To take just one example, consider the continuing profusion of exchange-traded fund products. ETFs started as another way to create broad market index funds at a very low cost. They were first used by institutional investors and then by individual investors wishing to copy their success. Once ETFs started to become popular with the investing public, the investment industry saw the opportunity to slice, dice and re-package the investment markets into an ever-expanding line of products to be sold.
Fund sponsors now offer funds tracking increasingly narrow and obscure bits of the markets, funds taking bets against the market direction and funds following novel investment strategies. What started as a good idea has, in many cases, become a tool for market speculation rather than sound investing.
A path to intelligent investing can be found in the good ideas buried within the mountain of books on investing and finance. Investors looking for sage advice, for candor and insight into what works and what does not, could do well by starting with these four books.
1. The Intelligent Investor by Benjamin Graham. This is the classic written by the man whose most famous protege is Warren Buffett. Buffett’s testimonial alone is sufficient endorsement: “by far the best book about investing ever written.”
This is a book for the lay person, unlike Graham’s earlier but more technical classic on value investing, Security Analysis. Graham provides the intellectual tools to distinguish “investment from speculation” and to differentiate “the market price from underlying value.”
“To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or insider information,” Buffet says. “What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework. You must supply the emotional discipline.”
2. The Investment Answerby Daniel C. Goldie, CFA, CFP, and Gordon S. Murray. Here, the authors approach the big, foundational issues facing investors by posing and answering five questions. Unlike Graham’s book, which is eminently readable but treatise-like in length, this is a compact discussion coming in at fewer than 100 pages
The questions, and the key decisions every investor needs to make, are:
- Should I do it myself or work with an adviser?
- How should I allocate my investments?
- How do I achieve diversification?
- Should I try to “beat the market” (the goal of active management) or try to capture market-like returns (passive or index investing)?
- When should I rebalance and when should I leave the portfolio alone?
Lacking such a framework, too many investors start and end with, “What fund should I buy?”
3. The Little Book of Common Sense Investing by John C. Bogle. Anything written by Bogle is worth reading, but this book is his most comprehensive case for passive, index-based investing. John Bogle is often referred to as “St. Jack,” sometimes affectionately and sometimes derisively. For the few who don’t know, Bogle is the founder and former CEO of The Vanguard Group.
Not everyone subscribes to his views on low-cost, index-based investing, something he advocates with almost religious fervor. Still, for those who favor active management by picking stocks, bonds or funds, Bogle will make them sharpen their thinking and understand the hurdles they must overcome in the quest to “beat the market.” For those who want to explore the case for indexing and to understand how to build a portfolio on this principle, this is the book to start with.
What’s particularly interesting is how Bogle’s arguments intersect with the views of Buffett and Graham. Graham is the intellectual founding father of security analysis, picking stocks and aiming for superior returns; Buffett is his most famous and perhaps most successful protege.
These guys are idolized by stock pickers, so it’s interesting to learn that both, late in their careers, became fans of indexing as the more sensible and, ultimately, successful approach for most individual and even institutional investors. Graham was coming to this conclusion as far back as 1976, about when Bogle was launching the first index mutual fund.
4. The Intelligent Asset Allocator by William Bernstein. Readers who want a deeper dive into portfolio theory might start by understanding the role of asset allocation.
Asset allocation can be thought of as the “90 percent solution.” Studies have shown that 90 percent or more of investment returns (both the variability and the absolute level of returns) is determined by asset allocation.
Theoretically, investors should be able to achieve superior returns through market timing and security selection. The problem is that no one seems able to identify any successful market timers and very few superior stock pickers.
Bernstein explains that asset allocation is one of the few things investors can actually control that has a significant impact on performance. He takes the reader through a discussion of why this is so and how to build portfolios by sensibly choosing and allocating among asset classes.
Read, enjoy and profit.
David Peartree, JD, CFP® is the principal of Worth Considering, Inc., a registered investment advisor offering fee-only investment and financial advice to individuals and families. Offices are located at 160 Linden Oaks, Rochester, N.Y. 14625; email firstname.lastname@example.org.