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Wednesday, August 10, 2011

Review: The Little Book of Common Sense Investing

I used to work for a mutual fund company.  I started my career there as an intern, and stayed for a total of five years before moving to a different company.  The great thing about working for such a firm so early in my career was that I learned a lot about 401(k) plans.  I'm in IT, so I wasn't working on the day-to-day investing side of things, but the basic principles of retirement planning were drilled into my head...

a) Invest as much as you can afford, and if you aren't at least putting your enough into your 401(k) to match what your company would match, you were throwing away money.

b) Once it's in there, don't move it around too much.  Set it and rebalance about once a year.

We learned the basics of risk, and how much of our investment should be at risk based on our age.  That being said, this was also in the midst of the tech bubble (I left the company in mid-2002), and a lot of us were putting a little more at risk than we probably should.

What I didn't learn was what I should be investing in.  I didn't really know one fund from another, and I didn't really understand how to choose my investments.  I did, though, have total faith that no matter what funds I was choosing, I would be doing well just to be in mutual funds.

If you ever check out my blogroll, you'll catch a few financial blogs in there.  I do really like to keep up with financial news, and my absolute favorite personal finance blog happens to be Get Rich Slowly.  It was this blog that suggested John Bogle's book The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns.  Get Rich Slowly recommends the methods of John Bogle, who is a former president of The Vanguard Group (not the mutual fund company where I used to work).  Bogle recommends investing in Index Funds.  Get Rich Slowly recommends index funds.  In fact, index funds keep coming up when I hear about investing.  I decided to check out the book and I downloaded it for my Kindle.

I'm new to index funds and I realized that I didn't learn as much at my former company as I'd thought.  I was convinced in only a couple of chapters.  Bogle talks about what an index fund is and why you should invest.  Each chapter tackles a different aspect of index funds and mutual funds in general, from tax implications to ETFs.  My favorite chapter was on expense ratios, which is basically how much money you are paying the mutual fund owner to maintain the fund for you.  Oh my.  This is when I realized how much I was PAYING my former employer to manage my money and I was floored.  Expenses had never really been emphasized to me, and in theory they seemed like such a small portion of my money that I didn't think it mattered.  Then, I checked out the funds that I was holding and saw a shocking .6-1.3% expense ratio.  Index funds from Vanguard were more like .10%.  This makes a HUGE difference to what you end up with over time!  I had no idea!

A side note:  If, like me, you really didn't know what an index fund is, here's an explanation.  It's a method of buying the "entire" stock market, or an index of the entire stock market.  So, for example, the S&P 500 is a collection of 500 large cap stocks in the US.  And S&P 500 Index buys some of each of those 500 stocks, properly weighted based on the percentage of that stock over the whole index.  These days, there are Total Stock Market Indexes that do the same thing with the entire US Stock market.  And since they're not actively managed, their fees are lower.

Even better, they represent the market, so rather than trying to beat the market (which almost no one can do), you simply match it, which is a terrific deal.

Now, the bad part about this book is that it is basically an advertisement for Vanguard Funds.  Do your research though, and you'll find that this method of investing is well respected and Vanguard is a very respectable firm.  Vanguard is not your only choice for index funds, either.  The point is that Index funds happen to be the way to go, regardless of who is actually offering them.  My former company, for example, offers several index funds.  And, having read this book, you'll be smarter when going through the prospectuses.  Personally, over the last few weeks I've moved all of my assets to Vanguard, even though I feel a little like I'm betraying the company that launched my career.  They're just too expensive, plain and simple.

This book is a must read for anyone who wants a smart, simple way to manage their investments.  I'm a convert, and I'm planning to follow this one up with The Bogleheads' Guide to Investing.

1 comment:

lindsay said...

Ugh blogger ate my comment and sorry but I don't feel like retyping it all on my phone!! It was long.

Anyway, dontfeel guilty - it's your money! Moving it to lower expense ration = smart.

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