Saturday, November 18, 2006

David Bach: 90% Good, 10% Evil

A lot of good things have been said about David Bach, author of The Automatic Millionaire. I do think that his work is largely good, and a lot of good things have been said about him. His book is especially helpful for those who are just starting to pull themselves out of debt, and starting to build on their savings. I won't repeat the positive things that have already been said. Instead, I'm going to focus on what I don't like about his books.

First of all, Bach has a way of oversimplifying things. Throughout the book, he uses examples of how you will end up with an astronomical amount of money, if you stop buying coffee drinks, and invest the money at a 10% annual return. Of course, he doesn't really tell you where you can get the 10% annual return. He dances around the issue in his book, and mentions a bunch of brokerages and mutual funds, but I don't see any one of them guaranteeing a 10% annual return.

Like many popular financial writers today, Bach's book reads like an advertisement. Indeed The Automatic Millionaire contains 5 full pages of advertisements for his website, his other books, and his 10 CD set for the complete Automatic Millionaire Audio System. And, did you realize that Bach trademarked the term "The Latte Factor (TM)"? Boy, I hope I don't owe Bach royalties for writing this post.

Aside from this, nothing irks me more than Bach's three paragraphs covering the term "leverage". In this one section, Bach describes buying a $250,000 home with $50,000 down. He states that if the home's value goes up to $300,000, then the investor has doubled his money. Fair enough. But, he goes on to finish the section with the following paragraph.

Over the last five years, many homes have doubled in price. Think of
what this means in terms of leverage. If you invested $50,000 in a
$250,000 home five years ago and it's now worth $500,000, you've made $250,000 on a $50,000 investment. In investment circles, that's called a five-bagger -- an amazing 500 percent return on your money.

Talk about glittering generalities! In any responsible coverage of the topic of leverage, the author would explain that leverage is a double-edged sword. While one can make outsized profits in an up market, one's loss could also be multiplied in a down market. In the stock market, the parallel example is buying stocks on margin. In this case, you are using leverage in the hopes of making multiplied gains when the stock market goes up. On the other hand, if the stock goes down, you could lose your entire investment and more.

Bach doesn't even mention the potential downside of leverage anywhere in his 240 page book; he only discusses the upside. I think that David Bach's omission here is at best irresponsible, and at worst criminal. While the term criminal may be a harsh assessment of The Automatic Millionaire, it is nonetheless accurate. You may have noticed that mutual fund prospectuses have a statement that goes something like this:

Past performance is not an indication of future performance.

Do you know why mutual funds are required by government regulators to print this in their prospectuses? That's because it's true! You can't make the assumption that if an investment is increasing in value at a certain rate, that it will continue to do that in the future. Similarly, you can't just assume that if the stock market has returned an average of 10% for several years, that it will only continue to do that in the future. Clearly, Bach is strongly implying that buying a home in this already overheated market is a great investment. And at that, he is peddling his advice to those who are least likely to know any better.

Anyway, so much for David Bach. As I have said, his material is pretty good for people who are just starting to pull themselves out of debt. I will say that his books do contain about 90% good advice. It is the other 10% that I have issues with.

Clearly, though, there are better personal finance books available. I would recommend a couple time-tested classics. My first recommendation is The Richest Man in Babylon, by George Clason. The second book is The Wealthy Barber by David Chilton. These books have a far better track record that Bach, and I think that they will better withstand the test of time.



fin_indie said...

I haven't read this one, but I did read and enjoy his book called Smart Couples finish Rich. My wife and I read it near the start of our marriage and I think it started us off on the same page and with a good push in the right direction.

That said, I agree with your examples, especially on the point about leverage. You may want to write him about it. I've heard he is very open to feedback.

pfstock said...

For the record, I did send a message informing David Bach (via his website: FinishRich) of my comments on this blog. This was was shortly after I published this post. Thus far, there has been no response to my commentary.

L. Marie Joseph said...

Most PF books, I cannot agree 100% there is always a part that the reader cannot follow or does not work for them.

Authors write books based upon what works for them, not necessary what works for everyone.

Overall as you said 90% of the book IS good.

Anonymous said...

You review was very prophetic!

I think alot of these gurus aren't really gurus when they happen to be in the right place at the right time.

"one's loss could also be multiplied in a down market."

There were lots of genius stock pickers in 1999, and some great real estate investors in 2005.

Now I just gotta figure out how far down to short Goldman Sachs...

L said...

This is a classic post of yours. Really like it. Over leveraging is very dangerous. That's why CFD accounts are accompanied with warning notes saying that you can easily lose 100% and beyond.

Margin accounts as well - when folks get margin calls and they haven't got the money to meet the calls and suffer a forced sale of their stock.

It's not just individuals who overleverage but also companies, much to shareholders dismay - these companies were brought undone by the GFC because they were unable to refinance their debt (ABC Childcare is a classic Aussie company that failed due to over leveraging).