Keep It Simple - ch 7 Boglehead Series
November 8th, 2006 by digerati
This is Chapter 1 of the Bogleheads Series. The series goes through the book The Bogleheads Guide to Investing and gives the highlights of each chapter along with my comments and additions.
Make Index Funds the Core, or All, of Your Portfolio
There is a crucially important difference about playing the game of investing compared to virtually any other activity. Most of us have no chance of being as good as the average in any pursuit where others practice and hone skills for many many hours. But we can be as good as the average investor in the stock market with no practice at all. — Jeremy Siegel, Professor of Finance at Wharton School of Business.
The stockbroker services his clients in the same way that Bonnie and Clyde serviced banks. — The Four Pillars of Investing.
The premise here is that simple investing is good investing. It has been said that brokers will make millionaires out of multi-millionaires. Instead of taking your chances with a broker or money manager, why not take a 70% chance of beating them in the long run with passive investing?
What is passive investing? It just means putting the money there and leaving it to let it grow. It turns out that you can throw money at a low cost index fund and beat 90% of the managed funds, and that’s before you pay taxes on the managed funds. The shocking statistic is that between 1984 and 2002 the S&P 500 Index averaged about 12.2% per year. The average mutual fund investor on the other hand, earned roughly 3.4% on their investments.
Here’s why you should invest in index funds rather than managed funds:
- There are no sales commissions
- Operating expenses are very low (typically 0.5% rather than 2-3% with a managed fund)
- Most index funds are tax efficient (every sale of a profitable stock a fund manager makes has taxes associated with it. Since Index funds are matching a market segment they rarely buy and sell)
- You don’t need a money manager or broker
- Index funds are highly diversified and less risky. The risk falls on the entire market segment it represents. Since an index is across sectors and industries, it represents the entire US economy. If the index funds crash in the style of Enron or Worldcom your main concern will not be your portfolio.
- It doesn’t matter who manages the funds since it operates on a formula to replicate the market
- Style drift and tracking errors are no a problem
Investing in Index funds takes no effort as there is no research involved. Also you need not concern yourself with market timing or the like as the general trend is up and you plan to hold for a long time (>20 years). The time it takes is substantially less than other methods of investing as well. I’ll admit it’s not nearly as exciting and you won’t lose any weight from stress.
Do not buy load index funds with high annual expense ratios. Cheap is best. With index funds you aren’t paying for anything but the shares; no advice, no brokerage services, nothing. The costs (expense ratios) should be at 0.5% or less, the less the better.
There are two kinds of index funds: index mutual funds and exchange traded funds (ETFs). ETFs have been a very popular topic on blogs and the news lately. Bogleheads Guide suggests it is better to go with index mutual funds rather than ETFs, though little explanation is given.
Buy the gook already! Boggleheads’ Guide to Investing.
Binary Dollar Says
Man I want to read the book but they keep having contests to give one out (hence rendering me from buying one).
When the contests end, I think I’ll buy a copy. It looks really really good.
Nov 8th, 2006 at 10:16 am