Brooke Allen

Can You Afford It?

Worried business woman sitting behind the desk with empty wallet © 2009 Brooke Allen
brooke@brookeallen.com www.BrookeAllen.com
Originally published in International Family Magazine

It is important not to buy stuff you cannot afford.

I attended a presentation by a professor who talked about how, as a child, his Dad drove their cars into the ground even though their less successful neighbors purchased new ones every few years. His father said they could not afford new cars. The young man did not understand – they had enough money. His Dad said, “people afford what they want.” His father wanted him to go to college and that meant he could not afford new cars. His dad’s statement led to a career – Lowell Catlett is now Dean of the Agricultural Economics Department at New Mexico State University.

There is an infinite amount of stuff out there and even the wealthiest person cannot afford it all. To lust after things you cannot afford will make you unhappy. To buy stuff you cannot afford will make you broke.

There are different levels of how well you can afford what you want:

Level 0 – There is no way you can buy what you want.

Level 1 – Someone will lend you the money to buy what you want.

Level 2 – Your cash flow from what you are currently doing is sufficient to buy what you want.

Level 3 – The cash flow from the next best thing you could be doing is sufficient to buy what you want.

Level 4 – The interest on your savings is sufficient to buy what you want.

When I was a college student in 1970, nobody in their right mind should have lent me any money, and given that bankers then were in their right minds, they didn’t. Today, there is a huge industry devoted to getting people hooked on living at Level 1. These people think you should care about your Credit Rating, which is a mathematical score lenders use to determine if you can stay at Level 1 long enough to repay them. If you can’t cover your debts, you will discover that you have dropped to Level 0, even for things you have already bought, like a house or a car.

My parents started at Level 2, and they suggested that I want to be at Level 2 as well. They gave me $500 to start me out. My college lent me $1,000, but living at Level 1 was so scary that I paid that money back on my second installment. I’ve stayed at Level 2, or above, the rest of my life. Living at Level 2 used to be called “living within your means” before marketers convinced people that the ability to borrow money was a “means.”

A friend sends his son to private school. He makes enough money to do this without borrowing. I asked him if he would consider leaving his current job for another that pays less. He said he could not because then he could not afford the school. So, he can afford what he wants at Level 2, but he cannot afford it at Level 3 since he cannot afford to lose his job.

There are two ways to advance from Level 2 to Level 3. 1) Lower what you want enough so that if you lose your current job you can still afford what you want with the next best job available to you, 2) Advance to a higher paying job without increasing your wants.

Living at Level 3 allows you to accumulate wealth. This comes from saving the difference between the money you are receiving and what you are spending. At this point, you will view Credit Ratings in a different light – from the point of view of a lender.

You might even accumulate enough wealth so that you can live your life entirely from the money generated by your wealth. Then, you will be free to do anything you want as long as you do not start wanting things you cannot afford at Level 4. People who get to Level 4 live well in retirement.

Charlie Munger, Warren Buffett’s partner, was asked how he became so successful.[1] He spent his money to meet his needs, not his desires. He also worked very hard on increasing the value of his second best option (known to economists as “opportunity cost”). Charlie was 60 years old, and a multi-millionaire, before he bought his first new car. He lived at Level 4 before deciding that a new car smell was worth wanting.

Many of us have been living at Level 1 far too long, and are now in the process of dropping to Level 0. This is sad, particularly at a time when the second best option is also declining, in many cases to zero (unemployment).

There is a bright side.

We will learn how little we really need.

We will learn how much we need each other.

Before you want a thing, determine how much you really need it.

Then determine how well you can afford it.

[1] For this and more wisdom from Charlie Munger, see: http://www.tilsonfunds.com/Whitney%20Tilson%27s%20notes%20from%20the%202007%20Wesco%20annual%20meeting-5-9-07.pdf

Your Education is Your Most Valuable Asset, not Your Schooling

My mother was born in West Virginia and that made her an American citizen by birth. Her father was a naturalized German-American, and her mother was a native Italian. Her parents decided to raise her in Florence, Italy.

When it became clear that the Fascists were going down a path of no return, my mother and her father decided they had to get out of Italy. They flew to Lisbon on the last airplane to leave Rome before the airport was shut, and they crossed the Atlantic on the last passenger ship before German U-Boats began sinking them. They arrived in New York with little more than their clothes. My grandmother stayed behind in Florence, and she never saw her husband again.

A few days before I left for college, my father told me, “Your education is your most valuable asset.” I was seventeen, and I thought everything my father said was stupid, so I challenged him, “How can that be?”

He said, “Because your education is the only thing they can’t take from you at the border.”

You see, besides her clothes, my mother brought something else with her when she arrived in New York. She was fluent in Italian, French, German, Spanish, and English. She was good enough at math and science to enter university as a Physics major.

She was educated – and the Fascists could not take that away.

Your Education is Your Most Valuable Asset.

Trade or Profession

I have just returned from the annual meeting of the Chicago Quantitative Alliance (www.cqa.org) where one speaker made a convincing case that the brokerage and banking systems are bankrupt and another made the case that so is the Federal Government.

The world is going to hell, and we don’t even have a hand basket.[1]

At the lunch break I asked the fellow sitting next to me what advice he had for my children in college.

He said, “Drop out of college and learn a trade; they can always go to college later.”

That reminded me of a joke. A lawyer has a leaky faucet. He calls the plumber who fixes the faucet and presents a bill for $100.25.

The lawyer is livid, “How do you justify such an expense?”

“Twenty-five cents for the washer and $100 an hour for my time – one hour minimum.”

The lawyer says, “I’m a lawyer and even I don’t get $100 an hour.”

The plumber says, “That’s funny – when I was a lawyer, I didn’t get $100 an hour either.”

The joke reminded me of the advice my father passed on from his dad, “Develop both a trade and a profession.” Even as he rose through the ranks of management at United Press International, granddad maintained his skill as one of the world’s top telegraphers.

In 1990 we moved to Japan to advance my career as a securities trader, but in 1993 I was laid off and returned to the United States to find the nation in a recession. There was a dearth jobs that offered career prospects. Luckily, throughout my rise in management, I’d kept up my skills as a Pretty Good Programmer and quickly found that there was plenty of work for those who were willing to trade an honest day’s work for an honest day’s pay.

Don’t trade a chance at a trade for a profession – get both.

[1] For those of you who have not heard the expression, “Going to hell in a hand basket,” now you have.

Sincerity

When my grandparents lived in Bogotá, Grandma became bored.

My grandfather told her that she could spend $1,000 (which was a fair bit of money in the Depression) on a hobby, but it would have to pay for itself.

She decided to become a painter.

She would have to sell her paintings to buy more art supplies if she was to continue to paint after the original money ran out.

This meant that she would have to become good enough that people would buy her paintings.

Eventually she made so much money she couldn’t spend it all on art supplies so she started buying real estate.

Some artists become attached to their work and hate to sell it.

Grandma Anne was the opposite. She said,

Everyone will compliment your work, but when they write a check, you know they are sincere.

Why? Why not?

Someone said, “Mardi Gras starts today.” Six of us shared a table for dinner at the small engineering college in Indiana.

I said, “Let’s go?”

Four people said, “Why?”

Roger said, “Why not?” Roger, who had grown up in Indiana, had only once ventured outside the state for a weekend in Chicago.

That snowy February evening our friends dropped the two of us on Interstate 70. All we had was $20 and our thumbs. Our friends gave us a phone number. “Call when you’ve had enough of this silliness and we’ll come and get you.”

The next day we called, “You can come and get us if you want.”

“Where are you?”

“New Orleans.”

That day my life changed.

“Why don’t we take a trip around the world next week?”

“Why not?”

“Why go to graduate school?”

“Why not?”

“Why get married?”

“Why not?”

“Why change careers without notice?”

“Why not?”

“Why have children?”

“Why not?”

“Why move your family to Japan for a few years?”

“Why not?”

“Why are you writing this?”

“Why not?”

My world opened up on that freezing day in 1971 when I changed how I react to opportunity.

Live not by “Why?” but by “Why not?”

Money

My father told me two things about money that had a profound effect on my life. They were:

“Money should buy freedom, not chains.”

and,

“It is easier to make money doing what makes you happy than to buy happiness with the money you are paid for doing what makes you miserable.”

Even though I can remember my father’s explanations, at the time (age 17) I thought he was off his rocker.

He explained that if you had a certain amount of money, and then someone gave you more money, you should have more options open to you.

This seemed self-evident, but I didn’t buy the part about chains.

Imagine someone who always wanted to be a school teacher who, in order to make more money, became a principal, then moved to the private sector as a salesman, manager, and finally a senior vice-president earning ten times his potential salary as a school teacher.

Since our hypothetical teacher had given up teaching for more money, you would expect that finally, as a highly paid executive, she (or he) should have plenty of money to finally fulfill an ambition of being a teacher without the money worries that plague most teachers.

But for nearly all, such a person sees their options dwindle rather than expand. They measure their success in how much money they make and the prestige that comes with position. From Senior Vice President, they only want to become President.

Worse yet, this person often borrows against an expectation of a rosier future and finds themselves a slave to home payments, credit card debt, private school bills, college tuition, and the economic cycle.

I recently had lunch with a friend who has started a financial consulting firm. His distinguishing feature is that he will tell his clients the truth rather than what they want to hear.

He said, “Ninety-percent of Americans live beyond their means — no matter what their means.” He gave an example of a client in mid-life who was worth $15 million from which he earns $650,000 a year. However, he spends $1.2 million a year and he wants my friend to find him a safe investment to support his lifestyle. This is a mathematical impossibility. My friend could calculate how quickly the client will find himself on welfare.

I wonder how much misery must this client need to overcome when $650,000 a year doesn’t do the trick.

I like to end these pieces with succinct words of wisdom. I can do no better than to repeat what my dad said to me during my Senior year in High School, just before he gave up a career in the business world to return to sculpture full-time.

Money should buy freedom, not chains.

It is easier to make money doing what makes you happy than to buy happiness with the money you are paid for doing what makes you miserable.

When Pigs Fly

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In 1977, American Airlines offered me a job in Manhattan in their Operations Research group and I took it.

One of our projects was to build a mathematical model to determine how much we should overbook each flight so as to maximize profit. You could generate happy clients when there isn’t enough room in coach by bumping them up to first class. But if you throw them off the plane entirely you might lose them forever.

On the other hand, since a full-fare customer could use their ticket on any airline at any time without penalty, if you kept a seat open for everyone who said they would fly with you then your planes would fly half-empty. It was an economic necessity to overbook, and every airline did it, but I was not about to tell my friends about this part of my job. Nobody really thought an airline should promise something and then not deliver. Nobody. Including me.

Fifteen years later, we found ourselves living in Tokyo and planning a visit to relatives in England. I made a reservation on Japan Airlines but, after we realized that the flight landed at a very inconvenient time, we made a second booking on British Airways.

Upon return, as we walked through the door to our home in Tokyo, the phone was ringing.

“Hello, is this Mister Allen?”

“Speaking.”

“Are you OK?”

“I’m fine.”

“And your family; is everyone all right?”

“Sure. Who is this?”

“This is Japan Airlines. A week ago you had a reservation on our flight from Tokyo bound for London’s Heathrow airport. You didn’t show up. We held the plane for 15 minutes and you still didn’t come so we took off without you. We can make up fifteen minutes in the air but eventually we had to go because it would be inconsiderate of our other passengers to wait any longer. We just want to make sure you are all well.”

“We’re fine. We flew on British Airways instead.”

“You flew on British Airways?”

“That’s right. We had full-fare tickets and they are good on any airline.”

“That’s true. But you didn’t tell us.”

“We don’t need to tell you. We can use our tickets on any airline at any time.”

“That’s true too. But, by not telling us, you were being inconsiderate.

Just because you are a customer does not make you always right.

——————

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Three Phase Theory

Experience has convinced me that there are three phases to the economic cycle:

Phase I – A period when it seems that everything you do succeeds

Phase II – A period when it seems that nothing you do succeeds

Phase III – A period when success depends on what you do

If you’ve studied the Roaring Twenties, Japan in the 1980s, the Dot.com bubble of the ’90s, our current housing market[1] – or even a gravity propelled roller coaster – then you know the slow climb of Phase I deserves to be the scariest for the worst is yet to be.

If what you are doing is working well you then you might convince yourself that you don’t need to learn anything new or do anything differently. You might be seduced into believing that it is wise to mortgage your future for an even more wonderful present. Fact is; these are the best times to save for bad times.

Eventually a hill will be crested that leaves nothing but a cliff in sight and if there is another hill in the distance the fog will be too thick too make it out. Phase II has begun.

During these times people have no trouble feeling fear and remorse but those feelings do them no good. If you’ve lost a job, you might conclude that no equivalent one exists to replace it, and you might be correct. People will switch from mortgaging their future to scrimping to make ends meet. Since no investment seems to pay a return, they stop investing and since nothing they do seems to work, they stop doing anything. These are symptoms of depression, both economic and emotional.

Eventually there comes a time when your investments do begin to pay off and success does depend on what you do. This is the beginning of Phase III.

How well your investments perform in Phase III depends on what you invested in during Phase II. You might object that during Phase II many people no longer have resources to invest. But, they have clear title to a brain and they own their own time. If nothing you do pays a current dividend then there is no opportunity cost to investing effort and time honing old skills and learning new ones.

The degree to which your efforts pay off depends on what you are capable of doing. What you are capable of doing in Phase III depends on what you were doing during Phase II.

Consider the story of how my grandmother and how she found amazing opportunity in the Great Depression that would have never presented themselves during normal times. You can read that story here: https://brookeallen.com/2008/04/01/great-depression-great-grandfather-great-grandmother/ and if you do then what follows will make more sense.

Out of necessity, my grandmother had become a real estate agent in the early 1930’s during a bad time to be one. Homes didn’t begin moving until the economy turned around, but when it did, she had mastered her craft, she had the prospects and she was on the job. Within seven years they owned a spectacular house of their own free-and-clear whereas had they used their meager savings to buy a house in 1928 then by 1937 they would be about 9 years into a 30 year mortgage and my grandmother would still be without a career — assuming, of course, they didn’t lose everything to the bank as did so many of their peers.

My grandfather kept his job at the United Press by volunteering for multiple pay cuts. Things didn’t open up for my Granddad until the environment improved, but when it did, he was there in the office with needed skills while others were still waiting things out.

If, during Phase I, you avoid having too high an opinion of yourself or too much confidence in the future but instead continue to evolve your skills and save for Phase II, then you will be better able to weather and adapt to hard times.

If, during Phase II, you continue to invest in yourself and work for the benefit of others even though your efforts are not immediately rewarded, then you will be in the best position to prosper when Phase III inevitably begins.

If you follow, believe in and espouse this Three Phase Theory, then:

During Phase I you will have been labeled a contrarian and a pessimist.

During Phase II you will have been thought a fool for working so hard without reward.

However, during Phase III, when prosperity seems to shine on you before others, you will be heralded as a genius and visionary.

It is what you do when it seems that nothing matters that determines your success later when you discover that it does.

[1] Note: The Yellow line (Japanese market) is the best illustration of my theory since Phase III doesn’t go down as far and is flatter after it stops rather than “bounces.”

I lived in Japan for Phase II and although the Japanese government tried to manipulate the market. I believe they succeeded in engineering a soft landing but they didn’t manipulate the market for a recovery, which I believe is wise.

In the 1920’s and 30’s (the Blue line) the market ran up just as much in the Roaring 1920’s as it did in Japan in the Roaring 1980’s. But the USA then fell more than Japan in the next few years and then government interventions helped with a recovery.

The Dot-Com bubble of the 1990’s was a bigger bubble than in the 1920’s and the collapse that started from the high in 2000 was more severe. While, in the lingo of so-called analysts, the collapse was a “correction” and the recovery from the low was due to “over-shooting” I believe the truth is that the so-called recovery is the beginning of another Phase I bubble rather than what some people call a “consolidation” and what I call Phase III.

If you want to experience the the the Red Line (Case Schiller Real Estate Index adusted for inflation) as a literal roller coaster ride then look at the Real Estate Roller Coaster video published in April, 2007. You can see it here: https://www.youtube.com/watch?v=kUldGc06S3U

This article was first published in May, 2008 in a publication called International Family Magazine that is now defunct. It is reproduced here with changes made over the years to correct typos and improve readability but the graph and the text describing the theory are unchanged from the original.

I formulated the theory in the 1980s and used it professionally and personally every since. At that time I was employed by Merrill Lynch in NY from 1986-87(Phase I) and kept my job through 1988-90 (Phase 2). Then I moved to Japan with Merrill and worked during Phase II there. I returned to the U. S. A. in 1993 during the depths of recession and bought a house for cash, which turned out to be perfect in retrospect since I timed Phase III within a few months of its beginning.

I was running a hedge fund during the dot-com bubble burst in 2000 and because of this theory we flourished when many peers went belly up. Like my grandparents we own two houses free-and-clear (one for weekday use near a good school and another in the country). There is no way we’d buy real estate during during what is obviously the beginning of Phase II.

Great Grandfather, Great Grandmother, Great Depression

As I detailed in the story How Grandmother Won Granddad in a Beauty Contest my grandparents met on a blind date in New York City in the 1920’s and decided to marry within a week.

Granddad Tom was sent to Havana to open an office for United Press International. He became El Presidente Local for the U. P. I. in Cuba.

When he returned near the end of the decade he was handed a 40% pay cut even though the cost of living was higher in New York City than in Cuba.

If that wasn’t bad enough, in October of 1929, the Stock Market crashed and the economy began a long slide into what became the Great Depression. Granddad survived multiple rounds of layoffs by accepting further pay cuts.

Grandmother Anne realized that they couldn’t afford rent on Granddad’s dwindling salary, so she took a job as a receptionist with a developer who was building houses on the farm next to their rented home in White Plains. Soon she was managing four salesmen. She received 2 ½ percent in commission on every home sold.

To help care for the children, she found a lovely couple at the unemployment office. The wife was a nurse trained in Canada but without a license to practice in New York. Her husband was a handyman. She exchanged room and board for childcare and yard work.

Grandmother convinced the developer to build (at cost) a model home for them with an extra room for their tenants. She became a stellar saleswoman in her own right. Before long, her commissions had completely covered the construction costs, and the home was theirs outright.

Granddad wrote to a friend that the Great Depression had been unbelievably good to them. Before the Crash they had had high hopes, but owning a house ‘free and clear’ in just a few years was inconceivable. Where could they have found a trained nurse and groundskeeper simply by letting them live in a spare bedroom and join them for meals? Freed of the burden of paying bills, the young couple soon saved enough money working odd-jobs to buy a gas station and start their own business. Because most of his coworkers had either been laid off (or quit rather than take a pay cut), Granddad had no competition as senior positions became available. His career took off.

In the 1920’s my grandparents had had Great Plans.

During the Great Depression they just tried to survive.

Sometimes just surviving is the winningest strategy of all.

What to Think About How to Think

When discussing “math phobia” our neighbor, a psychotherapist, said, “I can’t think mathematically.”

My son said, “Then you can’t think.”

She was taken aback. “Of course I can think. I just can’t think mathematically.”

My son said, “See, you’re not thinking.”

The conversation ended there.

Do you see? My son understands logic, which is a subset of mathematics. He knows that to say, “I can think; I just can’t think mathematically,” makes no more sense than saying, “I can drive; I just can’t make left turns.”

Try picking the right room air conditioner or planning your retirement without thinking mathematically. You can’t do it. Of course, you can exist without knowing how to do these things yourself, but if you do, you will be having others do some of your thinking for you. This is fine in the case of an air conditioner but it can be disaster when it comes to your retirement. If the guy at the store sold you the wrong air conditioner, you’ll know by August but by the time you discover that your retirement planner got it wrong it will be too late.

I understood all this when I was 16 except that: 1) I mostly thought mathematically, and, 2) I wasn’t thinking about retirement at all.

Now I know better. I understand why colleges require both Math and Verbal SAT scores.

Just as you can’t think very deep mathematical thoughts without writing down numbers and mathematical symbols, you can’t think about much else without writing down words.

Don’t believe me? Try some experiments.

First, plan your retirement in your head without paper, computer or calculator. You might already have performed this experiment.

Now try planning your retirement with the aid of numbers, a calculator, some financial models and a bit of data. When you are done, compare your results to the first experiment. Scary?

Next make a major decision that doesn’t involve mathematics without writing down words: Should I go to college? Should I take this job? Should I quit this job? Should I start this business? Should I marry this person? Should I divorce this person? Perhaps you’ve already made a big decision without writing down your thoughts.

Now, just as an experiment, treat your next (or most recent) major life decision as if it were a serious writing assignment; something worthy of a semester’s grade in college. And not just any grade but an A+. A paper that prompts your professor to say, “Wow, you could base a life on thinking like that!”

Don’t just write down your thoughts but edit them. Write down the opposite of your thoughts and contrast them to your first thoughts and then decide which you want to keep. Sleep on it. Forget about it and go out to a party. Incorporate any 2 A. M. insights and then reconsider them when you’re sober. No bullet points. No PowerPoint. Full sentences only. Subject. Verb. Noun. Have you considered everything? Are your words convincing?

Then read what you wrote out loud. Does it sound convincing? If you believe it, try reading it to another person.

When you are done, compare your final version with to your first draft and then think back to how hard it was to get that first draft onto paper. The distance between where you are now and where you were before you started can be measured in thoughts; thoughts you couldn’t have kept straight without writing things down.

When you declare your essay complete; act. Keep your words around. Later, compare your predicted future to what is now your recent past. Did you write well? Probably not. Most things take practice. Repeat this experiment from now on and you’ll get better.

You might say, “I’m not going to write an essay on whether I’m going to marry my lover. We’re in love. It isn’t an essay topic.”

Fine. But you can still write things down. If you don’t think people can write about love then where have you been?

Write a love letter worth mailing. Then mail it. A love letter is not just a letter to your lover; it is a gift of love to your lover in letter form. If you are like me, you’ll find that you either love the process or you hate the process and your feelings about the process will vary depending on the lover. So it’s not the process at fault.

Describe your lover in the third person as if you were painting a picture of a newly introduced character in a novel. Show it to some friends who know your lover. Do they think you got it right? If not, you might be in for a surprise when you stop producing, or responding to, the dopamine that floods your brain when “in love.” (Scientists have shown that this will happen within 12 months, 18 at the max.)

Do you find it hard to express your feelings but you still want to get married? OK. When are you going to start working on that? Or do you think marriage has nothing to do with expressing feelings?

To say that you know how to think without knowing how to write is like saying you know how to drive without knowing how to turn right.

Do you want to go through life without control of the steering wheel?

If you don’t know how to think mathematically, then you don’t know how to think.

If you don’t know how write, then you don’t know how to think.

If you feel these statements are false then you are feeling but you’re not thinking.[1]

[1] I am open to the possibility that I am wrong on this so feel free to make your case and mail it to me.

(Note: A few months after publishing this a woman wrote to say when she first read it she was furious and convinced I was wrong. So she sat down to write a letter and after an entire weekend attempting to compose her thoughts she realized I was right.)