The Elements of Investing: Book Summary

This post summarises the key ideas from the book ‘The Elements of Investing By Burton Malkiel and Charles Ellis’.

The key ideas are saving, indexing, diversification, avoiding major blunders, keeping it simple and asset allocation.

SAVING

It doesn’t matter if you make a return of 2 percent, 5 percent, or even 10 percent on your investments if you have nothing to invest.

Saving is very important. If your expenses are less than your income, you have saved something. It is important to do this regularly and from an early age. Then you will not have any regrets when you are older. However you should not deprive yourself because then you will have regrets later that you did not enjoy your life. Spending less and wisely, buying your own home( by taking a mortgage) and using tax-deductible instruments are three important things that you can do to increase your savings.

INDEX

This simple investment strategy-indexing-has outperformed all but a handful of the thousands of equity and bond funds that are sold to the public.

Buy low-cost index funds or ETFs ( depending on what is available and what is cheaper in your personal case) for all or most of your investment portfolio. This is because nobody knows more than the market when you look at long periods of time(>20-30 years). Use indexing for domestic and international stocks and bonds. If you want to invest in individual stocks, invest only a small percentage(not more than 10%) and do not invest your retirement funds in individual stocks.

DIVERSIFY

Protect yourself: Every investor should always diversify

Diversify across asset classes: Stocks, Bonds, Real estate, Real assets(timber and oil), Gold.
Diversify across markets: US, International, Emerging
Diversify over time: Use dollar cost averaging and value averaging
Rebalance: Rebalance your portfolio regularly to keep up allocated proportions of various asset classes. Rebalancing will not always increase returns. But it will always cut the riskiness of your portfolio and it will always make sure that your actual allocation stays consistent with the right allocation for your needs and temperament.

AVOID BLUNDERS

As in so many human endeavours, the secrets to success are patience, persistence and minimizing mistakes.

Do not be overconfident. No one can forecast what is going to happen to the market. Ignore all forecasts of the stock market, interest rates and the economy.
Do not try to time the market. Be aware of Mr. Market. Take advantage of Mr. Market by rebalancing regularly to your asset allocations. Buy at low prices and sell at high prices. You will automatically do this if you rebalance and buy underperforming assets.
Do not believe in seasonal patterns and do not make patterns where none exists.
Minimize investment costs. This will definitely increase investment returns. Do this by buying low-cost index funds.

KEEP IT SIMPLE

Everything should be made as simple as possible-but no simpler.

  • Save early and regularly.
  • Use the help of your employer and the taxman to supercharge your savings.
  • Set aside a cash reserve- at least six months of living expenses.
  • Make sure you are covered by insurance. Buy low-cost term life insurance. Buy disability insurance that covers you against disability that prevents you working for many years.
  • Diversify. It reduces anxiety
  • Avoid all credit card debt-period.
  • Ignore the short-term sound and fury of  Mr. Market.
  • Use low-cost index funds.
  • Focus on major investment categories. Avoid ‘exotics’ like venture capital, private equity and hedge funds. Focus on stocks, bonds and real estate(owning your own home)

ASSET ALLOCATION

Know thyself and match your  investing to who you are and where you are in life. Even an 80-year old might want an asset allocation more suitable for a 30-year old if she plans to leave most of her estate to her children or grandchildren.

Asset allocation depends on a few factors:

  • Your financial situation: assets, income, savings-now and in the future.
  • Your age.
  • Your emotional strengths-particularly at market highs and lows- and your attitude towards market risk.
  • Your knowledge of and interest in investing

Two tables of asset allocation guidelines are shown below. They will make sense for 90% of all investors.



If you have to buy an annuity, buy only a vanilla plain fixed annuity. Invest only 50% of your fixed income investments in an annuity

Specific index funds that are recommended are:

Stock component:

  • 100% total world-wide stock market index fund( VT or ACWI)
  • 50% US total market, 50% total international stock market index fund(VTI+VEU or IWV+CWI)

Bond component:

  • 100% total bond market(BND or AGG)

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