Tuesday, September 13, 2005

Financial Peace: Revisited

Dave Ramsey is a well known radio personality, hosting a three-hour personal financial advice show broadcast throughout the country. Dave's message is simple and can be described by the following tenets:

  • Maintain a written budget - spend every dollar on paper before the month begins
  • Personal finance is 80% behavior and only 20% math.
  • Debt is bad (there's no such thing as "good" debt)
  • Your income is your greatest wealth-building asset
  • Your success in life is largely dependent upon whether or not "you can leave the cave, kill something, and drag it home."

Dave got his start in life working as a real estate investor and, by the age of 25, had real estate holdings valued at over a million dollars. Problem was, he was highly over leveraged and really only had the illusion of wealth and prosperity. When the bank with whom he had most of the mortgages through was purchased by another bank, they called many of his loans, leading to an eventual bankruptcy.

At that point in life, Dave realized that his paper gains were just that - paper - and that in becoming a paper millionaire all he had really done was make a banker that much richer. The source of the problem was borrowing money. Dave vowed to never again borrow money from anyone for anything. He would live his life like his grandparents did, and what used to pass as common sense - if you want something you save up for it and pay cash.

Since losing his first million, Dave earned it all back and then some, starting as a financial counsellor and moving to books, radio shows, and speaking at live events. To this day, Dave does not borrow money for anything. He buys his cars with cash; any homes or vacation properties are paid for 100% up front. Dave, a Christian, quotes the Bible every now and then on his show, and one of his favorite passages is from Proverbs: "The borrower is servent to the lender."

Paying for a house or car with cash may sound like a nice idea, and may sound plausible for someone with the financial means of Dave Ramsey, but with credit card bills, kids, car payments, mortgages, and everyday "things" happening that cost money (a trip to the doctor's, a fender bender in a parking lot, a leaky gutter), it's hard enough to keep up, let alone getting ahead. Financial Peace Revisited is Dave's answer to those doubters. In this book, the second edition of Dave Ramsey's first book, Financial Peace, Dave shows the reader how to stretch their money, pay off debts, build up an emergency fund, and start winning with finances.

Financial Peace Revisited outlines Dave's "system" for achieving financial freedom. The book starts with Dave's life story, about his meteoric rise to wealth and his equally quick crash into brankruptcy.

After this rather personal chapter, Dave begins to outline his system, which starts with a written, monthly budget. Unlike The Wealthy Barber, Dave is adament about people keeping a budget, about having every dollar spent on paper before the month begins. Without a budget, Dave argues, the money will evaporate and you won't know where it's going! By having a budget, many people agree that it's like they have several hundred extra dollars per month that they didn't realize were being spent prior to a written budget.

A budget should always spend every dollar that comes in every month. If there is excess dollars after covering the necessities, place some money in accounts to cover expenses in the future, such as saving for a future car, or saving for property taxes that come due once every six months. Furthermore, the items in a budget should be prioritized, in case the money runs out before the month does. And regardless of your situation, the top three priorities should always be:

  1. Food
  2. Utilities (heat, lights, water, etc.)
  3. Shelter (rent/mortgage)

After covering the basics of budgeting, Dave goes over the fundamentals of money. "There's ony three things you can do with money," Dave explains: "Spend it, save it, or give it." This attitude is a fresh breath of air, and is rarely seen in personal finance books. Most personal finance books emphasize the personal aspect of finance, and encourage their readers to think me, me, me. Dave does the opposite - he contends that one needs to give in order to grow as a human being. And while Dave is a Christian and does bring in a discussion of tithing, his religious views are not overbearing and he does not make any attempt at pushing his beliefs upon his readers. Nevertheless, he does make a very good case in the power and importance in giving.

The middle part of the book reads pretty much like The Millionaire Next Door: live below your means; sacrifice now so you can prosper later; when investing, stick with simple, easy-to-use investment vehicles that are well-divesified with a long track record of above average growth; save more than you spend; the sooner you start saving for retirment, the better; be a frugal shopper. The latter portion of the book examines Dave's system for people in different places in life. There's a chapter for singles and a chapter for married couples. A chapter on money matters with children and a chapter on finances and family and friends.

The book concludes with a chapter on what Dave coins the baby steps. These are seven very simple steps for achieving financial peace. These steps are to be applied in order, with the participant giving "gazelle-like intesity" to each step. During a particular step, all income after the essentials are met should be put toward that step. If that means you are only paying minimum payments on your credit card balances, then so be it. The baby steps are as follows:

  1. Fund a $1,000 emergency fund. The emergency fund is only to be touched in an emergency, and is meant to provide a resource to tap in lieu of having to go into debt to handle the emergency.
  2. Work the debt snowball for all non-first mortgage debt. List your debt smallest to largest (ignore interest rates) and attack the debts in that order, paying only minimum payments on the other debts. Once a credit card debt has been paid off, cut up the card and cancel the account.
  3. At this point, the only debt you have is your home. Take the time to now fund a three to six month emergency fund.
  4. Save 15% of your income in a retirement plan.
  5. Start a college fund for your children.
  6. Start paying off your house early.
  7. Invest in real estate, mutual funds, and tax-deferred variable annuities.

By the time you reach step 7 you will have obtained financial peace and be 100% out of debt with three to six months worth of living expenses saved up. The final chapter on the baby steps in Financial Peace Revisited merely summarized each of the steps. In his second book, The Total Money Makeover, Dave delves into the specifics of each step in much greater detail and includes anecdotes from real-life singles and couples who have applies Dave's system and have obtained financial peace.

Overall I highly recommend Financial Peace Revisited, as it does a great job outlining Dave Ramsey's philosophy on personal finance. It is a bit skimpy on the baby steps details, but that can be picked up from either The Total Money Makerover or by listening to Dave's popular radio show.

Financial Peace Revisited : ISBN 0670032085 : Published by Viking Books, December 1, 2002

Friday, September 02, 2005

Rich Dad's Prophecy

Rich Dad's Prophecy is yet another book from self-made millionaire Robert T. Kiyosaki, who authored the popular book Rich Dad, Poor Dad. Prophecy talks about Rich Dad's prediction, made back in the 1970s, that the stock market would face a major crash sometime around or after 2012.

In short, Rich Dad's prediction was made due to the passing of ERISA in 1974. ERISA is the Employee Retirement Income Security Act, and is the law that setup the defined contribution retirement plans, of which the 401(k) is the most known. Defined contribution plans are retirement plans where an employee (and possibly the employer) make defined contributions to the retirement plan; they are opposite of defined benefits plan, which are pension plans that guarantee the retiree a defined benefit each year after they've retired.

Rich Dad argues that ERISA promises a major stock market correction around 2012 for a number of reasons, including:

  1. Whereas defined benefit plans had skilled teams managing the pension funds, ERISA moves the burden of retirement investing to the employee, who is not trained to be an investor. These untrained investors are more likely to invest in poor choices, to not monitor their investments, and to buy and sell at the absolutely wrong times. (Like The Wealthy Barber, Kiyosaki lambastes the lackluster job of financial education our public schools provide.)
  2. ERISA requires mandatory withdrawals beginning at age 70.5. The bulk of the baby boomer generation will be reaching this stage in life around 2012. This influx of forced sellers will drive the equity market down.
  3. People are living longer. With inflation and increased health costs, retirees will quickly run out of their defined contribution plan's nest egg, at which point they'll be dependent on family or the State.
There are some periphery reasons expounded on throughout the book, but those three are the main sticking points that Kiyosaki hammers home.

Clearly a stock market crash of the proportions discussed in this book would lead to a decimation of the U.S. economy. Kiyosaki talks about this, pointing out how "the fairy tale" may be over. Our nation has enjoyed more than a half century of prosperity, but Kiyosaki sees that coming to an end in large part because politicians have continually "passed the buck" to future generations. Rather than fixing existing serious fiscal problems, the government pushes the pain forward to the next generation. Think social security or Medicare. Both of these systems are doomed to fail if no changes are made, but rather than tackling this problem today, politicians keep pushing these grave matters onto the next generation. Kiyosaki argues that this must end at some point, and sees this end coming as the baby boomers wane into their golden years.

Like Kiyosaki's other books, Prophecy is an easy and quick read. Part of what makes this book so digestible is it's structure - it's divided into two sections, the first asking "Is the fairy tale over?" and the second examining how to build one's "financial ark" to withstand the coming storm. What I especially enjoyed was Kiyosaki's own story from rags to riches, which was interspersed throughout the first half of the book. I had always wanted to have more of a background on the Rich Dad, Poor Dad's own business background. The second half turned from more of the doom and gloom aspects of the first half and aims to motivate the reader to start planning today. Kiyosaki details how to build your "financial ark" and how to maintain control of it. He talks about how he built his ark, and how to gain control over those nagging elements that prevent people from building an ark (lack of time, excuses, fear of the unknown, and so on).

Kiyosaki's tips for building the "financial ark" are very boilerplate Rich Dad, Poor Dad mantra. If you're familiar with his other books, you'll not find anything new or insightful here. It's more of the same: increase assets, decrease liabilities; cashflow is king; investing in businesses and real estate is the road to wealth. If you are new to the Rich Dad, Poor Dad series, this is clearly not the book to start with; instead, start with the first book in the series,
Rich Dad, Poor Dad.

Kiyosaki concludes with a chapter aptly titled "A Prophet's Hope Is to Be Wrong." While Kiyosaki paints a rather bleak picture of what he thinks our nation's financial future will entail, he desperately wants to be wrong. And honestly, the truth is probably somewhere between the worst case and the best case, as it usually is. Overall, this book is one I'd recommend that everyone of working age read, as it brings up some great points about defined contribution retirement plans and some serious problems that we, as a nation, are going to need to face sooner than later. If you are a fan of Kiyosaki's past books, you'll also enjoy the insight he shared into his personal road from rags to riches.

Rich Dad's Prophecy: ISBN 0446530867: Published by Warner Books, 2002.

Wednesday, August 24, 2005

The Wealthy Barber, 3rd Edition

The Wealthy Barber, by David Chilton, discusses issues personal finance, retirement, savings, and insurance in a "novel" way. Rather than dispensing with advice like most personal finance books, Chilton's slim 224-page book is told through as a story.

The book is narrated through the eyes of Dave, a married school teacher probably in his late 20s. With the upcoming birth of his first child, Dave decides it's time to get his financial life in gear, and solicits his father for advice. His dad refers him to the Roy, local barber, who's sound financial know-how has made him the "wealthy barber." Each month Dave, his friend Tom, and his sister Cathy, visit the wealthy barber for a discussion that focuses on various aspects of financial planning. Each month's visit is a separate chapter in the book.

The first month's talk with the barber lays out the best secret for wealth, "the Ten Percent Solution." The idea behind this is to "pay yourself first," automatically moving 10% of your take home pay to a well-researched mutual fund that has exhibited a solid track record of strong growth. The idea is to save this money over a long stretch of time and let the powers of compound interest help grow that 10% contribution into a formidable nest egg. This fund, though, is not earmarked for retirement. Rather, it's there to be used later in life, to buy that vacation home or luxury car. The wealthy barber argues that one will hardly notice a change in lifestyle if they pay themselves 10% first. (And he's largely right, in my opinion; we easily spend 10% of our take home dollars on frivolous crap that we forget about by the end of the month.)

After discussing the Ten Percent Solution, the barber's next lesson is on wills and life insurance. Roy highlights the importance of a will to keep one's estate out of probate court and to ensure that the estate is bequeathed to those the deceased's intended. The barber also points out that a living trust is not something the average American needs, since it really is only useful for those that have multi-million dollar estates. Life insurance is also covered in depth, including how much to insure one's children (just enough to bury them), how much insurance parents should have, and even the important of insuring others who your income depends on (such as a business partner).

The remainder of the book covers other common topics for personal finance books, such as using tax deferred and tax free retirement savings accounts, whether or not it makes sense to own or rent a home (it's nice to see that the barber doesn't blindly recommend to own, as is often the case in today's manic home buying market), and other such morsels of information. One particular gem found in the retirement section that was a new idea to me was aimed at young, but conservative investors. For those folks who are decades away from retirement but still feel unsure about putting their money in a vehicle that may lose value, Roy suggests the following: place your retirement funds in a bank CD (or a series of staggered CDs) so that you receive interest payment each month. Then, rather than reinvesting that interest back into another CD, roll it into a well-researched mutual fund that's performed well over the long term. This way you have the security of knowing your retirement capital will never diminish, along with benefits of a (historically) faster growing investment vehicle. I found this idea to be particularly intriguing, and hadn't seen it previously.

On a personal level, I found myself nodding my head in agreement while reading the vast majority of the book. The only major point with which I disagreed was on the topic of budgeting and consumer debt. The wealthy barber argues that while he thinks budgets are an important part of fiscal health, he doesn't think they're essential because people who start a budget rarely stick to it. Furthermore, he contends that if you follow the Ten Percent Solution that you need not tell every other dollar how to behave via a budget. In addition to the lax views on budgets, the book doesn't make nearly a big enough stink against consumer debt. The barber doesn't come out and say, "Go ahead and charge up your credit card," but he does make comments that makes it sound as if he sees nothing wrong with someone have a few grand in credit card debt. In other words, no where in the book will you find a vehement argument for paying down your credit card balances, while you will find rather nonchalant comments where the barber talks about carrying a balance due at the end of the month.

The ideas espoused by the wealthy barber closely mimic those put forth by Dave Ramsey, which is why, I think, I enjoyed this book so much. The only major difference between David Chilton and Dave Ramsey's views is in budgets and consumer debt - whereas Chilton is rather lax of both issues, Ramsey is adamantly for budgets and against debt. (I find Ramsey's stance on debt and budgets to fall more in line with my personality and view on finance. )

The method by which Chilton's financial advice is dispensed is unique and helps hold the readers interest. Sure, the characters are one-dimensional and their dialog is a bit corny - they make a lot of un-funny jokes and references to the Detroit Tigers - but it works out well, in large part because the three "protagonists" - Dave, Tom, and Cathy - each represent a different archetype:
  • Dave is a young, married guy with a child on the way. He works at a school so is eligible for a 403(b) retirement plan. He bought his first house recently.
  • Tom is single and works in a factory that offers a 401(k) program. He rents, but recently purchased some rental property with a business partner.
  • Cathy is self-employed and lives in a condo. She's single, likes to travel, and is in a bit of consumer debt, we are led to believe. She makes about twice as much as Tom or Dave.
These three characters give Chilton plenty of room to explore the various insurance concerns, housing advantages, and retirement options available to different people. In addition to Roy the barber, there are also some secondary characters who are the "regulars" at the barber shop. They offer their own take on Roy's advice every now and then, which might reflect the attitudes of certain readers.

Overall, this book is well written and recommended. It's probably best suited for those new to the study of personal finance, but even one who's particularly savvy in personal finance might find a gem or two in this book. Like most personal finance books, the English used is very simple. Therefore you can whip through this rather short story in a couple days.

The Weathly Barber, 3rd Edition : ISBN 0761513116 : Published By Three Rivers Press, November 25, 1997.