My taxi driver to the airport – upon hearing I was a ‘finance guy’ – told me all about The Richest Man in Babylon by George S. Clason, a book which changed his life.From this one book, my driver told me, he had built his life plan for savings, investments, and wealth creation.
I had never heard of the book, and, of course, the fact that my taxi driver told me about the book reminded me of the classic sign of a frothy stock market: Be very cautious, for example, when the doorman in your building starts swapping stock tips with you.
I needn’t have worried, and I’m glad I set aside my initial snobbery and skepticism to read this.
Clason wrote and distributed a series of “Babylonian parables” in the 1920s in pamphlet form,[1] stories that later gathered wider distribution through banks and insurance companies throughout the 1930s.
The parables read like traditional biblical tales – like the Fishes and Loaves, or the Prodigal Son – full of Thy And Thou, Giveth and Taketh.We meet slaves and camel-traders, brick layers and money-lenders, soldiers and scribes.
Like all good parables, the stories are short, simple, and may be summed up at the end with a pithy phrase.They are also memorable, credible, and true.
In one chapter Dabasir, the camel-trader, relates the story of his long journey from slave to camel-trader to fat merchant through luck and determination, but most importantly the habit of living below his means.Beginning from poverty and deep indebtedness, Dabasir figures out how to live on 70% of his income, dedicating the remaining 20% to paying his creditors, and 10% to “paying himself,” through savings and eventually investment.The result, over time, is a debt free and eventually prosperous living.
The parables’ simplicity does not imply banality, but rather the permanence of a set of basic laws about money.Although Clason wrote them nearly one hundred years ago, it’s not absurd think that wealthy Babylonians, three thousand years ago, could have actually passed on these stories contained in The Richest Man in Babylon.
The plain fact: Financial wisdom doesn’t really change from millennium to millennium.
The vast majority of us go through life wishing we had a simple, memorable set of rules on complicated topics like love, faith, death, personal fitness, and of course, money.
Because these topics seem to combine mysterious, personal, taboo and embarrassing elements we gather information from weird, flawed sources.We trust pop songs to learn about love and sex.We consult people like Deepak Chopra on faith.We pretend, against all evidence to the contrary, that death is avoidable, or some kind of failure of life. We let some guy with great abs on late-night TV and a set of unproven nutritional supplements or an exercise gadget determine our fitness regime.
Our relationship to money is the worst of these failings, because we’re all such easy marks.The Financial Infotainment Industrial Complex knows that people who think they need more money (that’s all of us), with a fundamental ignorance about money (that’s most of us) are easily separated from our money.Most of what the Financial Infotainment Industrial Complex has to say about money is the opposite of wisdom about money.
It’s wrong, expensive, and misleading.
Can I give you some advice about money?
Turn off the damn television, lower the volume on the radio, peel your eyeballs away from the Interwebs for a day, and read some Babylonian parables.There’s more simple goodness here than a year of the other crap.
After you finish, pass it on to a young person who can use the advice too.
I’ve been searching in the past few years for the best book to explain the 2008 Crisis, but I have yet to find it.
John Lanchester’s novel Capital presents the 2007 and 2008 pre-conditions for the crisis in London – soaring real estate values, extraordinary inequality, random good and bad fortune, injustice, and fundamental cultural misunderstandings.
Lanchester’s diverse London characters occupy the same space – a single, gentrifying block in London – but arrive from entirely different worlds.
We meet the stand-in for pre-crisis London, the successful but clueless and doomed banker Roger, who finds his lifestyle nearly unaffordable at 1 million pounds per year.
A Banksy-style performance artist, his mother, and his dying grandmother show a temporal cross-section of England, unable to communicate across generations.
Lanchester has a gift for cultural nuance in portraying four distinct immigrant stories: The Zimbabwean meter maid working and living illegally, the Polish contractor riding the home renovations wave to save money before returning home, the Pakistani shopkeeper and his extended family, and the gifted 17 year-old footballer from Senegal signed to an extraordinary professional contract.
With few exceptions[1] Lanchester has empathy for all of his characters as they each suffer an existential crisis concurrent with the financial crisis.
Lanchester employs a unifying plot hook – a semi-mysterious harassment campaign affecting all of the homeowners of the single London block – that doesn’t quite matter to the novel.Neither the vague sense of dread the campaign engenders – nor the resolution of the harassment campaign – justify its prominence in most chapters.Nevermind, though, because the novel does not need it.
His sympathetic characters and gentle satire show us the way we live now, together in time and space but apart in everything else.
Capital does not explain the 2008 crisis, but it seems like an accurate time capsule of the “same street/different universe” world we occupy now – both before the crisis and since then.
McKinley’s book builds on the following, true, premise: kids and parents of young children rarely have much money. But the advantage they do have actually trumps money: They have time.
Time is the key ingredient to successfully exploiting the magic of compound interest. Enough time, plus a compounding return, makes anyone a millionaire.
And while we parents of young children generally feel unable to set aside savings on a monthly basis, McKinley rightly points out that we really could do it, if we decided to prioritize a little bit of savings over a little bit of luxury.
Painful, Powerful Prioritization Process
On the issue of eeking out savings to put away for our children, I appreciate his suggested step called the “Painful, Powerful Prioritization Process,” which is to fill out a monthly budget and then for each item in the non-priority column say out-loud to yourself “Spending $143 per month on my cell phone is more important to me than sending my child to college.” Or “having my nails done professionally means more to me than making my child financially independent.” [1]
As someone in complete agreement with McKinley’s premise, naturally I enjoy this book. A few of his specific techniques deserve special mention.
Roth IRA
I’ve written about this before, but the topic deserves repeating. The inter-generational tax-free wealth machine you can create simply and cheaply with the Roth IRA is almost too good. As McKinley writes, and I wholeheartedly agree:
I can’t emphasize strongly enough how potent an investment tool the Roth IRA is. There is virtually no other investment vehicle that is as flexible, available, and convenient, and that offers the potential for growth over the long term without incurring federal taxation!
Creating retirement accounts for minors
McKinley employed his infant daughter as a ‘model’ for marketing and promotional materials for his book, and he includes a picture of her in the introduction. He paid his daughter $2,000 for her trouble, giving her earned income that year.
Fortunately his infant daughter did not have the ability to blow her $2,000 in earnings on upmarket juice boxes and Ermenegildo Zegna cashmere-silk blend snuggly blankets, so McKinley opened up a $2,000 Roth IRA for his daughter.
As McKinley points out, many parents of small children have the opportunity to employ our children, pay them a “fair” wage, and then shepherd those annual earnings into a retirement account. [2]
Once our kids are teenagers, and have the ability to earn money outside of the house babysitting or doing chores for neighbors, those earning too can be funneled into a retirement account. Did seventeen year-old Johnny already blow his summer restaurant dishwasher job’s paycheck on frivolous things? It’s not illegal, if you as a parent have the extra money, to fully fund Johnny’s IRA that year, up to the amount of his earnings.
Because these retirement accounts created for our children may grow unimpeded for 50 years or so, until their retirement, the power of compound interest really helps.
One summer’s $5,000 in dishwashing earnings, growing for 50 years at 7% annual rate, becomes $147,285. That’s not millionaire status for one summer’s work in a smelly kitchen, but it ain’t nothin’ neither.
401K wisdom
McKinley drives home the point we all need to teach our kids – heck, we all need to teach ourselves – that almost nothing beats 401K participation. Especially when we’re young and poor.
Stop me if you’ve heard this one before, but the time to fully fund your 401K plan is during your first job, while you’re still in your twenties – when you can least afford it. I’m sorry, but it’s true.
Worker A, who funds his plan for his first ten working years – say age 22 to 32 will come out ahead of worker B, who skips the first ten years but funds his plan in equal annual amounts for the thirty years following age 32 – assuming an even annual compound return. It ain’t fair, but it’s simple math.
Estate Planning
I know the least about this area, but I learned quite a bit in the Chapter titled “Protecting your child’s wealth from your child.” The two goals seem to be a) reduce your tax bill, and b) do not give too much, too soon, to kids. Since McKinley’s a financial planner, and I’m not, I’ll assume his advice is solid for folks for whom this is an issue.
While I endorse this book, I have a few quibbles as well.
Assumed rate of return
The compound interest formula…
[which you’ll remember is FV = PV *(1+ Y)^N where:
FV = Future Value (how much money you’ll eventually have)
PV = Present Value (how much money you’ll start with)
Y = Yield, or Rate of Return, or Interest Rate (all equivalent ideas, usually expressed in annual terms)
N = Number of compounding periods (for example, number of years)]
…depends a great deal on what you assume Y, or rate of return, will be. McKinley wrote Make Your Kid A Millionaire in the sweet, innocent, days of the early 2000s so perhaps may be forgiven for assuming a 10% return whenever he shows the power of compound interest.
Were he to write this book today, I suspect McKinley would assume a more modest 5-7% return on risky equities over the long run. I know I would, even though this makes millionaire status less achievable. Unfortunately “Help your kid build a healthy six-figure nest egg!” has less of a ring to it.
Zero coupon bonds
In his chapter on setting aside funds for kids but retaining control over the money, McKinley suggests investing in zero coupon bonds. This strikes me as both overly complex for most people, as well as a way to earn a terrible return on your long-term money. Until interest rates change dramatically, and until purchasing zero coupon bonds becomes dramatically easier, I would not endorse this plan.
Variable Annuities
McKinley advocates using these as a kind of retirement plan for kids. I can’t agree. The extra layer of fees, opacity, and complexity, in my opinion, overwhelm any advantages that variable annuities have over traditional tax-sheltered retirement plans. Variable Annuities also violate my basic principal of insurance: use insurance products only for risk-transfer, not for investing.
These few quibbles aside, I still enjoyed this book and learned quite a few things. Parents of young children, this one’s worth it.
[1] I am drinking a large 3-shot cappuccino as I write this review. I can say out loud, with no remorse, that this 3-shot cappuccino really is more important than my kid’s financial security. But that’s because I’m an addict. Please forgive me.
[2] McKinley notes some legal limits on how children can earn wages. There are child labor laws of course, and a household ‘allowance’ does not count as ‘earnings’ that may be invested in an IRA. But there are still many ways young kids can make money, legitimately.
Can we invest our own personal portfolio in a sophisticated way, to maximize our risk-adjusted returns, without incurring high costs or having to be financial experts ourselves?
Kroijer was a hedge fund manager who argues forcefully against hedge funds, because of their high costs as well as because most active managers claim an ‘edge’ on markets which they are unlikely to really have.
A priest’s guide to atheism
As he says in his introduction, the irony of his position is not lost on him. It “may seem like a priest writing the guide to atheism.”
As “Anonymous Banker” of course I am personally all in favor of finance folks criticizing, from their experience, the financial industry’s areas of high cost/low value-added.
We need the Lars Kroijers of the world to tell us that “simple is better,” “low cost is better,” “retail investors should avoid complex financial products,” and a better solution exists.
The author says that he designed his book as the grey Volkswagen, rather than the red Ferrari, of investing.[1]
Sensible, unsexy, rational: The Volkswagen way to invest
60-Second Version of Investing Demystified.
Kroijer helpfully offers a “60-second version” of his book – the 4 take-aways to remember:
We as individuals do not have an ‘edge’ in financial markets. We should invest accordingly.
We can construct a cheap and simple optimized portfolio using world-equity tracking indexes and the highest-rated government bonds. We can then choose whether to add a level of complexity by deciding about a) What % of the portfolio should be in our ‘risky’ equities bucket, and b) Whether adding some corporate bonds or risky governments bonds also makes sense
We need to think carefully about personal a) risk appetite b) Tax consequences c) non-investment assets and liabilities such as real estate, income, and debt
We should pay attention to investment and transaction costs as these matter a whole lot in the long run
I like Kroijer’s 4 lessons because they are correct, simple, easy-to-remember guides to personal portfolio construction that eschew hype. His VW will get you from here to there with minimal cost, minimal risk, and maximum performance.
I also like that Kroijer’s personal background and professional experience make his advice free of national bias. What he says about personal portfolio construction applies equally to a Belgian, a Brazilian or a Bostonian.
International perspective advantage
One advantage Kroijer brings to the typical discussion of optimal, low-cost, low-maintenance personal investing is that he’s a Dane by birth, a Londoner by choice and profession, and a citizen of the world. As a result, he solves the personal portfolio puzzle differently than your average American who has a US-centric view of the investing universe. He’s unmoored from a parochial investment approach.
This matters because:
Your dominant currency may not be the US Dollar.
Your tax regime may not be the US tax regime.
Riskless bonds in your portfolio may not necessarily come denominated in your home currency, or from your own national government.
The best, low-cost diversified mutual fund from Kroijer’s perspective is not a Russell 5000 index tracker therefore, but rather a whole-world equity market tracker. Only through a ‘whole-world’ index tracker, Kroijer argues, can you achieve the optimal point of an efficient frontier portfolio.
Recommendation
I would recommend this book to a friend who has a traditional “Left Brain” orientation with an accounting, engineering, or mathematical background, but who may never have studied personal finance up to this point. For that person, Kroijer’s vocabulary and engagement with portfolio theory will be quite gentle, because Kroijer never actually goes too far with technical explanations.
For the creative or non-technically inclined, however, Kroijer’s grey Volkswagen approach – and especially the peeks under the hood at the financial theory – may leave them a bit cold.
The practical, diffident, Dane isn’t flashy, and he isn’t trying to entertain. He’s just rational, right, and could help you get wealthy.
[1] The jacket cover confirms his sensible/boring/diffident approach, as the grey cover with block letters is unconvincingly enlivened with awkward rainbow-colored arrows all pointing in the same direction. It’s not the red Ferrari of jacket covers either.
Gary Sirak’s primary insight in his book If Your Money Talked What Secrets Would It Tell– an insight I happen to agree with – is that the psychology of money, our personalrelationship with money – is usually our biggest personal finance problem.
Financial insecurity often plagues the professional making half a million dollars per year, even while financial sufficiency is possible for a person earning one tenth of that per year.
Whether you love money, or hate money, whether you accumulate it to excess like Scrooge McDuck or spend it wildly like Brewster, the underlying problem starts in our head, not in our paycheck.
Each person’s own personal money secret may be what Sirak calls a “self-limiting belief,” a deeply – probably unconsciously – held belief about money.
Self-limiting beliefs, Sirak explains, form at an early age. To overcome self-limiting beliefs we need to commit to self-examination and – one presumes – the additional intervention of a financial professional and personal finance books.
Sirak keeps this short enough to read on a flight between Chicago and New York. Pick this up at the airport bookstore, crack it open upon takeoff, and you’ll be done before the wheels touch down, with extra time leftover to solve the easy Sudoku puzzle in your inflight magazine.
Memorable Anecdotes
Sirak – just like anyone who has ever written a book like this – has a set of “8 Principles of Money,” common sense ideas not unlike ideas from, say, Thomas Stanley’s The Millionaire Next Door.
To makes his principles concrete, however, Sirak tells good stories. Over a thirty-year financial-planning career for individuals, Sirak accumulated illustrative anecdotes about people and their unhealthy relationships to money.
For each of his 8 Principles of Money, Sirak provides a brief and telling sketch from his own financial planning clients as illustration.
Getting tricked by smooth-talking scammers? – Sirak tells of his own gullibility about a start-up kids’ sports camp.
Worshipping money? Meet Roger, the ‘successful’ businessman who literally decorated his home with cash, while neglecting relationships with his wife and 5 year-old son.
Hiding debts from your spouse? – Sirak describes Ron and Alison, a married couple with totally incompatible spending patterns masked by secretiveness.
Spending money before you have it? We read about Dr. Allen, the newly minted MD who bought the twin BMWs instead of paying off student loan debt before the ink dried on his first paycheck because he felt he finally “deserved to live the good life.” Financial woes followed in short order.
Through his own and the mistakes of his clients, Sirak cautions us about common personal finance errors. With a quick series of “How Not To” stories, Sirak helps us begin to self-examine, exploring our self-limiting factors and money mistakes.
Gary Sirak blogs, and also has videos, sample budget spreadsheets, and a “Marriage Money Agreement” plus further information on his site www.ifyourmoneytalked.com
I took a mandatory course in high school[1] called “Theory of Knowledge,” meant to help us consider ‘How do we know things?”
“How do we know things?” turns out to be one of those big philosophical questions – dating from the time of Plato & Aristotle – irritating all of us for the last few millenia.
What Nate Silver addresses more than anything in The Signal and The Noise: Why So Many Prediction Fail – But Some Don’tis how we know things – in particular how we use and misuse information to understand and make predictions about complex phenomena such as baseball performance, political outcomes, the weather, earthquakes, terrorist attacks, chess, Texas Hold ‘em poker, climate change, the spread of infectious diseases, and financial markets.
Silver argues effectively that we frequently go wrong in many areas when we adopt a single model or approach to a problem, when an evolving, flexible, multiple-input, probabilistic approach would serve us better.
The problem of political pundits
Silver repeatedly returns in The Signal and the Noise to criticize political pundits on a TV show called The McLaughlin Group, on which commentators from the left and the right appear to make bold political predictions. Silver – among the most widely admired public forecasters of political outcomes – eviscerates this type of ‘prediction,’ citing data that shows these commentators make accurate predictions no more often than would a random coin toss.
But television rewards ‘bold stances’ and ‘big ideas’ of the type The McLaughlin Group traffics in, while largely ignoring more thoughtful approaches.
Silver labels and criticizes the “Big Idea” mindset that passes for political commentary on television in favor of a more modest, probabilistic, and empirical “Small Idea” mindset. Small ideas, nuanced, uncertain, and modest, however, make for poor television ratings.
But Silver does have a Big Idea himself
For complex, hard to predict phenomena[3], Silver explains his preferred method, based on a probability theorem attributed to an 18th Century English minister Thomas Bayes.
No doubt Silver thinks many more of us should become familiar with this branch of probability and statistics math. [4]
Beyond the Bayesian theory, however, Silver encourages us to adopt a probabilistic world-view. His big idea is for us to move away from “I have the explanation and I know what’s going to happen,” to a different way of understanding the world characterized by “I can articulate a range of outcomes and attach meaningful probabilities to the possible outcomes.”
Over time, as we refine our data gathering and multifaceted models, we can move our small ideas forward and become ‘less wrong’ about the world.
In the investment world the former style of traders – the one’s with big ideas and certainty – may have a good run of success, but generally get flushed out when markets turn. The best traders I’ve ever worked with think and speak in the latter way, considering new possibilities as markets evolve.
Some parts of this remind me of Nassim Taleb
The habits of mind Silver’s book encourages are not dissimilar to Nassim Taleb’s empirical skepticism, although they differ greatly in style and in points of emphasis. Taleb tends to be aggressively critical of everybody else’s models, whereas Silver more generously praises other theorists’ models and critiques his own.
Both Taleb and Silver share, however, a restless dissatisfaction with the inputs into our understanding right now. Both would say we do not know enough. We have not considered enough factors to explain whatever phenomenon we purport to explain. Our models need improvement and perpetual skepticism. The best we can do is to think probabilistically about future events.
Both encourage a learned humility about what we can know or patterns we think we observe in the world.
How does this relate to investing?
I’d estimate only about ten percent of Silver’s book explicitly addresses investing. As I mentioned, The Signal And The Noise is really a “Theory of Knowledge” book rather than in investing book.
But because Silver thinks like the best financial traders, uses probabilistic math effectively, and writes more clearly than almost anyone, his ideas are worth applying to investing.
1. Attribution of success
Among people who invest their own or other people’s money, 99.5%[5] of us attribute successful outcomes to personal investing acumen, while attributing unsuccessful outcomes to circumstances beyond our control.
The noise surrounding our own success – misinterpreting a generally rising market as stock-picking skill for example – leads us to overestimate our ability to influence investment returns. As a result, too many of us engage in security selection, or too many of us pay others to achieve superior investment results, despite the evidence that we’re overpaying.
2. Responsibility for failure
Conversely, our abdication of personal responsibility for losses – it must have been ‘the bad markets’ after all! – leads us to underestimate our own errors of judgment.
In both cases – success or failure – we’re prone to adopt an uncritical approach to the right level of responsibility for outcomes.
3. Efficient market hypothesis as an illustration of the Bayesian approach
Although Silver gives numerous examples of his Bayesian probabilistic approach to problems with numbers, one of his best examples is purely textual, on the efficient market hypothesis. He lists seven increasingly accurate, yet also qualified and probabilistic statements, on what we know about efficient markets.
The series of increasingly accurate, yet ‘less bold,’ statements are not only a great illustration of his big idea but also the right lesson for us on investing, so I reproduce it in full here:
b) No investor can beat the stock market over the long run.[7]
c) No investor can beat the stock market over the long run relative to his level of risk.[8]
d) No investor can beat the stock market over the long run relative to his level of risk and accounting for transaction costs.[9]
e) No investor can beat the stock market over the long run relative to his level of risk and accounting for his transaction costs, unless he has inside information[10]
f) Few investors can beat the stock market over the long run relative to their level of risk and accounting for their transaction costs, unless they have inside information[11]
g) It is hard to tell how many investors beat the stock market over the long run, because the data is very noisy, but we know that most cannot relative to their level of risk, since trading produces no net excess return but entails transaction costs, so unless you have inside information, you are probably better off investing in an index fund.[12]
The first approximation – the unqualified statement that no investor can beat the stock market – seems to be extremely powerful. By the time we get to the last one, which is full of expressions of uncertainty, we have nothing that would fit on a bumper sticker. But it is also a more complete description of the objective world.
If you want a 21st Century theory of knowledge, teaching you ‘how to think’ about the major world problems of global warming, financial crashes, avian flu, and terrorism, as well as ephemera like poker, chess, sports betting and baseball, start with The Signal and The Noise: Why So Many Prediction Fail – But Some Don’t by Nate Silver.
[1] Readers who study at an International Baccalaureate (IB) high school will be familiar with the “Theory of Knowledge” course. It’s a really great idea for a course, but I have yet to meet anyone who thought the experience of the course lived up to the idea that inspired it.
[3] Each chapter separately tackles baseball, political forecasting, weather, earthquakes, economic growth, infectious disease growth, sports betting, chess, poker, climate change, and terrorism – each in their own way posing a challenge of seeing into the future.
[4] The mathematics of Bayesian probability is relatively straightforward so I think I’ll try in a subsequent post to do it justice.
[5] I rounded down to be conservative, because that’s just good science.
[6] The original, powerful, efficient market thesis
[7] Because, clearly, some people sometimes do, for some period of time
[8] You can take some crazy stock-market risks and WAY outperform boring stodgy stocks much of the time. We have to match up comparable investment risk levels.
[9] A theoretical ‘market-beating’ high volume trading strategy often looks less market-beating when you take into account the frictions of trading.
[10] Inside information sure is helpful, when trying to beat the market
[11] Maybe some can do it, like Warren Buffett, but it’s super rare. Probably you can’t do it.
[12] So carefully hedged! So qualified and full of doubts! So true!
