I read the Little Book of Common Sense Investing. Here are the key takeaways.

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John Bogle, founder of The Vanguard Group shares his thoughts on sensible investing strategies in The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns.

An absolutely fantastic read for new investors in the stock market. Here are my key takeaways.

0. Introduction

• The winning strategy is to own all nation’s publicly held businesses — guarantees return in dividends and earnings growth.
• Corporate Profits and GDP growth are very strongly correlated.
• Buy S&P.

1. Parable

• For investors as a whole, returns decrease as motion increases. Stop buying and selling so often. You’re losing on fees. Best Advice — “Don’t do something. Just stand there.”
• Active managers as a whole cannot achieve gross returns exceeding the market as a whole, and they must underperform the indexes due to expense and transaction costs.
• Economics control long-term equity returns. Emotions control the short term.
• Real Returns = Nominal Returns — Inflation Rate — Management Fees

2. Rational Exuberance

• Without fail, Investment Return has increased over the decades. Speculative returns oscillate every decade. A move down will be compensated by a similar move up in the coming decade. Reversion To The Mean.
• In the short term, stock prices go up only when the expectations of investors rise, not necessarily when profits rise.
• The true investor will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.

3. Cast Your Lot With Business

• Occam’s Razor: When there are multiple solutions to a problem, choose the simplest one.
• The correlation between the Total Market Index vs. S&P 500 is 0.99.
• The S&P 500 outpaced 97% of actively managed large-cap core funds.

4. How Most Investors Turn a Winner’s game into a Loser’s game

• Keep MER as low as possible.

5. Focus on the Lowest-Cost Funds

• Fund performance comes and goes. Costs stay forever.
• Costs: Expense Ratio — Cost for managing the fund, Sales Charges — Cost for selling/facilitating the fund sales, Trading Commissions — Turnover cost.
• Higher cost funds tend to carry high risk and lower returns (because of the cost).
• In every single time period and data point tested, low-cost funds beat high-cost funds.
• Expense Ratios are strong predictors of performance.

6. Dividends are the Investor’s Best Friend

• Dividends account for 42% of the stock market’s annual return.
• Reinvest your dividends. DRIP.
• Actively managed fund fees consume 100% of the fund’s income.

7. The Grand Illusion

• A fund’s returns are different than an investor’s (far lower).
• Money flows in funds after good performance and goes out when bad performance follows.
• Equity Funds lag the market due to costs. Fund investors take away less than even half the returns of equity funds. Why? Counterproductive Market Timing and Adverse Fund Selection.
• Emotions need never enter the equation. Own the entire stock market and do nothing. Don’t forget to do nothing.

8. Taxes Are Costs, Too

• Managed mutual funds have high turnovers leading to greater tax incursions. Tax inefficiency gets passed onto the investors. In comparison, holding for longer periods means much lower capital gains rates.

9. When The Good Times No Longer Roll

• Speculative return fluctuations are due to P/E ratio changes. Revaluations affect P/E ratios and therefore the speculative returns.
• Developing future expectations for bonds is far simpler than stocks. There is a 0.95 correlation between 10-Year Note’s Initial Yield and Subsequent 10-year returns. This is because if the bond is kept for a decade, the principal is paid back. The interest rate fluctuations only affect the market price in the interim.

10. Selecting Long-Term Winners

• Don’t pick winning funds from past performance.
• 80% of the 355 equity funds that existed in 1970 have gone out of business. Only 2 funds exceeded the S&P 500 returns by 2% or more. Rest underperformed. Think about the odds of long term success.
• Portfolio Managers with consistent excellence even over the short term are a rare exception than the common rule in the mutual fund industry.
• Don’t look for the needle, buy the haystack.
• Portfolio Managers on average last 9 years.

11. Reversion To The Mean

• Yesterday’s winners, tomorrow’s losers.
• Only 14% of 5-star funds in 2004 still held that rating a decade later. This phenomenon gets worse and worse as the decades go by.
• RTM — Tendency of funds who have outperformed substantially to return towards the average or below.
• Buying funds based purely on past performance is one of the stupidest things an investor can do.

12. Seeking Advice To Select Funds

• 70% of American families invest in Mutual Funds through intermediaries.
• Average annual return of funds recommended by advisors: 2.9% vs. Purchased directly 6.6%.
• Financial Advisors add fees to your returns.

13. Profit from the Majesty of Simplicity and Parsimony

• Odds of an Actively Managed Portfolio outperforming a passive index fund decreases as the number of years increase.
• Stay away from front-end loaded funds. Sales charge to be able to purchase the shares.
• S&P’s international index outpaced 89% of actively managed international equity funds over the past 15 years.
• Picking winners is betting. Betting is a loser’s game.

14. Bond Funds

• Stocks generally have provided higher returns than bonds.
• Why own bonds? Bonds have outpaced stocks in shorter runs. Reduces portfolio volatility.
• Junk bonds increase volatility.
• Bond Index — Bloomberg Barclays U.S. Aggregate Bond Index.

15. ETFs

• Good implementation of Index Fund investing.
• Do not over-trade — adds commission fees, tracking errors reducing returns.

16. Index Funds That Promise To Beat The Market

• ETFs exist with different strategies like — Dividend Weighted, Fundamental Index Funds. The returns are somewhat similar to S&P 500 with higher MER.
• “The greatest enemy of a good plan is the dream of a perfect plan”.
• Trying to beat the market leads to disastrous results. Our actions lead to much lower returns than can be achieved by just staying in the market.

17. What would Benjamin Graham have thought about Indexing?

• It’s good.
• Provides the broadest possible diversification.

18. Asset Allocation 1

• For younger investors — Stock/Bond mix of 80/20. 70/30 for older investors.
• A low-cost portfolio with a lower allocation to stocks can earn the same or a higher net return than an actively managed portfolio with a far higher allocation to stocks. Chase low fees, not high returns.

19. Asset Allocation 2

• Balanced 60/40 Stock/Bond Balanced Index with a 0.14% expense ratio.
• The dividends on the S&P 500 have increased every year since the Index began 90 years ago.

20. Investment Advice That Meets The Test of Time

• Buy low-cost Index funds. Diversify. Apply Compounding Interest.
• An index-driven strategy may not be the best investment strategy ever devised, the number of investment strategies that are worse is infinite.

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