Monetary Offset

      No Comments on Monetary Offset

People are always enthralled with stories of the man behind the curtain, a force that doesn’t get much recognition, but actually runs the world. I think this is why the Narcos shows on Netflix are so popular.

Enter the ultimate economic version of this, monetary offset. In the last episode of my weekly market and economy recap show, I talked about how Trump is complaining about the Fed.

Monetary offset is the reason why.

We often hear about fiscal policy, whether you are for it or against it, the government spending dollars undeniably has an inflationary effect. However, fiscal policy has an older brother that is actually pulling the strings, and that’s monetary policy. Monetary policy is what the Fed sets, and the Fed has the luxury of seeing exactly what the government is doing with fiscal policy, and then can factor that in when deciding whether to tighten or loosen borrowing conditions.

This is the essence of monetary offset. Of course, if the Federal government pays people to dig holes and fill them back in, that will still happen, so clearly an economy is best served by having both sides doing a good job. However, just one doing a bad job can derail the other, and at the end of the day, the Fed controls inflation because the Fed can offset anything that the treasury does.

8 Reasons People Hate Stock Buybacks

      No Comments on 8 Reasons People Hate Stock Buybacks

With stock buybacks taking heat and even crazy uncle Bernie getting in on the action, I figured the time was right for me to join the chorus of finance professionals happy to give you their two cents about them.

I won’t focus much on the theoretical side, other than to briefly cover the main points that have been fleshed out many times. Here, here, here.

The theoretical argument goes pretty much as follows: a stock buyback is exactly the same as a dividend, except instead of cash landing in your account (as a taxable event, mind you), there are fewer shares outstanding and therefore the price of your stock goes up (ceteris paribus).

As the saying goes, in theory, there is no difference between theory and practice, in practice, there is.

So let’s talk about the differences.

As a brief refresher, dividends are pretty simple, and most of them are recurring (monthly, quarterly, or annual), and (mostly amateur) investment theses have been built around them. The company periodically takes some cash and distributes it to the shareholders, a certain amount per share that you own. This is taxable to you (usually between 15-24% Federally depending on your tax bracket).

Buybacks differ from dividends in a few key ways:

  1. They aren’t typically regularly recurring. This makes them feel special and unpredictable.
  2. They may be equivalent to many years of cash build-up, so you can get a nice headline grabbing number like $100 billion.
  3. They don’t show up as cash in your portfolio, you have to make the cash available yourself by selling a portion of your shares.
  4. It is hard to keep track of how much value is being returned to you via share buyback. Your portfolio does not have a section that tells you how much of the appreciation of your shares is due to the fact that you now own a larger portion of the company.
  5. The value of a buyback is small compared to the daily fluctuations of the market. A stock could easily be down the day of a substantial share buyback for reasons related to the economics of the company.
  6. Somehow dividends seem to escape scrutiny here (see #5 above), despite stocks losing value when the dividends become payable.
  7. Dividends have acquired a sheen of being deserved, we work hard at something and it pays dividends this is good.
  8. Buyback has a negative mood affiliation. I’m not sure if it is the ‘buy’ that sounds greedy, or ‘back’, where it also sounds greedy, or a combination of the two, but somehow share buybacks sound greedy to most people. It manages to bring out the Australian in all of us.

However, even given these concrete reasons, I think the most likely reason people dislike buybacks is simple misunderstanding. Dividends are simple. Own shares, get cash. Buybacks are complicated, and somewhat unseen.

Most people do not have the mental energy to spare on the thought exercise of a share buyback (see example at bottom here). To them, stock ownership is some form of gambling, and therefore buybacks do not confer value to the shareholders while dividends clearly do.

How the Athlete Retirement Calculator Works

      No Comments on How the Athlete Retirement Calculator Works

I built an athlete retirement calculator, and here is the breakdown of what the inputs are and how to use it, as well as a few caveats.

Let’s start with a walk through of what the inputs mean:

Annual Spending During Career: Just what it sounds like, outside of taxes and commissions/fees, how much do you spend each year while you are under contract?

Current Assets: Your current investment savings, probably doesn’t make sense to count the value of a house or anything.

% of Contract You Keep: Athletes only keep 40-60% of what they make after taxes and other costs are factored in. If you know what you keep, punch it in.

The rest of the sections are simple, they are current contract length and earnings per year (before taxes and fees) and there are two more identical sections so you can look at two additional contracts after your current one.

A few important comments. I made no attempt to factor in capital gains taxes over time, which would start to be a bigger factor decades down the line. I made no allowance for pensions or social security or the retirement account that is being maxed out each year by some of the leagues. Those would all be additive.

I assumed the portfolio gets 7% returns for the length of the combined contracts. Once the final contract is done, the balance of the portfolio is divided by 25, in other words, allowing the spend of 4% of the portfolio each year. Very simplified version of planning, but also very practical.

If you wanted to add in something like a house purchase, but didn’t want to mess up the other calculations, you could factor it in by subtracting the amount you pay for it from “Current Assets”, yes, it will work even if that makes the Current Assets number negative.

How much can an NBA player retire on?

      No Comments on How much can an NBA player retire on?

Everyone has heard the stat that 60% of NBA players and 80% of NFL players are bankrupt 5 years after they leave the league. Most people are incredulous — how could someone who makes millions spend it all?

I decided to run the numbers for myself and see just what kind of lifestyle an NBA career could guarantee somebody for the rest of their life.

The average NBA player is making about $7.7 million this year, and the average NBA player plays for about 5 years.

Now, NBA players only take home between 40-55% of their headline salary after taxes and fees are taken out.

So, I built a calculator to assist in answering my question. Using assumptions detailed on the calculator page, we can see that an NBA player’s ability to spend in retirement matters greatly on how much they spend during those NBA years.

If the player makes $7.7 million for five years and keeps 50% of that after taxes, agent fees, etc., if he spends $1 million per year, he would end his career with about $17.5 million put away, and be able to spend about $700,000 per year throughout the rest of his life.

According to Time, the average NBA player spends about $500,000 per year. In that case, the player would retire with over $20 million saved up and be able to spend $825,000 per year – more than when he was playing!

Of course, the numbers go the other way as well, a player who spends $2 million per year while he is playing would have to adjust his lifestyle to less than a quarter of that, below $500,000 per year to make it last in retirement.

Let’s have a little fun. What do the numbers look like for a number one pick? Markelle Fultz is set to make about $15 million guaranteed for the first two years, followed by a couple of team option years.

If all he gets (and I hope greatly that this is not the case) is this $15 million, and he’s spending $1 million per year while he plays, he can set himself up to spend about $250,000 each year for the rest of his life. Not bad. If the team picks up both of those options, that doubles – $500,000 per year! What if he buys a $2 million house in addition to his regular spending? That reduces his future spending by about $100,000 per year!

Tax Brackets

      No Comments on Tax Brackets

Taxes are very daunting the first time you encounter them, and can be confusing even for those who deal with them all the time.

This post is meant to clear up a misunderstanding that is extremely prevalent.

That misunderstanding is about how tax brackets work. I have heard many times, from friends and clients alike, that they do not want to earn a certain amount of money because it will ‘move them into a higher tax bracket’. Usually what they mean can be illustrated in the following example:

If there were two tax brackets, one from $1-100,000, where income is taxed at 10%, and one from $100,000 and beyond taxed at 20%, they believe that if they earn $95,000, they will pay $9,500 in taxes and keep $85,500, but if they earn $105,000, they will be taxed at 20%, paying $21,000 in taxes and keeping just $84,000.

In fact, the way income taxes work, you will almost always be better off by earning an extra dollar. That’s because brackets don’t go away once you pass them. In our example-world, everyone who earns up to $100,000 pays 10% in tax, and if you earn over $100,000, you pay $10,000 in tax on the first $100,000 that you earned, and 20% on all of the other dollars. Our hypothetical $105,000 earner will pay $10,000 in tax on the $100K and $1,000 in tax on the next $5K, paying total tax of $11,000 and keeping $94K.

I should note that there are a few exceptions (two examples below, but certainly not exhaustive) to the rule of thumb that these ‘cliffs’ do not exist, a common one is the price you pay for medicare. Other exceptions that come to mind are for those receiving significant assistance (mostly near poverty lines or receiving disability benefits). In some cases increasing their income by $1,000 may reduce benefits or increase taxes on them by close to or more than that same $1,000.

Assuming no exceptions apply to you, you can relax, there are no magic earnings numbers you need to avoid because they will cost you money.

Of course, you may be less inclined to work extra for the second $100K if it is taxed twice as much. An economy-wide application of this concept is the Laffer Curve.

Compounding

      No Comments on Compounding

Ah, compounding. Perhaps the most well known quote about compounding is an apocryphal one attributed to Albert Einstein.

Compound interest is the eighth wonder of the world.”

-[Almost certainly not] Albert Einstein

Regardless of the provenance of the quote, the gist is mostly correct. Compound interest is so powerful that it is very difficult to properly do compounding math in one’s head. The ‘rule of 72’ helps us with approximations. The rule says that if you divide 72 by the rate of return, the result is the amount of years it takes something to double. So for instance, if something returns 10% per year, we expect it to take 72/10 = 7.2 years to double. The actual answer is 7.28 in case you’re curious.

This is quite a bit shorter than the simple 10 you might get from saying that 100% return is doubling, and there are 10 10%s in 100% and therefore it will take 10 years.

Assuming 10% annual returns (which I’ll note is quite high), that means if you invest a dollar for 7.5 years you expect it to double, for 15 you expect it to quadruple, for 22.5 it will be 8x what you invested, and 30, 16x.

30 years is still shorter than many working careers and retirements, if you start working at 25, you might have savings invested for 35 years until you’re 60, and again for another 35 if you live till you are 95.

This is why compound math is so important.

It is also very important to understand when compound math is being used to trick you. I have seen many life insurance policies pitched to people around 30 years old that guarantees to be worth seven times what they put in by the time they are 80. This can sound great. However, if you crunch the numbers, you’ll find that an investment that increases seven-fold over 50 years has given you a return of under 4% per year. Not so attractive, perhaps.

Compound returns are why it can be so valuable to start investing early. A couple with $500,000 invested at age 40 and earning 7% per year will see that number grow to $2.7 million at age 65 with no further savings. If it takes you ten more years, only reaching that $500,000 by age 50, at age 65 you’ll have about $1.4 million.

In fact, to catch up to the same $2.7 million as the couple that reached $500,000 by 40 and didn’t save any more, the couple with $500,000 at 50 would need to save $53K per year from age 50 until 65.