The Geometry of Wealth – Brian Portnoy

The Geometry of Wealth – by Brian Portnoy
Date read: 7/4/18. Recommendation: 9/10.

A look into the relationship between money and meaning. Portnoy suggests that wealth and investing are about funding contentment and underwriting a meaningful life, as defined by you. Not about getting rich, having "more," and losing yourself on the hedonic treadmill. He explains that simplification is the path towards effectively managing expectations in money and life–and the trajectory of a happy life is shaped by expectations. The Geometry of Wealth is as practical as it is philosophical. À la Charlie Munger, Portnoy emphasizes individual behavior, mainly self-control and self-awareness, as the most important factor in investment success. He suggests we focus on being "less wrong" over being "more right," in the sense that asset allocation is far more important than security selection and market timing. But he also takes a deeper look at experienced happiness, reflective happiness, expectations, and human nature, which adds an entire extra dimension to this fascinating book.

See my notes below or Amazon for details and reviews.


My Notes:

"Do not hurry; do not rest." -Johann Wolfgang von Goethe

Examines the relationship between money and meaning, and how wealth figures into a joyful life.

Difference between rich and wealthy
-Rich is having "more" - hedonic treadmill on which satisfaction is fleeting
-Wealth is funded contentment, ability to underwrite a meaningful life, as defined by you
-Wealth is only achievable when purpose and practice are calibrated

Simplification is the smart path toward effectively managing expectations. In general terms, met expectations lead to temporary happiness and unmet ones lead to temporary sadness.

A "good" investment is one that meets expectations. And when expectations of the future don't match reality, we end up with dismal outcomes–not only financially, but emotionally. 

Dual Process Theory: "System 1" versus "System 2" (as popularized by Daniel Kahneman)
System 1: Fast brain loves consistency, biased to confirm beliefs and see patterns even when they don't exist. Avoid ambiguity and doubt.
System 2: Specializes in effortful mental activities, slow brain requires significantly more energy (glucose and other chemicals)

Three factors which determine lifelong happiness:
-Genetic disposition ~ 40%. This is your set point, return to this level (features and attitudes you're born with).

-Circumstance ~ 10%. Only a slight impact (and these are the attributes many of us define ourselves by). Where you live, what type of house you have, physical appearance, family dynamic, job, etc.
How can these have such a small impact? The brain is wired with an ability to adapt to whatever situation we find ourselves in, and it does it so much more quickly than we anticipate. It's a remarkable defense mechanism, for it allows us to transcend most setbacks in life. 

-Intention ~ 40%. Conscious decision-making and deliberate actions have significant impact on our quality of life experiences. Empowering, while you can't get around biological set point, still have capacity to make a big difference through personal drive and self-improvement.

"[Those who far better in life] have better coping strategies in the face of adversity–they confront problems rather than avoid them, plan better for the future, focus on what they can control and change, and persist when they encounter obstacles instead of giving up." -Timothy Wilson

Prepared mind = better life outcomes

When it comes to money, simplicity means having a limited number of clearly articulated concepts that both make sense of a noisy world and drive sharp, reasonable decisions.

Experienced Happiness: Maximize pleasure, narrower in scope, shorter in duration, hedonic, daily mood.
*Impact of money on experienced happiness caps out around $75k/year. Life's basic comforts met (which we become quickly accustomed to). Good and bad moods come at same pace for someone making $100k vs. $1m.

Reflective Happiness: Maximize contentment, broader in scope, longer in duration, eudaimonic (human flourishing), purpose, deeper sense of fulfillment.
*Reflective happiness does not cap out a specific income level. Does not diminish, keeps growing. But it always remains relative to your current position ($1000 raise for new college grad has larger impact than it would for CEO). When money is spent to underwrite sources of contentment, money buys happiness. 

Contentment = control (afford better nutrition, healthcare, more independence, time, flexibility), competence (invest in skills, potential), connection (sociality of experience, networks, memberships, access), context (time to find purpose). 

The "good life" is not the tweak of ephemeral pleasure, but the engagement with more meaningful, virtuous pursuits. Momentary pleasures are distinct from the enduring gravity of meaningful experience. 

"[Success stems not from] beating others at their game. It's about controlling yourself at your own game." -Jason Zweig
*Your own behavior far most important factor in investment success.

Much of what humans are good at does not center on weighing consequences of a possibility many years in the future.

Getting the restaurant right is more important than picking the right dish. Choosing investments works similarly. Big choice at hand is asset classes. Don't fetishize precision. Get it roughly right. Save yourself time and mental energy.

Asset allocation = far more influential than security selection and market timing. 
*90% of performance differences among investors are explained by asset allocation

Prioritize being "less wrong" over being "more right."

Only a handful of basic principles needed to achieve good investment results (but we crave complexity so we fail to execute):
-Buy low and sell high
-Stick to your plan

Crave complexity because we crave choice, which is a proxy for the control we perceive to have over our lives. More choice translates into a greater sense of safety (however false it might be).

A "good" decision is one that leads to a reasonable and appropriate outcome, not one that achieves other arbitrary goals like beating the market or trumping others. A "bad" decision starts with either vague or unrealistic expectations.

Accept the uncertainty of this game, remain humble in the pursuit of better things, and there's a decent chance that things will be okay.

"To achieve satisfactory investment results is easier than most realize; to achieve superior results is harder than it looks." -Benjamin Graham

The trajectory of a happy life is shaped by expectations. When the future meets or exceeds our expectations, we tend to be happy' when it doesn't, we're not.

Assessing annualized returns -- the longer the time frame, the narrower the range of outcomes (+/-10%). Shorter time frame, large (and more erratic) range of outcomes (170 to -70%). 

When we say that stocks make about 10% per year, it would be a mistake to assign the outcome of the entire group to any one member. Individual stock can be a dud or rocket ship. Best bet is to own a broad swath of the market.

With true diversification, there will always be something in your portfolio that sucks (and that's okay).

Compounding is the quiet protagonist in more tales of progress than nearly any of us has considered. Einstein supposedly called it the most powerful force in the universe.

Charlie Munger: "The first rule of compounding: Never interrupt it unnecessarily."

"Approximately 99% of the time, the single most important thing investors should do is absolutely nothing." -Jason Zweig

"The authentic individual is neither an end nor a beginning but a link between ages, both memory and expectation. Every moment is a new beginning with a continuum of history. It is fallacious to segregate a moment and not to sense its involvement in both the past and future." -Abraham Heschel

Our ability to think through time and see our future selves has limitations. Most profoundly, we discount the future: we value today more than tomorrow. Time discounting is an evolutionary instinct. We didn't pass on killing the small animal right in front of us in hopes of maintaining our energy to attack a larger herd of fatter animals that may or may not come later. We tend to live in the now because it seems the safer thing to do.

"Human beings are works in progress that mistakenly think they're finished." -Daniel Gilbert

Narrative of the book: Stoic playbook for navigating money life, moving from perception to action to will. Self-awareness and self-control are key principles. Embrace adaptive simplicity. 

I Will Teach You to Be Rich – Ramit Sethi

I Will Teach You to Be Rich – by Ramit Sethi
Date read: 7/22/17. Recommendation: 9/10.

The most accessible, practical book I've read on personal finance. Sethi dismisses trendy advice, such as cutting back on lattes, and instead emphasizes saving on the big purchases that really matter. And he's hilarious. This book is all about optimizing your strategy, prioritizing what matters most, and making money work for you (instead of obsessing over the minute details). This is a must read for anyone in their 20s or 30s, and should be a required reading for all who can still take advantage of the most valuable asset in investing: time.

See my notes below or Amazon for details and reviews.


My Notes:

When it comes to weight loss, 99.99% of us need to know only two things: Eat less and exercise more. Only elite athletes need to do more. But instead of accepting these simple truths and acting on them, we discuss trans fats, diet pills, and Atkins versus South Beach. *Finance similar in debating minutiae and valuing anecdotal over research.

An abundance of information can lead to decision paralysis.

I also often hear the cry that "credit-card companies and banks are out to profit off us." Yes, they are. So stop complaining and learn how to game the companies instead of letting them game you.

The single most important factor to getting rich is getting started, not being the smartest person in the room.

Just as the diet industry has overwhelmed us with too many choices, personal finance is a confusing mess of overblown hype, myths, outright deception.

Frankly, your goal probably isn't to become a financial expert. It's to live your life and let money serve you. So instead of saying, "How much money do I need to make?" you'll say, "What do I want to do with my life–and how can I use money to do it?"

To be extraordinary, you don't have to be a genius, but you do need to take some different steps than your folks did (like starting to manage your money and investing early).

Spend extravagantly on the things you love, and cut costs mercilessly on the things you don't.

This book isn't about telling you to stop buying lattes. Instead, it's about being able to actually spend more on the things you love by not spending money on all the knucklehead things you don't care about.

Money is just a small part of being rich...If you don't consciously choose what rich means, it's easy to end up mindlessly trying to keep up with your friends.

Chapter 1: Optimize Your Credit Cards
Establishing good credit is the first step in building an infrastructure for getting rich. Our largest purchases are almost always made on credit, and people with good credit save tens of thousands of dollars on these purchase. Credit has a far greater impact on your finances than saving a few dollars a day on a cup of coffee.

It's fine to be frugal, but you should focus on spending time on the things that matter, the big wins.

If you miss even one payment on your credit card:
- Credit can drop more than 100 points
- APR can go up to 30 percent
- Charged a late fee
- Trigger rate increases on other cards

If you miss a credit card payment, you might as well just get a shovel and repeatedly beat yourself in the face.

To improve your credit utilization rate (makes up 30% of your credit score) you have two choices: Stop carry so much debt on your credit cards or increase your total available credit (if you're debt free).

Every year call your credit cards and ask what advantages you're eligible for. Often, they can waive fees, extend credit, and give you private promotions. "Hi there. I just checked my credit and noticed that I have a 750 credit score, which is pretty good. I've been a customer of yours for the last four years, so I'm wondering what special promotions and offers you have for me...I'm thinking of fee waivers and special offers that you use for customer retention."

Although closing an account doesn't technically harm your credit score, it means you then have less available credit...People with zero debt get a free pass. If you have no debt, close as many accounts as you want. It won't affect your credit utilization score.

If you're applying for a major loan (car, home, education) don't close any accounts within six months of filing the loan application. You want as much credit as possible when you apply.

Chapter 3: Get Ready to Invest
Over the twentieth century, the average annual stock-market return was 11 percent, minus 3 percent for inflation, giving us 8 percent.

Of employees age 25 and under:
- Less than one-third participate in a 401(k)
- Less than 4 percent max out their contributions
- Only 16 percent contribute enough to get the full company match (literally free money)

Financial institutions have noticed an interesting phenomenon: When people enter their forties, they suddenly realize that they should have been saving money all along. As a result, the number one financial concern Americans have is not having enough money for retirement.

By opening an investment account, you give yourself access to the biggest moneymaking vehicle in the history of the world: the stock market.

Ladder of Personal Finance:

  • Rung 1: 401(k) match, contribute enough to get full match
  • Rung 2: Pay off your credit card and any other debt.
  • Rung 3: Open up a Roth IRA
  • Rung 4: If you have money left over, go back to your 401(k) and contribute as much as possible to it.
  • Rung 5: If you still have money left to invest, open a regular non-retirement account and put as much as possible there.

Benefits of 401(k):
Using pretax money means an instant 25 percent accelerator.

Chapter 4: Conscious Spending
Cheap vs. Frugal: Cheap people care about the cost of something. Frugal people care about the value of something.

Frugality, quite simply, is about choosing the things you love enough to spend extravagantly on and then cutting costs mercilessly on the things you don't love. The mind-set of frugal people is the key to being rich.

50% of more than one thousand millionaires surveyed have never paid more than $400 for a suit, $140 for a pair of shoes, and $235 for a wristwatch.

Instead of getting caught on a spending treadmill of new phones, new cars, new vacations, and new everything, they plan what's important to them and save on the rest.

A good rule of thumb is that fixed costs (rent, utilities, debt, etc.) should be 50-60% of your take-home pay.

A good rule of thumb is to invest 10 percent of your take-home pay (after taxes) for the long term.

Another solution is "The 60 Percent Solution" splitting your money into buckets. The largest being basic expenses (60%). The remaining split four ways: Retirement (10%), Long-term savings (10%), Short-term savings (10%), Fun money (10%).

Chapter 6: The Myth of Financial Expertise
Americas love experts....But ultimately, expertise is about results. You can have the fanciest degrees from the fanciest schools, but if you can't perform what you were hired to do, your expertise is meaningless.

More information is not always good, especially when it's not actionable and causes you to make errors in your investing. The key takeaway here is to ignore any predictions that pundits make. They simply do not know what will happen in future.

Recently, Helpburn Capital studied the performance of the S&P 500 from 1983 to 2003, during which time the annualized return of the stock market was 10.01 percent. They noted something amazing: During that twenty-year period. If you missed the best twenty days of investing (the days where the sock market gained the most points), your return would have dropped from 10.01 percent to 5.03 percent. And if you missed the best forty days of investing, your returns would equal only 1.6 percent–a pitiful payback on your money. Lesson: Do not try to time the market, invest regularly and for the long-term.

Ignore the last year or two of a fund's performance. A fund manager may be able to perform very well over the short term. But over the long term he will almost never beat the market–because of expenses, fees, and the growing mathematical difficulty of picking outperforming stocks.

Most people don't actually need a financial adviser–you can do it all on your own and come out ahead.

Many people use financial advisers as a crutch and end up paying tens of thousands of dollars over their lifetime simply because they didn't spend a few hours learning about investing. If you don't learn to manage your money in your twenties, you'll cost yourself a ton one way or another–whether you do nothing, or pay someone exorbitant feeds to "manage" your money.

Mutual funds use something called "active management." This means a portfolio manager actively tries to pick the best stocks and give you the best return. Index funds are run by "passive management." These funds work by replacing portfolio managers with computers. They simply and pick the same stocks that an index holds.

Index funds have lower fees than mutual funds because there's no expensive staff to pay. Vanguard's S&P 500 index fund, for example, has an expense ratio of 0.18 percent.

Passively managed index fund (.18% expense ratio, 8% return on investment of $100/month), after 25 years: $70,542.13
Actively managed index fund (2% expense ratio, 8% return on investment of $100/month), after 25 years: $44,649.70

*Half of actively managed funds between 1993 through 1998 failed to beat the market, and only 2% beat market from 1993 through 2003.

More than 90% of your portfolio's volatility is a result of your asset allocation (your mix of stocks and bonds, not individual stocks).

Your investment plan is more important than your actual investments. Just as the way I organized this book is more important than any given word in it.

1998: US large cap stocks +28.6%, international stocks +20%, REITs -17%
2000: US large cap stocks -9.10%, international stocks -14.7%, REITs +31.04%

If you're 25 and just starting out, your biggest danger isn't having a portfolio that's too risky. It's being lazy and overwhelmed and not doing any investing at all. That's why it's important to understand the basics but not get too wrapped up in all the variables and choices.

"I believe that 98 or 99 percent–maybe more than 99 percent–of people who invest should extensively diversify and not trade. That leads them to an index fund with very low costs." -Warren Buffet

"When you realize how few advisers have beaten the market over the last several decades, you may acquire the discipline to do something even better: become a long-term index fund investor." -Mark Hulbert

Lifecycle funds, also known as target-date funds, automatically pick a blend of investments for you based on your approximate age. The 85% percent solution, not perfect, but easy enough for anyone to get started.

If you're picking your own index funds, as a general guideline, you can create a great asset allocation using anywhere from three to seven funds. The goal isn't to be exhaustive and own every single aspect of the market. It's to create an effective asset allocation and move on with your life.

Dollar Cost Averaging: Investing regular amounts over time, rather than investing all your money into a fund at once, so you don't have to guess when the market is up or down. *Set up automatic investing at regular intervals so you don't have to think about it.

Chapter 8: Easy Maintenance
Ignore the noise: It doesn't matter what happened last year, it matters what happens in the next ten to twenty years.

Renting is actually an excellent decision in certain markets–and real estate is generally a poor financial investment.

Tax inefficient (i.e. income-generating) assets such as bonds should go into a tax advantaged account like an IRS or a 401(k). Conversely, taxable accounts should only hold tax-efficient investments like equity index funds.

Invest as much as possible into tax-deferred accounts like your 401(k) and Roth IRA. Because retirement accounts are tax advantaged, you'll enjoy significant rewards.

If you sell an investment that you've held for less than a year, you'll be subject to ordinary income tax, which is usually 25-35 percent.

If you hold your investment for more than a year, you'll only pay a capital-gains tax, which in most cases is currently 15 percent. This is a strong incentive to buy and hold for the long term.

Chapter 9: A Rich Life
Being rich is about freedom–it's about not having to think about money all the time and being able to travel and work on the things that interest me. It's about being able to use money to do whatever I want–and not having to worry about my budget, asset allocation, or how I'll ever be able to afford a house.

When you receive a raise, don't feel bad about celebrating–but do it modestly...A mere increase in your income is not a call to change your standard of living.

Big Purchases:
When it comes to saving money, big purchases are your chance to shine–and to dominate your clueless friends who are so proud of not ordering Cokes when they eat out, yet waste thousands when they buy large items like furniture, a car, or a house. When you buy something major, you can save massive amounts of money–$2000 on a car or $40,000 on a house–that will make your other attempts to save money pale in comparison.

Buying a Car:
Let me first tell you that the single most important decision associated with buying a car is not the brand or the mileage or the rims (please jump off a bridge if you buy specialty rims)...Most important factor is how long you keep the car before selling it. You could get the best deal in the world, but if you sell car after four years, you've lost money. Instead, understand how much you can afford, pick a reliable car, maintain it well, and drive it for as long as humanly possible. Yes, that means you need to drive it for more than ten years, because it's only once you finish the payments that the real savings start.

Buying a House:
Can you afford at least a 10 percent down payment for the house? If not, set a savings goal and don't even think about buying until you reach it.

I have to emphasize that buying a house is not just a natural step in getting older. Too many people assume this then get in over their heads. Buying a house changes your lifestyle forever.

If you can afford it and you're sure you'll be staying in the same area for a long time, buying a house can be a great way to make a significant purchase, build equity, and create a stable place to raise a family.

Real estate is the most overrated investment in America. It's a purchase first–a very expensive one–and an investment second.

As an investment, real estate provides mediocre returns at best. Risk: If your house is your biggest investment, how diversified is your portfolio? Poor returns: From 1890 to through 1990, the return on residential real estate was just about zero after inflation.

If someone buys a house for $250,000 and sells it for $400,000 twenty years later, they think, "Great! I made $150,000! But actually, they've forgotten to factor in important costs like property taxes, maintenance, and the opportunity cost of not having that money in the stock market.

The truth is that, over time, investing in the stock market has trumped real estate quite handily–even now–which is why renting isn't always a bad idea.

When you rent, you're not paying all those other assorted fees, which effectively frees up tons of cash that you would have been spending on a mortgage. The key is investing that extra money.

I urge you to stick by tried-and-true rules, like 20 percent down, a 30-year fixed-rate mortgage, and a total monthly payment that represents no more than 30 percent of your gross pay. If you can't do that, wait until you've saved more.

If You Can: How Millennials Can Get Rich Slowly – William J. Bernstein

If You Can: How Millennials Can Get Rich Slowly – William J. Bernstein
Date read: 7/15/17. Recommendation: 7/10.

An easy-to-read overview of the topics covered in his earlier book, The Investor's Manifesto. I prefer the depth and detail of the latter. But if you're looking for an introduction to investing in low-cost index funds and the importance of developing a financial strategy at an early age, this is a good starting place. 

See my notes below or Amazon for details and reviews.


My Notes:

Start by saving 15 percent of your salary at age 25 into a 401(k) plan, and IRA, or a taxable account (or all three). Put equal amounts of that 15 precent into just three different mutual funds:

  • A US total stock market index fund
  • An international total stock market index fund
  • A US total bond market index fund

     *Once per year you'll adjust their amounts so that they're equal again.

Rest assured that you will get Social Security; its imbalances are relatively minor and fixable, and even if nothing is done, which is highly unlikely in view of the program's popularity, you'll still get around three-quarters of your promised benefit.

Five Hurdles to Overcome:
1) People spend too much money.

2) You need adequate understanding of what finance is all about.

3) You need to learn the basics of financial and market history.

  • "History doesn't repeat itself, but it does rhyme." Fits finance to a tee.
  • Nothing more reassuring than being able to say to yourself, "I've seen this movie before and I know how it ends."

4) Overcoming yourself.

  • Human beings are simply not designed to manage long-term risks.
  • We've evolved to think about risk as a short term phenomenon.
  • Proper time horizon of assessing financial risk is several decades
  • From time to time you will lose large amounts of money in the stock market, but these are usually short-term events.

5) Recognize the monsters that populate the financial industry.

If you're starting to save at age 25 and want to retire at 65, you'll need to put away at least 15% of your salary.

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.

When you buy and sell stocks, the person on the other side of the trade almost certainly has a name like Goldman Sachs or Fidelity. And that's best case scenario. What's the worse case? Trading with a company insider who knows more about his employer than 99.9999% of the people on the planet.

If you want high returns, you're going to occasionally have to endure ferocious losses with equanimity, and if you want safety, you're going to have to endure low returns.

Reading Suggestion: Jack Bogle's Common Sense on Mutual Funds.

You should use your knowledge of financial history simply as an emotional stabilizer that will keep your portfolio on an even keel and prevent you from going all-in to the market when everyone is euphoric and selling you shares when the world seems to be going to hell in a hand-basket.

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.

People tend to be comically overconfident: for example, about eighty percent of us believe that we are above average drivers, a logical impossibility.

We tend to extrapolate the recent past indefinitely into the future...Both long bear and bull markets also seem to take on a life of their own.

Humans are "pattern seeking primates" who perceive relationships where in fact none exist. Ninety-five percent of what happens in finance is random noise, yet investors constantly convince themselves that they see patterns in market activity.

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.

Your biggest priority is to get yourself out of debt; until that point, the only investing you should be doing is with the minimum 401(k) or other defined contribution savings required to "max out" your employer match; beyond that, you should earmark every spare penny to eliminating your student and consumer debt.

Next, you'll need an emergency fund, enough for six months of living expenses.

Then, and only then, can you start to save seriously for retirement.

Your goal, as mentioned, is to save at least 15 percent of your salary in some combination of 401(k)/IRA/taxable savings. But in reality, the best strategy is to save as much as you can, and don't stop doing so until the day you die.

The optimal strategy for most young people is thus to first max out their 401(k) match, then contribute the maximum to a Roth IRA, then save in a taxable account on top of that.

Once a year you should rebalance your accounts back to equal status.

The Investor's Manifesto – William J. Bernstein

The Investor's Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between – William J. Bernstein
Date Read: 7/5/17. Recommendation: 8/10.

Champions an investment strategy focused on low-cost index funds that track the market, rather than attempting to guess on individual stocks. This is a must-read when it comes to investing. And it's not a massive encyclopedia. Bernstein offers a more rational approach to investing by detailing historic returns of various asset classes, the importance of diversification, and why you must play the long game if you have any hopes of coming out ahead. 

See my notes below or Amazon for details and reviews.


My Notes:

"In the past, stocks have had high returns because they have been really risky. But stocks are now so expensive that there are only two possibilities: either they are going to fall dramatically in price and then have higher returns after that (in which case investors are stupid for paying such high prices now), or there will be no big fall in price and little risk, but returns hereafter will be permanently low (in which case investors are smart). So which is it?

Diversification among different kinds of stock asset classes works well over the years and decades, but often quite poorly over weeks and months.

Investment wisdom, however, begins with the realization that long-term returns are the only ones that matter. Investors who can earn 8 percent annualized return will multiply their wealth tenfold over the course of 30 years.

Using historical returns to estimate future ones is an extremely dangerous exercise.

In the past, investors could expect only low returns when investing in safe assets; today this rule applies with a vengeance to Treasury bills, which currently have a near-zero yield.

Investors earn higher returns only by bearing risks–by seeking out risk premiums.

A house is most certainly not an investment, for one simple reason: You have to live somewhere, and you are either going to have to pay for it or rent it. Always remember, investment is the deferral of present consumption for future consumption, and if anything qualifies as present consumption, it is a residence. Further, if you pay for one in cash, then you are spending capital you could otherwise invest in something else.

How much does the price of a home rise over time? The best data on house prices suggest that, after taking inflation into account, the answer is slim to none.

Real house prices in the United States did not rise at all between 1890 and 1990.

If you own the house outright, you are tying up a large amount of capital you could profitably invest elsewhere, and the imputed rent, or use of the house, is your reward for doing so. On the other hand, if you have the ability to pay for a house outright but choose instead to rent, your unspent capital can earn a return in other assets, such as stocks and bonds.

The opposite reasoning applies if you cannot afford to purchase the house outright, but instead require a mortgage. By choosing to rent instead of own, you substitute rent payments for mortgage payments. True mortgage payments, at least early on, are largely deductible, but the advantage is more than offset by the catastrophic risk of default and repossession you take on with a mortgage.

Home ownership is not an investment; it is exactly the opposite, a consumption item. After taking into consideration maintenance costs and taxes, you are often better off renting.

A good rule of thumb is never, ever pay more than 15 years fair rental value for any residence. This computes out to a 6.7% (1/15th) gross rental dividend, or 3.7% after taxes, insurance, and maintenance.

Imputed rent does have one real advantage over the return from stocks and bonds, which is that it is tax-free.

The figure I keep in mind when house shopping is 150: the number of months in 12.5 years. After hearing a realtor's spiel, I will ask, "So, what would this house reasonably rent for?" If the number seems right, multiply it by 150; this will give you an excellent idea of the home's fair market value, above which you are better off renting.

On average the three small categories (growth, mid, value) had higher returns than the three large categories. This is not surprising; after all, small companies have more room to grow than large ones. Further, small stocks are certainly riskier than large ones, as well, since they have less diversified product lines and less access to capital and are more prone to failure.

How do value ("bad") companies tend to outperform growth ("good") companies in the stock exchange, when they manifestly do not in the consumer marketplace? Very simply, because they have to...In order to attract buyers for its far riskier stock, Ford must offer investors a higher expected return than Toyota.

"Efficient Market Hypothesis" (EMH), developed by Eugene Fama, which states, more or less, that all known information about a security has already been factored into its price.* This has two implications for investors: First, stock picking is futile, to say nothing of expensive, and second, stock prices move only in response to new information–that is, surprises. Since surprises are by definition unexpected, stocks, and the stock market overall, move in a purely random pattern.

*There are actually three forms of the EMH: the strong form, which posits that all information, public and private, has already been impounded into price; and the weak form, which posits only that past price action does not predict future price moves.

The implications of the EMH for the investor could not be clearer: Do not try to time the market, and do not try to pick stocks or fund managers.

In the long run, the advantages of the indexed and passive approaches over traditional active stock-picking are nearly insurmountable.

The investor cannot learn enough about the history of stock and bond returns. These are primarily useful as a measure of risk; they are far less reliable as a predictor of future returns.

Four essential preliminaries before making asset allocation decisions: Save as much as you can, make sure you have enough liquid taxable assets for emergencies, diversify widely, and do so with passive or index funds.

The consequences of oversaving pale next to those of undersaving.

Yes, picking a small number of stocks increases your chances of getting rich, but as we just learned, it also increases your chances of getting poor. By buying and holding the entire market through a passively managed or indexed mutual fund, you guarantee that you will own all of the winning companies and thus get all of the market return. True, you will own all of the losers as well, but that is not as important: the most that can vanish with any one stock is 100 percent of its purchase value, whereas the winners can easily make 1,000 percent, and exceptionally 10,00 percent, inside of a decade or two.

Asset allocation process, investor makes two important decisions:
1) The overall allocations to stocks and bonds.
2) The allocation among stock asset classes.

The rosiest scenario for the young investor is a long, brutal bear market. For the retiree, it most definitely is not.

The best time to buy stocks is often when the economic clouds are the blackest, and the worst times to buy are when the sky is the bluest.

The anticipation is better than the pleasure. Researchers have found that the nuclei accumbens respond much more to the prospect of reward than to the reward itself.

Caring, emotionally intelligent people often make the worst investors, as they become too overwhelmed by the feelings of others to think rationally about the investment process.

Advantages of mutual funds:
-Wide diversification
-Transparency of expenses
-Professional management (brokers = used car salesmen, fund managers = advanced degree)
-Protection (Investment Company Act of 1940)
-Ease of execution

The ownership structure of any financial services company ultimately determines just how well it serves its shareholders in the long run. Do not invest with any mutual fund family that is owned by a publicly traded parent company.

In the best of all possible worlds, the fund company has no publicly or privately owned shares and is instead held directly by the mutual fund shareholders. Only one fund company does this: the Vanguard Group.

Each dollar you do not save at 25 will mean two inflation adjusted dollars that you will need to save if you start at age 35, four if you begin at 45, and eight if you start at 55. In practice, if you lack substantial savings at 45, you are in serious trouble. Since a 25-year-old should be saving at least 10 percent of his or her salary, this means that a 45-year-old will need to save nearly half of his or her salary.

The possible adverse consequences of under-consuming in your youth or middle age pale in comparison to the risks of not saving enough for old age.

Retirement: My rule of thumb is that if you spend 2 percent of your nest egg per year, adjusted upward for the cost of living, you are as secure as possible at 3 percent, you are probably safe; at 4 percent, you are taking real risks.

For example, if, in addition to Social Security and pensions, you spend $50,000 per year in living expenses, that means you will need $2.5 million to be perfectly safe, and $1.67 million to be fairly secure.

The best annuity deal available: deferring Social Security until age 70. Waiting until 70 increases by almost one-third the monthly payment you would get starting at age 66...This calculates out to a guaranteed real return from waiting of 8 percent per year.

Dollar cost averaging (DCA): fixed dollar amount is periodically invested in stocks and bonds...Forces investors to invest equal amounts periodically. Lowers the average price paid for their purchases and increases overall returns.

Month 1: $100 purchase at $15/share = 6.67 shares bought.
Month 2: $100 purchase at $5/share = 20 shares bought.
Month 3: $100 purchase at $10/share = 10 shares bought.
*DCA = $8.18/share

Value averaging technique: based on targets.
Month 1: US Total Stock ($100), International ($100)
Month 2: US Total Stock ($200), International ($200)
Month 3: US Total Stock ($300), International ($300)
Month 4: US Total Stock ($400), International ($400)

If US Large Cap fund started Month 3 with $300 in assets, and then fell 10 percent in value over the next 30 days to $270, our saver would have to add $130, not $100, to top it off to $400 at the start of Month 4. Conversely, if international stocks rose by 10 percent to $330 in value, then only $70 must be added.

From time to time, the markets can go stark raving mad...Your primary defense against being swept up in the madness of such periods is a command of the history of the financial markets and the resulting ability to say, "I've been here before, and I know how the story ends."

Never forget that at the level of individual securities, the markets are brutally efficient. Whenever you buy or sell an individual stock or bond, you are likely trading with someone who is smarter and better informed than you are, and who is working harder at it.

The portfolio's the thing; do not pay too much attention to its best and worst performing asset classes.

Investors tend to be too susceptible to the emotional impact of the news and to the fear and greed of their neighbors. The better you can tune out this emotional noise, the wealthier you will be.

Human beings are pattern-seeking primates. Most of what goes on in the financial markets, by contrast, is random noise. Avoid imagining patterns; there usually are none.

Avoid fund companies that are owned by publicly traded parent firms.

You should live as modestly as you can and save as much as you can for as long as you can. Saving too much is not nearly as harmful as saving too little.

Consider tilting toward small and value stocks, since they will likely have higher expected returns than the overall market. Precisely how much you do so depends on the nature of your employment and your tolerance for temporarily underperforming the market for up to several years.