Book summary “The truth about money”: summary

Introduction

You want to achieve financial security, but conflicting advice from brokers, banks, and the media leaves you confused and vulnerable. The financial industry often promotes products that benefit institutions rather than your net worth.

Ric Edelman demonstrates in The Truth About Money that building wealth requires overcoming personal behavioral obstacles, understanding true economic risks, and constructing a diversified portfolio.

The book guides you through fixed income, equities, real estate, insurance, and estate planning to help you take control of your financial destiny.

• How do you build a portfolio that survives market volatility?
• Which insurance policies actually protect your family?
• Can you eliminate debt while growing your wealth?

1. The Four Obstacles to Building Wealth

Financial failure is primarily driven by internal personal habits and macroeconomic forces rather than external market crashes, categorized as four obstacles.

Ric Edelman identifies the four major obstacles as procrastination, spending habits, inflation, and taxes. You must recognize that the root cause of financial failure is usually yourself rather than the general economy or politics.

Time Value of Money

Starting to invest early matters far more than the total amount of capital invested due to the time value of money.

Jack invested $5,000 annually starting at age 18 for eight years for a total of $40,000. His sister Jill invested $5,000 annually starting at age 26 for 40 years for a total of $200,000. Both earned a 10 percent annual return, yet Jack accumulated $2,587,899 by age 65 while Jill collected $2,212,963.

Delaying savings by even a single year results in a massive deficit in final accumulated wealth due to lost compounding time. If a 30-year-old saves $100 a month at a 10 percent return until age 65, they accumulate $379,664. Waiting just one year to start at age 31 reduces the final amount to $342,539, costing you $37,125.

Benjamin Franklin demonstrated the immense power of compounding over centuries by leaving funds to Boston and Philadelphia with a mandatory multi-decade waiting period. He left 1,000 pounds sterling in his will in 1790, which was about $500,000 in modern inflation-adjusted dollars. By the 1990s, Philadelphia's trust held over $2 million and Boston's grew to $4.5 million.

Spending Habits

Seemingly insignificant daily micro-purchases accumulate into thousands of dollars over time, worsened by the fact that they must be funded with pre-tax earnings.

The Newmans spent $10.50 combined per day on coffee, donuts, and soda, totaling $2,520 a year. Assuming a 40 percent combined tax rate, they had to earn $4,200 in gross income to fund that spending.

Taxes and Inflation

Inflation steadily erodes purchasing power over time, requiring exponentially higher net worth and income to maintain a standard of living during retirement. Since 1926, inflation has averaged 3 percent per year, causing the cost of living to double every 23.5 years. You often fail to react to low inflation due to the Boiling Frog Syndrome, where gradual increases go unnoticed until financial damage is severe. A 50-year-old earning $75,000 a year who plans to retire at 65 will need a net worth of $2.25 million and a first-year retirement income of $120,297 to keep pace with historical inflation.

Financial success depends entirely on the after-tax, after-inflation rate of return rather than nominal earnings. In 1980, investors earning 15 percent on certificates of deposit faced 13 percent inflation, meaning they were losing in real terms despite high nominal rates.

The Rule of 72 provides a quick mental calculation to determine how long it takes for an investment to double or what interest rate is required:

• Divide 72 by the interest rate to find the number of years needed to double the money.
• Divide 72 by the number of years to find the required annual interest rate.

2. Fixed Income and Cash Reserves

Cash reserves and fixed income securities must be selected carefully to avoid the illusion of safety and protect purchasing power.

All financial securities are fundamentally divided into debt instruments or equity instruments. Bonds represent debt where the issuer promises fixed interest and principal repayment without granting company ownership. Stocks represent equity, making the buyer an owner with variable returns and no maturity date or guaranteed repayment. Acme Widgets issuing a bond must pay interest and return principal without giving company ownership, whereas issuing stock creates co-owners who share profits and losses without guaranteed repayment.

Cash Reserves and Bank Safety

Cash reserves must cover 12 to 24 months of unavoidable living expenses and be kept strictly safe and liquid. Sears notes that 15,000 washing machines break down every single day in America. Once funded, this reserve should never be touched except for a true financial crisis.

• Focus on how much you spend each month on unavoidable costs.
• Maintain 12 to 24 months' worth of such spending in cash reserves depending on income stability.
• Store reserves only in savings accounts, checking accounts, money market funds, U.S. Treasury Bills, or short-term bank CDs.
• Boost your reserves additionally if you know you will incur a large expense within the next two years or occasional expenses like holidays.
• If a crisis forces you to spend your reserves, build them back up immediately.

Certificates of deposit and bank accounts are deceptively volatile over long periods because their returns fail to outpace inflation, effectively causing conservative savers to go broke safely. An investor who put $10,000 into a one-year CD in 1981 at 14.9% earned $1,490 in interest. By 2009 that same investment earned only $171, while the cost of living jumped so that items costing $1,490 in 1981 required $3,519 in 2009. One-year CDs offered a 7.33% interest rate in 1986.

Bank and credit union deposits are only safe up to standard statutory limits if covered by specific federal deposit insurance agencies. When IndyMac Bank held $32 billion in assets and failed in July 2008, approximately 10,000 depositors lost $270 million in uninsured funds. Cheryl Hodgson lost $130,000 after selling her home.

• Use a bank for four reasons only: to store reserves, save for short-term purchases, get a loan, and execute financial transactions.
• Verify your deposit coverage using the FDIC Electronic Deposit Insurance Estimator or the NCUA Share Insurance Estimator.

Bonds and Municipal Investments

U.S. government securities are the world's safest investment standard because they carry an unconditional guarantee backed by the federal government's unlimited source of capital. The federal government has issued $7.2 trillion worth of securities, with nearly $600 billion worth of U.S. Government Securities trading on Wall Street every day. Ginnie Mae mortgage pass-through certificates carry a full government guarantee, but their actual duration is 12 to 15 years, which is significantly shorter than their 30-year maturity.

• Reinvest the monthly return of capital instead of spending it to harness the compounding effect.

Municipal bonds offer tax-free interest, but conventional taxable-equivalent yield advice is flawed because investors typically pay taxes from separate cash sources rather than liquidating their bond funds. A taxable bond fund generated 33% more wealth over 20 years compared to a muni fund by ignoring tax implications and paying taxes out of pocket. Eliminating tax advantages could trigger a 20% or more potential loss in muni bond value.

Nine major Wall Street firms including Merrill Lynch, Goldman Sachs, and Citigroup were required to reimburse retail investors $50 billion for auction-rate securities losses and pay at least $360 million in combined fines levied by states. The failed auction-rate securities held $330 billion.

• Avoid insured municipal bonds.

Zero coupon bonds generate phantom income by forcing investors to pay annual taxes on interest they never physically receive while exposing them to extreme price volatility and call risks. Losing a certificate costs 3% of investment value to buy a lost instrument bond, while SIPC protection limits coverage to $500,000 with $100,000 in cash and $400,000 in securities.

• Keep your securities certificates in your brokerage investment account rather than taking physical possession.

3. Mastering Risk and Total Return

Investors must prioritize total return over nominal yield and understand interest rate risks and credit ratings.

Credit rating agencies present a major conflict of interest because the companies being rated pay for their own evaluations. Agencies such as Moody's and Standard & Poor's provide consulting services and share board members with the firms they evaluate. Internal documents revealed S&P analysts stating they would rate a deal structured by cows, and a Moody's CEO memo noting analysts drink the kool-aid. In 2010, FINRA told bond mutual fund companies to remove credit rating references from marketing materials.

Event risk occurs when an unexpected event within a company, outside management control, adversely affects the value of its securities. Corporate takeovers or sudden scandals can drastically alter a company's financial structure overnight, dropping bond ratings from top investment-grade to junk status and wiping out market value instantly. When KKR bought Nabisco for $22 billion in 1988, KKR borrowed $26 billion for the takeover while putting down only $5 million of its own capital. S&P and Moody's cut Nabisco's rating from AAA to B, causing bondholders to lose 27 percent of their market value overnight.

Interest Rate Risk and Yield

Total return accounts for income plus or minus any fluctuations in the original principal value. High yields frequently mask declining principal values, making yield alone an unreliable metric for investment performance. A $10,000 starting investment used in book examples with a 3 percent dividend rate that gains 5 percent in principal value produces an 8 percent total return.

Interest rate risk causes existing bond prices to move in the opposite direction of prevailing market interest rates. When market interest rates rise, existing fixed-rate bonds lose market value because new bonds offer higher payouts. In 1994, interest rates rose 2.75 percent, producing a 27.5 percent loss for bondholders and $1.5 trillion in total losses against $815 billion of daily bond market trading volume in the U.S. Harry invests in a 30-year government bond at 6 percent, but when rates rise to 8 percent, he must sell his bond for $7,500 instead of $10,000 to remain competitive, losing 25 percent.

• Keep your bond until maturity to avoid losing money from interest rate fluctuations.
• Buy shorter-term bonds rather than long-term bonds if you expect interest rates to rise.
• Buy higher-quality bonds rather than lower-quality bonds if interest rates are rising.

Ederman Financial's Rule #1 states that investors should never buy an investment based on yield. Chasing yield leads you into high-risk vehicles like junk bonds and collateralized mortgage obligations, frequently resulting in catastrophic losses of principal. A retired widow invested her $40,000 life savings into Denver industrial development bonds yielding 18 percent before they defaulted completely.

• Never, never, never, never, never, never, never buy an investment based on yield.

Gold is a speculative investment that does not reliably hedge against inflation, weak currencies, or rising interest rates. Gold prices do not consistently correlate with Consumer Price Index rates or falling U.S. dollars, and gold generates no interest or dividends. Following the record gold price of $850 per ounce in January 1980, gold prices dropped for 235 months, bottoming out at $253 per ounce in July 1999.

Stocks provide four primary long-term benefits: capital growth, income generation through dividends, inflation hedging, and specific tax advantages. A $10,000 investment in the S&P 500 in 1926 grew to $25,866,626 by the end of 2009 when dividends were reinvested, driven by an average annual rate of appreciation of 5.5 percent and 4 percent average annual income from dividends.

Stock investments enjoy four distinct tax advantages compared to bank interest and other assets. Dividends and long-term capital gains are taxed at lower rates than ordinary income, capital gains taxes are deferred until the stock is sold, and capital gains can pass tax-free to heirs up to certain estate limits. In 2010, ordinary bank interest could be taxed as high as 35 percent, whereas most stock dividends and long-term capital gains were capped at 15 percent, with an estate limit of $1.3 million for passing capital gains tax-free to heirs.

• Defer taxes on stock growth by holding shares instead of selling them.
• Pass capital gains to heirs tax-free at death up to statutory estate limits.

4. Equities and Mutual Funds

Equities provide the primary engine for long-term growth, which should be captured through structured mutual funds and exchange-traded funds rather than individual stock picking.

Stock Market Principles

The stock market functions as a leading economic indicator because stock prices reflect what Wall Street expects companies to earn six to nine months in the future. Financial markets operate on future-speak rather than daily events.

In 2009, despite a terrible recession and massive layoffs, the stock market kept climbing because Wall Street believed the economy was going to improve.

Popular market indexes like the Dow Jones Industrial Average track a very narrow selection of companies, making them prone to unrepresentative conclusions. The Dow tracks only 30 U.S. stocks, whereas 20,000 publicly traded companies exist in the country.

In 2009, Citibank and General Motors were replaced in the Dow by Travelers and Cisco Systems, which would have made the index almost 300 points higher had the swap occurred two years prior. Investing in international stocks exposes you to foreign currency exchange rate fluctuations alongside regular stock market risks.

If you buy stock in Sony on the Tokyo market using Japanese yen, you are subject to both Sony's stock fluctuations and the exchange rate fluctuations between the dollar and the yen.

You can buy stocks through three primary avenues:

• full-service brokerage firms that charge commissions of about 1.5 percent each way;
• discount brokers that execute trades for lower fees without giving investment advice;
• direct Dividend Reinvestment Plans that let you buy from corporations to bypass brokers.

You must consider all transaction fees and spreads because you must earn enough profit to cover costs just to break even. Do not ask for advice from full-service brokers and then buy their recommendations from discount brokers.

Mutual Funds and ETFs

Individual investors face affordability, limited liquidity, lack of diversification, and little or no professional assistance when buying direct securities. Congress passed the Investment Company Act of 1940 to fix these four problems by enabling investment companies to pool consumer funds.

Open-end mutual funds continuously issue and redeem shares at Net Asset Value. Closed-end funds trade on exchanges and frequently trade 10 percent to 20 percent below their net asset values.

Exchange-traded funds offer lower costs, higher tax efficiency through in-kind redemptions, daily holdings disclosure, and real-time intraday pricing. The iShares North American Natural Resources ETF holds a precise allocation of 64 percent oil and gas, 16 percent metals and mining, and 15 percent energy equipment and services.

• Invest through structured investment companies to gain affordability, liquidity, and diversification.
• Categorize mutual funds based on basic concepts including time, quality, size, and style.
• Shift asset allocations into exchange-traded funds to minimize annual expense ratios and tax burdens.

5. Investment Strategies and Market Timing

Mutual funds and ETFs assess three types of charges, many of which are completely hidden from investors on their statements. The three expenses are commissions, fixed operating expenses, and variable operating expenses. Regulators call commissions sales charges while the media calls them loads.

Mutual fund and ETF expenses conceal true costs behind commissions, annual ratios, and hidden fees.

A 2009 study by AARP revealed that 65% of investors believe they pay no fees to invest in mutual funds. Fixed operating expenses are recovered through an annual expense ratio listed in the prospectus and assessed daily. Variable operating expenses include brokerage commissions, trading expenses, and shelf-space payments buried in the Statement of Additional Information.

Annuities are contracts with insurance companies that provide a stream of income in exchange for an investment, but they come with high fees and strict conditions. Executive Life of California Insurance Company went broke in 1991, leaving fixed annuity owners with frozen or lost funds while variable annuity owners were unaffected due to asset segregation.

Implementing specific behavioral savings strategies ensures that individuals can consistently set aside money for investing without relying on willpower alone. Ric Edelman used a Planters Peanuts tin can given to him by his big brother Brad to save change when he was eight years old.

Fund Fees and Savings Strategies

• Pay Yourself First by writing a check to yourself for $25 or $50 before paying any other bills, or use a retirement plan.
• Stop spending coins and put daily change into a piggy bank or tin can.
• Place the saved dollar from a supermarket coupon into your savings before leaving for the store.

Dollar Cost Averaging and Market Timing

Dollar cost averaging forces investors to buy fewer shares when prices are high and more shares when prices are low, resulting in a lower average cost and built-in profit. Investing $1,000 in the S&P 500 on January 1 of every year from 1974 through 2009 yielded an average annual return of 10.6%, compared to 11.2% if picked at the absolute lowest price day each year.

• Invest a specific amount of money at a specific interval regardless of market conditions.
• Sign up for automatic checkbook debiting to automate deposits.
• Invest in stock funds rather than individual stocks.
• Choose volatile, speculative stock funds that swing to great highs and lows to maximize share accumulation during drops.

From January 1, 1994 to December 31, 2009, removing just the 10 best-performing days out of 3,827 trading days reduced the 16-year average annual return of the S&P 500 to zero.

6. The Psychology of Investing and Diversification

Investor losses almost always begin with emotions, leading people to buy at market peaks and panic-sell during crashes. Following news reports triggers emotional cycles of hope, optimism, and euphoria, followed by anxiety, fear, and panic. Reacting to short-term market drops causes you to do the exact opposite of what you should.

In 1987, investors poured money into stocks just in time to catch the peak in August, only to panic and sell after the Dow dropped 12% in a single day on October 19th, resulting in a 35% total decline of the Dow from its August 22 high.

Human psychology is plagued by 16 cognitive biases that interfere with the ability to make logical financial decisions. Behavioral finance and neuroeconomics show that mental shortcuts prevent objective analysis.

Asset allocation and proper diversification overcome cognitive biases and volatility, driving portfolio success.

Psychology and Risk Measurement

Volatility is merely a normal characteristic of stocks rather than a reason to avoid them, and markets historically rebound quickly after crises. Since 1940, the average spread between the S&P 500's highest and lowest prices of the year has been 23%. In the weeks following every major crisis since the Korean War, stocks dropped an average of 10%, but gained an average of 14% in the subsequent six months and 18% in the year afterward.

Standard deviation measures an investment's average variation from its average return, exposing the true level of risk behind advertised performance figures. Statistically, there is a 67% probability that returns will fall within one standard deviation, and a 95% probability that they will fall within two standard deviations.

Asset Allocation and Optimization

Diversification allows you to take small, calculated risks where maximum losses are limited while gains are unlimited. Splitting a $25,000 investment into five piles, including a total loss on lottery tickets, zero interest in a mattress, a 1% bank savings account, a 3% U.S. Treasury, and an 8% stock market allocation, yielded $3,779 more after 25 years than putting the entire amount into a 3% CD.

Asset allocation accounts for the vast majority of a portfolio's performance differences, and adding risky assets can actually lower overall portfolio risk. A landmark study by Gary Brinson, Randolph Hood, and Gilbert Beebower found that 93.6% of the difference in volatility among large pension plans was due to asset allocation. Historical performance from 1926 to 2009 showed that a blended portfolio of 20% stocks and 80% bonds was lower in risk than a portfolio consisting entirely of 100% bonds.

Investors must never choose mutual funds based on short-term rankings or last year's performance because top-performing funds rarely repeat their success.

• Use fund rankings only to monitor and compare consistency over long-term intervals of 10 years or more.
• Ensure that comparisons are made within the same category.
• Verify that the fund offers volatility equal to or below that of its peers.

7. Portfolio Management and Debt Elimination

Systematic portfolio rebalancing, disciplined debt elimination, and tracking actual spending are essential for financial control.

Portfolio Maintenance

Over time, asset classes grow at different rates and distort your original model portfolio. Effective portfolio management requires systematic rebalancing to maintain your target risk profile. In a four-asset model split evenly at 25 percent each, faster-growing stocks eventually expand to represent 38 percent of total assets if left unmanaged.

• Choose a rebalancing method either by calendar date or by percentage drift limits.
• Monitor portfolio allocations regularly to detect when asset classes cross defined thresholds.
• Sell portions of outperforming asset classes and use the proceeds to buy underperforming asset classes.

Debt Elimination and Tracking

Getting out of debt requires abandoning theoretical budgets and tracking actual expenses. Budgets fail because they reflect plans rather than reality.

• Stop spending cash to ensure every transaction leaves a paper trail.
• Draw a series of columns on paper for payee, amount, and specific spending categories.
• Itemize store purchases and credit card bills across your categories.
• Total each column monthly and convert the dollar totals into percentages.

To eliminate debt efficiently, you must list your debts by interest rate and stop the accumulation of high costs. A client in the author's firm held a record of $370,000 in credit card debts with a minimum payment of $10,000 per month.

• Make four columns listing the creditor, amount owed, interest rate, and minimum payment.
• Order your creditors starting with the highest interest rate at the top.
• Pay the minimum monthly payment to each creditor consistently.
• Devote all remaining money exclusively to the creditor charging the highest rate.

8. Real Estate and Mortgages

Homeownership requires careful financial readiness, while carrying a large mortgage and avoiding prepayment maximizes long-term wealth.

Home Buying and Mortgages

To avoid becoming house poor, you should ignore real estate industry lending limits and restrict total debt payments to 36 percent or less of your gross income. Real estate professionals benefit from stretching buyers to a limit of 40 percent or more. Research shows homeowners are no happier than renters. They also experience 20 percent less leisure time and carry 12 pounds more weight.

Marvin and Beth bought a house based on their combined $70,000 income, but when Beth wanted to stay home with their baby, they discovered her income was mandatory just to pay the mortgage.

Lending Limit #1 dictates that monthly mortgage payments must not exceed 28 percent of gross income. Lending Limit #2 dictates that combined mortgage payments and other debts must not exceed 36 percent of gross income. Home buyers can reduce interest rates by paying points, but research shows few borrowers keep loans long enough to profit. One point equals 1 percent of the loan amount. A $150,000 loan with three points costing $4,500 reduces a 6 percent interest rate to 5 percent. Traditional agents legally represent the seller in many states. You can protect yourself by signing an agreement with a buyer-broker.

• Create a wish list of price range, location, structure, style, features, and amenities before looking for a home.
• Sign an agreement with a buyer-broker to ensure legal representation on the buy-side of the transaction.
• Work with only one real estate agent when actively trying to buy a house.
• Talk first with a mortgage broker or banker, not a real estate broker.
• Obtain a mortgage pre-approval letter before shopping for homes.

Mortgage Strategies

Ric Edelman's BLT Mortgage Strategy advises getting as big a mortgage as possible and never paying it off early. A Federal Reserve Bank of Chicago study found that U.S. households lose $1.5 billion per year by misallocating savings into mortgage prepayments. Fifteen-year mortgages and extra monthly principal payments destroy liquidity and reduce tax deductions.

• If you have a lot of equity in your house, consider obtaining a mortgage to get that equity out.
• If you have a mortgage that will be paid off in 10 years or less, consider refinancing to restart the 30-year clock.
• If you have a 15-year loan, consider replacing it with a 30-year loan and investing the monthly savings.
• If you participate in a bi-weekly mortgage plan, cancel it.
• If you send extra mortgage payments to the bank, stop and send that money to your investments instead.

10 Key Ideas

1. Starting to invest early matters far more than the total amount of capital invested due to the immense power of compounding over time.
2. Certifications of deposit and bank accounts are deceptively volatile over long periods because their returns consistently fail to outpace inflation.
3. Investors should never buy an investment based on yield because chasing high payouts frequently results in catastrophic losses of principal.
4. Stock investments enjoy significant tax advantages by deferring capital gains until sale and taxing dividends at lower rates than ordinary income.
5. Exchange-traded funds offer superior management options through lower costs, higher tax efficiency, daily holdings disclosure, and real-time intraday pricing.
6. Market timing fails completely because removing just a few of the best-performing trading days can reduce a multi-year average annual return to zero.
7. Asset allocation accounts for the vast majority of portfolio performance differences, allowing risky assets to work together to lower overall volatility.
8. Effective portfolio management requires systematic rebalancing to maintain target risk profiles as different asset classes grow at varying rates over time.
9. Home buyers should avoid becoming house poor by restricting total debt payments to 36 percent or less of their gross income.
10. Ric Edelman's BLT mortgage strategy advises getting as big a mortgage as possible and never paying it off early in order to maximize liquidity and long-term wealth.