Book Review: The Little Book of Bulletproof Investing
Do’s and Don’ts to Protect Your Financial Life
By Ben Stein and Phil DeMuth
The plight of the average American: “Right now you are on a luxurious private jet that is flying you in great style to an airport in a remote third world country, where you will be picked up in a broken-down bus, driven to the mountains, and never be heard from again.”
Jeremy Siegel did a study showing long-term real return on stocks of about 7% from 1801 to 2001. Keynes noted that in the long-run we are all dead. Unfortunately, Keynes’ long-run often comes before Siegel’s.
Ch. 1: Behavioral Finance
Crowds are pretty accurate on average when individuals are not influenced by others, but in the real world people in crowds do stupid things almost no one would do on their own.
Don’t trust your emotions when investing. They are contra-indicators.
Don’t invest in companies because you think they are cool and you want to be cool too.
Do approach the market with great humility and patience.
Don’t worry too much about short-term events.
Ch.2 Wall Street
Wall St. is after the money of the common man and tries to convince the public that it has all the answers and they need to listen to it. This is not to say that all financial advisors are bad. Financial advisors are good for helping people chart a direction and then stick with it. In other words, they keep people from doing stupid things.
Do have a financial plan.
Do control the things you can: asset allocation, minimizing fees and expenses, sticking with the plan, keeping it simple.
Don’t think you can just turn your finances over to someone else who is wiser and smarter.
Don’t assume that just because you can manage your finances yourself you are better off if you do.
Don’t pay attention to the financial media. Investing is not a competitive sport.
Don’t assume anyone else will ever care about your money as much as you do.
Ch. 3: How not to invest
If someone has great investment insight, they will not just sell it to you for $199/mo in a newsletter.
Don’t assume you can beat the market by stock picking. Do you know something the market doesn’t?
Don’t give weight to market forecasts. They are already priced in.
Don’t assume that if anyone were brilliant enough to develop a market beating strategy that they would be stupid enough to give it away.
Don’t engage in short-term market timing.
Don’t get caught up in investotainment.
Don’t follow fads, stock tips or use margin.
Do trade as infrequently as possible.
Ch.4 How to Invest
Simple and powerful concepts to invest well: simplify, diversify, invest passively and consistently, minimize expenses and taxes, buy and hold.
At some point you will hear that this time is different. This is bunk. There is no new thing.
Investors are not good at assessing their own risk tolerance. There supposed risk tolerance will be drastically higher in an up market than in a down one. “When people say they have a high risk tolerance, what they really mean is that they are willing to make a lot of money.”
Do keep it simple and conservative, both in your asset allocation and your security selection.
Don’t assume you are diversified just because you own a bunch of different mutual funds.
Do use passive index funds whenever possible.
Do keep an eye on expenses and taxes – buy and hold, don’t buy and sell.
Do monitor your investment performance.
Don’t use a “Cosmo-style” quiz to assess your risk tolerance.
Ch.5 Having your cake and eating it too
Stein and DeMuth develop what they call their “Tangency Portfolio” (named for being tangent to Markowitz’s efficient frontier curve) which starts with risk rather than return. They look at the largest historical one-year loss for different asset classes and then compile a portfolio that has exhibited a maximum one-year loss of varying amounts. The assets are the same for each level of risk, just the mix of the Tangent Portfolio and 5 year treasuries changes. The authors take advantage of a couple of market anomalies to earn better returns than the market in their portfolio. These include value stocks, low beta stocks and small caps. Value and small cap effects are combined and captured in a small cap value fund. There is no low beta fund, so instead they use sector ETFs for low beta sectors – HC, Energy, Consumer Staples and Utilities. The tangent portfolios outperform a mix of bonds and the SPX for every level of risk.
Do start by planning for the worst-case scenario instead of how much money you’d like to make.
Do consider overweighting small caps, low beta and value in your portfolio to raise your risk-adjusted return.
Do check out www.tangentportfolio.com.
Ch. 6 Bulletproofing your investments
This chapter shows the exact allocations and funds recommended by the authors to create a tangent portfolio. They recommend using low cost international funds to attain a 30% international exposure.
Do create your portfolio based on what you can stomach losing.
Do make Treasuries the bulk of your fixed income exposure. You don’t want to have to worry about credit risk in the next downturn. Use inflation protected bonds.
Do diversify globally with your stock and bond portfolios.
Do take your career into account when figuring out what you can afford to lose.
Ch. 7 Pulling the trigger
Do use a broker with low fees and low or no no-transaction fees.
Do be tax efficient in where you place components of your portfolio.
Don’t rebalance until you need to. Probably every three years is often enough, but this should be driven by the portfolio, not the passage of time.
Ch. 8 Become the CEO of You, inc.
Do regard college as part of life, not a vacation.
Don’t waste time with losers.
Do be a builder, not a critic.
Do get as much education as you can, particularly if it leads to gainful employment and improvement in your field.
Don’t indulge in drugs or alcohol.
Ch. 9 Human capital 411
“When it comes to allocating the scarce resource of love, a long-term investment will prove the most rewarding. Day traders will have a few good hits here and there but in the context of years of quiet desperation. High-quality bonds yield more than junk, after accounting for the high default rate among the latter. Junk situations can look superficially appealing, but the sooner you exit these positions, the better off you will be.
If you are going to get anything out of a relationship, you need to be fully invested. This assumes reciprocity and a monopoly. If, after a brief while, you still have to compete with others, sell the entire position at a loss and move to the sidelines until a better opportunity appears.
Over time, the returns on your investment should roughly equal the cost. What you put in by way of unselfishness, kindness and patience should be repaid. If this is not the case, you either failed to perform due diligence, your forecasts were unrealistic, or both.”
Do be a person of good character and earn the trust that others place in you.
Do pay attention to appearances and mind your manners; first impressions count.
Do remember that an attitude of gratitude is the surest get-rich-quick scheme.
Do get over the fact that life isn’t fair and start living in the real world.
Don’t’ waste your – or other people’s – time.
Do read the WSJ every morning.
Do stay married to one person, and remember that children are luxury goods.
Ch. 10 Save ‘til you drop
“Since the contingency of being old, sick, defenseless, and poor is too horrible to imagine, everything dictates that we err on the side of oversaving.”
Do live below your means – save til you drop!
Do what you can to protect your assets from creditors, law-suits, and evil ex-spouses.
Don’t play games with the IRS.
Do have a reserve fund.
Don’t borrow, except for an appreciating asset.
Ch.11 House of blues
Buying a house can be a good investment – primarily due to the tax code. [The authors focus on the fact that rent is taxable income, while rent avoided is not. In reality, a landlord who finances a rental house will likely not have rental income after interest and depreciation expense for the first several years of owning the rental, if not longer.]
Do buy a home once you can afford it and are ready to settle down.
Don’t become house poor.
Don’t buy in a hot market.
Don’t use anything other than a fixed rate 15 or 30 year mortgage.
Do rent vacation homes; don’t buy them.
Do be realistic about how much your home is worth when you go to sell it.
Don’t move too often. This is expensive. “Three moves equals one fire.”
Ch.12 Can you still retire comfortably?
The authors give a chart with maximum “Somewhat-safe” withdrawal rates. This was confusing to me as the rates were well below the expected returns of the portfolios. The withdrawal rates in the chart would generate estates greatly in excess of one’s nest egg at retirement.
www.quantext.com has a nice withdrawal rate calculator.
Don’t retire as soon as possible. The safest time to retire is never.
Do relocate to a lower cost of living area to have a higher standard of living.
Do use an immediate, inflation adjusted annuity, but the longer you can hold off on purchasing it, the better.
Don’t take out a reverse mortgage, except as a last resort.
Do recalculate your withdrawal rate from time to time.
Don’t take social security as soon as you can unless you need it.
Don’t take a lump sum payment from your employer’s pension unless you do the math.
Ch. 13 The End Game
Do take care of having a will, and every other document you will need. Also, write love letters to people who matter to you. And leave a letter describing your entire finances.
Do consider tax-saving estate strategies.