The action in Iran has dominated headlines over the past month, and for good reason. Unless your head has been buried in the sand, you’ve likely noticed the sharp rise in gas prices. Without a doubt, this event has introduced additional volatility into the financial markets. But how will this conflict affect your investments? As with most things its tough to say, but in large part I think it depends on how long the conflict lasts.

Up to this point the US and Israeli armed forces have relied on a large volume of airstrikes and likely some clandestine special forces operations to degrade Iran’s air defenses, eliminate Iranian political and military leadership, and generally just destroy any vulnerable military assets in Iran. Iran has responded by launching a variety of drones and ballistic missiles at both military and civilian targets as well as interrupting the flow of energy-related commodities through the Strait of Hormuz.

Israel and the US have had varying degrees of success protecting against Iranian attacks by using high-tech missile systems. But the US has yet to deploy any “boots on the ground” in significant numbers, although there are indications that the Pentagon is mobilizing some ground forces including a Marine Expeditionary Unit and parts of the 82nd Airborne Division. If I had to bet, I think that boots on the ground will be required to restore and maintain the flow of ships and fuel through the Strait of Hormuz, but of course I could be wrong. And of course, this is all complicated by the notion that a large deployment of US ground troops would likely be VERY unpopular from a political perspective.

So to my mind, I believe there are two likely outcomes.

1. A resolution to hostilities within the next month or two.
2. A prolonged engagement lasting another 6-12 months (or more).

If the Iranian mission is short-lived, then we’ll likely see many of the changes in the market reverse gradually. These would likely include a drop or stabilization in oil prices, a recovery in global stock prices, and reduced anxiety around future inflation. There has already been a significant amount of damage inflicted on energy infrastructure in multiple countries, but it’s possible that repairs could be executed and energy markets could adapt to adjust around any longer term repair work.

However, if both sides “take the gloves off” and start targeting energy infrastructure with more intensity, then a variety of ill effects are could come into play.

Higher inflation

First off would be the potential for elevated and persistent inflation in the mid-to-long-term. Hydrocarbons (i.e. oil, natural gas, etc.) still represent the lifeblood of our modern economies. So higher oil prices will boost a

As an example, the quickest way to estimate future long-term inflation is by comparing the yields on a standard treasury bond with the comparable treasury inflation-protected security (TIPS) bond. The current 10 year TIPS yield is about 2.1% and the current 10-year treasury yield is about 4.4%. This indicates a breakeven inflation rate of about 2.3%/year over the next 10 years. To me, this indicates that at least the treasury market isn’t too concerned about inflation. However, if oil prices reach $200+/bbl and stay there for a long time, then we could see a much higher realized inflation rate in the future.

Risk to reserve currency status

We could also see increasing risk around the US dollar’s status as the global reserve currency (albeit this would likely happen over a long period of time). Right now, the US dollar is widely used in global commerce, and the vast majority of all oil trading is priced in dollars. This provides a boost to prices of US treasury bonds as many countries use them to park their US dollar holdings. This helps keep US borrowing rates down and helps to finance US deficit spending.

However, based on this piece by Ray Dalio, a well regarded hedge fund investor, if the US cannot secure the free flow of goods through the Strait of Hormuz, or even if it takes the US a long time to do so, then the global economy could deem the US to have lost the conflict with Iran. Combined with unsustainable deficit spending of 5+% of GDP, you have a recipe for both human and financial capital looking for alternative homes outside the US.

For those who believe that the US military has all of this well in hand and will wrap things up soon, Dalio offers a good quote that I think is important to keep top of mind when analyzing any military conflict… “In war, one’s ability to withstand pain is even more important than one’s ability to inflict pain.”

Higher interest rates

All else equal, higher inflation would likely lead the Federal Reserve to raise short-term interest rates. If the international community begins to lose faith in the US dollar and sell off US treasuries, then we could see longer-term interest rates increase. We’ve already seen interest rates increase by about 0.4%, but that’s pretty negligible for the average investor. A longer engagement in Iran could drive rates much higher.

Possible recession and declining stock prices

Higher inflation and interest rates would likely cause a drag on economic growth and could very well induce a recession in the US. And at current valuations, a recession could very likely lead to a re-pricing of US stocks. As I outline in my investment philosophy, I believe that all long-term investors should expect to endure a decline of 50+% in stock prices at various points in time. Do I think that will happen in this case? Not really, but anything is possible. Thankfully, large declines in stock prices only happen rarely (about 3 times in the last 50ish years), but they are a risk and Iran likely elevates the potential for large stock market moves. Smaller declines are more frequent, but as you can see in the following table, it’s not too hard to wait them out.

So what should I do?

The short answer is likely nothing. Unfortunately, investing ain’t easy. It’s risky and fear inducing, and can often be downright miserable. But loads of academic research has demonstrated that market timing is a tough game to win, so be wary of market prognosticators who advise selling all of your stocks and going to cash.

If you have a investing plan or strategy, staying the course is generally your best option. It never hurts to review your target asset allocation. And of course if something significant has changed in your financial situation, then take time to reevaluate your strategy. If you MUST do something, consider making a small change to see if that helps you feel a bit better. For those investors without a plan, it’s never too late to craft one!

The short answer is not really. Here’s why:

#1 – Any proposed allocation would be tiny

Take a look at this article by Morningstar. In the last paragraph, Arnott points out that global private equity assets totaled about $11 trillion and the public equity markets totaled about $115 trillion. So the combination of private + public is about $126 trillion. Private equity represents 8.7% of the total. So if you are a passive investor and want to replicate the entire global stock market (private + public), then you would allocate 91.3% of your stock allocation to public equities and the other 8.7% to private equities.

Most people – especially retirees – don’t hold 100% stocks. What about a portfolio comprised of 50% stocks and 50% bonds? Then your theoretical allocation for private equity should be about 0.5 x 8.7% = 4.3% of your portfolio.

In the grand scheme of things, a 4% allocation won’t really make much of a difference. In fact, a 4% allocation for almost anything won’t really move the needle all that much. For example, if you are trying to decide whether you should own 50% stocks or 54% stocks, just flip a coin and be done with it. When it comes to asset allocation, I always recommend thinking in chunks of 10%. Anything less really isn’t worth the time or effort.

And this all assumes that you actually want to allocate a full share to private equity. As Arnott points out in the article, many investors will be scared off by the high fees and liquidity constraints of private equity funds, which could induce an investor to underweight their PE allocation. I have seen this play out quite often reviewing portfolios for potential new clients. If they have PE funds (or really any private investment), then it’s generally a pittance or token allocation. Often, just enough to offer the illusion of a more clever portfolio. But in practice, the portfolio would likely perform just the same (if not better) by removing the private equity allocation.

If you aren’t going to make a meaningful allocation to private equity, then you’ll likely be better off not making any allocation at all.

#2 – You’ll end up playing with the B-team or worse

The work of money managers, like most work produced in life, is 90% crap. This applies to PE fund managers as well. The biggest and best private equity firms (i.e. the top 10%), will almost always get the best deal flow with the best terms. These firms can also attract the best or most skilled investment professionals. All of this enables the top tier firms to generate the lion’s share of returns and out-performance (with much of that “alpha” flowing to the fund managers themselves).

Unfortunately for all of us regular folks, top tier PE funds are in high demand and mostly only take new capital from large institutional investors (think pension funds, university endowments, or billionaires). They won’t take your money unless you can write a check for $100 million. Let’s call these top tier firms the A-team.

The 2nd tier of private equity managers (let’s call them the B-team), are smaller or regional firms. Perhaps they have some reasonable competitive advantages such as an effective niche market or a talented founder or CEO. They may deliver some positive results, but likely not with the scale or consistency of the top tier firms. And they are going to be the second call for many companies looking to transact. That first call is going to the A-team firms.

We’ll call everyone else the C-team. These are the under-performers. They may have good marketing and sales practices which help them gather investor capital, and they may benefit from a positive market environment. After all, it’s easy to make money when the market is trending up. This can paper over any problems for a good long while. But eventually, results will demonstrate that these firms don’t have any true skill or competitive advantage in the marketplace. Clients of C-team firms would almost certainly be better off by simply owning a passive index fund.

Now what if I said that there are about 19,000 private equity funds in the US? What do you think your chances are of picking one of the few fund managers that has real skill and will generate good results? Remember, you can’t access the A-team, they are booked up. You’re forced to pick a B-team fund manager (or worse). Good luck.

#3 – Private Equity is really just leveraged small-cap exposure

Verdad Capital has made a convincing case that private equity investing is akin to buying small-cap companies, but using a lot of debt (or leverage) to do so. This makes intuitive sense, because this pretty much describes exactly what private equity funds are doing everyday. These funds are going out into the market and buying up small(er) companies and structuring the deals such that they put minimal amounts of their own capital at risk. Most of the capital used to make investments comes from the target company taking on significant debt.

Private equity companies likely do have some advantages over a leveraged small-cap strategy. This is mainly in the form of effective financial engineering and access to low cost debt capital. But even consumers these days have methods for accessing low-cost borrowing if they want to try to replicate PE returns leveraged small-cap investments.

#4 – The fees are very high

Here is a screenshot from the Morningstar article listing some retail private equity fund options. These are generally B and C tier PE funds – remember that A tier funds won’t take your money. Note the fees.

I’m going to ignore the Cashmere fund as an outlier. The remaining funds have an average annual fee around 2%. This means that a low-cost, passive index fund has a 2% head start each year. That’s like being in pretty good shape and running 5K race with a 5 or 10-minute head start. The elite runners (A-team) may be able to catch you. But the B and C-team folks will struggle to do so.

#5 – PE funds often engage in volatility “laundering”

One thing that attracts many investors to PE funds is the notion that they are less volatile than their publicly traded counterparts. This is a fallacy however. There’s no magic rule that says the value of a private company will fluctuate less than a public one. If two identical companies existed, and one was public and one was private, their intrinsic value and market prices should move in lockstep.

To lessen visible volatility, PE funds simply update their pricing less often and/or don’t fully adjust the values of portfolio holdings to reflect market conditions (i.e. during a stock market crash). This is known as volatility laundering and it gives PE funds the veneer of higher risk-adjusted returns (i.e. same or better return with less volatility).

And from the point of common sense, since PE funds mainly invest in small companies, and have less diversification than a passive index fund, there should be more volatility, not less.

Unfortunately, volatility laundering is not a bug, but rather a feature when it comes to the private investing ecosystem. Many PE fund investors are quite aware that the volatility is being laundered, and they are generally ok with it. After all, if your run a university endowment and your PE fund managers are artificially suppressing volatility, then it makes your risk-adjusted returns look better. You can then use this data in your annual performance report and argue for a bigger bonus. Many people in the institutional investing space stand to benefit from volatility laundering, this includes financial advisors that incorporate PE funds in client portfolios. As Charlie Munger used to say, “Show me the incentive and I’ll show you the outcome.”

Thanks for reading!

This is a common question posed by clients to financial advisors. I honestly couldn’t tell you how many times I’ve discussed this issue with clients, but it’s definitely one of the most common concerns of new retirees.

An IRA rollover is often an irrevocable decision. Please go into the choice fully informed. Here are some factors (in order of importance) that I like to think about when making this decision:

Investment costs and advisory fees

This is easily the most important factor. If your 401(k) or other qualified retirement plan is run by a large, efficient organization, then it’s likely the plan has low costs and reasonable fees. However, even this day in age, there are many 401(k) plans with very high fees. If your 401(k) plan has high fees, then switching to an IRA could make sense.

However, if you’re working with a financial advisor, then it’s important to consider any marginal advisory fees. For instance, if your financial advisor charges the typical 1%-of-assets on your IRA assets, but not on your 401(k) assets, then your advisor has an obvious conflict of interest and you’ll want to take a closer look.

Small business owners (i.e. plan sponsors)

If you own a small business with a 401(k) plan for the employees, then it’s likely that you’ll want to terminate the plan upon your retirement to avoid the significant costs around 401(k) administration. At that point, you generally must execute an IRA rollover.

Consolidation/Simplification (+ RMD tracking)

Some people might put consolidation considerations down further on this list, but I’m a huge fan of simplifying and consolidating accounts. I just believe that many people massively underweight the benefits of a simplified financial life.

I once worked with a client who had 35+ accounts spread across about six separate custodians, including about ten old 401(k) accounts. Fortunately, we were able to consolidate all of these accounts down to three (joint account + 2 IRAs), all at a single custodian. When everything was said and done, the client was thrilled! Way less administrative hassle.

When it comes to tracking RMDs, 401(k) accounts each require a separate distribution. For IRAs, you can take a single RMD to cover all of your IRAs. Generally, the fewer RMDs you need to keep track of, the better.

Tax planning

There are a host of tax planning considerations when it comes to IRA rollovers. For order of importance purposes, I’ll treat them as a single unit.

• Backdoor Roth IRA contributions – if you plan to continue working and your AGI is too high for direct Roth IRA contributions, then an IRA rollover will make it much more difficult to execute a backdoor Roth IRA.
• Removing after-tax basis from an existing IRA – if you have after-tax basis in your IRA, then it can sometimes make sense to go in the other direction and do what’s known as a “reverse rollover”. In this case, you transfer pre-tax IRA assets into the 401(k) plan (if the plan rules allow). The remaining funds in your IRA will be after-tax dollars, which you can then convert to a Roth IRA with minimal tax issues.
• Delay an RMD on the 401(k) assets – this applies to individuals who are still working + over RMD age + less than 5% owner of the employer. If you want to delay your RMD, skip the IRA rollover.
• Tax withholding flexibility – taxable 401(k) distributions have a mandatory 20% tax withholding. IRAs do not.
• Qualified Charitable Distributions (QCDs) – only IRAs are eligible for QCD treatment.
• Beneficiary Roth Conversions – qualified retirement plans allow you to convert non-spouse inherited assets to an inherited Roth IRA. Can’t do that with an IRA.
• Tax efficient payment of advisory fees – if your financial advisor charges an advisory fee on your 401(k), then you almost certainly have to pay those fees from a separate account (such as a taxable brokerage account). An IRA rollover would allow your advisor to deduct the portion of the advisory fee attributable to your pre-tax IRA from that account. In essence, you can likely pay a (larger) portion of your after-tax advisor’s bill with pre-tax dollars if you execute an IRA rollover.
• Net unrealized appreciation (NUA) – individuals who own low-basis employer stock in their 401(k) can take advantage of NUA tax treatment.

Liquidity planning

Your liquidity needs will also affect the IRA rollover decision.

• Plan loans – in many cases, you can borrow from your 401(k) plan. You can’t borrow from an IRA except with a 60-day rollover.
• Early withdrawals – if you need funds prior to age 59.5, then you’ll likely want to avoid early withdrawal penalties. If you plan to separate from service with your employer after age 55 (or 50 in some cases) and don’t want to use rule 72(t), then your qualified retirement plan likely offers better liquidity. But if you need the funds for higher education expenses, a first-time home purchase, or some health insurance premiums, then an IRA rollover can offer additional liquidity.
• Payout options – some qualified plans require a 10-year payout period. IRAs do not.

Quality of investment options

Most 401(k) plans offer a pre-determined “menu” of investment options. The investment options in an IRA are generally much more flexible. However, there can sometimes be workarounds. Many large 401(k) plans offer a “brokerage window” option, where you can invest your 401(k) plan assets just like you would inside an IRA.

Creditor protection

All else equal, qualified retirement plans covered by ERISA can offer a bit better creditor protection. Many folks focus on this factor to the exclusion of all the others. However, if you have sufficient liability insurance coverage, I would argue this a fairly minor factor. If creditor protection is a top concern, then consider talking with an attorney about your options in tandem with the IRA rollover decision.

Spousal beneficiary choice

If you are married, then you need your spouse’s permission to name someone else as primary beneficiary on your 401(k) account. IRA beneficiaries can be changed without approval.

Which is better?

At the end of the day, the choice of whether or not to execute an IRA rollover will depend on your personal circumstances. As I mentioned earlier, the key factor for most people is the difference in fees. For flat fee advisors like me, our fee generally doesn’t change when clients decide to execute an IRA rollover (or not). As a result, I like to believe that I provide a viewpoint with less bias than the average financial advisor.

But be sure to review all of the above factors before making a decision! For some people, even minor factors can have a big impact on the success of an IRA rollover.

Thanks for reading!

Obviously, no financial professional can guarantee a certain investment or financial outcome. The future is unknowable after all, and the best we can often do is come up with a plan and make prudent adjustments over time. However, I wanted to share some rules that I think can bring the chances of financial success as close to 100% as possible:

#1 – Start Early

Without a doubt, starting early down the path of financial discipline will pay tremendous benefits over time. As the proverbial tortoise did when racing the hare, one doesn’t need to run at a full on sprint to win the race. Slow and steady progress is what matters.

#2 – Save 15% for retirement

True wealth comes from spending less than you earn. Someone who earns $1,000,000 per year will never be wealthy if they live paycheck-to-paycheck (surveys indicate that 40% of people making $300,000+ live paycheck-to-paycheck).

Someone earning $50,000 per year can retire in their 30’s with proper spending discipline and planning. Saving 15% for retirement is a supreme gift to your future self.

Saving is important. But how you save can make a big difference. Making full use of tax-advantaged accounts for retirement savings can often add 1-3% per year to lifetime returns. By “full use” I mean maximizing contributions, getting all employer matching funds, and keeping assets in the accounts for as long as possible.

#3 – Make compounding work for you, not against you

Compound interest cuts both ways. If you have credit card debt, the 25%+ interest rate is like compounding in reverse. Keep debt to a minimum and never borrow money to purchase a car or any “toy” (i.e. boat, 4-wheeler, RV, etc.). Sure, if your car dealer offers a $1000 incentive to take out a loan, go ahead and take it out, but pay it off within a few months.

#4 – Hedge or avoid life changing risks

There are a few components to this.

First, buy sufficient insurance. If a house fire will destroy your finances, then you need insurance. Be sure to cover property, life, disability, medical, and liability risks.

Second, use commonsense. Drive safely. Remove hazards in or around your home (i.e. get rid of that giant trampoline).

Third, diversify your investment risk across multiple asset classes and securities. Think of broad diversification as insurance for your portfolio.

And last, do your best to manage relationship risk. Divorce is a huge financial hit for most people, so choose wisely.

#5 – Invest in yourself

Warren Buffett has extolled the virtues of investing in yourself through lifelong learning and skill development. Many skills are free or very low cost to learn, and can pay off handsomely in the form of a better job or promotion, or even just enhanced self-esteem. Above all, take care of your mental and physical health as best you can. And don’t neglect “soft” skills such as learning to make friends or network with business associates.

#6 – Stay the course

One interesting thing about compound interest is that, early on, you can barely tell that it’s working. Saving and investing for retirement in your 20’s can often feel like trying to fill up a swimming pool with a thimble. But if you stick with it, by your 30’s that thimble will be closer to a milk jug. And in your 50’s you’ve got a 5 gallon bucket! Big things have small beginnings!

However, if you get discouraged and stop filling that swimming pool at any point, then you’ll likely inflict significant damage on your lifetime financial success. So stay the course!

#7 – Be flexible (and relentless)

Last but not least… it’s important to remain flexible. For many people, life is hard. Really, really, really, really hard. And there will be setbacks. For sure. The markets won’t cooperate. You get fired from your job. Your health falters. Whatever horrible thing you can imagine.

But when life hits you, try to bend and not break. Roll with the punches and get back to work. If you put one foot in front of the other, you might be surprised with what happens.

It’s important to review property and casualty (P&C) insurance coverage at regular intervals. Doing so can help save money while still maintaining solid coverage.

Here are a few common mistakes I see when reviewing P&C policies:

Low deductibles

A deductible is the initial financial risk that a policyholder must cover before the insurance company will start paying out on a policy. For example, if the deductible on your car insurance is $250 and your car is damaged, then you will pay $250 towards the repair bill, while the insurance company covers the remaining repair costs (up to the policy’s maximum). Many people choose a deductible and stick with it year after year after year. So the deductible they chose in their 20’s, when they had close to zero savings, might be what they are using in their 50’s. However, if you have an adequate emergency fund or liquid savings, then there are often reasons to consider increasing the deductible.

The first reason is that your insurance company will generally reduce the premium on your policy if you increase the deductible. The savings from the lower premiums can compound over time, and if you can avoid any claims for a few years, you can generally recoup the value of the higher deductible.

Higher deductibles can also help reduce the number of small claims. Insurance companies track all claim activity, and even a small claim can put you in a high risk category for underwriting, which can lead to higher costs over time. By increasing the deductible, you will be incentivized to cover small repair bills on your own and avoid filing a claim. This can also reduce the overall hassle of dealing with your insurance company.

Taken to the extreme, it’s even possible to go with what’s known as a “liability-only” policy. This is most often seen in the context of auto insurance. For example, if you drive an old honda civic with 250,000 miles, it’s likely not worth very much. If the car is damaged, the insurance company likely won’t pay out much above the deductible level. In this case, it could make sense to remove any collision/comprehensive coverage on the vehicle, and just keep the liability coverage.

It’s also reasonable to carry a liability-only policy on a new vehicle if your financial circumstances allow for that. Remember that any insurance coverage you purchase is designed to provide a profit to the insurance company. To the extent that you can self-insure certain risks (i.e. replacing your damaged car), you should theoretically avoid the marginal insurance costs and come out ahead in the long run. Of course, it won’t be fun to write a big check if you crash your car!

No umbrella liability coverage

If you have a large amount of assets, then it’s likely a good idea to carry umbrella liability coverage. This type of coverage offers protection in excess of the liability levels embedded in regular your home/auto liability policies. Umbrella coverage is generally inexpensive (due to not getting used very often), and can provide immense peace of mind in our current litigious society.

Additionally, since umbrella liability coverage is inexpensive, it can sometimes make sense to “replace” some of the liability coverage on your home/auto policy with the umbrella coverage. This merely involves asking your insurance company about the lowest level of liability insurance coverage required on your home/auto policies, which will still allow you to purchase umbrella coverage.

Extraneous coverage

If you have a jewelry policy, roadside assistance coverage, or medical payment coverage, you may consider removing them.

Jewelry policies often cover things like engagement rings, but often the value of those rings is much less than you think (i.e. the diamond market is crazy). On the other hand, many insurance companies offer a discount if you buy a jewelry policy, so sometimes they can make sense.

Roadside coverage through your insurance company is often a bad idea. As mentioned earlier, all claim activity is tracked by your insurance company, including use of their roadside coverage. It’s often a better idea to purchase roadside coverage through a 3rd party such as AAA.

And contrary to common knowledge, medical payment coverage is not for other people. If someone gets hurt on your property, they are covered by the liability section of your policy. Instead, medical payments coverage provides some assistance for your own family’s medical bills associated with a covered event. However, most people can use their health insurance to pay those costs, so the medical payments coverage is redundant in that context.

Talk to your agent and shop around

Some financial advisors sell insurance, but I don’t. I help review coverages and then always recommend working with an independent insurance agent who can help advise on the fine details of any insurance program. This can provide a solid integration of your insurance coverages into your financial plan, while still getting the best expert advice possible. After all, a failure to maintain solid insurance can overwhelm even the best financial or investment strategy.

And be sure to shop around every 2-3 years. You might be surprised how often you can find a better deal when it comes to P&C insurance.

Box spreads = financial innovation?

For avoidance of doubt, my general position is that financial innovation is often terrible for customers. “Innovation” from the perspective of many financial companies merely involves coming up with more creative ways to separate people from their money. Financial innovations too often lead to more complexity. And if I’ve learned anything in my career, it’s that complexity is the mortal enemy of everyday investors. The financial industry simply isn’t very trustworthy in the eyes of the general public.

However, every once in a while, a financial innovation can offer value to regular folks like you and me. A couple of big examples include low-cost, passive index funds and the exchange-traded fund (ETF). Both of these products have improved conditions for investors all over the world and saved trillions of dollars in fees and taxes (not an exaggeration). If you don’t believe me, just ask any investor over 70 what it was like trading mutual funds back in the 1970’s and 80’s.

Are there any recent examples of good financial innovation? In response, I present the box spread as a potential candidate! I admit that the jury is still out on whether box spreads will be helpful or useful to regular, everyday investors, but there are some positive signs for certain subsets of investors (more on that later), so I think it’s worth taking a closer look.

I should also be more precise. Box spreads themselves have been around for a long time (decades). The “innovation” in this case comes in the form of products which allow for more democratized access to the use of box spreads. The two main products we’ll focus on include the box spread lending service from SytheticFI and the Alpha Architect 1-3 month Box ETF (BOXX).

What the heck is a box spread anyway?

In a nutshell, a box spread is a strategy using a combination of four call/put options in a precise way such that you can either lend or borrow at attractive rates and/or with attractive tax treatment. Confused yet? You’re not alone. Just remember that a box spread simply uses options to synthesize a debt instrument.

I’m not going to go into the mechanics on how box spreads are constructed.¹ The important thing to remember is that you can buy (aka “go long”) a box spread to lend money. Or you can sell (aka “short”) a box spread to borrow money. Using a box spread, it’s often possible to lend or borrow substantial amounts of money at rates around 0.20-0.30% above US Treasury yields.

Use caution if you plan to do it yourself

One note of caution is that, for the average investor, trading box spreads is not advisable. As I mentioned before, a box spread involves trading four options in a specific way. And while it’s true that most brokers offer tools to help trade box spreads, if you mess up trading a box spread, it could blow up in your face and leave you with an expensive mess to clean up. For that reason alone, it’s a good idea to be cautious around trading a box spread yourself.

If you work with a large financial advisory firm, it’s possible that they have an in-house trading team that can handle trade execution. But smaller firms (including myself) will likely hesitate to execute box spread trades unless they specialize in doing so.

Mortgage substitute?

Thankfully, it’s possible to outsource the trading (for a fee of course). One company, SyntheticFI, can help execute the trades in exchange for what amounts to an additional spread on the effective borrowing rate.

As an example of how a box spread can help with lending, let’s pretend that you want to buy a house for $500,000. Historically, most people would put 20% down ($100,000) and get a loan from the bank for the remaining $400,000 using a standard conforming mortgage (e.g. 5/1 ARM, 15 or 30 year fixed, etc.). Right now, the current 5 year box spread rate is about 3.8%. To compare apples-to-apples, we’ll benchmark that against the current 5/1 ARM rate, which is roughly 5.5%. Using a box spread instead of a 5/1 ARM could offer 1.7%/year of interest savings at current rates. This translates to about $6,800/year on a $400,000 loan, or about $34,000 over 5 years.² That’s not too bad!

But wait, there’s more! Some additional benefits of using box spreads include:

• No down payment.
• No monthly payment, just a balloon payment at maturity.
• No underwriting, which means fast access to funds.
• No mortgage-related closing costs.
• No escrow requirements.
• Capital loss treatment for the effective interest costs, which can offset other capital gains or ordinary income on your tax return.
• No deduction limit tied to the size of the loan (unlike with the $750,000 mortgage ceiling).
• Continued deferral of embedded capital gains on your taxable brokerage assets.

In addition to mortgages, box spread loans also offer a viable alternative to a HELOC, securities-based line of credit, margin loan, or personal loan.

Sounds pretty good right?

What’s the catch?

Unfortunately, there are some caveats. In addition to the trade execution difficulty, other limitations and downsides to using a box spread include:

#1 – You need a large taxable brokerage account

First, you’ll need a sizeable pool of assets in a taxable brokerage account (box spreads aren’t allowed in IRAs). Much like a portfolio line of credit or margin loan, the assets in your taxable brokerage account act as collateral for the box spread loan. Most brokers will allow you to borrow up to 50% of the value of your taxable brokerage assets, but sometimes you can borrow more depending on the make up of the underlying assets. But generally speaking, if you have a $1,000,000 brokerage account, the most you can borrow is $500,000. Using a box spread loan will subject you to potential margin calls by your broker. If you borrow too much or the markets don’t cooperate, you could be forced to come up with cash in a hurry.

The larger your taxable brokerage account, the more ability you’ll have to use the box spread as a funding mechanism. It’s still possible to use box spreads for smaller loans (say $10,000), but most of the benefit is only available to those investors with large taxable brokerage accounts.

Some of you may be wondering why box spread lending is subject to collateral requirements. After all, you aren’t borrowing from your brokerage firm directly. So can’t you just execute the trades, withdraw the cash, then re-deposit the cash just prior maturity? Well, imagine a guy named Trusty McTrusterton opened a brokerage account with zero dollars in it. Trusty then logs in to his brokerage platform, and sells a box spread worth $100 million. Now Trusty has two things in his account:

1. Just under $100 million of cash
2. A $100 million liability (in the form of four option positions)

Do you think it would be a good idea for Trusty’s brokerage firm to allow him to withdraw $100 million with a pinky promise to repay it when the options expire? No, it would not be a good idea. At all. Brokerage firms wisely force anyone selling a box spread to collateralize the liability with the other securities in the account.

#2 – The loan term only extends to 5 years

Another limitation of the box spread is the time horizon. Due to option mechanics, the most common option product used for box spread lending is the S&P 500 Equity Index Options on the CBOE. Currently, the CBOE only offers contracts out to 60 months. So the longest term you can borrow for is 5 years. If you need a 30-year loan, you’ll need to look for a regular mortgage product.

#3 – It’s hard to pay off early or make changes

Box spreads are also not easy to pay off early or adjust once executed. To do so, you need to buy back the strategy at then prevailing prices. For instance, if you take out a 5 year box spread, but decide later that you don’t need it, then you could incur a cost to unwind the position, especially if interest rates have shifted in the time you’ve had the position on. Generally, it’s best to hold a box spread loan until the options expire.

If you plan to borrow money on a revolving basis, that is borrow some money for a bit, pay it off, borrow some more, pay it off, etc. then it’s likely better to use a product like a HELOC or securities-based line of credit. It’s possible to use box spreads to facilitate revolver-type borrowing, but it would require more administrative hassle and trade execution risk.

#4 – The tax reporting gets more complicated

The effective interest charges on a box spread loan are treated as capital losses on your tax return. 60% is a long-term loss and 40% is a short-term loss. But you’ll need to make sure and let your CPA know about what you’re up to so they can correctly report everything on your return. I admit that this is a minor drawback as you’d likely have to do a similar level of admin work for loan interest expenses and your brokerage firm will likely do most of the heavy lifting by reporting the amounts you need on your 1099.

The risks are manageable

With all of the downsides I listed, I still think the risks of box spread loans are manageable. For example, if you are extra careful about the trading, you’ll limit issues around trade execution. Or you can use a HELOC as a backstop funding source in case markets crash and you receive a margin call. Another strategy is to use a series of smaller box spreads instead of one large one to allow for flexibility.

The other side of the coin

Most of this post has focused on using box spreads a source of cash. But you can also lend money to others using a box spread. After all, if so many people are borrowing money using box spreads, somebody must be lending to them right?

The main product in this space is the Alpha Architect 1-3 month Box ETF (BOXX). BOXX is a short-term fixed income fund that offers an alternative to investing in something like treasury bills.

There are two main benefits to using BOXX.

#1 – A slightly better yield than treasuries

With BOXX, you can lend money at rates 0.20-0.30% over treasuries. However, this is offset by the fund’s management fee of about 0.20%. So basically a wash.

#2 – A unique tax treatment

The second benefit is a unique (and disputed) tax treatment. Generally, if you purchase a treasury bill, or almost any fixed income investment, the interest payments that you receive are taxed as ordinary income. However, the creators of BOXX believe that they have designed the fund in such a way that the interest generated by the fund will be taxed as a capital gain, which generally has lower applicable tax rates.

The idea is, if you buy BOXX and hold it for at least a year, then your interest income could be taxed at a lower rate. The tax benefit could be substantial depending on your personal tax situation. For example, if you are a high-earner in the 37% tax bracket, then converting interest income to a capital gain will cut the tax rate down from 37% to between 15% or 20% (ignoring NIIT because it would apply either way). For ultra-high net worth folks, the tax savings could be substantial. In a nutshell, BOXX’s main value proposition is an enhanced after-tax yield on a short-term fixed income investment.

However, experts disagree about whether BOXX’s tax strategy is actually viable under the tax code. The IRS could decide down the road that BOXX is subject to the same rules and tax treatment as any other fixed income fund. If that came to pass, it could be a mess for investors (although I imagine the IRS could show mercy at the investor-level). And after that point, there wouldn’t be much incentive to invest in BOXX going forward. But as of right now, my understanding is that BOXX is still supporting the more advantageous tax treatment. And most investors are reporting their income in line with BOXX’s view. So we’ll have to wait and see.

The verdict = still unknown

These products are very exciting, but my sense is that it’s still a mixed bag for investors. Some people will see tremendous value from these products, but most won’t have any reason to use them.

I don’t see much risk in BOXX’s tax strategy at the moment. But there isn’t much upside either unless you find yourself in a very high tax bracket and have a lot of capital that you need to park in a short-term investment.

And box spread loans could definitely offer value to certain people. A box spread loan could be a good solution anytime you need to smooth out near-term cash flow issues. Essentially, anywhere you might need a bridge loan. For instance, if you plan to relocate, you could use a box spread to fund the purchase of the new house, and then pay everything off when you sell your old home in a month or two. This would avoid the hassle and cost of getting a mortgage for only a short period of time.

You could also use a box spread loan to simply reduce your borrowing costs. If you have a high interest mortgage, perhaps it makes sense to borrow using a box spread and use the proceeds to pay down the mortgage balance.

There are some good use cases for these products. But as I mentioned before, sometimes keeping things simple is the best way to approach a problem. On the other hand, Albert Einstein said, “Everything should be made as simple as possible, but not simpler.” So maybe a little complexity in the hope of reducing borrowing costs or enhancing the after-tax yield on your short-term bond fund makes sense.

Until next time.

1 If you want more information about the mechanics of box spreads, check out this and this.

2 Actually, the savings would be a bit less do to the amortization of the 5/1 balance.

When the topic of estate planning comes up with a client, often they will explain that they have a plan in place with a will, power of attorney, trust, etc. However, often they overlook an important item… a letter of instruction. To be clear, a letter of instruction (or LOI) is not a legal document and isn’t required for probate, trust administration, etc. However, done right, a letter of instruction can greatly ease the emotional and mental burden on your loved ones in what is likely to be a difficult period of time for them.

In simple terms, a letter of instruction provides guidance to your survivors, heirs, and loved ones. You can tell people where to find important stuff, who to contact for help, or any other information that you think might be helpful in your absence.

A letter of instruction is almost essential in families where one person manages the financial/admin tasks and survivors will face a learning curve to take on these tasks. If two spouses are equally familiar with their financial affairs, then a letter of instruction may be superfluous.

Since letters of instruction are not legal documents, they do not have any proscribed form or structure. Often, you’ll simply want to pretend you are writing a letter to your loved ones. Plain English and heartfelt/honest communication is best. You can include as much or as little information as you want. And nothing is set in stone… feel free to amend your letter of instruction at any point. It is a great idea to make sure that your loved ones know where to locate your letter, and if you feel comfortable doing so, it can make sense to share the letter with others ahead of time.

As a rough guide, here are a few ideas for what you may want to include in your letter of instruction:

Personal Messages

In the event of your death, you may want to deliver personal messages to the people you were close with in your life. These can provide some additional comfort to loved ones. These personal messages could include a packet of separate, individual letters or whatever is appropriate for your needs.

Contact Information

If you die or become incapacitated, your friends and family will want to know. Certain advisors or business partners may also benefit from notification. List out the names and contact information for each of these folks.

Primary contact…  Likely the same person as your executor or trustee. It’s a good idea to provide an alternate or two as needed.

Secondary contacts…  List any friends, family members, employer, business partner, or advisors (including financial, tax, legal, or even spiritual) here.

Dependents

If you have people or pets who are dependent on you, be sure to provide all information needed to secure their ongoing care. This can include minor children, adult children with additional care needs, older adults or parents, or pets.

Include any child support payments you make or receive and the location of any related court documents. Also include contact information for your child’s other parent/guardian if appropriate.

Provide as much information as you can about your dependent. The goal is to inform the new caregiver so they can get up to speed quickly. Information such as hobbies, habits, allergies, diet requirements, medications, doctors, fears, interests, educational details, sports, etc. Make a note of the location of birth certificate, medical records, school records, etc.

If you plan on a family member or friend taking over care for your pet, be sure to include a plan for funding care and any special considerations.

Important documents

List the location of important documents and how to access them. Essential documents generally include:

Personal Documents…

• Birth/marriage/death certificates
• Social Security card
• Will, trust agreement, power of attorney, etc.

Financial Documents…

• Account statements
• Insurance policies
• Pension/annuity documents
• Real estate deeds
• Vehicle titles
• Tax returns
• Business documents

Financial data

Paying bills can get tricky if you aren’t in the habit of doing so. To avoid the agony of late fees, service cutoffs, etc. be sure to leave a list of when bills need to be paid and how much they generally cost. If you have income coming in on a regular basis, list out how much and from what source. List out all of your important accounts (banks, investments, loans, credit/debt cards, etc.). Include the name of each financial institution, account numbers, owners/titling, any beneficiary designations or transfer on death or payable on death (TOD/POD).

If you have a business, include ownership documents and continuity planning instructions.

Tangible property

List out any real estate you own and the location of the relevant documents, including maintenance providers, etc. Be sure to mention any care instructions such as lawn mowing, gutter cleaning, cleaning service, etc. If you live in a rental property, list out your landlord’s information. If you own a rental property, list out the tenant’s information.

List out major personal property such as cars, boats, etc. Provide details on how to care for each item including recommended service centers, warranty information, etc.

List out any personal property that requires special handling (i.e. outside of your will or trust). Generally, this will include items with little monetary value, but high sentimental value such as heirlooms, photo albums, or items with special meaning to a loved one. If you have any items that could be embarrassing and require discretion, you can include instructions for how to protect or destroy them.

Digital property

It’s important to provide access to a list of digital accounts and passwords. Consider using a password manager.

If you want to immediately cancel your Netflix subscription, be sure to mention that. Social media accounts can often be transferred at death, but require special handling.

Any cloud data providers deserve special attention. These days many people store a lot of their important information with services such as Google Drive, DropBox, or Microsoft OneDrive. Provide instructions on how to access and manage this data. If your phone or computer stores large amounts of your personal data, be sure to include instructions around how to access and process that data.

If you have digital assets such as domain names, websites, etc., include detailed instructions for how to manage them or monetize them.

Funeral and obituary

If you have preferences about your funeral or burial plans, be sure to leave them in an accessible place. Generally, your executor won’t have time to access a safe deposit box in time to make the relevant decisions.

Already have a burial plot? Be sure to mention that! List any preferences for a funeral home, services, and final resting place, preferred pastor or religious leader, etc.. If you prefer that people make donations in lieu of flowers, include that information along with the contact information of the charity. Include desires for the funeral ceremony (music, location, speakers, etc.).

Speakers at your service will benefit from details about your life, such as where you were born and where you went to school or other anecdotes you would like shared at your service. Read a few obituaries to get an idea of the information typically required.

If you want an obituary published, provide some bullet points to include (or write it yourself!) as well as details about where to publish it. Don’t forget your epitaph.

Final thoughts

Your letter of instruction can take almost any form that you want. The goal is to reduce the hassle and friction that your loved ones will experience in the aftermath of your passing. Grief is hard enough, so a well done letter of instruction can really help out.

And don’t forget to update your letter of instruction as your life changes. If you can, review it every year or two. When you make changes, consider destroying the old letter to avoid confusion.

When it comes to investing, like many things in life, there is more than one way to “skin the cat”. And while everyone has their opinions, I thought I would share my top ten rules for investing.

1. Stay humble, stay curious… this is the most important rule of all. Overconfidence and lack of curiosity will damage any investor over the long term.
2. Invest for long periods of time… the day-to-day action in the stock market is just noise. Long-term investors have a super power of avoiding the chaos and focusing on what matters most, compounding over time.
3. Avoid doing stupid stuff… Charlie Munger said, “It’s remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid.” Often this takes the form of doing nothing, but no action is better than stupid action.
4. Don’t buy anything you can’t easily sell… for most people, illiquidity doesn’t offer much value. It’s also a good idea to allow yourself an easy way to change your mind.
5. Don’t buy individual stocks or sectors… remember rule #1? I’ll readily admit that I don’t have enough insight to outperform the market. I’ll certainly stay curious over time to see if any new evidence pops up, but right now the research strongly indicates that passive/index investing is the way to go for most people.
6. Keep costs low… high costs are a headwind for any investor. The main costs to keep an eye on are fund fees, trading fees, and taxes.
7. Avoid non-productive assets (e.g. gold, crypto, collectibles)… non-productive assets thrive on fear. Productive assets thrive on innovation, grit, and hard work. Non-productive assets are also next-to-impossible to value.
8. Don’t be the sucker at the poker table… If you don’t know who the sucker is when you sit down at the poker table, it’s you. Avoid investing in a way where your counterparty has a significant competitive advantage. Examples of games you don’t want to play include day trading, options, or other complex derivatives.
9. Avoid alternative investments… Ties in with rule #8 – private equity and hedge fund managers are sharks. Many alternatives also suffer from artificially suppressed volatility so it’s tough to fully understand the risks. Also see rule #4.
10. Don’t mix investing with insurance… most annuities and cash value life insurance products cost a fortune! Nevermind the fact that insurance contracts are quite complex and the insurance company often has the right to change the rules whenever they want. Don’t believe me? Take a look at a structured product or variable annuity prospectus.

In the 3rd quarter, the markets continued to perform well. Large US companies led the way with an 8%+ return, but small and international companies were not far behind. It appears that times are certainly good for stock investors!

However, I believe a dose of caution is in order. Stock valuations have stretched beyond historical norms. Especially in the US. And especially for large companies.

One key tenet of investing = all else equal, higher prices mean lower future returns. In the chart below, the Schiller CAPE ratio – a price-earnings ratio using the average of the past 10 years of stock market earnings – is approaching levels not seen since the dot-com bubble in 1999.

High valuations could represent a significant risk for stock market returns over the next 5-10 years. Those reading this may not remember, but after the dot-com bubble burst, the S&P 500 had a return of essentially zero – that’s right, zero – over the 13 years from 2000-2013 (partly due to the financial crisis in 2007-2009).

However, as long term investors, we must be comfortable with assessing the risks in our portfolios and making changes when necessary. One question I like to ask people is, “How would you feel if your stock portfolio got cut in half tomorrow?” The responses generally range from “mild anguish” to “inconsolable” to “why the hell are you asking me that?” The stark reality is that long term investors must expect to absorb and be able to tolerate losses of at least 50% in their stock portfolios. And to be clear, a 50% draw down is the expected or base case – not the worst case! If you cannot honestly tolerate a 50% loss in your stock portfolio, then it’s likely time to reduce risk.

Obviously, I could be wrong about future returns. My crystal ball is cloudy after all. The important thing to remember is avoid complacency when markets are doing well.¹

Economic update

The economy continues to chug along, albeit with some concerns in the labor markets. Ongoing immigration enforcement, tariffs, and the realignment of the federal government have all combined to stall hiring across various sectors. It remains to be seen whether these are short term hiccups or long term structural issues in the labor markets.

In response, the Federal Reserve Board acquiesced to lower interest rates in September with a 0.25% cut. Likely we can expect at least one more 0.25% cut before year end.

One thing to keep an eye on is the US dollar’s standing in the world. 2025 has been a tough year so far for the dollar, with a year-to-date decline of ~10%.

For US investors, a declining dollar represents a headwind to long term prosperity. As Warren Buffett said earlier this year, “We wouldn’t want to be owning anything that we thought was in a currency that was really going to hell, and that’s the big thing we worry about with the United States currency.”

On the political front, President Trump has indicated a desire to drive the dollar lower in an effort to make our exports more attractive on the international market. Deficit spending also has likely hurt the dollar. The current US federal spending deficit is ~6% of GDP. Many economists believe the deficit must move closer to 3% of GDP to provide long term support for the dollar.

Tax/planning updates

Congress passed the OBBBA over the summer. You can read my thoughts on the OBBBA tax changes here and here. As part of year end tax planning, I encourage all readers to learn about the OBBBA and the potential effects on your tax return for 2025 and beyond. I’ve already started incorporating the changes into my discussions with clients, but if you have specific questions or concerns, feel free to reach out.

¹ And to not lose hope when markets are crashing!

Inside your investment portfolio there are two components to investment growth: cash flow (or income) and capital appreciation. Your cash flow return is what you receive each year in the form of dividends and interest. The return from capital appreciation comes from increases in the market price of your investments over time. Together, these two sources of returns are known as “total return”.

One issue that I’ve encountered is that many people tend to favor the cash flow component and disfavor the capital appreciation component of total return. This is often embodied in the old saying, “never touch the principal.”

Consider Roger, a retiree who is trying to determine the best stock fund to invest in. If Roger invests $1,000,000 in the S&P 500 with a yield of 1.5%, he can expect to receive $15,000 of income each year. But if Roger invested that $1,000,000 in a high dividend stock fund with a yield of 3.0%, he can expect income of $30,000 each year. Is Roger better off with the higher income fund?

Don’t second guess the market

If Roger wanted to follow the “never touch the principal” ethos, he will likely choose the higher cash flow investment, which provides more money to spend each year. However, high cash flow investments don’t guarantee better investing outcomes. In fact, there is a solid possibility that, by focusing on high cash flow investments, Roger could suffer lower total returns over time.

To illuminate this further, let’s go back to the core foundation of passive investing. Namely that financial markets are highly efficient. Put another way… the average investor cannot outperform the market. This isn’t my opinion either. Just read William Sharpe’s seminal article, The Arithmetic of Active Management. Sharpe proves, using basic math, that all investors will collectively match the performance of the market.

Add in investment costs and fees, and investors will collectively underperform market by the amount of those costs and fees. That’s one reason why I always make a big deal out of costs and fees.

If we believe that the average investor can’t beat the market, then why should we favor investments with high cash flow over those with high capital appreciation? We shouldn’t. Our main focus should be on trying to gather the average total return of the broad market, not just the income returns. And often when we try to second guess the collective wisdom of markets, we end up “eating crow”.

What about taxes?

It’s safe to say that investments which pay out high levels of income are tax inefficient. That’s why most advisors recommend locating high income assets (e.g. bonds) in your IRA. Many tax planning opportunities rely on an investor’s flexibility around the timing of income recognition. But, all else equal, investing for high income reduces that flexibility.

As an example, look at Warren Buffett’s approach at Berkshire Hathaway. He famously (or notoriously) refuses to pay a dividend and instead relies solely on buybacks to return cash to investors. This does a couple things. First, it allows the world’s greatest investor to do what he does best, allocate capital. As Berkshire’s businesses generate cash, Buffett can survey the landscape of investment opportunities and allocate capital to the best one available. For example, if Buffett sees a great available investment opportunity, he doesn’t need to forgo it simply to meet the requirements of an upcoming cash dividend to shareholders.

Second, buybacks give Buffett the flexibility around the timing of shareholder capital returns. Simply put, when Buffett deems that shares of Berkshire Hathaway are priced at a discount to intrinsic value, he can go into the market and buy them. If the shares are priced above intrinsic value, he does nothing¹. This stands in contrast to dividends, which generally return capital to shareholders on a fixed schedule that doesn’t account for the price-to-value relationship.

Buffett’s approach to buybacks gives his shareholders the full authority around timing of their own investment income and can often help reduce the tax drag in their portfolios. For example, if a Berkshire investor needs cash, they can sell their shares whenever they want, rather than rely on a fixed dividend schedule. This provides Berkshire investors with an extraordinary ability to defer taxable investment income to the years when it is most advantageous to recognize it.

Safety for principal?

Some people might say, “Well, if I don’t touch the principal and only spend the cash flow, I will never run out of money.” And that sorta makes sense. If you only spend the cash that comes into your portfolio then theoretically your portfolio principal can remain untouched to allow for growth over time. However, there is no free lunch… in many cases if an investor is choosing to invest for higher income payments to justify additional lifestyle spending, then it could result in a lower portfolio value down the road.

You could also argue that investing for higher cash flow can lead you to miss out on investing in some great companies simply because they don’t pay a dividend. Think about technology companies (or even Berkshire Hathaway). Many of these companies don’t pay dividends or return capital to shareholders because they have high quality investment opportunities within the company. In fact, the managers of any company with a truly phenomenal business would be stupid to pay a dividend simply because they would likely have to forgo reinvesting that capital into growing their business.

And at the end of the day, is there actually any difference between a dollar received from dividends vs. a dollar received from capital appreciation? Not really! Money is fungible and if each dollar is the same, then it follows that we should not give a fig whether that dollar reaches our pocket via capital appreciation or income. Our main goal should be to find the best investment opportunities available for every dollar that we have.

So when it comes to investing, consider taking a total return approach. Try not to focus too much on the dividend/interest income generated by your portfolio, but rather aim to craft a high-quality, passive, and low-cost portfolio that can deliver an adequate total return over a long period of time. Let the markets worry about whether your returns come in the form of income or capital appreciation.

¹ It’s important to note that stock buybacks can also subtract value for shareholders. To do it right, company management should only execute buybacks when they can buy shares at a discount to intrinsic value. Many companies do not do this, they just blindly buy back shares whenever they feel like it in order to juice earnings per share results in the near term. Warren Buffett talks extensively about the folly of buybacks in his investor letters.