7/13/19

The Darker Side of Personal Finance (Part 2) Tony Robbins and Theodore Johnson


There are a lot of personal finance gurus out there that give sensible advice, that if followed, leads to a better life. Every once in a while they say something that on its face is very motivating, but after you think about it, it is hard to believe. When you look into it, you see that it's disingenuous, and this detracts from the personal finance guru's credibility. Last time we looked at Dave Ramsey and his 12% returns. In part two, we look at Tony Robbins and the story of Theodore Johnson.

There's an oft repeated quote, supposedly uttered by Albert Einstein, that compound interest is the 8th wonder of the world. Whether Einstein said it or not, it is true that it's the compounding of gains over time that can produce large amounts of wealth. And conversely, borrowing from and paying compounding amounts of interest to someone else is a sure recipe for financial disaster.

In his books MONEY Master the Game: 7 Simple Steps to Financial Freedom and Unshakeable: Your Financial Freedom Playbook Tony Robbins and the experts he interviews offer a lot of great financial advice, including the benefits of compounded returns over time.

One of Robbins's examples of the power of compounding in the books is the story of Theodore Johnson. Robbins has recounted this story many times since the books' publication in interviews and other media.

The Magic of Compounding and Theodore Johnson

The story goes something like this. Theodore Johnson worked for UPS and never earned more than $14,000 per year. He was persuaded to save and invest 20% of his salary. With some effort he managed to do this. As a result, his investments grew to $70 million, $36 million of which he donated to education.

Talk about the power of compounding! Johnson never earned more than $14k per year, but thanks to compounding he was able to donate $36 million and still have $34 million left over as spending money.

The moral of the story is that you should invest as much as you can, as soon as you can, and as often as you can. If you do, you too can be rich. Even if the amounts are small. Just look at Ted Johnson, who never earned more than $14,000 per year.

But if you think about it, even just a little, it doesn't make much sense. The story leads one to believe that Theodore Johnson had a low income. $14k a year is pretty much nothing. Did he even graduate from high school? Forget about being able to invest, how was he able to eat? Something about the story smells fishy. Maybe this was a few decades ago and adjusted for inflation the salary wasn't that low. Maybe he was a UPS delivery man or worked in one of their warehouses.

Not Quite as Exciting

Actually, Johnson retired as Vice President of Industrial Relations. $14k a year for a vice president position at UPS? What year was this? 1952. $14,000 in 1952 dollars is roughly equivalent to $135,000 in 2019 dollars.

The story isn't as exciting now. "Theodore Johnson never made more than $135,000 a year, but he amassed a fortune of $70 million." This doesn't sound as good. It's not turning a measly $14k salary into a fortune.

The other wrinkle in the story is that Johnson invested heavily in a single stock, UPS.

Put that together and you get, "a corporate executive earning $135k a year puts all his money in the company stock and ends up with $70 million when he's 90." Johnson retired in 1952. His fortune grew to $70 million by 1991, when he was 90 years old.

That's hardly motivating and you might wonder what else Robbins says that leaves out salient facts.

(Still, even with a salary of $135k and getting lucky with a spectacular stock, it seems kind of hard to end up with $70 million.

By the time he retired, Johnson owned $700,000 worth of UPS. From 1952 to 1991, a 39 year period, this amount grew to $70,000,000. That's a compound growth rate of 12.53%. Johnson's return from when he started buying the stock to 1952 had to be a lot higher for him to end up with $700k when he retired.)

The moral from the Theodore Johnson story is a good one, but I wish it weren't as sensationalized and was more nuanced. Invest as much as you can as early as you can. However, buying a single stock, no matter how much you know about the company, is not investing. It is gambling. We never know what the future holds. This is why Ashvin Chhabra says one's own business, or significant amounts of your employer's stock, belongs in the "aspirational" risk bucket, the same place where speculative investments should be allocated. It's where the potential rewards are great but the risks may be greater. Imagine working for Radio Shack and putting all your savings into its stock. Your story would never make the personal finance press because you'd end up with nothing.

Tony Robbins does not deserve all the blame. Here is how the NY Times tells it: "Theodore R. Johnson never made more than $14,000 a year, but he invested wisely -- so wisely that he made $70 million. Now he is donating $36 million of his fortune for education." I get that newspaper articles are meant to sell papers and personal finance stories are meant to motivate, but when you leave out certain facts that, intentionally or otherwise, cause the audience to get the wrong impression, you risk your credibility when the audience discovers the facts you left out and their interpretation of the story changes from one of "anyone can do this" to one of "that guy was already making a lot of money and then he got lucky."

7/7/19

The Darker Side of Personal Finance (Part 1) Dave Ramsey's 12% and the Difference Between Average and Compound Average


There are a lot of personal finance gurus out there that give sensible advice, that if followed, leads to a better life. But every once in a while they say something incredible and disingenuously false that ruins their credibility. One of those is Dave Ramsey and is 12% returns. You too can retire a millionaire. Just invest $100 per month in a good growth stock mutual fund that I recommend.

Dave Ramsey's 12% Returns

If you follow all of Dave Ramsey's advice to the letter you will be much better off financially, and probably as a person, than if you don't do any of the things he recommends. But one thing that he says that makes him less credible is that with "a good growth stock mutual fund" you will earn around 12% annually. Investing $100 a month into the fund for 40 years, say from the time you're 25 until the time you're 65, you will retire a millionaire.

Here is the claim on his website, where the data is from 1923 to 2016. The range may change by the time you read this as Ramsey's website is updated.

Putting aside the issue of the fees associated with the funds that Ramsey recommends and presumably gets a commission from, this is kind of disingenuous if you think about it.

Depending on the time frame that you pick, the S&P 500 has averaged around 12% annually. For example, from 1923 to 2016, a 93 year period, the S&P 500 has averaged an annual return of 12.5%. The key word here, however, is "averaged."

An average annual return is different from a compounded annual return.

Here's a simple example. Suppose a $10,0000 investment goes up 50% the first year and down 40% the next, and this pattern repeats every year. So, the investment grows to $15,000, then falls to $9,000, and so on:

Actual Investment

Year
Starting Value
Rate of Return
Ending Value
0
      10,000.00
50%
  15,000.00
1
      15,000.00
-40%
    9,000.00
2
         9,000.00
50%
  13,500.00
3
      13,500.00
-40%
    8,100.00
4
         8,100.00
50%
  12,150.00
5
      12,150.00
-40%
    7,290.00
6
         7,290.00
50%
  10,935.00
7
      10,935.00
-40%
    6,561.00
8
         6,561.00
50%
    9,841.50
9
         9,841.50
-40%
    5,904.90
10
         5,904.90
50%
    8,857.35


In the last year, the investment is valued at $8,857.35, for a total loss of $1,142.65 or 11.43%. The average annual return for this investment over the 11 years, however, is a positive 9%!

Let's say I'm trying to sell you this investment and I say, on average it returns 9% per year. That's true! But here's the disingenuous part. I say next, so if you put in $10,000, and you average 9% per year, your investment will be worth $23,673.64 in ten years:

Investment as Marketed

Year
Starting Value
Rate of Return
Ending Value
0
      10,000.00
9%
    10,900.00
1
      10,900.00
9%
    11,881.00
2
      11,881.00
9%
    12,950.29
3
      12,950.29
9%
    14,115.82
4
      14,115.82
9%
    15,386.24
5
      15,386.24
9%
    16,771.00
6
      16,771.00
9%
    18,280.39
7
      18,280.39
9%
    19,925.63
8
      19,925.63
9%
    21,718.93
9
      21,718.93
9%
    23,673.64

That's not true. Why? Because average and compound average returns are being conflated. But as you can see above, there's a big difference.

I'm not sure if Ramsey does it on purpose or not, but he makes the same conflation. He uses the historical average return of the market to forecast a compounded annual return. This makes his advice look much better than it is, and if you realize this you might start to question everything else he says.

So what are the real numbers?

From 1923 to 2016, the S&P 500 has averaged 12.25% per year. Investing $100 per month for 40 years would have produced a portfolio valued at $996,927.31 if the 12.25% were compounded.



The actual compound annual growth rate of the S&P 500 during this same period was 10.34%. That is seemingly not such a big difference from 12.25%, but it is huge (and is also why fees matter so much!).

Investing $100 per month for 40 years and having that compound at 10.34% would have yielded a portfolio of $587,779.81, which is a $409.147.50 difference from the advertised amount! And this doesn't factor in inflation or fees.



The saddest part for me is that this might reasonably lead one to conclude that Dave Ramsey is full of crap and that everything he recommends doing is worthless. I don't understand why he doesn't use the actual compound returns, they are even provided in the MoneyChimp calculator link on his website) and increase the monthly investment amount to compensate. A hundred dollars a month sounds a lot easier than three or four hundred, I guess.

7/6/19

The Aspirational Investor: Taming the Markets to Achieve Your Life's Goals | Book Review


Ashvin B. Chhabra's Aspirational Investor advocates what the author calls "an entirely new approach to managing wealth," which is based on achieving personal goals and managing risks rather than relying exclusively on the market. (If you think about the term Modern Portfolio Theory Plus, The Aspirational Investor is the plus.)

To this end, Dr. Chhabra, who was Chief Investment Officer at Merrill Lynch, proposes a Wealth Allocation Framework to accommodate three needs: financial security, maintaining one's standard of living despite inflation and living longer, and pursuing one's aspirational goals. He also characterizes these as essential goals (safety and shelter), important goals (being able to support those who are important to you), and aspirational goals (pursuing your dreams), respectively.

Naturally, the approach splits all of one's assets and goals into three buckets based on risk, where each bucket corresponds to each of the three needs. The safety bucket contains the lowest risk and lowest return assets, the important goals bucket contains a diversified market portfolio which should earn market returns, and the aspirational bucket contains speculative investments, one's business, and so on, basically anything that has the potential for high returns but can also go down to zero.

Chhabra provides a seven step process on how to implement the buckets and how to evaluate the riskiness of certain assets. How risky something is depends on one's situation and goals, and different people might have the same asset in different buckets.

Chhabra argues for converting one's goals into cash flows (how much money you need to save now to achieve your goals) and provides simple but powerful formulas to calculate them. In general, the formula is

savings required for [goal] this year = cost of goal in today's dollars divided by the number of years you have to achieve the goal

The following year, you perform the same calculation, except you use that year's dollars and subtract what you have already saved.

For example, let's say your goal is to pay for your kid's college, which will be in 18 years and currently costs $120,000 (four year tuition). Per the formula, the first year you should save $120,000 / 18 years, or $6,667. The second year, let's say college costs are $122,000. You reduce the $122,000 by the $6,667 you already saved, which is $115,333, and divide that by the number of years remaining, which is 17. Per the formula, you would save $6,784 the second year. Proceeding thus for the 18 years would enable you to save the inflation adjusted amount for the college tuition.

You should do this cash flow savings method for all of your goals, which includes retirement.

How you save the converted cashflows depends upon your goal and where it fits in the risk allocation framework.

This is quite powerful, but also daunting, especially for people who are short on savings and working years.

The Aspirational Investor seems to be targeted toward higher income earners and people who are already in the habit of saving. For the latter, Chhabra provides a method that reduces risk as well as a clearer picture of how much is needed for each goal.

Another category that would benefit most from the book is young people. I certainly would have benefited from reading it 15 years ago (not that I could, as it was published in 2015). Following its simple principles would have made me far better off. If you're young, read The Aspirational Investor!

Aside from the meat of the book, Chhabra does a good job of discussing many of our cognitive biases, our inability to predict markets, and how these lead to poor results. He also has two interesting chapters comparing the famous Yale Endowment investing model and Warren Buffett's Berkshire Hathaway in terms of the risk allocation framework. These serve as an illustration of how similar assets belong in different risk buckets for different institutions (or people).

The short book is well worth the time it takes to read it, but it's probably more cost effective to take it out from the library than to buy it.

7/4/19

$50 Per Pay Check Dividend Portfolio Update 7/3/19



I transferred $50 to M1 Finance on the morning of Wednesday 7/3/19 with the expectation that the money would hit the account on Friday or Monday, but the transfer happened seemingly instantly and one hundred trades were completed the same day during the shortened pre-holiday market session.

That was unexpected. Another thing I didn't foresee was that a portion of the $50 was not invested. $2.66 remains in cash and will have to wait for the next $50 installment in two weeks. The uninvested cash is probably the result of rounding and the target percentage for each stock (roughly 1% of the portfolio).



Per the gains section in the M1 account, the portfolio has also earned $0.14 in dividends since it was started, which I assume is included in the cash balance. Either I haven't figured out how to find it, or M1 doesn't provide this information, but I don't know which stocks paid the dividends. Unlike other brokers, M1 doesn't seem to include dividends in the account activity section. The account statement, dated 6/28/19, shows nothing in the estimated income column. Maybe it'll show up in the July statement.



Below is a table of where the dividend portfolio is now. As we accumulate datapoints I will add charts. I have debated whether to take the excess cash out of the portfolio value, or account for it in the benchmark, but have decided that doing so would add unnecessary complications as long as the excess cash balance stays low. We'll see what happens in the coming months.

Date
Additional Investment
Running Total Investment
Dividend Portfolio Account Value
Additional Benchmark SPY Shares
Running Total Benchmark SPY Shares
SPY Closing Share Price
Benchmark SPY Value
Dividend Portfolio VS Benchmark
6/24/2019
$200.00
$200.00
$200.00
0.681107
0.681107
$293.64
$200.00
0.000%
7/3/2019
$50.00
$250.00
$252.22
0.167336
0.848443
$298.80
$253.51
-0.511%



6/30/19

Save and Invest Spare Change without Acorns' Fees


Saving money is hard for most people. A relatively new approach at solving this problem is automatically investing spare change.

The way it works is all your purchases are rounded up to the nearest dollar, and then the difference between the rounded up amount and the actual purchase price is put into an investment account where it can grow. The appeal is that you won't even ever miss the money being saved. Say you buy something for $13.50. It is rounded up to $14, and the $0.50 difference is taken from your account and invested. It's as if you paid that extra fifty cents, which you would have done anyway had the item you bought cost that much more.

It's a great concept, and a neat trick to save some extra cash. The problem, however, is the fees. Acorns, the leading firm in this field of micro investing, charges between $1 and $3 dollars a month, depending on the account you have (college students are supposed to be free). This doesn't sound like a lot, but it could be a rather large percentage of how much one is saving.

For example, suppose all these round ups save you $100 per year. With the $1 monthly fee, you'd be paying 12% for this service and actually saving $88. It's better than nothing, but why pay so much? Why pay anything?

June was a typical month for me. Rounding up all my credit card purchases to the nearest dollar and then taking the difference yielded $6.05. Having to pay Acorns $1 out of that amounts to a 16.5% fee. I'd basically be paying Acorns a dollar to save $5, instead of just saving $6.

If you already track your expenses, you can replicate Acorns' services for free with just a few clicks and key presses at the end of the month in your favorite spreadsheet program. Better yet, you can figure out how much Acorns would have saved for you on a typical month (say $10), and then have that amount automatically taken from your checking account and deposited into a brokerage account by setting up a monthly funding transfer.

Investing the Spare Change

Acorns invests the spare change into a diversified set of low fee ETFs. To replicate this on your own, you need to find a brokerage where you can deposit small amounts and have them buy fractional shares of index ETFs or mutual funds.

Two great options are Fidelity and M1 Finance.

Fidelity

Fidelity is great because it has no minimums or fees to open a regular individual or retirement account. It also offers no transaction fee, no minimum investment amount index mutual funds. For example, you can divide your investment into the Fidelity Zero Total Market Index (FZROX) fund, which tracks the total US stock market and has no fees of any kind, and the Fidelity US Bond Index Fund (FXNAX), which tracks the aggregate US bond market and has an expense ratio of just 0.025%. If you would like international stock exposure, consider the Fidelity Zero International Index (FZILX) fund, which tracks stocks of companies based outside the US and has no fees of any kind. Just decide on your allocation to each fund. If you're not sure, make your age the percentage of your bond holdings and put the rest into the stock fund. For example, if you're 34 years old, put 34% into the bond bund and the rest (66%) into stocks.

In the Fidelity account you can set up automatic transfers from your checking account, then set up automatic investments on a monthly, quarterly, or custom basis, so that the money taken out of your checking account is invested into the mutual funds of your choice.

The one limitation that Fidelity has is that transfers from your checking account to Fidelity must be $10 or more.



M1 Finance

M1 Finance is also great, at least in concept (I haven't used it long enough to have an opinion yet), to replicate an Acorns style spare change investment strategy with no minimums or fees apart from the low ETF expense ratios.

M1's investment style is with something called "pies" that are made up of "slices" of stocks or ETFs. You can construct the pies yourself or choose from the many expert created ones, which consist mostly of low fee Vanguard ETFs. The expert pies are based on different themes, like general investing, investing for retirement, responsible investing, income earning, replicating hedge funds (at least the long portion, I don't think M1 has pies that have short positions), and so on. Each of these themes has a number of different pies to choose from, like "2060 Moderate," which is composed of 16 funds and is intended for someone retiring in 2060 that has a moderate risk tolerance, of "Berkshire Hathaway," which "seeks to replicate Berkshire Hathaway by matching the allocation in the most recent 13F filing. Berkshire Hathaway, run by legendary investor Warren Buffett, is a holding company engaged in many diverse business activities." This pie is composed of 24 stocks (which for some reason doesn't include Berkshire itself).

As with Fidelity, you can set up a recurring transfer from your checking account. Once the money hits your M1 Finance account it is automatically invested in whichever pies you selected. Piece of cake and you're only paying the low ETF fees.






If You Track Your Spending and Would Like to Round Up Monthly

If you use a budgeting program like YNAB, Personal Capital, or Mint, you can export all your transactions in a .csv file (comma separated values). If you don't use a budgeting program to track your spending, you can download your transactions from your bank and credit card providers the same way. The file can be opened with Excel, Google Sheets, LibreOffice, or any other spreadsheet program.

Once you open your transactions file, create a new column called "Round Up." In the first cell below, create the formula "=roundup(xx,0)" where xx is the cell location of the transaction amount in that row. So, if the transaction amount is in cell E2, your formula would be "=roundup(E2,0)". Drag this formula down or double click in the lower right corner of the cell the formula is in to make it propagate down through all the rows.

Next, create a new column called "Difference". In the first cell below, make the formula "=xx-yy" where xx is the location of the round up cell and yy is the location of the transaction amount. So, if the round up cell is in F2 and the transaction data is in E2, your formula would be "=F2-E2". Double click on the lower right corner of this cell or drag it down to have the formula propagate down.

Finally, sum up the difference column for whatever period you want. If you do it for the month, this is the amount Acorns would have saved for you (minus their fee). Transfer this amount to your brokerage and you have Acorns for free.