All of the involved countries have finally agreed to the Trans-Pacific Partnership. I could not be more excited. It was looking for awhile there that we were going to keep sugar tariffs and, while part of me was looking forward to a lifetime of smuggling bulk sugar across the Canadian border, I’m pretty glad that I won’t have to. After all, who wants to spend three years of their life rotting in some Canadian jail?
- 18,000 tariffs going away.
- Tariffs on Japanese made cars being phased out over 30 years.
- Japanese tariffs on beef are going away.
- Steel tariffs are going away
- Solar panel tariffs are going away
My single favorite quote in the NYT article on the subject is:
“It’s complete devastation of the auto supply chain,” Leo Gerard, the international president of the United Steelworkers, said in a telephone interview. “If you look at the autos these days, they’re assembled from parts from all over the place.”
Yes, my schadenfreude is strong. Yes, I’m still upset about the automaker bailout. (Sure, I’m upset about TARP as well. Its harder for me to be really upset about it though. Quiz question, what’s the major difference between TARP and the automobile bailout? Answer: The government turned a profit on TARP.)
Global Warming, Democrats, and Trade
First off, global warming/climate change or whatever you want to call it is definitely happening. Carbon dioxide really does absorb electromagnetic energy in a part of the spectrum that our planet produces, heating it up a small amount. Will the direst predictions of the IPCC reports come true? I don’t know. In the past the IPCC has overestimated the amount of warming. Do I think that the IPCC reports represents probably the best guess we have? Absolutely. Republicans in general stubbornly refuse to believe this and are quickly becoming labelled the anti-science party because of that stubbornness. That is a rant for another time. Democrats have their own climate change, and that is free trade.
In 1969 Stanislaw Ulam challenged Paul Samuelson (the first American to win the Nobel prize in economics, often referred to as the ) to “name me one proposition in all of the social sciences which is both true and non-trivial.” This caused Samuelson a great deal of consternation. How could it be that social science hadn’t generated one useful result? It took him years but he eventually realized that it was the concept of comparative advantage:
“That it is logically true need not be argued before a mathematician; that it is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them.”
Economics has one best, most tested, high-consensus result. Democrats, in general, would prefer to simply pretend that such a result wasn’t true. For if it was true, that would mean it would be in the best interest of the nation to unilaterally declare free trade. The US would be better off if they simply chose to set all tariffs to zero, even if no other countries followed suit. Fredrick Bastiat once said, “it makes no more sense to be protectionist because other countries have tariffs than it would to block up our harbors because other countries have rocky coasts.”
The reason comparative advantage is so tied to free trade is perhaps given in a simple example. Let’s suppose you have two countries. One is very good at making both self-righteous editorials and banana, so much so that they could make, with 600 minutes of labor, either 30 self-righteous editorials or 20 banana or some combination of the two (so they can make 1.5 self righteous editorials for every banana they don’t make). Another country is terrible at making both self righteous editorials and bananas, but they’re equally terrible. They can only make either 10 self righteous editorials or 10 bananas with 600 minutes of labor (60 hours per unit). So at best country B is consuming 10 of some combination and country A might consume 10 bananas and 15 self-righteous editorials. Now if they can trade country A might produce 30 self righteous editorials and no bananas while country B would produce 10 bananas. Country B could then trade 5 of its bananas for more than 5 self righteous editorials. County A could and would trade fewer than 7.5 self righteous editorials for bananas. In this manner both countries are better off. The trade might happen at a ratio of 6:5, with both countries able to consume more than they otherwise would. When this gets exchanged for a model with many, many goods the advantages get much stronger.
As it stands
Fortunately it appears that democratic presidents take the science on the subject seriously even if the democratic party does not. Both Clinton and Obama have fought really hard for two landmark trade deals. Hilary Clinton’s protectionism on the issue seems to be probably political in nature, and while it is disappointing for candidates to lie about their views in order to get elected it happens. The alternative, that she has somehow forgotten the benefits of free trade is substantially worse, in my view. It’d be like if a republican was staunchly supportive of climate change science, then in the republican presidential primary said she had doubts. I wouldn’t believe for one second that the republican flipped on climate change, she’d simply be lying to get elected. I leave you with one last quotation on the subject from a nobel prizewinning economist:
I am convinced that many economists, when they try to argue in favor of free trade, make the mistake of overestimating both their opponents and their audience. They cannot believe that famous intellectuals who write and speak often about world trade could be entirely ignorant of the most basic ideas. But they are — and so are their readers. This makes the task of explaining the benefits of trade harder — but it also means that it is remarkably easy to make fools of your opponents, catching them in elementary errors of logic and fact. This is playing dirty, and I advocate it strongly.
This quote, of course, is from the famously liberal New York Times columnist, Paul Krugman.
It seems to me that for the most part blogs on investing focus on the successes of the investors. Generally these blogs make investment suggestions then trumpet successes. Failures certainly seem to be under-reported. In the opposite spirit this is the story of the worst investment I ever made.
Maybe it’s because of the movie but most people I know have heard of the Titanic. My investment was like the titanic in two ways. First, it set out with high expectations and unfounded certainty in the safety of the vessel, only to sink like a stone. Second, it was in the titanic. I invested in the Titanic
No, I’m not wildly old. An investor in the actual Titanic at least had the justification that they were investing in a working ship. Lay-investors probably couldn’t have known that the ship was going to sink (though I’d have liked to have met the man that managed to get short on the Titanic because he thought it was going to sink). What I invested in was the Titanic artifacts, and the salvage rights on the Titanic. You see, a company named Premier Exhibitions had acquired the Titanic artifacts and the salvage rights. These are the guys that do the Bodies exhibition among other things. Someone had signed a letter of intent to buy these assets for 189 Million ($3.78 per share). That deal fell apart due to financing, and as part of it a court set some restrictions on how a potential buyer had to care for the artifacts. However, the company was profitable (barely) At this point I made my first investment when the stock was trading for $2.69 per share, I invested a relatively small amount of capital (2.5%).
The march of doom
The price proceeded to fall from $2.60 to $1.60 because a major holder had partially liquidated his holding. This by itself wasn’t terrible news, it would simply give me an opportunity to buy more of the stock at a discount. (At least that’s what I thought at the time). So I ponied up another 5% of the portfolio. In 2014 the stock fell again. This time down to about $0.85 per share. This drop was different. It was due to the fact that the company was no longer profitable and that they had taken out a loan on poor terms. The company might not survive to realize the value of the assets. I reasoned that I had not invested in the company for its earnings, so that didn’t matter to me, and that shareholders would be driven to make a sale of the titanic assets happen before the company went under. Even if they sold it at a 50% discount I would come out ahead (so I figured). I therefore invested another 7.5% of the portfolio on the way down to $0.85 per share. (Everyone keeping track, we’re up to 15%, obviously this investment was worth substantially less than that now.) The same reasoning applied the following year when the stock fell to about $0.50 per share and I invested another 5% of the portfolio. Eventually my string of errors became obvious to me and I sold, part at $0.50 per share and part at $0.22 per share. (The stock did a 10:1 reverse split so in order to compare these values with current numbers available on a finance portal you need to multiply them all by 10). By the time I exited Premier Exhibitions had fallen a gut-wrenching 92%. If you add up all of my purchases and sales I managed to lose 55% of the money I invested, this was about 10% of my portfolio.
What went wrong
The joke I liked to tell at this point was, what do you call a company that falls 90%? A company that Adam loses 80% of his money on, invests more and proceeds to lose 50% of that money. As far as I can see it there were two large mistakes here. First was that an asset is only worth the discounted values of the future cash it generates. The titanic artifacts weren’t making Premier any money, who would pay $190 million for them? Depending on other people having a irrational attachment to the artifacts was the entire basis of the investment. It didn’t work out. Second, I was excited about this investment. I was losing money on it and I liked trotting it out as an example of me doing badly in the market. I thought that this would balance me out and not get overconfident. The problem was that every time I explained my reasoning, I was just pounding this wrong idea harder into my head. So I’d explain why I thought it was a good idea even though I was losing money, then go and invest another 5% of the portfolio in it! Charlie Munger explained this in a famous speech he gave in 1995:
And of course, if you make a public disclosure of your conclusion, you’re pounding it into your own head. Many of these students that are screaming at us, you know, they aren’t convincing us, but they’re forming mental change for themselves, because what they’re shouting out [is] what they’re pounding in. And I think educational institutions that create a climate where too much of that goes on are…in a fundamental sense, they’re irresponsible institutions. It’s very important to not put your brain in chains too young by what you shout out.
I strongly advise you to read the whole speech called “the psychology of human misjudgment”, it is available here.
So what did I learn? First, diversification is really important, simply because if you are making an error it protects you. I still outperformed the market during the 2013 to 2015 period despite losing 10% of the portfolio because of diversification. Second, I should probably limit myself to only investing a certain percentage of the portfolio in a specific stock even if “better” opportunities present themselves. This might help protect me from confirmation bias in the future. Anyone else have any horror stories about buying individual stocks? I can’t be the only one out there with a massive loser.
I love talking about politics, but in the past have found arguing about politics to be wildly unproductive. I’ve found that the easiest way to talk about politics in any situation is that rather than making a statement such as, X is bad/good, I instead prefer X will probably result in Y. In economics these two types of statements are referred to as positive and normative respectively. The problem with saying something like, “Bernie Sanders would make a bad president” is that you never actually make a testable prediction. How would you be proven unambiguously right or wrong? An argument like that could go on forever. Instead preferred is, “Bernie Sanders will not be the Democratic Nominee.” (Probably true) or “Bernie Sanders will not be elected president.” (Very probably true) or in the case of this article, “If Bernie Sanders is elected president, and he manages to get his education proposal passed in its current form tuition costs will accelerate or quality of education will decline.” Specifically the return on investment from the all-in cost of college measured as change in lifetime earnings will probably drop precipitously.
Bernie Sanders proposal is basically to make college at State institutions free to undergraduate students. Here is a fact sheet from the Sanders campaign. Here is the actual text of the bill. Basically the idea is to provide 2:1 matching funds to States for the purpose of making tuition at their public universities $0. This would be paid for by imposing a tax on stock, bond and derivative trades. Sanders claims this will generate $300 billion.
The supply/demand problem
The price system is a core part of the market economy. The law of demand is that, in general, if the price of good/service to the consumer is reduced more will be demanded. If more college is demanded how will that demand be satisfied? Supply must be increased. The law of supply says that more of a good will be supplied if the price to suppliers increases. Therefore, one of two things can happen. Either universities become more restrictive about whom they accept, or they supply more education at a higher marginal cost. This cost will now be born by State and Federal taxpayers. The fact sheet from the Sanders campaign claims that states must meet requirements to reduce “ballooning costs” in order to receive the matching funds. I can’t find anything in the bill to support this. The only thing I can find in the bill is provisions that ensure that costs will never stop going up. Specifically Title I, paragraph c, point 1: “a State shall— … ensure that public institutions of higher education in the State maintain per-pupil expenditures on instruction at levels that meet or exceed the expenditures for the previous fiscal year”. Cost is guaranteed by the bill itself to increase. Furthermore the other provisions which set out the requirements for states to get the matching funds also have the effect of driving up costs: 75% of instruction will be required to be provided by tenured or tenure track faculty. This simply costs more than the alternative. If you think that university costs are currently overpriced this plan won’t fix that problem. It simply shifts the costs from one group of people to another. This is a really bad way to allocate scarce resources. Speaking hyperbolically this will draw educated people into an industry of creating more Bachelor’s of Arts in Basket Weaving. While education sounds good and you might think that having a more educated populace will improve the economy, misallocation of scarce resources (in this case smart folk who could be educators or do something else) will do more damage to the economy.
The tax problem
I can’t seem to verify the Sanders campaign’s numbers on the amount of money to be collected from the tax. As far as I can tell they just estimated the total dollar volume of transactions in the US multiplied it by the proposed tax rates, got something near $300 billion and called it a day. Fortunately, it appears as though the total cost of the program in the first year would be somewhat more than $70 billion. The main problem here is that trading volume in the US is assumed not to react to this new tax. Over 60% of trading volume in the US is high frequency trading. Most of those trading strategies flatly would not work if this tax was imposed. Therefore, volume would probably decrease substantially. My second testable prediction therefore is, in the first year the tax being in effect the program will collect less than $150 billion (obviously adjusted for economic growth from the date of the proposal to the year it actually gets implemented). Basically the tax interacts with stock trades according to the same laws that the subsidy interacts with higher education. The reduced proceeds lowers supply and the increased cost reduce demand. The question is what will be the amount of economic destruction (deadweight loss) caused by this tax? This gives my third testable prediction, the spread (defined as the difference between the bid and the ask) on stock trades will average at least 0.5%. Rather than having a bid of 31.56 and an ask of 31.57 we’ll have a bid of 31.50 and an ask of 31.64. This unfortunately means that the total cost to people buying and selling stocks won’t be 0.5%, but rather will be more like 0.75%, 0.5% for the tax and 0.25% for the spread*. In my view a tax that destroys at least $75 of value for every $50 of revenue is a bad tax.
I’m not saying all proposals to reduce the cost of higher education are bad. Don’t fall into the trap that politicians love to lay out. 1) A is a bad thing. 2) We must do something about A. 3) B is something! 4) Therefore if you oppose B you must like bad thing A. That being said its probably a bad idea to simply criticize something without offering a solution. My suggestion would be to restore regular bankruptcy treatment to student loans. Markets work best when the person risking the money is the same as the person making the purchasing decision. The job of a bank is to make sure that it weighs the risk of not getting repaid appropriately. When you take risk out of the equation for a bank, it ceases to behave responsibly. If the bank has skin in the game, its interests are aligned with the student. The bank then needs to make sure that the student is getting their money’s worth for the education, because if the student doesn’t get their money’s worth the bank doesn’t get repaid. In our current system the bank gets repaid no matter what, “education” and loans get foisted on young folk and taxpayers are left holding the bag. So goes my last prediction. If we go back to the system we used to have, where bankruptcy was an option for student loans, the rate of tuition increase will slow and the return on investment of a college degree will increase (again measured as a change in lifetime earnings).
*The spread is a zero sum game. The total spread is 0.5%. Someone pays that portion of the spread in each transaction. You may think that if you put a limit order in then you personally will be safe, however you have no guarantee to sell or buy at your limit price. The price could move in the other direction without you being able to make your transaction. I figure split the difference and say that a person pays half the spread on the round trip.
One question that comes up a bunch when you are starting to save seriously is whether to save in your work’s 401k plan or through your own IRA. We’ll talk about the difference between a Roth IRA/401k and traditional IRA/401k later but for now let’s assume we’re talking about traditional retirement accounts. The arguments will probably apply to both however.
The best advantage of a 401K is that you often get matching funds from your employer. Free money is free money. If your work offers a match and you aren’t taking advantage of it you’re commuting a worse financial crime than using high interest credit cards. It’s that bad. Stop eating out, cancel cable, do whatever you have to do to get the match. (Okay, don’t stop paying your mortgage.) (Do move into a cheaper place though). Another advantage is that since businesses are large institutions sometimes they can negotiate better deals on fees. Sometimes there are worse fees though and you should make a comparison so that you know. One of the last advantages is more restrictions. Generally in a 401(K) it’s harder to get your money out because you need permission. You won’t wake up one day and decide to buy a boat emptying your retirement to do it. You may think that only other people make mistakes like that, but that’s what they thought too, until it wasn’t.
The biggest advantage of the IRA is flexibility. You can choose almost any traded investment under the sun. You can hold gold or even real estate through an IRA. This is a huge advantage over 401(K) plans. Sometimes this means that you can find a better deal on an investment product like an index fund because you have more capability to shop around. You also have some more flexibility when it comes to taking your money out. Worse case scenario you pay regular taxes + 10%. You are never at the mercy of someone else telling you that you can’t have your own money. You might also find it a minor advantage that when you leave your job you don’t have to do any paperwork.
There are some tiers here. First thing, you need to put enough in the 401k to get the maximum match. Just do it, you think you’ll miss the money but you won’t. Sell anything that somebody will pay a buck for, go back to the article on ways to make money you haven’t tried.
Now there is a corner-case where you might not want to take the match. If the 401(K) plan is really bad and charges 2% more in fees annually than the investment you could make in your IRA and you are certain you’ll be in this position for the next 32 years. Then, and only then, invest in the IRA for the first year before getting the match in the second year and so on. That’s because the additional 2% in fees you don’t have to pay compound to a doubling over ~32 years. This is such a ridiculous scenario I feel dumb even suggesting it, but it goes to show how crazy the scenario has to be for you to skip the match.
After you’ve gotten at least the match it becomes a lot closer of a decision. If you think you’re an investment expert, you should probably just go with the 401(K). You need the restrictions because if you need this question answered for you and you think you’re an expert you’ll probably lose all your money. It’s a blessing that your 401(k) has some basic guardrails. Take advantage of them. If you’re very even tempered and are willing to read a bunch of textbooks on the subject of investing you’ll probably be better off with the IRA. Keep in mind that you still need to be careful. You’re in competition with professionals and you’re turning the bumpers off.
If you’re contributing more than the limit of your preferred one just try to max out both. Tax shelters are awesome. Use them. People constantly complain about the tax shelters the rich use and the reality is that they pale in comparison to the tax shelters the middle class has access to. Plan carefully enough and someone making $40,000 per year could pay zero income tax. Use your tax sheltered space!
Step 6: Register a Business Name
This is sometimes called a DBA (stands for “doing business as”) name. This turned out to be flatly easier than I really anticipated it to be. The SBA webpage has links to different state webpages. The one for Colorado, which I’ll be using as an example is here. Click on the “File a business document” link.
Finally in order to register my sole proprietorship I need to click on the “Trade Name” link.
Here we are at yet another screen. Makes you wonder how many forms there must be to have this many layers of this many options…
Now that we’re onto the form you’ll notice that we’re going to get charged $20. A surprisingly reasonable fee in my view. To be entirely honest I thought this was going to be somewhat more expensive. The form starts out straightforward. What’s your address etc. You’ll need to know what you want your “trade name” to be. The question here is, “what is the name of your business”. Hopefully you can answer that by now. There’s an additional section I found interesting though. The “delayed effective date”. Why would I want this?
This could be useful if you were converting a sole proprietorship to some other form of entity that was taxed a little differently. By filing with a delayed effective date you can make sure that the business takes its new tax treatment exactly on the first of the year or something useful, so that you don’t have to file an extra form for one year. Additionally, sometimes States get swamped with new business filings. If you wait until you need the business created then choose for it to take effect immediately you may have to wait longer for confirmation. If you file in advance and choose the delayed effective date you can control what day it begins on because you’ll be at the front of the line.
Step 7: Get a Tax Identification Number
To apply for an EIN (employer identification number) you have to go to this webpage. You can also do it by mail, but honestly, how crazy would you have to be? (Very). Judging from this questionairre I’m actually not required to get an EIN. I think I’ll go ahead and do it anyway, maybe I’ll end up hiring a secretary or something.
Fortunately the process is pretty simple. We do need to keep track of the Doing-Business-As name that we signed up for in Step 6. All-in-all this turned out to be more intimidating than it was difficult. Looking at all this I start to wonder how hard it would actually be to hire an employee.
Reading is simply the easiest way to cram a lot of new information into your skull. I’m a little skeptical that it does quite as much good if you end up reading exactly what everyone else is reading. With that in mind here are three books I bet you haven’t read.
Early Retirement Extreme by Jacob Lund Fisker
This is a fundamental reworking of how you view personal finance. I have always summarized the argument as, if you are an environmentalist libertarian you only need to work for five years. Jacob points out the massive waste and fragility of consumer society. He points out that if you’re willing to live in a house the size of your grandparents, drive a car as often as they did, and prepare your own meals in an efficient fashion you can probably save 80% of your income. You then invest this savings as you wish over five years, after which you are financially independent and no longer need to work. The book details a philosophy and grounding theory for the whole framework. It reads like a technical manual for quickly achieving financial independence, which it basically is.
I might be cheating with this one, maybe you have heard of it. If you have or haven’t pick it up again as it’s a fast read. It was originally published in the 1920’s and details the advice of the so-called Richest Man in Babylon. It probably doesn’t have any advice you’ve haven’t already heard in some form or another. It does drive home precisely how you should think about money. An exchange early in the book goes thusly:
Then he looked at me shrewdly from under his shaggy brows and said in a low, forceful tone, “I found the road to wealth when I decided that a part of all I earned was mine to keep. And so will you.”
Then he continued to look at me with a glance that I could feel pierce me but said no more.
“Is that all?” I asked.
“That was sufficient to change the heart of a sheep herder into the heart of a money lender,” he replied.
“But all I earn is mine to keep, is it not?” I demanded.
“Far from it,” he replied. “Do you not pay the garment- maker? Do you not pay the sandalmaker? Do you not pay for the things you eat? Can you live in Babylon without spending? What have you to show for your earnings of the past mouth? What for the past year? Fool! You pay to everyone but yourself. Dullard, you labor for others. As well be a slave and work for what your master gives you 12 to eat and wear. If you did keep for yourself one-tenth of all you earn, how much would you have in ten years?”
Basically everything you need to know about the standard theory of personal finance is in this book. Everything else is execution.
Reviving the Invisible Hand By Deepak Lal
This is an economics book which details why free markets are effective and how the fall of the first liberal economic order under the British empire caused a whole host of problems. It also covers the benefits of the current second liberal economic order under the United States. The book is full of all sorts evidence about the nature of capitalism and why things like free trade are so important. It covers almost every facet of classical liberal thinking. The citations often take you to economic papers which will get you well versed in the literature if that’s your thing. It is otherwise a completely indispensable book if you are currently a socialist. Nothing is more important in finance and investing than trying to figure out what’s actually going on compared to what you wish was going on. If you don’t have at least a cursory understanding of what your opponents actually think rather than some nonsensical straw men you’re going to have a bad time. If you already view yourself as a classical liberal it is still probably worth reading because of the sheer volume of information. I thought myself well versed on the subject and I couldn’t go a chapter without learning something really useful. One example stands out, “Why is an above market return on invested capital not a sign of market failure?”