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"You may not be able to have it all. But if you don't save, you won't have anything." Jonathan Clements
25 Myths You've Got To Avoid If You Want To Manage Your Money Right
By Jonathan Clements
25 Myths You've Got To Avoid If You Want To Manage Your Money Right by Jonathan Clements is a great personal finance book. The book gives a solid overall philosophy to managing your money.
Each chapter begins with an investment or personal finance myth. Clements explains where each myth goes wrong and concludes each chapter with new rules to replace the myth. The information provided runs from rather basic to quite profound.
For example, Clements dispels the myth that the bank is a great place to put money. Clements writes, "...if you want to get robbed, simply place your money in a bank," which pretty much sums up the ultra-low rates banks pay to savers. Better to go with a money market mutual fund. That's rather basic advice.
Clements also discusses the myth that you should invest in bonds for income. He says that investors love bonds because they love income. But, Clements says that investors loving bonds is a "masochistic relationship" when we factor in all of the negatives of bond investing.
Clements explains that the callable feature of bonds means that if interest rates drop significantly, bonds will probably be called in, depriving investors of the desirable and higher interest rate on their existing bonds. But, if interest rates shoot way up, the bonds won't be called in, and investors will be locked into receiving a low rate of return. Clements says that the call feature of bonds is a case of "heads I win, tails you lose."
And, as much as investors love bonds, Clements notes that the taxman loves bonds even more. After factoring in taxes and inflation, Clements shows us that bonds are a dismal investment. (Especially when we toss in default risk and interest rate risk). The chapter about bonds is particularly good and will give investors much to think about.
So, what about investors seeking income? Does Clements go along with the "No problem. Just sell some shares when you need some money" crowd? No. Clements realizes the inherent risk in needing to sell shares for income. The market might be down, and you could take a clubbing.
Clements writes: "Clearly, there's the risk that your stock and bond funds will be underwater when it comes time to sell. But if you are retired and living off your savings, you can get around this problem by calculating your spending needs for the next few years and then, when the stock and bond markets seem buoyant, selling securities and moving the proceeds to a money-market fund. Indeed, as a cushion, you might keep two or three years of spending money in a money-market fund. When stocks and bonds are going through one of their periodic bloodbaths, you can tap this cash reserve for spending money, thereby avoiding the need to sell stocks and bonds at rock-bottom prices."
Clements explains that stocks or mutual funds holding stocks "are your portfolio's engine of growth. Everything else is there to reduce risk, so that you won't get unnerved by market swings and can tap your portfolio for spending money without selling stocks at fire-sale prices."
So rather than following the conventional advice of holding a portfolio balanced between stocks and bonds (usually 60% stocks and 40% bonds), Clements suggests investors consider holding a portfolio of 25% cash and 75% stocks. I strongly agree that this is something to consider.
Ultimately, Clements tells us that it's our asset allocation which will determine the long-term rate of return our portfolio achieves. Rather than holding a portfolio composed of only 50% stocks and then trying to seek the next Microsoft, investors would probably do much better holding a higher percentage of stocks and foregoing the search for the next big winner.
Clements says it's a myth that you can beat the market. In addition to not liking market timing, he doesn't believe in sector rotation, or individual stock selection. Further, Clements doesn't tend to like actively managed mutual funds. Because Clements is of the earliest columnists to cover the mutual fund industry for The Wall Street Journal, we should probably listen when he gives mutual fund advice.
What typically happens, Clements explains, is that a superstar fund manager hits a streak. This might be due to his or her investing style coming into favor or it might be due to luck. Then typically the public relations department of the money management firm kicks in and the money under management balloons. Ultimately, the fund returns to moderate performance or bombs entirely. The superstars reputation fades away. A new superstar at another fund is born.
Clements has seen too many superstar fund managers wipe out to believe it's worth his time seeking the best mutual funds among the several thousand existing funds. He recommends indexing your stock market money among larger U.S. stocks, smaller U.S. stocks, and foreign stocks.
Clements asks individual investors if they really think they can beat the professional investors who know more than they do. My answer is: Sure. Why not? Professional money managers tend to focus upon short-term results. Individuals can focus upon long-term business results.
Warren Buffett and Peter Lynch are good examples of the few professional investors who have focused upon the long-term profit drivers of a business. Ultimately, long term, profit drives stock price. Many people who become very business-focused investors eventually decide they'd rather run their own business rather than put their time into studying businesses run by others. Their engine of financial growth becomes their own company. So, business people often index much of their money so they can focus their time upon their own company.
Clements includes a good discussion of the controversy surrounding whether to invest all of a lump sum at once or whether you should dollar cost average it into the market. He prefers dollar cost averaging it into the market as a means of reducing risk. Rather than aiming for the highest possible return, we want to minimize the risk of losing capital.
Clements says we probably won't get a 10% rate of return on our investments and that the new "Disney World for the post-teen set" is using compounding calculators, plugging in estimated rates of return, to calculate how large their retirement nest egg will be. Considering inflation, Clements corrects us showing that, due to inflation, the real return on stocks is closer to 7% a year. Those compounding calculators are fun, aren't they?
I disagree with some of Clements' advice. What he says about building a credit cushion rather than holding excessive savings in a low-yield, money-market fund is good. But, I'd much rather count upon a home equity line of credit than a (gulp!) margin account at a brokerage, which he suggests as an option.
Clements also suggests that if you're wealthy you probably don't need umbrella liability insurance as you can self-insure this risk. He says the same about health insurance. How rich is rich? We're not talking $5 million here. I'd recommend retaining both health insurance and umbrella liability insurance regardless of your wealth. But, as Clements says, you probably can forego termite reinfestation insurance. You can absorb the cost of annihilating the little bugs yourself.
Finally, 25 Myths You've Got To Avoid If You Want To Manage Your Money Right has a great discussion of why you might not want to max out your (non-Roth) IRA, but consider holding a global index portfolio in a taxable account instead. In addition to not having access to the money for a long-time, you're converting capital gains into more heavily-taxed income.
Overall, I really like 25 Myths You've Got To Avoid If You Want To Manage Your Money Right by Jonathan Clements. This book belongs next to Making The Most of Your Money on your personal finance bookshelf.