Finance

IRS loves inflation Since taxes are on nominal gains, in case of 10% inflation, the owner of a stock or a real estate becomes liable for a 10% increase in the equity value even though the real gain is 0%. Credit card companies hate inflation Imagine the scenario with 1% monthly inflation (~13% annual inflation). If you spend 10,000$ on day 1 of your billing, the statement closes on day 30, and you pay back in full by day 60, the credit card company lost 2 months of value ~200$! ...

Every business has revenues and costs. When the revenues and costs are not aligned, the business sooner or later risks bankruptcy. Let me illustrate with a few examples. A restaurant’s costs consist of raw food materials and labor. While the revenues are a function of the amount of food sold. So, in case the revenue falls, the cost of labor kills the restaurant business. A cloud kitchen, due to its reduced labor costs, is more resilient. The costs of oil (or mining) companies consist of drilling and transportation. While the revenue is a strong function of the unpredictable oil/mineral price. That’s why small oil and mining companies go out of business whenever there is a sharp fall in the price of the commodity sold. An airline’s costs consist primarily of the predictable cost of leasing the airplanes and unpredictable oil prices to fly the plane. While the revenue consists of the number of seats sold well in advance. So, any fall in seats sold or any sudden spikes in oil prices leads to a disaster. A software company’s costs consist mostly of labor and infrastructure. While the revenue comes from the increased sales of the software. The incremental cost of serving a user is marginal while the fixed costs are huge. That’s why landing a few big initial contracts to become default-alive can make a huge difference in the long run. An exchange takes a cut of transactions flowing through it. The costs and revenues are aligned. Further, if it is an electronic exchange, like stock exchanges or Ad exchanges then the infrastructural costs are minimal and employee costs are less material. This becomes a pure money-making exercise.

The price variance one sees in the United States is huge. It is not just that price of “organic” groceries can vary up to five times. Even, something as standardized as coke would be sold in a restaurant for 5-10 times more than the grocery store next door. The same goes for non-perishables like clothes where almost all of them, despite being manufactured in the same set of factories can have a huge price range. Sometimes, even the quality is identical.

A charity is when your customers capture value when you don’t. A scam is when you capture value but your customers don’t. A business is when you and your customers both capture value. - unknown

Car insurance in the United States is a system that more or less works well. You call up insurance agents representing different insurance companies with similar policies but varying quality of service. Then you buy it based on how much insurance premium they charge and how good/bad quality of service you are willing to accept. If you have an expensive car or you are a reckless driver, you end up paying more. The less you use your insurance, the lower your premium becomes over time.

The common belief is that in the case of perfect competition (“commoditized goods”), buyers will always buy the lowest priced item, and this will dwindle down profits to practically nothing, and that’s why it’s called red ocean in the first place. While this is true in general, there is at least one notable exception to it. Consider the example of toothpaste, in the US, a toothpaste is ~1-2$ a piece. Are buyers really going to buy a white Colgate for 10¢ lower price over a red Colgate? Most would just stick to whatever they are used to. And that’s where lies the real strategy if the good’s price is an extremely small fraction of the budget, it might never get optimized on. ...

KBB is used in the US for estimating the value of a used car before buying/selling it. While helping friends buy used cars, I felt that it always overvalued the car. I feel there is an anchoring effect in play here. A car owner (seller) feels happier checking the value of their car since it is being reported higher than what they expect. This provides a nice room for providing a discount for converting the buyer. A buyer, especially a first-time one, would feel happier since they are getting a discount on the KBB value. If instead KBB rightly priced the cars, it would leave no room for negotiation, leading to lower conversions. Thus, despite having no direct incentives, KBB would be inclined towards overvaluation. I wonder if the same thing applies for home-buying sites like Zillow and Trulia . ...

An economic activity has one more of the following impacts Wealth creation - for example, processes like extraction of oil, capturing solar energy and even repairing a broken device. Wealth transfer - for example, processes like selling a good, taxes and bribery/theft, though the last one is usually illegal. Wealth destruction - for example, processes like hurricanes, wars and riots. Most developing/underdeveloped countries usually lack sufficient wealth creation, but it does not stop there. They suffer a lot from man-made wealth destruction as well. Sometimes, they are obvious, as in the case of wars and riots. Sometimes, they are more subtle. For example, India loses 24% of electricity to transmission and distribution, as oppose to 6% in the USA. Or, for example, 30% of fruits and vegetable harvest is lost in India due to lack of proper storage. Tax, in principle, is a transfer of money to the government. Even if the government uses money inefficiently, it is still being used. While in the case of wealth destruction, the resources are simply lost leaving an overall poorer society. ...

Since I wrote the initial set of posts, quite a few people have asked me about good credit cards. So, I decided to write one about the same.

(Since my previous posts, quite a few people asked me a basic plan which can be followed, here it is) The items are ordered from first thing to be done to the last thing which can be done (assuming money is still left). Emergency savings Put 6 months worth of expenses in a Series I-Bonds (sold by treasurydirect.gov ) - they try to match inflation rates (but nothing more than that) and can be sold after holding them for at least a year. The idea behind this is to minimize downsides in case of a major market crash. Also, I-Bonds are not counted towards state taxes and a max of 10, 000$ can be purchased in a single year (per SSN). Another simpler approach is to put money in high yield savings account like Barclays Savings or American Express Savings , of course, there is no rate guarantee and rate do fluctuate (usually go down) over time. Max out pre-tax 401K Assuming there is an employer match or if the person can convert it into Roth IRA. Otherwise, don’t do it. Backdoor Roth IRA Invest 5, 500 $ in traditional IRA, hold that for a few weeks and then convert it into Roth IRA and let the money grow tax-free. REITs and Preferred’s Investing in dividend paying (or “fixed income” as they are called) equities is not the optimal strategy for someone who is working full time but I think its psychologically beneficial to get regular dividends especially when market tanks down. An approach for that is to first figure out the amount of monthly dividend one wants to receive and then invest accordingly. For example, to get 100$ pre-tax a month in dividends from saying HSBC preferred shares (HCS) which has an 8% annual yield, the total investment has to be 15, 000 $. A caveat here, dividends coming from preferred are qualified and taxed at a lower rate while dividends from REITs are not, they are considered a regular income. The trick is to hold REIT in Roth IRA account where the income becomes tax-free. Municipal Bonds(Disclaimer: I have not tried these) Municipal bonds are usually issued for long-term (30 years) and the dividends they pay are tax-free (no state or federal taxes) provided the person is resident of that state. Rich people love these especially because the dividends are tax-free and there is no risk (except for municipality filing bankruptcy ) if they are held till maturity. If they are not held till maturity there is in interest rate risk where bonds can go down in value if the interest rate goes up. So, the current market value of the bond will go down and vice versa. In the current scenario (2013), interest rates are low enough that they can only go up, so, investing in these does not make sense unless the person is planning to hold them till maturity. Three-fund portfolio Rest of the money should go into a three fund portfolio ( discussed earlier ).