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.

2 25 m a

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?

2 25 m b

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.

Top 5: Personal finance lessons from A Game of Thrones

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SPOILERS WARNING

Between the gore and the incest, there are some valuable personal finances lessons from A Game of Thrones.  This Top 5 list is dedicated to ­­­­­­­all those who fell fighting for the living against the Night King.

5. Debt creeps up on you:  King Robert’s reign was a largely peaceful and prosperous one.  Yet like so many people, Robert overspent and went into debt.  It wasn’t any one thing and at first he really didn’t seem to notice.  However, before too long Robert was hamstrung by his debt, and it force him to make bad choices—the terrible marriage to Cersei being forced upon him since the Lannisters held most of his debt. 

That marriage to Cersei: we all know how that turned out for Robert.  Oops.

4. Everyone likes to look richer than they are:  Rather ironic based on #5, but by season 4 the Lannisters are broke.  Their gold mines stopped producing and they are deeply indebted to the Iron Bank.

Sounds pretty dire, but you wouldn’t know it by looking at them.  They are still “rich as a Lannister” and give the outward appearance that they are rolling in the gold dragons.  In no way do they let that they aren’t rich as ever, and why would they?  Who would want to show their rear end to others?

For rival houses who are trying to “keep up with the Lannisters” it becomes an impossible task. 

3. “How would we know we can’t fly unless we leap from some tall tower”:  Euron Greyjoy is one of the creepiest dudes in the series, but I love this line. 

Life is about taking on risk, understanding it, and making decisions that give you the most upside for the risk you take.  This is especially true with investing.

So many people are way too conservative with investing.  They don’t jump from that tall tower, or invest in equities that could lose money but historically do really, REALLY well.  Those “mistakes” in asset allocation can cost tens or even hundreds of thousands of dollars.

The key is taking smart “leaps,” those where the rewards more than offset the risks.  Stocks definitely fall into that category.

2. “Power resides where people think it resides”:  Here Varys speaks one of the most important lines in the entire series. 

There’s probably no statement that describes our financial system better.  Banks work because people have think they work—you put your money in and you get it out.  Fiat currency is really just paper with colored ink, but they work because people think they can reliably use those pieces of paper to get other stuff.

The best, most recent example has been Bitcoin.  For a while people thought Bitcoin was really valuable so it went up to $19,000 (Dec 2017).  Then all the sudden people didn’t think it was valuable so it plunged down to $3200 (Dec 2018), and now it’s back up to $5300.  Nothing has really changed about its value or intrinsic net worth except what people think about its value.

1.   Being good at personal finance opens up A LOT of opportunities:  Littlefinger was my absolute favorite character, and he’s a great example of the power that comes with being really good with personal finances.

He started out as a nobody and rose to arguably the most important and richest person in the seven kingdoms.  How did he do it?  Investing well and being good with money.  He “had a gift for rubbing two golden dragons together and breeding a third.”

In our world financial literacy is abysmal.  Those who can master those skills can do quite well; the average salary for a financial planner is over $100,000.  Smart financial decisions can make a millionaire out of nearly anyone.  As Littlefinger shows, the sky’s the limit with this skillset.

Should you buy or rent your house?

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A few years back, I wrote a blog comparing the financials of renting versus buying your house. Back then renting came out ahead when you just looked at the dollars, which was a bit surprising. It seemed to buck conventional wisdom that buying is also the best option.

This seems especially important in light of some of the tax changes that impact your mortgage and property tax deductibility.

For this post, I want to look at the choice from a purely financial perspective.  And what better way to do that than break it down Dr Jack style?  Just to put a little meat on the analytical bone, let’s assume we have a home that we could buy for $400,000 or we could rent for $2000 (I did a quick search on Zillow in a few different markets and this seemed reasonable).

UP-FRONT COSTS:  When you rent, you have to give a deposit which is typically something like one month of rent, so that’s $2000.  Not a big deal in the grand scheme of things.  When you buy, your down payment is in the range of 20% (or maybe even higher since the 2008 financial crisis—the Fox family had to put 25% down on our house).  That would mean $80,000 if you’re buying.

At first glance that may not seem like a big deal because it’s still your money, it just happens to be “invested” (did you notice how I used quotes there?) in your home.  However, when your $80,000 is tied up in your house you can’t invest it (no quotes there) in the stock market.  Since the stock market historically returns about 6% that means you’re passing up $4800 per year on average.  Over an investing career that ends up being a TON of money.

Advantage: Bid advantage to RENTING

RISING INTEREST RATES: We’ve been living the last decade with historically low interest rates. A 30-year fixed loan was in the 3.5% range, and all was well. Since then interest rates have steadily crept up.

The math on interest rate increases is pretty powerful. A 1% increase would increase your monthly mortgage payment about $3200 per year or about $280 per month.

A couple months ago, interest rates rose to about 5%, but since then it has settled down to about 4%. Either way, interest rates are going up, and it seems that will probably be the long-term trend.

Advantage: RENTING

MONTHLY PAYMENT:  The most common knock I hear on renting is “every month you pay rent, you’re throwing that money away.”  I hate that comment, and part of this post is to show how little sense that makes.  Obviously when you are renting, your monthly payment is your rent, $2000 in this example.

When you buy, your monthly payment is your mortgage (here we aren’t going to include insurance and taxes, that will come later).  If you have a typical 30-year mortgage, let’s say at 4.5% interest, your payment is going to be about $1620 per month.  That’s quite a bit less than you’re paying in rent, so obviously that’s an advantage for buying, but then there’s another little bit of good news.  That $1620 you’re paying is mostly interest, but a small amount is going towards paying down your loan.  In a way that can be seen as you “saving” money.  In this example the amount going towards you’re loan would be about $200 per month.  So that’s pretty nice. Of course that “forced savings” has a low return compared to the stock market, so it’s not as good as it could be.

Of course, that means that about $1400 per month is going to interest.  So when people say that you’re throwing away your rent, can’t you say the same thing for the interest on your mortgage?  Either way, this is definitely an advantage to buying.

Advantage: BUYING

OTHER COSTS:  With renting, once you pay that rent check, you’re pretty much done.  With buying you have a lot of other expenses that nickel-and-dime you to death.  Property taxes have to be paid (let’s say 1% of the property value so that’s $333 per month).  If you live in a condo complex or an association you might have monthly dues that could range from pretty minor to a significant chunk of money (when the Foxes lived in a condo in downtown Chicago, our monthly association fees were $900 per month—ouch!!!).  Those can definitely add up, so that’s a nice advantage to renting.

Advantage: RENTING

TAX ADVANTAGES: This is where a huge change has happened recently. Before, all your mortgage interest and property taxes were tax deductible. Now there is a $10,000 limit on those deductions. In a lot of scenarios, your property taxes won’t be tax deductible. Because of the higher standard deduction, a lot of times it won’t make sense to deduct your mortgage interest either.

Before, the deduction for your mortgage interest and property taxes might be worth about $600 per month.  Now that is certainly less, maybe all the way down to nothing.

Advantage: WASH

INFLATION:  Once you buy your house your biggest cost, your mortgage, is going to stay put.  We’ve talked about inflation before, and the enormous impact that even a little inflation can have on expenses after many years, so this seems pretty awesome that you don’t need to worry about it for your biggest expense.

With rent “that’s where they get you”.  Rents almost always go up.  Often there are laws that put a cap on how much they can go up, 2% seems a number I’ve heard before, so that provides some relief, but even that 2% can be a big deal.  If today your rent is $2000, in 10 years it would be $2440, in 20 years it would be $2970, and in 50 years it would be $5390.  That sucks, especially when compared to buying where your mortgage payment will always stay the same.

Advantage: Big advantage to BUYING

SELF-DETERMINATION:  A neighbor was renting a few houses down from us.  The family loved the house, loved the neighborhood, loved the neighbors (of course they did).  But one day the landlord called her and said she wasn’t renewing the lease because she (the landlord) was moving into the house.  That family that was renting was FORCED to move even though they didn’t want to.  That sucks.

When you rent, you’re definitely at the whim of your landlord.  If you buy, you are in control of your own destiny, baby.  Get drunk off that power.

Advantage: BUYING

UPKEEP:  One of the super-nice things about renting is that you don’t need to worry about when things break down.  If there is a problem with the toilet, call the landlord.  Water damage from the really bad storm, call the landlord.  Fridge on the fritz, whatever—call the landlord.   In general this is an awesome advantage.  This is even better if you’re not a very handy person.

If you own a home, whenever anything goes wrong you need to fix it yourself (hence my “handy” comment) or worse you have to pay someone to fix it for you.  There’s no perfect estimate, but a generally accepted rule is you should plan on spending 1% of the home’s value on maintenance.  In our example that would be about $4000 per year.

Advantage:  RENTING

NICENESS:  As an owner, if you want to make your place nicer you absolutely can.  If you want a pool, build it; hardwood floors, install them; custom closets, wallpaper, nice landscaping, and on and on.  As a renter there’s a reluctance to do it because in some sense you’re paying to make someone else’s property nicer.  If you rent there for years and years, maybe that’s not a huge deal, but that “self-determination” issue rears its ugly head.

I don’t have statistics on this, but I bet that most renters would love to make their place nicer, but just don’t because there is some deep attitude that you don’t do that when you rent.  I totally get it and understand it, but it sucks that this keeps you from making your place as nice as it would otherwise be.

Advantage: BUYING

WORST-CASE SCENARIO:  I’m not talking about your hot-water heater going bad or having to replace the roof (those we captured in “Upkeep”).  Here I’m talking about real worst case scenarios like a natural disaster (in California earthquakes aren’t covered by most homeowners insurance policies; you can get earthquake insurance which is really expensive, so most don’t get it), or the neighborhood really turns bad, or termites or black mold infestations happen inside the walls.  Let your imagination run with this for a second and you can really think of some nasty stuff.

As a renter, you can pick up and leave the nightmare behind.  Just go somewhere else and start paying someone else rent, and problem solved.  Not so if you own the home.  Your single largest investment is at risk.  Sucks to be you.

By its nature, the worst-case scenario isn’t very likely, but still it could happen.  This is one of the things that keeps me up at night as a homeowner.

Advantage: RENTING

ASSET ALLOCATION:  A mortgage is a “forced savings” program in a way.  Every month you’re making a mortgage payment and part of that goes towards your equity that you can use as you get older (reverse mortgages, cash-out refinances) or pass on to your heirs.  After 30 years your house will probably be paid off and you’ll have a tidy little sum of cash to supplement your portfolio.  Also, because home values tend to be much steadier than stocks, in a way this investment might seem like a bond.

We saw how crazy important asset allocation is, so if you have a lot of home equity, that might make you feel more comfortable to put a bigger portion of your portfolio into stocks which historically have a higher return.  This is a bit of a tricky one, but there’s definitely some level of advantage there.

Advantage: WASH

REALTOR COSTS:  There will come a time when you are ready to leave your current home and move somewhere else.  If you’re renting this is easy (but not super-easy).  Usually, you’ll wait for your lease to expire and then head on down the road.  If you need to move right away and your lease isn’t up for a while, that can create a bit of a challenge of breaking you’re lease.  That could be as easy as paying a penalty of a month’s rent, or your landlord could play hardball and hold you to your lease until the end.  So this can be a pain, but more in the “moderate” zone.

When you own a home and have to sell it, that is a monumental undertaking.  Getting a home ready for sale, listing it, showing it, and ultimately closing the sale can take months from beginning to end.  Also, it’s not cheap.  While realtor fees vary, they average about 6% of the home’s value.  In our little example that would be $24,000.  That is a lot of money.  If you’ve been in the house for 30 years, that will amortize to less than $1000 per year, but if you’ve only been living there a few years that could be thousands of dollars per year that you need to tack on the to “Buy” expense column.

Advantage: Big advantage to RENTING

PRICE APPRECIATION:  We saved the best for last, kind of.  When you own your home, you get to take advantage of any price increases that your home experiences.  Of course, if your home goes down in value, you suffer those loses too.  However, like stocks, homes have historically increased in value over time, with notable exceptions like when home values crashed in 2008.

That’s great news, right?  No question.  However, it’s not as good as most people think.  You hear all sorts of crazy stories about people making a killing off their house, but those tend to be anecdotes rather than the rule.  The numbers are hard to come by but I think the most definitive and well-respected data, the Case-Shiller index (developed by my BFF Robert Schiller) shows that prices for existing homes have only increased 0.5% over the past 40 years after you account for inflation.

THAT’S CRAZY.  That goes against everything we hear.  How can that be?  Well his index controls for things like home sizes getting bigger, houses getting nicer features, etc.  So it really tries to do an apple-to-apples comparison of what you can expect will happen to your home.  So home prices do tend upward, but just not at anywhere near the pace that we’ve come to believe.

Advantage: BUYING

Buy Rent
Investment return on down payment $400
Interest/rent $1,333 $2,000
Property taxes $333
Tax advantage $0
Maintenance $333
Realtor fees (5 years) $400
TOTAL $2,800 $2,000

If you put it all together Buying “loses” with a score of 5-6-2.  Furthermore the math shows that Renting comes out ahead on a monthly expense basis, and it has become an even bigger advantage with the new tax laws.  Yet, Buying wins on a lot of those intangibles. Ahhhh, this is why the decision is so complex.  Hopefully you saw my point that buying isn’t the unambiguously better option.

If you look at the numbers, it really breaks down to two major factors—realtor costs and price appreciation.  The longer you’re in your home, the more years you can spread that 6% realty fee over.  So if you’re planning on moving after a few years, that becomes a major disadvantage to buying.  Your home appreciating in the icing on the cake that can really make the whole difference.  However, the Case-Schiller index showed that prices don’t rise nearly as fast as everyone seems to think (hence, I didn’t even include it in the expense comparison).

It’s a tough call, but the dollars are real. Renting costs about $800 less than Buying in our example; that 40%!!!

The Fox family owns our home, and it has turned out to be the best investment we’ve ever made.  We bought in 2010 when the housing market in Southern California had been thoroughly thrashed by the 2008 crisis.  In the past 5 years our home has rebounded, more than doubling in value.  We would have missed all that had we rented, but if I’m honest with myself, it was just really lucky timing.  Sometimes it’s better to be lucky that good.

Do you rent or do you own?  What do you think?

Should you invest in gold?

Long before there were ever stocks or bonds, the original investment was gold.  Heck, even before there was paper currency or even coins, gold was the original “money”. 

That begs the question, What role should gold have in your portfolio?  If you don’t want to read to the end, my quick answer is “None”.  However, if you want to have a bit of a better answer, let’s dig in.

Gold as an investment

Just like stocks and bonds, gold is an investment.  The idea is to buy it and have it increase in value.  Makes sense.  And historically, it seems to have been a good one—back in 1950 an ounce of gold was worth about $375 and today it’s worth about $1300.  Not bad (or is it???).

However, there is a major difference between gold (and broadly commodities) as an investment compared to stocks and bonds.  Gold is a store of value.  If you buy gold it doesn’t “do” anything.  It just sits in a vault collecting dust until you sell it to someone else.

That’s very different from stocks and bonds.  When you buy a stock that money “does” something.  It builds a factory that produces stuff or it buys a car that delivers goods or on and on.  What ever it is, it’s creating something of value, making the pie bigger.  That is a huge difference compared to gold, and it’s a huge advantage that stocks and bonds have over gold.  You actually see that play out by looking at the long-term investment performance of gold versus stocks.

Golden diversification

Statistically speaking, gold gives an investor more diversification than probably any other asset.  We all know that diversification is a good thing, so this means that gold is a great investment, right?

Well, not really.  Stick with me on this one.  Gold is negatively correlated with stocks (for you fellow statistics nerds, the correlation is about -0.12).  Basically, that means when stocks go up gold tends to go down, and when stocks go down gold tends to go up. 

Over the short term, that’s probably a pretty good thing, especially if you want to make sure that your investments don’t tank.  In fact, that’s one of the reasons gold is sometimes called “portfolio insurance”.  It helps protect the value of your portfolio if stocks start falling, since gold tends to go up when stocks go down.

However, over the long-term, that’s super counter-productive.  We all know that over longer periods of time, stocks have a very strong upward trend.  If gold is negatively correlated with stocks, and if over the long-term stocks nearly always go up, then that means that over the long-term gold nearly always goes (wait for it) . . . down.

That doesn’t seem right, but the data is solid.  Look back to 1950: an ounce of gold cost $375.  About 70 years later, in 2019, it’s about $1300.  That’s an increase of about 250% which might seem pretty good, but over 70 years that’s actually pretty bad, about 1.8% per year.

Contrast that with stocks.  Back in 1950 the S&P 500 started at 17, and today it’s at about 2900.  That’s an increase of about 17,000%, or about 7.7% per year.  WOW!!!

Just to add salt in the wound, inflation (it pains me to say since I think the data is suspect) was about 3.5% since 1950.  Put all that together, and gold has actually lost purchasing power since 1950.  Yikes!!!

A matter of faith

Fundamentally, if you have faith that the world will continue to operate with some sense of order, then gold isn’t a very good investment.  So long as people accept those green pieces of paper you call dollars in exchange for goods and services and our laws continue to work, gold is just a shiny yellow metal.

However, if society unravels, then gold becomes the universal currency.  The 1930s (Great Depression), the 1970s (OPEC shock), and 2008 (Great Recession) were all periods where gold experienced huge price increases.  Those are also when the viability of the financial world order were in question.  Each time, people were actively questioning if capitalism and banks and the general financial ecosystem worked. 

People got all worked up and thought we were on the brink of oblivion.  Gold became a “safe haven”. People knew no matter what happened, that shiny yellow metal would be worth something.  They didn’t necessarily believe that about pieces of paper called dollars, euros, and yuans.

Yet, the world order hasn’t crumbled.  Fiat currencies are still worth something.  Laws still work, so that stock you own means that 1/1,000,000 of that factory and all it’s input belongs to you.  Hence, gold remains just a shiny, yellow metal.  

The bottom line is that stocks have been a great long-term investment, and gold hasn’t.  And that’s directly tied to the world maintaining a sense of order.  So long as you think that world order is durable and we’re not going to descend into anarchy Walking-Dead style, then gold isn’t going to be a good investment.

So the survey says: “Stay away from gold as an investment in your portfolio.”

The best time to take social security

Social-Security-SSA

In the United States, Social Security is an important part of most peoples’ retirements, actually probably too important in many instances.  Social Security is a fairly simple program that was designed to be pretty idiot-proof.  You don’t really need to make many decisions for it, which contrasts sharply with all the decisions you need to make on your other investments (like tax strategiesasset allocationpicking investments, etc.).

With Social Security, you just work and the government takes its 12.4% (6.2% from you and 6.2% from your employer) of your compensation.  In fact, you don’t really have a choice in the matter and the government does it automatically.  Then when you get old, the government gives you a monthly pension.  Not real complicated on your end.

However, there is one really important decision you need to make regarding Social Security: when you start taking it.  Basically, you have three options: 1) Early retirement-when you turn 62; 2) Regular retirement-when you turn 67 for most of us; 3) Late retirement-when you turn 70.  And as you would expect, if you start taking Social Security later, you get a larger monthly check from the government.

This is obviously an important choice to make, and it’s one that gets a lot of press coverage with all sorts of people opining on what to do (I guess with this post, I am adding my opines to those ranks).  Generally speaking, the advice slants towards taking it later.  Yet, I wonder if that’s really good advice.  Using my handy-dandy computer, let’s go to the numbers to see what they tell us.

I checked my Social Security statement and I’ll be able to pick from one of the three choices:

Age to start taking Social SecurityMonthly check
Early retirement—age 62$1800
Full retirement—age 67$2600
Delayed retirement—age 70$3200

As you would expect, the answer to this riddle is a morbid one.  When do you expect to die?  The longer you live, the more it makes sense to delay taking Social Security so you can get the bigger check.  That’s not a tremendous insight, but when you do the math, you start to see some interesting things going on.  I fully appreciate that Social Security is very nuanced and complex, so I am just covering the simple basics here.

In my analysis to be able to compare the different scenarios, I assumed that I saved all the Social Security checks and was able to invest them at 4%, about the historic rate for a bond.  If you do that the table above expands to this:

Age to start taking Social SecurityMonthly checkHighest value
Early retirement—age 62$1800Die before age 79
Full retirement—age 67$2600Die between age 80 and 84
Delayed retirement—age 70$3200Die after age 85
Capture

That’s pretty profound actually.  The average life expectancy in the United States is 76 for men and 81 for women.  Doesn’t that mean that most of us should be taking Social Security with the early option?  That contradicts most of the advice out there on this topic.  That, ladies and gentlemen, is why Stocky is here for you.  This is where it starts to get fun, and we can apply a little game theory (awesome!!!).

When to start Social Security?

Actually, once you reach age 62, the life expectancy of those still alive (and able to make the decision on Social Security) is 82 for men and 85 for women.  This makes sense because you’ve survived to 62 so by definition you didn’t die before then (awesome insight, Stocky), and those early deaths pull down that initial life expectancy model.

Since women are better than men as a general rule (Foxy Lady took over typing for just a second there), let’s look at this decision as a 62 year-old-woman.  She needs to make a decision on when to take Social Security.  She knows her life expectancy at this point is 85, which means there’s about a 50% chance she makes it to 85.  So the worst choice for a 62 year-old is to take the early retirement option.  She’s probably going to live long enough that either full retirement or delayed retirement is the better option.

At 62 she does the smart thing, and decides to wait.  Her next decision comes at age 67, assuming she lives that long (there’s about a 5% chance she’ll die during those five years).  But a similar thing happens—when she was 62 her life expectancy was 85 (right on the border of picking between full retirement and delayed retirement), but now that she’s 67 her life expectancy jumps up a year to 86.  So if she makes it to 67 then she’s better off taking the delayed retirement (of course, there’s about a 4% chance she’ll die before she makes it to 70).

That’s a little bit weird though, isn’t it?  It kind of feels like you’re that horse with a carrot dangling over his head, keeping him walking forward.  It’s a bit of a conundrum.  At any given time, you’re better off delaying starting your Social Security, so the math tells you to keep waiting and waiting.  But if the dice come up snake eyes and you die, then you miss out on everything (not strictly true, but true enough for our analysis).

And keep in mind that since Foxy Lady hijacked Stocky’s computer, we’ve done this analysis for women.  The math tells you that it’s just about a wash between taking Social Security at 67 or 70.  Since women live on average 3 years longer, for men you would think it means that the advantage leans towards taking it early.

What does it really matter?

So the analysis tells us that we’re better off waiting if you’re a woman and it’s really close if you’re a man.  And of course the longer we wait, the further we come out ahead by taking delayed retirement instead of early or full retirement.  But how big of numbers are we talking?

Remember, the cut off for when full retirement becomes better is at about 80 years old.  The cut off for when delayed retirement becomes better is about 85 years old.

Future value of Social Security payments
AgeEarly retirement (62)Full retirement (67)Delayed retirement (70)
85$1,031,256$1,119,603$1,125,233
90$1,450,231$1,644,630$1,716,663
100$2,647,751$3,158,200$3,431,844

Those are meaningful differences.  If you make it to 100 years old, delayed retirement comes out about $800,000 higher than early retirement.  However, those are in future dollars, 38 years into the future if you’re 62 today and faced with this decision.  That $800,000 when you’re 100 would be worth about $370,000 today.  Of course that’s if you make it to 100, which isn’t really likely (about a 3% chance).

If you make it to 90 years old (you have less than a 30% chance) then the difference is about $260,000 in future dollars which is about $150,000 today.

Wrapping up, I’m really torn on this.  There’s a little bit of a prisoner’s dilemma type thing working that keeps making you want to push back when you start collecting.  And then when you look at the upside of delaying retirement, the numbers are pretty big (whenever you’re talking about hundreds of thousands of dollars, that’s real money), but the chances of us making it to that super-golden age are pretty small.

I suppose it’s best to wait, but I’m giving that a pretty “luke-warm” endorsement.  It certainly isn’t the “slam dunk” that so many pundits make it out to be.

Actually, I think the way the Social Security administration sets it up, the options are all pretty similar.  We all have this personal belief that we’ll live longer than average (but not everyone can live longer than average, expect if you’re from Lake Wobegon, MN).  And that makes us think we’re better off waiting, but it probably is all pretty equal.