Financial Literacy

Most people have a natural inclination to “keep their options open.” However, in most areas of life the greatest rewards come from eventually making commitments that limit your options. A few common examples include: romantic relationships, academic study, learning a new skill, competing to win, and making a geographic move.

When people approach their own investing, it is no different. The common first impulse is to insist that your investment money is available at any time and comes with a guaranteed return. There are some investments that have these features but they also offer the tiniest returns. These investments may have a suitable place as part of a minor part of an investment portfolio. But, these types of investments will never make a notable amount of return to maintain purchasing power above inflation, grow into any meaningful amount, let alone generate wealth.

On the other side of the spectrum are investments that generate the highest returns. These investments require all kinds of commitments. The investment will likely have long lock-up period (3-5 years before you can get your money back), no guarantee of any return (you may possibly lose all of your investment), and you need to educate yourself in order to make a prudent investment of this type. A few examples of this type of investment would be: a start-up company, the construction of a new apartment building, a hedge fund, or partnering with a producer split the proceeds on a crop or inventory.

The easy investments require no knowledge but offer almost no return. The high-return investments require a lot of knowledge and due diligence effort but there can be substantial financial gains. Do you invest solely to keep your options open or do you have a couple investments requiring homework and a long-term commitment so you can earn an outsized return?

You have likely heard the adage that, “Compound interest is the greatest invention in human history.”

Earning interest upon interest is a powerful mechanism and is something you should be using to your advantage.

It is best to employ compounding in two ways: compound your debts down with extra principal payments while compounding your assets upward with additional savings. The result is an ever-accelerating increase in your net worth.

For example, $1,000 turns into $1,000,000 with only 27 compounding turns at 30%. If your return is lower than it takes more compounding turns. Active management is the best way that you can control and determine the return rate and how long it will take to earn it. Active management means spending time, money, education, and effort to learn how to get your money to earn more money for you.

For a real-life example, a teenager in California employed quick compounding and within 2 years turned a used cell-phone into a convertible Porsche for himself at age 17. Steven Ortiz began his bartering streak with only a used cellphone as his inventory. He continued trading up to better cellphones, then dirt bikes, laptops, and finally cars. After only 14 trades, in 2 years, he was driving his own Porsche convertible. Steven used two critical elements: speed of transactions and profitable transactions that he created by doing a lot of research. He simply located people who have a valuable item that they were no longer using and then he would then offer them something that they did want so they were happy to swap for it.

Whatever active investing you choose to employ, add compounding to accelerate your investment income and net worth.

The 2014 State of the Union Address by President Obama included a new retirement account called a MyRA account. This is a retirement account for employees who do not have access to 401(k) or other employer-sponsored retirement plans.

Unfortunately, this MyRA account only has one investment option, a fund of government bonds which earned only 1.89% last year. These bonds are earning low returns because the Federal Reserve has been keeping interest rates low for 5-years in trying to jump-start the economy. A tiny 1.9% return on your retirement funds is not high enough to keep up with inflation, let alone accumulate into a meaningful amount of money. In spite of the White House claim that there won’t be fees, the government bond G Fund, which is where your money will be placed, does have fees embedded within it.

The second problem with the low yield is that investors in these bonds are not being compensated for the risk that they are taking. According to the President, only your bond principal amount is “guaranteed” by the government. However, there are several fundamental reasons why U.S. federal government has already lost its top ranking of a AAA credit rating back in 2011. In addition, the last three countries that forced retirees to buy government bonds (Argentina, Hungary, and Poland), ended up taking some of the money or offering puny returns, or both.

In my opinion, the MyRA account is a very poor location for anyone’s money; basically, they are for the financially illiterate. Yes, it can take time for someone starting out, who is working part-time, to save up the $500 needed to open a regular brokerage account. However, many brokerages allow no-minimum Roth-IRA accounts if you commit to regular deposits. Retirement savings in a brokerage account of any type can vastly outgrow anyone’s MyRA account over any 5-10 year period.

Most people only have investments in a retirement account that consists of a few mutual funds. For these investors, the first rung of professional financial advice is the financial adviser. They will accept a client with any amount of money and place them in common mutual funds or index funds. The next rung on the financial advice ladder is the financial advisory firm that has a minimum requirement of investable assets like $250,000, or $500,000, or even $1 million. These firms will offer more active management but the investments will still primarily be in stocks, mutual funds, annuities, and index funds. A higher rung on the adviser ladder is called wealth management companies. Their minimum requirement may be $10 million or $25 million of investable assets.

The wealth management approach to investing only has a few extra components over more modest portfolios. At this level of wealth, annual distributions from a portfolio should never exceed 3% if the money is going to last for generations (or at most, only a portion of the portfolio earnings for a given year). Second, they will assess someone’s financial cash flow needs over the next 5 years and buy bonds maturing at intervals that will coincide and fund these needs.

The main portion of the portfolio will be a diversified portfolio that anyone may recognize:

• U.S. Equities: Small, Medium and Large capitalization
• Foreign equities: Europe, Far East, Emerging and Frontier markets

The components for these equity positions may be index funds or leading companies within these categories, and the specific allocation to these positions may go up or down with the current market outlook.

The final portion of the portfolio is devoted to investments only legally allowed for accredited investors (someone who has an income over $200,000 or a net worth over a million, excluding their home). These investments only permitted to accredited investors include hedge funds, private equity funds, private placements, venture capital, private lending (shadow banking), direct real estate and oil wells, and long/short strategies. Although these are the sexy investments that make the news, they represent the smallest portion of the overall portfolio where a little more risk is taken to reach for higher returns since the other two elements of the portfolio are relatively safe.

Corn prices are at a three-year low and wheat is falling on excess exports from Canada and Australia. One way to find investing opportunities from this is to consider, “Whose raw material prices will be dropping as a result of this?” Companies involved in the feeding of domesticated animals like chickens, pigs, and horses along with food companies using grain or even the sweetener, high-fructose corn syrup.

Thinking through scenarios like these is an important element of economic literacy. Understanding the macro-economic elements and how their movement ripples through the economy creating effects and side-effects. Perhaps the price of corn does not impact you in a notable way, however, learning how to think this way will put you ahead of your peers in the workplace, in your investing, and your planning in general.