In this chap the author tells about the Index Funds by portraying a story of Gotrocks Family.
Once upon a time there was a wealthy family including thousands of relatives who had owned 100% of every stock in the United States and had grown each year for many years. But for a while a few fast talking helpers arrived and were successful in convincing some Gotrocks cousins that they can increase their share more than other family members but for that they needed to sell some of their shares in the companies to other family members and to buy some shares of others from them in return. For all these transactions the helpers were paid some commissions for their services. After this the growth of the family stock started to decrease because some of the return is now consumed by the Helpers, and the family’s share of the generous pie that U.S. industry baked each year—all those dividends paid, all those earnings reinvested in the business—100 percent at the outset, started to decline, simply because some of the return was now consumed by the Helpers. So, some smart cousins realised the plan and to save decreasing growth rate of the family they hired more helpers who also charged fee for their services and helped them to buy some good stock. To make matters still worse, the new managers feel compelled to earn their keep by trading the family’s stocks at feverish levels of activity, not only increasing the brokerage commissions paid to the first set of Helpers, but running up the tax bill as well.
After losing both the games Gotrocks played they hired more managers to advice them how they could get all that right which had gone wrong and effected their wealth. But ofcourse for that those managers also charged fees. Alas, the family’s share decreased again. Alarmed at last, the family sat down together and took stock of the events that had transpired since some of them began to try to outsmart the others. “How is it,” they ask, “that our original 100 percent share of the pie made up each year of all those dividends and earnings has dwindled to just 60 percent?” Their wisest member, an old uncle replied: “All that money you’ve paid to those Helpers and all those unnecessary extra taxes you’re paying come directly out of our family’s total earnings and dividends. Go back to square one, and do so immediately. Get rid of all your brokers. Get rid of all your money managers. Get rid of all your consultants. Then our family will again reap 100 percent of however large a pie that corporate America bakes for us, year after year.” They followed the old uncle’s wise advice, returning to their original passive but productive strategy, holding all the stocks of corporate America, and standing pat. That is exactly what an index fund does.
Taking lesson from the Gotrocks story the author decided to apply the lesson on the stock. While applying this he found a very close relationship between long term return on investment in businesses and the investment in stocks. This close relationship was because when investing in stocks for a long time period the investor may think twice before investing because the stock of the business will match the success of the business and the investor is not sure about the potential of the business. However, short term investment is totally a different thing and the bogle was not clear about the intention and emotions of the investor towards them.
Cast Your Lot With Business
William of Occam stated that: When there are multiple solutions to a problem, choose the simplest one. The author tells us about the general investing technique/strategy when investing in a wide range of stocks by using the example of Standard and Poor 500 named after 500 US corporations which composed it in 1926. The author explains by matching the success of the overall stock market over a longterm. Then he compared S&P 500 with those of the large cap funds (funds which invest a larger proportion of their corpus in companies with large market capitalisation) from other companies and came to know that since 26 years out of 35 the S&P 500 raises large cap funds than other companies averages.
How Most Investors Turn a Winner’s Game
into a Loser’s Game
There are 2 certainties:
Beating the market before cost is a zero sum game.
Beating the market after cost is a losers game.
The author is trying to tell us that these 2 stocks will match the market if we add them up. For Instance: an investor buys the stock that would beat the market and another buys that would not beat the market adding them together will match the market. However including all those expenses; brokerage commissions, operating fee, marketing fee, management fee an average investor’s return would be lesser than the market. So, this average investor should decrease his or her fees/expenses before anything else.
The Grand Illusion
This chapter tells how the investors emotions effects the return on investments. An investor always want to buy stocks as it’s value has chances to go up but by doing that they go without a large portion of gains. For Example: at the start of 2005 the stock market was at 10,000 , at the start of 2006 stock market was upto 11,000 , which means a 10% of gain. Seeing the increase in the stock market price people start to buy the stock hence the demand increases so does the price, attracting the new investors. Viceversa, in 2007 the matket goes at it’s peak upto 13,000 and then starts to fall and till the start of 2008 it was 11,500. The people at the beginning, earned an annual average of about 4%, while the people who bought only when it was increasing a year later only earned 2% annually.
Taxes Are Costs, Too
This chapter tells about another challenge for the shareholders which was taxes. In this chapter the author compares actively managed mutual funds with index funds in terms of tax payments and reached to the conclusion that index funds are better because the law states that actively managed funds should pay distributions on regular basis of it’s realises capital gains and dividend income each of atleast 90%. However, an index fund is managed just to match the index which requires a tiny amount of active management, so they rarely pay out a distribution and thus rarely incur taxes.
When The Good Times No Longer Roll
This chapter takes into account the periods of lower returns because we are heading towards such an era and it could also be seen that the returns on mutual fund will reach to 0% more quicker that index fund. Which means there is a period to come in which an investor has more chances to lose money in a mutual managed fund than in an index fund.
Selecting Long Term Winners
In this chapter the author explains the last 35 years of performance of index funds. Index funds which are managed for longer period of time are mostly beaten by the overall stock market. In 35 years of time period, just two percent of market funds are beaten by the less than 1% of the funds per year. Thus, surviving investors growth but none of them are able to defeat them next time.
Yesterday’s Winners, Tomorrow’s Losers
In last few chapters the author has been talking about longterm investments in this chapter he talks about the short term. Short term investments are done to take advantage of certain time of boom in some areas. What about the short term? Obviously, some funds are better poised to take advantage of boom times in certain areas than others. For example, in late 1990s some funds did a great job of increase it’s market value, dominating the market. But then later they collapsed so bad in 2000 to 2002 that there return was not even close to average returns of the market. Investing in a specific area when investing in a short term fund is not a good idea for an investor.
Seeking Advice To Select Funds?
In this chapter the author answers the question that, Do we need to spend money on investment advisor? And the answer is a big “NO.” In fact, mostly the advisors are not that experienced they just advise the investor to collect their ransom when the investor is trapped in their web as explained through a tale in chapter 1. The investor should directly invest their cash themselves into index funds. Because that is more safe.