The New Inflation Protected Security: The 42¢ Forever Stamp

December 5, 2006December 8, 2021 / Adam Nash / 4 Comments

Sorry, but I couldn’t pass this one up.

The introductory letter to the recent 2007 Investor Guide issue of Forbes magazine (12/11/2006) has a really neat little tongue-in-cheek reference to a new way to beat inflation. First, check out this graph from the article:

T-Bill Return

Yes, that’s depressing. Most people learn that typical “money market” returns for cash match inflation over time. That means that the interest you earn on cash accounts historically lines up with the amount prices go up every year. It’s why many people use money market funds and other similar cash equivalents, like certificates of deposit, to “protect” their savings.

Unfortunately, what this chart shows is that your cash equivalents only keep up with inflation when they aren’t taxed. T-Bills, which are the basic proxy for the cash equivalent market, actually lose money against inflation because the US government taxes their gains.

The chart plots what would have happened to a hypothetical dollar invested in T bills by a top-bracket taxpayer. The government that issues these bills gets you two ways. First is via inflation, what Ronald Reagan called the “thief in the night.” The other is to send around the Internal Revenue Service to rob you in broad daylight. Your real aftertax return over the past 75 years is a cumulative –72%.

Interestingly enough, there are real investment options today, in both Europe and the United States to protect your money from inflation. Several options, in fact:

Treasury Inflation-Protected Securities. This is the official, US, 10-year bond that is guaranteed to pay out both a real return and the inflation-adjustment based on the consumer price index. There are similar bonds in Europe as well. The only problem – you have to pay taxes on the inflation “gain” every year, even though it isn’t paid out until the end of the 10-year term. This also ignores the obvious fact that keeping up with inflation isn’t really a gain, so like the T-Bill, you are getting kicked in the stomach by the same government that inflated your currency.
Series I Savings Bonds. I love these. In business school, I independently did an analysis for my finance professor on the expected return of these incredible instruments. Conclusion: The government is heavily subsidizing them. Translation: the government is over-paying for these bonds, likely to help small savers and to encourage college savings. Let’s count the benefits:
- Taxes. None, until you cash in the bond. Up to 30 years of tax deferral!
- No State Taxes. None, ever. It’s excluded, a real perk for high tax states like good old California.
- No Taxes, education benefit. If you use the proceeds to pay for education, the gains are tax free.
- Inflation protected. You get paid a real rate of return plus inflation, every six months. Better yet, they use the CPI-U (consumer price index – urban), which tends to run hotter than the CPI overall, but better reflects costs when you live in the city.
In fact, the only limitation are the 1-year waiting period to cash out, the 3-month interest penalty you pay if you cash them in before 5 years, and the $30,000 per-person, per-year maximum (which I doubt many people hit).
Municipal Bonds. My understanding is that there are now inflation-protected municipal bonds in some areas… all the tax-free benefits of municipal bonds and inflation protection sounds good to me. (unfortunately, the real rate of return on these is negligible)
Gold. No, it’s not backed by any government, but the gold bugs out there will flame me to a crisp if I didn’t mention the oldest, and dearest inflation hedge in the world. The theory is that gold always stays the same price, and all other currencies just effectively float around based on how well they manage their money supply. You could make this argument about any precious metal, or even for commodities and real assets in general. Personally, I still think that one day we’re going to be able to find unlimited supplies of any metal, so not putting my 50-year money here…

But I am here today to mention a humble, fourth opportunity for inflation protection:

The new “Forever Stamp” proposed by the US Post Office.

The basic idea is that the post office will issue a new 42¢ stamp in 2007 (yes, another price increase), but one that will hold it’s value forever. No more price increases. The stamp will always be good for one first-class mail item, up to 4 ounces.

Let’s think about that.

First, we know that the US Postal rates have approximately kept pace with inflation over the past 25 years… maybe a bit more than inflation.

Second, there is no proposed “time limit” on the stamp. I guess the stamp will be valid as long as there is a US Post Office?

Third, there is no limit on resale. So, I am assuming that if postal rates increase, you could resell your stamps to someone else who needs them, for approximately full value.

Fourth, there is no accumulation limit. You could theoretically by $1M worth of these stamps, if you wanted to.

Fifth, no taxes. At least, right now, the IRS has not said that it will tax you on the appreciation of your first-class stamps. At minimum, there are no taxes until you “cash them in” by selling them.

The blog Marginal Revolution asserts this just gave the Post Office the ability to print money. Since the Post Office is effectively backed by the US Government, they can just print stamps to effectively increase the money supply. (I do love it when the stable money fanatics get worked up.)

The blog Economist’s View has another interesting take on the proposal.

There you go… tidbit for the day. If you are looking for a safe place to park your money, you may now have a new friend in the US Post Office. I will say that this looks like a very hot item for the Stamps category on eBay…

My First Job: Do You Know What a Dollar is Worth?

December 1, 2006 / Adam Nash

I started reading personal finance blogs with the discovery of My Open Wallet. Since then, I’ve started following more than a dozen of these sites, where real people anonymously provide significant details about their own finances, questions and progress towards their own financial goals.

Today, for some reason, the post on the blog “2Million” really resonated with me:

Do You Know What a Dollar Is Worth?

It’s a simple post about his first job as a dish washer, and the incredible realization that after a whole day of work, the end result was a $35 paycheck.

If you don’t count the times that my brother & I went door-to-door with a wagon selling lemons from our tree for a quarter, my first job was actually in the software industry.

It was the summer of 1991, and the father of a friend of mine hired me to work at his software company, an enterprise software play focused on one of the hot themes of that era: “Expert Systems“. The company was called Expert Edge Software. I was 16 years old, and it was the summer before I started college at Stanford University.

Like any normal Silicon Valley start-up, we had a small office space in a non-descript building in Mountain View. My job was to actually make the software. No programming – I literally was in charge of:

Copying the final build to production 3.5″ floppy disks
Testing the floppy disks
Typing labels for the floppy disks
Packaging together the floppy disks and manuals into the production boxes
Shrinkwrapping the boxes (which I did by wrapping them loosely and then using a hair dryer to shrink the plastic around the box).

8 weeks, and I was paid $4.25 per hour (minimum wage), before taxes.

Ironically, I almost worked myself out of a job in the first week. I quickly learned the task, and spent the first day forming an assembly line. On day 2, I made 20 copies of the disks (4 per set). I then tested them all, typed all the labels, made 20 boxes, and shrinkwrapped them all. On day 3, I met with my friend’s father (the CEO), and showed him the progress. He wasn’t thrilled.

Apparently, what I didn’t understand at the time was that for an enterprise software company, especially a startup, 20 copies was more than they were likely to sell in a year. Previously, the lead engineer had been packaging the software, but because he had much more important things to do, he rarely made more than 1 or 2 copies in a week. I guess somehow no one realized that making 20 boxes of software wasn’t going to take a whole summer, even for a high school student.

Fortunately, there is always more to do at a startup. I spent the rest of the summer learning about direct marketing. There was no email back then, but I learned how to purchase and mine commercial databases of contacts, and I put my assembly line skills to work sending out thousands of marketing brochures to manufacturing executives. I am still a force to be reckoned with, when it comes to Microsoft Word, Filemaker Pro, and Mail Merge. 🙂

Most of my memories from that summer are not from the work, but from the people at the company. I didn’t know them well, but I would hang out with the engineers, and we’d go to lunch in Los Altos or Mountain View. It was actually the summer I discovered Bueno Bueno Burritos & Yogurt, still my favorite burrito place (on El Camino, near San Antonio). I remember getting my lunch and realizing that at about $8, I was working almost half the day, after taxes, just to buy lunch.

Just one of those experiences that help frame your life. Thought I’d share.

Books: Yes, You Can Still Retire Comfortably by Ben Stein & Phil DeMuth

November 26, 2006November 28, 2006 / Adam Nash / 4 Comments

One of the original reasons that I thought that writing a blog would come naturally to me was because I’m an avid reader. When I started this blog in August 2006, I figured that many of my posts would be the standard “book reviews and baby pictures” type of posts that people make fun of blogs for.

Ironically, I realized tonight that I have not yet done even one book review post… until now. Recently, I wrote a post about Ben Stein, and in the process I discovered the commercial website for his new book. I ordered the book that night, and received it this week. I just completed reading it over the last few days, and it’s worth commenting on.

Yes, You Can Still Retire Comfortably! by Ben Stein & Phil DeMuth

Overall Rating: Good, but not great. I’m glad I read this book, and it had a significant amount of unique content. However, the style is dry & negative enough, that many people may not love the experience.

Synoposis: At least 25% of this book is just depressing. It basically lines up all of the reasons, at both a macroeconomic and microeconomic level, that the retirement of the Baby Boomer generation is going to strain the US economy and your own personal finances. There are three legs to retirement financing: social security, corporate pensions, and personal savings. None of these are looking very good for the Baby Boom generation and Generation X. At the same time, the percentage of people in the economy who are working and adding value is going to continue to fall sharply, straining many aspects of our economy.

I think the authors summarize their feelings well themselves here:

Ten percent of seniors already live below the poverty line. This is no way to spend your days when you are old. Your authors fear that many in our generation are going to be joining their numbers.

What’s more, the retired baby boomers are going to be living well compared to Gen Xers, because the bones will be picked completely clean by the time they retire.

Having said this, we’d like to add one more thing: Yes, you can still retire comfortably. Maybe not everyone will, but you can, and we’re about to tell you how. Don’t get overwhelmed with the fate of the whole generation. Just worry about yourself, and then plan to act. You don’t need to outrun the bear; you just need to outrun the other hunter. Read on.

The rest of the book is a fairly dense, well-researched walk through of how you can outrun the other hunter. It places a strong emphasis on saving, saving, and more saving, with a dollop of extending your working career as long as possible thrown in. The book features a lot of tables and numbers – it’s clear the authors have back-tested their program, and have provided a lot of “short cut” calculations to help the reader quickly assess where they are in terms of saving for retirement.

I have likely read over three dozen books over the years on this topic, and this book was fairly unique in a number of ways:

No magic path to high investment returns. The authors do not spend any time trying to explain how to beat the market, or how to achieve 10%+ annual returns on your portfolio. They basically advocate the “couch potato” portfolio of 50% total stock market, 50% aggregate bond market. (They do provide a more advanced portfolio breakdown of 25% each US Stocks, International Stocks, Inflation-protected bonds, and aggregate bond index).At first, I recoiled at this recommendation given it’s low growth potential. But having completed the book, I now realize that the authors primary concern is running out of money. Having run Monte Carlo simulations and historical back-testing, it’s very clear that the way to the poorhouse in retirement is having your stock portfolio hit a set of “bad years” early on. That depletes your funds, and since you are withdrawing every year, you never recover.
Try to be conservative in your saving plan, and then when you have it worked out, try to save even more. More than any other retirement planning book I’ve read, this one really emphasizes the fact that there are still a lot of economic unknowns to come with this generational shift. For example, marginal tax rates have been as high as 90% in the past 50 years. Who knows what rates will be when you retire! Will social security be there for you when you retire, or will “means testing” or some other political fiction be deployed to balance out the books of the dwindling “trust fund”. Even Roth IRAs may not be safe, since Congress could decide to start taxing or penalizing those withdrawals in future years.
Positive recommendation for variable annuities? It has been a very long time since I’ve seen anyone recommend these, given their notoriety for high fees and low returns. However, Ben has a positive family experience with these products, and he provides very sound analysis on how a mixture of fixed and variable annuities could help provide for a stable and comfortable retirement. In the end, however, the primary recommendation of the book is not annuity based, so I’ll let this one slide.
You need to plan for your maximum life span, not average life span. Most retirement books I have read tend to focus on average life spans. While these are high, they are not as high as planning for the possibility of a very long retirement. Most of the planning in this book focuses on either the 5% chance of living to 100, or the 1% chance of living to 105.This struck a chord with me, as I tend to be on the optimistic side of this equation. I believe that advances in technology related to longevity and health are on an inflection point that will hit in our lifetime.
4% is the only safe number. This is a really important point, so I’ve saved it for last here. In a previous post about Social Security, I explained the “Rule of 25” in terms of planning for assets to provide an ongoing income stream. That back-of-the-envelope rule was based on the idea that you can only withdraw 4% annually safely from your assets and protect your principle.Scott Kleper posts a comment on that entry that asked whether or not I was being too conservative with the 4% number. After all, you don’t need your money to last forever, right?At that time, I hadn’t read this book. If I had, I would have been able to answer that question better. This book goes into quite a bit of detail about different strategies for withdrawing money in retirement. The short answer is that 4% is really the only safe solution that handles out-of-band eras like the 1930s stock market, or the 1970s stock & bond markets.In fact, this book goes out of its way to explain that the only really safe income strategy is to have fifty times your income saved, so that you can invest it in inflation-protected securities paying 2% above inflation on an ongoing basis. Since that’s unreasonable, we’re left with a requirement to invest in stocks, with all the risks and variability associated with it.

The entire book is written in Ben’s typical terse and plain-spoken style. It’s not a long book, and there is clearly a lot of data behind the conclusions that are presented.

The book is also not a riveting page turner, and I am pretty sure that people who are naturally more “grasshopper” than “ant” will get irritated pretty quickly by the constant barrage of negativity about the future and about the need to save at all costs.

I am glad, however, to have read this book. While I’m not going to be shifting my portfolio to the “couch potato” blend so quickly, I may have to revisit my natural revulsion to bonds and consider adding them to my asset mix. The data in this book on withdrawal strategies has me convinced that the best defense is to save early and often.

One last note:

Check out this table from the book:

It’s amazing. This table shows, based on a number of assumptions, what percentage of your salary you should be saving every year, based on your age and how much you have already saved. Look at the power of saving while in your 20s & 30s. If you can save even 1/2 of your salary by the time you are 25, you only need to save 5% for the rest of your career to retire comfortably. If you wait until 35, you need to save 11% every year just to make up for lost time.

While this book was worth reading, I still prefer reading Ben Stein’s periodic articles to the book. He has a natural gift to provide very simple and compelling analysis in a very short space. It’s more powerful in small doses.

Your Employee Stock Purchase Plan (ESPP) is Worth a Lot More Than 15%

November 22, 2006April 22, 2017 / Adam Nash / 42 Comments

First, credit for this article goes largely to “The Finance Buff“, a great blog I just discovered today. He wrote a post about Employee Stock Purchase Plans (ESPP) that really struck a chord with me, and I thought I’d share it with my readers.

Employee Stock Purchase Plan (ESPP) Is A Fantastic Deal

Most people think of their ESPP plan as a nice little perk. But after running the numbers, it seems like it’s a much better return that people give it credit for. It’s definitely a much higher return, on average, than the 15% number that people tend to gravitate to.

Let’s walk through the highlights of why by walking through the original post. First, he defines the basics of what an ESPP plan is:

An ESPP typically works this way:

1. You contribute to the ESPP from 1% to 10% of your salary. The contribution is taken out from your paycheck. This is calculated on pre-tax salary but taken after tax (unlike 401k, no tax deduction on ESPP contributions).

2. At the end of a “purchase period,” usually every 6 months, the employer will purchase company stock for you using your contributions during the purchase period. You get a 15% discount on the purchase price. The employer takes the price of the company stock at the beginning of the purchase period and the price at the end of the purchase period, whichever is lower, and THEN gives you a 15% discount from that price.

3. You can sell the purchased stock right away or hold on to them longer for preferential tax treatment.

Your plan may work a little differently. Check with your employer for details.

OK, so that covers the basics. I have seen minor variations on the above, but nothing that eliminates the math that he is about to walk through:

The 15% discount is a big deal. It turns out to be a 90% annualized return or higher.

How so? Suppose the stock was $22 at the beginning of the purchase period and it went down to $20 at the end of the period 6 months later. Here’s what happens:

1. Because the stock went down, your purchase price will be 15% discount to the price at the end of the purchase period, which is $20 * 85% = $17/share.

2. Suppose you contributed $255 per paycheck twice a month. Over a 6-month period you contributed $255 * 12 = $3,060.

3. You will receive $3,060 / $17 = 180 shares. You sell 180 shares at $20/share and receive $20 * 180 = $3,600, earning a profit of $3,600 – $3,060 = $540.

Percentage-wise your return is $540 / $3,060 = 17.65%. But, because your $3,060 was contributed over a 6-month period, the first contribution was tied up for 6 months, and the last contribution was tied up for only a few days. On average your money is only tied up for 3 months. So, earning 17.65% risk free for tying up your money for 3 months is equivalent to earning (1 + 17.65%) ^ 4 – 1 = 91.6% a year.

90%+ a year return is fantastic, isn’t it? That’s when the employer’s stock went down. Had the stock gone up from $20 at the beginning of the purchase period to $22 at the end, your return will be even higher at 180%!

I think the reason people focus on the 15% is a classic example of why people, even very educated people, are not very good intuitively at dealing with money. 15% feels like the value of the ESPP program, because that is the “cash on cash return”, as we used to describe it in venture capital.

Let’s take the example of a hypothetical engineer, Joe, who makes $85,000 a year working for Big Tech, Inc. Joe is a saver, and as a result he puts 10% of his salary into his ESPP plan. Over the course of the period, the stock goes nowhere. Big Tech shares are always worth $50.

At the end of six months, Joe has contributed $4250 to his ESPP plan. They take the lower of the two stock prices, which are both $50, and set the price at 15% lower, $42.50 per share. (You can tell that I used to be a teacher… my numbers are suspiciously turning out to divide out evenly…)

$4250 buys 100 shares at $42.50 each. Since you got a 15% discount, people think that you got a 15% return.

Wrong. A 15% discount actually means you got a 17.65% return. (Read that line again). You have stock worth $5000. But you only paid $4250 for it, for a gain of $750. $750/$4250 = 17.65%.

This isn’t some sort of numbers trick – it’s actually just the difference between looking at what discount you got off full price (15%) versus the return on your money that you received (17.65%). Percentages going down are always more than percentages going back up. For example, if you got a 50% discount on a $1000 TV means you only have to pay $500. But if they raise the price from $500 to $1000, that’s a 100% increase.

So that’s the first gotcha. And 17.65% is nothing to sneeze at. That’s better than the historical average return of every easily accessible asset class I know of (I am excluding Private Equity & Venture Capital, since most people do not have access to them.)

The second gotcha is the fact that Joe didn’t just give them $4250 one day, wait six months, and then got $5000 back. He actually paid it in gradually, paycheck by paycheck. So, he didn’t get a 17.65% annual return.

Now, this is the place where I’ll get technical and explain that Joe didn’t get 17.65% return over 3 months either… that math is faulty. To calculate this correctly, you need to do a cash flow analysis where you evaluate the internal rate of return taking into account each paycheck that Joe made.

In fact, using the numbers provided in my example, I get an annualized return of 98.4% for Joe – and that’s for a stock that didn’t go up!

Salary: $85,000.00
ESPP: 10%
Paychecks/Year: 26

1/14/06 $(326.92)
1/28/06 $(326.92)
2/11/06 $(326.92)
2/25/06 $(326.92)
3/11/06 $(326.92)
3/25/06 $(326.92)
4/8/06 $(326.92)
4/22/06 $(326.92)
5/6/06 $(326.92)
5/20/06 $(326.92)
6/3/06 $(326.92)
6/17/06 $(326.92)
7/1/06 $(326.92)
7/1/06 $5,000.00

IRR 98.4%

So, I think the lesson here is pretty clear. The biggest problem with ESPP programs is that you can only contribute up to 10% of your salary to them, typically. Otherwise, it would make sense to take out almost any type of loan in order to participate. You’d easily be able to pay it back with interest.

However, be forewarned. All of this analysis assumes that you will sell your stock the day you get it. It also is a “pre-tax” return, since you own income taxes on the $750 gain the day your ESPP shares are purchased.

Disclaimer: I am not a financial professional, and every personal situation is different. This blog is personal opinion, not financial advice. You should thoroughly investigate and analyze any financial decision yourself before investing any money in any investment program.

Update (11/10/2007): There has been some commentary that questions the IRR calculation for this example. I’ve uploaded an Excel Spreadsheet for this example. It shows that for this series of cash flows every 2 weeks (13 negative, 1 positive) that the IRR is 98.4%. For this spreadsheet, I use the XIRR function, which is part of the Excel Analysis Toolpack Add-on, which handles IRR calculations for non-periodic cash flows.

From Excel Help:

XIRR returns the internal rate of return for a schedule of cash flows that is not necessarily periodic. To calculate the internal rate of return for a series of periodic cash flows, use the IRR function.

Vanguard Launches High Dividend Index Fund

November 18, 2006 / Adam Nash / 1 Comment

Two news tidbits this week that had me thinking about new investment options.

First, Vanguard just launched a new index fund: the High Dividend Index Fund. They are going to be providing access to the fund in both traditional mutual fund form (Ticker: VHDYX) and in ETF form (Ticker: VYM).

Based on the press release, it looks like the funds will match the FTSE High Dividend Yield Index, which is shrouded in some marketing double-speak mystery. I cannot find the actual companies included in this index anywhere. It looks like this index was created almost exclusively to be mirrored in the Vanguard fund.

The mutual fund version of the fund will have a 0.40% expense ratio, the ETF will have a 0.25% expense ratio. As a result, you’ll want to use the mutual fund as a vehicle if you are making small, regular investments in the fund (like $100 per month). Otherwise, the commissions will killd you. If you are putting a lot of money to work at one time, and you are using a low-cost broker, the ETF is going to be a better “buy and hold” vehicle given it’s low expense ratio.

This fund might seem to be similar to the Vanguard Dividend Appreciation Index Fund. They launched the mutual fund (Ticker: VDAIX) and ETF (Ticker: VIG) in April 2006, and those funds feature expense ratios of 0.40% and 0.28%, respectively. The difference is the index it tracks – this older fund tracks the performance of the Dividend Achievers Select Index, which includes stocks with a record of steadily increasing dividends. The fund’s focus on stocks exhibiting dividend growth distinguishes it from this new fund, which emphasizes purely yield.

I personally have a stock account made up of high dividend/cash flow companies as a conservative base to my retirement funds. Seeing this type of product from Vanguard has me thinking that it might make sense to just let them do the work for me here – the expense ratio is incredibly low.

This fund is clearly a response to the very high interest in more “fundamentals-based indexing”, which John C. Bogle, Vanguard Chairman, has been fairly vocal about dismissing. There is definitely a very grey area between an index fund and an actively managed fund. After all, an index itself is created by a group of people, and changed over time. So the truth is, index vs. active is somewhat in the eye of the beholder. The assumption is that an index will change infrequently, leading to lower trading costs and more consistent representation of some asset class or sub-class.

For those of you who are curious, it looks like the FTSE High Dividend Yield Index will be recalculated annually, based on the following formula:

The new custom index consists of stocks that are characterized by higher-than-average dividend yields, and is based on the U.S. component of the FTSE Global Equity Index Series (GEIS). Real estate investment trusts (REITs), whose income generally do not qualify for favorable tax treatment as qualified dividend income (QDI) are removed, as are stocks that have not paid a dividend during the previous 12 months. The remaining stocks are ranked by annual dividend yield and included in the target index until the cumulative market capitalization reaches 50% of the total market cap of this universe of stocks.

There are already a large number of “high dividend” focused mutual funds and ETFs out there (for example, the iShares Dow Select Dividend (Ticker: DVY)), but with Vanguard’s reputation and penchant for low costs, it’s always worth giving their offerings a strong look. As I’ve posted before, I am a huge fan of Vanguard, and truly believe that they work to lower costs to the bare bone for their investors.

Saving Energy: Installing New Windows & Doors

November 14, 2006November 28, 2016 / Adam Nash / 2 Comments

I have now received the first empirical evidence that replacing your old windows & doors can have an impact on your utility bill.

Our house is one of the standard, ranch-style houses that were popular in the SF Bay Area in the late 1960s. It had the original, single-pane aluminum windows, and hollow-core doors.

We replaced the exterior doors a couple of years ago, but we just completed last month the installation of new, double-pane windows throughout the house. We also replaced the large sliding glass doors in our living room.

It’s a large expense, and while you are comforted somewhat that the money will come back to you when you sell the house, that seems like it will be very hard to prove. As a result, I’m really glad to see that our heating bill (our kerosene heater is gas-driven) for the first cold month of the year is actually quite a bit lower than last year.

Of course, the low gas bill could also be the result of us doing less cooking at home around the birth of my second son on October 30th. I’ll keep monitoring, but hopefully, the energy savings promised around this type of improvement turn out to be accurate.

Blogs I Read: Ben Stein

November 13, 2006November 13, 2006 / Adam Nash / 2 Comments

I really love to read Ben Stein. His first burst of fame, as you may know, came from being the teacher in Ferris Bueller’s Day Off back in the 1980s. More recently, he hosted a game show for a while (Win Ben Stein’s Money), and he writes regularly for the New York Times on Sunday.

What people may not realize from his typical movie and TV stunts is that Ben Stein is really intelligent. Not just in a book smart kind of way, but in a profoundly intellectual way. As an actor, writer, economist and lawyer, he seems to have internalized not just the facts and theories of several different fields, but also how they fit together. I find his writing style compellingly simple, and yet rich and articulate.

More recently, Ben has become more proactive with writing articles to help guide people with their own financial lives. Here is an article he wrote in 2005 on saving for retirement:

The Early Bird Gets the Next Egg

An example passage, which I think demonstrates both his easy way with numbers and his compelling presentation of basic financial facts:

If you start at 25 with six months’ salary saved, you need only save 3 percent of your total, pre-tax salary per year to get the nest egg you need (roughly 15 times earnings at retirement) by age 65. But if you start at age 45, you need to save 18 percent of your salary (again, assuming you start out with six months’ of salary saved). If you start at age 50, you need to save 28 percent of your salary. And if you start at age 55, you need to save nearly 50 percent of your gross salary to get where you need to be.

In other words, if you start with a sensible plan at a young age, you can get to your savings goal without breaking a sweat. If you wait until you are middle aged, it takes some serious doing. If you wait until you are a silver fox, you’re required to do some heavy lifting indeed. If you assume the stock market has passed its glory days, you need to save even more.

I’ve found two great resources now for Ben Stein fans:

He has a website. It’s worth bookmarking.
He has an RSS feed. It’s worth subscribing to.

I’m going to be writing a follow up post on one of my favorite pieces by Ben Stein, clipped from the New York Times last year. I’m having trouble finding an online copy, so I may have to type up the whole thing. In the meantime, check out his RSS feed. It’s so exciting to me to find out that some of my favorite columnists and authors have their own feeds – it’s something I just wasn’t finding somehow before I started blogging myself.

Picking the best 529 College Savings Plan

November 11, 2006January 23, 2007 / Adam Nash / 16 Comments

As I mentioned in an earlier post, my wife and I were blessed with the birth of our second son eleven days ago. Believe it or not, my mind has already turned to the topic of college savings for our children, and I thought I’d share my research to date on the subject.

If you are not familar with 529 plans, you can think of them as 401k plans, but for college savings. They are an outgrowth of the original state-based, pre-paid tuition plans, which have since been adapted to become generic savings vehicles for college with significant tax advantages. There are other vehicles available, but none offer the combination of significant savings limits, tax benefits, college financial aid benefits, and control that the 529 plans offer.

Almost every personal finance journal now does annual reviews of each state-based 529 plan. Here is a great one from Money magazine that reviews them state-by-state.

When choosing a 529 plan, it is worth keeping the following things in mind:

You do not need to choose the plan from your state. This is really important, because some of the state plans are terrible, with high expenses and poor fund choices. The ability to pick any state plan is a really great option for investors – imagine if you could pick among not just your company’s 401k plan, but the 401k plan from any company!
Check to see if your state offers you tax advantages. Some states allow you to deduct 529 contributions from your state taxes. I live in California, which despite having a sky-high income tax rate, does not let you deduct anything. This is important, however, because in states with tax benefits, it might be worth sticking with the in-state plan.
You can open one for almost any family member. Most people think about college savings only for their children, but 529 plans can actually be opened for anyone under 30. The whole point is that the person who opens the plan controls the money, but it only has tax advantages if used towards the college education of a person under 30.
You are not locked in! You can actually change dependents on a plan once a year, and change state plans once a year. Don’t let the complexity stop you from opening a plan as soon as possible. It is very easy to change. Interestingly, you can use this ability to open a plan for your unborn children! Just open a plan for someone else, and once your children are born, switch the plan to them. A great way to get more than 18 years of compounded interest towards saving for college.
The sooner you start the better. In the past 20 years, college tuition rates have grown at a compounded rate of 8%. The only way you are going to keep up with that type of growth is to save early, save often, and use the high expected return of investments like stocks to meet your targets. Compounding works best the earlier you start. The money you contribute in years 0-4 is likely 2-4x more valuable than the money you contribute in years 14-18.
Expense ratios matter! Expense ratios are your enemy. This is money that is taken out of your investments, regardless of your return. A difference of 0.5% might seem small, but on $10,000 that is a loss of $4377 over 18 years. That’s real money. 529 plans often charge fees three different ways: on the funds, on the plan, and for the fund management firm.
Save big dollars like a 401K, but withdraw tax-free like a Roth IRA! 529 plans really are the best of both worlds. You can contribute up to $12,000 per year (with a special $60,000 if you want to bundle 5 years of contributions at once). But if you use the withdrawals for qualified education expenses, you will pay zero tax on the earnings. So this isn’t tax-deferred saving… this is truly tax-free saving on all gains in the account. More details on this site.
Save for retirement first. You can borrow money for college, but you cannot borrow money for retirement. College savings plans should only be put in place once your retirement savings plan is in place.

More tips from Money magazine and SmartMoney magazine are available.

When my son Jacob was born two years ago, I decided to open a Nevada 529 plan through Vanguard. Vanguard is known for its history of running low cost index funds, and for its tireless advocacy for investor rights. Vanguard actually runs plans for 13 different states, but the Nevada plan is the one that is fully integrated with Vanguard, which is an added bonus if you have retirement accounts with Vanguard (I do).

The expense ratios for the Nevada plan are good – depending on the fund, anywhere from 0.6% – 0.8% total. They also have a wide selection of investment choices.

However, last year I was disappointed to find out that Utah has an even cheaper plan run by Vanguard, with expense ratios closer to 0.4%. Of course, Utah charges a $25/year fee for out-of-state investors, but still, I started to think about moving Jacob’s plan over.

Then, yesterday, I get this letter from Vanguard. Given their commitment to low fees, they have reduced the expense ratios on the Nevada plan to 0.5% – 0.7%, still with no annual fee.

This is why I love to do business with firms like Vanguard. Their entire marketing message and differentiation is low fees. Like a company that always raises dividends on their stock, I firmly believe Vanguard is always working to lower the prices of their investment alternatives. They are like Wal-Mart for saving.

So, I’m sticking with the Nevada plan, and I’ll be opening one up for Joseph just as soon as I get his Social Security number. If you are interested in researching plans, CNN Money has a great set of recommendations (Utah, Nevada & Michigan top their list).

Update (1/21/2007): I’ve posted a new article on how to take advantage of the ability to change beneficiaries for 529 plans. Check it out.

Blogs I Read: Herb Greenberg

November 6, 2006 / Adam Nash

I have been reading Herb Greenberg since he was a financial columnist for the San Francisco Chronicle (yes, there was a time when I had a subscription to that paper).

I followed him to TheStreet.com, and even ponied up $99 a year for a while for the privilege of reading his articles.

Now, he is at CBS Marketwatch, and even better, he has a blog!

You want to read Herb regularly if you are a fundamentals-based investor, and you like to read pieces about hot companies where some of the numbers may be in question. Herb is very good about admitting mistakes, but I have to say, he’s normally very ahead of the curve with company problems. As a result, there are quite a few CEOs out there who hate him.

Here are a couple of posts from his blog today that explain why Patrick Byrne, CEO of Overstock.com, hates Herb:

Overstock: It’s a conspiracy, I tell ya – a conspiracy!

More Overstock: Why Investors got Byrned.

You might not realize it from these pieces, but Herb was writing about rising inventory levels and low turnover long before the public-facing numbers turned.

He’s fairly high on my RSS feed list. I think if you invest in individual stocks, he should be on yours as well.

Why I love Timber as an Asset Class

November 6, 2006June 13, 2007 / Adam Nash / 18 Comments

I found this article on the Motley Fool this week called “Is Lumber the New Gold“, and it reminded me why Timber might be my favorite asset class of all.

I was first introduced to Timber as an asset class at Harvard Business School, in one of my classes on Venture Capital & Private Equity. Dave Swensen, who managed the Yale endowment for over 20 years, discussed the strategy that led Yale to incredible outperformance in the 1980s and 1990s. He took the endowment from $1.3 Billion to $14 Billion, using a strategy very different than his colleagues.

It would be a whole different post to sing the praises of Mr. Swensen, and his philosophy on investing has now become public knowledge since he released a book on the subject. In his discussion with the class, I remember his specific comments on assets that had extremely attractive risk/reward ratios. Private Equity is one, to be sure, but he also allocated over 20% of his funds to “real assets”, which included Timber.

Timber is fascinating as an asset class. Here is a summary, cribbed from a recent post on Seeking Alpha:

Excellent Returns. Annual returns of 14.5% since 1972. Better returns than any common asset class (stocks, bonds, real estate, commodities)
Less Volatility than Stocks. What? More reward with less risk? It shouldn’t be true, but it here at least empirically.
Timber is counter-cyclical with Stocks. Especially nice to have an asset that zigs when the stock market zags.
Money grows on Trees. Fundamentally, you have to like the fact that 6% growth every year comes from the fact that trees just grow bigger with natural sun & water. The value of trees is also non-linear, in that growers can just “not cut” in weak years for timber prices, and make even more in subsequent years.

Here’s a nice post from Seeking Alpha in July on why Timber should outperform in an inflationary market. It even features my personal favorite REIT stock in the sector, Plum Creek Lumber (PCL), which I’ve owned since 2002.

You have to love the web. I found this fantastic blog post from 2005 on Timber. Couldn’t have said it better myself.

Until recently, it was very hard to invest in timber without a portfolio allocation in the millions of dollars. However, now, there are several ways to add timber to your portfolio. My favorite are the REIT stocks, like PCL & RYN, which allow you to own companies who have a primary business in owning & maintaining timber land. Given the regulations around managing timber land, and the tax-advantages of the REIT structure, it’s hard to get better direct exposure.

It’s interesting, but as the trend continues towards development & environmental protection, these firms should have an even more compelling advantage as the supply of quality timber dwindles, and the regulatory environment grows more arduous. Even the sleepy paper companies are starting to look more valuable for the timber land that they own, rather than the product they produce.

It’s so interesting that money, in some cases, really can grow on trees.

Update (6/13/2007): A commenter forwarded me to a webpage that had a link to one of my favorite articles on timber as an ivnestment, from a 2001 issue of Smart Money magazine. Check it out here.

Roth IRA Loophole: Everyone Can Qualify in 2010

November 4, 2006November 18, 2006 / Adam Nash / 41 Comments

This is not really new news, but I thought it was interesting enough to share broadly. Since it’s about saving for retirement, hopefully some of you out there will get some benefit from this information.

Om May 17, 2006, President Bush signed the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). It’s very likely that this news didn’t really get your attention, but if you are an active saver for retirement, it should.

One of the best innovations for retirement savings in the last ten years has been the Roth IRA. The Roth IRA is an Individual Retirement Account, and like other IRAs, it is a special type of account with tax advantages to help people save for their retirement.

The magic of the Roth IRA is that it turns the tax liability for normal IRAs on its head. Most retirement accounts, like 401Ks and IRAs allow you to put money into the account, and deduct the contributions from your income. Your savings then gets to build, tax-free, until you retire. You think have to pay full income tax on the withdrawals.

This is a big benefit, and a great way to help save for retirement. However, the Roth IRA improves on this quite a bit.

With a Roth IRA, you do not get the deduction up front. In fact, you can only fund a Roth IRA with post-tax money. However, the magic is, once it goes in a Roth IRA, you will never pay taxes on it again – or the gains. For a young person in their 20s and 30s, this is an amazing way to accumulate wealth over the long term. Roth IRAs also have some tax benefits for estate planning.

Sounds good, right? In fact, there is only one big problem with the Roth IRA. It’s a benefit that isn’t available to people who make higher incomes. The limits of the program are that you must make less than $95K as an individual, or $150K married, to either contribute or convert an existing IRA to a Roth IRA.

Here’s where the loophole comes in.

As part of the tax act, Congress has officially abolished the income limits for Roth IRA conversion in 2010. That means you will able to convert existing IRAs into Roth IRAs, regardless of income. You can’t contribute to a Roth IRA if your income is too high, but you can convert an existing IRA.

“Great,” you say. “Hooray for 2010.” But this is where the loophole comes in.

You can start funding your regular, non-deductible IRAs this year, in 2006. You can continue to do this in 2007, 2008 & 2009. Then in 2010, you can convert all of these funds over to the Roth IRA. And since the non-deductible IRA is funded with after-tax money, you will only have to pay a small amount of tax on the conversion based on the gains from 2006 to 2010.

This is a fantastic window to convert a sizeable amount of savings into a Roth IRA, even if Congress only keeps this window open for one year.

Some people might ask, why would Congress offer this great incentive? Actually, it was done to help bring in revenue in the short term. This opening in 2010 will draw a lot of money into the Roth IRA program, which will generate a lot of taxes in 2010 as people convert their funds over. Because our government tends to only focus on the short term (5-10 years), this looks like a gain because the lower tax revenue from the Roth accounts doesn’t hit for decades.

Everyone’s financial situation is different, but if you’ve been interested in Roth IRA accounts, and you’ve been unable to participate, your window is now open.

Here is another article I found on the same topic.

The $812K Question: Will Social Security Be Around in 2045?

November 3, 2006November 3, 2006 / Adam Nash / 4 Comments

Well, OK. $812,450. That’s what Social Security means to me, roughly.

Why? Well, I’m in a saving mindset these days. I’ve saved money over the years for many personal goals – a new computer, a vacation, and yes, even a first home. I also started saving for my retirement quite early, at the age of 20. Now, with two children, you also can add college to the mix of savings goals.

So, it’s ironic that this week I received my annual “Social Security” statement from the US Government. Unfortunately, it really doesn’t answer the fundamental question I have about the program – can/should I count on it, or not? This article came out today on the Vanguard feed, and it got me thinking about the issue.

Based on the best web sources I can dig up, it looks like I’m due $32,498 in 2045, the first year I’m going to be eligible for full benefits. That’s in 2005 dollars – with inflation, the nominal amount will be much more. However, using 2005 dollars makes it easier to place the value in the here & now.

When you think about retiring, you have to think about how to live off your assets. In a funny way, you are basically “endowing” yourself, much as the wealthy will endow tenured chairs at universities, or even departments. A typical endowment, like Harvard’s, will limit withdrawals to 4% a year, to ensure that they will never run out of money. They’ve been around more than 350 years, so it’s likely they know what they are doing.

I use the 4% rule myself when thinking about generating income from assets, safely, on an ongoing basis. It makes it very easy to figure out how much money you might need to retire, for example. Just take the annual income you want, and multiply by 25. Simple.

So, if you want $100K per year, in today’s dollars, you would need $2.5M invested, in today’s dollars. Simple, but sobering.

$32,498 per year may not sound like a wealthy income level, but it’s the maximum the US Government provides as part of the current Social Security program. Using the rule of 25, you’d have to have $812,450 saved up in your 401K to provide the same for yourself.

Scary number, given the fact that the average 55-year old has less than $50K saved in their 401K plan. Hopefully, our generation will be better about individual responsibility and saving than the previous generation, but I’m not sure I’ve found any economic statistic that actually suggests that.

I have never personally put much faith in the current incarnation of the Social Security program being around for me in 2045. In the late 1980s, I remember researching policy debate topics around retirement in high school, and the overwhelming evidence that the current system is not solvent, and will not last to the middle of the 21st century. In a funny way, it’s a curse of our own success. Social Security is an insurance program, and it was implicitly a bet that economic productivity growth would match or surpass the expected length of retirement (based on longevity).

Productivity growth in the US over the last 70 years has been spectacular. Unbelievable. That’s why we are sitting on a $12 Trillion economy. However, when Social Security was born in the 1930s, longevity was expected to be in the mid 1960s, so most people were not expected to collect from the program, and those that did would only collect for a short while.

Now, we live in a society where more than 50% of people who live to 80 can expect to live to 90. Think about it – 65 to 90 is 25 years. There are still many jobs where 25 years is considered full service, and grants you title to a complete pension. Amazing.

I’m a technology optimist. I believe that we’re likely to unlock longevity measuring into the mid-100s during my lifetime. But what does that mean for programs like Social Security, or even for retirement itself?

In any case, I now realize that for my personal financial planning, my opinion of whether I believe in Social Security or not has a real practical implication for my personal saving. $812,450 is a lot of money to save on your own.

Then again, maybe it would be easier to save that over a working lifetime if 12.4% of your salary didn’t go missing every paycheck.

I think I’m still going to base my planning on the assumption that Social Security won’t be around in its current form in 2045. I always like to leave some upside in my planning anyway.

Dow 12000? Could have been 22000! Berkshire Hathaway in the Dow Jones Industrial Average.

October 20, 2006October 20, 2006 / Adam Nash

Big news this week. The Dow has closed over 12,000. Whoopee.
Sometimes, I am amazed at how incredibly stable certain staples of culture can be, even in the face of overwhelming logic & reason.

One example of this is the continued fascination that people have with the Dow Industrials index. This group of 30 stocks has changed over the years, but dates back over 100 years (1896), ever since Dow & the Wall Street Journal attempted to capture a measure of the “Industrial Strength” of the US Economy.

The problem is, the equation they used to calculate it is nonsensical. Literally.

The Dow Jones Industrial Average is a “price-weighted” index. This means that a $1 move in a $25 stock is worth more than a $1 move in a $10 stock.

This, of course, makes absolutely, positively no sense.

Now, a “market-capitalization-weighted” index, like the S&P 500, makes sense. An “even-weighted” index makes sense. Even some of the cool new “fundamental-weighted” indexes, based on figures like the revenues or cash flows of companies makes sense.

But a price weighted index makes no sense. If a stock in the Dow Jones splits 2:1, it’s future impact on the average will be lower than if it never split at all.

This, compounded with the incredible unpredictable and poor timing that the index owners have used to add & remove stocks from the index has led to extremely unpredictable performance.

There is a really great piece in Business Week that illustrates how ridiculous this index is.

As you may have heard, Berkshire Hathaway, Warren Buffet’s company, hit its own milestone lately by trading at $100,000 per share. Yes, that’s right. The reason it is so high is that they have never split their stock, and it has compounded at extremely high rates since the 1960s.

Can you imagine what the Dow would be like if it had included Berkshire Hathaway as one of its stocks (which would be easy to justify)?

The answer is: if they had added it in 2000, the index would now be at 22000!

Buffett’s Baby: Too Big for the Dow

Despite this, every newspaper and television show seems to highlight this milestone for this nonsensical financial metric. And it really does influence investor behavior. I have family members who have told me they are reluctant to buy stocks right now because “the Dow is so high”.

For the 20 or so readers of this blog, hopefully now you know the truth. Spread the word. The DIA is meaningless.

Behavioral Finance, Product Design and Entrepreneurship

September 29, 2006September 30, 2006 / Adam Nash

Now that I’m entering my fourth week maintaining this blog, I’ve decided to come back to the subject of why I really believe that these three topics are intertwined. These three topics are the reason that I named this blog Psychohistory, and these three topics seem to completely dominate my education and professional career.

The reason for this belief is crystalizing, and it’s remarkably simple:
I truly believe that incredible opportunity lies at the intersection of the irrational (human emotion) with the rational (finance, technology, business).

Behavioral Finance offers us the opportunity to design financial systems based on the basic insight that the way that human beings relate to money involves far more emotion than intellect. To understand economics, you must understand your very human economic actor.

Product Design is based on the premise that deeply understanding the ways that people interact with technology can lead to profoundly more useful (and desirable) designs and products. To understand product design, you must understand your very human customer.

Entrepreneurship offers us the opportunity to build companies by figuring out how to replicate the economic miracle of creating billions of dollars in new value by unlocking the very human emotions of inspiration, motivation, cooperation, and self-determination. To understand entrepreneurship, you must understand your very human entrepreneur.

Like all good elevator pitches, I probably need to reduce this in complexity by an order of magnitude before I’ll be happy with it. But I’m excited about this insight, and more importantly, I’m already seeing incredible leverage from it in my industry, where everyone is talking about the intersection of technology, commerce, and community.

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