I received quite a few responses to my last couple topics as well as requests for me to evaluate several additional topics. Below I address the following in random order:
- Life Insurance – How much is enough?
- Balancing your checkbook
- Buying yourself a new car every 6 months by spending 3 hours of your time getting exercise and setting a good example for your kids.
- $1 saved v $1 earned
- Thinking about life from the book “Thinking Fast and Slow” chapter 38. How satisfied are you with your life? Love this one!!
Let’s tackle the first 4 first, and then the tough one last…
Life Insurance – How much is enough?
I’m only going to talk about life insurance in the purest sense of the term. True insurance against the death of the person insured. In years gone by there were different types of Life Insurance and some people bought life insurance as a form of investment. I don’t see that happening anymore.
As I’ve mentioned previously my family has chosen to “self insure” for Life Insurance. In other words we don’t carry any life insurance other than what comes for free with our health insurance from the company I or my wife happen to work for at the time. Many people do carry life insurance and the question is always how much insurance should we carry? In my view the answer is two part; part one is do you want the insurance to fully compensate financially as if the deceased person was still living. If not, what % would you be comfortable? 50%? 75%? The second part of the answer links directly back to the Family Financial Plan in a previous Blog Post. You need to evaluate the financial impact of the person in question (being considered for Life Insurance) on the family financial plan. Consider both the cost impact as well as the income potential. From here it gets pretty simple if you’ve developed your financial plan as described in the prior Blog Post. You add up all the income from today forward that person would likely earn for you to reach your goals and subtract what they would be personally costing the family over that same period of time and you get your answer. If that sum comes to say $4M and you want to insure for the full amount, you buy a $4M life insurance policy. If you feel you can downsize your lifestyle or modify your financial goals by say 25% then you insure for $3M. and so on…
Balancing your checkbook.
I have to say this one really shocked me as to how many people still do this. I can think of 4 reasons people might still balance their checking account; first would be to make sure the bank has not made a mistake (in the bank’s favor), second, to make sure you don’t overdraw the account due to a check that was written but has not yet been cashed, third, to make sure there is no fraudulent access to your account going on, and fourth, just because it’s emotionally gratifying in some way. Let’s take these in order. Can you recall the last time a bank made a mistake and didn’t catch it themselves? If they do make a mistake there are numerous easy ways in this modern online access world to catch it without needing to balance your checkbook. Risking overdraft can easily be handled by maintaining a larger balance or adding overdraft protection to the account so that no one outstanding check can send you into the red. You can also address this issue by setting alerts in your online account to alert you when the balance reaches a level you should be taking action. The same alert setting solution applies to fraud protection. In addition, in the US the bank is responsible for fraud so they will more likely catch it before you do by balancing your checkbook each month. I’ll let you answer #4 yourself. Bottom line in my opinion, balancing your checkbook can take a lot of time and be very frustrating. It’s not worth the time and frustration.
Buying yourself a new car every 6 months by spending 3 hours of your time getting exercise and setting a good example for your kids.
As my family will attest this is one of my favorites. If you’re like me and in a white collar management sort of job where you spend all day managing people, thinking strategically and planning for the long term, you come home most nights and think back on the day and ask yourself “what did I really get completely done today?”. In my case the answer is usually “nothing!”. If you’re also like me you like driving a nice car. By nice I mean one of top quality that runs like new, looks like new and even smells like new. Well, there are two ways to accomplish this on an ongoing basis; You can buy a new car (spending $50K or more) every 6 months or the alternative option is to spend 3 hours once every six months and restore it to “new” condition right in your own driveway, with water, car wash detergent, wheel wash soap, leather conditioner and so on. In addition, it’s good exercise, it sets a good example for the kids but most of all when you’re done you can say to yourself you really got something done today. Try it. Also a good way to catch up with the neighbors.
$1 saved v $1 earned
This one may be completely obvious but I still think it’s worth mentioning. When you complete your family financial plan and you conclude something has to be done to improve the situation, remember that money saved (not spent) is after tax money. The IRS will not tax you for saving money. If you’re in the 50% tax bracket (top bracket at least for now) that means for every dollar you can improve your financial situation by cutting an expense is worth $2 in incremental earnings. In previous blog posts I’ve talked about many ways to save money by simply being a bit more efficient and aware of what things should really cost without giving up on any utility or sacrificing any quality of life. I plan on digging into this much further in a future post. Bottom line is you don’t just have to work longer or take more risk with your investments or buy more lottery tickets.
Thinking about life from the book “Thinking Fast and Slow” chapter 38. How satisfied are you with your life?
If any of you have not read the Book “Thinking Fast and Slow” by Daniel Kahneman, and you have many analytical tendencies like I do you should definitely put it at the top of your list. It’s best read electronically as it has many interesting links to related research. One very interesting question it poses towards the end of the book (chapter 38) is “How satisfied are you with your life?”. The same basic premise explored in the book generally also applies when answering this question. In the book Kahneman developed this framework for thinking he simply labels “Level 1 and Level 2 thinking”. Yes, not very creative for a book full of so many insights into how we think about things. Level 1 thinking is your immediate gut reaction conclusion you reach when faced with a question or issue needing thought and needing an answer. You reach this conclusion instinctively based on your immediate frame of reference. Level 2 thinking is as I put it “doing the math”. It involves taking a much more structured and in-depth analytical approach to reaching a conclusion. It attempts to strip out the emotion from the decision and focus just on the facts. The book gives 100’s of examples whereby using only level 1 thinking to reach conclusions yields the wrong answer most of the time. The more important the decision the more you should extend to level 2 thinking to insure you reach the right answer. The less important it is to get there right answer and the less time you have to analyze the situation the the more appropriate the use of Level 1 thinking is.
I leave it to you to read chapter 38 and think about how you go about answering the question “How satisfied are you with your life?”. I would like to modify this question slightly to read “How satisfied are you with your current financial situation?”. The Level 1 response is what most of us apply when we ask ourselves this question. We might take a quick look at our investment portfolio, our bank account, the size of the home we live in and a few other things that require no serious time or in depth thought. From this we conclude something like “Ah we’re fine” or “Oh S_ _ t, we’re in trouble”. We reach this conclusion based on how we feel at that moment not from any scientific analytical process. It could literally be determined by events of that day or the last week. Maybe the stock markets had a good week. Maybe you received your bonus for the year just yesterday. Maybe your daughter’s volleyball team won the High School league championship, or a big Crew Regatta. These are all recent events that would give you a good or bad frame of reference that impact Level 1 thinking as it relates to how you feel about your financial well being at that moment. Simply being in a good mood or a bad mood will have a large impact on how you answer this question using Level 1 thinking.
The Level 2 thinking approach to answering this question is spelled out in my Blog on Financial Planning in the Modern Era. Using Level 2 thinking you carefully evaluate the facts and make projections into the future. You run numerous “what-if” scenarios and you develop an answer to this question that strips out the emotion and the most recent biases impacting your Level 1 frame of reference. It looks at the situation holistically and over a lengthy period of time. You can be much more confident in the conclusion you reach when it’s based on Level 2 analysis and therefor you will worry less about the answer you reach. You will find yourself asking that question much less often. If you only apply Level 1 thinking as soon as the recent events of the last week are now events of 6 weeks ago you will begin worrying again and asking the question all over again. The question “How satisfied are you with your financial situation?” is far too important a question to be left to Level 1 thinking. My guess is that most people don’t move beyond Level 1 when answering this question and it leads to a constant source of stress and anxiety. Taking the time to do the analysis laid out in my previous post will set the right framework for answering this question properly. Yes, the initial investment in time may be considerable when set against the backdrop of how much free time you may have, but when offset by the accompanying reduction in stress and worry my feeling is it’s a no brainer. Do the work! Take it to Level 2!!
Kent Godfrey 