Author Archives: yoyosconstruction

Dealing with China – Book Review

Dealing with China: An Insider Unmasks the New Economic Superpower by Hank Paulson. Published April 2015. 403 pages.

This book is true to its name.  Paulson has occupied a singular position of leadership in some powerful organizations, and there are plenty of tidbits drawn from his experiences:

  • CEO of Goldman Sachs (1999-2006)
  • U.S. Treasury Secretary (2006-2009)
  • Nature Conservancy (2004-2006)

The minor details that only he would have been privy to are the most fascinating – Zhu Rongji’s visible long-johns, Paulson’s irritation at Chinese leaders that read scripted remarks during meetings and then dozed off, or sharing take-out with Chinese and non-Chinese leaders during the sausage-making process that would shape a deal.  Even the origins around how Paulson assumed responsibility for China in 1990: after being named one of three co-heads of investment banking, he got China primarily because he was based in Chicago and was deemed to be “closer” to China than the folks in New York.

Each of the chapters is organized around a particular transaction or case study, and I found some of the specifics to be somewhat tedious at times, particularly in the first section that details Goldman Sach’s experiences with China.  While interesting to see what it was like to live through the drama surrounding some of those transactions (e.g., guiding companies in the telecom, energy and banking spaces through the IPO process, or considering making a strategic investment pre-IPO in a Chinese bank), much of it followed a similar theme: there was a massive opportunity, the Goldman team encountered some tough challenges operating in China, but through the hard work, intelligence and persistence of key folks within Goldman and the Chinese government, they were able to overcome those obstacles and get the task at hand done.  There is a remarkably high correlation between the Chinese leaders Paulson finds particularly praiseworthy and their current political standing.

The conclusions and observations did not seem to be particularly groundbreaking:

  • China’s objectives continue to be stability and economic development.  Paulson does not think they would jeopardize their economic interests through a military or security conflict.  China will continue to act more assertively, but they will look for ways to find a workable solution.
  • China’s leaders believe they live in a tough area, surrounded by countries that they have fought wars against in the last century, including Japan, India, Russia and forward-deployed U.S.
  • Two key China issues for the U.S.: (1) national security for cyber-war-making capabilities and (2) pilfering of American companies’ secrets.
  • Principles for the U.S. to keep in mind:
  1. “Help those who help ourselves”: help the Chinese reform on their own, and it will benefit us
  2. “Shine a light”: push for more transparency and adherence to universal standards
  3. “Speak with one voice”: be wary of over-complicating complex issues.  It’s better for there to be one go-to person to organize and lead the discussions
  4. “Find China a better seat at the table”: the U.S. should be pragmatic and prepared to compromise to encourage China to take a bigger role on global issues (e.g., WTO, open markets, greenhouse gas emissions)
  5. “Demonstrate economic leadership abroad”: China has taken the initiative in the developing world.  The U.S. must step up and compete with China from a position of strength
  6. “Find more ways to say yes”: better to devise new policies together with China than to attempt to persuade China to adopt our approach to everything
  7. “Avoid surprises but be alert for breakthroughs”: China combines thorough preparation with consensus-driven decision making, so the key to breakthroughs is to always be on the lookout for openings, to be opportunistic and creative
  8. “Act in ways that reflect Chinese realities”: need to focus on what is doable.


As an added benefit, this book gave me the motivation to get some more grounding on how the Chinese political structure is organized.  Paulson is very attuned to who holds power, and Chinese leadership can be very confusing.  I needed to refer to the Wikipedia entry on Chinese political leadership to get my bearings.  The Politburo Standing Committee is the most powerful body, consisting of 7 members who are the top leadership of the Communist Party.  It’s confusing because the members hold positions within the Communist Party as well as within the China state, although this has not always been the case.  For example, Xi Jinping is both the General Secretary of the Communist Party as well as the President of the People’s Republic of China.  Then you have Li Keqiang, the Premier of the State Council of the People’s Republic of China, or effectively the Prime Minister.  The President is the nominal head of state, but the General Secretary actually holds the highest political position.  Both positions are held by the same person, but this was not the case before 1993.  To add to the confusion, the post of Chairman of the Communist Party of China was the highest ranking position until it was abolished in 1982.  Most of the Chairman’s powers were transferred to the General Secretary.

Overall, I found the book good, but not great.  There are many detailed war stories, but you may find yourself skimming over sections to find something more interesting.

Empires of Food – Book Notes

Empires of Food – Feast, Famine and the Rise and Fall of Civilizations by Evan D. G. Fraser and Andrew Rimas.  Published June 2010.  254 pages.

I really enjoy reading books by Jared Diamond (Guns, Germs and Steel, and Collapse) and David Landes (The Wealth and Poverty of Nations).  Those works explore the foundational elements around why certain societies succeed and others fail.  This was a pleasant contrast to how history was taught in school, where it was presented as a progression of major events but never really dived into why those events may have unfolded the way that they did.  This book takes a similar approach but examines it through the lens of food and food empires in particular, as the critical basis of a functional society that allows urban life to flourish.  In the authors’ words, “this book is about how food, economics, agriculture, and human empires are all strands of the same narrative.”

Food empires (from Egypt, to China, to today) exist if three criteria are satisfied: (1) Surplus – farmers need to produce more food than they can eat; (2) Storage/shipping – farmers need a practical means to store or preserve food such that it doesn’t spoil, and transport that excess food to willing buyers; and (3) Exchange – they need a mechanism for exchanging food between farmers and buyers.

In primitive forms, a food empire is a web of farms and trails, rivers and vegetation that deliver food from the cultivated land to a group of interested eaters

Food empires have a tendency to grow, almost cancer-like, until they exceed sustainable limits and implode.  Sometimes this is overextension is due to a sustained period of mild weather and rainfall before some climate change event (e.g., droughts that span multiple years, massive flooding, or cold weather such as the little Ice Age during the 1700s) that drastically reduce food yields.  Other times, it is rapid expansion into new farming grounds – cutting down trees and forests to plant crops that deplete the land of nutrients and exposes the soil to erosion.  Or, it is fixating on specific cash crops that eliminates diversity and makes the empire vulnerable to disease or pests.

The world believes that the modern food empire is sustainable, but that belief is based upon several mistaken assumptions: (1) The Earth is fertile, when in fact, modern food yields are the result of engineered breeds of specific crops (rice, wheat, soybeans) and clever fertilizers based on fossil fuels.  (2) The weather will continue to be sunny, mild, and with adequate rainfall.  However, the weather has always been dynamic, even setting aside the impact of human-induced climate change.  A slight change in average temperature can have a drastic effect on the length of the growing period.  We’ve had a great spell of good weather over the past century.  The major famines that have taken place during that time have had economic or political root causes – a failure of getting excess food from elsewhere to the right place, rather than uncooperative weather resulting in bad harvests.  (3) It is good business to do one thing well.  Planting one crop in one place might be good economics but terrible ecology.  (4) Food supply takes cheap fossil fuels for granted.

The information here is fantastic, and it’s presented in a way that is engaging and interesting.  For example, the book traces why monks began to brew beer.  It turns out that after the fall of Rome, monasteries formed the beginnings of a new food network for exchange.  The primary constraint to trade, without an adequate road system, was that food products would spoil before they could reach their markets.  In order to preserve their excess wheat for trade, the monks brewed beer, along with cheese from milk, and wine from grapes.  There were only certain food products that could be made available for trade.

Overall, this is an excellent and relatively short read.  I read it over two weeknights.  I noticed that not all of the Amazon user reviews were very positive.  The criticisms centered around balance in coverage and how the book jumps around, making it hard to follow.  Some also didn’t really appreciate the authors’ use of the adventures of a Florentine trader as a narrative device.  I think some of those comments are justified, but I found the individual chapters to be well written and packed with interesting tidbits and stories.  In addition to Part I that lays out the key points as summarized above, I found Chapter 5 (on Dirt and the importance of nitrogen and fertilizers), Chapter 6 (on Ice and refrigeration), and Chapter 7 (on how the spice trade became so bloody) to be particularly fascinating.  That’s actually most of the book, so for me, this was definitely time well spent.

P.S. If this is not available in the library, consider buying a used copy.  There’s quite a difference in price between used vs. new condition.

Notes on China Stock Market Plunge


It’s been a breathtaking past few weeks for the Chinese stock markets.  Conditions have been so frothy for so long that the recent downturn is almost a welcome dose of sanity.  I am just starting to dig into what exactly is going on over there.  Below are a few of the better articles that I’ve come across, along with some of my observations.


Notes and observations:

1. The market is dominated by Chinese retail “investors.”  The scale is astounding, with 200 million individual retail traders.  These individual investors account for as much as 90% of daily stock trading turnover, in contrast to most developed markets where institutions account for most of the volume.  The pace of activity has also accelerated, with 30 million new accounts opened in the first 5 months of 2015.  Moreover, many of these new traders might not even have graduated from high school, which would suggest that a lot of unsophisticated folks with perhaps little reason to even be in the market have likely suffered the brunt of the recent decline.  They are certainly trading a lot, and at high frequency, with an average holding period of approximately one week.  According to the CNBC article, total trading activity for 2015 year-to-date has already surpassed all of the activity from 2014.   Most of the pain will be borne by Chinese traders, as strict regulations have limited foreign investors to only ~4% of Chinese shares.

2. Margin financing is prevalent.  Margin financing in China reached $355 billion at the peak, which represents 12% of the value of all freely traded shares on the market and 3.5% of China’s GDP.  The use of margin financing has also increased in the U.S. to over $500B as of April 2015, but it would seem that the rules in the U.S. around margin requirements are more established and the overall pool of tradable securities is much larger.   In the U.S., my understanding is that per Regulation T, the initial margin can be set up to 50%, and the maintenance margin can be up to 25%, but that individual brokerages may choose to follow more conservative rules.  Based on the demographics of Chinese traders from the earlier point, I would also assume that the typical trader in the U.S. is more sophisticated about using margin than the typical trader in China.  In fact, I’m still not quite sure what the specific rules around margin trading in China even are, though it would not surprise me if the margin rules are looser in China.

3. The Chinese government seems to be doing everything it can to stem the bleeding.  I’m trying to find an article or chart that provides a timeline and explanation of what the government has done, but so far have been unsuccessful.  Suffice it to say that all intervention options are being considered, if they haven’t been implemented already.  The central bank has cut interest rates.  Short selling has been disallowed.  Large (5%+) shareholders in listed companies have been banned from selling shares for at least the next 6 months.  The major brokerages have created a fund, with backing from the government, to buy shares and support blue chip companies.  Margin requirements have been relaxed.  With all of this manipulation and activity, it would be very tough to believe any signs of a rebound.

4. The financial impact is significant, and the effects will be felt in other sectors and markets.  China’s stock market had a combined market capitalization over $10 trillion, per CNN Money.  The Shanghai Stock Exchange had a market cap of $5.9 trillion, while the Shenzhen Stock Exchange had a market cap of $4.4 trillion.  Consequently, a 30%+ decline in China’s markets represents approximately $3 trillion of market value lost.  When compared to the major U.S. exchanges, NYSE ($19.7 trillion) and NASDAQ ($7.4 trillion), this amount is large but not particularly extreme.  However, when compared to other stock exchanges around the world, this is quite significant.  Whether in Europe or in Japan,  none are larger than $5 trillion in market cap.  With such concentration among Chinese retail traders, it wouldn’t be surprising to start seeing indications of that pain spilling over into other areas of the market.  In the U.S., the news have been dominated by Greece and Europe, perhaps because the impact to the U.S. is more apparent.  However, even though most foreign investors are not directly impacted by China, the situation there would seem to warrant a lot more concern.




Where Do I Put Cash When Interest Rates Are So Low?

Let’s face it.  It’s been quite the dry spell for conservative savers.  Interest rates are historically low, and they have been quite low for some time.

Risk vs. Reward

In such an environment, it is really easy to get discouraged.  After all, what is the point of putting cash into a savings account when I am hardly compensated to do so?  At the same time, it is also easy to be tantalized by the prospect of pursuing higher yields elsewhere.  Generally speaking, the tradeoff with higher yields is that you incur additional risk – either to the sustainability of the yield received, or to the certainty that you will receive all of your initial investment back.

In this post, I’m going to consider the available options and the criteria to assess what might make sense.

Safety of Principal

In theory, investors demand a certain rate of return even when they incur zero risk to their principal.  In practice, however, there is no such thing as a perfect investment with zero risk.

When I was taking finance classes, the commonly accepted assumption for an appropriate risk-free rate was around 4%.  Generally, this was taken from the prevailing rates from U.S. Treasuries.  Current rates have not been very appealing.  As of June 2015, the 3-month T-bill yields a whopping 0.00%.  Since the U.S. has seen its credit rating downgraded in the past few years, it’s not even clear to me whether U.S. Treasuries still represent the closest proxy for a risk-free instrument.

I would break down safety of principal into what is perceived and what is realistic.  The most apparent form of perceived protection comes from Federal Depository Insurance Corporation (FDIC) insurance, which is an implicit government insurance program that protects deposits up to a certain amount (currently $250k).  This coverage amount is per depositor, per insured bank, and for each account, so an investor could actually receive quite a bit of coverage once all of those coverage limits are aggregated.  The types of accounts covered include checking accounts, savings accounts, money market deposit accounts, and certificates of deposit.

FDIC coverage has provided the most comfort to investors, as that coverage is backed by the “full faith and credit of the United States government.”  Moreover, the FDIC can also draw on a line of credit with the U.S. Treasury if it is ever necessary.  Since its founding in 1933, no depositor has ever lost any money of FDIC-insured deposits.

The counter to this protection is whether the FDIC is sufficiently capitalized to survive a bona fide financial crisis.  A viable insurance company would need to have adequate funds to cover its obligations.  The FDIC should be subject to similar standards.  It certainly surprised me to discover that the FDIC does not actually receive funding from the government.  To cover any bank failures, the FDIC maintains a Deposit Insurance Fund (DIF) that is funded by premiums paid by member banks.  The FDIC is required to maintain a designated reserve ratio in this fund, which has been determined to be 2.0%.  On the surface, that seems pretty low.  In actuality, it’s even lower.  As of December 31, 2014, the DIF has a balance of $62.8 billion and a reserve ratio of 1.01%.   This marked five straight years of DIF balance growth from a low of negative $21 billion in 2009.  The Dodd-Frank Act set a minimum reserve ratio of 1.35% that the FDIC needs to reach by 2020.

When the FDIC was first started in 1933, the insurance coverage limit was $2,500.  The coverage limit has since been raised multiple times.  The most recent raise occurred in 2008 in the depths of the financial crisis when the limit was moved from $100,000 to $250,000.  While inflation has been significant since 1933, I’m pretty sure that it hasn’t been 100x.

For an insurance fund that is meant to cover bank deposits measured in the trillions of dollars, it is a bit scary for me to imagine what might happen if we did experience multiple bank failures.  The FDIC is a “symbol of confidence,” but is it actually a legitimate insurance fund?  In a major crisis or other black swan event, it would seem likely that special emergency injection by the federal government would be essential to cover any shortfalls.  These symbols are perceived to be bulletproof until they are not.  Credit ratings had been regarded nearly as gospel until their integrity was questioned during the crisis.

This is not meant to incite panic.  It is meant to illustrate what the reality of the situation is.  As with any potential investment, you cannot take the marketing at face value.  This is what I mean when I say there is a difference between what is perceived and what is realistic.

Optionality (0% Yield)

Cash is king.  I realize that with lofty prices in many asset classes, cash seems to be in abundance right now.  But there has never been a boom that has persisted.  When the environment eventually normalizes and potentially swings to the opposite extreme, having available cash on hand will prove to be very valuable.  Here is an interesting post that demonstrates that doing nothing for 5 years but then finding superior returns for the ensuing 10 years will yield better results than 15 years of mediocre returns.

Cash held in brokerage accounts will likely not earn much in interest.  Fortunately, there are options that will let you earn a bit more yield while keeping liquidity constraints to a minimum.

FDIC-Insured Alternatives (1% Yield)

Having opened your eyes to the limitations of the FDIC, it is still generally preferable to hold money in an account that is FDIC-insured as opposed to an account that is not FDIC-insured.  I say generally because it really depends on how you are compensated for the risk that you are taking on.  We’ll examine those later on, but understanding what you are

Chances are you are being paid a pittance in your current FDIC-insured account.  Most of the major banks have rates that are measured in basis points.

A quick scan of Bankrate shows multiple options that will produce a 1% yield.  I use GE Capital bank which currently has a 1.05% yield.  Surprisingly, these rates are higher than most short-term CDs, even though these accounts do not require you to keep your funds there for a set time period.

CD ladders are also a popular option.  There are several 5-year CD options that yield about 2%.  It’s admittedly not a super compelling rate, and I’m not sure if tying up funds for that period of time is worth an extra point of yield.

A quick note on taxes too.  If you happen to be in an Obamacare income bracket, and if you happen to live in a state with high income taxes like California, the net income that you receive from your interest income is going to be paltry – approximately 45% to 50% of your interest income will be paid out in taxes.

Index Funds / ETFs: Bond or Equity or Dividend (2%+ Yield)

Once you let go of the FDIC-insurance requirement, there are opportunities to get more yield.  Unfortunately, you are now also subject to volatility in your principal.

Time horizon is a pretty critical consideration here.  As a place to stash cash for the short-term, this is probably not the best alternative.  If there is a sudden downturn, you will not want to be in a position where you would need to liquidate at a loss.  Once again, you need to ensure that you are being adequately compensated for the risk you are taking on above the FDIC-insured alternatives.

However, if you have a long time horizon and would be willing to hold on (by tapping other investments or savings for necessary cash) or tax harvest in a downturn, then it might make sense to take on this risk.  Most prudent investors are likely contributing periodic amounts to these types of investments anyway, and this is a way to add more yield by adding amounts that might have gone toward cash.  If the price increases, then you would happily liquidate and use the cash elsewhere as originally intended.  If the price decreases, then you would just attribute it as a long-term investment and hold on.  This assumes that you don’t actually need to use the cash in the first place, which might be a luxury that not many of us have.

An interesting way to tailor your holdings here would be to consult the credit ratings of the individual companies in the major index funds and ETFs.  For example, you could choose to invest only in companies with a certain credit rating or better.  There are actually only 3 companies that currently possess an AAA rating: Exxon Mobil (3.4% dividend yield), Johnson & Johnson (3.0%), and Microsoft (2.7%).  You might choose to widen your net to include A or AA companies, and you’ll need to pay attention to transaction costs.  However, the benefit of the credit ratings in this context, while not a pure assessment of the likelihood of the business to continue to support and grow the dividend, is that you’ll at least have some comfort in the financial strength of these businesses.

The tax implications are also worth highlighting.  Most dividends will be paid at long-term capital gains tax rates, which means more of the income stream will net to the investor relative to interest income.

Preferred Stock (~5%)

Now, we are looking at some more unconventional alternatives, so be sure to do your own research beforehand.  Preferred stock is senior to common stock, but is junior to most debt.  They also generally pay a heftier dividend than common stock and bonds.  However, these securities also have a lot of terms that may vary depending on the specific issuance.

I use Quantum Online for most of my research into preferred stock.  You’ll notice that most of the issuers are financial institutions, and that you can often earn a higher yield on their securities than in their saving account products.  Take Wells Fargo as an example:

Wells Fargo likely has one of the strongest reputations among financial institutions.  Yet, relative to the rates that you can earn in the savings accounts that Wells offers, you can potentially earn a lot more investing in different parts of the company’s capital structure.

For preferred shares, there are a lot of unique risks that are introduced, including default risk and the risk that the company suspends its dividend payments.  However, this is an example where the additional yield may adequately compensate the added risk exposure.

Options (~5%+)

There are many option strategies that can generate income, but I’m going to focus on one particularly strategy that is fairly conservative as far as option strategies go: selling cash-secured put options.

We can take a look at Wells Fargo again as an example, which is trading at about $57.  If we are comfortable owning the stock at a lower price (say $55), we can sell a cash secured put to take the option premium today.  An option that expires in January 2017, or in about 18 months, currently sells for $5 per option contract, or at an implied 9% yield based on the strike price of $55.  Annualized, this is about 5%.

Wells Fargo is not even the best example, since it tends to not be very volatile.  The higher the implied volatility of the stock, the greater the potential yield by selling puts.  This strategy works on ETFs as well, and might be a good way to earn extra income while waiting for a good entry price.

The risk is that if there is a downturn, you may be committed to purchasing the stock at a higher price than the prevailing market price at the time of expiration.  However, as long as you consider only stocks that you would be willing to own, and at prices that you would be willing to own them at when you set the strike price, then all of the potential outcomes should be fine.


So where does that leave us?  This might seem like dodging the original question, but to me, the only solution to all of this uncertainty is to be diversified across all of these options.  How one chooses to allocate assets across these options is a personal decision since each option has its own risk/reward tradeoff, and it’s not necessary to be exposed to all of these alternatives.  I would probably prioritize optionality and safety of principal, which means that I’ll be holding on to more cash, even though I will still deploy some capital in the other categories.

As always, remember Warren Buffett’s first two rules of investing.

Disclosure: I may at any time hold, initiate or exit positions of any or all of the securities mentioned in this article.


Finding the Perfect Prime Rib Recipe


Ready for the oven

I’m a huge fan of steak, and prime rib in particular.

Unfortunately, the cost of dining out when it comes to prime rib can be quite expensive.  The better steakhouses that we’ve frequented in the Bay Area (e.g., Sundance Steakhouse, or House of Prime Rib) can easily run $40+ per person based on just the menu prices of the meat.  At nicer establishments, the menu prices can easily be a multiple of that.  Of course, we are also now well-versed in the fact that the true out-of-pocket cost is much more than the menu cost.  Factor in the time and expense to actually travel to the restaurant and potentially enduring a lengthy wait even with a reservation, and even the non-financial costs start to add up.  After all that, the food had better be worth it!

It’s for a scenario like this that motivates me to learn how to do something for myself.  If I can somehow replicate the food quality at home, maybe not to restaurant-quality but at least close enough, and potentially at much lower cost and hassle, then cooking and eating at home (at least when it comes to prime rib) would be quite the victory.

It turns out it’s not even that much of a hassle.  I’ve experimented with a few different approaches and have found what I think works pretty well for me.

Here’s a good overall summary for what to look for in a rib roast and how to cook it.


  • Roasting Pan (needed to catch the drippings for the au jus)
  • Meat thermometer (instant or oven-safe)



  • Prime rib roast
  • Butter
  • Garlic, minced
  • Salt
  • Pepper
  • Herbes de Provence



Prime Rib Roast

We typically will select a prime rib roast of 2 to 4 bones, depending on how much meat we want.  Note that a full rib roast has 7 bones.

In our experience, a 2-bone roast is about 4-5 pounds, a 3-bone roast is about 7-8 pounds, and a 4-bone roast is about 10 pounds.  We will typically figure about one pound of meat per person, though we inevitably wind up with leftover meat using this rule of thumb.

Note that the term “prime rib” is used colloquially to describe a method of cooking a rib roast.  The meat will likely not be labeled that way in the stores.  That’s because the term “Prime” is reserved by the USDA to denote a certain (top) quality grade of meat, along with the terms “Choice” and “Select.”  In stores, the roast will most commonly labeled as a rib roast or a standing rib roast, which indicates that the bones are still attached to the meat.  Fortunately, it’s easy to tell whether or not the roast still has the bones.

We typically buy meat from grocery stores, Costco or butcher / specialty meat shops.  Grocery stores will carry meat in the “Select” or “Choice” range, while Costco and specialty stores will carry “Choice” and “Prime” grades.  Typical prices are in the $10 per pound range for “Choice” grade, while “Prime” quality can be considerably more expensive ($17+ per pound).  Pay attention to the grade of meat that you’re getting, particularly at chain grocery stores.

It’s often worth checking with the butcher or meat counter to see if they can remove the meat from the bones and tie the bones back to the meat for you.  You can also do this yourself at home, but it’s easier to just let the experts handle that part.  It’s not necessary to separate the meat from the bones prior to roasting, but it definitely helps you serve the meat after you take it out of the oven.

Butter Rub

The purpose of the butter rub is to give the roast a nice delicious crust.  Smear the butter over the outside of the roast, with particular attention to the cut ends of the meat.  The top of the roast will already have a fatty layer, but it’s good to rub some of the mixture in there too for consistent seasoning.

We typically use about 1/3 stick of butter softened in the microwave, with perhaps 12 cloves’ worth of minced garlic and ground pepper mixed in.

Herbes de Provence

Including additional herbs into the butter spread can enhance the flavor, though my palate isn’t sophisticated enough to really notice much difference.  If you’re like me, you probably aren’t familiar with which herbs are actually associated with Provence.  You can use a specific herbes de provence recipe to prepare a large batch for future use, or you can do what I do and add a few shakes of whatever herbs I happen to have on hand.  Typical herbs include: marjoram, rosemary, thyme, oregano and lavender.


It is absolutely critical to give the roast adequate time to defrost prior to roasting.  You want the meat to be at or close to room temperature prior to roasting, but more importantly, you want the meat to cook evenly.

If it’s previously frozen, this could take a day or longer to defrost in the refrigerator, so you’ll need to plan ahead accordingly.  Otherwise, your meat may still be partially frozen when you cook it, resulting in an uneven mess when you finally take it out of the oven.

After defrosted, most recipes will instruct you to take the roast out of the refrigerator and let it stand for a few hours prior to roasting in order to bring it to room temperature.

The easiest way to circumvent this is to purchase the meat the day of or the day before you roast it.



  1. Pre-heat the oven.
  2. First, salt and pepper the the roast liberally.
  3. Make the rub, using soft butter, minced garlic, pepper, and herbes de provence.  I’m pretty generous with the butter; typically the roast has a coating that is almost like a layer of frosting.  Most of the butter will end up melting off into the pan, but it’s great for getting a delicious crust on the meat.
  4. At this point, there are two approaches.  You can either start off with high heat (500F +) to “lock” in the juices and then roast at lower heat (~300F) for a few hours, or you can start off with low heat to get to 120F, and then finish off with high heat at the end.

This is where the meat thermometer is key.  The challenge is that roasting times will differ depending on the size of the roast, as well as the state of the meat in when you put it in the oven (i.e., how close to room temperature it is).  The rule of thumb is generally 15 minutes per pound of roast at 325F.  Until you take a reading, however, you just won’t know where it is.

Rare120-125FCenter is bright red
Medium rare130-135FCenter is very pink
Medium140-145FCenter is light pink
Medium well150-155FNot pink
Well done160F+Meat is uniformly brown


There seems to be quite a bit of variation in the recommended beef temperature for cooking.  I took the above guidelines from this recipe, but in my experience, even that seems to be a bit overstated.  The primary reason is that when you take the meat out of the oven, the internal temperature will continue to rise, sometimes by 10 degrees F or more.  Additionally, there will be some variation depending on where you take the reading, (e.g., whether it’s near a bone).  Consequently, I will target an internal temperature reading of 120F to take the meat out of the oven.  By the time the meat is served, the internal temperature will likely be above 130F.

I used the high-heat-first method for my initial attempts.  I had been trying out several of Chef John’s recipes with excellent results.  His perfect prime rib actually calls for turning off the oven completely after the initial 500F segment and letting the roast sit in the oven until it’s ready.  I’ve never dared to try that out, as the margin for error seems high.  Opening the oven door would cause heat to leak out and disrupt the cooking process.  Under this method, I would reduce the heat to around 250F to 300F and take out the meat once I hit the 120F target.

More recently, I have switched to the low-heat-first method, and this has become my preferred approach.  This is also Alton Brown’s recommended approach.  Under this method, you start roasting at a low temperature (e.g., 200F),  Generally, the lower the temperature the better, but the tradeoff is the cooking time.  Once you hit the 120F internal temperature target, you remove the meat and cover in tin foil.  When you are approaching meal time, you reheat the oven to 500F and finish off the meat for 10-15 minutes to get the desired crust.

I think there are two key advantages to this approach.  First, the meat will be uniformly cooked at the lower temperature, which means that pink medium-rare area will be more uniform.  If you blast the meat at high heat right at the start, chances are that the meat will have a thick uneven border that is brown and more well done.  Second, this method allows you to better match cooking time to meal time.  Since finishing at high heat does not take much time and is relatively predictable, you can be assured that the meat will be perfectly done when you are ready to eat.

More links for reference:



There are plenty of sides that complement beef, but two must-haves are au Jus and mashed potatoes.  I follow Chef John’s recipes for both.  These are quite simple and can be prepared while the meat is being finished.

That’s about it.  It may take a few attempts to get the process down, but I think you will quickly conclude that it’s silly to splurge for a prime rib dinner at a restaurant when you can get great results at home.

Notes on the Berkshire Hathaway 2014 letter

It’s that time of year again – the release of Berkshire Hathaway’s annual shareholder letter.

I jotted down a few notes and thoughts as I went through it:

  • On the first page showing the historical performance of BRK, they have now started including BRK stock performance, in addition to per-share book value and S&P 500 + dividends returns.  Buffett’s commentary is that in the long-term, stock prices and intrinsic value will invariably converge, and both he and Munger believe that is true with BRK.  In the last three years, however, it’s interesting to note that BRK’s stock performance has outpaced the growth in BRK’s intrinsic value, and even the performance of the S&P 500.
  • The emphasis continues to shift to acquiring whole operating businesses, particularly finding assets where they can effectively and efficiently deploy the vast amounts of cash (~$15B in capex) that the other businesses throw off.  The most recent foray is in auto dealerships with the purchase of Van Tuyl Automotive, a group of 78 automotive dealerships (they’d be the 5th largest group in the U.S.), in October 2014.  I’m not too familiar with this segment, but Buffett makes it sound as though there is quite a bit of runway for consolidation.  There are 17,000 dealerships in the U.S., and they plan on acquiring additional dealerships at sensible prices.  I’m unclear as to the margin profile of these businesses as well as how they are valued, but it looks like Buffett thinks this is a good way to further deploy capital: “we will build a business that before long will be multiples the size of Van Tuyl’s $9 billion in sales.”
  • Speaking of reinvestment, it’s interesting that there was a referendum as to whether Berkshire should consider paying out a meaningful annual dividend.  The wording of the resolution was consider, not actually pay out.  The response from the shareholder base, for both the A and B shares, was overwhelmingly negative.  Essentially, 98% of the shareholder base voted in favor for Berkshire to continue reinvesting in Berkshire and deferring to Buffett to find effective ways to allocate capital.  As long as Buffett is running BRK, this really shouldn’t be a question at all.  The embedded premium in BRK has always been that you are hiring Buffett to make investment decisions on your behalf – for free (no absurd 2%+ management fees here).  This will be interesting to revisit once Buffett inevitably is no longer making those investment and allocation decisions, and hopefully that day is still a long way away.  Perhaps his successor might not get the same latitude from the shareholders as Buffett, and the dividend option becomes more compelling.
  • Buffett’s response to whether or not the conglomerate structure is warranted: if the conglomerate form is used judiciously, it is an ideal structure for maximizing long-term capital growth for the following reasons: (1) it’s the perfect structure to allocate capital rationally; (2) provides the ability to deploy capital across businesses in a tax-efficient manner; (3) provides flexibility to buy pieces of businesses rather than whole businesses; and (4) enables them to be the preferred buyer for certain owners (particularly family businesses) that want to exit but wish to preserve their company and culture.
  • Per-share investments value of $140,123.  The big 4 investments remain the same: IBM, KO, AXP, and WFC.  BAC should also be included on the list as Berkshire has an option through 2021 to purchase 700M shares for $5B, with a current market value of ~$11B (net value of ~$6B).  Although the media continues to scrutinize Berkshire Hathaway’s stock investments, the reality is that the company has long moved away from that.  IBM has been the one stock in which Buffett has actively increased share purchases.  The stake increases in the other stocks resulted from dividend repurchases.  It would be interesting to see if there were a dynamic intrinsic value calculator for BRK, at least for the stock investments.  Whitney Tilson at Kase Capital puts out a very good, comprehensive look at the intrinsic value of Berkshire Hathaway.  There are periodic updates to this deck, and the last update was back in September 2014.
  • A bit more color on Buffett’s successor.  Apart from the capital allocation and manager selection and retention responsibilities, Buffett mentions that his successor will need one particular strength: “the ability to fight off the ABCs of business decay, which are arrogance, bureaucracy and complacency.”  This criterion seems a bit ironic given how he has trumpeted IBM as a major stock pick.  The concern around Buffett’s successor has typically centered on whether that person would provide the same level of investment acumen, which seems to me a bit misplaced.  Buffett hasn’t really scoured the stock tables for cigar butt investments for quite some time.  The reality is that he gets his pick of investments, bets and mega-insurance deals to choose from, often at ridiculously sweet terms.  He’s not entering positions in Goldman Sachs or Bank of America through the open market like the rest of us.  This is the luxury of having built up an unparalleled reputation and a stellar collection of businesses and earnings power over the past several decades.  When he leaves, this legacy will still be there.  Deals might not happen over a handshake at first, but I could definitely see that issue quickly dissipating.  Berkshire will continue to have the pick of the litter of investments; there just isn’t any other comparable entity that can do what they do.
  • A welcome appearance from Munger.  Having eagerly read these letters for many years now, I feel fairly well-versed in how Buffett thinks.  When watching Buffett in action, I often find myself summoning the same examples that Buffett would mention in response to certain interview questions.  As a result, Munger’s contribution was quite refreshing.

All of this discussion of Buffett’s successor and the reasons for Berkshire’s success brings me to the key risk to Berkshire once Buffett departs.  In my mind, the key secret to Berkshire Hathaway’s success has been how Buffett has managed to repeatedly convince great managers to stay and run his collection of businesses.  Moreover, he also privately knows who is the likely successor for those businesses.  He has somehow determined the right incentive structure and compensation scheme to encourage long-term decision making and relatively minimal turnover among his manager ranks.  Getting this right is extremely critical as Buffett will routinely admit that he has neither the motivation nor ability to manage any of these businesses himself.

Berkshire evidently has a roster of superstar talent, but it’s relatively rare to see new CEOs of other companies with Berkshire in their background.  It seems much more common to see a GE or a top tier investment bank or consulting firm be the proving ground for an executive.  It’s also come to be sort of an accepted fact that such “talent” deserves a mind-blowing compensation package.  This has alarmingly led to the growing disparity in earnings between the top and bottom.

There must be some intangible benefits to working at Berkshire, but will the same caliber of managers still be attracted to run those businesses once Buffett leaves?  Is it possible that external opportunities become more attractive to those managers under different circumstances?  How would the incentive structures and compensation schemes have to change if Buffett is no longer in charge of capital allocation (supposing that some of the compensation is tied to Berkshire stock performance)?  These would be great questions for the shareholder meeting.

How to Never Pay Full Price for (Just About) Anything

Now that we know that the true cost of our spending is often much higher than we think, we should be eagerly striving to figure out ways to pay less.

It’s easy to get caught up in an obsessive search for discounts.  Some of the money-saving tips and habits espoused by other blogs and the media can become quite intense, and it might even be a turn off.

I’m pretty conscious of this myself.  While I do not like leaving money on the table, the reward needs to be compelling enough for me to go do it, and there are plenty of activities where the return on time doesn’t make sense to me.  For example, the energy needed to pore through circulars, clip coupons, and redeem them in-store (even with an assist from online tools) is simply not that interesting.  There are just too many small decisions to make with too small a payoff.  I would much rather focus my time on fewer activities that have greater reward potential.

It doesn’t have to be savings on large purchases either; consistent savings on frequent small-ticket purchases like coffee and movie tickets can also add up to a meaningful amount over time.  I can overlook small amounts of missed opportunities and not be too bothered about it.  You will need to determine for yourself what incentive is necessary to justify the time and energy needed to implement these savings.

The point of this post is to highlight what I think works for me.  I don’t think any of the below are particularly original strategies, but I’m often surprised by how infrequently they’re used.  So hopefully, perhaps there are a few ideas in here that might work for you.



This might seem like an obvious question, but it is still worth returning to and asking every time.

Can you borrow it?  Can you rent it?  Can you use something else as a substitute?

Take a moment to consider potential alternatives to get what you need apart from purchasing an item new.  These mainly fall under the following two categories:

(1) Money.  How much money can the savings become in the future?  I recall reading somewhere that this is how Warren Buffett thinks about his spending.  I’m pretty sure it was in The Snowball: Warren Buffett and the Business of Life, since the basic premise is about the magic of compounding.  Essentially, every dollar spent on an item today is a dollar that isn’t compounding to some ridiculous amount many years down the line.  If you’re able to think that objectively and rationally, and you are also reasonably confident in your investment abilities and temperament, it rarely makes sense to make a purchase today when the decision is framed in those terms.  I don’t really find this approach that effective, as it’s hard to get into the proper mindset, and the amounts of my spending are typically small relative to investment amounts.

(2) Hassle.  What I find effective is thinking about the hassle to get rid of what I have currently and what will likely happen.  For example, I have an almost visceral negative reaction to any new kitchen item that we might consider.  Consider a stand mixer, which seems to have become an essential kitchen accessory as popularized in the media recently.  This sort of purchase immediately gets me thinking: where are we going to put it; how often are we really going to use it; can’t we just mix dough with the tools we already have; and could we just borrow it from someone else if necessary?  We have a small kitchen as it is, and the bulkiness of the thing means that it might be challenging to resell down the road.  The key factor to me isn’t so much the cost as the hassle of owning it.



If you’ve decided that you do need to own the item, the next question is whether you need it to own it in new condition.

I certainly have had a preference toward buying new, so I can completely understand how this might not be for everyone.  My evolution has come to mean keeping an open mind about what I truly value about new items.  It’s not so much a strict adherence toward always seeking to buy pre-owned items, but assessing the differences between new and pre-owned and making a judgment based on the tradeoffs.

From my perspective, the primary tradeoff is between cost and certainty.  This is the certainty that the item will work as described, as well as the means to return the item if it does not.  That peace of mind seems to be what you’re paying for by buying new, as the actual functionality and brand value doesn’t really deteriorate over time for most items.  Brand value is actually important here as a signal of quality, and it seems to be reflected by how well an item retains its price.  There may be some wear-and-tear issues, but I can choose to either not consider those specific items or accept those issues as part of the package.  As long as I’m reasonable confident in what I’m getting and can deal with the consequences of getting a lemon, it might be worth the cost savings to buy used.

Books are a good example.  I’m always behind on my reading, and one of the silver linings is that I can often acquire former bestsellers at significant discount by buying used.  Both Amazon and eBay are great sources of used books.  I can also choose what condition I’m willing to pay for.  If it’s a book I only intend to read once, then something in fair condition might be sufficient.  I’ll happily overlook a torn cover and a few highlights to get the book 80%+ off.  If it’s a classic that I plan to refer to often, then I may be willing to shell out more for something in newer condition.

Clothes are a bit trickier.  For example, I’ve purchased a few pairs of premium jeans from sources like eBay and Goodwill.  These were in very good condition and could be acquired for a fraction (~$50) of what it would cost to buy them at retail (~$200+).  You are probably thinking that someone like me making this purchase is a bit incongruous to the principles of frugality.  It is admittedly somewhat indefensible.  My only justification is that these have been part of the de facto uniform in my area of work, even though the dress code is technically casual.

Certain electronics like Apple products and photography equipment are also viable candidates for buying used, though I’ve been surprised at how well these items maintain value when I’ve looked at sold prices on eBay.  In these cases, I’ve definitely considered buying used but found that the premium for buying the item new (i.e., 10-20%) was fairly reasonable.  To go back to #1 on this list for a moment, the price retention of higher quality and name brand items allow you to construct a synthetic rental.  For example, I might be willing to pay top dollar for professional grade camera equipment to sustain a photography hobby, since I can still recoup most of that outlay by selling the equipment if I lose interest or upgrade later on.

A car is likely the one item for most of us with the biggest source of potential savings between buying used versus buying new.  Surprisingly, I’ve never actually purchased a used car before.  Growing up, my family’s philosophy was to always buy new and to drive them until they stopped running.  This meant that buying a new car was a rare occurrence, as each of our cars for about 15 years on average.  I’ve had my current car for 7 years now, and I still feel as though I haven’t reached the midway point with that car yet.

With that prologue aside, suppose that you have decided that you need to buy the item, and you need to buy it new.  What do you do then?



Like I said, nothing too revolutionary.

Step 1: Search for coupons.

You need to search for coupon and offer codes through Google or a site like RetailMeNot before every purchase to see if there are any discounts that may or may not apply.  Most of you probably already do this.

For purchases where you have some time to plan, it’s also sometimes worthwhile to check sites like eBay to see if someone has listed something useful for sale.  In addition to more conventional retailer coupons and vouchers at discount, you may also find items like AMC gold/silver movie tickets, airline club passes and beverage vouchers available.  There’s a bit of caveat emptor here, so pick your spots carefully.

Step 2: Use a payment method that gives you a discount.

This is primarily through gift cards acquired at discount, and credit cards.

Gift Cards

For gift cards, the sites have changed over the years, but check sites like Raise and Cardpool periodically to see what gift cards might be available.  They may not always have something in stock for every retailer, and price changes happen quite frequently, with discounts often varying with denomination.

When purchasing gift cards, keep an eye out for what exactly you are buying.  For example, there are differences between an eGift, a voucher and a physical gift card.  Some can only be redeemed online or in-store, but others are valid for any purchase with that retailer (whether online or in-store).  Most gift cards also have no expiration date, but always confirm.

Watch out also for the denomination of the gift card that you are getting.  You can always buy several low-denomination gift cards (~$25 to $50) and combine them to pay for a single large purchase, but you might not want or need a gift card with a large $500+ balance.

Here are a couple categories that I like to target:

  • Movies: AMC Movie Theaters (25% off).  These cards are typically offered in the 15% range, so this is a great price.  I would get more, but we just don’t go to the movies that much anymore.  Buying morning matinee tickets with the gift card is the most economical way to see movies.  Even the added fees for 3D and IMAX films are less painful once you factor in the embedded discount in the gift card.
  • Clothes: Uniqlo (13% off), Macy’s (20% off), and Marshall’s (18% off).  Just about every clothing specialty retailer offers gift cards, and the cards with higher balances can easily be had at a 20%+ discount.  Clothing retailers also typically have the most frequent special offers for hitting certain amounts (e.g., a coupon code that lets you save $20 if you spend $100).  Use a gift card to pay for that $100 to get the stacked discount.  Shop in the clearance section on top of that, and the level of savings possible here can be quite astonishing.
  • Coffee: Dunkin Donuts (13% off), Peet’s (11% off), and Starbucks (12% off).  I much prefer making my own coffee at home, but I do keep a small balance on my Starbucks app for those occasions when I need to buy a cup.
  • General Merchandise: Target (5% off), Wal-Mart (4.5% off).  This category usually offered in the 2 to 3% discount range, so this week seems pretty good.  Some of these stores also offer their own rewards credit card that might offer discounts (e.g., Target has the REDcard program which gives 5% back on most purchases).  However, we have typically shied away from the store credit cards as the rewards are not as good as other options.  Also, keep in mind is that while shopping here may be convenient, not everything needs to be purchased here.  After you factor in the discounts, it may be more economical to buy certain items like clothes elsewhere.
  • Home and Home Improvement: Bed Bath & Beyond (8% off)Home Depot (10% off), Lowes (7% off).  I typically see these offered in the 8% range.  If you are planning any sort of significant home improvement project, there is no reason that you should not be paying for it with discounted gift cards.  This is also a good category for stacking discounts, as these retailers often have 10% coupons (particularly if you’ve recently moved), and they often will honor coupons from competitors.  If you’re like us, you may receive plenty of 20% off one item physical mailers from Bed Bath & Beyond to get you to visit their stores frequently.  Pay for the balance with a discounted gift card to save even more.
  • Major Purchases (e.g., electronics and appliances): Best Buy (6% off), Sears (8.5% off).  5% to 8% seems to be the typical range for this category, but check often.  Categories like electronics are notorious for low margins.  Best Buy’s profit margins have been averaging 2.5% or lower over the past 10 years, so it’s remarkable that you can get 6% off.
  • Other Categories: The above categories have been the most interesting to me, but there are plenty of other categories where it may make sense to pay with gift cards.  Peruse the other categories on Raise and Cardpool depending on where your spending lies.  For example, we don’t have any pets, but pet owners may want to consider running their purchases through a discounted Petco (8% off) or Petsmart (12% off) gift card.  Arts & crafts stores like Michael’s (16% off) practically demand that you take advantage of their various discounts; paying retail just seems silly.

As you can see, the breadth of discounts available through gift cards can be quite compelling.  However, not every category is suitable for saving money through gift cards.  For example, you’ll notice that I excluded Gas and Grocery.  These categories also offer gift cards, but the discounts available are typically so low (in the 1% to 3% range), that it isn’t really worth the hassle to implement them.  That’s not to say that you can’t save a lot of money in these areas; it just that going the gift card route is not the optimal path.  We’ll need to table this discussion for a future post.

One other hassle is that you will need to have these cards on you in order to take advantage of them.  Otherwise, it’s very easy to forget that you even have these gift cards.  No one wants to carry dozens of gift cards around in their wallet or purse.  It’s probably the reason why so many people choose to monetize their gift cards in the first place on those sites.  I’m sure there will be a digital wallet available soon enough that would enable you to store all of your gift cards on your phone.  Until then, you might want to sacrifice an old wallet to store all of these gift cards conveniently (e.g., in your car) so that that they’re available whenever you go shopping.

Credit Cards Rewards

Credit cards rewards are useful, but my preference is to pay with discounted gift cards.  Our level of spending is just not high enough to make the credit card rewards from ongoing spending volume that attractive relative to the initial sign up bonuses.

There are plenty of sites that talk about credit card strategies and the intricacies of the respective programs, so we won’t go into that here.

For general purchases, we currently favor Chase Freedom and Chase Sapphire Preferred (part of Chase’s Ultimate Rewards Mall shopping portal), and Barclaycard Arrival Plus (which runs the RewardsBoost shopping portal).

The areas of interest are the shopping portals and Chase Freedom’s rotating 5% categories.  The shopping portals typically offer bonus points if you purchase from online retailers by navigating there via the portal.  At stores that we are actually interested in, these can range from 2 extra points to 8 extra points per dollars (which basically translates to 2% to 8% off if you redeem those points for cash).  This is actually most interesting for some of the higher end retailers like Nordstrom and Neiman Marcus, which typically don’t offer many discounts.  The key drawback is that using these discounts often voids any other coupons that you might want to utilize, which often is more interesting than the elevated credit cards rewards.  There’s no such constraint if you pay with discounted gift cards

Chase Freedom selects a few categories like gas and department store purchases to offer 5% rewards every quarter, so it makes sense to pay attention and opt-in to these.  Chase Freedom’s Q1’2015 5% category includes grocery stores, which is fantastic considering it’s next to impossible to acquire a grocery gift card at that discount magnitude.  Even if you can’t take advantage of the $1,500 spending max this quarter because you don’t buy that many groceries, you can always buy grocery gift cards at the store to extend those savings year-round.

In the end, the credit card spending tactics can be quite hairy and full of fine print.  In practice, I’ve found that we typically take advantage of the standard rewards by using those credit cards to buy discounted gift cards from Cardpool and Raise.



Sometimes, you just need to ask: for a discount, or for something extra.  I am terrible at this.  Something about simply asking for something so blatantly makes me uncomfortable, as though I’m being rude and going way outside the boundaries of acceptable behavior.

My father, on the other hand, has absolutely no qualms about this.  It’s his preferred and only negotiation style.  The worst case is that you get a no for an answer, which also happens to be the status quo outcome.  So basically, there is really nothing to lose by asking.

Objectively, I know this.  And still, this requires quite a bit of effort and courage to pull off.  And even when I have had success, it doesn’t make me want to do it again, nor do I feel like I’m getting better at it.

We’ll need to explore this further in a future post.  Suffice it to say that it’s quite expensive to self-enforce your perceived norms of proper behavior.




That concludes the tour for the time being.  This is really just scratching the surface, and I’ve tried to highlight the areas that I think can be most impactful.  It does require a bit of planning, but hopefully nothing too unreasonable to implement.  I think that there is surprising opportunity to optimize spend, and taking simple steps to cut aggregate costs by ~5%+ to feed into savings can really be meaningful over the long-term.

Whew…3,000+ words, thanks for making it down here.

Fuzzy Math – How Much Money Are You Actually Spending?

In order to get serious about financial independence, we need to first understand how the numbers work.  The problem is that the world is not set up to help us think through the numbers accurately.  In fact, we are set up to overestimate how much we make, and underestimate how much we spend.  With the deck stacked that way, it is no wonder that the path to financial independence seems so steep.

The last post discussed the income side of the equation: are we really making what we think we are making?

This post addresses the spending side.

Dining out

A common solve to this would be to create a budget.  Some people enjoy this process, but I can understand how this might not be for everyone.  But even if you have created a detailed budget, it’s not always the most practical tool for day-to-day decision making.  Suppose a friend were to ask whether you would like to go grab dinner later in the week, you probably aren’t going to ask for a moment while you determine how your dining spend is tracking to plan that month.  What you need is a convenient mental model to estimate what something like that will cost you.

If we continue this example, let’s say we decide to patronize a nearby steakhouse, a fine establishment.  After settling down and perusing the menu, we might notice that a ribeye is listed for $50.  (Hopefully, you are already in the habit of noticing prices on the menu before ordering).  You might think to yourself that is not so bad.  It will end up being $50 plus a little bit extra for tax and tip.

But it’s those little extras that always seem to add up to an astonishing amount.  With ~9% sales tax and ~15%-20% for tip, we are already 25% to 30% above the list price.  Throw in a bottle or two of wine, some appetizers and sides for the table, maybe split a dessert, which will all include the 25% to 30% tax and tip surcharge, and the final tally can easily end up being twice what you had expected:

Total$50+$75 to $100+
Ribeye steak$50$50
Service charge?$10
Extras (sides, apps, wine)?$10 to $30
Tax and service on extras?$3 to $9

That eating out costs a lot might not be a surprise, and many of you are probably already aware that you are paying for these extra costs.  You may even be vigilant for the cost of extras that are inserted into the group bill.  Even with this awareness, however, how often do we look at the menu prices and accurately gauge what the final damage will actually be?  And when we are wrong, how often is the surprise more than what we thought, rather than less?  It’s just not something that you would normally think about while out to dinner, nor are these topics of discussion among most social circles.  Restaurants and businesses generally certainly do not make it easy for you to know or calculate the fully loaded cost.  There simply isn’t any motivation for them to help you understand that you are really going to be spending upwards of 30% above prices they’ve listed.  It’s our responsibility to remain cognizant of the real price.

As an aside, steak was one of the first meals I learned to cook, and one of the primary motivations for cooking was the cost difference between eating out and eating at home.  It’s remarkably easy to reproduce near-restaurant quality for steak at home.  Many years and meals later, I rarely would consider ordering a steak at a restaurant.

Big purchases

To take another example, suppose that we are on the market for a new kitchen appliance – a new refrigerator perhaps.  During our research, we might read some reviews that indicate the list price for such an item is $1,000.

Once again, sales tax is a hefty component of your fully-loaded cost, unless you happen to live in one of the few states that doesn’t have a sales tax.  However, in making this purchase decision, are we also considering all of the other costs to get the new refrigerator up and running: the delivery home, the installation and other parts that might be required for installation, the disposal of the old unit, etc.?  If we purchase online rather than in a store, are we considering the potential hassle of having to return the unit?  How often do these extra costs wind up being a significant chunk of the total cost?

Businesses are motivated to anchor you to the initial purchase price of the main item and to obscure the total costs of ownership.  They may be perfectly willing to use the headline item as a loss leader in order to upsell more profitable ancillary services later on.  This is a logical razor-and-cartridges business practice that shows up in many different categories: financing and insurance, maintenance and repairs, extended warranties, installation, etc.  Once again, it’s our responsibility to think through the total cost of ownership throughout the lifetime of the item.

Housing costs

This is likely the biggest expense category for most of us.  And it may be even bigger than we think it is.

Given how obsessed Silicon Valley is about real estate, I’m going to skip most of the common ancillary expenses here.  There are plenty of additional financial costs to housing that are covered in greater detail elsewhere, whether its the nasty shock of that first property tax bill, the necessary cost of insurance, or the ongoing expenses around utilities and deferred maintenance.  There are plenty of primers on how to compare the cost of owning versus the cost of renting.  What I want to focus on are the non-financial costs to housing:

  • Distance.  How much time is spent commuting to and from work?  How would you be spending that time if you didn’t have to commute?  How much would you pay to have that time available to you?
  • Size. How much time is spent on cleaning, yard work and other chores?  How much time is spent on furnishing and decorating extra rooms?  Is that how you would prefer to spend your free time?
  • Opportunity.  How would you value the flexibility to be able to move somewhere else to pursue a new job opportunity on short notice?
  • Peace of Mind.  There is a ton of pressure that accompanies most housing decisions.  It may be coming to grips with the huge financial commitment this entails.  It may be the relief that follows a move after a long period of fruitless searching.  There is a cost to bearing this pressure, and it’s not always reflected in the direct financial costs.


This post has meandered a bit, but my goal was to highlight that we need to be mindful of all of the costs (financial and non-financial) of our spending.  To boil it down to the key points:

  1. Consider the fully loaded costs.
  2. Consider the non-financial costs.

Fuzzy Math – How Much Money Are You Actually Making?

Suppose you make $120,000 a year.

Just to be perfectly clear, this is a fantastic sum of money anywhere in the world.  Even here in Silicon Valley.  Though it is becoming increasingly typical, as it is the average salary of an engineer, most of us would be thrilled to be making that amount.

I selected $120k primarily because the math that follows will be more convenient to explain: it breaks down to $10k in gross income per month.

And yet, $120k doesn’t seem like it’s enough.  Why is that?  That’s because it’s not really $120k, and we should stop thinking that it is.

The reality is that we overestimate how much income we actually make, and we underestimate the actual cost of our spending.

This would seem as though we are deliberately deluding ourselves about money.  That might be partially true, but I don’t think that is the main reason.  The primary culprit has more to do with how we as a society have come to think and talk about money.

For example, you probably are already well aware that what matters to long-term financial goals is the amount you actually take home and keep, not the headline gross compensation number.  But that does not mean we regularly think about our finances in those terms.  In fact, I suspect that if I were to ask you how much you made, your first thought would almost certainly be your gross salary, and you probably would not have a clue about your take-home amount.  Depending on how long you have been working, you have probably grown accustomed to the surprisingly meager amounts that actually get deposited to your bank account periodically.  You might be vaguely aware that there are significant automatic paycheck deductions that are responsible for this, but you might not fully understand the details.

The Income Side

Let’s break it down, assuming you’re a single person living in California with no allowances making $120k in 2015 and paid monthly, using the salary paycheck calculator from ADP:

  • Monthly Gross Income: $10,000  ($120,000 annually)
  • Federal Tax: $2,169
  • Social Security: $620
  • Medicare: $145
  • California Tax: $761
  • CA SDI: $90
  • Monthly Net Pay (After Taxes): $6,215  ($74,580 annually)

We’re only looking at the government-related stuff, and we’re already at ~38% taken off of gross income.

Federal Tax: This is pretty self-explanatory.  The one item of note is that the income tax bracket tiers are adjusted every year.  For this example at $120k, we would be in the 28% income tax bracket, which affects income above $90,750 to $189,300.  The 28% tax rate would be applied on the incremental dollar.  The blended tax rate per the calculator is ~21.7%, which reflects the lower tax rates that are applied on the first $90,750 in income.

Social Security: This is a 6.2% tax that ostensibly will be used to fund social security payments.  Of note is that the tax only applies to a certain wage limit, which rises every year.  For 2015, that limit is $118,500, so the maximum tax is $7,347.  This tax is quite insidious in the way the wage limit rises every year.  As can be seen from that table, it’s practically doubled in the last 20 years.  It seems tough for income growth to outpace the growth in the wage limit.  This is where our $120k just doesn’t seem to be quite enough – you really need to have a super high income for the FICA rate to become negligible.  For most of us, we are all basically paying an extra 6.2% in taxes.  It also seems to be a tax that gets overlooked, even though this is such a significant chunk.  Obama reduced this tax to 4.2% for 2011 and 2012 as part of the various stimulus programs, but it’s unclear how many people actually noticed.  Had the federal tax brackets been reduced by 2%, it likely would have received far more attention.

Medicare: This is basically like social security, but with two differences: (1) the tax rate is 1.45%, and (2) there is no wage limit.  In fact, the rate goes up to 2.35% if you have income above $200k thanks to Obamacare.  This is likely why there was such an uproar on this tax.  For social security, there is at least a limit and maximum tax.  For Medicare, there is no limit, so the tax is effectively uncapped.  Once you were to make above ~$390k, you would actually pay more in Medicare tax than Social Security tax.  Social Security and Medicare are typically referred to together as FICA (Federal Insurance Contributions Act) taxes.

California Tax: Not only do we owe taxes at the federal, we also owe taxes at the state level.  By the way, not all states have an income tax.  California, in spite of its dire budget issues, still manages to levy pretty high tax rates.  What is more, there is no distinction in earned income or investment income in California.  All income is taxed at the same rate.  In this example, we are at the 9.3% bracket, and a blended rate of 7.6%.  The one silver lining is that the taxes owed to California is deductible for federal income tax purposes.

California State Disability Insurance (SDI): Another social program that covers short-term disability income replacement.  It’s mechanically similar to Social Security.  The tax rate in 2015 is 0.9%, and the wage limit is $104,378, resulting in a maximum tax of $939.40.  The rates and limits change year-to-year, but the maximum tax has stayed around $1k per year.  The growth in the wage limit has been disconcerting, and it wouldn’t be a surprise to see this continue to go up.  As with FICA and Medicare, this doesn’t seem to get the attention that the income tax rates enjoy.


That covers the primary government deductions.  There are plenty of caveats to the above, of course, as the amounts will change depending on your ability to claim allowances, whether you have investment income versus earned income, and whether you have ways to reduce your amount of taxable income.  It’s a lot of detail that won’t be covered.  The complexities and unique situations are why most articles will focus on the federal tax brackets as that applies to everyone.

I think the key takeaway is to not underestimate the amount of taxes owed to the other categories.  In this example, these taxes in aggregate ($1,616) are almost as much as the federal taxes ($2,169).

And still, we’re not quite done yet.  This is not the amount that gets deposited into the bank account.  There are plenty of other categories of paycheck deductions, but at least these will generally be within our control and be contributions to our benefit.  Some of these include:

Retirement Savings: 401k contributions are the primary example, and they have the added benefit of being tax deductible.  But not for the FICA taxes.  Did I mention how insidious these taxes are?

Investments: Some companies offer employee stock purchase plans (sometimes at a discount), but require employees to take paycheck deductions in order to participate.

Benefits: The costs of health care insurance and any other benefits payments will be deducted here.  Depending on how generous your company is and how much coverage you need, these payments can be quite significant.

Free Money: Not everything is a cost, but you may need to opt-in to take advantage of this.  This might include employer matching of contributions to 401k accounts or HSA accounts, or discounts of stock purchases.  This is basically free money for the taking.


So after all of that, what are we actually taking home in this example?  Unfortunately, I haven’t found a good calculator that can accommodate all of the different categories.  The following presents the details including the maximum 401k contribution.

  • Monthly Gross Income: $10,000  ($120,000 annually)
    • Federal Tax: $1,749
    • Social Security: $620
    • Medicare: $145
    • California Tax: $607
    • CA SDI: $90
  • Monthly Net Pay (After Taxes): $6,789  ($81,468 annually)
    • 401k: $1,500 (pre-tax contribution)
    • Benefits: $500 (estimate)
  • Monthly Take Home Pay (After Taxes): $4,789  ($57,468 annually)

The complication is that the amounts contributed to the 401k and to benefits are generally pre-tax dollars and would impact the amount of federal and state taxes owed.  It’s tricky to factor the benefits cost in since this varies widely by employer.  I assumed an estimated benefits cost of $500 per month after-tax in this example.

Note that the inclusion of the 401k contribution reduced the overall taxes owed significantly, by close to $7k.  It took the implied overall blended tax rate from 38% down to 32%.

Note also that our take home pay of $4,789 per month is now less than 50% of the overall gross pay.

I would consider this amount to be the true income, rather than gross income.  Although the 401k and benefits costs are both technically discretionary, I think both of these categories are mandatory expenses as a practical matter.  Maxing out 401k contributions (or contributing at least 15% of gross income to the 401k) should be considered the minimum.  The benefits portion can even be considered as a kind of tax as well.  Although there is some flexibility as far as the level of coverage selected, most of us are likely stuck with whatever our employer offers us.  And although we could technically opt out of benefits coverage, that’s just very unlikely to happen.

Where does that leave us as far as how to think about how much we actually make?  It is a complex question.  I think the best we can do is come up with ranges as a percentage of total gross income:

  • Net pay after taxes: 65% to 70%
  • Monthly take home pay: 45% to 50%
  • Disposable income after savings contributions: 35% to 40%

The savings contribution assumes that you save 10% of gross income, which seems to be the default retirement advice.  That advice would typically include amounts contributed to a 401k, but we’re aiming for an early retirement.  If we want to do that, what’s leftover just isn’t very much.

The point is that we need to move off the anchor of gross income ($10k per month), and we need to recognize that our income is in reality only about 40% of that ($4k per month).  That is, we need to budget our lives based on the $4k as the reality and disregard the $10k as merely fantasy.  It might seem like a small step, but when the average rent in Silicon Valley will easily consumer your entire income, it might help to put things in the proper perspective when making significant decisions.  We just need to realize that we make much less than we think we do.

It would be hard enough if that were all there was to it.  Unfortunately, we also tend to think that expenses are much less than they actually are.

We’ll examine the implications on the spending side in a future post.

How to Reach Financial Independence

The answer to this question typically seems to center around hitting some magic number, sometimes with astonishing precision according to those ING commercials.  Accumulate a big enough financial nut, and you’ll be able to live off the interest for the rest of your life.

But that’s the problem.  It’s easy to fantasize about this, and it’s also very easy to get discouraged.  The focus on the number, a figure that is often quite ginormous and several orders of magnitude more than whatever I have today, makes the whole thing seem like a decades-long endeavor at minimum and most likely unattainable.  Might as well splurge on something that will offer me a bit of comfort right now.

Where to begin?

I’ve been pretty fascinated by this area for a long time, and fortunately a lot has been written about this already.  This is great, as it’s less writing for me, and savings in time are way better than savings in money.

Consider two very awesome and popular blogs on the topic and their takes on the path to the promised land:

  • Early Retirement Extreme: Emphasis is on the extreme.  If you can cut spending to the bone through extreme frugality and sustain those spartan habits into perpetuity, you can consider retiring within 5 years.  It’s a combination of philosophy and lifestyle design optimized for a poverty-level budget.  This approach seems pretty accessible, but one that few would likely pursue voluntarily.
  • Financial Samurai: In a way, this is the opposite end of the spectrum.  For all the faults that holding down a corporate job may have, it is still an incredibly effective way to earn a lot of income quickly.  Combine a few years of high earnings with high savings, and you can contemplate leaving those salaryman days behind soon enough.  It’s basically the traditional path to retirement, but accelerated and condensed into a decade.  This approach is somewhat less accessible than Early Retirement Extreme, as you would need to have the ability and drive to actually be hired into a well-paying corporate position.

Both of these blogs offer viable paths that worked out well for their respective authors.  On the other hand, I readily admit that neither of these approaches are a good fit for me.  I have to think that many others share a similar opinion.  I’m just not sure how practical it is to sustain myself on a diet of oatmeal and lentils, or to get rid of the car and ride a bicycle everywhere.  Or to keep a demanding job AND climb the corporate ladder for over a decade in order to score that first million.  There might have been a time in my life when I could summon that desire, but that time has long passed.

Don’t get me wrong; these are two of my favorite personal finance blogs.  As a source of inspiration and as a source of ideas for what is possible and what to do (here’s the path depicted as a cash flow diagram), these have been invaluable to my own education.  These are merely examples, and the beauty is that I can pick and choose among these and many more for what I think works for me.   I think the approach outlined in Mr. Money Mustache blog is the closest to my own thinking about how to become financially independent.

What does financial independence even mean?

At the most fundamental level, I think financial independence means not having to worry about money.

This is not quite the same as early retirement, as many resources (blogs, books, etc.) often conflate financial independence with early retirement.  The point isn’t to move from full-time wealth accumulation up until financial independence day, and then be dedicated solely to leisure activities thereafter.  The point is to be able to live life on your own terms, to be able to say no to requests from bosses that you don’t admire and to tasks that you feel disinclined to pursue, and to be able to bear comfortably whatever financial consequences that might entail.

This also means that I do not think that it’s absolutely necessary to have all anticipated expenses covered by assets or passive income sources.  I realize that some may consider this heresy.  From a purely mathematical standpoint, the precise point of financial independence is when passive income sources is sufficient to cover all expenses.  Much work has been done around retirement calculators and ideal withdrawal rates in this area to determine the right combination that minimizes the risk that you run out of money.

And I would agree that having all your bases covered would be the ideal situation.  However, I would also point out that:

1. Expenses can be fluid.  Unless you are planning for an absolutely bare-minimum budget, chances are your lifestyle will have sufficient flexibility to accommodate more frugal measures if necessary.  That flexibility will be necessary, as planning out your expenses for the rest of your anticipated life with any degree of accuracy seems unrealistic.

2. You may still find yourself engaging in income-generating activities post financial independence.  This isn’t meant to be a loophole.  It’s one thing to engage in an activity for personal enjoyment that includes income as a side benefit, versus working a job for the primary purpose for making money.

3. If you are actually going to spend your time differently and in a more fulfilling way once you are financially independent, then shifting to those activities earlier may ultimately be more valuable to you than continuing to spend time sub-optimally to simply accumulate a bit more in savings to bolster your passive income.

Of course, this might not apply to everyone.  What it means to not worry about money will be different for everyone.  Some may prefer the security of a perpetual income stream, while others might be fine having only 20 years covered, or 10 years covered.  If you are fortunate enough to have some useful and readily employable skill, whether it is programming or a trade skill or healthcare-related, you may likely never worry about the financial consequences of leaving a current job.  Or you may just have picked up an eclectic mix of handy skills over the years, and you can live your life while expending fewer financial resources.

The point is that if something is holding you back from changing your current situation, you probably don’t need as much as you might initially think you need.  And whatever amount that is will be a fluid number; it won’t be precise to the dollar.  Hopefully, this post, the links provided, and other writings to come will help to clarify that.

A few basic principles

The journey toward financial independence is going to be long and interesting, and one that I am still on.  Here are a few thoughts to keep everything in perspective.   Nothing too original here, but still worth outlining.

1. One step at a time.

We’re going to be dealing with big numbers and long time frames, and the incremental amounts that will be saved and earned will seem tiny and slow by comparison.  It will be easy to lose sight of the long-term goal when it feels like we’re hardly making a dent.  But it all adds up.  Dividends and other passive income streams will build from $10 to $100 to $1,000, and eventually cover 1 day’s worth of expenses into perpetuity, then a week’s worth, then a month, and then the better part of a year.

2. Not all capital is financial.

Money is just another resource.  It’s easy to get obsessed with the financial elements, but spending time picking up other useful skills may yield better returns.

3. Spend less than you earn.

This is the basic formula that it all boils down to.  You can achieve this by figuring out how to earn more, or figuring out how to spend less, or a combination of both.  The more you save, the faster you get to where you want to go.

4. Focus on net worth, particularly the assets that are working for you.

Whatever scenarios you run regarding savings rate and investment returns, the key takeaway is that the faster you accumulate a big chunk of capital, the closer you are to hitting your target.  If that capital is lying idle an unutilized as equity in your primary residence, then it doesn’t really help you.

5. Live your own life.

For whatever reason, there are going to be people that will choose to be the guardians of current societal norms.  Norms that include conventional career paths, working unceasingly for decades, leaning in for more responsibility, angling for raises and promotions, and pursuing consumerism.  I may have been guilty of that myself, once upon a time.  The important thing is to figure out what matters to you, determine how to get there, and then go out and get it done.