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September 20 - September 21, 2021
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.
People spend too much money.
You’ll need an adequate understanding of what finance is all about.
Learning the basics of financial and market history.
Human beings are simply not designed to manage long-term risks.
We were certainly not designed to think about financial risk over its proper time horizon, which is several decades.
They are also self-deluded monsters; most “finance professionals” don’t even realize that they’re moral cripples, since in order to function they’ve had to tell themselves a story about how they’re really helping their customers.
First, no matter how much debt you have, always, always max out the employer match on your 401(k), 403, or other defined contribution retirement plan, since the “return” on this money is usually between 50% and 100%, which is higher than even the worst credit card interest rates.
When, and only when, you’ve gotten rid of all your debt are you truly saving for retirement.
Thomas Stanley and William Danko’s The Millionaire Next Door. This is the most important book you’ll ever read, because it emphasizes the point that there’s an inverse correlation between spending and saving.
A plumber making $100,000 per year was far more likely to be a millionaire than an attorney with the same income, because the latter’s peer group was far harder to keep up with.
You and your brother are thus the “residual owners” of the business; if, and only if, you can pay off your lenders and your expenses do you make any money.
From the investors’ perspective, an ownership stake (a stock) is much riskier than a loan to your business (a bond), and so the stock deserves a higher expected return than a bond.
(Economists use examples like this to gauge “risk aversion.” The person who will not take a penny less than a certain fifty cents to avoid the coin toss has zero risk aversion; the person who will take a certain ten cents to avoid the coin toss is highly risk averse. This paradigm is a good way to think about your own risk aversion—that is, how much risk you can tolerate.)
bond ownership has no other upside beyond the full repayment of interest and principal, so it needs to be safe; stocks, on the other hand, need to have their potentially unlimited upside to entice investors who must endure their high risk.
loans to businesses—corporate bonds—are in general a bad deal, and it is a good idea to confine your bond holdings to government offerings.
When all is said and done, there are only two kinds of investors: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third kind: those who know they don’t know, but whose livelihoods depend on appearing to know.
At the end of the investing day, only two kinds of assets exist: risky ones (high returns and high risks, namely stocks), and what are known in finance as “riskless” ones (low risks and low returns, like T-bills, CDs, and money market funds).
Domestic stocks currently yield a dividend of around 2%, foreign stocks around 3%. This is a real yield, since historically the real dividend payout increases at around 1.5% per year.
Thus, a portfolio that is two thirds stocks and one third bonds should have a long-term expected real return of around 3%, and this is also where the suggested 15% savings rate for someone who starts saving at age 25 comes from.
The name of the game is to accumulate around 12 years of living expenses (cells H12 to H16), which, combined with Social Security, should provide for a reasonable retirement. How did I arrive at 12 years of living expenses? The average person needs to accumulate about twenty-five years of living expenses, and I’m assuming you’ll be getting about half of that from Social Security.
Jack Bogle’s Common Sense on Mutual Funds, perhaps the best introduction to basic finance that’s ever been written.
Vanguard’s fund expenses are generally the lowest in the industry,
Jack Bogle, while not a poor man, would almost certainly be a billionaire many times over had he retained ownership in the company, instead of giving it away to the fund shareholders. He is the only person in the history of the financial services industry to have done so and, as you might expect, he has remained, long after his retirement, a strong and clear voice for the rights of small investors everywhere.
The exact opposite is in fact true: market history shows that when there’s economic blue sky, future returns are low, and when the economy is on the skids, future returns are high; it is a truism in the market that the best fishing is done in the most stormy waters.
When the economy looks awful, risks seem high, and so stocks must offer high returns to entice people to buy them; contrariwise, when the economy looks great and stocks seem safe, they become more attractive to people, and this yields low future returns.
Driving the price of any asset higher requires the entry of new buyers, and when everyone is invested in stocks, real estate, or gold, there’s no one left to join the party; the entry of naïve, inexperienced investors usually signals the end.
Market bottoms behave the same way; when everyone is afraid of stocks, then there’s no one left to sell, so prices are much more likely to move up than down.
The real purpose of learning financial history is to give you the courage to do the selling at high prices and the buying at low ones mandated by the discipline of sticking to a fixed stock/bond allocation.
Devil Take the Hindmost by Edward Chancellor, a compendium of stock market manias; and its bookend, The Great Depression: A Diary, by Benjamin Roth, a portrait of how things look at the bottom.
The nearly instantaneous emotional responses that served us so well on the prehistoric African plains turn out to be fatal in finance, as manifested in the buy-high sell-low behavior epitomized by the Villa-Whites.
People tend to be comically overconfident:
We tend to extrapolate the recent past indefinitely into the future;
humans are “pattern seeking primates” who perceive relationships where in fact none exist.
Your Money and Your Brain, by the Wall Street Journal’s Jason Zweig; I can guarantee you that you’ll enjoy it immensely, and if Jason can’t save you from yourself, then no one can.
the prudent investor treats almost the entirety of the financial industry landscape as an urban-combat zone. To be avoided at all costs are: any stock broker or “full-service” brokerage firm; any newsletter; any advisor who purchases individual securities; any hedge fund. Most mutual fund companies spew more toxic waste into the investment environment than a third-world refinery. Most financial advisors can’t invest their way out of a paper bag.
