Reader Profile: MM

The following is the latest post on my new "Reader Profiles" series. Each post in this series details the financial situation and challenges of an FMF reader. The purpose of this series is to help us all identify with people like us (in similar situations -- not all will be, of course, but eventually I'm sure you will find someone like you here), get to know the frequent commenters on the site, and hear some financial wisdom/challenges from people other than me.

If you're interested in contributing to this series, then drop me an email.

Next in the series is FMF reader MM. He answered my questions (in red below) as follows:

Please tell us a bit about yourself.

I am 27 years old and reside in Boston.  I am an active duty military officer, at a fairly standard rank for this point in my career.  I am married with no children.  Currently I am deployed to a combat zone.  I went to Penn State University and had a full ROTC Scholarship, worked part time, had internships, and was able to study in the UK my junior year, with an intensive focus on the UK/Eurozone financial system and included a short internship in the City of London (financial district).  I double majored in Supply Chain Management and Economics with a few minors.  I also have a Master's degree in Finance with a Quantitative Emphasis from University of Colorado.  This is my second deployment in the past 2.5 years or so.
 
Describe your financial situation (who works in your family, how your income is (general), how your expenses are, etc.).

One of the "benefits" of being deployed is that your income is not subject to Federal or State Income Tax, though you do still pay Medicare and Medicaid.  There are various additional incentive pays that are associated with being in a dangerous area and away from your family. 

That said my gross salary is right around $100K, and I contribute 15% plus all special pays to my 401K equivalent, the TSP.  Contributions made while in a combat zone are completely tax exempt, and are allowed to exceed the traditional $16,500 limit on standard 401Ks, up to the annual cap of $47,500 that most other programs have when matches are considered (no match is given in the military).  However, when I return to the United States all contributions go back to "normal" 401K rules. According to the TSP website, tax-exempt contributions are "Contributions of money that will never be taxed. Such contributions can be made to the TSP by members of the uniformed services from pay that is covered by the combat zone tax exclusion." , which means I won't ever have to pay tax on this money, even when I withdraw it.  However, monies contributed at home are subject to standard tax-deferred plan laws. 

When I return from deployment, I will drop my contributions back down to 7% where they were before I left.  I will explain the rationale on this below. 

My net annualized salary while deployed is approximately $85K after all TSP contributions.  I currently put 97% of contributions to the S Class fund, which is a Dow Jones U.S. Completion Total Stock Market Index masquerading as a Midcap fund, and 3% to the F Class fund, which is indexed to the Barclays Capital U.S. Aggregate Bond Index.  I place that small amount into F class to smooth a little bit of volatility using some optimization and back testing as well as using the Modern Portfolio Theory thesis that you can actually maximize total adjusted returns while reducing risk with just a touch of bonds on top of any long equity exposure.  Due to some moves I made back in 2008, my current portfolio allocation is 87% S Fund, 10% F Fund, and 3% G Fund, which is US Treasuries.  This has served me well.

I max out both my and my wife's Roth IRA.  I have been contributing since I was 18, but she only started in 2010 (we are the same age), so I have some serious catching up to do with her.  My portfolio allocation is extremely aggressive, with 26% in Vanguard 500 Index, 20% in Dodge and Cox International, 15% in US Funds Natural Resources, 11% in Perritt Emerging Opportunities Fund,  10% in the Bruce Fund, 9% in TRowe Price Africa and Middle East, 8% in Matthews Asian Growth and Income Investor Class.  My dollar allocation to each is 91.67, 100, 75, 50, None to Bruce Fund, 50, and 50 per month respectively, which is autoplanned for $5,000 annually.  Right now I plow the $416.67 to wife's IRA in the Schwab S&P 500 Index fund, both for low overall cost, and low entry.  Once she is up to $10K, I will probably try to roll it into Vanguard 500 Admiral Class.

My wife works in the greater Boston area as a communications officer for an NGO that is focused on medical care in Haiti.  Her currently salary is right around $40K, and I deduct 10% for 403b purposes.  Right now those funds are sitting in cash as I am waiting for a retest of 2009 market lows before jumping in with her.  She is a journalist by trade, having worked for the Associated Press and having worked in several international capacities.  This career path was afforded to her by her attending Northwestern's Medill School of Journalism after graduating from Penn State.  While clearly one of the top schools in the world for her trade, it was not cheap, even with scholarships.  She currently has a boatload of student debt, like many recent college graduates.  Unfortunately, even though J-School is considered a professional school, in the same vein as MBA and Law School, salaries coming out of it pale in comparison.  I am legitimately talking about $18,000 offers for entry level jobs after paying tuition and costs of about $120K (Columbia is the other elite J-School).  If you ask me, this is a major reason "news" is so skewed these days.  The  only people who actually attend are the extremely wealthy to whom any graduate school cost wouldn't cause any hardship, or those who truly, truly do not care about money at all,  and are willing to be debt slaves for most of their adult lives.

She is an exceptionally talented writer and we have had some very interesting adventures, so she blogs about them at length and eventually wants to write a book about them.  In the meantime I am trying to gently suggest that we find a way to monetize the blog, or maybe she freelance some of her writing to a magazine (especially a travel one).

One caveat before I get into expenses, and some of my other asset considerations.  I take a contrarian viewpoint to most traditional financial "insight" and often employ these viewpoints.  So far it has not burned me.  We have a mortgage on a Condo in a very up and coming area of Boston.  It is in the city proper but it is not a traditional well heeled area like the Back Bay.  The neighborhood development, amenities and exposure to incoming capital are truly amazing considering a city as old and space limited as Boston.  We could honestly only afford the entry into this property via the VA Loan process.  That said, the monthly payments are very manageable, but would probably cause many people to scream considering the space we get.  It is just shy of 800 square feet and cost around $360K.  The monthly mortgage is approximately $2200 + a $345 HOA fee.  This includes all taxes.  Right now we are in a 5.0% 30 year fixed and I contribute an extra $50 per month to principal.  Sometimes if I have "mad" money I will throw it at principal, ranging from $500 - a few thousand at a time.  I am currently working on refinancing my house to a 3.875% 30 year fixed and expect to close in the next month and a half.  This will knock down monthly payments by about $300, and at that point I will start putting an extra $150 to the principal per month. 

With all of these considerations, we did over 8 months of market research before deciding to buy in this neighborhood.  We bought just before the flurry of new capital flowed to the area, and expect that in 10-15 years time the house could be worth double its current value (which would put it on the same level as Charlestown and Fenway neighborhood prices).  I know that we are in a nationwide housing crisis, and am completely locked into the Case-Shiller index and all sorts of real estate indicators, but case in point, property values in our neighborhood were up on average 20% last year.  There are pockets of growth throughout the nation.  Boston also led the recession and to a certain degree has "led" out of the recession, though if you ask me recession is unfortunately here to stick around a while for many parts of the United States.  Additionally, though we know we will be moving, I have no reservations about having purchased this place and only living in it for a temporary time.  Rent demand in Boston, especially in our neighborhood is insatiable.  I have property managers posting fliers and a few that I know calling me to ask if I am planning on renting out my place any time soon.  I feel that after the refi I can be CLOSE to, if not completely mortgage covered by potential rent; at this point am unsure about the HOA being covered.  That said, I know conventional wisdom is, "Never have negative cash flow real estate."  I look at this kind of like a growth stock that pays no dividend.  I'm willing to trade off a bit of cash flow for long term capital appreciation.  I will also address how I cover that negative cash flow without dipping into my current salaried income below.

We have two cars, because we both reverse commute out of Boston in the morning and return at night.  Surprisingly, parking is not too horrible in our neighborhood so we do not have to pay for dedicated parking spots so far.  One thing that irks me is that when we bought our property, it did not come with a deeded parking spot.  This is rather unfortunate because the going street rate (if you can even find a parking spot for sale) is about $25,000 cash for one.  In other neighborhoods it can be as high as $250,000!  My car is paid off and we bought hers on the cheap.  There is about $6500 left on it and it is at a 2% rate.  Originally when we moved to the area my wife took the T downtown to get around, but after getting this new job we had no choice.

There are other "debt" expenses, which I will articulate in the next category.

As for assets, that's where things take a serious turn for the better.  Due to my intense financial market interest since middle school, I have studied and traded the market (stocks and options) almost continuously since college.  I have a very unique strategy which I will now outline. 

As I am in my 20s, I take a few shots at what I call "outright speculation" which is maybe in some way accurate, but I'd like to think at least the speculation is educated.  At my age I have to try for a few grand slams.  As far as portfolio theory, I have a heavily structured liquid portfolio, which is about 45% biased toward very high current income (the reasoning behind this is I want to be able to afford a mortgage in my desired living location in the absence of a job, as well as to cover down on the potential minor negative cash flow issue indicated above), using things like Agency REITs, Preferreds, high yield closed end funds, and to some degree Canroys and MLPs.  I continue to explore Preferreds and Business Development companies.  As of now my weighted average yield on cost pays me 11.6% annualized on a monthly basis.  It alone could afford a mortgage in probably 80% of the country, and after refinancing my place will cover close to 75% of the monthly mortgage cost in Boston.  Another 40% of my portfolio I dedicate to mid cap and blue chip equities that pay high yield dividends, have a history of dividend increases (for examples look at David Fish's list of Champions and Contenders) and ALSO have high liquidity options.  I sell covered calls against them if I have a sizable enough position and roll them at least quarterly, usually looking 3-4 months out w/ a 20% upside strike.  I also trade strangles, straddles and spreads around my basis to manage risk and if I think the equity is significantly beaten down I will sell naked puts if I would be willing to buy at that lower price. Additionally I work on macro theses that I see 3-5 years out and try to use bottom up fundamental analysis per security sector, and then wait for the techincals to line up- I use RSI, MACD, and slow and fast stochastics to determine entry points... Still need to learn better risk management on the downside but have enough conviction to generally believe my thesis will see it through, and have generally been proven right.  5-10% of my portfolio is the "outright speculation" and I have had several microcap oil plays like GTE, BPZ (when they were in their infancy), EGAS, junior miners, and a few true "hope" companies like INTK and PWVI.  I have approximately a 5% allocation of my portfolio in physical silver, but it vacillates with the prices of my income oriented investments.  So it's really 45% Income, 40% Optionable mid/large caps, 5-10% speculation, 5% Physical Metal.

If I sold out the entire portfolio and physicals right now except for the income instruments, and put all toward principal of my property, with current income portion of portfolio and salary I could probably have the place paid off in 5 years or less.

I use margin but try to be prudent about it, and the monthly income more than offsets the cost of it, by a factor of 4.  The income allocation may not be very tax efficient but my AGI situation is unique at the moment and I find myself in a fairly low tax bracket.  I don't mind paying taxes on income as long as the mortgage interest tax benefit still exists. 

As indicated above I also max out my Roth and contribute as much as I can on a monthly basis to my TSP. 

My next foray is in investment real estate.  I am in the process of purchasing my first investment property with a partner; we've formed an LLC and are just about ready to make an offer.  He happens to be a CFA and is very conservative about his investments and we have strict metrics about cashflow considerations. For example, the current property we are evaluating, at current sticker price and after all tax, repair, vacancy discounts, and property management cost considerations, has a Debt Service Coverage Ratio of 2.5.  I hope over time that the positive cashflow generated from our properties will more than offset the negative cashflow from my current primary residence.  Goal would be to eventually own 5-10 properties.

What are the current financial issues you're facing (saving, paying off debt, etc.)?

As I eluded to above, student loan debt is pretty much the PRIMARY issue.  Her loans cost close to $1K per month and I still have a few sitting around at about $200 per month.  We also had a wedding that was somewhat more expensive than I'd planned and have a small balance remaining at 0% on a credit card.  We also have a few items on a 36 month 0% Best Buy card that were for "moving into first house" costs.  This is manageable but I'd prefer to just knock it out.  As I indicated above, I use margin, but in the past I also did a few Credit Card App-O-Ramas.  I have some outstanding balances at 0% for life or for several remaining months and have thrown those funds into very conservative investments.  Regardless all these little costs impact our cashflow as I pay well above minimum required payments so that I can have these balances paid off by the time the promotion periods end.  The primary difference is that I am happy to live austerely in the pursuit of long term benefit.  We both enjoy traveling, but my wife, god bless her, knows she is not great with money.  She very much enjoys high fashion and also planning out trips that are pricey.  She is excellent at finding deals, but I always jokingly accuse her of "dealing us into bankruptcy."   From time to time I make some comments that she takes personally, but I would really just like to see if there is anything we can do to take out her student debt.  We already have it on autodebit to reduce the overall interest rate by 0.5%. 

I do contribute a LOT of money to our liquid monthly portfolio and also into some DRIP plans with companies that offer discounts on reinvested shares.  I realize that I could take some of these funds to pay down her loans but I'm convinced I can outperform her interest rate.  I'm just in a conundrum about how to increase our monthly cashflow.  As I tell her, its never a situation where we don't have wealth, its often a case of liquidity, especially around mortgage time.  I keep very little in savings (about $1000 in primary account and approximately $500 in two other external savings accounts in case of extreme emergency).  I manage the checking account with the veracity of a CFO.  If I absolutely had to spend large money on something, I have plenty of credit cards with high limits, could borrow from my margin, and if necessary could sell stock.

We do have a few monthly recurring bills, Comcast and Verizon each at about $100 per month for Cable, Internet, and Phones.  We also have netflix at the 7.99 streaming plan rate.  Beyond that, car and property insurance, electricity, and some margin service are the only other expenses.

If I had it my way we would find a way to live on $800 per month in terms of discretionary expenditure plus gas for cars plus groceries.  My wife thinks I am crazy and that this is a completely unrealistic scenario in Boston.  I am not sure what a happy medium is but I do know that if we didn't have her student loans to deal with we would have double the discretionary funds.  Of course, to her credit if I reigned in some of the investing dollars we would have more to spend as well.

I break down my spending allocation like so (based off of Gross Income):

• Debt: 35.04%
• Bills:  8.20%
• Investing: 48% (This includes reinvestment of all dividends received, a substantial sum)
• Remainder: 8.76%

Based off of Net Income (subtract wife's taxes, TSP/403b, Dental & Health Insurance, Social Security, Medicare/Medicaid, and Servicemen's Group Life Insurance) and ACTUAL Expenditure (mostly plussing up above minimum debt service:

• Debt: 41.99%
• Bills: 6.8%
• Invest: 44.61%
• Remainder (Spending Money): 6.61%

Net Income allocation if only paid minimum on debt:

• Debt: 34.78%
• Bills: 6.8%
• Invest: 44.61%
• Remainder:13.82%

For both Net Income Scenarios, the reinvest portion is approximately 11.03% of Net, so could plus up "Remainder" with that, but as explained trying to eventually offset mortgage so reinvest every month to buy more shares and create higher dividend for future.

What are your plans for the future. (retire early, build your career, etc.)?

I'd like to be at $1M Net Worth by age 30.  I would like to run my own hedge fund or at least day trade a professionally sized portfolio.  Goal would be to generate enough income with portfolio so that I could pay for a permanent residence wherever i wanted (London, NY, wherever), and use that location as a platform for global travel with my wife.  Would really like to record music and write but don't have any desire to be a starving artist.  Probably 20% of the way there so far, and markets will make a huge difference as I do not currently the have time to run a short biased portfolio.
 
What's your best piece(s) of financial advice and/or your general philosophy on personal finances?

Be diligent in your efforts, realize that one month's austerity can give you a few months' worth of prosperity.  Go travel, read as much as you can.  Do not listen to anything talking heads on television say, I believe most media is manufactured narrative.  Be contrary by nature.  Don't stand on a silent platform, verbalize your intentions, write down your goals [short, intermediate, and long term], and be flexible (something that I could use more work on in real life).  Figure out how to create multiple streams of cashflow, especially passive forms of it.

Comments

[jeffbone]

First of all, thank you for your service.

You are in a much better position than I was as a junior officer at the same point in my career. We were still living in base housing (although it was Hawaii :-) ), with the higher expenses that come from living in Paradise, two kids, and only one income. Therefore, I don't have any recommendations for you other than if you've not heard about the DoD Savings Deposit Program (SDP), head over to your deployed site finance office (sounds like you might work there, actually) and ask for details. DFAS also has info on their site. It's only available to people serving in combat zones and is well worth the effort, especially since you're already maxing out your TSP.

BTW, be careful when/if you rollover your TSP -- some institutions don't know how to handle the non-taxable contributions you've made. I got slightly burned on that, but my non-taxable contributions were such a small percentage that in the long run it's not going to make much difference in overall returns. It might be better to leave those funds in the TSP if you're satisfied with the returns there.

[tom]

Great profile, MM.

Thanks for your service!

Some of your investment funds carry heavy expense ratios. For example the Perritt and US Funds both charge 1.74ish%, many of the others are over 1%.

So, blah blah blah, eating your profits, etc, etc. Do the benefits of these funds and the niche markets they cover outweigh the high costs?

[Nate]

Thank you so much for your service man!!!

Your situation scares the crap out of me :-) It is clear that your comfort level with debt is off the charts in comparison to mine. I get what you are saying about paying the price in the short/mid –term for long-term prosperity but the way you are going about this is extremely risky! Also you mention about 30 times in your post how this payment or that payment is reasonable and under control; your lack of cash flow is very (very) concerning. Also if you or your wife were to lose your jobs (obviously unlikely for you), you would most certainly be facing financial troubles as all the (currently) “manageable” payments come tumbling down on you.

Also I hate that I keep saying “you” because your wife is a big part of this equation. However you mentioned she is not good with money… Do you all do a budget together? Does she know what business decisions/ventures you are making at any given time with the household money? It feels like she is just off in another part of the world (literally in this case) spending money on stuff without a clue about what’s going on with the money. I would have at least 1 million I life insurance on yourself (probably closer to 2 million with the partnerships etc. you are getting ready to get into)… I would back out of the partnership right not if I were you. Have you all discussed what happens in the event of death, divorce, disinterest (all the Ds)??? What happens if you do a couple deals and he loses his job or gets a divorce (and his ex takes half his income/net worth) or even decides he just wants out of the game? This whole plan feels enormously risky…

These are obviously my opinions but hey I have a positive cash flow of over 6K (occasionally 8-10K) a month and very little debt… So take this for what it’s worth :-)

That all being said, I wish you the best brother!!! My hope is that it all works out and a couple decades from now you and your wife are living out your dream (maybe on a beach somewhere?!). Cheers!!

[Mom Equity]

By debt service coverage ratio for the property you're planning on buying, do you mean that, for example, your mortgage, management, taxes, repairs = $1000 per month and the total rent is $2500? I'm not really used to that term, but in your area that would be an insane return.

It sounds like you are extremely thoughtful about money and are aggressive. I'm right there with you - my goal is 1MM by 40 (I'm 29 now).

Good luck and thanks for your service!

[Rick Franics]

MM,

I think it is great that you have some big goals- and from your profile I can tell you are very intelligent. However, I suspect you might be too brave for your own good. You have a lot of exposure to risk- both physical and financial.

>Still need to learn better risk management on the downside 

I agree with that 100%! I'll second Nate's recommendation for a lot of term life insurance, you should get very good rates through USAA.

>Be contrary by nature.
I am going to suggest you read a book that is contrary to your nature- A Random Walk Down Wall Street
this book show the research of how hard active trading really is... very very few people pull it off successfully over the long term.

> As of now my weighted average yield on cost pays me 11.6% annualized on a monthly basis.

Wow, that is a great rate of return given how the market as a whole is doing.... but is it really sustainable? Have you had exceptionally bad results which canceled out those good results?
Have you compared your long term results to the indexes? You should do that to have a fair measure of your ability, even then- 9 years isn't that long of a history. Would you want a fund manager with less than a decade of history?

Another contrary point to consider- because you started investing at 18 and are contributing such a large amount you DON'T “NEED TO TAKE AS MUCH RISK. If you invest more conservatively for a longer period of time you may be MORE likely to reach your goals...You have many more productive years before you need your investments to take care of you, reaching $1M by 30 is a want not a need- so be careful that stretching for that goal won't risk your long term financial well being.

-Rick

[MM]

Nate,

No problem at all. I have a long family lineage of military service and wanted to follow suit. But the deployment tempo has gotten to be enough that I want to pursue other interests, for the benefit of my family.

Could you please be more specific about the debt situation? What do you find risky? I agree that the student loans are a concern. In fact they are my primary concern. Beyond that, are you referring to the mortgage debt? One thing worth mentioning is that Boston proper real estate has very inelastic demand with regard to rental pricing, especially in certain neighborhoods. As I eluded to, the instant I move out of my place I am certain I will have renters in short order as I still regularly have property managers who I've worked with in the past asking me about plans I might have for renting my place out. It's such an "unaffordable" place to buy that most people rent, similar to Manhattan and San Francisco. There's a particularly new business district in Boston that is booming right now, I kind of eluded to to it at the beginning of my housing description. The fact that the mayor is backing it kind of lends itself to continued buildout, and Boston's economy is doing significantly better than the US as a whole right now. I'm withing walking distance of public transportation and this area and have few concerns about a sudden depression in property values considering the performance of the area within the "controlled depression" I believe we are having in the United States. In my neighborhood property values were up 20% last YEAR. I realize this is not sustainable, but it's indicative of the strength in this area. Additionally, I got approved for the refinancing and was able to lock in 3.75% 30 Year fixed for negative 0.25 points. That will reduce the monthly mortgage by almost $330 per month.

I'm looking at the 4 investing vehicles that make up the highest percentage of the income portion of the liquid portfolio that is partially offset by my margin account, and for 10 year performance, before dividends, I see absolute asset value gains of 3.7%, 39.32%, 17.42%, and 14.6%. With dividends, I am looking at ANNUALIZED returns of 12.38%, 13.83%, 10.6%, and 9.4%. In 2008 and 2009, two of them dropped around 15% and took about 3 months to get back to net zero from that point. The other two dropped more substantially about 28-35%, and recovered in less than a year. The entire time dividends kept getting paid at the same rate, and I also increased my exposure where I saw humongous price aberrations, specifically October 2008 and March 2009. So I am actually sitting on large capital gains as a result. They have very low correlation to the overall market, in fact two of them have slightly negative correlation. I'm quite comfortable paying less than 5% margin on what constitutes about 35% percent of this particular slice of my portfolio. The entire rest of the portfolio is invested with cash. The monthly income increases at a rate of almost $10 per month as a result of reinvesting dividends, and with compounding increases each month. Like I said above, it is extremely heavily geared. The options I trade in the blue chip aspect of the portfolio which is not debt backed actually help limit my risk. If I see the market going very south, I will buy puts or sell call spreads (as I currently have on now), and can decide how much "market" risk I want to limit. SPY puts are a reasonable proxy for this. In order to get wealthy, some risks must be taken, unless you are just VERY lucky or VERY well connected. Mitigating the risks that are taken then must be a primary consideration.

As for cashflow, if I took the income that I get from the portfolio, stopped contributing to 401K, stopped contributing to IRAs, stopped contributing to our liquid portfolios, didn't service the margin, and paid the minimum due on the debts that we have, I see about $6,400 per month in free cashflow. Fact is, we overpay on all debts, including mortgage and student loans, and contribute in large part to all. The easiest low hanging fruit to free up cash is to stop contributing to the liquid portfolios, which if we have emergency expenses (such as my wife's car starter last month), I just contribute less to them.

For better or worse, my wife prefers that I manage the money in almost absolute fashion. Because I am so much a finance person, she prefers that we talk about life goals, and I figure out the money solution for getting there. I really wish that she took a closer interest to it, and talk to her about this quite a bit. I hate reading the horror stories about widows who get manipulated because they left their husbands to manage that aspect of their lives, but I think she happens to be fairly traditionalist in this sense. But she's not off spending on whatever she wants without communicating it to me. I guess that's the reason why it's "I" and not "we" with regard to managing the finances. She knows our cashflow situation, and we do talk about long term goals. She knows about the LLC, knows my partner very well, and is clued in on MOST of the investing, especially the IRAs and 401ks. I'd always prefer to put more in the liquid account, and she'd always prefer to buy more clothes (using this generically for spend on discretionary items), so we often compromise on these.

With regard to the partnership, it is an LLC that we drew up with a real estate attorney, has a Tax ID Number, and addresses all the questions you asked. He happens to be one of my best friends from childhood, we were each others' groomsmen, and he is more conservative than me. We just made our first offer, it got accepted, and we hope to close within a month's time. All of the tenants in the property are locked into 1 year leases which we have copies of, and is cash flow positive from Day 1. The property (and future properties) is not in Massachusetts, so the metrics for rental income to debt servicing are fundamentally different than my primary residence in Boston. With rent alone, the mortgage will be paid off in 6 or 7 years' time. However, we both plan on earning more money in the future and will consider either paying it down faster or working toward a down payment on another property, depending on the market.

I appreciate the questions though, because they help me clarify our financial issues. The takeaway so far seems to be, if so concerned about cashflow, why not just try to knock out some of the debt and contribute less to liquid portfolios.

[MM]

Tom,

Agree on the expense ratios. PREOX seems to fulfill its niche role with microcap exposure and I am very happy with its performance, PSPFX not so much and seems to be a has been. I'm actually thinking about rotating out of PSPFX bc the volatility is too high to justify the expense ratio. TRAMX is a pure hope one, as I believe the Middle East/Africa are the last true emerging markets, but it has consistently done terrible on an absolute returns basis. Lots of tumult coupled with global recession. I'll give it a few more years to run since it is such a small level of exposure but if it continues down this path, I will probably rotate into a more diversified emerging markets fund.

[MM]

Rick -

Appreciate your compliments as well as your constructive criticism. I use index options to hedge my downside exposure. I use moving stops on gains and decide when I enter a position the maximum tolerable loss that I find acceptable. This varies with the implied risk in the equity being considered (IE a junior miner like Silvercorp vs a megacap oil company like Conocophillips).

I have Servicemembers' Group Life Insurance for the maximum $400,000, but I haven't really thought about life insurance beyond that. This is not the first time that somebody has mentioned it to me, I guess that at age 27 I just didn't really think it was worth it. I will take a look into it, and appreciate the input.

I have read Malkiel and others of his ilk at length in both undergraduate and my Quantitative Finance graduate program. His theories are the reason I am contrary. I fundamentally disagree with him. I agree that MOST people cannot beat the market on average, if only for the law of large numbers and the fact that most people do not have the desire or discipline to put together systems to make this possible. I agree that the mutual fund industry proves this (I think that mutual funds are structured to lose in that, for the most part, they can only be on the buy side of the equation, unfortunately I burn money by putting our ROTH IRAs into them bc I do not want to eat transaction costs for an active trading account housed inside a retirement vehicle). Mutual funds to me are in many cases salesmen dressed up to sell sophistication and security when they are everything but, except for index funds. There are plenty of price aberrations that happen on an almost daily basis, and options allow one to inexpensively manage risk. The books I would suggest more people read regarding people who defy "normal" and "average" are Lessons from the Trader Wizard by Bill Cara, Techniques of Tape Reading by Vadym Graifer, Trading in the Zone by Mark Douglas, Come into my Trading Room by Alexander Elder, and Market Wizards by Jack Schwager.

The 11.6% return is just implied dividend yield on the cost basis of the income tranche of the portfolio. It is sustainable as long as the various securities do not stop paying or cut dividends. Some of them have been around since the 1980s, others the 1990s. They didn't cut in the Savings and Loan bust of the late 80s/early 90s, the Dot Com Bust of the late 90s/early 2000s, and have not cut through 2008 to current. I'm comfortable that they will maintain their dividends. Some of them are preferred convertible securities, some MREITs, some Closed End Funds. They aren't typical stocks, that's saved for a different aspect of the portfolio. Some may be called in which would force me to seek other vehicles and that could stop the potential long-term returns. If that happened, I would seriously consider taking the capital gains from the called in securities, pay off the margin, pay off the mortgage and call it a day.

"Another contrary point to consider- because you started investing at 18 and are contributing such a large amount you DON'T “NEED TO TAKE AS MUCH RISK. If you invest more conservatively for a longer period of time you may be MORE likely to reach your goals...You have many more productive years before you need your investments to take care of you, reaching $1M by 30 is a want not a need- so be careful that stretching for that goal won't risk your long term financial well being."

Awesome advice, I should probably learn to relax a little. I have a tendency to get too intense, and I hear what you are saying about overstretching.

[J1mbo01]

Boston real estate has not increased 20% year over year......as a real estate agent in Boston I can attest to that. What neighborhood is your condo in?? I am assuming it is in the Seaport or Leather district. If it is in the Seaport, I agree that it would be worth holding onto for an extended period of time; there could be some growth in that area. The problem with Realtors saying prices have increased 20% year over year is that they are basing their numbers on Median home prices.....in an area with a small number of sales a large or small sale can skew the median. I can give examples of homes that have sold for a loss in ANY Boston neighborhood, even if the home was purchased in 2009, 10 or 11.

[MM]

J1mbo01,

Agree that city-wide RE prices have not increased to that degree. In our neighborhood, there are still/currently luxury condos being constructed. You're in the vicinity with your guess, just don't want to further divulge information, feel I've been pretty transparent here. Fair point to make about realtors, I'm sure the study that I saw that referenced that data was constructed by Realtors' Association of Massachussets or whatever the entity is called. As with anything there are lies, damn lies, and statistics, in the finance realm that's called "sell-side" research. I will say that I've seen multiple top 10 lists of town/neighborhood real estate value increases with similar data; I get updates on $ / Sq Foot costs and they are roughly tracking (I'd guess within 2 standard deviations) the data that's quoted. Agreed there are losses in every neighborhood. Fairly uniform distribution of prices where we are, not insanely low or insanely high prices to skew data, relatively lepotkurtic.

[J1mbo01]

MM....Agreed. My only suggestion is that now is a great time to sell if you are planning on relocating to another part of the country. Interest rates are low and prices are lower compared to the boom years. I can see Boston taking a bath in the next few years in prices, both real and nominal, so unless you are planning to hold on to your condo for longer than 10 years, now would be a good time to get out from it with some equity. However, if your condo is in the Seaport district, I would definitely hold onto it. I cannot see how that area won't experience tremendous growth within the next decade. It is the absolutely last spot in "downtown" Boston that has not been fully developed. If they actually put a real subway stop in the Seaport it would help even more.

[Luis]

I see one mistake with you financial planning, that with attention could help you recover a potential loss with your refinance plan.

You said you would refinance at a new 30 year fixed rate. I would highly recommend against choosing a 30 year fixed versus finding a loan with a shorter time period. Rates are low, but you could save yourself FREE MONEY by finding even lower rates with a 20 or 15 year fixed. You have extra money each month to do it and you do not need that much extra cash flow in your present situation.

Only refi if you plan on keeping your property beyond the breakeven point, so check the closing costs and compare them against the amortization schedule and determine how long you will need to stay then make your decision.

[Rick Francis]

MM,

>Appreciate your compliments as well as your constructive criticism.
Thank you, I’ve never understood why people that don’t agree can’t be civil. How do you ever learn if you’re not open to the ideas of others that differ with yours?
That said I will have to read some of the books you suggested, if you had to pick one to start which would it be?

> I have Servicemembers' Group Life Insurance for the maximum
> $400,000, but I haven't really thought about life insurance
> beyond that. This is not the first time that somebody has
> mentioned it to me, I guess that at age 27 I just didn't
> really think it was worth it.

$400,000K is a good start, your wife won’t be left destitute but I suspect it does not come close to replacing your income potential.

You are an officer deployed in a combat zone- there is a very real chance that someone you don’t know will try to kill you. If you look at the statistics of # deaths/Deployed servicemen what are your chances of dying? I bet they are a lot more in line with a 50 year old civilian dying - not too likely but possible. If you look at it that way life insurance makes more sense.

When you are young it is easy to feel immortal but none of us are. Even if your deployment is uneventful you never know what the future will hold. A good friend of mine died from cancer in his early thirties. He was a weight lifter and was in great health before hand and younger than I was too, so I would never have guessed I would outlive him.

> I have read Malkiel and others of his ilk at length in both
> undergraduate and my Quantitative Finance graduate program.
> His theories are the reason I am contrary. I fundamentally
> disagree with him. I agree that MOST people cannot beat the
> market on average, if only for the law of large numbers and
> the fact that most people do not have the desire or discipline
> to put together systems to make this possible

If you do intend to manage a fund you aren’t going up against most people…. Even if you believe the mutual fund industry profits primarily through great sales and marketing. Being one of the top rated funds, is a huge marking and sales benefit.

The funds are going to be trying hard to maximize their returns to get that status. No fund manager is going to be undisciplined, and they wouldn’t hire slouches for their analysis department. If you are using strategies that are already published then established fund managers will know about them and have better resources to implement them.

Do you have a real competitive advantage? Is it one that will scale up? Can you handle a large enough portfolio size to provide a worthwhile income for you? Would you potentially do better as a financial advisor?

If you only plan to manage your own assets, - is it a good use of your time? I wrote a blog post on why you need half a million before picking individual stocks really makes sense, even if you are the next Warren Buffett. It’s a back of the envelope calculation but it’s the right order of magnitude.

Active management may make sense for you now since it sounds like you enjoy managing your own finances daily… what happens when you have kids? They take a huge amount of time and energy. How long would it be safe to leave your current investments unattended? If you were to pass away would your wife know what to do? Could she react fast enough to prevent significant losses?

Anyway, I've probably put up enough comments- but if you would like an contrary optionion from time to time- send me some email
ricksfrancisyahoocom.

-Rick Francis

[Easychange]

One question. Where do you bank? I think there are credit unions that cater to armed forces etc with better loan rates etc. Pen fed is one example. Ty for your service.

[Mark]

@MM....Your post was very well written, but I think you meant "alluded" with an "a", not "eluded". It really stood out in an otherwise well written post.

I also have to say I agree with Nate. It sounds like you're in a kind of risky position with the debt, aggressive investments, & dealmaking and it sounds like your wife is clueless, so those are weak areas you'll need to look at. You've obviously very smart, but perhaps overconfident, and that can kill you financially.

[MM]

Mark,

Good call on the spelling. Somehow I continuously kept making the same mistake!

WRT the riskiness with the debt, is it because the Debt to Income ratio is too high? If so, I agree with you. If the student loans disappeared, the net income allocation would fall to 24%. Unfortunately we won't be able to get into that situation for some time. Do you have any specific suggestions? Ratcheting back the risk on the portfolio? Not having a margin account at all? I tried to address some of those points in my response to Nate. Bringing the mortgage down will reduce it a little more than 3%. And I will be getting a small salary increase next year, perhaps good enough to offset a further percent or two. Although the partnership property is going to be a self-sustaining entity, if my partner and I chose to distribute excess cash to each of us individually instead of paying down principal, it would further offset debt service by about a percent. This is also the reason I try to pay extra to the debts that we do have, so as to pay them off faster; I realize it impinges on cashflow.

My wife is not clueless, but is sort of disinterested, other than in the result. She doesn't mind executing whatever strategy I implement. I do wish it were more collaborative. But when I bring up ideas or suggestions she seems to defer and says "I trust you." I really don't know what else I can do, I've suggested books, tv shows, podcasts, and even sat down and shown her the process, but it does seem to fall on impatient and neutral ears.

[Nate]

Hey again MM!!

I understand having a wife that is somewhat disinterested with the finances; it took me over 2 years to get my wife more involved in the day-to-day. Keep reaching out to her though!!!

Most off the concerns I have – you have already executed on (excessive mortgage/HOA, partnership etc.). It already seems as though you are becoming a little more averse to debt in your post (mentioning wanting to dump the student loans etc.). I think that is a good thing; I would not take on any more debt if I were you. Because here is the deal dude, you are wicked smart and very disciplined. If you continue to apply that to your career and double your income – you could start buying properties with cash in a couple years. The first property with cash is always the hardest. Then it gets easier. Once you have a couple – the cash the properties through off will continue to let you purchase properties all by itself.

Close down shop on the margin account and don’t ever touch it again (it’s gambling). You don’t need it and it introduces excessive risk (I don’t need to give you examples or tell you what happens if an equity position loses half its value – you know already). Basically you have played with fire and haven’t gotten burned – YET! Several of us are just trying to pull you back away from the flame ;-)

I actually do believe you will be just fine and you are taking a lot of steps to mitigate risk – it is just my personal opinion that you are taking on more risk (debt, partnerships, margin account etc.) than is necessary for the reward you are seeking. I mean if you applied all that gusto to a side business (of your own – not with a partner) you might be swimming in cash :-)

I do appreciate you being open to hearing others opinions today; you have responded with pure class. Thank you once again for your service!!! PS: FMF has my email if you ever want a second opinion. Cheers MM!!!

[08graduate]

@MM

You've opted for vastly more complexity than I would ever care to manage. Having read it a few times, though, I think I understand it well enough to agree that your risk is reasonable. Your investments are hedged, your salary is plenty large enough to cover the debt service and living expenses, and you're not at risk of layoffs. If this system is performing well so far, and you enjoy tending to it, why not?

Feeding off other comments, I do have one small suggestion. Have you written a document that walks your wife through shutting down this financial engine and investing the money in something simple? In the event of your death, it would mean one less source of anxiety for her. I also agree with everyone calling for extra life insurance. Given the disparity in salaries and financial attitudes, it sounds best that she have enough cash on hand to discharge all the debt immediately, and get some secure income in place.

Thanks for your service, and best of luck with everything.

[08graduate]

@MM

You've opted for vastly more complexity than I would ever care to manage. Having read it a few times, though, I think I understand it well enough to agree that your risk is reasonable. Your investments are hedged, your salary is plenty large enough to cover the debt service and living expenses, and you're not at risk of layoffs. If this system is performing well so far, and you enjoy tending to it, why not?

Feeding off other comments, I do have one small suggestion. Have you written a document that walks your wife through shutting down this financial engine and investing the money in something simple? In the event of your death, it would mean one less source of anxiety for her. I also agree with everyone calling for extra life insurance. Given the disparity in salaries and financial attitudes, it sounds best that she have enough cash on hand to discharge all the debt immediately, and get some secure income in place.

Thanks for your service, and best of luck with everything.

[Old Limey]

I have done extremely well throughout my life, both with my investments and in my 32 year career helping to design and analyze the rocket motors and re-entry vehicles of the US Navy's Fleet Ballistic Missile system that included the Polaris, Poseidon and Trident I and II missiles. My philosophy and methodology has always been to follow the KISS principal which is "Keep It Simple Stupid".

I manage the investments of our three grown children in addition to our own. A good example this year has been my son's 401K plan in which he only has 26 mutual funds available to him.
I have had him in a fund called FBIDX (Fidelity's Bond Index). Here's how it has performed by comparison with three broad market indexes.

............. YTD RETURN ..... UI .......... MDD
FBIDX............ +8.56% ..... 0.53 ........ -1.43%
NASDAQ....... -11.74% ..... 6.91 ...... -18.50%
S&P 500 ...... -13.14% ...... 7.11 ...... -17.90%
Total Mkt........ -14.92% ..... 7.57 ...... -19.09%

UI is the Ulcer Index which is a measure of downside volatility, the lower the number, the better.
MDD is the Maximum Drawdown, the worst loss during the period being measured.

It baffles me that the majority of investors are able to suffer volatility and drawdowns of this magnitude and still be able to sleep well at night. I know I couldn't possibly do it whether it was my money involved or that of our children. It doesn't take a rocket scientist to figure it out, my software computes the above values, as well as many others, after the market close each day and in this case ranks all of the funds in the family that my son has available to him.

[Old Limey]

One thing I forgot to mention is that when performing any kind of analysis involving bond funds it is absolutely essential to use data that has been adjusted for all of the monthly reinvestments of dividends. The proprietary database to which I subscribe does this for every fund in its database. In the case of stock funds, dividends are usually small or nonexistent, but the annual capital gain distributions are often quite large and ignoring them leads to badly skewed results. The majority of the charts freely available on the Internet have not been adjusted for the reinvestment of dividends or distributions and are of little value for quantitative comparisons.

[Mark]

@MM. Besides the debt, I think part of the problem I have with your investments, etc is you didn't lay it out in table form, so it's hard to evaluate. The other thing is it's very complicated, and that's kind of like juggling 8 plates in the air at one time. You only need one to come crashing down before all of them do. It sounds like you're a lot smarter than me, so maybe you can handle this. But the problem I see with smart people is they tend to get overconfident (as previously mentioned).

[bobbi]

Ok, I'll admit that your strategy was well beyond my comprehension. That being said, I stuck with the entire post and enjoyed it. What I got after I finished was that I agree with others that you are a bit over confident and you have a very complex strategy. IMO - I think you need to reel in the risk and focus on paying off your debt. I was pretty surprised to read about you cc debt at the end. My impression was a house of cards. A couple of things go south and it pulls everything out of whack and messes up the plan. Simple can often be better. I'm a software engineer and complex is rarely better. While it can be a thing of beauty to the person that created such a complex system - the simpler system will do the same thing, be easier to maintain and it isn't greek to those who also need to understand it. So, complex for the sake of complex isn't as great as people think it is.

IMO - reduce your risk and pay down your debt and have a liquid emergency fund. Another thing to consider... heaven forbid... is that if something were to happen to you what would your wife do? You said she isn't that good with money but she would be forced to deal with such a complex system. I would get your wife involved and educated on your system. She needs a basic understanding of what is going on financially and how to deal with it if she had to in the future. Make her part of the team instead of keeping it so far above her level that she can't even attempt to understand what is going on.

Thank you for your service.

[KMI]

Sounds like you definitely have a number of plans in place to increase your income streams! The two cautions I'd have follow along with comments some other people made. Make sure you have enough insurance (life AND Disability!) that your wife would not have to worry about how to pay off any of the debt should anything happen to you. As a second point, since she is not interested in the more complex financial plans you have, make sure you provide a full list of what you have and instructions for her on how to simplify your financial life if she needs to.

A worst-case scenario would be for you to be injured and for her to have to try to handle the finances while she figures out medical care and costs on a dramatically reduced income while also worrying about you. This is what you need to plan for. Walk your wife through these plans and make sure she is comfortable with them too.

If you prepare for the worst, hopefully you'll never need those plans!

[Matt]

Followup: I returned home from Afghanistan, We are moving out of Boston and were able to rent our apartment in one week with rent at $2500, making it profitable after PITI, HOA and Management Fees! Not to mention the Boston rental market has become incredibly hot and skewed so that just like in NYC and San Francisco, the TENANT paid broker fees, not the owner. Pretty amazing if you think about it.

The portfolio is doing better than ever.

We are very aggresively liquidating her student loans and have sold her car (at a profit to the outstanding balance) to prepare for our next move.