Book Review: The Smartest Investment Book You'll Ever Read

This is a book review for The Smartest Investment Book You'll Ever Read by Daniel Solin. The book has an arrogant title. The title is also a knockoff from the popular book The Only Investment Guide You'll Ever Need by Andrew Tobias. Andrew Tobias didn't say his book was the smartest. He only said it was the only investment guide you'll ever need, meaning you'll be OK if you just read that one book but everything else will be extra knowledge. I first came across this book last year while browsing at Barnes & Noble (I wrote about the misleading chart in the book). So the arrogant title worked as intended. It grabs people's attention.

Now that I had a chance to read the whole book, it isn't too bad. This is another book about investing in index funds (or ETFs). Basically another person "discovered" indexing. If you are a regular reader of this blog, you probably won't find anything new in this book. For someone new or who didn't pay much attention to investing, the book conveys that a simple strategy can be very effective and stress-free. For people who are still trapped by brokers and advisors (it's hard to believe, but there are still so many!), this book can be refreshing. The author Dan Solin is a securities arbitration lawyer. You can tell he has big problems with brokers and advisors because more than half of the book is about what not to do, i.e. don't listen to brokers, advisors, or the media. It says if you just invest in 3 broadly diversified mutual funds (U.S. stocks, International stocks, and bonds), you will be all set. The portfolio construction comes down to answering just one question:

"How much do you want to allocate your portfolio to stocks?"

The book gave four choices: 20%, 40%, 60%, 80%. After that, split the stocks to 70% U.S. and 30% international and you are done. It's basically the first two steps in my Cascading Asset Allocation Method. The book gives specific examples using Vanguard, Fidelity, and T. Rowe Price funds.

While the ideas in the book aren't anything new, the presentation is different from many other books. This small book (177 pages) is divided into 44 chapters and two appendices. The longest "chapter" is 4 pages. The shortest "chapter" is half of a page, shorter than a typical blog post you find here. I guess it was written with today's short-attention-span readers in mind. This style coming from a lawyer is a surprise to me*. For someone who is new to investing, this book is less overwhelming, although it feels to me just repackaging of what others have said all along. I have more original content on this blog than what's in the book. If you are looking for a book for a newbie, I would recommend Smart and Simple Financial Strategies for Busy People by Jane Bryant Quinn, the #1 book on my Recommended Reading List in the Basics category.

Final verdict: 2 stars out of 4. Skip; you won't miss anything.

 

* Only until the very end of the book, the tail of a lawyer finally showed. It says in tiny font and long sentences:

"The author and publisher specifically disclaim any responsibility for any liability, loss, or risk, personal or otherwise, which is incurred as a consequence, directly or indirectly, of the use and application of any of the contents of this book."

... ...

"The author does not assume any responsibility for actions or nonactions taken by people who have read this book, and no one shall be entitled to a claim for detrimental reliance based upon any information provided or expressed herein."

... ...

Book Review: While America Aged

I'm a fan of author Roger Lowenstein because he is able to turn complex business issues and events into something everybody can understand. I already reviewed and recommended his other books When Genius Failed and Origins of the Crash. Roger Lowenstein published a new book While America Aged in May. Once again, this new book lived up to the high standard I come to expect from him.

The book is about the challenges of private and public pension and retiree health care programs. It consists of three long case studies: General Motors, New York city subway system, and the City of San Diego. It showed how there is such a big gap between the funding and the benefits liability in the pension and retiree health care programs. The book chronicled how the gap was formed. It also gave some recommendations on how to reduce or eliminate the gap.

If you'd like to hear the author tell the stories himself, here's a video of a book talk he gave to a small audience at a bookstore. More than half of the 37-minute video is Q&A's, which are excellent.

The book is thoroughly researched. Every chapter has more than 50 references in the end notes. The story telling is amazing. For anyone interested in the history and the future of pension and health care programs, I highly recommend this book.

Although the book is not about Social Security and Medicare, I can't help but think about how Social Security and Medicare are in similar situations. The most I can relate to is what happened at General Motors. GM emerged after World War II as the dominant player in the auto industry. The industry was also growing rapidly. GM had great profits year after year starting in the 1950s. Over time it added more and more pension and health care benefits for its employees in order to buy their cooperation for not striking and disrupting the great business. In its hay day, GM represented a nation we crave for today. It had universal health care -- all employees and retirees, plus their families, are covered, for free. It had unemployment insurance -- 95% of pay for 6 months. It had a rich pension program. Workers could retire in their early fifties and receive on average $42,000 a year (in 2008 dollars) plus automatic cost of living adjustment ("COLA") for the rest of their life. After a worker or retiree died, the surviving spouse received a survivorship pension too. Blue Cross became GM's largest supplier. People jokingly said GM was actually a pension plan on wheels or a HMO with showrooms.

Then the game changed. Facing foreign competition, GM cratered under the weight of its long-term obligations. Because it paid out so much cash toward pension and retiree health care, it couldn't invest enough in R&D. Had GM thought about it carefully, they would've seen that the benefits programs were clearly not sustainable. Workers who retired while the times were good fared really well. Workers who weren't retired yet lost their jobs.

Social Security and Medicare also had a similar history of expansion. Social Security started in 1935. Over the years, dependent and survivorship benefits were added (1939). Disability benefits were added (1956). Benefits were increased many times and, in 1975, Cost of Living Adjustments became automatic. Average benefit check increased from about $400 a month to $1,100 a month today (all in 2008 dollars). Medicare started in 1965. It didn't cover prescription drugs. Then prescription drugs coverage was added in 2006. Because of the rapid increase in the cost of health care and the increase in longevity, Medicare is projected to be in serious deficit. Are Social Security and Medicare sustainable in their current form? No. If they are not sustainable, we should scale them back, now. I'd rather have a smaller sustainable program than a program which benefits one generation but bankrupts the next, like GM's rich benefits programs did to GM. Raise the retirement age. Slow down the COLA. Implement means-testing and make the program benefits a sliding scale relative to income and wealth. Make the programs last.

Book Review: The Two Income Trap

A few weeks ago Jonathan at My Money Blog posted a video presentation by Harvard Law School Professor Elizabeth Warren, The Coming Collapse of the Middle Class. It turned out to be a summary of her book The Two-Income Trap. The video presentation piqued my interest so I got the book and read it.

Professor Elizabeth Warren specializes in studying personal bankruptcies. She often appears before congressional hearings against credit card companies. She's also in the documentary Maxed Out. She and several other law professors blog at Credit Slips which I read and sometimes comment on. The subtitle of the book is "Why Middle-Class Mothers & Fathers Are Going Broke." The basic premise of her book is that families go bankrupt at a higher rate today because housing, health insurance, and education have become much more expensive than they were a generation ago in the 1970s. Families commit two incomes to these expenses today. Therefore they are vulnerable to any disruption of their income, like job loss, illness, and divorce. In the previous generation, the stay-at-home mom served as a valuable reserve. If dad lost his job or became ill, mom could enter the labor force and the family would survive without having to file bankruptcy. Today's two-income families don't have this reserve. They are worse off than the one-income families a generation ago. Hence the title of the book "The Two-Income Trap."

Because Professor Warren studies personal bankruptcies all the time, she probably developed great sympathy toward the families involved. In this book, she and her co-author (her daughter) spent a lot of time dismissing the myth of over-consumption, saying that families today don't spent more on unnecessary stuff than families did in the 1970s. After adjusting for inflation, the spending went down in many categories. It's the big item expenses -- housing, health insurance, cars, and education -- that are throwing these families over. And the reasons people file bankruptcy are dominated by the big three causes -- job loss, medical problems, and divorce or separation. Although the authors didn't necessarily say it out loud, I get the impression they are saying it's not these families' fault because it's out of their control. I'm not convinced. Here's my naive view of personal bankruptcy:

People have to file bankruptcy because their expenses exceed their income for an extended period of time which outlasts their available insurance, savings, and credit.

Think about it. If your expenses are always below your income ("live below your means"), you will never have to file bankruptcy. Or if you have high expenses (medical bills for example) or low income (job loss for example) temporarily, but you have insurance, savings, or credit that can tide you over until your income exceeds your expenses again, you won't have to file bankruptcy. How someone manages their expenses and incomes is their personal responsibility. While they don't have control over whether they will lose our job or become ill, they do have control over whether they will have insurance or how much they will save for a rainy day. They also have control over a long list of family finance decisions which directly affect how much cushion a family creates for itself. In other words, you don't have to live on the edge and leave no room for contingencies. If you live below your means, buy insurance and save for a rainy day, I don't see how you can put yourself at risk of bankruptcy. Make no excuses. We are all responsible for our own destiny.

I don't like it when people don't take responsibility for their own actions. There's too much of that going on in America. Whenever something goes wrong, it's always somebody else's fault. Over-consumption is a problem. It directly contributes to the bankruptcy problem. The book showed that since the 1970s savings went down and credit card debt went up. If people didn't save, then by definition they over-consumed. That's not a myth.

The book showed that housing, education and health care have become much more expensive from a generation ago. It attributed the increase in housing prices to two-income families entering into "bidding wars" for houses in good school districts. The book didn't offer any proof for that theory other than casual observations that houses in good school districts are more expensive (remember the authors are not economists). Considering that houses in average school districts also increased in value by a lot and commercial real estate which has little to do school districts also appreciated dramatically since the 1970s, I doubt the "bidding wars" are a significant factor. Housing, education, and health care are more expensive today because there is more demand and because there is high expectation. We are buying more housing, more education and more health care. Family sizes became smaller but house sizes became bigger. Preschools are no longer a luxury. More people are going to college. Health care industry is coming up with more and more expensive drugs and treatments. Consumers never say no. In order to revert this trend, we have to consume less housing, education and health care. Buy smaller houses in lower cost areas. Go to state universities and community colleges. Cover the basic health and forego expensive drugs and treatments. "Health care rationing" is not a dirty phrase. We just can't afford to give the health care industry a blank check.

We are in a different kind of economy today. In the post World War II era (1950s - 1970s), the United States dominated the world. American companies were prosperous. Jobs were well paid and more secure. Benefits were generous. Today we are competing with lower paid workers in a global economy. American companies are no longer in a position to offer secure and well paid jobs with generous benefits. The good ol' days are gone. Either you upgrade your skills for higher paying jobs or you have to change your lifestyle expectations. There's no other way around it.

Professor Warren made some public policy suggestions in the book. They may help a little at the edge but I think unless we reduce the aggregate demand for housing, education and health care, the prices won't come down. She suggested that credit card interest rates should be capped. OK, it will help a little. With less credit available, there won't be as many dollars chasing the limited supply of housing, health care or education. She also suggested that families should be given vouchers so they can send their kids to any public school. I'm afraid that does not change the overall supply and demand for education or housing. As long as there are good schools and there are bad schools, no all kids will be able to go to good schools. The premium on houses in good districts may disappear but the houses in other areas will go up. In aggregate families will still pay the same if everyone feels they are entitled to a big house.

It's difficult to give a star rating to this book. I can feel the authors' bleeding heart, although I disagree with their economic analysis. We don't need more books making excuses for people. Nevertheless, there is still a lot of good information in the book about the landscape of personal bankruptcies. So maybe 3 stars out of 4.

Finally, the "math question of the day" for all of you. The book says the bankruptcy filing rate for families with kids is 15 per 1,000 in a given year. So over a course of 20 years (from the time the first kid is born until the time the last kid reaches 18), what is the chance of this "family with kids" filing bankruptcy at least once?

Book Review: Gotcha Capitalism

I'm reviewing the book Gotcha Capitalism today. I first heard about the book on public radio. The author Bob Sullivan was interviewed on Fresh Air by Terry Gross (36 minutes) and on Marketplace by Tess Vigeland (7 minutes). This book is about the annoying fees and the disingenuous pricing and marketing schemes we face every day from many places.  You know those fees. They are everywhere.  I also wrote about a few of them in the past: ATM surcharges, bank overdraft or NSF fees, credit card late fees, 12-month-same-as-cash deferred interests, finance charge in insurance payment plans, 401(k) plan admin fees, and numerous fees in VUL policies. There are also many more I haven't touched on: airline excess baggage fees, cell phone early termination fees, hotel parking fees, many mysterious line items on rental car contracts and telephone bills, etc. etc.

Some of these fees are more of a nuisance while some (like 401(k) plan admin fees and VUL fees) are more serious. The author puts it very elegantly:

"Sneaky fees peck away at us like a swarm of mosquitoes that ruin an otherwise beautiful summer evening. And like mosquitoes, an individual bite might seem trivial, barely more than a nuisance, but repeated bites can actually change the way you live. They chase you inside, make you build a screened porch, and in extreme cases make you sick." (p. 4)

The book primarily serves two purposes: (1) expose the various fees; and (2) provide tips and strategies for fighting back on these fees. It's not a surprise that most of the fees the book talks about are from services, not physical products, because when you buy physical products, if you don't like the final amount, you can return them (most of the time, except when you buy a car). A lot of the services involved are also sold by a monopoly or an oligopoly, for example land line telephone and cable TV. Why are there so many fees and what should we do about them? The author says there are a lot of fees because businesses engage in "shrouding" which attempts to make the true cost of their service look lower than it actually is. They put in these fee traps to catch the "myopes." Myopes are customers who are drawn to the headline sticker price -- "free checking" or "$39.99 a month" -- but who can't understand the total cost before they sign up or who are not able to navigate through the minefields of fees and after-charges. People are usually overconfident. They think they won't bounce a check or they will always be able to refill the gas tank before they return the rental car. But for all consumers as a whole, some people eventually fall prey to those gotchas.

The art and science of complaining are a big emphasis of this book. In the author's own words,

"This book is designed to make you an expert complainer. Not a whiney complainer, not a bitchy person, and not a penny-wise and pound-foolish consumer. A well-informed, successful, efficient complainer." (p. 31)

The book provides estimated rate of success on reversing different fees so you can pick your battles. It also provides sample call scripts, letters and information on regulatory agencies for different industries.

This small paperback (selling for $10.46 on Amazon) is packed with good information. It is very worthwhile reading. If you can't get hold of the book yet, you can at least listen to the interviews I linked at the beginning of this post.

If I have to criticize it, I have to say the author didn't emphasize enough a very important weapon consumers have. That is voting by your wallet. Don't buy the service if you think the pricing is unfair or too complex. Favor businesses that have more transparent and straight forward pricing.  For example I don't subscribe to cable TV. I have no appetite for signing up for a promo rate for 6 months and calling the retention department every 6 months for a lower rate. I simply refuse to play their game. Netflix is much more straight forward. I also don't subscribe to any cell phone contract. I use a prepaid service. The per-minute cost is higher but I pay for what I use. There's never any surprise. I fly Southwest Airlines, which doesn't charge a change fee, even if their fare isn't always the lowest. Most of the time, there are alternatives to tricky prices. If banks are evil, use a credit union. Burn me once, shame on you. Burn me twice, shame on me. If you stay away from businesses with unfair or complex pricing schemes, you are less likely to be charged those fees in the first place and you won't have to worry about how to stage your complaint and get your fees refunded.

Also, because it was written by a journalist, the examples in the book are sometimes on the sensational side. Take credit card fees for example. The book told a story about a Mr. Wesley Wannemacher, who charged $3,200 for his wedding on a credit card and never used the card again. Because he went over the card's $3,000 credit limit, he was charged an over-the-limit fee. And because he didn't make enough payment to bring the balance below the credit limit, he was charged an over-the-limit fee again in the next month, and the next month. All told, he was charged the over-the-limit fee 47 times. Because he was also consistently late in making the payments, he was also charged a late fee more than 30 times. I mean, come on, if it stings, stop doing that. Pay it down, ask for a credit limit increase, or transfer the balance to another card with a higher credit limit. If nobody is willing to offer you a higher limit, that tells you something, doesn't it?

Related links:

• The Red Tape Chronicles - An online column on MSNBC.com written by the same author. It's very popular. Some posts get as many as 800 comments.
• Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets by Xavier Gabaix and David Laibson - A research paper by MIT and Harvard professors which forms the theoretical foundation for the book.

Book Review: When Genius Failed

I read the book When Genius Failed: The Rise and Fall of Long-Term Capital Management a long time ago. I re-read it last weekend in light of the recent news about the failure of hedge fund Carlyle Capital Corp. and the Fed's emergency loan to Bear Stearns. After I finished the book, news came that the Federal Reserve organized the sale of Bear Stearns to JPMorgan Chase for $2 a share (Bear Stearns closed last Friday at $30 a share). This is very similar to the story of Long-Term Capital Management 10 years ago. History has a habit of repeating itself.

Long-Term Capital Management (LTCM) was a hedge fund set up by some smartest Wall Street traders and academics including two Nobel laureates. It used complex math models for trading bonds. It was very successful. From its start in April 1994 to April 1998, in four years of time, it turned every dollar invested into four dollars. That's an average return of more than 40% a year. Then the tide turned. Everything worked against them. High leverage made things a lot worse. It went bust in six months. The Federal Reserve twisted the arms of some other Wall Street firms into rescuing LTCM. LTCM's investors were basically wiped out. The Wall Street firms took LTCM's positions and slowly unwound them.

The author Roger Lowenstein chronicled the rise and fall of LTCM in details. The fascinating tale reads more like a thriller than a business book. If you want to understand what's going on with Carlyle Capital or Bear Stearns, I highly recommend this book. It's amazing to see exactly the same story line unfolding right in front of us. Only time and characters changed.

What a Recession Feels Like

I rented from Netflix the documentary Roger & Me by Michael Moore. This is the first film by Michael Moore which made his name. Whether or not you agree with Michael Moore's liberal point of view, the film offered a good reminder of what a recession feels like.

In case you haven't seen it (the film was out nearly 20 years ago in 1989), it's about the impact of General Motors' closing of several auto assembly plants in Flint, Michigan. Michael Moore, a native of Flint, wanted to bring then GM chairman Roger Smith to Flint and show him the devastation of 30,000 laid off GM workers. The film showed how his repeated efforts failed to get Smith to come to Flint and how the workers and the town coped with the event.

Oh boy it's depressing. Workers got laid off. They got evicted from their apartments when they couldn't pay their rent. They took up other odd jobs. Even fast food restaurants wouldn't hire former GM workers because they were not good enough at working in fast food. The wife of a laid off worker became Amway saleswoman doing "color reading" for her customers. She later confessed in great horror that she had read herself into the wrong color! The scene of a former worker raising rabbits for a living and killing and skinning one on camera for meat and fur is absolutely shocking. I cringed and closed my eyes. Don't let your kids watch that scene.

The film stuck me on a nerve because I worked in an auto plant before. The workers in the film looked very familiar to me. The so-called blue collar workers  are hardworking and they care a lot about their families. Sadly, the site I worked in also closed a few years after I left. I wonder what happened to them.

The film reminded me of what a recession feels like. People lose their jobs and they can't find a new one. Are we in a recession now? I don't think so.

Have you been in a recession? What did it feel like to you? Do you think we are in a recession now based on your past experience?

Book Review: Unconventional Success

Today I'm reviewing the book Unconventional Success by David Swensen.

David Swensen is the celebrated Chief Investment Officer of Yale University. By allocating a large percentage of Yale's endowment to unconventional assets like private equity funds, absolute return hedge funds and real assets, Mr. Swensen got the Yale Endowment an average return of 18% per year for the last 10 years, which everybody else envies. When I first got the book from the library, I thought the book was about how he did it at Yale. But it's not. The unconventional success he refers to in the title of the book is rather conventional -- invest in a diversified allocation of stock index funds and treasury bonds through investor-friendly outfits.

So the title is a misnomer. There is nothing unconventional about investing in index funds. We already know that from many other books, like John Bogle's The Little Book of Common Sense Investing and Burton Malkiel's The Random Walk Guide To Investing. Swensen's book gave no guidance on asset allocation, which is often said to be the most important decision one makes in investing. The book showed one generic 70/30 model portfolio without going into details who should adopt an allocation like that. Is it for young people just starting out or people who already retired? The book doesn't say. It says you have to personalize it but it doesn't tell you how.

It's not in the book but Mr. Swensen suffers from "do as I say not as I do." The Yale Endowment's 2007 annual report (PDF) shows that it uses active management as opposed to indexing even for its domestic equity investments. The report contradicts what Mr. Swensen advocated in this book. For example, the report says on page 7:

"Despite recognizing that the U.S. equity market is highly efficient, Yale elects to pursue active management strategies, aspiring to outperform the market index by a few percentage points annually. Because superior stock selection provides the most consistent and reliable opportunity for generating excess returns, the University favors managers with exceptional bottom-up fundamental research capabilities. Managers searching for out-of-favor securities often find stocks that are cheap in relation to current fundamental measures such as book value, earnings, or cash flow."

And again on page 10,

"Yale's investment approach to foreign equities emphasizes active management designed to uncover attractive opportunities and exploit market inefficiencies. As in the domestic equity portfolio, Yale favors managers with strong bottom-up fundamental research capabilities."

Translation: I will try to beat the market, but you should buy index funds.

What I like about the book is the analysis on "alignment of interests." It is a major theme of the book. Mr. Swensen believes that investors should be keenly aware of the conflict of interests in investing. Some asset classes present conflict of interests problems by their own nature. Mr. Swensen didn't like all other bonds except treasury bonds and TIPS. He also didn't like hedge funds, leveraged buyouts and venture capital, although retail investors usually don't get to invest in those. Mr. Swensen showed that for-profit mutual funds are often a bad deal for investors because of conflict of interests. This is similar to what John Bogle wrote in his book The Battle for the Soul of Capitalism. Mr. Swensen recommended investing through not-for-profit organizations, namely Vanguard and TIAA-CREF, and institutional ETF managers Barclays and State Street.

Overall this is a good book about the conflict of interests in investing. It is not a guide book because it lacks practical guidance on what to do after you know you are supposed to invest in index funds with Vanguard. I don't think it's good enough to get on my recommended reading list, but you will learn something. Three stars out of four.

Book Review: The Bankers

I start the new year with a book review. I've been reading this book for a while. I only finished it over the holidays. It's The Bankers by Martin Meyer. I became a fan of Mr. Meyer's after I read his book The Greatest Ever Bank Robbery (see review).

The Bankers offers an insider's view of the banking industry. It's not a textbook. Mr. Meyer drew a picture of the banking industry through stories and quotes from people in the industry. The quotes and stories are much more interesting than dry texts. The book starts with the nature of money and its role in a society. It then explains in details how banks perform their various functions -- holding money, processing payments, lending money, and trading money. I especially like the chapters on payment processing and derivatives trading. The story on the journey of a personal check is fascinating. So are the stories on the history and the evolution of credit cards, the connected web of ATM switch networks, the invention of cash management brokerage accounts, derivative trading gone awry, and so on.

If you are interested in learning inside knowledge about banking and you don't mind reading a long book, this is a good one. I sure learned a lot from it. For example before I read this book I didn't know that the Federal Reserve is intimately involved in processing checks and electronic fund transfers, with thousands of employees working in these low-level operations. I thought it's just a policy making and regulatory body. I also learned that the systems for payments between banks are extremely efficient. The average transaction size on the Clearing House Inter-Bank Payments System (CHIPS) is $6 million a pop. The cost? 18 cents to the payer and 18 cents to the payee. Compare that to moving $200 from my credit card to Best Buy. It costs Best Buy $4.

Because this is an older book (published in 1997), you can probably find it in your local library. If you want to buy one, used copies are sold on Amazon for less than $5 including shipping.

Final verdict: *** (good, you will learn something).

Book Review: Where Are The Customers' Yachts

I heard about the book Where Are The Customers' Yachts a long time ago but I've never read it. Perhaps the title did the job too well. It came from an old joke that goes like this:

An out-of-town guest was given a tour in New York. The guide pointed out the beautiful yachts in the harbor and said "Look, those are the bankers' and brokers' yachts." The guest asked "Where are the customers' yachts?"

I thought the book was about bashing bankers and brokers. I was wrong. There is some bashing but it's way more than that.

This is an old book. It was first published in 1940(!). The author Fred Schweb, Jr. was a professional trader on Wall Street in the 1920s. He experienced the bull market leading to the Great Depression, the crash, and the slow recovery. The subtitle of the book is "Or a Good Look at Wall Street." He wrote about his observations in good humor. There's no lecturing, just observations. It's amazing how things don't change on Wall Street. In 1955, the author wanted to update the book. After adding a new introduction and a few footnotes, he realized the book didn't need updating because nothing changed. Today, more than 60 years after the book was published, what he wrote is still true.

It's a short, small book, just 200 pages. The language is amusing. The funny cartoons are a bonus. There is never a dull moment. I had good laughs. And I learned. I won't spoil it for you. I think if you read the book, it will become quite clear where the customers' yachts are.

Final verdict: **** (Excellent). Highly recommended for light-hearted reading of astute observations of how the investment world works.

Book Review: Your Credit Score

Today I'm reviewing the book Your Credit Score by Liz Pulliam Weston.   

The author Liz Pulliam Weston is a columnist at MSN Money. I picked up this book from the library when I browsed for new personal finance titles.

I hear a lot of buzz about the credit score and I don't understand what the hype is about. After reading this book I still don't understand why people think everybody should care about what their credit score is and everybody should manage their financial affairs around how the credit score is calculated.

The book gives information on what the credit score is, how it is used, what factors influence the credit score calculation, and how to improve your credit score if you have a bad one. Then it also says:

"You don't need to have the very highest score to get good credit. Any score over 720 or so is going to get you the best rates and terms with the vast majority of lenders. You'll have all the credit you need, and then some."

Bingo. 720 is the average credit score for all population in the United States. I think it's worth repeating: if you have an average credit score, you will be able to get the best rates and terms with the vast majority of lenders.

It turns out that people who have above average scores don't have to worry. Use a few credit cards if you want to. Pay your bills on time. Don't carry any balance. Use common sense. That's it. I don't know how much money is wasted by consumers who are scared into buying their credit score from the credit bureaus.

Final verdict: ** (fair) If you have below average credit, read it, otherwise, skip. You won't miss much.

Related post:

• Canceled Oldest Credit Card

Missing Name on Forbes 400 List

Forbes released its annual list of 400 richest Americans last week. There is one prominent name missing on the list.

His name is John Bogle, founder of The Vanguard Group. Mr. Bogle started Vanguard in 1975. Vanguard created the first index fund for retail investors a year later. Today, Vanguard manages over $1 trillion assets. The Vanguard 500 Index Fund (VFINX) is the world's largest mutual fund. Millions of investors benefit from the low cost Vanguard index funds you hear about everywhere. For such an achievement, John Bogle has very little to show for himself. He's not on the Forbes 400 list.

Edward ("Ned") Johnson III and his daughter Abigail Johnson are on the Forbes 400 list. Between the two of them, they have more than $25 billion. They made their fortune from Fidelity Investments, which manages mutual fund assets similar in size to Vanguard's. Charles Johnson and his brother Rupert Johnson Jr. are also on the Forbes 400 list. They have $11 billion. They made their money from Franklin Resources, which manages Franklin Templeton Funds. With about $620 billion under management, Franklin Resources manages 40% less assets than Vanguard.

There's nothing wrong with Fidelity and Franklin making a lot of money for their owners. That's capitalism. They offered a service that customers wanted and they should be rewarded for their success. John Bogle has also been successful. Had John Bogle made himself the owner of The Vanguard Group when he founded it, I'm sure he would be as rich as the Johnsons of Fidelity or the Johnsons of Franklin, if not richer. Instead, from the very beginning, he gave the company to the Vanguard mutual fund investors. He made Vanguard a mutual mutual fund company which provides mutual fund management services to the fund investors at cost. Over the years, Vanguard investors saved billions of dollars of mutual fund management fees. The billions of dollars that went to the owners of Fidelity, Franklin, and all other mutual fund management companies, didn't go to Mr. Bogle. He only drew a salary as an employee.

Rich people like Bill Gates usually make money first, then give to charity. Mr. Bogle has been giving what could've been his to the investing public every since he started the index funds revolution. Until this day, after retiring from Vanguard, Mr. Bogle is still making speeches advocating for "owner's capitalism" as opposed to "management's capitalism." He is the lone voice for the "small guys" in the financial services industry.

I recommend these books by Mr. Bogle:

The Little Book of Common Sense Investing -- The latest book by Mr. Bogle about index fund investing. If you know about these already, diversify, keep the costs low, buy index funds, give one to your brother then. If you don't, read directly from the person who started the index funds phenomenon.

John Bogle on Investing: The First 50 Years -- A collection of Mr. Bogle's speeches. The only place where Mr. Bogle's 1951 Princeton senior thesis is reprinted. The 1951 thesis was the paper that started it all. Mr. Bogle was 21 at that time. Used copy of this book is selling on Amazon for $6 shipped. What a bargain for owning a piece of history.

The Battle for the Soul of Capitalism -- Outlines why managers are reaping disproportional benefits at the cost of shareholders and what should be done.

Last but not the least, Mr. Bogle has a blog. He answers "ask Jack" questions there. How cool it is to have your question answered by John Bogle himself!

Book Review: The Greatest-Ever Bank Robbery

What was the greatest ever bank robbery? Try $124 billion. This was the cost to the taxpayers in the savings and loan crisis in the 1980s. If interests are included, the total cost approached $500 billion or $2,000 for every man, woman and child in the United States. In light of the recent subprime mortgage problems and the talk about government assistance to homeowners who cannot pay their mortgages, I find it intriguing in reading what happened back then and the aftermath.

In case you didn't know, here's a nutshell of what happened. Between 1986 and 1995, 1,043 savings and loans (a type of bank) with total assets of over $500 billion failed. It cost the U.S. taxpayers $124 billion to make the depositors whole because the bank deposits were insured by the U.S. government.

The savings and loans crisis is documented well in the book The Greatest-Ever Bank Robbery by Martin Mayer. I read it when I was traveling a couple of weeks ago. It's a great book which I couldn't put down. The book thoroughly analyzed the causes of the crisis, including the economic environment, ill-conceived legislation, poor accounting rules, indecisive regulatory authorities, and massive fraud and self-dealing aided and abetted by Wall Street, accounting and legal professionals  and politicians. The tidbits are also fascinating. Well respected people did things which they are probably not too proud of. Former Fed chairman Alan Greenspan worked for Charles Keating whose Lincoln Savings & Loan failure cost the taxpayers over $3 billion. 2008 Presidential candidate Senator John McCain was one of the five senators known as Keating Five who pressured regulators for favors for Keating. I also learned a lot, for example how the ubiquitous money market fund came about, how some of the institutions we commonly know as banks are really savings and loans, and how the moral hazard created by removing the downside risk can wreak havoc in the economy. More on these topics later.

Because this is an older book (published in 1990), you should be able to find it in your public library. If you want to buy it, used hardcovers sell on Amazon for $4 shipped. I highly recommend it if you are interested in economic history.

Magic Formula Investing: Will It Work?

Today I'm reviewing the idea of Magic Formula Investing (MFI) as introduced in the book The Little Book That Beats the Market by Joel Greenblatt.

The author Joel Greenblatt (Wikipedia bio) is a hedge fund manager. In this book he offered a "magic formula" that beats the market, or so he claimed. The underlying principles for the magic formula are very simple:

• Buy good companies
• Pay a bargain price

At first glance, there is nothing wrong with the two principles. All else being equal, everybody wants good companies, not bad ones. All else being equal, everybody would like to pay a bargain price, not an inflated price. But in real life all else are not equal. Good companies are usually not cheap. Cheap companies usually have something wrong with them. The magic formula attempts to solve this problem. It ranks companies by their return on capital (good companies) and earnings yield (bargain price). It then gives you stocks that rank high when both criteria are taken into consideration.

The book has a support site magicformulainvesting.com. It'll run the formula for you and produce a list of suggested stocks. For the time being, the site is free. You are supposed to buy 5-7 stocks every 2-3 months until you have 20-30 stocks. Then you will re-run the screen. If the first batch of stocks you bought a year ago are not on the list any more, sell them and replace with new stocks on the list. Repeat for each batch around their 1-year anniversary. It is a very concentrated and high turnover strategy. At any time you only have 20-30 stocks and you are replacing 100% of your portfolio every year if the stocks you own fall off the list. Instead, if you buy a total market index mutual fund, you will own thousands of stocks, not just 20 or 30, with very little turnover.

Does it work? Greenblatt said it did over 17 years from 1988 to 2004.

"Over the last 17 years, owning a portfolio of approximately 30 stocks that had the best combination of a high return on capital and a high earnings yield would have returned approximately 30.8 percent per year." (p. 52, italics original)

There's no way to independently verify that record but let's accept it as accurate. What about the next 17 years? That's what I'm interested in. I don't have a time machine which turns the clock back 17 years. And you know what they say about past performance and future performance. As rich as he may be, Greenblatt doesn't offer any warranty on how the magic formula will turn out in the future. If you have poor results, don't come crying. He will not make you whole. You are supposed to believe in the formula and stick with it.

"Remember, you must be committed to continuing this process for a minimum of three to five years, regardless of results. Otherwise, you will most likely quit before the magic formula has a chance to work!" (p. 135, italics original)

What if it didn't work out even after 5 years? I guess Greenblatt will say you should stick with the formula even longer. Or maybe you will get a "oops, sorry."

Is this strategy something you can use for your entire portfolio? I don't think so. Betting everything on 20-30 stocks is very risky. I went to magicformulainvesting.com and got my list of stocks with the minimum market capitalization set at $100 million, as the book recommended. I then run Morningstar's Instant X-Ray tool on them and here's what I got:

So basically it wants me to invest 64% of my money in small cap stocks, whereas small cap stocks make up only less than 10% of the U.S. stock market. No way. Can you spell RISKY? Will it beat the market? Maybe, maybe not. I'm not going to wager all my investment dollars on it to find out.

JLP at AllFinancialMatters.com started a simulation on Magic Formula Investing in January 2007. He got good results for the short 6-month period until the last update in early July. But note he is only doing it with hypothetical dollars, not real money. It will also be interesting to see how Magic Formula Investing did in the recent stock market sell-off. If blogger Marsh_Gerda's experience is typical, it's not pretty. He had accumulated healthy extra returns over the broad market since February 2006. In three weeks, those extra gains built up in the last 17 months were completely wiped out (link to chart).

What about doing this only for "play money"? Well, I don't have "play money." All my investments are from my hard earned dollars. Why do I want to "play" or gamble with them? Besides, what's the point of beating the market on only 2% of your investments? How much difference will it make?

Andrew Tobias, who wrote the foreword for Greenblatt's book, had this succinct statement in his book The Only Investment Guide You'll Ever Need:

"In the financial marketplace, you get what you pay for, if you are careful. If you try to get more, you get burned."

That's something you always have to remember whenever you are attracted to any scheme, no matter what it is. In the end, I guess I'm not that interested in beating the market. If I beat the market, something is wrong. That means I took a bet and the bet came in my favor. But wait a minute, why did I take a bet with my hard earned money in the first place? Gambling is not investing.

Movie Review: Barbarians At The Gate

Private equity buyouts are in vogue these days. It feels like almost every week there is an announcement that another company is bought by private equity firms. What's going on? What makes them so prevalent and how will these buyout end up? I know there was a wave of leveraged buyouts (LBOs) in the 1980s. I want to find out what happened back then. What triggered the LBOs in the 1980s? What made the activities stop? What happened after the companies were bought? Did the buyout firms make money?

The climax of leveraged buyouts in the 1980s was the purchase of RJR Nabisco by Kohlberg Kravis Roberts (KKR). Two Wall Street Journal reporters wrote about it in their book Barbarians At The Gate. It became the #1 bestseller on New York Times. Later it was made into a movie by the same name for HBO.

Because it takes less time watching a movie than reading a 600-page book, I opted for the movie from Netflix. The movie told the story of the fight for RJR Nabisco between its CEO F. Ross Johnson and KKR's Henry Kravis. After seeing how others made a ton of money doing LBOs, Johnson wanted to do one himself by taking RJR Nabisco private. He pissed off the LBO king Henry Kravis because although Kravis gave him the idea of doing an LBO, Johnson wanted to do it himself, not with Kravis, but with his buddies at American Express and Shearson Lehman. A bidding war ensued. Johnson first bid at $75 a share. Kravis topped it at $90. A few more rounds went by. Finally Johnson bid $112 a share and Kravis bid $109. The board of directors took the bid from Kravis because they despised Johnson after they learned that Johnson made secret deals with his bidding partners Shearson Lehman and Solomon which would give a big piece of the ownership to Johnson himself (Time, Dec. 5, 1988: "If I Fail, I'm on the Hook").

It's a good movie. It showed how high finance was conducted. Once the news got out that RJR Nabisco was considering buyout offers, multiple other bankers and lawyers swamped RJR like crazy. It also showed how the bigwigs were corrupt at the top. Johnson had multiple private jets. Keeping the jets was one of his top concerns.

However the movie didn't really answer my questions about private equity buyouts. How was the purchase price assessed? Did the board sell the company cheap? Did KKR pay too much? How did the employees fare? Perhaps I had my expectation too high. After all it's a movie, not a documentary. I was expecting it to be like Enron: The Smartest Guys in the Room which is really good. Maybe the book is better than the movie. I will have to read the book and see.

Settle for Good Enough

I came to know the book The Paradox of Choice: Why More Is Less by coincidence when I read an article in New York Times on a plane. I wrote about that article in Opt In or Opt Out: The Power of the Default Option which earned a Editor's Picks in Carnival of Personal Finance #98. After a long wait I finally got this book from the public library. I can tell you it's well worth the wait.  

The author Barry Schwartz is a psychology professor at the prestigious Swarthmore College in the suburb of Philadelphia. He wrote about how the abundance of choices actually makes us unhappy and how to deal with choice overload. We live in a world of choices. When the author shopped for jeans, there were 6 different fits. Buying a car? There are perhaps hundreds of different makes, models and trims, plus new versus used. Plethora of choices are supposed to make us happy. Everybody can get what they want. If someone doesn't care about the additional choices, they can just ignore them. No harm done. Not true. Instead, the choices overwhelm us, forcing us to become experts on everything.

In the personal finance area, we are confronted with all sorts of savings accounts, money market funds with different tax treatment, credit cards with different rewards structures, different types of mortgages, all kinds of stocks, bonds, mutual funds and ETFs, different types of workplace retirement plans, different types of IRAs with different tax rules, different types of educational savings plans, ... ... You get the picture. There are all kinds of traps everywhere. You read articles about "7 biggest mistakes ..." and "Beware ..." How does an average person cope with all these? The financial "advisors" come in and say "It's too complex. You can't deal with it. Let me handle it for you [for a handsome fee]." Now we have even more traps. We have to figure out whether the "advisors" are screwing us.

What should people do then? The author suggested

1. Choose when to choose. In other words, don't sweat the small stuff. If you didn't get in on the 6-month promo rates from FNBO savings account, so what?

2. Learn to accept "good enough." Don't feel like you have to find the absolute best for everything. The "best" may be out there somewhere, but "good enough" gets the job done.

3. Don’t worry about what you’re missing. There are tradeoffs to everything. Be happy with with the positive features of your choice.

4. Control expectations. Nothing is perfect. Move on with you've got. 

I have to admit that I tend to fall on the "maximizer" side on the author's Maximization Scale. I write a lot about minute details of finance and investment on this blog. Recently, especially after reading this book, I find myself saying "it doesn't matter" more often. I'm trying to become more of a "satisficer." Even when I write about the different things, I try to put in a dollar perspective.

Final verdict: **** (Excellent). I highly recommend this book. 

Mr. Schwartz also wrote a summary of his book in the article The Tyranny of Choice which appeared on the April 2004 issue of Scientific American. If you can't get hold of the book now, at least read the article and do the Maximization Scale quiz in it. See if you are a maximizer or a satisficer. I scored 4.25, in the middle 1/3 of the population, slightly over on the maximizer side. What's your score?

Maxed Out: Documentary About Debt in America

I watched a documentary Maxed Out on DVD over the weekend. It's about debt in America, especially credit card debt. It featured people who are in debt, people who lost their loved ones to debt, a Harvard Law School professor, Dave Ramsey, debt collectors, a pawn shop owner, and many other people involved in debt in one way or another. It presented a multifaceted picture of the debt problem in the United States. Here's the film on Google Video.

I got the DVD from Netflix. I think it's worth watching. A user on Netflix said this film is to the credit card industry like Super Size Me is to the fast food industry. I agree. I hope after watching this film everyone will vow not to take on credit card debt ever. By the way, Super Size Me is also very good. I rarely eat burgers any more after watching that film.

Maxed Out is of course not without shortcomings. I got the impression that it blamed the debt problem on the availability of credit. It stopped short of exploring why people got into debt in the first place. Just because credit is available to someone doesn't mean that one must borrow. Just like McDonalds having a restaurant around every corner doesn't mean that I must eat there. They sure make it easier to fall into debt or eat junk food though. The industry's marketing of easy credit to the masses is a problem. People who spend more than they can afford is also a big contributor to the problem. It's the classic "guns kill" or "people kill" problem. The interviews with the pawn shop owner sort of hinted at the overspending problem, but the film didn't delve into that angle.

Overall I think it's a good film. Debt is a big problem in this country. We can't expect a 1-1/2 hour documentary to cover every cause let alone solve it. To the extent it raises awareness, it's good. I've read about people's complaints about Dave Ramsey -- how he opposes to debt at the cost of everything else. But in a world inundated with marketing for debt and overspending, I'd rather have more Dave Ramsey's as offsets even if he's not 100% right or accurate.

If you have Netflix, I highly recommend Maxed Out for your queue.

Book Review: The Random Walk Guide to Investing

Today I'm reviewing the book The Random Walk Guide to Investing by Burton Malkiel.

Don't confuse this book with the classic book A Random Walk Down Wall Street by the same author. I also recommend the other book, but this one is much easier to read, while retaining the gist of the classic book. It comes as a small 200-page paperback, and it's packed with pretty much all you need to know about investing. If you want to cut to the chase and read the bullet points, this book is for you. If you want to read the elaborate proof and explanations, and you don't mind the extra pages, go for the larger A Random Walk Down Wall Street.

Mr. Malkiel condenses everything about investing into 3 Basic Points and 10 Rules. If you know these, you can invest your money and move on with your other life pursuits. Here's what Mr. Malkiel said when introducing the ten rules for financial success:

There is no magic potion in the investment world because the truth is that one doesn't exist. ... ... If an investment idea seems too good to be true, it is too good to be true.

You knew that, didn't you? Andrew Tobias wrote the same thing in his book The Only Investment Guide You'll Ever Need.

So what are those 3 basic points and ten rules? I'm not going to reproduce them here. You can browse the book's table of contents through Amazon.

The 10 rules are both simple and practical. Anybody can easily apply them. The book includes model portfolios for people in different age groups. If you are not sure what to do, use a model portfolio and you are all set.

Bottom line, this is the best $15 one can spend on an investment book. No gimmicks. Just practical advice. It's one of my favorite books on my Recommended Reading List.

See a list of my other book reviews.

Book Review: Common Sense on Mutual Funds

Today I'm reviewing the book Common Sense on Mutual Funds by John Bogle (see my other book reviews). You can browse the book's table of contents through Amazon reader.

John Bogle (Wikipedia bio) is the founder of The Vanguard Group, winner of TFB Award for Best Mutual Fund Company. I have the highest respect for Mr. Bogle for his innovation and altruism. Instead of making Vanguard a for-profit entity, which would've reaped billions of dollars for himself, Mr. Bogle gave the company to the fund investors, the general public, and only took compensation as an employee.

The book is divided in five parts:

1. On Investment Strategy
2. On Investment Choices
3. On Investment Performance
4. On Fund Management
5. On Spirit

The chapters are organized like a series of essays, each addressing a specific question. Because Vanguard, the company John Bogle founded, is best known for its low cost index funds, naturally the book advocates investing in low cost index fund. I think it made a compelling case, using many tables and charts throughout the book. I'm an index fund convert myself. This book, and my personal experience investing in actively managed mutual funds that charged too much and delivered too little, made me change the way I invested my money. Whenever possible, I