The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

29 November 2009

The Complete Guide to Investing in Index Funds - A review

The Complete Guide to Investing in Index Funds
Craig W Baird

Craig Baird begins his book, THE COMPLETE GUIDE TO INVESTING IN INDEX FUNDS by offering definitions: definitions of Wall Street jargon, definitions of acronyms, definitions of concepts. And a lot of history of financial products. If Baird offered only the definitions and history, the book would qualify as a good volume for tyro investors.

With investing in index funds as his primary thesis, Baird should devote most of the book to definitions (check), history (check), how to invest in index funds (check), why to invest in index funds (um, no check). Baird sprinkles his book with many value judgments that are open to vociferous argument; his worst precept, though, is his contrast between "active" and index investors. Consider the three snippets below that illustrate this problem:
• "An effective way to understand active investors is to compare them to gamblers. Their style of investing often goes on a gut feeling. Most active investors believe they have a special understanding of the market that others lack, which gives them an edge over everyone else. No different than gambling, active investing can be a hectic ride for investors that [sic -- dmg] enjoy the feeling of excitement through risking it all on the chance of the stock market." (p 57)


• "Active investors can be considered gamblers in disguise. Investing can turn into an addiction that can cost them everything, much like playing roulette can." (p 100)


• "Index fund investors can enjoy a relaxed state of mind because they are not pressured into beating anything, and they can approach the market by buying and holding globally diversified portfolios of index funds. This method of investing is supported by University of Chicago Nobel Prize winners." (p 60)

Baird's distinction is a cheap trick of argumentative logic; gosh, don't you want to align your portfolio efforts alongside a bunch of Nobel prize winners? Surely a group of smart guys, in any field (of course, Baird does not mention the discipline this group of people won their Nobel prizes, although he implies it), achieve fantastic rates of return on their investment portfolios. Right...? And any investor who invests with a plan and methodology can "enjoy a relaxed state of mind"... Right? I know many active investors whose methodology does not rely on gut feeling, but reasoned analysis. And disciplined investors invest dispassionately, never emotionally. Yes, amateur investors rule the roost, but that merely helps create the pricing inefficiencies Baird ignores, and that endure longer than a nano-second. Whoever Baird interviewed before writing this book, he missed the narrow field of professional investors, who know the what, where, when, why, and how of their profession.

One insight you will not find in his book: indexing has grown to become the tail that wags the dog, precisely because index investing has grown like a weed the past ~38 years, and especially the past 15 years. To his credit, Baird notes this phenomenon; unfortunately, he misses its effect. Index funds now are more the market than the market itself. Also is the phenomenon of a stock spiking on the rumor (or news) of its inclusion to an index. The active investors Baird disparages profit from the ephemeral pricing disparity that results, while index investors pay the higher price.

Which obliquely points out the true disparity between types of investor, time. The more time an investor grants while he or she awaits fruition of the investment, the less stress results from short term oscillations of price. (Price smoothing of risk via elapsed time.) But that effect is the same for all investors. Know your true investing objective helps you to invest successfully, and not gamble.

Fact is, any form of investing can resemble gambling, index investing included. We investors complicate the process to such a degree that we only confound and confuse ourselves. Investing, otherwise a simple process, thus becomes akin to gambling:
• We lack understanding, which results in
• No control of the process, which results in
• Losses.

This is where Baird's The Complete Guide to Investing in Index Funds really shines, as introductory text for investors who lack the rudiments of successful investing. What Baird offers his readers, he does well; with the book's many definitions, explanations, history, and brief biographies, this book makes for an excellent holiday gift for beginning investors.
-- David M Gordon / The Deipnosophist

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