In 2006, I purchased an XBOX 360 bundle from CostCo for about $550, including the console, a game and two wireless controllers.

In April of 2007, my 360 caught the “red ring of death” (“Ring around the rosy, pockets full of posies, ashes, ashes, we all fall down!“), at which point I brought it back to CostCo and exchanged it for the bundle they had available at the time, which was $475. They refunded me the difference!

Net return: $75 in one year on an initial investment of $550.

Earlier this month, my new 360 also caught the plague and I returned it again to CostCo, where the holiday bundle now costs $400.

Net return: $75 in 7 months on an initial investment of $475 in 58% of the time from the last return of this amount.

If this continues, at this rate I’ll have made my original investment back in another 9 months, at which point I’ll have had the use of an XBOX 360 for 28 months for the opportunity cost of the original $550, which is approximately $50 at 7% over two years after taxes, $1.80/month or 6 cents/day.

What a deal! : )

P.S. The moral of the story: buy your electronics at CostCo.

Save yourself the Suzy whoever and read this instead:

1. Be humble
2. Take calculated risks
3. Have an emergency fund
4. Mix it up
5. It’s the portfolio, stupid
6. Average is the new best
7. Practice patience
8. Don’t time the market
9. Be a cheapskate
10. Don’t follow the crowd
11. Buy low
12. Invest abroad
13. Keep perspective
14. Just do it
15. Borrow responsibly
16. Talk to your spouse
17. Exit gracefully
18. Pay only your share
19. Give wisely
20. Keep money in its place

Following this advice will put you in the top 20% of investors in the world.

OCTOBER: This is one of the peculiarly dangerous months to speculate in stocks in. The other are July, January, September, April, November, May, March, June, December, August, and February.

-Mark Twain

I find the idea of kids coming home from college to live with their parents again with they start a career, save for a house and build a relationship to be interesting. I like my kids, so wouldn’t mind this (although they’re not teenagers yet, so who knows if I’ll still like ’em? : ).

This one’s a double-header:

Eric Sink talks about how to find a product to build (if you’re a micro-ISV).

Joel talks about how much to charge for your product.

Both are excellent but both convince me yet again that such things are more luck than skill (which sucks for those of us that consider themselves skillful).

Since our credit scores have become such a big part of our lives, it has become federal law that everyone be able to get a free credit report annually. As of December 1^st, 2004, the western states are eligible and the web site lists when other groups of states will have access. For a blow-by-blow, check out the write-up on the Personal Finance Blog.

Here.

I found a new site focusing on a topic near and dear to my heart — educating kids about money — so I thought I’d log it for future reference (although you’re free to read my thoughts about it, too : ).

I’m a huge fan of talking to kids about money (actually, I’ll talk an adult’s ears off about money, too, if given half a chance – I once lectured Matt Pietrek and his girlfriend on the topic for an hour over pancakes [sorry, guys…]). When I was growing up, the training I got in school about money management has how to write a check, i.e. how to be a good little consumer. I also learned the basics of compound interest, but not as related to anything real, e.g. buying a house or saving for retirement. Most of what I didn’t learn in school, I also didn’t learn from my parents because one of them (who managed to buy high and sell low during the recent market correction) isn’t any good at money management and the other was very private about such things (although has been opening up on this topic recently).

Me, I go the other way. While they know not to talk about it outside of our immediate family, my kids know how much my wife and I make, how much we spend month to month, how we’re saving for their college education, how we’re saving for retirement, the investment property I’ve purchased with my money-savvy brother-in-law (whose parents also refused to talk money with him), etc. The Sells brothers have their own allowance that goes up annually on their hire date aka their birthday. I act as their bank, keeping track of their income and expenses in an Excel spreadsheet as they deposit and withdraw money, limiting them to a single week’s “advance” on their allowance (giving them the choice of spending what they’ve got now vs. saving for what they want in the future). In the future, I plan on letting them maintain their own balance sheet (subject to random audit), like my Mom let me maintain mine on a paper check register (I guess I did learn a little something from my parents — come to think of it, the way I award allowance is just like my Mom, too — way to go, Mom! : ).

Anyway, as open as I am about our money and as much as I bring it up with them in an attempt to stamp the consumer culture out of my children before it takes hold, there are still more things to be done, as I learned this morning on “the mint,” a web site dedicated to what kids should know about money and how teachers and parents can help. Check it out.

BTW, I’ve recently come to the conclusion that a parent paying for their child’s college education is a sucker’s game, as it drains much needed funds out of the parent’s own investments when it should be enjoying the magic of compound interest. Instead, grandparents should pay for college, letting each generation have another 20-30 years of compound interest before skimming off the top for college. The problem with this, of course, is that it requires one generation to pay for both their kids and their grandkids to shift into this new thinking (assuming, of course, that the parents can pay for their kid’s college at all, which isn’t a given with our current consumer-oriented society). I plan on being that bridge in my family, i.e. I plan to pay for my kids’ and my grandkids’ college education. I also plan to have myself cryogenically frozen, putting half of my money into a trust for myself when I’m rejuvenated, leaving the other half for my wife. Neither of these has anything to do with this subject, but I thought I’d stick them on the end here anyway. : )

Discuss

Here. Someone sent me a fabulous follow up email to “The Average Return Myth,” but in the heat of the PDC, I didn’t get a chance to read it and now that the PDC is over, I can’t find it again! All I remember is that the person’s email address started with “cat” (I think). Can you please send it again, Mr. Cat? Thanks!

Here. Gurley sums up nicely the tendency of the IT industry to eat other industries and itself, leading to nice things for consumers, but not industries.

Here. The recent economic conditions caused me to become very interested in not just making money (I’ve always been a capitalist : ), but also in keeping a careful eye on it. In the past, I’ve let most of the “keeping an eye on it” be done by a financial advisor (I’ve had one since I was 22). These days, I have a stack of financial books that I’m reading [1] and it’s been a fabulous educational experience. Given the supreme importance of money in our society, I think everyone should know the basics of money management. I’m very disappointed that I made it all the way through high school, let alone college, with no more instruction then how to fill in a check (something we want folks to do less of, not more!). Towards that end, I really love Bloomberg University’s no-frills financial tutorials, including one on the basics of a 401(k) and another on the basics of investing. They provide just the tip of the iceberg and I could recommend a lot of other reading, but this is a good place to start for folks that want to actually keep the money they make. [1] http://www.sellsbrothers.com/money

Let’s say that you have $1000 to invest. The first year, you invest it and get a 25% return, so you leave your money invested. The next year, the market doesn’t do as well and your return is -15%. What’s the average rate of return over the two years? You way think that it’s 5%, that is, (25% + (-15%))/2. Let’s do the math for 25% and -15%:

• Using simple interest, after 1 year, $1000 + $1000 * 25% = $1250
• After 2 years, $1250 + $1250 * -15% = $1062.50

Here we’re using Interest = Principle * Rate * Time calculation for yearly aka simple interest (I = PRT and Time is 1 year). Taking the numbers the other way, i.e. -15% the first year and 25% the next year, yields the same result:

• After 1 year, $1000 + $1000 * -15% = $850
• After 2 years, $850 + $850 * 25% = $1062.50

In fact, the result is the same no matter in which order that the rates come or how many there are:

Table 1: From Good to Bad

year	return	total
0	0	$1,000.00
1	25%	$1,250.00
2	15%	$1,437.50
3	5%	$1,509.38
4	-5%	$1,433.91
5	-15%	$1,218.82

Table 2: Starting Bad to Good

year	return	total
0	0	$1,000.00
1	-15%	$   850.00
2	-5%	$   807.50
3	5%	$   847.88
4	15%	$   975.06
5	25%	$1,218.82

Table 3: A Mixed Bag

year	return	total
0	0	$1,000.00
1	25%	$1,250.00
2	-15%	$1,062.50
3	5%	$1,115.63
4	15%	$1,282.97
5	-5%	$1,218.82

This result surprised me. I found it unintuitive that no matter how the rates vary over time, it doesn’t matter if they come first, last or in between. I expected large losses up front to swamp later gains or early gains to make up for late losses, but the change of the underlying principle amount evens things out, e.g. a smaller percentage drop later is against a larger principle if there have been early gains.

When you figure it as a single formula, Future Value = Principle * (1+Rate1) * (1+Rate2) * (1+Rate3) * (1+Rate4) * (1+Rate5) or F = P*(1+R1)*(1+R2)*(1+R3)*(1+R4)*(1+R5), the independence of the order makes more sense, since multiplication is commutative, i.e. it doesn’t matter in what order you do it:

f = p*    (1+r1)* (1+r2)* (1+r3)*(1+r4)* (1+r5)
f = $1000*(1+25%)*(1+15%)*(1+5%)*(1-5%)* (1-15%) = $1218.82
f = $1000*(1-15%)*(1-5%)* (1+5%)*(1+15%)*(1+25%) = $1218.82
f = $1000*(1+25%)*(1-15%)*(1+5%)*(1+15%)*(1-5%)  = $1218.82

Having varied rates like in Tables 1-3 in a stock or stock mutual fund investment isn’t uncommon (as we’ve just seen during and after the Internet bubble). On the other hand, if you compare this a fixed yield (like a bond) with our “average rate of return” of 5%, you’ll see a different result:

Table 4: Small But Fixed Rate of Return

year	return	total
0	0	$1,000.00
1	5%	$1,050.00
2	5%	$1,102.50
3	5%	$1,157.63
4	5%	$1,215.51
5	5%	$1,276.28

With a fixed interest rate, we can simply our calculations somewhat using Future value = Principle * (1 + Rate)^Number of compounds. So, $1000 at 5% for 5 years is:

f = p*(1+r)^n
f = $1000 * (1 + 5%)^5
f = $1000 * (1.05)^5
f = $1276.28

Any way you calculate it, not only does the boring, fixed interest rate bond out-perform the variable rate even for the same average rate of return, but clearly our average rate of return calculation isn’t very useful. We’re not really getting 5% year to year on our varied stock rates of return, or they’d show the same results as the bond. Instead, if you reverse the formula for Rate, we get:

r = (f/p)^(1/n) - 1
r = ($1218.82/$1000)^(1/5) -1
r = 1.21882^(1/5) -1
r = 4.037%

This gives us a annualized rate of return:

Table 5: Annualized Rate of Return

year	return	total
0	0	$1,000.00
1	4.037%	$1,040.37
2	4.037%	$1,082.37
3	4.037%	$1,126.07
4	4.037%	$1,171.52
5	4.037%	$1,218.82

Taking this further, because the future value of an investment is the same whether you consider a fixed rate of return or a variable rate of return, for any principle, you can calculate the fixed rate of return by deriving from this formula (assuming r0 is the fixed rate of return and r1-r5 are the variable rates of return):

p*(1+r0)^n = p*(1+r1)*(1+r2)*(1+r3)*(1+r4)*(1+r5)

Further, because principle plays the same role on each side of the equation, you can remove it:

(1+r0)^n = (1+r1)*(1+r2)*(1+r3)*(1+r4)*(1+r5)

Solving for the annualized rate of return from the variable rates of return gives you this:

r0 = ((1+r1)*(1+r2)*(1+r3)*(1+r4)*(1+r5))^(1/n) - 1

Applying it in our example:

r0 = ((1+25%)*(1+15%)*(1+5%)*(1-5%)*(1-15%))^(1/5) - 1
r0 = (1.25*1.15*1.05*0.95*0.85)^(1/5) - 1
r0 = 4.037%

So what happens when we increase the variability, but leave the average rate of return the same? The variability adjusted return gets smaller:

Table 6: Extended Variability

year	return	total
0	0%	$1,000.00
1	25%	$1,250.00
2	-15%	$1,062.50
3	5%	$1,115.63
4	15%	$1,282.97
5	-5%	$1,218.82
6	5%	$1,279.76
7	-25%	$   959.82
8	40%	$1,343.75
9	-30%	$   940.62
10	35%	$1,269.84

Notice that we’re still got an average rate of return of 5%, but increasing the variability gives us an annualized rate of return of 2.42%.

On the other hand, extending the same average without increasing the variability looks like this:

Table 7: Extended Time, Variability Unchanged

year	return	total
0	0%	$1,000.00
1	25%	$1,250.00
2	-15%	$1,062.50
3	5%	$1,115.63
4	15%	$1,282.97
5	-5%	$1,218.82
6	25%	$1,523.53
7	-15%	$1,295.00
8	5%	$1,359.75
9	15%	$1,563.71
10	-5%	$1,485.52

In this case, when the variability remains unchanged, the annualized rate of return remains unchanged at 4.037%. In other words, as the variability increases, the annualized rate of return gets further away and lower than the simple average rate. On the other hand, as the variability decreases, the annualized rate approaches the maximum value of a fixed rate of return, i.e. zero variability.

So, while it’s comforting that so long as your investment doesn’t go to zero, it doesn’t matter when the highs and lows come, it’s somewhat unintuitive that the average rate of return is not what you want to use to calculate the rate of return that you’re actually getting. In fact, the annualized rate of return will always be lower than the average rate as variability increases.

Chris’s Notes on The Instant Millionaire: A Tale of Wisdom and Wealth, Mark Fisher, New World Library, 1991. I recommend this book for folks that are willing to believe that the act of willing something to happen hard enough will make it happen.

On the one hand, I’ve solved many an engineering problem by simply letting my subconscious know that it needed solving. On the other hand, I’ve never been able to successfully wish for something to happen. The question is whether you view this book as channeling your subconscious energies into finding ways of making your dreams of financial independence come true or whether you view it as a fairy tale.

Chris’s Notes on Stock Options For Dummies, Alan R. Simon, Wiley Publishing, Inc., 2001. I recommend this book for folks that need to know the details of their company’s stock options, although the details aren’t interesting enough or important enough to warrant a book of this size, especially given how worthless most company’s stock options are these days.

I bought this book when I was too stupid to recognize it as a book about a company’s stock options instead of about publicly traded options. In general, the strategy that I’ve developed if I ever get the opportunity to exercise company stock options is as follows:

1. Exercise stock options as soon as possible, paying taxes as appropriate
2. Hold stocks for at least one year to reduce taxes on gains from normal income tax rates, e.g. ~30%, to the long-term capital gain tax rate, 15%, using 0 as the basis and subtracting the taxes already paid in step 1

Doesn’t seem like enough for an entire book…

Chris’s Notes on All the Math You Need to Get Rich: Thinking with Numbers for Financial Success, Robert L. Hershey, Open Court Pub Co, 2001. I recommend this book for the basics it covers, the slim size, the exercises and the approachable text.

I graduated from high school with all kinds of wonderful math grades (I finished all of my high school math a year early and had to attend a calculus course at a nearby college in my senior year), but managed to get out without a firm grasp of some simple ideas. Specifically, I never learned why it is that when I make a fixed house payment, the actual amount that goes to the interest and to the principle varies each month. The reason this is (as I’m sure all of my readers already know) is because the interest is only paid against the outstanding principle that remains on the total loan each month. It’s just like compound interest in reverse (an idea that I always did understand).

I haven’t been reading this book cover to cover (I already know how fractions, scientific notation and fractions work), but this one fact alone makes this book worth the price. Plus, it makes a wonderful reference (this is where I got F=P(1+R)^N used in The “Average Return” Myth). The world needs more short, focused, well-written books.

Chris’s Notes on The Motley Fool Investment Guide: How The Fool Beats Wall Streets Wise Men And How You Can Too, David Gardner, Tom Gardner, Fireside, 1997. I don’t recommend this book for anything but an example of the hubris that was rampant during the Internet bubble and a few chapters that hold the reader’s hand making the markets seem approachable.

In general, I recommend Peter Lynch’s Learn to Earn for the hand holding instead.

Chris’s Notes on Cashflow Quadrant: Rich Dad’s Guide to Financial Freedom, Robert T. Kiyosaki and Sharon L. Lechter, Warner Books, April, 2000. I recommend this book for the way it twisted my head around.

There aren’t any “how to” details in this book, but it still had some pretty valuable ideas in it that really changed my thinking and inspired me about what’s possible:

• There are four main ways to make money: as an employee, being self-employed, running a business and investing.
• Our society has trained the middle and lower classes that success looks like getting a good job and being a good little consumer. I’d long recognized the cycle of get into college->get a good job->save for your kids’ college education->they do it all over again for their kids, but I didn’t know what alternative I had.
• The alternatives, according to this book, are running a business and/or investing. Specifically, this book really pushed running a business to fund investments, mostly for the tax benefits. My own thoughts are that having a business to fund investments is the absolute right thing to do. However, having a business that generates extra money to invest is easier said than done. If that’s your plan, you should go away and do that first, then figure out the investing thing later in your leisure by the pool.
• Folks that run their own business or invest have a reasonable chance for financial independence, whereas employees and the self-employed do not.
• Financial independence has a specific definition: having more passive monthly income than your monthly expenses. Only when’s it’s passive income, i.e. you don’t have to do the work to generate the income, do your finances allow you to pursue whatever activities you want, regardless of their income generating abilities, e.g. write a novel or home school your kids.

In general, I really like the way that Kiyosaki writes, although it’s very marketing-style, so it turns me on and off at the same time. What I like is that he writes in a very personal way, talking about his two fathers, one trapped in the rat race like most of us and the other who’d learned how to become financially independent. He uses examples of his fathers’ behavior to illustrate his points and talks a lot about how be changed his own thinking to break himself out of the cycle.

On the other hand, it seems like his major business is selling financial education-related materials to fuel his own wealth, so right away you have to suspect his motives. Also, his books are light on details, although he’s happy to use them to point you at other produces that he or his partners have produced for more information. That’s not a business model that respects the needs or intelligence of his audience. Still, if you ignore that and look for the ideas, I find his writing useful.

In general, I suspect all members of the financial education market, from authors to radio talk show hosts and everyone in between. When I obtain financial independence, I don’t plan on teaching anyone but my own friends and family. Why would anyone do otherwise except to fleece the public?

And then, having said that, I realize that every single book I’ve written, I wrote because I had a burning story to tell; I couldn’t not write it. My motivation to write novels is grounded in my need to take my writing into a completely different direction w/o the requirement of generating an income stream. So it’s likely that at least *some* of the folks in the financial education market are in it for love, but how can you tell which ones?

Further, it’s not generally true that “them that know, don’t tell.” I know that I know how to write real software and how the technologies that form the topics of my writings and teachings really work, so at the very least, I’m the exception to that rule. However, there are an awful lot of exceptions, like all of my friends in the Windows developer education industry, so I reject the rule out of hand for at least a significant percentage of participants in any given field of education (certainly a significant percentage of them conform to the rule, of course, and those are likely to out number the ones that are the exception).

However, all of us in the Windows developer education industry make our living on education, not on the technology itself. We’ve chosen education because it’s more lucrative then being a practitioner. (This may help explain why elementary school teachers choose their field: can you think of a place that they can make more money on basic readin’, ‘ritin’ and ’rithmatic than as a teacher?)

So, if it’s the case that education is more lucrative than practice, why should I buy someone’s financial book, since they’ve obviously decided that selling me a book is more profitable than practicing what they’re preaching. Further, the real-time markets have the built-in handicap that when a technique for really making money is widely put into use, the market adjusts for it, bringing the returns for that technique back in line with the market as a whole. If I discovered a new way to make real money, publishing how it works is the last thing that I want to do. Definitely, those kinds of books, like The Motley Fool’s Investment Guide, are not what I want to put my trust into.

Things I find I can trust more are books that inspire me, like Rich Dad, Poor Dad, or change the way I look at things, like Fooled by Randomness, or help me to establish a foundation of knowledge, like Investing for Dummies or Learn to Earn. These are books that don’t promise to make me rich (except the Rich Dad, Poor Dad books, but I’ve learned to discount that promise : ), but that help me align my brain cells so that I can take control of my own financial health.

So, all of this boils down to “Be a skeptic” from the Epilogue to Effective COM, furthering my belief that the ability to learn how one system works, e.g. COM, can be effectively translated into learning how another system works, e.g. investing. And so what’s my motivation for this writing and others like it? It’s purely selfish, I assure you. Writing something clarifies my thinking and posting it gets me access to, and feedback from, like-minded folks that can help clarify my thinking even more.