The Miracle of Compounding Illustrated: How Much Easier Is It to Save $1 Million If You Start In Your 20’s?

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MO Savs For $1 Million

So you are in your 20’s or 30’s and retirement seems so far away. Why bother saving for the future when there are so many things vying for priority in your budget today? This chart is a great illustration of why. To reach $1 million before tax at a 6.5% annual return by your 65th birthday requires saving $438 a month starting at age 25, $904 a month starting at age 35, or $5,938 a month starting at age 55.

These are just illustrations, and they make no heroic assumptions about sky-high returns. You could do a lot worse than an index fund or target retirement fund from Vanguard. Just don’t invest money earmarked for a short-term need like living expenses or a downpayment on a house in the stock market. Put an amount in month after month, in up markets and down, and raise it if your income allows. Start your snowball young and give it a long time to build. Decades from now you will be happy you did.

Beyond putting the money aside, your biggest temptation may be to sell or at least stop buying when the stock market has one of its occasional meltdowns. As long as you are broadly diversified and won’t need to touch the money for 5 to 10 years or more, you should ignore the market’s gyrations. The real risk in investing is the loss of purchasing power from inflation. Don Yacktman really seared this into my brain in this video when he made this point: 3% inflation for 100 years turns a dollar into a nickel. This is why your long-term money should be stock heavy.

Life is all about choices and tradeoffs, and it can be hard to choose between spending now or investing for far away in the future. First of all, stay out of debt beyond a home mortgage, a car payment, or student loans. Paying debt down first makes a lot of sense. Beyond that, anything you put away today will make it much easier to reach your goals later. Your future self will thank you.

See also:

How Have Stocks Fared the Past 50 Years? You’ll Be Surprised

Beware of These Cognitive Biases

Charlie Munger’s Investment Principles And Checklists [IN-DEPTH]

S&P 500 Trailing 12-Month P/E Ratio Hits Six-Year High

Stocks That Triple In One Year

Karl Popper on The Line Between Science and Pseudoscience

“The future should be viewed not as a fixed outcome that’s destined to happen and capable of being predicted, but as a range of possibilities and, hopefully on the basis of insight into their respective likelihoods, as a probability distribution.”
— Howard Marks

Investors: Magical Thinking Is No Substitute For Common Sense

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There Is No Free Lunch

As Ben Carlson shows in his blog post “Investors in Search of 7-Minute Abs,” investors are always on the lookout for a way to earn big returns with no risk. And many con artists say they can deliver. This is why guys like Bernie Madoff get money. Everyone wants to believe. But great returns with no risk is an impossibility. Magical thinking is no way to manage your portfolio if you want to reach your financial goals.

Most Active Fund Managers Are Index-Huggers

Most active fund managers have low active share, which is how different a portfolio is from its benchmark. This means these managers amount to index huggers that don’t deviate that much from their benchmarks. This makes it very hard to outperform, even when we get the proverbial “stock picker’s market.” Of course, a fund with high active share can underperform as well as outperform significantly, but if you are in effect buying an index fund with higher costs, you aren’t going to be getting even the index returns.

Poor Investor Behavior Means Most Investors Don’t Get Fund Returns Even In Index Funds

When you look at the return data for your funds, you likely assume they represent your returns. Au contraire! As Morgan Housel shows here, the average investor in Vanguard’s S&P 500 index fund earned 1.9% per year less than the fund’s indicated returns. Why? Bad investor behavior. We tend to buy high and sell low. So if you are actually getting index returns, you are an above average investor! If so, congratulations on your mastery of your emotions. Focusing on controlling your behavior is likely to bear more fruit than chasing hot returns. Know thyself!

The Hedge Fund Myth

People drool at the idea that they can get one of the elite hedge fund guys to manage their money. And the hedge funds certainly promise big returns. Here are some hedge fund mandates from Bloomberg:

“Expects a return of 10 percent to 15 percent and drawdowns of no more than 5 percent to 10 percent.”

“Managers should have a strong pedigree and expect a return of at least 12 to 15 percent in the coming quarters.”

“The firm generally targets returns of 15 percent and volatility should be 7 percent.”

So how have they done against those promised big returns? Pretty lousy. Over the last decade, 2 major hedge fund indices are both negative.

And if you say you don’t want average, you want the cream of the crop, those legends aren’t taking your money. So, never mind.

What Is An Investor To Do?

So it all comes back to managing your own behavior and lengthening your time horizon. Patience and equanimity are the individual investor’s advantages over the pros who are focused on the next couple of quarters.

And for active investors I submit the following formula from Todd Wenning:

Investing Success = Good Company + Right Price + Investment + Patience

Simple, but not easy. But it’s the only game in town for real investors. Otherwise, you’re just taking your chances speculating in the casino at the corner of Wall and Broad Streets.

See also:

Active Mutual Funds With Large Holdings of ETFs Badly Underperform

The Anti-Reading List

New Rule to Shift Leases Onto Corporate Balance Sheets Starting in 2019

Why Do Stocks Beat Bonds?

What If The Future Is Better Than We Think?

Best Online Brokers: Fidelity Wins in Barron’s 2016 Survey

Todd Wenning’s New Book Is Out! — Keeping Your Dividend Edge: Strategies for Growing & Protecting Your Dividends

Edward Chancellor Interview About The Capital Cycle Approach To Investing: 5 Good Questions

Negative Interest Rates: An Idea Only An Academic Could Love

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Negative interest rates are a hot topic lately. They are already in use in Europe, Japan, and elsewhere. There is even talk that they may be coming to the USA. What an absolutely terrible idea. Those pushing it are pursuing a small, theoretical, short-term benefit at the price of a large, long-term cost.

“The bad economist pursues a small present good that will be followed by a great evil to come.”
— Frederic Bastiat

The intent of negative interest rates is to get the economy going by forcing banks to lend their excess reserves and penalizing individuals for saving so they will go out and spend, spend, spend. While this might give a slight bump to GDP in the short term, it would be a disaster for the long term. A great deal of capital would be misallocated to uneconomic endeavors, and much of the population would be broken of their habit of saving, perhaps for good. It would likely also finish off the attachment most people have to the current system of currency and finance. If you can’t rely on a dollar being a dollar, then why not bitcoins or gold?

Individual savers already suffer the hardships of negligible returns and their purchasing power being eaten away by inflation. To charge them a fee to save would be insult on top of injury. To tax saving is to tax virtue, and when you tax something, you get less of it. This can only be bad for individuals and society as a whole. What virtue we have left should be encouraged, not punished.

Resorting to a negative interest-rate policy would be to turn reality on its head. And markets and investors would likely see it as a desperate act that means things are much worse than they thought. This is an idea whose time will never come.

“The economy is a complex, nonlinear, adaptive system where short run effects are often opposite of long run effects.”
— Eric Falkenstein

See also:

Negative-Rates Fallout Makes ECB’s Task Harder

Negative 0.5% Interest Rate: Why People Are Paying to Save

NIRP

Lessons From The Kinder Morgan Bloodbath for Income Investors

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KMI Chart EOD 12-8-15

The Kinder Morgan (KMI) bloodbath that culminated in a 75% cut in its dividend last night after the bell and a roughly 60% loss year to date has been sickening to behold. A good deal less so for me as I sold Kinder Morgan Energy Partners (KMP) in the spring of 2014, largely on the recommendation of Josh Peters at Morningstar.

For a while this looked too cautious and even a bit foolish as KMI announced its takeover of KMP and both stocks put in a substantial rally. But such is the price of risk management. You give up some potential upside if everything goes great, but you’ll be in better shape if things turn south.

Here is a link to Josh’s rationale, in his own words:
Video: Josh Peters Not Buying the New Kinder 8-14-2014

Kinder’s Biggest Problem: No Margins of Safety

I mean “margin of safety” more broadly than just buying at a discount to fair value a la Ben Graham. There was no margin of safety around Kinder Morgan’s business model, leverage, or its distributable cash flow coverage ratio.

1. No Margin of Safety With Its Business Model — While advertised as a simple fee-based pipeline business, a significant portion of Kinder’s business is in enhanced oil recovery — oil production. This was great with $100 a barrel oil, but not so much after it fell to $40 a barrel. So cash flows were punished significantly by the oil price crash.

2. No Margin of Safety With Leverage — Running at almost 6 times debt to EBITDA, Kinder was roughly twice as indebted as its more conservative peers. Thus, it ran out of borrowing capacity when the decline in its stock price made it uneconomic to fund growth expenditures by issuing shares of stock. This crystallized recently when Moody’s put their debt on Creditwatch Negative for a downgrade to junk status. They had little choice but to cut the dividend in response.

3. No Margin of Safety With Their Distributable Cash Flow Coverage Ratio — Kinder Morgan has had the pedal to the floor by paying out every cent available for a long time, computed in an aggressive fashion. This kind of thing works as long as nothing goes wrong. Not very smart to own such a business as an income-focused investor.

Lessons From Kinder Morgan’s Bloodbath for Income Investors

Inverting the Kinder Morgan case, you want to look for a business with stable cash flows. Or to the degree that its cash flows are cyclical, you want to have excess distribution coverage so the stress on the distribution will be manageable in a downturn. And for sure, you don’t want a company that is levered up to the max in the good times so it has no excess borrowing capacity in a downturn.

Ideally, you want a company with a margin of safety in all three areas. 2 out of 3 should be a minimum for consideration. If you can learn these lessons without paying the tuition of a permanent loss of capital, you will be far ahead of the game.

“The essence of investment management is the management of risks, not the management of returns. Well-managed portfolios start with this precept.”
— Benjamin Graham

“The best investors do not target return; they focus first on risk, and only then decide whether the projected return justifies taking each particular risk.”
— Seth Klarman

See also:

As Oil Keeps Falling, Nobody Is Blinking

The Stock Market Is Missing the Warning from Junk

Donald Yacktman: “Viewing Stocks As Bonds” | Talks at Google

What Bill Gates Shares With the Skeptical Environmentalist

Mark Zuckerberg’s Billion-Dollar Chance to Save the World

WSJ: Population Implosion: How Demographics Rule the Global Economy

As Paris Meeting Approaches, Climate Change Movement Shows Its Lack of Seriousness

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I am not a Climate Change denier. There is some evidence that, all else equal, human activity may contribute at the margin to a very gradual increase in the Earth’s average temperature. However, that doesn’t mean that it will cause a cataclysm, that it is the biggest problem facing the world, or that an infinite price should be paid to halt or reverse it. The inability or unwillingness to put it in proper perspective, do sensible cost/benefit analysis, and seek realistic solutions is what keeps the Climate Change Movement from being a force for good.

The fundamental fact of human existence is that our wants are infinite and our resources are limited. I believe in spending reasonable sums for research and development on solar and other technological improvements that may solve the problem or help manage the consequences at an acceptable cost to humanity.

But as this peer reviewed paper by Bjorn Lomborg shows using the standard MAGICC Climate Model, the current prescriptions of the Climate Change Movement call for the world to spend on the order of $85 TRILLION through 2100, with an effect of only 0.17 degrees Celsius. This is almost zero progress for an incredible cost, while hundreds of millions of people in the world are starving, lack basic sanitation, and don’t have access to electricity.

What a stunning thing that such a group of people with collectively high IQs can be so blinded to common sense. Something tells me that incentive-caused bias (promoting the view that will keep their research budgets well-funded) is not limited to those pushing fossil fuels. Not to mention the profiteering by Al Gore and friends which by some accounts has him approaching billionaire status.

It is the responsibility of sensible people in the scientific community to think outside the box and work to create technological solutions to the problem. Not to demand a gigantic and pointless penance from humanity which cannot even properly feed and clothe all of its members.

See also:

Gambling the World Economy on Climate

Impact of Current Climate Proposals

The Tyranny of a Big Idea: The Attraction of the Secular Mind to the Politics of Impending Apocalypse

Capitalism Makes You Cleaner

Is Climate Science Really Settled?

The Scientific Method and Climate Change