Personal Finance (Sec. 1.1)

FUNDAMENTALS OF FINANCE

A Guide for Helping Professionals

Adam J. McKee


SECTION 1.1:
THE HIGH COST OF HELPING


This work is licensed under an Open Educational Resource-Quality Master Source (OER-QMS) License.

Open Education Resource--Quality Master Source License


Many people choose a career based on their perceptions of how a particular field of endeavor will increase their personal wealth.  One often hears that medicine, law, engineering, and business are highly lucrative fields.  Many people choose to study these fields in college not because they are passionate about medicine or business, but because they think they will “earn a good living” if they earn credentials that allow for employment in these high-income sectors of the economy.

Some people choose a major because they have a passion for a particular field.  A special few choose college majors not because they want to get rich, but because they want to make the world a better place in some way.  I label the diverse fields of criminal justice, social work, education, and others as “helping professions.”  Social workers, cops, and teachers are vastly different in what they do and how they think about the social world, but they have the improvement of people’s lives as the major thrust of what they do (or plan to do in the future).

I teach at a small public university.  Because of our size, I work in the “school of social and behavioral sciences” rather than a “criminal justice” department.  All of these folks are helping professionals engaged in teaching the next generation of helping professionals.  I work alongside some of the finest human beings that you would ever want to meet.  They are passionate about higher education, and they are passionate about making the world a better place.  They are passionate about training and educating the next generation of helping professionals.

What I have noticed over the years of talking with these people is that they have resigned themselves to the fact that they will never be wealthy.  They chose to make the world a better place, and the price of that seems (in the minds of many helping professionals) to be a rewarding life lived within modest means.  If we as college professors with doctoral degrees will never be wealthy, then what does that say about the student’s that we are sending out into the field with undergraduate degrees?  Are they destined for a life of poverty because they chose to help others?  The sad truth is that financial problems plague helping professionals, but it doesn’t have to be that way.

As I begin writing this little guide, Donald J. Trump has just been elected president of the United States.  Some folks are elated and are swelled with optimism for the future; others are seeking the aid of mental health professionals to deal with the trauma of the election results.  The election of 2016 has been hugely divisive.  Much of the prophecy, regardless of whether one thinks it is good or bad, has been overblown and distorted insofar as it affects to work and compensation of helping professionals.  The day after the election, I got up, got dress, came to work, and taught classes.  My paycheck did not change a penny.  I could still pay my bills, buy groceries, send my kids to school, and eat lunch out on Friday.  All of my basic human needs such as food, clothing, shelter, and medical care were met, as were those of my family.  Still, when I look at my pay stub, I am disappointed.  There are still many things I would like to do and would do if only I had more money!

A big reason that I don’t have more material things in life is that the university does not pay me enough money.  I spent ten years going to college and spent hundreds of thousands of dollars to become qualified for my job (and still have a massive student loan debt to show for it).  I work hard and I am good at what I do.  It is galling that they do not pay me more.  The strange thing about that is a simple undeniable fact:  I’m still here.  I chose to train the next generation of law enforcement and conduct research into how to make policing work better.  I chose to take a position at a small university that does not pay as well as the bigger research institutions.

I did so because I wanted teaching to be my primary job rather than conducting research and writing grants.  It is a little ironic that professors at the big “research intensive” universities don’t do much professing; they do research and solicit funding and graduate assistants teach most of the classes.  Seeking new knowledge is a fine thing, but I valued the classroom experience more.  You might say I’ve paid a premium for the luxury of focusing on teaching.  Teachers are not compensated as well as grant writing researchers.  That’s just the way the academic world works.

When I want something that is beyond my means, the above paragraph describes my thinking.  It just drips with self-pity.  The real truth of the matter is that I am here making what I am making because I chose to do so.  (That fact does not preclude me advocating for higher salaries, working for promotions, and asking my boss for raises).  Another truth is that I am blessed to be in a growth field where the demand for teaching professionals in my field outstrips the supply.  I could make a few phone calls, get a new job, and raise my salary about 50%.  I haven’t done so because I love my job and what I do.  I care about my students and truly believe that I am making a difference in their lives.

For all my whining and complaining, the truth is that I do not have as much money as I want because I chose people over money.  I’ve always said I don’t care about money.  That was self-delusion.  What a really meant (but didn’t fully realize for many years) is that I care more about people than I do money, but I still care about money.  It has often been said that “money can’t buy happiness.”  That is true.  Many people with fame and fortune have committed suicide.  It is also true that abject poverty and anxiety over how to pay the bills is a sure-fire recipe for being miserable.  I have come to realize that helping professionals can be wealthy if they are both smart and patient.

As an educator, I realize that the above sentence leaves you with two big questions:  What do you mean by smart?  What do you mean by patient?  By smart, I mean developing and honing your financial intelligence.  Most helping professionals make enough money to live well and even become wealthy, but they make bad decisions that leave them in a cycle of living paycheck to paycheck and never breaking out of the spiral of monthly bill paying anxiety.  You may become an expert in your field by studying at a university and earning a degree, but you will still likely be financially illiterate.  We (university faculty that set the curriculum) make you take literature and art classes as part of the general education curriculum.  These expand your horizons and are great things.  We have failed you miserably in that the curriculum has a terrible gap!  Higher education does not require you to take a single course that provides you with information that you desperately need to thrive in an economic environment that doesn’t reward (at least financially) a career helping other people.  It is up to you to fill the gap and ensure your future prosperity.  Your financial education is up to you.  I can tell you from my vast experience at making poor financial decisions that giving yourself a good financial education is critically important to your future financial success.

That leaves us to deal with the question about patience.  Money is like a colony of honey bees.  If you give it the right environment, it will grow and prosper.  It will grow all by itself, so long as the beekeeper makes sure the environment stays right for growth.  If conditions are right for long enough, one colony can send out extra bees to start a new colony.  Over a very long period of time, a careful beekeeper can have many colonies of bees.  This organic, natural growth takes time.  This slow, organic growth of the hives doesn’t require a lot of effort on the part of the beekeeper.  Many beekeepers are hobbyists and have day jobs that pay the bills.  They don’t fret about the bees while they are at work.  They check on them in the evenings and after work and on weekends.  The bees are doing all the real work; the beekeeper just has to put in a little effort to keep the environment right for the bees to do what they naturally do.

The takeaway from this admittedly odd bee analogy is that growing your money isn’t that hard, but it takes time.  You can’t really rush the process.  We’ve all heard about “get rich quick schemes,” and there is never anything good to say about them.  That is because they almost always fail to make you rich.  Get rich quick schemes usually make the person that came up with the scheme rich by fleecing “investors” who got so excited about getting rich that they didn’t obtain and analyze the facts.  There are some legitimate ways to build wealth very quickly, but most of these involve an unacceptable level of risk that can resemble the odds of casino gambling or playing the lottery.

Every once in a while, a sound investment will grow at an astonishing rate and yield very handsome rewards.  We have all heard these amazing stories, and many of them involve investing in incredibly successful businesses before the extent of their success was fully predicted and appreciated.  If only we had invested a few thousand dollars in Microsoft (or Google, Facebook, Amazon, Walmart, Starbucks and a host of others) when it first went public—we’d never have to work again!  The degree of prudence I suggest in this book is to invest in solid companies with good numbers, and if they multiply twentyfold, then it was a wonderful, delightful accident.   We must also consider the other side of prudence; money stuck under a mattress (or in a bank savings account) will never grow into anything appreciable.

If you are working for all of your money, then you will always be poor.  Becoming wealthy requires that you work for your money while your money works for you.

Caveats

“Caveat” is a fancy word for “Warning!”  I want to start out by giving you some warnings:

I am not a financial professional or an expert.   I am a criminal justice professor that has learned a lot about money and how to lose it and waste it.  The advice I offer herein is not professional financial advice; it is just food for thought.  I’ll try to point you in the direction of the real experts as we discuss various topics.  The only advice I am really qualified to give is that you are deficient in your financial knowledge, and you should educate yourself.  In other words, this book is not intended to give you specific financial advice and is intended for educational purposes only.

All economic activity entails risk.  A key facet of financial planning and execution is assessing that risk.  I encourage you to be prudent.  I also believe that an excess of prudence is a form of recklessness that will leave you poor.  You have to decide for yourself how much risk you are willing to accept.  When it comes to making money, the reward is often directly correlated with the amount of risk you are willing to accept to reap the reward.  As we will discuss in greater detail, all financial activity has some risk, even storing all of your money as cash under the mattress has risks.  Your house could burn down, and you would be wiped out.  Much of the content of this book will concern risk assessment and risk mitigation.  My strategy is to accept some risk in order to reap rewards but to understand the degree of risk and take prudent steps to mitigate the risk.

The economy changes over time.  By the time you read what I’ve written here, the economy may have changed such that my suggestions are the exact opposite of what you should really be doing.  Your financial education must be a continuous process.  You have to keep up with the economic forces that dictate where your money goes and how it grows.  The entire global economy can grow and prosper, and it can withdraw and contract.  Countries and sectors within those national economies can grow and contract.  Your investment strategies must undergo constant reevaluation.

Moving Forward

For the remainder of this book, I’ll assume that you are a helping professional.  I’ll further assume that you have a career job.  You’ll be there a long time, and you will have a decent benefits package along with a relatively low salary.  Before we move on, I will make some suggestions that are so important that I do not want to wait until you read about them later to take action.  These are things that can cause you misery and regret for the rest of your career!

Rule 1:  Never use credit cards.  We will talk a lot more about credit cards later, but consider this as a hard and fast rule for now.  Credit cards have interest rates that should be illegal (it used to be illegal!) and the odds are you will never get them paid off.  The minimum payment just pays the interest and you still owe all of the money to the credit card company.  Credit cards are evil.

Rule 2:  Get good health insurance.  Healthcare in the United States is a shameful mess and needs to be overhauled.  I’m all for generating wealth, but doing it on the backs of the injured, sick, and dying is disgusting.  While we are waiting on those reforms, you should make sure that an injury or illness doesn’t saddle you with a mountain of debt that you can’t hope to pay off.  We’re trying to make you wealthy, and mountains of medical bills are a black hole pulling your money in the wrong direction.

Rule 3:  Get a good disability policy.  If you are a traditional college student and mom and dad are still paying all of your bills, then you can ignore this one.  If you have bills and/or a spouse and children, it is vital you ensure that you have an income to cover costs should you become unable to work.  Many employers offer these for a very small premium.  If your employer doesn’t offer one, suck it up and purchase one on the open market.

Rule 4:  Learn to delay gratification.  We’ve all heard that “good things come to those who wait.”  When it comes to the world of finance and wealth building, this old adage is gospel truth.  Learning to delay gratification can pay huge dividends in every aspect of life.   Research has shown that children who could delay gratification at a young age would do better on college entrance exams, do better in college, get better jobs, make more money, and get into less trouble with the law than those children who could not delay gratification for bigger reward down the road.

Cash advance, payday loans, rent-to-own, title pawning, and “tote-the-note” car lots are all rip off artists that charge interest well beyond even that of dreaded credit cards.  Each of these “businesses” (I prefer to call them continuing criminal enterprises) fleece the poor among us and get very, very wealthy doing so.  This is loan sharking, but these wealthy and clever folks have found a way to make it legal.  The need for these “services” is usually brought on by poor money management in the form of people living beyond their means.   If you want to stay poor, invest in lottery tickets and the business services of these wealthy individuals.  Giving all of your money to them will help them stay wealthy, and keep you on the bottom.

But before you sign on the dotted line, consider this: renting to own can cost two to three times what you would pay if you bought with cash, on layaway, or on an installment plan. And if you miss one or more payments, the goods could be repossessed. You might be able to get back your stuff — if you can catch up on the payments. But if you can’t, you risk losing everything you paid.


And did you know that some rent-to-own merchandise may be several years old? It might even have been rented by other people before you. Also, there may be fees: for everything from processing to delivery and pick-up, to set-up/installation and excessive damage, to late payments and reinstatement fees.

~Federal Trade Commission


You have no doubt seen how easy it is to get cash to last you until payday.  The ads are on the radio, television, the Internet, even in the mail. They refer to payday loans, cash advance loans, check advance loans, post-dated check loans, or deferred deposit loans. The Federal Trade Commission (America’s consumer protection agency) says that regardless of their name, these small, short-term, high-rate loans all come at a very high price.

These loans are painfully simple to get.  A borrower writes a personal check payable to the lender for the amount the person wants to borrow, plus the fee they must pay for borrowing. The company gives the borrower the amount of the check less the fee and agrees to hold the check until the loan is due, which is usually the borrower’s next payday.  The borrower is charged new fees each time the same loan is extended or “rolled over.”  The federal Truth in Lending Act treats payday loans like other types of credit: the lenders must disclose the cost of the loan. Payday lenders must give you the finance charge (a dollar amount) and the annual percentage rate (APR — the cost of credit on a yearly basis) in writing before you sign for the loan. The APR is based on several things, including the amount you borrow, the interest rate and credit costs you’re being charged, and the length of your loan.

A payday loan is very expensive credit. For example, say you need to borrow $100 for two weeks. You write a personal check for $115, with $15 the fee to borrow the money. The check casher or payday lender agrees to hold your check until your next payday. When that day comes around, either the lender deposits the check and you redeem it by paying the $115 in cash, or you roll-over the loan and are charged $15 more to extend the financing for 14 more days. If you agree to electronic payments instead of a check, here’s what would happen on your next payday: the company would debit the full amount of the loan from your checking account electronically, or extend the loan for an additional $15. The cost of the initial $100 loan is a $15 finance charge and an annual percentage rate of 391 percent! If you roll-over the loan three times, the finance charge would climb to $60 to borrow the $100.

Rule 5:  Do the Math.  Just about everyone I know hates math.  My students often tell me that math was a reason that they gravitated away from high paying fields like technology and engineering.  Good personal finance management means keeping track of income and spending.  The only way to track your financial health is with math.  Don’t panic, but do get over your math phobia.  It’s not hard math; we don’t need calculus and trigonometry.  If you can add, subtract, multiply, and divide, you can do what must be done.

You can use a calculator, or you can use a software package on your laptop or tablet.  In fact, spreadsheets are the best and easiest way to keep track of money.  I’ll suggest several uses throughout this book.  If you don’t know how to use a spreadsheet, start learning now.  You can use Microsoft’s Excel, which is the most popular spreadsheet program in the world.  It may already be on your computer.  If you don’t have Excel, you can use the free Google Sheets program, which has the advantage of always storing your work in the cloud so you don’t lose it.  The bottom line:  No matter how badly you hate math, you should hate poverty enough to get over it.

A final note about work ethic before we move on to more “nuts and bolts” topics.  My father was one of the hardest working individuals I have ever known.  He believed with every fiber of his being that the key to success was hard work.  He worked a day job and availed himself of every opportunity to make “an honest dollar” that ever came along.  That idea of hard work being the key to success is often referred to as the “Protestant work ethic.”  Dad had the work ethic, but he struggled with money all of his life.  His money never worked for him; he always worked for his money.

I’m all for the value of hard work.  I’m also for the value of working smart.  Mere work really doesn’t do much for you unless it increases your wealth.  If you are making minimum wage and your money is making you nothing, then you are doing it wrong.  If you look at the truly successful figures of history, you’ll find that they worked very hard, they worked very smartly, and that they were extremely lucky.  We can’t change your luck, so you will probably never end up like Bill Gates or Warren Buffet.  You can only work so many hours per week before your quality of life starts to diminish, and that of your family in your absence.  At some point, the generation of real wealth requires that you put your money to work while you spend time with family and friends.  That is the ultimate in smart money.

The MaxMinCon Rule

Finally, I will leave you with a principle that will form the skeleton of the remainder of this book.  Many years ago, a brilliant social scientist named Fred Kerlinger came up with a way to optimize the power of experimental designs to explain social phenomena.  He called this his “MaxMinCon” principle.  This important new word was formed by the first three letters of his three important principles:  Maximize, Minimize, and Control.  For our purposes, I am going to steal Kerlinger’s word, but change the application.  We are not going to use it to talk about the optimization of experiments but to the optimization of your personal finances.


The MaxMinCon Finance Rule

Always seek to Maximize income, Minimize spending, and Control Debt.


 


Hope is wonderful, but hoping for a bright financial future will not get you there.  You have to actively plan for financial success.


Fourteen Critical Truths

We will spend a large portion of the second half of this book talking about making you rich.  That, in a nutshell, means that you must become an investor.  If you are looking for a get rich quick scheme or a system to build extraordinary wealth such that you can buy a football team, then you’ve come to the wrong book.  I am going to try and convince you of some things that go against conventional wisdom, and you are certain not to like some of them.  Some of these are as follows:

  1. You cannot beat the market, and you will lose money and time if you try.
  2. Nobody can beat the market for you, and you will lose money and time if you let them try.
  3. Mutual funds and ETFs, not individual stocks, are the key to generating wealth.
  4. Most financial advice is wrong.
  5. Hot stocks, hot funds, and hot managers will burn you.
  6. Asset allocation, not hot stock picking, is the most significant predictor of investment success.
  7. Past performance is not an indicator of future performance, just like the SEC warned you.
  8. You cannot be successful without taking risks, but that risk can be defined and minimized.
  9. Financial professionals define risk differently than real people, and you are a real person.
  10. Diversification is your best defense against risk.
  11. Portfolios behave differently than the assets that they are composed of.
  12. No one can predict where markets will go in the future, especially the talking heads on TV.
  13. Boring investing is profitable investing.
  14. You are not a unicorn.

I deal with each of these points in an in-depth way in the companion volume to this text, Fundamentals of Market Investing.  In this more general text, we will not develop full arguments as to why these things are so.  I will, however, attempt to make short justifications for each position.


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