Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Thursday, May 13, 2021

Tales from the Crypt

 Is Bitcoin and its sister digital currencies really money? 

Money represents work and earnings on that work or skill. It has 3 functions. It’s a medium of exchange. You can buy stuff with it-- trade it for food, housing, clothing, etc. Certainly, we are hearing more and more about cryptocurrency being accepted as a form of payment.

Money is also a store of value. The money I make today doesn’t have to be spent today. I can put it in the bank or under my mattress and store those earnings for another day. Okay, so crypto qualifies here.

Money is also a unit of account. That means the number of dollars, euros, renminbi, required to purchase something has meaning. When I travel overseas and find myself looking at price tags in another country, I’m clueless. They have no meaning to me, but prices in dollars and cents help me to peg a value on a good or service. Wow! That’s a good deal. Or, wow! That’s expensive. This is where crypto falters. Valuations fluctuate so widely that it is hard to translate the numbers to real value. Cryptocurrency lacks stability, and, so, fails the test on this function.

But crypto is pushing the bounds of our definition of money. We have used many types of currency through the ages. Maybe this is just a new one taking hold. At one time, we used whale teeth for money. Of course, the precious metals have had their run—gold, silver, copper. We’ve even used salt for money! Heaven help you if you had a hole in your pocket. Money has gone through many iterations as we humans have looked for ways to move beyond bartering as we trade goods. For a look at a really strange currency, check out The Island of Yap.

Money has 2 forms: commodity money and fiat money. Commodity money has value in and of itself. Think of gold and silver and even that salt. But fiat money has no real intrinsic value. Its value comes from the entity backing the currency. 

Anyone with old Confederate dollars in your attic? They only had value when the Confederacy was alive. Now, they are worthless (thank goodness). Ever pull out some coins from your trip to Canada at the convenience store? Sorry, worthless here. When it comes to fiat money, location is everything. Euros in Europe. Pound sterling in London. Renminbi in China. Each government issues its own currency, and the strength and stability of that currency is correlated to the strength and stability of that government.

But crypto is different. It isn’t issued by a government. As such, it’s not confined to a location and particular borders. And that’s what makes it so appealing. No converting from Euros to dollars and back again, with all the requisite fees in between. Supposedly, it would be universally accepted. No banker is keeping track of your account. The system is self-contained to assure coins are transmitted appropriately.

And crypto seems the natural transition as fewer and fewer actual coins and dollars are used. Rarely do I have actual dollars in my purse. My money is recorded in an account somewhere, and I pull out a debit card or use PayPal or Venmo to make purchases. The currency in my name is just a number on a computer screen somewhere, and isn’t that what crypto is? It’s just a digital currency.

In 2009, someone or some people with the name of Satoshi Nakamoto invented the first truly digital currency called bitcoin. The ability to move vast sums across borders very quickly made it quite appealing to the criminal element. The dark side of this currency caused it to languish until recently. More and more, reputable businesses are trading in and accumulating digital currency.

New digital currencies have sprouted up with names like Dogecoin, Ethereum, and even Polkadot. None are related to a particular government, but each serves different functions. Recently, we heard a presentation by an investment group solely focused on cryptocurrency. They have created exchange traded funds that own crypto and are encouraging advisors to include this in a diversified portfolio. We’re not convinced yet.

Implicit in our current system is the position of an intermediary. These are the folks who are in between each transaction as money changes hands throughout the day. They are the bankers. A digital currency that is self-contained does not need an intermediary. That sounds appealing since it would reduce cost and increase speed. Imagine going to your house closing and pushing the button at the table to transmit your down payment. Voila! Deal done.

But we still worry about the security of such a system. And we worry that the crypto we own today will lose value overnight. So, maybe it’s just not money… yet.

Certainly, crypto investors have been reaping big benefits in the last couple of years. Our presenters from Bitwise Asset Management told us to NOT think of it as a medium of exchange. They describe it as a new technology that can speed up the pace of business while keeping costs low. They also said to think of different types of crypto like different types of software.

It’s all so bizarre! Programmable money? Coins created from mining. Mining is just the solving of a puzzle. Coins stacked in blocks to create a blockchain. Money or not? Sort of. Maybe. But it’s crazy popular right now.

So how do you get your hands on (computers on) some crypto? Well, you can’t go through your regular brokerage account. You’ll have to go through a crypto-exchange like Coinbase or Gemini. Robinhood can give you access. You can also sign up with an investor group. There are several private crypto funds. BITW is the publicly traded exchange traded fund that we heard about.

But be careful. This is new. It’s exciting. It’s cutting edge. But it’s risky. As for us, we’re taking a “wait and see” approach. Digital currency may be the wave of the future, but, right now, it just feels like a tsunami. 


Saturday, February 20, 2021

Financial Resilience And Mutual Aid

We can't plan for every crisis. No matter what your financial resources are, you will find yourself in need some day. While money cannot buy you everything - the community you cultivate around yourself will always be a valuable asset.


There is a type of investor that always believes the world is ending. They may short stocks on the thesis that companies will stop making money, or are just fraudulent houses of cards. They may buy long term US Treasuries, putting their faith in the dollar and nothing else. They may eschew the dollar and our traditional financial system altogether, buying gold coins and bars just in case the apocalypse comes and nobody will take their dollars or buy their stocks.

Many years ago, one of the first investment fund salesman I met with had a streak of world ending beliefs. He painted a different picture, one that departed from a traditional investment portfolio.

“So, do you even garden?”

I explained I had been a gardener from a young age, and had just helped my mom plant blueberries and muscadines in her yard.

“Well, you probably don’t have chickens.”

Funnily enough, my roommate and I had just built a coop and bought three hens. We weren’t the only urban poulterers in the neighborhood either!

As amusing as it was for me to parry each claim of his, he had a unique way of looking at an “end of the world” scenario that has colored my thinking ever since.

He didn’t picture an asteroid wiping out half the earth or a foreign army marching down my street. He painted a picture of general decay, lack of services and a population growing more and more in need. The future he described was one where city and state services were less reliable, supply chains didn’t always link up and communities would be forced to rely more on what they could produce themselves.

In the world he described, your talents and your community are be the most valuable things you possess. As it turns out, these things are a valuable part of anyone’s financial picture. What we have seen recently is that a strong network is a community that supports you in times of crisis.


long abandoned grocery store in Chernobyl
When your world falls apart, who, not what, will you depend on?


It is valuable and important to have skills that you can rely on. The salesman gave an anecdote about darning his socks on a recent business trip, and noted that I had chickens to supply my breakfast every day. Being able to cook for yourself and perform repairs around the house not only save you significant amounts of money in the short term, but make you less reliant on others in the long term.

Many “end of the world” investors may also advocate for preparing for the end of the world: buying farmland, stocking up on canned goods, guns and tools. That is not a practical, or desirable course of action for most people. We can do something that humans have done for millennia: rely on our networks, neighbors and communities for mutual aid.

Mutual aid is simply people helping each other. People have been helping each other since time immemorial, how is mutual aid different? In a world of increased reliance on our friends and neighbors, mutual aid represents a more organized effort to allocate the resources of a network. Importantly, as the name implies, mutual aid is a two way street - you give what you can and receive what you need.

You are the first person that you must be able to rely on. Take the time to practice a new skill instead of relying on a paid service for a small repair. Keep your tools sharpened and your pantry filled for the times when you need to support yourself. When I moved into my house, I spent $800 to have someone replace a few broken window panes. The next cracked pane I noticed was fixed with $20 spent at a local hardware store and 20 minutes spent reading and watching videos.

When I was young, my mother would send me running to the neighbor’s house to borrow a cup of sugar. Being able to rely on a community for needs, small or large, is a huge financial benefit. In the moment of fixing dinner, being able to rely on a neighbor for a single ingredient saves a huge amount of time and strengthens social bonds. I have since leaned on my neighbors for housing for guests in town for a wedding or funeral, help moving, to borrow a truck, job recommendations and even the occasional piece of legal advice.

Your community will support you, but you need to cultivate relationships that you can rely on. People often turn to their churches, neighbors and professional organizations in times of need. Know who your community leaders are and who can connect you with resources when you need it. In the most recent ice storm, I have seen friends sharing important information about city services and offers for hot food. My network can connect me with resources, even if it is not my friends directly supplying them.

It is not a community unless you turn around and support it. Through the years I have also cooked for those in need, helped cut fallen limbs and lent a helping hand where needed. None of this has been a one to one relationship or an intricate system of favors. When you give freely to your community, it grows stronger. A strong community will support you when you are in need.

Supporting your community is how you strengthen it. Volunteer in organizations that you belong to - your church, your neighborhood and professional organizations all have ongoing needs that you may be able to help with. When you see or hear of a neighbor in need - support them. Deliver food for those shut in or suffering 

Looking back on difficult times, we often note that it is the people in our lives that got us through. While income, cash in the bank and insurance help, the biggest impacts come from our community.

Mutual aid can be as small and direct as borrowing a cup of sugar from your next door neighbor, to as big and indirect as helping arrange to feed strangers across your city. In every instance, it forms a valuable part of your well being.



Friday, February 19, 2021

On Preparedness

In every meeting we ask something along the lines of "do you have emergency savings?" The answer is different for everyone, as an emergency looks different to every client. Recently, those definitions have blown up again and again for many of us.

We did NOT see this coming!


One emergency came in March of 2020, when states, cities and businesses themselves closed down or severely restricted service, the economy contracted harshly. Many people found themselves out of income while we waited for customers to be able to return safely. For so long, we have viewed emergencies as a sudden need for cash - replacing a wrecked car, covering sudden medical bills or moving your family across the country. This emergency was one of a drastically reduced income.

Over and over again, I found myself in conversations with clients talking about how this crisis highlighted the unpredictable nature of emergencies, and how broad the task of preparing financially for an emergency is.

Loss of income is an emergency that we can prepare for. The classic advice is to have 3-6 months of your income safely saved away in cash. What we have seen recently is that this advice is not enough. We are nearly a year into this period of high unemployment. If you had three months of income saved and gritted your teeth in March, you would be out of money by June. If simply saving up won't protect you from losing your income, what can you do?

To survive a loss of income, you need savings, a strong community and a resilient budget. A resilient budget is one that can quickly adjust to a new income level. A resilient budget has low fixed expenses and high savings rate. If you are saving 5% of your income, then you are spending, and will need to replace, up to 95% of your income in an emergency. If you are saving 25% of your income, you will only need to replace up to 75%. Importantly, at a savings rate of 5%, it will take 19 months to save a month's worth of expenses, while a 25% savings rate can replace a month's worth of expenses with only three months of saving.

I generally view fixed expenses as things like housing, car and consumer debt payments, utilities and a basic level of groceries and gas. Many of these expenses are locked in for months or years to come with no real opportunity to change. If much of your spending can be cut out in any given month, your budget is flexible and resilient to loss of income.

More recently, snow and ice have blanketed much of the south - a region wholly unprepared for cold weather lasting more than a day. A perfect storm of precipitation and below freezing temperatures froze roads, keeping goods from reaching stores, and customers from getting what they needed. In Texas, oil wells and gas pipelines froze cutting off a vital supply of energy and electricity across the state.

This temporary crisis won't change paychecks for long, but it emphasizes non-monetary preparedness that people can take. Having neighbors that you can rely on for a meal when your power is out, or help clearing ice from your walkway is more important today than the dollars in your savings account. While there will be financial emergencies as people push their heaters to the limits, or slide off the road on the way to the grocery store, our immediate needs will be met with out own preparedness and deep networks.

After crises, many people reflect back on the people that helped them through. This is one of those times.

Over the years I have developed a framework for thinking about emergencies, but no matter how much you prepare, the unexpected can still happen. For the foreseeable emergencies, you need to identify big risks in your own life: aging parents, an old vehicle, a medical risk, or an income that may disappear. Each of these has a cost that can be calculated and set aside for. Setting aside money for regular expenses is important too, and a resilient budget will help there. Lastly, knowing where you will get non-financial resources can help in the most unexpected of crises. Knowing who you can rely on for help when the worst happens will be how you fulfill your immediate needs and stay financially solvent in the long term.

Saturday, February 06, 2021

Has the Game Stopped?

Ultimately what happened is that both side of the trade faced a risk, and they each pushed until they hit that risk. The short sellers risked a squeeze by shorting so much of a small stock and the buyers risked crashing their brokerage with their activity. Those risks were always there, they were just so far out there and obscure, nobody counted on them.

What happened here?

Gamestop is a video game retailer that you may recognize from the last time you strolled through a mall. From 2015-2020 their share price declined over 80% as their foot traffic, sales and profit declined. In late 2019, with the stock in the low single digits, stock analyst Keith Gill noticed that, while beaten up, the stock shouldn't be left for dead. Noting that there was significant cash on the balance sheet and a new CEO promising transformation, Gill, who goes by Roaring Kitty on YouTube bought and promoted the stock online and on an investment related page of Reddit. Many of those in Gill's audience were newer investors using the brokerage Robinhood.

On the other side of this trade were people who saw Gamestop's declining fortunes and saw an increasingly dark future for the company. Those investors sold the stock short. We talked briefly about this the other day, as the action was heating up. We are approaching a resolution now.

One particularly weird facet of this story is that the "short interest" in the stock was 140%. Short interest is the percentage of available shares that are "sold short." In this case, there were more shares sold short than shares in existence. How could that be? 

To back up a little but, buying long is betting on an increase in stock price. To be "long" a stock is simply to buy it at one price, hoping to sell it for more in the future. To be "short" a stock, you borrow the stock from someone who already owns it, and sell it along to another buyer in the market. The "short seller" receives cash up front, pays a fee or interest to borrow the stock, and hopes to buy the stock back and return it to the original holder in the future. The short seller makes money if the stock price declines.

The "short interest" is a gross exposure. The total number of shares being held long, minus the number of shares held short will generally equal 100%. If the short interest in Gamestop (GME) was 140%, that means there were 240% of the number of shares in existence were being held long in peoples accounts.

Say that person A owns 100 shares of GME because they think it will go up. Person B thinks it will go down, so they borrow the shares from person A and sells those shares to person C. Now, person A and C both show that they have 100 shares, or 200 between them, but it is the same 100 shares! Person B has -100 shares, so the net number of shares is still 200 - 100 = 100 shares. To go further, person C could lend out their shares to person D, who believes the stock is going down and sells it to person E. Now there are 300 - 200 = 100 shares outstanding.

This is possible because short selling is structured like a loan to the short seller: they receive money up front, pay interest, and have to deliver the original shares back in the future. Their broker facilitates this loan, so if the price moves against them, the broker may demand more collateral to support the loan.

In the case of Gamestop, there were a few large funds that were short the stock. There was word that one may have gone bankrupt. That loan is secured only to the account/accounts which sold it. If it goes awry and the fund looses 100% (or more!) if their capital, then the broker who loaned them the money in the first place is on the hook (much like if a bank loaned me money to buy a house, and I stopped paying and the house burned down, they’d have to write that loan off).

If that sounds like a risky loan, you are right! Stocks change price every day and in a much bigger way than say, houses or incomes (what other banks loan against). So, these loans are carefully scrutinized and very restrictive. They are monitored daily, and generally the borrower is required to post fresh collateral every day if the price changes. If the borrower doesn’t post collateral, the broker can reach in their account and start selling things for them (a margin call). There are often strict limits on the loan to value ratio typically starting at 50% or 2X leverage (with an FHA loan I can borrow 97% the value of my house, for 33X leverage) (that being said, there are certainly brokers who will loan more and certainly ways that a creative hedge fund can structure their loans to end up more levered). There are regulations that the brokers are under to watch the overall risk of their loan portfolio.

As the price rose dramatically, Melvin Capital lost a ton of money. They received outside investment from other funds, including Citadel Capital, in order to stay afloat. Citadel has two business lines - one is a hedge fund that made the investment in the short sellers, and the other side is a clearing broker that processes trades for Robinhood - the brokerage preferred by many of those buying GME.

This all came to a head when Robinhood stopped people from trading GME, amongst other stocks. This looks like a clear conspiracy, wealthy funds losing money and forcing the brokerage to stop letting people buy, bringing the price back down.

In reality, this is another interesting facet of market structure! Personally, I say let the people have their fun. While I do believe that everyone in the finance industry (advisors, brokerages, etc) have a duty to help maintain a well functioning market to protect investors and encourage participation, this is not like a pump and dump on a penny stock. This is just… misguided fun?

When you place a trade, the brokerage goes out and buys/sells the stock on your behalf. They immediately report to your account that you have the shares, prices, etc. However, it is actually two days before the trade settles. Settlement is just the day that the money and shares actually change hands on the exchange (we call this T+2 settlement, all very fine and normal, they could settle faster if they want, but it gives everyone time to do the ‘paperwork,' effectively). So, for the two days from purchase to settlement, the broker has extended their credit to you. Normally, this doesn’t lead to any issues because buys and sells match up well, brokerages discourage rapid trading (there are regulations to stop that too) and generally a single position doesn’t grow to be too big of a part of the broker’s risk pool.

HOWEVER, with several brokerages, Robinhood primarily, GME had become a very large part of their risk pool. Robinhood is also a smaller, newer brokerage with less capital to call on when things get tight. The DTCC (Depository Trust and Clearing Corporation, through whom trades are cleared) needed a larger deposit to handle that risk, a deposit that was apparently more than Robinhood could stump up. They were then forced to go and cancel client orders and sell positions where they deemed the risk too high.

Ultimately what happened is that both side of the trade faced a risk, and they each pushed until they hit that risk. The short sellers risked a squeeze by shorting so much of a small stock and the buyers risked crashing their brokerage with their activity. Those risks were always there, they were just so far out there and obscure, nobody counted on them.

Where does that leave us? Reports on how many people are short a stock come out with a two week lag, so it is still too soon to know for certain how these trades have turned out. There are already stories of investors, large and small, making a fortune from the dramatic rise in GME. The brokerages facilitating the trading frenzy have made a fortune as well.

Where will Gamestop go? The stock is still much higher than it was last year, but I do not know that the fortunes of the company have changed. A decline in share price, due to short sellers or other market action, is not enough to put a company out of business. While there is some indirect effect of a declining share price on executive and employee morale, companies go out of business because they don't make money. If Gamestop needed more investment to succeed, their rising share price presents an opportunity to raise money cheaply.


Wednesday, January 27, 2021

A Short Story about GameStop

The stock market is an auction house where companies raise money from investors who profit from their growth. Companies rely on stock exchanges to keep an orderly flow of information, money and trades to encourage maximum participation. Most days in the market are smooth, everyone reads the news, makes their decisions and buyers and sellers meet amicably to trade. But every so often comes a day in the market where that order breaks down to extravagant results. 

Today is one of those extravagant days. 

Investors can wager that a company will do well in the future, buying the stock and hoping to sell when the price increases. This is called being “long” a stock. Investors can also make the opposite wager, borrowing the stock to sell it in the hopes that they can buy it back for less later. This is called being “short” a stock.

Enter GameStop (ticker: GME).

GameStop is a retailer, often located in malls, that sells mostly new and used video games. It's sales, profit and stock price have been declining for years. With mall traffic dropping to practically zero last year, things weren’t looking good for the company. Some online analysts held out hope and bought the stock. On the other side of the trade, some hedge funds saw the company going out of business and went short - betting against the stock in a big way.

As market participation gets more social, a huge online community of investors took offense at how aggressively hedge funds had bet against the company. They started buying.

Tuesday, January 12th was a mild day for GameStop. The stock opened at $19.96, traded between $19.32 and $20.40 all day, closing at $19.95. Over the next several days, a flood of buyers pushed the price up to $65. With the price rising so fast, those who were short the stock had to back out of their trade: they were forced to buy shares and the stock price leapt to $150. For those betting on the stock’s demise was enough to wipe out their accounts.

Not only did the short sellers have to buy back the stock at ever higher prices, they had to sell other stocks they owned, causing other major stocks to decline temporarily.

Is this the end? Maybe. Reports are that most of these trades have been wound down. Many brokerages restricted trading in GameStop today, and as they allow trading to resume, I would expect some dislocations. As the recent buyers lose interest, the price fo GameStop will decline, possibly quickly.

Interested in more? Read about the Volkswagen short squeeze of 2008 or Matt Levine’s writing about GameStop Today, Yesterday or the day before!