Investing: Mean Revision

          I suspect that a lot of people who skim blogs like this will probably jump right past this topic, and others may get a little intimidated just by the boring name “mean revision”.  However, understanding this very simple concept will put you ahead of 99% of the people around you trying to retire with some dignity.

          As I have tried to drill into this book 100x times, no one knows the future, therefore, no one can have any special skill in selecting only investments that garner the highest return.  Otherwise, why would they have more than one investment in their portfolio?  Just buy the one that is going to do the best, everything else is a waste of money.  Mean revision is the cousin of predicting the future.

          Mutual funds, explained elsewhere in this book, are either set to match an index such as the DJIA or S&P 500, are industry specific, or are “professionally” managed.  That is, the manager does research to find the “best” stocks and cherry picks only the one’s he or she feels will do the best.  Hundreds, or even thousands of these funds are opened every year, and most of them close down in a short time due to under-performance.  However, sometimes these funds actually do well, making a return higher than the index.  Of course, this piques the interest of investors who flock into this over-performing fund.  The manager, who now has to invest this additional money, may or may not do as well with additional selections, or the selections initially made may not continue performing well.

          What happens next is that the fund begins to under-perform the market.  Of course, all of the people who poured into the fund before leave, chasing their next fix of supposedly superior returns.  The fund may or may not survive this.

          So essentially, mean revision is where a fund first achieves “alpha” or superior investment returns, followed by lower than average returns that put the overall average return of the fund to the average of the market.  This is typically achieved with managers attempting to outperform the market with their special “skills”. 

          As normal people with normal jobs, and (probably at best) 15% of our incomes going to retirement investing, we are not going to be able to afford a manager who actually can consistently outperform the market.  It would not even be enough if us normal people could magically hand over our entire lifetime income at birth to these professionals.  In terms of the stock market, it is best to simply ride the market averages rather than deal with snake oil salesmen promising the world.

          So, what to do when looking at mutual funds?  Look for the funds that have the broadest investment philosophy.  That is, a fund that invests in all of the biggest stocks, or all of the middle-sized stocks.  From there, look for a fund that has as little “churn” as possible.  That is, a fund that is not constantly trading in and out of stocks.  That costs money and rarely helps the overall return on investment. 

Finally, and most importantly, look for the lowest fees.  You are at best going to get the same return as the market, so doing so as cheaply as possible ensures that you keep more of your investment returns.  High fees are nothing to brag about, and higher fees will not guarantee a higher return.  They will only guarantee more of your money not being invested on your behalf.  That does not help you.

Investing: Advice

Investing Advice

          First off, I would like to reiterate that nothing in this book is investment “advice.”  I am writing from my experience and informal education.  I am not going to suggest any particular company or kind of investment.  I am certainly not going to suggest a particular investment where I will get a commission on a sale to you.  While I would love to get a cut of the investment portfolios of everyone who reads this book, I am happy with the portion of the sale of this book that I receive.

          Second, I am going to give an example of the worst investment advice that I have ever heard.  This advice is still floating around on the internet to this day, so bonus points to you if you find it and have a good laugh.  The person giving the advice went on two different shows that I had, until that point, had a tremendous amount of respect for.  However, after the first time this person explained their position, I had an incredibly difficult time taking them seriously.

          A point about the example I am going to give.  I am writing this book in what I hope to be a completely politically neutral way.  I’ve heard that Michael Jordan once said, “Republicans buy shoes, too.”  While I have my own personal biases in regards to politics, I will do everything possible to have that bias removed from anything to do with this book.  The example I am about to give is one of many reasons why.

          On a show that will remain unnamed, a guest, who will also remain unnamed explained that one of the critical things to consider in the near future was that the President of the United States (at the time) Donald Trump, would throw the entire 2020 presidential election into turmoil when he would drop out of the presidential race at the last second, simply to use it as a massive platform to launch a new television news network.  She based this on President Trump’s use of the phrase “fake news”.  After hearing this, I was quite interested in hearing the next episode of that podcast to see if they would say anything about how silly and ridiculous that sounded.  Absolutely nothing.  They stood with it as though it was legitimate advice that someone should absolutely consider when investing in the time period leading up to the election.

          If you follow the news, especially that regarding President Trump, a lot of it seems to be negative.  It is remarkable that he got elected at all if it is all true.  This podcast seemed to be feeding on that.  While I am writing this before the election, and certainly before this prediction came true, or not, I have a difficult time using that prediction in my own investing repertoire. 

          I suppose this would be no different than a guest coming onto a podcast and suggesting that President Obama’s reelection in 2012 would mean that he would nationalize every publicly traded company and turn the US into a socialist “worker’s paradise.”  Obviously, that did not happen, and anyone who took advice along those lines would have lost substantial amounts of money by not investing.

          The point is, consider the political bias of the person giving you investment advice.  Doom and gloom ahead because X got elected?  Really?  Who donates to the campaigns of these politicians?  Who “assists” in writing the legislation?  A lot of those who contribute are ones with significant amounts of money.  They may even be high level executives in publicly traded companies.  Regardless, they have enough money to either contribute to those laws, or to afford lawyers who can find ways around those laws.  Companies are going to protect themselves.

          If you get really bored, do some reading on investment advice following the election of President Trump.  Compare that to the next four years.  Technically, we should have been wiped out by a North Korean nuclear bomb within a few months after the election.  So much for advice.

          Another podcast I listen to calls virtually all investment media “investment porn” because of the tawdry nature of it all.  From what I have seen, this is spot on.  There are so many interviews with hedge fund managers and other investment “masters” telling you where to invest your money. 

          There are two things to remember when listening to such “experts”.  The first thing to understand is that no one knows the future.  Enron and MCI were great stocks to own until they were exposed as frauds.  To look at their growth at the time, they seemed like sure bets.  Things are always changing, but no one knows which way or when those changes will happen.  The scenarios given may certainly occur, and you may be convinced to make an investment based around those assumptions.  Perfectly okay, but not with a substantial portion of your wealth.  Later on we will be discussing diversification.

          The second thing to remember when listening to investment advice is, how much “skin in the game” does the person giving the advice have?  Do they have even more in other investments?  If they are putting more money into other investments, how good is the advice they are giving?   They may not even have ANY money invested in the idea they are giving you.  How good is the advice that they themselves are not taking? Along the same lines, what are the chances that they are going to come back on to tell you that things have changed and that you should get out of those investments suggested before?  That never happens.  It is up to you to “know” that.  The person giving the advice certainly is not going to give you a refund of your losses if they are wrong.

          The next thing to consider when getting investment advice is the motivation of the person giving the advice.  What does the person stand to gain from you making one decision over another?  Do they receive a higher commission from the people running the investment?  Are there hidden fees that will eat away your portfolio?  Does the investment even make sense for your goals?  Sadly, most investors are sheep being led to slaughter by the greed of their advisers and even themselves.

          Hopefully, by reading this book, and others, you will gain the discernment and understanding you need to gain the wisdom needed to succeed.  Your comfortable retirement (or other financial goal) is my success.

The Rich Get Richer

The Rich Get Richer

Almost everyone of at least a certain age has heard the phrase “the rich get richer and the poor get poorer.”  It’s absolutely true.  It’s true for two reasons.  First, rich people buy things that appreciate in value, while poor people buy things that depreciate in value.  Closely tied with the first item is the second.  Income gets taxed while appreciation on assets does not.

I know a lot of poor people with a lot of cool stuff.  Stuff that depreciates in value rather quickly.  I know some rich people, and they also own a lot of cool stuff, but it is stuff that appreciates in value.  The poor person buys a brand new car on credit, or leases it, while the rich person invests their money.

The poor person pays interest on an asset that decreases in value, while the rich person buys things that pay interest, dividends, and rents while increasing in value.

The poor person throws away their wealth building potential, their income, on things that burn away.  The rich person invests and gets a return that multiplies.

It is not really a poor person, though.  It is a poor train of thought.  Unlike what a certain political ideology tells you, the fact is, anyone can become wealthy.  It’s not some golden ring just out of reach, it is a set of habits that insures that your future will be better than your past.

You can have a huge income but not be rich.  How?  Well, if you spend it all on things that lose value, what you had will disappear.  Even a small change in the right direction will have a huge effect over time.  When you trade out depreciating assets for appreciating assets, a multiplier effect takes place because the wealth you gained from appreciation will also start appreciating.  Eventually, you will earn more on untaxed appreciation than you will on earned income, which is taxed.  That is how wealth is built.  That is how the rich get richer, and how you become one of them.

The thing is, you don’t have to start out with much money.  The easiest thing to do is to contribute to your 401k if you work for a company that offers one.  Put the money you contribute into an index fund that has the lowest fees possible.  If you don’t have the option of a 401k, you can still get an IRA through a bank or online investing service.  The key is to invest your money into an index fund that follows as much of the stock market as possible.  You’ll probably have to start with at least $1,000 but if you turn your thought process around from spend to save, this will happen fairly quickly.  A no load index fund with low expenses is where to start.  The company Vanguard is the best at this.

This information is not mine.  This information is just a small nugget of information from the book The Millionaire Next Door, but with my own little thoughts to go with it.  The idea I want to put across is that you don’t have to live paycheck to paycheck forever, with no hope.  Not having a safety net is insane when so many companies are downsizing through automation, or sending the work overseas where it is cheaper.  Most likely, only a few of my friends will read this, but I want all of my friends to be prepared for problems that inevitably occur.

Hardway Finance Part 1

Hardway Finance Part 1

Recently, I started listening to a finance-themed podcast that basically stole people’s finance blogs and read them out loud.  It’s kind of what motivated me to write this short series of blogs on my own history and experience with personal finance.  The reason I am calling this “hardway” is its use as a slang term in pro wrestling.  Doing something hardway basically means hurting yourself legitimately.  For instance, getting a black eye from a punch in the face, or breaking one’s nose from a big fall or kick in the face would be getting those injuries “hardway.”  Ideally, they intend not to get hurt.  I’m not a pro wrestler or in the industry at all, but as a hardcore fan, the term has been introduced to me that way.  As you will see, it’s a fairly descriptive way to name my blog.

Around the end of 2008 and beginning of 2009, I was starting to get serious about making the big jump from renting to owning.  The problem was, I had too much personal debt to make it work with the income I had.  At that point, I was in school (again) for engineering and spent my weekends going to independent professional wrestling shows.  To give you some idea of my situation, I had a brand new car that I had leased, substantial student loans from my business school education, and easily spent over $100 every weekend on wrestling.  At least once, I had attended three shows in three different states in one weekend.  Wrestlers actually recognized me.  I’ve met at least a couple guys who ended up being a champion in WWE, but before they were even on the WWE’s radar.  To me, that’s cool.

What getting a house meant, though, was that I needed to get rid of my debts and get money at the very least for the fees and down payment required to get a mortgage.  In order to do that in a reasonable amount of time meant raising my income.  To raise my income, I started doing overtime at work.  So, in 2009, with the exception of the very last week of the year and one other day, I was in the factory every day for 10 hours.  Conveniently for me, they were quite busy, but not busy enough to pay extra for me to work on holidays.  So, I worked every day, and I poured the vast majority of that money into three places.  I paid off my car lease early, I paid down $20,000 of my student loans, and I put the rest into savings bonds and a Scottrade account with stocks that I chose myself.

Every Friday, I would go to a restaurant in town and have a steak dinner after work.  I had made it to first shift just the year before, and felt as though I should do something on Friday nights since the option was now available.  Reading that last paragraph, it seems inconceivable that I was able to do as much as I did with what I had.  The car lease was at least $14,000 plus interest. $20,000 towards my student loans, and I think that my Scottrade balance was roughly $10,000.  Much of that was gains, though.  If a stock didn’t double while I owned it, it tripled.  Not everything, but much of it.  I didn’t lose on anything.

That’s what I was able to accomplish in one year.  Every day, I would get up early and start work at 5am and work until 3pm, or a little later in order to do a report.  Given a few more months, I was able to save up the payoff for my car and buy it outright.  From this excellent position, I was to make some decisions that you will learn about in part two.

Hardway Finance Part 2

Hardway Finance Part 2

In part one of Hardway Finance, I explained the amazing year of 2009 where I was able to make significant headway towards my goal of getting a house.  By the end of the year, I was on a split course, considering either having a house built, or buying one.

I was interested in energy efficiency, and found a local builder who specialized in building energy efficient homes.  I spoke to him and took a tour of one of the houses that he built.  I was also speaking to a man who was making blueprints for the house of my dreams, which was actually quite small, and would fit on some land that my grandfather was going to give me as a gift to get things rolling.  I had also signed up to be on the list for having a house built by the high school building trades class.  All of those options would spin wildly until one day when I would make a very important and expensive decision.  A decision that would destroy all of the hard work that I had done the previous year and put me into a wildly unreasonable amount of debt.

Remember the builder I mentioned in the previous paragraph?  Well, he was hot to sell the house that he showed me because he had put a substantial amount of money into building it.  Because of the financial crisis which was centered in housing, his income had dried up.  Long story short, I had the option of buying the house he showed me, fully furnished, or have my house built by building trades, but not furnished, for roughly the same price per square foot.  I chose the former, since it was quicker and I got a fully furnished house (furniture and high end appliances) thrown in for free.  I also got a $30,000 theater room for only $6,000.

I remember the day that the builder and I negotiated for the house.  I think the asking price for the house on realty websites at the time had been around $375,000 but we settled for $225,000 plus $6,000 for the theater room, and he was taking the TV in the living room for his kid.  I remember thinking that it was a lot of money, but also an amazing deal.  I set up meetings with a couple of mortgage companies that had been referred to me, one of which was interested in the deal.

This is where it starts to get insane.  This is where logic and reason started going out the window.  The mortgage broker set up a meeting at her office with the both of us.  She explained it this way; I only qualified for a $206,000 mortgage.  In order for things to move forward, the seller would have to bend even further.

(Insert dramatic pause here)

Quickly, yet at the same time with great hesitation, the builder agreed to the banker’s terms.  The bank had just negotiated the price down for me.  I took this as a good sign.  I was not being represented by a realtor, which thinking back, was absolutely insane. It ended up working out for me.  The seller’s business partner was a realtor, and he did all of the paperwork at no charge to me.  I also took this as a good sign, thinking that I had saved the common 7% sales commission.  My understanding is that the builder took out a substantial portion of his 401k to pay off the difference between what I was paying and what he owed on the house.  I also had to take out a 401k loan in order to get the last bit of money to make the deal happen.  I took that to mean that I was getting the house for a substantial discount and an amazing value.  What I got was taken to school.

Hardway Finance Part 3

Hardway Finance Part 3

In the first two parts of this series, I described the process where I had buckled down to do what it took to get a mortgage for a house, then went out and did it.

The good parts-
No realtor fees.
Bank negotiated the price down for me.
It was $64/sq.ft. For a brand new, fully furnished house.

But wait a second.  If you recall from part two, and just above, the bank negotiated the price down to the maximum amount that they felt that I could afford.  They based that on my 2009 income, which was nearly the maximum it could possibly be.  I remember this being a bit of a red flag for me, but that the broker assured me that it wouldn’t be a problem long-term because my salary would go up every year.  I’d grow into it.  At one point I remember joking with my friends at work that I had more overtime hours than I had regular time hours.  They used to post everyone’s numbers, and if a certain amount of overtime participation was required but not fulfilled, they started at the bottom of that list mandating people.  I was at the top.

From my understanding, the maximum amount allowed is 25% of your average monthly gross for the mortgage itself.  Tacked onto that would be the monthly pull for taxes and insurance.  In my case, I also had mortgage insurance since I put the least amount possible down.  I had more money, but they refused to take it.

What it meant was that if I didn’t do any overtime, my monthly payment all in was roughly 75% of my take home pay without overtime.  Add on top of that monthly utilities which were thankfully extremely low for a house that size.  So, if there was no overtime, I was cool as long as I didn’t have to buy any food or gas that month.

Of course, now I was all in on overtime, with no real choice in the matter.  I figured out that I needed at the very least to work every Saturday in order to make everything work.  I had to make it work.

Hardway Finance Part 4

Hardway Finance Part 4

Credit where credit is due.  In the six years I “owned” the house, I never, ever made a late payment.  Ever.  I always rounded up on the payment, too, bringing it up to the next hundred dollar level.  I would designate it towards principle reduction, but they just ignored that and sent it all back once every year or so.  I’d cash the check and blow the money on something stupid.  I’d look forward to it.

Things went wrong with the house pretty much immediately.  Water had gotten into the furnace exhaust and made a gurgling sound once I kicked it on.  That was fixed for free, as were most of the furnace issues.  Despite never being used before, the central air went out, requiring a $4,000 replacement.  The elaborate stonework for the shower cracked at a corner, and the mortar on the floor started cracking, too.  The shingles were of a poor design, and placed on the roof in a lazy way, which meant that if it rained from a certain direction, there was a leak in the roof that would come down from the hanging light in the dining room.

Brand new house.

Meanwhile, I got used to the payment, and all of the overtime, to the point that I would save up money and go on absolutely insane vacations.  I’ve been in deserts, jungles, mountain tops, pyramids (plural!) And more ancient cities than you could shake a stick at.  I’ve seen buildings that the Apostles also saw.  I’ve been to the Great Wall of China.  One year, with two vacations, I stepped foot in 12 countries on five continents.  I’ve spent more time on layovers in German airports than most of my friends have spent outside of the US full stop.  I’ve been through the Panama canal on a cruise ship.  I bought an emerald in Columbia and jade in China.  I’ve had a dinner of alpaca steak.  I’ve had a main course that stared back at me.  In all of my travels, I have visited 20 countries.  I estimate that I spent at least $1,000 per country visited in travel expenses.  On top of that, I had a mortgage that took up 75% of my base pay for a house that had things going wrong.

The house has an amazing home theater.  For 2006, when the house was built, it was state of the art.  It was still pretty good when I had it.  Well, except that I could never use it, because I was always working to pay for it.  It had a room that would protect me from tornadoes.  It had one and a half kitchens.  It was too much.