Making Better Decisions

“Thinking in Bets: Making Smarter Decisions When You Don't Have All the Facts”, by Annie Duke, describes how most people incorrectly view the outcome of a decision as being reflective of the quality of their decision process. They think good outcomes from a decision means there was a good decision process and bad outcomes are because of a bad decision process. According to the author, who was a professional gambler, the outcome is more often related to luck than a bad decision process. For example, if you decide to drive through a red light, the fact that you did not get into a crash is more related to luck than being the result of a good decision.

The author claims that people are very uncomfortable with the idea that luck plays such a big part in the outcome of their decisions and are even more uncomfortable with the idea luck plays a big part in their life. Instead of evaluating our choices as having different probabilities of success (like a poker hand), we see our choices as more black and white options with no shades of grey in which choices may be best. Like playing a game of poker, the more information you gain as the game progresses, the less luck controls the result and the better the probability of your chances of making a decision with positive outcomes. Rather than characterizing choices as black or white, her recommendation is to put a probability of success on choices and modify the probability as more information comes available.

Since reading this book, I have been looking more closely at how much information I have about my given set of choices. I noticed that as soon as I started adding a probability (my belief of the percentage chance of success) to each choice, it clarified how much I didn’t know about the future and what the overall risks I was taking with each choice.

I recently had a major decision about my car, since my 3 year lease was coming to an end. Should I buy it? Should I lease another car? Should I buy a new car? Should I use the same dealer? As I collected more and more information and calculated the costs and downside risks of each option, it became clear that a new lease had the best probability of long-term success for me. This process quickly ended my quandary as to what to do. It also made the process of leasing a new car much easier since I went into the negotiation aware of how much of the process was a gamble; would the car be great or a lemon? Time will tell.

It is fascinating to consider how much of the outcomes of my life decisions are just chance, out of my control.

This book is really well written which made understanding the concepts of probability easy to understand and enjoyable to read.
I highly recommended the book!

Happy Money

The book, Happy Money: The Science of Happier Spending by Elizabeth Dunn and Michael Norton, summarizes current research on how you spend money changes how happy and satisfied you are in life and affects your health and well being.

This is a wonderful book that explains how you can increase your happiness by spending on experiences with the people you value rather than spending on prestige belongings that many people think will make them happy.

According to the book, research shows that spending money on leisure activities like trips, movies, sporting events, gym memberships and the like leads to more happiness than buying expensive consumer and prestige items. Experiences tend to be appreciated more as time goes by whereas things tend to be less appreciated as time goes on as better things than they bought emerge. Experiences tend to make us feel more connected to other people which improves life satisfaction. When couples do exciting and novel things together, their relationships improve. Anything we do to make the time with our friends or partners special is money well spent. Experiences make memorable stories for retelling for years to come and give us a sense of who we are or who we want to be. Experiences can’t be compared  to things purchased. Experiences that remind of us of the past and give us nostalgia, like going to a museum, watching an old movie, or hearing a favorite song, can bolster our vitality and reduce stress.

Research indicates people earning over $75,000 a year do not have an increase in happiness. High income individuals spend more time doing high stress activities like working, commuting, and shopping than those who make less. High income individuals view their time as highly valuable which makes them feel like they have less time. In contrast, buying time, called time affluence, increases happiness. You can gain time affluence by moving closer to work to reduce your commute, working in a job that requires less hours, or hiring people to do your yard work or cleaning.

Research shows that having expensive things does not bring happiness, health, or well-being. The University of Michigan found that those with cheaper cars had the same satisfaction driving them as people with expensive cars. Surprisingly, homeowners are not happier than renters, and are on average are 12 lbs heavier than renters. Those who simplify their lives by reducing their wardrobe, moving into a smaller abode, changing their consumption patterns, and reducing their stuff are happier. The enemy of appreciation is abundance; if we make everything we do special it will increase appreciation and happiness.

I highly recommend this book for people wanting more happiness, time, and life satisfaction. Five Stars. 

Common Sense Investing

I found a lot to like about the The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns by John C. Bogle. Mr. Bogle was the founder of The Vanguard Group and is famous for creating the world’s first index mutual fund in 1975, the Vanguard 500 Index Fund.

The logic of his index fund was to invest in a large number of stocks, all the stocks comprising the S&P 500, to make money from the combination of their growth and dividends. This is a departure from the more common view of investing in undervalued stocks to make money from an increase in their stock value.

Bogle makes a convincing argument that the best way to get the value from the stock market is to invest in all the stocks by buying mutual funds based on indexes of the market that invest in all the stocks.

The author points out that the real net income from stock investments is the investments’ gain minus the cost of the investments. The costs are relatively easy to determine in the case of retail brokers charging for a stock trade when buying or selling  stocks. However, the costs are much more complicated for mutual funds because, in addition to the cost of the trade, in many cases there is an annual incentive sales fee for the broker for up to five years (up to 1.5% a year according to the author). I had no idea that there were hidden sales fees in addition to the purchase fee charged by the brokers. In addition to annual fees, most mutual funds typically have additional management fees of 2 to 3%. In comparison, index funds have low management fees (often .4% or lower) with no hidden sales fees.

What is more disturbing is that 99% of mutual funds significantly underperform the S&P 500 index. When the excessive costs combined with the underperformance of mutual funds are compared to S&P index funds, the long term income differences are shocking. The net return after taxes of $10,000 invested in an indexed fund from 1980 to 2005 would have been $76,200 versus $16,700 for other mutual funds (for those mutual funds that survived). This represents 456% more net income to the investor with far less risk.

If you are one of the 85% of investors who let their broker "manage" their assets, Bogle’s book may keep you awake at night. To sleep better, I switched to low cost, low risk index funds. 

The author’s perspective is unique since he invented the very first indexed funds. It is a little like reading Thomas Edison's thoughts about the light bulb. Bogle knows the issues and history of investing in indexes versus other types of mutual funds.

This "common sense investing" book was easy to read and easy to understand. I highly recommend it to anyone wanting their investments to produce more income with less risk.  Five Stars and hats off to the founder of index investing. 

How your Bank Balance buys you Happiness

I recently read an interesting study, How your bank balance buys happiness: The importance of "cash on hand" to life satisfaction, by Ruberton, Gladstone, and Lyubomirsky from the University of California, Riverside and Judge Business School, University of Cambridge. The study claims having more cash in your checking and saving accounts leads to increased life satisfaction.

This is the first study on money to use actual banking records from the participants to assess how their “liquid wealth” affected their life satisfaction. Previous studies only used self reported estimates of bank account information. In addition to the previous year of bank records, the participants took a Life Satisfaction survey and a two question Perceived Financial Well Being survey. Measures for the study also included Income, Total Spending, Total Investments, Indebtedness status, Employment status, and Relationship status. Another key detail was anyone who had greater debt than savings was excluded from the study.

The study’s results confirmed previous studies findings that people with higher debt have lower life satisfaction and people with investments have higher life satisfaction, as do people with an income high enough to have a moderately good quality of life (approximately $75,000). It also confirmed studies showing that life satisfaction is unrelated to income above $75,000 and people with no debts have higher life satisfaction.

The new revelation from the study was that having more cash in savings or checking accounts increased financial well being and life satisfaction more than any other factor, including total debt, income level, or investments. The study found that with each increase in cash by a factor of ten, life satisfaction increases by 3.45%. So an increase in savings from $1 to $1000 increases life satisfaction by about 10.35%. The next 3.45% increase in life satisfaction is at $10,000 in cash. And another 3.45% increase is at $100,000. The next 3.45% increase in life satisfaction requires a million dollars.

Even people with very large investments (over ten million dollars) who had small amounts of liquidity in their bank accounts had significantly lower levels of financial well being and life satisfaction than those with vastly lower investments yet more liquid wealth in cash.

What is unclear about this new finding is if it is the result of the 2008 financial collapse, since investments may not provide the same feeling of financial well being as before. Or is this something that has been true for a long time and not previously found due to self reporting biases, since actual bank statements were not used in the past. 


The researchers also raised the alarm about how much the long-term, extremely low interest rates from banks may be costing society in happiness and well being. These low rates punish those who have more cash in savings.  

How to Make Your Money Last in Retirement

I just finished reading Jane Bryant Quinn’s book "How to Make Your Money Last: The Indispensable Retirement Guide”. Ms. Quinn wrote this book last year and is now 78 years old, so her concepts are not theoretical or abstract. She shares clear, concrete, and very detailed information on how to make your retirement money last which made this book useful and enjoyable to read.

 

The most basic thing she recommends to do to make your money last is to earn income as long as you can (as old as possible) and not start taking your social security until you are 70 years old. The social security payout increases 8% a year for every year after age 62.

The second way to make your money last is to control spending. The happy place to be in retirement is where your expenses are equal to or less than your income.

For most retirees, their biggest reduction comes from downsizing the cost of their housing. 

Another major expense for many are high stock trade fees and hidden commissions in mutual funds, annuities, and life insurance products. These high costs and hidden fees can eat away as much as 50% or more of the long term value of a retirement portfolio. The best way to avoid this is to use a discount broker and manage investments yourself.

An area of great savings and great risk is Medicare. You can start taking Medicare at 65 and it may be much cheaper than your employers health coverage plan, however, there are big risks to doing this. If you start Medicare, the government will automatically start your social security payments. You have to have the payments stopped or you could lose your 8% lifetime increase. If you miss a payment to Medicare, they cover it with social security and that could impact your start date. You may not even be notified and only find out about it at age 70 when you file for social security. Not a small risk.

Although I have  considered Annuities and Reverse Mortgages foolish things to do, the author pointed out some circumstances where they can be very profitable. The book does a great job of explaining the difference between an IRA, a 401K and a Roth IRA and the tax implications of each. She describes the rules for taxes and inheritances and what income is and is not taxable.

One thing I found surprising is that you can open a Roth IRA at anytime and put in any amount. The earnings are not taxed and, unlike an IRAs, there is no minimum that must be withdrawn each year or maximum that can be withdrawn each year. Even better, the earnings are not taxed when taken out. It actually seems too good to be true, so I recently bought a book on the details of Roth IRAs to see what the downside might be.

The author recommends that you pay off all credit card debt before retiring; apparently people 50 and older have a lot of credit card debt - far more than younger people. She also thinks it is best to avoid buying rentals as a source of income because they are hard to manage.

The book’s detail and depth makes it a slow read but I found the information so useful that I used a highlighter to mark the critical details and consider it an important reference.


I highly recommend this book, five stars.

The Stock Market Index Revolution

The Index Revolution: Why Investors Should Join It Now by Dr. Charles Ellis explained a lot of the changes that I have witnessed in the stock market over the last 40 years. Dr. Ellis has a great deal of experience managing large pension funds and wealth funds. He explained the reasons why investing by amateurs like me no longer works and why it makes sense to invest in indexes.

In the 1960’s 99% of stock market trades were by amateur investors who traded just a few times a year. Today, less than 1% of stock trades are by amateur investors. Now, over 1.5 million professional traders, mutual funds, pension funds, and automated trading systems make 99% of the world-wide stock trades.

Full time professional and institutional traders take advantage of underpriced stocks by finding them faster than amateur investors. They do it by getting instant and detailed information about companies unavailable to amateurs.  Stock information sources can cost over $20,000 a year, impossibly expensive for an amateur like me managing my IRA and small portfolio of individual stocks.

Over the past 40 years, the trend toward professional and institutional stock trading led to the creation and spectacular growth of professionally managed mutual funds. Although the “famously successful mutual fund managers” paid huge salaries touted that their mutual funds performed better than the overall market, academic researchers found that over the past decade only one or two of their mutual funds out-performed the S&P 500 stock index. And, after the cost of trades and the high management fees, none of the mutual funds out performed the S&P 500 index.

The stock market generally goes up about 8% per year, averaged over 10 years. The expense of trades and staff, which is commonly 4% of the gain, can cut the long term appreciation of an investment portfolio by 50% of even the best performing mutual funds. Most of the mutual funds do not come close to matching the performance of the overall stock market index, but even if they did the net result would be less because of their costs.

These findings published by academia have led to a mass exodus from mutual funds to exchange traded index funds (ETFs).

The author’s career included managing foundation portfolios as well as researching stock fund results at Yale, Harvard, and Princeton. His unique experience makes the book an especially enjoyable read. I was so impressed with the data and view he presented that I immediately started moving out of individual stocks into ETFs. It has been about 90 days since I started and I am already very happy with the greater stability of the ETFs; no more disturbing daily volatility of individual stocks.

I highly recommend the book. Five stars. 

2014 Year of the Wood Horse

It is time for our annual predictions based on the Chinese lunar calendar for 2014 Year of the Wood Horse.  As we predicted, the current 2013 Water Snake year has been about rich people holding on to their wealth and countries becoming increasingly isolationist and possessive.  In contrast to the internal focus of Snake years, Horse years are about energy, expansionism, military power, physical feats, and economic change.  Although Horse years can bring good luck and fortune, they require quick thinking and decisive action.  The time for planning and introspection will be over when the year of the Snake ends on February 3^rd, (a bit unique this year since the Chinese New Year is January 31^st). During a Horse year we must be ready to react quickly to keep pace with world events and changes.

We find it useful to review what happened 60 years ago, during the last Wood Horse year, to see how events may relate to today’s world.  In 1954, the previous Wood Horse year, the new, secretive Hydrogen bomb project expanded to above ground testing around the Pacific.  The 1954 Congress was attacked by four gunmen with semi-automatic pistols who shot into the US House of Representatives chamber from a balcony and wounded 5 congressmen while they were debating an immigration bill.  The Snake year McCarthyism created new laws in the 1954 Wood Horse year that made being a “communist” illegal, authorized harsh penalties for spies, and approved the CIA opening US mail.  It would not be surprising for the wikileaks, NSA leaks, and other secrecy issues of the 2013 Snake year to result in harsh, new laws in the 2014 Horse Year Congress.

Horse years bring economic growth and chaos.  Although the last Wood Horse year of 1954 saw the Dow Jones close higher than its peak before the 1929 crash, most recent Horse years have seen major stock market crashes.  In the Horse year of 2002 the stock market dealt with the dot-com bust and in the  Horse year of 1990 the stock market took a dive after the Iraqi invasion of Kuwait.   In the 1978 Horse year, a stock market crash of 22% one day in October came to be known as black Monday and caused a global stock market decline.  No one ever figured out what caused the panic, but protective measures were installed to prevent a repeat of the disaster.

Horse years are military power and transportation minded.  During the last Wood Horse year of 1954 the US Army created the first helicopter battalion, the US Air Force Academy opened, the B52 bomber, C-130 Transport, and Air Force One all had maiden flights.  During the last Horse year in 2002, Fossett made the first solo, non-stop flight around the world in a balloon.  We expect a year of military advancements in space, the formation of drone battalions, and faster vehicles of all types.  We expect to see military coups, the unrest the Middle East and Asia to expand, and rapid changes in world leaders.

Horses are energetic and physically strong and Horse years often break records in human feats.  During that last Wood Horse year in 1954, the four minute mile record was broken and new records achieved for the 5K and marathon.  During the 2002 Horse year, records were broken in baseball, football, cycling, and other sports, by many athletes now accused of using performance enhancement drugs. 

There are health issues associated with Horse years, in particular issues with the lungs.  Smog and contaminated air may become recognized as a world-wide health problem.  Excessive heat, cold, storms, and earthquakes are also common during Horse years.

Horse years bring focus to fairness, equality, and humanitarianism.  We think sexual rights will progress in the Horse year, much like race rights did in 1954 with the ending of segregated regiments in the military and the start of school desegregation.  The Humane Society was formed in 1954 during the last Wood Horse year. 

Horse years are focused on entertainment, communication, and sociability.  During the last Wood Horse year of 1954, Disneyland was announced and construction started; Disney’s TV show and the Tonight show hosted by Steve Allen were started; color TVs became more common in American homes; and the world’s largest mall opened in Michigan. During Horse years, people spend more money and time on entertainment and fun.

From the introspection and isolation of the 2013 Snake Year, the 2014 Horse Year will bring explosive energy, a fast pace, adventure, unique forms of communication, and a focus on fun.

Creating an Ideal Life in Hawaii

Relocating to Hawaii from the mainland requires so much planning, effort, and money that we are alarmed when families leave the island in frustration after living here just a short time.  Two families in our condo complex just left, one after two years and another only six months after completing a major move of all their belongings.  Watching people leave the island so quickly has made us focus on how to flourish in Hawaii.  Here are things we are doing to help us live better:

Renting, instead of buying, has allowed us to experience living in many parts of the island over the past five years. Our desires in housing have changed dramatically, as we have, over the years. At first we wanted a great view of Hilo Bay, then we wanted to be closer to a white sand beach.   As we got into better shape we wanted to be near great walking and swimming areas and cared less about the view.  As we have focused more of our time on writing, we want more quiet, solitude, and better security.  For just the cost of moving, we have freedom in recreating our lifestyle in a new location whenever we desire.

Reducing our cost of living, has kept us aware of opportunities on the island.  We have been lucky to get more for less in the current economy in Hawaii.  Reducing our monthly expenses has reduced our stress and brought more workability to our life style. We have significantly cut our rent expenses by timing our moves to the low season and identifying in advance where we wanted to live next.  We have cut back in other areas of our living expenses by researching everything we buy and searching for the best prices. It may not seem like a big deal to buy the best coffee maker or the best coffee grinder, but year after year it adds up to a much more enjoyable life at a much lower cost.

Getting rid of stuff, gives us more space and peace of mind.  We moved everything we owned to Hawaii, and though we initially had to store many of our boxes, we have had time to slowly sort through all our belongings and get rid of things.  Every year we need less space as we shrink the volume of stuff we own.

Having time has been a great gift to us.  We have had time to research, think, contemplate our life, and focus on our health.  We have learned how to deal with our health issues, like gout, and to make changes in what we eat to lose weight and get healthier.  Time has allowed us to learn how to cook new foods and implement new diets, like going wheat-free.

Any time we start to lose touch with how much better our life is on this island compared to anywhere else we have ever lived, we head over to one of the nearby resorts.  We watch the sunset and listen to visitors from the mainland exclaiming with wonder over the beauty.  We watch furrowed faces of people in hotel lobbies at the end of their vacation, waiting for their ride to the airport, already stressed out, yelling in their cell phones about the problems waiting for them when they arrive home. We know that what we appreciate in life we get more of,  so every day we focus on appreciating every aspect of Hawaii that we love, no matter how small, so we will get many, many more years of it!

Your Ideal Hawaii Guides for Living Better in Hawaii

A sustainable life in Hawaii

We thank everyone that has bought our book, Your Ideal Hawaii Home, and the readers that have taken the time to write reviews and send us email.

One of our reviewers pointed out that we do not have a financially sustainable solution to living in Hawaii in the book. Though we have been downsizing our expenses and stuff since moving to Hawaii Island, we have yet to achieve a sustainable lifestyle.  There have been many times in our life when our lifestyle was unsustainable and we struggled to pay bills and amassed debt.  These times were followed by changes that suddenly swung us into good times where we had excess money. We have gone through these cycles over and over and find comfort and humor in remembering how one year in Santa Fe we hung our clothes on a line in the kitchen to save the $15 a month it cost to run the dryer and the next year in Silicon Valley we received a bonus that was more than our entire budget the year before. If we had known that cold winter in Santa Fe that good times were coming the next year, would we have worried so much?

Now, as we are working on our next books about moving to Hawaii and how Hawaii improves health, we are resolving to not worry about our sustainability this year. We do, after all, live in world where governments and companies are insolvent and most things seem unsustainable. We are focused on our health and happiness in Hawaii and waiting for the cycle of good things to come, for us and the world.

Debtocracy and global bankruptcy

Watching the European Union member countries demanding hundreds of billions of Euros to get through another quarter (Greece will go broke again in September), and the United States government arguing over increasing the national debt another couple trillion dollars to get through another year, and most states, cities, towns, and even school districts calculating the magnitude of their insolvency, we wonder how all this will end up.

We think there is a battle between  two major economic forces in the global economy. The first, well-known to most people, is the power of market forces where the best products (most efficient, most inexpensive, etc.) win. The second economic force is the rise of debtocracy, when a community or country takes on debt by voting for it, creating debt by democracy rather than by the market economy.  In school districts, residents and teachers and staff voted for new buildings, higher pay, and long-term benefits and committed their communities to long term debt as a result. States, countries and cities did the same thing. Since public employee contracts are not driven by market forces, like costs and employee wages are in private industry, there is nothing to correct the overpayment like a company going bankrupt. Debtocracy funded national social programs as well; their debt was also voted by elected officials keeping their commitments to their constituents.  In contrast to how the market price of oil drives the amount investors are willing to risk to drill for new oil, the huge local and national debt is not driven by risk and reward or any market forces at all.

The question is, what will the net affect be of the conflict between market economic forces and debtocracy? Here are some of our thoughts on the struggle and potential outcomes.

Those benefiting from the debtocracy will continue to use every means possible to maintain their income and the guarantee of long term benefits. They will get promises and money from anyone and anywhere to keep the insolvency from being revealed and maintain their lifestyle. We see this in Greece where both the government and the banks are doing whatever they can to extend the debt and the debt payments while ignoring the suffering of the people and the future of Greece. Debtocracy has allowed those with position and power to create debt for their nations without any possible way to pay it back.  

As the global debtocracy grows, it is driving away the real market economy. No organization or person living in the real market economy can afford to live in a debtocracy; it is too costly and too stressful. Local economies become warped as some things operate based on market economy while others are based on the massive debt voted into existence by local communities and congress.  In Hawaii for example, we see condos in the same community for dramatically different prices; some being offered by the government for low prices with no money down (actually Fannie Mae gives you 3.5% at closing) and federally subsidized interest rates and payments while others are being sold by their owners. Individual owners have to pay a real estate agent and their buyers must deal with loans at market interest rates and new stringent requirements. During this worst economic downturn of the century, many American workers are unemployed or working multiple jobs to earn a portion of the salaries and benefits they earned before the crash in 2008 whereas local and federal government employees are paid based on contracts signed by elected officials rather than based on the value of the tax base in their communities.

Debtocracy is causing secondary collateral damage by distorting the value of things. People can’t figure out how much they need to live on, what their houses are worth, or how much they can afford to borrow. In a local economy where some are able to obtain low interest subsidized loans while others are paying exorbitant interest rates, the amount you can afford to borrow varies greatly. Things that would normally be easy get really hard when you cannot distinguish what is real.

The debtocracy system is destroying the infrastructures of cities, counties, states and federal governments because the focus is on keeping the money flowing rather than cutting the spending back to a level consistent with what the communities and countries can afford. Debts are mounting to cover the shortages and push the problems into the future, making insolvency  and the complete collapse of the services offered more likely.  More and more cities may take the bankruptcy route to address their debts, like Vallejo, California did.

Two scenarios seem likely to us, one the federal government steps in to pay off the huge debts by printing more currency, or everything goes into default and the cities, counties and other entities collapse.  If the Fed creates a flood of currency to cover the debts, it will cause hyper-inflation and devalue money so much that it will not be a viable exchange medium. People will be forced to use gold, silver and bags of apples to buy things. If everything goes into default, then pensions will not paid, government employees will be laid off, and all the muni-bonds bought by the wealthy will become worthless making money scarce. Everyone being broke will cause hyper-deflation and people will forced to use gold, silver and bags of apples to buy things. 

In either scenario, a world where no one has any money or a world where money has no value, value will be in real assets and capabilities instead of currency.  Fresh air, clean water, non-radioactive land, nutritious food, and good health will be real wealth instead of a suitcase of paper currency or a promissory note for a pension.   From a personal perspective, we think one’s economic value will be what you know, what skills you have, and what you are able to accomplish for yourself, others and your community.   

Calculating a Sustainable Lifestyle

Like many Boomers, we realize that there is no way that the assets we have accrued and our investment income will support the retirement lifestyle we desire. We have reduced our run-rate from our big income earning days by over 50% and yet we know that the cuts aren’t deep enough to deal with the rising cost of food, rent, utilities, gasoline, and medical insurance as well as our other expenses, like college. We can only cut back our yearly expenses so much, so we have been looking for a way to calculate the minimum income we need to support the lifestyle we desire. The retirement calculators we have found focus on how fast savings will drain or how many millions of dollars of principal are needed to retire based on various interest earning settings. None of them calculate the income required to support a measurable and well defined lifestyle.

We find the logic of Michael Masterson to be a compelling way to define the income needed to support a given lifestyle. Masterson realized in his twenties that it would be impossible for him to save enough to retire on a normal salary. So, he found ways to make enough money to pay cash for expensive houses and luxury cars and ultimately was able to retire early and dedicate his time to writing short stories. But after a few years, the overhead of his lifestyle because of taxes, utilities, insurance, maintenance, clothing, furniture, and the expenses of keeping up with his neighbors could not be sustained by the huge wealth he had accrued.

According to Masterson, the value of the home determines a family’s expenses because of the pressures of neighbors, expectations, and surrounding businesses ratcheting up costs based on your neighborhood. He claims that it will cost you 40% of the value of your home every year to support the lifestyle that goes with the home and neighborhood. His calculation makes a lot of sense to us and is the first tangible method we have found to calculate the income stream we need to support our lifestyle.

We created a lifestyle calculator using Masterson’s cost of living algorithm to estimate the amount of after-tax income needed to support a lifestyle based on the value of a home.

There are several ways to use the calculator:

1. You can use the calculator to estimate the after-tax income you need to support the lifestyle based on your home value. You can determine the value of your home by checking zillow.com or the real estate section of your local paper for houses or condos similar to yours that have recently sold in your area. Enter your Current House Value and if you have any debt payments (mortgage, credit cards, etc.), enter your total Yearly Debt payments so that they can be subtracted from your available after tax income. Leave the Yearly Income value at $0 and press CALCULATE. The calculator will display the estimated annual after-tax Income Needed to support your current lifestyle.
2. You can also use the calculator to estimate how much house you can afford. Enter your after tax Yearly Income and then enter your total Yearly Debt payments (mortgage, credit cards, etc.) if you have any. Leave the Current House Value at $0 and press CALCULATE. The calculator will display the approximate House Value you can afford based on your after tax income.
3. If you are a renter, you can also use the calculator to estimate the income you need to support your rental home (assuming you rent a condo or house). First determine the current price for the property you are renting (as above #1) and enter that amount as your Current House Value. Next calculate your annual rent and subtract from it the estimated annual costs that rental owner has to cover (property taxes, property insurance, maintenance or home owner fees, etc.) and enter the remaining rent costs as Yearly Debt payments. If you have other debts, then add them to the remaining rent and put that figure in the Yearly Debt payments. Leave the Yearly Income value at $0 and press CALCULATE. The calculator will display the estimated annual after-tax Income Needed to support your current rental lifestyle.

Using Masterson's calculation, a debt-free $200,000 home will cost a couple $80,000 after taxes to pay for its associated lifestyle. Even earning 10% on savings, which is rare these days, would require a nest egg of $1.6 million (taxed at about 50%) to support the lifestyle. Assuming a $24,000 annual social security income, the maximum house affordable is $60,000 and this assumes the house is paid off and that the owners have no other debts. Of the 34,326,000 retired workers currently on social security, the average monthly payout is $1,171.60 or $14,059.20 annually. An after tax income of $14,000 will support the lifestyle associated with a fully paid off home valued at $35,000 assuming no other debt payments for cars or credit cards.

Although it may seem like a strange calculation, we have used the Lifestyle Calculator for various income and house value scenarios we have had in our life and it has held true to our experience of when our lifestyle was above our income and when it was below our income. Interestingly, the amount of income we need as renters right now is also accurate to the amount we are actually spending and it even takes into consideration the reduction in the value of the condo unit since it was last sold based on current listings.

It is clearer to us how our home’s value and the neighborhood in which we choose to live determines the income stream we need to sustain our lifestyle.

Will the Fed’s $600 billion cause hyperinflation?

Many think  that the Federal Reserve’s sudden creation of $600 billion will cause hyper-inflation.  However, when calculating the relative “inflationary” value of the new $600 billion compared to the huge dollar value that was created by the housing bubble, the Fed’s amount is very small in comparison.

Here’s the calculation:

Using census data one can make some ballpark calculations of the effective size of the liquidity created by the housing bubble.  Eighty million single family homes exist in the US and had an average value of $171K in 1997.  In 2007 the average value had gone up to $310K. This increase in value in 10 years meant an average increase of $13.9K per year for every house . That translates to an increase in total house values  (detached single family houses only) from $13.6 trillion in 1997 to $24.8 trillion in 2007. This represented an increase of $11.2 trillion dollars over 10 years.  And since it was easy to sell a house during most of that time or get a second mortgage on a house, this $11.2 trillion was largely available for people to spend.

Since 2007,  housing experts have estimated that housing prices nationally have fallen about 25% from their peak in 2007. That drop represents a  functional drop in liquidity of $6.2 trillion dollars in three years which is over 10 times the amount of the Federal Reserve’s instant $600 billion injection. And with the new higher lending standards and many people (as many as 50% in some States) underwater on their mortgages , the trend looks like it will continue to be strongly deflationary.  

If the instant currency creation by The Federal Reserve becomes routine, then the people claiming hyper inflation is coming will ultimately be right. If it is a onetime event, the $600 billion is not enough to ignite hyper-inflation by itself.

Calculating inflation

For decades, the US government has published their calculations of annual increases in inflation. These calculations have been very controversial since many economists claim that changes in the calculation over the years understate the real inflation that has been taking place. Though the government strongly defends their inflation statistics, the figure is meaningless without direct comparison of the cost of the same product from one time period to another.

The price of beef is one example of how the government has kept inflation numbers low.  In past inflation calculations beef steak prices were compared, but one year steak was suddenly replaced with  ground beef driving the inflation number for beef much lower. The price of steak in 1972 and the price of ground beef in 1984  hardly seems comparable and yet government economists insist their calculation is valid . Substituting lower quality  products in the inflation calculation has also resulted in an understatement of the true rate of inflation over the past three decades.

Though some of the substitutions are obvious like steak and ground beef, many are more subtle though every bit as substantial. Kitchen appliances for instance, are not comparable. A coffee maker with a timer and a carafe manufactured in America in 1990 cost about $110.  In 2002 you could buy two for that price making it appear that the cost had dropped by 50%. However, the difference in the quality of the 1990 product, tested by UL for safety and able to last 10 years is not comparable to the cheaper coffee pot manufactured by underpaid workers in Asia with minimal testing.  The price of children’s toys painted with lead and food products laced with melamine are being compared to the price of higher quality products we use to make in the US as though these products are equivalent.  

The US government’s official figure for inflation, or Consumer Price Index (CPI), is 260% between 1980 and 2010.  In other words, $1,000 in 1980 had the same buying power as $2,600 in 2010. But the reality is that $2,600 today has nowhere near the buying power of $1,000 in 1980.  One only has to look at the components of the American dream to gain a picture of the how out of reach the dream has now become.

House: In 1980 the average house cost $68,000. Using the US government consumer price index, an average U.S. house today should cost $176,800. Yet even after the crashing of housing prices over the past 3 years, the average house price is still $235,000.   So, the inflation in housing prices is actually 345%, not the CPI figure of 260%  which means the government is understating inflation by 85%.

Car: In 1980, the average price of new car was $7210, but in 2010, the average new car is $28,400.   According to the US inflation index, a car price on average should be $18,746, yet the actual price is 393% higher. The government is understating the inflation in new car prices by 133%.

College for our Kids: In 1980,  the average cost to attend a public college was $2373 a year for tuition, fees, room, and board and the average cost of a private college was $5470.  Now the cost for a public college has swollen to $20,000 a year and private colleges to $39,000 a year.  This is a cost increase of 843% for public colleges and 713% for private colleges. Government numbers are understating the inflation in college costs by 583% for public college and 453% for private colleges.

Health Care: In 1980, the average person spent $1072 a year on health care expenditures, but in 2008 the average person spent $7681 a year, an increase of 716%. The inflation of health care is being understated by over 456%.

Though inflation is being understated by 85-500% for the basics of American life, those that have been able to retain their jobs have not seen matching increases in wages.  In 1980, the average worker’s wage was $12,513.  In 2009, the average wage was $39,054 and using the US government inflation rate of 260%, the average wage today should be $32,500.  The small increase of $6,554 over the inflation index, or 20%, does not compensate for the dramatic increase over the published inflation numbers of everything else.

Seeing the inflated prices of houses, cars, college, health care, and the decreasing quality in products and foods helps us to understand why we , like so many other Americans, are struggling to gain the American dream of health, wealth and happiness.

Currency manipulation destroys Capitalism

During the last century, the question about which economic system would survive was answered when the Soviet Union collapsed and China adopted capitalistic methods. China transformed itself into the second largest economy and attracted trillions of dollars from investors around the world. Meanwhile, the economies in the western world have imploded and their labor market is rapidly disappearing.

As effective as capitalism is, it requires free market economics to function. Currency manipulation, like China’s fixed exchange rate, destroys the free market system. Any country that agrees to trade with another country that uses a fixed rate currency cancels out the benefits of a free market in their own economy. A fixed currency controls the price by guaranteeing a lower cost of goods and labor as opposed to a free market economy where price is driven by quality, productivity, and demand.

The loss of the free market economy in the US has become so pervasive that Americans no longer even think of the country’s economic problems in terms of free markets or global competiveness but in terms of how government give-aways can be increased and extended.

American consumers have been happy to ignore China’s currency manipulation because it resulted in ever cheaper manufactured goods. American companies have been happy to ignore the currency manipulation because it guaranteed them an easy increase in profit by moving production overseas and lowing labor costs and taxes. Investors have been happy to ignore currency manipulation because it made it easy to “invest” their money in Chinese companies since it pays higher returns and is less risky than in a free market system. The big losers in the scheme have been the American workers and small business owners as the free market economy that rewarded them for being smart and working hard is all but gone and they alone are left to tax in order for the US government to fund their give-aways.

Allowing China to fix their currency to a value less than the US dollar, rather than floating it based on actual market value, has effectively ended capitalism in the US. Not only does a fixed currency make it impossible for US made products to compete, it makes it impossible for the US economy to compete for capital investments.  US produced goods will always be more expensive against an artificially, lower currency rate and capital investors will be drawn to an economy where the fixed currency rates assures them of a higher rate of return.

Capitalism is based on free markets. Without a free market there is no capitalism.

If we want to return to a capitalistic economy and restore jobs and the high standard of living that capitalism brought the US, all of our trading partners must allow their currencies to be traded freely in the global currency markets. If we allow the world's second largest economy to continue to operate with a fixed currency rate, we do so at our own peril, as the current situation in the US and Europe demonstrates.

Politicians in Washington have considered global currency manipulation a minor issue that is not worth their time. We can only hope that the unemployed and unhappy country of voters will “educate” our current politicians to the importance of the free market system for a healthy, capitalistic economy in the US.

Health risks of investments gone bad

One of my prominent images of the Crash of 1929 is a Wall Street stock trader standing on the ledge of a high rise building preparing to jump. Yet even with that image rooted in our culture, people underestimate the risk of an investment going bad to their health and well being.

Numerous studies have highlighted the negative health effects of debt. A survey by Myvesta.org, a nonprofit financial crisis center, found nearly half of the people with debt problems experienced symptoms of depression and 90% felt some stress. Paying off debt lifts the stress and improves a person’s health. A study in Germany showed that over-indebtedness was associated with an increased prevalence of being overweight and obesity that was not explainable by the person’s socioeconomic status. And, a study of college students showed that debt and stress were associated with wide-ranging adverse health indicators.

It seems logical to think that the stress of bankruptcy would have negative health consequences. But studies have shown that people in the US and Canada that went through bankruptcy had a sudden improvement in their health status, family relations and their employment status. The relief of getting out from under debt and investments gone bad has a positive impact on health. Some of the relief of bankruptcy is cultural. For example, studies show that the impact of bankruptcy for Japanese debtors is harsh and resulted in family problems, health problems, suicides and running away from home. Recent changes in the US bankruptcy law as well as the current poor economy may not provide the same level of relief as bankruptcies have in the past.

We consider ourselves to be risk averse. We avoided the perils of penny stocks, the .com bubble, and house flipping. Our first sign of the extent of the current economic disaster was in 2006 when two major banks with our FDIC insured CDs were decertified by the FDIC in the same week (WaMu and Indymac). Since the CDs were purchased through an investment firm, the status of our money was up in the air for four weeks and our stress was high. It was inconceivable to us that FDIC protected CDs could become an investment gone bad. This has colored our view of investment risk under the current economic conditions. We are surprised to see people continue to take on second and third mortgages for foreclosed properties in Hawaii county and use their retirement savings to invest in businesses.

Considering the studies of the health effects due to debt and loss of money, there should be a health warning when purchasing stocks, taking on mortgages, buying bonds, and charging up high interest credit cards. In a tough economy, previously for-sure investments have become high risk investments. Now it is best to not only understand the risks of a specific investment but also the risk to your health if the investment goes bad.

WEALTH AND BEING OVERWEIGHT

As a part of our ongoing research on health and wealth, we found a project that studied the relationship of a person’s weight with their financial net worth. The study found that gaining weight resulted in a loss of wealth and returning to a prior healthy weight restored a person’s financial losses. Weight was measured using Body Mass Index (BMI), a calculation used to estimate a healthy body weight based on a person’s height.

The results differed by race and sex, but for whites, particularly women, high net worth was associated with a low BMI and high BMI levels were associated with lower net worth.



White females’ highest net worth was at the low end of the normal weight range (BMI 20) and white males’ highest net worth was at the upper end of the normal weight range (BMI 24). Small weight losses did not impact wealth much, but the study found that when a boomer aged person decreased their weight by 5.8 BMI points from the overweight range (BMI 27.5) to normal weight range (BMI 21.7), their net wealth improved by more than $4000. A 10 point decrease in BMI resulted in a wealth increase of $12,720 for white males and $11,880 for white females. To put the $12,720 increase into perspective, that amount is 25% of the average balance of Fidelity retirement savers’ 401K accounts in 2008

Although we have always felt that getting our BMIs back under 25 into the normal weight range was important for our health, we now realize that our weight is also important for sustaining our wealth and happiness.

RETIREMENT AND LONGEVITY INFLATION

As our Boomer generation approaches the magic retirement age of 65 years, there is increased news coverage about whether we all are going to get our due retirement payouts like our parents’ did. The relevance of the subject to us motivated us to track down where the modern concept of retirement originated.

During the late 1880’s in the United States, 78% of workers over the age of 65 still worked full time. The concept of retirement was introduced in Europe in the 1880s by European leaders who sought to quell the rising popularity of communism by proposing full pay for workers that left the work force after their 65th birthday. This was an easy promise in the 1880s when the average life expectancy of a worker was 45 years of age.

Somehow the age of 65 stuck and the fantasy of living a life of leisure after “retiring” from the workforce at 65 became the pervasive industrial age dream though few lived long enough to have it until the Boomers parents’ generation. By the early 1960s over 30% of large US corporations had some form of retirement plan for their workers along with the US government, state governments and military. Meanwhile, longevity increased from 45 years of age in 1880 to over 78 years of age today.

The original “promise” of retirement 130 years ago was only to the few who managed to survive 20 years past the average life expectancy of their generation. Our society has never adjusted the age of retirement to account for the increase in longevity. The average life expectancy is now 78, so using 65 as the retirement age has now become a promise of retirement 13 years before the average person in our generation dies. If we adjust the retirement age in 2010 based on current longevity as compared to the original retirement age suggested when the concept was introduced in the 1880’s, our “longevity adjusted retirement age” would be 98 years old.

Resetting the retirement age expectation to age 98 would make it pretty easy for governments and companies to fund those few who live that long. It would make saving for the remainder of one’s life after leaving the work force at 98 years of age feasible for most.

Since the modern world has conferred such great longevity upon our generation, it is unfeasible for most people to save enough money to support themselves without income for 20 to 30 years of life after age 65. Even those with million dollar windfalls during their career will be challenged to navigate through 30 years of global economic and political change to preserve their retirement savings.

Thinking about this has freed us from the stress and worry of saving enough money to support ourselves for 35 years of retirement. Like many boomers, we have small IRAs and doubts about ever receiving our social security payments in a decade and a half from now. We are starting to realize that the key to growing old with a great standard of living is to have excellent health, sharp minds, and income producing work that we enjoy and can continue to do well until we are 98 years old.

RISKS OF VOLUNTARY FORECLOSURES

We have been reading with dismay about people walking from their mortgages even though they have the income to make their mortgage payments; these are known as “voluntary foreclosures”. The motivation is to avoid paying for a house where they owe more than the current price of the house, forcing the bank to take the loss when the house is foreclosed upon.

According to Experian, a credit rating service, over half a million borrowers walked from mortgages that they could afford in 2008, double the number from 2007. These home owners are not unemployed or out of savings, they are just choosing to not pay their mortgages anymore because they see it as an easy way to make some quick cash with no long term downside. According to Citigroup one in five foreclosures are now voluntary, people with jobs and savings and able to pay the mortgage. They are using the fact that the banks are slow in foreclosing to get a free place to live for months and sometimes years before having to move out for non payment. Surprisingly, Experian found that people with high credit scores are 50% more likely than people with average or low credit scores to walk from an underwater mortgage believing that a foreclosure will be only a minor ding to their credit score.

It may seem as though they are right. After all, there has been no public outrage at this practice and there have been no stories of anyone being arrested for financial fraud for refusing to pay the money they owe the banks while still having the same financial conditions as when they were given the loan.

The US government has electronically created almost a trillion dollars to shore up the global banking system from the problems caused by borrowers defaulting on “sub prime” loans. The loss of income to the banks from voluntary foreclosures may have even greater implications to the global economy than the defaults of high risk borrowers. Deutsche Bank predicts that the number of homeowners underwater will grow from 14 million, or 27% of all homeowners with mortgages, in 2009 to 25 million homeowners, or 48% of all those with a mortgage, before home prices stabilize. Assuming that the practice of voluntary foreclosure continues unabated and 25 million Americans voluntarily walk from their mortgages the US tax payers will be left to cover the trillions in bank losses or let the global banking infrastructure collapse in bankruptcy.

In 1985 we bought 5 acres outside of Dallas, Texas during the oil boom and when the oil boom went bust, the property became worthless. When we needed to move from the area for a job, we were stuck with a mortgage for an amount that was huge to us at the time. We continued to pay the taxes and mortgage for the property until it was paid off. After 10 years the Dallas economy recovered enough for us to sell the property for what we originally paid for it. Though we lost the use of that money and the interest on that money for 10 years, we considered it our tuition in the school of hard knocks. It taught us a lot about the real value of real estate and that knowledge has been worth far more than the money we lost on that underwater property. We currently have a Hawaii property that is underwater by over 50% and dropping. Our mortgage, maintenance and tax payments are our current tuition payments in the new economic school of hard knocks. We make those payments because we promised in writing we would when we took on the mortgage and we think keeping our promises is very important. But we also believe that walking away from our property, as the voluntary mortgage walkers are doing, would be incredibly shortsighted.

Here are the reasons we believe the voluntary foreclosure walkers are making a big mistake:
1. RENTS WILL SKYROCKET: The majority of the mortgage walkers will have to live in rentals along with the massive number of Y gens (now bigger in size then boomers) and others not able to qualify for a house loan. The increased demand for rentals will cause a sharp increase in rents. As we experienced in the 1980’s, rental costs can greatly exceed the cost owning a house. The mortgage walker may find that they are never again able to buy a house on credit making them a renter for life and exposed to the ever increasing rental rates.

2. US DOLLAR BECOMES FORMALLY DEVALUED: The massive amount of US currency being created to keep the banks afloat is causing the dollar to lose value against other currencies like the Japanese Yen and Euro. In the last 3 years, the dollar has lost 30% of its value compared with the Yen. Many large currencies have fixed exchange rates with the dollar such as the Chinese Yuan and Saudi Arabian Riyal and there is growing international pressure for these countries to formally devalue the US dollar. This devaluation could happen without notice and easily be 30% or more causing raw materials that we compete for internationally to skyrocket in price. The building materials that we were able to buy cheaply in the past may make buying a new house in the future unaffordable.

3. PERSONAL CREDIT CONSEQUENCES: So far the only consequence of walking away from a mortgage that we have heard about is losing 100 points on one’s credit score. But what if Congress decides to collect the losses being incurred by the FDIC and bad mortgages being purchased to keep the banks afloat from widespread foreclosures? They have access to everyone’s IRS statements, bank statements, and IRA/401K arming them with the information they need to uncover who is really broke. What if stronger consequences are implemented by banks and mortgage walkers lose their right to credit of any kind. They may be relegated to paying for cars, college, and clothes the way it used to be done, through layaway plans, savings and cash.

The people with good credit and income that are walking away from their mortgages may be creating another economic backlash by requiring the federal government to put even more trillions of dollars in the banking system to cover their debt. This will further erode the value of the US dollar with other international currencies making the money saved by walking away from their mortgages seem insignificant. Owning real estate and a house where living costs are relatively fixed are the primary ways to financially survive the dropping value of the dollar.

ZERO IS A BIGGER NUMBER THAN -100,000

We watch the news from Silicon Valley and are surprised at the recent increase in unemployment and bankruptcies and the severe drop in housing. Housing prices in San Francisco, a city that had hoped to be immune from this deep recession, have dipped 41% in the past year leaving homebuyers with an average loss of $304,000. Many who bought houses in the last few years owe $300,000 or more than they can sell their houses for today.

In a recent discussion with an affluent resident of Hawaii about his trip to Southeast Asia, he marveled at how people in the country he visited were able to live on wages of $6 a day. When asked how happy the people there were he responded that in spite of their low wages they seemed surprisingly happy. It was hard for him to understand their happiness considering their monetary situation.

We went to high school in Southeast Asia and have long held the belief that happiness there is due to their different set of values; wealth and ownership are just not as highly rated. But I couldn’t resist pointing out that the $6 a day worker in South East Asia with $0 savings and no debts has a higher net worth than many highly paid workers in Silicon Valley today that bought their houses at the wrong time.

Assume the Silicon Valley worker has savings of $150,000 and a house worth $300,000 less than owed. The worker in Asia with no debt, no savings, earning $6 a day has a net worth $150,000 greater than the well paid Silicon Valley worker. It is astounding to us how quickly the wealth of so many seems to have evaporated. A little more than a year ago, we were concerned with how trivial $100,000 had become in California. Now workers, still with good jobs, are walking from their home loans because they are $100,000 underwater.