In clear and concise language, Bogleheads Larry Swedroe and co-author RC Balaban have identified "seventy-seven common mistakes" investors make. I have made many of them myself. Hopefully this book will help you avoid these investing pitfalls the easy way (by reading the book). These are some of the book's valuable quotes that I call "Investment Gems":
This book is not just about helping you avoid the mistakes even smart investors make, but about how to win the game of life.
Our education system almost totally ignores the field of finance and investments.
Save as much as you can as early as you can.
Unless it is for entertainment value, turn off CNBC, cancel your subscriptions to financial trade publications, and don’t visit Internet chat boards that tout great funds, great stocks, or new and interesting investment strategies.
Unfortunately, much of what is conventional wisdom on investing is wrong.
A critical part of the financial planning process is to consider a “Plan B.” This consists of the actions that might have to be taken if financial assets fail to such a degree that the investor may run out of assets.
“If you want to see the greatest threat to your financial future, go home and take a look in the mirror.” (Jonathan Clements quote)
It appears that a common characteristic of human behavior is that, on average, men have confidence in skills they don’t have, while women simply know better.
Individuals who traded the most produced the lowest net returns. (Barber/Odean study).
Overconfidence causes investors to seek only evidence confirming their own views and ignore contradicting evidence.
The Mensa Investment Club returned just 2.5% over the previous 15 years, underperforming the S&P 500 Index by almost 13% per year.
Recognizing our limited ability to predict the future is an important ingredient of the winning investment strategy.
It seems to be a simple human failing to fall prey to ‘recency’—the tendency to give too much weight to recent experience and ignore long-term historical evidence.
Morningstar tracked the performance of the least popular fund categories from 1987 through 2000. The three least popular categories of funds have beaten the average fund 70% of the time, and more amazingly, they have beaten the most popular funds 90% of the time.
Morningstar studied he performance of mutual funds and their investors and found that the returns earned by investors were below the returns of the funds themselves in all 17 fund categories they examined (primarily due to market-timing).
“Whenever some analyst seems to know what he’s talking about, remember that pigs will fly before he’ll ever release a full list of his past forecasts, including the bloopers.” (Jason Zweig quote)
There is a tremendous body of evidence that the vast majority of actively managed funds underperform their benchmarks, and the longer the time-frame the greater the likelihood of underperformance.
If you are going to use past performance to predict the future winners, the evidence is strong that your approach is likely to fail.
“It’s the big lie that, repeated often enough, is eventually accepted as truth: You can beat the market, Trounce the averages, Outpace the index. Beat the street. An entire industry strokes this fantasy.” (Jonathan Clements quote).
The average actively managed fund underperforms its benchmark by well over 1% per year on a pre-tax basis, and by far more on an after-tax basis.
Having the discipline to avoid the temptation of following the crowd and the noise of the moment is an important part of the winning investment strategy.
Today, there are about as many mutual funds as there are stocks. With so many active managers trying to win, statistics alone dictate that some will succeed.
There is no evidence of any persistence in fund performance beyond the randomly expected.
An investment policy statement (IPS) will help keep you from taking “scenic tours” of interesting investments best avoided.
It is style drift that causes investors to lose control over their asset allocation, and thus the risk and reward of their portfolio.
Risk can be defined as the probability of not achieving your financial objective.
Harry Markowitz demonstrated that one could add risky, but low correlating, assets to a portfolio and increase returns without increasing risk.
Studies have found the pain of a loss is at least twice as great as the joy we feel from an equivalent size gain.
What you paid for a security should have no bearing (except for tax consideration) on whether you should continue to hold it.
In times of global crisis, all risky assets tend to correlate highly. The only effective diversifier of equity risk is high quality fixed income investments.
The need to take risk is defined by the rate of return needed to meet the minimum financial goals set by the investor.
Diversification is the closest thing there is to a free lunch.
Wall Street’s product machines crank out securities that entice investors with extravagant yields, but come accompanied by great risks.
What you can be sure of is that if an investment carries a high yield there is risk, even when you cannot see it.
When the capital gains tax rates were lowered to 15% in 2003, the sales of variable annuities should have come to a screeching halt.
An astounding 15 to 20 percent of the premium paid by investors in EIAs (Equity Index Annuities) is a transfer of wealth from unsophisticated investors to insurance companies and their sales forces.
IPOs (Initial Public Offerings) have provided huge profits for the Wall Street firms that market them; they have generated very poor returns for investors.
Adding a small amount of equities to an all-bond portfolio raises returns while actually reducing volatility.
As a general rule investors with a 30-year or longer investment horizon should not withdraw more than 4% of the starting value of a portfolio.
It is hard to understand why anyone would give their hard earned assets to someone who invests those assets in a way that is not completely transparent.
The combination of the lack of predictability of returns, the low correlation, and their inflation hedge makes a strong case for including REITs as an asset class in an investment portfolio.
“A prediction about the direction of the stock market tells you nothing about where stocks are headed, but a whole lot about the person doing the predicting.” (Warren Buffett quote)
Optimists tend to be more accurate than pessimists. Keep this in mind the next time you read a doomsday forecast.
There are three types of investment forecasters: Those who don’t know where the market is going, those who know they don’t know, and those who know they don’t know but get paid a lot of money to pretend they do.
The 44 Wall Street Fund ranked as the top performing diversified U.S. stock fund in the 1970s. It ranked as the single worst performing fund in the 1980s, losing 73 percent.
Believing that the past performance of active managers is a good predictor of their future performance can be expensive.
International diversification provides us with insurance in case the U.S. capital markets and the dollar perform poorly.
It is difficult to fire an advisor who is also a friend, and even more difficult to fire one that is a relative.
While it is important to treat family wealth as a private matter, it should not be private within the family.
The broker-dealer community knows that individual investors lack sufficient knowledge about the bond market, which make exploiting them as easy as “taking candy from a baby.”
In a 2010 study, Morningstar found that expense ratios were a better predictor than its star ratings.
The average actively managed fund now has turnover about 100%, and the cost of all that turnover—commissions, bid-offer spreads and market impact costs can easily exceed 1 percent.
It is often a long way from the theoretical results of a strategy to the actual results that can be obtained.
When forecast investment returns, many individual make the mistake of simply extrapolating recent returns into the future.
The simplest way to implement the buy low/sell high strategy is to build a portfolio that is highly diversified by asset class, and then regularly rebalance.
The average Investment Club lagged a broad market index by 3.8% per year. (Odean/Barber study)
Goldman Sachs studied mutual fund cash holding from 1970 to 1989. The study found that mutual fund managers miscalled all nine major turning points.
Standard & Poor’s found that the majority of funds in 8 out of 9 domestic equity style boxes were outperformed by indexes in the negative markets of 2008. Results were similar during the bear market of 2000-02.
Jeffrey and Arnott showed the impact of taxes on returns in their study of 71 actively managed funds for the 10-year period 1982-1991. The found that while 15 of the 71 funds beat a passively managed fund on a pretax basis, only five did so on an after-tax basis.
Taxes are probably the largest expense investors incur, even greater than management fees or commissions.
Several academic studies have come to the conclusion that asset allocation determines the vast majority of not only the returns but also the risks of a portfolio.
Investors should logically avoid investing in hedge funds.
Vanguard is a highly respected firm and its funds are known for their low costs.
Good advice doesn’t have to be expensive. However, bad or untrustworthy advice almost always will cost you dearly.
(Nobel Laureate) Wm. Sharpe demonstrated that active management is a loser’s game whatever the asset class, whether markets are efficient or inefficient. The reason is simple: Costs matter.
Small companies are riskier than large companies. Therefore the market prices small-cap stocks to provide higher returns than large-cap stocks.
If you don’t have a plan, immediately sit down and develop one – and then be sure to stay the course, altering your plan only if your assumptions about your ability, willingness or need to take risk have changed.
Never have more than a very small percentage of your assets in the stock of any one company, especially your employer.
When the cost of a negative outcome is greater than one can bear, the risk should not be taken, no matter how great appear to be the odds of a favorable outcome.
“I’m a big believer in diversification, because I am totally convinced that forecasts will be wrong.” (Paul Samuelson quote)
Chasing the latest fad or hot asset class has proven to be a losing strategy and the result of confusing strategy and outcome.
In 1989, the Nikkei index hit a peak of almost 40,000. Twenty-two years later, it was still down about 75%.
“History teaches us that things that never happened before do happen.” (Nassim Taleb quote)
If your investment horizon is very short, then the way to control risk is to increase your allocation to short-term fixed-income assets.
If you start with an investment of $100 and it rises 90% in the first year, and it falls 45% in the second, your annualized return is only about 2% per year.
Locate your most tax-efficient asset classes in your taxable accounts, and your least tax-efficient asset classes in your tax-deferred accounts.
It is important for you to avoid making purchases of a taxable mutual fund just prior to the ex-dividend date. You will be taxed on income you didn’t really earn.
You should generally avoid intentionally taking any short-term gains. Simply wait until the long-term holding period is achieved.
Tax-managing a portfolio is a very important part of the winning strategy.
Good risk is the type you are compensated for taking. Bad risk is the type for which there is no such compensation. Thus, it is called uncompensated or unsystematic risk.
In finance, a “black swan” refers to a large-impact, hard-to—predict, rare event beyond the realm of normal expectations.
“Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.” (Peter Lynch quote)
Mark Hulbert, publisher of Hulbert’s Financial Digest, studied the performance of 32 of the portfolios of market timing newsletters for the 10 years ending in 1997. Here’s what he found: None of the market timers beat the market.
“This time it’s different.” Those are the four most dangerous words in the English language for investors.
The best solution to the unpredictability of the market is to build a globally diversified portfolio of index-passive asset class funds that reflects your unique ability, willingness and need to take risk.
Thank you Larry Swedroe and RC Balaban
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