Summary:
During mid-1990's, people in India lost their life savings due to ill-advised investments in chit funds run by fly by night operators. At that time, my view of those investments in chit funds was an obvious no-no. Passage of time has helped me understand the motivation of people to improve their personal financial position. Indian politicians were not interested in addressing systemic issues around people's hankering for sky high returns promised by chit funds. I observed a similar rush towards money during my initial days in America. When I talked to random Indians I met at chain stores, some of those meetings were with Amway people intent on signing me up towards their goals. Their desperation in camouflaging a business approach as a personal interaction eventually did work. I attended one of those Amway seminars and promptly fell asleep in the middle of the presentation (though I did finish off some cookies before that). Amway is one of the companies that sells the idea of entrepreneurship as a path to riches for individuals (even though its business model only serves to enrich the people at the top).
The increasing levels of income inequality in America has led to stagnating wages and a thin safety net for low and middle income people. As they near their retirement age, the realization that they are unprepared has forced them to look for investments that would provide them financial security in their future. Personal finance industry then steps in to offer them dubious investment products that do more harm than good. This book is written with American public in mind, to assure them that their failure to achieve comfortable financial cushion in their retirement is not all their fault. It lays bare the fantasy of personal financial growth during a time of stagnating wages, rising income inequality and a threadbare social safety net. Personal finance industry stands to benefit from the current individualistic approach in the form of fees and commissions which explains their lack of concern about systemic issues affecting personal finance in American society.The book title is a play on the famous aphorism 'Penny wise, pound foolish'. It directs a skeptical look at the claims of personal finance industry in stocks, real estate and insurance.
Analysis:
Personal finance industry in America is massive and keeps growing every year. Famous practitioners like Dave Ramsey, Suze Orman have made themselves into rich millionaires by propagating the message that personal finances are primarily an individual issue. The proliferation of personal finance gurus and websites has coincided with the increase in income inequality in America. Increasing income inequality has been used to prod Americans to take control of their personal finances. Because improving personal financial position falls on the individual, it has put increased stress on low and middle income people who are already in an impossible situation due to not having enough discretionary income to invest in stock market to take advantage of its red hot growth. Starting with the presidency of Ronald Reagan, the collective spirit of American society began tearing apart while the romantic vision of an individual becoming successful primarily as a result of their own efforts took hold. This vision ignored the increasing cost of housing, medical care and education (fixed costs) and the flat lining of wage growth. The individualistic culture encouraged a self help approach to what was fundamentally a societal issue. It resulted in poor people getting blamed for their perilous financial condition. When the Great Recession happened in 2008, it triggered a reckoning among Americans that however prudent they are with their personal finances, it was no match for an unexpected job loss or a catastrophic medical emergency. The Great Recession also showed the unrepentant nature of the personal finance gurus who had exhorted Americans to take advantage of the gains in stock market and real estate during boom times. Even when they admitted their part in cheer leading the headlong rush into stocks and real estate, they framed it as minor error instead of a major factor that devastated people's financial lives. Personal finance industry has now pivoted to cheering on "financial literacy" programs that are marketed as helping people prudently plan for their financial future. Personal finance industry as it currently exists is built on a contradiction - if they provide an answer that works, people will no longer use their services. To get around this contradiction, personal finance gurus sound authoritative and convince their listeners that they know what they are talking about. Sadly, a large number of Americans fall for these snake oil sales men (and women). All the personal finance gurus preach self abnegation when it comes to any purchases with the exception of their own products.
Conventional wisdom about stock market says that it provides the best opportunity for growing individual wealth - the oft repeated data point is that average annual return for S & P 500 from 1927 to 2011 was 9.75% excluding fees. However, if a person invested in stock market between 1999 - 2009, the average annual return on stocks for that period is -0.5%. This has led to disagreements between personal finance experts on the reality of stock market growth for individual investors. In the period between 1981 - 2011, bonds outperformed stocks by a full percentage point but the constant drumbeat of stock coverage has meant individual investors have piled into stocks instead of bonds. 2008 recession also showed American public the very real downside to spectacular growth in stock market and real estate. The complete transformation of American personal finance landscape from defined benefit plans (pensions) to defined contribution plans (401 (K)s, IRAs) has shifted the burden of retirement preparedness from employers to employees. In early 1980's, when Congress was pushing 401(K)s and IRAs to improve the savings rate of Americans, some critics like Teresa Ghilarducci pushed back hard that pensions should be strengthened. Her predictions about the flimsiness of the 401(K) model has come to pass - Americans have very low average account balances as they approach retirement. While 401(K)s and IRAs take advantage of the power of compound interest, stagnant wages and shaky employment prospects for Americans has meant that the retirement nest eggs of Americans has seen very little growth. Pensions were originally introduced in Germany under Chancellor Otto Von Bismarck as a way to counter the worst effects of Industrialization in that country. FDR used Bismarck's idea to set up social security during Great Depression. The booming American economy after World War II allowed social security payments and pensions to be dispensed liberally. The mainstays of retirement planning today, IRAs were originally meant to be a supplemental retirement plan for employees in private companies who did not have access to pensions and other retirement options. 401(K)s were started in 1981 to allow a few corporations to set up profit sharing plans for their high income employees. Once companies realized there was no legal hurdle to replacing pensions (which placed a lot more burdens on employers) with 401 (K)s and IRAs (which placed a lot more burden on employees), they wasted no time making the switch. Coincidentally, American stock market started its long bull run in the 1980's expanding the valuations of average Americans' portfolios. With every new milestone that stock market attained, Americans got used to the idea that their investments in stock markets would always go up, discounting the very real possibility of stock market slowdowns or crashes. By October 2008, when the Great Recession was in full swing, $2 trillion in retirement nest eggs of Americans had been wiped out. The push towards defined contribution plans has enriched financial services industry from the fees they charge for managing plans offered by employers. Legally, fund managers are not required to provide information on fee structure to their clients. That has been the result of intense lobbying directed by companies in financial services sector from Vanguard to Legg Mason towards Congress. The desire to make things easier for consumer has resulted in a new type of funds called Target date funds. They are meant to provide comfort to the customer that the returns from the fund will be optimal based on the target date that is selected - for example a target date fund for 2020 will be extremely conservative whereas a target date fund for 2050 will start off being aggressive in earlier years and turn towards conservative portfolio stocks and bonds in the later years. However, each fund manager has a different perception of their customer's risk tolerance - someone who is closer to retirement will have a lesser risk tolerance than someone far out from retirement. As with other financial instruments, financial services industry has developed a revenue stream with these funds by jacking up the expense ratios. Another approach to increasing average American's financial readiness for retirement has been to sign them up for automatic enrollment. Because employees are automatically enrolled by Human Resources departments at their respective companies, they assume that HR knows the correct amount to set aside for their retirement and leave the default 3% in place for a long time. The recommended best practice is to allocate 15% towards retirement. For defined contribution plans to work, an average person has to be a disciplined saver unaffected by any random negative events (sickness, unemployment, divorce etc.,.). They need to be aware of basics of investing and have a large amount of disposable income to take advantage of any tax benefits.
Personal finance columns in newspapers was started by S.F.Porter - her actual name was Sarianni "Sylvia" Feldman. She wrote the first article on personal finance in August 1935 in New York Post. Prior to her article, newspapers had focused on financial advice to wealthy people. The end of World War II kick started a boom in American economy that allowed S.F.Porter to target her financial advice to the low and middle income people. She became wildly successful by careful tending to her public image depending on the prevailing trends in American society - In 1930's, she painted herself as a courageous crusader picking fights on behalf of the American public against US Treasury, In 1950's she portrayed herself as a glamorous or practical housewife, In 1960's she argued in favor of consumer rights and in 1970's, she took up feminist causes. By mid 1970's, she had amassed considerable wealth which dulled her perception of the public needs. She was even caught pushing some corporate press releases through her column. She died of emphysema in 1991. After S.F.Porter, the personal finance torch was carried forward by Jane Bryant Quinn who became the premier personal finance expert just as Americans started relying more on television for their personal finance advice. The deregulation of financial markets in America also brought forth a dizzying array of new financial products - Adjustable Rate Mortgages, Home Equity Loans, 401 (K)s, IRAs. It also coincided with a long bull run in stocks - from a low of 770 in August 1982, Dow Jones Industrial Average rose above 10,000 in the year 2000. It crashed during the dotcom bubble but recovered to hit 14000 in 2007. It crashed to half that value after the 2008 recession but has now zoomed past 25000. Jane Bryant Quinn took the new flashy stock pickers to task for cheering on American public during the stock market craze. She correctly predicted that the same public would be blamed when the stock market inevitably crashed. The run up in stock market valuations convinced the American public that they too could become multi millionaires if only they could save and invest their savings prudently in the stock market. A very similar belief was in play in real estate as well. In reality, most of the growth in stock market went to the people at the top. Because wages for low and middle income people were stagnating or growing very slowly, they were left out of the gains in stock market. This situation was portrayed by personal finance industry as being the end result of Americans being spendthrifts with no regard for their future. By recasting personal finance as the realm of individual knowledge and smartness instead of society, personal finance gurus leveraged the perceived rugged individualism of Americans to their benefit. With the stock market setting new highs and real estate values steadily appreciating, Americans moved away from the collective spirit that had carried them to the pinnacle of the financial world. Personal finance industry is beholden to advertisers (car dealers, super market, real estate brokers, financial service firms) to get its message out to the broader public. Advertisers wanted to see some returns on their investment and for the most part, wanted Americans to spend money on their products and services. News publications faced declining revenues across the board and personal finance columns in those newspapers became cash cows bringing in much needed revenue. It was only a matter of time before these news publications allowed their personal finance columnists to promote investment vehicles from financial services firms in return for advertisement dollars.
Personal finance industry relied on newspapers as their track record in books was thin. The craze in books about becoming millionaires started with The Millionaire Next Door by Thomas J Stanley and William D Danko in 1996. As income inequality in America rose, the number of books about becoming millionaires also increased. In spite of American complaints about "Socialist" Europe, class mobility in Europe is much higher than US. The religious reverence for small businesses and entrepreneurs in America ignores the reality that 4 in 5 small businesses fail. While books on becoming millionaires dispense advice on cutting down on expenses to get ahead, actual research has shown that entry level millionaires (with net worth between $1 million to $5 million) spent a lot more money on business coaches to get ahead. People who are spendthrifts do reduce their financial resources that puts them in a precarious position when a crisis hits. However, even prudent savers are not exempt from financial ruin when hit by financial shocks like unemployment or a catastrophic medical condition. Personal finance industry and free marketers have argued that financial deregulation has reduced the cost of everyday goods like groceries making lives of average Americans better. However, they have conveniently ignored the stratospheric increases in fixed costs like education, housing and health care. In 1973, those 3 categories of fixed costs made up 50 percent of average household discretionary spending. By 2000's, that proportion had risen to 75 percent. Combined with stagnant or falling wages, it has become a double whammy for the people in 99%. This also explains why national savings rate started its decline and how Americans went from a nation that saved a decent amount of their earnings to spendthrifts. With increasing fixed costs and stagnant wages, there was not much money left to save.
Currently, Suze Orman is one of the most famous personal finance personalities. Her personal finance advice programs are carried across the US in multiple TV stations. Soundness of her financial advice has been overwhelmed by her popularity. With the passage of time, she has changed her positions on various personal finance subjects including prioritizing paying down credit card debt versus building up savings, level of liquid savings to have on hand etc.,. She charges $84,000 for a speaking engagement and has terrific following across the American media landscape (PBS to QVC to CNBC). She started her work life at Buttercup Bakery and Coffee shop in Berkeley California. Her customers raised $50,000 for her own business venture which she lost when her broker frittered it away in bad investments. She demanded a job at Merrill Lynch (where her broker worked) and became a successful broker herself by cold calling regular people like waitresses, truck drivers who were not Merrill Lynch's target market. Her success enabled her to branch out on her own by starting Suze Orman Financial Group. Along the way she came to rely on Lord Ganesh and follow the precepts of Siddha Yoga. She kept spending most of her income as soon as it came in, resulting in an eventual financial crisis. She rebounded her from her crisis by offering personal finance seminars. She portrays herself as someone whose brush with personal financial doldrums provides credibility to her advice. In her worldview, financial success is personal success and conversely, financial failure is personal failure. As anyone who has watched her shows know, she has a propensity to yell at her audience when denying their request. This is in contrast to her advice during stock market boom when she pitched the path to surefire riches was to believe that you could succeed. When Occupy Wall Street movement started gaining steam, she switched her advice to include references to systemic income inequality. The constant reinvention of her persona explains her success when compared to Jane Bryan Quinn who provided advice based on what was good for her readers. Suze Orman took advantage of Americans willingness to try "New Age" therapies in financial aspect of their lives. Her first book was targeted towards retirees - You've Earned it, Dont Lose it. She made it into a massive success that has put her on an upward trajectory ever since. She has since expanded her business empire with branded products like Approved card (from someone who yells regularly at people in her TV show for having too much debt) to Suze Orman Will and Trust kit. She also introduced Money Navigator, a newsletter providing investment advice for those close to retirement. Critics have attacked it savagely pointing to the inappropriateness of the newsletter advice - encouraging people nearing retirement to invest in short term profit seeking investments for their long term needs during retirement.
David Bach is another personal finance guru whose approach is to demand Americans cut down on spending on what he considers to be frivolous items. His textbook example of frivolous items is the Starbucks Latte. He was a Morgan Stanley money manager who leveraged his informational money management classes into a personal finance empire. He wants Americans to use automated savings strategies to become millionaires. Automatic savings strategies direct money to an investment account before the person can get their hands on it. If people complain about not having enough money, he suggests cutting down on their latte consumption and use those savings to build up their investments. According to his calculations, a daily savings of $5 from not purchasing Starbucks Latte would save $150/month or $2000/year. Investing it in stock market and assuming an average annual rate of 11% per year will provide that person with $2 million by the time they hit retirement. He went on Oprah Winfrey show to pitch his ideas through his book, 'The Automatic Millionaire' and immediately became successful. For people who did not drink Starbucks Latte, he suggested identifying other frivolous items they could get rid of. After his book became popular, critics pointed to $5 at Starbucks as lot of money for a Latte. When critics took inflation and taxes into account, the $2 million amount came down to $173,000 (which, to Suze Orman's credit, she came very close to in one of her earlier books when explaining the benefits of investing). When the critics assigned $3 to a daily Starbucks Latte, they could only come up with $50,000 based on David Bach's calculations which, even though a higher number, does not have the same cachet as a million.
Dave Ramsey is another personal finance guru who uses debt avoidance and Bible to dispense financial advice to his listeners. He counsels his listeners to attack their debt and avoid declaring bankruptcy (even though in his personal life, he declared bankruptcy to get out from a mountain load of debt). He grew up the son of a successful realtor and in college, he branched out into real estate. He maintained an extravagant lifestyle that required stretching his credit limit. When banks stopped lending to him, he hit rock bottom and declared bankruptcy in 1990. He turned to Bible and absorbed its lesson about not being in debt to his heart. He self published his first book, Financial Peace and with its eventual success, expanded his offerings to include radio programs. In his view, someone in a dire financial situation is responsible for it even if that situation is the result of unexpected job loss or medical emergency. While current financial research suggests the best way to pay down debt is to attack the biggest debt first and then work towards addressing smaller debts, Dave Ramsey recommends his listeners work in the opposite direction - start with the lowest debt first and after it clearing it successfully, concentrate on bigger and bigger debts. In his opinion, tackling the smaller debt and succeeding in addressing it provides the confidence to stick with the program of clearing other debts even if they are bigger. As part of expanding his empire, Dave Ramsey has convinced American courts that debtors who file for bankruptcy should take online course offered by his company (after paying him the requisite fees, of course) before their bankruptcy petition can be discharged.
Seniors are constantly afraid that their retirement funds will run out. Financial acument peaks at age 53 and seniors do not usually acknowledge gaps in their financial understanding. Because baby boomers close to retirement are viewed as cash cows, a whole sub sector of personal finance industry has sprung up selling all kinds of investment products to them. To capture the attention of seniors, the personal finance industry has honed a variety of techniques - dine and dash seminars where brokers, insurance agents and lawyers pitch all types of exotic investment products. They also use behavioral psychology techniques to get seniors to part with their money - some methods include showing dollar amounts on a monthly basis since most customers do their budgeting on a monthly basis, selling variable annuities even when it is not clear that the customer needs it.They paint a dire picture for the seniors about the safety of retirement nest egg and offer to protect it for the future. Because brokers are held to a lower standard with regards to their financial advice (suitability standard - as long as the recommended financial product is good enough, it is legal) compared to financial advisers (fiduciary standard - clients financial interest is paramount), they have far more leeway in the types of investment products that can be pitched to their customers. Brokers were in a spot of bother during Obama administration when they were expected to comply with fiduciary standard. With the transfer of power to Trump administration, that has been shelved and brokers are now held to suitability standard, allowing them to wreak havoc on seniors' financial future again. Like brokers, personal finance gurus are also held to suitability standard. They further insulate themselves legally by inserting a disclaimer that individual investors have to do their research and are liable for any financial consequences arising from their stock picks. Most customers operate under the mistaken assumption that brokers and personal finance gurus follow fiduciary standard. The desire of brokers to rake in commissions means customers are pushed into reckless investments since brokers commissions are not dependent on the performance of the stocks. The reluctance of brokers to be held to a higher standard is a testament to the broken nature of the personal finance industry. Apart from seniors, consumers interested in the hottest opportunities to make money can attend conferences like MoneyShows that serve as a platform for every shade of huckster parading their wares. Personal finance industry has pitched a variety of options towards seniors to improve their financial position including options trading. For seniors not able to visit conferences to know about the next hottest moneymaking opportunity, a parade of TV personalities do the same for free. The poster child for TV hucksters is Jim Cramer whose show Mad Money on CNBC is a massive hit in spite of his record of patchy stock recommendations.
Financial services industry portrays women as prone to an emotional style of investing. Given the lower wages of women across the economy compared to men in comparable positions, they have not been able to invest as much in the stock market. Where they have been able invest comparable sums in stock market, their returns are usually better than those of men. Women live longer than men and as a result, they look to stretch their retirement dollars for a much longer period. To achieve that, they quite sensibly approach stock market conservatively. That approach also means personal finance industry does not stand to make as much from women as men. Because men are arguably worse investors, they are a reliable source of revenue for personal finance industry. Furthermore, men have the confidence that they can make up for any losses in stock markets with future earnings which further stokes their aggressive approach.
In addition to stock market, real estate has been pitched as another vehicle to improve financial prospects of individuals. American society views home ownership as an indicator of middle class status. Individuals overestimate the profit they make from buying and selling houses by focusing only on the purchase and sale price and ignoring taxes, inflation and maintenance costs. Historically, a home has been looked upon as a long term investment with a minimum period of 7 years needed for any kind of decent return on a property. With the introduction of different types of mortgages and loosening of bank regulations, home ownership became another way to make money. As with the books on becoming a millionaire, the cavalcade of books on getting rich from real estate is long. The most famous one is Rich Dad Poor Dad written by Robert Kiyosaki, comparing a poor dad (his father) with a rich dad (his neighbor). In Kiyosaki's telling, rich dad became successful because he unshackled himself from a steady paycheck and instead focused on becoming a successful entrepreneur. He holds that being in debt is not bad, just that being in wrong kind of debt is bad. As with other hucksters, the seminars organized by Kiyosaki and his associates focus more on signing up future participants for their seminars than in dispensing any secret to making profit from real estate. Even though critics have ripped Kiyosaki's methods, people have continued to sign up for his courses in large numbers.
Financial literacy programs offered by personal finance industry has been pitched as an effort to improve the ability of Americans of all ages to improve their financial health. However, the personal finance industry has figured out to use these programs to their benefit as well - by plastering their brand names on all these programs, they have been able to engender brand loyalty in Americans for financial products from a very young age. At the same time, they have been able to mollify US Congress by pointing to these programs as a sign of their desire to do the right thing. Financial rules in US have been designed under the assumption that an average American is disciplined when it comes to money. The fetish around individual responsibility further inhibits any meaningful efforts that Americans can take collectively. Herculean efforts to put one's financial house in order can be wiped away by an ill timed health emergency or unexpected job loss. Focusing on systemic issues like soaring fixed costs (Healthcare, Education, Housing) would take away the gusher of revenue that the personal finance industry has come to rely on.The author draws a straight line between the personal finance crisis and obesity crisis in America. Poor people are more likely to be obese because unhealthy food choices are also the cheaper ones and with stagnating wages and unexpected job losses, lower and middle class Americans turn to those options (with active encouragement from food industry). Similarly, the lack of disposable income for building savings for retirement leads lower and middle class Americans to invest their money in dubious investment vehicles (with active encouragement from personal finance industry) leaving them poorer in the end. In contrast, high earners in America can afford to buy healthy food and exercise regularly leading to better health indicators for them. Their high income also allows them to invest their disposable income in stock market for the longer run, ending up with more riches.
Other Books for Reference:
Sham: How the Self-Help Movement Made America Helpless - Steve Salerno
Broke: How Debt Bankrupts the Middle Class - Katherine Porter
The Two-Income Trap: Why Middle Class Mothers and Fathers are Going Broke - Elizabeth Warren and Amelia Warren
During mid-1990's, people in India lost their life savings due to ill-advised investments in chit funds run by fly by night operators. At that time, my view of those investments in chit funds was an obvious no-no. Passage of time has helped me understand the motivation of people to improve their personal financial position. Indian politicians were not interested in addressing systemic issues around people's hankering for sky high returns promised by chit funds. I observed a similar rush towards money during my initial days in America. When I talked to random Indians I met at chain stores, some of those meetings were with Amway people intent on signing me up towards their goals. Their desperation in camouflaging a business approach as a personal interaction eventually did work. I attended one of those Amway seminars and promptly fell asleep in the middle of the presentation (though I did finish off some cookies before that). Amway is one of the companies that sells the idea of entrepreneurship as a path to riches for individuals (even though its business model only serves to enrich the people at the top).
The increasing levels of income inequality in America has led to stagnating wages and a thin safety net for low and middle income people. As they near their retirement age, the realization that they are unprepared has forced them to look for investments that would provide them financial security in their future. Personal finance industry then steps in to offer them dubious investment products that do more harm than good. This book is written with American public in mind, to assure them that their failure to achieve comfortable financial cushion in their retirement is not all their fault. It lays bare the fantasy of personal financial growth during a time of stagnating wages, rising income inequality and a threadbare social safety net. Personal finance industry stands to benefit from the current individualistic approach in the form of fees and commissions which explains their lack of concern about systemic issues affecting personal finance in American society.The book title is a play on the famous aphorism 'Penny wise, pound foolish'. It directs a skeptical look at the claims of personal finance industry in stocks, real estate and insurance.
Analysis:
Personal finance industry in America is massive and keeps growing every year. Famous practitioners like Dave Ramsey, Suze Orman have made themselves into rich millionaires by propagating the message that personal finances are primarily an individual issue. The proliferation of personal finance gurus and websites has coincided with the increase in income inequality in America. Increasing income inequality has been used to prod Americans to take control of their personal finances. Because improving personal financial position falls on the individual, it has put increased stress on low and middle income people who are already in an impossible situation due to not having enough discretionary income to invest in stock market to take advantage of its red hot growth. Starting with the presidency of Ronald Reagan, the collective spirit of American society began tearing apart while the romantic vision of an individual becoming successful primarily as a result of their own efforts took hold. This vision ignored the increasing cost of housing, medical care and education (fixed costs) and the flat lining of wage growth. The individualistic culture encouraged a self help approach to what was fundamentally a societal issue. It resulted in poor people getting blamed for their perilous financial condition. When the Great Recession happened in 2008, it triggered a reckoning among Americans that however prudent they are with their personal finances, it was no match for an unexpected job loss or a catastrophic medical emergency. The Great Recession also showed the unrepentant nature of the personal finance gurus who had exhorted Americans to take advantage of the gains in stock market and real estate during boom times. Even when they admitted their part in cheer leading the headlong rush into stocks and real estate, they framed it as minor error instead of a major factor that devastated people's financial lives. Personal finance industry has now pivoted to cheering on "financial literacy" programs that are marketed as helping people prudently plan for their financial future. Personal finance industry as it currently exists is built on a contradiction - if they provide an answer that works, people will no longer use their services. To get around this contradiction, personal finance gurus sound authoritative and convince their listeners that they know what they are talking about. Sadly, a large number of Americans fall for these snake oil sales men (and women). All the personal finance gurus preach self abnegation when it comes to any purchases with the exception of their own products.
Conventional wisdom about stock market says that it provides the best opportunity for growing individual wealth - the oft repeated data point is that average annual return for S & P 500 from 1927 to 2011 was 9.75% excluding fees. However, if a person invested in stock market between 1999 - 2009, the average annual return on stocks for that period is -0.5%. This has led to disagreements between personal finance experts on the reality of stock market growth for individual investors. In the period between 1981 - 2011, bonds outperformed stocks by a full percentage point but the constant drumbeat of stock coverage has meant individual investors have piled into stocks instead of bonds. 2008 recession also showed American public the very real downside to spectacular growth in stock market and real estate. The complete transformation of American personal finance landscape from defined benefit plans (pensions) to defined contribution plans (401 (K)s, IRAs) has shifted the burden of retirement preparedness from employers to employees. In early 1980's, when Congress was pushing 401(K)s and IRAs to improve the savings rate of Americans, some critics like Teresa Ghilarducci pushed back hard that pensions should be strengthened. Her predictions about the flimsiness of the 401(K) model has come to pass - Americans have very low average account balances as they approach retirement. While 401(K)s and IRAs take advantage of the power of compound interest, stagnant wages and shaky employment prospects for Americans has meant that the retirement nest eggs of Americans has seen very little growth. Pensions were originally introduced in Germany under Chancellor Otto Von Bismarck as a way to counter the worst effects of Industrialization in that country. FDR used Bismarck's idea to set up social security during Great Depression. The booming American economy after World War II allowed social security payments and pensions to be dispensed liberally. The mainstays of retirement planning today, IRAs were originally meant to be a supplemental retirement plan for employees in private companies who did not have access to pensions and other retirement options. 401(K)s were started in 1981 to allow a few corporations to set up profit sharing plans for their high income employees. Once companies realized there was no legal hurdle to replacing pensions (which placed a lot more burdens on employers) with 401 (K)s and IRAs (which placed a lot more burden on employees), they wasted no time making the switch. Coincidentally, American stock market started its long bull run in the 1980's expanding the valuations of average Americans' portfolios. With every new milestone that stock market attained, Americans got used to the idea that their investments in stock markets would always go up, discounting the very real possibility of stock market slowdowns or crashes. By October 2008, when the Great Recession was in full swing, $2 trillion in retirement nest eggs of Americans had been wiped out. The push towards defined contribution plans has enriched financial services industry from the fees they charge for managing plans offered by employers. Legally, fund managers are not required to provide information on fee structure to their clients. That has been the result of intense lobbying directed by companies in financial services sector from Vanguard to Legg Mason towards Congress. The desire to make things easier for consumer has resulted in a new type of funds called Target date funds. They are meant to provide comfort to the customer that the returns from the fund will be optimal based on the target date that is selected - for example a target date fund for 2020 will be extremely conservative whereas a target date fund for 2050 will start off being aggressive in earlier years and turn towards conservative portfolio stocks and bonds in the later years. However, each fund manager has a different perception of their customer's risk tolerance - someone who is closer to retirement will have a lesser risk tolerance than someone far out from retirement. As with other financial instruments, financial services industry has developed a revenue stream with these funds by jacking up the expense ratios. Another approach to increasing average American's financial readiness for retirement has been to sign them up for automatic enrollment. Because employees are automatically enrolled by Human Resources departments at their respective companies, they assume that HR knows the correct amount to set aside for their retirement and leave the default 3% in place for a long time. The recommended best practice is to allocate 15% towards retirement. For defined contribution plans to work, an average person has to be a disciplined saver unaffected by any random negative events (sickness, unemployment, divorce etc.,.). They need to be aware of basics of investing and have a large amount of disposable income to take advantage of any tax benefits.
Personal finance columns in newspapers was started by S.F.Porter - her actual name was Sarianni "Sylvia" Feldman. She wrote the first article on personal finance in August 1935 in New York Post. Prior to her article, newspapers had focused on financial advice to wealthy people. The end of World War II kick started a boom in American economy that allowed S.F.Porter to target her financial advice to the low and middle income people. She became wildly successful by careful tending to her public image depending on the prevailing trends in American society - In 1930's, she painted herself as a courageous crusader picking fights on behalf of the American public against US Treasury, In 1950's she portrayed herself as a glamorous or practical housewife, In 1960's she argued in favor of consumer rights and in 1970's, she took up feminist causes. By mid 1970's, she had amassed considerable wealth which dulled her perception of the public needs. She was even caught pushing some corporate press releases through her column. She died of emphysema in 1991. After S.F.Porter, the personal finance torch was carried forward by Jane Bryant Quinn who became the premier personal finance expert just as Americans started relying more on television for their personal finance advice. The deregulation of financial markets in America also brought forth a dizzying array of new financial products - Adjustable Rate Mortgages, Home Equity Loans, 401 (K)s, IRAs. It also coincided with a long bull run in stocks - from a low of 770 in August 1982, Dow Jones Industrial Average rose above 10,000 in the year 2000. It crashed during the dotcom bubble but recovered to hit 14000 in 2007. It crashed to half that value after the 2008 recession but has now zoomed past 25000. Jane Bryant Quinn took the new flashy stock pickers to task for cheering on American public during the stock market craze. She correctly predicted that the same public would be blamed when the stock market inevitably crashed. The run up in stock market valuations convinced the American public that they too could become multi millionaires if only they could save and invest their savings prudently in the stock market. A very similar belief was in play in real estate as well. In reality, most of the growth in stock market went to the people at the top. Because wages for low and middle income people were stagnating or growing very slowly, they were left out of the gains in stock market. This situation was portrayed by personal finance industry as being the end result of Americans being spendthrifts with no regard for their future. By recasting personal finance as the realm of individual knowledge and smartness instead of society, personal finance gurus leveraged the perceived rugged individualism of Americans to their benefit. With the stock market setting new highs and real estate values steadily appreciating, Americans moved away from the collective spirit that had carried them to the pinnacle of the financial world. Personal finance industry is beholden to advertisers (car dealers, super market, real estate brokers, financial service firms) to get its message out to the broader public. Advertisers wanted to see some returns on their investment and for the most part, wanted Americans to spend money on their products and services. News publications faced declining revenues across the board and personal finance columns in those newspapers became cash cows bringing in much needed revenue. It was only a matter of time before these news publications allowed their personal finance columnists to promote investment vehicles from financial services firms in return for advertisement dollars.
Personal finance industry relied on newspapers as their track record in books was thin. The craze in books about becoming millionaires started with The Millionaire Next Door by Thomas J Stanley and William D Danko in 1996. As income inequality in America rose, the number of books about becoming millionaires also increased. In spite of American complaints about "Socialist" Europe, class mobility in Europe is much higher than US. The religious reverence for small businesses and entrepreneurs in America ignores the reality that 4 in 5 small businesses fail. While books on becoming millionaires dispense advice on cutting down on expenses to get ahead, actual research has shown that entry level millionaires (with net worth between $1 million to $5 million) spent a lot more money on business coaches to get ahead. People who are spendthrifts do reduce their financial resources that puts them in a precarious position when a crisis hits. However, even prudent savers are not exempt from financial ruin when hit by financial shocks like unemployment or a catastrophic medical condition. Personal finance industry and free marketers have argued that financial deregulation has reduced the cost of everyday goods like groceries making lives of average Americans better. However, they have conveniently ignored the stratospheric increases in fixed costs like education, housing and health care. In 1973, those 3 categories of fixed costs made up 50 percent of average household discretionary spending. By 2000's, that proportion had risen to 75 percent. Combined with stagnant or falling wages, it has become a double whammy for the people in 99%. This also explains why national savings rate started its decline and how Americans went from a nation that saved a decent amount of their earnings to spendthrifts. With increasing fixed costs and stagnant wages, there was not much money left to save.
Currently, Suze Orman is one of the most famous personal finance personalities. Her personal finance advice programs are carried across the US in multiple TV stations. Soundness of her financial advice has been overwhelmed by her popularity. With the passage of time, she has changed her positions on various personal finance subjects including prioritizing paying down credit card debt versus building up savings, level of liquid savings to have on hand etc.,. She charges $84,000 for a speaking engagement and has terrific following across the American media landscape (PBS to QVC to CNBC). She started her work life at Buttercup Bakery and Coffee shop in Berkeley California. Her customers raised $50,000 for her own business venture which she lost when her broker frittered it away in bad investments. She demanded a job at Merrill Lynch (where her broker worked) and became a successful broker herself by cold calling regular people like waitresses, truck drivers who were not Merrill Lynch's target market. Her success enabled her to branch out on her own by starting Suze Orman Financial Group. Along the way she came to rely on Lord Ganesh and follow the precepts of Siddha Yoga. She kept spending most of her income as soon as it came in, resulting in an eventual financial crisis. She rebounded her from her crisis by offering personal finance seminars. She portrays herself as someone whose brush with personal financial doldrums provides credibility to her advice. In her worldview, financial success is personal success and conversely, financial failure is personal failure. As anyone who has watched her shows know, she has a propensity to yell at her audience when denying their request. This is in contrast to her advice during stock market boom when she pitched the path to surefire riches was to believe that you could succeed. When Occupy Wall Street movement started gaining steam, she switched her advice to include references to systemic income inequality. The constant reinvention of her persona explains her success when compared to Jane Bryan Quinn who provided advice based on what was good for her readers. Suze Orman took advantage of Americans willingness to try "New Age" therapies in financial aspect of their lives. Her first book was targeted towards retirees - You've Earned it, Dont Lose it. She made it into a massive success that has put her on an upward trajectory ever since. She has since expanded her business empire with branded products like Approved card (from someone who yells regularly at people in her TV show for having too much debt) to Suze Orman Will and Trust kit. She also introduced Money Navigator, a newsletter providing investment advice for those close to retirement. Critics have attacked it savagely pointing to the inappropriateness of the newsletter advice - encouraging people nearing retirement to invest in short term profit seeking investments for their long term needs during retirement.
David Bach is another personal finance guru whose approach is to demand Americans cut down on spending on what he considers to be frivolous items. His textbook example of frivolous items is the Starbucks Latte. He was a Morgan Stanley money manager who leveraged his informational money management classes into a personal finance empire. He wants Americans to use automated savings strategies to become millionaires. Automatic savings strategies direct money to an investment account before the person can get their hands on it. If people complain about not having enough money, he suggests cutting down on their latte consumption and use those savings to build up their investments. According to his calculations, a daily savings of $5 from not purchasing Starbucks Latte would save $150/month or $2000/year. Investing it in stock market and assuming an average annual rate of 11% per year will provide that person with $2 million by the time they hit retirement. He went on Oprah Winfrey show to pitch his ideas through his book, 'The Automatic Millionaire' and immediately became successful. For people who did not drink Starbucks Latte, he suggested identifying other frivolous items they could get rid of. After his book became popular, critics pointed to $5 at Starbucks as lot of money for a Latte. When critics took inflation and taxes into account, the $2 million amount came down to $173,000 (which, to Suze Orman's credit, she came very close to in one of her earlier books when explaining the benefits of investing). When the critics assigned $3 to a daily Starbucks Latte, they could only come up with $50,000 based on David Bach's calculations which, even though a higher number, does not have the same cachet as a million.
Dave Ramsey is another personal finance guru who uses debt avoidance and Bible to dispense financial advice to his listeners. He counsels his listeners to attack their debt and avoid declaring bankruptcy (even though in his personal life, he declared bankruptcy to get out from a mountain load of debt). He grew up the son of a successful realtor and in college, he branched out into real estate. He maintained an extravagant lifestyle that required stretching his credit limit. When banks stopped lending to him, he hit rock bottom and declared bankruptcy in 1990. He turned to Bible and absorbed its lesson about not being in debt to his heart. He self published his first book, Financial Peace and with its eventual success, expanded his offerings to include radio programs. In his view, someone in a dire financial situation is responsible for it even if that situation is the result of unexpected job loss or medical emergency. While current financial research suggests the best way to pay down debt is to attack the biggest debt first and then work towards addressing smaller debts, Dave Ramsey recommends his listeners work in the opposite direction - start with the lowest debt first and after it clearing it successfully, concentrate on bigger and bigger debts. In his opinion, tackling the smaller debt and succeeding in addressing it provides the confidence to stick with the program of clearing other debts even if they are bigger. As part of expanding his empire, Dave Ramsey has convinced American courts that debtors who file for bankruptcy should take online course offered by his company (after paying him the requisite fees, of course) before their bankruptcy petition can be discharged.
Seniors are constantly afraid that their retirement funds will run out. Financial acument peaks at age 53 and seniors do not usually acknowledge gaps in their financial understanding. Because baby boomers close to retirement are viewed as cash cows, a whole sub sector of personal finance industry has sprung up selling all kinds of investment products to them. To capture the attention of seniors, the personal finance industry has honed a variety of techniques - dine and dash seminars where brokers, insurance agents and lawyers pitch all types of exotic investment products. They also use behavioral psychology techniques to get seniors to part with their money - some methods include showing dollar amounts on a monthly basis since most customers do their budgeting on a monthly basis, selling variable annuities even when it is not clear that the customer needs it.They paint a dire picture for the seniors about the safety of retirement nest egg and offer to protect it for the future. Because brokers are held to a lower standard with regards to their financial advice (suitability standard - as long as the recommended financial product is good enough, it is legal) compared to financial advisers (fiduciary standard - clients financial interest is paramount), they have far more leeway in the types of investment products that can be pitched to their customers. Brokers were in a spot of bother during Obama administration when they were expected to comply with fiduciary standard. With the transfer of power to Trump administration, that has been shelved and brokers are now held to suitability standard, allowing them to wreak havoc on seniors' financial future again. Like brokers, personal finance gurus are also held to suitability standard. They further insulate themselves legally by inserting a disclaimer that individual investors have to do their research and are liable for any financial consequences arising from their stock picks. Most customers operate under the mistaken assumption that brokers and personal finance gurus follow fiduciary standard. The desire of brokers to rake in commissions means customers are pushed into reckless investments since brokers commissions are not dependent on the performance of the stocks. The reluctance of brokers to be held to a higher standard is a testament to the broken nature of the personal finance industry. Apart from seniors, consumers interested in the hottest opportunities to make money can attend conferences like MoneyShows that serve as a platform for every shade of huckster parading their wares. Personal finance industry has pitched a variety of options towards seniors to improve their financial position including options trading. For seniors not able to visit conferences to know about the next hottest moneymaking opportunity, a parade of TV personalities do the same for free. The poster child for TV hucksters is Jim Cramer whose show Mad Money on CNBC is a massive hit in spite of his record of patchy stock recommendations.
Financial services industry portrays women as prone to an emotional style of investing. Given the lower wages of women across the economy compared to men in comparable positions, they have not been able to invest as much in the stock market. Where they have been able invest comparable sums in stock market, their returns are usually better than those of men. Women live longer than men and as a result, they look to stretch their retirement dollars for a much longer period. To achieve that, they quite sensibly approach stock market conservatively. That approach also means personal finance industry does not stand to make as much from women as men. Because men are arguably worse investors, they are a reliable source of revenue for personal finance industry. Furthermore, men have the confidence that they can make up for any losses in stock markets with future earnings which further stokes their aggressive approach.
In addition to stock market, real estate has been pitched as another vehicle to improve financial prospects of individuals. American society views home ownership as an indicator of middle class status. Individuals overestimate the profit they make from buying and selling houses by focusing only on the purchase and sale price and ignoring taxes, inflation and maintenance costs. Historically, a home has been looked upon as a long term investment with a minimum period of 7 years needed for any kind of decent return on a property. With the introduction of different types of mortgages and loosening of bank regulations, home ownership became another way to make money. As with the books on becoming a millionaire, the cavalcade of books on getting rich from real estate is long. The most famous one is Rich Dad Poor Dad written by Robert Kiyosaki, comparing a poor dad (his father) with a rich dad (his neighbor). In Kiyosaki's telling, rich dad became successful because he unshackled himself from a steady paycheck and instead focused on becoming a successful entrepreneur. He holds that being in debt is not bad, just that being in wrong kind of debt is bad. As with other hucksters, the seminars organized by Kiyosaki and his associates focus more on signing up future participants for their seminars than in dispensing any secret to making profit from real estate. Even though critics have ripped Kiyosaki's methods, people have continued to sign up for his courses in large numbers.
Financial literacy programs offered by personal finance industry has been pitched as an effort to improve the ability of Americans of all ages to improve their financial health. However, the personal finance industry has figured out to use these programs to their benefit as well - by plastering their brand names on all these programs, they have been able to engender brand loyalty in Americans for financial products from a very young age. At the same time, they have been able to mollify US Congress by pointing to these programs as a sign of their desire to do the right thing. Financial rules in US have been designed under the assumption that an average American is disciplined when it comes to money. The fetish around individual responsibility further inhibits any meaningful efforts that Americans can take collectively. Herculean efforts to put one's financial house in order can be wiped away by an ill timed health emergency or unexpected job loss. Focusing on systemic issues like soaring fixed costs (Healthcare, Education, Housing) would take away the gusher of revenue that the personal finance industry has come to rely on.The author draws a straight line between the personal finance crisis and obesity crisis in America. Poor people are more likely to be obese because unhealthy food choices are also the cheaper ones and with stagnating wages and unexpected job losses, lower and middle class Americans turn to those options (with active encouragement from food industry). Similarly, the lack of disposable income for building savings for retirement leads lower and middle class Americans to invest their money in dubious investment vehicles (with active encouragement from personal finance industry) leaving them poorer in the end. In contrast, high earners in America can afford to buy healthy food and exercise regularly leading to better health indicators for them. Their high income also allows them to invest their disposable income in stock market for the longer run, ending up with more riches.
Other Books for Reference:
Sham: How the Self-Help Movement Made America Helpless - Steve Salerno
Broke: How Debt Bankrupts the Middle Class - Katherine Porter
The Two-Income Trap: Why Middle Class Mothers and Fathers are Going Broke - Elizabeth Warren and Amelia Warren
No comments:
Post a Comment