Growth

Context is Decisive

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Context is the air we breathe, the water we swim in. It’s our outlook, our worldview, how things occur to us, what we believe is true. It’s influenced by experiences, what we’ve been taught, things we’ve done and seen. Context is rooted in the past, much of it originates from childhood, from formative years. For that reason context is super sticky, it has a lot of staying power, it’s hard to change. And as people get older, they become less and less inclined to change their minds, or even to listen to different ideas.

Context is correlated with action; or, our actions naturally flow from our context. Context is similar to identity in this way. If you identify as an overweight person, you’ll take actions that are consistent with that identity. You’ll eat a lot of unhealthy food and you’ll spend a lot of time on couches. You’d have an incredibly difficult time losing weight, assuming you even wanted to try. If you identify as a healthy person, on the other hand, you’ll watch what you eat and make the gym a regular part of your routine. It’s baked into who you believe you are.

Context is partly what you believe about yourself, but it’s also what you believe about the world. If you believe people are generally nasty and selfish, you’ll have a hard time caring about a stranger. You won’t even want to meet a stranger. If you believe money is scarce (which the vast majority of us do), you’ll feel a measure of helplessness about your long-term earning prospects. The process of money-making feels like a grind, not the motivating ‘work hard’ grind, the boring, fruitless, hopeless grind. On the flip side, if you believe money is abundant, you’ll be inspired to work hard, be valuable, find ways to help people, and most likely accumulate more money.

Since context is sticky we often feel stuck in them, even if we realize they exist. We fall into ruts, or routines, or habits, that stem from our context and then we don’t change. It’s like our contexts are hardwired into our brains, like we’re in the Matrix, unable to detach from the machine. But, we’re not entirely powerless in relation to our contexts.

We can control our inputs, what we’re reading, watching, and interacting with. Good books can have a profound impact on how we think. Take time to interact with and evaluate other ideas and arguments and contexts. The world is way bigger than our limited experiences.

We can take a step back and evaluate them. If you can understand your context, and even some of the background that helped mold it, you can begin to see how it could be different.

We can also control what we say. Context is intricately tied to language. Words are how we organize and process what we see and experience, we speak and listen and think with words. And we can use different words, like ‘scarce’ instead of ‘abundant’, or ‘get to’ instead of ‘have to,’ or say ‘thank-you’ more often. Those are subtle changes, but sometimes what we need is a perspective that leans a different way.

So context is decisive, but it can also be changed. I would start with a good book.

Why don’t we use the gold standard anymore?

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Today we no longer use a gold-backed currency. Even when the dollar was backed by gold, the U.S. government would adjust the gold-to-dollar ratio with regularity, essentially muting any effect of the currency’s gold backing. So while officially abandoned in 1971, we’ve been off the gold standard for quite a while, since about 1914.

Beginning in and around the 19th century, developed nations almost universally adopted the gold standard. Uncoincidentally, the 2nd half of the 19th century is heralded as one of history’s great economic eras. But, in 1914, at the outset of WW1, developed nations involved in the fighting began moving away from the gold standard. They were faced with two options to finance war operations: 1) increase taxes, 2) leave the gold standard and print money. Option one would have been supremely unpopular, option two would accomplish the same thing as option one just without the national outrage. Taxes are one thing, people understand what’s happening, they’re giving up their money for a government to provide services that the collective majority generally agrees upon. Fiat money is different. Instead of imposing additional taxes, fiat money allows the government power to print money, devaluing the currency and causing citizens to end up with less money via inflation. Imposing taxes and printing money grant the same outcome for governments, they end up with more money, and it also creates the same outcome for citizens, they end up with less money. The issue is that citizens have a measure of control over taxation by voting, complaining, revolting, etc. They have very little control over printing money.

It’s impossible to prove, but nevertheless an interesting thought experiment: what if governments hadn’t abandoned the gold standard in 1914? In all likelihood the war would have endured for a fraction of the time it did in reality. Taxes would have been imposed (the only way for governments to fund the war), they would have been incredibly unpopular (because ordinary people didn’t care about petty monarchical conflicts between nations), governments would have run out of money to fund their war efforts, and the war would have ground to a halt, almost certainly sooner than four years, and more probably within one year. Again, it’s impossible to prove, but certainly possible.

Since 1914 little has changed, fiat (government-issued) money is the currency of the age. Taxation has steadily decreased over the last one hundred years while government spending has steadily increased by borrowing and printing notes. A return to the gold standard at this point is all but impossible. The fact is that gold, while a great purveyor of value, is impractical for day to day use. It’s heavy, it’s hard to divide into smaller bits, and it’s costly to keep secure. These are the reasons why gold was concentrated into central banks and traded via government promissory notes in the first place.

Unfortunately, every example in history involving the utilization of soft money (money that’s easily producible) has eventually resulted in large-scale economic collapse. That’s not to say it’s impossible for fiat money to succeed, the U.S. government, while far from perfect, has not inflated the currency to disastrous levels, and may not for a long time. But no human or human institution has been able to stave off the temptation to over-print currency indefinitely.

So that’s depressing, is there a solution? We know that hard money (money that’s scarce and/or hard to produce) is foundational to thriving economies. Gold is the best example we have of hard money, but it has inherent flaws that make it difficult to use in our modern world. An interesting development in the last decade is the inception and rise of crypto-currencies. I won’t pronounce Bitcoin the ultimate salve of modern economics, but it’s certainly worth keeping an eye on. Crypto-currencies offer many of the beneficial characteristics of gold (difficult or impossible to produce, widely accepted), and avoids many of gold’s pitfalls (it’s not heavy, not hard to divide, and inherently secure). The market will ultimately decide if some type of crypto-currency is any type of answer, for now, it’s a fascinating concept. 

Year-end investor review

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We made it, another year is in the books and everyone has an opinion on where the market is going. My line of work involves me adamantly advising people not to try to predict markets, but even I have an opinion about what might happen in the future. Thankfully, there’s a difference between having an opinion and making a poor investing decision.

So where are we now? We’re coming off of a historically great period of market returns, especially in the category of U.S. large growth companies (the S&P 500, which happens to be the category we almost exclusively hear about in the news). Since U.S. large growth companies have faired well, so have investors, because the vast majority of investors have the majority of their investments in large U.S. growth companies. That’s great news right now. But it’s also a problem.

Large growth companies are historically one of the poorest performing asset categories in the free market. This holds in performance data going back one hundred years, but it also makes sense a priori. Large growth companies are inherently less risky than small and value companies, they stay in business longer, they seldom go bankrupt (it happens, just not as often), and their prices don’t fluctuate as significantly. Small companies are often younger, less established, and more susceptible to tough markets. Value companies are often distressed and sometimes never recover. These small and value companies default more often and their prices are more volatile, they’re riskier.

You’ve heard the principle, risk equals return. That applies here. It makes sense that as entire asset classes, small companies and value companies outperform large growth companies by a significant margin over time because their additional risk brings additional return. The fact that large growth companies have performed so well over these last ten years is great, but it also means that at some point we’ll see these returns balance out. Now, I would never pretend to know which asset classes will perform better or worse next year, that’s a fool’s errand which we refer to as ‘market timing.’ But I do know that most years will favor a diversified portfolio that leans toward small and value asset classes instead of a heavy weighting towards large growth companies. Next year the most likely circumstance is that you’ll be happy to have left your large growth company portfolio to get into a more diversified situation, which, incidentally, is true at the end of every year.

So the obvious question is how to diversify with a lean towards small and value companies. I’ve covered this before, but total market index funds won’t help you here, because of cap weighting total market funds are invested almost entirely in large growth companies. Index funds have become very popular over the last 20 years and, while they’re certainly an improvement over active funds, they’re inherently flawed. To get into an ideal portfolio takes an advisor committed to the academics of investing utilizing structured funds (a solution to the index fund problem).

Take the opportunity to review your portfolio as we head into the new year. The returns may look great, but that doesn’t mean you’re in a great portfolio.

Affirmation is not the path to growth

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We live in an age of affirmation. It’s on church signs, it’s enforced in the court of public opinion (Twitter), it’s even taught to children in school. Everyone is great just the way they are (unless they’re not affirming). That’s obviously not all bad, but if affirmation is the highest good we’re missing something.

We tend to think of affirmation as a virtue on a spectrum. Affirmation occupies one side of the hypothetical spectrum and pure evil hatred exists on the other. If that’s true then anything less than affirmation is bad, or at least tainted. But that’s not a real spectrum. Affirmation and hate are not opposites, love and hate are opposites. And love and affirmation are two very different things. We tend to think that the loving thing to do for people is to affirm them, but that’s not true either. Love seeks what’s best for people.

Affirmation can be crippling if we begin to believe that we’re just right the way we are. If we’re affirmed as we are, why make an effort to change? Why take responsibility if it’s not your fault? Why take some initiative if you have no control over what happens to you? Instead of affirmation, you may benefit from a loving nudge towards something better.

Growth happens when we’re challenged, pushed, when we realize that we might not be great just the way we are, when we see a new world of potential. It doesn’t happen by affirmation but by relationships, by tough conversations and experiences, by a new way of seeing or understanding, by coaching.

We all want affirmation, but most of us would benefit from some growth.

Your 401k account is probably loaded up in the wrong asset class

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401k accounts good and bad. They’re mostly good because they provide an avenue for people to save and invest money for their future, but there are some things to watch out for.

Good stuff:

  • The main benefit of a 401k is that it allows you to invest qualified money. You could just invest money on your own, but investing in your 401k accounts means that you get some significant tax advantages (no capital gains on the growth of your investments and an income tax break). The same advantages apply to IRA accounts, but 401ks include two other significant advantages.
  • Many employers offer a matching contribution. For example, if you contribute a certain small percentage of your income (say 5%), the employer may kick in an additional small percentage into your 401k account (say 4%). That’s free money, and you should definitely take it.
  • 401k contributions are capped at $19,000 per year by the employee, employer contributions can exceed that. IRA contributions are capped at $6,000 per year. Not all of us are maxing out our qualified retirement accounts, but the larger cap offered by 401k accounts is certainly an advantage.

Bad stuff:

  • 401k accounts offer a limited number of investing options, and they’re almost never great. 401k Plan sponsors (employers) are typically concerned with one thing when choosing a plan: cost. If the plan seems expensive it will be harder to explain to the board, regardless of the value or benefits of the portfolio and the advisor.
  • Your money is locked up for as long as you work at the company. You’re stuck with the options available and you can’t move the money elsewhere unless you leave or retire.
  • Investors have little to no help deciding which funds or options to use within the 401k so they end up in default options, which are usually target dated funds. You may have seen these funds that end with a future year, like 2045, which you’d be in if you were expected to retire sometime around 2045. A target dated fund is not the worst investment you could be in (which isn’t saying much) but it’s far from ideal. A target dated fund will load you up in U.S. large growth companies (essentially the S&P 500), sprinkle in some international large growth companies, and decide what percentage of your money should be in bonds based on the target year. Unfortunately, in the history of the market, large growth company asset classes are among the lowest-performing of any asset classes over time. A target dated fund is usually made up of index funds (along with their inherent problems) so at least it’s not active, but it will sacrifice large amounts of return over time because of its poor diversification.

Don’t be afraid to use your 401k account, especially if your employer offers a matching contribution (again, free money). But if you’ve obtained the maximum matching contribution, think about investing additional money into a better portfolio through an IRA. Unfortunately, your 401k is probably loaded up in the wrong asset class.