You can’t really model a personal financial life because it would require accounting for marriage quality, job security, national economy, local real estate, schmoozing skills, resting heart rate, proclivity for gambling addictions, commitment to sunscreen, tendency to text and drive, and so on.
There is a perfectly valid criticism of social scientists that they use equations to pretend to be real scientists. The closer you are to the Sociology Department, the truer this is.
But such equations aren’t really an attempt to “prove” an irrefutable fact, so much as to reduce complexity down to something you can carefully follow. Just as prayer allows tiny humans to offer simplified thoughts up to an unfathomably complex God, so equations help us track the most important of a trillion variables all moving at the same time, most of which we can barely see, much less measure.
Equations are not “proofs” in the way a physicist would use them. They are more like intellectual stick-figure drawings. Is this the whole truth? No, but that is definitely the family dog beside Mommy and Daddy under a big yellow sun. Simple, but no confusion.
So with that, I present my stick figure equation of Fast and Slow Time.
The Equation
The factors that go into Fast Time and Slow Time roughly boil down to:
V= Volatility (the magnitude of price variance)
λ = how non-linear change is, or the “Wildness” of the randomness. We’ll call this the “Lambda Effect” (with apologies to physicists, who already use that term for solar turbulence)
C = Concentration, or if you prefer, Exposure. How exposed or concentrated is your financial life? Are you “all in” on one asset class or income stream?
DD = Debt Deadlines. It matters less how much debt you have, and much more when and how the debt is due. This includes payment schedules, but also how “callable” your loans are in a crisis. FYI, most HELOC loans are due when the bank says they are, and they are most likely to say “now” if you are in trouble.
L = Liquidity.
and, finally ….
ᵥ = applied volatility, or under the condition of volatility.
I am not aiming to provide a predictive equation because I can’t. But as a conceptual map, I think it helps in a stick-figure kind of way.
The factors work together something like:
The speed of financial time = Vλ x C x (DD/ Lᵥ)
The speed of financial time equals Volatility (and how wild it is) times your Concentration (how exposed you are on the volatility) times the relationship between your Debt Deadlines and your Liquidity when the volatility strikes. Notice a few key things:
1) Vλ means volatility amplified. Normal volatility stays linear: 1, 2, 3, 4. But when volatility explodes, the effects are exponential: 2, 4, 8, 16. In normal times, a change in one variable makes a small change in another. A 2% draw down in the market or a 5% raise matters, kind of. But in wild randomness, one change changes everything. The market goes up 30% and you’re rich! Or, instead of that raise, you get laid off and income goes from high to $0. Now all the ratios look different.
2) C is for concentration, or exposure. If you work on Wall Street, put all your money in index funds, and marry a stay-at-home spouse with a picket fence in Connecticut, you are highly concentrated in stock-world. You’re probably feeling as good today as your counterpart felt sick to their stomach in 2002. This describes me, btw (not the stay-at-home spouse part). 70% of my net worth is in real estate. If it goes up (as it has) I look great, and when it tightens (as recently) I can lose a year’s worth of salary in a month (a few percentage points on millions of dollars adds up). I’m highly concentrated. On the flip side, someone who has a job in tech, saves stocks and bonds, buys an annuity, is halfway through a 15-year mortgage, and dabbles in crypto is very much NOT concentrated. Volatility would have to be massive to wipe them out. When volatility catapults upward, though, their time is slower in that direction.
3) Notice what is NOT in this equation: “Equity.” Time doesn’t give a tinker’s dam about your net worth. My strong opinion on the meaninglessness of “Net Worth” is available on Amazon. In Fast Time, you’ll likely see your equity skyrocket or plummet before it can do you a lick of good. Historically, many people found out the hard way that their investments were most likely to crash at the very moments they needed them not to. When you must sell your house to get the money out, Zillow has no liability for changing the “Zestimate.” Speaking of which…
4) D (Debt) isn’t always dumb, but you can make it dumber with the other D (Deadlines). Historically, how much debt you had was less important than how the payments were structured. When (and how) is it due? If you have a 30-year 3.5% mortgage the size of that mortgage matters less than the payments. If you have a small business loan that fully matures in 6 months, time speeds up quickly. This is basically the entire history of Dakota farmers.
5) Lᵥ is liquidity when volatility hits, which is different than plain ole’ liquidity. Your HELOC, margin account, or credit card is liquidity, but under volatility it becomes less so. When loans get called, they shift from being L to being DD, and the equation goes with it. What you call liquidity very often dries up when you most need it. So be honest with yourself (and clients) about what counts, when.
To repeat:
FT/ST = Vλ x C x (DD/ Lᵥ)
I could do a whole thing where I assign a p-value and measure the exponent, but you’re already wondering if you should stop and so am I.
The point here is that you, your clients, and I live in financial time that speeds up and slows down as volatility (Vλ) hits our exposure (C, Concentration), and our exposure tests how capable we are to handle our debt deadlines (DD) with our suddenly very stress-tested liquidity (Lᵥ).
When Time speeds up, it can go well or poorly based on how you’ve aligned your ratios. Lots of Liquidity (i.e. a stable job) means you could take on loads of Debt Deadlines to overexpose yourself to one Concentration. That is exactly how I got rich… leveraging my job to take on debt to buy houses right as the shortage of them made their prices volatile (and exponential) to the upside. When Vλ struck, my C was high, because I’d increased my DD by lowering my Lᵥ.
Most people shouldn’t do that, and don’t want to. They want safety when Vλ hits, so they will want low C and a low DD over a high L. That’s what my grandfather did.
Of course, some people want one equation but are married to someone who wants the other, and that’s when you should call people who are experts in marital finance so another Big-D isn’t inserted into the equation.
Two Final Thoughts
I would value your feedback on this, since I think many people smarter than me will have their own insights, thoughts, feelings, or stones to throw. Hurl away.
I promise never to write like this again. What is the word? Obtuse? Stodgy? Turgid. No… I’ve got it… BORING! That’s it! In Part 3, we’ll talk about how to speed up or slow down time for yourself, which is kind of super-hero adjacent.