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The Little Book of Common Sense Investing by John Bogle | Book Review

Who Is John And Why Should You Care?

John Bogle is the founder of Vanguard, the highly successful investment management company with about $1.3 trillion in assets. He’s also the creator of the Vanguard 500 Index Fund, the world’s very first index mutual fund.

In this book, John seeks to demonstrate why investing through index funds is the smartest, cheapest, and easiest way to generate a profitable return on your money.

Main Points of The Book

  • Businesses create wealth, a positive-sum game for its owners. Therefore, The Little Book of Common Sense Investing by John Boglebeing a businessowner by owning all publicly held businesses at a low cost is a winning strategy.
  • All investors as a group earn the stock market’s return. If one of us earns an extra 2% return, another investor suffers a return shortfall of that same 2% as well. So before deducting the costs of investing, beating the market is a zero-sum game. For every winner, there’s also a loser.
  • The costs of investing (brokerage commissions, operating expenses, portfolio transaction costs, etc.) both reduce the gains of winners and increase the losses of losers. So after the costs of investing are deducted, beating the market is a loser’s game.
  • Picking funds based on either its recent or long-term performance superiority isn’t wise, because past performance is no guarantee of future performance. Of the 355 funds that existed in 1970, 223 of them went out of business. Of those remaining, 60 funds underperformed the S & P 500 by more than 1% each year. So about 80% of the original 355 funds have significantly underperformed.
  • With mutual funds, the typical costs of ownership include expense ratios (which averages 1.5%), sales loads (which averages 0.5%), and the hidden cost of portfolio turnover (which averages 1%), for a total of 3% per year. So a fund would have to beat the market by 3% every year in order for it to justify its cost. This is not an easy task.
  • For instance, if the market generates a return of 8% per year, an initial investment of $10,000 over 50 years would grow to $469,000. However, if the cost of an average mutual fund were 2.5% per year, that cost would reduce the same $10,000 investment to just $145,400. In other words, with the average fund you’d be losing $323,600!
  • Actively managed funds engage in buying and selling of securities. This buying and selling is paid for through commissions to stockbrokers. However, these costs aren’t paid by the mutual fund company. They’re passed on to you. This cost, which is hidden, averages 1% per year. It is the hidden cost of portfolio turnover.
  • Related to the buying and selling of securities is capital gains taxes. When the funds sell their stocks at a profit, they incur capital gains taxes. Again, these costs aren’t paid by the mutual fund company. They’re passed on to you. This is the cost of increased capital gains taxes, and it averages about 1.8% per year.
  • While the average fund earned an annual return of 10% over the past 25 years, this was not the return earned by the actual investor. The average fund investor actually earned a return of only 7.3% per year, which is 2.7% lower than what was reported by the fund. These people invested too little when stocks were cheap, chased hot funds after they already performed strongly, and also chose the wrong funds. These are the costs of counterproductive timing and adverse selection.
  • Although we can’t know or control how the market’s behave, what we do know and have the ability to control is the costs that we’re paying to invest. Costs go on forever, in years when you make money in the market, and in years when you lose money in the market. John calls them “the tyranny of compounding costs.” Therefore, it’s wise to keep them to the bare minimum. To do this, just buy the entire market and hold it forever. This can be done by choosing index funds, which don’t incur most of these costs and have low expense ratios.

John seems to believe that there are major flaws in our financial system. He notes that there is a conflict of interest between those who work in the investment business and those who invest in stocks and bonds. As such, we should not participate in the expensive foolishness of a system that doesn’t look after our interests.  I’d have to say that I agree. John makes a very convincing case in favor of investing in index funds.  He doesn’t seek to do this using fancy arguments, but rather using common sense and “the relentless rules of humble arithmetic.”

How This Book Has Affected Me

This book has convinced me to place the majority of my investment dollars into index funds. Prior to reading this, I thought about trying to beat the market through extensive studying and reading all kinds of finance books. While I do think that beating the market can be done, it does require lots of time, energy, and effort. I’d relate it to the equivalent of being a full-time job, and I don’t have time or desire to do so at this point. There are just too many other things I want to do in life.

One Minor Gripe

I’m a number-crunching kind of guy, so I would’ve liked to see the sources of all the data in his tables and charts. That way I’d be able to verify them myself. But if I were to dig deeper on my own, I’m sure I’d be able confirm his stats.

Final Thoughts

Investing with index funds is a timeless, no-nonsense, anti-get-rich-quick approach to building wealth gradually. This method of investing should still be relevant many years from now. So for now, until I find something better, I’m sold on the merits of index fund investing.

If you’re new to the world of investing, this is a great book to read in order to educate yourself. It does get a bit technical with some numbers and charts, but you don’t need to completely understand them all to gain something useful from reading it. Therefore, I definitely recommend this book to others.

How much do you think costs matter? Do you invest in actively managed funds, index funds, or individual stocks?

This post was included in the Book Review Blog Carnival for the week of April 11, 2010. You can find the review, along with reviews of other interesting books, at Books with a cup of coffee’s blog.

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