The Elements of Investing with Guest, Charley Ellis

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney

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The Elements of Investing with Guest, Charley Ellis
Jim Lange, CPA/Attorney
Guest: Charley Ellis, PhD
Episode 97

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TOPICS COVERED:

  1. Introduction of Guest – Charley Ellis, PhD
  2. Why Choose Index Investing Over Active Management?
  3. Paradigm About Fees
  4. Importance of Investment Policy
  5. Market Timing Is A Wicked Idea
  6. Choices For The Whole Experience Of Life And Living
  7. Vanguard Has Consistency of Success

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.


1. Introduction to Guest – Charley Ellis, PhD

David Bear:  Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks.  I’m David Bear, here in the KQV studio with Jim Lange, CPA/Attorney and author of two best-selling books, “Retire Secure!” and “The Roth Revolution: Pay Taxes Once and Never Again.”  We are honored to welcome a financial industry giant to this edition of The Lange Money Hour.  Charley Ellis was founder and for 28 years, managing partner of Greenwich Associates, a world leader in strategy consulting in institutional financial services.  A faculty member at Yale, Charley’s authored eleven books on investing including his best-selling classic, “Winning the Loser’s Game,” currently in its fifth edition, and “The Elements of Investing,” which he co-wrote with Burton Malkiel.  A strong proponent of index investing, Charley believes that most active investors fail to achieve market returns, that they pay too much for investment advice and services, and that those higher costs lead to lower returns.  He presently serves as managing principal of Partners of ‘63, a group of Harvard business school grads dedicated to working together again, pooling skills, networks and resources to make a difference on a pro bono basis.  Stay tuned for an interesting and informative hour, and with that, I’ll say hello, Jim and welcome, Charley.

Jim Lange:  Welcome to the show.  Charley, your most recent book, “The Elements of Investing: Easy Lessons for Every Investor,” and again, for people who are listening and like what you’re going to say, it’s again “The Elements of Investing: Easy Lessons for Every Investor” with a co-author Burton Malkiel and Charley Ellis.  But you also wrote “The Loser’s Game,” which is the great classic, and John Bogle, who was recently on the show, wrote about the kindest forward I think I’ve ever read from any book.  It was really impressive.  And many of the concepts John Bogle writes about, in fact, he’s in your recommended reading, are some of the same things that you talk about and Burton Malkiel talks about, and a lot of the discussion really revolves around index investing, and I know that you even believe that even with all the brilliant people out there, with all the computer analysis and people timing the market by milliseconds and everything else, you still believe in index investing.  Can you tell us why?


2. Why Choose Index Investing Over Active Management?

Charley Ellis:  Sure.  The reason why is because of all those wonderfully talented, very hard working, highly educated, very sophisticated, very well informed, extraordinary individuals who are professionals in investment management competing with each other to try to figure out in advance what is the best price for this particular security or that particular security.  They are, by nature, competitive people.  They are, by the accident of birth, extraordinary individuals in terms of acuity, brainpower, ambition to do things really, really well, and they’re highly motivated because they are competitive and the score is kept on a regular basis.  And they have access to wonderful technology.  Internet, for an example, is a very standard kind of device to be using all day, every day.  Bloomberg machines that give you access to all the historical information on any dimension you’re really interested in whatsoever in economies, in currencies, in stocks, industries, individual companies, it’s just terrific the access they have to having all the really right tools to do better in the market.  And because they’re competing with each other, and they are unrelenting in their competition, and they’re constantly comparison shopping all over the marketplace all the time, because of that, the irony is when there are enough of them, and there are enough of them, and they’re good enough, and they are good enough, and they work hard enough, and they do work hard enough, they figure it out well enough that it really doesn’t pay to try to figure out even better than they have done what is the right answer in terms of what is the right price?  And the nice thing about index funds is you just latch on to all the work they’ve done over all the years that they’ve been working with all the knowledge they’ve accumulated and ­all the hours they put in every single day.  You get the benefit of all of that free of charge, and you have the world’s most capable investors out there working for you at no expense to you, except the minor cost of an index fund, which is way less than the cost of an active manager.  So, you start out every day with a competitive advantage that they can’t catch up to.  And that competitive advantage is, it costs you less than it costs any investor who insists on using an active manager.  Then, if you get into details, there’s another round that gets pretty, pretty hard, and that is if you take any randomly selected twelve-month period, I don’t want to be fixed on a single calendar year, but just take a twelve-month period.  The data shows that about 60% of active investment managers fall short of the market return that they are trying to match.  So, if they say, “I’m a growth stock manager,” they fall short of the growth stock section.  If they’re a small cap manager, they fall short of the small cap manager.  If they’re a value manager, they fall short of the value index.  So, 60% in a twelve-month period?  You say, “Well, that’s too short.  Give me a longer time period?”  Fine.  Move it up to ten years, and the average is about 70% fall short. 

David:  Hmm!

Charley:  And then, if you say, “Well, gee, the last ten years have been pretty tough.  How about longer than that?”  Well, okay, if you went to twenty years, you’re certain to run out of really extensive, rigorous data, but by the time you get to twenty years, it looks as though 80% fall short.  And that’s just the first half of the story.  The second half of the story is that those who beat the market beat it by less than those who fall short.  So, if you under perform the market, you under perform by about one-and-a-half times as much as those who outperform the market.  If you believe in slugging average, it’s not just that 60-70-80% fall short, but they fall short by more than those who come ahead.  So, it’s just not a very good bet or proposition in anybody’s right mind who was able to say, “Look, I can get the market rate of return.  I’ll pay 10-15, maybe 20 basis points cost to have that market rate of return, but I know for sure, it’s the market rate of return and no more than the market level of risk, and that’s something I can have.  Now, let me see what you’re trying to get me to switch over to with active management.  You want me to pay the fee that is 5, 6, 7 times as much as the fee I’m now paying, and there will be errors and mistakes made, and when the errors and mistakes are made, some of the times, it’s really going to hurt.  Why in the world would I do that?  I’d much rather have low-cost, high value, high assurance index funds,” and as you very well know, more and more people, day after day, institutional investors who are very sophisticated, individual investors who are savvy, are shifting their investing over towards indexing because it works. 

Jim:  Well, the other thing that, when you said the 70%, and if you’re talking about mutual fund managers as John Bogle points out, that’s of the mutual funds that have survived, and the ones that are out of business aren’t even in those statistics, I assume.

Charley:  Well, also, Jim, you have to pay attention to taxes.  If you look at the actively managed mutual funds, their turnover is about 110% a year.  That means that they’re going to be incurring a lot of relatively short-term gains, when they do have gains.  And those are taxable at ordinary income rates.

David:  Umm-hmm.

Charley:  So, you have a very different tax drag if you have active management.  Index funds typically turn over about 5% a year, and a well-managed index fund will match gains and losses so that there actually is virtually no tax, and that’s really worth paying attention to if you’re a taxpayer. 

Jim:  Well, it’s particularly important.  As a CPA, I can tell you the frustration that clients have from what we call ‘phantom gains,’ meaning they’re not buying or selling the fund itself, they’re just sitting on the fund and the fund is generating taxable income for them, even though they don’t really have anything to show for it, so to speak. I would agree with you there.  But I guess what you’re really saying is that you think that we should trust the markets and that markets work? 

Charley:  Well, I do believe that markets work.  I don’t believe that it would be right for most people, most people hearing “You should trust the markets,” they would say, “Wait a minute, wait a minute!  I’ve seen what the market did in the financial crisis.  That didn’t look trustworthy to me.  I’d like something that was more trustable than that kind of gyration in the market.”  I can be very empathic with anybody who says that because they did go through a very, very difficult experience.  But the whole system went through that difficult experience, active managers, passive managers, index funds, large cap, small cap, value growth didn’t make any difference.  There was no hiding place.  Everybody went through a terrible disruption.  So, if you want the market to be sweet, kind, gentle and highly consistent over time, that’s just not available, just isn’t available, any more than you could hope to read the daily newspaper and have nothing but favorable, positive stories.  It just isn’t the way newspapers come out.  So, markets will go up and will go down, and there will be difficulties along that nature.  But if, over time, you wanted to have an experience that was as good as you could get, because the long-term, everybody knows the long-term returns and investments have been very, very pleasing.  If you wanted to have the largest chance of having that long-term experience be yours, then you will turn to indexing. 

Jim:  Well, I know you are an index guy, but you are very kind to the active money managers.  You said they’re highly educated, they work very hard, and they’re actually brilliant, and you said all types of nice things, which is a little bit different than Rex Sinquefield of Dimensional Fund Advisors, who says that “There are three classes of people who do not believe that markets work: the Cubans, the North Koreans and the active money managers.”  So, you’re actually being very kind to the money managers, even though I know that, in your soul, you are truly an index investor, and believe that people should be…

Charley:  Wait, wait, wait, wait, wait, wait, wait…

Jim:  All right, sorry.

Charley:  I’m being accurate twice.  I believe I’m being accurate that you will not find in any other constituency a group of people who are smarter or harder working or better educated or better informed or have better devices and tools to be able to keep right at the frontier of knowledge than the investment managers of the active investment management community.  Now, the fact that many of them are personal friends of mine is part of it, part of it is that I admire them very greatly, there are lots of extraordinary people who are drawn to and fascinated by and worked hard all through their careers in active management.  All I’m drawing the point is to say, and the net result of it is that they do such a good job, that there’s no reason for anybody to pay a full fee to be able to compete and try to do better.  It’s much smarter to say, “Yes, and I can get at a low fee access to all their talented work, and I’m going to do that.”  That, to me, is the main thesis.  I think Rex Sinquefield is definitely right about the Koreans and the Cubans don’t believe in free markets, but if you do believe in free markets, you know that they do have a tendency to figure it out, and once they figure it out, you don’t want to compete against the markets and say, “No, you must be wrong.”

David:  In the conversation we had with John Bogle, he actually indicts the whole financial industry, pretty much, from top to bottom, as people who are not following their fiduciary responsibilities to ultimately the client, and so one asks, we have all these bright people, but what’s their motivation?  And often, it seems like it’s to make as much money as they possibly can for themselves. 

Charley:  Well, there is real, legitimate truth there, but I don’t believe that there are very many people who would say to you, “I’m doing something that I don’t think is really the right thing for me to be doing for my clients.”

David:  Umm-hmm.

Charley:  “And I’m over charging them.”

David:  Umm-hmm.

Charley:  You might say that.  I might say that.  But I don’t think people in any sense would say “I know that what I’m doing is not the best that I could do, or the best that could be done, and if you ever turned the lights on, I would be embarrassed to admit that I’m doing what I’m doing.”  You know, I know Jack Bogle.  I’ve known him for, gee, forty years.  We’ve been very open friends back and forth.  I agree with Jack on many, many things.  But indicting other people and giving to them a different value set, I think that’s going too far.

David:  Umm-hmm.

Charley:  These are people who are really good at what they’re doing, and they’re trying to do really good work.  They just have a difficult time recognizing that the competition is so very, very good that they’ve wound up in a position of charging more than the service is really worth.

David:  Right.

3. Paradigm About Fees

Charley:  So, before we finish the conversation, I want to give you a quick paradigm on how to think about fees.  I’ve only recently figured out myself, and I’ve not been able to get anybody else to figure it out with me.  You know, there’s a lot of, sort of, oh gee, that’s interesting, and then walk past it.  And I think it is really central to this question.  Let me try it with you.  If the fees for active management are a little over 1%, which is the typical of mutual funds, maybe 120 basis points, or 1.2%.  Take that as the fee.  You say, “Wait a minute.  Say that again?”  Well, the answer is, “Charley, we’re charging you 1.2% fee, and it’s only 1.2%.”  I said, “Wait a minute.  Only 1.2% of what?”  “Well, of assets.”  Well now, listen for a minute, Jim.  Those are my assets. You must be offering me something other than my assets.  “Oh yeah.  We’re offering you a service, and the service is…”  “Well, is the service the returns?”  “Yes, actually Charley, that’s right.  The services will get you good returns.”  Okay.  The consensus in the market place these days is a return of something like 7% over the next decade would be on average, with lots of fluctuations around it, on average probably a realistic expectation.  So, what’s that fee as a percent of 7% return?  Well, 1%, it would be 15%.  If it’s 1.2%, it would be closer to 20%.  That sounds like a pretty high fee, 15% to 20% of the returns.  Well, it’s very hard work and we really have a lot of talented people doing it and it’s very, very difficult to do and it is expensive to produce, you know?  And I say, “Well, you know, I studied economics, and I remember my economics professor said, ‘All prices are relative.’”  “Well, what do you mean?”  “Well, price relative to value, and price relative to value compared to price relative to value.”  “Help me with that again?”  “Well, let’s start with a commodity product: index funds.  You can attain that for twenty basis points.  The custom product, active management, costs 120 basis points, right?  So, the incremental fee is a full 100 basis points, or 1% of the assets, or 15% of the returns, or it’s 100 basis points.”  “Now, tell me what the incremental return is that I would get active management?”  “Ooh, we don’t think about it that way, Charley.”  “Well, think about it that way just for a few minutes.  Here’s a pencil and paper.  You can figure it out.  Mathematically, how much higher return do you get from active management, incrementally, for that incremental fee of 100 basis points?”  “Well, the answer is, on average, it’s a negative number.  It’s not a positive number.  Active management actually deletes a little bit of return.”  “My goodness!  You mean, the fee is something like 100% of the value added?”  “Well, that’s one way of expressing it.  Yes, it is…the incremental fee, 100 basis points, is equal to or greater than, typically greater than, the incremental return.”  “You mean, this is a service that isn’t quite worth what it costs?”  “That’s one way of phrasing it.  We do provide also broad diversification.”  “Yes, so did index funds.”  “”Continuous management attention.”  “Yes, so do index funds.”  “Custody services and reliability, accurate reports.”  “Yes, so do index funds.”  So, what’s happened is that the fee structure that got larger and larger and larger, and got up to 120 basis points, fairly normal for mutual funds, is so large that even the brilliantly talented hard-working investment managers working in active management can’t do better by enough to cover the cost of the fee.  And the fee for active management actually is in excess of, but more than 100% of the value added.  That is a confrontation that the investment profession and the investment industry have not yet come to grips with, and I have to admit that I didn’t figure it out after being in the business for almost fifty years!  I didn’t figure it out until I was sitting in a conference room one day watching the slides from an active manager.  I realized, good lord!  I studied economics when I was in college!  I should have figured it out long before this.  The only consolation I’ve had is, nobody else had figured it out either! 

Jim:  And the other thing is, that’s just for the fund for the…

David:  That year.

Jim:  …the expenses for that year.  That’s not talking about your own individual situation, and then, maybe after the break, we can talk about some of the things that people should be thinking about.

Charley:  Love to.

David:  All right.  Yeah, so let’s take that break now. 

BREAK ONE

4. Importance of Investment Policy

David:  And welcome back to The Lange Money Hour with Jim Lange and Charley Ellis.

Jim:  And we are talking about a number of concepts, including indexing, and probably the most recent book that Charley wrote that would be very helpful to all our readers is “The Elements of Investing: Easy Lessons for Every Investor.”  And that’s a little bit of an easier read than Charley’s classic book, which I would still recommend, which is “Winning the Loser’s Game,” and that’s by Charley Ellis, and “The Elements of Investing: Easy Lessons for Every Investor,” that is written by Burton Malkiel and Charley Ellis.  So, right before the break, we were talking about some of the costs of the mutual funds, but that didn’t include any personal service to the client, and I know that you have written that it’s just not really purely investment return, and you actually cite four areas that either clients themselves if they are do-it-yourselfers, or money managers…and I don’t mean active money managers, but I really mean investment advisors that could potentially help a client with.  One is to understand the client’s real needs, number two: define realistic investment objectives, number three: establish the right asset mix for each particular portfolio, and number four: develop well-reasoned policies designed to achieve the client’s objectives.  And there’s just so much wisdom in all of those.  One of the things I thought maybe you could talk a little bit more about is the importance of investment policy, which you actually say is the foundation upon which portfolios should be constructed and managed.  What do you mean by ‘investment policy,’ and why is it so important, Charley?

Charley:  Well, let me step back just a second, Jim.

Jim:  Fair enough.

Charley:  If my fingerprint is so unusually different from everybody else’s, then I could go to prison based on my fingerprint if I committed a crime.  Likewise, the iris of my eye is so unique that even the federal government, this country and many other very carefully controlled countries in terms of border control, will let me into the United States on the basis of my iris, period.  Absolute positive identification.  In a similar way, it’s my belief that every individual investor in one dimension or another, usually in several different dimensions, differs from every other investor.  What’s some of the characteristics?  How much wealth do you have?  How old are you?  How many members of your family do you feel responsibility for and what kind of care and attention?  For some, it may be college education or graduate studies.  For some, it may be they’ve got a debilitating illness and they need help.  Some, it may be a trivial little incidental thing that you do because you’d like them to have a little bit of fun while they’re doing whatever they’re doing.  What kind of knowledge do you have about investing?  And we all differ on that spectrum.  What kind of emotional behavior do you have under duress, pressure, either negative pressure or positive pressure.  When the market’s gone way up, do you tend to get enthusiastic and positive?  When the market’s gone way down, and down, and then down again, do you tend to get upset and distressed?  Do you get frightened?  Or are you Mr. Calm?  All these things make us individually unique, and figuring out who we are, and then setting the policies that will work well for us as individuals, can pay enormous long-term returns simply by helping us avoid making mistakes that we otherwise would make in those moments of pressure when most of the mistakes in the world get made.  So, having some clear policies that you are going to follow through thick and thin, and the only way to get those policies is first, to think about who you really are, and then to examine history back over time and say…and I don’t mean the last couple of weeks of history.  I mean, the last decades and decades of history.  Under the most stress-generating moments, would you have been able to sustain the policy?   That’s the policy at the highest level of match to you, that you can live with, that will have the best chance of returning the results that you most aspire to have.  But don’t set your policy on the basis of what you aspire to without being very careful, to be sure that you have absolutely convinced yourself that you will be able to live through those stress points.  When your policy’s being tested, and people are telling you you’re wrong, and all the data that you normally look at tells you, “I think I might be wrong,” are you going to be able to be cold enough, calculating enough, rational enough, at that time, to stay with it?  Now, I was thinking of trying to make enough of a return in the market so that I could eat well, but then, I realized I also like to sleep well.  What do you, Mr. Expert, advise?  And the advice was own stocks up to, but not above, the sleeping point.  And that’s one way of getting at the same kind of a thing.  Be fair to yourself, true to yourself, don’t expect yourself to be the best you could ever be.  Take yourself as you are.  I’m 5’10”.  I’ve got brown eyes.  I’d much prefer to be 6’2” and have blue eyes.  Tough break, Charley.  It just ain’t going to happen.  Fine.  In the same way, you’ve got to be realistic about who you are as an investor so that you don’t put yourself in a position to be hurt later on.  Same thing in skiing.  If you’re a great skier, you’re seventeen years old.  You’ve got steel spring legs.  You can go on the Double Black Diamond trails and have one fall all day.  Fabulous!  If, on the other hand, you’re forty-four years old, you’ve never been skiing before, and you would like not to have a terrible thing happen to you, you probably don’t want to have anything to do with those other trails, and don’t want to go anywhere except what’s called the bunny slope, where it’s a very soft snow and very little incline, and you will never go very fast.  In fact, you will almost barely move at all, but you’ll be happy about it, and you and your seventeen-year old son can, at the end of a day, say, “Wasn’t the scenery beautiful?”  And it would be.  “Wasn’t the snow nice?”  And it was.  “Weren’t the gate attendants really nice at the lifts?”  Yes, they were.  “Wasn’t the food terrific?”  Yes, it was.  “Isn’t it glorious to be skiing?”  Yes, it is.  But you had two completely different experiences because you’re two completely different people, and you sort of stayed in league with who you really are.

Jim:  And I think you pointed out what was really important, and I’ve heard this in different forms from different people, that when you do set a course, that you stay on the course. 

Charley:  Don’t set a course you won’t comfortably be able to stay on when the going gets tough.

David:  But shouldn’t there be some possibility for reevaluation of the course as you go along?

Charley:  Not because of what happens in the market. 

David:  Ah-hah.

Charley:  Only because if something happens to you. 

David:  Gotcha.

Charley:  So, if you set out and you say, “This is the course for me,” and you’re twenty-five years old, I can promise you by the time you get to be seventy-five, you will have had reason to make some modifications and some changes.


5. Market Timing Is A Wicked Idea

Jim:  Right, but I think one of the things that you really rail against is market timing.  In fact, one of your quotes was “Market timing is a wicked idea.  Don’t try it EVER,” which is pretty strong. 

Charley:  Well, it should be very strong because the record is that even the smartest people, who work full-time in investment management get it wrong.  It’s dreadful.  When you look at the history of mutual fund investors behavior, what do they do at the top of the bull market when prices are really, really, really high?  They pile in.  And what do they buy?  They buy the most likely to drop off stocks.  The ones that are the most exciting at the top of the market?  Maybe.  Internet market was one of those, and then they go through a dreadful drop down in values, losing money, losing money, losing money, ‘till they get to the point of saying, “Damn it!  I’ve had enough.  I’m getting out of here!”  They sell out at the bottom, then the market starts going back up again and they’re in cash, and they miss it again.  And the amount of pain that individuals and professionals, individuals worse than professionals in this case, can inflict upon themselves by trying to beat the market, is notorious.  It’s dreadful.  And while it may be true that some people actually get it right once in a while, nobody in history has gotten it right on a regular basis.  Nobody in history!  And we ought to take at least a little bit of benefit of the other person’s pain and anguish and say, “I can learn a lesson from that!  If it hurt them that badly and they were trying the best they could, I don’t have to do that.”

Jim:  And another one of your quotes, I really like a lot of your quotes, and this also came from your book, again, the book “The Elements of Investing: Easy Lesson for Every Investor,” by Charley Ellis and Burton Malkiel, is you say “Only liars manage to be out of the market during bad times and in during good times.”  So, that’s one of your slightly less generous statements. 

Charley:  Well, remember the purpose of “Elements of Investing” was to put down in print what people, who are on their own as investors in 401(k) plans, IRAs, whatever, that they need to know on one absolute requirement.  Everybody who is not nuts about the investment business, not reading and thinking about it all the time, not reading the Wall Street Journal on a regular basis, whatever, normal people, rational, sensible, sane people, in my view, but normal people don’t have a hell of a lot of time that they could spend reading about what you should know about the stock market.  Okay.  What if you said, “We’re going to write a book that can be read comfortably, even by somebody who lip reads, in less than two hours?”  That is the book called “Elements of Investing.” 

Jim:  Which I, by the way, would give an unqualified recommendation that all our listeners should buy, and very frankly, if anybody buys it and isn’t happy, I will buy your copy from you because I think it is that important to get some of the concepts that we’re talking about today, and to actually read them, and you and Burton Malkiel have done a wonderful job of taking some complex topics and actually simplifying them into easy to read material. 

Charley:  I’m so glad to hear you say that.  That’s exactly what we set out to do. 

Jim:  Yeah, and it was surprising because most of these things, you know, even other books on index investing, even John Bogle, who is a wonderful writer, this was, let’s say, probably the most accessible of some of the concepts that I have seen actually you, Burton Malkiel and John Bogle and other index writers talk about.  So, again, the book “The Elements of Investing: Easy Lessons for Every Investor” by Charley Ellis and Burton Malkiel.

Charley:  I would like to emphasize, nobody would need two hours to complete reading the book, and it tells you everything you really need to know.


6. Choices For The Whole Experience Of Life And Living

Jim:  Right.  And one of the things that you do talk about in the book, and it kind of goes back to some of the four issues that I had mentioned before, which was understanding a client’s needs, and defining investment objectives, and establishing the right mix for each particular portfolio, and I know that you are a big believer in diversification, and I thought maybe you could help me out with a problem that I literally had the other day.  So, I had an engineer who, between his pensions and his Social Security, he had, in effect, guaranteed income of $110,000 a year, and he spent about $60,000 or $65,000 a year, and he had close to a million dollars in a 401(k) plan, all of which is currently in fixed income, on the theory that, “Well, gee, I don’t really need to take any risk because I’m not spending that much money.”  On the other hand, he did have family, and he’s realistically not likely to change his spending patterns.  Do you have any recommendations on how, perhaps, his asset allocation should be different than, say, somebody who literally needs growth? 

Charley:  First, I’m very reluctant to answer your question, which I will do.  I’m reluctant to answer it because, for me, the small number of data points that you provided are not enough to be able to give a complete or straight answer, and I would like to have another fifteen or twenty minutes of learning about the individual characteristics, his emotional temperament, how much he knows about investing, all that sort of stuff.  But let’s assume for a minute all that came out as being perfectly fine.  You’ve just described someone who has achieved the very unusual experience of having ‘won the money game.’  He has created a pool of assets sufficient to create a base of incomes and that substantially exceeds his spending pattern, and therefore is in a position of being free to choose what he’d really like to do.  Most people are in a position of having not as much income as they really need and therefore have to make decisions on what they have to do.  This wonderfully capable person has got a match that allows him to do what he wants to do, and I think there are a couple of things that, if I were in his position, I’d like to at least think about.  One is, is there anything that I might not have included in that description that might be a problem, or might go wrong in my life?  And if that were the case, I’d like to be alert to it.  And I don’t mean to be grim about this, but it’s worth thinking about if everything’s going along just fine.  It’s really worth double checking is there anything that could go wrong, and if there were, is there a way you could defend against it?  Second thing is this individual might very well decide, “I’ve taken care of myself so nicely that I can now think about what else I would like to do, from a financial point of view, with other members of my family, and are there people in my family that I could help go to college, or graduate school, and improve their earning power by making the best investment anybody can make, which is in the education of another individual?  Is there anyone in my family that actually doesn’t have as good a life as they would like to have, and I would like them to have a little bit of extra income or capital?  Would I like to do that?  And oughta think about it.”  Don’t rush.  Take plenty of time.  Maybe think about two or three times, but do at least give yourself a chance to say, “You know?  This is something I’d really like to do and make my life better.”  And then another dimension of that is, are there any institutions or organizations that you really care about because their values or the values they produce are values that are really meaningful to you?  In my case, I had the lucky, lucky experience of going to Yale University, and Yale College was a great experience for me.  So, I’ve been a donor to Yale, and I really feel great about that.  My wife has a similar feeling towards the college she went to, Hollins University in Virginia, and so we’ve had a very happy experience making modest contributions to both of those two organizations.  Some people, a very good friend of ours, deeply religious, wants to be able to give to her church, and she is a regular donor to her church, and it makes her feel better about the whole experience of life and living.  Now, I think all of us ought to go back through and think about that, so if you happen to be in a very nicely harmonic situation where your income is well better than your needs or spending levels, you’re in great shape.  Many of us should learn from your friend because if he was able to find a way to have relatively modest spending, that is, for most of us, the real secret of success.  Keep those cost structures down, it’s not that hard to get the income levels higher.  But he’s in a position of being able to have some choices, and I think he ought to think about them, and if they’re really choices he wants to have, he should express them. 

David:  Well, you know, that’s great advice for happiness, but let’s take one break here now before the end.

BREAK TWO

David:  And welcome back to The Lange Money Hour.  I’m David Bear here in the KQV studios with Jim Lange and Charley Ellis.

Jim:  And we are talking about a number of concepts, including many of the concepts from Charley’s most recent book that would be relevant to our listeners that I highly recommend, that Charley says that you will…and I agree with him, that you will get through in two hours or less, called “The Elements of Investing: Easy Lessons for Every Investor,” and again, that’s by Charley Ellis and Burton Malkiel.  And Charley, before the break, we were talking about somebody that had a pension plan, and whose income exceeded his needs, and then you were saying that maybe he could use some of those resources to help family and friends.  What I was really getting to, though, was should he consider having some money in the market, not necessarily money that he is intending to give away right now, or in the next year, but should he be thinking, at least for a portion of that portfolio, not just for himself, but also for his family and then any charities that he might leave behind when he’s gone, and think in terms of, at least, a portion of that money longer term than his own needs would provide.  That’s what I was getting to, and I don’t know if you have any feelings about that in terms of the asset allocation and diversification issues that you talk about in “The Elements of Investing.”

Charley:  Candidly, I’m all for it.  I’m in the happy position of being a grandfather.  I’ve got four grandchildren who are under ten.  Now, my first priority is to provide for my wife.  Second priority is to be sure that our children have had all the education that they really need.  My third priority after that is for the grandchildren, to be sure they have all the education that they would need, and I don’t mean ‘need’ in the sense of negative need.  I mean anyone who is smart enough to go to college should think about graduate school.  If they’re smart enough to go to graduate school, they can go to as much graduate school as they possibly can because that really does pay off for individuals.  It creates a happier person, better life, better income, you meet new and more interesting friends and all kinds of other positive things.  So, I’m a big fan for education, and the reality is my grandchildren, all of whom are single-digit ages, none of them will have gotten to graduate school before my time is up.  And I know that, and my children know that.  But it would please me to know that, when the time comes, my grandchildren will be able to go to the university of their choice and to stay in universities to do graduate work if they want to do that, too.  So, my time horizon is probably fifteen years.  Their time horizon is fifty, seventy-five years.  I’m actually, in part of my thinking should be aware of the fact that their horizon is the right horizon to use for investing, and therefore, I’ve been more involved with emerging market investing via index fund than would be your normal emphasis on emerging markets, because I think that in the long, long run, like forty, sixty, eighty years, that emerging markets will have had an opportunity to do some really great things.

Jim:  So, you’re saying that while your first goal is to provide for your spouse, and both of you, while you’re alive, and then if something should happen to you, to your spouse, then your kids, then your grandkids, but at least a portion of your portfolio, you’re not necessarily just thinking about your time horizon, but you’re actually thinking of your grandchildren’s time horizon.

Charley:  Most definitely not thinking of my time horizon. 


7. Vanguard Has Consistency of Success

Jim:  And the other thing that you mention in your books is you’re apparently a big fan of some of the tax-favored vehicles, and for education, probably, the 529 Plan seems to be one of your favorites.  Is that right?

Charley:  The general idea of the 529 Plan is terrific.  I do think anybody going in should carefully check to see what are the fees charged and what are the alternatives, and make a really “grown-up” decision, and then stay with it once they’ve made it.  There are some plans that are, candidly, a better deal than other plans, and they’re all available enough so that it’s really worth doing the comparison shopping. 

Jim:  Well, I should also mention that we’re actually broadcasting…and even though we have somewhat of a national audience, it is a local radio show and most of our listeners are probably Pennsylvania residents, and Pennsylvania has Vanguard as the choice of investments, which I think would probably please you, and the other thing that they have is they have an option where Vanguard itself shifts the asset allocation as the child gets older into obviously more and more conservative investments as the time for needing the money for tuition gets shorter.

David:  And all this also has a lot to do with Lange’s Cascading Beneficiaries, though.  Are you smiling?

Jim:  Well, yeah, but we’re not talking about estate planning.  When we have the expert, we’re going to try to get as much great information as we can, which we already have. 

Charley:  I do think it’s nice that you mention Vanguard.  I had the privilege of being on the board at Vanguard for several years, and that’s actually where I got a close friendship with Burt Malkiel, who’s a wonderful guy, Princeton’s favorite professor…

David:  Umm-hmm.

Charley:  …wrote the book “A Random Walk Down Wall Street,” which sold 1,500,000 copies…

Jim:  I think it’s on its fourteenth edition, or something like that, is it right?

Charley:  That is just a wonderful book and he’s a wonderful man and devoted to trying to be helpful to individuals who are working their way through “What should I be doing?” and “How should I be doing it?”  Vanguard is really good at keeping their costs down.  They’re really good at keeping the values up.  They’re really good on the service level.  They’re all a bunch of Girl Scouts and Boy Scouts.  They really believe in all this integrity stuff upside down and backwards, and they all stay at Vanguard for a long, long, long time because it’s a terrific outfit with a sense of real purpose and mission in life, and they are diligent on executing that mission:  the most value for the lowest cost, the most value for the lowest cost, and their consistency of success is really quite impressive.  I get a kick out of all my smart friends in the investment management business.  Almost all of them, one way or another, use Vanguard.  Then, as the years go by, they all use Vanguard more and more and more.

Jim:  That is interesting.  By the way, I have always been a Vanguard fan, and for the do-it-yourselfer, I am also a big advocate of Vanguard, and I’m never shy to tell people that.  Some of the other things, you have had some interesting quotes, and actually, you know something?  I’m being given the two-minute warning, so I’ll tell you what I would like to do is I’d like to repeat the recommendation that listeners purchase the book “The Elements of Investing: Easy Lessons for Every Investor” by Charley Ellis and Burton Malkiel, and the other book that is the classic by Charles Ellis is “Winning the Loser’s Game,” and I don’t know if you have any last thoughts for our listeners, let’s say within the next minute, but I do want to give you the opportunity to mention anything that we might not have already done during the interview.  Any last thoughts for our listeners?  And thank you again, Charley.

Charley:  Sure.  The most important single thought I can give is, contrary to the often made statements, not about you.  This is about you, your values, your history, your financial situation, and what will work best for you to accomplish the objectives you have in your life, and the most important variable is not the market, and it’s not the clever investment manager.  The most important variable and the prominent one or the opportunity to solve it is you, as an individual, get it right for you, and you’ll be very, very happy.  Get it not quite right for you, and you’ll wish you had. 

David:  Well, you know, on that note…

Jim:  Thank you again, and again, the book is “The Elements of Investing: Easy Lessons for Every Investor” by Charley Ellis and Burton Malkiel. 

Charley:  It’s a great gift to give to grandchildren, too.

David:  Well, thanks also to our program coordinator, Amanda Cassidy-Schweinsberg, and to Dan Weinberg, our in-studio producer.  As always, you can hear an encore broadcast of this show at 9:05 this Sunday morning, right on KQV, and you can always access the audio archive of past shows, including written transcripts, on the Lange Financial Group website, www.paytaxeslater.com.  And while there, check out the latest video clip of Jim’s interview with John Bogle, founder of the Vanguard Group, who explains what hurts the everyday investor now.  Finally, please join us on Wednesday, April 17th at 7:05 for the next edition of The Lange Money Hour, when Jim’s guest will be one of the nation’s leading commentators on personal finance, author and long-time CBS reporter Jane Bryan Quinn. 

END 

 

 

James Lange, CPA/Attorney

Jim is a nationally-recognized tax, retirement and estate planning attorney with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, will and trust preparation and intricate beneficiary designations for IRAs and other retirement plans.  Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.

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