John C. Bogle's The Little Book of Index Investing is a power-packed explanation of why outperforming the market is an investor illusion. Instead, the founder of The Vanguard Group—the man who's been called "the conscience of the investment industry"*—recommends a simple, time-tested investment strategy that can deliver the greatest return to the greatest number of investors: indexing. Why? Investing is a zero-sum game where transaction costs, taxes, poor investment diversification, and poor market-timing (an affliction for most investors) hurts your portfolio more than it helps. Indexing eliminates that hurt. Bottom-line, if you can't be an index, why not invest in one? And you'll be all the happier and richer for it.
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Mr. Bogle brought the first commercially-available index fund to investors around 1975 with the creation of the Vanguard 500 index fund. Its success over the last 30+ years is a testament to the index fund's simple, yet effective investment strategy. In this book, Mr. Bogle lays out his rational for why indexing works and how the average investor can benefit from it. In fact, he even explains why indexing MUST work in the long run.
Several important points are brought to the listener's attention. Firstly, he points to the fact that all investors (as a group) will earn the stock and bond market's average gross return, but that all investors (as a group) will fall short of this average return because of the costs of financial intermediation (and taxes). Remember, it's the net return that counts. Secondly, he show through extensive long-term studies that various strategies to outperform this average return have led most investors to fall short even further with their own returns. Counter-productive market timing strategies caused investors to be "out" of the market at the wrong times, missing key opportunities to invest in stocks at a discount. Mutual fund managers have not been able to produce portfolios of stocks to beat their respective market benchmarks, especially after subtracting high managerial expenses (the fund's expense ratio) and transaction costs from high portfolio turnover. Neither investors nor their fund managers excessive buying and selling has lead to improved returns. It has actually caused the opposite. Likewise, Mr. Bogle shows that investment advisers have not been able to direct investors into market-beating strategies and have themselves lead to a further shortfall in investment returns because the advisers also charge fees. Various other seemingly-intuitive strategies, like picking funds based on Morningstar ratings or picking investments based on past performance, have not proved profitable either.
The listener is encouraged to do away with these counter-productive strategies and return to the basics of investing. Focus on picking an asset allocation appropriate for your risk level and time horizon, and then invest in this strategy using low-cost index mutual funds, rebalancing periodically. Using a few broad-based index funds, you can hold the world's investible assets in an easy, low cost format. Simplicity trumps complexity since your plan is easier to stick to when the markets are volatile.