Pimp Your Finances

[edit - I changed the title of this article to more accurately reflect my thoughts, and also to point out that these tips are not mine]

Businessweek recently broke away from their traditional audience, and featured an article of Advice for Young Investors. The name is slightly misleading, as it includes all financial facets – from insurance to home ownership – as investments.

The advice is mediocre at best, but it’s an interesting read, because it offers insight into the young financial mind (or at least what the media is telling us to think).

As I like to do with these types of articles, here is their list, along with my commentary.

1. Cash is king

Although cash offers the lowest returns, it’s a good foundation for any financial plan.

Without a cash reserve, your plans are at risk to be derailed by emergencies or a loss of income. Most young people just make up the difference with credit cards, but others could be forced to sell assets at the worst possible times.

Having cash may not help you get ahead, but it will make sure you don’t go backwards.

How much of a reserve do you need? That’s a question of eternal debate, but the most common answers suggest anywhere from 3-9 months.

2. Got insurance?

It’s probably not the insurance you’re thinking about. Most young people don’t need life insurance, but everyone needs disability. You don’t want a lifetime of potential income to disappear because of an accident.

I signed up for as much disability insurance as possible from work, paying extra for additional coverage.

3. To own or not to own, that is the question

The biggest decision that most young people make is whether to rent or buy their home. The common perception is that owning is an investment, but real estate generally doesn’t perform as well as stocks, and it’s a lot more expensive. There is maintenance, taxes, emergency repairs, etc… that are exclusive to owning a house. Not to mention there is a significant time commitment.

In the end, it really comes down to your personal preference. Just make sure that you do the math, and consider all costs in your decision.

Also, don’t buy more house than you need, thinking it will increase as an investment… you’re much better off being modest and saving/investing the extra money you would’ve put into the house.

4. What job security?

The author points out that no ones job is safe right now, which I agree with. However, I disagree with one of his takeaways.

He says that your job security should be taken into considering when choosing a risk level for your investments. I disagree.

Investments are done over the long term. If you need your money to supplement your regular income, then you’re not really investing, and you’re gambling with cash that you don’t have.

Your risk tolerance should be determined by how long you’ll be investing… not how secure your current job is.

5. What’s your risk tolerance?

Another failure for the author. He underestimates the impact of long term investing.

If you’re saving for the long term, you probably have some time to ride out market turbulence… That’s how it’s supposed to work in the abstract, anyway. In reality, the ups and downs of the market can leave you anxious and cause you to bail out of investments too early.

While that statement is technically true, to me it doesn’t do enough to explain that short term ups and downs are normal, and you should just ride them out. It also doesn’t do anything to remind young investors that being overly cautious is a bigger threat than being too aggressive.

6. Stocks are risky

Another swing and a miss! Three in a row.

The author is right…stocks are risky, and you shouldn’t have any money in the market if you’ll need it in the next five years.

But the article again continues to be overly cautious, suggesting that:

For young people in their twenties, 50% or more of a 401K or other retirement plan could go into equities. (my emphasis).

Choosing 50% as a benchmark is misleading, because it suggests that it’s an upper limit. This could deceive people into choosing a 50% stock mix and thinking that they’re being aggressive enough. In reality, investors of any age – and almost certainly young investors – will probably want a portfolio that is more than 50% stocks.

Some people are even suggesting that young investors should put 100% of their portfolio in stocks (a strategy which I follow).

By choosing an overly cautious approach, you’re selling yourself short and missing out on decades of earning power.

7. Get started – now now now!

We’re back on solid ground with this one. Whatever your plan – start now. The best time to plant an oak tree is 20 years ago. The second best time is now.

8. Balance your priorities

Managing your finances is a lot like a juggling act. You’ve got to balance the short-term and long-term, paying down debt vs. investing for retirement, etc…. It’s important to make sure you’re meeting all your goals, and not selling yourself short by focusing on only one thing at a time.

As an example, I’m building an emergency fund as I’m paying down debt. I’ll be opening a Roth IRA soon. Starting on all three will be better for me financially than just focusing on one.

9. Be flexible

It sounds like decent advice at first, but this is another area where the author just doesn’t get it.

The financial crisis and stock market collapse have changed the rules for investors… For now, he’s allocating a maximum of only 50% of portfolios to stocks… This may not be the best time to set up a financial plan that you stick with for life.

Financial plans are not dependent upon the ebb and flow of the market. If anything, it’s more important to stick to your plan in tough times.

Being cautious after the market has crashed won’t help you get your money back. If anything, it will only hurt your recovery when it finally turns around.

10. Can you save and invest too much?

It’s rare that young people set aside too much money, so I don’t think we have to worry about this. If saving too much is a problem for you, then I’m jealous.

Most people should be saving more cash and investing more in their retirement, but there are times when it makes sense to put your money elsewhere. Investing money in yourself – through training or education – could greatly increase your earning ability over your lifetime.

My thoughts

The advice in this article says more about the media than it does finance.

I feel like the mainstream media just doesn’t get it when it comes to young adults and money. It seems like they’re trying to use the economy to frighten us, when in reality, it’s an opportunity. We have 30-40 years until retirement.

They should be giving on advice on how to take advantage of the market… not telling us to bury our heads in the sand because the economy is scary.