David Chilton’s bestseller The Wealthy Barber is an introduction to basic principles of personal finance. These principles are illustrated by means of a fictional story about a teacher (Dave), an auto plant worker (Tom), and a small business owner (Cathy) who seek financial guidance from a local barber (Roy). Roy has become wealthy by following the lessons he imparts to them. Roy’s (and thus Chilton’s) primary message is that steady, “boring” investments over time are the best way to accumulate wealth.
(Shortform note: The original version of The Wealthy Barber was published in 1989. This guide is based on the updated third edition of the book, released in April 2022. In this version, the setting of the fictional storyline has been moved from Canada to the US state of Michigan, among other changes. However, the financial numbers the book relies on are still very outdated (for example, the price of homes, the rates of return on investment, contribution caps for various retirement plans, and so on). Neither these outdated numbers nor the geographical setting is necessary to an understanding of the key principles; to avoid confusion or inaccuracies, this guide focuses instead on the book’s evergreen financial advice.)
During his barbershop lectures, Roy also addresses concerns and misconceptions that Dave, Tom, and Cathy have about financial planning. For example, he explains:
David Chilton is a Canadian author, investor, and television personality who holds a degree in economics from Wilfrid Laurier University. In 2011, Chilton released a second book in the wealthy barber series, called The Wealthy Barber Returns. This book covers many of the same topics as the original, but lacks the fictional barbershop narrative and addresses more recent developments in financial markets.
After the initial descriptions of the characters and their backstories, each of the remaining chapters in The Wealthy Barber represents a financial lesson (or group of lessons) that the barber imparts to his patrons as he’s giving them their monthly haircuts. To make these lessons clearer, this guide eliminates most of the fictional backdrop and reorganizes the advice into three parts, by topic:
We also point out areas in which Chilton’s advice or the assumptions on which it relies are outdated, and we provide updated information where applicable. Finally, we compare the book to other personal finance bestsellers such as The Simple Path to Wealth and The Total Money Makeover, noting where their financial advice differs from or overlaps with Chilton’s.
(Shortform note: While he doesn’t say so explicitly, Chilton makes clear that his advice is geared toward those who have already achieved a degree of financial stability: His characters have decent jobs with good benefits, they aren’t in any significant debt, and they don’t seem to have any psychological hang-ups about money. Examples of personal finance books that address audiences with specific financial challenges include The Barefoot Investor, which offers advice on how to eliminate debt, and Your Money or Your Life, which helps readers understand their relationship with money as a first step to reaching financial independence.)
Chilton begins his barbershop lessons with some general financial advice: Time is one of the most important factors in achieving financial success. How do you ensure that time is on your side when it comes to financial planning? First, start early. Starting to apply basic financial planning principles when you’re young can make all the difference in how much wealth you accumulate. (And of course, if you can’t start early, start now!) Second, be patient. If you invest your money for the long run (decades, rather than years), you’re likely to see much greater returns on your investment.
You can apply this general advice to many specific financial lessons, but none are more likely to put you on the road to affluence than these: Invest 10% of your earnings for long-term growth and contribute to a retirement plan.
The most important step you can take if you want to become financially successful is to invest 10% of your income for long-term growth. This means taking 10% off the top of your paycheck as soon as you get paid (before you have a chance to spend it!). Chilton says you should invest that money in index funds or mutual funds, then leave it alone so it has a chance to grow by virtue of what some have called “the most powerful force in the universe”—compound interest.
What Is Compound Interest and How Does It Work?
Although Chilton extolls the virtues of compound interest, he never actually defines it. Compound interest is essentially interest earned on interest. For example, if you invest $100 and it earns 10% interest every year, you’d have $110 at the end of the first year. By the end of the second year, you’d have $121—because in addition to earning $10 on the initial $100, you also earned $1 on the $10 in interest. Over many years, this compound growth adds up, as your money continues to make more money.
Through the “magic” of compound interest, if you invest $500 a month, with a 10% average rate of return, your portfolio will be worth $1.14 million after 30 years. And as Chilton points out, because you’re investing a percentage of your income, as your wages rise over time, the amount you’re investing also increases.
Inflation may put a damper on the power of compound growth, but the fact that prices will rise is all the more reason to save. If you invest your savings wisely, the rate at which your money grows should exceed the inflation rate.
Chilton explains that it’s much more profitable to invest in stocks than it is to leave your money in the bank. In the former scenario, you own your investments, while in the latter, you are loaning your money to the bank. You’ll get higher average rates of return in the long run if you’re an owner, not a loaner.
Nonetheless, it’s not a good idea to purchase common stock on your own or through a stockbroker. Stockbrokers are salespeople, not investment advisers. In addition, most people don’t have enough money or knowledge to properly diversify their portfolio. This is why Chilton recommends investing in mutual funds or index funds, which don’t require you to have any special investment expertise.
(Shortform note: To encapsulate his advice that you should save 10% off the top of your paycheck, Chilton uses the phrase, “Pay yourself first.” While some have credited him with originating this concept, it was likely first articulated in George S. Clason’s classic 1926 book, The Richest Man in Babylon. In fact, The Wealthy Barber and The Richest Man in Babylon share a number of financial lessons, including the advice that you invest your 10% savings to take advantage of compound interest, that you plan ahead for retirement, and that you live within your means. However, Chilton disagrees with Clason’s prescriptions that you should own your own home and make use of careful budgeting as the best way to control your spending.)
A mutual fund is a professionally managed pool of many people’s money, which is invested in an array of stocks, bonds, and other assets. Individuals own shares in that portfolio. Chilton advises that you put your 10% savings in equity-oriented mutual funds.
(Shortform note: Equity-oriented mutual funds, or equity funds, are funds that invest mainly in equity shares of companies (stocks).)
Besides diversification and professional money management, there are a few other advantages to equity mutual funds, according to Chilton. First, they are hands-off: You don’t need to constantly research individual stocks or make decisions about buying and selling. Second, they make use of dollar cost averaging: You invest a fixed amount of money in stocks at regular intervals. With this approach, when stock prices are up, your money buys less, but when they’re down, your money buys more. So market downturns can work to your advantage: In the long run, your average cost per share will be lower than the average price per share.
Chilton offers some tips on how to select a mutual fund:
1) Check out the manager’s record: Look at the fund manager’s past record: What is their average return over five years, 10 years, etc.? Has the fund performed consistently over time (as opposed to fluctuating wildly)?
2) Do your research: Read magazines that monitor mutual fund performance (Forbes, Worth, Kiplinger).
3) Pick a diversified fund: Buy a global fund that invests in both foreign and US securities across many different industries.
4) Don’t try to second-guess market or industry fluctuations: Avoid “market timing” and “sector-fund-switching,” which involve switching your money in and out of stocks or from one industry sector to another based on predictions about market fluctuations or industry rise and decline.
5) Watch your commissions: Keep an eye on the commission or “load” you’re paying for your fund to be managed, and make sure it comes along with good advice or is attached to a high-performing mutual fund.
Choose a Mutual Fund With Care
In The Intelligent Investor, Benjamin Graham offers similar tips for choosing a mutual fund, but he places more emphasis on being skeptical of funds that charge high fees and commissions. He points out that the higher the fees, the more the fund has to outperform the market for you to be in line with the market.
Others caution against relying too heavily on average mutual fund returns or global funds. In Money: Master the Game, Tony Robbins argues that average returns are misleading because they represent the average percentage of yearly net gains and losses, not how much you’ll actually get in returns, which will depend on your monthly contribution and variations in the market. And many investors recommend avoiding the risks inherent in foreign markets by investing only a small portion of one’s portfolio in global stocks.
Finally, in A Random Walk Down Wall Street, Burton Malkiel advises, don’t try to “beat the market” by trading frequently. He cites a study examining accounts at a discount brokerage, which found that the more frequently individual investors traded, the worse they did.
An index fund is a type of mutual fund that’s passively managed. In an index fund, your money is only invested in the stocks that make up the index, which seeks to mirror the components of a market index. Market indexes are themselves designed to reflect the state of the financial market. Two well-known examples of market indexes are the Dow Jones Industrial Average, which tracks the performance of the 30 largest US companies, and the S&P 500, which follows the 500 largest US companies.
Index funds have two main advantages over mutual funds. One, they are cheaper than mutual funds, because they don’t require active management. Two, they generally perform better than mutual funds over time. Mutual fund managers try to beat the market, which is very hard to do; with index funds, you’ll at least match the market’s performance.
(Shortform note: While Chilton notes the advantages of index funds over mutual funds, he nonetheless recommends both as sound investment choices. Many personal finance books disagree with this approach. For example, in I Will Teach You to Be Rich, Ramit Sethi advises avoiding mutual funds altogether, as many firms hide poor performance by dropping funds that fail and ranking only the funds that perform well. JL Collins says in The Simple Path to Wealth that you should choose index funds over mutual funds because index funds get better results and have lower fees. Similarly, Tony Robbins claims in Money: Master the Game that 96% of professional money managers lose against the market over the long term.)
Besides investing in equity mutual funds or index funds, another good way to invest your 10% savings is by purchasing real estate. For the most part, Chilton says, real estate prices rise consistently over time. However, Chilton doesn’t advise buying real estate until you’ve first built up some assets. Many young people aren’t in good enough financial shape to qualify for a loan on a down payment, so when you’re starting out it’s best to confine your investments to mutual funds for a while.
But Chilton warns there are a number of risks inherent in real estate investment. Real estate prices in your area may decrease rather than increase over time. Recessions may impact your ability to make your mortgage payments or sell your home for a profit. Interest rates on mortgages fluctuate; if you have a variable-rate mortgage and interest rates go up, so does your monthly payment. And of course, being a landlord can be a headache.
Is Real Estate Still a Good Investment?
Since Chilton wrote The Wealthy Barber, real estate markets (and financial markets in general) have been rocked by world events. Is Chilton’s recommendation to invest in real estate outdated?
The Great Recession of 2008-2009 was both triggered by and has had lasting repercussions for the housing market. That period of economic turmoil began when rising home prices, loose lending practices, and an increase in subprime mortgages caused a housing bubble that eventually burst. Subprime mortgages, which lenders offered to borrowers who lacked sufficient credit, often had adjustable interest rates that started out low, then jumped significantly. Unable to afford their mortgages, many people lost their homes to foreclosure—an estimated 10 million people from 2006-2014.
After the recession, Congress passed the Dodd-Frank Act in an effort to regulate the financial and housing industries and protect consumers. Among other reforms, the Act requires lenders to make people show proof of income before giving them a loan (rather than simply stating their income, as had been the case prior to the recession). Borrowers must also make a down payment on their mortgage. But homebuyers still shied away from adjustable-rate mortgages—as of 2021, less than 5% of total purchase and refinanced loans were adjustable rate mortgages, compared with over 35% at the peak of the previous cycle.
Home prices skyrocketed again as a result of the COVID-19 pandemic, as many people began working remotely, sought out more space, and had more money to spend. The primary cause of rising home prices, however, was low mortgage interest rates (the average rate for a 30-year mortgage in 2020-2021 was 3%, compared to 6% from 2002-2005). Since the early years of the pandemic, interest rates have gone up again, and adjustable-rate mortgages are once again becoming more popular (they represented 11% of overall mortgage applications as of 2022).
While Chilton’s claim that real estate prices tend to rise over long periods of time is generally accurate, the Great Recession and the COVID-19 pandemic demonstrate how wildly real estate prices can fluctuate over shorter periods of time, and the 2008 crash is a cautionary tale of the risks of adjustable-rate mortgages in particular. The US government has put safety measures in place to help prevent another housing collapse, but investing in real estate is nonetheless a riskier enterprise now than it was when Chilton wrote The Wealthy Barber.
In addition to investing 10% of your income for long-term growth, you should also be saving for retirement. According to Chilton, if you don’t save for retirement during your working years, you probably won’t have enough money to survive on during your retirement years. Here’s why:
1) Retirement brings new expenses. While it’s true that expenses can be lower in retirement (for example, your mortgage may be paid off and your children will be grown and no longer financially dependent on you), it’s also true that retirement can bring new expenses, such as travel, expensive hobbies, medical costs, and caring for dependent parents.
2) Social Security is insufficient to live on. When you retire, you’ll get some Social Security benefits, but you’ll need to make up the difference between that amount and your previous income (as well as take into account inflation, which is a retired person’s number one enemy).
3) Social Security is uncertain. Plus, the rules and regulations governing Social Security might change, decreasing its value or the likelihood that you’ll receive it.
4) Pensions may be insufficient to live on. If you have a pension plan, the amount you receive every month might be capped, so it probably won’t be enough to live on even combined with Social Security benefits (though certain jobs have better pension plans than others).
A major benefit of many retirement plans is that the money you put into the plan can continue to grow on a tax-deferred basis until you withdraw it. With some plans, such as a Roth IRA, your tax advantage comes not before retirement but during it. These tax and compound interest benefits offset the difficulty of saving additional money for retirement.
Because there are many different types of retirement plans, it can be helpful—and, if you’re self-employed, it’s a good idea—to consult an accountant, financial planner, or lawyer to help you decide which type of plan best suits your needs.
Retirement Savings Often Don’t Cover Long-Term Care
Chilton mentions medical costs in retirement, but he doesn’t discuss one of the biggest potential retirement costs: long-term care. People who suffer from a debilitating illness may require assistance with the tasks of daily living, in their own home or in a facility such as a nursing home. Paying for such care can quickly drain your savings; costs run in the tens to hundreds of thousands annually.
There are various methods of paying for long-term care, including long-term care insurance, personal savings and investments, health savings accounts, and Medicaid, which is only available to those living below the federal poverty line. If your retirement income and assets are substantial enough, you may be able to pay for long-term care costs out of pocket. If, on the other hand, you don’t have any retirement savings at all, you’ll quickly go into debt.
Chilton recommends a 401(k) retirement plan as the best choice for most Americans. (A similar option for teachers is the 403(b) plan.) In a 401(k) plan, your employer matches your contributions up to a certain amount every year, pre-tax. The law sets a limit on how much you can contribute to a 401(k) plan, but this cap is indexed to inflation, so it increases on a yearly basis. Employer matching may be as close as you can get to free money.
(Shortform note: While a 401(k) plan is a great choice for retirement saving, unfortunately it’s not available to many Americans. Only 67% of employers offer a 401(k) or similar plan at all, and of those, 18% don’t provide any matching. Those who do provide matching typically match an average of 4.5% of an employee’s contribution. And of course, you can’t have a 401(k) if you’re not an employee. Even without matching, however, there are significant tax advantages to a 401(k), and it has a higher contribution limit than a traditional or Roth IRA. As of 2022, the limit was $20,500.)
To contribute to an IRA, you must have earned income. As with a 401(k), there is a maximum contribution amount. Your contributions are likely tax-deductible, depending on your income and on whether you or your spouse is covered by any other type of retirement plan.
If you withdraw money from an IRA prior to age 59 ½, you have to pay standard tax on that amount plus a 10% penalty tax. If you withdraw money from an IRA after retirement, withdrawals are taxed at your standard income tax rate.
As with any investment, you can invest your IRA in mutual funds (ownership investments) or in “loanership” investments such as CDs (certificates of deposit) and bonds. The former generally perform better, but Chilton says that an IRA is one place where the latter, more conservative approach can also work well, because your money can compound year after year, unencumbered by taxes.
With a Roth IRA, your contributions are not tax-deductible, but withdrawals during retirement are tax-free. In other words, the main difference between a Roth IRA and a traditional IRA is the timing of the tax advantage.
In order to contribute to a Roth IRA, you must meet certain income eligibility requirements.
(Shortform note: The contribution limit for traditional or Roth IRAs for 2022 was $6,000.)
A Keogh plan is a type of retirement plan for people who are self-employed, either part time or full time. Like a traditional IRA, contributions to a Keogh plan are tax-deductible and growth within the plan is tax-deferred. You can contribute more to a Keogh plan than you can to an IRA; how much depends on which type of Keogh plan you choose.
(Shortform note: While various types of retirement plans exist, Chilton notes that millions of Americans nonetheless retire near the poverty line. More recent statistics show that approximately 8.9% of Americans aged 65 and over were living in poverty in 2019. In addition, approximately half of Americans ages 55 to 66 have no personal retirement savings at all. Gender and marriage affect whether a person has retirement savings: 60% of those who have never been married have no retirement savings, while this number is only 35% for those who have been married once. Women are about 3% more likely than men to have no retirement savings.)
Once you’ve started investing 10% of your income for long-term growth and contributing to a retirement plan, says Chilton, you’re well on your way to financial success. Continuing to apply these two principles will provide you with a strong foundation for everything that comes next.
As you move through life, you’ll be faced with a series of financial decisions: things like whether to buy a home or rent, whether to pay for a vacation with credit or save up for it, and how to pay for your child’s college education. When it comes to these choices, surprisingly enough, there’s no wrong answer—but there are ways to increase the odds that you’ll accumulate more money as you go.
Buying a home increases your assets and lowers your taxes. For most people, homeownership is an excellent investment. But Chilton points out that you should only buy a home if it’s right for you.
One situation in which it makes more sense to rent rather than own is when you simply can’t afford to purchase a home. Beyond the initial hurdle of coming up with a down payment, you might not be able to afford the mortgage payments, which are often significantly higher than rental payments. (This is due, in part, to the fact that people often size up when they move from an apartment to a home.) Whatever you do, don’t stretch yourself to your limit to afford a home.
And even if purchasing a home is within your budget, that doesn’t mean you should necessarily do it. If you choose to rent rather than own, investing the money you save by renting might even be a better investment than owning a home. Chilton writes that home ownership has its advantages and disadvantages.
Among the disadvantages of homeownership is the fact that homeowners have to pay for things like property taxes, insurance, utilities, upkeep, and home improvements—and they also have to invest the time to stay on top of all of these things. In addition, Chilton notes that many homeowners never benefit from their home’s increase in value over time because they never sell their home. In other words, they never get a return on their investment.
Another important caveat about home ownership is that it’s not a solid financial plan on its own. Investing in a home must take place in conjunction with contributing to a retirement plan, investing in mutual funds, and other financial planning priorities.
(Shortform note: In addition to these disadvantages of homeownership, each of the risks Chilton enumerates with respect to real estate investing applies to owning your own home as well. Another disadvantage of homeownership is the high upfront costs beyond the home’s selling price and the interest rate on your mortgage. For example, you’ll probably pay between 2-5% of the purchase price in closing costs. Experts say you need to live in your house for at least five years to recover those costs.)
While there are disadvantages to homeownership (and advantages to renting), Chilton claims that there are also many advantages to homeownership. First and foremost, your home is an asset that you can borrow against or, if it increases in value over the years, you can sell for a profit. Plus, there are tax advantages to owning a home.
Here are some of the primary advantages of owning a home:
(Shortform note: While owning a home does have tax benefits, these benefits were significantly reduced for some homeowners due to a 2017 tax law that limited the mortgage interest and property tax deductions. If you took out your mortgage before December 15, 2017, then this law likely doesn’t affect you, and you can still take deductions for property taxes as well as for interest on up to $1 million of debt. If you took out your mortgage after that date, your deduction is limited to interest on $750,000 of debt, and your property tax deductions are capped at $10,000, which includes property taxes plus state and local income taxes or sales taxes.)
If you choose to buy a home, Chilton advises that a fixed-rate mortgage is usually a better choice than an adjustable-rate mortgage. With a fixed-rate mortgage, your costs stay the same, while your income is likely rising over time. If mortgage rates go down, you might be overpaying, but you’ll probably still be able to afford your payments—and you can always refinance. If mortgage rates go up, your rate will stay stable. You’ll never find yourself in a position where you have to sell your house because you can’t afford the mortgage (unless it’s due to circumstances unrelated to the mortgage, such as a job loss).
Chilton’s recommendation for minimizing your tax bill is to make investments such as homeownership and retirement plans that provide tax breaks. Another way to maximize your deductions and minimize your bill is to hire a tax consultant. If your financial affairs are straightforward, it won’t cost you much; if, on the other hand, they’re more complex, hiring a consultant will be more warranted.
Other tips for reducing your taxes are:
(Shortform note: There is no shortage of additional tips available in books and online for lowering your taxes—everything from earning as much tax-free income as possible (by, among other things, selling your home, saving money for your children's education, investing in municipal bonds, or contributing to a health savings account) to taking advantage of tax credits, to reducing your tax rate.)
Besides homeownership and minimizing your tax bill, another way to save money is to live within your means. Chilton says that this doesn’t have to mean careful budgeting. If you implement big-picture financial planning, day-to-day spending choices like whether you buy coffee or order take-out don’t matter too much.
While you don’t have to pay attention to every cent, there are some steps you can take to help you live within your means.
Don’t borrow excessively to buy big-ticket items like cars or expensive products. Instead, save up until you can afford them. The best way to do this is by taking a certain amount off the top of your paycheck every pay period and investing it in guaranteed products like CDs. You don’t want to invest it in riskier products like stocks because you know you’ll need it relatively soon and can’t afford to lose it.
(Shortform note: When it comes to cars, some personal finance books go beyond this advice and tell you specifically which vehicles to buy: used cars. In The Millionaire Next Door, authors Thomas J. Stanley and William D. Danko indicate that wealthy people usually buy cars that are two or three years old, because they understand that new cars are overpriced. In fact, most car buyers spend 30% of their net worth on a car, whereas millionaires spend only 1%.)
It’s better to save money when making purchases than it is to earn the same amount in income, because your income is subject to taxes and deductions. As Chilton puts it, “a dollar saved is two dollars earned.”
For example, if you save $300 by buying an item on sale, it’s the same as if you had earned a $600 bonus. It’s not worth killing yourself at work to make more money when you could do better to shop around for the best price before buying expensive items.
(Shortform note: Other personal finance books agree with this approach. For example, in The Millionaire Next Door, Stanley and Danko claim that high-wealth individuals are often frugal and bargain-conscious, buying items on discount or at factory outlets.)
It’s never a good idea to carry credit card debt. The interest rate on credit card debt is much higher than it is for standard consumer loans. If you can’t pay off your credit card balance, borrow from the bank—the interest rate will be much lower on the bank loan.
In fact, Chilton advises against using credit cards at all, as they make it too easy to spend money you don’t have.
(Shortform note: Like Chilton, many authors advise against using credit cards, as well as counseling more generally against buying things you want, but don’t need (which credit cards facilitate). In Your Money or Your Life, Vicki Robin and Joe Dominguez explain that the marketing industry was born when factories in the early 20th century were producing more goods than ever before, and companies needed a way to convince people to buy things they didn’t need. They argue that this culture of over-consumption not only causes people to live beyond their means, it also depletes the planet of finite resources and accelerates climate change.)
Although it’s not necessary to budget meticulously, Chilton says it’s helpful to write down your monthly expenses periodically to see where your money’s going. That way, you’re not spending too much on the wrong thing, and you can make any adjustments that seem warranted.
(Shortform note: Many other personal finance books do recommend careful budgeting, including The Barefoot Investor, The Total Money Makeover, and The Millionaire Next Door. The latter states that more than half of all millionaires create monthly and annual budgets, and 62% of millionaires know their annual expenses for basic needs.)
Chilton says that, contrary to some advice, you don’t need four to six months of income in an emergency fund, but it is a good idea to keep some money on hand for emergencies. This is especially true if you’re a homeowner—you never know when unforeseen expenses might crop up.
He says keeping too much in an emergency fund is a waste because you could be investing that money or using it to pay down debt, rather than being taxed on it and earning low rates of return. Only people with unpredictable income or little job security should keep more than a modest amount in an emergency fund.
(Shortform note: As Chilton notes, other authors recommend a much larger emergency fund. In The Total Money Makeover, for example, Dave Ramsey says you need a fund big enough to cover three to six months of expenses, to protect you in the event of a job loss or medical bills.)
If you have excess cash (for example, from an inheritance), Chilton says the best investment decision you can make is to pay off any debt with non-deductible interest, such as car loans and credit-card balances. Make sure you always pay off the debt with the highest interest rate first.
If you have excess cash and you have no debt (and you’re implementing Chilton’s other financial principles), spend your money!
(Shortform note: Chilton advises paying off debt with excess cash; other personal finance books recommend that you pay off debt first, before you do anything else. In The Barefoot Investor, for example, Scott Pape recommends eliminating debt by taking steps such as listing all of your debts, renegotiating your interest rates, and paying off your debts one at a time, starting with the smallest.)
If you have kids, you may want to start saving for their college fund. There are many valid options for how to do so, but Chilton says a solid choice is making a monthly payment toward a mutual fund for your child, just as you do for yourself.
Like all investments in mutual funds, this approach works best if you start early, when your child is young. When your child is within a few years of college, look for a good time to redeem the funds (don’t wait until the last minute or you may be forced to sell when the market is down). There are limits on how much a child can earn in investment income without being taxed; an advantage of mutual funds is that the dividends they pay are usually under these limits.
Some other options for saving for college include US Savings Bonds, prepaid tuition plans, and education savings plans, or education IRAs. US Savings Bonds are guaranteed by the federal government, use an adjusted interest rate, may receive preferential tax treatment, and are exempt from state and local income taxes.
With prepaid tuition plans, you pay for tuition years before your child goes to college; the price is based on variables such as the state’s estimate of how much tuition rates will rise in the future. The advantage of this type of plan is that if tuition costs go way up by the time your child goes to college, you will have saved money. One disadvantage of prepaid tuition plans is that students have a limited choice of schools—these plans usually only cover public universities within your state.
With an education savings plan, or education IRA, you make contributions up to a certain amount in a tax-deferred account.
(Shortform note: In The Total Money Makeover, Ramsey recommends saving for college using an education savings plan, or Educational Savings Account (ESA). He says prepaid tuition plans just break even with inflation, while savings bonds and whole life insurance for babies generate returns of only about 2-5%. An ESA funded in a growth-stock mutual fund, however, can achieve much higher rates of return.)
If you’re expending the time and effort to become financially successful, you’ll want to ensure that you and your loved ones are provided for in the event of loss. Make sure you have sufficient life, health, and disability insurance, and be sure to make a will.
Because the purpose of life insurance is to protect your dependents in the event of your death, Chilton advises against buying life insurance if you’re single and you don’t have kids. Even if you do have dependents, you still don’t need to buy life insurance if your “living estate” (your assets minus your liabilities) is sufficient to provide for your spouse and children, pay off your debts, and pay for funeral expenses.
If you don’t fall into either of these categories, you should purchase life insurance. To determine how much to buy, first consider everything your dependents will need to live comfortably in your absence—for example, your debts paid off, funeral expenses paid, college expenses for your kids, and sufficient income for your spouse. Then purchase an additional amount of insurance coverage to factor in account inflation. For example, if you want to ensure that your spouse receives an annual income, you’ll need to account for the fact that any set amount will be worth less and less as the years go by.
Chilton explains that there are two main types of life insurance. Term insurance lasts for a specific period of time, and pays out the amount of the policy if the insured dies. This is basic life insurance, and it's relatively inexpensive.
Cash-value life insurance is a combination of term insurance and a forced savings program. The savings is invested for you and can be paid out if you cancel the policy. The premiums and commission rates are higher on this type of insurance, and rates of return are often lower, partly because the insurance company has to cover expenses and make a profit. In addition, up-front costs are high, and the term component costs more than it would outside the “bundle” of the cash-value policy.
The primary advantage of cash-value life insurance is that the savings portion of the policy is allowed to grow tax-free until withdrawal. However, this advantage is often negated by the disadvantages.
Chilton’s advice is to buy the cheaper term insurance and invest the money you saved, because you can probably make more by investing it on your own than a cash-value policy could by investing the savings portion of your policy for you.
You should also make sure that the term insurance you buy is renewable and convertible. Renewable means that when the term expires, you can renew the policy without having to take a physical to prove you’re insurable. Convertible means that if you need insurance past the time when you’re allowed to renew the term policy (usually 65 or 70), you can convert the face value of the policy to any cash-value plan sold by the insurance company without proving renewability.
(Shortform note: There are many different life insurance products with a variety of features and benefits. You might want to consider enlisting the services of an insurance broker who can help you search for life insurance (and other types of insurance) across several insurance companies. Whether or not you use a broker, make sure to shop for insurance carefully by comparing rates and selecting the policy that works best for you and your family. An important consideration is whether to include a long-term or chronic care rider in your life insurance plan. As discussed above, long-term care can be extremely costly; one method of planning ahead is to address the potential expense in your insurance policy.)
Of course, in addition to taking care of your loved ones, you should also take care of yourself. Make sure you have sufficient health and disability insurance. Chilton says most employer group disability policies are inadequate, so you’ll probably need an individual policy.
Although many people don’t think they’ll ever need disability insurance, statistics show that a 30-year-old’s chances of becoming disabled for a one-year period or more at some point in their life are one in four. Disability insurance is a way to insure your greatest asset—your earning power.
(Shortform note: When it comes to choosing disability insurance, you can select a short-term policy, which pays out for a few months to a year, or a long-term policy, which pays out for as long as the disability lasts. In addition, some disability policies define disability as “own occupation” and others define it as “any occupation.” The former provides coverage if you are unable to perform the occupation you were trained for, and the latter provides coverage only if you are unable to perform any reasonably suitable occupation.)
Last but certainly not least (in fact, you should do so as early as possible), Chilton stresses that you should make a will. Why is it important to make a will? In the absence of a will or revocable living trust, the court will pay off the deceased’s debts, then divide what’s left according to strict state laws. The laws do not take into consideration the wishes of the deceased or the needs of their survivors. Nor do the laws take into account anyone who does not have the requisite legal relationship to the deceased, such as common-law spouses, business partners, or charitable organizations.
A good lawyer can help you develop an estate plan. Before seeing the lawyer, decide how you want your estate to be divided, and choose an executor (the person or institution that will carry out your will’s instructions). The executor should be someone who’s the same age or younger than you, who lives nearby (so they don’t have to travel far to wind up your affairs), and who’s honest and reliable.
Finally, Chilton says, keep a net worth statement of everything you own and everything you owe, along with a copy of your will, at home and in a safety deposit box so that it’s easily accessible to executors.
(Shortform note: A will is the most basic part of an estate plan, which can also include a financial power of attorney, a health care directive, and a trust.)
After each financial lesson in The Wealthy Barber, Roy the barber asks Dave, Tom, and Cathy to bring him proof that they are taking his advice (for example, a copy of their lawyer’s bill to draft a will or revocable living trust). By the end of the book, all three have made big strides toward eventual financial success and are able to “graduate” from Roy’s financial school with flying colors.
When it comes to financial planning, Chilton emphasizes starting as early as you can, so you can take advantage of compound interest, dollar-cost averaging, tax deductions, and other methods for saving money and accumulating wealth. Consider where you are on your path to financial success, and what additional steps you want to take.
Describe where you are on the path to financial success. Are you just starting out? Do you have the fundamentals down, but feel you need to do more? Do you have a plan in place, but think it might be too heavy on certain types of investments?
In light of where you are on your financial journey, what additional steps do you want to take to achieve financial success (for example, saving for retirement, minimizing your taxes, making a will)?
How do you plan to implement those steps (for example, researching index funds, hiring a financial advisor, contributing to a Roth IRA, paying off your debts, and cutting up your credit cards)?