News and Commentary

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Should You Be Concerned About Wealth Inequality?

By Brad Thomason, CPA


If you follow the release of business books, it is likely that you are aware of a couple of block-busting new offerings:  Flash Boys by Michael Lewis, and Capital in the Twenty-First Century by French economist Thomas Piketty.

On the surface, these two books may not seem to have much in common.  But they both touch on the fact that certain people have a lot more than the average person.  And that this disparity has the potential to lead to some bad things.

This notion of the haves and the have-nots is by no means new.  Opinions vary as whether this is or isn’t a big deal, usually based on the relative position of the person offering the opinion.

The coolness of the bow and arrow notwithstanding, most readers of this blog are going to have a natural resistance to the charms of Robin Hood.  In the matter of stealing from the rich and giving to the poor, most of our readers don’t like which camp they are likely to be thrown into.  And whether you think of yourself as rich or not, nobody wants their stuff taken away.

But I think it’s reasonable to ask if large-scale wealth redistribution is a real concern for most of us, or merely something scary off in the dark.  When policy maker start talking about redistributing wealth, at least on a grand scale, are they really talking about you?  In other words, are you really “rich” within the context of their meaning?

Note that I referenced policy makers there.  That’s to highlight that the definition of rich changes depending on who you ask, and the definition that is the general stand-in from a public opinion perspective is different from the one used by those who really spend time thinking about this stuff.  John Q Public assumes that anyone-with-more-than-me, is rich.  Economists and think-tank-folk know better. 

The American idea of what it means to be rich is still very much tied to images from the first half of the last century.  When we hear the word rich we think of Humphrey Bogart and Cary Grant riding in limousines, and the actresses of the day dressed in elegant evening wear and weighed down with elaborate jewelry.  We think of books like The Great Gatsby.  It’s “champagne wishes and caviar dreams,” as Robin Leach used to croon.  That is to say, we have in mind a lifestyle that goes way beyond what a modern family with a one or two million dollar net worth is living.

In spite of what a blue collar worker from a union town in the Midwest might think, most families who have a million or two put back do not consider themselves rich.  Significantly, neither do most credible policy makers.  Which is to say, if that’s you, be aware that talk of substantial wealth redistribution is probably not aimed at you in the first place.

Even if it is, keep in mind that just because someone is talking about it, it doesn’t mean that it’s imminent.  Just as the have/have-not dynamic has been around for a long time, so has the notion of taking from one and giving to the other.  History doesn’t have much evidence of that happening at sustained levels so severe that it flips the table.  Short of revolutions, wealth redistribution becomes an ongoing, though ultimately tepid activity.  That’s probably because there are some naturally occurring checks and balances in place:  Extreme cases of redistribution start getting into property rights issues, which no group has a stake in watering down (if you don’t have a lot, being able to retain what’s yours becomes even more important than if you had excess).

Another potential factor has to do with the relative value of wealth.  Wealth has historically been viewed as having a major and minor mission.  The minor mission is that wealth is a back-up supply of extra resources that are available to supplement thin times.  But the major mission of capital has always been to produce new capital, in the form of investment returns.

However, if you look at investment returns for most common asset classes right now, they are markedly lower than what was the case in previous generations.  Reasons why this might be the case vary depending on whom you ask.  But what is not up for argument is the fact that rates of return are lower for the most common asset classes.  The implications are clear: those who use capital are simply not paying as much for it as they used to.  When savings don’t earn as much as a person thought they would, it seems fair to ask if the capital itself is as valuable as once thought.  So turning back to our conversation about the possibility of wealth redistribution, it seems plausible that if wealth is viewed as having less fundamental value in the first place, we could see less fervor on the part of those who favor redistribution.  The win they stand to get is smaller if the capital isn’t worth as much; perhaps to the point that the smaller win is less worth the effort of a very vigorous battle in the first place.

Bottomline, talk notwithstanding, if you are an owner of capital today there may be some risk that someone wants to take a chunk of it away in the future.  But the far more proximal risk is return underperformance in the here and now.  One may be a problem someday; but the other is a problem right now for a large percentage of investors, especially those who have stuck to traditional stock/bond/CD allocations and not explored the possibilities available from the various alternative asset classes out there.

Instead of worrying about an esoteric policy movement which may have an impact out in the future, most investors would gain an advantage by shifting that attention to a thoughtful review of current investment holdings, and taking action to explore alternatives for any of their portfolio components which they find wanting.    

BRIC … Really?

By Brad Thomason, CPA

If you are a reader of the financial press you have most likely come across the acronym BRIC before.  Brazil, Russia, India and China are the four countries whose economies would seem to have the most potential for growth in the coming century.  Just as the 19th century was the European century, and the 20th century the American one, so is the current century supposed to be the Emerging Nations’ century, with these four at the vanguard.

The oft-cited implication of this potential development is that the United States will be overtaken by one (or all four) of these countries as the preeminent economy, and in fact the most dominant new country on planet earth.  The rise of the risers, the theory goes, spells the downfall of the incumbent.  That is, us.

Well, not so fast.

I couldn’t help but notice the coincidental (I presume) appearance of three successive articles in the latest issue of Bloomberg’s Businessweek.  The first talked about how women in India were very much under the thumbs of their fathers and husbands, and that the notion that a woman would actually make up her own mind about how to cast her vote was a novel idea which was just starting to catch on in Indian culture.  Then came a piece about the Chinese government aggressively disrupting the activities of groups who are critical of the government.  Finally, from the crime blotter of about-to-be-host of the World Cup, Brazil, a love letter about the rise in muggings; with a featured quote that said, “I’ve told everyone who’s asked me about Brazil: Don’t bring anything too precious because there’s a good chance you won’t be taking it home.”

And I’ll assume you are already aware of what Russia has been up to recently (and the devastating effect that their entire economy has suffered just because of sanctions against a couple hundred of its wealthiest citizens).

Do any of those really strike you as the kind of problems you would expect in the country that is about to succeed in knocking the US out of the top spot?

I have personally been on panel discussions at conferences with well-meaning persons who are very worried about the demise of American supremacy.  Now, I’m not saying we don’t have our problems.  But I will point out here what I have pointed out in those forums: in order for the US to stop being first at anything, it necessarily means someone else has to be better.  And frankly I don’t see a whole lot of ready candidates, at least not today.  I offer the above references as substantiation of my opinion.

The US dollar is not the world’s reserve currency because everyone on the planet likes us: it’s because there is no suitable alternative.

The US is not the world’s largest economy simply because of the size of our land mass or the natural resources present here.  The BRIC countries actually can match or beat us on those stats, yet there is no parity.

The thing which makes the US the world leader is…not just one thing.  Our military might sure doesn’t hurt, and you could argue that it sets the stage for all the rest.  But that combination of all the rest is what seems to be the driver.

We have clearly defined civil rights.  Laws mean something here.  The political process, though exhausting, frustrating and often abused, is nonetheless ultimately respected and followed.  The press is nosy and loud and if you are a public official you better not step a toe out of line or there will be someone right there ready to hand you your walking papers.  The financial markets work the way they are supposed to far more often than not.  Innovation is revered and supported here.  People get up in the morning, go to work, and do what they do to drive our economic engine.  And perhaps more than all of this we simply want, as a nation, to try to be as good a place as we can be.

We may not do any of those things with perfection.  But we do them far and away better than anyone else has ever managed to pull off.  The American melting pot has produced a stew that has proven essentially impossible to replicate elsewhere.

And if you look at what is going on right now with the supposed heirs, I don’t think we have a lot to worry about at the moment.  Too many individual variables would have to change too much for the situations in those countries to come even close to the combination of factors we have here.

Even if somehow, someday they did, I’m unconvinced that we should regard that as a cause for worry.  Folks in western Europe still live a pretty good life, even after a century in the runner-up spots.  There is no reason to think that a post-supremacy America necessarily has to be a disaster.  But even if it does prove to be, such a day still seems a mighty long way off in the future.

My response to all of this is simple:  keep doing what I’ve been doing.  I’m going to keep trying to grow in my career, keep serving my clients, and keep investing capital into US assets.  The case for doing so seems pretty strong.  The case for worrying about a distant possibility with odds which are dubious at best, not so much.

Those who spend too much time fearing the “end of America” may find themselves unnecessarily missing out on all the good things our country has to offer in the here and now.  That’s not something I have an interest in doing.

Real Estate Investing: Direct vs Indirect

By Brad Thomason, CPA

Like many assets, there are both direct and indirect options for owning real estate.  Direct ownership is just that: you own the property itself (irrespective of how you acquired it, or whether you have someone else leasing and/or managing it).  Indirect ownership is available through a variety of means including REITs, mortgage paper, and funds that invest in pools of properties.

When considering how to approach a real estate investment, there’s an important point to understand:  the underlying asset may be the same, but the way you own it adds other variables to the equation.  These variables can end up having a big impact on how your investment performs, even if the real estate involved is largely identical.

One of the strongest points in favor of indirect ownership, especially when the investment is in some sort of pool of properties or property-backed debt, is diversification.  When you own a REIT share or a bond that’s been issued against a pool of assets, then you have an undivided piece of the whole, versus exposure to a specific property within.  So, if in a pool of 300 properties, one burns down and it turns out after the fact that there was not enough insurance coverage, the loss is relatively small when spread across the whole.  Conversely, if you were the sole owner and that was your only property, the same set of events would wind up being a pretty big deal.

But diversification, like any other form of protection/insurance, comes at a price.  In this case that price is denominated in terms of diminished yields.  Several large investment firms like Blackrock and Rialto have recently floated debt offerings against pools of real estate assets that they are managing or working-out (i.e. foreclosures, and distressed mortgages), which have coupon rates between 1.5% and 3%.  A number of publicly traded REITs have dividend yields right now between 2% and 4%.  Offerings of this type have a lot of internal diversification, and offer investors the chance to invest in something other than stocks and bonds, to facilitate further diversification/asset-class allocation within their own portfolio.  But the yields, while comparable to current corporate bond offering, may fall well short of what many need to earn on their capital to make their financial plan work.

By comparison, most of the direct-own investors that we work with expect (and routinely receive) much higher returns on their real estate holdings.  Those who buy individual properties to use as rentals often net between 9% and 14%; and that’s for all-cash deals with professional management.  Mortgaged deals, and self-managed properties can do even better.

Buyers of discounted notes usually avoid deals that don’t have the prospects for at least a 20% gain.  Such opportunities are less abundant than houses with good rental prospects, but they are by no means rare if you know where to look.

A little simple math will demonstrate that a blended portfolio with representation from these two types of real estate assets can substantially outperform the indirect offerings.  Or most other investments, for that matter.  Moreover, for higher-net worth individuals who can afford to purchase 3 or 4 rental houses and keep 2 or 3 note deals in the works, the diversification concern is largely ameliorated; without the decreased yield that’s part of a managed offering.

Not everyone is comfortable with direct ownership, and that’s fine.  Even if they are, the indirect route is comparatively easier.  Either can be a valid choice depending on what you are trying to accomplish via the investment.

But informed investing is always a good idea, and given the size of the current disparity in this space, it is unusually important to make a conscious assessment.  The convenience cost for indirect investing in this particular case can be quite high.  For many investors, higher than they feel like they can stomach – even if they find that their initial reaction to the prospect of direct ownership was less than enthusiastic.

Most people need a pretty good reason to leave that extra 5% to 15% on the table.  The problem we see is that most investors don’t realize that’s what they are doing.  But for the ones who are informed and take the time to weigh the options, the difference can be substantial.