Interview with Mint.com – I Give ALL The Answers

Finance website Mint.com asked me some good questions for their blog. You can visit them there or enjoy the repost below.
Interview_mint_Bankers_anonymous
As a former Wall Street insider, what do you think is the average person’s largest misconception about investing?

The average person thinks that what Wall Street does is so complex that it requires extremely bright specialists to handle the complex needs of individuals. And the average person thinks implicitly that complexity and special skills naturally justify high fees.

And while it is true that many to most people on Wall Street are bright and there are complex things happening there, all that intellect and complexity is irrelevant for the vast majority of individuals. For most Americans, including high net worth individuals, a very simple and inexpensive approach will serve them best.

If you had the ability to get every person in the United States to adhere to three financial principles, what would those be? Why?

Great question. More than principles, I would go with three financial attitudes. Those would be:

a) Optimism – You kind of have to trust that markets are going to work out fine in the long run, even when the short run and medium run look extremely frightening.

b) Skepticism – Most financial solutions you get pitched with constantly are irrelevant or overly costly.

c) Modesty – Be realistic and modest about your own ability to ‘beat the pros,’ and realistic and modest about the ability of professionals you hire to ‘beat the pros.’ Also, modesty about attributing one’s investment success can avoid mistakes due to excessive confidence.

How does life change when one has more financial literacy? What does it take to be financially literate? How illiterate are most people?

Financial literacy is a process that most people need to engage in, but a process for which there are too few guides. Most of our parents don’t know how to help. Certainly our teachers and professors are mostly unhelpful guides. Most of the ‘experts’ in the media are in fact salespeople in one form or another, so while they can tell you the positive features of what they sell, most are unhelpful in helping us sort out our different options in a suitably skeptical way.

Most well-educated people that I know are very uncertain what to do when it comes to financial decisions. Or worse, they have high certainty, but wrong ideas. Both versions of financial illiteracy can be very costly.

Financial literacy obtained in one’s early twenties, I think, would make the average, middle-class person $1 million richer at the end of their life. That’s the premise of my book. (More on that later, see below, the end of this post.)1

For higher earners, the benefits of financial literacy will be many multiples of that.

Investment is something that many people want to do, but don’t seem to fully take advantage of. What are some of the best practices one can employ to become better at investing?

The four biggest determinant of investment results are:

  • Time (longer is better)
  • Asset allocation (risky is better, and for non-experts/non-insiders, diversified is better)
  • Costs (lower is better)
  • Tax advantages (zero, low, or deferred taxes are better)

A powerful way to combine those four advantages – one that anyone can do but not enough of us do – would be to fund your (tax advantaged) retirement accounts (like an IRA or 401(k)), and purchase risky (100% equity) low-cost (probably index) mutual funds while still in your twenties.

A 22 year-old who does that for the next ten years is guaranteed wealth in his or her old age. In fact, it is impossible not to end up wealthy if a 22 year-old does that for ten years in a row.

If you’re not 22 right now, you won’t have as much time – which is a shame – but it’s probably still worth doing all the steps that I described above at any age.

The absence of 50 years of investment growth makes a wealthy old age still likely, but just less guaranteed.

Another important best practice is to employ automatic deduction as your main weapon to fund retirement and investment accounts. By that I mean you have to set up a system with your brokerage firm that automatically transfers money from your paycheck or your checking account every month (or every two weeks, or whatever) into your retirement and investment accounts.

The weird secret is that basically nobody has enough money left over at the end of the month or year for investing. But if we take that money out in small increments through automatic deductions, somehow we find we do have the money. This is one of those weird psychological tricks that make the difference between being wealthy or not being wealthy in our old age.

There seems to be a battle among many individuals who struggle with paying down debt and trying to save. What kind of advice can you give them?

If we have trouble paying down debt and saving, then we have to employ a series of Jedi mind tricks to get it done. Those Jedi mind tricks could involve three methods: a) automatic deduction b) budgeting, and c) radical transparency.

a) Automatic deduction, which I mentioned above, is probably the most powerful of these. You have to figure out a way to get your money out-of-sight, out-of-mind before you spend it. If you’re in debt, that means setting up automatic payments toward your high interest debt. If you’re trying to save or invest, that means setting up automatic payments out of your checking account and into a hard-to-reach savings vehicle or brokerage account.

b) Budgeting, which I hate to do – along with 99% of the rest of the planet – is not for me a long-term sustainable solution in itself. But over the short-term, it can actually help you alter your behavior when you start to write down every single freaking, nitpicky little transaction. The act of recording all transactions – even just for a couple of weeks or a month – I believe could change your behavior. That’s because you realize just how many non-essentials you purchase. It gets annoying writing down that packet of tic-tacs, and the latte, and the iTunes download, but then you realize you made $173.52 in non-essential purchases last month. And if you could dedicate the $173 extra to debt payments per month, you might actually be able to get rid your debt in this lifetime.

c) Radical transparency means announcing to your group of friends, or a single friend, or a debt-counseling group, your intention to get debt free in a set amount of time. Then you commit to regular (daily?) updates to your support person. The publically-stated intention, along with the support you will get from the group, may be the Jedi mind trick you need to actually kill your debt. There’s something powerful that AA members have figured out, which is that if you admit your powerlessness, and then you ask for help from an understanding group, you may be able to achieve the previously impossible-seeming task.

What do you think are some of the biggest challenges regarding debt (getting out of it, staying out of it, paying it off, etc)?

Debt exists in that psychological area of shame in which, like a cat with a broken leg, we want to hide our injury from others. We don’t want to admit our debts to others, and we don’t want to ask for help. We may even engage in self-destructive behavior – “Hey, let me buy this lunch for everyone!” – in order to hide our shame.

People stuck with excessive debt probably also have a fatalistic approach; they may believe that it’s not possible to reduce or manage their debt, so why even try? For people for whom this sounds familiar, I’d recommend a classic from the 1930s called The Richest Man in Babylon.

It may seem cheesy at first to the modern reader, but I think it effectively captures the psychology of a debtor’s resistance to getting out of debt. The book also has extremely practical steps toward becoming debt-free and then building wealth.

You say on your site that politicians are able to take advantage of citizens because those citizens are not as aware of financial matters as they should be. Please provide an example of this and how financial literacy can help fix this problem.

‘Taking advantage of’ is too strong a phrase. But I think citizens cannot properly police their officials if they don’t understand concepts like compound interest, which affects the future growth of government debt, public pension obligations, and Medicare and Social Security obligations.

Young people entering the professional world oftentimes come into adulthood with debt from student loans. What advice would you offer to these individuals?

The best situation would be to minimize student loan debt up front, but I suppose that line of thinking would get us talking about unlocked barn doors and horses that have already left the premises. It’s at least worth mentioning, however, that borrowing big sums of money to get a name-brand educational degree may not make as much financial sense as loading up on credits on the cheaper side (e.g. two years of community college, then transfer) before purchasing an expensive educational certificate.

Once you have a pile of student loan debt, I think the situation has to be tackled with optimism (student debt can be paid off) but realism (you may not be able to pursue your artist’s dream right now).

Stealing a page from the aforementioned The Richest Man in Babylon, I would suggest students do NOT forget to start an investment account. The author of that book has an interesting formula that, while it may not work for everyone, at least has the virtue of simplicity.

It goes like this:

1. Arrange your lifestyle such that you can live off of 70% of your take-home pay on a monthly basis. (I know, I know, this seems impossible. But still, it’s probably your only chance ever of making it all work out in the long run. Basically, yes, we’re talking about rice & beans, a subpar vehicle, and an apartment in a rougher neighborhood than you would prefer.)

2. Dedicate the next 20% of your take-home pay to paying off your debts.

3. Dedicate the final 10% of your take home pay to investments. In the beginning, this should to be channeled to an Individual IRA or 401(k).

When indebted, it seems like step #3 is an impossible kick-in-the-pants suggestion, because there’s no extra money to make this happen. The problem with skipping step #3, however, is that a student-loan-burdened individual will never get around to starting investing, until age 40. By then, it’s almost twenty years too late to get started.

So as impossible as it may seem, my advice for the student-loan-indebted recent graduate is to follow all three of the steps above. 70% for living expenses, 20% for debts, 10% for investments. Wash, rinse, repeat, every month. Rice and beans will suck for a while. But wealth will follow.

What are your thoughts on retirement and preparing for retirement? What about those who have already retired and are scared of outliving their money?

For people who are already putting away money in their tax-advantaged retirement accounts (IRAs and 401(k)s), the most important decision is probably their allocation to risky assets (like stocks) vs. non-risky assets (like bonds). The mistake most people make, in my opinion, is to dedicate too much money to the non-risky category.

This mistake is exacerbated by 98.75% of all investment advisors who tell their clients to invest in a mix of 60% stocks and 40% bonds. This piece of advice – which I strongly disagree with – serves the investment advisor well because you will not panic when the market crashes, and therefore you are less likely to fire your investment advisor for losing you money.

I think this advice serves the individual less well, since most people would end up far wealthier in the long run if they invested a higher percentage of their assets in the risky category.

My further thought process, which owes a heavy debt to the amazing book Simple Wealth, Inevitable Wealth by Nick Murray, goes like this:
a) Retirement accounts, by definition, are long-term investments. Even if you’re already retired, you need retirement money to last many years – often a few decades.

b) The longer your time horizon, the higher the probability that risky (like stocks) beats non-risky (like bonds).

c) Using the historical experience of the last 100 years, we can say the following: with a five-year horizon, stocks beat bonds 70% of the time. With a 10-year horizon, stocks beat bonds 80% of the time. With a 15-year horizon, stocks beat bonds 90% of the time. With a 20-year horizon, stocks beat bonds 99+% of the time.

d) Because most retirement money is invested for the longest time period, by allocating your retirement money to bonds you are basically saying that you believe that history is no guide at all, “it’s different this time,” and that odds-be-damned, you want to make a very low probability bet. That’s fine, and that’s what 98.75% of investment advisors tell you to do, but personally I think that’s a crying shame and a terrible choice, as well as a way to reduce your wealth in your retirement.

e) Although risky assets (like stocks) are extremely volatile in the short and medium run, a longer investment time horizon (plus automatic deduction dollar-cost averaging!) makes equity volatility less of a risk and more of an opportunity.

f) The real risk of investing your retirement money is actually with bonds, an allocation to which – for many people – will cause them to outlive their retirement funds. After taxes and inflation, bonds lose purchasing power. I understand this is contrary to conventional wisdom and contrary to what 98.75% of all investment advisors say, but that doesn’t make it any less true. Again, for a more articulate presentation of these ideas a) through f), I highly recommend Nick Murray’s Simple Wealth, Inevitable Wealth.

By the way, I’m not an investment advisor, so I suffer exactly zero consequences for people taking my advice on this topic or not. And that’s precisely why I have credibility on the issue. I’m not worried about being fired as somebody’s investment advisor when the market crashes.

And by the way, the market will definitely crash. I don’t know when, or by how much, but it will crash multiple times over the course of your investing lifetime. The key, however, is to not panic, and instead keep on doing what you were doing. Ideally, this means automatic deduction investing, so that you can dollar-cost average your stock investments at more advantageous prices when the market crashes.

Please share anything additional that you would like individuals to know about Bankers Anonymous.

I’m passionate about teaching finance. I’m on a mission!

My book The Financial Rules For New College Graduates: Invest Before Paying Off Debt And Other Tips Your Professors Didn’t Teach You is for the smart  college graduate just starting out trying to navigate the highly consequential financial choices regarding car loans, debt, savings, home-ownership v. renting, insurance, entrepreneurship … even philanthropy and retirement planning.

 

 

 

Please see related posts:

Book Review: The Richest Man In Babylon, by George Clason

Book Review: Simple Wealth, Inevitable Wealth by Nick Murray

Book Review: The Automatic Millionaire by David Bach

How To Be A Money Saving Jedi

Stocks vs. Bonds: The Probabilistic Answer

 

 

 

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  1. When this post first came out in 2015 I hadn’t written my book, but I very much wanted to. The book came out in 2018, and if you liked this post you should, well, buy it!

Entrepreneurs: Pack Half the Luggage, Bring Twice The Money

A version of this post ran in the San Antonio Express News.

In late high school and college I travelled to Mexico as often as I could. Some trips I went for ten days, later trips for a semester of school, then a whole summer. Finally, after graduating from college, I lived and studied in Mexico for a year.

I always carried the student travel bible at the time, Let’s Go Mexico, whenever I crossed the border.

I memorized two pieces of advice in the Introduction to my Let’s Go Mexico book.

“First, lay out all of your clothes and other luggage you intend to take in one pile on your bed. Next to that pile, place all of the money you think you will need to spend.

Now, pack half the stuff and take twice the money.”

The second piece of advice from Let’s Go Mexico was of a similar vein, something along the lines of “Take no more luggage than you could – if necessary – carry at a dead run in the middle of the night for a mile.”

I loved that advice and it always – for me at least – put me in the right adventurous frame of mind for border crossing.

Advice for Entrepreneurs

I’ve written before that it helps entrepreneurs to be a bit ignorant and maybe a touch funny in the head in order to launch themselves into a new business venture.

Entrepreneurs are risk takers. They exhibit the kind of crazy that would enjoy situations involving a dead run for a mile at midnight on the streets of Juarez.

Lately I’ve thought about the Let’s Go Mexico advice, and how that’s exactly the advice I would give to first-time entrepreneurs.

Instead of luggage, of course, you have your business start-up costs.

First, in your business plan, lay out all of the costs of things you think you need to get started. Next to that, figure out how much money you already have available for your venture. Here’s the thing: To survive your first year in business, you’ll have to make do with half those things, and you’ll need twice the money.

Also, if luggage in my analogy equals costs, try to start your business with no more costs than you can carry at a dead run for a mile in the middle of the night. Ok, the metaphor doesn’t quite work. But I hope my point is clear(-ish.) Entrepreneurship is incredibly difficult, your business will encounter the unexpected, and you’ve got to be ready to pivot in a totally unanticipated direction.

Writing a Business Plan

I work on educational videos for a regional non-profit microlender LiftFund that offers training for new (and experienced) entrepreneurs. Writing a business plan is one of those things which every business owner does.

A couple of my videos walk folks through the different component parts of a business plan. What I want to say at the end of the videos, however, is that – no matter what your plan says – you’ll need to cut your planned costs in half and figure out a way to put your hands on twice the cash.

Mike_Tyson_Strategy
Business Guru Mike Tyson

Everybody’s Got a Plan

I guess the following is a true story, since I found it on the interwebs.

Boxing great Mike Tyson was peppered, pre-fight, with journalists’ questions, asking how he would respond to his opponent’s plan for delivering a devastating left uppercut.

Mike responded sagely “Everybody has a plan ‘til they get punched in the mouth.”

(In my mind’s ear, I always hear that quote in a high-pitched voice, the final word pronounced ‘mouf.’)

Anyway, the point is, an entrepreneur’s written business plan only gets you so far. Because, at some point, everything goes into complete disarray.

Metaphorically speaking, you’ll be bleeding from the mouth, running your business at top speed for a mile in the middle of the night, just praying you make it to safety.

So remember, you entrepreneurs: carry half the luggage, and bring twice the money.

 

Please see related posts:

Videos Playlist for Entrepreneurs – Learn Excel

Video for Entrepreneurs – Personal Financial Statement

Entrepreneurship Part I – Fixed Income v. Equity

Entrepreneurship Part II – Lessons From Finance

Entrepreneurship Part III – The Air, Taxes, Retirement

Entrepreneurship and Its Discontents

 

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Book Review: What All Kids (And Adults) Should Know About Savings and Investing

I teach an adult course next month about teaching one’s kids about money and finance. I also engage in home-based experiments on my own guinea pigs (err, children) all the time, trying out lessons on stock investing, or compound interest. But most home-schooling requires a textbook (or e-book), so I was pleased to receive a copy of Rob Pivnick’s What All Kids (and Adults) Should Know About Savings and Investing.

Pivnick’s book boasts many virtues, not the least of which is that an adult could read the 38 pages in about an hour. (Kids, maybe two hours). The next virtue of his book – and this is no small thing – is that he covers a comprehensive range, hitting all the major points of savings, budgeting and investing for the long run. A third virtue – he’s right on so many of the important topics where the Financial Infotainment Industrial Complex is wrong, or at best, misleading.

I wrote yesterday that many parents are afraid or unable to start a conversation about money with their children, almost as if its a powerful taboo like sex. For that reason, I’m looking forward to reading Ron Lieber’s The Opposite of Spoiled, for further ideas about how to broach the subject.

But if you were looking for a single, efficient, comprehensive text with which to lay out the right ideas for your kids, you could have confidence in the right messages from Pivnick’s What All Kids Should Know About Saving and Investing. Pivnick and I have total alignment on a bunch of key topics which the Financial Infotainment Industrial Complex fails to make clear.

Pivnick’s right messages include:

I plan to write my own “Teach Your Kids About Finance” book some day, but Pivnick’s book fills the need quite nicely while you all wait, breathlessly, (I’d say maybe three more years?) for me to finally get my book written and published.

what_all_kids_should_know_about_saving_and_investing

In the meantime, any ideas for my snappy title?

Please see related posts:

Daughter’s First Stock Investment

The Allowance Experiment

Looking forward to reading Ron Lieber’s The Opposite of Spoiled

Rapunzel and Compound Interest

Book Review: Make Your Kid A Millionaire by Kevin McKinley

Book Review: The Only Investment Guide You’ll Ever Need by Andrew Tobias

 

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More Taboo Than Sex – Talking Money With Kids

Children and young people need to understand money and financial choices as much as any other topic, yet they don’t get ‘The Talk’ from their parents about money until they reach age, well actually, never. Most children never get The Talk.

children-money

We can easily list reasons for this, such as:

1. Most parents are barely scraping by and don’t want to scare the little ones about the reality of high interest credit card debt, empty bank accounts and zero college savings.

2. Parents have no idea what to do themselves, so teaching their children seems too daunting.

3. For the few parents that have a surplus, most are deathly afraid of ‘spoiling the children’ by letting on that there’s a surplus.

4. For the few parents with a surplus who aren’t worried about spoiling the children, there’s a catastrophe in the making. The kids are hateful, spoiled creatures.

5. Teachers (and by extension, professors) have absolutely no idea about money and finance. That’s why they’re teachers, duh.

6. The Financial Infotainment Industrial Complex offers so much nonsense and sales pitches disguised as news or advice that newbies have almost no chance of sorting through the crap, so how would parents, teachers and children know where to begin?

All of this depressing line of thinking makes me interested in New York Times financial columnist Ron Lieber’s new book The Opposite of Spoiled: Raising Kids Who Are Grounded Generous and Smart About Money. I haven’t read it yet (it’s now on my “To Read” list) but the Wall Street Journal‘s review today makes it clear that he’s preaching a good sermon.

Lieber’s overarching theme is that parents absolutely should attempt to engage in a dialogue about money with their children, and his chapters address topics and approaches we parents can use.

What are the right lessons of those ‘service trips’ to Central America? How do you teach compound interest in a nearly zero-interest world, how to answer the question ‘are we rich?,’ what lessons about consumerism and value can be taught in the course of setting proper boundaries?

These all seems useful and important and I’ll be reading the book soon.

 

Please see related posts:

Book Review of Make your Kid a Millionaire by Kevin McKinley

Daughter’s First Stock Investment

The Allowance Experiment

The Allowance Experiment Gets Better

Rapunzel and Compound Interest

 

 

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If You Like Feral Cats You’ll Love Compound Interest

A version of this post appeared in the San Antonio Express News.

feral cats

Nobody ever told me this, but I’ve always assumed that a first rule of writing is to never – ever – try to teach math through blog posts.

But I learned writing through blogging on the interwebs where a first rule of everything – always – is to involve kittens.

Today I would like to teach the compound interest math formula using the story of the feral kittens in my backyard.

Compound interest is the most important, most powerful, and never-taught financial concept in the universe. Compound interest is also how middle-class people can get rich slowly and inevitably, over a lifetime of ordinary earnings.

Please bow your heads with me. Forgive us, editors and readers for the math we are about to learn. Also, hey look, kittens!

Start with just a few kittens

When you start with a small number of feral cats – as I did in my backyard recently, and then neglect to ‘fix’ them right away – pretty soon the magical compounding power of the universe goes to work.

It feels like one day I noticed a couple of stray cats, then I blinked and went out for a cup of coffee, and suddenly my entire yard was overrun with the things.

How does this happen?

Just ignore their gawdawful screeches at 3am, and boom! 2 months later, you’ve got more kittens.

Mathematically, I can tell you precisely how it happens, using the “compound growth of kittens” formula. It’s a matter of gestation periods which I’ll call “N”, and a growth rate per gestation period, or “Y.”

kittens_multiplying
I can haz compound interest?

Using the compound growth formula in practice

I start with two kittens.

(Important note: they must be different genders for the math to work. I’ll spare you the science behind that assumption. Just trust me on this point.)

Let’s say we know that kittens multiply at a rate of 20% per gestation period. And let’s say I wait three years – that’s 18 gestation periods, since cat pregnancy lasts 2 months.

(By the way, all you animal experts and cat-lovers out there who have their claws out to correct me on these assumptions, please recognize: This is all a feline metaphor and not guaranteed to be biologically accurate. Thank you.)

So like I said, my N is 18, and my Y is 20%.

With those assumptions, I can tell you precisely how many future kittens we’ll have, using the compound Kitten Growth Formula.

Here’s the math formula:

The future number of feral cats equals “1+Y,” raised to the power of N gestation periods, all multiplied by the original number of cats.

For algebraically-inclined folks, we would write this kitten-growth formula “Future Number of Kittens equals Original Kittens * (1+Y)^N.”

Plugging my assumptions into the formula:

The future number of feral kittens I can expect in three years (all else being equal)[1] must be (1+20%)^18, multiplied by my original 2 kittens.[2]

So, my compound kitten formula tells me that at the end of 3 years I can expect to have 53 cats. Absolutely swarming all over my backyard! Excuse me while I sneeze just thinking about it.

All of you readers following my math so far (seriously, both of you!) should try that out with a spreadsheet. When you change the percent kitten growth rate Y, or the number of gestation (compounding) periods N, you can see how the future number of kittens changes.

For example, if you start with four “Original Kittens,” and they grow at a rate of 25% per gestation period (that’s Y), and you neglect them for 5 years (so N=30 two-month gestation periods) then you can expect 3,231 kittens in your backyard. Roawrrr!

compound_growth_kittens
These are a few of my favorite things

What about money?

Ok, back to money.

This compound growth formula is the key to understanding the importance of long-term savings and investment.

Allow me a few quick mathematical statements that you can prove to yourself on the spreadsheet you’ve taken out, using the compound interest formula.

Remember, your Future Money is just going to be “1+Y,” raised to the power of N, multiplied by your Original Amount of Money.

Hey, that’s weird, it works just like cats!

So, if you are 25 years old, and if you have $5,000, and if you can earn 7% on your money for the next 50 years (I understand, a lot of “ifs” but bear with me on the math part, because this can change your life for the better) you will have $147,285 in your account when you are 75.

Without you doing anything to your money, just neglecting it like a feral cat.[3] And $5,000 is just one years’ worth of contributions. Imagine making multiple years of retirement contributions when you are in your 20s.

If you buy a $200,000 house, experience 3% home-value inflation and live in that house for 40 years before selling, your house will be worth $652,407 when you sell.

Partly I’m mentioning these things because they illustrate, mathematically, how middle class people can build wealth slowly and inevitably.

More than partly, I’m hoping readers will be inspired to open up a spreadsheet and learn to use this formula to estimate the future value of their money. Or their future number of backyard feral cats, if they prefer.

Anne_hathaway_catwoman
Gratuitous catwoman picture

In real life, since you asked, I noticed a couple of feral cats in my backyard last Spring. By this Winter, we had eight. A neighbor with great cat-catching & fixing skills (Shout out to Cannoli Fund!) caught and fixed all eight for us. Thank goodness for my neighbor because that cat growth curve was about to hit the stratosphere.

 

[1] As an economist would say. Although an economist would insist on say it pretentiously in Latin, with the exact same number of syllables, thus saving no time at all, but giving the illusion of fanciness: “ceteris paribus”)

[2] By the way, always use a spreadsheet when using compound growth formulas. Don’t simply try this with your catculator. Ahahaha! Catculator! I’ll be here all week folks. Don’t forget to tip your server. And try the fish.

[3] Picture your money, multiplying itself at 3am, while you (try to) sleep. Strangely, dreaming about Anne Hathaway in the last Batman movie.

 

 

Please see related post:

Compound Interest and Wealth

Compound Interest, Blood, Lust and Vampires – guest post by The Banker’s Wife

Rapunzel and Compound Interest

College Savings and Compound Interest

 

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Sin and Profit

Jason Zwieg at the WSJ provides interesting data today on the relative returns of ‘socially irresponsible investing’ (my own phrase).

I recently wrote that I could not recommend to a friend any ‘socially responsible’ mutual fund. My reasons:

smoking drinking1. Funds like this tend to have relatively high costs (especially compared to index funds, which I would generally recommend)

2. I find it impossible to match up the specifics of my (or anybody’s) moral code with the blunt instrument of equity investing.

Less emphasized in my post – but possibly most importantly of all – the ‘sin stocks’ such as tobacco, alcohol, gambling, weapons may have an inherent advantage when it comes to making money.

Zwieg cites the returns of a small mutual fund that invests only in these unfavored sectors of the economy, and has a ten year track record better than the S&P 500. Since few actively managed funds actually beat an index like this over a ten year stretch, the fund deserves attention. USA Mutuals Barrier Fund (previously named “The Vice Fund”) invests in tobacco, gambling, alcohol and defense, and returned 8.3% annually for the past ten years, compared to 7.9% for the S&P500 and 7.2% for the Vanguard FTSE Social Index Fund.

Now, one fund’s return does not imply any kind of rule about anything. But Zwieg provides more data.

London Business School economists showed that over the past 115 years US tobacco stocks returned an average of 14.6% annually, compared to 9.6% for all US stocks over that time. That’s a huge effect. Because of the magic of compound interest applied over long time periods, it’s the difference between $1 growing to $38,255 (at a 9.6% return) and $1 growing to $6.3 million (at a 14.6% return.)

Big obvious examples of persistently high returns – above adjusted risk – in efficient markets are extremely rare, and therefore notable.

And yet while markets are generally efficient, it makes some sense to me that the natural aversion of individual investors to certain companies, and the added preference of socially responsible investors against certain ‘sin’ sectors, would leave a persistent opportunity for outperformance investing in unlikeable companies and industries.

This follows the basic notion that if capital is scarce, the returns on that capital need to be relatively higher in order to attract and sufficiently compensate scarce capital. I’m enough of a contrarian cuss to smile at the irony/evil of capitalism, if this ‘sin investing’ strategy actually works in the long run.

I also appreciated learning from Zwieg that there’s a SINdex, which has tracked comparative returns since 1998, and has gained 16.1% annually vs. 5.2% in the S&P500. That’s probably not a big enough sample (there are only 29 companies in the SINdex) to prove anything yet, and 16 years is not enough time, but I’m intrigued by this possible market-beating approach in a Random Walk world.

Please see related post: Not A Fan Of Socially Responsible Investing

and Book Review: A Random Walk Down Wall Street by Burton Malkiel

 

 

 

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