Tom’s Quarterly Reads

Here is what I’ve been thinking about, plus the best articles I read over the past three months, mostly all finance-related. Your feedback is always welcome, and please share this with anyone else who might be interested. Subscribe here.

How Big is the Racial Wealth Gap? (Of Dollars and Data): “The actual wealth gap between a typical Black household and a typical White household is a factor of 10. We shouldn’t have to adjust for education or income to explain it away. This, in itself, is defeat. Instead, we should ask ourselves why there is a massive gap in education and income between Black households and White households in the first place. This is where we must start.”

Everyone has something they enjoy doing with their money. In fact, the purpose of having a financial plan is so that there is money available to be spend of something that you get enjoyment out of. But structuring your accounts and decision-making process is essential to enjoying yourself while not impacting your larger financial life.

Structure on a day-to-day level is the difference between paying for each drink at the bar with cash versus having an open tab that you might run up too fast. Structure on a longer-term level is having your 401(k) contributions taken out of your paycheck before the money even comes to your bank account.

So find where you want to play, and then build what I like to refer to as a sandbox. I like this analogy because it’s where you can let your inhibitions go and truly enjoy yourself. But most importantly, as long as the sandbox is built correctly, whatever you do inside the sandbox doesn’t matter – the sand can be re-leveled and you’ve done no lasting damage to your financial future.

A specific example of this sandbox idea involves those who like to play in the stock market. This is a conversation I’ve had with quite a number of people so far this year, and it’s very timely with the recent focus on day-trading in general, and Robinhood in particular, in financial media. While playing around in the stock market certainly doesn’t appeal to everyone, the concept of structuring things so you can play without doing damage applies to all of us in one way or another.

Similar to going out for a nice dinner, or playing in a fantasy football league with a buy-in, those that enjoy making moves in the market get enjoyment from more than one source. There is enjoyment in researching all of the restaurant options, or players available, or stocks that might perform well. There is the enjoyment of the food itself, watching your fantasy players perform well after you put them in your line-up, and watching the stocks you picked go up and up. And then there are the bragging rights, which we all love: posting a picture of your meal on social media, talking trash to the team you played against in the fantasy league, and bragging at parties about the awesome stocks you picked.

In all of these cases, the money spent, or deposited up front, is the cost of enjoying the process; on a budget, these expenses would all be best categorized under “Entertainment”. None of these is a question of “or”, but rather of “and”. You don’t choose between nice dinners out or a nice retirement; you want to figure out how to do both. It usually makes sense to avoid eating at a Michelin-starred restaurants every night of the week. And I don’t put up a house as my fantasy league buy-in. If someone gets enjoyment from taking chances in the market, we want to set up a way to do that and to maintain a long-term investment plan.

My approach to building an investing sandbox is to create what I call a “steam valve” account. It is a small amount of money (in percentage terms), usually in a separate account, that can be invested however you see fit. The advantage of the steam valve account it that it provides an outlet to make moves and feel like you’re doing something when the market is making big moves up or down, so that you leave the vast majority of your portfolio on autopilot.

The steam valve sits alongside a large, well-diversified, long-term investment portfolio that properly takes your risk tolerance and risk capacity into account. How small is the account? Optimally it’s no more than 5% of your portfolio; small enough that if it goes to zero it won’t hurt your long-term financial situation.

To be clear, I don’t want your steam valve account to go to zero. In fact, I’d love to hear about how well it’s doing and what smart stock picks you made. But the key is to never depend on the steam valve account to provide the funding for any of your goals. Given that the investment approach is likely to be on the much riskier side of things, you wouldn’t want to put your financial plan at risk of a sudden market drop or bad decision. But if the account grows immensely, and some funds can be pulled out to spend more that you planned, then that’s just the cherry on top.

Given that the steam valve is often an entirely separate account – to reduce the temptation to mix up funds that have different purposes – you can put that wherever you’d like. And a cheap way to set up a small trading account these days is Robinhood. To be clear, I’m not specifically in favor of using the app; it’s designed to get your adrenaline going and increase your trading speed, which leaves less time for considered investment decisions. But many of the macro concerns about Robinhood – that it has been manipulating the market, that trading costs are exorbitant, that they are selling order flow, etc – are probably overblown (the story does a good job of looking at some Robinhood myths and concrete examples of the costs of trading with them). But, if you’re going to use Robinhood, then you certainly should understand exactly how Robinhood makes money, And more importantly understand the stocks that you’re buying and selling – particularly if you get into options trading. Understanding what you own makes it more likely you’ll stick with the position through a temporary rough patch, and it can help avoid shockingly sad stories.

But no matter what platform you use to trade, the idea is the same: put a structure in place so that you don’t impair your long-term finances.

No matter what you like to do with your money, build a sandbox so you can play in the way that’s most enjoyable for you.

It’s OK to Spend Your Savings (She Picks Up Pennies): Your emergency fund is for emergencies. A night out with friends (remember those?) isn’t an emergency. Don’t use your emergency fund for that. A pandemic is an emergency. Use your emergency fund for that.

Who Pays For This? (Collaborative Fund): Government spending for Covid-related relief has been massive; so how do we pay for it? Possibly taxes; here’s a VAT proposal. But from Morgan Housel’s perspective: “You don’t pay it off. You grow your way out of it. This isn’t intuitive because it doesn’t apply to people… because people have finite careers and lifespans, so there’s an “end date” where all debts have to be repaid. Countries (and to some extent companies) are different. They have indefinite lives.”.

The Worst Dilemma in Investing (Blair Belle Curve): Selling all of your stock and going to cash means you are presented with an impossible problem: when to buy again.

What Prior Market Crashes Can Teach Us About Navigating the Current One (Morningstar): A comprehensive look at market crashes over the last 150 years, with charts for visual people like me.

Stock Market’s Wild Mood Swings Can Be Explained by Mr. Spock (Bloomberg): Not as inane of an article asthe headline suggests. Why does the stock market seem to be moving completely opposite the direction of the economy as a whole? The stock market is both rational and irrational; it is both efficient and inefficient. We understand less than we think.

Market Update X: A Corporate Life Cycle Perspective (Aswath Damodaran): “It should therefore come as no surprise that just as the virus has had its most deadly effects on the elderly and the infirm, the market is meting out its biggest punishment to mature and aging companies.”

Debate: Should Advisors Have Taken PPP Loans? (Barron’s): An interesting question in the advising community, but very relevant for clients to consider, especially since taking PPP loans will likely have to be disclosed on regulatory filings going forward. I did not take out a PPP loan, or even apply for one. However, that doesn’t make me better or worse than advisors or other business owners who did take the PPP loans – it just means we were in different situations.

Farewell Yield (Humble Dollar): Could this rough of interest rate drops means the end of safe yields in bonds? While rates may not stay low forever, it makes sense to readjust our savings, and revisit how our investment expectations compare with the loans we’re currently paying down.

A Look at the Mushrooming Menu of Thematic Funds (Morningstar): Marketing is everything; the company that puts together an ETF makes money from more people buying the ETF. Always know what you are buying and specifically what it’s investing in – don’t let a fund name lure you in. Also worth noting that a new breed of less-transparent ETFs is entering the market as well.

Vatican calls on Catholics to divest from fossil fuels (CNN): This one got an audible whistle from me. In ‘Laudato Si’, Pope Francis said “Building safe, accessible, reliable and efficient energy systems based on renewable energy sources would make it possible to respond to the needs of the poorest populations and at the same time limit global warming,” and among other topics it also included support for a carbon emissions tax.

DOL Gives Green Light for Private Equity in 401(k)s (ThinkAdvisor): This approval lets 401(k) plans include multi-asset funds that have private equity holdings – very different from allowing funds that are solely private equity, but seems like a step in that direction. As always, understand what you are buying.

A Thrift Savings Plan Update (Morningstar): More positive changes to TSP that were long overdue; the L Funds (lifecycle, or target-date funds) are moving much closer to industry averages and best practices. Good to see continuing changes; TSP has improved immensely in the last 10-15 years.

When poignant stories outweigh cold hard facts (ScienceDirect): Academic paper that finds “anecdotal evidence to be more persuasive than statistical evidence when emotional engagement is high, as when issues involve a severe threat, health, or oneself.” Seems like something we should all keep in mind these days.

Nearly Half of Men Say They Do Most of the Home Schooling. 3 Percent of Women Agree (NY Times): I’m shocked, shocked. Had to include this since we could all use a good laugh. (My money is not on the guys here.)

The Price of Isolation (Rolling Stone): “A study of the 2003 SARS epidemic — localized though it was — found that ‘quarantined persons … exhibited a high prevalence of psychological distress,’ with PTSD observed in almost 30 percent of cases. The longer someone was isolated, the greater their chance of developing PTSD grew.”

The Coming Disruption (New York Magazine): While it should be noted that the guy making the predictions in this article has founded his own virtual classroom start-up, it is certainly interesting to try and see what the future of higher education will look like. An interesting vision: “There will be a dip, the mother of all V’s, among the top-50 universities, where the revenues are hit in the short run and then technology will expand their enrollments and they will come back stronger. In ten years, it’s feasible to think that MIT doesn’t welcome 1,000 freshmen to campus; it welcomes 10,000. What that means is the top-20 universities globally are going to become even stronger. What it also means is that universities Nos. 20 to 50 are fine. But Nos. 50 to 1,000 go out of business or become a shadow of themselves.”