2024 Capital gains taxes, the sequel | Jun. 14 Why both profit centers and bankruptcy are important | May. 17 Beware of optionality loss | Apr. 12 Financial planning ideas as you think about retirement | Mar. 15 Inflation equals the end of money printing | Feb. 16 Zombie Firms | Jan. 19 2023 Draw what you see | Dec. 18 The asymmetry of the bond market | Nov. 17 The divergence of short-term and long-term perspectives | Oct. 13 Is dominance of big tech in the S&P 500 a problem? | Sep. 15 Financial planning: the effect of withdrawals versus savings in down markets | Aug. 18 Profits declined and the market rose. What's going on? | Jul. 21 Match your investments with your time horizon | Jun. 16 Applying Berkshire Hathaway techniques to your own investing life. | May. 12 One Day In July named Best Investment Firm in the State of Vermont / Plus real estate thoughts... | Apr. 18 Silicon Valley Bank, and its applicability to you | Mar. 17 Optionality is good | Feb. 17 One thing to think about for your 2023 financial life. It will matter. | Jan. 20 2022 2022, and winning the loser's game | Dec. 28 2022 Growth and Value + Businesses start to scale back. | Dec. 16 FTX. And an example of why diversification matters | Nov. 18 Some interesting longer-term financial perspective | Oct. 14 Looking for patterns in markets | Sep. 16 Are Wall St Analysts getting it perfectly wrong again? | Aug. 12 Harold Hamm is not happy | Jul. 15 Staying with what has worked long-term in investing | Jun. 17 Markets cause butterflies | May. 13 Things are not predictable | Apr. 15 Real Estate and Inflation | Mar. 25 On Russia... | Mar. 4 An important principle of markets | Feb. 18 Sliding into 2022 | Jan. 28 2021 Asset Performance - Year in Review | Jan. 7 2021 Wrapping up 2021 | Dec. 31 Some inflation history, and inflation optimism | Dec. 17 Behavior, Bubbles, and Inflation | Nov. 30 Financial Technologies: look but don't touch | Nov. 5 Wealth vs Money | Oct. 15 Free Riding and Indexing | Sep. 24 Back to school: breaking down an index fund | Sep. 3 Space Rocketeers and Creation of Industries | Aug. 13 Captialism Mechanics | Jul. 23 Bird, Jordan, Hamilton, Jefferson: an American Fourth | Jul. 2 Interest rates = financial gravity | Jun. 11 School Bus Jenga. Plus Bitcoin. | May. 21 Taxes. Fun. | Apr. 29 An observation worth considering from Vermont monks | Apr. 9 Investing lessons from bitcoin and baseball | Mar. 19 The Segway | Feb. 26 Firm Update/ One thing to ask... | Feb. 12 Fun things with Gamestop | Feb. 5 Good patterns for 2021 | Jan. 15 2020 A final thought for 2020... | Dec. 22 The dazzling stock market of November 2020 | Dec. 4 Annuities, please go away | Nov. 13 The search, sometimes financial, for happiness | Oct. 23 Advice + Products = Conflicts of Interest | Oct. 2 Investing and politics do not mix well | Sep. 11 Dot-com 2.0? | Aug. 28 Experts and dissenting views | Aug. 14 Two thoughts on market timing | Jul. 31 The U.S. Government opens the door for the financial industry in 401k | Jul. 17 Walt Whitman and the United States | Jul. 3 The bright side of collapse: simplification | Jun. 18 Inequality is emerging as a big winner from Coronavirus | Jun. 5 What is going on with the stock market? | May. 22 Explaining the purpose of bankruptcy | May. 8 Hazards | Apr. 24 United Flight 232 | Apr. 9 A roller-coaster week | Mar. 27 A primer on viral spread | Mar. 23 Fear is normal. It's part of why we're here. | Mar. 20 A crisis builds. Mental preparation. | Mar. 17 Coronavirus | Mar. 4 How to take lots of money from average Americans. A primer. | Feb. 21 Even Warren Buffett didn't beat indexing | Feb. 7 Two paths for real estate investments | Jan. 24 2019 in Review | Jan. 10 2019 A final thought for 2019... | Dec. 27 Predictions and antifragility | Dec. 13 The bowling alley of investing | Nov. 29 Politics, investments, and change | Nov. 15 Crashes and swans | Nov. 1 Markets are high, but so is fear. Why? | Oct. 18 Hedge fund training 101: go after indexing to get attention for your fund | Sep. 20 After inflation, the average stock fund investor lost more than 11 last year. This is one reason why. | Sep. 6 Will we have have a recession? The yield curve weighs in. | Aug. 23 How financial firms make money from your cash | Aug. 9 Looking back a year: 3 things to learn from the Treasury bond market | Jul. 26 Dividends as a form of annuity | Jul. 12 Something to think about on July 4th | Jun. 28 Alternatives to tariffs | Jun. 14 On emotions in investing | May. 31 A cacophony of signals | May. 17 The not-surprising decline of the internal combustion engine | May. 3 Decisions made at the edge | Apr. 19 Looking back to the future | Apr. 5 Our obligation as we see it and first quarter notes | Mar. 22 Share buybacks, an introduction | Mar. 6 A way to think about market ups and downs | Feb. 22 Is art a financial investment? | Feb. 8 Europe vs the United States - an investor lesson | Jan. 25 John Bogle, creator of the index fund, has died | Jan. 17 2018 stock market observations | Jan. 11 2018 A final thought for 2018 | Dec. 28 Fear and risk protection | Dec. 14 Peeling back the onion: the financial advice business | Nov. 30 Explaining the Dow Jones | Nov. 16 Keeping a wary eye out for inflation | Nov. 1 Two thoughts on current markets | Oct. 19 Consider the null hypothesis | Oct. 5 What do we know? | Sep. 21 The Chart of Shame | Sep. 7 How nouns can help you | Aug. 24 5 big tech stocks. And 5 of their strategies. | Aug. 10 Saving a lot. Often. And again. | Jul. 27 The chemistry of decision paralysis | Jul. 13 The Soviet Union vs Microsoft | Jun. 29 Peanut butter, jelly, and Wall St | Jun. 15 Laggards and leaders | Jun. 1 Every now and then, friction is good | May. 18 Changing and not changing | May. 4 The (arguably boring) importance of a strong Plan B | Apr. 20 Finding Real Estate Joy | Apr. 6 Fiduciary Rule R.I.P | Mar. 23 Indexing and the Venture Capitalists | Mar. 9 Signal vs Noise | Feb. 23 The long-term, quiet glory of dividends | Feb. 9 Elusive Simplicity | Jan. 26 What makes up investment return. It's these three things | Jan. 12 2017 And one final thought for 2017... | Dec. 29 Bitcoin: is it mania, or merely revolution? | Dec. 15 Mutual fund survivorship bias | Dec. 1 The end depends on the beginning | Nov. 3 What we can learn from Scott Legacy | Oct. 20 Preparing for downturns is like landing airplanes without engines: you have to practice | Oct. 6 Unusual thoughts on saving | Sep. 22 Social networks, dopamine, and their relation to investing | Sep. 17 On the value of focusing | Sep. 8 Firm update and some industry observations | Aug. 25 Theologian teaches capitalists a thing or two | Aug. 11 4 behavioral traits that a great investor must have | Jul. 28 The oil business, and why industry sector bets are a terrible idea | Jul. 14 On clients' minds when they first talk to us... | Jun. 30 Investing is a probabilities game. (I'm 97% certain.) | Jun. 2 The lessons of Puerto Rico, and an example of the fee machine of active funds | May. 19 The hedge funder Warren Buffett trounced wasn't all wrong. Just mostly | May. 5 Taxes float and the lessons of April 15th | Apr. 21 Q1 observations, the drag of taxes, and our bull market's future | Apr. 7 401K and 403B, Q1 Dividends, and the mechanics of why active managers almost never outperform | Mar. 24 Optimism in investing wins, big time. Market timing doesn't. | Mar. 10 Index fund portfolio construction. No yawning, this is important stuff | Feb. 24 Fiduciary rule, and where investors lose big money | Feb. 10 Oh attention-grabbing Dow Jones, you toy with us so... | Jan. 27 Index Fund Fundamentals | Jan. 13 2016 2016 Wrap-Up Observations | Dec. 30 A Heartfelt Thought | Dec. 16 The predictable nature of unpredictability | Dec. 2 We know at least 4 things to be true. Maybe more | Nov. 18

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Capital gains taxes, the sequel

June 14, 2024

Vanderbilt's former Dean of Students Madison Sarratt once summarized the university's honor code as such:

"Today I am going to give you two examinations, one in trigonometry and one in honesty. I hope you will pass them both, but, if you fail one, let it be trigonometry, for there are many good men in this world today who cannot pass an examination in trigonometry, but there are no good men in the world who cannot pass an examination in honesty."

The financial world should take note.

The main topic today is one that no one ever disagrees about, and one that engenders no emotion: taxes. I promised you an update on capital gains taxes, and after the quote about honesty, I feel compelled to deliver.

You cannot have a productive economic system without labor and capital, and if you are short either, things do not work well.

The reason this relates to capital gains tax rates is that if the rates are high, capital tends to lock into silos. When you are raising money for a startup, for example, an investor who wants to invest in your startup generally has to sell something else to do so. If that investor has a 30% tax to pay, she is going to think twice about doing so. In many cases she won't, and a good idea or business will wither because of the tax-imposed friction. No capital means no jobs.

This shows up in publicly traded mutual funds and ETFs all the time. One of the advantages to being an established fund player when capital gains rates are high is that you worry less about investors leaving your fund, because you know in brokerage accounts those investors will have a tax on the way out. This protects you as the establishment, and puts a headwind on the more efficient disruptor. At One Day In July, we try to figure out how to unwind this predicament for new clients, but there isn't always a good solution.

Frequently, we see similar funds from the same ETF provider, priced at different levels. It's obvious what is going on: they want to preserve the high profit margins in the older fund, knowing many of the investors cannot leave due to capital gains taxes, and yet they want to capture new money inflows and need a more competitive price. So they create a new ETF that is basically the same thing, but at a lower price.

We have inquired to these fund companies about this, and the responses would be amusing if so much money weren't on the line. Ok, ok, trying to get back to the honesty thing... the responses are amusing. We feel a little badly because the employees at those firms can't just say what we know or they'll probably lose their jobs. I mean I would be tempted to respond:

Well Dan this thing is a cash cow at these price points. I mean we have a fund manager, a few associates, a sales team, and a bunch of software on this beauty and it's running $44 billion at 0.15%. It's tracking an index we license, so not much to do! While we're out on the golf course do yourself a fun-one and run that through your calculator." (Hypothetical me did, it's $66 million in revenue.)1

We at least feel like we should put some pressure on them to lower prices.

One way to address this would be to drop the capital gains rate to zero. But this would have other issues in that capital can compound disproportionately. With no taxation on capital, ever, the system will go out of balance.

This is a hard problem. One idea is to lower rates on people who are alive and making decisions, and offset that by raising them via the estate tax on people who are not alive and not making decisions.

- Dan Cunningham


1. Note that 0.15% is still an excellent price to the investor versus most funds. One Day In July averages at about 0.06% fund fees on new portfolios, though it varies by portfolio and circumstance. Click here or here to learn more on our site (sources listed here as well).

Why both profit centers and bankruptcy are important

May 17, 2024

I want to discuss two effects that often are misunderstood in American business. Both are critical to the functioning of a market system, and hence the indexes that you own. The effects are at opposite ends of the success spectrum.

On the positive side, you can see the giant profits Nvidia is generating. The gross (gross, not net) margin is coming in at 76%, and because the firm smartly does not run its own fabrication plants, every incremental chip sold drives that margin slightly higher. Nvidia invested for over a decade, taking huge risks to establish its AI infrastructure. In this case the gamble worked, and they are being rewarded.

The important thing to observe is how everyone else is reacting to Nvidia's windfall. Notice the flood of competitors trying to chip into that profit pool. AMD and Intel are furiously innovating. ARM is outsourcing designs for its customers to help them speed up their processes. Most of the big tech firms are designing their own processors, partly in an effort to pay Nvidia less. Startups are back into chip design, putting the "silicon" back in "Silicon Valley." (Sorry DoorDash).

People do not let these profit pools sit around, they go after them, trying to take some for themselves, and in the process the profit pool is competed away. This drives innovation forward.

We discussed this previously, but notice that there is a problem here with the indexer. The indexer (that's you) doesn't necessarily care if Nvidia or AMD wins the battle. The indexer owns them both. This is why I believe the index holders should not get voting say in the running of corporations. Only active shareholders, including active fund managers, should get to vote.

On the other side of the success spectrum is bankruptcy. Like profit pools, this is critical to the economy functioning well. Without bankruptcy, assets get tied up in poorly run firms, and something has to be the wildfire that burns out the dead wood, that reignites the new seedlings from the pine cones on the economic forest floor.

This is important, and you can take it to the bank: no system is going to run well that doesn't have the ability for participants to fail.

As an example, one of the reasons religion is so nominal in Europe is that for hundreds of years the church was hooked to the state. Despite Martin Luther running around nailing stuff to doors, the church couldn't really fail, and it would say pithy things but not be responsive to its members. There was no way to improve the system, so it dwindled but could not be killed off. In contrast, over the course of the American experiment, religion has been quite competitive, and churches fail all the time. This has kept them more responsive to current day needs and higher American churchgoing participation reflects that.

Back on the corporate side, the bankruptcy system in the United States is well designed, in that it is intended to preserve jobs, potentially protect bondholders, and wipe out equity holders and management teams.

By the time a firm is near bankruptcy, it generally has been removed from the index, so it's not affecting your investments directly. But well-run firms that are in the index might be buying assets from bankrupt firms and trying to refactor them, which adds value. And it matters to overall economic health.

- Dan Cunningham

Beware of optionality loss

April 12, 2024

Optionality has value in finance. Think about it this way. If you are dating someone, there might be, there likely are, a lot of plusses in the relationship. However, there is a slight loss in that your optionality to date someone else diminishes. Or at least there is more friction in the switching process.

Financial firms like to design products that remove optionality, because it makes it harder to move capital. As an example: private real estate investment trusts (REITs), private equity positions, annuities, whole life insurance, and CDs from banks. Even owning a rental house as an investment. All of these remove optionality. Capital gains taxes do so as well, in that they trap capital in areas of lower return and lower productivity when it should be moving to more dynamic, higher return parts of the economy. 1,

When optionality (and related liquidity) are removed from an investment, the expected return needs to be higher to compensate the investor.

As portfolios arrive here, we are seeing growing use of "alternatives," including private REITs and private equity. These products perpetuate the myth that there is a secret sauce beyond indexing to higher returns. The problem is compounded because the accounting often is manipulated.

The problem is that these private markets are not liquid or transparent, and so there is no force that says "this is what the investment is worth" in a timely manner, the way a publicly traded index fund does. Say a private equity manager had a bad year, which many did with their leveraged funds in 2022. If they report the true drop in the fund, not only will their own fees collapse, but the limited partner that invested the capital is going to be unhappy and turn down the invite to play golf at Pebble Beach. So the private equity manager has an incentive to use accounting gimmicks to "smooth out the loss" so that it doesn't hit in one year. Problem resolved, back to the links everyone!

Almost five years ago, Sebastien Canderle at the CFA Institute dove into this topic, if you are interested. This is a well-done piece, and shows the pitfalls of investing in private markets: read it here.

This is something to watch out for. It's not a good situation: as an investor, you don't know the value of your assets. It likely will take many years to find out. In the meantime, your optionality is shut down, as these funds can be difficult to exit.

When someone mentions a financial product that reduces your optionality, you should think hard about the compensation. You are giving something up, you deserve something extra in return.

Dan Cunningham


1. This is a real effect, and it exists at One Day In July. We probably hold north of $50 million of client investments that we would sell and exchange for better positions if it weren't for capital gains taxes. So weirdly, these taxes help entrenched, wealthy financial firms get even wealthier, to the detriment of more efficient firms, or entrepreneurs that could use the capital. I probably should do a full newsletter on this, as the topic is complex.

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