[The following is a guest article by frequent writer, Kosmo.]
My son is learning about investing and personal finance in school (8th grade). While the overall content is solid, I’ve occasionally had some concerns.
Stock picking
There is a contest among the students to see who does the best job of picking stocks — actually, there are two contests – one for individuals and one for teams. My main concern is that there’s too much focus on the return and not as much on volatility.
At the end of the fairly short period, winners are determined. These will almost certainly be people who took some gambles and had them pay off. If this same cohort of students repeated the contest every month for the next year, how much turnover would there be at the top? I suspect there would be quite a lot of turnover, as volatility will cause many ups and downs. Having the kids repeat the contest would help drive home the point that random fluctuations can significantly impact short-term results. The goal in life isn’t simply to pick the stocks that perform well for a month or two. Instead, it’s choosing the investments that perform the best over a lifetime.
[Editor’s Note: This sounds a lot like the Stock Market Game. It teaches kids very poor investing concepts instead of buying and holding diversified funds.]
Risk versus reward
I’ll admit that I’m a boring investor. Most of my money (401K and brokerage) is invested in date-targeted or index funds. It won’t make me yacht wealthy, but it should provide a comfortable retirement. If I put money into more speculative investments, I’d have a better shot at becoming yacht-wealthy – but it would also come with more risk of substantial losses. Ultimately, I want to avoid being an 80-year-old guy mopping floors at Walmart to pay the bills. I’ll trade the slight chance of living a Robin Leach lifestyle if it reduces my chance of working until I die. When I reach my target retirement age, I don’t want to ever be in a situation where I need to work.
The substitute teacher
One day, my son had a substitute teacher in the class. The substitute dropped a couple of interesting comments during this class:
- People should invest in Roth IRAs because they aren’t taxed.
- Amazon and Apple will not exist in twenty-five years
Let’s dig into these and see why they are bad advice.
Roth vs Traditional
Indeed, withdrawals from Roth accounts aren’t taxed, and withdrawals from traditional retirement accounts are taxed. However, this teacher is overlooking the fact that Roth IRAs have already been taxed.
Let’s say you’re in the 24% federal and 5% state tax brackets. If you want to invest $1000 into a 401(k), you’ll need $1000 to fund this investment. But if you invest $1000 into a Roth IRA, it will cost you $775.19.
Here’s another way of looking at it – you have $775.19 to invest. You have two options:
- Put the entire $775.19 into a 401(k)
- Pay taxes on the $775.19 and put the net amount ($500) into a Roth account
If you see people comparing a $500 401(k) contribution to a $500 Roth contribution, they aren’t making an apples-to-apples comparison since the starting amounts are different.
If you want to do a deeper dive into Roth vs 401(k), I wrote a more in-depth article several years ago. There are a lot of nuances to determine the best strategy for you, especially if you live in a state where retirement income isn’t subject to state income tax.
Amazon and Apple will be bankrupt
When my son repeated what the teacher had said about Amazon and Apple being bankrupt, I conceded that it was possible. Huge companies do go bankrupt. However, I told him that I thought these two companies were probably unlikely to go bankrupt in the foreseeable future. Then I asked him how he thought Amazon and Apple make their money.
Amazon
I asked my son where most of Amazon’s profits came from. I let him spin his wheels for a while before telling him the truth.
Last quarter, the most profitable division within Amazon generated $7 billion of Amazon’s $9.9 billion in profits and $23 billion of the $143 billion in revenue. You’ll notice that the share of income is much higher than the share of revenue – meaning that this division has a much higher margin than the rest of Amazon.
What does this division sell? Books? Alexa devices? Furnace filters?
The answer is in the clouds. Amazon is a leading provider of cloud computing. Amazon Web Services (AWS) has a 30 percent market share, followed by Microsoft’s Azure at 23% and Google Cloud at about 10%. You’ll often see AWS mentioned as the technology that powers a lot of streaming services, but beyond that, they have a significant footprint in the corporate world. When it comes to cloud computing, it’s usually a decision between Amazon and Microsoft.
Amazon.com, of course, is powered by AWS. How often do you encounter a glitch when you’re trying to buy something on Amazon? If your experience is like mine, it’s extremely rare. When Amazon is trying to pitch its architecture to a potential customer, it could point to the Amazon store as an example of the high uptime provided by AWS.
[Editor’s Note: Amazon also makes a ton of money from advertising. It’s about half of the amount that they make from AWS. That’s why you always see sponsored products when you search.]Apple
I asked my son why people can’t buy a Kindle book from the Amazon
iPhone app. He was stumped. The answer is simple – Apple takes a 30% commission on any in-app sales. If you were able to buy a $10 Kindle book through an iPhone app, Amazon would only get $7. If you buy it through a browser, Amazon gets the entire $10.
With few exceptions, Apple takes 30% of all in-app sales. Did you spend $10 in-app within Fortnite? Apple got $3.
For decades, Apple made money selling hardware and operating system software. The company had devoted followers (including me) but struggled to gain significant market share, especially outside of the education and creative segments. While Apple still sells Mac computers, they have become a small part of the company’s portfolio.
The flagship product has become the iPhone, with 232 million sold in 2022—even sales of iPads (61 million) dwarf sales of Macs (26 million). Apple also sells watches and earbuds.
Beyond physical devices, Apple makes a lot of money selling services: Apple TV, Apple Music, iCloud, and the aforementioned app store.
Diversification
One of the keys to long-term success is diversification. As we learned as children, you shouldn’t keep all your eggs in one basket. What Apple and Amazon have been able to do is build multiple profitable revenue streams rather than relying on a single segment. While that’s no guarantee that they won’t fulfill the prophecy of the substitute teacher and go belly up, it makes it considerably less likely. These aren’t the buggy whip manufacturers of a bygone era. If one revenue stream dries up, they still have other revenue streams to power the company forward.
What about you?
What bad advice have you heard recently?
Have there been times in your life that you have followed bad advice? What was the impact on your life?
Joe says
I guess most teachers aren’t very good investors. They all should take the Intro to Personal Finance class. I participated in one of those stock market game when I was in college. The way to win is to invest in penny stocks and hope for the best. That’s a terrible lesson. It doesn’t work in the long run.