money

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When I wrote my three ingredients post, a few of you commented that I was crazy to have so much of our portfolio in stocks and so little in bonds (less than 1% in bonds).  Did I have a death wish or something?  What if I told you that I think a ton of people are leaving  gobs of money on the table because they are investing too conservatively?  Tell me more, you say.

We know that you need to balance risk and return in our investments.  This is most clearly done when we choose our mix of stocks (more risky, higher average returns) and bonds (less risky, lower average returns).  As an investor gets older they want to shift their asset allocation towards less risky investments because their time horizon is shortening.  We all agree with this.  So where is this hidden pot of gold I’m talking about?

Let’s look at the example of Mr and Mrs Grizzly.  They are both 65 years old and entering retirement.  They worked hard over the years and socked away $1 million that will see them through their golden years.  They do some internet research and learn that a sensible asset allocation in retirement is 40% stocks and 60% bonds, so they invest $400k in stocks and $600k in bonds.  Knowing the long term average returns are 8% for stocks and 4% for bonds, they expect their $1 million nest egg to generate about $56,000 per year ($400k * 8% + $600k *4%) , knowing that some years it will be more and some years it will be less.   So far so good, right?

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THEY ARE LEAVING MAYBE $20,000 PER YEAR ON THE TABLE.  That’s a ton of money.  How can this be?  They seem to be doing everything right.  The answer is they are being way too conservative with their asset allocation.  They shouldn’t be investing $600k in bonds and $400 in stocks; stocks should be a much higher percentage.

Waaaaiiiiiiiittttttttt!!!  But didn’t we agree that about 60% of their portfolio should be in less risky investments?  Yes, we did.  Are you confused yet?

Hidden cash

Here’s what I didn’t tell you.  Mr and Mrs Grizzly have other investments that act a lot like bonds that aren’t included in that $1 million.  Both Mr Grizzly and Mrs Grizzly are eligible for Social Security with their monthly payments being $2000 each.  If Mr Grizzly (age 65) went to a company like Fidelity and bought an annuity that paid him $2000 each month until he died (doesn’t that sound a lot like Social Security), that would cost about $450k.  So in a way, Mr Grizzly’s Social Security payments are acting like a $450k government bond (theoretically it would be more than $450k since the US government has a better credit rating than Fidelity).  And remember that Mrs Grizzly is getting similar payments, so as a couple they have about $900k worth of “bond-ish” investments.

Also, Mr and Mrs Grizzly own their home that they could probably sell for $300k.  They don’t plan on selling but if they ever needed to they could tap the equity in their home either by selling it or doing a reverse mortgage.  So in a way, their house is another savings account for $300k.

If you add that up, all the sudden the picture looks really different.  They have about $950k of Social Security benefits that have the safety of a government bond.  Plus they have that $300k equity in their house.  That’s $1.25 million right there.

Investing your portfolio

So now let’s bring this bad boy full circle.  Remember their $1 million nest egg they were looking to invest?  Look at that in the context of their Social Security and house.  Now their total “assets” are about $2.25 million.  If you believe that the Social Security and house kind of feel like a bond, just those by themselves account for 55% of their portfolio.  If on top of that if you invest 60% of their $1 million nest egg in bonds, they have over 80% of their money in bonds, and that seems way too high.

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On the other hand, let’s say they only put $100k of their nest egg into bonds and the rest into stocks, after you include their social security and home, they’d be at about 60% bonds and 40% stocks.  Isn’t that what they were aiming for the whole time?

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Wow.  It took a long time to get there, Stocky.  The punchline better be worth it.  Remember that with $600k in bonds and $400k in stocks, they had an expected return of about $56,000 per year.  However, if they have $100k in bonds and $900k in stocks, because stocks are more volatile but have a higher expected return, they can expect about $76,000 ($800k * 8% + $100k *4%).  THAT’S $20,000!!! 

But aren’t they taking on a lot more risk to get that extra $20k?  Remember, there’s no such thing as a free lunch.  For sure, but if you look at it in the context of their Social Security benefits and their home, they have a fair amount of cushion from “safe investments” to see them through any rough patches in the stock market.

I wrote this post to show that people really need to take account all the financial resources they have.  In the Grizzly’s case, it was their Social Security benefits and their home.  Others of you may be getting a pension (Medtronic is generous enough to offer the Fox family one) or a second home or a dozen other things like that.

When you take those cash flows into account, all the sudden it seems a lot more reasonable to invest the rest of your money a little more heavily in stocks which you know over the long haul will give you a better return.