Monday, January 6, 2014

Stop Over-Thinking Your Money

Most people believe that doing well with personal finance and investing is complicated. Preet Banerjee shows why this isn’t true in his new book, Stop Over-Thinking Your Money: The Five Simple Rules of Financial Success. He says that while it can be a lot of work to get an A+ in how you handle your money, you can get an easy A with his 5 rules, and right now “most people are somewhere near a C–”. (Disclosure: Preet is a friend of mine. However, as my long-time readers have likely figured out, I say what I really think, even if it involves criticizing a friend’s work or praising a foe’s work.)

The book is written in a conversational style that’s very easy to read. Banerjee explains that while the money rules are easy to understand, they can be challenging to follow the way that it can be challenging to stick with healthy eating and exercising. But the good news is that “getting physically fit is much harder than getting financially fit.” Financially, you only need “discipline for a short time, because once you get started down the right path, it gets easier.”

Banerjee has what I call a good sense of scale. He knows which mistakes have a small cost and which have a large cost. If you don’t save, “who cares about the difference in taxation of dividends and capital gains in your portfolio? What portfolio?” With his 5 rules, Banerjee focuses on the actions that give the biggest return. If a financial choice has only a modest impact, he says you should only worry about that if you’re going for your A+. When you’re focusing on your A first, things get much simpler.

For the rest of this review, I’ll pick out a few parts of the book I found particularly interesting.

Life Insurance Underwriting

Most books that discuss life insurance don’t even mention the critical issue of the time of underwriting; Banerjee leads with it. Mortgage life insurance typically gets underwritten at the time of the claim. That’s a fancy way of saying that they wait until you die to check your mortgage insurance application to see if you qualify for life insurance. What good is life insurance if you don’t know if it will pay?

Cash

Banerjee recommends that you “have a few hundred dollars (or more) in cash stored in a safe place in your home” to “buy necessities if there is a natural disaster that knocks out the ability to pay ... with debit and credit cards.” That’s one I hadn’t thought about before.

Financial Fire Drill

“Pretend you lost your job today and you won’t find work again until the end of the year.” Banerjee doesn’t want you to just imagine this scenario; he wants you to live it for a few months. Except for things that are difficult to cut for just a few months, he wants you to try living for a while as though you must cut way back on expenses.

Real After-Tax Interest

Banerjee goes through an example to show that today’s interest rates on savings aren’t much different from what they were in 1980 after you deduct taxes and inflation. This directly contradicts claims by others that savers fared better in the past when interest rates were high.

The Right Way to Think about Borrowing

“Think of borrowing money as negotiating a pay-cut with your future self.”

Passive vs. Active Investing

“Most people are better off in a low-cost, passively managed portfolio.” However, “the good news is that [portfolio cost] doesn’t matter if you’re just starting out.”

“How you set up your investments when you have a large portfolio is phenomenally important. How you set up your investments when you have a small portfolio is phenomenally unimportant. How much you contribute is what you need to focus on first.”

Financial Advice

Banerjee believes that most people need financial advice, but not just about their investments. He gives the clearest description I’ve seen of the different models for how funds charge you money and how financial advisors are compensated.

His description of the advantage of being able to write off the cost of a fee-based advisor leaves out the added taxes on the higher investment returns. He says he will clarify this point in a future version of the book.

Conclusion

Overall, I highly recommend this book as a way to get the message out that running your personal finances well can be simple. People would do well to make sure that they deserve an A based on Banerjee’s rules.

7 comments:

  1. I don't see it as over-thinking, because a lot of mistakes don't come from rational thought. Instead people come in with a collections of fears based on a mix of past experiences. Based on those they come up with a complicated way to prevent them from facing decisions where they are sure they will be wrong no matter what. Hopefully the book allows people to reduce some of those fears.

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    1. @Richard: You make a good point, but I think it's different from what Banerjee means. I'm definitely a supporter of thinking. We make a lot of dumb mistakes when we don't think things through properly, as you say. But some people end up paralyzed or they just give up while trying to make the perfect plan. Banerjee shows how to make a simple above-average plan. For most people, starting here is a great idea. After implementing a good simple plan, they can slowly improve it.

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    2. Exactly - if the book gives people the basic rules to avoid major mistakes, and that gives them the confidence to act, then they can make better choices.

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  2. This may or may not relate to your post...

    I have been wondering about ETFs versus Mutuals. Given that I have certain amount of money to invest (and I invested in an Index fund) - would it be more beneficial for me to invest in an ETF as opossed to a Mutual?

    I obviously can sell and get the current price - so, it seems better in that sense.

    Any advice that you can give would be appreciated.

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    1. @Anonymous: It depends ... There are so many things I don't know about your situation that it's impossible to give a definitive answer to your question. From a purely cost point of view for Canadians, the cheapest index ETFs have lower fees than the cheapest mutual funds. But this means little if you use an advisor or are an active trader. Having a solid investment plan and sticking to it is more important than saving 0.2% per year (the difference between the ETF VCN and the corresponding TD e-Series mutual fund (not that I'm suggesting that either of these is right for your situation)).

      I have a good-sized portfolio and a plan that I intend to stock to. This plan involves almost never doing any trading. I use low-cost index ETFs from Vanguard (in both Canada and the U.S.). So I've voted this way with my own money. Your mileage may vary.

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    2. Thanks, you have given me the advice I needed.

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  3. Preet's book is well-worth reading.

    Life insurance designed to protect your family has underwriting at the time you apply for coverage. You decide where the proceeds go and have full control. That's the ideal form and generally what independent advisors sell. If you get rejected or face a surcharge due to poor health, you may be able to get coverage from another company.

    Mortgage life insurance from the bank is not cheap. It's called creditor insurance and is designed to protect them, not you. The issuer saves money by deferring the underwriting to the time of claim since few claim. This makes business sense for them but does not provide you peace of mind. At the time of claim, you can't shop around to see if another insurer would have covered you.

    Buyer beware!

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