Personal
Finance (Maxims Part II)
This essay was written by Ron Muhlenkamp,
originally published in 1992 and updated in April 2005, © 2005.
All rights reserved.
Dear Nephew:
Some additional notes and things I didn’t cover in "Basic
Financial Maxims I Want My Kids to Know." 
- There are books available which go into great
detail (maybe too much) on a whole shopping list of items relevant
to spending and saving money. Two that I think you will find useful
are: Making the Most of Your Money, by Jane Bryant Quinn
and Wealth Without Risk, by Charles Givens. Both are probably
available at your local library. (Givens is also willing to sell
you a whole program of videos, audios and workbooks for $900 but
that seems to defeat its own purpose). Their sections on spending
and savings are quite good while their sections on investing are
less so - partly because investing must change as the financial
climate changes.
To this end, The New York Times’
Book of Personal Finance, by Leonard Sloan gives good descriptions
of financial instruments all the way from CDs to stocks and annuities.
The descriptions are concise, factual and focus on the inherent
nature of the instrument, both pros and cons. In ten minutes on
any one topic, you will understand more about it than 95 percent
of the salesmen who are trying to sell it to you. To determine which
investment climate we are in, and therefore which instruments are
not appropriate, your best bet is to ask me.
- Make a list of your assets and debts and their
relevant returns or interest rates. (It may look like this):
ASSET |
VALUE |
RATE |
Savings
Account – CD |
$10,000 |
2% |
Emergency
Fund |
$10,000 |
2% |
Personal
Goods |
$20,000 |
Depreciating |
Car
#1 |
$10,000 |
Depreciating |
Car
#2 |
$5,000 |
Depreciating |
House |
$150,000 |
Inflation |
Mutual
Fund |
$10,000 |
8
- 9% |
IRA
Stock Account |
$20,000 |
8
- 9% and Tax Deferred |
Pension
or 401K |
$30,000 |
7
- 9% Tax Deferred |
DEBT |
AMOUNT |
RATE |
Charge
Card |
$1500 |
-18% |
Auto
Loan |
$6,000 |
-13% |
Mortgage |
$120,000 |
-6% |
Then work to move your assets toward
the areas where returns are high and pay off debts where the costs
are high. In this case, I would keep the Emergency Account intact
but would use the savings account to pay off the charge card debt
and part of the auto loan or fund the individual retirement account
(IRA). I would continue to fund my IRA (rate 8% - 9% and tax deferred)
or pay off my auto loan (saving 13% interest) with money I had been
depositing into my savings account or certificate of deposit that
earned only 2% interest.
- To make your savings plan seem more of a reality,
keep a notebook and enter each prepayment just as you did in the
savings account. When you want to feel like you are getting ahead,
take a look at your notebook. It will read:
3/14/1992 – Paid off Charge
Card $1500 at -18%
3/14/1992 – Deposited
into IRA $ 500 at 8%
4/14/1992 – Deposited
into IRA $ 200 at 8%
5/15/1992 – Extra Payment
on Auto Loan $ 200 at –13%
You should be more satisfied seeing
that you have been saving money at 8% to 18% instead of 2%.
- Be aware that when you go to the bank for a
mortgage or for any other purpose, the bank will ask you to fill
out a statement similar to the one above. They will look at all
of your assets and liabilities. They will be more impressed by
your prepaying or not having high cost debt than they will be
by your having a savings account while carrying the high cost
of debt. When you get to the point that the bulk of your assets
are high return and your debts are low cost, your financial position
will improve rapidly.
If you really want to impress your
banker that you’re a good credit risk, put together the above
statement, jot down your plans for paying off debt and set up your
prepayment note book. Then make an appointment with the bank president
and ask his advice on what you’ve done. He will be impressed
with your plan and will think you’re very smart for asking
his advice. He will also remember you when you apply for a mortgage.
Of course, all of this can turn negative if you don’t actually
follow through on the plan. Note: One of the best ways to impress
people with your intelligence is to ask for their advice. (Parents
and uncles are absolutes pushovers for this!)
Good luck,
Uncle Ron
Ron Muhlenkamp
© 2005. All rights reserved.