China’s economic outlook in the year of the rooster

As we look ahead to 2017 and consider those factors that will influence our investment strategy and decisions, China will continue to have a significant impact. It’s sheer size, scale and development affects the world’s markets and economies – as well as influencing some of the companies that interest investors the most.

In China, 2017 is the year of the rooster – a year to work hard and be patient, yet spend time in solitude and harmony with friends and family. People will be more polite, but may complicate things.

Take the property market. Some believe it is overheating, as house price inflation was the highest ever recorded in September 2016. While this was initially limited to the Northern provinces, it’s spreading to smaller cities, which account for most transactions.

Other experts believe the sharp increase only affected a few cities and, overall, prices have risen in line with income. In any case, even a price collapse wouldn’t cause undue economic problems. And, while the ratio of house prices to income is high, this characteristic is shared by many cities – including London and New York.

How will China’s economic outlook impact investment strategy in 2017?

It’s highly probable that the property rally in China will end. Conditions will soften over the next 6-12 months – but commentators are considering whether ‘bubble’ conditions exist and whether any slowdown will seriously affect China’s economic outlook.

At the least, any slowdown in the property market will revive ‘hard landing’ fears, but we believe this is unlikely to happen. First, no-one credits China’s official GDP figures; it’s commonly accepted that the economy is growing more slowly than they suggest. Second, these fears have been around for years, yet the economy is still expanding. In 2008, the catalyst for a hard landing was expected to be an Olympics ‘disaster’; in 2011 it was the growth in shadow banking and spike in food inflation. Neither has happened.

The other highly divisive issue is corporate debt, as Beijing has seemingly resorted to massive lending to boost economic growth.

Again, any analysis of headline numbers needs caveats. First, it’s not just the debt level that causes concern, but the speed with which these liabilities have accumulated.

Chinese debt was 148% of GDP at end 2007, and had grown to 255% by end 2015. However, most problem loans have been made by State-controlled banks to State firms – basically the Chinese Government lending money to itself. Much of the increase has also been concentrated in sectors related to infrastructure stimulus – a strategy for which Donald Trump has been lauded!

Chinese policymakers have tried to deleverage and rebalance the economy, reflecting a desire for more sustainable growth centred on consumers – but every time growth slows, they fall back on debt-fuelled investment as a stop-gap. This can’t continue, and President Xi Jinping has suggested he’ll forgo the growth target as supply side reforms are implemented.

Rebalancing won’t be a smooth process, but the trend is clear. As far as growth is concerned, the slowdown in economic expansion reflects the fact that the economy is significantly larger than a decade ago.

We see any negative market reaction to China’s economic outlook as a potential opportunity to consider further investment. Let the dragon welcome the rooster.

Does it make sense to hold on to ‘bond proxies’?

Until very recently, bond markets have experienced a bull run for the last 35 years. Interest rates are at all-time lows and investors have crowded into equities. But one group of equities in particular has stood out – ‘bond proxies’.

‘Bond proxy’ describes equities, such as consumer staples and utilities, with safe, predictable returns and often with yields higher than the bond market.

But over the last quarter of 2016, some pundits have started to talk about the ‘bonfire of the bond proxies’. So, should investors continue to hold these shares in 2017 or will more traditional value-style stocks do better?

Why have bond proxies performed so well?

Companies holding the bond proxy name tend to generate strong cash flows and high returns on their invested capital. These returns can either be reinvested by the business, used to enhance shareholder growth or used to increase dividends.

Another possible advantage is that they may possess barriers to entry that allow these companies to continually outperform their peers. These barriers may be intellectual property, such as patents, or brands that are difficult to replicate, such as Microsoft, Johnson & Johnson, Nestlé or Unilever.

Another trait shared by many bond proxies is relatively low borrowings. This gives them greater solidity in times of market stress and allows them to make value-creating acquisitions at opportune moments. Take brewer AB Inbev, for example. It has made a string of big acquisitions and built up an unrivalled portfolio of beer brands that is almost impossible to replicate.

Regulator support

Another type of bond proxy stock is a company with solid earnings underpinned by regulation. Utilities are a great example of this: a regulator sets both the pricing and the returns companies can generate over multi-year periods. These companies benefit from steady cash flows and earnings, giving them bond-like properties, although if regulation changes, their existing business model may come under pressure.

Some bond proxy stocks have built up exposure to emerging markets, and can exploit the quicker economic growth in these countries. Unilever, for example, derives around 60pc of its revenues from emerging markets.

The laws of supply and demand also apply to bond proxies. When the availability of something reduces (in this case earnings), the price (valuation) goes up. In some cases valuations have become inflated, with price earnings (PE) ratios often in the high 20s or low 30s. After the EU referendum result, when bond yields fell to all-time lows, the share prices of companies considered bond proxies rose sharply.

Impact of political change

However, since then bond yields have risen back to the levels of early 2016. This has been driven by the fall of sterling since the Brexit vote, and unexpectedly robust economic growth and low levels of unemployment in the US and the UK. President-elect Donald Trump is also pro-growth, with several policies that will increase spending on infrastructure.

Towards the end of 2016 we saw bond yields rise more quickly. Inflation expectations prompted a sell-off in government bonds, which pushed the price of bonds down and the yield you can get from them up. That’s because rising inflation makes it less attractive to hold government bonds, which lock investors in at set interest rates.

Although bond yields may stabilise in the short term, we can expect this trend to continue into 2017 for a while at least. This may keep the pressure on bond proxies for a while longer.

However, the solidity, high returns and strong cash flows of these companies are compelling reasons to own them over the longer term. And given the levels of debt in the world, bond yields will not rise forever. The bond proxies are down, but certainly not out.

What if… there’s an attack on the new technological world order?

This final blog in our series of potential surprises for 2018 considers the impact on economies and markets if the FAANGs (Facebook, Amazon, Apple, Netflix and Google/Alphabet) were to be finally defanged. Imagine coming to the end of 2018 and finding today’s technology giants were no longer the most powerful and biggest companies in the world. What might the investment prospects look like then?

What we know about the technology giants

We all know that the wonderful utility that social network, search engine and internet media companies offer us comes at a cost. The new economy giants evade taxation, facilitate fake news, corrupt the democratic process, invade the privacy of citizens and destroy countless thousands of jobs through unfair competition. Their power appears to exceed that of elected politicians.

So imagine a world where the FAANGs start to fall from grace

In this nasty surprise, Google and Amazon are investigated by the US Department of Justice anti-trust authorities with a view to breaking them up. Facebook is caught up in investigations on its role in recent elections. Advertisers leave the social networks, eroding their earnings. Meanwhile, on the advice of Bill Gates and others, Congress implements legislation that taxes industrial robots as factors of production, just as human wages were taxed before those human jobs were supplanted by machines.

Governments find ways to tax internet retailing, damaging the ability of companies like Amazon to disrupt areas of commerce. The use of Artificial Intelligence is strictly regulated. In China, the Communist Party takes effective control of the internet giants there, like Baidu, Tencent and Alibaba. These companies become instruments of state control, just as in George Orwell’s 1984.

How would this affect the economy and the markets?

The result is a collapse in the share prices of the FAANGs. This leads to a severe market correction, exacerbated by sector-thematic ETFs all heading for the exit at the same time. Equity risk is re-priced across all sectors, with the market de-rating dramatically. Bonds do better, acting as a store of value in the technology sector rout. Although this period of volatility throws up many excellent long-term opportunities, the market mood music shifts into a very dark, minor key.

How can I prepare for surprises in 2018?

How technology giants fair in 2018 is just one of the many potential surprises in 2018. The good news is that our experts are continually exploring and analysing the markets to spot what’s happening long before it affects investments. They’ll help you prepare for the unexpected so you don’t have to worry about known, or even unknown unknowns.

Investing in artificial intelligence companies

In investment terms, the concept of artificial intelligence (AI) stretches beyond laboratories of scientists trying to develop neural networks. It now includes machine learning (a field of computer science where computers learn without being programmed), deep data (looking for specific information to help predict trends or make calculations), natural language and autonomous vehicles. It also includes any company that could feasibly benefit from these technological advances. These areas are presented hand in hand with industrial automation and smart robotics to present a holistic investment universe.

How does the world of investment view artificial intelligence?

Investment providers have developed several ways to access this theme. The past 12 months have seen the launch of at least three actively managed funds with some degree of AI as a theme, while there are also exchange traded funds (ETFs) which offer exposure to the specific areas of automation and robotics.

  • The London-listed Robo Global Robotics and Automation GO UCITS ETF share issuance has risen from just 4.4 million shares in May 2016 to 57.9 million by the middle of November 2017.
  • iShares Automation & Robotics was launched in September 2016, but already has a market capitalisation of US$1.3 billion.

Should CGWM be seeking to invest in artificial intelligence companies?

At first glance, the economics of the AI and robotics industry appear compelling. According to a prominent AI fund manager, “we are at the start of the adoption of AI. Those positioned to benefit will enjoy a sustained period of growth.” Even more eye catchingly from an economic perspective, “AI has the potential to double economic growth rates over the next 20 years.

The corporate world seems to agree.

 

Do statistics support investing in artificial intelligence companies?

  • CB Insights, which offers “machine learning, algorithms and data visualisation to help replace the 3 Gs (Google searches, gut instinct and guys with MBAs)” to predict future trends, estimates that US$1.5 billion has been invested in AI companies in the last five years.
  • Many of the largest companies in the world are investing in AI and machine learning, including Apple, Google, Amazon, IBM, Intel, Microsoft, Nvidia, Qualcomm and Tesla.
  • Research and Markets, an organisation with 1,700 research teams in 81 countries, expects the global AI market to reach US$36 billion of revenue by 2025, growing at a compound annual growth rate of 57% between 2017 to 2025, growing at a compound annual growth rate of 57% between 2017 to 2025.
  • McKinsey estimates that 30% of tasks in 60% of occupations could be automated.

Robotics also appears to be a growth industry. The International Federation of Robotics highlights that in 2016 global sales of robots increased by 18%, to US$13.1 billion, while robot supplies are expected to rise by 21% in Asia, 16% in the US and 8% in Europe.

Unsurprisingly, the shares of companies involved in automation have responded favourably. Fanuc rose nearly 35% between mid-September and mid-November, while Yaskawa and Kuka doubled within the year.

 

Investing in robotics/artificial intelligence stocks – what’s not to like?

At CGWM we prefer to avoid investing in fads and fashions. While AI and robotics may not prove to be a passing fad, they are certainly in fashion at present.

There is also a fallacy that faster growth automatically feeds through to higher investment returns. Unfortunately, there are flaws in this argument. For example, many of the growth statistics surrounding artificial intelligence investment focus on revenues, as profitability within much of the industry is a scarce commodity. This is reminiscent of the late 1990s tech boom, and at this stage it is impossible to know which areas of AI, and which companies, are likely to survive and thrive. If history is any guide, there will be as many failures as successes.

 

What does the future hold for investment in artificial intelligence?

We should beware of relying heavily on forecasts which look too far into the future, particularly from those who have a vested interest in the area. While economic growth may be boosted by the adoption of AI and deep-thinking algorithms, this is by no means certain. Just as today’s world looks nothing like the one envisaged by sci-fi writers of the past, tomorrow’s world may look vastly different from current predictions. The forecast ‘winners’ in certain scenarios may not be the existing incumbents; they may not even exist yet.

History also shows that the benefits of new technologies often take longer to materialise than first expected. For example, Paul David, the academic economist who has undertaken analysis of scientific progress and technological changes, found that when factories first started to use electricity, they became slightly more productive. It was only later, when the factories went further and began changing their configurations to capitalise on electricity, that the surge in productivity really began. Maybe humans will need to adapt their behaviour to deliver the true benefits of AI and automation.

Another issue is whether anyone considering the benefits of investing in artificial intelligence companies can truly allocate to or between the various AI sectors, or whether a wider technology exposure should prove sufficient. Would a broad technology fund, managed by experts in their field and who understand the fact and fiction of the AI investment universe, be a better investment route? The definitions of AI are so variable, and the artificial intelligence investment management universe so ‘non-standard’, that a compelling top-down view can quickly become blurred.

We always need to be sceptical of the claims made by the proponents of investment opportunities. The prospects offered by investment in AI, robotics and automation certainly seem compelling. However, we don’t take such claims at face value, or assume that they automatically guarantee a successful investment outcome. Instead, we will weigh the pros and cons of the investment rationale and suggest that investors also tread carefully before committing to this area.

 

Risk Warning

Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.

The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.

The information contained herein is based on materials and sources that we believe to be reliable, however, Canaccord Genuity Wealth Management makes no representation or warranty, either expressed or implied, in relation to the accuracy, completeness or reliability of the information contained herein. All opinions and estimates included in this document are subject to change without notice and Canaccord Genuity Wealth Management is under no obligation to update the information contained herein.

Where investment is made in currencies other than the investor’s base currency, the value of those investments, and any income from them, will be affected by movements in exchange rates. This effect may be unfavourable as well as favourable.

My 15-Year Journey to Financial Independence

When we started our real estate investing business in 2003, I had $1,000 in the bank, a paid-off 1994 Toyota Camry, and no college debt thanks to a football scholarship from Clemson University (Go Tigers!). My business partner, who was a little older, owned a home and had an internet business that paid his bills (barely).

We faced many of the same challenges other new entrepreneurs and investors face: we couldn’t possibly learn everything we needed to know, yet we couldn’t wait forever to get started.

So, I initially apprenticed for a year finding deals for a more experienced investor. Down south in the US, we call this being a “bird dog” because I sniffed out deals for someone else. I learned an incredible amount from this on-the-job training and saved some cash. At the same time, my business partner and I gave ourselves a crash course of real estate education from books and seminars.

After this first year of learning, we began buying properties on our own to resell at higher prices (aka flips). We used money partners, debt leverage, and a small amount of our own cash to fund the purchases.

About the time of our 2nd or 3rd purchase, we attended a real estate class that made a big impression on us.

Can We Buy 50 Houses Per Year?

The class was taught by an experienced house flipper with an impressive business. At the time she was flipping fifty houses per year for an average profit of $20,000 per house.

I did hit my head a few times playing football in college, but even I could do that back-of-the-envelope math. 50 deals x $20,000 = $1 million per year!

This will likely sound naive (and it was), but my business partner and I decided that 50 deals per year and 1 million dollars were probably good enough for us (ha, ha). So, we decided that our goal was to build a real estate business as “successful” as the teacher of that class.

We figured the wealth building would take care of itself as we grew our business (oops again).

Between 2004 and 2007 was our sprint up the real estate mountain. My business partner and I ramped up to buy and sell more properties by creating business systems and investing a lot of money into marketing.

We became REALLY good at finding real estate deals. We also became good at finding the money to buy them. As self-employed investors in their 20’s, we were not exactly attractive borrowers for traditional financing. As a result, a large majority of our financing came from private loans and seller financing.

By 2007 (right before the cliff of the Great Recession), we had our buying machine in full motion. We had nearly 50 acquisition closings in that year alone! Somewhere in between that crazy amount of activity, I also found time to get married to my wonderful (and patient) wife.

But had we reached the goal we set earlier? Were we an impressive business like the teacher at the class? Not exactly.

The Results of the Sprint

Our 2007 sprint up the mountain did achieve a similar level of yearly volume as the teacher who inspired us. But our results were a little different.

On the positive side, some of our 2007 acquisitions were flips that generated even better profits than the teacher had made. We also did more than just flip houses. Some of our acquisitions were keeper rental properties. By the end of the year, we had 43 separate buildings (58 units) either owned or under our control with lease option contracts. And some of these rentals had low-interest financing that would pay off in only 10-15 years.

But not all was positive. A large enough handful of the new properties were NOT good deals. Some were in bad locations that made them harder to sell or to attract good tenants. On others, we underestimated repair costs, which meant we had to invest more of our own cash. And some properties had negative rental cash flow because we underestimated operating costs like maintenance and vacancy.

Plus, by the second half of 2007, we noticed signs of a slowing real estate market. We did not predict the severity of the recession to come, but we certainly saw the storm clouds brewing.

All of this caused us to step back and reflect on our journey up to that point.

Reflections From High Altitude

financial independence mountain

In some ways, we had reached a milestone. We were successfully buying, selling, and holding profitable real estate. We had more cash in the bank and equity in real estate than ever before. But the economic realities and our mistakes weighed on us.

My business partner and I sat down to talk towards the end of 2007. We realized some important lessons.

  1. We realized we had used borrowed goals. The lady who flipped 50 houses per year was impressive, but we needed to find our own path. We learned that a massive, fast-growing real estate empire wouldn’t automatically give us the life we imagined.
  2. We realized that business and investing weren’t just about making money. They were most of all about life! So, what did we want our lives to look like anyway? I can still vividly remember writing down some of my favorite things to do in life. These included playing pick-up basketball in the middle of the day. Learning something new, like a foreign language. And traveling to new, interesting places with my wife, family, and friends. I can also remember being shocked that these activities that constituted “the good life” didn’t even cost that much money!
  3. We realized that life didn’t start once we reached our final goals. Financial independence for us was both the peak and the plateaus along the way. We didn’t have to put our lives on hold until “someday.” We could enjoy life while continuing to climb the financial mountain.

Bracing For the Economic Storm

My business partner and I had our work cut out for us as the storm of the 2008-2010 recession hit. Because the market was soft, we had to keep a lot of properties rather than resell them. And as I explained before, we had to handle the mistake properties that we acquired in 2007 and before.

But our frugal habits and low cost of living now benefited us. We had not spent most of the cash we made during our sprint up the real estate mountain, so we drew on that to cover many of our mistakes. This allowed us to enjoy life during a time of decreased income.

But more than simply surviving, I wanted to enjoy the plateaus during my climb towards financial independence.

I Got Fired.

There – I said it out loud.  I got fired.

And just like that I’m a full-time blogger 🙂

What do you say when that happens to you?  When you’re drafting a post one minute titled  “Designing Your Own Lifestyle”, and then seconds later it becomes a reality?  Is that fate?  Luck?  What are the odds that you get terminated the day before you give your 2 weeks notice?  I don’t know… but I’ve got to say I haven’t felt this alive in quite a while.

How it happened

All kinds of fast, that’s how.  First, I read a memo to all employees that our paycheck’s going to be delayed a week.  I’m pissed off because it’s just thrown out there as if that’s totally normal and OK, without any explanations whatsoever, so I decide it would be smart/ballsy/awesome to reply all with a quick “Does that mean our company is in trouble??” Little did I know I was already on the chopping block, and my email would get shut off 5 minutes later (classy).

Within seconds, I get a half-dozen frantic calls from a co-worker, and a pile of text messages saying it was urgent to call him back (I was currently indisposed on the metro).  I call him back and hear that he was just let go, and that I should probably watch my back when I walk through that door. The one that’s staring me right in the face 3 feet away.  Wow.

I stand there for about 15 seconds running through all the possibilities of what’s about, or not about, to happen – and then I walk in.  The whole time I’m climbing up those stairs, I just keep thinking “Today could be your last day. Today could be your last day.” I was a little giddy, and I was a little nervous. (okay, a LOT nervous)

As soon as I walk through that door I’m called into “the office.”  I’m told to take a seat, and I say something stupid like “is that the seat for fired people?” and I refuse to sit down 😉  And then he Donald Trumps me.  “Restructuring” he says. “Aka our company is flat broke,” I think. Goes on to tell me 1/2 of the start-up is canned, and that he’s sorry it *had to be* done now, right before Xmas. No talk of severance, no signing of anything, no insurance mention, nothing.  Just a 1-2-3 out the door you go.  (after turning over my keys, of course.)

5 years at the company over. Just like that.

What I did over the next hour

There’s a lot of things that go through your mind at this point – but the one thing I didn’t want to do was burn any bridges.   After all, a man’s gotta keep his reputation!  Do you want to be known as the guy who told you to F*ck off and that he hates your face? Of course not.  You want to leave that joint as smoothly and smartly as the first day you signed on.

Plus, as far as my situation went, who the hell was going to MAKE all the stuff our company was selling? All those websites and baubles and widgets, etc? I’m the only designer?? They hadn’t thought about that yet (you’ll see why in a bit), so I promptly emailed everyone in the company – from my personal email since my work email had been disabled – and let them know it was a pleasure working with them.  And it had been – for the most part 🙂  And then I called my CEO (who wasn’t the one who fired me) and thanked him as well. Because I think it’s an important thing to do, and it also shows respect.

But ultimately, all that thanking and ass kissing helps set you up for one thing, and one thing only – future business.  Maybe off a reference, or a lead, or even with the same company down the road – you just never know. So within all the thank yous and “let’s grab beers” sometimes, I planted the seed that the Design Shop of J$ is now open for business! Even though I have no idea if it is, or if I’d even want to be associated w/ the company ever again.

And guess what happened?  The same guy that fired me 4 hours earlier called me up and said he needed my help?!!! HAH!  Didn’t see that one coming 😉  Who knows if anything will come of it (we’re still in talks to see if this new relationship makes sense – aka if they want to pay my now higher freelance rates!), but the point is you just really never know.  And if you can be proactive about it, and let people know how you can benefit THEM – even when they’re least expecting it (like when they’re firing you) or they don’t even know they need you – the chances of success becomes much higher.

It was then time to pack up, and get out of there.

My Newly Designed Lifestyle

So now what? What happens when you’re now part of an ugly statistic of unemployment? Party time – Wooooo!!!!  Haha….   nah, this ain’t the old J$ anymore 😉 While I did consume 2 adult beverages with a friend right after, I simply went into survival mode and powered up Plan B.  The plan I was trying to pull off come January 1st, and the one I’d been saving up $50,000 for.  You know – The “be the boss of me” one!  We’re two weeks ahead of schedule, and about $4,000 off (boooooo) but reality is what it is and you’ve gotta do what it takes to make $hit happen.

I called up my girl who’d been holding a desk for me at her awesomely sexy design studio (where I’m currently typing this out) and I told her the time has finally come.  She welcomed me in, I signed my new $500/mo office lease, and one hour later I was unpacked and working out of the new J. Money Headquarters 🙂  Pretty insane, huh?

Moving forward…

I’m not exactly sure what happens going forward as I’ve never worked for myself before.  I know I’ll need more money, and that I need to hustle even MORE than I was before (I just lost $70,000+ a year for crying out loud), but I’m feeling pretty damn positive about things.

THIS IS IT!!  MY DREAM STARTS NOW!!!

I’m a freakin’ full-blown entrepreneur bitches!!!   Haha… This is how I choose to use my time now. I am no longer working anymore. I am blogging, and building, and learning, and networking, and helping, and collaborating, and purely doing exactly what makes me happy every day. And I’m giving myself 1 year to make it sustainable – absolutely no job searching (yes – the wife has signed off!)

I know things won’t be perfect, and I’ll probably have a financial break at next month’s Net Worth update, but at the end of the day I can say I’m DOING it.  I am taking this opportunity and running as far as I possibly can with it.If I fail, F it. It’s not every day you get a wake up call like that 😉

————————–
UPDATE: There are rumors going around that my (ex) CEO is getting $480,000 a year.  How sick is that?  For a company 10 6 people strong? Also heard the remaining employees may have to defer paychecks for the next 2 months… it’s safe to say I don’t miss that place.

UPDATE #2: THANK YOU!!!! Wow, guys, THANK YOU for all the love & support!!!  I wish I could get fired every week 🙂 Seriously, I have never ever been this bombarded with messages and emails and calls and tweets and everything y’all have been sending over so far.  I don’t know what to say.  Just know that I am deeply touched, and I am reading every last comment you guys leave! Thank you so much for believing in me – it means everything in the world.  The next time I doubt myself the first thing I’m doing is coming back here to re-read all your kind words 🙂  God bless everyone, have a happy holidays!!!

UPDATE #3: The company has since went under.

That Time We Carried $20,000 Across The Border

This is the true story of how we transported $20,000 in cash across international borders. I would have loved to been able to provide photographic evidence of this, but frankly I was scared out of my mind when my boyfriend (now husband) and I decided to actually go through with this.

Instead, here’s a photo of the two of us back in our youth:

sarah and husband

Before I get into how we actually carried across all that money, let’s go over why we actually did it.

I lived in China for 8 years. I must have really liked it because that’s where I met my husband, got married and had a kid.

Among the cool things you get to do? Visit really crazy places. One of the most memorable places was a restaurant called “Modern Toilet” where you literally get served chocolate ice cream in toilet bowls. I’m not kidding.

 

While there were many great things I loved about China, unfortunately the major drawback was their banking system. (It has gotten noticeably better over the years for expats, but at the time we were living there it was terribly frustrating)

Language barriers aside, doing any kind of international transactions was a pain in the ass. My husband and I each saved quite a bit of money in our accounts living there, and we both needed to transfer this money into our home country’s accounts to pay bills and for other reasons. This meant that every month or so, we had to go to the bank to do two wire transfers: one to my bank in Canada where I’m originally from, and another into my husband’s account in the U.S..

The rules in China, however, are that you’re only allowed to transfer a certain amount of money internationally every month. On top of that, whenever you wanted to make a transfer you not only needed your IDs, but a whole slew of paperwork as well. This included our work contracts, our Chinese tax returns, official declarations from the government about how much we made, and a stack of forms from the bank. There was also no online banking or instructions/bank tellers who spoke English there at the time (7 years ago), so we had to rely on Google Translate to figure everything out.

I waited at least two hours every time I went to the bank on a good day, and it wasn’t ever fun for the tellers either. They had to stamp every freaking piece of paper, get approval from the manager for every button they pressed on the computer, and all the while trying their best to speak broken English.

My husband didn’t fair any better during his visit either. In fact, he’d go multiple rounds trying to make the transfers happen while each time wasting two hours and then at the end being denied over and over!

We even tried giving Western Union a shot to see if it’d be any easier (and cheaper).

Nope.

We ended up paying almost 10% in fees alone and it was equally as frustrating.

Then one day my husband joked that we should just buy a briefcase and carry all our cash over when we both went home for the holidays.

I’m always up for a challenge, so why the heck not? What could go wrong?

It was about three months from the time we decided to bring cash across to the U.S. and Canada to when we actually did it. Our plan was to exchange our money into U.S. and Canadian currency first, hide it in our apartment, pack it all in a suitcase, and then deposit everything once we landed in our home countries.

We looked up the maximum amount we could each carry across the border, and it came out to $10,000 USD per family. Since my husband and I weren’t technically married yet, that meant we could each carry $10,000 across the border without raising any eyebrows (or so we hoped).

Unfortunately, once again our plan hit some road bumps.

When we tried to convert our Chinese currency (RMB) into U.S. and Canadian dollars at the bank, we were met with solid resistance. The manager would literally give us “a look” and then flat out refuse to speak to us. We later found a translator who told us that it was virtually impossible for even locals to get foreign currency, and that the amount we were requesting was unheard of.

After grilling a local friend for alternatives, we eventually decided to take out Chinese RMB in cash, and then take that directly to a currency exchange stand in order to convert it over. She warned us that these places are usually located in sketchy areas, however, and that not so reputable people hang out there (though I hear it’s not the case anymore). These places will also try to rip you off by giving you decent exchange rates, but then sneaking in counterfeit bills.

So off my husband and I went. We didn’t want to do too large a transaction at first just to be safe, so we started with $1,000 and found a place to exchange our money. My husband is six feet tall and I’m pretty sure that helped keep the loiters at bay. When we got our money, we hid around a corner to check each and every single bill to make sure they were legit, and then went on our merry way when it was good.

It took us about six weeks to exchange $10,000 each. You’re only allowed to exchange a certain amount each time, so we had to make multiple visits which was for the best as neither of us enjoys carrying around too much cash at one time.

During this time we hid the money around our apartments. I literally stuck hundred dollar bills under my mattress among other places as I was so paranoid about someone breaking in! We also hid money:

  • In jacket pockets
  • In shoes
  • In crockpots we barely used
  • And in tupperware

When it came time to go visit our families at Christmas, we gathered all our money in one place and planned how we were going to pack it all.

I don’t know about you, but seeing $20,000 in physical cash is A LOT. We had it stacked on my bed and it looked like a giant mountain to me. I looked at my husband and literally asked if I could swim in it. After all, it was a once in a lifetime experience!

Next thing we knew, we threw a bunch of bills up in the air and were frolicking around in money. There’s something about doing backstrokes on a bed with $20,000 that does it for you 🙂

money pool

Finally, We Carry The Cash Over

Now came the hard part: how do we actually carry all this cash? Without getting stopped at the border?

We crossed off the suitcase idea as that would just be way too suspicious, and eventually figured that dispersing our money was the way go to. The x-rays will show we had money, but at least there wouldn’t be huge stacks all in one place.

Here’s what my husband did:

  • Bought special cargo pants with multiple pockets so he could take the cash in and out when going through security
  • Sewed secret pockets in his laptop case
  • Rolled up t-shirts in his carry on luggage with money in it
  • Carried cash in his wallet

Here’s what I did:

  • Hid cash in my laptop case and purse
  • Stuffed some money in my bra (this was before those fancy machines at the TSA security check)
  • Stuffed money in my makeup case
  • Put bills in-between pages of the books I was “reading”

Keep in mind, we weren’t doing anything illegal although it sure as hell felt like we were. In hindsight we probably went a little crazy on hiding everything, but I wasn’t going to take any chances with people either stealing from us or being stopped at the border. Our track record up to this point hadn’t been that smooth.

Then off we went!

Step #1: Go through security in China and board the plane. Success! We stated we were carrying cash, but nobody asked us how much so we easily got our exit stamps.

Step #2: Relax on the plane. Fail. We could barely sleep, as we were just too paranoid the entire trip.

Step #3: Get across the U.S. border! (We made our first stop in my husband’s country before heading to Canada). My hands were shaking the entire time as I filled out the immigration form –  I felt like I was lying when the form asked if I was carrying more than $10,000 in cash, but I checked the “no” box.

Then it was the moment of truth…

I walked over to the customs agent, he looks at me and then down at the form, asks me where I’m staying (I manage to utter “my future in-laws”), looks back down again, and then stamps the passport and says, “have a nice time.”

And just like that it was over! WE DID IT!!

My husband had the same experience clearing customs, and it was a piece of cake getting the second half of our money into my Canadian bank as well.

Pretty anti-climactic, I know – sorry – but what a whirlwind getting to this point… I’m just super grateful I never have to deal with this again. Though I have to admit, it was pretty fun swimming in all that money for a few minutes!

Anyone else ever launder move large amounts of cash across the border? Any tips for anyone who may have to do it themselves one day?

My Top 7 Disagreements With Personal Finance Experts

As members of the FIRE (Financial Independence, Retire Early) community, we are all nonconformist. We scoff at conspicuous consumption of our neighbors in their full-size SUVs and McMansions, and instead budget with a very sharp pencil (spreadsheets are fine, too) and grow our stealth wealth, one dollar at a time.

But the FIRE community is far from monolithic. For example, I consider myself nonconformist even inside our nonconformist movement! I hold some pretty strong non-consensus views on many financial topics. I’m a rebel among the rebels, imagine that!

Here’s a list of my seven favorite disagreements with the personal finance consensus:

#1: The 4% Safe Withdrawal Rate is safe! (No it is not)

The Trinity Study and the resulting 4% recommended safe withdrawal rate have become the gold standard when designing a savings target (25x annual spending) and the eventual withdrawal strategy. Even J$ here uses it. There are (at least) two problems when extrapolating the Trinity calculations to the early retirement community.

First, instead of a 30-year horizon in the Trinity Study, the average early retiree faces a 50-60 year horizon. That wouldn’t be a problem if the success criterion in the Trinity had been capital preservation, i.e., preserving the purchasing power of the initial portfolio value for 30 years. If your capital lasts for 30 years, then why shouldn’t it last another 20-30 years? But for the Trinity Study, even a portfolio value $0.01 after 30 years is considered a success. That one cent will not last another 20-30 years!

To gauge how much of a “haircut” we should apply to the 30-year safe withdrawal rates when extending the retirement horizon, let’s do the following thought-experiment.

Imagine we have a $1m portfolio that generates 4% p.a. (per annum) of real return in the long-term, but we got unlucky and suffer 10% losses for the first three years, followed by three years of 10% gains and then 4% returns after that (assume all returns are real and all withdrawals adjusted for inflation). That’s not even a worst-case scenario, more of a garden-variety bear market.

Our portfolio can then sustain a withdrawal rate of about 4.27% p.a. for a 30-year horizon. But over longer horizons that number will be significantly lower: Only 3.26% over 60 years, a whole percentage point less and that’s all because of the longer horizon!

safe withdrawal routes time horizons

[Figure 1: Path of portfolio values over 30, 40, 50, and 60-year horizon with different withdrawal rates, targeting capital depletion.]

The second objection is that today’s expected asset returns are significantly lower than the average returns observed since 1926. The Trinity Study averages over many decades with different financial market regimes. Sometimes the stock market was overvalued, sometimes undervalued. Sometimes bond yields were very high, sometimes they were very low.

Does anybody else see a problem with that procedure? Relying on safe withdrawal rates that are averaged over the past 90 years is a little bit like calculating the probability of getting into a traffic jam by averaging over the entire 24 hours of the day. That may not be the most informative figure if you already know that you will be driving during rush hour!

For today’s retirees, only today’s market conditions matter, not the averages over the last 90 years. And more than seven years in the current economic expansion, equities look more expensive than over the last 90 years (measured by the CAPE ratio) as I show in this blog post. Bonds don’t look too hot either. Since 1926, the real, inflation-adjusted bond returns were solidly above 2% for government bonds, and even above 3% for corporate bonds, but today’s yields are far lower. Lower bond yields and expensive equity valuations support only significantly lower safe withdrawal rates than 4%.

If 4% doesn’t work, then what’s the alternative? Personally, I plan to start with a lower withdrawal rate of 3-3.25% out of our equity portfolio to account for today’s expensive valuations and the long retirement horizon. Having income-producing assets with a less than perfect equity correlation is also a good idea, so, I started moving some of my investments into rental real estate. Owning rental properties with a 4%+ rental yield (after all maintenance and repair costs!) I can probably push the overall withdrawal rate to 3.5%.

This number, though, is not set in stone. If the CAPE ratio were to drop to a more normal level, say, under 20 (currently around 27) I could move the withdrawal rate closer to 4% again.

#2: Robo-Advisers are great! (If by “great” you mean “expensive”)

You can’t read through the personal finance blog world without finding glowing endorsements of Robo-Advisers, like Betterment and Wealthfront. I beg to differ though, and recommend Robo-Advisers only to my most financially disinterested friends.

But folks in the FIRE community? We are the masters of budgeting and frugality, financial hackers (not hacks) and always on our toes to find new ways to eke out a basis point (0.01%) of return. Why would we want to throw away anywhere between 0.15% and 0.35% in fees p.a.?

Robo-Advisers do nothing magical and are nothing but expensive gimmicks. You can go to their website, find out their recommended asset allocation and simply implement it with inexpensive index funds at Vanguard or Fidelity. But do you even want to use their recommended asset allocation? You could do significantly better by further hacking their recommended allocation, for example moving ETFs with a high dividend yield and taxable bonds from taxable to tax-deferred accounts.

But what about tax loss harvesting? Tax loss harvesting is a neat tool that can lower your taxable income by up to $3,000 p.a., so folks in high tax brackets can save $1,000 or more on their annual tax bill. In taxable accounts, simply sell your underwater investments, i.e., equities, ETFs and mutual fund shares that have a cost basis greater than their current value, and the loss can be used to offset up to $3,000 of ordinary income per year. Check Bogleheads for more details.

Robo-Advisers can do this process really well and in a systematic and automated fashion. But apart from the fact that we find Tax Loss Harvesting overrated (see #7 below), it’s also something that most investors should be able to do themselves. Here’s my guide to becoming your own homebrew Robo-Adviser. Do it yourself and save thousands of dollars over the years!

Finally, under no circumstances should anybody ever shift an existing brokerage account with sizable capital gains to the Robo-Advisers, because they might first liquidate your holdings to purchase their recommended ETFs.

And that’s true whether you are an experienced financial hacker or complete finance novice. I’ve saved $42,000 by not switching to Betterment! The tax bill could be so excessive you’ll never recover the loss even under the most optimistic assumptions for harvesting future tax losses.

#3: Everyone Needs an Emergency Fund! (Not everyone)

The almost universally accepted wisdom is that not only do we all need an emergency fund, but building that emergency fund is the number one priority of personal finance, taking higher priority than saving for retirement. Some even want you to start an emergency fund before paying off high-interest credit card debt. That’s nuts!

I laid out our plan for having no emergency fund (featured on RockstarFinance on 5/25/2016!) and two follow-up posts as well to debunk some of the common arguments in favor of the emergency fund. With our savings rate of 60%+ we are usually able to finance all expected and unexpected expenses out of our current cash flow.

Just to be sure, I’m not saying that anyone should forego savings altogether. An emergency fund is better than having no savings at all. I merely take offense in keeping large amounts of money in unproductive, low-interest money market accounts. I consider our entire portfolio our emergency fund and like to put our hard-earned dollars where they can work harder for us: in equity and real estate investments.

Am I not afraid of having to dig into an equity portfolio right when the market is down? Yes, to a degree, but as a passive investor, I try to stay away from timing the market. Keeping cash on the sidelines for fear of a market decline exactly coinciding with a cash flow need is market timing on steroids!

#4: Use bonds to diversify equity risk. (Don’t get your hopes up too high!)

What was the correlation between an all-equity portfolio and a portfolio with 80% equities and 20% bonds over the last ten years? 0.998. For all practical purposes, that’s a correlation of one.

To be sure, the 80/20 portfolio has a lower volatility; pretty much exactly 20% lower. But that volatility reduction came from the lower equity weight and had little to do with bonds reducing risk. In fact, simply keeping the 20% in a money market account would have achieved that exact same volatility reduction. That said, bonds delivered very nice average returns over the last few years, so the appeal of an 80/20 stock/bond portfolio came mostly from better returns than investing 20% in a money market account.

But that could change in the future; yields have been heading higher since November 8th, and bonds could have a rocky road ahead of them. In addition to having little diversification, they could also lose their potential to boost returns.

#5: Bonds are safer than stocks. (Depends on the horizon!)

Of course, stocks tend to have higher daily, weekly, monthly, even annual volatility than most bonds. No discussion about that. So, for folks with a very short investment horizon stocks may seem unattractive. But over a 50-year investment horizon, we should weigh the short-term volatility with the long-term sustainability of funding our expenses in retirement.

There have been extended periods of very poor bond returns. For example, there was one 80-year window (!) of zero real (inflation adjusted) bond returns from about 1900 to 1982. True, equities can be volatile in the short-term. You see overreactions both on the upside (late 1990s) and downside (2009). But equities normally return to a long-term trend growth path within a few years, see chart below.

Bonds, on the other hand, can move sideways for many decades. That’s poison for the retiree who relies on a nest egg to last for half a century! And what’s worse, the spectacular run of good bond returns that started in 1982, might be overdue for a reversal as has happened with the other two bond bull markets in the late 1800s and 1920-1940. I’m not saying that this will start now, but bonds did get crushed after the spike in interest rates since November 8th!

bonds riskier than stocks
[Figure 2: Which one is the risky asset now? Cumulative real total returns (CPI-Adjusted) of the S&P 500 and 10-year U.S. government bonds. January 1871- December 2015.]

So, to stay with our “financial rebel” theme, just like our American Founding Fathers preferred “dangerous liberty over peaceful servitude,” this writer likes dangerous equity volatility more than running out of money for sure with low volatility bonds!

#6: Cash serves as great bear market insurance in retirement. (Think again)

The idea sounds almost too good to be true: simply keep a few years’ worth of expenses in a money market account, enough to fund expenses during the occasional bear market, and we never have to worry about market volatility. Unfortunately, it is too good to be true.

The first issue is opportunity cost. The cash cushion is a little bit like leaving the house every morning wearing a Robin Hood costume, just in case I might come across a fancy-dress party that day. That strategy works beautifully every year in late October, but it would be a bit of a burden for the rest of the year. Likewise, the opportunity cost of carrying too much unneeded cash when there isn’t a bear market can compromise the average portfolio return. Remember, timing Halloween parties in late October is easier than timing the next bear market!

But even if you do get lucky and have the cash cushion ready to go at the onset of a bear market, it’s not going to make much of a difference. If you were unlucky and started your retirement too close to the market peak in 2000, then with or without the cash cushion your retirement portfolio would have been seriously compromised; we are talking about “going back to work” compromised! True, the portfolio with the cash cushion would have been slightly less compromised than an all-equity portfolio, but still seriously underwater. The cash cushion is no panacea because you will have to replenish the cash cushion right around the time when the stock market rallies again.

One way or another, opportunity costs will catch up with you! It’s very simple: there is no true bear market insurance. A good start would be using a lower withdrawal rate (see #1 above) and being prepared for plan B, plan C, and all the way to plan J (Money).

#7: Tax loss harvesting saves you a ton! (It’s nice, but you won’t get rich)

As mentioned above, I do the tax loss harvesting by hand without any help from the Robo-Advisers and my guide on how to be your own Robo-Adviser has a lot of the details on how to do this right.

Did I become rich from tax loss harvesting? Absolutely not! The claims of 0.7% or even north of 1% of additional annual returns from tax-loss harvesting claimed by the Robo-Advisers are vastly exaggerated. If you are like me your taxable portfolio is the result of many years of regular investments. So, even a bear market with a 20%+ drop right now would result in much less than 20% harvestable losses. I have some tax lots that would require a 50%, even all the way up to 70% drop in the stock market before generating even a single tax loss dollar.

My personal estimate is that I have generated less than 0.10% in additional annual return from tax-loss harvesting so far. Going forward, especially once I retire, the benefit will likely go away altogether.

I put together some calculations on how much extra return you’ll likely generate depending on different marginal tax rate scenarios and portfolio sizes. Under most realistic assumptions, the benefit is even lower than the 0.15% to 0.35% Robo-Advisers fees. It’s a benefit large enough to not leave on the table, but don’t get your hopes up too high. And don’t pay anyone 0.35% p.a. to do it for you, either!

I’ll now be taking all questions and concerns below 🙂

That Time I Maximized Regret

My home has two HVAC systems, one for the downstairs and one for the upstairs bedrooms and bathrooms. I had both installed after we moved here eleven years ago.

Eleven years isn’t an awfully long lifespan for a modern HVAC system; one hopes to get 15 years and perhaps 20 years of service before replacing them.

Ours had become unreliable. We had failures at least once in each of the past three winters so I decided to replace the downstairs unit with a more efficient gas furnace last fall. I hoped to get a year or two more service from the upstairs unit and reasoned that, even if it failed, we could limp along with the new downstairs unit while we repaired the upstairs. Besides, squeezing a couple more years out of the old unit and postponing the replacement costs was only good economics, right?

Last week, the Raleigh area experienced the worst cold spell in the past 130 years according to local news reports and measured at RDU. No doubt it was actually longer but they’ve only kept records for 130 years. Not surprisingly, our upstairs unit failed (heating systems rarely fail around here in July) plunging our bedroom and bathroom into a permafrost zone as temperatures outside fell to as low as 4º F.

(As an aside, please note that improbable events are not impossible, like 4º low temperatures in Chapel Hill, NC and investment portfolio failures, but I digress.)

Now, that may sound wimpy to the sturdy folks of Embarrass, Minnesota, but let’s just say that I had different expectations when I retired to North Carolina.

Given the cold spell’s demand on local HVAC service companies, it took two days to have a repairman spend 10 minutes determining that the cost of repairs would be nearly the cost of installing a new system. I learned this late Friday afternoon and had to wait until Monday morning to have the new furnace installed.We lost heat on Wednesday, the day the cold spell began, and had an operational system again on Monday evening, the day the cold spell ended, proving for the umpteenth time that Murphy was not only a genius but also an optimist.

For five days, I slept in long flannel pajamas, wool socks, and a hoodie with a hot water bottle near my feet. (And let me just throw this out there: hot water bottles are a delight that we maybe shouldn’t relegate to history’s dustbin, as they say.)

I learned to shower, shave and get dressed in under 90 seconds.

Had I followed my own advice when deciding to delay installation of the upstairs heat pump instead of replacing both during the perfect temperatures last fall, I would have anticipated my regret from all possible outcomes.

Had I replaced the upstairs system last fall and missed out on the few dollars of savings I would gain from delaying, my inner financial analyst would have regretted the lost savings opportunity.

I would have anticipated regretting much more my actual outcome, a week of frosty indoor temperatures for the want of saving a hundred bucks or so.

By failing to give my decision the gravity it deserved, I maximized regret.

To put this into a retirement planning context, consider the ever-popular «probability of ruin.» We can build a retirement plan that has «only» a 1-in-10 to 1-in-20 chance that we will outlive our savings, but it’s probably worth a few minutes considering how much we might regret our plan if we lost that bet.

To my credit, I avoided the Tech Crash by reasoning that, while I would regret selling my tech stocks if prices continued to soar, I would regret far more losing the financial security I had already attained on paper.

A dear friend lost his entire $4M retirement savings when MCI crashed. He was nearing retirement age. That’s a lot of regret.

It was 34º when we headed for the coffee shop the morning after we got the heat fixed.

It felt downright balmy.

Minimizing Regret

I’m reading Algorithms to Live By: The Computer Science of Human Decisionsby Brian Christian and Tom Griffiths[1]. Following is an excerpt.

Regret can also be highly motivating. Before he decided to start Amazon.com, Jeff Bezos had a secure and well-paid position at the investment company D. E. Shaw & Co. in New York. Starting an online bookstore in Seattle was going to be a big leap—something that his boss (that’s D. E. Shaw) advised him to think about carefully. Says Bezos:

«The framework I found, which made the decision incredibly easy, was what I called—which only a nerd would call—a “regret minimization framework.” So I wanted to project myself forward to age 80 and say, “Okay, now I’m looking back on my life. I want to have minimized the number of regrets I have.” I knew that when I was 80 I was not going to regret having tried this. I was not going to regret trying to participate in this thing called the Internet that I thought was going to be a really big deal. I knew that if I failed I wouldn’t regret that, but I knew the one thing I might regret is not ever having tried. I knew that that would haunt me every day, and so, when I thought about it that way it was an incredibly easy decision.»

Regret minimization can be a powerful tool for making retirement planning decisions. I have always used a similar approach to my critical life decisions. I wrote about it in a post some time back, but my process works like this.

I imagine myself at some point in the future long after having made the decision and I imagine that it turned out very badly. My future self then asks, «Do I still think it was a good decision? Would I make it again?» If my future self answers no, then my present self doesn’t make that decision.

Even though I assume my decision turned out badly, I recognize that good decisions can have bad outcomes. I can accept bad outcomes if I made the best decision available to me at the time. A poor decision that ends well is just dumb luck.

Imagine that you are a basketball player about to take a game-winning (or losing) shot. Your shot is a low-percentage gamble but you can also pass to a teammate who has a better shot.

If you take the shot and win, you will have a great outcome from a poor decision. Try that often and you will lose a lot.

If you pass to the open teammate and he misses, you suffer a poor outcome from a good decision. Make that kind of decision often and you’ll win more than you lose.

The fact that nearly all retirement finance decisions are probabilistic means that we can make bad decisions that turn out well or good decisions that turn out badly. To complicate matters, our own retirement is a one-time event. If we could have many retirements, a 90% probability of success would mean that 90% of our retirements would be successful, but we only get one. We can and should bet on the 90% probability but if we lose the bet, 100% of our outcomes (there will only be one) will be bad. When we lose the bet, the outcome won’t be bad 10% of the time or only 10% bad.

Still, the better strategy is to consistently make good decisions or «the best bets», if you prefer. While we only get one shot at claiming Social Security benefits, for example, we will make many other retirement decisions and if we choose the 90% probability bet every time we are likely to win most of them.

Recently, a reader commented that since we can’t be sure that delaying Social Security benefits will have a good outcome we really can’t make a blanket assessment of the strategy. We can’t make a blanket statement about the outcomes, true enough, but we can make a blanket statement about the quality of the decision.

Minimizing regret is an excellent tool for deciding when to claim Social Security benefits, assuming your financial circumstances afford you the option.

Retirees who delay claiming and die early in retirement might regret that they could have received greater benefits had they not delayed, at least to the extent that people who are no longer living have regrets.

Married retirees, however, will have surviving spouses whose survivors benefits may be limited (if they are the lower earner) by the higher-earning spouse claiming early and that spouse may not regret your decision to delay even if you do regret it.

Retirees who claim early and live a very long time will likely regret their lower lifetime benefits. Widows who live on reduced survivors benefits long after their husband passes because he claimed early might regret having let him make the financial decisions.

We might regret delaying claiming if Social Security were to be abandoned entirely by the federal government early in our retirement. I wouldn’t regret my decision to delay in that scenario because I assign a low probability to my cohort losing those benefits. After that outcome, I believe I would say that I would make the same decision under the same circumstances if I had it to do over.

You, however, might not agree with that assessment or might be substantially younger and have a different outlook. Regret minimization can be subjective and risk can be dependent on one’s life expectancy.

Regret can be a personal thing, though it can often be measured objectively in dollars. The dollar amount of regret can be defined as the difference between the outcome you expect and the outcome that would have resulted from clairvoyance, ie., from knowing the best answer. If the best possible strategy would have resulted in a $100 profit and yours results in $90, you have $10 of regret.One way to look at the Social Security claiming decision is to consider how much you or your surviving spouse would regret that decision in various scenarios and to make the choice based on avoiding scenarios with the greatest regret. This process won’t favor delaying claims for every person in every scenario, but often it will.

Minimizing regret doesn’t have to be the only tool you use for a specific decision but it may provide an additional perspective. Optimization tools like MaximizeMySocial Security[2], Financial Engines[3] or AARP[4], for example, also provide useful input.

Likewise, Social Security claiming isn’t the only retirement decision for which regret minimization might be useful. Let’s look at asset allocation.

I am thoroughly enjoying Algorithms and plan to read it again as soon as I finish. Be forewarned, however, that if you’re not a computer scientist, you might be happier reading tax tables. That having been said, here’s another excerpt that I enjoyed.

Harry Markowitz won the Nobel Prize in Economics for developing Modern Portfolio Theory (MPT). MPT calculates an «efficient frontier» of portfolio allocations that maximizes portfolio returns for various levels of market risk.

MPT determines an optimal asset allocation based on risk tolerance, market volatility, risk-free rates and the covariance of asset classes.

How did the father of Modern Portfolio Theory allocate the assets in his own retirement portfolio?

«I should have computed the historical covariances of the asset classes and drawn an efficient frontier. Instead, I visualized my grief if the stock market went way up and I wasn’t in it—or if it went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions fifty-fifty between bonds and equities.»

Interestingly, a 50% equity allocation falls into the sweet spot of several very different research strategies. Using a complicated simulation strategy, Gordon Irlam found that the 95% confidence interval for the optimal asset allocation ranges from 10% to 80% equities.

Using a much simpler simulation strategy, William Bengen’s work on sustainable withdrawal rates shows optimum asset allocations between about 35% and 60%.

In a paper entitled Nearly optimal asset allocations in retirement[5], Wade Pfau concludes, «with Monte Carlo simulations based on historical data parameters, a 4.4 percent withdrawal rate for a 30-year horizon could be supported with a 10 percent chance of failure using a 50/50 asset allocation of stocks and bonds. But the range of stock allocations supporting a withdrawal rate within 0.1 percentage points of this maximum extend from 27 to 87 percent.»

That’s a lot of research to find answers consistent with «My intention was to minimize my future regret. . . So I split my contributions fifty-fifty.«

The Markowitz story also struck a chord with me on a topic to which I have been giving a great deal of thought lately.

We have faster computers, better algorithms, and more in-depth research into retirement financial planning but very little empirical evidence to show how much they actually improve outcomes.

There is talk of «evidence-based» strategies, but retirement research doesn’t work like medical research. We can’t ask one group of retirees to use a portfolio-spending strategy and a control group to buy annuities and compare the results after 30 years. Even if we could, market uncertainty means we can’t expect similar outcomes the next time we run the experiment.

What we will find is evidence of uncertainty.

If Harry Markowitz thought that a fifty-fifty regret-minimizing strategy was preferable to mean-variance optimization, I won’t argue.