If I had to recommend just one book about investing, I would recommend The Bogleheads’ Guide to Investing. It presents information in a very easy to digest format and the authors cover many different subjects that are relevant to all stages of life, from what to do with that first paycheck, all the way to how to plan an estate.
I was able to skim through the book in a single night, mostly because I am already familiar with the Boglehead approach to investing. Hint, it is the same one advocated by Vanguard.
So if you haven’t jumped into the investment pool yet because of fears or apprehension, then this is the book for you. If you are already swimming in the waters and want a refresher, this is also the book for you.
Deflation, by Chris Farrell, covers a topic that is almost unheard of in present day America, what happens when prices fall? We are so accustomed to inflation, the opposite of deflation, where prices rise over time and a dollar is worth less tomorrow than it is today that we hardly even think about deflation.
In his book, Mr Farrell argues that the next century will be ruled by deflation. He pins the trend reversal on increasing globalization, the spread of capitalism, and the internet. I can attest to the internet’s deflationary power because I experience it first hand with my software business. Not only can I sell to customers around the world, I also have to compete with other companies around the world. Some of those companies reside in 2nd or 3rd world countries with lower costs of living and lower income needs. That means they can drag my prices down. To remain competitive, companies including my own lose pricing power and the customer gains it.
It sounds like deflation is a great thing for John and Jane Doe consumer right? Well, as companies lower prices to remain competitive, they bring in less revenue. Why should I buy a car today when it will be cheaper tomorrow? With less revenue due to slimmer margins and deferred sales, businesses cannot support their payroll expenses. Worker wages are often referred to as “sticky”, meaning that workers are resistant to lowering wages. Who *wants* to have their income cut?! When a business cannot lower wages across the board, they resort to laying off workers. Sure, a carton of eggs in deflationary times might only cost 50¢ but that doesn’t help the unemployed person very much.
The biggest losers in a prolonged deflation are debt holders. The “Buy it now, pay for it later” mentality of inflationary times does not transition well to a deflationary setting. Consider this scenario. John Doe buys a house with a $250,000 30 year mortgage at 4%. At the time he buys the house, he is making the median American income of $50,000. The monthly mortgage payment is around $1200. That would peg his yearly housing costs around 29%, a number that falls into the popular rule of thumb to keep housing costs below 30% of gross income. Fifteen years later amidst constant deflation and his income may have been reduced to $30,000, but his mortgage has not deflated. It now consumes 48% of his gross income. Everything else that John buys costs less due to deflation, but his mortgage payment has not decreased.
A deflationary threat will likely continue to hover over the world. In aggregate, reflationary monetary policies will continue to counteract the disinflationary drag of post-financial crisis global deleveraging. As suggested in Vanguard’s past outlooks, recent consumer price inflation remains near generational lows and, in several major economies, is below the targeted inflation rate.
Key drivers of U.S. consumer inflation generally point to price stability, with core inflation in the 1%–3% range over the next several years. Nascent wage pressures should build in the United States in 2015 and beyond, but low commodity prices and the prospects of a strong U.S. dollar should keep inflation expectations anchored. In Europe, deflation remains a significant risk that will not soon disappear
Some of those words might have stuck out to you, like “targeted inflation rate” and “price stability”. After learning hard lessons over the past century, central banks have agreed that a targeted inflation rate of about 2% is ideal. They try and control that by raising or lowering interest rates (this is what ultimately sets your mortgage rate) and adding or removing money from circulation (liquidity).
I wouldn’t recommend the book Deflation to anyone unless they were die hard monetary fans. The book reads a lot like a term paper or thesis and tends to take its time snaking around various historic examples and anecdotes to make its points. I had to check it out of the library twice and still gave up before finishing it. You can read more about macro economics (what inflation and deflation are categorized under) on this website.
School starts tomorrow for our local K-12 schools. That means that you should be wrapping up your summer reading program. We finished ours and turned in our logs a couple of weeks ago. Some of the goodies that we got included a half pound of beer nuts, a free haircut coupon, and a free zoo admission coupon.
I didn’t finish Do Fathers Matter as there are only so many ways that the same conclusion can be reached in the span of 200 pages. I was in the mood for another personal finance book so I picked up a copy of Dave Ramsey’s The Total Money Makeover from our local library. For those of you who are unfamiliar with Dave Ramsey, let me give you a few bullet points about him.
He runs a self syndicated radio show that ranks in the top 10 in listenership
He has authored several New York Times best selling books about personal finance
He is anti debt
He is openly Christian and uses bible quotes in his books and on the air
His methods are controversial
The last point I will share my own thoughts as I walk through my summary of The Total Money Makeover.
What’s it all about?
Ramsey models the book after a fitness plan (there are many fitness analogies) and lays out seven steps to take the reader from debt laden to a golden retirement. The first five chapters cover some (un)common sense items about personal finance such as the importance of not racking up debt, ignoring the Joneses, the stupidity of gambling, and the importance of insurance. The next seven chapters Ramsey describes each of the seven steps of his plan along with some of the frequently asked questions. The last chapter paints a rosy picture of how good life will be once you have completed the makeover. It is also the chapter where his Christian ideologies come out in full force for better or for worse.
Step 1: Save $1,000
According to Ramsey, the first thing you should do to get out of debt and start building wealth is to put aside $1k for emergencies. Well, technically there is a step 0 where you have to get current, pay off any past due bills, on all of your existing debts. I digress. Ramsey spells out what qualifies as an emergency and what doesn’t. Christmas for example, isn’t an emergency because Christmas comes at the same time every year. The reasoning behind saving up $1k first is to keep you from sinking into any more debt when a real emergency such as your car’s strut coil blows out.
Step 2: The Debt Snowball
The second step of Ramsey’s plan is in my mind one of the most controversial points in the entire book. First I’ll describe the step as detailed by the author and then I will add in my 2¢.
With a $1k emergency fund in place, Ramsey suggests that the next prioritization to building wealth is to eliminate all debt. To do this, he recommends that you list all of your debts that are less than 50% of your gross annual income on a sheet of paper from smallest balance (e.g. $54 cell phone bill) to largest (e.g. $35,000 student loan). Then cut up all of your credit cards so you won’t use credit ever again. Finally, put every penny you can muster into paying off the smallest balance first while continuing to make the minimum payment on all of your other bills. When the smallest balance is paid off start on the next smallest and so on. If at any time your emergency fund dips below $1000, stop making extra debt payments and replenish the rainy day fund. According to Ramsey, most people should be able to finish steps 1 and 2 with two years.
Here is where I have some bones to pick with the author.
Number one, I don’t think that credit is the anti-christ. Ramsey tends to portray things in a very black and white world view; good vs evil, up and down, on and off. Credit cards are labeled as bad and dangerous when in reality they are no more dangerous than say a hammer. Sure, if you continually hit yourself or someone else in the face with a hammer, you can do a lot of damage. If you use the tool properly, it can make life a little easier for you. His assertion that debit cards provide the same level of protection as credit cards is incorrect. Yes, on paper they offer the same protection against fraud, but reality doesn’t line up nicely with what is written in the fine print. I had my debit card number stolen earlier this year and let me tell you what a pain in the ass that was. For starters, when a thief makes a bunch of charges using your debit card, that money is GONE from your checking account. Bye bye money, I hope you weren’t planning on buying anything important anytime soon. You contact your bank’s fraud department and they ask you a series of questions, then you print off, sign, and mail some affidavits to back up your claim. They credit your account with what is missing (assuming everything has gone according to plan) and you wait 4-6 weeks for confirmation that you really were robbed and the temporary credit will be made permanent. Compare that to when my credit card number was stolen several years ago. It was issued by the same card company. I called them up and reported the fraudulent purchases and because it was the company’s money that was taken, not mine, they took IMMEDIATE action.
With all of that said, if you are one of 60% of individuals who carries a card balance, aka you don’t pay the card off in full each month, then you should probably consider cutting up your credit cards. Hitting yourself with a hammer is no fun.
Number two, I cannot whole heartedly agree with his prioritization of debt repayment. Smallest balance to largest completely ignores the interest rates associated with the balance. Mathematically speaking, one should pay off the highest interest rate balance first and continue down the line until they are at the lowest rate. Logically, my way saves more money and would have debts paid off sooner, but humans are illogical and the psychological boost from paying off small debts probably does help individuals tackle the harder larger debts later on.
Step 3: Finish the Emergency Fund
Once all your debts except the house are paid off, Ramsey encourages the reader to finish funding their emergency stash. For the average American a full funded rainy day stash will be between $10-15k. Ideally that money should be kept in a savings, checking, or money market (with check writing) account for easy but not too easy access. CDs, bonds, and dresser drawers are not recommended because they are either too easy or too hard to access money in an emergency.
Step 4: Invest in Retirement
Only after paying off all debts except the mortgage and having a fully funded emergency fund does Ramsey suggest that you start contributing to a retirement account. Even if your company offers a match, he still doesn’t recommend contributing until the first three steps are complete. I have another beef with this because you are giving up FREE money for the sake of having debts paid off a month or two sooner. If I had to pick just one point of contention between Ramsey and other talking heads in the personal finance world, it would be concerning his investment advice. Ramsey swears by large cap growth mutual funds and their ‘unshakeable’ 12% annum return. Many of his calculations later on in the book use this magical 12% number to support ostentatious claims about golden retirements on small monthly investments. In fact, Ramsey only wants individuals to contribute 15% of their gross income to a tax preferred retirement account because that will be sufficient. If you have ever played around with a retirement calculator, you know that a change of even 1% return compounded over 20-40 years will have a HUGE impact on the final outcome. Consider for a moment that the de facto number used for most stock market investments is 8% and you have a pretty glaring difference between what Ramsey is preaching as truth and what may be truth.
Step 5: College Funding
If you don’t have kids or they have already graduated college you can skip this step. Going along with step 4, Ramsey discourages the practice of prepaying tuition at todays rates in favor of investing in a large cap growth mutual funds via an Education Savings Account, or ESA. His justification is that prepaid credits will only earn the rate of college tuition inflation, 8%, which is less than his superior 12% mutual funds. While 529 plans are okay, he thought they were too restrictive, mostly because they don’t allow you to arbitrarily pick investments like an ESA does. An ESA isn’t without restrictions. For starters, you can only contribute up to $2000 a year. Unlike 529s, you cannot roll the money over to another beneficiary. If money remains when the ESA beneficiary turns 30 years old, it must be withdrawn at a 10% penalty on top of regular capital gains taxes.
Either way, I would highly recommend that parents set up something for their kids education expenses. Student loans are a great catalyst for a life in debt.
Step 6: Pay off the home mortgage
If you forgive the fact that we haven’t cut up our credit cards (because we pay the balance each month), then this is the step that we are currently working on.
whittling down the mortgage
As you have probably learned by now, Ramsey despises debt. His first recommendation is that people should avoid mortgages and put down 100% cash on home purchases. Failing that, they should secure a 15 year fixed rate mortgage and work to pay it off early (that’s the route we went). One of the interesting conundrums that this step is challenged with is how one secures a mortgage if they have religiously followed the above steps. By closing all credit accounts, one’s credit score will drop. A low credit score makes it more challenging to get a prime mortgage. Ramsey’s ‘solution’ is to find a small bank or credit union that still does in house underwriting without relying on a FICO score. To me, this sounds like scuttling around the issue. Sure, there are probably some financial institutions out there that won’t pull your credit score but c’mon, most of them will.
Step 7: Build Wealth
By now you should be completely debt free, including your house, your retirement is on track for a dignified exit from this world, and your children are set to graduate from college with no student loan debt. Invest, spend, and give become the motto for this step. Continue to build your wealth but take some time to spend money on yourself and the wants that you have denied yourself for so long. Finally, Ramsey encourages a healthy dose of charity to help those that are less fortunate. In Ramsey’s eyes, you are considered wealthy when your money makes enough for you to live on.
So there you have it, one of the most popular financial planning books on the shelves. Is it a perfect one size fits all plan? No. Would I recommend the book to someone caught in a debt vortex. Yes.
Share your thoughts on The Total Money Makeover plan in the comments. What step are you on?
I mentioned previously that we are participating in our library’s Summer reading program. The first book that I read was the Millionaire Next Door by Stanley and Danko. It was an interesting book and worth the read. The book, published in 1995, did feel dated at times, especially when talking about average incomes. It also made no mention of the burgeoning field of technology and all of the entrepreneurship opportunities there (the book talks a lot about how self employed individuals are statistically more likely to be millionaires compared to their rank and file counterparts).
The big takeaway that the authors hammer away at for the duration of the book is that wealthy individuals live below their means. In other words, they are frugal. Keeping up with the Joneses is stupid, because the Jones don’t have any money, they spend it all and spend everything that they can borrow. I like to think that we are living below our means. We have been in our house for 13 months now and have paid off 20% of the mortgage. Contrast that to the Joneses who most likely have a 30 year loan and would only be 3.6% done. How have we paid off so much of our mortgage in so little time? We live below our means and have started making quadruple mortgage payments each month. We also saved up before buying and were able to put down 66% on the house. If you put down less than 20% you are usually hit with PMI, private mortgage insurance. Those 3 little letters can add a substantial amount to your monthly mortgage payment so it is best to put at least 20% down on a house.
At this point, you may be wondering “What’s the point of being wealthy if you don’t spend money?” According to Stanley and Danko, millionaires do spend money on priorities such as tuition for their children and grandchildren, professional services including health care, accountants, and lawyers, and investing in their retirement accounts. The last one is most likely the largest motivator to accumulate wealth. Financial Independence, or the ability to live off one’s accumulated wealth without having to work to pay for necessities is the cornerstone of retirement.
The American dream/promise is that if you put in your 35-45 years of work, you can retire and laze about while enjoying the lifestyle that you had whilst working. The reality is that many Americans cannot afford to retire or maintain their lifestyles due to small savings and/or having a lifestyle beyond their means.
Retirement is a privilege, not a right
If that sounds too harsh read some of the statistics out there about the impending retirement catastrophe (okay the article and my wording are a wee bit hyperbolic, but my point remains).
Now for something completely different
I’ll step off my personal finance soapbox for now and pick up the next book on my reading list, Do Father’s Matter? by Paul Raeburn. I have read through the first chapter and so far the most interesting topic has been epigenetic inheritance. Way back when in 9th grade biology class, I was taught that a new living organism developed according to its DNA ‘blueprint’. My limited understanding of epigenetics is that they are kind of like doodles on the blueprint. Most of the time they are ignored or wiped off completely, but sometimes they affect the developing organism. In this way, it is possible for a male’s sperm to contain information in addition to the DNA. This information, according to Raeburn, acts as an environmental weather forecast for the developing fetus. “Hey fetus, there is no food out here in the real world, so turn on the genes that help you fend off starvation”. In this way, a father’s health at the time of conception plays a large role in the resultant baby just like the mother’s nutrition during pregnancy affects the fetus.
School is out for summer around here and that means that Summer reading programs are starting up. Our public library offers three programs, one for kids, one for teens, and even one for adults. Signing up was as easy as going online and filling out a form. All we have to do to complete the program is read 22 hours worth by August. Participants who complete the requirements are entered into a drawing for prizes. Last year they gave away nice things like iPads. Not a bad deal eh?!
We have been going to bed much earlier now that Frugal Boy is starting to get into a bit of a routine. Reading before bed is a great way to relax and unwind from a long day and it also makes reaching that 22 hour goal a walk in the park.
The first book that I am reading for the program is The Millionaire Next Door. I’m about a 3rd of the way through the book and it has had some good points even if it takes a long path to get there.
The book starts by categorizing everyone into 3 groups, under accumulators, average accumulators, and prodigious accumulators. It does so by using a somewhat controversial formula to determine one’s expected net worth.
Expected Net Worth = Age * Gross Realized Annual Income * 0.1
If your spouse works, then average your age and use your household income. Your net worth should include all of your assets (including house) minus any liabilities (mortgage, car payments, student loans, etc).
The authors say that anyone with half the expected net worth is an under accumulator of wealth and anyone with double the expected is a prodigious accumulator of wealth. Everyone else is average. Our ratio of 0.93 would place us in the average category.
The rest of the book goes on to examine why people are in the under or over groups. Most of it can be summarized by simply stating, wealthy individuals are frugal.
What books are you wanting to read this summer? By the way, if you have a public library, by all means use it. It is *free* only if you do not pay property taxes. Our *free* library cards cost us around $280 in taxes last year, so you’d better believe that we are going to try and get every dollar out of them.