Tuesday, December 23, 2014

Book Review #20: The Wealthy Barber: Author: David Chilton

There are few singular aspects about the book 'The Wealthy Barber: Everyone's commonsense guide to becoming financially independent'. First is that the author of the book, which discusses tools available for an american investor, is a Canadian. The second is that the protagonist of the book is Dave and his wife is Sue. The author of this book is David Chilton ('Dave') and his wife is Susan ('Sue'). Coincidence? I don't think so.

The third, and I think infuriating, aspect of the book is that in various pages in the book, the characters ask questions which remain unanswered. If there is no intention of answering the question, then why ask?

In a small, crisp volume of about 10 Chapters (of which first three are irrelevant to the main theme of theme of the book) condensed in about 200 pages, the books explains the key aspects of Financial Planning. The target audience is the Layman who do not have much knowledge of financial planning. The book covers financial planning, retirement planning, insurance, home purchase and budgeting. In each of the above areas, there are some innovative ideas that even an experienced person will find educative.

In the first three chapters, the book introduces the characters of his book. There is Dave, a school teacher, whose wife Sue is expecting. Dave has a plan to buy a new house but is worried that his financials are not in order and approaches his father for financial advice. Father directs him to Roy Miller, the town barber, who also doubles up as a financial consultant. Despite being a barber, Roy is very wealthy with a House on the lake and running his own successful business.

From chapter 4 through chapter 10, Roy covers various areas of Financial Planning. Chapter 4 covers long-term investment. Chapter 5 discusses Wills and Life Insurance while Chapter 6 touches upon Retirement Planning. The remaining chapters cover Real Estate Investment, Saving and Investment and Income tax. The books rounds off by summarizing the concepts discussed in the book.

To become wealthy, one has to become 'An Owner, not a loaner'. One must remember to own assets rather than keeping money in savings (checking) account. Financial planning is planning for major life goals like buying a home, buying vehicle, children's education etc. To meet the goals, Roy suggests to invest 10% of the income every month in carefully selected mutual funds. This provides three advantages. One is compounding of returns, two is diversification and three is dollar cost averaging. Roy recommends to do a thorough review of the fund manager before investing in any fund. The expense ratio and entry load are two other factors that the investor has to consider before selecting the fund. A better approach will be to invest in Index Funds which has low expense ratio.

Roy advises against market timing and sector switching as a strategy since both tend to increase one's loss. Also one should avoid funds following complex investment strategies.

People tend to confuse financial planning with retirement planning. The difference between the two is that while financial planning is for specific goals, retirement planning is for handling the uncertainties of retirement including duration (longevity) and loss of purchase power due to inflation. Tax is an important part in retirement planning. Roy recommends to keep Government as a partner when it comes to retirement planning. Government has provided many tax deductible and tax deferred options to help investors plan for their retirements. The book details a number of such options from the legal perspective of USA. Readers from other countries could skip this section. One option that Roy do not recommend is investing in private annuity plans.

There are some reasons why one should plan for retirement. First of all, with improvement in medical facilities, the average lifespan is increasing over the years. Second, it is incorrect to say that your needs will come down after retirement. Needs will change, but may not come down. Third, while it is true that children will become self-dependent, you may have to consider the possibility of having dependent parents living with you.

Roy recommends that each individual prepare his / her Will and regularly update the same. Prior to preparing the will, it is better to discuss the same with a lawyer and identify a group of people as the executors of the will. There is a detailed discussion of the legal provision if an individual dies intestate. When it comes to buying insurance, the recommendation is to have three type of insurance. One, life insurance, purchased through a term plan, two, medical (health) insurance and three, disability insurance. To stress the importance of disability insurance, Roy ominously mentions that there is a high probability that a 30 year old individual will spend at least one year with disability before they touch 60 !.

Buy versus rent is the question that Roy addresses in the next section. The advantage of buying a home by taking a mortgage loan is that it provides 'Leveragibility', Tax Incentives and Forced Savings. By 'leveragibility' Roy means that while one has to pay the lender on home equity, the same can be retrieved from the rentee, leaving nothing to be paid by the owner. Renting is suitable if rent is much lower than mortgage payments (a point which I cover in THIS POST). Renting is also recommended if you are relocating every two years. A house should not only meet the needs and wants of the owner, it should also be a sound investment. Roy advises against stretching oneself to the financial limit to buy a house. In the final part of this section, Roy suggests some innovative ways in which one can raise the down payment to buy the house.

'A dollar saved is two dollars earned' is the key lesson in the next section. If you regularly invest 10 percent of your income in mutual funds, have sufficient insurance and have an ongoing retirement plan, you may not need to do budgeting. However, Roy recommends budgeting as a best practice. One counter intuitive point being made is that one should spend to make oneself happy.

When it comes to income tax, Roy recommends each of us to fill our long-form income tax forms. This will give us an idea of potential tax saving opportunities available for us. One way to do tax planning is to replace your non-deductible consumer loans with tax deductible equity top up loans where applicable. Roy advises  Tax Avoidance but forbids Tax evasion, since latter is a crime.

The book is an easy read and packs a lot of information. However, some of the points made may have been superseded by changes to applicable tax laws. After reading this book the reader while appreciating the points made should also take steps to collect the latest investment options available. If the objective of the book is to put the reader on a path to financial planning, I think it has met the same.

One final point. There is an urgent need for such books in the Indian context. Here in India, most of the investment advice is given by tax experts who has a singular inability to connect with the readers. A simple yet informative book of this type is the need of the hour here.

PS: There at least one avoidable mistake in this book. Somewhere it says that DJIA 'invests' in 30 stocks. This is not correct. DJIA is an index with 30 stocks as its  components. 

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