David Stein Money For The Rest Of Us

Praise for Money for the Rest of Us

"One of the biggest pitfalls in any decision we make is thinking we know more than we do. In Money for the Rest of Us, David Stein provides investors a framework that focuses attention on what we don't know, reduces overconfidence, and highlights the value of considering where things might go wrong. This is a high-impact framework for making any decision, not just investing."

—ANNIE DUKE, decision strategist and bestselling author of Thinking in Bets

David provides a clear road map for investors, brought to life through a series of personal anecdotes. He recognizes that past is not prologue, that the successful strategies of recent years may not fare as well in the years ahead.

—ROB ARNOTT, Chairman, Research Affiliates

You don't need to be a math whiz or financial expert to be a successful investor. Instead, you need a disciplined investment process, a framework that you can use to provide peace of mind when others are freaking out. The most honest and successful investors have no more idea about what is going to happen in the future than you or I do. What makes them different? They have an investment philosophy and decision-making process that directs their investment choices. Stein gives us the best framework I've seen for easily evaluating the most important aspects of any investment so you can accomplish your personal finance goals.

—MICHAEL PORT, New York Times and Wall Street Journal bestselling author of seven books including Steal the Show and Book Yourself Solid

"They say you should write the book you want to read; with Money for the Rest of Us, David has gone one better. He's written the book he knows his audience wants to read because he's spent years understanding their needs and addressing their unanswered questions. David doesn't want to tell people how to invest—he wants to help people to have the confidence to make smart investment decisions for themselves. If you are one of those people, then this book is for you."

—BERNADETTE JIWA, bestselling author, Australian top business thinker

"We all have 50 questions about investing. David Stein proves what a great teacher he is by distilling the list to the 10 you really need to know. Whether you're investing to grow your nest egg or to protect it, there's something here for everyone. A must read."

—JOE SAUL-SEHY, creator and cohost of Stacking Benjamins podcast

"If you want to be a successful investor, Money for the Rest of Us should be a marked-up resource sitting on your desk. David Stein presents a valuable outline for making better investing decisions."

—ROGER P. WHITNEY, CFP®, CIMA®, CPWA®, RMA®, AIF, and Retirement Answer Man

"David Stein's Money for the Rest of Us is a superb and accessible guide to investing. He gets right to the point and provides the reader with answers to the most pertinent questions we all have when trying to navigate the investment landscape. This book is a valuable addition to anyone's library."

—CULLEN ROCHE, founder of Orcam Financial Group and author of Pragmatic Capitalism

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ACKNOWLEDGMENTS

INTRODUCTION

Making Investment Mistakes Is Normal

You Are a Portfolio Manager

A Different Kind of Investing Book

What You Will Learn

1 WHAT IS IT?

If We Can't Explain an Investment, Then We Shouldn't Invest

The Primary Reason to Buy an Individual Stock

If You Can't Explain It, Don't Invest

Who Is Selling It?

We May Not Know as Much as We Think

Dealing with Unknowns

Complex Adaptive Systems

Reacting to Available Information

Why Accurately Predicting the Future Is So Difficult

Investing on the Leading Edge of the Present

The Math and Emotion of Investing

An Investing Framework

Chapter Summary

2 IS IT INVESTING, SPECULATING, OR GAMBLING?

A Simple Filter for Segmenting the Investing Universe

What Is Investing?

What Is Speculating?

Attempting to Day-Trade

What Is Gambling?

Chapter Summary

3 WHAT IS THE UPSIDE?

Rules of Thumb for Estimating Investment Returns

A Flawed Financial Plan

Rules of Thumb

Estimating Bond Returns

Estimating Stock Returns

How to Estimate Returns in Your Portfolio

A More Reasonable Financial Plan

Chapter Summary

4 WHAT IS THE DOWNSIDE?

Rules of Thumb for Evaluating Risk

Navigating the Global Financial Crisis

What Is Risk?

Maximum Drawdowns and Recoveries

The Potential Devastating Impact of Large Portfolio Losses

Why Assets Fall in Price

How to Manage Risk in Your Portfolio

Chapter Summary

5 WHO IS ON THE OTHER SIDE OF THE TRADE?

Evaluating What the Seller Knows About an Investment

With Whom Are You Trading?

Financial Markets Are Increasingly More Competitive

Active Manager Underperformance

Are Markets Efficient?

Adaptive Markets

How to Balance Active and Passive Investing in Your Portfolio

Chapter Summary

6 WHAT IS THE INVESTMENT VEHICLE?

Evaluating Exchange-Traded Funds, Mutual Funds, and Other Investment Securities

Applying the Investment Framework

Evaluating Investment Vehicles

Closed-End Funds

Exchange-Traded Funds

Chapter Summary

7 WHAT DOES IT TAKE TO BE SUCCESSFUL?

Identifying What Drives Investment Outcomes

Wayfinding

Return Drivers

Dividend Investing

Market Conditions

Multiple Return Drivers

Chapter Summary

8 WHO IS GETTING A CUT?

Managing Fees and Taxes

Types of Investment Expenses

Managing Investment Fees

Retaining a Financial Advisor

Taxes

Rebalancing Your Portfolio

Inflation and Asset Allocation

How to Manage Investment Costs in Your Portfolio

Chapter Summary

9 HOW DOES IT IMPACT YOUR PORTFOLIO?

Asset Allocation

Asset Allocation Using Modern Portfolio Theory

The Asset Garden Approach to Asset Allocation

International Stocks and Bonds

Fundamental Indexing

How to Allocate Assets in Your Portfolio

An Alternative Approach

Chapter Summary

10 SHOULD YOU INVEST?

Applying the Investment Framework

Dollar-Cost Averaging

Position Size

Market Timing Versus Risk Management

Economic Trends

Socially Responsible Investing

Piecemeal Portfolio Managers

Chapter Summary

CONCLUSION

GLOSSARY

BIBLIOGRAPHY

NOTES

INDEX

Acknowledgments

Thanks to Bernadette Jiwa for coming up with the Money for the Rest of Us book title and to my agent Paul Lucas for the motivation to write the book four years after I had a title. To my editor, Noah Schwartzberg, for believing in and supporting the project. To my sons, Bret and Camden, for your countless hours of editing help. To the tens of thousands of Money For the Rest of Us podcast listeners for your support, questions, and ideas. To the 1,000 Money For the Rest of Us Plus members for being there as we help each other on our respective financial journeys. Special thanks to Plus members who served as early readers for the candid feedback that made for a better book: Catherine Anderson, Kent Baggett, Justin Belk, James Blandford, Robin Crisler, Marc DuVal, Christopher Ellis, Peter Forint, Simon Gogolin, Greg Golich, Anthony Indovina, Julia Khanova, Paul LaFrance, Mick Parent, Joseph Pelusi, Kathleen Pritchard, Michael Reese, Joe Talbert, David Toberisky, Dr. Alexander Walkhoff, Matt Weiser, and one member who chose to remain anonymous.

Introduction

THE TEN QUESTIONS

1. What is it?

2. Is it investing, speculating, or gambling?

3. What is the upside?

4. What is the downside?

5. Who is on the other side of the trade?

6. What is the investment vehicle?

7. What does it take to be successful?

8. Who is getting a cut?

9. How does it impact your portfolio?

10. Should you invest?

Several years ago, I met an exterminator at our farm in Teton Valley, Idaho. The 80-acre investment property and vacation home has sweeping views of barley fields and the Teton mountain range. Elk and moose frequent the land, and mountain bluebirds flit from tree to tree.

Our dream property had two problems. The first was a mice infestation in the house. Hence, the exterminator. The second problem was more serious. Across the road and down a bit from our farm, an abandoned gravel pit that had sat idle for almost a decade was again in full operation. Every few minutes, a dump truck loaded with gravel drove past our house, stirring up dust. The silence that attracted us to this beautiful spot was broken. A rock crusher operated at the gravel pit 12 hours a day. The great bargain we thought we got when we purchased the farm at the bottom of the housing collapse no longer seemed so attractive.

The exterminator and I chatted as he placed bait boxes around the house. I mentioned to him I used to be an institutional investment advisor and now taught individuals about money, investing, and the economy on my podcast and membership community.

He turned to me and asked, How much can someone earn per year investing in stocks?

Before I could reply, he answered his own question. I think 80% is reasonable.

It turns out he had bought his first stock earlier that year, and it had appreciated over 80%. That was the rate of return that now anchored his expectations. He was unpersuaded by my attempt to explain what determined stock returns and why his expectations were off by a factor of 10.

MAKING INVESTMENT MISTAKES IS NORMAL

The exterminator and I both made investment mistakes. His was he didn't really understand how stocks worked, so his expectations were unrealistic; and mine was falling in love with a piece of real estate without adequately researching the status of the nearby gravel pit. Making investing mistakes is normal. All investors, even highly successful hedge funds, make mistakes. Ned Davis, a renowned investor and market technician, said: We are in the business of making mistakes. The only difference between the winners and the losers is that the winners make small mistakes, while the losers make big mistakes. ¹

As individuals saving and investing for retirement, we need to get comfortable with the fact we will make some mistakes. We can't let the fear of doing so keep us from investing. At the same time, we can't afford to make big investment mistakes. Being a loser in that realm means running out of money during retirement or not being able to retire at all. Over my investment career, I've interviewed hundreds of money managers, including stock investors, bond managers, hedge funds, and venture capitalists, in order to understand how they invest. I always asked them to give me an example of an investment mistake they made and what they learned from it. Not only have I learned from other investors' mistakes, but I have also learned from my own. I advised and made financial recommendations to dozens of endowments and foundations with billions of dollars of assets. Some of my recommendations worked out, while others were mistakes. As Chief Portfolio and Investment Strategist, I also had day-to-day responsibility for managing a $2 billion investment portfolio, guiding it through the 2008 global financial crisis with clients and partners evaluating and critiquing every portfolio move, including my mistakes.

Warren Buffett, one of the most successful investors ever, has said we beat ourselves up too much over our mistakes.² Yet we all do it. I remember my investment mistakes way more than I remember my successes. One reason we are so hard on ourselves about our mistakes is we have a difficult time separating a bad outcome from the decision-making process.

Professional poker player and decision-making specialist Annie Duke, in her book Thinking in Bets: Making Smarter Decisions When You Don't Have All the Facts, wrote: What makes a decision great is not that it has a great outcome. A great decision is the result of a good process. . . . Decisions are bets on the future, and they aren't right or wrong based on whether they turn out well on any particular iteration. An unwanted result doesn't make our decisions wrong if we thought about the alternatives and probabilities in advance and allocated our resources accordingly. ³ Sometimes investments don't work out as expected, but that does not mean it was a mistake if the decision was well thought out. We have to take what we can learn from the experience and move on to the next investment opportunity.

YOU ARE A PORTFOLIO MANAGER

When it comes to investing, you and I are portfolio managers. Portfolio managers compare different investment opportunities and allocate money among them. A key aim of this book is to teach you a framework, a good process, for making those allocation decisions so that even if there is an occasional bad outcome, the impact on your financial livelihood is small. In the face of extreme uncertainty, a disciplined investment process can give you confidence and peace of mind when others are overwhelmed with the number of financial choices or panicking during the latest market sell-off. An investment discipline can help you overcome the fear of making mistakes while avoiding large ones.

A DIFFERENT KIND OF INVESTING BOOK

I no longer manage money professionally. Now my biggest financial challenge is the same as yours: making sure I have enough money to retire and that those resources last. For the past five years, I've hosted one of the world's most popular investment podcasts, Money For the Rest of Us. Listeners often ask if there is a book I can recommend that will teach them how to invest. There are, of course, a lot of investing books. Many are for beginners, walking readers through the steps of opening up a brokerage account, explaining what an index fund is, and discussing why it is important to save and diversify. Other investment books get into the nitty-gritty details of trying to beat the stock market by employing value investing or momentum strategies, trading options or foreign currencies, or building a portfolio of real estate investments.

This book is different. Although it includes plenty of information on various investment strategies, its main goal is to take a step back and show you how to evaluate investment opportunities so that you can decide whether you should even be trading options, building out a real estate portfolio, or trying to beat the stock market by investing like Warren Buffett. This book is organized into a ten-question framework for analyzing any investment, so you can avoid big mistakes and increase your odds at profiting from successful investments no matter what they are. In short, this book is for investors who are portfolio and asset class focused, who have demonstrated the discipline to save and invest for retirement, and who want to make sure they are doing everything they can to confidently protect and grow their wealth.

WHAT YOU WILL LEARN

The truth is you don't need to be an expert to be a successful investor. We are able to navigate many complex domains without being an expert. These domains include managing our homes and businesses, traveling the world, and playing a sport. We navigate complexity through rules of thumb: heuristics that guide our actions. In this book I share rules of thumb to guide your investment decisions.

You will learn about the answers to these questions:

What is the difference between investing, speculating, and gambling?

How do you determine an investment's expected return, its potential upside, and its potential downside?

What is required to beat the stock market, and should you try?

How do you build a diversified portfolio without getting bogged down in the minutiae of modern portfolio theory?

What is the difference between exchange-traded funds (ETFs), mutual funds, and closed-end funds, and what are the risks of each?

Does using passive index funds mean you should be passive in all areas of your investing?

Is it better to invest a lump sum all at once or to dollar-cost average?

Should you own gold or cryptocurrencies, and should you trade foreign currencies?

Should you pursue dividend investing or invest outside your home country?

And much, much more.

This book is designed to be approachable and helpful to both beginners and those that have been investing on their own for years. It is a book that you can feel good about sharing with others, and I would be honored if you would do so. Many of the quotes I have included in this book are from investment mentors. Some I have met in person, but most I have not. These are virtual mentors, individuals whose approach to investing and managing risk I have followed and admired for years. I have included these quotes not only to reinforce the book's core principles but also to serve as a reminder of how much we can learn about investing from the experience of others.

I don't know how my exterminator's stock portfolio is doing, but our investment in our Teton Valley farm worked out despite the gravel pit. We split the property into two 40-acre parcels and sold the parcel with the house, pastures, barn, and other outbuildings to a woman who is operating it as an overnight camp and retreat center for those that want to work with horses and experience living on a ranch. We will more than likely sell her the remaining 40 acres as her new enterprise becomes more established. We broke even on the investment financially, and if we factor in the wonderful experiences we had with family and friends on the property, then we came out well ahead.

1

What Is It?

If We Can't Explain an Investment, Then We Shouldn't Invest

THE TEN QUESTIONS

1.What is it?

2. Is it investing, speculating, or gambling?

3. What is the upside?

4. What is the downside?

5. Who is on the other side of the trade?

6. What is the investment vehicle?

7. What does it take to be successful?

8. Who is getting a cut?

9. How does it impact your portfolio?

10. Should you invest?

QUESTION ONE: WHAT IS IT?

Before we invest, we should seek to understand and explain in simple terms an investment's characteristics. The act of explaining keeps us humble and helps us realize what we don't know. Answering the ten questions discussed in this book forms an investment discipline that can give us confidence in the face of uncertainty.

Do you remember your first stock investment? I bought my first stock when I was in graduate school getting an MBA with an emphasis in finance. The stock was Novell. Every night after school, I watched the Nightly Business Report on PBS to see how the stock performed that day. This was 1991, so it was several years before you could browse