Archives for December 2010

5.3 billion birds in the hand

A bird in the hand

We had the hardest time keeping the little freak still for the picture

Is the ability to recognize opportunities a characteristic from birth, or a teachable skill?

Most of us miss out on most opportunities, by definition. Otherwise we all would have sold our houses in 2008, invested the proceeds in Cost Plus stock, then bought the houses back this fall for pennies on the dollar. You didn’t, which is why you’re still reading personal finance articles and trying to make sense of the world.

Are you familiar with Groupon? Not a ridiculous question – we asked a fairly with-it 24-year old woman about it the other day. She’d never heard of it. The company’s clever name gives you a hint as to how it works. You enter your location at Every day, in every city Groupon serves, the company pairs with a local retailer to offer a limited-time deal. This isn’t 10¢ off a jar of lemon curd, either. Current Groupon deals include $49 for a 1-hour facial, $10 off a ticket to a Stanford University basketball game, $50 of food at the Pewter Rose Bistro in Charlotte, NC for $25, etc. The catch is that a certain number of people have to sign on or the deal won’t go into effect. (That number is posted for each deal, along with the number of remaining people needed to activate the deal.)

The mutual benefit here is obvious. Customers save money if enough of them exist to activate the coupon, but lose nothing if there aren’t (membership is free for both customers and businesses.) Meanwhile, the merchant gets guaranteed customers who went out of their way to show an interest in buying the product. If too few people sign up to activate the deal, the merchant loses nothing (and gains information – either “we need to offer a sweeter deal” or “what we’re selling is so bad that no one’s interested.”) Groupon keeps half the coupon revenue.

Like Twitter and eBay, Groupon is the kind of enterprise that makes a rational person kick himself for not thinking of the idea first. The website is sleek, informative, and easily navigable, particularly on a phone. Even the descriptions of the deals are entertaining to read – a staff of moonlighting comedy writers and stand-up comics creates them. Groupon started a little over 2 years ago in Chicago, offering discounted pizzas at one particular joint. Today, the company has 35 million members in 250 cities on 4 continents. It employs 3,000 people, most of them in sales. When the venture capitalists came calling, Groupon management stood at attention. Liberal estimates say the company will take in $350 million this year. It’s hard to imagine that Groupon’s expenses are more than a tiny fraction of that. Back in April – 1/3 of Groupon’s life ago – the company was making $1 million weekly. Groupon founder Andrew Mason has lofty ideas – he claims that he wants to do for local businesses what Amazon did for online retail.

Mason might be a visionary, but his business acumen is curious. A few weeks ago, Google offered $5.3 billion (excluding incentives) for Groupon. That’s about what Sirius XM is worth, but Groupon makes money. Whether the Google offer was in cash or Google’s resilient stock, Mason and his partners could have gotten ultra-rich faster than just about anyone in the history of commerce.

Mason turned Google down, because he’s insane.

Groupon is a great idea, and one that’s easy to copy – just ask LivingSocial, CrowdSavings, Tippr or one of Groupon’s hundreds of other new competitors. LivingSocial already has almost as many visitors as Groupon, with a website that’s hard to distinguish from Groupon’s at times. Groupon didn’t just get big quickly: it reached its perihelion shortly thereafter. Sure, there are millions of non-members to convert, but why should they patronize Groupon when its competitors are offering the same thing free? The competitors are increasing exponentially while the potential customer base grows arithmetically. It’s a Malthusian problem for a different century, only this one doesn’t involve cannibalism and starving orphans. Besides, how many discounted spa treatments can the world handle? (Groupon’s clientele is overwhelmingly 30ish and female.)

Mason’s strategy, at least as he tells it, is to do an initial public offering and turn his company over to ordinary investors by 2014. By which time we’ll have discount-searching polycarbonate chips implanted in our heads. Seriously, at the rate the number of his competitors is growing, Mason could have 2000 Groupon knockoffs to contend with by then. The greater the dilution, the less interest Google or anyone else will have in Groupon’s targeted customer information. Groupon management let a winning lottery ticket expire in the name of future aspirations. The iron is almost cool to the touch as this point, and Mason still isn’t striking it. Check back in a few months when another potential suitor makes a low-9-digit offer for Groupon. If that.

And if someone offers you what seems like a ridiculously high price for something, don’t double down on your own good fortune. Take the freaking money.

**This post is featured in the inaugural edition of Totally Money Carnival**

Is a flat tax feasible?

US Taxcode

Not enlarged to show texture

Formally, federal tax law is a particular chapter (Title 26) of the United States Code. The federal tax law contains 11 subtitles, which among them comprise 9,833 sections.

The number of words in the tax code? No one knows. Seriously, no one knows. The lower bound seems to be 16,000 pages, and even that’s not definite. A conservative 250 words per page, and that’s 4 million words. Even counting the number of sections is exhausting. They go from 1 to 9873, and counting, but plenty of numbers are missing.

The IRS estimates that it collected $2,691,538,000,000 in the last fiscal year available, 2007. There are three horrible truths enclosed in that statement, the first one being that $2.7 trillion is way too much money to run a government:

-There’s an electronic record of everything. The IRS should be able to calculate how much it collects to the penny, not merely to the nearest million dollars.
-Ditto for the most recent year available. Why can’t the IRS have accurate figures for 2009, or at least 2008?

That’s about $8,900 per person, not counting the hours that go into calculating the tax we each owe.

Thus our recommendation of the diagonal tax. This is what’s commonly referred to as a “flat” tax, but that name implies that we’d all pay the same rate. No serious flat tax plan really works that way, because it makes it difficult for low-income people to ever catch up and build any wealth. The proposal involves a standard deduction for every taxpayer, ideally enough to cover all cost-of-living expenses. Tax collectors then levy a flat tax on the remainder after the deduction, which means the tax is anything but flat.

The Tax Foundation estimates that we spend a total of $25 billion and 21 hours per taxpayer preparing or getting other people to prepare our taxes. 174 million returns a year, that’s almost 3.7 billion hours. Estimate an average wage of $16/hour, that’s another $58 billion in opportunity cost.

There’s more. The IRS has 101,000 employees. Assuming they each work 1800 hours a year, that’s 181,800,000 hours. A diagonal tax form would be the size of the fabled postcard, and wouldn’t require any creature more advanced than a trained chimp to process it. Let’s assume that a diagonal tax could reduce the ranks of the IRS teatsuckers by 90%, and that the average IRS employee makes $20/hour. That’s another $3,272,400,000 we could save. The very act of collecting taxes costs our economy $86 billion a year before one dollar goes to anything other than the IRS’ own continued existence. Granted, that’s only 3% of the IRS’ returns, but it’s a start.

So…how to confiscate that $2.7 trillion by fairer means?

The Census Bureau estimates that 47.37% of all Americans make under $25,000 a year. That’s the set of all Americans, not the subset of tax filers, so we have to account for that. Does $25,000 sound like a reasonable amount to keep exempt from taxes? Let’s make that the standard deduction then and, using the Census Bureau’s remaining numbers, figure out how much income remains taxable.

Can you trust us that we did the math accurately? You can repeat the results yourself. We used this page and calculated how much income remains in each bracket after deducting $25,000 per person. We assumed that the numbers were evenly distributed in each bracket. For instance, the chart says that 9,192,000 Americans made between $25,000 and $27,500 last year. We thus assumed that the average person among those 9,192,000 made $26,250. This might be reasonable and might not, but there’s little room for fluctuation in the numbers. We then repeated the process for every bracket up to $95,000– $100,000.

The taxable income of all Americans making under $100,000 would thus total about $2,251,340,000,000.

Subtracting that from the nation’s gross domestic product, and dividing by the number of people making over $100,000, our conclusion?

If our elected representatives authorized a straight 28% tax, given the $25,000 exemption, the IRS’ tax collectors would take in as much as they do today.

How would that affect you? It’s easy to figure out. If you make $30,000, your tax bill would be $1,400 – an effective tax rate of an eminently livable 4.7%. If you make $90,000, you’d pay $18,200, or barely 20%.


You wouldn’t waste your time looking for artificial ways to reduce your tax bill, counterintuitive activities such as tallying up your gambling losses. You wouldn’t have to save a single receipt. Doing your taxes would take 8 seconds. Not only would everything run more simply and efficiently, but more to the point, you’d have incentive to continue working and helping the economy grow.

Right now, the highest marginal tax rate in the United States is 35%. Reduce it to 28%, and it’d be at its lowest level since 1931.

The downside? Politicians wouldn’t be able to curry favor with certain people. Lobbying for a particular industry (which means, by definition, doing so at others’ expense) wouldn’t make any sense. You wouldn’t get punished for not having kids, or rewarded for borrowing money to buy a house – but if you tell the average person that he’s gaining a tax advantage, even if he’s losing a concomitant smaller one, all he’ll think about is the latter. Heck, the authors have a standing bet that at least one commenter will mention that it’s unfair to tax poor and rich people at the same rate, conveniently ignoring the part about the standard deduction. God bless our uneducated country.

**This post is featured in the Tax Carnival #78**

Dartboard investing only works when you stand inches away

Dartboard Investing

Those ancient Mayans had one messed-up clock


Every day, people miss out on great investments because they don’t know how to quantify risk vs. return. You need written investment criteria.  Here’s a sample.

If you don’t have the energy to click the link, it’s mostly a series of questions that read something like this:

What type of investment is it?
Real estate.

This is a straightforward question with a clear answer. Knowing what classification the investment falls into tells you how liquid it is and how much its value might fluctuate. If the investment were a stock it’d be easy to sell, though not necessarily for a premium. A plot of dirt, improved or raw, has tangible value. But selling it, even in a seller’s market, can burn a lot of hours.

If I bite, how will this affect my allocation?

You don’t necessarily want your eggs in a million baskets, nor in one, but you do need to know how many they’re in. And if the breakdown among the baskets gets out of proportion, you want to know that, too. Say your portfolio starts out with 33% in growth stocks, 33% in long-term notes and 33% in real estate. Six months later, if the percentages have changed to 5, 34 and 61, you’ll want to rearrange to keep things in balance (or ride the 61% component if so inclined.)

But what if this transaction did affect allocation? What would you do to balance the imbalance? You could sell an asset, buy other assets, or decide you’re going to live with a different breakdown.

What do you estimate the return will be?
4½–8%, plus however much the property appreciates, which we estimate will be nothing for the next 3-5 years.

We keep score when building wealth. Amazingly, some people haven’t figured this out yet or refuse to acknowledge it. If you think investing has an emotional component, and that either being a nice person or playing hunches is part of the game, please stop reading Control Your Cash and find something less demanding. Seriously. See, we said “please”. Didn’t hurt your feelings or anything. You should be happy.

What exactly is the investment?
A 2
nd floor, 1-bedroom/1-bath 770 ft2 condo in an above-average part of town. The condo’s listed at $50,000 and approved for a short sale*.

Meanwhile, nearby condos rent for $650-750 a month.  Estimated annual expenses read like this. (This is something called an annual property operating data worksheet. Download it at your leisure.)

The above question is self-explanatory, right? And its relevance should be self-evident. If it isn’t, return to kindergarten and start over. We’ll be waiting.


Anyhow, this investment allows for multiple variables that affect ROI (that’s return on investment, in case you forgot.) Variables include things like rents, and whether you can buy the property as owner-occupied, which means you should be able to get a cheaper loan with lower closing costs. Here’s what we mean:

There are two primary ways to buy this condo as an investment if you have neither the cash up front nor excellent credit. Find a partner, or incorporate.

1. Find a partner (a joint venture.)

An investor lends you $50,000 interest-free to complete the sale. You buy the house and live in it.

Nothing’s free, of course. Under this form of owner occupancy, you pay the investor 70% of the house’s net operating income (i.e., the rent.) Another 10% of the rent goes into a reserve maintenance account – out of which you pay for things like appliance repair. Which you shouldn’t need to if you have a home warranty. But there’ll always be some unexpected expense that a warranty won’t cover: stucco repair, interior paint, etc.

What about the remaining 20% of the rent? That’s yours to keep. Yes, under this arrangement you pay only 80% of fair-market rent. On the other hand, doing it this way you can’t write off your expenses on your tax return.

Who would work out a scheme like this? Lots of people. It’s a perfect vehicle for a father who wants to help his kid buy a home and still earn a return.


2. Form a limited liability company (details here, here, here, and here.)

You and the person who’s lending you money are partners in the LLC, which becomes the official and legal owner of the property. Once you create the LLC and it takes ownership of the property, it’s the sole owner: nobody and nothing else. It’s not as if you own x% of the property and your partner owns 100-x%. The LLC owns it all. You own a particular share of the LLC, but that’s a different issue.

Each LLC has an operating agreement that lays out the details of the deal: such as who gets to write expenses off, how you’ll split profits when you sell the property, and specific duties for each partner. The LLC also protects you from unlimited liability in case a tenant or a visitor decides to sue. They can sue for $1 trillion if they want, and even have a case, but they can’t get more than your investment in the LLC.

With this example, the investor again lends you $50,000 interest-free. You find a tenant, charge her the going rate and again keep 10% in a maintenance account.

This scheme works for partners with disparate skills – e.g. one partner with the time and expertise to find the property (in this example, you) and the other with most of the money.

What’s the downside?

Property values could drop even further, meaning you might need years just to break even. If the property doesn’t rent immediately, your return will decline.

The renter might damage the property. This is why you qualify prospective tenants and collect a security deposit. If you really want to avoid headaches, spend 10% of the rent on a property manager. If you value your time at all, hiring a property manager will pay for itself quickly.

You and your partner might disagree on how to manage the place and, when it comes time, how to sell it. You solve this with an operating agreement, one that looks something like this:

That’s pretty much it. Just make sure that every conceivable subject of potential dispute finds its way into the operating agreement, and that you register your LLC in a state that’s business-friendly. That usually means Delaware or Nevada. Or failing that, your home state. (You can live and operate in, say, North Dakota but register in Maine if you want. It’s totally legal.) Just don’t register in California, and never New York: their LLCs don’t protect you enough.

The old pessimistic saw says you have to have money to make money. That’s not true if you leverage someone else’s.

*Selling a house short means begging the lender’s representatives to take less than they originally agreed to, on the theory that a wounded bird in the hand is worth more than a potentially rabid pair in the bush. Details here.

**This post is featured in the 1/4/11 edition of the real estate investing carnival**

**This post is also featured in the Carnival of the Road to Financial Independence**