Personal finance during the pandemic

Become a Patron!As you may have heard, the world is in the throes of a new, as-yet-untreatable, easily-communicable, fairly-deadly virus. I'm not going to tell you to wash your hands, stay home, maintain physical distance, etc. You already know that, unless you're a dedicated OANN viewer. Instead, I want to share a few suggestions about how I'm thinking about the pandemic from a personal finance point of view.

Don't rush to buy

I am what you might call an indiscriminate buyer of stocks: I contribute to my IRA every week, on the same day (it's Wednesday, if you must know), and receive that day's price. When the market is overvalued and doomed to decades of sub-par returns, I buy. When the market is undervalued and prepared for a huge run-up, I buy. In every market cycle, there will be times when the absolute peak falls on a Wednesday, and I get screwed. In every market cycle, there will be times when the absolute bottom falls on a Wednesday, and I look like some kind of genius. On average, over the next 40 years, I figure my returns will look like the market's: I'll get my share of the profits of publicly traded companies. Definitely no more, but hopefully not too much less.The markets have fallen a lot in the last few weeks — stocks are on sale! But if I max out my IRA contribution today, and the markets fall another 80% by the end of the year, I'll have missed out on 9 months of lows. So, I'll just keep plugging along.

Do rebalance

That being said, if you have a well-diversified, long-term target asset allocation, it's definitely out of whack by now. All but your safest, shortest-term bond funds have likely fallen somewhat, while your stocks have been gutted. That means it might be time to take a look at your portfolio and rebalance your holdings. But remember, you're not trying to "buy low," you're trying to bring your actual asset allocation in line with your target asset allocation.This is true even if both your stock and bond funds have lost value: a 60/40 stock/bond portfolio where the stocks have lost 35% and the bonds have lost 10% is now a 52/48 portfolio. That's not your target allocation, so it makes sense to rebalance back towards stocks. You can think of this as "buying low" if you absolutely must, but that's not the point: the point is to bring the actual risk exposure of your portfolio back in line with your target risk exposure.

If you kept your job (or at least your income)

If you have a job that has to be done during during the crisis, are able to telework, or work for an employer that has been bullied into paying employees while they're stuck at home, congratulations! The good news is, as you've no doubt already noticed, you're spending a lot less money. You're saving money on commuting costs, putting less wear and tear on your clothes and vehicles, and shopping, eating and drinking out less (takeout and delivery only, please!).There is some hope that in the emergency bill forthcoming from Congress we may see unconditional cash transfers to some, if not all, adults and children; the most prominent current suggestions are in the range of $600 to $2,000 per adult. The most ambitious proposal, from Rashida Tlaib, includes recurring $1,000 monthly transfers until the crisis is past.The first, most obvious suggestion in these conditions is to build up a cash cushion, if you don't have one already. You may have dodged the first bullet, but that's no excuse to tempt fate. You may know, in the abstract, you need 6 months of living expenses in safe, liquid assets. But think about what that means: what are you going to use to pay your bills if you don't have any income until November 1? If you don't have an emergency fund already, your first priority should be using the money you're saving to build up that fund. I'd suggest a high-interest rewards checking account, but I'm already a broken record on that front. Keep it under your mattress if you insist, just keep it.Second, support local businesses. I promise you that Amazon, Walmart, Target, and CostCo will still be around in a year. It's not clear that many local restaurants and retailers will be. I'm not suggesting you splurge, and I'm not suggesting you buy gift cards you'll never use as some weird kind of charity (depending on the gift card issuer, the store may not even receive the cash until the card is redeemed). I'm just saying, if you like your local Thai restaurant, see if they're still offering pickup or delivery, and eat some Thai food. If you like your local bookstore, see if they'll deliver or arrange special social distancing hours like Capitol Hill Books here in DC.Third, consider taking out a low-interest or no-interest loan as a supplementary emergency fund. As the economic crisis unfolds, there's going to be a credit crunch, which means the right time to take out a loan is before you need it (and while you still have verifiable income). Lots of credit cards offer 12-15 month 0% introductory rates (I personally like the Chase Slate for this purpose), and home equity lines of credit can still be obtained with very favorable rates. With rock-bottom Federal Reserve targets, interest rates themselves are unlikely to increase, but underwriting standards will grow more and more strict until the credit markets seize up completely. It's better to take out a 0% APR loan you don't need now than a 25% APR loan when you do.

If you lost your job

Whether you're "furloughed," "laid off," "fired" or "made redundant," losing your job sucks, plain and simple. If you lose your job in the face of this crisis, you need to very quickly evaluate your options.The most important, basic assumption is that you're going to be unemployed for at least 6 months. Even in a healthy economy, there's plenty of job turnover: dental hygienists move from one practice to another for better pay, hours or benefits. Construction workers have a few weeks off after one job ends and another starts. Adjunct professors may or may not pick up a class or two between Spring and Fall semesters.This isn't like that. If you are newly unemployed, plan on being unemployed for a while.File for unemployment insurance benefits immediately. Our unemployment insurance system is designed to be deliberately slow, on the assumption that most laid-off workers will receive one or two more paychecks (for the last few weeks they worked), and most unemployed people will be rehired within a few weeks. That means you need to file for unemployment insurance immediately. You still won't receive your first check for 2-4 weeks, but the sooner you set the process in motion, the sooner you'll receive your benefits and be able to develop a plan.Apply for Medicaid immediately. If you have an ACA marketplace plan, or employer-based insurance, you should apply for Medicaid the second you know you're being laid off. Medicaid is premium-free health insurance with no deductibles and no co-pays; it's the insurance all Americans deserve. Fortunately, once you apply you're usually eligible for retroactive coverage, but applying and qualifying can be tricky, and the sooner you start the process the sooner you're likely to complete it. So-called "COBRA" coverage is often suggested as a stop-gap measure, because of its optionality: if you use your COBRA coverage during the period after unemployment, you can pay for retroactive coverage; if you don't, you don't have to pay. Under the present circumstances, this stratagem is absurd: apply for Medicaid immediately.Apply for SNAP immediately. The Supplemental Nutritional Assistance Program is the most comprehensive welfare program remaining in the United States — but the requirements are even more onerous than for Medicaid, and you may need to submit documents multiple times before your state or territory accepts them. Once you're approved, you'll receive a debit-style card that can be used to pay for unprepared food at most grocery and convenience stores.

Conclusion: figure out what you owe to whom

So far, so good, right? Lots of paperwork to fill out, but you've got lots of free time, and most of the documents can be filled out online. Now we need to talk about the serious stuff.If you're a singer, or a dancer, or an orchestra performer on Broadway, you're not going back to work anytime soon. But if you're a singer, dancer, or orchestra performer on Broadway, you're also probably renting an apartment somewhere in the greater New York metropolitan area you can't afford anymore. You do not owe your landlord rent you cannot afford to pay.I want to be as clear as possible: the problem is real. The problem is your newly-limited financial resources. The solution cannot be paying the people who harass you the most at odd hours, or the people who have the most control over your credit report, or the people who threaten to shut off your water, or electricity, or internet, or phone service.You have real obligations to real people: if you have roommates, they might not be able to cover your share of the rent if you bail. But you also have obligations to yourself, your friends, and your family. And as the crisis progresses, the tradeoffs between those obligations are going to require a real moral sensibility.I'm not here to tell you which obligations, to whom, should command your newly-limited resources. That's a question you need to answer for yourself. But I am here to tell you that your new job is to figure out what your moral sensibilities are, so you can fulfill as many of the obligations that matter to you, whether that's to your family, your friends, your roommates, your landlord, or your bank.Become a Patron!

The more unrealistic your goals are, the more of them you need

I got to thinking the other day, as I so often do, after seeing somebody toss off a joke on Twitter. The gag is an asset manager being told by a prospective client, "I need real, net of fee returns of 8%, so I don’t think you are a fit." The asset manager drily replies in .gif form, "Correct." My immediate response was not to the "realistic" or "unrealistic" element of an 8% return, net of fees. My response was to the idea of "needing" one return or another.

What return do you need?

If you want to operate a private space program like Jeff Bezos or Elon Musk, you need many billions of dollars. For the sake of argument, let's say ten billion of them. Now, ten billion dollars sounds like a lot of money, but it's not an impossibly large amount of money. According to Forbes's (always-suspect) list, there are about 150 people in the world with fortunes that large. The formula is simple: you start a company (or, like Eduardo Saverin, be roommates with someone who starts a company, sue him, renounce your US citizenship, and move to Singapore), hire some competent managers, wait for the stock market to get frothy, go public, and presto, you're worth $10 billion.The trouble is, there's no point in operating half a space program. That means if your managers are a little less competent or the stock market is a little less frothy, you might only walk away with $5 billion — not nearly enough to land a man on Mars. If you don't want to strand Matt Damon halfway there, then you need a different goal. For example, the University of California system budgeted the collection of $3.15 billion in tuition and fees in 2016-2017, meaning with $5 billion you could pay the tuition and fees for every student in the University of California system for a year (and still hang on to almost $2 billion).The point is not that financing public education in California is a less worthy goal than sending Matt Damon to Mars. The point is that you can't afford to send Matt Damon to Mars, so you need a backup goal.And indeed, this is a perfectly common situation to find oneself in. On a visit to a steakhouse you might prefer the $150 cut of meat to the $45 cut, but choose the $45 piece anyway because you can't afford the $150 option. It doesn't make your choice "less authentic" or "worse" in any meaningful way; it simply means you've arrived at a particular balance of your preferences and your constraints.

Your goals don't need to be realistic if you have enough of them

At this point you might object that there's a big difference between a $150 steak and a reusable rocket that can land on a platform floating at sea. But I don't see any difference at all: to afford the steak you need another $105, to afford the rocket you need another $9,999,999,955. In both cases, your ability to meet your goal depends on your starting assets, your income, your savings rate, and the return on your investments.Personal finance advice often ends up eliding this by saying the only goal worth thinking about is to acquire "as much as possible." Traditionally, that's been used to mean as much money as possible. "The Millionaire Next Door" became a classic of the genre by observing that even a middle-class income allows healthy white people to accumulate millions of dollars if they live frugally enough. In our own time, the FIRE community turns this logic on its head and says the goal is to acquire as much freedom as possible, i.e. working the least possible amount of time required to liberate oneself from the drudgery of work.If "as much (money, freedom, whatever) as possible" is the only way you know how to think about your goals, then you end up with more or less identical advice: earn as much money as possible, spend as little money as possible, and invest in the most aggressive portfolio you will be able to stick with through market volatility.But acquiring "as much as possible" is obviously not the only way to set goals. Most significantly, it takes all potential goals that decrease your net worth off the table. Giving away a million dollars may feel good for a moment, but it also reduces your net worth by a million dollars, which makes it theoretically indistinguishable from buying a new car, renovating your kitchen, buying organic groceries, or sending your kids to private schools.

Have enough goals to accommodate reality

Fortunately for them, but much to the consternation of personal financial columnists and bloggers, in the real world people seem to have no trouble organizing their lives around multiple goals. People do buy organic groceries, even though they could invest the difference in price. People do renovate their kitchens, even if the renovations cost more than any higher final sale price of their house. People even send their kids to private schools, unfortunately.While I find people are in general extremely effective at forming and executing goals within their means, they don't pay nearly enough attention to "upside risk:" the possibility that their income, savings, and return on investments will dramatically outpace their goals. Of course, setting unrealistic goals is, by definition, unrealistic. You don't want to commit to donating $1 million in 10 years, only to discover that a job loss, unexpected medical expenses, or global financial crisis leaves you with just $250,000.But you also don't want to commit to donating $250,000 and find that your investment has swollen to $1 million, leaving you with $750,000 you can't fathom what to do with. Is that a better problem to have than the reverse? Of course. But there's no such thing as a good problem, and if you find yourself suddenly on the spot trying to figure out what to do with $750,000, you're vulnerable to two serious errors.First, you might simply spend the money foolishly, or not at all. If you check your brokerage statement the same day you get a mail or phone solicitation from the Wounded Warrior Project, you might ship the money off to them to be spent on their lavish headquarters and advertising budget. Worse in its own way is simply choosing not to spend it and passing the problem on to the next generation.But the second problem is one I consider almost as dire: a big part of the pleasure of setting goals is working towards them, and experiencing satisfaction and disappointment as you draw nearer and farther away from them. In my other career as a travel hacker, I see my loyalty program balances rise towards the values I need to book the trips I want to take. Money's not entirely like that: there will always be things to spend as much or as little money as you like on. But the principle is the same: working towards a goal has a satisfaction independent of actually achieving it.

Conclusion: set unrealistic goals!

Most people have a sense of what they will do if their investments end up returning 5% instead of 8%. They'll move to a smaller house, they'll replace the car less often, they'll take fewer vacations, they'll leave less money to their children. But fewer people know what they'll do if their investments end up returning 11%, or 20%, or 100%, instead of 8%. Thinking about that problem sooner, rather than later, gives you more time to formulate the right goals and more time to relish getting closer to them, whether or not you ever end up getting Matt Damon to Mars. 

Five questions about immigration

Immigration has emerged somewhat abruptly and I gather somewhat unexpectedly as a major political issue in 2018 due to the president's decision to end the Deferred Action for Childhood Arrivals program, which offered work permits and reprieve from deportation to immigrants who entered the United States without authorization as children (this group of immigrants is sometimes called "kids" but the population is in fact mostly adults, given the effect of time on the human body).Immigration is an issue that famously divided both political parties for decades, so while these days it's always tempting to retreat into partisan corners, I want to ask five questions relevant both to the current political squabble and to figuring out what kind of immigration policy you actually favor. (Note: these questions deliberately exclude all racist arguments for and against immigration from particular countries. I'm not interested).

What is E-Verify, and should it be mandatory?

E-Verify is a system developed by US Citizenship and Immigration Services to instantly verify employees' authorization to work in the United States. While CIS brags that it is "used nationwide by more than 700,000 employers of all sizes," according to the best data I could scrounge there are about 17 million employers in the United States. So currently, about 4% of employers are enrolled in E-Verify (note that some employers are enrolled but don't use it)."Mandatory E-Verify" is the term of art used by people who think the use of E-Verify should be mandatory for all employers. This has become a key demand of some Republicans in the current immigration debate.Should use of E-Verify be mandatory? Here are some things to consider:

• The overwhelming majority of new hires in the United States are authorized to work here. Remember that E-Verify is designed to detect people who are present in the United States, are not authorized to work here, and are applying for new jobs. This will only ever be a tiny fraction of the total number of new hires. To pick a recent non-seasonally-adjusted peak, in June, 2017, there were 6.2 million new hires; the 2017 low was in February, at 4.4 million. Averaging and annualizing those gives 63.6 million annual new hires. The total unauthorized population in the United States in 2015 was 11.3 million. Assume 50% of those are workers (and not infants, students, the self-employed, and retirees), and 50% of those get a new job each year, and you're forcing 64 million authorized workers to go through E-Verify in order to potentially catch 2.8 million unauthorized workers.
• E-Verify isn't free. In order to accommodate 25 times as many employers, E-Verify would need to radically expand its capacity. This would be very expensive for both the federal government and for employers who aren't able to proceed with hiring due to the overwhelmed system.
• E-Verify isn't easy. I would encourage you, right now, to head on over to E-Verify and set up an account. This time I actually got all the way to the end before I got the error message: "Please verify your input parameters and try again. If the problem persists, contact the help desk. Object reference not set to an instance of an object." Maybe next time.

This is the question I feel most strongly about as an advocate for entrepreneurs and entrepreneurship. Is starting a business too easy? Is hiring your first employee too easy? Is managing payroll too easy? In order to make the process of hiring employees manifestly more difficult for every employer in the country, the benefits would have to be overwhelming. Are they? Or is this just a massive subsidy for payroll firms to add an additional "service" they're happy to provide — as long as companies are able to afford it?

Is it preferable for immigrants to be older or younger?

This is an interesting question that people have extremely strong opinions about, but about which I have no opinion:

• Very young immigrants are entitled to free public education, which makes them more expensive to support initially but also has the potential to better integrate them into American society and culture, possibly giving them higher lifetime incomes.
• Very old immigrants (often parsed as "the parents of US citizens" because they are often able to immigrate relatively late in life through family reunification provisions) have fewer productive working years remaining, but are also able to provide valuable home work like childcare and cost relatively little (assuming they arrive too late to earn enough Social Security and Medicare work credits). They are also, perhaps needless to say, unlikely to commit many crimes.
• Are there "just right" immigrants? If so, what is the right age to permanently relocate to a foreign land? Should we try to guess? Should we try to use our limited and fractured dataset of past immigration patterns to decide which age on immigration is most predictive of lifetime success?

As I say, this is a legitimately interesting question, but one about which I have no opinion whatsoever.

How much education should immigrants have relative to the native population?

If you know anything about immigration, you know that immigrants to the United States are more educated, overall, than the native-born population. So one way to phrase this question is, should we admit additional immigrants until the immigrant population has the same educational attainment as the native population, or should we reduce immigration until the immigrant population has an even higher educational attainment than the native population? How much more educated should an immigrant be than a native-born citizen to be considered worth admitting?Are we willing to pay more for, or give up completely, the childcare, valet parking, landscaping services, construction, and other jobs relatively unskilled immigrants perform?

Is it preferable to have immigrants with or without connections to the United States?

This is a question that I had literally never considered until I recently listened to episode 73 of "The Editors" podcast from National Review and heard Reihan Salam explain why he thought family reunification (or "chain") immigration to the United States was a problem. In every other area of American life, liberals and conservatives are united in believing that family and community are essential to human thriving.But Reihan Salam passionately expressed the view that immigrants should have no ties to the United States because if they do, they'll form communities that keep them from integrating into American culture. This argument is, I believe, totally novel in the history of American immigration policy. Every period of American immigration has been characterized by the formation of communities based on national or religious identity that have provided mutual support as they integrate into mainstream society. I don't know what Salam's vision of scattering isolated immigrants across the country surrounded by strangers would even look like.

Are periodic immigration amnesties a problem?

Until the immigration amnesty of 1986, the word "amnesty" had, as far as I can tell, an exclusively positive connotation. An amnesty was a period of mercy, of slate-cleansing, of rebirth, like the ancient Jewish concept of jubilee.Since then, the word "amnesty" has become a kind of weapon against any attempt to normalize the status of unauthorized immigrants. Even those in favor of such normalization insist that it doesn't constitute "amnesty" since there will be fines and paperwork involved.Immigration "hawks" believe any amnesty has to be accompanied by assurances that it's "the last time," the problem will be solved "once and for all." That's the unfulfilled promise of the 1986 amnesty.But that seems symptomatic of the general conservative pathology of insisting on a final solution for every problem. No matter what immigration compromise is agreed to, and indeed if no compromise is agreed to at all, tourists, students, and temporary workers will continue to enter the United States, they'll continue to overstay their visas, they'll continue to fall in love, get married, and have children. Why should this year's immigration bill be the last bill ever passed? Why should every potential immigrant begin to abide by US immigration restrictions in this year that they ignored in every previous year?The United States is, hopefully, going to be around for a long time. Why do we have to solve every problem we'll ever face this year?

How Ron Johnson’s weird idea for corporate tax reform might work

Senator Ron Johnson of Wisconsin announced last week that he couldn’t support the Senate tax reform bill because it failed to align the treatment of corporate income (which is taxed once when it’s recorded as profit and again when distributed to shareholders) with “passthrough” income, which is taxed only when it is reported on an individual taxpayer’s return. Rather than trying to align the total tax paid on the two forms of income through crazy schemes of allocating certain income to capital and other income to labor, Johnson’s preferred approach is to tax all business income as passthrough income.This is a surprisingly good idea, and if you have the political will to radically reform the tax system it has a lot of advantages over the current Republican proposals. However, implementing it would require a lot of interlocking changes in order to more-or-less replicate the total taxes we levy on corporate profits today. Here’s how I would set up such a system.

Tax dividends and capital gains as ordinary income

Today taxes are paid on corporate profits once at a rate up to 35%, then again on qualified dividends and long term capital gains at a preferential rate of between 0% and 20%. That means the total tax collected on a corporation's profits theoretically ranges from 35% to 55% depending on the precise composition of the corporation’s shareholders: if a corporation happens to have a disproportionate number of shares owned by low-income taxpayers, tax-free or tax-deferred savings vehicles, and untaxed endowments, its profits will be taxed less than a corporation with a disproportionate number of shares owned in taxable accounts by high-income taxpayers.Since the point of Johnson’s proposal is not to privilege one business structure over another, you would want to strip out that difference by taxing all corporate distributions at ordinary income tax rates. Otherwise, profits distributed to low-income shareholders would never be taxed at all (because of the preferential 0% capital gains rate), while high-income taxpayers would see a 64% cut in the taxes they pay on corporate profits, since they would only pay taxes on profits once, at the 20% rate.If a business's profits ultimately belong to the business’s owners, applying the same progressive income tax rates to business income as we do to labor income makes perfect sense: low-income business owners will pay lower income tax rates on their combined labor and capital income, and high-income business owners will pay higher income tax rates on their total income, without the artificial floor created by the corporate income tax.This also has the advantage of obviating the need to distinguish “active” and “passive” ownership, since income, rather than ownership, would become the basis for taxation.

Impose an excise tax on corporate profits distributed to foreign shareholders and endowments

Similarly, if corporate profits were distributed to foreign shareholders without being taxed at the corporate level, they would never be taxed at all, so you’d need to impose an excise tax of 30-40% on corporate profits distributed to non-US persons in order to not create a massive distortion in the ownership of US assets. Presumably our hardworking diplomats could hammer out the details in tax treaties to include reciprocal treatment of such income so foreign shareholders aren’t punished for investing in US companies, and vice versa.A similar logic applies to untaxed foundations and endowments. Currently their income from corporate ownership is taxed when the corporation records it but not when it’s distributed to them; levying a roughly 35% excise tax on such distributions would keep such entities from shielding corporate profit from taxes indefinitely.

Lower the estate and gift tax exemption

The extremely high estate and gift tax exemptions we have today mean that assets in tax-deferred savings vehicles are only taxed once, at the corporate level, and then never taxed again as their distributions and appreciation accumulate before being transferred to heirs tax-free. If we eliminated the tax on corporate profits, then those profits would never be taxed at all. This may be reasonable for small inheritances in order to avoid the administrative hassle of filing estate tax returns, but lowering the exemption to $500,000 or $1,000,000 would ensure that as much untaxed corporate profit as possible is eventually recorded. This could be even paired with a lower rate for smaller estates which are less likely to engage in the elaborate tax planning extremely wealthy shareholders have access to, and therefore more likely to have paid taxes at some point on the corporate profits they contain.You can imagine achieving a similar result by eliminating the stepped-up basis rule but that approach would be much more administratively complex and we’re trying to simplify, not complicate the tax code!

Conclusion

This is one combination of policies that would achieve the dual objectives of treating business income equally regardless of the legal structure the business uses to organize and raising roughly the same amount of revenue from capital income as we do today. I suspect that if completely implemented this combination of policies would in fact raise an enormous amount of revenue which could be used to cut the marginal tax rates paid on all forms of income (if you were so inclined).So, hand it to Ron Johnson: he may not have any idea what he’s doing in the Senate, but the idea of equalizing corporate income taxation with passthrough income taxation makes a hell of a lot more sense than the attempts in the House and Senate to do the opposite.

On mutual understanding

I think that, to a degree that sometimes seems unusual in these heated times, I enjoy reading and listening to people who don't just disagree with me, but fundamentally disagree with me.This is partly because I don't even agree with the people who agree with me, so I get annoyed whenever a Democrat suggests a new means-tested tax credit and I see in my mind's eye the dozens of pages of forms and instructions unfolding before me (see, e.g., Second Lowest Cost Silver Plan, and IRS Form 8962).But it's also because if you listen to people in their own words, they're often making somewhat different arguments than the ones that your own ideological filters pass along to you. Not necessarily good arguments, or bad arguments, just different ones.For example, conservatives in the United States will often pretend to make arguments in public about the size of the US national debt in order to justify their opposition to policies that make healthcare, childcare, or retirement affordable to their fellow citizens. When they do so, progressive media outlets inevitably take great pleasure in pointing out that the size of the US national debt poses no obstacle to conservatives passing enormous deficit-financed tax cuts. This is all very fun and gets people very excited but I think represents purely empty calories of self-righteousness. Since the Republican party does not, in fact, care about the size of the national debt, there are no "gotcha points" in "catching" them not caring about the size of the national debt.On the flip side I think conservatives are quite ill-served in general by their captured media outlets, but when it comes to issues like the North Carolina restroom-access law you see this starkly elevated, with the view being imputed to liberals something along the lines of "Democrats want sexual predators to kill your children." This is, needless to say, not something Democrats want.In other words, you can learn a lot more about your ideological opposition's views by listening to them, instead of listening to how your ideological allies filter their views back to you.As a fire-breathing leftist, I can tell you that I support legally entitling people to use the bathroom that corresponds to their gender identity so that people are not faced with the absurd situation of being thrown out of one restroom for dressing or looking the wrong way or the other restroom for having the wrong anatomy. Given the extremely high level of violence in American society, policing, and criminal justice, explicitly protecting people in such vulnerable situations seems like common sense to me.Likewise, when I read conservatives describing, in their own words and to each other, their objections to Democratic governance, I don't see any indication they are concerned that large amounts of deficit spending will cause interest rates to rise, crowding out private investment (the ostensible economic objection to running large and growing deficits). How could they, given that the Republican party just committed itself to increasing the 10-year deficit by $1.5 trillion? "Catching" people not holding a view they obviously don't hold doesn't have any appeal to me. Rather, in the view of conservative writers, Democratic governance is supposed to be dedicated to the idea that the overall size of the economy can and will be sacrificed in order to give a larger share of a smaller pie to Democratic voters. The preferred Republican alternative is a rapidly growing economy in which an arbitrarily large share of economic growth is accumulated by the wealthiest owners of capital.

Conclusion

This is not an argument that you should "change your mind" or "keep an open mind." I don't think I keep a particularly open mind, and I struggle to remember the last thing I changed my mind about. Rather, it's an argument to try to meet people where they are. If you think Democrats want to station sexual predators in your restrooms, you're not going to have a very generous view of their suggestions for zoning reform. If you think Republicans are relentless hypocrites on deficit spending, you're not going to have a very generous view of their proposal to limit the mortgage interest deduction.But I continue to think that, as a rule, good policies are worth adopting and bad policies are worth rejecting regardless of which ideological quarter they come from. It would, at least, be worth a try.

An unbridgeable divide in American life

I recently returned from a long weekend trip to my hometown (made longer by one voluntary bump and one involuntary missed connection), and have been turning over in my head something that has come to seem more and more important to me.Here it is: small-town life is so obviously superior to big-city or suburban life that the suggestion that big cities or suburbs are better places to live feels like it can only be a strawman argument designed to attract ridicule.Now, I know intellectually that this is not true. I've lived in big cities all over the world since I was 17, and it would be hard to imagine moving back to a small town at this point. But when I interrogate my feelings, I still come to the same conclusion: big cities and suburbs are obviously, patently inferior to small towns — preferably your hometown.This is not, on its own, a particularly striking observation: people prefer the kind of place they grew up. But I think ignoring or dismissing it drives a lot of muddled thinking. For example, it's often suggested with varying degrees of condescension that people living in struggling communities should move to where jobs are available. If all communities of a given type are struggling, however, this is implicitly the suggestion to leave the kind of community you want to live in and move to a kind of community you don't want to live in.Likewise, you can find lengthy exegeses of the problem of affordable housing in America's most economically dynamic cities. It would no doubt be good for America's economy if more people who wanted to were able to live in the places where their productivity is highest. But that's not a solution for the people who don't want to live in big cities, who don't want to move at all, because they like the place they live.You can find truly vile characters like Kevin Williamson of National Review arguing that it is the duty of the poor to move to where jobs are available, and government assistance should be targeted at achieving that goal. But the problem with communities struggling with the loss of manufacturing or mineral extraction jobs isn't that the citizens don't know there are better jobs elsewhere. The push out of small communities is strong and omnipresent (I left town to go to a "better" university even though there's a perfectly good university in my hometown). The "problem" is that people don't want to leave.There's no question you can force people out. The widespread sabotage of state universities and community colleges has been extremely effective at forcing young people with a shred of talent or ambition out of their communities. Allowing trade to devastate small town industry, and making it so hard to start businesses that it's out of reach for most people, has made it hard enough to survive that people do, indeed, pick up stakes and move from the communities they love.But it also comes with costs. People left behind resent the forces that push their children and neighbors out of their communities. Those who leave find themselves in unfamiliar cultural milieux and struggle to adapt to new norms.I've written this from the perspective of a small-town boy, since that's my perspective. But if you grew up in a big city, imagine being lectured your whole life that you should move to West Virginia because that's where the coal mining jobs are. You'd say, "that's crazy, there's no nightlife in West Virginia" (with apologies to West Virginia, it's a lovely place). If you grew up in a leafy suburb, imagine being told you need to move to downtown Las Angeles and that actually having a yard and a spare bedroom isn't all it's cracked up to be. You'd say, "no, actually yards are great."Those of my readers who are libertarian-inclined will no doubt come up with something pithy about life being full of despair and suffering and so economically devastated towns don't deserve any special sympathy. But as long as we're in charge of governing ourselves we have to find a better answer to suffering than that, because if we don't, we might be stuck with the answer those who suffer come up with.

Independently Financed has a Patreon page!

Many people are saying, "sure, I love Independently Financed, but I'm upset there's no way I can express my support in tangible terms, like a monthly contribution."Other people are saying, "Independently Financed is literally the worst blog, but I don't have any way to express my disgust with its author's constant hectoring about entrepreneurship and economic justice."Having listened carefully to arguments on both sides, I've devised what I believe is the perfect solution: a Patreon page!Patreon is a site that takes itself way too seriously, but does perform one important function: it allows people to set up recurring payments to people who produce "content" they want to support. On my other blog I use Stripe and a front-end interface called Moonclerk to perform this function, but the fact is, reliance on a single payments processor makes you subject to that company's cultural, political, or ideological vulnerabilities.So, diversification is crucial in both investing and payment processing!For that reason, I've launched a Patreon page that I hope will appeal to both my fans and my critics. You can find it at https://www.patreon.com/indyfinance.As you can see, for now readers can vote with their wallets for whether this is a good blog or a bad blog. I'm also entirely open to adding features like reader requests for posts on a particular topic, livestreamed videos, or whatever else readers are interested in. So become a "patron" (Patreon has all sorts of annoying terminology you have to get used to), and let me know what you love, hate, or merely tolerate about the blog!

Why do people operate investment vehicles?

There is a question which I find fascinating but which everyone else seems to treat as utterly banal: why do people operate mutual funds, hedge funds, real estate investment trusts, and other investment vehicles for the benefit of other owners and shareholders?After all, if you really believed that a long/short market-neutral trading strategy will generate returns in excess of the market, why would you want to share those returns with anyone else? Moving from a 6% annual return to an 8% annual return will, over the course of a lifetime, make you phenomenally wealthy. What would motivate you to let anyone else in on your secrets?But I listen to a lot of investing podcasts and what I find is not people modestly explaining how they became phenomenally wealthy investing on their own behalf, but rather a range of pitchmen trying to gather assets for this or that investment vehicle — explaining how they plan to use their genius to invest your money.With that in mind, here are my four best explanations for why people run investment vehicles open to outsiders.

Poverty

This is essentially the pitch that William H. Macy's character in "Fargo" makes to his father-in-law: he's got a sweet deal lined up for a parking lot (really sweet), but he doesn't personally have the money to execute it. He wants his father-in-law to provide the money as a loan. His father-in-law, sensibly, answers that while he's willing to pay Jerry a finder's fee, he's not going to loan him the money without an ownership stake — he's not a bank.This is a perfectly sensible reason to seek money from outside investors! Creative, energetic individuals raising money from the wealthy and indolent in order to pursue expensive, lucrative projects is just about as close to the heart of capitalism as you're likely to get.

Greed

I like to say investing will make you rich in 30 years, while selling investing ideas to others will make you rich in 5 years. Investing in real estate is hard work; selling tickets to real estate investing seminars is easy work.A $100,000 investment in an investing idea that returns 10% will double your investment every 7 years. A $100,000 investment to start a hedge fund that charges 2% of $5,000,000 under management will double your investment in a single year.This is essentially the business of sales. The return on your investment doesn't depend on the quality of your investing idea, it depends on your ability to sell the idea to others. If you're a good salesperson it doesn't matter how good an investor you are: you're being paid to sell, not invest.

Risk management

What if you had an investing idea you thought would probably, but not certainly, return more than the market? One thing you could do is split your capital between that idea and the market, limiting your total exposure to each. If you put up only $500,000 of a $1,000,000 investment, you can invest the other $500,000 in the market and hedge your exposure to your alternative idea.I recently read Edward Thorpe's excellent "A Man For All Markets" (review to come next week) and while he never says it explicitly, I gather this is an important concern for him. He thinks but doesn't know he can beat blackjack and roulette. He thinks but doesn't know he can earn excess returns through market-neutral derivatives trading strategies.Since he doesn't know he'll outperform the market, or even have positive returns, he manages his risk by not managing exclusively his own money, but also the money of others.

Economies of scale

When Vanguard launched the First Index Investment Trust (now the Vanguard 500 Index Fund) in 1976, it charged a sales load of 6%. I can't easily find definitive information about its expense ratio prior to 1991, but in that year the fund had an annual expense ratio of 0.2%. Today of course the Vanguard 500 charges no sales load and Admiral shares carry an expense ratio of just 0.04%.What if Jack Bogle had kept his idea to himself, taken his severance package from Wellington and simply bought a market-cap-weighted basket of S&P 500 stocks? It would have been a disaster! He wouldn't have been able to buy round lots, the tracking error would have been astronomical, and he'd be paying brokerage commissions every time he bought shares to rebalance his portfolio.Taking the money of outside investors allowed him to build a more efficient machine for himself (and his investors) to pursue the investment strategy he designed.I think many investment vehicles have this kind of basic logic to them. Even if you are technically able to implement your options trading strategy with your own money and an Interactive Brokers account, you probably can't do so at the scale necessary to achieve perfect implementation. Even a perfectly designed strategy that's guaranteed to produce excess returns across the entire market may fail if you only have the resources to implement it across a subset of that market.

Conclusion

I don't know why Wes Gray runs Alpha Architect, why Jeremy Siegel runs WisdomTree, or why Meb Faber runs Cambria. Presumably it's some combination of all four reasons I mention above, and others I haven't considered.But just listening to these guys talk, you'd come to the conclusion that they're running these investment vehicles as a charitable contribution to the financial well-being of the American public!The trouble is, if someone won't tell you why they're actually doing something, you have to figure it out for yourself — and you might be wrong. If you think Wes Gray got into the ETF business out of poverty, but he actually got into it out of greed, you may invest too much with him. If you think Jeremy Siegel invested in WisdomTree for risk management purposes but he actually invested for purposes of economies of scale, you may invest too little with him.My point isn't to warn you against these vehicles or recommend them to you. It's that unless you know why someone is doing something, you have no basis to decide one way or the other whether what they're doing is in your best interests or not.So why would you invest with someone who can't open their mouth without lying?

Work is broken and we have to fix it - or else

I am a great believer in self-employment, and think many more people should be self-employed than currently are. But I don't think everybody should be self-employed, for the simple reason that not everybody wants to be self-employed. But if work is to continue to be a part of our economic tapestry, then it needs to undergo some major restoration work.

Is work primarily a source of dignity?

Arthur Brooks, the president of the American Enterprise Institute, has led a major rebranding of that institution from one promoting the most extreme forms of Objectivist libertarianism into a softer, gentler giant that frames their agenda in terms designed to appeal to more moderate voters and politicians.A major component of this project has been recasting the dismantling of the welfare state as "pro-work labor market reform." And work, Brooks has been eager to argue, is the key to human happiness.In the New York Times, Brooks wrote, "I learned that rewarding work is unbelievably important, and this is emphatically not about money...relieving poverty brings big happiness, but income, per se, does not...Work can bring happiness by marrying our passions to our skills, empowering us to create value in our lives and in the lives of others."This is work as talisman, endowing the bearer with dignity, self-respect, and the respect of others. While I was glued to C-SPAN on Wednesday watching the Senate debate repealing the Affordable Care Act, Senator Rand Paul of Kentucky made this exact argument:

"Frankly, one of the misunderstandings of this debate is that any Republican is up here talking about trying to take away stuff from those who are disabled, can't work, and do have to have care. That is traditional Medicaid. They will continue to be cared for. Under this, we are talking only about able-bodied people. Should able-bodied people--people who walk around, hop out of their truck--should they be working? Should they be providing for their health insurance? Yes. Can there be a transition zone? Yes. We have transition programs between unemployment back to employment. We shouldn't have people permanently unemployed--people permanently on benefits who don't work or won't work. There should be work requirements. I am not afraid to say that every able-bodied person on Medicaid ought to work. There should be a work requirement. I meet many people on both sides of the aisle who are for that."I don't say they should work as punishment. I think everyone in America should work as a reward. I think work is a reward. I don't care whether you are from the lowest job on the totem pole to the top, to the chief executive. Work is where you get self-esteem. No one can give you self-esteem. Your self-esteem comes from work. I think we are wrong. In fact, I think what we have done--in some cases, we now have multigenerational dependency on government, and they are so distraught and so lacking in self-esteem that it also compounds the drug problem that we have."

The logic of Arthur Brooks and Rand Paul is that unemployment has become too easy, too comfortable, and that by making unemployment painful enough, we can draw more people into the workforce. Importantly, in this framing we are doing so for their own good. The argument is that the unemployed incorrectly believe that they are happier outside the work force, when in fact they would be happier working at a job — any job.

Or is work primarily a source of money?

You may or may not be surprised, depending on your economic background and your own work experience, to learn that actual workers tend to see work very differently: as a source of money, which they can then use to pay their bills and expenses.The Fight for 15 is a movement to increase the incomes of minimum-wage workers by raising the minimum wage.The Center for Popular Democracy is leading a Fair Workweek Initiative to require shifts to be scheduled in advance — and for workers to be paid for the shifts they're scheduled to work.Likewise the workers who lost their lawsuit against an Amazon subcontractor because they were searched at the end of every shift were not suing in order to end the practice of searching them at the end of every shift. They were suing for the money they were owed for the time they spent waiting to be searched.This is not to say that workers are not concerned about dignity. Workers are extremely concerned about dignity! But this primarily takes the form of indignities inflicted on them by their employers and coworkers. Being sexually harassed is an indignity. Having your bathroom breaks timed and monitored is an indignity. There is a college debate argument, typically made by freshman and particularly dense sophomores, that workers should be able to enter into "harassment contracts" which allow their bosses to sexually harass them in exchange for higher wages. In reality, of course, it's the lowest-paid workers and those with the fewest alternatives who are the most vulnerable to workplace abuses.

If work is a source of dignity, we must make it dignified

I have tried to be as fair as possible to both views of work, because I'm not particularly concerned which of the two models of work you personally endorse. That's because whichever version you ascribe to, the fact is that work is failing workers.If work is a source of dignity and self-respect, how can it be that we allow employers to fire workers based on their sexual orientation or gender identity? If work is what lets a woman hold up her head proudly, how can we allow her employer to decide which forms of birth control her insurance will cover? If work is to be a source of dignity, how can we let employers continually violate workplace safety rules? If you, like Rand Paul, believe that "work is a reward," the only acceptable conclusion is a radical reform of our labor laws so that the ultimate fruits of that labor are not death, dismemberment, and disability (find me the dignity in incident #1227660: "One worker died and another hospitalized after being ejected from bucket"). A logical way to make work dignified is by expanding collective bargaining rights, so workers can participate in the creation of work environments that dignify, but certainly more aggressive state and federal oversight of working conditions is indispensable if work is to fulfill its destiny of conferring dignity on the worker.But even more importantly, if work is to be a source of dignity, rather than money, workers will need some other source of money. What form that income should take is not especially relevant. A universal basic income would give workers leverage to bargain for more dignified working conditions, since they would have a fallback option in case of intolerable indignities. A refundable tax credit like the Earned Income Credit could be used to "top up" the incomes of workers, although as currently conceived the EIC creates unnecessary and harmful marginal tax rate headaches, as part of the credit is clawed back with each dollar a worker earns above a certain threshold.Work need not be a worker's primary source of income, but if it is not, we must find something to replace it.

If work is a source of money, we must make it pay

On the other hand, especially if you know anybody who works for a living, you may have the view that people work not to secure dignity and self-respect, but rather money. Here, too, we find that work is not doing its job. If employment is to be the primary or exclusive source of income for workers, then work must produce sufficient income for a worker to survive. Today we have the bizarre situation where:

• prime-age male labor force participation is at historic lows (this is a problematic measure, but it is true);
• the inflation-adjusted minimum wage is 35% lower than it was in 1968;
• and millions of workers hold multiple jobs in order to make ends meet!

If you believe the point of work is to earn an income, then this situation cannot be tolerable. Wages are too low, forcing people to hoard jobs: instead of two jobs going to two different workers, each of whom earns enough to live, a single worker will hold two or more jobs. The worker earns enough to live while the unemployed goes without any income at all.The question of how to make work pay is an interesting one and there is no shortage of suggestions:

• An increased minimum wage, especially one indexed to inflation and without gimmicks like tipped-worker exclusions, would force employers to pay each employee more, enticing more workers off the sidelines into the labor force. Proponents points out this option would also "internalize" to firms the expenses the state currently pays to top up the income of low-wage workers, like SNAP benefits, EIC, and Medicaid.
• Wage subsidies to low-income workers would give employees more take-home pay without imposing additional costs on employers. An advantage of this plan is an increase in employees' income without depressing employment overall. A disadvantage would be "externalizing" to the state the living expenses of low-income workers. There's no obvious reason why the public as a whole should subsidize the country's least productive private businesses.

Conclusion

You may think that the problems and solutions I've outlined here are commonsensical, or you may find them dangerous and incendiary, depending on your prior political inclinations.So let me share one, basic, elementary, essential truth: work is at a critical crossroads. If the return to work continues to be sabotaged by a capitalist class intent on retaining all the profits of industry for itself, and by a political class intent on immiserating workers by destroying, step-by-step, their ability to control the terms, conditions, and yes, dignity, of their employment, then work has no future in America.If you think today's youth lack a work ethic, wait and see what they'll be like once you've completely destroyed work as an institution.

What should I change my mind about?

It's become very fashionable in certain circles to prove your intellectual and critical thinking bona fides by changing your mind about ideas in the face of evidence or arguments to the contrary. In that spirit journalist David Leonhardt wrote this summer challenge in the New York Times, and I'm perfectly game. Now I just need some suggestions.There are some obvious caveats. I'm not going to change my mind about whether women should have control over their reproductive choices because I'm not a lunatic (full disclosure: I also don't think men should be forced by the state to undergo dangerous medical procedures). I'm not going to entertain the suggestion that #actually the GULAG was good.

Maybe restricting housing density in vibrant cities is good?

Personally, I love cities, and wish they'd get a lot denser so I, and others like me, could afford to live in more of them. But maybe I'm wrong! I recently heard Tyler Cowen make what seemed to me a very strange argument that the utter unaffordability of housing in Silicon Valley is a kind of subsidy for the very most creative and industrious people in society.That seems nuts to me right now, but maybe I'm wrong, and housing density is actually bad in economically vibrant cities!

Maybe publicly-funded vouchers for private schools are good?

I went to a public elementary, middle, and high school. It was fine. We had some pretty bad teachers, but it seems to have worked out. That informs my view that public schools are fine and taking money away from them to pay tuition at private schools is a bad idea.Further, it does not seem to me to be factually true that actual human beings at public schools are engaged in cutthroat competition with private schools. Instead, those people just run their schools and try to do the best job they can, like everybody else on Earth.But maybe I'm wrong and #actually it would be good for public school teachers to be constantly worrying about losing their jobs if they can't force their students to learn as much as the parochial school across town does.

Other ideas

I have a lot of strongly-held opinions! Maybe they're wrong:

• maybe self-employment is #actually bad and more people should be employed in traditional full-time jobs by large firms;
• maybe unions are #actually bad and people are better off when they don't have the ability to collectively bargain over wages and work conditions;
• maybe the complexity of the tax code is #actually good and the vast tax-preparation, tax-avoidance, and tax-evasion industries are a net positive for America or the world;
• maybe widespread police violence and violations of civil liberties are #actually the only thing standing between civilization and anarchy and we should stop struggling against it.

These are views that appear to me to be widely held by huge numbers of Americans. Maybe they're right and I'm wrong!So, what should I change my mind about?

How can you be paid to take risks you don't understand?

Let me state right off the bat: I love alternative investments. Today there are a huge range of opportunities to invest outside of the public markets, and I've written about some of them in the past:

• Wunder Capital. You can buy unsecured notes from Wunder Capital that are paid back from repayments on solar panel installation loans.
• Rich Uncles. Rich Uncles is a non-traded REIT that invests in commercial real estate and passes the rent through to investors each month.
• Lending Club and Prosper. The original crowd-funded loan marketplaces let you contribute to personal loans made to individual borrowers.
• Kickfurther. You can contribute to inventory purchased on behalf of small merchants, and are paid back as the inventory is sold.
• Kiva. It's kind of hard to describe what Kiva does, but basically you can claim the principal repayments of loans made to individual and groups of borrowers around the world (you don't earn any interest, but can fund transactions with rewards-earning credit cards).

Why, you ask, would anyone invest in one of these vehicles? Good question!The primary reason these vehicles are attractive is that they offer the possibility of higher returns than investments on the public markets. I say they offer that "possibility," but in fact they seem to practically guarantee it in their public advertising. Wunder Capital's "Wunder Term Fund" has an "Annual Target Return" of 8.5%. What does that mean? Well, once you open an account you can read the offering memorandum, where you'll find out your notes are a "risky and speculative investments," that you "should not purchase Notes unless [you] can afford to lose their entire investment," and that the notes "are not secured by any assets of Issuer or any other party, including the Underlying Loans."A second reason you might invest in one or more of these alternatives is out of a belief that the investment is uncorrelated with your other investments. For example, you might think that homeowners will continue to repay their solar panel installation loans even if the stock market experiences a sustained drawdown.And of course many of these investments have some kind of emotional hook, like investing in environmental sustainability, women in the developing world, or small businesses.

Return is supposed to correspond to risk

When financiers and academics get together they meticulously calculate what they call "risk," which is generally used to refer to the amount an asset's price fluctuates (either up or down). Since "riskier" assets offer the possibility of loss if the owner is forced to liquidate them (since the asset might be fluctuating down at the time of sale), the owner demands a higher return on their investment.You'll sometimes hear about the "equity risk premium," which refers to the added return investors demand to hold stocks instead of less-volatile bonds, but you can call anything a "risk premium:" long-dated bonds have a "duration premium," lower-rated bonds have a "credit premium."Alternative investments pay a lot of premia! Wunder Capital's Wunder Term Fund 8.5% "Annual Target Return" logically is the combination of an issuer risk premium (Wunder Capital could go bankrupt), a borrower risk premium (homeowners could stop repaying their loans), a liquidity premium (investments can't be liquidated until the 84-month term is up), a duration premium (if interest rates on safe bonds go up in the next 84 months then the value to investors of the risky Wunder Term Fund will fall due to higher risk-free returns elsewhere), and probably a couple more I'm forgetting.

You will never know if you're being paid enough for the risks you're taking

The problem with these investment vehicles is not that they're risky. Risk is lucrative! The problem is that they are so illiquid that there is no meaningful way to determine if you're being paid appropriately for the risks you're taking.If you invest in a fund with an 8.5% "target return" that actually does return 8.5%, were you overpaid for what was, in fact, a risk-free investment? If the investment instead becomes worthless were you underpaid for what was, in fact, an extremely risky investment?It's impossible to say because there's no way to measure the fluctuation of the liquidation value of the asset, so there's no way to determine what kind of return it merits. Even the secondary market for Lending Club notes doesn't give insight into the market-clearing price of notes over time since notes themselves aren't fungible and a given note isn't always for sale (many, if not most, notes are held to maturity).

I love alternative investments, but not these

When I say "alternative" investments I mean everything outside the publicly traded markets, and it turns out there are a lot of things outside the publicly traded markets. On a recent podcast episode I heard a financial independence blogger say that he had earned $40,000 in the previous year from his blog (selling credit cards, I assume). Well, to earn $40,000 from Treasury bonds you'd need about $1.34 million worth at 2.99% APY. Writing a financial independence blog is a highly risky, illiquid asset, so you can slice and dice the return however you like: maybe he has a $670,000 asset yielding 6%, or a $335,000 asset yielding 12%. Obviously I'm not talking about return on invested capital — the website probably costs a few hundred dollars a year to run. Rather, I'm talking about the risk-adjusted, capitalized value of the income stream.The fact is, there are countless opportunities to deploy capital outside the public markets in order to earn a higher return without introducing the risks involved with the prepackaged alternatives I listed above. If you want to invest in real estate, invest in real estate (I recommend Vanguard mutual funds, but obviously you can just buy houses and stuff too). If you want to get paid by homeowners who install solar panels, become a solar panel installation technician. If you want to invest in retailing knick-knacks, become a knick-knack merchant. These aren't risk-free investments — that's not the point. Rather, these are investments where the risks are apparent and, most importantly, you receive the entire risk premium without having to divvy it up between middlemen.If you're not happy that the Federal Reserve has depressed the return on publicly traded assets, you have two options: you can invest more in the public markets to make up for lower forward-looking returns, or you can take the hint and seek return elsewhere.

Is your car a cost center or a profit center?

I've been catching up on some episodes of a podcast targeted towards financial independence enthusiasts called ChooseFI. The hosts make up for a fairly rudimentary understanding of money with a ton of enthusiasm, which makes it fairly enjoyable depending on the episode. In a recent episode they started talking about car ownership, and something clicked with me about how people both inside and outside the FIRE community understand, or misunderstand, car ownership.

Why do people own houses?

I've written before about the appeal of real estate investing to early "retirees," but that's a small part of a bigger question: why do people own houses at all? The most straightforward answer is that since people need somewhere to sleep at night and keep their stuff, they have a need for a finished product we normally call "housing."Of course there are multiple ways to purchase that finished product, the two most common being renting and owning a home. There's an important difference between the two, however: when a renter pays rent to the provider of their housing, the provider has to treat the payment as taxable income. When a homeowner provides herself with the finished product, the exchange is tax-free. Homeownership is, in this way, an extremely lucrative tax shelter: by requisitioning needed housing from assets held by the household, the conversion of the asset into income is completely shielded from taxes. In the economics literature this is referred to as "imputed rent:" the rent a homeowner doesn't charge herself, doesn't receive from herself, and doesn't pay taxes on, to live in her own home.

Why do people own yachts?

Yachting, I'm given to understand, is a wonderful hobby. Wealthy people who enjoy spending time on the water with friends and family purchase or rent yachts in order to fish, swim, or play basketball.What yachts are not, however, is a way to generate the finished product of shelter (admittedly, if I personally owned a yacht I'd probably live on it). Yachts are a depreciating asset that is used for recreation, like tennis rackets or golf clubs.

A car is an asset that converts energy into transportation

Financial independence enthusiasts typically frame the question of car ownership something like this: "is it better to pay more in rent to live within walking or biking distance of work, or pay less in rent but be forced to own a car in order to get to work?"In other words, you can tally up your total expenses for housing and car ownership under both circumstances, and the one with a lower total cost is your best bet for achieving financial independence, leaving as it does more residual income to invest.The problem with this framing is that it treats your costs as variables but your income as fixed. And indeed, this is how most people go through life: given a job, what is the most cost-effective way to build your life around that job?A different way of looking at car ownership is that on-demand, independent, self-contained automotive transportation is an extremely valuable intermediate good in its own right. Transportation to your workplace is an important input into your ability to work and receive income. Transportation can be converted directly into cash using apps like Uber or Lyft by offering rides to strangers. And transportation is an intermediate good in many other kinds of money-making schemes, like sourcing products cheaply to resell at a profit.Being someone else's employee lends itself to the first, cramped view of car ownership: "I need a car to get to work, so a car is an expense I have to incur to get paid." Being self-employed, the true value of car ownership is much more obvious.For example, when I lived in Wisconsin, I had a credit card that allowed me to earn thousands of dollar a month on certain purchases. The merchants involved were spread so far apart that I needed to use a car to efficiently travel between them each day. The gas and depreciation of the car weren't a cost center for me, they were a profit center: the car was an asset that allowed me to convert gasoline into transportation, which I used to visit merchants and earn money.Note that I wasn't forced to own a car. I chose to have and use a car because the car gave me access to income in excess of the expenses of driving and maintaining the car.

Is your car more like a house or a yacht?

Homeownership is a tax-advantaged way of securing housing.Yacht ownership is an expensive way to relax.For most people, car ownership plays both roles. Commuting to work in a car you own is tax-advantaged in the same way homeownership is: if you took a cab the fare would be taxable income to the driver, if you took a public bus the driver, mechanics, civil engineers, and others would all pay taxes on the income your fare contributes to, while you don't have to pay any income tax on the imputed fare you provide yourself with.Car ownership can also be an expensive way to relax: the closer a substitute a bus or train would be for car ownership, for example a car owner who lives directly above a subway station, the more car ownership will seem like an expensive extravagance, like yacht ownership.The question, then, is not whether you can arrange your life such that car ownership becomes unnecessary. Of course you can. The question is whether the acquisition of an asset that gives you access to on-demand, independent automative transportation is worthwhile given the opportunities you have available to convert transportation into income.

What should stocks cost?

As you may have heard, US stocks are expensive. You may even think you know what that means. Personally, I have no idea.I buy organic milk. Organic milk costs more than milk from corn-fed antibiotic cows. In other words, it's "more expensive."I buy t-shirts made by union workers in downtown Los Angeles. They cost more than t-shirts made in Southeast Asian child labor mills. They're "more expensive."But when I buy US stocks by making contributions to the Vanguard 500 fund I hold in my IRA, I don't know what the point of comparison is supposed to be. You can tell me the Russian stock market has a lower price/earnings ratio than the US stock market, but Apple isn't listed on the Russian stock market; it's listed on the US stock market. You can tell me that the price/earnings ratio of the US stock market used to be lower than it is today. But I don't live back then, so I can't pay the historical low price, or even the historical average price, for US stocks. The only price I can pay is today's price. Is today's price "expensive?" Compared to what?

Stocks, flows and stocks

Say you happened to enter the workforce in March, 2009, and started directing monthly contributions into an IRA invested entirely in the Vanguard Total Stock Market Index Fund. Every single one of those purchases in the last 8 years has been "expensive" compared to your original purchase: you've received fewer shares per dollar contributed to the fund. Why would anyone pay $58.19 for a share that's identical to the one they used to pay $16.43 for?That being the case, you might arrive at a sensible conclusion: "there's no way I'm paying that much for a mutual fund share that I used to be able to buy for $16.43. I'm not going to buy a single share more until the price falls to something more sensible."But that leaves you with an obvious dilemma: all those other lunatics are willing to pay you $58.19 each for shares you purchased starting at $16.43. If you're not willing to pay such a ridiculously inflated price, and are waiting for prices to fall, why not unload your shares now and hold onto the cash, "dry powder" for when the market finally comes to its senses?

What should stocks cost?

There is a very fashionable line of inquiry that asserts that the historical average Shiller CAPE ratio of "about 15" is a kind of dividing line between an "expensive" and a "cheap" stock market. Does that mean stocks should cost 15 times their inflation-adjusted 10-year average earnings? I don't know anyone who would agree with that. For one, it means any company that has run a loss on average over the last 10 years is worthless. Whatever you think about Amazon's business model, clearly the warehouses, technology, and patents they own aren't worth nothing.You're free to say that I'm being ridiculous, and that while an individual company's "correct" share price can't be calculated so mechanically, the correct price of an entire market can be, averaged as it is across so many different companies.But if it's ridiculous to use such a mechanical calculation for an individual stock, it's equally ridiculous to use it for the stock market as a whole, which is of course composed entirely of those individual stocks.

Why own stocks?

No one would ask "how much should a car cost?" without first asking "do I need to buy a car?" No one would ask "how much should a coffee machine cost?" without first asking "do I need a coffee machine?" But plenty of people are willing to ask "how much should stocks cost?" without first asking "do I need to own stocks?"The reason I own stocks is in order to have a broadly diversified, inflation-protected income stream denominated in my home currency. Stocks will not make me rich (nothing will make me rich), but owning a very broad swathe of US stocks will give me access to the overall profits of the publicly-traded US economy.

Publicly-traded securities are a weird thing to own if you have other options

The great democratization of the stock market in the latter half of the 20th century, spurred on by the adoption and growth of 401(k) and IRA accounts, has obscured a much older and more fundamental truth: people invest in securities when they are out of other things to buy.After all, cobblers did not historically own stocks: they owned shoe stores. Blacksmiths did not own stocks: they owned smithies. Even lawyers didn't own stocks: they owned law firms. The idea that ordinary people, and even professionals, should own stocks instead of investing in themselves or their businesses is a relatively new phenomenon.That's worth remembering when deciding whether to buy stocks or not, however much stocks cost. If you have credit card debt accruing 21% interest, you should pay it off before buying stocks no matter how cheap stocks are. If you have a business idea that needs capital, you should pour capital into it before buying stocks.Of course, most people today don't own their own businesses. They're employees, they're paid a more-or-less fixed wage, and they have to decide how to save their excess income. My point is that when determining what to do with that excess income, the past performance of a given market is largely, if not entirely, irrelevant. You should decide whether or not you need to own stocks before the question of whether stocks are "expensive" or not can even begin to become relevant.

Demographics, inflows and outflows

Finally, I want to mention a topic that some people seem to believe has unusual explanatory powers: the question of demographics and market flows. The simplest version of this theory goes that aging Americans today, who have accumulated a vast treasure trove of assets, will begin to sell off those assets as they enter and proceed through retirement, forcing down asset prices and crushing the US stock market, impoverishing their children and grandchildren who are still investing in that market.This is an excellent theory with absolutely no logic behind it. A senior citizen who sells a share of Berkshire Hathaway at $245,000 in order to spend $245,000 in the US economy has liberated $245,000 in idle capital (from the person they purchased the share from) and converted it into $245,000 in consumption. The fact that the sale puts marginal downward pressure on the share price of Berkshire Hathaway is offset by the marginal increase in expenditures by the seller, raising the market's overall earnings.Now, it is certainly true that the across-the-board aging of the US workforce needs to be offset by increased immigration and births by people living in the United States in order to ensure the continued prosperity of the country, but the conversion of capital assets into cash, which is then spent on consumption, cannot on its own have a large negative effect on the earnings of US companies. Their decreased share prices will be precisely mirrored by increased earnings when that cash is spent.

All-in margin account rates at Robinhood and IB

I've written elsewhere about the Robinhood app and Robinhood margin accounts (branded as "Robinhood Gold"). One issue raised on the Saverocity Forum was that Robinhood's margin interest rates were high compared to those offered by Interactive Brokers, generally considered one of the cheapest sources of margin credit for retail investors.I looked into it, and there are a couple moving pieces I think are worth mentioning. I'm not thrilled by the pricing disclosure of either site, so if there's something I'm missing I hope readers with more experience will chime in.

Robinhood Gold's flat margin lending APR

Robinhood's margin lending product is unorthodox, and presumably they hope to make some profits on the confusion induced from that weirdness, but the basic premise is simple: you pick the amount of margin credit you want Robinhood to extend, and you pay a flat fee for it whether you use it or not.I can pay $120 per year for $2,000 in "Gold Buying Power," i.e. margin credit, on the Robinhood trading platform. That works out to a 6% APR, although any unused Gold Buying Power doesn't reduce the amount paid. If you only use $1,000 of your $2,000 limit, you'll end up paying 12% APR, for example.Since Robinhood doesn't charge for domestic ETF and stock trades, that gives you a flat margin lending APR that you know in advance (as long as you use your entire margin credit line).

Interactive Brokers' layers of fees and interest

The thing said, both by Interactive Brokers and by their defenders, is that their margin lending rates are much lower than their competitors. This is true. Using their margin interest calculator, the same $2,000 margin credit line that would cost $120 per year at Robinhood would cost just $48.20 at Interactive Brokers.But Interactive Brokers, unlike Robinhood, doesn't offer commission-free trades. Not only that, but if you don't earn Interactive Brokers $10 per month in commissions, they'll charge you the difference!That means you are guaranteed to spend $120 per year — the same 6% APR Robinhood charges on a margin line of credit of $2,000 — plus your margin interest, in order to take advantage of Interactive Brokers lower margin interest rate.

Of course there's a breakeven point

Interactive Brokers' margin lending rate is so much lower than Robinhood's that even with the fixed overhead cost of $120, you quickly reach the breakeven point between their service and Robinhood Gold: at $3,342 in margin, to be precise. By the time you got to Robinhood's next threshold of $4,000 in margin (costing $240 per year) you'd save $23.60 with Interactive Brokers' $120 annual fee and $96.40 in interest.

Which service to use depends on both your needs and expectations

Interactive Brokers, as far as I can tell, is a profitable company that is able to leverage its scale to offer lower costs to its customers.Robinhood, as far as I can tell, is a deeply unprofitable company trying to seize as much market share as possible while it's still being pumped full of cash by its early-stage investors, hoping to eventually raise prices and become profitable.None of that matters to you, per se: your securities are insured on either platform, whether one or both eventually goes bust. What might matter to you is that in order to get and retain market share, Robinhood might keep its margin lending rates lower longer than Interactive Brokers does. If that's the case, then Interactive Broker's interest rate might creep up high enough to make Robinhood the cheaper source of margin credit, once you take Interactive Broker's flat monthly fees into account.

No, you still shouldn't buy the dividend

Finance, like many professions stocked with men trying to impress each other, has accumulated a plethora of cliches like barnacles on the hull of a ship. Among the hoariest is the admonition, "don't buy the dividend." Since I, personally, love dividend-paying stocks, not because of their "outperformance" or their "value" but simply because they pay dividends, I decided to check whether or not "buying the dividend" really is a bad idea.

Why buying the dividend shouldn't work

In a stock market that has already perfectly priced in every participant's expectations of the future, you might expect share prices to be stable as well. Not so! In fact, in such a market each day share prices should increase by the discounted value of their dividend payments until the final day when owners are eligible to receive that dividend. The next day (the ex-dividend date), the share price should fall by the amount of the dividend, before starting to gradually rise up until the next eligible payment date.This is, in fact, what you see in mutual funds whose net asset value is calculated at the end of each day. The mutual fund's value is the sum of the shares it holds and the cash dividends it has accumulated for distribution; upon distribution, the cash value falls to (or near to) zero and the net asset value of the fund likewise falls. Shareholders receive the difference in cash, which they can reinvest or keep, thus leaving the account value unchanged.

Why buying the dividend might work

One reason why buying the dividend might work is that, in general, stocks are very volatile but tend to go up in value over time. Let's take a stylized example: there are roughly 63 trading days in each quarter. A stock that pays a dividend of $1 per quarter, according to the logic above, should rise in value about 1.6 cents per trading day, before falling $1 on the ex-dividend date. If the stock typically moves $2 up or down on any given trading day, but moves up 60% of the time and down 40% of the time, then 40% of the time the stock will drop $3 on the ex-dividend date (the normal volatility of $2 plus the decreased intrinsic value of $1) while 60% of the time the stock will similarly gain $1. Since in either case you get to keep the $1 dividend, your expected value should be $0.40 per share.

Why it would be nice if buying the dividend worked

The reason why it's worth asking whether buying the dividend works is that it would be a way of capturing the dividend yield of a stock with very little exposure to its underlying risk — just four days per year in the case of a stock that pays dividends quarterly. In an extreme case, if a stock's price was completely indifferent to its dividend payout schedule then the stylized case above would have an expected value not of $0.40 per share, but rather $1.40 per share: the $1 dividend plus the $0.40 expected value of a single day's ownership.You could quickly jump from one stock to another and use the same money over and over again to buy as many dividends as possible each quarter, or you could put the money in a high-interest savings account the 246 trading days of the year your stock of choice isn't about to go ex-dividend.

But buying the dividend doesn't work

Anyway, since I take money literally, I decided to see whether buying the dividend does or doesn't work. My methodology was simple, since a purely mechanical trading strategy like this needs purely mechanical rules:

• I took the 52 companies on this list of S&P 500 "Dividend Aristocrats."
• I sorted them by their nominal dividend payout, on the grounds that the highest nominal payouts will appear most clearly in the stocks' historical price data.
• For the top ten stocks ranked by nominal dividend payout, I looked at the last 4 dividend payouts. This usually meant going back 4 quarters, but in the case of annual or biannual dividend payouts I looked back further.
• For each of the top ten stocks, I looked at the opening price on the last day investors were eligible for the dividend, and the opening price on the ex-dividend date.

To implement this strategy, you would place a market buy order before the market opened the day before the ex-dividend date, then a market sell order before the market opened on the ex-dividend date. You'd be exposed to one day of market volatility, either positive or negative, and receive each company's dividend. Here's what I found:This is just about as close to a random walk as you're gonna get in the real world:

• 5 of the 10 companies showed a profit buying the dividend and 5 showed a loss.
• 21 of the 40 datapoints showed a profit and 19 showed a loss.
• 3 of the 10 companies showed a profit on 75% of datapoints.
• 5 of the 10 companies showed a profit on 50% of datapoints.
• 2 of the 10 companies showed a profit on 25% of datapoints.
• Interesting, none of the companies showed a profit on all four of their datapoints.
• On the other hand, the entire loss of the strategy is accounted for by a single company: Sherwin-Williams. With that company's dividends excluded, the strategy flips to a positive $1.63 return!

Conclusion

I think the best way to think of this strategy is as a negative-expected-value gamble but with only a modest house edge. To take an analogy from craps, it's like making a come bet on every roll once a point has been established: you'll lose money over the course of an evening, but you'll win a little bit back every time you seven out, which helps take the sting off.

What would you do if the risk-free rate was 7%?

While it's a cliche to say that investors have short memories, I'm frequently surprised to realize just how short most people's memories are:

• I'm old enough to remember when the United States was running a budget surplus and the chairman of the Federal Reserve endorsed a tax cut because of the risk of the debt falling too low.
• I'm old enough to remember when mortgages were so easy to obtain that "flipping houses," literally just waiting for local real estate prices to increase before selling a piece of property onward to the next speculator, was treated as a legitimate business enterprise.
• And I'm old enough to remember when PayPal offered a money market account paying over 5% APY on your entire balance.

I do not know if we will ever see such a high interest rate rate environment again. To get there from here would require 4 years of economic growth with a 1 percentage point rise in rates each year, 2 years of economic growth with a 2 percentage point rise in rates each year, or 1 year of economic growth with a 4 percentage point rise in interest rates this year. I don't think that will happen, and indeed I don't think the United States will ever experience 5% APY interest rates again.But what if it did?

 

What is the point of investing?

This is a post that I've thought about writing in a number of different ways, and that I suspect I will write in a number of different ways. The fundamental question I'm interested in is this: what is the point of investing? Is it to achieve lifetime spending goals, with a margin of safety based on the risk of an unexpectedly long lifespan? Or is it to accumulate as much money as possible?Establishing an objective is essential if you're to identify what behavior is most likely to achieve your objective. This may sound trivial, but is in fact absolutely essential to the entire enterprise of investing. Consider the following two scenarios:

• A person making $25,000 per year wants to retire in 30 years with $1,000,000 in savings;
• A person making $1,000,000 per year wants to retire in 30 years with $1,000,000 in savings.

The first person needs to save 57% of their income compounded at 5% per year for 30 years to achieve their goal. The second person needs to save 10% of their salary compounded at 0% per year for 10 years to achieve their goal.There is no reason for the second person to take any risk at all with their savings: They can easily achieve their savings goal through mechanically adding to their savings each year from current income.

Don't scoff at the risk-free rate of return

 Today, the risk-free rate of return is about 0.91%. That's the rate of return that you're guaranteed, in inflation-adjusted dollars, by buying a 30-year TIPS bond today.That's very low!On the other hand, it's guaranteed to keep up with inflation, and a million dollars is a lot of money. It seems perfectly reasonable to me that the first million dollars a millionaire earns should go into a 30-year TIPS bond that's guaranteed to keep up with inflation. That way, in 30 years, they'll still be an inflation-adjusted millionaire no matter what happens.On the other hand, the first saver above can't settle for a 0.91% APY real yield. Saving the same 57% of their income as above, after 30 years they'll have just $496,000 in savings, over 50% short of their goal. "Clearly," that saver needs a more aggressive investment portfolio, including domestic equities, international equities, emerging markets, real estate, and whatever else you think belongs in a "balanced, diversified portfolio" or whatever today's nostrum is.But what if the 30-year real yield on TIPS was 5%? Of course if the risk-free rate were that high, you'd have to assume stocks were badly beaten down, the world was in a state of depression or war, and blood was in the streets — the perfect time to invest in an aggressive portfolio. But why? If your goal can be achieved with less risk, what is the purpose of taking on more risk?There are many possible answers. Here are a few:

• To spend more in the present. If you can exceed your investment goals by taking on more risk, you can reduce your savings and spend more out of current income. This is sometimes referred to as "lifestyle inflation," a term that always makes me chuckle.
• To increase your margin of safety. Remember we're talking about inflation-adjusted dollars here, but certainly you may decide over the course of your investing career that one million dollars really isn't enough to retire on, what with the increasing cost of prescription drugs, the war on health insurance, the deportation of our low-wage nursing home workers, etc. If you think you can accumulate $1.25 million, why not do so in order to be on the safe side?
• To pass down a larger estate to your heirs. Many people want to leave their partners and dependents a heap of money after they find out what happens next. If that's your goal, then your investment portfolio might be perpetually focused on earning a rate of return above the risk-free rate.

What will you do if you achieve your financial goals ahead of schedule?

Pick a large-capitalization stock today and you'll find someone has written an almost identical cliche about it:

• "An investment of $1,000 on Berkshire Hathaway's estimated 1964 stock price in 1964 would have generated over $9.98 million."
• "if instead of paying $2,495 for a Macintosh in 1984 and customers put that money into Apple stock, their shares would now be worth $715,943, or more than $710,000 after fees."
• "if you would have invested $5,000 in Walmart stock (WMT) at the beginning of 1976 and reinvested all your dividends into more Walmart stock, 30 years later you would have over 5.4 million dollars today."

These are literally just the first three companies I thought of. My question is, what if you do buy the Berkshire Hathaway, Apple, or Walmart of tomorrow and see your investment soar beyond your wildest dreams? Should your goals change as your net worth does? Maybe $1,000,000 sounds like a lot of money, but if you reach that amount of savings at age 40, maybe you'll decide that a million dollars actually isn't cool — a billion dollars is.

If the risk-free rate of return were 7%, your financial advisor's charts would be correct

Google "benefits of compound interest" (I did) and you'll find some inspiring charts about the value of your account, smoothly sailing upward over time as the interest on your interest makes you wealthy beyond your imagination (not to mention right on schedule). And then if you zoom in close enough, you'll see some fine print tucked away somewhere reading "assumes a 7% annual return."Assumptions, as I like to say, are fun. But what if the risk-free rate of return really were 7%? What if you could lock in those inflation-adjusted returns for years or decades? What purpose, then, would a diversified, well-balanced portfolio of stocks and bonds serve?

Conclusion

All of this brings me back to the question posed in the title: what would you do if the risk-free rate were 7% APY? Would you save less? Would you retire earlier? Would you chase riskier assets in pursuit of a "risk premium" you don't need? Or would you sit back and actually watch your assets climb your financial advisor's compound interest graph?

 

What is, or might be, a pension crisis?

A spectre is haunting the United States — the spectre of pension crises. Since "the pension crisis" is on the lips of policy-makers around the country, I think it is well worthwhile taking a moment to discuss what is, what might be, and what is not a pension crisis. For additional details I recommend this recent Haas Institute paper on public pensions.

Pensions are a mechanism to save money

Today, in the throes of this supposed crisis, pensions are treated as an unaffordable luxury extracted by lazy employees from their unwitting employers.This is dangerous nonsense.Consider the following stylized example: the going rate to employ a firefighter is $60,000 per year. You could, of course, pay the firefighter $60,000 per year. Or you could pay the firefighter $30,000 per year and offer $30,000 in pension benefits. The firefighter still receives $60,000 per year, but your out-of-pocket expenses are just $30,000 per year. Pensions are a way to save organizations money by deferring their payroll expenses into the future.Of course, the firefighter would only be willing to make this deal if she were assured that she'd receive the value of that $30,000, with a reasonable rate of return, in future income. An organization guaranteeing a 5% rate of return, but assuming a 7% actual rate of return on its investments, is able to save money on its current payroll expenses by deferring them into the future at a discount. This is the iron logic of pension accounting.

Public pension funds are a convenient but unnecessary expedient

The current conversation around the pension crisis revolves around the ratio by which pension funds are "fully funded," that is to say, able to pay out all the benefits they're obligated to provide.But pension funds themselves have nothing to do with the underlying mechanics of pension obligations. This is illustrated most clearly by the largest US pension fund: the Social Security trust funds.All the money paid in Social Security taxes in excess of the current payouts of the program are used to purchase Treasury bonds, which are assigned to the Social Security trust funds. The demand for those Treasury securities by the Social Security trust funds decreases the market rate of interest the United States is forced to pay on its debt obligations.It is true that excess Social Security funds could be used to purchase other securities, like stocks or commodities. But using the excess funds in that manner would mechanically decrease the demand for US Treasury bonds and increase the interest rate paid on government borrowing. The increased earning on the Social Security trust funds would be offset by increased debt interest that has to be paid off by American taxpayers. Again, this relationship is mechanical, not ideological in any way.

State pension funds are one answer to a particular question

State pension funds differ from the Social Security trust funds in two related ways:

• they have no control over their tax base;
• they have no control over their currency.

Since people can move freely between the states, each individual state has a peculiar problem: you may pay a teacher to educate children in 2016, but if that child moves out of the state by 2046 he won't be available to provide tax revenue to pay his teacher's pension.Similarly, while the United States can print money to pay the obligations of the Social Security Administration, individual states have to find dollar tax revenue from the taxpayers currently living within the state's jurisdiction.State pension funds are one answer to those problems: the money saved on public salaries in the present (see above) are saved in investments outside the state, so that funds will be available to pay future pensions regardless of the economic conditions of the state itself when those obligations come due. Note that in our stylized example above, the money saved at 7% is less than the future value of the pension paid at 5%, creating a concrete, real-time payroll saving for the public entity involved.It is worth stressing at this point that this is not the only answer to this question! States could, like the Social Security trust funds, simply take pension "contributions" (the decreased payroll expenses of their public employees) and invest them in infrastructure, in lower taxes, in education, in health care, or in absolutely anything else they feel like investing in.

Private workers are right to demand pension funds

A different situation exists in the private sector, where even the most well-established firms can collapse in ignominy from something as significant as a major economic transformation or as trivial as a crisis of governance. Relying on the continued existence and profitability of your employer for both your current and retirement income is a dangerous gamble, so it makes perfect sense for private employees to insist that their pension funds be invested and managed independently of their employer.However, this is correctly understood as an insurance policy, not an intrinsic characteristic of pensions. Apple has never declared bankruptcy since its founding in 1976. It could have promised its earliest employees pensions after 25 years of employment (say 2001) and been able to easily pay those pensions out of current cash flows without ever starting or running a pension fund. Meanwhile it could have used the difference between what it paid its employees and what they were worth to finance ongoing investment in the company, just as the Social Security trust funds do for the United States of America.An independently management pension fund is an insurance policy against bankruptcy, nothing more and nothing less. Perpetual entities like the United States and California have no intrinsic need for such an insurance policy.

What is a pension crisis?

Hopefully all the foregoing illustrates what a pension crisis isn't, and cannot be: a pension crisis cannot be that a pension fund isn't "fully funded," and it cannot be that taxpayers are unwilling to pay higher taxes in order to pay their pension obligations. That is a perfectly reasonable preference of taxpayers that should nevertheless be ignored, because they have already received the services which entitle pensioners to their retirement income.A pension crisis is properly understood to be when the resources available to an entity, whether public or private, are not sufficient to pay the pension obligations that entity has incurred. It does not matter whether it is pleasant or unpleasant to find the resources to pay those obligations; it matters whether it is possible. If it is possible, then there is no crisis. If it is not possible, then there is a crisis.The preferences of current taxpayers as to whether their taxes should be raised or lowered are immaterial to this discussion once the original services have been rendered and the obligations have been incurred.

Where does your marginal dollar go?

On Twitter the other day I had a short exchange with Noah at Money Metagame about a question that I find fascinating: what do you do with your next dollar in income?

Budgets are fine but don't aid ongoing decision-making

For a little bit of context, here are my recurring monthly expenses:

• Rent
• Phone
• Internet
• Blog subscription service
• Google business account

I also have a few recurring annual expenses:

• Credit card annual fees
• Website hosting fee

Finally I have recurring weekly investments:

• IRA contributions
• Solo 401(k) contributions

All together these expenses add up to something like $1,604 per month (I can't be bothered to crunch my credit card annual fees but those would add a few hundred dollars per year, perhaps adding up to as much as $50 per month).So in a very concrete sense, it's important that I earn, on average, $1,650 per month in order to meet those recurring expenses out of current income, i.e. without incurring additional debt.When personal finance gurus tell you to create a budget, they are normally hectoring you to use that budget to restrain your spending. For me, the more interesting question is the one I posed to Noah: once your income meets your budgeted expenses, what do you do with each additional dollar you earn?After all, it's true that if my income fell I could move to a cheaper apartment, or buy slower internet service, or make smaller IRA contributions. But when my income rises, it's less obvious what I should do.

I don't care what you do with your marginal dollar, but it's worth thinking about in advance

Noah had an immediate answer to my question: "Yeah, retirement accounts are maxed already. The marginal dollar gets swept into a brokerage acct ~monthly"Noah is trying to achieve his goal of early retirement by making additional contributions to a taxable brokerage account with his marginal dollar, which is perfectly reasonable. But it's not the only thing you could do with a marginal dollar of income:

• Pay down debt. Student loans, mortgages, car loans, installment loans and any other kind of debt without a prepayment penalty costs less the sooner you pay it off. By using your marginal dollar to pay down those debts you can get a risk-free rate of return that may exceed your other investment opportunities (note: many people will tell you that your risk-free return when paying down mortgage debt should be discounted by the amount of the mortgage interest tax deduction, but those people are part of the problem and should be ignored, if possible).
• Increase your budget. If your income regularly exceeds your budgeted expenses, you can increase your budgeted expenses by moving to a bigger apartment, buying faster internet, or signing up for more expensive credit cards. That would bring your budget up to your income, and minimize the question of the marginal dollar.
• Build up cash savings. Many people think that having a cushion of cash savings is important in order to prepare for or withstand unexpected events. If you're one of those people, then your marginal income can be directed into a high-interest rewards checking account in order to maximize the interest you earn on your federally-insured savings (I personally use Consumers Credit Union due to the high maximum balances and easy-to-meet monthly requirements).
• Buy more/better/sooner stuff. One popular option for people who see irregular bursts of income is to buy stuff. This is so popular that it has become a kind of cliche around tax season when people receive tax refunds and quickly use them to upgrade older appliances or buy new ones.
• Invest. This was Noah's answer, and involves moving his marginal income each month into a brokerage account to hopefully speed his progress towards early retirement.

This is a subject of frantic and unnecessary moralizing

I have attempted above to present the variety of things you could do with a marginal dollar of income as even-handedly as possible, but different readers are likely to attach different moral valence to each one. To one reader paying down debt is obviously a higher priority than upgrading a television set, while to another saving for retirement is clearly superior to moving to a more expensive apartment.My primary concern is that if you don't have an idea of what you would do with a marginal dollar of income, you're exceedingly unlikely to spend it in the way you really want to. Spending a few minutes with a notepad thinking about where you'll put your next "spare" $1,000, $5,000, or $10,000 doesn't mean you'll spend it more wisely according to somebody else's idea of personal responsibility, but might make it marginally more likely that you'll spend it in a way that you'll feel good about once it's gone, whether it's gone into a savings account, a television, an index fund, or a trip to Vegas.

The effects of late-career Social Security contributions

I've written before (and expect to write more) about the Social Security Administration, which is both the primary source of disability insurance for low-income workers and one of the lowest-cost guaranteed retirement savings vehicles available to all workers in the United States.I want to address a few curious issues that arise with late-career Social Security contributions, since for a variety of reasons they're handled somewhat differently than the contributions you make throughout most of your working life.

Delaying retirement versus delaying Social Security benefits

First I need to untangle two slightly different questions. In my experience personal finance journalism focuses primarily on the benefits of delaying claiming Social Security benefits. The numbers differ very slightly depending on your birth year, but the general principle is that if you claim Social Security retirement benefits prior to your full retirement age your retirement benefit (what I calculated in this post) is reduced according to the following formula:

"a benefit is reduced 5/9 of one percent for each month before normal retirement age, up to 36 months. If the number of months exceeds 36, then the benefit is further reduced 5/12 of one percent per month."

Meanwhile if you wait to claim until after your full retirement age your retirement benefit is increased by 8% per year you delay initiating your benefit.That's not what I'm talking about. As opposed to delaying claiming Social Security retirement benefits, I want to address issues arising from delaying retirement, which is to say continuing to contribute to Social Security in the last decade or so of your working life.

If you have reported earnings in fewer than 35 years, continuing to work will increase your benefit

Social Security retirement benefits are calculated based on your highest-earning 35 years, including years in which you earned nothing, so the addition of earnings up to 35 years will always increase your retirement benefit since it reduces the number of zeroes dragging down your average earnings.For very-low-income workers there is a minimum retirement benefit, but very few workers both qualify for retirement benefits and are eligible for only the minimum benefit so I'll set that special case aside for now.

If you have reported earnings in 35 or more years, continuing to work may or may not increase your benefit

One of the most important things to know about how Social Security benefits are calculated is that they're on the basis of your wage-inflation-adjusted earnings. While up to $118,500 in 2016 earnings are subject to Social Security taxes, that's the inflation-adjusted (according to their calculations) value of just $39,600 in 1985 earnings (to pick the year of my birth at random).There's a natural intuition that late-career workers earn more money than early-career workers, and so their increased earnings should increase their average 35-year earnings and drag up their retirement benefit.But that is only true if their increased earnings outpaced the Social Security Administration's wage-inflation gauge.Now, obviously many people do, in fact, earn higher inflation-adjusted wages later in life than they do earlier in life, due to experience and seniority if nothing else. The key point here is that continuing to work after receiving 35 years of credit only increases your benefit according to the inflation-adjusted difference in your income.Suppose a late-career worker with 35 years of credited income and whose income is above the taxable maximum of $118,500 has 1985 earnings not of $39,600 but instead half that, just $19,800. Using Social Security's inflation adjustment, that works out to $56,628 in 2015 dollars. An additional year of crediting $118,500 in earnings to Social Security will definitely increase the worker's retirement benefit, but by a fairly modest amount. To calculate it, deduct the annuity purchased by the $56,628 "rolled off" the worker's earning history and add back the annuity purchased by the $118,500 added to the worker's earning history (this exercise is left to the reader).

If you like your Social Security retirement benefit, you can keep it

Obviously most people treat their Social Security retirement benefit as something that happens to them. You work all your life, then you decide whether to start claiming at 62, at your full retirement age, or at age 70.But late-career people who have already accumulated 35 years of Social Security earnings credit have other choices. They can keep working in their current profession and, if their wage-inflation-adjusted income is higher than their lowest lifetime earning year, marginally increase their retirement benefit.Or they can do something else. This blog is independently financed, with an emphasis on independence. If your domestic labor income isn't earning you a higher old-age pension, maybe you should consider something else. Start a business, travel, make a difference in the world. Your Social Security benefits will be waiting for you.

Why do we tax corporate profits?

There is a periodically-fashionable argument in the United States that a key obstacle to economic growth is the "double-taxation" of corporate earnings: once at the corporate level, and a second time when profits are distributed to shareholders and (eventually) reported on their individual income tax returns.This argument is typically made by people who, for ideological or self-interested reasons, want to eliminate either one tax or the other: either tax corporate profits but not dividends and capital gains, or tax dividends and capital gains but not corporate profits.In fact, this so-called "double" taxation is a very sensible answer to a very particular problem.

The corporate tax rate is relatively flat

Many people use as a shorthand for corporate profit taxation the maximum corporate profit tax of 35%. This is not strictly speaking true since like the personal tax code the corporate income tax is somewhat progressive. However, for large corporations it's true that profits are taxed, in general, at a marginal rate of 35%.

The federal income tax is relatively progressive

Unlike the relatively flat corporate tax rate, the federal income tax on qualified dividends and long-term capital gains is quite progressive. No federal income tax at all is owed on such income for taxpayers in the 10% and 15% federal income tax brackets, and the federal income tax tops out at 20% for taxpayers in the top income tax bracket (there is an additional Medicare surcharge I'm ignoring for simplicity's sake).

Many corporate distributions are untaxed

While relatively few low-income taxpayers receive any qualified dividends or long-term capital gains, there's another class of entities that receives a vast quantity of dividends and capital gains: untaxed endowments and foundations.Harvard University's $35 billion endowment pays no taxes whatsoever on any dividends it receives from its extensive portfolio or on any capital gains it realizes on its investments.However, its investment portfolio is still taxed: what critics call "double" taxation of both corporate profits and capital gains in fact results in the only form of taxation Harvard's endowment is ever subject to!

Corporate profits are taxed twice, but differently

In reality, we have two taxes sitting on top of each other: a relatively flat corporate income tax on profits as they are realized and before they are distributed to shareholders, and a relatively progressive personal income tax that is applied only to distributions and capital gains realized in taxable accounts, and completely untaxed for the endowments and foundations that hold a great many shares.Today's tax on corporate profits has a floor of 35% (for distributions to untaxed shareholders) and a ceiling of 59.6% (for distributions to high-income shareholders in taxable accounts). Referring to that as "double" taxation misses the point: it's a relatively progressive taxation scheme, based primarily on ability to pay.A world with only a corporate income tax would be a world with a flat tax on corporate profits, without respect to ability to pay: low-income shareholders would pay the same tax rate as wealthy shareholders.A world with taxes levied only on profits distributed to shareholders would be one where corporate profits distributed to tax-exempt shareholders and to those with shares held in tax-advantaged accounts avoided taxes completely.Instead, we levy one tax on corporations based on the profits they choose to distribute to shareholders, and a second tax is levied on shareholders based on their ability to pay.This system may not be (in fact, is certainly not) ideal, but it is a concrete solution to a real problem: with many shares held in different structures, including tax-exempt, tax-advantaged, and overseas accounts, profits are taxed in multiple different places to ensure they are, in fact, taxed at all.