Sunday, March 18, 2007

John Bogle's Little Book of Common Sense Investing - Book Review

The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns

What Is It About?

This book is about investing in businesses rather than stocks. The book demonstrates that for most investors purchasing an index fund guarantees the best stock market success. By using simple math and common sense John Bogle demonstrates that, for most investors, an index fund will result in higher returns than the same investment in an actively managed fund.

What Did I Get Out Of It As A New Investor?

This is the first investing book a new investor should read.

Whether you decide to invest in mutual funds or manage your own portfolio of individual stocks, understanding the power of index investing becomes the most important thing for any new investor. Why? Understanding that most investors will have better success by purchasing an index fund can serve to ground one's expectations of just how much value they can add by managing their own portfolio.

Before I begin to describe what Mr. Bogle does say in his book I would like to address what he does not say. Mr. Bogle does not state anywhere in his book that a motivated individual willing to dedicate a sufficient amount of time and effort cannot achieve above market returns. Therefore, this book does not reject the premise that an enterprising investor or trader may have the ability to beat the market.

Mr. Bogle does say that if you have a choice between investing in a managed mutual fund or an index fund, choose an index fund because not only will the managed fund risk under performing the market, the mutual fund investor must overcome the fees charged by the mutual fund (i.e., management fees, transaction fees, and taxes) which will eat away returns such that the mutual fund will not beat the index. In other words, why take the risk of figuring out which fund manager to choose, which mutual fund to choose, which style to choose, and what fees to pay, when you are better off in a total market index.

That's it. That is all Mr. Bogle says. He does not, anywhere in the book, say that a focused (or enterprising) investor who is willing to invest the time should index. He simply agrees with what Warren Buffett says "the know nothing investor can actually out perform most investment professionals" by investing in an index fund.

In making this point Mr. Bogle looked at the 36 year period from 1970-2006. At the start of 1970 there were 355 equity funds. By 2006, only three out of the original 355 funds beat the index consistently over the 36 year period. Clearly, the investor with a multi-decade horizon should accept the return of the index fund.

With respect to the investor who desires to manage his own account, this is the best of the three books in the “Little Book” series. Why? The book sets the baseline for the new investor. You can buy the U.S./Intl total market index and know that you will do no better or worse than what businesses will do over time.

Indexing requires little or no effort and about $10-20 per year for every $10,000 invested. Compare that to a mutual fund that charges $100-300+ year after year for every $10,000 invested with no guarantee that it will beat the index fund. By making this point the book shows a new investor a way to participate in the market with little effort and do as well as the best money managers over the long term. For those who must choose between mutual funds and index funds, this book makes obvious the path to take.

For the investor who desires to manage his own account the book tells a scary tale. Again, Mr. Bogle never says that one cannot beat the market or in anyway disparages those who have found success. He does not have to. Over and over Mr. Bogle, using simple math, demonstrates the relentless nature of a total stock market index. The index never rests and will not make mistakes. You will do all those things.

Consequently, in order to beat the index one must obtain above average results. Yet the fact is we can't all achieve above average results. A few will, most will not, and a lot will just end up matching it – but, with a lot of wasted effort and unneeded stress when they simply could have bought the index and spent the time saved with their family.

This book makes you take a close look and ask yourself whether you have what it takes to beat the index when so many others do not. Depending on your investment style will you spend hours and hours reading annual reports, thinking about businesses, thinking about the market, studying charts, or developing trading systems? Will you do this year after year with the knowledge that so few do it successfully? Will you have the necessary emotional control to maintain a consistent approach no matter how negative the short term results? If the answer is anything less than an unqualified affirmative, the book demonstrates that perhaps indexing is for you.

Overall, the book does not say individual investing has no utility. The book just uses simple math to show that the odds of you (or anyone else) practicing it in a manner which will allow you to beat the index weigh against you. That is why Mr. Bogle’s book is so good; it forces one to confront reality and assess whether to make the commitment necessary to succeed against an index fund.

The Good News

An outstanding book because it forces all investors to honestly question whether they or anyone else has what it takes to beat the index.

The Bad News

If you use “Maverick” as a nickname and think index funds are for widows and orphans, you probably won't get much out of this book.

The Bottom Line

A must read because the book provides sobering advice to a new investor on the merits of index investing as compared to active portfolio management..

Other Related Reading:



Shane said...

Totally agree with your appraisal.

I do feel that he was unnecessarily down on ETF's. If you are investing with a long horizon and buy large amounts of ETF to hold then it is a superior investment to Index Funds due to the tax advantages.

He does concede this but only after railing against them at length

mjh said...

You might consider listening to John Bogle's podcast on econtalk. In it, he pretty much does say that investment fund managers, over the long term, can't beat the market. It doesn't matter if you pay a manager or if you are the manager.

Here's the link:

You might also be interested in:

(Apologies if any of this is old news)

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