The Little Book on Common Sense Investing

The Only Way to Guarantee Your Fair Share of Stock Market
Returns (Little Books. Big Profits)

• The traditional index fund (TIF), by definition, basically represents the entire stock market basket, not just a few scattered eggs. It eliminates the risk of picking individual stocks, the risk of emphasizing certain market sectors,and the risk of manager selection. Only stock market risk remains. (That risk is quite large enough, thank you!). Index funds make up for their lack of short-term excitement by their truly exciting long-term productivity. The TIF is designed to be held for a lifetime.

Simply buy a Standard & Poor’s 500 Index fund or a total stock market index fund. Then, once you have bought your stocks, get out of the casino — and stay out. Just hold the market portfolio forever. And that’s what the
traditional index fund does.

Keep in mind that an index may also be constructed around the bond market, or even “road less traveled” asset classes such as commodities or real estate.

• Warren Buffett puts the moral of his story this way: For investors as a whole, returns decrease as motion increases.
• Successful investing is about owning businesses and reaping the huge rewards provided by the dividends and earnings growth of our nation’s — and, for that matter, the world’s — corporations. The higher the level of their investment activity, the greater the cost of financial intermediation and taxes, the less the net return that shareholders — as a group, the owners of our businesses — receive. The lower the costs that investors as a group incur, the higher the rewards that they reap. So to enjoy the winning returns generated by businesses over the long term, the intelligent investor will reduce to the bare-bones minimum the costs of financial intermediation.
  That’s what common sense tells us. That’s what indexing is all about. And that’s the central message of this book.
• Successful investing is about owning businesses and reaping the huge rewards provided by the dividends and earnings growth of our nation’s — and, for that matter, the world’s — corporations. The higher the level of their investment activity, the greater the cost of financial intermediation and taxes, the less the net return that shareholders — as a group, the owners of our businesses — receive. The lower the costs that investors as a group incur, the higher the rewards that they reap. So to enjoy the winning returns generated by businesses over the long term, the intelligent investor will reduce to the bare-bones minimum the costs of financial intermediation.
  That’s what common sense tells us. That’s what indexing is all about. And that’s the central message of this book.
  book.
• if essential, linkage between the cumulative long-term returns earned by U.S. business — the annual dividend yield plus the annual rate of earnings growth.
• Just look at the record since the beginning of the 20th century. The average annual total return on stocks was 9.5 percent. The investment return alone was 9.0 percent — 4.4 percent from dividend yield and 4.6 percent from earnings growth.
• Periods of subpar performance tend to be followed by periods of recovery, and vice versa. Then, amazingly, during the 1990s, there was an unprecedented second consecutive exuberant increase, a pattern never before inevidence. A return to sanity.
• In April 1999, the P/E ratio had risen to an unprecedented level of 34 times, setting the stage for the return to sanity in valuations that soon followed. The tumble in stock market prices gave us our comeuppance. Withearnings.
• the market causes investors to focus on transitory and volatile short-term expectations, rather than on what is really important — the gradual accumulation of the returns earned by corporate businesses.
• Our measure of the P/E ratio at the close of 2016 is based on the year-end price of 2247 for the S&P 500 relative to reported earnings for 2016 of $95 per share — a P/E of 23.7. Wall Street analysts tend to rely on operating earnings (before write-offs and other negatives) that are forecast for the coming year ($118 per share). Resulting P/E: 17.4x.
• the Standard & Poor’s 500 Index (the S&P 500). It was created in 1926 as the Composite Index, and now lists 500 stocks.2 It is essentially composed of the 500 largest U.S. corporations, weighted
• Dow Jones Wilshire Total Stock Market Index.3 It now includes some 3,599 stocks, including the 500 stocks in the S&P 500. Because its component stocks also are weighted by their market capitalization, those remaining 3,099 stocks with smaller capitalizations account for only about 15 percent of its value.
• Vanguard 500 Index Fund. It began operations back on August 31, 1976.
• You should know that, in establishing a trust for his wife’s estate, Warren Buffett directed that 90 percent of its assets be invested in a low-cost S&P 500 Index fund.
• The TSP also offers Roth contributions, which are treated similarly to Roth IRAs for tax purposes. Roth contributions are made with after-tax income, but all subsequent growth
• dividends have contributed an average annual return of 4.2 percent, accounting for fully 42 percent of the stock market’s annual return of 10.0 percent for the period.
  Almost majority of index returns from dividends assuming dividends are reinvested!
• The wise Warren Buffett shares my view. Consider what I call his four E’s. “The greatest Enemies of the Equity
  investor are Expenses and Emotions.”Emotions and Expenses
• Fund returns are devastated by costs, adverse fund selections, bad timing, taxes, and inflation, and taxes.
• one-half of all equity mutual fund shares are held by individual investors in fully taxable investment accounts.
  The other half are held in tax-deferred accounts such as individual retirement accounts (IRAs)
  One half in IRAs!
• The index fund investor would be subject to taxes on any gains realized when liquidating shares. But for an investor who bequeaths shares to heirs, the cost would be “stepped up” to their market value on date of death, and no capital gain would be recognized or taxed.
• Wall Street strategists generally prefer to calculate the P/E using projected operating earnings for the coming year, rather than past reported earnings. Such operating earnings exclude write-offs for discontinued business
  activities and other bad stuff, and projections of future earnings that may or may not be realized. Using projected operating earnings, Wall Street’s P/E ratio is only 17 times. I would disregard that projection. My guess — an informed guess, but still a guess — is that, by decade’s end, the P/E ratio might ease down to, say, 20 times or even less. Such a revaluation would reduce the market’s return by about 2 percentage points per year, resulting in an annual rate of return of 4 percent for the U.S. stock market. If you don’t agree with my 4 percent
  Currently may be adjusted for post COVID normalization
• Historically, the initial yield has proved to be a reliable indicator of future returns. In fact, fully 95 percent of the decade-long returns on bonds since 1900 have been explained by the initial yield. Of course!
  EXHIBIT 9.3 Initial Bond Yields and Subsequent Returns Why is this so? Because the issuer of a 10-year bond is pledged to repay its initial principal at 100 cents on the dollar at the end of a decade, and for investment-grade
  bonds, that promise has usually been fulfilled. So virtually all of its return is derived from interest payments.
  Yes, in the interim the market value of the bond will vary with changing levels of interest rates. But when the bond is held to maturity, those the 117 years since 1900, bonds have outpaced stocks in 42 years; in the 112 five-year periods, bonds have outpaced stocks 29 times; and even in the 103 fifteen-year periods, bonds have outpaced stocks 13 times.
• Few times bonds have outpaced stocks
• while bond yields are near their lowest levels since the early 1960s, the current yield on bonds (3.1 percent) still exceeds the dividend yield on stocks (2 percent).
  Are bond yields better than dividend yields?
• Short-term portfolios are designed for investors who are willing to sacrifice yield to reduce volatility risk.
• The Spider 500 remains the largest ETF, with assets of more than $240 billion in early 2017. During 2016, some 26 billion shares of the Spider S&P 500 were traded, a total dollar volume of an amazing $5.5 trillion, and an
  annual turnover rate of 2,900 percent. In terms of dollar volume, every day the Spider was the most widely traded stock in the world. Spiders and other similar ETFs are primarily used by short-term investors. The largest users, holding about one-half of all ETF assets, are banks, active money managers, hedgers, and professional traders, who trade their ETF shares with a frenzy. These large traders turned over their holdings at an average
  rate of nearly 1,000 percent(!) in 2016. ETF
• Pioneered an entire new category to rival the TIF
• Among the 20 best-performing ETFs, for 19 funds, investor returns fell short of ETF returns.
• consider the records of the 20 best-performing ETFs during 2003–2006. Only one ETF earned a better return for its shareholders than the return reported by the ETF itself.
• the Vanguard 500 ETF or the Spider 500 ETF —
• the original S&P 500 Index model have stood the test of time. Today, the lion’s share of the assets of TIFs are those that track the broad U.S. stock market (the S&P 500 or the total stock market index), the broad
  international stock market, and the broad U.S. bond market.
• Broad-market ETFs constitute the only instance in which an ETF can replicate, and possibly even improve on,
  the five paradigms listed earlier for the original index fund — but only when they are bought and held for the long term. Their annual expense ratios tend to be comparable to their TIF counterparts, although their transaction commissions erode the returns that investors earn. The early advertisements for the Spider claimed, “Now you can trade the S&P 500 all day long, in real time.” And so you can. But to what avail? I can’t help likening the ETF — a cleverly designed financial instrument — to the renowned Purdey shotgun, supposedly the world’s best.
• the original S&P 500 Index model have stood the test of time. Today, the lion’s share of the assets of TIFs are those that track the broad U.S. stock market (the S&P 500 or the total stock market index), the broad
  international stock market, and the broad U.S. bond market.
• Check out Vanguard TIFs Traditional stock index funds, broader US stocks, bonds, international,
• the investor should never have less than 25 percent or more than 75 percent of his funds in common stocks, with a consequent inverse range of between 75 percent and 25 percent in bonds. There is an implication here that the standard division should be an equal one, or 50–50, between the two major investment mediums.
• My recommendations for investors in the accumulation phase of their lives, working to build their wealth, focused on a stock/bond mix of 80/20 for younger investors and 70/30 for older investors. For investors starting the post-retirement distribution phase, 60/40 for younger investors, 50/50 for older investors.
• My own total portfolio holds about 50/50 indexed stocks and bonds, largely indexed short- and intermediate-termAt my age of 88, I’m comfortable with that allocation. But I confess that half of the time I worry that I have too much in equities, and the other half of the time that I don’t have enough in equities. Finally, we’re all just human beings, operating in a fog of ignorance and relying on our circumstances and our common sense to establish an appropriate asset allocation.
• The Evaluate costs and expense ratios whatever returns each sector ETF may earn, the investors in those narrow ETFs will likely, if not certainly, earn returns that fall well behind them. There is abundant evidence that the most popular sector funds of the day are those that have recently enjoyed the most spectacular recent performance but such success does not endure.
  (Again, remember reversion to the mean [RTM].) In Mean reversion on returns for popular ETFs
• Among the 20 best-performing ETFs, for 19 funds, investor returns fell short of ETF returns.
• Among the 20 best-performing ETFs, for 19 funds, investor returns fell short of ETF returns.
• Deferring Social Security payments substantially enhances the monthly payments you later receive, but at the expense of not receiving any Social Security payments at all during the interim years. Investors must balance the opportunity to increase their eventual monthly payments against the absence of those monthly payments over a full decade.
• The most common DC plan is the 401(k), which allows you to save money for retirement on a pretax basis, and your contributions are often matched by your employer according to a predetermined formula. Investment returns on your assets grow on a tax-deferred basis until you withdraw them in retirement.
• NACUBO-Commonfund Study of Endowments” reports the investment returns achieved by “more than 800 college endowments, representing $515 billion in assets.” Check out the annual report!