Jack’s Links

Two weeks worth of links because I was gone at conferences last week — XYPN and FinCon. Summary posts to come.

  • NYT Article on Chilean Pensions: Spoiler: they are very small. Disclaimer: I know very little about the political/financial history of Chile. This is a perfect example of a totally worthless article, not because it is poorly written, but because there is absolutely no clue given as to the root cause of the problem. Yes, I get it, the pensions are low, but is that because contributions were low? fees were high? returns were low? payouts are below market? The article paints Chileans in a terrible light, it reads to me as if they are asking for more money because what they saved isn’t enough, and that the retirees are demanding the government take from the young to give to the old. A poor country isn’t going to magically be able to let citizens retire at the standard of living of a rich country because it’s a nice thing to do.

“The A.F.P.s have never lost money, stolen money or gone bankrupt,” Mr. Pérez said. “Does that mean that pensions are good? No, they are not. The system needs important changes. But the A.F.P.s administer the funds of those who save, and they’ve done that very well.”

  • NatGeo on BASE jumpers dying in record numbers: Super interesting article on a pretty glamorous sport. To answer the titular question, it’s pretty obvious that more people are dying because more people are doing it, it doesn’t seem like BASE jumping (sans wingsuit) has gotten much more dangerous.

Clif Bar’s official statement read that it was no longer comfortable “benefitting from the amount of risk certain athletes are taking in areas of the sport where there is no margin for error; where there is no safety net.”

At the opposite end of the spectrum are companies like Red Bull, GoPro, and, most recently, Stride Gum—which backed a skydiving stunt this summer in which Luke Aikens jumped out of a plane without a parachuteand landed in a large net.

If foreigners buy more bonds, then Americans buy fewer bonds and invest in those “risky, innovative enterprises.” So it’s hard to see why foreigners buying bonds means that there’s less investment in those enterprises.

Now it’s quite possible that the higher U.S. federal budget deficit crowds out investment in those enterprises. But then it’s the U.S. budget deficit doing that, not the foreigners’ choice of U.S. assets to invest in.

For those who are offended by surge pricing at a time of crisis, please tell me your preferred method for getting some people (drivers) to head toward danger when everyone else prefers to head in the other direction. And then tell me how you are going to get people who are heading out to the grocery or are thinking of going out for a drink to postpone or cancel their plans.

But at least you are in the MFTE program, so five of your apartments will offer a discounted rent of $1,020 per month to people whose incomes qualify. (You facepalm in disbelief, however, that whereas your original plan offered 40 units, unsubsidized, at $900 a month, your new version has just five units, subsidized, at $1,020.)

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Jack’s Links

Short links this week, China and monetary policy are two areas that almost anyone who considers themselves financially savvy probably has an opinion in which they are too confident by a factor of 10.

I for one still believe that low rates (and/or QE) don’t mean easy money, that monetary policy is still highly effective at zero rates, that fiscal policy is mostly ineffective, even at zero rates, that level targeting is especially beneficial at the zero bound, that central banks should target the market forecast, that markets are efficient…

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  • Scott Sumner on monetary offset: Understanding the implications of monetary offset is one of the prerequisites for intelligent conversation of economics.

There are so many fallacies here one hardly knows where to begin. The central banks have not done any “heavy lifting”. They can print money at virtually zero cost and their massive portfolio of bonds is generating enormous profits, more than twice as large as before the recession.

Henry Farber, a Princeton economist and author of several studiesaffirming the traditional view, echoed this sentiment, saying even his papers suggest that beginners frequently do not drive enough when business is brisk. “New drivers who can’t figure it out leave the business,” he said. “The ones who stay tend to learn.”

  • WCI on investing a lump sum in your 80s: good analysis and one of the classic examples of the potential usefulness of immediate annuities. Though of course the point is well made that he could simply live off of the cash for 17 years. The common mistake people make in this spot that I see is trying to protect the principal, stretching for excess dividend/interest yield to meet their 6% need.

While the income need/portfolio size ratio (6%) might not seem large to a 60 year old, it is quite good for an 83 year old.

But now an attempt to replicate this modern classic of psychology research, involving 17 labs around the world and a collective subject pool of 1894 students, has failed. “Overall, the results were inconsistent with the original result,” the researchers said.

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  • Joseph Belth on Long Term Care Insurance: Whether Long Term Care Insurance (LTCI) is necessary or wise is a common question when people are nearing retirement. The topic deserves a more thorough treatment than a links blurb, but the article gives a taste of why many savvy people choose to self-insure (i.e. not buy insurance) rather than shell out for LTCI coverage.

Your premiums will never increase because of your age or any changes in your health.” I wrote to the company expressing concern that the sentence, although technically correct, was deceptive. I said the letter should make clear that the company has the right to increase premiums on a class basis.

  • Low Interest Rates: Not Easy Money: For years I’ve been cautioning very smart people that I don’t know of a reason why interest rates are bound to return to ‘normal levels’, whatever that means.

Of course if that were true, then the Fed tightening of last December would have led to higher interest rates. Instead, bond yields have fallen sharply over the past 8 months.

  • How Long Do 65 Year Olds Live?: Having a basic understanding of the current landscape for people entering retirement is a prerequisite if one wants to discuss the finances and economics that accompany them. Great primer from Wade Pfau here.

wade1

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Short links this week, not much caught my eye as particularly good. These three are the exception, and I think they are exceptionally good.

  • CuriousGnu post on the profitability of day traders: Admittedly, this post is based off of what I would call extremely anecdotal data, but is compelling nonetheless. You’ll see in the data from the graph below — about 80% of people lost money over 12 months. There are a million follow-up questions, but this confirms about what one might expect this distribution should look like. Lots of people who lost everything on presumably high leverage or highly concentrated bets, a lot of people who were burned down by transaction costs, and then a general grouping around 0% for people who had decent bankroll management, but for whom investing is essentially a zero-sum game. More than anything, this post (and the others on the website) are great encouragement to learn the basic programming needed to scrape data.

eToro 12M Gains

  • This discussion between Gene Fama and Richard Thaler is about 45 days old, but I just found it (h/t David Henderson), and is well worth the watch/read: The competing schools of thought — taking essentially opposite views of whether ‘bubbles’ exist as generally defined. Both players are involved in the crossover between economics and finance, i.e., their works are directly applicable to investing.

Fama: I’m an economist. Economics is behavioral, no doubt about it. The difference is your concern is irrational behavior; mine is just behavior.

  • Another David Henderson h/t, this video on the economics of sweatshops is a great watch. Being able to simultaneously hope for better future outcomes for developing countries and recognizing that ‘sweatshops’ are part of those better outcomes is a skill worth developing.

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Jack’s Links

Back with the best links of the week, don’t engage in public discourse without reading them, or you’ll make us all dumber.

  • Ramit Sethi on young people ‘investing’ in a home: I don’t know if I’ve written about this before, or just said it a million times, but I’m consistently amazed by how pervasive the ideas that rent is ‘throwing away money’ and that real estate is the best investment you can make have become in the thinking of people in their 20s and 30s. This is amplified by the total obliviousness to the risks inherent with what is usually an extremely levered investment.

“I don’t want to waste money paying rent.” I’m convinced this awful phrase was invented by Realtors BECAUSE IT’S SIMPLY NOT TRUE FOR EVERYONE. YOU ARE NOT WASTING RENT IF YOU LIVE IN AN EXPENSIVE AREA.

  • Alex Nowrasteh from the Cato Institute on Common Arguments against Immigration: h/t to David Henderson on this link, great breakdown of the common arguments that get thrown around and what we know about the actual economic effects of immigration (especially low-skill immigrants).

6.  “Immigrants are especially crime prone.”

This myth has been around for over a century.  It wasn’t true in 1896, 1909, 1931, 1994, and more recently.

  • Jacob Falkovich on the wage gap: Similar to immigration, the wage gap has a bunch of facts that everyone knows the headlines for, but nobody has bothered to think critically about. I recommend the whole post. If the below quote doesn’t convince you to read it, hope is lost.

Economics tells us that if a wage gap existed, smart companies would profit by hiring women, driving the sexist companies out of business.

  • Sabine Hossenfelder on being a consultant for amateur physicists (the title of the article uses the word autodidact): Fascinating both from the implications of the success of the business, but also for the insight into how (extremely invested) amateurs approach problems, take things out of context, and are generally unfamiliar with the required pre-requisites for engaging in the industry in a productive way.

My clients read way too much into pictures, measuring every angle, scrutinising every colour, counting every dash.

7. “I always give the most difficult and complicated assignment I have to the most overworked person in the company. There’s a reason they don’t have time — work is a marketplace, and it’s telling you this person is good.”

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Jack’s Links

Fresh links are back in your eyedrums.

  • Controversial investments generally yield positive abnormal (risk-adjusted) returns using the Carhart four-factor model (beta, size, value and momentum). Screening them out produces suboptimal financial performance.
  • Scott Sumner has a post on free lunches: This is something that intelligent people shouldn’t have to be constantly reminded about, but alas, it is. Please keep in mind, everything needs to be paid for, and if you give something away for free, people will consume more of it than is efficient. See: water subsidies in California.

nearly 90% were in favor of making college free for students from lower income families

  • Speaking of terrible California policies, a blog from Alex Tabarrok on house prices and land use: the numbers really speak for themselves here, but I can never get over how the people who want affordable housing for everybody are the same people who turn around and push for zoning and regulation when it comes to building.

tokyo

 

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Socially Responsible Investing – An Alternative

Larry Swedroe had a wonderful piece a couple of weeks ago on the costs of building a portfolio on a foundation of socially responsible investing.

SRI vs. Impact

I had a conversation with a colleague who is more well versed than most in the subject — it seems that socially responsible investing (SRI) is a bit out of vogue with those in the know. Probably for the reasons Larry gives in his post. The new hotness is “impact investing”, which focuses on positive screening, finding attributes in a company that you like regardless of where they operate. An example would be the oil & gas sector, where I am told the big behemoths (Exxon, Conoco, Chevron, etc.) are actually the companies pushing the hardest toward more sustainable practices, since in the long run their survival depends on it. Standard SRI makes those a big no-buy zone, whereas impact investing might not.

Investing Optimally to Give Optimally

I have a rather different take on the matter, assuming the average Joe Blow with $1 to $1 million dollars is what we’re talking about here, I’m pretty sure the GTO (that’s ‘game theory optimal’ for the non-initiated) move is to invest in whatever you expect will give you the best returns.

Then, either when you die or clearly don’t need the money, giving it to causes that relate to what you care about. Not buying 200 shares of Exxon isn’t going to change anything, especially in the secondary market, because you’re just buying Exxon from a mutual fund or day trading dentist, and none of your money is going to or coming from the company itself. Giving a few extra thousand dollars to a local charity on the other hand, now that might have a real effect.

Real Impact Investing

Now, if you have some real cash, (and I’m going to skip a big group of tweeners here) say, $5 million+, you can start to make a real difference by investing in primary offerings. In other words, a company (usually still very small) takes your money and gives you shares. These are usually not publicly traded, and are extremely risky, which is why people put together funds of these things, to diversify. However, your $50k (along with a few other peoples’) might make the difference between the company being able to make payroll for a few more weeks, keeping the lights on, and making a big discovery that changes the world in a small way.

A Dish Best Served Rich

While I can appreciate the idea of not wanting to be an ‘owner’ of a company that operates in a way you don’t agree with, I think most SRI pitches are just that, a pitch intended to sell a fund. Plus, if something you really don’t agree with is legal and makes a ton of money, is there a better way to fight the power than to funnel the profits to a cause you care about? I can’t think of one.

Retirement Savings Checkpoints

One of the most common questions that I wonder about is what sorts of savings ‘checkpoints’ people should be aiming for, especially early on in their careers.

The Inspiration

I was recently pointed in the direction of the J.P. Morgan Guide to Retirement, which I found to be a thoroughly enjoyable, if not always actionable read. It includes a slide with the same name as the title of this post.

Page 15 looks like this (and do visit the entire page at the above link):

Retirement Checkpoints

I found this to be very practicable (if it is a truly useful approximation). If a 30 year old makes $100,000, and wants to retire at age 65 that same standard of living they should have saved $130,000 by now.

The Assumptions

This obviously opens the door to questions about what the other assumptions are:

  • Retire when?
  • Portfolio returns?
  • Inflation?
  • Retirement age?
  • Years of retirement?
  • Future contributions rate?

J.P. Morgan kindly provides us with some of those as well (though I have no idea what confidence level “80%” means).

Retirement Checkpoint Assumptions

They also include data on the assumed income replacement rates (if you make $200,000 and pay $100,000 in taxes, you have to replace only $100,000 (50%) of your income to live the same lifestyle in retirement (actually, $100,000 minus annual savings). If you make $30,000 and pay $3,000 in taxes, you have to find a way to replace 90% of your income. They also factor in social security (which has the opposite effect, as it replaces a much higher % of lower earners’ income).

Building My Own

Like any red-blooded nerd, I realized that if I wanted to play with the model I would need to rebuild it, make it stronger.

Pretty quickly it became apparent that even if I take the other assumptions at face value, the question of tax assumptions looms large, especially:

  • Are all contributions being made to retirement accounts?
  • Is there a static or dynamic tax assumption (at withdrawal or other)?

Another small question, are contributions inflation-adjusted? E.g., does a 5% contribution go up by 2.25% and mean a 5.1125% contribution the next year? Equivalent to 5% on an income that increased with inflation.

So, as close as I can figure (without doing anything smart like actually asking the authors [stay tuned]), basically eyeballing the data here, assuming the below is a pretty reasonable start:

  • Yes, contributions are increased to keep up with inflation, and;
  • All contributions are made to retirement accounts, and;
  • All distributions are taxed at 28%

(Click for side-by-side)

MyVersion2

New Scenarios

So now that I have my own model that works under some reasonable conditions, I can start playing with the inputs.

First, I like the flexibility, but prefer to keep returns equal pre and post-retirement. I think 6.5% is still reasonable. Then, what about retiring at 55 instead of 65? And what if my annual contribution rate is actually 15%?

New Scenario

New checkpoints! Now, there is not a linear relationship here, because of the higher savings rate, the earlier checkpoints are more forgiving, while by 55, they are much higher. Since we changed multiple inputs at once, it is hard to see from the table how much of the change came from the extra 1.5% return in retirement versus the (opposite) forces of earlier retirement and a higher contribution rate.

We also run into a problem with the income replacement rate — because J.P. Morgan was assuming age 65, Medicare was in play for all of retirement, and they assumed that social security was being taken as well. For someone retiring at 55, we need to go back and add some excess draw for those ten years. We’ll save that for another post.

Age 65 Retirement Scenarios

So without backing into some assumptions for how much income to replace in the years before age 65, we can still play with other scenarios.

Here is 15% savings rate with 6.5% returns.

15and65

It doesn’t take much teasing of the data to find an interesting conclusion – if you are going to retire at 65 and are able to consistently save 15% throughout your working life, it’s important to get started by 35, but it is okay if you haven’t made much progress yet.

On the flip side of the coin, if you’re approaching 50 and make $200-250k (and want to maintain that lifestyle), you best be closing in on a million dollars, or planning to save even more going forward.

The Limits

This model is incredibly simple, major variables like taxable accounts are omitted entirely. I’ll probably revisit this at some point, including inquiring about the actual assumptions the folks at J.P. Morgan used, building in better ‘early retirement’ capabilities, making my own estimates for income replacement rates, etc..

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Jack’s Links

Mostly investment/market focused this week:

  • WCI on how to retire in 10 years: He’s focused on doctors, but really any high income professional has the option open to them to retire in 10 years. The catch, as is mentioned early and often in the article, is that to retire in 10 years requires retiring at a significantly lower standard of living than the typical professional lives at (because the typical professional both works for much more than 10 years, and probably doesn’t put away enough money to sustain that standard of living either). I share his optimism that it is never too late to save for retirement, at least while you can work.

If you really want to punch out of medicine in 10 years, you can’t live like a doctor now, and you can’t do it later. What you really need is a middle class lifestyle. And I’m not talking about the middle class where one spouse is a pharmacist and the other is an engineer. I’m talking about the middle class where the household income is $50,000.

  • Morningstar on who was on the good side of bad market timing: The author, John Rekenthaler, opens with an interesting point about markets that often goes ignored, transactions are symmetrical. There is a buyer of a share for a seller of a share. Therefore, in a claim he quotes, for every bad timer, there is a good timer (whether intentional or not).

In 2009, I attended several investment conferences, some targeting institutions and others targeting advisors. The message was identical: stocks out, alternatives in.

But I also think that when the blogosphere is really on form, its interactions throw up insights of a depth and quality that the mainstream media simply cannot accommodate.

  • Scott Sumner invokes the EMH: he does it to defend the idea of an NGDP market (some of the criticisms are asinine). It appears he agrees with my usual explanation when asked about the EMH – something like: “To a first approximation the EMH is true, to a second approximation it is obviously not true.” If that doesn’t make sense to you intuitively, then it is probably worth reading the post.

In fact, we do see lots of trading. We see speculation and arbitrage, even though asset prices are usually close to a position where risk-free arbitrage is almost impossible.

With apologies to my faithful subscribers, I think the links in my emails are broken, I am trying to fix it.