First Book on Investing

Yale’s Chief Investment Officer, David Swensen introduces The Elements of Investing with a troubling reality:

Having already written two of the finest books on financial markets, Ellis’s Winning the Loser’s Game and Malkiel’s A Random Walk Down Wall Street, why should the authors revisit the subject of their already classic volumes? The sad fact is that in the cacophony of advice for individual investors, few sane voices are raised.

Savings, fees and passive strategies are the focus of this book, and for most individuals otherwise occupied by a career in an unrelated industry, it is spectacular advice:

  1. Without savings, there is no potential for investment.
  2. Fees lead to perverse incentives, and encourage investment professionals to create complicated solutions where simple strategies will outperform. Fees also make yield more difficult to achieve.
  3. Finally, most investors should seek a low-fee passive strategy that they contribute to regularly, and avoid attempting to time the market.

The authors wrote this book “to provide individual investors … the basic principles for a lifetime of financial success in savings and investing, all in 208 pages of straight talk that can be read in just two hours.” It does an incredible job of introducing all of the necessary elements without any unnecessary vocabulary. It is simple, unsexy, and incredibly relevant.

(Note: Perhaps the only quibble I have with the book is that I don’t believe home ownership is always a brilliant idea. My thoughts on this topic: What are the most common mistakes that home buyers make?)

I genuinely believe that unless you want to commit yourself daily to the practice of investing, this is the best strategy. Should you require further proof, Warren Buffett provides similar advice in Berkshire Hathaway’s 2013 investor letter:

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers. [1]

But as famed professor Bruce Greenwald points out in a recent Barron’s interview, while that may be Buffett’s advice for others, it is not what he practices himself:

Buffett isn’t telling you the full story, because he doesn’t want to create competition for himself. He is saying yes, by all means do passive investing, but [he isn’t saying that] to people who understand and apply these principles in a disciplined way. Is he going to do passive investing himself? Of course not. [2]

If this peaks your curiosity, I would suggest pursuing the investment strategy described above, but continuing to educate yourself should you later decide to explore a more active form of investing later in your career.

My next suggestion would be Joel Greenblatt’s book The Little Book That Still Beats the Market - this book introduces Greenblatt’s “magic formula” for investing. Whether you want to take this approach or not, the book does an excellent job explaining what he believes are the most important metrics: earnings yield and return on capital. This is described in an incredibly simple and insightful way. (For a more detailed review of this book: How do hedge funds find trading patterns?)

(Note: Greenblatt is an extraordinarily successful investor. He managed an annualized return of 50% over the course of a decade at Gotham Capital.)

I cannot emphasize enough that most investors are better off pursuing a passive strategy, and continuing to educate themselves. The latter is critical, because eventually something will go wrong - even with a passive strategy - and doubt will lend an ear to bad advice and greater fees.

As for the decision to participate as an active or passive investor, if you don’t intend to spend a substantial amount of time studying investment opportunities, you will likely underperform the market as an active investor. I would further add that if you do not educate yourself, you will fail to identify active managers that make the fees worthwhile. The reality is that there are exceptions, and frankly I believe I have been lucky enough to work at one such firm (I joined in 2009, but from 1989 to 2016 the firm achieved an annualized rate of return of 27% net of fees), but they will be impossible to identify if you do not know which questions to ask.

Finally, the footnotes are great reads as well:


[2] Bruce Greenwald: Channeling Graham and Dodd

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