Post #17 Financial Planning Made Simple
I just finished a very good book called Your Money Ratios: 8 Simple Tools for Financial Security
Mr. Farrell’s overall theme of the book is providing the average individual tools (his money ratios) to move from a “Laborer to a Capitalist.” I like this concept he has embraced, “moving from a laborer to a capitalist.” It describes what, in fact, should be every person’s financial goal in life. You start out your life with nothing and 100% of your income is generated by your own labor, thus you are a laborer. By saving a portion of your earnings and investing intelligently over your working life, you accumulate enough assets you eventually become a capitalist. 100% of your income comes, not from your labor, but from your accumulated capital. In a nutshell the concept of moving from a laborer to a capitalist is another way of saying, at the beginning of your life; you work for your money and at the end of your life, your money works for you.
I like concepts that can be reduced down to a simple formula or table. This is consistent with this blog site’s theme, “Retirement Planning simplified.” So I like the way Mr. Farrell uses simple ratios based on your age and/or income to guide your retirement planning. Some of these concepts I have described in earlier blog posts and some I will touch on in future posts.
The book describes 8 different methods (his money ratios) that guide a person during his life transition from a laborer to a capitalist. The ratios are simple financial formulas such as your “capital to income” ratio, your “savings” ratio, your “debt” ratio, your “investment” ratio, insurance ratios and a few others. The ratios are simple to apply. If you know how old you are and you know what your annual income is, you just apply his ratios and you are done. No high level mathematics involved. The book goes into a lot of background as to how and why he came up with the ratios which may or may not interest the reader. I think it is always a good idea to understand the basis of any financial concept you are employing. This understanding often gives a person the strength to persevere when adversity strikes.
However I think the book excels in several ways besides the author’s description of the 8 money ratios. The author describes the games Wall Street and brokerage firms play by trying to get investors to buy “New hot” products that promise to do things that sound to be good to be true but rarely deliver on such promises while charging high fees.
One of the best sections in the book the author covers in detail equity market risks and risk management. This explanation of market risks is one of the best I have read anywhere and is written in simple to understand language that should allow anyone to appreciate the risks involved in investing.
What makes the book as much a financial planning guide as a retirement guide is the author devotes a considerable amount of time to the subject of insurance. The book shows how life insurance, disability insurance, health insurance, and long-term care insurance are all necessary to move from being a laborer to a capitalist. Everyone knows they need insurance, but this book advances the subject by providing formulas for how much you should have, how to be sure not to overpay for insurance, and to be sure you don’t buy insurance that is not needed.
The final chapter of the book discusses several “special situations” such as what to do if a couple is far apart in age, what to do if you experience a large increase in income in your later years, etc.
There are a couple of concepts in the book that I would disagree with, but only to a small degree. The author advocates an equity allocation percentage of 50% from age 25 until age 55, at which point he advocates the equity allocation be dropped to 40%. This is extremely conservative, even for me. If we are to believe that the equity markets will continue to increase over the long term, I think people who are more than 20 years from retirement (people below 45 years of age) can have an equity allocation greater than 50% as I described in my previous Post #12 and Post #13.
The author also discusses the important concept of re-balancing which, as you all should know by now, I think is critical in bear markets. However, the author believes once you get to about age 55 and you have a 40% equity allocation and a 60% fixed income allocation that you should no longer re-balance your portfolio when the equity markets decline. In other words after age 55, if the equity markets decline, the author advises not to move any fixed income assets into equities when you perform your periodic re-balancing review.
I think an investor is missing an opportunity to buy equity assets when they are a better value if you do not re-balance on a market decline when your portfolio review time arrives. The author’s advice here stems from his discussion of asset risk management which I generally agree with. However, I would modify the author’s advice slightly. Unless you are already retired, I would still re-balance assets into equities when the opportunity arises, but with one exception. If you are at retirement’s door step and your fixed income assets are not enough to provide you at least 10 years of income in retirement, then I would not move any income assets into equities.
Overall, Your Money Ratios: 8 Simple Tools for Financial Security
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