For those of you interested in personal finance,
Ric Edelman is one of the most popular authors on this topic. His 2009 book
titled, Rescue Your Money, makes for a quick read, but the content is very
powerful. Below is a summary of the book.
Essentially, the trick to investment success is
buying low and selling high. People want to beat the market which they
typically gauge as the S&P 500. This is a basket of the top 500 US public
companies. The problem with this mentality is that your investment happiness is
determined against the index rather than the overall performance.
For example, in 2008 if you lost only 20%
instead of 35% that the market lost, you would have beat the market and
therefore consider that a success. But losing money should not be a happy event.
Ric states “only one thing matters when it comes to investing: achieving
financial security. That is your one major goal.” (Page 8)
His book, and our Personal Finance Under One Hour both explain that the main reducer of return on investments are taxes and
investments, and there are multiple levels of taxes. See the two charts below:
Top
Tax Rates (Page 13) Inflation (Page 15)
These are the biggest
reducer because they generally are overlooked! Ric shows a great example in his
book of this very concept.
“Let’s
assume that you pay both federal and state income taxes. Let’s further assume
that your combined federal/state tax bracket is 30 percent. Since the CD paid
3.1%, you lose .93% to taxes, leaving you with a profit of 2.17%. But let’s not
forget inflation. If inflation is averaging 3.2%, you’re actually losing 1.03%
on every dollar you invested in that CD. Now, losing 1.03% annually might not
seem like much, considering the S&P 500 lost 38.5% in 2008. But the stock
market doesn’t lose every year, while the CD does.” (Page 16 & 17)
The figure below shows
the numerical example of taxes and inflation affecting your CD returns.
Taxes and Inflation (Page 18)
We explain CD’s in our
book, Personal Finance Under One Hour, and they can be a good investment in
some cases. For instance, today’s CD rates are better than leaving the money in
a savings account, however, you cannot touch the money and you still lose on
the taxes and inflation. Safety is the main reason consumers like CD’s. “As a
result, millions of Americans are going broke safely and they don’t even know
it!” (Page 20)
This next picture lists
all of the products that are safe, but not great for generating the returns to
rely on.
Product Returns (Page 25)
Parts of this next
section in his book are worth quoting directly. It is a great look into the big
picture of consumer investing. It explains the issues with fads and the media.
“What
about CNBC’s Jim Cramer, who offers a barrage of advice on each night’s
broadcast? Barron’s studied each of Cramer’s recommendations in 2006 and 2007,
and in its August 20, 2007, issue concluded that his picks gained an average of
12 percent. Barron’s
noted that for the same period the S&P 500 gained 22 percent. Cramer was
about half as good.” (Page 39)
“Clearly,
trusting the media’s investment advice is not a successful strategy, yet
judging from the millions of people who read, listen, and watch all the
commentaries, it’s also clear that most people don’t know this.” (Page 42)
“It
doesn’t surprise us when the weathermen get it wrong. It doesn’t surprise us
when sportswriters get it wrong. Why, then, does it surprise us to think that
an investment analyst or portfolio manager might be wrong? And why are so many
people willing to invest their life savings on the prognostications of such a
person?” (Page 44)
Another common pitfall
is investing in large companies. There is nothing wrong with investing with
them, however, they do lose money from time to time and many people focus
solely on these companies for the majority of their retirement or investing.
One of the biggest
mistakes can be investing the most in your employer. Typically, you can buy
your company’s stock at a slight discount which makes buying very beneficial.
While you may believe in the company you work for, what happens if the company
folds? Not only do you lose a job (your source of income) but you could also
lose all you have invested over the years. “Do you really want to risk your
financial security on the fortunes of a company over which you have little
knowledge and no control?” (Page 49)
The basics of Buy Low,
Sell High.
This chart shows how the
stock market typically performs during the booms and busts. The market
typically rises for a longer period of time than the market falls. This is due
to more money going into the market, companies continuing to grow, and the
economy expanding. Essentially, every time the market falls from a previous
high, it will climb even higher over time. The market never falls and stays
down.
So when the markets are
troubled, such as January of 2016, it is usually a good time to buy, not sell.
The key is your intention for investing, and typically that is not to pull your
money out within a month or two. Usually, you are looking at investing for a
long period of time. That said, Ric asks,
“Why
bother looking at your account each hour, day, or month? Looking often at your
investments is likely to make you do the opposite of what you should do. If you
see that prices are down, you’ll become upset and want to sell. If you see that
prices are up, you’ll get excited and want to buy.” (Page 64)
“History
provides the reason why you shouldn’t do that: past recessions, panics, and
depressions have taught us that stock markets recover with astonishing
suddenness and velocity. By the time you realize that the bottom has been
reached, prices have already risen sharply – meaning that you are forced to buy
back in at prices that are higher than when you sold.” (Page 113)
Can
you predict when those short spurts are going to occur? Me neither. That’s why
we remain invested the entire time, so we can catch the profits when they come.”
(Page 107)
Ric, and many other
advisors, recommend patience with the market. Diversify your portfolio, then
let it sit. Over time, he recommends strategic rebalancing.
Jan 1st
Portfolio (Page 117) Dec 31st
Portfolio (Page 119)
The idea is
counterintuitive at first. You would think that since Stocks performed better
than cash, we would take money out of cash and put more into stocks…However,
this is not what Ric recommends, and so many investors do what was just
mentioned. Instead, he recommends selling stocks as that has become the
majority of the portfolio and therefore subjects the portfolio to the ups and
downs significantly more; If the stock market declines, your portfolio will be
affected much greater.
“In other words, we sell
the asset that made the most money and we buy the asset that made the least (or
maybe even lost) money.” (Page 120) This is kind of like buying and selling on
Ebay; you want to buy coins when they are cheap, and sell them at a higher
price. Most of the time, investors want to buy the investments that made the
most money recently.
“No
one wants to buy gold at $200 an ounce. But when it reaches $1,000 an ounce,
they load up. Later, when it falls to $700 and they’ve lost 30%, they sell and
swear that never again will they buy gold.” (Page 123)
For
instance, a short-term anomaly might cause an asset class to jump in price
momentarily. A quick sale of high-priced assets and a purchase of low-cost
assets would have locked in your gains. But calendar rebalancing will miss it.”
(Page 127)
To diversify, Ric, as well as our book, recommends exchange-traded funds (ETF’s).
With mutual funds, the fees will eat into your returns while ETF’s have very
low or negligible fees. Mutual funds might also trade in and out of stocks
meaning that the short-term gains and losses actually turn you into a
short-term trader when tax time comes around.
“In
all, you’re paying the average retail mutual fund 2.67% per year. Based on the stock
market’s average annual return of 9.6% a year, that means you’re giving away
28% of your profits on an annual basis.” (Page 148)
The
U.S. retail mutual fund industry is a $9.4 trillion industry. Collectively,
U.S. equity and bond mutual funds charge $248 billion in fees each year. No
wonder these guys are among the wealthiest people in America.” (Page 151)
As a recap, Ric’s advice
sums up to the following:
· Diversify into several non-related
asset classes (S&P 500 ETF, International ETF, Bond ETF, Short term
Security ETF, and cash to name a few)
· Rebalance periodically
based on the pieces of the pie in your portfolio becoming too large compared to
your other investments. Sell the part that made the most money, and put that in
the parts that lost money.
· This is not to say sell
the S&P 500 ETF to put in your single failing experimental biotech stock,
but instead put it into another non-correlated ETF. Avoid putting a significant
amount of money in a single stock.
Buy the book:
Have you read this book? If not, does this summary inspire you to read it? If you are interested, you can get Rescue Your Money by Ric Edelman here.
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