The Anatomy (and Pathology) of Financial Health

I had a nasty summer cold last week. Like most upper respiratory infections, the virus likely gained access via the mucosal membranes of my mouth or nose, evaded my immune system, and started a house party in my body. My nose ran, my head ached, and I coughed uncontrollably for a few days. I had a poor appetite and little energy. My mind felt more sluggish than usual. It’s amazing how one little virus can cripple the entire body.*

In the mental fog, I began to see parallels between bodily health and personal financial health. In each case, interacting and interrelated components depend on each other to work as a whole. If one part malfunctions, it can throw the whole system out of whack, or even bring it to a halt.

*Dr-Mrs-Dr. Curious assures me this was merely a “man cold”: a regular cold experienced through the lens of my gender’s weaker constitution.

What are the critical components for healthy personal finances, and what are some financial “diseases” to avoid?

SKIN = SPENDING LESS THAN YOU EARN

Your skin surface provides an initial, critical barrier to infection for most of your body surface.

Spending less than you earn similarly represents a first-line defense against financial catastrophe. Extra money each month is a beautiful thing, and can be used to improve other parts of your financial health, i.e., padding your retirement savings accounts or paying down high interest debt.

Related pathology: Debt Spiral Syndrome. If more money goes out than comes in on a perpetual basis, debt will grow and grow. Avoid consumer debt (credit cards, auto loans, etc.) if at all possible.

HEART = SAVING FOR RETIREMENT

The heart is the body’s mechanical engine, pumping oxygen- and nutrient-rich blood necessary for survival through our circulatory system. Without it, the rest of the body would soon die.

Saving for retirement is the most critical step to ensure we can survive financially in retirement. It might take the form of a 401(k), IRA, taxable savings, or pension, but the type of savings is less important than the fact you are saving in the first place. Most experts recommend saving at least 20% of your pre-tax income each year.

Related pathology: Fancy Feast Indigestion. Didn’t save enough for retirement? You might find out what cat food tastes like, or have to mooch off your family.

LUNGS = AVOIDING HIGH INTEREST DEBT

Our lungs allow us to breathe by facilitating the exchange of oxygen and carbon dioxide with the air all around us.

High interest debt can sap financial resources and suffocate retirement savings. Depending on the situation, it can surpass retirement savings in order of importance. If your debt—especially consumer debt—is greater than 8-10% interest, you should probably pay this debt off before starting to save for retirement. If you can’t “breathe,” you can’t live.

Related pathology: Chronic Minimum Payment Disease. Minimum payments on large amounts of high interest debt will be with you for a long, long time. Make larger payments to chip away at the principal or, better yet, pay off your credit card bills completely each month.

GI SYSTEM = CHOOSING THE RIGHT ASSET ALLOCATION

We ingest Cap’n Crunch and french fries, and our gastrointestinal system extracts the energy and nutrients, and gets rid of the…uh…waste.

Your asset allocation—the mix of stocks and bonds in your investment portfolio—should match your desired risk tolerance. A portfolio heavily weighted in stocks will be more volatile (but potentially grow more rapidly) than a portfolio heavily weighted heavily in bonds. In other words, what you put into the “system” will determine what comes out.

Related pathology: Market Crash Diarrhea. If your portfolio is too weighted with stocks for your situation and your risk tolerance, a rapid contraction of your nest egg value can result in a rapid contraction of your colon.

BONES AND MUSCLES = KEEPING FEES AND EXPENSES LOW

Our musculoskeletal system provides structural support for our bodies, and is responsible for movement.

By keeping fees and expenses low, our investments can keep moving forward, unencumbered by the drag of high fees. Annual expenses of “only” 2% may not sound terrible, until you consider that—in a portfolio with 6% annual growth—those expenses eat up 33% of your gains!

We can get burned by excessive fees in two main areas:

1. Financial planner fees. Some financial planners charge an annual percentage fee—usually in the 1-3% range—based on the value of the assets they manage. As your portfolio grows, these fees can skyrocket; 2% of a $1,000,000 portfolio equals $20,000 per year! Fee-only financial planners—those who work for a flat, pre-determined fee—are a great alternative if you are uncomfortable managing investments completely on your own.
2. Mutual fund fees. The expense ratio of a mutual fund represents the annual operating costs. Actively-managed mutual funds generally have higher expense ratios than their hands-off, index mutual fund counterparts. Sales fees and transactional costs can also eat away at mutual funds profits, so buyer beware.

Related pathology: Active Management Sprain. Your investments are lumbering toward retirement with a sprained knee, and you might not even know it. Pay attention to those fees and keep your portfolio running at full speed!

IMMUNE SYSTEM = MAINTAINING ADEQUATE INSURANCE

Your immune system protects you from infection in the case of an unexpected germ attack. (Mine must have missed the memo last week.)

Maintaining adequate insurance in all parts of your life can protect your finances from unexpected disaster.

• Most of us should carry an individual term life insurance policy. Be wary of life insurance salesmen agents pushing “whole” or “universal” life insurance policies; these are expensive and a poor choice for 99% of people.
• Depending on your occupation, you should consider individual disability insurance as well. A true-own occupation policy ensures that you will be able to collect benefit if you cannot perform the occupation in which you have been trained; they can’t make you work at McDonalds if you are unable to perform as a trained neurosurgeon.
• Umbrella insurance is additional personal liability insurance beyond homeowners/renters and car insurance, and can protect against potentially catastrophic lawsuits. Policies in the $1-5M range are relatively inexpensive, and can often be purchased from your homeowner/car insurance provide at a discount.

Related pathology: Oh Sh*t-itis. An otherwise perfectly-planned retirement can be instantly derailed by lack of insurance in the setting of death, disability, or lawyers. If you are adequately insured, you can take solace in the fact that your finances will not be ruined when the you-know-what hits the fan.

KIDNEYS = FILTERING OUT THE NOISE

The kidneys filter waste in the blood and excrete it in your urine.

Filtering out (financial) noise is a perpetual challenge in our 24-hour new cycle. The Jim Cramers of the world garner big ratings by telling you what and when to buy and sell. 99% of this information is of little consequence to your long-term financial plans, and should be flushed down the toilet. Focus on the basics—the other key elements of financial health described here—and ignore the rest.

Related pathology: Performance Chasing Incontinence. Continually searching for the next hot stock can be an exhausting and futile exercise. Don’t wet the bed; make a plan and stick to it.

BRAIN = YOU

Your brain and central nervous system is the control center for the rest of your body.

You control your financial destiny. In a few months of reading in your free time, you can learn the financial basics necessary to orchestrate your financial plans. Remember, the only one who has your best financial interests in mind is you.

Related pathology: Lack of Confidence. If you had talked to me 8 years ago, I would have been scared to death to make my own retirement investments. Now, I would be scared to death to hand control over to someone else. You can do it!