In our blog, “Making the Bet - Part 1: The Game”, we made the point that concentration is often viewed in a vacuum and instead needs to be viewed holistically. Doing so can uncover concentration and previously-unknown risks. However, concentration from a finite level – such as a portfolio level – is just as concerning. If possible, one must be aware of their concentration on a macro level (“The Game”) and a micro level (“The Hand”).
The word concentration is frequently used in the financial world. Phrases like “you need to be more diversified to avoid concentration” or “you are over-concentrated in equities” are often thrown around by financial professionals, and for good reason, as concentration is a real risk. The issue, however, is these phrases likely pertain to concentration in an asset class, individual company, or some other related stock market investment. Such assessments are made with isolated information, instead of being examined from a holistic view point.
This month’s blog is going to be slightly different than usual; rather than having Tim, Nathaniel or Dan discuss a financial topic, I’ll be writing about my perspective of the financial services industry. But before we get into that, a brief introduction is in order.
How LBW Sees It
When defining the 2017 market, one could use phrases such as “good”, “better than expected”, or even “great”; just look at Chart 1
At some point in life you’ve probably thought, “I wish I could get paid without having to go to work.” Luckily for you, that’s exactly what an IRA is for: saving enough money now so that you can pay yourself not to work (commonly known as retirement). To understand how this is done, let’s start with the basics:
The first day of my (Tim) Introductory Microeconomics class our teacher provided us with a few key tenants surrounding microeconomics; 1) assumptions must and will be made (I still don’t agree with this principle and feel it can distort the real world – maybe it will be our next blog post), and 2) there is no such thing as a free lunch. The second point baffled me at first. I had heard of opportunity cost, but I had never truly sat down and thought of its real-life application. Our teacher began peppering us, attempting to see if we could break this fundamental rule. It is a difficult and an almost impossible task. Anything you do has another side of the story; as humans, we are constantly battling a zero-sum game. Opportunity cost is real and is a core tenant not only in economics, but in your financial plan as well.
When a family or individual approaches us to begin assessing their ability to retire and live on a fixed income, we explain that financial planning comes down to a simple equation: income (I) – expenses (e) = free cash flow (FCF). Where things become subjective and more complicated is the composition of I and more specifically E. A subjective piece to E, is the rate at which it is increasing over time, otherwise known as inflation. One metric used to describe inflation is the Consumer Price Index (CPI), which measures the rate of change for a basket of goods and services purchased by households. CPI is a general indicator of the rate at which E is increasing over time. The issue – not every E category is inflating at the same rate. Furthermore, each E category has a differently weighted percentage relative to E. Meaning, averaging CPI over time and applying that percentage across all E categories may produce results that are not indicative of the future. To produce a more accurate picture, you must understand the amount you will be spending for each E category and then apply an appropriate inflation rate. Moving forward, one E category one must truly understand is healthcare.
How LBW Sees It
Humans have been bartering since the beginning of time. For example, between 9000 – 6000 B.C. humans used cattle as a form of currency to trade for other objects and by 1200 B.C. Cowry Shells were used as a form of currency. Fast forward to today, fancy cotton-based paper and metal coinage is used to pay for a movie and popcorn (we sure have made some advances). Even though the physical form of currency hasn’t changed much for many years, the backing of currency has. Today, most countries support and back their own currency – otherwise known as fiat money. This type of currency is regulated and backed by the full faith of governments. The U.S. dollar was originally backed by gold, meaning each piece of currency could be converted into its respective share of gold. This meant the government did not have the option to print more money as they would have needed more gold to support such an idea. In 1971 President Nixon officially took the U.S. dollar off the gold standard, allowing the government to have full control over the expansion of its money supply in addition to backing it 100% - yes, the $100 bill in your pocket is only worth $100 because people feel it is worth that much. In essence, the money supply for most countries is a monopoly and can be controlled or manipulated at the government’s discretion. They can print more money to increase money supply causing the value of their currency to decrease. Or, they can restrict or take money out of the system to help pump up the value of their currency. At this point you’re probably wondering to yourself “What does this have to do with cryptocurrency?” – the answer: everything.
401(k) accounts are meant for retirement, making it difficult to withdraw money. For example, the IRS states the following:
Generally, distributions of elective deferrals cannot be made until one of the following occurs:
And if you decide to challenge the rules, any money withdrawn will be taxed as ordinary income, in addition to a 10% penalty. In a perfect world, an individual would leave their 401(k) alone until retirement, but we all know that’s not realistic and individuals may need access to their funds, even if it is temporary. To assist, Congress created relief for employees via the 401(k) loan, which allows employees to take loans directly against their 401(k) or other qualified plan balances, subject to certain restrictions. So, let’s dive into the structure and some of the basics surrounding 401(k) loans.