Book Review: ETF Strategies and Tactics by Laurence Rosenberg, Neal Weintraub and Andrew Hyman

This book is betwixt and between audiences. It presents complicated trading strategies at such a simple level, that it is hard to imagine how it could be useful to either neophyte or expert. The neophyte may get a general understanding of what is possible but will not learn enough detail of how to apply the suggested methods to have any hope of doing it successfully. The expert will already know this stuff from applying the methods to regular stocks and futures trading to need any guidance provided by this book.

The first half of the book defines and describes ETFs - how they differ from mutual funds, their structure and regulatory framework, their indices, their categories. The second part of the book, to which the "Strategies and Tactics" part of the title applies, deals with short-selling, options trading, market timing, technical analysis, financial ratio analysis. All of it has to with speculative trading and none to do with portfolio construction, asset allocation, rebalancing, correlation and diversification for long term investors that I would have expected to see occupy a major part of the content.

The book inevitably suffers from the reality that it was written in 2007 and has been rendered fairly significantly out of date by the explosion of ETFs when it lists the range and breadth of ETFs currently available. Strangely, given its speculative trading focus, there is almost no mention of leveraged and inverse ETFs, which had already appeared on the scene at that time (all I found was one paragraph on page 155). There isn't even an entry in the book's index for leverage or inverse ETFs. The authors would have been better off giving links to websites where one can obtain current lists of ETFs (one of my favorites for a fairly complete and quick way to find what is available with links to the actual provider websites for details is Stock Encyclopedia).

A final complaint about an inaccuracy that I have seen repeated elsewhere .... on page 242 the book says the first ETF launched (in 1993) was the SPDR ( they mean the famous Spider, symbol SPY). Well, I hate to break it to them but it was not the first, or even the first successful ETF (though it is the biggest by far). The Canadian TIPS 35 (speaking of which, I wish they would bring that one back with its MER of only 0.04%) preceded SPY by several years (see The Development and Evolution of ETFs). TIPS 35, launched in March 1990, was the first successful ETF, till it got merged into what is now the TSX60 ETF (XIU) in March 2000 in a deal with Barclays, but even it wasn't the first. According to the excellent Atkinson book The New Investment Frontier III (see my review) the honour goes to an unsuccessful extinct animal called SuperUnits and SuperShares.

An ironic quote from the book: "Good luck in your ETF trading." Indeed, if speculative trading with ETFs is what you decide to do, I wish you luck too.

My rating: 1 out of 5 stars.

Thank you to McGraw Hill for providing a review copy.

Time to Put Some RSP in the RRSP?

Once you deposit cash into the RRSP the question then becomes what to invest the money in. One of the key pieces of most diversified portfolios is US equities and a popular choice is an index fund based on the S&P 500, perhaps the SPDR S&P 500 (symbol SPY).

Here's an intriguing complement or perhaps alternative - the Ryder S&P Equal Weight Fund which has the memorable ticker symbol of RSP (the connection to Canada's RRSP cannot be a coincidence, surely this is a prophetic sign ;-). For those more pragmatic and try-to-be-rational people, like me, a closer look at RSP reveals some tantalizing data.

The RSP is a passive index fund that differs from the traditional cap-weighted SPY by weighting the portion of each stock holding equally - i.e. each of the same 500 stocks in the S&P 500 comprises 0.2% (100% divided by 500) of the total. Keith Hawkins' excellent Investopedia article S&P 500 ETFs: Market Weight vs Equal Weight explains the similarities and the differences between the two approaches. The article compares results based on the underlying indices but what about the actual ETFs?

The simple Google Finance chart below of SPY vs RSP since the 2003 launch of RSP looks mighty good as RSP is up 42% compared to SPY's 12.6%.

But that's not the whole story. First, there is the question of total returns, which takes account of differences in taxes/ turnover/ capital gains, MER, bid-ask spreads, dividends etc. Turning to Morningstar, the Performance tab of the data on RSP and SPY shows us that RSP looks just as good if not better on a Total Return basis - despite an MER of 0.40% vs only 0.09% for SPY and turnover of 22% vs only 7%, RSP outperformed SPY by a massive 2.21% per year (2.08% 5-yr annualized trailing total return for RSP vs -0.13%) from 2003 to date. What is more, RSP's tax efficiency (see Tax tab) as expressed in the lower tax ratio of 0.48 vs 0.57 is better and RSP has capital losses stored up (against which future capital gains will be offset so that no capital gains will be distributed to fundholders causing tax liability) of minus 23% vs a gain of 3% on the books of SPY. Given the much higher turnover of RSP, I'd guess what is going on is that RSP is accumulating capital losses by having to sell losers leaving the S&P500 at the bottom (they sure cannot be obliged to sell by some company moving up, the S&P 500 is the top category!).

That's pretty good, but the second question is critical. Is this outperformance is only a manifestation of the value and smaller-cap tilt inherent in RSP's indexing method or of a fundamentally better method of tracking the market and thus sustainable in the long term through different market cycles and conditions? That the latter might be the case finds support from studies done by the EDHEC who found that cap-weighted indices in the USA, Europe and Japan were inefficient compared to equal-weighted indices they built, which were similar though not identical to RSP - e.g. Assessing the Quality of Stock Market Indices: Requirements for Asset Allocation and Performance Measurement by Noël Amenc, Felix Goltz and Véronique Le Sour. Standard and Poors' Equal Weighted Indexing Five Years Later on SSRN by Srikant Dash and Keith Loggie also reach the conclusion that equal weight indexing really works both for US stocks and internationally.

If the net effect of equal weight indexed funds is only to under-perform during strong bull markets (and bubbles) and outperform during bear markets, as the commentary by the Rydex's Carl Resnick says in this interview, then that is a very valuable quality, especially for the portfolios of people in retirement, when downside risk is a prime concern.

The big question I have not seen addressed directly, though the Dash-Loggie paper does show the recent varying correlation between the S&P 500 Equal vs Cap-Weight Indices, (it lessened considerably during the tech bubble which is a very good thing), is the correlation of equal-weighted indices with other asset classes. It is the combined effect in the overall portfolio that counts above all. If equal weight is significantly un-correlated with them, the added volatility of RSP on its own is not a concern since the overall portfolio volatility will decline. That characteristic is the reason I think having commodities in my portfolio, among other holdings, is worthwhile.

The idea of putting some RSP into an RRSP merits serious consideration.

Three ETFs that have No Securities Lending Issues

On and off people like Larry MacDonald in Investors: Wake Up to Securities Lending have noted abuses and dangers of the common practise amongst ETF managers to lend out the securities in the portfolio to short-sellers and thereby gain fees, either for the benefit of the ETF holders or of the managers.

Three prominent US ETFs do no securities lending at all by virtue of being set up as Unit Investment Trusts, as opposed to the prevalent Open-End fund structure of most ETFs. UITs are much more restricted by regulation as the Nasdaq website notes in ETF Product Structures. The three ETFS?

• SPDR S&P 500 (Symbol: SPY) - the oldest US ETF (est. 1993) and the biggest by assets of all by far with a puny MER of 0.09%
• Dow Diamonds (DIA) - tracker of the famous Dow Jones Industrial Average, est. 1998 MER 0.167%
• Invesco Powershares QQQ (QQQQ) - holds 100 of the most prominent Nasdaq worthies, est 1999, MER 0.20%

With such rock-bottom MERs, investors have little need for securities lending to lower their costs. The prohibition against lending in the very structure adds the comfort of knowing that the fund managers won't be tempted to scoop lending fees using the investors' assets at the investors' risk. The fact that these ETFs are the oldest too brings to mind the hoary but true saying, "if it ain't broke, don't fix it".

Tax Breakdown of 2009 Distributions for iShares ETFs Now Available

It's nearing the time to prepare the 2009 tax return and iShares Canada has released the breakdown for tax purposes of the 2009 distributions of all its funds. Knowing the actual cash distribution received during the course of the year is not enough to do taxes since distributions are not the same as dividends. Some of the distributions are dividends (which themselves can be eligible or ineligible and taxed at different rates) but others are interest, capital gains or foreign income and there is also possibly credit for foreign taxes paid and deductions of Return of Capital to be made against the Adjusted Cost Base of holdings in taxable accounts.

The data is available for each ETF in the Distribution History link in the left hand margin of the individual ETF webpage (e.g. the TSX Composite ETF XIC) as well as a convenient pdf table of all the funds here.

The Myth that ETFs are Always and Necessarily Better than Mutual Funds

It's all about costs and investment strategy. Whether a fund is an ETF or a mutual fund doesn't matter all that much. If the costs to buy into, to manage and to run the fund are low and it passively invests in a broad market index, the results for the retail individual investor will be good. The fact that mutual fund fees in Canada have been high and net investor returns have been low as a consequence does not mean it has to be so. In fact, ETFs are catching up to mutual funds in both good and bad ways. The recent proliferation of new ETFs with active trading strategies, narrow asset groupings and leveraging, foretell that investor returns will be poor.

That it is possible for mutual funds to equal the original virtues of ETFs is evident at the US fund company Vanguard, which offers both ETFs and mutual funds.

Here is a sample of funds with identical holdings and thus returns, apart from fees. In fact, the ETFs of Vanguard are merely a share class of the same asset base.

• US Total Stock Market ETF (symbol: VTI) - MER 0.09%
• US Total Stock Market Index Fund (VTSMX) - MER 0.18% no purchase or redemption fee

• US total Bond Market ETF (BND) - MER 0.14%
• US Total Bond Market Index Fund (VBMFX) - MER 0.22% no purchase or redemption fee

• Emerging Markets ETF (VWO) - MER 0.27%
• Emerging Markets Fund (VEIEX) - MER 0.39% plus purchase fee 0.50% and redemption fee 0.25%

The mutual fund on-going MER fees are a bit higher but for someone trying to make regular small purchases through an automatic savings and investment plan, avoiding the payment of trading commissions on ETFs, even when they are $1o per trade from a discount broker (a $10 cost on a $1000 purchase is a 1% "fee") makes the two alternatives very similar. Add in the convenience of automatic dividend reinvesting (DRIP) and tax record keeping that mutual funds offer, and ETFs lose their advantage. Vanguard even has a handy ETF vs mutual fund calculator to compare which version you would be better off to buy, considering fees, holding period, frequency and amount of purchases and commission costs.

The big problem for Canadians, of course, is that Canadians are not allowed to buy US mutual funds.

To its credit, one Canadian ETF provider - Claymore Canada - has adopted useful mutual fund features by offering pre-authorized chequing contributions (PACC) for buying its ETFs, along with a DRIP and a systematic withdrawal plan (SWP), all at no transaction cost. And all of BMO'sETF family new offer DRIP as an option, though not the PACC and SWP (yet?).

If only some mutual fund visionary in Canada would catch up to good aspects of ETFs ....

Plans for Working in Retirement and Insurance Needs

RBC just released a new poll today that shows a lot of people expect to be working later in life, in their what-used-to-be-called retirement years. For many that will be a requirement, as working bridges the retirement savings gap we hear so much about these days. I've been investigating possible needs for insurance during retirement and have discovered that the traditional way to cover the risk of a health problem like a heart attack or a bout of cancer interrupting work and cash inflow - dis-ability insurance - typically stops at 65 age. The risk of health incidents rises with age, especially after 65, and is much higher than the chances of actually dying in any given year till quite an advanced age. As the press release says, if you are alive at 65, a man can expect to live to 83 and a woman to 86. Yet, about one in two people aged 65 can apparently expect to have and survive a serious or critical illness by age 75.

There's another type of insurance, not so well known, called critical illness insurance, which covers all the most frequent health problems (cancer, heart, stroke, dementia, MS, Parkinson's etc) but it's hard to initiate after 65 and premiums are said to rise steeply. In addition, blogger Peter Benedek at Retirement Action took a detailed look at Critical Illness insurance and wasn't impressed with what he found in terms of it being a fair deal for the consumer.

The poll shows people don't think of retirement as a set point at age 65 anymore. Maybe the insurance industry needs to consider how it can adapt its products to longer life expectancy and new types of later life circumstances just like the average person must.

Global Investment Returns Yearbook - More Great Stuff in 2010 Edition

The 2010 edition of the justly renowned Credit Suisse Global Investment Returns Yearbook compiled by Elroy Dimson, Paul Marsh, Mike Staunton and Jonathan Wilmot is now available here (pick UK as your download country of origin as it blocks downloads to Canada for 'legal reasons'). As in past editions, it provides the individual investor with insight into global equity markets from a long term perspective. This year it takes a special look at:

• emerging markets,
  
• economic growth and stock market returns
  
• US equity returns
  

Along the way it provides excellent primers on each subject and is definitely recommended reading.

Some highlights:

Emerging Markets

• countries that are emerging tend to stay merging and don't move up into developed very often (only 6 in 110 years), and can just as easily slip back down into "frontier" territory. why not? - dictatorship, corruption, civil strife, wars, communism, disastrous economic policies and hyperinflation - "emerging markets have been accident prone in the past"
  
• "more emerging markets have been downgraded to frontier than have been upgraded to developed. S&P’s downgrades include Argentina, Colombia, Jordan, Nigeria, Pakistan, Sri Lanka, Venezuela and Zimbabwe."
• "... China expected to displace the USA as the world’s largest economy by around 2020, and with India overtaking the USA by 2050."
• "In the late 1970s, emerging markets gave similar returns to those of developed markets, but they underperformed in the 1980s and 1990s. In the 2000s, however, they beat developed markets by 10% per year."
• "... the emerging markets index has been consistently more volatile than the MSCI World"
• higher risk of emerging markets should be worth up to 1.5% per annum extra return compared to developed markets
• correlation of returns between emerging and developed markets has been rising steadily for 30 years but are still low enough to provide significant diversification benefits to the global investor
• there was a big jump up in correlations from about 80% to 90% as a result of the 2008 crash so future correlations should be lower than 90% unless another similar crash comes along
• surprise! the country with the highest return of any during the decade 2000-2009 was .... drum roll please - COLUMBIA!! at over 30% or so annualized return
• from the March 2009 bottom to Dec.31st, a whole raft of emerging countries had phenomenal gains of 100% or more
  
• it is impossible for individuals to invest in emerging markets according to the actual market cap due to restrictions placed on foreign investors or shares being in private or government hands, a prime example being China; moral of the story - market cap weighting is a theoretical ideal that is difficult to even approach
  

Economic Growth and Stock Returns

• "... the link between GDP growth and stock returns is empirically far weaker than many suppose."
• "Looking at 83 countries over 110 years, we find no evidence that investing in growth economies produced superior returns."; the reason is simple, investors predicted and expected higher growth so bid up prices too high to provide good future returns - stock returns are a good predictor of economic growth rather than the other way round.
• however, if you could perfectly predict future economic growth and not base investment on recent past economic growth, then you would make a high return; stock markets seem to extrapolate growth, price it in too high to be able to gain better future returns
• they explicitly liken this to value vs growth investing - fast growing countries are the growth countries while the slow growers are the value countries "In recent decades, investors have historically earned the highest returns - though with greater risk - by adopting a policy of investing in countries that have shown recent economic weakness, rather than investing in those countries that have grown most rapidly."
  
• their conclusion: "Investors should ensure that their global portfolio is diversified across slow and fast-growing economies."

Prospects for US Stock Returns

• "looking forward, it is more likely that real dividends and earnings will grow in line" (with each other)
  
• "... if you believe that America will likely renew itself yet again and deliver trend productivity growth of 2% p.a. in the future then US equities are arguably closer to “fair value” than normal, and nowhere near bubble territory"
• "... given the size of the American market, its importance to emerging country exports and the risk of protectionism in a bad scenario, investing in emerging equities would likely provide no hedge against a steep drop in US consumption, GDP and equity returns."
• "... nearly a quarter of total US profits and about 30% of S&P 500 sales are generated abroad"
  
• "When people assert that the market is overvalued, they are really expressing their skepticism about the future of US productivity growth and/or the future of globalization. Logically enough, the reverse is also true: if you believe in the potential benefits of accelerating technological change and the dramatic rise of the emerging world, then the next decade for US equities is likely to be a bright one."
• the message seem to be, don't count out the USA - as the French saying goes, "plus ça change, plus c'est la même chose"
  

There is also an individual country snapshot for 22 developed countries.

Canada

• real return on equities 5.8% per year since 1900 compared to 2.0% o bonds but ...
• in the last ten years bonds have outdone equities by 2.0%

Australia

• about the only developed country to have a positive real return to equities over bonds (along with Norway) in the "lost decade" from 2000 to 2009 - all of 1.0%
• equities have returned 7.5% annualized since 2009, the highest anywhere

Japan

• the worst performing stock market during 1990 to 2009, losing two thirds of its value in real terms. ouch!

South Africa

• equity returns of 7.2% since 1900, the second best country; both before and after apartheid, the line looks the same, trending steadily ever upwards

Spain

• very volatile up and down historically; they are hurting now, if you have a decade or two to wait, maybe this is a "value play" country?

Sweden

• only country to have returns to its equities, bonds and T-bills all in the top three of the 22 countries

UK

• equity real returns of 5.3% since 1900

World Other Than the USA

• "from the perspective of a US-based international investor, the real return on the world ex-US equity index was 5.0% per year, which is 1.2% per year below that for the USA."

13 European Countries Together

• they under-performed with only 4.8% real equity returns since 1900 vs the 5.4% world average
• possible reasons for the lagging performance that the authors suggest without analysis - wars, resource rich and more vibrant New World economies

Blogging and Money - Flattr a Potential Step Forward?

A virtue of good personal finance blogs is their neutrality and their consumer viewpoint. To produce regular, solid content instead of fluff takes a lot of time and effort. Bloggers often start because of a passion for the subject but praising comments and mounting readership can make the blogger think of making a bit of money from it, perhaps even do it as a full-time occupation.

One way to do that is through ads. But there are two problems: threat to neutrality and low, low payoff. Any time an advertiser is paying, it gets more awkward to criticise their product and praise becomes suspect. Google ads make money for Google but not the blogger (after three years of blogging I am still waiting to break through the $100 barrier in Google revenue - I consider the Google ad block as a way of paying for the "free" Blogger account). Sponsored ads can make more money but unless the blogger caters to an enormous readership (like a US audience, as opposed to a Canadian one), it is small pocket money.

Along comes Flattr, which allows a reader to show financial appreciation and support for a website/blog by one click on a button. You as a reader sign up with Flattr for a monthly clicking fee, which can be tiny at a minimum of 2 euros (CAD $ 2.86). Flattr tallies up your clicks then apportions your monthly subscription dollars amongst all the websites clicked according to the proportion of clicks received. Flattr takes 10% for admin, which seems pretty reasonable. For the reader there is the convenience of the single click of a button, a single place to pay and control over the monthly total spent. For the blogger, the big plusses are not having to do any billing and tracking of advertising and receiving the money passively and automatically (i.e. allowing more time for creating content). One downside may be that a reader would feel pressured to use the Internet and to click so as to not waste the monthly fee and thus not be willing to sign up at all.

The 4% Retirement Withdrawal Rule Gets Potshots from Nobel Laureate

Came across The 4% Rule—At What Price? by Jason S. Scott, William F. Sharpe, and John G. Watson (SSW) on the A Loonie Saved blog (who posted some interesting comments on the paper). Sharpe won the Nobel Laureate for Economics in 1990 so it behooves us to pay attention, especially when he deals, along with his co-authors who, of course, should share the credit equally, with the critically important topic of how to manage one's finances and investments in retirement.

The 4% rule states that a retiree can withdraw 4% of portfolio value, adjusted upwards for inflation each year, based on the portfolio at the start of retirement. This provides a constant real spending amount. The portfolio is assumed to be a mix of about 40% bonds and 60% equity. Based on the past history of the US market going back as far as the late 1920s, various researchers have found that no portfolio would ever have run out of money in 30 years or less. Who can argue with that?

SSW have harsh words for the 4% rule, calling it wasteful, inefficient, fundamentally flawed. Their main criticism: "A retiree using a 4% rule faces spending shortfalls when risky investments underperform, may accumulate wasted surpluses when they outperform, and in any case, could likely purchase exactly the same spending distributions more cheaply." And the cause they say is the bad strategy of trying to match volatile investments with a desired fixed income stream. They claim that even highly diversified low volatility portfolios have some risk of running out early in a 30 year retirement horizon - a 3.9% risk for a portfolio with 9% standard deviation. They also say that portfolios waste10-20% of the initial funds generating un-necessary surpluses and another 2-4% spending money the wrong way. They ask, why bother with the 4% rule when a risk-free inflation adjusted bond (RRB) can guarantee 4.46% for 30 years?

My comments
The logic is fine as one would expect, but are the assumptions complete and correct and do practical realities affect the bottom line? To some degree I think they do.

1. Life expectancy - Will you live exactly 30 years? Do you want to plan retirement based on that certainty? At age 65, there is a 6% chance that one of a couple will still be alive 30 years later. After 30 years, the real return bond is done, there is no money left with 100% certainty but a portfolio will survive (... most likely? [there being arguments about whether 4% is sufficient to guarantee perpetual life, according to market history, or possibly less than that using Monte Carlo simulation]). If you die before 30 years, then you also have a "wasteful surplus" using an RRB. The waste label applied to a portfolio compared to an RRB only is true in the context of a retirement spending plan which lasts exactly 30 years.
2. Surplus = Legacy - maybe the implicit spending on surplus isn't so bad since many people want to leave money to the next generation. Any money left over is not therefore wasted. With the RRB method, one would need to decide at retirement how much bequest money to leave and set that aside, which would of course mean a reduction in net funds available to live off, i.e. a lower withdrawal rate
3. Returns - SSW assume a 2% return on RRBs. At one time that may have been true and it may happen again, but right now Canadian Fixed Income is showing yields on Canada RRBs ranging from 1.36% to 1.60%. The little chart below shows how withdrawal/income rates change according to yield and length of retirement. So, if you pick 1.4% as the current base and 35 years to be safe(r) the withdrawal rate is 3.63%. The 4.46% RRB withdrawal rate that SSW cite doesn't seem so available any more.
4. Transaction costs - will also affect net returns; to be realistic, one would have to get real data on rebalancing costs, purchase and sale of securities and I am not sure how it would work out in a stock/bond portfolio vs RRBs. Maybe it would not even be possible to buy a complete ladder of RRB strips for the time required. The longest maturity Canada RRB is 2036, only 26 years away. What would you do, put 4-5 years worth of money in a money market fund with about 0% effective yield?
5. Taxes - it doesn't matter in a tax-deferred account since all returns are treated as income and only when withdrawn, but in a taxable account the favourable tax rates on capital gains and dividends that would come from a portfolio mean better after tax money to spend. RRBs in Canada in a taxable account get taxed on the interest (or imputed interest) and the inflation adjustment component and that happens every year so net returns are reduced quite a bit.

Bottom line:
There is much sense to SSW's basic idea that one should match the nature of asset (income generating) cash flows with liability (living expense) cash flows. Essential living expenses in retirement need to be supported by an equally solid and steady income stream. RRBs and government CPP and OAS/GIS fit into the highly certain category. Non-essential / luxury retirement spending is quite flexible and controllable and that's the bit a portfolio can fund, whether it's according to the 4% rule or other types like 4 or 5% of year-end portfolio value, or year-to-year floor and ceiling limits.

Inflation and Corporate Earnings

How inflation can destroy shareholder value in the latest McKinsey Quarterly (free registration required to get access) brilliantly illustrates with a simple easy-to-follow example how inflation can surreptitiously erode real profitability in a company and thereby undermine its shares. The point made is essentially that when inflation jumps up, it is not enough for earnings to rise by the inflation amount. Unless cash flows do too, the company and the shareholder lose ground. Earnings must appear to rise by a much greater amount just to keep pace (it is worth pondering that if that were to happen, there would be public outcry about corporations gouging ordinary people, whereas they would actually be losing ground). The driver is that depreciation, a non-cash flow item, does not rise as fast as inflation and this skews profitability ratios and hides loss of real earnings.

The piece also includes a neat graph showing how returns on invested capital during the high inflation 1970s did not move outside their remarkably constant band of 8 to 11%, whereas they should have gone up to 25 to 30% to maintain real profitability during that decade. Accordingly, stocks did very poorly.

The lesson of inflation during the 1970s is worth noting. If inflation reignites, stocks / equities are not likely a good place to be.

Book Review: Winning the Loser's Game by Charles D. Ellis

Call this book A Random Talk About Wall Street. That is both a compliment and a criticism.

It is a compliment because comparing this book to Burton Malkiel's famous A Random Walk Down Wall Street puts it in a special category. Indeed much of the message is the same in the two books - valuable and sage advice on how to survive and prosper as an individual investor in a financial world filled with many predators and some good guys. Ellis pushes many familiar themes: diversify, buy index funds, trade seldom, take a portfolio view, re-balance to maintain asset allocation, adopt a long-term perspective and ignore short-term market fluctuations, consider inflation and real return bonds, market timing futility, avoid excessive mutual fund fees, take account of how various risks work.

The "Random" comparison is also a criticism in that I found the book meanders quite a bit. A chapter topic is begun, and part way through, the text diverges onto a peripheral topic. Ellis' method of exposition feels like a fireside chat from wise old uncle Charley as one idea spurs another. Maybe some readers like that style but I found myself muttering "stick to the topic, will you?" The epitome of this is Chapter 20 Endgame, at once the best chapter in the book and the worst. Endgame talks about leaving the world a better place after you are done, through using your money wisely so that it is a positive force and not a negative force, as it can end up being. There is much text that I found to be inspiring e.g. "Investors who have enjoyed substantial financial success should give careful consideration - no matter what their hopes or intentions - to whether the amount of wealth they can transfer to their children might do real harm by distorting their offspring's values and priorities or by taking away their descendants' joy of making their own way in life." Every parent must think of their money actions with kids from a very early age even if they are not rich e.g. giving a child an allowance to spend or save and considering how to guide the child into using it wisely. Ellis quotes another author who suggests people should give younger family members as much responsibility as they can manage as soon as possible. So true, I experienced that myself and wish I had done it more with my own kids. Suddenly Ellis switches gears. On the next page, there begins a series of numbered paragraphs on IRS limits for IRA accounts, tax-free gift limits, compounding rates, personal residence tax exemptions, trust concepts and the like. After four pages of too-general-to-be-useful such info on tax nitty-gritty, he goes back to the original theme and philosophical level of discussion. He could simply have said at the end of the chapter, "once you have decided what you want do, go talk to a good accountant to make it happen."

The informal presentation does have its benefits - short, easily read and digestible chapters. There are lots of good quotes and anecdotes to illustrate his points. I got lots of ideas for blog posts! e.g. on why this statement is wise in the sense he means it, and silly in another sense - "Never risk more than you know you can afford to lose."

Overall, this book does deliver on its sub-title promise to provide "timeless strategies for successful investing". It is definitely worth reading.

My rating: 4 out of 5 stars

Thank you to publisher McGraw Hill for providing me with a review copy.

Institutional Investors Lose Money Just Like Individual Investors

Absence of Value: An Analysis of Investment Allocation Decisions by Institutional Plan Sponsors by Scott D. Stewart, John J. Neumann, Christopher R. Knittel and Jeffrey Heisler in the Nov/Dec 2009 issue of the Financial Analysts Journal tells us that pension plans, endowments, foundations and other large pools of assets ($10 trillion in 2006) make exactly the same mistakes and get the same poor results as individual investors. "Much like individual investors, who seem to switch mutual funds at the wrong time, institutional investors do not appear to create value from their investment decisions." In fact, the study shows they lost money and lots of it.

This is despite the fact that "Pension plans, endowments and foundations are typically staffed with professionals with years of experience and advanced degrees."

Index investing with a fixed asset allocation seems more sensible every time a new study comes out.

I am left with this question - if individual investors lose money on average over extended periods and the pros do too, who the heck IS making money?

PS - acknowledgement to Index Funds Advisors whose excellent newsletter included the link to the study.

PPS just realized that I've been doing this blog for three complete years now. It is a sort of full circle in that my second post on Feb.1, 2007 was about a paper on the same subject as today's. The 7 Deadly Sins of Investors seems to apply as much to institutional investors as individuals.