10 Rules for Financial Success from Burton G. Malkiel
This post goes over the 10 Rules For Financial Success from Burton G. Malkeil’s book The Random Walk Guide to Investing.
Malkeil is a professor at Princeton, but more importantly, he wrote the best selling book A Random Walk Down Wall Street, which showed how low cost index funds beat out expensive managed funds.
Basically he’s saved a lot of hard working people money by showing them the benefit of cutting out the excessive fees of money managers.
What I liked about this book is that it was written to help people do their investing without the middle man, including links to the Treasury, Index Funds, and other valuable resources.
It also goes over everything a beginner investor needs to get started.
Rule #1 Start Saving Now, Not Later: Time is Money
If you start saving money earlier, it has longer to grow at a compounded rate of return.
It is often hard to comprehend the difference time can make, so he has an example to prove his point:
Twin brothers have 2 different saving strategies.
The first twin started saving $2,000/yr every year since he was 20 years old until he was 40 years old. Then he stopped saving.
The second twin started saving $2,000/yr every year since he was 40 years old until he was 65 years old.
Their savings grows tax-free at 10%.
At 65 Years old, how much money does each twin have in their savings account?
The first twin has $1.25 million dollars.
The second twin has less than $200,000.
Even though the second twin saved more money, he still came out with $1,000,000 less than the first twin, because of the time compounding.
Rule #2 Keep A Steady Course: The Only Sure Road to Wealth is Regular Savings
He has some strategies to help you find ways to save, especially when you think you can’t.
Pay yourself first with automatic payroll deductions into retirement accounts. That way you never see the money and don’t think about spending it.
Find a Save More Tomorrow Plan. This is a plan where every time you get a raise at work, you increase your retirement savings contribution until you are up to the maximum limit.
Make Out a Budget – Track your spending at least for 2 to 3 months, if not all the time. Just looking at what you are buying you can see if you are buying things you need or things that you just wanted at the time.
Change a Spending Habit or Two. See if you can spend less on movies, eating out, auto insurance…
Think in Terms of Opportunity Costs. What you spend money on today is taking away from future investment income.
Be Saving In Your Spending. Use coupons, shop at discount stores, drink water not soda.
Pay Off Your Credit Card Balance. That’s a very high interest rate that you are paying. It’s higher than most investments you can find, so pay it off first.
STRATEGIES FOR CATCHING UP
Downsize Your Lifestyle and Start Saving Now
Consider Pushing Retirement Back a Few Years
Make the Most of Your Home Equity
RETIREMENT PLANNING WEBSITES
Rule #3 Don’t Be Caught Empty-Handed: Insurance and Cash Reserves
Be sure to have cash reserves. Set aside money enough to cover 3 months worth of expenses.
You can put it into different savings vehicles such as money-market funds, Bank Certificates of Deposit (CDs), Internet Bank savings accounts and Treasury Bills.
Be sure to have Term Life Insurance if you have dependents like your spouse and your children.
If you are single, Malkiel advises not buying life insurance as there are better investments.
Rule #4 Stiff the Tax Collector
Retirement
Pay as little as you can in taxes by using IRA accounts and other retirement accounts that will inhibit taxes being collected on the money you are saving.
Traditional IRA allow you to make deposits and if your income is low enough, you don’t pay taxes on your deposits until when you are forced to make distributions at retirement age.
Roth IRA allow you to make deposits (after tax) and your gains can be withdrawn at retirement tax free.
Pension plans and 401Ks are employer sponsored plans that allow for deposits (pre tax) and you are taxed when you take distributions at retirement.
Here are his recommended Priorities in Saving For Retirement
First: Contribute to your employer 401(k) or 403(b) up to the limit for matching contributions.
Second: Contribute to your employer plan, or an IRA, or your self-employment Keogh plan, or other available tax advantaged retirement plan from your employer up to the maximum contribution limit set by the government that will be tax-deductible.
Third: Fund your IRA. Even if it is not tax-deductible, any earnings will accumulate tax-deferred, and everyone who can should make contributions up to the limit allowed.
Fourth: Once you have maxed out on all other tax-advantaged opportunities, you could consider a variable annuity contract, which does have the advantage of tax deferral. Only use low-expense ones, without sales charges.
Fifth: Buy tax-exempt bonds issued by entities within your state and buy common stocks through tax-efficient index funds.
Education
There are also tax free savings for education in 529 plans, Education Savings Accounts and Education Savings Bonds (I and EE).
Buy Your Own Home
The best strategy he recommends is to buy your own home.
At the time he wrote the book, there were great tax deductions you could take for owning your own home as opposed to renting.
One is that you are not taxed on realized capital gains on your home up to $500,000 for joint filers.
Rule #5 Match Your Asset Mix to Your Investment
Invest only the amount that will let you sleep at night.
If you are too invested in the stock market and you get stressed out, then change your allocation so you won’t think about it anymore.
Every person’s risk tolerance is unique to their personality.
He uses an example that if you are very risk averse, even if you are in your thirties, then do a more conservative strategy. He says 50% bonds and 50% stocks may be appropriate.
Overtime, if the stock market shoots up in value, you can then sell off some and use the money to buy bonds, until you are back at your 50% allocation.
This is called rebalancing.
Rule #6 Never Forget That Diversity Reduces Adversity
There’s actually 2 kinds of diversity that Malkiel discusses: Asset Class and Time.
Asset Class Diversity
Malkiel recommends investing in many different kinds of stock and real estate bonds.
The reason for this is that you don’t know if the company or real estate you are investing in is going to succeed or fail.
In addition, diversify by buying not only stocks, but also bonds, keeping cash reserves and real estate investment trusts.
He cites an example where an employee from Enron invested all of her retirement money into Enron stock, and it all vanished when Enron suddenly went out of business.
In this way, you bring more stability to your investment portfolio.
Time Diversity
Diversifying over time means investing with small regular deposits over many years.
This strategy of investing beats out investing in chunks of money at random times, or trying to time the market.
The reason is because if you are always buying at regular intervals, then you are buying during both up (when stocks are overpriced) and down markets (when stocks are underpriced).
Hence, over time you will make the average return for the market, which has been on the rise.
This is called Dollar-Cost Averaging.
Rule #7 Pay Yourself, Not the Piper
Here is where Malkiel recommends removing middle men and increasing the money you keep, and decreasing fees paid to others.
The first thing he recommends is to pay off credit cards, as their interest rates are very high. As he puts it, where else are you going to get an 18% return on your money?
The second thing he recommends is to only invest in low cost mutual funds. Management fees can eat up half of your earnings over time.
If you know exactly what you stocks you want to buy, then he recommends using a discount broker, as they charge much lower fees than a typical broker.
Rule #8 Bow to the Wisdom of the Market
The market is smarter than us because it already incorporates all of the data from world events, to earnings, to investor sentiment and on and on in real time.
Malkiel argues that there is no way for any individual to know what the market will do and they won’t have access to this type of information.
He points out that most managed investment funds underperformed the market. Most day traders lose money.
Even though there are some who did well, there is no way to know who they will be.
In addition, the great investor Warren Buffet didn’t buy just stocks, he bought whole businesses and oftentimes got actively involved in the businesses to turn them around when they had difficulties.
So in this sense, Warren Buffet is actually a businessman, and not a typical investor or money manager.
If you are someone who is investing and you do not have specialized business skills like Warren Buffet, then it is best not to try to beat the market, but to mimic it.
Rule #9 Back Proven Winners: Index Funds
Index investing is nothing more than a strategy of buying a fund that holds all, or a representative sample of all, the stocks in a broad stock-market index.
He recommends investing in all stocks in the market, instead of trying to pick winners.
Data demonstrates that if you invest this way, you will beat 90 of all investors, including the professionals.
Advantages of index funds are that they:
- Simplify investing – just buy everything
- Cost-efficient – the index funds he recommends have no sales charges and minuscule expense charges. In addition, they do a minimal amount of trading, thereby reducing your trading fees.
- Index funds regularly produce higher returns for investors than managed funds
- Predictable – they are the market, so you will make the same returns as the market over time.
- Tax-efficient – Index funds do minimal trading, and hence reduce short term capital gains and taxes on growth.
There are various types of indexes: top US companies (S&P 500 index) and top tech companies (Nasdaq 100) are just two of the most popular ones.
ETFs (Exchange Traded Funds)
Malkiel explains what ETFs (exchange traded funds) are and why average investors who make regular investment deposits should avoid them.
The reason is that ETFs incur transaction fees every time you buy them, and there are also dividends issued. If you use index mutual funds, you avoid all of these fees.
Total Market Index Funds
Malkiel recommends investing in the entire market with a Total Market Index fund.
Here are some that he recommends:
Fidelity Spartan Total Index – http://www.fidelity.com
Schwab 1000 Investor – http://www.schwab.com
T Rowe Price Total Equity Market Index – http://troweprice.com
TIAA-CREF Equity Index Fund – http://www.TIAA-CREF.org
Vanguard Total Stock Market Index – http://www.vanguard.com
Total Bond Indexes
Dreyfus Bond Market Index – Basic – http://www.dreyfus.com
Schwab Total Bond Market Index – http://www.schwab.com
USAA Income Fund – http://www.usaa.com
Vanguard Total Bond Market Index Fund – http://www.vanguard.com
Real Estate Mutual Funds
At the time, Malkiel said there weren’t many index funds for real estate. The only one is the Vanguard fund which he helped to create.
The other funds recommended here were based on lower expense ratios, though you have to verify them to be sure they are still low. He listed funds that have expense ratios of 1% or less, with Vanguard being the lowest.
Cohen & Steers Realty – http://www.cohenandsteers.com
Fidelity Real Estate – http://www.fidelity.com
TIAA-CREF Real Estate Securities Fund – http://www.tiaa-cref.org
Vanguard REIT Index Fund – http://www.vanguard.com
Allocations
He recommends investing in more stocks of you are young and just starting your working career.
Then if you are older he recommends converting stocks into income producing assets such as real estate investment trusts and bonds.
Rule #10 Don’t Be Your Own Worst Enemy: Avoid Stupid Investor Tricks
There are common patterns of investor behavior that lead to losses in investing.
Overconfidence – studies have been performed that show people tend to be pretty confident that their abilities are better than others.
This explains why people think they can beat the market, and that day trading will make them rich. It also explains why we have money managers running investment funds.
The best way to handle overconfidence is to recognize it.
Herding – we want to be a part of something and don’t want to miss out.
Thus we tend to follow the crowd.
If everyone is investing in Bitcoin, tulips, tech stocks or whatever is the next greatest investment, we feel like we should too…even if we know nothing about it, have no guarantees of a return or even getting our money back at all.
Illusion of Control – studies show that people tend to think they have control over things that they really have no control over.
In investing, people will hold onto losing stocks that they’ve chosen, longer than is wise.
They will feel that they have the ability to make money in the market by being in control, choosing stocks, etc.
Malkiel reminds us that no one person controls the market.
Loss Aversion – people tend to fear losses more than they are overjoyed by gains.
Investors thus tend to take more risks to avoid losses, than to achieve gains.
They will keep their losers (because if they sold them then they would have to admit that they made a mistake), and they will sell their winners because that lets them enjoy the success of being correct.
Susceptibility to Hot Tip Investing – there are no hot tips for the average investor, don’t listen or follow them.
Gin Rummy Behavior – Buy and hold. Constantly switching from fund to fund will only rack up fees and transfer costs. Just leave your investment alone!
Believing in Foolproof Schemes – nothing is fool proof. Beat most investors by mimicking the market
Ignoring Costs – people tend to overlook fees, and yet they are extremely important when it comes to growing your investment returns.
Conclusion
I hoped you enjoyed this blog about the 10 Rules For Financial Success from Burton G. Malkeil’s book The Random Walk Guide to Investing.
I learned some key points in the book, especially that I could go directly to the US Treasury to buy bonds and other types of US debt (http://www.publicdebt.treas.gov).
The biggest insight was why I hold onto loser stocks and sell winners!!!
I am going to be honest with you, that it was a bit of a struggle writing this post as I’ve been reading the book by Robert Kiyosaki titled Who Took My Money?
In Kiyosaki’s book he has a very compelling argument on why buy, hold and diversify will lose you money.
However, upon further review, I realize that most people won’t invest like Robert Kiyosaki suggests (he even says his book is for people who want to be rich).
Most people won’t spend the time to acquire the business and real estate skills.
Most people would lose their money if it weren’t for Mr. Malkiel’s groundbreaking work, and his insights on how most money managers will never beat the market.
The average worker did lose money, in expensive mutual funds.
The average investor might try to invest in only one stock, the one at their own company.
Malkiel’s work has influenced companies to provide low cost index funds to their employees, as well as structured dollar cost averaging strategies such as payroll deductions into retirement accounts.
About Mey Duldulao
Back in 2011 I had over $30,000 in credit card and line of credit debt, was living paycheck to paycheck and was stressed out over my lack of success in my financial life.
In April of 2016, I became debt free and had a monthly passive income stream.
I quit my job on December 23, 2016, and started doing my dream work of mentoring others on what I did to create the freedom to quit my job.
In 2017 we bought our first condo in Waikiki, and we went on 5 weeks of vacation (including a 7 day cruise to the Mexican Riviera)!!!
In 2018 we bought our first investment property and we converted our first condo into our 2nd investment property.
In 2019 we sold an investment property to buy our dream home steps away from Waikiki beach.
I spend most of my time doing what I dreamed of for years, spending my days with my son Jordan and my husband Jomel, enjoying motherhood and being a wife.
I also enjoy researching Financial Freedom and sharing what I learn with my clients and on my blog.
If you want to learn more about how I can help take back control of your money and your time, then CLICK HERE, watch the free video and get started!