Book Review: The Bogleheads’ Guide to Investing - Part 2
By Taylor Larimore, Mel Lindauer, and Michael LeBoeuf
This is part 2 of a multi-post book review of the excellent book, The Bogleheads’ Guide to Investing . If you haven’t already, please check out part 1 now .
What else is good about the book?
Consider taxes
When we left off yesterday, we had just finished talking about how costs were critically important when choosing mutual funds. If you are investing in a taxable account, it is most likely that the biggest expenses you will face are taxes. It is therefore quite important to consider taxes when planning your portfolio. The most important suggestion the authors have is to ensure that your least tax efficient funds are in your tax-advantaged accounts. If you don’t have the luxury of any tax-advantaged accounts, make sure that you are investing in tax-friendly mutual funds.
Why would I want to invest in index funds to only get the market average?
Of course it makes perfect sense that you should strive to get better returns on your investments than the market in general, as provided by index funds. This is one case, however, where common sense is just not correct. In yesterday’s post I listed the reasons the authors give for investing in index funds. Another item the authors would like you to consider is that it is extremely difficult to pick the best mutual funds in advance.
Multiple studies are referenced by the authors showing that the "hot" funds for one-year, five-year, or ten-year periods are very unlikely to be the "hot" funds in the subsequent period. An example presented is from a Vanguard study where they looked at the top 20 US equity funds for the ten-year period ending in 1993. Over the next ten-year period, only one of those top 20 funds were even in the top 100! Remember, you need to pick a fund before it experiences its great growth. It does you no good to have last year’s hot fund if it is performing below average this year.
The authors wrap up Part I of the book with chapters on investing for college, managing a windfall, and a discussion on whether or not you need to hire a financial advisor to manage your money for you.
The importance of rebalancing
Part II of the book starts off with a discussion on rebalancing. The authors present two basic rebalancing strategies:
- Time-based - Rebalance after a certain time period. Most people do this quarterly or yearly. Of note is a Morningstar study mentioned in the book that showed people who rebalance every 18 months get the same benefit and lower costs than those who do it more frequently.
- Expansion bands - Rebalance when your original asset allocation gets skewed by more than a predetermined percentage (say 5%).
Behavioral Economics
There was some fantastic information in this chapter about why smart people make bad investment decisions. I will list the items presented by the authors here but I can’t do into more detail today. I am planning to do a number of posts on these topics, however, as I find them very interesting and important to understand.
- Greed & Fear
- Ego & Overconfidence
- Loss aversion -a loss if felt more than an equal gain
- Paralysis by analysis - spending too much time analyzing a situation and never acting
- The endowment effect - people tend to confuse familiar with safe and overvalue what they already know
- Following the herd
- Mental accounting - treating money differently based on where it comes from – i.e., viewing your tax return as a windfall
- Anchoring - clinging to an old belief or comfortable opinion even if it is wrong
- Financial negligence
The final three chapters stray off of strict investment advice and cover the topics of ensuring you outlive your money, protecting yourself through insurance coverage, and passing on your estate when you die. These contain some useful information and act to round out the book. Again, this book is certainly more than a strictly investment advice book. Though it does not go into terrible detail on these other topics, there is some good "bullet-point" level information in them.
What is not-so-good about the book?
Overall, I really found this to be a useful book but there were some issues with it. First, if you are not into index funds, you are going to have a hard time reading this book. The authors are very pro-index funds and that philosophy is reflected throughout the book. Of course, if that is you, maybe this is a good book for you to read to examine what the authors claim about their strategy and give it a fair look.
Though this book is not strictly about Vanguard, there are references to Vanguard littered throughout it. They do mention other index funds, but they clearly love Vanguard. Of course, what can you expect from a book with this title?
Finally, I didn’t really get the organization of the book. The chapters do not flow logically for me. I know that this is a minor point (and it probably says more about the way my brain works then the authors’ organizational capability) but it can give the feel that the book is disjointed and somewhat scatter-brained.
So what is my recommendation?
I really think this is a useful book for someone who wants to learn the basics of investing. There is a lot of educational information in here about the stock market and especially index funds. Of course, the authors are espousing a certain investment philosophy and I just so happen to agree with that philosophy. Actually, I wasn’t totally sold on the low-cost index fund thing when I first started reading this book. It did a good job of explaining some of the issues that I was confused about in a way that made the index fund strategy more understandable and plausible.
After reading through the book and my notes, I have decided to put this book onto my virtual bookshelf. It really does present a great overview of the low cost mutual fund strategy of investing. I feel it is a valuable read for that reason. I highly recommend that you read this book as I think you might learn a lot from it. Whether you buy or borrow it does not matter, though at over 300 pages, you might have to renew it. For full disclosure purposes, I borrowed it from my local library (twice).
Want to borrow this book? Search your local library
Want your own copy? Buy this book now at Amazon.com
Check out the other books currently on my virtual bookshelf
Book Review: The Bogleheads’ Guide to Investing - Part 1
By Taylor Larimore, Mel Lindauer, and Michael LeBoeuf
BFN Book Reviews
Here at BFN, I have been periodically reviewing personal finance books. In each review, I provide a brief overview of the book and the author(s), touch on the good and bad in the book, and give you my personal recommendation for whether you should borrow the book, buy the book, or neither. This is a fairly thick book with a lot of useful information so I am not going to be able to cover it in a single post. This will be Part 1 and Part 2 will follow soon after.
What is this book about?
Don’t be fooled by the title, though this is a book about investing, it contains much more than just investment advice. The authors do spend the bulk of their time discussing and educating the reader on the various aspects of investing. However, they also touch on other related topics such as financial lifestyle, insurance, estate planning, etc.
Who are the authors?
Not only are the authors "Bogleheads," but Taylor Larimore is actually the founder of the Bogleheads. Co-authors Mel Lindauer and Michael LeBoeuf also spend a lot of time reading and responding to posts on the Bogleheads forum hosted at bogleheads.org . At this point, you might be asking, "What is a Boglehead? " (good question!) A Boglehead is a person who shares the investment philoshophy espoused by John Bogle, the founder of The Vanguard Group. In a nutshell, that philosophy is based on investing in a diversified manner with very low cost investments. (yes, that picture on the cover is John Bogle’s head)
What are the best parts of the book?
There is a great deal of useful and interesting information in this book. I really enjoyed reading it. I felt like I learned much about the stock market and especially mutual funds as a result. I’d heard how important mutual fund costs were to a portfolio, but really learned the "why" in this book. I can’t really go into too much detail on all of what they wrote in the book (it is going to take multiple posts as it is!), so I will present the information and you can check out the book if you want a more detailed treatment of each topic.
The authors start out by pointing out why investing is different than the rest of life by claiming that the following statements are NOT true for investing:
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If you don’t know how to do something, hire an expert
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You get what you pay for
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If there’s a crisis, take action!
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The best predictor of future performance is past performance
These are the investment principles that do work:
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Choose a sound financial lifestyle - I covered their three financial lifestyles in a recent post.
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Start early and invest regularly
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Know what you’re buying
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Preserve your buying power
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Keep costs and taxes low
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Diversify your stock portfolio
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Diversify your stock risk with a bond portfolio
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I thought it was a good idea for the authors to spend time discussing the importance of the extra-investing topics. Basically, the fundamental point is that the more you can do to free up money to invest, the more investment success you will have.
Chapters 1 & 2 focus on financial lifestyle and ways to spend less or make more money so you have more to invest. The following few chapters go into detail explaining what some of the common investments types are and how they work. These include various bonds (with an entire chapter on inflation protected bonds), mutual funds, ETFs, annuities, etc.
The investment part of the book starts in chapter 7. The authors, as you might expect, recommend using index funds as the core, if not the entirety, of your portfolio. The authors present the following list of why index funds are a great choice:
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No sales commissions
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Low operating expenses
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A 1% difference makes an 18% difference in returns when compounded over 20 years
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Many index funds are tax efficient
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You don’t have to hire a money manager
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Index funds are highly diversified and less risky than individual stocks
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It doesn’t matter who manages the fund
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Style drift and tracking errors aren’t a problem
Asset Allocation
Asset allocation is portrayed in this book as the cornerstone of successful investing. Some of the same theory is discussed in another book recently reviewed at BFN, The Intelligent Asset Allocator . The authors reference a 1986 study of pension plans by Brinson, Hood, & Beebower that found the following:
- Allocation between stocks, bonds, and cash determined 93.6% of the variability of the studied pension plans’ returns
- Manager’s attempts to actively manage their fund cost the average fund a 1.1% reduction in return compared to the indexes
Costs Matter
How is it possible that professional money managers actually cost their funds money, you ask? To borrow (and alter) a phrase, "It’s the costs, stupid!" The authors reference another study that found the expense ratio is the only reliable predictor of future mutual fund performance. Also, there are a number of hidden costs that investors never hear about in a mutual funds’ prospectus:
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Hidden Transaction costs
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Brokerage commissions
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Soft dollar arrangements
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Spread costs
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Market impact costs
The investing takeaway from these chapters: buy a diversified mix of low-cost index funds in the context of an appropriate asset allocation. (you have to figure out your exact "appropriate" asset allocation yourself though there are some very general guidelines in the book)
That’s enough for one post
Ok, I’m stopping here for this post. I appreciate you sticking around as long as you did - and I’m only half way through the book! Update - please check out part 2 of the review .
If you’re already sold on the book….
Want to borrow this book? Search your local library
Want your own copy? Buy this book now at Amazon.com
Check out the books I’ve chosen for my virtual bookshelf
Book Review: The Intelligent Asset Allocator
How to Build Your Portfolio to Maximize Returns and Minimize Risk
by William Bernstein, PhD, MD
BFN Book Reviews
Every Thursday I have been reviewing a personal finance book. I provide a brief overview of the book and the author, touch on the good and bad in the book, and finally, give you my personal recommendation for whether you should borrow the book, buy the book, or neither.
What is this book about?
As you probably have already figured out, this book is about investing and, specifically, asset allocation. The author discusses numerous investment concepts covering both theory and practical advice. Be warned, however, the information you read here will not be what you would hear from a typical financial advisor (well, maybe a fee-only one). The author presents this book as a guide to enable a normal person to construct and manage his/her own investment portfolio.
Who is the author?
William Bernstein is not a financial advisor or a wall street analyst. Instead, he is a neurologist. So, I’m not sure if that makes him less qualified or more qualified to write this book. He writes the book not as an expert in the field but as a person, probably like you and me, who desires to figure this investing stuff out for himself. Dismissing the typical wall-street wisdom and advice from self-serving brokers, his philosophy is that a normal person can do a good job of managing his/her own portfolio. Bernstein also maintains efficientfrontier.com which provides investing and asset allocation resources.
What are the best parts of the book?
There is a great deal of theory in this book but it is also packed with really practical, useful information. Bernstein gives practical information and backs it up with statistical analysis. Here are some of the really valuable concepts that the author provided in this book (don’t worry - I won’t bother you with the statistics - you can read the book for that information)
- Effective portfolio diversification can increase return while reducing risk (diversification means creating a portfolio of multiple non-correlated or weakly correlated assets)
- Adding a small amount of stock to a bond portfolio increases return and reduces risk
- Adding a small amount of bonds to a stock portfolio significantly reduces risk while reducing return only slightly
- Favor short-term bonds (6 months to 5 years) rather than long term bonds
- Indexing is the best way to invest
- One possible exception: Small-cap growth stocks
- Periodically re-balance your portfolio back to your target allocation
- Sticking to your target asset allocation through thick and thin is much more important than picking the right asset allocation
- Value investing typically returns more than growth investing (good companies make
- The market is not exactly a "random walk" – a good return this months means a slightly better than average chance of a good return next month.
- Dynamic asset allocation – changes in allocation that are purely market valuation driven are likely to increase return. Changes in response to economic or political conditions are a very bad idea.
- There are more expenses to an actively managed mutual fund than just the management expense fee disclosed in the prospectus:
- Expense ratio
- Commission ratio
- Bid-Ask spread
- Market-impact costs
The author also provides these key pieces of knowledge and advice as a final summary:
- Risk and reward are inextricably intertwined
- Those who do not learn from history are condemned to repeat it
- Portfolios behave differently than their constituent parts
- For a given degree of risk, there is a portfolio that will deliver the most return; this portfolio occupies the "efficient frontier" of portfolio compositions
- Focus on the behavior of your portfolio, not on its constituent parts
- Recognize the benefits of rebalancing (but not too often)
- The markets are smarter than you are; they are also smarter than the experts
- Know how expensive the tomatoes are (investigate Price/Earnings, Price/Book Value, Dividend yield)
- Good companies are usually bad stocks; bad companies are usually good stocks (Lowest P/E stocks typically outperform highest P/E stocks)
- In the long run, it is very hard to beat a low-expense index mutual fund.
In the interest of brevity, I won’t go into the detailed explanations of these concepts or his advice right now (Don’t worry, though, I plan on doing numerous posts on these investing concepts in the future). If you’re intrigued by some of these concepts and more more information or you don’t believe the author and want the proof behind them, then you should grab a copy of the book and delve into it.
The three questions to ask yourself when determining asset allocation
The author shows you how to use your answers to these questions to determine a comfortable asset allocation:
- How many different asset classes do I want to own?
- How conventional of a portfolio do I want (how much difference from the S&P 500 can I tolerate?)
- How much risk do I want to take?
Besides the theory and concepts, there is also some very practical information
The author also describes various example asset allocations tailored to how many different types of asset classes you want to include in your portfolio. He also includes a table that lists actual mutual funds to use in your portfolios. He even divides this table into three sections describing which funds are best for tax-sheltered accounts, taxable accounts, and those that are acceptable for either type.
What is not-so-good about the book?
I did not find much bad information in this book. Actually, the biggest issue with the book is that there are a lot of statistics in it. That can be good or bad, depending on your perspective. If you don’t really enjoy reading a lot about the details of the numbers, then this book will be a tedious read for you. In fact, on Bernstein’s website, he notes that this book is "for the Sophisticated Investor" while his similar book, The Four Pillars of Investing 
So what is my recommendation?
If you are not concerned with the mathematical details of why asset allocation and low-cost investing is important, then you probably don’t really need to read this book. Instead, you might want to read Paul Farrell’s The Lazy Person’s Guide to Investing. That book ascribes to the same investment philosophy. It will provide you with some practical examples of actual investment portfolios without bogging you down with all the theory and math.
If you are really interested in understanding why asset allocation is so important, then I think this is a good book to read. As I mentioned, this book contains some really useful and informative information covering both theory and practical advice. I have repeatedly mentioned that the book contains a lot of statistics, but don’t let that scare you. It’s not like this is a statistics textbook (and you can always skip a section or two if you want).
I would say that this is a good candidate for checking out from your local library. Borrow it, read it (maybe renew it), digest it, and become much more knowledgeable about what is important when constructing your portfolio and get inspired that you can do it yourself and do it well!
Want to borrow this book? Search your local library
Want your own copy? Buy this book now at Amazon.com
Check out the books I’ve chosen for my virtual bookshelf
Book Review: The Total Money Makeover
A Proven Plan for Financial Fitness
By Dave Ramsey
BFN Book Reviews
Since I started Borrow From None, I have been reviewing a personal finance book each Thursday. I will provide a brief overview of the book and the author, touch on the good and bad in the book, and finally, give you my personal recommendation for whether you should borrow the book, buy the book, or neither.
What is this book about?
Click here to continue reading…
Book Review: The Lazy Person’s Guide to Investing
A Book for Procrastinators, the Financially Challenged, and Everyone Who Worries About Dealing with Their Money
by Paul B. Farrell, JD, PhD
BFN Book Reviews
Over the years, I have found it tremendously helpful to see what other people with similar interests have been reading on the topics of personal finance. That is why I am periodically publishing my own reviews - to hopefully be helpful to others. I will provide a brief overview of the book and the author, touch on the good and bad in the book, and finally, give you my personal recommendation for whether you should borrow the book, buy the book, or neither.
What is this book about?
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