Cathie Wood, the head of ARK Investment Management, was interviewed on CNBC last week. Ms. Wood is one of the most visible fund managers of this Covid and post-Covid era, and is renowned for taking large positions in firms where emerging but scalable technologies are central to their businesses. Tesla, for instance, is one of her funds’ top positions. Read this NY Times article if you want to learn more about Ms. Wood and where she comes from.

Wright’s Law

One notion that Ms. Wood addressed during the CNBC interview was Wright’s Law. I knew about Moore’s Law, but not Wright’s Law, so I looked it up. Theodore Wright was an airplane engineer during the 1930’s. Despite his last name and involvement with airplanes, Theodore does not appear to have been related to Wilbur or Orville, as the latter two did not have children. Anyhow, Theodore developed a formula that forecasted by how much the cost of manufacturing airplane components would decline as production increased. The “by how much” is the key. Whereas Moore’s Law posited that the number of transistors on a chip would double every two years, Wright’s Law predicts by how much the cost of components would decrease over time. As the concept of Moore’s Law has been broadened to address many other (mostly high-tech) industries, so too does Wright’s Law apply to industries other than the airplane industry.

ARK’s Usage of Wright’s Law

Ms. Wood and the people at ARK use Wright’s Law to calculate how much costs will come down over time as companies’ production grows. ARK has found that Wright’s Law is remarkably accurate in forecasting these costs. For instance, ARK uses Wright’s Law to calculate the cost of lithium ion batteries, which are central to Tesla. According to this article from 2019 on ARK’s website, ARK forecast that Tesla’s gross margin for the Model 3 would be 30% by the end of 2020. Guess what? According to its latest annual report, Tesla’s “automotive gross margin” as of Q2 2021 was 28.4%. Pretty darn close to the 30% forecast. It has helped also that Tesla has been able to maintain its sales prices, a function to which Wright’s Law does not apply. As a result, while other investors concern themselves with supply and production issues or with Covid and the likelihood that electric car sales would increase, ARK’s focus is mostly on declining production costs as calculated through the application of Wright’s Law.

Secret Sauce

The more I investigated, the more it appears that ARK’s use of Wright’s Law is really its secret sauce. By using Wright’s Law, ARK has calculated by how much costs should decrease in fields such as autonomous tech and robotics, genomics, FinTech, and Space. ARK looks far into the future but it may not look so hazy to them if they believe the costs of all of these futuristic technologies will decline and by a specific amount. As a result, ARK’s assets under management in its principal Innovation Fund have grown from about $8 Billion a year ago to about $21.6 Billion currently.

IMO

I find it interesting that this theorem was devised not from the professorial ranks but from an engineer who worked within the industry. Likewise with Moore’s Law. All of that practical, hands-on experience is invaluable. Also, that Cathie Wood and ARK use the Wright’s Law concept and apply it to all of these other industries is a good way to get a handle and focus on what the future may look like. Let’s keep watch on them.

FYI

Wright’s Law is as follows:

Y = aX^b

Where:

Y = cumulative average time or cost per unit

a = time or cost required to produce the first unit

X= cumulative number of units produced

b = slope of the function

I read a post titled something like “Top Mistakes People Make With Their Money.” One of the Mistakes was what the blogger called Icebergs, and I thought that was clever. When you think about an iceberg, what comes to mind? Perhaps the first thing is The Titanic. Hopefully the second thing is that most of the hazard is underwater, where you can’t see. This is why The Titanic sunk. In the financial planning field, icebergs are investments or purchases you make wherein the initial purchase necessitates substantial future purchases, such that you are on the hook for a lot more money than you forked up for the initial purchase. Icebergs are especially prevalent with hobbies, and I am guilty of iceberg purchases that have cost me. Let’s examine.

Boating

Lots of people go boating, but most of those people don’t really need the boat. Boating is an excellent example of an iceberg purchase. Once you buy your boat, you have to store it somewhere, either in the water or on dry dock. That costs money, as does gas and maintenance. Oh, yeah, gotta insure the boat, and also maybe your liability insurance goes up due to the boat. Maybe instead of just a boat slip, why not just buy a place on the water that has a dock? That’s more iceberg spending. Then, what are you going to do with the boat? Go fishing? Then you need special expensive fishing equipment. Water skiing? Same thing. Soon, you can see why people say the 2 best days of a boat owner are the day they buy the boat and the day they sell the boat. Boats are really fun, though.

Music

You love music and you either already play the guitar or you want to learn, or maybe you want to be part of the new interest in vinyl. You buy your first guitar, and then soon you want a second. And then a third. All justified because they all sound a bit different, of course. Or you buy a nice new turntable, but you decide after playing them that those old LPs you saved from 40 years ago don’t sound that great any more, so you need to buy new ones. Pretty soon your high-end sound Jones starts to cost you a pretty penny. Guitar players are famous for their appetite for more and more guitars. Apple Music at $15/month sounds like a good deal by comparison. Music is a great example of an iceberg hobby.

Rental Property

Let’s turn to something that you think (hope) will make you some money in the future. You want to diversify your portfolio and so you decide to buy some rental property. Beware of icebergs here! Unless you are handy, you will have to hire others to do the upkeep and maintenance work. There is a labor shortage, so what does that mean for how much you will need to pay for your maintenance? Then there is the eviction moratorium: landlords cannot evict non-paying tenants due to the Covid-caused economic disruption. Now you have a property that you need to continue to maintain but you have reduced or perhaps no income from your tenants. Because of supply disruptions, the costs of lumber or plumbing that you need for your repairs are likely higher. There are icebergs aplenty with rental properties.

IMO

Everyone needs hobbies. Either undertake hobbies wherein the iceberg expenses are limited, or understand and prepare for the iceberg expenses of the hobbies that you do have. Be careful even with purchases wherein you hope to make a return at the end. Once you own something, there is a good chance you will need to have some further outlay in order to use your something or even just to make it run. Make sure your eyes are open to that likelihood.

This post is especially appropriate for younger readers, and you can determine for yourself what “younger” means. I recently read an article written by someone my kids’ age. The article said that saving money is a “bogus” financial planning recommendation, and that one should invest money rather than save money. Now, I will forgive the young lad who wrote the article that there is a serious flaw in his thinking – that one first has to save money in order to invest it. However, the more I thought about the article and and that it was written by someone my kids’ age, the point became clearer: Saving is boring, but Investing is exciting. If we change our focus from the boring part to the exciting part, perhaps things will improve overall.

Saving is Boring

Who wants to save? Where is the excitement in that? Save for what or for when? Many people, youngers especially, live only for today, either by choice or out of necessity. And, when you are younger, you likely don’t want to sacrifice a good time or a new purchase in order to stow away money for a rainy day that may never come. Moreover, if you save money, you might risk being labeled a Cheapskate. The peer pressure is on the side of spending money and not saving it. Your parents told you to save, but your parents also told you to clean up your room, and what fun is there in that? Yet, as everyone knows deep down that they should keep a neat room, they also know they should save some money. Perhaps what we need to do as planners is to change the focus from the “saving” aspect to the “investing” aspect.

Investing is Exciting

Investing money is now becoming cool, especially among the younger, just out of college demographic. Newly IPO’d Robinhood is a favorite among this group, as are chat sites through Reddit and other platforms that allow investors to brag about their success. It is a lot more interesting on social media to discuss your stock portfolio and winners therein than to talk about what you saved or didn’t spend. It is also a lot more interesting to earn a return on the money you save and invest, even if the risk is greater.

IMO

The young author of the article I read said that, although they have only a small amount of “savings”, they did own a sizable (for their age) investment portfolio. So, in a way, all we are talking about here is asset-class allocation within one’s portfolio. For younger people especially, and with the interest rates on money market or other savings accounts at banks near the 0% mark, it is more prudent to allocate a higher percentage of one’s portfolio to riskier asset classes such as stocks. If you take a hit on an investment, you have a lot of years to make it up. By changing the focus from less-exciting savings to more-exciting investing, perhaps we planners can persuade more younger people of all ages to put themselves in a better financial place, more able to withstand the challenges that life gives them.