Monday, October 20, 2014

Times Like These

It's times like these you learn to live again
It's times like these you give and give again
It's times like these you learn to love again
It's times like these time and time again

- Foo Fighters, Times Like These

The oblique reference to giving amidst suffering in the above lyrics aptly conveys one of the more enduring mysteries of our existence.  When pain and adversity come, our natural inclination is to start clutching and grasping for all things - not just money, but time, possessions, words, and even relationships.  Giving is usually the furthest thing from our mind.

The irony is that often giving is exactly what can start us on the road to recovering from suffering.  No, giving can't solve the original pain point - it can't cure the disease, reconcile the relationship, or provide us the material things we lost.  But it can change our mental attitude, which is often the longest lasting part of the suffering.

Personally, I have yet to experience a downturn in my life that began to get better until I was willing to give a little of my time to help someone else, to give a kind word to another hurting soul, to part with something I didn't really need as much as someone else did, and to be less of a taker and more of a giver in relationships.

While there is irony that giving can alleviate suffering, there is perhaps a greater irony that no matter how many times we learn this lesson, we always seem to have to relearn it, time and time again.  Apparently the tendency to keep and retain everything is so instinctive that when we are suffering, we are generally not able to realize that there is a better choice.  I hope that writing this article will help me make that connection sooner the next time I'm in that situation.

Saturday, October 18, 2014

Ranking My Startup Ideas

London 2012 Olympic 100m final start

Yes, I'm going to use that word.  Startup.  And since this was not in any of my original plans, let's see how I got to where I am now.

Thousands of Ideas

I'm that annoying kind of person who is always looking at the world and thinking it can be improved in some way.  Every mechanical device has some deficiency that can be remedied, and every parking lot could be better designed.  Even the line at the local coffee shop could be optimized.

But I'm also a skeptic.  I love shooting down my own ideas as technically unworkable or financially impractical.  And I'm also happy to shoot down the ideas of others when they come to me asking for a sanity check.  It's a dual nature that most people have.

For a very long time, my skeptical side dominated my inventive side.  But in the last few years, the tide slowly began to turn.  First of all, I began to be more aware of incentives.  Given that I had already achieved a financial base, even one moderately successful idea might produce enough income to make a real difference in my future.  Second, I longed for a creative outlet.  Lastly, I began to realize that some of these ideas were not so impractical after all.

Hundreds of Ideas

Two years ago marked a major shift in my thinking.  Another year before that point, I had an idea that I thought was both novel and financially viable.  I did a little investigating for a few weeks and could not find any trace of this idea elsewhere.  Despite the fact that it would have been relatively easy to pursue, I decided that the lack of a market indicated a lack of interest.  I abandoned the idea and forgot about it.

A year later, I stumbled onto this idea again.  A new company had built a multimillion dollar business on this exact idea.  Sure, I felt frustrated, but I did not feel cheated.  I chose not to pursue it, and even if I had, there is no guarantee I would have achieved the same level of success.  Nonetheless, I did have one takeaway from the episode: my ideas might be more viable than I originally thought.  I began to write the good ideas down on paper, and it turns out that several of these ideas have subsequently been successfully others.

20 Ideas

At the beginning of this year, I decided to choose the best ideas I had and potentially begin working on a few of them.  I'm afraid the selection was not all that deliberate, and I ended up with about 20 ideas to choose from.  I then decided that I needed a more formal evaluation process.

5 Ideas

I used the following 8 questions to filter my ideas.  The first 7 questions were basic business criteria.  The last question related to my personal need to find more meaning in my work.  One morning in early summer, I sat on the beach and ranked my ideas.
  1. Need.  Do I wish I had the product or service myself?  Would I use it?  Would I pay for it?
  2. Simplicity.  Could I explain this idea to a "person on the street" in 2 or 3 minutes?  Could I explain it to my children?
  3. Monetization.  Is there an easy way to monetize this?  Are there multiple possibilities for monetization?
  4. Annuitization.  Does the idea have some sort of natural recurring customer interaction?  Are there follow-up possibilities for the product or service?
  5. Competition.  Is the market dominated by an existing player?  Or are there a few weak players?  Or is this a new market?
  6. Flexibility.  Are there ways the product or service can be easily changed beyond the original idea?
  7. Funding.  Could a formal business plan be developed for the idea?  Would an investor realistically be potentially interested after seeing the plan?  Would a larger company conceivably buy it?
  8. Creativity.  Would I consider it a creative endeavor to be working on this idea?  Would I be happier working on it rather than my current job?
When I was done, I had five ideas, and I spent the rest of the summer working on all five of them.  (Now you know why there were so many failures!)  I also decided to re-rank these ideas at the end of the summer, after I had more experience with them.

I was not sure what to expect.  I assumed some of the ideas would eventually fizzle out, but actually none of them did.  I still consider all of the ideas to be viable, although one turned out to be less enjoyable than the others.  I also wondered whether it would be difficult and subjective to determine which ideas were better than the others at the end of the summer.  But here I was in for a surprise.

One Idea

One idea was clearly better than all the others.  In fact, it was so much better in every single category that I was a little bewildered at first.  Could it really be that easy?  What about the other viable ideas?

The idea of choosing one thing has always been difficult for me.  I'm the sort of person who has trouble answering questions about my favorite movie or food or city.  The idea of ranking one item above all others (and actually believing that) is a pretty foreign concept for me.  So it has taken me a few weeks to mentally process everything, but in the end, I am still 100% convinced that this one idea stands out and that is where I need to go.

From Idea to Startup

Many bloggers have a lot of moneymaking ideas that they often refer to as "side hustles."  These types of ideas may be the safest because they are generally easy to start, require little capital, and can be effectively managed by a single person.  Examples of side hustles would include web sites, e-books, tutoring, and consulting.  While my ideas tend to be a little less "virtual" than most bloggers, they generally still fit into the same risk/reward profile.

But this one idea is a different kind of idea than my others.  From the very beginning, it actually had "startup" written all over it.  Every single day I wished I had this product: not to sell, but to use myself!  Thus, I have a certain passion for this idea.  Second, given the nature of the idea, it really feels more like a venture or a company than an attempt an a part-time income.  Third, the business plan practically wrote itself.  This does not mean it will be successful, but it does show that the idea is framed as a business in my mind and not merely as a cool idea.

In my moments of doubt, I still wonder if this is just a small idea, elegant but insignificant.  Perhaps it would be something interesting to work on for a while and I might eke out a few bucks from it.  But in my moments of hubris, I wonder if it could be transformative.

So it's going to be exciting to see what comes from all of this!  In many ways, I feel like I'm being dragged into this process, kicking and screaming.  I don't feel ready for it.  Yet I know that after all the thinking and prototyping I've done this year, I can't now decide to wimp out.  I would feel enormous regret in 5 years if I failed to even give it a shot.


All of this will require a substantial commitment of time and focus.  Yes, it means this blog will need to go back into hibernation mode.  I have two small articles about giving that I have already written and will post next week.  After that, I'm not likely to be blogging again until 2015. 

Sunday, October 5, 2014

The Surprising Math of Taxable Investments


Most people don't seem to be aware of just how much repeated taxation affects the compounding phase of taxable investments.  I want to highlight this issue and put a slightly different slant on it than you might have seen in the past.

Nontaxable Investments

But first, so as not to create any confusion, I want to state for the record that it's true that the effect of a one-time taxable event at the beginning of your growth (Roth IRA) or the end of your growth (Traditional IRA) is identical, assuming the tax rates are the same.  You start with a certain amount of money.  You then have a growth factor of your investment over time.  You also have a taxable event.  So at the end, you either have (money * growth factor * tax factor) or (money * tax factor * growth factor).  I'm not sure why this is confusing to many people, but the last time I checked, multiplication was still associative.  :-)  I refer you to this humorous article if you still don't believe that the basic tax advantages of a Roth IRA and a Traditional IRA are equivalent

Taxable Investments

With taxable investments, however, we generally incur taxes whenever gains are realized.  In other words, the more frequently we sell, the more frequently we encounter taxes.  It turns out that this is a very significant factor in the overall growth of our wealth.

The Lower Bound

If we sell everything each year, our actual (after-tax) growth rate will equal our pretax investment growth rate multiplied by the amount we keep after taxes (i.e. 100% - tax rate).  Here is an example.  Let's assume our pretax rate of return is 10% and our tax rate is 30%.  This means our after-tax return is equal to 10% * 70% = 7%.  This is the lower bound.

The Effect of Buy and Hold

But suppose we are willing and able to hold onto our investments longer.  Here is where it gets interesting.  Let's assume that instead of selling all of our investments every year, we hold on a little longer and sell all of our investments every 2 years.  The final amount is actually better than 7% annualized because we are not incurring yearly taxes.  Thus, the gains from the first year are allowed to compound before being taxed at the end of the second year.  I'll spare you the arithmetic, but the end result is that the after-tax annualized growth rate increases from 7.0% to 7.1%.

While the increase is small at the two year holding interval, it nonetheless illustrates something very important.  Even if our (pretax) investment returns are the same and our tax rates are the same, we will end up with a higher annualized after-tax return if we simply don't sell as often.  And if you've guessed that extending the holding period will result in even greater after-tax returns, you are correct.

The Upper Bound

Let's stick with our example of 10% annualized pretax growth and 30% tax rates because it makes the numbers easy to compare.  Here are the annualized after-tax returns for different holding periods.  Obviously the last two periods are not realistic to achieve, but are included to illustrate the math.

   1 Year  = 7.00%
   2 Years = 7.10%
   5 Years = 7.38%
  10 Years = 7.78%
  20 Years = 8.39%
  30 Years = 8.79%
  40 Years = 9.05%
 100 Years = 9.61%
1000 Years = 9.96%

Surprised?  Yes, the longer you hold, the higher your after-tax returns.  And in an interesting case of limits, as the holding period increases to very large numbers, the annualized after-tax return actually approaches the annualized pretax return!

You may have heard Warren Buffett say that his "favorite holding period is forever."  Perhaps now you have a greater understanding of this quote.  Frequent trading can not only invite bad timing, but can also directly decrease returns in taxable accounts.

Wednesday, October 1, 2014

Asymmetric Emotions Will Kill Your Portfolio

Delacroix - Ramasseuses de coquillages surprises par la marée

Allegorie flämisch 1604 Geiz

One of the essential ingredients of successful investing is keeping a healthy balance between greed and fear.

We are all familiar with how unbalanced these factors become at market tops and bottoms.  At the top, even negative information is met with more greed, and at the bottom, even positive information elicits fear.  Yet the reality is that life rarely unfolds in such a lopsided fashion.  In most situations, there are numerous favorable and unfavorable influences, and we must perform a delicate weighing of the situation.

For those who select individual investments of any kind, this lack of balance occurs even more frequently.  You can choose almost any stock in the Dow Jones Industrial Average and find that it has been the pariah of Wall Street at some point in the last 5 years.  And yet in most cases, we find the same company can do no wrong less than a year later.  Surely this is collective madness.

We may think we are above all this folly, but I'm not so sure.  When people talk about their investments on financial blogs, I often see a more subtle form of emotional asymmetry.  If the purchase in question immediately goes down, there is all manner of talk about random short-term fluctuations and taking the long view.  But if the purchase goes right up, there is often a claim to have "seen it coming."  That is extraordinarily dangerous thinking, where short-term losses are viewed as market noise but short-term gains are viewed as evidence of superior analysis and timing.  This is not only a mismatch of short-term and long-term thinking, but also of the greed and fear balance.

This line of reasoning distorts your response to information flow and absolves yourself from taking full responsibility for your decisions.  If this asymmetry becomes pervasive, it will ultimately kill your portfolio.