Warren Buffett is a Hypocrite, Part I

September 23, 2011

Amass an 11-digit fortune, and you should probably forgo a name tag

We’ve never done a post on The Oracle of Omaha, which makes us unique among personal finance blogs. We also didn’t misspell his name as “Buffet”, which also makes us unique among personal finance blogs.

Yes, he’s the greatest investor of all time. No one disputes this. The problem is when he starts talking about topics he either knows nothing about, or is being deliberately obtuse about. Amassing wealth doesn’t make you an authority on every subject. Case in point, his recent lament about taxes.

Buffett wrote in The New York Times that the current progressive tax system in this country, in which rich people bankroll most everything, just isn’t progressive enough. He pointed out, yet again, the absurdity of his secretary paying a higher percentage of her salary in taxes than he does.

Summarizing, Buffett claims that at least one of his employees allegedly pays an effective tax rate of around 41% on income, while Buffett himself pays 17%.

First, the former claim is a lie. The highest marginal tax rate in this country isn’t even 41%, let alone the highest average tax rate. The highest marginal tax rate is 35%, and given the income level at which the IRS administers it, to pay an effective tax rate of 35% you’d have to make $6 million a year.

So Buffett’s not comparing himself to the woman who answers phones at Berkshire Hathaway. He’s comparing himself to a manager who makes a higher salary than almost everyone in America, even more than your average NBA or major league baseball player.

We’re giving Buffett the benefit of the doubt here, assuming that he meant 35% instead of 41% even though those numbers are easy to distinguish. No one knows where he got the 41% figure from.

Furthermore, that 35% maximum rate is on taxable income. Anyone who’s ever filled out a 1040, or had someone else do it, knows that taxable income is considerably less than total income. There are these things called deductions and credits, which Buffett is presumably familiar with (and which any manager who makes $6 million a year must be familiar with, too.)

It makes for a great class warfare talking point: every dollar that I fail to make is somehow some richer person’s doing. And who better to inspire envy among the poor salaried millions than a tycoon who’s finally seen the error of his ways?

Buffett – and we salute him for this – has spent a lifetime earning money via capital gains, rather than salary. Do we think this is a good idea? Hell, we wrote a book about it.

Capital gains are taxed at lower rates than salaries are. The people who write the tax code, and make it the most cumbersome and impenetrable thing on the planet, ensure this. Of course they do. Legislators write the code to accommodate and exploit this, because they derive most of their income through capital gains.

Let’s assume that Buffett indeed has employees who are paying twice the proportion of their income in taxes as he is. What’s the fairest way to make things fair? Again, multiple-choice.

  1. Further soak the rich.
  2. Get government’s foot off the throat of the poor.

Raise the rich people’s taxes to make things even, or lower the poor’s? Rich people seem to enjoy being rich. Why not reduce rates on the salaried masses to put them in line with whatever Buffett’s definition of “rich” is, instead of the other way around? Instead of creating prosthetic limbs for amputees, Buffett wants to break the right arms of the able-bodied.

The reactionary answer is “Because it’ll reduce much-needed tax revenue.” It wouldn’t. People respond to incentives, and will have incentive to work harder, longer hours if they get to keep more of what they make. When I can keep 84¢ of my next marginal dollar, there’s a better chance I’ll work for that dollar than if I only get to keep 67¢.

It’s the height of arrogance to complain about the tax system not because it hurts you, but because it benefits you. Especially when there are so many ways for Buffett to fix this perceived injustice. Sure, he could cut Washington a check for whatever amount he feels he should be paying. He could increase his employees’ pay enough to offset any tax advantage.

Or, and this is the least likely of the three, he could rework the dividends that flow through his corporations so that he could receive all his income as salary, rather than capital gains.  The chance of this happening is roughly equivalent to the likelihood of Buffett running a 4-minute mile.

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We’ve been pushing the concept of a diagonal tax since we were old enough to understand the concept. Everyone gets a basic personal deduction – say $20,000 – and pays some percentage – say 17 – on the rest.

The guy making $6 million would thus pay 16.94% of his income in taxes. The guy making $30,000 would pay 6% of his income in taxes. The guy whose net worth increases $10 billion in a year would pay 16.99997% of his income in taxes.

People who want to soak the rich should love this system. It treats the rich and the hyper-rich almost identically, biting them almost 3 times as hard as the working stiff, relative to what all three make. If that’s not enough, just manipulate the deduction and percentage numbers until it all makes sense.

 **This article is featured in the Yakezie Carnival-October 2, 2011 Welcome Fall Edition**

Filed Under: Bad Examples, Economy, Education, Estate Planning Tagged With: , , , ,

Follow these steps for guaranteed wealth. Seriously.

September 16, 2011

 

Make fun of this guy and his fellow investment advisors all you want, but what they lack in sexy they more than make up for in forbearance.

I need an investment policy? (yawn) Spare me, please. I just want to be rich.

An investment policy sounds like something that’s calibrated during long, torturous hours in someone’s corner office. Where you’re sitting across from a prim and effete financial advisor, fresh out of business school, all proud of his MBA and his new job and those reams of theoretical knowledge practically spilling out of his overcoiffed head. Do you seriously need that?

Almost certainly not. If you do, most likely you’re already rich and have better things to do than read a blog. In that case, you need an accountant, maybe a tax lawyer. A portfolio manager? Go away now.

Here’s a quiet truth about personal finance and many of the industries that have arisen surrounding it: there’s not a tremendous difference between the professionals and you. As a discipline, personal finance is similar to sociology and women’s studies in that there’s almost no hands-on knowledge involved. Unlike petroleum engineering, where you have to get oil on your fingers and have some physical representation of your data. Or medicine, where you have to treat real patients with ailments and sometimes risk their lives.  What separates a professional financial advisor from an amateur is little more than a few officially administered multiple-choice tests.

Learning the details of personal finance can be intensive and demanding, but the basics are available to anyone with opposable thumbs.

For starters, you don’t merely throw money into the stock market and hope for the best. You don’t even read financial statements, invest in the stock market and hope for the best. You’ve got to look at when you’re going to die, and what you’re going to do before then.

If that sounds morbid, that’s what a formal investment policy is, for the most part. The way the professionals formulate and administer an investment policy, a client is supposed to sit down and list rules that the person in charge of her money then adheres to. But it can’t just be “I want to maximize my return and minimize my risk”, which describes every investor in the history of the universe. You need to be more specific, with regard to:

1. How old you are. Obviously, the more life you have ahead of you, the less conservative you can afford to be and the less calamitous it is if you lose everything.

2. How liquid you need to be. Having cash on hand and being wealthy aren’t always the same thing. Your average meth dealer has plenty of money in his wallet, and probably sleeps in a room that you wouldn’t feel comfortable entering without wearing a surgical mask.

In a famous story from the 1980s, baseball pitcher Rick Sutcliffe loaned $500,000 to Bruce Springsteen so he could close on a house. The Boss was at his apex of popularity at the time. He obviously wasn’t poor, but his money was tied up in investments that he couldn’t immediately get out of and convert to cash without paying a big penalty. Even if you have a billion dollars socked away in inflation-protected securities, you still need a few readily available bucks for day-to-day living.

In the end a formal investment policy will begin with something like this, only written in legalese and incorporating a service fee that’ll eat up part of your principal:

  • I’m a 25-year old woman. I have no kids, and thus smaller expenses than a mother would. Also, I live with my boyfriend, so my expenses are even less than they’d be if I was living alone. We rent a townhome, while we’re waiting to build up equity to buy a house.
  • I make $40,000 in annual salary. After taxes and expenses, I can save around $10,000 a year.
  • My 401(k) is worth $2,500, but I don’t even know what it’s invested in and wouldn’t mind finding something a little more aggressive.
  • I live in Chicago, which means I’m paying a relatively high cost of living. We want to get married and move to Nebraska, where the people are friendlier and everything’s cheaper.
  • My job is unfulfilling but secure. It’s so secure that I know what I’ll be making for the next 5 years if I stay in it. I’m willing to invest in volatile stocks rather than super-safe T-bills if it means having a chance to reach my goals more quickly.
  • Oh yeah, my goals. I want my investments to clear $75,000 a year when I turn 65, tax-free, and continue to until I die.
  • I don’t have any dependents and won’t, so I don’t care about leaving a will.

You almost want to do this backwards, starting with the answer, and then work your way back to the questions. “I want a principal of $x, and an annual cash flow of $y. How much do I have to save, how hard to I have to work, what kind of return on my investments do I need to make this happen?”

You should be able to do this yourself – ask the right questions, and give yourself honest answers. And don’t limit yourself. Start big. Don’t designate the summer villa in Provençe as either achievable or unachievable – it’s simply a goal that you can devise a plan to reach, or not. The same goes for the 4 kids you want to have or the kitchen you want to renovate.

Let’s take the kitchen renovation. You shop around and figure that putting in new appliances, wall tiles, wooden floors with a decorative inlay and an island will cost you $10,000.

Sure, you could take it out of your available cash and pay for it today. But if you’re the woman from our example, you just wiped out your entire savings and had better hope that no unforeseen expense finds you.

If you’re willing to wait 9 months, you can invest $5,000 of that $10,000 in what you believe to be an undervalued stock. You can continue saving your salary at your current rate, which would net you another $7500. The stock might gain 20%, which means that the redone kitchen would make a far smaller dent in your nest egg then than it would now.

Some people choose to place such expenses on their credit cards and pay 19% interest on them until the end of time. Others like to do some calculations first. You can probably figure out which is the better idea.

**This article is featured in the Yakezie Carnival September 25, 2011**

Filed Under: Estate Planning, Personal Finance, Taxes Tagged With: , ,

Au M G!

September 2, 2011

This bears revisiting, yet again. 88 weeks ago we encouraged you to look at the “rising” price of gold from a different, opposite perspective.

Why is “rising” in quotes? Because it implies that gold is getting more expensive, when technically all it means is that it takes more dollars to buy the same amount of gold than it did previously.

No, that’s not splitting hairs. It’s a distinction with a gigantic difference. Again, it takes more dollars to buy the same amount of gold than it did previously. In other words, each dollar now buys less gold.

Why do we assume that it’s the dollar that’s the consistent source of value and the gold whose price is deviating from some norm, rather than the other way around? Especially since the supply and inherent value of gold are far less subject to political pressure and artificial maneuvering than are the supply (and inherent value) of the dollar?

We proposed that instead of quoting the price of a fixed quantity of gold in dollars, we quote the price of a dollar in the corresponding amount of gold. Hence a new makeshift currency, the Aumg (milligram of gold.)

For instance, as of this writing the price of gold is listed as $1830 per ounce. Using the reciprocal of that, a dollar is thus worth .00056 ounces of gold. Clearly ounces are unwieldy units to use here, so instead we use milligrams. There are 31,103 milligrams in a troy ounce*, therefore a dollar is worth 17 Aumg.

Which means nothing on its own. Instead we have to look at comparisons over time and across currencies.

When we first devised this idea, the dollar was trading at 30 Aumg.

Last November, it was down to 22 Aumg.

And in 1968, it was worth 883 Aumg.

It’s not as if gold suddenly got less plentiful over the last 43 years, or even the last 43 weeks. The world’s gold reserves didn’t exit the atmosphere and head for Venus. It still takes unbelievably long man-hours and prohibitively expensive capital investments for mining companies to dig gold out of the ground and turn it into something shiny and marketable. That’s part of the reason gold has been such a constant source of value throughout human history: unlike oil, natural gas, pork bellies or other commodities, the annual output of gold stays consistent (and low, especially relative to what’s already been mined.)

Dollars are a different story. First off, they’re artificial. They’re an arbitrary representation of value, created and put into circulation by a government that controls all the printing presses. Not to go Montana Freeman on you, but even the most ardent monetarist in the world would have to concede that. It’s a fact, not an opinion. And because dollars are imaginary, there’s no limit to the number of dollars the government can create. If Federal Reserve Chairman Ben Bernanke orders the Fed to create $38 octillion, it can and will. The number isn’t even limited by the amount of paper and ink available: all the Fed would have to do is increase the denominations.

Dollars are imaginary, but that doesn’t mean they’re worthless. (You can place an ad on the ControlYourCash.com sidebar, and we’ll take dollars as payment. At least for now.) But look at the numbers above if you don’t believe they’re a declining source of value.

So who cares? Prices rise, wages rise correspondingly. They’re just numbers, right? My grandparents bought a house for $40,000, but it still represented 4 years’ wages like a similar house would today. What’s the problem?

The problem is that the government owes money. Lots of it. To future retirees, to foreign governments, etc. The federal debt is the largest dollar figure regularly quoted in the media. Either those bills need to be paid, or the government must default.

Government “of, by and for the people” means that 1/300,000,000 of that debt is yours. If that sounds overwhelming, you can thank the representatives and executives you chose to represent you.

Those payments are quoted in dollars. An insolvent government has every incentive to weaken the value of each dollar it owes. It does that by printing more of them, making each dollar worth fewer and fewer Aumg.

Here’s all the proof you need that the number of dollars in circulation isn’t close to keeping pace with the gold in circulation. Those annual increases in the money supply far exceed any increases in population.

What does this mean for you? Relative to the pound, the euro, and the Canadian dollar, the U.S. dollar might stabilize. It might even increase in value. But relative to gold, wagering on the dollar is a losing bet.

Unless that federal debt gets any smaller.
(Try to contain your laughter.)

*You know that childhood brainteaser, “What weighs more, a pound of feathers or a pound of gold?” The answer is the feathers. Metals are measured in troy weight, just about everything else is measured in avoirdupois weight. An “everyday” ounce is larger than a troy ounce, and besides, there are 16 avoirdupois ounces to an avoirdupois pound as opposed to 12 troy ounces to a troy pound.

**This article is featured in Totally Money Carnival #36: Football is Back Edition**

Filed Under: Economy, Estate Planning, Math Tagged With: , , , , , ,
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