Thursday, January 10, 2008

Edelman on Mortgages, Book Review Part 2

This is the second part of a review of Ric Edelman’s audio book “No-Nonsense System for Building Wealth.” This review began here.

Edelman recommends keeping your mortgage, making the minimum payments, and investing any extra money you have even if you’re able to pay off your mortgage. The main support he gives for this advice is that many of his wealthy clients keep their mortgages.

Any time you borrow to invest, you are said to be using leverage, and this increases your investment risk. It stings any time your investments drop in value, but the sting is worse if their value drops below the amount you owe.

This idea of leverage is similar to the leverage you may have used as a kid on the teeter-totter. I remember pulling my side out to make it longer than the other side so that I could control the movement even if the other kid was heavier. I could make him go way up more easily. With a well-timed hard push I could also make him crash into the ground more easily. It works the same way when using financial leverage; the ups and downs get magnified.

Keeping your mortgage maxed out for decades may make sense for some people, but is definitely not for everyone. One thing is sure, though: following this advice will give people more money to invest and will increase the size of the commissions financial advisors get, including Edelman’s financial planning firm.

This advice makes more sense for Americans who can deduct mortgage interest on their taxes than for Canadians who cannot. However, Canadians with equity in their homes who are determined to borrow to invest can read this essay on the “Smith Manoeuvre” for writing off loan interest on their taxes.

In part 3 of this review, we look at Edelman’s view of market indices and index funds.

3 comments:

  1. I'm glad to find a critique of Ric Edelman.

    I have been investing for a few decades so a lot of what he says is old news to me. However, I
    was persuaded by his latest book, "Lies about Money" to change my
    brokerage IRA account positions to a diverse collection of ETFs.

    The book and his web site will give you a somewhat detailed and personalized asset allocation based
    your answers to questions.
    It wasn't hard for me to figure out a set of bond mutual funds and ETFs that implement that allocation.
    The plus for me is that I no longer have to worry about being in the right stocks at the right time.
    Now it is just a matter of using "constant ratio" re balancing to maintain the asset allocation.

    Of course, the self-promoting, self-serving aspects of his presentation are pretty obvious.
    He makes a big push for funds you can only get through an advisor.
    But the 2% annual charge for his firm is just too big for me to swallow.

    My gut also told me to keep paying extra on my mortgage, despite his advice. I have a nice, 30 year fixed mortgage, but I don't feel like I can retire without having it paid off. Currently that would be at age 71, so that is why I am paying extra principal. If I lose my job or something like that, I can back off to the minimum payment.

    I feel that Jim Cramer gives bad advice without a lot of self-interest (other than ego).
    In contrast, Ric Edelman gives mostly good advice with a self-interest you have to filter out.

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  2. Anonymous:

    It sounds like you are knowledgable enough to take advantage of Edelman's good advice without getting caught by his self-promotion. I think you're making the right call about your mortgage. Higher debt means higher risk.

    I'm actually planning a review of "Lies About Money" probably sometime around April 15-17. He hints that the institutional funds have loads between 0.5% and 2%, but I didn't see anything about his annual charge. Did you get that from his web site? I'd like to include a discussion of his annual fee if I can confirm it with a source.

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  3. I can't remember where I heard the 2% annual fee. Of course, you know that the website for his money management service is here.

    I read the "Lies About Money" and have listened to a few podcast episodes of his radio show.

    The personalized asset allocation link (aka GPS) can be found on this page.



    I "Lies About Money" Ric talks about implementing the asset allocation with ETFs as a sort of second-best approach versus institutional funds. The latter requires going through an advisor, which is better for some people, worse for others.

    His money management firm seems to be well regarded. I can imagine someone with enough money but not enough time or interest getting good value out of their services.

    I am a software engineer and know other engineers who made a lot of money on their jobs and turned around and lost it trading stocks on margin. They would have been better off having Edelman's firm manage their money.

    I was thinking last night about my characterization of Jim Cramer as not being self-promoting. Then I remembered his "Action Alerts.com."
    I guess anybody that provides investment advice is going to try to find a way to make money doing it.

    One of the things that Ric Edelman has right is the idea of knowing your risk tolerance. My version of this idea is this:

    1) Risk and Reward are intertwined, you can't get more reward without more risk.

    2) You need to know your risk tolerance.

    3) If you are higher on the risk/reward curve than your risk tolerance, you will sell low when it drops.

    4) If you are lower on the risk/reward curve than your risk tolerance, you will risk not having enough to meet your goals (usually retirement).

    Anyway, I think most of Ric's advice is good.

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