Summary And Review of The Bogleheads’ Guide to Investing

Summary of The Bogleheads’ Guide to Investing

The Bogleheads’ Guide to Investing was set up in two parts, “Essentials of Successful Investing” and “Follow-Through Strategies to Keep You on Target.” There were 23 chapters in the book and I like the way the book was set up and the flow was very well put together. The book is written by three authors, Taylor Larimore, Mel Lindauer and Michael LeBoeuf. They are part of a group of people such as investors, lawyers, doctors, teachers, waiters and average joe’s that call themselves Bogleheads’. They get the name bogleheads’ from a man named John C. “Jack” Bogle. He is the founder and retired chairman of the Vanguard Group and has devoted his life to helping investors with their investing decisions. As well as teaching them how to invest, he created a family of low-cost mutual funds that Jack has been tirelessly advocating for individual investors. The three authors have over a century of investing experience between them. They have since, in a way, devoted part of their lives to helping others reach their investing goals. They each spend several hours a day on Moringstar.com Vanguard Diehard Forum answering questions for free.

The book begins with a brief description about how the Bogleheads’ were started. After a decade-plus of existence, they moved from a loose association of investors to a web site by Morningstar, identified there as “Vanguard Diehards.” More than 25,000 visitors are recorded daily. After a few well known investors and writers who followed Jack Bogle’s investment advice invited Jack to Miami to meet. They called this meeting Diehards I. Some 20 investors who had never met one another before quickly became friends. The following year, the group met in Valley Forge, called “Diehards II” and met with 40 Bogleheads and from there it flourished. The book talks mostly about how to save you earnings and how to invest them correctly. It seems to be revolving around retirement and living a happy and financial free retirement. They also discuss the types of stock and bond options offered through the Vanguard Group with low-fees and proven track record returns.

Chapter one discusses choosing a sound financial lifestyle. Each chapter starts off with an interesting quote usually pertaining to what the chapter is discussing. This one is no different and I find the quote sort of funny, “Drive-in banks were established so most of the cars today could see their real owners.” The very first statistic that they tell in the book is very disturbing to me,

“It’s an old statistic that has held very consistent over time. Take 100 young Americans starting out at age 25. By age 65, one will be rich and four will be financially independent. The remaining 95 will reach the traditional retirement age unable to self-sustain the lifestyle to which they have become accustomed.”

It describes that without government programs such as Social Security, Medicare, and Medicaid many people would literally starve. They expect that as soon as the baby boomers begin to retire and start collecting the government handouts, they will go broke. The first chapter tries to help the reader figure out what kind of financial lifestyle you live, from Betty Borrower to Chad Consumer to finally Ken Keeper. They describe the differences in all three and how they feel that the borrowers and the consumers have a bad view on how to life financially by taking on too much debt and spending all their paycheck after their bills are paid. The keepers live in their means and don’t finance many possessions they can’t afford to pay off and invest 10% of their paycheck first before paying themselves. They tell you three steps to take before you start investing. First, leave the paycheck mentality and go to the net worth mentality. Second, pay off credit card and high-interest debt. Third, start an emergency fund.

Chapter two is about starting early and investing regularly. The magic is compounding. The rule of 72 is extremely simple: To find out how many years it would take for an investment to double in value, divide 72 by the annual rate of return. An investment that returns 9% doubles every 8 years because of the magic of compounding. For someone to have $1 million at the age 65 and with an 8% annual return they would need to invest the amount shown in the table just one time at that certain age. This table shows the amount after expenses and taxes and what the power of compounding can do to our investments.  Here is another example of how starting early is extremely beneficial:                

“At age 25, Eric Early invests $4,000 per year in a Roth IRA for 10 years and stops investing. His total investment is $40,000 Larry Lately makes yearly deposits of $4,000 in his Roth IRA starting at age 35 for 30 years. His total investment is $120,000. Assuming both portfolios earn 8 percent average annual return, at age 65, Eric’s IRA will be worth $629,741, but Larry’s IRA will be worth only $489,383. By starting out 10 years earlier and making one third of the investment, Eric ends up with 29 percent more.”

An interesting point made in this chapter is that the authors say to “Pay Yourself First”. The earlier you start investing, the sooner you can reach your financial freedom. The authors discuss making smarting purchasing decisions. They explain that buying a 2-3 year old car is a smarter investment that buying a brand new car because a cars main depreciation is the first few years of its life.

Chapter three begins with talking about knowing what your buying, part one. This chapter talks about different types of Stocks and bonds. Chapter three goes into detail about all of these types of investments. Stocks are a representation of an ownership interest in a corporation. Each stock share is actually a small fraction of its business to each person who buys the stock. Bonds are actually lending a specific amount of money to the issuer of the bond. You receive a return on your investment that is the bond’s yield to maturity and the return of the face value of the bond at a specific date, known as maturity date. There are also Treasury issues that are considered the safest bond investments since they are backed by the faith and credit of the U.S. government. T-bills, T-notes, T-bonds, Treasury Inflation Indexed Securities, Treasury Inflation-Protected Securities, U.S. Savings Bonds are all forms of bonds that the U.S. government sells. You might be wondering how much you should invest in bonds and Mr. Bogle suggests that you should own your age in bonds as a good starting point. I should have 25 percent of my investments in bonds.

Chapter four is very much like chapter three; however it talks about mutual funds, Exchange-Traded Funds (ETFs), and annuities. Mutual Funds pool lots of money from many investors to buy securities. There are different types of mutual funds such as equity mutual funds that invest in stocks, bond funds that invest in bonds, and hybrid/balanced funds that invest in both stocks and bonds. There are 10 strong reasons/advantages of investing in mutual funds. The ten are as listed, diversification, Professional management, low minimums, no-load or commissions, liquidity, automatic reinvestment, convenience, customer service, variety and communication and record keeping. An annuity is an investment with an insurance wrapper. There are a few different types of annuities. There are fixed, variable and immediate. Exchange-Traded Funds are mutual funds that trade like stocks on an exchange.  

Chapter five talks about preserving you buying power with inflation-protected bonds and it starts off telling us that in chapter two we learned about how the power of compounding can work for us. But it can also work against us when it comes to inflation. “An inflation rate of 3 percent means that when a 25-year old investor retires in 40 years, she’ll need $3,262 to buy the same basket of goods and services that she can buy for $1,000 today.” Just imagine that if you were to keep $1,000 in a cookie jar for 40 years and then take it out and try to use it. You wouldn’t be able to buy anything close to what you thought it would. The big problem most people have understanding what real return is. Real return is the amount we have left after we subtract inflation form our rate of return. The U.S. treasury offers two choices that help fight inflation; I bonds and Treasury Inflation Indexed Securities (TIPS). The I bond works by two components, first there is a fixed rate on the bond when you purchase it that keeps the amount over and above inflation. Second is the variable inflation-adjustment rate that is recalculated and announced twice a year annually. TIPS are the same in that respect, but are purchased at Treasury auctions, in the secondary market.

Chapter six was the one I was hoping to tell me the best information. However, there is no formula to tell the investor how much they need to save for retirement. There are a lot of factors that can help us figure out the amount we need to accumulate to achieve our dream retirement: For starters, we need to save, the more the better. Next, our current age because this will help determine how many years we have to save and invest. Next, the hard one, how many years we’ll have to live off our retirement account, based on our life expectancy. Another is whether we plan to leave an estate, or if we will simply want to make sure that we don’t run out of money before we run out of breath. Another thing is a source of income in retirement and finally the rate of return on our investments. One of the toughest things to determine is our life expectancy. We would like to know when we will meet our maker so we will know how much we need to save up to that day. There is a saying in finance; a perfect investor will have the last check he ever writes to bounce. They discuss a few internet websites that have financial calculators to calculate your current portfolio, annual contributions and you’re expected total value at retirement and many more. Those can be located at www.bloomberg.com,  www.bankrate.com,  www.callan.com.

The next chapter talks about keeping it simple. The authors are all members of the Vanguard group and talk very highly about the Vanguard Index 500. It seeks to replicate the return of the S&P 500. They show lots of statistics for and against the index and it always seems to outperform the other index. The Vanguard Index 500 has outperformed the top 3 index by an average of 3 to 5 percent on a consistent basis. They are very firm advocates of investing regularly and over a long period of time. The do not believe in getting rich quick investing.

Chapter eight is all about Asset Allocation. Just like diversification, they want you to have stocks, bonds and cash. While you are getting your assets allocated, you need to figure out your risk tolerance. Knowing your risk tolerance is a very important aspect of investing. They have a chart in the book that shows he maximum decline based on allocation. This chart shows the maximum decline that would have occurred during the 2000 to 2002 bear market. It is made up of two Vanguard funds, Vanguard’s Total Stock Market Index Fund and Vanguard’s Total Bond Market Index Fund. This shows why nearly every portfolio should contain an allocation to bonds. Deciding on your risk tolerance and your asset allocation for your long-term portfolio is the most important portfolio decision you will make.

Cost matters. That is the theme of chapter nine. They are very stern on explaining that cost matters and you should keep them as low as possible. They have it estimated that the total cost in the U.S. equity market is about $300 billion annually. These consist of brokerage commissions, customer fees, legal fees, marketing expenditures, sales load, advisory fees, and transaction costs. Taxes are not included in these figures. Many investor pay front-end sales commission (load) when they purchase funds share. For example if you pay a 5% front-end load from a $10,000 investment, you are only getting $950 invested. If after a year you see your funds have had a 10% return and think that you just made $1,000 your wrong. You only made $950. Back-end loads are exactly what they sound like; they take their commission when you take your money out. There are no-load mutual funds, but those have purchase, exchange, account, redemption, management 12b-1 and other expenses tied into them. They highly recommend anyone getting ready to invest money to do their homework and find what the lowest cost to them is.

The next two chapters talk about taxes and how they affect you investment, from bonds to stocks to IRA’s. They explain in mostly about IRA’s and Roth IRA’s. A traditional IRA is a personal savings plan that gives you some advantages with your taxes while saving for your retirement. They don’t get taxed until you withdraw your money. There are limits to how much you are allowed to contribute. The maximum limit for a single individual to contribute to an IRA in 2005 is generally the smaller of $4,000 or your taxable compensation for that year. When you reach 50, you are allowed to invest $4,500. There is a 10% tax penalty for withdrawing money from a traditional IRA if the distribution takes place before you are 59 ½ years old. Roth IRA’s, like traditional IRA’s is also a personal savings plan but it operates in reverse. While IRA’s contributions are tax deductible, Roth IRA’s are not. One of the reasons that people prefer a Roth IRA over a traditional one is because you may expect your future tax rate to be higher. Also Roth IRA’s are worth more from a tax stand point. There is no penalty on early withdrawal of your contributions. Withdrawals are not reported as income. There is a way that the owners of a traditional IRA can convert to a Roth IRA if they meet two requirements: One, their adjusted gross income is not more than $100,000. Two, you are not a married individual filing a separate return.

Chapter twelve starts off with another quote I found funny. It is by Warren Buffet, “Diversification is a protection against ignorance.” When it comes to investing, the old saying goes, “Don’t put all your eggs in one basket.” Millions of investors put all of their money in the latest and hottest dot.com stock that “couldn’t fail.” Most of them did eventually fail. They lost everything when the market nosedived in 2002. Diversification offers two big benefits to investors. First, it helps reduce the risk of having “all your eggs in one basket.” And second, you can increase your market return at the same time.

The next chapter was very brief and talked about not being a performance chaser and trying to time the market. They are firm advocates on staying the course in a well organized index fund. They used a great example of how the news tries to sell anything they can to the public:                

In August 2003, Mr. Fabian confidently announced to Chuck Jaffee on CBS Marketwatch that he could produce a 100 percent return in 365 days using a turbocharged version on the system he sells investors. To prove that his market timing system worked, Fabian publicly invested $500,000 of his own money using the system. Big mistake! Unfortunately for Fabian, his $500,000 investment subsequently lost $192,000, and he was unable to hide that fact from readers…. One of the primary reasons we’re writing this book is to ensure that your lessons about investing will be much less expensive.

They again prove their point about staying the course and not being an active trader. It the following graph, it shows the research results from two professors at the University of California. They did a study of 66,400 investors from the year 1991 through 1997 to see how trading affected those investors’ returns. The buy and hold traders beat the most active traders by a whopping 7.1% a year. Warren Buffet said it well when he said, “Inactivity strikes us as intelligent behavior.”

Savvy ways to invest for college, I wish my mom would of read this. This chapter shows so methods for saving for your college educations. I am glad mine will hopefully be over this Saturday unless graduate school calls later! The statistics show that a high school degree would have a lifetime earnings of $1,000,000. Associate degree would have a lifetime earnings of $1,600,000 and a Masters degree would have earned $2,500,000. Education pays in the long run. The authors give a website called www.saveingforcollege.com that has lots of free information on various college savings plans. The authors have discussed personal savings, custodial accounts (UGMA & UTMA) and U.S. Savings Bonds, IRA withdrawals and Coverdell Educational Savings Accounts (Educational IRAs or ESA). UTMA and UGMA’s are very dangerous things to give to your children. There are certain rules and laws with them that the initial giver of the account didn’t take into consideration. First the child gains full control of the account automatically at either the age of 18 or 21. At this point, they can spend it on anything they want like a car, TV or motorcycle and there is nothing you can do about it. The ESA are just like the UGMA and UTMA’s but they are tax free as long as they proceeds go to any qualified educational expense. I plan on using this when I have kids and decide to start saving for them unless something better comes out by then.

How to manage windfalls successfully? A windfall is an inheritance, settlement, sale, bonus, retirement or really any money that wasn’t originally accounted for. NBC reported that more than 70% of lottery winners use all the money they won in less than 3 years. They advise to deposit the money somewhere and leave it for 6 months to think of what to do with it the smart way. They say put a small portion aside to treat yourself to something you always wanted but to invest the rest.

Chapter sixteen starts off with a quote from one of the authors, Michael LeBoeuf, “I helped put two children through Harvard-my broker’s children.” They basically say that anyone that has the willpower to invest their money has the will power to learn and do it themselves. It is not hard, a little research and self learning can save thousands of dollars of your money that should be invested and not in the brokers pockets.

Part II of the book is a follow up on the first part. Chapters seventeen through twenty three reassure what the first part has gone over. Tracking

your progress and making sure you know where your money is at all times. They talk about tuning out the “noise” which the media is selling quick rich schemes and hot stocks. There are things the investment media don’t want us to know. Three things that make effective investing incredibility simple: Create a simple, diversified asset allocation plan, Invest a part of each paycheck in a low-cost, no-load index fund and check your investment periodically and stay the course. They say you should never invest with your emotions. When the market is down, most average people with life savings and retirements invested get nervous and withdraw their money for a huge loss instead of staying the course and letting it bounce back. They also talk about having your money last longer than you do and leaving your heirs with a check, not a bill. The main thing is living in your means and not over doing it.

Finally, they say “You can do it” and the bogleheads will help.  This final quote really means a lot to me when I read it and really for anyone who has made mistakes in the past, whether it is in finance or in life in general. Carl Bard puts it nicely, “Though no one can go back and make a brand new start, anyone can start from now and make a brand new ending.” I really feel this book is giving me a new outlook on my financial future. They talk about what we have learned in the book and how the bogleheads want to help. They are a large group of people from all walks of life that have a common interest in investing and retiring sooner than later and enjoying every day of it. They give the website where the Vanguard Diehards Forum is at. Www.morningstar.com.  There is so much information at this website and hundreds of people that love to help beginning and experienced investors reach their goals. In closing, they reiterate STAY THE COURSE. If you get lost, we are here to help!

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To contact the author of this summary/review, please email Jason Chigoy at Chigoyboy33@yahoo.com.

David C. Wyld (dwyld@selu.edu) is the Robert Maurin Professor of Management at Southeastern Louisiana University in Hammond, Louisiana. He is a management consultant, researcher/writer, and executive educator. His blog, Wyld About Business, can be viewed at https://wyld-business.blogspot.com/.  He also has a book summary/review blog that is a collection of his students’ works at https://wyld-about-books.blogspot.com/.   

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