May 232016
 

The Problem with Vertical Structures

I once applied for a job at McDonald’s. But I soon got myself into a pickle when I couldn’t cut the mustard answering some tough interview questions. 😆  I’ve always admired how quickly fast food workers can be promoted to manager if they work hard enough. When most people think about their careers they imagine themselves moving up the ranks, or climbing the ladder, which are both vertical analogies. In today’s corporate world, the idea of a hierarchy is not only a way to organize a company, but it also dictates how people think about relationships, contribution, accountability, and power.

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But in a fast changing economy that requires communication and interdependence across multiple disciplines, locations, and specialties, the top down method of management often isn’t flexible enough to deal with every situation. Instead, a sideways approach that aligns the values of same level workers might provide more value. 🙂

Let’s pretend there is a boat in a lake. If we want to raise the boat higher, we could try to lift it out of the water. But that would take a lot of energy and sooner or later the boat will drop back to its original level. But if we add water to the lake the boat will eventually rise on its own. This is the essence of the horizontal approach to financial success.

A big impressive job title doesn’t trump a good idea. The best value-creating initiative can come from literally anyone in an organization. In fact, the person who most understands the processes, concerns, and responsibilities of a software engineer isn’t his or her manager. It’s other software engineers. 😀 Real influence doesn’t come from controlling others that report to us. It comes from our ability to add value across the field we’re in.

The horizontal approach has seen success in real life situations. Valve Corporation develops video games such as the Counter-Strike and Portal series. It also operates Steam, a popular digital distribution platform with over 125 million active users.

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According to its employee handbook the company has no managers or bosses. The company employs about 300 workers. There are different roles and disciplines within Valve but everyone is treated as equals in terms of their job positions.

Horizontal Approach to Everything

Branching out horizontally to find success can be applied to pretty much anything.

  • One way to become the best point guard on a basketball team is to play other positions. By adding skills horizontally instead of aiming for one specific goal we can develop a better understanding of how the entire game is played.
  • One way to become a good parent and have a healthy relationship with our kids is to be more supportive to our spouse. By helping to lift each other up the family bond will become even stronger.
  • One way to become the best pastry chef is to study a wide variety of other culinary baking skills to gain inspiration and unique ideas. 🍴
  • When it comes to personal development, meditation and positive thinking is important to create a happier and healthier state of mind. But doing these things alone may not be enough. Instead of focusing 100% on spiritual enlightenment, we could also extend our efforts horizontally to other aspects of our well-being such as eating a cleaner diet or getting more exercise. A healthy body will help to create a more fulfilled mind and spirit. 😉

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May 162016
 

The Enemy of Success is Delusion

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Author and public speaker Steve Siebold has helped many people with their careers. His clients include Fortune 500 companies and his books are considered by many to be the gold standard in the field of psychological performance training. One important distinction that Steve notices between the middle class and the wealthy is in how they think.

“The average person believes they are far more competent at what they do for a living than they actually are. Many people believe they are overworked and underpaid, but this is rarely true. In a free market economy we are normally getting paid very close to what we’re worth.” ~Steve

I happen to agree. An employer probably wont pay someone $30/hour if the labor is only worth $20/hour. Workers are replaceable. If a company consistently overpays its employees then it won’t stay in business for very long, assuming all other market conditions being equal. The employee can make the same choice. If a pharmacist is being paid $20/hour but believes he is worth $30/hour then he is free to offer his professional services to another company. Since the labor market is based on supply and demand, it’s important to consider both sides when thinking about compensation.

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May 092016
 

Time and Annual Returns

I recently watched an interesting YouTube video about time and the rate of return, by finance columnist Preet Banerjee. He explains the relationship between an investor’s time horizon and his or her rate of return. Here’s a question to illustrate an example. If our goal is to accumulate $100,000 by age 65, how much do we need to save per month?

Here’s a table that breaks down how much investors will need to put away each month depending on their current age and the expected rate of return. For example, we can see that someone at age 30 who expects their portfolio to return 4% a year should save $109 per month.

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As we can see, the rate of return is a much stronger factor for investors with a longer time horizon. The 20 year old still has 45 years until retirement and how much he has to save is heavily influenced by his average investment returns. On the other hand, the 60 year old investor only has 5 more years before retirement so most of his accumulated wealth will come from savings rather than from investment gains. This means he shouldn’t take on more investment risk and reach for higher returns since the his rate of return simply doesn’t matter very much. This is why I have a relatively high risk tolerance, even though some people don’t approve. It’s because I’m in my twenties and if I can get that higher rate of return on my portfolio now, my life would be so much better in the future. 😀

The other thing to note about the table is that time trumps rate of return in most cases. If one person starts to invest at age 40 and earns a 2% rate of return, and someone else starts just 10 years later but earns a 6% rate of return, then the first person would still come out ahead despite making 4% a year less. In other words if we start investing 10 years earlier than our peers, then that will have the same effect as outperforming their investments by more than 4% each year. Wow! Let that sink in. 😆

We can also track our retirement progress with this information. For example if we plan to retire in 15 years we can use the AGE 50 row of numbers in the table above. Let’s say we want to accumulate an extra $300,000 between now and our retirement date. We know the table is based on an accumulation of $100,000. So to find out how much we need to save each month we just multiply the green numbers by 3, since $300,000 is 3 times $100,000. The tricky part is guessing which rate of return we are most likely going to see over the next 15 years, but I think 4% sounds like a reasonable assumption.

So start investing as early as possible and front load more risk to the earlier stages of wealth accumulation. 🙂

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Random Useless Fact:

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May 052016
 

The Pessimism in the Markets

Corporate profits have been disappointing lately. Apple (AAPL) recently said its revenue fell for the first time in 13 years due to a decline in iPhone sales compared to the same time last year. Apple shares are worth 26% less now than a year ago. Investors are warned the decline could continue. 🙁 Other publicly traded companies are experiencing similar challenges. Top line growth is slowing down, and its becoming harder to maintain profitability levels.

A recent article on Bloomberg.com suggests that future investment returns for millennials will be lower than prior years. It cites a study by consulting firm, McKinsey & Co, which proposes that “the forces that have driven exceptional investment returns over the past 30 years are weakening, and even reversing.” So maybe it’s time for investors to lower our expectations. 😕

Lower Investment Returns for Millennials

The last 30 years was actually a bit of an anomaly because on average we’ve had a couple of percentage points better annual returns when compared to the past 100 years in general. Falling inflation rate has helped drive real returns, and bond prices increased substantially as interest rates fell for the last couple of decades. 🙂 But going forward we may face secular stagnation and a lack of economic growth due to an older population. Let’s take a look at the study’s findings, and future return estimates.

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Regarding U.S. equities for the time being, it appears growth in the following 20 years will be 1.4% to 3.9% lower than in the past 30 years. The director of the study, Richard Dobbs, warns that the people who will lose out the most are the millennials. Oh no. That’s me! 😱 It appears we’ll have to either work longer or find other ways to put more money in our retirement accounts. The alternative is to retire poorer and live off government cheese, which is actually a luxury in Canada considering the expensive tariffs we have on dairy products, haha. 😀

Preparing for the Next 20 Years

So here are a few of things I’m doing to deal with all this information. They may not work for you, but I will share anyway.

First, the most important thing is to lower the cost of investing. This is even more crucial if market returns will underperform in the future. Using the numbers from the graph above, the average return on U.S. equities over the last 30 years was 7.9%. So if our management fee and other combined costs were 1%, then our actual return would be 6.9% after fees. The 1% fee would effectively eat away 13% of our actual market return.

But the “slow-growth scenario” claims that over the next 20 year period the annual return of U.S. equities will be only 4%. If we still pay the same 1% portfolio fee as before, then this cost will eat away 25% of our future annual return, nearly twice as high in percentage proportion to a 7.9% market return. Bummer. 🙁

So how can we lower pesky fees and reduce the overall cost of investing? It’s simple. 🙂

How do we reduce the long term costs of plumbing? We learn some basic DIY plumbing skills. How do we reduce the cost of food? We learn to cook and meal plan. 🍗 How do we reduce the cost of car repairs? We learn some basic knowledge about car maintenance like how to check the tire pressure, change the oil and air filter, etc. We can reduce the cost of any aspect of our lives by simply educating ourselves on the subject. 😉

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So if we want to lower our investment fees, we just have to better understand how to invest and manage our own money. With the advent of ETFs and robo-advisors, I hope everyone reading this blog is paying less than 1% management fee on their portfolio.

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Mar 212016
 

Retirement Account – Taxation

Many folks should use tax deferred programs such as the RRSP or 401(k). Contributions made into a retirement account is tax-deductible and can grow tax-free in the account. When it is eventually withdrawn and taxed the plan holder will likely be in a lower income tax bracket. I would personally try to keep investments that produce mostly capital gains or eligible Canadian dividends out of my RRSP. But that’s just my personal preference for tax efficiency. The picture in this link here definitely says otherwise. 😝

Most people expect to be in a lower tax bracket when they retire so contributing money into an RRSP to defer taxation to a later date when their tax rate is lower makes sense. But some experts say it’s probably not a good idea to use RRSPs if we expect to retire in either the same or a higher tax bracket as we are in now. However, there might be another way to look at it. 😀

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What if it’s still smarter to contribute to an RRSP today even if our marginal tax rate will be higher in retirement? When we make a tax deductible contribution to our RRSP today, the immediate tax relief we get is based on our marginal tax rate. So if our marginal tax rate is 30%, then we would receive $300 by contributing $1,000 to a registered retirement account. But when we withdraw money from this RRSP (or RRIF,) the money we take out is only taxed at our average tax rate, not the marginal tax rate. For example, if we request 12 monthly withdrawals a year from our retirement account then these payments would be taxed similarly to receiving work income from a job where each payment reflects our average income tax rate.

This is due to our progressive income tax system. In Ontario for example, the first $45K of income is taxed at roughly 21%, then the next $28K of income is taxed at 30%, and so on. So if we make $100,000, then we actually pay about $26,000 of income tax, which makes our average tax rate 26%, even though our marginal tax rate would be 38%.

So I’m going to continue maxing out my RRSP contributions each year even if there’s a chance my income will be higher in my 60s and 70s than it is now. 🙂

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Random Useless Fact:

Some people on the internet can’t figure out how many girls are in this picture.

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