The book is divided into four parts:
Part 1 Master the Basics
Part 2 Construct a Sensible Portfolio
Part 3 Manage your investment with Focus and Discipline
Portfolio Part 4 Stay on Course
The first six chapters are an easy breeze and I didn’t feel there was anything worth repeating or summarizing. Chapter 7 onwards, I wish everyone could read, learn, invest. Since it’s a wish that I can’t fulfill, here’s the next best thing; some of my takeaways that I believe is important to revisit every so often.
Investment Horizon: Two general rules of thumb apply
For an investment horizon of less than 5 years, don’t invest in stocks. That’s because of volatility risk.
For a long time-horizon of 20 or more years, invest a good portion of your money in stocks.
For a time-horizon somewhere in the middle, a mix of bonds and stocks is appropriate.
Power of Bonds:
Aren’t just for retired people. It helps offset stock volatility
Don’t need to have a bond gene to invest in them
Most important thing to understand is that bond prices and interest rates move in opposite directions
Rules for constructing an investment portfolio: Take the OTROC approach by addressing these issues
Objectives: What is your purpose in investing?
Time Horizon: How soon will you need the money? Short-term, mid-term, long-term?
Risk Tolerance: How much stomach do you have for volatility?
Other investments: What holdings do you have? How much do they offer in terms of balance and diversification?
Choose: Use above four to decide your portfolio’s asset mix
Bond Funds: Before buying bond funds, be clear on the role you want bonds to play in your portfolio. Two roles they can play- provide income or price stability The major types of bond funds need to address following questions:
Tax status. Taxable or tax exempt? -Never pick tax-exempt funds for an IRA or a 401(k) or any account already tax sheltered. Tax-exempt funds typically have lower yields than similar taxable funds.
Credit quality. High, medium or low? The credit quality relates to the issuer’s ability to pay interest on the bond and, ultimately, to repay the principal upon maturity. Lower credits pay higher interest.
Short, medium, or long? Longer maturity means more sensitive to change in prevailing market interest rates. Duration is a handy statistic to judge this interest rate sensitivity.
Reading a Prospectus: Think like an owner: Eight Important Reasons to read the Prospectus
What is the fund’s investment objectives? A money market fund’s objective is to provide current income while keeping the share price constant. An aggressive growth fund’s objective is capital appreciation- it is trying to buy stocks that will rise in value over time.
How will the fund go about making money? Look for the section on investment strategy. They should tell you types of securities the fund typically holds.
What risk will you encounter? Read the section about primary risks.
Who’s running the fund? Look for the section on the fund’s “investment adviser”, the manager (or team) in charge of the fund. How long have they been managing the fund?
What are you paying? In the summary, you will find a full list of the feeds and expenses charged by the fund, including its expense ratio and any sales commissions, purchase or redemption fees, low-balance fees etc.
How long has the fund been around?
What services does it offer? Do you want to write checks or conduct transactions online?
How has the fund performed? Past performance is not a good indicator of how a fund will perform for you. Look at the “financial highlights” portion of the prospectus for more on this.
Characteristics of a good fund:
Low costs
Solid performance
Consistency
Three simple tips for reducing your investment costs:
Avoid sales charges or “loads”. This happens when you buy a fund through a broker, financial adviser, or other intermediaries. If not doing online, the way to buy no-load funds is to call the fund’s toll-free number after researching it, ask for a prospectus of that fund and then send in a check with a completed application form.
Choose low-cost funds. Every fund has an expense ratio. Expenses covered include legal and accounting services, telephone services, postage, printing etc. These expenses are subtracted from the fund’s gross investment return before shareholders see any of the return. Keep cost within industry average which is between 0.2% and 2.5%. Be skeptical of 12b-1 fees. These fees cover distribution-related expenses, including advertising and broker feeds.
Be aware of transaction costs. The more frequently a fund buys and sells securities, the higher its transaction costs are likely to be. Some funds have turnovers as high as 300% to 400%. It’s not necessarily a bad thing but a warning sign. These information pieces are also on the Prospectus.
Taxes are costs too!
Tax tip #1- Resist the temptation to trade a lot. As a mutual fund investor, you can incur taxes in 3 ways
When the fund distributes income dividends
When the fund distributes capital gains from the sales of securities
When we as investors sell or exchange fund shares at a profit
US Treasury securities and municipal bond funds are exempt from federal income tax.
Tax tip#2- Choose tax-efficient funds. Three types are tax-friendly.
Stock index funds
Tax-managed funds
Tax-exempt funds
Tax tip#3- Use tax-deferred and taxable accounts wisely. Bond funds, income-oriented stock funds, aggressive stock funds with high turnover rates all can heighten the tax bill. Hold these kinds of funds in your retirement plan or your IRA
How to cleanup a messy portfolio:
Do you know why you own each of your funds? Each should be part of this grid
Do two or more of your funds share the same investment objectives or style? Again, refer to the above grid.
Think about some pruning if you have more than 10 funds in your portfolio
Rebalancing your portfolio:
It’s done to fend off the risk monster
Should be done in a disciplined manner periodically; once a year, semi-annually or once a quarter
Rebalance only if your asset mix has strayed from its target by more than 5%
Consider tax liabilities when rebalancing.
Stupid math tricks for smart investors:
Estimate your yearly rate of return and divide into 72. The result is the number of years it will take for your investment to roughly double in value.
Cumulative returns can be misleading. 250% over 20 years is same as a 6% annual return.
Sometimes falling share prices is good news.
In a nutshell:
Develop a financial game plan
Become a disciplined saver
Start investing early and keep it up
Invest with balance and diversification
Control your costs
Manage risks prudentially
Be a buy and hold investor
Avoid fads and “can’t miss” opportunities
Tune out distractions
Maintain a long-term perspective
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