Principles of Wealth #10*

Every asset class and financial strategy has its own inherent characteristics, investment advantages and disadvantages, profit and growth potentialities, and risk profiles. The smart investor understands this and balances his portfolio accordingly. 

Knowing what the current and historic returns are for every type of investment, the smart investor will curtail his ambitions to what is reasonable to expect. For example, the smart investor plans to get 8% to 12% on his stock portfolio over time. He doesn’t try to get much more than that. He knows that if he does try, he will probably make much less. (Studies show he’ll probably make only 2% to 3%.)

The same is true of every other asset class – government securities, corporate bonds, convertible bonds, natural resource stocks, penny stocks, private placement deals, commodities, currencies, real estate, etc. Trying to do much better than general market averages is foolish.

Let’s look at real estate, as an illustration.

Over a period of maybe 20 years, I invested in six or eight deals with EP, a trusted friend, who built high-end residential communities. The investments I made were as a partner in a Limited Liability Corporation (LLC).

I was a limited partner, which means I invested a sum of money in exchange for a percentage of the deal. EP and his partner were general partners. They put the deal together, built the development, sold it, and got a nice piece of the profits even if they didn’t put in any money.

As limited partners, we put up a good chunk of the capital needed to get the project going. We got most of the benefits we’d get from developing real estate ourselves, but with two advantages:

1. We didn’t have to run the business.
2. Our risk was limited to the money we put in.

The downside was that we had to pay EP and his partner fees for everything they did.

Overall, I did reasonably well for that sort of investment strategy. If I had to guess, I’d say my annual ROI amounted to about 12%. But the individual results varied widely. On one deal, I doubled my money in less than two years. On another, I made a 60% return in three years. One deal went broke and I got nothing back. The results of the rest were somewhere in between.

In all of them, the management group was the same, the deals were structured pretty much the same, and the developments were all in South Florida. So why were my results so varied?

It was because of factors that I had never considered.

Timing, for example…

One deal got held up for almost two years because of evidence that the land had once been an Indian burial ground. Ultimately, it was decided that it wasn’t – or that if it was, it was insignificant. But with large development projects, time is money. And the cost of those two years was so great that the project, even though it sold well, never made a profit.

Another one, a development of about the same size, had three advantages: It was completed ahead of schedule, at the peak of the real estate bubble, and it sold out within three months. This is the one where I doubled my money.

As I said, my overall return was about 12%, which I was satisfied with. But I went into those investments hoping to make 25% or better. Several times, as I said, I had those kinds of returns. But several times, I did worse. What I learned was that these sorts of real estate deals can be good if you invest in a basket of them during an economy that is gradually getting stronger. But I would never again set my hopes at 25% on a limited partnership deal. I know now that a more reasonable expectation is 12% to 18%. (And that’s if you have a fair amount of luck.)

Moving on to single-family homes… 

Halfway through my run with EP, I tried something else. I began to buy inexpensive single-family houses, fix them up, and rent them out.

I’m not sure why I was attracted to that particular market. But since I knew nothing about it, I decided to start small and move slowly. And I’m glad I did. Investing in this sort of real estate turned out to be very different than the investing I’d done with EP.

Acquiring rental properties, I found, has some distinct advantages. The first is that the arithmetic is relatively easy to understand. You find out how much it will cost to buy and restore a particular house. You compare that total cost to the yearly rent you can get after it’s fixed up. And if the numbers work, you buy it.

The formula I used was one my brother (who was ahead of me in this game) taught me. Don’t spend more than eight times gross rent, he said. Example: If the house costs $80,000 plus $20,000 to fix it up, my total cost is $100,000. So, based on the formula, I had to be able to rent it for $8400 a year. Conversely, if I found a house that I could rent for $1000 a month or $12,000 a year, I would not pay more than $96,000 for it. (8 x 12,000 = $96,000)

I’ve learned lots more about this kind of real estate investing over the years, but this simple rule of thumb has kept me from making the mistake that kills most people in this market: paying too much for a house just before the market crashes.

Over the years, I’ve probably seen an average return of about 15% to 20% – including income and appreciation – on my rental properties. You can grow a lot of wealth over 20 to 30 years at 15% to 20%.

I’ve also experimented with buying and flipping. This can be fun and profitable if you like that sort of thing. Even in an up market, you can pick up houses that are undervalued because of some aesthetic or structural issue that seems worse than it is. If you can find undervalued properties and have the ability to fix them quickly and cheaply, you can make good money. The big challenge here is your emotions. You have to be able to stop buying and exit the market when the bargains no longer exist.

And apartment buildings… 

The big advantage that apartment buildings have over single-family rentals is the cost of management. For a 50-unit building, it could easily be 5% or 6% of your rent roll. For a single-family home, it would be closer to 10%.

The challenge is that apartment buildings are typically valued by cash flow, not intrinsic property value. So if you are in a seller’s market, it’s going to be difficult if not impossible to buy at a good price. Sometimes, however, you can find a building in some sort of distress that can be restored and then rented out at a good rate.

And with apartment buildings, as with single-family homes, if you can find a good partner who is willing to manage the property (for a fee), as I did, you can build a substantial real estate portfolio over the years while having a full-time job and a family. The time commitment with a partner is about an hour a month.

Then land banking… 

I’ve sometimes done something called land banking. Land banking means buying up raw land and holding it, hoping it will appreciate. The upside is considerable. If you can afford to hold on to the property for 10 or 20 years, it’s possible to see it rise amazingly in value. A lot that I bought in Nicaragua years ago for about $50,000 is worth at least $500,000 today. A 10-acre parcel of farmland that I bought in western Delray Beach, Florida, five years ago for $800,000 I sold two years later for $1.3 million.

Like every other type of real estate investing, land banking has its unique advantages. Chief among them: There’s very little work to do. You buy the land. You pay the taxes (and sometimes cut the grass) for a few years or decades. And then you sell it for, hopefully, a big profit.

Another advantage is that if you buy the property right, when values are clearly low (as they were for me in Nicaragua), the risk of losing on your investment is relatively small. But the downside is the upside. It might take much longer than you imagined to double or triple your money.

The questions to ask yourself… 

As I hope I’ve made clear, every type of investment has its own opportunities, challenges, and risks. The secret to being successful in any one of them is to understand its inherent characteristics. What sort of ROI can you reasonably expect, based on history not promises? What sort of risks are you taking, and can you afford to take them? What level of personal involvement are you getting yourself into?

Before you invest a nickel, do your homework. Do your best to make smart decisions, but expect to get average returns over the long run.

By taking that conservative approach, you will be doing the most important thing to optimize your long-term wealth: choosing the asset classes that you are most comfortable managing, while diversifying your portfolio to achieve safe, realistic returns.

* In this series of essays, I’m trying to make a book about wealth building that is based on the discoveries and observations I’ve made over the years: What wealth is, what it’s not, how it can be acquired, and how it is usually lost. 

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“I’d like to think that anxiety is a form of emotional intelligence – alerting one to future threats that others ignore. The problem is it doesn’t work that way because anxiety is always forward facing. By the time tomorrow comes, you are worried about some new threat.” – Michael Masterson

11 Ways the COVID Lockdown Will Change the World, Good and Bad

1. More zoom meetings.

Most breakthrough technologies make only a superficial difference, but Zoom is a game-changer. It has all the benefits of being in a room with others, with none of the drawbacks. Zoom meetings are, without question, more efficient. There is something about them that encourages people to spend less time chatting and stick more closely to the agenda. Plus, nobody has to waste time traveling – in some cases, for hours – to attend.

2. Less office space.

The lockdown has woken us up to the reality that most of our work can get done as well, or better, remotely. Even, as I said above, meetings. Office space is expensive. If you don’t need it, why pay for it? Two-thirds of our economy is now information-based. As a result of this trend, I’m guessing that businesses like those of my clients will graduate eventually to about 20% of the office space they currently use.

3. A recession in commercial real estate.

My partners and I just put a halt on a plan to raze the converted warehouse I work out of and replace it with a much larger, $14 million, glass and steel office building. We’ve always been big buyers of real estate. That’s over. We’ll be looking, instead, at selling ours. And we won’t be alone. According to Moody Analytics, the country’s office vacancy rate has been rising. So far, it’s gone from 9% in Q1 2020 to 15% in Q2.

4. A new market for commercial conversions.

The bulk of the office space that goes empty will be converted to apartments and condos. This will be a boon for construction companies that are able to efficiently do that sort of thing. But it will also put a pause on the new construction of apartments and condos for as many years as it takes to absorb the unused space.

5. Subscription services as the norm in selling information.

All forms of information – from entertainment to news to advisory services – will convert their marketing models to subscription-based services. This change has been going on for some time, but it’s going to speed up. According to Zion Market Research, the subscription business model, valued at $3.8 billion in 2018, is expected to grow to $10.5 billion by 2025.

6. A much-needed revolution in higher education.

Despite claims that we can’t replace in-class learning, people are quickly discovering that remote education is perfectly well suited for at least 60% of the subject matter being taught today. Private colleges will realize, as other information businesses already have, that they can make more money and do a better job with computer-assisted programs.

Campuses will continue to exist for the social aspects of the college experience, but the amount of time kids spend in class will be slashed by 80%. Even more important – and this, I admit, is a wish rather than a prediction – students will opt out of such useless courses as gender theory and Marxist economics and spend their education dollars on courses they can profit from.

7. The end of most shopping malls…

There is no longer any reason to travel to a mall, except for the enjoyment of having someplace to go. Strip malls will be the first to go. Half of those in existence are already dead in the water and won’t be coming back. Some larger, luxurious, shopping malls will thrive, but only a fraction of those that exist today.

Coresight Research predicts that 25% of all the malls in the US will close within five years. In February, Macy’s announced the closing of 125 stores over the next three years. JC Penny has plans to close as many as 150 stores. And, in fact, Simon Property Group (the largest owner of US malls) is working on a potential deal to turn closed department stores into Amazon fulfillment centers.

8. And the end of brick-and-mortar retail.

For most products, direct-to-consumer marketing will be the standard in selling. Online shopping and next-day delivery will become the norm. And even for products you might want to try on or try out – like clothes or tools or TV sets – increasingly easy return policies will bolster direct-to-consumer commerce.

9. An increase in the use of psychopharmacological drugs and psychiatric services

All this remote (i.e., solo) shopping, entertainment, and education will cause an epidemic of anxiety, addiction, and depression – a serious problem that began surging as early as March.

Three examples:

* In March, the Substance Abuse and Mental Health Administration’s “emotional distress” phone hotlines spiked 338%; their text hotlines skyrocketed from 1790 last April to 20,000 in April of this year.

* An analysis by the White House’s drug policy office reported an 11.4% year-over-year increase in fatal overdoses in the first four months of this year.

* An August poll taken by the CDC revealed that 25% of respondents aged 18-24 had considered suicide in the prior 30 days; 40% reported at least one adverse mental health condition as a result of the coronavirus.

10. Amazon’s revenues will double in the next 5 years.

 Amazon’s current revenues are more than $300 billion a year, but the lockdown has given millions the opportunity to get used to online shopping. Amazon has big plans, and I don’t see how – other than by some kind of antitrust action – they can be stopped. I wouldn’t be surprised to see them bypass the $500 billion barrier in the next few years and go on to bypass Walmart.

11. The Googles and Facebooks of the world will become the first digital countries, eventually replacing nation states. 

What is a country but a political, economic, and cultural entity held together by a common mythology of identity and a touch of police and military power? Internet businesses like Google, Facebook, and YouTube have established their own cultures, economies, and politics that are funded by voluntary taxes and enforced by unilateral power over their hundreds of millions of digital citizens.

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Note: The following essay is an excerpt from the upcoming new and revised edition of Ready, Fire, Aim. 

Survival of the Fastest 

The first challenge an entrepreneur faces in launching a new business is to figure out the optimal selling strategy (OSS) – how to acquire a steady flow of new customers by selling them a “front-end” product at an allowable acquisition cost. This is mostly about exploring a variety of media, testing a range of offers, and discovering the product features and benefits that are most attractive to the target audience.

It usually takes a few years to accomplish this goal. So it’s understandable that when you get your Stage One business to the point where you’re ready to break into Stage Two (with approximately $1 million in revenue), you and your team will be exhausted from all the testing, from the many disappointments and occasional advances, and you’ll want to relax a bit and let the successful selling strategy you developed roll out on its own.

Many entrepreneurs do this. And some are content to let the business settle in at that level and grow gently from there.

I have never been able to do this. The moment a business achieves its primary Stage One goal – discovering the OSS – I want to double down on the time, energy, and resources we’ve been giving to the project and grow through Stage Two (from $1 million to $10 million in revenue) as quickly as possible.

I feel that way for two reasons. First, I have seen too many start-ups begin to founder after a year or two of breaking into Stage Two and eventually fail. Second, I’m just not interested in maintaining status quo. For me, the fun of being in business is the challenge of growing it.

I don’t think there’s anything wrong with putting a business on cruise control. In fact, I secretly admire people that can do it. They are wise enough to be happy with what is.

But not me. And especially not at this stage of growth. Getting through Stage One is hard. It’s like slogging up a high hill with a heavy pack on your back. But Stage Two is a different experience. If you can make the needed adjustments, it can be like jetting up to the peak of a snow-covered mountain on a motor bike.

Stage Two is where you can experience the greatest changes and the fastest growth. But you can’t do it with the same ideas, habits, and protocols that got you through Stage One.

In my last essay on this subject, we talked about innovation – how to create a culture that is open to and proficient at developing new and improved products. Today, we are going to talk about innovation’s counterpart: how to create a culture of speed.

I’ve always been impatient. When I decide to do something or accomplish something or acquire something, I want it right away. Although I know it’s sometimes very true, I cannot accept that slow and steady will ever win the race.

Most people are not like me. My guess is that being asked to move quickly makes four out of five people very uncomfortable. They don’t like the pressure. And they worry about accidents and mistakes.

If your start-up product is an airplane or a treatment for cancer, it makes sense to populate your business with slow-twitch workers and to implement procedures and protocols that favor accuracy. But for the vast majority of businesses, getting from Stage One through Stage Two is largely about speed.

A Simple Formula for Second-Stage Growth 

It may have taken several years to produce and market your first product successfully. But to take your company to the next level, you will have to develop and test multiple products in a much shorter period of time. You are already up and running. You have bills to pay. The competition is increasing. The only way to keep ahead is to transform your business into a super-speedy innovation and testing machine.

The thesis, very simply, is this:

The amount of growth a company can expect at its second stage of development is directly related to its ability to generate and test new-product ideas quickly. 

If you prefer math, here’s the equation: 80% of G = IV² (where G equals second-stage growth, I equals innovation, and Vequals velocity).

By surrounding yourself with smart people and following the suggestions in my August 5 essay, [LINK] you should be able to come up with more worthy ideas than you can possibly test by having a brainstorming meeting every three or four months.

The real challenge is the implementation. Unless you can get these new ideas into motion almost immediately and keep them in motion through the testing process, you will almost certainly find that they never amount to anything. However good they were when you first brainstormed them, the months or years that have passed since then will have rendered them yesterday’s news.

In terms of “Ready, Fire, Aim,” the number one problem of a Stage Two business is that the ideas, habits, and practices that got you this far are insufficient to get you to the next level. Frugality, flexibility, and tenacity were the virtues you and your team needed to get that first product out and running. But in Stage Two, you have to get dozens of products out and running – many at the same time.

As your company’s leader, you have to rally the troops with a speech that goes something like this:

Congratulations and thank you! We have accomplished the biggest challenge all new companies must face. We’ve figured out how to successfully sell our first front-end product and our first backends. I know you’ve all been working tirelessly to help make this happen. Now we have another challenge. We have to double, triple, or quadruple our production. And to do that, we’ve got to figure out how to double, triple, or quadruple the speed at which we do just about everything.

You are going to be making that speech to people that are still very busy with the work they’ve been doing. Few will be eager to take on this new challenge. And yet, unless you can get them on board your new high-speed train, the future of your business will be bland or even bleak.

Speed Up… or Give Up 

As I said, most people don’t like speed. And for good reasons. But as the CEO of your

Stage Two business, you have to not just embrace speed yourself but get your key people to embrace it, too.

To do that, you are going to have to convey to them the reality of the arena you have entered – where the size of the market, the competition you face, the demands of your customers, and the costs of running your business are so much higher.

You are going to have to convince them that there is no other option. That unless everyone gets behind this new paradigm, the company will die.

At the same time, point out that there’s a lot to like about working in this kind of high-pressure environment. Remind your key people that growth means less routine, less boredom, more fun, and much greater opportunities for personal advancement. Make them feel that in speeding up the business, they are speeding up their own careers.

Taking a new idea from concept to completion is exciting, but the process itself is often long and laborious. During tedious patches, there’s always the danger that your key people (and even you) will be tempted to pull away from the action and leave too much to chance.

Teach your key people that when ideas are left in limbo, details are forgotten. Obstacles arise. Enthusiasm wanes. And, finally, the idea is forgotten or – worse – implemented so weakly that it fails.

The space of time that stands between the birth of an idea and its execution is filled with the potential for failure. It’s your job to make sure that doesn’t happen.

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The Foundations of Economics, Part I: Hesiod’s Formula for Growing Wealth 

Work hard. Spend wisely. Save assiduously. Respect the law. If I were to write the Ten Commandments of Wealth Building, those might be the first four. Cultures that embrace these values grow rich and prosper. Cultures that ignore them languish at the bottom of the economies they inhabit.

As Murray Rothbard says in chapter one of History of Economic Thought, “It all began, as usual, with the Greeks. The ancient Greeks were the first civilized people to use their reason to think systematically about the world around them.”

In my August 31 essay, I listed some of their scientific, political, and cultural achievements. But I failed to mention the very good thinking they did on economics. The word itself stems from the Greek oikonomia, which refers to matters of saving, budgeting, and household management.

Aristotle (384 BC to 322 BC) contributed enormously to early economic thinking. (And I’ll be talking about his contributions in a future essay.) But Hesiod, a shepherd and poet that lived 400 years earlier, laid the foundation upon which Aristotle and those that followed him built their theories.

Hesiod identified the essential problem that all economists struggle with: the conflict between the ideal of unlimited abundance and the reality of limitations and scarcity.

From Rothbard: “Hesiod lived in the small, self-sufficient agricultural community of Ascra [and] was therefore naturally attuned to the eternal problem of scarcity, of the niggardliness of resources as contrasted to the sweep of man’s goals and desires.”

In his epic poem, Works and Days, Hesiod employs a mythology of human cultural evolution in five stages: the Golden Age, ruled by Cronos; the Silver Age, ruled by Zeus; the Bronze Age; the Heroic Age, the time of the Trojan war; and the Iron Age, Hesiod’s time, which he characterizes as corrupt.

He talks about the Golden Age, when people lived long and happy lives, free from sorrow because they had everything they could possibly want. But, he says, those days are over. Three things that were once infinitely abundant – labor, materials, and time – have become scarce. Which means, he says, that they must now be seen as valuable, limited resources, and allocated efficiently to minimize waste and maximize their benefits.

He then devotes nearly half of the poem (383 of 828 verses) to suggesting how that could and should be done.

He starts with the concept of hard work.

We humans have a natural inclination for leisure, he says, stemming somehow from our earlier existence in the Golden Age. But this desire for leisure is not useful in the real world of limited resources. To live a good and comfortable life, he says, we must reject our impulse for leisure and embrace a strong work ethic. We must, in other words, accept that we are not entitled to anything. We must accept labor as our natural duty and the natural way to have a happy and prosperous life.

Next, we must embrace the idea of saving. In order to contend with winters, droughts, and pestilence, we must work harder and longer during times of plenty to produce a surplus, which we should then save for our future needs.

This commitment to labor and saving, Hesiod contends, gives rise to an innate human ethic. Recognizing the value of work, he says, men develop a deep-seated emotional disapproval of sloth. This, combined with wanting what their neighbors have, creates a desire to emulate what their neighbors do to accumulate wealth.

“To Hesiod,” Rothbard explains, “[this] emulation leads to the healthy development of a spirit of competition, which he calls ‘good conflict,’ a vital force in relieving the basic problem of scarcity.” And “to keep competition just and harmonious, Hesiod vigorously excludes such unjust methods of acquiring wealth as robbery, and advocates a rule of law… to allow competition to develop within a matrix of harmony and justice.”

So, there you have it…

Deep within the human psyche is the memory of Edenic bliss – a world of unlimited abundance where leisure was the natural state of man. We don’t live in that world now, and yet the memory haunts us.

There is a voice in our heads that tells us we are entitled to everything it offered. That conflicts with our experience and frustrates us.

We yearn irrationally to return to that imagined state, but we cannot go back. We are stuck in the real world.

It is a world of hardship and suffering… but it is also a world of bounty.

We can have that if we like, but it won’t come to us from hoping or praying or believing. There is only one path and that is the path of work. We must work hard and spend frugally and save a portion of the fruits of our labor. We must have the stamina to work harder than we want to. We must have the courage to compete. We must have the discipline to restrain our consumption. And we must have the wisdom to save our profits for when we can no longer successfully compete.

And all this must be done in a community that values individuality, freedom, and the rule of law.

It’s as simple as that.

Hesiod figured this out more than 2500 years ago. In the millennia that have passed since then, all sorts of theories have been tested and failed.

Work hard. Spend wisely. Save assiduously. Respect the law. There is certainly more to economics than these four rules. But without them, nothing else works.

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“The possessors of wealth can scarcely be indifferent to processes which, nearly or remotely, have been the fertile source of their possessions.” – Charles Babbage

Principles of Wealth #8* 

When buying “things,” intelligent wealth builders are careful to consider whether they are appreciating or depreciating assets.

My friend Bernard has done very well in the furniture business, manufacturing his pieces in China and selling them to his retail outlets along the eastern seaboard.

In most respects, Bernard is a modest, self-effacing guy. He’s humble. He never boasts. He has a beautiful home that is not ostentatious. But he does wear very fine watches. And he drives high-end luxury cars.

I’ve asked him about this anomaly. As it turns out, those watches and cars are not, like most luxury products, diminishing assets. They are inventory in a side business that he’s been enjoying privately for most of his adult life.

Bernard makes a six-figure second income with these luxury goods. Through a network of contacts that he’s developed over the years, he regularly buys slightly used cars and a select group of expensive watches, enjoys them for 6 to 12 months, and then resells them. He buys them not from retailers or brokers but from people. From wannabe wealth builders who didn’t understand that, as I explained in Principle of Wealth #7, exchanging cash for such status symbols generally makes you poorer.

Generally, but not always.

There are a few exceptions. What Bernard does is one of them.

Here’s a typical example of how it works:

Hank, a 36-year-old hedge fund manager, makes a $400,000 bonus. He spends $320,000 of it on a brand-new Rolls Royce. Six months later, the stock market takes a dive. And a month after that, his income tax comes due.

Not having set aside cash for Uncle Sam, this foolish young man must sell his almost-brand-new car to pay his tax bill. He puts it on the market for $290,000. A week goes by without a single offer. He lowers the price to $265,000. No response. Desperate, he drops it to $190,000. Still no buyers. Finally, he sees a small ad in the paper: “Selling Your Royce? I’m a Buyer.” Hank calls the number and Bernard offers to buy it that day for $160,000.

“I can’t believe I’m doing this,” Hank says, as he signs over his car to Bernard.

“Call me anytime,” Bernard says. “And by the way, I like that Submariner (Rolex) you’ve got there. Want to sell it?”

“How much will you give me?” Hank says.

“Forty grand in cash.”

“No way,” Hank says. I paid $87,000 for it.”

“No problem,” Bernard says.

A week later, Hank calls him and sells him the watch for $42,500.

Bernard wears the watch and drives the Rolls for the next six months, and then sells them for a total profit of $65,000.

Both Bernard and Hank have enjoyed owning these luxuries. The difference is that, ultimately, Bernard made a profit of $65,000 on them, while Hank lost about $200,000.

Here’s the point: You don’t have to eschew luxury goods to build wealth intelligently. You can enjoy them and sometimes even profit from them if you understand, and take advantage of, the difference between appreciating and depreciating assets.

* In this series of essays, I’m trying to make a book about wealth building that is based on the discoveries and observations I’ve made over the years: What wealth is, what it’s not, how it can be acquired, and how it is usually lost. 

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“If you don’t have a real stake in the new, then just surviving on the old… I don’t think is a long-term game.” – Satya Nadella

Is Automation Scarier Than COVID-19? 

Does automation put people out of work?

Economists, politicians, and union leaders have been asking this question for as long as I can remember. And it’s a legitimate concern.

Consider driverless vehicles.

In the last 16 years, since the first DARPA Grand Challenge was held in the Mojave Desert, the race to develop a fully autonomous vehicle has been on. (See “Did You Know?” below.)

More than two dozen companies are working on it. The current leader is Alphabet Inc.’s Waymo, whose fleet of 600 vehicles have logged in more than 20 million miles. (Waymo stands for “a new way forward in mobility.”) And although we are not there yet, industry experts suggest that the first commercial autonomous vehicle will make its appearance in the next several years.

Considering the advantages (safer, cheaper to operate, etc.), it seems inevitable that driverless cars will replace conventional cars just as conventional cars replaced the horse and buggy.

How will that affect the workforce?

In Ride Sharing

I’m sure that Uber’s smartest executives are already doing the math on how much money they would save by replacing their 750,000 drivers with driverless vehicles. Add to those the drivers for Lyft, etc., and you’ve got about 1.5 million people out of work.

In Trucking

There are an estimated 1.2 million trucking companies in the US. When the trucking industry goes driverless, at least another 3.5 million Americans will be unemployed.

In the Bus Business

There are half a million school buses on the road, and another 600,000 commercial buses. Which means that 2 or 3 million bus drivers could lose their jobs.

And that’s not to mention the millions of UPS, FedEx, and other delivery service workers that will become obsolete when we have driverless vehicles and automated drop-off facilities.

What will all those people do?

Some Historical Perspective 

The average American is not enthusiastic about the increased use of automation by just about every industry you can name. Many fear that it will lead to widespread unemployment and even greater economic inequality.

I have that fear myself. But the facts don’t support it.

When, for example, ATMs were introduced in the mid 1970s, it was thought that the jobs of tens of thousands of bank tellers were on the line.

That didn’t happen. Since then, in fact, the number of bank tellers in the US has doubled, from about 125,000 to 250,000.

The reason?

The hyper-efficiency of the ATMs gave banks more operating profits. And those profits were invested in opening new branches.

Thus, although the number of tellers at each bank did go down by a third, the number of branches increased by almost half.

It gets better.

Because the ATMs handle a majority of routine banking functions, tellers are freed up to to do more challenging – and higher-paying – work. (Such as customer service and loan processing.) And that means they make more money.

This is not to say that some jobs aren’t lost through automation.

From 1850 to 1970, the US agricultural sector shrank from 60% of the general workforce to 5%. Today, it’s 1%!

Manufacturing jobs, too, have been on the decline. Partly because some operations were moved overseas, but even more so through automation. In 1960, manufacturing workers represented 26% of the labor force. Today, that number is barely 9%.

But here’s the thing: Except for the Great Depression and the Great Recession, US employment opportunities, in general, did not shrink. On the contrary, they expanded.

One example:  In 2012, after putting robots to work in its warehouses, Amazon was accused of being “determined to profit by creating a future where automation replaces good jobs.” But within a year, instead of having fewer employees, Amazon had added nearly 30,000.

Out With the Old… 

When I was starting out in business in the late 1970s, every executive I knew had a secretary.

Being a secretary was a decent job for a smart person with a high school education and good typing skills. You could make $14,000 a year with benefits. But it was also mind-numbing. All you did was type, file, answer the phone, and book appointments.

Today, thanks in large part to computers and changes in the way businesses are run, secretarial jobs have pretty much disappeared. (My primary client has more than 1000 employees, and I don’t think there’s a single secretary among them.)

So what are all the people that once might have been secretaries doing? They are event planners, graphic artists, paralegals, personal assistants, and freelancers in dozens of fields – jobs that didn’t exist 50 years ago.

In much the same way, that’s what automation is all about.

Yes, automation replaces human labor. But countless studies, both in the US and in Europe, have found that innovations in technology, particularly in automation, have actually created more jobs.

What’s happening, I think, is this: By lowering the cost of the dullest and most tedious forms of human labor, automation generally increases profitability. A general increase in profitability stimulates economic growth. And when the economy grows, new jobs are created in every industry. Jobs that are more demanding, more interesting, and more financially rewarding than the ones that were lost.

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“History is philosophy teaching by example.” – Thucydides

Western Culture in One Lesson, Part I 

Today, let’s talk about this idea of Western Civilization. The idea that America and Western Europe share a common culture that dates back to the ancient Greeks and Romans. And that this culture is the bedrock that has supported the accomplishments of the West for the last 2600 years.

When I was a kid, it was an accepted fact.

Now, it’s debatable. The ties that bound us together have unwound. Our core values are being called into question. We no longer see ourselves as Westerners in the European tradition. Instead, we are members of political or identity groups – each with its own views – that are fighting with one another like warring tribes.

This is destructive. It’s also not true. Even a cursory review of the institutions and conventions we take for granted – government, democracy, liberty, privacy, the sovereign individual, and economics, among other things – would make it clear that we share much more with the rest of the Western world than we don’t. And that more than 90% of what we value can be traced back to a common source: the ancient worlds of Greece and Rome.

All of the following fields of human knowledge are rooted in Greek and Roman thinking.

* Logic and Reason: first, the Milesian School (circa 600 BC), which gave rise to the scientific method; then, and most influentially, Aristotle (384 BC to 322 BC)

* Mathematics: Pythagoras (582 BC to 507 BC) and Euclid (325 BC to 265 BC)

* Physics: Empedocles (495 BC to 435 BC) and Democritus (460 BC to 370 BC); then Aristotle.

* Ethics: Aristotle and Plato (469 BC to 399 BC)

* Individuality and Idealism: Plato

* Astronomy: Aristarchus (325 BC to 250 BC)

* Geography and Paleontology: Xenophanes (570 BC to 475 BC)

* Stoicism: Zeno (340 BC to 226 BC), Epictetus (50 AD to 138 AD), and Marcus Aurelius (121 AD to 180 AD)

* Medicine: Hippocrates (460 BC to 370 BC)

* Skepticism and Relativism: Protagoras (490 BC to 421 BC), the Sophists (5th and 4th centuries BC), and Pyrrho of Elis (365 BC to 275 BC)

* Politics: Aristotle and Plato

There is a good explanation for this. Before Greece and Rome, primitive religions determined the answers to life’s most important questions – everything from how the world works to how one should conduct oneself.

But ancient Greece didn’t have a state religion. It wasn’t even a sovereign nation. It was a collection of city states, each with its own ideas about ethics, politics, and so on. And when Rome conquered Greece, as Herodotus tells us in TheHistories (430 BC), it adopted Greek culture.

As a result, instead of looking to religion for answers to their questions, the citizens of Greece and Rome began to discuss these issues amongst themselves. And by doing so, they developed what could be called the core curriculum of Western Civilization.

By the way, this curriculum includes much more than the scientific and philosophical categories listed above. The ancient Greeks and Romans also initiated and incorporated into their cultures such big ideas as free trade, currency, democracy, anti-tyranny (Cato 95 BC to 46 BC), duty to country, family values, law (“innocent until proven guilty”), and public service, to name a few.

So don’t tell me there is no such thing as Western Civilization or that Americans and Europeans are not connected to one another by a common intellectual history.

There have been significant contributions to philosophy, politics, and science that came from outside the Western cannon. But not many. It seems to me, from the reading I’ve done (see “Worth Reading,” below), that 90% of the best and most useful ideas were figured out at least two thousand years ago.

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“Cautious, careful people, always casting about to preserve their reputations… can never effect a reform.” – Susan B. Anthony

What I Will Do as Dictator Pro Tem

Part I: My Educational Reforms

I don’t want to be president. I should be. But I’m not going to throw my hat in the ring. It’s a miserable, thankless job. But I would accept a six-month gig as Dictator Pro Tem. Get in. Get out. Make America great like it’s never been before.

(Yes, I know. You, too, should be put in charge. And I’m sure you’d do a fine job. But this is my essay. So we’ll focus on what I would do.)

I was hoping to lay out all of my reforms in a single essay. But I’ve got too many of them. So today, I’m just going to lay out my ideas for education. These, of course, will be more than ideas. They will be mandates.

The Overall Problem 

Education is, in theory, a great thing. Everyone should want to be educated. The more educated you are, the more access you have to everything our country has to offer.

The problem is, our educational system is based on a falsehood: that people can be coddled and coerced into learning. The fact is, teaching doesn’t work. Only learning does.

To quote Zig Ziglar: “If you are not willing to learn, no one can help you. If you are determined to learn, no one can stop you.

My Solution 

1. Abolish public schooling. 

Tens of thousands – probably hundreds of thousands – of children are moving from grade school into high school without basic reading, math, and language skills. This pretty much determines that they will suffer through high school, bored and hyper-aware of their lack of learning.

This is especially true in our largest cities. And although everybody knows that this is so, we don’t talk about it. We tell ourselves stories about the rare exceptions, the one in ten that manages to succeed, ignoring the nine that don’t.

Public schooling is just too big and too bureaucratic. But the worst thing about it is that it treats all students equally. This is a great disservice to the kids that are financially and culturally disadvantaged.

2. Break the public schools up into small learning academies and institute a simplified core curriculum. 

Each elementary school will be broken into learning academies, each one taught by a single teacher. Class sizes will range from 12 to 16, depending on circumstances. The teachers will follow a very basic curriculum: reading, writing, and arithmetic, and – in seventh and eighth grades – history and science.

The teachers will be compensated on the basis of how many students enroll in their classes, with a bonus of up to 10% of their compensation depending on how well those students perform on a standardized test each year.

Apart from the curriculum and some basic health and safety requirements, the teachers will make all of the decisions about how they run their classes. They will, for example, determine their teaching methods, including their policies regarding assignments, homework, testing, and truancy.

They will be under no pressure to move kids along with their coevals. Entrance into high school will be earned by passing a standardized test on the fundamentals: reading, writing, arithmetic, history, and science.

High schools will operate in a similar way, with teachers compensated similarly. But they will generally teach only the subjects they are specifically qualified to teach. As with elementary school, graduation will be determined by passing a standardized test.

Parents will be free to enroll their children in any school with available space.

3. Institute a universal, progressive voucher system. 

It costs local, state, and federal governments anywhere from $7,000 to $22,000 a year, depending on the school district, to provide a child with a public school education. The average is $10,000 to $12,000, depending on how you calculate the averages.

Under my plan, tax revenues will provide the funding for education at $12,000 per enrolled child.

A fixed amount of that total budget (about $2,000) will go towards paying for the schools themselves, which will be run like for-profit businesses, and also for standardized testing, which will be done at the end of every year.

What remains will be used to issue vouchers.

The vouchers will not be equally distributed. They will be progressive, like income tax, based on the relative income or wealth of the parents.

Thus, wealthy parents might have to kick in additional funds to cover their children’s tuition, while low-income parents will get vouchers sufficient to cover classes, after-school programs, and such amenities as in-school meals and personal computers. (See #5, below.)

4. Authorize shorter school days and higher teacher pay. 

 Children cannot sit still for six hours, and they should not be asked to. A child can learn all he needs to learn in three or four hours a day.

Elementary school classes will be limited to three hours a day – an hour for each of the basic areas of study: reading, writing, and math. In seventh and eighth grades, an additional hour will be devoted to science and history.

There will be two sessions: one in the morning and one in the afternoon. (Generally, from 9:00 to noon and then from 1:00 to 4:00 through sixth grade. And from 8:00 to noon and from 1:00 to 5:00 for grades seven and eight.)

This will allow willing elementary school teachers to effectively double their salaries.

High school classes will be limited to five one-hour sessions – an hour for each area of study: reading, writing, math, history, and economics. High school teachers will earn proportionally more than elementary school teachers, to make up for the impossibility of doing two sessions a day.

5. Install before- and after-school programs. 

 Sports, drama, debate, and other “enrichment” programs will be available to interested students on a voluntary basis. They will be designed and run by specialists in each area.

Low-income and working-class parents will be able to use the extra money they receive on their vouchers to pay for such programs. Affluent parents will pay out of pocket.

There will also be programs for special needs children and programs that teach trades. Again, they will be designed and run by specialists.

None of these programs will be graded. A certificate of completion will be given if/when the student satisfies the program director’s requirements.

Since attendance at these after-school programs will be voluntary,  the compensation of those running them will be determined on a market basis. Program directors that develop the most successful programs will attract the most students and earn the most revenue.

6. End the idea that education is an entitlement. 

You don’t have to be a sociologist to understand that our nature as Homo sapiens is to value what we work for and devalue what we don’t. (Consider oxygen, for example.)

Paying for something – whether with dollars, time, or public commitment – creates confirmation bias. Confirmation bias stimulates perceived value. And that encourages work.

Vouchers provided by the government can be said to be “free” money. But to prevent entitlement mentality, parents will be required to pay an additional fee for their children’s education, ranging from as little as ten dollars a month to several hundred. This fee will be symbolic. There will be no penalty for parents who, for whatever reason, cannot afford it.

7. Demand transparency in educational results. 

 Testing will be mandatory, and all test results will be publicly available. Thus, parents “shopping” for a school for their children will be able to rate the individual academies and teachers based on the past success of their students.

8. Give parents access to all the information they need to make an informed decision. 

In addition to having access to the above (and below) test results, parents will have the opportunity to tour the various facilities and ask questions during interviews with the teachers and program directors.

9. Eliminate educational requirements for teachers and program directors. 

 The only requirement to become a teacher or program director will be to pass a test to demonstrate competency. The results, like all of the tests I am decreeing, will be public.

You Love It. Admit It. 

I’m sure you are 100% agreed that putting my reforms into practice will have an immediate and immensely positive impact on the quality of education in the US.

Students will learn better and quicker and in fewer hours. Literacy and numeracy will skyrocket.

Plus…

Parents will be happier because they will have the ability to judge the success of the teachers and program directors they are paying for with their vouchers. They will also be able to decide what extra-curricular activities their children will take.

Teachers will be happier because they will be given more independence in terms of how they teach, greater responsibility for the success of their students… and many of them will have the opportunity to earn more money.

So that’s my plan.

Principles of Wealth #7*

To acquire wealth, it is helpful to know what it is… and what it is not. 

There are many sorts of wealth. This essay is about only one of them: financial wealth.

Financial wealth can easily be defined as net worth – the sum of one’s assets less the sum of one’s liabilities.

You’d think a concept so simple and straightforward would be easy to understand. But surprisingly few people do.

Years ago, at an investment conference, I asked the audience to volunteer definitions of financial wealth. About a half-dozen were proffered, none of which was net worth. The two most popular were having a lot of valuable things and making a lot of money.

Neither one is true.

I bought a Richard Mille watch years ago in Paris.  It was new to the market then, and I was in some kind of spendthrift mood. I bought it on impulse for $35,000.

A few years later, it stopped working. Getting it fixed cost me another several thousand dollars. A few years ago, it broke down again. That brought my total investment in the watch up to nearly 40 grand.

It’s a handsome watch, but it’s not any better looking than several other watches I’ve bought for a fraction of the price. And in terms of keeping time and reliability, it doesn’t compare to a digital Casio I could have bought at the time for $35.

I should be ashamed of myself for buying it in the first place. From a financial perspective, it was foolish. But I didn’t buy it to keep time. I bought it to give me a dose of serotonin – i.e., the thrill of spending money foolishly. And the purchase delivered that.

Since then, several people have complimented me on the watch. Those moments felt pretty good, too. And somehow, the combination of that first thrill and those half-dozen compliments feels like a fair deal to me.

On an ego-gratification basis, I feel like I got what I paid for. But from a net-worth perspective, I would have been better off buying a Casio and investing the rest in real estate.

When we acquire things for emotional reasons, we almost always pay more than they are intrinsically worth. And when we exchange our cash for status symbols, we generally make ourselves poorer in terms of net worth.

Acquiring status symbols is a bad way to build wealth. And having lots of expensive things is not a valid indication of wealth.

That kid driving the red Ferrari? The doctor with the ocean-front mansion? The woman wearing the Oscar de la Renta gown? The look says, “I’m wealthy.” But you can’t know that. The kid in the Ferrari might be making $40,000 a year. The lady in the gown could be in the middle of an expensive divorce. The doctor in the mansion might be worth less than nothing.

No, you can’t measure wealth by the things people have.

What making a huge income?

What about your idiot college friend that is “pulling down 200 Gs a year” selling life insurance? Or that jerk you met in law school that charges $700 an hour for his services?

Alas, that is no indication of wealth either. Earning a big income is certainly a very solid step in the right direction, but it is useful only if a good percentage of that income is saved.

What commonly happens when our income increases is that we reward ourselves by increasing our spending, too. The temptation to do this is almost impossible to resist for most people. And the serotonin hit we get from spending more becomes addictive. Before we know it, our spending has matched or exceeded all that extra income.

Once again, we end up poorer, not richer, despite the appearance – and even the feeling – of gaining wealth.

We cannot escape the simple truth of personal economics: Wealth is net worth, and net worth can only be grown by making more than we spend.

* In this series of essays, I’m trying to make a book about wealth building that is based on the discoveries and observations I’ve made over the years: What wealth is, what it’s not, how it can be acquired, and how it is usually lost. 

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“People everywhere enjoy believing things that they know are not true. It spares them the ordeal of thinking for themselves and taking responsibility for what they know.” – Brooks Atkinson

Sweden’s Democratic Socialism:

Can We Have It in the US?

Are We Willing to Do What It Takes? 

On Friday, we talked about Sweden – Bernie Sanders’s economic model for what the US could become. As I said then, there’s much to be admired about Sweden’s economy and social welfare system. Swedes enjoy high living standards, low poverty, government funded education through college, universal health coverage, generous parental-leave policies, and much more.

And the Swedish government does this without printing fake dollars and going into trillions of dollars’ worth of debt, like the US government does.

I wondered: “How does Sweden do it? How does it provide so many benefits for its population and yet remain prosperous? And what can we learn from them?”

Let’s start with the best-known answer: Swedes pay a lot in taxes.

Swedish Taxation: It’s Not What You Think 

It’s true. The Swedish government puts a heavy burden on its taxpayers. But here’s something I found interesting. Swedes are generally happy with their tax system because they feel like they are getting a fair shake. Despite paying higher taxes than their American counterparts, working- and middle-class Swedes trust their politicians.

What’s going on?

Like the US, Sweden has a “progressive” income tax. If you make less than 18,000 kroners, you pay no income tax. (Roughly the same as in the US.) If you earn more than 18,000 kroners but less than 434,000, you pay about 31%. If you earn more than 434,000 kroners but less than 509,000 kroners, you pay 52% (32% plus 20%). And if you earn more than 509,000 kroners, you pay 57% (32% plus 25%).

57% is about 20 points higher  than high-income earners pay in the US. And that has given many people – including, presumably, Bernie Sanders – the idea that all those great Swedish benefits are paid for by the rich. In Bernie’s terms, they are paying their “fair share” of the tax roll.

But the fact is that Sweden’s heralded social service programs are paid for, mostly, by working-class and middle-class Swedes. Despite that 57% tier at the top, the overall taxation in Sweden puts the heaviest load on the bulk of the population.

Let’s see how that works.

Income tax in Sweden has three components: a municipal tax, a national tax, and a social services tax.  And as I said, it is designed so that higher earners pay not just more kroners but a lot more, because they are taxed in tiers that increase as the taxpayer’s earnings increase.

If that were the entire tax system, the perception of the rich paying the bulk of the taxes would be true. But Sweden has another very significant source of tax revenue that most Americans know nothing about. They have a national 25% sales tax that is built into the price of almost everything.

Think about that for a moment. This is a tax that applies to everyone: the rich, the middle-class, the working class, and even the poor!

(NOTE: To mitigate the effect on those earning less than 18,000 kroners, there are a few exceptions (e.g., basic foodstuffs) where the sales tax is lower or doesn’t apply.)

If you are making, say, 50,000 kroners a year, you’ll pay 31% of that in taxes, which would be about 17,000 kroners. Then, with the 33,000 kroners you have left, you’ll pay another 25% on everything you buy!

Thus, most working-class and middle-class citizens in Sweden end up paying between 40% and 50% of their income in taxes, depending on their spending.

So that’s one big surprise for anyone that thinks the Swedish model would affect only the top 1% –  or even the top 10% – of US taxpayers. If we used it here, taxes would go up for probably 80% of the population.

Here’s something else that might surprise you (that Bernie may not know): Sweden has no property tax, no gift tax, andno inheritance tax. In the US, these three taxes account for a significant share of the common tax burden. And they are almost entirely paid for by the top 10%.

The bottom line: Swedes pay a lot of taxes – considerably more than Americans that make the same income. And although the top income tax rate in Sweden is 20 points higher than it is in the US, when you consider the national sales tax and the lack of property, gift, and estate taxes, you find that, from a tax perspective, it’s actually better to be rich in Sweden than it is in the US.

Capitalism vs. Socialism: Again, It’s Not What You Think

Sweden has a long and interesting history of free-market Capitalism and social welfare programs.

In the 19th century, Sweden introduced large-scale economic reforms. It reduced the size of the government, deregulated the financial sector, eliminated trade barriers, and lowered taxes across the board. As a result, Sweden became one of the strongest and freest economies in Europe and remained so during the first 60 years of the 20th century.

Feeling flush, it began its grand experiment with Socialism – introducing massive social welfare programs, increasing regulations of and restrictions on business and finance, and imposing new taxes and raising existing ones. Starting in the late-1970s, the Swedish economy began to slow down. Among other things, Swedish exports had become too expensive due to the high wages and payments made by employers into the government welfare-state programs. As economic growth slowed, Sweden found it increasingly difficult to pay for its system of social welfare benefits.

Rather than increase already sky-high taxes, the government publicly admitted that its grand experiment in Socialism had failed. And it immediately set in place a wide range of reforms, including lowering taxes, re-imposing trade barriers, reducing business regulations, and promoting free trade. They also began the widespread turnover of publicly owned and run industries into private hands. This happened in every key sector, including health, education, and banking.

Approximately 90% of all resources and companies are now privately owned, with a minority of 5% owned by the state and another 5% operating as either consumer or producer cooperatives. Sweden is a world leader in privatized pensions, and its pension funding problems are small compared to many other Western European countries. The state owns one bank, which mainly offers mortgage loans.

It’s also important to note that one of the factors in Sweden’s economic success has been its longstanding commitment to avoid foreign entanglements. Following WWI and WWII, unlike many other countries, it didn’t have to struggle to pay back huge war debts.

It maintained its neutrality during the second half of the 20th century, abstaining from involvement in at least a dozen of the proxy wars that followed WWII. As a result, Sweden never developed a military industrial complex, as we did in the US, which means that its defense budget is relatively insignificant in terms of the country’s economy.

(FACT: Only 5% of taxpayer money in Sweden goes to the police and military combined. In contrast, the US military consumes more than 30% of government spending.)

While economic freedom has decreased in the US and the UK in the last 30 years, it has increased in Sweden.

Bottom Line: In terms of its economy, Sweden is about as far from Socialist as an economy can be.

So… Could It Work in the US?

Sweden did not become wealthy through social democracy, big government, and a large welfare state. It developed economically by adopting free-market policies in the late 19th century and early 20th century. As late as 1950, Swedish tax revenues were still only around 21% of GDP.

Rapid growth of taxes, state ownership of businesses, and government regulation in the late 1960s, 1970s, and 1980s led to a large decline in Sweden’s relative economic performance. In 1975, it was the 4th-richest industrialized country in terms of per capita GDP. By 1993, it had fallen to 14th.

To reverse that decline, Sweden again introduced market reforms in almost every sector of the economy. And, again, it worked. Sweden’s relative economic performance improved accordingly.

If we wanted to adopt the Swedish model and provide such social services as (mostly) free healthcare, (mostly) free education, universal retirement benefits, and 5-week vacations, this is what we would have to do:

* Close down the war on poverty.

* Close down the war on drugs.

* End the cold war with China and Russia.

* Drastically shrink the military.

* Decrease tariffs and other trade barriers and encourage more free trade.

* Deregulate industries, almost across the board.

* Abolish minimum-wage laws.

* Do away with occupational licensing.

* Reduce the corporate tax rate.

* Reduce banking regulations.

* Abolish property taxes.

* Abolish gift taxes.

* Abolish inheritance taxes.

* Increase private schooling by instituting a national voucher system for education.

* Reform Social Security from defined benefits to defined contributions.

* Provide private pension accounts in lieu of Social Security.

* Institute a national sales tax of 25%.

* Increase the Social Security tax to 25% and apply it to all taxpayers.

Given the fact that Swedes are, by every survey, happier with not just their lives generally but with their government, their policing, their welfare system, and their taxes, this might be the way to go. For someone like me who believes in personal freedom, limited government, and free-market Capitalism, it is a very attractive prospect. But I’m not sure that if Bernie and his supporters actually understood the economic realities of Sweden they would go for it.

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