Hacker Finances: Introduction

“Silicon Valley”, HBO

A hacker’s deep desire for understanding how things work translates into a prolonged focus on the technical attributes, merits and demerits of the systems that capture their interest. The more complex the system, or the more reducible its complexity, the more intense this focus can become. This interest can be relentless to the extent that while engrossed in the system, a hacker attends to little else. Their health, their relationships and their finances may get sparse attention.

Managing one’s finances is in the same realm of importance as managing one’s health and relationships and poor financial circumstance will reduce a hacker’s efficiency, just as poor health would. Still, many hackers don’t find the time or interest to focus on their finances, and their financial circumstances under-perform. And, as it happens, one’s finances comprise a system itself, with sufficient complexity to capture the hacker mind, at least long enough to profit from occasional focus.

Personally, I’m waning into the realm of graybeard hacker. I’m faced squarely with the prospect of retirement and decreasing employment opportunities. I’ve accumulated a reasonable nest egg, not through windfalls of liquidity events, but through a lifetime of ad-hoc, trial and error investing. I paid my tuition in financial management to companies like Noodles & Company (-74%), Gupta Technologies (-82%) and Copper Mountain Networks (-101%) [1]. In spite of those embarrassments, I’ll be the first to admit, a rising tide raises all boats. One of them was mine. Over the last 25 years of my investing life, the NASDAQ stock market rose at 9.6% on an annualized basis, and housing in my region rose at 4.4%. That means that if you had invested $20,000 in the NASDAQ in 1991, it would now be worth $197,732, and a $100,000 home purchased in my region in 1991 would now be worth $290,000. No special knowledge was required to take advantage those gains. You just had to have a boat in the water.

To give a flavor for the nuance of investing, which is a better investment, the NASDAQ or real estate? Clearly, 9.6% annually exceeds 4.4%. However, assuming you’re taking an $80,000 mortgage, the 4.4% starts on a $100,000 basis, whereas the 9.6% starts on a $20,000 basis. Basic math tells us that at some point in the future, no matter the initial starting difference, the higher return will prevail. But if that time period is longer than an investing lifetime, the real estate yields a better, usable return. The two investments, based on these assumptions, cross over in 34 years[2]. So the stock investment does not generate a greater absolute return than the real estate, unless you sit on it for 34 years. It may look like the home is going to be a better investment [3]. But even that reasoning is not necessarily conclusive: Real estate is not a liquid investment. If for some reason you need the cash from the equity in your home, it can take a month or more to actually get a 2nd mortgage, and longer if you need to sell it outright. Not to mention, you’ll still need a place to live. Compare that to the stock investment, where you could have the cash in your account in seconds when the market is open. Ideally, you’d like a portfolio that is diversified to include both attributes: The better return of leveraged real estate, and the liquidity of stocks. But how to do that when you’re just getting started?

Suffice it to say, every hacker is going to have a different system for financial management. Age, time in profession, family situation, the region you’re in, and most importantly, the way your desires for your current lifestyle play against your plans for the future, all factor when considering where to start, how to apportion your investments and how those apportions modulate over time.

Let’s get started. Like managing your physical health, it is beneficial to pay a little attention daily to how your finances are doing. For your health, you might do 50 sit ups daily or bike to work. And you might constrain eating in restaurants to weekends. To get a sense for investing, check how the major stock markets are doing each day, and take a look at the headlines to see what economic factors are influencing them. Perhaps find a stock you are interested in and track it. Learn the internal and external forces that can push the price up or down. Once in a while, take a look at real estate prices in your area and understand what is causing them to change. Check in on interest rates every few months, both the major indexes that the government manages, and the rates paid for municipal bonds and certificates of deposit. Take a look at mortgage rates. Just like a set of sit-ups, all of this should take no more than a few minutes a day, but over time, it will provide you with a sense of what is normal in the economy, what is not normal, and how the various investment opportunities are affected by economic behavior. This basic understanding, call it keeping your finger on the pulse of the economy, is critical at those rare times when the economy is not normal and you may need to react, or, when you have important financial decisions to make.

With that framework, here’s a prelude to the first discussion on “Adopting a Saving Lifestyle”. Yes, there are ways to make money from other people’s money and start with little or no cash. You could buy stocks on margin, take a 2nd mortgage on your home if you have one or cash out a credit card. These may seem like viable financial options, but they all involve taking on debt. There are places where debt is reasonable, but borrowing for the purpose of investing can lead to ruin. As a reality check, I had a conversation with my wife about taking a second mortgage and investing the cash in the stock market. At the time, the idea seemed like it was worth exploring. My good friend had done it, as had a neighbor on my street. My friend borrowed $50,000 against his home and my neighbor borrowed $100,000 against his. My friend invested the money in a company called VA Linux. If you recall VA Linux, you know what happened. This conversation with my wife was in 1999. VA Linux, like so many others, evaporated over a few weeks of furious panic in 2000 and my friend’s second mortgage went with it. My neighbor didn’t say where he invested his cash, but he had to sell his home and move out of the state. As my very good fortune would have it, and it is just fortune mind you, not insight, my wife and I never took the conversation far enough to make a decision and were spared their fate. The lesson has been indelible.

My strong recommendation is to first lay the foundation with a basic investment strategy that has little chance of being wiped out and requires little daily oversight. That means saving money and investing what you save in ways that do not require a lot of managing or finesse. Mutual funds are most likely the place to start. But first, you’ll need something to put in them. You’ll need to “Adopt a Saving Lifestyle”.

Coming soon to a display near you:

· Hacker Finances: Adopting a Saving Lifestyle

· Hacker Finances: Stocks Versus Mutual Funds, Part I

· Hacker Finances: Stocks Versus Mutual Funds, Part II

· Hacker Finances: Stocks Versus Mutual Funds, Part III

· Hacker Finances: Growth, Value and Income Stocks

· Hacker Finances: Renting Versus Owning a Home

· Hacker Finances: Family and Major Life Expenses

· Hacker Finances: Transitioning from Growth to Income

· Hacker Finances: Investing for Cash Yields: Bonds

· Hacker Finances: Investing for Cash Yields: Dividends

· Hacker Finances: Investing for Cash Yields: FinTech

· Hacker Finances: Accredited and Certified Investing

· Hacker Finances: Retirement

[1] By the time I sold CMTN, the value of the shares was less than the cost of selling them. So I lost more than 100% on the purchase. There are ways to do worse, but that was a pretty conclusive fail, I thought.

[2] 1.096 raised to the 34 power = 22.57142. Times 20,000 = 451,428. 1.044 raised to the 34 power = 3.97. Times 100,000 = $432,332.

[3] Ok, here is the math on the example:

The $20,000 in the stock market is simple. Invest it in a NASDAQ mutual fund and leave it for 25 years and the $20,000 becomes worth $197,500. So your profit is $177,500.

The home is much more involved, and we have to make some assumptions about down payment, mortgage interest rate, the influence of the mortgage interest on your income taxes (it is deductible), the mortgage payments and in many states, property taxes (also deductible). Let’s assume you’ve put 20% down on the home and took a traditional 30 year mortgage at 7.5%, the prevailing rate in 1991. Over 25 years, your payments would total $167,811, of which $60,237 is principle. Property taxes vary widely by state. It is about 1% of the purchase price annually in California. But you have to have a place to live, so if you weren’t making mortgage payments, you’d be making rent payments.

All of that makes it really involved to model, and I’ll go into it in gory detail in my post on Renting vs. Buying.

So for the sake of continuing the example, let’s oversimplify and say that the rent on a home would exactly offset the ongoing cost of owning. With that assumption, your profit on the $20,000 down payment in 25 years would be $290,000 — $20,000 = $270,000.