By Brad Thomason, CPA

​​Did you realize that stocks are basically worth exactly as much right now as they were a year ago?
 
Wait a minute, you say.  I thought that there has been a big run up this year.
 
There has been.
 
It’s just that in the final 10 weeks or so of last year, there was a big drop, too.
 
Despite the fact that we have indeed had new all-time highs on the Dow this year, most of the gains have just been a recovery of already-gained ground that was lost as we went into the final weeks of 2018.  And those new highs?  Just a few points higher than where we got to last October.  This year’s 27,400 level (which we’ve flirted with a few times) is not much of a jump from the 26,950 we had in the first week of October 2018.
 
All of the fluctuation in between may or may not have meant anything to you.  If you did not change your holdings – in other words no new money in, nor the withdrawal of any of your existing capital – the last twelve months have been flat for you.  No net change (even if there was some heartburn and/or excitement along the way).
 
If you added to your portfolio, you may have had the opportunity to do so at lower levels; and if so you have some sort of gain on those dollars, even if not the rest.
 
If you had to take money out though, you may have had to do so during the dip, in which case you traded in the shares for what were essentially discounted dollars.  The amount you ended up having available to spend (on whatever you needed the money for) was a lesser amount than you would be getting today if you were redeeming at post-recovery levels.
 
There are a couple of quick items I’ll mention merely as food for thought.  First, the scenario I described affects more investors these days than it might have a few decades ago, due to the popularity of index funds.  Even though the index levels have not had a lot of net change, the amount of rising and falling of the individual stocks that make up the totals has been much more active.  It always is.  Which on the one hand is part of the case for using the index fund in the first place.  It mutes the effect of those individual movements.
 
Those movements, however, are where the potential for profit lies, especially during times that the market as a whole is not going anywhere.  Just as with any other form of insurance (because that’s what a diversified portfolio is, whether you divide it up yourself or buy the diversification prepackaged in a fund or ETF), there’s a cost.  Creating a situation in which you might lose less than you would have, comes at the expense of possibly earning less than you could have.  Although the following statement is Monday-morning quarterbacking of the most brazen sort, it will nonetheless be true:  Many investors over the last 12 months would have seen much more growth had they been holding a self-selected basket of individual stocks, as opposed to the prepackaged basket of a large index fund. 
 
Second, if you feel like you are getting too old to be dealing with ups, downs, years of zero return without any reduction in capital risk, and conundrums over index funds versus individual stocks, well, you’re probably right.  The general presumption as people get older and move closer to retirement is that the balance of the retirement savings will get bigger.  It may not be possible to drive these balances to high enough levels without accepting some exposure to market risk during the working years.  But as people approach retirement age, especially if the investment campaign has been successful, the attention should turn from making more to protecting what you already have.  There is a point in just about every case where it becomes difficult, if not impossible, to continue to back the argument that equity holdings are suitable for the situation.  When that happens – and preferably just before it happens – folks should consider an orderly retreat from such investments.
 
The stock market has been responsible for a lot of capital growth and the funding of a lot of retirement needs.  It has been reliably up-tilted throughout all of modern American history, and is likely to continue to be.  But not in a straight line, not without weird periods of unusual return activity, and absolutely never without an element of risk of loss.
 
If you are in the part of your life when you are still growing your balances for some far-off future, spend some time contemplating the pros and cons of being all-index, or perhaps mixing in some tactically-selected individual holdings, too.
 
If you are in the part of your life when it seems prudent to exit equities, or at least seems onerously stressful to stay, then maybe it’s time to listen to that little voice and plot a course to transition your capital into holdings that behave differently.

By Brad Thomason, CPA​

Youngest son took critical comments I made about the state of his (truly deplorable) posture and parlayed them into a new desk chair for his room.  I happened to be home when the delivery man arrived.  He carried the box to the front door, where I took it from him and set it in the foyer to await the homecoming of its new owner.  As I set it down I noticed a diagram on the side indicating that it was deemed to be a 2-person-lift item.
 
From the evidence at hand, neither I nor the delivery man apparently thought so.  But it raises a point worth noting.
 
The thesis behind two people carrying something is of course that neither person has to support as much weight as a person alone would.  The job is easier, and safer, because the load is being distributed.  Whether or not one person alone could pick the thing up, as with our example, it is still the case that if two people do it, each person does less.  The excess lifting capacity isn’t needed, because the collective force available exceeds that which is required for the item.
 
This principle is at play in the personal finance space, as well.  The amount of money that a person needs to make for a given period of time (e.g. a year) from their efforts is tied to whether or not there is also a pool of investment capital in the picture.  Just as the load on a single lifter changes when another one joins the effort, the financial mechanics of being salary-only differ from salary-plus-portfolio.
 
If you need $100 and you don’t have any investments, you have to work to earn $100.  But if your investments make $25, you only have to earn $75.  If they produce $75, then that only leaves $25 for the paycheck to have to cover.
 
In practice, this effect usually plays out over the course of our careers.  When we first start out, pretty much anything we have is the result of going to work and getting paid.  Toward the end of our careers, hopefully, there is a substantial portfolio of investments in the picture.  The presence of that portfolio means that the math is different.  Even if we choose to keep working, the load is divided and what we need to contribute from the effort side is reduced because of the contribution of the capital’s earnings.
 
To fully round out the picture of a typical case, note that at the end of the career we would expect the need to be lesser because you have finished raising and educating your kids; and if the retirement savings are fully endowed, you don’t have to worry about adding more principal.  Lower income means less of a tax liability to fund, too, which further reduces the total required.  So the need for a particular year could well be a lesser amount than in previous periods.  And at some point Social Security is kicking in, so that acts like a third person (fraction of a person?) to help with the lifting, too.  The percentage of the load that the earned income has to carry gets smaller and smaller.
 
The reason that this all matters, above and beyond the always-worthwhile aim of better understanding the specific operations of how your money works, is because of the potential lifestyle impact. 
 
Whenever you take a job or engage in a business pursuit, you are implicitly making a decision about the price you are willing to accept to sell your time.  In the early and middle parts of your career you are likely going to be looking for the highest price possible, even if it means doing some things you really don’t love, and doing them with an intensity and constancy that is at times exhausting.  Since there is nothing else to help carry the load during those years, you may not feel like you have a choice.
 
But later on, once you get over the hump of getting your savings squared away, things change.  Now to be clear, I am not advocating that you “retire early” and start dipping into your portfolio before it can tolerate such withdrawals (and still be there for decades to come).  But as I have pointed out in other posts, amounts of money that seem insignificant in comparison to your career earnings behave very differently when there is also a big pool of capital in the picture.
 
Which in turn means that you have a lot more latitude when it comes to selling your time.  Things that you never could have considered as a younger person now become reasonable, provided that you have everything squared away over on the savings side.  Even if you can still keep earning at your prior levels, you might not have to. 
 
To be sure, you need to step carefully here.  Interrupting a win before it has the chance to fully come together is too awful to even think about.  But continuing to push yourself hard after the point that it’s necessary isn’t the best outcome, either.  Nor is missing out on something you really have an interest in just because of some vague sense of it not being worth your time.
 
Before you decide that the price being offered for your time is too small to say ‘yes’ to, do a bit of math and confirm that is actually the case.  Because if you have done what you needed to on the savings front, what you can say ‘yes’ to at 65 or 70 may be a lot different than anything you could have considered at 40 or 50.

By Brad Thomason, CPA
 
 
I’m one of those people who believes the universe has a certain sense of humor.  For evidence, one need look no further than the fact that Jimmy Buffett has got a really good shot at being remembered by history as one of the most influential philosophical voices of the current age.
 
Another honorable mention on that list might be Kris Kristofferson.  Years ago he wrote, among other things, a song called To Beat the Devil.  The most well-known cover of that song that I’m aware of was done by Johnny Cash.  I still quite clearly remember the first time I heard it.
 
The chorus starts out like this:
 
If you waste your time talking to the people who don’t listen
to the things that you are saying, who do you think’s gonna hear? 
And if you should die explaining how the things that they complain about
are things they could be changing, who do you think’s gonna care? 
 
I won’t belabor the point.  I’m sure you can see how that would resonate with someone who does the kind of work that I do.
 
I know beyond a shadow of a doubt that retirement planning and its related topics are important.  It is, in fact, inconceivable to me that you would ever be able to convince me otherwise; anymore than you could convince me that water molecules contain something other than hydrogen and oxygen, or that the sun actually wasn’t there.  It is a settled matter as far as I’m concerned.
 
I would even go so far as to say that all of personal finance is in fact, retirement planning.  Every decision you make about every dollar you earn, don’t earn or spend, your entire adult life, will be a factor in what’s required to fund your life in the years after you stop working.  Retirement planning plays ocean to the many trickles of dollars that make up its contributing estuary systems.  It’s the place that everything is headed, the final destination.  It is, financially speaking, the whole point of the exercise.
 
Yet if you look at what the averages say about retirement savings, you come away with an unavoidable conclusion:  most people don’t appear to be very interested in this stuff.
 
Depending on where you look, you will get differing data, but most of it seems to cluster around the idea that the average balance for retirement savings in the US is south of $100,000. 
 
Now that’s a weird result, for a couple of reasons.  First, because it seems like a misprint given how much money is likely to be needed.  A popular rule of thumb is that you need to have an amount equal to ten times your annual salary; and frankly our work suggests that’s not a very good rule of thumb (10x is not enough money).  It’s also weird though because, in my experience, the average person is a pretty rare creature.
 
In other words, what that average probably reflects is a minority of people who have a lot more than that, and a majority that, unfortunately, don’t have even that much.  If they have anything, at all. 
 
If you really want to get a full view of this, do a bit of Googling yourself, and pay attention to the differences between average/mean savings and median savings.  The point will become obvious right away.
 
Since resources are required for planning to be anything other than an impotent act, it is necessarily the case that discussions about retirement are de facto discussions to the minority.
 
But even among the minority who have more than the mythical average person, it is only the minority of that smaller group who are building toward something resembling what the drawing board suggests is going to be necessary to pull off a successful retirement (i.e. one which encompasses several decades of bill paying, and what not). 
 
The messages about the importance of retirement planning (retirement preparedness, really) are never ending, constantly washing over all members of our society in newscasts, TV ads, billboards, those little things that interrupt Youtube videos...  Yet seemingly only a few actually listen and act, and fewer still give it the attention that would seem to be both needed and beneficial.
 
And ultimately, it is for that small group within the larger whole that we do what we do.  We know that most people don’t listen to the words that we are saying.  I wish they did.  But they don’t.  And experience has taught me that I probably can’t convince them to change their ways, no matter how lucid or impassioned the plea.
 
So instead we focus our efforts on those who have decided, for themselves, that this stuff is both important and worth the effort to do right.  When those people go looking for information on what and how, our goal is to provide them with things that are useful.  When those people need help taking some step that is necessary to move them closer to their goal, we want to be available if they want that help from us.
 
I have not yet reached a point where I am OK with the vastness of the group who doesn’t listen and doesn’t care.  When I wonder if I ever will be, I usually conclude it’s unlikely.  But I decided a long time ago that couldn’t be the focus.  Rather than despairing over the ones who don’t and wouldn’t, we needed to be spending our time doing things which would support the ones that did and would.  Even if that group only represented a minority of the minority, they would still think it was important that they do a good job for their own family.  And that was certainly sufficient motivation, and justification, for the part in their effort that we could play.
 
If you are reading this, there’s a good chance that you are one of that small group.  Good for you.  I hope that we have done our part to provide you with some things that have been valuable to you.  We’re going to keep at it, and if you have suggestions about other topics we need to address, or better explanations for the ones we already have, I hope you’ll let us know.  You’re the person we had in mind when we did all of this in the first place.  So we want to make sure that it’s something you find beneficial.

By Brad Thomason, CPA
 
​
There is a lot more to retirement income than simply saving money.  But saving money is the thing that sets everything else in motion, and the better the job you do of adding principal to the equation, the easier it is for all of the other factors to do what they need to do.
 
People often lament that it is difficult to save for retirement because they don’t have any money left after paying for “the basics.”
 
In my experience, most people have raced right past the basics and are living lives that are quite a long way from mere subsistence.
 
Still, an admonition to just spend less isn’t really very helpful advice.  So instead let me point out a few places where money has a tendency to go.
 
The first distinction I would make is between one-time expenses and recurring expenses.  The single price tag stuff tends to get the attention, but the stuff that you pay for year after year has the potential to be what really drains your batteries.  For a stark example that you can do for yourself, compare the cost of a tube of toothpaste to the amount of money that a person is likely to spend on toothpaste over the course of a lifetime. 
 
It is because of this aspect of spending that people can end up allocating more money to their pets or their yards than they do to saving for retirement.  Making such expenditures in the moment seems pretty innocuous; yet when viewed big-picture one comes to see how frankly absurd it is.
 
As a result, this little mundane stuff can hurt you more in the long-run than a single big chunk spent at one time.  A person contemplating some special trip of a lifetime might decide it is too expensive.  In which case saying ‘no’ will feel like a responsible act.  Which it is.  But from a strict financial perspective, had the person required himself/herself to tighten up on nonessential routine spending, and then taken the trip as reward for being diligent, the net effect could easily have been better than denying the trip and letting the leakage continue.
 
Now that said, if we are talking about an expensive trip every year, then we are right back to talking about a recurring expense.  Recurring doesn’t necessarily mean there’s a cash flow every week or every month.  If you drop $10,000 on a vacation trip every year for two decades, that’s a recurring expense.  Not to mention an eventual $500K to $800K or so that won’t end up in your portfolio.
 
Another key place to look at is vehicles.  With cars, there are two main culprits, which often occur in tandem.  The first is spending more money on a vehicle than is really necessary to get from point A to point B.  The other is replacing the “old” one (before it is actually old) with a new one, too frequently.
 
People buy more car than they need just because they do.  I tend to drive pretty basic stuff, but admit to having bought my wife nicer vehicles than was necessary.  Doing so had the twin benefit of avoiding an argument, and doing something that made her happy.  So those things have value in their own right, and I’m not trying to come off as judgmental in any of this.  I’m just pointing out the mechanics.  Which in this case is spending behavior that I’ve done, too.
 
As far as the replacement interval though, this one is largely based on superstition.  The general line is that you want to get a new one before the current one starts wearing out and having problems.  As such, at around 50,000 or 60,000 miles, it has to go.
 
This is basically hogwash.  Modern vehicles routinely go 150,000 to 200,000 miles without any need for anything but standard care and maintenance.  Early replacement is a classic example of how risk looms larger, and people take actions which are outside what the data suggests simply because they perceive the negative outcome as more costly and more likely than it actually is.
 
These two factors working in tandem can cost you a lot of money over the course of your life.  Cars depreciate faster the newer they are.  So if you flip that around, you realize that your average cost for owning any particular car – whether a basic car or one that was more luxurious than strictly necessary – drops every year that you own it.  Therefore, if you are always buying new cars, then you are always getting the highest yearly costs.
 
Bottomline is that most people end up acting out of fear of a repair bill, and in so doing spend many times the amount the repair would have likely been, by way of steep depreciation on expensive cars that they turn over at a high rate.

Also on the vehicle front we should mention boats.  Which some wiseass years ago defined as, “a hole in the water into which one pours money.”  An accurate description, it turns out.  Enough said.
 
Now, to the extent that some or all of that sounded like a rant, please know that wasn’t the intent.  I have been a consistent advocate of the principle that you can do with your money that which you wish, and that position is well-documented now in a written record that is approaching a decade’s worth of blogs, alone. Moreover, I have spent money - at least a little bit - on every single one of the things I mentioned.  So don't receive any of this as preachy.

 That said, if you were wondering where you might look for a few extra bucks to stick in your retirement account, perhaps now you have a few ideas that you weren’t thinking about five minutes ago.

By Brad Thomason, CPA
 
As the rapidly-passing summer is now more or less in the past, many of us have started to reorient to our young-uns being back in school.  So I thought now might be an opportune time to tell you about an interesting conversation that I had a while back.
 
The general theory that a lot of us operate on – me included – is that the cost of getting a kid ready to go live his/her life is a cost that Mom and Dad (perhaps with some assistance from the Grandparents) should be picking up.  Or to say it another way, it is not the ideal situation for a young person to have to pick up the tab for his/her own education.  They need to be focused on getting the education, not finding the means to pay for it. 
 
Up to a point, by the way.  My kids have been told quite clearly that they can have all the extra majors and Master’s degrees they want.  But Daddy ain’t payin’ for ‘em.  You get one Bachelor’s degree on your package deal of being raised.  After that, it’s on you.
 
But as I alluded to earlier, a year or two ago I had a conversation with a fellow which I thought was particularly interesting, because it offered some perspective on the down-side of this philosophy.
 
Essentially this guy had gone to college and his parents had paid for it so he wouldn’t have to work or end up with a bunch of student loans putting drag on his ability to start building wealth once he got out.  Which he appreciated.
 
But they did so at the expense of saving enough for their own retirement.  Then, due to medical reasons, one of his parents had to stop working at a younger age than had been originally planned.  The net result was that he was pretty sure that at some point in the next few years he would have to start helping them to keep the bills paid.  Because the balance of the retirement accounts never grew to the heights they had hoped for, it wasn’t going to last as long as it needed to.  And although it wasn’t the only factor, the prime factor was the reduced amount of principal which was added in the first place.  Principal that paid for his education, instead of endowing their retirement portfolio.
 
The person who was telling me this story seemed genuinely grateful for the fact that his parents wanted him to have smooth sailing, and that they cared enough about him to put their money where their mouths (hearts?) were.  But he also pointed out that from the very start of his college years he was on track to enter a well-paying field; and that while he acknowledged that not having to pay off student loans was nice, it was something that he reasonably could have done.  Significantly, he said that the cost of doing so would have ended up being less than what he felt like he was in store for, in terms of having to supplement his parents’ income. 
 
The whole situation had naturally put strain into the relationship, and was causing him to rethink what he would do when his own young children got to the point in their lives that this set of issues would resurface.  He did not want to propagate the problem into the next generation. 
 
Frankly, the whole thing was not a lot of fun for me to listen to, either.  Even though I know how important it is to properly fund the retirement need, and needed neither an example nor a reminder to make the point, hearing about a real world cases of not doing so still bummed me out.  I felt bad for the guy, and I felt bad for his parents.  But what could you do?  Which was sort of the whole point.  The actions were in the past, and all that was left now was the future effects; which unfortunately didn’t seem reversible.  He concluded by saying, “Sometimes I wish they hadn’t done me any favor.”  
 
 Food for thought.

 By Brad Thomason, CPA
 
In the years after the Vietnam War, the US military spent a lot of time looking into what was necessary to assure victory in warfare.  What they concluded, in simple terms, was that if it was important to win, you couldn’t really be thinking about minimum requirements or efficiency or things like that.  The best way to win was to throw overwhelming force at the target, force of such magnitude that the target simply couldn’t hold up under the onslaught.  Obliteration was the key to sure-victory.
 
Which, to their chagrin, they realized is something which they already knew, but apparently forgot.  In World War II, our forces attacked by land, by sea and by air.  In the major battles, all three at once.  If you wanted to you could view the whole thing as being similar to a demonstration in high school physics class:  you just keep piling on the force until the thing collapses.  Ultimately it comes down to math.  When the sum of the effects gets high enough, destruction becomes inevitable.
 
How would you like to do that to your chances of a successful retirement?  Because if you would, I have the perfect three-prong attack that you can launch at your portfolio.  Unless you have extraordinary resources (or a very short time to live), it is almost certain to blow it to smithereens.  Ready?
 
Retire early.
 
Here’s why:
 
1.It will reduce the total amount of principal that you feed into the system, which will inevitably, irrespective of any other factors, lead to the balance failing to reach the height that it could have achieved.
2.It will reduce the number of years that your (already-reduced) savings get to compound and grow.
3.It will make the job that your portfolio has to do, bigger.  You will have a greater number of years to have to pay for than if you retired later.
 
Yes, folks, that’s a complete attack package.  The financial version of land, sea and air.  All the branches of the military converging on that poor, single target.  The perfect concerted strike.  It’s brilliant, I tell you.  If you wanted to bring your portfolio to its knees, it is hard to imagine any single act which stands as good a chance of such effective damage-dealing.  There may be more elaborate ways to do it, but if you are looking for a simple way to get the job done.  In terms of having a big ole club to swing at it, this is the ticket.
 
I’ll presume my point is sufficiently made, and dismiss class early.  Have a good one.

By Brad Thomason, CPA
​
For some reason, certain topics in the retirement planning/retirement income space tend to get talked about more than others.  One of the ones which I see less content about is the idea of working at another job after your formal career has come to an end.  So let’s spend a minute on that today.
 
This is something I often discuss in continuing ed classes and other live presentations.  There’s a particular nuance that’s easy to miss, and I try to make it a point of shining some light on it.  It has to do with the fact that the kinds of job opportunities which may be available later in life often pay less than what you were used to during your “regular” working years.  The inevitable question comes down to, “For this amount of money, is it even worth my time?” 
 
The answer is probably, “yes.”  That’s because the benefit that you receive could be much larger than the amount of the paycheck itself. 
 
Here’s why:  any money you get from working after you retire represents money that you don’t have to pull out of your savings.  Think about it.  The act of working a few days a week probably doesn’t have much effect on your expenses.  So you were already on course to have to spend $x that year, anyway.  If you have some portion of that money in your checking account as the result of getting a paycheck, of any amount, then those are dollars which necessarily don’t have to be withdrawn from savings.
 
Mechanically, that’s simple enough to see.  But the part that really matters is less obvious.  We’re aware of it because of all of the work we’ve done modeling income projections on a year-by-year basis (which is a pretty standard step we take anytime we’re doing planning work).  But it’s not the kind of thing that would just be apparent at a glance.
 
The simplest way to explain it is like this: the dollars you don’t take out essentially go to the back of the line.  They become the last dollars you will take out when at some future point you finally approach the point of depletion.  And what are those dollars doing as they sit there in your account for the next 20 or 30 years?  Yep, earning investment returns.
 
Even at a modest 6% rate, money doubles more than twice in 25 years.  Which means that if you earn $10,000 next year at a part-time gig, the effect of doing so could be $40,000 to $50,000 of eventual benefit out in the future.
 
In other words, when you are contemplating a pay rate, you can’t just think of it in terms of its face value.  Instead, you have to multiply it by some amount which is based on the number of years you expect your current savings to last.  That becomes the de facto compounding period for the un-withdrawn funds. 
 
The new money is essentially going to get tacked onto the back end.  Yes, I know that you are going to spend the actual dollars about as soon as they come in.  But others dollars that you would have had to take out of production get to stay there, ginning away.  That’s what creates the effect.
 
Note that the thing which allows this to work is the portfolio that’s already in place before the new paycheck starts.  If you didn’t have any savings or other means of funding your income then there would be no benefit carried into the future.  You would be in the same boat as anyone else who had a lower income.  But since your earnings from the post retirement job, economically speaking, are not actually funding your current income, but buying you the ability to delay withdrawals, the profit engine of your capital gets to keep on going.  If there was no profit engine to begin with, then none of this would be applicable.
 
In some respects I guess that qualifies as extra incentive to do what’s necessary to build a sizeable nest egg.  The bigger it is, the greater the multiplier effect for the eventual benefits (because the bigger it is, the longer we would expect it to last).  For one retiree, a year of earning $10,000 might translate into $20,000 of benefit down the road, whereas it might be worth $30,000 to someone with a larger portfolio (or smaller annual withdrawal need).
 
But in both cases, in all cases where there’s a pool of earning assets out there, the benefit stands to be worth more than the nominal amount of the paycheck.  So make sure you factor that in when deciding if something is worth your time.  If you get caught up in the fact that the pay rate is a lot less than you were earning at the height of your career, you may inadvertently take a pass on something that is actually worth quite a bit more than it may seem to be on the surface.

By Brad Thomason, CPA
 
My general position on asset selection is that it’s your money, and you can invest it however you see fit.  That said, I also support the position that it’s a good idea to have a solid familiarity with the specifics of any investment which you participate in.
 
Just because you are free, as a matter of right, to go launching off into whatever you want doesn’t serve as an argument that you should.
 
When you understand the particulars of various investments, it sets the stage for solid logical conclusions about when and how to use the various alternatives.
 
If you have a chunk of money that you are looking to park for 9 months until your kid goes off to school, you are very unlikely to use those funds to purchase an office building for rental income production, as a for instance.  At least you aren’t, provided you understand what you are getting into.
 
Understanding the details doesn’t necessarily grant a person any special power to make investment risk go away, completely.  But it is useful in terms of setting expectations and using those expectations for projection purposes which are often a lot more realistic than uninformed guessing.
 
Perhaps the greatest value is that it helps you know what not to do.  Some things are simply not a good fit for a particular situation, but your odds of knowing that are severely constrained if you don’t have any familiarity with the inner workings of a particular investment, beforehand.
 
On the surface, this might seem like a consolation prize.  After all, I think we’d all prefer to have certainty about what we ought to do, not a bunch of superfluous commentary on what not to do.
 
Except that I don’t think commentary on what not to do is superfluous.  Far from it.  A single bad investment can wipe out benefits won over the course of many past investments which did go the right way.  This stuff has teeth.
 
As the old saying goes, sometimes the best deals are the ones you don’t do.  So anything which serves to keep you from stepping off into a hole – even if it doesn’t tell you specifically where you should step – has value.
 
You just have to recognize it for what it is. 
 
And you have to spend some time doing the homework in order to gain the kind of understandings which people only get as the result of meaning to and working at it.

By Brad Thomason, CPA
 
Human beings do not do well when they have run-ins with cobra venom.  This is a universal truth.  Cobra venom is highly toxic no matter what your home town.
 
That said, folks from Helena don’t have as much to worry about as folks from the outskirts of Mumbai.  It’s not that a Helenite (is that what they call them?) is immune to the effects; but rather that cobras are in pretty short supply up in Montana.
 
When we look at risk from the investment perspective, it is more useful to look at exposure than the elemental aspects of the thing that can go wrong.  While this may seem like a strange statement, it is something that you already do in other aspects of your life, perhaps without even realizing it. 
 
When we bring electricity into our homes, we do not change the fundamental nature of the electricity; rather we put in place counter-measures to limit how much it can hurt us if something goes wrong.  We make it workable without removing its innate dangerousness.  Ditto with fire.  The eyes on your gas cook-top are not 36 inches in diameter for a reason.  
 
When we talk about exposure we are talking about the combination of incidence and impact.  Incidence is how likely the negative event is to occur.  Impact is the degree of damage it will cause if it does.
 
Again, people in Montana don’t have to worry about cobras as much because there aren’t any cobras around, in the first place.  The incidence is sufficiently low that the risk is essentially nullified.  The exposure is pretty much nonexistent.
 
In portfolio design, we accomplish a similar result through the way we allocate capital.
 
If you asked most people whether or not trading derivatives is too risky an activity for a retirement account, I think most people would say it is.
 
But I also think you could make the case that I didn’t give you enough information to answer the question.
 
If two people had a million dollars in savings, but one had $20,000 in a trading account, while the other had $400,000, wouldn’t we have to regard that as two very different scenarios?  In the end, the part that would draw our attention would not be the trading itself, but the amount involved, right?
 
It’s very hard for the $20,000 we have walking around in the Indian countryside to hurt the $980,000 we have stashed back in Montana, so to speak.
 
Risk is a sufficiently important matter that we should understand it thoroughly, and that includes an understanding of a particular thing’s fundamental potential for destructiveness.  But we should also understand that fundamental potential is largely theoretical.  In practice, our exposure to the risk – not the risk itself – is what we need to be thinking about.  How likely it is to happen, and how much it can hurt us, are what will impact our actual results. 
 
The sun may be a fire so hot that it is basically a floating nuclear reactor.  But knowing not to take the kettle off the stove and pour the contents on your hand is a more useful tidbit for making it through the typical day.
 
If this were an episode of Seinfeld I would figure out some way to end this post by serving tea to a cobra, or something like that.
 
But it isn’t. 
 
So just keep in mind that your exposure to risk is what matters; and that one of the primary ways to control the exposure is via capital allocation.  OK?

​By Brad Thomason, CPA
  
Consider the following situation.  You have access to a supply of investments which make a stated amount of interest, and you build an investment portfolio out of these assets.  Some sort of bonds, perhaps; although in reality they could be anything.  But let’s go with bonds to keep it simple, and let’s say they pay 6% annually.
 
Question:  If the bonds earn 6% would it be your expectation that a portfolio composed of these bonds would also earn 6%?
 
Because it might not.  In fact, it probably won’t.
 
This is a key aspect of investment returns that people need to understand in order to make quality projections about future earnings.  Yet it is a topic that I don’t see addressed very often.
 
To understand how a portfolio composed of 6% assets could earn less than 6%, you have to get down in the weeds of what actually happens at the mechanical level with the assets.  Bonds mature (properties get sold, etc).  When they mature they stop accruing interest, and it is more likely than not that there will be some lag between the day of maturity and the day that the capital is reinvested.  Every time there is a maturity, this will be a factor, for all of the dollars associated with that particular instrument.
 
In other words, the overall portfolio can’t possibly earn a full 6% because something less than all of its capital is earning a return every day.
 
Professional managers refer to this as capital deployment, and the odds of capital deployment reaching 100% at any given time are often low; and even if it happens from time to time, it never stays there permanently.  Turnover in specific holdings is standard practice.  So some portion of the capital ends up being on the sidelines as a result of the normal investment cycle playing out.
 
Note that this can be a factor even if you are on the ball with monitoring your maturities and have already decided what the next investment will be.  Perhaps the broker doesn’t clear the capital right away (delays are actually the default procedure under Fed regulations, and most brokers do not voluntarily advance funds before the statutory clearing period has run).  Maybe someone has to mail something to someone for a “wet ink” signature.  Original documents still play a big role in finance.  Or it may come down to the matter of how the proceeds are disbursed: for years we have advised our real estate clients to do everything via wire transfer because large checks – even certified funds – often get put on hold by the receiving bank for a period of a week or two. 
 
In the end, a lot of mundane stuff, all of it perfectly common place, can work together such that your capital is on the sidelines for a month or two. 
 
If the bonds you invest in earn 6% a year but the allocated capital only stays deployed for 10 out of 12 months, that capital will only make a 5% contribution to your portfolio return for that year.  The result is that the portfolio will necessarily earn less than the 6% asset yield.  As a matter of simple arithmetic, no other outcome is possible.
 
Beyond that, there are reductions to stated yield from carrying costs.  Overnight shipping, wire transfers, custodial services and brokerage fees all go into an investor’s cost of doing business.  These widen the gap even farther.
 
Now, to be certain, there is an entire category of situations in which the investment assets actually don’t make as much as you thought they would on the return front.  This too is an unavoidable outcome which from time to time comes home to roost; it is the most obvious reason that investment risk is a thing.  Sometimes things don’t go the way you think they will.  But the important point here is that even if everything does manage to go exactly according to plan at the asset level, it is still possible (if not certain) for the portfolio as a whole to earn some lesser amount.
 
So the next time you are reviewing your level changes from one year to the next, and the net winnings are less than what you were expecting, don’t automatically assume there’s something wrong with the statement or that something wasn’t properly credited to your account.  What you are seeing might indicate something like that.  But it could just as easily be the effect of the naturally-occurring accumulation math which lives inside all multi-piece investment portfolios. 
 
Better still, expect it to happen, so that it doesn’t come as a shock or a source of stress. 
 
This aspect of portfolio behavior is in turn one of the prime reasons why it is so important to be diligent about periodically updating (annually, for instance) your plan so that you can keep tabs on these impacts and others.  Since even the best planning in the world can’t predict exactly what will happen, it is important to only use projections as far as necessary.  When previous estimates become – through the passage of time – settled reality, it is best to throw the estimates out and recalculate with the actual data.
 
When you do, replacing an expected return with a lower actual return is a frustrating thing to have to do.  But as I said earlier, it’s probably something you should expect to happen, at least to some degree.  Moreover, perhaps you can take solace in the fact that the universe hasn’t singled you out for poor treatment.  It’s something that happens to every portfolio owner from time to time.
 
Although it still irks me when I have to do it.