A Comprehensive Synopsis of "The Automatic Millionaire" by David Bach

I found this on FWF, its a review of the book"The Automatic Millionaire" by David Bach. He has written some other personal finance books such as "Smart Couples Finish Rich". For those who have given some thought to reading the book but do not have the time nor energy, you should definately take a gander. A special thanks to user kamalktk for the great hard work.

Chapter 1, in which we meet our prototypical automatic millionaire.

The young author meets a millionaire next door type who give the secrets of their $2 million net worth in their early 50's on a combined salary maxing out at $55k. All personal finance books seem to start with an example story that lays out the basic points that form later chapters and serves as motivation, there's nothing new here. It's a good example of laying out what you're going to be talking about later. The idea of this book is to simplify saving for retirement, automating as much as possible so you don't have to think about it. Inevitably, this is going to lead to a less than FWF optimal strategy.

Chapter 2, "The Latte Factor"

The basic idea here is that small unnecessary expenses add up. Start the process by keeping track of what you spend (including credit purchases) for one day (or even better, one week), and then sort the list into essential and non-essential. The goal is to identify where you can cut back. Replace the morning Starbucks with the office coffee pot, etc. "The Latte Factor" shows up in all Bach's books, I wouldn't be surprised if he's trademarked the phrase, and here he also calls it the Cigarette Factor (those little nicotine delivery devices are expensive). You want to identify places you can cut back or substitute to find the money to save, this is to fight the "I spend my whole paycheck" argument against saving.

The potential weakness here is because you are self rating what's essential, you might mark that latte or those smokes as "essential" in a fit of self justification. Perhaps someone else could mark your essentials list. With long discussions on FWF about packing lunches and living economically, there are no great FWF sins here in this chapter.


Chapter 3. Pay Yourself First

First off don't keep a budget, it doesn't work, it's not realistic as it fights human nature. Paying yourself first actually reduces the need for discipline in spending because you set aside untouchable money. With the rest of the money you make, do what you want.

You want to know who "Pays themselves first"? The government, that's who. Your taxes are automatically deducted, your savings should be too. So how much to pay yourself? Bach provides these estimates, 5-10% of your gross income and you'll have a middle class retirement, 10-15% nets you upper middle, 15-20% and you'll retire rich, 20+ and you'll retire not only rich but early. These numbers seems to be clearly aimed towards people who have middle class to begin with, which, given this is a financial self help book, is reasonable.

Chapter 4, Automate, Automate, Automate

The key here is you want to remove the need for discipline. Set things up so they happen automatically, and then you can forget about them. Since they're forgotten about, there is no need for discipline in saving. If you can't bear to start with even 10% of gross savings, start anywhere, even 1%, but make sure you save percentages, not absolute amounts, that way your savings grow as your earnings do, automatically. Once you're comfortable with what you're saving, increase the percentages until you reach your goal percent.

Bach is a fan of 401k's over Roth, both for the company match, and because it's easy to automate in his opinion and requires less discipline (his concept). He does acknowledge future tax uncertainty and tax rate hedging. We also get some charts on the wonders of compound interest. It's not he FWF optimal strategy of maxing out company contributions in 401k, then funding Roth, then maxing the 401k.

So what to invest in? Bach provides some charts and espouses diversification. He says treat stock in the company you work for as if it is aggressive growth whether or not the company would fall into that area. That way you minimize having all your eggs in one basket if something happens to the company. Want to make things even simpler? Go for target date funds. If you have more questions about retirement planning, he refers people to try IRS pub 590 (IRA's/401k) or pub 560 (small business owners)

Automate bill paying as well. This removes the desire to spend the money on something else. Automation/simplification is the overriding theme of the book.

Chapter 5, Automate your Emergency Fund

According to Bach, you want at least 3 months of emergency cash, more if you feel that's not enough, maybe you're afraid of UFO's like one example couple. Bach states a good place to stash that cash is in MMA accounts, and make sure you shop around for rates. Don't try to build up the fund as quickly as possible, try to automate deposits into your emergency fund of 5% of gross until you reach your emergency goal. Since buildng up he emergency fund is one of the first steps to
take, he wants it to be psychologically doable, thus the 5% until full funded target. Bach has never been one to encourage a ramen noodle diet in pursuit of financial wealth.

But what if you have credit card debt? Then go for one month of emergency funds and focus the rest on paying down your cc debt. CC debt gets it's own chapter later.

Chapter 6. Automatic Debt Free Home Ownership

"You can't get rich renting". Home ownership has a number of financial and emotional benefits: it's forced savings (as you pay principal), it uses leverage, it uses Other People's Money (he lists this separately, but I couldn't figure out how this differs from leverage), there are tax breaks to ownership, home ownership is a proven investment, and it provides pride of ownership. Given the current housing situation, this would seem to be bad advice as rent/mortgage payment ratios have gotten out of what across many parts of the country. So for the general population it's good advice over the longer term, for us FWF'ers there are other things to consider, like what you think housing will do.

He does go into how much people can afford, which is where things are out of whack right now in many places, and recommends spending between 29-41% of gross income on mortgage. A faithful reader will catch on to the affordability issue and not focus on owning at all costs, but the emphasis is definitely on owning being preferable.

Bach is a fan of the 30 year fixed mortgage plus making additional payments to shorten the term of the mortgage. He advocates either biweekly, or pay an extra 10%, in order to make an extra mortgage payment a year. He doesn't say why he doesn't advocate just getting a 20 or 15 year mortgage since that would do the same thing. I can only assume it's to give more financial flexibility in case of emergency. This isn't exactly the FWF financially optimum thing to do, since he
does advocate investing in the stock market to gain "typically 10%" returns, he is aware you can do better than investing at the mortgage interest rate.

Chapter 7, Automate a debt free lifestyle

Here's Bach's plan for dealing with cc debt:
1. stop spending so much/don't buy stuff you can't afford (this goes back to his "Latte Factor");
2. negotiate lower rates if possible, and consolidate to simplify repayments;
3. Split your Pay Yourself First money 50/50 towards savings / cc debt elimination. He acknowledges this is not financially optimal, but necessary for psychological reasons, people want to be able to see savings progress, not just debt elimination progress;
4. Pay off cc debt via a "DOLP" method. DOLP stands for Dead on Last Payment, and is a score determined by dividing total amount for the card by the minimum payment. Thus a $500 debt with a $50 min. payment has a DOLP of 10, with a $100 min payment it's DOLP score is 5. You want to identify the card with the lowest DOLP number, and pay minimum towards the rest of the cards while sending anything extra towards the low DOLP number card. Sound anything like the "Debt Snowball"? It should....
5. Automate this process as much as possible, and once paid off, cards should be closed, leaving only one or two cards.

He doesn't seem to advocate going all cash, as there is a sentence or two in there about using cc's only when you can pay it off immediately.

Chapter 8, Make a Difference via Automated Tithing
Here, tithing refers not necessarily to giving 10%, and not necessarily to giving it to your religious institution of choice, but giving to a charity of your choice. This is something Bach has promoted in other books. Sure, it's not financially optimal, after all you are your own best charity, but the psychological/spiritual rewards of giving raise your quality of life, karmic circle and all that. His other books have also talked about spending money on your values to promote personal happiness and quality of life, so he's being consistent.

Overall, a good book for the general population. He doesn't say you're going to get rich quick, in fact he says it'll take years/decades (that alone is pretty much guarantee that he's not a scammer). He's encouraging people to be realistic, and not adopt a ramen noodle diet to achieve goals. He thinks the ramen noodle diet is bound to fail because people in general just can't stick with something so stringent.

Are his ideas FWF mathematically optimal? No they are not. Do they include techniques like AOR? No. Is it a good starting point for beginners? Yes. Something easy enough to implement for a loved one without a current financial plan? Yes (it is focused on automating as much as possible
after all, in order to reduce your need to supervise the money).

I've read several books by Bach, he has an easy to read style that makes his books a quick breeze (I finished the 228 page book in about 3 hours). This is not my favorite book by the author, I prefer "Smart Couples Finish Rich" for it's focus on identifying your personal values and using them to guide your spending to increase your personal well being. I appreciated him asking the question of what to do with your money once you have it.
A hat tip to kamalktk on FWF




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