Credit is important to financial life and even the development of advanced economies. So much so, in fact that Nobel Prizes have been won arguing that it is indeed even a basic human right. Certainly it may not be hard to understand this in a macroeconomic way, India would be better off if its citizens had access to financial services, but it is also perhaps the most important economic component of your personal financial situation as well. Consider:
- a home and property has traditionally been a ladder into the middle class and an important method of increasing wealth.
- your business idea likely needs some amount of startup investment ( even in the form of bootstrapping by using personal credit cards) in order to grow your wealth.
- your education, vital to your earning potential over your life, would likely be impossible without credit via student loans.
-credit card sign up bonuses are important tools of funding money for fun expenses like travel or providing cash back for discretionary spending and even investment.
Pivotal to this the. Is understanding the credit game. Many borrow too much and get in debt and negate the power of credit. Many others, equally misguided, eschew the use of credit almost completely even to the point of not using lucrative credit cards.
Here at credereargentum credit is even in our title and we will make it one of our missions to better explain the game of credit.
The most important asset all of us have is ourselves and our ability to earn and income. This seems self-evident to most and explains the popularity of life insurance, a hedge against and untimely death and a protection for your children and family.
Yet, there is a far higher likelihood that you will experience loss of income and your ability to generate a return on your skills through disability. The Social Security Administration estimates it is as high as 20%, particularly in fields that require any amount of physical stamina and ability as muscle/skeletal claims are the vast majority of cases of disability. Yet, even if one works with more brain than brawn, an early stroke (ischemic are actually somewhat common in younger otherwise vigorous people), head injury, or cancer can suddenly change your life.
So why don’t more people talk about disability insurance and why is not more aggressively marketed by insurance companies when so many might benefit? This article in the New York Times goes a long way in explaining some of the reasons (without actually clearly explaining the reasons).
First, many actually have disability insurance and may not realize it. If you pay into Social Security you have modest protection up to around $1,100 a month. That may make the marginal return of more insurance low, especially considering the cost which I will discuss more in a bit.
Second, many people have insurance at work and probably feel they don’t need more. As a teacher, my state pension system has more than adequate coverage if something were to happen to me.
Third, it is expensive! The article discusses how it is on order of magnitude much greater than life insurance, costing exponentially more per $1000 of coverage than the average life insurance policy. Especially, when considering term life insurance, it is almost insane not to get some modest coverage as it is cheap. Disability insurance is anything but cheap.
Fourth, those that can afford disability insurance are moderately wealthy, and these folks are also the least likely to need at as they can get by on one spouse’s income, or have jobs with good benefits that probably already provide coverage.
Still, these reasons do not make it a bad to actually get covered. For example if you are the sole bread winner, making an above average wage, in an industry more prone to physical maladies, it might very well make a great deal of sense to hedge against the rather real and high risk you can no longer generate an income.
Today I continue our discussion of the process to take when buying a new insurance policy. Remember that what you are insuring often changes the specifics of the quotes and what you are comparing, so be sure to become literate with the technical lingo. For example uninsured motorist protection is not something you would be looking at with anything other than auto insurance!
Step 3: Examine The Quotes From Each Insurance Dealer
A dealer will send you a quote detailing their coverage and cost. Be warned, you may get many of these and they may get pushy as this business is commission based. It may be worthwhile to create a temporary email account just for this exercise. Be sure to take a close look at how much the policy costs, how long the term is for, and if there are any significant variables in what is covered. Don’t be afraid to ask questions.
Step 4: Barter and Ask For Incentives
If you have nailed down your options to two or three agencies, now might be a good time for you to call and follow up again. Make sure you have specific information about this company’s policy and how it compares to your other offers. If one company is a bit higher, be sure to ask if they can lower their price, or explain to you what they are providing in service and coverage to offset the cost. This is also a good time to ask about any incentives and discounts as most insurance companies offer “bundling” deals to bring in all of your insurance policies to them. If you bring all of your business to them, this could be a huge day for them so be sure to get specifics and never be afraid to ask questions. Remember, you have the leverage as they need your business!
Step 5: Make a Decision
This is an obvious one, but one of the nice things about shopping around is that you probably have a good feel for the personalities of the agents involved. Be sure to check out reviews of the agent and company online, but do remember to take these with a grain of salt as most responders are either overly positive or negative, thus making it hard to figure out what is really going on. This is also a good time to ask about how much rates might be lowered if you raise your deductibles. Remember, having a higher deductible is always easy savings for unless you know you are particularly and tragically accident prone or can’t afford the deductible.
Step 6: Listen Politely to Other Offers, But Be Ready to Decline
Once you commit for the policy you were looking for, the agent may try and sell you life insurance or other policies. This can be a good deal, but be sure to do your homework (and repeat the above steps if necessary!) and think carefully. In particular, if the agent tries to sell you whole life, or life insurance with an investment component, be sure to say “no” as this is almost always a poor deal. Insurance is not investing and the two should never mix!
Now that we have covered some of the basic theory about insurance and when you need (and when you don’t), let’s move on to what people really want to know: how to buy the best policy at the best price. I have developed this as an actionable step by step list.
Step One, Figure Out How Much You Need and What Kind of Insurance
Of course all insurance is not created equal and since insurance is a hedge against risk and a bet by both parties, you are betting the policy will save you money while the insurance company is betting you’ll pay and not make a claim thereby making them money, the price is adjusted for the inherent risk the company is assuming. Insurance like renters’ insurance is cheap and low cost, because the likelihood of making a claim is small and there is a clear limit to how much your stuff is actually worth. Car insurance, on the other hand, is typically the most expensive form of insurance we carry as the car is often of substantial value AND the damage done to another person’s health and and care can easily run into the millions of dollars. There are various online sites that provide calculators in determining how much insurance one might need. Since each person is so individual, though, it may be best to sit down with a financial planner or at least a trusted friend/parent/spouse/child and go over your situation.
Step Two, Find local agents, consider submitting your query to an online quote site.
When I last looked for insurance I simply Googled insurance agents in my local area. You will find there is almost always several branches of major companies in your immediate area. Submit your request to them and you will almost always get an instant response as their pay is commission driven. Also consider submitting to one of the many online sites but be warned you will get potentially many dozens of calls and emails (almost spam level) trying to entice you to pick up their particular policy. This can be a quick way to comparison shop but can easily get annoying and not very personal. Also remember some sites, like Geico, may not have a brick and mortar branch and sometimes this can save you money as they use an internet only model. Since you are getting a product that is financial and therefore broadly more similar than almost any other product on Earth, it is worth it to shop around if it can save you hundreds of dollars a year. When this process gets annoying close your eyes and think of those hundreds of dollars being a plane ticket someplace or a nice night out on the town, or a new toy to spoil your kid
Steps 3-6 will be continued next post!
–From the realm of absurdity. This article about how to protect New York City from what is likely to be more frequent weather-related mayhem puts the price tag of a series of sea locks at $10 billion. Meanwhile, this story puts the Halloween costume and decoration industry at $8 billion in business. A further $800 million is spent on outfitting pets for the holiday, according to NPR.
An excellent example of wise budgeting and opportunity cost decisions! We can save New York City or buy crappy masks that will be thrown away in a week.
–As the election nears it is worth keeping an eye on tax-related plans both parties are presenting. The words of politicians never seem like they matter in campaigns where anything and everything gets said, but elections matter and promises are sometimes actually kept. Both candidates are talking about reducing or even eliminating the mortgage interest deduction, which would take thousands of dollars out of many people’s pockets every year.
As a necessary, boring, yet important component of a personal financial plan, insurance is the Jekyll and Hyde of most peoples’ budgets. We hate it when we see the auto-payment for it deducted from their checking account each month, yet it can be a financial safety net (Life insurance has to be the most altruistic of all purchases. Its benefit, fraud excepted, no person will ever have the utility of enjoying in this life. So why am I paying thousands of dollars a year for it?!). Interaction with its salesmen and agents are among the more sleazy and uncomfortable of all financial transactions, yet agencies are built on personal relationships with clients. Health insurance we hope to never need and find its policies and limitations maddening, yet we drive many of our decisions in life around acquiring it. Insurance is a product that would seem to be perfectly substituteable, any company’s auto insurance should be the same as any other’s, yet we find its rules and terms need a law degree to decipher.
Insurance is also incredibly vital, yet constantly pushed when we don’t really need it. Many may then make the choice of buying too much insurance too often, or the equally profound err of being underinsured and exposed to bad luck. With recent headlines of Hurricane Sandy in the news, we know that disaster can violently attack at any moment.
Let me provide one important rule of thumb, though, that should cut through most of the confusion: Only by insurance policies to protect what would be a financial calamity if bad things were to happen.
Insurance on a rental when you already have your own policy and coverage on your credit card? Pass. Insurance on that new TV or iPhone you bought? Pass, pass.
Insurance on your health in case you get a bad illness? Yes. Insurance on a primary residence or investment property? Of course.
Insurance against lawsuits and liabilities that would be tens of thousands to millions of dollars? Absolutely if you can get it, and if it is common in your profession.
We are overinsured in things that don’t matter (extended car warranties and purchase protection) and underinsured in things that do (think about how much money your kids really will depend on you for, do you have that much insurance over your life if you were to die tomorrow?)
Once you get the idea of only protecting what would be a disaster, confidently say “no” to all other requests (we’ll talk about how to be your own insurance company in a bit) to purchase insurance. Then, shop around for good rates and clear terms on the rest. We will cover these steps in a future article.
Yesterday I laid out my notion of “making pie” and think about your budget by first penciling in the “five pillars” of housing, transportation, savings, utilities, and insurance. Like any good pillar, they are basic and boring and a tad obvious, but when properly managed they allow you a large amount of money for “discretionary spending”. In our example of a person with net (after tax) income of $30k a year, they were allowed over $1000 for what I call discretionary spending. This includes some pretty important items like food and any health related expenses, but allows for a lot of flexibility in how you manage your budget.
Today I want to build on this by arguing that with this money, what you build on it or how it works should be fun and interesting and provide substantial marginal satisfaction with each purchase. For those unfamiliar with the term, marginal satisfaction is the idea of each additionally unit (if such a thing exists) of satisfaction for each dollar spent. Maximize your fun and your budget turns into a much more exciting spending plan (and idea advocated by a great book on personal finance from the Wall Street Journal listed below). Eat good cheap street food ala Anthony Bourdain. Carefully craft your recipes and make your own healthy lunch and bring it to work. Go out to eat a bar to watch the big game rather than plunking for expensive cable or satellite bills. Or, get that satellite subscription and get take out and have friends bring the beer over to save money that way. Life is about decisions like this, but make sure whatever decision you make is really what you want and enjoy! Remember, TV is even free if you get it over the good old public airwaves!
Apologies for talking so much about this kind of expense but it is an example that proves the rule.
What if I have dependents?
One of the key challenges, of course, is if your income drops much below this number of $2500 a month, and you are supporting children. Readers of this blog (I hope) are from all walks of life and perhaps have dependents, or sick parents that they are caring for, or any number of other situations. Perhaps the major problem with having dependents is that it makes it difficult indeed to reduce housing expenses by having roommates. Also one’s ability to take risks to increase income may be reduced, and child care expenses move in to create a sixth pillar of mandated fixed spending. These are real and substantial, particularly when children are not in the public school system. The best advice, of course, is to plan this very carefully as single income households suffer from obvious strain. An interesting study of this was recently published by Charles Murray and is described well in this David Brooks column.
Still, the challenge can be met, but you must more aggressively stick to your budgetary items and may have to reduce savings, transportation, and insurance costs still further. This exposes you to more risk, but the trick can be done. Also, think more carefully about what is really necessary and what is a luxury and compare your lifestyle to someone several generations ago. Do not skimp on housing costs and work your tail off to put your kids in a good school district with positive ways to spend their time. Living near relatives and friends can also help with finances in a pinch. Never forget that throughout history we have always relied on our families, friends, neighbors, churches, and societies to help pitch in and raise our children. You are not an island unto yourself.
Over the last three posts, we have discussed ways to construct a budget and some conceptual ideas on how to make this all work. Most importantly, among these conceptual ideas is controlling your behaviors and being an “independent thinker” in order to maintain control. Today we will take a look at some more specific breakdowns of how budgets can work. In each of these we have started with five pillars: housing, transportation, savings, utilities, and insurance. Each of these represent the bread and butter of any necessary household expense and are vital to ensuring a modicum of comfort and stability. I have thus labelled these categories “mandated spending”. From there, we have labelled all else “discretionary spending”. To be sure, not all of this is truly discretionary as I have included items like “food and clothing” in this pie. That is clearly not something you can do without, but that being said, I think it best for each individual to know their individual food budget and such. Therefore, it is up to your discretion how to structure that portion of the budget. My other categories are more hard and fast.
Yearly Income $30,000 (monthly income $2500)
This example can really depend radically one your marital and family status. If single, I would advise getting housing expenses as low as possible so that you can build up some savings. Live with roommates, find a cheaper “up and coming area”, whatever it takes. Also this would likely entail renting, which is a good thing as it limits your exposure to the need for insurance. I would also highly recommend living in an urban area with smaller living quarters to save on utilities and hopefully gain access to public transportation and free forms of entertainment.
If you are a family or have dependents, I would look for the most decent housing in the safest area with the best possible school district. Again, renting is probably best to avoid the unknowns of repairs and insurance. Try and live near work if possible as well to cut down on transportation costs.
It should be said that in this level of income transportation costs are absolute killer. Filling up on gas once a week is $200 over the course of a month, nearly a quarter or the advised housing expense and with the no benefit as it is being burned up into nothing. Even an 8% conservative car budget, which comes out to $200 is quite unaffordable when you consider fuel and insurance. Spending more on transport would make the discretionary income quite challenging, while spending less on transportation could make life in many ways more enjoyable.
- Housing: $625-$825
- Savings: $200
- Transportation: $200
- Utilities: $150
- Insurance: $125
- Discretionary: $1000-$1015
We will continue with this series tomorrow.
Much modern economic research has been devoted to the intersection between neuroscience, psychology, and economic behavior. Consistently, what this research challenges is the very notion of man as the “rational economic actor”, homo economicus. This assumption is so basic to almost all premises about economic policy and personal finance, yet is also clearly and basically plain wrong.
Take your own life, do you ever really know every single option that you have available and then make a completely precise and logical choice? Most of us are subject to location bias (buying somewhere close to us), brand bias (buying a brand we have before or because it’s advertised well), or just plain old routine bias (it’s how we our or family have always done it). This is the very opposite of the homo economicus, rational choice paradigm.
In refuting this paradigm, the research has made a few broad insights into how our brain’s work. First of all, we have an extreme problem making strategic and rational decisions when there is an instant gratification. In one study, if you asked players for $100 now, or $110 a week from now, most would take the $100 now, even while waiting would be something like a 480% return on investment. However, if you said you would give them $100 next year, or a $110 a year and a week from now, then people would wait the week. We clearly want our brains to have the gratification and feeling of accomplishment right now.
So how to combat this? It is tough to walk past the extra shirt, or not buy the gadget that you just kind of feel like you want and would be fun to have. You only live once. Borrowing from the research, I suggest a mandatory 5 business day waiting period on all items that would be “substantial” impacts on your budget (obviously different depending on your income level). If you still really want the item after that, and it is otherwise within your budget even if not exactly essential, go and buy it. I bet most times you would find that you would be glad you did not, and even if you waited would be all the more happy for it. Having the shoes a week from now instead of today really is no significant difference in time, and it may prevent you from buyer’s remorse.
Studies also showed after engaging participants in economic “games” that players did best when their rational and emotional sides of their brain were lighting up. This could mean that those gut feelings you have about a major purchase not being great right now should be listened to. Keep your own counsel and don’t let salespeople (especially when it is not a hard sell and the salespersons explanations have a measure of logic) or friends and relatives talk you into something too quick. Wait for it to feel right and make sense rationally.
Finally, and this is not grounded in research at all, but be a free-spirited contrarian. Revel in finding the hidden awesome restaurant, the pair of pants that fit great without being name brand, or the cool website with great furniture without name brand prices. By having a bit of fun by finding your own path, you just might feel both empowered and enriched.
Everyone wants to live within their means. It allows you to feel and be more free, able to make decisions without a looming cloud of doubt and worry, and, even when spending less, actually enjoy what you purchase more. To use economics jargon, it allows just about everything to have a higher marginal satisfaction.
But of course, many seem to struggle with how to make it work in the real world. In my last post I described how one of the building blocks of a sound budget is “making pie”: parceling off your income into various chunks of cash devoted for a specific purpose. This then turns your budget into a spending plan, which is much more fun and fulfilling. Clearly, then, the problem with living up to this is keeping to these chunks of pie.
Most of the time spending goes awry, over time, because of behaviors and attitudes. It isn’t rocket science, many of us just put ourselves in positions where we find it difficult to keep ourselves to our monthly budget. Research into neuro-economics, the way our brains process economic information, reveals we may in fact be hard-wired to not think about the long term and push ourselves into momentary satisfaction instead.
In my next post I will discuss some ways to avoid this problem and trick yourself into doing the economical thing.