Compared to all people who have ever lived, the worker earning the median $48,202 a year is Bill Gates. Almost everyone who has ever lived has lived in extreme poverty by our standards. We inhabit a world of luxury and opportunity unimaginable to our forefathers, to whom we would appear as race of supermen living in a land of dreams. Any king who lived before the nineteenth century would faint if you dropped him off at Costco.
You don’t feel like a top hat-wearing millionaire. You feel middle-class. Your biggest concern is hanging on to what you’ve got. It is far more important to you that you not lose a lot of money than it is for you to make a lot more money. In other words, you have become conservative. In spite of being affluent, you are afraid of running out of money.
If you are a parent about to send your child full freight to a middling private college, my guess is that your child will end up richer if you spent the same quarter-million dollars buying her a 7-Eleven franchise instead.
Statistics teach us how to avoid poverty: finish high school, take any legitimate job, work full time, year-round, and avoid having children until after you are married. This is also the way to become well-off: you do the same things, only you do them more. More education, more work, and more postponed gratification. Of course, we all know rich people whose lives haven’t followed this template. Luck plays a tremendous role. That is all the more reason to stack the deck in your favor.
Imagine that that it was possible to find out every minute precisely how risky your investments were just by turning on CNBC, but you only learned their returns once a year. This would immediately promote a lot of sensible and productive investing behavior. People would manage their risks diligently and then settle for the returns they could get. This is exactly correct.
Has anyone noticed? The financial services industry is bankrupt when it comes to ideas for retirees. The smart kids all work in finance, and yet they’ve come up with nothing.
The mutual fund will be replaced by the personal fund. You will hold one fund: Fund U. It will not be exactly like anyone else’s. It will be uniquely computer-optimized to your personal ecosystem, taking into account your age, life expectancy, life-stage, employment, residence, geography, tax profile, appetite for risk, concentrated holdings, employee stock options, total indebtedness, and your personal goals. It will fit like a glove. While the mutual fund was supposed to neutralize all but market risk, the personal fund will diversify personal risk. The personal fund will try to cancel out your overexposure to your job. It will compare your profile to econometric factors and try to hedge your exposure to risks in the changing economy. It will change when you change, when the market changes, and when the economy changes, automatically adjusting itself along a number of dimensions – including volatility – in real-time. It will be far from perfect, but it will represent a significant improvement for most investors. Thanks to the computer, it will be cheap – it will cost less to own than the obsolete funds we use today. It should also be more profitable. By diversifying away a lot of your idiosyncratic risk, it will let you invest more aggressively at the same level of volatility, or, alternatively, it could let you invest more conservatively at the same level of return.
The stock market is a place where two different agents can operate working past each other: on the one hand, investors looking for a stream of dividends, and on the other, speculators who don’t know Cisco from Crisco gambling in a casino where their animal spirits can find release trying to guess the winner in a beauty pageant.
To Wall Street, the high-net-worth are a livestock commodity: sheep to be shorn. The industry is a confidence game that offers them friendship and trust, but all the while simply transfuses assets from clients to itself while the investors lie on the table etherized by Wall Street doubletalk. Have you ever been to a world financial capital like London or Manhattan? Perhaps you noticed all the elegant buildings and well-dressed rich people who live and eat lunch there. Ask yourself, where do they get all their money? Then, to see the surprising answer, look in the mirror.
Marshall McLuhan said that the wheel is an extension of the foot and clothing is an extension of the skin. Electric technology is an extension of the central nervous system. With the launch of Telstar in 1962, planet earth became the content of its own reality TV show. Electric technology has taken the efficient market theory and boosted it by a million volts into a monster. Markets that used to be merely efficient are now electric. The efficient monster relentlessly devours information, stomps on Tokyo, and breathes fire onto the active investor, turning him into a burnt match. The best you can do is to harness its energy in your portfolio and put efficient monster theory in your corner. Let someone else try to slay it. When you go to fight the invincible foe, you will lose.
To wonder why value, small company, low beta, and momentum stocks outperform is to ask the question the wrong way. The better question is, why do investors overinvest in speculative growth stocks that so often disappoint? The truth is, investors are fearful creatures who seek comfort buying the famous, glamorous, in-the-news companies that everyone else is also buying in the hope that it will make them rich. Then, as investors crowd into the latest new thing, they end up overpaying for a fantasy of growth.
Carefully weigh the trade-offs between asset protection, estate planning, taxes, and the overall expense of setting up and maintaining whatever apparatus you put in place for asset protection versus the actuarial probability of the risks you face. These stars do not always, or even often, align.
The tax code exists in a world of Heraclitan flux, such that you cannot dip your toe into the same provision twice. The basic idea is for it to be as complicated as possible so that politicians can sell exemptions in exchange for campaign contributions. Given a future fraught with legislative uncertainty, there is an argument for presenting a diversified tax picture to the taxing authorities.
Over your lifetime you will be transforming your human capital into financial capital, and then into social capital. The social capital will either be allocated by the government or by a charity. If you like how the government spends your money, you are all set – do nothing. If you have a different idea, get behind a charity. Naturally, this isn’t as easy as it sounds. Charities are fully aware that they are a captive alternative tax system for the rich, and as you would expect, they notoriously provide poor service at high expense.
The Success Tax (p. 189): has been repealed. R.I.P. However, capping the size of IRAs is being debated.
529 Plans: Wealthy family or friends can legally cross-gift to each other’s children’s 529 plans, effectively boosting the amount of money removed from their estates, sheltered from creditors, and compounding tax-free. We know that a husband and wife filing a joint return can each make a one-time, five-year $70,000 contribution to their own child’s 529 Plan without triggering gift tax consequences, for a total of $140,000. Additionally, they can do the same for their niece’s or nephew’s (or anyone’s) plan, and your brother’s or sister’s family can reciprocate. This way, each plan can start with a significantly higher balance. The Ohio CollegeAdvantage Savings 529 Plan mentioned in the book has a ceiling currently set at $377,000, which is typical. If the account balance is greater than this – their estimate of the high end of what a college education might cost — they will not accept further contributions.
Master Limited Partnerships (MLPs): purchased individually (instead of inside a fund wrapper) can be a source of tax-free income. Distributions are treated as a return of principal. The trade-off, apart from having to file K-1s every year, is that eventually your cost basis in the LP goes to zero, and subsequently your income will all be capital gains. In certain circumstances, this can be obviated: for example, you might choose to donate these shares to charity, or they might become part of your estate where there would be a step-up in cost basis.
As always, check with your own financial advisors before proceeding.
The S&P International Dividend Fund (DWX) I mentioned is one of the riskier offerings in the field. In decreasing order of risk (but with lower dividends as a trade-off), investors might want to consider the iShare Dow Jones International Select Dividend Index (IDV) and the WisdomTree International Dividend ex-Financials (DOO) as alternatives.