The Bogleheads' Guide to Investing

by Mel Lindauer

Do not value money for any more nor any less than its worth; it is a good servant but a bad master. —Alexander Dumas fils, Camille, 1852

Drive-in banks were established so most of the cars today could see their real owners. —E. Joseph Grossman

Income is how much money you earn in a given period of time. If you earn a million in a year and spend it all, you add nothing to your wealth.

It’s not how much you make, it’s how much you keep.

The measure of wealth is net worth: the total dollar amount of the assets you own minus the sum of your debts.

Adding time to investing is like adding fertilizer to a garden: It makes everything grow. —Meg Green Miami, Florida, Certified Financial Planner

The Rule of 72 is very simple: To determine how many years it will take an investment to double in value, simply divide 72 by the annual rate of return. For example, an investment that returns 8 percent doubles every 9 years (72/8 = 9). Similarly, an investment that returns 9 percent doubles every 8 years and one that returns 12 percent doubles every 6 years. On the surface that may not seem like such a big deal, until you realize that every time the money doubles, it becomes 4, then 8, then 16, and then 32 times your original investment.

Bogleheads are investors, not speculators. Investing is about buying assets, holding them for long periods of time, and reaping the harvest years later. Sure, it requires taking risks, but only when the odds are in your favor. Speculating is similar to gambling. Speculators buy an investment with the hope of selling it quickly and turning a fast profit. Like gamblers, some speculators do win, but the odds are stacked against them.

“The problem with getting rich quick is you have to do it so often.”

When you earn a dollar, try to save a minimum of 20 cents.

The more you save, the sooner you achieve your financial goals. There is no substitute for frugality. Deciding how much to save is the most important decision you will ever make because you can’t invest what you don’t save.

You have a choice about what to do with every dollar that comes into your life. You can spend it today or save and invest it to make more dollars tomorrow. The key to successful money management lies in striking a healthy balance between the two.

All good wealth builders have just one thing in common: They spend less than they earn. There are two basic ways to find money to invest: You can either earn more money or spend less than you currently earn. We recommend doing both.

If you decide to create added sources of income, do your homework. The secret of any successful business lies in fulfilling unmet needs and wants. Find a need and fill it. Find a problem and solve it. Find a hurt and heal it. People pay money for goods and services that make them feel good and solve their problems. Odds of success are good if you choose an activity that’s in step with your educational background, previous job experiences, aptitudes, and interests.

“When a man with experience meets a man with money, the man with money gets the experience, and the man with experience gets the money.”

Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years. —Warren Buffett

When you purchase individual bonds at initial issue, you’re actually lending a specific amount of your money to the bond issuer. In return for lending your money to the issuer, you’re promised 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 specified future date, known as the maturity date. These maturity dates can be short-term (1 year or less), intermediate-term (2 to 10 years), and long-term (10 or more years). So, in reality, a bond is nothing more than an IOU or promissory note that pays interest from time to time (usually semiannually) until maturity.

Bond and bond fund values move in the opposite direction of interest rates.

It’s important to understand that bonds and bond funds have a low correlation (they don’t always move in the same direction at the same time) to stocks, so bonds can be a stabilizing force for a portion of your portfolio.

Mr. Bogle suggests that owning your age in bonds is a good starting point. So, a 20-year-old would hold 20 percent of his/her portfolio in bonds. By the time this investor reaches 50, the bond portion of the portfolio would have gradually increased, in 1 percent increments, to now represent 50 percent of his portfolio.

Increase your percentage of bond holdings if you are a more conservative investor, and decrease your percentage of bond holdings if you want to be more aggressive with your portfolio.

It’s hard to go wrong with any good quality, low-cost short- or intermediate-term bond fund.

I’ve found that when the market’s going down and you buy funds wisely, at some point in the future you will be happy. You won’t get there by reading, “Now is the time to buy.” —Peter Lynch

Mutual funds pool money from lots of investors to buy securities. Those securities can be stocks, bonds, or money market instruments, as well as other types of investments. As an investor in a mutual fund, you actually own a small fractional interest in the underlying pool of securities purchased by the managers of your mutual fund.

Read the fund’s prospectus and understand what you’re investing in!

Exchange-traded funds (ETFs) are basically mutual funds that trade like stocks on an exchange. They are bought and sold continuously throughout the day when the stock market is open. The ETF’s stocklike features appeal to a wide range of investors, including long-term buy-and-hold investors, as well as short-term traders. Perhaps one of the biggest benefits of owning ETFs is the low cost. ETF expenses can be as low, or even lower, than many mutual funds that track the same index.

This makes ETFs attractive to those investors who wish to trade during the day and know the exact price of their trade.

Because ETFs are market traded, they can trade at a slight premium or discount to the value of the underlying securities held in the fund. Generally, the premium or discount is not very large, but you need to be aware of it.

It’s important to note that Vanguard offers their low-cost ETFs commission-free, eliminating the previously mentioned downside associated with having to pay commissions to buy and sell ETFs.

When used properly, low-cost ETFs can certainly play an important role in a long-term investor’s buy-and-hold portfolio. On the other hand, investors are likely to shoot themselves in the foot if they plan to use ETFs as day trading or market timing vehicles.

At the end of that journey, we’ve come to the conclusion that low-cost mutual funds should be the primary investment of choice for most investors.

Control your destiny or somebody else will. —Jack Welch

(Remember, we said earlier that real return is the amount we have left after we subtract inflation from our rate of return.)

You really don’t need to begin saving for retirement before you reach 60. At that point, simply save 250 percent of your income each year and you’ll be able to retire comfortably at 70. —Jonathan Pond

Remember, one of the greatest gifts you can give your children is to be financially independent in your old age, thus ensuring that you won’t become a financial burden to them.

There is a crucially important difference about playing the game of investing compared to virtually any other activity. Most of us have no chance of being as good as the average in any pursuit where others practice and hone skills for many, many hours. But we can be as good as the average investor in the stock market with no practice at all. —Jeremy Siegel, Professor of Finance, Wharton School, University of Pennsylvania, and author of Stocks for the Long Run

That’s the indexer’s edge. More specifically, here are the cost and other advantages of indexing: There are no sales commissions. Operating expenses are low. Many index funds are tax efficient. You don’t have to hire a money manager. Index funds are highly diversified and less risky. It doesn’t much matter who manages the fund. Style drift and tracking errors aren’t a problem. Let’s look at these advantages in more detail.

Only consider investing in no-load funds with annual expense ratios of 0.5 percent or less, the cheaper the better.

The most fundamental decision of investing is the allocation of your assets: How much should you own in stocks? How much should you own in bonds? How much should you own in cash reserve?” —Jack Bogle

Your most important portfolio decision can be summed up in just two words: asset allocation.

It was Sancho Panza, Don Quixote’s sidekick, who observed: “It is the part of a wise man to keep himself today for tomorrow and not to venture all his eggs in one basket.” Asset allocation is the process of dividing our investments among different kinds of asset classes (baskets) to minimize our risk, and also to maximize our return for what the academics call an efficient portfolio.

How do we do this? Well, we begin by asking ourselves two questions: “What investments should we select?” and “What percentage should we allocate to each investment?”

EMT can be described as “an investment theory that states that it is impossible to ‘beat the market’ because existing share prices already incorporate and reflect all relevant information.”

This relationship of risk and return is crucial for us to understand if we are to build efficient portfolios—portfolios that offer the highest return with the least amount of risk.

This is an important lesson for every investor: The greater the risk of loss, the greater the expected return.

Now, let’s start designing our personal asset allocation plan. What are your goals? What is your time frame? What is your risk tolerance? What is your personal financial situation?

The first thing to do when developing an allocation is to come up with a risk profile. —Errold F. Moody

Their experiments prove that most investors are more fearful of a loss than they are happy with a gain.

Don’t fool yourself. There almost certainly is some point during a market decline when you would consider selling.

When setting up an asset allocation plan, investors should ask themselves: “Can I sleep soundly without worrying about my investments with this particular asset allocation?”