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Oldies but Goodies

William Ehart  |  November 26, 2019

BAD INVESTMENT and personal finance books get cranked out every year with catchy titles and celebrity authors. But skip such pulp fiction. Instead, give yourself or someone you know the gift of timeless investment wisdom with one—or all—of the following classics. 

Why? Perhaps you’ve heard that indexing is the way to go. Or that you should insist on low-cost funds. Or that stocks are the best asset class, and should be bought and held. But you’re not quite convinced or you hold these truths lightly.

Three of the books recommended below provide the rock-solid intellectual underpinnings for all these propositions and more. They are among the founding documents of modern investing. Other investment classics, such as Ben Graham’s The Intelligent Investor and Peter Lynch’s One Up on Wall Street, fade in significance, because virtually no one can consistently beat the market through security selection. 

As a bonus, I’ve thrown in a fourth book—a delight for the intellectually curious, showing how we got from ancient Greek games of dice to behavioral finance. Read or gift these books. Hardcover, paperback or digital, it doesn’t matter: Their truths are etched in stone, yet the words jump lightly off the page. That said, I don’t recommend the audio versions, as you’ll want to see the accompanying charts.

By now, you know that actively managed funds as a group will trail the market averages. Burt Malkiel, an economist who would go on to high positions at Yale and Princeton, demonstrated that was true decades before it caught on—and two years before Vanguard Group founder Jack Bogle started the first index mutual fund.

Despite the title, Malkiel doesn’t argue that the movement of stock prices is completely random. After all, there is an upward bias from earnings and dividend growth. Rather, he proves that you can’t consistently beat the market with knowledge of past price movements (technical analysis) or publicly available information (fundamental analysis).

Malkiel—chief investment officer at robo-advisory firm Wealthfront—also argues that any strategy that does boost returns will cease working once enough investors try to follow it. Solution: Mimicking the market averages.

Not everyone accepts that stocks are the essential investment for building wealth or realizes that the risks of owning them shrink over long holding periods. Jeremy Siegel wrote the book that proves it.

Siegel, a professor at the University of Pennsylvania’s Wharton School, tracked U.S. share prices back to 1802 and showed not only that stocks leave bonds, gold and cash in the dust, but also they’ve appreciated at a remarkably consistent rate through three major time periods. Despite wars, depressions and traumatic transitions from rural to industrial to a post-industrial economy, stocks as a group returned about 6.5% a year after inflation in 1802-1870, 1871-1925 and 1926-2012.

Going further, he demonstrates that the safest long-term investment is a diversified portfolio of stocks. Over 20-year-plus holding periods, stocks have “both a higher return and lower after-inflation risk than bonds.”

Siegel advises investors to keep most of their assets in index mutual funds and exchange-traded index funds (ETFs), in a mix of capitalization-weighted funds and those with a value orientation. Siegel is an advisor to WisdomTree, a provider of smart-beta ETFs, many with a value tilt.

In addition to creating the first index fund at year-end 1975—much ridiculed then and for many years afterward—the late Jack Bogle long preached the gospel of low investment costs, and he lived to get the last laugh. 

You see index mutual fund expenses plunging to zero in some cases? Thank Jack Bogle for starting the trend (though it was his archrival Fidelity Investments that introduced the first zero-cost index funds last year). Bogle was not a fan of ETFs, saying they would encourage too much trading, but he deserves credit for the low-cost indexing boom they embody.

In Common Sense, he skewers the for-profit mutual fund industry for its sales loads, high expense ratios, hidden fees and marketing tactics. He also demonstrates the futility of active management and enumerates how costs are a major predictor of results. 

In fact, costs and asset allocation are by far the biggest drivers of investment returns. Forget about technical analysis, market timing or paying up for today’s star stock pickers. Stellar short-term performance almost certainly will revert to the mean—that is, toward the market averages and usually lower still, once fund expenses and portfolio turnover costs are factored in.

Where did Malkiel get the statistical framework to demonstrate that short-term stock price movements are unpredictable, or Siegel to analyze the standard deviation of long-term investment results, or Bogle the notion of reversion to the mean?

The late Peter Bernstein’s brightly written historical tour de force lays it all out, starting with the ancient Greeks, who would throw marked bones, thinking that the results they revealed were determined by fate. Eventually, gambling men joined with Renaissance mathematicians in getting a handle on probability, with great implications for the development of insurance. That, in turn, enabled greater human risk-taking and larger endeavors.

Other central figures, such as Charles Darwin’s cousin, Sir Francis Galton, measured everything from people to sweet peas to discover reversion to the mean. All this statistical progress led to Modern Portfolio Theory, the mathematical demonstration of why you shouldn’t put all your eggs in one basket. But it also led to behavioral finance, which grapples with why humans make irrational choices when rational solutions are evident. It’s a fascinating tale.

William Ehart is a journalist in the Washington, D.C., area. Bill’s previous articles for HumbleDollar include Mild Salsa, Weight Problem and Not My Guru. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart.

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