The Pattern

[Matt]

The Pattern is what I call the path of most efficiency, the order in which things should be done. Everything has a Pattern, here’s one you might understand and can apply to other things. For my morning coffee I sometimes have to wash a French Press. This means that I need water from the one tap in the kitchen. If I decide to wash the Press before filling the kettle my elected navigation is slowed by my own blocking of the pipeline.

In contrast, if I first fill the kettle with water, and allow it to boil while I am cleaning the Press, I’ve created an efficient Pattern. Effectively, I’m employing the kettle as an assistant, and outsourcing a role to it while I do something else. The coffee example is pretty fixed, it will always take 60 seconds for the water to boil, and 30 seconds to wash the Press. It is my choice whether the process takes a total of 60, or 90 seconds.

Some things are fixed in duration like the coffee and others have a variable nature. A variable pattern comes in with probability decisions. I use this for booking elaborate travel. I know that the airline seats are vastly more limited (especially when seeking 3 business class seats using points) than finding a place to stay at my destination. The rules surrounding the pattern are important.

• Coffee rules: water boil time, press clean time.
• Travel rules: value of plane ticket vs hotel room leans in favor of plane, and cancellation rules allow me to act faster and fix errors later.

With finance, I see an interesting pattern. Many people like to take on debt at the same time as save. It’s a broadly encouraged attitude where people look at arbitrage, but what happens to the pattern when the reality doesn’t meet the theory? Let’s look at a simplified example first, with just two mediums, a debt vehicle (30 yr mortgage, 4%) and brokerage account, with indexing and inflation rising at 3.69%

• Age 30
• $80K Salary
• $20K living expenses
• $300K Mortgage ($1265 pmt)
• $0 Brokerage Account

Let’s look at some different scenarios

Brokerage Rate of Return 4.62% Pay mortgage monthly

Excess funds are invested in brokerage earning 4.62%

Compare that with scenario 2, where no money is invested into the Brokerage account until the mortgage is paid.

Making additional $25000 payments to mortgage

We get a lifetime gain of $78.263, and by age 65 a gain of $29,459. There’s actually some upside to paying off the mortgage at this level. However, if we swap the Brokerage rate of return to 7%, the following happens.

Brokerage Rate of Return 7% Pay mortgage monthly

Mortgage Pay Monthly Return at 7%

The increased rate of return from 4.62% to 7% creates additional portfolio value of $11,305,563. Whereas, if the person had elected to pay their mortgage early, their gain would be less:

No money invested in Brokerage until Mortgage Paid (7% brokerage rate of return)

Rate of return 7% but paying the mortgage first

As you can see, the pattern when the rate is 7% is clearly in favor of retaining the debt and paying the mortgage slowly, as you are borrowing low in order to invest high. This is the classic case of debt arbitrage at play.

However, what these charts are not showing is Probability of Success, which is very different from what you see above. Probability of success when the plan relies more on removing debt (a fixed rate of return) is higher than when relying on a variable rate of return from the market. When it comes to building a financial plan and thinking of the ‘Pattern’ many people forget the value of the probability aspect, and focus on the notion that a variable rate of return has historically produced a higher amount than the cost of their debt.

Probability when it comes to a financial plan is the key to everything.
​

When you look at various charts or models, keep this in mind as you decide on the Pattern, it isn’t what you ‘might’ get, but what is the minimum that you need to get with the lowest possible chance of it not happening. When planning in a more sophisticated manner, tax law comes into play. The relative valuation of a fixed liability in relation to a tax advantaged account vs a taxable account is different, so an order must develop. It might be that due to your tax bracket a 401(k) before paying debt is favorable, as the reduction in taxes creates greater cash flow. In another case, when income is low, and debt prices are high, it might be better to skip the 401(k) altogether and take the guaranteed rate of return first.

Patterns of most efficiency are everywhere. When looking for them remember that there are fixed and variable components. Try to visualize yourself being a manager, outsourcing roles. When it comes to the coffee, make sure someone is boiling the water while you are using it for something else, when it comes to debt, consider if your outsourced debt is working for you (in positive arbitrage) or against you, as real returns might not be at their historical levels.


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[Vic Diaz]

Interesting blog post, I was just working on a spreadsheet that did this, although it was a bit different. The scenario I was evaluating was pay extra to the mortgage for a predefined set of years, at that time switch the extra payments into investment vehicles and when I finished paying my mortgage then invest the entire amount of the mortgage payment in addition to what I was already investing monthly. From my calculations it looks like at the end of the time period your investment account will be bigger but the return would not have been as big.

 

[Matt]

Interesting blog post, I was just working on a spreadsheet that did this, although it was a bit different. The scenario I was evaluating was pay extra to the mortgage for a predefined set of years, at that time switch the extra payments into investment vehicles and when I finished paying my mortgage then invest the entire amount of the mortgage payment in addition to what I was already investing monthly. From my calculations it looks like at the end of the time period your investment account will be bigger but the return would not have been as big.

From the investment side of the post, I imagine you'd need to find a variable rate assumption. How did you discount that amount for randomness?

 

[Cytraveler]

The other big probability elephant-in-the-room is the human element. Nearly all of us don't take our own psychology of money and investment into account enough, both on the discipline of investment, as well as how we'll feel about it. None of us are computers; some are more rational than others, but none of us completely so - thank goodness!

On the discipline end, which are you more likely to follow through on, ALL of the time? We all think we'll be very disciplined both with respect to consistently making the investments, as well as not panicking when things don't go as expected. But take a deep look at yourself. Did you pull money out of stocks after 2008 (at the wrong time...)? Do you constantly trade? Will you really take ALL of the money you would have put into paying off the mortgage, and put it into investments? Are there ways you can "trick" yourself into doing what your rational mind knows is best, like autopay and autoinvestment? I refuse to do free trials that turn into automatic paid subscriptions unless I can set it up from the start so that doesn't happen, because I know I am terrible at following up on cancellation. I think to myself: this time, I'll be sure to stop it from rolling over into paid. But past behavior indicates otherwise, so I stand firm. In your coffee analogy, this would be taking into account whether you get discombobulated by the whistle of the boiling water and based on past experience in 1 out of 4 cases you drop the press on the floor, which then requires 2 minutes to clean up.

On the end of how we'll feel about our money/investment choices, maybe it would be particularly satisfying to you to have your house paid off; enough to offset some reduction in totals. Or maybe it's more satisfying to own some stocks. This can impact whether you save in tax-deferred accounts for retirement, or non-tax deferred accounts. After all, money doesn't have value in and of itself, but rather what it can do for us. The coffee analogy would be that maybe you are simply a very methodical person, who likes to do things in a precise order. Washing the press first then boiling water feels personally satisfying, allows you to daydream a little while the water boils, and sets you on a great start to your day. If that's the case, don't let anyone let you feel bad about that decision.

 

[Matt]

Good points. Basically there is value in inefficiency, because not all wasted time is really 'wasted'.

Washing the press first then boiling water feels personally satisfying, allows you to daydream a little while the water boils, and sets you on a great start to your day. If that's the case, don't let anyone let you feel bad about that decision.

The direction I'm going here is that daydreaming is fine, but understanding the use of time is very important. I have no objection with someone daydreaming for twice the time it takes for the water to boil, I just want them to be aware of the impact to getting to the goal at hand.

This becomes very important when components in the cycle are co-dependant. For example, in the kitchen again, if you were to cook a roast beef (I'm British after all) you'd need to start the veggies before the Beef was finished in order to present a meal that was cooked properly.

In broader aspects of life there are many things that are co-dependent. In sales it is true too. An example here might be that you can only possible work on one project at a time, but you have two in the pipeline that are almost closed. It is knowing the probability of closing them and knowing the timeline to bring a deal from prospect to won that is key. Therefore, it might seem weird, but you need to start asking for the next deal before you've closed the first one else you'll have that lull in productivity down the pike that you can't do anything with.

 

[Vic Diaz]

From the investment side of the post, I imagine you'd need to find a variable rate assumption. How did you discount that amount for randomness?

I made some assumptions on the average return of a 30 yr investments approximately 7% return. So not a perfect model but really useful in giving you an idea of where I would be.

 

[Vic Diaz]

Good points. Basically there is value in inefficiency, because not all wasted time is really 'wasted'.



The direction I'm going here is that daydreaming is fine, but understanding the use of time is very important. I have no objection with someone daydreaming for twice the time it takes for the water to boil, I just want them to be aware of the impact to getting to the goal at hand.

This becomes very important when components in the cycle are co-dependant. For example, in the kitchen again, if you were to cook a roast beef (I'm British after all) you'd need to start the veggies before the Beef was finished in order to present a meal that was cooked properly.

In broader aspects of life there are many things that are co-dependent. In sales it is true too. An example here might be that you can only possible work on one project at a time, but you have two in the pipeline that are almost closed. It is knowing the probability of closing them and knowing the timeline to bring a deal from prospect to won that is key. Therefore, it might seem weird, but you need to start asking for the next deal before you've closed the first one else you'll have that lull in productivity down the pike that you can't do anything with.

I like the idea of the co-dependence of things. To tag onto your roast beef example the use of the time could be very important here, you can prepare the veggies while the roast beef is cooking and begin doing these tasks in parallel, kind of with your french press example. I found that when I start stacking my tasks this way I get more things done and it allows for more free time. I recently got the Anova Sous Vide machine for this exact reason (other than it cooking awesome steak), it allows me to clean, read, etc. while my meal is cooking.

 

[MickiSue]

Once you figure out the most efficient way to complete a series of tasks, it really does make a difference. Whether it's making breakfast, or paying your CCs with the funds you MSed, knowing without needing to go through the computations each time what comes next makes a big difference in your day, and, eventually, in your life.

I can clean the counters, put away all the clean dishes, put the water on for tea, mix the scrambled eggs, get the shades open on the entire first floor, water the plants, feed the cat and make the tea, cook the eggs and be done, all in under 20 minutes, if I stick to my best practices.

If I don't, it can take 45 minutes.