Should we own something small wholly or own something big partially
Warren Buffett likes to buy high dividend paying companies and turn them into private companies. Then he stops distributing dividends from these companies. In that way, he doesn’t have to pay tax on dividends. How much is the difference with and without dividend tax?
Suppose a company has constant earning every year. The dividend payout is 6% of asset value. Suppose the dividend can be reinvested with the same level of return. Suppose the initial value of the company is 1 billion. What is the final value of the investment with and without dividend tax, after 40 years? Assume the dividend tax rate is 25%.
With tax the final value is
1*(1+6%*(1-25%))^40 = 5.82 billion
Without tax the final value is
1*(1+6%)^40 = 10.29 billion
Wealth level without tax almost doubles that with tax.
Sometimes, Buffett traded part ownership of a company for a whole subsidiary. For example, he once traded some stocks of P&G for the whole of Duracell, a subsidiary of P&G. Since Duracell becomes a private company, Buffett doesn’t have to pay dividend. With few exceptions, almost all public companies at mature stage have to pay dividends. Otherwise, investors would be very uncomfortable to hold a company that never distribute dividends. But one doesn’t have to pay dividend if it is private. In that way, one saves a lot of taxes, which can be understood as part of the transaction costs.
In general, should we own something small wholly or own something big partially? The above example shows that it is more profitable to own something small wholly. In that way, you don’t have to pay inevitable transaction costs that are associated with shared ownerships. Similarly, should we put more effort to our families or engage in more external activities? Should the tax and regulatory system encourage small family businesses or large corporations? Currently, complex regulatory systems deter small companies from entry and protect established large companies from competition.
Money is a type of performance enhancement drug. When two persons compete, the one who uses drug usually wins and takes away trophies. But things don’t stop here. More and more people will use drugs, with larger and larger doses. In the end, the situations often turn fatal to individuals and the societies.
Similarly, two persons compete, the one who uses money usually wins and takes away trophies. But things don’t stop here. More and more people will use money, with larger and larger amount. In the end, the situations often turn fatal to individuals and the societies. Highly monetized societies usually collapse spectacularly.
Religions are developed as a tool to counter the lure of money. In bible, it is said the love of money is the root of all evil. In islam, money lending is prohibited. The suppression of money is the secret of long term success of religions. But the success of a religion will ultimately bring back large amount of money and wealth to that society.
How to deal with money? We may reflect on the life cycle of plants. In spring time, flowers flourish to attract mating opportunities. After mating, plants shed expensive flowers to concentrate on fruits, the next generation.
In Chinese language, many idioms are about the relationship between flowers and fruits. One is spring flower, autumn fruit (春华秋实). This is nature’s way. Another is flowering but not fruiting (华而不实). This is against the nature.
But today’s society is very much against the nature. When one is young, one is heavily burdened by low incomes, taxes, pension deductions, student loans. The youth can’t flourish. Many people can’t form families. But when people reach their fifties, sixties, seventies and even eighties, their incomes and old age benefits enable them to live opulent lives. Many of them flaunt their expensive houses, expensive cars and expensive tastes to attract new mates and new admirers.
Why old people, who are physically and mentally weaker than youth, are socially dominant? It is the prevalence of money. In a highly monetized society, the distribution of resources inevitably becomes highly inefficient. Over time, a highly monetized society is being destroyed by simpler societies, as we are witnessing now.
Many articles talked about the benefit we will receive upon retirement. Few articles talk about how much we have to pay for the potential benefit. We will briefly discuss the cost we pay for retirement.
The easiest part to calculate is CPP (Canada Pension Plan) contribution. For people earning $55,000 or higher a year, CPP contribution is over $5000, including the employer‘s contribution. OAS (Old Age Security) benefits come from general tax income. It is not directly connected to your individual tax contribution. As OAS benefits cover everyone and benefit amount is of similar value to CPP, we can estimate our average tax contribution to OAS is at least $5000. With CPP and OAS, an average person pays about $10,000 per year for retirement.
Most companies provide company sponsored pension plans. Total contribution, including employer’s contribution, is about 10% of your income. An average Canadian worker makes about $50,000 a year. His company pension contribution is about $5000 a year. Together with CPP and OAS contribution, we already pay about $15,000 for retirement every year.
There are many optional retirement plans with tax benefits. It is up to individuals to determine how much one wants to pay. For me, it is much more valuable to spend money when one is young than one is old. We can have one more memorable vacation, one more precious child, and one more beautiful memory when we are old. Why squeeze our youth to pursue a mirage of paradise in old age?
Finally, we will estimate the efficiency of retirement benefit. Our average CPP and OAS contribution is $10,000 a year. Over 40 years, our total contribution is $400,000, without counting time value. Average Canadian life span is 81 years old. On average, we will receive 81-65 = 16 years benefits. The maximum retirement benefit for a single pensioner from the government is $24000, or $23997 to be precise, in the year 2017. But not every one is a single, and majority have other incomes, such as company pensions. The average payout may be much lower than $20,000. Suppose the average payout is $20,000. Over 16 years, the total payout is $320000, which is much lower than the total contribution of $400,000. Forget about the supposed huge time value over such a huge time span. We can’t even get the principal back.
Given the dismal performance of the government pension system, one might recommend reducing pension contribution. But the contribution has been increasing over time to cover the supposed shortfalls.
To many people, financial matters are extremely complex. They cause great anxiety over our lifetime. The following are several simple rules that simplify our financial decision making. They can help reduce our anxiety over financial matters.
1. Don’t invest before paying off debts
More and more people accumulated debt over their lifetime. That is often a source of great anxiety. At the same time many people invest heavily in the stock market. They will be better off to pay off debt first. In that way, they greatly reduce the number of financial transactions. They neither have to worry about debt nor the fluctuation of the stock market.
Some might say that the cost of debt is lower than the return of the stock market. So it makes sense to invest in the stock market while accumulating debt. But if we include the fees and the taxes, the results may be different. From the law of one price, it is unlikely to expect the return from one asset class to be much higher than the other. Most people cite statistics from the US market. United States is the largest stock market. Japan and China are the second and third largest stock markets in the world. When we use Japanese or Chinese stock market returns to measure investment performance, we probably won’t reach the conclusion that stock markets provide fantastic returns, even over long term.
Borrowing and investing simultaneously involve two rounds of transaction costs. But from the perspective of financial institutions they involve two rounds of income. That is why financial institutions will recommend borrowing and investing simultaneously.
Pay off debt before we start investing. This greatly reduces the number of financial transactions and the related costs. This greatly reduces the complexity of financial decision making.
2. Don’t accumulate credit card debt
Interest rates on credit card debt are very high. But over time, people are carrying or “managing” more and more credit card debt. Some think using debt will increase our spending power. They don’t. High interest payments quickly erode our ability to spend.
It is better to pay off all balance each month than to “manage” a debt with high interest rate.
3. Don’t worry about retirement before fulfilling other obligations
Financial advisors often advise us to save for retirement as early as possible. If you start saving at 25 and withdrawing at 65, you pay service fees for 40 years. That is great for financial advisors but not necessarily great for you. When you have a mortgage or other debts, pay down the debts first. If you are mortgage free, even if you don’t have much other retirement money, you can always draw down your home equity.
There are more ways to reduce anxiety over financial matters. The key is to reduce the amount of financing. The use of financing is necessary for large capital investment, such as house and car. But financing for routine expenses will constrain, not free our life.
The above suggestions are to reduce complexity and anxiety over financial matters. They are not aimed at wealth maximization. To maximize wealth, people often take the opposite route, to utilize financing extensively. But isn’t maximizing wealth the main goal in life? Darwin made the following observation many years ago in his book, The Descent of Man.
The very poor and reckless, who are often degraded by vice, almost invariably marry early, whilst the careful and frugal, who are generally otherwise virtuous, marry late in life, so that they may be able to support themselves and their children in comfort. Those who marry early produce with a given period not only a greater number of generations, but ... they produce many more children. The children, moreover, that are born by mothers during the prime of life are heavier and larger, and therefore probably more vigorous, than those born at other periods. Thus the reckless, degraded, and often vicious members of society, tend to increase at a quicker rate than the provident and generally virtuous members. Or as Mr. Greg puts the case: “The careless, squalid, unaspiring Irishman multiplies like rabbits: the frugal, foreseeing, self-respecting, ambitious Scot, stern in his morality, spiritual in his faith, sagacious and disciplined in his intelligence, passed his best years in struggle and in celibacy, marries late, and leaves few behind him. Given a land originally peopled by a thousand Saxons and a thousand Celts --- and in a dozen generations five-sixths of the population would be Celts, but five-sixths of the property, of the power, of the intellect, would belong to the one-sixth of Saxons that remained. In the eternal ‘struggle for existence,’ it would be the inferior and less favoured race that had prevailed --- and prevailed by virtue not of its good qualities but of its faults.”
Like most other people from upper class, Darwin has low opinion of lower classes. However, he is an honest scientist. He observed that “The children,” from lower classes “are heavier and larger, and therefore probably more vigorous.”
In doing anything, the concept of economy need to be applied. The best environment parents can create for their kids is to have more siblings. If we exhaust ourselves with even one child, it is unlikely that we will have many kids. I think the biggest problem in modern society is the over consumption, physically and mentally, on each individual. This makes it impossible to have more kids in an average family.
Suo Gân is a traditional Welsh lullaby. The name of the song means sleep song. This is very close to Chinese pronunciation of sleep song. The Welsh lyrics, with English translation is attached below. The Welsh language sounds similar to Chinese. Welsh national flag is a dragon. These could suggest Welsh and Chinese share similar heritage in ancient times.
Hunan blentyn, are fy mynwes Clyd a chynnes ydyw hon Breichiau mam sy'n dyn amdanat Cariad mam sy dan fy mron Ni chaiff dim amharu'th gyntun Ni wna undyn a thi gam Huna'n dawel, annwyl bientyn Huna'n fwyn are fron dy famHuna'n dawel hana huna
Huna'n fwyn why del ei lun Pam yr wyt yn awr yn gwenum Gwenu'n dirion yn dy hun Ai angylion fry sy'n gwenu Arnat yno'n gwenu'n lion Titha'you'n gwenu'n ol a huno Huno'n dawel are fy mronPaid ag ofni, dim ond deilen Gura, gura are why ddor
Paid aga ofni ton fach unig Sua, sua are lan why mor Huna blentyn nid oes yma Ddim i roddi iti fraw Gwena'n dawel are fy mynwes are yr engyl gwynion draw
To my lullaby surrender Warm and tender is my breast Mother's arms with love caressing Lay their blessing on your rest Nothing shall tonight alarm you None shall harm you, have no fear Lie contented, calmly slumber On your mother's breast, my dear
Here tonight I tightly hold you And enfold you while you sleep Why, I wonder, are you smiling Smiling in your slumber deep? Are the angels on you smiling And beguiling you with charm While you also smile, my blossom In my bosom soft and warm?
Have no fear now, leaves are knocking Gently knocking at our door Have no fear now, waves are beating Gently beating on the shore Sleep, my darling, none shall harm you Nor alarm you, never cry In my bosom sweetly smiling And beguiling those on high