I’ve Paid For This Twice Already…

Wise Investing Made Simple Review Part 1: Markets and Performance

For the next several weeks, I’ll be working my way through the book Wise Investing Made Simple by Larry Swedroe. This review covers the first eight chapters.

When I started Wise Investing Made Simple, I expected to be told to invest in index funds simply because that’s what I read on personal finance blogs as the “right” strategy. Other than that, I had no idea what it might say. I will be the first to admit, I know very little about investing. I want to know more about it, but obviously, I don’t want to know badly enough to have actually made some effort to learn much. So although I had no idea what else this book might say, I was still very excited to read it and see. I’ve divided the book up into sections for my review based on the topic of the chapters, and my first section covers the first 8 chapters.

This section basically talks about the market as a whole and how it works, financial advisors, and the elusive pursuit of beating the market, as well as how markets are efficient. The book used both explanations and stories to illustrate concepts, and I found that style very appealing. Be warned though that the majority of the analogies are sports ones, and although I enjoy sports and therefore liked them, it may not appeal to everyone. There are a few key concepts I learned about in this section, and I am going to explore those in detail for I found them really enlightening. Understanding the “why” of passive investing as well as the “how” is something that is very appealing to me, and this book so far has helped to do that. This is by no means everything the book covers, but these are the ideas that really clicked in my head and made me examine some assumptions about the stock market and investment strategies I didn’t even know I had.

Do financial advisors who claim to be able to beat the market recommend the same funds now they recommended 5 years ago?

The first concept that really made me think was this one. The first chapter is a story about a woman who has the choice between two financial advisors, one who has a passive investment strategy (not trying to beat the market simply establish a level of risk they find acceptable) and the other has an actively managed approach (trying to beat the market). When the woman talks to the passive-approach manager and asks how they can compete with the actively managed fund, he tells her to ask the broker what he was recommending five years ago and see if those lists are the same. The idea is that it is easy to find funds that outperformed the market in the past, but hard to predict which will in the future. I’d never really considered it that way, but it makes a lot of sense.

Markets are efficient.

The stock market in this section was compared and contrasted to betting on sports. In sports, we have amateurs (you and me) betting on different teams and basically setting the prices and point spread by our limited knowledge. We’re allowed to use insider information (if I know someone on a team is hurt I can use that knowledge in placing my bet) and yet, the only people who truly become rich betting on sports is the bookies. Compare that to the market, where professionals (financial advisors) are the ones making decisions about who to bet on (buy) and against (sell) and insider information is not allowed - and it is easier to see why the stock market runs efficiently and is hard to exploit. By the time the average person hears anything about a stock, it has already been incorporated into the price the stock is selling for. And the financial advisors are the ones making money (from fees) not the investors.

It’s not impossible to find an undervalued stock and exploit it, but it is self-limiting.

This was one of my favorite analogies in the entire book. The idea is, if you find a $20 bill on the ground, you pick it up, right? But you don’t then abandon your job and spend the rest of your life searching for $20 bills on the ground. An investment strategy based on finding winners other people have overlooked is like that. It is not impossible to do, but basing your entire strategy on trying to do it again and again is very hard. And once the undervalued stock is found, it is only undervalued for so long before other people realize it and get in on it too, and the market corrects itself.

Collective Wisdom Sets Prices

The prices of the market are not just set by a single investor or a single institution. They are set by the entirety of the market - the collective wisdom of all the people who participate. You may be able to outperform this collective wisdom, but the concept that you will be able to do so consistently and in perpetuity is a very tough one to take on. In this part the book goes into detail about a few different funds, showing how at one point they were great outperformers but they all eventually became underperformers. Looking back, you can pick what funds to invest in and where to jump ship, but the question is, can you do that looking forward? And in some cases, if you don’t know exactly the right time to sell and move on, you can lose a significant portion of your investment at once and not recover it. I loved this quote: “I own last year’s top performing funds. Unfortunately, I bought them this year.”

So, what is an investor to do?

So, now that we’ve talked about why market-timing strategies to “beat the market” don’t work, what is an investor to do? That’s what we’ll talk about next week. There’s a little more about breaking down assumptions that people make about investing and about the market, and then Swedroe starts talking about the “wise investing” part - ideas on how to make smart choices and let the efficiency of the market work *for* you instead of *against* you. Hopefully we’ll all learn how to provide for our futures with a level of risk we’re comfortable with.

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