How to achieve financial fitness forever

This post contains my personal notes and reflections from the book, ” Financial Fitness Forever by Paul Merriman and Richard Buck “.

1. There are things within your control as an investor. You can decide when to buy and when to sell. A good strategy for most people is not to buy or sell based on prediction, but to buy good diversified index funds when you have the money and sell only many decades later when you need the money.

2. There things that is not within your control as an investor. You cannot predict what is going to happen to the market, the economy or the government. Therefore do not change your course on some whim or fancy or belief or prediction. Do not get upset by trends or forces you cannot control. They can paralyze your decision-making. Focus on what you can control.

3. The role of bonds in investment is to reduce risk, nothing else. There may be many things that look like bonds, like income producing real-estate but they are actually not. There is no harm with having a 100% allocation to equities and real estate but then you must be willing to bear the risk of your portfolio falling down considerably and living with the consequences of that. You may have a large enough portfolio to do that and that is okay.

4. Investing today has become easy and costs are relatively low compared to the costs in 1960s. We have to make sure we do not squander away our advantage by engaging in counter productive activities like short-term trading if our goal is investing for the long-term.

5. We, as human beings are influenced by emotion a lot and do not always act rationally:

  • We often follow rules of thumb instead of logic.
  • We assume that whatever is happening right now is likely to continue happening far into the future.
  • We explain events using our personal experiences and stereotypes instead of reason.
  • We give more importance to recent information(” the news “) than to things we’ve known for a long time. The recent past seems much more important than the past 50 years.
  • We would rather have an answer, even if it is the wrong answer, than be left with a question.
  • We look for – and usually find – what we think are meaningful patterns in random events.
  • We think we are luckier, more skillful, and more insightful than in fact we are.
  • We have a herd mentality, and we are overly influenced by what other people are doing, even in the face of compelling evidence that this is contrary to our best interests.
  • We fail to understand statistics and probability.

When we buy a stock we do with great anticipation, hoping we have made a brilliant decision. If it goes up you love it, if it falls down you hate it. But you forget that the stock you own and love or hate is a tiny piece of some business. Its price can change a lot depending on supply or demand. When you start ascribing human qualities to such a thing, you will often make bad decisions.We will often engage in very risky behaviour because we think we have risk management tools that will prevent catastrophe.We often invest based on gut feelings. Investments need careful analysis. One of the clearest signals that you are wrong about an investment is having a hunch you are right about it.Our brains respond to changes while ignoring what remains constant. Most of the market price changes are usually noise of the market trading, but we do not ignore them.We often do not invest by asking the hard questions and doing detailed analysis. We often just ask simple questions that we can easily answer even if it does not answer whether the investment is good or not. You decide to buy or sell a stock and you create the reasons for doing so and then do what you want to do.We often do not pay enough attention and are sloppy, greedy and ignorant about a lot of things that are obvious when we invest.We are addicted to the emotional highs that profits give us and we care about how much money we might conceivably make rather than we care about the probability of making anything at all.Many studies have shown that experts don’t have any insight into the future, but we are still eager to have answers that we can easily abandon our common sense.When financial risk is lowest( when markets are at their lowest), emotional risk is highest.We think we can figure out short-price movements when usually they are random.We think we are better than we really are. We think we have beliefs and capabilities that we don’t have. We think we can predict the future but we really cannot.Our emotions prevent us from rebalancing and selling losers.We are not willing to say we don’t know.

6. It is better for us as investors to trust academic research, rather than the financial media, Wall Street and your neighbours and family regarding our investments.

7. In the long run, it is difficult to beat the market. Yes, a small proportion can but for most it is not possible. In the quest of trying to beat the market, we will often end up underperforming the market. The key things to do are to constantly and periodically invest in the market using index funds. Don’t try to time the market. Think in terms of decades. Be diversified. Buy more of an asset class when it falls in price.

8. When equities fall a lot, bonds will rise or usually fall a little only. If you have bonds, your risk will be lower. But your return will also be lower in the very long run. So for someone who wants to invest for a long time, 100% stocks may be okay, but you have to remember that long means 30 or 40 years, not 10 years.When we really lose money, it is different from theoretically talking about losing money. So remember this and that is why, it may be better to own both stocks and bonds.

10. Diversification with index funds or even actively managed mutual funds reduces a lot of risk.

11. Markets are unpredictable. Over the very long-term the world’s stock markets have had a uptrend and this likely to be true over the long-term. We can always analyse the past and say what we should have done. But it is difficult to do the same for the future. In the short run, the market’s response is exaggerated. The best way to deal with the short-term market response is to ignore it. The markets reward perspective and patience. No investment approach  works best every year.

12. You are taking a lot of emotional risk in investing if:

  • You are losing sleep over your investments.
  • You feel compelled, not just curious to watch the financial news and check fund prices daily or weekly.
  • The financial news makes you worry about your future.

13. In good and bad times, successful investing is bout managing risk and managing your emotions. If you can do this well, you are well on your way to success.

14. The best way to make investing easy and to protect oneself from oneself is to make everything automatic: automatic savings every month( invest a fixed amount every month), automatic stock selection( index funds or an actively managed fund that you will invest for the long-term), automatic rebalancing regularly among your asset classes( say x% equities and y% bonds, x+y=100%) and when the time comes to reap the harvest, automatic withdrawal( say 2% -4% of your corpus every year).  This way you will be financially free for the rest of your life and possibly even for generations.

15.  The best in investing: Three great books on investing are: Mutual Funds for Dummies by Eric Tyson. The Little Book of Common Sense Investing by John Bogle. Your Money and Your Brain by Jason Zweig. The best mutual fund families are Vanguard and DFA. The best 1 fund portfolio is Vanguard STAR fund. The best 2 fund portfolio is Vanguard Global Equity Fund and Vanguard Total Bond Market Index Fund. The best target rate retirement funds are bought from Vanguard. The best source of information on mutual funds is The best asset class to own in the future would be small cap value( Vanguard small cap value, Wisdom Tree International Small Cap Dividend Fund, and the DFA funds( small cap, international small cap and emerging markets small cap value). The best investment strategy is the strategy that you will actually carry out and the one that keeps you within your comfort zone and many of us may need a financial advisor for that. You can get good source of investment advice from: Vanguard, T.Rowe Price. You can get very good retirement planning advice from The best financial writer may be Jason Zweig. The best person to predict the future may be Fama and French. The best bet to beat Buffett over the long run would be a value manager with global exposure to large-cap, mid-cap and small-cap value stock funds.

16. Do not invest in futures contracts. Do not invest in high-load, high expense mutual funds. Do not trust commissioned sales people. Do not invest in variable annuities and equity indexed annuities.

17. Three recent films that show the worst ways of Wall Street are:

  • Enron: The Smartest Guys in the Room
  • Inside Job
  • Too Big to Fail

18. The worst mistakes you can make as an investor are:

  • Trusting advice from others without understanding the investment process.
  • Trying to beat the market.
  • Believing that investing is too complicated and difficult to understand.
  • Taking too much risk and then ditching your long-term plans when a bear market turns confidence into panic.
  • Waiting to get started.

19. Twelve numbers that will change your life are, regarding how to plan for your retirement:

  • Your current cost of living.
  • The rate of inflation you assume for the future.
  • Number of years before you plan to retire.
  • Your inflation-adjusted cost of living after you retire.
  • Retirement income you can count upon
  • Retirement income you will need every year from your portfolio
  • Portfolio you will need at retirement
  • The current size of your investment portfolio
  • Your annual retirement savings
  • The annual return you will need from now until you retire
  • The overall stock allocation of your portfolio now
  • The amount of risk in your portfolio now

20. The five key attitudes of successful investors are:

  • Trust: You need to trust in what you invest and you need to trust in a better future.
  • Resilience: You need to be willing and able to bounce back even from serious adversities.
  • Perspective: You need to deal competently with small and big things, to tell the difference between what is important and what is unimportant and look beyond short-term concerns and focus on success in the long run.
  • Patience: The most successful investors understand that time is their ally and they can wait for results.
  • Common sense: You need to have good common sense. If you hear about an investment that offers very good returns without any risk, you can be certain that you are missing something. If an investment is really as wonderful as it is made out to be, why hasn’t it been snapped by full-time money managers. Why no pension funds have equity indexed annuities. The importance of saving. All this is common sense.

21. The six key habits of good investors are:

  • Successful investors know where they are going and set goals for getting there.
  • Successful investors make plans to achieve their goals, and then follow the plans.
  • Successful investors save regularly and routinely.
  • Successful investors make a practice of delaying gratification and living below their means.
  • Successful investors have emotions, but they don’t let greed blind them, and they don’t let fear spook them.
  • Successful investors expect setbacks and stay in the game anyway.

22. Asset allocation

  • This means the % in stocks and the % in bonds.
  • Stock %= 100- age( very conservative)
  • Stock % = 110 or 120 – age( better)
  • If your age is less than 35: 100% in stocks. At age 35: 90% in stocks( aggressive), 80%( conservative). Then every 5 years decrease % is stocks by 5%. At age 40: 85% in stocks( aggressive), 75%( conservative) and so on. You can stop this reduction when you reach 60% stocks( aggressive) or 50%(conservative).
  • A less optimal option is to buy a target date retirement fund( this will have little exposure to international, small company and value stocks and are overweighted in fixed income)
  • You can also start by determining how much of your portfolio, in percentage terms, you will be willing to lose without abandoning your long-term strategy. For this you need access to historical returns for many decades. This table: Fine tuning your asset allocation is an example.
  • Or you can look at how much return you need to achieve your goals and fine tune your asset allocation accordingly. But remember not to take too much risk ans stay within your comfort zone and save more, work longer, live on less in retirement or work part-time in retirement.
  • If you are in retirement and worried about the risk of stocks, put enough of your portfolio into bond funds so that the interest meets your cash flow needs. Then put the rest into stocks. If inflation increases you cash flow needs, then withdraw from the stock portion of your funds.
  • If you have accumulated enough assets to meet your needs, then scale back your level of risk to become more defensive.
  • One portfolio for life would be a 60% global stocks/40% bonds portfolio for life.
  • Keep a portion of your funds in safe assets like government bonds so that you are sure that you will not lose that portion.

23. Important practical strategical ideas:

24. For more ideas go to Paul Merriman’s website.


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