Sunday, May 04, 2014

Law school preparation, Thomas Pinketty and Capital in the 21st Century.

To a few friends who know what I've been plotting scheming for the past year, Law School was known as Plan A. Plan A was the best in a series of post-retirement outcomes after I stop work. It was designed to be high-risk, high-reward ( reward being more social status, not necessarily finance-driven )  and will give me something really intellectually challenging  to do until I am very very old. I was'nt relying on Plan A to succeed and actually took a lot of pains to create three other credible alternatives, all less cool, but certainly would allow me to way richer than if Plan A would take place.

So with Plan A, a problem will be created for my financial portfolio.

Law school costs about $3,000 a month for the first two years. My dividends, which will be needed to pay for my family expenses, will now need to cover my expenses upon moving into my new EC and tuition fees. My condominium payments will be covered for the next 3 years by my CPF account, so that leaves barely $1,500 for my personal expenses and conservancy fees.

Making matters are the financial market movements. Mid-2015 interest rates will start rising, which will negatively impact my condominium loans as well the loans of the REITs I invest in. Making matters worse, industrial REITs will start facing oversupply in my first year of school. Needless to say, I've been tilting my portfolio to dividend yielding stocks slowly for the past year to maintain my current yields.  

This means more than 50% probability of eating into my capital which I have been building for decades, which many push me to take a bet on the legal employment scene in 4 years time ( Which admittedly is still a good bet for legal professionals ) 

Of course, upon graduation, things will get better. With a renewed career, I will have options beyond tech and finance and even an entry-level role will provide adequate diversification for my future portfolio.

I'm sharing this to lead into a simple discussion on Capital in the 21st Century. French economist Thomas Pinketty wrote a fine work which rattled economists so badly that it's hard not to get something on your feed which reviews or criticizes his work. 

It's not easy for a amateur to mount a credible offense on Thomas Pinketty's work, which is a difficult read. I leave the heavy lifting to the academics. I will only talk about a small part of his work.

Thomas Pinketty's basic idea is that in most economies, the rate of return of capital is higher than then GDP growth of a country. ( Expressed in equation r > g ) What this means when expressed on the ground is that the return of REITs and dividend yielding stocks (5-7 %) generally exceeds that of your annual increment or the GDP growth of the Singapore economy which is about 2-3%. This has the effect of making income inequality worse as investors make more money from investments while workers can only have a small increment on an annual basis. 

I am only capable of making a small dent in Thomas Pinketty's argument based on my personal experience. And if I made a mistake in my reasoning, do feel free to correct me here for the benefit of all readers.

Everyday, someone like me applies and gets into Law School. In SIM, a polytechnic graduate may get into a private degree program. Some A-grader parent pumps $2,000 to put their kids into Montessori school thinking that it'll provide an edge in the PSLE exams. If Pinketty is right, then we're all better off cornering plots of industrial property. So why do so many Singaporeans invest their life savings into education ?

The answer is that the value of human capital often trumps financial assets :

Very often -> R_capital > r > g

Sure, GDP grows at 2-3%, but getting into the legal or medical profession gets yourself into a career which has regulatory restrictions, building a moat which makes it hard for other people to join the profession. - As is finding a job where you can dominate a small niche regardless of which profession you belong to (i.e. can you program in JCL for the AS/400 ? ). This can be way better than finding a stock with that mythical investment moat around it.

I think a better way to look at modern society from reading Pinketty is as follows :

Sometimes R_capital > r : In such a case, you go back to school, invest in a qualification like the CFA, build domain knowledge to get a better increment, get your ass back to work. Become a Super-manager. This is often the case when you are younger or in your 20s or 30s. 

Sometimes r > R_capital : In such a case, you start building a portfolio of assets or create a business for yourself. Retool your life to that of a Rentier/Rent-seeker. Generally this happens in your 40s. 

In summary, appealing to the authorities to seek redistribution of wealth is futile as you need to wait for consensus for that to happen. 

You are better off putting in effort to benchmark the value of your human capital versus your financial capital and putting in a scheme to manage these two all-important assets. 

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