The Only Guide Series

“Confirmation bias (also called confirmatory bias, myside bias or verification bias) is a tendency of people to favor information that confirms their beliefs or hypotheses.” Wikipedia

We all suffer from it. That is why it is important to read different points of view from serious authors, as we go about investing our money. “The Only Guides” series by Larry Swedroe give a well reasoned approach to investing that is somewhat different from the authors I usually favor, but not really all that different. He presents sound statistical data to support his positions, which according to both his critics and his proponents are more focused on not losing money than they are on making money. After all, why take unnecessary risks with your hard earned dollars?

This review covers two of his books, The Only Guide You’ll Ever Need for the Right Financial Plan and The Only Guide You’ll Ever Need to Alternative Investments, The Good, The Bad, The Flawed, and the Ugly. I intend to buy a copy of the Right Financial Plan. Alternative Investments, while well worth reading, spends too much time discussing investments that are so obviously bad that I don’t want to know enough about them to justify the cost of a hardback book. Sadly, these alternative programs are sold to the naïve, the greedy, and the fearful. The author recommends, If you don’t understand it don’t buy it. If you are excited by greed or fear, run away until you are capable of making a rational decision. Emotion is the enemy of intelligent decisions.

Like all the good authors, Swedroe repeatedly observes there are no “right” answers. Every investor has different goals, different resources, and a different tolerance for risk. Swedroe demands is too weak a word that before beginning an investment program, that you develop a written plan stating your goals, your investment philosophy, limits on investment types (for example: 50% in stocks means that if your holdings in common stock grows past 50%, you sell even if your portfolio is going up). Consider this Investment Policy Statement a contract with yourself. To change any underlying element of your behavior requires a change to a written document. He also councils consulting with a CPA or a fee only investment advisor who will never receive any commission from any product he recommends.

Swedroe is a proponent of diversification, carefully selected to minimize total portfolio risk. Hence, a small amount of money invested in a very risky class of stocks may well lower the risk of the entire portfolio if that asset tends to move in a different direction than your other holdings. The discussion of what to buy and why is too complex to cover in detail in this review, but he is a proponent of a mix of large and small cap stocks and a variety of different bond types that serve to mitigate different kinds of risk. Unlike most authors he is not all that concerned with sector diversification.

The most controversial material in these texts addresses the argument between those who believe they can pick individual stocks and those who believe the market is efficient, that is everyone has access to the same information, therefore the best one can do is buy low cost index funds that mimic the action of the entire market. Statistical studies do indicate that picking stocks contains a greater amount of luck than a sport like football. However, Swedroe’s position is rather extreme. He believes that buying anything other than low cost index funds is a waste of time. He does admit that at moments in time the market may not be efficient. Think Enron. This company was for all intents and purposes bankrupt for months prior to that fact becoming public. During that period the “opaque” market in those shares destroyed thousands of investors. He also allows that very smart people can take advantage of special situations, but only for a very short time with limited amounts of money. Bond arbitrage* with a few million dollars is a lot easier than the manipulation of billions. The author provides an example of how scale bankrupted a major hedge fund run by the best economists and statisticians money could buy, including two Nobel Prize winners.

What did I learn about myself while reading these books? First, I do buy individual stocks when I believe I know enough to make an intelligent decision. Fortunately I have been right more often than I have been wrong. I tend to buy stock in well managed companies that pay a sustainable dividend. This policy is not bulletproof, remember British Petroleum was one of the most profitable well run companies in the world until one of their deep water platform caught fire. Then BP lost half its value in a few weeks.

Most of my holdings are in funds of the sort recommended by the author. I buy funds when I have no choice, as in the case of my holdings in the Government version of a 401K, I do not believe I am capable of making an intelligent selection of individual issues, as in my tax free municipal bond fund, or owning individual securities outside of a fund is just too inconvenient.

Swedroe points to a major weakness in my portfolio, holdings in developing markets such as Brazil, Russia, India, and China. I keep putting off that decision because I have been thinking in terms of individual stocks or individual countries which I perceive as very risky. I believe, following the author’s recommendation, I will purchase some shares in a Vanguard fund that invests both in large and small companies located in all these countries. I have about 15% of my holdings in foreign shares, an amount frequently suggested for moderately conservative investors. Swedroe makes a compelling case that this number should be 30% or more. Again this money is to be carefully diversified between large and small cap stocks in developed and developing markets. About half the world’s wealth is still in America but about half is now located in the rest of the world and that number is growing. He is probably right about foreign investments.

I have been operating under the assumption it is more important to make money than to worry about paying taxes. Yes, I am conscious enough to keep my tax free bonds in a taxable account. Not worrying about taxes has been OK because I rarely sell stocks so there are not often any tax consequences to worry about. However, that is about to change. When I retire, how I use my savings and when and how I choose to liquate certain assets could have major tax implications. Swedroe is constantly concerned with the tax implications of every investment decision. Fortunately I have a CPA to hold my hand when the time comes.

In conclusion, these books are well worth the time it takes to study them. They are not written for the novice investor. The author assumes that his reader has at least an intermediate understanding of finance, statistics, and other relevant subjects. However, a degree in Finance is not necessary to comprehend his arguments.

*Arbitrage: “The simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. Arbitrage exists as a result of market inefficiencies; it provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time.”--Investopedia