Cultivating Habits in Good Soil

“The chains of habit are too light to be felt until they are too heavy to be broken.”

— Bertrand Russell

One of the ironies of life is that many bad habits provide immediate rewards while negative consequences are concealed for a long period of time. If I decide to eat a donut and smoke a cigarette as I type these words, my immediate state of mind would be significantly improved and I would face no serious risk of adverse harm on this day, or the next, or the one after that. But I am taking the risk of forming a nefarious habit where my mind would begin associating sugar and nicotine with the act of writing. Although helpful in the near term, these habits could very well become crutches upon which I would increasingly rely in the years to come.

Good habits often seem to offer the opposite scenario: immediate discomfort that is only rewarded in the long run. If you are an obese smoker eating a donut every morning when you start your day, that first bout of exercise is going to be nothing but sheer misery and it won’t really improve the next day. But by the second or third week, most people will begin to see the dawning of noticeable improvement. Through the passage of time will your body change and harden to the point where you will, one day, come to regard exercise as a highlight of your day and perhaps achieve the release of endorphins knows as a “runner’s high”. But what if that runner, now addicted to the daily release of endorphins, allows his habit to morph into dysfunction by running while injured or sick? A good habit can be transformed into a dysfunctional one if we are not careful.

In contrast with most other animals, human beings have a capacity to act with thoughtful agency rather than merely respond to a series of stimuli in a purely deterministic process. We can connect cause and effect over long periods of time and act to optimize our outcomes in cases where the impact of our actions is not immediately apparent. But it is one thing to understand this at an intellectual level and quite another to break free of powerful psychological impulses that could frustrate our best intentions. It is much easier to structure one’s life with the tailwind of human nature at our backs rather than to constantly fight a losing battle.

There are few things that I find less appealing than “self-help” books that promise to cure intractable problems through a series of easy steps. For the most part, there are no shortcuts in life and self-help literature is rife with easy and unrealistic answers. Fortunately, James Clear’s Atomic Habits is much more accurately characterized as a book in the field of human psychology. It is through understanding psychology and establishing strategies intended to make our inherent nature a tailwind rather than an obstacle that Clear bases his thesis for achieving remarkable results through tiny changes. Clear advocates a strategy in which one accrues the “aggregation of marginal gains” to achieve long-term results. This concept is the equivalent of harnessing the power of compound interest to increase your wealth, except Clear’s strategies aim at self-improvement rather than financial returns.

“Habits are the compound interest of self-improvement. The same way that money multiplies through compound interest, the effects of your habits multiply as you repeat them. They seem to make little difference on any given day and yet the impact they deliver over the months and years can be enormous. It is only when looking back two, five, or perhaps ten years later that the value of good habits and the cost of bad ones becomes strikingly apparent.”

Atomic habits, p. 16

Just a few pages into the book, Clear puts forth a seductive proposition that is especially likely to resonate with people who have spent their energy trying to harness the power of compound interest in their financial lives … but is the analogy an apt one? Do habits truly compound as transparently and regularly as the exponential function governing compound interest?

The Physical and Intellectual Spheres

One way to approach the question of linear and exponential functions as they relate to habits is to consider the difference between the physical and intellectual worlds. A habit governed by a physical constraint is likely to exhibit less of an exponential function of improvement than an intellectual habit.

At the early stage of a habit, one is likely to see noticeable improvement in either category. Someone who is out of shape will be unable to run a mile without stopping and might fail to complete the distance in less than fifteen minutes. But daily practice will cut that time by ten, twenty, or thirty percent and soon enough, the runner will break what seemed to be an elusive ten minute mile! But then progress will slow down and a further thirty percent improvement and achievement of a seven minute mile will take months or years of effort, if it is achievable at all. This type of habit is characterized by quick initial progress followed by a plateau beyond which further progress becomes more difficult.

In contrast, consider an intellectual habit such as reading widely. What is the likely pattern of returns for someone who decides to spend one hour every night reading — not just reading randomly but embarking on a thoughtful program of self-improvement intended to result in exposure to multiple fields?

Progress will seem slow at first. It will be hard work as the intellectual muscles gain form and function, but eventually dedicated study will result in internalization of that first mental model, and then another, but the long-term effects will be anything but linear and progress will speed up rather than plateau over time.

Intellectual fitness will build up at an increasingly rapid rate. But why?

The human mind does not learn new subjects and mental models in isolation. As we add additional models to our repertoire, the models start to interact with each other. It is as if pieces of a puzzle start fitting together exposing greater pieces of the intellectual universe.

“You must know the big ideas in the big disciplines and use them routinely — all of them, not just a few. Most people are trained in one model — economics, for example — and try to solve all problems in one way. You know the old saying: ‘To the man with a hammer, the world looks like a nail.’ This is a dumb way of handling problems.”


As Charlie Munger says, if you only have capabilities in one field, such as economics, you will be hamstrung in your intellectual life and unable to view problems through multiple lenses. But as you gain additional mental models, the interaction that occurs magically compounds your ability to solve problems, as Shane Parrish notes in The Great Mental Models 1:

“A latticework is an excellent way to conceptualize mental models, because it demonstrates the reality and value of interconnecting knowledge. The world does not isolate itself into discrete disciplines. We only break it down that way because it makes it easier to study it. But once we learn something, we need to put it back into the complex system in which it occurs. We need to see where it connects to other bits of knowledge, to build our understanding of the whole. This is the value of putting the knowledge contained in mental models into a latticework.”

The Great Mental Models, P. 35

Interconnecting knowledge, built through the habit of reading, results in a latticework that represents exponential returns … and never before in history has it been more accessible for individuals to access all of this knowledge. Clearly, the habit of reading for one hour every evening is one that promises incremental self-improvement that simply compounds over long periods of time without any physical limitations — the sky is the limit and one is never “done” learning.

It’s About Who We Are

Regardless of the rate of potential compounding of a habit, we should seek to maximize our chances of benefiting from positive compounding while eliminating or at least minimizing the bad habits that lead to negative compounding. This is the entire purpose of James Clear’s book which I read in two sittings over just a few hours. I would recommend reading the book to benefit from those insights and will not attempt to provide a summary here. However, I do want to highlight one very profound point that Clear makes early in the book.

Clear outlines three layers of behavioral change: Outcomes, Processes, and Identity. If we have a desire to lose weight, that is an outcome based habit and this is where most people begin. We know what we want to achieve and we seek to bring about that change. We then build a process designed to achieve the outcome that we desire. The process might involve a new routine or changing your environment in some way. However, the deepest layer of change involves our own identity and only comes about when we alter our worldview. Only habits that involve behavioral change that is congruent with your sense of identity will last:

“Behavior that is incongruent with the self will not last. You may want more money, but if your identity is someone who consumes rather than creates, then you’ll continue to be pulled toward spending rather than earning. You may want better health, but if you continue to prioritize comfort over accomplishment, you’ll be drawn to relaxing rather than training. It’s hard to change your habits if you never change the underlying beliefs that led to your past behavior. You have a new goal and a new plan, but you haven’t changed who you are.”

Atomic habits, p. 33

All habits that last are ones that are ultimately about changing our identity in some way. For example, if I want to build a running habit, if my mindset is that I am an out-of-shape middle aged guy who wants to run, I will have less success than if my mindset is that it is my goal to become a runner. The same is true for writing. I am not just someone who wants to sit down first thing in the morning to write. Instead, I am a writer and this is just one part of my identity. It is what I do. If you pick up a musical instrument, your goal shouldn’t be to learn that instrument but to become a musician. If you want to stop smoking, you are not a smoker who is trying to cut back. You are now a non-smoker. The list of examples is clearly endless.

Practical Self Help

Nearly everyone wants to create better habits or get rid of bad ones but most people simply do not know how to go about the process of change in a way that will last. The majority of “self-help” books seem to focus on bringing about an outcome-based change that could persist for a while but soon fall away.

Earlier, I wrote that I find few things more annoying than self-help books, but isn’t the goal of reading any book really about self-improvement? Taking Clear’s concept of identity based change to heart, rather than picking up reading material with the explicit goal of self-improvement, I am simply someone who is always improving and books assist with that goal by providing new insights or novel ways of thinking about old problems.

I am reminded of the Parable of the Sower which makes the point, in a religious context, that seeds of faith that are planted in poor soil might germinate but will soon wither and die. In the case of habits, attempting to sow seeds indiscriminately without preparing the ground is unlikely to result in success. But by preparing the ground ahead of time and seeking to internalize habits into a change in our identity, the seeds of habits can germinate in good soil and last a lifetime.

  1. The Great Mental Models Volume 1 was reviewed on The Rational Walk in early 2000, followed by a review of Volume 2. []

The Crazy Election of 1800

People with a limited sense of history often struggle to interpret current events in a way that makes sense. Facing challenging times can be terrifying if you believe that no one has ever faced similar difficulties. Understanding that human nature changes slowly and that most events we witness are variations of things that have repeated throughout human history can make the present easier to bear.

I cannot recall a more toxic political environment in the United States. The country is divided in ways that I have never seen before. However, I have personally lived through only twenty percent of the history of the United States. I did not experience the revolution, the civil war, the pandemic of 1918, the great depression, the world wars, the civil rights movement, or the Vietnam war, and I was less than a year old when Richard Nixon was forced to resign in disgrace.

Logic and humility would dictate that I should at least look at the nearly two hundred years of American history that preceded my birth before I draw conclusions about what is happening right now. Especially because tomorrow is a historic day — the 59th presidential inauguration, and not just any inauguration but a transfer of executive power between rival political parties that agree on very little.

The Election of 1800

Prior to the ratification of the 12th Amendment to the Constitution, the winner of the electoral college became President while the runner-up became Vice President. This resulted in political rivals being forced to serve together in the executive branch as was the case in 1797 when John Adams was sworn in as President and Thomas Jefferson reluctantly took office as Vice President. 

Although Adams and Jefferson had been friends as younger men, by 1800 they were bitter political rivals. As much as George Washington wanted to avoid the calcifying effects of political parties, the 1790s had drawn clear partisan lines between the Federalist Party represented by Adams and Hamilton and the Democratic-Republican Party led by Jefferson.

The election of 1800 was absolutely wild — it had everything from slanderous personal attacks, anonymously written screeds in newspapers, claims that Adams was a monarchist, counter-claims that Jefferson was a radical who favored the lawlessness of the French Revolution — and the outcome was eventually decided by the House of Representatives in a contingent election that required 36 rounds of voting before Jefferson was declared the President-elect, with Aaron Burr winning the Vice Presidency.

On March 4, 1801, Thomas Jefferson walked to the Capitol to take the oath of office as the third President but John Adams was already on a stagecoach heading north. Clay Jenkinson’s article examining the reasons for Adams snubbing his successor is an interesting read. Although Adams was grieving over the death of his son a few months earlier, he could have delayed his departure by a few hours to hand over power to Jefferson personally.

America faced its first transition of executive power from one political party to another amid an environment of terrible acrimony. Could anyone witnessing those events believe that the country would go through dozens of peaceful transitions of power over the next two centuries with the incumbent president nearly always attending the inaugural of his successor? 

The Election of 2020

Knowing about the election of 1800 does nothing to make the election of 2020 any less momentous in American history. But knowing that a young country went through massive turmoil, found a way to correct course, and then went on to experience dozens of peaceful transitions of power over the next 220 years inspires some hope for the future. 

Technology has changed but human nature has not. If you wanted to attack your opponent with disinformation in 1800, you would pen an article under a pseudonym and have it published in various friendly newspapers without any “fact checking” or attribution. In 2020, you would leverage social media to do the same thing, except instantly, and on a much broader scale.

The barriers to entry for entering the political debate have fallen dramatically. This has given voice to more people but has also made it harder to separate fiction from fact. We can either delegate “fact checking” to the media or rely on our own sense of history and current events to judge for ourselves.

Nothing that happened in 1800 normalizes what has happened over the past three months or excuses Donald Trump’s boycott of Joe Biden’s inauguration. It is important for the country to see a peaceful transition occur, in person, from one party to another. It is also important for America’s enemies to believe that a transition of power is not an “opening” to take adverse action against us. The point is that what we are seeing is not particularly new or surprising when viewed in historical context.


Those who know the history of the election of 1800 are aware of the fact that Alexander Hamilton played a decisive role and set an example of putting his country’s interests first. 

Hamilton and Adams were both Federalists but they were also political rivals. Adams was a moderate while Hamilton was far more ideological. However, Hamilton was also a patriot and a realist. 

The Federalists were soundly defeated in 1800 and Jefferson and Burr were tied in the electoral college. Hamilton and Jefferson agreed on very little, but Hamilton knew Jefferson was a man of character and principle while Burr was morally bankrupt. Hamilton supported Jefferson which influenced his allies in Congress and proved decisive on the 36th ballot:

There is no doubt but that upon every virtuous and prudent calculation Jefferson is to be preferred. He is by far not so dangerous a man and he has pretensions to character.

As to Burr there is nothing in his favour. His private character is not defended by his most partial friends. He is bankrupt beyond redemption except by the plunder of his country. 

Alexander Hamilton to Oliver Wolcott, December 16, 1800

The acrimony between Hamilton and Burr further escalated in subsequent years. The men finally settled the matter in 1804 in the form of a duel in which Hamilton suffered a mortal injury inflicted by the sitting Vice President of the United States.

As for the relationship between Jefferson and Adams, both men rose above the acrimony during retirement. This is documented for posterity in the form of a close correspondence that lasted for over a decade.

Jefferson and Adams both died on the same day, July 4, 1826, fifty years to the day after the signing of the Declaration of Independence.

Further Reading

Alexander Hamilton by Ron Chernow

Jefferson and the Ordeal of Liberty by Dumas Malone

Jefferson the President: First Term by Dumas Malone

John Adams by David McCullough

Founding Brothers: The Revolutionary Generation by Joseph Ellis

The Adams-Jefferson Letters: The Complete Correspondence Between Thomas Jefferson and Abigail and John Adams

Reward and Punishment Superresponse Tendency

“Never, ever, think about something else when you should be thinking about the power of incentives.”

— Charlie Munger

The power of incentives is obvious. Even small children will modify their behavior in response to incentives set by their parents. “Now, Johnny, you must eat your peas or you will not get ice cream for dessert!” When thoughtfully considered and consistently applied, incentives can be used to promote social good, from the micro level at the dinner table to behavior that impacts society as a whole. However, a naive and simplistic understanding of incentives can easily cause much more harm than good.

The Road to Hell is Paved With Good Intentions

On many occasions, poorly thought out incentive structures have caused serious harm. A famous example of this phenomenon is known as The Cobra Effect. When India was under British colonial rule, government officials were alarmed by the number of venomous cobras that infested the city of Delhi. This was an obvious public health menace. The scope of the problem was so great that the government could not hope to catch and exterminate all of the cobras without the help of the public.

A scheme was developed that compensated citizens who turned in cobra skins. Surely enough, this caught the attention of the people. However, the government did not anticipate that industrious citizens would begin farming cobras just to profit from bounties. Eventually, the bounty scheme was abandoned. Without a market for cobra skins, the farmers released the snakes into the city and the problem was worse than it ever had been before.

We can laugh at this today because, in hindsight, it seems so obvious that this would occur. However, the cobra effect is alive and well today. One must consider not only the direct effects of an incentive but the long-run side effects as well. As Howard Marks advocates, we must be sure to give adequate attention to second-order effects. Marks calls this second-level thinking and it’s what the British rulers failed to do.

Recently, there has been a great need for blood plasma from individuals who have survived a COVID infection. Antibody therapy has been useful for treatment of COVID so why not offer incentives for people who have been exposed to make plasma donations? It makes sense until you consider the incentives this creates for people to expose themselves to COVID in order to sell their plasma. Ridiculous, you say! Maybe not, at least not for college students at BYU who found the $100-200 they could earn from plasma donations to be worth the risk of intentionally getting infected.

Incentives in Business

My favorite example of misaligned incentives in business involves the case of the Federal Express distribution system. Charlie Munger uses the FedEx example in a talk on the psychology of human misjudgment, which appears as a chapter in Poor Charlie’s Almanack. FedEx was having a terrible time shifting packages between airplanes at its central distribution site each night. No matter what management tried, the night shift kept failing to complete its task. Of course, this had a cascading impact on delivery times and customers did not receive the service they thought they were paying for.

The problem was that management was paying the night shift an hourly wage. As soon as management switched its pay model to a fixed amount of pay per shift, the problem disappeared. Employees now had an incentive to complete the sorting process as quickly as possible so they could go home. Of course, presumably management had to ensure accountability to prevent sloppy and inaccurate work, but the existential problem disappeared immediately. Without timely delivery, the entire premise of FedEx’s business model would have failed.

Incentive problems extend all the way from the shift worker sorting packages to the very top of an organization. Every year, public companies prepare what is known as a proxy statement that describes, among other things, the compensation program that rewards top executives. Most large companies employ compensation consultants to develop programs that supposedly align the incentives of management with shareholders. Unfortunately, compensation programs often reward undesirable behavior. For example, any compensation scheme that is tied to the short-term price of a company’s stock will inevitably result in executives watching the ticker constantly and they will have a laser-focus on managing Wall Street expectations on a quarter-to-quarter basis.

The intrinsic value of a company depends on its ability to generate free cash flow for years and decades to come, but it is often possible to juice short-term results in a way that is nearly certain to reduce long term value. This is most obvious in matters of capital allocation. If a certain capital investment is likely to depress profitability for several years before it begins to bear fruit, why would a 62 year old CEO three years from mandatory retirement opt for it if his compensation is tied to the stock price over the next twelve months? Compensation arrangements that are complicated can have a cascading series of negative incentive effects that are very difficult to understand. However, no compensation consultant who proposes a simple arrangement is likely to be viewed as earning his or her pay.

Incentive Caused Bias

“The compensation committee relies on its own good judgment in carrying out its duties and does not waste shareholder money on compensation consultants.”

— Daily Journal’s 2020 Proxy Statement

One way to avoid incentive-caused bias is to avoid advisors. This is what Charlie Munger’s Daily Journal does when it comes to arranging compensation agreements with its top executives. However, sometimes you cannot avoid advisors and in these situations Munger suggests the following antidotes:

The general antidotes here are: (1) especially fear professional advice when it is especially good for the advisor; (2) learn and use the basic elements of your advisor’s trade as you deal with your advisor; and (3) double check, disbelieve, or replace much of what you’re told, to the degree that seems appropriate after objective thought.

Psychology of Human MISJUDGMENT

Learning and using basic elements of your advisor’s trade is perhaps the most effective antidote. If you approach your auto mechanic speaking the language of someone who understands cars, you are far less likely to be ripped off than if you seem naive and confused. I always make it a point to mention to realtors some detail about the local market that obviously took research to learn, such as the average recent selling price per square foot for comparable properties.

The cash register is an invention that Munger often lauds as one of the greatest moral instruments of its time. As I discussed in a recent article, the invention of the cash register had the effect of reducing the temptation to steal. Those who have ingrained criminal minds would not be deterred from following a morally bankrupt path and would attempt to find ways to defeat the cash register. But those who are basically good people yet have a surface-level incentive to steal can be “kept honest” by the fact that they know theft is likely to be detected. Making dishonest behavior unpleasant and difficult to accomplish is a moral imperative.

Retroactive Bribery

One especially pernicious incentive effect that we have seen all too often is the phenomenon that I think of as “retroactive bribery”. In conventional bribery, someone in a position of authority is offered something of value in order to favor the interests of the briber. This type of bribery is common but can be discovered, especially when the bribe involves money in an age where almost every monetary transaction leaves an electronic fingerprint. In contrast, retroactive bribery is devilishly difficult to detect and often the “bribe” itself is not even discussed; it is instead implicitly assumed.

Consider the case of a member of Congress who serves on committees that have a significant influence on military procurement. The scourge of lobbying is well known in Washington and the stereotype is the explicit bribe: Please vote for this bill and we will give you a suitcase with $100,000 in cash. However, this type of bribery is for amateurs. Instead, lobbyists and members of Congress develop cozy relationships over long periods of time. Members of the committee might see a longtime colleague retire from Congress and then magically end up on the board of directors of a major defense contractor earning a quarter-million dollar sinecure annually. The next time the lobbyist approaches the Congressman asking for support on a bill, the member will understand the incentive effects well enough. Not a word need be spoken. Friends take care of friends.

Trust and Incentives

As I discussed in The Paradox of Trust, it would be truly exhausting to go through life without extending a basic level of trust to others, at least when it comes to routine and low-stakes matters. The power of incentives is present everywhere but it would be exhausting to attempt to study and examine the incentives involved in every small interaction of life. Instead, we rely on the norms and customs of society to function on a day-to-day basis and accept some risk, including the risk that the incentives of someone we are dealing with might lead them to cheat us.

When the stakes are high, however, we are well served to internalize Charlie Munger’s advice regarding the superpower of incentives. When you are buying a car or a home, you should carefully think about the incentives of the seller as well as the intermediaries who are involved in the process because the purchase could have consequences that last years or decades. But do not restrict your awareness just to incentive effects. By going through a list of potential areas of misjudgment check-list style, you will likely spot cognitive errors in time to take corrective action. Failure to do so can be disastrous when the stakes are high.

Note to readers: This article is part of a series on Charlie Munger’s Psychology of Human Misjudgment.

The Case for U.S. Savings Bonds


I know that is probably your reaction to the title of this article and I can’t really blame you.

There is nothing exciting about savings bonds and you’ll never get rich by investing in them. In fact, you may not even keep up with the cost of living. For most people, there are normally far better alternatives for long-term investments. Yet as we approach the end of 2020, a case can be made to use these mind numbingly boring savings vehicles. Individuals who find themselves in certain common situations could conclude that savings bonds represent the “least bad” alternative.

Bear with me and you might find that savings bonds could be a useful tool in your situation.

The Basics

Except in the case of electing to receive savings bonds through tax refunds, all bonds have been issued in electronic form for several years. TreasuryDirect offers an easy way for investors to purchase savings bonds as well as other treasury securities. Unlike treasury bills and notes, savings bonds are not marketable securities, meaning that the purchaser cannot sell these bonds to other investors. Instead, savings bonds are held by the investor until they are redeemed or reach maturity after thirty years. Savings bonds are not redeemable at all during the first year of ownership and bonds redeemed prior to five years incur a three month interest penalty. The government intends savings bonds to be a medium to long-term investment vehicle for small investors.

Savings bonds offer important tax advantages. They are free of state income tax and while you will be liable for federal income tax, the tax is only due when you redeem the bond or it matures after thirty years. This means that savings bonds offer tax deferral, a rare feature outside of retirement accounts.

There are two types of savings bonds currently offered by the government: Series EE and Series I. One can purchase up to $10,000 of each series every year. Let’s take a quick look at how the two series differ:

Series EE savings bonds earn a fixed rate of interest for the life of the bond. The current interest rate is a minuscule 0.1 percent. Why am I reading this, you might ask? Who in the world would sign up for a bond paying 0.1 percent for thirty years when the Federal Reserve has a 2 percent inflation target? Well, an important but often overlooked feature of the Series EE savings bond is that the government guarantees that the value of the bond will double if, and only if, you hold it for at least twenty years. A doubling of value over twenty years implies a 3.5 percent interest rate. But that is only the case for bonds held at least twenty years.

Series I savings bonds are intended to offer investors inflation protection. These bonds pay a fixed “real” return plus they earn the equivalent of the rate of increase of the consumer price index for urban consumers (CPI-U). Currently, the fixed “real” rate is 0 percent. That’s right, when you purchase a Series I bond, you are agreeing that you will receive no real return whatsoever. Your return will be comprised of only the rate of inflation as measured by CPI-U. In the unlikely event of deflation, the government guarantees that you will never receive less than the purchase price of the bond. Unlike Series EE bonds, there is no guarantee that Series I bonds will double over twenty years. The rate of return is entirely unknown at the time of purchase because the rate of increase of the CPI-U is unknown.

The government also offers Treasury Inflation Protected Securities (TIPS) but TIPS are not savings bonds. TIPS are marketable securities and have complexities that are beyond the scope of this article. However, I should note that the real return on TIPS is currently negative as of late December 2020, which makes the Series I fixed rate of 0 percent superior to TIPS at the time of this writing.

Now that we have a basic understanding of the two types of savings bonds, let’s consider how an investor might use each series.

The Case for Series EE Savings Bonds

There’s no doubt about it – the 0.1 percent fixed rate currently offered for Series EE bonds is pathetically low and inferior to many online savings accounts. There would be no reason whatsoever to purchase EE bonds for an intended holding period under twenty years unless you are expecting significant deflation and the imposition of negative interest rates on bank deposits. In such a situation, Series EE bonds could offer protection from negative rates.

So unless you are expecting deflation, why consider EE bonds?

Most small investors do not think in terms of matching the duration of their assets and liabilities. Insurance companies, for example, think of duration matching when they construct their portfolios. A life insurance company might have a high degree of confidence, from an actuarial perspective, that they will have to pay out a certain amount of nominal dollars twenty years from now. Many insurance companies will seek to match the duration of their investment portfolio to the duration of their expected liabilities.

Consider that mortgage rates are at historic lows in December 2020 with thirty year fixed rate mortgages available as low as 2.5 percent. Let’s say that Michael and Elizabeth, a newly married couple, just purchased a home for $475,000. They were able to make a 20 percent down payment of $95,000. The monthly payment on the $380,000 fixed rate 30 year mortgage works out to just over $1,500.

Michael and Elizabeth are both 35 and plan to retire in twenty years at the age of 55. This isn’t a starter home for them — they plan to live in it for decades to come and have a high degree of confidence that they will not be forced to relocate. Having a 2.5 percent mortgage for 30 years is very cheap money but they don’t like the fact that mortgage payments will continue beyond their retirement date.

The risk of inflation is a huge problem because most future expenses can and will rise as the cost of living rises. However, Michael and Elizabeth’s mortgage payment is fixed for the life of the loan. It will be $1,500 per month or $18,000 per year during the first year and all subsequent years.

If the newlyweds want to provide for the mortgage payment during years 21 through 30 of the mortgage, when they will be retired, using Series EE savings bonds could be a perfect way to achieve this objective. By investing $10,000 per year in Series EE bonds for the next ten years, they know that they will have $20,000 per year during years 21 through 30 of the mortgage. Although they will have to pay income taxes when the bonds are redeemed, the proceeds should still be enough to pay the vast majority of the $18,000 annual mortgage service. The risk of inflation is not relevant in this situation because they duration matched the asset with the liability they know they need to service. And they are better off for doing so because the interest rate on the EE bonds will work out to 3.5 percent which is a full percent greater than the 2.5 percent rate on their mortgage.

Granted, this isn’t so exciting and the couple would very likely do better invested in an equity index over two decades. But few things in life are guaranteed. Using EE bonds to fund a fixed payment obligation bearing an interest rate lower than the EE bond rate is an option worth considering. Of course, there are risks. If Michael and Elizabeth cash those EE bonds even a month before reaching the twenty year mark, they will not earn 3.5 percent annually, but the miserable 0.1 percent fixed rate that would apply in the absence of the twenty year doubling guarantee. This is not an insignificant risk.

The Case for Series I Savings Bonds

The case for using Series I savings bonds differs from the Series EE scenario in terms of the duration of the commitment. Unlike Series EE bonds, Series I bonds are not guaranteed to double over twenty years. All you will ever receive from these bonds, at today’s 0 percent fixed rate, is the rate at which the CPI-U increases. This rate is reset twice a year and is currently 1.68 percent.

With online savings accounts paying only 0.5 percent as of December 2020, an investor could do better with Series I savings bonds even if the bond is held the bare minimum of one year. Sacrificing three months of interest would still result in a return of over 1.2 percent, more than double the rate offered by the highest yielding online savings accounts. Of course, if the CPI-U resets to a lower level in six months, the return the investor will get will be lower than 1.68 percent, but it seems unlikely that we are going to have disinflation or outright deflation in the United States given that the Federal Reserve is determined to create inflation of 2 percent, and perhaps more than that as the economy recovers from the COVID pandemic in 2021.

The idea of using Series I bonds as a substitute for one year treasury bills is also attractive given that the one year treasury yields just 0.09 percent as of late December 2020.

A significant limitation is that you cannot invest more than $10,000 per year in each savings bond series. However, the new year will soon be upon us. There is no reason that you cannot invest $10,000 in the remaining days of 2020 and another $10,000 in January 2021. In addition, you could direct the IRS to invest up to $5,000 of a tax refund in savings bonds. There is nothing prohibiting a taxpayer from overpaying 2020 taxes and directing the refund in early 2021 toward $5,000 of additional savings bonds. So, an investor could put around $25,000 into Series I Bonds in this manner over the coming weeks.

Picking Up Crumbs

Yes, this is all quite boring but we find ourselves in a very low return world and sometimes eking out just a small additional return can be worthwhile.

I have purchased I Bonds in recent days and will be doing so again in early 2021 with the intent of using these bonds as part of my bond ladder. In my case, I will likely hold these bonds for five years in order to avoid the three month interest penalty for cashing out sooner than five years. The five year treasury note currently yields 0.37 percent and it is hard to see the Series I bond returning less than that between now and 2025.

I am under no illusions that Series I bonds represent a good investment. They just seem to be the “least bad” alternative at the moment for funds that I plan to need within the next several years. For longer term commitments, owning well run businesses, either directly or via stocks, offers the prospect of better long term returns, but the key words here are “long term”. Anything can and will happen in equity markets over short periods of time. Having a bond ladder might be boring but it helps me sleep at night and prevents forced sales of stock at distressed prices.

Obviously, everyone has a different financial situation and these ideas may not make sense in your situation. As always, this isn’t tax or investment advice but hopefully the article was at least a little less boring than you thought it would be.

The Psychology of Money

“Like Warren, I had a considerable passion to get rich, not because I wanted Ferraris — I wanted the independence. I desperately wanted it.”

— Charlie Munger

The world can appear vastly unequal in terms of the goods and services that people are able to consume. To the slum dweller in Mumbai or Rio de Janeiro, the lifestyle of a middle class American would seem utterly unbelievable. A middle class American would find the spending power of a family worth $20 million completely inconceivable. And the family worth $20 million cannot conceive of the spending power of a billionaire like Warren Buffett or Jeff Bezos.

Wealth can buy material goods and services and this is what most people focus on, both in terms of satisfying their desire to consume as well as their desire to appear successful in the eyes of their peers. But a relentless focus on the material goods that wealth can purchase badly misses the point.

The truth is that time is the currency of life.

The ability to control your time means that you have the ability to control how the most valuable resource you own is spent. The middle class American’s life expectancy might not be quite as long as the life expectancy of a billionaire. Money can indeed purchase better medical care and, for some people, that can provide more time. But the truth is that Jeff Bezos and Warren Buffett cannot hope to enjoy multiples of the time that the rest of us can enjoy on this earth. Their time is limited, just as time is limited for all of us. However, they have both had something that most of us do not have: the ability to control how they spend every day of their lives starting from a very early age.

Most people will never be worth $5 million or $20 million, let alone worth billions. But it is within the power of people earning middle class incomes to design their lives in a manner that gives them increasing control of their time, and with that control comes the prospect of an increased level of satisfaction with life and greater happiness.

As Morgan Housel writes in The Psychology of Money, “The ability to do what you want, when you want, with who you want, for as long as you want, is priceless. It is the highest dividend money pays.” If you are reading these words and nodding your head in agreement, you are vastly ahead of the game because this idea is far outside the mainstream of how people view money. For most people, the thought of money is inextricably linked with the goods and services it can buy and how those things will make their lives better and happier. The idea of saving money is grudgingly conceded to be a necessary, but distasteful, thing that responsible people must do. Most consumers view the next paycheck or bonus in terms of what it can buy, not the independence it can provide. And this makes intuitive sense at first glance. Aren’t the wealthy happier than the middle class and the middle class happier than the poor? It seems obvious that this would be the case. How could it not be the case when money can be used to buy so much cool stuff?

For someone in poverty, being able to consume more stuff clearly will increase happiness. The ability to have as much food as your family needs, to have warm clothing in the winter, to be able to air-condition your home in summer, and to have a washer and dryer to avoid going to the laundromat — these are all tangible improvements for someone moving from poverty into the middle class. But beyond a certain point, hedonic adaptation takes hold. You keep ratcheting up your consumption, which brings transitory happiness at best, but soon find yourself right back where you started, except now your baseline set of expectations has grown requiring you to maintain your spending to avoid feeling deprived.

Morgan Housel has been writing about finance and investing for over a decade, getting his start at The Motley Fool and later writing a column for The Wall Street Journal. Housel is currently a partner at the Collaborative Fund and writes frequently on personal finance topics. His approach to money and investing is to view it through the lens of psychology because the human element stands far above all other factors when it comes to the results a person can expect to achieve over time. As Housel notes, investing is one of the very few fields that offer ordinary people daily opportunities for extreme rewards. If you view money through the lens of consumption, the temptation to try your luck in this casino can be overwhelming. However, if you view losing money or interrupting the process of compounding as losing control of your time and sacrificing your liberty, the temptation to gamble is much reduced.

Tame Your Ego

Ego is often the root cause of dysfunctional financial decisions. What are we really trying to accomplish when we buy a fancy house or a $100,000 car? Sure, such things might offer personal utility and enjoyment, at least for a while. But eventually, hedonic adaptation takes over and these new things become the baseline. What many people who consume such items are actually trying to do is signal to others that they have “made it”. They are successful and wealthy and should be looked up to. They want to be admired. And maybe even envied.

Housel asserts that “past a certain level of income, what you need is just what sits below your ego.” Would it bother you if your neighbors do not admire the car that you drive to work each morning? Or if they see you waiting for the bus a block away instead of driving at all? Would it bother you if your co-workers find out that you live in a more modest neighborhood than someone of your income could “afford”? As Housel says, people who are successful with their personal finances “tend to have a propensity to not give a damn what others think about them.”

Wealth is What You Don’t See

There are some interesting paradoxes in personal finance that seem totally obvious once you think about them but escape the consciousness of almost everyone. Housel’s chapter entitled “Wealth is What You Don’t See” gets the prize for an insight that is both extremely valuable and obvious, at least once you pause for a few moments to think about it.

When you see a person driving down the street in a Ferrari, what do you automatically think? “Oh, that’s a rich guy driving down the street.” But do we really know that about the driver? We have no real idea if that is the case or not. Housel uses his experiences as a valet at an upscale hotel to note several important things about drivers of expensive cars. One of the regulars at the hotel who drove a Porsche later showed up in an old Honda after the Porsche was repossessed. But when the regular drove the Porsche, did Housel admire the driver? No, he admired the car, not the driver! Driving a fancy car is evidence of either debt or extinguished wealth. It is not evidence of wealth.

Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes foregone and the first-class upgrade declined. Wealth is financial assets that haven’t yet been converted into the stuff you see.

That’s not how we think about wealth, because you can’t contextualize what you can’t see.

When most people say they want to be a millionaire, what they might actually mean is “I’d like to spend a million dollars.” And that is literally the opposite of being a millionaire.

The Psychology of Money, p. 98

What could be more obvious? If you want to be wealthy, you must defer consumption. Your wealth, to the extent you invest it in financial assets, is hidden from the world. Few things remain taboo in modern American society, but it is still taboo to go around talking about the size of your bank account or how many shares of stock you own. Those things are invisible whereas what you wear, what you drive, and the home you live in are visible to all. But all of those things are the opposite of wealth. Many people who consume such items are wealthy because they also have financial assets. But they are less wealthy when they consume these items. They may enjoy it, it may be easily affordable, and there’s nothing wrong with consumption, but the fact is that what people think of as wealth is really the opposite of wealth.

What Should You Do?

Providing financial advice is notoriously difficult and those who provide it have an awesome responsibility. Financial advisors are responsible for guiding a client’s financial health in the same way that a doctor is responsible for guiding a patient’s health. Most personal finance books have roadmaps that purport to be actionable things that people can do to achieve their objectives. But Housel does not provide specific prescriptions for what you should do with your money. Why? He doesn’t know you, he doesn’t know what you want, he doesn’t know when you want it, and he has no idea regarding your motivations. This is refreshingly honest but, as is the case with many areas of the book, quite obvious once you pause to think about it.

Instead of providing specific financial advice, Housel does a great job of framing money and wealth in the context of the psychology of human beings, recognizing that it is wrong to simply assume that others are crazy because their decisions do not seem rational to us.

However, this does not mean that the book lacks practical advice.

The wisdom contained in these pages is not going to come from some specific prescription regarding what to do with your investment portfolio, but it could convince people to have an investment portfolio because savings is important, whether you have a specific goal for saving or not. It could convince people that time is the true currency of life and that having control of that time is perhaps the ultimate benefit of wealth. It could increase the humility of those who believe that conspicuous consumption leads to recognition and respect.

It’s All About Freedom

The bottom line is that financial independence is not about what you can consume. It is also not necessarily about quitting your job and retiring. Instead, financial independence is about freedom. Freedom to choose to spend your time as you see fit. Freedom to not do things that you do not want to do. Freedom to not associate with people who you dislike.

When viewed through the lens of freedom, personal finance is no longer the boring and tedious topic that many perceive it to be. Instead, it becomes an essential component of living a good life.


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