Phipps Lane

Or — How to turn $173,000 into only $61,679 “safely”

Have you heard this “joke:” How do you make a small fortune? Start out with a large one. Long-term investors – that’s most of us — usually start out wanting a high rate of return combined with low risk or volatility. If only that were possible. You don’t have to become a casualty of financial malpractice. That fantasy is just what drove the recent Ponzi scandals.

Human nature also dictates that investors would like a high degree of certainty about the performance of their investments in the long-term. That is, most would like consistency. Like the old salesman said, “you can have any two of the following three: cheap; fast; good — but only two of them. Which two do you want?”

You can have high, reliable and predictable returns.
But not consistently; nor with certainty.

Perhaps a good perspective on the COST of consistency (or certainty) is to examine what is arguably the most certain and safe investment of all time — a 30-year U.S. Treasury Bond. Throughout the history of investing, the 30-year US Treasury Bonds may be the safest and most certain investment ever crafted by mankind.

Let’s assume that a conservative investor committed $100,000 to a 30-year Treasury Bond; currently, the investor would realize a yield of about 3.75% annually. After appropriate allowances for a 35% tax rate and a 3.5% inflation rate, the net return in real dollars to our investor typically and consistently would be negative 1% per year.

How does that happen?

Not only did your nominal after tax return of $73,170 actually only have a purchase value of $26,069 over the years, but also the $39,415 in actual taxes paid has the opposite effect of costing $67,884. And the initial $100,000, though returned in total, now only has the purchase power of $35,628.

So although the nominal effect is a total return of $173,000; but, the effective TOTAL RETURN (after adding the $35,628 and the $26,069) now acts and feels like ONLY $61,679. Hence, you would have achieved an awful reverse alchemy.

Yes, that’s right. A loss of over $38,000.

How is that for safety and certainty? The unfortunate reality is that the taxes are paid currently, and the inflation is compounded: a double whammy.

Therefore, our investors will get virtually no real return; however, he/she could take great comfort in the “certainty” that the initial investment amount will be returned in 30 years.

This is the price of certainty.

Since it is impossible to obtain satisfactory, high long-term investment returns, with safety and certainty, our choices boil down to the following:

–First, we can opt for “certainty” as illustrated by the preceding example. How much of that certainty would you like? A false sense of security.

–The second alternative is to work with a true financial coach to invest to achieve the most efficient long-term rate of return, Healthy Returns, while controlling and reducing uncertainty and risk as much as possible. True peace of mind.

It has been said that there are only two sure things in life—death and taxes. No one can stop or predict your death. And, we are in this business of Financial Coaching specifically to show you how to avoid, defer, eliminate or reduce your tax burden, through “bright line”, legal, solid, and proven strategies, while optimizing your investment performance. (For a discussion on some of the inappropriate offerings that you must avoid contact us directly).

So what is the third sure thing? First allow me to digress. John Maynard Keynes, who is venerated by some and abhorred by others, nevertheless was a clever and educated person. He said in the “long run, we are all dead.”

That is a truism. Even though it may be a little vacuous. And it may not be exactly true: for many of us, we expect to leave a legacy for our families or for our charities. So the investments need to last, perhaps, several lifetimes.

But how should most of us measure the long run for our investment purposes? For us, I submit it is 20 years or more.

In life, that third sure thing is INFLATION.

No one can stop inflation. Yet, not enough inflation is a bad thing. Think deflation, and the depression.

Too much may be a worse thing. It destroys wealth and income and results in perverse incentives and behaviors. The “right” amount of inflation seems to be in the 2-3% range.

Historically, over the past several centuries, by all measures, in all countries examined, inflation has averaged 3-3.5%. That also has been the average rate of inflation over the past 50 years in the United States when my father purchased his first house.

For the affluent, it has been shown that inflation is even significantly HIGHER than that.

Think about how much more it costs now to consume or to own luxury goods and services. Art, caviar and wine, travel, jewelry, personal security, education, to name a few. (For an analysis that lends support to that ever-increasing rate of inflation for the affluent, contact us directly).

How does the long run relate to inflation? As an example of inflation, my father recently purchased a Lexus. Not the top of the line model, either. In fact, it was the entry level ES 330. He paid twice as much for that car as he did for his first house.

That is inflation’s long-term erosion of your purchasing power. That erosion is inevitable. We must plan for inflation and be prepared for it. We must combat inflation. How?

It is not urban myth: if you took the $24 in Wampum paid for Manhattan Island about 400 years ago, and invested it at 1.8% over the 3.3% rate of inflation (the documented average annual long term rate of return for real estate investments), that investment would now equal the total value of all the real estate on the island.

Even if that is a myth, the point is clear.

(But it is probably true: using a compound interest calculator you can verify for it yourself: $24 at 5.1% annual rate of return, compounded daily, for 400 years yields over $1 Trillion — that is $1 followed by 12 zeroes; in 2004, the City of New York’s own web site of assessed, not actual, real estate value was $169 Billion. But why quibble about only a factor of 10?). Inflation is a major threat, a real threat, to your investments.

Could inflation be the world’s eighth deadly evil?

Well, inflation is the inverse of compound interest. Albert Einstein called compound interest the eighth wonder of the world. Invest so that you harness the power of compound interest to combat inflation and the other risks.

Applying our expertise can help guide you through the maze, and the fog of investing. As a professional, we can help you avoid the big, and costly mistakes. Let us make investing clear and simple. Not easy, but simple.

Let us show you how to achieve market returns, while limiting and managing your risks. Let us help you achieve clarity, comfort, and confidence. Because after all, it is not only how much you make; it is how much you keep.

It is our mission to bring you a prudent process for investing and prosperity. To empower investors:

“Empowering Investors to Achieve Healthy Returns™.”

Through transparency. Through full disclosure. Through true universal access. Through alignment of interests. To enable you to progress from scarcity, losses, fear, and frustration to abundance and peace of mind. To bring you clarity and confidence. To bring you Financial Freedom.

The equity markets historically have been the best way for investors to achieve their long-term financial goals. According to the book, “Triumph of the Optimists”, this has been true for at least 230 years, and in all 16 of the countries that have had equity markets for that duration. Through — and despite — all the wars, natural disasters, revolutions, and financial calamities and depressions.

But what is your long-term, and real, time horizon? How much yield do you need to sacrifice for a decrease in risk? How do you know?

Because, there are numerous and tremendously treacherous traps set by the misguided and innocent, but with the unintended consequence that shares the same results (or the miscreants who apparently actually may have designs) — to separate you from your wealth: the IRS, trial attorneys, government policy, unscrupulous bankers, unwitting advisors, feckless associates — waiting to lose or to take (which is worse?) what is yours.

Beware of these traps. There are risks we know, risks we know we don’t know, and risks we don’t know we don’t know.

As Mark Twain said, “it ain’t what he don’t know,
it’s what he knows that just ain’t so…”

Among so many others, here is just a smattering of risks:

–There is business risk for each individual stock or bond you may purchase.

–There is sector or industry risk (think buggy whip, or type writer industry), especially if you invest in funds.

–There is geographic risk (think Detroit versus the South for automobiles, or Western developed countries with rule of law and property rights versus countries designated as not-free, with weak rule of law and property rights).

–There is the “black swan” risk, where extraordinary and unexpected things take place that theoretically never should have.

–There is behavior risk. Your own behavior, as well that of others. Your emotions may get in the way of good decisions. Your advisors may not be immune to these same emotions, either. Investors –large and small, sophisticated and novice — are subject to their own misbehaviors (and this is compounded by the “advice” of investment advisors, financial planners, industry shills, and financial media to continue doing the exact wrong things). The misbehaviors contribute to the Financial Cancer™ and to the Financial Malpractice™ . One such misbehavior is Alpha seeking: sounds mysterious or sophisticated, but just means that you are trying to beat the markets. Sure, some can and do beat the markets. In some cases it appears they beat the markets consistently. But how can you identify these market beaters in advance? You can’t. And when you chase them, the results are usually very disappointing or worse. Misbehaviors include buying high and selling low, track record chasing, market-timing, and speculating and gambling. These misbehaviors are not investing at all.

–There are fees and expenses, which put your returns at risk. These are often gigantic. All funds have their “net expense ratio” which is their cost to do business on your behalf. In addition, there are the hidden fees, such as the cost of the “bid-ask spreads” on the underlying securities, and the transaction costs due to turnover. This is true with mutual funds, and even separately managed accounts, but especially so with hedge funds, and private equity funds.

–There is liquidity risk. How can liquidity be risky? It is either subject to very low interest rates of return because it is tied to debt instruments (CD’s, Money Market Mutual Funds, Bonds, etc.) and thus erosion of principal return, or to equity markets’ fluctuations (something we endured in 2001-2 and again in 2007-8).

–Taxation is a risk we all know. Taxation is probably the biggest risk we face. If you do not believe me, or need proof or corroboration, or just are unsure how big the problem is, contact me to share with you a spreadsheet that shows just how your largest creditors (the taxing authorities) place your investments at risk. Insidiously, or overtly. But continuously and inevitably.

However as counter-intuitive it may be, and however contrary to what some financial media “pundits” have espoused, the biggest risks are taxation, and inflation (another government “policy”, though sometimes not intentional).