Tiny Houses, Tiny Wallets

This post originally appeared on The Rich Investor.

My buddy Ari was a self-made millionaire by his early 30s. But he didn’t earn his nest egg the way you might expect.
It seems like most of the young and well-to-do hit the jackpot by writing a popular app or creating a viral YouTube video.
That’s not Ari. For a young guy, he made his money in a surprisingly old-fashioned manner: building an empire of mini-storage units, strip malls and other steady income-producing properties.

(Ari looks old fashioned too, by the way. Despite being a Millennial in his mid-30s, he wears a three-piece suit and wingtips to the office every day. Give him a fedora, and he’d look like my grandfather circa 1940.)

Ari is my go-to “real estate guy,” the person who can reliably give me a boots-on-the-ground account of what’s happening in the property market. So I asked him the other day about the health of the Dallas apartment market. Everywhere you turn, there are cranes and construction crews throwing up towers full of luxury apartments.

“It’s a joke,” Ari deadpanned. “Most barely break even. They’re just looking to sell to a private equity fund and take the money and run.”

That might sound like a flippant answer, but Ari was just getting started.

“This property market is a house of cards, bro. Look at the trend of microapartments. Do you think anyone actually wants to live in one of those? They do it because they can’t afford anything bigger.”

Ari’s phone rang, and that was the end of the conversation. But he left me with some good food for thought.

In case you’re not familiar with them, “microapartments” are tiny one-room apartments of 50 to 350 square feet. Your toilet doubles as living room chair. They’re that small. (I’m only slightly exaggerating.)

Microapartments are billed as a great option for the young and trendy. They are tiny and thus eco-friendly. You’re not cooling or heating a lot of unused space. They tend to be located in urban areas close to public transportation and close to bars and other entertainment options.

All of that sounds great. But again, your toilet is doubling as a living room chair.

And living within walking distance to your job and to your local Starbucks matters a lot less when you can actually afford a car.

I think Ari was on to something.

So much of what is viewed as eclectic Millennial behavior – microapartments, not owning a car, the “sharing economy,” no immediate plans to marry or start families, etc. – has a lot less to do with the fickle preferences of the young and a lot more to do with them struggling to stay afloat financially.

Let’s look at the broader housing market.

Since 2000, the Case-Shiller 20-City Composite Home Price Index is up 111%, and this includes the major collapse in home prices starting in 2006. In most markets, home prices are at new all-time highs.

Average wages, in contrast, have risen a little over 50% in that same period (neither data series is indexed for inflation).
You don’t have to be a math whiz to see that it’s a real problem when housing prices have more than doubled while wages of the would-be buyers of those houses have risen by barely half.

Given this, it’s not surprising that something as ridiculous as a 50-square-foot apartment is now fairly common.
Most of our readers tend to be professionals that are well advanced into their careers, so if you’re reading this it’s pretty unlikely that you’re living in a microapartment and taking the bus to work.

But if you also want to save your children and grandchildren from that fate, teach them to save and invest early. They don’t have to swing for the fences. Regular, disciplined investment into a portfolio yielding 6% to 10% will grow a nest egg quickly, at any age, really.

Investing just $200 per month will grow to a nest egg of well over $30,000 in 10 years if invested at 6%. That number jumps to nearly $40,000 if invested at a 10% annual return.

If you can convince your child or grandchild to start saving like that at age 20, they’ll have plenty of cash on hand to make a nice down payment on a proper house.

I can’t make your kid save. But in Peak Income I can help them (and you) grow their savings steadily and conservatively through some of my favorite long-term income producers.

 

This article first appeared on Sizemore Insights as Tiny Houses, Tiny Wallets

Competing with the Quants

I was having a drink a while back with my friend and fellow Rich Investor contributor John Del Vecchio, and we were reminiscing about how much this business has changed since we started our careers.

John is a forensic accountant who knows exactly where to look in the financial statements for accounting shenanigans; where “the bodies are buried,” so to speak. I call him the “Horatio Caine of finance” after David Caruso’s character on CSI: Miami. John has the same no-nonsense demeanor.

The late 1990s were a fantastic time to be a short seller. With the internet bubble entering the final blow-off stages, a disciplined forensic account had an almost unlimited supply of short candidates.

But you had to know what warning signs to look for. This often meant spending hours digging through the footnotes of a company’s income statement, cash flow statement and balance sheet.

Back then, John spent 10 hours per day on the LexisNexis database, pouring over every line of a short candidate’s financial statements. And often, it would all be for naught. Not every investigation ended with a perp walk.

Today, John presses a button and his system does the heavy lifting for him in a matter of seconds.

When the system finds irregularities, John still has to roll up his sleeves, put on the green visor, and dig into the books. But his quantitative system saves him hours (if not days) of exhausting research.

And the 1990s weren’t all that long ago. Let’s go a little further back in time.

Benjamin Graham – Warren Buffett’s mentor and the man that invented value investing as a discipline – made a fortune in the 1930s and 1940s by doing painstaking research.

He’d dig through the financial statements and calculate valuation ratios (price/earnings, CAPE, etc.) by hand.

As early as the 1950s, after Wall Street had starting hiring armies of analysts to do the same work, Graham had started to question whether he could still find bargains using his old methods.

By the 1970s, Graham has more or less given up and converted to an efficient market advocate.

Warren Buffett is most famous for owning large positions in household names like Geico and Coca-Cola. But earlier in his long career, Buffett literally walked door to door in Omaha asking little old ladies if they were interested in selling their paper stock certificates to him.

In today’s world of instant stock trading on your smartphone, that seems ridiculously quaint and old timey.

Fundamental investors have flocked to quantitative tools to help them pick through mountains of data faster than their competitors.

Forbes even coined a term for it – “quantimental” investing.

But is more data always better?

That’s a lot less certain. Last week, Bloomberg reported that quant funds are “reeling from the worst run in eight years.” AQR – considered one of the best quant managers in history – is down nearly 9% this year in one of its flagship funds after suffering a miserable June.

There are so many points to be made here, it’s actually hard to know where to start. But here we go…

1. You can’t realistically invest today without using at least some basic quantitative tools.

There are simply too many stocks to research and not enough hours in the day. Not all of us are crunching numbers using computers designed for NASA, of course. But even something as basic as a simple screen or ranking system can narrow your universe to a manageable size.

If Ben Graham were alive today, he wouldn’t be calculating ratios by hand after digging the numbers out of a quarterly report. It’s also highly unlikely he’d be using the same screening criteria that he recommended using in the 1930s.

Graham was a smart guy, and he would have evolved with the times, probably coming up with new ratios we’ve never heard of.

2. You’re never going to be able to compete with the big boys in technology investment. 

The biggest Wall Street banks and hedge funds really do use computers that were designed for NASA and have teams of PhD eggheads to run them. You can’t realistically compete with that, so you have to play a different game.

Look for opportunities in small- and medium-sized companies that the big boys can’t realistically touch. (A large fund can’t take a meaningful position in a smaller company without moving the market.)

3. Beware of false correlations. 

I wrote a couple months ago that butter production in Bangladesh was statistically proven to be the best predictor of U.S. market returns.

Now, this is obviously a quirky coincidence. No rational human being would really believe that dairy production half a world away makes a dime’s bit of difference to the stock market here.

But quantitative investing is full of little traps like these. So before you trade, your screen needs to pass a “smell test.”

If the criteria seems farfetched (seriously, Bangladeshi butter?) it’s likely that you’re mistaking statistical noise for worthwhile information.

 

 

This article first appeared on Sizemore Insights as Competing with the Quants

Can You Trust the Social Security Trust Fund?

Did you see this bit of news recently?

The Social Security Administration announced earlier this month that it would have to dip into its trust fund for the first time in 36 years.

With the Baby Boomers retiring in droves, the Social Security system is now paying out more in benefits than it’s taking in as tax revenue.

And if current trends hold, the trust fund will be completely depleted by 2034.

That sounds bad. Really bad.

But it’s actually worse than you think.

Social Security is dipping into a trust fund that doesn’t actually exist. There is no trust fund.

No, it wasn’t stolen in some Ocean’s Eleven-caliber heist. And no, I’m not a conspiracy theorist who believes it was an elaborate plot by our government to lie to us.

But I’m 100% serious when I say the Social Security trust fund doesn’t exist, nor has it ever existed – at least not in the way you or I would understand a “trust fund.”

Let’s start with the basics.

What is the Social Security trust fund?

The Social Security Administration essentially has two accounts at the U.S. Treasury: The Old-Age and Survivors Insurance Trust Fund and the Disability Insurance Trust Fund. We’ll call both collectively the “trust fund.”

You and I and every other working American contribute to these funds through our payroll taxes: 6.2% of your paycheck (up to the first $128,400) goes to Social Security, and your employer chips in another 6.2%.

For the past 36 years, tax revenue coming in was greater than benefits going out. The accumulated surplus makes up the trust fund.

That sounds straightforward enough. At its heart, it’s not too different than the way all of us save for retirement.

There’s just one big problem. The surplus cash might go to the trust fund, but it doesn’t stay there. It gets sucked into the current expenses of the U.S. government and replaced with an IOU.

The trust fund’s assets are “invested” in U.S. Treasury bonds, and the cash is used to fund the current expenses of the government.

If you or I buy a U.S. Treasury bond, that debt obligation of the government is an asset to us.

But that’s not exactly what is happening here. Remember, Social Security is the government. So, the government is lending to itself and calling it an asset.

That doesn’t work in the real world.

I can write myself a check for a million dollars, but that doesn’t make me a single penny richer. I’m just shuffling the money from one pocket to another.

So, when I hear that Social Security is having to dip into its trust fund, I roll my eyes.

The so-called trust fund was never more than an accounting trick.

The idea that there was cash set aside for our retirement by the wise mandarins running the government was a convenient fantasy.

Keeping the fantasy alive actually isn’t that hard. If Congress raises payroll taxes, raises the retirement age or finds other stealthy ways to reduce benefits, such as by means testing or tinkering with inflation assumptions, we can rebuild the “trust funds” in a hurry.

For that matter, the U.S. Treasury could create a quadrillion-dollar superbond to prefund the trust fund from now until the end of time, and then promptly lend the money back to itself.

But what difference would it make? It’s all just accounting.

The reality is that the retirement of the Boomers is going to force the government to make some uncomfortable choices.

A current deficit (benefits going out being larger than payroll taxes coming in) means that the money has to come from somewhere else.

That means that taxes go up, other spending goes down or we simply borrow more. None of those options are desirable.

I don’t know about you, but I don’t feel comfortable depending on accounting gimmickry to fund my retirement needs or those of my family.

And, if anything, this just reinforces my belief that you must create your own income streams in order to have the type of retirement you want.

That’s why I started writing Peak Income, my newsletter dedicated this exact idea. Click here to learn more about it.

This article first appeared on Sizemore Insights as Can You Trust the Social Security Trust Fund?