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Recommended Reading: A Social Security Owner’s Manual

Since finishing up my book on retirement planning, I’ve known that the next addition to the “in 100 Pages or Less” series would be a book about Social Security. I expect it to be my major project for the second half of this year.

I have good news, though, for those of you who don’t want to wait.

This last week, I finally got the chance to read A Social Security Owner’s Manual by Jim Blankenship — a CFP and enrolled agent who blogs at Financial Ducks in a Row. I cannot recommend the book highly enough for anyone looking for a brief, easy-to-read resource on the topic of Social Security.*

The first two-thirds of the book walk you through the nuts and bolts of Social Security:

  1. The terminology (What’s a “primary insurance amount”? What does “full retirement age” mean?),
  2. The calculations (How are retirement benefits calculated? What about spousal benefits and survivor benefits?), and
  3. The related rules (How is Social Security taxed? How is your benefit affected if you have a government pension?).

Then the final part of the book digs into the nitty gritty of Social Security planning: At what age should you (and your spouse, if applicable) take Social Security, and how does that fit into the rest of your retirement planning picture?

Of course, the book doesn’t address every single situation, as there are simply too many variables to consider without thoroughly overburdening the reader (e.g., difference in ages between spouses, difference in earnings history between spouses, tax rates, assumed rate of return if you take the money early and invest it, unusual life expectancies due to medical conditions, etc.). But it does a great job of providing a few different strategies that are likely to work out well in most circumstances, and it provides you with guidance for choosing between them.

You can find the book here on Amazon. (Also, if you’re an Amazon Prime member, you can read the Kindle version free of charge.)

*The book focuses primarily on Social Security retirement benefits. In other words, if you’re looking for a book about Social Security disability benefits, this is probably not the book for you.

Learning about TIPS (Inflation-Protected Bonds)

I recently finished reading Explore TIPS: A Practical Guide to Investing in Inflation Protected Securities by fellow blogger The Finance Buff.

It was actually my second time reading it. You see, the author mistakenly thought that I might have something meaningful to add to the book, so he sent me a proof copy during the editing stage.

Instead, I found myself scribbling down several pages of notes. (The second time through the book resulted in two more pages of notes.) The honest truth is that, while I have a pretty good grasp of the basics of how TIPS work, I still had much to learn.

Random example #1: I never would have guessed that, when purchasing TIPS in the secondary market, it’s often more cost effective to place a buy order over the phone rather than online, despite the higher commission. (Reason being that the rep on the phone may be able to find you a better price on a given bond.)

Random example #2: At any given moment, every financial website may be quoting completely different yields for a given TIPS fund. The Finance Buff explains how to figure out what each of the yield figures means, and he provides advice on which figures to pay the most attention to if you’re trying to figure out what yield you’re going to get if you buy the fund. (Hint: Look for something forward-looking that’s inflation-adjusted.)

Explore TIPS covers everything that you’d need to know about investing in TIPS, things like:

  • When to buy individual TIPS and when to use a mutual fund or ETF,
  • How individual TIPS are taxed (and why you might want to consider a fund rather than individual TIPS if you’re investing in a taxable account),
  • How to buy TIPS at auction, and
  • How to buy TIPS in the secondary market (both how to understand the quote screens as well as how to minimize transaction costs).

For as much of our portfolios as bonds–and TIPS–make up, they sure get a lot less coverage than stocks and stock mutual funds. If you’re like me in that you could use a little more background on the other half of your portfolio, I’d suggest picking up a copy of the book. It’s short, it’s easy to understand, and it’s only $10 (and change) on Amazon.

Review: Worry-Free Investing by Zvi Bodie

I recently read Zvi Bodie’s Worry-Free Investing. It’s a brief book that makes basically one argument.

Bodie (a Professor of Finance and Economics at Boston University) points out that the reason stocks have high expected returns is that they’re risky. And no matter how long we hold them, there’s always a chance that that risk will show up in the form of poor returns.

Bodie argues that the long-term riskiness of stocks is dramatically understated by conventional investment wisdom and that most investors have far too much allocated to stocks and far too little allocated to safer, inflation-indexed investments such as TIPS and I Bonds. In many cases, Bodie recommends a portfolio comprised exclusively of TIPS and I Bonds.

100% TIPS?

The problem, in my opinion, is that Bodie significantly understates the rate of savings that would be required for most people to reach their goals using a 100% TIPS portfolio. The reason for this underestimate is that he makes a few shoddy assumptions:

  1. He assumes every investor will die at or prior to his/her life expectancy.
  2. He assumes that you’ll earn a 2% real return from TIPS over any time period.
  3. He assumes that the amount you pay into Social Security will also earn a 2% real return.

Life Expectancy

In Bodie’s calculations, if someone retires at 65 and has a life expectancy of 90, Bodie does the math assuming that the investor needs enough money to last for 25 years.

The catch, of course, is that approximately 50% of people will live beyond their life expectancy. Planning to only meet your life expectancy hardly seems worry-free to me.

(Real) interest rates change.

Throughout the book, Bodie assumes that you can earn a 2% real return with TIPS. This works reasonably well for an investor with a lump sum to invest, who is already some years into retirement, and who can currently buy TIPS with a 2% real return.

Of course, that overlooks a great many scenarios. For example, for the 30-year-old investor, even if TIPS are currently yielding 2% (or even more), there’s no way to know what rate of return he’ll get on the TIPS he buys at age 40, 50, or 60.

I’m not arguing that a 2% real return is unreasonably optimistic. But relying on a given return (even from a portfolio comprised entirely of TIPS) is neither risk-free nor worry-free.

Social Security is risk-free?

In most of Bodie’s examples, his math shows that the hypothetical investors need to save somewhere from 20% to 40% of their income in order to reach their goals. Bodie argues that that’s not as hard as it sounds because they’re already saving 15% of their income in the form of social security taxes.

The unspoken assumption here is that you will earn that same 2% real return on your Social Security tax payments that Bodie assumes you will earn from a TIPS portfolio.

For younger investors especially, this assumption seems questionable. Again, neither worry-free nor risk-free.

Is it worth reading?

To be clear: my point in all of this is not that TIPS are riskier than stocks. They aren’t. My point is simply that an investor following Bodie’s plan is not 100% certain of success. Not even close.

That said, Worry-Free Investing provides a thought-provoking counterpoint to the conventional wisdom of stock-heavy allocations. And for that, I’d say it’s worth reading.

Review: Unconventional Success by David Swenson

I recently finished reading David Swenson’s Unconventional Success: A Fundamental Approach to Personal Investment. (For those unfamiliar with Swenson: he’s Yale University’s Chief Investment Officer.)

The book is broken down into three sections:

  1. Asset Allocation
  2. Market Timing
  3. Security Selection

Asset Allocation

The first section is a thorough run-down of each asset class, discussing various characteristics that make it either worthy or unworthy of investment. Swenson suggests a portfolio (one of my favorite “lazy portfolios” actually) consisting of 6 asset classes:

  • 30% domestic equity,
  • 15% foreign developed equity,
  • 5% emerging markets equity,
  • 20% REITs
  • 15% U.S. Treasury Bonds
  • 15% Treasury Inflation-Protected Securities

It’s good information, and I’m on board with his advice. The problem? This section of the book is boring, wordy, and repetitive. Given how engaging Swenson is as a speaker, I was disappointed.

Market Timing

The second section provides guidance on how to avoid behavioral investment mistakes. Specifically, Swenson warns against chasing performance and neglecting to rebalance your portfolio. Like the first section, it’s good advice, but not the most exciting reading.

Security Selection

Roughly halfway through the book and so far unimpressed, I was just looking forward to being done with it. Little did I know, this tamely-named section would be arguably the finest piece of investment industry muckraking I’d ever read!

In a degree of detail I’ve never seen before, Swenson highlights the various conflicts of interest between fund management companies and fund investors. I suspect that the majority of the information in this section will be eye-opening for most investors. I’m as cynical as they come with regard to the financial services industry, and there were a few moments when even I felt scandalized.

Recommended Read?

For a general introduction to investing, I’d recommend Bernstein’s The Investor’s Manifesto above this book. And in terms of avoiding behavioral investment mistakes, I’d suggest anything by Jason Zweig.

If, however, you’ve ever considered investing a portion of your wealth via actively managed mutual funds, I strongly recommend you read (the third section of) Swenson’s Unconventional Success. In all likelihood, it’ll convince you to stick with index funds and ETFs. But if it doesn’t, you’ll at least know what you’re up against (namely, the company managing your money on your behalf).

Review: The Intelligent Asset Allocator

I recently finished reading Bill Bernstein’s The Intelligent Asset Allocator.

In the introduction to Bernstein’s most recent book (The Investor’s Manifesto), he describes The Intelligent Asset Allocator as a failed attempt at writing a plain-English guide to prudent investing:

I was gratified with the response to it, both among academics and general readers. Sadly, I was less than pleased by what my friends and family told me, which usually went something like this:  ‘Jeez, Bill, it seems you know what you’re talking about, but I fell sound asleep by the second chapter.’

So I went in with the assumption that this book was going to be packed full of calculus functions and statistical jargon.

Not at all. It was really quite readable.

The Gordon Equation

As in Four Pillars and The Investor’s Manifesto, one of Bernstein’s major points is that it’s important to pay attention to valuation levels before buying an investment. For example, he argues that we can achieve a reasonable estimate of future stock market returns by using the Gordon Equation, which states that:

Expected Return = Dividend Yield + Dividend Growth Rate

It’s worthwhile to note that one of his messages in The Intelligent Asset Allocator (written in the late 90s) was that stocks were highly priced and had very low expected returns going forward, whereas in The Investor’s Manifesto (written in early 2009) the message is the opposite: stocks have taken a beating, and have pretty good expected returns going forward.

Important reminder: The Gordon Equation, while rather accurate over extended periods (20 years or more), has essentially no predictive ability for short periods–what the stock market will do next year, for instance.

Efficient Frontier

A second major lesson of The Intelligent Asset Allocator is the concept of  the “efficient frontier.” The idea is that, for any given period, there are a number of efficient portfolios, each of which provides the highest return for a given level of volatility, or the lowest volatility for a given level of return.

Of course, there’s no way to know ahead of time precisely where the efficient frontier will lie for a given period. But if we look at enough periods, we can get a sense of the types of portfolios that tend to be pretty close, thereby allowing us to draw some conclusions about intelligent portfolio design. For example:

  • A portfolio comprised 10% of stocks and 90% of bonds often has higher return and lower volatility than a 100% bond portfolio.
  • Over most extended periods, allocating a portion of your portfolio to international stocks will simultaneously increase return while decreasing volatility.

Would I Recommend This Book?

Absolutely–if you’re someone who finds mathematical explanations to be “meaningful and practical” rather than “abstruse and boring.”

That said, before reading The Intelligent Asset Allocator, I’d recommend reading Bernstein’s newer The Investor’s Manifesto. The message is similar, the writing is arguably better, and the data is more up-to-date (and, therefore, more relevant-feeling).

Review: The Investor’s Manifesto

Investor'sManifestoIt’s always fun to hear that one of your favorite authors has released a new book. Given that William Bernstein’s The Four Pillars of Investing is quite literally my favorite book on investing, you can imagine how eager I was to read his newest release: The Investor’s Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between.

End result: I might have a new favorite. If nothing else, I have a new favorite to recommend for people just beginning to invest.

The Book’s Message

The Investor’s Manifesto is essentially a more accessible version of Four Pillars. The book’s core messages are that:

  • Risk and expected return are related. There’s no escaping it.
  • The best potential future returns are available when things are scariest (i.e., when risk is at its highest).
  • Picking stocks is a bad idea for individual investors. No, you’re not an exception.
  • Picking actively managed funds is perhaps worse than picking stocks.
  • With a handful of exceptions, the financial services industry exists to steal your money.

Behavioral Investing Mistakes

Lots of books and articles claim that our brains are hardwired to fail us when it comes to investing. I agree with that general premise, but I’ve always been somewhat hesitant to accept at face value any claims about the workings of a brain–perhaps the single least-understood organ in the human body–written by a financial author/journalist.

However, when the person making the claims is an M.D. (a neurologist in fact), such claims have an entirely different level of credibility. In The Investor’s Manifesto, Bernstein lays out several aspects of human psychology that detract from our ability to invest successfully. For example:

We use stories to understand things once they become too complex. And in the process, we oversimplify things to the point where our understanding is as wrong as it is right.

We want to be entertained. We love picking stocks, especially the high-flying growth stocks of popular companies.

We make too many analogies. We transfer characteristics across categories, even when it’s inappropriate to do so. For example, we assume that a good company must make a great stock, or that a quickly growing economy must mean high market returns. (Jeremy Siegel calls this the “growth trap.”)

We all think we’re better than average. We pick stocks (and expect to succeed!) even though the people we’re trading with are, in all probability, full-time investment professionals with far larger resources of data and computing power.

Highly Recommended

At just under 200 pages, The Investor’s Manifesto is a quick read. Its advice is sound. And it’s entertaining to boot. I can’t recommend this one highly enough.

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