What was behind Robinhood's very bad week?

Since the product was announced on Thursday I've been following with interest the drama surrounding Robinhood's "Checking and Savings" product, which has since been put on hold and rebranded as a "Cash Management" account. It's an interesting story about the brokerage and banking industries, and I think it's possible at this point to piece together what Robinhood was thinking, and what went wrong.

Cash in brokerage accounts absolutely is insured by SIPC

This is something a lot of people seemed to get hung up on in the early stages of the drama, but Robinhood was 100% correct that cash deposits with a SIPC-insured brokerage are insured by SIPC up to $250,000.

Doctor of Credit's early take on this was that SIPC insurance might somehow be less trustworthy than FDIC insurance, but there's no reason to believe that's the case. Essentially 100% ("well over 99%") of SIPC-insured claims have been paid in full over the 45 years the program has been in existence.

Despite the now-famous quote from the chairman of SIPC, it's totally normal and legal for brokerage accounts to hold cash. If you own dividend-paying stocks or ETF's in your Robinhood account, the dividends are paid out in cash and deposited in your Robinhood account as cash. No one has ever questioned, nor would it occur to them to question, whether those cash holdings are SIPC-insured in full up to $250,000.

But most brokerage accounts hold very little cash

Back in August Jason Zweig wrote usefully about how brokerages handle idle cash. Best-in-class firms like Vanguard sweep idle cash into a money market fund like the Vanguard Federal Money Market Fund, which currently has an SEC yield of 2.24%. 

Interactive Brokers, a popular choice for active traders, currently pays 1.69% on idle cash balances above $10,000, but only for accounts with a net asset value above $100,000.

As Zweig explains, even less scrupulous firms sweep idle cash balances into accounts with partner banks, where the cash is FDIC-insured but earns virtually nothing in interest, with the bank and brokerage splitting the difference between prevailing interest rates and what they pay out to customers. This is how Fidelity Cash Management accounts work, which currently share just 0.31% in annual interest with accountholders.

Money market funds are neither fish nor fowl

Money market funds are interesting because they have characteristics of both mutual funds and bank deposits. Like open-ended mutual funds, they collect money and issue shares, and are priced based on their net asset value. But like bank deposits, they seek to maintain a price per share of exactly $1. In order to achieve this, they hold very short-term, government-backed assets, precisely the kind of assets Robinhood promised to invest in.

Figuratively speaking, they use the interest from those securities to "top up" the value of shares, and pay out any excess interest as dividends in order to maintain the value of each share at $1.

Most importantly for our purposes, until 2008, money market mutual funds were not FDIC-insured, and since they were securities, their value was not insured by SIPC either. To be clear, the securities themselves were insured (so your broker couldn't run off with your money market fund shares), but if their value dropped below $1 per share, you were out of luck. Investing involves risk: it's a cliche for a reason.

Money market funds were more vulnerable than people thought

And indeed, that's just what happened in 2008, when the system broke down after the Primary Fund "broke the buck" by reporting a share price below $1.

This posed a catastrophic risk to the financial system: for years, investors had been encouraged to invest their cash in supposedly-safe money market funds instead of ordinary bank accounts or certificates of deposit in order to earn perhaps another 0.5% in interest on their balances. But if money market funds were no longer safe from market volatility, what was the point in holding them? The threat was a flood out of money market funds, a collapse in the price of short-term securities, and a spike in interest rates at the very moment they would do the most damage to the economy.

In response the federal government stepped in, temporarily extended FDIC insurance to money market funds, and provided unlimited liquidity to the financial system. The day was saved.

What Robinhood could have done

All this background is meant to illustrate the options Robinhood had available:

• they could have contracted with a bank to sweep idle cash into an FDIC-insured deposit account and passed along the interest to their customers. If they wanted to be "good guys," they could have passed along their entire share of the interest, which might add up to as much as 1.5% if they partnered with a particularly good bank or banks;
• they could have chartered a bank and swept idle cash into accounts at their own in-house bank, paying out as high an interest rate to their customers as their lending was able to support;
• they could have contracted with a mutual fund company like Fidelity or Charles Schwab to sweep idle cash into a third-party money market mutual fund;
• they could have registered their own money market mutual fund and swept idle cash into it, as Vanguard does.

Each of these options has advantages and disadvantages. But the disadvantage they all have in common is that they're expensive. Using an outside bank or mutual fund means you don't have any more interest to pay your customers than the outside firm is willing to share with you. Using an in-house bank or mutual fund would provide more flexibility but incur vastly higher start-up and regulatory costs, not something that appeals to an asset-light startup like Robinhood.

What Robinhood was thinking

So, they got clever. If they could create an account under the auspices of their brokerage, then the cash would be SIPC-insured just as it is today. Short-term treasury rates aren't quite at 3% yet, but you could imagine a blend of short- and long-term treasuries that gets you within spitting distance, which you could then top up with MasterCard interchange fees from the debit card and your investors' capital as needed, at least until it ran out.

Put this way, you can see why the CEO of SIPC was skeptical of the project: if Robinhood wants to guarantee the value of deposits from loss, then they need a bank charter and FDIC insurance, while if they want to pass along the performance of actual securities then the money is being invested and the SIPC doesn't insure the value of investments from losses.

Conclusion

There are two ways to think about the interest a depositor receives. On the one hand, it's the price banks pay for the money they need to lend out: a bank is willing to pay depositors 3% on a 10-year CD if it can loan out that money at 5%.

The other way to think about the interest a depositor receives is that it's "what's left over." A bank that lends out money at 5% and pays 3% of that in broker commissions and overhead only has 2% left to pay to depositors.

As a thought exercise, forget the 3% offered by Robinhood. Why doesn't some bank decide to pay depositors 10% on their balances? They'd immediately attract hundreds of millions of dollars in deposits and become one of the largest banks overnight, crushing their competitors.

Well, it's because no bank has 10% left over after expenses. Any bank that tried it would immediately deplete their capital reserves and the FDIC would have to step in to bail out their customers.

Whom amongst us doesn't have a brilliant strategy to turn a small fortune into a large fortune? If Robinhood thinks they can return 3% to depositors after paying their expenses and providing their investors with an expected return on capital, they're welcome to try.

But for now they're going back to the drawing board.

The SEC offers free financial planning tools. Are they any good?

This is a funny thing I was unaware of until I saw someone mention it on Twitter the other day: the SEC hosts a website offering free financial planning tools. I was surprised, since I think of the SEC as having a "hands-off" approach to investing: they don't want people to commit too much fraud or anything, but they're mostly indifferent to whether you invest well or poorly and make good or bad decisions with your money.Financial planning is a totally different animal because financial planners really do make right and wrong decisions. For example, SPICX is an S&P 500 mutual fund with an expense ratio of 1.31%, 33 times more than Vanguard's equivalent fund. That's not something that bothers the SEC (assuming the expense ratio is properly calculated and reported), but it's something that should bother a financial planner.So, I decided to find out: are the SEC's free financial planning tools any good?

401(k) and IRA Required Minimum Distribution Calculator: 3/10

The 401(k) and IRA Required Minimum Distribution Calculator is functional, but primitive. It asks for just two pieces of information: your account balance at the end of the previous year and your age at the end of the current year. From that, it calculates your "withdrawal factor," which is the reciprocal of the percentage of your assets you need to take as required minimum distributions. Finally, it calculates that amount. There are two main design problems with the tool that earn it such a low rating:

• It doesn't help you calculate the relevant year-end account balances or help you interpret the rules around them. For people with multiple IRA's, 401(k)'s, and 403(b) plans, with some Roth balances and some traditional balances, it would be helpful if the tool had multiple fields to enter each balance separately and apply the relevant rules to each account type. For example, someone with multiple 401(k) accounts and multiple traditional IRA accounts may not know that 401(k) RMD's have to be taken from each account separately, while IRA RMD's can be combined and withdrawn from a single account. And while they mention IRA and 401(k) plans, they don't even ask about 403(b) balances, which have their own slightly different rules.
• It doesn't calculate RMD's for people using the joint-life-expectancy exception. If the owner of a retirement account has a spouse more than 10 years younger, they're able to calculate their RMD's using their spouse's joint life expectancy instead of their own. The tool acknowledges this, but merely says "Note: If your spouse is more than ten years younger than you, please review IRS Publication 590-B to calculate your required minimum distribution." But the joint life expectancy rules aren't subjective, they're just a math problem — precisely the kind of math problem a tool like this should be able to solve. It also doesn't help that the site they link to is barely functional (the actual publication is here if you're curious).

Compound Interest Calculator: 8/10

The Compound Interest Calculator is pretty good and well-designed, with the one advantage over the Moneychimp calculator I normally use (because it's the first Google hit) that it is able to display 3 growth rates simultaneously.The only minor tweaks I would make is providing some default suggestions of what kinds of contributions and earning rates are realistic. For example, the IRA contribution limit of $5,500 (increasing to $6,000 in 2019) works out to about $458 a month, which they could offer as a suggested monthly savings rate.Likewise, what's a realistic interest rate, and what's a realistic range of interest rates around it?Finally, I've never seen a tool that incorporates inflation rates on both the contribution and earnings side. Someone who diligently maxes out their IRA every year will contribute $5,500 in 2018 and $6,000 in 2019...and perhaps $15,000 in 2038. Anchoring is an important feature of human psychology, and I suspect quite a few people anchor their IRA contributions on the maximum allowable contribution. It would be nice for a tool to try to reflect that.But these are quibbles. Overall, the Compound Interest Calculator is fine.

Savings Goal Calculator: 5/10

The Savings Goal Calculator suffers from the same problems as the Compound Interest Calculator, while adding no additional value. If these are financial planning tools then they need more inputs than you can get from a basic finance calculator. What is an appropriate savings goal? What is it based on? I'm not asking for the SEC to predict health or transportation expenses 30 years in the future, but a simple approach would be to look at the median savings amount of retirees today and apply a range of inflation expectations.I understand why they don't want to do this: they don't want people to say "the SEC told me I'd be alright if I saved such-and-such an amount!" But if you're going to offer a "Savings Goal Calculator," you've got to take some responsibility for its calculations.

Ballpark E$timate: 0/10

The less said about Ballpark E$timate, the better. First of all, it's not actually operated by the SEC like the previous 3 tools. Second, it requires even more speculative assumptions about the future. Why do the people who design these tools think that a person who needs an online tool to decide how much to save will have an accurate guess about future inflation rates? Whatever you think about the ability of experts to predict future inflation rates, you should have much, much less confidence in the ability of the average person to do so.

Social Security Retirement Estimator: ?/10

I have no idea if this tool works because the Social Security Retirement Estimator will only return a result if you already have 40 Social Security credits (at least 10 years of covered work earning the maximum 4 Social Security credits per year). The plus side is that it's based on your actual earning history, so should be somewhat more accurate than the back-of-the-envelope calculations I'm typically forced to use.

Mutual Fund Analyzer: 3/10

Another external tool, this time offered by FINRA, the Fund Analyzer works ok, but has some serious flaws. To test the Fund Analyzer, I plugged in the high-cost Invesco S&P 500 Index Fund (SPICX) and the low-cost Vanguard 500 Index Fund Admiral Shares (VFIAX) to see what the Fund Analyzer was able to conclude. Feel free to plug in the same funds so you can follow along with this analysis at home.

• Fund Analyzer correctly observed that SPICX would cost 30 times more over a 10-year holding period: $1,574.28 versus $51.45 for the Vanguard fund.
• Frustratingly, Fund Analyzer did not point out that if you sold SPICX within 12 months, you'd be hit with a 1% back-end load fee. To identify that, I had to reduce the holding period to 1 year, and suddenly the fee materialized. Since how long you will ultimately hold an investment is obviously a matter of speculation, those contingent fees should be displayed much more prominently.
• The annual operating expenses are not compared on a like-for-like basis. This apparently comes from the fact that Vanguard filed their fund as a "Growth" mutual fund, while Invesco filed theirs as a "Growth and Income" mutual fund. Remember, these are both S&P 500 index mutual funds.
• The visual "expense ratio bubble" graphic depiction of mutual fund expenses is useless because there's no way to zoom in and tell them apart. It also includes funds that are closed to new investors or only available through proprietary products like target retirement date funds.
• The data is out of date. FINRA still reports that VFIAX has a $10,000 minimum investment, when in fact Vanguard recently lowered the minimum investment for most of their index fund Admiral Shares to $3,000.

529 Expense Analyzer: 0/10

The final financial planning tool recommended by the SEC is the 529 Expense Analyzer, also provided by FINRA. This tool, as far as I can tell, is worthless. The instructions are:

"You can find the information you will need to input into the analyzer in the plan's program disclosure statement, program brochure or plan description. If the plan invests in mutual funds, you may also need the prospectuses for these funds. If you don't have copies of these documents, you can find electronic copies on most 529 plan websites. The College Savings Plans Network website provides links that take you to each state's 529 plan website. If you are having difficulty locating a disclosure statement or plan description on the state's website, it may be included with the 'enrollment information.' Once you download the document, check the Table of Contents for a section on fees and expenses (unlike a mutual fund prospectus, this data is often not presented in a fee table)."

This reminds me of nothing so much as the folk story "Stone Soup." FINRA makes a seemingly outlandish promise: they'll calculate the expenses of any 529 plan in the world. Intrigued, you ask what you must do to receive this extremely valuable gift. And FINRA explains: all you have to do for FINRA is one little favor. Go to the website of every 529 plan, download all the enrollment and investment documentation, carefully input it into a spreadsheet, and presto! FINRA does the rest.

Conclusion: do better, SEC

Let me be clear: I'm not trying to make some kind of abstract argument about the futility of replacing human financial planners with automated tools. On the contrary, I think it would be easy to produce online tools that actually perform the financial planning functions the SEC describes!Vanguard, for example, already has a pretty great tool showing a lot of the information you need to select the right 529 plan for you, including essential information like state-level tax benefits. The key difference is that they don't require you to hunt down the information on your own: they actually did the work to create a useful tool to help people draw correct conclusions.But you can't design useful tools with a view from nowhere. You actually have to make judgment calls, and those judgment calls might be wrong. In a mutual fund low fees are better than high fees. In an index fund, less cash on hand to meet redemptions is better than more cash on hand (the SPICX fund mentioned above has 7% of its net asset value in cash — you're paying 1.32% for someone to manage cash for you!). Lower tracking error is better than higher tracking error. Except when it isn't!A tool that tells you how much you need to save needs to have reality-based estimates of investment returns and inflation in order to produce useful conclusions, even though those estimates might be wrong. Asking people off the street "what do you think the inflation rate will be for the next 30 years?" relieves you of responsibility for the accuracy of your estimates, but it also prevents your tool from providing useful information.There are lots of potential solutions to these issues: Monte Carlo simulations, historical evidence, fundamental analysis, etc. Some of those solutions might work better than others, or perhaps a combination of them would work best of all. But if all do is throw up your hands and say "figure it out for yourself," you haven't provided a financial planning tool, you've provided a 9th grade math exercise.

Book review: Reihan Salam and the limits of American greatness

The local public library recently spit into my hands Reihan Salam's slender volume about US immigration policy, "Melting Pot or Civil War? A Son of Immigrants Makes the Case Against Open Borders." The "son of immigrants" in question is Salam himself, who is so thoroughly integrated into American life he manages to hold down a gig writing for the fringe conservative website National Review.Reading the work of conservative "intellectuals," whether it's Reihan Salam, Ben Sasse or Jeffrey Goldberg, is obviously a curious exercise given how fundamentally our politics and values differ, but I never fail to learn something from these books about the conservative mind, and Salam's latest book proved to be no exception.

What's the problem with immigration?

I always try to give the most generous interpretation possible of these conservative ideologues so no one can claim I'm taking them out of context or setting up straw man versions of their arguments just because I disagree. Salam's argument against immigration (or against "open borders" as he puts it), hinges on the following observations:

• the foreign-born share of the population is historically high and rising;
• the foreign-born share of the working-age population is historically high and rising;
• a community of immigrants that is replenished with new arrivals is less likely to encourage integration into established American institutions, and may even "draw established Americans into its cultural orbit" (horrors!);
• low-skilled immigrants are likely to have low-skilled children, who will both use means-tested programs and agitate for social justice.

Rarely has anyone interpreted the "melting pot" so literally

It's true that humans don't actually melt, even at very high temperatures, with the Indiana Jones canon notwithstanding. But they do the next best thing: they marry. And Reihan Salam is obsessed with marriage. In particular, intermarriage:

• "Marrying outside one's own ethnic community was often frowned upon"
• "The children and grandchildren of European immigrants became much more likely to marry outside their ethnic tribes"
• "It would be one thing if the likelihood of intermarriage were identical for more- and less-educated Hispanics, but that's far from the case"
• "Today, rising rates of intermarriage and residential integration suggest that a growing minority of blacks are finding a place in the mainstream"
• "When Italians stopped arriving in America, Italian Americans had little choice but to marry non-Italian Americans"
• "Assuming these college-educated, native-born Hispanic women are marrying college-educated non-Hispanics, it's quite likely both that their children will be college-educated themselves, and that they'd find themselves in social networks that are more Anglo than Hispanic"

Now, I have to confess, I'm the marrying type. I myself got married in August. Two of my brothers are married. My late father loved marrying so much he did it 4 times!But even as a marital fellow, I found Salam's obsession with marriage and breeding creepy as hell. The reason for it, however, soon becomes clear: Salam uses marriage, and particularly intermarriage, as one of many substitutes for a vigorous state.

Reihan Salam's vision is of America's weaknesses and limitations

The key to understanding Salam's vision of the United States, I realized, is that buried somewhere deep inside the United States, perhaps somewhere under Kansas or Nebraska, is a powerful enchanted object that grants the United States certain powers:

• the United States, alone amongst the nations of the world, can integrate immigrants into its multiethnic, participatory democracy.
• the United States, also uniquely, has the power to improve the economic well-being of its residents by training them to take its good-paying, middle-class jobs.

Unfortunately, while the "opportunity crystal" (as I've dubbed it) is powerful indeed, its powers are limited, and thus those responsible for this magical object must carefully allocate that limited power between these two admittedly worthy goals.As Salam writes: "I find it useful to distinguish between amalgamation, in which intermarriage and other forms of cultural intermingling cause the ethnic boundaries separating different groups of Americans to blur to the point of insignificance, and racialization, in which a minority group finds itself ghettoized in segregated social networks [emphasis his]."Amalgamation is one of the enchanted gemstone's powers, but it must be carefully rationed in order to make sure the middle class is accessible to as many natives as possible, and if there are too many immigrants and not enough leftover power, we face the dire threat of racialization instead.But all this is false. The limits on the ability of the United States to assimilate immigrants come from the willingness of the United States to assimilate immigrants. The limits on the ability of the United States to afford decent pay and working conditions to the working class come from the unwillingness of the United States to guarantee decent pay and working conditions to the working class. There's no enchanted object whose power we need to carefully ration. It's just us.

Salam's immigrant hellscape is social democracy

What's wrong, you might ask, with a continent-straddling country that happens to have some pockets of people who are, by comparison with the rest of the population, relatively homogenous, relatively recent arrivals, and relatively low-skilled?Salam has an answer, and it goes back directly to the passage I quoted above about "racialization." You see, "racialized" immigrants, or those who "find themselves ghettoized in segregated social networks," might not like it very much. Specifically, the children of low-skilled immigrants (whether documented or undocumented), will use their influence as US citizens who can't be simply deported if they become inconvenient, to try to ameliorate some of the poor conditions they find themselves in.Which brings us to the core of the question: what don't low-skilled, low-income second-generation citizens like about the United States? Salam provides 3 basic answers:

• they don't like their wages, which are too low;
• they don't like their working conditions, which are too inhumane;
• and they don't like their living conditions, which are too primitive.

In other words, they're right. Wages in the United States are too low. Working conditions in the United States are too inhumane. Living conditions in the United States are too primitive. And it turns out the children of relatively recent immigrants aren't thrilled about it and might do something to change it!Salam is so concerned about this possibility that he wants to preemptively keep them out. I'm so thrilled about this possibility that I want to preemptively admit them.

If you aren't willing to pay taxes nothing is possible

Americans today have inherited an incredible array of institutions, from public universities to building inspectors, from public water and power utilities to post offices, from subways to regional rail. Most of them are still staggering along well enough, despite every attempt to bankrupt and dismantle them in the last 30 years. You can still get a drivers license replaced, you can still register to vote, you can even still get a building permit approved, eventually (here in DC we have a special bribes-only channel for approving building permits).But if the plan, from now until the heat death of the universe, is to reduce the government's financing stream by 20% every 8 years while dismantling all the institutions of accountability, then we're simply doomed. Without vigorous wage and hour enforcement, wage theft will continue regardless of the number of immigrants. Without fair scheduling and paid family leave laws, working conditions will deteriorate regardless of the number of immigrants. Without new construction and vigorous enforcement of tenants rights, living conditions will deteriorate regardless of the number of immigrants.Immigration, in this sense, is Reihan Salam's canard. He hates immigrants as much as everyone else in his party, he just hates them in a kinder, gentler way: it's not because they're foreign, it's because of the strain they'll put on the system. But the only reason the system is under strain at all is because of, you guessed it, Reihan Salam.

"Effective altruism" is as stupid an idea as "smart beta"

A spectre is haunting the United States — the spectre of "effective altruism." This is the idea, lifted from the corridors of financial capital, that philanthropy can and should be streamlined, optimized, A/B tested, and transformed to make sure each dollar is deployed "effectively."The other day I saw Dylan Matthews, in honor of "Giving Tuesday," write about his own recommendations for effective altruism ("Made possible by The Rockefeller Foundation"). Dylan Matthews is a very weird guy (he gave his kidney to a stranger), but I don't have any doubt he's a good guy trying to do his best, and modeling your philanthropy after his (with or without the kidney donation) is a perfectly good way to get started if you're interested in giving away some money.What baffles me is what "effective" altruism is supposed to be so deliberately contrasted with.

Shoveling cash into a raging furnace is an admittedly bad idea

You can imagine a completely altruistic person, finding they have no use for their money, deciding to go down to the boiler room of their apartment building, opening the grate, and throwing carefully bundled stacks of $100 bills into the fire. This is a perfectly reasonable exercise of self-abnegation, or "altruism," and I would have no serious objection.You can also see how this would be ineffective: it wouldn't work. Nothing would happen. Burning physical bills in the boiler room, or dumping sacks full of coins in the Potomac, would not have the slightest effect on the economy of the United States or the well-being of anyone anywhere in the world, no matter how many people indulged in the conflagration. That's because the monetary supply of the United States has nothing to do with the number of notes and coins in circulation; it's completely controlled by the policymakers at the Federal Reserve.This silly thought exercise is merely to point out that I understand perfectly well the meaning of "ineffective" altruism: when your sacrifice is completely pointless, you are being altruistic, but not having any effect, i.e., ineffective.

Almost no forms of altruism are like this

What bothers me about the "effective altruism" canard is that the Dylan Matthews of the world consider any form of altruism that is not optimized according the preferences of the speaker by definition "ineffective," and that simply makes no sense unless you ask another question: effective at what?Take, for example, the Wounded Warrior Project. The Wounded Warrior Project gets a lot of criticism since it's a fairly elaborate hoax. They spend very little money on what a normal person would consider "philanthropy," and an enormous amount on fund-raising and salaries for their executives, salespeople, press agents, etc. In the fiscal year ending in 2017 one in four contributed dollars went to...raising more dollars.But the Wounded Warriors Project isn't "ineffective" in any obvious sense. It may not help "wounded warriors" much, but it also doesn't incinerate cash: it pays it out in fundraising contracts, advertising, staffing, travel reimbursement, office leases, all the normal activities a sprawling, $200 million organization engages in ($371 million in net assets at the end of their 2017 fiscal year). If you wished it out of existence tomorrow, you wouldn't increase the effectiveness of altruism in the slightest, you'd just create some vacant office space, empty bus stop ads, and unemployed con artists.Now take another form of altruism the "effective" kind is juxtaposed against: simply giving money to panhandlers on the street. This violates all the rules of effective altruism: you're giving to an uncertified recipient, without conducting adequate research, at home instead of abroad. So it must be ineffective, right? Well, that depends: ineffective at what? If you think a panhandler is going to tear up your money and throw it away, then we're back in furnace territory. But if you think the panhandler is going to spend the money, then it seems to me your altruism was perfectly effective: in the course of handing a dollar from your wallet to a panhandler, you successfully transferred one dollar in value to its intended recipient. Zero overhead, tax-free, and no credit card commissions.That sounds to me like 100% effective altruism!

Effective altruism and smart beta

In the world of finance, one of the greatest marketing coups of all time was the invention of "smart beta." Smart beta is the suggestion that unlike the dummies who settle for low-cost market-capitalization-weighted index funds, the knowledgable few can attain higher returns by tilting their investments towards cheap, or small, or profitable, or liquid, or expensive, or big, or unprofitable, or illiquid companies. Pick one or two or 10 "factors" and all of a sudden your beta is smart, instead of dumb.And who wants to be dumb? So the markets have been swarmed with smart beta funds, which promise you the market return...just a little bit smarter.Effective altruism strikes me as precisely the same branding exercise, in that merely saying it instantly conjures into existence the nonsensical idea of its counterpart, "ineffective" altruism, without specifying what ineffective altruism is supposed to be so ineffective at.Ineffective altruism is surely ineffective at the things it does not try to do, just as dumb beta is dumb at the things it does not try to do. You don't buy a total US stock market index fund in order to track value stocks any more than you buy it to track international stocks. But it's not broken, it's doing exactly what it's intended to do. Similarly, ineffective altruism is perfectly effective at what it is.In other words, there are no furnaces full of cash. It all gets spent.

The Better Billionaire Project

It's very fashionable in leftist circles to talk about the problem of wealth and income inequality in the United States and around the world. The problem of wealth and income inequality is, no doubt, very serious, but I take comfort in the words, "It is easier for a camel to go through the eye of a needle, than for a rich man to enter into the kingdom of God."Therefore what concerns me about the consolidation of wealth is not its concentration, but the hands it is concentrated in. Particularly, how unimaginative those hands are. There's no mystery why that should be the case. To become a billionaire in one lifetime, you need to combine talent, luck, perseverance, and in a pinch you can always steal intellectual property and sell it to the Soviets.Having mastered the desktop computing, digital payment, or car insurance industries, naturally you'd be tempted to treat philanthropy as yet another industry ripe for innovation and disruption. But there are an enormous number of fields that don't require any innovation or disruption at all. They just require money.Take the case of cash bail. Cash bail is such a terrible idea even the gross framers of our Constitution wrote into the Bill of Rights that "Excessive bail shall not be required." But today, excessive bail is so ubiquitous it's treated as a feature of the system, since holding people behind bars, keeping them from their jobs and families, is one of the surest ways to negotiate guilty pleas and reduce the workload of the courts and juries who were supposed to serve as the guarantors of American liberty.Just ask the Orleans Parish district attorney, when people started posting bail for his victims: "I think they are very naive as to what they are dealing with, especially with this criminal justice system," and "It's extremely disturbing." This is someone who is fundamentally uncomfortable having to accommodate the rights guaranteed to his victims by the United States Constitution.There are efforts around the country to eliminate the problem of cash bail, which require the diligent work of staffers and volunteers in cities, counties, statehouses, and in Washington to achieve their goals. That's expensive, difficult, important work.But writing checks is easy. You can go down to the courthouse every morning, sit in the back, and write checks made out to the city or county for the amount of each defendant's bail. Your hand might start cramping after a few days, you might need to order some more checks, but this is a problem that can be solved immediately by any billionaire in the country. And as far as I can tell, it hasn't occurred to a single one of them.Is that because it's ineffective? No, it's one of the most effective thing you can do to make real, immediate change in your community. It's because it's boring. No mosquito nets, no genetic engineering, no balloons broadcasting wifi into the Sahel, just money. And money, conveniently, is the thing billionaires have the most of.

Getting started

So for this, the inaugural edition of the Better Billionaire Project, let me introduce you to the National Bail Fund Network. If I were a billionaire, or even a low millionaire, I'd go down to the courthouse myself, but I understand y'all are busy. So check out the list of member funds, contact them directly, and figure which you want to contribute to. Some are focused on immigrant justice, others on disadvantaged communities, and others on low-level offenses. Ask how your contribution will be used, what their turnover rate is (bail funds are returned when a defendant returns for trial), and how quickly they're able or willing to expand their operations.Then once you find one or more funds you're comfortable with, all you have to do is give till it hurts. Remember, you can't take it with you.

"Opportunity Zones" are a terrible idea, poorly implemented, but big ambitious policies can and do work

Over the course of 2018 we've seen increasing clarity about the so-called "Opportunity Zones" included in the Republican smash-and-grab tax heist of 2017. Over at Alpha Architect they have an excellent breakdown of the tax advantages of these investment vehicles, so I'll stick to the roughest possible outline:

• taxable capital gains (e.g. from the sale of an appreciated security in a taxable account) can be rolled into an "Opportunity Fund;"
• those rolled capital gains are untaxed for between 5 and 7 years, then are taxed at a preferential rate depending on the holding period;
• any gains within the Opportunity Fund itself are completely tax free after a 10-year holding period.

The one thing I would add to Alpha Architect's otherwise-comprehensive post is that they actually understate the advantages of Opportunity Funds: there are three separate discounts that should be applied to the initial taxable capital gains rolled into the Opportunity Fund. Alpha Architect discusses only the explicit, 10-15% step up in basis for rolled capital gains. But that amount is also fixed in nominal terms, while the taxes are actually paid in less valuable future dollars. That means in real terms your taxes are reduced three times:

• Once by deferring them 5-7 years (you'd rather pay taxes later rather than sooner);
• Once by reducing them by 10-15% (you'd rather pay less than more);
• Once by paying them in 2027 instead of in 2018 (you'd rather pay in worthless 2027 dollars than in precious 2018 dollars).

For way more details on the tax implications of these investments, do check out the Alpha Architect post linked above.

Should economic policy be pro-business or pro-capital?

Consider, if you will, Census Tract 2.01, in Missoula County, Montana. This census tract describes, more or less, the part of Missoula locals call "the Northside," and it's eligible for Opportunity Zone tax incentives.The first thing to realize is that there are already businesses on the Northside. The KettleHouse Brewing Company has a big brewery and event space there. All the big box stores on the East side of Reserve Street are in the Opportunity Zone; all the big box stores on the West side of Reserve Street are out of the Opportunity Zone. The hottest new restaurant in town is in the Opportunity Zone. The beloved, run-down local bowling alley falls just outside it. Just for fun I checked, and poor Karl Tyler Chevrolet is just over the census tract line, while DeMarois Buick GMC Mercedes-Benz is safely within it.The most obvious problem this raises is the question of fairness, and it's a perfectly fair objection, if you're so inclined. If Mr. DeMarois sells his dealership to an Opportunity Fund, then not only is he going to get a better price than if Mr. Tyler sold, but the outside investors who purchase his dealership are going to be able to sell Buicks, GMC's, and Mercedes-Benzes at lower prices due to their lower after-tax cost of capital, compounding the injustice.But I'm not particularly concerned with the cost of capital. My concern is with business, which has nothing to do with the cost of capital, no matter how much financial capitalists try to convince you otherwise. Whether a brewery is profitable depends on whether it is making more money from selling beer than it costs to make beer. Whether a car dealership is profitable depends on whether it makes more money selling cars than it pays the manufacturer for cars. Whether a bowling alley is profitable depends on whether it makes more money selling games of bowling than it pays people to rummage around in the bowels of the building freeing stuck pins and whatnot.And the problem with Opportunity Zones is that it's an extravagant, expensive tax advantage handed out only to financial capital, not to businesses, including within the Opportunity Zone itself. If the Burns St. Bistro expands their hours, or adds more space, or hires more staff, they owe taxes on their expanded profits. If an Opportunity Fund buys the lot next door, hires their staff away, and sells the place in 10 years, their investors walk away without paying a cent in taxes.

Opportunity Zones point the way towards bold, ambitious policies

Like most people, I detest the 2017 tax reform bill because of its enormous transfer of the nation's wealth to the owners of existing capital. But while the structure of Opportunity Zones is just another example of that looting of the public, the enthusiasm among the financial elite does illustrate the potential of bold, ambitious policies.The key insight of the creators of Opportunity Zones was the magic of 0%. If you tell people they'll get a 10%, or 50%, or 90% discount you might be able to budge their behavior a bit one way or the other. This is, indeed, how municipal bonds work today. But when you tell people they'll pay nothing, ever, in taxes on an investment, they don't just get excited, they lose their minds.

What would a bold, ambitious, pro-business policy look like?

The fact that Republicans were willing to sign off on a policy with literally unlimited cost to the American taxpayer (remember, unlimited capital gains within the Opportunity Fund are completely tax-free after 10 years) should be an invitation to people who believe in the value of business, as opposed to capital, to be more ambitious in our demands.

• If we want to target specific areas for business development and growth, why not simply exempt payroll within Opportunity Zones from FICA taxes? That way existing businesses and new businesses would enjoy the same benefits as financial capital.
• If we want to encourage hiring, why not make hiring easy? Create a single federal portal to process payroll and withholding for employees, so there's no quantum leap between zero employees and one employee.
• If we want to level the playing field between small and independent businesses and those owned by financial capital, why not eliminate the employer's role in providing health insurance and retirement benefits?
• If we want to encourage worker-centered economic development, why not reduce business taxes to 0% on worker-owned cooperatives?

The key difference between these proposals and Opportunity Zones is that they are focused on businesses, not capital. The money spent, which would be considerable, goes to the businesses that are engaged in economic activity specifically to encourage that economic activity. For worker-owned businesses, that money goes to the workers. For privately owned businesses, it goes to the owner. And for corporate entities it goes to the corporation.Some people want to single out corporations for punishment; I don't feel any need to go that far. The corporation is a perfectly reasonably form of economic organization, where appropriate.But the one thing I know is that we shouldn't be singling out financial capital and specialized investment vehicles for special treatment while leaving actual operating businesses to suffer what they must at their hands.

Vanguard just made lower-cost Admiral funds available to (almost) everyone

While not as complicated as the offerings of some mutual fund companies, Vanguard has long sold several different share classes to the public: "Investor" shares, "Admiral" shares, and ETF shares. While all three share classes hold the same underlying assets, they can have quite different expense ratios, with Investor shares the most expensive, and lower-cost Admiral and ETF shares similarly, although not identically, priced. Certain large asset managers also have access to even-lower-cost "Institutional" shares.

Minimum investment amounts have been lowered for virtually all Admiral index shares

Effective immediately, the minimum investment required for 38 existing index mutual fund Admiral shares has been lowered from $10,000 to $3,000, which was the prior minimum investment for Investor shares.Five additional Admiral shares will become available in January 2019 with the same reduced minimum investment.

Convert your Investor shares now (or later)

Vanguard says they'll automatically convert eligible Investor share holdings above the $3,000 threshold into Admiral shares in the middle of 2019, but you can also do so manually as of today. Just log into your Vanguard account and click on the lowercase "i" next to each of your Investor share holdings, and you'll be prompted to convert any eligible index fund holdings into lower-cost Admiral shares.

This may even apply to Vanguard-administered individual 401(k) accounts

When I wrote last year about the process of setting up a Vanguard solo 401(k) account, I noted that such accounts didn't have access to Admiral shares. While going through the somewhat tedious process above of converting my Investor shares into Admiral shares, I wondered whether the change also applied to solo 401(k) accounts. I didn't execute the trade, but I also didn't run into any error messages when trying to exchange my current LifeStrategy fund for Admiral shares of an index fund.The reason you might care about this is that Vanguard's Target Retirement and LifeStrategy funds hold Investor shares as their underlying constituents, and pass those higher costs on to you. If you can reconstruct those holdings with lower-cost Admiral shares (and you don't mind periodically rebalancing), you can theoretically save some money each year due to the lower Admiral share expense ratios.I'm not sure if that's worth doing for a "set it and forget it" investor, but it's an option as long as you can trust yourself not to trade the constituent funds recklessly.

Regulatory uncertainty, business confidence, and entrepreneurship

The driving force behind this site is promoting a culture of entrepreneurs and entrepreneurship.As I like to say: not everyone should be an entrepreneur because not everyone wants to be an entrepreneur, but a lot more people should be entrepreneurs than are currently entrepreneurs, and I'm here to do a little hand-holding along the way.On Tuesday night, I was thrilled to see Democrats win back the House of Representatives, and tweeted "If you like your comprehensive affordable health insurance, you can keep your comprehensive affordable health insurance (for 2 more years)." In fact, the title of this blog post was going to be, "you have two more years to start a business and receive affordable, comprehensive health insurance."And then I remembered, isn't there still a Republican lawsuit trying to destroy the Affordable Care Act? There sure is!

Does regulatory uncertainty matter or not, and why?

There has, historically, been a straightforward argument made by business-oriented politicians on both sides of the aisle: private enterprise is discouraged when people are unable to make reliable predictions about the future.Of course, nothing is entirely predictable (ask the dwindling number of stable owners in New York City), but a steady policy hand is best suited to encourage the private sector to put its capital to work in an inherently risky world, and constant policy gyrations scare off anyone trying to make long-term plans. You can find this argument deployed whenever a city tries to raise the minimum wage, enact fair scheduling laws, or provide paid family leave to employees.But today, the Republican Party has adopted a completely different view towards business formation. Entrepreneurs are extended health insurance one year at a time and one (shrinking) open enrollment period at a time, while a legal effort is coordinated across the country to make sure that this is the last year they'll have access to affordable, comprehensive health insurance. Or if not this year, next year. Or if not next year, the following.How could anyone make plans under these conditions? How could anyone start a business? How could anyone start a family?

We only see the businesses that are created

In the finance industry one of the most important red flags to watch for is "survivorship bias." In the most flagrant cases, a mutual fund company might only report the 10-year performance of its funds that are still operating after 10 years, concealing the lackluster results of all the funds that have already been closed due to underperformance.The decade-long sabotage of the Affordable Care Act has left us with a version of the same problem. We see all the businesses that have been created by entrepreneurs who have had the confidence to strike out on their own, knowing they'll have access to affordable comprehensive health insurance whether they succeed or fail, but we don't see the businesses that would have been formed if the entire country hadn't been subjected to the Republican deluge of lawsuits, appeals, and legislative attempts to strip that protection from entrepreneurs.

Even employees should root for entrepreneurs

When I write about this problem there's always a commenter or two who insists that it's actually good that only young, healthy single men start businesses, and that the old, the sick, the pregnant, or the female should just keep working at their jobs and forget about entrepreneurship. So let me make a case to the employees, as well.You don't have to ever start a business to benefit from other folks starting businesses.Maybe you'll be a customer: if one of your coworkers quits to start a secondhand jewelry store, maybe you'll buy some jewelry from her.Maybe you'll be an employee: if the jewelry store gets successful enough, your former coworker might hire you away.And even if you never see your former coworker again, maybe you'll be able to extract a raise from your employer sooner if they see your coworkers leaving to strike out on their own.

Conclusion

The media sometimes has a deliberately blinkered view of private enterprise. The so-called "small businesses" you sometimes see interviews with are inevitably Midwestern jet-ski dealerships or insurance salesmen with dozens of employees, while the "entrepreneurs" are Silicon Valley startups with millions in venture capital.But those cliches are not what entrepreneurship has ever really looked like. Entrepreneurs are mostly just normal people trying to make a little more money than they spend, day in and day out. Some of them succeed spectacularly and some of them fail miserably, but in a world without universal access to affordable, comprehensive health insurance, we're never going to have the opportunity to find out what we're missing.

Why is it necessary to give the problem a name?

Last week I wrote a brief post explaining why guaranteed government old age pensions, like Social Security in the United States, the State Pension in the United Kingdom, or Old Age Security in Canada, are the only mechanism that has ever been invented for ensuring security and dignity in retirement, and need to be centered in any attempt to reduce elder poverty.This is not an ideological, partisan, or political claim, it's simply a fact: every other attempt to provide retirement security has either failed, like IRA's and 401(k) plans in the United States, or relied on a supplemental government guarantee, like our Pension Benefit Guaranty Corporation. You can conceptually push back the government guarantee as far as you like, but if senior citizens are going to be able to count on income in retirement, that income is ultimately going to have to come from the public coffers, either directly or through some feat of financial engineering.At the end of that post, I mentioned in passing that "my preference would be fewer wars, higher taxes, and less debt, while if you’re a Republican your preference might be for more wars, lower taxes, and more debt." Reader Ben asked a thoughtful question:

"One thing that bothers me though is how you tend to attack Republicans and conservatives when you don’t have to.You could have just said you prefer fewer wars, higher taxes, and less debt. Which would be a valid, generalized, statement. Why did you feel the need to have to take a jab at Republicans/conservatives?"

Since Ben seems to have asked the question in good faith, I think I owe him a good faith answer.

Why must we give the problem we're facing a name?

We are 6 days away from a general election in which a third of the seats in the United States Senate and the entire House of Representatives will be filled, and if you did not know anything else about the world, you might carefully examine the résumés of the candidates in your district and select the most intelligent, honorable, and industrious public servants to fill those seats.But you would be wrong to do so. That's because the crisis facing America is not a lack of intelligence, a lack of honor, or a lack of industry in our public servants. The crisis facing America is the Republican Party.The Republican Party is a coalition of plutocrats committed to activating the racial and cultural grievances of their elderly voting base in order to secure power long enough to dismantle the regulatory state, tax base, and welfare system of the United States. And there are no exceptions.The "good," "honorable" members of the Republican Party are just as committed to dismantling our society as the vile reprobates. Ben Sasse wants to cut Social Security benefits just as much as Ted Cruz. Jeff Flake wants to poison our water, air, and soil just as much as Mitch McConnell. Susan Collins wants to cut taxes just as much as Rand Paul.Mitt Romney, the Republican Senate candidate in Utah, is by all accounts an honorable man, who will nonetheless immediately and passionately set about voting to strip health insurance from millions of Americans the second he takes office. The problem is not that Mitt Romney is a bad person; the problem is that Mitt Romney is a Republican.

The Republic may be doomed but we still have to live here

The shredding of our system of government in the hands of conservative ideologues is not something that gives me any pleasure. Gerrymandering, voter suppression, and the gutting of the Voting Rights Act by the god-emperors on the Supreme Court have caused a serious breakdown in the transmission mechanism between the needs of the population and the desire of elected officials to address them, and the entrenching of a conservative amateur judiciary means those losses will be extraordinarily difficult to recover from, if we are indeed ever able to.But we still have to live here. There will never be a moment when we get to say "ah, well, the bad guys won." Every single day we will still have to make the choices in our lives that will make the world a better place for ourselves, our children, and every future generation. And on Tuesday, November 6, 2018, that means sending Democrats to Congress.

The risks of specialized knowledge

The other day, I received an invitation to an event at the Brookings Institution called "The new American dream: Retirement security." This seemed right up my alley, so I clicked through to see the event details. The description starts off with some generic language:

"The American dream has drawn millions to the 'land of opportunity' and long encapsulated the idea that every citizen has the right to improve their lives. Yet, the current state of the U.S. retirement system may threaten the ability of some to fully achieve the American dream by ensuring their health and quality of life in retirement."

I naturally found myself nodding along, since the inadequacy of our old age insurance programs is a subject near to my heart. The description continued:

"The traditional three-legged stool of retirement—social security, pension, and retirement savings—is transforming into a wobbly one-legged stool,"

so far, so good,

"with personal savings and investment providing the only retirement security."

Wait, what?

Social Security is the only source of income security in retirement

It's been a while since I've written about Social Security, so let's do a quick refresher on how the program works:

• any time between age 62 and age 70, you can claim an old age benefit based on your income in the highest 35 wage-inflation-adjusted years for which you reported earnings;
• the longer you wait after turning 62, the higher your benefit is;
• your benefit will never fall;
• and your benefit is adjusted upward for inflation each year.

Because the benefit is paid in US dollars by the United States federal government, the system can never go bankrupt. This is retirement security.

Personal savings and investment provide income, not security

What is the difference between income and security?First, income fluctuates. If your savings are in a savings account then the interest rate might fluctuate monthly or quarterly. If they're in a CD ladder, then each time a CD matures you're forced to reinvest the principle at the currently prevailing interest rate. If they're in stocks, bonds, or mutual funds, then the dividends and coupon payments you receive will likewise fluctuate along with interest rates and economic conditions.Second, income is risky. If you don't have control over when you sell your investments, you risk selling them at depressed prices, permanently impairing your ability to generate additional income in the future.Finally, income is vulnerable to inflation. The very safest federally insured deposits may pay little or nothing in excess of inflation, meaning to generate real income you need to draw down your principal or invest in riskier assets.No one in their right mind should confuse personal savings and investment for retirement security. So why did the Brookings Institution?

The risks of specialized knowledge

If you said to me, "Social Security succeeded in lowering the elder poverty rate from 35% in 1965 to 10% in 1995, but some elderly people are still in poverty," I would say, "that's because Social Security benefits are too low and the minimum benefit needs to be raised so no seniors live in poverty."If you said to me, "many children in the United States live in poverty," I would say, "that's because children don't earn income, while requiring adult supervision, and we need a universal child allowance that reflects that fact."Specialized knowledge, the kind of knowledge possessed by scholars at the Brookings Institution, makes it very difficult for people to identify problems and propose solutions that address them directly. Once you know that 401(k) accounts exist, but that most people don't have access to them, and most people who do have access to them don't participate in them, then it's the most natural thing in the world to find yourself talking about how to expand access to 401(k) plans, how to increase participation, how to increase the quality of the investment options, how to ensure people are getting unbiased investment advice, etc, and calling that a set of solutions to "retirement security."But those questions are all downstream from, "how do we provide retirement security to elderly Americans?" That's a question we already know the answer to: bigger Social Security checks.Likewise, once you know the Social Security Administration collects more money than it spends and saves that money in a "trust fund" that will be used to pay benefits once outlays begin to exceed FICA tax revenue, and that the "trust fund" will be "exhausted" in 2034, then it's natural to start frantically wondering what combination of benefit cuts and payroll tax increases will be necessary to make the program "solvent."But if all you want to know is "how will the federal government pay for Social Security benefits in the future?" then the answer is obvious: the same way it pays all its other bills, a combination of corporate and individual taxes, estate taxes, licensing fees, seignorage, and debt. My preference would be fewer wars, higher taxes, and less debt, while if you're a Republican your preference might be for more wars, lower taxes, and more debt, but there's no use pretending Social Security benefits pose some unique threat to the Republic. That is the risk of specialized knowledge.

What's the optimal amount of self-employment income?

Because of the antipathy of American politicians to low-income people, who mostly don't vote and mostly don't make large campaign contributions, we've been blessed with a fractured and dysfunctional welfare state, designed to make income support as cumbersome and difficult as possible to receive, even or perhaps especially for those people who are, in fact, entitled to it.One of the worst manifestations of that dysfunction is that programs have different, overlapping rules for eligibility: the earned income and child tax credits phase in, plateau, and then phase out, while the Supplemental Nutritional Assistance Program starts high and begins dropping almost immediately with each additional dollar of income you earn.While this creates certain benefit cliffs, for example between eligibility for Medicaid and eligibility for Affordable Care Act exchange subsidies, it mostly just creates confusion: will an extra dollar of income increase your earned income credit by more or less than it decreases your SNAP benefit?While employees may have little or no control over their annual income, and in fact may not even know their annual income in advance depending on how predictable their assigned hours are each week or month, people reporting self-employment income may be able to dial in their reported income to the dollar to maximize the available state and federal benefits.While Jared Kushner has a team of lawyers and accountants working tirelessly to help him maximize the benefits of the tax code, you just have me. So here we go!

The four primary federal anti-poverty programs

Federal income support is composed of four primary programs, which I want to split up to make them easier to digest:

• Supplemental Nutrition Assistance Program (SNAP). Monthly benefits begin at $192 and increase by $161 for the second household member, $152 for the third, $137 for the fourth, and so on. For most beneficiaries (excluding those with unusually low housing and utility costs), benefits decrease by roughly $24 per month for every $100 in additional income you earn above roughly $900 per month. Unlike benefits administered through the tax code, the number used in SNAP benefit calculations is your net self-employment income before income or self-employment taxes are deducted. That means $900 in monthly self-employment income will pass through to your 1040 as $10,800 in business income, from which you'll deduct $763 in self-employment taxes, resulting in $10,037 in adjusted gross income.
• Earned income credit. The EIC is one of the original "trapezoid programs," with a rapid phase-in, a benefit plateau, then a gradual phase-out. The EIC is maximized for single childless filers with "earned income" between $6,650 and $8,350, for married childless filers between $6,650 and $13,950, for couples with one child between $10,000 and $18,350, and for couples with two or more children between $14,000 and $18,350. Every additional $100 in self-employment income in the phase-out period reduces childless filers' EIC by $7.11, filers with one child by $14.85, and those with two children by $19.57. Note that for the self-employed, earned income is calculated based on your net self-employment income after deducting half your self-employment taxes.

Let's take a breather here and consider how you would maximize your benefits if these were the only two federal income support programs, since we'll have more moving pieces later.Childless adults, whether single or married, have an incentive to absolutely minimize their reported earnings, while remaining eligible for SNAP. This is because the earned income credit phases in too slowly for these filers: an additional $100 of self-employment income increases their self-employment taxes by $14.13, while increasing their earned income credit by just $7.11. Since SNAP benefits begin to phase out at $10,800 in self-employment income, single childless filers are best off keeping their reported earnings below that level, since each additional dollar they earn costs them more in taxes than the amount they receive in income support.The picture is different for filers with one child: here, the optimal self-employment income is $10,760 for married couples with one child, producing earned income of $10,000. Why? Because for filers with children, the earned income credit phases in faster than SNAP benefits are phased out. Each $100 in additional self-employment income increases the EIC by $31.60, while reducing SNAP benefits by just $2 and increasing taxes by $14.13, leaving such filers with $15.47 more disposable income.The same logic would apply to married couples with two children: maximizing SNAP benefits requires $10,800 in self-employment income, while maximizing the EIC requires $15,064 in self-employment income. Again, we need to compare three values: the phase-in rate of the EIC, the phase-out rate of SNAP, and the marginal tax rate: $100 of additional self-employment income increases the EIC by $37.57, decreases SNAP by $2; and increases self-employment taxes by $14.13, leaving you with $21.44 more in disposable income.Since $100 of additional self-employment income increases disposable income by $21.44, the optimal amount of self-employment income is the EIC-maximizing value of $15,064. Reporting income above that point decreases SNAP benefits and increases self-employment taxes without generating any additional benefits.Simple enough? Unfortunately, we've still got two more anti-poverty programs to go.

• The reformed 2018 child tax credit is another trapezoid program for households with children. Families can begin claiming the credit when their self-employment income reaches $2,690, and each $100 in self-employment income above that level produces a credit of $13.94 per child, up to a maximum credit of $1,400 per child when self-employment income reaches $12,732.
• Medicaid is the final keystone of the American welfare state, and there are very important income restrictions to keep in mind, depending on your state. In Medicaid expansion states, virtually all low-income people are eligible for Medicaid, while in most non-expansion states, most self-employed people are not eligible (Wisconsin is an exception, since they did not expand Medicaid but reached an agreement with the federal government to extend exchange subsidies to the Medicaid-expansion population). Since the Affordable Care Act was designed to make Medicaid expansion universal, in most non-expansion states households aren't eligible for subsidies on the private health exchanges until their income reaches 139% of the federal poverty line, based on household size. That means if you live in a Medicaid-expansion state, you need to keep your income below that threshold to qualify for Medicaid, while if you live in a non-expansion state, you need to make sure your income is above that level to qualify for the maximum ACA subsidy.

The child tax credit doesn't affect our calculation for married couples with one child, since each additional $100 in self-employment income above $10,760 will increase their self-employment taxes by $14.13 and decrease their SNAP benefits by $2, while only increasing their child tax credit by $13.94 and leaving the earned income credit flat, leaving them with $2.19 less in disposable income.In the case of a married couple with two children, however, we see $100 in increased self-employment income raising the child tax credit by $27.88, and the earned income by $37.17, swamping the $16.13 in increased taxes and lost benefits. That means the optimal self-employment income for married couples with two children rises all the way to the EIC-maximizing value of $15,064, at which point their total federal picture will be:

• $2,800 child tax credit;
• $5,616 earned income credit;
• $6,708 SNAP benefit;
• while paying $2,142 in self-employment taxes.

Their next $100 earned above this point will increase their self-employment taxes by $14.13 and decrease their SNAP benefits by $2, but have no effect on their child tax credit or earned income credit, leaving them with an effective marginal income tax rate of 16.13%.

Conclusion

So there you have it. If you have complete control over the amount of self-employment income you report each year, the amounts that optimize your federal income support benefits are:

• For childless adults (single or married): $10,800 or less. SNAP is the primary income support benefit for these households, so be sure to report 20 or more hours of self-employment per week.
• For parents of one child: $10,760. The EIC phases in more quickly than SNAP phases out, so your decreased food-only SNAP benefits are offset by a higher and more flexible EIC. Above that level, the increased child tax credit doesn't fully offset your higher taxes and lower SNAP benefits.
• For parents of two children: $15,064. At this level, the EIC and child tax credit are both fully phased in, so any earnings above this point increase your taxes and lower your SNAP benefits without providing any additional benefits.

Something finally happened in the stock market. What did you do?

It's been a boring year in the stock market. If you bought Vanguard's S&P 500 ETF on October 16, 2017, and held it until this last Friday, you would have earned a mere 10% in price appreciation, and a mere 2-4% in dividends (I can't be bothered to look up the exact historical dividend yield at the moment). If you assume 2% inflation (and no, I don't know why people assume 2% inflation), you've earned "about" 10% in real returns on your investment over the last 12 months. That's a little bit above the historical average, and a lot below truly breakout years like 1933, 1954, or 2013.But it's been an interesting week in the stock market! So let's talk about it.

All of this has happened before and will happen again

The same Vanguard S&P 500 ETF has lost 3.9% of its value this week (and 5.6% of its value since September 20). Some people get upset by price swings like this, but I have exactly the opposite view: price volatility is absolutely essential, not for any economic or financial purpose, but rather as an opportunity to learn something about your own reactions to price volatility.Let's be clear about one thing up front: most Americans have virtually no assets invested in markets of any kind. The price movements of the stock market are of concern to a small number of people beginning with the upper middle class and stretching all the way up to the oligarchs, and matter not at all to workers who experience, if anything, glee when their boss's savings are wiped out.Having said that, among the sliver of people with assets invested in the stock market, it's easy to identify at least three very different reactions to price movements like this week's:

• Total indifference. My partner participates in a workplace retirement savings plan, which is invested entirely in the Vanguard LifeStrategy Growth fund (the same fund my solo 401(k) is invested in). If her payroll cycle happens to coincide with a market downturn, she buys the dip, and if it coincides with an all-time high, she buys the peak.
• Greedy buying. I don't know what path the price of the stock market will carve over the next 30 years, but I have a high degree of confidence that, with dividends reinvested, a stock market investment today will be worth between 5 and 6 times more 30 years from now. This is not a one-year prediction: a year ago, I would have been off by a full 50% (the stock market returned twice my estimated 6%). In any case, for long-term investors dips are obviously better times to buy than peaks, so one thing you might do when prices fall is use the opportunity to buy stocks you intend to hold for the long term.
• Panic selling. The only real mistake you can make when stock prices fall "dramatically" (a 5.6% decrease in a month is not, in any objective sense, dramatic), is to sell your stocks in a panic. The mistake is not selling your stocks — the mistake is selling them in a panic. The price of your stocks will fall 50% or more at least once in your lifetime. If you can't handle a 50% or more fall in the price of your stocks, you own too many stocks, and are right to sell them. But you're wrong to sell them in a panic.

A modest proposal for finding out what your "risk tolerance" really is

It's standard for investment advisors, whether you're talking about the sales teams employed by the big banks, fee-only fiduciaries, or roboadvisors like Betterment, to pose a series of standardized questions to identify your "risk tolerance," so they can recommend an asset allocation. I'm sure a lot of work goes into formulating and processing those questionnaires.But they all suffer from the same problem: they capture your "risk tolerance" at a particular moment in time. If stocks have been sailing smoothly higher, I can bet your "risk tolerance" will be pretty high. After a 50% drop in the stock market, I'm certain your "risk tolerance" will likewise be in the doldrums.Thinking about this problem led me to a modest proposal for a way to assess the amount of stocks a person should actually hold: the investment attention journal. For a period, even a period as short as a week, carry around a pad and jot down every single time you think or do anything about any of your investments. How many times a day do you check stock prices? How many times a week do you buy or sell your investments? How many times a month do you reallocate your investments?If at the end of a week, or a month, or a year, you have a blank page in front of you, you've shown yourself perfectly invulnerable to stock market movements, and might want to invest even more of your portfolio into volatile assets (which you'll never check the value of).If at the end of a day, or a week, or a month, you have a page full of timestamps showing how meticulously you track the price of all your assets, you might be too heavily invested in assets that are too volatile.

Sell down (or buy up) to the sleeping point

There's a cliche in the asset allocation field that the right place to invest your assets is the "sleeping point:" where what happens to your investments isn't keeping you up at night. The cliche usually goes, "sell down to the sleeping point." But I'm so neutral on the question that I'm willing to entertain the flip side: there are people who are sleeping too well, and need to scale up their exposure to volatile investments!In other words, your "risk tolerance" is not, or should not be, how you happen to feel about the stock market at a particular moment in time. It's how you consistently, reliably, and verifiably react to movements in actual market prices.

It's October, time to shuffle around your high-interest accounts

As I wrote last month, my favorite high-interest checking account, the Free Rewards Checking account from Consumers Credit Union, has dropped the maximum balance eligible for their highest interest rate tier from $20,000 to $10,000 (while raising that rate up to 5.09%). While the account is still more than worthwhile (it also offers unlimited worldwide ATM fee reimbursement), there's no reason to hold more than $10,000 in your account anymore, which means you may suddenly have some extra underperforming cash lying around.Here are a few suggestions for what to do with it.

Kasasa Checking

I'm not going to lie and say I know exactly who or what a Kasasa is. If I had to guess, I'd say it's a way for smaller banks and credit unions to pool their deposits and earn higher interest rates on them, part of which they pass along to their depositors in the form of higher interest rates.How high? This high:

• First Financial Bank: 4.07% APY on up to $15,000
• Park City Credit Union: 4% APY on up to $10,000
• Marshall Community Credit Union: 3.75% APY on up to $15,000
• Leighton State Bank: 3.56% APY on up to $15,000
• Texomo Community Credit Union: 3.51% APY on up to $10,000
• One American Bank: 3.5% APY on up to $10,000

All these accounts have slightly different calendar schedules and monthly requirements for triggering their interest rates, so be sure to read through the requirements carefully to make sure you will be able to trigger the advertised rates before opening an account.

Other Rewards Checking Accounts

Two additional non-Kasasa options are:

• Department of Commerce Federal Credit Union Performance Checking: 3.47% APY on up to $20,000
• and Heritage Bank eCentive Account: 3.33% APY on up to $25,000.

What to do with the rest of your cash

I love cash for its two great virtues: it doesn't go down in price (although of course it may go down in value due to inflation), and it can be exchanged for goods and services. Those are virtues I'm willing to pay something for, but I'm not willing to pay an unlimited amount for. That's why I would think twice before deciding to hold onto cash that was earning less than the 3.33% APY offered by Heritage Bank.So, what are your other options?

• Certificates of Deposit. I'm not generally a huge fan of CD's, simply because most people willing to apply a little elbow grease can get higher interest rates from rewards checking accounts. But if you've already exhausted the rewards checking accounts you're eligible for, there are a few places you can get decent rates on CD's. People's Community Bank, United States Senate Federal Credit Union, and KS StateBank all offer medium-term CD's paying between 3.37% and 3.63% APY.
• Pay down debt. If you financed a car or house at the depths of the Great Recession, you may well be paying less in interest than you can earn on the high-interest-rate accounts. But once your savings exceed the eligible balances on those accounts, you can convert your additional cash savings into savings on interest by aggressively paying down those loan balances.
• Low-cost bond funds. While I've been focusing on investments of cash that are federally guaranteed to maintain their value and liquidity, interest rates have gradually crept up enough that there are finally opportunities worth considering in the bond market. Vanguard's Short-Term Corporate Bond Index Fund (VSCSX) currently has an SEC yield of 3.41%, their Intermediate-Term Investment-Grade Fund (VFIDX) yields 3.64%, and Intermediate-Term Corporate Bond Index Fund (VICSX) yields 4.08%. The essential thing to keep in mind when investing in bond index funds is the relationship between duration and return: an intermediate-term bond fund is more volatile than a short-term bond fund over the short term, which means its higher yield can be more than outweighed by its sensitivity to interest rates if you need to sell your shares within a year or two. If you need a short-term investment, you should buy a short-term bond fund!

Conclusion

No one of these options, or any one combination of these options, will be right for everybody. But it's equally true that most Americans are not earning as much as they could be on their savings, and I'd like to help them get started.Politicians often cast the failure of Americans to save as the fault of individuals for not making sufficient contributions to their workplace retirement accounts, or not saving enough in IRA's, or HSA's, or 529 plans. My Councilmember has an insane plan to encourage people to save by deferring their tax refunds and earning a "bonus match" or some such nonsense.But it's all ridiculous. What you need to do to make your savings grow is earn as much interest as possible on your savings. High interest rates encourage people to save, low interest rates discourage people from saving, and that's the whole ballgame. If you save more money than everybody else, at higher interest rates than everybody else, you'll end up with more money than everybody else.So why not get started today?

Free Business Idea: Virtual Reality Saloons

The other day I went down to the mall and happened to arrive during a shift change at the customer service desk. I wandered over to a row of couches and sat down to watch a Microsoft Store employee playing a game using the store's virtual reality set-up. Seeing as I had 15 minutes to kill, I asked him if I could try it out.I believe the system they had set up was this HTC VIVE Pro Virtual Reality System, which involves two ceiling-mounted sensors, two wireless handsets, and a tethered headset (although it seems a version without the headset cable may be launching later this month).If, like me, you haven't used a virtual reality system since the Virtual Boy, it's difficult to convey just how incredible the technology has become. Immersive virtual reality like you see in "Ready Player One" is not science fiction, and it's not 5 or 10 years away — it's here right now.While the technology is ready, the people aren't, for two main reasons: it's too expensive, and it requires too much space. The answer is today's free business idea: virtual reality saloons.

What is a virtual reality saloon?

A virtual reality saloon is a karaoke bar for virtual reality gaming.A fully functional virtual reality gaming setup requires a fair amount of sophistication. The two ceiling-mounted sensors I mentioned have to be mounted on a ceiling, and oriented properly. The gaming area itself has to be free of obstructions. And you also need to pay for the equipment and the games themselves.For those reasons, I don't think home-based virtual reality systems have much of a future for the next 5-10 years. But the technology is already there, which means the obvious solution is for a business to undertake the upfront equipment cost, setup, and maintenance, and then rent the equipment out on an hourly or daily basis to individuals and groups.

Nuts and bolts

While the upfront equipment costs are quite high for an individual, they're quite modest for a business, at perhaps $4,000-5,000 per rig, including all the virtual reality equipment, a top-of-the-line gaming computer, and every currently-available virtual reality game. A virtual reality saloon could start at as little as one room customers could reserve for wedding parties, corporate events, etc, much like "escape rooms" do already.Since only one or two people can play the actual games at a time, the profit center would naturally be the bar. The model works better the more gaming saloons you can put under one roof, in order to keep the bar as busy as possible.Commercial real estate, liability insurance, and alcohol licensing are complex issues you'll want to consult with local specialists about. But if you want to own and operate your own business but don't have any business ideas, feel free to use one of mine. After all, they're free!

What goes into a good active savings strategy?

A headline passed across my Twitter feed yesterday that seemed like a good bank account signup bonus: "$500 Bonus for New Money Market Account at Capital One." $500 is a lot of money, so I clicked through to check out what the requirements were. As usual, there were some deposit requirements, in this case a $50,000 deposit of outside money, held in the account for 6-8 weeks (until the signup bonus posts). $50,000 is a lot of money, certainly more money than I have, so I moved along.But, a few hours later, I circled back and started thinking: what is the right way to think about these signup bonuses, and how should you incorporate them into an active savings strategy?

How much cash do you have, and why?

I love cash. It's considered fashionable among some financial advisors to talk about how your cash is constantly losing its value due to inflation, it's not earning a high enough rate of return, it's not backed by gold, whatever. But actual people understand the great thing about cash is that it's cash. You can use it to buy things, you can give it away, you can invest it, you can do anything you want with it! Cash is great, and anyone who tries to convince you cash isn't great is probably trying to sell you something.But as great as cash is, it isn't everything. On the contrary, cash is always and everywhere a substitute for something. If you have a mortgage, car loan, or credit card debt, cash is a substitute for paying down those balances. It might be a good substitute (you might be able to earn more on your cash balances than your current mortgage interest rate) or it might be a bad substitute (unless you have a promotional rate, your credit cards are probably charging more interest than what you can earn on cash deposits). Likewise, up to the relevant balances, cash might be a good substitute for short-term bonds, but a bad substitute for long-term stock investments.

How active is your active savings strategy really going to be?

It doesn't matter how lazy you think you are, it matters how lazy you actually are.Consider the Capital One money market account I mentioned above. It offers a $500 bonus after 8 weeks, and 1.85% APY, which roughly works out to the equivalent of 8.35% APY for the 8 weeks it takes the bonus to post — a high interest rate by anyone's standards. However, it only offers that interest rate for 8 weeks. If you leave your money there for 16 weeks, your blended APY will be 5.1%. At 24 weeks, it'll be 4.01%. If you leave it there for a full year, you'll earn just 2.85% APY.Commenter Kim pointed out last week that Heritage Bank's eCentive account earns 3.33% APY on balances up to $25,000 (she also said she had three of them), while my favorite Consumers Credit Union rewards checking account earns up to 5.09% APY on up to $10,000 (starting in October).In other words, if you only muster up the initiative to actually move your cash savings or your direct deposit from bank to bank once per year in order to trigger a bonus, you're probably earning less than if you simply sat on the cash in the highest-earning accounts you have access to year-round!

Where are you getting the cash?

One tempting option is to say that instead of having a pool of cash you're constantly chasing bank account signup bonuses with, you're going to selectively target just the highest signup bonuses that come around.While it avoids the problem of decaying interest rates I described above, the problem with this strategy is that the cash still has to come from somewhere. If you already have a large cash balance, then the problem is easy to solve by moving the cash from one account to another and back again, but in that case your profit is only the difference between the bonus-inclusive APY and the basic interest rate you earn year-round. That may still be worth doing on a case-by-case basis, of course.Alternatively, you could combine chasing signup bonuses with a more comprehensive strategy of harvesting losses in taxable brokerage accounts. If you have a taxable portfolio with $50,000 in assets showing a loss, then you can sell those assets, realizing a deductible loss, then instead of immediately reinvesting the assets, deposit them in bank accounts offering the highest current signup bonuses. Since bank account bonuses typically take at least 30 days to post, this is also a convenient way to avoid the "wash sale rule," allowing you to reinvest your cash into the same investment you had originally sold (just be careful that ongoing contributions aren't being made to that investment or you're going to run into all kinds of trouble come tax time).Finally, you could borrow the money to chase bank account signup bonuses. While this may or may not be more expensive than the other two options, it's not strictly speaking "riskier." The simplest example would be funding a new account using a credit card, waiting for the bonus to post, then paying off the credit card with money from the same account. A more complicated option, popular back when money market accounts were paying 6% APY or more on liquid deposits, is to open a credit card with a 0% introductory APR and no balance transfer fees to spin up lots of cash that can be invested across a variety of accounts for the entire introductory period.

Conclusion

I love robbing banks and encourage anyone and everyone to get in on the action to the degree it makes sense for them individually. However, there are real risks to trying to dive into the signup bonus game without thinking through a strategy ahead of time:

• how active are you willing to be? The less work you put into your bank account signup strategy, the more your lived interest rate will decay compared to the advertised rate.
• how much is your cash costing you? Do you have other debt that cash could be used to pay down at a higher interest rate than a bank account signup bonus earns?
• are you integrating your cash holdings into a comprehensive investment strategy? If you have $100,000 invested in a 60/40 equity/fixed income portfolio and another $50,000 held in cash, you have just 40% of your investable assets in equities. Does that correspond to your long-term investment goals?

Once you've answered those questions to your satisfaction, there really are opportunities to get outsized returns on short-term deposits, and those opportunities are well worth considering.

Winners and losers from changes to Consumers Credit Union Free Rewards Checking accounts (and why it matters)

I've been an enthusiastic fan of high-interest checking and savings accounts ever since you could earn 6% APY on your PayPal account balance back in the early 2000's (unfortunately I was in college at the time and barely had two quarters to rub together at 6% APY). The boring reason is that the more work your risk-free assets are able to do, the less work your riskier investments have to do in order to meet your long-term financial needs.That made me immediately concerned when I saw Doctor of Credit report some Consumers Credit Union Free Rewards Checking accountholders had received notification of changes to the conditions required to qualify for elevated interest rates. Now that I received my own notification, I want to dig into the details.

Background

As long as I've been a member, Consumers Credit Union has offered three interest rate tiers for qualifying Free Rewards Checking accountholders. While the exact interest rates have bounced around a little, the basic rules were:

• Tier C: 12 signature debit transactions per month and a direct deposit or ACH credit of $500 per month to your account, plus signing up for electronic statements.
• Tier B: Tier C requirements plus $500 spent on a Consumers Credit Union credit card.
• Tier A: Tier C requirements plus $1,000 spent on a Consumers Credit Union credit card.

The three key changes they've made, starting on October 1, 2018, are:

• the debit transactions no longer have to be signature-based, i.e. they can be PIN-based instead;
• the 12 transactions must total $100 or more per qualifying period (previously no minimum);
• and the increased interest rates are only available on deposits up to $10,000 for all three tiers (previously $15,000 for Tier B and $20,000 for Tier A).

Winners: high-interest, low-balance savers

If you were already triggering the Tier B or Tier A requirements each month, but had $10,000 or less in your Free Rewards Checking account, then congratulations! Your interest rate is being raised from 3.59% to 4.09% or from 4.59% to 5.09% APY. On a $10,000 balance, you just got a $50 annual raise.And if you were stuck at Tier B, you just got another nudge to qualify for Tier A instead each month!

Losers: high-interest, high-balance savers

On the other hand, if you were holding $20,000 in your Free Rewards Checking account and meeting the Tier A requirements, your annual interest income is dropping from $918 to $529 (5.09% on the first $10,000 and 0.2% on the second $10,000).

Losers: low-cost automators

I've found that Consumers Credit Union has been pretty good about treating my microtransactions as signature purchases. For example, $0.50 Amazon balance refills and $1.00 Plastiq bill payments have all counted towards my 12-transaction requirement. On the other hand, I've had a misfire or two, like buying $0.50 in Kiva credit, which was processed as a PIN-less debit transaction and did not count towards my qualifying transactions.The new puzzle for low-cost automators is how to get to 12 total transactions with those transactions totaling to at least $100. The first 11 transactions can still be automated using a service like Plastiq, especially if you have access to fee-free dollars (you earn $500 Fee-Free Dollars when you sign up and make $500 in payments, and $1,000 Fee-Free Dollars when someone signs up with your referral code), but if you're making $100 per month in payments (eleven $1 payments and one $88.01 payment), then you'll end up paying something like $0.99 in fees (or using $100 in Fee-Free Dollars). Not ideal!The obvious solution for most folks will be to automate the first 11 transactions and then set up a monthly $89+ payment to a recurring biller like a cable or phone company. I don't have any bills that high, so come October I plan to set up my 12th payment to my student loans until I run out of Fee-Free Dollars.

Why it matters

Folks with workplace 401(k) or 403(b) plans, IRA's, HSA's, mortgages and car loans find my interest in these high-interest opportunities a distraction. But I think there are two reasons everyone should care about maximizing the return on their FDIC-insured savings.

• First, most people have no investment or retirement savings at all. For many US workers, the balance on the prepaid debit card their paycheck is deposited to is the entirety of their "savings." Simply moving from a high-fee prepaid debit card to a high-interest Free Rewards Checking account is the single most important thing most workers can do to maximize the value of their savings.
• Second, even folks who do have a comprehensive, well-rounded investment strategy should be aware that integrating a high-interest, FDIC-insured account into that strategy increases the investor's ability to take risk in the other parts of their portfolio.

To illustrate a stylized version of the second point: if someone has $20,000 of investable assets and wants to achieve the exact return and volatility of a 50/50 investment of $10,000 in US equities and $10,000 in fixed income, they could invest $10,000 in VTI and $10,000 in BND, Vanguard's total stock market and total bond market ETF's.However, substituting their $10,000 of fixed income exposure with a higher-interest FDIC-insured checking account allows them to either increase their equity exposure in order to expose more of their savings to riskier assets and try to achieve a higher overall return with the same volatility, or reduce their equity exposure in order to achieve the same overall return with fewer assets exposed to equity volatility.

Conclusion

If you consider volatility the cost you pay for investment returns, then you should try to reduce that cost just as hard as you try to reduce the costs you incur through expense ratios and trading commissions.High-interest, FDIC-insured rewards checking accounts are one of the lowest-volatility, highest-interest fixed income investments available to most people, and most people would be better off substituting them in to the degree possible for their more expensive fixed-income investments.

Index construction is the most important, least understood part of the indexing revolution

Modestly improved investor education and extensive marketing have made investors today more conscious of the costs of their investment decisions, and helped promote the use of index-tracking mutual funds and exchange-traded funds as opportunities to reduce expenses and allow investors to keep more of their investment returns.While cost-consciousness is a clear positive for investors, the move to indexing has created another source of risk investors rarely hear about: index construction.

How much exposure do you want to South Korea?

My favorite example of the risks of index construction is the FTSE and MSCI definitions of "developed" and "developing" countries outside the United States. They're almost identical, except FTSE places South Korean equities in the "developed" bucket and MSCI includes them in the "developing" index.This is fine if you're invested entirely in funds from issuers tracking the same indices: iShares' core developed (IDEV) and developing (IEMG) market funds both track MSCI indices, so South Korea's inclusion in one and exclusion from the other doesn't affect your exposure. Likewise, Vanguard's developed (VEA) and developing (VWO) market funds both track FTSE indices, so if you only own Vanguard funds you're still able to get exactly the exposure you want.The flip side of that is someone who for whatever reason invests in a developing market fund provided by one company and a developed market fund provided by another. Owning a FTSE developed market fund and a MSCI developing market fund gives you exposure to South Korean equities in both funds, while owning a MSCI developed market fund and FTSE developing market fund leaves you without any exposure to South Korea in either fund.I'm not trying to exaggerate the importance of South Korea to global capitalism (although South Korea has certainly played an important role in the development of global capitalism). I'm trying to say that if your goal is to invest in indexed mutual funds in order to reduce your need for ongoing supervision and maintenance, you need to put in more time up front to figure out exactly which indices your funds are tracking.To put a little more meat on this bone, the MSCI-tracking IEMG has returned an average of 3.86% annually since October 2012, while the FTSE-tracking VWO has returned an average of 3.27%, while the MSCI-tracking IDEV has too short a history to be very interesting, but has slightly underperformed the FTSE-tracking VEA since inception.

Fidelity launched US and international index funds that track...something

That brings me to the news hook for this post: Fidelity made a splash this summer by introducing two funds with 0.00% expense ratios. The funds are only available to Fidelity customers, so you can't buy them in Vanguard, Merrill Edge, or other brokerage accounts, but if you have some reason to invest through a Fidelity brokerage account, they're certainly the cheapest funds available to you, charging as they do no fees on the amount invested in the funds.Some people have suggested that these 0.00% expense ratio funds are being offered as a "loss leader," but that's not exactly right. In fact, they're an experiment in charging people nothing in order to invest in Fidelity's own bespoke indices, which they have the luxury of paying little or nothing for.Here's what Fidelity has to say about the "Fidelity ZERO International Index Fund:"

"Geode normally invests at least 80% of the fund's assets in securities included in the Fidelity Global ex U.S. Index and in depository receipts representing securities included in the index. The Fidelity Global ex U.S. Index is a float-adjusted market capitalization-weighted index designed to reflect the performance of non-U.S. large-and mid-cap stocks."The fund may not always hold all of the same securities as the Fidelity Global ex U.S. Index. Geode may use statistical sampling techniques to attempt to replicate the returns of the Fidelity Global ex U.S. Index. Statistical sampling techniques attempt to match the investment characteristics of the index and the fund by taking into account such factors as capitalization, industry exposures, dividend yield, P/E ratio, P/B ratio, earnings growth, country weightings, and the effect of foreign taxes."

And here's what they have to say about the "Fidelity ZERO Total Market Index Fund:"

"Normally investing at least 80% of its assets in common stocks included in the Fidelity U.S. Total Investable Market Index, which is a float-adjusted market capitalization-weighted index designed to reflect the performance of the U.S. equity market, including large-, mid- and small-capitalization stocks."Using statistical sampling techniques based on such factors as capitalization, industry exposures, dividend yield, price/earnings (P/E) ratio, price/book (P/B) ratio, and earnings growth to attempt to replicate the returns of the Fidelity U.S. Total Investable Market Index using a smaller number of securities."

Emphasis mine.

A bad fund can track a good index

Today, you could buy any of the following three ETF's, all based on versions of the S&P 500 index:

• SPY tracks a market-cap-weighted S&P 500 index;
• RSP tracks an equal-weighted S&P 500 index;
• RVRS tracks an inverse-market-cap-weighted S&P 500 index.

All three options require you to decide whether the S&P 500 is a "good" index or a "bad" index. If it's a bad index, you shouldn't buy any of them!But even once you've decided it's a good index, you aren't relieved of your responsibility. The existence of the three funds means you also have to decide what the best strategy is for investing in the companies that make up that index.SPY has an expense ratio of 0.09%, RSP has an expense ratio of 0.20%, and RVRS has an expense ratio of 0.29%, so even if the funds have identical performance of their underlying assets, you'd be 0.11-0.2 percentage points per year ahead using SPY. However, in order to maintain their equal and inverse-market-cap weights, the latter two funds also have to do much more trading, incurring additional costs that aren't reported in the expense ratio. That means your confidence in the investment strategy needs to be "somewhat higher" than the difference in expense ratios.

Conclusion

I'm sure Fidelity's bespoke indices are fine, I'm sure their ZERO funds will track those indices very closely, and I'm sure they'll perform similarly to the low-cost market-capitalization-weighted index funds offered by their competitors.But my point is broader: you aren't a passive investor just because you invest in low-cost, passively-managed mutual funds or ETF's. You're still making at least three very important, very active decisions:

1. which indices to track,
2. how to track them (market-capitalization, equal-weighted, inverse, leveraged, etc.),
3. and how to allocate your assets between them.

You can carefully research those decisions, you can shrug those decisions off, or you can let me or the Bogleheads forums make them for you, but careful research, indifference, and reliance on the advice of others are all decisions too.As the saying goes, it's turtles all the way down.

Vanguard commission-free ETF trading is here

I wrote last month about Vanguard's announcement of commission-free ETF trading coming "in August." Well, it's August, and commission-free ETF trading is here!

Which ETF's are commission-free to trade?

You can find the full list of commission-free ETF's here, but as a rule of thumb, it is supposed to include essentially all non-inverse and non-leveraged ETF's.

Potential uses of non-Vanguard ETF's

Vanguard already offers a suite of low-cost ETF's that are best-in-class for building blocks of a portfolio if you're inclined to use ETF's instead of mutual funds, for example in taxable brokerage accounts.But there are lots of potential investment strategies Vanguard doesn't have ETF's (or mutual funds) corresponding to, and which are now available commission-free on their trading platform.

• Country-specific ETF's. The iShares line of ETF's offers exposure to the public companies in an incredible number of developed and emerging economies, from Poland to Belgium to Malaysia to Peru. Since ETF trading is commission-free, if you have the patience and interest to do so you could even recreate the exposure of a developed market or emerging market fund, but with enough increased granularity to also take advantage of opportunities to harvest capital gains and losses in a taxable account. Note that many of these countries have very few publicly traded companies, so these ETF's are extremely concentrated bets on a small number of publicly listed companies — just 25 in the case of Peru.
• Currency-hedged ETF's. Like iShares, WisdomTree offers a number of country-specific ETF's, many of which are hedged back into US dollars. So if you think a particular country will perform well in its home currency and don't want to take on additional currency risk, WisdomTree offers a number of options that incorporate country exposure while removing currency exposure.
• Bespoke strategies. Some ETF's incorporate specific investment strategies. For example, I find Cambria's "shareholder yield" ETF's interesting, since they combine dividend yield and net share buybacks to get a more comprehensive picture of how much money is being paid out to shareholders. In other words a company that pays out a high dividend but is aggressively issuing shares (diluting current shareholders) might look worse from a shareholder yield perspective than a company that is paying a lower dividend but is aggressively buying back shares.

If you're going to invest, seek low costs and diversification

I think Vanguard funds are fine for virtually all long-term investing purposes, but I also think it's perfectly reasonable for a dividend investor to look at Vanguard's high dividend or dividend growth ETF's (VYM and VIG for US stocks) and decide they prefer Cambria's shareholder yield model (SYLD for the US). But the two options give exposure to essentially the same asset class; they're substitutes for each other, not complements, so if you own both you're not "diversifying" your portfolio, you're just adding a minuscule tilt towards share buybacks and away from dividends.Likewise there's no reason to own a low-cost Vanguard emerging markets mutual fund and a bunch of iShares country-specific emerging market ETF's.

If you're going to gamble, make bold moves with small amounts of money

On the other hand, setting aside 5% or 10% of your investable assets to make aggressive bets on particular funds seems perfectly reasonable to me, as long as you know what you're buying, why you're buying it, and what you're paying for it.I don't think you're very likely to outperform a market-cap-weighted low-cost portfolio over time, just like I don't think you're very likely to walk off a casino floor with more money than you walked on with, but unlike some scolds, I also know that gambling is fun. And, thanks to Vanguard, it's cheaper than ever.

Conclusion

As I wrote in my original post, the best thing about Vanguard offering commission-free ETF's is that Vanguard provides a full-service brokerage platform, allowing things like specific identification of shares that Robinhood currently does not. That means if you buy into a position over the course of months or years, you have more options for controlling your tax liability when you decide to exit it, either to realize taxable gains on shares during low-income years, taxable losses during high-income years, or weighting the two in order to reduce or eliminate any overall impact on your tax liability.

The stock buyback "controversy" is everything wrong with the finance sector in a nutshell

In the wake of the Republican smash-and-grab tax heist of 2017, many American corporations have had to decide what to do with their freshly repatriated profits and newly distended profit margins, so news junkies have been treated to an extended conversation about investment, payroll, and capital structure. This conversation has been complicated by the insistence of one particular party to the controversy on lying about what's going on.

What can a company do with money?

I'm not speaking specifically of profits here. Lots of companies that don't have any profits at all still have plenty of money: the money of their lenders and shareholders, for instance. Uber has money and no profits, Berkshire Hathaway has profits and money, and my sole proprietorship has profits but no money (since the profits are distributed to me every month, or whenever else I want).But once a company has money, it has to decide what to do with it.

• A company can, of course, retain the cash, as many corporations did in their "foreign" subsidiaries for years while waiting for the opportunity to repatriate it cheaply.
• A company can spend the cash, for example on expanding operations, raising wages, giving employees bonuses, or buying new equipment.
• A company can pay out the money in dividends to shareholders.
• A company can pay down or retire its outstanding debt.
• Or a company can buy back its shares on the open market.

364 days a year financiers are perfectly honest about stock buybacks

Corporate profits in the United States are supposed to be taxed twice: once at the corporation level, and a second time when profits are distributed to shareholders. Long-term capital gains and qualified dividends are taxed at preferential levels for precisely this reason: corporate profits are taxed once at the corporation's tax rate, then a second time at a rate depending on the shareholder's taxable income (as low as 0%).364 days out of the year, financial professionals are happy to tell you why they like stock buybacks: since stock buybacks are voluntary (it's up to the shareholder whether or not to participate), the second step of taxation can be avoided, managed, or minimized.A company can reduce its share count (increasing the proportional stake in the business of remaining shareholders, and their claim on future profits), without requiring the remaining shareholders to pay taxes on the increased value of their stake. In other words, share buybacks are a way for corporations to manage the individual income tax liability of their shareholders.To be clear, dividends also allow shareholders to increase their stake in a company and their share of its future profits. If a company distributes a dividend to every shareholder and half the shareholders reinvest the dividend in the company and the other half do not, the half that reinvested the dividend have a higher proportional claim on the company's future profits than the half that don't, just as shareholders that don't participate in a buyback have a higher proportional claim on future profits than shareholders that do.This is what financiers mean when they say buybacks and dividends are "theoretically" identical. The difference is that all dividend recipients, those who choose to reinvest their dividend and those who don't, are properly assessed income tax on the amount of their distribution.

On the 365th day, they tell the most preposterous lies

In the abstract of a forthcoming paper by Cliff Assmess of AQR Capital Management, titled "Buyback Derangement Syndrome," he writes:

"The popular press is replete with commentary seeking to damn the behavior of corporate managers in handing free cash flow back into the hands of shareholders. These criticisms are often, even regularly, without merit (at least merit that can be demonstrated), sometimes glaringly so. Aggregate share repurchase activity has not been at historical highs when measured properly, and when netted against debt issuance is almost a non-event, does not mechanically create earnings (EPS) growth, does not stifle aggregate investment activity, and has not been the primary cause for recent stock market strength. These myths should be discarded."

But this is nonsense. The problem with share buybacks is not that they "mechanically create earnings growth," nor that they "stifle aggregate investment activity," nor that they "cause...stock market strength." The problem with share buybacks is that they let corporations distribute profits to shareholders selectively, as Cliff would be happy to tell you the 364 days a year he's not lying about why he likes them.

If you think buybacks and dividends are the same, let's treat them the same

I don't see any reason why share buybacks should be legal, but if the sages of our engorged and indulged finance industry think share buybacks are identical to dividend distributions, then let's treat them identically. I have no objection to a company forcing all of its shareholders to sell back a certain percentage of their shares, thereby maintaining their proportional ownership of the company but reducing the number of outstanding shares — and resulting in the same tax liability on shareholders as a dividend distribution.

Conclusion

The pro-buyback propaganda sweeping the investment management space is just one recent example of a longstanding problem that has infected American discourse in a lot of different fields, and that the internet and social media have made more apparent in a lot of ways.In earlier eras it may have been possible to deliver different messages to different audiences: "buybacks are a straightforward way to avoid capital gains taxes" to your investors and "buybacks are identical to dividends in every way and you're an idiot for thinking otherwise" to any regulators who came snooping around your capital structure.But today it's a lot harder to get away with. If investment managers think the preferential tax treatment of stock buybacks is a good thing, they're going to have to start defending it on the merits, if there are, indeed, any merits to defend.Needless to say, I have my doubts.

So-called "personal finance education" is a distraction

About a year or so ago I noticed a cliche spreading among a certain set of prominent investors and money managers: that a key obstacle to success among young people today is a lack of personal finance erudition. Today's entry in the genre came from Ben Carlson at Ritholtz Wealth Management, who wrote:

"I wish high schools and colleges would teach personal finance. They could show young people things like how to do their taxes, which it seems like maybe 3-4% of the population knows how to do (and that’s being generous)."The U.S. federal tax code is around 4 million words and almost 75,000 page long. To say it can be confusing would be an understatement. Changes from the latest tax overhaul throw another wrench into this equation because now people must figure out how it affects them."

This is an unusually clear example of the role "personal finance education" plays in this ideology. You can clearly identify a problem (people can't do their own taxes), you can clearly identify the cause of the problem (the tax code is too complicated), but instead of demanding that the cause of problem be solved, and the tax code simplified, you demand that teenagers receive specialized education in tax preparation!

"Personal finance education" dodges all the hard problems we face

The beauty of the personal finance education meme is that it allows you to acknowledge real-world problems, without having to undertake any of the effort required to solve them:

• wages are too low;
• housing is too expensive;
• health insurance is too expensive, and leaves even insured individuals vulnerable to catastrophic medical expenses;
• Social Security's current financing stream is inadequate to pay out its present benefits, let alone the benefits that would be needed to permanently eliminate elder poverty;
• the Family and Medical Leave Act covers too few workers, with too few protections, for too little time;
• occupational licensing regimes pose too many obstacles to entry for too many professions.

These are problems with solutions. But a higher minimum wage, more housing construction, single payer health insurance, higher and uncapped FICA taxes, comprehensive family leave, and occupational licensing reform are hard.There are interests on the other side who will do everything in their power to fight against efforts to solve these problems. Businesses want to pay low wages, homeowners want to keep housing scarce, insurance companies want to keep earning record profits, high-income individuals want their FICA taxes low and capped, and every licensed occupation wants to minimize the number of new entrants.So why would a genteel financial advisor, money manager, or financier want to take on those fights? High-income homeowners with occupational licenses are the bread and butter of the upper-middle-class economy! They already have workplace retirement plans, gold-plated health insurance, and generous family leave."Personal finance education," on the other hand, is easy. Sure, it might take a few classroom hours away from actual education, but that's the teacher's problem, not your problem. Plus, once it's up and running you might even be able to sell your consulting services on the side to school districts that, for obvious reasons, don't want to hire a full-time "personal finance educator," because there's no such thing.

Conclusion

Let me be clear about one thing: ignorance is also a problem. Educating people about how things really work is an important and valuable service, indeed one I try to perform here to the best of my limited abilities.The fact that IRA's, for example, are privately marketed means there's an incredible scope for abuse by savvy marketers, with both the victims and the government ultimately paying the price. An education campaign about what to look for in an IRA would be at least as good a public service as the "National Responsible Fatherhood Clearinghouse." Even better would be strict limits on the kinds of assets eligible to be held within IRA's.But "personal finance education" is just a savvy marketing technique for inaction, insisting that we need do nothing to fix the actual problems we face, because the problems were inside us all along.

Marco Rubio wants to end retirement security for you and everyone you know and love

It's often pointed out that Americans are the only people in the developed world who don't have access to guaranteed paid leave from their jobs to care for themselves and their families.But that's not exactly right: while we don't have a nationwide paid family leave program, lots of people in America do have access to paid family leave. According to the National Partnership, California, New Jersey, Rhode Island, and New York have statewide plans covering many private sector employees, and many cities and counties extend paid leave benefits to their own employees.The success of those programs raises the obvious question: why don't we have a nationwide paid leave program?

Marco Rubio has a commonsense solution to make your retirement more precarious

That brings me to Marco Rubio's "Economic Security for New Parents Act," which, to be clear, does not provide economic security for new parents. Instead, it allows new parents to claim a cash benefit after giving birth, and then permanently reduces their Social Security old age benefit in retirement.It took me quite a bit of searching to find the actual text of the bill, so I'll save you the trouble and link to it here.To understand how the bill works, you need to keep three numbers in mind:

• everyone is eligible for "early retirement" benefits at age 62;
• people are eligible for "retirement" at an age determined by their year of birth (67 for most people living today, slightly earlier for some Boomers);
• and "delayed retirement credits" if they delay claiming benefits past their "retirement" age.

If you begin to claim old age benefits between your "early retirement" and your "retirement" age, your primary insurance amount is reduced (by 6.67% per year for the first 36 months and 5% per year after that).If you claim old age benefits at your retirement age, you get your primary insurance amount.And if you delay claiming old age benefits past your retirement age, your primary insurance amount increases by 8% percent per year.

This bill would destroy millions of lives

Once you know how Social Security old age benefits work, you can see why Rubio's bill is so devastating:

• people who take parental leave have their early retirement age deferred: "the early retirement age with respect to such individual shall be deemed to be the early retirement age determined with respect to such individual plus the parental leave benefit adjustment with respect to such individual."
• people who take parental leave have their full retirement age deferred: "the retirement age with respect to such individual shall be deemed to be the retirement age determined with respect to such individual plus the parental leave benefit adjustment with respect to such individual."
• people who take parental leave will lose deferred retirement credits: "the Social Security Act is amended by inserting after 'age 70' each place it appears the following: '(or, in the case of an individual described, age 70 plus the parental leave benefit adjustment).'

While these penalties sound similar, it's important to differentiate them. Between 42% and 48% of workers start claiming their old age benefit at age 62. For these workers, the changes to Social Security would mean for every child they have, they're forced to delay claiming their already-reduced old age benefit.Workers who claim their old age benefit at their full retirement age will also be penalized: a millennial eligible to claim their full benefit at age 67 who made the mistake of spending time with their child will instead receive 1-2% less per year, per child, permanently.And a worker who wants to wait to claim their old age benefit until they've maximized their deferred retirement credits will have to wait, not until age 70, but months or years after that depending on the number of children they have.

Social Security is a guarantee of income during old age and disability

Social Security is not a savings account. It's not a trust fund. It's not an investment. You cannot "draw" on it, you cannot "make contributions" to it, and needless to say you cannot "fund YOUR paid leave with a portion of YOUR social security benefits which YOU paid for with YOUR taxes."That is not, and has never been, and never will be how the Social Security Administration works. You cannot "borrow against" your future Social Security benefits. You cannot "withdraw" your Social Security benefits. You cannot "invest" your Social Security benefits.Social Security is a guarantee of income during old age and disability. You can sabotage it if you want to — that's the nature of politics, there will always be people trying to sabotage the income security of the old, the sick, and the poor.But if you sabotage Social Security, the outcome will be lower incomes, for more people, during old age and disability. There's no hack, or workaround, or trick to keep Social Security benefit cuts from making the oldest, sickest, and poorest people in our society worse off.And shame on Marco Rubio for trying.