Stocky – Page 10 – The Stocky Fox

You missed the boat

October 16, 2017October 16, 2017 Stocky Leave a comment

We all know that stocks have been on an absolute tear lately (that’s the reason I’m smarter than a Nobel Prize winner). In fact, if you look at 11 months since Donald Trump was elected, stocks are up about 20%.

On election night the S&P 500 was at 2140 and now it’s at 2550. It’s blown through major milestones like 2200, 2300, 2400, and a few weeks ago 2500; all in fairly short order. If you are fully invested you’re loving it and obsessively looking at your spreadsheet to see how your net worth is climbing (okay, maybe that’s just me).

If you aren’t invested, this is a definite missed opportunity. There are a couple ways you can go with that:

Just don’t invest because you feel you missed the boat already.
Go all in now to not miss any more.
Hold off to wait for the market to fall again, and then invest on the dip.

As you can probably guess, I think #1 is a bad idea and I would recommend #2. However, what about #3?

Waiting for the downturn

We all know that stocks have been on an unrelenting upward path. The S&P 500 started at 17 in 1950. Today it is over 2500. Of course, it’s never a smooth path. You’ve had bumper years like this one, really since 2008, all of the 1980s and 1990s, etc.

You’ve also had your downturns. Some have been long grinds like the 1970s while others have been sharp like the Great Recession. However, even with those, we’ve definitely done well. That said, if you missed out on a good run, should you just wait for the next downturn to get back in?

First, I believe that it’s impossible to time that well. But let’s say your crystal ball is working really well. How often will stocks fall back so you can get back in at the lower levels you missed before?

I looked back at the S&P 500 since it started in 1950, and I looked at all the major milestones for the index. On January 1, 1950 it started at 16.66, so the first major milestone was 20. It passed that level in Oct 1950 and it never looked back. Never again did you as an investor have a chance to get in at 20*.

Same story for milestones 30, 40, and 50. In the 1950s the stock market did its relentless march, and every time it passed those levels they were never seen again.

It was a different story in the late 1960s and early 1970s. A MAJOR milestone was hit in June 1968—100 on the S&P 500. You could imagine this was accompanied by the usual fanfare of surpassing such a level. The 1970s proved a lousy time for stocks, and the S&P 500 had major moves above and below 100 eleven times. That’s a lot. It wasn’t until the Reagan bull market of the 1980s that the stock market broke the trend.

For milestones 150, 200, 400, and 500 there were no pull backs (300 had a pullback thanks to the crazy one-day plunge in 1987). So again, just like the 1950s, the 1980s and 1990s had a stock market that just blazed through, and if you missed it you missed the boat. Never again would those levels be seen again.

Milestone	First time	Revisited
20	Oct-50	0
30	Jul-54	0
40	Jun-55	0
50	Sep-58	0
75	Dec-63	2
100	Jun-68	11
150	Mar-83	0
200	Nov-85	0
300	Mar-87	2
400	Dec-91	0
500	Mar-95	0
750	Nov-96	0
1000	Feb-98	3
1500	Mar-00	6
2000	Aug-14	3
2500	Sep-17	0

Since the 2000s we’ve crossed four major milestones—1000, 1500, 2000, and most recently 2500. All of those were revisited, mostly due to the Great Recession where the S&P fell from about 1565 all the way down to 670.

Since the Great Recession, the market has been blazing, but it’s been crazy in the process. The market cleared 2000 in August 2014, but has gone through some brief downturns with fast recoveries like January 2016. I think more recently we’ve experienced greater volatility in the market, so revisiting might be more common.

Bottom line

That was a gripping history lesson, but what does that mean we should be doing now? Overall, I think the data shows that stocks always go up. Sure there will be bumps, but if you invest now, the data shows that, at least based on history, you’ll make money.

On the other hand, despite this crazy good bear market recent years, there have been revisits of these levels. Are we going to see the S&P 500 at 2000 again? Maybe. Based on recent history, I wouldn’t be surprised. However, I certainly wouldn’t bet on it. I mean that in the literal sense—I wouldn’t wait to invest my money until I saw a market downturn. I think it more likely things will keep cranking along and 10 years from now we’ll remember the good ole days when the S&P was at 2500 the same way we think about $0.10 hamburgers from McDonald’s.

You might have missed this boat, but you don’t want to be on the sidelines when the next boat (S&P 500 at 3000) comes around and miss that one too.

* I defined “revisited” is going under the milestone at least 100 days after it passed it. This is to keep from counting times when it gyrates above and below the milestone over the short term. For this we wanted to look at times where the market was comfortably above the milestone and then at a later time period fell below it.

Vacation homes—don’t do it

October 12, 2017October 21, 2017 Stocky Leave a comment

Summer has come and gone, and it’s one more year that I haven’t surfed a 15-foot wave. I blame the move from LA for a lot of that because I just can’t get out to the ocean as often as I need to (now we’re about 3 hours from the Atlantic).

The obvious solution is for Foxy and I to get a beach house. This is something we have talked about seriously, off and on, since we moved to North Carolina over two years ago. The clear benefit is we would have an awesome second home on the Atlantic Ocean: it would be beautiful and peaceful and a blast for the cubs as they grow up, plus the SURFING.

Why wouldn’t we do that? As with many things the answer is—cut to Stocky rubbing his thumb and middle finger together—money. It would be a huge expense, but just because something costs a lot doesn’t mean it’s not worth it. After all, vacations and leisure time are very important. We’re fortunate that it is a possibility for us.

Ultimately, I think vacation homes tend to be lousy ideas for most people because of two main reasons: 1) They are expensive compared to other options. 2) They really limit what you can do (or want to do) for vacations.

Breaking down the numbers

A vacation house is typically not cheap. Let’s say a decent beach house right on the water would cost $500,000. Definitely they can vary widely in price, but we’ll see that the price really doesn’t change our calculations.

Based on some of our recent blogs, we know that you’d typically buy a house with a mortgage, although vacation homes have mortgages less frequently than primary residences. For simplicity’s sake less assume we bought it outright (again, this won’t really impact our decision). If we sink $500,000 into a vacation house that means we wouldn’t be able to invest it at a market average of about 7%. That comes to about $35,000 per year.

Also, owning a vacation home comes with considerable costs. There’s property taxes—let’s say $4,000 each year. We’d also have utilities, including luxuries like internet and cable—we’ll put that at $500 per month or $6,000 annually. Then, because the ocean is such a harsh environment you have a lot of upkeep. Air conditioners rust, wood needs to be restained, and on and on; I asked a neighbor who used to live on the beach and they said that was probably another $5,000 annually AT LEAST.

The expenses come to $15,000 a year plus the investment potential at $35,000 a year, so now we’re talking $50,000 annually. My, oh, my. What we could do with $50,000? More on this in a second.

Of course, as we talked about a lot in looking at rental properties and your house as an investment, there are some upsides. Our beach house could appreciate, but national averages put that at about 0.4% annually, so that comes to about $2,000 each year. Not a big deal.

Plus, I think (I haven’t found a lot of hard data on this) prices for vacation homes are much more volatile than primary residences.

Also, we could rent it out. That’s what most people do with vacation homes. There are some major risks with that. Best case someone else is putting their butt on my toilet seat. Worst case is someone turns my slice of heaven into a meth lab.

The fun we could have

If we look at all the calculations above, we can simplify it to thinking we have $50,000 annually on vacation. Think of all the things we could do with $50,000.

If we were super committed to the beach to fulfill my surfing dream, we could rent a place on Airbnb.com. After a few minutes of searching I found similarly sized places to the one that cost about $500,000 which are also right on the beach. We could rent those for $6,000ish for the month of July. Throw in June and August, and we could rent a beach house for the entire summer for $18,000. If you annualized that $6,000 per month it comes to $72,000 which is more than the $50,000 we were saying owning a beach house would cost, but there are some problems with that.

Since it’s a beach house aren’t those three summer months really the most important? Honestly, how often would you be going to the beach in November or March? Maybe a little bit but probably not that much.

You could imagine a similar scenario with a ski cabin in the mountains. You’d love it during the winter months when the snow was there, but the other times probably wouldn’t be as awesome.

Oh, and there’s that little thing called . . . the cubs. We have two little cubs who have school and friends and all that. So it’s not realistic for us to be away from home during the school year. Maybe we could pull off a whole summer away at a beach house, but if it was a mountain cabin how often could we spend there?

Add in things like sports, friends’ birthday parties, boy scouts, and on and on. It just doesn’t seem realistic that we could spend enough time there to justify the $50,000 cost. That leads to the idea of renting it out when we don’t want to be there, that creates a conundrum too.

We’d want to be at our vacation house during the best times (summer months, holiday weekends) when the rental demand would be the highest. We could get high rents during those peak times, but then that kind of defeats the purpose of US having the place. We could rent it out when we didn’t want to go (think March), but that’s when most other people wouldn’t want to go either. You can see the problem.

There’s a huge connection between the amount of time we’d spend at the beach house and the “goodness” of the decision it would be to buy—the more time we spend the better it would be to purchase. We just talked about how it’s not really realistic to spend all our time there or even most of our time there. For a beach house you’d probably max out at all three summer months, and maybe 5 weekends scattered throughout the rest of the year. That’s the absolute most.

Call that a total of 18 weeks or 4.5 months, and that’s really pushing it. At $6,000 per month (which is inflated because that is all high season), your rental expenses would come to $27,000 a year. Doesn’t look good.

Tied to an anchor

In some way, if we bought the beach house it would seem like a sunk cost. We’d be paying for it whether we spent time there or not. That would really motivate us to spend every possible moment there, certainly every vacation there.

Yet, that would be a bit of a miss, no? Beaches are awesome, but what if we wanted to spend a week in the summer visiting Mimi and Grandpa Ocelot in Michigan? That’s a week we wouldn’t be at the beach house. Or Disney, or going up to the mountains, or a trip to Washington DC or California. Just owning that place would put us in a weird spot where we would feel we’d have to go there all the time even if we wanted to go somewhere else.

Now if we rented, we could go to the beach when it suited us but also anywhere else that caught our fancy. Plus, apparently there is more than one beach in the world. If we rented we could go to the beach we would have bought at, let’s say Surf City, but also Virginia Beach, Myrtle Beach, Nags Head, Florida, and on and on. I understand that going to the same place would be nice to get comfortable there, but variety is the spice of life too.

For those main reasons, I think that a vacation home for us doesn’t make sense. It’s too much, and it ties us to one place. But I do think there are situations where it does make sense.

If you don’t have little kids, a vacation home makes a lot more sense because you don’t have your calendar dictated by school. After kids, we could spend the summer months at our beach house but also April and May and then September and October. Those are beautiful months to stroll on the sand and watch the sun rise over the water.

Plus, as you get older I think you tend to shift from wanting to see a lot of different places to knowing what you like and just wanting that. My in-laws, Mimi and Grandpa Ocelot are at that stage. As an example, they have gone to the same timeshare in Florida ever since I’ve known them. They like the place, like the people, know there won’t be any surprises or anything.

For someone like them you could imagine a vacation home would make sense. It’s predictable and they could spend enough time there to justify the costs. Just for Foxy and me, at our age, when we still have an itch to see a lot more of the country and the world, plus with two little cubs, I think you can get a lot more bang for your vacation buck buy NOT buying a vacation home.

Congratulations to Professor Thaler

October 9, 2017October 9, 2017 Stocky Leave a comment

Today, Richard Thaler won the Nobel Prize in economics. Professor Thaler was one of my professors at the University of Chicago.

I know I openly questioned the value of a college education, and I still stand behind those posts. However, as I look back on my own life, the University of Chicago has played such a monumental role. It springboarded my career, allowing me to make a healthy income that permitted me to retire in my mid-30s. It had such a rich and vibrant learning environment which really changed the way I looked at, and continue to look at, the world. Oh, and I also met my wife there.

Don’t quote me on this, but I believe that the University of Chicago is home to more Nobel Prize winners for Economics than any other institution. When I was there we had two laureates on the faculty—Professors Becker (1992) and Fogel (1993). Since I graduated, two professors who were on faculty at the time have won: Fama (2013) and today Thaler.

We can’t forget Coase (1991), Scholes (1997)—yes, he’s the guy who developed the Black-Scholes pricing model which is how pretty much all options are priced now, and Miller (1990)—any intro to finance course spends extensive time on his M&M models. Let that sink in for a minute—a UofC professor won the Nobel Prize in four consecutive years from 1990 to 1993.

Now get ready for the big guns. Stigler (1982) and the most important economist of the 20^th century, Milton Friedman (1976).

That’s a pretty incredible collection of the smartest economists in the world all in one place. It was very humbling to have learned from such world-changing people. I am thrilled that Professor Thaler’s amazing contributions have been recognized at the highest level.

You only need three investing ingredients

October 5, 2017October 5, 2017 Stocky 2 Comments

“Less is more” –Robert Browning

The fine people at McIlhenny make Tabasco sauce, one of the most popular condiments in America. Can you guess how many ingredients go into their sauce (you might have an idea from the title of this post)? You guessed it, three: peppers, vinegar, and salt. That’s it. Nothing else. Only those three. In investing you can take a similar approach. In a world where there are thousands of stocks to pick from, thousands of bonds, tens of thousands of mutual funds, how do you pick which ones to go with?

Let’s break this down one step at a time. First we know from Asset Allocation that our portfolio needs some stocks and some bonds. That’s at least two different investments—one for stocks and one for bonds.

Second, we know from Diversification that we should be . . . well, diversified. There are a ton of mutual funds out there that can give us plenty of diversification with the stock market. I personally like either the Total Stock Market Index from Vanguard (VTSMX) or the Spartan Total Market Index from Fidelity (FSTMX). But wait, those are all (or very nearly all) US stocks. To be really diversified don’t we need international stocks as well? The answer is an unequivocal “YES”. So let’s add a highly diversified international stock mutual fund like Vanguard’s Total International Stock Index (VGTSX) or Fidelity’s Spartan International Index Fund (FSIIX).

With a broad US stock mutual fund and an international mutual fund, you pretty much own a small sliver of every stock in the world. Add to those two mutual funds a bond mutual fund like VTSMX or FBIDX, and you have your three ingredients, just like Tabasco sauce.

Can it really be that easy? I say “yes” but let’s look at some of the objections you might have:

What about an international bond fund?

Fair point. We have an international stock fund to give us diversification for our US stocks. Shouldn’t we have an international bond fund for a similar purpose? Maybe.

I don’t because bonds are such a small portion of my portfolio right now (less than 5%), mostly due to the stage of our lives that Foxy Lady and I are at. So I don’t think it’s really worth the hassle. When we get older and Asset Allocation dictates that a larger portion of our portfolio should be bonds, then having two bond funds might make a lot of sense from a diversification perspective.

Why not use a total world fund?

Vanguard does have a total world stock index fund (VTWSX) that combines both US and international equities. You could imagine just having this one mutual fund for stocks instead of two (a US fund and an international fund). That’s reasonable and knocks your ingredient list down to two.

Yet I choose not to do this because I am cheap. The total world index fund as a management fee of 0.27%. That’s low but the management fee is 0.17% for Vanguard’s US fund and 0.22% for their international fund. Shame on you Vanguard!!! Why are you charging more when you combine them. It’s not a ton, but we know that even increasing your returns a small amount like 0.05% can still be thousands of dollars over the years.

Why not use a target date fund?

You could do a total one-stop shop using a target fund like Vanguard Target Retirement 2050 (VFIFX) or whichever year makes sense. You get your US and international stocks and your US and international bonds all in a single mutual fund. As I mentioned before, I’m not a huge fan of these because I think figuring out your asset allocation is a little more nuanced than just picking a year, but I’m a little OCD when it comes to this. That might be the best choice for someone who is willing to trade a small amount of mutual fund performance for a lot of simplicity.

What about all the other investments out there?

Ahhhhh. That’s the question we’ve been waiting for. I am a firm advocate of efficient markets so I really don’t think I can successfully pick individual stocks or even stock sectors. I’d rather just pick a really broad index mutual fund knowing that the winners and losers will balance each other out and over the long run I will do okay.

That said, beyond those basic three ingredients, the Foxes have invested in two other investments. We have a commodity ETF (DJP) which has turned out to be the worst investment that we’ve ever made (which I chronicled here). Also, we invested in a REIT index fund (VGSLX) when I thought that real estate would be a good investment. From 2010 to 2014 this turned out to be the case and we did quite well with this, but since 2017 it has been mediocre to bad. That just goes to show that trying to beat the market is a futile effort.

Does Stocky Fox eat his own cooking?

For the sake of full disclosure, I’ll tell you where our investments are.

Investment	Ticker symbol	% of portfolio
US stock fund	VTSAX	51%
International stock fund	VTIAX	36%
Bond fund	VBMFX	1%
REIT fund	VGSLX	7%
Commodities	DJP	3%
Others		2%

I already mentioned the REIT and commodities investments. The “Other” is composed mostly of Lady Fox’s 401k accounts, our money in Lending Club (which has been a total disaster which I’ll chronicle in a future post), and a couple other odds and ends.

So there you go. With all the crazy things going on in the world, and all the things that need your attention, I think which investments to pick is an easy one. With three fundamental building blocks—a US stock mutual fund, an international stock mutual fund, and a bond mutual fund—you can build a rock solid portfolio.

So which investments do you pick?

Invest in 401k before you payoff student debt

October 2, 2017October 2, 2017 Stocky Leave a comment

“The longest journey begins with a single step” –Laozi (580 BCE)

Investing is a long-term game. As that really smart Chinese philosopher said, that long-term game needs to start with your first move. For most people, investing will start when they get their first “adult” job after college (you already know how I feel about college).

Some people start with a clean financial slate when they leave college, but many have student debt from all the loans they took for that degree. That sets up an interesting question as they get their first paychecks: what to do with the money? You can even make the question more precise and ask: should I use my savings to payoff my student loans or start investing? Let’s dive right in

My niece Starty Fox just graduated with her engineering degree from State U. She has $20,000 in student loans that has an interest rate of 4.45% (I think that’s the current rate for government backed student loans). Because she listened to her wise uncle, she got an engineering degree which presents many job opportunities. She took a good job paying $54,000 per year (luckily her salary is divisible by 12 so this post is a little easier to write). Plus, they offer a 401k which matches her contributions up to 6% of her salary.

After she accounts for rent (her parents made it clear she could visit, but not live with them), her car payment, food, and other living expenses she is able to save 10% of her income each month. She makes $4,500 per month and has $450 left over at the end of each month (let’s ignore taxes for a second, but just a second).

So what should she do, payoff that nagging student debt as fast as she can or start investing in her company’s 401k?

A match lights the world on fire

Let’s say Starty has a neurosis about her debt. She was raised never to have any debt (although maybe that’s not always the best idea—here and here), so she wants to pay it off as quickly as she can.

If she applied all $450 each month to her student loans, she would pay off that whole $20,000 in a little over 5 years. There would be a couple things she wouldn’t like. First, that $450 would be taxed (just like the rest of her income). Let’s say her marginal tax rate is 20%, so that means the $450 she has set aside is really only $360 after she pays Uncle Sam. Taxes are unavoidable, so while that’s a bummer for Starty, she accepts it as a fact of life (although maybe she shouldn’t—more on that in a second).

When it is all said and done, she will have paid everything off by the time she turns 27, which isn’t bad. Through it all she would have paid about $2,300 in interest. That interest is tax deductible, so it would only feel like about $1,840. After everything is paid off, she can start investing in her 401k with a clear conscious.

Let’s take the other extreme, and assume that Starty watched Wall Street a lot with her adoring uncle when she was little. She’s not too concerned about debt, especially when there are other good investment opportunities out there. She pays her minimum payment on her loan ($150 per month before taxes, $120 after taxes) and then invests the rest in her 401k.

Obviously, the downside of this is it takes her a lot longer to pay off her loan; instead of being done by age 27, she’ll have the debt until she’s 40. That sucks. But she more than makes up for that with her 401k. Every year she contributes $3,600 to her 401k. When she does this she has three really big spoonfuls of awesomeness working for her:

Tax free—her 401k contributions are pre-tax so just off the top she is saving $30 per month that would go to taxes if she used that money to pay off her loan. That’s enough to buy a new Lululemon outfit and splurge on extra spin classes each year (Foxy Lady just took over my computer for a second). Sure, eventually she’ll have to pay that in taxes, but there are a lot of things she can do to minimize that when the time comes.
Match—the big one is that Starty gets to take advantage of her company’s match. They match dollar-for-dollar up to 6% of her salary. Since she’s contributing more than that, she takes complete advantage of the match, and that comes to $270 each month.
Investment returns—obviously this is why we do invest money. On average Starty is going to earn a 6-8% return on her 401k.

If you put that all into the pot and mix it, you’d have a 27-year-old Starty who is debt-free but with nothing in her 401k, or you could have a 27-year-old with $41,000 in her 401k and still with $16,000 in student loans. Obviously, the 401k option is much better. She has a net worth of $25,000 on her 27^th birthday (versus $0 if she paid off her student loans first).

The cause of it all

Those numbers tell a pretty powerful story that from a mathematical point of view, paying off your student loan at the lowest level is best so long as you put that money into your 401k (and not spend it on stupid crap). However, there are some fairly big assumptions there.

Match—obviously the match is a big part of it all. Without the match the numbers don’t look nearly as good, but the 401k option still comes out ahead. On her 27^th birthday, she would have a net worth of $5,500, without the match. Many people may complain that this example isn’t realistic because Starty’s 401k match is so generous, but without the match she still comes out to the good. And we know a 401k without a match is basically like a traditional IRA which is available to everyone.

Liquidity—when Starty chooses to go all in on her 401k she’s losing a lot of financial flexibility. At 27 she’ll still have $15,000 of debt that she’ll have to pay off plus she’ll have a lot of her money tied up in her 401k which is very hard to access. If something happened at ages 22-27 she’d be in pretty much the same boat either way, but after age 27 she’d have a little more flexibility if she had killed the college debt. This becomes a question very similar to the one we raised with the post on the emergency fund. Personally, I would be willing to roll the dice for that extra $5-25k over five years, but risk aversion is different for all of us.

That’s all good, but fundamentally this boils down to Starty being able to borrow money at 4.45% (3.6% after taxes) and being able to invest it at a higher rate, 7% for argument’s sake. Over a 20 year time horizon (about how long it takes her to pay off her student loan), stocks have historically done much better than that 4% hurdle. For all these reasons, it does make a lot of sense—in Starty’s case thousands of dollars each year—to slowly pay off her college debt and put that money into her 401k.

Emergency fund

September 28, 2017September 28, 2017 Stocky 2 Comments

As you might imagine, I talk to a lot of people about what they’re doing with their investments. One of the things I hear a lot is, “I’d like to start investing, but before I do that, I need to build up my emergency fund.” That sounds pretty prudent. You don’t want to get caught in the lurch when life throws a curve ball at you. Yet, I actually think this is a really bad move. I freely admit that the Fox family does not have an emergency fund. We have investments, and if the unforeseen happens that’s what we’ll use.

How likely is an emergency?

What are the types of things that you’d use an emergency fund for? Almost by definition, an emergency is something that is unpredictable and somewhat rare. If your 12-year-old Honda Civic is starting to die and you know in the next couple years you need to get a new one, that isn’t really an emergency as much as something you need to budget for (that was the exact circumstance of the Fox family a few years back). If you’re having an “emergency” every year, either you’re the unluckiest of people, or probably more likely you just have a lifestyle that needs to be budgeted a little differently.

When I think of things that you’d spend an emergency fund on it’s stuff like: your hot water heater gives out, you’re 7-year car gets totaled and insurance only gives you $6000 to get a new one, your son goes into the NICU for four days because of croup and your portion of the bill is $4000 (as happened with Lil’ Fox last year), or you are fired from your job.

As I was writing this post, I asked Foxy Lady if she could remember any emergencies that we have faced since we were married 7 years ago. The hospital thing with Lil’ Fox was the only one we came up with. There were smaller things like when we had to replace the dishwasher ($500) or fix the clothes dryer ($400), or fly back to Michigan for a funeral ($400), but the hospital thing was the only major one (I’m defining “major” as more than $1000). So that means we have averaged one emergency every several years. Once every several years—I don’t know if we’re more or less prone to emergencies than the general population, but that seems about right.

So be a little more cautious and use once every five years as an average—you have about a 20% chance in any given year of needing to tap into your emergency fund. We’ll use that in a second.

How likely is it you’ll make money in the stock market?

Obviously we put a huge caveat on this, but we can look at historical performance to get a sense for how likely it is that you’ll make money or lose money if you invest your emergency fund in stocks. Actually, we kind of did this in a post a while back.

Remember that historically, if you have a one-year investment time horizon, you make money with stocks about 70% of the time. That is actually pretty good odds that investing your emergency fund in stocks would have you come out ahead, just looking at it for one year. In fact, we can do the math, and the chances of you having an emergency in a given year and losing money in the market are about 6% (20% chance you’ll have an emergency x 30% chance you’ll lose money in the market that year).

But remember, emergencies don’t happen every year—they tend to be much less frequent than that. For the Fox family, they happen on average once every five years. Just for the fun of it I put a table together that estimated the chances of having an emergency if you assume in any given years there’s a 20% chance of having one. Also, I looked at the historic data to see the probability that you would have lost money in the market over different time horizons.

Time horizon	Chance of an emergency	Chance of losing money in stock market*	Chance of emergency and losing money
1 year	20%	28%	6%
2 years	36%	24%	9%
3 years	49%	18%	9%
5 years	67%	13%	9%
10 years	89%	3%	3%

As we mentioned above, there’s a 6% chance that in any given year you would need to tap your emergency fund when the market was down. Looking at other time frames you get similar results. Pretty much any time frame has a less than 10% chance of you needing that emergency money at a time that you would have lost money in the market*. You need to decide if you’re willing to take that risk, but to me that seems like a no-brainer. If I have a 90%+ chance of coming out ahead on something, I’m doing it.

You can see where I’m going with this. First, emergencies don’t happen all that often (if they do, you probably need to come up with another name for them other than “emergency”). Second, if you give yourself a few years in the stock market, the probability of losing money goes down a lot (of course, it never goes to zero). That seems like a perfect combination for investing your emergency fund the same way you invest any of your other money. $10,000 invested in stocks with an average return of 6% would give you about $13,300 after five years; keeping that same amount if your savings account at today’s interest rates would give you about $10,050. Seriously, that’s ridiculous.

I get that many people look at that and say, “the whole point of an emergency fund is you never know when you’ll need it, so don’t put the money somewhere where you might lose it.” That’s a very understandable concern, but it’s also where a lot of people are leaving a ton of money on the table. Over the past 150 years, investing in stocks has a really good track record, and the more time you give it, the better that track record becomes. You’ll never eliminate all the risk from investing, whether it’s your 401k or US bonds or the cash in your checking account, there will always be some type of risk.

It’s the successful investors who understand that risk and understand how to decrease the risk (expanding that time horizon to five years cuts in half the likelihood of losing money), that are able to get the most bang for their buck. This is definitely one of those areas where you can get a 1% coupon.

The Fox family eats on our cooking on this one. We don’t have an emergency fund. When emergencies do happen like with Lil’ Fox, we pay for it out of our investments, absolutely believing that over our lifetimes there may be one or two instances where we lose money but there will be many, many more where we come out ahead.

Let me know what you think. Do you have an emergency fund? Do you think I’m crazy not to have one?

*I used the same methodology for this table that I did for my post “Will you lose money with stocks?”

North Korea not a problem, so says the market

September 25, 2017September 25, 2017 Stocky Leave a comment

A few days ago, a client called me a bit freaked out. He wanted to sell out of stocks because of fears that the issue with North Korea could escalate into something terrible, possibly World War III. Of course I told him to sit tight, because even in the darkest times stocks tend to do well over the long term.

Even so, what makes me so confident that the problems with North Korea won’t lead to a global catastrophe? Simply put . . . THE MARKET TOLD ME SO.

The stakes are very high

Certainly, the stakes with North Korea are very high. If things went bad, the outcomes could range from the Korean peninsula being destroyed to a nuclear war enveloping the globe.

If armed conflict broke out, almost assuredly North Korea would attack South Korea and particularly Seoul with a deadly barrage of artillery. The human cost would be immense. Also the damage to companies and their property would be vast. That doesn’t seem important when compared to all the lives that would be lost, but more on that in a minute.

If the conflict spread, Japan would probably be the next victim of North Korea before the US and its allies took control. Then the two absolute worst case scenarios would be a) North Korea realizing its nuclear-tipped ICBM dream and hitting the US mainland or b) China and Russia being drawn into a war against the US. Those last two scenarios would lead to unparalleled loss of life and destruction of company property.

Destruction is bad for the stock market

Why do I keep saying “destruction of company property?” That seems to pale in importance compared to the thousands or millions of lives that could be lost with the doomsday scenarios we’re talking about.

If war broke out a lot of company property, plant, and equipment would be destroyed. Also a lot of company employees would be killed. Potentially, if we went to a wartime economy like in World War II, companies would stop making cars and phones and shirts, and start making fighter jets, military gadgets, and uniforms.

All those things would be horrible for the companies’ profitability and therefore their stock price. Here’s the punchline—if war broke out, that would be terrible for the world’s stock markets overall. That terribleness would be most acute where the fighting was taking place.

The stock market is pretty smart

There has been a lot of academic study of the wisdom of groups over the individual. I took a class with Nick Epley at the University of Chicago that looked into this, and that’s one of the lessons that has really stuck with me over the years. The idea is that if you have a bunch of people with a bunch of different opinions, the “average” opinion is going to turn out to be more right than most of the individual opinions.

Where is the biggest, most organized collection of opinions? In the stock market. It is fundamentally people with opinions (will things be good and stocks go up, or will things be bad and stocks go down?) betting against each other. The result of all the bets results in the general movement of the stock market. If more people bet good things will happen, stocks go up. If more people bet bad things will happen, stocks go down.

Stock markets have a lot more credibility than talking heads because the former involves people putting their money where their mouth is. It’s easy to say you are certain that something is going to happen; it’s another bet your money that something is going to happen. That’s why the stock market tends to get it right, because greedy people who want to make more money are betting.

With regard to the Korean conflict, it’s easy for guests on news channels to say how bad that nuclear test is or how much closer that missile launch puts us to war. But are those concerns credible? Does the talking head or the new network really believe that, or is it just a flamboyant statement meant to capture viewer’s interest?

Divining the markets’ message

We’ve talked about geopolitics and stock markets and the destructive potential of a war with North Korea. Let’s bring it all together.

If war breaks out, a lot of destruction will occur, and that will be horrible for the stock market. That’s particularly true as you get closer to the epicenter—things will be worse for South Korean stocks since they’ll be the first victims of the war, probably followed by Japan, and then the rest of the world.

If things were REALLY bad, you should see that reflected in the stock markets, yet it isn’t. If you compare the S&P 500 and a broad Pacific Index (Japan, South Korea, Australia, etc.) and a South Korean stock index, none show signs that a horrible event is going to happen. In fact, of those three, the South Korean index has VASTLY outperformed the other two. So much for a real concern that unparalleled destruction is imminent.

That’s not to say there haven’t been reactions. In the beginning of July (point A) North Korea tested a long-range missile. South Korean and Pacific markets reacted a little (about 1-2%) and US markets were unfazed.

Later in the month, North Korea tested a second missile that put Guam within range (point B). Again, there was a reaction from the markets, this time larger and this time the US markets also reacted.

Finally, at the beginning of September, North Korea tested its largest nuclear device yet (point C). Again, all three markets reacted.

So what does it all mean? The market did react downward every time one of these tests occurred which means that more people (or more accurately more money) think there is something to be worried about. However, the shallowness of the dips show that the bad things that “are likely to happen” really aren’t that bad and are more than offset by the good things going on with companies, profits, employment, etc.

Particularly interesting is the South Korean stock market. If conflict did break out, they would be on the front line and they would suffer the most devastation. Their reaction to North Korea’s developments are the largest which makes sense. But like the rest of the world, the South Korean stock market quickly shrugs off the threat and moves on. As I mentioned earlier, the South Korean stock market has done really well this year, which must mean that they don’t view the threat of war to be that likely.

I hope this gives you comfort; it does to me. It’s not hard to get wrapped up in all this crap. Trump and Kim Jong Un certainly don’t make things calmer, and those missile tests keep flying longer and longer distances. When someone gets on CNN saying we are on the doorstep of Armageddon, it’s easy to believe it, but I think those people are full of crap.

The stock market has a powerful collective wisdom that has a really good track record of being right when individuals are dead wrong. I think looking at how the stock market has reacted to all of this, and particularly how the South Korean stock market has, should give us all some comfort.

How to invest a windfall

September 21, 2017September 21, 2017 Stocky Leave a comment

This is a first-world problem for sure, but many of us at one point or another will get large amount of money all at once. We know from asset allocation that we should invest it in stocks, but the questions becomes one of timing. Maybe it’s an insurance payout, a tax refund in April, a bonus check, or a bunch of cash you’ve accumulated in your checking account. In fact, when I was still working at Medtronic every July the Fox family would face this exact scenario when I get my bonus check. Let me tell you my thoughts on the matter (which of course is not an expert opinion, and which looks at historical price movements but makes no prediction on future stock movements).

When I would get my bonus, and what I would have suggested, is to take the big chunk of money and invest it in equal pieces over a couple months. Vanguard and most places will let you set up an automatic investment, so in the words of Ron Popeil “you can set it and forget it.” So let’s imagine someone would invest equal amounts each week for the next 10 weeks. Why do I do it this way? Because I’m a spaz.

If I invested all the money at once, I would be totally freaked out that I would buy at the wrong time—either I would buy the day after stocks went up 1% or I would buy the day before stocks dropped 1%. Using simple scenario of $10,000 to invest, that would mean I could “lose” $100 by investing at the wrong time. That would totally tie me up in knots and I would be looking at the stock market trying to find the exact right time to jump in, like a kid on the playground playing jump-rope. Of course we know from A Random Walk Down Wall Street, that all that stuff is random so there’s no point trying to time it, but I’m not totally rational when dealing with that much money.

For the blog, I did a little analysis and found that 12% of the time stocks* lose at least 1% in a single day; if I bought the day before that happened, I’m out at least $100. On the other side, about 13% of the time stocks rise 1% or more in a day; if I bought the day after that I’d similarly be out $100.

My fragile nerves just can’t take that so I want to “diversify” the timing of my purchases to even out those big ups and big downs. This is a strategy called “dollar cost averaging”. So as I said, initially I would have recommended is to take the cautious path, take $10,000 and split it into $1,000 chunks, and invest those each week for the next 10 weeks.

But then using the magic of spreadsheets and the internet, I decided to see what the actual data said. I looked at every week for the market since 1950 and did a comparison of the two scenarios:

Invest your entire chunk of money all at once
Spread your investment evenly over 10 weeks (dollar cost averaging)

Wouldn’t you know that on average it’s better to invest your entire chunk at once? I’ve been doing it wrong this whole time, so thank you Stocky Fox. In fact it’s not even close—historically it has been better to do option #1 about 61% of the time.

The thinking is that historically, stocks have always gone up. Sure there have been some rough patches, some of which can last a really long time, but the general trend is definitely upwards. So if you wait to invest your money over a longer time period, you’re missing out on some of that upward trend. I looked at every week since 1950 (if you were curious, there are about 3400 weeks) and on average you gain about 0.7% by going with option #1 instead of option #2. 0.7%!!! Holy cow. Remember that post on The power of a single percentage? We just found a 1% coupon right there.

So my advice is to pick a day this week and invest it all in one fell swoop. You might get hit with bad luck, but the odds are better that you’ll get hit with good luck to the tune of about 0.7% (which in your case is about $700). On the day you do it, don’t even look at the stock market and have several tablets of Alka Seltzer on hand.

*For this analysis I am using the S&P 500 data going back to 1950.

Your house–the leveraged buyout

September 18, 2017September 18, 2017 Stocky Leave a comment

Last week I did a post looking at if your house was a good investment or not. A classmate named Karthee from ChicagoBooth made a really smart comment:

“Isnt the house purchase a Leveraged Buy out? You didn’t actually put in all the $785K, but took all the profits (1.15M – 785K) – so shouldn’t the return math be based on your down payment rather than the cost of the house (unless you paid for the house in full – which most people don’t)”

Before we dive into the issues, a quick thought: Karthee and I got our MBA together 10+ years ago. He was a tremendously smart guy and has been very successful since we were at U of Chicago. When I did my post looking at the value of college, I left out the value of personal relationships that you can develop with your classmates and the network you can build. I did that deliberately because so many college grads are struggling to pay student debt and make ends meet. A strong personal network that doesn’t translate into professional opportunities seems like a bit of a luxury.

That said, the people I met at ChicagoBooth are absolutely the smartest and most talented people I ever spent so much time with. I don’t know if that alone was worth the cost of attendance, but as I get older and my professional career takes on a new look and feel, being connected to so many really amazing and scary smart people becomes the more dominant value I enjoy from my MBA experience. You know, other than meeting my wife and the mother of my children there.

On to Karthee’s comment

I think he’s mostly right, but a little bit wrong. Let’s talk about how he’s wrong first and then we’ll get to how he’s right.

His comment has less to do with the performance of the asset (did the house increase in price?) and more to do with how the purchase was financed. Definitely in that he was right that we bought the house with a mortgage, paying a 25% down payment. The house cost $785,000 and we had to “invest” $196,250 as the down payment. Then every month we made a mortgage payment of $2,811, of which about $1,000 went to paying off our mortgage (the rest was interest).

He’s absolutely right that if you look at our investment as $196,250 and our gain as $365,000 that changes the numbers substantially. But should you? Maybe. More on this when we talk about how he’s right.

If you just look at the assets’ performance—the house compared to the stock market—the house didn’t do as well. In our particular case, our house increased about 46% over the five years we owned it; the stock market increased about 76% over the same time period (about 90% if you include dividends which you should). The broader data shows that houses on average return about 0.4% annually while stocks have historically returned 8-10%.

How Karthee’s right

Should we consider how you finance an asset purchase when you make an investment choice? Certainly, money is money. Again, if we were doing apples to apples, you could put 25% down to get a house and compare that to if you bought stock on margin and leveraged it 3:1 (put $1 of your own and borrowed $3 to invest). In that scenario you would have the same results that the stock market does better.

However, that’s a bit of a theoretical construct and Karthee’s point is much closer to reality. Not many ordinary investors buy stock on margin; I certainly don’t. About half to two-thirds of people borrow money when they buy a personal residence (I was shocked that it wasn’t higher). So in that way, the default for home tends to be “leveraged” while that’s not the case for stocks.

Furthermore, interest rates when you borrow for a mortgage are much, much more favorable than if you bought stocks on margin. Our mortgage is 2.2%; if I bought stocks on margin the rate would be about 6-9%. Also, our mortgage is tax deductible which brings it down to an effective rate of about 1.5%. I’m no tax expert so I don’t know if interest on margin purchases are tax deductible. If not, that further supports Karthee’s point.

Certainly in a practical example of making the choice between buying a house and renting and then investing the money, reality is closer to Karthee’s point. That said, most of the return comes from the decision on how you financed your house, not that you bought a house that increased in value.

We can put a little table together that figures this out. The last row includes an adjusted CAGR which accounts for all the costs—realty fees, home improvements, plus the “value” we got from the house acting as a shelter. We’ll also include the returns if we invested the money in the stock market and invested on margin (maxing out at 1:1 margin ratio at an 8% interest rate).

	House paid with cash	House paid with mortgage	Buy stocks	Buy stocks on margin
Cost to house (2010)	$785,000	$785,000	$785,000	$500,000
Money “invested”	$785,000	$250,000	$785,000	$250,000
Sale price of house (2015)	$1,150,000	$1,150,000	$1,511,450	$595,375
Profit	$365,000	$365,000	$726,450	$345,375
Gross return	46%	146%	93%	138%
CAGR	8%	20%	14%	19%
Adjusted CAGR	9%	21%

This leads to some pretty insightful results. To Karthee’s very correct point, when you look at your house as a leveraged-buyout, the profits are greatly magnified. In our case, instead a 9% return assuming no mortgage, when you factor in our mortgage we would have a 21% return. That’s enormous, and that’s really Karthee’s whole point.

You can compare that, as I did before to investing in the stock market. The stock market had about a 14% return, so a house with a mortgage would have done much better. However, if you leverage your investment in a similar way to how you did with your house, they end up about equal—the house is at 21% and stocks bought on margin have a return of about 19%.

19% and 21% are close, but the house is slightly ahead. That speaks to some inherent advantages you get when borrowing money with a house. For the stocks on margin, I assumed the most you could do is borrow at a 1:1 ratio (you could only borrow as much money as you were investing). Keep in mind for a mortgage, we got a 3:1 ratio; we borrowed $3 for every $1 of cash we brought to the table. Also, I assumed that when you borrow on margin you pay an 8% rate; that is much higher than the 2.2% rate we have on our mortgage. Those two factors—ability to leverage at a 3:1 ratio and to borrow at such a low rate—give the house a great advantage.

So with all of this KARTHEE IS RIGHT. If you consider a house as a leveraged investment, our housing experience did outperform the stock market.

What if we weren’t so lucky?

Our house appreciated at a particularly high rate, but most houses only increase at about 0.4% when you strip out all the home improvement and other stuff we talked about last week. But to Karthee’s point, your house is a leveraged investment and we know that should increase the returns you experience as a home owner.

If we assume a very vanilla situation, if you put 20% down on your mortgage and the house appreciated 0.4% annually, the math would tell you that you would realize a 2% return per year due to the leverage you have on your house. Obviously 2% is significantly lower than you could get in the stock market, on average.

Plus, that 2% number is a bit of a best case. Over time, you’ll be paying off your mortgage so your investment will creep up over 20%, decreasing the impact of the leverage. Also, as we mentioned last time, when you sell your house you’re likely going to have realty fees which basically act as a massive transaction fee which can really zap your profits.

We’re at 1500 words. Karthee had a really great point that we should look at our house as a “leveraged” investment and that definitely enhances the positive returns if you house does increase in value (we didn’t touch the nightmare scenario of an underwater mortgage ☹). In our case, the leverage put us ahead of what we could have done in the stock market, so that did make our house a good investment, I suppose.

However, the data shows that even with leverage houses tend to underperform the stock market pretty drastically. As I said last time, that doesn’t mean you shouldn’t own a home. We do. There are a lot of great reasons beyond the investment angle to do so. Let’s just be weary of thinking they are these great investments.

Teaching personal finance in schools

September 13, 2017September 13, 2017 Stocky 2 Comments

If any teacher wants to convert their math problems to have a financial element, please email ([email protected]) and I will be happy to do it. If you know any teachers, please share this with them.

Prepare for a rant. However, I will include a solution at the end, so maybe that makes it a little easier to stomach.

As a loyal Stocky Fox reader you know succeeding with personal finance can be extremely beneficial (no kidding). Also, personal finance is a skill learned just like any other skill. It’s not really hard to learn the basics—asset allocation, tax optimization, long-term view—but you definitely need to know them.

Financial literacy is low among adults

There are a lot of challenges we face as a society. We all have our own lists. At or near the top of my list is financial literacy, or the lack thereof. Not knowing this has a crippling impact on someone’s ability to achieve their life’s goals.

FINRA, which is the governing body for financial advisors (when I took my Series 65 it was administered by FINRA) has a handy little quiz you can use to test your financial literacy. I have listed the questions at the end of this post if you want to take it.

There are five questions (plus a bonus question that is quite a bit harder) that have to do with finance, but really they are math questions dressed in financial clothing. They fundamentally test addition, multiplication, and division. We were all taught the mathematical skills needed to answer these by 5^th grade.

Do you know what the average adult scores on this test? 3 of 5. 60% correct. Knowing the answers to these questions will mean the difference of hundreds of thousands of dollars. Knowing these answers will help keep people out of the nightmare death spiral of credit card debt that will limit their opportunities for their entire lives. Knowing these answers can allow people on a moderate income to build generational wealth.

Yet people don’t know these. What’s even worse is the problem is getting worse. In 2009 people got at least 4 of the questions right 42% of the time; in 2015 that number dropped to 37%. YIKES!!!

Reasonable people can debate, but I can’t think of a life skill that can have a more direct and enormous benefit on someone’s life, but which is lacking across such a wide swath of the population.

Status Quo

School got very real for us this year since ‘Lil Fox just started elementary school. We love the school and his teacher (Mrs Sheppard-Jones) is awesome.

I have volunteered at his school the past three years, and several years before that at the local elementary school when we lived in Los Angeles. I work on advanced math concepts with 3^rd and 4^th graders. I am no expert, and certainly I am not as close to it as the dedicated teachers who do it all day every day, but I have been struck by how little personal finance (let’s say that’s anything with a “$”) comes into the math curriculums.

That’s not to say that it’s not there at all. There are some math problems that involve money and finance, but I wonder if it’s enough. Why doesn’t every single math problem incorporate finance. Every. Single. Problem.

I’m not talking about hard core personal finance concepts; students are welcome to come to this blog for that ?. If you have an addition problem like 3 + 5, why not make it $3 + $5?

Suzie has five apples, and she gives 3 to Steve. How many apples does she have left? Could easily become Suzie has $5, and she buys a toy for $3. How much money does she have left?

Byron has already filled 6 buckets with water. If he can fill 2 buckets per minute, how long until he has 20 buckets filled? That could just as well be: Byron has $6 saved. If his weekly allowance is $2, how long until he can buy a $20 video game?

Obviously, each of those questions are identical, testing the exact same mathematical concepts. The difference is for the second of each pair, there is a financial layer that also gets the student thinking about money, saving, investing, etc. Those financial layers are going to pay major dividends, literally and figuratively, if the student retains them.

The questions on Suzie and Byron are real questions that I have seen given to students. As important as counting apples is or filling buckets of water is, managing your finances is much more important.

Pretty much every math problem can be written as a math/financial problem, with the possible exceptions of some geometry and trigonometry concepts. Even then, I think if you are creative enough you could pull it off.

The mother of all concepts

This is obviously up for debate, but I think that compound interest is probably the most important concept in personal finance. If you are a borrower, it’s impact can be devastating. If you are an investor, it’s impact can be liberating. Thanks to this little jewel, I was able to quit my job in my mid-30s and live off our savings.

As powerful as it is, it’s a purely mathematical concept. We’re first taught it as exponents like 3⁴=? It starts to look a little more like finance with something like 1.08⁵=? This isn’t a hard concept to learn. Most scientific calculators have a specific button for this, so all you have to do is enter the numbers.

My major complaint here is exponents tend to be taught in a very sterile environment, at least in my experience. Sure, you can do all the mechanics of 5³, 7⁶, 2⁸, 3^4.6, and on. As a high schooler I remember doing pages of them. I became a robot punching buttons on a calculator, producing answers that I wrote on my paper.

What if instead you had questions which involved $1 of debt at different interest rates for different lengths of time like 1.1⁵, 1.08²⁰, 1.2¹⁰, 1.2⁵, 1.09²⁰? You still pushed the exact same buttons, but now there is some upside. Worst case is the student learns exactly what he would have anyway.

Best case is that a student notices that 1.08²⁰ is surprisingly larger than 1.07²⁰. If she makes the link that a 7% interest rate over twenty years produces a much lower amount than an 8% interest rate over the same time frame, she’s learned a powerful concept.

Right now it would just be a seed, but eventually that seed will grow. That exponent problem shows the difference between a 7% return and an 8% return over 20 years. That’s the difference between using an index fund with a low management fee and an actively managed fund with a high fee. That’s the difference of several hundred thousand dollars over her investing lifetime. If that seed never grows, she’s no worse off than she was. If it does, then when it’s time to pick her investments for her 401k, she will realize how big an impact one little percentage can have when compounded over time . . . well, you know how I feel about that.

This is real—we live in a world where millions of homeowners could refinance their mortgage at lower interest rates to save billions, but they don’t. I guarantee you the biggest reason is that most people don’t realize how much money they could save by lowering their mortgage rate a measly 0.4%. Why aren’t we teaching that very thing when we teach exponents?

I am ready to do my part

There’s nothing I like more than when people find a problem but not a solution. It’s awesome to hear people bitch on Facebook about some difficult issue, and then implore other people to do more.

So we have this big problem and I am going to ask everyone other than me to do something about it.

JUST KIDDING. For all the teachers, educators, parents, or anyone else out there who works with kids in math, I am here to help. I’m being totally serious. Email ([email protected]) me any questions you have in a regular format, and I will change them so they are finance-related math problems.

Financial literacy is a huge problem, but it also has a really easy and costless solution. Incorporating math won’t take away from any other learning; it won’t consume time that right now is spent learning other skills. The kids are already doing the math, let’s just put a financial watermark on all those math problems.

FINRA quiz

Suppose you have $100 in a savings account earning 2 percent interest a year. After five years, do you have more than $102, less than $102, or exactly $102?
Imagine that the interest rate on your savings account is 1 percent a year and inflation is 2 percent a year. After one year, would the money in the account buy more than it does today, exactly the same or less than today?
If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or is there no relationship?
True or false: A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage but the total interest over the life of the loan will be less.
True or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.
(BONUS) Suppose you owe $1,000 on a loan and the interest rate you are charged is 20% per year compounded annually. If you didn’t pay anything off, at this interest rate, how many years would it take for the amount you owe to double?