Market dips are awesome?!?!

Holy crap!!!  The last week of the market has been insane.  We’ve seen the largest point drops in the history of the Dow—1175 drop on Monday and 1033 drop on Thursday, although neither ranked within the worst 50 drops in percentage terms.  This is crazy, yet why would I possibly think that this is a good thing?  Over the past 6 trading days, the market is down about 7%.  Yowza!!!

I am, and most of you are, long term investors.  The money I am investing in the stock market is meant to be spent years, or more likely decades, from now.  Sure, what happened right now sucks and maybe is scary (although I think it’s actually the opposite).  That should be comforting because, although we’ve taken a huge body blow, the good news is that we have a really long time to recover.

 

Dollar cost averaging

OK, that might explain why it’s not so bad, but how could it possibly be good?  If you can take a Pepto and keep your head, this is actually a great time to be investing, be it regular contributions to your 401k and IRA or just regular stock purchases.  If you were excited to buy stocks two weeks ago when the market was frothing, you should be even more so now that stocks are “on sale” at 7% off.

Sure, that might make sense philosophically, but how does that work in real life.  Let’s look at my nephews Risky Fox and Safey Fox.  Risky Fox invests $10 every day no matter what happens.  His twin Safey Fox cut a deal with the investing gods where every day the stock market goes up an equal amount.  Both twins started investing on January 1, 2000, and each has invested $10 every day for those 18 years.  They both start when the S&P 500 was at 1455 at the start of the millennium and they both end last Friday when the market was at 2,620.

Those 18 years have had crazy bull markets and crazy crashes—the dot-com bubble and it’s popping in 2001, the Great Recession of 2008, and the Trump run of 2017.  Those are the big ones but there have been mini-crashes and corrections too like August 2011 and January 2016.

Through all of that Risky invested $10 through thick and thin, no matter where the market was, high or low.  In her bizzaro alternative universe, Safey invested $10 every day , knowing each day the market went up a small but consistent amount (0.0129% each day if you’re curious).

Who ends up ahead?  It would be a pretty stupid column if it was Safey . . . of course it was Risky Fox.  Each invested $45,560 over those 18 years.  Safey ends up with $62,011 which isn’t bad.  But Risky ends up with $89,773, about 45% more.

How does such a thing happen?  In 2001 the dot-com bubble popped and stocks fell 45% over three years.  Throughout all that Risky kept plugging away, investing his $10 each day, but now he was getting stocks at a huge discount.  Stocks recovered after a few years and that looked like a great buying opportunity in hindsight.  Then in 2008 the Great Recession his and stocks fell about 55% in a little over one year.  Again, Stocky keeps investing and when stocks bounce back, he looks like a genius for having kept faith and picking up stocks at a substantial discount the whole time.

And just to prove it isn’t a unique thing, if you did the same Risky/Safey experiment for the 1970s, 1980s, and 1990s, you get similar results.  The 1960s and 1950s have Safey coming out ahead, but by a much smaller amount.

 

Risky

Safey

Difference

2000 to 2018

$89,733

$62,011

45%

1990s

$69,324

$56,044

24%

1980s

$51,181

$48,492

6%

1970s

$28,650

$27,538

4%

1960s

$29,951

$31,100

-4%

1950s

$48,480

$50,926

-5%

 

And never lose sight of the fact that what Safey is doing is impossible.  The market doesn’t work like this.  This just shows that what Risky is doing, something we all “have” to do, really isn’t all that bad.

It’s similar to asking if you can get from point A to point B faster by walking with your feet or flying with your wings.  You can get there with your feet most of the time more quickly, but even if that wasn’t so, none of us have wings.  The whole point is that buying through market down turns (or walking with your feet) does pretty well, even when compared to some fantasy construct.

 

Faith

Ultimately, this is a lesson of faith.  When we were in the depths of the Great Recession, Warren Buffet famously professed his faith in the US economy.  He turned out to be right and made tens billions (billions with a “B”) along the way.

There’s no proof that markets will always go up (predicting the future of human behavior is always impossible), and at the end of the day it’s a matter of faith.  If you believe in capitalism then you believe that stocks will always go up.  I do believe in capitalism so I do believe that stocks will always go up.

That’s what makes the little experiment with Risky and Safey work.  Even when things look horrible, like it did in the dot-com bust and the Great Recession, if you have faith in capitalism you’ll look at the downturn as a temporary turn that will ultimately return to rising prices.  You can see this by looking at a long term stock chart of US stocks: they have an unrelenting upward march through all sorts of markets over 100 years.  Or you can look at the data that shows that historically consistently investing in stocks has never lost money over a 20-year horizon.

S&P 500 since 1950

That brings us full circle.  We’ve been bashed in the face the past 6 trading days.  Stuff like this happens.  I have total faith in capitalism which means I have total faith that things will recover.

When people have asked me what I think will happen/what I think they should do, I tell them to keep on keeping on.  Keep investing in your 401k, keep putting away money in the 529 and your IRA.  It’s probably a lousy time to withdraw a ton of money for a beach house or some other massive expenditure, but beyond that, what’s going on in the stock market really shouldn’t be impacting you at all.

BOOM—Top 5 impressions of Dow’s 1150 free fall

Yowza.  Yesterday was a crazy day.  There’s an ancient Chinese saying: “you are lucky to live in interesting times.”  Definitely the past couple days the stock market has been interesting.

Yesterday I got cocky and wrote a post on the 666 point fall on Friday.  I was a bit aloof, and the investing gods love nothing more than to humble people like that.  So in a weird way, I take some of the responsibility for the 1175 point drop yesterday.

Seriously though, let’s take a look at what’s going on.  Here are my Top 5 impressions of what happened, and what it all means.

 

  1. Biggest point drop in a day

Yesterday’s 1175 point drop for the Dow was the largest of all time.  Living in interesting times, right?  But at a 4.1% decrease (I’m going to be using S&P 500 for percentages just because it’s a broader market and the data is easier to get), yesterday was about the 30th biggest drop since 1950.

A top 30 (or bottom 30 depending on how you want to look at it) is notable given there have been over 17,000 trading days since 1950.  However, top 30 means that on average, something like this happens about every other year or so.  Maybe not so special.

Remember the last time we had a drop this big?  Of course you don’t.  In August of 2011 there was a -4.5%.  Actually, August 2011 was a crazy month—there were FOUR days with percentage drops greater than the one we had yesterday.  Think about that for a second.  The month of August 2011 was a major rollercoaster with a lot of ups and downs.  Stocks were down 5.7% for the month.  But we don’t remember that at all because it was just a blip.  Just.  A.  Blip.

That’s how I think we’ll remember this one.  There are never guarantees, but this stuff happens all the time in investing during your 60+ year investing career.  Get used to it.

 

  1. See the horrors of automated trading

Look closely at the daily chart right around 3pm.  It took a super-steep nosedive, at that point falling to about 1500 points.  But then, nearly as quickly it recovered about 500 points.  That a huge swing in about 10 minutes.

What caused that: Automated trading.  Computers saw all the selling around them and were programmed to sell too.  However, what should be very comforting is that humans (and other computers with different programming) saw that and realized that the selling was overdone.  They stepped in and started buying.

Computer algorithms are a newer phenomenon in the market.  I did a post of how they lead to much more volatility (written the last time the market went really crazy).  However, while volatility may rise, it really doesn’t have any long-term impact on returns.

But the lesson here is realizing that a lot of what goes on is driven by thoughtless, emotionless computers that don’t really realize if there is an “overreaction”.  As a human who has perspective, that means you can keep your cool when that stupid machine thinks it’s all going to hell.

 

  1. How bad are things really?

This is important.  What has fundamentally changed since a week ago when stocks were at an all-time high?

Really not much.  There was a jobs report that showed wages had crept up a bit.  On top of that Janet Yellen has stepped down as Chairwoman of the Federal Reserve, and is being replaced by Jerome Powell.   Yellen was seen as fairly dovish on inflation, tending to keep rates lower for longer to spur higher employment.  Powell is a bit more hawkish and is seen as more likely to raise rates more quickly to fight inflation.  That goes to the whole thing we were talking about with the Fed yesterday.

Beyond that, which I think is a bit of a Red Herring, there aren’t any fundamental economic problems that are causing this.  In 2008 the mortgage crises exposed the rotten foundation of the banking industry; in 2001 the internet bubble popped and exposed massive accounting frauds; in the 1970s OPEC exercised considerable cartel power (something that I wrote about here as unlikely to occur again).

That’s a quick rundown of all the major stock market disasters of the past 60 years.  I don’t think there are any fundamental issues like that which we are uncovering to cause that to happen now.  Rather, while we remember those three listed above, just like August 2011 there are a dozen mini-disasters that turned out to be much bigger bark than bite.  I think that’s what we’ll have here.

 

  1. What I think is going to happen

Making predictions on the stock market is a sure way to look stupid, but I’ll do it anyway.

I think we’re definitely in for a wild month.  I bet today (Tuesday 6-Feb-2018) the market will be up 200 points, then down 300 and another 500 the next two days.  We’ll have a ton of volatility for the rest of the month, and we’ll end February down 4.8%.  For the year, I will stick with my prediction from December 2017, and I think we’ll be up 5%.

What am I basing that on?  A lot of gut, and that’s never a good thing.  The market has had an unprecedented run.  These things can’t last forever, and the market does take “breathers” (sometimes called corrections).  I think that’s what we’re going through right now.

However, the fundamentals are strong.  The tax break is a big boon.  Even more important, the tax break and a lot of other things are spurring innovation.  Money is being deployed in R&D instead of sitting in banks in Ireland and Switzerland.

Being as involved as I am in the medical device space, I know tremendous innovation is happening.  Diabetes is on the brink of being cured by Medtronic; bear in mind in the US we spend about $250 billion (read that again, a quarter TRILLION) to treat that.  Think of all the benefits that will follow.  Also we’re on the brink of having driverless cars which that alone will create well over a trillion dollars in sales and societal benefit.  Those are just two of probably a dozen you could rattle off.  Bottom line, I think things are really good right now.

 

  1. How this should impact your portfolio

It shouldn’t.  Definitely this shouldn’t scare you off into selling your portfolio.  There’s a famous saying in the stock market that says “You should be scared when others are greedy, and you should be greedy when others are scared.”

A week ago stocks were flying high and everyone was greedy.  As it turns out we should have been scared, but hindsight is 20/20.  Now that everyone is scared, we should be greedy.

That said, I wouldn’t try to time the market either.  A friend, Mr Snow Leopard, has a bit of cash sitting on the sideline and we were chatting about this and what to do.  I said if it was me, I would invest in equal installments over the next three or so months.  I know that goes against my analysis on how to invest a windfall, but I think things are so crazy right now, I wouldn’t feel comfortable putting all the chips in on one hand.  I’m going with my heart over my head, but oh well.

I think we’ll definitely be in for a rocky ride and I think there are going to be a few of these really good buying opportunities interspersed with glimpses of optimism.  Either way, DEFINITELY DON’T PANIC AND SELL OUT.

Fed rate hike spooks Wall Street

Last Friday there was blood flowing down Wall Street.  The Dow suffered its 6th largest point drop in a single day, falling 666 points (que Iron Maiden).  Being a top 10 worst day seems like it’s important, but that really overstates things.  The Dow is so high now, at 26,000, that a 700-odd point drop really isn’t that big.

If you look at the list of the Top 20 biggest point drops, this one ranks at #6.  But in percentage terms it’s lowest on that list.  In fact, since 1950 there have been about 200 or so drops in percentage terms this bad.  That comes to about 2-3 per year.  So let’s not get too freaked out.

Also, let’s keep in mind that the stocks are up 3% so far for the year.  That’s really good, and no one would normally complain about that after just a month.  But it’s human nature to complain, so that’s what we do.

OK, I’m a little calmer.  But it’s still worth trying to figure out why the drop happened.  Most economists look to the Federal Reserve as the culprit.  Or more precisely the idea that inflation is steadily rising and that will prompt the Fed to start raising interest rates.  You know my feelings on inflation in general, and specifically I predicted a few weeks back that over the long term we would have really low interest rates.  Either way, new ideas on inflation weren’t what spooked the market, but the idea that the Fed would start raising interest rates.

That begs the question, how do interest rates impact the market?  And that’s really French for Why is the Fed so important.

 

How does the Fed impact the economy?

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

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

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

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

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

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

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

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

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

 

What’s going on today?

Now that you have that little lesson under your belt, how does that relate to what’s going on with the Fed right now?  Currently, the Fed has interest rates at about 1.5%.  That’s really low, but actually over the past couple years the Fed has been raising interest rates from when it was at 0%.  Obviously that’s super low, so shouldn’t the Fed be worried about inflation?

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

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

But what keeps them in the news is “the specter of inflation on the horizon.”  If you follow this stuff (like I do) in the past few months, every time inflation numbers come out, everyone looks at those and tries to predict what the Fed will do.

Every time this happens the market swings like a pendulum.  If rates are going to go up, the stock market gets crushed because firms will be less profitable (as we saw on Friday and in the little illustration above).  If that changes and we think rates are going to stay low, the market shoots up like a rocket.

 

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

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

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

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

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

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

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

Shopping for health insurance (part 3)

On Monday we talked about the fat, dumb, and happy path we took when we got our health insurance from our employer.  On Tuesday we talked about how insurance works and what are the shoals you have to navigate through.  Today, we’ll talk about how the Fox family is going to go forward.

 

 

What we have been spending on health insurance in the past

Let’s look at what we’re going to do and how that impacts us financially.

First, let’s remember what we’ve been paying when covered by traditional, employer-sponsored health insurance.  We directly pay about $1,100 per month, plus the company pays about $1,200 per month.  Remember that $1,200 is really your money.  Your employer doesn’t give that to you out of charity.  You earn that money and you are paid that in the form of subsidized health insurance.  Add those together and it’s about $2,300 per month which comes to about $28,000 annually.

Plus, you have to add all the copays and deductibles.  I track this stuff because I am a nut.  Going back to when Foxy and I got married in 2010, we typically spend about $1,200 each year on copays.  However, there were two years where it was closer to $4,000.  That’s when ‘Lil Fox had to be hospitalized for croup.  More on that scary episode in a second.

Our average premiums were about $28,000 each year, and our out-of-pocket is about $2,000 each year, knowing some years are higher than others.  That’s $30,000 each year that we were spending on health insurance, not that far off from what Obamacare was going to charge.  I had no idea I was spending so much.  I just barfed in my mouth.

 

What we’ll end up doing now

After extensive searching, we found a really good policy from United Healthcare that costs about $500 per month.  It gives us access to their negotiated rates which is the most important thing, and then it covers certain things up to a set amount.

For example, it covers a regular doctor visit up to $100, after which I am responsible for the excess charges.  As I said, figuring out negotiated rates are really hard, but I think on average a doctor visit with the negotiated rate is about $150.  So, I would pay the $50 not covered.

This stuff is really confusing, but looking at all the coverage I figure that I would pay a bit more under this plan than I would in copays under the traditional employer-sponsored plan (or Obamacare which looks a lot like a traditional employer-sponsored plan).  But you can pay for a lot of copays with an $1,800 per month difference in premiums.

With this coverage, we get #1 and #3 of what insurance coverage offers.  But we’re missing #2 which is that protection from some catastrophic medical event like a car accident or something.  For that we can get a supplemental policy that costs about $100 per month and it covers us for any expenses that exceed $15,000 in a three-month period.

That ensures that if tragedy strikes in the form of a car accident or a fire where one of us are stuck inside or . . . I don’t even like thinking about this.  You get my point.  If something really bad happens and one of us (or all of us) is in the hospital for a long time and the medical bills really rack up, we’ll max out at $15,000.

 

How we’ll probably end up ahead

Good news.  We get all our coverage—access to negotiated rates, typical coverage of basic stuff, and protection against catastrophic costs—for about $600 per month or $7,000 per year.  That compares pretty favorably to the $28,000 in monthly premiums from my employee-sponsored plan (or even the $1,100 per month or $13,000 per year that was my portion, but again make no mistake that I was paying for both portions).

There’s no questions that our out-of-pockets will be higher now than they were before.  Typically, we spend $2,000 per year on that stuff, so let’s say it doubles to $4,000 per year (about $350 per month).  That’s a lot of money, but we’re still ending up way ahead because although we spend an extra $2,000 on out-of-pockets we are spending about $21,000 less on premiums.  That’s a huge windfall.  $21,000 a year is enough on its own to fund a nice retirement (about $5 million over a 40-year investing lifetime!!!).

Of course, those numbers assume we’re pretty healthy and don’t consume a ton of medical care.  Let’s say Foxy and I each get our annual check-ups, the boys go twice a year, and there’s one ER visit and a couple urgent care visits thrown in for fun.

But what if catastrophe happens?  After all, that’s the whole point of insurance, right?  God forbid we have a repeat of 2013 when ‘Lil Fox was in the PICU for 4 days with a nasty case of croup.  At the time we were covered under my Medtronic insurance and the total cost was about $32,000 of which we had to pay out-of-pocket about $4,000.

Those are some big numbers.  But let’s say that we were on the hook for the whole $28,000 (instead of just the $4,000).  First, we’d be helped out by the catastrophic coverage, so we’d only pay $15,000.  Given that we’re saving about $22,000 annually on premiums we’d come out about even.  Bear in mind, we’ve had kids for seven years now (including in utero), and that one event was the biggest medical issue we’ve had.  If at it’s worst we break even and then all the other years we come out way ahead, that seems like a winning combination.

 

How we’ll change our behavior

Given that the plan we’ll get is pretty bare-bones, there’s a much closer link between the healthcare we actually use and what we pay out-of-pocket.  This provides a lot of transparency which is actually a good thing (basically what my friend Oguz said in a comment on Tuesday).  One of the big problems is that when things are “covered” by insurance and people don’t have to pay for it, they use a lot more.

For us, we’ll pay when ever we see a doctor or get a prescription.  That will make us more selective of when we actually go see a doctor.  If Mini Fox has a cough (which he actually does right now), we’ll probably wait an extra day or two before going to the doctor (which we are in fact doing right now).  Maybe that sounds like terrible parenting, but actually most experts agree that people are hypochondriacs, and waiting a bit gives your body the chance to heal.  We’d never put our family in harms way, but the body does have the ability to heal itself pretty miraculously.  We’ll take advantage of that.

Also, we’ll be more mindful of using the most expensive types of care.  The most obvious example is an emergency room versus an office visit or urgent care.  If you don’t pay the costs, it doesn’t matter and most people will do the quickest thing they can (ER).  However, if you’re paying for it, you’re a lot more likely to have the inner dialogue at 11:30pm when you’re kid is puking: “Do I really need to go to the ER or can I wait until morning and go to the urgent care?”

Those are the little things that can save the healthcare system a ton of money.  But we as consumers only think about it when we have skin in the game (again, to Oguz’s point).  Now that we’ll have a more bare-bones policy, we’ll be thinking about that, and it’s a good thing.

 

There are bargains to be had

Another major benefit of the bare-bones coverage is that with less things “covered” we’ll need to shop around more for our medical treatment.  We’re becoming more engaged in the process which is a good thing.  Also, this allows us to actually find some major bargains out there, and who says “no” to getting better quality while paying less?

There’s a fun little procedure a fox can get when he doesn’t want to have any more cubs.  Vasectomies are covered under most plans.  The total cost is very opaque (again Oguz’s point on transparency), but the typical out-of-pocket was about $200.

However, there are clinics that don’t accept insurance and are only cash pay.  I must say they seem A LOT nicer.  The receptionist answers the phone by the third ring, not after you’re on hold for 20 minutes (literally, I’ve had that experience).  The facilities are beautiful and totally modern.  They do the consult and the procedure all in one meeting which is awesome.  Everything is better.  All for the low cost of $750 which you pay with a credit card at the time of the procedure.  Bear in mind, the monthly premium for coverage that covers vasectomies is $2,300 per month and the premium for the plan that doesn’t cover vasectomies is $600.  Simple math to me.

This very similar example can extend to all sorts of stuff like Lasix.

Another example close to our heart is speech therapy.  That’s an optional piece of healthcare which is also fairly predictable, so it doesn’t fall under the traditional definition of “insurance”.

Under our employer plan (and Obamacare as well), we could sign up with an approved provider.  The list price was $200 per 45-minute session, and the negotiated price came down to $150.  Our copay was $50.

I ended up talking to a guy who used to give us speech therapy (so he’s licensed and the same high quality).  He left his company that was covered by insurance and went out on his own.  He and I came up with an awesome deal.

His previous company would charge insurance $150 of which I paid $50.  He actually got about $30 per session.  He and I agreed to cut the middleman out.  We bypass insurance, and I pay him directly $40 per session.  He comes to our house to do the speech therapy which is a ton more convenient, plus he does it for 60 minutes because he’s hustling and wants the business.  Everyone wins.

He makes more money, I pay less, and we get a better-quality product.  This only happens because I go outside the health insurance paradigm and used that awesome thing in capitalism called competition.

 

There you have it.  After 4,300 words in three parts, you now have a sense for how we are handling our health insurance.

Having to do it on our own, away from the protection of an employee-sponsored plan was a bit unnerving at first, but after I went through it all, I’m actually fairly optimistic.  I’m still going to get great healthcare (and the speech therapy and vasectomy examples show that maybe even better quality), all the while saving a ton of money.

Remember, that each month we’ll save about $1,700 in premiums.  Maybe we’ll pay an extra $200 per month in copays, but still that’s $1,500 to the good each month.  That is HUGE, coming to about $5 million over a typical healthcare consumer’s investing lifetime.

 

Shopping for health insurance (part 2)

Yesterday I started the story of how the Fox family had to shop for health insurance in the open market.  Mostly, I talked about how we had always had employee-sponsored health insurance; we were shocked by how much Obamacare cost, but it turns out we were always paying that much, and we just didn’t know it (which is part of the problem).

Today we’ll talk about how health insurance has gotten so screwed up.  Thursday we’ll finish up with how the Fox family is going to beat the system and save enough to completely fund our retirement (at about $5 million) along the way.

 

The definition of “insurance”

Part of the problem is the word “insurance” has been bastardized.  Anywhere you go except for healthcare, the concept of insurance means you pay a small amount of money and if an unpredictable catastrophe occurs, those expenses are covered.  Think auto insurance or homeowner’s insurance.

For a lot of political reasons, “insurance” has taken on a very different meaning when applied to healthcare.  Health insurance isn’t meant to cover only unforeseen expenses and very large expenses.  It has come to mean to many people “paying for all medical expenses”, including those that are optional (Viagra, psychological counseling, baby head helmets) and very predictable (birth control, contact lenses, dialysis).

Always remember that Las Vegas wasn’t built on winners and neither are insurance companies.  Insurance companies have to make money or they go out of business.  To cover all those expenses, they need to raise premiums or increase the patient’s share of the expenses through deductibles or out-of-pockets.

That’s coming out of your pocket.  So when your insurance plan offers chiropractic visits or smoking cessation or a million other things that you’re pretty confident that you won’t ever use, you’re still paying for that.

The point is that “health insurance” has become more of a “healthcare buffet”.  For a monthly cost you get (or at least can get) a bunch of stuff, some of which you’ll use and much of it you won’t.  This has predictably lead to health insurance costs spiraling out of control (Obamacare costs rose about 10% in 2017).  More on this in a minute.

 

What health insurance really provides

When you buy health insurance, what are you actually getting?  This seems like an easy question, but it actually breaks down into three major components (two of which you probably know right away, but one that’s a bit more subtle):

  1. Payment of medical expenses: This seems obvious.  When you have health insurance, you can go to the doctor and your health insurance pays some or all of those costs.  This isn’t that big of a deal because for those predictable healthcare expenditures, you’re really paying these costs anyway through your premiums.
  2. Protection from major expenditures: In the more traditional sense of insurance, if you have some catastrophic medical event (in a major car accident, get diagnosed with cancer, etc.) your health insurance will cover the enormous expenses that would otherwise bankrupt most people.
  3. Negotiated rates: This is the subtle one.  In addition to #1 and #2, when you have health insurance, you get access to the rates they negotiate with healthcare providers.

So when you “buy” health insurance, either one on your own like the Fox family is getting ready to do, or as part of your employee benefit package (and make no mistake, you’re paying for all of that), you are getting those three things.

 

Negotiated rates are a big deal

#3 is such a big deal that it deserves its own section.

When you go to a hospital, there is a list price that someone off the street without insurance would be charged.  Then there is the negotiated rate that insurance companies work out with the hospital which is much, much lower.

Negotiated rates are a closely guarded secret, so it’s hard to figure out exactly how large the negotiated rate discount is, but if you know where to look, you can find it.  It tends to be about 1.5 to 3x.  For every $3 a person without insurance in charged for something, an insurance company will negotiate that rate down to $1.  That’s a HUGE benefit!!!

This is one of those things that really pisses me off.  When I am elected to Congress, I am going to work hard to remedy this.

The argument goes that insurance companies use their volume to negotiate better prices, but do they really?  How many of those patients go to St Mary’s Hospital instead of Sinai Medical Center because of their insurance?  My experience is that most insurers allow patients to go most places.

Second, when you use insurance it takes a long period of time for the insurance claim to be processed and paid, the deductible to be calculated and that invoice to be sent out and paid.  Contrast that to a cash patient who could pay with a credit card that day (or a check to avoid credit card fees), and you could actually argue that cash patients should pay less than insurance patients, not three times more.

Also, where else would it be acceptable to charge a customer 3x compared to another.  If you did that based on race (charge black people more than white) or gender (charge women more than men) or wealth (charge poor people more than rich people) or ethnicity (charge Asians more than Jews) people would throw a total fit, and it would totally be justified.

Scaling it down a notch, charging people 3x more because they are ready to pay you in US legal tender really isn’t all that different.  People are throwing a fit about unaffordable healthcare in America, but I really don’t hear a lot about this.  This is where you could make some real progress and give real relief to those who aren’t insured.

I’m not saying that hospitals and other healthcare providers should take less.  I’m just saying they should charge everyone the same price, and it should be transparent.

Bottom line, in the country we live in today, probably the biggest benefit of health insurance is having access to those negotiated rates.

 

Everything is available at the buffet

Another major factor that has made health insurance more complicated and a lot more expensive is the breadth of coverage that is now fairly typical with most plans like Obamacare and employee-sponsored plans.

Obamacare has a special name these “extra” things—minimum essential coverage.  They are things like: pregnancy, birth control, drug and alcohol abuse treatment, mental therapy to name a few.  Those are required to be included in any Obamacare plan.  Many employee-sponsored plans (like the one I had at Medtronic) had a lot more stuff too like: chiropractor visits, fitness counselors, etc.  Plus, of course, Medtronic had amazingly good coverage for diabetes patients.

Look at that list.  In our situation, we wouldn’t use any of those.  We aren’t planning on having any more children and other steps have been taken to assure ongoing birth control isn’t needed 😉.  We don’t abuse drugs, don’t use chiropractors, don’t have diabetes, and don’t have high cholesterol.

However, when plans offer that coverage for things that are fairly predictable (not the classic definition of “insurance”) it has to be paid for somehow, and that somehow is with higher premiums.  Whether we used it or not we pay those higher costs, and that’s one of the reasons health insurance is so expensive.  It offers and charges you for so much that you won’t end up using.  I guess that’s how we get to a crazy high cost like $2,300 per month as a premium.

For us (and a lot of people out there), we’re pretty healthy and really don’t take advantage of some of those gray areas of healthcare like chiropractors.  We just want something simple that covers our doctor’s visits and catastrophic events.

As medicine gets more and more socialized (and you move away from the ability to choose a bare-bones plan—what we’ll be doing), you open yourself up to an ugly word in healthcare—Lobbyists.  There are a lot of companies making incredible technology that helps people (I speak first hand on this, having worked for Medtronic for almost 20 years).  It’s understandable that they are going to do everything they can, legally and otherwise, to get their products covered on insurance formularies.  They aren’t bad people per se; they are just advocating for the products they believe in (and the products which also pay their bills).

Of course, nationalized medicine offers the biggest opportunity for this.  Whether it’s Pfizer trying to explain how Viagra must absolutely be offered as a part of health insurance, or Medtronic and continuous glucose monitoring, or Bayer and birth control, or the American Association of Chiropractors, or the American Institute of Homeopathy.  On and on and on.

There’s so much that could be offered as a part of insurance, the vast majority of which a very, very small portion of the population actually uses.  Simply put, we can’t afford it all.  In that case, it becomes a game of lobbyists who can best convince bureaucrats to support what they want.  That’s not a good situation.

That leads to out-of-control costs, which we’re already seeing today–$2,300 per month.  But if you have choices in the market, you can pick the plans that only give you what you want, and you can save a ton of money (about $5 million over your lifetime).  That’s what we’ll talk about tomorrow.

 

Shopping for health insurance (part 1)

 

The Fox family had to shop for health insurance on the open market recently.  It was quite an eye-opening experience.  Given what a sensitive issue health insurance has become, I think our experience definitely offers insights into how screwed up the healthcare landscape is, but also how reasonable health insurance is.  This “reasonable” -ness actually has the potential to be a huge gold mine that it alone could fund your entire retirement.

Here is our story—this is an epic post so I’ll be cutting it into two (or dare I say three) sections.  Here’s part 1.

 

Up to this point

Until recently, I lived my entire adult life being covered by corporate health insurance (and I think that’s part of the problem—more on this in a second).  At age 21 I started with Medtronic and was covered with their employee health plan.  All the way through 2015, since I always had a corporate job, I was always covered by my employer’s health insurance.  Once the cubs came around, they were covered by my employer’s plan as well.

After I left Medtronic and retired, our family was covered on Foxy Lady’s employer plan.  So really nothing changed except we went from one corporate plan to a different one.

In 2017 when Foxy was laid off from her job we had to get a little creative.  I was doing consulting, and I cut a deal with one client—take some of what I was charging them, and make me an employee and give me health insurance.  That worked for a year, so again we were covered under a corporate plan.

Then in December we got a call from that client that they were changing their benefits and I couldn’t get health insurance from them any longer.  All good things must come to an end.  So we had to look for health insurance like one of the millions of families who don’t get it through their employer.

 

Obamacare is no bueno

Fortunately, when we got the call from my consulting client saying our health insurance was ending, it was in early December.  The deadline to enroll in Obamacare was December 15.

I admit, the idea of finding health insurance on my own was a bit daunting.  It was something I had never done before, and given all the media coverage it gets about how awful it was, I was a bit intimidated.

I didn’t really know where to start the search.  Of course, I knew about Obamacare (in this day and age, how could you not?), so that’s where I started.  After I entered in all our information in the online form, I saw we could get a policy with a premium of about $2,300 per month.  Depending on our income, we could get a subsidy that would push that down to about $500 per month.  A subsidy could be in play given our income is very “feast or famine”, but realistically we were going to pay full price.

Our coverage would cost about $2,300 per month.  That’s a bitter pill, but if that’s what it is, that’s what it is.  However, the bad news didn’t stop there.  Obamacare had really high deductibles and out-of-pocket.  The maximum out-of-pocket for a family was about $15,000 for the family.

It’s complex and there are a ton of nuisances, but basically if the disaster situation struck and we had a ton of medical bills, we would be on the hook for all our monthly premiums (about $28k for the year) plus the out-of-pocket (about $15k).  After that first $43k we’d be good (that’s meant to be very sarcastic).

After going through all this Foxy Lady and I looked at each other with defeated countenances.  No wonder why most families can’t afford health insurance.  We were staring down the barrel of a $45k shotgun.  We’re pretty wealthy thanks to good jobs and smart investing, but even for us this would take a painful chunk of our nest egg.  Best case we’d pay $28k in premiums and worst case we’d pay $45k.

 

Who really knows what health insurance actually costs?

You can imagine after seeing those numbers for Obamacare, we weren’t in a good place.  But how was it possible that it was that bad?

I’d lived my whole life with health insurance, including my whole adult life where I was paying for it myself.  It was never this bad . . . or was it?

Actually, I’m not sure I ever really knew what I was paying for health insurance, and sadly I think this is fairly common.  When I was with Medtronic, I got paid every two weeks.  As with most of us, there were a ton of deductions in my paycheck that whittled down what actually went into my checking account compared to what Medtronic was shelling out.  We all know the culprits: taxes, 401k, flex spending, and of course health insurance.

Psychologically, I think when something is automatically deducted from your paycheck, you don’t really think about it or appreciate how much it costs (and that’s a major problem).  Every two weeks I was paying about $500 for our family’s health insurance.  That comes to about $1100 per month, and that actually seems like a lot of money . . .

. . . But it didn’t stop there.  Typically, what gets deducted from our paychecks only covers a fraction of the real health insurance cost.  As an employee benefit, many companies pay the other part.  That makes it really hard to figure out how much your health insurance costs.

Every year Medtronic would send out a sheet to each employee outlining all the wonderful things they did for us, and they included the cost they paid for my health insurance.  As it turned out, they paid about 50% of the total cost.  All in, the monthly cost for our health insurance was about $2,300, surprisingly close to the Obamacare costs.

How many people realize what they’re paying for health insurance?  Probably not many.  How many people realize what their employer is paying?  Probably even less.

At the end of the day, we live in a country where most people are paying for health insurance one way or another, and almost no one knows how much it costs.  That’s a real problem, a real problem for an entire society that is trying to figure out how to pay for health care.

 

Wow!!!  We’re already at over 1,000 words and we’ve barely scratched the surface.  We’re totally doing this in three parts.  Tune in tomorrow to see my take on how health insurance works, and then Thursday to see what we did and how we’ll actually save a ton of money (about $5 million over our lifetime) by doing health insurance in the open market.

Jan 2018 has been sizzling . . .

. . . and it shows you can’t outsmart the market.

It’s been a mere three weeks into the new year, and stocks are way, way up: US stocks are up over 5%, and international stocks are up nearly 6%.  IN THREE WEEKS!!!  That’s crazy . . . crazy awesome.

As you sit back and count all the money you’re making in the market, let’s put January 2018 into perspective.

 

How special is this?

5% in a month (and we aren’t done yet) is good, but not too special.  Since the S&P 500 began in 1950, there have been 90 months at least as good as this January has been.  That’s about 11% of the time, so a little more than once per year on average.  So that’s not too special . . .

. . . But this one is coming off the heels of some really strong performance.  In the past, most months at had at least a 5% return were rebounding from the previous month which wasn’t that good.  So for example, in September of 2015 that month had a 6.6% return but the month before the market was down.  Same thing in October 2015, October 2011, December 2010, September 2010, and July 2010 (those are the most recent 6 instances).

It might make sense for a really good month if it was sling-shotting off a really bad month, like those most recent examples.  Yet, that’s definitely not what we’ve seen.

January is actually the 10th month in a row that the S&P 500 has been up.  Since 1950 there have been two other streaks like that, in 1954 and 1958 (both of which were 11-month streaks).  So we’re in one of the longest, sustained market runs of all time, and we just busted out a 5.1% month.  That’s a bit like running a marathon and in the 22nd mile kicking out a 4:00 minute-pace.

No matter how you cut this, the market for the past year has been really special.  We’ll be telling our grandchildren about this.

 

You can’t outsmart things

The market is a benevolent teacher.  Actually, maybe not benevolent (some of the market’s lessons can be quite harsh), but certainly a teacher.  There’s a valuable lesson here.

Go back in time three weeks ago.  We were all enjoying football games on New Year’s Day, making resolutions we probably won’t keep, and taking stock (pun intended) of how our investments went in 2017 and what we can expect in 2018.

There was every reason to think 2018 might be a bad year for stocks.  Stocks had just been on an incredible run, so it wasn’t unreasonable to predict a bit of a correction.

Of course, there are a million ways you could go, but there are a ton of really reasonable arguments you could make for why the market might not do so well in 2018.  Yet, so far in January it has busted out a huge month, and if you are fully invested you have made a ton of money.

On the other hand, if you tried to outsmart things and time a market decline, you missed out on a really great month, and that has costed you hundreds or thousands or hundreds of thousands of dollars.

The point of all this is, and I certainly eat my own cooking on this, that you can’t predict the market.  You can spend countless hours trying to figure it out, but it’s unfigured-outable.  The best thing you can do it invest your money and keep it in the market until you need it.

 

That said, I hope you have been fully invested and those numbers on your spreadsheet have been going up and up.

 

Inflation Killers—Credit Card Rebates

NOTE: If after reading this, you would like to apply for one of the credit cards that the Fox family uses to max out credit card rebates, we can send you a link and that lines our pockets with a bit of money at no additional cost to you.  Let me know if you’d like to do that.

We’ve talked about how your cell phones are a great killer of inflation, along with other things store brand groceries and Craig’s List and the sharing economy.  But there’s another product that is totally killing inflation that makes those seem like small potatoes—your credit card and the rebates you can now get.

Back in the day credit cards allowed a convenient way to purchase products without having to carry around a lot of cash.  Eventually competition among credit card companies began to heat up, and by the late 1990s they started offering rebates to card holders on their purchases.

Let’s take a quick look at how credit card companies make money:

  1. They charge interest and fees to those who carry a balance. This is where there is a ton of money to be made.  For the purposes of this post, we’ll ignore this other than saying the Fox family never carries a credit card balance.
  2. They take a cut of all purchases. When you buy something for $10 at the store with your credit card, you end up paying $10.00 for it, but the store only gets about $9.41.  That’s because the credit card processing company charges 2.9% of the purchase plus $0.30 on each transaction.  Most people don’t think about this revenue stream, but it definitely adds up.

 

So obviously to maximize revenue from #2, credit card companies want as many people buying as much stuff as possible on their credit cards.  That leads to competition from the likes of Chase and Capital One and a ton of others, and that competition has taken the form of credit card rebates that over the last 20 years have gotten more and more generous.  Credit card companies are enticing you into using their products by giving you a cut of #2.

My first credit card was a Visa associated with Exxon.  It offered a rebate that could be redeemed for free gas.  It was something like 0.5% of my purchases, but it was better than nothing.  I was already buying gas so once a month I would get something like $12 off a fill-up.  Over the course of a year that added up to maybe $150, not a ton of money but free money nonetheless.  Given that I wasn’t getting that before, that was definitely “deflation” on my gas purchases—SCORE.  Compared to what is offered today, that was just a pittance.

 

Credit card arms race

Fast forward to 2018 and things have definitely become higher stakes.  We are bombarded with commercials where Discover gives you a rebate and then matches it at the end of the year, Capital One gives you a 1.5% rebate on all your purchases, and Chase gives 2 airline miles for every dollar you spend.

Credit cards are even offering one-time bonuses of hundreds of dollars if you sign up and spend a few thousand dollars in the first few months.

It’s easy to get overwhelmed by all the marketing and confused by all the intricacies of the rebate programs.  But there’s gold in them hills.

If you take a few minutes (and that’s really all it is) to understand the different programs and figure out which one is the best for you, it can be thousands of dollars each year in your pocket.  THOUSANDS OF DOLLARS.

 

The impact is huge

I’ve mentioned this a few times, but the Fox family plays the credit card roulette game and last year it amounted to about $4,000 in our pockets.  Given we spend about $120,000 a year on expenses, that’s almost 4% of our expenses each year.

You’re probably not surprised that I look at the impact with a spreadsheet, and when you do the numbers it has an enormous impact.  Let’s genericize it and look at my cousin Savvy Fox.  He’s a 22-year-old who graduated from college making $50,000 per year and spending about $40,000 per year of which 80% is stuff on his credit card.  His only major expense that he doesn’t put on his credit card is his rent (and eventually his mortgage); but for everything else he uses his credit card.  Of course, he pays his credit card off each month to avoid usurious interest expenses.

Over the course of his life his income and expenses will grow 3% each year until he’s spending $120,000 per year (like us) when it flattens out.

At age 22 Savvy spends a total of $40,000 of which $32,000 (80% of the total) he uses credit cards for.  Because he’s savvy with his credit cards, he gets about a 4% rebate on those purchases which is $1,280 for the year.  This is found money so Savvy invests it in and index fund and gets about 8% each year.  If he follows this plan for his entire working life (until age 65), when he retires this little exercise will give him a nice little treasure chest of about $660,000.

$660k for doing nothing more than maximizing his credit card rebates!!!  Go ahead and read that again.  In a world where the average net worth of a person is $80k, this little gambit by itself gives you 8x that.  BOOM!!!

To further illustrate the point, $660k is when Savvy is really savvy with credit cards and gets the 4% rebate.  If he wasn’t savvy and just got a 1% rebate, at age 65 he’d have $165k.  That’s really, really good; twice the net worth of the average American, but still HALF A MILLION less than what he could have.

That should show you the stakes.  Now let’s talk about how you get there.

 

Specifically what the Fox family does

It’s important to find a credit card with the highest rebate.  Right now the ranges from about 1.5% to 2.0%.  But the key is the sign-up bonus.  You can fairly easily get a credit card with a sign-up bonus of $200 and higher, and you get that if you spend something like $1,500 in the first few months.

Our family typically plays this game 2-3 times per year, for both Foxy and me.  So we sign up for a new credit card every few months.  Our normal spending easily gets us to that threshold for the bonus.  So take 3 new credit cards per year times 2 people, and you get a total of 6 new credit cards per year, each of which has a $200 rebate.  Just the rebate gets us at least $1,200.  Add to that 1.5% rebate on all our purchases that we can use a credit card for, let’s say $6,000 per month, and you have another $1,080.  That’s over $2,000 right there of found money.  That gets us to about 3.2%, but we do better.

As generous as personal credit card rebate programs are, business credit card rebate programs are better.  Since Foxy Lady and I hung up our own consulting shingles, we had to set up a business.  Because we have a business we can get business credit cards!!!

At Capital One a typical personal credit card has a rebate of $150 and a 1.5% cash back.  Not bad.  Their business credit card has a rebate of $500 and a 2% cash back.  Much better.  At Chase, they have a business credit card with a $700 rebate (after you account for the annual fee).  Now we’re talking.

You can easily imagine that if Foxy Lady gets two Capital One credit cards per year and two Chase cards, and I do the same, the rebate dollars add up.  I’ll do the math for you—it’s $4,800.  Add to that the cash back which is around 2%, and that’s another $1,440.  We’re getting about $6,200 EVERY YEAR for doing nothing more than using credit cards.  That’s a ton of money that is just sitting out there for the taking.

 

Bringing this full circle, there is a ton of money out there for people who put maybe two hours per year into getting it by playing the credit card game.  That money hasn’t always been there, so that by definition is DEFLATION.  Credit cards can be a huge inflation killer.

If you are interested in signing up for one of the cards we use, if we send you a link we get a bit of a bonus from Chase or Capital One.  If you want to do that, just shoot me an email.

International Perspectives–Venezuela Redux

A few years back I chatted with Alberto, my classmate from graduate school who grew up in Venezuela.  It was supposed to be a post on how people invest when they live in Venezuela.  However, we learned that the idea of investing is very different from what it is here in the US and other rich countries because of the precarious state of the economy . . . and that was in 2015.

Fast forward to today, and the Socialist experiment in Venezuela has gotten much worse, to the point where is it a full-fledged humanitarian crises.  Painting a macabre, funny face on it, people refer to the Maduro Diet (Venezuela’s Socialist president’s name is Nicolas Maduro) where food is so scarce in the country that the majority of Venezuelans have lost about 20 pounds–THAT’S DUE TO STARVATION, PEOPLE!!!

In light of that, it seems in poor taste to discuss economics, but here are a couple comparisons of the current state of Venezuela to when Alberto and I did this post:

 

2015

Today

Official exchange rate

6

10

Real exchange rate (on black market)

700

103,000

GDP per capita (in US $)

$16,769

$15,603

At the time of the interview, Alberto said that inflation was about 700% and was astonished by the number.  Tragically, today it’s around 4000% and that is directly leading to lack of food and medicine that is literally killing children.  Horrible.

Last point, Alberto talked about ways Venezuela could improve and it involved really smart Venezuelans (like Alberto who is one of the smartest dudes I know) staying in the country to turn things around.  Unfortunately, as he prophetically said three years ago, smart and talented Venezuelans are leaving the sinking ship of their own country in droves, and that “brain drain” which was already high in 2015 is now even higher.  There’s no good answer here.

On that note, here is the interview from three years ago:

 

ve

Alberto and Stocky got our MBAs together from the University of Chicago in the 2000s.  He was one of the smartest classmates I knew and went to McKinsey after business school, then to private equity, and now to a big data start-up.  Plus, his Facebook picture is of him and Milton Friedman, so you know he takes his economics seriously.  Alberto grew up in Venezuela and is going to help us with a second installment of International Perspective, by telling us how investing works in Venezuela.

 

Stocky:  Thank you so much for taking the time to educate our readers on how investing works in Venezuela.

Alberto:  I’m happy to.  After reading this, they might come to appreciate how not-screwed-up things are in their own country.

Stocky:  Wow.  That’s a certainly enticing.  So how do Venezuelans approach investing.

Alberto:  Sadly, the biggest goal for most people is to get their money out of Venezuela and into the United States.  Once their money is in the US, then they can invest it in bonds, real estate, etc.

Stocky:  Wait.  What?  That doesn’t make sense.  Why would they do that?

Alberto:  The Venezuelan economy is so screwed up (thanks to decades of socialist economic policies, which were then turbo-charged by Hugo Chavez and his cronies in the last 16 years).  There really aren’t capital markets to speak of, so you can’t invest in stocks.  Also inflation is about 200% (the government claims 60% but no way it’s that low, even though they stopped publishing any sort of figure on the subject several months ago).  Although you can get maybe 15% interest in a savings account (which seems really high at first), you’re losing a ton of money due to inflation.  So people want to get out of Venezuelan bolivars and into US dollars.

Stocky:  Man.  That’s pretty different from maximizing your 401k or investing in index mutual funds, like we do in the US.  So how do people go about moving their money to the US.

Alberto:  First, Miami is the destination for maybe 90% of all the money leaving Venezuela.  It’s good because it’s geographically close, it has a very strong Latin American community, and there are a lot of ex-patriots from Venezuela.

Stocky:  Isn’t that where Tony Montana from Scarface lived?

Alberto:  Yeah, but he was Cuban, not Venezuelan.  Since Venezuelan law doesn’t allow people to take their money out of the country, it leads to a black market.  So your average Venezuelan with money will send bolivars to a “money exchanger” who will take that, convert it into US dollars, and then deposit that money into a US bank like Chase or Citi or any other bank like that.  It’s all done at the black market exchange rate which is about 700 bolivars to the dollar; although the “official” exchange rate according to the government is 6 bolivars to the dollar.

Stocky:  That sounds pretty “cloak and dagger”.  Is that safe?  I could imagine crazy stories of people getting ripped off with stuff like that.

Alberto:  Yeah, sometimes people get ripped off, but these black market transactions have become so common that pretty much everyone knows someone who does this.  Maybe it’s your uncle or your dad’s best friend or someone like that who will handle things for you.  That’s pretty common.

When you start working with someone, you start small.  Maybe $500 worth, or something like that.  After you see if they are honest, then you can give them more and more money.  Through it all, people just want to get as much money out of the country as possible because the economy is in freefall.  So I suppose they’re willing to take on a fair amount of risk.  If you tried to move your money and lost it that sucks, but if you keep it in Venezuela you’re pretty much guaranteed that you’ll lose it to hyperinflation.

Stocky:  Ouch.  Once people get their money to the US, how do they invest it?

Alberto:  Mostly it’s either in CDs or bonds, or those who can afford it will buy American real estate.

Stocky:  I spend a lot of time talking about asset allocation and how people should invest in stocks and not too much in bonds.  It sounds like these people aren’t listening to my advice.  Who would do such a thing?

Alberto:  Surprisingly, www.thestockyfox.com is not the #1 website in Venezuela, at least not yet.  I think there are a couple reasons behind that.  First, remember that the goal is getting the money out of a country with hyperinflation.  If people can make 2-3% with scant inflation by moving their money to the US, that’s a nice win for them.

Second, most Venezuelans, even most upper-middle class ones, are not that financially literate.  Learning the intricacies of investing, asset allocation, the differences between stocks and bonds, etc., just aren’t that high of priorities.  So once people get their money to Miami, they just choose a pretty simple investment which is a savings account or bond.

Stocky:  After the money is in Miami and invested how do people get it back to Venezuela.  After all, isn’t the whole point of investing so you can take money today, let it grow over time, and then spend it on your needs tomorrow?

Alberto:  That’s an interesting point.  I don’t think most people are giving much thought to bring the money back home.  People are waiting to see what’s going to happen to the country.  Politically, and therefore economically, Venezuela has been a crazy roller coaster.  When Chavez took control in 1999 he implemented a ton of social reforms that turned the economy on its head.  When oil prices were high, we could afford to do that, but now that oil prices have come way down, things are pretty bad.

Because of all of that, I think people are just waiting to see what happens to the country.  If there is a miracle turnaround like what happened in Colombia or better yet Chile, then people will see a future in Venezuela and bring their money back to spend.  However, I’m not optimistic, and if things continue to stay bad, I think people with the means will look to leave the country and join their money in the US.

Stocky:  That’s just crazy.  What do people do who can’t move their money abroad?

Alberto:  It’s really, really sad.  If people can’t move their money out of the country, you end up with some really bizarre economic activities.  Some people will invest in things like appliances.  Literally, it’s not uncommon to buy something like a washing machine with the intent to sell in.  Let’s say you buy one for 20,000 bolivars, use it for a couple years, and then because of inflation you can sell it for 50,000.  You made money plus you got the use of the appliance for a while.  Had you just kept that money in cash, you’d end up with much less.  There are active secondary markets for appliances, cars are a big one, really anything that you can buy that is durable.

Stocky:  Are you serious?  We had a mailbag question from Ally about investing in consumer electronics, and the idea just seemed so crazy to me.

Alberto:  You’re right, it is crazy, but that’s the reality in a country where the economy is just strangled by inflation.  Consider yourself lucky that you’re from a country where you’re pretty confident that your dollar will buy something very close to a dollar’s worth of stuff next year.

Stocky:  You’re painting a pretty grim picture of Venezuela.  What do you think the future holds for your home country?

Alberto:  It pains me to say that I’m just not confident.  Maybe you could have a massive turnaround like what happened to Chile in the 1970s of even Col0mbia in the 2000s, but I think the socialist government is so entrenched, and the magnitude of the brain drain has been too large for things are going to get better any time soon.

You’ll continue to have money flow out of the country as fast as it can go, but even more troubling is that you’ll have the most talented people leave.  Back at school there were probably a dozen of us Venezuelans who were getting our MBAs from one of the best schools in the world.  None of us went back home because there just aren’t any opportunities.  But for Venezuela to succeed it needs people like us to go drive change.  It’s a catch-22: change won’t happen without smart and capable leaders, but the country is so screwed up that all those people leave.  It’s not a good situation.

Stocky:  On that happy note, I want to thank you for sharing how things work in Venezuela with us.

Alberto:  Thank you.  Venezuela had a lot going for it when I was a child, but unfortunately, the government has thrown a lot of that away, and mortgaged the country in the process.  I hope that things do get better, I truly do.

 

For all my international readers, I plan on doing more of these types of posts that tell us how investing works in different parts of the world.  If you would be interested in sharing how it is done in your country, please contact me and we can set something up.

Keeping up with the Jones . . . financially that is

 

Quick story

Los Angeles is a pretty bizzaro place in general, and this is especially true when it comes to personal finances.  Houses are so expensive, that it’s hard to understand how people do it.  Also, there’s a culture of conspicuous consumption that pervades everything; everyone looks like they’re spending a ton of money (and often they are).  A friend once very wisely said “In LA the BMW 3-series is what Honda Civic is to the rest of the country.”

Foxey and I both had good jobs, were saving a lot, and thought we were “making it”.  Yet, in a lot of ways we looked like the “poor” people on the street.  Our house was fairly average looking, we mowed our own lawn, we both drove old cars (a 1998 Toyota 4-Runner and a 2001 Honda Civic), and in general we had a humble existence.  There seemed a disconnect, and it took an emotional toll.  We were working so hard to save but it didn’t seem like it was making an impact.  Everyone else “looked” richer than we.  What gives?!?!

One day we were at a party, talking to a neighbor who was a mortgage broker.  The neighbor had a few glasses of wine in her and mentioned that she did the mortgages for several people on the street.  She didn’t violate anyone’s confidentiality, but she made a general statement that “you would be shocked at the shit-show that is most of our neighbor’s finances.”  She left it at that.

We’ll come back to this in a second.

 

Looking at the data

According to the US census, the median net worth for an American is . . . $80,000—and that includes home equity; if you strip out home equity it falls to $25,000.  Since this is an investing blog, and also since you know I don’t think you should rush to pay off your mortgage, let’s just look at net worth excluding home equity.

If your first reaction toggled between “that can’t be right” and “that’s really low” and “Holy Crap!!!” then you’re in good company—that was my reaction. My other reaction was “a really large percentage of their net worth is in their home, and that’s no good.”  But that’s a topic for another post.

The Census Bureau breaks it down every which way.  I think the most interesting is by age:

Age Net worth—with house Net worth—without house
Less than 35 years $6,900 $4,138
35 to 44 years $45,740 $18,197
45 to 54 years $100,404 $38,626
55 to 64 years $164,498 $66,547
.65 to 69 years $193,833 $66,168
.70 to 74 years $225,390 $68,716
.75 and over $197,758 $46,936

 

There’s an obvious trend that you would expect.  As you get older your net worth grows, peaks in your older years, and then towards the end starts to fall as you spend your nest egg.

 

People don’t like showing their rear-ends

How do you reconcile all this?  The obvious answer is that, sadly, many people live way beyond their means, showing off a glitzy façade while the financial foundation is completely rotted.  Back in LA, I am certain that we had a net worth higher than nearly all our neighbors.  We certainly had cars crappier than all our neighbors.  We were certainly one of the very few (only?) that mowed our own lawn.

No one wants to “seem” poor, especially when they aren’t.  As I said, it took a bit of a toll.  Fortunately, Foxey and I have good, midwestern roots and were raised to save a big part of our income.  But that’s no fun.  I’m a bit of a freak so I actually derive a lot of pleasure from buying index mutual funds and watching numbers on a spreadsheet get larger.  Foxey is much more normal, and enjoys buying actual things rather than just socking the money away.

Our neighbors, on the other hand, were not saving as much as we were.  If you believe the mortgage brokers comments, many were spending much more than they were making, and weren’t saving at all.  Looking at the national data, they had that in common with much of America.

I don’t want to seem as though I don’t think $100,000 is a lot of money.  It definitely is, but it doesn’t seem like a lot over a lifetime of savings.  Yet, that $100,000 is significantly more than most Americans have saved.  I’m guessing it is probably more than many had on our street, despite all outward appearances seeming to indicate otherwise.  It just seems weird and sad.

 

The point of all of this is that it’s good to know how much you have saved.  Hopefully, one of the things you get from this blog is how to take stock of where you are and what your plan is to achieve your financial goal.

It’s also good to put your savings into perspective.  Saving money is HARD work, especially emotionally given that we live in a world of conspicuous consumption where we are inundated, in the words of Tyler Durden: “Advertising has us chasing cars and clothes, working jobs we hate so we can buy shit we don’t need.”

It may not always be apparent, but I think it’s always worthwhile.  Amazingly, and very sadly too, just doing a little bit of savings over a long time will put you well ahead of the average American.  Take a look at those median values again—it’s sobering.

Maybe all of us savers need a special handshake or something so we can know that we aren’t alone.  I hope this post makes you as a saver feel that you aren’t alone and that it is worth while.