Bogleheads Guide to Investing Review: Chapter 7 - Keep It Simple
Welcome to a review of the seventh chapter of the Boglehead’s Guide to Investing titled Keep It Simple. While the message of this chapter is quite elementary, the backing behind the argument, that one should “keep it simple” when it comes to investing, is quite compelling. Through very little work, very little investment knowledge, zero skill, and with almost no time whatsoever - you can outperform 80% of all investors. How is that possible? Index funds.
Here is the crux of the strategy: Instead of hiring an expert, or spending a lot of time trying to decide which stocks or actively managed funds are likely to be top performers, just invest in index funds and forget about it!
The chapter goes on to list and explain why index funds are so good and here are the seven reasons they list:
- There are no sales commissions.
- Operating expenses are low.
- Many index funds are tax efficient.
- You don’t have to hire a money manager.
- Index funds are highly diversified and less risky.
- It doesn’t much matter who manages the fund.
- Style drift and tracking errors aren’t a problem.
Of course I won’t go into those seven reasons, I invite you to read the book if you want a deeper explanation around those reasons but they seem pretty straight forward. Passive investing is a strategy that has been repeated by many an investment guru and the Boglehead’s even included quotes from twenty contemporary names you’ll likely recognize (including Warren Buffett, Jane Bryant Quinn, Charles Schwab, and John C. Bogle himself).
Tomorrow, Chapter 8, about Asset Allocation, will get put under the microscope by none other than my pal and yours, Flexo at Consumerism Commentary. For additional chapters, check out the Bogleheads October Project.
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11 Comments - Share Your Thoughts
[...] Simple. If you get a chance, you might want to go check it out. To see the full schedule as well as links to previous chapter reviews, see my page for the Bogleheads’ October Project. Bookmarkto: [link] [...]
Interesting review. I agree with most of it. Clearly index funds, or ETFs are the simplest, most efficient way for investors to go. The only point among the 7 items listed that surprised me was the last one, “Style drift and tracking errors aren’t a problem.” Actually, the style drift part in particular. One problem that index funds have is the natural overweighting of the most recent hottest performing group.
For example, by early 2000, even index funds were heavily weighted in technology stocks. This is not because the manager intentionally overweighted to beat the market, as was the case with many managed funds, but the market value of tech stocks overwhelmed the rest of the market, resulting in many index funds being 30-35% invested in the tech sector.
The lesson of my comment is that index investing should be accompanied by a well thought out asset allocation plan and regular rebalancing. Otherwise, the most risk is taken at the peak of markets, because that which went up the most will represent the largest weighting in the indices. And typically, what goes up the most, goes down the most.
LAMoneyGuy: That’s a good point, there is a bit of a popularity game with index funds only because they match the market and the hottest things going will be more heavily represented in an index fund.
I don’t think LAMoneyGuy understands Style Drift. What he refers to is simply an asset allocation that needs to be rebalanced. Style Drift is a term that refers to when an active manager deviates from a style, class or index as described in the strategy of the fund.
E.G. you invest in a small cap fund. The prospectus allows the manager leeway to invest up to 20% in foreign securities. In between sem-annual reports, your manager takes your domestic fund and turns it into a partial foreign fund. This changes your risk/return profile.
This does not happen with an index fund so I believe the authors’ statement is correct.
Paul
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[...] Blueprint keeps it simple. [...]
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LAMoneyGuy.
There is a common misperception that indexing just means an S&P 500 or total market fund. But there are also good index funds that cover every segment of the market, from microcaps to REITs to emerging markets.
By building a sensible allocation among the various asset classes (including bonds) and rebalancing at regular intervals, you avoid the worst excesses of bubbles and benefit over time from being forced to sell the relatively overpriced assets and buy the relatively underpriced. Which is the exact opposite of how most people invest.
Weekly Roundup - 10/13/06
Book Review - The Bogleheads’ Guide To Investing
AllFinancialMatters has started a remarkable project named “The Boggleheads’ October Project”. In this project a group of 23 personal finance bloggers are reviewing each of the 23 chapters of the book “The Bogleheads’ Guide To Investing”. The goa…
It’s too bad simplicity is so unexciting. I think people like to hear the cool new thing they can do with their money. I for one am relieved that I can put money into simply managed accounts and leave it. I keep some outside of that to play with other investments. Here’s my take on Keeping It Simple, part of the Bogleheads Series at Successful Personal Finance.com.
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