"The Smartest 401(k) Book You'll Ever Read"--A Gem

[Taylor Larimore]

Hi Bogleheads:
Daniel Solin is a securities arbitration attorney and financial advisor. His latest book is easy to read and about much more than the title suggests. I have selected these "Investment Gems" to help make us better investors:

"If we don't start doing a better job of managing the nation's retirement wealth, in another 10 or 15 years, we could be facing a social crisis that dwarves the Great Depression in terms of magnitude and duration." (Center for Fiduciary Studies)

The current retirement system benefits brokerage firms, brokers, pension consultants, insurance companies, insurance agents, the mutual fund industry, and employers. Employees get the short end of the stick. This must be changed."

"Employees are stuck with high-cost plans filled with underperforming investment choices that make it extremely difficult to reach their retirement goals."

"Smart investing is very simple: Focus on your asset allocation. Invest in a broadly diversified portfolio of low-cost index funds or ETFs. Avoid nearly all annuities and expensive, hyperactively managed funds."

"Your goal is to capture market returns. They are superior returns, based on all historical data. They are yours for the taking."

"One study looked at over 23,000 funds in the Morningstar data base over an 11-year period. It found that an average of only 14% of top-performing funds were able to repeat that performance in the following year."

"If you only remember one cardinal rule about investing, this is it: Lower costs directly relate to higher returns."

"The average actively managed fund has an expense ratio of 1.50%. The average index fund has an expense ratio of only 0.25%."

"Unfortunately, the daily media grist of hype and hysteria that promotes certain stocks and actively managed mutual funds influences many investors."

"During one 15 year period, 91% of institutional money managers who were overseeing more than 200 major corporate pension funds -- couldn't beat a portfolio that sank 60% of its assets into the S&P 500 Index and 40% into the Lehman Brothers Aggregate Bond Index."

"One study looked at 237 market-timing investment newsletters from 1980 to 1992. Almost all of the newsletters went out of business by the end of the study."

"Another study of mutual funds selected by Morningstar for its own 401(k) plan found that these funds significantly underperformed a broad U.S. market index for the period 1991-99."

"Add picking "hot" mutual funds to your list of bad investment practices. It's just as bad as stock picking or market timing."

"During the past 20 years, the S&P 500 stock index generated an annualized yearly return of 11.8%. -- But during the same period, Dalbar determined that mutual fund investors captured an average yearly return of a paltry 4.3%."

"Your portfolio should consist of a mix of different classes of stocks and bonds."

"Most people don't gather investments in any sort of systematic way. They collect their financial goodies based on emotions, tips, or conventional wisdom."

The data supporting the wisdom of investing in index funds and not trying to 'beat the markets' with hyperactively managed funds is so extensive and overwhelming that just listing it could fill up a book."

"You can get as simple or as complicated as you'd like. You can keep it very simple by owning just three mutual funds that invests in domestic stocks, foreign stocks, and bonds. That's precisely what I recommend in my model portfolios."

"When constructing a portfolio, nothing is more important than your asset allocation."

"Research shows that asset allocation accounts for 90% or more of the variability of your returns."

"Any pension fund manager who doesn't have the vast majority in passive investments is guilty of malfeasance, nonfeasance or some other kind of bad feasance!"

"Selling your winners and buying the losers (rebalancing) is a prudent way to keep your portfolio in good shape, but it's a very hard thing to have the discipline to do."

"If you don't want to do your own rebalancing, you can simply invest your retirement savings in one of the Vanguard Target Funds."

"Once you understand this history, you start to appreciate that the primary beneficiary of 401(k) plans is the employer."

"Highly compensated consultants are quietly paid to steer companies into picking expensive, underperforming funds for inclusion in 401(k) plans."

"Enron workers had close to 58% of their money sunk into that corporate scallywag when its stock dropped nearly 99%."

"A minimum savings rate of 15%, including your employer's match, is critical for a successful retirement."

"Most 401(K) plans are 'dumb plans.' They offer a bevy of high-expense-ratio, underperforming, hyperactively managed mutual funds and precious few low-expense-ratio index funds, ETFs, and passively managed funds."

"Select investment for your IRA to compensate for the weakest, or missing, links in your 401(k)."

"Step back and think of all your retirement holdings as sitting in one big pot."

"30% of your stock assets should be in an international stock index fund and the balance should be in a broad domestic stock index fund that uses the Wilshire 5000 as its benchmark."

"To the extent possible, you should try to put bonds in tax-deferrred or tax-free account and put stocks in taxable accounts."

"Consider transferring company stock in your 401(k) into a taxable account and taking the tax hit instead of transferring the stock to an IRA."

"Just because the advisor sitting across from you was hired by your company doesn't mean you should trust him with your financial future."

"According to Forbes magazine, the mutual fund industry is the world's most profitable as it earns a consistent 30% pretax profit."

"In September 2007 the Harvard School of Business and the University of Oregon released a devastating study that made stockbrokers and advisors look like a bunch of bozos. Individual investors earned a yearly return of 10.54% for their stock funds during the period from 1996-2004. The brokers' clients? They mustered a yearly return of 8.04%."

"The financial field is rife with impostors. Almost anyone can call himself a "financial expert.' Beautificians face higher certification hurdles than financial advisors."

"Work exclusively with fee-only advisors: It eliminates a huge conflict of interest."

"Bill Bernstein (a Boglehead) is generally regarded as one of the most astute financial minds of our time."

"Any advisor who tells you she can 'beat the markets' is about to beat you out of your retirement nest egg."

"If you feel you need a financial advisor, make sure the advisor is an RIA (Registered Investment Advisor) who will focus on your asset allocation and the use of low-cost index funds for your portfolio."

"There is no doubt that employees would be immeasurably better off if their 401(k) plans adopted the basic features of the (government) Thrift Savings Plan."

If your 401(k) plan does not give you the option to invest in at least three broad-based low-cost index funds and a range of Target Retirment Funds, you have a subpar plan."

"If you invest in a Roth IRA, you don't have to worry as much about whether taxes will skyrocket because you won't owe taxes on this money when it's withdrawn."

"Investing in an IRA is a smart option for most investors."

"If you're just starting out, you might want to select an all-in-one Lifecycle or Target Retirement Fund that spreads your money across a wide swath of investments."

"If you name your spouse as the beneficiary of your IRA, they get to treat the inherited IRA just like it was their own--a major benefit."

"403(b) plans and annuities--They make 401(k) plans look good!"

"403(b) plans offer worse investment options than the high-expense-ratio, underperforming, hyperactive managed funds that populate most 401(k) plans."

"Annuities are particularly bad investments within a plan, where the tax deferral they offer is like wearing a raincoat indoors."

"School lounges around the country host a daily feeding frinzy, as annuity salesmen descend upon teachers like vultures, pitching their retirement products."

"Don't assume your union or administrator has your best interests at heart when it endorses 403(b) investment options."

"The costs of 403(b) annuities can range from 2 to 5 percent-putting these investments squarely in bloodsucking territory."

"There's a notable exception to high-cost annuity providers: TIAA-CREF. Think of it as the 'Vanguard' of annuity providers."

"Variable annuities rarely make sense for investors in 403(b) plans or outside of them.

"Equity indexed annuities (EIAs) are the new flavor of the month for annuity salesmen.--They're not suitable for anyone."

"Equity indexed annuities have as much chance of making investors rich as a handful of Monopoly money."

"If you can't afford to lose any cash, stick with money market and/or an FDIC-insured certificate of deposit."

"Explore available options for escaping your high-cost annuity."

"New regulations (January 1, 2009) should improve your 403(b) plan, but you need to remain vigilant."

"One kind of annuity might be an appealing option for those who want to create a steady and reliable income stream in retirement: An immediate annuity."

"An immediate annuity will essentially tranform all or part of your retirment savings into your own individual pension -- you don't have to worry about outliving your assets."

Vanguard offers a low-cost immediate annuity that does adjust for inflation, which may be worthy of consideration."

"An immediate annuity is a permanent decision-you can't revoke it. So it is important to keep a portion of your portfolio in liquid investments."

"There is no motivation for employers, 401(k) advisors, and the mutual fund industry to disturb the lucrative and cozy system that is working so well for them. It is up to you to make something positive happen. Lobby for a better 401(k) plan."

Thank you Dan Solin!

You can read more "Investment Gems" here:

http://www.bogleheads.org/forum/viewtopic.php?t=881

Best wishes
Taylor

[MR_Rossi]

Thank you for posting this Taylor. I found several of these gems useful.

MR

[DocHolliday]

"Any advisor who tells you she can 'beat the markets' is about to beat you out of your retirement nest egg."

That is perfect.

Thanks for the all great gems.

[Hondo]

"Smart investing is very simple: Focus on your asset allocation. Invest in a broadly diversified portfolio of low-cost index funds or ETFs. Avoid nearly all annuities and expensive, hyperactively managed funds."

... Yes, and unfortunately it took me many expensive years to learn this simple truth.

[OptionAl]

Thank you, a very good list, not just bromides.

But I wonder what his rationale is for (1) a 70/30 domestic international split (wants to avoid too much currency risk?) and (2) recommending the non-inflation adjusted Vanguard annuity (assumes you shouldn't do it until a late age, hence inflation is less of a long term risk?).

[Ducks]

Thanks for posting this, Taylor. This sounds like a great book.

Now if only I could get TPTB at my husband's company to read it...!!

[tfb]

I'm not very impressed by Solin's book. He basically just repeats and repackages what others said with very little original content of his own.

[rich]

Thanks for the gems Taylor!

There is one quote I don't understand.

"Consider transferring company stock in your 401(k) into a taxable account and taking the tax hit instead of transferring the stock to an IRA."

Can someone explain why it make sense to do this? Thanks!

[Taylor Larimore]

Thanks for the gems Taylor!

There is one quote I don't understand.

"Consider transferring company stock in your 401(k) into a taxable account and taking the tax hit instead of transferring the stock to an IRA."

Can someone explain why it make sense to do this? Thanks!

Hi Rich:
Mr. Solin devotes an entire Chapter explaining when and how this is done. Here's a portion:

"You leave your company with 1,000 shares of company stock that you purchased at different prices over the years. Today's share price is $50, so today your stock is worth $50,000. The cost basis however is just $10,000.

You're in the 35% tax bracket, and you rolled the stock and everything else in your 401(k) into an IRA. Years later, you sell the stock in your IRA for $75,000 and withdraw these funds. The federal tax bite, based on your tax bracket, would be $26,250 (assuming current tax rates).

In contrast, if you had stuck those stock shares in a taxable account when you quit your job, you would have paid an income tax of $3,500 and a $1,000 penalty, both based on the cost basis.

But when you sold the stock, your profit ($65,000) would have been taxed a the vastly preferable long-term capital gains rate of 15%. You'd have paid $9,750. When you add that to the tax and early withdrawal penalty you paid earlier ($4,500), your total bill would have been $14,250.

That's a lot better than $26,250."

Best wishes.
Taylor

[LHerr]

" His latest book is easy to read and about much more than the title suggests. "

Taylor,

I checked Amazon and I see he wrote one by a similar title in 2006. Are you referring to his 2008 book? Thanks for identifying which book you are recommending.

LHerr

[statsman]

"To the extent possible, you should try to put bonds in tax-deferrred or tax-free account and put stocks in taxable accounts."

In general, the comments I read are "if you have enough room for your entire bond allocation, put it in the tax-deferred accounts". But is this always true? Even if your bond allocation would fill up your tax-deferred accounts, wouldn't you still want some stocks in your tax-deferred accounts?

My last question is based on the belief that you want your tax-deferred accounts to be as large as possible heading into retirement. Going with all bonds would seem to limit its possible growth compared to having some stocks and some bonds in the tax-deferred accounts.

I guess the downside would be having to hold more tax-exempt muni bond funds in your taxable accounts, and some here seem to dislike that selection in their portfolios.

[rich]

Hi Rich:
Mr. Solin devotes an entire Chapter explaining when and how this is done. Here's a portion:

"You leave your company with 1,000 shares of company stock that you purchased at different prices over the years. Today's share price is $50, so today your stock is worth $50,000. The cost basis however is just $10,000.

You're in the 35% tax bracket, and you rolled the stock and everything else in your 401(k) into an IRA. Years later, you sell the stock in your IRA for $75,000 and withdraw these funds. The federal tax bite, based on your tax bracket, would be $26,250 (assuming current tax rates).

In contrast, if you had stuck those stock shares in a taxable account when you quit your job, you would have paid an income tax of $3,500 and a $1,000 penalty, both based on the cost basis.

But when you sold the stock, your profit ($65,000) would have been taxed a the vastly preferable long-term capital gains rate of 15%. You'd have paid $9,750. When you add that to the tax and early withdrawal penalty you paid earlier ($4,500), your total bill would have been $14,250.

That's a lot better than $26,250."

Thank you!

[retired at 48]

Thanks for the gems Taylor!

There is one quote I don't understand.

"Consider transferring company stock in your 401(k) into a taxable account and taking the tax hit instead of transferring the stock to an IRA."

Can someone explain why it make sense to do this? Thanks!

Hi Rich:
Mr. Solin devotes an entire Chapter explaining when and how this is done. Here's a portion:

"You leave your company with 1,000 shares of company stock that you purchased at different prices over the years. Today's share price is $50, so today your stock is worth $50,000. The cost basis however is just $10,000.

You're in the 35% tax bracket, and you rolled the stock and everything else in your 401(k) into an IRA. Years later, you sell the stock in your IRA for $75,000 and withdraw these funds. The federal tax bite, based on your tax bracket, would be $26,250 (assuming current tax rates).

In contrast, if you had stuck those stock shares in a taxable account when you quit your job, you would have paid an income tax of $3,500 and a $1,000 penalty, both based on the cost basis.

But when you sold the stock, your profit ($65,000) would have been taxed a the vastly preferable long-term capital gains rate of 15%. You'd have paid $9,750. When you add that to the tax and early withdrawal penalty you paid earlier ($4,500), your total bill would have been $14,250.

That's a lot better than $26,250."

Best wishes.
Taylor

A contrarian viewpoint. Most people do not just sell $75,000 of stock from an IRA, later.

Rather, how about this. Most peoples goal is to retire comfortably at some future date. Their savings and investment performances dictate when this date is, along with social security and pension income. Some may retire early. But the goal is a comfortable annual income withdrawn from the IRA that makes this early retirement possible.

I feel a $75,000 shot is too high. Most probably need much less a supplement. So the government has created this IRA investment vehicle that let's one accumulate the monies the fastest (ie no taxes along the way), yet perhaps pay the piper more later. I vote for getting to that retirement date, the fastest, then worry about minimizing taxes. Heck, I generally pay zero taxes, most years, with substantial IRA's.

Most should rollover into IRA's, IMHO.

R48

[Adrian Nenu]

I did not read Solin's book "The Smartest 401(k) Book You'll Ever Read" but a friend of mine who did e-mailed me and stated that Solin recommended Fidelity. That's not too smart in my book.

Adrian
anenu@tampabay.rr.com

[Taylor Larimore]

I did not read Solin's book "The Smartest 401(k) Book You'll Ever Read" but a friend of mine who did e-mailed me and stated that Solin recommended Fidelity. That's not too smart in my book.

Adrian
anenu@tampabay.rr.com

Hi Adrian:
I have read both of Mr. Solin's books. In his first book he recommends three model portfolios. The first is Vanguard, next Fidelity, last T. Rowe Price (not alphabetical).

Here are excerpts:

"It was Bogel and Vanguard who created the opportunity for all investors to invest for the market returns."

"Both Fidelity and the Vanguard Group are well-known and highly reputable firms."

"You can open an account with Vanguard by going to www.vanguard.com.

"Throughout this book, I have used Fidelity and Vanguard as the primary examples for two reasons. First, they are among the largest and most well-known fund families. Second and more important, currently they have the lowest annual fees attached to the index funds that I recommend that you use."

My overall opinion is that Mr. Solin recommends Fidelity and Vanguard evenly. You can judge for yourself by reading "Investment Gem" excerpts from his first book here:

http://socialize.morningstar.com/NewSocialize/asp/FullConv.asp?forumId=F100000015&lastConvSeq=54472&t1=1214686481

--------------------------------------------

This second book "gem" by Dan Solin has Mr. Bogle's endorsement on the front cover:

"Dan Solin's wonderful book explains why the idea of tax-deferred retirement plans is so good and why so many plans are bad. Read it, attend to its cautions, act on its recommendations, and when the time comes, enjoy a comfortable retirement." --John C. Bogle

I helped Dan by reviewing and editing this second book before it was published. Again, I detected no favoritism for Fidelity in his book or in our discussions.

There is more than one road to Dublin.

Best wishes.
Taylor

[statsman]

"To the extent possible, you should try to put bonds in tax-deferrred or tax-free account and put stocks in taxable accounts."

In general, the comments I read are "if you have enough room for your entire bond allocation, put it in the tax-deferred accounts". But is this always true? Even if your bond allocation would fill up your tax-deferred accounts, wouldn't you still want some stocks in your tax-deferred accounts?

My last question is based on the belief that you want your tax-deferred accounts to be as large as possible heading into retirement. Going with all bonds would seem to limit its possible growth compared to having some stocks and some bonds in the tax-deferred accounts.

I guess the downside would be having to hold more tax-exempt muni bond funds in your taxable accounts, and some here seem to dislike that selection in their portfolios.

Anyone? No opinions?

[Gregory]

I'm not very impressed by Solin's book. He basically just repeats and repackages what others said with very little original content of his own.

Additionally, his last book (The Smartest Investing Book You'll Ever Read, which it certainly was not) devoted space to the risks of small cap value, but I could find nothing about large cap value within its pages. That book was not aimed at a sophisticated reader.

I agree, his stuff is repackaged. If there are any novel financial insights, they're not glaring.

[dave.d]

statsman --

Taylor and I had a discussion about this on the old board, with my taking your stated view originally. There is a very impressive paper (with 3-dimension graphs etc.) by Damon, Spatt & Zhang (you can Google it, I'm sure) on this question, which proves (on certain important assumptions) that Taylor's recommended asset location is correct. One of the assumptions of that DSZ paper is that you are saving at a high rate compared to the size of the portfolio, which means you can rebalance with new money. But that assumption demolishes the only real advantage of stocks in tax-exempt, which is tax-free rebalancing.

Taylor's quote is absolutely right, at least for the usual cases: an accumulator who can rebalance with new money, and a retiree who will be able to sell stocks in taxable for rebalancing at low capital gain rates. I think there are only two needs that will ever justify holding stocks in tax-protected while also holding bonds (tax-exempt, of course) in taxable: short-term need for funds, and to avoid taxes on rebalancing where new savings will be small compared to the portfolio.

My wife and I are in our peak expense years, with three kids at home and the biggest house and cars we'll ever own; our net savings rate is roughly zero but we are contributing at full capacity into IRA's and a 401k by spending simultaneously out of taxable assets. Our portfolio is mostly taxable (so rebalancing boundary would naturally be there), but I won't have new savings to rebalance, and any sale of stocks in taxable to rebalance will incur maximum capital gain rates (soon to be worse than they are now). I hope to retire in about 10 years. In light of all this, I have chosen to hold about 20% of my stocks in tax-protected, figuring that I will have just about exhausted those in rebalancing over 10 years. Market goes up, I sell stocks in tax-protected; market goes down, I buy stocks in taxable. The plan is, at retirement I'll be down to 0% of my stocks in tax-protected.

[Taylor Larimore]

Hi Statsman:

In general, the comments I read are "if you have enough room for your entire bond allocation, put it in the tax-deferred accounts. But is this always true? ".

I shy away from "always" because there is usually some exception. Nevertheless, there is seldom a better place for bonds than in tax-deferred accounts.

Even if your bond allocation would fill up your tax-deferred accounts, wouldn't you still want some stocks in your tax-deferred accounts?

Nearly all authorities recommend placing taxable bonds in tax-deferred accounts and tax-efficient stocks in taxable accounts when we have both type accounts. Both bonds and stocks benefit from being in tax-deferred accounts when there is room for both.

I might add that our retirement accounts hold only bonds and a REIT fund. Our stock funds (except REIT) are all in our taxable account.

I hope this answers your questions

Best wishes.
Taylor

[retired at 48]

statsman...don't forget that a legacy with stocks in the taxable accounts gets a step up in basis for tax purposes, per current law. Watch for this to be repealed, however.

The thread has been bandying about the word "stocks." Are you meaning stocks, or stock mutual funds? Where is all this stock buying coming from?

R48

[statsman]

dave.d, Taylor, R48,

Thanks for the responses. I'll do a search on the old discussions to review them.

Maybe this one?

http://wpweb2.tepper.cmu.edu/spatt/location.pdf

[HerbertSitz]

I did not read Solin's book "The Smartest 401(k) Book You'll Ever Read" but a friend of mine who did e-mailed me and stated that Solin recommended Fidelity. That's not too smart in my book.

I haven't read Solin's 401(k) book. But in his book, "Does Your Broker Owe You Money" he says:

". . . you should be wary of advisors who do not at least consider Vanguard or DFA as the best option for most invetors." (at p. 238)

[pitt76]

The fact that he is a columnist for the Huffington post makes me a little leary. I did read his 2006 book and it is basically a total rehash of everything on this site and the books recommended here. If you read these books , you could skip his.

[baw703916]

dave.d

Taylor and I had a discussion about this on the old board, with my taking your stated view originally. There is a very impressive paper (with 3-dimension graphs etc.) by Damon, Spatt & Zhang (you can Google it, I'm sure) on this question, which proves (on certain important assumptions) that Taylor's recommended asset location is correct. One of the assumptions of that DSZ paper is that you are saving at a high rate compared to the size of the portfolio, which means you can rebalance with new money. But that assumption demolishes the only real advantage of stocks in tax-exempt, which is tax-free rebalancing.

Thanks for pointing out that paper. One of the underlying assumptions they make is about the implied tax rate given by the differential yields between risk-free tax-exempt and taxable bonds. For this number they use the long-term historical average of 25% (in other words, tax-exempt bonds have 75% of the yield of taxable bonds).

But for the last nine months or so, things have been stood on their head:

As of 6/30/2008:
Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares (VWITX): Duration: 5.1 years, SEC yield: 3.72%
Vanguard Intermediate-Term Treasury Fund Investor Shares (VFITX) Duration: 5.1 years, SEC yield: 3.49%

So right now, the implied tax rate is negative! That makes a lot of conventional wisdom go out the window, as least for the time being...

If there is no yield penalty for buying tax-exempt rather than taxable bonds, why wouldn't you buy the tax exempt and put equities in tax-advantaged?

Best wishes,
Brad

[statsman]

If there is no yield penalty for buying tax-exempt rather than taxable bonds, why wouldn't you buy the tax exempt and put equities in tax-advantaged?

I suppose the reason might be that the tax-exempt muni bonds are considered more risky than the taxable Treasury bonds, although you are receiving a better yield with the tax-exempt at the moment (and that doesn't include the tax savings).

If we started retirement with a portfolio that was 50% tax-deferred and 50% taxable and our AA was 50/50, I would be inclined to have 50% stocks and 50% bonds in both the tax-deferred (with taxable bonds) and in the taxable (with tax-exempt bonds).

But that's just me, and as we all know, I am not a Boglehead.

[Taylor Larimore]

But that's just me, and as we all know, I am not a Boglehead.

Hi Statsman:

Keep reading and learning and I am confident you will become a "Boglehead" like the rest of us.

Best wishes.
Taylor

[CABob]

Thanks for the "Gem", Taylor. You are fast. Amazon doesn't have the book listed yet, but, I found it on Barnes & Noble.

Bob

[NOLA]

Just finished the book and I liked it. Like someone mentioned before, it seems like it wasn't any new material but it was helpful for me. One question that I have, do you really need a DFA advisor (that might charge 1%) if you are gonna invest in the big 3 portfolio anyway to avoid charges? Who knows, DFA funds might outperform a lot of index funds over the next 10 years, but doesn't he contradict himself a little bit?