The Little Book of Safe Money: Book Notes

This post contains the main ideas in the book ” The Little Book of Safe Money” by Jason Zweig.

1. Never invest without thinking twice and consulting the Three Commandments. The Three Commandments of Investing are the three central rules for keeping your money safe. They will help you shape an investment policy, telling you not only where to put your money but also why.

a. Do not take any risk that you need not need to take.
Is this risk necessary?
Are there safer alternatives that can meet the same goal?
Have I studied the pros and cons of each before settling on this choice as the single best way to meet my goal?

b. Do not take any risk that is unlikely  to reward you for taking the risk.
How do I know this risk will be rewarded?
What is the historical evidence?
What is the worst loss historically?

c. Do not put any money at risk that you cannot afford to lose.
How much are you willing to lose?
What will you do if you have a loss?
Will other assets and investments sustain you if you lose?

2. The ideal portfolio is solid and liquid at the same time.

  • A solid investment is one which is unlikely to lose the majority of its market value based on decades of historical evidence.
  • A liquid investment is one which you can convert to cash at any time with losing more than a miniscule amount of money.
  • A solid asset like a house is illiquid and if you want to raise cash quickly, you might need to sell it at below market price. If you have a lot of debt, then your liquidity is at risk and you have a good chance to lose money. If you have a lot of liquidity, then you can weather bad times by depending on that liquidity.
  • See how much liquid investments you have and how much illiquid but solid investments.Look at how much you own and how much you owe and what is your net worth.
  • You need to have enough liquidity- not too much, not too little. You need to have liquid assets to cover one year’s worth of living expenses. To do that you must take time to track and calculate your family budget.

3. The biggest single holding in your portfolio is your human capital.

  • Human capital is the income that your career will generate over the rest of your life. So if you do not have a job, you will have to live on investment income. However if you have invested a lot in your company stock, and your company goes bust or if you invest at lot in your sector and your sector goes into a downturn you will lose a lot.
  • Your human capital has general risks and specific risks.
  • General risks are death, disability, location, inflation and alteration risk.
  • Location risk means that the value of your skills depends largely on where( and when) you happen to live and the health of the national economy that surrounds you. A struggling economy depresses the human capital of almost everyone in that country.
  • As you grow more experienced, you generally earn more. But this has to be greater than inflation for you to benefit. This is inflation risk.
  • Alteration risk is the ability to alter how and how much you work and whether you have the flexibility to do so depending on your circumstances.
  • Specific risks are those risks that are specific to you and your work. To reduce specific risks:

You should not put your financial capital into the same basket already occupied by your human capital.
Do not invest more than 10% of your total stock portfolio in your company stock.
Do not invest in a sector fund that invests in the same industry you work in.
Buy inflation protected bonds.
Consider investing in assets that should do well when your industry does badly.

4. The cash that you have needs to be safe.

  • You can have low risk or you can have high yield, but you cannot have both.
  • The bank or fund where you keep your cash should be safe.
  • If the yield of a money market fund goes up rapidly, it means the risk is going up. Make sure the fund is not taking undue risks with your money.
  • Look at the expenses of a money market fund. You want one with the least expenses.
  • Don’t be fooled by temporary fee reductions that will magically disappear right after you invest.
  • TIPS( Treasury Inflation Protected Securities) are risk-free and keep pace with inflation because there is a minimum chance of default, the price rises in tandem with inflation and does not fall with deflation. They have a place in your retirement fund.

5.  Make sure your bank deposits are insured.

6. Invest safely when investing in bonds

  • When investing in bonds buy bond funds with low annual expenses. The expenses should be less than 0.75% at the maximum. You can also use the 1.5% rule. (Yield+ expenses) of fund- (yield + expenses) of the category should be less than 1.5.
  • Do not chase yield as higher yield means higher risk.
  • The total return of a bond fund is equal to yield+ change in  principal value of the bond. Look for total return and not yield when investing in bonds.

7. Stocks do not really become risk free if you merely hold them long enough.

  • Your own emotions are a decent guide to future stock returns: When you think gains will be great, they are likely to shrink. When you think the world is coming to an end, stocks are probably cheap.
  • Don’t believe anyone who tells you that stocks are certain to beat every alternative in the long run. That depends on how expensive stocks are today and how cheap other assets like bonds are.
  • Invest as if stocks are likely- but not certain- to beat all other assets. Keep some money in bonds, cash, and real estate just in case they do better.

8. Follow the rules of Graham and the three commandments when investing in stocks.

Graham had three great insights:

  • Focus not on stock price, but on business value.
  • Understand Mr. Market.
  • Maintain a margin of safety.

The defensive investor does not spend a lot of time and effort in investing. The enterprising investor does. Follow the three commandments if you are a defensive investor:

  • Do not take any risk you need not need to take. Do not overinvest in company stock. Do not risk college savings by investing in the stock market.
  •  Do not take any risk that is unlikely  to reward you for taking the risk. Therefore invest in index funds rather than individual stocks.
  •  Do not put any money at risk that you cannot afford to lose. Do not invest in IPOs. Do not gamble in stocks. Be aware of the risks of investing in stocks, before you invest as the stocks can go down by 50% any time. If you cannot handle that, you should not invest in stocks.

9. Pennies saved today turn into dollars down the road – the surest and safest way of all to increase your wealth.

  • Drive more efficiently. Drive at about 55 miles per hour whenever possible.
  • Set your thermostat to 65 degrees in the winter and wear a sweater.
  • Walk or bike to work if possible. Otherwise use public transport rather than driving.
  • Make and take your lunch.
  • Cut back on dining out, and when dining out makes choices intelligently considering money and quality.
  • Quit smoking.
  • Get your videos free from the local library.
  • Use a clothes line to dry your clothes.
  • Don’t shop on an empty stomach.
  • Open your fridge only when necessary. Do not keep opening and closing it many times as it increases your electricity bill.
  • Avoid signing up for insurance, service contracts, or extended warranties on appliances and consumer electronics.
  • Manage your credit card spending wisely.

10. For college savings, don’t pick a standard 529 plan until you have ruled out a prepaid plan first. Although standard 529 plans may have tax advantages and less restrictions for wht you can use them, propaid plans guarantee a certain amount of money and a certain rate of return which is enough for most people.

11. Do not invest in leveraged and inverse ETFs. Leave them to professional traders.

12. Hedge fund returns are not what it seems to be. Carry out due diligence if you need to invest in them, if at all. Never invest with anyone who claims never to lose money, reports amazingly smooth returns, will not explain the strategy used, and refuses to disclose basic information or discuss potential risks.

13. Commodities are for trading, not investing for the long run. The money in commodities will be made by direct producers and industrial consumers, who hedge in vast volumes. It will be made by professional traders. It is unlikely to be made by the individual investors. Therefore stay away from it, unless you fall into the above categories.

14. Emerging markets are not guaranteed to produce higher returns. Research has shown that the faster a country’s economy grows, the worse an investment in its stock market is likely to be. Do not fall for the bogus argument that emerging markets are a sure bet to earn higher returns than US markets. The role of investing in emerging markets is to provide diversification, not to add to returns. Own emerging markets permanently in your portfolio. Don’t chase their returns only when they’re hot.

15. Approach any Wall Street or investing acronym with caution. Ask what the initials stand for, and if you can’t understand the full terms, don’t invest.

16. Cooperate with your wife in investing.  Women value safety, are less overconfident and are less competitive. Therefore they make better investors. They also tend to wait out market declines, rather than do something foolish. They also have the ability to look at more alternatives. Therefore managing investing together is better for the family.

17. Keep your unconscious biases from making decisions for you.

  • Resist anchors. A stock is not cheap or expensive because its price is below or above a certain number. It is cheap or expensive in relation to the fundamental value of the underlying business.
  • Control framing by reframing the data in different ways and see if it still makes sense.
  • Try to make information unfamiliar by analyzing it as if you were a stranger to the facts. See if an investment still makes sense.
  • When you think about risks, ask if you are worrying about the right thing. You may have overlooked a subtle, but more dangerous risk. Don’t just think of the probabilities and rewards of being right. Make a honest effort to evaluate the consequences of being wrong.
  • To combat the halo effect of investments, evaluate investments just by the numbers.
  • Track your forecasts to see whether you really predict well or your success is just random.
  • The most dangerous belief is to believe than you are unbiased. Remember you are prone to the same biases you recognize in others.
  • None of us is perfectly rational. We all make mental mistakes. The only way to rise above them, and to start to minimize them, is by recognizing our own human frailty. It is much harder to know yourself, truly and deeply, than you may have ever imagined.

18. Your tolerance for risk is so changeable there’s no point trying to measure it. Sleep on your investing ideas. Never act on it the same day you get it. If the market is open, your wallet should be closed. Wait till the next day to act, in order to see whether the facts still seem the same. Sleeping on your investment ideas is one of the simplest and best ways to make sure your decision is not just a momentary whim based on on moods and situations.

19. Invest plenty of time in picking a good financial adviser. It will be one of the most important relationships you ever have, so you want to make just the right match.

20. Keep crooks away from stealing your money.

  • No matter who has already signed on, there is no substitute for doing your own homework. An investment doesn’t just have to make sense to other people; it has to make sense to you.
  • If a standard, almost boring investment is repackaged into something that sounds innovative or exciting, it is most likely a scam.
  • Scamsters often use flowery vocabulary.
  • Scamsters often promise high rates of return, market monthly rates of return and talk of unfamiliar investing strategies. Remember that the annual return of Warren Buffet is around 20% per year, and that’s Warren Buffet.
  • Scamsters call to say you have won  a lot of cash and then ask you send some cash to send that cash to you.
  • Never open emails that tout high rates of return.
  • Never provide any personal or financial information to a stranger.
  • Never give or send money, by any means, to anyone you do not know.
  • Never invest on the recommendation of a friend or family member alone. Always use a checklist and sleep on it.
  • Anyone touting a monthly rate of return is highly likely to be shyster.
  • If it sounds too good to be true, it definitely is. Getting rich quickly is not just difficult or a secret art; it’s an impossibility. Anyone who tells you otherwise is a fraud.
  • When somebody calls and promotes an investment: ask whether it is a solicitation, say you never invest in something without doing your homework, ask them to send something in writing, and hang up if you feel it is a scam.

21. Earn higher returns by being inactive. Buy index funds, hold them for the long run, dollar cost average, rebalance yearly, don’t trade often and don’t chase performance. Track the performance of every investment you sell, to see whether you would have been better off holding on. The evidence suggests that trading will reduce your return by at least 1.5% per year- before tax and trading costs. Embrace funds that charge short-term redemption fees, or penalties for frequent trading. In investing, less is more.

22. Learn to pick apart financial propaganda.

  • Always ask the five questions:
  1. Who says so?
  2. How does he know?
  3. What’s missing?
  4. Did somebody change the subject?
  5. Does it make sense?
  • From any claimed return, subtract a realistic estimate of expenses( at least two percentage points per year)
  • Always be sure you have followed the Three Commandments.
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