Category: analysis

The Trump stock bubble

Stocky Leave a comment

The normally very calm and thoughtful T. Lee (a good friend from my Medtronic days) expressed some strong anti-Trump feelings in a comment a couple days ago.  That puts him in good company with a large portion of the country.  But then he asked the following question:

“At what point, if there is one, should we consider pulling our money out of stocks and investments and holding cash, based on the disorder, confusion, and unbelievable uncertainty this tiny man of a president is causing domestically and abroad? Are there any telltale signals? I also ask because the housing market and stock market are at historic highs, and seem due for a pullback. I know it’s impossible to time the market this way, but just wondering perhaps there is an exception under extraordinary times.”

Let’s dig into this and see what we come up with.

 

Things aren’t that bad

Times are insanely partisan right now.  If you don’t like Trump it’s easy to think we are on the brink of oblivion, but things aren’t really that bad.  Let’s look at some times when things were REALLY bad and how stocks did (some of this is from a post I did a couple years ago so you can check that out here).

Let’s think of the worse times in the past 100 years.  A short list probably includes the start of WWII, the atomic bomb dropped, and the assassination of MLK.  In each of those things look bad, really bad, and maybe we would have thought that things were about to fall apart:

When Hitler invaded Poland and started World War II (Sep 1939)

When the US dropped two atomic bombs on Japan and started the nuclear era (August 1945)

When Martin Luther King was assassinated setting of some of the worst race relations since the Civil War (April 1968)

The civil unrest that’s going on in the US right now is a drop in the bucket compared those examples.  Even so, when things looked darkest, being an investor turned out to be a good thing.  That table looks at if you invested $1,000 per month starting at that bad event in the Dow Jones index, and how you would have ended up over different time periods.   Over a 20- or 30-year time horizon we know that we almost always come out ahead.  That definitely held true even in these examples.

I don’t think we have anything to worry about as investors because of Trump or all the current drama.  It’s important to keep things in perspective.

 

Pullbacks do happen

Definitely there will be a point when stocks will pull back.  That’s just the nature of the stock market.  Given that Trump has taken so much credit for the rise in the stock market, it will be interesting to see how he tries to avoid blame when it has a bad few months or a bad year.  Of course, he has shown his ability to grab credit and shed blame as well as any politician, so I’m sure he’ll come up with something.

In my post where I proved I was smarter than a Nobel Prize winner, I based that on the fact that two years ago Robert Schiller predicted stocks would not do well.  I disagreed and was much more optimistic.  Since then stock have been on a major tear, so there you go.

But it can’t last forever.  Here are the stock returns for each of the last nine years since the Great Recession: 28%, 17%, 8%, 9%, 29%, 9%, 0%, 13%, and 12% so far this year.  That’s a dream, and eventually we’ll take a pause from that incredible pace, but of course we don’t know when that will happen.  Robert Schiller, one of the very smartest people in the world, predicted it a couple years ago.  Maybe it will be this year (I did suggest maybe we’re seeing some early signs), or maybe it will be two years from now.  If it’s two years from now, there could very well be another 10% or 20% upside that you don’t want to miss.  As always I recommend holding tight and doing the long-and-steady investment strategy.

 

Bubbles

Despite the craziness going on in the White House right now, things actually seem fairly strong in the economy which makes me think a huge bubble burst unlikely.  If you look back over the past major financial bubbles in the US three come to mind—the Great Depression (1929), the Dot com bust (2001), and the Great Recession (2008)—the issues that caused those don’t seem to be in place.

Of course, it’s impossible to predict what will cause a bubble but if we look at those in turn I think we’ll see that things look okay.

Great Depression—That was the big one that was caused by a perfect storm of bad stuff.  You had an insane asset bubble that captivated the nation and was held up by fraudulent companies.  It was so bad that most of the SEC laws came about afterwards.  What is going on now isn’t anywhere close to that.

Dot com bust—Again we had an asset bubble where stocks that had no profits, and no prospect of getting profits any time soon were being valued through the roof.  Maybe there’s a bit of that now, but it seems fairly tame compared to back then.  Now companies like Amazon and Apple dominate the news, but those are very profitable companies.

Great Recession—This actually had little to do with the stock markets but more to do with the big bets banks were making backed up by small amounts of equity.  Things went bad for a bit, but then rebounded quickly.

That’s a quick rundown, and there’s a lot of detail we could go into for each of those, but none of those telltale signs seems to be with us now.  Banks are stronger than they were, there doesn’t seem to be widespread fraud, and the stocks driving the market are profitable.  But bubbles by their nature are hard to predict, so who knows.

That said, I will give you the steady advice that I always do which is to sit tight, do dollar cost averaging, and in the end you will very likely come out ahead.

Plumber Fox or Electrician Fox

Stocky 1 Comment

For the past two posts, you’ve heard me rail about college, fundamentally questioning whether the astronomical tuition costs are worth it (here and here).  The real test is what I do with ‘Lil and Mini Fox.  Here are my thoughts:

 

Saving in a 529

Currently we are saving $1,000 per month in a 529.  That will build to about $400,000 which will allow both cubs to attend a public college (like UNC-Chapel Hill) with a fair amount left over, both to attend a private college (like Duke) but we’ll need to come up with more money, or one to go to a public college and the other a private college and we’ll pretty much spend it all.

If you are planning on your child getting any education beyond high school, 529s are a no-brainer.  They act like a Roth IRA in that they invest after tax money, but then all the investment returns are tax free.  That can really add up to some significant tax savings.

 

The best or . . . something really good

Foxy Lady and I have been blessed to have good jobs that have allowed us to build a comfortable nestegg.  One of the things we want to do with that is afford our cubs the opportunities to help them succeed.

If either ‘Lil Fox or Mini Fox turns out to be super smart and super hard working and super ambitious and is able to leverage those to get into one of the very best colleges in the country, we want to make the financial considerations a non-issue.

However, “best colleges” is a tricky term.  If either got into Harvard or Stanford, they would go and Foxy Lady and I would come up with the money, no questions asked.  You can include U of Chicago (where Foxy and I got our MBAs), MIT, Duke, Penn, Princeton, and CalTech as similarly expensive schools that we would swallow hard but also pay to gladly send our cubs to.

Beyond that, it’s hard to think of private colleges that would justify the 3x money that a public school would cost.  That’s not to say there aren’t great private colleges that didn’t make my list of eight, but are they worth the extra cost?  I don’t think so.

 

Local public college, but only if . . .

We’re lucky that in North Carolina we have some really great public universities.  UNC-Chapel Hill is regularly rated as one of the very best.  As a North Carolina tax payer we get access to that fine institution at a substantial discount.  Also, NC State is very strong, especially in STEM.  ‘Lil and Mini could get world class educations there.

Yet, Dad’s going to put some strings on that.  If that’s the path they take they have to major in STEM, business, pre-law, pre-med, or some other area that can reliably offer jobs that justify the educational expense.  I was a finance major and that has paid off.  Foxy Lady was a marketing major and that paid off.

UNC is a great school and I have no reason to believe their drama and literature and sports science and art history and music and Asian studies and creative writing departments are great, being taught by dedicated professionals.  But none of those majors offer good-paying jobs to the average graduate.  The main point of my last post was looking at the significant expenses of college and making sure the job you get with that degree offsets those costs.  For all those majors and many, many more, it’s not even close.  I’m not about to spend a hundred grand so my cub can get a journalism degree then become a host at Applebees.

 

Trade college for a trade

This is the one I really get excited about.  If our cubs aren’t Harvard material and aren’t interested in STEM, pursuing the trades is something Foxy and I are really going to push.  Follow my logic:

Being a plumber or electrician has some great things going for it.  First they make really good money.  A plumber makes on average about $51,000.  Remember that an average college graduate makes about $60,000, so they’re pretty close.  Add in to that our discussion last post about “smart non-college kids” and if our cubs are smart enough and hard enough workers to average $60,000 as college graduates if they got that degree, they’ll definitely be able to make more than $51,000—probably fairly close to $60,000.  That makes the salary a wash.

Also, the cubs can hit the ground running right out of high school.  It takes about a couple years to get your license and a few years after that to become a master plumber.  But you’re still being paid during that time, not paying tuition during that time.  Big difference.  Plus, by the time they would have finished college and entered the workforce making about $33,000 they could be a master plumber earning substantially more than that.

When you choose your education, you want to get something that will be in demand.  It’s hard to say what the future will hold, but people will definitely continue to poop.  Joking aside (although I do believe they will), there are a lot of reasons to believe that plumbers and electricians will continue to be in demand.  First, those vocations currently skew older because that’s when the trades were taught more widely.  There are a lot of 50- and 60-year old plumbers and electricians.  It’s not a sexy job that kids today want to pursue, so those who actually do will make a killing.

Second, the world is changing in ways that will probably need that skillset.  Plumbing and electrical wires are constantly breaking down so that will always provide steady business.  Plus, changes are coming that play right into their hands.  Two years ago we installed solar panels on our roof, and you know who did a lot of that work?  California just went through a major drought which caused everyone to roll back their water usage; you know who installed those water-efficient showerheads and toilets?

 

An ace in the hole

You can tell I have an interest here.  So it’s probably not surprising that whenever a plumber or electrician comes to our house (and charges about $200 for 20 minutes of work—not bad) I ask a lot of questions.

One thing that often comes up is what success looks like for them.  Like everyone in any job, there are always those things that remain just out of their reach, but “man, if I could get that I’d have it made.”  For a lot of tradespeople, it’s being able to go out on their own.

There was one electrician I talked to a lot when we installed our solar panels.  He was about 35 and had been working for this company for about 8 years.  He said he made about $50,000 a year and he was happy with that but he knew he could do better.  He’d love to start his own business.  When I asked him what was stopping him, he rubbed his fingers together.  MONEY.

He just didn’t have the money saved up to go out on his own.  I asked more details and he said it came down to having a truck and all the necessary tools (there are a lot).  Once he had that, he could do his own thing, be his own boss, and keep everything he made instead of a portion going to his boss.

How much were we talking to get him set up like that?  Between $80,000 and $100,000.  That’s a lot of money, no question.  For this guy, as well as most Americans whether or not they have a college degree, that’s an unattainable sum.  That causes him to continue to work for someone else and not realize his full potential.

Do you know who does have $100,000?  A kid like ‘Lil or Mini, whose parents have saved more than that for their college education.  If ‘Lil Fox foregoes $100,000 (or $280,000 at a private college) of college costs, that money will be there and could be used for setting him up as an independent plumber.  That puts him at a huge advantage, and isn’t that what Foxy Lady and I want to do with the education money we have saved for our cubs?

You could easily imagine our conversation with him: “We have saved $200,000 for your college, and we know you would be successful there if you wanted to be.  Instead, become a plumber.  In two years you’ll be licensed and three years after that you’ll be a master plumber.  When that happens, as a ‘graduation gift’ we will get you the best work truck with the best tools, plus we’ll cover your business’s expenses for the first six months.”

 

Who knows how all this will pan out.  These are my ideas right now.  We have 13 years until ‘Lil Fox needs to make this decision, and a lot can change in that time.  Also, there’s the little thing of what he want to do.  But as of now, unless he gets accepted to Harvard or wants to become an engineer, I am really liking the plumber idea.

However, this post particularly the two before it really shed light on this enormously important decision and how all of us as loving parents can think about it a bit differently than we have been brainwashed to.

Making college pay off

Stocky 2 Comments

 

On Monday we asked the insane question: “Is college a waste of money?”  We came up with an insane answer: “A person would do much better financially saving that tuition money and not going to college.”

Such a bold conclusion deserves some intense scrutiny.  Let’s look at this more closely and see what the key drivers are.

 

Base case

Recall from the last post that Smarty goes to private school ($280,000 total).  Fasty works at a job making $36,000 per year straight out of high school and Smarty spends four years in college then makes $60,000 per year once she’s out of school.

Results—FASTY comes out ahead by $2.7 million (11% better than her sister).  This is where we were yesterday.  Now let’s start looking at our assumptions.

 

Scholarships

Of course, this is a big one.  Scholarships effectively bring down the cost of college, potentially to zero if you get a full-ride scholarship.  The larger scholarship Smarty gets, the more the race tilts in her favor.

 

Public college

Public college is a much more affordable option, at $100,000 instead of $280,000.  Except at the very top (Harvard, Stanford, Chicago) there’s no reason to believe that Smarty couldn’t get as good an education at a public school like University of North Carolina-Chapel Hill compared to an average private school like Wake Forest.

Results—This has a huge impact.  SMARTY comes out ahead by $680,000 (4%) if she goes to a public school.  It’s not an overwhelming advantage, but the decision between public and private school makes a huge difference.

 

Wage growth

We assumed that Fasty would make $36,000 her whole career and Smarty would make $60,000 her whole career.  Those are the average incomes for people, but in real life people’s wages start lower and grow higher.  There’s a lot of debate and controversy here about wage growth and if it goes to everyone or just those at the very top (here is a link that a grad school friend posted).

If you look at more detailed data, it shows that those with college degrees have wage growth 33% higher than those without degrees.  To account for this, let’s assume Fasty starts out at $22,000 and Smarty starts out at $33,000.  Then let’s assume that Fasty’s wages grow 2.0% each year while Smarty’s grow at 2.7%.

Results—This actually has a pretty low impact.  FASTY comes out ahead.  If you assume public college Fasty is $233k (2%) ahead which is pretty much a tie.  If you assume private college then Fasty is ahead $4.8 million (39%).

 

College major

Let’s cut to the chase.  This is where the real action happens.  What you study at college has the biggest impact on what you earn.  Starting salaries for STEM (science, technology, engineering, math) majors are 30-50% higher than those for liberal arts and teaching majors.

Also, the income growth is much higher.  STEM majors can expect their wages to grow about 50% faster than teaching and liberal arts majors.  In fact, teaching majors have wages that grow SLOWER than those people without a college degree.  So if Smarty went into teaching, she would make more than Fasty at first, but Fasty’s income would pass Smarty’s eventually.

Results—This actually has a profound impact, even when you assume public college.  With a STEM degree, SMARTY will come out $3.0 million (19%) ahead.  You can play with the numbers, but it’s really hard to find a realistic set of assumptions where Smarty doesn’t win with a STEM degree, with the possible exception of private college.  This is true for medical and business degrees as well, just not to the same degree (degree-degree, did you see what I just did there ??).

As good as things look for a STEM degree they look that dismal for a liberal arts, career-focused (journalism, public policy, recreation, industrial arts, agriculture, etc.), social sciences, or teaching degree.  FASTY will easily come out ahead to the tune of $3.2 million (33%) if Smarty gets a liberal arts or teaching degree.  This assume public college; if we assumed private college, that would be drastically worse for Smarty.

 

Master’s degree

By attending college Smarty will give herself an option that Fasty just won’t have: the ability to get a master’s degree.  This is the route I took, going to college and then after working a few years getting my MBA. In a way, this is really more of the same, and links very closely to the “College major” discussion.

Getting a graduate degree doubles down on your college decision.  If you pick a major which puts you ahead, typically getting a master’s degree in that same area will puts you further ahead.  Conversely, if you pick a major that puts you behind, getting a master’s degree will put you even further behind.

Results—If Smarty gets a STEM degree she’ll come out ahead.  If she gets her master’s, instead of being about $3.0 million ahead she’d be about $3.6 million ahead.  That’s a bit of upside but not too much.  Conversely, if she gets a liberal arts degree and then a master’s on top of that she’d go from being $3.2 million behind to $6.0 million behind.  Yikes!!!

 

Taxes

Taxes always suck, but they are going to hurt Smarty a lot more then they’ll hurt Fasty.  Smarty got her degree and got a higher paying job, and that means she’ll be paying a much higher tax rate than Fasty.  Fasty makes less money and that helps in two ways.  First, she pays a lower tax rate.  Second, because her income is low she doesn’t pay taxes on her investment income.

As Smarty makes more money which is really her whole strategy by going to college, that will help her win the race against her twin, but that will also mean she’ll pay higher taxes and that has a moderating effect.

Results—The very best outcome for Smarty was a STEM degree from a public college, and then her master’s.  That resulted in her coming out ahead by about $3.6 million.  If you add taxes to that, she only comes out ahead about $1 million.  That’s still a lot, but taxes are making something that was a total sure thing a bit more suspect.

Of course, if you consider taxes on all the less favorable scenarios for Smarty (private college, liberal arts degree, etc.) it takes a bad situation and makes it even worse.

 

Smart non-college kids

We’ve been making an assumption that I think is actually flawed, and has the potential to tip the scales in Fasty’s favor pretty drastically.  Remember, we assumed that Fasty and Smarty are identical in every way—equally smart and equally hard working.

In our society, smart and hard-working high school graduates typically go to college.  That’s just what they do because they’ve been told a million times that is what they should do.  It’s a bit of a circular argument.

When we look at the data for high-school graduates with no college, those are people who never went on to college.  Maybe they were late bloomers, maybe not ambitious, maybe just plain not smart.  Based on my argument above, very few (although some for sure) had the option to go to college and passed it by.

I say all this because what would happen if Fasty is smart enough and hard working enough to go to college but chooses not to?  There’s every reason to believe that she would do much better in her career and make much more money that the “average” high school degree person we’ve been talking about.

Imagine she gets an entry-level job at a factory.  She is punctual, hard-working, figures out better ways to do things; all those things would have helped her in college but now she is applying that to her non-college job.  That will set her apart from many of the other high-school graduates who didn’t have those qualities and abilities, probably one of the main reasons why they didn’t go to college.  Eventually her talents will be recognized and she’ll get more opportunities at higher wages.  Maybe it won’t be as fast as if she earned her degree, but it doesn’t have to be.  Remember, she also has $280,000 in her bank account.

Results—If Fasty’s salary is higher or can grow faster than the average for a high-school grad, then the calculations drastically shift towards Fasty.  Remember that Fasty won the race most of the time.  It was when Smarty got a STEM degree that things changed, and that’s because Smarty had a higher salary and faster income growth.  However, if Fasty’s hard work got her even a little bit higher salary and faster salary growth, she would close the gap.

 

Other considerations

College dropouts—This is the real killer.  How many kids start college but don’t finish.  They end up with the job prospects of Fasty but without the head start.

Fifth-year seniors—Increasingly college kids aren’t finishing their degree in four years.  That is a double whammy because it delays them making money for another year and they have to pay an extra year of tuition.

Living at home—There are a lot of ways to get the benefits of college without the full-blown college experience.  Living at home (and eating Mom’s cooking) is one that drastically cuts down the cost of attendance.

 

We’ve come along way.  After Monday’s post I was pretty pessimistic on college.  I don’t know if this post made that better or worse.

Definitely we learned that private college makes it near impossible to come out ahead financially.  More importantly, what you study makes or breaks the decision; STEM and healthcare and business will probably put you ahead while liberal arts and teaching and social sciences will doom you.  There’s other stuff too, but I think those are the two most important.

Come back on Monday when I tell you what Foxy Lady and I are planning on doing with ‘Lil Fox and Mini Fox.

College is a waste of money

Stocky 5 Comments

Holy crap!?!?!?  Did I just say college is a waste of money?

The very idea seems anathema to everything our society has drilled into us.  Education is the best investment you can make.  College allows the poor but smart to have access to lucrative job markets, allowing for incredible social mobility.  Broad access to college is often credited for many of the amazing advances in our society over the past century.

However, this is also one of the most stressful areas of personal finance.  Whenever I work with a someone on their finances I always ask what their goals are.  Nearly universally, it is to pay for their kids’ college educations and to retire comfortably.  Paying for college is a primary goal and a huge expense which causes an incredible amount of stress.

A good rule of thumb I tell people is that you’ll need to save about $500 per month to pay for a child’s college education starting when the child’s a baby.  That’s for a state school, so if you want to pay for private school the number is closer to $1,500 per month, PER CHILD.  A family with a couple children could easily need to save a few thousand dollars a month.  That, ladies and gentlemen, is real money.  Given the huge investment we’re talking about, it seems worthwhile to ask the question: Is college worth all that money?

On a personal level, I got my bachelor’s degree in finance from the University of Pittsburgh and my master’s degree in business from the University of Chicago.  That education played an essential role in allowing me to make a very comfortable income to the point that I was able to retire in my mid-30s.

For our own cubs, Foxy Lady and I save $1,000 each month in their 529s which will one day go to pay for their college educations.  When the time comes we think we’ll have about $400,000ish total combined for both of them.  That will allow us to pay for each of them to go to a state school (think University of North Carolina-Chapel Hill) with some left over, or for each of them to go to a private school (think Harvard) but they’ll need to take some loans.  Based on that, you can decide if I am eating my own cooking here.

So what gives?  Why would I even ask such a seemingly self-evident question?

 

College is expensive

College is expensive, but that doesn’t mean it’s not worth it.  There are a lot of things that are expensive but are totally worth it.

The key question for college is does the increased income available because you can get a better job thanks to your degree offset the cost of attendance.  In that way, it becomes a pretty simple calculation.

Fortunately, because this is such an important issue in society, there’s actually a lot of data out there to help us with this calculation.  Unfortunately, because this is such a politically and socially charged issue, a lot of people misanalyze this data to achieve their own agendas.  The goal of this post is to get to the bottom of it all in as objective a way as possible.

This table shows how much college costs.

Total cost of attendance per year
Typical public college (UNC, UCLA, Michigan, etc.)

$25,000
Typical private college (Wake Forest, Harvard, Stanford, etc.)

$70,000

 

This table shows the average income for people with different levels of education.  There are some real problems with this table that we’ll discuss probably in the next post, but let’s start with this.

Education level

Average income
High school dropout

$26,200
High school degree

$36,000
College degree

$60,000
Graduate degree

$71,800
Professional degree (doctor, lawyer, etc.)

$90,700

 

The race of the fast versus the smart

We’re going to use my cousins Smarty Fox and Fasty Fox on this one.  They are twins, identical in every way—they are equally smart, equally hard working, equally ambitious, equally anything that would impact their career prospects.  The only difference is that Smarty decides to go to college while Fasty decides to start working right after high school.

Also, Smarty’s and Fasty’s parents saved enough for both cubs to go to a private college ($280,000 for each cub).  They’ll use that to pay for Smarty’s education.  For Fasty, they will put the $280,000 into a trust that will invest that money in the stock market and be available in her later adulthood (the comparison we’ll do doesn’t really require that Fasty and Smarty have that money upfront in a college fund, just that Smarty pays it and Fasty doesn’t). Let’s compare who ends up with more at the end of their careers.

As you would expect, Fasty starts with a huge lead.  First, she invests the $280,000 her parents had saved for her college.  We know, especially over a long time horizon, she’s virtually guaranteed to make money in the stock market.  Second, that $280,000 is growing each year; if we use an average return of 7%, in her first year she gets about $19,600 which her studious twin doesn’t get.  Third, Fasty starts working right out of high school; in her first year she makes $36,000 while her twin doesn’t make anything.

For the first four years of her career Fasty builds her lead with the salary from her job and the returns from her $280,000.  After four years, Fasty has about $525,000 while Smarty is starting at $0.  However, Smarty has a degree and can get a job at a much higher salary than her twin.  Smarty’s first job pays $60,000 which obviously is much more than the $36,000 Fasty is making.

Fasty has that head start but Smarty has the higher income.  Which will prevail?

As it turns out, it’s not even close.  Fasty’s lead is just too big for Smarty to catch up.  Smarty will be making about $24,000 more each year than Fasty, which seems like a lot.  However, Fasty’s $525,000 lead allows her to earn an investment return of about $37,000.  That more than offsets Smarty’s higher salary.   By the time Fasty and Smarty have reached 65, Fasty will be MILLIONS ahead of Smarty.

So there you have it.  Don’t go to college.  Just invest the money and you’ll come out ahead.  But . . .

 

Is college education really a rip-off?

This is a tough one.  I’ll go back to how I started this post.  College is such an integrated part of our lives and society.  Colleges also have historically been universally revered—these are good places, doing good work, making the world a better place.  But maybe those are the very places where we should question that absolute goodness.

From a purely financial point of view, college may not be worth it.  Hold on though; I’ll beat you to the punch and say all the things this quick analysis didn’t factor: college major, drop-out rate, intelligence of person, future educational options, income growth, and taxes just to name a few.  Tune in on Wednesday when we’ll go over that.

The other big thing this post missed is all the non-financial elements of college.  College might be a time to spread your wings and discover yourself.  There are so many opportunities to pursue so many interests, many of which you may never have known you had.  You’ll make lifelong friends and maybe even your life partner (as was the case for me and Foxy Lady in grad school).  Of course, I’m not sure that college, and it’s really high costs, is the only place you can get those experiences.

Also, life isn’t always about money.  This is a personal finance blog so that’s what we tend to look at, but that doesn’t mean every decision needs to be based on money.  That said, this becomes a bit philosophical.  What is the purpose of college?  My view is those non-financial things are nice-to-haves compared to college’s ultimate purpose of preparing young people for gainful employment so they can become self-sufficient and contributing members of society.

Complex stuff.  Tune in on Wednesday for part 2.

When can you retire?

Stocky 1 Comment

“Time heals all wounds”

 

Over the last two blogs we started to answer the central question of personal finance—when can I retire.  This complex question really breaks down to two elements: How much will you need?, and How much will you have?  This blog ties them together with the time element of WHEN.  When will what you have be enough for what you need?  This blog will tie those two pieces together and we can figure out When Skinny Fox can retire.

 

“X” marks the spot

You can imagine drawing a graph looking at how much you’ll need in retirement based on how many years you plan on being retired.  At the extreme, if you planned on working until the day you died, you would be in retirement for 0 years, so you would need to save $0 for your retirement.  You’ll need more for a 10-year retirement than a five-year retirement, and so on.  Hopefully that is fairly intuitive.

The assumptions we made for spending in retirement would make the following table (just to make things easy, let’s assume we’ll live to 90 years old):

Age

Nestegg size needed—in today’s dollars
90

$0 (remember, we die at 90)
89

$43,000
85

$205,000
80

$383,000
70

$731,000
60

$1,122,000
50

$1,309,000
40

$1,556,000

 

That graph would look something like this:

 

Also, in the last post we drew a graph that showed how much we would have saved at different ages.  It looked something like this:

 

If you ever took an economics class you know that the answer to pretty much any question is “where the lines intersect.”  If you put those graphs together, where they crossed is where you would have saved enough money (blue line) to be able to afford your spending in retirement (red line).  In this case, the answer is $3.5 million (future dollars).

 

If you look at Skinny Fox’s age, she’ll have saved that much money when she’s 60.  Also, at age 60 is when she’ll need $3.5 million to see her through retirement.  X marks the spot.

 

It’s the process, not the answer

There you go.  Skinny Fox can retire at 60.  We should all retire at 60.  Glad we figured all that out.  Buuuuuutttttt, wait a second.  The whole point of this isn’t to figure out a number, per se.  That’s important, but what is much more important, especially as you are planning your financial future, is figuring out how your decisions impact that number.

This process we went through is enormously complex with a ton of variables and calculations on a fairly involved spreadsheet   .  If you’re good with spreadsheets and compound interest, you can figure all this stuff out and understand the impact of your choices.  If not, maybe your friendly neighborhood Stocky Fox can help.

To keep things simple let’s look at the two major variables that got us here:

  1. Spending in retirement: Skinny would spend about $6,500 per month in retirement, and that would naturally go down as she ages.
  2. Savings while working: Skinny would save 6% of her salary in her 401k, save $5,000 in her IRA, and of course get Social Security.

As is, those two ingredients spit out age 63.  It becomes really interesting when you start to change those inputs.

 

Enjoy life in the now

Maybe Skinny Fox looks at life and thinks that you only live once, so you have to enjoy life in the “now.”  You never know what the future holds.

She wants to use her handy dandy spreadsheet to figure out what would happen if she saved less today.  The intuitive answer is obviously that saving less today means she’ll need to retire later or she’ll be able to spend less in retirement.

Instead of saving $5,000 in her IRA each year, let’s say she cut that in half and only saved $2,500.  She could still retire at 60 but that would mean she could only spend about $5,700 per month in retirement, a decrease of about $800 or 15%.  Conversely, she could still spend $6,500 monthly in retirement, but then she would have to push her retirement back to age 62.

We could run a few scenarios and get the following table:

IRA/extra savings Retirement spending Age of retirement
$5,000 (base case)

$6,500

60
$2,500

$5,700 (spend less)

60
$2,500

$6,500

62 (work longer)
$0

$5,000

60
$0

$6,500

64 (work longer)

 

Retire in style

Maybe Skinny takes the opposite approach and wants to work hard now to ensure she can spend to her heart’s desire once she’s retired.  We can use a similar approach.

Instead of spending $6,500 per month, she could spend $7,500.  That would require her to save an additional $x,xxx per month while she’s working, or it would require her to push her retirement from 63 to xx.

Again, we could run a few scenarios:

IRA/extra savings

Retirement spending

Age of retirement
$5,000 (base case)

$6,500

60
$8,200

$7,500

60
$5,000

$7,500

62 (work longer)
$15,800

$10,000

60
$5,000

$10,000

67 (work longer)

 

Time is the most valuable thing we have

You’re probably starting to get the point.  There are two variables, how much you save and how much you spend.  You can move those around however you want.  The third variable of age balances everything out.

Interestingly, the age variable seems to be the most powerful.  If Skinny wanted to retire five years earlier, at age 55, she would either have to save an extra $4,800 each month or she would need to reduce her spending in retirement by $1,100 each month (that’s about 20% which seems like a big reduction).

Conversely, if Skinny was willing to work an extra five years, retiring at age 65, she could spend $3,300 more each month in retirement or completely skip her IRA.

That seems a bit surprising that over a 40+ year career that just a five year swing (a little over 10% of a working career), one way or the other, has such a big impact.  The reason is working an extra year has a triple-effect.  It gives your investments an extra year to grow, it gives you an extra year to build your nestegg, and it reduces the time you’ll be retired.  Obviously, the opposite is true too if you want to retire at a younger age.

Clearly you can see the tradeoffs Skinny needs to make.  Is it work spending more now if that means having to work longer?  Or having less to spend in her golden years?

There’s no right or wrong answer, and it’s a deeply personal decision.  For the Fox family we made the decision to retire early.  This meant spending less in retirement, but when we did our math we found that we could stop working and still maintain a reasonable lifestyle.  Sure there are times now when we wish we could spend more, but given the time/spending tradeoff, I think we’re pretty happy with our decision.

How do you feel about the time/spending now/spending later tradeoff?

 

 

We’ve covered a lot of ground here.  I hope this gives you a sense of “what is reasonable,” both in terms of how much you’ll likely spend in retirement and how much you’ll save.  Also, it let’s you get a sense for the tradeoffs you make by spending today and how that impacts tomorrow, and vice versa.

However, I think the biggest epiphany for me at least was how important timing is.  Everyone will be able to retire.  It’s just a matter of when.

 

How much should I save during my working years?

Stocky 2 Comments

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Monday we started tacking the enormous question of “How much do I need to retire?”  We dove into the first sub-question:  How much will I spend in retirement?  Now we’re going to take on the next question: How much should I save during my working years?  Then tomorrow we’ll bring it all together by answering the third question: When can I retire?

Let’s start talking about savings.  We know that savings is the fundamental ingredient in investing and we know that starting early provides a great advantage.  We’re going to use the example of my cousin, Skinny Fox.  Skinny is 22 years old, just starting out with a $50,000 per year job.  She expects salary increases of 5% (a little more than inflation) and she’ll eventually top out at a salary of $150,000 per year (in future dollars).

Social Security

The first place to start when thinking about your nestegg is Social Security.  That’s the “forced” savings plan the US government makes you do.  It’s complex and there is a lot of nuance, but basically they’ll take 6.2% of Skinny’s income (plus another 6.2% from Skinny’s employer) over her working career.  When it’s time to hang up the spurs, she’ll get a monthly pension.  So in a very real way, Social Security is your first “savings” method.

Unfortunately, the rules for Social Security aren’t very straight-forward when it comes to figuring out how much you’ll get based on how much you put in.  However, it seems reasonable that a middle-class fox like Skinny will get a middle-class payout from Social Security like $2,000 (in today’s dollars) per month starting when she turns 67.

For Social Security, when Skinny “saves” her 6.2% of income ($3,100 in her first year of work), that gives her a pension that will be worth about $450,000 in today’s dollars; that’s about $1.6 million when Skinny turns 67.

401k

When Skinny Fox was looking for her job she knew how important it was to consider the company’s benefits beyond just the salary.  Her company offers a 401k and matches $0.50 for every dollar up to 6% of her salary.  Skinny knows she should max out her 401k because of tax reasons, but that’s just not realistic for her, so she just contributes the 6% to get her company match.

Her first year she contributes $3,000 to her 401k and her company kicks in a $1,500 match.  Over her entire career her 401k will steadily build until she turns 67 and it’s worth about $1.9 million (in future dollars)!!!

 

IRA and other savings

Skinny is a nervous soul whose father fox always taught her to save, save, save.  She knows that she can contribute to an IRA, after reading this blog she knows it should be a traditional IRA and not a Roth, with $5,000 per year.

When Skinny turns 65, that IRA is worth about $1.2 million.

If she’s still nervous, she can save in a regular brokerage account that doesn’t have the tax advantages of a 401k or IRA.  Each $1,000 per year she saves equates to about $200,000 when she turns 65.

This really illustrates the power of compounding.  I’m not saying that $3,000 per year for her 401k or $5,000 annually for her IRA isn’t a lot of money.  Especially when she’s first starting out—it’s definitely a lot.  But $8,000 doesn’t seem insurmountably unrealistic for Skinny.  Each year after that it gets a little easier.

However, the payoff seems huge.  Slowly and steadily, over her 43-year working career, her 401k will have steadily grown to $1.9 million and her IRA to $1.2 million.  She’ll also have a backstop of Social Security which would have a lump-sum value of about $1.6 million.  Combine all those, and she’s got a nest egg of about $4.7 million in future dollars (about $1.3 million in today’s dollars).

That certainly seems like a lot, but is it enough?  We know from yesterday’s post that $1.1-1.6 million is right in the range of a pretty decent retirement.  So Skinny’s there just based on her 401k, IRA, and Social Security.  The good news is that doesn’t include any home equity she builds over her adult life, extra savings just from making more than she spends, or any inheritances or other unexpected windfalls.  So maybe there’s some cushion there.

On the other hand, she maybe she shouldn’t feel especially comfortable.  She has a clear path to $1.3 million and she’ll need $1.1-1.6 million.  That’s definitely within the margin of error.  What is a vixen to do?

Come back next Monday for our final installment of this blog mini-series where we bring together what you’re going to spend in retirement with how much you have saved for retirement, and we’ll see if it all works.

Smarter than a Nobel Prize winner

Stocky 3 Comments

I’m making a bad habit out of taking extended (very, very extended) breaks from the blog.  What can I say?  I guess being retired can keep you pretty busy.  In fact, in retirement I have been doing a lot of freelance consulting work which has been fairly lucrative, but more on that in a future post.

Since I last posted, so much has happened in the investing world, so we have a lot to cover.  However, the thing that deserves the most attention is the roaring bull market we have enjoyed over the past 12 months.

 

Smarter than Schiller

Back in 2015 Robert Schiller, who had just recently won the Nobel Prize, wrote an article warning investors that future returns might not look so good.  I took the contrary position, thinking that stocks would do well.  Of course, since I’m bringing this up it must mean that I was right and the Nobel Prize winner was wrong.  Ha.

Stock performance since March 2015. The red line is international stocks and blue line is US stocks

As it turns out, US stocks are up an incredible 18.5% since then and International stocks are up 6.8%.  Those are pretty heady numbers, and hopefully you were invested and enjoyed the run up.

To be fair, when Schiller reads this and comments on this post (I am sure he is a loyal reader) he will certainly point out that he was making comments about the long term (let’s say 20-30 years), not just the next 2-3 years.  That’s fair, but facts are facts and the so far the race is not looking good for Schiller’s predictions.

 

The more things change the more they stay the same

Let’s look at the world and how it has changed since Schiller’s predictions, and try to figure out what has driven the changes.  The world’s a big place with a lot of stuff happening so I’m not going to cover everything, but here’s my short list of major developments that have impacted the stock market:

Greece—Two years ago Greece dominated the financial headlines.  The questions of whether or not Greece would get a financial bailout, if it would stay in the European Union, if it would continue to use the Euro, and the broader idea of how much austerity was too much were paramount.  Somewhat predictably, the EU waited until the last second before giving Greece the necessary loans, and the world kept on going.  I’m no expert, but my sense is Greece is still an economic mess but, as politicians are apt to do, it was easier to kick the can down the road.

Brexit—After the Greece drama, in June 2016 Great Britain voted to leave the Eurozone.  The vote was not expected, and it sent crazy reverberations through the stock market for the next couple days.

US starts raising interest rates—Back in 2008 during the great recession, the federal reserve and the rest of the world banks slashed interest rates to near zero.  And there they stayed for many years.  Many questioned if we were in a new normal.  However the US economy started to strengthen and in December of 2015 they raised the rate for the first time in seven years.  At the time this was such a major news event in the financial press it’s hard to overstate it.  Since then they have raised rates three more times.

Trump election—And the biggie.  Donald Trump defied all odds, first by capturing the Republican presidential nomination and then pulling off a shocking upset over Hillary Clinton to become the US’s 45th president.  He ran on a platform being pro-business and bringing a “business know-how” to the office.  Without getting too political, it’s been a bit of a roller coaster, but the US stock market is up about 16% since he was elected 8 months ago.

 

Keep on truckin’

Those are just my short list, and each of those could have a multi-part post.  In fact, at the time they produced thousands of articles and opinion pieces.

The point with all those, and also my point at the time of Schiller’s prediction and my rebuttal over two years ago still stands—we have a tremendously strong economy and things just keep on truckin’.  It’s impossible to predict the stock market in the short term, and certainly Schiller would agree with that.  I think it’s also impossible to predict when the stock market is going to fundamentally change for the foreseeable future, as Schiller did.

In the intervening 2+ years since Schiller’s prediction amazing things have happened to the US and global economy.  The US is producing nearly as much oil as Saudi Arabia (who would have thought) thanks to technology breakthroughs.  That’s employed thousands and lowered the price of oil to billions.

Airbnb and uber have revolutionized fairly old industries and ushered in a “sharing economy”.  Self-driving cars are now on the road and have the potential to bring the biggest life change in a generation.

The point of all this is since Schiller’s prediction back in March 2015 so much good stuff has happened.  So much innovation has occurred and so much value has been created.  Maybe the point is all that doesn’t seem abnormally high, it’s just what happens every month and every year.  And I think it would be foolish to think that won’t continue in the future.

 

In my first post in a while I wanted to make sure we reflected on how well the stock market has done despite some of the smartest people in the world saying our best days are behind us.  I promise I will be posting regularly now, and we’ll continue to look at the best way to get fat off of our investments.

Why are falling oil prices dragging the market down?

Stocky 2 Comments

oil-well-art-d0e8499fbec07478-1-

Oil is pretty special.  After air and water, it’s probably the most important substance for mankind.  Different from air and water, oil is not free (or nearly free).  Oil touches every part of our life, even the lives of “green” people who drive electric cars and have solar panels on their roofs.  Oil takes us from point A to point B in our cars and airplanes.  It gets every single product from its producer to its consumer—food, clothes, cars, phones, everything.  In many communities it powers the plants that literally keep our lights on.

Historically, going all the way back to its discovery in Pennsylvania in the 1859, the price of oil has been prone to booms and busts.  Early on, the discovery of a single well could send prices plummeting, driven by fears of over-supply.  More recently, supply restrictions like OPEC or geopolitical conflict can send the price soaring; while signs of weakness in demand like a global economic recession can send prices diving.

The past couple years have been no different.  Oil has fallen from over $100 per barrel to where it stands today, less than $35.  That’s quite a fall in prices, but why is that such a big deal?  Interestingly, as the market has been struggling the past few months, many market pundits cite the fall in oil is hurting the stock market.  But does that really make sense?  Let’s take a look.

 

Market pundits, as usual, are full of crap

As we all know, the market has been extremely volatile lately.  That coupled with the price of oil falling has led a lot of talking heads on channels like CNBC to correlate the fall in the market to the fall in oil.  However, if you look closely, you’ll see that there isn’t much of a correlation.

Since 2014, the price of oil has fallen 65 weeks and risen 47 weeks, while the S&P 500 has fallen 49 weeks and risen 63 weeks.  So there different but the real nail in the coffin is that of the 112 weeks, oil and the S&P 500 have moved in the same direction . . . (wait for it) 53% of the time.  So they have both risen or both fallen a little more than half the time.  They have gone in opposite directions, one goes up and the other goes down, 47% of the time.  That seems like a flip of the coin to me.  So the data totally refutes the idea that oil is driving the market in a major way.

The markets are incredibly complex, and it’s naïve to believe that the price of a single commodity, even the most important commodity there is, would drive the market.  Those talking heads need their sound bytes and need to appear as though they’re explaining what’s going on, but we know better.

So first, and foremost, don’t believe everything you hear from CNBC.  They have a lot of airtime to fill, and they say a lot of stuff that under the slight of Stocky’s analytic scrutiny is total crap.

 

Case for the fall in oil hurting the stock market

Obviously if the price of oil falls 70% over the course of a couple years that is going to have a devastating impact on the oil industry.  And remember that the oil industry is incredibly big (probably about the third largest industry in the US) and incredibly complex.  There are geologists looking for new oil deposits, drillers, truckers and pipeline people taking oil to/from refineries, refiners, all the way down to gas station attendants.  So let’s look at how the price of oil impacts them.

The people who run gas stations aren’t going to be affected at all.  Drivers are still filling up their cars (probably even more than before because gas is so cheap), and the gas stations are still making their couple cents markup on each gallon of gas.  No Impact.

Refiners are probably impacted a little bit, not because their business is going down (similar to the gas station people, it’s probably going up), but because their customers, the oil producers are getting squeezed by price, so that is probably trickling down to them.  My neighbor owns a couple oil refineries and he has mentioned that they normally charge something like 15% of the cost of the oil they refine, so obviously if prices go down they get impacted.  But people are still using plenty of oil so the refiners are still going to be plenty busy, and if they have to raise prices to make it work, basic economics say they should be able to.  Small impact.

Geologists and drillers in the US are feeling the pain.  When oil was at $100 there was a huge incentive to try to find extra supply so that kept a lot of these people employed looking for and then drilling new oil wells.  However, as you can easily imagine, when oil is trading at $30 there’s no where near that incentive to find new wells.  Plus you have all the industry that goes with helping set up wells and keeping them running.  Think of cranes and enormous drills, wiring and tubing; all sorts of crap (Halliburton is a big player here).  When you aren’t looking for new wells, you don’t need all that other stuff.  A lot of those people are out of work.  Major impact.

That even flows through (pun intended) to the people running the wells that are online.  Even after you factor in the huge start-up costs to find a well and get it going (more on that in a minute), there are significant costs in keeping a well up and running.  If a well is profitable at $100 but not at $30, then those wells might get shut down, and those people might lose their jobs.  Medium-major impact.

Finally you have the truckers who transport the oil around.  They are probably getting less business taking crude oil from US fields to the refineries, but they should have just as much business as ever from taking refined gasoline to the gas stations.  Plus, truckers are pretty flexible; if they aren’t driving oil they can easily drive something else.  Small-medium impact.

There are a lot of players in the oil industry, and some of them, especially those involved in the discovery of oil are really hurting.  And of course this has a compounding effect where they lose their job, can’t buy things other people product, and on with the downward spiral.  But let’s not lose sight of the bigger picture.  There are probably 150 million working Americans.  Only a very, very small fraction of those are in the energy industry, and only some of them are losing their jobs.  So this impacts a relatively small number of people, but it impacts them in a large way.

 

Case against the fall in oil hurting the stock market

How about the rest of us?  Oil’s price falling is unambiguously a good thing.  Something we all need is getting less expensive.  Obviously we feel that at the pump where it used to cost $60 to fill up our car and now it only costs $25.  We can all use that $35 to spend on other things which keep other people employed, or we could (gasp!!!) save it.

And as I said above, oil permeates through every part of the economy.  So if you don’t drive a gasoline car, you’re still getting the positive benefit because it cost less to get your food to the grocery store, to fly your FedEx package across the country, and nearly every other thing you use in your daily life.  This is what the press has called the “oil dividend,” the extra money that we’re all getting because things aren’t as expensive.  It won’t add up to millions, but it’s not unreasonable to imagine a family saving $1000 a year because of the lower oil prices.

If you compare two scenarios though, it seems lopsided.  An oil worker is losing his job while a family is saving $1000.  But remember it’s a numbers game.  Maybe there are a tens of thousands of people (and that seems high to me) in the oil industry who lost their jobs.  But there are a hundred million people who are getting a small benefit.  It’s a numbers game and the masses, with their small benefit, clearly make up for the relatively small amount of people who get crushed.

 

Final verdict

So if you look at all that, clearly the fall in oil prices should be a good thing for the economy.  And largely it is.  The nation is pulling out of a recession and there is broad-based economic growth.

But there’s still a nagging voice that is saying “not so fast”.  The problem with oil prices isn’t that it’s low now and a while ago it was high.  We have an amazingly adaptive economy that can thrive with low oil prices just as easily as it can with high oil prices.

What screws things up is when oil price change so quickly.  As I briefly mentioned earlier, starting up a new oil well is a major undertaking, and “major undertaking” is French for “expensive”.  Before a single drop of oil comes to the surface, companies are investing tens and hundreds of millions of dollars.

Of course, they would only do this if they thought they could generate a profit.  If oil was at $100 then they would look at all the places that can profitably produce oil at $100 and start getting to business.  Now they aren’t dummies and they know oil prices can move, so there’s a risk involved but that gets factored in too.  But when the bottom falls out of the price of oil and those wells become unprofitable, at some point they have to shut down the well and much of that initial investment gets lost.

And it’s not just oil producers.  Look at a company like Tesla.  They make electric cars, and as you can easily imagine, electric cars are really attractive when oil prices (and thus gas prices) are high.  You can see it in their numbers: sales have slowed down considerably as oil prices as fallen.  Just like the oil producers, the fine people at Tesla need to figure out if they should expand, make a new factory, all that stuff.  If they did that when oil prices were high (which in fact they did) then a lot of that investment might be in trouble now that oil prices are low.

Making it even more local, imagine your neighbor was looking to buy a new car.  When gas prices were high she was considering a Nissan Leaf (about $30,000) instead of a Honda Civic ($18,000), in large part to take advantage of savings on gas.  She buys her Leaf figuring she’ll save $2000 per year on gas, but then gas plummets and her savings are only $1000.  Her “investment” of the extra $12,000 she spent on the Leaf is in bad shape.

 

To bring this home, I think it’s unquestionable that lower oil prices are a good thing.  Yeah, a few people might get hurt, but that’s pretty small compared to the masses that are helped.  But the real problem isn’t high or low oil prices, but it’s unpredictable oil prices.  That’s when people or communities or companies make large investments which might turn out to be really bad decisions.

What about you?  How is the low cost of oil impacting you?

Stocky’s 2015 performance

Stocky 5 Comments

happy-new-year-blue-greeting-card-d-numbers-balloons-confetti-45166483-compressed

We talk about investing a lot and what you should do or what the historic data says is likely to happen.  But the rubber does eventually hit the road and real investments are made.  So now that 2015 is over, how did the Fox family do with our portfolio?  It only seems fair to ask.

 

Investment performance

From an investment performance perspective, 2015 was definitely a subpar year.  If historic returns are about 6-8%, we were well below that, sadly even dipping into negative territory for a couple investments.

Investment

Portfolio weight (beginning of 2015)

Portfolio weight (end of 2015)

2015 return
US stock index

33%

43%

0.3%
International stock index

35%

36%

-4.4%
REIT index

11%

11%

2.4%
Commodities

8%

5%

-28.2%
Medtronic

9%

1%

8.1%
Bonds/Cash

4%

4%

0.4%
TOTAL      -3%

 

As you can see, pretty much all our investments were either flat or fell in value.  Luckily, Medtronic had another good year, but even that wasn’t enough to compensate for the losers.

If you put it all in the pot and mix it up, our portfolio had a return of about -3%.  Obviously that isn’t what we want, and returns like that aren’t going to make the Fox family secure in its retirement and other financial goals.  But it’s important to keep in mind 2015 was the first down year since the disastrous year which was 2008.  That was a 6-year winning streak, so it’s probably reasonable to expect that to end.  Fortunately, if you were going to have a down year, this one was pretty benign as those things go.

 

Changes in investment weightings

If you read this column regularly, you know that in 2015 we had two major life changes that had a big impact on our finances.  First, I quit my job at Medtronic, and second Foxy Lady got a job in North Carolina which sent the Fox family east.  If you look closely you can see the impact of those events on our portfolio pretty clearly.

Because I quit Medtronic all my stock options and company stock developed a “use it or lose it” quality.  So I exercised all my options and sold nearly all my company stock.  We used that money to help with the downpayment on our North Carolina house (since it took longer than we expected to sell our Los Angeles house).  So because of all of that you can see why our Medtronic holdings really fell.

Also, anticipating my leaving Medtronic, I front loaded my 401k to make sure I hit the $18,000 max before I left.  Since my 401k was all in US stock index funds (that had the lowest management fee), plus since Foxy Lady’s 401k is similarly all in US stock index funds, that led to the increase in the percentage of our portfolio that is in US stocks.  That and the fact that US stocks outperformed international stocks.

Finally, we did add another investment to our portfolio—Lending Club.  This definitely deserves its own post, but basically it’s a peer-to-peer lending website (so I grouped it with “Bonds/Cash”).  Right now it’s a small amount of money, but Foxy Lady and I have gotten our feet wet and like performance we’re seeing from this investment, so we’ll be increasing it over time.

 

Net worth increase

So all that’s great, but the bottom line is the bottom line.  What happened to our net worth in 2015?  Fortunately, despite a lower market dragging things down, our net worth was able to grow about 16%.

net worth graph

How is that possible, you ask?  Well, it’s just good ole saving money.  As I mentioned a couple paragraphs above, Foxy Lady and I both max out our 401k accounts, that being the primary way we save these days.  So despite the stock market not being very loving this year, we were able to offset that by putting more money in.

And as two foxes in our late 30s (Foxy Lady just glared and said “37 is clearly still considered mid-30s”), I actually look at this market dip as a bit of a good thing.  Using dollar-cost averaging, our 401k accounts were able to buy the same mutual funds we always did, but this time we were able to do so at a bit of a discount from what it would have cost before.

As you all know, I am incredibly optimistic about the future of the US and the world and the stock market.  So I know things will go up over the long haul.  If in the meantime I can buy some investments on the cheap, all the better.

 

That’s how we did with our portfolio.  The investments weren’t great, but we kept our nose to the grindstone and kept plugging away, which is really the most important thing you can do when saving for retirement.  How about you?  How did you do in 2015?

 

What’s causing the volatility? Part 2

Stocky 1 Comment

Welcome back.  Yesterday I started listing off reasons we’re seeing so much more volatility in the stock market. In this blog I’ll take you home.

 

 “Skynet becomes self-aware at 2:14 a.m. Eastern time, August 29th.” –Terminator 2 (1991)

Terminator 2 - 5

Computer-initiated trading drives a major, and increasingly larger, portion of the volume in stock markets.  It’s a good thing for a few reasons.  It gives people more options in their trading strategies, it offers precision that humans can’t match, it doesn’t get tired or forget or anything like that.  But it also leads to a lot of volatility.

One of the major types of automated trading is “stop-loss” trades.  This is when someone owns a stock like Nike and says something like: “I only want to sell it if it starts to fall.  Right now the stock is at $50, so sell it if it goes below $45.”  Emotionally it makes sense.  Everyone knows crazy things can happen with stocks and it can all go to hell in the blink of an eye (see: Enron or Worldcom or Blackberry).  So as the name implies, this stops your losses at some level you establish.  Awesome.  You have more control.

The reason this increases volatility is that this type of trade tends to compound the problem.  When stocks are going down these stop losses trigger which sells more stock which drives the prices down further which triggers more sell orders and so on and so on in a downward spiral.  The obvious flaw is that the computers which are doing this don’t have any idea of the intrinsic value of the stock they are selling; they just know they are supposed to sell when the stocks hit a certain level so that’s what they do.

When rational humans look at these types of situation (maybe like Boeing on July 12) and can “see” that the market is overreacting, things tend to go back to levels that make sense.  Probably the best example of this is the Flash Crash of 2010.  On May 6 of that year, probably the craziest 30 minutes ever of stock trading occurred.  In a matter of minutes the market fell about 10% (equivalent to about 1700 points on the Dow Jones Industrial Average if this happened today!!!), and then just as quickly recovered nearly all the loss.

What made it so crazy was that no news drove it.  Maybe news of a nuclear war starting or a meteor on a collision course for earth would justify such a rapid move.  Of course there wasn’t that, but there wasn’t anything—no news from the Federal Reserve, no companies going bankrupt or countries defaulting on their debt, or a regional skirmish, or a refinery blowing up, nothing.

In the aftermath, the leading theories all ultimately pointed to automated trading.  Some sell order lowered prices slightly but just enough to started triggering stop-loss orders.  That started a selling frenzy that drove prices down, leading to more stop-loss orders and in an instant everything went to hell.  Once thinking people saw this and knew that something weird was going on, they started buying those shares which were selling at 10% or 20% or even 50% less than they were 20 minutes before and made things normal again.  Like so many examples here, we ended where we started, but we had a crazy ride in the meantime.  More volatility.

 

“We keep inventing better ways to kill ourselves”

The stock market is an evolving landscape.  There was a time long, long ago when it was just stocks.  Then derivatives like options and futures came along as well as buying on margin (borrowing money to buy your stock); and now we have stuff like credit-default swaps (I can’t say I fully understand those), virtual currencies, and other really exotic things.  Like a gun or a power saw or a car, these financial tools can be very useful when used correctly but they can be disastrous when used recklessly.

Generally speaking these investments lead to higher volatility because they tend to be very leveraged.  You can make really, really large investments without a lot of money.  To buy 1000 share of Medtronic would cost you about $75,000; but to “buy” that same amount using call options would cost maybe something like $2000.  Of course, derivatives like stock options are much more volatile, and can lose all their value really quickly.

All the sudden that means you can be a small-time investor who decides to throw a Hail Mary in the stock market.  Instead of needing a bunch of money to take a major position, you could do it with much less.  Realistically, I as an individual probably couldn’t take such a big position to impact the market, but certainly a small bank could.  There are dozens of stories where some trader at a bank took a crazy big position, often times using derivatives, that went bad.  Not only does it take the bank down, but when that bank falls, just like dominos, others fall with it.  Same story: increased volatility.

 

So we’ve covered a lot of ground and come up with a lot of things that make today’s stock market much more volatile than it’s ever been in the past.  But let’s remember that the stock market is ultimately about fundamentals.  How strong are the companies?  Are they coming up with new products?  Are they finding better, faster, cheaper ways to meet our needs?  Those are the things that make the stock market go up over time.  And I believe all those things are there in today’s stock market.

In fact, of all the reasons I cited for increased volatility, I think all of them are good for the long-term value of the stock market.  Information traveling faster is a good thing; a globalized economy is a good thing; computer assisted trading is a good thing; financial derivatives are a good thing.  They’re all good and they all are making stocks continue to be a good investment.  Remember, stocks have been on a relentless climb for over a century.  In 2015, despite all the craziness, we were still hitting new all-time highs.

Sure, sometimes people screw things up, and because of this new age, those mistakes make a big impact.  But that big impact fades, usually very quickly.  So Mimi, as always, I think the stock market has great prospects for the long-term future, and I’m putting my money where my muzzle is on this one.  Your daughter-vixen’s retirement money as well as your grandcubs’ college funds are fully invested.