personal finance Archives - Bankers Anonymous

June 13, 2023June 13, 2023

USAA Wobbles

Tell me: do you want the good news first, or the bad news? Fine, we’ll start with the bad news.

In 2022, USAA reported its first yearly “net income” loss since 1923 – the first loss in one hundred years! – of $1.3 billion.

Next, the CFO reported that the company’s own measure of its “net worth,” the difference basically between what it owns and what it owes, dropped dramatically from $40.1 billion to $27.4 billion from 2021 to 2022.

That’s a $12.7 billion drop in net worth, or a 31.6 percent drop year-over-year. Not great.

Finally, USAA had reported a line in its consolidated statements called “Other comprehensive income (loss), net of tax,” a loss of $10.5 billion. Since that was 8 times bigger than its “net income” loss, and roughly the size of its reported drop in “net worth” over the year, I reached out to the company to tell me what the heck “other comprehensive income (loss), net of tax” actually means. It’s not an accounting term with which I was previously familiar.

Brett Seybold, Corporate Treasurer, responded to my query. “The ‘other comprehensive income loss’ was due to unrealized losses in our investment portfolio across all lines of business, about half of which is in our bank. This is the result of lower market valuations from rising interest rates, which impacted the full financial services industry last year. It’s important to note that this accounting value change is temporary and has already improved in 2023 – and any undervalued securities can simply be held to maturity.”

This makes sense (in fact this was my best guess before Seybold confirmed it). It is also worth contextualizing his response with what’s happened lately with other banks.

The larger US banking context

The recent failure and seizures of First Republic Bank, SVB, and Signature Bank by the FDIC (the 2nd, 3rd, and 4th largest bank failures in US history, respectively) have bank customers (and regulators!) on edge a bit these days.

Listed as the largest Texas-headquartered bank by both assets and deposits, USAA carries a sort of flag for the industry in the state.

Unlike past eras of finance wobble, recent bank failures haven’t happened because of crazy risk-taking or irregular accounting or any number of traditionally morally questionable actions for which we might judge bank executives harshly.

Instead, a simple and simplified model of recent bank failures is this.

Step one is that banks like SVB held lots of super-safe assets like US Treasurys which lost their current market value when interest rates rose rapidly throughout 2022. Fixed income assets – the finance term for bonds and similar investments – drop in price as interest rates go up. As long as a bank still holds these super-safe assets and doesn’t sell them, the losses aren’t necessarily locked in. That’s what USAA’s Seybold confirmed made up what happened at USAA with the $10.5 billion loss under the line item “other comprehensive income (loss).” Roughly half the number for the bank portfolio, and half for the insurance portfolio.

The not-necessarily-market-value generally is not a problem because depositors don’t all ask for their money at once. These super-safe bonds will all pay out in full eventually. Regulators are cool with it too. Usually.

Step two with SVB, Signature, and First Republic Banks, however, was that they catered to customers who held large deposits, with a (now we understand to be an overly) large proportion above the FDIC-guaranteed $250 thousand threshold. Those large and relatively sophisticated depositors moved their accounts too rapidly for the banks to sell their assets in an orderly way. Because a significant portion of bank assets were actually worth less than their value on the books of the banks, and the withdrawals happened fast, the market value of the banks – roughly their “net worth” was wiped out just as they faced a liquidity crunch. So, we got FDIC receiverships and forced sales over a weekend for the 2nd, 3rd, and 4th largest bank failures in US history.

There were things these failed banks could have and should have done better, we now know in hindsight. Financial institutions can use interest rate swaps to hedge their declining bond values. They can underwrite or hold shorter-maturity assets that allow them to pivot more nimbly when interest rates rise. They can diversify away from an over-concentration on high-deposit customers, although that last move takes time, and for bank executives is probably counter-intuitive. (Banks generally love and want to attract high-deposit value customers!) But that’s all in hindsight for those particular banks.

What we should concentrate on are banks today. Specifically today, what should we think about USAA’s 2022 performance?

The Good News, or Why I’m Not Worried About USAA

Without insider insight into their fixed-income hedging strategies (although again in hindsight they maybe did not hedge rising rates enough in 2022) two things about USAA seem true, and comforting.

First, USAA is not simply a bank but a diversified financial services company. They are foremost a property and casualty insurance company, and also a life insurance company, and then also a bank. Insurance had its own specific 2022 problems like higher loss claims due to inflation and supply-chain bottlenecks. But in general, with 77 percent of annual revenues coming from insurance premiums, they operate in a different category than traditional banks. Insurance companies always run and manage risks, but bank runs aren’t really their main worry.

More broadly, their banking customer base is not primarily high-net worth individuals, but rather active or retired military personnel and their families. As Seybond confirmed, “Our bank is consumer based, 93% of deposits are within the applicable FDIC insurance limits, and we have access to excess liquidity to serve the needs of our members.”

I’m not at all worried about USAA personally as my bank, since I (sadly for me) do not have balances larger than the FDIC-guaranteed $250 thousand. Mo’ money, mo’ problems as the saying goes, and the inverse is also true when it comes to this specific consumer-banking risk: less money, less problems. Alas for me.

Maybe I should have mentioned, I bank with USAA. My checking, savings, credit card, home mortgage accounts, plus my kids’ bank accounts, are all with the company.

I insure with USAA as well: auto insurance, home insurance, and term life insurance.

I live in the hometown of their headquarters, and have many friends and acquaintances who work for USAA. I wish the company tremendous success but also I am self-interestedly curious about their setback years as well.

People are nervous right now about financial institutions. A once-in-a-hundred-year loss naturally prompts a question of whether it is anomalous bad luck or a trend. As the largest bank headquartered in Texas, USAA enhances public trust by explaining even the bad years when they occur. And even the obscure accounting lines when asked. I appreciate their letting me dig in a bit. Ninety-nine years before hitting a loss year is a pretty good track record.

A version of this post ran in the San Antonio Express News and Houston Chronicle.

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August 25, 2022June 14, 2023

Social Security – The 50 Year View

In the beginning of June, Social Security issued its annual Summary Report noting that the primary trust fund for paying reserves will run out in 2034. Twelve years.

Also, I was reading this past week a book by Peter Ferrera published in 1980 called Social Security: The Inherent Contradiction.

In 1980, Ferrera forecast the trust fund would run out in 2030, to which I have two reactions. First – that’s some amazingly accurate forecasting of a complex actuarial system over the span of 50 years! Well done, actuaries. Second – you Boomers have had at least 42 years to fix this. Like, what the heck? I am first eligible for Social Security retirement payments in that same year, 2034. Coincidence? I’m a Gen X kid, I’m used to this kind of treatment by now. It’s fine. Really. I’m fine.

More seriously, the real thing we should understand about the trust fund is this: It’s a useful fiction.

The trust fund isn’t particularly important.

Benefits get paid from current Social Security payroll taxes. The government is not actually investing our dollars. Technically, yes, a partial and temporary surplus of payroll taxes gets parked in low-interest Treasurys, but by no means is this the real source of our Social Security payments. It’s a pay-as-you-go system. Current workers pay for past workers.

In fact, understanding this is a fiction is the key to remaining calm about Social Security. Rather than panic, we should take comfort. The trust fund has never particularly mattered.

As Ferrera wrote in 1980, the idea itself of a trust fund is “a carefully contrived deception meant to mislead the public.”

Ferrera continued, “the entire purpose of this deception is to hide the welfare elements in the social security system and attempt to create the impression that social security is simply insurance without any welfare elements.” I agree.

Whenever I write about Social Security I receive panicked (or conversely, overly certain) emails asking – or informing – me about the Ponzi scheme underlying our biggest government program. This is neither true nor helpful. Ponzi schemes are not backed by mandatory payroll taxes. Social Security is.

I 100 percent do not worry about Social Security running out of money. It’s never been a true trust fund. Rather, it has always been primarily “pay as you go,” transferring tax dollars from current workers to current retirees.

Ferrara’s big idea from 1980 was that Social Security has two functions, insurance and welfare. Most Americans focus on the insurance aspect, in which they think they pay into the system during their working years and they think they get a return on investment back in retirement years. That insurance function is the fakery, and the trust fund a symbolic misdirection to assist in the legerdemain. The true function of Social Security is a welfare transfer.

Although I haven’t spoken with Ferrera, I’m certain we disagree on whether the welfare element is good. I think it is. He thinks it is not.

A not-sufficiently-understood aspect of Social Security benefits is that it deeply favors modest lifetime incomes over higher incomes, when it comes to benefits. This is partly accomplished through “bend points,” which mean Social Security pays based on 90 percent of an extremely modest lifetime salary, 32 percent of a medium lifetime salary, and only 15 percent of higher earnings. I’m simplifying the language around these “bend points,” but the idea is that the welfare benefit of Social Security favors the neediest. To match this focus on welfare, annual income above a certain amount ($147K in 2022) is not taxed for Social Security.

I am confident that in my own life, under reasonable assumptions, I would have achieved a greater net worth if I had never been taxed for Social Security and instead had invested those funds myself. The “welfare” part of Social Security will turn out to be a net loss for me, personally.

For most of my fellow citizens however, the welfare benefit of Social Security is a net gain. And that’s fine by me. This is socialism and should be understood as such.

I say that not as a diss of Social Security. In fact, ninety-six percent of adults polled consider Social Security an important government program. I mean to point out to a Texas readership with all of its preconceptions that a little bit of socialism can be pretty comfortable. Very popular and indeed, necessary. Not having elderly people die of starvation for example is a win in my book.

As for Social Security staying solvent, the real key is in understanding that this is solved with just a series of technocratic tax rule adjustments. The issue is not running out of money in the trust fund (again, the trust fund is largely irrelevant) but rather what small adjustments to delay and diminish benefits or boost taxes will be made to render the entire system solvent.

That was addressed in another 1980s throwback way this past week by former Senator Rudy Boschwitz (R-MN).

While serving in the Senate (1978 to 1990), Boschwitz had written a key memo in 1982 with proposals for shoring up the program. Yes, it is clear folks were worried back in the 80s about the issue.

Last week, in the Wall Street Journal, he listed the various ways to do it again.

Raise the “full” retirement age to beyond 67.

Raise the “early” retirement age to beyond 62.

Fiddle with the “bend points” so that payments are even less generous to higher earners.

Slow the rise in benefits by linking to a different, probably better, inflation index.

Slow the rise in benefits for higher earners.

Make inflation adjustments less frequently.

Tax Social Security income more heavily for higher earners.

Raise the payroll tax slightly to bring in more revenue.

This can all be phased in with many years’ lead time, in a boring, technocratic way. No need to panic. Which again is why I don’t worry about the so-called trust fund running out of money in 2034.

Big thanks to reader Steven Alexander who contributed data and analysis to Ferrera’s 1980 book, crunching numbers on computers back in the 1970s that accurately modeled things like return on investment and the end of the trust fund in the 2030s. I was reading his copy signed by the author.

A version of this ran in the San Antonio Express News and Houston Chronicle.

Please see related posts

My nerdy Social Security Spreadsheet, Part I

My nerdy Social Security Spreadsheet, Part 2

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April 6, 2016

Book Review: Money Mindset by Jacob Gold

In The Money Mindset – Formulating a Wealth Strategy in the 21^st Century, Jacob Gold traces the key components for building financial fitness, such as finding the right mindset, understanding risk, asset allocation, and diversification. He introduces the importance of understanding taxes and insurance.

He gets the big picture on taxes, which is that you should pay the minimum allowable, but if you pay a lot in taxes you should feel fortunate because that means you earn a lot. Similarly, he gets the point of insurance, which is solely to transfer risk to another entity.[1]

You could possibly start with this book for a newbie, but it wouldn’t be my first choice by a long shot.

I’m not a fan of a couple of Gold’s approaches.

First, although he says stocks and bonds both make up a portion of many portfolios, he does not guide the reader to know exactly how to come up with an optimal asset allocation. I think there is a correct answer, or at least a fruitful discussion to be had about the right mix between major asset classes.

At one point, presumably through laziness, he introduces an absurd situation, in the course of explaining the advantages of diversification and rebalancing:

“Rebalancing is really a forced way to incorporate the “buy low, sell high” mantra. For example, if you had $100,000 and 70 percent of that money was allocated to stocks, 20 percent to bonds; and 10 percent in cash, it might be that the next year that $100,000 grows to $150,000 but the growth was from the bonds. [Emphasis mine.] Since the bonds appreciated in value, that takes the asset allocation that you had determined based on the risk tolerance questionnaire, and throws the balance of investments out of whack…”

Um, no. Rebalancing is the right idea, but there is no conceivable universe in which your 20 percent allocation to bonds makes your portfolio grow from $100,000 to $150,000 in a year and “the growth was from the bonds.” So that part of the book didn’t appeal to me.

My second problem with the book – and I have found this with the vast majority of personal finance/investing books – is that Gold abdicates responsibility to really teach compound interest. Instead, he returns to the ‘Rule of 72’ (gag, barf) to show how money doubles according to the rule of 72 divided by the annual % return.

Sure, that works, but is entirely too inflexible to use for anything but that simple function. How large will my money grow at 3.5% return per year for 27 years? How large will my money grow at 1.4% per year for 8 years? How large will my money grow at 17.3% per year for 14 years? We need to teach compound interest in a real way, and not depend on the ‘Rule of 72.’ We can do better, people.

Please see related posts:

Book Review: The Only Investment Guide You’ll Ever Need by Andrew Tobias

Book Review: Simple Wealth Inevitable Wealth by Nick Murray

Book Review: Stocks For The Long Run by Jeremy Siegel

Compound Interest and Wealth

Compound Interest and Kittens

The Princess and Compound Interest

[1] Although I don’t think he properly distinguishes between term and whole life insurance.

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June 18, 2015April 14, 2017

Ask An Ex-Banker: FICOs Score and Monthly Balances

Note: See Part I on FICO Scores, which inspired this question from a reader.

Dear Banker,

I’ve been getting copies of my 3 credit reports annually since 2005.

I’m concerned about a change in the reported information from Capital One and Chase. My reports used to reflect
1) amount billed
2) scheduled (minimum) payment
3) actual payment

The latest reports from Transunion and Experian no longer reflect the “actual payment” amount, so although my reports show all payments made on time, it doesn’t reflect the full balance being paid monthly as opposed to the minimum payment.

I feel like I have to alternate credit cards in order to have a zero balance every other month so it doesn’t appear that I’m making minimum payments and carrying an unpaid balance.

I’ve contacted Capital One and Chase to ask them to report the actual payment amount as they used to, but all I get is a standard response “we’re correctly reporting your account” to the credit bureaus.

Am I wrong in thinking that if they report amounts in addition to whether or not the account is “paid on time”, they should include actual amount paid as well as amount billed?

Thank you
Bette in SA

—

Dear Bette,

Thanks for reading, and for your good question.

The most important element for FICO scoring (35%) is whether bills are paid ‘on time,’ so if you’re consistently doing that, your score will reflect that, and the fact that there’s a balance on your report is (mostly) irrelevant.

The FICO algorithm doesn’t care whether you make minimum monthly payments or full-balance payments. As long as payments are being made ‘as agreed’ according to the fine print you signed with your credit card company, your FICO score can’t distinguish between people who carry a balance and people who pay off their balance every month. What I mean is your score won’t be hurt by minimum monthly payments, nor can you really boost your score by making maximum/full balance payments. There is (almost) no distinction between them, for scoring purposes.

Small caveat: One small part of your score reflects your ‘usage amount,’ meaning what proportion of your available credit balances are used at the time of the score. Meaning, if you had a total of $10,000 in available credit among all your cards, and you were using $9,750 of that with a credit card balance, that could slightly lower your score. Not much, but a little.
Conversely, If you had a total of $10,000 available credit, but only showed up with a monthly balance of say $300 (leaving you with $9,700 available unused credit), that would slightly raise your score. Not much, but a little.

credit_score_auto_loans — A useful graphic linking credit scores and auto-loan rates

That would be the only sense you could be concerned about the monthly reported balance as you described. However, if you have many thousands in available credit and only hundreds in reported balances, those reported balances are basically irrelevant for your score.

As for you question to Chase and Capital One – I’m sure they won’t change their reporting methods. They just do an automated snapshot on a monthly basis to send to the credit bureaus. On any given day of that snapshot, we (the consumer) may have an outstanding balance on our card, even if we don’t carry any balance month-to-month.

My strong advice – don’t try to alternate card usage, and don’t worry about it, it’s not hurting your credit.

Michael

Please see related Posts

FICO Part I – What’s in the Score?

FICO Part II – Ignoring FICO and also why FICO is awesome

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June 15, 2015June 7, 2018

FICO Scores – Part I

I’m 43 years old and I have a terrible confession to make: I still know my SAT scores by heart. Wait, it gets worse. I still know my PSAT scores by heart. I know, I know, I’m that guy. I’m not proud of this so let’s move on quickly to another semi-related topic: FICO scores.

Unlike the SAT, everybody should track his or her FICO score throughout adulthood.

I bring up the SAT analogy because you should no more apply for a loan without knowing your FICO score than you would think of applying to college without knowing your SAT score. Like the SAT, FICO serves as a sorting mechanism determining your eligibility, in this case, for lending products.

Any credit card, auto-loan, mortgage, or business loan application you submit will prompt your lender to pull your credit score as a major determinant of your access to their best, or worst, products.

Unlike the SAT, however, you only need to remember one single number to achieve total success: a 720 FICO.

An online universe of FICO-score nerds exists and I’m not writing with that audience in mind, any more than I would encourage SAT nerds to remember their scores 25 years too many. (Yes, I’m looking right at you, mirror.)

FICO determines loan quality
If you’ve got a 720 FICO, considered by most banks the cutoff for “Prime” loans – the ones with the lowest interest rate and best terms – then you can stop nerding out about your FICO score. A higher score than 720 gives you nothing but bragging rights.

If you’ve got lower than a 720 FICO, expect to pay more in fees and interest, with fewer options. Borrowers in the high 600s may still qualify for what’s known in the banking world as “Alt-A” loans. Borrowers with a FICO score in the mid 600s or below either qualify for Subprime loans – a high interest rate, high fees, and somewhat punitive terms – or no loan at all.

What to do

So how do you access your score? The FICO company, as well as the three credit bureaus Equifax, Experian, and TransUnion each offer personal credit reports and scores for less than $20 each. You can spend a couple of minutes online to access your report and score, and I highly recommend doing this before applying for a loan anywhere.
You really don’t need to buy more than one score with one report from one bureau, so you should be able to accomplish your goal for under $20.

Free credit report?
Consumer advocates trumpet the idea that you can get a free credit report each year, which is true.
But that report does not come with a FICO score. I don’t think that a credit report without a credit score fully equips you with all the knowledge that you need.

To return to my college analogy, a free credit report with no FICO score is like a college application full of essays but no SAT score. You are not getting the full benefit of seeing your application the way a bank sees it, which is ultimately one of the main points of reviewing your credit profile. I advocate spending the money to get the score along with your credit report.

Inputs to FICO
So what does FICO measure? The Fair Isaac Corporation, the company behind FICO, reports that five factors go into their mathematical formula, all of them measurements of past borrower behavior.

I’ll list the factors in order of importance, according to their formula.

First: – Have you ever missed debt payments, and if so, how often and how recently? (35 percent)
Second – How much do you owe now? High debt lowers your score, while low debt compared to your available credit actually raises you score. (30 percent)
Third – How long have you been borrowing money? A longer time raises your score, while a shorter time lowers your score. (15 percent)
Fourth – FICO considers some types of credit like installment loans riskier than other types of credit like mortgage loans, and adjusts your score as a result. (10 percent)
Fifth – Have you applied recently for credit? This lowers your score a bit, as it shows you need to borrow money. (10 percent)

Lesson One: Time
Reviewing these five factors, we can see that the biggest determinant of your score is time: Specifically, are you timely with your bills, and how long have you responsibly handled debt?
Because of the impact of time, even younger borrowers with perfect credit history cannot achieve very high FICO scores (in the 800s), whereas older borrowers have a natural advantage because they may have very ‘old’ credit lines boosting their scores.

Lesson Two: No tricks
You should never make a financial or borrowing decision based on how it will affect your FICO score. Instead, just do the ‘right thing’ in your situation, and the FICO will work itself out. Paying your bills on time, lowering your balances when you can, building up a long-term track record of ‘safe’ borrowing behavior is the only reliable method for boosting your FICO.

Plenty of ‘services’ claim to be able to boost your credit score, but I would never recommend attempting any of these. Like many other areas of finance, the best practice is to ignore short cuts and tricks. Just stay focused on the long-term unsexy practice of paying back your debts. The FICO score will work itself out in the long run.

When I say you should avoid tricks and mostly ignore your FICO score, I don’t mean to ignore the underlying issue of settling past debts. The best practice is to make like a Lannister, and always pay your debts.

Next week I’ll write about when to totally ignore your FICO score, but also the financial advantages of not ignoring your FICO.

A version of this post ran in the San Antonio Express News.

Please see related posts:

Ask an ex-banker: FICO scores and monthly balances

FICO Part 2 – When to ignore FICO, and why FICO is awesome

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May 1, 2015May 1, 2015

Audio Interview Wendy Kowalik Part II – On Insurance And Getting Rich Slowly

Podcast: Play in new window | Download

Please see related discussion with Wendy Kowalik in Part One on investment advisory fees.

Michael: Hi, my name is Michael and I used to be a banker.

Wendy: Hi, Michael. Wendy Kowalik, I founded Predico Partners. We’re a financial consulting firm. I started my career with an insurance company and sold insurance for the same 17 years that we managed money.

Try to save your money from all these nice folks

On Insurance

Michael: That is my pet peeve, insurance. I think too many people who are engaging with insurance as if insurance was a form of investing make a deep error. I find when people buy insurance they’re being told that it’s some kind of good investment. You and I previously spoke about this guy Dave Ramsey, who for all his flaws, has told me the number one thing I need to know about insurance, which is: figure out what the risk transfer is. And that’s what insurance is for. It’s not for mixing with investments. I deeply believe that.

You came from a firm that did quite a bit of insurance. As we’ve spoken in the past, that’s not always how insurance is sold. Probably the majority of the time it is some kind of weird blend between a supposed investment in addition to a risk transfer. You’ve done it. I haven’t sold insurance or been involved in that, but what do you think about my ideas?

Wendy: “It depends,” is the worst answer, but globally you’re on the right track. You’re exactly right. And what I’ll tell you is if someone is walking through the door saying you should use it as an investment vehicle, you’re probably on the wrong track.

predico_partners — Interview with Wendy Kowalik of Predico Partners

Very seldom will you find that working well. The insurance industry’s argument on that side of it is it’s disciplined savings. It grows tax deferred. Well, so does your 401(k). Make sure you’re making that out first. That’s the first place you need to be saving, on that side.

The other argument is you can go in and take a loan out tax-free. Very true statement except for the fact that if the policy doesn’t last for the long term, then you pay taxes on every dollar you took out. That’s where it’s all the details within the insurance that many times make them not work as they were originally sold.

Yes, for globally, I would tell everybody that there’s only two reasons to purchase insurance.

To protect an income source if you’ve got a spouse that’s working and you need their income to make your monthly budget. You need to protect that.

The second side of the table is if you have estate taxes. You can use insurance to basically pay a lower dollar amount for you estate taxes. Outside of those two pieces of the puzzle, I don’t really see a huge need for life insurance.

Michael: The second part, the estate taxes, is going to be much more of a high net-worth problem than an ordinary investor problem. We’re talking up at the top 5%, 1% or .01%. It gets more plausible that they’re going to be able to have a tax savings and estate planning through insurance, right?

Wendy: Right, sitting here today, an estate over 10-million dollars for a married couple and an estate over 5-million dollars for a single individual.

Michael: What I tell people, and most of my ordinary acquaintances are not in that category, I just say “You need to focus on self-insuring” through trying to invest your money so that when it comes time where you can no longer work, or you choose to not work, you’re not worried about an income stream, and you’ve self-insured though actual investments, rather than this expensive version, which is paying an insurance company to be this mix of asset protection, asset building, and income replacement.

Wendy: That’s exactly right. You should have two different pieces of the puzzle. You should have term insurance if you’re protecting an income stream for a period of time. And use your savings separate from that.

Michael: Right. I just don’t trust that most insurance sales people in the industry is parsing that out for people to say “If you’re got a risk of loss of income, you need term for the period of time in which you’re worried about that, and then use the savings to put that in the market.”

This is what I always tell people — without knowing — having not worked in the insurance industry that just seems to be the right thing.

Wendy: Right.

Michael: For most people, with obvious exceptions. If you’ve got a ten-million-dollar estate it’s a whole different situation and you probably need different set of advice, which I’m not qualified to give. We’ve got term insurance in my family related to how old my kids are, when they are going to be no longer under my protection, and can fend for themselves in a sense. But it’s super-duper cheap to get that, for a certain number of years, and a certain amount of money, not a huge amount, but sufficient to not leave them in a lurch.

Wendy: That’s the biggest struggle on the insurance side, is figuring out what that number is.

Michael: Tight.Certainly back to your two reasons to have insurance. One is replacing income stream, and the second is estate planning and possible tax reduction. The folks for whom that second part is relevant, estate planning — the first part seems to me to be totally irrelevant. You’re either in one or the other. You’re probably not in both because if you have ten million somewhere in assets, you don’t really need to ensure further a loss of income stream. You’re probably going to be able to feed and clothe yourself now. Or am I not thinking about that right?

Wendy: Yes, no you’re right. Could they self-insure? Absolutely. What you’ll find a lot of times, though, is you’ve got people in that situation that have purchased property or they’ve got a family-owned business that makes that up. Then it becomes a liquidity event. Do I really want to unload Pepsi to pay the estate taxes? Or do I want to have to sell at that point or do I want to buy some time? It still may not be this massive convoluted structure, but I may be that I want to purchase an amount to give me time to figure out what I want to do with the asset.

On Budgeting, and Getting Rich Slow

Michael: So, any other topics you think we should get onto the podcast?

Wendy: The other thing you put on there was budgeting. How do people come up with a budget.

Michael: Oh yeah, let’s talk about that.

Wendy: I do think that is a big piece of the puzzle. The number-one side we run through is no matter how much money you have, you’ve got to understand how much you spend that’s fixed expenses and will not change, no matter what you do right now, unless you actually make radical lifestyle changes, such as selling your home, changing your cars, that type of thing. Or is it just discretionary, and to me that is such a big piece of the puzzle, is understanding exactly what you’ve got that’s fixed, what you’ve got that’s discretionary, because that’s the only way you can determine can I really cut back and make some changes, and start saving more, because we don’t need to eat out as much or go do this as much. Or is it that we’ve extended beyond what we can truly afford either in a home, or cars, or things such as that, and we need to change lifestyles more dramatically than just not going out to eat on Friday nights.

Michael: I’ve taken to saying to people, my friends, or peers, or people that ask my advice that nobody has any extra money at the end of the month. Whether you make 350,000 bucks a year or you make 35,000 bucks a year. There’s no extra money. Your lifestyle builds to whatever you’ve gotten comfortable with, and I tell people you basically have to trick yourself into creating little streams of savings and investments. This isn’t true for everybody and to bring up my nine-year-old daughter, she’s basically a hoarder. Her babysitter basically said early on she’s going to be on the hoarder TV show. She never throws anything away, so if you give her some money — there’s a few people like that, who save all their pennies, nuts, and squirrel them away.

But for most people there is no money. There’s no salary that’s enough to make sure you have extra money. If you move up from the Honda to the Audi, then you have to get the Jaguar. You’re still just buying a car, but somehow if you make 350,000 dollars. It’s not hard to go bankrupt on 400,000 dollars a year. Mike Tyson went bankrupt after earning 300-million dollars in his life. There isn’t any real money…[that’s sufficient.] You have to figure out tricks and ways to get the excesses.

Then you have these weird stories of the person who never made more than 40,000 dollars in their life, and they have huge investment accounts, relatively speaking, at the end of their life. They were able to do it.

Wendy: My favorite was we had a client referred to us in my former firm. That was exactly it. He had been a civil service employee, never made over 40,000 dollars for many years, and finally topped out at 65,000 dollars. She was in her early 80s, late 70s, and her investment account was worth 15 million dollars. She purchased with every extra few dollars, at the end of the month, she’d say this is what we’re going to set aside for savings. He would purchase bank stocks because he decided that it paid a little bit in dividends, and that was what he followed. He did financial stocks and he purchased six stocks, followed them. He never once sold a dollar of them. He never cashed them in for anything, and just added to those same six. That’s what it grew to. It was absolutely incredible.

Michael: That is incredible. If you have 60 years of doing that, there’s the compound returns of equity exposure to a couple of good stocks or six different bank stocks over a certain period of time. That’s incredible, yet mathematically very plausible when you look at it, how much you could put away, and if you let it ride for 40 to 60 years. It’s totally doable. It doesn’t feel like that until holy cow, 30 years later suddenly it’s grown.

Wendy: Right.

Michael: I feel like that message doesn’t get out to enough people or it gets out when you turn 62 and you’re like huh, so I should have been starting 40 years ago? Now you tell me?

Wendy: That’s right. And I think it’s hard to withstand, and I think what many people strive for is they keep trying to find a better way to get to the investment returns. They’re looking for that — there’s some trick to get there. A lot of it is just hard work and discipline.

Michael: I think automatic deductions from paychecks or your checking account, so you never see it — just like investment advisors are going to secretly, stealthily take out 1% or 1.5% per year. If you can get your 401(k) and then your brokerage account to sneakily take out a few hundred and then a few thousand dollars per pay period, it works out in the long run.

Wendy: Exactly. You’re right.

Michael: It’s hard to make the affirmative choice to do it, but if just sneakily happens by default you can build up wealth, I think.

Wendy: I completely agree. We tell everybody if you take it and send it to a brokerage account that’s not in your bank, leave it in cash for 90 days, that way you know can you really make it without that money, without having to go back and take it back. You normally won’t call the brokerage account and ask them to send you a check. You really do need it if you’re doing that. So then at the end of 90 days put it to work. See if you can increase it and put away more in the next pay period.

Michael: I think that method works. GET RICH SLOW. It’s hard to get rich quick.

Wendy: Very true.

Michael: Thank you for discussing all these things. I think there’s lots of interesting ideas here that people should be paying attention to.