Investment Moats

First REIT Proposal to Restructure Master Leases – Some Thoughts

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Yesterday evening, First REIT announced a restructuring proposal with their master leasor Lippo Karawaci.

This proposal would still have to be approved by unit holders during an extra general meeting.

I am just going to do a short note here.

First REIT generally masters lease a portfolio of hospitals bought from parent Lippo Karawaci… back to Lippo Karawaci. The lease tenure is rather long at 15 years. The first set of hospital lease was during the IPO in 2006 (the lease term is almost up for the first batch). The actual operator of the hospital is PT Siloam International Hospitals.

PT Siloam do not pay the rent to First REIT. Instead, Lippo Karawaci pays the rent to First REIT. PT Siloam does pay rental expense to Lippo Karawaci but the rent in the past years have not equate to the amount Lippo Karawaci paid First REIT (there in lies the problem)

First REIT’s Problem

First REIT manager, Bow Spirit have like a few problems all coming together:

  1. The gross rent for each master lease is paid in SGD instead of Indonesia Rupiah (IDR). This means that Singapore investors are fortified against currency fluctuations. The rent was fixed based on the SGD to IDR rate in 2006. SGD has been strengthening against the IDR. This puts a lot of pressure on Lippo Karawaci to pay the rent. PT Siloam does not pay them a lot in IDR and they have to pay First REIT in SGD.
  2. Since First REIT’s master lessor Lippo is wobbly, First REIT runs into a problem trying to refinance their debts… and 80% are coming due in the next 18 months
  3. If the leases that are coming due are renewed at the current SGDIDR exchange rate, the rental revenue takes a massive fall. The value of the property, based on the aggregate of future cash flow, will fall as well

What This Restructuring Does

So Lippo is desperate to bring down the rent. The best outcome is not to pay it in that old SGDIDR peg.

If Lippo have some breathing space, they show that they can pay the rent, the banks would let them refinance.

The first proposal is that the rent is in IDR instead of SGD. The second thing you would notice is that the base rent is like 38% lower than current.

The rent payable is now calculated not based on base rent + variable incentive but the higher of base or performance base rent.

The rental escalation is not capped at 2% of Singapore’s CPI increase but a flat 4.5% a year.

This would renew the master lease for another 15 years.

In a way, the master lessor Lippo Karawaci would pay much lower rent and might help them a bit.

The net property income takes a 33% dive. So will the forecasted dividend per unit. Based on their forecast, the FY 2019 DPU will go down from 8.6 cents to 4.44 cents. ( at the current share price of S$0.475 this is a 9.34% dividend yield)

I used the FY2019 forecast by First REIT management instead of the 1H2020 forecast. The 1H2020 forecast is lower, because the rental revenue is also lower by 33% due to the two month rental relief extended to all tenants to alleviate the economic stress caused by COVID-19 pandemic.

The net asset value will also take a dive from 91 cents to 49 cents (future rental revenue fall, the property value is based on the aggregate of future rental income). Interestingly, it is pretty close to the current unit price of 47.5 cents.

Does the market know something that we don’t?

The leverage will shoot up from 34.9% to 48.6%.

What this does is that it also extends the weighted average lease expiry to 12.6 years.

Some Thoughts

This is probably a one time pain for the REIT and unit holders. I think whether you are an existing unit holder or a prospective one, you need to look at the quality (or lack of quality) of this REIT going forward.

We gave up a lot when the rental revenue is converted from SGD to IDR. The existing rental revenue is like an emerging market bond hedged back to SGD. There was a rental escalation of between 0-2% at least.

With the rent now in IDR and a 4.5% a year escalation, whether this is good or not would depend on the SGD and IDR currency movement.

  1. If SGD weakens against the IDR, the investor enhances their purchasing power by investing in IDR. Additionally, they get a boost in a rental escalation of 4.5% a year
  2. If SGD strengthens against the IDR, the investor loses purchasing power by investing in IDR. The 4.5% a year escalation would try to balance things out and preserve your purchasing power. The extent of the loss in purchasing power would depend on the magnitude of the currency depreciation
  3. IF SGD and IDR are largely flat, the investor gains based on the 4.5% a year rental escalation.

So a lot depends on the currency movement.

I managed to pull some historical SGD vs IDR currency trend from Bloomberg:

click to view larger chart

The time period was from the point close to when First REIT IPO in 2006 till today.

During this period, the SGD appreciated 77% versus the IDR. That is an annualized 4.1% a year. Hey! quite close to the 4.5% a year under the new proposal.

If we measure from the halfway point in 2013 till today, SGD strengthens 3.95% a year against the IDR.

You can now understand why they give 4.5%. In this way, you are likely to maintain your purchasing power but also gain a little.

Are there a possibility that IDR will do well against the SGD?

Here is a longer SGD vs IDR chart:

This is from 1990 to 2020 or about 31 years. The annualized gain of SGD over IDR during this period is 7.73% a year. There are probably 1 to 2-year periods where IDR did well but largely, you know the trend.

First REIT leverage, due to the reduction in NAV looks very, very high. I wonder if they will have a problem refinancing the loan. This may not include the $60 million perpetual securities still on their balance sheet.

Depending on how that turns out, there might be a rights issue coming.

This definitely make acquisition difficult.

The saving grace is that the lease expiry is longer and First REIT does not have to worry so much about expiring leases.

But if you think about it, First REIT is at the mercy of the tenant. If Lippo Kawaraci and Siloam do not run the hospitals, who would run the hospitals?

In local boutique fund Lighthouse Advisers Q3 2020 letter, they mentioned this unique trait of healthcare REIT:

A lot will hinge on how well the hospital does. In a way, what may look ugly today could change if the hospitals become healthy. They have not perform well this year due to Covid but even before this, they were struggling.

The yield looks juicy but likely at this dividend yield close to 9% it will make future acquisitions hard. The growth would really need to come from the hospitals doing very well, IDR do not depreciate against SGD.

And of course if you trust the Riady family.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

  1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
  2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
  3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
  4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
  5. Free Stock Portfolio Tracking Google Sheets that many love
  6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
  7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works

4 Potential Ways to Estate Tax-Proof Your Investments

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If you hold a portfolio of US stocks or the US incorporated exchange-traded funds (ETF), you might want to take note of the potential estate tax implication should you suddenly passed away.

An estate tax is a tax on the net worth of an individual above an exempted amount. These taxes are usually levied when the person passed away. They are also known as Death Tax.

For example, if you are a non-US resident and have accumulated US$1 million on your portfolio of US incorporated assets, you would have to pay estate tax officially. There is usually an exempted amount and in the case of the US, the exempted amount is US$60,000. Thus, US$940,000 will be subjected to estate tax.

Currently, the tax is tiered from 18% to 40% for non-US residents (depending on the taxable amount). This would mean that the beneficiary of your estate would inherit about US$322,400 less.

Usually, investors would debate whether the 30% dividend withholding tax is something that they can live with (you can read my comprehensive guide to dividend withholding tax here) but I think this is something that you should seriously think about when structuring your wealth.

Estate tax is not limited to the assets in United States. Many countries have estate tax and inheritance tax.

Per Wikipedia, here are the countries with the highest inheritance tax or estate tax:

  1. Japan: 55%
  2. South Korea: 50%
  3. France: 45%
  4. UK: 40%
  5. USA: 18% to 40% (tiered)
  6. Ecuador: 35%
  7. Spain: 34%
  8. Ireland: 33%
  9. Belgium: 30%
  10. Germany: 30%

That said, there are some possible solutions that we can consider to circumvent this problem as well. We will explore them in this article.

Now before we begin, what you read here is based on what I understand about the subject. This topic involves taxes in different countries interacting with more countries. Each interaction is a body of work.

If you tried to find out more about this subject from your broker, robo-adviser, fund distributor, financial planner, what is likely going to happen is that many would ask you to check with your tax accountant. The reason is that not many want to touch this domain.

This domain can get complicated pretty quickly and many of us may not know the intricate work to advise you well. So the easy solution is to tell you to go ask a tax accountant.

I do think that on a high level, there is a framework that you can use to understand these things. The right way to use what I wrote here is more as a primer to go down the right rabbit hole and not treat this as the absolute facts.

Ok lets get started.

Estate Taxes and Inheritance Tax are Potentially Bigger Deal than Withholding Taxes

A large segment of investors buy and hold exchange-traded funds (ETF). At this point, many of these ETF have rather low dividend yield.

If there is a 20-30% withholding tax on a 1.6% dividend yield, the withholding tax will shave 0.48% from your overall returns. Over time, this cost can be substantial.

We can try our best to save on this by using more tax-efficient ETF or fund solutions.

However, the estate taxes and inheritance tax will pose a bigger deal simply because the potential tax incurred by your beneficiary is much higher.

If you have accumulated US$1 million, the potential taxes that would be paid out of the estate is US$322,400.

Thus, while I can let some of these withholding tax considerations slide, you have to ask yourself whether it is wise to lose such a large amount of money to the US government.

The Difference Between Inheritance Tax and Estate Taxes

In layman terms:

  1. Inheritance tax – Is a tax on what your beneficiary will receive
  2. Estate tax – This is a tax on your estate (the stuff you are left with a net of your debts and expenses). This is charged regardless of who inherits your net wealth

Usually, gift tax is lump together with inheritance tax.

The confusing thing is that, for some countries, they call the tax inheritance tax but if you read the description of the tax, it behaves like a tax on the estate.

Here is an example of the United Kingdom’s inheritance tax:

If you read the description, it describes the inheritance tax as a tax on your estate.

However, in the case of Ireland (for those domiciled Irish folks), it is worded more as a tax on the benficiary:

Whether it is 33% or 40% tax, it still feels painful for the people receiving the money. They either pay more on accepting the inheritance from you or accept a lower inheriance (since the estate is smaller).

There is however a difference.

You could work in Ireland for 5 years. You never wanted Ireland to be your domicile or where you call home officially. However, while you are there, one of parent passes away and leave you with a sum of money.

Non-domiciled individuals who have been tax residents in Ireland for five consecutive years are liable to pay inheritance tax. (You are a tax resident because you work and pay taxes there).

Of course, there are nuances such as what is the amount and whether this amount is above or below the set value.

To circumvent this, you might need to do something to ensure that you do not satisfy that five consecutive year rule. It means that, you need to have a certain understanding about the tax law in another country.

Which can be a real pain.

There are Exempted Amount, Set Limits that Limits the Estate Taxes and Inheritance Taxes that you have to Pay

That said, governments tend to set limits such that the tax usually fall on the people that are more well-off.

For example, the current estate tax exemption for US citizens is above US$11.5 million. If you are a non-tax resident (you the investor who invests in US-domiciled companies or ETF), the exempted amount is US$60,000 (not a lot of exemption thus it is a problem).

Based on the UK inheritance tax example before, the UK limit is pretty alright at 325,000 pounds (SG$575,000).

This means that if a person leaves behind an estate of 500,000 pounds, the tax on his estate would be (500,000-325,000) x 40% = 70,000 pounds.

Different countries will also have their own exemptions for certain groups of beneficiaries. For example, in the UK context, married couples and civil partners are allowed to pass their possessions and assets to each other tax-free in most cases.

The surviving partner is allowed to use both tax-free allowances (the 325,000-pound limit not used by your deceased partner), providing the first spouse to die did not use up their full inheritance tax allowance by giving away a big chunk of money in their will.

What are the Potential Recommendations to Address these Estate/Inheritance Tax Issues?

If you would like to have less tax slippage so that your beneficiaries can have more usable wealth to enhance their lives, maybe you can explore how you can optimize your wealth better.

Here are some recommendations. They have their pros and cons like always.

1. Invest Mainly in Markets, Companies that Are Domiciled in Estate Tax-Free Countries or Low in Estate Taxes

The first solution is to choose where you invest. If majority of your estate are in jurisdiction where you do not have to pay estate taxes, then you avoid a lot of these headaches.

There are a few countries that currently do not levy estate taxes and some are pretty popular investing markets for Singaporeans:

  1. Singapore
  2. Hong Kong

Companies, unit-trust, ETF incorporated in Singapore or Hong Kong should be estate tax-free. They tend to be listed on the SGX and Hong Kong Stock Exchanges.

For the fund investors, most of the funds incorporated in Singapore should be free of estate taxes.

How do you check this?

You can take a look at the fact sheet. I have attached a section of the factsheet of a Singapore incorporated fund, Schroder Asian Growth:

Secondly, there are also countries that currently do not levy estate taxes. Companies, unit-trust, and ETF choose to incorporate or domicile them in these countries.

For the buy-and-hold investors who wish to invest in a low-cost unit trust or ETF, a popular option is to invest in Irish-domiciled UCITS funds.

Now, you might be spooked by the 33% inheritance tax example I have given you previously. That is for Irish citizens.

You can consider these UCITS funds a lawful permanent resident of Ireland but are afforded different set of rules. Ireland have long been recognized as a destination of choice for investment funds due in no small part to the government’s encouragement in creating a flexible system advantageous to setting up funds.

UCITS stands for Undertakings for Collective Investment in Transferable Securities and they account for the vast majority of Irish domiciled assets and are distributed worldwide to more than 60 countries (based on 2010 Lipper data).

UCITS funds’ advantage is that the investors in other European member countries can invest in them more easily.

The advantage of funds domiciled in Ireland is that Ireland does not levy any inheritance, estate taxes on these Ireland domiciled ETFs and unit trust.

23.6 Exemption of certain investment entities

CATCA 2003 s.75 provides an exemption from tax for gifts and inheritances of units of certain investment entities (defined in the TCA 1997, Part 27).

Units held in collective investment schemes, common contractual funds, investment limited partnerships or investment undertakings are exempt from tax in cases where neither the disponer nor the donee or successor is domiciled or ordinarily resident in the State, at the date of the disposition and at the date of the gift or inheritance, respectively. The CAT exemption applies in the case of the transfer of units in an investment limited partnership notwithstanding that this type of entity has been removed from the definition of “investment undertaking” in section 739B(1) TCA 1997.[5]

– Revenue Ireland

These Irish-domiciled UCTIS funds are listed on the London Stock Exchange under popular brand names such as BlackRock iShares, Vanguard, Wisdom Tree.

Some of the funds have been mentioned in previous articles such as IWDA and VWRA here, emerging market bond JPEA, High yield IHYA.

At Providend, we also advise our clients to consider managing these potential tax implications by structuring their wealth in Vanguard, Dimensional funds that are low-cost, broadly diversified, fundamentally sound that allows them to capture the returns to meet their financial goals.

By placing their wealth in these UCITS funds, they have one less tax worry on their minds.

Here is a portion taken from the factsheet of a Dimensional fund:

Finally, there are companies that are listed in countries that you would make the estate liable to future estate taxes but are domiciled in countries that are currently free of estate taxes.

One example could be Sea Limited the Singapore company listed on the stock exchange in United States.Sea Limited is incorporated in Cayman island.

Cayman island currently do not have inheritance or estate taxes.

The caveat to this recommendation is that tax laws will potentially change. Companies can merge and change the places where they call home. Ireland could change their perspective on how they conduct this fund domicile business.

I think it is very unlikely they will change. However, even if they do, there are other countries that are tax-friendly waiting to eat their lunch.

The notable one: Singapore with their VCC structure (Singapore variable capital company).

Ireland is not the only European country with UCITS funds. Luxembourg has its own set of UCTIS funds domiciled over there as well. From what I understand they do not face estate taxes and inheritance taxes for investors as well.

I will list out some countries that do not have these kind of death taxes in a lower section in this article.

2. Setup Your Brokerage or Investment Account as a Joint Account

This is a common solution for many couples (then again you can do that with your parents as well)

If you setup as a joint account, the suriving spouse can still manage the account. They could sell off the shares of companies incorporated in countries that have estate taxes.

By right, the demise of one spouse should trigger an estate tax event on the entire amount. The suriving spouse should submit a death cert for tax clearance.

That is the official way.

But I think the unofficial way is not to declare and just sell off your shares.

From the words of some who have checked with the brokers, they do not care so much what you do with the shares in your brokerage account.

I think most likely, if you submit the death cert, as per my experience trying to get my late mom’s money out of her account, they will force you to close the account.

But if you ask me, it is a risk that you would have to take. Officially, I would not recommend you to do this.

If you think about it, if your family is peaceful this is OK.

However, if your children are at odds with your surviving spouse, what would happen if they start suing your surviving spouse for doing something illegal. In a way, this is not very legal at all.

Back in my school days, I have a friend who told us this tale of his family. He is not on speaking terms with one of his sibling. When his dad passed away, his sibling tried to monopolize the money and tried chasing them out of their home.

This is more common than you think.

The reason we tried to setup our estate well is so that our wealth don’t become a divisive thing when we are not around.

This is something our client advisers try to enlighten the clients and prospects who are interested in setting up their estate. Sometimes, it is not just about the money but what you wish to communicate with the people around you, through your estate decision, when you are not around.

An alternative to the joint account, is to keep a log of your brokerage accounts, their access credentials and tell someone you really trust where to find it should something happen to you.

This is so that they can log into your account and do the same thing as the surviving spouse.

The consequences are the same as well. In fact, if the family is damn messy, this is even worse if the person you trusted is not a direct line family member.

3. Setup an Investment Bond to hold the Shares and Funds

Some of our client advisers have clients with company shares of firms incorporated in countries with high estate taxes.

Depending on their situation, we may recommend them to rationalize their exposure. However, if there are grounds that they prefer to keep those shares, we could help them structure as an Investment bond.

You can think of an investment bond as a wrapper container that holds these funds and shares. Instead of the shares directly own by you, you relinquesh the ownership by transferring the shares to this investment bond.

This investment bond is like a lawful resident of a tax-free country such as Jersey, Isle of Man or Cayman islands. You would own this investment bond.

Should the person passes away, the shares are still own by this “living” investment bond, incorporated in Jersey/Isle of Man or Cayman island. It would depend on whether Jersey/Isle of Man or Cayman island levies estate taxes on the deceased.

There are currently no estate tax in Jersey, Isle of Man and Cayman Island.

There are more details about such bonds that I will not go deep into.

These bonds are popularly owned by expatriates because of their frequent deployments from country to country. They have been recommended these types of products by advisers because of the “tax savings” that they could enjoy.

Unfortunately, they might be lead around by advisers. They have saved on the taxes, but the commissions they paid to the advisers more than take away the advantages. How are we suppose to be able to compound our wealth when the cost can be more than 2% (excluding the total expense ratio of the underlying funds)

There are also some charges and restrictions to how much and when they can take out their holdings.

Our expat adviser Max have spend enough of his time helping prospects and clients make sense of whether they need products such as these or they been lead around to focus on the wrong stuff.

The truth is, these wrapper bonds can be useful and cost-efficient under a more humane adviser fee structure. Sometimes what you need is someone with enough transparency to explain to you how these products work, what are they useful for, when you do not need it, what are the alternatives to this.

4. Use Term Insurance to Make Up for the Estate Taxes

Term insurance is a cost effective solution to address this problem.

Suppose your portfolio is worth US$1 million. So you will potentially need to pay US$375,000 in estate taxes.

That will be an equivalent of SG$500,000.

The annual premium for a term life insurance of that amount is $500. That is about a 0.10% portfolio cost.

As your portfolio goes up, gradually buy more term insurance. Term life insurance is much cheaper today than years ago due to longer life expectancy (refer to my cheapest term life insurance article)

What will happen when you live past 65 years old?

As you get older, the cost of term life insurance would not be worth it.

If you have built your wealth, you might want to think about perhaps shifting your assets to investments that are more estate tax-efficient as recommended here.

5. Just Lived With it

This is not quite a solution but I will throw it out there.

Sometimes, you need to know whether you have enough.

If even after potentially paying the estate taxes, you will leave more than enough for the next generation, then you have done the responsible thing!

You are not gonna be around anymore and you have done all that you could to pass down the right values, principles and money to give them a good platform to live a good life.

Additionally, if the potential return of the investment, its quality is better than what you can get anywhere else, maybe the benefit will still outweigh this estate tax, inheritance tax consideration.

For example, currently you have $1 million. The investment vehicles available to you in more estate tax or inheritance tax friendly countries can earn you 7% a year compounded returns.

In 15 years, the $1 million would grow to $2.76 million. However, if the rate of return that you can compound is at 11% a year, the same $1 million may have grown to $4.8 million. After a 40% estate tax, you would be left with $2.88 million.

Net net it might still be worth it.

But if we think about it, does it make sense to deploy our wealth in assets that earn a greater rate of return but end up getting shaved?

I have more of a philosophical answer.

The assets may be able to compound and give less headache to your heirs. Eventually, it might prove to be a better investment versus investing in something that is tax-efficient but is not built to last. Passing these assets to them is also a way of communicating your wealth management philosophy. They might learn a bit from that.

There are some counter point to this:

  1. Growth rate from my experience are not so cast in stone most of the time. You can try and invest in areas where potentially the growth rate is better but your result might disappoint. If the person passes away, it is a double whammy
  2. Your heirs might still sell off those assets for their own personal goals
  3. The lifespan of individual companies are getting very short (average lifespan now is 18 years), so a good company during your life time might not continue to be good in their lifetime.

The Countries with No Estate Tax or Death Taxes

If you are looking for unit trust or exchange-traded funds, companies that have less estate tax issues, here is a list of companies that currently do not have estate tax.

The issue is… while they might not have estate taxes, they may have other taxes that would be a deal-breaker. These may not be applicable if you do not wish to change your domicile to that country.

  1. Australia – there could be some capital gains tax
  2. New Zealand
  3. Canada – there could be some capital gains tax
  4. Estonia – gains on transfer of property as a gift or inheritance is subjected to income tax
  5. Hong Kong
  6. Macau – foreign source income is exempted as well. Stamp duty may apply with regards to real estate transfers
  7. Singapore
  8. Luxembourg
  9. Norway
  10. Portugal – family members who are not deceased’s immediate family would face a 10% stamp duty
  11. Serbia – there are estate tax but family members directly connected are exempted from inheritance tax.
  12. Slovakia – no inheritance tax but there are capital taxes on appreciation in the value of the estate assets when sold
  13. Sweden
  14. Isreal – pretty heavy capital gains tax on assets sold

Summary

I hope this article have given you some ideas to think about when it comes to addressing the estate tax, inheritance tax issue for the portfolio.

I think I have provided more ideas for the estate tax part, less for the inheritance tax. If you are going to move overseas to work, perhaps you can look up the tax laws in that country. Try to make sense of the income tax, what are the conditions that would make you a tax resident of the country, under what conditions would you need to pay gift taxes, and whether there are any outrageous taxes that might potentially be a problem.

You could also check with the liason person in your company to see if they can provide some advise in that area.

I think we are lucky also that we lived in a country that currently do not have estate taxes, dividend withholding taxes (for individuals. There are withholding taxes for companies and partnerships), taxes on foreign source income.

But some of these might change during your lifetime. We will never know. There were enough murmurs of the return of estate taxes.

If you need some help to better structure your wealth, be more optimized in terms of the estate/inheritance tax aspect, planning your will and estate, you can look up Providend here. We work with expatriates in Singapore and around the region as well.

Disclaimer: This post is for information purpose only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

  1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
  2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
  3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
  4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
  5. Free Stock Portfolio Tracking Google Sheets that many love
  6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
  7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works

How I view COVID as an Opportunity to Stress Test My F.I.R.E Plan

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A couple of months ago, someone asked on Reddit about how our experience these few months living in financial independence.

He was also curious if our friends are more open-minded about pursuing financial independence, retiring early (FIRE) than a lot of his peers.

That is how I first got to know BOCH. We went out for coffee one afternoon and chatted for over two hours about financial independence, work, and life in general.

I decided to explore whether BOCH is open to sharing his experiences with my readers because of a few things.

The first reason is that I want you to hear a perspective that is not mine. Some may find that after hearing what I said, the FIRE process might be very hard to achieve. So other perspective may help.

The second reason is that BOCH took the plunge, cut away from his job, with his family depending on his accumulated wealth. There is the emotional side of FIRE that is seldom discussed. In my conversation with BOCH, I do pick up that living without your job as a fall-back plan, having your portfolio value go up and down with the market is something not to be discounted.

The final reason is to give him, whom I now considered as a friend, room to pen his thoughts and exercise his creativity and storytelling. If you enjoy what he has written, leave a note below and maybe he would write something to address your query in the future.

In this article, BOCH will share with you how he determines whether he has accumulated enough to be financially independent. He would also share how he deals with the uncertainties of life in his plan (which is definitely going to happen). Finally, he shared how he lived through his first big test without a job, living with portfolio volatility and the “self-talk” that got him through things.

I will come back and round off this article with my personal thoughts.

Way back in March and early April this year (2020 as of this writing), which seems like a lifetime ago, the COVID case counts continued to rise, and the markets around the world seemed to be going through an unending rollercoaster ride on a daily basis. 

The volatility did not seem to want to end. Ever.  The stock index graph seems to have lost its vitality and have been perpetually pointing south, unable to turn the corner.  Doom and gloom was everywhere as you turned to the news. 

Non-stop. 

Et tu, Bane? (You too, Bane?)

At the time, I was having this nagging feeling of uncertainty, percolating, and permeating with its ebbs and flows throughout the days.  I am sure I am not alone.  It was like an unseen phantom that sucker-punched in your stomach every time you caught a glance of a stock index graph.

This sensation is familiar to me, a la 2008 global financial crisis or the 1999 dot-com bust, yet this time it felt very different.  It felt more personal.  The dread of the market crash is like the relentless Bane, in the Batman movie, going after the Dark Crusader, only I am far from being like Batman, and more like a skinny nerdy chap going into a cage fight over my retirement nest egg. 

You see, this time is different for me.

This time, I am no longer working, unlike the other crises, I have experienced. This means my portfolio will be my main source of income, rather than having income from employment. 

In the other crises, I saw my portfolio drop in a similar, spectacular fashion as the index.  As gut-wrenching as it may be, it was comforting to continue to be employed, knowing you have income coming through. 

This time, it felt like all your cumulative investment decisions leading up to this point in your life are being tested.  Did I make the right choices, the voice in the back of my mind asked?

Through the Looking Glass

Let me backtrack a bit. 

I left the company I worked for, an MNC that is a leader within its chosen industry, in September in the previous year. 

I worked as the CFO for the region and helped it grow over a number of years.  As the company grew, so did my responsibilities and my paycheck. 

However, with the growth, it also brought along with more politics, disagreements about the direction of the company, and treatment of employees.

This is no different than other roles I had previously, nor my bosses or colleagues any better or worse than my previous companies.  However, at this stage in my life, I was fortunate and grateful to be able to have saved a nest egg and grew my financial resources over the years. 

At the time when I left, I was 48 years old. 

I started strategizing my exit a little more than a year before I took the plunge.  I have a loving family with a young child in Singapore, and a widowed mother living in a different country.  Spending more time with them became a higher priority as I aged. 

I am sure some of you can relate to the dilemma and thoughts about the question of time versus money and the preciousness of seeing a young child growing up versus earning more financial resources. I was extremely fortunate to come to a point in my life where I can ponder making such a choice. 

However, being naturally risk-averse, making this choice cannot be a sporadic, “at the moment” consideration out of frustration, but rather it must be a deliberate, methodical choice for me. 

Being a numbers guy, the very first thing I turned to in order to make such a choice is my plethora of tools (spreadsheets, retirement calculators, Monte Carlo simulations, etc.) that I have accumulated and refined over the years. 

The question I was seeking an answer to at that time was this:

If I leave the workplace now, is my nest egg financially feasible to last an extended long time horizon, without unduly downgrade of lifestyle, and with sufficient financial buffer to counteract unforeseeable or unexpected life circumstances?

There is no easy answer to this.  For one, whatever tools and analysis you choose to use, will not give you a definitive “yes” or “no” answer.  It may, at most, gives you a confidence level, or a probability.

Even that is probably guesswork at best, given the uncertainty relating to forecasting for a long period of time.

Is a failure of 1 out of 10 chances good enough for you? How about 1 out of 20? 

YOU are still the one who can make the decision that you are happy with, living within a certain confidence level or probability, and bear the consequences of the decision.  However, it is still a chance, which means it is not completely fool-proof.  To make this assessment, I need to have a set of consistent criteria that I can come back to and revisit periodically, and especially when times are bad.

How Do I Determine Whether I am Financially Independent and Ready to Retire?

My financial criteria were relatively simple.

You can find some of these terms and definitions within Investment Moats or other websites on the internet.  The range within these criteria is a personal choice based on my own risk tolerance. 

You can have a higher or lower range within the metric than mine depending on your own tolerance. 

Here are my personal metrics or formula:

  1. Does my nest egg (or total portfolio) generate sufficient cash flow to support my annual expenses?
    • Guideline: (Dividends + Interest + Capital Gain – Expenses)>0
    • My spending should not be greater than the dividends, interests, and capital gain
  2. Is my safe withdrawal rate (SWR) over the projected long haul within a limit that I am comfortable with?
    • Guideline: Safe Withdrawal Rate between 3.2% – 3.8%
  3. Does my nest egg have sufficient cash resources, in terms of the number of years’ worth of expenses to spend, such that I don’t need to divest my invested portfolio if there is a multi-year market downturn?
    • Guideline: “Convertible cash” / annual expenses is between 3-5 years
    • “convertible cash” is in instruments that will unlikely to subject to probability to lose value when converted to cash.
  4. Does my nest egg have sufficient “buffer”, in terms of percentage, compared to a required amount based on meeting reasonable essential expenses at a standard SWR? (Admittedly, this is a little theoretical with will need further explanation later)
    • Guideline: Reasonable excess of Current Nest Egg over Annual Essential Expenses (such as rent, tuition, etc) divided by 4%

The first two criteria are really answering the question of whether I have enough money to live on over a long-term period

The last two criteria are really answering the question of whether I have enough buffer if bad things happen.

Allow me to clarify each of the above four personal criteria and to provide each a bit of a context.

1. Does my nest egg (or total portfolio) generate sufficient cash flow to support my annual expenses?

This one is simple enough.  If my total portfolio is generating sufficient cash flow to support my household expenses, I feel I am in good shape.  The key question is “what are my household expenses?” 

If you do not keep track of it, you will have no idea.  One thing to note is that your household expenses will likely have some “one-off” that you may be tempted to take out in your calculation. 

But if you have different kinds of “one-off” every year, you really have a recurring expense so I would not remove it.  I have been tracking my household expense for a very, very long time so I have a very good idea what it is. 

Another item to note is that I use total return (dividends + interests + capital gain) as a gauge, not just dividends and interests.  This is because in reality, the dividend is just part of the reduction of capital (i.e. accounting mumbo jumbo) and I expect to have annual rebalancing to sell a small portion of my portion to support my living, so I would include capital gain.  You don’t have to. 

But if you don’t, your nest egg will likely need to be much larger and you will likely leave a large bequest to your heirs.  This is not my intent and I plan to use up a good portion of my nest egg before I go.  I value my time and enjoyment over the accumulation phase. 

However, I would only plan to support my son for a bit of a leg up in education or seed money.  Rather, I would like to teach him the skills so he can fight his own battles in life rather than living off the inheritance.  As an aside, when I was young, I read a book called The Millionaire Next Door by Thomas J. Stanley.  It has a profound impact on my views on money.  It has a chapter on raising kids and I highly recommend this book for nuggets about having the right mindset for wealth creation.

2. Is my safe withdrawal rate (SWR) over the projected time horizon within a limit that I am comfortable with?

There is a very wide body of literature on the discussion of safe withdrawal rate so I am not going to go through them. 

There is a range of what an ideal rate is (but they are debatable in many cases)

  • The consensus seems to be 4% for a retirement time horizon of about 30 years.
  • Given the depressed inflation experienced globally in recent years, the original author (William Bengen) who developed the SWR concept has now come out and suggested 5% will be the new 4%. 
  • However, for someone like me who has a longer time horizon, I have dialed down my range to 3.2% to 3.8%. 

Some may say I should have a lower SWR just to be truly safe.  While this is likely true, my view on this is about a tradeoff of two different risks. 

While I can save more with a higher nest egg and enjoy a lower SWR, I would see that with each additional year of work I would likely incur a bit of higher health risks and risk of death.  

To me, life would totally suck if you get to a comfortable SWR, and then you only get to enjoy it for a very, very short time.  In other words, I am comparing two opposing risks:

  • The risks of running out of funds or living a lower standard of living if I leave sooner and accumulate less versus
  • The risks of higher health risks or mortality risks if I stay longer and accumulate more funds

While the health or dying sooner risks has a much smaller quantum of risks than, say, running out of money, the issue for me is not about the size of the risks, but more about the willingness to accept the risks.  For me, even the health risks are smaller, by comparison, I am more willing to accept the risks of a lower standard of living than having all the money but have no sanity, health, or relationship to enjoy it.

The risk of over accumulation and passing on early has not been studied thoroughly, but I am convinced it is real, given the stress that we accumulate in our modern lifestyle.  Your range of values will be a matter of personal choice in alignment with your risk tolerance.

3. Does my nest egg have sufficient cash resources, in terms of the number of years’ worth of expenses, to spend such that I don’t need to divest my invested portfolio if there is a multi-year market downturn?

This metric is my measurement of how long I can “ride” out a market correction and let the investment portfolio recover without a significant drawdown on my nest egg. 

There is much research out there on the length of recovery versus the depth of a market correction. 

  • When the market corrects over 30% of its value, it may take over 6 years or more to recover. 
  • When market correction with a lesser degree, its recovery tends to be quicker (1/2 year to 3 years). 

The correction we see back in March while recovering in the U.S. has yet been fully recovered to its former height in many markets around the world.  It’s a good example to have sufficient cash to ride out a down market.  There were many who panic and sold on the crash. 

There were a lot of professional managers who incurred losses when they sold during the crash and were unable to get back into the market quickly when it snapped back for recovery.  Timing the market is hard and I am quite terrible at it.  I think the cash buffer I have built prior to leaving my workplace helps me to sleep a lot better at night. 

Not all my buffer is sitting in cash.  I would say, cash or cash equivalent makes sense where the instruments can be redeemed without losing value.  Singapore Saving Bonds is very safe, and fairly liquid, as are cash or fixed deposits. 

I have at least 1 year worth of “true cash” for my day to day spending and a few years of convertible cash to ride out the market crash.

4. Does my nest egg have sufficient “buffer”, in terms of percentage, compared to a required amount based on meeting a reasonable essential expense at a standard SWR?

This part gets a little more theoretical but it is not too bad. 

This metric also allows me to assess how much shock my portfolio can absorb.  In the beginning, the key item to know is what is your true essential expenses within your household expenses.  So again, tracking expenses is important and I have over two decades of data to analyze my spending patterns. You don’t need that much data to come up with a reasonable projection, but you have to be factual and honest with yourself about what is truly deemed to be essential expenses.  Data simply allows you to have more precision, but not a prerequisite. 

For me, all the household spend such as rent, cellphone, internet, grocery, insurance, tuition, etc. are essential. 

My discretionary spending is on travel, hobbies, gym membership, etc.  Your definitions may vary. 

Having a contractual commitment may be a non-discretionary for the short-term but nothing is fixed for the long-term.  One of the key success factor I felt it is important to emphasize is the following:

You have to know what your basic standard of living is without going crazy and feeling depressed, and this is different for everyone. 

We also know that the standard FIRE SWR is 4% based on a huge body of literatures out there. 

So if you divide the essential expenses by 4% (or a rate you feel more comfortable with), you can get a theoretical size of a nest egg that you will need to minimally retire. 

Of course, you can add a little more or less to make it livable, but the idea is to get to a minimum spend and a minimum portfolio size for your retirement. 

Whatever that number is, I can then compare against my current portfolio size and see how much excess I have against this minimum number.  This excess, as a percentage, is also the percentage of market correction my portfolio can absorb before I cry “uncle”.  Simply put, if you have a buffer of 50% or more, you will likely be able to withstand a significant market correction. 

What this reasonable excess as a buffer over a minimum portfolio size differs for everyone. It depends on how much you want your portfolio to absorb a market correction.  Personally, I believe this buffer should be at least a minimum of 20% to 30% because a market correction can easily be of this size.  I am risk-averse so I am looking towards a buffer great than 50% and beyond. 

However, please keep in mind that the accumulation of more capital is not the only way to keep the buffer size up.  Lowering your essential spending is a way to reduce the minimum portfolio size, and this can be accomplished by various means, such as redefining the meaning of “essential” or move to a lower cost of living country, if such opportunity is available.

Let’s have an example:

If you spend $50K a year and your “hardwire” essential expense is about 30K (or 60% of your total spend), at a 4% Safe Withdrawal Rate, your theoretical minimum portfolio size is $30K/4%, of $750K. 

So, if your current portfolio is $1M, at your current spend of $50K, you have an SWR of 5%.  It is a little on the risky side or not egregiously bad. In this example, your buffer against a theoretic minimum nest egg is a 33% buffer ($1M less $750K divided by 750K). 

Is this good or bad?  Let’s say the equity market corrected by 25%.  However, assuming your investment portfolio is well-diversified and not everything is in equity, so your portfolio may be reduced by only 20%, not 25%. 

Now you have $800K, rather than $1M (20% off).  If you cut out your discretionary spending and only spend 30K of the non-discretionary, you are still okay for a good while. 

Your new SWR is $30K/800K or 3.75%.  However, life may not be as comfortable but you still have a roof over your head and food to eat, assuming you have properly tracked and classified what is non-discretionary spending and you are not overly depressed with your new frugal lifestyle. 

This will still give you time for your portfolio to recover.

How I Incorporate Life Uncertainties into My F.I.R.E Plan

All plans would come with a set of assumptions. These assumptions define the conditions where my plan would succeed and unsuccessfully work.

I should be comfortable with these assumptions. They should also fall within my risk tolerance.

Life can be uncertain. There are chances something bad will happen or something good will happen.

I could budget a number of “bad things” into what my nest egg could withstand. However, the nest egg needed would be so big that the amount needed would be very substantial.

With all the good intentions, you may still fail without any interventions. 

I use this concept of “Good guys” and “Bad guys” to explain how I frame the remedies to uncertainties in the plan.

  1. “Good guys”. A set of potential action steps that I can implement to improve unforseen financial situation
  2. “Bad guys”. A set of unforseen financial situations that may derail your plan

The way that my mind works is that if I have interventions (or “good guys” actions I can take to offset the “bad guys”) readily available when bad things happen, I feel more comfortable in taking more risks in the first place.

Risk tolerance does come into play and whether you have other “good guys” (or positive factors) that you can count on to offset the “bad guys” (or negative factors) you experience along your post-retirement journey. 

So when it was time to assess the “stay or go” decision, I used the criterion above to assess the viability of taking the plunge of leaving a company I have worked with for quite a number of years. 

There is always this nagging feeling of “work just one more year and you will have $X dollar” or “Are you insane? You are leaving $X on the table if you leave!?” 

Yes, these thoughts went through my mind and it was pretty insane. 

Being a numbers guy, who is rational and risk-averse, this was certainly one of the tougher life choices I have made and it also came back to nag on me during the onset of the pandemic. 

While my nest egg met the above criteria I set up, I want to also anticipate some of the “bad guys” scenarios where I have appropriate “good guys” actions to counteract them. 

I asked myself, “What are the bad things that can negatively impact my finances and what can I do about them?” So, these are the “bad guys” I can come up with at the time:

  1. My nest egg experiences a sequence of return risks (this is the “Bane” of every early retiree and you can google the term)
  2. There is some unexpected permanent decline in value in the investments of my nest egg
  3. I have unexpected expenses that I need to pay
  4. I experience a significant health issue
  5. My family members experience significant health issues

If I can boil down the above, they are really about two buckets of risks in financial terms:

  1. A declined in value in my nest egg, so it will have less funds to “dip” into for spending, and also it has decreased in its ability to generate future income
  2. More spending to cover (like unexpected health expenses) but this could be recurring or non-recurring expenses

Rationally, these two buckets can be offset by some of the assumptions that you have “baked in” while accumulating the nest egg. 

For example, the amount of buffer I have in the nest egg should be an answer to the risk of permanent declined in the value of the nest egg.  Or the number of expenses that would be considered as “discretionary” or “luxury” should be an answer to offset some of the unexpected spendings.

However, I want to identify further actionable items I can do when the “bad guys” strike.  I.e. If I know I will be locked into a cage fight with the proverbial “Bane”, what can I do now before I leave the workplace and what options will I have when the time comes?  At the time, I consider the following to be the items I can action on:

  1. When it comes to health or health-related risks, I will take the time I “bought” from retirement to exercise, eat better, sleep better to enhance my health outcome. Preventive actions are better than dealing with the fallout afterward.
  2. I will purchase the proper insurance for my family in case of an emergency prior to leaving my workplace.
  3. I will go back to work if things are dire.  This means I should continue to keep up the relevance of my skills
  4. I can also move to a different location or countries where there may be better health care or better cost advantage if required
  5. I will restructure my portfolio such that it will minimize the sequence of return risks and have better diversifications through a “Bond tent” prior to leaving the workplace.

All of these things are discrete and actionable prior to my big plunge.  They can be acted on or prepared or researched within the year prior to leaving the workplace or shortly after.  Having said that, I did not expect the need to revisit these thoughts and the financial criteria I outlined above so soon at the time of the COVID market correction!

The first half of retirement, while fulfilling in many aspects, was also full of adjustments. 

I managed to teach a course at a local university about personal financial planning.  Teaching has always been something I wanted to do so I am very happy I got that “fill” and gave something back to the community. 

I have also spent some quality time traveling with my mother and we were able to communicate a lot more since my father passed away a few years back.  We caught up on a lot of lost time and were able to build a more robust relationship. 

I slept more, but not necessarily better, and was able to catch up with some of my favorite TV shows and movies.  I read more books than in the past three years combined. My son and I have made a bunch of silly faced photos which he loved so much that his official greetings to me now is “My Ugly Daddy”. 

In addition, some of my work contacts in a niche industry reached out to me to do some contract consulting work and I happily obliged, knowing that I control my own time and this is an option rather than a necessity.

The Ongoing Questions I Asked About My Financial Model from Time to Time

Oh yeah, remember my proverbial Bane?

Well, all is well for my retirement plan until it is not. 

The COVID-induced market volatility has made me questioned some of the assumptions I have used, and also questioned the timing of the life choices I have made. 

It shows that while everyone can talk a good game about not selling into your emotions when it comes to managing your investments, it is another thing when your money is on the line and you have to put your money where your mouth is.

Luckily, being decades in the financial business, I have developed a relatively rational head on my shoulder when it comes to investments.

Having dealt with more than my share of fire drills in my finance role at work has helped me to be clear-headed in times like this.  Nevertheless, the emotion is still there and it is a matter of managing the emotions when it comes to making investment decisions. 

I have also developed tools in my pre-retirement phase to analyze the sensitivity of my plan’s success against various assumptions (ie from bad case scenarios to really bad case scenarios).  These tools have helped me during the volatility back in 1999 and 2008. 

My tools have evolved over time, but nevertheless, the usage at this time as a sounding board is similar.

Around April and May this year, when the market was moving like a rollercoaster ride, I have gone back to my models and tools and revisited the assumptions I have made. 

Some of the questions and scenarios I have plugged into the model we’re trying to answer the following:

  1. If the nest egg remains at this current depressed valuation, can the investment return of my nest egg support my lifestyle? For how long? What is the incremental probability of running out of money before my time horizon given the current reduction of the size of the nest egg?
  2. How much can your nest decline further without hitting a “red zone”?
  3. How much buffer does my nest egg still have? Has the buffer run out?
  4. How many years of cash, in terms of expenses, exists without forcing a sale of investments at this current depressed value?
  5. How many expenses can be trimmed, without impacting life style unduly? Does it require any reduction of discretionary expenses, and if so, how much?

With the market volatility came a new set of data on the market and my portfolio for analysis.  I dutifully plugged in the data to see where I am at.  This is where you have some kind of objective measurements to validate against your emotions and see what actions can be taken to ride out the uncertain times. 

I found that I am satisfied with most of the outcomes of the analysis. Using the four criteria I mentioned above helped me have a more rational view of where my tolerance level is.  In particular, I know where I can trim my expenses if required, and also what is the “red line” of the market decline before I should consider other more drastic actions. In addition, I also know from an emotional point of view how the market volatility impacted my mood and whether the emotions are rational or not.  I came away with a better sense of understanding my own risk tolerance and the actions I can take (or avoid) to manage my investments that are more aligned with my long-term goals. 

I ended up not selling into fear and also kept buying into the market on a selected, broadly diversified basis to maintain my intended asset allocations.

After all, I have discussed the importance of diversification, portfolio construction, and rebalancing in my course.  It would be hypocritical of me to not follow my own advice.  I can say that as of this writing my portfolio is healthy and was able to earn me a living in a consistent, predictable manner.

You Will Only Know if You Have a Successful FIRE When You Die

Is this a happy ending and did I make the right decision last September?

Yes, a definitely “maybe”. 

As someone has once asked me, “How do you know you can retire?” My answer was “I don’t!” and I continued, “I don’t think anyone will know until the day they pass away for pure certainty, because there will always be the unknown unknowns!”

The COVID experience taught me about being prepared before the “big plunge” of leaving the workforce, having the right tools to rationally assess my portfolio, and have the right set of realistic questions and criteria ahead of time to assess the healthiness of the portfolio when there is a big change in the market.

The experience allows me to know myself better, in particular, what my risk tolerance is. 

The criteria I have outlined above is what I used when I am unsure about the market, or when I am rebalancing my portfolio in my periodic review. I hope the above thought process helps you to develop your own metrics and guidelines that you can revisit during your pre-retirement planning and also in the time of financial uncertainty. 

In my next post, I am happy to share about what are some of the hits and misses in my accumulation phase and in my career that have led up to this point.  Thank you for reading!

There are a few things I wish to bring to your attention to what BOCH shared.

The first thing is that there is a similarity between how he goes about figuring out his FI number and how I would go about figuring how much is enough for a person’s financial independence or financial security.

But he has a different way of computing how much is enough for him to pull the plug. In a way, in order to be able to pull the plug from your job and live on your portfolio, I think your plan needs to have a certain degree of robustness.

If our plan is less robust, either we realize too late that things are blowing up, or that we get overly anxious.

The second thing is that, even with all the preparation work, it does not mean that you will sail through your retirement and not worry about anything.

Some of us are naturally anxious but that can be reduced if you have a certain degree of confidence you have taken care of the important things about retirement that you need to think about. But you can never wipe out the cautiousness. BOCH and I tend to lean closer to more cautious people.

But I think it’s also irrational that we do not review whether our plan is still ok once in a while. The ongoing questions BOCH talked about are necessary because he shared that he doesn’t check things so often. For sure, he does check on his portfolio occasionally. However, he does not check the current withdrawal rate, his buffer, expenses that often.

The key to a retirement plan is not just about working out if you are ready to retire, what you need to take care of upfront. The important part is what happens when your life, your portfolio, your family deviates from the original assumptions.

Those deviation will certainly come, and you need a way to navigate them.

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Preventing Risk of Ruin, Financial Scams, and Lawyer Letter Threats

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Yesterday, I watched two videos.

One of the videos is on this YouTuber named Rishi, who made a few videos calling out scams. One of the person/company he called out decide to serve him a lawyer letter. So now he has a Go Fund Me campaign to fund his court case because he wishes to fight this case.

The second video was put up by IQuadrant who has been in the news a fair bit. They are in the news because a few people, including Rishi, tried to expose their “scams”.

In this video, the two co-founders explain in detail, with a lot of numbers, primarily how the little to no money down plan is not as dangerous as it looks.

The second video made me reflect upon something Morgan Housel wrote in his book The Psychology of Money.

I would comment on the Rishi video at the end. So let me talked about this IQuadrant thing in brief.

I think like a lot of things this year, Morgan describes it perfectly that a lot of these things would have good outcomes. But these things need a lot of things going right for it.

Financial ruin occurs when your plan, which is suppose to go right, didn’t go right and you have not build in the other what-if scenarios.

To be fair to Shawn from that IQuadrant video, he did build in some margin of safety in his example. The margin of safety is 24 months of vacancy, which amounts to 6 months of vacancy per year.

I think if you ask around with people in the know and ask them how they would build in reasonable assumption, this is fairly conservative. But the devils is in the detail.

There still has to be much things going right for this investor so that there would not be a risk of ruin.

The Story of Rick Guerin

Morgan cites what happened to Rick Guerin to help us contrast the concept of growing wealth and keeping wealth can be two different things.

They require us to have different attributes.

Here is from the book:

You’ve likely heard of the investing duo of Warren Buffett and Charlie Munger. But 40 years ago there was a third member of the group, Rick Guerin.

Warren, Charlie, and Rick made investments together and interviewed business managers together. Then Rick kind of disappeared, at least relative to Buffett and Munger’s success. Investor Mohnish Pabrai once asked Buffett what happened to Rick.

Mohnish recalled:

[Warren said] “Charlie and I always knew that we would become incredibly wealthy. We were not in a hurry to get wealthy; we knew it would happen. Rick was just as smart as us, but he was in a hurry.”

What happened was that in the 1973-1974 downturn, Rick was levered with margin loans.

And the stock market went down almost 70% in those two years, so he got margin calls. He sold his Berkshire stock to Warren- Warren actually said “I bought Rick’s Berkshire stock” – at under $40 apiece. Rick was forced to sell because he was levered.

Charlie, Warren, and Rick were equally skilled at getting wealthy. But Warren and Charlie had the added skill of staying wealthy.

Which, over time, is the skill that matters most.

Nassim Taleb put it this way: “Having an ‘edge’ and surviving are two different things: the first requires the second. You need to avoid ruin. At all costs.“

– Psychology of Money

Morgan summarized money success into a single word: Survival.

In one of the chapters, he showed us evidence that what propels our wealth are tail events. The majority of the companies failed or in my latest article, have a lifespan that is shorter than what you believe.

Not “growth” or “brains” or “insight”. The ability to stick around for a long time, without wiping out or being forced to give up, is what makes the biggest difference. This should be the cornerstone of your strategy, whether it’s in investing or your career or a business you own.

There are two reasons why a survival mentality is so key with money.

One is obvious: few gains are so great that they’re worth wiping yourself out over.

The other is the counterintuitive math of compounding. Compounding only works if you can give asset years and years to grow. It’s like planting oak trees: A year of growth will never show much progress, 10 years can make a meaningful difference, and 50 years can create something absolutely extraordinary.

– Psychology of Money

Morgan explains that applying the survival mindset to the real world comes down to appreciating three things. I will list out the one that is applicable to this case study.

Most Important Part of the Plan

Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.

What’s the saying?

You plan, God laughs.

Financial and investment planning are critical because they let you know whether your current actions are within the realm of reasonable.

But few plans of any kind survive their first encounter with the real world. If you’re projecting your income, savings rate, and market returns over the next 20 years, think about all the big stuff that’s happened in the last 20 years that no one could have foreseen:

  1. September 11th
  2. A housing boom and bust that cause nearly 10 million Americans to lose their homes
  3. A financial crisis that caused almost nine million to lose their jobs
  4. A record-breaking stock-market rally that ensued
  5. A coronavirus that shakes the world as I write

A plan is only useful if it can survive reality.

And a future filled with unknowns is everyone’s reality.

A good plan doesn’t pretend this weren’t true; it embraces it and emphasizes room fo error.

The more you need specific elements of a plan to be true, the more fragile your financial life becomes.

If there’s enough room for error in your savings rate that you can say, “It’d be great if the market returns 8% a year over the next 30 years, but if it only does 4% a year I’ll still be OK,” the more valuable your plan becomes.

Many bets fail not because they were wrong, but because they were mostly right in a situation that required thigns to be exactly right. Room for error – often called margin of safety – is one of the most underappreciated forces in finance.

It comes in many forms:

  • A frugal budget
  • Flexible thinking
  • A loose timeline

Anything that lets you live happily with a range of outcomes.

It’s different from being conservative.

Conservative is avoiding a certain level of risk. The margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival.

Its magic is that the higher your margin of safety, the smaller your edge needs to be to have a favorable outcome.

Lawsuit Threats

The ironic thing also is that IQuadrant threathen another prominant person on Facebook who spoke out about their practices.

This is in the same way how Rishi got himself tangled up in this.

I have mixed feelings about this whole episode. Let me try and explain.

Imagine if you do everything proper and your business partner decide to create an elaborate scheme to get you off the company. Your now ex-business partner goes even further by doing all sorts of things so that you won’t have access to a single existing client. He then do a lot of things to drag your name through the mud so that you won’t have any new business.

You want a judicial system where you can fight it out and clear your name.

The issue is that there are some who have more resources than the others, and decide to use these means to get you to retract what you said or to get you to back off.

They know that for most people, they do not have the know-how or the resources to fight something lengthy.

This is not the first time that I am seeing this. For those of us in the industry, you would know what I am talking about. Most of the time, these folks with resources win.

And you know what hurts… it is that they continue with the business. The issue is that in the specturm of value delivery, they deliver on the very low end. For some, its not even value. It is outright scam.

In a Way, You want What They Give

I have developed this perspective: Some of the highest form of marketing is be able to know what you really want, appeals to you deep down inside, and deliver a message that speaks to you.

In a way, a lot of these internet marketing scams prey on those who do not have much options.

It also preys on those who are looking for passive income. (You do not see a lot of marketing materials telling you that you can have residual income or passive cash flow. There is a certain familiarity with that term)

While scams prey on those desperate folks, some of these courses prey on you because you have a lack of investment options, and you do not wish to do a lot of work, and a lack of sophistication.

But it is not always negative. We all have a starting point where we lack sophistication.

Two days ago, I had lunch with a friend who want to thank me for troubleshooting her stock portfolio tracker on and off. She came a long way from not knowing so much of personal finance and investing to somewhere where her friends turned to her for bits and pieces of advice.

While there are many free content, she shared that the difficulty during her less sophisticated phase was that investing is not written in a very procedural way.

Bascially, when you are learning, you need something more step by step.

I get very ticked off when I keep hearing people say information is free all around, why do you need to attend courses that are so expensive? You should just join this chat and learn from the people with more experience there.

Many experience folks forget how they started all this. They probably forget the knocks that they suffered along the way. There should be something procedural in their way of learning and for a lot of things, it is fundamental that we learn in a procedural way.

In November, the company send us to a 2-day ettiquete and learning course. If you ask me, for this kind of thing, it is even worse. There is less uncertainty and less impactful that we would need to invest money for this sort of thing.

For whatever that you need to learn there is a search cost. There is also tuition fees paid for making mistakes. If you do not wish to incur such a cost you would need to pay up.

There is a Spectrum of Value In Whatever Lessons You Pay For

In that spectrum, some are very useful but they are priced cheaply. Some are not very useful, but are not cheap.

There are some stuff that are priced very expensive and just do not work. They do not work because fundamentally, what they are asking you to do is not fundamentally workable over the long term.

This is what I would term close to being a scam.

The unfortunate thing is that, since you are not very sophisticated, you would not be the best person to evaluate that.

Even if you ask me, I would need to roughly know your level of sophistication and what the course provide, to know if going for a particular investing course is the right fit. I think is a total mismatch.

Often, there is a mismatch in expectation because the marketing was too good and the value provided is not up to the marketing.

So people feel cheated.

I think we got a lot of value out of our grooming course. There is a lot of nuances provided that are valuable.

Nuances in a particular subject are very very tough to learn and very valuable. How do you know that you have a problem? What is the problem? How do you articulate your problem clearly to yourself? If you cannot articulate the problem, how do you know what to search for? How do you know who to find to get this problem address?

Our more experience staff (which includes the advisers) are no slouch when it comes to grooming and looking very presentable in front of clients and prospects. Even then, there were enough questions in case studies that made us wonder if we really know how to dress well or not.

But at the end of the day, all our mileage will be different. Going for a grooming course like this is more of a primer to speed us our journey. We still have to build good habits to apply it in our daily lives.

The most fxxk thing I keep hearing people throw at these investing stuff is how good it works.

I came across this commenter who was sharing with us the amount of money paid to change people’s sleep routines:

The amount that they cited is probably around some investing courses.

Here is the rub:

  1. This space is most likely not regulated
  2. Some of the people know what they are talking about
  3. Some are downright scams
  4. Even if you attend, it might not work for you as well. The issue with addressing sleep-related issues dare I say, is more challenging than investing. We would roughly know more about how market works than why you cannot sleep well
  5. Addressing this problem is much needed

I do not have a good solution for this. Some call for authorities to do more. But at the same time, if there is heavy regulations, positive and better investing ideas might not bobbled to the surface.

There are Potential Consequences

Lastly, if you made a decision to call out someone, always know that there are some consequences coming your way.

And you should prepare for these consequences.

Companies pay for indemnity insurance because there are always potential legal liability.

If the potential magnitude of the damage is big, then like financial risk management, you avoid it. If not, prepare the money!

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