Well, here we are at the end of the week. We've covered a lot of ground this week. If none of the books we reviewed this week appeal to you, be sure to check out my list of recommended books. We hit some physician specific books on Monday, some books aimed at more advanced readers on Tuesday, an “alternative” investment book on Wednesday, niche Social Security books on Thursday, and now today we're going to cover some books on the basics. In fact, our first book is one of my favorites by one of my favorite authors, William Bernstein, MD.
If You Can
If You Can is perhaps the best first investment book for a millenial 20 something. Not only is it short, very readable, and correct, but it is also free (my favorite price.) Plus, when I recommend it I get to take advantage of the fact that it gives homework assignments which are basically a book or two for each of the five chapters. So those who read it really have to read several books, instead of just one, to do it correctly. Dr. William Bernstein, neurologist turned financial theorist, was one of the biggest influences on my personal finances when I started reading financial books more than a decade ago. As he went along from one book to another, he made each book more simple than the last, from The Intelligent Asset Allocator to The Four Pillars of Investing to The Investor's Manifesto. Even the “adult” books were purposely kept quite short. This book goes one step further- nothing but the basics here.
It is subtitled “How Millenials Can Get Rich Slowly” and is a 16 page PDF, and 2 of those 16 pages have fewer than 10 words on them. Seriously. That's it. You can do it. If you are one of those people who can't read a financial book because it is so darn boring, you can read this one. Here's how he introduces it:
Would you believe me if I told you that there's an investment strategy that a seven-year-old could understand, will take you fifteen minutes of work a year, outperform 90 percent of finance professionals in the long run, and make you a millionaire over time? Well, it is true, and here it is: Start by saving 15 percent of your salary at age 25 into a 401(k) plan, an IRA, or a taxable account (or all three.) Put equal amounts of that 15 percent into just three different mutual funds:
- A U.S Total Stock Market Index Fund
- An International Total Stock Market Index Fund
- A U.S. Total Bond Market Index Fund…
[But] the most important word in this book is “IF” … because, you see, it's a very, very big if. At first blush, consistently saving 15 percent of your income into three index funds seems easy, but saying you can become comfortably well-to-do and retire successfully by doing so is the same as saying you'll get trim and fit by eating less and exercising more….Dieting and investing are both simple, but neither is easy.
The “chapters” in the book are five “hurdles,” which are:
- Even if you can invest like Warren Buffett, if you can't save, you'll die poor.
- Finance isn't rocket science, but you'd better understand it clearly.
- Those who ignore financial history are condemned to repeat it.
- We have met the enemy, and he is us.
- The financial services industry wants to make you poor and stupid.
Amazingly, those five sentences sum up Bernstein's first three books quite nicely! If I go on any longer about this book, I might as well just publish it here as a blog post. If you haven't yet read it, do it today, then pass it on to someone you care about.
The Thirteen Word Retirement Plan
Like Bernstein, WCI reader Stephen Nelson, CPA, MBA, has been doing this financial writing thing for much longer than I have. The Thirteen Word Retirement Plan is his version of an ideal first book for a beginner investor. He subtitles it “A Simple Roadmap for Joining The Top Ten Percent.” Obviously not physician specific (in fact he aims this at the “average” American making $55k), but that can be a good thing. It's only available on Kindle ($4.99) but as a Word document it is only 45 pages long, so you can get through this one too. Or if you can't, well, at least you can get through all thirteen words which are, without further ado:
$5,500 annually into an IRA or 401(k) invested in cheap target retirement funds
It's not exactly the same as Bernstein's plan, but it's awfully similar, and that ought to tell you something. In chapter one, he sets your expectations. He shows how $5,500 a year will turn into $365K after 30 years or $497K after 35 years. Then he points out that only 14% of retirees retire with a nest egg larger than $365K and only 10% retire with a nest egg larger than $497K. So there you go, $5,500 a year gets you into the top 10% by the time you retire.
Chapter two explains why people fail at this simple task- they make the task too complicated, they misunderstand that they need to earn for 30 years, but spend for 60 years, that many people treat retirement savings like death (including five stages of grief), and they get bummed out by the difficulty of carving out 10% of their income a year. He offers great suggestions to help you avoid being bummed out, like the fact that between the match and the tax deduction, you don't have to save nearly as much as you might think.
Chapter three explains why you should be using a 401(k) or IRA and why those retirement accounts are so valuable. Chapter four explains why you SHOULDN'T be using a Roth IRA. I love a little controversy, but he's right. If you're only making $55K a year, don't ever expect to make any more, and are only saving $5,500 a year, you're going to come out ahead with a tax-deferred account. This chapter also nicely includes the exceptions when a Roth account may be better. I love that Nelson “gets” the math on this, because many people don't.
Chapter five tells you to keep your costs low because they matter a lot. That's important, but I've already beaten it to death around here. If this is the first time you've heard that, I've failed you. Chapter six talks about target retirement funds, and why they can be awesome for those who save $5,500 a year. That's not most readers of this blog (I hope) but it might be many of their friends and family members. Chapter seven talks all about “percentages”, like your savings rate, expected returns, the 4% rule, and other important rules of thumb in personal finance. This information is basic, but critical, and lacking in far too many personal finance and investing books.
Chapter eight includes 12 “tricks” to find money to save. Many of these apply to physicians just as well as the middle class and include things like a match, tax deductions, delaying Social Security, and making your IRA contribution early in the year. Chapter nine talks about “awkward questions” like “Can I rely on Social Security?” and “What if my household can't save $5,500 annually?”
All in all, this one might be three times as long as Bernstein's, but it also contains three times as much high yield stuff. They both make excellent books for a beginning investor. If that is you, start reading. For less than $5 you can get two of the most easy to understand and highest yield investing books available anywhere.
The Index Revolution
The third book we'll be reviewing today is The Index Revolution by investing legend Charley Ellis, with the foreword by another investing legend, Burton Malkiel. Although this is a real book, unlike the above “books” that are closer to pamphlet length, it is small (5×7 inches) and only 240 pages long and assumes that you don't know much, if anything, about investing. If you have not yet been convinced that the best way to invest in publicly traded stocks is to buy low-cost, broadly diversified index funds, this book will convince you. The other two options- picking stocks yourself or hiring someone else to do it, not only introduce unnecessary, uncompensated risk and manager risk, but are very unlikely to increase your returns. This fact is mostly empirical, because it isn't intuitive, and sometimes it takes a few books for you to really believe it. That must be why there are so many that continue to be published to basically demonstrate that fact. Despite the fact that Bogle and Malkiel wrote about it in the 90s, there are a plethora of books that continue to come out, perhaps most recently Ferri's The Power of Passive Investing and Swedroe's The Quest For Alpha.
However, Ellis's book is a lot easier to read and understand than any of those other books. It is subtitled “Why Investors Should Join It Now” and is comprised primarily of two parts. The first part is his story, entitled “My Half Century Odyssey” of how he became a proponent of index fund investing. Then he begins the second part pointing out that the world has changed. It isn't that active investing didn't use to work, nor that it doesn't work because active managers have no talent. It is primarily that active managers are too good and there are too many of them doing it. They have basically eliminated all the available alpha. They can no longer overcome their own fees. The remainder of the book, aside from the appendices, is 10 Good Reasons to Index. If you understand and believe all of these reasons just from reading the table of contents, you probably don't NEED to read the book, but it still provides good reinforcement. Here is the list:
- Indexing outperforms active management (do you need any more reasons?)
- Low fees are an important reason to index
- Indexing makes it much easier to focus on your most important investment decisions (I love this one.)
- Your taxes are lower when you index
- Indexing saves operational costs
- Indexing makes most investment risks easier to live with
- Indexing avoids manager risk
- Indexing helps you avoid costly trouble with Mr. Market
- You have much better things to do with your time (so true.)
- Experts agree most investors should index
For those who choose active management, getting started means committing to a long series of detailed and often difficult decisions–some large, some small, many fraught with uncertainty and risk, and many coming at inconvenient times. By contrast, the basic indexing decisions are simple and, once made, stay decided until the time comes for a change in your long-term investment strategy because your goals have changed in an important way.
Perhaps most important, some of [the academic work showing the value of indexing] has strongly suggested that certain elements of investment activity may not be particularly useful or not worth the cost. Can you think of any group that hasn't resisted the idea that their contribution may be worth less than they are being paid?…I feel sorry for a lot of these guys. They were trained to do things a certain way and have spent years working hard to do it in that familiar way. Now, suddenly, they're beginning to discover that what they've been doing all their lives hasn't worked and they've been doing everything the wrong way. Think of the psychological shock these guys must be going through. Sometimes I wonder how they manage to get up in the morning.
The stunning reality is that most actively managed mutual funds fail to keep up with index funds that match those active funds' chosen benchmarks. The problem gets worse as the time period gets longer. (This is important because while they may change specific investments or managers, most investors will be continuously investing one way or another for the next 20, 30, or 40 years or even longer–and much longer when including the investing years of their heirs. The point on low success rates is made dramatically in a table showing the 10 year rate of beating an index fund in various asset classes ranging from 12-42%. The 20-30 year data, of course, is even stronger.)
Take a look from a different perspective and you'll never again think…that fees can be fairly described as “only 1 percent.” Since you already have your assets, the right way to quantify investment fees is not as a percentage of the assets you have, but as a percentage of the returns that the investment manager produces. This simple first step into reality changes fees from a low “only 1 percent” to (assuming the consensus of 7 percent future returns on equities) a substantial 14 percent. This surely warrants deleting the four-letter word only. And that leap of insight turns out to be just the first toward a full understanding of investment management fees….Since all investors can invest via index funds…the true cost of active investing is the incremental fee above indexing as a percentage of the incremental return above investing…actually the grim reality…is that a majority of active managers, after fees, fall short of the index they chose as their target to beat, so for those managers, incremental fees as a percentage of incremental returns are over 100 percent–or infinity.
One of my favorite parts of the book was when Ellis explains how and when AUM fees came to be. Prior to the Great Depression, the main way investment managers were compensated was by hourly fees, since most were attorneys running trusts. One firm decided to charge fees based on dividends and assets under management. Then, when asset size fell in the Great Depression they switched to AUM only, and were commended for doing so as evidence of professional integrity. Ellis says:
Though they never do, every investment manager should celebrate that day with song, feasts, and much dancing. Changing the basis for fees from hours to assets would, in time, transform the economics of investment management. What had previously been at best a modestly compensated profession would, in time, become the world's most highly paid professional business.
One more quote:
Investing is a continuous process like refining petroleum or manufacturing cookies, chemicals, or integrated circuits. If anything in the process is “interesting,” it's almost surely wrong. That's why the biggest challenge for most investors is not intellectual; it's emotional….the hardest work is not figuring out the optimal investment policy. It's maintaining a long-term focus…and staying committed to an optimal investment policy.
Overall, The Index Revolution is an excellent book for those wavering in their faith about index fund investing, or who have never developed that faith in the first place. A committed Boglehead may find a few nuggets of wisdom and pearls of truth there, but little of what it teaches will be new. But the book isn't written for committed Bogleheads. It's written for investors who have not yet joined the index revolution, and so it is an excellent option for a relative beginner who needs a good CFE book for this year.
Buy If You Can Today! (Free PDF here.)
Buy The Thirteen Word Retirement Plan Today!
Buy The Index Revolution Today!
What do you think? Have you read any of these books? What did you like or dislike about them? Which one do you think is the best one for an investor who has read fewer than 3 financial books in his life? Comment below!