On Investing

Investing has changed significantly during the 25 or so years that I have been following both the market and also the tools available for an investor to participate within the market.  The following trends are key:

  • The cost of trading and investing has declined significantly.  Trades used to cost more than $25 and now are essentially free in many cases.  Mutual funds used to have “loads” of 5% or more standard when you made an investment, meaning that $100 invested only went to work for you as $95.  These sorts of up-front costs have almost totally been eliminated
  • ETF’s have (mostly) replaced mutual funds.  ETF’s “trade like stocks”, meaning that you can buy and sell anytime (mutual funds traded once a day, after being priced with that days’ activity) and they don’t have income tax gains and losses unless you actually make a trade (mutual funds often had gains due to changes in the portfolio that you had to pay taxes on even if you were just holding the fund)
  • CD’s and Government Debt are all electronic.  You used to have to go to a bank for various governmental bond products or to buy a CD.  Now you not only can buy all of this online, you can choose from myriad banks instantly rather than settle for whatever your main bank (Chase, Wells Fargo, etc…) offers up to you
  • Interest Rates are Near Zero.  One of the key concepts in investing is “compound interest”, where interest is re-invested and even small, continuous investments held for a long time can end up amounting to large sums (in nominal terms, because inflation often eats away at “real” returns).  However, with interest rates basically near zero, you need to earn dividend income or take on more risk (i.e. “junk bonds”) in order to receive any sort of interest income.  There is no “safe” way to earn income any more
  • Currency Fluctuations Matter.  When the Euro initially came out it was $1.30 for each US dollar, and then it went to 70 cents per dollar, and now it is about $1.10 per dollar.  At one point the dollar fell 30-40% against many currencies world wide (when “commodity” currencies like the Canadian and Australian dollar were surging).   For many years currencies were relatively stable against one another but that era seems to be ending, and thus the change in relationship between the US dollar and their currency can be much greater than the return that is earned on the international investments
  • Active Trading Has Mostly Been Beaten By Passive Trading.  While there are many exceptions, initially the majority of investments were “active”, but over the years many of the “active” managers have substantially under-performed the market, wilst charging investors more in fees (it is cheaper to run a “passive” index).  As a result, there has been a massive shift away from active investors to passive investors like Vanguard
  • Correlation Among Stocks and Investment Classes Is Much Higher.  Correlation means that stocks or asset classes tend to “move up” together or “move down” together.  It is not unusual for me to look at a portfolio of 20 stocks and 19 or 20 of them have all gone up or down on a single day.  This is related to active managers being unable to “beat” the market (see above)
  • The “Risk Premium” for Lower Quality Debt is Small.  The amount of extra interest required for low quality borrowers over the US Treasury benchmark is very small.  Investors are taking on a lot of risk to just earn a few more percentage points of return.  If there is a downturn in the economy (such as what happened only recently in US oil companies), there are likely to be significant declines in junk bond values that wouldn’t justify the modest risk premium you receive for holding these types of assets
  • ETF’s Provide an Easy Way to Participate in Commodity Markets.  It was more difficult to buy and invest in commodities like gold and crude in the past, and it was often limited to relatively sophisticated investors or those willing to hold on to physical commodities like gold (which can be risky since they need to be stored and protected due to high value and inability to trace once stolen).  Today you can easily buy a liquid ETF to participate in the commodity markets for key areas like precious metals (gold and silver) and crude oil / natural gas
  • Fewer Companies are Going Public and the Market is Shrinking (in terms of issuers, not total value) – It is easy for start up companies to access private capital (venture funds) and they tend to “go IPO” at high values, making a further upside (after the initial IPO) more difficult.  The total market is shrinking in terms of listings due to M&A (companies buying other companies) faster than the new IPO’s and many companies are “buying back” shares which also reduces the total value of the public markets
  • Bonds have had a Gigantic Bull Market that is Nearing It’s End – Bond prices move inversely to yield; thus if you held on to a 5% low risk bond (which would have been available everywhere in the early 2000’s), that bond would currently be priced at much more than 100 cents on the dollar today.  Interest rates peaked around 20% near 1980 and now are not far from zero; in this sense bonds are part of an enormous “bubble market” that has not yet peaked.  But given how low rates are (they are even negative), it seems like this bull run is about to come to an end
  • Ensure That You Include Dividends and Total Return.  A common mistake is to look at performance just in terms of stock or asset prices, and avoid including the compounding impact of dividends received, especially since dividends often rise each year.  Dividend income can make up a significant portion (25% and up) of total return, so selecting assets that provide dividend income is critical.  Finally, dividends provide favorable tax rates when compared to interest income

What does all of this mean?  I would sum it up in two ways:

  1. It is easy for individual investors to set up a simple and low cost way to track the market – the “basic plan” that I set up as a simple example can be used by anyone and it does what it says.  Here is a second plan that also includes some hedging of the non-US investment
  2. You will need to save much more (or take on more risk) because interest rates are low – with near zero interest rates, you can’t make much money on low risk interest bearing products (like CD’s, savings accounts, and simple government debt).  If you are earning risk income, you likely are taking on substantial risk of default because there is no “free lunch”.  As a result, you need to put more cash into stocks in order to earn dividends or see real returns, but this also could lead to significant losses if there is a market crash like 2008-9.

I try to promote financial literacy and have helped many friends and some family members when they ask questions.  Ideally we would actually drive financial literacy through school and into the university.  Even those who have a degree in finance or accounting often lack practical advice on personal finance and don’t know how to approach these issues.

One key concept is “net worth”.  Net worth isn’t how much you earn in salary, it is what remains in savings after taxes (or through long term deferral of taxes).  The only “assets” that count are those that you can turn into cash if needed, and they are “net” of the debt (such as on your house).  Most people have a negative or near-zero net worth, which is also linked to the concept that they are essentially a couple of missed paychecks away from very bad outcomes such as having to take out a payday loan or borrow money from relatives.

Another key concept is trying to avoid excessive student debt.  Unlike all other forms of debt (loans on your house, your car, or credit card debt) your student debt cannot be discharged through bankruptcy.  You essentially have no options except to repay your loans, and if you miss payments or fall behind the fees and penalties will greatly increase your balance due.  Student financial literacy is critical because they are making decisions that will impact themselves and their families for the rest of their lives and they must be made thoughtfully and with the end in mind (if you are taking out all of this debt, you must be driven in your career to make money in order to pay it off and get on with building net worth).

Cross posted at Chicago Boyz


Terrell Owens Illustrates “Income” vs. “Wealth”

Terrell Owens is a football celebrity who has earned millions over his 15 year career as a receiver.  He has made more than $30M in salaries over that time and also had endorsement opportunities due to his high profile.

In a recent video Terrell Owens describes his financial predicament due to the NFL lockout.  Here is a link to the video, where he apparently sheds a tear.

In the video, Terrell is calling his “financial advisor” who apparently hasn’t been returning his calls.  Terrell can’t see his statements, and is confused by his low credit score.

You can’t tell what is “made for TV” and what is reality, but even the least web-savvy person knows how to get to their account balances online.  And your credit score is easily found; you can get a credit report for free from each of the major agencies to check any blemishes and anytime you buy a car or apply for a major purchase you usually also have the opportunity to see your score (if you ask). This type of behavior is sad and reflects a very low level of financial literacy.

Then Terrell talks about his “predicament”.  With the NFL lockout he has “no income” and yet he has “mortgages to pay” on his real estate as well as child support payments.

Note that this is an individual who has earned over $30M in his lifetime, along with other endorsement and income opportunities that are available to a high profile public figure.  He has had many opportunities to receive and re-invest this money, which should be making him MORE money today.

He has had the opportunity to build a large net worth position, meaning cash in the bank or hard assets (land, equity in a house, or financial assets like stocks or bonds), but he obviously hasn’t done this, because the minute his “income” stream is done, he is unable to remain current on his bills.

Terrell’s position isn’t hard for the financially literate to understand, but it is lost on him and most professional athletes, who often end up broke or bankrupt after they stop playing the game.  This site, called “Celebrity Net Worth”, also completely misses the point.  I don’t know how they attempt to calculate net worth, but they appear to show lifetime earnings and current earnings instead and they assume that Terrell has maintained this money, not spent it.  Obviously it is ALL spent because he is unable even to make child support payments of $5000 / month, which would be a drop in the bucket if he had retained even one years’ salary after taxes in the bank.

It is possible that one of these portfolios (at trust funds for kids) would provide someone a higher NET WORTH than Terrell Owens, at $20,000.  That is a profoundly sad statement, since Terrell does not seem to be stupid and he has gotten knocked around plenty in 15 years of NFL football, and has NOTHING to show for it.

It isn’t what you make, it is what you save, which is a function of 1) not spending it on consumables 2) not paying for the bills of your hangers-on 3) not paying for your kids out of wedlock or for ex-wives 4) not paying “managers” large fees while remaining personally ignorant 5) not investing in businesses with your friends, especially if they have a limited or non-existent professional track record.  Terrell Owens probably fails all of these items.

And someone should re-name “celebrity net worth” something like “celebrity lifetime earnings”.  They are NOT one and the same, as Terrell illustrates.

Antoine Walker An Example of Net Worth vs. Earnings

One of the prime concepts behind this site is the difference between “net worth” and “earnings”.  Net worth is what you have, left over, after all of your liabilities (mortgage, car payment, student loans, and other debts) are paid off.  For most people, unfortunately, their net worth is very near zero.

Antoine Walker, the former Celtic who resides in Chicago, is a prime example of someone who earned a large amount of money during his lifetime and yet has a negative net worth.  He recently declared bankruptcy, as summarized in this article:

After a 13-year career and over $110 million in salary, Antoine Walker has filed for bankruptcy after being hit with a $2.3 million foreclosure lawsuit on a mansion that he bought for his mother in Tinley Park, a small city south of Chicago. Walker, of Wiggle (or Shimmy) fame, just has too much debt.  “Off the court, there were the cars, the jewelry, the houses, the suits, the gambling. He liked to move in an outsized entourage; his mother estimates that, during his playing days, he was supporting 70 friends and family members in one way or another. And speaking of his mother, he built her a mansion in the Chicago suburbs, complete with an indoor pool, 10 bathrooms, and a full-size basketball court.  And then this: “Walker turned the pavement surrounding his home into a virtual luxury car lot – two Bentleys, two Mercedes, a Range Rover, a Cadillac Escalade, a bright red Hummer. Often, the vehicles were tricked out with custom paint jobs, rims, and sound systems at considerable added expense. He also collected top-line watches – Rolexes and diamond-encrusted Cartiers.”

There you can see where the EARNINGS go – onto cars, watches, supporting non-working friends, and also clothes.

One part of the article I disagree with because it is poorly worded:

Mr. Walker owns four properties: a $2.34-million home in Miami; two South Side apartment buildings each worth $190,000, and the Tinley Park home, valued at $1.4 million, according to the bankruptcy filing.

Mr. Walker, as they refer to him, owns NOTHING.  He possesses some assets, but cannot make the payments to keep up with his liabilities, so net, he has no assets.

Mr. Walker, 33, lists liabilities of $12.74 million vs. assets of $4.28 million in the bankruptcy filing. Mr. Walker’s 2006 NBA championship ring, valued at $6,000, is listed among his assets, according to the Chapter 7 filing May 18 in U.S. Bankruptcy Court in Southern Florida.

This is a very sad story but one to learn from; no matter how high your earnings, if you keep spending enough money and taking on more debt, you will inevitably end up on the wrong side of the ledger.

Net Worth in Perspective

“Net Worth” is a key concept in personal finance. From the wikipedia definition:

In personal finance, net worth (or wealth) refers to an individual’s net economic position; similarly, it uses the value of all assets (long term assets) minus the value of all liabilities.

For the layman, “assets” are what you own – your cash on hand, the stock in your account, and any accumulated value in your pension and 401(k). People tend to over-value their personal belongings (collectibles, clothes, jewelry, etc…) – this is worth what someone ELSE would pay for them (think of the pawn shop) not what you paid for them, typically a few cents on the dollar. “Liabilities” are what you owe to someone else – so for your car, if you are paying on payments, typically you are underwater – as soon as you drive it off the lot the value drops by 20%, plus you are paying interest, so you likely have very little value in your car, unless you paid it off already. For your house, it is more complicated, but many people are “under water” where their mortgage is worth more than the current value of the house, or very close.

According to this “Net Worth Calculator” at CNN Money, you can put in your age and income and see how your personal net worth compares against others. For example, a 30 year old making $40,000 / year, on average, would have a net worth of $8,250.

Why is the net worth so low? Because net worth is what is left after EVERYTHING is paid for, including taxes. When you see your paycheck there goes Federal taxes, state taxes, FICA (social security and medicare), plus sales taxes on everything you buy. If you own a home, there are property taxes, and when you rent there are utilities. Don’t forget your house payment, or rent, and your car payment. Plus – you have to eat, you need to pay for that cell phone and data plan, and cable, and then you might want to date, and everything else. After all this is done, whatever you save after taxes, goes into your net worth.

I remember working near the dot-com explosion in 2000-2002 and many of the companies I worked with and for were having hard times. They changed the timing of payments (from bi-weekly to monthly) and many people, even those making over $100,000, were complaining vocally because they were living check-to-check and this 2 week, one time lag, was killing them. Their savings that were accessible to them were almost nil. At least back then real estate was still appreciating – but now even the cash that isn’t immediately accessible (in your home equity) is gone, too.

Why is this significant? Portfolio one, which we have been running for ten years, has accumulated over $16,000. This is more than the net worth of the typical 30 year old making the average salary who has been working for almost a decade out of college. This means that by accumulating $16k-$20k you have the equivalent value in terms of net worth of working for a decade, which does mean something. Of course this analogy is imperfect because working 10 years means that you can earn more going forward, but it is a powerful analogy nonetheless.

Negative Net Worth


The Chicago Tribune business section has a series where readers write in with their financial issues and the columnists seek professional help and recommendations and publish the results. This column is titled “Law Degree on Her Side” and shows the plight of a woman under 30 who is a lawyer but is struggling under a mound of student debt and is considering bankruptcy.


A big element in our economy’s struggle is the fact that the analysts and “experts” were focused on the income statement and not the balance sheet. An income statement view focuses on profits, or the difference between earnings (in her case, salaries) and expenses (rent, living expenses, etc…) and what remains each year. Companies often report earnings EBITA which stands for “Earnings Before Interest, Taxes and (depreciation) and Amortization”. In this model, you become a lawyer because you can make a lot of money (top line revenue) and use it to support the rest of your living expenses.

However, this “income statement” model ignores the debt needed to finance education and expenses related to education. This debt keeps piling up and is a negative item on your balance sheet, which is the long term debt that you owe others, along with the annual interest that you need to pay to service this debt. In an analogy to the stock market, it is the debt payments, along with the fact that companies can’t come up with the cash to pay off principal (or roll-over debt) that is causing the liquidation of companies like Circuit City, Linens & Things, Mervyns, and soon to be many others.

In this lawyer’s case, her balance sheet is “negative” meaning that she is insolvent or has a negative net worth. She has a tiny amount of assets (a bit of retirement savings, some cash on hand, and maybe equity in a car or something) which is all she can show to offset a mountain of debt.

I don’t have exact statistics but I would venture that most Americans have a negative net worth nowadays. By this I mean that the value of their debts exceeds the value of their assets. I also run a site called “trust funds for kids” and I often tell my nephews and nieces that even the relatively small amounts that we put aside ($10,000 or so), as long as they don’t accrue debt, will make them better off than most Americans who have worked their entire lives, since they will have a positive net worth. Obviously some of this is tongue-in-cheek since you need a steady stream of income to pay minimal living expenses but there is much fundamental truth in that analysis in that if you pile up debt you will never accrue enough assets to offset this debt. And if you have a negative net worth, you can never stop working (retire) unless you have a guaranteed string of income high enough to offset your living expenses, interest costs and principal repayments.

These debts cost money to finance, and this cost is in the interest rate. The woman in this article is drowning because $200k of debt will mean that interest payments of $14k ($200,000 * 7% or so) would be needed just to service the debt, without putting ANY sort of dent in the principal. Likely the principal is going to be due over a certain amount of years – let’s say 20 years – so she needs to pay $10,000 / year in principal plus $14,000 in interest (the interest will go down in future years as the principal is paid down) on the current balance. If her income is below certain thresholds (her income, at $75,000, is for now) then she can receive a tax deduction of $2500 based on the interest component (see IRS publication 970). Thus (using this relatively simplistic analysis) of her $75,000 / year salary, $24,000 (or almost 1/3) would go for debt principal and repayment (the tax deduction would likely offset this for about $1500 in cash, depending on her tax bracket).


One very unfortunate difference between companies and this student is that companies can eliminate debt through bankruptcy (if they are cash flow positive on an EBITA base and can obtain interim financing), but the student debt can NEVER be discharged. I remember when I was studying for my CPA exam (20+ years ago, so maybe it isn’t an exact quote) that they had a section on bankruptcy and they mentioned that the discharge of student loans through bankruptcy was eliminated because

Doctors, who require mounds of debt to pay for medical school as well as finance living expenses while they are interns and only modestly paid, used to accept the diploma with one hand and declare bankruptcy with the other. Tiring of this tactic, the schools lobbied and changed the laws so that student loan could not be discharged through bankruptcy

Thus taking up student debt is serious indeed; unlike your house (which you can walk away from or short-sell to the bank) or auto, you can NEVER discharge this debt, and have to either pay it off or have this debt hanging over your head for the rest of your life (essentially meaning that you can’t accumulate any assets).

If you read the article, not only did the woman take on student debt, she also took a vacation and put it on her credit cards, which have a much higher interest rate (maybe 20% or so) and need to be paid off before she can make a serious dent in the student loans, unless she wants to declare bankruptcy. And even if she does declare bankruptcy, given her level of income, it is likely that the court will make her repay at least some of these obligations.


When you incur tens of thousands of dollars in debt to get your degree (or $200,000, in this unfortunate case) you need to ensure that your degree will pay enough to not only support you going forward (and your family, if you intend to have one) but also to pay off the student loan debt and interest accrued on that debt.

In the case of this woman, she has a law degree. However, one item that wasn’t advice in this article is that she has to leverage this degree to make a lot more money. She needs to work for a firm with high billing rates and she needs to put in a lot of hours. Traditionally law firm employees had to bill 2,000 hours / year – note that this is BILLABLE work so everything that isn’t billable has to go into the rest of the week (or weekend) after you are done with a full days’ work, including what shred of a social life you’d like to have.

Given all the taxes and costs of living in Chicago (remember that the sales tax is over 10%, property taxes are high, and Federal and state tax rates are going up) if she increases her income to pay down debt effectively almost 50% of every dollar is going to be taken away from her between social security and taxes of all stripes. So she needs to increase her income by $50,000 to come up with the extra $25,000 which would allow her to pay down this debt sooner.

My uncle (now deceased) was a man who fought for the little guy. He was a lawyer with his own firm and he represented the poor and often did death penalty cases for the state (as a defender). He summed it up to me that

You can either represent poor innocent people or rich guilty people

I suggest that she find some major companies with problems and burn up a lot of billable hours helping them. Her $75,000 / year job will never pay enough.


The other more subtle point in this article and overall in finance is that the implied rate of return for investments has been decreasing. Anyone who hasn’t been fully invested in gold and treasuries has seen the value of their investments plummet, possibly by as much as 50%. Various articles come and go about how the DOW is now back to 1992 or prior – although this is kind of specious unless you were heavily invested all this time – sadly enough most people bought into the market much nearer its peak, so they took big losses on actual cash put into the market (and didn’t just lose gains from prior years).

If the markets are down 50%, it will likely take YEARS of sustained 15%+ growth, for instance, just to get back to where we were in 2007. Thus while those returns might be prominently featured in advertisements, essentially for the average investor those returns are needed just to get you back to zero, and then you need to make returns BEYOND this in order to increase your asset base.

Why does this matter? Because while the implied return on YOUR investments has declined (is frankly negative) and banks are paying about 1% in interest (BEFORE taxes), a loan at 7% is very pricey. In the old days when people put in 10% / year return in their model, they figured that a 7% loan was cheap money. Now with negative returns or puny returns in the risk-free market, 7% means that your loans are outpacing your gains and that your problems increase every day that you don’t pay off that loan. I won’t even go into the impact of a 20% credit card loan (plus the fact that consumer interest isn’t even deductible).


ANY students who are considering taking out debt to finance their education NEEDS to understand the gravity of the situation:

1) these loans can NEVER be discharged through bankruptcy
2) the interest rate you are paying is likely higher than the return that you will make on your own assets
3) you need to earn enough money to pay off the principal and interest, as soon as possible
4) as you earn more money and try to pay off these loans, high taxes and cost of living eat up the value of each dollar earned so that you essentially have to earn $2 to get $1 to pay towards your obligations
5) you need to live as cheaply as possible and get this done as quickly as possible – in this case the woman worked as an unpaid intern which just let her interest accrue and she took expensive overseas vacations which caused her to add credit card debt
6) based on all of the above items, it likely isn’t worth accruing debt for a degree unless your degree is extremely marketable (law, medicine, finance, engineering) – that doesn’t mean that you can’t follow your passion, but it does mean that you need to pay-as-you-go or find a way to do it through scholarships or at your local community college
7) if you incur debt, you need to make money ASAP and forgo other social options, expenses and fun – else you will never escape the debt trap. You spent all this money for the degree, so now you have to leverage it to the hilt and make as much money as possible

Cross posted at Chicago Boyz