10 Questions for Larry Swedroe, Author of “The Right Financial Plan”

Here is an email interview I conducted with Larry Swedroe, author of lots of books on personal finance and investing, including his newest book, The Only Guide You’ll Ever Need for the Right Financial Plan. This was a great interview. If you agree, PLEASE share this with your friends (whether they be on facebook, twitter, or elsewhere). I appreciate Larry taking the time out of his busy schedule to answer these questions.

Oh, and if you haven’t had a chance, enter The Right Financial Plan Giveaway here on AFM. I’ll announce the winners on Thursday morning so you still have time to enter. I’m giving away three books.

What led you to write The Only Guide You’ll Ever Need for the Right Financial Plan?

The three other “Only Guides” (links provided at end of interview) presented the academic research on equities, bonds and alternative investments. They presented what I call the science of investing. The new book is all about the “art of investing”—how do you take the academic research and best apply it to your personal situation. So the book discusses issues like who should own more equities and who should own less, who should own more small caps and who should own less, and similarly for all equity asset classes. It also does the same type thing for bonds. So it addresses such issues as who should own more TIPS and who should own more nominal bonds, who should own shorter term bonds and who should own longer term bonds, and so on.

It also is the first book I am aware of that not only helps individual investors write their own investment plan, but helps them with the ongoing care and maintenance of the plan, addressing issues such as rebalancing, tax management, asset location and withdrawal strategies. But the book goes well beyond that as it also addresses issues like mortgages, social security, long term health care and the designing of a family wealth mission statement. In other words it teaches people how to write a financial plan, not just an investment plan.

To my knowledge, this book is the first of its kind to take on this large task and do it in a way that is accessible for the typical individual investor.

What did the financial crisis of 2008 (and longer) teach you?

I really don’t think it taught me anything, just provided reminders about how risky stock investing is, and what the winning strategy is. Don’t take more risk than you have the ability, willingness or need to take. And the reason is that basically everything that happened in 2008 had already happened and thus investors that knew their financial history should have been well prepared for the events. In other words, while investors could not anticipate when such a crisis would occur, their plan should have incorporated the virtual certainty that such a crisis would occur and the only things we would not know were when it would occur, how long it would last and how deep it would be. In other words, a well-thought-out plan anticipates the risks and builds those risks into the plan. That is why Chapter 2 on The Investment Policy Statement includes a discussion on the need for a plan B: What you will do if the risks show up, as they did in 2008.

What have your clients learned from 2008?

Unfortunately, some people learned that they were overconfident of their stomach’s ability to deal with the stress of severe bear market. Thus, they took more equity risk than they should have, and that in a very few cases led to panicked selling which is almost impossible to recover from. And they did this despite all the education we provide on an ongoing basis. For example, during bull markets we persistently remind clients of the risks of equities and that severe bear markets can occur. Then during bear markets we remind them that we fully expect that they will end (though we cannot be certain) and how important it is to remain disciplined. We also remind them that we had discussed the fact that such bear markets were virtually a certainty and that they were built into the plan and they signed off on that plan, indicating that they understood the risks and were prepared to deal with them.

But there were many other lessons investors in general learned. For example, they learned that as much as they would like to believe otherwise, active managers don’t protect investors from bear markets. They underperform at least as poorly in bear markets as they do in bull markets. They also learned the dangers of stretching for yield, investing in such high risk fixed income investments (which we avoid) as preferred stocks, junk bonds, convertible bonds and emerging market bonds. Those investments, as my book discusses, should be avoided for several reasons, including their risks don’t mix well with the risks of equities.

If you were to pick one thing that is most important to a person’s financial plan, what would it be?

While there are many components to a good financial plan, the most important I think is to make sure that the investor’s equity allocation does not exceed his ability, willingness and the often-overlooked category of need to take risk. The great shame is that so much money was lost by people who took risks they had no need to take because they had already “won the game.” In other words, they could meet their financial needs with very low equity allocations, such as 20-30%.

In your opinion, where do people fail most frequently when it comes to financial planning?

The most frequent failure is the failure to not even have an investment plan in the first place. And we all know that those that fail to plan, plan to fail. The vast majority of investors, even many who work with financial advisors, do not have a written and signed investment plan that lays out their goals, defines the risks they are willing to take and includes an asset allocation and rebalancing table. The second biggest mistake is the failure to integrate a well-thought-out investment plan into a well-thought-out estate, tax and risk management plan. A great example is I knew of an investment advisor that had a great investment plan but he did not have sufficient life insurance to take care of his family in the case of his premature demise. Fortunately we performed a needs analysis for him and convinced him to buy a large life insurance policy. That was the good news. The bad news was that he died a year or so later from cancer. Now he had a great investment plan but it would have failed because he did not live long enough, and thus had not saved enough. His plan failed for reasons other than bad investments. The same type mistakes can occur because people don’t title assets appropriately, designate the wrong beneficiaries, or fail to buy appropriate amounts of liability insurance of all kinds (especially umbrella policies). A good financial advisor should identify such issues, eliminating those risks and mistakes as much as possible.

What does a financial plan look like?

As we discussed above, a good investment plan should clearly spell out the investor’s financial goals as well as the risks they are willing to accept. It should have an asset allocation and rebalancing table as well, and lay down the rules for rebalancing and tax loss harvesting (such as how often they will be checked–I recommend at least quarterly, though we basically do it daily, thanks to technology we have invested in). And as I discussed, the plan should also include what I call Plan B: what options you will exercise if severe bear markets occur. As the book discusses, those options might include cutting spending, working longer than planned, moving to area with a lower cost of living, and so on.

How often should people look at their financial plans? Life changes? Yearly?

This should not be a timed based event, though I recommend it be reviewed annually just to be on the safe side. The only right way to do it is as follows: Since the plan is based on certain assumptions about ability, willingness or need to take risk, whenever any of the assumptions changes, you should change the plan. Generally that will be caused by a life event such as a death in the family, divorce, loss of job, promotion, inheritance, and so on. However, bear markets sometimes teach us lessons as well, as I mentioned. For example, I think it likely that even investors that did not abandon their investment plans may have cut back on spending. This would be a natural thing to do given that risks had increased. Having cut back on spending they may have learned that they really did not need the higher spending levels they were used to and they could be just as happy spending less. Such a person should then consider lowering their equity allocation because they now have a reduced need to take risk.

What are you advising your clients with regards to the future of social security? Does the strategy change based on age?

First, there is a great book on the subject called The Coming Generational Storm: What You Need to Know about America’s Economic Future*, which I highly recommend. While one of my favorite expressions is “my crystal ball is always cloudy,” I think it is safe to say that because of the depth of the problem it will be necessary to attack it from all directions. That means we will almost certainly see cuts in benefits (including perhaps change in the inflation adjustment), increased age requirements and increased taxes. But, in my opinion social security will remain an important part of the safety net we provide the elderly.

In your 40-year career, what is one thing you wish you would have done differently?

Learned just how tyrannical the power of the Efficient Markets Hypothesis is at an earlier age. Fortunately, eventually I learned that while it was possible to beat the market it was so unlikely that you would succeed that it was foolish to try. That not only led to superior investment results but a higher quality of life as I stopped reading (or watching or listening to) what I learned was nothing more than what Jane Bryant Quinn accurately called investment porn. That gave me more time to spend on far more important things such as my family, friends and hobbies such as reading. I read about 60 or so books every year, most of which have nothing to do with investments. My favorite category is historical fiction, with two of my favorite authors being Philippa Gregory and Bernard Cornwell. I also like good detective novels, and among my favorites are Robert Crais, Michael Connelly, Dennis Lahane, Ross Thomas and T. Jefferson Parker.

What’s next on your plate? Any more books to look forward to?

Actually my plate is pretty full. I have a new book called The Search for Alpha. Wiley will be publishing it, with expected release of February 2011. The book examines the evidence on active investing by looking at the research on mutual funds, individual investors, pension plans, 401k plans, venture capital, hedge funds and behavioral finance. It then shows how individual investors can outperform the vast majority of pros by building globally diversified portfolios and staying the course. It will be a much shorter book than some of my others, along the lines of “the Little Book” series.

Then I am in the process of completing an updated and thoroughly revised version of Rational Investing in Irrational Times. The new book is tentatively titled 76 Investment Mistakes Even Smart People Make and How to Avoid them. The prior book only covered 52 of them.

And I have also just finished the third in the Wise Investing Made Simple series. Hopefully the second will be successful and the publisher will be interested in doing the third.

Thanks for your time, Larry. Good luck to you in all your adventures.

Larry also told me that he and his co-authors would be happy to answer any questions AFM readers might have. Send them to me in an email (JLP-at-AllFinancialMatters.com) and I’ll forward them to Larry. Or, leave them as a comment and I’ll see if I can get Larry to stop by and respond that way.

Also, Larry writes a regular blog called Wise Investing for MoneyWatch.

Related books (affiliate links):

Wise Investing Made Simpler (Second in a series)

The Only Guide to a Winning Investment Strategy You’ll Ever Need: The Way Smart Money Invests Today

The Only Guide to a Winning Bond Strategy You’ll Ever Need: The Way Smart Money Preserves Wealth Today

The Only Guide to Alternative Investments You’ll Ever Need: The Good, the Flawed, the Bad, and the Ugly (Bloomberg)

*Affiliate Link

3 thoughts on “10 Questions for Larry Swedroe, Author of “The Right Financial Plan””

  1. Glad you enjoyed the interview. Hope you enjoy the book. One benefit readers have is that I am always happy to answer questions from readers

    And hope you also enjoy my other new book, Wise Investing Made Simpler, the second in the Wise Investing Series.

    Best wishes

  2. Hmmm–I really enjoy Larry’s books and also this interview. I wonder if liking the same mystery authors, esp. Crais and Connelly, is a good enough reason to follow his advice. How about an Elvis Cole/Joe Pike portfolio?

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