The Automatic Millionaire: book review and criticism

Can you become a millionaire…without making a lot of money or having willpower? You can, promises money writer David Bach in The Automatic Millionaire. Bach is one of the most popular money advisers and his explanations can be very catchy (he’s the one who coined the term “the latte factor”).

Does The Automatic Millionaire deliver on its promise? Is it a good book?

My answers to those questions are no and…no. Honestly there was little in the book more than what I knew at 16 years of age (but to be fair, I had read an unusual number of money books by then). But hold on, even though I didn’t like the book, there are two good reasons why I’m reviewing it.

The first reason is that while the book isn’t suitable for the smart readers of this site, it might be useful as a gift for someone getting started. The Automatic Millionaire is a money book for beginners and it offers explanations that seem to connect with people in credit card debt and need a plan. (I can guess from Amazon reviews of The Automatic Millionaire that the book has helped thousands of people).

The second reason has to do with education. The Automatic Millionaire repeats some conventional money advice based on misleading math. I’d like to offer some criticism and a balancing view.

This article is divided into two parts. The first is a summary of the book’s contents. The second is my criticism.

Summary

The book is divided into eight chapters. Each chapter is 20 to 30 pages and the entire book is about 230 pages. Each chapter includes a story or two from Bach’s seminars or media appearances. The book is light reading and can probably be finished in a four hour plane ride, or a week of leisurely reading at home.

Here are the chapter titles followed by my summaries of them:

1. Meeting the Automatic Millionaire

This chapter relates how an average American couple created an automatic plan to retire early with over one million dollars. The couple earned a combined income of $55,000 but they followed specific steps so they could retire at 55 with lots of money. The rest of the book explains some of the things Bach learned when he met this couple.

2. The Latte Factor: Becoming an Automatic Millionaire on Just a Few Dollars a Day

A few dollars a day (of lattes or other expenses) can add up to a lot of money. People often joke about how foolish the latte factor is, but Bach defends himself by explaining the problem most people have is spending. Bach suggests you record your expenses to stay on track.

3. Learn to Pay Yourself First

It is more sensible to plan for saving than to hope for saving, and this method addresses that. Paying yourself first involves setting aside money every month or paycheck for yourself to invest.

4. Now Make it Automatic

You shouldn’t let discipline and limited willpower get in the way of your money success because you can automate tasks like saving, investing, etc.

5. Automate for a Rainy Day

Emergencies happen and one should be prepared with anywhere from 3 months to as much as 24 months depending on the specific situation.

6. Automatic Debt-Free Homeownership

Owning a home is claimed to be better than renting, and there are (er, used to be) ways to own a home even with a very low-down payment.

7. The Automatic Debt-Free Lifestyle

Credit card debt can be tackled with consolidation, planned repayment, and as part of a plan to save for the future.

8. Make a Difference with Automatic Tithing

Giving is rewarding and one should consider making planned and automatic gifts.

Criticism of advice

I have reservations about many of the book’s claims that use math. It is misleading math like this that makes us math and statistics guys look bad. Properly formulated math arguments do not lie! I’ll go over two arguments that really got my head spinning.

The “pay yourself first” formula (pages 75-76)

Bach explains there is a formula for how much you can save. Basically the richer you want to be, the more you need to save. Middle Class people pay themselves 5-10 percent whereas Upper Middle Class pay themselves 10-15. The Rich pay 15-20 percent and the Rich Enough to Retire Early pay themselves at least 20 percent.

This “formula” doesn’t come with a justification, and it leaves out an important variable like the possibility of increasing savings by earning more money.

On top of that, everyone has different insurance needs and saving often depends on market conditions. This type of formula is what makes real math look so bad (for good example of thinking about how much to save, check out what financial writer Scott Burns says about retirement)

The power of pretax investing (table on page 85)

Bach suggests pretax investing in 401(k) plans is a great idea. The difference between pretax and taxable investing is huge, he claims.

Here is an example he gives to illustrate. Suppose you are in a 30% income tax bracket and you invest $1 in a 401(k) account versus $1 in a taxable account that both grow 10 percent. What’s the difference after one year?

The table in the book gives the following information:

From my understanding of taxes (remember: I am not a tax expert), there are two things wrong with the table.

First, 401(k) gains ARE taxable! Putting money in a 401(k) is not your ticket out of taxes…it only defers taxes on gains and contributions until you withdraw it.

Second, I think Bach is comparing apples to oranges! He is comparing the balance of the pre-tax account versus the balance of the taxable account. This is not a fair comparison because you can spend the balance in the taxable account but you cannot spend the balance of a pretax account. You must first withdraw money from the pretax account and (surprise, surprise) pay taxes.

A better test would be comparing how much you can spend… And when you do that, it’s possible the pretax account is worse. The answer depends on how tax rates are when you withdraw the money. No one can reliably predict tax rates, so we must base our decision by guessing future tax rates.

Here is the same table where I have accounted for scenarios of taxes going down (20%), staying the same (30%), going up a bit (35%), and going up a lot (40%):

See how the taxable balance is better in the case where tax rates go up to 35 or 40 percent? The point is that pretax investing isn’t a slam dunk–it is a bet and often times a bad one. Many of us expect tax rates to go up, especially for young workers. In that case, post-tax investing in a Roth IRA or Roth 401(k) would make more sense.

(A few caveats. First, an employee match changes the numbers a lot. If you’re getting one, then this “free money” will usually make the 401(k) a good bet despite any possible loss to increased taxes. Second, the 401(k) does have one true advantage in that earnings are tax deferred, rather than taxed year after year. But this advantage is often overstated since losses in taxable accounts can be carried forward, and it also comes at the cost that your money is locked in the 401(k) until retirement age).

Bach isn’t the only one who makes this misguided comparison. Check virtually any financial blog or the resources of any brokerage. You’ll see the same picture comparing the balance of pretax and taxable accounts. I guess it’s one way for brokerages to sell retirement products…but perhaps not the most honest.

What are your thoughts?

Have you read The Automatic Millionaire? Have you read other books by Bach? What conventional financial advice irks you the most? Do you like the idea of the latte factor or do you find it insulting to your intelligence? What money books do you like?