Sunday, April 04, 2010

Moist von Lipwig

In general, I've enjoyed becoming a finance geek.  As with most topics I get interested in, it's fun to chase down interesting nuggets, organize them in my brain, and think about how they relate to one another.  There is one downside to this area of geekiness, though.  When it comes to science fiction, or anime, or video games, or modern novels, there's a nearly limitless supply of high quality out there; I never need to worry about reading all the books.  In contrast, when it comes to finance, there's really just a finite amount of useful information.  Once I've grasped that, there's very little reason for me to continue geeking out.

Note that I said "useful."  Obviously, there are entire newspapers, magazines, and 24-hour television channels devoted to financial topics, and they require a steady stream of new analyses, theories, opinions, and forecasts.  For the most part, these aren't just useless, but are actually dangerous.  If you buy every hot stock that's pumped on Mad Money, you'll get poorer a lot more quickly than if you stuck to boring mutual funds.

I remain convinced that most people can learn all that they need to, or should, know about personal finance and investing by reading just one or two books.  They'll need to read more closely than, say, a novel; I guess that "study" might be a closer word.  Still, there just isn't all that much out there that you need to learn, and the less you try to stuff in your head, the less likely you are to be distracted by the lure of get-richer-quicker messaging out there.

For a few years now, my recommended "If you just read one money book..." has been "Smart and Simple Financial Strategies for Busy People" by Jane Bryant Quinn.  It's a relatively slender book for the field, at just a few hundred pages, and it covers all of the most important topics that will define the financial lives of 90% of us.  For me, it reaffirmed what I'd learned elsewhere, and gave some really practical ideas of how to implement certain goals.

I was impressed enough by that book that I followed up with JBQ's latest, "Making the Most of Your Money Now."  This is a revised edition of an earlier book of hers that I haven't read, and the cover copy talks about how it has been rewritten to take into account the financial and housing crises.  That's technically true, but one of the best things about this book is actually in how it downplays those events.  The overall message is, "Yes, these things are bad, and show why you should be diversified and consider your time horizon; but don't panic and stick your head in the sand, because if you avoid stocks you'll be hurting your long-term success."  In other words, it strives for timelessness, which is what one wants in a book like this.

This is a positively massive tome, weighing in at over 1000 pages.  I found it a surprisingly quick read, but then again, I am a nerd.  The book is very well organized; the first few chapters focus on personal finance fundamentals (defining goals, writing a spending plan, etc.); the next few talk about essentials (selecting and buying insurance, choosing a bank, where to save short-term money); the bulk of the book is devoted to specific finance topics (saving for college, purchasing a house, choosing mutual funds, bonds, etc.); and the last section is given over to retirement (both planning and spending) and selecting a financial adviser.  I read practically every word of it all, even the things that don't really apply to me like annuities; the only bits I skipped were the sections on credit-card debt and college savings, both of which are fortunately long behind me.

Throughout the book, the question in the back of my head was, "Will the extra pages in here result in a better book than S&SFSFBP?"  The answer is a qualified "Yes."  If you have the patience to read through it, you'll get more information and, broadly, a better grounding in the topic at hand.  I don't think that this book would cause you to pick radically different strategies than the shorter one, but it may give you a fuller appreciation for why you're doing what you're doing.  In some specific cases, this book does improve upon the former, either by providing more up-to-date information on specific topics, or offering some niche strategies that will be of use to a limited number of people (for example, she describes what you need to do to pass an IRA along tax-free to your heirs, if you're in a position to do that). 

On a practical note, the most significant updated advice may be regarding target-date retirement funds.  The shorter book was written just a few years after those started becoming popular, and at that time, Vanguard's funds were rather poorly designed, with too little of their portfolio in stocks; because of this, Jane suggested looking at similar offerings from T Rowe Price, which were more costly but had a better balance.  In the years since then, Vanguard has fixed their funds, and her treatment of them is much more positive here.  (Like most finance writers, Jane seems reluctant to just come out and say "You should buy Vanguard funds," but that does seem to be what she means most of the time.)  I personally think that most people's retirement planning could begin and end by putting the maximum into a 401(k) invested in a Target Date retirement fund.  Jane only needs to provide a couple of pages to the topic, since it's so simple, but as usual simpler is better. 

Stuff like this slightly diminishes from the timelessness of the book, while adding to its usefulness.  It's really helpful to get concrete advice on what particular investments are good to make; the risk is that, when people pick this book up five years from now, the rules and the products will have changed, and it will feel dated as a result.  Then again, because of Jane's long-term focus, this may not be as big of a risk as it seems.  Yes, Vanguard has the lowest rates on index funds today; but it has had the lowest rate on index funds for decades, and since their company defines itself on low cost, there's a good chance that this will continue to be true for the future.

There are several parts in the book where Jane takes advantage of the extra length to write about stuff that she would ordinarily skip over.  My favorite was her section on stocks; she starts off the chapter basically saying, "Here's what you need to know about stocks.  For almost everyone, you should pick an index-based mutual funds.  However, if you choose to ignore my advice and purchase individual stocks, here's how you would do that."  Then she spends the rest of the chapter talking about working with brokers, buying on margin, puts and calls, dividends, interest rates, and other stuff.  It's the kind of pure information that warms a geek's heart, even while I know that I shouldn't be paying too much attention to it.  I was pleased to note how much of this was familiar from my high-school Advanced Economics class, where I made a virtual killing by investing in Bangor HE.  Anyways... like I said, the stuff in this chapter shouldn't be important to most investors, but it is great information if, like me, you're interested in knowing how things work.  It's a great education, and helps you understand better what's going on in the news, and also gives you a better idea of exactly what is happening in that diversified mutual fund of yours; it isn't just a black box that provides a long-term annual return of 8%, it is the result of thousands of individual stocks doing their weird individual stock things.

The single most useful part of this book for me was her chapter on bonds.  Most of the book felt like a really good and useful review, but the bond stuff was a good education in and of itself.  I've been generally aware of the "what" and the "why" of bonds before - they're debt, loans that you make to governments and corporations; and you should have some because they behave differently from stocks and help reduce your overall portfolio risk.  However, I've always been a little fuzzy on the "how," and Jane gives a wonderful explanation.  She talks through how you go about buying an individual Treasury bond online, describes how it will pay you, and how to compare the yields of tax-advantaged federal bonds to taxable corporate bonds and tax-free municipal bonds.  She then describes how bond mutual funds work, which, surprisingly is kind of the opposite of how individual bonds work.  She talks about the rating agencies, time horizons, all sorts of really useful stuff.  As a result, this book has actually had an impact on my attitude towards bonds.  First of all, I should confess that I don't have any direct exposure to bonds at all.  This is a personal decision, largely based on my young age and high tolerance for risk.  Currently, all of my private investments and 401(k) investments are in mutual stock funds.  (I do have bond exposure through the Target Date fund of my IRA and Roth.)  That said, I've known for a while that I'll want to ramp up my bonds at some point.  Previously, I had assumed that I would do the same thing for bonds as I do for stocks: buy a Vanguard index fund, either for the Total Bond Market or their California Tax-Advantaged fund.  I now know that this is a decent strategy, but not necessarily the best; often, it can make more sense to buy a bond directly.  As a result, when the time comes to increase my bond holdings, I will be checking out munis, treasuries, and bond funds, deciding what makes the most sense for my tax bracket and time horizon.  Jane calls out a lot of stuff to be aware of, like callable bonds, that I otherwise might not have been aware of.

My one complaint about the book: there are a few things in here that are just incorrect.  I'm not sure if they were missed by proofreaders or what, but some specific figures are wrong.  For example, in the section on Roth accounts Jane says that the maximum amount a single person can earn and be eligible to contribute to a Roth is $150,000.  (I wish!)  This is pretty clearly a typo, as later in the paragraph she lists a lower income as the point where the phase-out for singles ends.  In another part, she presents a table that predicts how long a nest egg will last in retirement, given an initial withdrawal percentage and a predicted rate of return.  In the text she gives an example and says that it would last for 20 years, while the table shows it lasting 29 years.  Needless to say, that does not build confidence, as you don't know whether it's the table or the text that is wrong.  However, to a large extent stuff like this doesn't really matter.  Jane is focusing on strategies and principles; when it comes time to retire, you aren't going to make that decision based on a table in this book, you're going to follow her advice and speak with a (fee only!) financial planner.  So while these errors are discouraging, they're not awful.

I think that most people should be able to pick-and-choose their way through the book.  Almost nobody will need to read all 1000 pages.  This would be a great book to keep on your bookshelf.  When you first get it, you might carefully read the first few chapters, skip ahead to a few other chapters that sound relevant to your current stage of life (buying a home, estate planning, whatever), and skimming the section on retirement planning.  Then, when other stuff comes up in the future, you can dust it off and see what Aunt Jane recommends.

As for the other question, of which book is better, I need to wuss out and say "It depends."  I'll probably continue to recommend S&SFSFBP to most people; its bulk is less intimidating, and it still covers all the important topics.  MTMOYMN is probably more useful for wealthier people who are interested in maximizing their investments and/or avoiding taxes; it's also great for nerds like me who are interested in learning more about the mechanics that underlie the general principles.  At the end of the day, both books should do an equally job of teaching the four or five things that you'll keep in mind to establish a solid financial footing.

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