Freedom Formula
Sanjib Saha | May 28, 2020
EARLY RETIREMENT isn’t a common goal among my friends. When I talk about my semi-retirement, many assume I either made a quick buck in the stock market or benefitted from some sort of financial windfall. I counter this misconception by narrating the magic formula: Financial freedom is frugality, multiplied by simplicity, compounded by patience. My response often seems mysterious until I explain the two basic math concepts behind it. We learn them in school, but rarely internalize them. One is simple subtraction and the other is compounding. Subtraction tells us that savings equals income minus spending. The more we save, the faster our nest egg piles up. But looking at it from a savings perspective tells only half the story. If we let our lifestyle grow ever more lavish, even regular salary increases won’t get us to financial freedom any sooner. Indeed, keeping our spending in check has a double benefit. First, a reduction in spending increases our regular savings by the same amount. We can sock away more money and reach our target sooner. Second, lower spending means that we need less to cover our living expenses and that shrinks our target nest egg proportionately. In other words, if we hold down spending, we not only go faster, but also we have less distance to cover. Consider a 25-year-old man and woman, both earning $75,000 a year. To them, financial freedom is about having enough money so that a conservative 3% annual withdrawal rate can cover half of their spending. The man saves 10% of pretax income, while the woman socks away 25%. Let’s assume their savings earn 6% a year. The two charts below track their progress toward financial freedom, with the green bars showing their nest egg's current value and the peach-colored area indicating the sum that…
Read more » A Narrow Escape
Sanjib Saha | Aug 12, 2022
I ENVY THOSE WHO can remain patient and calm in almost any situation. Thanks to my neurotic personality, I find it hard to wait for an outcome over which I have little control. This year, I narrowly escaped that sort of agonizing experience. What happened? We found ourselves selling our home during 2022’s suddenly cooling real estate market. I was surprised last year when the red-hot property market pushed our modest home past the $1 million mark. With prices so high, we decided to sell our paid-off house and move to one that offered more space and privacy. The place we settled on as our next home was a 50-year-old house in dire need of repairs and a facelift. We wanted to remodel it before moving in—and before selling the house we currently lived in. The remodeling started last summer at a sluggish pace. It was great not to live in a house that’s being remodeled, but it also made it harder for us to monitor progress and deal with contractors. The work dragged on, thanks to supply issues, contractor delays and COVID. I pretended to stay patient. My anxiety started rising as whispers about a possible cooling of the housing market grew louder. After all, we had to sell the old house after we moved into the new one. If it didn’t sell within a reasonable time and at a reasonable price, it would mess up our financial plans. I neither fancied being a landlord nor wanted to leave a large chunk of our assets locked up in real estate. As mortgage rates ticked higher, we revised our plan. Instead of waiting for the remodeling to be wrapped up, we decided to move in by early spring. We called up a moving company and set a date in March. We…
Read more » Mounting Costs
Sanjib Saha | Aug 14, 2022
INFLATION CROPS UP in almost every conversation I have with friends and acquaintances. Everyone’s getting squeezed by higher prices. Folks complain not only about where prices are today, but also about how quickly they rose. Prices today seem shocking compared to last year or the year before that. But how do they compare to prices from 10 years ago? To find out, I calculated the average annual inflation rate over trailing 10-year periods using the Consumer Price Index for All Urban Consumers (CPI-U). The chart below shows the rolling 10-year average annual inflation rate for the past 80 years. Lately, 12-month CPI-U has been running around 9%. But if we extend the time horizon back 10 years, to mid-2012, the recent spike barely registers, with the average annual increase for the past decade coming in at just 2.6%. From this longer-term perspective, inflation looks deceptively mild. Going back 10 more years, the average annual price increase for the 10 years through mid-2012 was 2.5%, almost identical to the most recent 10-year stretch. Does anyone remember a ruckus being made about price increases in 2012 similar to the one being raised today? My point: A sudden surge in inflation causes panic, but the insidious effect of slow and steady inflation gets little attention. When I pointed this out to a friend, he wasn’t impressed. It seems he would’ve preferred steady, annual price increases of 2.6%, instead of the low inflation we’ve enjoyed for much of the past decade followed by a sudden spike. I wasn’t so sure. Why not? Let’s assume my friend’s annual spending as of mid-2012 was $10,000 a year and his yearly expenses went up in lockstep with CPI-U. His total expenses from July 2012 to June 2022 would amount to $110,267. But if, instead, he got his…
Read more » Measuring Up
Sanjib Saha | Nov 14, 2019
IT BAFFLES ME that people often favor stock-picking over index funds—and yet they fail to measure their portfolio’s performance against a proper benchmark. I’m not talking about those who buy a few individual stocks for entertainment or education. For them, it’s a worthwhile pastime and the stakes are low. But there are others who ignore the evidence and arguments against active management, and devote serious money to picking stocks and timing the market in hopes they’ll earn market-beating returns. This group includes a number of people I know—folks I otherwise admire for their intelligence, critical thinking and self-awareness. These acquaintances are do-it-yourself investors who actively manage their investment accounts, and they do so with confidence. I’ve probed a little to find out what lies behind this confidence. My conclusion: Improper benchmarking is a common cause. In other words, many think their strategy has played out well, but—in reality—their investments have lagged behind an appropriate market benchmark. Why don’t they realize this? I’ve spotted two mistakes. First, they’re misled by the outsized performance of a few stock picks. I have a friend from work, whom I’ll call Techie. A few years ago, he researched and bought a dozen stocks—all members of the popular Nasdaq 100 Index. A few years later, Techie’s picks rode the bull wave upward. Two stocks did especially well, the rest not so much. The net result: Techie’s portfolio underperformed the indexes that his investments should have been benchmarked against. Yet the outperformance of the two picks, coupled with his portfolio’s overall gain, gave Techie false confidence in his stock-picking skills. That brings me to the second error that I’ve seen drive overconfidence. This mistake affects people who make regular contributions to—and withdrawals from—their investment account. At issue is comparing an account’s dollar-weighted return to a benchmark index’s time-weighted…
Read more » Risky Option
Sanjib Saha | Jan 7, 2020
AS A KID, MY MOST revered manmade invention was not a train or a record player, but rather the Swiss Army pocketknife. When I saw it for the first time at a friend’s home, I was fascinated that it could cut paper, open bottles, file nails and more. I marveled at the engineering beauty and wished I had one of my own. Years later, I was in Switzerland for a short business trip and had some free time for souvenir shopping. I saw a Wenger Swiss Army knife and fondly remembered my childhood wish. Without a second thought, I bought one that had a dozen or so attachments. After returning home, I was eager to show off my new toy to my wife and daughter. I used it wherever I could. My daughter was amused to discover the child in her dad. My wife teased me about my sudden interest in kitchen chores. Sadly, a minor mishap soon ended my excitement. My wife was trying to open a jar that was stubbornly jammed. I offered to help and took out my pocketknife to showcase its versatility. The first few attempts failed, and yet I didn’t want to give up on my favorite tool. I opened more blades and applied pressure. The knife slipped and I badly cut my hand. I recalled this incident a few years ago, when I was learning about financial derivatives, and specifically stock and index options. I was intrigued by Warren Buffett’s view of derivatives as “financial weapons of mass destruction.” I researched online, attended webinars and even studied a 1,000-page book. It struck me that options were the Swiss Army knife of investment tools. They’re elegant, versatile and nifty, but also deceptively dangerous even for experienced investors. Their elegance lies in the simplicity of the basic…
Read more » Inflated Anxiety
Sanjib Saha | Jul 26, 2021
MY EMPLOYER’S 401(K) plan is great, with a generous matching contribution and lots of investment options. Those looking for even more choice can open a brokerage subaccount within the 401(k), allowing them to buy thousands of securities. I’ve stayed away from the brokerage option, in part because I feared the extra choice might affect my investment discipline. But my growing anxiety about inflation forced me to reconsider. I want a predictable cash reserve to cover my expenses for the next 10 years, independent of how the financial markets perform. That’s why a large portion of my 401(k) is invested in Vanguard Short-Term Bond Index Fund (symbol: VBIPX). Problem is, while the fund should hold its own in a broad market decline, it does little to preserve my money’s purchasing power. Everywhere I look, I’ve been noticing price creep. Initially, I took it as temporary phenomenon, the result of a post-lockdown spending surge. But the inflation spikes of recent months have spooked me. My anxiety kept rising despite the Federal Reserve’s insistence that this was only temporary. I’ve always felt that even the Fed—the expert of experts—has a hard time predicting and controlling inflation. To tame my anxiety, I opened a brokerage subaccount in my 401(k). The process was simple and quick. In a few days, I was able to raise cash by selling a large portion of my Vanguard Short-Term Bond Index Fund. I used the proceeds to invest in inflation-indexed Treasury bonds through another low-cost Vanguard fund (VTIP). Was it a good move? My rational self is half-convinced. But my emotional self couldn’t be happier. Sometimes it feels good to have a little insurance.
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