Scott Buchanan

Is “Rich Dad Poor Dad” a Fraud?

February 13, 2024June 20, 2024Scott Buchanan9 Comments

With my interest in personal finance, the headline

Robert Kiyosaki, ‘Rich Dad Poor Dad’ Author, Says, ‘I Am a Billionaire in Debt’ — And Calls Dave Ramsey An Idiot For Encouraging People To Live Debt-Free

got my attention. I happen to know many people who have been helped by Dave Ramsey‘s sensible courses and books on managing personal finances. But I don’t know a single person who has gotten rich by following Kiyosaki’s advice. So, I decided to do a little fact checking here.

Richard Kiyosaki published his financial self-help book Rich Dad Poor Dad in 1997. The book purports to be non-fiction, and dispenses financial advice through a supposed autobiographical narrative which contrasts his well-educated, hard-working but not-rich father (“poor dad”) with the father of his next-door neighbor Mike. Mike’s father (“rich dad”) was an eight-grade dropout who owned “convenient stores, restaurants, and a construction company. “

According to the narrative, Kiyosaki learned financial business secrets from this rich dad, which Kiyosaki applied to quickly build a vast real estate empire, using the magic of borrowed money.
Rich Dad Poor Dad became a runaway success, selling over 32 million copies, and remaining on the New York Times best seller list for over six years. Kiyosaki has parlayed its success into a series of further books and related products. Kiyosaki’s narrative has fired the imaginations of millions, and made him rich through the sales of his books and other products.

I read his book back around 2000, and came away with mixed impressions. On the one hand, there was sensible advice to put your resources into money-generating assets rather than frittering it away on consumer goods. The narrative of how easy it is to make big money in rental real estate was alluring, and motivated me to delve further into the subject. On the other hand, the book was pretty short on specifics of how to actually do this, beyond recommending expensive courses offered by Mr. Kiyosaki. It seemed too good to be true, but hey, how could I argue with such apparent success?

It turns out that that skeptical intuition of mine was justified: the promises offered in Rich Dad Poor Dad are too good to be true, and in fact the whole narrative of the book appears to have been made up in order to appeal to gullible readers.

Various people have probed into the Kiyosaki story. The most extensive treatment I know of is “John T. Reed’s analysis of Robert T. Kiyosaki’s book Rich Dad, Poor Dad”, but see also “ Shocking Revelation: Kiyosaki’s “Rich Dad” Is Not Real, but a Myth Like Harry Potter “, by KSCHANG at Tough Nickel, and others.

As best anybody can tell, there never was this “rich dad” character as described by Kiyosaki. Also, there’s no evidence that Kiyosaki actually made significant money by real estate dealings, prior to making millions of dollars with his book sales (and presumably putting some of that into real estate.)

As a person who values personal integrity, I tend to be peeved when authors or screenwriters present a book or a movie as fact, when key parts of it are actually fictional. The usual “Based on a true story“ disclaimer doesn’t cut it, since readers/viewers can’t help coming away with the impression that this is what happened, when really it didn’t (Think: Roots, A Beautiful Mind, etc., etc.).

So the dishonesty at the core of Rich Dad Poor Dad annoys me. What is more significant is that much of the advice is actually counterproductive, harmful, or even illegal. For instance, Kiyosaki recommends trading stocks based on private tips from friends in corporations; this is called “insider trading”, and people like Martha Stewart have gone to jail in connection with it. He also tells of how he can back out of contracts by inserting a clause “subject to the approval of my partner”, where said partner was actually his cat. That is called “fraud”.

Richard Emert at The Motley Fool opines, “Kiyosaki’s material is almost completely devoid of specific financial advice. Further, his material on making money in real estate appears to be little more than repackaged hype from the “no money down” real estate hucksters of the late ’80s.”
In deference to his exhaustive investigation, I’ll give John Reed the last words here (tell us how you really feel, John):

Rich Dad, Poor Dad is one of the dumbest financial advice books I have ever read. It contains many factual errors and numerous extremely unlikely accounts of events that supposedly occurred.

Kiyosaki is a salesman and a motivational speaker. He has no financial expertise and won’t disclose his supposed real estate or other investment success.

Rich Dad, Poor Dad contains much wrong advice, much bad advice, some dangerous advice, and virtually no good advice.

[emphases in the original]

…the book goes on to deliver a pack of lies that make getting rich seem much easier than it really is and make education sound much less valuable than it really is. Basically, people want to get rich quick without effort or risk. Kiyosaki is just the latest in a long line of con men who pander to that fantasy.

… [But] to members of Kiyosaki’s cult, it matters not how many false or probably-false statements I find in Kiyosaki’s writings. They just like the guy. Personality is an appropriate criterion for selecting someone to hang around with. But it is a highly inappropriate criterion for evaluating Kiyosaki’s advice, because he’s not going to let you hang around with him and your family’s finances are serious business.

Bride Who Called Off Wedding Donates $15,000 Reception to Special Needs Families; and Other Good News.

February 6, 2024February 6, 2024Scott BuchananLeave a comment

My eye was caught my a recent random headline, “Bride Donates $15,000 Reception to Special Needs Families After Calling off Her Wedding”:

In the true definition of a worst-case scenario, an unnamed California bride-to-be is reported to have called off her entire non-refundable wedding reception worth $15,000, after learning something about her fiance.

But…she took the disaster and turned it on its head, donating the reception party complete with dinner, dessert, drinks, DJ, dancing, and photo booth to a non-profit called Parents Helping Parents which provides community support to parents with children who have special needs.

…Organizers at PHP sent out invitations for the “Ball for All” and had all the seats reserved 48 hours before the event. … “Nearly everyone [there] was a young adult with special needs, their parent or a member of the care team,” Daane said. “Their joy and delight really told the story about how special and unique this event was—the moment the ballroom was opened, and we all filed into a beautiful candlelit room with tables draped in white linen.”

Yay!

This cheering item is on the “Good News Network”, which I had never heard of before. Other headlines on this site include:

Irishman Whips Out Fiddle to Entertain Passengers in Flight–and People Dance a Jig in the Aisle (WATCH)

Singing or Playing Music Throughout Life is Linked with Better Brain Health While You Age

and

She’s a Pet Detective Who’s Tracked Down and Reunited 330 Lost Dogs with Owners for Free–Using Thermal Imaging.

I think it is great to publicize such civic acts. Let’s make this the new normal.

Stop Using Your Administrator Account Routinely on Your PC

January 30, 2024February 1, 2024Scott BuchananLeave a comment

I recently got a new PC. Windows 11 Media Player will play music CDs, and certain kinds of video files, but does not do much in the way of editing, and it will not play commercial movie DVDs. I planned to download the free, widely used, widely loved, highly capable VLC media program for my audio and video needs.

But first, as a cautionary measure, I did a quick Internet search on the safety of this program. I was mainly concerned about malware being bundled in with the installation. This does not seem to be a problem if you get it from the source, VideoLAN. This is a benevolent, non-profit enterprise led by volunteers trying to make the world a better place. However, it turns out the notorious China-based Cicada hacking group has utilized VLC to infiltrate computers and suck out sensitive information. This sounded really bad for VLC. Digging a little deeper, though, the story was a more nuanced. The actual hacks occurred when incautious users used VLC to open a contaminated video file that the hackers had sown on the Internet, which then started to do all the bad stuff on the computer.

But what really caught my attention, and has become the subject of this blog post, was VLC‘s response to all the criticisms of it being a vector for hackers. In so many words, they said, “Hey, if users would use a little common sense and not run as Administrators all the time, this would not be an issue. It’s only when they run as administrators and use our program to open infected files that the malware can get a foothold and to do anything really bad to the computer. Lots and lots of other programs out there have the same vulnerabilities that our program does towards opening infected files. If users are going to be stupid enough to run as administrators all the time, don’t blame us.” Or something like that.

That got me concerned about looking into the hazards of routinely running as an administrator. This is something nobody really warned me about. When you get your shiny new PC, and open up your first user account to operate your computer with, it is always an administrator account. That allows you to install and uninstall programs, which of course you need to do. Most of us, dumb and happy, just keep using that same account.

But when I dug into it, it does seem like that is a bad idea. It opens your computer to hacking in a serious way. Two quotes to make that point:

A recent study from security vendor Avecto found that 94% of critical vulnerabilities announced by Microsoft could be mitigated by simply removing administrative rights. These vulnerabilities range from phishing attacks that can hijack the system via applications like Microsoft Word to packets that are specially crafted to hit Windows Server. In most cases, they can be leveraged to remotely execute code and take control of the PC, potentially accessing sensitive data and applications deeper within the network. ( Joe Kozlowicz at Lunavi blog)

And:

The principle of least privileges is why we do not do our day-to-day computing from an Administrators account. If you are a Standard user, and your account gets hacked, the most an attacker can do is to rifle through your personal files, which is not a worthwhile use of an attacker’s time. If attackers are looking for bank account numbers, credit card information, Social Security Numbers, and the like, they can easily and cheaply find thousands of people’s records on the dark web. They are unlikely to waste their time on your user account.

But if you’re using an Administrators account that gets hacked … now that’s the grand prize. Now they’ve got an entire computer to work with, and with that computer they can do tremendous damage, not only to your computer – for example, by using it to mine bitcoin, or torrent stolen content – but to other computers too, by using your computer to attack other computers. (per “A. User” on Microsoft forum).

(My jaw dropped a little at the off-hand remark that “…If attackers are looking for bank account numbers, credit card information, Social Security Numbers, and the like, they can easily and cheaply find thousands of people’s records on the dark web. They are unlikely to waste their time on your user account…,” but we will pass over that for now.)

Interestingly, on that same Microsoft forum there were other complacent users pooh-poohing the notion that running with an Administrator account was hazardous. As I said, dumb and happy.

So, I realized (hangs head in shame) I was one of that innumerable company of stupid users who routinely run their PCs from an Administrator account. Well, what is the alternative? Besides an Administrator account, the other type of account on a PC is a Standard account. With a Standard account, you can run all your programs and save all your data and do pretty much everything you normally do.

Oh, but you ask, what if I want to install a new program or uninstall an unwanted program? It turns out that is straightforward to do using a Standard account, as long as you know your administrator account password (never lose that password!!). If you do a software installation as a standard user, at some point in the process it will simply ask you for an administrator password, which you can enter to make that one action, and then the process just proceeds along.

If are working as a Standard user, but then you know you’re going to make some unusual system alterations, it is easy enough to don your Superman cape and open up a second, administrator, account on your PC, leaving your working files and programs live in your standard account. Just do the venerable simultaneous CNTL-ALT-DEL, and click on Switch User. You can then click on an Administrator account and do what you need to do, then switch back to the Standard account to keep on going there.

And so, on my new PC, I have set up a second, Standard account, and plan to run routinely from that. I invite others to do likewise. A brief tutorial is below.

APPENDIX: How To Set Up Another, Standard Account on Your PC

This whole process may take about 30 minutes, depending. In Windows 11, go to:

Settings – – Accounts – – Other Users – – Add Account

At this point the system will ask you for the new user’s email address or Microsoft account, which you can give if you want, or you can say you don’t know and keep going. Assign this account a new name and password (this will become the normal password you sign into your PC with, going forward).

It’s similar in Windows 10:

Settings — Accounts – – Family and Other Users – – Add Someone Else to this PC – – I don’t have [Microsoft account] sign-in information – – Add User Without Microsoft Account

At this point you are done. You are ready to use this new account as your normal user log-in, and only unleash the Administrator account on rare occasions.

That was quick. But what I found took more time was re-customizing the settings and bookmarks on my apps like browser (I use Brave for privacy) and Word (I tweak the settings to prevent Word from sending all my keystrokes back to Microsoft), for use within the new account. Apparently, these apps treat each new user as a new user, and come in with the standard settings. Also, I took my working files/documents from my Admin account, copied them to a thumb drive, and then pasted them into the Documents folder of my new Standard account. (There is probably a more clever way to do this, using Public folders on your C: drive).

Hazards of the Internet of Things 2. Big Brother Is Watching Your Every Breath

January 23, 2024January 23, 2024Scott Buchanan1 Comment

There seems to be something of a generational divide as to how important is your personal privacy. Folks under, say, age 40, have lived such a large fraction of their lives with Facebook and Amazon and Google and Twitter logging and analyzing and reselling information on what they view and listen to and say and buy, that they seem rather numb to the issue of internet privacy. Install an Alexa that ships out every sound in your home and a smart doorbell that transmits every coming and going to some corporate server, fine, what could possibly be the objection? So what if your automobile, in addition to tracking and reporting your location, feeds all your personal phone text messages to the vehicle manufacturer?

For us older folks whose brain pathways were largely shaped in a time when communication meant talking in person or on a (presumably untapped) phone, this seems just creepy. Polls show that a majority of Americans are uneasy about the amount of data on them being collected, but “do not think it is possible to go about daily life without corporate and government entities collecting data about them.”

There are substantive concerns that can be raised about the uses to which all this information may be put, and about its security. Per VPNOverview:

Over 1,800 data leaks took place last year in the US alone, according to Statista. These breaches compromised the records of over 420 million people.” . With smartwatches having access to so much sensitive information, here’s what kind of data can fall into the wrong hands in case of a data leak:

Your personal information, including name, address, and sometimes even Social Security Number
Sensitive health information collected by the smartwatch
Login credentials to all the online platforms connected to your smartwatch
Credit card and other payment information
Digital identifiers like your IP address, device ID, or browser fingerprint
Remote access information to smart home devices

Several times a year now, I get notices from a doctor’s office or finance company or on-line business noting blandly that their computer systems have been hacked and bad guys now have my name, address, birthdate, social security number, medical records, etc., etc. (They generously offer me a year of free ID fraud monitoring. )

The Internet of Things (IoT) promises to ramp up the snooping to a whole new level. I took note four years ago when Google acquired Fitbit. At one gulp, the internet giant gained access to a whole world of activity and health data on, well, you. The use of medical and other sensors, routed through the internet, keeps growing. One family member uses a CPAP machine for breathing (avoid sleep apnea) at night; the company wanted the machine to be connected on the internet for them to monitor and presumably profit from tracking your sleep habits and your very breath. And of course when you don a smart watch, your every movement, as well as your heartbeat, are being sent off into the ether. (I wonder if the next sensor to be put into a smart watch will be galvanic skin response, so Big Tech can log when you are lying).

According to a senior systems architect: “The IoT is inevitable, like getting to the Pacific Ocean was inevitable. It’s manifest destiny. Ninety eight percent of the things in the world are not connected. So we’re gonna connect them. It could be a moisture sensor that sits in the ground. It could be your liver. That’s your IoT. The next step is what we do with the data. We’ll visualize it, make sense of it, and monetize it. That’s our IoT.”

When my kids were little, we let them use cassette tape players to play Winnie the Pooh stories. With my grandkids, the comparable device is a Yoto player. This also plays stories (which is good, better than screens), but it only operates in connection with the internet. The default is that the Yoto makers collect and sell personal information on usage by you and your child (which would include time of day as well as choice of stories). You can opt out, if you are willing to take the trouble to write to their legal team (thanks, guys).

There are cities in the world, in China but also some European cities, where there are monitoring cameras (IoT) everywhere. Individuals can be recognized by facial features and even by the way they walk; governmental authorities compile and track this information. These surveillance systems are being sold to the public with the promise of increased “security.” Whether it really makes we the people more secure is heavily dependent on the benevolence and impartiality of the state powers. Supposing a department of the federal government with access to surveillance data became politicized and then harassed members of the opposing party?

I’ll conclude with several slides from Timothy Wallace’s 2023 presentation on the Internet of things:

The dystopian novel 1984 by George Orwell was published in 1949. It describes a repressive totalitarian state, headed by Big Brother, which was characterized by pervasive surveillance. Ubiquitous posters reminded citizens, “Big Brother is watching you.” Presumably the various cameras and microphones used in the mass surveillance there were paid for and installed by the eavesdropping authorities. It is perhaps ironic that so many Americans now purchase and install devices that allow some corporate or governmental entity to snoop them more intimately than Orwell could have imagined.

Hazards of the Internet of Things 1. Hacking of Devices (Baby Monitors, Freezers, Hospital Ventilators) in Homes and Institutions

January 16, 2024January 15, 2024Scott BuchananLeave a comment

For my birthday this year, someone gave me a “smart” plug-in power socket. You plug it into the wall, and then can plug in something, say a lamp, into the smart socket, which you can then control via the internet. Yay, I am now a part of the Internet of Things (IoT). What could possibly go wrong?

However, my Spidey-sense started to tingle, and I chose to give this device away. At that point, I was thinking mainly of the potential for such devices to get hacked and then recruited to be part of a vast bot-net which can then (under the control of bad actors) conduct massive attacks on crucial internet components. For instance,

Mirai [way back in 2016] infected IoT devices from routers to video cameras and video recorders by successfully attempting to log in using a table of 61 common hard-coded default usernames and passwords.

The malware created a vast botnet. It “enslaved” a string of 400,000 connected devices. In September 2016, Mirai-infected devices (who became “zombies”) were used to launch the world’s first 1Tbps Distributed Denial-of-Service (DDoS) attack on servers at the heart of internet services. It took down parts of Amazon Web Services and its clients, including GitHub, Netflix, Twitter, and Airbnb.

But it turns out the hazards with smart devices are widespread indeed. IoT devices are so useful for bad guys that that they are attacked more than either mobile devices or computers. One layer of hazard is the hacking of specific, poorly-secured devices in a home or institution, with subsequent control of devices and infiltration of broader computing systems. This will be the focus of today’s blog post. Another layer of hazard is the use to which masses of (sometimes private and personal) data snooped from “unhacked” smart devices are put by large corporations and state actors; that will be considered in a part 2 post.

Here are results from one study from nearly three years ago:

https://www.thalesgroup.com/en/markets/digital-identity-and-security/iot/magazine/internet-threats

A study published in July 2020 analyzed over 5 million IoT, IoMT (Internet of Medical Things), and unmanaged connected devices in healthcare, retail, manufacturing, and life sciences. It reveals an astonishing number of vulnerabilities and risks across a stunningly diverse set of connected objects….

The report brings to light disturbing facts and trends:

Up to 15% of devices were unknown or unauthorized.
5 to 19% were using unsupported legacy operating systems.
49% of IT teams were guessing or had tinkered with their existing IT solutions to get visibility.
51% of them were unaware of what types of smart objects were active in their network.
75% of deployments had VLAN violations
86% of healthcare deployments included more than ten FDA-recalled devices.
95% of healthcare networks integrated Amazon Alexa and Echo devices alongside hospital surveillance equipment.

…Ransomware gangs specifically target healthcare more than any other domain in the United States. It’s now, by far, the #1 healthcare breach root cause in the country. …The mix of old legacy systems and connected devices like patient monitors, ventilators, infusion pumps, lights, and thermostats with very poor security features are sometimes especially prone to attacks.

So, these criminals understand that stopping critical applications and holding patient data can put lives at risk and that these organizations are more likely to pay a ransom.

I know people in organizations which have been brought to their knees by ransomware attacks. And I have read of the dilemma of the guy who was on vacation in the Caribbean or whatever, and got a text from a hacker instructing him to deposit several hundred dollars in a Bitcoin account, or else his “smart” refrigerator/freezer would be turned off and he would come home to a spoiled, moldy mess.

What brought all this IoT stuff to my attention this week was a talk I ran across from retired MIT researcher Timothy Wallace, titled “Effects, Side Effects and Risks of the Internet of Things”, presented at the 2023 American Scientific Affiliation meeting. The slides for his talk are here. I will paste in a few snipped excerpts from his talk, that are fairly self-explanatory:

(My comment: 10 billion is a really, really big number…)

(My comment: this type of catastrophic compromise of computer systems being enabled by hacking some piddling little IoT device that happens to be in the home or institution local network is not uncommon. Which is why I am reluctant to put IoT devices, especially from no-name foreign manufacturers, on my home wireless network).

Many of these vulnerabilities could in theory be addressed by better practices like always resetting factory passwords on your smart devices, but it is easy for forget to do that.

And just to end on a light note (this cartoon also lifted from Wallace’s slides):

San Francisco Fed Says Pandemic Surplus Is Gone; Boston Fed Demurs

January 9, 2024January 8, 2024Scott Buchanan2 Comments

Is it the best of times or the worst of times? This question I asked myself as I saw the following three headlines juxtaposed last week:

“US consumers are in the best shape ever” is sandwiched between two downers. The American consumer’s ongoing spending has staved off the long-predicted recession, quarter after quarter after quarter. Can we keep those plates spinning?

We noted earlier that the huge windfall of pandemic benefits (direct stimulus plus enhanced unemployment benefits) put trillions of dollars into our bank accounts, and the spending down of that surplus seems to have powered the overall economy and hence employment (and inflation). How the economy does going forward is still largely determined by that ongoing spend-down. Thus, the size of the remaining hoard is critically important.

Unfortunately, it seems to be difficult to come up with an agreed-on answer here. The San Francisco Fed maintains a web page dedicated to tracking “Pandemic-Era Excess Savings.” Here is a key chart, tracking the ups and downs of “Aggregate Personal Savings”:

This is compared to a linear projection of pre-pandemic savings, which is the dotted line. (Which dotted line you choose is crucial, see below) . The next chart plots the cumulative savings relative to that line, showing a steady spend-down, and that this excess savings is just about exhausted:

If this represents reality, then we might expect an imminent slowdown in consumer spending and in GDP growth, and presumably a lessening in inflationary pressures, which may in turn justify more rate cuts by the Fed.

But the Boston Fed says, “Maybe not.” A study by Omar Barbiero and Dhiren Patki published in November titled Have US Households Depleted All the Excess Savings They Accumulated during the Pandemic? showed that it makes a huge difference which savings rate trend you choose for a baseline.

The following chart shows two versions of the first plot shown above, with (on the left) a linear, increasing projection of 2018-2019 savings trends, versus a flat savings rate baseline:

Two significant differences between these plots and the San Francisco Fed plot shown above are that these plots only run through the end of 2022, and that they display per cent savings rate rather than dollar amounts. However, they demonstrate the difference that the baseline makes. Using an increasing savings rate baseline (2018-2019 trend projection), the surplus was nearly exhausted at the end of 2022. Using a flat rate average of 2016-2019 for the baseline, the surplus was barely dented.

We will see how this plays out. My guess is that at the first whiff of actual recession and job losses, the administration will gush out the maximum amount of largesse; while we may have ongoing inflation and high interest rates due to the deficit spending, we will not have a hard landing. I think.

Stock Options Tutorial 2. How Options Are Priced

January 2, 2024January 2, 2024Scott Buchanan5 Comments

This continues our occasional series on stock options for amateurs.

I find options to be a nice tool in my investing arsenal. The previous post in this series was Stock Options Tutorial 1. Options Fundamentals. That post dealt with buying options, to provide simple examples. For reasons to explained in a future post, I usually prefer to sell options. Anyway, here we will look briefly at how options are priced. It is important to get an intuitive understanding of this, in order to be comfortable actually using options in your account.

The current price of an option, if you wanted to buy or sell it, is called the premium. There are two components that go into the premium, the intrinsic value and the extrinsic (or “time”) value:

Source: OptionAlpha

Intrinsic Value of Options

The intrinsic value is easy to figure out, once you understand it. It is simply how much you would profit if you owned the option, and decided to exercise it right now. For instance, if you owned a call with a strike price of $50, but the stock price is $55, you could exercise the call and force whoever sold you the call to sell you the stock at a price of $50/share; you could turn around and immediately sell that share for $55, pocketing $5/share. We say that the option in this case is $5 in the money, and the intrinsic value is $5.

If the stock price were $60, it would be $10 in the money; you could pocket $10/share for exercising it. If the stock price were say $90, the option would be $40 in the money, and so on.

However, if the stock price were $50 (the $50 option is “at the money”) or lower (option is “out of the money”), you would get no benefit from being able to purchase this stock for $50, and so the intrinsic value of the option would be zero.

With a put (which is an option to sell a stock at a particular price), this is all reversed. If the stock is $5 lower than the option strike price, the option is $5 in the money and has a $5 intrinsic value, since if you own it, you could say buy the stock at $45, and force the put option seller to buy it from you at $50/share:

Source: OptionAlpha

Extrinsic (Time) Value of Options

Suppose the current price of a stock is $50. And suppose you suspect its price may be above $50, say $60 sometime in the next month, so you would like to have the option of buying it at $50 sometime in the future, and then selling it into the market at (say) $60, for a quick, guaranteed profit of $10. Sounds great, yes?

Since a $50 call is right at the money (since the stock price is also $50), the intrinsic value of a $50 call is zero. Does this mean you could go out and buy a $50 call option for nothing? No, because the seller of the option is taking a risk by providing you that option. If the stock really does go to $60, he could be out the $10. Therefore, he will demand a higher price than the intrinsic price, to make it worth his while. This extra premium over the intrinsic premium is the extrinsic premium, which varies greatly with the time till expiration of the option.

If you wanted the option of buying the stock at $50 sometime in the next week, the option seller would charge only a small amount; after all, what are the odds that the stock will rise a lot in one week? However, if you wanted to extend that option period out to one year, he will charge you a high extrinsic premium, since there is a bigger chance that the stock could soar will over $50 sometime in that long timeframe.

Another way of framing this is, if you buy a $50 call option today with an expiration date a year from now, you will pay a high extrinsic value. But as the months roll by, and it gets closer to the expiration date, this extrinsic value or time premium will shrink down ever more quickly towards zero:

Source: QuantStackExchange, on Seeking Alpha

Now, computing the actual amount of the extrinsic value is really gnarly. The Black-Scholes model provides a theoretical value under idealized conditions, but for us amateurs, we pretty much have to just take what the market gives us. In deciding whether to buy or sell an option, I look at what the current market pricing is for it.

It turns out that an option which is priced at the money has the highest extrinsic value. As you get further into or out of the money, the extrinsic component of the total premium for the option diminishes. Below is one final graphic which pulls all this together:

Source: OptionTradingTips

The call option strike price is $25. The blue line shows the intrinsic value (labeled as “payoff at expiration”) at each stock price – this is zero at or below $25, and increases 1:1 as the stock price climbs above $25. The red curve shows the full market price of the option, including the extrinsic (time) premium. The spacing between the red and the blue lines shows the amount of the extrinsic premium. That spacing is greatest when the stock price is equal to the $25 strike price. The shaded areas specify the intrinsic and extrinsic values at a stock price of $27.

And (not shown here) as time passed and the option got closer to expiry, the extrinsic value would shrink (decay), and the red curve would creep closer and closer to the blue curve.

Saba Closed-End Funds ETF (CEFS): Have Finance Legend Boaz Weinstein Manage Your Closed End Fund Investments

December 26, 2023December 26, 2023Scott Buchanan1 Comment

Boaz Weinstein and the London Whale

Boaz Weinstein is a really smart guy. At age 16 the US Chess Federation conferred on him the second highest (“Life Master”) of the eight master ratings. As a junior in high school, he won a stock-picking contest sponsored by Newsday, beating out a field of about 5000 students. He started interning with Merrill Lynch at age 15, during summer breaks. He has the honor of being blacklisted at casinos for his ability to count cards.

He entered into heavy duty financial trading right out of college, and quickly became a rock star. He joined international investment bank Deutsche Bank in 1998, and led their trading of then-esoteric credit default swaps (securities that payout when borrowers default). Within a few years his group was managing some $30 billion in positions, and typically netting hundreds of millions in profits per year. In 2001, Weinstein was named a managing director of the company, at the tender age of 27.

Weinstein left Deutsche Bank in 2009 and started his own credit-focused hedge fund, Saba Capital Management. One of its many coups was to identify some massive, seemingly irrational trades in 2012 that were skewing the credit default markets. Weinstein pounced early, and made bank by taking the opposite sides of these trades. He let other traders in on the secret, and they also took opposing positions.

(It turned out these huge trades were made by a trader in J. P. Morgan’s London trading office, Bruno Iksil, who was nick-named the London Whale. Morgan’s losses from Iksil’s trades mounted to some $6.2 billion.)

For what it’s worth, Weinstein is by all accounts a really nice guy. This is not necessarily typical for many high-powered Wall Street traders who have been as successful as he.

Weinstein and the Sprawling World of Closed End Funds

If you have a brokerage account, you can buy individual securities, like Microsoft common stock shares, or bonds issued by General Motors. Many investors would prefer not to have to do the work of screening and buying and holding hundreds of stocks or bonds. No problem, there exist many funds, which do all the work for you. For instance, the SPY fund holds shares of all 500 large-cap American companies that are in the S&P 500 index, so you can simply buy shares of the one fund, SPY.

Without going too deeply into all this, there are three main types of funds held by retail investors. These are traditional open-end mutual funds, the more common exchange-traded funds (ETFs), and closed end funds (CEFs). CEFs come in many flavors, with some holding plain stocks, and others holding high-yield bonds or loans, or less-common assets like spicy CLO securities. A distinctive feature of CEFs is that the market price per share often differs from the net asset value (NAV) per share. A CEF may trade at a premium or a discount to NAV, and that premium or discount can vary widely with time and among otherwise-similar funds. This makes optimal investing in CEFs very complex, but potentially-rewarding: if you can keep rotating among CEF’s, buying ones that are heavily discounted, then selling them when the discount closes, you can in theory do much better than a simple buy and hold investor.

I played around in this area, but did not want to devote the time and attention to doing it well, considering I only wanted to devote 3-4% of my personal portfolio to CEFs. There are over 400 closed end funds out there. So, I looked into funds whose managers would (for a small fee) do that optimized buying and selling of CEFs for me.

It turns out that there are several such funds-of-CEF-funds. These include ETFs with the symbols YYY and PCEF, CEFS, and also the closed end funds FOF and RIV. YYY and PCEF tend to operate passively, using fairly mechanical rules. PCEF aims to simply replicate a broad-based index of the CEF universe, while YYY rebalances periodically to replicate an “intelligent” index which ranks CEFs by yield, discount to net asset value and liquidity. FOF holds and adjusts a basket of undervalued CEFs chosen by active managers, while RIV holds a diverse pot of high-yield securities, including CEFs. The consensus among most advisers I follow is that FOF is a decent buy when it is trading at a significant discount, but it makes no sense to buy it now, when it is at a relatively high premium; you would be better off just buying a basket of CEFs yourself.

I settled on using CEFS (Saba Closed-End Funds ETF) for my closed end fund exposure. It is very actively co-managed by Saba Capital Management, which is headed by none other than Boaz Weinstein. I trust whatever team he puts together. Among other things, Saba will buy shares in a CEF that trades at a discount, then pressure that fund’s management to take actions to close the discount.

The results speak for themselves. Here is a plot of CEFS (orange line) versus SP500 index (blue), and two passively-managed ETFs that hold CEFs, PCEF (purple) and YYY (green) over the past three years:

The Y axis is total return (price action plus reinvestment of dividends). CEFS smoked the other two funds-of-funds, and even edged out the S&P in this time period. It currently pays out a juicy 9% annualized distribution. Thank you, Mr. Weinstein, and Merry Christmas to all my fellow investors.

Boilerplate disclaimer: Nothing in this article should be regarded as advice to buy or sell any security.

Former Treasury Official Defends Decision to Issue Short Term Debt for Pandemic; I’m Not Buying It

December 12, 2023December 11, 2023Scott BuchananLeave a comment

We noted earlier (see “The Biggest Blunder in The History of The Treasury”: Yellen’s Failure to Issue Longer-Term Treasury Debt When Rates Were Low ), along with many other observers, that it seemed like a mistake for the Treasure to have issued lots of short-term (e.g. 1-2 year) bonds to finance the sudden multi-trillion dollar budget deficit from the pandemic-related spending surge in 2020-2021. Rates were near-zero (thanks to the almighty Fed) back then.

Now, driven by that spending surge, inflation has also surged, and thus the Fed has been obliged to raise interest rates. And so now, in addition to the enormous current deficit spending, that tsunami of short-term debt from 2020-2021 is coming due, to be refinanced at much higher rates. This high interest expense will contribute further to the growing government debt.

Hedge fund manager Stanley Druckenmiller commented in an interview:

When rates were practically zero, every Tom, Dick and Harry in the U.S. refinanced their mortgage… corporations extended [their debt],” he said. “Unfortunately, we had one entity that did not: the U.S. Treasury….

Janet Yellen, I guess because political myopia or whatever, was issuing 2-years at 15 basis points[0.15%] when she could have issued 10-years at 70 basis points [0.70 %] or 30-years at 180 basis points [1.80%],” he said. “I literally think if you go back to Alexander Hamilton, it is the biggest blunder in the history of the Treasury. I have no idea why she has not been called out on this. She has no right to still be in that job.

Unsurprisingly, Yellen pushed back on this charge (unconvincingly). More recently, former Treasury official Amar Reganti has issued a more detailed defense. Here are some excerpts of his points:

( 1 ) …The Treasury’s functions are intimately tied to the dollar’s role as a reserve currency. It is simply not possible to have a reserve currency without a massive supply of short-duration fixed income securities that carry no credit risk.

( 2 ) …For the Treasury to transition the bulk of its issuance primarily to the long end of the yield curve would be self-defeating since it would most likely destabilise fixed income markets. Why? The demand for long end duration simply does not amount to trillions of dollars each year. This is a key reason why the Treasury decided not to issue ultralong bonds at the 50-year or 100-year maturities. Simply put, it did not expect deep continued investor demand at these points on the curve.

( 3 ) …The Treasury has well over $23tn of marketable debt. Typically, in a given year, anywhere from 28% to 40% of that debt comes due…so as not to disturb broader market functioning, it would take the Treasury years to noticeably shift its weighted average maturity even longer.

( 4 ) …The Treasury does not face rollover risk like private sector issuers.

Here is my reaction:

What Reganti says would be generally valid if the trillions of excess T-bond issuance in 2020-2021 were sold into the general public credit market. In that case, yes, it would have been bad to overwhelm the market with more long-term bonds than were desired. But that is simply not what happened. It was the Fed that vacuumed up nearly all those Treasuries, not the markets. The markets were desperate for cash, and hence the Fed was madly buying any and every kind of fixed income security, public and corporate and mortgage (even junk bonds that probably violated the Fed’s bylaws), and exchanging them mainly for cash. Sure, the markets wanted some short-term Treasuries as liquid, safe collateral, but again, most of what the Treasury issued ended up housed in the Fed’s digital vaults.

So, I remain unconvinced that the issuance of mainly long-term (say 10-year and some 30-year; no need to muddy the waters like Reganti did with harping on 50–100-year bonds) debt would have been a problem. So much fixed-income debt was vomited forth from the Treasury that even making a minor portion of it short-term would, I believe, have satisfied market needs. The Fed could have concentrated on buying and holding the longer-term bonds, and rolling them over eventually as needed, without disturbing the markets. That would have bought the country a decade or so of respite before the real interest rate effects of the pandemic debt issuance began to bite.

But nobody asked my opinion at the time.

Charlie Munger’s Rule for a Happy Life

December 5, 2023December 5, 2023Scott Buchanan1 Comment

A big piece of news in the investment world has been the passing of Charlie Munger on Nov 28 at age 99. He was vice chair of Berkshire Hathaway, and Warren Buffett’s right-hand man there.

Munger grew up in Omaha, Nebraska, which is Warren Buffett’s hometown as well. They met at a dinner party there in 1959, and hit it off with one another personally. Munger was a really smart guy. After joining the US Army Air Corps in1943, he scored highly on an intelligence test and was sent to study meteorology at Caltech. After the war he was accepted into Harvard Law School despite lacking a formal undergraduate degree, and graduated summa cum laude.

In his 50s, Munger lost his left eye after cataract surgery failed. A doctor warned he could lose his right eye too, so he began learning braille, but the condition improved.

He entered law practice, and eventually started his own firm, but he became more interested in investing. He racked up 19.8% annual returns investing on his own, between 1962 and 1975. Buffett convince Munger to give up law and join him as vice-chairman of Berkshire Hathaway in 1978.

Perhaps Buffett’s most famous investing saying is “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”. He credits this approach to Munger: “Charlie understood this early – I was a slow learner.” Before being influenced here by Munger, Buffett had been more inclined to buy very low-priced shares in mediocre companies.

Munger was heavily involved with Buffett’s decisions. “Berkshire Hathaway could not have been built to its present status without Charlie’s inspiration, wisdom and participation,” Buffett said following Munger’s death. That tribute is no overstatement: from the time Munger joined Berkshire Hathaway in 1978 till now, shares of the company soared 396,182% (i.e., $100 invested in Berkshire Hathaway in 1978 is worth $396,282 today). This performance dwarfs the 16,427% appreciation of the S&P 500 over the same time period. When he died, Munger was personally worth $2.6 billion.

(See more on Berkshire Hathaway’s formula for success at: Warren Buffett’s Secret Sauce: Investing the Insurance “Float” )

Quotations From Vice-Chairman Charlie

The internet is rife with sites displaying memorable or useful quotes from Charlie Munger. For example, “I never allow myself to have an opinion on anything that I don’t know the other side’s argument better than they do”; and three rules for a career: “1) Don’t sell anything [to others] you wouldn’t buy yourself; 2) Don’t work for anyone you don’t respect and admire; and 3) Work only with people you enjoy.”

Some of these quote lists focus on sayings which provide guidance to individual investors, such as this from CNBC:

“I think you would understand any presentation using the word EBITDA, if every time you saw that word you just substituted the phrase, ‘bull—- earnings.’ ″

The 2003 Berkshire shareholder meeting was one of the many occasions Munger called out what he saw as shady accounting practices, in this case EBITDA — a measure of corporate profitability short for earnings before interest, taxes, depreciation and amortization.

In short, Munger felt that companies often highlighted convoluted profitability metrics to obscure the fact that they were severely indebted or producing very little cash.

“There are two kinds of businesses: The first earns 12%, and you can take it out at the end of the year. The second earns 12%, but all the excess cash must be reinvested — there’s never any cash,” Munger said at the same meeting. “It reminds me of the guy who looks at all of his equipment and says, ‘There’s all of my profit.’ We hate that kind of business.”

To invest like Munger and Buffett, don’t fall for the flashiest numbers in the firms’ investor presentations. Instead, dig into a company’s fundamentals in their totality. The more a company or an investment advisor tries to win you over with esoteric terms, the more skeptical you should likely be.

As Buffett put it in his 2008 letter to shareholders: “Beware of geeks bearing formulas.”

Munger’s Secret to Happiness

Out of all these witty and helpful quotes, I’ll conclude by zeroing in on what Charlie Munger thought was the single most important factor in achieving personal happiness. He said it a number of different ways:

The secret to happiness is to lower your expectations. …that is what you compare your experience with. If your expectations and standards are very high and only allow yourself to be happy when things are exquisite, you’ll never be happy and grateful. There will always be some flaw. But compare your experience with lower expectations, especially something not as good, and you’ll find much in your experience of the world to love, cherish and enjoy, every single moment.

and

The world is not going to give you extra return just because you want it. You have to be very shrewd and hard working to get a little extra. It’s so much easier to reduce your wants. There are a lot of smart people and a lot of them cheat, so it’s not easy to win.

and finally:

A happy life is very simple. The first rule of a happy life is low expectations. That’s one you can easily arrange. And if you have unrealistic expectations, you’re going to be miserable all your life. I was good at having low expectations and that helped me. And also, when you [experience] reversals, if you just suck it in and cope, that helps if you don’t just stew yourself into a lot of misery.