So, recently I’ve been getting really into personal finance. You know, if I could go back, I would have majored in Economics. I’m not joking. It just fascinates me. I would have doubled in Symbolic Systems and Economics, and I should never have done all that pre med nonsense. I actually have a distant cousin (from Korea) who’s getting his PhD in Economics from Harvard. Maybe it’s in the genes.
During the summer of 1998, me and Henry stayed up late one night and he explained to me the stock market. It was extremely enlightening. Up to that point, I seriously had no understanding of the stock market whatsoever. When I think about it, I thought it was built purely upon speculation. And if you don’t understand the fundamental concept of what a stock price means, you can’t see it any other way, I think.
Anyway, I’m requesting/demanding that Henry write an entry explaining the stock market to the rest of us plebians. I don’t know if that’s enough to make him do it, though. I should probably write something to make him angry, since nowadays he only writes entries when he’s angry and thinks people are wrong.
Henry slammed Dave pretty hard in this old post of his. But, I think in part he was wrong. You know, his whole thing is risk/reward. One thing he says is that even an index mutual fund is not the lowest on the risk/reward scale. And I suppose that’s strictly true, but it’s not really. If you look at the performance of stocks and bonds since 1896, if you have a sufficient time window (which isn’t that large, I think it’s 5 years or less), stocks always outperform bonds. That means, pick any year between 1906 and 1995, and 5 years later, stocks have done better. And the larger the time window, the more stocks outperform bonds. So, strictly speaking, index mutual funds are higher risk than bonds. But practically speaking, it’s not really, and if you’re investment time table is more than 5 years, you can’t really say it’s riskier to invest in stocks over bonds. Unless you’re John Yoon and believe the United States’ will collapse. In which case your investments are the least of your worries.
Secondly, while it’s true that it’s not wrong just to be higher on the risk/reward scale, what I think Dave was saying is that the strategy to go with tech stocks is wrong because it carries a great deal of risk, without the corresponding reward. In other words, Dave disagrees with the assessment of the possible payoff, because in his view, tech stocks are in general overvalued, and their increase in value is not likely to be that much greater than the stock market as a whole to justify the extra risk.
To be honest, I’m inclined to agree with him. I know there will be winners, but all I know is that there’s no way I’ll be able to pick them. It’s not as easy as figuring out who’s going to be the leader, you know? There are just so many other factors that you have to know and research that for me it’s pretty much impossible.
So I have a new hero – John Bogle of the Vanguard group. He pioneered the use of index funds, and, I’m a big believer.
First of all, a little knowledge is a dangerous thing. Does anyone know the context of this quote? I think it has to do with the whole tier thing that I talk about all the time. Anyway, there are ignorant people who know they’re ignorant, and that’s fine. Then there are people who know a little bit, but think they know everything. That’s the little knowledge group, and why that’s dangerous. Then there are people who know more, enough to know they don’t know everything. Then there are people who know everything.
Anyways, in regards to personal finance, I’m in the little knowledge group, so take everything I say with a grain of salt. Everytime I think I know enough about something, about a week later I find out I don’t know anything at all. So, just keep that in mind.
Anyway, I’m a big believer in index funds. In the long run, they’re not more risky than other investments (bonds, money market). What index funds are are mutual funds whose goal is to reflect as accurately as possible, particular stock market indices. As opposed to active mutual funds, whose goal is to beat these indices.
Henry’s said it before, and I’ve read a lot about it, but the vast majority of mutual funds do not beat indices over time. The vast majority. And some of them do far, far worse. So, if you’re going to do mutual funds, there’s pretty much no reason to choose anything other than index funds. I’m a serious believer in that.
There are other considerations also. So, a big mistake people make with stocks, I think, is that they misjudge their rate of return. That is, they ignore stuff like trading fees and tax consequences when they’re calculating their gains. But, in real life, trading fees and taxes make a difference, sometimes significantly so.
Anyway, with a good index fund, there are no trading fees, and there’s less stock turnover, so it has better tax consequences. Also, index funds have much lower fees than other mutual funds. Much lower fees. And that’s another thing you have to keep in mind when calculating your rate of return.
So, I’m also against investing in individual stocks also, except for fun. Just, it takes too much time and research to do it well, and if you don’t know what you’re doing, you shouldn’t do it. If you invest in index funds, you won’t strike it rich. But the thing is, you’re essentially guaranteed a certain rate of return. That’s very powerful.
So, I’m a huge believer in index funds. Even if you invest internationally, I’m a fan of international index funds, which exist. Also, the S&P 500 is a big-cap fund. From what I hear, it’s a good idea to get exposure to mid and small caps as well, and there are indices for those also. In particular, the Wilshire 4500 (essentially every stock besides those in the S&P 500), and the Russell 3000/2000.
Umm, this was pretty much totally uninteresting. I’m just posting to get Henry to post.