A Gem --"The Elements of Investing"

[Taylor Larimore]

Bogleheads:
Two giants of the investing world are Burton Malkiel and Charles Ellis. They have written a small, easily understandable book based on five major elements to become a successful investor. These are excerpts from each of the five:

1. SAVE:
"The fast way to affluence is simple: Reduce your expenses well below your income."

"There are few, if any, absolute rules in saving and investing, but here's ours: Never, never, never take on credit card debt."

"The secret of getting rich slowly but surely is the miracle of compound interest."

"Rebalancing reduces the volatility and riskiness of your investment portfolio and can often enhance your returns."

"A 10% rate of return will double your money in 7.2years, it will double your money again in the next 7.2 years. In less than 15 years you'll have four times your money--and sixteen times your money in 28.8 years."

"Luck in picking the right time to invest is all well and good, but time is much more important than timing."

"Credit card debt is the exact opposite of a great investment."

"If you feel you need life insurance, buy inexpensive term insurance sold by local savings banks or available on the Internet."

"The dollar a young person spends on some nonessential today would mean that $10 or more will be given up in retirement."

"We urge you to take full advantage of the variety of opportunities to make your savings tax deductible and to let your savings and investments grow tax free."

"(If you started late) the only way to make up for lost time is to start a disciplined program of savings--NOW."

"One thing is certain: By spending less, you can save more--and saving more is essential."

"Suppose that you have entered the workforce at age 23 and that you invest $5,000 each year over a 45-year period (at 8%). A person who followed such a program of IRA savings would have a final value of over $2 million."

2. INDEX:
"If your plan is clear, it will be easier for you to stay on plan. That's why you'll want to develop a clear and simple financial plan and stay the course."

"By buying a share in a total market index fund, you acquire an ownership share in all the major businesses in the economy. Index funds eliminate the anxiety and expense of trying to predict which individual stocks, bonds, or mutual funds will beat the market."

"This simple investment strategy--indexing--has outperformed all but a handful of the thousands of equity and bond funds that are sold to the public."

"It is difficult for most investors to believe that the stock market is actually smarter or better informed than they are."

"Almost no investor consistently outperforms the market either by predicting its movements or by selecting particular stocks."

"There are three classes of people who do not believe that markets work: the Cubans, the North Koreans, and active managers." (Rex Sinquefield)

"Over 10-year periods, broad stock market index funds have regularly outperformed two-thirds or more of the actively managed mutual funds."

"Professional investors as a whole are responsible for about 90% of all stock market trading."

"Since 1970, you can count on the fingers of one hand the number of managers who have managed to beat the market by any meaningful amount."

"Nobody, repeat nobody, has been able to figure out in advance which funds will do better. The failure to forecast certainly includes all the popular public rating sources, including Morningstar."

"During the 9-year period through December 31, 2007, 14 equity mutual funds had managed to beat the S&P 500 for nine years in a row.--How many of those funds do you think managed to beat the market in 2008? Only one out of the 14."

"Study after study comes to the same conclusion. Chasing hot performance is a costly and self-defeating exercise. Don't do it!"

"We are convinced there will be another Warren Buffett over the next 40 years. But, we are even more convinced we will never know in advance who they will be."

"To overcome the drag of expenses and taxes, an actively managed fund would have to outperform the market by 4.3% per year just to break even with index funds."

"Index the core of your portfolio and then, if you must, make the individual bets around the edges."

"Our retirement funds are safely indexed--and our children use index funds too!"

"With index funds, you don't get average performance. You get above-average performance because index funds have lower expense charges and avoid most unnecessary costs and unnecessary taxes."

3. DIVERSIFY:

"One of the few absolute rules of investing: Diversify, Diversify, Diversify."

"Diversify across securities, across asset classes, across markets--and across time."

"One asset class that belongs in most portfolios is bonds."

"When interst rates fall, bond prices rise. When interest rates rise, bond prices fall."

"So-called 'total stock market' funds will include both real estate companies and commodity products. Broad equity diversification can be achieved with one-stop shopping."

"The lower stock prices go, the better the bargains if you are truly a long-term investor."

"Rebalancing will not always increase returns, but it will always reduce the riskiness of the portfolio and it will always ensure that your actual allocation stays consistent with the right allocation for your needs and temperament."

4. AVOID BLUNDERS:
"YOU, far more than the market or the economy, are the most important factor in your long-term investment success."

"As in so many human endeavors, the secrets to success are patience, persistence, and minimizing mistakes."

"We are often our worst enemies. We tend to be overconfident, harbor illusions of control, and get stampeded by the crowd."

"Investors should avoid any urge to forecast the stock market."

"Market forecasts have a poor record because the market is already the aggregate result of many, many well-informed investors making their best estimates and expressing their views with real money."

"Mr. Markert tries to trick us into changing our investments at the wrong time--and he's really good at it."

"It's not today's price or even next year's price that matters; it's the price you'll get when it's your time to sell during your years of retirement."

"As an investor, you have one powerful way to keep from getting distressed by devilish Mr. Market: Ignore him. Just buy and hold a broad-based index fund."

"Charting is akin to astrology. The changes in stock prices are very close to a 'random walk': There is no dependable way to predict the future movements of a stock's price from its past wanderings."

"Selling winners means paying capital gain taxes (in taxable accounts) while selling losers can produce tax deductions."

"We have spent two lifetimes thinking about which mutual fund managers will have the best performance year in and year out. Here's what we now know: It was and is hopeless."

"There is one investment truism that, if followed, can dependably increase your investment returns: Minimize your investment costs."

"The stockbroker's real job is not to make money FOR you but to make money FROM you.."

"No investor should take on risks outside his or her comfort zone."

5. KEEP IT SIMPLE:
"Despite all the convoluted gimmicks some charlatans would like to sell you (because they are so profitable for the sellers), you can prosper by embracing simplicity."

"The only way to get rich--unless you inherit or marry a fortune or hit the lottery--is to get rich slowly."

"Buy simple, low-cost term life insurance, not complex 'whole life' insurance, which combines a high-cost investment program with the life insurnance you need."

"When everyone around you is losing his or her head, just stand there and DO NOTHING. Keep your eyes and your mind focused on the long term."

"Salespeople will regale you with fascinating stories about how certain exotic investments such as hedge funds, commodities, private equity, or venture capital can make you rich, even quickly. Do not listen."

"The best choice for your equity investments is a fund indexed to the total world stock market.--For your bonds, choose a total U.S. bond market index fund."

"Here is our KISS advice: If you are reasonably healthy as you enter the retirement years (and especially if you have good genes for a long life and few bad risk factors), invest half of your fixed-income investments in an annuity."

"Buy only a plain vanilla fixed (life) annuity."

"KISS investing--Keep It Simple, Sweetheart--is the best and easiest and lowest cost and worry-free way to invest for retirement security. Go for it!"
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Thank you Mr Ellis and Professor Malkiel (whose first book, "Random Walk Down Wall Street," changed my investing life).

More Investment Gems

[Random Walker]

Charles Ellis and Burton Malkiel are two of my favorite authors on the investing book shelf. One book written by both of them; a must buy! What's the title?

Dave

[Kenster1]

Charles Ellis and Burton Malkiel are two of my favorite authors on the investing book shelf. One book written by both of them; a must buy! What's the title?

Dave

It was in the title of this thread --- "The Elements of Investing"

So far 2 positive reviews on Amazon: http://www.amazon.com/Elements-Investing-Burton-G-Malkiel/dp/0470528494/ref=sr_1_1?ie=UTF8&s=books&qid=1261588146&sr=8-1

Glad to see these guys promoting broad diversification...

"The best choice for your equity investments is a fund indexed to the total world stock market.--For your bonds, choose a total U.S. bond market index fund."

Thanks Taylor for posting those excerpts. Good stuff.

+++

"These noted authors have distilled all you need to know about investing into a very small package. The best time to read this book is when you turn eighteen (or maybe thirteen) and every year thereafter."
—Harry Markowitz, Nobel Laureate in Economics 1990

"Struggling to find money to save? Befuddled by the bewildering array of investment choices? As you venture into the financial markets for the first time, it's helpful to have a trusted guide—and, in Charley Ellis and Burt Malkiel, you have two of the finest."
—Jonathan Clements, author of The Little Book of Main Street Money

"No one knows more about investing than Charley Ellis and Burt Malkiel and no one has written a better investment guide. These are the best basic rules of investing by two of the world's greatest financial thinkers."
—Consuelo Mack, Anchor and Managing Editor, Consuelo Mack WealthTrack

[bob90245]

"So-called 'total stock market' funds will include both real estate companies and commodity products. Broad equity diversification can be achieved with one-stop shopping."

I know commodities are not part of Malkiel's life-cycle portfolios, but REITs are. From another thread:

Burton Malkiel's "A Random Walk Down Wall Street" recommends REITs, and specifically REIT index funds, in his suggested life-cycle portfolios. He separates them from "stocks" and suggest a REIT index allocation of 10% of total portfolio for mid-twenties, increasing to 15% in late sixties and beyond.

viewtopic.php?p=208243#208243

[cinghiale]

Taylor,
As always, thanks so very much for sharing the "gems" from this book. You must have been particularly gratified that "The Majesty of Simplicity" was the fifth principle that they covered.

Here's one quote that I found particularly worthwhile:

"It's not today's price or even next year's price that matters; it's the price you'll get when it's your time to sell during your years of retirement."

Lots of reinforcement of the Boglehead gospel. Lots of good stuff to ponder.

[norookie]

I love your selected cliff notes* from the book Taylor . I think this should be bumped for those that do not plan on reading this great book*. I think I got more out of the "notes" than I'd get out of the book having had it reviewed by individual in the know. 8)

[ddb]

In the spirit of Scrooge, I'll pick apart some of the quotes from this book:

"There are few, if any, absolute rules in saving and investing, but here's ours: Never, never, never take on credit card debt."

Unless the rate is below that which you would earn in a savings account and you have the discipline to not spend extra as a result of using credit cards. E.g. 0% promotional offers when savings accounts are yielding positive rates of return.

"Rebalancing reduces the volatility and riskiness of your investment portfolio and can often enhance your returns."

I wouldn't say this. Rebalancing maintains a constant risk profile - sometimes rebalancing will make you riskier, sometimes it will make you less risky.

"A 10% rate of return will double your money in 7.2years, it will double your money again in the next 7.2 years. In less than 15 years you'll have four times your money--and sixteen times your money in 28.8 years."

This pie-in-the-sky thinking causes a lot of investors to undersave. "Gee, all I have to do is earn 10%, and then I only need to put 7% of my salary into my 401k!".

"Credit card debt is the exact opposite of a great investment."

See above. Credit card debt is not always a bad thing.

"If you feel you need life insurance, buy inexpensive term insurance sold by local savings banks or available on the Internet."

Two things matter when buying term insurance - the rate and the financial strength of the issuer. Who you buy it from doesn't matter, but I would never trust a bank to offer the most competitive term products. Also, there are certainly scenarios where permanent insurance is suitable.

"Suppose that you have entered the workforce at age 23 and that you invest $5,000 each year over a 45-year period (at 8%). A person who followed such a program of IRA savings would have a final value of over $2 million."

Assumes fixed 8% per year, doesn't factor in the impact of volatility on a systematic savings program - even if you average 8%, the person who has more "good" years at the end ends up with a lot more money than the person who has more "bad" years at the end.

"If your plan is clear, it will be easier for you to stay on plan. That's why you'll want to develop a clear and simple financial plan and stay the course."

Unless you hit your breaking point and have to adopt a Plan B.

"There are three classes of people who do not believe that markets work: the Cubans, the North Koreans, and active managers." (Rex Sinquefield)

Flagged for political content!

"To overcome the drag of expenses and taxes, an actively managed fund would have to outperform the market by 4.3% per year just to break even with index funds."

??? - this example may be true for certain funds, but is an exaggeration of the typical costs involved in active management, isn't it?

"Index the core of your portfolio and then, if you must, make the individual bets around the edges."

Seems inconsistent - if indexing works, then it works. I've always thought the "core-satellite" approach was nonsense, because it reflects the investor trying to have it both ways.

"So-called 'total stock market' funds will include both real estate companies and commodity products. Broad equity diversification can be achieved with one-stop shopping."

A total market equity index includes publicly-traded securities. Not sure how there is commodity exposure, unless you consider that, say, Exxon Mobil owns some oil and therefore you own oil as an owner of Exxon.

"The lower stock prices go, the better the bargains if you are truly a long-term investor."

Stocks aren't like scarves at Macy's. If a $20 scarf can be bought for $10, I'm getting the same scarf either way. On the other hand, stock prices change as a result of changing information about the underlying company - you're not buying the same company at $10/share that you were buying when it was traded for $20.

"Rebalancing will not always increase returns, but it will always reduce the riskiness of the portfolio and it will always ensure that your actual allocation stays consistent with the right allocation for your needs and temperament."

Rebalancing does not always reduce riskiness! Consider an environment where stocks decline consistently over a long period. A Japanese investor who invested 50/50 with a home country bias would have incurred much less risk by not rebalancing from 1985 through today.

- DDB

[Lucio]

In the spirit of Scrooge, I'll pick apart some of the quotes from this book:
(snip)

"To overcome the drag of expenses and taxes, an actively managed fund would have to outperform the market by 4.3% per year just to break even with index funds."

??? - this example may be true for certain funds, but is an exaggeration of the typical costs involved in active management, isn't it?

I suspect that the authors made this calculation:
Average Active Management Expense + Avg Active Turnover Costs + Avg Tax Costs = 4.3%,
with all costs relative to a total market index fund.

I recall Bill Bernstein making a similar estimation in The Intelligent Asset Allocator.

Lucio

[CABob]

Taylor,
Thanks for posting this "gem". Would you consider this book a good one for a beginner? By beginner I mean someone fairly new to investing and most likely one who is not looking forward to a book that is too "deep". For example, I would consider the Bogleheads Gudes and Eric Tyson's books as being for beginners. Perhaps Rick and Larrys early books would be in that category.

[ddb]

In the spirit of Scrooge, I'll pick apart some of the quotes from this book:
(snip)

"To overcome the drag of expenses and taxes, an actively managed fund would have to outperform the market by 4.3% per year just to break even with index funds."

??? - this example may be true for certain funds, but is an exaggeration of the typical costs involved in active management, isn't it?

I suspect that the authors made this calculation:
Average Active Management Expense + Avg Active Turnover Costs + Avg Tax Costs = 4.3%,
with all costs relative to a total market index fund.

I recall Bill Bernstein making a similar estimation in The Intelligent Asset Allocator.

Misleading, then. Paying taxes today is bad, but it does have the impact of increasing your basis so that you pay less taxes later when you sell the position. Is that factored into this simple calculation?

- DDB

[Taylor Larimore]

Taylor,
Thanks for posting this "gem". Would you consider this book a good one for a beginner? By beginner I mean someone fairly new to investing and most likely one who is not looking forward to a book that is too "deep". For example, I would consider the Bogleheads Guides and Eric Tyson's books as being for beginners. Perhaps Rick and Larrys early books would be in that category.

Hi Bob:

As I read the book, I kept saying to myself that this is an excellent book for beginners. More than any other good financial book that I've read, it emphasizes the importance of starting early and saving regularly.

Two other good books for real beginners are Bill Schultheis's The Coffeehouse Investor and Mr. Bogle's, The Little Book of Common Sense Investing.

You can get a good idea of all these books by using the link at the bottom of my opening post. Frankly, I don't know a better or quicker way to get a solid education in how to achieve financial success than reading the excerpts in these books.

[DriftingDudeSC]

Thank you for posting Taylor. What a great source of common sense investment advice.

Michael aka DD

[MIARay]

Thank you for taking the time to pick out these gems Taylor. This thread deserves a bump.

Ray

[Beagler]

Thank you for taking the time to dtstill this book's most salient points, Taylor.

[Lbill]

I'm waiting for someone to say that Malkiel is now running a China hedge fund. Just wanted to get that out of the way so we can stay on topic and move on. . .