I Just Can’t Buy Bonds


Bonds and income stocks are an important part of a portfolio.  While bonds won’t provide the returns that stocks will over long periods of time, when there are falls and crashes in the stock market like in 2008, bonds will usually hold up in price while stocks will fall.  Indeed, in 2008, those who were 50% in bonds, say, might only have seen their portfolio’s decline by 5% or 10%, while those 100% in stocks were looking at 40% drops.  Some bond holders even made money while everyone else was seeing their portfolios decimated. 

A rule of thumb is that you should invest a percentage of your portfolio equal to your age in bonds.  If you are 20, you should be 20% in bonds and 80% in stocks.  If you are 80, you should be 80% in bonds and 20% in stocks.  If you are 100, you should be thankful you’re alive and be 100% invested in bonds.  If you’re 110, I guess you need to short 10% of your portfolio and invest the proceeds in bonds or something.  This is the conventional wisdom and we should never doubt the wisdom, right?

Except I do.  I am in my 40’s, so I should be 40% in bonds, but instead I’m 100% in equities.  (OK, maybe 97% in equities and maybe 3% in cash.)  I plan to be the same way when I’m in my 50’s, and I hope that I can be the same way when I’m in my 60’s and 70’s, although I may diversify into real estate at some point by buying some vacation homes, just for the fun of it.

I know that buying bonds (and income producing stocks) reduces risk, and I know that the additional reward that I can get for being 100% in stocks is just a little better than it is for being 70% in stocks and 30% in bonds, say.  But that’s just it.  By putting money into bonds that could be in stocks, I’m giving up a few percentage points of return that I could be getting from a 100% equity portfolio.  I know that over a long period of time, like 20 years, the difference between making a 12% return or a 15% return and a 10% return is huge.  You see, at a 15% return, by portfolio value will double every 4.6 years, while at 10% it will double every 7.1 years.  In 20 years, 100,000 will be worth about $400,000.  At a 15% return, the same $100,000 will be worth more than $800,000.

Now what is the consequence of not owning bonds?  Well, in years like 2000 and 2008, I’ll see a big drop in portfolio value compared to a portfolio with more bonds.  A portfolio with about 70% bonds and 30% stocks will be lowest risk of all, meaning swings in portfolio value will be substantially less than a portfolio that is 100% stocks or even 100% bonds.  During years like 2008, people who had 60% bond/40% stock portfolios may have even seen an increase in their portfolio values while those with 100% stock portfolios saw 40% declines.  During the next year, however, the 100% stock portfolio saw a 30-40% increase, and another 20-30% increase the year after that.   You risk having big drops in the value of your portfolio, but you’ll also see recovery if you can just stick it out or, better yet, invest more while prices are low.

Having a 100% stock portfolio when you are a few years away from  retirement can definitely be a bad idea.  Certainly there are a lot of people who were ready to retire in 2007 after seeing the value of their 401k’s increase from 2003-2007, only to see their plans of spending time on the beach put on hold after suffering substantial losses in 2008.  In 2008 they were still heavily invested in stocks, hoping to get one more great year to feather their retirement nest.  Instead they saw a bear market for the record books.  

Many advisers propose being very conservative going into retirement, having maybe a 60% bond and 40% stock portfolio, and then actually getting more aggressive as time passes.  There are studies that show starting very conservative right when you retire but then being more aggressive later in retirement increase your chances of outliving your money.  The idea is that when you are just starting out in retirement, a big loss would be devastating, but it becomes less significant as you get older and no longer looking at as many years of life.  Someone who is 70 might be 70% stocks and 30% bonds again. 

Despite the risk of suffering a big setback, I would still like to be mainly invested in stocks even going into retirement, however.  I know that I’ll enjoy much better returns in equities, and therefore have more cash flow to enjoy life, if I’m in stocks instead of being heavily in bonds.  Even at age 65, I still have about 20 years to invest and I know that for periods of 10 years or longer, I’ll have returns on the order of 12% in stocks before inflation.  

Staying fully invested in stocks is not an option, however, if you have just enough money for retirement, which today is somewhere in the $1M to $3M range.  In that case, if you had a large, 50% portfolio loss, you would run the risk of running out of money,  This is because, after a large drop, you’ll need to take more money out of your portfolio for expenses than it can withstand.  Once you reduce the balance of the portfolio enough that it no longer produces enough to regenerate itself for the amount you extract, it becomes a vicious cycle.  Each time you take more out, you reduce the amount of income it can generate.  Next thing you know, you’re moving in with your kids.

I’m hoping (and planning) to have more that I need for expenses, however.  If I have a $6 M portfolio, I can set aside a relatively small portion in bonds (or even just put five years’ worth of expenses in cash) and keep the rest invested in stocks.  If the market takes a tumble, I can just wait for it to rebound since I’ll have expenses covered.  When the market does well, I can sell some shares and build up my cash position.  When it does poorly, I can sit pat and use the cash I have.

The other advantage of building up a bigger portfolio than the bare minimum is that I can stay mostly fully invested even as I approach retirement.  When you are just starting to invest, the return on my account was relatively small (maybe a few hundred dollars a year.  When I get to the point where I have a few million dollars in my account, however, I would be making a million dollars or even two million dollars during years where the market goes up 20 or 30%.  Most people miss out on these big gains because they need to start transitioning to bonds just as their portfolios start to get large because they can’t withstand a big downturn.  They cross a million dollars when they reach 60 years old or so, then transition half of the portfolio to bonds and limit themselves to maybe a $50,000 gain in a given year.  If I have two to three times the minimum needed, I can stay invested in stocks because I know even if I lose 50% in a given year, I’ll still be set for retirement.  I can then take advantage of the opportunity to have really big gains.

If you want to stay fully invested in stocks and get that extra return like me, you don’t start when you’re in your fifties or even your forties.  You need to be putting money away regularly when you are in your twenties.  If you can find a way to put $5000-$10,000 per year into investments when you’re in your twenties, by maybe buying a smaller home when everyone else is buying big homes, or buying older used cars when others are buying new, you can set yourself up to have much more than the minimum to retire.  Then you won’t need to give up return by putting a bunch of your portfolio in bonds either.

Got something to say?  Have a question?  Please leave a comment or contact me at vtsioriginal@yahoo.com.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

You Can Beat the Market


Many people try to “beat the market,” which is to say that they try to get a better return than some index such as the Dow Jones Industrial Average, the S&P 500 Index, or the Russell 2000 index.  There are many strategies that are tried, including looking for patterns in the prices of the stocks, buying stocks considered to be undervalued, finding stocks that are going up and buying in, hoping that they will continue to go up, and trying to find stocks that are likely buy-out candidates.  While some people may beat the market for a period of time, these strategies rarely work for longer than a year or two.  If someone actually does find some strategy that works because of some inefficiency in the market or something, other people pile in and the strategy no longer works.

There are a few people who do beat the markets, however.  One of the most famous people to do so is Warren Buffett, but there are hundreds, perhaps thousands of others who have done so as well, although perhaps not to the same extent.  The strategy they use is available to all and isn’t subject to the same issues that dooms others to failure.  Perhaps the strategy also goes against human nature, which wants a quick return, and that keeps too many people from using the same strategy to the point where it no longer works.

This strategy is what I refer to as serious investing.   It is not for those who want to invest for entertainment.  It is for those who want to beat the markets and become financially independent.  It takes some degree of stock picking, but more so it takes discipline and patience.  Lots and lots of patience.  

So what is this strategy?  Here are the steps:

Step 1:  Give in to the fact that you have no control over the markets and what they will do to your portfolio in short periods of time.  Anything you know about a given stock or the economy is already known by millions of others.  Any idea that you have about the effect of this or that on this company or that industry, others have as well and they are making trades at the same time you do.  The reason that great parking space is open is because the guy is parked over the line and no one else could park there either.  If he weren’t parked poorly, it wouldn’t be there when you pulled up.  Accept the fact that the markets will do what the markets will do and you will not outperform the markets by jumping in and out.

Step 2:  Start thinking like a venture capitalist.  Venture capitalist put their money into companies that they think have lots of room to grow.  They also find companies that have a very high probability of success and only buy in if they can get a good price that will allow them for a big return if things work out.  They then put their money in and plan to sit and wait for things to happen.  They don’t make a small gain and jump out.  They wait for the huge returns that make up for the companies that don’t work out.

Step 3:  Invest regularly.  Remember step 1.  You’ll never hit the timing just right.  The more often you invest, the more you average out the prices you pay and improve your cost basis.  Plan on making an initial investment, then plan on buying more on dips and falls.  This means putting aside money regularly so that you can acquire more shares.  

Step 4:  Make significant investments.  If you make only small investments in several different companies, you might as well be investing through mutual funds because that is what you are creating.  Find your best companies and focus your resources on them.  Spread out into different sectors of the markets, but only buy your top pick in each sector.  Larger positions mean much larger profits when your positions pay off.

Step 5:  Only invest when you’re really excited.  Don’t buy a stock just because you have some money to invest or it has a decent dividend.  Find stocks that have great prospects and make you very excited about where they may be in five to ten years.  Develop a watch list of these stocks and then buy the one that have the best price when you have cash available.

Step 6:  Sell when things change or a position gets too large.  If you buy a company because they have a great line of sportswear and then they start selling dress clothes, get out.  Likewise, if a position grows to the point where it constitutes a significant portion of your portfolio, cut the position back to manageable levels and put some of the money elsewhere.

Step 7:  Be in it for the long haul.  Truly great, life changing profits are made over decades, not months.  Why sell out just when things are getting good?  Find a great company that has a great products and room to grow, then don’t worry about the small ups and downs.  Wait for the huge payoff that comes from years of compounding.  

Got something to say?  Have a question?  Please leave a comment or contact me at vtsioriginal@yahoo.com.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

8 Million Reasons to Learn to Invest Now


 

futureroadYoung people are often seen as fearless, taking part in adventure sports, going on trips to foreign countries, and trying new things with little in the way of inhibitions.  People tend to get more cautious as they get older, especially when it comes to physical activities, as they start to realize that they are less bulletproof than they were when they were younger and that a hard fall could result in a significant injury.  Most young people don’t even worry about falling down because they know they’ll be able to bounce right back.

Unfortunately, one place young people tend to be too cautious is in the area of investing.  They are at a time in their lives when they could take a nasty investment “fall,” dust themselves off, and get back on track financially very easily, but instead of taking the risk they put off investing until a later time.  In fact, it is often older people a few years out from retirement that are taking way to much risk by being fully invested in stocks or heavily leveraged on their home because they are trying to make up for lost time.  Many people saw their retirement plans delayed after the 2008 stock market crash because they were totally invested in stocks and saw their retirement accounts cut by 40%. 

The main reasons young people site for not investing is that they don’t have the time and they don’t have the knowledge needed.  To those who have this view, let me ask you this:  How much effort would you put into a task that would pay you $8 million?  Would you devote 100 hours per week for a few months or even a couple of years?  Would you put aside other things in your life and do what was needed?  I’ll bet you would.  Most people would work 100 hour weeks for five years to get $1 million.  Imagine getting eight!

Take a look at the table below.  This shows the account value you would have at age 70 if you started investing $5,000 per year at ages 20 through 45, assuming the historic rate of return of the stock market.  Note that $5000 per year is 15% of $33,000 – the amount that someone who is making $33,000 per year should be putting away for retirement.  It also shows your total contributions – how much money you would have invested.  If you started investing at age 20, you would retire at age 70 with $12 M.  If you wait until you are 30 before you start investing, you would only retire with $3.8 M – an $8 M difference!  By waiting to start investing because you are too busy to spend a half hour going to a website and setting up an IRA account or choosing investment options in your company’s 401k account, you are giving up $8 M at retirement.  By texting friends or watching sports on TV instead of reading books on investing and using other resources to learn investing, you are giving up $8 M.  

Starting Age Balance at Retirement Total Contributions
20 $12 M $250,000
25 $6.8 M $225,000
30 $3.8 M $200,000
35 $2.2 M $175,000
40 $1.2 M $150,000
45 $0.67 M $125,000
* Assumes $5000 per year contribution, 12% return, Retire at age 70

What if you just invest more later?  Can’t you just make up the difference by investing more later?  Well, the table below shows where you will be starting from age 30 to age 45 if you invest $10,000 per year instead of $5,000.  Even starting at age 30, you would have $4.3 M less investing $10,000 per year than if you invested $5,000 per year starting at age 20. Note also that you would contribute $150,000 more over your lifetime, meaning that you would have $150,000 less for cars, college expenses, or vacations than the guy who started investing at age 20.  Heck, the guy who started investing at age 20 could even stop at age 45, have an extra $5,000 per year to spend however he wanted, and only come out $670,000 poorer at retirement.  He would only have invested $125,000 and come out $3.5 M ahead of the person who invested $400,000 starting at age 30.   

Starting Age Balance at Retirement Total Contributions
30 $7.7 M $400,000
35 $4.3 M $350,000
40 $2.4 M $300,000
45 $1.2 M $250,000
* Assumes $10,000 per year contribution, 12% return, Retire at age 70

And what about not knowing how to invest?  The SmallIvy Book of Investing costs only $12.99, and is currently on sale for only $9.99 (shameless plug, but it’s my website).  Just by reading chapters 2 and 3, you could learn a great deal about the different types of assets and the risks involved and know a lot more about investing than many financial advisers.  Heck, just skip to Chapter 9 and read about mutual fund investing and you’ll be in good shape.  Is spending $9.99 too much to learn the information you need to make an extra $8 M?  You can get the electronic version for only $3.99!

Beyond my book, there are tons of other great books on investing.  Just go to Amazon or your local bookstore and head to the investing section.  Just find a book that gives the basics, particularly on mutual fund investing.  Get a few and spend a weekend learning.  You can also find great online resources such as the Bogleheads site and past issues of this blog.  

Enough excuses.  Get in there and start investing today.  Every day you wait will mean less money when you are ready to retire.  Take a chance and start investing.

Your investing questions are wanted. Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Why Giving is Important


The main reason for becoming financially independent is to protect yourself and your family from the uncertainties of life.  As people are learning as they enter their fifties and early sixties, planning to work until they are seventy or even eighty because they have not saved for retirement, only to be laid off and then not able to find another job, you can’t count on working to meet your needs indefinitely.  There may not always be a job you’re suited to do, or you may have health problems that prevent you from working.  There are also times in your life when you may lose your job and it may take some time to find another suitable position.  You might also have medical emergencies, burglaries, major home damage, vehicle accidents, or other events that require a large amount of money in short order to fix.

A second, equally important reason to become financially independent is a moral reason:  Someone who is able to take care of himself should not rely on others.  If you spend all of the money you make as it comes in, you’ll likely find a time in your life when you’re burdening others because of the bad or irresponsible financial decisions you have made.  You may need to go into a nursing home and rely on Medicaid to pay for it.  You may need a major operation and leave the hospital with the bill.  You may need to send your children through college using financial aid or student loans that are later “forgiven,” leaving others to pay the bill.  It is not right to leave others with the bills because you have not saved the money when it was available.

A third reason for becoming financially independent is to be able to give to others.  At first this idea may seem to go against the previous paragraph.  If everyone is supposed to take care of themselves, why should people give to others?  Take a deeper look, however, and you’ll see that giving is critical in making the free enterprise system, which allows people to become financially independent, work.  There is good giving – that which helps people and without which a society would fall apart – and bad giving that hurts people and destroys the production of wealth.

Good giving is critical to maintain society and for the preservation of all.  Certainly no man is an island and we all need to rely on each other to survive and prosper.  Most of the time this reliance depends on trade between individuals, where each creates things of value and trades for what is needed.  There are times, however, when a person is truly in need.  For example, after an earthquake, flood, or other natural disaster, people need food and shelter for a period to get their lives back together.  Likewise, a friend or neighbor may have a personal disaster in the form of a job loss, a home fire, or an injury.  At times we need to rely on each other because, despite all of our planning and best efforts, things beyond our control impact our lives.

Being financially independent allows you to help people when they are in need.  If you have your feet firmly planted in financial security, rather than sinking in debt, you are able to find the resources to help others.  It may be a matter of simply diverting some of the money you were using for luxuries to help someone else out.  You might also buy assets whose proceeds are specifically meant to be used to help others.  Maybe you buy a mutual fund and give away the proceeds generated by the fund each year.  Maybe you buy a building and let charitable groups use it free of charge.

Bad giving hurts people and hurts society.  It is wrong to give to people who could provide for themselves but choose not to do so.  This causes them to continue to make bad choices that keeps them in the  position of needing help from others.  If there are too many people not doing what they can, it reduces the total wealth of society and discourages others from pulling their weight.  More importantly, giving to people who don’t need the help robs them of the chance to do things for other people.  A person who sits at home all day and gets their food, rent, and clothing provided is free to think only of himself.  A person who must get up go to a job and work for a living does things for other people all day long.  A sandwich maker provides food to hungry people.  A construction worker builds homes for people.  A secretary in a doctor’s office helps sick people get care.  It is by expecting others to do good things that we truly show them respect and give them their dignity.

So how do you tell if what you’re doing is good giving or bad giving?  The question you must ask is whether you are making their lives better.  If you give a person on the street money and see him there the next day and the next week and the next year, you are hurting him by enabling him to continue to  make bad choices.  If you support an organization that takes people on the streets, helps them defeat their addictions, and teaches them employment skills, you are helping them.

Your investing questions are wanted. Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Determining your Retirement Goal and How You’re Doing in Saving for Retirement


Saving for retirement can seem daunting.  It seems impossible to save up the millions of dollars that will be needed for you to live a comfortable and secure retirement.  Luckily, if you start early and put interest on your side, instead of against you as many people do by racking up debt, you can get to your goal with patience and persistence.  The first step is calculating how much you need in retirement and then the next step is to calculate how much you need to be putting away each month to get there.  

Calculating how much money you’ll need in retirement to maintain your current lifestyle is fairly simple:

1) Find your current income from all sources.  If your are relatively new to your career and you expect a higher salary due to promotions or getting better jobs, adjust your current salary accordingly to the salary you expect to make later in life. One option to get a good number is to use a website to find salaries for people in your career path right now who have 20-30 years experience  (or some higher income, if you want to have a lifestyle better than you currently have in retirement).  You want the current earnings for those careers right now, not in several years.

2) Go to an investing or saving calculator (there is a good one in the links to the right) and put in your current earnings in the initial investment line, 3% for an interest rate, and the number of years to retirement in the investment term line.  Compound yearly and at the end of the period.  Press calculate – the number produced should be close to your salary at retirement, including inflation.  

3) Multiply the result by 20, record the number.  Then, multiply the original number by 30 and record that number.  This gives you the range of assets you’ll need at retirement to replace the income you’ll be making.  The low number assumes you can withdraw 5% per year from your savings each year, while the higher number assumes you can withdraw only 3.3% from your savings.  The true number will lie somewhere in between.  In actuality, if you make the high number, you’ll be able to invest more aggressively and be able to withdraw closer to the 5% number, where if you make the lower number you’ll have to be more careful and withdraw closer to the 3.3% number, so shoot for the higher number.

The next step is to determine how you’re doing.  Basically, where you are on your retirement path and what you need to do to make your goal.  To do this:

1) Add up your current savings, investments, and other assets.  Note that assets are things that hold their value or increase in value, and preferable pay you an income (don’t include your home equity unless you plan to sell and downsize). This is your current net worth.

2) Put your net worth in the in investment/savings calculator as the current value or starting value.

3) Put 10% in for your expected rate of return, and put in the number of years you have until retirement.  Guess a monthly payment of $500, then, hit calculate.  Iterate up and down on your monthly payment until the final value matches your retirement goal.  When they match, the monthly payment you have inserted is the amount you need to be saving each month to reach your goal.

Let’s look at an example.  Let’s say that you’re 35, have an income of $57,000, and expect a couple of more promotions before you retire, so you think you may make $80,000 at retirement.  Let’s say you have $60,000 in your IRAs and 401k, a few bank accounts, and a modest investment account.  You plan to retire at age 70.  Here’s what your investment calculator would look like:

 Starting Balance: $80,000

Annual Rate of Return: 3%

Monthly Contribution: $0

Years to contribute: 35

Calculate Balance in: 35 years

Result: $225,109

So, you should expect that your final salary will be about $225,000 in 35 years, which will buy about what $80,000 per year buys today.   To find the amount you will need to have saved up to generate this income, you multiply your future income by 20 and 30:

20x: $4,502,180

30x: $6,753,270

You should target $6.7 M in retirement savings, just to be safe.

Now, to calculate how much you need to save each month, here’s what the investment/savings calculator would look like on the first iteration:

 Starting Balance: $60,000

Annual Rate of Return: 10%

Monthly Contribution: $500

Years to contribute: 35

Calculate Balance in: 35 years

Result: $3,474,907.19

This is below your goal, so you would increase your monthly contribution amount.  Doing this a few times, you get the result:

Starting Balance: $60,000

Annual Rate of Return: 10%

Monthly Contribution: $1420

Years to contribute: 35

Calculate Balance in: 35 years

Result: $6,766,226.93

This is close enough to your goal to use.  You would need to be putting away $1420 per month.  Note, there are other calculators that calculate the monthly payment needed to reach a goal that you could use as well.  It doesn’t take too many iterations, however, so the one I used is good enough if you don’t make this calculation too often.

If you are saving 15% of your salary in a 401k or other retirement account, as most people should, you’ll already be putting away $750 per month.  If you have a matching amount from your employer, you might get another $150 per month, so you are putting away $900 and only need to come up with another $520 per month.  Sound impossible?  It really is possible with just a few sacrifices.  In the next post, I’ll discuss ways you could go about hitting this savings goal.

Your investing questions are wanted. Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Should Solar Panel Users Pay a Fee for Reverse Meters?


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There are stories going around about big utilities and solar panel users that go something like this:

Solar panels are getting cheaper, which is causing big problems for utilities.  Due to legislation in place in many areas, utilities are required to allow reverse metering, where  they must pay the customers who have solar panels at least retail power rates for excess power the customer generates and feeds back to the utility.  Big utilities have gotten together with wealthy individuals to oppose reverse metering through local legislatures, or add a fee for reverse metering since they say they need money to pay for upkeep of the grid.

At first you might think, “Those greedy utilities.  They have been soaking us for years and now that people are starting to be able to get away from the utilities, they are doing what they can to keep their monopoly and kill solar.  They are also backed by big oil and big coal who don’t want to see their grip on society loosened.  I could care less if the grid deteriorates.  Who needs it?”

 Now let me say that I’m certainly not a fan of regulated monopolies.  I find that a lack of competition tends to result in higher prices.  Even regulations, which are supposed to protect the consumer and keep prices low, can actually increase rates by requiring all sorts of work to comply with regulations.  Many of these regulation may make no sense and require all sorts of work to create paperwork that is then reviewed, stamped, and filed somewhere.  You would like to think that some experts were studying how much sulfur dioxide can be released into the air until it becomes dangerous to people nearby, or how much nitrous oxide can be exhausted, but you quickly discover that there are few experts involved in the process and it is really more about filing the right paperwork.  The utility then just pays for the expense by increasing costs for the customers, so they don’t tend to fight it too hard.

So I love the idea of dispersed power generation where maybe power producers have small generating facilities located near the population centers, such that different companies would compete to supply your home.  Even better would be personal power generation where you buy a generator that sits in your backyard near your air conditioner or solar panels that sit on your roof.  They even now have a solar panel in the form of a bendable plastic that can be made to look like the leaves of a tree.

But before you throw the utilities to the wolves, realize that in this case they have a valid point.  Solar energy has a big problem, as do virtually all forms of renewable energy, and that is storage.  You need to have the ability to store the excess energy that you make to use when you aren’t making enough  Being connected to the grid is about the best possible way to store solar energy since you convert it into cash that you can then use to pay for power when needed.  Otherwise, homeowners would need to have large battery banks which can be corrosive, expensive to maintain, possibly explosive, and let’s face it, not remotely green.  Luckily, utilities need more power when the sun is shining bright and temperatures are hot since that is when everyone turns their air conditioners on.

Homeowners with solar panels and reversible meters depend on the grid every bit as much as those who do not and they should want to keep it around as much as anyone.  Their homes would be just as dark at night if a tree takes out a power line leading to their neighborhood as the next person, and they count on the utility to send their people out in the storm to get power flowing again.    They should also be paying for its upkeep.  Now we’re talking about expensive stuff here, with a 161 KV line costing tens of thousands of dollars per foot to construct.  The issue is the way in which utilities have traditionally charged customers for use of the electric grid:  They set their retail rates based on their costs, including the cost of maintenance of high voltage lines and the poles around town, and then charge customers by the kilowatt that flows forward through the meter at that rate.  

When the solar panel user gets paid for reverse flow through the meter, they get paid the retail rate, which means they are cancelling out the fees they were paying to maintain the grid when power was flowing forward.  Not only that, if they generate enough power, the power company, by paying the customer the retail rate (and sometimes an additional surcharge), might be paying the customer the charge for maintaining the grid, yet the power company then needs to go out and maintain the grid!  The solar panel user gets to use the grid for free, leaving other customers to pay more for the upkeep.  More and more people could fight back by getting their own solar panels, but that would leave those who can’t afford to get solar panels or aren’t in a situation where solar panels are practical – including the poor living in apartments or small homes-to subsidize the others.

To give an analogy, imagine if restaurants were required to pay customers retail menu prices if they brought raw food and gave it to the restaurant.  You could go into a steak house, have a nice steak with a baked potato and a salad, then hand them a bag of groceries.  You would have enjoyed their tables and chairs, used their cutlery, dirtied their silverware and glasses, used the work of their cooks and wait staff, yet you would be paying only for the food you were eating, and then in a less useful form.  If you gave them an extra few steaks and they had to pay you at the menu price, they would need to pay you for all of the things listed above that the restaurant provides to you when you get a meal, yet you would be providing none of those things to them.  If enough people started paying in groceries, how long do you think restaurants would stay open?

So what would be fair?  Well, one idea would be to reduce the rates paid by the utilities to customers with reverse meters for the power they generate.  It should be at least low enough to remove the amount retail customers pay for maintenance of the grid since the homeowner isn’t providing that service to the power company.  The rate should probably reduced still further to account for maintaining the grid as the power flows back from the home to the power company.  I’m sure that solar panel owners would complain that hey had to buy these expensive solar panels and now it will take fifty years or more to make back their money, if then, but the only reason they are making back their money so quickly now is because they are getting subsidized by their neighbors.  You can drive your car more cheaply if you steal gasoline out of your neighbor’s car, but that doesn’t mean you have the right to do so.

Another idea to pay for the upkeep of the grid would be to simply have a fee for being connected to the grid that covers its maintenance.  The fee could be scaled by how much usage the customer does, including flow in both directions for those with solar panels.  For example, a mining operation would pay a much higher fee than a homeowner with a 2000 square foot home.

So before you get on the band wagon and start saying that it is just greedy big power colluding with greedy big oil and big coal, look at the facts.  I’d love to get away from the grid, but I’m sure glad I have it at this point.  You’ll miss it when it’s gone.

Your investing questions are wanted. Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Why Subsidies are Bad, Especially for the Middle Class


The Small Investor

The Small Investor

It’s a simple idea:  Everybody needs something.  Some people can’t afford it.  Let’s subsidize then so that they can afford it.  We’ve seen this for years with college tuition and more recently with healthcare in the Affordable Care Act.  At its face value, providing a subsidy makes sense – everyone pays what they can afford to pay and then gets a free ride on the rest.  The trouble with providing a subsidy that covers what you can’t afford to pay, however, is just that – you pay what you can “afford to pay,” and all that you can afford to pay.  Because the subsidies decrease with income, combined with a lack of the normal controls on price and usage that free enterprise normally creates, the middle class end up paying everything they have. 

Think about how you run a buffet.  You tell everyone they can eat as much as they want, you limit what they can get (the kinds of food) based on what they will be willing to pay for the buffet, and then charge enough so that the average customer pays enough to cover food and service costs, plus a reasonable profit.  If you have a buffet filled with pasta and pizza, you might charge $6.99.  If you have a seafood buffet, you might charge $24.99.  People who cannot afford to go to the seafood buffet go to the pasta buffet.  The cost of the buffet is based on the cost of the food.  So long as you price the buffet correctly and the mix of people using the buffet remain about constant (you don’t get an influx of super-eaters), you will make a predictable profit.  You don’t have foods on the buffet that will cost you so much that the price would be too high for the buffet to get enough customers.

Now let’s say that you have a buffet but the food is in the style of a cafeteria, where everything that someone takes normally would cost them extra and you have all kinds of foods, including some that are very expensive like lobster tail and caviar, but you only charge people what they are “able to pay.”  Let’s say to start that your average cost per person is $30. One person comes in who has $20, so you charge him $20 and give him a $10 subsidy.  The next person has $5, so you charge her $5 and give her a $25 subsidy.  A third person comes in who has $40.  You charge him $40, even though the average cost is only $30, because you need to pay for the subsidies.  It is only if someone has $100 that you might charge him only $50 or something and allow him to walk out the door with some money in his pocket.

Now the people coming in can pick anything, and there is no reason for them not to load up bowls full of caviar and plates full of lobster tail, ignoring the iceberg salad and the spaghetti and meatballs, because it all costs the same to them.  This would cause your average cost per person to increase, forcing you to increase your full price.  Because this would mean that fewer people would be able to pay full price, you would need to increase the subsidies you give out, increasing the full price still more to cover the increased subsidies.  This would cause some of the people to stop coming (the ones who were paying the most, meaning you’d have more subsidized people and therefore need to raise the full price higher) and have the effect of encouraging everyone to go for the more expensive foods so that they could “get their money’s worth.”  This would cause the price to continue to increase and more people to go on subsidies.

This cycle would continue until almost every one was highly subsidized and almost no one paid full price.  The quality would then need to decrease since it would not be possible to raise the full price anymore, so you would remove the lobster tail and the caviar while keeping the full price the same.  Eventually you would have the equivalent quality of the pasta buffet, but the full price would be $50, meaning that everyone who had up to $50 would be walking out with nothing in their pockets even though the food they were buying was worth nowhere near $50.  If people were forced to buy the buffet no matter what, even if they didn’t want to eat at your buffet, then everyone who had less than $50 would be trapped eating your buffet.   Even though they were paying way too much for the buffet (unless they only had $6.99 or less and had a huge subsidy, such that the food was worth at least the price they were paying out of their pockets), because they would not have any money left over after paying for the subsidized buffet, they would not have the choice to go anywhere else.  They would not have the money because they were forced to overpay for your buffet that they really didn’t want.  The choice to go somewhere else would be reserved for the very rich who could afford to pay for both (or the people who mandated everyone pay for the buffet but then excluded themselves from the requirement).  

(Note that most people in the middle class send their kids to public schools even if the private schools in their area are better and cost about the same per student as the public schools.  To do so would require they pay twice.  How many would choose the private school instead if they could direct their public school dollars there?)

So the price for something that is subsidized and which has no other form of price control is “everything you have” unless you are very rich.  For the middle class, things like the Affordable Care Act will take everything they have left after paying for the bare necessities because that is how the subsidies are set.  This will mean they will not have any money left over to invest and to save up for healthcare on their own.  They will be trapped in the subsidized system, paying way more than the value of what they are receiving because they’ll be paying for everyone else and because the costs will continue to grow and grow since there is no incentive for people to spend less.  People will get the $20 per pill name brand instead of the $20 per bottle generic because it costs the same to them.  Then they’ll talk about how much they’re saving on pills, ignoring the huge amount they and their neighbors are paying in premiums.

Colleges are the same way since students are subsidized.  It costs no more to the students to go to a school that has high-speed internet galore, an expensive work-out center, and a lavish student union, so they demand it and the costs go up.  There is no reason not to pay professors who teach no classes and just come in once a week to use the school’s resources $150,000 per year since the school can just add the costs to tuition, so tuition goes up.  There is no reason not to pay $300,000 per tree to move two large trees across a path rather than cut them down (true story while I was at Berkeley) since they can just add the costs to tuition, so tuition goes up.  Tuition goes up to pay for these things, which would normally cause fewer people to attend since they could not afford the new price without the subsidies, but the subsidies just rise so the same number of students attend.

So what is the solution?  End the subsidies, or at least limit the subsidies to a very  low threshold such that only the very poor would get a subsidy.  Also, make the most expensive things, those that go beyond just the bare necessities, cost more to limit their use.  If our buffet charged extra for lobster and caviar, providing only the pasta bar in the base price, the food costs for the people buying just the basic buffet would match the price they were paying, so the costs would stay reasonable.

In the case of college, if almost everyone was paying full price and raising tuition would result in fewer students attending, the price would be a lot lower.  Schools would need to get rid of unnecessary things that cost a lot of money to keep the costs low enough that almost everyone could afford to pay.  They might limit high-speed internet to educational needs, meaning the students couldn’t spend all weekend watching YouTube videos, but they could still get a great education and tuition costs would only be what most students could earn in a summer.  They might have to run the track or ride their bikes around campus to exercise rather than go to a rec center with a lap pool and a sauna, but they would be able to leave college with a good education without a house payment’s worth of loans.

For healthcare, because you don’t want people dying in the streets, special considerations would need to be given.  Still, most people earn plenty of money to pay for their own healthcare during their lives if they would just save it for healthcare instead of spending it on stupid stuff like smart phones and new cars.  If you required that everyone put away 3% of their pay into a health savings account, and set up those accounts with special debit cards that could only be used at doctor’s offices and for prescriptions and OTC medicines, most people would have plenty of money to pay their bills when needed.  Costs would also decrease since most people would be paying their full bills and doctor’s wouldn’t need to pay the cost of filing everything through insurance.  Add on a required major medical insurance policy that kicks in for big things like hospital stays and major surgeries and the problem would be solved for 99% of people.

For the final 1% – the people who are just really unfortunate because they get a serious condition early in life or get something that cleans out their health savings account but they still need care – their costs could be covered by a combination of charity from doctors and individuals because the cost would be very low relative to the size of the population.  If really needed, a small surcharge could also be applied, but again it would be almost nothing per person paying because almost everyone would be paying for themselves.

For those who squander their health care money, free clinics could be set up that would provide minimal care.  These should not be equal in quality to the care that is paid for since that would provide an incentive for people to not squander their money.  People would know that if they waste their HSA money, or don’t get a job to put money into an HSA, their healthcare would not be as good as if they did, maybe involving limited procedures and longer waits.  Keeping the differential in care is what makes the system work and makes care for almost everyone better.

Your investing questions are wanted. Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.