What if Everyone only got Paid once a Year?
I have no idea what I was thinking about the other day…but this thought popped into my mind:
"Would people take better care or worse care of their finances if everyone only got paid once per year?"
I like to come up with these strange questions to try to get myself and others thinking – I feel like it stretches my brain somehow (not literally) (I guess this is why I ended up having to answer most of my own questions in that Bible study we used to host in Arizona) (I should really stop talking to myself). I know it isn’t practical and it would never work and all of that – but practicality is not the point of this exercise.
Payday
So, on January 2nd (the 1st is still a holiday) (ok, the first weekday after January 1st – how’s that?), everyone got their single paycheck for the entire year. What happens next?
At first, I thought this would be a complete train-wreck. A number of people would have that money blown by Groundhog day. On the other hand, for fiscally responsible people, this would actually be somewhat of a boon. If you had all your entire year’s salary up-front instead of accumulating it little by little throughout the year, you’d be able to earn significantly more interest during the year.
Taking into account how much credit card debt the average American has, I think it is obvious that some people have a problem delaying immediate gratification to focus on the long term. Therefore, would people flush with cash at the beginning of the year run out and satisfy their every whim? I would say "probably." (you might say, "at least they’re not using a credit card," and this is true…but come the end of the year all expenses would end up on the CC)
But maybe, just maybe, if people knew that they only got this one paycheck and they were not getting any more, maybe they would be inspired to be more careful about their planning and living. Yeah, you’re right, that’s unlikely and it would probably end up being worse than now. Now that I think about it, that large lump sum would probably distract some normally fiscally responsible people and cause them to overspend early in the year as well.
So, I would answer the question like this: for some people it would work out a lot better. For some others, they would be inspired to get more serious about saving and planning. Unfortunately, I’d guess that some people would get distracted by the money, lose sight of the long-term, and end up being worse off. And, of course, I still believe that a number of people would have it all spent by MLK, Jr Day. The bottom line is it would be a lot better for some and a lot worse for others.
What do you think? Better? Worse? Why am I even wondering about this?
This Week in the Blogosphere
- This is just a great post discussing the different stages of how we view the purpose of money (@ The Happy Rock )
- Here’s a post discussing debt, debt myths, acceptable debt, and reasons to avoid debt . There are some really good reasons in his list of why to avoid debt. (@ Bible Money Matters )
- Frugality sometimes gets a bad rap – but I agree with Bob that there is a difference between being frugal and being cheap (@ ChristianPF )
- Tithing! Anyone still here? Here’s a story about someone going through the process of tithing for the first time (Guest post for Gather Little by Little written by Capital Couples Finance )
Have a great weekend and God bless…
Book Review: The Intelligent Asset Allocator
How to Build Your Portfolio to Maximize Returns and Minimize Risk
by William Bernstein, PhD, MD
BFN Book Reviews
Every Thursday I have been reviewing a personal finance book. I provide a brief overview of the book and the author, touch on the good and bad in the book, and finally, give you my personal recommendation for whether you should borrow the book, buy the book, or neither.
What is this book about?
As you probably have already figured out, this book is about investing and, specifically, asset allocation. The author discusses numerous investment concepts covering both theory and practical advice. Be warned, however, the information you read here will not be what you would hear from a typical financial advisor (well, maybe a fee-only one). The author presents this book as a guide to enable a normal person to construct and manage his/her own investment portfolio.
Who is the author?
William Bernstein is not a financial advisor or a wall street analyst. Instead, he is a neurologist. So, I’m not sure if that makes him less qualified or more qualified to write this book. He writes the book not as an expert in the field but as a person, probably like you and me, who desires to figure this investing stuff out for himself. Dismissing the typical wall-street wisdom and advice from self-serving brokers, his philosophy is that a normal person can do a good job of managing his/her own portfolio. Bernstein also maintains efficientfrontier.com which provides investing and asset allocation resources.
What are the best parts of the book?
There is a great deal of theory in this book but it is also packed with really practical, useful information. Bernstein gives practical information and backs it up with statistical analysis. Here are some of the really valuable concepts that the author provided in this book (don’t worry – I won’t bother you with the statistics – you can read the book for that information)
- Effective portfolio diversification can increase return while reducing risk (diversification means creating a portfolio of multiple non-correlated or weakly correlated assets)
- Adding a small amount of stock to a bond portfolio increases return and reduces risk
- Adding a small amount of bonds to a stock portfolio significantly reduces risk while reducing return only slightly
- Favor short-term bonds (6 months to 5 years) rather than long term bonds
- Indexing is the best way to invest
- One possible exception: Small-cap growth stocks
- Periodically re-balance your portfolio back to your target allocation
- Sticking to your target asset allocation through thick and thin is much more important than picking the right asset allocation
- Value investing typically returns more than growth investing (good companies make
- The market is not exactly a "random walk" – a good return this months means a slightly better than average chance of a good return next month.
- Dynamic asset allocation – changes in allocation that are purely market valuation driven are likely to increase return. Changes in response to economic or political conditions are a very bad idea.
- There are more expenses to an actively managed mutual fund than just the management expense fee disclosed in the prospectus:
- Expense ratio
- Commission ratio
- Bid-Ask spread
- Market-impact costs
The author also provides these key pieces of knowledge and advice as a final summary:
- Risk and reward are inextricably intertwined
- Those who do not learn from history are condemned to repeat it
- Portfolios behave differently than their constituent parts
- For a given degree of risk, there is a portfolio that will deliver the most return; this portfolio occupies the "efficient frontier" of portfolio compositions
- Focus on the behavior of your portfolio, not on its constituent parts
- Recognize the benefits of rebalancing (but not too often)
- The markets are smarter than you are; they are also smarter than the experts
- Know how expensive the tomatoes are (investigate Price/Earnings, Price/Book Value, Dividend yield)
- Good companies are usually bad stocks; bad companies are usually good stocks (Lowest P/E stocks typically outperform highest P/E stocks)
- In the long run, it is very hard to beat a low-expense index mutual fund.
In the interest of brevity, I won’t go into the detailed explanations of these concepts or his advice right now (Don’t worry, though, I plan on doing numerous posts on these investing concepts in the future). If you’re intrigued by some of these concepts and more more information or you don’t believe the author and want the proof behind them, then you should grab a copy of the book and delve into it.
The three questions to ask yourself when determining asset allocation
The author shows you how to use your answers to these questions to determine a comfortable asset allocation:
- How many different asset classes do I want to own?
- How conventional of a portfolio do I want (how much difference from the S&P 500 can I tolerate?)
- How much risk do I want to take?
Besides the theory and concepts, there is also some very practical information
The author also describes various example asset allocations tailored to how many different types of asset classes you want to include in your portfolio. He also includes a table that lists actual mutual funds to use in your portfolios. He even divides this table into three sections describing which funds are best for tax-sheltered accounts, taxable accounts, and those that are acceptable for either type.
What is not-so-good about the book?
I did not find much bad information in this book. Actually, the biggest issue with the book is that there are a lot of statistics in it. That can be good or bad, depending on your perspective. If you don’t really enjoy reading a lot about the details of the numbers, then this book will be a tedious read for you. In fact, on Bernstein’s website, he notes that this book is "for the Sophisticated Investor" while his similar book, The Four Pillars of Investing 
So what is my recommendation?
If you are not concerned with the mathematical details of why asset allocation and low-cost investing is important, then you probably don’t really need to read this book. Instead, you might want to read Paul Farrell’s The Lazy Person’s Guide to Investing. That book ascribes to the same investment philosophy. It will provide you with some practical examples of actual investment portfolios without bogging you down with all the theory and math.
If you are really interested in understanding why asset allocation is so important, then I think this is a good book to read. As I mentioned, this book contains some really useful and informative information covering both theory and practical advice. I have repeatedly mentioned that the book contains a lot of statistics, but don’t let that scare you. It’s not like this is a statistics textbook (and you can always skip a section or two if you want).
I would say that this is a good candidate for checking out from your local library. Borrow it, read it (maybe renew it), digest it, and become much more knowledgeable about what is important when constructing your portfolio and get inspired that you can do it yourself and do it well!
Want to borrow this book? Search your local library
Want your own copy? Buy this book now at Amazon.com
Check out the books I’ve chosen for my virtual bookshelf
We Did It – No More Student Loans!
As I heard the garage door open, I grabbed my papers and ran downstairs to meet my wife and two older kids. I put the two papers on top of the new box and went to the door to meet them. "Quick – come in, I have something to show you." As we all came into the kitchen, I said, "I have good news and I have great news, which do you want to hear first?" "Start with the good news, of course," my wife replied. Click here to continue reading…
45 Ways to Earn Some Extra Money
In the personal finance basics series that I’m currently doing, the first step was to earn some money (pretty obvious, eh?). While thinking about going into more detail on this step, I realized that there are numerous directions I can go with this post. I’ve decided to start with a list of ways to earn some "extra" money – outside of your current career/job. I’m going to periodically add to this list and, over time, create a large list of such ideas.
The point of the list is to be comprehensive but not detailed. I will go into more detail on some of the ideas in the future as needed. You can search other blogs or the web to find out more information on the ones that strike your fancy. My hope is that reading through the list will pique your interest in one or more of these ideas or it will get your creative juices flowing and trigger some great ideas of your own (if you have any, leave a comment for others to see too and I’ll put it in a future list). Click here to continue reading…
How I Track My Net Worth with a Spreadsheet
Last week I started a series on the basics of a personal finance plan. In the coming days and weeks, I’ll be going into more detail on each of the topics covered in the first two posts.
It’s a common precept in business these days that if you are going to manage something, you need to measure it. I feel the best way to measure how well you are doing with your financial plan is to monitor your net worth. The net worth gives you a bottom line measure of your finances wrapping up all of your saving and spending decisions. Therefore, the first post in this series will be an explanation of how I use a simple spreadsheet to measure my net worth. Click here to continue reading…
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