The New Rules of Money

88 Simple Strategies for Financial Success Today

Ric Edelman

• Publisher: HarperCollins e-books
• Year: 2010
• ISBN:
  9780062013538
• Topic: Personal Development
• Subtopic: Personal Finance

Are You Playing By the New Rules?

Forget what you know about personal finance. The old rules no longer apply. Ric Edelman's 88 strategies, tailor-made for today's economy, will show you how to achieve financial success. Ric is famous for making personal finance fun, and you'll discover how easy it is to put his advice into action!

Is it smart to buy company stock with your 402 (k) plan? Discover the right way to handle your company retirement plan.
See Rule #85

Learn why you must carry a big, long mortgage -- and never pay it off!
See Rule #21

Learn why not to invest in the new Roth IRA-and discover the most powerful anti-tax investment available today.
See Rules #69 and #76

Planning to retire? Learn why you won't -- and what you must do instead.
See Rule #88

Find out why those who invest in S&P 500 Index Funds will wish they hadn't.
See Rule #36

Learn why that higher - paying job could actually cost you money.
See Rule #32

the new investment strategies

RULE
#26
DON’T REFUSE TO SELL ASSETS MERELY BECAUSE THEY HAVE DROPPED IN VALUE.

It’s astounding how often people tie their sense of self to the investments they make. If an investment falls in value, they feel like a failure, and they won’t sell the asset because doing so would be admitting that they’ve failed.

If they hold on, they figure, the investment might recover, maybe even turn a profit. If it did, their sense of self-worth would be restored.

Unfortunately, investments don’t care how you feel about them. Mathematically speaking, it is twice as difficult for an investment to rise as it is to fall, and you need to understand this simple principle.

Say your $75 stock drops by 50%, to $37.50. In order for a $37.50 stock to climb back to $75, it must gain 100%. So it takes a 100% gain to offset a 50% loss. This is one reason why investments that fall often don’t return to their original values—and if they do, it takes much longer.

This is why you must be willing to sell an asset that has fallen in value. “Holding on” conjures up images of clinging to a rope for dear life—and investing need not be so melodramatic. If one of your investments has failed to live up to expectations, or if there are better opportunities elsewhere, cut the rope.

RULE
#27
STOP TRYING TO BE RIGHT, PART 1.

I remember a call I once got from my client Betty. “I want to buy gold,” she announced.

A rather unusual request, I thought. “Why?” I asked.

“Because I think gold is going to rise!” she gushed.

“Okay,” I said. “But is it going to rise any faster than the investments you already have?”

“Sure!” she proclaimed. “I think gold’s going to hit $500 an ounce!” At the time, gold was trading for about $300. A move to $500 would be a gain of 67%.

“How long will it take for gold to get there?” I asked.

“Not too long,” Betty said. “Within five years.”

Well, I told her, going from $300 to $500 over five years is an annual return of 10.8%.

“Is that all?” she asked, somewhat deflated. After all, that’s no better than what she’d expect from her current investments, and actually a bit worse than she actually had been earning.

Which was my point. When it comes to investing, being right is often not enough. You must be so right that being right justifies the gamble you plan to make. In most cases, that gamble just isn’t worth it, because being right isn’t likely to put you any further ahead than if you had simply ignored the whole idea in the first place.

RULE
#28
STOP TRYING TO BE RIGHT, PART 2.

My friend John, 35, doesn’t save much of his money. Although he earns $45,000, he barely contributes to his company retirement plan, and he has little money in the bank. He figures he doesn’t need to save much.

You see, when John does save, he picks highly speculative investments that he thinks will produce super-high returns. So, last time I spoke with him, he owned half a dozen stocks, and he had invested about $1,500 in each one. John figures three will go bust, two might make average returns, but one has got to be a winner—the kind of stock grandchildren talk about.⁵⁸

Let’s assume John is right. Say that over the next 30 years, three of his stocks bomb, two earn 10% per year, and the sixth hits a home run—quickly doubling in value, then quadrupling and quintupling, eventually settling down to become one of the best stocks of the early 21st century, earning an incredible 20% per year for the entire 30 years.⁵⁹

The results? As John enters retirement at age 65, he finds himself with $408,400. Considering he started with just $9,000, that’s pretty amazing. But is it really all that much money?

Not when you contrast John with Mary. She knew she would be unable to pick the next Microsoft—so she didn’t even try. Instead, she saved regularly, putting 10% of her $45,000 salary into mutual funds for 30 years. Like John, she got a 4% raise each year, but unlike John, she earned a mere 7.5% annual return on her investments. The results after 30 years? She has $835,000—more than twice as much as John.

Stop trying to pick the one hare. It’s no substitute for choosing lots of turtles.

RULE
#29
STOP KEEPING SCORE.

Joe, a client worth about $1.5 million, wanted me to look at a deal he was considering. It’s a new cable TV operation, he said, and it was being offered to only a few people. He heard about it from his lawyer,⁶⁰ who represents the sponsors of the deal.

“How much do they want you to invest?” I asked.

“One hundred fifty thousand,” he replied.

“And how much do you expect it to earn?”

“Well,” Joe answered, “they’re projecting nothing for the first year, and then a 15% return for years two through five. They’d then sell after the fifth year, and investors would receive back their capital plus any profits.”

“So after six years, you’ll have gotten $90,000 plus any profits. How much are they estimating the profit to be?”

“They think they’ll be able to sell for twice what it’s costing to build,” he said.

“Then that’s another $300,000. So all told, your original investment of $150,000 would return $390,000 over six years.” I did some fast math. “That’s an internal rate of return of just under 20%. I can see why you’re attracted to this, Joe, but tell me, how risky would you say this investment is?”

“It’ll probably be all or nothing,” he said. “It’s definitely a gamble.”

“Would you say that this investment is riskier than your current investments?”

“Much! But actually, that’s part of the fun. If it works, I’ll make a lot of money.”

“And what will that do for you?”

Joe paused on the other end of the phone. “I don’t get your question,” he offered.

“Here’s what I mean, Joe. Let’s say you’re right, and over the next six years, your $150,000 turns into $390,000—boosting your net worth from $1.5 million to $1.9 million. What will you do with the newfound money? Will you use the money to buy a new house?”

“No, I just moved a year ago. You know that.”

“Will you retire earlier than you otherwise would?”

“No.”

“Will you buy a new car? Eat out more often, or at more expensive restaurants? Will you do anything that you will not otherwise do anyway?”

“I see your point,” he replied. “No, making this profit will not change anything for me.”

“You’re right, Joe, it won’t—especially considering that your money is already earning in the low double digits,” I explained. “The difference over six years between what this investment offers and what you’ll have anyway, by just doing what you’re already doing, isn’t all that significant. Do you agree?”

“Yes,” he said.

“Then let me ask you this, Joe,” I said. “How much extra money would you need to have in six years in order for this investment to produce a really meaningful difference to you? I mean, you’ve just said that having a net worth of $1.9 million wouldn’t cause you to retire or buy a new house. What would get you to do that?”

“I might retire if I had $3 million,” Joe said.

“Okay, that’s exactly what you told me three years ago when I first produced your financial plan,” I said. “Now, on that basis, how much would you have to invest in this deal in order for it to return $1.5 million in six years—thereby giving you the $3 million net worth that you’d need so you could retire?”

“I don’t know,” Joe said. “How much?”

“Based on your projections of how well the investment would do, you’d need to invest almost $600,000. Are you willing to invest six hundred grand—40% of your net worth—into this deal?”

“No, of course not,” Joe answered. “That’s too much money.”

“But that’s what it would take, Joe, to make this deal worthwhile for you. Because if you invest $150,000 and it works, it will have absolutely no effect on your lifestyle. Therefore, the investment is pointless and not worth doing. But if you invest $600,000 and it fails—which is quite possible—the effect on your lifestyle would be devastating, wouldn’t you agree?”

“Absolutely,” he said. “I probably wouldn’t be able to retire for an extra 10 years!”

“Then the conclusion is clear, Joe. You should not participate in this investment. Winning won’t help you, but losing would hurt. That’s a poor combination for an investment.”

“But the deal sounds like so much fun,” he said. “And it would be neat to pick such a winner.”

“Yes, Joe, but investments are supposed to be designed to contribute to your lifestyle—either present or future—or to help you achieve some personal goal. If you’re not accomplishing that with your investments—if you’re picking investments simply because you think they’re going to make money, or if you’re leaving your money untouched because you like to watch it grow, or because you want to be able to say you are worth a certain amount (not for any particular reason, mind you, other than you just like the way it sounds)—well then, you’re not engaging in financial planning. All you’re doing is keeping score.”

Keeping score matters only when you play games, and playing games is something you do for fun. And fun is supposed to be an activity whose outcome has no impact on your life. So if you’re starting to demand fun from your investments, it’s time you started a new hobby. Leave your investments alone, and seek fun elsewhere.

RULE
#30
KNOW WHEN IT’S TIME TO STOP CLIMBING THE MOUNTAIN.

I was very impressed with Jack and Candy. When I first met them, Jack had already been retired for a year; Candy had always been a stay-at-home mom. They put five kids through college on his working-class salary, and have never received an inheritance. Still, they owned a portfolio worth more than $1.2 million.

“How’d you do it?” I asked. I love to hear rags-to-riches stories.

They looked at each other as if they didn’t know, hoping the other would have the answer. “We just saved all our lives,” Jack said, rather embarrassed.

“We were careful with our mone...

Table of contents

• Cover
• Title Page
• Dedication
• Contents
• How to Use This Book
• Foreword
• Preface
• Your Income, Expenses—and Debt
• The New Rules Regarding College Planning
• Mortgages, Home Ownership, and Real Estate
• The New Investment Strategies
• Your Family, Money, and the Law
• The New Tax Rules
• The New Insurance Rules
• The New Rules of Retirement
• Searchable Terms
• Acknowledgments
• About the Author
• Praise
• Copyright
• About the Publisher