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THE BLUE MONEY REPORT.
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The Blue Money Report
"Money frees you from doing things you dislike. Since I dislike doing nearly everything, money is handy."
~ Groucho Marx (1890 - 1977)
Welcome to the Blue Money Report
Today's Commentary: 12.02.02
A couple of weeks ago, a financial company that will remain nameless, contacted me asking if I would like to contribute to their website/newsletter. Sure I responded, asking for more details. Shortly after that note, details did arrive. I was told in the e-mail that I would be sent a series of questions to determine whether I would be a good fit for their readers. So I played along. Below you will find the first four questions (of twelve). I thought, for the sake of analysis, answer them in the column. Now this will probably cost me the opportunity of exposure on their site, but oh well.
This will run over the week, so sit back and relax. It will be like reading over my shoulder. Most references, it is important to note, are directed towards the BlueCollarDollar, the sister site to this column.
QUESTION 1: Your website describes personal finance as being complex. Few people would disagree. However, one of your site's goals is to help people understand that complex world. Do you believe that personal finance is inherently complex or is it perceived as being so because people generally are not taught how to understand its intricacies in a logical way?
I once revisited my high school many years after graduation. It was a college prep school with the focus on getting as many students into the realm of higher education. But they never offered those going or those planning on working instead of college any practical education on how to save, balance a checkbook, or otherwise handle credit. It was the classic deep pool theory. Throw 'em in the deep end, they will learn to swim. This unfortunately, set far too many of my classmates on the road to financial disaster first before they could progress as adults.
The complexities of personal finance are inherent in the system. Even those that understand it to its fullest, rely on histories of preceding events, market conditions, the ability to discern vast reams of information and to some extent, plain old luck. Folks with limited means do not have the luxury of amassing enough information in a sensible way to make anything but a random guess.
There is no logical way. Too much of the information is transitory and I believe it is that way by design. If it were simple, then there would be no need for financial planners, portfolio advice, or the general feeling from those in finance that they are in possession of something every one wants, few people have, and almost no one can guarantee.
QUESTION 2: One area within personal finance which is believed by many to be the most complex is insurance. However, many financial planners spend a great deal of time encouraging their clients to carry as much as possible. Do you have a rule of thumb which people just starting out on their own should use to help them determine how much life insurance to buy and how to increase their coverage as they age and reach certain milestones in their life?
No and I doubt that any one does. The very nature of insurance is a gamble. The insurance company is betting based on statistical evidence that a certain age, sex, health, and lifestyle will be a safe bet. The insured on the other hand places no wager at all and with any luck will never need what they have purchased.
When folks purchase insurance, it is usually at the suggestion of someone they respect. They are encouraged to protect their loved ones from the chance that something will happen, something unforeseen that will bring more than physical loss but also financial disarray and possibly ruin for those left behind.
The whole notion of insurance plays on this fear. Life insurance, which is different from the protection provided by auto, business, or home insurance, is basically a guestimation on what your potential income will be, how the loss of it will effect those left behind, and how much debt you will leave those surviving. If you are young and unmarried, you do not need any insurance. If you have married, insurance should be considered if you have purchased a house. They should buy term, insuring the primary wage earner no more than the balance of the mortgage and the cost of the funeral. Purchasing more than that doesn't do anyone but the insurer any good. And they shouldn't fall for one of those myriad of products produced by the industry such as mortgage insurance.
The arrival of a family changes everything and should put you back into the market for additional coverage. At this point, you should purchase as much as you can afford. If you can't afford more than they are currently carrying, then they should wait until they can afford more. Each milestone should be based on affordability. At no time, should any one purchase more insurance than they can afford. And when they do purchase insurance, they should purchase just enough so they can sleep at night.
Insurance affordability is a progressive joke. When someone interested in purchasing additional coverage that they can now afford, they will probably be older. Insurance coverage, in a clever Catch-22, becomes more expensive with age. But then so should a person's investment situation and horizons. Leaving your loved ones with a house that's paid for and enough money to keep them going for a couple of years while they sort ot their options, is enough insurance. Use any additional money to fund your retirement, which will become theirs at your passing. Don't forget the will either. It is the single most important piece of insurance that what you have will go to those you intend on receiving it.
QUESTION 3: One type of insurance which often becomes de riguer during economic recessions is income protection. What is your take on the value of such coverage? Are there better alternatives for the average worker?
My take on income protection insurance is simple. Stupid. I hate to surmise what some insurance people see as an answer to a need as something short of idiotic, but this group never ceases to amaze me how they can invent new ways to prey on basic human fears. For years, the suggestion that three months of income stashed in the form of cash would be enough to weather any sort of financial misstep caused by unemployment or income loss, fell mostly on deaf ears. Who, most folks thought, could save that kind of money outside their expenses and plans for retirement. The average worker should ignore this clever product, save their money as best they can knowing that in a Roth IRA, they can withdraw the principle without penalty, in a 401(k), they can borrow the money from themselves, and should they be living so large that unemployment benefits won't sustain them in the short term. no amount of income protection can save them.
QUESTION 4: On the subject of good debt versus bad debt, your website states plainly that no type of debt should be considered good, although some types of debt are better than others. It goes on to refute the argument of the relative merits of paying down a mortgage early versus investing surplus income in a mutual fund. Since the majority of low to middle-income earners never could purchase a house in one lump-sum payment, do you consider mortgages to be an exception to the rule?
I had to revisit this article I penned back in early '99. I did say that any debt should be considered bad. The reasoning went that if you owe someone money, you are in a situation that is indeed challenging. I did however make the exception when it came to housing. I believe in mortgages... that are affordable.
At the time, there seemed to be an awful lot of mailings and advertisements floating around suggesting that a homeowner would be better off if they made additional payments on their mortgage, reducing the amount of long term debt and eventually the overall amount of interest to be paid. The offers, if memory serves me, suggested that a mortgage could be refinanced, allowing you to make two payments a month, equaling the current one payment a month. The math showed the mortgage being paid of quicker but failed to show the benefit for the homeowner was greater than that provided the lender. Without locking yourself into a deal that had upfront paperwork fees, a regular mortgage holder could prepay that thirteenth month on their own, when they could afford it. The key is to make any pre-payment to the principle not make an additional loan payment that included interest.
At first glance, this seems like a great idea. You own your house sooner and you seem to save money at the same time. But how many of us stay in the first home we purchase until the entire loan is paid in full? My research at the time, showed that number to be relatively low. So why would you strap yourself to additional payments on your home when the chances of you staying are so slim?
Your home is not an investment. It is not liquid. It is shelter. Period. It is a necessity but it isn't necessary for survival that you purchase one. Incentives, provided courtesy of your federal government and the tax code are the primary reason wage earners purchase a home. If there was a flat tax without deductions for homeownership, the sales for new and previously owned homes would probably plummet. Folks would begin to reason and wonder, why buy when you can keep your options mobile. There is money to be made in real estate, without a doubt, but few do it with their primary residence. There is comfort in owning "the American Dream". But to enter into a mortgage with the notion that there is profit to be made is not only unwise, but unrealistic. And lately, homeowners have been using the low interest rates and inflated prices of real estate in some areas to turn their home into their own personal ATM. But they have borrowed to do so.
Your IRA, your 401(k), and any money squirreled away for your future is an investment.
Back to the debt part. When mortgage holders opt for fixed, short term loans, they have created the perfect breeding ground for debt. They become cash poor and real estate rich. Cash poor means that the first available chance at credit will be justified by their aggressive stance on their home. This is when debt deemed good becomes bad.
Questions five through eight.
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