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Personal Finance

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

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

Author: John Bogle
Publish Date: March 5th, 2007
ISBN: 9780470102107
Amazon: https://www.amazon.com/dp/0470102101/
Table of Contents

Chapter 1 A Parable
Chapter 2 Rational Exuberance
Chapter 3 Cast Your Lot with Business
Chapter 4 How Most Investors Turn a Winner’s Game into a Loser’s Game
Chapter 5 The Grand Illusion
Chapter 6 Taxes Are Costs, Too
Chapter 7 When the Good Times No Longer Roll
Chapter 8 Selecting Long-Term Winners
Chapter 9 Yesterday’s Winners, Tomorrow’s Losers
Chapter 10 Seeking Advice to Select Funds?
Chapter 11 Focus on the Lowest-Cost Funds
Chapter 12 Profit from the Majesty of Simplicity
Chapter 13 Bond Funds and Money Market Funds
Chapter 14 Index Funds That Promise to Beat the Market
Chapter 15 The Exchange Traded Fund
Chapter 16 What Would Benjamin Graham Have Thought about Indexing?
Chapter 17 “The Relentless Rules of Humble Arithmetic”
Chapter 18 What Should I Do Now?

My Review

I have been a huge fan of Jack Bogle and Vanguard since I discovered them over 8 years ago.  My sister had worked in the mutual fund industry so I had been blindly invested in mutual funds prior to investing in Vanguard. In 2012, I started reading more about the benefits of index investing and made my first Vanguard purchase of VFAIX on July 3rd, 2012. Over the next year, I would transfer all of my retirement accounts to Vanguad as well as opening a taxable brokerage account.  After that first purchase of VFAIX, I switched to VTSAX and have been 100% investing in VTSAX since June of 2013.

While I had been a fan of Vanguard, and read lots of articles online about Jack Bogle, I had never read any of his books. After reading The Simple Path to Wealth last week, I decided I needed to read The Little Book of Common Sense Investing that is so widely praised and referenced in the financial independence community.

The premise of this book is very simple and Bogle does a great job summarizing the six key concepts in Chapter 17 that is applicably titled “The Relentless Rules of Humble Arithmetic” I will parapharse his six key messages as follows:

  1. Over the long term, stock market returns are created by real investments returns earned by real businesses: dividends and earnings growth
  2. Over the short term, speculative investments drive changes in equity prices based on how much investors are willing to pay for each dollar of earnings growth.  These speculative investments are eventually a wash over the long term
  3. Businesses come and go. The best protection for individual investors against individual stocks is to own the entire market
  4. As a group, all investors earn the gross market returns before taking costs into account.
  5. While investors earn the entire market return they do not capture the entire market as fees, commissions, sales loads, and transaction costs eat away at returns. Gross market returns – costs = net returns for investors
  6. Mutual fund investors have real returns that are lower than the advertised net returns of the fund due to emotional market timing. Gross market returns – costs – timing and selection penalties = net retunrs for mutal funds.

There is a lot more to this book but these are the simple messages that are the foundation to his thinking and methodology. Some have criticized this book as being too simplistic in nature, but I enjoyed reading it.  I have understood most of the benefits of indexing but Bogle goes into a lot of detail backing up his strategy.  He uses a lot of math and numbers to explain the benefits along with this quote:

Remember O Stranger, arithmetic is the first of the sciences, and the mother of safety

The numbers and the math don’t lie and this book is very well researched with a ton of data behind it.  He also does a nice job sprinkling in “Don’t take my word for it” segments from some of the biggest names on Wall Street and why they too believe that indexing is the way to go. The most famous investor of all time Warren Buffet has his four “E’s” quoted

The greatest Enemies of the Equity investor are Expenses and Emotions

I love this!  It could not be any simpler or any truer.  There is a reason it is called personal finance.  In Buffet’s 2013 annual shareholder letter he goes into more detail:

My money…is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors—whether pension funds, institutions or individuals—who employ high-fee managers.

Bogle takes on the mutal fund industry in chapters 7, 8, and 9 and points out how bad a deal investors are getting from these funds and how over the long term they simply can not compete with index investing.  After being a mutual fund investor for almost a decade I read these chapters and cringe! He also does a good job addressing the impact of capital flows and how “yesterday’s winners are tomorrow’s losers”. Investors pour money in during the bull market runs and pull money our during the bear markets.  This is the exact opposite of what should be done and thus weighs on performance of mutual fund investors.  His explanation on the difference between real returns of the mutual fund industry and advertised net returns is really well done:

To remind you, the nominal return of fund investors came to just 7.3% per year during 1980 to 2005, despite a wonderful stock market in which a simple S&P 500 index fund earned a return of 12.3%

If you have not read this book, I highly recommend it.  If you are new to indexing, it is a must read and may be the most important book you read on investing.  If you are already on the index train like I am, it will further reinforce this strategy and give you the confidence to stay the course.  I only wish someone had handed me this book earlier in my investing career!

My Rating: 4 Stars

 

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Personal Finance

Dollar Cost Averaging – The Worry Free Way to Invest

During the financial crisis of 2008, I started to figure out just how important the psychology of personal finance was compared to the math. The numbers and math are simple. If you save 10-15% of your income, and invest it for 40 years in a boring index fund you will end up with a pile of money at 65 to comfortably retire. So why is this so hard? Why do people not have more money saved for retirement? The simple answer is we are our own worst enemy:

  1. We don’t prioritize saving enough and get caught up in the consumerism of keeping up with the Joneses
  2. We try and time the market
  3. We buy high and sell low in a panic
  4. We don’t know how to evaluate risk
  5. We listen to all the media that have advocated and pushed this for decades. I am looking at you CNBC.

While my awareness to the mental aspects of personal finance started in 2008, it still took me a few more years to realize that dollar cost averaging was the single best way to fight and win against the psychology of money.

Like many things I write about, this concept is not complex or difficult to understand. Dollar cost averaging is an investment strategy where you buy shares over a period of time and the number of shares acquired fluctuates depending on the price at the time of purchase. In practical terms, a $500 investment each month in your Roth IRA is an example of dolalr cost averaging. The same concept applies to your paycheck deductions for things like your 401k or HSA. You are making investments over a period of time and are continually investing regardless of the direction of the market.

This last statement is why dollar cost averaging is so powerful for personal finance.  You no longer care which direction the market is going.  If the market is up, GREAT my assets are appreciating, if the market is down, GREAT I am buying in when the market is on sale!  I can’t tell you how liberating this concept is and how it changed my entire mental state regarding my personal finance invstments.  I no longer worry about when to buy, since it happens automatically every two weeks! When you combine dollar cost averaging, with my 100% VTSAX investment strategy, you have a powerful system to achieve financial independance.

I want to emphasize that there is a lot of well respected research that suggests that lump sum investing is actually better in the long run than dollar cost averaging.  My counter argument to this is that personal finance has never actually been about the numbers, it is about human behavior!  So yes, lump sum investing may lead to higher theoretical returns dollar cost averaging is still a powerful tool.  If you are deciding what to do with a windfall or inheritance that is a different story, and depending on your own situation and risk tolerance levels, you may prefer to out it all in at once. For me, I will continue on the slow, steady, and boring path of dollar cost averaging VTSAX to financial independence.

 

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Personal Finance

The Simple Path to Investing and Growing Wealth

A search on Amazon for “Investing” returns 40,000 books on the topic.  There is no shortage of books, opinions, or information written on investing.  For the new investor, it is an intimidating topic that can seem somewhat overwhelming.  I have conversations with many people who think investing is too complicated, or they are paralyzed by the fear of making a mistake.  We have been tricked to believe that investing is a complex and difficult subject, one that is better left to the professionals on Wall Street.  My goal here is to break this topic into 3 simple steps that create a road map for the average investor.  These steps will not cover every scenario or personal situation, but I truly believe that for 99% of people this is the simplest path to investing, growing wealth and becoming financially independent.

Step 1: Saving to Invest

This is often an overlooked step, but you can’t invest money if you don’t have anything left at the end of the month and are saddled with debt.  To create a situation where you have the money to invest, you must spend less than you make, by creating and sticking to a monthly budget. Once you are generating savings at the end of each month, you are now ready to begin what I call “The Investment Walk”.

Photo Credit: Chaval Brasil

Step 2: The Investment Walk

I believe there is a very specific path you should take when it comes to investing and deciding on where and how to invest your savings.  I am not talking about investment allocations between stocks and bonds, or even what kind of financial instrument you should buy.  I am talking about the programs and accounts you have available to invest in: 401k’s, Roth IRA’s, IRA’s, brokerage accounts etc.  Here is the path laid out one brick at a time:

  1. Have an emergency fund with 6 months of expenses. Life happens.  An emergency fund is to help smooth out the unexpected that will inevitably happen. Having funds tucked away in an online savings account like Ally Bank, will help prevent these events from derailing your investment walk.
  2. Be debt free except for your house.  I have always had an aversion to debt.  It is simply how I am wired, and it has served me well over the years. The only acceptable debt I believe you should carry is a mortgage on your primary residence.  Get rid of all other debts, and you are truly ready to make your first investment.
  3. Fund your 401k up to your employer match.  Many employers will offer a 401k (or simmilar) savings plan along with a company match. Participating in a 401k, up to your employer match, equates to a guaranteed 100% return on your investment.  You won’t find anything that provides better returns than this! If your employer offers a 401k match,  you are literally leaving free money on the table if you don’t take advantage of this.  It blows my mind, the number of people I see in my job not participating in the company matched 401k’s.
  4. Fund your Roth IRA up to the maximum allowed.  The Roth IRA is a fantastic retirement vehicle.  Unlike your 401k, which is taken out pre-tax, the Roth IRA contribution is done with after tax dollars.  While this might initially be seen as a negative, the huge benefit of the Roth IRA is that withdrawals are tax free and there are no minimum required distributions!  If you contribute to a Roth IRA early in your career, you can build a sizable tax free nest egg. Maximum contributions for 2020 are $6,000.  The only downside to the Roth IRA is that is is not available to individuals making over $139k or married couples making over $206k per year.  Learn more
  5. Fund your remaining 401k up to the maximum allowed. If you have completed steps 1-4 you are really starting to make some progress on your long term retirement goals!  If you still have funds left we go back to the 401k and fund the remainder up to the maximum which is $19,500 in 2020.
  6. Fund your Health Savings Account (HSA) to the maximum.  If you participate in a high deductible health plan, you can contribute $7,100 in 2020 to an HSA pre-tax for future medical expenses. Leveraging this benefit is a great hedge against rising healthcare costs. Read more about why I love Health Savings Accounts.
  7. If you have kids, contribute to a 529 college savings plan.  College is expensive, but the 529 savings plan allows for tax free investment growth to help pay for college
  8. Pay down your mortgage until it is paid off. There is probably no topic in the personal finance community that is debated more than paying off your mortgage.  There are some that are strongly for it and there are just as many that are against it.  For me, I simply don’t like debt of any kind, and recommend paying off your mortgage.
  9. Invest in a taxable Vanguard brokerage account. If you have made it this far, you are a personal finance rock star. You have a strong income, you are spending significantly less than you make, and you have just paid off your house! What next?  Now you can take your mortgage payment and start investing that each month!

Step 3: Investment Allocations

After laying out the investment path above, we now need to turn to the allocation side of investing.  What are we actually going to invest in? Are we going to buy stocks, bonds, or mutual funds? This step is where I see people struggle the most and where most bad decisions are made.  The good news is that I am going to make this super simple!

Invest in low cost, broad market, index funds

If you are at least 10 years from retirement, invest in an index fund like the Vanguard Total Stock Market Index Fund (VTSAX).

That is it?  Yup. I told you this was going to be easy.

What about diversification?  You are diversified across the entire stock market!

Uncle Bob told me index funds are boring, and I should be buying XYZ stock? Uncle Bob is not going to beat the market.

Isn’t being 100% invested in stocks risky? Not if you have a long time horizon.

I could go on and on.  If you still think you can consistently beat the market please read: The Little Book of Common Sense Investing.

As much as I love VTSAX, unfortunately not every account provider is going to offer it, however, most should offer something similar. Here are our current accounts and how they are invested:

Roth IRA: 100% Vanguard Total Stock Market Index (VTSAX)
Rollover IRA: 100% Vanguard Total Stock Market Index (VTSAX)
401k: 100% Fidelity® 500 Index Fund (FXAIX)
HSA: 100% Schwab S&P 500 Index Fund (SWPPX).
529: 100% TIAA-CREF Equity Index Fund (TIEIX)
Taxable Brokerage: 100% Vanguard Total Stock Market Index (VTSAX)

Since we have a long time horizon, we are 100% invested in low cost, broad market, index funds! 

What if you are closer to retirement?

If you are closer to retirement, or if you just want to adjust your risk profile you can always add the Vanguard Total Bond Market Index Fund (VBTLX) to your portfolio.  With just these two funds, VTSAX and VBTLX, you can easily control your investing approach and risk tolerance.  It does not get any easier than that!

With these three simple concepts, combined with my investment walk, you can start down the path of growing wealth and achieving your financial goals.