Teaching Our Children About Investments

Average Rate of Return

I think the first thing a child should learn is what is a reasonable investment return.  Once your child has an investment, say a Roth IRA after starting to work and make money, then your child might be surprised that the investment does not skyrocket out of sight.  The article The Market Isn’t Going to Save You From Saving Too Little by James Mackintosh, July 26, 2018, Wall Street Journal, says, "Since 1900, U.S. stocks have returned 6.5% a year after inflation, including dividends, according to academics Elroy Dimson, Paul Marsh and Mike Staunton."

Inflation

Explain to your child that inflation steals his money.  So if the investment fund says the investment returned 9% last year, and the Federal Reserve claims 2% inflation, then assume the real inflation was at least 3% because the Fed lies about inflation.  Thus a 9% rate of return, minus 3% inflation produces 6% real return, which is like the historical average.

It so happens that the long term average inflation rate in America has been 3.22% per this article:  Long Term U.S. Inflation by Tim McMahon (April 2014).

The Rule of 72

I suggested you teach your children about the Rule of 72 back in April 2015:  Teaching Our Kids About Interest and Inflation.  Now you can point out that 72 / 6% = 12 years for the investment to double.  The investment will grow, but patience is required.  Some other time we might talk about dollar cost averaging.

Safeguarding Savings

I suggest you teach your children to guard their money against losses.  Here is an example I use:  You start with $20,000 in an investment.  It is a risky and volatile investment, so one year you lose 50%.  Now your investment has dropped to $10,000.  The next year your investment bounces back with a 50% gain.  Have you gotten your money back?  Fifty percent down and then fifty percent up, so are you good?  The math says that a 50% gain on $10,000 gives you $15,000, so you are still down $5,000.  It is easier to lose money than to make money in investments.  Investments are a long game. Taking risk for high gains is gambling, it is speculation, but it is not investment.

Hot Shots Like to Crow

I also tell my children that when people they know make a lot of money with an investment, then they might crow about it.  But when they lose a lot of money in the market, they rarely confess their failures.  They will hear plenty about success and little about failures.  Most hot-shot investors profiled in the news eventually run out of luck and hit a stretch of bad luck.  I have steered my children towards mutual funds.  If you do not want to read the book A Random Walk Down Wall Street by Burton Malkiel, you can read the summary of it in Wikipedia.

It is up to us to teach our children!

Robert

Life is Not Fair - Bad Bosses and Swindles

Bad Bosses

I have decided to explain to my son how life is not fair, and I also decided to share this with other Plano parents.  Our children need to understand the unfairness of life because living in a nice middle-class town -- living in a bubble -- they might not fully appreciate how good a life they have and how tough it can be outside the bubble.

Here are a few examples of how people can lose their jobs unfairly.  John Lasseter, famous for his work at Pixar (Toy Story, Bugs Life, etc.), was fired from Disney for pushing computer animation.  He was fired for being right.  Francis Ford Coppola wrote the script for Patton, and he was fired for writing the iconic scene where George C. Scott stands in front of a large flag and speaks.  Lee Iacocca was manager of the famous Mustang and was eventually fired by Henry Ford II.  Iacocca claims Henry Ford II said: "Well, sometimes, you just don't like somebody."

A common scenario is where you are hired by a manager who likes you and values you.  Then something happens and your manager is replaced by a new manager who hates you.  You might get fired.  You might get treated badly until you leave.  This happens very often.  When a manager who is good to you is replaced by another manager, it might just be a matter of time before you are forced to leave.  It is important to be aware of this, to not be surprised that you go from being valued to being disparaged.  Some people will like you.  Some people will dislike you.  You have not changed, and you have not done anything wrong, but circumstances change and you must leave.  Maybe this seems unfair, but that is life.  This happens so often that someone today at church just told me a similar story:  (1) she was a manager, then (2) her boss quit, then (3) her new boss did not like her, and (4) now she is working elsewhere.

Swindles

It is important to realize a lot of cheating happens in business.  I remember reading about a medical doctor who had a contract with an insurance company that the doctor did not understand.  He naively thought that the insurance company would not offer him a contract that would be bad for him.  After signing the contract he discovered he lost money on every patient.  The doctor went bankrupt because believed in the goodness of people.  But when people work for a company they are sometimes not allowed to be good, they are sometimes required to be ruthless and deceitful.  I read this story about the doctor in a newspaper, either the New York Times or the Wall Street Journal.

Rolls Royce went bankrupt when it signed a contract with Lockheed.  Rolls Royce was losing money on every engine it sold for the Lockheed Tristar jet.  Lockheed held Rolls Royce to the contract and Rolls Royce went bankrupt.  A swindle is legal if you signed the contract and contract turns out to be bad for you.  Sometimes you do not understand that the contract allows you to be cheated.  You can be cheated and it is still legal because you signed the contract.

Here is a recent article: How Regulators Averted a Debacle in Credit-Default Swaps by Gabriel Rubin and Andrew Scurria, Wall Street Journal, July 8, 2018.  Here, Blackstone Group had a credit default swap on a loan made to Hovnanian Enterprises.  Blackstone asked Hovnanian to make a late payment so Blackstone could cash in on some credit default swaps.  Solus Alternative Asset Management felt that was fraud and sued.  A judge said no, it was not illegal.  If conspiring is not prohibited by the contract, then is is legal.

Cheating in business is as old as business.  In the book On Duties by Cicero, Book III within the book is a catalog of swindles.  The ancient Romans were not just conquerors, they were businessmen and well versed in swindling.  On page 122 of On Duties we see Cicero give a definition of "malicious fraud," then he gives some examples.

Sales

I should mention how salesmen get cheated.  Cicero gives examples of how people cheat when selling a property.  But when salesmen are employees, then they too get cheated.  But since this article is getting long, I will save the details of this topic for another day.

Robert

In the same vein as "life is not fair," is "Why ‘Can I Sue My Employer?’ Is Often the Wrong Question" in The Workologist column by Rob Walker, New York Times online August 3, 2018.
Here is the question asked by a reader:  "I have a new boss who is very unfair and abrasive to everyone. Hypothetically, would he be allowed to fire me just because he doesn’t like me? And if he did, what could I do procedurally and legally to fight back? "
Here is the answer:  "As a legal matter, unless you have an employment contract that says otherwise, he could absolutely fire you because he doesn’t like you."
The underlining is mine, added to highlight the point made in this blog entry.

Business Bio by Alexis Ohanian

I think our children can benefit from the biographies of businessmen.  Alexis Ohanian is an internet millionaire who wrote a book describing how he got rich:  Without Their Permission.  I read it and shared the highlights with my son, which I share now with you so you can share them with your children.

He chose to go to school out of state, going to the University of Virginia instead of going to school in Maryland.  He started a business, Reddit, with his room mate Steve.

Here are the key points: (1)  His room mate Steve had the technical skills to code the website and Ohanian did not have those skills.  (2) Steve did not throw Ohanian over-board like Mark Zuckerberg disposed of so many people.  (3)  Ohanian made the contributions he could, like drawing the spaceman logo for Reddit. (4) Ohanian's biggest contributions were in sales.  He pitched the business to a company called Y Combinator, which provided funding.  (5) Eventually Ohanian pitched the business to the Condé Nast publishing company, making Steve and Alexis Ohanian rich.

And if you are a technical wizard, like Steve Wozniak of Apple, you still need a salesman to make money from your invention.  Sales is a challenging business.  Inventions only make money with sales.  No sales, no money.  You can take that to the bank, or the poor house as circumstances dictate.

Finally, I like to describe to my son the stories of businessmen when their lives appear in the Wall Street Journal Obituaries.

Here is an example from today's newspaper:  Robert Klein Set Up Firm to Help Lenders Protect Homes Going Through Foreclosure by James R. Hagerty, Wall Street Journal, May 11, 2018 (May 12 in the hard copy edition).  The online article has much more detail than the hard copy.

Here are highlights from the obit:

Robert Klein’s father once told him: “God blessed you with a brain and cursed you with a mouth.” Working for a boss would be difficult.

So Mr. Klein, a high-school dropout, was always his own boss, starting as a New York taxi driver and later running his own fruit-and-vegetable wholesaling business in Cleveland. In 1990, he founded Safeguard Properties in the obscure business of mortgage field services. Such firms do foreclosure-related chores for lenders, including changing locks on abandoned homes, sealing broken windows and handling basic repairs so houses can be resold

He started with one employee and grew to around 1,000 as Safeguard expanded nationwide and became one of the largest companies of its type.

Notice he was a high school drop out, yet he provided jobs for thousands of people.  There are more details in the article, such as the business becoming a legacy for the family.

Robert

Protect Your Children from Income Share Agreements

Loans are Understood and Predictable

Many children have been hurt by large student loans.  I remember an article about a medical doctor who borrowed so much money to become a doctor that she would be paying on her loans to the day she died and would never be able to own a home.

Many young people do not understand loans.  Their parents need to guide them through the process of borrowing money for college.  There have been many night-mare stories of huge debt and meager incomes.  But there are formulas and on-line calculators that allow you to calculate the monthly bill for a loan given the loan amount, interest, and the length of the loan payoff.  With a tool like this you can analyze your potential debt before you commit to the debt. If you google "Loan Repayment Calculator, " then you can see something like this:

(Click on the image to see it expanded.)  You can see that a 6% loan of $20,000 will take $491.05 monthly to pay off, meaning you pay back $29,463, which is $9,463 more than you borrowed.  Many kids graduate with more than $20,000 of debt and many young people will find paying 4491.05 a steep cost.

A $40,000 yearly income, and 28% taxes means a young person will have (40000 * (1 - 0.28))/12 = $2400 per month income and $491.05 is 20% of the monthly income.  Try living in an urban area for less than $1200/month for rent and utilities.  Now you can picture $491.05 as 41% of the remaining $1200 a month after rent and utilities.  A student loan is a serious commitment, but mathematics and planning can lead one to project the economic consequences, including the total cost of the loan.

Income Share Agreements are New and Poorly Understood

Some universities started debt instrument called a Income Share Agreement (ISA)as an alternative to student loans.  Investors wanting to make money off of your children have turned to Congress to pass laws making it easier and safer for them to loan money to your children.

After reading the details of these bills, here are my concerns.

1. The congressional bills strip away state laws that protect your children from excessive interest rates or claims against their income.
2. Your children cannot escape a bad ISA through bankruptcy.
3. These ISAs have an equivalent interest rate and the interest your children pay on ISAs is not tax deductible like a regular loan.
4. Senate bill S.268 amends the Investment Company Act of 1940 to strip away protections we might have from this law. 

Details from the bills (and web links to them) are at the bottom of this blog posting.

Banks can already loan money to our children, but banks are regulated.  Now a new batch of investors want to own our children's debt without the regulations currently in place to protect our children.  No one can imagine at this time how bad this could be for our children.  We can write our congressmen to protest these bills, but we must surely warn our children to avoid these debt instruments until the dangers are understood.

Your friend and neighbor,
Robert

Details
Senate Bill S.268 — 115th Congress (2017-2018)

Introduced in Senate (02/01/2017)

Investing in Student Success Act of 2017

This bill authorizes an individual (i.e., a student) and another person (i.e., an investor) to enter an income-share agreement (ISA) in which the student agrees to pay a percentage of future income, for a specified period of time, in exchange for funds to pay for postsecondary education, workforce development, or other purposes.

An ISA that complies with specified terms and conditions and meets certain disclosure requirements is a valid, binding, and enforceable contract and is not subject to state laws that limit interest rates or regulate assignments of future income.

The bill amends the Internal Revenue Code to include an ISA as a qualified education loan (a qualified education loan is not dischargeable in bankruptcy), but it prohibits a tax deduction for interest paid on an ISA (interest paid on a qualified education loan is tax deductible).

The bill amends the Investment Company Act of 1940 to exclude as an investment company any person whose business substantially consists of making ISAs.

https://www.congress.gov/bill/115th-congress/senate-bill/268/all-info

House Bill H.R.3145 — 115th Congress (2017-2018)

SECTION 1. Short title; table of contents.

(a) Short title.—This Act may be cited as the “Investing in Student Achievement Act of 2017” or the “ISA Act of 2017”.

SEC. 201. Lawfulness of contracts; preemption of State law.

Any income-share agreement that complies with the requirements of section 102 shall be a valid, binding, and enforceable contract notwithstanding any State law limiting or otherwise regulating assignments of future wages or other income.

SEC. 202. Preemption of State law with respect to usury.

A Qualified ISA shall not be subject to State law with respect to usury, unless such State law was issued after the date of the enactment of this Act and such State law expressly states that it is intended to apply to income-share agreements.

SEC. 203. Preemption pre-existing State laws with respect to ability-to-repay and licensing laws.

A Qualified ISA shall not be subject to a State law with respect to “ability-to-repay” requirements, and an ISA funder issuing a Qualified ISA shall not be subject to any State law with respect to licensing or registration, unless such State law was issued after the date of the enactment of this Act and such State law expressly states that it is intended to apply to income-share agreements.

https://www.congress.gov/bill/115th-congress/house-bill/3145/text

Money from a Humble Business

We should tell our children not to turn their backs on a humble business.  Educated middle class parents want their children to go to a good college in order to be hired by a good company.  But sometimes the people who start businesses do not graduate from college.  The most famous college drop outs are Bill Gates (Microsoft), Michael Dell (Dell Computer), Mark Zuckerberg (Facebook), and Larry Ellison (Oracle).

We can add Wayne Huizenga to the list of successful businessmen who dropped out of college.  His obituary is "Wayne Huizenga, Entrepreneur Behind Blockbuster and AutoNation, Dies at 80" by James R. Hagerty, Wall Street Journal, 3-24-2018 pages B1 - B2 in the print edition.
https://www.wsj.com/articles/wayne-huizenga-entrepreneur-behind-blockbuster-and-autonation-dies-at-80-1521822048

Mr. Hagerty (1937 to 2018) dropped out of Calvin College in Grand Rapids, Michigan.  His grandfather ran a garbage hauling business in Chicago.  Mr. Hagerty joined the Army reserves and after that he got a job managing a trash-hauling business in Florida.  Soon, he started his own trash-hauling business, expanding to 40 trucks by 1968.  Eventually he merged his trash-hauling business with his grandfather's business and went public as Waste Management.

To cut to the chase, Mr. Hagerty started Blockbuster, selling it for $8.4 Billion to Viacom. Then he started AutoNation and Extended Stay America.  He had other businesses and you can read about them in his obituary.

Wayne Huizenga became a wealthy man because he was willing to work in the humble business of hauling trash.

I think everyone should experience some college, but graduating from college is not necessary for success.

Robert

Leadership: The West Point Lecture by William Deresiewicz

William Deresiewicz was a professor at Yale.  He quit and wrote a book called Excellent Sheep: The Miseducation of the American Elite and the Way to a Meaningful Life .  I am finding it an interesting book, although I do not agree with his views on the Liberal Arts education.  Dr. Deresiewicz was invited to speak at West Point.  Here are two copies of his speech.  This one is in PDF so you can download it.  This copy is at the American Scholar website, March 1, 2010.

Here is the major thrust of his concerns.  He is talking about students at Yale.

So what I saw around me were great kids who had been trained to be world-class hoop jumpers. Any goal you set them, they could achieve. Any test you gave them, they could pass with flying colors. They were, as one of them put it herself, “excellent sheep.” I had no doubt that they would continue to jump through hoops and ace tests and go on to Harvard Business School, or Michigan Law School, or Johns Hopkins Medical School, or Goldman Sachs, or McKinsey consulting, or whatever. And this approach would indeed take them far in life. They would come back for their 25th reunion as a partner at White & Case, or an attending physician at Mass General, or an assistant secretary in the Department of State.

That is exactly what places like Yale mean when they talk about training leaders. Educating people who make a big name for themselves in the world, people with impressive titles, people the university can brag about. People who make it to the top. People who can climb the greasy pole of whatever hierarchy they decide to attach themselves to.

But I think there’s something desperately wrong, and even dangerous, about that idea

He raises excellent objections to elitist education, but I do not agree with his solutions.  He cannot offer a good solution because, as an English professor, he is too much a part of the problem to see a solution.

Because he spoke at West  Point, Dr. Deresiewicz mentioned General David Petraeus in his talk, but his references to the general struck me as shallow, just rehashing commonly available facts from newspaper articles. 

This article gives you the flavor of his Excellent Sheep book.  The most important take-away from Deresiewicz is that elitist education is deeply flawed.  We must remember that Vietnam was an elitist war.  It was run by elitist Harvard and Yale graduates like Robert McNamara (Harvard MBA), General William Westmoreland (Harvard MBA), McGeorge Bundy, Walt Rostow and Paul Warnke.

Many parents in Plano would like their children to go to Harvard or Yale, but it is important to recognize that there are serious problems with the education offered at Harvard and Yale.

Robert

Arrival: Chinese Influence on American Culture

I just finished watching the film Arrival for a second time. It is a very thoughtful and imaginative film.  A friend said it was slow, but that slowness is really a French influence.  I looked up the director, Denis Villeneaue, and found that he is French Canadian.  The author of the science fiction novella upon which the film is based, Ted Chiang, is Chinese American.  His parents were born in China , he was born in New York state, and he made a nice contribution to our American culture with his story, Story of Your Life, upon which the movie was based.

Story of Your Life received  the Best Novella of 1999 Nebula Award.
 https://nebulas.sfwa.org/award-year/1999/

Robert