The Devil's Financial Dictionary with Jason Zweig

The Devil's Financial Dictionary with Jason Zweig

Episode 161
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The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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TOPICS COVERED:

  1. Guest Introduction: Jason Zweig
  2. Jason’s Definitions
  3. Fiduciary Advising
  4. Psychology, Neuroscience and Investing?
  5. The Insight into Index Funds
  6. Limiting Yourself to Domestic Investments

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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. Guest Introduction: Jason Zweig

Dan Weinberg:  Welcome to The Lange Money Hour.  I’m Dan Weinberg along with CPA and attorney Jim Lange.  Tonight, we welcome widely respected Wall Street Journal columnist Jason Zweig to the program.  Jason’s column appears in The Wall Street Journal every weekend.  He’s also written several books, including Your Money and Your Brain, which deals with the neuroscience of investing, and his latest, The Devil’s Financial Dictionary, which takes a serious, but also humorous, look at the financial world.  Jason also edited and provided updated commentary for a new edition of Benjamin Graham’s classic financial book, The Intelligent Investor.  Before joining the Journal, Jason Zweig wrote for Money magazine, Time, Forbes and CNN.com, as well.  Now tonight, Jason and Jim will cover a number of topics including the difficulty of getting good investment advice, the political landscape as we head into 2016 and what it means to investors, as well as the wisdom of index investing and the stability of international markets.  Our show is live this evening, so please do give us a call at (412) 333-9385 with your specific questions, and with that, let’s say good evening to Jim Lange and Jason Zweig.

Jim Lange:  Welcome, Jason.

Jason Zweig:  Great to be with you, Jim.

Jim Lange:  Well, I’ll tell you: The Devil’s Financial Dictionary (and that is your most recent book, I understand it) is, by far, the funniest financial book I ever read, and I’m sure you had a humorous intent, but there was also a lot of very intelligent, good information in it.  So, I will congratulate you on a very well-written and really hilarious book.

Jason Zweig:  Well, Jim, thank you.  You know, I do hope people find it funny.  You know, one of the frustrations in being a regular financial columnist for The Wall Street Journal is that it sometimes seems I talk a lot and nobody listens, and I hope, if I can maybe help people laugh, I can help them learn at the same time.

Jim Lange:  Well, I think you’ve really hit a nerve here because I looked at the testimonials on your books because I also write books and I attempt to get testimonials, but you have the most impressive list I’ve ever seen: John Bogle, Burton Malkiel, Jane Bryant Quinn, Bill Bernstein, Charles Ellis, many more.  Jack Bogle doesn’t review a book, and he won’t write you a good testimonial unless he’s read it and he liked it.  Jane Bryant Quinn told me she doesn’t even offer testimonials or blurbs.  Why do you think you hit such a nerve with these financial giants?

Jason Zweig:  Well, I guess, Jim, people had been waiting for a long time to have permission to laugh at what is absurd and ridiculous about Wall Street, and I think the overriding emotion a lot of people have felt with the financial industry is either confusion or frustration, or sometimes outright anger.  But I think giving people permission to laugh at what’s ridiculous makes them feel good about what they’re learning.  At least, I hope that’s what the book will do for people, because a lot of the financial industry, as you know, is ridiculous even when it’s being most serious, and I sometimes like to say that if economics is the dismal science, that investing must be the abysmal art because people spend their whole professional lives trying to make something that’s pretty simple and pretty basic into something that’s incredibly complex and stupefyingly boring, and it doesn’t really need to be that way.


2. Jason’s Definitions

Jim Lange:  Well, I hope to get more into some of your philosophies, though I do want to give the listeners just a flavor.  So, for example, let’s talk about one of your definitions, which is the bull market.  What is a bull market?  “A period in rising prices that leads many investors to believe that their IQ has risen at least as much as the market value of their portfolios.  After the inevitable fall in prices, they will learn that both increases were temporary.”  I mean, to me, that is just classic.  Do you have a couple favorites?

Jason Zweig:  Well, I do have a couple favorites, and I guess I could look a couple up right now.  One would be “Big Producer: a stock broker or insurance agent who produces big commissions.”  The term is erroneous however.  The broker or agent doesn’t produce the commissions.  It is his clients who produce them.  He just collects them.  And another one I might point to, Jim, is “Stock: noun: the right to own a fraction of a business, regarded by most investors as the right to play a video game.” 

Jim Lange:  All right.  Do you want to give us one more? 

Jason Zweig:  Sure.   

Jim Lange:  Because these are such gems, and the thing that’s so interesting is even though it is funny, you’re kind of telling people what’s going on.  So, that, to me, was what was so endearing.  It was both funny and educational at the same time.

Jason Zweig:  Yeah.  One of my favorites is one of the shortest of all the definitions in the book.  “Potential conflict of interest: noun: an actual conflict of interest.”  And I think there’s an important lesson in that.  You know, whenever anybody tells you (and often it’s in writing in a prospectus or in other disclosure documents from a mutual fund or other investment) “Well, there’s a potential conflict of interest here,” you, as an investor, should immediately say, “No.  There isn’t a potential conflict of interest; there’s a real one because if I’m counting on your will power, or your integrity, to prevent that conflict from arising, then I’m probably in trouble because when it does arise, you will probably do what’s in your best interest rather than mine, and that is a conflict of interest.”  Maybe I could read one more definition, Jim.

Jim Lange:  Please do.

Jason Zweig:  Yeah, which is structured product, and I think your listeners have probably heard a lot about these in the past couple of years.  “Structured product: noun: investment products structured to be profitable to the firms that sell them and incomprehensible to the clients who buy them.” 

Jim Lange:  Well, I think that’s great.  Why don’t we take a look at the combination of the last two definitions that you’ve talked about?  One is conflict of interest, and two, structured products, which, to me, sounds like a commercial annuity.  And one of the things that might be helpful, and you have never been a great friend to the annuity salesman, particularly the high fee, structured product annuity salesman, but some of these products pay commissions of eight, ten, sometimes I’ve seen as high as twelve percent.  So, let’s think about this.  Let’s say that you have a million dollars and somebody tells you about all these wonderful bonuses (and yes, in the prospectus, it’s a potential conflict of interest), and he makes a hundred thousand dollar commission.  Now, if you think, to me, about what’s really going on, if he’s making a hundred thousand dollars, then the insurance company doesn’t have a million to invest.  They have nine hundred thousand, and do you really think some big, dumb insurance company is going to invest nine hundred thousand dollars, as well as Jack Bogle will at Vanguard, or invest a million dollars?  So, to me, if somebody understands a little bit about structured products, and they know that the guy who’s selling it stands to make a ten percent commission, then maybe they might think, “Well, maybe that might not be the best thing for me.  Maybe that’s the best thing for him.”  Is that a fair analysis?

Jason Zweig:  Yeah, and I think that’s very astute, Jim, and there’s also another aspect to it.  The thing that’s troublesome about complicated investments is not just that somebody is earning a very high fee to sell them.  It’s the other side of the problem you already pointed out, which is if you write a check for a million dollars and only nine hundred thousand gets invested on your behalf, and the firm that’s investing it on your behalf has to take extra risk with the nine hundred thousand after the commission has been taken out in order just to get you back to breakeven, where you would have been if you’d invested the whole million dollars.  They know that, and you know that, and they know you know that.  So, you’ve invested in a strategy that almost certainly will be riskier by design, simply because of the fee that’s embedded in it.  So, you’re paying a high fee, which is turning the investment into something riskier than it otherwise would be, and that’s a very, very dangerous combination for people.

Jim Lange:  Well, and the other thing that you put in your definition is terms that people don’t understand.  So, for example, he might say, “Well, yeah, it’s guaranteed for a five percent rate of return even if the market goes down,” but if you read it closely, that’s the death benefit.  So, you don’t get a five percent rate of return unless you die, and maybe you need that money before you die.

Jason Zweig:  Right, and it certainly won’t be of much use to you after you die.

Jim Lange:  No, so it’s really a problem.  Even just reading the definitions, I think there’s a lot of serious lessons readers can gleam from your book.  Are there a couple that you think are particularly compelling, and even if it’s just some of the things that you’ve been writing about for years and years because, you know, I put you in the same category, for example, as Jonathan Clements and Jane Bryant Quinn, as, let’s call it, the true champion of the consumer?  I don’t know if that’s fair or not or if you’re insulted, but, I mean, to me, that’s high praise because I think you’re always looking out for the little guy, and not for Wall Street or the high commission brokers.

Jason Zweig:  Yeah, well, that’s very kind of you, Jim.  Thank you.  I mean, I think a couple of things that really developed in my mind as I was working on writing The Devil’s Financial Dictionary are that, I guess, first of all, there’s a reason that financial firms fling jargon at their clients.  If something really were simple and good for you, it wouldn’t be cloaked in these long complicated names or reduced to some weird acronym, like a CMO or something like that.  I mean, when you go to a farmer’s market and you pick up a vegetable, it’s called a tomato.  It’s not called a lycopene nutritional delivery system.

Jim Lange:  By the way, the people in the radio show are chuckling right now!

Jason Zweig:  Yeah.  I mean, basically, when anybody throws jargon at you, you should realize that’s a pretty good sign that someone’s about to take advantage of you.  I mean, you and I have just used the term ‘product’ several times in the past couple minutes, and I define that term in the dictionary, too.  “Product: a term added to the word investment, as in ‘We’ve just introduced this investment product’ to cloak complexity or create the illusion of sophistication.  Just as a wine product is wine adulterated with water, sugar or fruit juice, and a cheese product contains such substances as calcium phosphate, sodium alginate and apocarotenal, so an investment product often has risky additives or structural oddities as well as high fees that can surprise the unwary.”  And that’s really a sign that even simple words can trip you up if you’re not listening carefully.  You know, if I were sitting down with a financial advisor who said to me, “You know, we have just the right product that could suit your need,” I would immediately hear a bell going off saying, “Hmmm, why is this thing called a product?  I’m not in a grocery store or a drug store or a factory.  I’m in a financial advisor’s office.  Shouldn’t he be giving me advice?  Why is he talking to me about a product?”  And it’s that kind of thinking that I hope The Devil’s Financial Dictionary will instill in people, just to be skeptical and to remember that words have very specific purposes that sometimes go beyond what you would hear if you aren’t really listening carefully.

Jim Lange:  Well, I think this also loops back to one of the things that you often talk about, which is a fiduciary duty, and maybe this might be a good time to talk about fiduciary duty and what that is, and what the difference is between seeing somebody that does have a fiduciary duty…and no, I realize you’re not a financial advisor, but, to me, you’re kind of a writer that recognizes fiduciary duty and writes in the best interests of their reader.  Would it be fair for me to ask you to just give our listeners an idea of what a fiduciary is, and what the difference between a fiduciary and a non-fiduciary is and which one you recommend going to or talking with?


3. Fiduciary Advising

Jason Zweig:  Well, sure.  Thanks, Jim.  You know, there’s a definition of it in The Devil’s Financial Dictionary, so I might as well read it.  “Fiduciary duty: the requirement that financial advice should be at least as good for the person receiving it as for the person providing it,” an idea so radical that Wall Street is attacking it with every weapon in its arsenal.  If brokers became subject to a fiduciary duty, they would no longer be able to charge high fees to put their own interests ahead of their clients.  That, according to the brokerage industry, would force many investors to make their own decisions for free, which would somehow leave these investors worse off than before.  If you don’t find that at least slightly confusing, you haven’t been paying attention. 

Jim Lange:  Well, I think that’s great because I think a lot of people don’t understand that if you walk into an office of a non-fiduciary advisor, the presumption is that the advisor has your best interests at heart, but really, he has either his or the insurance company’s, or the products that he’s representing, or somebody’s other than yours, at heart, and if that’s true, then how can they give you a good piece of advice that’s in your interest, particularly if they have a financial interest that is inconsistent with the best advice?

Jason Zweig:  Yeah.  Well, I think you’ve just highlighted that definition we talked about earlier, Jim, which is potential conflict of interest, and I think one of the difficulties is that we ask a lot of financial salespeople, who earn a commission for giving us advice, and we expect them to act in our best interest, when, in fact, they might be getting paid to do something else.  As a general rule, when you give people an economic incentive to do ‘A,’ they don’t turn around and do ‘B,’ and, you know, someone on a commission does have a clear incentive to generate commissions.  That doesn’t mean that they can’t ever give good advice or sell appropriate investments to the right people.  But it does mean they face a continual temptation that they have to fight, and we’re asking a lot of them to fight that battle every day and always come down on the right side. 

Jim Lange:  And I would even expand that to not just people who sell products with high commissions, but even in giving advice that might not come under investment advice, per say.  So, for example, as you probably know, I have long been a big fan of Roth IRA conversions.  Well, if you think about it, if somebody does a Roth IRA conversion, and even using a relatively ethical fee for service-type business, where the advisor is charging a fee rather than a commission for items sold or bought, if their client makes a Roth IRA conversion, they are managing less money.  Hence, their fee goes down.

Jason Zweig:  Yep.

Jim Lange:  Or, for example, I’ve been a long fan of a technique for Social Security called ‘apply and suspend,’ and then there’s another one called a ‘restricted application.’  Well, all these things, if the client does it, it’s actually holding off on getting money from Social Security so they can get more later, which means that they have to spend more from their portfolio in the short term, which means that the amount paid to the advisor is lower, and it’s a real problem because unless somebody has a fiduciary duty and is acting in such a way, then the client isn’t going to get the benefit of that advice.

Jason Zweig:  Yeah, and there are a lot of other ways that this turns up, Jim, some of which I’m sure you’re familiar with.  I mean, for many people, you know, paying down your mortgage, just getting rid of your mortgage debt completely, is advantageous, even after accounting for the tax benefit you might get on the interest payments, and it’s not advice that’s given as often as I think it should be because people will generally fund paying off their mortgage by reducing the amount of money that the financial advisor has under management, thereby reducing the financial advisor’s fees.  So, a lot of advisors sort of overlook the usefulness of that advice.  And there’s another really simple example, which is, you know, many, many financial advisors do charge a management fee on the cash portion of an investor’s account, and a lot of that cash is in money market funds, where it might be yielding as little as, you know, one-hundredth of a percentage point because the advisor still will get a management fee on that.  But if it were in CDs, the person might earn a hundred times more than that, but the advisor probably wouldn’t earn a fee.  So, you always have to be vigilant as an investor and recognize that even well-intentioned financial advisors might have conflicts of interest that they themselves aren’t fully aware of.

Jim Lange:  And I want to take it one step further, which is there are a lot of advisors that actually encourage people to take out mortgages on their homes, and, you know, there’s a number of acronyms for it and found money, but there’s entire strategies (and I don’t want to mention his name because he’ll probably sue me), but there’s an entire industry of having people take mortgages on their house, and then using those funds for certain investments, and that kind of arbitrage to me is really dangerous. 

All right.  We’re here with Jason Zweig, whose most recent book is The Devil’s Financial Dictionary, which I would recommend to anybody listening here.  It is truly enjoyable.  It has testimonials from everybody.  I laughed out loud, and I think that there’s some very good lessons in the book that we have been talking about.  Of course, Jason, you’ve written others, and the one that I wanted to mention, because it’s just, to me, such an honor that you are a part of one of the best financial books of all time, and I’m referring, of course, to The Intelligent Investor, that was written by Benjamin Graham.

Jason Zweig:  Umm-hmm.


4. Psychology, Neuroscience and Investing?

Jim Lange:  And in the most recent edition, you, in effect, kind of update that.  So, you’re reading the original words of Benjamin Graham with your, let’s say, updated objective consumer report-type mentality, and this continues to be a classic.  You know, even now, today, I was looking on Amazon.  It’s number one in a bunch of categories.  Why do you think that this book has just stayed so strong?  Again, we’re talking about the most recent edition of The Intelligent Investor, originally written by Benjamin Graham, but, let’s say, updated by Jason Zweig. 

Jason Zweig:  Well, I think, Jim, really the key is that, you know, Benjamin Graham, who today is probably best known as being Warren Buffett’s teacher, was really one of the greatest investment thinkers who ever lived, and I think the reason the book continues to do so well is that he combined common sense and psychological insight into how people think with an incredibly brilliant mathematical, analytical mind, so that it’s kind of the total package.  Plus, he wrote beautifully, and, you know, all I tried to do with my portion of the book was annotate it so people could understand some of the references that might be a bit out of date for younger readers, and also just to use some more contemporary references to show how his ideas still apply.

Jim Lange:  Well, you mentioned psychological insights, and your last book actually talked about, let’s say, some of the physiology, if you will, of the brain and investing.  Can you maybe tell our listeners a little bit about that, and whether that book is still available and if it’s something that you think you could recommend?

Jason Zweig:  Well, sure.  That book was called Your Money and Your Brain, and it was about the neuroscience of investing, and essentially, what I found when I researched the book is that, you know, the human mind is an amazing machine.  It has sent people to the moon, it gives us computers in our pockets, and, you know, skyscrapers fifteen hundred feet high, but it’s not great at everything, and investing decisions in particular require a different kind of thinking than the human mind was really developed to excel at.  You know, for example, humans are amazing at recognizing patterns and that really helped our ancestors in ancient times.  You know, if you saw leaves ruffle a certain way, you knew maybe a saber-tooth tiger was lurking and about to attack you.  But in the financial markets, which are electronic and highly competitive, if you see a pattern that you think you recognize from earlier, you might well be mistaken because if it was that obvious, somebody already would have taken advantage of it, and that’s why, for example, index funds work so well, because they really enable you to take advantage of other people’s knowledge at a very low price.  So, yeah, sure, I think the book is still worth looking at and still interesting.  The science has progressed quite a bit since I wrote it in 2007, but I’m not sure the human mind has changed very much in eight years.

Jim Lange:  Well, I think that it makes so much sense because if you think about it, we are human animals.  We are taught to run from danger.  So, in 2008, if the market goes way down…I was with somebody today, and when the market went way down, rather than just waiting it out, they ran from danger, pulled their money out of the stock market, put it in fixed income, haven’t gone back in and they will forever be in a weakened position.  If they had read your book, they might have understood why they were thinking like that and maybe they would have stayed in the market.

Jason Zweig:  Well, we can certainly hope so.  I mean, I think anybody who gives advice to the investing public always hopes that people will listen.  I think emotion is a very powerful force, and people often know what the right thing to do is, but their feelings get in the way, and it’s often easy to say that when push comes to shove, you’ll do the right thing, but then when push does come to shove, often people don’t.  I mean, getting good advice is very, very important for people.


5. The Insight into Index Funds

Jim Lange:  Well, I think so, and you also mentioned index funds, and I, myself, have seen the light and I’m now an index fund fan.  Could you tell our listeners a little bit about the difference between an actively managed fund, or even individual stock selections, and an index fund, and which one you prefer of the two and why?

Jason Zweig:  Well, sure.  I do have a definition of an index fund in my new book The Devil’s Financial Dictionary, but it’s a little long, so I’ll just give a shorter definition.  You know, an index fund essentially owns all the securities in an entire market, maybe the entire U.S. stock market or the entire U.S. bond market, or all foreign stocks, and the chief advantage that an index fund has is that it’s very, very, very, very, very cheap, and the typical index fund will manage your money for a twentieth of what an actively managed fund would charge, and you then have to ask yourself whether you think the people picking the stocks or bonds for this actively managed fund are at least twenty times better than average, and in my experience, they’re not, and the data really would bear that out because over a long period, roughly three-quarters of all the actively managed funds tend to fall behind the index, and there’s a very simple reason for that, Jim, which is that actively managed funds are run by extremely intelligent, very skilled people, and at that level of skill, the differences between them are really very small.  If you think about your favorite sport, you know, baseball, basketball, football, soccer or whatever it might be, tennis, and think about the elite professional athletes who are at the top of that sport, think how many times in a critical game the outcome is decided by a bad bounce of the ball, a bad call by a referee, an injury to one of the key players, or a single error committed by a player who normally never makes mistakes because he or she is nervous, or something goes wrong, and at that high level of skill, the difference between the players is really dominated by luck: that pebble that the ball hits and bounces the wrong way, and the financial markets work very much the same way, where so many people are so skilled that luck separates them.  So, on average, you would expect half the stock pickers or half the bond pickers to do better than average and half to do less.  But once you factor in their expenses, over time, those percentages really shift so that roughly three-quarters of them will tend to underperform over time, and I don’t like those odds.  I would much rather own the entire market and know that, over time, I will match the returns in the market with very close to certainty.

Jim Lange:  One of the things that I often get, and I’d love to ask you about this because I think that you’ve been, with all due respect, around for a while and have written for a long time, but I have a lot of clients who say, and I’m sure there’s many of our listeners who are thinking, “Oh, everything’s completely different today.  We are in unprecedented times.  Of course, the Republicans think Obama’s a moron.  The Democrats, you know, are thinking Congress is a dysfunctional mess.  Maybe Democrats and Republicans are thinking that.  You know, we have problems with the Middle East and war in Russia and China and Mexico and global warming, and now ISIS is creating a huge fur.  Should we be scared of the next market crash and be more conservative?  Are these unprecedented times, or does it just seem that way because we happen to be going through them now?”

Jason Zweig:  Well, yes and no, Jim.  I mean, every time is unprecedented.  Things are always different.  But then again, things never are different.  I mean, if you think back to our parent’s generation, certainly in my father’s lifetime and my mother’s lifetime (she’s still alive), you know, we had the Great Depression, we had World War II, we had decades of cold war where the entire world seemed to be on the brink of nuclear annihilation for decades on end, we had stagflation, we had raging inflation, we had severe recessions every few years.  It’s never been much better than it is today, and arguably, in many ways, the social and economic future for the world is as bright as it’s ever been.  I think a lot of it depends on your own temperament.  If you’re the kind of person who looks at the glass and says it’s half empty, then you probably don’t like what you see right now.  But I think there are a lot of reasons to be optimistic, at least in the long run, and I don’t think the world is a more dangerous place than it used to be.  You know, the governments of Russia and the United States don’t have their finger on the nuclear button anymore.  There’s no Hitler.  There’s no Stalin.  There’s no Mao.  Billions of people aren’t on the brink of starvation every day.  There’s a lot of reasons to be optimistic and worried.  I think it’s kind of the same as it ever was, maybe slightly better.

Jim Lange:  All right.  We are here with Jason Zweig, who is one of the top financial writers in the country, and we are talking, among other things, about his new book, which I would highly recommend that people get, which is The Devil’s Financial Dictionary.  And also, even though it’s not, let’s say, the newest and hottest and latest, it is the greatest, and that is The Intelligent Investor, which was originally written by Benjamin Graham, one of, if not the top, financial books ever, but Jason has updated that book and put it in a more modern perspective, and nobody could go wrong with either of these books.  One is The Intelligent Investor, originally written by Benjamin Graham, updated by Jason Zweig, and then Jason’s own book, The Devil’s Financial Dictionary.

Jason, one of the things that clients don’t like, and they tell me they feel nervous about, is international markets, so they have an inclination not to get into international markets, and even more specifically, Asia and the Pacific Rim.  What advice would you have for clients that are more comfortable with having only domestic or U.S. investments?


6. Limiting Yourself to Domestic Investments

Jason Zweig:  Well, I guess I would look at it a couple of different ways, Jim.  One is that the U.S. represents less than fifty percent of the total value of global stock markets.  So, if you restrict yourself only to stocks that are based in and traded in the U.S., you’re sort of leaving out half your opportunity set, and there’s a lot of great companies based overseas and in Asia, but more importantly, China and India alone have about two-and-a-half billion people, and that’s a very big market, and if you’re comfortable investing in U.S. companies that do a lot of their business there, and there are many American companies that do the majority of their business in Asia at this point, then you probably should be comfortable owning companies that are based there in the first place.  But if you’re not, then I think you have to say to yourself, “What would happen to my assets if it turns out that the U.S. economy doesn’t grow at the rate it has grown so far in my lifetime, and Asian economies turn out to dominate the world in the decades to come?  Won’t I get left behind?”  And what I like to tell people is, “You know, tip toe in.  These markets statistically are quite a bit cheaper than the U.S. market at this point, and if you put one percent of your money in there, it’s not going to hurt you.  Even if they go to zero, you’ll only lose one percent, and if they do well, you could make a decent amount of money.  And just add to it over time as you get more comfortable.”  And I think diversifying throughout the world is a very sensible approach and I would encourage everybody to get more comfortable with it.

Jim Lange:  All right.  The other thing that you sometimes talk about is not just international versus domestic, but I have a lot of clients, and I’m sure there’s a lot of listeners who are essentially U.S. blue chip, meaning the very large companies, often growth companies.  Can you tell our listeners any impressions that you have about, say, smaller companies or small cap value companies, how they’ve done historically, and whether you think there is a part of their portfolio that should be invested in small companies, and specifically small cap value companies?

Jason Zweig:  Well, yes.  I mean, I think there’s a natural human tendency to invest in stocks we’re familiar with.  You know, Peter Lynch, the manager of the Fidelity Magellan Fund, had this expression ‘buy what you know,’ and sort of encouraged people to think about major brand names and, you know, some obvious examples would be Apple, Coca Cola, Nike, Wal-Mart, you know, that sort of name brand, obvious companies everyone is familiar with.  But there’s a couple problems with that.  One is if everybody is familiar with an investment idea, it might be too popular.  It might be so popular that it’s a bit overpriced.  There’s another aspect too, which is all of those companies once were small, and many of them generated very good returns when they were smaller.  I’m not a believer that people should put large amounts of their money into small companies, but I do think you should have some of your money in small companies.  You know, the only concept I’m familiar with in all of investing, Jim, is that it is always a good idea, and has no logical objections to it that really hold water, to diversify.  You should spread your bets.  You shouldn’t put all of your chips down on one part of the table, and if all you own is blue chip stocks, then you might be over concentrated in that area of the stock market, and you should just spread yourself a little thinner, a little wider, and own some smaller companies.  I wouldn’t go crazy with it.

Jim Lange:  All right, well, for, let’s say, international companies and small companies and then the subsets, meaning international large and international small and international growth and international value and U.S. small and U.S. small value, etc. etc., if somebody is interested in diversifying, like you have said, would you recommend low-cost index funds as opposed to individual securities, or even actively managed index funds?  Because I know that you have written about index funds probably more often on the large U.S. companies.  Would the same thinking apply to the smaller and international companies?

Jason Zweig:  It definitely does.  You know, there’s even a simpler approach, which is you could just own what’s called a total stock market index fund, and then you would essentially own all the stocks: large, medium and small.  Those are available for the U.S. market, for international markets and any number of other segments.  You know, there’s a kind of a myth, Jim, that index funds only work for large U.S. stocks, and it simply is not true, and we have decades of data on this now and the evidence is overwhelming that indexing works because it’s cheap, and to the extent that those other markets are less efficient, they’re more expensive to invest in.  So, if you have a choice between investing in them in a way that costs a lot of money and a way that costs a little money, I think you’d be crazy not to pick the one that costs the little, and that would steer you toward index funds.  The only exception is if you’re the kind of investor who really likes doing your own research and relishes doing your homework on individual securities, and you get pleasure and satisfaction from learning about individual companies, then, of course, I would encourage you to have a portion of your portfolio in individual stocks, because even if your financial return isn’t spectacular, you’ll get an emotional and intellectual return that are obviously valuable to you.

Jim Lange:  You know, Jason, funny that you should say that because, as you know, my business model is that our office does things like the Roth conversion, the Social Security, how much you could spend, estate planning, these types of things, and the money manager that we use, who uses exclusively low-cost index funds, he has a saying about that, and what he tells people who like to do some of their own investing, he actually calls that their Las Vegas money, and he says, “Hey, if you want to take five or ten percent of your portfolio, or something that you could afford to lose, you know, go ahead and use that as your Las Vegas money.”  But he, I think, like you, fundamentally agrees that the majority of your portfolio should be in a well-diversified portfolio of index funds.  And with about forty-five seconds left, you think that that is a fair characterization?

Jason Zweig:  I do, and I think, you know, it’s important that investors never feel embarrassed or sheepish about what they’re comfortable doing.  You know, if you don’t want to take a lot of risk, you shouldn’t let somebody tell you you’re too conservative, and if you want to take a little gamble, that’s fine, as long as you understand that what you’re doing is gambling.  If you think you’re investing when you’re speculating, you’re in for a big surprise.  But as long as you know what you’re doing, it’s fine.

Jim Lange:  Well, thank you so much.  Again, this has been Jason Zweig, who is really one of the great all-time financial writers that we have, and his new book is The Devil’s Financial Dictionary, which I highly recommend that everybody get, as well as the classic The Intelligent Investor, by Benjamin Graham, that Jason has updated.     

END

 

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James Lange, CPA

Jim is a nationally-recognized tax, retirement and estate planning CPA 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, 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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