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Book Review: The Little Book of Common Sense Investing

by Ram Balakrishnan
April 3, 2007
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[Front Cover of The Little Book of Common Sense Investing]

You are probably not surprised to hear that I liked John Bogle’s message in the latest in The Little Book series (aff link). Mr. Bogle has been preaching the virtues of indexing for more than three decades and founded Vanguard to enable investors to put his message into practise. Many of the arguments that Mr. Bogle makes in the book would be familiar to readers: the drawbacks of investing in mutual funds, the importance of keeping down frictional costs such as fees, commissions, sales charges and taxes, the virtues of index funds etc. In my opinion, the interesting bits in the book are Mr. Bogle’s estimate of future returns and his negative opinion on fundamental indexing and ETFs.

Mr. Bogle warns his readers that future returns from equities are likely to be modest. He points out that stock market returns are driven by investment returns (initial dividend yield plus earnings growth rate) and speculative returns (changes in the market p/e ratio). Today, the US market has a dividend yield of slightly less than 2% and earnings can be expected to grow at the historical rate of 6%. So, investment returns should be in the neighbourhood of 8%. Mr. Bogle guesses that speculative return could be -1% over the next ten years and stocks should return a very modest 7% (even less if you think market p/e is going to fall even further).

Fundamental Indexing is getting a lot of press these days because of its supposed superiority over capitalization-weighted indices. However, Mr. Bogle is sceptical that such claims will hold true in the future because it is not clear why the markets under priced some fundamental factors in the past. More to the point, fundamental indices could revert to mean and under perform in the future.

While Mr. Bogle rightly criticizes ETFs because they encourage excessive trading, I am still a fan of ETFs because Canadian investors do not have the opportunity to invest in Vanguard index mutual funds but can easily buy their ETF equivalents.

I think this book is certainly worth reading and would also make a nice addition to your bookshelf (I am adding it to my list of recommended books). Mutual fund investors should pay special attention to the chapters on the hidden costs of investing in funds. Index investors will feel encouraged to stay the course. A sample chapter is available here.

Related: John Bogle’s blog

Related posts:

  1. Finding a Financial Advisor, Part 1
  2. Carnival of Debt Reduction # 19
  3. The Income Tax Cut is Better
  4. This and That
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