"Lombard Street" is a marvelous little book

This is a review of "Lombard Street: A Description of the Money Market" by Walter Bagehot. You can find all my previous book reviews here. If you're interested in buying a copy, I hope you'll consider using my Amazon Associates referral link.

19th century Britain, like all capitalist economies before and since, suffered periodic banking panics, during which the entire banking system froze and the economy was thrown into deep recession as the population waited to see when, and indeed whether, confidence in the system would be restored.

Walter Bagehot's "Lombard Street" is a careful description of the mechanics and aftermath of these panics, written by someone who experienced several of them firsthand. It has, I think, two great virtues that make it useful to the modern reader: he was writing about an economy which was operating on the gold standard by default, rather than by intention; and most, if not all, of today's market phenomena already existed at the time of his writing, but operated at a much slower pace.

Bagehot treats the gold standard as a feature of nature, not a regulatory decision

Today any introductory economics textbook will explain to you the importance of banks in the process of "money creation." Banks create money by loaning out a majority of their deposits. When those loans are deposited in a bank (either the same bank or any other), that bank then loans out a majority of those deposits. In this way money is "created" (in excess of deposits) and entered into circulation. A bank's regulator can slow or speed the process of money creation by increasing or decreasing the proportion of each bank's deposits it is required to keep on hand.

Bagehot would reject this idea outright. Banks cannot create money. They accept deposits, and then they can loan out some portion of those deposits and accept, in exchange, some security. The total amount of "money" within the banking system cannot be increased or decreased through this process, because the total amount of gold reserves kept by the banks in reserve is fixed.

To Bagehot, cash is gold and gold is cash. He literally uses the words interchangeably.

Bagehot's panics were gold panics

The source of Bagehot's panics is obvious: the banks of 19th century England were engaged in money creation just as our fractional reserve banks are today, but unlike ours, his banks refused to admit it! So the amount of deposits redeemable on demand for gold was, in fact, far higher than the amount of gold available for redemption. If enough people suddenly sensed that the amount of gold available was inadequate to cover their deposits, they would rush to the banks and attempt to withdraw gold before everyone else beat them to it.

This happened with some regularity.

Bagehot's solution is our solution

Today the Bank of England and the Federal Reserve solve the problem of banking panics through the "discount window," where they offer liquidity to any bank in need of it to meet customer demands for cash.

This is precisely the solution that Bagehot describes, except Bagehot's Bank of England had an important limitation our modern system does not: the quantity of gold bullion held in its vaults. Thus the central banking problem of Bagehot's time was maintaining a high enough bullion reserve to meet demand in time of crisis.

In those times of crisis, Bagehot says the Bank of England should lend freely to any and all banks, accepting any "security considered good in normal times." This is, almost exactly, the legal restriction the Federal Reserve in the United States operates under, being forbidden by law from making loans to "insolvent" banks.

Economic crises used to be banking crises

One of the best chapters in "Lombard Street" is when Bagehot explains what happens when the price of a commodity increases:

"When the agriculture of the world is ill off, food is dear. And as the amount of absolute necessaries which a people consumes cannot be much diminished, the additional amount which has to be spent on them is so much subtracted from what used to be spent on other things. All the industries...are somewhat affected by an augmentation in the price of corn, and the most affected are the large ones, which produce the objects in ordinary times most consumed by the working classes. The clothing trades feel the difference at once, and in this country the liquor trade (a great source of English revenue) feels it almost equally soon. Especially when for two or three years harvests have been bad, and corn has long been dear, every industry is impoverished, and almost every one, by becoming poorer, makes every other poorer too. All tracks are slack from diminished custom, and the consequence is a vast stagnant capital, much idle labour, and a greatly retarded production." (p. 56)

This is what we would call today a "supply shock," with a sudden decrease in supply in one sector causing higher prices and a decrease in production economy-wide. But the important thing to remember here is that Bagehot is only able to describe an increase in the price of corn denominated in gold, or as he would call it, "money." Every change in supply and demand for a particular commodity is also moderated through the supply and demand for gold bullion.

That means a sudden shortage of corn, and resulting economic contraction, also results in a banking crisis as people realize their deposits were lent out to businesses who are suddenly unlikely to be able to repay them. Panic quickly sets in and each depositor is anxious to withdraw their cash before the bullion reserve is exhausted.

The only solution is a rapid increase in the interest rate to attract deposits of gold bullion from overseas, in order to meet the sudden demands on the Bank of England.

A fiat currency works on the everything standard

Developed economies today issue fiat currencies, which people sometimes claim means they are backed by "nothing." But of course dollars, pounds, and euros are backed by gold — they're backed by the amount of gold you can buy with them. They're also backed by the amount of land you can buy with them, the amount of beer you can buy with them, and the amount of refrigerator you can buy with them.

It's true that dollars and pounds used to backed by fixed amounts of gold, instead of market rate amounts of gold, but that just meant that everything else — all the stuff you actually wanted to buy — was mediated through the supply and demand for gold.

Now not just the exchange rate between euros, pounds, and dollars float based on market forces, but the exchange rate between gold, land, beer and refrigerators floats as well.

And best of all, there is not, and can never be, a shortage of the convenient, wallet-sized, digitally-accounted-for, currency units of value.


Bagehot's description of the money market is of a system that is based on the psychology, and whims, of a diverse group of market participants. It takes only the slightest rumor to send the bill brokers and private bankers dashing through the streets trying to shore up their balance sheets before complete panic sets in and the nation is ruined.

Basically, if you were alive in 2008, it will all be familiar to you. Bagehot's advantage over the chroniclers of the Great Recession is his fine prose and step-by-step analysis of the psychology and business practices of bankers of every sort, from the country banker to the Governor of the Bank of the England.

"The Black Swan" is not a very good book

This is a review of "The Black Swan" by Nassim Nicholas Taleb. You can find all my previous book reviews here. If you're interested in buying a copy, I hope you'll consider using my Amazon Associates referral link.

"The Black Swan" captured the imagination of the reading, writing, and investing public the moment it was published in 2007, and sprang to even greater prominence as the global financial crisis ran its course over the following years. While I'd been looking forward to reading the book for some time, last month I finally found the time to plow through it.

I was disappointed.

"The Black Swan" is a book about one interesting and true observation

Taleb has one main point, which he approaches from a variety of angles: the impulse to apply Gaussian (bell curve) statistical distribution models to real-world phenomena is based on the ease of applying them, and not on their accuracy in describing those phenomena.

I took introductory statistics in college, and in my experience this is precisely correct: introductory statistics professors teach statistics as if the goal of the science is to acquire a large enough sample to discover the correct Gaussian distribution. If your sample doesn't follow a bell curve distribution, then you need to collect more samples until you discover the true, underlying bell curve.

Taleb argues convincingly that there is no reason to believe "social" phenomena have bell curve distributions. Wealth and income are not physical phenomena which become increasingly rare the further you move from the average; on the contrary, an arbitrarily large amount of income or wealth can be concentrated among an arbitrarily small number of people.

Nassim Taleb is not entirely hinged

Once you realize that Gaussian distributions are not entirely, or even not particularly, applicable to the real world, then it's natural to draw unusual conclusions.

If stock market performance is random but not Gaussian then "unusually" large stock market moves will occur far more often than would be predicted by models based on the bell curve (see: 2000 and 2008).

If success in business is random but not Gaussian then risky bets will produce extreme wins and losses more often than a bell curve would predict, so exposing yourself to those extreme wins while protecting yourself from extreme losses (Taleb's so-called "barbell" approach) will produce higher returns than a consistently mediocre portfolio.

Unfortunately, Nassim Taleb does not confine himself to his area of obvious expertise: trying to profit from large advantageous market moves while protecting himself from large, irrecoverable losses.

Taleb thinks black swans are everywhere

Taleb accidentally makes an interesting point about the difference between predicting the behavior of individual subatomic particles (completely impossible) and predicting the behavior of large grouping of subatomic particles, i.e., physical objects. He asks why, if his coffee mug is composed of subatomic particles moving in unpredictable ways, his mug doesn't leap off the desk into the air. The answer, of course, is that subatomic particles in large groups behave according to extremely predictable rules. Mugs don't jump off desks.

What Taleb gets wrong is that more human institutions are like coffee mugs than like subatomic particles.

For example, in chapter 11 Taleb advances his idea of "academic libertarianism:"

"[T]he problem with organized knowledge is that there is an occasional divergence of interests between academic guilds and knowledge itself. So I cannot for the life of me understand why today's libertarians do not go after tenured faculty (except perhaps because many libertarians are academics). We saw that companies can go bust, while governments remain. But while governments remain, civil servants can be demoted and congressmen and senators can be eventually voted out of office. In academia a tenured faculty is permanent — the business of knowledge has permanent 'owners.' Simply, the charlatan is more the product of control than the result of freedom and lack of structure."

Academia, of course, is an educational system much more like a coffee mug than a subatomic particle: the objective of higher education is to educate at a level as consistently high as possible. When people don't have control over the quality of education they receive, making it as consistent as possible is a perfectly reasonable goal.

Taleb has nothing to say about the large, functional systems we depend on

The subtitle of Taleb's book is "the impact of the highly improbable." The tendency since the book's release is to refer to any unforeseen event as a "black swan." This tendency is largely Taleb's fault, because while he has since become extremely protective of the term, in the actual text of the book it's barely defined at all. Taleb says a black swan must be "rare, impactful, and predictable in retrospect but not prospectively."

What event does that not apply to?

The fact is that vast majority of the systems actual people rely on are extremely resilient against "black swans," and virtually impossible to "hedge" against the failure of.

  • Social Security is a system virtually all American workers pay into and which pays out checks to the retired and disabled.
  • Medicare is a system virtually all American workers pay into and which pays out checks to doctors, hospitals, and pharmacies.
  • The Department of Education's Direct Loan Program collects information on students and disburses funds to their institutions of higher education.

We can break these systems by electing politicians dedicated to destroying them. But that is not a "black swan," that's the unfortunate outcome of a process of collective decision making.


The solution to Gaussian, bell curve fantasies is not this sprawling 400-page tome of artistic criticism and intellectual wankery. It's reality.

Don't take out an interest-only mortgage with a teaser rate and balloon payment — the domestic housing market isn't Gaussian.

Don't invest money you can't afford to lose in a single car company, bank, or oil company — disasters are unpredictable.

And don't ask more out of your investments than they're capable of giving you. Buying a low-cost total stock market mutual fund from Vanguard will give you exposure to the total stock market. Buying a bond fund will give you a stream of income. Buying a bunch of Beanie Babies will give you exposure to the 90's hobbyist market.

But there's no added value to thinking of a collapse in the US stock market, a rise in interest rates, and people realizing Beanie Babies aren't worth anything as "black swans," outside "the normal distribution." They're all guaranteed to happen eventually.

Trying to develop resilience against these events is worthwhile, but doesn't require any additional intellectual framework beyond:

  1. Don't risk more than you can afford to lose;
  2. Don't take risks you don't understand;
  3. Diversify what you can afford to lose among risks you understand.

"Common Stocks and Uncommon Profits" is a beautiful, not-very-useful book

This is a review of "Common Stocks and Uncommon Profits" by Philip A. Fisher. You can find all my previous book reviews here. If you're interested in buying a copy, I hope you'll consider using my Amazon Associates referral link.

In my May review of the "Masters in Business" podcast I mentioned that the host asks his guests for book recommendations, and one extremely common recommendation is "Common Stocks and Uncommon Profits," by Philip A. Fisher. In it, the legendary fund manager describes his investment philosophy and, in great depth, his strategy for selecting stocks he believes will dramatically increase in price over a period of many years.

"Common Stocks and Uncommon Profits" is a book about late-1950's America

It is rare to come across a book that is so strongly rooted in a particular time and place. When reading "Pride and Prejudice" you notice some quirks of English law (like perpetual entails) but you basically get the idea that it's a story about a bunch of young people growing up and getting married.

"Common Stocks and Uncommon Profits" is not like that. Here's Fisher writing about labor unions:

"In this day of widespread unionization, those companies that still have no union or a company union probably also have well above average labor and personnel relations. If they did not, the unions would have organized them long ago. The investor can feel rather sure, for example, that Motorola, located in highly unionized Chicago, and Texas Instruments, Inc., in increasingly unionized Dallas, have convinced at least an important part of their work force of the company's genuine desire and ability to threat its employees well. Lack of affiliation with an international union can only be explained by successful personnel policies in instances of this sort."

That is an almost-unrecognizable vision of the American labor movement, but it's listed as one of the most important considerations when deciding whether to invest in a company!

Needless to say, an investor today should not base their decisions on 1958's union environment, which we now know was almost literally the peak of union membership as a percentage of the American workforce.

This is also a book about America as a manufacturing powerhouse. Fisher describes with wonder the almost-miraculous invention of titanium and exciting new uses for aluminum. Even DDT gets a nod as an exciting new insecticide, guaranteed to increase American agricultural production for many years to come (it's now illegal).

Importantly, Fisher is describing a world where the only investment choices for working Americans are actively-managed mutual funds and stock brokers. Because of that, the book can be read in two ways: if you're an active manager of a mutual fund, it's advice on how to do your job. If you're in investor, it's advice on how to select an active fund manager: pick one who agrees with Philip A. Fisher!

"Common Stocks and Uncommon Profits" provides no useful information about picking stocks

If you picked up a book like Michael Covel's "Trend Following," and read it cover to cover, you could start trading stocks using the strategies in that book.

You'd lose a lot of money, perhaps slowly at first, and then all at once, but the book does give you instructions on how to trade according to Covel's theories.

"Common Stocks and Uncommon Profits" isn't really like that. Fisher's strategy requires you to gather information about companies that is not publicly available. I don't mean "insider" information, but simply information that is not knowable without spending a lot of time hunting down employees, customers, vendors, and competitors and communicating with them at length. It's a strategy that could only be followed by a wealthy, well-connected mutual fund manager with a lot of money to invest.

The problem, of course, is that identifying the disciple of Philip A. Fisher (the author died in 2004) who truly and correctly follows his investment principles is impossible in advance. The successful fundamental fund manager will naturally say that he "correctly" applied Fisher's strategy, while his unsuccessful competitors "incorrectly" applied it, and give you all sorts of reasons why. Unfortunately, there's no reason to believe past performance is any indicator of future results.

Fisher has some interesting insights about dividends

Fisher makes two interesting arguments in his discussion of whether dividend-paying stocks are better or worse investments than companies that retain most or all of their profit for further investment.

The first is a straightforward mathematical insight that's frequently glossed over: the dividend yield that should matter to you is the yield on the price you purchased a stock at, not its current price. If a company pays the same 2% of its share price in dividends, but its share price quadruples over 15 years, the lucky owner over that time period will be earning an 8% yield on the price she paid for it, despite the stock never paying a "high" dividend at any point in the entire period.

The second point has to do with transaction costs. The high historical stock market yields you frequently see quoted in investing propaganda require the reinvestment of all dividends paid. If you, quite rightly, plan to reinvest all your dividends, you have three problems: first, until very recently, fixed commissions on stock purchases meant it was as expensive to make small purchases as large ones. If you immediately reinvest dividends, purchase commissions eat up a higher percentage of your capital. If you wait to invest a large amount, you suffer from having more time out of the market, losing some of the benefits of compounding.

The second problem is that it can be cumbersome to reinvest dividends because of the need to buy integer values of stocks.

And third, you also have to find a stock to invest in! It may be your current stocks have already gone up too much in value to be good candidates for further investment, which means you have to find something new to buy. That friction imposes another transaction cost. Retained earnings reinvested in a quality business, on the other hand, eliminate all those transaction costs by (hopefully) increasing further the value of your existing shares.

Basically, Fisher is not a big fan of dividends.

Conclusion: read this book for nostalgia, not for advice

This may sound like I'm being harsh on the author: after all, what period was he supposed to write about if not the period he was living in?

On the contrary, I actually found "Common Stocks and Uncommon Profits" to be a beautifully written description of the world our Baby Boomer leaders grew up in. When Donald Trump says he wants to make America great again, this is the America he has in mind: heavily unionized, highly-paid, a manufacturing powerhouse, with exciting research developments that would only years later prove to be toxic to humans and the environment. Men work in labs and factories, women purchase previously-unheard-of consumer goods, and during periods of economic recession the government runs a deficit of "25 to 30 billion dollars."

It sounds like a lovely place to visit, but I'm not sure I'd like to live there, and I definitely wouldn't recommend investing as if you did live there today!

"Where Are the Customers' Yachts?" is a pretty good book

This is a review of "Where Are the Customers' Yachts?" by Fred Schwed Jr. You can find all my previous book reviews here. If you're interested in buying a copy, I hope you'll consider using my Amazon Associates referral link.

I have a technique I like to call "reverse showrooming." In retail parlance, "showrooming" is when a customer comes into a physical store to inspect a product, then ultimately orders it for a lower price on Amazon.com. I "reverse showroom" by keeping track of books I'm interested in reading by adding them to my Amazon wish list, then checking them out for free from the public library.

"Where Are the Customers' Yachts?" is the first book I've ever checked out from the public library that was so good I immediately ordered 2 copies from Amazon in order to lend them out to friends and family.

It isn't the only book you'll ever need to read about investing in the stock market, but it should be the first book you read about investing in the stock market.

History doesn't repeat itself, but it rhymes

Fred Schwed Jr. originally published "Where Are the Customers' Yachts?" in 1940. Despite the intervening years, with all its wars and revolutions, there's scarcely a single word in the book that doesn't apply just as accurately today as it did when it was written (with one exception, below). Moreover, a vast corpus of economic research has developed to provide statistical proof for what Schwed learned from practical experience.

Schwed is much funnier than I am, but I will attempt to do justice to his basic attitude towards investing:

  • Making predictions is hard, especially about the future;
  • If someone can consistently and accurately predict future price movements, they are able to command vast sums for doing so;
  • But even someone who consistently and accurately predicts price movements is almost certainly just lucky.

Schwed predicted almost every development in the world of investing

Decades of economic research have now established that active mutual funds perform no better than passive index funds, after management fees. But Fred Schwed doesn't need your decades of economic research. In 1940, he wrote:

"The subject of choosing profitable financial investments does not lend itself to competence. There is almost no visible supply."

It is breathtaking to read Schwed recommend — in 1940 — a primitive system of passive index investing:

"The average small investor needs a certain amount of diversification, but he can get it for himself by buying five-share lots instead of hundred-share lots. The added expense of doing his business this way is negligible. If his funds are too limited even for that procedure, the only diversification he needs is to put some of his money into life-insurance payments, some into the savings bank, and the remainder into his right-hand trouser pocket."

Michael Lewis catalogued the difficulties large investment banks have buying and selling large blocks of shares in his 2014 book "Flash Boys." Fred Schwed described them in 1940:

"An investment trust [i.e. mutual fund] should be good and large, because this tends to make the expenses of running it a negligible percentage of the whole. But when the trust is big in size, the investing problem becomes increasingly difficult. A fifty-thousand-share position is a hard thing to buy and usually a harder one to sell. If the quotation on such a position rises twenty points in the newspaper, the trust scores up a million-dollar profit on their book value, but of course actually realizing on profit on such a block is apt to be quite a different thing."

Schwed is curiously obsessed with margin investing

The only part of "Where Are the Customers' Yachts?" that doesn't seem as relevant today as it was when it was written is his discussion of "margin." Margin, for those born after 1930, refers to the regrettable willingness of brokers to allow their customers to buy stocks not with money, but with a line of credit backed by a small amount of collateral. As Schwed explains:

"We assume that it is a wise and profitable venture to buy 100 shares of United Fido at ten, paying $1,000 for it. Ergo, wouldn't it be even better to buy 200 shares paying the same $1,000? And even better to make it three or four hundred if we can find a sufficiently kindly broker to do us this favor?

"The answer is no. But I only know one way of proving it to you conclusively. Go try it."

While investing on margin is still legal and, I assume, encouraged by the more unscrupulous stock brokers, it doesn't occupy the American imagination in the way it seems to have when Schwed was writing. Although in fairness, Tim Geithner did something indistinguishable when he borrowed money from JPMorgan in order to back his stake at his new Warburg Pincus gig.

Let's check back in 10 years to see how that plays out.

In 76 years, investor psychology has changed not one jot nor tittle

Ultimately, "Where Are the Customers' Yachts?" is a book about psychology: specifically, the psychology of people who decide to put a little bit of money to work for them in the stock market. If you don't recognize yourself in it, then you've probably never put a little bit of money to work for you in the stock market.

Fortunately, you have one great tool Fred Schwed Jr. and his clients and customers didn't have and indeed didn't imagine: low-fee, passive, indexed Vanguard mutual funds.

Unfortunately, you can only take advantage of those funds if you can convince yourself to actually invest in them. And as much as it pains me to say it, neither Schwed nor I are going to be any help in that department.

"Pop Finance" is a pretty good book

This is a review of "Pop Finance," by Brooke Harrington. You can find all my previous book reviews here. If you're interested in buying a copy, I hope you consider using my Amazon Associates referral link.

I first heard about "investment clubs" from my Italian immigrant barber back in New England. He and some of his business associates and cronies get together once a month and contribute a nominal sum to a common pot. They then vote on which stocks to buy with that month's contributions.

My barber seemed to realize that this was a strange way to invest in the stock market, but explained that the real point wasn't necessarily to pick winning stocks, but as a forced savings vehicle: if you wanted to hang out with your buddies, you needed to find $50 to save each month, which was enough incentive to get people to save money who otherwise wouldn't bother.

With that in mind, I was excited to stumble across "Pop Finance," an ethnography of investment clubs in the San Francisco Bay Area written by Brooke Harrington. The principle research behind the book was conducted over the course of 1998 — in other words, at the peak of the 1990's tech bubble — with followup research in 2004, in the midst of the Bush Administration stock market doldrums.

Mass participation in the stock market is something that requires explanation

Today, popular ownership of publicly-traded shares, either individually or through mutual funds, is so common that it seems part of the natural order of American economic life. So it's worth pointing out that this isn't the only way that it's possible to save money, whether for retirement, health care, or educational expenses.

To this day, it's perfectly legal to simply save half your salary from age 25 to age 65 in FDIC-insured vehicles like savings accounts and certificates of deposit that earn market interest rates on the money saved. That volume of savings would allow you to then continue spending the same amount of money (half your lifetime salary) from age 65 to age 105, with a little left over depending on where market interest rates happen to fall during your lifetime.

Of course, Social Security exists, so you don't need to replace your entire annual consumption through savings — Social Security will replace 18-90% of your income (depending on your lifetime earnings), so you only need to replace the remaining portion, meaning you can spend more than 50% of your income and still spend the same amount during your working life and your retired years.

A private pension replacing even more of your income would mean even less savings would be required to smooth out your consumption over your entire lifetime.

Harrington convincingly argues that mass participation in the stock market, in her case in the form of investment clubs, was the result of two factors that made the above logic fall apart in the 1990's:

  • Corporate defined benefit pensions were replaced with defined contribution plans, often self-directed and invested in stocks and bonds;
  • Between 1985 and 1995, real wages declined while corporate profits tripled. In other words, for the average American, saving half their salary in FDIC-insured savings vehicles would mean a decline in living standards in retirement, while purchasing "the market" would mean an increase in living standards in retirement, or even early retirement.

Finally, I'll add that obviously the overwhelming majority of Americans today are incapable of or unwilling to live on half their salary. There are many reasons for this: status anxiety, a feeling that they've "earned" the right to enjoy their money, and of course in the case of prosperous coastal cities, the accelerating cost of living.

Ultimately, that means either settling for a much lower standard of living in retirement, or investing in riskier assets with a higher potential rate of return than FDIC-insured savings vehicles.

Day trading is a very intuitive way to invest in the stock market

Once you've decided that the stock market is the only way to secure the lifestyle you envision for yourself in retirement, day trading is the obvious method of doing so: since different stocks move in different directions on a daily basis, by buying stocks before they go up, and selling them before they go down, you can earn more on a daily basis than in a whole year of FDIC-insured interest.

In fact, if your wins are big enough and your losses are small enough, you don't even need to be right a majority of the time! After all, one 10% gain offsets four 2% losses with 2% left over as your profit, not annually, but daily!

Investment clubs are day trading by committee

Investment clubs, like day traders, also purchase individual stocks for short term profits. The problem is that unlike an actual day trader, investment clubs can't react quickly to changes in the prices of their stocks. At the beginning of March a club may vote to buy Pfizer, the stock may peak in mid-March and be lower than where they bought it by the time they get together again in April. And at that point, they have to vote on whether they think it'll do it again!

One club Harrington profiles attempts to deal with this problem by putting stop-loss orders on all their stock holdings: if a stock declines by 20%, they sell the stock — then frequently buy it again at their next meeting, when the price has had time to recover!

This is not a good way to invest

I believe virtually all people should save for retirement in Vanguard target retirement date funds.

But even if you have a different risk tolerance than the ones reflected in Vanguard's target retirement date funds, you probably should implement that risk tolerance through low-cost indexed mutual funds.

But even if you believe that you're preternaturally gifted at predicting the short-term movement of stocks, you should simply act on your gift by buying and selling stocks, not waiting weeks at a time and then spending time convincing your fellow investment club members that you know which direction a stock will move before your next meeting.

But creative forced savings mechanisms are pretty cool!

That brings me back to my Italian barber. He is really convinced that many members of his investment club would save nothing if they weren't saving $50 a month in monthly club contributions.

And at the same time, over a working lifetime, $600 per year invested in the broad stock market really will return more than the same $600 invested in FDIC-insured savings vehicles.

So I'm all in favor of crazy schemes to force yourself to save! Here a few I came up with that make at least as much sense as investment clubs:

  • Every time you withdraw money from an ATM, withdraw an extra $20 and set it aside for a monthly retirement savings contribution;
  • Deposit your credit card cash back rewards into a designated retirement savings account;
  • When you redeem your miles or points for an award trip, deposit the cash value of the trip into a designated retirement account — be your own mileage broker!

A final note on tax-advantaged accounts

It's no secret that I'm a strong advocate for simplifying the US income tax code. Not simplifying it and reducing rates, just simplifying it, full stop.

One reason for that is that the current configuration of tax advantaged savings vehicles (employer-based retirement and health savings accounts, traditional and Roth Individual Retirement Accounts, and the mortgage interest deduction) leads people to spend extraordinary amounts of time gaming the tax code instead of simply saving money.

In other words, once you've maximized your tax advantaged savings vehicles by contributing to a 401(k), IRA, and buying an unnecessarily expensive house, you feel like you've done all the savings necessary (perhaps adding a 529 College Savings Plan as icing on your tax-advantaged cake).

But that's ridiculous: it's perfectly legal to simply buy stocks and bonds. You can invest in a Vanguard target retirement date account in a taxable account, and it will generate the same long-term returns as the identical fund held in your tax-advantaged accounts. You just have to pay long term capital gains on the returns when you eventually sell (although you avoid the 10% early withdrawal penalty on the exact same fund if held in your IRA).

"The $100 Startup" is not a very good book

This is a review of "The $100 Startup," by Chris Guillebeau. For a previous book review, see "Pound Foolish" is a pretty good book.

Chris Guillebeau has a lot of interesting friends and acquaintances

The conceit of "The $100 Startup" is that entrepreneur extraordinaire Chris Guillebeau had a flash of inspiration: everywhere he went, he met people who shared their stories of achieving "freedom" (a concept we'll return to in a moment) through low-startup-cost enterprises: at its most basic, just a website, an e-mail address, and a PayPal account.

So Guillebeau, being an entrepreneur extraordinaire, decided to survey, compile, and analyze the experiences of those entrepreneurs to see if he could identify the general principles which led to the success of their micro-enterprises, and share them with the world.

Unsurprisingly, Guillebeau's profiles of entrepreneurs are the highlight of the book. It is genuinely interesting to read about a variety of ways people are getting by in an era where anyone can be paid by anyone for anything they feel like paying for.

Guillebeau is not a particularly effective storyteller

If that sounds familiar, it's because for the last 15 to 20 years, anyone with access to the internet has access to thousands of stories of entrepreneurs starting with virtually no capital developing successful online products. Many of those articles are well-written and informative for people considering starting their own online businesses.

This is a fascinating topic that has been treated extensively by the news media, which knows a good story when it sees one. But Guillebeau brings no particular expertise to this storytelling project. Rather, he roots around in his survey data until he finds a piece of Talmudic wisdom, like, "Offer an incredible guarantee, or don't."

Well, yes, Chris, those are the options.

For someone supposedly concerned with "freedom," Guillebeau is oddly obsessed with financial success

Guillebeau frames his book as a series of stories, including his own, of entrepreneurs who, often accidentally or via unexpected misfortune, find themselves forced to support their families through small businesses of their own design.

But the more you read, the more you find that he's talking about businesses that are so profitable they replace the income the entrepreneur was earning through traditional employment. In other words, this is a world much closer to traditional entrepreneurship than he lets on: it's ambitious, money-oriented, self-motivated people making middle-class incomes through sole proprietorship.

Here's one of his informants talking about her business philosophy: "Remember that the goal of business is profit. It's not being liked, or having a huge social media presence, or having amazing products that nobody buys...Business is not a popularity contest...There's nothing wrong with having a hobby, but if you want to call it a business, you have to make money" [165].

Needless to say, that philosophy is deeply ingrained in American society — yet Guillebeau appears to believe he can claim to have discovered the profit motive by cloaking it in the language of "freedom."

Of course anyone would be excited to discover that they can make as much money from a small business as they do from formal employment; it's no doubt an incredibly exciting thing to discover. But Guillebeau never gives a coherent explanation for why formal employment is "less free" than self-employment; why making wedding dresses at home is "more free" than making wedding dresses in a factory; why making award bookings for strangers (yes, Gary Leff is one of the case studies) is "more free" than running a North Carolina research center. More profitable, maybe, but that's a much less interesting claim than the one Guillebeau seems to think he is making.

"The $100 Startup" misses the trees for the forest

Guillebeau repeats variations on the following mantra throughout the book: "You can open a PayPal account in five minutes and receive funds from buyers in more than 180 countries" [xvi].

But astonishingly, his only anecdote from an actual entrepreneur using PayPal is devastating: "The problem was access to money. Because Naomi is Canadian but has lived in the United States, the United Kingdom, and elsewhere, she often has issues with her PayPal account being closed as she travels the world, leaving her with plenty of funds in the account but no way to access them" [181, emphasis in original].

Instead of turning this into a teachable moment about the vagaries of using PayPal for your online payments processing (which I'd be happy to tell Chris all about), he describes her borrowing money from a stranger to pay conference registration fees. I'm glad Naomi worked something out, but for your typical entrepreneur who foolishly depended on PayPal for worldwide payments processing, this situation would be simply devastating.

And indeed, the entire book is full of inspirational aphorisms rather than concrete advice on the mechanics of running a small business.

Guillebeau is either gullible or naive about the 1099 economy

Repeatedly through "The $100 Startup," Guillebeau refers to people "deciding" whether to work or employ workers as employees or independent contractors.

Regarding a designer who returned to work after leaving her job to start a small business, he writes, "Also, Tsilli now worked as a contractor instead of an employee, and that gave her an unexpected but important sense of still earning all her income 'on her own,' with roughly half coming from the studio and half from her business" [230].

Regarding a transcription service: "Then she made another key decision: not to hire employees but only hire contractors. By building the team on a contract-only basis, she had more flexibility to increase or downsize the numbers, depending on market needs...(The contractors all understand that the work is cyclical and future projects aren't guaranteed)" [222].

Let me be clear: a wide swath of the American workforce is improperly classified as independent contractors in order to reduce the payroll tax burden on their employers. Employee and independent contractor status is not properly a "decision" made by either the employee or the employer: it's a legal determination based on the facts and circumstances of their employment. And the default, absent a raft of mitigating circumstances, is for employee status.

Guillebeau's studied ignorance of this problem treats the classification as a "business decision." It's not, and he invites abuse by suggesting it is.

I run a $205 startup, and I'm glad I didn't read this book before I started

Over two years into this project, I've made a lot of mistakes, many of which I recognize in the stories in this book (can you say affiliate links?). But if I had in mind the mechanistic, profit-oriented vision this book proselytizes when I started, I don't think I would have made it to my one-year anniversary, let alone still be blogging over two years later.

Guillebeau's vision of entrepreneurship is deadening, profit-oriented, and capitalistic, red in tooth and claw. That's fine: American culture is deadening, profit-oriented, and capitalistic. But his attempt to reimagine that culture and the role of the entrepreneur within it as a lone voice crying out in the wilderness for freedom does a disservice to those who truly reject the relentless pursuit of wealth as the principle goal of life.

"Pound Foolish" is a pretty good book

I recently finished "Pound Foolish: Exposing the Dark Side of the Personal Finance Industry" by Helaine Olen, and thought I'd share some of my initial reactions to the book, since it's a topic that's related to travel hacking in odd ways.

Personal Finance is a fantastically lucrative industry

As someone who has never had the good fortune to pick up one of Suze Orman's exhortations to "stand in my truth" or "own the power to control my destiny," I had no idea this industry really existed at all.

I thought "personal" finance was just meant as a juxtaposition to corporate finance or government finance. It turns out it's something of a term of art for "charismatic salesmen telling you how to live – with an emphasis on buying more personal finance products."

While there are certainly people who need help organizing their finances, the only personal finance advice I've ever followed is pretty simple:

  1. Don't pay interest if you're earning less interest on your investments than you're paying on your debt;
  2. Max out your IRA contributions;
  3. and invest in Vanguard target retirement date funds.

If really hard-pressed, I might add something like "spread your IRA contributions throughout the year to account for natural fluctuations in prices."

That would add up to a medium-length article, but it would make for a pretty short book. Nonetheless, these hucksters write countless books, host popular TV shows, and exhort their followers to engage in unbelievably convoluted schemes, the riskiest of which involve buying real estate speculatively and engaging in options trading with borrowed money (what my brother refers to as "unlimited downside" trading).

No one shares easy ways to get rich on the stock market

The "efficient markets hypothesis" gets a pretty bad rap, but at its core contains a basic truth: opportunities to take advantage of differences between public information and asset prices are vanishingly short-lived.

If a person really knew a sure-fire way to pick stocks or design stock-picking algorithms that invariably resulted in profitable trades, that person would receive a huge salary and even bigger annual bonus implementing that strategy for any one of thousands of investment banks, hedge funds, or sovereign wealth funds – not writing a monthly newsletter or hosting a TV show on a fourth-rate cable channel.

Of course, the real problem is that even if the schemes of personal finance "experts" worked for some or even most people, there's no way to know in advance if you're one of those people.

Olen is right about the little things and wrong about the big things

Olen is absolutely right about all this, as far as it goes. There is, however, an odd current running through the book, of hopelessness in the face of the massed forces of banks, publishing houses, cable news channels, and in-person appeals.

In fact, she more or less endorses a fanciful scheme by Teresa Ghilarducci to replace individual retirement savings with a universal forced savings program. Here's a rundown of the program in Olen's words:

  • "create a pension plan for all of us by having workers and their employers contribute a minimum of 5 percent of pay into a guaranteed account via mandatory automatic deduction;"
  • "all this money would be placed in United States bonds which would promise an annual minimum return of 3 percent above the rate of inflation, so participants would be protected from market downturns;"
  • "And who would manage all this money? Ghilarducci would shift the funds from the retail/commercial sector...to the institutional sector, and to hedge funds that mange our nation's pension monies at a significantly lower cost."

Well, did you see the slight of hand there? The same money that was just invested in United States bonds with a guaranteed rate of return was suddenly being "managed" by the "institutional sector." So which is it: is the money in risk-free Treasuries with a special, higher interest rate, or is the money being "managed" by hedge funds, i.e., invested into markets that fluctuate over time?

What do travel hacking and personal finance have in common?

I view travel hacking as the antidote to the madness that is the personal finance industrial complex. That's because when we manufacture spend, we aren't guessing about the performance of our rental properties or scrambling to find money to pay the mortgage: we see our costs up front and we see our returns every time a credit card statement closes.

When we book award tickets, we easily calculate the value we receive per mile redeemed and compare it to our acquisition (and opportunity) costs, to make adjustments to our miles and points strategy.

So I struggled while reading Olen's book to find the best way to express this fundamental fact: the house can be beat, it just can't be beat through magic. It can be beat through a clear-eyed and thorough evaluation of all the tools available, good organization, and a willingness to change along with the game.


With all that said, "Pound Foolish" is a rollicking good and often funny trip through every part of the personal finance industrial complex, from advisors who are paid based on the number of times they churn their clients' investments each year to the television channels that promote day-trading as a get-rich-quick scheme for the struggling middle class. Pick up a copy at your public library (like I did) or order a copy through Amazon.