The Smartest Retirement Book You'll Ever Read
An Excerpt From
The Smartest Retirement Book You'll Ever Read

Chapter 1

Deflating Inflation

Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair. — Sam Ewing, humorist

Retirees should be as concerned about investing their retirement nest eggs as they are about withdrawing from them— the 2008 market crash exacerbated these concerns and makes this issue even more critical.

Fortunately, Smart Investing before or during retirement is not difficult. While you'll hear lots of ballyhoo about the special investment needs of retirees, the basic investment rules— the Smart Investing rules— are the same for everyone, no matter what their age or stage of their investing lives.

In Chapter 5 and Appendix B, I provide recommended portfolios that will take the mystery out of this process. Before jumping in, we'll review in the chapters ahead some basic investing principles you need to understand.

Let's start with the most commonly overlooked one: inflation.

Inflation: The Natural Predator of Your Nest Egg

Retirees understandably worry about the stock market's gyrations. Who wouldn't, especially given the current unprecedented fiancial meltdown? But they don't spend nearly as much time fretting about inflation.

In recent years, inflation doesn't seem to have been much of an issue. For more than a decade, the nation's annual inflation rate has rarely inched above 3 percent. As 2009 began, economists were far more worried about deflation.

Yet even a seemingly innocuous inflation rate can flatten the cushion of a retiree's otherwise solid budget. When inflation is running at 3 percent, the value of $100 will plummet to $76 in just ten years. If you wait two decades, the value of that $100 is worth no more than $56.

It's easy to illustrate how destructive inflation can be if you lookat hypothetical portfolios of retirees from twenty or thirty years ago.Today's retirees can easily live that long or longer.

I used the inflation calculator from the federal Bureau of Labor Statisticsto see how much money a retiree would need today to matchthe buying power of an American who retired with a $500,000 nestegg twenty years ago. Thanks to inflation, today's retiree wouldrequire $924,695. (You can play with your own numbers at www.bls.gov/data/inflation_calculator.htm.)

The current crop of retirees will likely feel the pinch of inflationmore acutely because it is likely they will have to spend more on medicalcosts, which have been rising faster than inflation.

Unfortunately, the only inflation indexing that most retirees cancount on today is their Social Security checks, which provide anannual cost of living allowance.

Countless research has illustrated that conservative portfoliosrun the risk of running on fumes. One landmark study examinedwhat would happen if an investor withdrew 6 percent a year from anall- bond portfolio. The study concluded that the investor had only a 27percent chance of having anything left after thirty years.

As you contemplate how you're going to structure your portfolio inretirement, you'll want to plan to deal with inflation.

The solution— as hard as this might be to swallow in today's volatilemarkets— involves adding stocks to your portfolio. I'll discussexactly how you should do that in Part Two.

What's the Point?
If you don't fortify your portfolio against inflation, you're likelyto outlive your money.

Chapter 7

The Investing Secret Your Broker Won't Tell You

Index funds have a large following among institutional investorssuch as pension funds and insurance companies. Ironically,one of the most vocal advocates of index funds forindividual investors is Warren Buffett, self-made billionaireand chairman of Berkshire Hathaway Inc. [who] madehis fortune through individual stock selection.

— Richard A. Ferri, CFA, author of All About Asset Allocation

Indexing can make you feel like an investing genius.

Here are the major benefits of indexing:

  • Market returns (which are superior returns)
  • Low cost
  • Broad diversification
  • Tax efficiency
  • Minimal cash holdings

Let's take a look at these more closely.

Market Returns

Index funds make a simple promise: Everybody who indexes willearn market returns minus low transaction costs.

Here's an example: If the S&P 500 index (the popular benchmarkfor blue chip stocks) generated a yearly return of 9 percent, you couldcount on the Vanguard 500 Index Fund, the Fidelity Spartan 500 IndexFund, or some other large- cap index fund to produce a return that'salmost identical.

The goal of an index fund manager is to be a clone of a corresponding index.

When an index stumbles, so will its index fund. When the index isdoing well, so will the index fund. Over time, stocks and bonds of everysize and category have grown, which means index funds have too.

It is perfectly understandable if you're not impressed by "average"market returns. After all, it's far easier to tout the stellar returnsof carefully selected actively managed funds. Unfortunately, thesereturns are almost always ephemeral. An actively managed fund canenjoy a streak of phenomenal luck— but nearly all actively managedfunds eventually stumble. Their long-term (and even shorter- term)performance returns lag behind comparable index funds.

Why do proponents of actively managed funds struggle so muchagainst those average returns?

These stock jockeys eventually smack into a brick wall called the"efficient market." Think about it this way: Wall Street is transparent—any news about any stock quickly makes the rounds, and the stock isadjusted accordingly. Consequently, it's almost impossible for professionalsto outsmart all the other investors trying to beat the markets.

The difficulty of surpassing index returns on a sustained basis iseven harder than it appears, thanks to something called "survivorbias." Every year, a huge number of actively managed funds go out ofbusiness. During one recent five-year period, according to Standard & Poor's, more than one in four stock funds vanished. The funds thatdisappear are typically the ones with terrible performance statistics.Fund companies will often get rid of the embarrassing funds by mergingthem into more successful ones.

With the dead bodies hidden away, the remaining actively managedfunds look better than they deserve.

Low Cost and Lovin' It

Index funds are the cheapest game in town. The Vanguard 500Index Fund, which is the nation's most popular index fund, chargesshareholders just 0.15 percent to manage their assets. That means ifyou had $10,000 invested in the fund, your tab for the year would be apaltry $15. There are even cheaper class shares for larger investors. Fora new shareholder who invests at least $100,000 in the Vanguard 500Index, the cost would drop to 0.07 percent, or only $70 a year.

The typical mutual fund can easily charge ten times more than acomparable index fund. People don't appreciate that price gap, becausethe difference doesn't seem wide. A fund that charges 1.7 percentdoesn't seem like a porker compared to one that charges 0.07 percent.In reality, the gulf is huge.

Let's suppose you invested $50,000 in a stock index fund that charges0.20 percent in expenses, and your neighbor invested the same amountin an actively managed stock fund that charges 2 percent. Let's assumeyou both earned an annual 8 percent return before expenses.

A decade later, your index fund would be worth $105,964. The fundof the poor guy next door would be worth $89,542. Your neighbor'scost for holding this fund would have been $16,422.

Broad Diversification

Index funds hold more securities than actively managed funds. Bydiversifying the number of holdings, index funds reduce the risk ofhaving a concentrated position in a smaller number of stocks.

Tax Efficiency

When judging mutual funds, investors look at total returns. But performance statistics can be misleading. When investments aren't sheltered in retirement accounts, after-tax returns are the key feature.

Taxes can mangle the returns of actively managed funds. Too many portfolio managers trade stocks with little regard for the tax consequences that are borne by the investor. Index funds are considered paragons of tax efficiency because there is little turnover in their  portfolios.

John Bogle, the former head of the Vanguard Group, conducted a study that illustrated how devastating the tax bite can be for actively managed funds. Over a sixteen-year period, Bogle concluded that investors kept only 47 percent of the cumulative return of the average actively managed stock fund. Indexers kept 87 percent.

Can you afford to leave that much of your money on the table?

Minimal Cash Holdings

Large cash holdings reduce returns in a rising market. Index funds typically have less cash holdings than actively managed funds because they don't have to keep cash on hand to time the market. Index fund portfolios stay focused on meeting the returns of the index.

What's the Point?
Investors who index achieve superior returns.

Chapter 58

Ten Golden Rules

Practicing the Golden Rule is not a sacrifice; it is an investment.

— Author unknown

The Ten Golden Rules that I've put forth here won't work for everyone, but they should be considered by all investors, regardless of your age, whether you are currently planning for retirement or are already retired.

  1. If you have an account with a brokerage firm, close it. I can't think of any reason to do business with a broker. They can't pick outperforming stocks or mutual funds. They can't time the markets. They are expensive. They are not fiduciaries.
  2. Never buy an individual stock or an individual bond, with the exception of Treasury bills. Your expected return with individual stocks and bonds is the same as an index of comparable stocks or bonds, but your risk is vastly increased.
  3. If you need help coming up with a financial plan, use a fee-only financial planner (or a certified public accountant) who charges an hourly or a fl at fee and who limits advice to preparing a plan and answering your questions.
  4. If you need assistance in making investment decisions, use a registered investment advisor who focuses on your asset allocation and who recommends investing only in a globally diversified portfolio of low- cost index, passively managed stock and bond funds, or in an immediate annuity, where appropriate. Ask the advisor to confirm in writing that she will act as a fiduciary in all her dealings with you.
  5. Be sure your funds are held at an independent, well- known custodian, like Charles Schwab, Fidelity Investments, or TD Ameritrade. Make all checks payable only to the custodian and ensure that you receive account statements directly from the  custodian.
  6. If you are investing on your own, use a well- known fund family, such as Vanguard, Fidelity, T. Rowe Price, or Charles Schwab. Consider one of my recommended portfolios (see Appendix B).
  7. Avoid alternative investments like hedge funds, limited partnerships, and private equity deals.
  8. Add up your monthly expenses. Deduct the amount of your Social Security and other income you can count on. Consider purchasing an immediate annuity directly from a low- cost provider such as Vanguard or TIAA-CREF for the difference. You can now sleep well knowing that you have enough money to meet your monthly expenses.
  9. Keep funds sufficient to meet two years of living expenses in an FDIC-insured savings account, a certificate of deposit, Treasury bills, or a money market fund from a major fund family.
  10. Prepare a will. A will is the first important step in estate planning.

Sometimes intelligent retirement planning can seem overwhelming. However, these basic rules are really quite easy to implement.

You now have the knowledge to do it. Don't let anyone cause you to stray from the path toward a successful retirement.

"Reading this book is smart.

Solin's previous entries in this series were clever, breezy guides to navigating through the financial morass without getting hurt... This new book gets into the basics of investment in context with the present economic scene, so reading the earlier volumes doesn't mean that you won't get anything out of this one.

...Solin casts his wise eye and sharp pen on other important subjects like reverse mortgages, age of social security distribution, prenuptial agreements for seniors, options and implications of delaying retirement...

The best thing that Solin brings to the party is his shrewd and skeptical approach to the art and science of investing. ...there's no question that his focus is on what's best for individuals, not institutions.

Throughout, Solin writes clearly with style and humor but stays on topic and doesn't bloviate or pontificate excessively. He includes a number of charts and other tools to figure out what to do with your money so it grows into the amount you will need to live on for the rest of your days."
--Richard Pachter, Miami Herald

"These two books are very different in format-Solin (The Smartest Investment Book You'll Ever Read) offers short chapters on a variety of retirement subjects, each concluding with a pithy summarization, while Jason (principal, Jackson, Grant Investment Advisers, Inc.) gives a more explanatory dissertation. But both are clearly written and easy to understand, tackling such topics as stocks, bonds, annuities, pensions, and cash withdrawal strategies (although Solin's book offers a handy section on care costs, Jason's does not). Jason's will be better for readers not as familiar with basic finance concepts, while Solin's may appeal to a more financially literate crowd."
--Library Journal

It appears that people’s biggest concern is that they will outlive their money. Other than robbing a bank, do you have one suggestion that will help pretty well anyone?

While much depends how much people save and how smartly they invest before and during retirement, I recommend getting a fixed annuity (also known as an immediate annuity) from one of the low cost providers like Vanguard or TIAA-CREF. With an immediate annuity, you give the insurance company a lump sum and they give you monthly, quarterly or yearly checks for the rest of your life or longer, at your option.

Who can people rely on for advice about saving for retirement?

An advisor whose focus is on asset allocation (the division of a portfolio between stocks, bonds and cash) and who recommends investing only in a globally diversified portfolio of low cost stock and bond index funds. Sadly, the vast majority of traditional brokers and financial advisors would be disqualified from consideration based on these criteria.

Many people’s portfolios were decimated by the market crash and they don’t think they can now afford to retire. What should they do?

Hard times require hard decisions. There is no magic bullet – as some investors duped by the likes of Bernie Madoff will now attest. But anyone can dramatically boost their retirement nest egg by working an additional three or four years. One study showed that these added years of employment increased retirement income by a staggering 25%.

The Smartest Retirement Book You'll Ever Read

The Smartest Retirement Book You'll Ever Read