Rereading The Truth About Money Parts 2-5 (2007-10-11/)

Many people fail to save because they simply don't want to stop spending. Fine. Keep spending. In fact, I want you to.
Just change what you spend your money on:
Instead of buying a bottle of ketchup, buy Heinz stock.

--Ric Edelman, The Truth About Money

Like Kiyosaki, Edelman writes, "instead of buying things that later will have no value (like an empty ketchup bottle or a vacation), or virtually no value (like costume jewelry, clothing, or furniture), make sure the things you buy will retain and even grow in value." What are these things? Unlike a bottle of ketchup, there's no grocery store for investments. Parts 2 through 5 of The Truth About Money explain things that retain or grow in value, with many examples, graphs, and stories. (The cover is right that it's "personal finance that's fun to read!") This grocery store of investments has aisles for cash equivalents, income-producing investments, growth investments, and packaged products:

1. Cash Equivalents have little or no default risk. They can mature in more than one year--e.g., some bank certificates of deposit or commercial paper, U.S. EE Savings Bonds, U.S. Treasury Notes, and U.S. Treasury Bonds--or less than one year--e.g., checking accounts, savings accounts, money market funds, some certificates of deposit, and U.S. Treasury Bills. Ric recommends having six to twelve months' expenses available in less than one year, but otherwise avoiding cash equivalents because inflation erases their returns. Some cash equivalents have surrender charges and tax penalties--e.g., life insurance cash value or fixed annuities. These are not appropriate for cash reserves.
   
2. Income-producing investments are subject to default risk (indicated by the bond rating), event risk, and interest rate risk--which one can reduce by holding to maturity or hedging (e.g., with gold). Ric recommends favoring total return rather than rate or even yield. The Truth About Money discusses these income-producing investments:
   
• U.S. Government Securities include--in addition to cash equivalents--Ginnie Mae, Fannie Mae, Sallie Mae, and Freddie Mac. A GNMA repays principal as well as interest, and can prepay in 12-15 years instead 30 years.
  
• Municipal Bonds may be (currently) income-tax-free, but Ric disputes the relevance of this--and the wisdom of insuring them. In addition, municipal bonds are often callable.
  
• Ric recommends against Zero Coupon Bonds because they give low returns, lack payment before possible default, incur taxes on phantom income, and are callable. He also discourages taking physical possession of their certificates.
  
3. Investments that confer ownership or equity instead of (or in addition to) income rely on growth for their value. The Truth About Money discusses these growth investments:
   
• Stocks grow in value, generate income, have returns that beat inflation, and have tax advantages (tax on capital gains is less than the tax on income or interest, tax isn't due until sale, and heirs don't pay capital gains tax). One can purchase stocks through brokerage firms, discount brokers, or dividend reinvestment plans. Although buying international stock adds currency risk exposure, Ric observes that the international stocks and companies are increasing in value.
  
• Real Estate investing adds diversity--but also hassle. For real estate investment Ric recommends lots of cash, for reserves and purchases.
  
• Collectibles don't make good investments due to the possibility of fraud or damage, and inability or unwillingness to sell.
  
• Hedge Positions could help insure against inflation (e.g., gold), deflation (e.g., bonds, dividend-paying stocks, and cash), recession (e.g., oil and gas, minerals, forest products), lack of confidence (e.g., real estate, gold, and precious metals), collapse of the dollar (e.g., foreign stocks and currencies), and stock market crash (e.g., selling short or options trading like covered call writing).
  
4. Just as a real grocery store has prepared foods, the investment grocery store has packaged products--which are really investment companies. These make investments affordable, liquid, diversified, and professionally managed. Open-end or mutual funds have an annual expense ratio and a sales charge (front-end load, back-end load, level load, or no-load). The Truth About Money discusses these packaged products, beginning with six mutual fund types:
   
• U.S. Government Securities Funds exist, despite the perception that mutual funds are mostly a method to invest in stocks. These include Ginnie Mae funds, zero-coupon funds, intermediate funds, short-term funds, and ultra-short funds. Related funds are adjustable rate mortgage funds and global government funds.
  
• Municipal Bond Funds include money market funds, single-state funds (to avoid state income tax), Puerto Rico funds (to avoid all income taxes), insured muni funds, and high-yield muni funds.
  
• High-Yield Corporate Bond Funds (in contrast with short-term and intermediate funds) invest in long-term speculative grade bonds. Investors thus face credit risk in addition to interest rate risk.
  
• Balanced Funds invest in four asset classes: cash and cash equivalents, government securities, corporate bonds, and corporate stocks. There are related fund types: Asset Allocation Funds add other asset classes, Growth and Income funds limit asset classes to stock and bonds only, and Equity Income invest in stocks which pay dividends.
  
• Stock Funds can focus on different categories of market capitalization, different sectors, or different indexes.
  
• International Funds are open-end or mutual funds available in a variety of types: global funds, international funds, single nation funds, regional funds, or sector funds.
  
• Closed-End Funds, while still investment companies, differ from open-end or mutual funds. Shares generally trade on a stock exchange rather directly with the fund.
  
• Unit Investment Trusts are the third type of investment company different from open-end or closed-end funds. They have a fixed portfolio and definite maturity date.
  
• Wrap Accounts are not investment companies but accounts that protect investors from unnecessary trading commissions. However, Ric lists "11 Reasons to Avoid Wrap Accounts."
  
• Annuities are available from insurance companies. Variable annuities are securities products, however. They provide tax-deferred growth and guarantees against loss (in the form of living benefits and death benefits) at the cost of fees similar to mutual funds, plus contract fees and mortality charges.
  
• Real Estate Limited Partnerships are companies that permit investing in real estate with less hassle (for the limited partners). The Tax Reform Act of 1986 retroactively classified their income as passive, so investors cannot deduct losses from active income.
  
• Real Estate Investment Trusts (REIT) are like Real Estate Limited Partnerships, except that they are publicly traded.
  

This ends the tour of the investment grocery store (complete with links to Wikipedia). See the book for more detail. And have fun shopping!

Rereading The Truth About Money Part 1 (2007-10-10)

It is for all these reasons--to protect against risk; to eliminate debt; you're going to live a long time; to hand such major expenses as children, college costs and weddings; to buy cars and homes; to afford a comfortable retirement; to protect against long-term care costs; and to pass wealth to your heirs--that you need to create a financial plan.

--Ric Edelman, The Truth About Money

Part I of The Truth About Money, "Introduction to Financial Planning," discusses the reasons one needs and wants money. Chapter 1 then lists "The Four Obstacles to Building Wealth": procrastination, spending habits, inflation, and taxes.

Imagine a raise of $100 per month invested in stocks producing a combined 10% return. As Kiyosaki writes, buy an asset the produces portfolio income. Investing $100 per month from age 28 to age 65 (e.g., now until 2044) would be a total investment of $44,400. Compounding would make the investment worth almost $414,000.

This scenario enables calculating an example of the four obstacles Ric Edelman lists:

1. First, reducing the years of contribution from 37 to 25 (e.g., now until 2032) illustrates the effects of procrastination. If the same investment begins at age 40 instead of age 28, the total contributions decrease to $30,000, while the investment value at age 65 decreases to a little more than $123,000. This is almost $291,000 less than original scenario!
2. Imagine celebrating the raise by buying a Starbucks Grande Caffè Mocha on the way to work each day, except two vacation weeks. This spending habit could reduce the $100 raise by about $67, leaving $33 per month for investment. At age 65 there would be almost $135,000, or $279,000 less than the original scenario.
3. The preceding examples ignore inflation. If inflation were nominally 3% per year, $1.00 at age 28 would buy as much as $3.03 at age 65. So the $414,000 at age 65 would only buy as much as $137,000 did at age 28. Inflation would remove more than $277,000 of purchasing power.
   
4. Finally, consider taxes. A $100 raise could have a marginal tax rate of 33%. Kiyosaki notes the US government taxes earned income the most. This could reduce contributions to $67 per month, less than $30,000 total. At age 65--ignoring capital gains taxes--there would be almost $279,000. Withdrawing from the investment each year to pay capital gains tax, however, would reduce the value to about $203,000, or about $210,000 less than the original scenario.
   

In summary, the example effects of the four obstacles to wealth are as follows:

1. Twelve years of procrastination reduces the value of the sample investment by $291,000.
2. A workday mocha spending habit reduces the sample investment by $279,000.
3. Three percent inflation reduces the purchasing power of the sample investment by $277,000.
4. Income and capital gains taxes could reduce the value of the sample investment by $210,000.

The conclusions appear to be start now, buy assets instead of consumable expenses, invest to beat personal inflation, and take advantage of tax deferral. These are beyond the scope of this blog post, however.

(The remainder of this post explains calculation details: As an example--not an endorsement--, First American Mutual Funds FSKSX had a past performance of approximately 10%. The calculations use 9.569% compounded monthly, with no volatility for simplicity. Each scenario has additional assumptions:

1. The future value (37 years * 12 months/year =) 444 months later of a $100 per month annuity at (9.569%/year / 12 months/year = ) 0.7974 % per month is $413,890.79. The future value of the same annuity only (25 years * 12 months/year =) 300 months later is $123,333.15.
   
2. On Capitol Hill, Seattle, 8.9% sales tax makes a $2.95 mocha cost $3.21. Five mocha purchases per week for 50 weeks of the year is an average of 21 mocha purchases per month. The average cost is then $67.41 per month.
3. The inflation calculation assumes 0.25% per month, which is similar to current values but low considering long-term averages. The present value of a future sum of $413,890.79 at a rate of 0.25% per month for 444 months is $136,590.49.
4. A "regular" employee who earns $30,651 to $74,200 per year in Washington state would have no state income tax, but would pay 25% United States income tax plus 6.2% for Social Security plus 1.45% for Medicare. For that tax bracket capital gains taxes are 15%. The calculation assumes this applies to all the gains, which is the worst-case scenario--but still has less effect than the spending habit or procrastination example.)
   

Reading Rich Dad, Poor Dad (2007-10-07)

If you want a lesson in confusion, simply look up the words "asset" and "liability" in the dictionary.... An asset is something that puts money in my pocket. A liability is something that takes money out of my pocket. This is really all you need to know. If you want to be rich, simply spend your life buying assets. If you want to be poor or middle class, spend your life buying liabilities.

Robert T. Kiyosaki, Rich Dad, Poor Dad: What the Rich Teach Their Kids about Money--That the Poor and Middle Class Do Not!

Being from a middle-class background, the subtitle of Rich Dad, Poor Dad caught my eye in the Barnes and Noble personal finance area Saturday. As several responses to Don't Let's Go to the Dogs Tonight show, I like anecdotes. I read with interest Kiyosaki's contrast between his rich capitalist businessman dad and his poor socialist employee dad during his childhood in Hawai`i.

The folksy capitalist philosophy in Rich Dad, Poor Dad begins with an income statement and balance sheet. Kiyosaki simplifies each into two boxes with a line in the middle: for the income statement the line is horizontal, and for the balance sheet the line is vertical.

In the top of the income statement are earned income ("work for owner"), passive income, and portfolio income. In the bottom of the income statement are taxes ("work for government"), ownership-related expenses, and other expenses. Subsequent diagrams expand on portfolio income (dividends, interest, rental income, royalties), ownership-related expenses (mortgage payments, real property taxes, insurance, maintenance, utilities), and other expenses (fixed expenses, food, clothing, fun).

In the left side of the balance sheet are assets which create income--your business, stocks, bonds, mutual funds, income-generating real estate, notes, and intellectual property. In the right side of the balance sheet are liabilities ("work for bank") which create expenses--consumer loans, credit cards, and mortgages.

Poor Dad says, "Go to school, get good grades, and find a safe secure job." In other words, concentrate on earned income in the top of the income sheet. Rich Dad says, "The rich don't work for money, they have their money work for them." In other words, concentrate on passive and portfolio income in the top of the income sheet--with passive income being faster. In the bottom of the income sheet, the government taxes earned income the most, and passive income the least.

Rich Dad, Poor Dad consequently characterizes classes using these boxes. The earned income of the poor pays expenses in the income statement and little affects the balance sheet. For the middle class, expenses and taxes rise with income in the income statement, as do liabilities incurred on the balance sheet. The income of the rich purchases income-producing assets, with less rise in expenses or liabilities. (For example, a corporation deducts expenses from income before taxation.) In this way they practice the "pay yourself first" advice of The Richest Man in Babylon.

The challenge is defining "your business." Kiyosaki writes, "If I have to work there, it's not a business. It becomes my job." Timothy Ferriss has similar suggestions for a "muse" in the "Income Autopilot" chapters in "Step III: A is Automation" of The 4-Hour Workweek.

The goal for both Ferriss and Kiyosaki is freedom. The latter explains his wants:

I want to be free to travel the world and live in the lifestyle I love. I want to be young when I do this. I want to simply be free. I want control over my time and my life. I want money to work for me.

Readers of this blog will recognize this desire to travel and live abroad.

[Added diagram and corrected word.]

Simplifying on Saturday (2007-10-06)

I set aside days to reduce, organize, and save time. I want less clutter, and less to move if we live abroad. Between the winter solstice and the following new moon is one of the quarterly periods of Discardia, so I picked the first Saturday of the month.

This was similar to the three Saturdays in 2007-04-28/05-12. In April and May Ryan and I did "spring cleaning": cleaned carpets, framed prints, organized books, replaced lights, washed cupboards, and recycled as usual. This also including giving away books, clothes, and household items. This October Saturday we recycled, and cleaned and organized bathroom drawers, discarding unneeded items. Then we started walking.

Our Northgate neighborhood has a walk score of 75-- not as high as Jim's neighborhood. Nevertheless we were able to walk instead of drive to our errands: getting coffee (in personal cups), giving away household items (baskets, mugs, sweaters) at Value Village, recycling a mobile phone at Best Buy, and getting Ryan to work.

At the end of An Inconvenient Truth is "So here's what you can do personally to solve the climate crisis." Under "Get around on less" is "Reduce the number of miles you drive by walking, biking, carpooling or taking mass transit wherever possible." Under "Consume less, conserve more" are "Recycle" and "Carry your own refillable bottle for water and other beverages." I'm pleased to think this Saturday was healthy for my body (by exercising), my mind (by reducing clutter), and the environment (by driving less and recycling).

Reading Quarantine (2007-09-29)

Given my enjoyment of speculative fiction, it makes sense to follow a science book with a science fiction book. While I make occasional references to fantasy, most of my speculative fiction reading is science fiction; the books I've read this year include /, The Moon is a Harsh Mistress, and The Diamond Age. (I recommended in their reviews the following science fiction books: Xenocide, Children of the Mind, A Deepness in the Sky, Stranger in a Strange Land, The Number of the Beast, Animal Farm, Brave New World, Fahrenheit 451, The Left Hand of Darkness, Nineteen Eight-Four, and Cryptonomicon).

I didn't follow An Inconvenient Truth with a rereading of Dune, Dune Messiah, and Children of Dune. However, The Universe in a Nutshell discusses such science fiction topics as time travel (albeit concluding with Hawking's Chronology Protection Conjecture). Consequently I followed it with the Greg Egan's novel Quarantine.

The Universe in a Nutshell discusses the uncertainty principle often, including Feynman's multiple histories idea. Stephen Hawking explains the wave function as "a number at each point of space that gives the probability that the particle is to be found at that position." He discusses particle motion as a sum over multiple histories. In addition, he notes that "[t]he anthropic principle says that the universe has to be more or less as we see it, because if it were different, there wouldn't be anyone here to observe it."

These ideas appear in Quarantine. In Quarantine, Earth after the year 2034 is surrounded by a bubble preventing observation outside the solar system. Afterward researchers develop a mental device to inhibit wave function collapse. While the device operates, the first-person protagonist plays with probable histories, all the while wondering which history will happen, and which version of himself will observe the results.

The setting of Quarantine relies to some degree on the Copenhagen interpretation of quantum mechanics, with reference to other interpretations. The many worlds interpretation appears when the book's story line is several times inconsistent between periods in the protagonist prevents wave function collapse and subsequent events (e.g., a combination that is 1450045409 in one part of the narrative and ten nines in another). Even the Ensemble interpretation appears in name.

Greg Egan's plot is like a thought experiment, similar to Wigner's friend. As such it imagines how the quantum scales of books like The Universe in a Nutshell could affect observable life. In this way it is both entertaining and instructive.

Reading The Universe in a Nutshell (2007-09-14/18)

I have several scientific friends so I like to stay informed of recent theories. My physics familiarity extends from Newtonian mechanics to special and general relativity, but not beyond--and there have been more theories since I was in school. Consequently I selected one of Stephen Hawking's latest books, The Universe in a Nutshell.

I find I prefer science I can observe. Quantum scales are too small and relativistic scales are too large for me to see. (Though Arthur Eddington has observed the effects of general relativity.) In most of my life--except perhaps the night sky--classical theory is fine.

Nevertheless The Universe in a Nutshell was entertaining. I'm caught up, and relieved that superstring theory--which I missed entirely--may be superseded by M-theory anyway. I now know a generalist's overview of theoretical physics.

Reading Blink (2007-09-04/13)

Decisions are difficult. A good decision requires work; a bad decision brings consequences. More information sometimes helps, and--with the Internet--much information is available. However, consultant work gives me this perspective: more research delays a decision and increases its fee. Even if the decision is better as a result, the difference may be marginal and of less value than the lost time. During the delay no action is taken, which may have an opportunity cost. So I "sleep on it", stare out the window, or take a walk. I sometimes use these approaches--and my judgment--instead of additional information.

Malcolm Gladwell filled Blink: The Power of Thinking Without Thinking with anecdotes and studies about the effect of additional information on decisions. Some people assume that additional information always improves thinking; Gladwell cites situations in which that is not the case. An example is classical music auditions, which were biased against women until held behind a screen. The additional visual information actually distracted from evaluating the performance.

In the Afterward, Blink asks "When to Blink--And When to Think." The initial answer comes from Ap Dijksterhuis' studies on "unconscious thought" (which BBC News and New Scientist have summarized): think about simple decisions, sleep on complex ones. However, further reflection leads Gladwell to two qualifications: unconscious thought requires training, and statistical summaries suggest significant factors.

Gladwell gives examples of effect on judgment, both good and bad. Training improves judgment in the battle of Chancellorsville and the Millennium Challenge 2002. Biases have a bad effect on decisions we make in the "blink of an eye"; examples are the shooting of Amadou Diallo and the results of an Implicit Association Test.

In addition to training, statistical summaries also improve decisions by suggesting significant factors. The Wages of Wins suggests it is difficult to estimate summaries from incomplete observations of small differences. A report from Cook County Hospital exemplifies how statistics can isolate the factors relevant to a decision.

Statistical summaries also have their role in my consulting. I just completed a project requiring analysis of millions of records I imported from daily data and queried for mapping and evaluation. I use statistics, training, and unconscious thinking to improve the speed of my decision-making.

Walking to Work (2006-10-26)

Walking to the bus reminds me of my morning commute in Paris and renews my commitment to venture and work abroad again. In Paris Tuesdays through Thursdays we would awaken in Pigalle. Ryan went to school in Saint-Germain-des-Prés and Jean Claude went to work in Montmartre. I followed Jean Claude out onto Rue André Antoine, smelling the wet cobblestones as the street cleaners washed away the previous day. I heard the sounds of other pedestrian's shoes on the wet cobblestones and an occasional car vibrating along the street. The October air cooled me as I leaned into the steep hill and climbed. One morning in late October I took a photograph of the sunrise in Montmartre. Later on those weekdays I walked back down to Le Chao-Ba-Café for the afternoon sunlight.

On weekends--sometimes long weekends including Friday and Monday--Ryan and I would travel. We visited Montpellier, Nantes and Tours, Chamonix, Berlin, and London. We didn't visit Barcelona or Venice like we had hoped.

Memories and daydreams make me think of "Disappearing Act: How to Escape the Office", chapter 12 of The 4-Hour Workweek. A colleague who also develops software for Geographic information systems is currently in Turkey while his wife teaches. Perhaps I can do the same somewhere while Ryan teaches ESL.

Reading The Diamond Age (2007-08-26/09-03)

Neal Stephenson's The Diamond Age: Or, a Young Lady's Illustrated Primer has a future earth setting in which nanotechnology has significantly reduced scarcity but artificial intelligence has not been achieved. I enjoyed Cryptonomicon by Neal Stephenson (especially its encryption themes, which are present as well in The Diamond Age) and decided to read another of his books.

The "Diamond Age" is due to molecular control of matter making diamond--with multiple productive properties--a common material. (Wikipedia attributes this idea to "It's a Small, Small, Small, Small World" by Ralph C. Merkle.) It is interesting that the social organization in the story still contains classes, even though matter compilers make clothing, food, and covering available to all. I like to imagine how a just society would work.

The lack of artificial intelligence appears reasonable. The actual achievements of AI have always fallen short of predictions. Alan Turing estimated that by the year 2000 machines would be able to fool 30 percent of human judges during a 5-minute Turing Test. In 1965 H. A. Simon wrote that "machines will be capable, within twenty years, of doing any work a man can do." In 1967 Marvin Minsky wrote, "Within a generation ... the problem of creating 'artificial intelligence' will substantially be solved." Clearly none of these predictions have appeared.

I look forward to seeing how these areas--nanotechnology, scarcity, justice, and artificial intelligence--develop during my lifetime. Perhaps I will see some possibilities fulfilled.

Walking (2007-09-07/14)

Walking has long been and probably will continue to be important. For me it is part of a happy and healthy mobile lifestyle.

Walking was part of my life in various ways in the past. Summer visits to the houses of each set of grandparents involved a daily walk. During a few years of grade school I lived a block from public land in which I hiked and daydreamed short stories I would write. During high school I walked several miles to and from each Medford school I attended, each day choosing a different route than the previous. Later I again lived on the edge of public land. During undergraduate education I walked around Corvallis--especially the Oregon State University campus--alone or with friends, thinking or talking about life. During and after graduate school I similarly liked to walk the University of Washington campus.

My business partner recently revived his own childhood love of walking. A few years ago when my company moved to from the University District to Westlake, I encouraged walking to lunch in South Lake Union the way we had walked to lunch on The Ave. At most we would walk half a mile. Then he purchased a pedometer to compete with friends. Now he tracks his walks, totaling 10,000 steps per day, around the office and his neighborhood. He even ordered an Omron HJ-720ITC pedometer for me.

Consequently I have begun tracking my walking as well. I suspected I already met the guideline of 30 minutes of moderate activity 5 to 7 days per week, in walking to the bus, to coffee, to lunch (e.g., to Paddy Coynes in South Lake Union), and on the elliptical trainers (at the IMA). Now I am carrying a pedometer to verify that.

It is helpful to distinguish moderate activity like brisk walking from other steps. The U.S. Department of Health and Human Services cites publications suggesting that 30 to 60 minutes of activity broken into smaller segments of 10 or 15 minutes throughout the day has significant health benefits. The Omron HJ-720ITC has an aerobic step function that displays the minutes walked and number of steps walked at more than 60 steps per minute for more than 10 minutes continuously.

This past week provides me preliminary step estimates for moderate activity. Evidence suggests 30 minutes of moderate activity is equivalent to 3000 to 4000 (aerobic) steps, and that even sedentary adults accumulate 5000 (other) steps. I'm pleased that my average aerobic walking time was 35 minutes per day (3860 steps), but this week only three days had more than 30 minutes (3240 steps). Other (not aerobic) steps ranged from 3310 to 8740 with an average of 6480. An average day for me with 30 minutes of moderate activity therefore would have 9720 steps (though carrying a pedometer may have an effect like the Hawthorne effect). Perhaps I'll join 10,000 steps.

In addition to the health and happiness benefits of moderate activity, there are lifestyle benefits. Walking to and from the bus stop is part of a lifestyle in which I drive cars less and read more books on the bus. It is also part of a lifestyle in which I am fit enough for adventure.