My latest quarterly ramblings to my Financial Professionals list are out: Financial Professionals Winter 2023

The recent higher inflation has dampened enthusiasm for this somewhat, but I hope with a short explanation to drive a stake through its heart.

(If you have no idea what this is, see this and this – or just go and enjoy your life!)

This is a very simple explanation that glosses over a little of the detail, but I don’t think misses anything essential.

Assuming the global economy grows there is a need for more dollars (global, not domestic, because a lot of dollars are held elsewhere). Right now, to increase the money supply, the Federal Reserve (the Fed) buys Treasurys. Those holdings of Treasurys are basically permanent (unless the global economy shrinks at some point or the dollar is no longer used as much). The Fed uses the interest from those to pay its expenses and then remits the rest of the interest to the U.S. Treasury. So if we think of this as a household, you find some money (the amount the Fed prints, which we will assume is exogenous) and redeem some debt (pay down your credit card) and then have the extra funds to spend (the interest is now less) on stuff. If you just spent the funds directly it isn’t different. (I.e. assuming the spending is the same, the level of credit card debt is eventually exactly the same. Just in one case you pretend to pay down your debt and then run it back up, where in the other you just spend it directly.) So, for MMT, if the level of money printing is held to the same level that the Fed would have created with open market purchases it leads to the same place.

It appears that the MMT proponents don’t realize that you are still constrained by the normal growth of the money supply or you will have higher inflation. They seem to believe it is a “free lunch” of some sort. The problem (IMHO) is that “borrowing” to buy stuff feels/seems worse than “printing” to buy stuff. Since I think the problem is the expenditure level is too high, I don’t like anything that makes it easier to tax/borrow/spend even if it’s just a change in mental framing. I would love it if there was no withholding allowed, no sales taxes at point-of-sale, etc. Everyone should have to write a check every April 15th for their total contribution to the commonweal. That would lead to a very different level of expenditure and much better debates on taxes and spending! Withholding was originally Friedman’s idea but he wished it didn’t last.

TANSTAAFL!

Imagine I have 1,000 shares of stock with a price of $20/share; a basis of $4/share; and a marginal tax rate (now and forever) of 25% (just for simplicity).

I can think of that as a combination of:

1. A stock position worth 1,000 * $20 = $20,000
2. A liability of ($20 – $4) * 1,000 * 25% = $4,000. This is the tax I owe at-the-money (ATM hereafter).
3. A short ATM call option on 25% of the position. So I have essentially sold a call option on 250 shares with a strike price of $20 and an expiration of whenever I think I will sell (or death, given a step-up). This is the additional taxes I owe if the stock goes up.
4. A long ATM put option on 25% of the position. So I have essentially bought a put option on 250 shares with a strike price of $20 and an expiration of whenever I think I will sell (or death, given a step-up). This is the taxes I save if the stock declines. (And if it goes below the basis, I assume I can use the loss against another gain elsewhere.)

That description above is sort of a collar on 250 shares of stock. A collar has treasury equivalent value. In other words, a collar with the positions all at the money, would be a short call plus a long put, plus the stock which equals a Treasury. Plugging in the previous values, I can create a treasury by using 25% of the stock (250 shares), plus the ATM short calls on 250 shares, plus the long ATM puts on 250 shares. Assuming everything is ATM initially, and we assume no time value on the options, that would be a “value” of 250 * $20 = $5,000 for the Treasury. No risk. (Leaving aside the other 750 shares of stock I own.) Plus I owe $4,000 in embedded taxes. So that nets to long 750 shares of stock plus $1,000. (Which is the tax rate times the basis of the whole position.)

So, when you buy a stock, it’s like owning one minus your tax bracket percent of it in a Roth (so 75% or 750 shares in this case) plus your tax bracket times the basis of dollars (no interest on this fixed income position; it’s like holding actual currency). So if I purchased, right now, 1,000 shares of the stock at $20 and I have a marginal tax bracket of 25%; it’s like having $5,000 plus 750 shares of tax-free stock. That is much lower risk (beta) than the 1,000 shares of the stock in a Roth.

This is one reason why you should hold riskier assets in taxable accounts rather than in retirement accounts.

(For more on these issues, see After-Tax Portfolio Allocations and Asset Location Strategy.)

My latest quarterly ramblings to my Financial Professionals list are out: Financial Professionals Fall 2022

When asked, we refer to ourselves as “wealth managers” and this month I thought I would explain that term and a few related things.

Wikipedia defines Wealth Management as:

[S]ervices to a wide array of clients ranging from affluent to high-net-worth (HNW) and ultra-high-net-worth (UHNW) individuals and families. It is a discipline which incorporates structuring and planning wealth to assist in growing, preserving, and protecting wealth, whilst passing it onto the family in a tax-efficient manner and in accordance with their wishes. Wealth management brings together tax planning, wealth protection, estate planning, succession planning, and family governance.

I want to explain it in a slightly different way. You may remember Maslow’s Hierarchy of Needs (probably from an Introduction to Psychology class in college). In Maslow’s Hierarchy, each need must be satisfied before the next one is relevant (though there is frequently some overlap). In other words, if you are in immediate physical danger you don’t really worry that much about whether you are loved and respected. I believe there is a similar paradigm that I call the “Financial Planning Hierarchy of Needs” which proceeds from a focus on the individual’s immediate personal finances to a focus on needs that are more distant both temporally (i.e. much later) and relationally (i.e. for more distant people):

1. Desire to be okay financially in the short run. This is the most pressing need. If an individual can’t pay their current bills, the next items aren’t really a concern. (This typically isn’t an issue for our clients, but it is for much of the population.)
2. Desire to be okay financially in the long run. Once the current bills are paid it is time to be concerned about the future. This is a focus on the individual still, but incorporates a longer time period – including retirement.
3. Desire to help your descendants. The next goal is usually to help the children (or grandchildren, and possibly even more distant descendants). Frequently this starts with education expenses, but also potentially includes other gifts or bequests.
4. Desire to help others. This usually takes the form of charitable giving or bequests.

Generally these are funded in order. Item one is generally funded (or is on track to be so) before two, two before three, etc. Financial planning focuses more on the top of the list compared to wealth management.

Over time most people start with a lot of human capital and little financial capital. In other words, in your 20’s you typically don’t have much money but you have a lot of future wages expected. In your 70’s (hopefully) the reverse is true as you have converted wages to financial capital over time by working and saving. Thus, there are two categories of obstacles to achieving the goals mentioned previously that are of varying importance depending on the specific situation:

1. Human capital impairment
   1. Disability
   2. Premature death
   3. Job loss
2. Financial capital impairment
   1. Expropriation (primarily through inflation and taxes)
   2. Divorce
   3. Personal liability (e.g. you cause a car accident)
   4. Unexpected health costs (including long-term care)
   5. Low returns
   6. Casualty (e.g. your house burns down)

Generally financial planning can address most of those risks and at least mitigate if not eliminate them by using appropriate insurance, portfolio construction, legal documents, legal entities, etc. As noted earlier, as compared with financial planning, wealth management addresses these issues in a more integrated and comprehensive manner, and typically for people with somewhat higher net worth.

To summarize, as the wealth of the individual or family increases, the focus typically includes more distant descendants (in time) and more distant people (in space). In other words:

• If you don’t have a particularly high net worth you may just be trying to pay for your children’s college. (financial planning)
• If you have a significant net worth you may be trying to make sure there are trust funds that will provide for your family for generations, or that your gifts to local charities are made as efficient as possible. (wealth management)
• If you have enormous net worth you may move to another whole level and try to end malaria in Africa! (large-scale philanthropy)