Freedom Guarantees Inequality

Let’s start in grade school, the first time in life there is some correlation between performance and reward. Take any two random children. One of them will be smarter. One of them will work harder. The results of their efforts, in simplistic terms, are some combination of their native ability combined with the level of effort they apply to the task at hand. If one child produces measurable results that meet the criteria for a superior rating and the other child efforts are rated a failure, should both children receive a letter grade of C? Should all children receive a trophy even if they lose the little league game? Even children know what that trophy is worth?

Equal isn’t fair.

Let’s move on into adult life. Most people, by definition, are just average. Like most humans in matters of employment, I was not a risk taker. I didn’t want to start my own company. I didn’t want to work as a commission sales person. I don’t have a single salesman’s bone in my body. I wanted someone to give me a job. This is the approach that will be used by almost everyone in the world.

There are two inherent problems found in “working for the man.” First, you will need to cover your expenses plus contribute a reasonable profit to the enterprise or you will very quickly join the ranks of the unemployed.

Companies do not pay employees’ salaries. Customers pay employees’ salaries.

The second problem is time. It doesn’t matter if you are a world famous heart surgeon working for a great research hospital or a barista at Starbucks boiling coffee water and handing out a few pennies in change from a ten dollar bill to your customers. Your salary, whether minimum wage or something in the top 1% is limited by the number of hours you can work. In order to earn money, your presence at the job site is a necessary condition of your employment.

Assuming a free economy in which individuals are protected from immoral coercion by rule of law and property rights, your hourly pay is a direct measure of the value of your contribution to the welfare of your neighbor. If you want more money, find a way to become a greater blessing. There is a reason a man with a BS/RN earns more money than someone who pushes a lawnmower for a lawn service. I discovered that for some strange reason, the economy valued my degree in Mechanical Engineering at a higher level than my degree in English Literature and U.S. History.

Go figure.

I can’t see why any rational person wouldn’t expect to pay a heart surgeon more than someone who can spin a weed whacker. However, that is not where the one finds the greatest income inequalities in our economy. The really big numbers are generated when an individual finds a way to produce revenue without requiring their physical presence or by generating economies of scale.

In the 19th century the earnings of performing artists and athletes was limited by the size of the theaters and arenas of the day. An actor’s physical presence was required to give a performance. This limited his salary. With the introduction of new technologies such as radio, movies, and the Victrola wind up phonograph the salaries of performing artists and athletes began to rise to unheard of levels. Babe Ruth was asked why he deserved a higher salary than the President of the United States, his famous reply, “I had a better year.” while certainly true didn’t explain the fundamental change that had occurred in the economy of professional baseball. Now the amount of income the Babe could generate for the owner of the New York Yankees was no longer limited by the number of tickets he could sell to a game. The description of Babe Ruth’s exploits now could be broadcast on radio stations all over the country. Advertisers would pay top dollar to promote their products on this new medium. Today a major box office draw can earn $20 million or more working three months, the length of time required to film a movie. The producers consider it a bargain because that actor can appear simultaneously on thousands screens in movie theaters all over the world. Then the movie can appear on television, sold on DVDs, and downloaded from the Internet, generating more income for the owners of the film and for the actors even after their death.

Economies of scale can generate geometric increases in profits with mere arithmetic increases in efforts. Consider: One of my former neighbors started flipping houses on the side. He would buy a run down house from owners who need to make a quick sale for a bargain basement price. He would then spend six months or so rehabilitating the property for a quick sale at a reasonable profit. This worked quite well until 2006 when the bubble popped. He was funding this operation with borrowed money. When he could no longer make the payments, he lost everything including his own personal residence. The math worked something like this. He would buy a property for $150K, put about $85K of improvements into the house, and then sell it for $400K. Really, this is pretty much the same thing that made Donald Trump a billionaire. The Donald would buy a run down building in New York City for $100 million, spend two years rehabbing the place, and selling the finished product as a condominium development for $300 million. It maybe takes four times as long to generate 1,000 times the profit. The relationship between time spent and profitability is nonlinear. An interesting side note, early in his career Donald Trump came close to personal bankruptcy, as always debt was the culprit. However, there is an old saying, “If you owe the bank $1,000 and you can’t pay; you have a problem. If (as in the case of The Donald) you owe the bank $800 million; the bank has a problem.” Reasonable men allowed Trump the opportunity to work his way back to profitability thereby saving themselves from losses that would have cost their institutions hundreds of millions in an avoidable beat down.

This becomes even more dramatic in the stock market. It takes no more research or time to buy 400 shares of stock than it takes to buy 400,000 shares in the same company.

The same principal is at work in the development of passive income from sales of a digital product on a website. Once an independent musical artist has made a recording that can be sold from her website, it will generate income for as long as people want to hear her music. Her presence is not required once the product is in the can. I will be interested to see how this phenomenon might affect teachers’ salaries as Web based education begins to take hold. Today a teacher’s salary is limited by her presence in the classroom. Will superstar teachers command much higher salaries to develop and record course material in some brave new world of $2,000 college degrees?

So far so good; income inequality is not only fair, but it is a signal to those who have the ears to hear. Temporary shortages create opportunities for those who have the necessary skills and courage to make a quick profit. The demand for qualified experts in various computer languages and programming protocols come and go like changes in women’s fashions. Every few years we read stories about high school dropouts who are earning six figure incomes writing code for the latest and greatest operating system. Then articles are published lamenting that the market is now over saturated with unemployed programmers writing in the same language that is now considered obsolete.

The problems arise when the economy becomes distorted by direct Government coercion through punitive taxation, Government malinvestment, corruption, a politically well connected union such as the American Medical Association, or the power of a predatory monopoly such as Microsoft during the 1990s. In the past eight years we have witnessed one of the greatest transfers of wealth in history. The Federal Reserve Bank along with the Department of Treasury have mortgaged the future of our nation to benefit the major money center banks and similar “too big to fail” financial institutions. By allowing these corporations the opportunity to borrow nearly limitless amounts of money at close to zero percent interest, not only are the middle class investors and savers punished to benefit the well connected and powerful, but distortions in regulations and the tax code encourage these institutions to engage in financial engineering rather than investing in creating factories that would provide the economy with new jobs. This money, created at taxpayer expense, is also in use enslaving the naive (think student loans) or the impoverished (think payday loans). Government malinvestment seems to be the rule, rather than the exception. From bridges to nowhere to wars for no reason, hardly a day goes by without a report of Government waste, fraud, or abuse.

If there is any tectonic shift in the strata underlying the American republic that concerns me it would be the marriage between big Government and big business. We have had the military industrial complex since World War II. Today the profitability of the financial sector of our economy, automobile manufacturing, and a good portion of the health care industry is guaranteed by the American taxpayer. There is movement towards a national police force equipped with military style weapons. If this comes to pass we will have created the American equivalent of the First Triumvirate. I can assure you that Caesar’s children will not share the same opportunities given our children. Freedom guarantees inequality, but then so does tyranny.

How Do You Learn?

“Writing is like jazz, it can be learned, but it can’t be taught.
Paul Desmond

How do I learn? I have discovered that I have three different learning styles that seem to work for me when dealing with different kinds of material, hard classes, soft classes, and life classes.

Let’s start with hard classes. This is material that isn’t opinion on any level. From multiplication tables in grade school to a graduate level class in fluid dynamics, I have been confronted with subject matter that really doesn’t care what I think or how I feel about it. I have to learn how to do it or if I can’t understand it, I just have to memorize it. In the second semester of Calculus, I ran into peculiar, one of a kind, integration methods that I never understood. I memorized them for the exam. It was nothing but hand eye coordination. In real life it didn’t matter because I had access to a computer and the CRC Math Tables.

Soft classes would include the liberal arts, economics, political science, theology and the like. You are really just learning opinions. In the end, these are subjects where your beliefs are ultimately more important to your life than the opinion of your professors. I found it interesting that my fellow engineering students found the mandatory two semesters of economics incredibly difficult because there was no “right” answer. One week they learned what one economist stated on a particular subject. Then the following week they read about an economist who totally disagreed with the first author. I thought these courses were an automatic 4 credit hour A. If you just read the book or just attended the classes there was no excuse for not getting at least a B. All you needed to learn was one guy said this and the other guy said that.

Actually “learning,” really learning, one of these subjects is different. In such situations I learn best using some form of the Socratic Method. I am an auditory learner by natural preference. I have also developed the necessary visual skills to learn from a book. I am not a kinesthetic learner. When practicing the martial arts, I had to put the movement into words before I could practice it properly. I like to listen to someone put forth an opinion on something like the interpretation of a particular passage in Scripture. Then when I think I understand it, I like to repeat it in my words to see if I have a proper grasp of what the teacher is presenting. Then I like to attack the position to see it stands up under severe questioning. If it survives, I add it to my toolkit. If not, I discard it. Over the years, I have discovered my mind likes to make strange connections across disciplines and different kinds of life experiences. I guess I could describe it as my own personal version of Hegel’s triad, thesis, antithesis, and synthesis. This has helped me develop, not only my own philosophy of life, but also has helped me become a better person.

I always want to be learning, changing, and growing as long as there is breath in my body.

Then there are subjects like writing, living in the same house with another human being, or investing that can’t be taught. They have to be learned. In this blog, I am learning how to write about my experiences learning the ins and outs of Christian Personal Finance. Of course, I study the classics. I recommend that you read the writings of the great investors from King Solomon to Warren Buffet. They can save you from a lot of unnecessary pain. I am convinced that if you really understand Proverbs and Ecclesiastes, you have more than enough tools in you kit to find financial freedom. Next, learn from those around you, preferably people who know more than you know. Seek them out. But, you can even learn from the mistakes of those who know less than you know. It is better to learn from the mistakes of others than from your own mistakes. When you make a mistake or when a good plan goes awry, don’t beat yourself up. Just consider it feedback from the universe.

Pick yourself up. Dust yourself off. Start all over again.

“By three methods we may learn wisdom: First by reflection, which is the noblest; second by imitation, which is the easiest; and third by experience, which is the bitterest.”
Confucius

I Don't Know Nothin'

I found Kinematics and Machine Dynamics to be the most difficult course I ever encountered while obtaining two undergraduate degrees and one graduate degree. It was not unusual to spend 3 hours working on a single homework problem. We were encouraged to work in teams, as the professor wasn’t confident we could complete all our assignments without group cooperation. Actually this wasn’t a bad idea. In real life almost all engineering problems are solved by project teams. One of our assignments called for the analysis of what the professor termed a “donkey engine,” an early type of steam engine used on paddle wheel river boats. It was called a donkey engine because it would “kick” in unpredictable ways. Later engines used governors to control this behavior. Recently I discovered that James Maxwell wrote the definitive paper on this subject back in the mid nineteenth century just before he published his famous equations that became the basis of the science of electrodynamics.

None of us were able to solve the donkey engine problem. The professor never provided us with the answer. Early in my career at the laboratory, I told this story to my coworkers. They didn’t believe me, so I gave them the opportunity to find the solution. They were experienced engineers. Most of them had their master’s degree. None of them could solve the problem. Finally my boss, a brilliant man with a PhD in mechanical engineering tried and failed to derive the equations of motion for the donkey engine. He concluded the system was too close to instability to be solved using normal, linear predictive methods.

From time to time, I am asked to predict the movement of stock market. If I could perform this miracle on even a semi-regular basis, you could try to visit me on my beachfront estate on the island of Maui, if you could get past my security force. People like the rube in the painting believe or at least entertain the idea that someone can predict the movement of the market with mathematical certainty, while the fortuneteller’s confederate is busy picking the victim’s pocket. Think about it. If I had the magic box that could predict the movement of the market, why would I share it with you?

I started studying investment as a discipline about 14 years ago. After much effort, I have come to the conclusion that, “I don’t know nothin,” at least not with anything that approaches mathematical rigor. What I have learned are some rules of thumb that have helped me save and successfully invest enough that I was able to retire comfortably at age 62.

Here are some of those rules of thumb, rules that work “thumb” of the time. Remember all these statements are based on past performance, which may or may not have anything to do with the future.

1) If you invest in American equities your money will grow at approximately 7% per year over any sufficiently long period of time. That sufficiently long period of time may not reach fruition until after you and your coffin have been carried home to victory on the Wabash Cannonball.

2) In any given year you can lose as much as half the money that you are holding in stocks. It happens. If you lose half your money, you will need to double your money to get back to even. That could take a long time. It is better to lose ½ of ½ of your money, especially if you are retired. If half of your money is in bonds and cash you will be able to pick up bargains after the market collapse, just like Joe Kennedy did back in 1933.

3) Bonds are not guaranteed. A wise man looking around for safe investments in 1910 might well select some German and Russian bonds for his portfolio. His great grandchildren may still have these souvenirs of a better time framed and hung on the wall of their study as a historical curiosity.

4) The world will end every eight to twelve years. About once a decade the market will suffer something that falls between a major correction and a crash. Count on it.

5) Indicators may or may not be of any use. For two or three years, all the fundamental indicators have been telling us the market is over valued. However, there is another rule of thumb at work here, “Never fight the Fed.” As long as the Federal Reserve Bank and the Department of the Treasury continue to pump astronomical sums of funny money into the economy, indicators are indicating something but not providing us with any useful information.

6) Debt is bad. Corporate debt is bad. Over the course of about two months, I discovered, KMI, one of my “safe” stocks that performed well for a long time had a debt problem. Now, I’m pretty much back where I started on that one. Large scale individual debt is bad for an economy. Excessive Sovereign debt is dangerous for a country. Debt has to be repaid. The principal and interest repaid to the creditor are funds that can’t be used to generate new sales and salaries in the private sector that can then be taxed by the public sector. During this “winter season” when debt is being squeezed out of the economy, the donkey engine can kick in unpredictable ways—like hyperinflation or bankruptcies for individuals or default for Governments. These events can cascade through society with truly disastrous results, like World War II.

So what can I say that is of any value to the beginner or even the experienced investor? If you spend less than you make over a working lifetime, you will have a surplus to invest in stocks, bonds, or real estate. If you don’t invest too much in any one thing or too much at any one time, it is likely that you are going to be all right.

I really can’t beat what Solomon wrote a long time ago. A broadly diversified portfolio containing different types of investments and wise trustworthy friends and counselors who have your back are your best protection against the uncertainties one finds under the sun.

Ecclesiastes 11:2
Invest in seven ventures, yes in eight, you do not know what disaster may come upon the land.

Ecclesiastes 11:6
Sow your seed in the morning, And at evening let your hands not be idle,

Proverbs 15:22
Plans fail for lack of counsel, but with many advisers they succeed.

Ecclesiastes 12:13
Now all has been heard, here is the conclusion of the matter. Fear God and keep his commandments, for this is the duty of all mankind.

Pushing Water Up the Hill

First of all, I need to convince you that debt is generally a bad idea. Then I need to convince you that you can push water up hill.

The following is a highly embellished version of a thought experiment proposed in an interview by Nassim Taleb, an author who studies the impact of highly improbable events on economies and nations.

Consider twin brothers who have just graduated from school. One gets a job and begins to save 10% of his take home pay. He pays $1,000 cash for his uncle’s ten year old truck that was actually probably worth $3,000. He puts off buying a house until he can make that 20% down payment to avoid the dreaded PMI (Private Mortgage Insurance). The other brother gets the identical job. However, he buys a brand new pickup with a low down payment and a 72 month note that he can easily afford. He thinks he gets lucky when a local developer offers condos for sale with no money down to young folks with good credit ratings. After all, his mortgage payment will be less than the rent he is paying for a two bedroom apartment.

After three years their employer goes belly up. What happens next? One brother has $12,000 in the bank. He shrugs his shoulders, loads up the truck, and moves to Greenville, SC when he hears the words, “They’re hiring down here,” from one of his buddies, who made the move last year. The other brother can’t make the payments on his truck. It is repossessed. He can’t sell the condo because he is underwater. That is he owes more on the condo than it is worth.

Three months later the first brother found a job making widgets that are sold to the BMW factory in Greer, SC. He still has $6,000 in the bank and a beat up old truck on its last legs. The other brother is living in his parent’s basement with no job, no wheels, and a wrecked credit rating.

Savings are good because the impact of highly improbable events is often bad.

You can push water up hill. However, it requires wise decisions, energy, and discipline over long time periods. You will need some pipes, a pump, a source of electricity to run the pump, and some kind of reservoirs at different levels to store the water as it moves on its way up the hill.

For most of us, your job is the source of your money, the water you need to move up the hill of life. You start by moving a percentage of your income into a storage tank we will call an emergency fund. Once that tanks starts filling up, you can divert the flow of a portion of your savings to a 401(k) or some other tax favored retirement account. If your employer offers matching money, do this sooner rather than later. Later on, install a big tank for a down payment on a home. Once you have a mortgage, pay it down sooner rather than later, remembering how much sooner is a function of the interest rate you are paying. Finally, open a reservoir for your children’s education.

Here is how that worked during most of the years of my working life. First I had a checking account. I kept more than enough money in there to cover expenses for a couple of months. Later, I opened up a money market fund to cover emergencies and save for big ticket items like cars. My employer offered a 401(k) so I began by contributing some trifling percentage from day one. I don’t remember the actual number, but it was too low. When I had enough to make the then traditional 10% down payment, I became a home owner. Finally, I opened a taxable investment account at Schwab. Money went into that account but never came out of it for any reason until I retired.

Pushing water up the hill is a pretty simple task, but it isn’t easy. When dealing with money there is a bonus you don’t get with water. Once you have pushed enough money up the hill, you will find that the miracle of compound interest begins to fill your tanks without any further effort on your part. However, those tanks, your piping system, and valves still will need periodic inspection and repair.

The Medicare Card Blues

Recently I received my Medicare card in the mail. A little over a month from today I will celebrate my 65th birthday, one of those important birthdays. I am old enough to have buried a few of my contemporaries, but still young enough to have a functioning body and mind, although neither works quite as well as it did thirty years ago. I am at a point in life when I am watching a third generation pass out of childhood to begin the long march to the grave.

Although this is a personal finance blog with an intentional over-emphasis on investment, I have been thinking about the importance of position, direction, and velocity as it applies to my walk as a Christian. My beliefs about the Bible, the Church, and what constitutes the Faith have evolved over the years of my life. My beliefs are not the same as they were when I came close to trapping God in a box during my twenties. It would be profoundly depressing if they hadn’t changed over all that time. My prayer is that they continue to change as I continue to move through my remaining years.

As I look at people moving through their careers and the seasons of family life, I have learned that direction and velocity are more important than initial position. Your current position, financial, spiritual, or relational is what it is (as the football players are fond of saying). Are you moving in a direction that will bring you closer to your goal? How fast are you moving? These are the important questions.

To what degree we are the product of our environment and to what degree we are responsible for our current situation, really doesn’t matter as much as what we choose to do to move towards something better. It is a matter of the heart. A person who has made the decision not to accept the status quo and is taking action to improve some dimension of their life is already better off that someone who doesn’t care or has just given up.

Recently I watched the documentary Born Rich, produced by Jamie Johnson, one the heirs to the Johnson & Johnson pharmaceutical fortune. He interviews young adult children of billionaires, not just your regular run of the mill billionaires, but really serious billionaires. Some of these young people seem to be doing a pretty credible job finding a purpose for their life and goals that give their efforts meaning. Others can charitably be described as—a mess. I suspect that most of this group would be a mess with or without money. A surprisingly small number of these young adults have made the decision to kick back and enjoy an obscenely decadent and somewhat debauched lifestyle that can only be supported by a nearly inexhaustible supply of money.

They didn’t do anything to enjoy the benefits or the real, serious problems associated with wealth and celebrity status. Imagine learning that your parents are going to divorce for the first time from a horde of reporters and paparazzi descending on you at the end of your school day. At stressful times I like to joke that in my next life I will do a better job selecting my family, but on that Day I won’t be asked by my Lord and Savior about the hand I was dealt.

I will be asked to explain how I chose to play the cards in my hand.

May God have mercy.

Learning about Investment from Gimli son of Glóin

“I do not foretell, for all foretelling is now vain: on the one hand lies darkness, and on the other only hope. But if hope should not fail, then I say to you, Gimli son of Glóin, that your hands shall flow with gold, and yet over you gold shall have no dominion.” Galadriel, Lady of the Golden Wood

In the Lord of the Rings, Gimli the dwarf, representing the most acquisitive species in the Middle Earth in the great quest, asks a favor of, “The mightiest and fairest of all the Elves that remained in the Middle Earth and the greatest of elven women,” three strands of her golden hair to mount in crystal.

Pleased with this bold yet courteous request, the lady grants his wish along with the blessing quoted above. This story contains a truth that we should all pursue. Not many will reach the goal, but all of us who choose to invest in the market can do better, moving closer to that state of perfection that was ultimately achieved by Gimli the dwarf after a great deal of hard work. I don’t know who first said it, but someone observed, invest as though you do not need the market. What is the meaning of this koan? We invest our money to earn what we will need for the big expenses of life like college educations for our children, retirement, and a legacy for future generations.

It seems like we kind of need the market.

As you begin the saving process early in your working life, your first major goal is building an emergency fund. Of course, if your employer offers a 401(k), by all means take advantage of the opportunity to begin saving for your retirement, even if at a very low level. During this time you are not investing money that you can not afford to lose. Later, you will begin to invest more aggressively, building a diversified portfolio that uses shares from many asset classes to protect your future against individual risk. Hopefully, someday you will have a large enough stream of interest and dividends, so that you can not only survive major disruptions to the economy, but use those times as an opportunity to buy when those around you are selling in fear and desperation. If you achieve this goal, you have protected yourself and your legacy from systemic risk.

Recently at age 87, T. Boone Pickens took some horrendous losses in the oil downturn, losing his status as a billionaire. He laughed, observing at his age the $900 million he had left was probably going to be enough. He added that since he had given over $1 billion to charity, he had given away more than he was currently worth. Don’t worry about Mr. Pickens he is already planning on how to recover his wealth.

But note: He doesn’t need the market.

The first step is a desire in your heart to be content with what you have in the present moment even as you plan to have more in the future. This requires a great deal of trust in something, hopefully the goodness of God your provider. If you look to credit to fulfill the desires of your heart, you need the market. Remember, banks are a just another asset class in what is termed “the market.”

When you are in your working years, buying a house and raising a family, live on less than you earn, using the surplus, money that doesn’t need the market to fulfill your ultimate dreams. If a thirty year old man saving $100 a month has $5,000 in a 401(k) a stock market crash such as the one that occurred in 2008 simply doesn’t matter. $2,500 over the course of the remaining 35 years of our young man’s working years is pretty irrelevant. He doesn’t need the market in order to survive.

In both the dotcom bust of 2000-2002 and again during the slow motion train wreck that occurred between 2006 and 2009, I watched intelligent, successful men who had achieved more than I could ever imagine for myself, suffer losses that broke their will. They sold out at the bottom, locking in their losses to protect what remained of their devastated retirement portfolios. They were investing in a manner that required the market to deliver their retirement needs.

This is why diversification is so important.

In early 2000, at the height of the dotcom bubble, one investor I follow had 10% of his holdings in Internet companies. He was creamed, just like everyone else, but even an 80% loss of 10% is not going to kill your future. Another very knowledgeable investor who taught me some of my early lessons believed the great lie, “This time it’s different.” He thought Internet stocks would go up forever. He needed the market for both survival and for his self identity. Putting together the pieces from our various conversations, I know he lost an amount of money somewhere in the mid six figures. I don’t know if he ever recovered.

Don’t forget to let that gold flow through your hands, even if you have a trickle rather than a river. After the War of the Rings ended, Gimli now know as the Lord of the Glittering Caves, started a one dwarf Marshall Plan to rebuild the Middle Earth, particularly Gondor, the city of the king, his buddy Aragorn son of Arathom, Elessar the Elfstone, Dunadain, heir of Isildur. By the way after living a long and fulfilling life, Gimli was the only dwarf allowed to pass over the sea to the Undying Lands of the West.

Using your money to build the Kingdom of God is another indication that you don’t need the market.

It is harder now than it was even during the dark years of the first oil crisis when the best job I could find was packing cloth in a bleachery or when I lost my job in great recession of the early 1980s. Walking in contentment isn’t easy in a consumer society that isn’t creating enough stable quality jobs in the private sector. Yet, in good times and in bad we are challenged to trust God and walk in the truth and I for one could do better learning to live and invest without needing the market.

1 Timothy 6:6-8

“But Godliness with contentment is great gain, for we brought nothing into the world, and we cannot take anything out of the world. But if we have food and clothing, with these we will be content.”

An Efficient Frontier

Yesterday, I sold some shares in two different companies. One was a happy story, Piedmont Natural Gas a consistent dividend producer that recently produced some nice capital gains, is going to be purchased by Duke Energy. There is a chance the Government will not approve the deal, so I decided not to hang around to get the last couple of dollars. I also needed to harvest a loss to help lower my tax bill. I decided to sell my shares in GoldCorp. I bought this stock before the big run up in gold and then watched it run back down faster than the value of the underlying precious metal. Under normal circumstances, I would have held on to this dog because I believe gold will go back up in the future.

In the next week or two I need to decide what to do with that money. Since I don’t have any hot tip that I find particularly convincing, I need to drop back to Harry Markowitz’s presentation of Modern Portfolio Theory that demonstrates that selection of an optimum mix of asset class is more important that selecting particular members of that asset class.

A caveat: Benoit Mandelbrot has demonstrated that the market is a much more dangerous place than is predicted by Modern Portfolio Theory.

Part of Markowitz’s work is now termed, an efficient frontier. This is a line showing the risk reward ratio of any portfolio. If your holdings fall on the line you have optimized your return for a particular level of risk. A selected base interest rate, such as ten year Treasuries, will form the low point on the graph, currently a miserable 1.28%. While I am showing a generic graph without numbers, an actual graph will have a bit of a nose, showing that as you diversify a portfolio of 100% bonds with some equities, your expected rate of return will increase as you lower your risk. Soon, however, increasing your stock holdings will increase both your risk and your expected rate of return.

I am not posting a graph with numbers, because no one can predict the future by back testing the past. However, let’s discuss some numbers based on an efficient frontier graph produced as an advertisement by a nameless investment advisor and the most recent recommendations found in a news letter I generally trust written by Richard Young.

Nameless shows that a portfolio of 100% bonds producing a return of 9% with a risk of 9% and a portfolio of 75% bonds and 25% stocks producing a return of 10% while the risk drops to 8%. 40% bonds and 60% stocks raises your expected return to 11% and your risk to 11%.

Richard Young drops the current 100% bond point to a little over 4%, realistic if you have a few junk bonds in your mix. This comes with a risk of 6.75%. 40% bonds and 60% stocks increase your expected rate of return to 6.75% and the associated risk to 8.75%. By the time you jump to 30% bonds and 70% stocks, you can expect an 8% return on your money, but the risk to your portfolio has increased to 13%.

Is it worth it?

What does risk in this example actually mean? Generally the person proposing a particular efficient frontier is talking about one standard deviation, a statistical measure that shows how much your portfolio will vary from its expected average return in a given year. So, for an expected 6% return with 4% risk means that in a given year there is a 68% chance your actual results will fall between 2% and 10%. An 8% return on your money with a 13% risk would mean that it is likely your actual return would fall between 21% and -5% (ouch!).

I think I will put at least half the money in a boring hybrid fund, Vanguard Wellesley Income, containing 65% in investment grade bonds and 35% in dividend paying stocks. I don’t think this is a time to increase my exposure to equities, but I while I should never have 100% of my investments in stocks, I should always have some of my money in corporate shares.

Of course, if I knew what I was doing, I would be dictating this blog post to my secretary while waiting for the maid to bring me breakfast on a veranda overlooking the Pacific Ocean in my beachfront estate in Hawaii.

Please! Let’s be careful out there.

The Romulans are Different

In the later incarnations of Star Trek, the Romulans used a quantum singularity, a distortion of space and time that may be related to black holes, to drive their starships through the galaxy. The Romulans just had to be different. Everybody else was using your everyday ordinary antimatter warp drive. When an antimatter warp drive failed, it just blew up. I guess if a singularity drive failed it would implode, sucking everything around it into a miniature black hole of some sort.

Guess what? You are flying around in starship powered by a singularity drive called compound interest.

Consider the money equation:

Money In = Money Stored + Money Out

When Money Stored reaches critical mass, compound interest will generate enough new money, all by itself, to propel you on your merry way, “To explore strange new worlds, to seek out new life and new civilizations, to boldly go where no man has gone before.” Unfortunately, debt can drive Money Stored into negative territory. Then compound interest will increase Money Out until your little space cruiser implodes into nothingness.

This also happens to countries.

The iconic Texas oilman, T. Boone Pickens, started life in a poor family during the depression. He would hide the money he earned from his paper route from his mother’s prying eyes. Once, she demanded to see all of it. At age 14, he had $286 hidden in a crawl space under a rug in his closet. At age 87, he still remembers that his mother was stupefied that a child could have amassed such an amazing sum of money. He believes the two most important truths about money he could share with young people are develop a good work ethic and don’t ever let yourself get caught without money. Once you have those two cornerstones in place, then get busy “working smart.” Get an education, but don’t limit your idea of what constitutes an education to college. I suspect that not even Pickens’s beloved Oklahoma State offers courses in how to become a successful Texas wildcatter.

We live in a society where we are constantly encouraged to take on more debt. It is so easy. Children are taught nothing about the power of compound interest during the K-12 years. Then they are given student loans to pursue degrees that are unlikely to result in a job. They are given credit cards before they take their first college course! Once they graduate, if the graduate, they are encouraged to take out six year car notes. Of course, no one can live without a thirty year mortgage.

On the other hand, The Federal Reserve Bank and the taxman relentlessly punish savers. These people are the backbone of a healthy economy. The wealth that they generate and do not consume ultimately provides the fuel to drive a family and a nation to financial freedom.

If it violates the Word of God and common sense it is probably a bad idea. Most of the people I personally know who have found financial freedom have a decent work ethic and the ability to defer gratification. This is not only encouraged by T. Boone Pickens, but by both the Protestant and Confucian work ethics. Proverbs observes, “The wise store up choice food and olive oil, but fools gulp theirs down.”

Make the decision today to provide fuel for your warp drive rather than finding new ways to sell yourself into debt slavery. Take small consistent steps every day. In ten years, or less, you will not believe how far you have progressed.

Idolatry

“Thou shalt have no other gods before me.”

I listened to Tim Keller speaking on idolatry. His lecture got me thinking about our many problems with the first commandment, particularly as it relates to money. I would define an idol as anything we look to for salvation, fulfillment, and deliverance other than God. The more obvious of our cultural idols would be related to money, sex, and power, but ferreting out our idols is not a simple task. Self fulfillment, political ideologies, and even our church or its dogmas can become idols that supersede the importance of God in our lives and our heart. Keller suggested that the loss of something important in our lives would certainly make us sad, but the loss of an idol would tempt us to despair or even suicide. If when someone questions one of your beliefs or practices, you find yourself driven to demonize your opponent or resort to nasty, sarcastic attacks, chances are you are defending one of your idols. If you feel the necessity to resort to violence, especially when you haven’t been physically attacked, chances are you are defending one of your idols.

I spent the majority of my working life in the suburbs of Washington, DC. In that city, the gods of political power, liberal and conservative, Democratic and Republican, were worshiped in their many shrines. Tim Keller lives in New York City, home to the gods of finance. He points out that child sacrifice is routinely practiced in Babylon on the Hudson. It is also practiced in Washington, DC. If you really want to go somewhere in your career, you are talking a minimum of fifty hours a week, plus time for your commute, and a half hour a day for lunch (if you take a lunch break). If you are looking to reach the highest levels of your ziggurat, sixty hours a week are a minimum.

Does that leave much time for parenting?

Greed is one of those tricky sins. It is hard to know when someone else is committing the sin of greed (excess in the desire for and pursuit of material possessions, especially money for its own sake). I have seen wealthy men who are unaffected by their money. It is simply a tool they use as a carpenter would use a saw or a hammer. I have seen wealthy people become a slave to their own money. I have seen wealthy people so overcome by the importance of money in their lives that the loss of it led to their suicide. I also spent nine years of my life toiling in southern factories with the working poor. I can tell you that greed is not a sin limited to the wealthy. I have seen the poor lust after money and the things it can buy.

So how are you doing with money? Do you ever compromise your morals to get more of it? If you routinely pilfer office supplies, money is probably a problem. “Thou shalt not steal,” commandment number eight comes to mind.

Do you envy the success and possessions of others? “Thou shalt not covet thy neighbour's house, thou shalt not covet thy neighbour's wife, nor his manservant, nor his maidservant, nor his ox, nor his ass, nor any thing that is thy neighbour's.” commandment number ten bites all of us now and then. Just the other day I saw a new SL series Mercedes tooling through our neighborhood.

Money is an absolute necessity in this material world. It is necessary for survival. Enough of it allows you the freedom to live a good life and do some good things in this material world. However, “He who dies with the most toys, wins.” The motto of our society is an indication that we, as a culture, have a real problem with greed and its idol, money. If you are working so many hours you forget your child’s birthday, you have a problem. If you are overwhelmed with credit card debt, it is quite possible that you have a problem with greed. Although there is a close correlation between money and happiness up to an annual salary of $70,000 a year in this country, ultimately money can not buy you happiness. Finding the middle ground between greed and prodigality, the reckless misuse of money and time is tricky.

Matthew 22:36-40

“Teacher, which is the greatest commandment in the Law?”

Jesus replied: “‘Love the Lord your God with all your heart and with all your soul and with all your mind.’ This is the first and greatest commandment. And the second is like it: ‘Love your neighbor as yourself.’All the Law and the Prophets hang on these two commandments.”

Is the Present the New Normal?

The traditional rule of thumb was your age in bonds. If you were 60 years old you should hold 60% of your investment portfolio in bonds and 40% in stocks. The new conventional wisdom states that given the risk of inflation, you need about 15% more in stocks than suggested by the old rule of thumb. Hence, at age 60 you would hold 45% in bonds and 65% in stocks. I haven’t checked recently, but I am somewhere around a 50/50 split at age 64. I tend to buy into the argument that it is wise to be a little too conservative in the first years of retirement, as it would be very difficult to recover from a major market crash while maintaining a 4% draw.

Scott Puritz, managing director of Rebalance IRA, believes that such traditional models of asset allocation are hopelessly outdated. Instead, he recommends:

100% in stocks during your 20s and 30s
90% to 100% during your 40s
75% to 85% during your 50s
70% to 80% during your 60s
40% to 60% during your 70s

His logic is based on the historic low interest rates offered by bonds. Ten year Treasuries pay a pitiful 2.15%, while AT&T stock current pays 5.74%. In his mind, shares in AT&T should be considered as part of your bond portfolio. Bond funds, CDs, and the like are paying just about nothing these days, but the market has been artificially inflated by the policies of the Federal Reserve Bank. Right now the Shiller price earning index is at 26.22, a dangerous number. Is this really a good time to put 75% of my liquid net worth into overpriced equities? I see a whole lot of downside risk and not as much upside potential. How much more can the Fed do without the risk of inflation?

For the record, I am a huge fan of stocks that pay a good sustainable dividend. In fact, if it doesn’t pay a dividend, I am not sure why I would want to own it. Of course, there are stocks that don’t pay dividends represented in my mutual funds and I do own some gold. Studies indicate that about 50% of the increase in your portfolio over time will be generated by dividends.

Puritz also recommends investing more in foreign equities. I agree. I would guess that I am running somewhere around 15% in foreign equities, maybe a bit more. Today the U.S. still controls about 50% of the world’s wealth, but the rest of the world is headed up and we are headed down. I should probably consider bumping that number up closer to 25% or even 30%. U.S. markets are way safer than those of the developing world (Brazil, Russia, India, and China) but the markets of Europe and Canada are pretty similar to our markets. Japan is worrisome. Their deficit is screaming danger. If that nation wasn’t so incredibly productive, I believe their economy and the value of the Yen would have already crashed.

I think that even in your twenties you should hold a small percentage in bonds and such. When the market tanks, and it will, the young investor would then be in a position to convert his holdings in bonds into a once in a generation opportunity to load up on high quality stocks at a very low price.

It is said that J.P. Morgan had a friend who told him he was so worried about his stock portfolio that he couldn’t sleep. The distraught investor asked the great master for advice. Morgan replied, “Sell down to your sleeping point.”

Puritz puts a different spin on this advice.

“There’s no sense in creating the optimal asset allocation that works at an intellectual level if when the markets drop, the investor can’t sleep at night,” Puritz says. “Particularly, as people get older, have families and mortgages and are paying down debt, their financial situations get more complex, so it’s good to have a seasoned professional in the mix to strike the right balance for you personally.” (USA Today: The 60/40 stock-and-bond portfolio mix is dead in 2016)

Even a seasoned professional can’t see into the future. Remember. If the market loses 50% of its value, you will need to double your money to get back to even. Even if the market rebounds from such a crash at 12% a year, it is going to take several years to get back to your starting point. However, if you have maybe a little more than you should in your bond portfolio, you will be able to buy shares at a time when a blind monkey throwing darts could put together a winning portfolio. It’s a bad time to buy stocks. It’s a bad time to buy bonds. It’s probably not a good time to buy real estate, but real estate is not my game. Please—Let’s be careful out there.

myRA Good but Could be Better

Social Security, America’s great contract with itself, has proven a success over the decades. It is almost universally accepted by voters of all persuasions. The Government, in its infinite wisdom, takes a portion of my income, not as a tax, but as an enforced savings program. The promise is that MY MONEY with interest will be returned to me when I am old and feeble. That has happened as promised since the act was first signed into law in 1935. Social Security is termed the “third rail of American politics” for good reason. The politician that touches it, will surely be electrocuted by the electorate.

The problem is that Social Security was never intended to provide a living income in retirement. It was a guarantee to cover minimal food and shelter, the first leg in the traditional three legged stool of Social Security, pension, and personal savings. The defined pension has almost disappeared from the American corporate landscape. Public pensions, while generous, are threatened by local and perhaps state funding shortfalls. The largest chunk of personal savings came from the equity in the big house in the expensive neighborhood that was exchanged in retirement for the little cottage in a low cost region of the country. That worked until 2006. Then the slow motion train wreck of the real estate bubble and the stock market crash of 2008-2009 did a number on the savings of the average prudent American.

The myRA was introduced to encourage low wage earners without access to a company sponsored 401(k) the opportunity to save for their retirement on a regular basis, a good idea.

All that is offered to the applicant is the G fund (Government Security Fund) that is offered Federal employees who participate in the Thrift Savings Plan. This fund paid a measly 2.31% in 2014. Don’t get me wrong, I actually own shares in the G fund. Your money is secure, but unlikely to beat inflation by even a single percentage point. Every portfolio should contain at least some Government Securities, but it should also contain stocks and commercial bonds that offer great risk with the probability of greater returns. The Thrift Savings Plan also offers four more low cost index funds to supplement the G fund. I own shares in all of them.

F fund: A fund that mimics the performance of Barclay’s Capital U.S. Aggregate Bond Index

C fund: An S&P 500 index fund

S fund: A fund designed to match the performance of the Dow Jones U.S. Completion Total Stock Market index of U.S. companies not listed in the S&P 500.

I fund: A fund designed to match the performance of the MSCI EAFE index of international companies.

One more note on the G fund: It is structured in such a way as to guarantee a slightly higher rate of return than is offered by similar commercial funds. Some in Congress wish to end this disparity, as a cost cutting measure.

The myRA is essentially a mini-Roth-IRA sponsored by the Government. This is a good thing. It can be funded by any after-tax income, including direct withdrawal from a paycheck. This is a very good thing. Money that you never seen isn’t missed. Direct withdrawal is a significant plus. In addition, money can be withdrawn from your checking account, not a good idea for the low income worker, or deposited on a one time basis.

Up to $5,500 per year can be contributed to a myRA account. This number is $6,500 for individuals over 50 years of age or older. Although it is unlikely that a low income worker would have $5,500 a year to deposit in his account during any given year, it is a nice option. Who knows, he may have a very good year.

The big plus offered by the myRA to the low income employee is no minimum contribution. Most commercial Roth-IRAs have some minimum requirement to open an account, usually $1,000 or $3,000. This could be a deal breaker for a near minimum income worker. This is a very good idea.

There is a $15,000 limit on the amount that can be held in a myRA account. Any money beyond $15,000 needs to go into a private Roth-IRA. Any money held in a myRA account can be transferred to a commercial Roth at the discretion of the investor, a good thing.

All things considered, I am pretty happy with the myRA. I would be happier if it was offered to low income workers on an “opt out” rather than an “opt in” basis. Companies threatened with discrimination suits due to uneven participation in their 401(k) programs, have learned that forcing the employee to “opt out” by checking a box, significantly raise the participation rates of all groups. I would be happier still if the participants were offered a full range of investment options along with some very simple information on the virtues of asset allocation.

Getting something like this passed and signed is at best difficult. I am thankful to get “good,” but I hope that in some future modification of this law, we will be offered better.

This is Really Important

Before you fill out your budget, before you spend a penny, do two things for yourself and your future. Pay yourself first. Take 10% of your take home pay and put it in the bank. Then take something (I’ll never tell you how much or where to give, Christianity is a religion of freedom and grace) and return it to God. If 10% to savings is a pipedream given your current circumstances, don’t beat yourself up. Start with something. Start today.

In my last post, we looked at some pretty prosperous Americans who didn’t even have a $1,000 Baby Step 1 emergency fund. I believe that your emergency fund should ultimately reach six months take home pay, in cash, stored in an insured savings account or money market fund. Again, don’t beat yourself up if it seems impossible. I was well into my early 40s before I reached that goal. Given the length of time out of work suffered by those who lost their jobs in the last recession, Suze Orman believes your emergency fund should be able to cover eight months of your normal expenses.

There aren’t many people who are telling you to save your money for tomorrow.

Businesses want you to spend more than you make. A car company that sells you a new automobile on credit, not only makes a profit today, but they own a piece of your future. By the time you pay off that five year loan, your car is worth less than ½ of what you paid for it when it was new. Many politicians don’t want you to believe you can make it without Government assistance. They want large numbers of poor people who believe they are helpless voting for their party and their programs. You don’t believe me? Check out the income, perks, and net worth of some of our political leaders. Ask yourself, “How did they get all that money if we are all so helpless?”

In an article entitled, America is Full of High-Earning Poor People, by Allison Schrager, graphs are presented that I can’t copy into this blog article. Reading her graph of financial asset holdings for American families earning $50,000-$75,000 a year it appears that their average financial net worth is about $25,000. For Americans earning $75,000-$100,000 that number would be around $72,000. That would include all savings, taxable investment accounts, and tax favored retirement accounts. Remember median household income is $55,000 a year, so these people are doing pretty good.

These numbers give me the same kind of queasy feeling I experienced just before the real estate crash of 2006. I knew something bad was going to happen. I just didn’t know how bad or when. My generation, the Baby Boom, isn’t doing too well. Many of us believe that we will need to work into our seventies in order to have enough money to retire. Real health issues and age discrimination make that an unlikely scenario. Delayed retirement also handicaps the aspirations of Gen-X and the Millennial Generation, looking to move up in the workforce.

According to the Census Bureau if you are an American between the ages of 55 and 64 your net worth would be:

$39,057 30th Percentile
$144,200 50th Percentile
$333,750 70th Percentile

If you are over 65 those numbers become:

$68,783 30th Percentile
$171,135 50th Percentile
$334,870 70th Percentile

Net worth not only includes your financial assets, but any equity you might have in your home. Even if you are in the 50th percentile at age 65 and you sell your home, a 4% draw on a $171,135 portfolio of stocks and bonds would generate a monthly check of $570. Add something on the order of $2,500 a month in Social Security to this number.

As you can see, the average American is looking a pretty scary retirement scenario.

One more thing to worry about—debt. Returning to Allison Schrager’s article, the leverage ratio for an American family earning $50,000-$75,000 a year is running around 38%. Families in the $75,000-$100,000 a year range are only doing a tad better at somewhere around 36%. We are still hovering near record levels of individual debt that ultimately needs to be paid down prior to retirement.

Which brings us back to the first paragraph; you know what you need to do. You know how to do it—one dollar, one step at a time. I can encourage you to start an emergency fund, pay down your debts, and contribute more to your 401(k), but I can’t do it for you. You are going to make those decisions every day for the rest of your life. Those little bits of money will grow. Over time, the miracle of compound interest will begin to work for you instead of eating you alive.

If you persist, you will find financial freedom.

The Emergency Fund (No Excuses!)

This is yet another post on the importance of having an emergency fund. It is a subject that has been beaten to exhaustion by every living personal finance author and probably some that are dead, but every year another survey is presented that shows the average American family is horribly ill prepared for even a small emergency. Please, even if you are living on public assistance, save a little something every time any money crosses your palm. The pay yourself first rule of thumb is skim 10% of your pay before you spend a penny. Put it in a bank account—or a cigar box hidden under the sofa—if you don’t have enough to open a savings account. If 10% isn’t a realistic possibility given your monthly bills, start with something small, like a ten dollar bill.

I agree with Dave Ramsey’s minimum $1,000 emergency fund. If you are an adult living in America and you can’t put your hands on $1,000 cash, you have an emergency. The fact is most Americans have bought into a materialist nightmare. We not only spend everything we have but we routinely spend more than we make.

Let’s look at families earning between $75,000 and $99,000 a year:

21.1% reported that they didn’t have a savings account.
21.8% reported that they had $0 in savings!
10.4% reported that they had between $1,000 and $4,999 in savings.
9.3% reported that they had between $5,000 and $9,999 in savings.

Let’s look at families earning between $100,000 and $149,000 a year:

7.7% reported that they didn’t have a savings account.
13.8% reported that they had $0 in savings!
23.1% reported that they had between $1,000 and $4,999 in savings.
7.7% reported that they had between $5,000 and $9,999 in savings.

OK. I get it if you are earning $30,000 or less it is going to be hard to skim off even a few bucks for savings on a regular basis, but do it anyway. Even ten or twenty dollars a week is better than nothing. You might even want to consider a temporary part time job for a couple of months to get something into that emergency fund.

People! If you are earning over $100,000 a year, you are in the top quintile. Your salary puts you into the top 20%. And you have to tap the credit card to get your $60,000 SUV through state inspection if one of your tires doesn’t have enough tread left to pass? Unless your family recently suffered a major uninsured catastrophe, I don’t want to hear your excuses. Start saving money for the future. Emergencies happen to everyone, but if you have an emergency fund, that emergency is no longer an emergency.

I hope I don’t have to write another article on this subject anytime during the next six months, but I expect there will be another survey and that I will feel obliged to write another post.

Tony Robbins Last Word

At last I have finished reading all 600 + pages of Tony Robbin’s book, Money: Master the Game, and returned it to the library. If you want a solid basic education in the discipline of investment, go down to your local library and check it out. If you can deal with the motivational speeches, some admittedly well deserved self congratulation on a life well lived by the author, and his personal relationship with the investment firm that he endorses, go out and buy a copy for your bookshelf. You won’t regret following the advice offered by the money masters Tony Robbins selected to model as he went about researching the problems faced by the average American.

This brings up another question. Who were those money masters he interviewed while writing this book? Tony Robbins has included short excerpts from the actual conversations he had with these men and women, many of them lasted several hours. I guess being the personal coach to the wealthy, famous, and powerful gives one a certain entrée denied to us ordinary mortals.

Here is the list,

Carl Icahn
David Swensen
John C. Bogle
Warren Buffett
Paul Tudor Jones
Ray Dalio
Mary Callahan Erdoes
T. Boone Pickens
Kyle Bass
Marc Faber
Charles Schwab
Sir John Templeton

I can’t imagine that I could put together a better list of twelve names who could answer my investment questions.

One of the rituals I practice in retirement is the morning coffee lecture. Before I eat breakfast or go for a walk, I make a cup of coffee and select an educational or inspirational video to watch in preparation for the day. The wealth of knowledge and wisdom available on Youtube and other sources is absolutely unbelievable. I am currently using Tony Robbins’s list as a source for my continuing education.

I started with Ray Dalio because I didn’t know he existed until I read this book. Dalio, manager of the world’s largest hedge fund, comes across as a calm dispassionate Zen master, viewing the rise and fall of economic waves with perfect equanimity. He uses the term, “cause and effect,” over and over without anger or remorse. After watching two of his lectures, I am impressed with the clarity and simplicity of his presentation of very complex issues such as credit cycles underlying the economy that last for as long as a hundred years.

Just like the printing press, radio, television, and the cassette tape player that came before, one author predicted that the Internet would make smart people smarter and dumb people dumber. Model Tony Robbins’s behavior! Use everything at your disposal to learn how to make better decisions. Then take that “massive action” so often recommended by the author. Who knows where you will finally discover your limits?

More From Tony Robbins

I can’t remember having had such a difficult time finishing a book that I really liked, but Money: Master the Game by Tony Robbins is wearing me out. There is just too much fluff and not enough stuff to justify over 600 pages. Note: I have finally reached page 524. The end is near. Still, I recommend this book as an excellent primer for the novice investor in search of financial freedom. Tony has done his homework. I understand that he is a motivational speaker attempting to lead his readers into, “Taking massive action,” that will change their lives, but 350 pages would have been overkill.

I really would like to attend one of his live events some day. Although, if I am offered the opportunity to do some fire walking, I think I will pass. I bet his shows really are unforgettable, but it just doesn’t work for me on the printed page.

After spending over 300 pages on the gospel according to John C Bogle (an age appropriate mix of low cost index funds) Robbins spends some time looking at other options that might be suitable for his readers after they have passed something on the order of the $2 million dollar mark. He also presents the obligatory model portfolios. One is the well known “Yale” portfolio developed by David Swensen, the stunningly successful Chief Investment Officer of Yale University. This portfolio has been covered in many places including this blog, but for those of you who haven’t seen it, here it is again.

20% Wilshire 5000 Total Market TR (total return) USD (US dollars)
20% FTSE NAREIT All REITs TR
20% MSCI ACWI Ex USA GR USD (Morgan Stanley Capital International All Country World Index)
15% Barclays US Long Credit TR USD
15% Barclays US Treasury US TIPS TR USD
10% MSCI Emerging Markets PR USD

The other model portfolio present in this book was developed by Ray Dalio, manager of the world’s largest hedge fund. I haven’t seen this information presented anywhere else. It is remarkable for its simplicity, yet it back tests in all investment climates back to before the Great Depression.

30% Stocks (S&P Index and other Indices)
15% Intermediate Term US Treasury Bonds (seven to ten year maturity)
40% Long Term US Treasury Bonds (twenty to twenty five year maturity)
7.5% Gold
7.5% Commodities

Dalio believes that if an investor is diligent in maintaining this balance, he has truly developed a portfolio for all seasons. Yes. He does put his money where his mouth is.

I enjoy reading about model portfolios. Although my portfolio, while appropriate for my age and circumstances, (I hope) just kind of grew as I saved and learned more about investing. I have consciously taken actions to rebalance it from time to time, usually when I get nervous. I also have learned I don’t need to rebalance it every time I get nervous. I am a little worried that the readers of this book might get carried away with Robbins’s extraordinary enthusiasm for everything he mentions. Don’t believe in silver bullets. They don’t exist. No one can predict the future. Still, both those model portfolios are pretty interesting and have proven their worth IN THE PAST.

As always, “Let’s be careful out there.”

The Rules and the Game

We are winding our way towards another insufferable presidential election cycle. Financial regulation is always one of the topics under discussion. Expect to hear a lot of simplistic nonsense from our candidates. However, there will be another crisis sometime in the future, perhaps the equal of the slow motion train wreck that started with the housing bubble and subprime crisis in 2006 and ended in the crash of 2008-2009. Then Congress will pass some sort of financial reform package to avoid the mistakes of the past. Inevitably the new law will contain the seeds of the next crisis.

We, the American people, ultimately elect the committees that make the rules. Then the market plays the game. Sometimes the outcome is unexpected and undesirable. It isn’t the market’s fault.

It didn’t make the rules.

Consider the National Football League. Without a rules committee overseeing professional football, my favorite game would quickly turn into a blood sport that would be promptly outlawed. The owners want continued and increasing profits. The players want a game that is profitable and reasonably safe. The fans want a game that is fun to watch. To achieve these ends, the competition committee, a blue ribbon panel of respected managers and coaches are constantly watching the games and tweaking the rules. They know the fans want to see touchdowns, particularly passing touchdowns, but not a game without defense, like professional basketball. The fans and the owners don’t want to see their favorite players recovering from injuries during the season. Every time a rule is modified it changes the game, sometimes in unexpected ways.

Human ingenuity is quite remarkable.

“Why both Clinton and Sanders are Wrong About How to Fix Wall Street,” an article written by David Dayen, explores some options that could lead to a simpler, less coupled financial system starting with the reinstatement of the Glass Stegall law that put a firewall between investment banking and commercial banking. Many believe that the repeal of this law contributed to the liquidity crisis of 2008 that almost brought down the world’s banking system. The author considers this a good idea, but certainly not a fix to an enormously complex and interrelated problem. He prefers ideas found in a book entitled Other People’s Money written by John Kay a professor at the London School of Economics that borrows concepts from systems engineering.

Consider the electo-mechanical switch that controlled your old wall phone. Banks of these switches, one for each phone number, were once housed in little brick windowless buildings located in every town and neighborhood throughout our land. By the early 1990s these switches had been replaced by complex computer systems that could simultaneously control tens of millions of phones all over the country. The new system was faster, more reliable, and less expensive to operate. However, when it failed, it failed spectacularly. One of these “computer switches” failed, wiping out all long distance service in the Eastern United States for about twelve hours. If one electro-mechanical switch fails only one phone is affected.

Computer trading has been a godsend for the average investor, lowering the cost of buying and selling stocks from over $100 per transaction to just a few dollars per transaction. It has also created a monster, high frequency trading, a parasitical practice that buys and sells shares on minuscule movements allowing the computer program to skim tiny amounts, sometimes less than a penny a share off the profits of “real buyers and sellers” by holding those shares for only a few seconds.

In the most recent housing crisis, the Government pressured the banks to make loans to low income households that could not reasonably be expected to ever be repaid. The Government also provided funding and guarantees to encourage this activity. The banks bundled up these loans into “synthetic” packages that included a certain number of mortgages that could be best described as toxic waste. The Government controls the number of rating agencies tasked with grading these kinds of securities. These companies were charging banks higher rates to receive higher ratings on their securities, essentially a bribe. These “bonds” were then sold to unsuspecting customers who actually believed they were buying a AAA security. It gets worse. Insurance companies were selling policies on European bonds to people who didn’t own the underlying securities. Imagine if some stranger could buy an insurance policy on your life? The insurance companies were even selling insurance policies on these insurance policies, ad infinitum.

When the whole mess came unraveled, the bankruptcy courts couldn’t determine who owed what to whom. In many foreclosures, it wasn’t at all clear who owned the mortgage. Basically, while staring into the maw of abyss, the world’s central banks started printing money to buy up all this toxic waste and inject liquidity back into the system. The taxpayer and his grandchildren’s children are ultimately on the hook for their actions.

The “too big to fail” banks were saved by the taxpayer. The poor lost their homes. Their credit ratings now reflect these foreclosures. It is unlikely they will ever be able to buy another home. For the first time ever, large investment houses bought up large numbers of single family homes for rental properties. In some netherworld of the damned reserved for famous film villains, Henry Potter is smiling.

What if “too big to fail” banks were broken up into their component pieces, allowing them to continue doing business as separate, unconnected financial entities? What if local banks were expected to hold the mortgages they write for the entire term of the loan instead of packaging and selling them as secondary financial products? What if these banks could only buy insurance on mortgages they actually hold? What if our tax code was simplified? What if we removed perverse incentives from our corporate tax code that rewards bad behavior? Excreta. Excreta.

All these topics should be discussed by mathematicians, game theory experts, system analysts, economic professors, and the men and women who actually play the game. Simplistic sound bites offered by manipulative politicians preaching blood and soil to energize their base isn’t enough to address these very important issues.

Remember, the rules will determine how the game is to be played.

The Money Game and Tony Robbins

Yes. “They” are out to get you. If you play their game by their rules, you will lose. They are looking for docile debt slaves who are willing to be trapped in a never ending cycle of, “buying what you don’t need, with money you don’t have, to impress people you don’t like.” “They” are looking for deaf, dumb, and blind tax donkeys who don’t understand they are giving away most of their life to a combination of national, state, and local governments and the apparatchiks and members of the nomenklatura who actually benefit from their loss.

How bad is it? Enquiring minds want to know.

54.4% of the average American’s total earnings over the course of a lifetime go to taxes of all sorts.

17.25% of the average American’s total earnings over the course of a lifetime go pay interest on personal debt.

That leaves you with 28.5% of your hard earned money to pay your bills, buy a few nice luxuries, and retire with dignity.

Those are average numbers. I expect the poor pay more in interest and less in taxes. So, how to escape the trap?

I am currently reading Money: Master the Game by Tony Robbins, the motivational speaker famous for his boxed courses sold by TV infomercial and his unfortunate fascination with fire walking. As a mechanical engineer I understand that fire walking has nothing to do with a mental state and everything to do with the proper preparation of the bed of red hot coals. A sufficiently thick layer of ash has a very low coefficient of heat transfer. Anyone foolish enough to engage in such nonsense can safely walk across such a properly prepared bed of coals. It proves nothing. If I were to lay an iron grate across the same bed of coals, anyone, no matter how spiritually advanced, would suffer serious burns. Iron has a very high coefficient of heat transfer.

Having covered the obvious criticism from the knowledgeable reader, let’s continue with the story. Tony Robbins has built a $500 million net worth by combining classic old school motivational speaking techniques learned from his mentor, Jim Rohn, with his deep understanding of Neuro-Linguistic Programming (NLP), a psychological method developed from the work of Milton Erickson, Virginia Satir, and others.

Obviously, his methods work.

Tony Robbins set out to discover a more or less idiot proof method for the “little guy” to get a share of the money available to those who choose to invest in the stock market. As a student of NLP, Tony Robbins believes in the power of modeling, what is termed “best practices” in management studies. Using his contacts with the rich and famous, Robbins set out to learn what they know and practice, then condense their knowledge into a set of techniques that could be practiced by an average American. After having read almost 300 pages of a 600 page tome, I can condense what he has to say into a few words.

Buy an age appropriate mix of low cost index funds in small incremental amounts over the course of a lifetime and retire rich. Start small. Start today.

The rest of it is long emotional passages meant to capture your attention and motivate you to take actions that will radically alter your life. This method works on his Youtube videos. I bet they really work at his live events. I would kind of like to participate in one those conferences some day. However when reading the book, I keep finding myself wishing he would get to the point.

If you know nothing about investments, want to change your life, and you respond well to this writing style, it appears that Money: Master the Game will be a very good first book for the beginner contemplating his initial steps into the world of investments. When I first started on this journey to financial freedom, I would have loved to get my hands on this book.

Two Hundred Year Floods and the Mercedes Maybach

The year is 1950. You are a county commissioner living in a growing suburban area. Your citizens are going to need more water, a lot more water, in the coming years. A plan is proposed to float a bond issue to fund a new reservoir to meet the demand generated by projected population growth for maybe the next twenty years. You have a lot of decisions to make. Being a prudent man, you consult with a professor of civil engineering from a nearby university. The engineer using the best available methods tells you that a properly constructed earthen dam will meet your requirements at a cost of $3 million. When you ask him if the dam will be safe, he might give you this answer, “This dam will have a 98.6% chance of surviving a once in a century flood.” You might ask him if something safer could be built. He might tell you that a reinforced concrete dam would be safer, but would cost $30 million to build.

Since your total budget for the project is capped at $15 million, your decision has already been made for you.

Sixty five years later, a once in 200 year flood hit the Midlands of South Carolina. Several small dams suffered varying types of failure, adding to the region’s difficulties. It will take the state some time to recover from this disaster. Your prayers and assistance for the victims is appreciated.

Risk evaluation is an important skill not only in selecting investments, but for living in this material world. People make statements like, “A once in a hundred year event,” all the time. What does it really mean if your town suffered a once in a thirty year flood twice in one year as happened in Maryland not so many years ago.

In The Plight of the Fortunetellers by Riccardo Rebonato, the author analyzes why the quants, some of the brightest mathematicians on the planet armed with the largest computers money could buy failed to properly evaluate risk during the real estate crash of 2006 and the subsequent stock market crash of 2008. In short, they were applying statistical methods that while mathematically correct were treating all available data, say 200 years worth, as equally valuable then using that data to predict events that might only happen once in 1,000 years. Such an approach is deeply flawed. While we can make such statements about events like flipping a fair coin with a limited data set, the stock market is not as predictable, since it is driven by human greed and fear more than by rational behavior.

Not only do we live in a world that contains an element of randomness, it is also at times a very nonlinear world. Very small differences in initial conditions, such as the exact date you choose to buy a particular stock, can produce radically different results over an extended period of time. Modern portfolio theory (MPT), the best investment tool available to the normal prudent investor, assumes that changes in the stock market can be described by a Gaussian distribution. The theory assumes that the probability of a share price moving more than 10 or 20 times the average daily move in a particular day is diminishing small. Even excluding events like the declaration of war or fraudulent activities such as insider trading, Benoit Mandelbrot has demonstrated that the market is a much more dangerous place than can be predicted by MPT. The truth is we can expect a significant stock market crash about once every ten years, more often than can be explained by MPT. The bottom line is that the market can and does move as much in a matter or minutes or even seconds as one would expect in years.

Such decisions are not limited to engineers, politicians, and investors. We all make such decisions all the time. All of us wish to drive around in a safe car. However, there is that pesky question, “How safe at what cost?” Most years, the safest production car in the world will be the flagship of the Mercedes Benz line. This year that would be the Maybach, a car that can be had for around $200,000 depending on the options selected. Yet most of us drive around in cars that cost $28,000 or less when new. They aren’t as safe as a Mercedes, but we judge them as “safe enough.”

Predicting the future is at best a risky proposition, but it is something that must be done both implicitly when we open our garage door and drive our Toyota Corolla out into rush hour traffic and explicitly when choose to invest in a particular mix of low cost index funds. Most mornings, most of us make it to work without incident. Just as we know that market crashes occur from time to time, we also know that Jeremy Siegel has demonstrated that investing in American equities has produced a remarkably steady return of about 7% after inflation and taxes over any sufficiently long period of time.

Now, Lets be careful out there.

Joseph in Egypt

“Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you. You think about it; it’s true. If you hire somebody without integrity, you really want them to be dumb and lazy.”
Warren Buffett

I would imagine most of the people reading this blog would be familiar with the story of Joseph in Egypt. For those of you who haven’t heard the story it goes something like this.

Joseph, the second youngest and favorite son of the Patriarch Jacob, was given a dream that his brothers would bow down before him. His siblings, tired of the brat, decided to kill him. On the way to do the deed, one of the brothers decided it would be more profitable to sell him as a slave to some passing Arab traders. The Arabs sold Joseph to a rich important man living in Egypt. He proved such a diligent and trustworthy person that the rich man put him in charge of his entire house. The rich man’s wife, liking what she saw, tried to seduce Joseph. Rather than betray his master, Joseph ran off as fast as his feet could carry him. “Hell hath no fury like a woman scorned.” The wife told her husband that she had been raped by Joseph. Our innocent hero ended up in jail. There he interpreted dreams for his fellow inmates. One of them, a servant of Pharaoh, after being released from prison, remembered Joseph when the wise men and magicians of Egypt failed to interpret their master’s dream. Joseph was paroled. He correctly interpreted the Pharaoh’s dream and provided him with wise counsel that simultaneously carried Egypt through seven years of famine and made Pharaoh the wealthiest man on the planet. While Pharaoh retained his status as Chairman of the Board, he was so impressed with Joseph that he made him Chief Executive Officer and Chief Financial Officer of Egypt, Inc. In this position Joseph was able to save his entire family group from starvation. When his brothers were kind of sort of apologizing to Joseph, he blew it off stating, “You meant it for evil. God meant it for good.”

Amy Rees Anderson, as a divorced single mom, built a start up, MediConnect Global, into a powerhouse cloud based medical records service that she eventually sold for $377 Million! Along the way she discovered that while any sufficiently bright person could be trained to write code or make a sales call, it was nearly impossible to develop character in her employees. They either got it while growing up or they didn’t. Therefore, she started emphasizing integrity in the hiring process over the normal requirements like proper credentials and experience. Here is the list of what MediConnect was looking for in new employees from one of their ads.

Integrity: Always do the right thing for the right reasons.

Respect: Treat everyone as if they matter equally because they do.

Attitude: Act with positivity in both words and actions.

Dependable/Trustworthy: Do what you say you will do.

Flexible: Adapts to change and receives and shares ideas for improvement.

Open & Implements Feedback: Ongoing willingness to improve.

Goes the Extra Mile: Go above what is expected in every task.

After hearing this list in one of her Youtube lectures, I came up with the obvious question, “How do you tell who is lying about being a person of integrity?” For the second time I sent off an email to Mrs. Anderson. For the second time she demonstrated respect to a random stranger pestering her with questions by providing an answer in less than one business day.

Here is her answer.

“When interviewing we used personality profiling tests to help us get a sense of honesty called the CPP by Wonderlic. It doesn’t work perfectly but it is a good indication to start with. Also, doing reference calls is an important piece of that as well. Then once the person is hired that is when you truly get to know their level of integrity – watch their behavior and see if it matches what they say their values are. Behavior ends up being the best indicator.”

Time to tell the truth: If you were an employer wouldn’t you want to hire people, like Joseph, who meet all the criteria enumerated on the MediConnect list? I promise you that if you managed to find somebody like that you would create a job out of thin air to get them and keep them on your team. Believe me. I have seen it. At a Government laboratory I watched a janitor, a contractor employee who could hardly speak English. Unlike his buddies, he didn’t stand around gossiping and complaining, while taking cigarette breaks. After he had finished his assigned tasks, he worked at sweeping out an entire building that was about five eights of a mile in length. Eventually, he finished this Herculean task; I believe for the first time in the sixty years of its existence. One of the shop foremen was so impressed that he wore out his management until a special entry level job was created for this particular individual. He honored his patron with continued excellence in filling his new role as a facility mechanic.

Remember, God was working for Joseph because Joseph was working for God. I like to think that I have walked in a few of the MediConnect virtues most of the time and all of them at least some of the time. I know for a fact I have failed to walk in all of them all of the time--not even close. Still, I have tried to take the high road even when betrayed by circumstances. Twice in my career I suffered a serious injustice at the hands of wicked men. On each occasion, I heard a friend speak Joseph into my life. They told me, “They meant it for evil, but God meant it for good.” Even though I was angry that these events happened and in the second case I couldn’t see how God could possibly use what happened to me for good, I heard those words deep down in my soul.

I am here to report that on both occasions Joseph was spoken into my life, God redeemed the situation in ways I couldn’t have possibly imagined. If you are walking the MediConnect virtues, the universe is watching. God has a way of setting things right over the course of a lifetime. If you don’t live your life with integrity, it is unlikely that you will find success and fulfillment in this world. Even if you do, the universe is watching. Psalm 73 assures us that God has placed these people on a slippery place. Their end will be their destruction. This is not your concern, but keep on watching. Over the course of my lifetime I have seen the wicked in my workplaces come to a bad end too many times for it to be coincidence.

Your Problems, My Problems, The World's Problems

As I was heading down the railroad grade towards on my morning walk, I was hard at work finding solutions to our nation’s economic and political woes. It occurred to me that it was a lot easier and more pleasant to unravel the world’s problems than it was to solve my own problems.

Once on a flight back from Denver to Washington, I noted that the man sitting in front of me on the airplane had a thick Washington Redskin’s playbook. Although I didn’t then know who he was, it was obvious he was a coach. I told him quite seriously, “You better not let people see your playbook.”

Looking a bit concerned he asked, “Why?”

I informed him that then people like me would tell him how to do his job. I added with a touch of sorrow in my voice, “I have been telling the coaches of the Washington Redskins what to do every Sunday for over twenty years. They don’t listen to me.” We had a good laugh.

Sadly, he didn’t listen to my Solomonic wisdom either. After a few years, like all football coaches, he was fired. Currently he works for the Atlanta Falcons. I wish him well.

But who is to blame if I don’t heed my own advice to me?

I think if we are honest we usually know what caused our problems with money and we know what we need to do to make changes for the better. The real problem is that doing what needs to be done is usually hard and quite painful. There is also the looming possibility of another failure.

Maybe you lost your job. If so, you might have to give up a dream. It happens to professional athletes all the time. Some of them go on to successful second careers. Some, who have invested their millions wisely, spend the rest of their lives playing golf in Hawaii with their buddies. Some end up dead of an overdose, alone in a dark alley, or doing hard time in prison.

Perhaps you are a salesman. You know you need to make more cold calls. Personally, I am not cut out for that life. I don’t know how many times a day I could stand hearing the words, “No! Go away!” However if you are a salesman, you know what it takes to get your numbers up.

It is a lot easier to remain in some familiar place where no one is demanding that you do anything to better your life. It is hard to seek out new horizons, new friends, and new opportunities.

But if what you are doing doesn’t work. Please try something else.

If you honestly don’t know ask God, your higher power, or the universe according to your understanding of things. As the Apostle James observes, “If any of you lacks wisdom, you should ask God who gives generously to all without finding fault, and it will be given to you.”

If you spend the necessary time asking yourself hard questions about your situation; if you honestly look deeply with clear unblinking eyes at the truth of your life; I believe you will find the guidance you need to overcome your problems.

However, (and this is the hard part) once you know the truth, Wisdom is proven correct by her deeds. James also observes, “Remember, it is sin to know what you ought to do and then not do it.”