The 3 Simple Rules of Investing: Why Everything You've Heard about Investing Is Wrong # and What to Do Instead
264
The 3 Simple Rules of Investing: Why Everything You've Heard about Investing Is Wrong # and What to Do Instead
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Product Details
| ISBN-13: | 9781626561625 |
|---|---|
| Publisher: | Berrett-Koehler Publishers |
| Publication date: | 06/16/2014 |
| Pages: | 264 |
| Sales rank: | 1,094,902 |
| Product dimensions: | 5.50(w) x 8.40(h) x 0.90(d) |
About the Author
Kwok L. Tsui is chair professor at City University of Hong Kong and heads its Department of Systems Engineering and Engineering Management.
Carol Fabbri is a managing partner at Fair Advisors LLC and coauthor of Personal Investing: The Missing Manual.
A 27-year investment industry veteran, GEORGE PEACOCK is a principal at Compendium Financial Investment Advisory, the founder and manager of the Purchasing Power Portfolio, the author of the Yoga of Investing blog, and the managing editor, investments for the online financial site FrankInsight.com. He entered the financial advisory business as an associate at American Express Financial Services (now Ameriprise). He also worked at the Wallace Financial Group, a regional insurance, investment, retirement, and financial planning firm, and Mullin Consulting, advising Fortune 1000 companies on niche compensation benefits for their senior executives. He returned to advising high-net-worth individuals and families when he joined the D.C. office of US Trust, which was later purchased by Bank of America. Mr. Peacock left Bank of America when the firm, like the rest of the investment industry, began relying increasingly on mathematical models whose output depended on a myriad of unknowable assumptions. At Euclid, he immediately established the Purchasing Power Portfolio, a precursor to the Simplify Wall Street approach described in this book. Mr. Peacock is the president of the Georgetown University Alumni Association and is an ex-officio member of the University’s board of directors. He is also a member of the External Advisory Board of the Georgetown University Alumni and Student Federal Credit Union, the largest student-run credit union in the country, and The Georgetown Chimes, an all-male a capella singing group. A part-time stand-up comic, he lives in Bethesda, Maryland, with his four children, Duncan, June, Hayley, and Mackenzie.
Read an Excerpt
THE 3 SIMPLE RULES OF INVESTING
WHY EVERYTHING YOU'VE HEARD ABOUT INVESTING IS WRONG â?"AND WHAT TO DO INSTEAD
By Michael Edesess, Kwok L. Tsui, Carol Fabbri, George Peacock
Berrett-Koehler Publishers, Inc.
Copyright © 2014 Three Rules LLCAll rights reserved.
ISBN: 978-1-62656-162-5
CHAPTER 1
RULE #1
Simplify Your Options
You may not believe this: Whether you're a small investor with a few thousand dollars to invest, or a wealthy investor with a few million dollars, or a gigantic pension fund with a hundred billion dollars, you need only consider at most about 10 investment products. The rest are of no use and aren't worth thinking about.
If you were going to buy a computer, how many brands do you need to choose from? About 10? And the same thing for a smartphone—maybe 10 models, at most? This point applies whether you're a teenager doing homework or a top executive at a Fortune 500 firm.
Shopping for investments is a little different. You're faced with tens of thousands of investment vehicles to choose from, offered by thousands of investment firms. There are more than 80,000 mutual funds and ETFs (exchange-traded funds) worldwide. There are almost 10,000 hedge funds. The array is mind-boggling. And it keeps expensive financial advisors busy trying to guide confused investors through the mess. They let you know it's difficult to choose because there are so many choices.
But, actually, there aren't. If there were 100,000 computers or smartphones to choose from and 99.9% of them cost 5 to 80 times as much as the other 0.1% but weren't any better, how many would there really be to choose from?
Why aren't there 100,000 computers or smartphones for the consumer to choose from but there are 100,000 investment vehicles? Because of product and price confusion—a topic we covered in the introduction. Consumers don't realize that 99.9% of investments cost so much more than the others. Neither do they realize that those few that cost so much less are just as good as or even better than the rest. They have been so confused by the product that they think they're buying a luxury convertible when they're only buying a bicycle—and paying 50 times too much for it. They're so confused that they don't even know what, exactly, they're paying.
Hiring a financial advisor to guide you through the mess of investment products is usually no help. Most financial advisors will only reinforce and even add to the confusion because it is what they were taught, it is the industry status quo, and most of them—perhaps too uncritically—believe it. They believe they're trying to help their clients while also making a living, and they have no incentive to depart from the industry line.
THE ONLY INVESTMENT VEHICLES YOU'LL EVER NEED
In this book, we're talking about "passive" or indirect investing—in other words, investing in businesses in which you're not an owner or employee. We're not trying to tell you how to actively and directly invest in or run your own business selling, say, hamburgers. (Note, too, that a completely different meaning of "passive" applies to an investment vehicle that invests in all the securities in a market index instead of trying to pick certain ones; an index fund, then, is passive in this way.) If you've got savings in a 401(k), an IRA, or taxable individual or joint account, or investments you oversee by being the administrator of a university endowment fund, a pension fund, a foundation fund, or a wealthy family's office—we're talking to you. You'll want to invest these funds very wisely. We'll name the investment vehicles that you should consider—forget all the others. Of course, you'll need information about how to use them, but reducing the number of choices will go a long way to reduce the complexity, too, so that the rest will also be easier.
You need only consider a very few types of investments, or what's known as asset classes: stocks (also called equities), fixed income (bonds and short-term investments like bank accounts, certificates of deposit [CDs], etc.), perhaps real estate, and simple forms of insurance that ensure meeting cash flow needs. Specifically, here's all you need:
* Government inflation-protected securities (in the United States, these are Treasury Inflation-Protected Securities, or TIPS)
* A low-cost total U.S. domestic equity index fund, either a mutual fund or an ETF (this would be part of a world stock fund)
* A low-cost total international equity index fund, either a mutual fund or an ETF (the other part of the same world stock fund—with one fund, then, you're investing in both U.S. and international stocks)
* Single-premium income annuities
* Low-cost term life insurance
That's it. If you want to, you could also add these:
* A low-cost total U.S. domestic bond market index mutual fund or ETF
* A low-cost total international bond market index mutual fund or ETF
* A low-cost REIT (real estate investment trust) index mutual fund or ETF (U.S. and global)
* Individual stocks or bonds you buy yourself through a low-cost broker and keep for many years
* Small amounts from a very short list of other investments that we'll discuss later
That's 10 investment vehicles, max—all you'll ever need.
In the case of the stock, bond, and REIT index funds, competing versions are offered by a small number of providers for fees of less than a quarter of a percent annually, and often much less. You should confine yourself to only those. Examples appear on the 3 Rules of Investing website, with regularly updated information.
Now we will describe each investment vehicle in more detail.
Government Inflation-Protected Securities (GIPS)
GIPS are the least risky investment on the planet. No other investment you can make or action you can take is closer to 100% certain to preserve the purchasing power of your money for decades to come. That includes stuffing your money under the mattress, buying gold—anything.
The best-known GIPS is the U.S. Treasury inflation-protected securities (TIPS). These can be purchased easily online at the TreasuryDirect website of the U.S. Department of the Treasury. Several other national governments also issue inflation-protected securities. The United States is the biggest issuer, however, so to keep things simple we'll talk mainly about TIPS.
TIPS protect against inflation by increasing the face value by the inflation rate each year. Let's start with an example. Suppose you buy a TIPS contract for its face value of $1,000, and the interest rate is 1%. Hence, the first year the interest is 1% of $1,000, or $10.
But each year the Treasury increases the TIPS' face value for inflation. Let's suppose that in the first year after you bought it, inflation is 2%. That means the face value becomes $1,020, so next year you will get interest of 1% on $1,020, or $10.20. And so on, for the length of the TIPS contract. As this example shows, as the TIPS contract matures, the government continues to pay you interest on the inflated face value. The final payment, then, is likely to be much more than what you paid for the TIPS in the first place, to keep up with inflation.
Another nice thing about TIPS is that they also protect you against deflation. If inflation was actually negative from the time you bought the TIPS until maturity, then you'll still get your $1,000 back at maturity, not its deflated value.
Is There Really No Risk with TIPS?
Well, no. There's never no risk. But you can't get a smaller risk with a long-term investment than with TIPS. There just isn't one.
There are two risks with TIPS. One is that the government will default on its obligation. That's a negligible risk, however, if it's the government of a major developed country. The second risk is a little greater: that the government's inflation rate may not be your inflation rate. The government calculates inflation based on the "average" basket of goods consumed by the average person in the country. But your consumption might be of a different basket of goods. Your goods might increase in price faster than the average—then you could be in trouble. (Of course, their prices could also increase slower than the average, and then you'd be fine.) For example, the price or cost of health care and nursing homes has increased much faster than average prices. And guess what? As you grow older, that's what you'll be spending a lot of money on, like it or not. So if the price of health care increases faster than the rate of general inflation, TIPS payments will lag behind.
Be that as it may, the main use of TIPS is to protect against huge fluctuations in general inflation, which really could occur; they occurred in the United States as recently as the 1970s and early 1980s and more recently in some other countries. So if you're depending on payments from investments over the next 30 to 60 years, it's a good idea to protect against those fluctuations if you can.
Here's one more point to keep in mind: TIPS' longest maturity is 30 years. You can guarantee yourself an income until 30 years out, but what about after that? If you're retired at age 60, there's a decent chance you'll still need to collect an income after age 90. For that you need an annuity—the simplest kind available. It's on our list of core investment vehicles, and we'll discuss it soon.
Global Diversification in Global Inflation-Protected Securities (GIPS)
In addition to the United States, a number of other countries issue inflation-protected securities, notably the United Kingdom's Index-linked Gilts and France's OATi. To hedge against sovereign risk—that is, the very small risk that a major developed country cannot or will not honor its guarantee—an investor could invest in a diversified portfolio of GIPS maturing on the desired dates. Doing so would take more effort than investing only in the inflation-protected securities of one's own government; but it would add a small measure of diversification, which will reduce risk.
World Stock Index Funds
The second investment is different. Global stocks—that is, stocks that are listed on stock exchanges in the United States, Europe, Hong Kong, Tokyo, Australia, Brazil, and many other places in the world—are the riskiest major category of investments. When you invest in stocks, there's no contract to say you'll ever receive anything back.
Because global stocks are not as certain as GIPS to pay your money back, they have to offer you more. As we noted earlier, at this writing, U.S. TIPS offered a return of only about 1.5% above inflation over the next 30 years. Global stocks, however, are likely to provide a higher return, if you wait long enough. As we noted in the introduction, studies suggest that if you hold a diversified stock portfolio for 30 years or more, history suggests you're likely to get a good return (i.e., about a 5% return, above inflation, on average, give or take perhaps 3%). That likelihood is as high as possible if the portfolio is globally diversified. But it's not guaranteed, not at all. GIPS, in contrast, are guaranteed by the government that issued them.
Fortunately, it's easy and very inexpensive to invest in a globally diversified stock portfolio. The simplest way is to buy a world stock index ETF. "Index" in this context simply means a single investment vessel that holds a lot of different shares in various stocks—in fact, hundreds or thousands of them. You're in effect investing in multiple firms at once, rather than investing in Firm A, Firm B, and so forth. A few world stock index ETFs are similar—from companies like Vanguard, BlackRock iShares, State Street SPDRs, and Schwab. It's easiest to buy one that simply holds the whole global stock market (e.g., available at the time of this book's printing, and in the United States, from Vanguard, iShares, and SPDR). They can be purchased easily online after opening an online brokerage account with, for example, Schwab, E*TRADE, or TD Ameritrade. These funds have low "expense ratios," the fees their managements charge per year. For example, two of the lowest-cost world stock ETFs currently have expense ratios of 0.19%7 and 0.24%, respectively. Hence, for every $10,000 of the assets you've invested, you'll pay either $19 or $24 in fees that year, depending on which you choose. These two world stock funds are divided in approximately the same way the stocks of the world are divided. One of them reports that it holds 45% in U.S. stocks, 45% in international developed-market stocks, and 10% in stocks of emerging-market countries like Indonesia, Turkey, and China. The other is similar.
World stock funds can be purchased as a single fund or as two funds. You can buy them as one low-cost fund that holds nearly all global stocks or an approximation thereto. This is the way we've presented this investment vehicle in our earlier list of the only investments you really need. You may get a better expense ratio, however, by buying two funds, one a U.S. domestic total market fund, the second an international fund comprising the rest of the world stock fund (all countries except the United States). For example, one U.S. domestic total stock market ETF currently has an expense ratio of only 0.05%, one-twentieth of a percent. The same provider's total international stock index ETF has an expense ratio of 0.16%. If you combine these two funds in the same ratio as in the world stock fund (45% U.S., 55% international), your resulting expense ratio will be only 0.11%, as compared to the 0.19% expense ratio for the lowest-cost world stock ETF. (The low cost of the U.S. total market index fund may be due to the large size of its total assets, about 10 times that of the world stock ETF.) More information is available at the 3 Rules of Investing website.
(Continues...)
Excerpted from THE 3 SIMPLE RULES OF INVESTING by Michael Edesess, Kwok L. Tsui, Carol Fabbri, George Peacock. Copyright © 2014 Three Rules LLC. Excerpted by permission of Berrett-Koehler Publishers, Inc..
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Table of Contents
ForewordPreface
Introduction. The Simplify Wall Street Portfolio
Prologue. Why the Financial Industry Will Do Everything in Its Power to Stop You from Doing This
Part I. The 3 Simple Rules of Investing
Rule #1. Simplify Your Options
Rule #2. Look Only Forward
Rule #3. Tune out Noise
Part II. Wall Street’s 7 Deadly Temptations
Deadly Temptation #1. Beat the Market
Deadly Temptation #2. Trust It All to Our Expertise
Deadly Temptation #3. Precisely Calibrate Your Portfolio
Deadly Temptation #4. Sleep Well at Night with Your Risk under Control
Deadly Temptation #5. Use the Strategies That Always Work
Deadly Temptation #6. Do What Wealthy and Sophisticated Investors Do
Deadly Temptation #7. Use Modern Scientific Financial Theory
Epilogue. Systemic Risk, Concentration of Economic Power, and the Financial Industry
Notes
Index
About the Authors