I’m not a serious investor and for the most part don’t follow the day to day doings of the stock market and bond market to know what’s going on. I’m not the best saver in general, although I have contributed to 401k accounts where I’ve worked.
Recently, after a realization that I’m not going to win the lottery, or make millions of dollars a year in business, I’ve reconciled to the fact that I’ll be working for a living for the next 30+ years or so. This of course is a situation that nearly everyone is going to be in. Luckily I have a career and background in software and technology, so I’m fortunate enough to make a pretty good living.
I also came to the realization that I was going to have to be a little more proactive concerning my retirement, and take it a little more seriously. It’s pretty clear that relying on social security benefits once I reach retirement most definitely won’t be enough to live comfortably. This means that I need to start saving and investing more of my money on a regular basis.
I had read David Ramsey’s book Total Money Makeover and that triggered some of my new focus on thinking about money. That book is pretty radical on it’s advice for getting ahold of your money, but it’s pretty much spot on for what you should be doing. I’m not following all of it and I’ve made a few mistakes such as taking out a loan for my car and spending more then I should in general.
Despite not following Ramsey’s advice in full, which would involve paying off all of your debt before starting to invest, I feel more comfortable putting money away even though I still have some debt. Especially after playing around with the compound interest calculator. You should play with one too to see how much money you could have depending upon different market returns.
So with my new found interest in starting to handle my investing a little more intelligently I decided to do some research. My approach before had been sign up for the 401k and pick a target retirement mutual fund, but I wanted to understand a little bit more and try to get an idea of what to expect.
So in typical fashion for myself I bought a few books. I just finished the first one, which is a little book by John Bogle, called The Little Book on Common Sense Investing.
The book isn’t that long and I finished reading it in a couple of days. I’m glad that I did. It’s exactly what it purports to be, a little book with a lot of common sense backed up by some math. It’s definitely not a get rich quick book or anything even close to that, but I do feel that armed with the information from that book, while I won’t get rich, I may on average get better results following its guidance than I would trying to just pick a good mutual fund.
Bogle, the author, is the founder of Vanguard, which is a well respected company which offers investment services and funds to invest in. He is the inventor of the Index Fund, which is to a large extent what the book is about. An index fund, is a fund which basically owns a large number of stocks, in porportion to their capitalization in the market. This in effect tracks the market as a whole, instead of being more invested in a particular sector or group of companies.
The book goes over what an index fund is, and how it compares to typical mutual funds offered. The big difference, and one that the book makes very clear, is that over the long term, the stock market as a whole has performed better percentage wise than nearly every mutual fund. Whether this is by a percent or two, or larger, when Bogle gives the numbers, you can see that very few mutual funds actually perform any better then the market as a whole, and that over more then five years or so, they nearly all perform either worse then or close to how an index fund would perform.
The central thesis of the book, in my opinion, is that the average investor should invest in a low cost index fund as opposed to a mutual fund. Besides the fact that the index fund over time almost certainly performs better than a typical mutual fund does, Bogle gives an even more important reason to seriously look at an index fund. That reason, is cost. Mutual funds, and in particular actively managed mutual funds, typically have a higher annual cost then an index fund does, sometimes as high as a one percent more.
This makes sense, given that an index fund simply aims to hold a representation of the market as a whole for the long term, whereas a mutual fund is more frequently trading and reallocating its holdings, and therefore is more actively “managed”.
This may not seem like a big deal, but it means that even if the mutual fund was going to outperform the index fund, it would need to do so by more than its annual cost, because otherwise that would eat away at the gains anyway.
The book also teaches a bit more about stocks and tries to explain how speculative behavior contributes to the price of stocks. The core message is that the most sane course of reasoning is to realize that owning a stock gives you ownership in the company and it means that you are entitled to dividends. The intrinsic value of the market is tied to GDP and corporate profits. The speculative betting is what drives a lot of the price changes, with active traders betting on optimism or pessimism.
So I didn’t explain that last part that well, but I have a few more books to read. The core thing to take away from the book is that the typical investor in it for the long haul should be looking for very low cost index funds which track the market as a whole. A little bit of time in the book is spent on the bond market as well, and here, the message of the book is similiar in that you should look for an index fund here as well.
The book also talks about the value of using different types of financial advisors and investment professionals, which, if you’re even a little bit cynical, won’t surprise you when it says these folks are of dubious value. That being said it does say that some investment advisors can be helpful for other reasons, such as asset allocation and navigating taxes. For the most part the book is not all that friendly to a lot of investment firms. This book advocates for buying and holding for a long time, whereas a lot of the finanical industries profit is tied to people buying and trading frequently.
As this book makes abundantly clear and repeats throughout past performance is not a gaurantee of future performance. This book is certainly a common sense guide to investing, and unfortunately, it sounds like a lot of people don’t have very much common sense.
It’s a really good read. It’s totally about index funds and why you should invest in them. There isn’t anything about evaluating individual stocks or anything like that. It’s a simple forumula for investing for the long haul. If you don’t know much about the market this book is great, and will help you understand the mutual fund industry much better. A percent here and there over 30 or 40 years makes a big difference, and there’s a good chance the advice in this book, if only to seriously look at the annual cost of your investments, might earn you a percent more per year on your portfolio.
If a percent doesn’t sound like a lot, you need to play with the compound interest calculator. Because it is.
Anyway, you should read this book.