jankythoughts2

Foreword

For most people, retirement/financial planning (1) is often thought of as simply how you deal with excess money (disposable income) after paying for living expenses, taxes, etc.

In my opinion, that is a very limited and limiting way of thinking about some of the most consequential decisions you would have to make in your lifetime.

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Human net worth

As I’ve discussed in “Net Worth“, net worth and cash flow are related topics, and in general, outside of less common cases like illiquid non-cash flowing assets, they can be thought of as the same thing.

Now, if you subscribe to that view, then it may seem odd that when people talk about net worth, they very rarely talk about their incomes from their jobs. In a hand-wavy, abstract sense, you can think of your knowledge, health and age as assets, and your knowledge + health + age enable you to generate cash flow via using your labor to create value for others, i.e. performing a job and getting paid for it.

So, in that sense, your knowledge + health + age should have some implied “worth”. In a more crude sense, you can imagine (a) someone who’s 26, but terminally ill and bed-bound, (b) someone who’s 80 but healthy for their age and (c) someone who’s 26 and healthy for their age. Clearly, in most cases, (c) will be able to generate much more income from their labor than (a) or (b).

Now, and again, being crude, if we were to put a number on it, how much would we value our knowledge + health + age?

Job incomes tend to be fairly stable and dependable in the short/medium terms(2), but health and age deteriorates with time, while knowledge improves with time, though deteriorate beyond some point due to old age. Unlike most financial assets like bonds, stocks, etc., the value of knowledge + health + age is extremely hard to compute, as there are other factors that muck things up — e.g. you may be a natural genius in the medical field, but were never afforded the chance to attend medical school and thus your genius is entirely trapped as “potential”.

Without going too much into theoretical modeling, I’m just going to use something simple — take your expected retirement age, subtract your current age. This is your number of working years left. Multiple that number by your current pretax salary, and we’ll call it your “human net worth”. This simplistic model assumes your salary increases at the rate of inflation, and doesn’t change other than that. It also assumes that the rate of discount is just the rate of inflation, so we can use current nominal values in place of imputed future discounted values. Feel free to nerd out and use more complex models.

If you’ve done the exercise above, you’ll quickly notice that your “human net worth” is probably pretty significant. If you are below the age of 35, I’m guessing your “human net worth” is probably quite a bit higher than your “financial net worth” (3).

Think like a business person

The one thing that most successful business people know, is how to maximize the value of their assets by focusing on what’s important. For example, it simply doesn’t make sense spending a lot of time trying to save a few thousand dollars by being draconian on office supplies if you are a multi-billion (or even trillion!) dollar software company. The same amount of effort, if directed towards more productive endeavors like improving employee productivity, would yield far greater results.

In a similar vein, if you are a software engineer with a portfolio of, say, $300k, and an annual salary of $184k, it simply doesn’t make sense spending a lot of time trying to optimize your portfolio. Even if you manage to outperform the market by 10% (assuming market returns is 10%, this would be a 20% return) (4), you will only make about $30k more. If you spend your effort concentrating on your career, getting promoted just once can easily yield more than double the benefits:

Clearly, the exact numbers depend a lot on your personal situation, but the point is that in many cases, especially for those who are below the age of ~40, where you simply haven’t had enough time to accumulate a significant portfolio, your best financial/retirement planning move is very likely to just be throw your money into something simple to manage and not too risky, and then concentrate your efforts on developing your career.

Always do the math

Many people dive headlong into finance and investing, others take up side hustles, thinking that they can supplement their main sources of incomes. In many cases, they completely ignore the one thing that is most likely to benefit their financial situations the most profoundly — simply doing better at their day job (and getting recognized for it via higher commissions or promotions), or finding another line of work with more advancement opportunities.

Before diving headlong into any new endeavor, it probably makes sense to just spend a week or two figuring out if the effort is even worth it, or if you could get more out of your efforts if you just redirect your focus elsewhere.

Personal experience

Some random notes based on personal experience and talking to people:

• Many people think real estate investments are passive (6). They are not.
  • If you are owning the property outright, then you have to deal with managing the property (or paying someone to manage it, and then managing the property manager). If you only have 1 or 2 properties, this is probably not a big deal, but does take quite a bit of time. If you have more than 5 or 6 properties, this easily becomes a full time job.
  • If you are investing via a fund or syndication, then you’ll have to spend a lot of time sourcing deals and vetting sponsors, reading their periodic reports to make sure everything is on track and deciding how to deploy your future dollars. In some ways, this is very similar to the pros/cons of investing in stocks.
  • In both cases, you’ll have to understand the economics/finance of real estate investing, and how macroeconomics affect it and thus you. Keeping up with these generally involve a lot of reading, attending conferences/webinars/seminars, etc., which again take up a lot of time.
• Many people think trading stocks can be passive — once you’ve figured out a winning strategy, just make a bot and watch the money roll in. It doesn’t work this way.
  • As someone who has written and ran multiple trading bots before for personal trading, and who has worked in a quant hedge fund, I can assure you that it is not so simple.
  • All strategies eventually lose their edge. It may be 1 week after you find the strategy, or it may be 1 year. But it eventually happens. And the tricky part is trying to figure out if your current losses are due to a change in the regime (i.e. your strategy losing its edge) or just an expected drawdown. Deciding wrongly will be punishingly expensive.
  • The trading space is unbelievably crowded. Outside of large funds, millions of personal traders trade either as a full time job or with bots. Thus, you’ll need to be nimble, and be able to change and adapt depending on financial/economic forces, so that you can stay one step ahead of the competition.
  • Again, all the above means that a long term successful trading operation is almost always a full time job.
• If you are a software engineer (7), then unless you have $10m+ in your portfolio, your best path to financial security is almost definitely to improve yourself so that you can perform your day job better, and get to your “terminal level” (8) as quickly as possible. As shown by surveyed salaries of Facebook software engineers (5), each promotion comes with a pretty hefty and permanent (9) salary increase, each of which would easily equal a double digits return on most common portfolio sizes for people of those income levels.
  • Of course, if you are personally interested in finance, and are doing it as a hobby, then by all means go ahead. All work and no play makes Jordan a dull kid. But be sure to understand the limitations of this, and do not fool yourself into thinking it is something beyond what it really is.

Footnotes

1. Many people treat retirement planning and financial planning as different things. They aren’t really — it’s probably more accurate to think of retirement planning as a facet of financial planning, the goal of which is to, naturally, retire by some age.
2. This isn’t true for everyone, but generally true for most people under most economic circumstances.
3. “Financial net worth” is a made up term, here meaning the traditional “net worth” definition — the net value of your assets.
4. It’s pretty damn hard to consistently beat the market by 10%. Many hedge funds get paid millions/billions of dollars just to beat the market by 2-3% every now and then.
5. I am not endorsing the numbers on levels.fyi for Facebook. I do not know if these numbers are accurate at all, though I assume they are close enough to be a reasonable comparison in this case.
6. Here, “real estate investments” mean private real estate investments, not buying publicly traded REITs, etc. Buying publicly traded REITs have all the usual pros and cons of trading stocks, which are touched on later.
7. I’m specifically calling out software engineers here, because I am one, and understand the economics here better. Other professionals may have similar dynamics, I simply do not know.
8. Due to luck, experience, knowledge, life commitments and other factors, most people have a “terminal level” beyond which they find it hard to impossible to get promoted beyond. At Facebook/Google/Uber and most tech companies with a similar level structure, this is generally around levels 5 – 7.
9. OK, fine, it’s technically not permanent. But it’s pretty rare (outside of sign on bonuses and dramatic market events) to see annual total compensation drop at one of the big tech companies.

Foreword

Housing is a touchy subject. On the one hand, nobody likes to hear about homeless children, or elderly retirees forced out of their homes. On the other hand, nobody seems particularly obliged to go out of their way to help those in need obtain and retain housing. So what then?

For full disclosure, I have a fairly large portfolio of real estate investments, of which a majority are residential. Obviously, I am not an impartial observer. At the same time, having been both a tenant and an (indirect) landlord for multiple years and in many different locales, while also keeping constant tabs on the managers who oversee my investments, I feel I can provide a perspective that is often lacking in the media.

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Costs of building a home

According to RocketMortgage, the average cost to build a home is about $282,299 in 2022. Granted that a portion of those homes are larger, luxury homes, so the actual cost of building a “starter home” for someone of more modest means is probably lower. On the same article, the average cost to build a 1 bedroom is about $80,000 on the low end — much better!

But let’s dig a little more — according to BusinessInsider, the median American family has a net worth of around $121,700. Suddenly, that $80,000 looks a lot tighter. Also, recall that the $80,000 figure is at the low end of the scale — in most parts of the country, it may not even be a feasible number. At the same time, the $80,000 cost doesn’t even include the cost of the land which, depending on location and size, can easily cost $100,000 or more.

Next, building a home takes time, from a few months to a year or more, depending on the location and scope of the project. During this time, the new owners will need a place to live, likely rented which means monthly rent payments.

Finally, home insurers and mortgage lenders typically do not service new builds. A new build is much more risky for the insurer, as there is active work being done and thus more chances for accidents. At the same time, if the borrower defaults on their mortgage, the lender has no real collateral (i.e. the house) to foreclose on to recoup their money. As a result, both insurance premiums and mortgage rates for a new build tend to be much, much higher than for a regular home.

Why is building so expensive?

A large part of the reason why building new housing is so expensive is because of existing rules and laws. Modern day housing units must fulfil a myriad of rules and laws built over decades of experience. Unfortunately, these necessarily add to the costs of building.

For example, in practically everywhere in the USA, all homes must have proper heating and cooling depending on the local climate, bedrooms must have an exterior wall and have exterior facing windows for safety reasons, wall paint must be lead free for health reasons, bathrooms must have proper plumbing, etc.

For the most part, I personally believe these to be sensible and reasonable — no one should be poisoned by lead paint just because of their financial situation.

Separately, the craftspeople who build our homes deserve to be compensated fairly — theirs is a job involving manual labor and, often, very real risks to their bodies and health. They should also be protected by adequate insurance policies so that them and their families are taken care of if the worst were to happen.

Finally, to ensure that all the proper building rules were adhered to, and that nobody made a mistake that might lead to potential disaster, most counties in the USA have enforced inspections by local engineers and experts, to ensure that buildings are “up to code”. While overall a good thing, these inspections do add to the overhead both in terms of costs (inspections typically are not free) and time (and they take a while to schedule, while any issues found need to be remedied).

And remember, we’ve just discussed the cost of building the home. Maintaining a home incurs another set of expenses such as property taxes, utility bills, etc.

Grim reality

When you put together all the requirements a modern home needs, and the costs of building that home, you arrive at a very grim conclusion — for a very large portion of the country, buying a home is simply an expense they cannot afford.

Renting

Given that so many people cannot afford to buy a home, yet still require a roof over their heads, it’s no wonder that many people choose the next option, which is to rent a home from a landlord.

Unfortunately, the facts that renters tend to be less affluent, housing costs are high, and investors (landlords) need to make profits result in some very contentious relationships. In particular, landlords tend to be portrayed in the media as unscrupulous capitalists, out to suck up every last cent from their hapless tenants.

While clearly not every landlord is a saint, it seems unduly combative to assume every landlord is the devil. While there are certain valid criticisms, there’s also a lot of just simple misunderstandings and well poisoning.

Houses are for living, not for investing

On the surface, this seems like a valid complaint, but is it really?

For better or for worse, in the USA, the government has decided that it is incapable of providing housing for the people. As such, this critical role has been outsourced to the private sector, with incentives such as tax advantages for real estate investments, etc. to encourage development.

The private sector, being capitalistic in nature, is incentivized by profits — private individuals and entities simply do not, in general, offer up their resources for free.

Given that the country has a general lack of housing, in order to correct that imbalance, housing prices need to rise, essentially increasing profit margins and incentivizing investment, so that enough housing will be built for everyone who needs it.

Until the government’s stance on the matter is changed (see below), the only real way to ensure enough housing units being built annually to accommodate new household formation is, unfortunately, higher home prices.

Investors push up the price of homes, forcing others to rent

There is some truth to this — real estate investors are driven by the profit motive, and as long as the numbers work, they will willingly bid up the price of homes, sometimes beyond the means of Regular Joe’s.

But that’s just one side of the equation. The investors clearly needed to buy the homes from someone else (in order to push up the prices) — someone who benefitted from the increase in home prices. Someone who, too, maybe a Regular Joe. What then? Are real estate investors now Santa Clauses handing out bags of money?

The fact is that this is a more nuanced issue — investors benefit existing homeowners, while hurting new ones. In more concrete terms, baby boomers and Gen X’ers tend to benefit from real estate investors, while millennials and Gen Z’ers tend to suffer.

Whether this is desirable, then, likely depends a lot on whether you already own your home.

Landlords raising rent is predatory

Tenants tend to complain that landlords seem to raise rents every year, and at rates that tenants generally feel are unfair. So let’s break it down.

As we’ve discussed before, housing is expensive, and maintaining them is also expensive. At the same time, landlords (investors) are capitalists and out to make a profit. Which means that whatever costs the landlord bear, must eventually be passed on to the renter, along with a markup for profits.

Yes, that means renters tend to pay more in rent than the landlord pays in costs. And as we’ve discussed earlier in order for the supply of housing to meet the demands of new households, this must necessarily remain true.

Given that the landlord’s costs increase every year due to inflation, so too must the rent. At the same time, in order to stimulate more housing to be built, areas with a severe lack of housing must necessarily see rents rise faster than inflation — the temporary supernormal profits incentivizes new housing to be built, which then will increase competition amongst landlords, which in turn reduce future rents.

But if renters are paying for the cost of the homes to begin with, what are landlords for? As it turns out, a lot.

Recall that renters tend to be less affluent. As a result, they tend to have trouble getting the necessary financing for building or buying homes. Landlords step in here, as an intermediary between the banks and the renters — the landlord puts up their reputation and assets as collateral to the bank to obtain the financing needed, and they then charge the renter for the “lease” of their balance sheet.

If you’ve worked in finance, you’ll know that while financing rates for the first ~75% of a project is relatively cheap, rates jump dramatically as the loan to value increases — the lender naturally assumes more risk as the equity cushion is reduced.

Similarly, the cost of borrowing 100% of the cost of a home needs to be much higher than borrowing 80% of the cost of the same home — the higher rates compensate for the higher risk assumed by the lender + landlord.

Secondly, landlords tend to manage more than 1 home. This often translates into savings in terms of maintenance costs via economies of scale — it is fairly common for landlords to build relationships with local craftspeople in a win-win relationship — the landlord provides the craftsperson a steady stream of jobs and income, while the craftsperson gives the landlord a discount for their services. This discount can then be passed on to the tenant.

Next, the landlord, by virtue of having to deal with constant maintenance issues across their tenants, will naturally build up a rolodex of known and trustworthy craftspeople, saving the tenant time and potential costs of engaging a less skilled or even outright fraudulent contractor.

Finally, the landlord also provides a service — essentially a 24 hours contact for maintenance issues, as well as aggregation of various expenses into a single, tidy monthly rent payment.

Solutions

Personally, I believe strongly that everyone benefits if everyone has proper housing — homelessness tends to bring with it many social problems.

However, and I say this as a beneficiary of the current system (being a real estate investor), the private sector is simply not equipped nor incentivized to achieve that goal. The most profits can be extracted when relative demand is high, since as supply increases marginal profits fall. So given a free market, supply will likely never ever rise enough for everyone to be suitably accommodated.

Given that the benefits of 100% housing is a benefit shared by all, basic economics then suggest that affordable housing, as opposed to luxury housing for those more affluent, should really be provided or subsidized by the government in some way. Forcing the private sector to subsidize housing for the less affluent such as the use of rent control, rent stabilization or other coercive means will just lead to less investment and thus even worse problems in the future.

Section 8 housing

As a start, section 8 housing, I feel, is a pretty good program. Its main issues are 2 fold. First of all, the program is severely underfunded, and really needs to be a much bigger priority of the government’s budget, so that everyone those in need can reliably qualify and get the assistance they need.

Secondly, the stigma associated with it must be eliminated. That can likely be achieved with a bigger budget, so that more graduated assistance can be provided to more people — those who are living in poverty may get, say, 99% of their rents covered, while those much above the poverty line but are still struggling can get, say, 10% of their rents covered.

With an expanded program aimed at everyone from those in dire need up to those in, say, the lower 85 percentile in terms of income, the program can conceivably be seen as just as social benefit, and not “aid for the poor”, and hopefully that will remove the stigma, allowing more people to benefit.

Along with the above, enforcement of the rules to prevent abuse should also be strengthened. Those receiving aid should be required to show actual need, while landlords should be on the hook for providing quality housing at a reasonable price, and not just taking advantage of desperate people who don’t have much of a choice.

Government built housing

Section 8 housing works by engaging with the private sector via subsidies. It is, however, not the only way, and to be honest, the fact that the private sector is involved necessarily means that the overall costs are higher to account for private profits.

As an alternative to section 8 housing, the government can also opt to just do-it-itself so as to save on costs. As we know from examples around the world, large scale public housing programs can work, though like section 8 housing, it needs to be properly funded and managed, while also at a scale large enough to overcome the stigma of receiving government aid.

Not that long ago, the US government used to build and sell subsidized housing to those in need. Technically, remnants of this program and its offshoots still exist around the country, though the scale is at a level that’s much too small to really address actual needs. A dramatic expansion of that program, with adequate funding, proper oversight and management may revitalize the program enough to help address the housing issues faced by those most financially vulnerable.

Altruism?

Ultimately, I think it is important to acknowledge a few basic facts:

• A lot of people, with their own means, simply cannot afford to own a home. Some may not even be able to afford to rent.
• Homelessness is a social problem which affects everyone, even those who are not homeless. As such, everyone benefits if homelessness is reduced or eliminated.
• To a lesser extent, giving everyone a stake in society, via home ownership, has benefits too. People who feel that they have a stake tend to behave better, leading to less social issues.
• To bootstrap these programs will likely involve large public programs and associated large public spending. Yes, that means those who are financially better off necessarily must take on some temporary discomfort. But if we can get it right, the future benefits should outweigh the current costs.