This past week has been pretty busy for me, as I attended the Berkshire Hathaway annual meeting last weekend, and the Wesco annual meeting on Wednesday.  Wesco is run by Warren Buffett's partner Charlie Munger.  Whereas the Berkshire meeting has the atmosphere of a very popular circus, the Wesco meeting features about 1% of the attendees of the Berkshire meeting, and it allows for more unfiltered Mungerisms, which makes it well worth the effort.

Last year I took voluminous notes at the Berkshire meeting, and barely shared any of them.  The process felt daunting and I was very busy.  That's no different this year, but I think there is a lot of value in what was communicated, and that value is definitely worth sharing.  Nonetheless, I plan to do this in digestible pieces, which should make it more readable and more feasible for me.

One point about the logistics of the meeting:  beginning last year, the Q&A process alternated between those being asked by three journalists, and those being asked by members of the audience.  The journalists were Carol Loomis, Becky Quick and Andrew Ross Sorkin.  They each receive thousands of questions from the investing public, and whittle them down into broad themes and form specific questions accordingly.  I took notes on most questions asked by the journalists, but not on all questions asked by the audience.  Some just didn't hold much interest for me.  Other questions didn't strike me as worthy of particulary insightful responses.  Consequently, my sharing will be selective.

First up (next post):  Warren Buffet's view of the recent troubles at Goldman Sachs.

I found an interesting article in the NY Times from a couple of years ago on the admission prospects for twins and triplets when they apply for the same college.

The basic question the article seeks to resolve is "does the candidacy of one sibling of the same class negatively impact the candidacy of another"?

It has always been my perception that selective schools seek geographic and demographic diversity.  For obvious reasons twins and triplets will be the least diverse prospects imaginable, at least on paper.  In fact, my kids have very different personalities, and that is consistent with other multiples that I know.  Nonetheless, environment plays a significant role in shaping one's views, and I think to some degree the college admissions process is a statistical crap shoot, so assuming a lack of diversity seems pretty rational.  If the siblings go to a small high school in a small town, and all apply to an Ivy League School, it seems logical that the likelihood of all being selected is low, even if their applications are very similar.  I'm not sure the article dispels that theory, although Harvard's Dean of Admissions suggests the diversity quota is a myth.  Interestingly, Duke University considers twins individually and as a unit.  I'm not sure how the average twin or triplet would view being evaluated for college admission as a package with a sister or brother, but at least nobody would be ruled out strictly by virtue of one being admitted.

Speaking from experience, one of the daunting things facing parents of multiples is paying multiple college bills simultaneously.

In an earlier post, I listed some of the college scholarship options available to twins, triplets and other multiples.  Another consideration is the impact on the Expected Family Contribution (or EFC) of having several children in college.  As the name suggests, the EFC describes the amount of money a family is able and expected to chip in to pay for the cost of college, as calculated in the federal student aid application process.  It is used to determine "financial need" in this process. After taking the EFC into account, a loan and/or grant package can be developed to bridge the gap and help pay for schooling.  Of course, the lower the EFC, the higher the financial need.  Families that can show high financial need are eligible to receive more financial assistance.

The "silver lining" in the case of multiple siblings attending college at the same time is that the EFC is a family-level calcuation.  In other words, if it is determined that a family can contribute $21,000 per year to college and there is one child in school, it will be expected that all $21,000 of that EFC will be available for that child.  If three kids are in school, it will be assumed that roughly $7,000 is availabe for each student.  If those kids are triplets that all complete their schooling in four years, and they all have a $21,000 total bill for school each year, each student will be eligible for $14,000 per year of aid.  On the other hand, if three children were each born two years apart but otherwise followed the same path and paid $21,000 each (ignoring inflation), the family would a) have eight years of college ahead of them, and b) in four of those years they would not be eligible for traditional federal aid at all.  In the middle four years they would only be eligible for $10,500 per student of such aid.

It should be noted that the calculation of the EFC and financial need is a somewhat complex process.  In reality, the numbers will not work out this precisely.  Although this is a simplistic example, the message is valid regardless of the numbers used.

This all may seem like cold comfort to my fellow triplet parents, but why not look on the bright side when there is one?

Earlier this week, Kathleen Pender wrote an article titled "Dodd bill punts on strict rules for brokers" in the Net Worth column of the San Francisco Chronicle addressing the lack of a fiduciary standard for stockbrokers.  It's a quick read, and sums up the reality of why it is hard to be optimistic that there will be meaningful regulatory reform in this area.  If you're not familiar with this issue and are currently using or seeking financial advice from a professional, it makes a lot of sense to educate yourself on compensation arrangements for financial advisors.

The article concludes with a recommendation to ask a prospective advisor whether he or she is required to act in your best interests.  Good advice.  To that I would add:  "How are you being paid to provide me with advice, and by whom?  Please list all sources".

Read the article here:  http://tinyurl.com/SFGateFidArticle.

Intuit has decided to leverage its considerable data to provide an anonymous, aggregate view of employment trends for small business in the United States.  The index focuses on small businesses that employ fewer than 20 people, which they say make up more than 87% of all American employers.  It pulls data from approximately 50,000 US businesses.  Intuit views small businesses as a sort of bellwether for overall employment, as they see small businesses hiring earlier than larger employers.

So what can we learn from the data this month?  In short, small business is on the comeback trail.  Employment in this space has been gradually trending upward since June, 2009 and accelerated a bit in February.  Although I have no reason to discount the statistical validity of 50,000 businesses, any representative index like this will have a margin of error.  The "acceleration" indicated in February still translates to a .2% rise in employment; in other words, we're not experiencing a surge in employment at this point.  Nonetheless, the upward curve seems to be steepening slightly, and I think the stats are positive, if muted.

Full Disclosure:  Foothills Financial Planning uses Intuit’s payroll service.  Although we’re perfectly happy with it, the point of this article is not to offer an opinion for or against the service.

Much has been made recently about the story of Grace Groner.  For good reason.  If you're unfamiliar, Ms. Groner died last week at the age of 100.  While working at Abbott Labs, she bought 3 shares of stock in 1935, reinvested the dividends, and lived within her means for the rest of her life.  That investment is now worth $7 million, which she has donated to her alma mater.

There are a couple of interesting story lines associated with this.  Most of them center on frugality and charity.  Again, deservedly so. This is a great lesson in both.  Although she doesn't perfectly fit the mold, Grace Groner's behavior would have made her a good subject for Thomas Stanley's The Millionaire Next Door series.

There are a couple of other vectors here that are interesting, though.  In his Wealth Report column, Robert Frank highlights one of them, which involves the power and risk of putting all one's eggs in one investing basket, especially when that basket belongs to your employer.  He points out that luck played a big role here.

In reality, though, if she had invested in the broader market, she would have enjoyed impressive returns as well.  But how impressive?  That is the story line that is most instructive, and it involves the power of compounding, which is coincidentally a favorite topic of this blog.

Let's look at some data.  In 1935, stocks were up 46.74%.  That's a nice way to launch a long-term investment.  The next year, the market was up 31.94%.  In other words, if Grace Groner would have invested in a broad stock index fund on January 1, 1935 (had they existed then), she would have almost doubled her money after two years!  Of course, the market is a volatile beast, and 1937's 35.34% drop was undoubtedly a good reminder.  Nonetheless, from 1935 through 2009, the average broad stock market return was 12.23%, according to the Federal Reserve's numbers.  What was Grace Groner's return?  By my calculation, it was just under 15.4%, with full reinvestment of dividends, etc.  That is what allowed Ms. Groner to donate $7 million to Lake Forest College.

But what about Robert Frank's assertion that luck played a huge role in her investing success?  How much would she have been able to donate to Lake Forest if she had instead been able to invest in the broad market for 75 years? $919,042.85!  In other words, the difference between a 12.2% and a 15.4% per year average return on a $180 investment for 75 years is more than $6 million and almost 87% of the final value of the investment.

That leads me back to two fundamental points:  1) the power of compounding cannot be overstated, and investing early is a huge advantage if one is hoping to build wealth, and consequently 2) finding inexpensive investment vehicles makes a huge difference, provided the associated returns are similar.  If Ms. Groner had paid 100 basis points, or 1%, for management of her Abbott investment, she would have ended up with a bit less than $3.8 million.

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On Saturday Warren Buffett released the Berkshire Hathaway annual report for 2009, accompanied by his customary shareholder letter.  It won’t hit mailboxes in printed form for a little while, but undoubtedly many people will read it online long before it gets to them.  I thought I’d dedicate a post or two to sharing what I see are some key points emanating from the brain of Buffett via his shareholder letter.  I’ve always felt this was an entertaining and informative read, and this year has not been a disappointment.  You might wonder why you should care what Warren Buffett thinks.  Like anybody else, he has made some good calls and has been off base about some things.  (I should point out that when he's wrong it's usually a matter of timing, and it happens much more infrequently than when he's right).  Regardless, through the companies he owns and the people he knows, he has an almost unequaled perspective on the American economy.  He also has a very rational view of the world, unencumbered by politics, and to a large degree, personal political ideology.  The engine of Berkshire is the insurance business.  They own banks and other financial services companies, as well as having major exposure to residential real estate.  The roots are based in basic, industrial companies.  In other words, Berkshire is directly exposed to pretty much all of the areas of the economy that have caused great concern over the past couple of years.  Although Buffett may be hands-off to a large degree in the operations of most of his businesses, he knows precisely what is going on in all of them.  The last obvious point in favor of lending credence to his views is simply that his investing performance has been unparalleled.  

One thing about the letter that is clear right off the bat is the fact that he felt the need to restate the basic tenets of owning Berkshire Hathaway.  The Berkshire Owner’s Manual is posted online on an ongoing basis.  Recently, however, Berkshire’s B shares have split 50 for 1 to facilitate the purchase of Burlington Northern, and there has been a huge influx of new shareholders.  For that reason, Buffett seems to give more attention than in most years to reiterating the overall philosophy of Berkshire Hathaway.   While it’s true that he reinforces basic concepts every year – and really every chance he gets -  this remains valuable information whether you’ve owned shares for several decades, or you are merely interested in learning from a great investor.

Perhaps the most universally interesting topic Buffett addressed was the state of residential real estate.  He may not typically be associated with this industry.  However, as he points out in the letter, Berkshire-owned MidAmerican Energy in turn owns HomeServices of America.  HomeServcies owns a broad collection of regional realty firms that combined make them the second largest real estate brokerage firm in the US.  Additionally, their website specifies that they are the “largest brokerage-owned settlement services (mortgage, title, escrow and insurance) provider in the United States.”  Berkshire also owns Clayton Homes, which has become the largest maker of modular and manufactured homes in the US.  This is all a long-winded way of saying that Buffett has a pretty good vantage point from which to view the problems and opportunities facing residential real estate.

First, some numbers.  Total industry output of manufactured homes has dropped from 382,000 in 1999 to 60,000 in 2009.  That has led to the bankruptcy of 1999’s top three manufacturers.  More generally, housing starts in the US have dropped to a fifty year low, at 554,000. (For some context on the trend of housing starts, see the chart at the bottom of this post.)

At last year’s annual meeting, Buffett talked at some length about the supply and demand dynamics in real estate, and how prices will start to pick up again when we work off the excess inventory that existed then in the system.  Typical, rational view of things, and of course he had the numbers at the tip of his tongue. 

The big news coming out of this discussion?  Warren Buffett believes that within the next “year or so” our housing problems should be largely behind us.  Of course, housing is overwhelmingly a local phenomenon, and there will be regions that continue to feel the effects of overbuilding well beyond 2011.  Furthermore, the upper end of the spectrum in many areas may still be years away from real recovery.  For instance, I recently saw data for the Phoenix area that indicated that inventory for homes under $400,000 was actually approaching neutral, meaning that it didn’t particularly favor buyers or sellers.  However, above $3m (I think…may have been $2m) there was enough inventory to serve buyers for over five years!  Note:  don’t hang your hat on these numbers as they are approximate and a couple of months old.  The point remains, though.

We may still be in for some bumps, but I suspect it’s comforting for most people to hear one of the most rational players in American business state that there’s light at the end of the tunnel.

Housing Start Data, courtesy of the US Census Bureau

I resisted reading The Millionaire Next Door for a long time, because the title led me to the assumption that it was a get-rich-quick tome.  I was very wrong about that, and I was disappointed that I waited so long.  I’ve now read the book twice.  To be precise, on both cases I listened to an audio version that I purchase from Audible.com, a favorite service of mine.  Far from being a book in the genre of Rich Dad, Poor Dad and its ilk, the book, written by Thomas J. Stanley, Ph.D. and William D. Danko, Ph.D, grew out of hard research they had performed about the affluent in America.

I should point out that a premise of the book seems to be that achieving millionaire status is an important goal and worthy of focus.  Not all readers would deem that a worthy goal.  Nonetheless, there are lessons in this book about financial comfort and independence that are universally applicable.  The impact of stress on our immune systems and overall health is undeniable.  An Ohio State University study has found that money-related stress had a stronger link to depression symptoms among breast cancer patients than even stress related to the recent death or illness of a loved one!  Living within our means is a sure way to reduce our stress, and that is the underlying message that I took from this book.

Before I go any further, I should stress that the book was originally published in 1996, and one million dollars went a bit further then.  We’ve had three significant shocks to the financial system in the interim!  Alas, the lessons still apply, even if some of the statistics are outdated.  In fact, applying the concepts in this book would have saved a lot of people some pain over the last couple of years.

There are a few fundamental concepts that I think are important.  Beyond that, I highly recommend getting this book (preferably at the library) and reading it closely.

The basic thrust of the book is that the average millionaire in the United States probably does not fit the profile that most people imagine when they think of millionaires.

What is wealthy?

The authors appropriately define wealth in terms of net worth rather than the number of expensive vehicles in the garage or the size of the house.  In 1996, they used a crude, absolute threshold of $1 million in net worth to be considered “wealthy”.  In today’s dollars, that translates to something close to $1.4 million.  However, they define a much more informative measure that describes how wealthy a person should be given his or her age and income level.  The formula is as follows:

Expected wealth = Age multiplied by pretax annual income (from all sources except inheritance), divided by ten

This is a much more useful measure, as it factors in standard of living.  To a significant degree, this metric captures whether or not an individual is living within his or her means.

PAWs and UAWs

The authors highlight two categories of savers:  Prodigious Accumulators of Wealth and Under Accumulators of Wealth, or PAWs and UAWs.  Accumulating wealth at a rate greater than at least 75% of the population qualifies an individual as a PAW, while doing so at a pace that is less than 25% puts one in the UAW group.  To make this more universal, they offer a simpler rule:  your net worth should be twice the level of expected wealth to be a PAW, while less than half of the expected net worth would place you in the UAW range.  So, if you’re 35 and making $100,000 per year, your expected wealth is $350,000.  If your net worth exceeds $700,000, you’re a PAW.  If it is less than $175,000, you fall into the UAW category.

This highlights another distinction called out by the authors:  balance sheet affluent vs. income statement affluent.  Examples abound of doctors and lawyers making over $500,000 per year while having little in the way of sustainable assets to show for it.  More impressive are the examples of individuals who make less than $100,000 per year in earned income, but can never work another day and be comfortable.  It’s all about living within your means.  (In fairness, many examples of the latter case lived well below their means).

They earned it

Another interesting point was that 80% of the wealthy in this study were first-generation millionaires.  They did not inherit wealth.  However, the country clubs of America are littered with inheritors who are quickly blowing through the cash their parents have left them, with no means of replenishing it.

That brings us to the concept of economic outpatient care.  This was much more of a black-and-white issue for me before I had children, but the statistics are still very powerful.  Adult children who had received any kind of financial assistance from their parents suffered for it.  The authors “found that the giving of such gifts is the single most significant factor that explains lack of productivity among the adult children of the affluent."  In eight of ten occupations held by children of the affluent, households that received regular gifts had lower net worth than those who did not.  Overall, such individuals had an average of 81% of the wealth of their non-receiving counterparts, although this was skewed upward by teachers, who apparently used the gifts they received to build additional wealth.  Receivers of EOC invest less and use more credit.  They come to depend on the gifts as supplements to their income, and proceed to live at a higher level.

The book offers a lot of data that is very eye-opening, and it clearly demonstrates that the average wealthy individual is not driving around in a Ferrari.  However, the takeaway ideas are pretty straightforward and common sensical.  That doesn't mean they're easy to apply, though.  Reading this book really reinforces that common sense.  Similarly, Thomas J. Stanley's latest book - Stop Acting Rich - doesn't really present radical new concepts beyond those of The Millionaire Next Door.  It does, however, reinforce the concepts in much the same way as its predecessor.  It, too, is worth reading several times.

I just read a somewhat provocative article by Liz Pulliam Weston entitled 4 Reasons we get ripped off, and I think you should read it, too.  It’s concise, but points to some actions that consumers can take to avoid falling prey to those who would take advantage of weakness, legal or illegal.

I’ll summarize the reasons here and provide my perspective.

Americans stink at math

No argument here, but this is pretty easily fixable.  The Department of Labor states that 58% of American adults cannot add 60 cents to $1.95 and calculate a 10% tip.  That is startling.  If you fall into this category, I recommend taking a remedial math class.  My guess is that elementary school students would fare a bit better in this survey, because they’re doing these kinds of calculations more frequently.

We don't recognize sociopaths

This reason is kind of depressing and little bit scary, but undoubtedly true.  In fact, I am not sure it is only  sociopaths about whom we should be concerned.  An even bigger concern for me is the number of salespeople who do not act in the best interest of their customers but feel that is the standard way of doing business.  Sometimes the lines are not so clear.  When you buy a car, the salesperson receives a commission, and it’s entirely appropriate for her to be compensated for her effort.  How much compensation is okay?  That’s a blurry line, but too often the answer is “as much as possible”.

In my business, the norm is probably to not act in the best interest of the client.  Most financial “advisors” are simply salespeople who are not obligated to act in their clients' best interests.  In this case, my recommendation – self-serving though it may seem – is to work with an advisor who is a fiduciary and thus is legally required to act in the best interest of the client.

In general, try to understand how a salesperson is compensated and what his or her incentives are.  Do they make more money pushing certain products over others?  Is it obvious what your total cost will be?  If any of this is unclear, ask!  Furthermore, before making a purchase of consequence, develop a plan and stick to it, including a budget for the purchase.  It is much harder to be persuaded to go beyond what makes sense when you’ve established firm boundaries.

Bait-and-switch capitalism is now the norm

This is definitely a problem.  I think it’s important to try to find alternatives whenever possible, including cancelling your service in favor of a more transparent one.  Most importantly, ask about the total cost up front.  You still may get a lie in response (back to the sociopath concern), but at least that will become obvious pretty quickly after the fact and you can take steps to rectify the situation then.

Half the police force has disappeared

There is a lot of debate in our society about the appropriateness of new legislation and the size of government. Certainly, the legislative framework in several areas is imperfect. Nonetheless, I think effective enforcement is a more important consideration at this stage.