When it comes to financial matters, it's hard to find a more trusted voice, than Marketplace Money's Chris Farrell. I love the down-home and simple advice he gives during interviews as well as his syndicated newspaper and magazine columns. He's a firm believer in developing a “margin of safety” within your personal finances and has authored several books including his latest – The New Frugality (that Charlie reviewed in July of 2010). Farrell was nice enough to answer a few of our questions. We hope you find them beneficial.
What one thing do you think more people should be doing with their finances today – but aren’t?
Well, I think people are doing a good job trying to save more and pay down debts. It isn’t easy with high unemployment, underemployment and stingy pay raises. What I do think people should focus a lot more on is on planning their careers and developing their networks. Of course, it isn’t easy getting a job these days and many people are struggling to hang on to their job or find a new one.
Still, the main lesson of two bear markets and two recessions in less than a decade is that most of us will need to work longer, well into the traditional retirement years. What does that mean for you? What kind of jobs would you like to do? What skills or education do you need to launch a second or third career? It’s important to manage a career over a lifetime and in the personal finance advice business, I don’t think it gets emphasized enough.
What’s the number one question you get most often – and how do you answer?
The big question these days involves college and student loans. (It used to be credit cards and credit scores.) Parents and their students are worried about the high cost of attending college. Recent college graduates are struggling to pay down their student loans.
Let’s get one thing out of the way: A college education pays, although what I should really say is what counts is postsecondary education. To me, a college education includes everything from a certificate earned at a community college to a community college associates degree to a B.A. from a 4-year university; The Great Recession has been brutal on most workers, but those without a college degree have suffered the most.
For those heading off to college, my advice is to borrow with extreme care. Parents and their students should think through the financial downside as well as the upside of their college choices. Too much debt is a mistake. Everyone should adopt a green-eyeshade mentality and shop for the best deal. Borrow as little as you can with federal student loans. Avoid private student loans. The former gives you a number of options to restructure your student loans if your financial circumstances are hard. The latter don’t. For those who have graduated from college with student loans, I advocate picking the repayment option with the lowest monthly tab—for now. Buy yourself some financial breathing room. The drawback to this strategy is it can raise the overall cost of your college sheepskin. There is no prepayment penalty with student loans, however. Once you start making a decent income you should get aggressive about eliminating the debt.
Do you think 401k’s will become a thing of the past with the “newer” revelations of their high fees?
No, 401(k)s will be with us for a long time, although the retirement savings product will be tinkered with, in an attempt to improve it. The revelation about fees is only the latest reform. Fees will come down, which is good. It’s about time.
The big problem with the 401(k)s is employees bear all the risk, deciding how much to invest and where to invest it (among the options chosen by their employer). A cottage industry of behavioral economists has chronicled how poor most people are at making sound investment decisions. Finance economists are devising alternatives that merge the portability benefits of 401(k)s (the 401(k) fits the needs of a mobile workforce with a more assured income in retirement, reminiscent of the traditional pension plan. Problem is, major reform fatigue has set in Washington and it is hard to see much of a change in the coming years. Too bad.
In your book, the New Frugality, you talk a lot about creating a “margin of safety”. Can you explain this idea a bit?
In practical terms, creating a margin of safety is siphoning more of our earnings into savings, paying off debts, and borrowing less. Some examples of managing money with a margin of safety perspective include putting a down payment of 20% or more on a home, savings covering 12 months or so of expenses, and spending less than you earn. A healthy financial buffer offers shelter against terrifying downturns in the economy, as well as life’s inevitable setbacks, such as an illness.
But a margin of safety involves much more than taking out an insurance policy against tragedy and trauma. By finding the right balance between caution and boldness a margin of safety allows for sensible risk-taking over a lifetime. A healthy household balance sheet lets us pursue intriguing opportunities when they come along, to take risks that might lead to a more satisfying career, to embrace changes in our lives that could lead to greater happiness. Safety and opportunity, like risk and return, are two sides of the margin-of-safety coin.
You also talk about how folks turn their money over to professionals too much (to manage). How can people get past their fears in managing investments, etc.
Are there a couple of rules to follow that make it more simple? For one thing, simplicity is an underappreciated virtue with money. The risks and rewards of simple investments are easy to grasp and monitor. The expenses associated with plain vanilla products are low. Another reason for keeping it simple is how busy we all are today. We don’t have the time to become a financial specialist, and most of us don’t want to spend hours managing our money. You want to control your money. You don’t want your money to control you.
Stick to what is safe and simple. You’ll be better off financially and you’ll have more time for the more important things in life. How do you do it? Well, even though you’re hardly getting paid anything for your money, you know the principal is safe socking it away every month into an online savings account, a credit union savings account, and U.S. Treasury bills. The key here is to build up a margin of financial safety. When it comes to saving for your retirement you can’t go wrong following the advice in books like The Random Walk Guide To Investing by Burton Malkiel. It’s short and to the point, with an emphasis on low fees and index funds. Don’t try to beat the market or be a Wall Street trader.
Some are predicting more troubled days ahead for the economy (student loan bubble, deep US debt from bailouts, etc). Are you more optimist or pessimistic about where things are headed for the US?
I’m essentially optimistic about the economy, with some bumps along the way. We’re well educated. We have a lot of human capital. Our major corporations are globally competitive. Technological innovation is flourishing. I think it’s a mistake to underestimate the wellsprings of creativity in the economy.