Many of you know that my favorite investor is Peter Lynch, who is the basis for the creative processes I incorporate into my investment thinking. He showed that investing doesn’t have to be all about endlessly reading financial filings. While they do matter, you can have fun with the process too.

Experience the Investment

Perhaps my favorite thing I learned from Peter Lynch on the fun side of investing is to experience your investment. Go out and see it, feel it, observe it. This is how golf led me to an investment idea.

I am by no means a ‘good’ golfer, but I enjoy it. I also love Topgolf and always make it a point to visit one when I’m in a new city. My favorite so far has been the Tampa Topgolf with the massive TV screens at the end of the range. I remember it clearly due to the fact that we watched my beloved Montreal Canadiens lose to Tampa in Game 5 of the 2021 Stanley Cup Final. This was one of my earlier experiences at Topgolf and I wouldn’t end up investing in them until about 4 years later, but this started the process that eventually led to me thinking, “Hmm, would Topgolf be a good investment?”

I thought back on every visit and then went again for a current view. What’d I notice?

Each time I went, they were very busy; it was often larger groups of 4-6 people rather than 1-2 people in bays. They served food, quality enough to order while playing, pricier but not so expensive that you watch the cost.

There are so many games you can play, not just hitting golf balls mindlessly like a regular driving range (although, of course, we always do the longest drive competition).

They even have an app where you can see any games you’ve ever played and scores with everyone you played with. The biggest thing: you don’t have to be good at hitting a golf ball to have fun. This opens the market right up.

Now, if I had gone and it was quiet, a lot of empty bays, with food and drinks so expensive it makes you want to eat before you leave the house, those would have been poor signs.

As a surprising bonus, Topgolf wasn’t a standalone stock. It was part of Topgolf Callaway Brands, the company behind Callaway golf equipment. Callaway is a name anyone who golfs even a little has heard of. I had initially come for Topgolf and found a second brand I already trusted.

I then dove into the financials, which had a few issues, but there were some solid management decisions that confirmed it as an investment for me back in 2025, along with some technical analysis we won’t get into here.

Then in November 2025, the company agreed to sell a 60% majority stake in Topgolf to the private equity firm Leonard Green & Partners. The deal later closed on January 1, 2026.

Topgolf was the reason I looked into the company in the first place, but that didn’t mean that the investment was no longer viable. In fact, it made the company stronger. The sale brought in about $800 million in cash. This helped them pay off $1 billion in debt and fund a $200 million buyback. They did also keep a 40% stake in Topgolf, which meant I still had a piece of the business my journey had started with, but now it was attached to a much healthier Callaway business.

For the Callaway portion of the business, it was a debt burden off its back. Topgolf was expensive to run, considering that every new venue takes a lot of money to build. Selling a majority of Topgolf meant less debt, which in turn led to lower interest costs, and room to put money back into the core golf business such as the clubs and apparel brands. The company took back its old name, Callaway Golf, all while keeping its Topgolf upside through the 40% stake they retained and an added marketing partnership.

Staying at Your Investment’s Biggest Competitor

One of Lynch’s best tips was asking executives one question: who’s your biggest competitor? That one question could lead him to his next potential great investment.

In this case, he spoke with a vice president of United Inns, a company he was already invested in. They ran more Holiday Inn franchises than anyone else. When Lynch asked who their biggest competitor was, the answer was La Quinta.

This led to Lynch spending a few nights at a La Quinta. He liked what he saw and experienced, giving him the basis for what would be a fantastic investment for his fund, the Magellan Fund.

What he noticed was that La Quinta had built rooms similar to those of Holiday Inn’s rooms, but they dropped the in-house restaurant, instead often building next to Denny’s or similar 24-hour restaurants. They were able to build for 30% less, meaning they could charge 30% less and realize the same profit.

Remember, he never bought on what he experienced alone. Every visit was followed by a thorough breakdown of the financials. The experience only started the process, while it was the research that confirmed whether or not it was worth the investment.

Friends, Family, and the Mall

Lynch also got some of his best ideas from his family.

His wife Carolyn led him to one of the best investments he made. Hanes was test-marketing a new pantyhose called L’eggs around Boston, which were sold in plastic eggs at the supermarket instead of in department stores. Carolyn loved them, which Lynch took notice of. This prompted him to do the research, and Hanes became one of Magellan’s biggest holdings.

While the product was good, the key was where it was being sold. Women were already at the grocery store every week, so Hanes put L’eggs right where they were already shopping.

His three daughters were essentially unofficial analysts for him, though he didn’t always listen. They liked wearing Chili’s sweatshirts, and he still passed on the stock. He would let them lead him around the mall, where he would observe. They walked him straight into stores like The Body Shop, which became a big winner for investors.

A while back I asked the women in my family, “what are your three favorite stores to shop at. They listed off T.J Maxx, Marshalls, and HomeGoods. My interest had been peaked so I wen to research said companies. Imagine my surprise when I found out all 3 businessed were owned by the same company, ‘TJX Companies Inc. I then began on my embargo to research this company. This was only about a year ago, where I had looked at the chart and financials and all I could say is I wish I had asked them a few years sooner. TJX through the eyars has had some of the best steafy growth I’ve seen from a larger company. While I did not make an investment in it, at least not yet, it stands to say that the management has historically done an extremely good job.

So the next time you see a family member, ask them: “What are three of your favorite stores to shop at?”

The Addition of the Internet

The internet has changed a lot since Lynch ran the Magellan Fund from 1977 to 1990. A large portion of our shopping now takes place online, and it’s where a lot of new businesses get their start.

The idea is the same as walking the mall, you’re just looking at screens instead of storefronts. Ask friends which apps they open every day, what they’ve bought off TikTok, which delivery service they actually use, or which brands they shop online, even if it’s just clothing.

People Still Need to Eat

One thing that doesn’t change is food. People still need to eat, and dining out is a social activity the majority loves to do. Anybody who knows me knows that I love to go out for dinner for a nice meal, and so crossing this with investment is almost like going to a candy shop as a kid. I’ll go to restaurants both to explore new food/cuisines and for investment ideas. The first one that comes to mind is Texas Roadhouse.

Most of us have been there at some point, and I know from personal experience that it seems like no matter when I go, where I go, or how long it's been since the restaurant first opened its doors, it’s always packed. Not only that, but my food is almost always very good and on par with expectations if not slightly above (I get the Ribeye most of the time). Looking back on it from the experience side of things, this would have been a fantastic stock to own throughout the years.

Even back during COVID, only 6 years ago, Texas Roadhouse (TXRH) was at a low of around $23, and just this year hit a high of $216.30 before the pullback to where we are now, around $165.

Of course, I would have wanted to then dive into the company's financials and confirm my thinking at the time.

The Lesson

Investing doesn’t have to be daunting. Make it enjoyable, have fun with it, and discuss ideas with other people. If you have a few friends who also like to invest, go to dinners or make weekend trips to stores and experience new foods and products while also getting baseline ideas about potential investments.

This will have you thinking about investments everywhere you go. If you become like me, you’ll constantly be looking up a business to see if it’s publicly traded or not.

Experience gives you the idea, research decides whether it’s worth owning, and once both check out, you then still have to act. Lynch missed Chili’s, and I missed Texas Roadhouse, because we both stopped at step one.

For anyone looking to read more about Peter Lynch, I highly recommend all three of the books he co-wrote with John Rothchild: One Up on Wall Street (1989), Beating the Street (1993), and Learn to Earn (1995).

- Luke

Disclaimer: This article is for educational purposes only and is not financial advice.

You open your brokerage app, tap “Buy” on a call option, and before your thumb leaves the screen, you’re filled. No haggling, no waiting, no one on the other end of the phone. It feels like buying something off a shelf.

But an option isn’t a product sitting in a warehouse. It’s a contract, and every contract has two sides. When you bought that call, somebody sold it to you. Somebody agreed to deliver 100 shares at the strike price if you ever asked for them.

That somebody is rarely another person like you. According to Cboe’s Q3 2025 industry data, retail traders now account for nearly half of all options volume. Millions of small orders, every day, all needing a counterparty in milliseconds. In our introduction to options, Keeping Your Options Open, which is where we initially mentioned the options volume stat you see above, we discussed that there’s always another side to the transaction. Today, we are going to explore that side of the transaction.

Enter the Market Maker

A market maker is a firm that stands ready to both buy and sell an option at all times. It posts two prices: the price it will pay you (the bid) and the price it will sell to you (the ask). The gap between them is known as the bid-ask spread.

In U.S. options, a handful of large firms handle most retail flow, names like Citadel Securities and Susquehanna. You’ll rarely see their names in your brokerage app, but when you buy a call, there’s a very good chance one of them sold it to you.

However, market makers are not trying to guess where the stock is going. They aren’t sitting across the table hoping your call expires worthless. Their business is simpler, and far more consistent than that.

The Toll Booth, Not the Casino

Think of a market maker as a toll booth on a busy highway. It doesn’t care which direction the cars are heading. It cares that they keep driving through.

Let’s use a simple example. Say a call option on stock XYZ is quoted like this:

Bid: $2.40 / $240

Ask: $2.50 /$250

Midpoint: $2.45 /$245

You buy 10 contracts at the ask and pay $2,500. The midpoint value of what you bought is $2,450. The market maker has just earned $50 of edge before anything else happens.

Now flip it around and look at it from your side. If you turned right back around and sold those same 10 contracts at the bid, you’d get $2,400. You’d be down $100, and the stock didn’t move a penny.

Fifty dollars doesn’t sound like much. But multiply it by millions of contracts a day, and you start to see why this is one of the most profitable businesses on Wall Street. The market maker doesn’t need to be right about direction; rather, they need volume, and they need to manage the risk they pick up along the way.

Why Your Broker Gets Paid for Your Order

If you’ve ever wondered how your broker offers commission-free trading, this is where the answer lives.

Market makers pay brokers to send them retail orders. It’s called payment for order flow, or PFOF. Your broker routes your order to a market maker, the market maker fills it, and the broker gets a small payment per contract.

The numbers are not small. According to SEC disclosures reported by The TRADE, Citadel Securities paid about $2.6 billion in payments for order flow across 2020 and 2021, and roughly $1.7 billion of that was for options orders, not stocks.

You can see the same thing from the broker’s side. In the third quarter of 2025, Robinhood reported $304 million in options revenue, compared with $86 million from equities. Options orders are worth far more to the people routing them than stock orders are.

Why would a market maker pay for your order? Because retail orders are, on average, small and not based on inside information. A market maker filling a retail order is usually collecting the spread from someone who isn’t about to blindside it. That’s a much safer customer than a hedge fund that might know something the dealer doesn’t.

Pay attention here, because this distinction is important. “Commission-free” does not mean free. You pay through the spread. The narrower the spread, the less you pay. The wider it is, the more that fee adds up.

But the Market Maker Now Has a Problem

Let’s go back to our dealer that just sold you 10 XYZ calls. It collected its $50 of edge. Good news.

The bad news is that it’s now short 10 calls. If XYZ rips higher, those calls gain value, and the dealer is on the hook for every dollar of it. A $50 gain can be wiped out in an afternoon by a stock that moves the wrong way.

So the market maker has two jobs, not one:

1. Earn the spread by buying at the bid and selling at the ask, over and over.

2. Neutralize the risk of whatever inventory it’s left holding, so a move in the stock doesn’t swallow the spread it earned.

What the Toll Booth Picture Doesn’t Tell You

The toll booth analogy is a good starting point, but like any rule of thumb, it has limitations.

Spreads aren’t fixed. On a heavily traded stock with near-term expirations, spreads can be a penny or two. On a thinly traded stock, a far-out strike, or a long-dated contract, they can be dimes or even dollars wide. The toll changes with the road.

During earnings, big news, or a market selloff, market makers widen quotes to protect themselves. The moments you most want to get out are often the most expensive moments to do it.

Market makers can lose. They manage risk, they don’t eliminate it. A sudden gap in a stock overnight can hand a dealer losses its hedges can’t offset. They win by being small and consistent across millions of trades, not by winning every one.

The Bottom Line

Every option you buy was sold to you by someone, and most of the time that someone is a market maker running a high-volume, low-margin business. They aren’t rooting against you. They simply charge you a fee, and then work hard to make sure the stock doesn’t take that fee back.

Which leaves one question. The market maker just sold you a call and is now exposed to the stock going up. How does it make that risk disappear? The answer is a single number that tells Wall Street how much stock is necessary to mitigate that risk. Tune in for our next article to learn more about the mechanics of one of the Greeks, Delta.

— Paul

But what if I said that debt was more than that? That it doesn’t have to be a bad thing.

Bad for the majority of people is considered a bad thing because most people don’t understand how to properly use it, and they end up misusing it, which leads to more debt than they can handle and a lot of financial stress.

Examples of Bad Debt

Bad debt is simply debt that is used to purchase things that lose value rapidly and cost you more money as time goes on. But sometimes debt for a purchase of this nature is necessary and financially viable, but is too often taken further than it must be.

Take an auto loan, for example. It’s common knowledge that a car loses about 10% of its value in the first month after you drive it off the lot, as it immediately becomes labeled a ‘used car’. In the first year, the value drops by about 12.5%, and over the course of the next 4 years it depreciates at roughly 5% each year according to CarFax (CarFax Car Depreciation). So from this standpoint, a car is a horrible investment, and that’s generally true. But it’s also true that a car is a necessity for the vast majority of the population to get to work, get groceries, travel, etc. So this means it falls into the bad debt category but also the necessity category. Where does this leave us? It means that if you need to take on some debt to purchase a vehicle, then it is acceptable, but the issue then arises that many people take out auto loans for vehicles that are well above their financial means and that surpass the basic necessity required. What I mean by this is that instead of taking a loan for a $15,000 used car in good condition that gets you from A to B, people tend to take out much larger loans than they need to purchase a new vehicle with all kinds of bells and whistles for, say, $45,000, therefore taking on more ‘bad debt’ than is necessary and putting themselves in a potentially strenuous financial position.

Another ‘bad debt’ is credit card debt. Credit cards can be a great tool, but they often get misused as well. Do you see the recurring theme here?

Credit cards are great for helping to build credit and learning good debt habits like making on-time payments and not carrying a balance. We won’t dive too deep into it because we’ve covered credit cards before in another article, which you can read here. But credit cards are notorious for people building up balances, which then require extremely high rates of interest to be paid on them, such as 18%-28% annually. This can lead to an extremely deep hole to get out of and destroy your credit score.

Yet, similar to the auto loan, it is us, the people using the tool, who cause our own demise as we misuse it.

Some Examples of Good Debt

Debt is not always a bad thing, but because of the debt listed above, it is too often associated with always being a bad thing to stay away from.

Mortgages are often associated with being a ‘good debt’ because you are buying an asset that historically appreciates over time, and it’s also a necessity. You need a place to live, so owning a home can be viewed as a necessary purchase. But there are caveats to this type of debt as well. A perfect proxy is the 2008 financial crisis. Many people hurried to buy homes that were not in their affordability range, sometimes with little or no money down, low ‘initial’ rates that eventually skyrocketed once they became floating rates rather than fixed, and the housing market did what everyone thought it couldn’t: it fell. When home values dropped, these owners now owed more money than the house was worth, with payments they couldn’t afford. So even though a mortgage is generally viewed as good debt, there are always scenarios where a good debt can become a bad debt.

Business loans are another type of debt that can be a good debt. You borrow money at a fixed rate to generate cash flow to cover the interest payments from that cash flow and realize a profit from it. Buying a car or material item under that umbrella generally doesn’t provide any kind of cash flow on its own (although if you then used that car to Uber or rent it out, it then has a cash flow, so you can get creative). But this debt, like any other, can become bad debt. Overall, it is generally considered good debt, but the interest payments are guaranteed while the cash flow expected is not, so sloppy math or assumptions can lead to bad debt.

Real estate loans are another type of cash flow-producing debt. Typically, you put a down payment on the property, and then the tenant(s) rent essentially covers the loan payments. The idea is that each month the tenant is building up equity for you while the asset is simultaneously appreciating. This is not without risk either, though, as it assumes you have tenants in it all the time and tenants who pay. There are other risks associated, but this is a primary one.

Nuances in Different Scenarios

I saw somewhere that ‘good debt’ you can’t afford is just bad debt with a better reputation, and I think that is a perfect way to describe it.

Any debt, good or bad, should be given an evaluation based on its interest rate, whether the purchase appreciates or depreciates over time, the opportunity cost, and the risk of a loss of income.

So is there really simply just ‘good’ or ‘bad’ debt? The answer is no.

You have to look at the areas above and then classify.

Final Thoughts

Surely you’ve heard someone say before ‘all debt is bad’, and as we discussed, this couldn’t be further from the truth. Debt is a tool, one which, if used properly, can benefit you greatly. But be careful, because misuse it, you can quickly go broke, and it's easier than it seems, which is why we have so many debt issues currently; even our government doesn’t seem to understand it, and they're supposed to be leading us. Also, thinking good debt is always safe is incorrect, as we saw good debt can become bad debt with something such as an unexpected loss of income that affects affordability.

I’ll leave you with this: ask yourself, does this debt make me wealthier or poorer? You may be surprised at the answer when you actually think about it.

- Luke

The growth in index options is tied to numerous factors, including increased retail engagement as retail traders were responsible for nearly half the total daily options volume. Additionally, a resurgence in large-block institutional trades over 1,000 contracts in size drove the growth in index options as they made up nearly 10 million contracts per day alongside sustained periods of high realized and implied volatility. - CBOE Q3 2025 Data

So retail is now half the tape, but what actually is an option?

An option is a type of derivative, a contract that gives you the right, but not the obligation, to buy or sell shares in a stock. It is a derivative because its value is derived from another financial instrument. 1 contract is equal to 100 shares, which is why price quotes are the premium (what you pay for the option) times 100, since it is per share and there are 100 shares per contract (a call option priced at $1.34 really costs $134, because it is $1.34 per share and you are paying for the right to buy 100 shares).

How Call and Put Options Work Using Amazon as an Example

Say you buy a call option on Amazon ($AMZN); this gives you the right to buy the stock at a predetermined price, known as the strike price.

The value of that contract is determined by the value of Amazon’s stock.

In general, when the price of the underlying, Amazon in this case, rises, so does the value of the call. When the price of Amazon’s stock falls, so does the value of that call.

Let’s say that the call option on Amazon has a strike price of 270, and the current stock price is 265. You buy the call option because you think Amazon’s stock price will rise to 290, and if it does, you can then exercise the call option and buy shares for 270, realizing a $20 gain per share.

But options also have something called an expiration date, which is when the contract expires. If the Amazon 270 strike call has an expiration date of August 14, and it is August 7, our contract expires in 7 days.

So what happens if the price is below 270, say at 260, at the expiration date? The call option expires worthless, because why would you buy shares at 270 when you can buy them on the market for 260? You wouldn’t. So calls expire worthless if the price is at or below the strike price at the expiration date.

This is what can make options tough. Even if you are right about the direction of the price, if you are incorrect about the time horizon, it doesn’t matter, and you can lose money. If on August 14 the price is at 260, your option is worthless, but what if it jumps to 280 on Monday, August 17, 3 days after your expiration date? Doesn’t matter. The contract has expired, so it is still worth $0 because the contract is gone.

Now that you understand the call, let’s talk about the put option, which is essentially the reverse. A put option gives you the right to sell shares at the predetermined strike price.

So if you instead buy a 270 put on Amazon, while the price is at 280, you want the price to fall below 270 to realize a profit. This is because if the price remains above 270, the option is worthless at expiration, because since your contract gives you the right to sell 100 shares of Amazon at 270, why would you sell the stock at 270 if you can sell it at 280? That’s $10 in gains per share you would be giving up.

But if the price of Amazon falls to 260, you could exercise the option and sell 100 shares at 270, while the market price for shares is 260, realizing a $10 gain.

The expiration date mechanics work the same as the calls do but in reverse. If your Amazon put option with a 270 strike price expires with Amazon’s stock price above 270, it is worthless, and if it expires with Amazon’s stock price below 270, it expires with value.

What Type of Money is It?

Here are the terms for describing where the stock sits relative to the strike.

If the stock is at a price that the option would expire worthless at the point in time, it is considered Out of the Money (OTM). If the stock is at a price equal to the strike price, it is considered At the Money (ATM). And if the stock is at a price where it would not be worthless if it expired at that exact moment, and it in fact would have value, then it is considered In the Money (ITM).

An option that is in the money has what is called intrinsic value. This is one of the two components of an option's price. Simply put, if the option were to expire at that moment, and it didn’t expire worthless, then it has intrinsic value, because it actually has value.

An option that is out of the money has no intrinsic value, and only what we refer to as extrinsic value. This is because if that option expired at that exact moment, it would expire worthless. So why does it have any value at all? Because of the potential for it to go in the money and hold real intrinsic value.

Essentially, all options have extrinsic value before expiration, but only in-the-money options hold intrinsic value. This is because for an in-the-money option, they hold the possibility of going more in the money before expiration; hence, they hold some extrinsic value in addition to the intrinsic value.

Two Sides to Every Transaction

The call and put options we just discussed are what we call long options, meaning you are buying the option. But there must be another side to the transaction, meaning someone is selling the option. The one selling the option is short options.

For the sake of this article, we aren’t going to dive into selling options very much, but it's worth knowing there's another side. When you buy that option, you pay a premium, and the person selling you that option receives that premium as payment for the right you obtain to buy or sell with it. Selling options uncovered or naked (meaning not actually owning the shares to back it) can be much more dangerous than buying options because you can lose more than you put in. With a long option, you can never lose more than the premium you pay for it.

But what is this premium? Well, let’s go back to the Amazon example. The call option you enter into, it isn’t just a free contract; you have to pay a fee for that right to buy/sell the stock at a predetermined price, and that fee is known as the premium you pay to the option seller. This is an important distinction, because it shows that just because an option doesn’t expire worthless, it doesn’t exactly mean you automatically profited.

This is because let’s say that an Amazon 270 call for August 7 expiration cost you a premium of $1.50 (really it costs you $150 because remember it is $1.50 per share and one options contract controls 100 shares, so we multiply the premium by 100). You now need to surpass that premium paid past the strike price to see a profit. The math looks like this

Call BE Formula: $270 (strike) + $1.50 (premium) = $271.50 (breakeven price)

So from that, you see how simple it is to calculate your breakeven price and where you begin realizing profit. On a call option, you add the premium to the strike. This means that if the price closes below 271.50 at expiration, you lose money, even if it closes at 271.40. If the price closes above 271.50 at expiration, then you have made a profit. On a put options it’s the opposite; you subtract the premium from the strike, as shown below.

Put BE Formula $270 (strike) - $1.50 (premium) = $268.50 (breakeven price)

The formula above assumes a put strike of 270, a premium of $1.50 per share, resulting in a breakeven price of $268.50. This means that the put option you bought will have lost money if the price closes above 268.50 at expiration, and will have made money if the price closes below 268.50 at expiration.

You have to factor in the cost of the option when determining where and if you make a profit.

Exercise vs Assignment vs Selling to Close

Three actions determine how an options contract ends: exercise, assignment, and selling to close. Which one applies to you depends on whether you're the buyer or the seller.

Only you, the buyer of the option, can exercise it. It means you are invoking the right that was afforded to you. So remember how a call option gave you the right to buy 100 shares at the strike price? Well, if you exercise the option, then you are taking that action to buy those 100 shares through your contract.

As for assignment, this happens to the seller of the contract. They don’t have a choice. When the buyer exercises, the seller is obligated to fulfill it.

In practice, the vast majority of retail traders take the third option: sell to close. This is where you exit the position in the open market. You are selling the contract to whoever will buy it, and thereafter your position is flat, and you never had to own any shares. As an example, if you bought the Amazon 270 strike call for 1.50, and Amazon stock rises, pushing the value of your call to 2.50, you can now sell to close the call option and realize a $100 gain.

Option buyers rarely ever exercise a contract and should not. This is because it destroys the extrinsic value you had. Think of it like this: if you had that 270 strike call on Amazon that you bought for $1.50, and the price of Amazon was now at 272, while the price of your option rose to $2.50, meaning there was $2.00 of intrinsic value and $0.50 of extrinsic value, that if you then exercised the position, you would only recognize a $50 profit (200-150=50), on top of the $150 you paid, purely the intrinsic value, as you would take 100 shares of Amazon at 270, which you could sell for 272, so $0.50 profit per share (2.00-1.50) times 100 for that $50 profit. Whereas if instead you just sold to close the position, you could sell it for $2.50 and realize a $100 profit rather than $50 because you are selling the option that includes that $0.50 of extrinsic value still, and never even have to take ownership of the shares.

If you just never sell the contract, then at expiration there is no extrinsic value. You wouldn’t be losing that value if you took possession of the shares through exercising them at expiration, but usually it is more profitable to sell before expiration.

Moral of the story: Don’t exercise your option position, especially before expiration.

Keep in mind that if you exercise an option, you need to be prepared to have the capital to take on those shares. You don’t need it to trade options, but if a call contract for Amazon with a strike price of 270 gets exercised, then you need to have $27,000 available to purchase the 100 shares at $270 a share.

And if you exercise a put, then you should already own 100 shares to sell; otherwise you’re now short 100 shares of the stock, which can lead to theoretically unlimited losses.

We recently learned that Leopold Aschenbrenner, the ‘star’ AI investor who amassed incredible returns in a very short period of time, has now gone for broke. His fund has been forced to sell all of its public holdings, and the once-star has now become a clown to many.

But let’s back this story up quickly and start from the top.

Who is Leopold Aschenbrenner?

Aschenbrenner is a former OpenAI safety researcher who moved into hedge fund management after his firing at OpenAI. He founded the fund Situational Awareness LP, where he predicted a massive boom in AI infrastructure and placed large bets on the sector. He was backed by multiple high-profile investors, and then leveraged the fund up to 4x before a market downturn in the tech and AI sector caused his fund to be forced to unwind its positions.

Oh, and did I mention he’s only 25?

Leveraged Leopold

Now to the main part of the story: leverage.

Leverage is when you borrow money to buy more investments. It not only magnifies your gains (which made Leopold Aschenbrenner the “star” that everyone called him), but it also magnifies losses (which led to the collapse and unwind of all of Aschenbrenner’s equity positions).

In this case, he was allegedly levered 4x, which means that for every $1 of the fund’s own money, it borrowed $3 from a lender.

If Aschenbrenner had $5 billion of investor cash (these numbers are figurative, not the actual numbers), that means at 4x leverage he borrowed $15 billion for a total of $20 billion to invest.

This money that he borrowed is secured by the cash or equity holdings they have that were purchased by their own cash. This means that $15 billion in borrowings is being secured by $5 billion in their own equity.

Every time the stocks drop in value, the collateral that is protecting these loans shrinks in size. A 10% drop in the overall portfolio's value reduces it from $20 billion to $18 billion.

The fund still owes the bank that original $15 billion, so the fund’s equity takes the $2 billion hit, as its equity falls from $5 billion to $3 billion. So a 10% drop in the portfolio causes a 40% loss of the fund’s cash. That’s why leverage is so dangerous.

No More Money

This is when a margin call comes into the picture. Banks don’t want to lose money, same as anyone else, so they have strict rules to protect their money in the event of something like this occurring. If the fund’s equity falls below a certain percentage, then the bank will issue a margin call.

A margin call is when your collateral isn’t worth enough, so you are required to either deposit more cash, or the bank will sell your stocks to get the $15 billion they loaned you back.

A Failed Attempt to Save the Fund

Aschenbrenner allegedly tried to get more cash through what is called ad-hoc capital-raising, where it was not planned investment in the fund by investors, but rather an emergency where he was scrambling to find fundraising to prevent his fund from the massive margin call he was facing.

This attempt failed as he wasn’t able to raise nearly the amount of cash needed. His entire fund was invested in the tech market, meaning they had little to no cash, so he was margin called.

Assets on Fire

Due to the margin call, he was forced to sell his assets immediately. You’ll see many refer to this forced selling as a ‘fire sale’ because buyers know that you have to sell no matter what, so you have no pricing power.

This allows other large players such as Citadel, who actually bought Aschenbrenner’s assets, to buy these stocks at depressed prices, often realizing a solid return, buying when someone else is pressed against the wall.

Liquidity is Everything: Remnants From the Past

The collapse of Situational Awareness is a textbook reminder that liquidity is oxygen. Aschenbrenner learned the hard way that genius means nothing if you can't survive a margin call.

This is not the first time something like this has happened, nor will it be the last time. Just ask Lehman Brothers, who at one point was levered up to 30.7x, but you’ll be waiting an awful long time for a response.

- Luke

For the early decades of Americans' lives, they focus on accumulation. Every dollar that hits your checking account was evaluated through one lens: how much of it can I invest? Countless contributions to your Roth IRA, maxing out your 401k, and building a taxable brokerage account, for what?

When retirement arrives, everything changes. Your paychecks no longer flow in, and the accounts that you have fed for decades now need to feed you. How much can you safely spend? What if the market crashes right after you retire? What if you live to 100 years old? What about taxes and the rising cost of living? These are important questions to ask.

This is the “distribution phase,” and it is psychologically and mathematically very different from accumulation. In accumulation, volatility is your friend, and market downturns are buying opportunities. In distribution, volatility can be devastating, especially early in retirement. This is sequence-of-returns risk, and it is the single biggest threat to retirement sustainability.

The good news is that there are well-researched strategies for navigating this transition. The bad news is that, despite this, there is no one-size-fits-all answer. Your optimal withdrawal strategy depends on your age, asset allocation, spending needs, other income sources, tax situation, and risk tolerance. Here is what you need to know.

The 4% Rule: A Starting Point For Withdrawal Strategy

The 4% rule, developed by financial planner William Bengen in 1994, is the most well-known retirement withdrawal guideline. You can withdraw 4% of your portfolio in the first year of retirement, then adjust that dollar amount for inflation each subsequent year, and have a high probability of not running out of money over a 30-year retirement.

For example, with a $2 million portfolio, you would withdraw $80,000 in year one. If inflation is 3%, you would withdraw $82,400 in year two, $84,872 in year three, and so on. Bengen’s research tested this approach against every historical period starting in 1926 and found that it succeeded in essentially all 30-year periods for a 50/50 stock-bond portfolio.

The 4% rule is elegant in its simplicity, but faces several limitations:

It assumes a 30-year retirement. If you retire at 60 and live to 95, that is 35 years. The 4% rule was not designed for 35-40 year retirements, which are increasingly common. For longer retirements, a lower initial withdrawal rate, such as 3.25-3.5%, is more appropriate.

It assumes rigid spending. In reality, most retirees have some flexibility in their spending. If markets perform poorly, they can cut discretionary spending. If markets do well, they can spend more. This flexibility allows for higher initial withdrawals than the 4% rule suggests.

It does not account for taxes. The 4% rule tells you how much to withdraw, not how much you will actually have to spend after taxes. A $80,000 withdrawal from a traditional 401k is very different from an $80,000 withdrawal from a Roth IRA or a taxable account with significant basis.

It assumes a 50/50 portfolio. More conservative portfolios have lower sustainable withdrawal rates. More aggressive portfolios can support slightly higher rates but with more volatility. Asset allocation matters significantly.

Bengen and others’ research has shown that the “safe” withdrawal rate varies significantly based on market conditions at retirement. Someone who retired in 2000, just before the dot-com crash and the 2008 financial crisis, faced one of the worst possible sequences of returns. The 4% rule held, but barely. Someone who retired in 1982, at the start of an 18-year bull market, could have safely withdrawn 6% or more.

This insight leads to what I think is a more useful framework: a dynamic withdrawal strategy.

Dynamic Withdrawal Strategies: Adapting to Reality

Rather than blindly following a fixed inflation-adjusted withdrawal, dynamic strategies adjust spending based on portfolio performance. This reflects how people actually behave. People tend to spend less when their portfolio is down and feel more comfortable spending when it is up.

Developed by financial planners Jonathan Guyton and William Klinger, the Guardrails approach sets upper and lower bounds on withdrawals. You start with an initial withdrawal rate, say 5%. Each year, you adjust for inflation, but you also apply guardrails. If your withdrawal rate rises above 6% of your current portfolio (because the portfolio has fallen), you cut spending by 10%. If it falls below 4% (because the portfolio has grown), you increase spending by 10%. This provides automatic adjustments that keep withdrawals sustainable while allowing spending increases when markets cooperate.

The Variable Percentage Withdrawal, another approach, popularized by the Bogleheads community, uses a lookup table based on your age and asset allocation to determine a withdrawal percentage each year. At age 65 with a 60/40 portfolio, the rate might be around 4.5%. At age 80, it rises to around 6.5% because your remaining time horizon is shorter. VPW is designed to fully deplete the portfolio by a very advanced age, such as 100, providing higher spending than the 4% rule but requiring flexibility to handle year-to-year variation.

Another strategy called the Floor and Ceiling follows a more unique framework. You establish a spending floor and a spending ceiling. Essential expenses such as housing, healthcare, food, or insurance are covered by guaranteed income sources or conservative portfolio withdrawals. Discretionary spending adjusts with portfolio performance. This approach provides security for needs while allowing flexibility for wants.

The RMD Method (Required Minimum Distribution): The IRS requires minimum distributions from traditional retirement accounts starting at age 73. The RMD percentage starts around 3.65% at age 73 and increases with age, reaching 5.35% at 80, 6.76% at 85, and so on. Some researchers have found that simply withdrawing your RMD amount each year provides a reasonable dynamic withdrawal strategy. This approach is simple, tax-efficient (since you are required to take the distribution anyway), and naturally adjusts for age and portfolio size.

In practice, most retirees benefit from a hybrid approach. Supplementation of a base withdrawal strategy with built-in flexibility to adjust based on market conditions and personal circumstances.

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Tax-Efficient Withdrawals

Pay attention here, as this is one of the most important and typically misunderstood sections when it comes to withdrawals.

How you withdraw from different account types can dramatically impact your after-tax retirement income. This is one of the most overlooked aspects of retirement planning, and getting it right can mean tens or even hundreds of thousands of dollars in additional retirement spending.

Conventional wisdom suggests withdrawing from taxable accounts first, then traditional retirement accounts, then Roth accounts last. The logic is to let your tax-advantaged accounts continue growing for as long as possible. This approach defers taxes and allows Roth assets, those that grow tax-free and are not subject to RMDs, to compound for the longest period.

However, this traditional approach can create a "tax torpedo" in your 70s. If you delay traditional account withdrawals until RMDs begin at 73, those RMDs, combined with Social Security and any pension income, can unintentionally push you into higher tax brackets. You may end up paying more in taxes over your lifetime than if you had spread the tax burden more evenly.

Many retirees benefit from strategically converting traditional IRA or 401(k) assets to Roth IRAs during low-income years, typically between retirement and when RMDs begin, and before Social Security and pensions fully kick in. You pay ordinary income tax on the converted amount, but once in the Roth, the money grows tax-free and can be withdrawn tax-free. Done correctly, this fills up your lower tax brackets in years when you have little other income, reducing future RMDs and providing tax-free assets for later in retirement.

For example, let us say you retire at 62 and delay Social Security until 70. You might have five to eight years of very low taxable income. By converting enough traditional assets to Roth each year to fill up the 12% or even 22% tax bracket, you lock in relatively low tax rates and reduce your future RMDs. This requires paying taxes now rather than later, which feels wrong but can be mathematically optimal.

Many retirees do not realize that Social Security benefits can become taxable. If your “combined income” (adjusted gross income + nontaxable interest + half your Social Security benefits) exceeds certain thresholds, up to 85% of your benefits may be subject to federal income tax. Strategic withdrawals from different account types can help manage this. Roth withdrawals do not count toward combined income, making them particularly valuable for keeping Social Security taxation in check.

Once you reach age 70½, you can donate up to $100,000 annually directly from your traditional IRA to qualified charities. This counts toward your RMD, does not count as taxable income, and reduces your adjusted gross income. For charitably inclined retirees who do not itemize deductions, qualified charitable distributions are dramatically more tax-efficient than donating cash.

Managing Sequence-of-Returns Risk

Sequence-of-returns risk, the danger of poor market returns in the early years of retirement, is the single biggest threat to portfolio sustainability. It deserves emphasis here.

The mathematical reality is harsh: two retirees with identical average returns over 30 years can have dramatically different outcomes depending on the order of those returns. If negative returns occur early, the portfolio is depleted while withdrawals are still large relative to the remaining balance. If negative returns occur late, the portfolio has already benefited from years of compounding.

Consider two retirees with $2 million portfolios, both withdrawing $80,000 annually, both experiencing the same returns over 30 years, just in reverse order. The unlucky retiree who gets the negative returns first runs out of money in year 20. The lucky retiree who gets positive returns first ends up with $5 million at age 95. The average return is identical. The outcomes could not be more different.

However, several strategies can mitigate this risk.

For example, by implementing the following “Bucket” strategy, you can mitigate your risk. Divide your portfolio into three "buckets." Bucket 1 holds 1-2 years of expenses in cash and short-term bonds. Bucket 2 holds 3-7 years of expenses in intermediate-term bonds and conservative investments. Bucket 3 holds the remainder in growth-oriented investments. You spend from Bucket 1, refill it from Bucket 2, and refill Bucket 2 from Bucket 3 when markets perform well. During market downturns, you stop refilling from Bucket 3, giving it time to recover. This provides psychological comfort and practical protection against selling stocks during crashes.

Social Security, pensions, and annuities provide income that does not depend on market performance. Delaying Social Security until age 70 maximizes this guaranteed income, and benefits increase by approximately 8% for each year you delay past full retirement age. A larger Social Security benefit means less pressure on your portfolio during market downturns. Some retirees purchase single premium immediate annuities (SPIAs) to create additional guaranteed income, essentially creating a personal pension.

Research by Wade Pfau and others shows that being flexible with withdrawals, cutting spending by 10-15% after a significant market decline, can dramatically improve portfolio sustainability. Most retirees have discretionary spending that can be reduced during difficult periods. Travel can be postponed. Dining out can be reduced. Large purchases can be delayed. This flexibility is enormously valuable.

This might seem counterintuitive, but reducing stock allocation too much in retirement actually increases the risk of outliving your money over long time horizons. A 30-year retirement requires continued growth, and bonds alone will not provide sufficient returns after inflation. Research suggests that a 40-60% equity allocation throughout retirement provides the best balance of growth and stability for most retirees.

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Healthcare, Longevity, and Other Risks

Withdrawal strategies do not exist in a vacuum. Several other risks need to be considered.

Fidelity estimates that a 65-year-old couple retiring in 2024 will need approximately $315,000 to cover healthcare expenses throughout retirement. This does not include long-term care, which can add hundreds of thousands more. Medicare does not cover everything, such as premiums, deductibles, copays, and uncovered services, which add up. Health Savings Accounts, if you have been fortunate enough to build one, are the most tax-efficient way to pay for healthcare in retirement. After age 65, HSA funds can also be used for non-medical expenses, making them functionally similar to traditional IRAs with the added benefit of tax-free medical withdrawals.

Half of 65-year-old men will live past 84, and half of 65-year-old women will live past 87. One in four will live past 92, and one in ten past 97. A retirement plan that only lasts to age 85 has a significant chance of failure. Annuities, particularly deferred income annuities or qualified longevity annuity contracts, can provide income that starts at advanced ages and continues for life, providing insurance against outliving your assets.

A 3% annual inflation rate cuts purchasing power in half over 23 years. At 4%, it takes just 18 years. Inflation is particularly dangerous because it is gradual and easy to ignore year-to-year, but compounds relentlessly. Maintaining equity exposure, owning Treasury Inflation-Protected Securities (TIPS), and having some flexibility to increase withdrawals if markets perform well all help address inflation risk.

This is uncomfortable to discuss, but important to plan for. Financial decision-making ability typically peaks in our 50s and 60s and declines gradually thereafter. By our 80s, even cognitively healthy individuals show measurable declines in financial judgment. Simplifying your financial life, consolidating accounts, using target-date or balanced funds, automating withdrawals, establishing trusted contacts with your financial institutions, and having a durable power of attorney in place all become increasingly important as you age.

A Practical Framework for Building Your Strategy

So how do you actually put this together into a coherent strategy? Here is the framework I recommend.

Determine Your Essential vs. Discretionary Spending

Separate your retirement spending into needs and wants. Needs include housing, healthcare, food, insurance, taxes, and basic utilities. Wants include travel, entertainment, dining out, hobbies, gifts, and charitable giving. This distinction is crucial because it defines how much flexibility you have.

Ideally, your essential spending should be covered by guaranteed income sources, such as Social Security, pensions, and potentially annuities. This means that even in a worst-case scenario, your basic needs are met. Your portfolio withdrawals cover discretionary spending, which can be adjusted based on market performance.

Optimize Social Security Timing

For most people, delaying Social Security until age 70 maximizes lifetime income and provides the best inflation-adjusted annuity available. The breakeven age for delaying is typically around 82-83, so if you live past that, delaying was the right call. Given that half of 65-year-old people will live well into their 80s, delaying is statistically optimal, especially for the higher-earning spouse in a married couple.

However, exceptions do exist. If you have a short life expectancy, if you absolutely need the income now, or if you are subject to the Social Security earnings test and still working. But for most healthy retirees, patience pays.

Develop a Tax-Efficient Withdrawal Strategy

Work with a tax advisor or financial planner to model different withdrawal strategies. Consider Roth conversions during low-income years. Plan for RMDs before they begin. Use QCDs (Qualified Charitable Donations) for charitable giving after 70½. Manage your tax brackets proactively rather than just taking withdrawals as they come.

Choose a Withdrawal Method

Select a withdrawal strategy that matches your risk tolerance and flexibility. If you have significant discretionary spending and can tolerate year-to-year variation, a dynamic method like VPW or guardrails may allow higher overall spending. If you value stability and predictable income, a more conservative fixed-percentage approach or the bucket strategy may be preferable.

Plan for Healthcare and Long-Term Care

Understand Medicare coverage and costs. Consider supplemental insurance or Medicare Advantage plans. If you have an HSA, plan how you will use it. Evaluate long-term care insurance, as it is expensive and getting more and more expensive every year, but for those with significant assets to protect, it can be worth considering. Hybrid life insurance policies with long-term care riders are an increasingly popular alternative to standalone long-term care insurance.

Build in Flexibility and Review Regularly

Retirement planning is not a one-time calculation. Review your strategy annually. Adjust for changes in health, spending needs, market conditions, and tax laws. Consider working with a fiduciary financial planner who can provide objective guidance and stress-test your plan against various scenarios.

The Bottom Line

Retirement withdrawal planning is where decades of accumulation meet reality. The transition from saver to spender is psychologically difficult as it goes against everything you have been doing for 30+ years. But this is what you saved for.

The key principles are straightforward. Fully understand your spending needs, maximize guaranteed income, manage taxes efficiently, maintain some equity exposure for growth, and build in flexibility to adapt to whatever the markets and life throw at you.

There is no perfect withdrawal rate or perfect strategy. But there is a strategy that is right for your specific situation. Take the time to develop it, work with professionals who can help you stress test it, and then have the discipline to follow it while maintaining the wisdom to adapt when circumstances change.

You worked hard to build this wealth. With thoughtful planning, it can provide the retirement you have envisioned and the peace of mind that comes from knowing you have prepared for the road ahead.

— Paul

To many people I know, they don’t ever consider their credit score, aside from the occasional check when they need a loan. Often, though, that is the only thought put towards it.

The downside to this is they’re missing out on some easy ways to help build and solidify that credit even further. This is especially true for younger people in their mid to late teens and early twenties.

There's a second cost as well, which is having good money management habits that can be ingrained in them from a young age as a byproduct of this.

So let’s break this down from the standpoint of a teen, working our way up through the age classes as we go.

Starting Early: 13-17

When you’re this young, you probably aren’t reading personal finance articles on Substack and thinking about your credit score (if you are, great!). So this section is going to be directed more at the parents of the adolescents.

The goal here is not to have your kid able to take out a mortgage on their own by 19 (good luck if you’re trying that), but rather to give them exposure to how credit works and the aspect of personal liability that comes with it.

One of the simplest ways to do this is through a credit card. Now I don’t mean opening up a credit card for just your 15 year old, considering that one, at that point they may go out and spend the entire available credit on something dumb, and two, you need to be at least 18 with a qualifying income to obtain your own credit card account anyway, but more on that in the next section.

What I mean is adding them as an authorized user.

An authorized user is when you get permission to use another person’s credit card account, but without the legal responsibility to pay the bill. Now that sounds bad, but as a parent, it just means you need to be monitoring them since you are the one legally responsible for paying it.

The authorized user, in this case, your child, gets their own card that is tied to the parent’s account and can be used to make purchases. Again, remember, the primary cardholder is legally responsible for paying it back, not the authorized user.

This is a great credit-building strategy for your young child. It works because the card issuer can report the account’s history to the credit bureau under not just the parent’s Social Security number, but also the child’s. For your child, that means that the account’s age, payment history, and utilization can start showing up on their own credit report, even though they’re not legally responsible for the debt.

The authorized user doesn’t have to ever even use the card, and the credit history reporting would still occur. Some parents do this, adding their child as an authorized user but never actually giving them a physical card or account access. Personally, I think giving them a card with strict rules is a good idea so that you can teach them how to spend responsibly.

That being said, there are caveats even to this. Not every card issuer will report authorized user activity. Many of the major ones do, but it’s not guaranteed, so this may be worth confirming with the issuer beforehand.

And before continuing, I want to quickly go over what actually goes into a credit score. Often, it is graded by FICO (a company that provides credit scores). 5 factors go into it.

1. Payment History (35%) is whether you pay on time, which is the most important factor.

2. Utilization (30%) is how much of the credit limit you use.

3. Length of History (15%) is out of your control to an extent, which is why it is so important to start as soon as possible to build it up.

4. Credit Mix (10%), meaning your revolving credit (credit cards) and your installment loans (think auto loans and mortgages).

5. New Credit (10%), which is both the number of credit accounts you’ve opened recently, as well as how many hard inquiries you’ve had recently.

Now that we’ve covered the 5 areas in determining the credit score, let’s talk about another potential downside to the child, which is dependent on the adult: payment history and utilization.

If the primary cardholder (the adult) pays late or maintains a high revolving utilization, it can actually drag the authorized user’s credit score down as well. So don’t allow your child to be an authorized user if you can’t or won’t be able to maintain payments on time and keep a safe level of utilization.

If you’re wondering at what age you can add your child as an authorized user, it actually depends on the card issuer. Some issuers have no minimum age, while others set it at 13 or 15. It’s always a good idea to check first.

You should also add them to a card with a solid history on it (although I suppose if one card is strong, you likely keep them all strong, which is great). This means no late payments, good history of low utilization, etc. Adding them to an account with a strong history can actually give a boost as opposed to an account that is newer or has a rough history.

Giving your kid a card this young also opens the door to teaching them the little nuances of financial responsibility. For example, signing up for a 7-day free trial that auto-renews monthly after those 7 days. It's so easy to forget about it and get charged for months without even realizing it (I myself fell victim to this recently, which, needless to say, has been taken care of).

Earning Your Own Line: 18-21

Once you hit 18, you can get your own credit card, but you need a qualifying income (it does not need to be a full-time job, but you do have to show income) or a cosigner. The cosigner must be at least 21, but they also have to be willing to take on joint liability for the newly created account. Without one of those two, the credit card issuer cannot legally give you a credit card.

There is a caveat to the cosigner route. While it is an option, it’s not an option that all companies allow. Many of the major companies don’t allow cosigners in any way, even though it is legal for them to allow it if they so choose to do so. This means if you’re 18-21 and you don’t have a qualifying income, even though it’s legal, it’s an unlikely option, as you may have a hard time finding an issuer that would allow it. A viable alternative to the co-signer dilemma is the authorized user approach we talked about earlier.

There are two major rules: don’t ever miss a payment, and never carry a balance. You do not need to carry debt each month to build credit, contrary to common belief. However, the first rule is much more important than the second. It’s common that people do carry a balance, but better to have a small balance you can manage than miss a payment. Never miss a payment.

Then, when it comes to utilization, it’s measured at your statement closing date, which means it’s a snapshot of the amount you owe at that moment, regardless of whether you pay it off in full before the due date. This is key, because it can sometimes be confusing, even if you always pay in full, running up a big balance right before your statement’s closing date can still cause a spike in your utilization, which in turn can cause your score to decrease temporarily.

That's why you should aim for a baseline utilization of under 30%, but realistically keep it between 1-10%, and ideally pay down your balance before the statement closes, not just before the bill is due.

The Expansive Twenties: 21-29
By this point, you’ve had some experience with credit cards, and now your focus shifts to expanding your credit profile. This is a good time to add a second card, but from a separate issuer.

For me, I started with a Discover Student card, and I used it all through college, at which point thereafter I opened a new credit card with Robinhood, which was a Visa. The rewards were great with Discover, but Visa is accepted virtually anywhere, so it was great to have two options when the occasional place didn’t accept Discover, or we were traveling internationally, and I ran into trouble with it.

Don’t overapply, though, because hard inquiries into your credit can add up and actually hurt your score.

Earlier, we mentioned loans. This is around the age when it becomes a crucial part of your credit, although this could be included in the 18-21 range as well, since many teens and young adults drive cars, either taking on auto loans or leases. Another really big one is student loans. More and more people are taking on debt for college, and this counts as an installment loan.

The hope is that by the time you reach the point where you take your first auto loan or you get a mortgage, the habits you had ingrained in you from a young age with credit cards will positively influence your decisions.

Installment loans don’t interact with your credit in the same way as a credit card does. While you should never miss a credit card payment, missing a payment on an installment loan, such as an auto loan, can spell much more serious consequences for both your credit score and your actual finances. If you miss a payment on your auto loan, you run the risk of repossession, where they take the car back. Even bigger, if you miss payments on a mortgage, they can foreclose on your house, and you can lose it.

The point of mentioning that is not to scare anyone from using those options, but rather to see them as a precaution and warning to always maintain good finances and not to take on more than you can reasonably handle.

As for the credit mix, if you’ve only ever had a credit card but no installment loans, then your score should see an increase after taking on an installment loan for the first time, provided you actually keep up with the payments.

The other thing, if you’ve maintained good credit on your credit card up to the point where you’re ready for your first installment loan, it can be the difference between having to pay extra thousands of dollars in interest due to having a solid credit score beforehand.

Midlife Credit (Not Crisis): 30-40

By this stage in your life, you should have a strong credit score, and if you don’t and you’re at that age, that’s a discussion for another time. At this point, you shift from building your score to protecting and leveraging it to your benefit.

With the good credit you’ve accumulated, this results in cash savings. You have access to better mortgage rates, better refinance rates on loans such as auto loans, greater rewards on credit cards, and in the event you ever need to restructure debt, you typically have access to 0% balance transfer offers. A credit score gap of 100 points can be the difference between small savings and thousands of dollars in interest.

This is also the time to look at upgrading your credit card. Just like better loan terms due to a higher credit score, you also get access to cards with better rewards and lower APRs (Annual Percentage Rate). You now have the credit history that you didn’t have in your early 20s, so use that to your advantage.

And don’t forget to manage your utilization. Your credit limit may have grown, which allows you to borrow more while maintaining the same or less utilization rate. Just ensure you don’t get sloppy with it and end up increasing your utilization rate because of an increased credit limit.

Also, keep an eye on fraud and identity theft, making use of credit monitoring, because at this stage, you typically have more open accounts, which expose you to these risks increasingly.

From Authorized User to Cosigner: 40+

Much of the second half of your life follows the same rules as the 30s-40s, but there are some common issues people tend to run into.

Lifestyle creep becomes an increased risk, where higher income becomes a justification for carrying balances, something you never did in your youth if you followed this guide. We actually have an article that talks more about lifestyle creep called What Keeps Most Americans Broke?, which is another great article on how to break free of personal finance traps most people fall victim to.

One other issue is that having a mature credit score tends to give false comfort that it can absorb poor financial habits, which is a flat-out lie. Just because you have done well up to this point does not mean you now have leniency to begin making poorer financial decisions. You must maintain the standard to which you’ve held yourself to this point.

Then the stages flip if you’re now in your 40s and you were once that teenager who was an authorized user or needed a co-signer for a credit card or for a loan. You are now the adult who is the primary cardholder or co-signer.

Whereas before you were the kid learning how to properly use credit, now you are the adult who is taking on the risk and must ensure you educate whoever you make an authorized user or you co-sign for. And in the event you are co-signing for an auto loan or a mortgage, the stakes have now drastically increased, and you need to be diligent about that. The formula doesn’t change, but now it’s no longer just a credit card we’re talking about. It’s large installment loans, which can damage your credit if the person you co-sign for demonstrates poor credit management.

Its Never Too Late (Or Too Early)

I don’t expect every parent, young adult, or teen to already know this, and you shouldn’t feel like you’ve made a mistake or it’s too late by not doing so if you were simply unaware. The truth is, many people are.

What matters is that you start now.

Start teaching your child, or start practicing these habits yourself. If you do happen to be a young teen or young adult reading this, bring it up to your parents, get the conversation started, so they can do their own due diligence and start putting these habits into practice.

The point here is that these habits can be taught and passed along, without having to learn a lesson the hard way, or preventing it as much as possible. It’s never too late to start, and it only benefits you in the long-run to learn proper credit management.

- Luke

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Don’t Rely on Selling Assets to Fund Immediate Expenditures

There are a few complications that arise when you sell your assets. Let’s say you are doing quite well this year, your portfolio is up, and you need some extra cash, so you sell some of your stock.

When you do this, you create a taxable event. Depending on whether you held it for less than a year (short-term capital gains) or longer than a year (long-term capital gains) determines what tax rate you pay on your gains.

If you end up having to do this on multiple occasions that year, you’ve now created multiple taxable events, and that adds up. You’re now losing some of that money to taxes.

But what if the market is down and you need to sell? This is possibly an even worse position to be in. Not only are you selling a position, but you’re locking in that loss, a loss that an investor who didn’t need the cash and doesn’t need to sell that stock would be able to hold through and recover from.

This can severely damage what your long-term returns look like as you’re setting back the compounding cycle significantly. You’ve now downsized the monetary base you were compounding from.

This is where the sequence-of-returns risk comes into play. This is the notion that the order in which your returns occur is just as important. This is often associated with retirees, but it is true of anyone who treats their investment portfolio like a checking account rather than a growth account. It doesn’t matter if you’re withdrawing due to an emergency, a new car, or to cover a period in between jobs, it has the same effect. This is in part why it’s recommended that people maintain an emergency fund (aka a rainy day fund), which has enough to get you through the rough patch without having to pull from your investment accounts.

But again, perhaps the most important piece is the damage caused to your compounding power. Pulling out $5,000 for a new purchase may not seem like much at the time, but when you figure in the loss of 30 years of compounding on that money, you aren’t taking out $5,000; you’re missing what would have grown to ~$87,000 assuming the market average of ~10%. That’s a lot from a little. Now, figure in that if you do this multiple times, the math gets uglier. You’re hurting your future self at the expense of a pleasure for your current self, a tradeoff that most would tend to regret later in life, but more on that later.

Become Financially Independent

One thing that I wish I had learned from a much younger age, which I feel is often not talked about enough, is your cash flow. We hear about it in terms of large companies, but rarely do we see people talk about it in terms of themself.

Most of us have an idea in mind where retirement isn’t in the traditional sense. Instead, we seek the ability to choose when to stop working rather than being guided by an arbitrary age, such as 65.

The best way to do that is to solve the cash flow puzzle. Once you’ve done this, you no longer have to work in a traditional setting to save up and support both your current and future lifestyles. And if you’re a young investor, you’re in the best position for this, as you have plenty of time to structure it in such a way.

This gives you financial freedom.

The Structure

Start building a portfolio that pays you. First, let’s think about what some means of income are. Well, we have dividends, interest, distributions, etc. The best part about these is that they don’t require you to sell any assets.

If you want to see an extreme example, Warren Buffett’s Berkshire Hathaway earned $816 million in just dividends from Coca-Cola during 2025. He paid $1.3 billion to acquire that stake in the company between 1988-1994, so it's safe to say the dividends have more than paid for themselves over the years, especially considering those shares themselves are now worth a total of ~$33 billion. Truly incredible.

That is what we’re trying to do here, just on a much smaller scale. It’s actually quite easy to figure out how large the size of your portfolio needs to be to support your yearly expenses. You simply take the annual expenses and divide them by the target yield to get the size of the portfolio needed. Let’s use an example. If I plan to spend $80,000 a year in retirement, and my yield is 4%, then I need $2,000,000 in the bank (since $80,000 in 4% of $2,000,000).

This may sound like a lot, and to many it is, but it's absolutely obtainable to someone starting at a young age and taking the time to save and build their portfolio up. One of the biggest advantages is that as you build it, you don’t always need to take income from it, you can reinvest it back into the portfolio to allow it to compound faster.

You can also have multiple portfolios. The portfolio we just discussed can be distribution-based, where you use what you receive for purchases, and then you have another portfolio for purely long-term, growth. You don’t ever pull from it, you just let it compound. If the market sees a significant drawdown and you need money, you can use the distributions from one portfolio rather than pulling from your growth portfolio when the market is weak.

Which Assets to Look At

While the assets we’re about to discuss are great for an investment portfolio, it is not a fully inclusive list. Some people receive cash flows from real estate, such as residential or commercial properties, and some people may see cash flow from a business they own. The biggest thing is that you create these cash flows, not necessarily how you receive them. Far too many people struggle to understand the difference between owning cash-flowing assets and using their job for their cash flow needs.

In terms of an investment portfolio, however, we have stocks that pay dividends, bonds that pay interest, and Real Estate Investment Trust (REIT) distributions. There are many others, but these are what we’re going to focus on for now.

Dividend Stocks: Remember Warren Buffett and Coca-Cola? That falls into this category. A dividend is a portion of a company’s profit that is paid out to shareholders. Typically, well-established companies pay steady dividends, like Coca-Cola, Verizon Communications, and Johnson and Johnson. You typically want a high-quality company that has proven itself, with a long historical track record of dividend growth. As we talked about for oneself, you also want to see strong free cash flows. While the dividend is what we’re looking for, you still want a company that can offer some appreciation as well.

Bonds: This is pretty straightforward, a bond is essentially a loan, where you typically lend money to a corporation, government, municipality, etc. Because of this, they usually pay you interest on that loan on a fixed schedule (some bond types get wacky, but the majority of them are like this). These tend to be much more stable than equities. This topic can get pretty deep very fast as well, so we’ll leave it at that for now.

Real Estate Investment Trusts (REITs): REITs provide exposure to real estate without having to directly own the properties. They are legally required by law to distribute a minimum of 90% of taxable income to their shareholders, which is great for those seeking steady income. However, there are questions about how that law may potentially stunt the growth of the operation, as some of that profit could otherwise be used to expand.

In our search to create an income-producing portfolio, it is not limited to those that we’ve discussed, and can include strategies involving selling covered calls, certificates of deposits (CDs), and other consistent yield assets.

The Biggest Advantage

Structuring a portfolio in such a way creates a big advantage. You are no longer concerned about the current state of the market, good or bad.

During a bull market, the value of your holdings increases and your income grows as those companies raise their dividends. The tradeoff to an increasing market is that reinvested dividends buy fewer shares at higher prices, but your overall wealth is compounding upward regardless.

In a downturn, the opposite dynamic kicks in. Your portfolio drops on paper, but if you’re invested in good companies that are quality dividend payers, they tend to keep paying. The best part is you're not forced to sell depressed assets to continue to fund your life. This means you can ride the recovery fully intact, without hurting your compounding power by selling into market weakness. A downturn is actually the best environment for reinvestment if you are still in your accumulation phase. Your dividends are buying more shares at lower prices, which sets you up for even larger returns when the market eventually recovers.

This is the single biggest advantage to owning these income-producing assets: when you detach your income from the daily movements of the market, you don’t fear volatility in the same way as many others will.

Get Started Now

Too many people fall victim to the belief that you need to already have a large sum of money to begin, which is false. Even if it starts with you buying 10 shares today of an income-producing asset such as Warren Buffett’s Coca-Cola, you’re now adding a cash flow that will begin compounding for decades to come.

Your 20s and 30s are when you should be starting this, regardless of what size you start at. The goal of this portfolio is not necessarily a retirement account, but to become an eventual replacement for the income you work so hard for currently. Start early, let compounding help you out as much as possible.

Payments, Not Withdrawals

Some of the issues with this are how people think about it. We are taught to think about it in terms of withdrawing money in retirement to live off of, when in reality, we should be viewing our portfolio as something that pays us.

Setting up a portfolio that pays you will change your life in the long run. And that doesn’t mean that you shouldn’t also set up retirement accounts, those are great too, but you should be building a portfolio whose main focus is paying you.

A Note on Withdrawing in Retirement

We have a few recent articles discussing retirement and saving for it, such as How to Start Investing in Your 20s, Rethinking How You Should Invest as You Age, and Asset Allocation 101: Building Portfolios to Match Risk Tolerance.

One thing we didn’t really touch on in those articles, but relates to them all as well as this one, is how important the rate at which you withdraw in retirement is. The relation to this article is our discussion of the rate at which to aim for distributions to cover your living expenses. 4% has become the gold standard, although there are variations that have come up and different strategies using slightly different withdrawal rates, each with its own benefits and risks. 4% has been shown to be able to handle continued distributions, even through recessions, bear markets, and periods of inflation, without diminishing the principle.

One strategy that I personally like is adjusting your withdrawal rate depending on the environment. What I mean by this is lowering your withdrawal rate slightly in the years after a market downturn, and increasing it slightly in the strong years thereafter. This can protect you from selling more during lower prices in a market downturn, and getting closer to maximizing your returns.

- Luke

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A few years ago, an acquaintance of mine’s father passed away unexpectedly. He had yet to retire, was seemingly healthy, and had accumulated a respectable sum of money through decades of careful investing and saving. However, he had done virtually no estate planning. He had no will, no beneficiary designations, no trusts, and no powers of attorney.

What followed this disaster was yet another disaster, a two-year legal back-and-forth battle. His assets were tied up in probate court (a specialized court that oversees the administration and settlement of an estate) whilst family members argued over “what he would have wanted.” The attorney took a significant cut from the estate. Decades strong relationships were strained to the breaking point. Not only did this family lose a father, but also his legacy.

This is what happens when people avoid the conversation. Estate planning is not about you, it’s about the people you leave behind when you are no longer here. It is an act of care and responsibility, and yet, studies consistently show that the majority of Americans either have no estate plan whatsoever or have one that is woefully outdated.

If you have built any measure of wealth, whether that is $50,000 or $50 million, estate planning is how you ensure it goes where you want it to go, with little friction, cost, or drama. This article is designed to walk you through what you need to actually know and what you need to do.

Why Estate Planning Matters For Everyone

There is a common misconception that estate planning is reserved for the ultra-wealthy. This is false. If you have any assets at all, you need an estate plan.

Consider this: In most states, if you die without a will, state law determines who gets your assets. This might align with your wishes, or it might not. If you are unmarried but have a partner you intend to provide for, intestacy laws almost certainly do NOT recognize that relationship. If you have children from a previous relationship, the distribution can get complicated very fast. If both parents die without guardianship designation, the courts decide who will raise your children, and it might be someone you do not want raising your kids.

Even with modest assets, probates (the actual process of administering and settling the estate) can eat up 3-7% of your total assets in just attorney fees and court costs. In California, attorney fees for probate are set by statute and can reach tens of thousands of dollars on relatively small estates. Proper planning can reduce or eliminate probate entirely.

Estate planning is not just about death. What happens if you are incapacitated by an accident or illness and are unable to make financial or medical decisions for yourself? Without proper documentation in place, your loved ones may need to go to court to get proper authority to pay your bills or make decisions on your behalf, which is expensive, time-consuming, and stressful during already tumultuous times.

The Essentials: Documents Everyone Needs

Last Will & Testament: Your will specifies how your probate assets should be distributed post mortem. It names the executor, or the person who carries out your wishes, and can establish guardianship for children. A will does not avoid probate; assets passing through a will must generally go through the probate process. But without a will, you are letting state law make those decisions for you.

Your will should be clear, specific, and updated post major life events such as marriage, divorce, childbirth, significant asset changes, or deaths of beneficiaries or executors. Keep in mind that beneficiary designations on retirement accounts, life insurance policies, and payable on death accounts supersede your will. If your will says your IRA goes to your brother, but your beneficiary designation says it will go to your ex-spouse, the ex-spouse gets it. This is a common and very costly mistake.

Revocable Living Trust: For many people, a revocable living trust is the centerpiece of estate planning. You create the trust and transfer your assets into it. You control the trust as the trustee during your lifetime and can modify or revoke it at any time. When you die, the assets pass to your beneficiaries according to the trust terms, without going through probate.

The primary advantage of a revocable trust is probate avoidance. Assets properly titled in the trust pass directly to beneficiaries, typically in weeks rather than months or years. This provides privacy and reduces cost. The only trade-off is upfront effort. Make sure you actually transfer assets into the trust. For larger estates, trusts also provide flexibility in distribution timing. Rather than beneficiaries receiving a lump sum at 18 or 21, you can structure distributions over time. This protects against young adults inheriting more money than they are equipped to handle.

Durable Financial Power of Attorney: This document designates someone to handle your financial affairs if you become incapacitated. "Durable" means it remains in effect if you become incapacitated. Your agent can pay bills, manage investments, file taxes, and handle other financial matters on your behalf.

Choose this person very carefully. They have significant power and could potentially abuse it. It should be someone you trust implicitly, who is financially responsible, and who understands your wishes. Consider naming a successor agent in case your first choice is unable or unwilling to serve.

Healthcare Power of Attorney: This person can make healthcare decisions on your behalf if you cannot make them yourself. This is not just end-of-life care; it could be decisions about surgery, treatment options, or where you receive care after an accident.

Living Will: This document specifies your wishes for end-of-life medical care. Do you want life-sustaining treatment if you are in a permanent vegetative state? Do you want artificial nutrition and hydration? These are deeply personal decisions, and making them in advance spares your loved ones from having to guess at your wishes during an already agonizing time.

HIPAA Authorization: The Health Insurance Portability and Accountability Act restricts medical information sharing. A HIPAA authorization allows designated people to access your medical information and communicate with your healthcare providers. Without this, your healthcare agent may struggle to get the information they need to make informed decisions.

Beneficiary Designations: As mentioned earlier, beneficiary designations on retirement accounts, life insurance, annuities, and payable-on-death bank accounts pass directly to the named beneficiary, bypassing both wills and probate. Review these regularly. Aforementioned life changes should trigger a review.

Trusts for Specific Purposes

Irrevocable Life Insurance Trust: If you have a significant life insurance policy, an ILIT can remove the proceeds from your taxable estate while ensuring they are distributed according to your wishes. Life insurance proceeds are income-tax-free to beneficiaries, but if you own the policy at death, they are included in your estate for estate tax purposes. An ILIT solves this problem but requires giving up control of the policy, as you cannot be the trustee or have the power to change beneficiaries.

Special Needs Trust: If you have a beneficiary with disabilities who receives or may receive government benefits such as Medicaid or SSI, a direct inheritance could disqualify them from those benefits. A special needs trust provides for supplemental needs such as entertainment, education, and personal care, without jeopardizing the government assistance they could receive. These trusts have strict requirements and should be drafted by an attorney experienced in special needs planning.

Charitable Remainder Trust: For the charitably inclined with appreciated assets, a CRT allows you to donate assets to the trust, receive an income stream for life or a term of years, and claim a charitable tax deduction. The remainder goes to charity at the end of the term. This can be particularly powerful for highly appreciated assets because you avoid capital gains tax on the transfer and receive an income tax deduction for the present value of the charitable remainder.

Spousal Lifetime Access Trust: For married couples with estates approaching or exceeding the estate tax exemption, a SLAT allows one spouse to create an irrevocable trust for the benefit of the other spouse, removing assets from the grantor’s estate while still providing indirect access through the beneficiary spouse. These are complex vehicles requiring experienced estate planning attorneys and work best when structured carefully to avoid reciprocal trust issues.

Estate and Gift Tax: Need to Knows

For most Americans, estate taxes aren’t a concern. Federal estate tax exemptions in 2026 are $15 million per person. Married couples can effectively double this, as the deceased spouse’s unused exemption transfers to the surviving spouse via portability.

However, some states have their own estate or inheritance taxes with much lower exemptions. Oregon and Massachusetts have estate tax exemptions of just $1 million. Other states with estate taxes include Connecticut, Hawaii, Illinois, Maine, Maryland, Minnesota, New York, Rhode Island, Vermont, and Washington, plus the District of Columbia. If you live in one of these states, your estate could owe state-level estate tax even if you are well below the federal threshold.

The annual gift tax exclusion allows you to give up to $18,000 per person without using your lifetime exemption or filing a gift tax return. Married couples can gift-split, effectively giving $36,000 per recipient. This is a powerful wealth transfer tool. A couple with two married children and four grandchildren could transfer $216,000 per year ($36,000 × 6 recipients) without touching their lifetime exemption. Over a decade, that is over $2 million moved out of the estate, plus all the growth that occurs on those assets outside the estate.

Gifts above the annual exclusion count against your lifetime exemption, and you will need to file a gift tax return, Form 709, to track this. You will not actually owe tax until cumulative taxable gifts exceed the lifetime exemption, but the reporting is required.

Life Insurance as an Estate Planning Tool

Life insurance deserves special mention because it is one of the most versatile estate planning tools available.

For young families with children, term life insurance provides affordable protection during the years when the financial impact of a parent’s death would be most devastating. A 30-year-old in good health can typically buy a $1 million 20-year term policy for a few hundred dollars per year. That is financial security for your family at a price that is almost certainly affordable.

For estate liquidity purposes, permanent life insurance such as whole life, universal life, or variable universal life can provide a tax-free death benefit that beneficiaries can use to pay estate taxes, settle debts, or equalize inheritances among children. If one child is taking over the family business and the other is not, a life insurance policy can provide equivalent value to the non-participating child.

For high-net-worth individuals, premium financing strategies can acquire large permanent policies with minimal out-of-pocket cost, though these are sophisticated arrangements requiring specialized advisors. Irrevocable Life Insurance Trusts, as mentioned earlier, can remove proceeds from the taxable estate.

As a rule of thumb, if you have anyone who depends on your income, carry term life insurance at least until your dependents are financially independent and your debts are manageable without your income. The "how much" question varies, but 10-15 times your annual income is a common rule of thumb. Err on the side of more rather than less; it is always better to leave your family slightly over-insured than underinsured.

Challenges of Estate Planning With Digital Assets

Twenty years ago, estate planning did not need to account for cryptocurrency wallets, social media accounts, digital photo libraries, and online financial accounts. Today, these are significant assets that require planning.

Cryptocurrency presents particular challenges. If you hold crypto in a self-custody wallet and your heirs do not have the private keys or seed phrase, those assets are effectively lost forever. There are an estimated millions of bitcoin that are permanently inaccessible due to lost keys, some of which belong to deceased individuals whose families had no idea how to access them.

You need a secure but accessible way to pass this information to your heirs. Some people use safety deposit boxes. Others use specialized digital asset estate planning services. The key is having a plan that provides access without creating security vulnerabilities during your lifetime.

For online accounts more broadly, consider using a password manager that allows emergency access. Most major password managers, such as 1Password, Bitwarden, and LastPass, have features where a designated emergency contact can request access, and if you do not deny the request within a set period, they gain access to your vault. This provides a balance between security and accessibility.

Also consider what you want to happen to your social media accounts and digital presence. Facebook and Google both allow you to designate legacy contacts. Other platforms have varying policies. If you have a digital business, online presence, or intellectual property stored digitally, these need to be addressed specifically in your estate plan.

Working With Professionals

Estate planning requires professional help. This is not an area for DIY except in the simplest situations.

An estate planning attorney should draft your documents. Look for someone who specializes in this area, not a generalist who “also does wills.” Complex situations may require attorneys with specific expertise, i.e., tax specialists for large estates, special needs planning attorneys for disabled beneficiaries, and business attorneys for closely-held business interests.

A financial planner can help coordinate your investment strategy with your estate plan, model different scenarios, and ensure your retirement planning and estate planning work together. Fee-only fiduciary planners are generally preferable as they do not earn commissions on products they recommend.

A CPA or tax advisor can help with the tax implications of various strategies and ensure gift tax returns and other filings are handled correctly.

For life insurance needs, an independent insurance broker can shop multiple carriers to find the best rates. For large or complex policies, consider working with a broker who specializes in high-net-worth cases.

Estate Planning Is Not a One-Time Event

Your estate plan needs to evolve as your life does. I recommend reviewing your entire plan every three to five years, and immediately after any major life event: marriage, divorce, birth or adoption of children, death of a beneficiary or fiduciary, significant change in assets, move to a different state, or changes in your wishes. An outdated estate plan can be worse than no plan at all because it creates a false sense of security.

The Bottom Line

Estate planning is not fun to think about. It forces us to confront our own mortality, make difficult decisions, and have uncomfortable conversations with family members. But it is one of the most important things you can do for the people you care about.

If you have worked hard to build wealth, invest wisely, and secure your financial future, do not leave the final chapter unwritten. An afternoon spent with an estate planning attorney can prevent years of legal headaches, family conflict, and unnecessary costs for the people you leave behind.

The goal is not just to transfer assets efficiently. It is to provide clarity, reduce stress, and ensure that your legacy reflects your values and intentions. That is worth a few uncomfortable conversations and some upfront planning costs.

If you do not have an estate plan, make this the week you start. Call an attorney. Make a list of your assets. Think about who you trust to make decisions on your behalf. Your future self and your family will be grateful you did.

- Paul

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Research backs this principle up. A famous study by Brinson, Hood, and Beebower published in the Financial Analysts Journal found that asset allocation explains over 90% of the variance in portfolio returns year over year. But, somehow, most investors spend a majority of their time worrying about the exact opposite.

So what exactly is asset allocation, and how can we use it to our own benefit? Simply put, it is the art of dividing your investments across different asset categories, whether these are bonds, stocks, cash, real estate, land, etc. The important part is that the assets you diversify into are the blueprint of your portfolio. You cannot succeed in investing by trying to build a portfolio that differs from your blueprint.

The Pillars of Portfolio Building

Pillar 1: Know Thyself

Before you can build your portfolio, you need to understand something that the majority of investors skip right past: your own relationship with risk. This isn’t about what you think your risk tolerance is, it’s about what it is when the markets actually get ugly.

Learning this lesson is painful, but necessary. When you see your account in x% drawdown, there will be panic. Your emotional response dictates your relationship with risk.

There are two components to risk tolerance. The first is your ability to take risk, which is objective and mathematical. You can build this projection based off a few key factors: length of investment, stability of income, and overall financial position. Someone in their 20s with a stable job, no dependencies, can objectively afford to take on more risk than someone in their 60s preparing to retire in a few years.

The second component to risk tolerance is your willingness to expose yourself to risk, which is an emotional and psychological barrier. This is where you need to truly ask yourself, and sometimes, find out firsthand, what you are willing to sacrifice. It is crucial that you are honest with yourself.

Pillar 2: Core Asset Classes - The Foundations

Let’s do a brief walkthrough of the main asset classes that are typically worked with in portfolio building.

Stocks/Equities: Stocks represent ownership in companies and have historically provided the highest long-term returns of any major asset class. Over the past century, the U.S. stock market has returned roughly 7% - 10% annually on average. But that average comes with significant swings in volatility. For example, in 2008, the S&P500 fell 37%. In 2022, it fell by about 19%. Stocks are the growth vehicle of many portfolios, but can add unwarranted stress during periods of market uncertainty.

Within stocks, you can further diversify. Companies are classified by size into three categories: large, mid, and small-cap. Moving forward, companies can be classified by their geography (already developed, emerging, etc.), and their investment style (growth vs. value). Small-cap stocks have historically outperformed large-caps over very long periods, but with more volatility. International diversification matters as different economies do not always move together in tandem.

Bonds are loans that you make to a government or corporation in exchange for a regular interest payment and the return of the principal payment at the maturation date. They’re the ballast of the portfolio. When stocks falter, high-quality bonds typically hold, or even appreciate in value.

Treasury bonds are considered virtually risk-free in nominal terms. Corporate bonds pay higher yields, but then, in turn, carry credit risk. Bond prices move inversely to interest rates, which is why 2022 was brutal for bond investors as the Fed raised rates aggressively.

Money market funds, treasury bills, and savings accounts all fall into the catch-all category of cash equivalents. Cash provides liquidity and stability, but historically returns barely enough to keep pace with inflation. In high-interest-rate environments, cash becomes more attractive, but over a long period, holding cash becomes an opportunity cost.

Into more physical assets, ownership of physical property and real-estate investment trusts (REITs) are ways to diversify your portfolio. Real estate can provide supplemental income through rent, diversification from stocks and bonds, and a potential hedge against inflation. REITs are particularly useful because they offer exposure to real estate without having to be a hands-on landlord.

Other forms of investments include commodities, hedge funds, private equity, and more. For most individual investors, small allocations into broad commodities or specific alternatives are sufficient. Commodities can sometimes serve as inflation hedges, but are volatile and do not produce income like stocks or bonds.

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Classic Allocation Models

With an understanding of the building blocks, let’s observe some traditional allocation frameworks.

60/40 Portfolio:

Perhaps the most famous model, this portfolio holds 60% in stocks and 40% in bonds. For decades, this has been a default recommendation for moderate investors. It provides meaningful growth potential from the allocation in equities, while the bonds help smooth returns and provide income. Historically, this structure returns about 7-8% with significantly less volatility than an all-stock portfolio.

A simple heuristic people follow is to hold their age in bonds and the rest in stock. At 30, you’d be at a 30/70 split. At 50, you’d be at a 50/50 split. This rule automatically reduces risk as you age and your time horizon shortens.

Three-Fund Portfolio

This approach uses just three broad index funds: A total US stock fund, a total international stock fund, and a total US bond fund. You adjust the percentages of holdings based on your risk tolerance, and set it and forget it. The beauty is in the simplicity, low cost, and broad diversification. There is no overlap, no complexity, and no need to constantly monitor and rebalance.

Target-Date Funds

These are the ultimate set-and-forget options. You pick a fund with a target year close to your expected retirement date, and the fund automatically adjusts its allocations over time, becoming more conservative as that date approaches. The underlying holdings tend to be broader index funds. How the allocations shift over time depends on the provider, so it’s worth comparing funds from various sources before making any decisions.

Pillar 3: Rebalancing

What most people don’t know is that your asset allocation actually drifts over time without you intervening. If stocks have a great year, and your bonds are flat, your stock percentage has actually grown. Therefore, you are now taking more risk than anticipated.

Rebalancing is the process of bringing your portfolio back to its target allocations. You sell some of the excess and buy what you’re short of.

Research suggests that threshold-based rebalancing (when asset classes drift by x%, you rebalance) is generally more effective. The hard part is behavioral. Rebalancing forces you to sell what’s done well, and then buy up what’s done poorly. It feels wrong. It means selling stocks after a great run, and buying bonds after they’ve dragged their feet through the mud. However, this disciplined approach builds a systematic approach to the market.

Vanguard found that rebalancing once or twice per year is generally sufficient. Rebalancing too frequently can increase costs and taxes without too much meaningful benefit. For tax-advantaged accounts like 401(k)’s and IRAs, you can rebalance without tax consequences. In taxable accounts, you need to be mindful of capital gains taxes.

Pillar 4: Tailoring Allocation to Age

Your asset allocation should not be static. It should evolve as you do.

In your 20s and 30s, time is your biggest asset. You can afford to be aggressive because you have decades to recover from any market downturns. 90/10 or even 100/0 allocations aren’t entirely unreasonable here, especially if you have stable employment and a rainy-day fund built. When you won’t touch this money for 30+ years, short-term volatility is simply irrelevant. Your focus should be entirely on maximizing growth.

This is also the time to weigh heavily on equities instead of holding onto cash. I see too many people my age with thousands in savings accounts, for what reason? Holding onto too much cash will bite you in the ass.

As you age into your 40s, retirement is getting closer. At this point, you should begin adding bonds. 70/30 or 75/25 is common at this point. This is also when international diversification should become more important to you. Life changes, such as children approaching college, paying off your mortgage, and changing careers, will all influence your allocation strategy.

In your 50s and 60s, the runway is beginning to shorten. The sequence of returns risks becomes much more plausible as you get closer to retirement age. At this point, 50/50 or 60/40 allocations are more typical. Your portfolio is still growing, but preservation becomes way more important.

At and through retirement, the strategy becomes somewhat counterintuitive. Conventional wisdom says to be very conservative in retirement, and for good reason. Most tend to lean towards a 30/70 or 40/60 split, but with longer life expectancy, many retirees need their portfolios to continue sustaining their lives for 20-30 years. Being too conservative can dry the well fast.

The key takeaway is that retirement is not the finish line for growth. It is a phase that can last for decades, so conservative growth is a more realistic approach.

Pillar 5: Alternatives and Specializations

Once you have a core stock and bond foundation in place, you might consider where and when to place alternatives in your portfolio.

Small allocations into broad commodities can provide diversification and hedge against inflation. During periods of unexpected inflation, commodities have historically performed well while stocks and bonds struggled. You can access commodities through low-cost ETFs.

Treasury bonds whose principal adjusts with inflation (TIPS) are also good vehicles for hedging against inflation. These can be particularly valuable to retirees concerned about purchasing power. Holding a ladder of TIPS with various maturation dates can provide inflation-protected income throughout retirement.

Common Allocation Mistakes

I have made my fair share of mistakes over the years, and I’ve seen many others make even more. Here are the big ones to avoid.

Do not chase performance. The worst time to increase your stock allocation is after stocks have already gone up. The worst time to add bonds is after they’ve rallied. Resist the urge to add onto what is already doing well, and instead, trim the fat and add to what has fallen behind.

Do not build a home bias. U.S. investors tend to have a predisposition to U.S.-based stocks. It is familiar, it is comfortable, and U.S. markets have performed exceptionally well for a long time. But times change. You should not be the one on the short end of the stick when that change comes. A globally diverse portfolio provides better risk-adjusted returns over long periods.

Do not ignore correlations. During normal times, different asset classes provide genuine diversification. But during crises, correlations often spike. This does not mean your diversification failed, but that there are fewer protections during times of crisis. The solution is not to abandon diversification, but, rather, ensure your allocations can withstand periods of time where nothing is winning.

Set and forget. Automation is your friend. Set up automatic contributions, use target-date funds if you don’t want to manage allocation directly. The point is, the less you need to actively think about your allocation, the less likely you are to make emotionally driven changes at the wrong time.

The Bottom Line

Portfolio building is not exciting. Nobody brags about the percent split of stocks and bonds at the dinner table. Yet, it is the single most important investment decision you will ever make.

The right allocation strategy is the one you can stick with through times of good and times of bad. If you’re just getting started, keep it simple. A three-fund or target-date fund will serve you better than trying to doctor up something complex that you do not fully understand yet. Complexity often leads to paying higher fees or making frequent changes, and then being more stressed.

The perfect allocation is the one you actually maintain. An imperfect allocation that you stick with beats a theoretically optimal allocation that you abandon at the first sign of trouble.

-Paul

It didn’t take long to give that money I made back and then some, but that money lost was the most valuable money I’ve ever lost, because it started me on the journey of investing, and I mean actually investing, not what I was doing that I thought was investing at the time.

Time is Your Biggest Tool

My only regret is that I didn’t make this mistake sooner, but we can’t all start investing at 9.

When you realize the power that compounding money can do for you (once you finish this article), you’ll want to go out and immediately start investing. But what is compounding?

Compounding is when you take the money you earned and reinvest it back into the money you started with, so that future interest is based on both the initial investment amount, and the money earned so far. Let’s break it down.

Say you start with a modest investing base of $1,000, and you earn a market average 10% annually. Well 10% of $1,000 is $100, so now after year 1, you have $1,100, your principle plus the money earned. If you were to take that $100 out and keep only the $1,000 in, then after year 2 you would have another $100. This isn’t compounding. If you instead take that $100 and reinvest it so that now you have $1,100 earning 10% a year, well then in year 2 you earn $110, since that is 10% of $1,100. So, you made $10 more than year 1.

This may not seem like a lot, but the power of compounding takes time. If you were to now repeat this process over the next 40 years, and you started investing at 18, at the 10% annually, compounded you would now have $45,259.26 at age 58. Now if you compare that to if you pulled your 10% profit out each year and just received the 10% annually on the $1,000, you would have only earned $4,000 over those 40 years and still have your original $1,000 for a total value of $5,000. Now do you see the difference?

If you take it one step further, and each month you add $100 to your original $1,000 at age 18, compounding over 40 years, you now will have $686,108.62 at 58, after contributing a total of $49,000. Mind you, these numbers do account for the fact that with monthly contributions, in the same year some months begin compounding earlier, so if you try to recreate these numbers using $1,200 a year, you’ll get somewhat lower numbers, even though it’s the same contribution amount. Now it should be obvious why we compound and add contributions to investment accounts and retirement accounts.

The more years you do this for, the faster it gets larger. If you added 7 years so that you contributed till retirement age at 65, you now have $1,389,746.37, after contributing a total of $57,400. You only added $8,400 of your own money as compared to stopping at age 58, but in those 7 years your money grew by $703,637.75. Of that increase, $8,400 of your own money came from your additional contributions and $695,237.75 came from investment growth. I’m willing to say that the tradeoff was worth it.

So now it should all be making sense, and you should be hooked on wanting to be investing now that you understand what compounding is and why it’s so powerful. Let’s add the disclaimer though that there are many factors that add to this, such as inflation, but this suffices for the getting the general idea across.

Don’t forget, you do have time, but not in the “waiting” sense. If you wait two years to start, you didn’t “postpone” those two years, you lost them. While you do have time, you also have a finite amount of it. The sooner you start, the better off you’ll be, and that’s a fact, not an opinion.

So, how do you get started and what do you invest in?

Getting Started - Retirement Accounts

One way to get started is by beginning your retirement accounts. There are so many different types of retirement accounts but let’s just briefly cover the most well-known ones.

401 (k): These are employer sponsored retirement plans that offer a tax advantage, and often has a contribution match up to a cap by the employer. That means if they match 100% of contributions up to 5% of your salary, then you essentially just doubled that 5% of your salary immediately and have a larger base to now compound with. Maxing employer matching is at the top of the list.

Traditional IRA: An IRA is an Investment Retirement Account. It is another retirement account that has tax advantages. It’s a personal savings account, and you control the contributions as well as the mix of assets that it holds. In a Traditional IRA, contributions can be tax-deductible, dependent upon a few factors. The contributions are made with pre-tax dollars, meaning you don’t pay taxes on the contributions or earnings until you withdraw the money in retirement. This means the money grows tax deferred.

Roth IRA: In a Roth IRA, contributions are made with after-tax dollars, and qualified withdrawals of both your contributions and earnings are tax-free.

There are so many other forms of retirement accounts but those are a few of the biggest, and they can go much deeper than those brief explanations.

Getting Started - Alternative Long-Term Investing

Brokerage Account: You can open an account with a broker such as Fidelity or Charles Schwab. These are very simple, you deposit money into the account and invest in any product you want that is available. These accounts are taxable through capital gains tax upon selling the asset but are another avenue for investing. These accounts are free of contribution limits, income restrictions, and early withdrawal penalties. Money you may need before retirement is great in these accounts since you can pull it out without penalty, as well as money in excess of contribution limits to your retirement accounts that you may still want to invest.

Health Savings Account (HSA): While this is a healthcare account, it provides amazing tax advantages for long term investors. Contributions are pre-tax, growth is tax-free, and withdrawals are tax-free for qualified medical expenses. Once you hit 65 you can then withdraw anything penalty-free, you just pay ordinary income tax. But to show why this is so tax advantageous, you need to understand that the IRS (Internal Revenue Service) has no time limit on distributions for qualified medical expenses, meaning you can pay medical expenses out of pocket, and leave the money growing in the HSA, and then 20-30 years later pull the amount you have for qualified medical expenses out completely tax free. So, if you spent $1,000 a year for 25 years on these qualified medical expenses, then you could pull out $25,000 completely tax free from the account, with the rest being penalty free after 65 at ordinary income tax. The critical thing here is you MUST keep all receipts for the expenses, and they must have incurred after the HSA was opened, not prior. The expense also cannot have been reimbursed or claimed as a tax deduction somewhere else. These are not available to everyone though, as you need to have a high-deductible health plan.

Real Estate: This one doesn’t necessarily pertain the financial markets but is a good one to cover briefly. You can earn returns from appreciation and rental income. In real estate leverage is available, as well as deprecation tax deductions, and perhaps most importantly, the 1031 exchange, where you can defer capital gains taxes indefinitely by rolling it into another investment. You can actually access real estate in financial markets through REITs (Real Estate Investment Trusts), which you give you exposure to real estate from a brokerage account without having own properties.

Just a Small Piece of the Puzzle

The above listed accounts are only a few of many different ways to invest for the long-term and make as much use of tax advantages as you possibly can. But what about what you actually buy once you have any of the above listed accounts? Well, let’s get into it.

What to Buy

Stock in Good Companies (Equities): This one can be a little tougher than simply putting your money in an ETF that tracks something and earns an average annual return like the S&P 500 historical return of ~10% annually. But it is also true that investing is often made to appear much more complex than it has to be. Yes, you should understand basic financial statements, and yes, you should understand how the business you invest in actually operates and makes money. But people don’t realize that often researching a company does not have to all be just sifting through thousands of pages of documents. Peter Lynch was one of the best at this, where some of his ideas came from his daughters, based on what stores they were visiting or said were most popular, and taking the idea further. He would then go the store himself and observe it, how busy it was, how it worked, etc., and then he would dive into financials and future prospects for the company. Investing can be made fun for the average person if done right, almost like a game. If taken seriously, one can earn a return that beats the market and is worth the time taken to achieve it. That being said, if you can’t honestly take the minimal time required to do so, it’s best not to attempt doing so.

Bonds (Fixed-Income): Most people have heard of bonds, but for those who haven’t, a bond is essentially a loan by the investor to the borrower. It’s a debt security. The borrower could be the US government, a foreign government, a municipality, or a corporation. There are different types of bond structures, but for now what you need to know is a typical bond pays regular interest payments, with the repayment of the principal amount (the initial amount invested) at maturity. For example, you buy a $1,000 10-year US government bond with an annual interest rate of 5%. Each year, you receive $50, 5% of $1,000, until the final year, where you receive your final interest payment of $50, and your original $1,000. If a company were to go bankrupt, bondholders have priority on repayment over shareholders.

ETFs (Exchange Trade Funds): An ETF is an investment fund that pools money from investors and buys a diversified portfolio of assets. They typically track specific indexes, sectors bonds, commodities, or other topics. They trade on stock exchanges the same way a stock does. These tend to be low cost, since expense ratios are usually low. Currently the most well-known ETFs in the world are QQQ, which tracks the Nasdaq-100, and SPY, which tracks the S&P 500. One that I personally invest in on recurring schedule regardless of what the ETFs price is doing, is QQQJ. Now that is not investment advice in any means, as none of this is since its purely educational, it’s just something I’m holding onto for the long-term. QQQJ tracks the Nasdaq Next Generation 100 Index.

REITs (Real Estate Investment Trusts): We discussed this one briefly earlier, but it fits in here perfectly. They are publicly traded companies that own income-producing real estate like malls, apartment buildings, office towers, etc. They tend to be high yield due to law requiring them to distribute 90% of taxable income as dividends. The dividend is taxed as ordinary income not the qualified dividend rate, so these work great in retirement accounts like Roth IRAs. But due to the high distribution return law it does stunt them from potentially growing a lot since they keep very little cash on hand.

Mutual Funds: These work similarly to ETFs, as they are also a pool of money that holds a collection of assets. These however, trade once per day, at the end of the day. Traditional mutual funds do not trade on public stock exchanges but can be accessed in both your brokerage account and retirement accounts. Many mutual funds are actively managed, but data suggests the vast majority of actively managed funds tend to struggle to beat or even match basic market indexes, especially when taking their management fees into account.

As time horizons extend, these style effects wash out and costs compound. A fund charging 80 basis points more than an index fund must beat the index by 0.80% every year just to break even, and that hurdle accumulates relentlessly. Over five years, the cumulative cost drag on a fund with a 1% expense ratio versus a 0.05% index fund exceeds 4.75% before compounding effects. - IBF

The above quote, which can be found and you can read more of here, shows part of the reason actively managed funds struggle so much to outperform. The image below is from the same article, showing some data on actively managed funds and their underperformance.

This does not mean you can’t or shouldn’t invest in mutual funds, it just shows that historically they struggle, across the board. Mutual funds also have some tax inefficiencies. In a taxable brokerage account, it is possible to generate capital gains taxes that get distributed to all the remaining shareholders, even if you didn’t sell anything. This is because if other investors redeem shares, it sometimes requires the fund manager to sell holdings to raise the cash needed to meet those redemptions, which can create those capital gains taxes.

Money Market Funds: This actually falls under the mutual fund category, but we’re giving it its own section due to its everyday use. These funds invest in short-term debt instruments that are investment grade. The value remains so stable due to the maturities being days to weeks. It typically includes holdings such as treasury bills, commercial paper, repurchase agreements, etc. It’s yield floats daily, based on the environment surrounding short-term interest rates. There are also sub tiers within this category, but we won’t go that deep. Tip: Typically, this is where your uninvested cash sits in brokerages, but some brokerages default this to lower yielding sweep accounts opposed to true money market funds, so check on this and make sure you’re getting a more beneficial return on your uninvested cash.

CDs (Certificates of Deposit): You are basically lending money to a bank for a fixed term and at a fixed rate. At the end of the term, you get your interest back and the principal. CDs in nature are similar to bonds, but they definitely have their differences. CDs are FDIC insured up to $250,000, guaranteed by the government. Since government bonds are considered risk-free, not much difference. But corporate bonds, however, carry what’s called credit risk, meaning the company could default. CDs cannot be traded on open markets, so they are illiquid compared to bonds. They are locked in until maturity unless you pay the early withdrawal penalty. There are however brokerage CDs, which do have secondary markets, but are extremely thin, so it’s tough to get a good price for it. Overall, CDs work well for guaranteed, fixed returns, especially when you know you’ll need a certain amount in the future, like a downpayment for a mortgage. For short-term maturities such as a year or less, most CDs just accumulate interest and pay it all at maturity. Longer-term CDs tend to pay monthly or quarterly interest.

Options: A less used one, mostly because many people associate it with speculating, is options. There are a few ways to generate income using options that aren’t extremely complex to use.

• The first one is covered calls. If you already own stock of a company, you can sell covered calls on it and earn passive income. You have to own over 100 shares because options contracts are based on 100 shares per contract. You can sell covered calls on a position and earn monthly income from it. That income is from the “premium” that gets deposited in your account for selling the call. It’s “covered” because if you get exercised, you actually own the shares. You can sell calls without owning the stock, which is termed selling “naked calls”, but it’s much riskier due to unlimited risk since a stock can keep rising. So, with covered calls the risk is that the stock rises above the strike price you sold, and you have to sell your stock at the strike price that is lower than the current price, which means you lost the opportunity to profit more from the move up. Usually, we reserve these for stocks we think will rise very little, remain flat or even decline slightly in the near term. This strategy is very popular and very conservative.

• Then there’s cash secured puts. You can sell a put option at the price you want to buy a stock and collect premium from it as you wait for price to fall. If price falls to your strike price or lower, you’ll get exercised and have to take delivery (buy) of 100 shares of the stock. This is fine since you wanted to buy it at that price anyways. Sometimes it will never reach the price you wanted to buy, but in that case, you still collected premium in the meantime.

• Let’s not forget about protective puts. This is essentially buying insurance on your portfolio. You are buying put options to protect yourself from downside risk. This related directly to our other article that was recently released, where we discussed “sequence-of-returns” risk, especially at the start of retirement. A new retiree could purchase puts as they begin retirement as insurance against the potential for a crash in their early years which causes significant damage, especially if actively withdrawing. You can read more about that in our article here.

• There are also LEAPS (Long-Term Equity Anticipation Securities). These are long dated option contracts, typically 1-2 years out. You can buy call LEAPS that are deep in the money on an index or a stock as a cheaper alternative to owning shares outright. I personally don’t actively do much with LEAPS, but some people find them very useful, so I felt it necessary to mention them.

• Finally, there are spreads on options. There are so many different types of spreads and strategies, but some of them are great passive income producers. Personally, my favorite is selling credit spreads, but debit spreads can be great too. These are both a type of vertical spread, you buy an option and sell another one at a different strike price, but with the same expiration. But that’s as far into that topic as we’ll get, since it does take a little more background knowledge to execute.

What to Take Away from It

Investing in your 20s isn't about finding the perfect strategy or even picking the right stocks. It's about understanding the investment landscape well enough to make informed decisions and which leads to you actually starting your investment portfolio.

By this point, you should have a fairly good idea of what to do now. Everyone has different amounts of time available as well as different levels of interest in investing.

If you have little time and little interest in investing, maybe ETFs are right up your ally. If you have a lot of time and are very interested in investing, then maybe doing deeper research and choosing your own stocks is right for you. Maybe you need cash in the near future so investing that money in a short-term money market fund is a good idea. Or maybe you want to combine multiple different strategies and take full advantage of all the options available to you.

Regardless of the direction you want to go moving forward, if I have you thinking about it at all or considering it, then I’ve successfully reached my goal. My point is to create a sense of urgency about time and get you on your way to starting if you haven’t already or potentially optimize your situation if you are already investing.

The investing world is broader than most people realize, but the foundation of it never changes no matter how sophisticated your portfolio eventually becomes.

Start early, contribute consistently, and keep costs low. But none of this matters more than the one variable money cannot buy back: time. Some mistakes in investing are costly. Starting late is a mistake we can’t undo.

- Luke

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Some believe that this long-held belief may not actually be the most efficient way to manage your assets, so we’re going to dive into what the typical thought process is and has been, and also alternative solutions that have been raised as being potentially more effective.

The Theory

The consensus is that as you age your optimal asset allocation should slowly become more conservative, transferring into safer assets that preserve wealth in times of hardship.

One such rule for this was known as “Hold your age in bonds”. This implied that if your age was 30 you should hold 30% of your portfolio in bonds and 70% of it in stocks, and if your age was 65 you should hold 65% of your portfolio in bonds and 35% of your portfolio in stocks. Aside from this method, there are many other tips and tricks to calculate a good bond-stock allocation ratio.

Going back to the primary reason we do this, times of hardship, it is due to the fact that when you’re young in your 20s and 30s, and even into your 40s, you’re in your contribution phase where you are working and actively putting money away for retirement. You have plenty of time to whether the storm of a market crash if one were to occur (spoiler alert, there’s a very high probability every generation will go through at least 1), as you could continue buying especially during such low points, and by the time you withdraw, everything will have very likely recovered and that crash will look like a tiny blip in the grand scheme of things.

But when you hit retirement (65 for most), you enter into your withdrawing phase, where you are no longer working and putting money into your retirement, but rather you are selling assets as needed and using that many you invested throughout your life. The issue that arises here is if you are 64 and about to go into retirement, or 70 and in retirement with most of your assets in riskier, more aggressive investments like stocks and a market crash occurs, now not only has the value of your investments/savings fallen drastically, but you are now withdrawing your money, potentially selling these assets during this period, locking in permanent losses.

For the sake of visualization, imagine you had $1 million saved up when you hit 65 to live on for the remainder of your life. Now say shortly thereafter a major market crash occurs and the market goes down over 50%, and the value of your investments goes down over 50% with it. Now you’re starting retirement with half of what you originally had, and you are withdrawing from it, not contributing. This is a very dangerous position to be in.

Something that is quite popular now to sort of automate this optimal asset allocation is target-date funds. They use what’s called a “glide path” to slowly shift your portfolios allocation from equities to fixed income as you progress towards retirement. These are actually very common and typical of a baseline for 401(k) retirement plans. These are often provided by institutions like Vanguard, Fidelity, Charles Schwab, etc.

Contradictions with Some Credibility

Many people and studies argue that shifting allocation from riskier assets to safer assets as you age is actually not the best option available. Rather, they indicate that you’re optimal solution is to keep the majority of your portfolio in equities regardless of age.

First let introduce an important term here: Sequence of Returns Risk

This is the risk that the order investment returns, primarily in the early years of retirement, can have a significant impact on the longevity of your retirement portfolio. So, while the “average” returns over a period of time may be 10%, it’s important to take into account the order in which each year making up that average occurred. If the slow or negative years occur early on, then they are much more likely to deplete their portfolio at an increased rate than someone who experience the slow or negative years later on, even if both investors averaged 10% over that time horizon.

The visual above was provided from a Charles Schwab article to show how much of a difference the timing of a market downturn can affect when you run money dry. After 18 years, Investor 1 runs out of money, and Investor 2 still has around $400,000.

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Rising Equity Glidepath Theory

As for alternative solutions for optimal asset allocation, there are many variations, but perhaps one of the most intriguing is one known as a “rising equity glidepath”.

In this instance, you hold more bond exposure during early retirement and increase equity exposure (thereby decreasing bond exposure) as retirement progresses, forming a sort of “U” curve in the bond-stock ratio as an individual ages. This path has generated quite a bit of intense debate, as the authors Wade D. Pfau and Michael Kitces have really brought an unconventional method to the forefront.

They argued that the first 15 years of retirement are crucial, since a strong market in the early years puts you ahead enough to bear the effects of a large correction in the later years, whereas if returns fall short or are negative in the first years, a strong market will be needed later on to ensure it lasts the remainer of your retirement.

This strategy becomes even more powerful if you have other sources of income such as a pension or Social Security (if you’re younger and reading this, plan for retirement as if you won’t receive SS, because there’s a chance you won’t). If you have flexibility in spending and other sources of income can cover the majority of your daily living costs, then you are even better suited to whether a market downturn.

Exploring a 100% Equity Portfolio

Another proclaimed “efficient” strategy is known as “100% Equity”. If you couldn’t tell from the name, it means 100% of your portfolio remains in equities.

This was primarily discussed in the paper “Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice” (Anarkulova; Cederburg; O’Doherty). They argued that a 50/50 mix of domestic and international equity holding outperformed other investment strategies including fixed incomes.

They acknowledged the risks that occur in the short term and noted that if someone was the type to panic sell into a falling market, that they would in fact be better off in a mix of equities and fixed income. But if they were willing to continue to hold the equities throughout downturns, large economic gains would thoroughly outweigh any short-term fluctuations. I’ll attach a paper that was written by Navya Khurana that I felt did a great job at both simplifying and explaining the aforementioned paper.

Expected Pushback to the 100% Equity Portfolio

In a piece written by Larry Swedroe of Morningstar, he outlined some of the flaws in this 100% equity approach. He mentioned that they weren’t taking into account the “risk-adjusted return”. This term simply means how much risk was taken on to receive a certain return. If investor A returned 10%, and investor B returned 8%, well you would say it’s better to be invested in what investor A invested in right? Well, what if investor A achieved that 10% return by risking a potential 50% drawdown, while investor B reached that 8% return by only risking 20% drawdown. You’d likely now say Investor B did better because he returned a slightly lower return but took on much less risk, which eventually may catch up to investor A. This is one of Swedroe’s main points, that the authors did not take into account risk properly, and focused solely on the return aspect of it.

He also argued that strong equity returns following World War II, and poor performance of bonds in the 1980s, gave the appearance that there was always an equity premium and stocks outperforming. However, if you looked back further, the opposite was true, where stocks either were on par with bonds or underperformed over a longer holding period, if you dated back further even to the Civil War era.

What to Make of All of This?

It should be noted that there are other options for diversification of assets and wealth, such as real estate or other cash-flowing assets.

Aside from that, I want to make it clear that there is no universally correct strategy for optimizing one’s asset allocation. Every person has different inputs such as different living situations, different retirement saving amounts, different risk tolerance, etc. What works for you or me may not work for the next person.

As technology improves and average life spans increase, we need more in retirement to account for the potential of a much longer retirement. In 1950 the average life expectancy was ~68, while today that number is ~79 (Macro Trends). Nobody wants to outlive their retirement savings they’ve built up.

The saying of “holding your age in bonds”, while not a bad strategy, may not be the most efficient anymore as economic environments evolve. I implore you to explore alternatives and dive into researching different strategies as there are far more than I’ve discussed here.

And if you didn’t take this away already, let me make it clear: the early years of your retirement are the most important. If you can have a cash flow where even if a market downturn occurs in those early years, it permits you to not be forced into selling assets while prices are depressed, and you pull from your other sources, that is extremely valuable.

The results of the strategy you choose will depend on if you stick to it and don’t change course due to external factors. By this I mean an equity heavy retirement portfolio means nothing if as soon as the market falls you decide to panic sell instead of continuing to hold. You must stick to the plan you choose and not diverge from that path.

Words From the Greatest Mutual Fund Manager in History

As a final word, I want to mention one of my favorite investors of all time, Peter Lynch. While I’ll have deeper reads on his work in the future, his feelings on bonds tie into this discussion neatly.

One of his most famous sayings was “In the long run, a portfolio of well-chosen stocks and/or equity mutual funds will always outperform a portfolio of bonds or a money-market account. In the long run, a portfolio of poorly chosen stocks won't outperform the money left under the mattress.” This remark, while funny, is also true. He pointed out that bonds can also be a risky proposition as long-term bond funds can drop 25-30%, and they include both inflation risk and interest rate risk.

The one piece where what Lynch did and what retirees do differ, was that retirees withdraw from this amount while Lynch didn’t, so he could hold through downturns. This is where a cash buffer comes in handy, as it can bridge you through withdrawing from your retirement until you are through the other side, without having to sell assets while they are low. Lynch knew that an investors behavior mattered just as much, which is why he stressed not panic selling.

My Personal Plan of Attack

As for me, I enjoy finance and all the nuances of it, as well as researching for good companies at value prices, so I aim to invest in companies that Lynch would as well. This means I’ll likely take the increased equity side of retirement, as I agree, that in the long-run, well-chosen stocks will outperform bonds, while poorly chose stocks won’t beat anything. And contrary to what many think, as Lynch would say, 20+ years of retirement is still long-term.

How do you plan to invest in retirement and what strategies are you exploring? Let us know down below in the comment section.

- Luke

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Sources

What Is Sequence-of-Returns Risk? (Charles Schwab)

Reducing Retirement Risk with a Rising Equity Glide-Path (Pfau; Kitces)

Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice (Anarkulova; Cederburg; O’Doherty)

Challenging Lifecycle Investing: The Case for an All-Equity Strategy (Khurana)

Should Long-Term Investors Be 100% in Equities? (Larry Swedroe)

The US dollar has been the backbone of global trade for nearly 80 years. It lies in central bank vaults as far as Tokyo, to Buenos Aires. Oil is priced in US dollars, and debt is denominated in it as well. When chaos hits, investors rarely run from the dollar, instead, choosing to run straight to it.

Most people miss the nuance though. Dominance is not the same thing as permanence. For example, the British pound once held the crown. Before that, the Dutch guilder. And if you think it can’t happen again, you are not paying attention to the flashing signals right in front of our faces.

The 3 Dollar Deaths

Let’s be upfront, the dollar has not collapsed. Not yet, at least. But it has come close enough that we should pay attention. Here are three moments where the dollar has stared into that dark abyss.

1971: Nixon Slams the Gold Window

In 1944, Bretton Woods pegged global currencies to the US dollar, and the US dollar to gold at a fixed price of $35 per ounce. It was a sweet deal, America printed the currency the world needed, yet every dollar was backed by gold. By the late 60s, that promise showed strain. The Vietnam War and Great Society programs ran up government debt, and foreign governments showed their reasonable uncertainty. Foreign entities began to question whether their dollars could actually be traded in for gold.

On August 15, 1971, Nixon answered that question with a resounding no. The gold window had closed, and with it, the dollar was no longer convertible to gold, transforming into a fiat currency, backed by nothing except trust.

Trust held, but the death certificate of the dollar began to form that day.

1979: The Dollar Falls Abroad

The 70s were a brutal time for the dollar. Oil shocks, wage price spirals, and a Federal Reserve failing to keep its reins on a ~13% inflation. But the real damage happening to the dollar was dealt overseas in foreign exchange markets.

By October of 1979, the DXY, which measures the dollar against a plethora of major currencies, fell to historic lows. The world was losing faith in the almighty dollar. Michael Blumenthal, the Treasury Secretary at the time, publicly talked down the dollar in efforts to boost exports, and markets took his words at face value.

Paul Volcker stepped in to slam the brakes. He jacked the federal funds rate above 20%, triggered a recession, and wrung inflation out of the economy by sheer force of nature. It worked, but make no mistake, without this intervention, the dollar’s decline would have become irreversible.

2008’s Financial Freeze

The 2008 crisis is remembered as a housing collapse, but at its core, it was a crisis of confidence in the dollar-denominated system itself.

When Lehman Brothers fell, the global interbank lending market seized. Banks stopped trusting each other’s dollars. The repo market froze, and with it, the financial markets. For a few terrifying weeks, nobody had an inkling of a clue if the dollar-based system would hold.

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The Federal Reserve responded in tandem by creating over $3.6 trillion in new money through quantitative easing. The system survived, but the message was clear. When push comes to shove, the dollar’s value is whatever the Fed says it is. That shows power, but conversely, shows fragility.

De-dollarization vs Dollar Hegemony

So why hasn’t the dollar fallen yet? The answer lies in hegemony, a fancy word for ‘everybody needs it, so everybody uses it.’

What is Dollar Hegemony?

Dollar hegemony refers to the US dollar’s dominant role in global trade, finance, and central reserves. Roughly 58% of global foreign exchange reserves are held in dollars. Oil, gold, and most commodities are priced in US dollars. When Brazil buys soybeans from Argentina, they often settle in dollars, even though neither country uses the currency.

This gives the United States an enormous advantage. We can borrow cheaply. We can sanction enemies by cutting off their access to our currency, and we get to run persistent trade deficits because the world needs our currency more than we need theirs.

The Push to De-dollarize

The cracks are showing. China and Russia have been settling bilateral trade in yuan and rubles since 2022. The BRICS nations have openly discussed creating alternative payment systems. Even traditional US allies like Saudi Arabia are now accepting yuan for oil.

Central banks are buying gold at the fastest pace in decades. In 2024, central bank gold purchases hit over 1,000 tons for the third consecutive year. This is not diversification, but rather a preparation for what’s to come next.

Here’s the catch though. Replacing the dollar is not that easy. The euro, yen, and yuan each have their own problems. Liquidity, convertibility, or trust issues, that make them imperfect substitutes for the dollar. The dollar’s network web effect is massive. Banks, business, and bond markets are wired to operate with the dollar at the helm.

The Tipping Point

De-dollarization is not about tomorrow. It is about momentum. Every sanctioned country that finds a way to avoid using the dollar, every oil deal settled in yuan, every ton of gold moved to a non-Western vault adds to the seeds of upheaval.

The dollar will not die with a bang. More likely, it will fade slowly, a reduced share of trade here, a smaller slice in the reserve there. And one day, we wake up and realize that the world has quietly reorganized itself around something else entirely.

What This Means for You

Most people honestly don’t think about currency risk because it is invisible. You get paid in dollars, you spend in dollars, so why worry?

A declining dollar implies declining purchasing power. Even if you cannot see it day to day, your savings will buy less on the global stage. It means that the safe assets you’ve been told to hold might not be as safe as you think.

Diversification is not just for stock portfolios. Consider foreign assets, real assets such as real estate or commodities, and yes, allocation towards gold is not a paranoid move to be warned against. Having your ducks in a row is not paranoia; rather, preparation in case of change.

The dollar has survived three near-death experiences. Survival is not the same as invincibility, and the fourth time might not be as forgiving as before.

How are you positioning yourself for currency risk? Let us know in the comments.

- Paul

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Data Sources

Currency Composition of Official Foreign Exchange Reserves (COFER), International Monetary Fund

World Gold Council — Central Bank Gold Reserves Survey

Federal Reserve History — The Great Inflation

Board of Governors of the Federal Reserve System — Quantitative Easing

Investopedia — Nixon Shock

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When money becomes nothing more than pixels and code, what exactly are we trusting? And on the flipside, who are we trusting to control it?

We currently lie in the midst of the most profound currency transformation since the death of the gold standard in 1971. Central banks are racing to build digital currencies. Commercial banks close branches by the hundreds, and cash is disappearing at an unprecedented rate. While most of us sleepwalk through it, the architecture of our financial world is being rebuilt beneath our very feet.

From Greenbacks to Digital

Let’s rewind. In 1862, the U.S. government printed the first greenback, a paper currency, unbacked by silver or gold, but by the full faith and credit of the United States. This concept was radical and controversial, yet it worked well enough that modern economies are built entirely around it.

The Long March to Plastic

For over a century, cash was king. You carried it, and you earned it. You hid it under your mattress if you didn’t trust banks. But then came the 1950’s, and with it, Diners Club cards, the first form of general-purpose charge cards. By the 70s, Visa and Mastercard were everywhere. By the 90s, you could swipe a card to buy groceries.

The shift was gradual at first, and then, sudden. Debit cards overtook cash for in-person payments in the United States around 2018. Then, COVID-19 hit, and what had been a slow transition, transformed into a stampede. Nobody wanted to touch physical money with a 5-foot pole. Stores stopped accepting cash entirely, and QR codes appeared on every counter.

The Mobile Wallet Takeover

Today, mobile payment apps such as Apple Pay, Google Pay, Venmo, Cash App, and more process trillions of dollars annually. China went even further with WeChat Pay and Alipay. These apps have essentially replaced cash as a form of payment for over a billion people. The People’s Bank of China estimates that 86% of all consumer payments are now digital.

Most people think this is just due to convenience. No more fumbling for loose change or keeping track of a bulky wallet. However, here is what most people miss: when every transaction is digital, every transaction is tracked. Not just by your bank, but by the app’s parent company, by data brokers, and by the government.

Cash was anonymous. Digital money maintains permanence.

Enter the CBDC

Now central banks want in on this action. A Central Bank Digital Currency, or CBDC, is exactly what it sounds like. CBDCs are digital currencies issued directly by a nation’s central bank, instead of commercial banks.

Over 130 countries, representing 98% of the global GDP, are currently exploring CBDCs in some format. China’s digital yuan is already in circulation in over 260 million wallets. The European Central Bank is in a preparation phase for a digital euro. The Federal Reserve, albeit moving more slowly, has made it clear that it is studying the plausibility of implementing a CBDC.

Here’s why it matters. Today, most digital dollars in your bank account are not dollars issued by the Fed. They are liabilities that your commercial bank promises to pay you if you ask for them. A CBDC would let the Federal Reserve issue digital money directly to you, entirely avoiding the need for commercial banks.

That changes everything about how the current banking system works, and raises its own questions that most people haven’t even considered asking yet.

The Strong Dollar Paradox

Now let’s talk about the weird parts. The US dollar, measured against other currencies, has been remarkably strong. The dollar index, DXY. that tracks the greenback against six major currencies, hit major 20-year highs in 2022, and has stayed elevated. By a traditional measure, the dollar has never been more powerful.

Strong Currency, Emptying Bank

But here’s the paradox: a strong currency does not mean strong money. It just means the dollar is winning a beauty contest between itself and currencies that are even uglier. The euro has energy problems, the yen has a debt-to-GDP ratio over 260%, and the yuan is not freely convertible. This makes the dollar look good by comparison, not necessarily great, but rather, due to the alternatives being worse.

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Meanwhile, the number of actual banks in America is collapsing. In 1990, there were over 15,000 commercial banks in the United States. Today, there are fewer than 4,500. That trend is not slowing down. Every month, another round of branch closures hits small towns or rural communities.

Why does this decline perpetuate? Due to banking being a volume business, and digital banking killing the economics of physical branches. When you can deposit your check from your phone, get mortgages from apps, why does a bank need a physical building?

The Unbanked and Underbanked

Here’s where it gets grossly uncomfortable. As banking goes digital, those who need physical access to financial services, such as the elderly, the poor, the rural communities, and recent immigrants, all get left behind. In 2023, approximately 6% of American adults, about 15 million people, were unbanked. Another 13% were underbanked.

A strong dollar does not help you if you cannot access a bank account. It does not help you if your nearest branch is 50 miles away and your phone cannot run the latest banking app. A digital revolution that excludes the most vulnerable is not a form of progress, but rather separation.

The Next Frontier of Programmable Currency

The scariest, or most exciting development in digital money is programmability.

Programmable money is currency with conditions built into the code. A government could issue stimulus funds that expire if not spent within 30 days, or welfare payments that can only be used for groceries. Tax refunds can be locked until certain dates even.

China’s digital yuan already implements these capabilities. Brazil’s central banks have tested conditional payments. The European Central Bank has acknowledged that a digital euro could include these programmable features.

The arguments in favor of this are compelling. Reducing fraud, ensuring aid is given to the right places, and speeding up monetary policy transmission are all possibilities. But the arguments against it should give you some pause. Do we want governments deciding when and where we can spend our money? Do we want every purchase catalogued and analyzed? Do we want financial exclusion weaponized against us?

What This Means for You

The digital money revolution is not coming; it is already here. The only question is whether you understand its implications before it understands you.

Cash will not disappear overnight. But, its role is shrinking every year, and with it goes the last truly anonymous form of payment most people have access to. The future is digital, which means that your future is tracked, programmable, and controlled by institutions that don’t always have your best interests at heart.

So what should you do? Diversify your financial relationships. Don’t put everything in one app or one bank. Pay attention to CBDC developments in your country, because the design choices made in the next few years will shape your financial privacy for generations to come.

Kids today believe money has always been numbers on a screen. In their lifetimes, this may be true. But what those numbers mean, who controls them, and what conditions come attached, is a fight that we are still resolving today. Do not lie idle through this transitional period.

Are you worried about the move to digital money, or do you think it is all progress to a more utopian future? Drop your thoughts in the comments below.

- Paul

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Data Sources

Federal Reserve Bank of San Francisco — Diary of Consumer Payment Choice

People’s Bank of China — Digital Currency Progress Reports

Atlantic Council — Central Bank Digital Currency Tracker

Federal Deposit Insurance Corporation — Bank Data & Statistics

Federal Reserve — Economic Well-Being of U.S. Households

European Central Bank — Digital Euro Investigation Phase Report

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But while the order is the same, the cost is not.

That same order, with the same (or less) amount of ice cream, now costs over $5. I call it highway robbery, but most people just call it inflation.

The Shiny Red Bike

Let’s create a hypothetical example with easier numbers for understanding.

5 years ago, you decided to put away $200 in your savings. At the time you put it away, you knew you could’ve bought a shiny red bike for exactly $200. After the 5 years had passed, you decided you wanted to buy that red bike, and you go to the bike store only to find out that the exact same bike now costs $300.

But what changed?

The bike is the same. The $200 you have is the same, or so it appeared. That $200 was physically the same as it was 5 years prior, but it was now worth less than it was before.

This is due to inflation.

Why Is Inflation Killing My Purchasing Power?

Inflation refers to the general increase in prices or the money supply, both of which can cause the purchasing power of a currency to decline. (Britannica Money)

But wait, what is purchasing power?

Purchasing power refers to how much money you can buy with a unit of currency; essentially, a measure of what your money is worth in terms of goods and services. (Investopedia)

These terms go hand in hand which is what most people miss. Many understand that inflation means prices going up, but they fail to understand the other side of the relationship where your purchasing power goes down.

Most of the time, it’s something that happens slowly over many years. The United States and many other foreign countries set their target at 2% annual inflation. So, let’s do some math to show this erosion of money that burns a hole in your pocket.

Below is a graph pulled directly from the Federal Reserve Economic Data (FRED), showing the loss of purchasing power from 1970 to 2025, using 1970 as the base index with a value of 100.

Imagine the index value in dollar terms. The indexes starting value of 100, means you have $100 in 1970. Move our attention to 2025, the index is at 12.1, or $12.10, representing an 88% fall in purchasing power. Wow.

$100 in 1970 is the equivalent of having $12.10 today. To put it another way, you’d need about $807 today to match the buying power of $100 in 1970.

I guess grandma really wasn’t kidding about those 10-cent candy bars!

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Your Wallet Is Feeling It at the Grocery Store

Here's the catch with inflation: just because it's slowing, it doesn't mean prices are coming down. The damage has already been done.

Think of it this way, if your $100 grocery bill jumps 10% in a year, you're now paying $110 for the exact same cart of food. When inflation cools back down to 2% the following year, that 2% isn't applied to the original $100. It's applied to the new $110. Prices don't rewind. They just climb from a higher starting point.

In this graph what we’re seeing is grocery prices from January 2021 to March 2026. January 2021 is where the index is based at 100, and again we can think of this in dollar terms. In 2021, every $100 we spent on groceries now costs us $126.10 to buy that same basket of goods. That’s about a 26% increase overall.

No wonder your checkbook feels it at the grocery store.

Not the 70s Again

Some of the worst inflation ever seen was in the 1970s. While we average around 3% annually in the United States, we have had a few brutal periods where it exceeded that.

During the 1970s, inflation surpassed 13% at its peak. This period from the 1970s to the early 80s is known as the Great Inflation

Since that period, we’ve had mini flair ups in inflation, but nothing major until Covid in 2020-2022 caused inflation to surge over 7%.

Argentina and Friends Would Like a Word

13% inflation is way too high, but by no means the worst that has ever been seen around the globe, just ask Argentina. In recent years their annual inflation has repeatedly surpassed 100%, which means prices were doubling within a single calendar year.

This is known as hyperinflation.

Hyperinflation refers to a situation where a country experiences a dramatic and rapid increase in prices, severely weakening the currency's value and disrupting the economy. (Investopedia)

Turkey, Venezuela, and Zimbabwe have all experienced periods of hyperinflation so severe that their currencies became functionally worthless.

In Zimbabwe's most extreme episode (the height to which inflation reached has been the subject of debate), inflation peaked in November 2008 at 89.7 sextillion percent annually (Cato Institute), meaning prices were doubling every 24.7 hours. Not every year. Not every month. Every single day.

The government's response was to print a hundred-trillion-dollar bill that still couldn't cover basic groceries. By that point, one U.S. dollar was worth over 2.6 billion Zimbabwean dollars. Americans were watching the financial crisis unfold on the same news cycle. The U.S. hitting 9% inflation felt like a gut punch, meanwhile Zimbabwe was staring down the barrel of inflation that was unheard of.

Don’t Keep Cash Saved Up or in A Checking Account

If you’re storing all your cash under the mattress or in the closet at home because you don’t trust banks, or for whatever reason, don’t. While you think you are saving money, you’re actually guaranteeing yourself a loss in real purchasing power. That $10,000 you saved up over the last years, isn’t actually worth $10,000 anymore, since it won’t by the same amount of goods it would’ve 10 years ago.

And if you keep all your savings in a checking account, well that’s not much better. Checking accounts pay almost nothing on your money, and with inflation averaging around 3% annually, you’re still losing purchasing power.

Most people don’t save much to begin with since the personal saving rate, which is the percentage of income people set aside for savings, is ~4%, which is actually lower than the pre-Covid average. Then the little that they do save is being eroded by inflation since the majority of those savings rest in checking accounts. You can see below that overall saving has gone down significantly from what it was before the 1980s.

So, what should you be doing with your money?

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Well, we know checking accounts are a no go, although let’s make it clear that some money in here is okay because you do need to pay for daily and monthly expenses.

There is a High-Yield Savings Account (HYSA), which currently is paying ~3-4% Annual Percentage Yield (APY) depending on a few factors. And they are FDIC insured and liquid, meaning it isn’t hard to withdraw that money if you needed it. They can be good places to keep an emergency fund (which everyone should have).

Then there’s Treasury Bills (T-bills). These are backed by the full faith of the US government and are considered the “risk-free” rate. T-bill interest is exempt from state and local income tax while HYSA’s are fully taxable. T-bill unlike HYSA’s though is not as liquid and have a fixed maturity, so if you need the money before maturity you have to sell it on the secondary market. The rate on a T-bill locks in the rate at purchase while the HYSA fluctuates with the Fed, which gives an advantage to both in certain environments.

Ever heard of I-Bonds or TIPS? Most haven’t and that’s ok. They’re both issued by the US government and created to protect your money from inflation. The “I” in I-Bond stands for inflation, and TIPS stands for Treasury Inflation Protected Securities. I-Bonds are simpler, your return adjusts every 6 months with the Consumer Price Index (CPI), and your principle is always protected. The downside of I-Bonds is the cap of $10,000 per year and you can’t touch the money for at least 12 months. TIPS on the other hand, are similar in design, but they trade like any regular bond through brokerages, there is no purchase cap, and you can sell them at any time. Neither of them is meant to be a wealth builder, but the point is if you are going to have cash laying around or in a checking account, you might as well earn something to keep up with the erosion that inflation is causing.

Finally, there is Investing. Historically the S&P 500 returns ~10-11% annually on average. This is where wealth can begin to be built. The other options keep you afloat just enough to survive the destruction of inflation, but investing can build true wealth. Those short-term accounts still have their purpose, but they serve no real use for long-term money. They preserve minimum value, but they don’t fund growth. When inflation historically runs ~3% annually, and the market averages ~10-11%, then you’re gaining a spread of ~7-8% on your money, truly growing.

The key point is this:

When your money is stashed away, it’s not just sitting still and holding value, it’s actively shrinking in value.

Is It Just Me, Or Did the Candy Package Get Smaller?

This is a common phenomenon termed shrinkflation, where companies hide price increases in smaller packaging. The price is the same, but there’s less product. Think of a bag of chips that used to contain 16 ounces now weighing 13 ounces. Many notice it, either consciously or subconsciously, questioning if they’re crazy or if it’s really smaller. This is a sneaky tactic companies use when they face rising costs that also lowers your purchasing power.

Stop Losing and Start Doing

The best way to structure it would be keeping a certain amount of money in short-term vehicles and the rest in long-term investments. Which vehicle to use depends on how much liquidity you require.

Your checking account should hold what is necessary for everyday purchases and monthly recurring bills like rent or utilities. Past that, keeping money in a HYSA, T-bills, I-Bonds, TIPS, or another short-term vehicle is your best bet to preserve your money.

The money you plan to build wealth and save for the future on a long-term scale, should be invested. There are so many different avenues for investing long-term, but it can be as simple as parking your money in an ETF such as SPY which tracks the S&P 500 or QQQ which tracks the Nasdaq-100 Index, and will return those average ~10-11% annual returns (remember past returns are not always indicative of future performance). But for those who are savvier and want to try their hand in picking their own investments, the markets are a good learning place.

Taking into consideration the dollar losing 88% of its value since 1970, this isn’t something you should take lightly, especially when planning for the long-term.

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What are some things you look for in a stock investment or how do you protect yourself against inflation? Let us know in the comments!

- Luke

Data Sources

Consumer Price Index for All Urban Consumers: Purchasing Power of the Consumer Dollar in U.S. City Average

Consumer Price Index for All Urban Consumers: Food at Home in U.S. City Average

Inflation, consumer prices for the United States

CATO Institute

Personal Saving Rate

The US dollar got its start over 200 years ago, in 1792. Before that point the American colonies had used Spanish silver dollars and colonial currency like the Continental Dollar, among other things.

The Continental Dollar actually has an interesting storyline behind it, an early story of hyperinflation. The Continental Congress issued Continental Currency to fund military expenses for the American Revolutionary War. If you’ve ever heard the term “not worth a Continental”, this is where it comes from. They began issuing this paper currency, Continentals, which had no backing aside from a promise of future tax revenue, in 1775. By 1781, they it lost about 99% of its value, rendering it essentially worthless.

The US Dollar Gets Its Beginning

It all begins with the Coinage Act of 1792, which not only created the US dollar, but also established the first US Mint in Philadelphia to produce coins.

The dollar was set to 371.25 grains of silver so that it matched the Spanish milled dollar since that was the most trusted coin already in circulation. They wanted to anchor the currency to one that already had trust in it.

The system wasn’t just silver though, it was bimetallic, with gold coins minted alongside silver at a fixed 15:1 ratio. This quickly led to major problems though. When market prices drifted from that ratio, people would melt down whichever coin was undervalued and sell the metal. As a result, gold coins disappeared from circulation almost immediately as it was slightly undervalued at current world prices with the 15:1 ratio. When the Coinage Act of 1834 adjusted the ratio to 16:1 to try and account for this drifting of the ratio, it then caused the same problem in the other direction, leading gold to be overvalued and silver to be drove out.

Behind the system was a philosophical war being waged between two founding fathers, Hamilton and Thomas Jefferson. Jefferson pushed for the decimal structure we still use today but opposed nearly everything else Hamilton was building.

Hamilton vs. Jefferson: The Battle Over Money

These two argued constantly, disagreeing on almost everything. But by far, the biggest disagreement always befell on the topic of money.

Hamilton believed it was necessary to have a strong national currency and central bank in order to make America a genuine economic power. He championed for the First Bank of the United States to be chartered. To him a nations financial credibility is where its power lied, as a country that cannot borrow and has unstable currency cannot win wars nor attract investment.

Jefferson, however, was a major skeptic of banks and paper money, believing that they were tools of elite manipulation that would concentrate both wealth and power to the few in banking, leaving ordinary citizens as forever debtors, destroying their independence. Paper currency required one to have trust in someone or something, which he did not have. Because of this lack of trust, he argued that real money was metal because it had intrinsic value and didn’t rely on the promise of another. To him, America should be a nation of farmers who own their own land, did not have to answer to anyone, and lived without the need for bankers.

Hamilton would win the battle in the short term, but Jefferson's fears would prove to have some validity, as the First Bank of the United States would lose its charter in 1811. Following that, the Second Bank would be destroyed by Andrew Jackson in the 1830s, leaving the United States without a central bank until the creation of the Federal Reserve in 1913. Jeffersons fears still to this day resonate with many.

But let’s look deeper.

The Free Banking Era (1816–1863)

Jackson had the same fears as Jefferson, that the Bank was corrupt and held a monopoly, serving the elites and foreign investors at the expense of ordinary Americans. When Congress approved the recharter bill in 1832, he vetoed it, and incredibly, was so proud of it, that he had his tombstone read, “I killed the bank”. This is consequentially what gave way for the chaos of the Free Banking Era that ensued.

Beginning towards the end of the 1830s, states passed “free banking” laws, which allowed essentially anyone to charter a bank. This further allowed these banks to issue their own paper banknotes, which would be backed by the state bonds they held. If you recall, paper banknotes was one of Jeffersons primary concerns due to the requirement of trust, which would prove costly very soon.

The quality of the bonds would vary greatly from state to state, and because the bonds were the backing for the paper banknotes, this meant that the reliability of the banknotes varied just as much. This created a major issue: a dollar issued by a bank in one state may be worth significantly less than one issued in another, or entirely worthless if the bank had already failed, as many did. This gave life to a new job, titled “banknote reporters”. They would update publications that listed all the currency discount rates for notes across hundreds of banks. But another issue also arose: counterfeiting. Counterfeit detection guides began to be sold alongside the reporters, and this meant that almost any merchant kept both the banknote reporters’ publication of currency discount rates and counterfeit detection guides on hand at all times.

Then it got even crazier. If you’ve ever heard the term “wildcat banking”, this is there era the term was coined from. “Wildcat banks”, which got their names because the areas they operated in were so remote that it was said only wildcats lived there. This meant that for a noteholder to actually show up for redemption of silver and gold, it would be nearly impossible. Knowing this, these banks would issue far more notes than they could back, collecting real goods in exchange, and then disappear without a trace before anyone came looking for their redemption. It was fraud. This is where you would look to the state regulators, but at this point in time corruption was running rampant.

It was actually very common for a bank to fail, which is quite scary to think about. Imagine you have all your money at a bank and all of a sudden that bank fails, and you have nothing left. When these banks failed, that meant all the notes they issued were rendered worthless. And just as Jefferson feared, it was often the ordinary Americans who had accepted these notes and lost everything that was tied up in them. There was no such thing as deposit insurance, like we have now with the Federal Deposit Insurance Corporation (FDIC). In just one night, your savings could become worthless.

But while Jeffersons fears came true, there was an irony to whole thing. Ordinary Americans did become the ones who were oppressed, but not due to the centralized financial power that Hamilton wanted that Jefferson feared, but because of the decentralized financial power that Jefferson wanted. Under this decentralization, ordinary Americans remained oppressed, but there was no accountability whatsoever. At least under Hamiltons centralized bank the bank had to answer to Congress. Under decentralized power, the wildcat bankers answered to nobody, meaning they faced no repercussions while they defrauded the average American.

The Panic of 1857 set off a wave of bank failures that bankrupted many ordinary Americans who had accepted their banknotes which were now worthless. Without going too deep into it, the panic was set off by the collapse of the Ohio Life Insurance and Trust Company. It was a large financial institution that had massively overleveraged itself through bad loans and speculation (we’ve seen that before) on railroad construction and the export business to Europe. This was such a trigger due to the interconnectedness of the financial system at this point in time. Questions of solvency wrang loudly due to the collapse. The system was extremely fragile, but yet it would still take something as big as the Civil War for the government to put an end to the chaos and take control of the American monetary system.

The Greenback & the Civil War Period (1861–1879)

Wars are expensive, and this created a major problem for the federal government who didn’t have enough to gold to afford one in 1961. With the traditional methods of borrowing being too slow, Congress created the Legal Tender Act of 1862, which authorized the Treasury to print paper money backed by nothing other than the governments promise to repay it, similar to today. This trust is exactly what Jefferson was so worried about.

This paper money was termed “Greenbacks” because of the green ink that was printed on the back. It was a landmark moment in American history, marking the first time that the federal government had issued a fiat currency where it was declared as legal tender, which meant it was legally required to be accepted by both businesses and creditors regardless of whether they trusted its soundness or not.

The government printed hundreds of millions of dollars in Greenbacks to finance the Civil War, which many people were skeptical of due to its value being based on trust, not intrinsic value, which many didn’t trust it at all. This caused the value to fluctuate greatly based on who was winning the war at any point in time.

After the war eventually concluded and the Union won, there was still the problem of what to do with all the paper money that was still in circulation. The two sides are the same two sides to this day that battle over monetary policy: creditors and debtors.

The creditors wanted the Greenbacks to be retired and a return to gold because debt becomes more valuable under a deflationary environment. Put simply, deflation makes money worth more over time, so hard money is beneficial if you're the one who owns it because it causes deflation since it limits how much currency can exist. If you lend $1,000, you get $1,000 back that buys more than it did when you lent it. So, it comes down to purchasing power, which today too many people overlook, and they only look at nominal figures.

The debtors on the other hand, wanted Greenbacks to be kept in circulation and actually be expanded as it would devalue the currency, meaning the money they owed would be worth less, therefore easier to pay back. Inflation erodes debt. In other words, they wanted the government to print more money, which if there is more money it means that each dollar will buy less of the same amount of goods, since the currency supply is increasing, pushing prices up and the value of the currency down, which is called inflation. If you borrowed $1,000, you still have to pay back the $1,000, but if inflation is high then the amount you have to pay back will buy less than it did when you originally lent it, meaning it was cheaper to borrow than if deflation was present. Again, this is why purchasing power is so important.

In the end, the hard money advocates would win, and the government would return to a gold-backed foundation by exchanging Greenbacks for gold by 1879 through the Resumption Act of 1875. This decision, however, would lead to the famous Populist Movement in the 1890s, due to the many farmers and debtors who were against it, and watched as their livelihoods continued to deteriorate.

The Rise of the Gold Standard (1879–1933)

From 1879, every dollar was backed by gold and was redeemable at any bank for 1/20.67 of a troy ounce. It created real price stability, but when the economy contracted there was no flexibility. The money supply couldn’t expand to cushion the fall since you couldn’t just print more gold, and ordinary Americans had to bear the worst of economic downturns that lasted longer and were much harsher due to the tightness of the money supply.

The pushback came before the gold standard even fully took hold. During the 1875–1879 transition period, farmers, debtors, and silver mine owners in western states saw what was coming and formed an unlikely coalition, the silver coalition.

Farmers wanted silver coinage to inflate the money supply and ease their debt burdens while silver miners, whose massive new deposits had flooded the market and crashed silver prices, wanted the government buying their metal at guaranteed prices. Together they had enough political weight to pass the Bland-Allison Act of 1878, even as President Hayes’s vetoed it. This act required the Treasury to purchase $2–4 million of silver every month. At first glance it seemed as though the farmers and miners had won, but such was not the case. The Treasury bought the minimum amount of silver every time making the benefit of these silver purchases negligible.

This only made the outrage grow. Eventually the Sherman Silver Purchase Act of 1890 would be passed, which mandated even larger silver purchases, 4.5 million ounces of silver each month to be exact, as well as paper notes to be issued that were backed by it. These notes, however, were still redeemable in gold at the Treasury’s discretion. This led to a problem: The silver was being piled up but gold was still being demanded for redemption. This “compromise” satisfied nobody as the silver coalition was upset at the limited silver purchase amount, and foreign investors became wary of the situation as if more silver came into the system, they feared the US could abandon gold. This led them to redeem dollars for gold, which helped trigger the Panic of 1893. If the US abandoned gold, their dollar denominated assets would be worthless, so they got out before that could happen. Gold reserves nearly ran dry because of this foreign capital flee.

But how could gold reserves run dry if they weren’t printing paper in excess of the gold reserves? Because it wasn’t a pure one dollar issued for one dollar of gold held. It was more complex than that. They were issuing more paper claims than they had gold to back it, through a mix of Greenbacks still in circulation not fully retired by the government that didn’t have a 1:1 gold backing, silver notes that that were backed by silver purchases but were being issued by an asset (silver) that was worth less than the gold it was supposed to be redeemable for as silver continued to lose value relative to gold, and bond backed currency which were notes issued by national banks that were backed by government bonds instead of gold directly. You can see how this gets kind of complex.

The assumption was not everyone would need their gold at the same time, so even though there wasn’t enough gold to back full redemptions, it was an invisible issue as long as confidence was strong and everyone didn’t try and redeem all at once. But as soon as there were cracks in confidence, people would rush to redeem for gold simultaneously, and what the bank held on hand wasn’t enough to satisfy redemptions. This is the same idea of how a bank run works. JP Morgan had to personally organize a private bailout of the US Treasury.

The bailout was organized by Morgan but was a syndicate including the Rothschild banking family. They sold the Treasury 3.5 million ounces of gold in exchange for 30-year government bonds. Morgan then used his massive influence over financial networks to slow the rate of redemptions, preventing further redemptions just long enough for confidence to return.

While it did work, it had implications. President Grover Cleveland had to secretly meet with a Morgan at the White House and essentially had no other choice but to accept his terms immediately. A single man had bailed out one of the most powerful countries in the world.

After the Panic of 1893, President Cleveland convinced congress to repeal the Sherman Silver Purchase Act of 1890, as he blamed it for being the reason foreign investors got spooked in the first place. This was a major loss for the silver coalition.

But the US Treasury’s bailout gave the silver coalition the perfect argument. The gold standard, which was supposed to be a trustworthy system with hard money and free of manipulation, upon its breakdown, had been saved by a single person who saved it not out of kindness, but because he realized a tidy profit from it as the government had no cards to play and was forced to accept.

Jefferson warned about this. While he did want hard money, he would’ve despised the central bank and paper banknotes.

William Jennings Bryan, who won the Democratic nomination but lost the presidential election in 1896, argued that tying the dollar to limited amounts of gold while ordinary Americans suffered was a moral crime. He became the face of the soft currency movement. He lost to McKinley due to massive financial backing by Eastern banking and business interests, as well as new gold discoveries in the 1890s which allowed the money supply to expand without the need for silver, therefore relieving deflationary pressures. Bryan would run a total of three times, losing each time.

The Federal Reserve is Born & the Beginning of the End for Gold (1913–1933)

As is typical, history repeated itself in 1907. In almost exactly the same fashion, the Panic of 1907 again required JP Morgan to come to the rescue. To make a long story short, multiple trust companies collapsed after attempting to corner the copper market and failing miserably. These trust companies operated like banks but with far less regulations and without the emergency reserves, which you can see how that might be an issue. Bank runs began to show up again, credit came to a halt, and the Treasury had to physically ship gold between cities to stop the bleeding.

Just as in 1983, foreign investors began redeeming dollars for gold, but this time not out of fear of abandonment of gold, but out of fear for general financial instability, so they wanted the stability of gold in a panic. 1893 was about confidence in the system itself decaying, whereas 1907 was about confidence in financial institutions wearing thin.

When Morgan once again stepped in, he forced New York’s major bankers to pool resources in order to stabilize the system. Morgan alone decided which institutions were worth being saved and which ones weren't. While it worked, it finally made the US realize it needed an institution to do what JP Morgan was doing, without having to rely on the willingness of a single private individual.

It was from here that The Federal Reserve Act of 1913 created the Fed, a system of 12 regional banks with a Board in Washington. The dollar would remain gold-backed for now, but the Fed now had the capability to act as a lender of last resort. This meant that banks in trouble could borrow from the Fed instead of waiting for a private banker like JP Morgan to save them.

Not long after came the Great Depression, which gave the Fed a serious test. The stock market was crashing, unemployment was going through the roof, and those who still had any savings were fearful of losing it. This led to many Americans trying to convert their paper dollars into gold, leading to a similar dilemma to what we saw in 1893, except this time the system failed. The country became plagued with bank runs in the early 1930s. Many of these banks failed as a result of not being able to meet demand for gold redemptions. In total from 1930-1933 over 9,000 banks failed, wiping out $7 billion in depositors’ assets, with deposit insurance being non-existent at that time.

FDR acted immediately after taking office, signing Executive Order 6102 on April 5, 1933. The order made it illegal to own gold, with few exceptions. Anyone holding gold was required to turn it into the Federal Reserve at $20.67 per ounce.

The government couldn't expand the money supply if people could still exchange dollars for gold, so by forcing citizens to turn their gold in it automatically made the money supply expand since they now had more gold in the reserve to create paper dollars. Many argue this was a necessary condition for ending the Great Depression.

The following year, the Gold Reserve Act of 1934 reset the official gold price from $20.67to $35 per ounce. The impact on the dollar was immediate. Since gold increased 69% in dollar terms, each dollar now bought significantly less gold, translating to roughly a 41% devaluation of the dollar relative to gold overnight. In nominal terms, a dollar that had been worth $1.00 in gold value was now worth about $0.59.

This also handed the government an instant profit. Gold collected at $20.67 was now worth $35 on the books, with the difference on every ounce going straight to the Treasury, helping fund FDR's New Deal programs. The New Deal was an enormous package of government spending designed to pull the country out of the Depression, and while the gold revaluation funded a significant portion of it, the government still had to borrow heavily to cover the rest.

At this point the dollar was effectively fiat currency for ordinary Americans because it was paper you couldn't personally redeem for anything tangible. But the government maintained one exception for foreign governments and central banks so they could still exchange dollars for gold at the $35 rate. This kept the dollar credible internationally, giving other countries confidence to hold dollars as reserve assets knowing redemption was still available to them. That arrangement would remain until 1971.

Bretton Woods and a New World Reserve Currency: The Dollar (1944–1971)

With WWII was still actively being fought, in July 1944, representatives from 44 Allied nations met at the Mount Washington Hotel in Bretton Woods, New Hampshire. The task at hand was the world needed a new monetary framework to rebuild around. After the war, the US was essentially the only major economy that was still standing, and it held the majority of the world's gold reserves. At this point, the dollar was the only currency anyone had trust in. Because of this, the world decided to peg itself to the dollar, meaning every participating currency pegged itself to the dollar at fixed exchange rates, while the dollar itself remained pegged to gold at $35 per ounce. Out of this agreement came the establishment of the IMF and World Bank to manage the new system that was put in place, and to lend aid to economies that were under economic stress and hardship.

This new tie to the US Dollar of so many other currencies around the world was a major advantage for the US. The majority of global trade was priced in dollars, much of foreign reserves were kept in dollars, commodities were priced in dollars. Essentially if you wanted to participate in the global economy you had to use dollars to do it.

Being the world’s reserve currency allows you to have a few privileges that other countries don’t have. You have the ability to run deficits, print dollars, and export inflation to the rest of the world. This works because no matter how much money the US prints, there is always global demand for them because it is tied to everything. If a small country printed money like this, investors would flee as inflation would rise potentially rapidly. When the US prints money the rest of the world absorbs it because they need them for global trade. The term economists use for this power is exorbitant privilege.

President Nixon and the End of a Gold(en) Era (1971)

Less than 20 years after that meeting in New Hampshire, the Bretton Woods Agreement was showing signs of distress. As we mentioned was a benefit of being the world reserve currency, the US had been running huge deficits to finance the Vietnam War and spending programs domestically. They didn’t have the gold to support this spending, so they were printing a lot more dollars than the reserves of gold they had. Beginning with France under De Gaulle, central banks began to aggressively redeem dollars for gold at the $35 per ounce rate it was pegged at. As this accelerated, it sped up the draining of the US gold reserves. This was becoming a repeat of the prior panics, but this time it was on a global stage, not domestic.

Then Nixon went on tv on August 15, 1971, to announce that the US was temporarily suspending its commitment to convert dollars for gold effective immediately. And while he claimed it was only temporary, as a way to slow the pace at which gold was being redeemed by foreign governments so confidence could be restored, it would end up being permanent. This would mark the start of the US Dollar as a fully fiat currency both domestically and internationally. And just so it’s understood, fiat currency is money that the value relies on trust of the government. The government declares it as legal tender and the citizens “accept” it. It isn’t backed by anything tangible, only the faith of the government issuing it.

This decoupling of the dollar and gold (those farmers from a century before sure would be happy now), caused the dollar to devalue sharply. It marked a turning point in global economics, as the world shifted to floating exchange rates in 1973. Many expected the dominance of the dollar to weaken or collapse, but to their surprise, it didn’t. From this, a new system emerged, the petrodollar.

The US, primarily Henry Kissinger who was Nixon’s Secretary of State and William Simon who was the Treasury Secretary, traveled to Saudi Arabia and negotiated in secret with them and OPEC (Organization of the Petroleum Exporting Countries). The terms of the deal were the US would provide Saudi Arabia with military protection, security guarantees, and access to American weapons and equipment. In return, Saudi Arabia would price all oil sales exclusively in dollars, as well as funnel their surplus oil revenues, which were petrodollars, back into US Treasury bonds, which effectively lent the money straight back to America.

It wasn’t long before the rest of OPEC was under the same arrangement. Saudi Arabia was the dominant player in the cartel, so once they had committed to dollar pricing, it didn’t take long for the others to follow. In only a span of a few years, almost all global oil trade was denominated in dollars.

This arrangement was strategic and calculated. It not only established a new source of global demand for dollars that the gold standard had once provided, all without needing a single ounce of gold backing it. Almost every country on earth needed to import oil, and they needed US dollars to do pay for it. So regardless of what the US was doing monetarily, there was global demand for the dollar.

20% Interest Rates and the Dollar's Second Wind (1979-1987)

When gold was finally completely cut from the dollar, the combined effect with oil shocks in 1973 and 1979 caused inflation to rage out of control. The 1973 oil shock was caused by an Arab oil embargo that lasted 5 months, which caused crude oil prices to skyrocket and quadruple until the Iranian Revolution created the second crisis in 1979, which tripled the cost of oil. In 1979, inflation pushed just shy of 15%, which meant the dollar was losing over 1/10 of purchasing power every year.

This culminated a new term, stagflation. This meant a combination of high inflation and a stagnant economy that many economists believed simply couldn’t occur.

In 1979, Paul Volcker would be appointed as the Fed Chair by President Jimmy Carter. He would remain as the Fed Chair through President Ronald Reagans time as president. Volcker viewed the situation as a serious one, where the only way to get back to long-term prosperity was to have short-term pain. In June 1981 he would raise the federal funds rate to a peak of 20% to try and break inflation. The results were devastating in the short-term, as Volcker essentially engineered a recession to stop inflations rampage. Businesses failed and unemployment surged.

But the long-term results spared him from the short-term verbal abuse he had faced. By 1983 inflation collapsed from its peak of around 13.5% to around 3%. This was a major turning point for the dollar as it showed the world that a dollar that had once held credibility due to a tangible material, gold, could also hold credibility due to institutional discipline. This was the Fed’s willingness to do what was painful, but necessary in order to restore faith. This built trust and stabilized the dollar.

Even to present day, this is what holds the dollar together. There are no ties to gold, oil, or anything tangible, only the Fed's credibility and the global consensus that it will do whatever is necessary to defend price stability and keep inflation at bay. If that belief ever disappears, the dollar's foundation disappears with it. This is why you’ve likely heard about the Feds independence and inflation credibility in the media as it is one of the most scrutinized variables in global finance and economics.

The Dollar Today: Dominant but Not Untouchable (1980s-Current)

The dollar has remained as the world’s primary reserve currency since the 80s. Approximately 56% of global foreign exchange reserves were held in dollars as of mid-2025. And on top of that, the majority of global trade, commodities, and international debt are still dollar denominated.

Pointing back to the power that a country gains by having the world reserve currency, it also allows the US to weaponize access to the dollar through financial sanctions. After the Russia invaded Ukraine in 2022, the US froze Russia's dollar reserves. This was a wakeup call for many countries, as it showed to all the countries who held dollars that the access to it could be revoked at any moment. This caused nations that weren't already thinking about alternatives, like China, to begin looking at alternatives.

And perhaps one of the most often discussed topics, the US national debt, has climbed to over an astonishing $38 trillion, which has raised credibility concerns in the long-term. With competition from digital currencies like Bitcoin and other countries like BRICS (Brazil, Russia, India, China, South Africa) nations who are trying to build systems that allow trade in local currencies, the dollar is facing new competition it hasn’t seen before.

In Trust We Dollar

The dollar’s journey to becoming the world’s dominant fiat currency is one full of mistakes, panics, and constant change. But it all ties back to one thing, trust. Belief in the dollar has survived wars, depressions, political crises, and complete reinventions of the monetary system itself. The question of whether that belief holds is one the entire world, specifically central bankers and foreign governments, are watching closely. And while the dollar remains dominant, for the first time since Bretton Woods in 1944, that dominance is facing challenges from multiple directions.

- Luke

The USD has been the world’s dominant reserve currency for nearly eight decades. This status shapes everything from interest rates on your mortgage, to prices at the gas pump. Despite recurring predictions of the decline of the USD, the dollar compromised 57.74% of global foreign exchange reserves during the first fiscal quarter of 2025. (COEFR) Additionally, the USD appeared on at least one side of 89.2% foreign exchange transactions worldwide, according to the April 2025 Triennial Central Bank Survey.

This article aims to examine what a reserve currency is, how the dollar achieved this status, maintains this status, and the concrete benefits it delivers to the American household. Furthermore, we will address the growing challenges from rival currencies seeking to diminish the power of the USD, and how history can teach us about how transitioning between reserve currencies unfolds. Preliminary evidence suggests that while the dollar’s share of global reserves has gradually declined from a peak of 72% in 2001, there are currently no viable alternatives to replace it in the near or medium term, and the structural advantage of the USD as a reserve currency remain formidable challenges for successors to surmount.

For the average American, dollar dominance translates directly into lower mortgage rates, cheaper imports, greater purchasing power abroad, and immunities from currency crises that periodically devastate emerging economies. Understanding these mechanisms is a critical asset to financial literacy for anyone who earns, saves, spends, or invests in dollars.

What is a Reserve Currency?

To understand the reserve currency system, we must first establish an understanding of the fundamental mechanisms that drive international trade. For example, when a German manufacturer sells machinery to a Brazilian buyer, neither party necessarily wants to receive the other’s domestic currency. The Brazilian real may be difficult to convert in Frankfurt, and the euro may be equally as unwelcome in Sao Paulo. Instead, both parties prefer to transact in a currency that is universally accepted, highly liquid, and most importantly, stable in value. Historically, this role has been filled by a small handful of currencies, with the dominance of the U.S. dollar beginning post World War II.

According to the International Monetary Fund, reserve assets are external assets controlled by monetary authorities that are readily available for meeting balance of payments financing needs, intervening in exchange markets to affect currency values, and serving as a basis for foreign borrowing. The IMF identifies a few key criteria for a currency to qualify as a reserve currency. These are as follows: The size of the domestic economy must be of a certain threshold, the importance of this economy within the international trade landscape, the size, depth, and accessibility of financial markets, the convertibility of the currency, the use of the currency as a foreign exchange peg, and the stability of the macroeconomic environment and policies of the currency. The U.S. dollar scores highly on every single one of these necessary metrics.

Functions of Reserve Currencies

A reserve currency aims to perform three critical functions within the global economic landscape. First, it serves as a medium of exchange. This means it facilitates international trade and financial transactions. The dollar’s dominance in this role is staggering. According to the European Central Bank’s June 2025 report on global trade invoicing patterns, the U.S. dollar and Euro together account for over 80% of global trade invoicing, with the dollar remaining as the dominant vehicle currency for trade between countries that do not involve the United States directly. The dollar’s share of exports invoiced far exceeds the share of exports that are destined for the United States, which is the defining characteristic of vehicle currencies.

Secondly, a reserve currency serves as a unit of account. This implies the reserve currency acts as a common denominator for the pricing of commodities and financial instruments. Oil, gold, and most internationally traded commodities are priced in dollars. This convention means that when the dollar strengthens against other currencies, commodities become cheaper for Americans while borrowing becomes more expensive for everyone else. The SWIFT global payment network reported in December 2025 that the dollar’s share of global payments reached 50.5%, it’s highest level since 2023.

Third, a reserve currency functions as a store of value. This means the reserve currency is a safe asset that governments and institutions can hold with confidence that it will retain its purchasing power over time. The U.S. Treasury market, with roughly $900 billion in daily transactions, and status as the deepest and most liquid government securities market in the world, serves as the primary destination for central bank reserves. As former Federal Reserve official Nellie Liang noted in November 2024 remarks, the Treasury market serves critical functions: financing the government at the lowest cost to taxpayers, providing the benchmark risk-free yield curve for global markets, underpinning the dollar in global transactions, and serving as a key source of safe and liquid assets for investors worldwide.

The History of Dollar Dominance

The story of dollar dominance begins in July 1944, when 730 delegates from 44 allied nations gathered in Bretton Woods, New Hampshire to design the post-war international monetary system. The conference, primarily shaped by the competing visions of American Treasury Harry Dexter White and British economist John Maynard Keynes, produced an agreement that would fundamentally reshape global finance. The delegates created the International Monetary Fund and the World Bank, establishing a system of fixed exchange rates solely anchored to the U.S. dollar, which itself was convertible to gold at $35 per ounce.

This Bretton Woods system gave the dollar a privileged role because the United States held approximately three quarters of the world’s monetary gold reserves at the end of the second World War and produced roughly 40% of global gold output. Other countries then fixed their currencies to the dollar, and the United States promised to redeem foreign central bank holdings of dollars for gold at the fixed $35/oz rate. As the Federal Reserve History project documents, this system made the dollar the main intervention currency, and, by extension, the dominant reserve currency. Countries accumulated dollar assets to defend against exchange rate pegs from speculative attacks, and dollars entered foreign holdings through U.S. aid programs and through the simple act of exporting goods and services to the United States.

Nixon Shock and Petrodollar Era

The Bretton Woods system functioned with mixed results through the 1950s and 1960s, but persistent U.S. balance of payment deficits drained American gold reserves. By the early 1970s, foreign held dollars exceeded the U.S. gold stock, meaning that the United States could not fulfill its obligation to redeem all dollars for gold at the official price. On August 15, 1971, President Richard Nixon announced the suspension of dollar convertibility to gold, an event known as the Nixon Shock. The Bretton Woods system was formally terminated by March 1973, and the world moved to a system of floating exchange rates.

Many observations tended to expect the dollar’s international role to diminish after the gold window closed. Instead, the United States forged a new arrangement that would sustain the demand of the dollar for decades to come. In 1974, Saudi oil would be priced and sold in U.S. dollars, and in return the United States would provide security guarantees and access to American financial markets. Other OPEC members largely followed suit, creating what is known as the petrodollar system. Because oil is the world’s most traded commodity, every country that imported oil in turn needed dollars, and oil exporters recycled those dollar revenues into U.S. Treasury securities, a process known as “petrodollar recycling”. As the Independent Institute documented in February 2026, roughly 80% of global oil transactions remain denominated in dollars to this day, though the arrangement is now sustained more by convention, liquidity, and network effects as opposed to formal treaties.

Failed Challengers: The Euro and Yen

The rise of Germany and Japan as major economic powers in the 1970s and 1980s led many financial analysts to predict that the deutschemark and yen would rival the dollar, dividing the world into three currency blocs. The yen’s share of global foreign currency reserves did rise in the 1980s, but it peaked close to 9% in 1991 and subsequently declined to less than 3%. The creation of the European monetary union as well as the launch of the euro in 1999 generated new predictions of the dollar’s decline. Yet as a 2009 U.S. Treasury Department analysis noted, the euro is currently he only other major reserve currency, accounting for roughly 20% of foreign currency reserves, while the dollar’s share today is roughly the same as it was 30 years ago.

Why the USD Remains Dominant

Understanding why the dollar retains its dominant position requires examining the structural features that create what economists refer to as network effects and path dependence. In short, the dollar remains dominant because of already established dominance, and the costs of switching to an alternative solution are prohibitively high for most market participants. This is not tautology, but rather, a deeply rooted feature of financial infrastructure, legal framework, and market behavior.

Depth, Liquidity, and Openness of U.S. Financial Markets

The single most important factor sustaining dollar dominance is the unparalleled depth and liquidity of the U.S. financial markets. No larger thoroughfare for global capital exists than the U.S. Treasury market, which averages around $900 billion in transactions daily, with high volume days reaching $1.5 trillion. There is roughly $4 trillion in daily repo financing, and the U.S. Treasury futures market itself averages about $750 billion in daily trading volume. This liquidity means that investors can buy and sell massive quantities of dollar-denominated assets without significantly moving prices, a feature that no other market can come near to matching.

The openness of U.S. markets is equally critical. Foreign investors can generally purchase U.S. Treasury securities, corporate bonds, and equities without significant restrictions. This openness stands in sharp contrast to China, where capital controls limit the ability of foreigners to invest in domestic markets and restrict the ability of Chinese citizens to move capital abroad. As the Federal Reserve’s 2025 edition of “The International Role of the U.S. Dollar” observed, the share of foreign currency debt denominated in dollars has remained around 60 percent since 2010, putting the dollar well ahead of the euro at 26 percent. This persistent preference reflects the practical reality that when corporations, governments, and institutions anywhere in the world need to borrow in a foreign currency, the dollar market offers the best combination of size, liquidity, and accessibility.

The Dollar as a Safe Haven

A defining feature of the dollar’s international role is its behavior during periods of global stress. When crises erupt, whether financial, geopolitical, or natural, investors around the world flock to dollar-denominated assets, particularly U.S. Treasury securities. This pattern, known as “flight to safety,” reinforces the dollar’s dominant position precisely when alternative assets are under pressure. As the Council on Foreign Relations explained in its July 2023 analysis, the dollar’s safe-haven status means that in times of global uncertainty, investors flock to U.S. dollar assets, reinforcing demand and lowering yields when cheap financing is most needed.

The Federal Reserve’s 2025 analysis confirmed that there is widespread confidence in the dollar as a store of value, and notably, the dollar share has been basically unchanged since 2022, suggesting that U.S. sanctions on Russia following the invasion of Ukraine have not led to fears of dollar “weaponization” causing a notable reallocation of reserves out of dollars. This resilience surprised many analysts who predicted that financial sanctions would accelerate de-dollarization. Instead, the data suggest that the very factors that make the dollar attractive in normal times, its liquidity and safety, become even more valuable during periods of geopolitical tension.

Institutional Trust and the Rule of Law

Beneath the quantitative metrics of market depth and trading volume lies a less tangible but equally important factor: institutional trust. Foreign governments and investors hold dollar assets because they trust that the United States will honor its debts, maintain an independent central bank, respect property rights, and allow capital to flow freely across its borders. This trust has been built over decades and is reinforced by the transparency of U.S. financial markets, the independence of the Federal Reserve, and the legal protections available to investors. The dollar’s primacy across daily currency trading, lending and financing activity, international payment systems, trade invoicing, and central bank reserves has actually strengthened in recent decades, despite rising de-dollarization incentives.

Exorbitant Privilege

In the 1960s, Valery Giscard d’Estaing, then France’s Minister of Finance and later President of France, famously described the unique advantages of the U.S. dollar as the world’s reserve currency as an “exorbitant privilege.” He was referring to the United States’ ability to finance deficits cheaply, accumulate foreign goods and services by issuing its own currency, and avoid the balance-of-payments constraints faced by other nations. Decades later, this privilege, while perhaps less exorbitant than it once was, remains substantial and consequential for the American economy and its citizens.

Lower Borrowing Costs for Governments and Consumers

The most direct and measurable benefit of reserve currency status is lower borrowing costs. Because foreign central banks, sovereign wealth funds, and private investors around the world demand dollar-denominated assets, the United States government can issue Treasury securities at lower interest rates than would otherwise be necessary. The Bipartisan Policy Center estimates that U.S. borrowing costs are 10 to 30 basis points lower due to the dollar’s reserve status. While this may sound modest, on a national debt exceeding $36 trillion, even a 0.1 percentage point reduction translates to tens of billions of dollars in annual interest savings.

These lower government borrowing costs cascade through the entire financial system. The yield on the 10-year Treasury note serves as the benchmark “risk-free” rate against which virtually all other U.S. interest rates are measured. When Treasury yields are lower, mortgage rates, corporate bond yields, auto loan rates, and student loan interest rates all tend to follow. As Bankrate explained in March 2026, fixed-rate mortgages track the 10-year Treasury yield, and when that yield is suppressed by global demand for dollar assets, American homebuyers benefit directly. The Brookings Institution confirmed in August 2024 that the dollar’s role as the world’s savings vehicle contributed to U.S. economic success over the last 75 years by lowering the cost of borrowing and debt service for the U.S. government and American consumers.

Seigniorage and Persistent Deficits

Seigniorage refers to the profit that a government earns by issuing currency. When the Federal Reserve creates dollars, it does so essentially at zero cost, yet those dollars can be exchanged for real goods, services, and assets from around the world. Because a significant portion of U.S. currency circulates outside the United States, estimated at roughly 60 to 70 percent of all Federal Reserve notes, the United States effectively receives an interest-free loan from foreign holders of cash. As the Wilson Center noted in May 2023, this unique position means that the U.S. can sustain trade deficits without triggering currency crises as foreign exporters reinvest their dollar earnings into U.S. assets.

This arrangement has allowed the United States to run persistent current account deficits for decades. While most countries must earn foreign currency through exports to pay for imports, the United States can simply print the currency that the world accepts for payment. As economist Michael Pettis of the Carnegie Endowment for International Peace explained, the United States must let capital flow freely across its borders and absorb the savings and demand imbalances of other countries, running deficits to offset others’ surpluses. While this creates its own economic challenges, including job displacement in tradable sectors, it also means that American consumers have access to a wider variety of goods at lower prices than would be possible under a more constrained international monetary arrangement.

How Reserve Status Affects Your Wallet

The macroeconomic abstractions of reserve currency status and exorbitant privilege translate into concrete, tangible effects on the daily financial lives of ordinary Americans. From the interest rate you pay on your mortgage to the price you pay at the grocery store, the dollar’s global role reaches into virtually every transaction. Understanding these mechanisms is essential for making informed financial decisions.

Mortgage Rates and Home Affordability

Perhaps the most direct way reserve currency status affects American households is through mortgage rates. The 30-year fixed-rate mortgage, a financial product virtually unique to the United States, depends heavily on the depth and liquidity of the U.S. Treasury market. When global demand for Treasuries is strong, yields fall, and mortgage rates follow. As Discover’s banking education team explained in December 2025, when the Federal Reserve adjusts interest rates, the effects ripple through the entire borrowing landscape. A Fed rate cut translates to lower mortgage rates for prospective homebuyers, while rate increases make borrowing more expensive.

The global demand for dollar assets amplifies these effects. Because foreign investors consistently purchase U.S. mortgage-backed securities, the supply of capital available for home lending is larger than it would be in a closed economy. This foreign demand helps keep mortgage rates lower than they otherwise would be, making homeownership more accessible for millions of Americans. As the Treasury Borrowing Advisory Committee reported in February 2026, foreign demand for the ballooning U.S. Treasury debt is an increasingly important issue, and institutional buyers, including foreign central banks, help absorb the substantial issuance required to fund the federal budget.

Purchasing Power and Import Prices

A strong dollar, sustained in part by global reserve demand, means cheaper imports for American consumers. When the dollar appreciates against other currencies, goods produced abroad become less expensive in dollar terms. As the U.S. Bureau of Labor Statistics documented in March 2023, a currency appreciation in the United States means that one dollar can now buy more of a good valued in a foreign currency, and accordingly, as the dollar strengthened, import consumer goods prices fell. The BLS analysis found that consumer goods import prices declined during dollar appreciation periods, even as supply chain constraints affected broader inflation dynamics.

The Federal Reserve Bank of Boston’s analysis of the 2014-2015 dollar appreciation episode found that a 15 percent dollar appreciation should reduce consumer prices by a quarter of a percentage point in the short run, and by four-tenths of a percentage point after two years. While these effects may seem modest, they compound over time and across the vast array of imported goods and services that American consumers purchase. Everything from electronics manufactured in Asia to wine imported from Europe to vacations abroad becomes more affordable when the dollar is strong. Conversely, as RSM chief economist Joseph Brusuelas warned in July 2025, a weaker dollar adds to inflation pressure as import prices rise, and should the dollar hold near current levels or decline further, one should anticipate a possible 0.5 percent increase in inflation because of dollar weakness.

Immunity from Currency Crises

One of the most significant but least appreciated benefits of dollar dominance is immunity from the currency crises that periodically devastate emerging market economies. When a country borrows heavily in foreign currency, a sudden depreciation of its domestic currency can make debt servicing impossible, triggering bank failures, sovereign defaults, and severe recessions. Because the United States borrows overwhelmingly in its own currency, it faces no such risk. The dollar’s global reserve status reduces the chance that the U.S. will face a currency crisis, in which a sudden devaluation of the dollar could halt imports, deteriorate the terms of trade, and cause a financial crisis.

This immunity is not merely theoretical. During the 1997 Asian Financial Crisis, countries from Thailand to South Korea saw their currencies collapse by 30 to 50 percent against the dollar, plunging millions into poverty. During the 2018 Turkish lira crisis, the currency lost nearly 40 percent of its value in months. American households are shielded from such volatility because the dollar’s reserve status creates a self-reinforcing stability. The global demand for dollars supports the currency’s value, which in turn reinforces global confidence in dollar assets.

Investment Returns and Retirement Savings

The benefits of dollar dominance extend to investment portfolios and retirement savings. Because U.S. financial markets are the deepest and most liquid in the world, American investors enjoy access to a broader range of investment opportunities, lower transaction costs, and greater price efficiency than investors in most other countries. The dollar’s dominant role in international finance means that U.S. investors face less currency risk when investing abroad, and foreign investment flows into U.S. markets help support asset prices, from stocks to bonds to real estate.

The Bipartisan Policy Center noted that as global investors hold dollars, they are more likely to invest in the U.S. market, especially given its size, openness, and stability. For these reasons, the United States is the largest recipient of foreign direct investment, receiving $5.3 trillion in 2023. This foreign investment supports American businesses, creates jobs, and contributes to the long-term growth of retirement accounts held in 401(k)s, IRAs, and pension funds.

De-Dollarization in Focus

Despite the dollar’s enduring dominance, a growing chorus of governments and analysts argue that the international monetary system should move away from dollar dependence. The motivations for this “de-dollarization” movement are varied: some countries resent the extraterritorial reach of U.S. financial sanctions, others seek to reduce their vulnerability to Federal Reserve policy decisions, and still others hope to elevate their own currencies to greater international prominence. Understanding these challenges is essential for assessing the dollar’s future trajectory.

The Weaponization of Finance and Sanctions Risk

The most immediate catalyst for de-dollarization efforts has been the increasing use of financial sanctions by the United States and its allies. Following Russia’s invasion of Ukraine in February 2022, unprecedented sanctions cut Russia off from the dollar, freezing approximately $300 billion in Russian central bank assets and triggering a default on the country’s sovereign debt. The Council on Foreign Relations noted that there is no doubt that if the dollar were not so widely used, the reach of sanctions would be reduced. While sanctions are a tool of foreign policy, their deployment has created a powerful incentive for targeted countries and their trading partners to develop alternative payment systems.

A March 2026 academic analysis in the Journal of Risk and Financial Management identified what it termed “four macro-drivers of active de-dollarization.” The first and most significant is geopolitical shock and freezing risk. The analysis cited the “weaponized interdependence” framework, which explains how the asymmetric structure of global financial networks allows central states to exert coercive power through key chokepoints like SWIFT and the dollar-clearing system. Countries facing sanctions risk have increasingly shifted toward gold accumulation and explored alternative payment infrastructure.

Progress and Limitations of the Chinese Yuan

The most frequently cited potential challenger to the dollar is the Chinese renminbi, also known as the yuan. China’s economy is the world’s second largest, its share of global trade is substantial, and its government has actively promoted the internationalization of its currency. The milestone moment came in November 2015, when the IMF approved the inclusion of the renminbi in the Special Drawing Rights basket alongside the dollar, euro, yen, and pound, effective October 1, 2016. The IMF stated that this move represented an important milestone in the integration of the Chinese economy into the global financial system.

Yet despite these efforts, the renminbi’s international role remains limited. According to the IMF’s COFER data for Q1 2025, the renminbi’s share of allocated global reserves was just 2.12 percent, down from 2.18 percent in the previous quarter. The BIS 2025 Triennial Survey showed the renminbi on one side of 8.5 percent of global FX turnover, up from previous surveys but still far below the dollar’s 89.2 percent. The SWIFT network reported that the yuan accounted for only 2.7 percent of global payments in December 2025.

The primary obstacle to renminbi internationalization is not economic size but institutional openness. China maintains significant capital controls that limit the free flow of money across its borders. Foreign investors face restrictions on their ability to buy and sell Chinese assets, and Chinese citizens face limits on their ability to move money abroad. Until these restrictions are substantially relaxed, the renminbi cannot serve as a true reserve currency, because reserve assets must be liquid and freely usable. As the Federal Reserve’s 2025 analysis concluded, viable alternatives to the dollar remain limited, and the Chinese renminbi faces significant structural constraints.

Alternative Payment Infrastructure: BRICS

The BRICS group, Brazil, Russia, India, China, and South Africa, plus newer members, has become the most vocal proponent of de-dollarization. At the 2024 BRICS Summit in Kazan, Russia, leaders discussed alternatives including a blockchain-based payment system and the concept of a settlement unit for intra-BRICS trade. As Asia Times reported in January 2026, the focus for the upcoming India-hosted BRICS summit will be on developing a payment system built on interoperable central bank digital currencies.

However, as GIS Reports noted in October 2025, BRICS has discovered what any challenger to an entrenched system learns: replacing the incumbent is far harder than criticizing it. The combination of internal BRICS rivalries, particularly the competitive tension between China and India, and the dollar’s genuine structural advantages has forced a retreat from revolutionary ambitions. The most realistic timeline, according to trade law specialists at JD Supra, involves BRICS Pay pilots through 2027, followed perhaps by a settlement unit for intra-BRICS trade by 2028-2030, not a global reserve currency, but a regional mechanism that reduces friction costs and dollar exposure within the bloc.

Gold and the Rise of Non-Traditional Reserves

One trend that has genuinely shifted the composition of global reserves is the increased allocation to gold. According to the Federal Reserve’s 2025 analysis, the share of gold in official reserve assets has more than doubled from below 10 percent in 2015 to over 23 percent now. However, this increase mostly reflects the over 200 percent increase in the gold price over that period; the physical quantity of gold holdings has only increased by less than 10 percent. Furthermore, the analysis showed that increases in gold holdings are generally not associated with a decline in U.S. dollar reserves except for China, Russia, and Turkey. So even though gold has become more popular as a reserve asset, the increase in gold holdings is not necessarily linked to a decline in dollar holdings.

Lessons from the British Pound

History offers only one genuine precedent for the displacement of a global reserve currency: the gradual decline of the British pound sterling and its eventual replacement by the U.S. dollar. Understanding this transition provides crucial insights into how reserve currency shifts actually occur and why they take far longer than most commentators anticipate.

At its peak, the British Empire covered about 25 percent of the world’s land area and oversaw between 470 and 570 million people across more than 50 colonies. The pound sterling served as the backbone of international finance, anchored by the gold standard and the Bank of England. Heading into the 1900s, the pound comprised about 63 percent of the world’s reserves. By the late 19th century, London financed most global trade, and the gold standard made sterling the backbone of international finance during the height of the British Empire.

World War I drained Britain’s gold reserves and forced the country to borrow heavily from the United States, shifting global financial power toward New York. In 1925, Britain controversially restored the pound to the gold standard at its pre-war exchange rate, an overvaluation that damaged British industry and employment. The country abandoned the gold standard in 1931, yet sterling’s reserve role persisted for decades afterward. As archival research by Catherine Schenk demonstrates, sterling played a much greater role for a longer period after 1945 than is usually acknowledged, and its retreat was carefully managed rather than left to market forces.

The key lesson from sterling’s experience is that reserve currencies fade through long financial transitions, not sudden collapse. By 1950, over 55 percent of foreign exchange reserves were still held in sterling, and even after the 1967 devaluation, the share remained close to 30 percent until a sharp fall in 1970. The final transformation was eased by several factors: rising international liquidity and inflation decreased the real value of existing liabilities, and international cooperation prevented a damaging tipping point that would have undermined confidence in the entire reserve currency system. As one financial historian observed, reserve currencies don’t collapse overnight. They fade slowly, as financial systems resist change long after political power has shifted.

The Road Ahead

The future of the dollar’s reserve currency status is not a binary question of dominance versus collapse, but rather a spectrum of gradual adjustment. The evidence suggests that while the dollar’s share of global reserves will likely continue its slow, decades-long decline, no currency currently exists that can replace the dollar’s multifaceted role in the foreseeable future. The most probable outcome is a slow evolution toward a more multipolar currency system, in which the dollar remains first among equals but faces increasing competition in specific regions and transaction types.

Several factors will determine the pace of this evolution. First, the willingness of the United States to maintain the institutional foundations of dollar dominance, including an independent Federal Reserve, open capital markets, and predictable fiscal policy, will be critical. Second, China’s willingness to liberalize its capital account and strengthen the rule of law will determine whether the renminbi can evolve from a regional trading currency into a genuine reserve asset. Third, technological developments, including central bank digital currencies and blockchain-based settlement systems, could gradually reduce the network effects that currently favor the dollar.

For American households, the most important implication is that dollar dominance is likely to persist long enough to continue delivering its current benefits, including lower borrowing costs, cheaper imports, and immunity from currency crises, for at least the next decade and probably longer. However, the gradual diversification of global reserves into non-traditional currencies and gold suggests that the margin of advantage may slowly narrow over time. Prudent financial planning should account for the possibility of a slightly less dollar-centric world, but should not be based on predictions of imminent dollar collapse that find little support in the data.

As the Atlantic Council’s Dollar Dominance Monitor concluded, while central banks have slowly diversified away from the dollar since 2018, viable alternatives remain limited, and the dollar’s multifaceted role in the global financial system, with each function deeply embedded in institutional trust, market infrastructure, and historical precedent, makes any challenge to the dollar’s dominance a complex and gradual process. For now, the Almighty Dollar retains its throne, and your wallet continues to benefit.

References

1. International Monetary Fund, “Currency Composition of Official Foreign Exchange Reserves (COFER),” Q1 2025 Data Release, July 9, 2025. https://data.imf.org/

2. Bank for International Settlements, “Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Markets,” April 2025, Preliminary Results, September 30, 2025. https://www.bis.org/statistics/rpfx25.htm

3. Federal Reserve Board, “The International Role of the U.S. Dollar -- 2025 Edition,” FEDS Notes, July 18, 2025. https://www.federalreserve.gov/

4. Federal Reserve History, “Creation of the Bretton Woods System,” https://www.federalreservehistory.org/

5. Council on Foreign Relations, “The Dollar: The World’s Reserve Currency,” Backgrounder, July 19, 2023. https://www.cfr.org/

6. U.S. Bureau of Labor Statistics, “How Currency Appreciation Can Impact Prices: The Rise of the U.S. Dollar,” Beyond the Numbers, March 16, 2023. https://www.bls.gov/

7. Brookings Institution, “The Changing Role of the US Dollar,” August 23, 2024. https://www.brookings.edu/

8. European Central Bank, “Global Trade Invoicing Patterns: New Insights and the Influence of Geopolitics,” The International Role of the Euro, June 2025. https://www.ecb.europa.eu/

9. SWIFT, Global Payment Data, December 2025. https://www.swift.com/

10. U.S. Department of the Treasury, “Major Foreign Holders of Treasury Securities,” TIC Data, 2025-2026. https://ticdata.treasury.gov/

11. Wilson Center, “Exorbitant Privilege: Now a Risk for the Once and Future Almighty Dollar,” May 2023. https://www.wilsoncenter.org/

12. Bipartisan Policy Center, “What’s Behind the U.S. Dollar’s Dominance and Why It Matters,” September 2025. https://bipartisanpolicy.org/

13. RBC Wealth Management, “It’s Been a Privilege,” April 8, 2025. https://www.rbcwealthmanagement.com/

14. St. Louis Fed Open Vault, “The U.S. Dollar’s Role as a Reserve Currency,” February 25, 2026. https://www.stlouisfed.org/

15. Investment Week, “Partner Insight: US Debt Is Surging -- But Is the Dollar’s Global Dominance Really at Risk?” April 20, 2026. https://www.investmentweek.co.uk/

16. U.S. Treasury Department, “An Historical Perspective on the Reserve Currency Status of the US Dollar,” October 2009. https://home.treasury.gov/

17. MDPI Journal of Risk and Financial Management, “De-Dollarization of Central Bank Reserves in the World Economy: 2015-2025,” March 7, 2026. https://www.mdpi.com/

18. Asia Times, “BRICS Laying First Tracks for New Global Payment System,” January 29, 2026. https://asiatimes.com/

19. GIS Reports, “BRICS Making Incremental Progress in Dollar-Free Trade,” October 2, 2025. https://www.gisreportsonline.com/

20. Catherine Schenk, “The Retirement of Sterling as a Reserve Currency after 1945,” University of Tokyo CIRJE Discussion Paper. https://www.cirje.e.u-tokyo.ac.jp/

The stock has been cut in half, plummeting over 65% from its 2024 peak. The question this article attempts to answer is whether that repricing reflects a company that has been permanently impaired, or if it’s just a premium brand going through a temporary, cyclical bump in the road.

Our view is the latter, but with conditions. The recovery thesis is contingent on three things: gross margin stabilizing, the comparable sales in the Americas improving, and the incoming CEO articulating a credible product strategy. If Lululemon can succeed in making those three things happen, the current multiple is almost certainly wrong. If they don’t, it may be right.

Cyclical or Structural?

The distinction between cyclical and structural headwinds matters here. Cyclical pressures such as cautious consumer spending and post-pandemic normalization of discretionary purchases will ease with time and are not unique to Lululemon.

The structural pressures, however, are a different story. Lululemon spent over a decade operating in a premium athleisure category it basically created. But now that category is no longer just theirs, as new competition enters the market. Those companies have taken both shelf space, and consumer sentiment share. This is a big deal because brand loyalty in apparel, once diluted, is rarely fully recovered. That gives credence to a structural shift now that the competitive moat has narrowed permanently, and likely no product refresh or leadership change restores it to what it was.

The cyclical piece will resolve. The structural piece on the other hand requires Lululemon to earn back relevance in a way it has never had to before. Is this just a period of product malaise?

Trouble in The Americas

What Lululemon has built over the past decade is one of the most enviable brands in retail, which makes what is happening now all the more important. The decline in stock value stems from accelerating weakness in its largest market - the Americas. Accounting for 68% of total revenue, it has seen comparable sales deteriorate from -3% (Q1 2025) to -4% (Q2) to -5% (Q3).

What’s of even more concern is both traffic and conversion declining simultaneously, which suggests fundamental demand weakness rather than temporary softness.

“The teams have been addressing opportunities head on and making meaningful progress from product creation and activation to enterprise efficiency... You’ll see the impact of this work beginning in spring 2026.” Quote from Q3 earnings call, by CEO Calvin McDonald.

Product mistakes can be recognized and resolved. The bigger issue at hand is that the environment in which they operate has changed. American consumers are spending more carefully, especially on premium items.

With Lululemon now facing major competition that wasn’t always there, such as Alo Yoga and Vuori, it is pulling customers away. Better products will help, but they won’t undo five years of the market catching up to Lululemon.

According to Earnest Analytics credit card data, Vuori and Alo Yoga have each gained roughly 1 percentage point of U.S. athleisure market share since 2023, reaching 2.9% and 1.3% respectively. In absolute terms this is still small, but the direction of the trend is what’s key here.

Wallet share gives an even more intriguing story. Vuori’s existing customers increased their spending at the brand from 21.6% to 27.4% of their total athleisure wallet in a single year, while 52% of Vuori shoppers and 63% of Alo shoppers also shop at Lululemon.

It is likely a much larger change will have to occur with the brand going forward, and with CEO Calvin McDonald stepping down as of January 31, 2026, maybe this is where that change begins.

A Reset to Leadership

Calvin McDonald’s stepping down comes after seven years of him leading the company. When the announcement initially came out on the same day as the Q3 2025 earnings release, Lululemon saw a 13% decline in quarterly profit, showing that the market’s initial reaction to McDonald’s departing was positive, as shares rose 10% in after-hours trading.

CFO Meghan Frank and Chief Commercial Officer André Maestrini have taken over the CEO position as interim co-CEOs while the company searches for a new ‘permanent’ CEO. The division of responsibilities between the two is deliberate, with Frank overseeing product merchandising, design, and brand, while Maestrini focuses on managing global markets. The brand and product have been the central criticism, so putting the CFO directly over that function is a clear signal that the board appears to understand what needs to be fixed.

The co-CEO structure is inherently transitional, accompanied by real risks. A company experiencing pressure on their margins, inventory, and more specifically for Lululemon, U.S. demand, now has to try and do so without a permanent CEO, while also taking time and resources to conduct an executive search for a new CEO. The board has said it is looking for a leader with a track record of driving companies through periods of growth and transformation.

Growth in China and Bridging the Americas Gap

China Mainland has been an entirely different story. According to Q3 2025, revenue has surged 46.2% year-over-year to $465 million, with comparable sales up 24%, with the country now officially Lululemon’s second largest market, jumping from 13% to 18% of total revenue in a single year. However, the dollar amount China added this quarter was still less than what the Americas lost relative to trend.

China is the current growth engine while the Americas is the main business. And right now, one isn’t keeping pace with the other. Lululemon is leaning into China growth with the majority of new planned store openings for 2025 being allocated to China and looking to grow presence in cities where brand awareness is low.

But domestic brands like Anta are going to pose a real competitive threat. While Lululemon continues to build brand awareness in China from a low base, this means the window of opportunity for them to establish a premium positioning could potentially close faster than management is expecting if domestic players manage to move upmarket first.

If the momentum in China slows and the Americas doesn’t recover or deteriorates further, Lululemon will be over-extended in a high-risk market with a deteriorating core. This is often overlooked when reading about the surge in revenue.

If strong revenue growth and improving margins in China can persist, and the Americas gross margin, comparable sales and revenue can turn around and stabilize, a potentially great opportunity will present itself.

That being said, with the competition growing in China, I wouldn’t put all my marbles on China keeping Lululemon in the game. China is a real growth story, but we can’t forget that it is a secondary market being asked to carry a primary one. That is not a sustainable arrangement.

If this is to work, they need to resolve and find a solution for their main market, the Americas. They have said that is exactly what they are going to do, but talk and execution are two different things. What makes this harder to dismiss as a rough patch is that the weakness is showing up everywhere at once. Comparable sales, margins, and now inventory are seeing repercussions.

Inventory Overflows

As demand has continued to weaken, inventory has grown to $1.998 billion as of November 2, 2025. This is a 38.6% increase since February 2, 2025, and a 17% increase YoY. This creates a dangerous dynamic, where rising inventory in addition to falling demand can lead to markdown risk.

When markdowns occur, it creates margin compression, and this margin compression leads to cash flow deterioration. One thing leads to another creating a dangerous financial waterfall. Is this the case with Lululemon? Maybe.

Management has claimed that the inventory build is “holiday preparation”. CEO Meghan Frank consistently attributed the inventory build to holiday preparation, claiming stocking core items ahead of peak season while chasing newness in an attempt to refresh the assortment.

The unit-versus-dollar discrepancy, she explained, was driven by tariffs and foreign exchange rather than excess product. This is measurable and real, and entering the holiday quarter lean is a real operational risk. The message they have been trying to get across has been clear: the inventory build is intentional and management is in control.

They used Thanksgiving weekend performance for further validation, looking to the traffic surge to clear seasonal product. This is what a disciplined inventory strategy should look like. But it may not be all that it seems to be.

A recurring explanation starts to look less like a plan and more like a cover story. On the Q3 2025 earnings call, CFO Meghan Frank guided for a full-year gross margin decline of approximately 270 basis points, which on its own is not necessarily a positive, but when taken in the context of their prior guidance being a margin decline of 300 basis points, it is a slight improvement on guidance. The 30 basis point improvement is being driven by lower than expected tariff impact

But markdowns alone are expected to run approximately 70 basis points higher than last year, and Q3 already showed 90 basis points of markdown pressure, with management guiding for a further 100 basis points in Q4. For a brand that spent years never needing a sale to move product, that trajectory is a significant admission.

The holiday preparation story isn’t wrong, but it isn’t the whole truth either. In a stronger year, there would have been nothing to explain.

Q4 results will serve as a direct referendum on management’s credibility. If the numbers contradict the narrative they have been building over recent quarters, the market will likely not be forgiving.

Days Inventory Outstanding Story

One thing I’d like to also discuss while on the topic of inventory is Days Inventory Outstanding (DIO). DIO is the average number of days a company’s inventory is held before it sells, which can indicate if inventory management is efficient or not.

Below is a quick chart I had created just to show the Q3 trend in DIO (numbers are close but may not be exact as they are mainly for illustrative purposes).

You can see that DIO increased YoY slightly from 2017 until 2021, with a major peak in 2022 that relates to supply chains. During this period every apparel company was over-ordering for the same reason, which was during Covid, lead times stretched from the typical 3-4 months to 9-12 months. So massive orders were placed far in advance just to ensure they had anything to sell. When supply chains normalized in 2022, all that inventory arrived at the same time inflating inventories. Lululemon’s inventory surged 85% that year, and it wasn’t them being reckless, it was what every major retailer did.

Lululemon posted 28% revenue growth in Q3 FY2022. When the top line grows that quickly, investors have a tendency to look past balance sheet warning signs because the momentum feels like it accounts for everything.

High DIO when you’re growing 28% looks like you’re stocking up for growth, while high DIO when you’re growing 7% with negative Americas comparable sales looks like products aren’t moving.

The real problem revealed itself after the Q1 2024 earnings call, when management missed on product while simultaneously guiding down. At that moment the market decided this was a demand and brand issue, not just the supply chain trouble from before.

When we look at the current situation, we see that DIO has been fairly steady after falling from its 2022 peak. Maybe 150s-160s is the new norm and the days of 120s-130s are gone forever. Regardless, we would want to see them work to lower DIO. This happens by either carrying less inventory or selling more products, which ideally we’d want to see both.

Selling more is the easiest near-term resolution. In FY2023 inventory barely moved but 19% revenue growth expanded COGS enough that DIO fell from 194 to 160 days almost entirely because the denominator got bigger.

The problem that results from this is that selling happens through markdowns and promotions. You’re damaging your gross margins to make a ratio look better.

That being said, every 10 days of DIO reduction frees roughly $120M in cash at Lululemon’s current scale, so a normalization from 160 toward 130-140 days would release $300-400M in working capital. And the gross margin connection runs in parallel.

Every markdown represents inventory that didn’t sell at full price, so structurally lower inventory means less promotional pressure, which in turn means higher margins. Lululemon’s gross margin has slid from a peak of 58-59% toward 55-56%, and regaining it requires product execution and inventory normalization happening in lock-step.

Cashflow Woes and Buyback Grows

The inventory buildup has crushed their operating cashflows (OCF), with YTD 2024 operating cash flows of $871 million falling to $460 million YTD 2025, a 47% drop! The primary drivers behind this are a -$517 million cash outflow for inventory buildup, and reduced profitability through lower margins.

Recently Lululemon has been buying back stock while burning through cash. Cash reserves fell from $1.984 billion YTD 2024 to $1.035 billion YTD 2025, a decline of $948.4 million, or a 48% depletion of cash reserves. According to Q3 2025, they spent $907 million on share buybacks, which YTD is ~197% of their OCF. The amount they spent on Total Investing Activities also amounted to ~106% of OCF. With this, we see that combining buybacks and capital deployment consumed ~303% of OCF in the first three quarters of the fiscal year. The only way this can happen is by burning through cash reserves or taking on debt. So far, they have only chosen to burn through cash reserves, which can be very destructive.

It makes sense for a company to engage in buybacks when they have strong cash generation, excess cash after funding growth, the stock is undervalued, and there is no better use for capital.

But with Lululemon having a -47% decline in operating cash flows, while burning through cash reserves, purchasing most of its buybacks at relatively expensive prices, and having other potentially better avenues for capital use like investing in recovery in the Americas, they don’t check a single box.

But how much of a capital destruction has really occurred from these share buybacks? Considering the share repurchases were at mostly inflated prices, taking into account all share buybacks and their price at the time, then taking the current price on March 6, 2026 of ~$168.40, we see that a total loss on the $907 million spent from Q1-Q3 2025 of about ~$311.6 million, a 34.4% loss in just those three quarters.

Only in the last two months of Q3 did they buy at prices that were anywhere near profitable. America’s business deterioration arguably needed that capital more.

To add to the mayhem, management authorized another $1 billion in buybacks on December 3, 2025, bringing total authorization to $1.6 billion. Returning this much capital while the business is weakening suggests one of two things: either management is underestimating how serious the underlying issues are, or they’re leaning on buybacks to support the share price. In either case, it raises real concerns about capital allocation discipline.

Gross Margin Crisis or Speed Bump?

Gross Margins have collapsed, with Q3 2025 gross margin at 55.6% compared to 58.5% Q3 2024, a decline of 290 basis points in a year’s time, which is the worst in company history.

What happens if it declines another 150 basis points? This means gross margin falls to 54.1%, and with Q3 revenue of $2.566 billion and gross profits of $1.426 billion, we would see an impact of -$38.5 million per quarter on that gross profit, with an annualized impact of -$154 million.

So, taking our Q3 numbers, our operating income falls from $435.886 million to $397.386 million, which after taxes of about 30.5%, causes net income to drop about $26.76 million to $280.075 million, a decrease in earnings of 8.72%, all from just a 1.5% decrease in gross margins.

This is based on if Q4 numbers were exactly the same as Q3 figures, but it does a thorough job at getting the point across. And with Q3 already showing 290 bps compression from one year prior, 150 bps more is easily achievable if tariffs escalate further, inventory requires markdowns in Q4, or pricing power continues eroding.

With an effective tax rate of 30.5%, we are left with a -$26.8 million quarterly impact and a -$107 million annual impact. With approximately 118.6 million shares outstanding, this equates to about a -$0.23 per quarter, or an annual impact of -$0.90. Q3 diluted EPS was 2.59, so if we multiply that by 4 to get a rough annual figure, we get annual earnings of $10.36.

This 150-basis point drop in gross margins leads to a $0.90 drop in that number, leaving us with annual EPS of $9.46, an EPS drop of about 8.7%. All from that 1.5% decrease to gross margins. Incredible.

Gross Margin Path to Recovery

All of that being said, there is a potentially bright future. Not all of the Q3 gross margin decline is permanent. Much of it reflects temporary pressures, not a deterioration of the fundamentals. The $210 million tariff headwind management cited is actually a net figure.

The gross impact is worse, but pricing actions and vendor negotiations are already working to close the gap between the two. As sourcing shifts away from higher-tariff countries over time, that mitigation compounds, reducing per-unit cost pressure without requiring the top line to do all the heavy lifting.

On markdowns, lululemon’s inventory grew 11% year over year in dollars but only 4% in units, meaning cost inflation rather than a unit glut is driving the balance.

If the Americas comparable sales stabilize, then even if flat, the urgency to promote diminishes and product margin should recover passively.

Along with this, Lululemon’s customer base has never been particularly price sensitive. So far, this appears to be continuing to hold true. The company has quietly raised prices on select products as part of its tariff mitigation strategy, and so far demand hasn’t waned in any kind of meaningful way. This suggests the brand still commands the pricing authority it has historically benefited from.

A recovery to 57% gross margin, which would meet in the middle between today’s 55.6% and the pre-tariff 58.5% — would add approximately $36 million in quarterly gross profit at current revenue levels and roughly $0.85 in annualized EPS after tax.

None of these conditions are unreasonable to expect. Tariff headwinds don’t need to disappear, they need to stop getting worse. Inventory discipline is already improving. The Americas business, while pressured, has not structurally deteriorated. A 12-to-18-month window for meaningful margin recovery is ambitious but not unrealistic. Whether it arrives before investor patience runs out is the real question.

Debt? Never Heard of It

One of the biggest things that stands out about Lululemon is the company carries no conventional debt. As of Q3 FY2025, total liabilities were $3.45 billion, which at first glance, triggers concern for some. But the composition of those liabilities tells a very different story than the headline suggests.

These liabilities include no bank loans, no bonds, no notes payable, and no cash borrowings on lululemon’s $600 million revolving credit facility, of which $593 million remained fully available at quarter-end (the $7 million gap from the full $600 million represents outstanding letters of credit, leaving $593 million of cash capacity fully available). None of the $3.45 billion is interest-bearing. There are no interest payments to make and no debt maturities to worry about.

Roughly 90% of that $3.45 billion is operating liabilities, including line items like accounts payable, accrued compensation, and deferred revenue. The largest single piece is lease obligations. Lululemon operates 796 company-owned stores worldwide, nearly all of which lease their retail space.

With typical lease terms of 7 to 10 years, those future rent commitments, spread across hundreds of locations and thousands of aggregate lease-years, get discounted to present value and appear on the balance sheet as a liability. It looks large because it is large. But it behaves nothing like debt.

The key distinction is how these obligations are actually paid. As lease payments come within 12 months of being due, they migrate from non-current to current liabilities and are paid from operating cash flow as they fall due: no lump sums, no maturities, no acceleration clauses.

For a company with strong cash flows, this is simply the routine cost of running a global retail network. The $1.445 billion in non-current lease obligations isn’t a ticking clock, it’s a predictable series of manageable payments spread over the better part of a decade.

The lease structure that looks so benign in a healthy cash flow environment can become uncomfortable if conditions deteriorate. Those rent commitments don’t flex with revenue, they’re fixed obligations against a store base built for a growth trajectory the Americas has, at least for now, stepped back from.

Lululemon holds $1 billion in cash against zero long-term debt, and the business today generates more than enough to service its obligations with room to spare. But “no debt, strong balance sheet” deserves a qualifier: it’s a balance sheet built for growth, and its resilience depends entirely on protecting the cash flows that make those lease payments routine rather than stressful.

On pure liquidity and solvency metrics, lululemon is strongly positioned, with $1.04 billion in cash, zero interest-bearing debt, no principal repayments, no debt maturities pressing on the near term, and no interest expense eating into earnings. Current assets of $3.92 billion comfortably cover current liabilities of $1.84 billion, implying a current ratio about 2.1x, a healthy ratio for a retailer.

Add in the $593 million of undrawn capacity on the revolving credit facility that we mentioned, and the total liquidity available to the business sits well above $1.6 billion at any given moment.

From a solvency standpoint, total liabilities of $3.45 billion sit against stockholders’ equity of $4.50 billion and total assets of $7.96 billion. This is a debt-to-equity and debt-to-assets profile that most retailers would envy.

The business also converts earnings to cash at an above-average rate, generating over $1.25 in operating cash flow for every dollar of reported net income. Aside from a severe and sustained deterioration in operating performance, there is no credible near-term scenario in which lululemon struggles to meet its obligations.

The risks discussed in this article are real, but they are margin and growth risks, not solvency and liquidity risks, a major distinction that lays the framework for whether this company is a good buy or not.

Brand Strength

Throughout the years Lululemon has achieved something that most retailers only dream of, genuine loyalty.

Their membership program has grown to nearly 30 million members, up from 22 million members in mid-2024, which continues to expand across all age groups, even as the Americas revenue line disappoints. This is impressive growth considering the program began in 2022.

These members are not just passive loyalty card holders who signed up for a discount, they are customers who have built Lululemon into their identity. They shop frequently, pay full price, and a competitor simply offering a sale or promotion does not move them.

Building that kind of customer relationship takes years and is not easily broken. This plays massively to Lululemon’s advantage.

P/E Multiple Valuations

The P/E multiple and valuation based on it has a story of its own. Lululemon has historically commanded a premium multiple because the market recognized the brand’s quality.

The 3-year P/E multiple average sits at approximately 31x. The 5-year average P/E multiple, on the other hand, sits at around a commanding 40x, with the 10-year average at around 42x.

The stock currently trades at approximately 12x earnings, about 71% below the 10-year average, which implies one of two things: either the market is correctly repricing a growth company that has slowed/stopped growing, or the market is extrapolating a cyclical trough into a permanent condition.

In other words, the market overexaggerating, which is what markets tend to do. That exact point is the topic of debate in this article, structural or cyclical bump in the road.

For investors who believe the current headwinds are cyclical rather than terminal, that gap between today’s multiple and the historical norm represents the opportunity.

If Lululemon earns $14.44 in TTM EPS (its current EPS) and the stock re-rates to a 20x P/E multiple, that would imply a stock price of $288.80, or 67% above March 6, 2026 close price of $173.18. A return to the five-year average of 40x would imply a stock price of $577.60.

None of those scenarios require outrageous assumptions about the business. Instead, it is more dependent on whether 12x is a fair price for this company, or a trough multiple being applied to a trough earnings period.

At this multiple, the market is essentially pricing Lululemon as a no growth retailer. But we should not base estimations off the P/E multiple alone.

Q4 is Shaping up to be a Pivotal Moment

Let’s briefly talk about Q4 FY2025, which is either the beginning of a turnaround or confirmation of continued deterioration.

Guidance calls for a 580bps gross margin decline in Q4 FY2025 from Q4 FY2024. The full year FY2025 figure is expected to come in at -270bps, which as we mentioned earlier, is a slight improvement from the original -300bps guide, as Q1-Q3 came in better than feared.

Full year EPS of $12.92-$13.02 against FY2024’s $14.64 represents 11% earnings decline primarily driven by the tariff, gross margin, and comparable sales trouble mentioned previously.

Remember, Lululemon has not historically relied on markdowns and promotions to move product, and the full price discipline was a core pillar of its premium positioning. Any sustained erosion of that would be a more troubling signal than tariffs alone.

Tariffs raising inventory costs are real, but they are an economic problem, not a structural one, and are solvable through sourcing shifts, vendor negotiations, and selective price increases, which Lululemon has stated they are already in the works to improve on.

The January 2026 update guiding to the high end of Q4 ranges was the first meaningful positive signal in several quarters. With Q4 FY2025 results releasing on March 17, 2026, there is a lot riding on these results and those of the eventual Q1 FY2026.

Lululemon Scorecard (1-10)

Below I went through and scored each category I think is important to Lululemon and weighted it to the overall picture to give it a probabilistic representation of where we are at currently.

Then I took those same categories and weighting, estimated what the positive scenario could look like. This assumes that gross margins hold steady/improve, international growth slows slightly/steadies, they stop the decline or reverse the trend in Americas comparable sales and also find better uses for capital allocation.

By no means does this have to occur. This is assuming they manage to turn things around and solve the majority of their problems. If they neglect or fail to do so, then we won’t see the needle move much or we could actually fall further. Again, the Q4 results will be telling.

Final Thoughts

Much more could be said on Lululemon, and I am more than happy to answer any questions on this. But, for what we’ve dissected, Lululemon is not a broken company.

It is a premium brand facing a convergence of self-inflicted wounds and external headwinds at the same time. The inventory build, the margin compression, the Americas weakness, the leadership vacuum, none of these exist in isolation, and none of them are necessarily permanent. They are happening simultaneously, and that is what makes the next two quarters so consequential.

The scorecard above reflects a business trading at 5.9 out of 10 today, with a credible path to 8.0 if management executes. That 2.1 point gap is the entire investment thesis at $173.18.

The bull case does not require Lululemon to reclaim its peak, it only requires the business to stop deteriorating and prove that 12x earnings is a trough multiple applied to a trough earnings period, not a fair price for a structurally impaired retailer.

When Q4 FY2025 results come out, if gross margins stabilize, Americas comparable sales show any sign of a floor, and the incoming CEO search produces a credible candidate, the re-rating begins. If not, the narrative of permanent impairment gets harder to dismiss.

This is a company that built something rare, a premium brand with real pricing power, a loyal customer base, and a global runway. This leaves us with one question: Can the company protect what was built long enough for the recovery to arrive?

Appendix: How Inventory Impacts Cash Flows

I wanted to separate this section from the rest of the article even though it likely could’ve been woven in under the inventory section as some of it flirts with parts already mentioned.

Inventory is one of the largest levers on cash generation for any apparel retailer, and lululemon’s Q3 FY2025 10-Q makes the mechanics impossible to ignore.

The company reported net income of $992.3 million for the first three quarters of fiscal 2025 which is a strong headline number. But on the cash flow statement, the inventory line item within operating activities shows a $517.5 million outflow for the same period.

So over half of Lululemon’s net income was absorbed by the build-up of products sitting in warehouses and stores (inventory). The balance sheet further confirms this as it saw inventories rise from $1.44 billion at the fiscal year-end on February 2, 2025 (Q4 FY2024) to $2.0 billion by November 2, 2025 (Q3 FY2025), a $555 million increase in nine months.

The gap between those two figures partially reflects foreign currency translation effects on internationally held inventory, but any way you slice it we are left with the same economic result, with Lululemon deploying over half a billion dollars in cash to build its inventory position heading into the holiday quarter.

Net income and cash generation are not the same thing, and inventory is the primary driver of why they diverge with retailers.

Cash leaves the business when inventory grows as product is purchased and paid for, but the revenue hasn’t been collected yet since the purchased product has not been sold yet.

The $517.5 million inventory outflow this year compares to $477.7 million over the same period in the prior year. This hints at the drag worsening by about $39.8 million year-over-year even as revenue growth slowed. Whether that inventory converts cleanly into Q4 revenue at full price, or requires markdowns to move, is the single most consequential variable for lululemon’s cash position and fourth-quarter margins.

A clean sell-through restores the cash and validates the build while excess inventory that requires discounting destroys both.

SPAC stands for Special Purpose Acquisition Company, and it is a publicly listed shell company created specifically to raise capital through an IPO and then merge with a private company by using that capital it raised to purchase the private company, therefore taking that company public. This is done so the private company does not have to go through the traditional IPO process. A SPAC is also called a blank check company. The reasoning for this nickname lends important understanding of a SPAC, as it is because the SPAC has no operating income and investors give money before they know which private company the SPAC will buy. Usually there is a set timeframe by management for finding an acquisition target like 18-24 months.

Oh, and just for full understanding, IPO stands Initial Public Offering, which is where a private company goes public by selling shares to the public for the first time, meaning the company then trades on a publicly traded stock exchange like the New York Stock Exchange and can be bought and sold by anyone.

The SPAC Process

Before we get into the SPAC bubble, lets delve a little deeper into how they work. They start with sponsors (usually private equity, hedge funds, financiers, etc.) who create the SPAC and invest a relatively small amount of capital in return for a larger portion of ownership in the SPAC such as 20-25%. This ownership is called the promote.

To see how this promote works, imagine a SPAC raises $100 million with its IPO, with shares selling at $10 each, meaning there are 10 million shares issued to the public. But the sponsors receive shares equal to that 20-25% of the total post-IPO shares we mentioned, so let’s say 20% in this case. So, since there were 10 million shares at the IPO, the sponsors receive 2.5 million shares after the IPO, as that would be 20% of 12.5 million shares (10 million/0.80=12.5 million total shares, so 12.5 million-10 million= 2.5 million sponsor shares). At $10 per share the sponsor stake is $25 million. So even though the SPAC raised $100 million, the sponsors received 2.5 million shares for a relatively small investment. So, the sponsors did not put in 20% of the capital, but they own 20% of the equity, even though they likely only put in $2-5 million for the setup costs. This means that if the SPAC has a successful merger and that stock trades for the same value as the SPAC at $10 a share, then that $2 million investment is worth $25 million, a 12.5x return immediately.

This sounds like a money printing machine on paper, but the merger must be completed. If no merger occurs in the allotted timeline such as 8-24 months, then the SPAC liquidates, giving all the public investors their money back, while the sponsors lose their entire investment. As you can imagine this distorts incentives, incentivizing sponsors to close any deal regardless of how good an investment it is if the time limit is nearing, which is what led to the SPAC bubble associated with the boom in SPACs in 2020-2021, but it’s not quite time to talk about that yet.

So back to the IPO. Investors who buy the shares that are offered have no knowledge of what the acquisition target may be. The money from the IPO gets put into a trust account to earn interest, because if it can take 18-24 months to complete a deal, nobody wants to lose money on inflation or devaluation by letting that money do nothing.

We should briefly cover SPAC warrants. A warrant gives the holder the right to purchase shares at a fixed price farther down the road. This leads to another potential issue, dilution. Upon IPO, the public investors typically receive a fraction (1/3 or 1/2) of a warrant per one share. If we have 1/2 warrant tied to each public share at a fixed price of $12, then the original 10 million shares now have 5 million warrants, with each warrant allowing the purchase of one share at $12. If all 5 million warrants are exercised, then 5 million new shares are created, diluting current shareholders. Now instead of a total of 12.5 million shares, there are 17.5 million shares, which is a 40% increase in share count. Sponsors and original shareholder shares are now worth a lesser percentage of company ownership.

Then add PIPE (Private Investment in Public Equity) Financing, where institutional investors would commit additional capital during the merger at favorable terms, furthering dilution, and we could go much deeper. But for the context of this discussion this should suffice.

When the SPAC finally finds a private company to merge with, the shareholders of the SPAC vote on it, and investors can redeem their shares for cash.

If investors redeem their shares for $10 and get cash back, the public share count lowers. So, if 70% of shareholders in the SPAC redeem prior to the merger, only 3 million public shares remain, but the sponsors still own 2.5 million shares, so they now own a whopping 45% of the company instead of the original 20%. And since investors cashed out, this also means far less cash for the company than they were expecting.

But once through that process, if they obtain approval, the private company is then taken public through this merger. This is called a de-SPAC transaction. It is an alternative to a traditional IPO where a private company takes itself public by selling shares of itself to the public.

Why Use a SPAC Instead of a Traditional IPO?

Theres a few reasons that private companies would choose to use a SPAC instead of a traditional IPO to go public. SPACs are a much faster process due regulatory processes associated with traditional IPOs that can significantly slow the whole process down. This is in part due to a traditional IPO needing multiple years of audited financials, the drafting of S-1 filings and revisions, the roadshow, and pricing, among other factors. A SPAC is already public, so the SEC focuses more on the merger proxy (S-4) instead of the drawn-out process associated with traditional IPOs.

A SPAC also avoids the risk that roadshows add due to pricing risk since pricing depends on demand for shares in the stock, meanwhile the valuation on a SPAC is negotiated up front with the sponsor.

With a SPAC, forward-looking projections are less restricted meaning they can use much more aggressive projections, which can mean exaggerated projections that can benefit the private company, but lead to false narratives for the SPAC investors. This is in comparison to traditional IPOs where aggressive forward projections are heavily restricted and liability is much higher due to litigation risks if forward projections are aggressive and considered misleading to investors down the road.

When capital is abundant, SPACs become more appealing, as they can go public before they are even profitable while simultaneously obtaining high valuations. While this may be a benefit to private companies, let it also serve as a warning to SPAC investors and future buyers of SPAC companies. Do your due diligence before making any major investments.

Things have since changed somewhat since the bubble, which we will now get into since I would say we have sufficiently covered what a SPAC is and how it works.

The SPAC-tacular Bubble of 2020-2021

During this period, SPACS became wildly popular with their issuance exploding. This was due to low interest rates, liquidity in the market due to stimulus money injected into the economy due to COVID, and a surge in speculation.

But this all goes back to those incentives we were discussing earlier. Since sponsors lose their entire investment if no deal is made, and they stand to realize a large if a deal is made, they have an incentive to close any deal, regardless of whether it is a good investment or not. Speculation from retail traders only added to the frenzy as they drove prices up prior to the completion of the merger.

But as is typical, when money policies are loose, and credit is both cheap and easy, we see increased risk taking and spending. In this case, with interest rates near zero to try and stimulate an economy that was depressed due to COVID, and plenty of liquidity abound (remember this is due to the stimulus money injected into the economy to try and jumpstart it as well as quantitative easing from the Fed, causing the money supply to expand rapidly), the risk people were willing to take on was at abnormally high levels. To add to it, when rates are low it increases the present value of future cash flows, which means the valuation of high growth companies get inflated. Many of these companies likely would not have been allowed to IPO through traditional means, yet they went public through SPACs anyway.

Then, as we so repeat throughout history, when interest rates begin to rise, money becomes more expensive, and credit becomes tighter, causing risk-appetite to collapse. This is exactly what happened in 2022 when the Fed raised interest rates, which made the present value of cash flows we mentioned earlier work in reverse, meaning lower valuations, as well as tightening liquidity. This means investors now are becoming more risk averse as their appetite for risk subsided.

SPACs, being highly speculative, suffered disproportionately as a large number of SPACs fell 70-90% in value, with many of them trading below their IPO price. This meant that most of the companies underperformed their highly aggressive forward projections. Who would’ve thought?

To add to the madness, effective dilution could mean 30-50% dilution of shares, with a thin public float. There is plenty of data that suggests that post-merger SPAC returns significantly underperformed traditional IPOs. So, when taking into account the economies role, sponsor promote dilution, warrant dilution, the misalignment of incentives, and the decrease in regulation and scrutiny these SPACs had to face, it is easy to understand how a bubble was able to form.

Just How Big Was the Bubble?

In 2020 there were 248 SPAC IPOs, followed by an even grander 613 SPAC IPOs in 2021. This was massive when you consider that from 2009-2019 there were a total of 226 SPAC IPOs, with 59 of those being in 2019. This data is provided by SPAC Insider. In 2022 that number fell sharply to 86 SPAC IPOs, and then even further to just 31 in 2023.

Across 2020 and 2021 SPAC IPOs raised proceeds of ~$245 billion according to SPAC Analytics, an incredible number reflecting this bubble. This is in comparison to just ~$13.6 billion in 2019 and $13.4 billion in 2022.

There was a very high redemption rate during this period with investors pulling their money prior to the merger. Bankruptcies of de-SPAC companies followed.

The SEC also put SPAC IPOs under regulatory scrutiny, something there wasn’t much of prior to the bubble. Accounting rules were tightened, aggressive/excessively optimistic projections were targeted, similar to how they are under traditional IPOs, and disclosure requirements were increased.

These companies included many EV, fintech, space, and biotech companies, although the list goes on as long as they matched the lower quality traits we talked about earlier such as little to no revenues or profits yet and aggressive forecasts.

How Did This Relate to Dr. Burry’s Deep Dive on Palantir?

Dr Burry had the following remarks in his article Palantir’s New Clothes: Foundry, AIP, & the Failure of Reason, when talking about Palantir and SPACs.

Palantir invested $450.5 million into approximately two dozen SPACs at the height of 2021’s SPAC mania.

The investments came with quid pro quo terms – the SPACs were to purchase Palantir’s software and consulting. The investments were instead cast as strategic in nature.

Bloomberg and SEC filings show it lost the vast majority of its investment in the SPAC bubble. All three companies that Sankar touted during the conference call are now bankrupt or zombified. Lillium spent $1.5 billion over nine years to build a drone that could not fly much longer than 5 minutes. Sarcos was to make Iron Man suits. Just silly.

The fall was not pretty.

This circular revenue arrangement involving those “Day 0” SPAC companies is likely not the only example in Palantir’s short history as a public company. Of course, it is rampant in the AI buildout, as I have mentioned.

Dr. Burry is talking about large investments that Palantir made in SPACs specifically during the SPAC IPO boom we just discussed. The investments were essentially false in nature. Dr. Burry claims, and makes a good case for the claim, that these investments in SPACs by Palantir were not based on investments into good companies, but rather investments in companies to increase their revenues, regardless of whether it was a good investment or not. He then talks about three companies that were prime examples of failed investments with the purpose of inflating or artificially creating customers and revenue.

Again, I highly recommend that you go read his article, which does require a subscription, but I assure you, in my opinion, is well worth the investment. And now that we’ve covered SPAC IPOs thoroughly, we can look to the next topic, or investment idea. If you have any you’d like to see or have featured, please leave a comment and I can make it happen. Thank you all for taking the time to read this!

So why do I mention all this? To bring to attention some of the largest success stories attributed to venture capital that have impacted your life in a multitude of ways. But now that we see some of what venture capitalism has done, let’s take a look at what it actually is

The Underlying Mechanisms

Venture Capitalism (VC) is where firms or funds provide funding for young companies with high growth. This is a form of investing but in exchange for the funding, the VC firm receives some equity ownership in the company, hoping to profit from the success of the company.

But the risks associated with this form of investing are high. Many companies end up failing, so the VC firms hope that the success of their few winners will overcome the losses of their failed investments.

But VC firms play a crucial role in entrepreneurship as they fund a gap in the growing stage that otherwise likely would not be filled. This is due to startups at this stage being too risky for banks or public markets (through IPOs) to take on, so VC fills that gap.

Understand that these VC firms are not lending money like a bank would, they are buying a part of the company (equity). Banks won’t lend to them because since they are in the early stages still, they tend to have very low revenue, few assets to use as collateral, and they tend to have negative profits (losing money). So, a risky company with none/little profits, very little collateral, and low revenues - you can see why a bank wouldn’t want to loan to them at this stage.

The Early Years of a Startup and VC firms’ Role

Once an idea is born, funding is required to pursue it. Most usually start with investments from friends and family, angel investors or their own savings, but after that comes the funding rounds.

Usually, the first rounds of funding are referred to in stages, with the first stage being Seed Funding. This is the first significant round of funding to help the company grow. It usually allows the startup to build early prototypes, hire employees, and test the market to gauge interest. While VC firms usually don’t run day-to-day operations, they do tend to guide the startup. This is where VC can begin to come in.

After the Seed Funding round comes the Series funding where big VC firms step in. First is the Series A, followed by Series B, then by Series C, and so on until it is time to do an Initial Public Offering (IPO). Each of these funding rounds sells ownership in the company so the less funding needed usually the better. But these funding rounds are where the startup sees major growth.

The IPO is one way in which VC firms and other investors realize a return on their investment, by selling their shares to those in public markets antsy to buy this company that the VC firm has already made a lot of money on. Note that the IPO is another sale of ownership in the company, but this time to the public. But VC firms can also exit through the acquisition by another company or through the sale of secondary shares, which just means you are selling the shares to another investor in the startup.

How involved the VC firm is depends on both how that VC firm operates and the stage the startup is at, but usually the VC firm will take a board seat, help strategize, increase the startups network and connections, and aid in raising money down the line. If its later stage it may not need as much guidance as an early-stage startup would need. While VC firms usually don’t run day-to-day operations, they do tend to guide the startup.

• Using VC funds dilutes ownership and makes rapid growth the main priority over general survival.

Results of VC Funding and Guidance

There are usually three results that are seen from VC Funding, with the most common one being failure. Many startups fail because the product/service they are building doesn’t have an actual market need, as some ideas sound good in theory, but in application are obsolete or not of much use or improvement. No matter how good your invention may be or is, if there isn’t demand for it then it won’t succeed. Sometimes it may be a good product/service, but the startup runs out of cash because they aren’t seeing the required growth needed to continue operations, since startups burn cash rapidly. With this, the costs sometimes don’t generate enough profit for it to be worth it, making it uneconomical, even if the product/service has a beneficial use. These startups can fail due to large companies who are competitors in the market they are trying to enter making it tougher to succeed. Large companies have advantages such as being able to engineer the same or a similar product, having much larger spending budgets. These corporations do not want to lose market share. And lastly just like anything in life, timing is everything. Sometimes ideas are ahead of their time, or sometimes they may be late to the party where it is hard to join an already crowded market.

The middle ground result is where the startup sees some success but never really produce the mouth-watering returns that VC firms and the startups themselves dream of. This can be due to a market being existent, but smaller than anticipated limiting growth. Competition may also be heavy preventing companies from dominating a market. In terms of lower profits for the VC firm, it can be a result of the startup being acquired by another company to early. One of the most overlooked perhaps is that just because a company is increasing revenues, does not mean it is also scaling its profits. If margins are low, or customer acquisition costs are high, this can become a persistent issue.

And then there are the superstars. These are your Google’s, Amazons, and Netflix’s. These are the companies that see massive success and usually make up for all of the failed startup investments. These companies enter into markets that have a lot of room to grow or are massive in size already. The market must accept them. They run efficiently scaling the business in all aspects, most importantly, profits. Again, timing is important here too, too early or too late can spell failure or modest success that may also been seen as a failure. And one thing that goes for all startups if they want to success, but can also lead to failure, is the founders and executives giving everything. They have to be willing to do whatever necessary, making smart decisions with who they hire and how the business is ran. These are not the only reasons why startups either fail or succeed, but they are some major ones that you need to have an understanding of.

And for those of you who like numbers, an average VC fund has the following expectations:

• 65-80% of investments will fail

• 10-20% will return modest gains

• 1-5% will generate massive returns

We need to be clear on our definition of fail. It does not mean a complete loss of investment, because there are many numbers to look at. 30-40% of these startups end up liquidating completely (no money returned to VC firm), with another 35-45% returning less than they capital they invested. Another interesting number, the top 10% of venture investments generate 60-80% of all returns in the industry. These numbers are provided by an article written by Gil Pignol, which I will link at the bottom, and is a great read for why startups should avoid VC.

What this means is that out of every 100 companies, about 65-80 of them will lose all money or not return the full investment, 10-20 of them will see some success but never reach glory status, and 1-5 of them will see massive success and contribute the vast majority of the firms returns.

Power-Law Distribution

The Power-Law Distribution explains that a small number of things account for a large share of the outcome, while the majority of things contribute very little. In VC, the ‘thing’ is startups, and the ‘outcome’ is the returns. There is an uneven distribution, due to outliers dominating, so VC funds diversify to increase their odds of hitting it big on one of these companies

.

Why Tech Companies Seem to be Favored

Tech companies have the advantageous ability to scale fast, since software can easily reach millions of people, especially with how much technology itself has been incorporated into our lives - and it can do this relatively cheaply. On top of this, margins can be very large, another major green light for VC funds.

But this isn’t rainbows and lollipops. Some of the risks can be massive, such as a company experiencing major growth without profit. This is something we saw during the Dot-com bubble in the late 1990s into the early 2000s creating extremely overvalued companies. An economic downturn can also cause weaker startups to fail even if they have a solid product/service.

What This all Means

VC plays a critical role in our financial infrastructure, as mentioned at the top of this article. Many major innovations we have today likely wouldn’t exist or would not be what they are without the access to funding that VC provided. Think of how much cheaper and easier access to resources we have gained due to this. Anyone with internet has access to a massive amount of information than can be used for education thanks to companies like Google, Amazon has made shopping both cheaper and much easier to do as you can just scroll on your phone or laptop, and both Uber and Airbnb have led to cheaper, easier access ways to travel. And these are just a few examples; there are many more like it. VC leads to faster innovation and economic changes.

Gil Pignol Article Link

Why Most Startups Shouldn’t Raise Venture Capital