Championship—Asset allocation v. Tax optimization

Basketball hoop

This is what we’ve all been waiting for.  After two weeks of amazing investing tournament challenge action (just indulge me, will you?), in this post we will crown the champion of investing strategies.  Here we have Asset allocation taking on Tax optimization.  In the Final Four, Asset allocation pounded Index mutual funds with higher returns early on and limiting risk as you approach retirement.  Tax optimization made it two thrillers in a row, beating Savings rate on the strength of major tax savings with a little bit of work and education, but not a lot of monetary sacrifice.  As always, see the disclaimer.

bracket-game 6

Obviously both these strategies have tremendous upside, otherwise they wouldn’t be here.  So how do you pick between them?  It’s no easy task, but for you, my loyal readers, I’m ready to take it on.  Let’s see who cuts down the nets.


Reasons for picking Asset allocation:

In some ways Asset allocation seems really easy, since all you’re doing is figuring out what percentage of your portfolio goes into stocks, bonds, and cash.  90% Stocks, 10% bonds, and 0% cash; there, I’m done.  That didn’t seem so hard.  Obviously it’s more complicated than that.  We already know that Asset allocation is critically important throughout your investing time horizon.  When you’re younger you probably want to be mostly in stocks (even now the Fox family is 99% in stocks).  As you approach and ultimately enter retirement you want to be more in bonds, but stocks still probably need to be a significant part of your portfolio.

About 10 or so years ago, the mutual fund companies came out with a really cool innovation called target-date funds.  The basic idea is that these handle your Asset allocation for you.  Imagine today you’re 35 and you want to retire when you’re 60, in 2040.  You could invest in a fund like Vanguard’s Target Retirement 2040, and it will automatically shift your Asset allocation from mostly stocks today (currently it’s about 90% stocks, 10% bonds) to gradually less stocks and more bonds as you get closer to retirement.  It’s been a wonderful innovation that has proven extremely popular among investors.

So there you go.  Problem solved, right?  Well, not so fast.  I actually don’t think these really solve the Asset allocation problem because they figure everyone retiring in 2040 is in the same situation, but that’s definitely not the case.  Let’s say you and your twin retire in 2040, but you will get $1000 from Social Security while she’ll get $3000.  What if she had her house paid off completely while you have always rented?  What if you worked for a company with a 401k and she worked for a company with a pension?

All those scenarios are very real for investors, and require more individualization than knowing you want to retire in 2040 can give.  For all those, conventional wisdom would say that your twin should take on more risk (French for “invest in more stocks”) than you because she has other “assets” that are generating more cash.  Reasonable people can debate that last point, but clearly the idea is that Asset allocation is much more complex than just picking a year and being done with it.

So where does that leave us?  I am a firm believer in investing DIY, and Asset allocation is no different.  But I think this is one of the areas where the degree of difficulty is much higher just because you’re balancing a couple opposing forces and there’s never a clearly “right answer”.  You want to be in stocks but not too much in stocks, and then that changes over time.  Oh yeah, and the stakes are super-high.  Getting it “right” whatever that means could give you an extra few percentage points in return and it could also save your nestegg from catastrophic failure if another 2008 rolls around.  When I work on the Fox’s nestegg, this is probably where I spend the most time.


Reasons for picking Tax optimization:

As we’ve said ad nauseam, Tax optimization is important and can lead to enormous savings.  What makes taxes so difficult is that the tax code is constantly changing and the stakes are super-duper high (the stakes for Asset allocation were only “super high”).

Every year there are hundreds of changes to the tax code which keeps accountants employed and programs like Turbo Tax (the Fox family uses Turbo Tax) flying off the shelves.  With the new tax reform bill that just passed, there were major changes to your taxes like the deductibility of mortgage interest and local taxes.  Those changes have massive implications on choices of where to live–both at the level of which state to live in but also whether to buy or rent.  These were huge and made the news.  What about the others that do hit the media’s radar and you never hear about?

There’s always talk about more changes, perhaps profound ones like a wealth tax.  You have to keep up.  Also, it can get really confusing.  I think I’m fairly knowledgeable on these matters but I am still befuddled by the Alternative Minimum Tax, and I know I screw up the foreign interest paid on my international mutual funds.  This stuff definitely isn’t easy.

Also, look at the stakes.  If you screw up on your taxes, theoretically you could go to prison.  If it’s an honest mistake I don’t think the Internal Revenue Service will push it that far, but horizontal stripes are definitely in play as Wesley Snipes can attest.  What is more likely is the IRS will hit you with a fine composed of a penalty plus interest.  Oh, by the way, that interest rate is about 6%; that’s not “Pay-day Loan” high, but it’s still pretty freaking high these days.  That certainly can make someone cautious about how far to push Tax optimization, even when they’re clearly in the right.

However, there is a silver lining.  If you want professional help, there are thousands of Certified Public Accountants who are there to help you out.  For under a few hundred dollars most people can probably have their taxes done by a CPA who can make sure that you stay on the IRS’s good side.  Unfortunately, when it comes to developing creative Tax optimization strategies, my experience says there’s a huge range in quality that you’ll get from CPAs.  Several years back I had a horrible experience with H&R Block and thought they were border-line incompetent.  No way would I trust them to advise me on the finer points of maximizing the tax advantages of investing.  But there are amazing CPAs out there right now (like David Silkman who did our small business’s taxes when we lived in California) who I do think can really help.  But this is a real caveat emptor situation.  Maybe Angie’s List might help.


Who wins it all?

It all comes down to this.  In the end, I have Asset allocation pulling it out 76-70.  Obviously both investing strategies are amazingly important and getting them right can have an exponential impact on your portfolio.  For me I gave the nod to Asset allocation over Tax optimization for a couple of reasons:

First, if I met a total train wreck of an investor (he was just stuffing cash in his mattress) and I could only give him one piece of advice, I think it would be to get that money invested in some combination of stocks and bonds.  Tax optimization strategies like an IRA or 401k are nice, but first things first.

Second, I think the big rocks for Tax optimization seem to me better understood and more accessible than for Asset allocation.  Most investors probably know that investing in your 401k or an IRA is a good idea, and probably most could tell you why (at least be able to say “it helps with taxes”).  I think that’s different for Asset allocation where you have a lot of investors who are totally off on what is probably appropriate for their situation (age, income, other assets, etc.).

Third, there’s no real “right” answer for Asset allocation.  I could have a lively debate with my dear friends/loyal readers who work in the financial industry like Jessamyn and Mike, where we argued whether the Fox family should be more in stocks or more in bonds.  But there’s no right answer (other than if stocks go up a year from now, then you know you should have been more in stocks).  It depends on so many variables as well as risk tolerance which are super-hard to quantify.  With Tax optimization you can get closer to a right answer—either the tax code allows you to do that or not.  Of course, you typically sacrifice ease of access to your money for tax benefits, so that does add a complication.

Finally, I think it’s easier and cheaper to get expert advice on Tax optimization.  As I mentioned, a good CPA can probably really help guide you on Tax optimization.  Sure, the quality of CPAs is pretty wide, but good ones are out there, and probably they’ll charge you something with in the three-digit range.  With Asset allocation if you want professional help you typically need a financial adviser.  Unfortunately, and this is just my opinion, it’s a little more Wild West for financial advisers than CPAs.  A really good financial adviser is probably worth her weight in gold (140 pound of gold is worth about $2.6 million, so maybe they aren’t worth quite that much), but the range of quality is staggering; there are some real shysters out there.  Also, they’ll probably charge you in the four- or five-digits range.

So there you go.  Put that all together and I think Asset allocation comes out on top 78-71, finishing the sentence, “if you only do one thing in investing make sure you get Asset allocation right.”



I hope you have enjoyed reading all these posts on investing as much as I have enjoyed writing them.  While Asset allocation “won” remember that all eight of these are important and should be definitely be considered as you think about bulking up your portfolio.

Final Four–Asset allocation v. Index mutual funds

Basketball hoop

Welcome to the first game of the Final Four of my investing strategies tournament.  Here we have Asset allocation taking on Index mutual funds.  In the first round, Asset allocation blew out Diversifying mostly due to the higher returns that younger investors can get by investing more in stocks early in their investing career.  Index mutual funds upset Free money on the strength of lower management fees that can apply throughout an investor’s career and across every account type.  As always, check out the disclaimer.  With that out of the way, let’s see who wins.

bracket-game 4

Reasons for picking Asset allocation:

Last round we saw how being too conservative with Asset allocation can really reduce the returns of younger investors who aren’t as heavily invested in stocks as they should be.  If you go to the other end of the investor’s time horizon, when he or she is older and nearing retirement, you can make equally harmful mistakes.

On one end of the spectrum older investors can become way too risky.  As the years tick by and people get closer to retirement, they begin to take stock (pun intended) of where they are probably a little more closely than they did in their 20s or 30s.  If they aren’t quite where they want to be, knowing that on average stocks have higher returns than bonds, one natural response is to allocate more of their nestegg to stocks to “catch up”.  According to generally accepted investing theory, this is the exact wrong thing to do—as we get closer to retirement you should be reducing your allocation of stocks to lower your risk, not increase it.  Here you’re stepping away from the world of investing and into the world of gambling.  Maybe you’ll get lucky and ride a bull market up to get your portfolio back to where you want it, but you’re definitely putting yourself at risk of hitting a market pothole and putting yourself further behind.

On the other end of the spectrum, they can become way too conservative.  Some people have the natural instinct to want to get completely off the investing train in retirement because they don’t want to have any risk, so they put all their money in bonds or cash.  This is understandable because they’re going to be depending on that nestegg, so it’s got to last.  But the problem is that even in retirement, many people still need the higher returns that stocks provide to balance out the relative safety of their bonds.  This is especially true in a world where people are living longer and it’s not unreasonable to expect retirement to last a few decades or longer.  And actually, that time element also makes the case for stocks being a significant part of your retirement portfolio—you have time to ride out the storms, just not as much time as you had before.

These are what make Asset allocation one of the harder investing strategies to get right, because it’s changing over time and there are shades of grey (at least 50 shades of grey).  Other strategies like Diversification and Free money are much simpler because your strategy is absolute.  Diversification—you should be diversified at all times.  Free money—you should get as much of it as you can at all times.  But with Asset allocation, the right thing to do gradually changes from being mostly in stocks during your early years, and then slowly switching to more bonds and cash as you start to near retirement, but never shifting completely to bonds.

There’s no strict rule on what your Asset allocation should be at different stages of life, but I always look at Vanguard target retirement funds as a bit of a guide (although I’ll write about some of my issues with these types funds in a future post).  With 40 years until retirement, right around when you’re first starting out, Vanguard suggests about 90% stocks and 10% in bonds.  Once you hit retirement Vanguard suggests 40% stocks and 60% bonds.  Notice that even in retirement a very significant portion is still in stocks.

Vanguard target date funds % in stocks % in bonds
2055 (40 years to go) 90% 10%
2035 (20 years to go) 85% 15%
2025 (10 years to go) 70% 30%
In retirement 40% 60%


So what does that all mean?  Well early on Asset allocation done properly can get you higher returns over the long run, historically about 3-4% higher than if you completely screwed it up.  Later on, it’s going to help protect you from any market crashes, market corrections, or general market zaniness that occurs.


Reasons for picking Index mutual funds:

We know from the Elite Eight round, that one of the major advantages of Index mutual funds is their lower management fees, which are on average about 1% less than actively managed mutual funds.  We also know from The power of a single percentage that saving 1% of your portfolio year after year can lead to some serious ducats (I’ve decided to use as many slang terms for money over the next few posts, so prepare yourself).  But we’re in the Final Four now so we need something more than that.

Not above a little chicanery, Index mutual funds is going to steal a page from Asset allocation’splaybook.  Often with actively managed funds, they keep a significant portion of the fund’s assets in cash so they can buy an investment when the opportunity presents itself.  Of course we know from above that holding cash over the long term leads to lower returns than holding stocks.  Index mutual funds are able to be almost 100% invested in stocks (or whatever asset class you want) because they aren’t picking investments so much as just following the index.  Just doing some simple math, if actively managed funds have 5% of their assets in cash, and over the long term stocks return 6% more than cash let’s say, that comes to a long term benefit of about 0.3% (5% x 6%).  That’s not going to change the world, but even those little bits compounded over decades can make a huge difference.

Index mutual funds is also copying Tax optimization.  When your mutual fund sells shares there are tax implications on that (death and taxes, baby).  That’s why you get that statement every year from your mutual fund telling you what you need to report to the IRS. The more frequently your mutual fund trades stocks, the more likely it is that you’ll have short term gains which are taxed at higher rates.  But with Index mutual funds, trading is minimized because the fund is only following an index like the S&P 500 which doesn’t change that often.  That leads to lower taxes which we know can add up to some serious cheddar (see, I did it again).

There are also people who argue that Index mutual funds do better than actively managed funds because they take the human element out of it.  This is pretty controversial, and if you believe in the theories from A Random Walk Down Wall Street, which I unabashedly do, then shouldn’t active managers do just as well as a passive index?  Hmmm, that sounds like fodder for another post.  People debate this all the time and I’m not convinced that this really drives the needle.

The final major benefit of Index mutual funds is that they’re super easy, especially compared to some of the more difficult investing strategies like Asset allocation.  You can go to a place like Vanguard (that’s where the Fox family’s money is) or Fidelity or a dozen other places and sign up for one of their index funds, then as Ron Popeil says, “you set it and forget it.”  That means you’re getting pretty incredible value for a relatively small amount of work.


Who goes on to the championship game?

Index mutual funds pulled out all the stops, but in the end Asset allocation was just too strong.  Index mutual funds will definitely help build your nestegg, probably juicing your returns 1% compared to actively managed funds and maybe even 1.5% if you’re feeling charitable.  That’s nothing to sneeze at, but we’re talking about punching your ticket to the Championship round here, people.

Let’s say you completely abandoned the idea of Index mutual funds and went totally with actively managed funds.  How bad would that be?  It wouldn’t be ideal (just my opinion and one not shared by my good friend Mike), but you’d be fine in the end.  Actually this is what millions of people do all the time and it tends to work out.

Compare that worst-case scenario to Asset allocation’s and you see why they won.  Screwing up early on and investing too much in bonds and cash instead of stocks can cost 3-4% on your returns.  That dwarfs what Index mutual funds bring to the table.  Screwing up closer to retirement can put your whole financial plan at risk.  Ask near-retirees who were to heavily invested in stocks before the 2001 or 2008 crashes what they think.  In the immortal words of Winston Zeddemore “I have seen s%$t that will turn you white.

bracket-game 5

With Asset allocation the stakes are just too high.  I have Asset allocation pulling away, 68-59.  Be sure to come back tomorrow to see who they take on in the final, either Savings rate or Tax optimization.

First Round: Mortgage versus Savings rate

Basketball hoop

After a thrilling contest between Index mutual funds and Free money yesterday, we are now pitting Mortgage against Savings rate.  As always, I am not an expert on these matters.

bracket-game 2


Reasons for picking mortgage:

For most families, their Mortgage payment on their home is the single largest expenditure they have.  Also, due to its nature as a commodity, it’s also one of the easiest places to really save a lot of money pretty painlessly.  For a lot of products there’s a trade off between price and quality.  A BMW 325 owner could pay $20,000 less and drive a Honda Civic, but there is a trade-off, either real or perceived, between those two cars.  Sure you’re saving a lot of money, but you’re also getting not nearly as nice a car.

Mortgages are very different because money is a commodity, so there’s no difference.  If you get a Mortgage from Bank of America it acts pretty much identically as the Mortgage you get from Roundpoint (incidentally, the Fox family used to have our mortgage with BofA and now we’re with Roundpoint).  Money is money so here you want to go with whoever can give you the lowest rate (there are some features that might be important like prepayment penalties or ability to refinance within a certain period of time, but in my experience those are pretty rare).

Here we’ll use the Grizzly family as an example; they owe $400,000 on their home.  One of the easiest ways to save money on a mortgage is by refinancing when interest rates go down.  In the past few years, rates have been at historic lows and that means Mortgage interest rates have been similarly low.  Let’s say the Grizzlys got their mortgage 8 years ago with a rate of 6%, but now they can refinance at about 4%.  That alone would reduce the interest payments over the life of their mortgage about $175,000!!!  That’s an incredible amount of money for going through a process that takes maybe a month from beginning to end, and probably about 5 hours of work on your part.  As easy as this is, there are millions of homeowners out there who haven’t done this yet.

You can move a little up the difficulty spectrum and save even more.  Some Mortgages are sold with “points” which is basically prepaying interest; for example you might pay an extra $5000 when you get your loan and for that you would have an interest rate of 3.5% instead of 4.0%.  Points aren’t very well understood and because of that a lot of people tend to stay away, but if you are planning on staying in your house for a long time, they can be the best money you ever spent.  Using that above example, paying the $5000 to get the lower interest rate would net you a savings of about $35,000 over the life of the loan.

Kind of the opposite of points are adjustable rate mortgages (ARMs).  Instead of a 30-year fixed loan (the interest rate stays constant for the 30 year life of the loan) you could get a 5-year ARM where the interest rate is fixed for the first 5 years of the loan and then adjusts based on market conditions for the remaining 25 years.  The benefit of these is ARMs tend to be about 1% less than fixed rates, but the major concern is that rates could rise after the 5 years is up and that could increase the cost of your Mortgage.  In my opinion ARMs make sense if you don’t think you’ll be in your home for very long.

In fact the Fox family got a 5-year ARM when we relocated to North Carolina.  In the here and now we enjoy a rate about 0.8% lower than if we got a 30-year-fixed (our rate is 2.2% and it would have been about 3% with a fixed).  That’s worth about $300 each month.  Rates have been rising, so in 2020 when the ARM starts to float (rates can move) we can either pay a higher rate (remember, we’re still ahead of the game so long as rates stay below 3%), refinance to a fixed mortgage and pocket five years of monthly $300 savings, or just pay off the entire mortgage.  We’ll see.

  What it does?
Refinance Take out a new loan at a lower interest rate to decrease the amount of interest you pay
Buy points Pay more in closing costs to get a lower interest rate
ARM Get a lower interest rate that is fixed in the beginning but then becomes adjustable (usually after 5 years)


So all these seem to be pretty big numbers, especially since you aren’t really giving anything up to achieve them.  But they aren’t going to be quite that big because interest on mortgages is tax deductible, so saving $100,000 in interest on the life of your mortgage may only put you ahead $60,000 because of the tax deduction.  On the other side of the spectrum, you might end up with significantly more if you took those savings and invested them.  Either way, your Mortgage is a great way to pad your nestegg.


Reasons for picking savings rate:

Savings rate is probably the most fundamental element of investing.  You can’t really invest until you have saved some money to invest with (Gee Stocky, thanks for that tremendous insight into what we already know).  And certainly, the more you save, the more you can invest, and the larger your nestegg will become.  But how much can saving more really move the need?

savings rate

The impact can be pretty staggering.  Over a 38-year period, from 22 when most of us enter the workforce, until we turn 60 and hopefully retire, if you invest $100 per month (assume a 6% return) you will end up with about $175,000!!!  It’s not that $100 isn’t a lot of money (it definitely isn’t chump change), but that seems pretty incredible that such a modest amount every month can lead to such a large number at the end of the run.  Over those 38 years, you would have invested a total of about $47,000, and because of investing returns you would have ended up with about 4 times that amount.

And the math works so if you save $200 per month, you end up with about $350,000; $1000 per month, you end up with $1.75 million.  Ladies and gentleman, say “hello” to the power of compounding.


Who wins?

Mortgage gives it a good fight, but in the end Savings rate is able to generate numbers that are so much bigger.  Also, while refinancing at a lower rate is a pretty sure-fire way to save money with your Mortgage, the more complicated maneuvers like buying points or using an ARM do entail some risk which could cost you serious dollars if you move too early or too late.  On the other hand, there is really no way that saving more can hurt your nestegg.  In the end Savings rate crushes Mortgage 65-51.

Come back on tomorrow to see the final match of the first round, Starting early against Tax optimization.


bracket-game 3

First round: Free money versus Index mutual funds

Basketball hoop

After a thrilling first day where we saw Asset allocation blow out Diversification, we are now on to day two where Free money will face off against Index mutual funds.  As always, I am not an expert on these matters.


bracket-game 1

Reasons for picking free money:

Free money is . . . well . . . FREE.  And obviously the more money you can contribute to your portfolio the closer you’ll be to retirement, the better you’ll be able to ride out stock market downturns, and the more financial flexibility you’ll have generally.  I’m not telling you anything you don’t already know.

In the US, by far the most common opportunity for Free money is the company match for your 401k.  Of course, credit card rebates are another nice source of free money, but let’s stick with 401k’s.  Typically it looks something like they will match $0.50 for every dollar you contribute up to 6% of your pay.  And there are some companies that are even more generous; Medtronic has historically matched about $0.90 for every dollar up to 6% of your pay.  Do the simple math and your average 401k match comes in at about 3% ($0.50 * 6%).  Ever since I started working in 1999 I have always contributed at least enough to get the entire company match.

If you do a quick calculation (assume you work from 22 to 60, with a salary that starts at $50,000 and rises to $100,000 over the years, with a 6% investment return), the value of that match is about $350,000.  That’s not what your whole 401k would be worth, that’s just the value of the match!!!  Not bad considering the median nestegg for a 60-year-old living in the US is about $160,000.

So who says no to this?  Sadly, about one-third of employees who have access to a 401k plan are “leaving money on the table” by not contributing up to the amount that their employer will match.  This is some really low hanging fruit that is going unpicked.  I get that there is only so much money to go around, but man, every dollar you’re putting in gets you another $0.50 of FREE MONEY.  That’s a guaranteed 50% return; there are a lot of investors who would give their first born for something like that.


Reasons for picking index mutual funds:

Index mutual funds are mutual funds that mimic an index like the S&P 500, Barclays Bond index, FTSE Global Cap, or the MSCI US REIT index.  That may sound confusing—the point is these mutual funds find an index already established in the market and do their best to copy it exactly.

Index fund advocates, and I count myself among them with probably about 95% of the Fox’s nestegg in Index mutual funds, believe that these funds actually perform better than actively-managed mutual funds (an actively managed fund is one where the mutual fund manager picks individual stocks or bonds that he or she believes will out-perform the general market).  I personally think the data here is mixed to slightly favorable for index mutual funds (mostly because of tax implications), but that is a pretty deep discussion probably for another blog post.  For this analysis, I’ll assume that actively managed mutual funds and index mutual funds return the same amount.

The undeniable advantage of Index mutual funds is their lower management fee.  Like all things, mutual funds charge a fee for their services; it is a percentage that the fund managers skim off the top to pay for managing the fund.  For actively managed funds that fee averages to about 1% with some higher and some lower.  This goes to paying for all the research done, salaries for the different teams, brochures and disclosures, travel to different conferences, etc., and it tends to be a pretty decent chunk of change.  For Index mutual funds, you really don’t need all that because all the team is doing is tracking a pre-existing index; because of this management fees tends to be fairly low—in the 0.05% to 0.2% range.

Remember The power of a single percentage?  We actually called out mutual fund management fees there as ripe for a 1% coupon.  Running the numbers using the same scenario we just used for Free money (assume you work from 22 to 60, with a salary that starts at $50,000 and rises to $100,000 over the years, with a 6% investment return), that 401k account using a index mutual fund with a fee of 0.2% would leave you with about $990,000.  An actively managed account with a fee of 1% would leave you with about $820,000.  That a difference of $170,000 in your 401k over the course of your investing career.

But that’s just for one account.  Index mutual funds can be used for pretty much all your investing accounts—401k, IRA, 529, brokerage.  Also, they can be used throughout for investing career, from the time you open your first account as a youngster all the way through the end when you shuffle off this mortal coil and leave some cash to your loved ones (more cash than you would otherwise because you were paying lower fees).


Who wins?

This turned out to be much closer than I anticipated.  At first I figured that Free money would win this going away, but Index mutual funds definitely came to play.  Free money has a power effect (about 3% of your salary on average), but that is generally limited only to 401k accounts, only to the first 6% of your compensation, and only while you are working.  Even with all those limitations, it makes an enormous difference over your investing lifetime.  Index mutual funds have a smaller impact but a much broader application.  You can use them on every account, with every dollar invested, for every year you’re investing.

In a game that came down to the absolute wire, I think Index mutual funds barely edges out Free money in a Bryce Drew-style miracle finish.  The final score, Index mutual funds 70, Free money 69.  Ultimately I think Index mutual funds and that lower management fee will save more of your money in every corner of your investing portfolio, and that will ultimately lead to a bigger impact on your nest egg.  I hope to see you tomorrow when your Mortgage takes on Savings rate.

bracket-game 2

Top 5—investing moves when you’re just getting started

A week ago, my Uncle Lynx passed away.  At the funeral I was chatting with some distant family members (my cousin’s wife’s nephew).  He and his wife are a super cute couple.  They are in their early 20s and just getting started on this crazy journey called adulthood.

As we were chatting, the subject veered towards personal finance (me talking about personal finance . . . imagine that).  This couple’s ears perked up and then seemed genuinely interested; I suppose it’s possible they were just really polite, but I think it was something more.

It got me to thinking about what are the most important things to do in the world of personal finance when you are just getting started.  Here is my Top 5 list:


5. Figure out your debt situation: If you’re lucky, you won’t have a lot (or any) debt.  For most of us there is some out there, and that isn’t necessarily a bad thing.  List out every debt you have (student loan, mortgage, credit card, car payment, etc.), the balance, and the interest rate.

On a spreadsheet (see #4) rank them in order of interest rate.  As a general rule I use a cutoff of about 6%.  If your interest rate is above that pay those off right away, starting with the highest interest rate debt first.  If your interest rate is below that, that might be okay to keep that debt and just make the normal monthly payments.

If you have any debt (especially credit card debt) at any rate higher than 10%, that’s a “debt emergency”.  Really look at every purchase you make—if it’s not critical to your survival (food, shelter) then pass that up until your debt is paid off.  The only exception to this is #1—funding your 401k.

You can get creative with your debt by consolidating high interest rate cards onto a lower rate card or one that offers a low teaser rate.  That could save you a ton of money, and you should probably look into that, but ultimately, you’ll need to pay that sucker off.  So just hitting the grindstone of paying off your credit cards is a must.


4. Make a budget on a spreadsheet: Take a spreadsheet and put a quick budget together that includes your income, your expenses, and the difference between those two.  This can be simple at first (and it should be simple at first).  Over time, you’ll add more and more sheets to the spreadsheet for things like your mortgage, investments, kids’ education, and other things.

But at the beginning, you need to get a sense of where your money is going.  The budget will give you an aspirational view of this.  After your budget is done, you can track your spending with a website like  This two-step process lets you figure where you want to spend your money, and then also look at where you actually spend it.

Of course, this is an iterative process, and as you close a month and look at your expenses, you can see if you’re spending more than what you budgeted.  This isn’t a time to beat yourself up (being too hard on yourself is a sure way to stop looking at your finances closely, and that’s a REALLY bad thing), but a time to ask yourself why you spent more and if it was worth it.

As an aside, using a spreadsheet is a really good skill in general.  I was really good at spreadsheets and it’s hard to overstate the incredible impact it had on my career, as well as the incredible wealth those skills gave me and my family.  And really, my experience with spreadsheets started in college when I was creating a financial budget.


3. Educate yourself on investing: At a young age, educate yourself on investing.  Obviously, this blog is the universally acknowledged best place to learn about investing, but I have heard rumors there are others. is a great website that looks at personal spending and his early posts had a tremendous impact on my outlook.  A Random Walk Down Wall Street is a book on investing that really defined my investing strategy; I read that as a 19-year-old and still think about its insights today.

There are a lot of websites written by millennials about spending and personal finance that might resonate even more.  A few are:,, and  Most are about reducing spending and budgets and that sort of thing, but there are some on the nitty gritty of making investing choices.  You’ll want perspectives on both.

The whole point is that you need to know what you are doing here.  Spending 20 hours early in your life to figure out basics like asset allocation, tax avoidance, and fee minimization as well as a general attitude towards saving early can easily lead to hundreds of thousands or millions of dollars.  That comes to about $50,000 per hour—not bad.


2. Start an IRA with $1,000: This is as much about the experience gained as it is about actually investing your money.  Vanguard lets you start an IRA with $1,000 as the minimum amount.

You’ll navigate through their website, figure out how to make choices (like Roth or Traditional IRA—go traditional).  You’ll pick your investments, and then you’ll have something to look at every once in a while to see how it’s doing.

So many people are just at a total loss when it comes to setting up accounts for their investments.  That becomes a real problem once you hit 30 or 40 and you’re starting to get behind the 8-ball; you know you need to do something but are kind of clueless on where to start.  Doing it now lets you get your toes wet in this world and makes the next accounts you need to set up (529, 401k, brokerage, etc.) all the less daunting.


1. Get the company match on your 401k: #2 was more for experience than for investment.  Here is where you should start walking down the path for investments.  At a minimum, contribute the match and take the free money.

This is so important for a couple reasons.  First, you’re getting that free money.  Second, you’re making your first “asset allocation” decision.  When it comes time to pick which fund to invest in, unless you have very unique circumstances for an early-20s person, I would definitely go with a 100% equity index fund.

Third, your 401k is a really powerful tool.  If you had no other investing tool, you could still grow a 401k to well over a $1 million during your working career.  That is enough to fully fund your retirement.


BONUS—Stay poor:  Too many young adults make a huge mistake of trying to mimic the lifestyle their parents provided, once they (the young adults) get out of school.  That first paycheck of $2,000 is going to seem like a ton of money (and it is).  It’s really tempting to decide to buy a new car or go on a kickin’ vacation or upgrade the furniture.  Resist the urge.

Your parents took 25 or more years of working (with pay increases and investment returns) to provide the house and cars and vacations you enjoyed your senior year of high school.  It’s not realistic to think you can have stuff at that level of niceness so early.

A car is a really good example.  In general, automobiles are horrible investments.  To the degree you have a car that can get you from point A to point B, keep it.  A new car will be nice and cool and make your friends gawk, but it’s a horrible use of money.  A couple hundred dollars a month for a car, plus insurance, and maybe $50 for a gym membership, $50 for cable, and $80 for four dinners at a restaurant—those numbers add up.  Those alone could fund your savings in the early years.

Your early 20s are a time when it’s still okay not to have the best and nicest of everything.  If you can embrace that, even when you do have the money, and put that extra money to work in investments you’ll build a very strong financial foundation that will afford you many more opportunities are you reach your 30s and 40s (remember, I did that and I retired at 36).

Should you use an investment advisor?

I started writing this blog because I wanted to share my own experiences with investing, including how to navigate the complex world of investing on your own.  I am a firm believer in DIY financial management.  That is what worked for me, and I believe all people can get really great results doing it on their own.  That said, many readers ask about using a broker or investment adviser or financial planner.  Here’s my take.

Quick disclosure: I am an investment adviser.  I passed my Series 65 and work with a small number of friends, helping them with their finances.


Are financial professionals worth it?

As with any purchase you make, you need to evaluate a investment adviser on the basis of how much she costs, and how much value you get in return.  On the surface I would say “no, it probably isn’t worth it,” however there are definitely some factors which may reverse that decision.

First, let’s look at how much investment advisers cost.  The rates range widely.  Plus there isn’t a lot of transparency in the marketplace so it’s not always easy to know what the going rate is.  My experience says that 1-2% is typical.  This can come in many forms—typically brokers get paid fees from the mutual funds they suggest for you or from the transaction costs for trades.  Advisers tend to charge a percentage of your portfolio.  We know that 1% coupons are really valuable, so those fees are a lot.  Over an investing career they can add up to hundreds of thousands of dollars.  That’s a pretty big deal.

Of course, if you’re getting a lot of value from your investment adviser, maybe it’s worth it.  I just bought Metallica tickets today and they were expensive, but I’ll get a lot of value, so there you go.  One of the main missions of this blog is to show you how you can invest successfully on your own, and I think most people can do that without having to hire a professional.  Sure you have to make decisions on asset allocation, which accounts to use, what investments to make; but those aren’t really all that complex.  Also, thanks to the efficient market lessons from A Random Walk Down Wall Street we know that you’re as good a stock picker as anyone.

So my general feeling is that investment professionals aren’t worth the money; a motivated investor can do just as well on their own and pocket the fees.  Wait, what???  You said “motivated”.  As it turns out, a lot of people, despite their best intentions, aren’t able to put their financial plan in motion.  If you’re one of those people, and if an investment adviser can help motivate you to do the right things, then I do think they are more than worth it.

In this way, investment advisers are a lot like personal trainers.  Most of us know that exercise is good for us, and most of us know how to run on the treadmill and lift weights properly (or you can find out by watching a 3-minute video on Youtube).  But if a trainer can motivate you to actually hit the treadmill and the weights, they’re definitely worth the money, right?  How much is your physical health worth to you?  Same thing with finances.  If you know what you should be doing, but for one of a million reasons you never end up actually doing it, maybe you should get an investment adviser to help you out.

Nearly every post I’ve done shows that there is a ton of value out there if you invest properly, taking into account things like time horizon, taxes, etc.  But if you don’t do anything, you’re losing ALL that value.  If an investment adviser helps you in ways you won’t or can’t, then you’ll probably end up ahead of the game, even after you take his fees into account.


How would you pick a financial professional?

So let’s say you’ve decided that an investment adviser makes sense for you.  How do you pick a good one?  This is one of the biggest challenges, and in my opinion one of the reasons a lot of people don’t get investment advisers: They don’t know a good one they can trust.  The problem is there are a ton of them and the quality varies greatly.  Sadly, there are a lot of unskilled people in the industry who don’t know what they’re doing.  Even worse, there are some real shysters who might take your money, either overtly steal it or use other schemes to siphon away your money and put it in their pockets.  It’s a legitimate concern.

First, you need to find someone you can trust.  Ideally, this would come from a personal reference.  Today you also have things like or Angie’s List that gives ratings.  Additionally, there are government agencies like that track these people so you can look them up to see how long they have been around and any complaints that have been files against them, etc.  These are okay, but for my money, nothing beats a personal reference from someone you trust.  Of course, it’s not always easy to have those conversations with friends: “So Mary, who is helping you with your money, and can I talk to them?”

Second, you need to find someone who is good.  Of course, knowing this isn’t always easy.  Using that same personal trainer analogy, you probably wouldn’t hire an obese trainer.  You’d want someone who is ripped, someone who has shown they have been successful at physical fitness themselves (like my totally buff friends Christel and Tobias).

If you have a personal trainer, he should be ripped like Tobias here. Similarly, if you have an investment adviser, that person should be rich.


Similarly, you want a rich investment adviser.  You want someone who has been successful creating wealth for themselves.  But this is where the challenge comes in: if the investment adviser is wealthy then why is he working with you?  Seriously.  You have a lot of young kids who are doing this (let’s say less than 30).  I’m sure there are some good ones, but I’m not trusting my family’s financial well-being to someone without a lot of experience.  You also have a lot of people who just aren’t that good.  If someone has been an investment adviser for 20 years or more and they aren’t a multi-millionaire, how good can he really be?  I’m not trying to be mean, but shouldn’t that be more than enough time to accumulate some serious wealth?


Questions to ask:

If you do decide to go with a investment adviser, make sure you ask a lot, A LOT, of questions.  Beyond your doctor or minister/rabbi, this person will probably have the biggest impact on your well being.  Take the time to make sure you find a good one.

How long have you been doing this?  This is an area where experience definitely matters.  In particular, you want her to have lived through a few bear markets.  At a minimum she should have been doing advising people since 2008 and even better if she’s been doing it since 2001.

What did you do during 2001 and 2008?  Investing is a lot easier when things are going well.  You prove your mettle during the tough times.  Figure out how he handled himself when everyone thought the world was coming to an end.

What are you paid?  This should be answered in excruciating detail.  Does he get paid by you (how is the amount determined, when is it paid), by others like mutual fund companies (how much, how do you make sure you serve my interests ahead of theirs)?

What is your personal financial situation?  No point sugar-coating it.  Find what his financial situation is like.  As mentioned above, if he isn’t rich, how good is he really?  Also, the relationship you have with him needs to be based on trust because you’re going to be sharing everything with him.  If he isn’t willing to reciprocate in some way, that might tell you something.

How will you ensure you serve my best interests?  This is a biggie.  Ideally you want her to have a fiduciary relationship which is a legal standard where she serves your interests ahead of anyone else’s, including her own.  No matter how this turns out, you’re going to need to trust this person, and you should get a sense of how she will ensure that you are #1.

What is your investing strategy?  Obviously, there are a lot of nuisances to this, especially as he customizes it to your specific situation.  But he should definitely have an approach and a philosophy that he can articulate clearly and understandably.

What type of power will you have over my money?  Will she be able to make trades and move money between accounts with your express permission, on her own, or not at all?  This is a tricky one because maybe you want to offload these activities completely, so her having a ton of control may be okay.  No matter, you should definitely understand this completely.

How will you take into account other assets that you won’t manage?  Most situations will have him managing an account like your IRA or brokerage account but not others like your 401k, mortgage, pension, etc.  Most times, he’s only paid on the accounts he manages, but to do his job well he’ll need to take into consideration those other accounts as well.


Those are what I came up with off the top of my head.  At the end of the day, if you do go with an investment adviser make sure you find someone who has demonstrated they have the skills to build your wealth.  Just as importantly, make sure you find someone who you can trust completely.


Driver-less cars impact your decisions now

I don’t think there’s any doubt that driverless cars are going to change the world.  They’ll be safer, cleaner, more efficient, eliminate/reduce traffic jams, and on and on.  The future looks bright . . . but what does that have to do with today?

The big question isn’t if but when.  A few years back Google and Uber and GM and everyone else were figuring out prototypes, and putting them on the road in a very limited way.  They told us not to get too excited—driverless cars wouldn’t become mainstream until way in the future: Think 2030 or 2040 when they became standard fare.

Yet that seems to have inched significantly closer.  Tesla today has driveless cars.  GM claims it will sell cars without steering wheels and pedals in 2019—THAT’S NEXT YEAR PEOPLE!!!

But back to the question at hand: what does that have to do with today?


Buying a car has big financial implications

Purchasing a car is a big deal that can greatly impact your personal finances (finally, Stocky, you’re getting to the point).  Getting that right or wrong can mean hundreds of thousands or millions of dollars.  Let’s really simplify the world to two scenarios:

  1. The Stocky method: You buy a car new, finance it at the teaser rate, and drive it until it goes to heaven.
  2. The Ocelot method: You lease a car and then turn it in after 3 years.

Certainly there are other options (1a—you buy a three year old car and drive that into the ground), but let’s just look at these two.

As you would expect, from a financial perspective option #1 wins big time.  A “typical” car like a Honda Accord costs about $22,000.  You could buy it for $2,500 down and then take advantage of 1% APR financing so you’ll have monthly payments of $332 for the next 5 years.  Or you could lease it for $2,500 down, and then pay $200 per month for the next three years; after which you turn the old car in and start it all over again.

Cars are engineered incredibly well, so let’s assume the car you buy lasts 24 years (I am the proud owner of a 1998 Toyota 4Runner).  If you run the numbers, buying a car comes out ahead to the tune of about $90,000.  That’s astounding considering the original purchase is only $22,000.

Bear in mind that’s $90,000 per car each time you make a purchase/lease decision.  For a married couple, it comes to about $800k over their investing horizon.  Remember that the average American has a net worth of about $80,000.  Heck, if you didn’t save a dime in your 401k or do any of the other stuff we talk about, just the car purchase decision could fund your retirement.

Of course, it’s not a perfect comparison.  The major advantage of a lease is you get a new car every three years—that’s a safer car, a nicer car, plus the option to change the car as your situation changes.  But $800,000 is $800,000 after all.

The point is that financially it makes a lot more sense to buy a car than lease.


Driverless cars completely changes the car purchasing decision

Let’s bring this full circle now.  We’re on the brink of driverless cars changing everything.  Once they come out, you’d be crazy not to go with that option.  In fact, I think car insurance will make it much more expensive not to use driverless cars, and before too long human-driven cars will be banned (the same way horse carriages are banned on highways today).

We’re definitely in the kill zone.  Foxy and I are wondering how much longer the 4Runner has—I say many more years but I think she secretly tries to put sugar in the gas tank to kill it when I’m not paying attention.

If we had to get a new car today, what would we do?  Normally it’s a no-brainer: you buy a new car and drive it forever.  However, for that decision to make sense you have to drive that car for years.  Actually, the breakeven point is at about 8 years.  Is there any doubt that by 2026 we’ll have really good driverless cars?  At the rate things are going, we’ll have them in 8 months, not 8 years.

Futurists make a really exciting debate about what the future of cars will look like.  Personally, I think ‘Lil Fox and Mini Fox will never own cars.  Rather they’ll subscribe to a service similar to your cell phone: for $300 per month you get your 16-mile work commute (with up to 2 other commuters, 2 minute max wait time) plus 500 miles of other driving in a 4-person sedan (with up to 100 miles in a minivan or SUV).

That will fundamentally change things like car insurance, garages (both at home and parking structures), and a million other things.  And I bet it’s a lot sooner than we think.  Bear in mind, 5 years ago, everyone was saying driverless care are decades away; now GM says it’s a year.

In the meantime, we have to still get to work and pick up groceries and take the kids to baseball practice today.  How does all this impact what you want to be a sound financial decision if we have to get a new car today?


The verdict—lease your next car

While this pains me to say, I think the best financial move for your next car is to lease.  Who would have thought I would ever type those words?

If you buy, in 10 years or so you’ll be just getting ahead on your financial decision, but you’ll be sooooo behind the times plus be a bit of a hazard on the road.  Imagine hanging out with your friends as they take selfies and you pull out your Blackberry.

Going all in with stocks


With the recent craziness in the stock market, I’ve chatted with friends about how much of their portfolio should be in stocks.  Actually the conversation goes more like:

THEM:  I am about 50% stocks, 50% bonds.  How does that sound?

ME:  50% stocks and you’re 41 years old, and you have a good job?!?!?!?  Are you crazy?  That’s way too conservative.

THEM:  But I don’t want to be too risky.

ME:  You have a lot of safe investments that you probably don’t even know about.  The investments you can invest in stocks you should so you can get the higher return over the long term.

THEM:  ??????


So here is what I am talking about–the hidden cash in your portfolio.

We know that you need to balance risk and return in our investments.  This is most clearly done when we choose our mix of stocks (more risky, higher average returns) and bonds (less risky, lower average returns).  As an investor gets older they want to shift their asset allocation towards less risky investments because their time horizon is shortening.  We all agree with this.  So where is this hidden pot of gold I’m talking about?


Let’s look at the example of Mr and Mrs Grizzly.  They are both 65 years old and entering retirement.  They worked hard over the years and socked away $1 million that will see them through their golden years.  They do some internet research and learn that a sensible asset allocation in retirement is 40% stocks and 60% bonds, so they invest $400k in stocks and $600k in bonds.  Knowing the long term average returns are 8% for stocks and 4% for bonds, they expect their $1 million nest egg to generate about $56,000 per year ($400k * 8% + $600k *4%) , knowing that some years it will be more and some years it will be less.   So far so good, right?

1 m

THEY ARE LEAVING MAYBE $20,000 PER YEAR ON THE TABLE.  That’s a ton of money.  How can this be?  They seem to be doing everything right.  The answer is they are being way too conservative with their asset allocation.  They shouldn’t be investing $600k in bonds and $400 in stocks; stocks should be a much higher percentage.

Waaaaiiiiiiiittttttttt!!!  But didn’t we agree that about 60% of their portfolio should be in less risky investments?  Yes, we did.  Are you confused yet?


Hidden cash

Here’s what I didn’t tell you.  Mr and Mrs Grizzly have other investments that act a lot like bonds that aren’t included in that $1 million.  Both Mr Grizzly and Mrs Grizzly are eligible for Social Security with their monthly payments being $2000 each.  If Mr Grizzly (age 65) went to a company like Fidelity and bought an annuity that paid him $2000 each month until he died (doesn’t that sound a lot like Social Security), that would cost about $450k.  So in a way, Mr Grizzly’s Social Security payments are acting like a $450k government bond (theoretically it would be worth more than $450k since the US government has a better credit rating than Fidelity).  And remember that Mrs Grizzly is getting similar payments, so as a couple they have about $900k worth of “bond-ish” investments.

Also, Mr and Mrs Grizzly own their home that they could probably sell for $300k.  They don’t plan on selling but if they ever needed to they could tap the equity in their home either by selling it or doing a reverse mortgage.  So in a way, their house is another savings account for $300k.

If you add that up, all the sudden the picture looks really different.  They have about $950k of Social Security benefits that have the safety of a government bond.  Plus they have that $300k equity in their house.  That’s $1.25 million right there.


Investing your portfolio

So now let’s bring this bad boy full circle.  Remember their $1 million nest egg they were looking to invest?  Look at that in the context of their Social Security and house.  Now their total “assets” are about $2.25 million.  If you believe that the Social Security and house kind of feel like a bond, just those by themselves account for 55% of their portfolio.  If on top of that if you invest 60% of their $1 million nest egg in bonds, they have over 80% of their money in bonds, and that seems way too high.

2 25 m a

On the other hand, let’s say they only put $100k of their nest egg into bonds and the rest into stocks, after you include their social security and home, they’d be at about 60% bonds and 40% stocks.  Isn’t that what they were aiming for the whole time?

2 25 m b

Wow.  It took a long time to get there, Stocky.  The punchline better be worth it.  Remember that with $600k in bonds and $400k in stocks, they had an expected return of about $56,000 per year.  However, if they have $100k in bonds and $900k in stocks, because stocks are more volatile but have a higher expected return, they can expect about $76,000 ($900k * 8% + $100k *4%).  THAT’S $20,000!!! 

But aren’t they taking on a lot more risk to get that extra $20k?  Remember, there’s no such thing as a free lunch.  For sure, but if you look at it in the context of their Social Security benefits and their home, they have a fair amount of cushion from “safe investments” to see them through any rough patches in the stock market.


I wrote this post to show that people really need to take account all the financial resources they have.  In the Grizzly’s case, it was their Social Security benefits and their home.  Others of you may be getting a pension (Medtronic is generous enough to offer the Fox family one) or a second home or a dozen other things like that.

When you take those cash flows into account, all the sudden it seems a lot more reasonable to invest the rest of your money a little more heavily in stocks which you know over the long haul will give you a better return.

Shopping for health insurance (part 3)

On Monday we talked about the fat, dumb, and happy path we took when we got our health insurance from our employer.  On Tuesday we talked about how insurance works and what are the shoals you have to navigate through.  Today, we’ll talk about how the Fox family is going to go forward.



What we have been spending on health insurance in the past

Let’s look at what we’re going to do and how that impacts us financially.

First, let’s remember what we’ve been paying when covered by traditional, employer-sponsored health insurance.  We directly pay about $1,100 per month, plus the company pays about $1,200 per month.  Remember that $1,200 is really your money.  Your employer doesn’t give that to you out of charity.  You earn that money and you are paid that in the form of subsidized health insurance.  Add those together and it’s about $2,300 per month which comes to about $28,000 annually.

Plus, you have to add all the copays and deductibles.  I track this stuff because I am a nut.  Going back to when Foxy and I got married in 2010, we typically spend about $1,200 each year on copays.  However, there were two years where it was closer to $4,000.  That’s when ‘Lil Fox had to be hospitalized for croup.  More on that scary episode in a second.

Our average premiums were about $28,000 each year, and our out-of-pocket is about $2,000 each year, knowing some years are higher than others.  That’s $30,000 each year that we were spending on health insurance, not that far off from what Obamacare was going to charge.  I had no idea I was spending so much.  I just barfed in my mouth.


What we’ll end up doing now

After extensive searching, we found a really good policy from United Healthcare that costs about $500 per month.  It gives us access to their negotiated rates which is the most important thing, and then it covers certain things up to a set amount.

For example, it covers a regular doctor visit up to $100, after which I am responsible for the excess charges.  As I said, figuring out negotiated rates are really hard, but I think on average a doctor visit with the negotiated rate is about $150.  So, I would pay the $50 not covered.

This stuff is really confusing, but looking at all the coverage I figure that I would pay a bit more under this plan than I would in copays under the traditional employer-sponsored plan (or Obamacare which looks a lot like a traditional employer-sponsored plan).  But you can pay for a lot of copays with an $1,800 per month difference in premiums.

With this coverage, we get #1 and #3 of what insurance coverage offers.  But we’re missing #2 which is that protection from some catastrophic medical event like a car accident or something.  For that we can get a supplemental policy that costs about $100 per month and it covers us for any expenses that exceed $15,000 in a three-month period.

That ensures that if tragedy strikes in the form of a car accident or a fire where one of us are stuck inside or . . . I don’t even like thinking about this.  You get my point.  If something really bad happens and one of us (or all of us) is in the hospital for a long time and the medical bills really rack up, we’ll max out at $15,000.


How we’ll probably end up ahead

Good news.  We get all our coverage—access to negotiated rates, typical coverage of basic stuff, and protection against catastrophic costs—for about $600 per month or $7,000 per year.  That compares pretty favorably to the $28,000 in monthly premiums from my employee-sponsored plan (or even the $1,100 per month or $13,000 per year that was my portion, but again make no mistake that I was paying for both portions).

There’s no questions that our out-of-pockets will be higher now than they were before.  Typically, we spend $2,000 per year on that stuff, so let’s say it doubles to $4,000 per year (about $350 per month).  That’s a lot of money, but we’re still ending up way ahead because although we spend an extra $2,000 on out-of-pockets we are spending about $21,000 less on premiums.  That’s a huge windfall.  $21,000 a year is enough on its own to fund a nice retirement (about $5 million over a 40-year investing lifetime!!!).

Of course, those numbers assume we’re pretty healthy and don’t consume a ton of medical care.  Let’s say Foxy and I each get our annual check-ups, the boys go twice a year, and there’s one ER visit and a couple urgent care visits thrown in for fun.

But what if catastrophe happens?  After all, that’s the whole point of insurance, right?  God forbid we have a repeat of 2013 when ‘Lil Fox was in the PICU for 4 days with a nasty case of croup.  At the time we were covered under my Medtronic insurance and the total cost was about $32,000 of which we had to pay out-of-pocket about $4,000.

Those are some big numbers.  But let’s say that we were on the hook for the whole $28,000 (instead of just the $4,000).  First, we’d be helped out by the catastrophic coverage, so we’d only pay $15,000.  Given that we’re saving about $22,000 annually on premiums we’d come out about even.  Bear in mind, we’ve had kids for seven years now (including in utero), and that one event was the biggest medical issue we’ve had.  If at it’s worst we break even and then all the other years we come out way ahead, that seems like a winning combination.


How we’ll change our behavior

Given that the plan we’ll get is pretty bare-bones, there’s a much closer link between the healthcare we actually use and what we pay out-of-pocket.  This provides a lot of transparency which is actually a good thing (basically what my friend Oguz said in a comment on Tuesday).  One of the big problems is that when things are “covered” by insurance and people don’t have to pay for it, they use a lot more.

For us, we’ll pay when ever we see a doctor or get a prescription.  That will make us more selective of when we actually go see a doctor.  If Mini Fox has a cough (which he actually does right now), we’ll probably wait an extra day or two before going to the doctor (which we are in fact doing right now).  Maybe that sounds like terrible parenting, but actually most experts agree that people are hypochondriacs, and waiting a bit gives your body the chance to heal.  We’d never put our family in harms way, but the body does have the ability to heal itself pretty miraculously.  We’ll take advantage of that.

Also, we’ll be more mindful of using the most expensive types of care.  The most obvious example is an emergency room versus an office visit or urgent care.  If you don’t pay the costs, it doesn’t matter and most people will do the quickest thing they can (ER).  However, if you’re paying for it, you’re a lot more likely to have the inner dialogue at 11:30pm when you’re kid is puking: “Do I really need to go to the ER or can I wait until morning and go to the urgent care?”

Those are the little things that can save the healthcare system a ton of money.  But we as consumers only think about it when we have skin in the game (again, to Oguz’s point).  Now that we’ll have a more bare-bones policy, we’ll be thinking about that, and it’s a good thing.


There are bargains to be had

Another major benefit of the bare-bones coverage is that with less things “covered” we’ll need to shop around more for our medical treatment.  We’re becoming more engaged in the process which is a good thing.  Also, this allows us to actually find some major bargains out there, and who says “no” to getting better quality while paying less?

There’s a fun little procedure a fox can get when he doesn’t want to have any more cubs.  Vasectomies are covered under most plans.  The total cost is very opaque (again Oguz’s point on transparency), but the typical out-of-pocket was about $200.

However, there are clinics that don’t accept insurance and are only cash pay.  I must say they seem A LOT nicer.  The receptionist answers the phone by the third ring, not after you’re on hold for 20 minutes (literally, I’ve had that experience).  The facilities are beautiful and totally modern.  They do the consult and the procedure all in one meeting which is awesome.  Everything is better.  All for the low cost of $750 which you pay with a credit card at the time of the procedure.  Bear in mind, the monthly premium for coverage that covers vasectomies is $2,300 per month and the premium for the plan that doesn’t cover vasectomies is $600.  Simple math to me.

This very similar example can extend to all sorts of stuff like Lasix.

Another example close to our heart is speech therapy.  That’s an optional piece of healthcare which is also fairly predictable, so it doesn’t fall under the traditional definition of “insurance”.

Under our employer plan (and Obamacare as well), we could sign up with an approved provider.  The list price was $200 per 45-minute session, and the negotiated price came down to $150.  Our copay was $50.

I ended up talking to a guy who used to give us speech therapy (so he’s licensed and the same high quality).  He left his company that was covered by insurance and went out on his own.  He and I came up with an awesome deal.

His previous company would charge insurance $150 of which I paid $50.  He actually got about $30 per session.  He and I agreed to cut the middleman out.  We bypass insurance, and I pay him directly $40 per session.  He comes to our house to do the speech therapy which is a ton more convenient, plus he does it for 60 minutes because he’s hustling and wants the business.  Everyone wins.

He makes more money, I pay less, and we get a better-quality product.  This only happens because I go outside the health insurance paradigm and used that awesome thing in capitalism called competition.


There you have it.  After 4,300 words in three parts, you now have a sense for how we are handling our health insurance.

Having to do it on our own, away from the protection of an employee-sponsored plan was a bit unnerving at first, but after I went through it all, I’m actually fairly optimistic.  I’m still going to get great healthcare (and the speech therapy and vasectomy examples show that maybe even better quality), all the while saving a ton of money.

Remember, that each month we’ll save about $1,700 in premiums.  Maybe we’ll pay an extra $200 per month in copays, but still that’s $1,500 to the good each month.  That is HUGE, coming to about $5 million over a typical healthcare consumer’s investing lifetime.


Shopping for health insurance (part 2)

Yesterday I started the story of how the Fox family had to shop for health insurance in the open market.  Mostly, I talked about how we had always had employee-sponsored health insurance; we were shocked by how much Obamacare cost, but it turns out we were always paying that much, and we just didn’t know it (which is part of the problem).

Today we’ll talk about how health insurance has gotten so screwed up.  Thursday we’ll finish up with how the Fox family is going to beat the system and save enough to completely fund our retirement (at about $5 million) along the way.


The definition of “insurance”

Part of the problem is the word “insurance” has been bastardized.  Anywhere you go except for healthcare, the concept of insurance means you pay a small amount of money and if an unpredictable catastrophe occurs, those expenses are covered.  Think auto insurance or homeowner’s insurance.

For a lot of political reasons, “insurance” has taken on a very different meaning when applied to healthcare.  Health insurance isn’t meant to cover only unforeseen expenses and very large expenses.  It has come to mean to many people “paying for all medical expenses”, including those that are optional (Viagra, psychological counseling, baby head helmets) and very predictable (birth control, contact lenses, dialysis).

Always remember that Las Vegas wasn’t built on winners and neither are insurance companies.  Insurance companies have to make money or they go out of business.  To cover all those expenses, they need to raise premiums or increase the patient’s share of the expenses through deductibles or out-of-pockets.

That’s coming out of your pocket.  So when your insurance plan offers chiropractic visits or smoking cessation or a million other things that you’re pretty confident that you won’t ever use, you’re still paying for that.

The point is that “health insurance” has become more of a “healthcare buffet”.  For a monthly cost you get (or at least can get) a bunch of stuff, some of which you’ll use and much of it you won’t.  This has predictably lead to health insurance costs spiraling out of control (Obamacare costs rose about 10% in 2017).  More on this in a minute.


What health insurance really provides

When you buy health insurance, what are you actually getting?  This seems like an easy question, but it actually breaks down into three major components (two of which you probably know right away, but one that’s a bit more subtle):

  1. Payment of medical expenses: This seems obvious.  When you have health insurance, you can go to the doctor and your health insurance pays some or all of those costs.  This isn’t that big of a deal because for those predictable healthcare expenditures, you’re really paying these costs anyway through your premiums.
  2. Protection from major expenditures: In the more traditional sense of insurance, if you have some catastrophic medical event (in a major car accident, get diagnosed with cancer, etc.) your health insurance will cover the enormous expenses that would otherwise bankrupt most people.
  3. Negotiated rates: This is the subtle one.  In addition to #1 and #2, when you have health insurance, you get access to the rates they negotiate with healthcare providers.

So when you “buy” health insurance, either one on your own like the Fox family is getting ready to do, or as part of your employee benefit package (and make no mistake, you’re paying for all of that), you are getting those three things.


Negotiated rates are a big deal

#3 is such a big deal that it deserves its own section.

When you go to a hospital, there is a list price that someone off the street without insurance would be charged.  Then there is the negotiated rate that insurance companies work out with the hospital which is much, much lower.

Negotiated rates are a closely guarded secret, so it’s hard to figure out exactly how large the negotiated rate discount is, but if you know where to look, you can find it.  It tends to be about 1.5 to 3x.  For every $3 a person without insurance in charged for something, an insurance company will negotiate that rate down to $1.  That’s a HUGE benefit!!!

This is one of those things that really pisses me off.  When I am elected to Congress, I am going to work hard to remedy this.

The argument goes that insurance companies use their volume to negotiate better prices, but do they really?  How many of those patients go to St Mary’s Hospital instead of Sinai Medical Center because of their insurance?  My experience is that most insurers allow patients to go most places.

Second, when you use insurance it takes a long period of time for the insurance claim to be processed and paid, the deductible to be calculated and that invoice to be sent out and paid.  Contrast that to a cash patient who could pay with a credit card that day (or a check to avoid credit card fees), and you could actually argue that cash patients should pay less than insurance patients, not three times more.

Also, where else would it be acceptable to charge a customer 3x compared to another.  If you did that based on race (charge black people more than white) or gender (charge women more than men) or wealth (charge poor people more than rich people) or ethnicity (charge Asians more than Jews) people would throw a total fit, and it would totally be justified.

Scaling it down a notch, charging people 3x more because they are ready to pay you in US legal tender really isn’t all that different.  People are throwing a fit about unaffordable healthcare in America, but I really don’t hear a lot about this.  This is where you could make some real progress and give real relief to those who aren’t insured.

I’m not saying that hospitals and other healthcare providers should take less.  I’m just saying they should charge everyone the same price, and it should be transparent.

Bottom line, in the country we live in today, probably the biggest benefit of health insurance is having access to those negotiated rates.


Everything is available at the buffet

Another major factor that has made health insurance more complicated and a lot more expensive is the breadth of coverage that is now fairly typical with most plans like Obamacare and employee-sponsored plans.

Obamacare has a special name these “extra” things—minimum essential coverage.  They are things like: pregnancy, birth control, drug and alcohol abuse treatment, mental therapy to name a few.  Those are required to be included in any Obamacare plan.  Many employee-sponsored plans (like the one I had at Medtronic) had a lot more stuff too like: chiropractor visits, fitness counselors, etc.  Plus, of course, Medtronic had amazingly good coverage for diabetes patients.

Look at that list.  In our situation, we wouldn’t use any of those.  We aren’t planning on having any more children and other steps have been taken to assure ongoing birth control isn’t needed 😉.  We don’t abuse drugs, don’t use chiropractors, don’t have diabetes, and don’t have high cholesterol.

However, when plans offer that coverage for things that are fairly predictable (not the classic definition of “insurance”) it has to be paid for somehow, and that somehow is with higher premiums.  Whether we used it or not we pay those higher costs, and that’s one of the reasons health insurance is so expensive.  It offers and charges you for so much that you won’t end up using.  I guess that’s how we get to a crazy high cost like $2,300 per month as a premium.

For us (and a lot of people out there), we’re pretty healthy and really don’t take advantage of some of those gray areas of healthcare like chiropractors.  We just want something simple that covers our doctor’s visits and catastrophic events.

As medicine gets more and more socialized (and you move away from the ability to choose a bare-bones plan—what we’ll be doing), you open yourself up to an ugly word in healthcare—Lobbyists.  There are a lot of companies making incredible technology that helps people (I speak first hand on this, having worked for Medtronic for almost 20 years).  It’s understandable that they are going to do everything they can, legally and otherwise, to get their products covered on insurance formularies.  They aren’t bad people per se; they are just advocating for the products they believe in (and the products which also pay their bills).

Of course, nationalized medicine offers the biggest opportunity for this.  Whether it’s Pfizer trying to explain how Viagra must absolutely be offered as a part of health insurance, or Medtronic and continuous glucose monitoring, or Bayer and birth control, or the American Association of Chiropractors, or the American Institute of Homeopathy.  On and on and on.

There’s so much that could be offered as a part of insurance, the vast majority of which a very, very small portion of the population actually uses.  Simply put, we can’t afford it all.  In that case, it becomes a game of lobbyists who can best convince bureaucrats to support what they want.  That’s not a good situation.

That leads to out-of-control costs, which we’re already seeing today–$2,300 per month.  But if you have choices in the market, you can pick the plans that only give you what you want, and you can save a ton of money (about $5 million over your lifetime).  That’s what we’ll talk about tomorrow.