Accelerating payments versus making good decisions

Here at Saverocity, our glorious leader Matt and I have a difference in opinion, which is always more fun than agreement, so I thought I'd take a few minutes to give the strong form of our disagreement. I don't think either of us actually holds the strong form of these opinions, but the strong form illustrates the difference most dramatically.Anyone who has met Matt knows he's an excellent financial planner and thus takes the sensible view that accelerating the payment of debt offers a guaranteed return (the interest rate on your debt) while investing in risk assets offers an unknown return (whatever return the asset you invest in happens to produce). That's a view I emphatically share.The confusing thing about this to me is that accelerating payments on a loan is still more expensive than taking the right loan out in the first place. It may be true that making two mortgage payments per month will let you pay off a 30-year mortgage in 23 years, but it's also true that for all 23 of those years you'll be paying the interest rate on a 30-year mortgage. Why not just take out a 23-year mortgage to begin with?That's not a rhetorical question: there are reasons you might prefer a lower "minimum" payment while reserving the option of making excess payments in any given year. But if you're planning to make excess payments every single year for the life of the mortgage, you should take out a shorter-term mortgage at a lower interest rate!Similarly, the way student loans work in the United States is that you are offered a loan with a fixed amount based on your year in college, you take out the loan, you spend the money, then you repay it (hopefully using income-based repayment, the best form of repayment). But of course one thing you might do is borrow less money, if you knew you didn't need the full amount of the loan, for example if you could supplement your financial aid with work while in school. In other words, just as above, accelerating repayment of a loan is a poor substitute for borrowing less money and paying less interest during the lifetime of the loan.This thread in the Saverocity Forum sums up both of our views in our own words. But since this is my blog, I'll close with my words:

"If something has changed since you made that decision, or if you have learned more things and consider yourself better-informed and better-educated about the risks and rewards of investing in the market while carrying a mortgage, good, reassess your situation and potentially arrive at a different conclusion."On the other hand, if you made the decision impetuously, and are now making another decision impetuously, then your problem is making impetuous decisions, not carrying a mortgage while investing in the stock market! Fix the real problem, which is not your mortgage/stock allocation."And finally, you need to consider the possibility that your younger self was right. Maybe it was that younger self that thought through everything and decided that carrying the mortgage while investing in the market was worthwhile, and he thought through all the risks and rewards and arrived at a sensible conclusion, and would be furious that you, older self, are second-guessing his careful homework."

Bitcoin seems fine, but there's no reason to own any

The other day someone on Twitter linked to this very interesting essay by Marc Andreesen of Andreesen Horowitz, the prominent venture capital firm, which I highly recommend if, like me, you missed it when it was published in 2014. I think the essay crystalized for me two points in the cryptocurrency/blockchain discussion that are sometimes passed over or muddled.

The fundamental value of Bitcoin is the value of dedicated computing power

If you're of a certain age, you may remember a program called SETI@home, which took advantage of your computer's processing power (and your home electricity) when idle to search the vast amount of data cataloged by the SETI project for signals which might be signs of alien civilizations. Many of my friends enabled it as their screensaver, and we got a little philanthropic (xenophilic?) rush whenever we saw our crummy little computers parsing through millions of bytes of data. We never found an alien, though.The same principle applies to Bitcoin, except instead of feeling good about using (wasting?) the free electricity our college provided, Bitcoin miners get to feel good about earning Bitcoin, which has value in the real world when converted to money, which can be exchanged for goods and services.As I think the Andreesen essay makes clear, the value of Bitcoin is the value of being able to call upon the electricity and computing power of Bitcoin miners to process, verify, and record Bitcoin transactions.Bitcoin as a currency is utterly irrelevant to this process — miners' compensation is denominated in Bitcoin but they are free to instantly exchange their Bitcoin for their home-country currency at the prevailing exchange rate. That exchange rate, meanwhile, is set as all such rates are by the supply and demand for Bitcoin or by the laws of the country in question. It may be illegal to exchange a country's currency for Bitcoin, for example, or a country may set a fixed Bitcoin exchange rate. A sustained high exchange rate between Bitcoin and a country's currency is supposed to bring more miners online. But they don't have to keep the Bitcoin they earn; on the contrary, the reasonable thing to do would be to sell the Bitcoin for their country's currency, because money can be used to pay for goods and services.Note that I said this is the logic behind the fundamental value of Bitcoin. That's to distinguish it from the price of Bitcoin. The price of Bitcoin is established by the amount people are willing to pay for it, and the price people are willing to sell it for. But its fundamental value is established by the amount people are willing to pay for the computing power needed to process transactions on the Bitcoin blockchain in a given amount of time (the more computing power is available to the system the less time a transaction takes to be verified).The difference matters because the price of Bitcoin should be irrelevant to the users of Bitcoin. If you are using the blockchain to transmit money from the United States to Canada, you should be concerned with the exchange rate between the US and Canadian dollars. Assuming the exchange rate between each currency and Bitcoin corresponds to the exchange rate between the two currencies, and assuming all 3 exchange rates remain stable during the time the transaction takes to process on the Bitcoin network, the price of Bitcoin is irrelevant to the transaction. Whether US$1,000 buys 4 Bitcoin or 0.25 Bitcoin is irrelevant if the Bitcoin are immediately converted to CAD$1,219.60 (as of today).That's a lot of assumptions! Maybe the USD:BTC and BTC:CAD exchange rates don't correspond to the USD:CAD exchange rate. Maybe the value of Bitcoin is so volatile, and there's so little computing power available to the system, that one participant or the other is unwilling to take the risk of seeing their payment swing wildly in value either up or down: after all, no one wants to pay $1,500 for something they planned to pay just $1,000 for, and no one wants to receive $500 for something they planned to sell for $1,000.On the other hand, this is the kind of problem late capitalism is extremely adept at solving. A company offering international transfers using the Bitcoin blockchain could buy insurance contracts against short-term swings in the value of Bitcoin relative to the currencies it operates in. A sufficiently large company could even choose to self-insure against those swings. In other words, they could guarantee a given USD payment would be a worth a given amount of CAD to the recipient, even if the BTC-intermediated exchange rate fluctuated in that time.

Bitcoin is not a way of opting out of the real world

The other thing that Andreesen's essay makes clear is that Bitcoin and its blockchain will only ever be overlaid onto a world of humans, governments, and laws — what some wags used to call "meatspace."Consider the Dread Pirate Roberts, who ran the Silk Road marketplace on the dark web in the early days of both the TOR anonymous browsing service and Bitcoin. To be as reductive as possible, Silk Road served as a non-state intermediary between buyers and sellers. A buyer would send Bitcoin to Silk Road, the seller would send the guns, drugs, porn, or whatever to the buyer, and then Silk Road would release the Bitcoin to the seller.This system only worked for as long as it did because people trusted the Dread Pirate Roberts, whether because of his libertarian screeds online or the simple reputational value of having successfully executed so many transactions.But the fact is, Western civilization is built upon an extremely similar system, whereby trust between buyers and sellers isn't necessary because the state is present to mediate complaints between them. If you pay someone for something and they don't provide it, you don't need the Dread Pirate Roberts to take out a hit on them; you can sue them. If you sell something and the buyer never pays you, the courts are likewise open to you. It can be a real hassle, but it's a lot less of a hassle than tracking them down and killing them.

Conclusion: I am optimistic about Bitcoin and remain totally agnostic about Bitcoin's price

Thinking through Andreesen's essay I found myself thoroughly convinced that distributed blockchain technology is an important technological advance which will eventually be used to verify and record many kinds of transactions. The financial press has an unfortunate tendency to focus on the price of Bitcoin, since that's the metric they're used to covering and Bitcoin devotees have elected to call Bitcoin a "cryptocurrency," as if there were goods and services denominated in Bitcoin, rather than mechanical conversions between Bitcoin and real money (which Bitcoin's devotees derogatorily and hilariously call "fiat" money).But it would be perfectly reasonable to report news about the average time Bitcoin transactions take to complete, the typical volatility of exchange rates between Bitcoin and real currencies, and any resulting distortions introduced in those exchange rates. That would give news consumers a real idea about how ready the Bitcoin blockchain is to handle large numbers of real-world transactions.But the price which speculators are willing to pay for Bitcoin will never matter, except to the extent it brings additional computing power online or pushes it offline as unprofitable.

The problem of class projection

A few different situations have recently set me to ruminating on a curious problem that I think doesn't receive the attention it deserves. My working name for this problem is "class projection," although I'm sure the academics have already come up with a much better, or at least longer, term for it. The problem is that when people imagine how other people think, they project onto them an experience deeply informed by their own socio-economic class, instead of the class of the person they're trying to understand. Let me share a few examples to see if I can make this point clearly.

Workers project working class problems onto their bosses

Working people see, every day, the problems afflicting their organization. They see how faulty software slows them down, they see how some coworkers show up late or leave early, they know who contributes the most to the functioning of the organization and who contributes the least. Where class projection comes in is when a worker assumes that the problems they observe are, in fact, the most important problems faced by the business as a whole.To give a concrete example, I spend an hour or two every week at Walmart customer service centers. Each customer service center is different, and each employee is different. Over time, you can start to pick up who's more competent, who's less competent, who has a better attitude, who has a worse attitude. From the perspective of the customer service employee, such differences are even more profound. A slow worker can cause a line to back up, an inattentive worker can require constant supervisor intervention to correct errors, etc.It would be perfectly understandable for a customer service worker who notices all these problems to conclude that the key problem Walmart faces is lazy, inattentive, and poorly trained customer service workers.But of course nothing could be further from the truth. A Walmart customer service center is a loss leader. It's where they take back broken junk and have to give customers refunds. It has to exist (Walmart's return policy is one reason people shop there), but the slower and less efficiently it works, the less money Walmart has to return to its customers! A poorly-functioning customer service center is a real problem for individual customer service employees and a real boon for the Walmart Corporation.I'm not saying this is actually Walmart's corporate strategy. I'm saying that it's an example of workers projecting their own very real problems onto the firm they work for.

Bosses project their own class experience onto workers

We have turned life for the middle and upper-middle classes into a labyrinth of programs they're expected to deftly navigate simply in order to stay solvent. You, dear reader, no doubt read dozens of pages of documents about the different health care plans your employer offers. You dug into the different investment options in your 401(k). You're excited about shielding some of your income in an HSA which you plan to invest aggressively in order to use in retirement.First, to state the obvious, we did not have to do this. We did not have to make health insurance tax-free compensation. We did not have to make HSA's available to employees with high-deductible health insurance plans. We did not have to make retirement so precarious people are desperate to leap on any promise of some modicum of dignity in old age.But having done it, we have also introduced the problem of class projection. A person who pays enough in mortgage interest to itemize their deductions becomes incensed by the possibility of a working class person wrongly claiming the earned income credit. A person who shields tens of thousands of dollars in income from taxes insists on vigorous work requirements for SNAP benefits to root out any "cheaters."This is class projection at its worst: asking "what would I do if earning a little more income suddenly cost me access to food support, health care, or refundable tax credits?" The answer is always, "I'd cheat," which is why gallons of digital ink have been spilled over supposedly pressing national issues like earned income credit fraud.The earned income credit was projected to cost, in 2016, $58.7 billion. That is a lot of money, although it's less than the $75.2 billion in foregone taxes due to the mortgage interest deduction and much less than the cost of excluding health insurance costs from taxable income ($216 billion). Earned income credit "fraud," Medicaid "fraud," and all other kinds of "fraud" against the welfare state are fantasies concocted by the wealthy who imagine how good they would have it if they could take advantage of welfare programs the way the cheating poor do. That's because our system does, in fact, encourage the wealthy to cheat as much as possible.The same logic applies to the "voter fraud" sensation that has swept the Republican party in recent years. I believe it is genuinely shocking to the relatively well-off that all you need to do to vote is fill out a form with your name and address on it.Filing their taxes is so much harder than that. Applying for financial aid for their children is so much harder than that. Deciding on their asset allocation is so much harder than that. It's so easy to vote, how could it not be the case that millions of people illegally register to vote, then vote, and then get away with it?The answer, of course, is that it's illegal, so virtually no one does it, because if they did it they would be breaking the law. This is common sense to the actual poor, but totally preposterous to policymakers who see the mere existence of poverty as a kind of fraud against capitalism itself.

Do we have a retirement savings crisis or a retirement income crisis (or neither)?

I'd like to set some facts up on the board:

If you knew nothing else about the world, you could arrange these facts in different ways in order to draw different conclusions. For example, it might be that early Social Security filers are disproportionately high-income individuals who accumulated a lot of private savings during their working lives, and so don't need to rely on Social Security in retirement, while low-income individuals without private savings wait to claim their higher old age benefit at full retirement age or later, making up for their lack of private savings and lower lifetime earnings.Alternatively, it may be that while defined benefit pension plans have been in overall decline, they remain concentrated in low-income sectors, so early Social Security filers have their retirement incomes "topped up" by defined benefit pension plans.Of course, in reality low-income workers are much less likely to have defined benefit pension plans and much more likely to claim Social Security old age benefits as soon as they're eligible. But elder poverty has still been in decline for the last 50 years.

Social Security replaces a large share of low-paid workers' income

Unpacking this mystery requires a little knowledge of Social Security's old age benefit calculation. Consider a worker making the federal minimum wage of $7.25 an hour at age 62, and assume their annual income has only kept up with wage inflation for the last 35 years. That lets us use the worker's current monthly income of $1,256 as their average indexed monthly income, which produces a primary insurance amount of $915 (90% of $885 plus 32% of $371). That's their monthly benefit at their full retirement age of 66 (assuming they were born in 1954 and turned 62 in 2016), and it replaces about 73% of their gross income. Note that since they won't be paying FICA taxes on their old age benefit, it replaces closer to 79% of their net income.If the worker starts collecting at age 62 instead, their benefit will be reduced by 25%, to $686, a 55% gross or 59% net replacement rate. On its own, a $7,872 annual benefit is not enough to put our new retiree above the poverty line (neither would their full retirement age benefit of $10,980).

Social Security benefits are only taxable for relatively high earners

High-income workers are often advised to delay claiming their old age benefit, for three good reasons: the longer you continue working the more high-income years you can add to your Social Security work record, the longer you delay claiming the fewer penalty months or more bonus months you'll receive on your ultimate benefit, and some Social Security benefits are taxable for high-income households.How do these considerations apply to low-income workers?With respect to the first, we know that wages have been stagnant for lower-income Americans for decades. If you're low-income at age 62, there's no reason to believe your next year's income is going to "roll off" a low-income year in your youth. In fact, thanks to the way the wage-inflation-adjusted federal minimum wage has bounced around in the last 35 years, you may be earning less in wage-inflation-adjusted terms than you were in your youth!As shown above, the second consideration still applies, with your benefit increasing each month you delay filing for your old age benefit.But the third consideration is irrelevant: Social Security old age benefits are only taxable to the extent that your adjusted gross income, plus half your old age benefit, exceeds $25,000. In the case of our minimum wage earner, that sum only comes to $19,188, well below the taxable threshold.That means at age 62 a low-income worker can claim their old age benefit completely tax-free while continuing to work. The old age benefit doesn't replace their income, it supplements their income. You can see this clearly in Chart 5 of this report, showing that among Social Security recipients aged 62-64 (by definition "early" filers), in 2009 Social Security made up about 31% of income, while earnings represented about 38% (older age groups also show significant earnings but the report doesn't separate early filers from full retirement age filers in the older age groups).

Raising the full retirement age is the worst way to "save" Social Security

I'm not a fan of the "Social Security in crisis" narrative ginned up periodically to justify attacks on the welfare state (today's entry in the genre). The United States is a woefully undertaxed country and modest tax increases would solve a slew of problems, including the financing of Social Security. But maybe you're an enthusiast for this crisis narrative! If you think the solvency of the Social Security trust fund in 2033 is a pressing national issue, you might be familiar with some of the options people float to "save" Social Security:

  • raise or eliminate the cap on taxable earnings, increasing the amount of money flowing into the Social Security trust fund;
  • investing the Social Security trust fund in riskier assets, hopefully improving its long-term returns;
  • use a chained inflation measure for cost-of-living adjustments instead of the current unchained CPI, which would represent a modest cut in benefits over time;
  • raising the full retirement age.

Of these options, raising the full retirement age is the one that targets the income of the elderly poor most directly. Increasing the full retirement age from 67 to 68 would represent a cut of 9.3% to the old age benefit of someone filing at age 62 (reducing their benefit from 75% to 70% of their primary insurance amount). This would be a permanent reduction in the retirement income of the lowest-income elderly, who are by definition the marginal elderly who have been pulled out of poverty by the program in the last 50 years.It would be hard to come up with a plan more narrowly targeted at the people who need Social Security the most.

What is a retirement savings crisis?

The finance industry has gone to great lengths to convince American policymakers that the country is undergoing a "retirement savings crisis." There are two reasons they've done this:

  • the finance industry is in the business of managing money, so the more urgency they can gin up about the savings rate, the more money they can convince people to save;
  • the finance industry is populated by the kinds of wealthy individuals who receive the majority of the benefit of the tax-advantaged savings vehicles they've convinced policymakers to create.

Now to be clear, I don't have anything against saving a high percentage of your income; I save a high percentage of my income. But there are other things you can do with money as well, like using it to pay down debts. But using your savings to pay down debts instead of invest is a double-whammy to the finance industry: fewer assets to manage and less debt to charge interest on!In fact, it does not seem to me that we have a retirement savings crisis. We have a glut of tax-advantaged savings vehicles, and consequently a shortage of collected tax, which is certainly a problem, if not a crisis. We also have a fairly extensive scam economy featuring things like reverse mortgages, deeply conflicted financial advice, and variable indexed annuities. Those are real problems we could come up with policy solutions to, but they're primarily problems of elder abuse, not elder poverty (although elderly people can certainly be impoverished by abuse).

A retirement income crisis demands retirement income solutions

What is true is that we have a retirement income problem, which is real but manageable. As mentioned above, 9.1% of those over the age of 65 were living below the poverty line in 2012. Obviously age 65 is too late to build a Social Security earnings history or save enough money to live on in retirement. I'm not familiar with the exact composition of this group, but there's no difficulty imagining how someone would fall into this category:

  • Workers whose earnings weren't reported because they worked off the books, or were improperly reported due to employer fraud. They may have a spotty official work history and underreported wages that produce a lower old age benefit than they'd otherwise be eligible for.
  • People who didn't work and don't have a spouse's work history to rely on. This may be as complex as not wanting to attract attention to an undocumented spouse or child, or as simple as being in a gay relationship and losing your partner before gay marriage was legalized.
  • The long term disabled elderly who lost the ability to work before accumulating a sufficient work history and don't have family to rely on.
  • Low-income workers like the one described above who file for an old age benefit and leave the workforce at age 62.

This is a disparate group with different needs, none of which are tax-advantaged savings vehicles:

  • Workers whose income isn't being properly reported need vigorous enforcement of our labor laws (and not to fear deportation). We also need a streamlined system for reporting household and casual workers' income, so employers have less incentive to hire people off the books.
  • Developing a way for unmarried couples to claim their partner's work record would need to be carefully thought out to prevent potential fraud.
  • The long-term disabled elderly are a unique problem that can probably best be solved with simple cash payments.
  • Low-income early retirees can be easily helped by lowering the full retirement age back to 65 (thereby reducing the penalty for early retirement) or following Canada's example and supplementing the earnings-based old age benefit with a fixed payment to all retirees, taxable at your marginal income tax rate (Canada's is a bit more complex than that).

What all these solutions have in common is that they address the real problem of insufficient retirement income, rather than the imaginary problem of insufficient retirement assets.

How much is your obsession with tax efficiency costing you?

Something that I find separates me from the classical financial independence/early retirement community is the particular obsession of that community with achieving financial independence in order to retire early from work.In the framing I see regularly repeated, you're supposed to study for the most lucrative degree possible, then get the most lucrative job available, then earn as much money as possible and save as much of your income as possible, in order to quit the job you despise as soon as possible.To me this is obviously nuts: if you're able to survive on a pittance, why not cut out all the middlemen and simply earn a pittance doing something you actually want to do?But much more importantly to me, the focus on paid labor means FIRE types tend to put off entrepreneurship until after retirement, or look at it as a means to finance retirement, rather than as a shortcut to the life they actually want to live.An under-appreciated obstacle to pursuing entrepreneurship earlier in life is the focus on the tax efficiency of investment decisions. I think that focus is a mistake.

The strong case for tax efficiency

One offshoot of the obsession with paid work is the obsession with tax efficiency of the investments made with one's labor income. I always like to address the strongest possible case for positions I disagree with (partly because sometimes I change my mind!), and the strong case for taking maximal advantage of tax-advantaged savings plans is quite strong:

  • The upfront tax savings afforded by traditional IRA's and 401(k) plans allows your after-tax income to be invested at a higher value than they otherwise would. In the 25% marginal income tax bracket, $1,000 in after-tax savings would require $1,333 in pre-tax disposable income. That same $1,333 in pre-tax disposable income could instead be used to invest $1,333 if directed to a traditional IRA or 401(k) plan. That's a 33% "bonus" to your initial capital, which will hopefully compound happily for years to come.
  • The tax-free withdrawal of Roth assets allows the appreciation on your assets to be withdrawn without tax liability in retirement and in certain other circumstances. A $1,000 contribution compounding at 5% annually for 30 years will produce $3,321 in capital gains. In a taxable account, dividends would be taxed annually and any final capital appreciation would be taxed on withdrawal. Meanwhile rebalancing transactions within the account may produce additional intermediate taxable gains (although they might also create losses).
  • Both types of account permit tax-free internal compounding, which both disentangles your total return from the vagaries of your year-to-year tax situation and saves you the hassle of calculating your capital gains tax liability each year, which is not fun.

The simple case against tax efficiency

The simplest way to explain the problem with tax-efficient investing is through the restrictions on what kinds of investments can be made with tax-advantaged retirement vehicles:

  • you cannot live in real estate owned by your tax-advantaged retirement vehicles (or receive any other pre-retirement benefit from your investments);
  • S-corporations cannot accept investments from tax-advantaged retirement vehicles.

Of course most custodians restrict your investment options even more, limiting you to publicly traded securities offered through their own brokerage platform. My point is broader though: in exchange for the tax efficiency of your investment you explicitly restrict your ability to invest your excess income in your own business.

The best case for investing in public markets is that you don't have any ideas

I constantly have ideas for businesses, so I find it kind of hard to get inside the head of someone who doesn't have any ideas for businesses (I occasionally post free business ideas if you're having trouble coming up with one of your own).But the most convincing case to direct as much of your disposable income as possible into tax-advantaged savings vehicles is that you think the public markets as a whole, your preferred asset allocation, or even a particular active mutual fund or hedge fund manager will perform better, taking into account the relevant tax advantages, than you will investing in your own business.In my experience, this intuition isn't very convincing.

Business is more profitable than you think (but less profitable than you want)

I have a sort of unique position since, on the one hand, my own business is extremely capital-unintensive: I pay a few hundred dollars per year for my web domain and content management system, then I get paid depending on how good people think my websites are.At the same time, I have a lot of friends who have extremely capital-intensive businesses: buying and reselling merchandise and gift cards. Their overall profit depends largely on the amount of volume they're able to push through their supply and distribution chains, and the more capital they have to buy products, the higher their profits are.The reason I raise this juxtaposition is that I think it's informative about how you should direct the profits from any given line of business. A capital-light business that has a rapidly decreasing return on reinvested capital makes tax-advantaged investment accounts more attractive as a way to boost the returns on the business's retained earnings. Meanwhile, a capital-intensive business that has a steady or only-slowly declining return on reinvested capital should make tax-advantaged accounts less attractive since once profits are shielded they're unavailable for reinvestment in the business.The reason this result should be counter-intuitive is that the capital-intensive business is likely more profitable than the capital-light business! In other words, the more profitable your business is, and the higher your returns are on reinvested capital, the less you should want to shield your profits in tax-advantaged accounts which can only be invested in public markets.

We don't need tax reform, we need mind reform

Alright, the preceding was a bit pedantic. My unfortunate literal tendency at work, no doubt. But I wanted to lay it all out to make as clear as possible my case for abandoning your obsession with the tax advantages of your workplace retirement plan and finding, as soon as possible, the business that will let you live the life you actually want.If we want to create a society of entrepreneurs and entrepreneurship, we don't need to cut corporate taxes, or cut taxes on pass-through income, or accelerate depreciation, or have a tax holiday on repatriated earnings.We don't need tax reform, we need mind reform.We need to tell people that it's good and right that they leave their jobs to start their own businesses. Every second spent on the potential tax consequences if or when they ever turn a profit, and how to shield that profit from taxes, is time that could be spent on the actual business an entrepreneur is trying to bring into the world. Our economy needs more businesses and fewer workers, and the obsession with tax policy is a major obstacle in the way of that vision.The reason tax reform can't be the answer is that even in our current tax regime entrepreneurship is much more profitable than labor. What anti-tax evangelists have done is convince entrepreneurs that the taxes they pay are extravagant, exploitative, and destructive, when they're nothing of the sort: business is just so profitable that entrepreneurs end up paying more in taxes on their small businesses than they did as employees. That's because their income is higher as entrepreneurs than as employees.At the end of the day, no just system of taxation is going to levy lower taxes on entrepreneurs with a given level of income than on employees with the same income. Yet that's precisely the regime Republican members of Congress are currently trying to implement. I think they'll fail, and I hope they'll fail, but your decision whether or not to start your own business should have nothing to do with their eventual success or failure. You should start a business based on the life you want to live.The taxes will work themselves out. Of course you can decide to withhold your own ingenuity from the marketplace, but the marketplace is going to be fine without you. Will you be fine without the marketplace?

Business is not work is not investing

One of the more curious tricks played by late capitalism on the minds of its subjects is conceptually transforming all aspects of life into different forms of capital. From this trick arises the idea of "social" capital, which turns relationships with friends, neighbors, and loved ones into assets that can be assigned a precise value based on discounted future cash flows. Knowledge, education, and experience become "human" capital. Customs and manners become "cultural" capital.With so many forms of capital available, actual capital — ownership of the country's productive capacity — puts on a blue suit and tries to blend in with the drapes.

Don't confuse business, work, and investing

Perhaps because I have my hands in so many pots, I have a particularly acute sense of the difference between business, work, and investing:

  • I run a business producing travel hacking and personal finance content on the internet;
  • I have a bunch of jobs, where I do work and receive pay;
  • and I own a bunch of Vanguard mutual funds, one Vanguard ETF, and 50 shares each of Fannie Mae and Freddie Mac (because gambling is fun and this Mnuchin guy is going to make me rich).

A business makes money from customers

In my business, I sell ad space (through Google Adsense), subscriptions, and Patreon patronages or whatever they're called. In order to entice customers, I have to be funny, smart, sarcastic, valuable, or whatever else customers want in order to voluntarily pay me.This is the nature of business: you can put as much time or money into an idea as you like, but if no one wants to buy anything from you, you won't make any money.

A job makes money from an employer

The defining characteristic of a job, as opposed to a business, is that you are paid for your work. Now, over the history of capitalism different models have been used to pay workers so I don't want to get hung up on a single model: there are hourly, salaried, piece-work, and commission models of employment, and plenty of others I've probably never heard of. What they have in common, though, is that the employee is entitled to payment from their employer for the work done regardless of their value to the employer.The distinction between a business and a job could not be more clear: businesses are paid voluntarily by customers, while workers are required to be paid by their employer. In US law this is even enshrined in the Bankruptcy Code, which places wages owed above the claims of other unsecured creditors.

Investing is an inherently passive enterprise

By "passive" I'm not referring to passively-managed mutual funds, but rather to the nature of investing. Investing is the process of holding an ownership stake in an undertaking you are not running and are not employed in. Unlike a business, where your income depends on how skillfully you execute the undertaking, or a job, where your income depends on your ability to satisfy your employer, when you invest, your income depends entirely on other people's successful execution of the underlying business. When you buy a bond the return of your coupons and principal depends on someone else earning enough money to make those payments. When you buy a stock your dividends depend on someone else generating enough free cash flow to make those distributions.

Understand which part of your income comes from which activity

The US tax code at times seems deliberately designed to confuse this fundamental distinction between business, work, and investing. For example, many doctors legally organize their practices into "businesses" when what they're really doing is work: billing insurance companies for services rendered at a predetermined rate. Likewise many actual business owners legally organize a certain portion of their business income as wages, dividends, and capital distributions. And of course hedge funds are rightly famous for deliberately confusing their business activities (attracting capital from investors), work activities (picking investments), and investing activities (sitting around waiting for stock prices to rise or fall) in order to secure the most generous tax treatment for each.These games can be fun and lucrative (albeit time-consuming) but I would encourage you to be honest about which part of your income actually comes from each enterprise, not for the sake of manipulating your income taxes, but to understand what you're really being paid for. Owning rental real estate, for instance, is part business (attracting tenants to your buildings), part work (maintenance you do yourself), and part investing (depositing rent checks). Running a blog is all business (attracting readers), while writing for someone else's blog is all work (whether you're paid per word, per post, or per month).

Conclusion: find the combination of income sources that works best for you

About 33% of my income is business income, about 66% is income from work, and about 1% is investment income. This is not, notably, how I report it on my tax return. Rather, it reflects the reality of how I'm compensated for different activities: for which do I rely on attracting customers to voluntarily pay me and for which am I paid for the work I do?I don't personally privilege any one income source over any other, as each has its own charms:

  • running a business has the advantage of making me fully responsible for all my successes and failures, with no one to answer to but myself (unfortunately I'm a terrible boss);
  • working jobs has the advantage of being able to focus on a particular task instead of fretting about my impact on the business's bottom line;
  • and investing has the advantage of not requiring (or allowing) any input from me, besides voting the occasional proxy (I always vote against all the director nominees, on principle, and you should too).

I think the rejection of wage work by FIRE types is often a bit overwrought. If you don't like your job, you ought to get another job. If you don't like your hours, you ought to work different hours. If you don't like your co-workers, you ought to find some different co-workers. On the other hand, the idea of working even more hours, with co-workers you like even less, at jobs you hate even more, just to eventually replace your work income with investment income seems at its core like a tragic miscalculation.My suggestion is to find the combination of income sources across businesses, jobs, and investments, that let you achieve your goals with the minimal amount of existential despair today, not two, five, or ten years in the future.

How good are Roth IRA's for emergency funds?

Roth IRA's are interesting vehicles because, among other things, contributions can be withdrawn at any time penalty-free. Since contributions are capped annually but can be withdrawn at any time penalty-free, this leads to the following logic: make your maximum contribution each year whether or not you intend to invest it. After all, if you need the money later you can always withdraw the contribution penalty-free, but if you don't need the money you haven't forfeited that year's contribution eligibility.I think this is good and true, as far as it goes, but if you plan on doing it there are some things you need to take into account.

An advantage of tax-advantaged accounts is tax-free compounding

Depending on which marginal income tax bracket you fall into, long term capital gains and dividends paid on taxable accounts are subject to a marginal income tax rate between 0% and 23.8%. Capital gains and dividends realized within a tax-advantaged account like a Roth IRA aren't taxed when they accrue, and if withdrawn during retirement or for other qualified distributions are never taxed at all (in a traditional IRA they're taxed at your marginal income tax rates in retirement). Hence the "advantage" in "tax-advantaged account."The problem with using a tax-advantaged account — even one without penalties for the early withdrawal of contributions — is that in order to preserve your capital you have to invest in risk-free or low-risk assets, which won't produce the dividends and capital gains tax-advantaged accounts are designed to shield from taxation!

To use a Roth IRA as an emergency fund, pair in-account and out-of-account transactions

The solution to this riddle isn't very complicated, but you need to be aware of it if you're going to implement it properly. To explain, I'll give a stylized example.Say your desired emergency fund is $11,000, whether that's 3 months, 6 months, or 2 years of emergency expenses — I don't have a preferred theory for how many months' expenses you need in your emergency fund. You have room in your budget to save $105 per week — $5,500 per year, the current annual IRA contribution limit.In order to keep from losing your current-year IRA contribution limit, you contribute $105 per week to a Roth IRA, and leave it invested in cash, a money market account, or very short term bonds. Should you need the money for emergency expenses, it'll be there waiting for you (assuming you can communicate with your custodian to request the withdrawal!).At the end of the second year, you'll have $11,000 in your Roth IRA, and your emergency fund will be "full." God willing, you won't have faced an emergency, and so can start directing your weekly contributions to actual investments with an appropriate risk profile and time horizon.What happens if you find over the course of time that you're able to save more than $105 per week? Each dollar you save outside your Roth IRA can be paired with a dollar moved from your Roth IRA "emergency fund" to actual investments. This pairing of in-account and out-of-account transactions mean that your investments most likely to increase in value (creating capital gains) and pay dividends or coupons are inside the advantaged account, while your safest, least likely to appreciate assets are held outside the advantaged account (I like Consumers Credit Union's Free Rewards Checking).

I don't think much of Roth IRA's as emergency funds, but they're great for investments on different time horizons

The objection I have to using Roth IRA's as emergency funds is that an emergency fund, by definition, has a time horizon of zero, and on a zero time horizon you're forfeiting a key advantage of a tax-advantaged account.On the other hand, using Roth IRA's for tax-free compounding of assets on time horizons other than retirement is a great idea! That's because in addition to contributions, earnings on Roth IRA's can be withdrawn penalty-free under a variety of circumstances, including most importantly the purchase of a first home (up to $10,000 in earnings) and paying for qualified education expenses (unlimited earnings).I don't know if a perfect solution exists for doing this, but it would be easy to come up with a simple kludge. For example, if you plan to buy a house in 5 years, and pay for higher education in 25 years, you could split your contributions between appropriately-dated target retirement date funds:

  • In the event of a bull market the higher education fund would rise faster than the housing fund (being more heavily allocated to equities), and when you achieved $10,000 in earnings you could move your total contributions to date, plus $10,000, to cash in preparation for your withdrawal and house purchase;
  • In the event of a bear market, the housing target date fund would decline less than the higher education fund (being allocated more heavily to bonds), preserving your housing purchasing power.

Conclusion

The high degree of flexibility in Roth IRA withdrawals makes them so useful that it leads some people to become a little too enthusiastic about the accounts. They are flexible, and they are useful, but they're most useful when they're used for the goals they're best designed for.

See how "frugal" I am

I always have a good time reading the latest explanation for how easy it is to save money if you just make a few simple sacrifices, whether it's your daily latte, your breakfast avocado toast, or whatever other "excess" has seized the imagination of our Baby Boomer media publishing overlords.But even I was surprised when a reader tweeted me the other day to say "you are brilliant at being frugal."

Here are all my great frugal living tips

  • Instead of buying a morning latte, I make a pot of coffee every morning, which produces roughly 12 cups of coffee. A 24 ounce bag of coffee from Whole Foods costs about $12 (more like Whole Paycheck, amiright?), and lasts about a week. I pay $0.14 per cup of coffee!
  • Instead of renting phones from wireless companies and buying into preposterously expensive contracts, I buy my iPhones outright and then pay $55 per month for wireless and data service. I also keep my iPhones for years and years instead of replacing them every one or two years.
  • Instead of making car payments, paying for car insurance, and buying gas, I ride the subway and walk.
  • Instead of owning a TV and paying for cable TV service (and replacing my TV every few years), I stream, buy, or steal whatever I want to watch.

How much money am I saving?

  • If a daily latte costs $4 per day, that's $28 per week, so I save $16 per week buying coffee in bulk.
  • If an iPhone SE costs $499 and lasts 4 years, by paying $55 instead of $100 per month, I make back my "full price" iPhone in about 11 months and every month after I save $45 per month.
  • I spend about $100 per month in subway fares, compared to whatever my monthly budget would be as a car commuter.
  • I spend $39.99 per month for internet from a local cable internet service provider, that provides no premium channels, no sports, and no news — because they don't provide any television service at all.

I'm not frugal

The idea of calling this "frugality" is based on the idea that a person starts out life with cable TV, a new smartphone, a cup of designer coffee, and a car. From that maximal viewpoint, everything you don't do can be credited to your "frugality bank" as some kind of merit you can store up in heaven, or elsewhere.But I never bought a cup of espresso every day. I never signed up for a never-ending treadmill of mobile phone contracts. I never bought a car, let alone borrowed money to buy a car. I never bought a television, or paid for cable TV service.I can't take credit for all the money I'm saving because I think it would be absurd to spend money on the things you spend money on.

I don't know why you do the things you do

I am struggling, if it's not apparent, to keep this from coming across as judgmental. But it's not judgmental at all! I don't have the slightest interest or desire to sign up for the kind of expensive, ongoing purchases that are apparently treated as normal by your typical Baby Boomer financial columnist.But you know yourself much better than I do. Maybe a new television gives you the kind of pleasure a trip back home to watch the rodeo gives me. In that case we can agree that neither of our activities is more or less frugal than the other: I spend money to go watch the Western Montana rodeo, you spend money to hang a new 11D TV on your wall.

Conclusion

At the end of the day, I've never cut anything out of my life in the name of frugality. I wouldn't "prefer" to rent a cell phone than buy my own phone and pay for service. I wouldn't "prefer" to rearrange my apartment in order to liberate a wall I could mount a flat-screen TV on. I wouldn't "prefer" to drive instead of walk. I wouldn't "prefer" to drink store-bought espresso instead of my own home-brewed coffee.But that's often the language used around frugality: that people should sacrifice something or other in order to meet one financial goal or another. I don't buy it. I say you can build the life you want to lead from the ground up, instead of tearing somebody else's ideal life down to the studs.

Investing your values, from easy to hard

I've been meaning to write this post for a while, but this afternoon a podcast I was listening to finally inspired me to put digital pen to internet paper. The question is simple: what is a wealthy individual who despairs over the excesses of capitalism to do with their wealth? The traditional answer provided by capitalism, conveniently, has been to invest their wealth in order to maximize their return on capital, and then use that return to promote the philanthropic causes of their choice.This is, needless to say, unsatisfactory to many people who seek to integrate their values into every aspect of their life, whether it's their profession, their housing choices, or the schools they send their children to. Why should they choose to profit from sweatshops in their investment portfolio when they refuse to wear anything but union-made clothes?There are other answers, and they range from easy to tricky to hard to implement. Here are a few.

Secondary Markets: cheap and easy

The easiest, but least impactful, way you can invest your values is by recreating a traditional asset allocation, while using funds that correspond to your values instead of traditional market-capitalization-weighted index funds. For example, a simple 60/40 portfolio could be replaced with:

  • 60% Vanguard FTSE Social Index Fund (VFTSX, 0.22% expense ratio), and
  • 40% TIAA-CREF Social Choice Bond (TSBIX, 0.4% expense ratio).

You'd have a blended expense ratio of 0.292%, which is higher than the expense ratio on a similar market-cap-weighted portfolio, but honestly, not that much higher. Paying $3,000 per year in expenses on a million-dollar portfolio that you find better reflects your values feels to me very close to a rounding error.If you want to get some more geographic diversification, TIAA-CREF also offers a Social Choice International Equity (TSONX, 0.4% expense ratio) fund you could use to replace international equities in your portfolio as well.Of course, the flip side of this being the cheap and easy way to invest your values is that it's also the least effective. Investing your values in secondary markets is first and foremost declining to profit from the behavior of firms whose actions don't reflect your values. In other words it's divestment, not investment.On the other hand, investing on the secondary market isn't completely ineffective: the more people who invest in such funds, the more deep and liquid the market for their shares will be, and the more firms will be encouraged to adopt policies that lead to their inclusion in them. The claim that your particular investment will be ineffective is identical to the claim that your vote is ineffective. On its own, sure, but if 80,000 individual votes had been cast differently in 2016 we'd be living in a different world entirely.Collective action is the sum of lots of individual actions so as for me, I politely decline to claim that individual actions don't matter. The fact that they do underlies our political and economic system.

Primary Markets: tricky, but fun

Another option for investing your values is to identify and buy appropriate securities on the primary market. In general this is a bit tricky, but if you read in the newspaper that your city is issuing bonds you can generally find out a way to buy them during the "retail order period." You'll need to have an account with one of the underwriting banks, and your order may or may not be completely filled — like I say, it's tricky.On the other hand, this is just about as close you can come to the "war bonds" issued to finance World War II — the funds go directly to the project being financed, giving you participation in the projects of your choice, whether it's schools, sewers, waterworks, or stadiums and ballparks.If your goal is to finance projects within your community, another option is to find a local "Community Development Financial Institution." This is a designation made by the Treasury Department for banks, credit unions, and other institutions that "expand the availability of credit, investment capital, and financial services in distressed urban and rural communities." You can easily Google the name of your community and CDFI and find a slew of institutions. The simplest way to invest is to simply buy certificates of deposit from such an institution, providing stable, long-term financing they can use to make loans to individuals and businesses in your community. Keep in mind the $250,000-per-institution cap on federal insurance for such deposits — if you're investing more than that you may want to invest with multiple institutions in order to ensure your certificates are completely insured.

Private Markets: effective and difficult

Another option for even wealthier individuals is to invest directly in — or even better, start — businesses that put your money to work directly in service of your values. If you think union-made apparel is too hard to find in your community, you can start a business selling it. If you think it's too hard to find fresh fruits and vegetables in your neighborhood, you can start selling them. If you think there's not enough affordable housing in your city, you can buy or construct a building and start renting it at below-market rates (this is, interestingly, what George Lucas tried to do in Marin County before his neighbors lost their shit at the idea of poors living among them).Private markets are the place you can see your money deployed most directly to effect the changes you want to see in the world. After all, when you donate to the Gates Foundation there's no way to know exactly which vial of vaccine you paid for, versus which 10,000 vaccinations Warren Buffett paid for this week. If you find that dispiriting, investing directly in businesses or organizations that act according to your values is one solution.This is, needless to say, hard. But if you've reached the point, in retirement or before, where you have accumulated a significant amount of money you may not ever need, why should it be that investing that money is easy? Maybe a new challenge is exactly what you need.

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.

Things I learned from an actual big bank advisor portfolio

If you follow the world of financial advice at all, you know that professional financial advisors don't have much patience for the so-called advisors you find tucked away in the corner of bank branches or affiliated with brokerage houses. Unlike fee-only Registered Investment Advisors, such firms have substantial flexibility to give "advice" that operates in the best interests of the firm, instead of the best interests of their customers. They may accept commissions for the sale of certain products, and they may be restricted by their proprietary platforms from offering clients certain funds.I knew all that in the abstract, but a concrete example is always more useful than abstract knowledge. Fortunately, last weekend I had the chance to examine an actual portfolio put together by an advisor with a big bank's advisory arm, and it was illuminating. Here are some of my biggest takeaways.

Ignore the equity/fixed income allocation

The portfolio I was looking at ostensibly had a 65/35 equity/fixed-income allocation. At least, that's what it said on the front page. Digging into the actual fixed income portion, I found a large portion of the "fixed-income" position was a long-short PIMCO fund. Now, I'm not here to tell you whether PIMCO is good or bad at buying and selling bonds. They may be the best at buying and selling bonds. But some PIMCO fund manager gambling with your money is clearly not what most people think of as a "fixed-income allocation." It's simply a bet that you've picked the right active manager, and he happens to be gambling in bonds instead of equities.I don't have any bonds in my portfolio, but I don't have any problems with bonds in the abstract. I've even written before about what you might do if the risk-free rate of return was enough to meet your investing goals. If you are nearing retirement, or have near-term obligations like down payments or educational expenses, it might make perfect sense to move assets into short-term or intermediate-term bonds in order to preserve your purchasing power against the coming economic calamities. That's what the "fixed-income" portion of a portfolio means to me.But if the actively-managed fund you're invested in just happens to use bonds in order to gamble with your money, that's properly allocated to your "gambling" asset allocation, not your fixed-income allocation.

Beware of fake diversification

There are two essential things you need to know about diversification. First, the purpose of diversification is not to improve the total return of a portfolio; it's to improve the risk-adjusted return of a portfolio. Second, diversification only improves the risk-adjusted return of a portfolio if you diversify into uncorrelated assets. The lower the correlation between assets, the better they play the role of portfolio diversifier (if diversification is something you want in your portfolio).The portfolio I examined had 11 mutual funds with equities (10 equity mutual funds, 1 "balanced" fund). I looked at the top 5 holdings in each mutual fund, and discovered the following:

  • 4 held Microsoft;
  • 4 held Google;
  • 3 held Apple;
  • 2 held Johnson and Johnson;
  • 2 held Proctor and Gamble;
  • 2 held Verizon;
  • 2 held Investors Bancorp.

Meanwhile Amazon and Berkshire Hathaway were each owned by one fund.The Vanguard Total Stock Market Index Fund's top 10 holdings are:

  1. Apple Inc
  2. Microsoft Corp
  3. Alphabet Inc
  4. Amazon.com Inc
  5. Facebook Inc.
  6. Johnson & Johnson
  7. Berkshire Hathaway Inc
  8. Exxon Mobil Corp
  9. JPMorgan Chase & Co
  10. Wells Fargo & Co.

This isn't an endorsement of the Vanguard Total Stock Market Index Fund (although it's a very good, very cheap domestic stock fund). It is an indictment of obfuscating a client's actual holdings through overlapping mutual funds. When you own a market-capitalization-weighted mutual fund you know exactly what share of each fund is represented by each company (if you can do a little math). When you own 11 equity mutual funds with overlapping holdings, how can you possibly hope to know what your actual exposure is to any given company or industry?Maybe Facebook, Exxon Mobil, JPMorgan Chase, and Wells Fargo are bad companies and you don't want to own any mutual funds that hold them (at least in their top 5 holdings — I didn't check every single holding). That's up to you. What doesn't make any sense is to own 11 different mutual funds just to avoid 4 individual stocks.Worst of all, in addition to mutual funds holding the largest domestic US stocks, the portfolio also included the individual stocks themselves! Under these circumstances it's virtually impossible to determine how exposed the investor is to a single large company.Simply put, this isn't what people mean when they say "diversification."

Costs Matter (1)

The cheapest domestic equity mutual fund (actually an ETF) in this portfolio had an expense ratio of 0.5%. The most expensive had an expense ratio of 1.08%. The cheapest held, in its top five holdings, both Google A shares and Google B shares. The most expensive held Google A shares. I do not care if you want to overweight or underweight Google in your equity portfolio. But there's no earthly reason to pay over twice as much to hold Google in one mutual fund when you're already holding it in another, cheaper fund.

Costs Matter (2)

This portfolio included as its primary real estate holding the Cohen & Steers Global Realty Majors ETF, ticker symbol GRI. This ETF aims to hold an allocation of 55% North American securitized real estate (mainly US) and 45% securitized real estate outside North America. It has an expense ratio of 0.55%.I took the liberty of comparing GRI to an identically composed portfolio of Vanguard's domestic (VNQ, 0.12% expense ratio) and international (VNQI, 0.15% expense ratio) real estate holdings. You may or may not be shocked to learn that the low-cost Vanguard blended portfolio outperforms GRI.But you shouldn't be.

Even blind squirrels find the occasional nut

I was modestly surprised to find in this expensive, weirdly-weighted portfolio that the advisor had also included what seems like an excellent intermediate-term socially-responsible bond fund, the TIAA-CREF Social Choice Bond. It has a not-unreasonable expense ratio of 0.4%, and is actually invested in legitimately interesting issues like water and sewer projects around the country. If that were the entire fixed-income allocation in this portfolio, I wouldn't have anything else to say about it. Unfortunately, it was far outweighed (by an order of magnitude) by the kind of speculative "fixed-income" products I mentioned above.

Conclusion

If you've made it this far (hell, if you've even made it to this blog) you may think this is all old news and anyone who knows anything about investing, or has any money to invest, is already in a sensible Boglehead 3-fund or 4-fund portfolio.The fact that you think that is why I wrote this post. Lots of people are not in sensible 3-fund or 4-fund portfolios, and it's not their fault. It's the fault of the people they trust to advise them.It's not unreasonable to pick an investment portfolio that reflects your values. There's no law that says investments must be made with the goal of maximizing risk-adjusted returns, or even to produce any returns at all.If you want to invest in socially- or environmentally-responsible companies, or buy the bonds of countries or municipalities that reflect your values, you have no obligation to put financial returns ahead of your values.But no matter what your investment philosophy is, there's no reason to let middlemen pocket 1-3% of your capital per year in order to implement it.

If a gap year is good, a gap life is even better

Last week Noah at Money Metagame announced he and his wife were considering what he called a "gap year:" taking time off from the workforce to go on an "epic road trip across the country." I thought this was an excellent idea, and told him so on Twitter. Then I started riffing on gap years and realized the thing I liked least about it was the idea of limiting it to a year: if a gap year is good, surely a gap life is even better.

What is a gap year for?

Noah presumably took the idea of a "gap year" from the current enthusiasm among upper-middle-class parents to encourage their kids to take a year off between graduating from high school and enrolling in college. During such a gap year, a youngster who has been on the "academic treadmill" (in Time's nomenclature) can "work, travel, volunteer or explore other interests" before enrolling in a higher education program.You can see why someone who didn't take such time off in their youth might be attracted to the opportunity to learn more about the world and oneself than is possible in some kind of career-track job they joined straight out of college (which they enrolled in straight out of high school). And rightly so!Noah and Becky will no doubt discover people and places they never could have imagined during their gap year. They'll also discover things about themselves and each other, unburdened by the 9-t0-5 (plus an hour commute in each direction) schedule they've shackled themselves to so far.

Why a gap life is even better

As for me, the arguments in favor of a gap year are so compelling, I simply don't see any reason to limit the gap to a single year. Personally, my preference is for a gap life, where you can "work, travel, volunteer or explore other interests" in whichever ratio works for you, for as long as you (both shall?) live.

  • During a gap year you might pick a single job, like waiter or barista, to experiment with. During a gap life, you can pick as many jobs as you can find time for, from factory worker in Wisconsin to shale oil roughneck in North Dakota to sleep experiment subject in Massachusetts.
  • During a gap year you might travel across Eastern Europe, or Southeast Asia, or Latin America. During a gap life you can travel anywhere you like, as many times as you like, whenever you like.
  • And when you're off the "academic treadmill," you ironically have access to a virtually unlimited amount of education. Almost anywhere you live is sure to have a school where you can enroll for next to nothing to learn almost anything under the sun. If you develop a particular interest in a subject, you're also free to move somewhere that subject is taught better than anywhere else.

A gap life is the inverse of early retirement

The early retirement philosophy is "now that I have a ton of money I can do anything I want." A gap life is about asking the question, "what do I want to do?"And it turns out that most things don't cost that much money; many of them are even profitable!If you want to find out what working in a factory is like, people will pay you to work in their factories. If you want to find out what teaching English is like, you can find people to pay you to teach English. If you want to learn Spanish, it's pretty easy to find someone to teach you Spanish.

A gap life isn't easy; life isn't supposed to be easy

Before you start angrily commenting about raising children and picking school districts and paying mortgages, let me stop you: I understand that choosing to live the life you want to live instead of the life you were convinced at age 14 you were supposed to live isn't easy.I simply don't see the advantages of an easy life over a complex, messy, frustrating and annoying life! Moreover, it's not at all clear to me that following the rules, attending the right classes, getting the right degrees, applying for the right jobs, and saving the right amount for retirement actually makes your life any easier.If it did, why would Noah and Becky be so desperate to bail out 5 years after getting started? What is the early retirement movement but a collective admission that "traditional" career paths are working for fewer and fewer people?The obvious answer to me isn't that people should get off the traditional career path 10, 20, or 30 years early through extreme frugality and a high savings rate. It's that they should decide for themselves whether they want to get on a traditional career path at all!

Conclusion

Among the chattering classes there's a growing consensus that we need to find new and different ways to talk about work, and I've written before about how that discourse is failing to deliver answers that are meaningful to actual, human workers. While you're more than free to treat it as tongue-in-cheek, my idea of the "gap life" is one suggestion for how to cannibalize our culture's existing rhetoric in service to the actual people who live in it.So the next time someone asks you what you do for a living, feel free to answer:"I'm actually in the middle of a gap life, trying to figure out what I want to do next."

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?

Ben Sasse is running for President and wants you to buy his book

Ben Sasse, the junior Republican Senator from Nebraska, has begun his campaign for what we used to call the highest office in the land, and he has begun it with a lie. The lie is found in the opening paragraphs of his recently published book, "The Vanishing American Adult, Our Coming-of-Age Crisis — and How to Rebuild a Culture of Self-Reliance," and for your benefit I will reproduce the lie in its entirety:

Early in my tenure at Midland University, a group of students in the athletic department was tasked with setting up a twenty-foot Christmas tree in the lobby of our basketball arena. These were hearty and healthy kids, 18- and 19-year-olds. They got the tree up, took out some decorations, dressed the tree, and began to leave, concluding that the job was done. That was when one of the university's vice presidents happened by and noticed something odd. The Christmas tree was decorated only on the bottom seven or eight feet, on the branches the kids could easily reach.Why, she asked, was the work only half done?The head of a sorority replied, "We couldn't figure out how to get the ornaments on the top.""Was there not a ladder in the gym?" the vice president queried. "Was maintenance unwilling to bring one?"She was met with shrugs. No one had bothered to look or thought to ask.This day's failure wasn't at all about lacking brains; it was about will. It was about ownership. It was about not having much experience or interest in seeing tasks through to completion.

Every word in this story is a lie:

  • what is "a group of students in the athletic department?" Were they just walking by the basketball arena when they were impressed with the duty of Christmas tree decoration?
  • Midland University does offer a major in Athletic Training; is part of the coursework of Athletic Training majors to decorate Christmas trees unsupervised?
  • Midland University, like all such institutions, does have a lot of vice presidents. So this story could have been referring to the "Vice President for Finance and Administration," the "Vice President for Admissions and Enrollment," the "Vice President of Development," the "Vice President for Academic Affairs," the "Vice President for Student Affairs," or the "Vice President for Human Resources." But not only does it not specify which vice president "happened by," it also doesn't explain what on earth the vice president was doing in the lobby of the basketball arena, or what her interest was in this supposed Christmas tree! I should note here that there is some evidence that a Christmas tree has been decorated on Midland's campus at least once.

Everything about this foundational lie goes to the core of Ben Sasse's ideological project. How did students become tasked with decorating a twenty-foot Christmas tree? Were they employees? Where was their supervisor? Who would be responsible if one of these hale and hearty young people fell from a twenty-foot ladder and was killed or disabled?This lie is not the only problem, or the most important problem, with Ben Sasse's book, but it's important to keep in mind as the central conceit of it colors the rest of the text.

An abbreviated list of problems Ben Sasse has with kids these days

  • They talk differently;
  • They watch YouTube;
  • They use social media;
  • They rewatch The Office;
  • They lack agency, initiative, and liveliness;
  • They do not seem to enjoy having conversations with their parents;
  • They seem tired, listless, and enervated;
  • They have trouble sleeping when it is hot.

I am making fun of Ben Sasse, and will make fun of Ben Sasse a lot more before this review is over, but what I'm not doing is exaggerating. To understand what Ben Sasse is wrong about, you have to understand what Ben Sasse thinks is wrong, and the above is a list of the symptoms Ben Sasse has identified of the disease he believes today's youth are suffering from.

To understand Ben Sasse you have to understand lifecycle effects

In perhaps the only moment of self-awareness in his entire 273-page book, Sasse writes on page 8, "How do we know the situation with our kids has really gotten worse; don't all parents always worry about their teens?"The answer, of course, is yes. I use the term "lifecyle effects" to refer to the ways in which predictable changes in the perspective of the observer over a lifetime influence his or her opinion about the conditions being observed.To give a simple example, I find that temperatures in the summer are much less comfortable for me in my early 30's than they were in my early teens. Someone ignorant of lifecycle effects would conclude that summers are hotter than they used to be, while someone who is conscious of lifecycle effects would wonder whether people in their 30's are consistently less comfortable with summer heat than people in their teens. You should always rule out lifecycle effects before trying to find an explanation for something you think has changed since you were younger.Sasse does not. Instead, his criticism of America's youth is based entirely on his memories of how his own adolescence differed from the adolescence of today. Correcting this error is not as easy as it seems. Consider, for example, if Sasse's father were alive today. You might think he could turn to his father and ask, "dad, I know due to my biases I can't render a useful judgment, but you saw me grow up and you're seeing my daughters grow up, so you can be objective: are kids today less self-reliant than I was when I was a kid?"Now that you know about lifecycle effects, you know this can't work. 45-year-old Ben would be asking 75-year-old Grandpa what 75-year-old Grandpa thought about 14-year-old Granddaughter Sasse compared to 45-year-old Ben. Since Ben has made a Senator of himself, nothing would be more natural than for Grandpa to judge that Ben had an ideal upbringing. Since Ben's kids are homeschooled teenagers, Grandpa may have natural and inevitable concerns about their immaturity.But lifecycle effects don't end when you turn 45 — they continue until they end as all lifecycles do. No, to find out whether kids these days really are suffering in an unprecedented way from the maladies Ben Sasse has diagnosed, he would need to ask 45-year-old Grandpa Sasse what he thought about 14-year-old Ben. In other words, he would need to interrogate contemporaneous records to see whether the particular complaints 45-year-old Ben registers were made by other 45-year-olds about young people in previous times.If they were, then Sasse would be forced to reckon with the fact that the basic conceit of his book is wrong: adolescents today do not suffer in an unusual or unprecedented way from the maladies he diagnoses them with.

What do contemporaneous records show about adults' views of adolescents?

Here I have to confess: I love PSA's. Public Service Announcements and other educational films of earlier eras are not historical records of America's past (for one, they're in black and white). What they are is a perfect crystallization of what some adults — writers, directors, and producers — thought would appeal to other adults — parents — when it came to the education and upbringing of their children.Even more importantly, given the income and wealth disparities of race and class, such films are focused almost entirely on the precise population Ben Sasse is concerned with: the parents and children of white middle-class and upper-middle-class families.So, what do the PSA's of the past have to say about the concerns of parents of the past about the youth of the past?The 1954 educational film "Habit Patterns" is a personal favorite of mine. The first time I saw it I was fairly sure it was about a girl unexpectedly beginning a menstrual cycle, but it's actually quite a bit more interesting than that. In it, the villainess Barbara (unlike Ben Sasse's daughter Helen across the street):

  • sleeps in past her alarm clock;
  • makes her mother shout up the staircase to get her out of bed;
  • tells little lies;
  • has no plan for her day at all;
  • puts off mending the collar on her dresses;
  • decides to cover the spots on her sweater with a scarf;
  • wasn't ready in time for her father to take her to school, disappointing him;
  • didn't have time to be picky about her food or think about her diet;
  • didn't have time for milk, to say "good morning," or for manners;
  • made a pretty picture with her rumpled skirt, her spotted sweater and her hair in a tizzy;
  • was late for school.

These are not cherry-picked examples. I have transcribed the precise crimes alleged against young Barbara in 1954. They don't just have a striking resemblance to the inadequacies and disappointments alleged by Ben Sasse, they are identical, all the way down to listlessness and enervation.

The rest of the book

Ben Sasse is running for President of the United States, and "The Vanishing American Adult" has a kind of genius about it: targeted at the voting-age parents of children under the age of 18 in order to make them feel as sympathetic as possible to Ben Sasse's view of their children's inadequacy. The children, naturally, don't get a say in it.To achieve the goal of being elected President, Ben Sasse's actual prescriptions by necessity can't be too specific, and so the rest of the book is filled with predictable banalities. Children should work, read, save, travel, and spend time with their elders. Also, they should love America.This is Benjamin Spock with an American flag waving over it (there is, happily, an American flag on the book's cover). You can, technically, take parenting advice from it, if you're the kind of person who wants to lecture their toddler about the importance of resilience.This is a bad book, and Ben Sasse is a bad man, but no review of it and him would be complete without a final quote of the most Bensassian passage in the entire text, in which he describes finding the perfect ranch for his daughter to learn the essentials of ranching:

We thought it would be a special formative experience for Corrie to spend time working on a ranch. The rancher would get some free labor and out daughter would build some character by an unrelenting encounter with daily necessity. Our poopotologist [ed: don't ask] helped us find a rancher who was willing to take on a teenage girl for a month. For obvious reasons we didn't want her to go to some remote cattle operation with a bunch of 20- and 21-year-old men working as hired hands. We were hoping for a family environment. We found just the place: a family-owned-and-operated ranch, where an earthy old rancher and his wife and three grown children and a new grandbaby lived and worked.

To call this pandering would be to give a bad name to the great panderers of history. If Ben Sasse thinks his political fortunes lie in the pool of late-middle-aged men who are concerned about their daughters spending time with virile, unmarried men, he has every right to hunt down their votes everywhere he can find them.But the rest of us have the luxury of shaking our heads in disbelief at this pitiful shell of a man.

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:

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 is going to happen to your financial independence after the crash?

There is a phrase I frequently read and hear from financial independence types that I find extremely confusing, and which is one of many reasons I find the concept of financial independence troubling, at least as I've seen it promoted on the internet. The phrase is: "depending on what the markets do."A typical formulation is, "we'll be financially independent in 2018, depending on what the markets do." Or: "I'll quit my job in February, depending on what the markets do."This is the corollary of the "4% rule" (or the 3% rule, or the 5% rule), which suggests that you can calculate the market value of assets needed to retire by dividing your needed income by some predetermined percentage.Only one of two things can be true: you can become financially independent based on the market value of your assets, in which case you can likewise become newly financially dependent based on the market value of your assets. Alternately, if you are still financially independent when your assets decline in price, then you were already financially independent when your assets passed through those new, lower prices, and you were wrong to rely on the safe withdrawal rate — you should have been using some other, better metric.My personal guess is that faith in these "safe withdrawal" models is based on the fact that most financial independence types have been pursuing early retirement only in the aftermath of the global financial crisis, and thus have only limited experience with large, sustained collapses in prices across approximately all asset classes. The belief that US equities will rise by 8% per year in perpetuity seems, if anything, conservative given the sustained run stocks have been on since 2009.But economies enter recessions, asset prices fall, and when they do I think the knock-on effects are going to be devastating to many early retirees.

Let's talk about correlation

For example, Coach Carson describes a technique he calls "house hacking" in the following way:

"Once I had 3 of the 4 units rented out, I moved into the 4th unit, lived there for 6 months, and applied for a refinance. Because the value was now much higher (about $155,000), I was able to borrow $120,000 and pull out 100% of my invested money. This particular strategy is known in online real estate circles as the BRRRR Strategy (Buy, Rehab, Rent, Refinance, Repeat). But I’ll talk about that more in the financing section of this guide."

What has Coach Carson done here? First he creates an asset (the property) and a liability (a bank loan and "private financing"). Then he spends some money improving the property. Then he creates 3 new assets (3 contracts with tenants to pay him) and 3 new liabilities (3 contracts with tenants to provide them with housing). Then he creates a new liability using the increased value of the property as collateral, and a new asset, the cash in his bank account.At this point Coach Carson is probably ok. Even if all 3 of his tenants broke their leases tomorrow, he's still got $120,000 in his bank account, which could presumably service his mortgage, private financing, and line of credit for years. Hell, if he wanted to he could just abscond with the money and leave his creditors holding the bag.But Coach Carson isn't going to sit on $120,000 forever. He's going to invest it, and therein lies the problem. When the crash comes, his assets will halve in liquidation value, but his liabilities will remain unchanged. Even worse, his tenants will lose their jobs, break their leases, and move back home. Coach Carson is going to have a hard time replacing them, and will be forced to accept lower rents — if he's able to find new tenants at all. Suddenly his cash-flow-positive or -neutral asset has become a cash-flow negative asset, forcing him to find more and more money elsewhere — like his recently cratered stocks. Coach Carson no doubt thinks he's going to go on a buying spree when he can get stocks at a deep discount to their current prices. Instead, he's going to be liquidating them at fire sale prices.Ok, I don't know anything about Coach Carson, and this has nothing to do with him personally. But what he is describing clearly has nothing to do with financial independence.

What is your model for financial independence?

Many financial independence types have gotten into the content game lately, and good for them — the more the merrier! But the basic pattern I described above applies with minor adjustments to this business model as well. When the economy next stumbles and people start canceling their Blue Apron subscriptions, who is going to pay for weekly podcast ad spots? When venture capital dries up, are the warring mail-order mattress companies still going to be around to dole out sales commissions? When credit tightens and defaults rise, are banks going to be paying anyone who asks nicely for credit card referrals?In other words, the part-time job you're counting on to insulate you from the vagaries of the market cannot perform that function if it is also subject to market forces. "I can always drive for Uber" won't work when Uber collapses amidst lawsuits from creditors and employees.

Dependence is the natural state of man

I've been referring to "financial" independence as a nod to the genre, but if you widen the aperture just slightly you can see that financial independence isn't impossible due to some nuance of double-entry bookkeeping, it's impossible because independence is impossible.It makes as much sense to talk about financial independence as it does to talk about medical independence. Even a surgeon with the skill and confidence to perform surgery on herself (awake!) doesn't know how to compound the anesthetics and antibiotics needed to survive the procedure: she's medically dependent on a pharmacist.A stable and growing economy is full of exciting opportunities, and I am a fierce advocate for people to seek out and explore those opportunities rather than rotting in a cubicle (although if you are rotting in a cubicle I hope you follow me on Twitter to stay distracted). But to live in a stable and growing economy we're dependent on good macroeconomic policy from policymakers we individually have little influence on. We depend on the quality of our representatives and, for their selection and election, on our fellow citizens.

None of this has anything to do with work

I'm a great believer in early retirement — so much so that I retired at 28. But I am not, and have no intention of ever being, financially independent. I depend on the Affordable Care Act to provide affordable, comprehensive health insurance. I depend on the courts to protect me from being wrongfully evicted. I depend on water utilities to provide access to potable water. I depend on Google to accurately track visitors and pay me my share of their ad revenue. On my other site, I depend on Stripe to collect and distribute readers' subscription payments. I depend on the Automated Clearing House to deposit the payments in my bank account. I depend on elected officials to defend Social Security so in old age I'll have a guaranteed source of inflation-protected income.In other words, I'm as dependent as a newborn child, and always will be. If you're waiting to retire until you're financially independent, you're going to be waiting a long, long time.

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?

6 things I wish I knew before starting a business

Running a small business is as fun and easy as you'd expect, and more people should do it. I'm an unabashed promoter of self-employment, not because it will make you rich quickly (getting rich quick is the wrong goal on the wrong time frame), but because it will make you self-employed. That's my unfortunate literal tendency which I can never seem to keep suppressed for long.Saverocity's glorious leader Matt recently posted on the Forum a request for suggestions about what he should include in an entrepreneurship course he'll be leading. I assume he's going to include all sorts of important lessons about networking, flexibility, failing fast, and all sorts of other things I never learned.Instead, I thought I'd share a few things I wish someone had told me before I became self-employed.

1. Immediately apply for an EIN and use it for everything

I've written about this before, but the fundamental lesson is this: the IRS "prefers" you use your Social Security Number for your tax and payment documents because the IRS thinks your business is going to fail. If your business is not going to fail, then it's going to be a pain in the ass to start using your EIN in the future when you want to hire people, apply for business credit cards, open business bank accounts, etc.Apply for an EIN immediately here, and use it for everything, the IRS's "preferences" be damned.

2. Use (and adapt) this spreadsheet

I created this spreadsheet to calculate my own quarterly self-employment tax liability, retirement savings account eligibility, and earned income. Obviously I wish someone had given it to me so I didn't have to make it myself!Self-employment spreadsheetThat basic spreadsheet gets me within $2-3 of my self-employment tax liability every year.Once you have a spreadsheet that you're plugging your income and expenses into each month, you can start tricking it out with additional calculations. My own has calculations like the self-employment retirement plan contributions I'm eligible for, earned income (to see if I qualify for the Earned Income Credit), and others.

3. Starting a self-employment retirement plan is easier than you think

The government makes it inhumanly difficult to find, fill and file required taxes and paperwork properly. But private companies actually want your money, and make it substantially easier.When I finally got around to opening a solo 401(k) for my business, it was laughably easy. Just download the paperwork from Vanguard, correctly identify your beneficiaries (I didn't), and choose your mutual funds wisely.Why start a self-employment retirement plan? Because you can contribute the first $18,000 you make and deduct that contribution from your taxable income (assuming you don't contribute to a retirement plan at another job), plus 25% of every dollar you make after that (up to an annual limit). This makes self-employment extremely tax-advantaged compared to employment, since your ability to shield income from present-year taxes at a traditional job depends on your employer's contributions to your plan. If you're the employer, you get to decide those contributions, and they can be very high.

4. 92.35%, or 0.9235

For very simple, but extremely boring reasons, you never use your actual net self-employment income for anything: you use 92.35% of it (you can see this on line 19 of the spreadsheet in item #2).So in item #3 above, I said you can contribute your first $18,000 in self-employment income to a solo 401(k) plan. I was lying. You can contribute $18,000 of your first $19,941 in self-employment income, because the federal government is waging a war on entrepreneurs and the self-employed.

5. Per diem meal deductions while traveling

When traveling for your business, you can deduct the actual cost of your meals subject to fairly complicated restrictions, or you can deduct the federal government's "meals and incidental expenses" amount for each full day of travel and half that amount for the day you arrive and leave.It is a pain in the ass to find these rates each time you travel; bookmark this page.

6. Every dollar you spend costs 85.8 cents or less

As you can see looking at the spreadsheet in #2, if you increase your expenses by one dollar, the amount of your income subject to tax falls by 92.35 cents, and the amount of self-employment tax you pay falls by 14.12 cents. That means the net cost of spending a dollar on your business is, at a maximum, 85.8 cents. If your income puts you in a higher tax bracket, the cost is even lower.This discount is worth taking into account when you see opportunities that might have value to your business: what might not be worth $1,000 may well be worth $858.

Conclusion

I bragged on Twitter that I had 8 things I wish I knew before starting a business, so for now consider #7 and #8 reserved for a future post.

On sophistication

One of my favorite euphemisms in the entire galaxy of finance and investing is the "sophisticated investor." A sophisticated investor, in legal terms, is one determined to be wealthy enough to be fleeced by con artists without missing the money too much.For example, not just anybody could invest in Bernie Madoff's hedge fund. Only those with plenty of money to spare could invest, with the understanding that when he absconded with it they wouldn't miss it too much.Likewise with the solar, housing, and other non-tradable asset classes with "annual target returns" in the high single digits: if you're poor enough to actually need your money, you can't participate, because of the unlikelihood that you'll get it back.What this has to do with sophistication has always eluded me. Whenever I meet someone who tells me about their stock-picking prowess, or the "really good team" at their brokerage firm, I quickly determine that person is an extremely unsophisticated investor, since they are not invested in low-cost passively indexed mutual funds (note: you can disagree with me. There are many excellent blogs describing all manner of contortions their authors believe are more sophisticated than a low-cost passively indexed portfolio). There's nothing wrong with being an unsophisticated investor, it's just fairly expensive compared to the alternative.So I treat the "sophisticated investor" standard as allowing con artists to ply their trade, but only on those with enough money not to mind being ripped off, and who might enjoy the ride anyway.Why do I bring this up? Because while it's an odd (and oddly-named) standard, at least the sophisticated investor standard protects the most vulnerable people from losing their shirts. And it was introduced because, left to their own devices, con artists aren't particularly picky about whose shirts they end up with.Unfortunately, the guru economy doesn't have any such guardrails. The other day I stumbled across this post at the White Coat Investor, in which he promotes some bank that refinances student loans at lower interest rates in exchange for giving up the protection of income-based repayment on federal student loans. This is far from an exception. Mr. Money Mustache pitches credit cards (as do many prominent financial independence sites). Others promote insurance companies, mortgage brokers, or whomever else they can find to finance their operation.But there's no "sophisticated reader" standard in the blogosphere. There's no way to ensure your sponsored blog posts are only displayed to readers who understand the consequences of taking their advice. On the contrary, blogs are often targeted at folks who are unfamiliar with the relevant concepts (if they were familiar with them they wouldn't be reading blogs about them), and thus more vulnerable to misleading advertisements, especially when they're cast in the voice of a trusted author.Whenever I raise these issues readers harangue me about the importance of personal responsibility. But of course the concept of personal or individual responsibility proves far too much: if we're really individually responsible, then why should we publicly promote the virtues of financial independence/early retirement/weight loss/child-rearing/etc? When you take your advice public you make a public claim that the public will be better off if they follow your advice. Selling that platform to the highest bidder is the equivalent of saying that, having improved the public's well-being by so much, it's only fair that you claw a little bit of it back.I don't buy it.If you only think something is worth doing if you can make money doing it, congratulations, you belong to a long and storied line of American capitalists.If you think something is still worth doing even if it makes others worse off, congratulations, you belong to a long and storied line of American con artists.Just don't tell me you're here to help.