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For the past several weeks, I’ve been working my way through the book Wise Investing Made Simple by Larry Swedroe. The first review covers chapters 1-8, the second review is chapters 9-16, the third review is chapters 17-22, and this is the conclusion of the series.

So far, I’ve found Wise Investing Made Simple very informative. Most of what I’ve learned from it involves thinking critically about the assumptions I hold, and I’ve found that very valuable. Investing as a concept is so foreign to me that my brain accepts commonly spoken ideas as the truth a lot more readily than I would have thought. I’ve especially enjoyed some of the examples and stories used to illustrate points. I don’t think I will ever forget the idea about finding a $20 on the ground and then abandoning your job to search for $20 bills for the rest of your life. How silly would that be?

The end of the book basically asks you to examine what is important to you. It brings forth the “Big Rocks” theory, that I have heard several times before as many of you have I am sure, and talks about deciding what the Big Rocks are in your life. For those of you unfamiliar with the concept, if you imagine your life as a glass jar, you fill the jar with big rocks, then pour gravel into the spaces, then sand, and finally water. The idea is, if you don’t follow that order, you’ll never get the big rocks in the jar at all. The big rocks symbolize what is truly important to you - family, love, faith, your dreams, whatever you place the most value on in your life. The smaller stuff is progressively less important.

By adopting an active management strategy, you focus on the smaller rocks in life at the expense of the bigger rocks. Now, I don’t buy this 100%. There are select people, I think, that active management *is* a big rock for. But, I am not one of them. I have far too many other things in my life I would like to focus my time and energy on. The book then has examples of both how focusing on investing strategies takes time away from what is important (relationships, family) and then examples from Swedroe’s own life of how passive management has allowed him time to spend involved in his kids’ lives in a positive manner. So the take home lesson really is - what do you value most? Knowing that will help you decide how active a role you want to have to take in managing your investments.

The end of the book goes through examples (as far as asset allocation) of some “Big Rocks” portfolios and how to choose a financial advisor. There is a lot of emphasis on having a plan and a goal in investing, and that makes sense to me. The question the book asks is would you set off on a long trip without a map or directions, and I can say, I don’t. And along that line of thinking, I do have financial goals, but I’d never really thought about specific investment goals and I certainly do not have a roadmap to the future. But of course, I want to be able to retire and not starve, so it’d be more than prudent to start thinking about goals.

All in all, the book has convinced me I need to see some sort of financial planner. And, hopefully I can use the tips in the book to help choose one. I thought the book was a very easy read overall and contained a lot of useful “thinking” material. This isn’t a “how-to-do” book as much as a “how-to-challenge-assumptions” book, and I enjoy thinking.

Next week, I’m going to start figuring out what my plan is - or at least, see if the book I bought will help me. I used my Barnes and Noble store credit to buy “The Number” by Lee Eisenberg and theoretically, it should help me figure out how much I need to save for retirement. We’ll see, I haven’t quite started the book yet.

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For the past several weeks, I’ve been working my way through the book Wise Investing Made Simple by Larry Swedroe. The first review covers chapters 1-8, the second review is chapters 9-16, and this review is chapters 17-22. Come back next week for the conclusion of the series!

Where we left off last week, Swedroe had addressed several myths in investing and shown how when examined, they didn’t hold water. This section of the book continues that theme, but takes a slightly different tack. Understanding information - what is useful and what is not - is important to being able to choose an investment strategy, and Swedroe looks at some little-discussed but important information as well as some much discussed that is widely misused and looks at what it all means.

Uniform Prudent Investor Act

According to Swedroe, this act is law in virtually all states. The act governs the investment activities of trustees and effectively makes passive investing the standard upon which all fiduciaries (basically, in my understanding, a fancy word for trustee) should be judged. It addressed diversification and cost control as important elements to prudent investing. So the question is, if it is law to use a passive investing strategy for those who have their money in trust for them to protect them, do we think we can come up with an even better strategy consistently? I don’t think I can.

Economic Forecasts and Market Forecasts

Economic forecasts are what market forecasts are based on. Looking at forecasts and leading investment research from 1970 to 1995, a number of key and disturbing points can be noted if you want to use forecasts to predict the future:

• 46 out of 48 economists missed correctly predicting the turning points in the economy
• Economists forecasting skill is worse statistically than pure chance
• No specific economic forecasters lead the pack in accuracy
• Consensus forecasts offer little improvement

This is what is used to create market forecasts. Knowing this, it seems to me that market forecasts are a game of chance at best. In fact, Swedroe compares market forecasts to astrology (a guessing game) and says too many people treat them as astronomy (a science) instead.

What If Everyone Indexed?

This was one of my biggest questions going into the book. If passive investing is the winning strategy, and investing in index funds is a key component of passive investing, what would happen if the majority really did just invest in index funds? Would it actually work any longer?

The reality is that is unlikely to happen - institutions still only invest about 40% of assets as an average in passive strategies and individuals as a whole have about 90% of assets in stocks or actively managed funds. But even if that went to 100% passive (unlikely) there is still trading activity from the activity of individuals exercising stock options, liquidating estates, etc and companies buying and selling companies through mergers and acquisitions.

There’s also a story here about how the trend to passive investing happens. Basically, as a person has bad active management experience, they become more likely to go a passive investing route. Behavioral studies indicate that what initiates the change is bad experiences, not just recognizing that your active management success has been luck. That shifts the “competition” in active management to be tougher and tougher (as only successful investors stay with it). This means in most cases, it ends up better to not play the game but instead, benefit from the most successful setting the tone for the overall market.

Investing as Entertainment

Follow TV market gurus and pick their stock picks - they rise for a short time (as everyone watching buys them) and then just bottom out. This is basically the same as thinking you have specialized investing information because you watched a TV show which was nationally televised. There’s a quote I really liked here from Steve Forbes of Forbes magazine: “You make more money selling the advice than following it.”

So, overall, I learned that there is actually in our legal code an prudent investment strategy, and that economic and market forecasts are kind of like predicting the weather… sometimes it works (today we are supposed to have 3-10 inches of snow and that seems to be coming true) and sometimes it doesn’t (Tuesday we were also supposed to have 3-10 inches of snow and we ended up with a light dusting). Next week we’ll finish off the book by looking at the strategies and portfolios that Swedroe recommends.

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For the next several weeks, I’ll be working my way through the book Wise Investing Made Simple by Larry Swedroe. The first review covers chapters 1-8, and this review is chapters 9-16.

Where we left off last week in Wise Investing Made Simple, Swedroe had explained how markets work efficiently and because of that, how it is very difficult for even the most skilled, trained, and informed of investors to consistently beat the market. Honestly, he has me convinced. In fact, I know I’m neither skilled nor informed, but I’m pretty well convinced that it wouldn’t be worth my time to try and find a broker who is - because even brokers don’t really do all that well against the market. In the next eight chapters, Swedroe goes through a number of different myths about smart ways to invest, and uses analogies and stories to show why they aren’t so smart after all. Because I found them so interesting, I am going to briefly highlight them, and also go through myhts that Swedroe debunks by examples from the market itself.

Great companies make high-return investments? No.

Basically, this section talks about how risk is rewarded, and that if a company is highly regarded as a safe investment, its price is high enough to negate the fact that it has higher earnings. He uses a number of different scenarios to illustrate this including real estate investing and WalMart vs JC Penney. I thought about it in terms of Google, because I like Google and I wish I had some Google stock. However, Google is expensive now and you can expect a low rate of return for your investment because it is pretty solid and “safe”. The people who made money hand over fist on Google were early investors who took it on when it was a huge risk. With risk can come reward (but also, can come a complete loss, which is why it is risk). That doesn’t make Google a bad investment now - but it does mean I probably missed the boat on getting astronomical profits from that investment.

That analogy can be totally off the mark, it is something I came up with while reading the chapter. Take it with a grain of salt.

Stocks are only risky if your investment timeline is short - not quite.

This section uses a number of different 20 year samples to show that stocks do not always outperform other, less risky investments over a 20 year period. Stocks generally, but not always, provide a greater level of return over a long period of time, but you have to be comfortable with your unique level of risk. Honestly, I learned something here, and I’m going to have to study the asset allocation of my spouse’s 401K more carefully and think on that some more.

Buy what you know? Confusing “information” with “knowledge”.

Again, Swedroe takes specific examples here of “great” companies and shows how if you buy them at the wrong time, you may never make your initial investment back. There are so many individual stocks, that choosing to buy them as an investment vehicle individually is a very very risky proposition. He also covers the idea that if you have a piece of information (that everyone has) about a trend or forecast, that isn’t knowledge, it is just information. Buying stocks in medical companies because the population is aging isn’t a secret idea - and the market, being efficient, is already going to reflect that in prices.

Too many eggs in one basket.

This refers to owning too much of your own company’s stock. Basically the take home lesson is - if you have $3 million invested and 75% is in your company’s stock, if instead I just gave you $3 million and you could invest it whereever you wanted, would you really make that same decision about allocation? Just… think about Enron. Don’t put all your eggs in one basket.

Strategy vs Outcome - Don’t confuse them.

You can’t judge the correctness of a strategy based on the outcome. For example - life insurance. If you buy 30 year term life insurance and you don’t die in that 30 years, was the decision to buy life insurance a bad one? No, it was a reasonable protection against a possibility. You can take the outcomes of a host of different risky investing strategies and decide that they were the best based on outcome, but you can take just as many other risky strategies and find that the outcome was awful. Just like last week’s idea that past performance is not a prediction of the future, hindsight is 20/20 and it is being able to diversify risk for the future that is key, not picking the risk that panned out in the past. Diversification is like insurance - the strategy works if you collect on the policy or not.

I have life insurance. I’m still hoping I don’t die.

Making one great shot - the investor’s worst enemy.

Like the story from last week of finding a $20 bill on the ground and then devoting the rest of your life to trying to find more $20 bills lying around, one great move can be the investor’s worst enemy - because they’ll spend decades trying to repeat it. I can think of lots of places in my life I act like this, so it makes sense to me. Human nature is an interesting thing.

Overall, I am really enjoying the book. I didn’t know all these myths before but I had heard and believed several of them, and now I have a lot more to think about. Next week we’ll look at even more myths in investing, and then in two weeks, I’ll finish the book with the “wise” investing strategy reinforced. See you then!

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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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My next book review is Wise Investing Made Simple by Larry Swedroe. I was given this book by Pinyo of Moolanomy, because he thinks it is a great book and wanted to pass it on, and he probably thinks I need the help. And he’s probably right.

Before even receiving the book, from the title and the synopsis I had read about it, I basically thought it would be a book with one message: Invest in Index Funds. Navigating the personal finance blogosphere, that strategy is touted as the way to go for many people, and when I hear “investing” and “simple” in the same sentence, that is what my brain jumps to. I’m looking forward to getting into the book in detail and seeing if my initial assumption is right, or if there is a lot more to it than that. I don’t think there can be a *lot* more to it, or it wouldn’t be “simple”, right?  But I’ve been wrong before.

I was interested in seeing how someone was going to turn that advice into an entire book, and also learn more about index funds in general, because all I know about them is that they follow an index. Meaning their investments mirror a group of stocks as a whole, I think, like the Dow Jones Index.  I think.

Okay - now we see I still have a lot to learn and understand, and why I thought this book would be interesting.

When I received the book, I leafed through it, and it seems that the book is organized into very short chapters, some which relate a story to illustrate a point, and some which are full of information relating to the stories and explaining what they mean in terms of investing. There are 27 chapters, and I won’t be reviewing them one by one like I did with Smart Couples Finish Rich, but I am going to break my review into several parts (probably 5 or 6) and review a chunk of the book at a time and my reaction to it, and what I think I’ve learned and can apply to my own situation. I’m excited to read this book and digest it and come up with what I think of the advice overall, and how accessible it makes understanding investing to me, the novice.

So that’s what will be going on here Fridays at lunchtime for the next few weeks. Learn about investing along with me! Once we all have some money (it’ll happen!), we’re going to need to know what to do with it….

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