Survivorship Bias and MLM’s

 

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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.

I Got Hacked!!

Several years ago in another state, our home was broken into while we were on vacation. We filed an insurance claim and within a few weeks, most everything was back to normal. For the rest of the time we lived there though, I always got a pit in my stomach coming home.

Last week, our digital house was broken into. Somehow, someone got my login info for my investment accounts and made some unauthorized trades. Having gone through both experiences, I can tell you that neither is fun. But being the victim of a digital crime sure beats being a victim in the physical world.

This would always be a big deal, but it was a bigger deal than just having our retirement accounts hacked since we also use our brokerage account as our primary checking account. Even though they don’t accept or disburse cash or have any locations near us, this works just as good as having a local bank or credit union. We rarely use cash for anything and if we need to get any, our ATM fees are reimbursed so I never care what the charge is to use a random gas station ATM.

What Happened

One day I was in a series of all-day meetings and took the chance to check my phone during a quick break. I saw that I had a series of notifications, including two missed calls, a voicemail, and a notification that some stock orders had been executed in my IRA.

I normally would brush off the other alerts (I hate voicemail), but the stock trade didn’t seem right. We have some automatic investments set up, but it wasn’t the right time of the month for that to be happening. My wife has joint access to all of our accounts but doesn’t usually do any transactions outside of our checking account. And lastly, what the heck is USAK and why did my phone say that I was the proud new owner of 15,000 shares?!?

I quickly excused myself from the meeting and did some more research. The voicemail was from my brokerage firm letting my know that they had noticed some suspicious activity on my accounts. As a result, they proactively had frozen my account from any more online transactions. Their fraud team was already all over it before I even let them know that this was, in fact, fraud.

The suspicious activity involved selling off my S&P 500 ETF, and immediately using the proceeds to buy shares of a somewhat thinly traded stock. My first thought was that this was a part of a “pump and dump” scheme. So far, though, I haven’t seen any activity that looks like dumping. In fact, whoever placed the order got the shares for under $6.30 and they are up >6% since then. Even though that’s better than my ETF over the same period, I’m glad things are back to normal.

I’ve been primarily invested in ETFs for a while now, but this experience has gotten me to think about going back to traditional Index Mutual Funds. Since they only can be bought or sold once a day, it wouldn’t be possible for someone to do intra-day trading like this.

What If You Get Hacked

The first thing to do if you find yourself in this situation is to know your brokerage firm’s fraud policy. Most big firms will have a policy that essentially boils down to you not being responsible for fraud. Just don’t do something stupid like give a crazy ex-girlfriend your password since that could imply authorization.

Fidelity has a Customer Protection Guarantee, Schwab has a Security Guarantee, and Vanguard has an Online Fraud Pledge. Each of these pages gives some tips on how to avoid this from happening. I follow most of these steps, but no one is completely immune. If you’re with one of these firms, relax. Call them as soon as you can to get it resolved, but don’t freak out either.

When I called in, they made me answer some additional security questions before changing my username and password. Because there could be a virus on my computer, they wouldn’t allow online transactions until I told them all my computers had been professionally scrubbed.

I trust myself more than Geek Squad’s competence and they were okay with me doing my own virus scans. As it turns out, something nasty was discovered during a virus scan on one of our seldom used laptops but all our machines are now squeaky clean.

The Aftermath

Because of this fraud, I had to spend about an hour on the phone and get new account numbers. They automatically set up the new accounts like the old ones, but we had to reestablish payments for our mortgage. I also had to reconfigure the new accounts in Mint and Personal Capital. We got a new checkbook over-nighted to us and I changed my direct deposit. The only remaining inconvenience is that we still don’t have a new debit card. I primarily use a credit card (that I pay in full every month) so this is fine.

In hindsight, this could have been MUCH worse. I’ve known people that have had this happen to in the past so I knew not to worry. I was surprised at how quickly it was resolved and how little was needed to prove that it was fraud. I hope you don’t ever have to go through this. But if you do, it isn’t as bad as you might think.

A Big Risk to Early Retirement – Inflation Risk

Lest you read my last post and think that I completely ignore the very real inflation risk in retirement, allow me to walk you through my thought process of how I account for it.

I already mentioned that when I project out our portfolio growth I’m assuming a non-inflation adjusted rate of return of 8%. If inflation were to average 2%, then my real return would actually be just 6%. I could just assume a lower rate of return, but I prefer to make some more granular assumptions about inflation.

It All Starts with Budgeting

Each year, I pull our full years’ expenses by category and make some minor adjustments to come up with a representative retirement budget.

First, I eliminate principal and interest payments on our house. Our mortgage will be paid off well in advance of retirement, so this won’t be needed. Next, I reduce our income taxes to account for lower income in retirement. I also reduce our charitable giving amount to account for us not having an income to tithe from, but not to zero since we will still want to be generous in retirement. Lastly, I eliminate any retirement account contributions since I won’t be eligible to contribute.

Not all of our expenses will be lower in retirement. I adjust our healthcare and travel expenses by assuming they will each be double current levels. Everything else stays the same. After all of these adjustments, I’m left with a budget that is roughly half of our household expenses. That sounds really low, but the majority of our current expenses are paying down the house, income taxes, and charitable giving so it is not unrealistic. In some categories like groceries, it may even be high given that we currently cover food for a family of six and will someday be empty nesters.

Inflation Assumptions

With this representative budget, I then apply inflation assumptions. The key difference here is that I use different inflation assumptions for different categories. Historical inflation has been 3-4% and I assume for most categories an inflation rate of 3%. The average for my lifespan hasn’t exceeded 3%, but it’s a real risk that it could be much higher. For me, medical expenses are the big wildcard. Not only do I assume they will be double my current level of spending, I also assume an inflation rate of 7% on medical expenses. If I were budgeting to be paying for higher education costs in retirement (I’m not), I would use a 7% inflation assumption for those costs as well.

Using this representative budget and specific inflation rates, I then inflate our expenses by the number of years between now and retirement to get an inflation adjusted retirement budget. Each year of retirement, I assume that expenses will continue to increase at the rates outlined above.

Inflation Impact on Retirement Income

One very interesting thing to consider is how inflation can eat away at your portfolio. For simple numbers, let’s assume you retire and have $1M worth of investments to live off of. It’s an oversimplification, but let’s also assume a steady 8% return, 3.5% inflation, and first-year expenses of $60,000. Since $60,000 is 6% of $1,000,000 and you’re earning 8%, then you can live off the earnings forever, right? Wrong.

You see, what happens is that even though you are consistently earning 8%, the growth of your earnings is lower than that because you aren’t reinvesting all of those earnings. Because your expenses are growing at 3.5%, and your income isn’t growing as quickly, your expenses will actually be greater than your income after just 15 years. After that, you begin whittling away your principal until year 33 when you run out of money entirely.

In this way, inflation is one of the biggest risks to early retirement. Everyone is impacted by inflation. The longer your retirement, the more time inflation has to grow and exceed your investment income.

Below I’ve outlined what hypothetical portfolio values would be with the assumptions outlined earlier.

How to protect against inflation?

There are a few things I am doing to protect our retirement dreams from inflation. The first is to have an initial withdrawal rate much lower than 6%. In your working years, you want to have as big a gap as possible between income and expenses. In retirement, you want to have a gap between expected investment income and expenses. Whether you plan to spend most of your money in your lifetime or leave an inheritance, inflation can derail either of those plans.

The primary other strategy is to remain invested in stocks. Over time, stocks are the only asset class that has consistently outperformed inflation. While earnings growth may not exceed inflation, left untouched a diversified stock portfolio would not lose purchasing power over time.

There are many ways to account for inflation in retirement planning, but this simple method works for me for now. It is absolutely something you don’t want to ignore, but I don’t lose sleep over it either. What are your inflation assumptions?

Assumptions for Early Retirement

I recently was talking to a friend who disagreed with my retirement planning assumption that our investments would average an 8% return. I had felt that my assumption was conservative given that I am close to 100% invested in equities. He felt that 4-5% was a better long-term assumption. Dave Ramsey assumes 12%. Who is right?

At the end the day, who really knows? We’re doing our best to save and invest a good chunk of our income and staying invested in the asset class with the best track record and best potential growth. But the conversation did get me thinking so I did some additional research.

Over at Moneychimp.com, there is a great resource that shows annual returns on the S&P 500 going back to 1871. You can look at any date range and see returns adjusted for inflation. This is great data for us because the majority of our portfolio is in index funds that track the S&P500. Their biggest takeaway is that:

“Over the very long run, the stock market has had an inflation-adjusted annualized return rate of between six and seven percent.”

When I assume 8% return, I’m assuming that to be before inflation. Is that what my friend meant? I don’t think so, but I’ll have to follow up. My impression was that he was just particularly pessimistic.

I was curious though, so I did some digging into the data set and found some things worth sharing (all numbers not adjusted for inflation).

S&P 500 Historical Returns

  • The best 1-year return for the S&P 500 was 56.8% (1933)
  • The worst 1-year return was -44.2% (1931)
  • Average annual returns from 1871-2016 were 10.7%

As you would expect, the longer you invest the more likely that you wouldn’t have lost any money.

  • The best 5-year annual return was 29.8% (1924-1928)
  • The worse 5-year annual return was -6.9% (1928-1932)
  • The average 5-year return was 10.7%/yr

It took going out to a 10-year time frame before there were no periods where you would have lost money. Investing in the worst 9-year period of 2000-2008, you would have averaged -1.7% per year.

  • The best 10-year annual return was 21.6% (1949-1958)
  • The worst 10-year annual return was 0.6% (1999-2008)
  • The average 10-year return has been 10.8%/yr

Our Retirement Plan Assumptions

The length of time I’m really interested in is even longer than 10 years. My goal is to have my working years last around 25 years and then to be retired for 40+ years. I’m about 10 years in with another 15 to go.

  • The average 25-year period has been an 11.1% return
  • The best 25-year period was 18.2% (1975-1999)
  • The worst 25-year period was 5.8% (1872-1896) 

We first started saving for retirement in 2006 and average market returns from 2007-2016 have been 8.8%. Our returns have been slightly higher than this, but aren’t as clean to track since we have been continuously investing new money for the past 11 years.

All this to say, we’re assuming 8% returns over the next 15 years and based on what we’ve seen so far and what has happened long before we started investing, we remain comfortable with that assumption.

I should have even more years in retirement than in my career, but my plan assumes a low withdrawal rate, under 4%. In retirement, we won’t be relying on sustained market returns to provide for our lifestyle but will remain invested primarily in equities similar to the strategy outlined in Simple Wealth, Inevitable Wealth.

I’m currently reading Nassim Taleb’s book Antifragile and he makes the very valid point that until the worst of anything happened, it wasn’t actually the worst. Said another way, just because a mountain is the tallest you’ve seen doesn’t mean it’s the tallest in the world. I know that future returns could be worse (or better) than we’ve ever seen before, but planning on an early retirement allows me to have sufficient margin in my plan to compensate for unexpected downturns.

See below for some more info on different investment horizons high, low, and average annual returns for a specific number of years.

What rate of return do you use for your retirement planning assumptions?

Overreaction leads to Underperformace

Have you ever heard of the Dalbar study? This company does an annual study that looks at the impact of investor behavior on returns. What they’ve found is that over time not only do mutual fund investors underperform the market, but they also underperform the underperforming mutual funds. Wow…that’s a lot of underperforming.

This underperformance is attributed to picking the wrong mutual funds and getting in and out of the market at the wrong times. Since it is impossible to time the market, I would argue that it is always the wrong time to be getting out of the market.

Here’s an example of a chart Vanguard put together using data from the Dalbar study:

source: Vanguard

What do YOU do when the market gets scary?

The answer to this question should be “nothing” or “buy more”. Sadly, research shows that many people do exactly the opposite. Selling everything when things are scary can feel good and provide a sense of safety in the short term. These same people will buy back in ‘when the coast is clear’, which typically means prices are much higher than when they sold in the first place.

For your long-term investment strategy, sitting out of the market is the one big mistake that you can’t afford to make. With craziness looming in North Korea and other parts of the world, it would be easy to self-justify getting out of the market right now. But when do you get back in?

Do you remember how Greece’s economy was going to destroy global markets? How about the fiscal cliff and government shutdown? Oh, and let’s not forget about the debt ceiling or the flash crash. For eight years the market has continued to rise, quickly recovering from any number of fear-inducing events. Over longer periods of time, short-term declines aren’t even noticeable.

It can best be summed up by a chart I have framed on my desk at work from Behavior Gap.

The Value of a Financial Advisor

I am a Do-It-Yourself investor. I think most anyone can successfully manage their investments without a financial advisor. Financial advisors will point to the chart above and argue that you need to have your accounts professionally managed to protect you from yourself. While there may be some truth to that, I think all you need is someone who can talk you off the ledge.

Even though I am a DIY investor, I have a financial advisor. He is someone I used to work with and trust his judgment and integrity. He doesn’t manage my accounts, but I get free dedicated access to him because of the size of my accounts. We talk a few times a year and he helps validate that I’m still on track to reach my goals.

If I ever were considering selling everything, he would (hopefully) be able to talk some sense into me and prevent me from making that huge mistake. The real value of a financial advisor is when they can remind you of your long-term goals in times of short-term uncertainty.

Evaluating Life Insurance Needs

It’s that time of year again, where I get the invoice for my annual life insurance payment and re-evaluate our life insurance needs. This year is a little different than previous years because we also welcomed our fourth child into the family last month.

WHY HAVE LIFE INSURANCE?

To me, the purpose of having life insurance is to provide for my family in the event of my death. It is no coincidence that my policy payment occurs in the same month as my oldest child’s birthday. Prior to having children, the only life insurance I had was whatever was offered free through my employer (4x salary plus $50,000). While that was certainly generous, as a newly married couple it was actually more than we probably needed. My wife had a good job, and either of our incomes was enough to support us both. When we found out we were expecting our firstborn, we knew that we wanted to have more coverage.

During my wife’s pregnancy, we were saving 100% of her income and our plan was for her to be a stay-at-home parent. We wanted to have enough life insurance so that if something were to happen to me, she would be able to continue to stay home with our children at least until they finished high school. If something were to happen to her, the plan was (and is) for me to move closer to family, but still to have some life insurance to help cover childcare costs that we currently aren’t incurring.

At the time, our household expenses were under $50,000/year and we settled on 20-year term life insurance policies of $500,000 for me and $250,000 on her. This, in addition to my employer provided plan felt like plenty of coverage. I have since moved on to a new employer but still have life insurance provided by the company equal to one year of my salary. It’s worth pointing out too that the death benefit of life insurance policies is not taxed, so 100% of the benefit actually would be received as cash.

RE-EVALUATING OUR NEEDS

Each year when we pay our life insurance bills, we ask ourselves if we still feel that we have the right amount of coverage. So far, that answer has always been yes. As our family has grown, we’ve been able to keep our expenses pretty well contained and we’ve continued to save and grow our net worth.

Although much of our net worth is tied up in retirement accounts and home equity, if I were to die Mrs. DIY$ would sell the house and be able to access my retirement accounts without any penalties and would have a net worth over $1M. We are targeting to have more than $1M in net worth before we fully retire, but this would be plenty of cushion to allow her to sustain the household long enough to get all of the kids grown and then some. She hasn’t been in the workplace since becoming a mom but looks forward to being able to re-enter the workforce at some point in life, so this would not be a burden if she weren’t left with enough for an immediate lifetime retirement.

SIMPLE ADVICE FOR CONSIDERING WHOLE LIFE INSURANCE

Life insurance salespeople will sometimes argue that buying term life insurance is throwing money away and that you should consider whole life insurance for the savings and investing benefits. To that my simple rule of thumb is this.

“Don’t invest using and insurance product and don’t expect insurance from an investment product”.

If you can remember that one simple rule, you’ll avoid significantly overpaying for life insurance and also have more realistic expectations from your investment portfolio.

To the life insurance salesperson who says we’re wasting money on term life, I’d add that we have 14 years left in our 20-year policy and my policy costs $365/year. I’ll be thrilled if 20 years passes and I end up having flushed $1 a day down the toilet for that time, but my mind is at ease knowing my family would be taken care of should the awful happen.

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?

Kids and Money

Over the past several months, we’ve been working on teaching our 5-year-old more about money and work and it has been fun to see him grow and to have him pitch in more around the house. Much of our approach is based on principles taught in Smart Money Smart Kids by Dave Ramsey and Rachel Cruze, the main one being the give/save/spend approach. Just like we do as adults, we encourage our children that every time they earn money, some of it should be given away, some saved for the future, and some spent.

EARNING

Throughout the week, our kids can do a variety of chores that they know will result in various amounts of income. We try to keep the chores age appropriate but our younger daughter has surprised me by stepping up and doing chores that I intended to be for our older son. It’s been a learning experience for us all. Some of the chores include:

  • Emptying the dishwasher
  • Folding/putting away clean clothes
  • Filling up a toy box in the play room
  • Filling up a bucket with pine cones to burn in the fire pit
  • Taking out trash / recycling
  • Get good behavior reports for a whole week at school

This list isn’t an exhaustive list of everything our kids are expected to do around the house. As they get older, more difficult chores with more earning potential will be added (when is a kid too young to use a riding lawnmower?). As of now our 5-year-old has been averaging $2 in weekly earnings.

GIVING

For us, the principle of tithing is something we strongly believe in and each week when we pay our kids it is an opportunity to teach about it. I make sure that when they are paid, we have sufficient change to carve out 10% (and for convenience sake all of the chores they can do are paid in amounts that divide by 10 evenly – no $0.75 chores around here!). One of the great conveniences of the internet is that we actually make most of our donations online and have done so since before our kids were born. The downside to this is that our kids never see us physically giving a donation at church and we wanted to be able to teach by example. Now that our kids have their own money this allows them to be the ones taking that action at church.

SAVING

Once money has been set aside for tithing, we split the rest in half and put the first half in savings. I actually keep the money in the ‘Bank of Dad’, and we review a spreadsheet that I use to keep track of how much money they have in savings and how much they are adding to the total. I worried that it would be too abstract for them, but they seem to be just fine with knowing that they have money in savings somewhere. Plus, there’s no way they can do better than the interest rates we pay.

In an effort to teach about interest, and for it to actually be something worthwhile, we pay them 1% interest per month (12% per year). On the first of each month, we’ll pull out the spreadsheet and make a big deal about adding 1% interest to the month-ending balance. Some books I’ve read recommend lending your kids money at a similar interest rate to teach about debt but we have no plans to loan our kids money. I’d rather our kids learn to hear no and to tell themselves no than to go into debt. They already know that mommy and daddy don’t borrow money and I don’t want them to start thinking that it’s ok for them to do so.

We haven’t quite figured out what he is saving for yet, but the only rule I’ve made is that it has to be something that costs more than $20 since anything cheaper than that can be saved for relatively quickly. The topic of saving for college and cars will come up soon enough but 5 years old feels too young for that to sink in and we are saving to help with college separately.

SPENDING

After giving and saving are done, the remaining 45% of earnings can be spent however and whenever he wants. So far, most of the spending money has been spent at his school on ice cream. This isn’t my first choice of how I would spend money but there haven’t been any issues with him not having money for other small things he also wants so it’s worked for now. I’ve been reminding myself that his preferences don’t necessarily need to be the same as mine and so long as he’s not spending money on something I actively oppose then there’s no need for me to step in. For now his preferences are somewhat simple and he’s been easy to please, but we’re laying the groundwork to respond to desires for more and more expensive tastes.

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October 2016 Net Worth Update

I hope you all had a happy Halloween and aren’t too far into a sugar induced coma. This year we had three rounds of trick or treating between school, church, and neighborhood and I wouldn’t be surprised if we ended up throwing out some of the candy. Yes, we are those parents. The first of the month means it is a good time to reflect on how we are tracking towards our wealth building goals.

During the month of October, we lost a little bit of ground, but not because of any actions we took. Our net worth declined $4k to $580,516. Let’s dive in to see what happened.

CASH

Our cash balance increased by $1,900 but this is mostly timing. Going forward though, you should expect to see our cash balance increase. For a little while now, we’ve tried to keep our cash balance in the $20-25k range and put anything above that towards paying off the house. Back in April, we decided that we wanted to save up for the new Tesla as my next replacement car, but haven’t really started saving towards that goal yet. Since we are opposed to borrowing money for purchasing cars and still want to buy a nice car, we are planning to start adding to our savings account each month earmarking anything over $20k for the purchase of my next car.

Between now and the end of the year, we’ll have a few thousand in home repair related expenses (driveway leveling and hiring someone to paint the highest parts of the house we aren’t comfortable reaching ourselves). We have some travel plans for the holidays as well, but shouldn’t see very large expenses for them.

INVESTMENTS

Nothing to see here – the S&P 500 was down nearly 2% for the month and our largest holding is IVV, the iShares S&P 500 ETF. We continued to add to 401k and haven’t made any changes to our allocations. I do have a small Robinhood account that I occasionally use for small trades but sometimes I question the benefit of using it for such small trades when I need to enter all my trades into TurboTax when I do my taxes.

CARS

My little Corolla is still chugging along and getting closer every day to 200,000 miles. I’ll need to get new tires here in the next few months but other than that there really isn’t much excitement in our garage at the moment. I expect the cars to depreciate and a $225 reduction for the month sounds about right.

HOUSE/MORTGAGE

I’m not surprised to see the house value come down this month. Not because anything had changed for the worse, but rather because the value had gone up so much in recent months. We’re only 2.9% higher than the value at the end of last year, and that feels like a pretty conservative growth rate for what we’ve been hearing. We also made the same extra mortgage payment amount this month as last month and were able to reduce the amount of our payment that went towards interest by a whopping $6! (What, that isn’t motivating?) Last year when we did our taxes it was a bit frustrating to see how much we had paid in mortgage interest and it will still be a huge amount this year even though we will have paid off over $15k during the same time period. The milestones that we can get excited about are each time we pay off $10,000 increments and we’ve got another one of those coming up soon. One of our 2017 goals will be to get the balance below $200k. This should be a very easy goal, so we’ll need to see how quickly we think we’ll be able to do it and set a more ambitious goal for the full year. As of now, we are tracking ahead of where I thought we would be in paying down the house for 2016.

I’m considering breaking one of my own rules

When I was a financial advisor, many of my clients worked for publicly traded companies and often had significant portions of their nest egg invested in their employers stock. Many companies have employee stock purchase plans (ESPP) that allow you to purchase stock (often at a discount) that accumulates similar to a 401k, but without diversification. A lot of large 401k plans also have company stock as an option for your 401k contributions. Combine these two methods of buying company stock with paternalistic companies with multi-generational histories and you end up with people who have 90+% of their net worth tied up in company stock.

My advice was always to sell off the company stock and diversify. Did no one learn anything from Enron? If you have too much of your world tied up in company stock and things go south, you have risk of losing your nest egg AND your job. It is riskier for you to own shares of your employer than it is for someone who doesn’t also work there. Trying to convince people to sell company stock was always a difficult conversation, and I likened it to telling someone their kids were ugly. Holding the same stock for decades, people often would feel that the stock was partly responsible for their financial success, even if the stock had been a terrible performer.

My current employer is a large, publicly traded company, and I have made it a point to avoid buying any shares of stock. In addition to my concerns about diversification, because I work in finance I often have access to confidential information and so am only able to trade the stock during certain times (i.e., no transactions allowed near earning release dates or other major events).

From the time I was hired, our stock is up considerably (>3x), but so far this year hasn’t really kept up with the rest of the market. I attended a leadership meeting this past week and while listening to the CEO and CFO speak, I found myself thinking “Wow, we’re doing really well and our future is bright. Why don’t I have any shares of our stock?” I came home and mentioned this to my wife thinking/hoping she’d tell me to snap out of it and don’t do something stupid, but instead she just said “if you want to buy a few shares, just keep it small.

In the not too distant future, I could be in a position where a portion of my compensation is given in the form of company stock. At that point, what I decide to do with the stock will make a larger difference in my overall plan. My current strategy for stock received from my employer is to immediately sell at least half of any stock given, but to keep a small amount to show confidence in the work I am doing. Keeping stock that was granted to me somehow feels different than proactively going out and buying shares on my own though.

So here I stand…I’m probably only talking about a couple hundred dollars, which really isn’t going to make a difference long term, it’s more about the principle and not wanting to deviate from the advice I’ve given to so many other people.