Month: February 2018

Should you use an investment advisor?

Stocky 2 Comments

I started writing this blog because I wanted to share my own experiences with investing, including how to navigate the complex world of investing on your own.  I am a firm believer in DIY financial management.  That is what worked for me, and I believe all people can get really great results doing it on their own.  That said, many readers ask about using a broker or investment adviser or financial planner.  Here’s my take.

Quick disclosure: I am an investment adviser.  I passed my Series 65 and work with a small number of friends, helping them with their finances.

 

Are financial professionals worth it?

As with any purchase you make, you need to evaluate a investment adviser on the basis of how much she costs, and how much value you get in return.  On the surface I would say “no, it probably isn’t worth it,” however there are definitely some factors which may reverse that decision.

First, let’s look at how much investment advisers cost.  The rates range widely.  Plus there isn’t a lot of transparency in the marketplace so it’s not always easy to know what the going rate is.  My experience says that 1-2% is typical.  This can come in many forms—typically brokers get paid fees from the mutual funds they suggest for you or from the transaction costs for trades.  Advisers tend to charge a percentage of your portfolio.  We know that 1% coupons are really valuable, so those fees are a lot.  Over an investing career they can add up to hundreds of thousands of dollars.  That’s a pretty big deal.

Of course, if you’re getting a lot of value from your investment adviser, maybe it’s worth it.  I just bought Metallica tickets today and they were expensive, but I’ll get a lot of value, so there you go.  One of the main missions of this blog is to show you how you can invest successfully on your own, and I think most people can do that without having to hire a professional.  Sure you have to make decisions on asset allocation, which accounts to use, what investments to make; but those aren’t really all that complex.  Also, thanks to the efficient market lessons from A Random Walk Down Wall Street we know that you’re as good a stock picker as anyone.

So my general feeling is that investment professionals aren’t worth the money; a motivated investor can do just as well on their own and pocket the fees.  Wait, what???  You said “motivated”.  As it turns out, a lot of people, despite their best intentions, aren’t able to put their financial plan in motion.  If you’re one of those people, and if an investment adviser can help motivate you to do the right things, then I do think they are more than worth it.

In this way, investment advisers are a lot like personal trainers.  Most of us know that exercise is good for us, and most of us know how to run on the treadmill and lift weights properly (or you can find out by watching a 3-minute video on Youtube).  But if a trainer can motivate you to actually hit the treadmill and the weights, they’re definitely worth the money, right?  How much is your physical health worth to you?  Same thing with finances.  If you know what you should be doing, but for one of a million reasons you never end up actually doing it, maybe you should get an investment adviser to help you out.

Nearly every post I’ve done shows that there is a ton of value out there if you invest properly, taking into account things like time horizon, taxes, etc.  But if you don’t do anything, you’re losing ALL that value.  If an investment adviser helps you in ways you won’t or can’t, then you’ll probably end up ahead of the game, even after you take his fees into account.

 

How would you pick a financial professional?

So let’s say you’ve decided that an investment adviser makes sense for you.  How do you pick a good one?  This is one of the biggest challenges, and in my opinion one of the reasons a lot of people don’t get investment advisers: They don’t know a good one they can trust.  The problem is there are a ton of them and the quality varies greatly.  Sadly, there are a lot of unskilled people in the industry who don’t know what they’re doing.  Even worse, there are some real shysters who might take your money, either overtly steal it or use other schemes to siphon away your money and put it in their pockets.  It’s a legitimate concern.

First, you need to find someone you can trust.  Ideally, this would come from a personal reference.  Today you also have things like yelp.com or Angie’s List that gives ratings.  Additionally, there are government agencies like FINRA.org that track these people so you can look them up to see how long they have been around and any complaints that have been files against them, etc.  These are okay, but for my money, nothing beats a personal reference from someone you trust.  Of course, it’s not always easy to have those conversations with friends: “So Mary, who is helping you with your money, and can I talk to them?”

Second, you need to find someone who is good.  Of course, knowing this isn’t always easy.  Using that same personal trainer analogy, you probably wouldn’t hire an obese trainer.  You’d want someone who is ripped, someone who has shown they have been successful at physical fitness themselves (like my totally buff friends Christel and Tobias).

Tobias
If you have a personal trainer, he should be ripped like Tobias here. Similarly, if you have an investment adviser, that person should be rich.

 

Similarly, you want a rich investment adviser.  You want someone who has been successful creating wealth for themselves.  But this is where the challenge comes in: if the investment adviser is wealthy then why is he working with you?  Seriously.  You have a lot of young kids who are doing this (let’s say less than 30).  I’m sure there are some good ones, but I’m not trusting my family’s financial well-being to someone without a lot of experience.  You also have a lot of people who just aren’t that good.  If someone has been an investment adviser for 20 years or more and they aren’t a multi-millionaire, how good can he really be?  I’m not trying to be mean, but shouldn’t that be more than enough time to accumulate some serious wealth?

 

Questions to ask:

If you do decide to go with a investment adviser, make sure you ask a lot, A LOT, of questions.  Beyond your doctor or minister/rabbi, this person will probably have the biggest impact on your well being.  Take the time to make sure you find a good one.

How long have you been doing this?  This is an area where experience definitely matters.  In particular, you want her to have lived through a few bear markets.  At a minimum she should have been doing advising people since 2008 and even better if she’s been doing it since 2001.

What did you do during 2001 and 2008?  Investing is a lot easier when things are going well.  You prove your mettle during the tough times.  Figure out how he handled himself when everyone thought the world was coming to an end.

What are you paid?  This should be answered in excruciating detail.  Does he get paid by you (how is the amount determined, when is it paid), by others like mutual fund companies (how much, how do you make sure you serve my interests ahead of theirs)?

What is your personal financial situation?  No point sugar-coating it.  Find what his financial situation is like.  As mentioned above, if he isn’t rich, how good is he really?  Also, the relationship you have with him needs to be based on trust because you’re going to be sharing everything with him.  If he isn’t willing to reciprocate in some way, that might tell you something.

How will you ensure you serve my best interests?  This is a biggie.  Ideally you want her to have a fiduciary relationship which is a legal standard where she serves your interests ahead of anyone else’s, including her own.  No matter how this turns out, you’re going to need to trust this person, and you should get a sense of how she will ensure that you are #1.

What is your investing strategy?  Obviously, there are a lot of nuisances to this, especially as he customizes it to your specific situation.  But he should definitely have an approach and a philosophy that he can articulate clearly and understandably.

What type of power will you have over my money?  Will she be able to make trades and move money between accounts with your express permission, on her own, or not at all?  This is a tricky one because maybe you want to offload these activities completely, so her having a ton of control may be okay.  No matter, you should definitely understand this completely.

How will you take into account other assets that you won’t manage?  Most situations will have him managing an account like your IRA or brokerage account but not others like your 401k, mortgage, pension, etc.  Most times, he’s only paid on the accounts he manages, but to do his job well he’ll need to take into consideration those other accounts as well.

 

Those are what I came up with off the top of my head.  At the end of the day, if you do go with an investment adviser make sure you find someone who has demonstrated they have the skills to build your wealth.  Just as importantly, make sure you find someone who you can trust completely.

 

Driver-less cars impact your decisions now

Stocky 2 Comments

I don’t think there’s any doubt that driverless cars are going to change the world.  They’ll be safer, cleaner, more efficient, eliminate/reduce traffic jams, and on and on.  The future looks bright . . . but what does that have to do with today?

The big question isn’t if but when.  A few years back Google and Uber and GM and everyone else were figuring out prototypes, and putting them on the road in a very limited way.  They told us not to get too excited—driverless cars wouldn’t become mainstream until way in the future: Think 2030 or 2040 when they became standard fare.

Yet that seems to have inched significantly closer.  Tesla today has driveless cars.  GM claims it will sell cars without steering wheels and pedals in 2019—THAT’S NEXT YEAR PEOPLE!!!

But back to the question at hand: what does that have to do with today?

 

Buying a car has big financial implications

Purchasing a car is a big deal that can greatly impact your personal finances (finally, Stocky, you’re getting to the point).  Getting that right or wrong can mean hundreds of thousands or millions of dollars.  Let’s really simplify the world to two scenarios:

  1. The Stocky method: You buy a car new, finance it at the teaser rate, and drive it until it goes to heaven.
  2. The Ocelot method: You lease a car and then turn it in after 3 years.

Certainly there are other options (1a—you buy a three year old car and drive that into the ground), but let’s just look at these two.

As you would expect, from a financial perspective option #1 wins big time.  A “typical” car like a Honda Accord costs about $22,000.  You could buy it for $2,500 down and then take advantage of 1% APR financing so you’ll have monthly payments of $332 for the next 5 years.  Or you could lease it for $2,500 down, and then pay $200 per month for the next three years; after which you turn the old car in and start it all over again.

Cars are engineered incredibly well, so let’s assume the car you buy lasts 24 years (I am the proud owner of a 1998 Toyota 4Runner).  If you run the numbers, buying a car comes out ahead to the tune of about $90,000.  That’s astounding considering the original purchase is only $22,000.

Bear in mind that’s $90,000 per car each time you make a purchase/lease decision.  For a married couple, it comes to about $800k over their investing horizon.  Remember that the average American has a net worth of about $80,000.  Heck, if you didn’t save a dime in your 401k or do any of the other stuff we talk about, just the car purchase decision could fund your retirement.

Of course, it’s not a perfect comparison.  The major advantage of a lease is you get a new car every three years—that’s a safer car, a nicer car, plus the option to change the car as your situation changes.  But $800,000 is $800,000 after all.

The point is that financially it makes a lot more sense to buy a car than lease.

 

Driverless cars completely changes the car purchasing decision

Let’s bring this full circle now.  We’re on the brink of driverless cars changing everything.  Once they come out, you’d be crazy not to go with that option.  In fact, I think car insurance will make it much more expensive not to use driverless cars, and before too long human-driven cars will be banned (the same way horse carriages are banned on highways today).

We’re definitely in the kill zone.  Foxy and I are wondering how much longer the 4Runner has—I say many more years but I think she secretly tries to put sugar in the gas tank to kill it when I’m not paying attention.

If we had to get a new car today, what would we do?  Normally it’s a no-brainer: you buy a new car and drive it forever.  However, for that decision to make sense you have to drive that car for years.  Actually, the breakeven point is at about 8 years.  Is there any doubt that by 2026 we’ll have really good driverless cars?  At the rate things are going, we’ll have them in 8 months, not 8 years.

Futurists make a really exciting debate about what the future of cars will look like.  Personally, I think ‘Lil Fox and Mini Fox will never own cars.  Rather they’ll subscribe to a service similar to your cell phone: for $300 per month you get your 16-mile work commute (with up to 2 other commuters, 2 minute max wait time) plus 500 miles of other driving in a 4-person sedan (with up to 100 miles in a minivan or SUV).

That will fundamentally change things like car insurance, garages (both at home and parking structures), and a million other things.  And I bet it’s a lot sooner than we think.  Bear in mind, 5 years ago, everyone was saying driverless care are decades away; now GM says it’s a year.

In the meantime, we have to still get to work and pick up groceries and take the kids to baseball practice today.  How does all this impact what you want to be a sound financial decision if we have to get a new car today?

 

The verdict—lease your next car

While this pains me to say, I think the best financial move for your next car is to lease.  Who would have thought I would ever type those words?

If you buy, in 10 years or so you’ll be just getting ahead on your financial decision, but you’ll be sooooo behind the times plus be a bit of a hazard on the road.  Imagine hanging out with your friends as they take selfies and you pull out your Blackberry.

Going all in with stocks

Stocky Leave a comment

buried-money

With the recent craziness in the stock market, I’ve chatted with friends about how much of their portfolio should be in stocks.  Actually the conversation goes more like:

THEM:  I am about 50% stocks, 50% bonds.  How does that sound?

ME:  50% stocks and you’re 41 years old, and you have a good job?!?!?!?  Are you crazy?  That’s way too conservative.

THEM:  But I don’t want to be too risky.

ME:  You have a lot of safe investments that you probably don’t even know about.  The investments you can invest in stocks you should so you can get the higher return over the long term.

THEM:  ??????

 

So here is what I am talking about–the hidden cash in your portfolio.

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?

1 m

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 worth 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 ($900k * 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.

Market dips are awesome?!?!

Stocky Leave a comment

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

Stocky 1 Comment

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

Stocky 1 Comment

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)

Stocky 2 Comments

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.