The Millionaire Next Door

Several people have asked for personal finance book recommendations lately, so I’ll to start with the book that got me started thinking about spending, saving, and investing.

Throughout high school, I worked at various jobs and spent whatever I earned. If I earned more, I spent more. If I worked less, I spent less. I don’t recall consciously deciding to adjust my spending up and down; I just spent whatever was in my pocket (or bank account).

Reading The Millionaire Next Door changed that. The authors (Thomas J. Stanley and William D. Danko) interviewed hundreds of millionaires and shared their findings in the book. The overarching theme was to live within one’s means and the book criticized mindless consumption or spending to “keep up with the Joneses.” The book didn’t just advocate frugality though, as it did encourage readers to spend money on quality goods and services outside one’s area of expertise (ie. buy a good pair of shoes that will last or pay a professional to fix your plumbing). On the income side, the book illustrated the benefits of owning a business and spending time learning about and managing investments. The book is light on actual advice, but I believe it provides a great foundation for understanding personal finance.

While the book made an implicit assumption that foregone spending should be saved and invested, the larger takeaway for me was that approaching spending thoughtfully provides flexibility to do what you want (whether that’s to save for future consumption, having money to buy memorable experiences, save for investing, better provide for one’s family, or give and donate). I’m not sure there’s inherent value in becoming a millionaire, but there is value in spending more intentionally.

The book is not without it’s critics. A primary criticism is that the authors’ study of millionaires suffers from survivorship bias. In other words, many people work hard, start businesses, live within their means, and so on, but not all of them become millionaires. But the authors only interview the millionaires who may misattribute their wealth to the aforementioned factors, while ignoring other common factors like the region or era in which they lived or simple luck.

It’s been about 20 years since I first read the book and 15 years since I began working in financial services. Although the critics have valid points about survivorship bias and perhaps the book’s lessons will not guarantee financial success, it is very difficult to achieve financial success without the book’s lessons. Thus, even though it is not an educational or “how-to” book, I believe The Millionaire Next Door is a great introductory read for those interested in learning more about personal finance.

Brad’s Status

Last week’s post about the differences between national and global income distributions reminded me of this scene from Brad’s Status. One of the film’s main themes is social comparison and my favorite scene highlights the fact that we often fail to acknowledge our global position and privilege. I could not find a clip of scene, but was able to find the below transcript:

BRAD : What are you thinking? Please tell me.

ANANYA : I’m thinking… you’re lucky. You’re fifty years old and you still think the world was made for you.

BRAD : I’m forty-seven.

ANANYA : It’s like you’re mad because you don’t like your position in the ruling class. Most people don’t even have a position. Most people can’t even get in the door to see what’s inside. Do you even know poor people?

BRAD: Of course.

ANANYA: When I visit my mother’s family in Delhi, a lot of people there live on two dollars a day.

BRAD: Right, I get that…

ANANYA: They don’t complain about being ignored at dinner parties. They’re happy they get dinner.

BRAD: Right – but I’m not competing with those people. You compete with the people who are your markers in life.

ANANYA: Why are you competing at all?

BRAD: It’s the way this world is.

ANANYA: From my point of view – you competing with your friends from college? That competition is the history of colonialism, okay? And the oppression of women – and the fucking up of the environment…

BRAD : Look, don’t go there, okay?

ANANYA : Stop competing already. The future of the world depends on it…

BRAD : I’m not the problem, all right? I work for a non-profit for fuck’s sake.

ANANYA : Sounds like you just kinda backed into it ‘cause nothing else worked out.

BRAD : That’s not nice.

ANANYA : Sorry. It’s just – from where I sit, it kinda sounds like white privilege, male privilege, first-class problems.

BRAD : Maybe I seem like a cliche to you – but this is my life, you know?

ANANYA : Just don’t ask me to feel bad for you. You’re doing fine. Trust me. I promise you. You have enough. I’m going to use the rest room.

National Incomes vs Global Incomes

Some of my favorite data visualizations are the charts produced by Branko Milanovic, which compare national income distributions to global income distributions. So I was thrilled to discover this website (created by Boris Yakubchik) which transforms Milanovic’s data into an interactive format where users can select which countries they want to graph. Below is a sample that I created using some of my favorite countries.

It can take a minute to understand what is going on, so here’s a brief primer and some examples. The vertical y-axis displays PPP-adjusted income and global income percentile, while the horizontal x-axis displays national income percentile. Let’s look at some examples from my chart:

  • An American earning $5,000/year is in the 8th percentile of American earners, but in the 70% percentile globally.
  • An Indonesian earning $3,000/year earns more than 90% of Indonesians, but only more than 60% of people globally.
  • A Dane earning $20,000/year is a very average Dane (~50% percentile), although they are close to the top 5% of earners globally.

It is easy to see that even poorer Americans and Danes are generally wealthier than the richer Indians, Indonesians, and Nepalis. This is just one observation made about a handful of countries, but there are many more ideas to takeaway from this data. Check out the website and create your own!

Giving More, Tomorrow

For one reason or another, people often share with me that they want to start donating money or increase the amount that they are donating. This is always great news, but often accompanied by real and/or perceived challenges. A few common ones that I hear include:

  • I want to start donating, but I don’t feel like I can right now.
  • I’m donating x% of my income. I feel compelled to give >x% of my income, but I don’t think I can do that right now.
  • I want to give $x, but my spouse is not on board with that.

In an ideal world, we could all just start donating our desired amount or increase to our desired amount at any time. Sometimes, we are unable to make these changes immediately or are looking for a more gradual approach. Several years ago, Shlomo Benartzi gave a TED Talk titled “Saving for Tomorrow, Tomorrow,” which relates to saving, but it could just as easily apply to giving.

Benartzi’s basic recommendation is to commit to saving a percentage of future increases in income (like raises and bonuses). Saving a portion of an increase requires no sacrifice today and takes the edge off of future sacrifices because net income still increases (because the new saving is just a portion on the increased amount). As an example, let’s say that I make $50,000 and want to save $5,000. It may be difficult to save 10% of my income immediately, but I could commit to saving 50% of my next raise. If I get a $1,000 raise, then I’ll save $500. Even though I’ve stuffed $500 into savings, I’m still netting an additional $500 of income. 

As mentioned, we could easily apply the same principles to giving. Below are some examples:

  • Someone who’s currently donating 10% of their income could try to get up to 12% by donating 20% of their future increases in income until their overall giving hits 12%.
  • Someone who wants to start donating could commit to donating 100% of any bonus.
  • There are all sorts of derivations and room for creativity. Suppose someone wanted to donate 6% of their income this year. They could donate 1% of income in Month 1, 2% of income in Month 2, and so on until Month 12 when they donate 12%. This is both gradual and would get them to their 6% annual giving target in Year 1 (a great feat). AND, the person would feel some relief when they drop their 12% donation rate back down to 6% in Month 13 (assuming they want to donate 6% each month in Year 2).

Sometimes getting started is the hardest part. Hopefully, the above is helpful in thinking about how to start giving or how to give more generously.

The Mexican Fisherman

The famous “Mexican Fisherman” story is at least fifty years old, but it is a timeless tale that is both revealing and enlightening. Below is one version of the story:

An American investment banker was taking a much-needed vacation in a small coastal Mexican village when a small boat with just one fisherman docked. The boat had several large, fresh fish in it.

The investment banker was impressed by the quality of the fish and asked the Mexican how long it took to catch them. The Mexican replied, “Only a little while.” The banker then asked why he didn’t stay out longer and catch more fish?

The Mexican fisherman replied he had enough to support his family’s immediate needs.

The American then asked “But what do you do with the rest of your time?”

The Mexican fisherman replied, “I sleep late, fish a little, play with my children, take siesta with my wife, stroll into the village each evening where I sip wine and play guitar with my amigos: I have a full and busy life, señor.”

The investment banker scoffed, “I am an Ivy League MBA, and I could help you. You could spend more time fishing and with the proceeds buy a bigger boat, and with the proceeds from the bigger boat you could buy several boats until eventually you would have a whole fleet of fishing boats. Instead of selling your catch to the middleman you could sell directly to the processor, eventually opening your own cannery. You could control the product, processing and distribution.”

Then he added, “Of course, you would need to leave this small coastal fishing village and move to Mexico City where you would run your growing enterprise.”

The Mexican fisherman asked, “But señor, how long will this all take?”

To which the American replied, “15–20 years.”

“But what then?” asked the Mexican.

The American laughed and said, “That’s the best part. When the time is right you would announce an IPO and sell your company stock to the public and become very rich. You could make millions.”

“Millions, señor? Then what?”

To which the investment banker replied, “Then you would retire. You could move to a small coastal fishing village where you would sleep late, fish a little, play with your kids, take siesta with your wife, stroll to the village in the evenings where you could sip wine and play your guitar with your amigos.”

(This story was originally written by Heinrich Böll, although Tim Ferriss published the above adapted version which can be found across the internet.)

Additionality

Additionality has been on my mind lately. Although the term is most commonly used in an emissions context, I believe the concept is helpful in many domains.

Let’s start with definitions. Additionality occurs when a particular action will provide a benefit in “addition” to a “baseline” alternative of taking no action. 

For example, let’s say that I invest in a solar energy project. I’ll pat myself on the back because I’m generating a financial return AND a positive environmental impact. However, if there were other investors competing to allocate to the project, then:

  • The project would’ve been built anyways, regardless of whether I invested.
  • If I didn’t invest in the project, another investor would have.
  • Taking action (investing in the solar project) would not have generated any more environmental impact than the baseline of not taking action (not investing in the solar project).
  • In this example, there would have been no additionality from my investment.

The above is a textbook example, but we find similar situations in both investing and philanthropy.

  • Within impact investing, the above example is a common situation that occurs when an impact strategy is capacity constrained or a fund is oversubscribed.
  • For portfolios of public companies/stocks, I believe the concept of additionality implies that ESG integration is more about alignment of values than effecting change. In aggregate, ESG investors may lower a responsible company’s cost of capital or vote proxies in a unique way, but even the largest investors are typically very small minority shareholders in most public companies. Thus, the additionality of individual investor decisions is either theoretical or infinitesimally small.
  • Investors invest to generate financial returns (and some may consider additionality). Philanthropists donate to generate additionality. This creates a powerful incentive for non-profit organizations to promote the appearance of additionality even if it does not exist. Some organizations generate tons of additionality and some probably generate negative additionality, so caveat dator (Latin for “let the donor beware”).

Although this post is thematic and the examples are more illustrative than practical, I hope to write more detailed posts about how investors and donors can actually evaluate the balance of need, capital, and capacity in order to get a better sense of additionality.

“Never Waste A Good Worry”

I joined a book discussion group and read the following in this week’s book: “As the world’s population reaches seven billion people, the earth is filled. Not only is the earth filled, human population is in danger of overwhelming the earth, and of making life exceedingly difficult for future generations.” The author seems thoughtful and concerned and his point seems reasonable. The only problem is that it’s completely wrong.

The aforementioned population problem (called the “Malthusian Trap”) is the crux of “Malthusian Theory,” which argues that the human population will overwhelm the available resources. These terms are named after Thomas Robert Malthus, who warned about these dangers in…1798. Or, put another way, over 220 years ago. This fear of overpopulation has been around for at least 220+ years and there are still people worrying about it. “Just wait,” they say. 

Another issue people have worried about for centuries is the national debt. Ever since Alexander Hamilton led the federal government’s decision to assume the colonies’ Revolutionary War debts (called “assumption”), Americans have been worrying about the debt. Thomas Jefferson famously opposed assumption, railed against the national debt, and even tried to pay it down while in office (just a couple years after Malthus penned his theory). Yet, like Malthus, Jefferson’s fear has not yet been realized after 200+ years. The national debt has been an issue in nearly every political election for 200 years, often framed as an imminent threat that is out of control. Yet, America grew from 13 rebel colonies to the wealthiest most powerful nation on earth. Of course, these debt worriers also say, “Just wait.”

Perhaps the global population will overwhelm the available resources or the national debt will drive America to ruin. But I wouldn’t bet on those things. I’d bet that agriculture and technology continue to improve as they always have and that we will not run out of resources. I’ll bet that the national debt will not harm the US in my lifetime. I could be wrong on either issue, but other side has been wrong for 200+ years on both issues. 

So, what does this have to do with investing? There are fears based on real risks and there are fears based on perceived risks. I obviously believe the above two issues are way more perceived than real, but there are many other less obvious examples where we tend to fear unnecessarily. Add in that humans are wired to overreact to fear, pessimism often sounds more convincing that optimism, and that we are easily seduced by logic and theories even when reality, history, and empirical evidence doesn’t agree. Clearly, there are times to be cautious and exercise caution, but not always.

To close, I’ll share that I was a worrisome kid (heck, I’m still a worrier). Whenever I shared a worry or fear with my dad, he nearly always gave me the same advice: “Matt, I’ve learned that most of my fears are never realized. Most of my worries never come to pass. I learned to ‘never waste a good worry.'”

The Credit Card Points Game

Photos from 2018 and 2019 trips that have been paid for with points. Clockwise from top left: trekking to Gokyo-Ri in Nepal (Everest in the background), family trip to Osaka in Japan, family trip to the Dolomites in Italy, diving off the coast of Belize. That’s 10 roundtrip tickets that I’ve bought with points in the past 18 months, plus 4 more to Hawaii very soon.

My family of four is headed to Hawaii this summer and our airfare is free. Well, I should clarify that we are technically paying for the airfare, but we are paying with points rather than dollars. I’ve written about my Hawaii strategy in the past, but the reality is that most of the international trips that I’ve taken over the past decade have been paid for with points. Playing the “credit card points game” is a great way to save on travel costs and I’ve certainly benefited from participating.

Without getting into the details of where the points come from, who pays for them, or how to maximize their value (check out thepointsguy.com or flyertalk.com for in-depth knowledge and strategies) below are some general guidelines for playing the credit card points game.

  1. The biggest value is in the sign-up bonuses. Opening a new card and spending some specified dollar amount within a few months typically yields tens of thousands of points. Although there are opportunities to arbitrage the difference in airfares that are denominated in points vs those denominated in dollars, most points are worth 1-3 cents each. Thus, the bonus from opening a new card can easily be worth over $1,000. Points can also be accumulated by spending, but a simple cashback card will often deliver the same value as a card offering points (~2 cents per dollar spent). A common strategy (called “churning”) is to open a new card and spend enough to collect the bonus, before moving on to another card, and repeating this over and over.
  2. Keep a spreadsheet. Many cards charge an annual fee upon account opening or after one year. These fees can offset a portion or even all of the benefit from sign-up bonuses, so it is important to cancel each card before an avoidable fee hits. Tracking multiple cards and when to cancel them can be difficult without a spreadsheet.

I should note that the credit card points game is not for everyone as the benefits can be more than offset in the following cases:

  1. Someone who cannot keep a spreadsheet and cancel cards as needed. Fees could wipe out the potential benefits.
  2. Someone who has trouble regulating their spending. Accumulating points could become an incentive to spend more than one would otherwise and could more than offset the benefit.
  3. Someone who needs the very best credit score. Churning is not typically impactful to someone’s credit score in the long-term, but I would not recommend opening multiple cards in quick succession immediately before applying for a mortgage as the lower score and resulting higher mortgage rate could more than offset the benefits from points.

Also, a final word of caution: the credit card points game can become a hobby in and of itself, similar to investing, sports, or politics. Just ask my wife, who instagrammed the below from a recent wedding:

Why I Don’t Post Specific Investment Recommendations

A good question that’s come up is, “Why don’t you post specific investment recommendations on the blog?”

Investment advice is personal and recommendations should be made within the context of an investor’s situation. To make a good recommendation, I’d need to know someone’s ability to take risk, willingness to take risk, time horizon, liquidity needs, tax situation, net worth, account details, and a lot more. I do not know everyone who reads this blog nor their financial details, so how can I make a recommendation? 

To illustrate the above, consider that I will often make different recommendations to the exact same client! Suppose a client has four accounts, but wants to invest all of them identically. I may recommend a specific index fund for one account, a different share class of the same fund for the second account, a different fund targeting the same index for a third account because it is taxed differently than the first two, and a separately managed account targeting the same index for the fourth account due to tax considerations. The client may be purchasing the same underlying holdings in all four accounts, but there are four different recommendations.

If I were to make a specific recommendation on this blog, I’d have to list out all of the nuances, caveats, exceptions, and so on. So I will leave the specific recommendations to the talking heads on CNBC and the writers who contribute to Seeking Alpha. Publishing specific recommendations for the general public is not something I want to do, nor do I believe it is especially helpful to individual investors.

Before You Open a 529…

Many of my friends are having kids these days, which means I’m being asked about 529s more than anything else. Below are just a few of the common questions:

  • “Should I open a 529?”
  • “Which company should I use?”
  • “How much should I contribute?”

Ready for the answers? My answer is:

  • Are you properly insured?
  • Is your estate plan in order?

If not, my advice is generally “Go get properly insured and engage an estate planning attorney. Before investing money for an uncertain future, invest to protect your family should anything unexpected happen.” The baby books don’t cover this, but this is Parenting 101.