Sunday, February 28, 2010

The Printed Word

There have been many articles about Apple’s new iPad. Everyone has his opinion regarding its novelty, redundancy, and even its subtlety. I will try not to burden the internet with yet another opinion on the iPad, though I believe it will open to great hype, fizzle with the first reality check, and rise again with the third generation model. One of the lesser advertised capabilities of the iPad is its ability to display ebooks. Many have taken notice of this function, since there are already prophets predicting the demise of Amazon’s Kindle and Barnes and Noble’s Nook readers. But while I do not believe the iPad will be able to destroy the Kindle and Nook, I do wonder what it might do to the rest of the printed word. In fact, this is the basis of the iPad. By putting the web in a just large enough sized screen, it is rivaling all printed word. The web, after all, is predominately reading material with video and audio mixed in, but mostly it is reading material. So the greatest draw of the iPad is its ability to bring together the two things that people want when getting information—the web or the digitized word, and convenient portability.

Let us look at the printed word. It has dominated the world of information until the last decade. You could read the articles and look at the pictures on paper. And you could carry it around with you in a book, a magazine, or a newspaper. You were limited in how much information you could carry due to the weight of paper. But then came the web. It essentially took the information as printed word and digitized it. Suddenly the quantity of information you could carry relative to weight was astronomical—you could carry all of Shakespeare’s plays on a very cheap SD card. Imagine carrying all those books! In the beginning of the web, however, you could not read this digitized word without a computer. You needed to be at a monitor or at least a laptop to read. And given the way laptops are still, to many it is not obviously more convenient than carrying around the printed word version.

Then came the PDA and smartphones. Certainly a much more compact screen, and for many it became easier to read with these devices. They were still limited by their very small screens, unfortunately. And then netbooks came out. Much better in terms of size, but still lacking in terms of battery life and ease of reading—the screen is turned the wrong way. So when the Kindle debuted, it seemed to have hit all the marks. It was light, it was easy to read, and it carried a lot of books and newspapers. It had people talking about the end of the printed word. But alas, it was also expensive, did not have color, and many people simply still liked the feels of an actual book in their hand. And so the printed word would live on to fight another day.

During this time the printed word was losing another battle to the web. More and more content was showing up on the web. It was also legal to recap and reuse someone’s content as long as you maintained the same heading. Thus paid content could drift into free content. And why would you pay for content when you could find it for free on the web? So many newspapers began offering the web versions of their print for free, thinking they would make money from ads. This turned out not to work because web ads pay very little. Because content could drift so easily, you needed a look and feel of a website that people wanted along with content that was robust. Few newspapers have this combination. The New York Times and the Wall Street Journal have it. They are able to require subscriptions to view full articles on the web.

The question then, is why is some content worth more than others? And the answer, I believe, is that it was also what is coupled with the content that makes the difference. Branded content, like the look and feel of the NYT, makes the already quality content more desirable. If the price is not too steep, I would pay to read the NYT on my computer as I would if I had its newspaper subscription. But charge too much and I would decide it is not too bad reading free drifted NYT content on Joe Schmoe’s blog or free similar content on Yahoo. This is the big question with a device like the iPad that can both browse the web and display the printed word as it looks on paper along with the portability of the printed word. Many believe that the iPad will kill the printed word because people will just surf the web for free content that is drifted or similar. Others believe the printed word will be reborn to appear on the iPad, and new life will be given to newspapers, magazines (no color on the Kindle!), and books.

Sadly, despite all this discussion regarding the digitization of the printed word and the different ways to sell and view content, I believe that the printed word’s days are numbered. It will be transitioned into the digital word, because future generations will see less and less printed word. It is just like digital cameras. Children born today will have no concept of developing film. Future generations will eventually have little concept of the printed word. I do not believe that the iPad will change the fate of the printed word. It only serves to spotlight what has already begun to happen. The battle between information on the web and subscribed digital content is no different than free printed information and subscribed printed information. The battle has simply gone high tech, but the conflict remains the same—you must decide on your balance between quality of information and cost of information.

Sunday, February 21, 2010

The Next CDO

I am going to make a bold prediction. I am going to predict the next big fiasco. It does not take a lot of thought to figure out what will become a problem. You just have to be able to divest yourself from the matter. For example, collateralized debt obligations, or CDOs, were a great fiasco. Very few people understood how they were set up. They were mystery financial vehicles developed to allow people to invest or gamble more money. The problem with CDOs is that they contain layers and layers of risk without adequate risk ratings. And there were no adequate risk ratings because the creators buried it within the CDOs and risk assessors had insufficient information to make the assessment. So they hummed along for several years until the housing market started to change dramatically with the housing crisis, which then set off the financial crisis because some much financing was in CDOs, based on mortgages. Had it not been for the housing crisis, CDOs and their cousins might likely have stuck around for years soaking up the money of ignorants and the unwitting public.

So you see, it does not take much to create a disaster. All you need is a mysterious vehicle or process in which a large part of the nation becomes invested passively. Then when something goes wrong, all hell breaks lose. It is the causing of the disaster that is difficult. Setting one up is easy as pie.

Thus my prediction for the next crisis will be digital information. I do not mean the information on your home computer or on your flash drive. I mean the data in the internet, or cloud, or whatever term floats your boat. Consider that data for a moment. Where is that data, exactly? When you type in a Google search, for instance, what happens? Your computer connects to your internet service provider (ISP), which routes you to a Google server, which then does the search and returns the results to you. When you check your mail you are routed to the mail server of whichever client you use (yahoo, google, hotmail, etc) which has your email on its drives. It reads this data and sends it back to you. All the information that is out there is on a physical drive somewhere. In fact, it may be on several drives in different places, given the redundancy that is rationally required for data storage.

So where are these drives? And how well encrypted is it? Take your bank account. For online banking, most people are concerned with whether the web page is an encrypted page (with https, for example), or if they are using an unencrypted wifi connection. They are typically not worried about whether the server where their bank account information is stored is secure or not. They take that for granted. They should not, but they also have no choice. Locations of servers are usually kept very confidential, though it may not take a lot to figure out where they are hidden. After all, if you have hundreds of drives on 24/7, you need a lot of power to keep those drives cool and from overheating. So a nondescript building using a lot of power is usually very suspicious for a server site. And how secure are the drives? Aside from the physical security of locks, guards, and cameras, there is also likely to be encryption preventing unsolicited handling of the information. Yet not all server sites are created equal. Some are more secure than others. How secure is the server that holds your sensitive information? Do you know? No, you do not. You can only hope it is secure because the website tells you it is.

And that is where I predict the next crisis will occur. Anything that cascades down and affects the function of the servers will cause a myriad of problems with both access and possibly protection of information. This could be anything from a power crisis to another real estate crisis to a magnetic crisis (not all Faraday cages are created equal). This crisis could be prevented, but it would take the owners of these servers to take the necessary precautions to protect them, which they have little to gain from if there are renting them out. Google surely takes server protection very seriously, given its stake in the future of the internet. Users could come together to demand a standardization in server security, but it is doubtful that will change anything.

So even if you are on the lookout for phishing and disreputable websites, know that even your trusted companies may be using servers that leave your information at risk of theft or even loss.

Monday, February 15, 2010

Traditional Roth

There has been big financial news this year. I do not mean the big bonuses that Wall Street is handing out to its undeserved staff. (Really, how many traders beat the stock market index consistently? And so you are rewarding luck? Or bankers that brought in money to be funneled into complex debt obligations? If they understood the problem with CDOs, shame on them. If they did not do their homework to learn about CDOs, shame on them.) I am talking about the removal of the income limit for conversion to a Roth IRA.

It seems simple enough. Financial advisers are all busy counseling clients about whether or not they should convert an IRA to a Roth IRA. Unfortunately, that distracts everyone from actually learning about IRAs, as I am sure most people have forgotten how they decided on their current retirement strategy. Now I am no tax expert, and I am by no means trying to tell anyone how to manage money. I just think people should understand why this news is important and also why it is somewhat ludicrous.

To start, all money that you save will be taxed at least once. That’s right. If you play your cards incorrectly, you could actually pay taxes twice on your nest egg. But that is a rare bird. Forget I even mentioned it. The difference between some IRAs is when you pay those taxes. You can pay them up front by using posttax money to fund the IRA. Then you would not pay taxes when you withdraw the money later. Or you use pretax money to fund the IRA and pay taxes later at the time of withdrawal. Seems simple, right? Wrong. There are several other factors that complicate things. First, your tax bracket may change. If you earn a lot of money now, you are in a higher tax bracket. Let us say your bracket is 33% for simplicity’s sake. That means that if you are funding your IRA with posttax money you have to earn $150 to put $100 posttax into the IRA. Now let us say that IRA grows to $1000 over 30 years at 8% and you withdraw it. You have already paid taxes on that money, so you get all $1000. But what if you used pretax money? You would then invest $150 to start. Over 30 years at 8% you would have about $1650. But you do not get all that because now you have to pay taxes. At a 33% tax bracket you are left with $1100. Certainly seems that a pretax or deductible method would be preferable, right? Let us look a two other scenarios.

If your tax bracket goes down over time because you retire and earn less wages, say from 33% to 25%, what happens to the numbers? If you still invest $100 in the posttax scenario, you would have $1000 after 30 years. In the pretax scenario, you would still invest $150 (since you start in the 33% tax bracket) and end up with $1650 pretax. But because you are now in the 25% tax bracket at the time of withdrawal, you get $1238. Certainly building the case for using a pretax money or deductible money to fund the IRA. If your tax bracket goes up over time, say from 33% to 40%, you would still have $1000 in the posttax method after 30 years. In the pretax method you would still invest $150 and end up with $1650 pretax. But after 40% taxes at the time of withdrawal you would be left with $990. Not a good case for using pretax money to fund your IRA.

To sum up, if your tax bracket stays the same, the pay taxes later works out. If your tax bracket goes down the pay taxes later works out. If your tax bracket goes up the pay taxes now works better. So for most people, since most people will go down a tax bracket or two over their lifetime, it makes sense to fund a pretax IRA. These are for the most part traditional IRAs. That would mean posttax IRAs are Roth IRAs, and for most people that is true. If you take this separation in this simplistic sense, there is a catch that makes the posttax IRA or Roth IRA preferable, and that is the contribution limit. IRAs have a yearly contribution limit, most recently set at $5000. What that means is that if you contribute the maximum $5000 to a posttax Roth IRA, it is equivalent to $6944 invested in a pretax traditional IRA if you are in a 28% tax bracket. The catch is that you cannot invest $6944 pretax. You can only invest $5000 pretax, which is the equivalent of $3600 posttax. Thus, it is to your advantage to use a posttax Roth IRA method if you intend to contribute the maximum each year. This is why the general rule of thumb is to fund a Roth IRA if you can.

Then there is the circumstance that needs explanation, since the explanation is not easily found on the internet. There are income restrictions on who can open a Roth IRA. If you make too much money you cannot fund a Roth IRA. However, anyone can convert another IRA into a Roth IRA. This is what the new rule states. Effectively, this then means that someone who makes too much money to fund a Roth IRA could simply fund a traditional IRA and convert it every year to a Roth IRA. They would simply have to pay taxes on the converted amount. Makes you wonder why the government did not just remove the income limit for contributing to a Roth IRA. Well they did not, so some will have to take the convoluted path to a Roth IRA.

The other circumstance that is worth mentioning is when a traditional IRA becomes posttax. Typically you get to deduct your contributions to a traditional IRA. However, once your income passes a certain limit and you participate in an employer retirement plan (401k, 403b, or the like), your contributions to a traditional IRA become nondeductible, meaning that all contributions are posttax dollars. In this circumstance, you will also have to pay taxes on withdrawals when retirement comes. You pay taxes now and your pay taxes later. You do not pay double tax because you can track the tax basis of your contributions over the years and at least get credit for the taxes you have paid. But compared to a Roth IRA, where the growth of your money remains untaxed at the time of withdrawal, why would even bother with a traditional IRA? And the catch to that is that if you convert a large traditional IRA now you have to pay the taxes on it now. 2010 is special in that you can spread the taxes over 2010 and 2011, but still, if you convert a $100,000 traditional IRA to a Roth IRA, and you are in a 28% tax bracket, you need to have $28,000 on hand to pay the taxes. Most people would not have that money lying around.

So that is the short story on the big Roth IRA conversion news. There are certainly many other nuances to the IRA story, and I think I have only covered the most common scenarios. I for one will be moving my money to a traditional Roth IRA. Because this stuff is not confusing at all.

Sunday, February 7, 2010

Golden Boy

There is always someone that we all know—at work, at school, or even at home—who seems to not be able to do any wrong. If they did something satisfactorily, it is seen as a miracle. If they blunder fantastically, it is seen as just a misstep on the way to greatness. These people are infuriating for two reasons. First, they grow to believe their infallibility, which leads to a degree of hubris. Second, everyone starts to actually believe that the person can do no wrong—that everything they touch is or will turn to gold. For most people this inevitably leads to problems down the road. Either things they are involved in start to fail or things they are involved do not fail but should and the success that is built on a house of cards eventually crumbles, taking out everyone involved. These golden boys, as I will call them, are the black swans of sociology. I believe Steve Jobs is a golden boy.

It is easy to see why Jobs is a golden boy. He created the Macintosh. Then he popularized USB. He brought us the iPod. Then the iPhone. And if you ignore the AppleTV and the Macbook Air, Jobs is on a winning streak. The Apple board believes in Jobs—they gave him a plane after the success of the iPod. The shareholders believe in Jobs--Apple stock is rising. Shareholders believe if Jobs more than Apple because Apple stock fell when Jobs left rather unexpectedly for a liver transplant. His possible absence from Apple was seen as a tragedy. To Apple and the world, Jobs is Apple. Few people believe that the iPod would have come from Apple without Jobs.

In all the success of the iPod and iPhone, people have already touted the iPad as a world changing device. It is not even out on the market and people say that it will change the world. This is not a mere difference of saying whether or not it will turn a profit for Apple. People are saying it will shape society. A bit extreme, don’t you think? Neither the iPod nor the iPhone has done that. What is happening is that the successes of the iPod and iPhone have trickled over the iPad, so that regardless of its merit, the iPad will be hugely successful for Apple. At least in the beginning. Apple stock will and has surely risen just from the news. But unlike the iPod and iPhone, both of which replaced devices that we had already used for certain functions—CD players and walkmans and PDAs and other smartphones, the iPad does not truly replace any device. It was meant to create a new niche. One that allows fanboys to say the iPad is the device you didn’t know you had to have.

The biggest selling point of the iPad is that it delivers true web access to your hands. With a larger screen and multitouch technology, you can now surf the web as it was meant to be done whenever and wherever you desire. With the exception of flash, you can read webpages just as you do on your computer without being tied to your desktop and without being restricted by a “mobile” web page. You can also run apps similar to the apps on the iPhone, but newer apps taking advantage of the size will likely be written over time. And though not designed to compete with the ebook readers, it boasts the ability to display the written word. So the question is, how big will the portable web be? Laptops and netbooks are already available. Do people carry them around to surf the web? It does not seem that they do, but it does not mean that it is not convenient enough for people that way. If you could turn on the iPad like you do the iPhone and not like you do a netbook, that might change things. (Though netbooks with solid state drives boot incredibly quickly—mine boots un under 30 seconds.)

I do not believe the people need or want a device that lets them surf the web wherever they are (only WiFi will be available on the first iPads, 3G comes in a later release—I cannot explain the marketing reasoning either), especially for $500. And that is without tax and shipping and warranty. Yet, I suspect the iPad will sell well because people will buy it because, well, just because. It will be a material technology bubble. Or perhaps the public will actually decide for themselves if they need the web “in their hands” and not just accept the decree from Jobs. We will know in April.

There is one thing that is rarer than a golden boy, and that is a true golden boy. History has a theory that explains this. The theory, mind you, involves Abraham Lincoln and John F. Kennedy. It says that if Lincoln had not existed, the slaves would still have been freed, indicating that Lincoln, while responsible for the end of slavery, was not necessary for the end of slavery. On the other hand, if JFK had not been assassinated, the world as we know it would likely be very different, indicating that JFK himself was a world changer and was necessary for that change. Not to detract from Lincoln’s importance in history, but he would be the golden boy and JFK would be the true golden boy. I think the iPad will tell us which one Jobs really is.