A lot of people love to give advice. The trouble is that their advice can come from experiences that are vastly different from today's financial climate (and therefore not exactly applicable) or, worse, from a misunderstanding of the exact thing they want you to understand.
In this episode of Industry Focus: Financials, Gaby Lapera and contributor John Maxfield combat three of the worst and most-shared pieces of investing advice, share two of the best, and recommend a book about one of the richest and most generous people in America's history, Stephen Girard.
A full transcript follows the video.
This podcast was recorded on Dec. 21, 2015.
Gaby Lapera: Hello, everyone. Welcome to Industry Focus: Financials Edition! In the spirit of the holiday season and enforced family time, we thought we'd do an episode on the best and worst financial advice given to us by family members and friends. We polled a fair number of people at Fool HQ, as well as some personal experiences. Names will not be named, but you know who you are.
I'm going to go ahead and get started. This is in no particular order, but the one thing I hear over and over again as terrible advice is "Carry a credit card balance to improve your credit score." I've heard this a lot, and I think it's because people don't really understand how credit scores are calculated. Credit agencies really want you to pay off your balance in full every month, if at all possible.
This is because, that ends up factoring into your credit utilization ratio, which is basically how much you've spent over your total credit limit on all your credit cards. If it's over 30%, credit agencies are like, "Man, I don't know if this person can pay this back," so they start lowering your credit score. So, if you're paying a balance from month to month, you're less likely to have that below-30% credit utilization ratio that they're really looking for.
The other thing that's really important, even if you can't pay off your balance in full every month right this minute, is paying on time. Everyone knows you're supposed to pay on time, but it's something that I frequently talk to some of my friends about, and they'll be like, "Oh, yeah, I forgot to pay my credit card this month. It's OK. It'll just be a few days late -- it's no big deal." And I'm like, "But it is a big deal. It's affecting your credit score every time you do that!" And I guess that's a weird thing for a 26-year-old to worry about, but I worry a lot for them.
John Maxfield: I would say that's a good thing to worry about. Your credit score, at your age -- and I'm a little bit older. I don't want to reveal how much older I may be, but, yeah, we're at that point in our lives where our credit scores matter, because we're going to be buying houses.
Lapera: Absolutely. And just in case you don't know, credit scores are really important for big purchases like that, because it dictates what kind of terms you get on your loan. So the better your credit score, the less you're going to have to pay in interest, which will save you thousands of dollars over the course of your lifetime.
Maxfield: And keep in mind, when you're talking about credit score, Gaby's going through with these five elements, there's just a formula that calculates your credit score. So, after you hear the rest of these five things, all you have to do is look it up online, figure out the exact formula, and tweak your own personal behaviors around that.
Lapera: We have nothing to do with this company, but I want to put a plug out there for CreditKarma.com. They let you monitor your credit score for free. Most credit agencies will send you a credit report for free once a year, so you only have a chance to check it three times. But Credit Karma monitors it constantly, so you can log in and check whenever you want. They update it every month, which I think is a really helpful tool for people who are just starting out, or who, like me, are worried about identity theft, because, I don't know if I told you this, Maxfield, my fingerprints and Social Security number got stolen.
Maxfield: I didn't do it.
Lapera: I think it was hackers, I can't remember what country it was. I had security clearance. And that's out there in the world now. Fantastic.
Maxfield: That's great.
Lapera: Anyways, worst advice No. 2: It's "Buy gold." And I'm not talking about stock in gold. I'm talking about gold bullion. I dated this guy who had these crazy friends, and his friend's dad was an immigrant from eastern Europe, so what he did was, all of his savings, he would put it into gold bullion. He had the secret bunker somewhere out in the woods of Massachusetts, where he had all his gold bullion stored. And as far as I know, he's continuing to do that, because he's still working. And that's just not really a great idea. It's not a super liquid asset, and the price of gold fluctuates so much. That's kind of insane. What do you think, Maxfield?
Maxfield: Well, the first thing I think is that I want to go to Massachusetts and start digging around in the wood. That's amazing! But other than that... here's how I think about gold, and this is how I would recommend that investors think about gold or anyone who's thinking about buying gold for any type of investing purposes. As a general rule, investing in gold is a bad idea and here's why.
When you invest, your biggest ally is compound returns, because that grows the size of your returns without you doing anything on an annual basis, and pretty soon, your small returns of 1% or 2% a year turn into 50%, 60% a year on your original basis. But in order to tap into compound returns, you've got to be invested into an income-earning asset. And the problem with gold is it doesn't own any assets. So, your biggest ally as an investor of compound returns isn't present when you're buying gold. So, that is the main reason that, as a general rule, you should avoid gold as an investment.
But there are three exceptions to this rule. The first is in times of stress and fear in the market, when money flees to safety. We saw this during the financial crisis, when the price of gold per ounce on an inflation-adjusted basis went from $350 an ounce all the way up to $2,000 an ounce, which makes it seem like, "Oh, gold must be a great investment." Well, it is, in that particular time period.
The problem is, when you're dealing with times of stress, it's very difficult -- it seems like you'd be able to time the market, get in when it's cheap and out when it's high -- but that's actually a very difficult thing to do. We have quantitative proof that timing the market is very difficult.
The second exception is in times of severe inflation. If you look at a gold chart, there's really two huge spikes over the last 100 years. The first was the one I just talked about in the financial crisis. Then, if you go back, there's another spike in the late '70s and early '80s, when we had double-digit inflation. Gold is good because it can store value in times like that. But right now, anybody who's thinking about inflation being a concern right now, I would urge you to moderate that belief, because we really have no evidence that inflation is anywhere even remotely an issue that the United States is going to be facing anytime soon. So, that's something you should probably put to the side.
And then, the final one, and this is probably where you're getting to with the point of your story, Gaby, is what I like to call a "hedge against anarchy." You have some people that believe that society is fragile, and that if society breaks, you're still going to need to buy things. And that when society breaks and you're still going to need to buy things, paper dollars won't work, and therefore, gold bullion will be the thing you want to transact with.
Well, that's fine and dandy. But what I would recommend is that unless you have a ton of extra money, you probably shouldn't approach that strategy, because it's not an investment strategy. It's just like sticking toilet paper in your cellar is all that is.
Lapera: Yeah. If we do end up in a world anarchy situation, I recommend that you loot a pharmacy first, because I'm pretty sure antibiotics are going to be more valuable than gold at that point.
Maxfield: That's a great point. That's the first thing I'm going to do.
Lapera: So, point No. 3, which is kind of related to point No. 2. This was really common -- "Keep cash." Now, I'm not saying this is terrible advice in and of itself. I keep cash, I used to be a bartender and used to keep quite a bit of cash on me at all times. You never know when a business only takes cash. I guess, now you do, because you can check online.
Some people try to do all their purchases with cash because it acts as a psychological curb that says, "OK, I'm physically handing over something for this, and I'm getting something back," and it makes it harder for them to impulse buy as opposed to with a credit card. There's not that feeling that you're really spending anything, you know what I mean?
Maxfield: The thing about cash is that cash has a time and a place. It gives you what our colleague Morgan Housel calls "optionality." If you have a ton of cash and the market tanks, you have the dry powder, if you will, to go out and buy cheap stocks. If you don't have cash, you don't have that.
But everything in moderation. As a general rule -- I'm a lawyer, so I think in general rules and exceptions -- you're going to want to keep cash. But if you're keeping more than whatever you perceive to be necessary to give you peace of mind in terms of a safety fund, what does at six months or a year, if you're keeping anything more than that, you're losing value. Even though inflation isn't an issue, it is still increasing at 0.5% or 1% per year, so you're losing value simply by keeping it in cash.
Lapera: I just want to interject here, and I think you're correct 100% in what you just said, but I'm talking about physical stock piles of cash that you stash underneath your mattress.
Maxfield: Oh, like Floyd Mayweather.
Lapera: Yes. Like, this is very common with, like, grandmas especially, to take your cash and just stash it somewhere in your house. So, instead of having a savings account, you just have all of that in cash somewhere. So, there's a few problems with this.
One, if you have a lot of money, where are you going to put it all? Two, even if it's in a money market account, even though money market accounts aren't making a ton of money, that money could be making some interest in the bank, even if it's not a lot. Three, this is the same issue that you have with gold bullion, which is, what if someone breaks into your house and steals all your cash? What if your house burns down? Your cash is just gone, all your savings.
Maxfield: Can you imagine? That would be horrible.
Lapera: It's awful. I'm laughing, but it's so bad.
Maxfield: Yeah, it would be so horrible. Yeah, I would say there's definitely an added element of danger actually keeping it in paper.
Lapera: This tends to be one you hear from older relatives who maybe lived through the Depression and the bank runs and things like that. But it's not an uncommon sentiment, is what I gathered from asking people in the office.
So, let's flip over to good advice that we've gotten. This is advice that I got from my parents, who think that they did an excellent job raising me, which I personally agree with, but you know.
Maxfield: The jury's still out on that one, Gaby.
Lapera: Noted. The advice is, "Talk to your kids about budgeting and personal finance. Help them get started if you can." I have been shocked by the number of young people that I know who, getting out of college, for example, they never had a credit card, which meant that they couldn't rent an apartment by themselves. They couldn't buy a car post-college because they had no credit score. They had nothing. Or kids who get their first credit card and just go hog wild because they don't understand how it works.
Maxfield: Yeah, I mean, when I think about it, I have two young boys. Teaching them about finance is such a central thing, because finance, if you look at what causes stress in so many people's lives later on down the road, it's the inability to manage finances. So, if you can cut that off at the pass when they're young, it's a great benefit to them later on.
Lapera: Absolutely. And you hear about all sorts of different methods. For example, if your kid gets an allowance, having them have to take part of their allowance and put it in a savings, and part of it goes to charity, if that's important to you, and then the rest of it can be spending money. That's a really easy way to start young kids understanding how budgets work for them, and how they need to save up for things they want, they can't just blow it all at once, because of what happens later on.
Another bit of advice that we got was more in terms of stocks. "Buy things you see around you." The story that I got was a friend of mine who was really active in the lacrosse scene growing up, and he would go to tournaments, and all the kids would have Under Armour. And this is back before Under Armour was big, but his parents were like, "Maybe we should buy stock in this thing, it seems like a lot of the kids are wearing it." And, as you know, Under Armour's stock has just gone up and up and up. So, if you have young adults around you, often things that they find popular and that they're using tend to be market movers. So, that's a good way to invest.
Maxfield: Last week, we talked about great books that we recommended to investors. And one of the top five that people at The Motley Fool was Peter Lynch's "One Up on Wall Street," where he really digs into the "buy what you know" philosophy. And the other great investor who delves into the same philosophy in terms of investing is Warren Buffett. But he pitches it as you always want to buy investments that are within your circle of confidence. That's why, as a general rule, he avoided technology stocks, which had been good, but it just wasn't something that he knew about.
Lapera: Absolutely. You can apply this to your own life however you want. For example, I really love burritos. I know what makes a good burrito, so I can go out and try a bunch of different burritos, and say, "You know what? This is the best burrito I've ever had" and then invest in that burrito company. That's a common-place example for how that might work.
Maxfield: The funny thing is, you kind of chuckle about it, but you're right. I can literally remember the first time I ever ate a Chipotle burrito. I loved it. To think back, if I had acted on that impulse and bought stock, well, Gaby, I probably wouldn't be a co-host on the podcast right now. You know what I mean? I'd be living a life of leisure, the life of a gentleman. Trotting around on horses and things like that.
Lapera: I would have a Maxfield-shaped hole in my heart.
My last point of good advice I've received -- again, from my parents -- is, "If at all possible, spend less than you earn." This is a really basic concept that a lot of people seem to have trouble with.
Maxfield: Keep this in mind -- if you want to be a capitalist, you have to have capital. And the only way to gain capital, if you don't inherit it, is by saving, spending less than you earn, and allowing that to accumulate.
Lapera: Absolutely. In the vein of last week, when we gave our book recommendations, and this week, when were talking about good financial advice and people who had their head screwed on straight, do you want to talk about a book that you're reading, Maxfield? You were telling me about it this morning.
Maxfield: The book I want to talk about is a biography of a man named Stephen Girard. Stephen Girard was the richest American from roughly the year 1800 to the year 1831 when he died. And what's so remarkable about Stephen Girard is that not only did he beat all of the odds to become the richest man in America, but he also acted in an extremely not only patriotic but also a very kind way, despite his incredible wealth. Let me give you a few examples.
He was born in France, and when he was born, he had a defective right eye that contemporaries described as grotesque. Keep in mind the odds this man is fighting against to eventually become the richest man in the United States. So, he goes on, becomes a ship captain, he's in France, he's trading with the West Indies, some of which are French colonies, and he's over in the West Indies at one point, on what we now call Haiti, but, he was there right when the American Revolution broke out.
The problem with that, from his perspective, was that because he needed to get back to France or somewhere else, Britain had put a blockade on all shipping, because it was both in conflict with France and in conflict with the United States. So, he couldn't get back. So, where he ended up going with to Philadelphia, which was the biggest port in the United States at the time, and it was eventually going to be the capital of the United States, before Washington, D.C. So, he ended up in this wonderful place for what turned out to be a man with incredible talent trading merchandise and building a trade network that went all around the world. So, that's how we got so rich.
But here's the interesting thing about Stephen Girard. In 1793, he'd already gotten to the United States, he's been there for a while, he'd been one of the richest people in Philadelphia, albeit not the United States at the time. In 1793, there was a yellow fever epidemic in Philadelphia that killed 10% of Philadelphia's residents. So, one in 10 people in Philadelphia died from yellow fever in 1793 over a period of five months. Well, yellow fever came from the West Indies, which Stephen Girard had, it seems, because he never came down with it, had built up some antibodies to it. But he didn't know it at the time.
So, the mayor of Philadelphia asked for people -- because 40% of the city fled, as any sane person would do. But the mayor asked citizens to stay and help people who are sick with this extremely contagious disease. Well, Stephen Girard was one of 12 -- only 12 in the entire city of Philadelphia -- who volunteered to stay.
But Stephen Girard didn't just volunteer to stay in some sort of administrative capacity. He volunteered to run the hospital, a makeshift hospital that was called a "human slaughterhouse" for yellow fever victims, because you couldn't take yellow fever victims to the Pennsylvania Hospital, because then they would infect everybody else. But Stephen Girard didn't just run this -- he actually acted as a nurse in it, because he couldn't get enough people to help the patients. So, this was a man who was literally in contact with yellow fever victims, literally helping save their lives, at the time that he was one of the richest Americans of all time.
He did all these incredible things. He helped bail out the United States in the midst of the War of 1812, which, had we lost, we probably would have lost our independence again to Great Britain. So, he's done all these incredible things. And then, at the end of his life, and he really set the tone for what you see now today with your Mark Zuckerbergs, your Warren Buffetts, your Bill Gates who are donating the vast majority of their wealth to charity, he gave 98% of his wealth to charity.
But here's what he did, and this is really his crowning achievement, if you will, in all of history: He put the money in trust and designated people in the city of Philadelphia who would be the trustees of this trust. And this trust was created for the purpose of creating an enduring forevermore a school for low-income orphans from all over the United States.
This school has been in operation, giving full scholarships to low-income orphans ever since it was created in the 1830s. So, you're talking about thousands of lives that are directly affected by this. And not only those thousands of lives that are directly affected by this, but these are life-changing opportunities for people, because it is free education from kindergarten all the way through high school. So, many of them, we can presume, are becoming the first people in their families to go to college, which is a transformative thing for subsequent generations of a family.
So, in the spirit of Christmas and Thanksgiving and all of these different things, and at the same time that we have this political scene going on, where vitriol is part and parcel with it, it's so nice to think about these people in our history that live extraordinary lives and extraordinarily kind lives.
Lapera: Do you want to say what the name of the book was and who it's by?
Maxfield: I do! It's kind of a niche book, as you can imagine. It's called Stephen Girard: The Life and Times of America's First Tycoon by a man named George Wilson. It is a phenomenal book. I loved every second of it. It's well written, it's a fantastic story, and I highly recommend it to anybody who's listening.
Lapera: All right, thank you for that recommendation. It's time to wrap up now.
As usual, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell based solely on what you hear. Thank you very much for joining us, I hope you like this week's episode. Write to us at firstname.lastname@example.org to tell us about best and worst financial advice given to you by your family members. Everyone, have a great holiday!