Tuesday, August 05, 2014

I am almost ready to hire this guy

kw: book reviews, nonfiction, investing, retirement planning

Ric Edelman is heard on the local radio station, sometimes advertising and sometimes hosting a talk show about investing. His advice and approach seem sensible to me, so I was glad to run across his book The Truth About Retirement Plans and IRAs. His advice compares well with that from Peter Lynch in a book he wrote just after retiring from managing the Magellan Fund. Both make the point that long-term, stocks perform better than any other investment (except perhaps high-end real estate, if you have billions to invest).

Based on the Lynch book, I invested heavily in stock funds while I had a 401(k) available, then reallocated as I neared retirement. It turns out, I'd have done the same had this book been available 30 years ago! The difference is, Ric Edelman advises investing in everything available to the small investor. Here is an asset allocation model generated by the "GPS" tool at www.ricedelman.com:

Count 'em up: 18 asset classes, plus Cash. I ran the tool several times, for both myself and my father, in his 90s. This model is for someone about 10 years before retirement with a pretty good tolerance for risk. If you add the international bonds to the "International" category, which is for stocks, global exposure is 18%, a surprisingly aggressive stance. And although he mentions gold or precious metals a few times in passing, I see none in this model, nor any discussion in the book. I suspect that is due to their double risk: gold went from $1,800/ozT a couple of years ago to $1,200 early this year, and is creeping back up at best. In real terms gold has yet to reach values it had during the Reagan presidency. Such fluctuations are risk type 1. The second type of risk is, you either pay for a custodian to guard it, or you take custody and risk being robbed. If anyone is paying attention (someone usually is), you are vulnerable when it is in your possession, before you get to your safe deposit box.

Back to the model. Non-bond non-cash totals 65%, about right for someone about 55. There is a joke hidden in the GPS. To answer one question, you have to choose one of 5 levels of risk, from zero to a scary graphic of zigging up and zagging down. If you choose the zero-risk tab, you are admonished that risk is never zero, and if you really have no tolerance for risk, you're on the wrong planet (that's how I'd word it; Edelman's webmaster is more tactful). So there are really 4 levels of risk tolerance. Then there is another question that evaluates the same trait in a different way, a few about objectives, your age and how much you'll be allocating, and you get your model.

The book has three parts. The first 7 chapters discuss retirement plans in all their variety, with frequent exhortations to take full advantage of any plan you're offered. In fact, if you don't at least have a 401(k) with some amount of company matching (AKA free money), he recommends changing employers. Of course it is also a good idea to fund your IRA every year also. Chapter 5 is titled "How to Save for Retirement When You Think You Can't Afford it". In a sidebar he mentions a study that found people making less than $13,000/yr spend about 9% of their income on lottery tickets. That's more than $90/month. For everyone who didn't win the lottery, it is lost money. If you have a way to put $90 into a passive stock fund, that is, an index fund tied to S&P 500 for example, after 40 years you'll have invested more than $43,000 and it'll be worth $200,000 to $300,000. That is the slow way to win the lottery!

He writes a lot about compound earnings. A halfway decent bond fund earns 4%/yr. Depending on market fluctuation, the index stock fund will gain 7%-10%. Let's pick 7% to be conservative. The first $90 you invest will grow to $1,350 in 40 years. Ninety dollars invested for 20 years will grow to $348. Each $90 investment grows for a different period, but they all add up to more than $260,000 over the total 40 years. Compare that to the lottery. One in 1,000 tickets wins a few hundred bucks in a "pick 3", one in 10,000 wins a few thousand dollars in a "pick 4", and one ticket in 100 million (or more) wins the millions at Powerball or a similar game. Everyone else has simply put a few bucks into a piece of paper they can throw away. This is why the lottery is called "a tax on people who can't do math."

The second section of the book consists of 5 chapters that discuss all the investment options (but as I wrote above, precious metals are not discussed only mentioned in passing). The 18 asset classes in the GPS model are all mutual funds or ETF's. Edelman doesn't recommend buying individual stocks or directly owning T-bills or other bonds. He has unearthed a marvelous principle for picking a fund: go for the lowest Expense Ratio, and of course, one with no "loads" (A load is the commission paid to the broker who sells you the fund. It is typically 4%, and some funds add another load when you sell, though it is a lower percent). The expense ratio is a management fee for choosing and trading the stocks or bonds or whatever. A study by Morningstar found that the performance of a mutual fund was better, the lower its expense ratio. Actively managed stock funds have ER's of 1% or more, averaging 1.4%. Bond funds may be lower, but usually exceed 0.7%. If a stock fund's basic performance is 8%, but you pay the manager 1.4%, your real performance is 6.6%. A passively managed (index) fund typically has an ER of 0.15% or less. One of those I own is at 0.05%. That is because these are easy to manage, and the fund company doesn't have to hire a highly-hyped "power manager". And they perform better. Even if my fund were to earn "only" 7.5% (it earns more), if I only pay 0.05%, the rest, 7.45%, is mine, and grows compounded!

Ah, compounding. It has been called the Eighth Wonder of the World. Over 40 years, $1,000 that earns 6.6% will become $12,891. But at 7.45%, it will become $17,711. That active, "higher returns" fund actually costs $4,820 per $1,000 you originally invested!!

OK, once you get to the third section, you have the meat of the book, 14 "best way" chapters that cover every situation leading up to retirement, living in retirement, how to (financially) handle life events such as divorce, and the best way to care for your heirs, should you see fit to leave something for them. I touched on a few items he covers in the discussion above, so I won't belabor. The 14 "best ways" are truly comprehensive, and of course, he advises seeking his services to get into more detail about your particular situation.

If you have no other book of such advice, or even if you have several, be sure to get this one and read it all. Even if you think you know everything in the first two parts, read them anyway, for the grounding, and to get used to the author's writing style: breezy, cheerful, and relentlessly right on the money!

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