Wednesday, February 8, 2006

Chapter 10
Final Thoughts, References, Glossary

While this little investment guide touches on proper investment fundamentals, it isn’t intended to cover all you need to know. It is more of a map rather than the destination itself.

I hope I have provided enough to give you an idea of the mountain of research, data and facts that exists on the subject - information that you won’t find by asking an industry that prefers you remain in the dark. I also hope you now have developed a warning radar for detecting information, suggestions and advice that are in conflict with the investing principles I’ve brought to your attention.

Don’t overestimate your abilities. “Control what you can - Asset allocation, diversification, and costs.”
From Ralph Wanger, Acorn funds.

Investing in stocks is a way to generate future income that is better than you can get without taking risk. Settle on a risk/reward measure that will help you achieve your goals while protecting what you’ve accumulated, not one designed to best the market average.

There is no hurdle you need to jump. Don’t try to beat the market, but rather balance risk against a reasonable return. Investing is not a competitive sport—don’t get fancy, don’t listen to TV or magazine hype—what Jane Bryant Quinn calls “investment porn.” Ignore temptations to go after hot funds or choose funds based on recent past performance.

If stock returns came from history books, then the wealthiest people would be librarians.”
Warren Buffett

Managing your money is about the unglamorous task of being a defensive lineman, not the star quarterback.”
Ben Stein, Phil DeMuth - "Yes, You Can Time The Market

Don't begin by looking at funds. Do a risk analysis and choose an allocation first, then figure out how you want to diversify your investments - large caps, small caps, international, REITs, value, blend and growth. Only then should you consider funds.

If you're just starting out, you may not enough to invest to meet the fund's minimum investment in every category. If not, then look for funds called target retirement funds, LifeStrategy funds, or other funds that give you exposure to several funds in one. Also look at balanced funds that contain both stocks and bonds.

If you have already accumulated a larger portfolio, the process is the same. But you might wish to choose individual funds to fill your diversification slots.

And One Last Time:
The best way to beat the average investor, professional or otherwise, is to save regularly, avoid mistakes, keep your costs low (including taxes), diversify, and stay the course.
Taylor Larimore

The most important investment a person can make is in education.


1. Harry Markowitz, "Portfolio Selection," 1952.
The fundamental core of modern portfolio theory, (MPT)
2. Vanguard Group study, "Use Asset Allocation to Build a Better Portfolio, 2003."

3 Frank Armstrong, Investing During Retirement, Part II Constructing the Investment Policy,
4. Larry Swedroe, from the book, "What Wall Street Doesn't Want You to Know."
5. Daniel Kahneman and Amos Tversky, “Prospect Theory”, 1981

6. Frank Armstrong, "Investment Strategies for the 21st Century", Ch.6, The Asset Allocation Decision,
7. Paula Hogan, CFP

8. Larry Swedroe, "Explaining the Value Premium," 2/2002,
9. For information on closed-end funds, see
10. See Internet discussions such as Morningstar's Mutual Fund forum,
11. Add a fund name or ticker symbol to Morningstar's Mutual Fund "Quotes" box, and then click on "Risk Measures” Measures."
12. Gus Sauter, "Vanguard Chief Investment Officer Discusses State of Indexing,'" 1/25/2005,
13. Walter Updegrave, "Rebalancing Act," 11/2003,
14. For information on tax-efficiency, see Morningstar’s Mutual Fund "Quotes/Reports" search box, and then click on "Tax Analysis"
15. T. Larimore, M. Lindaur, M. LeBoeuf, The Bogleheads' Guide to Investing, Ch 10

Where to get more information

Good First Books
"The Bogleheads' Guide to Investing" by Taylor Larimore, Mel Lindaur and Michael LeBoeuf
"The Little Book of Common Sense Investing" by John Bogle
"All About Asset Allocation" by Rick Ferri
"The Coffeehouse Investor" by Bill Schultheis
"The Only Guide to a Winning Investment Strategy You'll Ever Need" by Larry Swedroe
"The Informed Investor" by Frank Armstrong

Behavioral Finance
Why Smart People Make Big Money Mistakes” by Belsky and Gilovich

Books with More Depth
John Bogle on Mutual Funds” by John Bogle
Common Sense on Mutual Funds” by John Bogle
Four Pillars of Investing” by William Bernstein
What Wall St. Doesn’t Want You to Know” by Larry Swedroe
Random Walk Down Wall Street” by Burton Malkiel
The Intelligent Asset Allocator” by William Bernstein

Online Books

“Investing for the 21st Century” by Frank Armstrong,
“Serious Money, Straight Talk About Investing for Retirement” by Rick Ferri,

For General Information on Investment Basics (general information, recommendations, discussions based on MPT) (articles)

Advanced Information and articles on Investing (many excellent articles) (many good articles)

For General Information on Mutual Funds (Reference Library) (fund information and leaning center)

For Advanced Information on the portfolio selection method (modern portfolio theory) (theory and practice) (academic articles)

For Information on Exchange Traded Funds (ETFs)

For Information on 401k and IRA (401k help) (IRA help)

For Information on Financial Planners

For Information on Retirement Withdrawals


For a complete glossary try Investopedia

4x25 - A portfolio composed of equal weightings of large cap, large value, small cap, and small value

5x20 - same as 4x25 except REIT is added.

5%/25% rule - formula used to determine when to rebalance a portfolio. Rebalance when asset value moves more than 5%. For allocations less than 20%, rebalance when allocation moves more than 25%. Example: When a 10% allocation moves 25% it will be 12.5% of the portfolio.

Active Management - Mutual fund managed by someone who selects individual stocks or other assets in an attempt to meet specified performance goals.

AMT - Alternative Minimum Tax

Asset Allocation - Percent of money put into major asset classes of stocks, bond, cash

Asset Classes - A group of assets with similar risk and reward characteristics. Cash, debt instruments, real estate, and equities are examples of asset classes. Within a general asset class, such as equities, there are more specific classes such as large and small companies and domestic and international companies. Large growth, Small value, Emerging markets, foreign value, Reits, etc. are different classes of assets. Asset classes are used in diversifying a portfolio

AUM - Assets Under Management

Beta - Indicator of a fund’s movement sensitivity in relation to an index such as the S&P500. See Morningstar's definition in Ratings and Risk section of Quotes. Look at bottom of page for “show data definitions.”

Bogie (Bogy) - A benchmark, usually an index, used for tracking performance

CAGR - Compound annual growth rate

Cap – Shorthand for capitalization. A measure of how large or small a company is.

CAPM - Capital Asset Pricing Model

CMA - Cash management account

CRSP - Center for Research in Security Pricing. Located at University of Chicago. CRSP divides market capitalization into deciles. 1-2=large cap, 3-5=mid cap, 6-8=small cap, 9-10= micro cap. Also divides deciles into style. 1-3= growth, 4-7=core, 8-10=value

Couch potato portfolio - #1 - 50% Total Stock Market (TSM)(VTSMX), 50% Total Bond Market (TBM) (VBMFX). #2 - 75% TSM, 25% TBM

Coward’s Portfolio - Author Larry Swedroe usually refers to the coward’s portfolio as a portfolio of equally weighed asset classes. Takes no “bet” on over weighting any one asset class. Wm. J. Bernstein has proposed several other “cowards portfolios”. See

DCA - Dollar Cost Averaging - Method of investing in the market by making regular periodic investments.

DFA - Dimensional Fund Advisors. Investment management company that applies academic research teachings to asset management.

DI - Debt instrument

Diversification - spreading money into different investments in order to manage risk

Dunn’s Law - States that if an asset class does well, an index fund in that class will outperform non-indexed funds of the same class.

EAFE - Europe, Australasia, Far East

Efficient Frontier - From modern portfolio theory (MPT). A certain combination of holdings (asset classes) that results in the maximum possible return for a given level of risk is called “efficient.” A graph plotting different risk levels results in a line of best possible results. That line is called the “efficient frontier.” Nicely explained in Frank Armstrong’s book “Investing for the 21st Century.”
Online at

EM - Emerging Market

EMH (EMT) - Efficient Market Hypothesis or Efficient Market Theory - Proposed by Eugene Fama. EMH says that an investor cannot expect to improve returns through technical analysis, fundamental analysis, or by other means because all relevant information that might influence the price of a stock is immediately known and already priced in. Furthermore, the next piece of information received about the stock could be either positive or negative; in other words random (unpredictable).

ETF - Exchange Traded Fund. Like a mutual fund in that it contains many stocks, but it trades like an individual stock. Can be purchased or sold any time during trading hours.

ER- Expense Ratio. The annual fee charged by a mutual fund company to run the fund.

I Bonds - Inflation Bonds. A bond that provides both a fixed rate of return and an inflation protection component.

Index Fund - A passively managed fund that seeks to replicate the performance of a particular index (such as the Wilshire 5000, the S&P 500, or the Russell 2000) by buying all (or a representative sampling) of the securities in that index, in direct proportion to their weight, by market capitalization, and then changing them only when the index itself changes.

Investment pornography - Advice on market or securities values that is designed to titillate, stimulate, and excite you into action but has no basis in reality.

IPS - Investment Policy Statement

ishares - Exchange traded index funds marketed by Barclay’s Global Investors.

Load Fund - A mutual fund which has a sales commission of some type.

M* - Morningstar

MM - Money Market

MPT - Modern Portfolio Theory. Portfolio risk can be reduced for a given rate of return by diversifying with two or more investments that react differently from one another when the market moves up or down (low correlation i.e., low co-variance).

MSCI - Morgan Stanley Capital International

MVI - Multiple variable income. Method of withdrawing from a retirement account.

MVO - Mean Variance Optimization. Math program used to determine correlation of asset classes

NAV - net asset value. The share price of a mutual fund

No-Load - Mutual fund with no sales commissions attached.

Passive Management - Management of a mutual fund by NOT actively trading stocks or other assets in an attempt to outperform the market. Passive management is used with index funds.

P/B - Price-to-book Ratio. An indicator of a fund’s “value” content. The lower the ratio, the more toward value a fund is. See M* definition in portfolio section of Quotes Report. Look at bottom of page for “show data definitions”

P/E - Price to Earnings Ratio. See M* definition in portfolio section of Quotes Report. Look at bottom of page for “show data definitions.”

R2 - Compares a fund’s movement against its benchmark index. A number of 100 means that the fund tracks its benchmark perfectly. See M* definitions in ratings and risk section of Quotes Report. Look at bottom of page for “show data definitions.”

RE- REIT - Real estate Investment Trust.

RTM - Reversion to the mean: A tendency of a fund that has been over- or under-performing to return to its historical average.

SD - Standard Deviation: Measure of a fund’s volatility. See M* definition in Ratings and Risk section of Quotes Report. Look at bottom of page for “show data definitions.”

S&D - Slice and Dice. An alternative to using Total Stock Market. Simple S&D uses large cap, large value. small cap, small value.

S&P 400 Index: A market cap-weighted index of 400 mid-cap stocks.

S&P 500 Index: A market cap-weighted index of 500 of the largest U.S. stocks.

S& P 600 Index - A market-cap weighted index of 600 small-cap stocks.

Spiders (SPDR) - Exchange traded funds that replicate the various Standard and Poors Indices.

TBM - Total Bond Market Index (VBMFX)

Ticker Symbols - Letters identifying a mutual fund or stock (See Vanguard)

TIPS - Treasury Inflation Protected Securities. A bond that receives a fixed stated rate of return, but also increases its principal by the changes in the Consumer Price Index.

TM - Tax Managed

TSM - Total Stock Market Index (VTSMX). Tracks the Wilshire 5000

Turnover – Transaction activity (buying and selling) that occurs in a mutual fund. Actively managed funds often have higher turnover than passively managed (index) funds. A fund with higher turnover will typically generate more capital gain distributions at year end.

Value - Most people associate value with funds that have lower than average P/E and P/B and overall lower risk than growth funds. The academic definition is quite different. It refers to funds that hold securities of companies that are indeed riskier because they are distressed and have high business risk.

WEBS - World Equity Benchmark Securities are exchange traded funds that track various foreign country indices such as the U.K., German, and French equivalents of the S&P 500 Index.

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