Survivorship Bias and MLM’s

 

XKCD.com

I’ve been thinking a lot lately about survivorship bias and how it can cloud our judgment in evaluating financial opportunities.

We are guilty of survivorship bias when we see someone being successful and think that all we have to do is do whatever they did to reasonably expect the same results. What this way of thinking ignores is that in most cases MANY other people have done some of the exact same things and yet haven’t had nearly the same success.

Survivorship Bias Unpacked

For example, If we were to stage a competition of flipping coins where you advance to the next round simply by flipping heads, you would expect to lose about 50% of coin flippers in each round. If you start with 1,024 contestants, you’d expect the number of participants in each round to be roughly:

1,024 -> 512 -> 256 -> 128 -> 64 -> 32 -> 16 -> 8 -> 4 -> 2 -> 1

So after 10 rounds, you’d expect to only have one person left. Is he/she the best coin flipper in the world? How else is it possible that they flipped heads 10 times in a row! We need to interview them and have them give motivational speeches and buy their books, etc.

Seems pretty ridiculous, right? Except we do it all the time when we prop up legendary investors, the 19-year-old in California who won the lottery twice in one week, or those rare few individuals who achieve some degree of financial success with a multi-level marketing company.

What we miss in all of this thinking is that there were 1,023 other people who did the exact same thing and didn’t get the same result. We admire the sole survivor, yet ignore the existence of the other competitors. Nassim Taleb has written extensively about this and related topics in his book Black Swan but you really can’t go wrong with reading any of his books.

MLM Survivorship Bias

It’s the MLM’s that really get me with this. You know how this works by now. You get a Facebook friend request from someone you haven’t heard from in years and accept it thinking “oh, I wonder what they’ve been up to”. After accepting, you check out their profile and quickly notice that they’re involved in Rodan & Fields, or Beachbody, or Lipsense, or Isagenix, or Herbalife, or Essential Oils, or whatever else they dream up next. Now that you’re ‘friends’ they’ve got a great ‘opportunity’ for you to ‘be your own boss’ and generate ‘passive income’. They make it sound so easy and they all seem to project an air of success, following the ‘fake it ’til you make it’ strategy.

This got under my skin recently when a friend of a friend went all over social media touting all the success she’s had selling makeup through an MLM. She’s reached a new level and qualified for a free trip to a resort in Costa Rica. Good for her. She’s just doing her job, and so is the company. She gets a nice trip, and now probably dozens of people see what she’s doing and now want to get in.

For every success story you see in any MLM, there are literally thousands of failure stories you’ll never hear about. If you’ve got Netflix, I recommend watching Betting on Zero. I’m glad that this is helping get the issue out there, but I’m not sure these pyramid scheme type of companies will ever go away. The lure of a simple path to wealth and riches is too appealing, even if too good to be true. There is no simple or fast way to wealth. It requires hard work and time.

Some thoughts on Bubbles and Student Loans

“The market can stay irrational longer than you can stay solvent” – John Maynard Keynes

These words from the famous economist John Maynard Keynes come to mind whenever I think I see some type of bubble in the stock market or elsewhere. The saying refers to the risk of taking a short position, or betting that a particular investment will go down in value. When you simply purchase an investment, your risk of loss is your purchase price and your potential gain is unlimited. When taking a short position, you profit as the investment loses value and lose as the investment gains in value. In shorting, your gains are limited to the point that the investment goes to $0 but your risk of loss is unlimited.

Michael Lewis’ book turned movie, The Big Short, popularized short selling by showcasing investors who won big betting against the U.S. housing market in 2008. The Greatest Trade Ever showcases other traders who made even larger gains on similar types of trades. One thing that was common between both stories was the serious risk of insolvency many of the investors faced as they continued to pay premiums waiting, and waiting, and waiting, to be proven correct. They knew that the housing market couldn’t continue rising indefinitely, yet it continued to defy their predictions almost to the point that they (and their investors) could no longer handle the continued losses.

FINDING THE NEXT BUBBLE

It seems like every week I come across an article predicting the rise of another bubble. There’s the ‘Auto Loan Bubble’, the ‘Housing Bubble’ (again), and don’t forget the ‘Student Loan Bubble’.

“An investment in knowledge pays the best interest” – Benjamin Franklin

For hundreds of years, this mantra has been repeated in this country and for the most part, I tend to agree. Education can be the key to a better life and can allow for significantly higher lifetime income. What is missed from this simple quote though, was clarified by John Adams who said:

“I must study politics and war that my sons may have liberty to study mathematics and philosophy. My sons ought to study mathematics and philosophy, geography, natural history, naval architecture, navigation, commerce, and agriculture, in order to give their children a right to study painting, poetry, music, architecture, statuary, tapestry, and porcelain.” – John Adams

Interpreted for our day and age, I take this to mean that education is great, but don’t study something that doesn’t have a financial return unless you don’t need a financial return. If you build a legacy sufficient to sustain the next generation, then by all means, allow them to study something they love that may not pay the bills, because you’ve got that covered for them. If you don’t have this luxury and do actually need your education to provide a return, then you need to study something that has value in the marketplace.

TOO MUCH OF A GOOD THING IS BAD

Where we run into problems is the belief that an education is worthwhile at any cost. I recently was reading about the astounding levels of debt the average dentist owes. The author of this article finds the average dentist just starting out has an average of $450,000 in student loans with an income of just $120,000 without even taking into consideration the cost of buying into a practice or other borrowing such as a mortgage. Add it all up and it’s not difficult to find a dentist with over $1,000,000 in total debt. An income of $120,000 sounds great, but it doesn’t go very far with debt levels approaching 4x annual income.

Is this a new thing? One of my favorite fiction authors, Michael Crichton, started his career going through Harvard Medical School (which later helped him as a writer for the hit TV show E.R.). While he was a student there, he wrote Five Patients where he walks through the hospital visits of 5 hospital patients in the 1960s. The book was first published in 1970 and I read it 40 years later in 2010. Even though the book was 40 years old, I was surprised how relevant some of the stories were and was shocked that some of the same problems that existed in the medical field then, persist to this day. I specifically remember that he highlighted that in order to enter the medical profession one had to either come from a well-off family or have a strong tolerance for high levels of debt.

I’ve been saying for years that it doesn’t make sense that students are able to borrow as much as they do and that reform is imminent, yet for years I’ve been proven wrong. Thankfully I haven’t made any investments based on that theory. If people have been saying this as far back as 1970 though, are we truly close to the bubble bursting?

We created our own Sabbatical

Throughout my career I have had jobs with varying degrees of schedule flexibility and work/life balance. When I first entered the workforce, I was able to take two weeks of vacation per year and am now at a point where I get 4 weeks per year. The one thing that has been consistent across any job I’ve ever had is that it has been difficult to take vacation for much longer than one week at a time. I’ve always been envious of jobs that allowed for significant amounts of time off, but always thought that type of flexibility was only for people like teachers or professors.

There are, however, several employers in a variety of industries that still offer sabbaticals. For example, Charles Schwab offers 4 week sabbaticals every five years. Intel has a program that offers any US based employee an 8-week paid sabbatical every seven years. I even know people at Intel who have combined their sabbatical with all of their vacation and turned their sabbatical into 12 weeks. These programs sound great, except I’ve never worked for an employer that had a similar benefit.

So far in my career, the longest vacation I’ve taken has been 11 days (7 work days and 2 weekends). Oh yeah, except for that one time that we created our own 8-week sabbatical…Allow me to explain.

THE SETUP

In 2012, I was in my last year of a part-time MBA and was working full-time as a financial advisor. I knew that I wanted to transition to working in corporate finance and was using the career center at my school to get interviews with big name companies that were coming on campus to recruit. Throughout Fall 2012, I interviewed with 15-20 Fortune 100 companies and ended up accepting an offer right around Thanksgiving 2012 to start in June of the following year. Most of the time you receive a job offer you would be expected to start soon, but hiring through school campuses tends to be different since students are hired contingent upon finishing their degrees. I was looking forward to the new job but wasn’t in a huge hurry to start since I would be taking a pay cut and would need to sell my house and move to another part of the country.

Over the next few months, I continued on at work like nothing had changed and outperformed expectations while making sure I did not make any promises I couldn’t keep (ie, I knew I would be leaving and didn’t want to promise anything I couldn’t fulfill). We narrowed down where we wanted to start looking for houses in the new area and listed our house for sale. My boss at the time had an idea that I would be leaving the company when I graduated the following Spring, but I hadn’t let him know the details until that end came closer as I had fears (with basis) that he would be forced to fire me if he was given formal notification I had accepted another offer even though it wasn’t from a competitor and there was no conflict of interest. If I were let go before the end of the year it would have been unpleasant as I wouldn’t get my year-end bonuses that made up a decent portion of my total annual income.

In that job, roughly 75% of my income came in the form of quarterly and annual bonuses so if I quit without working an entire quarter I would be leaving a good chunk of money on the table. Since I was expected to start the new job in June, I decided that it didn’t really make sense for me to work for April and May (meaning 25% of my normal pay), so we decided that I would give my formal notice on April 1st.

QUITTING

Leading up to that date, I think everyone in the office knew I was leaving except my actual boss. There are times when I regret not telling him, but I had seen too many people walked out when providing notice that I really didn’t want to risk it. When I finally dropped the news that I was giving two weeks’ notice, he wasn’t surprised that I was leaving but was surprised that it was then and not three months later. My fears of being walked out did not come to pass and over the next week or so was able to help transition my clients to the advisor I felt would be best for each of them individually.

Leading up to quitting, we had put our house up for sale and were under contract and timed it so that our closing date was also my last date of work. My new job came with a relocation package that provided movers who packed up all of our things and kept them in storage until we found a new place to live, which allowed us a ton of flexibility. If I ever have to move again I will definitely make sure to get a similar relocation benefit or else I’ll pay for it myself. We packed up my little Corolla with everything we would need to live for 8 weeks for me, my wife, and our two kids (ages 5 months and 2 years), and we set off on a fantastic adventure.

THE TRIP

Our first day of our trip started with a real-estate closing. All our things had been packed up so we stayed the night at a friend’s house and showed up the next morning to finalize the sale of our house. We had been aggressively paying down the mortgage so were excited to get nearly $90k of cash out. We didn’t need any of this money for our trip since we had pre-paid some of the more expensive parts and I would still be getting paid bonuses and commissions for the next two months, but it was a huge relief knowing that we had signed what we needed to sign and could embark on our massive road trip and never have to look back.

Over the next 8 weeks, we spent a week on the west coast of Florida, then a week on the east coast of Florida, then a third week at yet another beach in the Florida panhandle (we like the beach, ok?). We liked the last beach so much it has become our new favorite and we’ve been back a few times in the intervening years. Since we were travelling before school was out, most everywhere we went we were able to get good deals on places to stay and we mostly had the beaches to ourselves. After about the two week mark I started to forget what day of the week it was and it was AWESOME. I was able to catch up on my reading, exercise, and overall not be tied to any schedule for anything. The only thing that I kept track of was Sunday, where we ended up visiting a new church in a new part of the country pretty much each week for this entire time.

If you haven’t been to Miramar Beach FL (near Destin) in the off-season, you’re missing out

When our time in Florida was up, we headed across the country again to pay visits to some of our scattered extended family before ending up at a family members’ house that we made our home base for the last few weeks. At pretty much every stop we visited with cousins, parents, siblings, or grandparents and were able to see most of our extended families. By this time, I think I had also memorized the audio of at least a half dozen Disney movies that we had playing in the backseat for our kids, so it was good to have a few weeks with no long drives planned.

Our last big hurrah was a trip to Mexico where we brought some other family with us to spend a week at an all-inclusive resort near Cancun. This particular resort came highly recommended from good friends and I had never been to a resort like it so I didn’t have a reference point to know how it compared on price. I booked the trip and didn’t think much more about it until we got to the resort and realized that we had booked a huge suite with spectacular ocean views. Had I done some more research I may have downgraded our suite to something smaller without an ocean view, so for once I’m actually glad I didn’t do more research. These views made the entire trip.

Sunrise was always amazing

Sunset wasn’t bad either

The kids spent a lot of time napping, but we totally didn’t mind staying within our suite while they did so.

Many nights I just sat out on the balcony and read with the sound of the ocean in the background. It was heaven.


 

BACK TO REALITY – RECAP

Eventually we had to get back to the real world and start my new job, requiring yet another cross-country drive. I made the drive alone and my family flew to join me a month later when we closed on our new home (I lived in a hotel for that first month and visited them on the weekends).

From the time I quit my job to the time I started my new job, we drove nearly 7,000 miles in 8 weeks and were in 17 different states. We visited most of our extended family members throughout the country and spent around $7,000 on hotels and airfare, $1,600 on gas and car repairs (brakes, tires, oil changes), and $1,500 on food/groceries. Because I waited until April to give my resignation, our income for these two months was more than enough to replenish our savings for all these expenses, and the time off to rejuvenate allowed me to prepare well and start fresh at my new job.

This trip gave me a taste of what early retirement could look like and has encouraged me in the years since to continue to save aggressively towards that goal. If I didn’t have another job lined up, the trip wouldn’t have been nearly as enjoyable since we hadn’t achieved financial independence yet. We still haven’t achieved financial independence, but our net worth has more than doubled since this trip and only needs to double two more times before I’d feel comfortable retiring for real.

I’ve heard the phrase that you should ‘Retire Early and Often’ which I guess is what we did (minus the often part). As much as I loved it, I’m not sure we’ll be doing anything like it again. As time passes, I’ll just have to weigh the benefit of taking another sabbatical/mini-retirement against delaying my true full-retirement date. I’m only about 15 years away from being able to fully retire. Some days that seems farther than others, but most of the time I feel that I can ride things out until then and have made changes that will help prevent my burning out.

2017 Goals

With 2016 now in the rearview mirror we’re now looking forward to 2017 and have set some new goals to build upon the progress we’ve made in 2016. As I was contemplating goals, I heard Dave Ramsey’s podcast where he outlined seven areas of life to have goals that help with overall personal development. Those areas are:

  • Career
  • Personal Finances
  • Spiritual Growth
  • Physical Health
  • Intellectual Growth
  • Family
  • Social Relationships

 

I generally tend to have goals in most of the categories anyways and thought that I would share some of my 2017 goals that are relevant to the topics discussed on this site.

INTELLECTUAL GROWTH

I read 57 books in 2016, a little more than one per week. When I track my reading, I do include audiobooks but do not include books I read with my kids or my scripture study. Some books are very short and can be read in one sitting (like this one), others take several weeks (like this one) I use Goodreads to track my reading and try to read roughly 50/50 fiction and non-fiction. In years past, I have read as much as 75 books in a year and as few as 57.

My goal for 2017 is to read 52 books in the year. Given my historical trends this is not an extremely lofty goal, but that indicates my desire to continue to read a lot combined with the knowledge that I have other things I would like to take care of. I just finished book #3 for 2017 so I am well on my way. One thing I would like to do this year is to focus on reading books that are already on my ‘to-read’ list (currently over 100) instead of some more random titles that I may come across.

CAREER

At work I was promoted within the past year and would love to get another promotion, but don’t plan on that happening this year. It is typical within the company I am with to wait at least two years to be promoted to the next level from where I’m at and I certainly have aspirations to do so when the right thing becomes available. I have some things I am working on that will help me by going above and beyond and have also recently taken on some additional responsibilities that offer significant visibility within the organization and will help develop some skills that will be valuable throughout my career. I won’t get into specifics, but my goals focus around some projects at work that have the potential to save several million dollars (for the company) as well as branching out and doing well on some special projects that are outside my normal job description.

PERSONAL FINANCES

We ended 2016 with a net worth just over $600k. We’ve spent some time going over our budget and are now setting a goal to achieve a net worth of $700,000 in 2017. Just like last year some of this will depend on market gains but not as much as last year. If we don’t get there simply because the market doesn’t cooperate, I’ll still consider it a success if we stick to our plans for the amounts we earn, save, and invest. Here is a breakdown of how we think we can get there:

As you can see, we do need some growth in our investments and real estate to get to our number but other than that the numbers all seem very doable. I’d love to be able to pay more towards the house but am pleased that we will easily get the mortgage balance below $200,000 soon. Some things that could have an impact on this goal are expenses related to another baby we are expecting soon, home improvement projects planned for this spring/summer, and travel expenses. All of these things are budgeted for outside of these figures but the actual costs may vary from our estimates, which will impact the amount of cash savings or extra mortgage payments we’re able to make.

We have goals set up in other areas as well but wanted to share these publicly for additional accountability and insight into our decision making. Best of luck to all in your 2017 goals and endeavors!

Broker No More

As of today, I am officially no longer a licensed stockbroker or financial advisor. I knew this day would come, and it is a relief to formally have that chapter in life behind me. This isn’t exactly a surprise, since I formally left the industry two years ago, but since then, my licenses have been dormant. Until now, I could have taken another financial services job and simply picked up where I left off from a licensing perspective. Now that my licenses have officially lapsed, I have to retake all of the licensing exams if I want to work as a broker again. Thankfully, I don’t want to do that.

What that means for this site is that I now feel some additional freedom to discuss topics that I wouldn’t have felt comfortable discussing while I still held licenses. My opinions and advice have not changed, but when I worked as an advisor there was always the fear of being vocal about opinions that differed from those of the company. For example, I personally prefer index funds to actively managed mutual funds. I’ll write more about this preference later, but as you might expect this contradicted the investment philosophy of my former employer. Even though I recommended index funds all of the time to clients, it was clear that they would have preferred clients to invest in actively managed funds or managed accounts.

This matters to this site because I feel more at ease sharing my opinions now that I won’t be representing anyone besides myself.

My Work History (part 2)

I quit working at the 100% commission based financial advisor job just a few months after I started and began to look for another job. I was still in school, but the prime period for on-campus job recruiting had passed, so I had to do a lot of work researching companies in the area and apply for jobs without the assistance of any type of on-campus interviews or job postings.

I had enjoyed working with clients in my former job, and would have stayed at the job if there was a way that I could have made a decent living while also offering only investment products that I was comfortable with ethically. This would have also been easier if I had clients with a lot of money to invest, but generally speaking, anyone with a lot of money is going to want a financial advisor who has experience and isn’t just a recent college graduate with little to no real experience. I had seen something that I liked doing, but needed experience to be able to do it well. How then, was I to get the experience?

The solution I found was to get a job at a large financial services company working in one of their call centers. It wasn’t what I initially had thought I would be doing, but it ended up being ideal for what I needed to learn. Starting out servicing accounts and talking to clients without initially having any ownership stake in their financial plans, I was able to see firsthand the consequences of many different decisions, both good and bad. This experience proved invaluable a couple of years later when I was placed in a position where I was again a financial advisor and had a responsibility for the financial success of my various clients. One of the main things I was able to take away from this experience was the understanding that even though a portfolio may look ideal on paper, the plan is useless if an investor isn’t going to stick with it. Keeping this in mind, I was able to build more customized solutions for clients, which resulted in happier clients, more referrals, as well as more income for me.

Over the course of seven years with that employer, I had a total of 6 different job titles (one for only 2 months), and was able to see my pay increase from a $35,000 to over $150,000 just a few years later.

While I truly enjoyed many aspects of my work in financial services, I chose to leave the industry for a career in corporate finance to further develop additional skills. Below, I have detailed my annual income over the years to further illustrate this point.

You’ll notice that my total income has come down a bit in recent years. One of the things I was looking for in a career move was more stable income. Although my income in 2012 was over $160,000, only $45,000 of that was guaranteed base salary with the rest being highly variable, whereas now my salary is over $100,000 with a much smaller portion of my income coming in the form of variable bonuses. I also have higher growth potential with my current job whereas I was nearly at my peak earning potential in my previous role. Also, because the majority of my pay in 2011-2013 was paid in semi-annual bonuses, I had to live on a much smaller income during the year until those paychecks arrived. I knew that I wasn’t going to spend the rest of my career in that job and chose to save and invest the majority of those bonuses while living on little more than the base salary.

One other thing worth pointing out is that my income didn’t decrease from 2008 to 2009, rather my 2008 income included a relocation bonus for when I moved across the country. My income was relatively flat from 2008 to 2009 because overtime and bonuses were slashed amidst the financial crisis.

My Work History (part 1)

While thinking about the importance of growing your income, I wanted to take some time to outline my work and career history. In a later post, I may do a more comprehensive work history like J Money over at BudgetsareSexy.com, but for the next couple of posts I wanted to focus on the income and jobs I consider to part of my career, and not all the different jobs I have done before. The hope is that this will illustrate not only how I have grown my income, but when income is managed properly instead of living beyond your means or succumbing to lifestyle inflation you can truly begin to build wealth (see evidence in my recent post on net worth).

My first foray into the financial services industry was during my senior year of college, and was where I learned an important lesson that has helped me significantly since then. I was hired as a financial advisor by a company that resonated with me in the way they talked about doing the right thing for the customer and helping people reach their dreams, and was told that once I was licensed, I would be given clients to work with that the office didn’t have the bandwidth to properly support. I would be working 100% on commission, but the average rep made $40,000 in the first year, and to not let the 100% commission part worry me. Over the course of a month or two, I got all of my study materials and studied my brains out and passed all the necessary exams. The next day I went to the office, excited to get started helping people reach their goals. I still remember my heart sink when my boss said something like “All right! Now that you’re licensed and ready to sell, let’s make a list of all your friends and family and start calling them and selling them crap you wouldn’t buy if you actually had any money of your own!” At least, that’s what I heard. Wait a second, what about all the clients they had told me about who simply needed a rep assigned to their account that I could call to set up an annual review? Anything besides trying to pitch a variable annuity to my grandma! Sadly, my experience isn’t all that uncommon but could have been avoided had I done better research on the industry or had someone I trusted teach me what to look for.

The next carrot that was dangled in front of me was that I would be given some existing clients to work with once I had generated $3,000 in gross commissions, and I was given 90 days to do so or be let go. On the surface this didn’t sound very difficult since I had been told that ‘average’ new hires made $40,000 in their first year. When I started to dig into what I would have to do to get to that number, I wasn’t quite as optimistic. The products that paid the most commission were the ones that I didn’t want to be selling to ANYONE (whole life insurance, variable annuities, etc). In the end, I did meet with several people that I was able to help get started investing for retirement, and I didn’t sell any investments that I felt betrayed what was right. I ended up working for about a month and had a mutual parting of the ways with the company.

I learned a lot of things while working for this company, but the main takeaway for me was that I will never feel comfortable with anyone I know investing through a company where the reps are paid solely on a commission basis. I have yet to hear an argument for the commission model that makes any sense and isn’t from someone who has some type of vested interest in the model. The vast majority of people who join this type of company don’t make it through their first year, and because of this, these companies will often have low entry requirements to be hired (which perpetuates the turnover problem).

This may not be the best example of ‘growing your income’, but was a very helpful step in getting me to my next job that I’ll be talking about in my next post. It also was useful down the road when I actively helped people to avoid investing in companies like the one I was with for a short time.