Tuesday, January 5, 2016

The Index Card

Is good personal finance advice so simple that it can fit on a single index card? Sort of, but not really. That’s why Helaine Olen and Harold Pollack had to write the book The Index Card to explain a list of 10 rules of personal finance created by Pollack. This book lays out a series of simple steps for managing our money that steer us away from the unnecessary complexity that gets marketed to us.

Each chapter of the book explains one of the 10 points on Pollack’s index card. Some are standard fare, such as “Strive to Save 10 to 20 Percent of Your Income,” but others may surprise readers, such as “Never Buy or Sell Individual Stocks.” This book is aimed at Americans with its discussions of 401(k) plans, health insurance, and tax breaks for mortgages, but most of the advice carries over well to Canada.

The authors sprinkle stories of their own mistakes and successes throughout the book. One example is a clever idea Olen uses to deal with erratic income: “All incoming funds are deposited to her savings account. She then grants herself a monthly ‘salary.’”

These authors don’t pander to readers who want to believe nonsense about how life is harder today than it was years ago, but they do make a good point about debt. One “secret to our grandparents’ extraordinary financial discipline was a ... lack of access to credit.” The marketing of debt is one way that managing personal finances today is harder than it was many decades ago. Of course, there are many reasons why managing money today is much easier than it used to be. For example, almost everything is much cheaper relative to our incomes.

After making a strong case that credit card rewards are a bad deal for most people, the authors suggest that you “Reduce your own credit card spending, and then buy yourself a prize.”

In my opinion, the best sections were based on the rules “Never Buy or Sell Individual Stocks” and “Buy Inexpensive, Well-Diversified Indexed Mutual Funds and Exchange-Traded Funds.” Canadians tend to get steered toward ETFs because we don’t have access to many low-cost mutual funds. But some investors prefer ETFs for reasons other than low costs. “If the ability to buy and sell your investment at all times of the day is important to you, you have bigger issues.”

The sixth rule is “Make Your Advisor Commit to the Fiduciary Standard.” This makes a lot of sense to me, but would be tough to execute for modest portfolios. It would be best if all financial advisors had to meet a fiduciary standard. This would cut out the bulk of the poor financial advice choices and make it easier for people to find the remaining good choices.

“Experts recommend spending no more than a third of your take-home pay on housing.” This sounds too high if it only counts a mortgage. But if we toss in property taxes, home insurance, and repairs, it may be a little low. This type of advice needs more explanation that the authors don’t provide.

On the subject of real estate investments, the authors warn that there are professional property managers with “skills, time, and money” who can “research local markets.” “They’re the people who recently took a pass on that tempting investment property you’re now considering.”

I had to laugh at a dig at the insurance industry: “where there is fear and there are commission-based salespeople, there will be people looking to exploit and profit from that fear.” Another good bit in the insurance section is “Go for the high-deductible option.” I wouldn’t even make a claim for less than $1000, so having a deductible below $1000 makes no sense.

One piece of insurance advice I couldn’t understand is “Adequate liability coverage is at least twice your net worth.” This makes no sense to me. It’s the amount of the judgement that matters, not what you own. If I get sued for $2 million, I want to be covered for $2 million. If my net worth is $600k and I follow this advice, I’ll be covered for only $1.2M and would be on the hook for the remaining $800k. I’d be wiped out.

One bit of pandering was to women, mothers in particular. Some salary survey says that a mom “often provides services worth more than $100,000 a year if you actually needed to purchase these services.” Sure. And all the little odd jobs dads do would cost the same if you called someone into the house every day to do them. So what? All the contributions people make to their families are valuable, but putting an inflated dollar figure on them is pointless.

Overall, there was a lot to like about this book and the problems were very minor. Personal finance needs to be simple. But much of the messages marketed to us advocate complexity. The index card rules are a sensible antidote.

14 comments:

  1. A Harvard finance prof conducted a study last year on (personal) financial education and financial behaviour. To the dismay of the professor, the study "couldn’t find any effect of financial education on behavior.” There was correlation but not causation.

    The study found that the biggest factor influencing successful financial behaviour was math skill/knowledge.

    This book kind of cements that dichotomy. Too many people want simple little catch phrases to dumb down/unscarify finance. I guess following the flash cards in this book might keep you from going broke, but the advice probably won't make you wealthy.

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    1. @SST: I think the biggest value of this book for the masses is that it might get people to avoid the biggest mistakes. The trouble is that those who make their livings marketing these mistakes to the masses adapt as necessary.

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  2. Thanks for the substantive and fair-minded review of our book.

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    1. @Harold: It was a pleasure to read. I'm always looking for new material to help family members with their finances.

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  3. "Never Buy or Sell Individual Stocks” and “Buy Inexpensive, Well-Diversified Indexed Mutual Funds and Exchange-Traded Funds.”

    This is something I have been following for a while. Given that most advisers and books are now recommending indexing, the benefits of this approach will likely diminish or disappear in the not too distant future.

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    1. @BHCh: Indexing has certainly been on the rise in recent years, but it is nowhere near dominating yet. The number of advisors advocating indexing is on the rise, but the majority still peddle expensive actively-managed funds.

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    2. re: "Given that most advisers and books are now recommending indexing, the benefits of this approach will likely diminish or disappear in the not too distant future."

      Not necessarily so:
      What If Everyone Indexed
      http://www.pragcap.com/what-if-everyone-indexed/

      The index fund/ETF is only "passive" on your side; there is plenty of "active" buying and selling of individual stocks (and funds) on the institutional side. If we all indexed we would all get the aggregate market return. Simple.

      re: "The number of advisors advocating indexing is on the rise, but the majority still peddle expensive actively-managed funds."

      And they are finding new and sneaky ways of selling those active funds as passive index funds:
      Indexing Doesn’t Win When It’s Implemented Via a High Fee Advisor
      http://www.pragcap.com/indexing-doesnt-win-when-its-implemented-via-a-high-fee-advisor/

      "...a fee structure no different than the investor who owns the high fee mutual fund..."



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    3. @SST: No matter what lower cost options become popular, we can expect the financial industry to create high-cost variants.

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    4. Sst, once indexing reaches a critical mass, it will become less efficient than alternatives. There are issues already, such as front running.

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    5. @BHCh: Vanguard has already taken steps to address front-running. I don't know about other index providers. What alternatives do you think are more efficient than indexing?

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    6. re: "once indexing reaches a critical mass, it will become less efficient than alternatives."

      I'm confused by your use of 'efficient', please explain. Thanks.

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    7. vanguard took steps, but the bigger its funds the more it will depend on front-running. In the future active managers will have a much better chance of beating the index.

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    8. @BHCh: I'm skeptical. It's true that we can't all be indexers, but we're nowhere near that point now. I see no reason to believe that we'll get close to the point where we're all indexing. I'll believe that active managers are beating the index when I see it.

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  4. Going for the big deductible on insurance worries people, but given how much extra you are paying for that option, your "break even point" is sooner than you think. Sounds like another book I should read (number 43 on the list).

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