Consider Income When Considering Career

In an earlier post, I referenced an article that discussed Bloomberg’s Shift: The Commission on Work, Workers, and Technology. That’s Bloomberg-as in Michael Bloomberg, the former mayor of New York City. I was shocked at the credit given to the capitalist economic system. From the report: “Today, the poorest Americans have higher living standards-and live healthier, longer lives-than the richest Americans in the 19th century.” It goes on to praise technological advances because increased productivity is the only real way to advance our quality of life. Unfortunately, advancement also means some workers are rendered obsolete. The point of the study was to address the state of workers in the near future (10-20 years). The commission had 100 members in 5 cities create 44 scenarios, which were whittled to 4 scenarios to analyze. More importantly, they surveyed workers about their jobs, satisfaction and expectations.

The conclusions and comments aren’t all that productive. The report seems to mostly provide the opportunity for the members to virtue signal (i.e., talk how much they care about workers). That said, some of the survey results are interesting:

1) There’s the disturbing part about unexpected expenses: 28% said they would have to worry about a $10 unexpected expense. That what my previous post was about.

2) The amazing result, to me, was the response to “What matters most to you about work?” While the report highlights the desire for stability (a top 3 response for every income bracket), a higher response was “Doing things I enjoy”… #1 for all income brackets except $50K-$75K, which had it at #2 (behind stability).

While everyone wants to do things they enjoy, they have to figure out how to get paid for it. Basic Personal Finance points out that work is called work because, for the most part, people don’t want to do it. Picking an occupation is about finding a good or service that you can provide that people are willing to pay for. It is important to consider future job prospects when you decide to invest in yourself through any kind of education or training. Studying a subject that you like but with little prospect of a job (either from no demand or abundance of supply) is not a good investment. Going into an industry on the verge of automation (e.g., truck driving) is also not a good investment.

All CFPs Come From Lake Wobegon

It’s amazing how two people can read the same article and come to completely opposite conclusions. A couple days ago, I mentioned a study by Arizona State professor Hendrick Bessembinder that likened individual stocks to lottery tickets. The study itself looked at all stocks from 1926 and concluded (among other things) that 58% of individual stocks failed to outperform 1-month Treasury bills over their lifetimes. That last part is key. Any stock can have a good day, good month, or good year. Bessembinder pointed out that over half of them do not perform well over their lifetimes (years). Enter your typical financial advisor. For a fee, they’ll reallocate your portfolio every year (or month!) using their super-secret formula to ensure you only have the winner stocks, and you can beat the market average (but only with the advisor’s help). The catch is, you have to beat the average by more than the advisor’s fee PLUS the added trade costs PLUS the additional capital gains taxes you’ll pay.

Bessembinder’s final conclusion was that your typical investor is better served by index funds. As an economist who understands the efficient market hypothesis and many other studies that have the same conclusions, I simply added Bessembinder’s study as another data point supporting index funds. Lauren Rudd read it and decided to channel his inner Lake Wobegon CFP… don’t you know, they all earn above average returns! Rudd claimed some secret unpublished method to construct “portfolios capable of outperforming the S&P 500 index over a 3, 5 and 10-year timeframe.” Anyone can do that with historical data. If, on Feb 5th, Dan Quinn had today’s knowledge of Bill Belichick’s play calls from Feb 5th, the Lombardi Trophy would be in Atlanta.

The saying goes “past performance is not indicative of future performance.” Market returns are essentially random, and anyone who says otherwise is trying to sell you something.

When financial planners face an uncertain future, rather than using known historical returns, their performance rarely lives up to the bluster. Academic studies consistently show the majority of brokers and financial planners underperform the market in the long run. Just last month, the Wall Street Journal reported on academic research showing that 82% of all U.S. stock mutual funds have trailed their respective benchmarks over the last 15 years.

Rudd also claimed that other advisers recommend closed-ended (ETF) index funds. That’s a total straw man argument. Brokers might recommend ETFs (good commissions and/or fees), but everything I’ve read (including my own book) says to use open-ended, low cost (<0.25%) index funds. This will provide higher after-tax and after-expense returns to the majority of investors.


The Future of Trading is Scary

My last post discussed Robinhood’s targeting of millennial investors, suggesting Robinhood was the real winner of the Snap, Inc. IPO. It may be hard to see how they “won,” given that Robinhood allows free trades. What they did was build a customer base by targeting a generation that expects everything to be free.

But how does Robinhood expect to survive as a “sub-discount” broker with free trades? Investopedia has some ideas: (1) low costs (no physical locations or PR campaigns), (2) interest earned from customers’ unused cash deposits, and (3) venture capital. That last one is the real reason Robinhood exists: $16M in venture capital. Future income streams will come from margin trading with a 3.5% fee, phone-assisted trades for $10, and a subscription service for pre- and after-hours trading.

If this is the future of trading, I fear for young investors. Free trades are bad enough because they practically encourage day trading, which is essentially the same as gambling. Trading on margin takes a dangerous thing like day trading and takes it nuclear (pronounce it nuke-you-lar for added emphasis). One of the top rules of gambling is to not do it with money you can’t afford to lose. With margin trading, people are gambling with money they don’t even have. This type of rampant speculation causes asset bubbles and subsequent crashes (see the 1929 Black Tuesday crash or the 2008 real estate crash).

Chapter 7 of Basic Personal Finance clearly explains why most investors would be better off automatically depositing a monthly amount into low-cost index mutual funds, which allow them to diversify and get higher after-tax and after-expense returns.

Privatizing Social Security, Part III

The Expense of Transition Will Prevent Privatization

The previous posts already showed how privatizing Social Security would result in better returns for beneficiaries and how most opponents to privatization simply make emotional arguments in opposition to privatization. The real reason the system will not get privatized is the same reason the system will eventually collapse: it’s a Ponzi scheme. If that term is too inflammatory, call it a pay-as-you-go system.

John Goodman (not the actor) provides a list of reasons why most democratic voting countries have pay-as-you-go social security systems rather than privatized systems. The main reason is that such a system allows politicians to “appear to meet the need without really paying for it.” Next, the system generates revenues that exceed required payouts in the early years, allowing politicians to raid the “trust fund” to transfer money to their constituents (i.e., buy votes). The system cannot be dismantled because of the “ratchet effect.” That is, as the beneficiary base expands, it becomes too costly to transition them into another system.

As many people have pointed out, the Social Security system will eventually collapse because the number of beneficiaries continues to increase while the number of  contributors per beneficiary is decreasing. The promised benefits impose a huge unfunded liability to the government. Transitioning to a privatized system would be better for future beneficiaries but removes the funding of current beneficiaries. In short, privatizing Social Security would force the government to acknowledge the unfunded liabilities, and the deficit (and debt) would explode. No politician wants to take the blame for that.

Incentives Matter… Even in Education

A couple weeks ago, there was an article in the Gainesville Sun that said the average out-of-pocket expenses for tuition and fees for a bachelor’s degree from the University of Florida was only $10,660. That same day, I happened to be looking at the school’s website and something caught my eye: The school received $724 million in research grants last year. My inner economist quickly realized the incentive problem that leads to poor quality teaching at UF (at least from the perspective of the students I tutor). I did some quick math and confirmed that incentives do in fact matter, even at public universities. Follow the money…

Assuming a four year program, the $10,660 figure translates into $2,665 per year per student (out-of-pocket). The school has 35,043 undergrad students. That means the school collects about $93M per year directly from these students. In other words, they get over 7.5 times more money from research grants than they do from students. (At my Air Force retirement, when asked if I was planning to teach at UF, I joked: “They don’t teach at UF, they write grant proposals.” At the time I didn’t realize how true that statement was.)

Let’s be fair: the school collects more for students than just their out-of-pocket expenses. According to the school’s own numbers, tuition and fees come to $6,380 per year ($22,278 for out-of-state students, who comprise 3% of students). That means the school collects $247M for students (assuming someone else pays the difference). That still makes research grants almost 3 times more than money from students.

So what happens at a school that’s not focused on students? It doesn’t hurt their reputation. UF is ranked #14 for best public colleges by U.S. News & World Report. Part of their formula relies on the student-faculty ratio, which they say is 21:1. (Other sites say the number is 20:1.) A lower number is supposed to imply a student focus because they’re more likely to get more personalized attention from professors. But at a research school, faculty who focus on research may only step into a classroom to lecture to one very large section of students, so the figure could be misleading. A better measure would be actual class sizes. Trying to find the average class size is difficult, but we know what a good standard should be from UF: Their website says “the honors classes are limited to 25 or fewer students.”

What’s the average class size for regular classes at UF? says “full-time faculty teaching undergraduates” and “regular class size” are not reported. That doesn’t sound like a school that wants to brag about student focus. has students talking about 300+ and 500+ student classes (a number confirmed anecdotally from students I’ve tutored). Surprisingly, says “Small class sizes (mostly 10-19 students).” UF’s own website says this: “Class size averages depend, of course, on the program, the college and the level of the student. Instructional Faculty & Class Size can be found on the Office of Institutional Research site.”

Visiting the link to Office of Institutional Planning and Research shows class sizes from Fall 2012:

UF Class Size

That’s where got its number, but while 10-19 is the median size, it’s less than 30% of the total. Realize that classes with 30+ students make up 32.6%, and over a fifth of the classes (23%) have over 40 students. If you remove those honors classes and majors classes, the average class size for freshmen and sophomores will be even worse. Like I said, not student focused.

I don’t mean to imply there aren’t good teachers at UF, or that all professors do not care about their students. I’m just pointing out that it appears quality education (at least as measured by average class size) is not the focus at the institutional level. The money shows why.

You could argue another reason for the lack of student focus is that students pay less than 40% of the cost (and even that is likely paid by parents). That brings up the same third-party payer issues we have in healthcare. That’s a blog post for another time.