As a personal finance blogger I get the opportunity of receiving books about well, personal finance from time to time. I don’t always get to read them all (yet) but some I do while others are moved to the front of my reading list for when I get a chance. I wanted to tell you about one that’s on my short list to read.
The Power of Passive Investing by Rick Ferri
I haven’t read this book yet but I will soon. In The Power of Passive Investing, Ferri makes the case for owning only low-cost index funds and ETF’s. I’ve heard a lot about how active funds tend to not beat the market and that most of us would do better with low-cost index funds (Warren Buffet and Tom Gardner come to mind).
I certainly don’t want to have my returns eaten up by commissions and taxes. Investing in ETF index funds is something I’ve slowly been doing but I want to learn more. I was excited to get a copy of this book and start expanding my investing knowledge.
This is from the press release:
The Power of Passive Investing offers clear insight into the index fund world and the intellectual framework behind passive investment. Written for the inquisitive retail investor who doesn’t want to read dense academic papers or sift through fund documents, the book highlights the major issues in clear, sharp prose:
- Defines passive investing, differentiates between passive and active strategies, and walks readers through the basic concepts and terminology needed to understand passive investing
- Compares the returns from portfolios of active funds to portfolios of index funds with startling conclusions
- Argues for redefining the relationship between the money manager and the investor, lowering costs and shifting the balance of power back toward the investor
- Gives a detailed history of the origins of passive investing and a thorough survey of academic material comparing passive and active strategies
- Identifies the shortfall from active fund investing across all asset classes and all regions of the world
- Punctures myths about alpha and talks about what’s really behind Wall Street’s battle against indexing and low-cost investment options
The Power of Passive Investing shows investors the way forward: higher returns with less effort.
Remember how I told you I got to meet The Motley Fool’s Tom Gardner a little while back? Well one of the things he talked about was the fact that the guys on Wall Street spend their days selling people their “hot” mutual funds while the Wall St. folk themselves buy index funds for their investing. Why? They make money on the fees and commissions their active funds generate while the index funds are better suited to generate real returns in your portfolio. Interesting, huh?
I’m finding that I want to learn a lot more about investing and get more involved in it. I don’t want to buy and sell a lot of stocks though. I want to learn how to better diversify and allocate as well as make the most of my investments.
The Power of Passive Investing sounds like a good book to help me along in that quest for learning.
The forward to the book is by none other than mister index fund himself, John C. Bogle, founder of the Vanguard Group.
Inside, Ferri backs up his argument with research showing how index funds are a better choice than active funds.
Looking through the book, it seems there may be terminology that could be above the heads of the most basic investors and those who don’t know much about investing yet. It looks easy to read though so don’t let a few terms stop you from reading this.
It geared for those investing in mutual funds, those who want to know how ETF’s work, and those who are wondering if their money managers are doing all they can with your money. As I said in the beginning, this will be one of the next few books I read.
For more information on Rick Ferri visit www.rickferri.com.
You can read more about The Power of Passive Investing and buy a copy at Amazon.
Still with me?
Here’s some more reading for you from some great personal finance sites:
Financial Highway | Your Thoughts: The Gold Bubble?.
Own The Dollar | Recapping My Predictions For The Economy and Our Wallets In 2010.
Budgeting In The Fun Stuff | How to Save on Heating Bill AND Stay Warm!.
Oblivious Investor | Does This Count As Market Timing?.
Amateur Asset Allocator | Congress Can’t Beat The Market, Even When It Cheats.
Frugal Dad | Brace Yourself for $5-per-Gallon Gas.
Money Help for Christians | 21 Best Money Blogs of 2010.
The Financial Blogger | Best Stock Picks 2011 Contest – Add your picks in the comments to join!
Free Money Finance | Where to Get Income These Days.
The Millionaire Nurse Blog | Groupon: What, Why, and Where!.
The Wisdom Journal | A Resolution Worth Keeping: Find a new or better job.
Money Smarts Blog | My 2010 Couch Potato Investment Return .
Personal Dividends | Giving Back During the Holidays – The holidays are over but there’s always time to give.
Lending Club Blog | Get a Peer-to-Peer Personal Loan for the Holidays.
Investor Junkie | Why You Shouldn’t Prepay Your Mortgage.
Man Vs Debt | Debt-Free for Life: An Interview with David Bach – Read this interview!
Wealth Pilgrim | Can You Retire Now?
Soldier of Finance | 400,000 Miles? No Problem. How Driving a Tank Can Make You a Millionaire .
Studenomics | Vagabonding 101: Everything You Need to Know to Travel the World .
PT Money | Roth IRA Contribution Limits.
Good Financial Cents | 7 Things You Must Know Roth IRA Rules for 2011.
Bible Money Matters | 2011 Home Improvement Tax Credits For Energy Efficient Products (Insulation, Windows, Heaters, Etc).
Moolanomy | 2011 IRA Contribution Limits for Traditional and Roth IRAs.
And these are the blog carnivals Free From Broke took part in:
1st Ever Carnival of Passive Investing – December 31, 2010 – Hittin’ The Open Road Again Edition.
2010 Year-end Carnival of Credit Card Blog Posts | Credit Cards Canada.
Dodgeblogium » BoMSing into the new year….
Carnival of Wealth #19 – The New Year Edition — Personal Dividends – Money+Lifestyle.
Carnival of Financial Planning – Edition #169 – January 2, 2011.
Carnival of Money Stories #86: New Year’s Resolution Edition.
Carnival of Personal Finance – It’s a New Year Edition | Sustainable Personal Finance.
Cheapest Man Alive Edition of the Festival of Frugality.
Carnival of Wealth – December 26th, 2010 – Fantabulous YouTube Christmas Videos Edition.
If, after finishing the book, you want to read the case AGAINST passive investing, I encourage you to take a look at the materials at my site, FFB. I have studied this matter in great depth (I’ve devoted the last nine years of my life to it). I’ve come to the conclusion that Passive Investing (it’s often referred to as “Buy-and-Hold” Investing) is a dangerous Get Rich Quick approach. I’ve posted with Rick Ferri and he seems to be a smart fellow and a nice enough fellow. But I view the investing strategy that he is pushing as a marketing gimmick (my sense is that he personally does not intend to be pushing a Get Rich Quick scheme, however).
The problem with Passive Investing is that passive investors do not change their stock allocations in response to big price swings. Stocks are like anything else you can buy — they offer a great buy at some prices and an awful buy at some other prices. Stocks offered an amazing deal for the most of the time-period from 1975 through 1995. But they offered a horrible deal for most of the time-period from 1996 through today. We should have been telling people this. Instead, those who push passive have been telling people that it is ALWAYS a good time to buy stocks. Huh? How can anything be a good buy at all possible prices? This makes zero sense.
Rob
Wow Rob. Those are some powerful statements you are making. I can’t see how passive investing, where a person is buying an index rather than individual stocks or an active mutual fund is a get rich quick scheme. Seems to me the marketing gimmick is when people chase after active funds based on past performance and the funds don’t continue to perform.
What is the best method for a basic/beginning investor? How does someone go about figuring out the price of the market and its value and what to buy and sell?
Are you against dollar cost averaging as well? I’d have to guess you are as it’s also a form of passive investing.
What is a big price swing? Is the for the entire market or just for particular stocks?
I’m willing to hear better plans Rob. I think most people are looking to find the best way for them to invest.
Still, this looks to be a book that I’m eager to read and get my head around.
I will keep this short– thanks for the link.
MD, if you continue to write long responses like this then I may have to censor your comments!
You’re quite welcome too, hrmph…!
FFB:
Thanks for your response. You certainly should read Rick’s book. As I noted, Rick is a smart guy and a nice guy and there’s certainly value in knowing his take. There are a lot (a lot!) more people who think Rick’s investing views are worth hearing than there are people who think Rob Bennett’s investing views are worth hearing. So I would never want to be the one to persuade you not to read Rick’s book.
I can’t answer all of those good questions in a single comment. I write a weekly column called “Beyond Buy-and-Hold” that appears at the Out of Your Rut site on Wednesday mornings. If you have a chance, you might want to check that out from time to time:
http://outofyourrut.com/blog/category/investing/
If you have any interest in a Guest Blog Entry addressing any of the points you raised or any related ones, I would be thrilled to put one together. Please just let me know if there is an interest.
The root problem here is that, at the time Buy-and-Hold was developed (the early 1970s) we just didn’t know all there was to know about stock investing. The big breakthrough came with the publication of research that was done by Yale Economics Professor Robert Shiller in 1981. The Buy-and-Holders were very excited by what they had come up with and had a hard time accepting what Shiller had shown. And stocks were priced in the early 1980s to provide amazing returns for many years to come. So most experts ignored Shiller and stocks did fantastic and most of us attributed that to Buy-and-Hold.
Buy-and-Hold can work for 15 or 20 years. Not because it is a good strategy. But because any strategy that puts you heavily in stocks at a time of low prices is going to do well for a good bit of time. The problem is that any gains experienced due to overvaluation need to be paid back in subsequent years. The amount of overvaluation in January 2000 was $12 trillion. We are now in the process of paying back that debt. That’s why we are in an economic crisis. Paying back that debt has reduced our wealth by so much that most of us are afraid to spend, and when we don’t spend, businesses collapse.
Buy-and-Hold Investing is like credit-card spending. It makes you feel that you are rich for a short period of time because you have all this pretend money in your portfolio. But when it comes time to pay back the huge debt accumulated you end up wishing that you had just lived within your means all along.
There are tools available that tell you when valuations are so high that stocks are more risky than usual. My view is that we all should try to keep our risk levels roughly constant. As valuations go up, our stock allocations should go down, and, as valuations go down , our stock allocations should go up. That way, we would be taking price into account when buying stocks just as we take price into account when buying anything else. If we exercised some price discipline, the sort of overvaluation that we saw in the late 1990s would become a logical impossibility.
Rob
Rob,
When you talk about buying stocks, do you mean as an index or individually?
I understand it’s difficult to answer every question via a comment but your response is also pretty broad and definite.
I’d love to see a clear, easy-to-understand article on why buy and hold is inefficient. Shoot me an email when you get a chance.
Part of the value of the “passive investing” philosophy is the peace of mind it brings, and the ability to sleep at night. I personally get tired of watching Cramer and all the other screamers on CNBC who at the end of the day dont really tell you what to do, just offer opinions. With the passive approach you at least know what is happening, dont have to watch it minute by minute, and can focus on other wealth building strategies.
During the height of mortgage boom 2003-2006 every one was being told to get an ARM. A lot of people said they would sleep better getting a 30 year fixed loan even if they were going to pay an extra 1-2% in interest. I’ll bet they sleep better now!
A good companion piece to this book review is our interview with Rick Ferri – you can find it here: http://ratenerd.com/how-index-funds-and-etf-funds-can-improve-your-portfolio-3438.
The thing about these financial shows is they need to be spectacular to keep the viewers interest which in turn keeps the sponsor’s interest (which earns money for the network). I’m sure a show about passive investing, while informative to folks like us, would be boring to most.
So then the book is making a case just for ETF’s and index funds? Is that the entirety? Does it present a case against other types of investment vehicles?
Haven’t gotten into the book but I think it makes the case against actively managed funds.
Having been an active trader, and not great at it, I can say that passive investing offers people a more easily manageable system for investing. You don’t have to worry about individual stock prices, you aren’t looking up charts at work and making moves while others are at lunch.
That said, I agree completely with Rob Bennett. There is either a good time to buy, or a bad time, but there can’t be both. Lazy portfolios however, have performed quite well the past two years. I will say that someone needs to come up with a system that is:
1.) Passive enough that you don’t worry daily
2.) Active enough that you understand when to hold off on buying
3.) Encouraging of selling off at certain profit margins
4.) Rebalancing itself and checking gains/losses over time
Regarding a good time to buy stocks – what about dollar cost averaging where you put in the same amount in increments over the year? When prices are high you buy fewer shares and when prices are low you get more shares for your dollar.
This can be combined with reallocating to help take advantage of pricing.
“Stocks offered an amazing deal for the most of the time-period from 1975 through 1995. But they offered a horrible deal for most of the time-period from 1996 through today.”
Oh? Not if one had used any of these Lazy Portfolio approaches. Vanguard’s Balanced Index, Wellington and Star Funds only required investing in a single balanced (stock and bond) fund while the Coffeehouse Portfolio consists of six different equity classes plus a bond fund.
[Growth of $1,000 invested on 1/1/1996]
VANGUARD BALANCED INDEX (VBINX) VANGUARD STAR (VGSTX)
1996 13.95% $1,140 1996 16.11% $1,161
1997 22.24% $1,394 1997 21.15% $1,407
1998 17.85% $1,643 1998 12.38% $1,581
1999 13.61% $1,867 1999 7.13% $1,694
2000 -2.04% $1,829 2000 10.96% $1,880
2001 -3.02% $1,774 2001 .50% $1,889
2002 -9.52% $1,605 2002 -9.87% $1,703
2003 19.87% $1,924 2003 22.70% $2,090
2004 9.33% $2,104 2004 11.60% $2,332
2005 4.65% $2,202 2005 7.44% $2,506
2006 11.02% $2,445 2006 11.64% $2,798
2007 6.16% $2,596 2007 6.58% $2,982
2008 -22.21% $2,019 2008 -25.10% $2,234
2009 20.05% $2,424 2009 24.85% $2,789
2010 13.13% $2,742 2010 11.70% $3,115
VANGUARD WELLINGTON FUND (VWELX) COFFEEHOUSE PORTFOLIO
1996 16.19% $1,162 1996 14.53% $1,145
1997 23.23% $1,432 1997 17.95% $1,351
1998 12.06$ $1,605 1998 6.89% $1,444
1999 4.41% $1,676 1999 8.30% $1,564
2000 10.40% $1,850 2000 7.25% $1,677
2001 4.19% $1,928 2001 1.88% $1,709
2002 -6.90% $1,796 2002 -5.56% $1,614
2003 20.75% $2,169 2003 23.54% $1,994
2004 11.17% $2,411 2004 13.80% $2,269
2005 6.82% $2,575 2005 6.24% $2,411
2006 14.97% $2,960 2006 15.15% $2,776
2007 8.34% $3,207 2007 2.63% $2,849
2008 -22.30% $2,492 2008 -20.21% $2,273
2009 22.20% $3,045 2009 20.26% $2,734
2010 10.94% $3,378 2010 14.68% $3,135
“Lazy portfolios however, have performed quite well the past two years.”
And indeed, for far longer periods as well;
Vanguard Balanced Index Fund (VBINX) 7.87% annual return since inception on 11/9/1992
Vanguard Wellington Fund (VWELX) 8.18% annual return since inception on 7/1/1929
Vanguard Star Fund (VGSTX) 0.77% annual return since inception on 3/29/1985
Coffeehouse Portfolio 9.10% since 1991
“There is either a good time to buy, or a bad time, but there can’t be both. ”
Of course, the problem lies in knowing how to distiguish the good times from the bad times. Lazy Portfolios rely upon rebalancing to try eliminate the need to hazard a guess, continually in the case of Vanguard’s Balanced Index, Wellington or Star Funds and annually for the Coffeehouse Portfolio. As a particular asset class strays from its original allotment, rebalancing provides a convenient means to capture that possible overvaluation be restoring the portfolio to its orignal stock to bond ratio.
My apologies for the formatting (or lack thereof!).
Thanks for the info Carlyle and no worries about formatting.
When you talk about buying stocks, do you mean as an index or individually?
I’m talking about indexes, FFB.
I understand it’s difficult to answer every question via a comment but your response is also pretty broad and definite.
My guess is that the reason I sound confident is that I have spent the last nine years of my life researching these questions. It’s not my intent to brag, but I have looked at every possible angle and examined aspects of this that others just have not been able to examine. That of course does not mean that it’s not possible that I could have gotten things wrong. Anyone can get things wrong. I’ve gotten things wrong in the past. Still, if I do possess confidence because of the work I have done I think it is part of my job in telling the story to let people know that I now possess that confidence (I certainly was not nearly so confident in earlier days, when I was first questioning the Buy-and-Hold concept).
I’d love to see a clear, easy-to-understand article on why buy and hold is inefficient.
Here’s a link to a Google Knol that I wrote titled “Why Buy-and-Hold Can Never Work.”
http://knol.google.com/k/why-buy-and-hold-investing-can-never-work#
You may want to take a look at my bio to gain a sense of where I am coming from:
http://knol.google.com/k/rob-bennett/rob-bennett/1y5zzbysw7pgd/4#
Part of what drives me is my appreciation (again, developed only over a long period of time) of the broad significance of the mistakes that were made in development of the Buy-and-Hold Model. The link below is to an article titled “The True Cause of the Current Financial Crisis Is Buy-and-Hold Investing.”
http://www.passionsaving.com/cause-current-financial-crisis.html
The short version (for those who don’t have time to look at the links) is that Buy-and-Hold is a research-based model. The idea of rooting investment advice in academic research is wonderful; in this sense Buy-and-Hold was a breakthrough. The trouble with taking a scientific approach back in the time when Buy-and-Hold was developed was that at that time we just did not know all there was to know. Buy-and-Hold is rooted in something called the Efficient Market Theory, which posits that valuations are of no significance. The Efficient Market Theory was discredited by research done in later years by Yale Economics Professor Robert Shiller (author of “Irrational Exuberance”).
If the EMT is right, Buy-and-Hold is the best investment strategy ever developed by the mind of mortal man. If Shiller is right, Buy-and-Hold is the most dangerous investment strategy ever developed by the mind of mortal man. There is now a mountain of evidence that Shiller is right. In fact, all of the experts in the Shiller camp predicted today’s economic crisis years before it happened. If Shiller is right, the widespread promotion of Buy-and-Hold made the crisis inevitable. The problem we face today is that the experts who promoted Buy-and-Hold now feel a great reluctance to acknowledge that they have come close to destroying the U.S. economic system and have caused millions of failed retirements.
Thanks for showing some interest in the new ideas, FFB. I will also send an e-mail in the event that I can help with any follow-up questions. Any time these issues are debated is a plus, in my view. So I am happy that some people were exposed to them here regardless of whether any are immediately convinced or not.
Rob
I’m interested in anything that makes sense and works.
Too often we follow what people say blindly without knowing why. That’s dangerous.
I’m not saying I agree with you but I’m willing to see what it is that makes you passionately believe in your case. I agree that real debate is helpful.